Handbook On Credit

FOREWORD
Credit being one of the core banking functions require specialized skills in finance
area for building quality assets portfolio in the Bank. Of late, it has been observed
that functional units need to focus on Due Diligence apart from compliance of usual
laid down guidelines while handling credit business. We need to understand financials
beyond the statistics, and to carry out industry analysis while processing the credit
business.
It gives me great pleasure to write this foreword for ―Hand Book on Credit‖
prepared by the TEAM at Staff College, Ahmedabad, which is specifically brought
out for newly recruited officers in our Bank. This book is a compilation of Bank‘s
policies, guidelines, practices, and procedures that will serve as a useful reference
guide for the staff working in credit department at various levels in branches /
offices for effectively handling the credit portfolio.
This Handbook presents a composite of information about the evaluation and

accreditation of credit focusing on Due Diligence at various stages of credit
processing & monitoring, significance of pre-sanction appraisal, checkpoints and
suggestive narration on proposal preparation in Board (MCB) format besides all
general subjects of credit. A good understanding of policies, guidelines, practices, and
procedures are instrumental for building quality loan books of the Bank. The book has
two parts – first part consisting texts of important applicable guidelines while second
part of the book which is in electronic form has almost all standard formats being
used by credit department in our Bank. We are also uploading the handbook at
Knowledge Portal of the Bank for the benefits of all our staff.
It is endeavor to present guidelines at one place in form of Hand Book for those who
are handling credit operations in the Bank. We welcome to have valuable suggestions
from our staff at sc.ahmedabad@bankofbaroda.com for adding more value to the
ensuing editions of the book.
I wish all users‘ great success in their endeavors.
(S K Das)
General Manager
(HRM)
Baroda Academy Inventing Methods for Igniting Minds

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INDEX
1 PRINCIPLES OF LENDING
2 TYPES OF BORROWERS
3 PRE SANCTION APPRAISAL
4 ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS
5 RATIO ANALYSIS & INTERPRETATION
6 BREAKEVEN POINT ANALYSIS
7 DOCTORING OF BALANCE SHEET - CREATIVE ACCOUNTING
8 TYPES OF CREDIT FACILITIES
9 WORKING CAPITAL FINANCE
10 NON FUND BASED LIMITS
11 TERM LOAN APPRAISAL
12 DOCUMENTATION
13 CHARGING OF SECURITIES
14 OVERVIEW OF SME POLICY
15 CREDIT RATING
16 CREDIT AUDIT
17 CREDIT MONITORING - MMR
18 POST SANCTION REPORTING
19 PREVENTIVE VIGILANCE
20 IMPORTANT TIPS / CHECKPOINTS
21 PROPOSAL PREPARATION

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FORMATS
1 Application form
2 Checklist format
3 Due Diligence Report format
4 Credit Information Report
5 Information disclosure by borrowers to banks for Multiple Banking
6 Arrangement
7 Format for Agreement – in – principle
8 Adhoc Sanctions / Concessions / Modifications in terms and conditions
9 CMA data format
10 Proposal format upto 20 lacs
11 Proposal format above 20 lacs upto 50 lacs
12 Proposal format above 50 lacs-MCB Note format
13 General Terms and Conditions
14 Scorecard based Credit Rating for SMEs
15 Pre-sanction inspection reports
16 Sharing of Credit Information for takeover MMR Format
17 Credit Audit Format
Note: These are available in electronic form in CD attached with this.

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1- PRINCIPLES OF LENDING
Learning bites: This chapter deals with various principles on which lending activity is
performed e.g. three ‗Cs‘ of the borrower can established a foundation of sound credit.
The business of lending, which is main business of the banks, carry certain inherent
risks and bank cannot take more than calculated risk whenever it wants to lend. Hence
lending activity has to necessarily adhere to certain principles. Lending principles can be
conveniently divided into two areas i) activity and individual.
i) Activity :
1) Principle of safety of funds
2) Principle of profitability
3) Principle of liquidity
4) Principle of purpose
5) Principle of risk spread
6) Principle of security.
Principle of Safety of Funds :-
 It is a major concern of a Banker.

 It essentially means ability of a banker to critically assess the borrower‘s capacity to
repay the amount lent to him.
 This factor now assumes great importance due to stringent NPA norms.
Principle of Profitability
 Profitability is the key word for every business organization and Bank is not the
exception to it.
 The profit is the result of sound business decision and is related to cost of funds and
other related risks.
Principle of Liquidity
 It deals with Bankers ability to get advance liquidated expeditiously.

 The deposits are payable on demand or at short notice and hence banker should not lock
up funds in long-term loans.
 This aspect has now assumed great importance due to introduction of ALM.
Principle of Purpose
 Lending should be for an approved purpose.

 All Banks lend for productive purpose as well as for consumption purpose.
 Bank should formulate its lending policy in respect of purpose.

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Principle of Risk Spread
 You should not keep all eggs in one basket.

 Bank should strike a balance between short term, medium term & long term loans.
 Bank should not concentrate advances to one industry or one field.
 Care should also be taken for giving loan to one employer.
Principle of Security
 Security gives a leverage to the lender in case borrower is not in a position to repay the
loans.
 The collateral security should be utilized only under extreme circumstances where the
borrower cannot repay.
ii) INDIVIDUAL :-
Process of Lending
5 ‗C‘s of the borrower = Character, Capacity, Capital, Collateral, Conditions
 Character implies honesty, integrity, and reputation in the market, business morality and
dependability.
 Capacity means knowledge of the borrower about his business and ability to conduct the
affairs successfully.
 Capital is the funds to be employed by the borrower in the business.
 In case of partnership/ proprietary concerns the banker should also anticipate the
problem of succession, sharing of work amongst themselves.
 In case of a limited company, a study of the directors/ key men, managing the unit is
essential.
Character :-
(1) Character is the greatest and the most important asset, which any individual can have.
Even if a borrower has the capacity and capital to repay a loan, it is the character of the
borrower which indicates his intention to repay. If the character or integrity of a
borrower is known to be questionable, every banker would avoid him even if backed by
sufficient collaterals.
(2) Character of a borrower is constituted by honesty, sobriety, good habits, personality,

the ability and willingness to keep his word under all circumstances, reputation of the
people with whom he deals etc.
Capacity :-
It deals with the ability of the borrower to manage an enterprise or venture

successfully with the resources available to him. His educational, technical and
professional qualifications, his antecedents, present activity, experience in the line of

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business, experiences of the family, special skill or knowledge possessed by him, his past
record etc. would give a hindsight into his capacity to manage the show successfully and
repay the loan.
Capital:-
It is his ability to meet the loss, if any, sustained in the business or venture from his
own investment or capital without shifting it to his creditor or banker. Unless a
borrower has some stake in the business, he may not take much interest in its success.
Collateral:-
Collateral may be required in certain cases depending upon the risk involved in the
proposal or to secure unsecured portion.
Conditions:
Loans / Credit facilities may granted / sanctioned / disbursed based on certain terms
and conditions. Hence, borrower is committed to fulfill all terms and conditions in
totality.
Sources of information available to assess the borrower
 Loan application
 Market reports
 Operation in the account
 Report from other Bankers
 Financial statements, IT returns etc.
 Personal interview
 Unit inspection prior to sanction
Security Appraisal
 Primary & collateral security should be ‗MASTDAY‘
M – Marketability
A – Easy to ascertain its title, value, quantity and quality.
S - Stability of value.
T - Transferability of title.
D – Durability – not perishable.
A – Absence of contingent liability. I.e. the bank may not have to spend more money
on the security to make it marketable or even to maintain it.
Y – Yield. The security should provide some on-going income to the borrower/ bank
to cover interest & or partial repayment.
External factors affecting borrowers business :
Changes in Government policy.

Foreign exchange rate variation.
Competition : Local/ Imported products.
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Remedial Strategies
Scrutiny of Loan Proposal

Scrutiny of Security
Stipulating Terms & Conditions of Sanction
Proper Documentation
Disbursement and ensuring end use of funds
Close monitoring of operations and account
Periodic inspection
Immediate follow up in case of adverse symptoms
Nursing of the account
Rescheduling, Rephasement and Restructuring of account
Avoid ever greening of loan account
Safeguarding of security
Timely legal action for recovery
Cash Credit Monitoring
C – Credit Summations
A – Adequacy of credit summations
S – Stock Statement
H – HO approval/ rectification
C – Cash/ Cheque operation
R – Return of cheques
E – Expiry of limit
D – Drawing power
I - Insurance
T – Tension of recovery.
Any Credit Proposal must answer the following key questions

 Who is to be financed?
 What is to be financed?
 Why is to be financed?
 How much to be financed?
 What should the mode be of financed?
 What will be the terms and conditions of finance?
 What is likely happen after financing?

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2-TYPES OF BORROWERS
Quick bites: This chapter deals with granting of an advance or a credit facility to
borrower may be an individual, HUF, Sole Proprietorship, Partnership, Limited
Company, Co-operative Society or any other type of constituent permissible under
law.
1. INDIVIDUALS
As per law, every individual to whom a credit facility is sanctioned must be competent to
contract. Minors, persons of unsound mind and un-discharged insolvents are incompetent
to enter into a valid contract.
2. SOLE PROPRIETORSHIP FIRMS
When an individual decides to venture into a business, then a simple form of business to
set up is a Sole Proprietor. To illustrate the difference between sole proprietor and sole
proprietorship, let us take an example Mr. Raman start a business of readymade garment
in the name of Fashion World. The sole proprietor is Mr. Raman. The name of sole
proprietorship business is Fashion World. As per KYC guidelines, we are required to
obtain documentary evidences (i.e. including registration of firm with respective
authority under Shop & Establishment Act, VAT Registration etc.) to ensure that the
proprietorship firm is actually in existence.
As far as signing or execution of loan documents is concern, it is a common practice to

sign and affix the rubber stamp in the name of business (i.e. proprietor is to sign in the
capacity of proprietor as well as in individual capacity) .
Hindu Undivided Family can be considered for granting the credit facilities. However, as
per guidelines (Circular No. BCC: BR: 98 / 203 dated 01.07.2006) providing any credit
facilities where HUF is shown as a partner in a partnership firm, should not be
considered at all. This is in connection with Hon'ble Supreme Court, in their Judgment,
held that HUF has no juristic personality and hence it can not be called as a person (and
not being a person, can not enter into an agreement with an individual or body corporate
or company, as the case may be), to form a partnership and carry on the business of
partnership firm. Further, section 5 of the Partnership Act provides that the
relationship of a partner arises by means of a contract and not from status. Further,
the said Act also excludes the members of HUF carrying on the family business as such
from the description of partners.
3. PARTNERSHIP FIRMS
A Partnership is an association of two or more persons to do a business for profit, like a

sole proprietorship. It is a firm with no legal entity; however the partnership business is
governed by the Indian Partnership Act, 1932.

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 While the Act is in place, it is a common practice for the firms to draw up their own
Partnership Deed. In absence of partnership deed, the Partnership Act will prevail.
 To enter into a partnership, there has to be a contract which may be oral or in writing.
Being a legal contract, persons having legal capacity to contract (minors, insolvents, alien
enemy excluded) only can enter into a partnership.
 The number of partners in a partnership firm should not exceed ten, if it is engaged in
banking business and twenty in other cases.
 There are no restrictions on the borrowing powers of a partnership firm.The firm need
not be a registered one for granting advance facilities.
 No partner should be a lunatic or un-discharged insolvent and no other partnership

firm should be a partner in another firm.
 As per Section 32 of Indian Partnership Act 1932, a minor can be admitted to the
benefits of a partnership with the consent of all the partners but he will not be liable
for losses of the firm. Within six months after he attains the majority, the minor has an
option to repudiate his liability as a partner otherwise will be held liable as a partner of
the firm, from the date he was admitted for the benefits of partnership. As such the
minor should not be mentioned as a full fledged partner and neither his nor his
guardian's signature obtained on security documents.
 Joint Stock Company/ Trust can become the partner in a firm and in such cases the
bankers need to ensure that they are eligible to become the partner.
Action on the part of Lending Bank in case of Admission of a new partner/ Dissolution of
the firm (Mutually, Death/insolvency/ retirement/ operation of law) when the account is
showing debit balance-
Case Action
Admission of Obtain LAD/balance confirmation letter, signatures and record date of
new partner admission before allowing operations
Death, Stop operations to avoid rule in Clayton‘s case. LAD/Balance
insolvency or confirmation to be obtained from legal heirs in case of death to make
lunacy them liable.
Retirement of If it is decided to permit the loan facility to the firm with remaining
partner partners, LAD/balance confirmation letter to be obtained from them.
Action on the part of Lending Bank in case of reconstitution of the firm

On receipt of notice of death, retirement or insolvency, exclusion or inclusion of a
partner the branches should treat the limit granted to the old firm as cancelled and
extension of credit facilities to the new (reconstituted) firm be considered afresh
after reviewing the credit worthiness of the reconstituted partners and all other
relevant factors having a bearing on the grant of advances.
 When the account of the reconstituted firm is opened, fresh documents should be
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obtained and thereafter the outstanding balance in the old account be adjusted by a
cheque drawn on the new account and signed jointly by all the partners of the
reconstituted firm or by obtaining a letter of authority signed by all the partners.
 Change in the constitution of the firm should invariably be brought to the notice of the
sanctioning authority and instructions sought for the continuance of the facilities to the
reconstituted firm along with full details and the position of the firm consequent to the
death/retirement of a partner. Impact of reconstitution of the firm on its capital
structure and management should be studied carefully.
 However, with a view to ensuring that the activities of the firm, are not affected and
that they continue to have dealings with the bank till all the formalities are completed,
the firm may be allowed to operate on their existing accounts after obtaining a stamped
indemnity signed by all the partners including the partners who has/have joined/retired
along with the confirmation from the guarantor/s; if any.
4. LIMITED COMPANIES
The companies Act, 1956 recognizes a joint stock company as a legal person, due to
which it is a separate legal entity and bankers have to deal with such organization more
carefully-
Different types of companies- Generally, the bankers deal with two types of companies-
PRIVATE LIMITED COMPANIES
 Such companies have minimum 2 and maximum 50 shareholders.

 There should be minimum 2 directors and its name must end with the words ―private
limited‖.
 A private Limited company can start business on receiving certificate of incorporation
and need not to wait for certificate of commencement of business.
 The shares of private limited companies are not quoted in the stock market and there
is restriction on right of transfer of the shares. The public is not invited to subscribe
the shares.
 The minimum paid up capital is Rs.1.00 lacs.
PUBLIC LIMITED COMPANIES
Public company" is defined in section 3(1) (iv) of the Act and it means a company which —
a. is not a private company;
b. has a minimum paid-up capital of five lakh rupees or such higher paid-up capital, as may
be prescribed;
c. is a private company which is a subsidiary of a company which is not a private company.
 Public limited companies must have minimum 3 directors and seven shareholders.
 Public Limited can invite/transfer shares to or from public and such shares are quoted in
stock market.

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PRIVILEGES ENJOYED BY A PRIVATE LIMITED COMPANY OVER PUBLIC LIMITED
COMPANY
Section Description of the matter
3(1)(iii) A Private Company (Pvt. Co.) can operate with Minimum paid-up
capital of Rs. 1 lakh as against Rs. 5 lakhs for Public Company.
12(1) A Pvt. Co. can be formed by only two persons as against requirement
of at least seven persons in case of Public Company.
58A Deposit taken by Pvt. Co. from members enjoys total exemption
from the clutches of this section. Kindly note that as per the
provisions of sec. 58A read with rule 2(b) of the Companies
(Acceptance of Deposits) Rules, 1975 — amount received from its
shareholders by a private company (provided the shareholder
concerned furnishes at the time of giving the money to the
company, a declaration that the amount is not being given out of
funds acquired by him by borrowing or accepting from others) is not
included in the meaning of deposit. If the depositor ceases to be a
shareholder, the deposits made by him cease to qualify for
exemption from the date of such cessation
70(3) A Pvt. Co. need not file Statement in lieu of Prospectus with ROC.
77(2 & There is no restriction for Pvt. Co. which is not a subsidiary of a
3) public company to provide financial assistance to anyone for
purchasing or subscribing for its own shares or of its holding
company.
81 A Pvt. Co. can issue further shares in any manner; i.e., rights shares
to the existing shareholders need not be offered.
85 to 90 The restrictions relating to kinds of share capital, issue of shares
with differential voting rights, etc. do not apply to Pvt. Co.
111 Appeal against refusal to register a transfer or transmission of
shares.
149 Procedures for obtaining certificate of commencement of business
do not apply to Pvt. Co. A Pvt. Co. can commence its business as soon
as the certificate of incorporation is issued.
165 Pvt. Co. is not required to hold statutory meeting or prepare any
statutory report.
170 to Relaxation in the length of Notice for calling General Meeting,
186 contents and manner of Service of Notices, Explanatory
Statements, Quorum for meeting, Chairman of meeting,
Restrictions of voting rights etc. to the extent to which the
company makes its own provisions by its articles..
192A Passing of resolution by Postal Ballot not relevant for Pvt. Co.

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198 Ceiling on overall managerial remuneration not applicable to Pvt. Co.
204 No restriction on appointment of any firm, body corporate to office
or place of profit.
220 Inspection of P & L A/c of a Pvt. Co. by Public is not permitted.
224(1B) Limit of appointment of Auditors are exclusive of Pvt. Cos.
252 & Minimum Directors for Pvt. Co. is 2 (two) against 3 (three) in case
252A of Public Co. Requirement of Independent Directors or Small
Shareholders‘ Directors not applicable to Pvt. Co.
255 No proportion of directors to retire by rotation every year.
256 A Pvt Co. need not adopt the procedure relating to appointment,
retirement, reappointment of directors etc. applicable to a public
company.
257 The provision requiring the giving of 14 days notice by new
candidates seeking election as directors and deposit of certain
amount (Rs. 500) are not applicable to Pvt. Cos.
259 Central Government approval for increasing number of directors
beyond the permissible maximum (presently 12) not required.
262 The provision relating to manner of filling casual vacancy among
directors and the duration of the period of office of those so
appointed do not apply to Pvt. Co.
263(1) Appointment of two or more persons as directors by a single
resolution can be done by Pvt. Co.
264 No requirement of filing consent by the directors to be filed with
the Registrar to act as director.
266(5) Restrictions on appointment of director and qualification of shares
not applicable to Pvt. Co.
268, 269 Central Government approval for amendment relating to
appointment/reappointment of a whole-time director/director not
liable to retire by rotation.
270-273 Requirements of holding share qualification by directors and fixing
the time within which the qualification is to be acquired and filing
with the Registrar a declaration of his share qualification by each
director is not applicable to Pvt. Co.
274(1)(g) The prohibition against person disqualified u/s. 274(1) clause (g)
does not apply to director of Pvt. Co.
275, 278 Person not to become director of more than 15 companies
(Directorships of Pvt. Co. not to be counted for this limit.)
292A Provisions relating to formation of Audit Committee not applicable.
293 Restriction in relation to certain acts on powers of Board of
directors is not applicable to Pvt. Co.
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295 Restriction on loans to directors/relatives etc. does not apply to
Pvt. Co.
300 No restriction on interested directors from participating in the
proceedings of the Board and exercising their votes.
309, Payment of remuneration to the directors or increase in their
310, 311 remuneration; Procedures like filing Form 25C not required in case
of Pvt. Co.
316, 317 No restriction on period of appointment of managing director /
manager for more than 5 years at a time.
349,350 Provision relating to the determination of net profits and
ascertainment of depreciation shall not apply.
372A No restrictions on giving loans or guarantees to other companies or
on making investment in the shares of the other companies.
386,388 No. of companies on which a person may be appointed manager, the
remuneration of a manager and the application of sections 269, 310
to 312 and 317 in relation to managers do not apply.
409(3) Powers given to the Central Government to prevent change in the
Board of directors not applicable to Pvt. Co.
416(1) Contract by agents of the company in which the company is the
undisclosed principal shall not apply
Important Documents in respect of limited companies
Memorandum of Association (MOA) — It should contain following clauses:

The name of the proposed company — It should be the same as given in the name
approval letter.
 Domicile of the company; i.e., the state in which the proposed company is sought to be
registered.
 Objects Clause should consist of
a. Main Object: It should clearly State the activities to be carried on by the company upon
incorporation. Generally, ROC does not allow more than one or two clauses under this
Clause.
b. Objects Ancillary or incidental to the main Objects of the Company: This should contain
objects, which are required to be carried out to attain the Main Objects of the
company.
c. Other Objects: These are the objects, which the company is likely to carry out either
along with the Main Objects or in place of Main Objects.
 The Capital Clause should show the Authorized Capital of the company, in case the
company is being registered with share capital. It should also state that the paid-up
capital of the company shall be minimum Rs. 1 lakh [5 lakhs in case of Public company]. In
case the liability of the members is limited, the same should be mentioned in the
Memorandum of Association. The Stamp Duty and ROC fees are payable based on the
Authorized Capital.
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 The Subscription clause should be signed by all the subscribers (Minimum two in case of
Private Company & Seven in case of Public Company) and mentioning in their own
handwriting, name, address, occupation and number of shares agreed to be subscribed
before a witness. Witness also has to write his details in his own handwriting.
 The Liability clause should mention the fact that the liability of the company is limited
(by shares or by Guarantee as the case may be).
 Articles of Association (AOA) - Document of indoor management– For all companies, to

the extent applicable:
 A/A, if filed, may contain clauses like capital structure, power to issue further shares,
make call, forfeit, issue bonus shares, or buy back of shares including power to increase,
convert, cancel, consolidate and/or spilt the shares etc.
 A/A must not be ultra vires the Act or the M/A.
 The relationship of promoters inter se or rights — powers duties of each promoter may
be described in A/A.
 Any MoU or shareholders agreement etc. between promoting groups may be suitably
referred to in A/A, if it is desired that company should take cognizance of such MoU
etc.
 The method and mode of valuation of shares, further allotment etc., if desired, may be
enclosed in A/A.
 Minimum/maximum number of Directors, their rights, and duties can be contained in
A/A.
 Appointment/Reappointment, Retirement, Remuneration of Directors may also be
mentioned in A/A.
 Certificate of incorporation is birth certificate of a company and is issued by the

Registrar of Companies to all types of the companies i.e. private and public etc. It is
conclusive evidence that all formalities in formation of a company are duly complied with.
 Certificate of commencement of business is also issued by the Registrar of Companies
to all public limited companies after ensuring that the minimum capital required by the
company is subscribed the public. Private limited companies are not required to obtain
this certificate.
 Resolutions of the Board (LDOC-75 to 79, 100 and/or 131, as the case may be):
shareholders are the owners of the company but a company functions through its Boards
of Directors (who represent shareholders and all the decisions are taken by the Board
(no one else authorized to take decision of the company. A per 292, for raising a loan a
resolution should be passed in duly meeting of the board.
 Action on the part of the bankers while granting credit facility to the limited
companies-
 A bankers must obtain and verify the copies of MOA, AOA, Certificate of Incorporation
and certificate of commencement of business (for public limited companies) to see that
the borrowing is for the objective of the company and board of directors has power to
borrow.
 Borrowing powers of the company arise due to objective clause in MOA. The borrowing
powers of the Board are stated in AOA. In case of public limited company and a private

Page 17
limited company, which is a subsidiary of a public limited company where such company
borrows in excess of the paid-up capital and free reserves with the consent of the
general meeting, a certified true copy of the resolution passed at the meeting should be
obtained.
 Section 125 of the Companies Act, 1956 provides for registration of a charge within a
period of 30 days after the date of its creation. The Registrar has been authorised to
permit the filing of such documents within 30 days next immediately following the
expiry of the initial period of 30 days on payment of additional fee in terms of Section
611(2). The same provisions are applicable to the modification of charges under Section
135. However, the facility of extension of period of 30 days is not available to the
Registrar for the registration of satisfaction of charges under Section 138 of the Act.
The powers to condone the delay and grant extension for filing these documents beyond
a period of 60 days or 30 days, as the case may be, vest in the Company Law Board (CLB)
in terms of provisions contained in Section 141 of the Act. -General Circular No: 1 /2008
dated 1st July 2008 of Ministry of Corporate Affairs.
 Any omission to register the charge will make it void as against the liquidator and any
creditor of the company and make the charge holder an unsecured creditor.
 As per Section 125 of the Companies Act, the following charges should be registered:
i. A charge for the purpose of securing any issue of debentures.
ii. A charge on uncalled share capital of the company.
iii. A charge on any immovable properly, wherever situated, or any interest therein.
iv. A charge on book-debts of the company.
v. A charge not being a pledge, on any movable property of the company.
vi. A floating charge on the undertaking or any property of the company including
stock-in-trade.
vii. A charge on calls made but not paid.
viii. A charge on ship or any share in ship.
ix. A charge on goodwill, on a patent or licence under a patent, on a trade mark or
on a copyright or a licence under copyright.
 Advance granted to any company against pledge of goods will not be registered as the
same is a fixed charge and not a floating charge.
 The supplementary agreements for increase in hypothecation limit, additional security
etc. should also be registered.
 The period of limitation will commence from the date of creation of the charge
(i.e. date of the documents) and not from the date of signing the Form No. 8 (G.S.R. 284
(E) dated 24th April 2009 of Ministry of Corporate Affairs).
 Affixation of Common Seal of the company on various loan documents should be in the
manner prescribed in Article of Association. The resolution for affixation of common
seal should be passed in conformity with the seal clause and the affixation of common
seal to the documents should be accordingly.
5. Clubs, Associations and Societies
(i) As unregistered societies cannot be sued in law, credit facilities should be

considered only to clubs, and societies which are registered under the Societies

Page 18
Registration Act, 1860 or the Companies Act, 1956 or the State Co-operatives Act.
(ii) Clean advances to clubs and associations should not be considered and the secured
facilities may be considered in special cases after obtaining the approval of the Regional
Authority.
(iii) The committee members, both existing and future, should guarantee the facility
sanctioned in their personal capacity. This is to ensure that the committee members
take personal interest in liquidating the advances granted.
(iv) The clubs and associations should pass a resolution (as per LDOC-81) and submit a
certified true copy to the branch. However, branches should ensure that the
borrowings and charging of securities are in conformity with the provisions
contained in the bye-laws.
6. Trusts
(i) Advances should be considered only for registered trusts.

(ii) Trust deed should confer specific powers to the trustees to borrow for the purpose of
the trust and also to charge its assets.
(iii) Advances to the trust should be guaranteed by all the trustees in their personal
capacity. Permission of the Charity Commissioner should be obtained wherever
necessary. The trust should pass a resolution (as per LDOC-82) and submit a
certified copy to the branch.
(iv) Advances to trusts should be considered only after obtaining prior approval of the
Regional Authority.
LIMITED LIABILITY PARTNERSHIP [LLP]
With the growth of Indian economy, the role played by its entrepreneurs as well as its
technical and professional manpower has been acknowledged internationally. In this
background, a need was felt for a new corporate form that would provide an alternative
to the traditional partnership which exposes its partners to unlimited personal liability
and a statute based governance structure of limited liability companies.
Limited Liability Partnership [LLP] is viewed as an alternative corporate business vehicle

that provides the benefits of the limited liability but allows its members the flexibility
of organizing their internal structure as a partnership based on a mutually arrived
agreement.
Every LLP shall have at least two partners. The following persons can be partners in LLP:
1. Individuals
2. Limited Liability Partnerships
3. Companies
4. Foreign Limited Liability Partnerships
5. LLPs incorporated outside India
6. Foreign Companies
Karta representing a Hindu Undivided Family can be a partner. However, the Act is not
Page 19
clear in respect of admission of HUF as partner. Since an HUF is neither a person nor a
legal entity, in the opinion of bank‘s guidelines vide Circular No.BCC / BR /102/139 dated
17.05.2011 that it can not be taken as a partner. A Cooperative society, Society and
Corporation can also not be member of LLP. Obviously, minor, a person of unsound mind
and undercharged insolvent can not be admitted as partner of LLP as they lack capacity
to contract.
CARE BEFORE GRANTING CREDIT FACILITIES TO LLP
a. The branches should verify the LLP Agreement which is the main document governing
the relationship between the partners inter se and partners and the LLP.
b. Resolution for borrowing and execution of documents would be a must notwithstanding
that common seal for LLP is optional.
c. Execution of documents on behalf of LLP shall be either under common seal or under
the signatures of the authorized partners signing for and on behalf of the LLP as may be
resolved.
d. Signature of each and every partner is not required in the documents executed on
behalf of LLP as LLP is a corporate entity.
e. Since the number of partners would be unlimited binding each and every partner
personally may not be feasible.
f. Personal Guarantee of the partners having majority share holding can be stipulated and
obtained.
g. A major problem that banks may have to face would be in respect of encumbrances over
the LLP assets as there is no provision of registration of charges with RoC unlike a
limited Company.
h. Further, since the partners would not be personally liable except to the extent of
his/her share in the LLP, to protect the interest of the bank, sanctioning authority may
stipulate for personal guarantees of partners and mortgage of their personal assets in
addition to the LLP assets depending on the credit decision.
i. Before financing an LLP branches to inspect thoroughly the registers of LLP containing
the number and names of partners, the pattern and extent of liability of partners, the
charges created on LLP assets, the amount of insurance coverage on LLP assets, Books
of Account of LLP, Annual Return and Statement filed with RoC etc.

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3-PRE-SANCTION APPRAISAL(CREDIT APPRAISAL)
Quick Bites: Pre-Sanction Appraisal or Credit Appraisal is a critical part of the sanction.
This chapter deals with various components of Credit appraisal i.e. Borrower Appraisal,
Technical Appraisal, Management Appraisal, Financial Appraisal, Economic Appraisal,
Market Appraisal and Environmental Appraisal. Borrower Appraisal – 5 Cs character,
capacity, capital, collateral and conditions
WHAT IS PRE-SANCTION APPRAISAL?
When a credit proposal is received from a prospective borrower for sanction by an

appropriate authority, the appropriate authority on the basis of careful analysis of
various facts and data presented by the borrower may either sanction or reject the
proposal. The decision to sanction or reject the proposal has to be based on a careful
analysis and in depth study of various facts and data presented by the borrower
concerning him and his project. Such an in-depth study is called the pre-sanction credit
appraisal. It provides the sanctioning authority with the reasons and justifications for
either sanctioning or rejecting a credit proposal. It, thus, helps in the decision making
process of the sanctioning authority.
The pre sanction appraisal is necessary to get answer of following questions, while
considering a credit proposal.
 HOW IS THE BORROWER?

 WHY CREDIT IS REQUIRED?
 HOW MUCH DOES HE REQUIRE?
 WHAT TERMS /CONDITIONS FOR BORROWER?
 WHAT IS THE SECURITY?
 HOW IS HE GOING TO USE THE CREDIT?
 HOW IS HE GOING TO REPAY?
The entire gamut of credit appraisal can be segregated into 7 sections is under:
1. Borrower Appraisal
2. Technical Appraisal
3. Management Appraisal
4. Financial Appraisal
5. Economic Appraisal
6. Market Appraisal
7. Environmental Appraisal
1. BORROWER APPRAISAL
Every credit proposal, howsoever, small or big, is sponsored either by an individual, group
of individuals or a body run by individuals. A project which may be considered technically
feasible, economically viable and financially sound may run into difficulties if it is not
backed by a competent person who will be manning the enterprise. Thus, ‗the man behind
the project is very important‘.

Page 21
Confidence is the basis of all credit transactions. The basis of this confidence is
generally derived from the 5 'C's of the borrower i.e. character, capacity, capital,
collateral and conditions. In additions to the 5 C's reliability, responsibility and
resources are also looked into for gaining the confidence.
Character:
Character is the greatest and the most important asset, which any individual can have.
Even if a borrower has the capacity and capital to repay a loan, it is the character of the
borrower which indicates his intention to repay. If the character or integrity of a
borrower is known to be questionable, every banker would avoid him even if the credit
proposal is backed by sufficient collaterals. Character of a borrower is constituted by
honesty, sobriety, good habits, personality, the ability and willingness to keep his word
under all circumstances, reputation of the people with whom he deals etc.
Capacity:
It deals with the ability of the borrower to manage an enterprise or venture
successfully with the resources available to him. His educational, technical and
professional qualifications, his antecedents, present activity, experience in the line of
business, experiences of the family, special skill or knowledge possessed by him, his past
record etc. would give a hindsight into his capacity to manage the show successfully and
repay the loan.
Capital:
It is his ability to meet the loss, if any, sustained in the business or venture from his
own investment or capital without shifting it to his creditor or banker. Unless a
borrower has some stake in the business, he may not take much interest in its success.
Besides this, the following qualities of a borrower also help the bank in appraising the
borrower for a lending decision.
Collateral:
It is about securities offered by the borrowers to cover credit facility sanctioned by
the bank. The securities act as a protection for a banker in case of default by the
borrower. Security may be primary or collateral or both. Security should be ‗MASTDAY‘
i.e.
M- Marketability
A- Ascertainably of its title, value, quantity and quality
S- Stability of value
T- Transferability of title
D- Durability- not perishable
A- Absence of contingent liability
Y- Yield
Condition:

Page 22
It is about the overall environment that the borrower is operating in. Banker assesses
the conditions surrounding the borrower and its industry to determine the key risks
facing borrower‘s business, and also, whether or not those risks are sufficiently
mitigated. Even if the borrower‘s company historical financial performance is strong,
bank wants to be sure of the future viability of the company.
Succession planning:
It is also to be satisfied that the unit has in its fold adequately groomed/trained
second line of key persons to run its business.
Credit report on borrower

Having decided about the qualities as above, that are to be looked for in a borrower the
question that arises is how can a branch obtain/gather the necessary information
regarding these qualities. The following are the sources from where these can be
obtained:
1. Application form- A careful study of the information given by the borrower in
application form for credit facilities and cross checking the same with documentary
evidence wherever required, would give the bank a detailed knowledge about the
background of the borrower and indicate the further investigations required.
Verification of the ration card, driving license, income-tax, wealth tax returns etc.
gives valuable information about the means of the borrower .About the proposed
borrowers who are residing on rent, a careful study about their permanent residence
is must during pre sanction inspection.
2. Borrower's past dealings with the branch in conduct of various deposit accounts or
repayment of earlier loans if any, would give a clue about his honesty and character.
3. Reports obtained from persons having dealings, links with the borrower: Borrowers'
creditors constitute a very important source of information about the credit
worthiness of the borrower. The suppliers of goods and customers of the borrowers
would also provide useful information on the reputation of borrower.
4. Reports from the guarantors: The guarantors who have offered to stand as surety
for the borrower would not agree for the same unless they have faith about the
borrower to repay the loan
5. Reputation in the society or community to which he belongs: A discreet enquiry with
some members of the community or society to which the borrower belongs usually
proves a reliable source of information
6. Credit information from other banks and financial institutions with whom he is having
dealings- It is a practice among banks to exchange credit information and credit
opinion on the standing of their customers/borrowers. Such reports/opinions are
generally conveyed in general terms. It is not necessary to sign the format on the
credit information report since the authority of the information is provided in the
forwarding disclaimer letter signed by the branch officials. The Bank furnishing the
information will not sign the report. But the forwarding letter enclosing the report
will be signed. An acknowledgement letter should be sent thanking for issuance of
the report. The Indian Bank's Association has suggested a uniform format for
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submission of credit information by banks. The Performa of the suggested IBA
format is available in BOI Vol. Chapter –I at page 26.
7. Credit Information Bureau of (India) Ltd (CIBIL): CIBIL credit reports are
important source of information about financial dealings of borrower with banks/
financial institutions/ credit card companies. CIBIL reports are available under 3
heads 1. Consumer 2. Commercial & 3. Mortgage. List of suit filed cases of all banks
is also available on CIBIL website.
8. Other sources: The other sources from where the information about the borrowers
could be obtained are:
In case borrower is a company – MCA-21 website
Income tax site – for verification of PAN/TAN
Newspaper reports.
Public notices in newspapers etc.
Scrutiny of balance-sheet and profit & loss accounts.
Compliance of Know Your Customer (KYC) norms

Reserve Bank of India has issued instructions from time to time relating to proper
identification of account holders and the need for compliance of extant system and
procedures to help in preventing frauds. It has been advised to branches to comply with
‗Know Your Customer‘ i.e. KYC norms so as to prevent occurrence of frauds. Branches
should adhere to KYC norms not only in deposit accounts but in all types of accounts
including advances whether fund based or non fund based finance under the schemes of
Agriculture, Retail Trade, or Commercial/ Institutional Sector, Small Scale Industries
etc.
2. Technical Appraisal
The technical appraisal of a credit proposal involves a detailed study of the
following aspects:
 Availability of basic infrastructure
 Licensing/registration requirements
 Selection of technology
 Availability of suitable technical process, raw material skilled labour etc
3. Management Appraisal
In case of projects, units or enterprises run by individuals as sole proprietors or
partnership firms, it is usually one or two persons who manage the entire project, unit or
the enterprise whether it be of manufacturing or trading. In such cases a careful
appraisal of the individual borrowers who run the show as enumerated in Para 1-
(Borrower Appraisal) to decide whether to finance such a project, firm or enterprise or
not.
However, in case of corporate borrowers and also in case of large borrowal accounts, it
is usually a set of professionals who manage the entity each specialized in a specific area
of management i.e. production, finance, marketing, personnel etc. Unless there is a

Page 24
complete integration of all these functions within an organization, it cannot function
effectively.
Various forms of organizations
The borrowers approaching banks for financial assistance can be divided into 4 broad
categories:
1. Individuals
2. Proprietary concerns
3. Partnership firms
4. Corporate sector
I. Individuals and Proprietary Concerns:

a) In case of proprietary concerns, it is the sole proprietor who will be primarily liable to
repay the bank's loan and as such qualities of the sole proprietor as enumerated in Para
1 (Borrower Appraisal) are to be studied carefully. It is also possible that even though
the unit is owned by a sole proprietor, the actual production, sales etc. are managed by
qualified personnel. In such cases their experience, qualifications etc. should be studied
with reference to their responsibility and requirements of the project.
b) Every project has some critical areas. Branches must ensure that the enterprise has
necessary key expertise required for the critical functions.
II. Partnership Firms:
In case of partnership firms, knowledge and experience of each partner should be
studied in relation to the requirement of the project. Relationship among all the
partners should also be studied. In many cases, partners are also associated with other
firms either as proprietors or partners. The track record of such units should also be
studied.
III. Corporate Borrowers:
In case of corporate borrowers, the most important criteria is the main promoter of the
company. The main promoter or the person with whom the management control rests is
the key to the success of the company. A promoter having a good track record,
reputation in the financial and commercial markets is likely to ensure the success of the
company even against all odds. This will ensure the timely repayment of banks dues. Due
to the constraints of prudential exposure norms and 'Group approach' concept
enumerated by the RBI, the bank has set limits for financing to individual borrowers
singly or in a group. Besides, the bank as a policy may restrict further exposure to a
firm belonging to a particular group of borrowers.
Many companies are so closely held that the entire shareholding of the company rests
with a few individuals and even the different managerial personnel are their close
associates. In such cases, a very careful appraisal of the management/the board of
directors should be carried out.
In the case of widely held companies i.e. companies where the shareholding is spread
over a wide range of individuals and corporate, it should be ensured that independent
persons with experience in diverse fields like finance, marketing, technical, legal,
Page 25
personnel etc. are inducted into the board of directors. It should also be ensured that
the Board meetings are held as frequently as possible or at least once in a quarter as
per statutory requirements.
In the case of joint sector projects relationship between the financial institutions and
the private promoters should be studied and necessary precautions taken to avoid
conflict between them.
Documents to be scrutinized while lending to Corporate borrowers (Companies)

Memorandum of Association : It is a document which indicates the relationship of the
company with outside world. The document contains the name of the company, address
of the Registered office, authorized capital, object clause and liability clause of the
share holders.
Article of Association: This statutory document contains internal rules, regulations,
activities and management of the company. It contains right and powers of the
directors, use of common seal etc. Before granting any advances to Corporate, banker
should verify object clause, borrowing powers and Article of Association.
Certificate of incorporation: It is a certificate issued by the Registrar of the company
certifying the formalities for formation of the company is complied with. It is to be
obtained in case of private and public limited company.
Certificate of commencement of Business: This is a certificate issued by Registrar of
Companies to Public Limited Companies. In case of private limited company it is not
required.
Board Resolution: As per section 292 of the Companies Act a resolution must be passed
in the meeting of the Directors for opening and maintenance of the account. In case of
raising the loan it should specify the type of facility and name of the banks and
documents to be executed, etc. Specimen for resolution for various purposes are given
in Vol.9 – Documentation. It is signed by the Chairman of the meeting and counter signed
by the Secretary.
Borrowing Powers: Borrowing power of the Board of Directors is mentioned in AOA. It
should be backed by a resolution under section 292 specifying the total amount which
can be borrowed and remain outstanding at any point of time.
Where total borrowing of a company exceeds powers of the Board, the Board has to
seek approval of its shareholder U/S 293(I)(d). Temporary loans for a period not
exceeding six months and are not meant for financing expenditure of a capital nature,
obtained by the company from the bank in their ordinary course of business are
excluded from the purview of this section. Therefore, a certificate to be obtained
from the Directors that their total borrowings together with the limit sanctioned by
the bank is not exceeding the prescribed ceiling under the section and they will see
that such limit is not exceeded at any time. This is applicable to public limited company
and a private limited company which is a subsidiary of public limited company.

Page 26
4. Financial Appraisal:
The term financial appraisal refers to the study and ascertainment of the following
aspects of the project/unit:
a. Determination of the cost of the project.
b. Assessment of the source of funds/means of financing the project.
c. Profitability estimates.
d. Break even analysis.
e. Cash flow projections.
f. Projected balance-sheet.
5. Economic Appraisal:
The performance of a project is influenced by a variety of other economic, social and
cultural factors. Even if a project is technically feasible and financially viable, it may
not satisfy the economic needs viz. employment potential, development of industrially
backward areas, environmental pollution etc.
Further as capital is a scarce resource, it is necessary that it must be allocated in such
a way that it yields best possible return to the society in general and the investor in
particular. As such a detailed appraisal of the project in terms of the return it
generates to the investor and the lending institutions is necessary before a decision is
taken to commit resources.
Method of economic appraisal includes sensitivity analysis and computation of the
Internal Rate of Return of the project.
6. Market Appraisal:
While appraising a proposal it is not only necessary to find out whether it is technically
feasible and financially viable, but also important to ascertain the marketability of the
product manufactured/sold. If goods produced cannot be sold there would be no point in
producing them. Hence the marketability or saleability of goods is of great importance.
Existence of a market for the product provides the rationale for its production. If the
product sought to be manufactured is the only one of its kind for which there are no
substitutes, the marketing of the same may not be a problem excepting when it can be
freely imported and that too at a lesser cost. However, if there are many competitors,
the entrepreneur may find the going tough. However a combination of the factors like
man behind the show, the quality of the product and the strategy for its sale will result
in its successful marketing.
Therefore, a careful survey of the market to determine the following aspects is called
the Market Appraisal:
a. General Market Prospects for the Product
b. Position of the product vis-à-vis the competitors
c. Size of the market and share of the proposed unit
d. Price structure
e. Raw Material
f. Marketing Strategy

Page 27
7. Environment Appraisal
Environmental appraisal concerns with the impact of environment on the
project and vise versa. The factors which may affect a project include the
water, air, land, sound, geographical location etc. Borrower should have
obtained all necessary clearances from pollution control board of the state,
permission and licenses to run the business.

Page 28
4-ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS
Quick Bites:
This handout explains the rationale behind the Analysis & Interpretation of Financial
Statements, the concept of Balance Sheet, the concept of Profit & Loss Account, the
importance of Cash Flow & Fund Flow statements.
1 Introduction:
Banks require to assess financial strength and the performance of the borrowers for
proposal & appraisal. The main source of information for assessing the viability and
financial strength of operations of the borrower, are financial statements which
consist of –
1. Balance Sheet
2. Profit & loss Account and
3. Cash flow (it gives total cash flow of the firm / Company)
 Directors Report (This include the Financial results, Operations, Dividends,

Achievements, Any major events of that year, management discussion & analysis,
subsidiaries & groups, Directors Responsibility Statement, Corporate Governance, Vision
for the coming year, etc.),
 Auditors Report on Financial Statement (The report include premises of their audit, the
standard they have adopted for audit, the records they have been provided to peruse,
whether the company/ firm has paid the tax as per guideline, whether the company/
firm has observed the laid down guideline for them, etc.),
Both Director‘s Report & Auditor‘s Report are part of financial statement & should
important indicator of the business performance of the firm / Company. The system or
approach for analysing Financial Statements depends upon the purpose for which the
study is undertaken. Our purpose of analysing the financial statements is doing credit
analysis which is different from that of an investor, government authority etc.
Credit Appraisal:
While analysing a credit proposal, several factors, apart from analysis of statements,
are taken into account like Financial Statement, Operational data, Study of personal
credit-worthiness of the borrower/ guarantor, Dealings with other banks, Technical
feasibility, production process, particulars of plant & machinery, infrastructure
facilities, technical report, Financial viability, cost of the project, sources of finance,
relationship between cost of project & source of finance, Economic viability, repayment
capacity, return on capital employed, return on equity capital/net worth, Marketing
prospects, Management, Personal Competence of the Promoters, Financial
Resourcefulness. The process of credit analysis can broadly be divided into the following
major heads:
 Promoters and their business background
Page 29
 Nature of the industry/business
 Factors of production i.e. Land, Building, Machinery, Labour, Entrepreneur
etc.
 Past financial record, present position and future profitability
 Financial Planning
 Borrower's integrity
 Purpose of advance
 Repayment programme
 Security and other terms and conditions
 Associate concerns, if any, and their performance
 Promoters'/Borrowers' dealings with our Bank and other banks, where
applicable
This handout describes meaning of Financial Statement and their analysis /
interpretation from banker‘s point of view.
2 Financial Statements :
(i) Whether the business organisation is a sole proprietary concern, partnership or a Joint
Hindu Family firm or a company registered under the Companies Act, it has to
maintain a record of all its assets and liabilities. They should also maintain proper
records of all transactions, receipts and payments. All these transactions are
written up and the accounts are finalised as at the end of a twelve month period
which will be the concern's accounting year. The accounting year of a concern
need not necessarily synchronise with the calendar year. The period of the
accounting year can be reduced or increased with the permission of the appropriate
authority. On finalising the accounts, a statement of profit & loss account and balance
sheet will be drawn up.
(ii)Balance sheet and profit & loss account are different in character. Profit & loss
account shows the result of operations of the concern for a given period, whereas
balance sheet depicts the position of assets and liabilities of the concern as on a
particular day. The position of assets and liabilities of a concern is influenced by
its operations during a given period.
2.1 PROFIT AND LOSS ACCOUNT :

(i) It shows the income and expenditure of a concern for the relevant accounting year. It is
usually divided into three sections viz. manufacturing/trading Account, general profit
and loss account and an appropriation account.
(ii) The manufacturing/trading account will show manufacturing/trading income on right side
and expenses as well the resultant gross profit on the left side. The general profit and
loss account will open from the gross profit/loss and end with the net profit/loss. The
appropriation account will show the appropriation of net profit under various heads.
(iii) The profit and loss account is an important statement, as it shows the income and
expenditure of a concern during the year. The real protection to the lender is the
ability of the concern to perform well and make a reasonable profit and this
information will be available only in the profit and loss account. A weak balance sheet
Page 30
may not necessarily represent a bad credit risk if profitability is good and is improving
from year to year. Conversely, a concern with a sound balance sheet may not be a good
fir credit , if it is incurring losses consistently.
Study of Profit and Loss Account :
(i) It should be seen that amounts of expenditure shown in profit and loss account are
not exorbitant or unduly high in relation to the nature of the activity. It may so
happen that there is a spurt in office expenditure in a particular year, which
drains away the profit of the concern, which may in fact be due to diversion of funds.
If the interest paid appears to be rather high in relation to the interest charged by
the Bank, reasons therefore should be ascertained, particularly when there are
covenants and non-interest/low interest bearing deposits should be brought in
and/or the concern should not resort to outside borrowings.
(ii) A careful scrutiny of profit and loss account will also reveal, whether all the usual
expenses are accounted for or not. Otherwise enquiries should be made with the
borrower. Adjustments at the year end play a vital role in determining the net profit.
Usual adjustments are as under :
1. Basis of valuation of inventory should be consistent and as per accepted mode. The
usual practice is to value the raw material at average cost, others at actual
prices and finished goods at cost or market value, whichever is lower.
2. Rate and mode of depreciation should be consistent and full amount should be
provided for.
3. Adequate provision for accrued liabilities and outstanding expenses should be made.
4. Provision for Bad and Doubtful Accounts should be adequate.
5. Efficiency of operations should also be assessed by study of various ratios.
Different groups of expenses like (i) Production expenses (ii) Selling and
distribution expenses (iii) Administrative expenses etc. should also be studied.
2.2 STUDY OF BALANCE SHEET :
It is a statement of assets and liabilities of a concern as of the close of business on a

particular day. In nutshell, it shows what the concern owes (liabilities) to others and
what others owe to it (assets) which should be equal. It also indicates the sources of
funds and the utilisation thereof. Liabilities provide sources of funds which are utilized
for acquiring assets. If a concern suffers a loss, it is also treated as "use of funds".
Hence loss is shown on assets side.
All limited companies are required to publish their financial statements only in the
prescribed formats laid down in the Companies Act, 1956.
The mode of classification of assets and liabilities for our analysis of the balance
sheet is different from the mode of classification as per the Companies Act, e.g.
term loan installments falling due within one year from the date of the balance
sheet, are to be shown as current liabilities even though the entire term loan is shown
as term liability in the printed balance sheet.

Page 31
ASSETS:
Assets will have to be classified into four groups viz. fixed assets, current assets, non-
current/miscellaneous assets and intangible/fictitious assets.
Fixed Assets:
 Fixed assets will have the same meaning, as what is given in the balance sheet. They
include land & building, plant & machinery, equipment, installations, fixtures & fittings,
vehicles, furniture, leasehold rights, land development and also capital works in progress.
The finance for acquisition of fixed assets should normally be from long term sources
like own funds, i.e. capital, retained profits etc., term loan, debentures etc. While
analysing the balance sheet, it should be verified whether there is any increase in the
gross block and if so, the source of finance availed for acquiring them. In no case,
working capital should be diverted for financing fixed assets.
 Staff handling the Proposal should examine whether revaluation of assets is done.
Change in method of depreciation is affects the profitability and financial indicators of
an entity.
All the above factors would distort this head and hence the effect thereof, should be
highlighted while analysing the balance sheet to arrive at otherwise true picture.
Current Assets:
This term means the assets which enter the process of production/sales and the circle
of movement is complete by their ultimate recovery in cash. Classification of assets into
current assets should be strictly as per Bank's/RBI's guidelines and it is to be ensured
that the other assets are not included under this head, while assessing working capital
requirements or analysing the balance sheet. They include cash, bank balances,
inventories, receivables, amounts due from proprietor, partners, associate concerns or
others on current account (not in the nature of long term advances), advances to
suppliers of raw materials, stores, spares and consumables, advance payment of tax,
other trade advances, prepaid expenses and the like. Current assets do not include
doubtful debts, deferred receivables maturing after one year, investments other than in
Government Promissory Notes, deposits of a permanent nature with statutory bodies,
advances to suppliers of capital equipment or for acquisition of a capital asset and the
like. The composition of current assets requires to be closely examined from the angle
of their chargeability as security for Bank's advances, besides ensuring that there is a
healthy mix of different components of currents assets.
Miscellaneous / Non-Current Assets :
All tangible assets other than fixed and current assets are to be classified under this
head. In addition, it will include unequated investments of any kind.
Intangible and Fictitious Assets :
Intangible assets are those which carry some value to the concern (but are not
tangible) like goodwill, patents, copyrights, trade mark etc. Although in strict
commercial terms, these items are valuable, for analytical purposes, branches
should not attach any value to these items. Fictitious assets include deferred revenue
expenditure, share issue expenses, pre-operative expenses etc. which are to be written
Page 32
off in due course and the debit balance in Profit and Loss Account. Branches should
ignore the value of both intangible and fictitious items and they should be
subtracted from the net worth of the concern.
LIABILITIES:
Liabilities, which are the sources of funds, should be grouped under two categories
viz., long term liabilities and current liabilities.
Long Term Liabilities :
1. Long term liabilities will have two components viz. own funds or net worth and
external liabilities (long term debts).
2. Net worth (own funds) includes paid-up capital and reserves of all kinds after
providing for doubtful/bad debts in advances, fictitious and intangible assets. (In
case paid-up capital includes redeemable preference shares maturing within 10 years,
they should be treated as 'Term Liability'. Any part of these preference shares is
redeemable within the next 12 months, the amount thereof should be considered as
"Current Liability.")
3. Long term debt is a debt which is payable one year after the date of balance sheet
and it includes the following :
a) Debentures and public deposits, excluding the amount maturing for repayment within
next 12 months.
b) Redeemable preference shares maturing within 10 years and not within next 12
months.
c) All term borrowings, both secured and unsecured, from banks and financial institutions,
excluding installments falling due within the next 12 months. All deferred payment
liabilities, excluding installments/accepted bills maturing during the next 12 months.
Private borrowings payable after one year. Any other liability payable after one year.
Current Liabilities :
All liabilities, other than term liabilities, are to be classified as current liabilities and
branches should ensure that these liabilities are due for payment within the next 12
months, which includes following :
1. Sundry Creditors, including Bills Payable.
2. Short term borrowings, including outstanding bills discounted / purchased with banks
(both secured and unsecured).
4. Interest and other charges accrued and outstanding/not due for payment.
5. Advance payments received from customers.
6. Deposits from dealers etc.
7. Public deposits and/or debentures payable during the current year.
8. All installments due under term loans, deferred payment liabilities, redeemable
preference shares etc. within the next 12 months.
9. Statutory liabilities like PF dues, ESI dues, sales tax, excise duty etc.
10. Provisions for payment of dividend, bonus, liabilities for expenses, gratuity and any
other dues falling due within the next 12 months.
Contingent Liabilities:

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 These items are indicated by way of a foot-note in the balance sheet as they are
not prima facie crystallised liabilities affecting the overall liability position.
Hence, very often sufficient attention is not paid to study them carefully.
However, a closer look at these items may, many a times, reveal that they often
include liabilities/commitments with serious financial implications, which may have
adverse impact later on. For example, claims not acknowledged as debts, payment
for capital contracts not provided for etc.
 Similarly, issues of far-reaching implications like change in the accounting practices and
procedures, as also special accounting treatment given to certain transactions are quite
often included under this heading. Each and every special comment should be carefully
and critically analysed to understand its implications for the amounts included in the
balance sheet e.g. liabilities under lease agreement etc. Particular care should be taken
to fully satisfy that the company has made satisfactory arrangements for meeting
commitment.
2.3 FUND FLOW AND CASH FLOW STATEMENTS
Funds do not mean only cash. Funds flow means inflow and outflow of funds. Inflow of
funds takes place from different sources and outflow through various uses. Funds flow
analysis is an evaluation of sources and use of funds. It is a statement showing the
different "sources" and "uses" of funds.
Sometimes fund is defined as the ‗Net working Capital‘. Liabilities are the source of
funds and assets are the application of fund. Inflow and outflow of the fund can be
noticed by increase or decrease in assets and liabilities. The movement of the fund
would be as under:
Assets/Liab. Increase (+) Decrease (-)

Liabilities Source Application
Assets Application Source
If we see two consecutive years‘ balance sheet, we noticed that certain items of assets
and liabilities have been changed. The changes in assets and liabilities as compared to
previous year outstanding balance, represents the fund flow or financial position of the
firm/ company.
(A) SOURCES OF FUND (Inflow of the funds):

Broadly the sources of fund are divided into two parts namely, (1) Long term sources and
(2) Short term sources.
(1) Long term sources of fund are issue of capital, borrowed capital and other long term
sources which are payable over more than one year. Like, capital, debentures, public
deposit, term loans etc.
(2) Short term fund includes current liabilities and provisions which shall be liquidated
within a short period not more than one year. Like, sundry creditors, working capital
finance from bank/s, provisions for unpaid expenditures etc.
(B) APPLICATION OF FUND (Outflow of the fund) :

Application of funds are also divided into two parts namely,

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(1) Long term application (uses) of funds invested in acquiring fixed assets and investment
as well as repayment of capital etc.
(2) Short term application of funds includes funds invested in acquiring current assets
required for day to day working capital needs.
UTILITY OF FUND FLOW STATEMENT:
The fund flow statement helps to know

(1) Where have the profit gone?
(2) Why there is imbalance exists between liquidity position & profitability?
(3) Why the firm is financially sound inspite of losses?
STEPS FOR CONSTRUCTION OF FUND FLOW STATEMENT:
Take the figures of Net Profit before tax from the profit and loss account as base to
draw fund flow statement. But to have clear idea about the fund generated out of
trading activity/ manufacturing activity etc. there are certain debit items on profit and
loss account which are to be added back. These items are as under:
Depreciation : It is a part of retained profit. The depreciation is provided by debiting

the profit and loss account. However, it is non fund item which is to be added back to
the profit. This will give figures of Gross fund generated from the main business
activity.
Profit or Loss on account of sale of Assets : These are not the transactions relating to
business operations. Any profit out of such transactions must have resulted in to
augmenting the figures of profit. Hence, the same amount to be deducted from the
gross fund generated. Conversely, any loss due to such transactions is to be added back
to profit.
Provision for taxation: Any provision for the current year should be added back to
profit. However, any provision for tax during the previous year should be assumed to
have been paid during the current year. Hence, no change is to be considered for fund
flow statement.
Dividend: Any provision for proposed dividend is to be added back to profit for fund
flow statement. But, Interim dividend paid during the year will be considered as
application of fund during the year by debiting the profit and loss account. Same way
any proposed dividend of previous year should be treated as paid during the year by
debiting provision for dividend. Hence, not to be added / deducted from profit figures.
Preliminary and pre-operative expenses: the amount written off during the year is to be
added back to the profit.
1. Take the figures of previous year outstanding balance of each items of assets and
liabilities.

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2. Compute the changes in respect of each individual assets and liabilities between two
consecutive years. Please ensure that sum total of changes in the assets is equal to the
sum total of changes in the liabilities.
3. Even if changes in assets and liabilities are in two different directions i.e. Inflow and
outflow both, no netting to be done. Both are to be shown separately as sources and
application of fund e.g. Change in fixed assets due to sale or purchase during the year or
change in term loan due to fresh disbursement and repayment of existing installments
are to be shown on two different side.
4. Work out the total inflow and out flow of the funds during the year. Analyse the total
inflow and outflow into long term and short term resources and applications. Satisfy
yourself that long term surplus over the long term application is adequate to margin or
NWC for working capital.
CASH FLOW STATEMENT:
Cash is a part of total fund of the firm/ company. However to know the increase /
decrease in liquid position (Cash and bank Balance) at the end of financial year cash flow
statement is prepared.
Commercial banks in India are following the cash flow method especially in the context
of assessment and monitoring of working capital credit facilities. The computation would
be as per the fund flow statements, by working out changes in assets and liabilities over
the previous year.
1. As per the accounting Standard AS-3 of ICAI, following categories of business

enterprises have to prepare and present the cash flow statement.
a. Companies or enterprises in respect of which equity or debt securities are listed

or proposed to be listed on any Stock Exchange.
b. All other Commercial, industrial and business enterprises whose turnover for the
accounting period exceeds Rs. 50 crores.
2. Cash flow means cash and bank balance, cash equivalents which includes short term
highly liquid investments that are readily convertible into cash.
3. Cash flow statement is prepared in following groups:

a. Net operating activities cash flow
b. (Operating inflow less Operating outflow).
c. Cash flow from investment activities.
d. Cash flow from financing activities.
e. Net increase in cash or cash equivalent
Restructuring of Balance Sheet as per CMA Requirement :

The Balance sheet prepared as per the Companies Act needs to be restructured by the
Bank for meaningful analysis.
2.4 Terms Relating to Financial Analysis

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1. Authorized capital: The level up to which company is legally permitted to issue the
shares.
2. Issued capital : The capital for which the prospectus is issued and subscription
is invited.
3. Subscribed capital : The amount and number of the shares for which the
subscription is received by the company for the issue.
4. Paid up capital : The amount and number of shares allotted to the share holders by
the company against the subscribed capital.
5. Capital Reserve : The reserve which is not freely distributable to the share holder.
It is generally created out of capital operations such as share premium account.
6. General Reserve : This is also called revenue reserve which is created out of profit
and available for general purpose say for distribution to share holders.
7. Revaluation Reserve : Reserve created out of revaluation of the fixed assets. This
is not a inflow of the fund but mere book entry resulting into increase in size of the
balance sheet. It should be given a netting effect with the fixed assets for
reconstruction purpose.
8. Net worth : It is a sum of total, capital and reserve. This is called owners capital.
9. Tangible net worth : Net worth less any intangible assets and accumulated loss.
10. Current liabilities : The liabilities which are to be paid within short duration say
within 12 months from the date of the balance sheet are to be classified/called as
Current liabilities. This is also called temporary loans.
11. Contingent liabilities : The liabilities which are not crystalised as on the date of
balance sheet but may or may not arise is depending upon the happening of certain
circumstances. This is shown as foot note/auditor‘s report.
12. Net Block of Fixed Assets : The net value of the fixed assets after deducting the
amount of depreciation. This means Gross block of Fixed assets less block of
depreciation.
13. Current Assets : The assets which are changing their forms within short duration,
normally within 12 months, easily converted into cash are called current assets.
This is also called gross working capital.
14. Non Current Assets : The assets which are neither a current assets nor a fixed
assets or fictitious assets are called non-current assets. This is also called non
business assets. This may include, advances to directors, loans to associate
concerns, etc.
15. Net working capital : It is excess of current assets over the total current
liabilities. It is called borrower‘s own contribution in working capital. It is always
from the long term sources.
16. Net sales : Means sales minus sales return minus excise duty if any payable.
17. Gross profit : It is a difference of net sales and cost of sales.

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18. Operating profit : This is called profit from main business activity. Gross profit
less operating expenses (financial charges, selling general administration expenses.)
19. Cash profit : Net profit plus depreciation. If unit has reported net loss which is
less than amount of depreciation it would be cash profit but if net loss is higher
than the amount of depreciation then it would be cash loss.

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5-Ratio Analysis
Quick Bites:
Ratio is an efficiency index reflects performance excellence of an entity. This handout
deals with important financial ratio required for proposal / appraisal enabling the reader
to evaluating liquidity, solvency & efficiency of the borrower through various Ratios.
RATIO ANALYSIS:
 Ratio Analysis means the process of computing, determining and presenting the
relationship of related items and groups of items of the financial statements.
 Ratio analysis is a meaningful comparison between items of financial statements.
 A ratio can be expressed as a percentage (Profit of 20%) or as pure number/times
(ex: sale is 3 times of net profit) or as a proportion (like 2:1).
 Whenever we recast the profit & loss and balance sheet, the recast figures should be
taken into account for analysis.
 Various ratios can be obtained from a balance sheet and Profit and Loss Account by
such comparisons. However, we as a banker focus on key ratios falling under three
main groups viz. Liquidity, Solvency and Efficiency through which we arrive at the
following characteristics : –
 Liquidity position
 Profitability
 Solvency
 Financial Stability
 Quality of the management
 Safety/Security of the loans to be provided/already been provided
Important ratios to be incorporated in proposal / appraisal are given below:

1 Current Ratio : (liquidity indicator)
It is also called the Liquidity Ratio and a test for short-term solvency. Current ratio is
arrived at by dividing, as on a date, total value of current assets by current liabilities.
Current Ratio = Current Assets/ Current Liabilities.
This ratio reflects the current assets cover for the current liabilities quantitatively at
any point of time. It is the barometer of short term liquidity of the company. In other
words, the working capital resources position is reflected in current ratio and hence
higher the ratio, better the liquidity. Slip back or fall in current ratio would generally
indicate diversion of short term funds (either for acquisition of fixed assets or for
outside investment) or cash loss.

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Hence, any adverse trend in current ratio should be carefully examined. It should be
kept in mind that it does not reflect the quality of non-cash current assets i.e. the
frequency of non-cash current assets turning over to cash. Generally a current ratio
of 1.33:1 is considered satisfactory. However, in our bank its benchmarking is fixed in
light of nature of borrower i.e. Wholesale Banking, SME regulatory and SME (expanded
definition) which is tabulated below for ready reference.
Business Segmentation Bench-mark Parameter Current Ratio

Wholesale Banking 1.33
SME (Mrg. & Services) under Regulatory Micro & Small 1.17
definition
Medium 1.20
SME (expanded definition) 1.33
The reasons for a lower or higher current ratio to the benchmark need to be examined.
The sanctioning authority may take a view and satisfy himself / herself while accepting a
lower current ratio and the reasons may be suitably recorded. While taking a final view
on the current ratio and/or projected level of current ratio, the sanctioning authority
may examine various options to improve the ratio such as exploring possibility of
injection of additional funds and / or ploughing back of profits, stipulations for not
declaring dividend / non withdrawal of profits, reduction in the level of non-current
assets and liquidation of investments outside business, if any, within a reasonable time.
2 Debt-Equity Ratio (solvency indicator)

This ratio indicates relationship between the external term borrowings and the own
funds of the concern. Bank takes total term liabilities as Debt i.e. total liabilities minus
net worth and total current liabilities. Equity means net worth of the concern minus
intangible and fictitious assets. However, the subordinated funds (i.e. long-term
unsecured loans from friends and relatives, etc.) may be considered as quasi-equity,
generally for non-corporate borrowers, and included in equity while arriving at ratio, if
the borrower retains the same at the existing level/ projected level during the
currency of Bank Loan. The subordinated debt however should not exceed borrower‘s
tier I capital i.e. capital plus free reserves less intangible assets.
Debt-Equity Ratio = Total Term Liabilities (TTL)/Tangible Net Worth (TNW).
A ratio of 3:1 is considered satisfactory. However, higher ratio may be allowed keeping
in view the activity of the borrower, industry, sectoral classification such as SSI units,
other priority sector advances etc.
Apart from DER (TTL/TNW), bank assesses the Debt Equity Ratio as Total Outside
Liabilities (TOL) to Tangible Net Worth (TNW) also. Total Outside Liabilities (TOL) will
be calculated as total of all liabilities of a company/firm on liability side of balance
sheet MINUS the net worth. A ratio of 4.5:1 of DER (TOL/TNW) may be considered
satisfactory.

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In our Bank, following ratio is considered for financial statement analysis :
DER = Total Term Liability = Benchmark for all types of borrowers is 3:1
Tangible Net Worth
TOL/ TNW = Total Outside Liability
Tangible Net Worth
Business Segmentation Bench-mark Parameter : TOL / TNW
Wholesale Banking 4.50:1
SME (Mrg. & Services) under Regulatory Micro & Small 4.50:1
definition
Medium 4.50:1
SME (expanded definition) 4.50:1
3 Fixed Assets Coverage Ratio : (security indicator)

This shows the number of times the value of fixed assets (after providing
depreciation) covers term liabilities.
Fixed Assets Coverage Ratio = Net Fixed Assets/Long/Medium Term Debts
This should be more than 1.
4 Debtors Turnover Ratio (liquidity indicator)
This ratio is expressed in number of days. This ratio indicates the average period of
credit extended to its customers by the firm. This refers to the borrower / client‘s
credit policy as a part of its overall financial management. The larger the amount
outstanding there-under, the more the depletion of funds for the concern.
Debtors Turnover Ratio = Outstanding Debtors x 365

(Number of days) Gross Credit Sales
Lower figure would indicate that the concern is extending less credit and consequently
more resources are available for its operations. However, depending upon the industry
trend, the levels may vary.
5 Creditors Turnover Ratio (liquidity indicator)

This is arrived at as under:
Creditors Turnover Ratio = Outstanding Creditors x 365
(Number of days) Credit Purchases
This ratio indicates credit period available to the firm from its suppliers.
Large creditors may not be a healthy sign. When a concern is facing financial stringency,
there is a tendency to postpone payment to creditors. Such situations should be
distinguished from other usual situations. In such cases creditors outstanding will be
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much beyond contracted period. Also liberal creditors may cost the concern either in
the form of inflated prices for purchases or by way of payment of interest.
This can be injurious in the interest of the concern. Branches should note that there can
be fraudulent transactions on the part of the firm through debtors and creditors
undermining the overall interests of the firm. In the name of retaining the customers
the firm may offer longer credit to known/interested parties or agree to pay higher
rate of interest or higher prices to creditors under the guise of enjoying larger credit
terms. These kind of fraudulent dealings can be observed only if market trends are
analysed and purchases and sales portfolios of the concern are critically examined.
However, depending upon the industry trend, the levels may vary.
6 Material Management Ratios (liquidity and financial stability)

The basic ratio falling under this head is Inventory Turnover Ratio. Inventory means raw
materials, stores, stocks-in-process and finished goods. All these items put together are
related to cost of sales for the year. Cost of sales is calculated as under:
Cost of Sales = Cost of Production + Opening Stock of FG – Closing Stock FG
where FG = finished goods.
The cost of production is arrived at by adding all direct costs, viz. raw materials
consumed, power and fuel, direct labour, consumable stores, repairs and maintenance to
machinery and other manufacturing expenses adding opening stock of stock in process
and deducting closing stock of stock in process. Cost of sales reflects the
ability/production efficiency and as such has an important bearing on the performance
of a concern. This ratio is calculated in number of days' consumption.
Inventory Turnover Ratio = Inventory x 365
(Number of days) Cost of Sales
Here inventory means closing stock of RM, SIP and FG. This shows the total inventory
held for number of days. The lower the ratio, the more efficient is the inventory
management.
Raw Material Turnover Ratio = Raw Materials on hand x 365

(Number of days) Raw Materials Consumed during the year
This shows stock of raw materials on hand in number of days. Here also the endeavour
should be on a lower ratio unless of course, the raw materials are imported items or
canalised items, in which case larger raw materials holding may be permitted.
Finished Goods Turnover Ratio = Finished Goods on hand X 365
(Number of days) Cost of Sales during the year
This shows for how much period finished goods are on hand. Branches should study the
reason for holding the finished goods and especially beware of rejected goods,
defective goods and unsaleable goods being included in the value of finished goods.
All the above ratios give an indication about the material management by the concern.
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7 Debt Service Coverage Ratio (DSCR) (financial stability)
Ability of a concern to service its term liabilities can be assessed from this ratio, which
is applied while appraising all term loans proposals, studying rehabilitation/
reschedulement / restructuring proposals, etc. DSCR measures whether interest and
instalments can be paid out of internal generation of funds. A ratio of 1.75 would
indicate that the concern‘s internal generation of funds would be 1.75 times of its
commitments towards term loan obligations and interest thereon.
It works out as under: -
DSCR = (PAT + Depr.+ Int. on TL) / (Int. on TL+TL Instalments).
The average DSCR (i.e. the sum of numerator divided by the sum of denominator of
DSCR
formula as stated above for entire repayment period of the loan) of 1.75 is considered
reasonable. However, in any year it should not be less than 1.25. The sanctioning
authority may consider lower average DSCR depending upon the nature of project /
Industry after recording the reasons for the same.
In case of Real Estate, the existing method for arriving at DSCR is not relevant since
the repayment is made out of sale of assets which is proposed to be financed.
Business Segmentation Bench-mark Parameter : DSCR

Wholesale Banking Average : 1.75 with minimum 1.25
SME (Mrg. & Services) under Regulatory Micro & Small Average : 1.75 with
definition minimum 1.00
Medium Average : 1.75 with
minimum 1.25
SME (expanded definition) Average : 1.75 with minimum 1.25
8 Break Even Analysis, NPV and IRR :
The Break-Even Point (BEP) is the point where Total Costs equal Sales. The BEP is the
point at which, cost or expenses and revenue are equal: there is no net loss or gain, and
the unit has "broken even". The ratio is extremely useful in analysis of Term Loan
proposals.
BEP is calculated in order to determine at what level of sales the unit will be able to
recover the costs and will be generating profit at the sales level above BEP. The BEP is
calculated as per below mentioned formulae:-
Break Even Point (No. of unit) = fixed cost / contribution per unit

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Where contribution (per unit) = selling price (per unit) - variable cost (per unit)
Break Even Point (sales) ={fixed cost/ contribution (per unit)} * sales price (per unit)
Branches should calculate BEP in all credit proposals involving sanction of fresh term
loan of Rs. 20 Crore and above to part fund setting up of new units or expansion of
existing facilities. A lower BEP suggests that unit has adequate margin of safety.
Margin of safety is computed as 1minus BEP and indicates the proportion of sales which
is available as cushion for any increase in variable costs and is considered as
profitability zone of the unit. The sanctioning authority should assess the viability of
unit in terms of BEP and justification of accepted BEP should be recorded in the
proposal.
INTERNAL RATE OF RETURN AND NET PRESENT VALUE (APPLICABLE FOR TERM
LOAN OF RS. 20 CRORE & ABOVE)
NPV
Net present value (NPV) is the total present value (PV) of the project cash flows. It is a
standard method for using the time value of money to appraise long-term projects. NPV
measures the excess or shortfall of cash flows, in present value terms, once financing
charges are met. Borrower‘s weighted average cost of capital (after tax) can be used
to discount back the cash flows of the project to arrive at the Present Value.
Alternatively the discount rate could be the rate, which the capital needed for the
project could return, if invested in an alternative venture. When analyzing projects, it
will be appropriate to use the applicable interest rate as the discount factor.
IRR
The internal rate of return (IRR) is used to measure and compare the profitability of
investment in financing a large project. It is also called the discounted cash flow rate of
return (DCFROR) or simply the rate of return (ROR).
The internal rate of return on an investment or potential investment is the annualized

effective compounded return rate that can be earned on the invested capital. The IRR
of an investment is the interest rate at which the investment has a zero net present
value. A project is considered viable if it is generating an IRR greater than cost of
capital. Branches can compare the project IRR with the weighted average cost of funds
proposed to be invested in the project. The projects with an IRR greater than cost of
funds should be considered for funding.
The following sums up the NPVs in various situations.
If... It means... Then...
NPV > 0 the investment the project may be accepted

would add
value to the
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firm
NPV < 0 the investment the project should be rejected
would subtract
value from the
firm
NPV = 0 the investment We should be indifferent in the decision whether to accept or
would neither reject the project. This project adds no monetary value.
gain nor lose Decision should be based on other criteria, e.g. strategic
value for the positioning or other factors not explicitly included in the
firm calculation.
RATIO CALCULATION CHART
RATIO FORMULA Interpretation and benchmark

Current Ratio Current Assets Ability to meet current liabilities
Current Liabilities Higher the ratio better the
(1.33 is desirable) liquidity. Shortfall may indicate
diversion of short term fund.
Debt-Equity TOL/TNW Coverage of outside liabilities to
Ratio TTL/TNW own fund. Lower the ratio higher
the safety. As per loan policy,
TTL/TNW max3:1 & TOL/TNW
max 4.5 :1,
FACR Net Block of Fixed Assets Extent to which FAs cover Term
(Fixed Assets Term Liability Liabilities. More than 1 is desirable.
Coverage
Ratio
Debt-Service PAT + Dep. + Int. on Loan Debt Servicing Ability.
Coverage Ratio Instal. of TL + Int. on Loan To work out repayment capacity.
Minimum must be 1.25 and Average
should be at least 1.75. Total of
numerators to be divided by total
of all denominators to calculate
average DSCR. In case of real
estate DSCR is not relevant since
the repayment is made out of sale
of assets which is proposed to be
financed.
Inventory holding Total Closing Stock x 365
period Cost of Sales
(No. of days) Efficiency of Inventory
Raw material holding Closing RM X365 Management
period (days) Raw Material Consumed Holding Period of Inventory.

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SIP holding period Closing SIP X365
(days) Cost of Production
Fin. Goods holding Closing FG X365
period (days) Cost of Sales
Debtor turnover Closing Debtors x 365 Credit policy of the unit/ firm.
Ratio (No of Days) Gross Credit Sales Average Period of the credit
extended to customers.
Creditor Closing Creditors x 365 Ability to get goods on credit.
Turn over Ratio Credit Purchases Ability to repay
(No.of days)
Operating Profit PBDIT –Other income X 100 Operating Profitability
Margin Net Sales Efficiency of Production and
Pricing.
Net profit Profit After tax X 100 Net Profit margin on business.
Margin Net Sales Overall efficiency of the unit.
Earning left for Dividend.
Return on Capital PBIT-OI X 100 Measures efficiency of capital
Employed CE +TL(<1yr)+ BB-FIOB employed in the business
Interest Coverage PBDIT X 100 It measures the ability to pay
Ratio Interest interest-due from the operating
cash flows of the firm.
Break Even analysis BEP in Qty.= BEP of the Unit. High BEP is risky
Fixed Cost Contribution of Profit to meet
Contribution p.u. Fixed cost of the Unit.
Sales Means net Sales.
Contribution means SP p.u.
minus VC p.u. In our bank, BEP to be calculated in
all proposal including TL of Rs. 20
BEP Sales = BEP in units X SP crores and above.
p.u.
Margin of Safety Sales Value - BEP Sales % of variance sustainable by the

MOS Actual Sales unit. Cushion available in case of
variance.
PAT = Profit after Tax, FA = Fixed Assets BEP = Break Even Points MOS = Margin of
Safety. BB=Bank Borrowings, OI = Other Income, CE = TNW + TL>1 yr. FIOB = Funds
Invested Outside Business, SP = Selling Price, VC=Variable Cost, p.u. = per unit.

Page 46
6- Break Even Point – An Overview
Definition of Break-even point:
Break even point is the that level of sales at which profit is zero.
In the short run COST can be bifurcated into Fixed Cost and Variable Cost.
Variable Cost changes in proportion to change in number of units produced whereas
fixed cost remains same irrespective of level of production.
According to this definition, at break even point sales are equal to fixed cost plus
variable cost. This concept is further explained by the following equation:
[Break even sales = fixed cost + variable cost]
The break even point can be calculated using either the equation method or Contribution
method. These two methods are equivalent.
Equation Method:
The equation method centers on the contribution approach to the income statement.
Sales = Cost + Profit
Sales = (Fixed Cost + Variable Cost) + Profit
According to the definition of break even point, break even point is the level of sales
where profits are zero. Therefore the break even point can be computed by finding that
point where sales just equal the total of the variable expenses plus fixed expenses and
profit is zero.
Example:
For example we can use the following data to calculate break even point.
 Sales price per unit = Rs.250
 variable cost per unit = Rs.150
 Total fixed expenses = Rs.35,000
Calculation:
Sales = Fixed Cost + Variable Cost + Profit
Rs.250Q = Rs.35,000 + Rs.150Q + Rs.0
where Q stands for quantity.
Rs.100Q = Rs.35000
Q = Rs.35,000 /Rs.100
Q = 350 Units
Q = Number (Quantity) of units sold.
The break even point can be computed by finding that point where profit is zero
The break even point in sales rupees can be computed by multiplying the break even level
of unit sales by the selling price per unit.
350 Units × Rs.250 p.u. = Rs.87,500 /-
Contribution Margin Method:
The contribution method is actually just a short cut conversion of the equation method
already described. The approach centers on the idea discussed earlier that each unit
sold provides a certain amount of contribution margin that goes toward covering fixed

Page 47
cost. To find out how many units must be sold to break even, divide the total fixed cost
by the unit contribution margin.
Contribution p.u. = Selling Price p.u. – Variable Cost p.u.
Break Even Point = Fixed Cost

Contrib. p.u.
BEP = Rs.35000 / Rs.100 p.u. i.e. 350 units
The following formula is also used to calculate break even point
Break Even Sales in Dollars = [Fixed Cost / 1 – (Variable Cost / Sales)]
Break Even Point = [Rs.35,000 / 1 – (150 / 250)]
= Rs.35,000 / 1 – 0.6
= Rs.35,000 / 0.4
= Rs.87,500
Benefits / Advantages of Break Even Analysis:
The main advantages of break even point analysis are that it explains the relationship
between cost, production, volume and returns. It can be extended to show how changes
in fixed cost, variable cost, commodity prices, and revenues will affect profit levels and
break even points. Break even analysis is most useful when used with partial budgeting,
capital budgeting techniques. The major benefits to use break even analysis are that it
indicates the lowest amount of business activity necessary to prevent losses.
[
Assumption of Break Even Point:
The Break-even Analysis depends on three key assumptions:

1. Average per-unit sales price (per-unit revenue):This is the price that you receive per
unit of sales. Take into account sales discounts and special offers. Get this number
from your Sales Forecast. For non-unit based businesses, make the per-unit revenue $1
and enter your costs as a percent of a dollar. The most common questions about this
input relate to averaging many different products into a single estimate. The analysis
requires a single number, and if you build your Sales Forecast first, then you will have
this number. You are not alone in this, the vast majority of businesses sell more than
one item, and have to average for their Break-even Analysis.
2. Average per-unit cost:
This is the incremental cost, or variable cost, of each unit of sales. If you buy goods for
resale, this is what you paid, on average, for the goods you sell. If you sell a service, this
is what it costs you, per dollar of revenue or unit of service delivered, to deliver that

Page 48
service. If you are using a Units-Based Sales Forecast table (for manufacturing and
mixed business types), you can project unit costs from the Sales Forecast table. If you
are using the basic Sales Forecast table for retail, service and distribution businesses,
use a percentage estimate, e.g., a retail store running a 50% margin would have a per-
unit cost of .5, and per-unit revenue of 1.
3. Monthly fixed costs:
Technically, a break-even analysis defines fixed costs as costs that would continue even
if you went broke. Instead, we recommend that you use your regular running fixed costs,
including payroll and normal expenses (total monthly Operating Expenses). This will give
you a better insight on financial realities. If averaging and estimating is difficult, use
your Profit and Loss table to calculate a working fixed cost estimate—it will be a rough
estimate, but it will provide a useful input for a conservative Break-even Analysis.
Limitations of Break Even Analysis:
(1)It is best suited to the analysis of one product at a time. It may be difficult to
classify a cost as all variable or all fixed; and there may be a tendency to continue to use
a break even analysis after the cost and income functions have changed.
(2) Conditions of growth and expansion in a business activity not assumed.
(3) Fixed costs do not always remain constant.
(4) Variable costs do not always vary proportionately.
(5) As in case of costs/expenses, sales revenue also does not always change
proportionately.
(6) BEP analysis is applicable only in short run since in the long run all costs are variable
cost and there is no such thing as fixed cost in the long run.

Page 49
7-DOCTORING OF BALANCE SHEET (CREATIVEACCOUNTING)
Quick Bites: Firms/companies that manipulate their expenses and revenues to manage
reported earnings often do it in subtle ways that are hard to detect. However, the
experts say that some careful "sleuth work" by the well informed finance savvy bankers
can often search it out. How can you detect whether a company is following WorldCom‘s
example and manipulating its expenses to manage corporate profits?
A lender or an investor takes

a decision on the basis of
information furnished in the
published balance sheets, but
what if the information itself
is wrong. It is like crossing
India-Pakistan Border without
knowing where the land mines
are. Spate of scandals
involving "creative
accounting" have distorted
the pristine image of audited
Balance Sheets of companies.
The satirical saying attributed to a Pseudo Osama "Forget terrorism, I want to be an
Accountant" underlines the extent of damage which Accounting juggleries can create.
The recent shenanigans associated with financial statements have made accountancy
profession suspect and target of criticism and the Accounting Professionals are being
looked upon as potential lawbreakers. Under the circumstances, the common investors /
lenders are bewildered and need a few simple techniques to decipher doctoring of
balance sheets, glamorously known as "Creative Accounting", which is quite frequently
resorted to not only by private entrepreneurs, but also by piously regarded public sector
undertakings.
What is doctoring?
There are number of definitions of 'Doctoring" But all the definitions indicate that "An
expression, omission, misrepresentation or concealment of material fact made with the
knowledge of its falsity or in reckless disregard of its truth or falsity and with the
intent to deceive another and that is reasonably relied on by the other who is injured
thereby". Thus, incompetence, poor management does not constitute doctoring.
Doctoring of balance sheet involves steps which could appear to be within the four
corners of the law, but disaggregating them and understanding the implications
facilitate reading between the lines, and may reveal the real picture. Most of these
steps aim at inflating revenue and deflating expenses though in some cases, the other
way round may also be true.
So, wading into mud of accounting requires a deep plunge into the accounting-world to
know, at least the most common, sleight-of-hand tricks, that companies play on
unsuspecting investors / lenders, to enable sniffing out the fishy business; (- but,
Page 50
remember, there is nothing illegal simply because Indian Accounting norms are malleable
ones and, as for creative accountants, there is no dearth of that breed in India):
The doctoring is mainly relating to:
(1) Earning management - manipulates earning to achieve preconceived notion of

expected earning.
(2) Income smoothing - manipulates to produce a steady growth of profit.
(3) Creative accounting or window dressing to produce expected result.
(4) Big bath accounting - heavy reduction of earnings by deferring revenues or
accelerating write off and/or to account for value of assets with extreme
pessimism.
Inter-division transfers:
Several companies have more than one division / concern which carry out different
Operations. In the production / trade process, the output of one division/ concern may
be used or, at least usable, by other divisions / concern as input. In order to boost sales
and consequently profits for the year, a division / company may resort to "show" output
sales to its division /concern.
The simple steps to find a near-correct picture are:
1) Aggregate the profits figures of all the group concerns and have an inter-year
comparison.
2) Read the Balance Sheet-notes stating "Related Party Disclosures"- (AS -18).
Boosting year ending sales level vs Sales Return:
Generally, at the end of the year / period, the higher volumes of sales are "recorded"
without any real transactions / physical movement of the goods, but fulfilling on record
the basic conditions to qualify such transactions as sales. Such sales boost the sales-
level and consequently the profits for the relevant year / period. This step is mostly
used by consumer durable companies, which are usually hard pressed to meet the
targets. However, other companies too are observed to resort this step.
At the end of the year / period, the higher volumes of sales are "made", fulfilling on
record the basic conditions to qualify such transactions as sales, to certain disgustedly
associate concerns. Such sales boost the sales-level and consequently the profits for
the relevant year / period. At the start of the next year / period, such sales are
reversed as "Sales-returns". There is no ban if such sales entries are reversed in the
next year by mentioning that the order cancelled/ rejected.
The simple test to find a correct picture is

(1) To have inter-year comparison for at least last three years between cost of sales
to sales. (cost of sales/ Sales x 100).
(2) The year showing an attractively lower ratio may in fact be the year when this
common step might have been resorted to.
(3) Ask for the figure of sales & sales returns during the current year is the better
yielding step.

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Excise duty:
Excise duty is an indirect tax, which means that the company collects it from the
consumers and pays back to the government. The correct practice is that excise-
component is added to sales revenue and at the same time, is shown as expenses in the
Profit & Loss account leading to ZERO effect on account of excise. Any departure from
this practice, i.e., adding excise component to sales revenue but not showing it as
expenses or deferring its appearance in the Profit & Loss account creates illusion of
higher profits. Also, in course of inter-firm comparison, the company resorting to this
"smart" step may seem to be attractive.
The simple test is

(1) To ascertain relationship between excise duty and the sales in previous years and also in
current year for the industry / activity.
(2) Thereafter, make a snap calculation of excise payable and excise actually shown in the
Profit & Loss account. Any major difference needs to be probed into.
Spreading income and cost - a below the line trick:
According to the accepted accounting practices, the effect of any transaction should be
shown over the time-horizon in which the benefit is derived or the expenses incurred.
Thus, a simple trick involves recording long-term income benefits over a shorter period
than what they will actually accrue over. Similarly, spreading out a cost over a longer
time-horizon or straightway capitalizing it to ensure a smaller / zero hit in the current
Profit & Loss account.
Detection of such tricks actually necessitates deep study of the notes on the Balance
Sheet, Directors' Report and the Auditors report besides inter-year comparison of
revenue and expenses items.
Change in depreciation:
There are two methods for charging depreciation on assets - one is straight-line method
where a fixed amount is written off every year, and another is reducing balance method
(written down value) where a fixed percentage is written off on the reducing balance at
the beginning of each period. Depending upon the rates charged under the two methods,
a change from one method to the other would allow the quantum of the charged
depreciation to change, thus, impacting the Profit / Loss for that period.
Detection of such step is the easiest: just read the notes on Balance Sheet and the
auditors' report. There would be clear mention as to how change in depreciation has
impacted the shown profit / Loss.
Some times the company are not providing depreciation on plant and machinery under
the pretext that its plant and machinery are well maintained and promptly repaired
which do not erode the life/ increase the life of the P&M. This is under SLM method of
depreciation.
Deferment of revenue expenses:

The methodology is simple - Defer the current year's revenue expense from being
debited to current year's Profit & Loss Account, instead, show it in the Balance Sheet
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under "Miscellaneous Expenses / Preoperative Expenses / Research & Development
Expenses" so that the current year's profit does not get impacted. Next years, do not
amortize it to the debit of Profit & Loss Account, but simply debit to "Reserves &
Surplus" so that next years' profits too are not impacted.
TELCO did it when it wrote-off Rs 1178 crore of deferred revenue expenses (the
development expenses of ‗Indica car‘); - by doing so, TELCO could show loss at around
half of the actual loss incurred. The simple test is to have inter-year comparison of
Tangible Net Worth taking into account the retained profits / losses and other
accretions to the "Reserves & Surplus".
Big bath accounting or simulating income stream:
The company takes a leap in debiting the Profit & Loss Account in one year eying to show
"turnaround profits" in the next year so that in that next year, the already envisaged
merger / Public issue of shares or bonds or massive borrowing plan can materialize
glamorously. It is a way to clean up the books during the bad times so that when the tide
turns, there is no impediment to good performance.
Another way is to make huge provision in a good year with the intention to "write back"
the provision in a foreseeable bad year / period to even out the impact of prevailing
realties. Also, huge losses are booked in the Profit & Loss account in a bad year publicly
known due to reasons beyond control of the company and / or on account of remain
immune from the public wrath.
The simple test is to reason out the suddenly ballooned expenses / losses / provisions.
Show one time gain as operating profit:
Showing profits on sale of investments as part of operating profits is the step nowadays
mostly resorted to even by new generation private banks like HDFC and also by many
PSBs. The driver in this methodology is to befool the public / regulators by pumping-up
the revenues and thus, profits.
A simple test is to reason out the sudden increase in "other income" / income from
treasury operations reveals the real picture.
Revenue expenditure as Capital expenditure:
Some times the expenses relating to profit and loss account are considered as capital
expenditure thereby increasing the size of the balance sheet and increasing the profit
of the enterprise.
Steps to detect- verify the auditors note and ascertain the correctness
Revaluation of Brand/ Fixed Assets:
It is observed that many firms are adjusting their strength of balance sheet/ size of
the balance sheet by revaluation of brand/ Fixed assets. This revaluation is often
carried out to increase the assets value of a company.
Steps - to verify and compare each increase in assets and sources also.

Page 53
Why Boost the Balance Sheet?
Companies that manipulate their balance sheet are often seeking to increase their
earnings power in future periods (or the current period) or create the appearance of a
strong financial condition. After all, financially-sound companies can more easily obtain
lines of credit at low interest rates, as well as more easily issue debt financing or issue
bonds on better terms.
Overvaluing Assets
Provision for Doubtful Accounts

Accounts receivables play a key role in detecting premature or fabricated revenues, but
they can also be used to inflate earnings on their own by way of the provision for
doubtful accounts. Of course, the reserve for doubtful accounts will prove to be
inadequate in the future if adversely modified, but accounts receivable will receive a
temporary boost in the short term.
Investors can detect when the reserves for doubtful accounts are inadequate by
comparing accounts receivable to net income and revenue. When the balance sheet item
is growing at a faster pace than the income statement item, then investors may want to
look into whether or not the provision for doubtful accounts is adequate by further
investigating.
Inventory Manipulation
Inventory represents the value of goods that were manufactured but not yet sold. When
these goods are sold, the value is transferred over to the income statement as cost of
goods sold. As a result, overstating inventory value will lead to an understated of cost of
goods sold, and therefore an artificially higher net income, assuming actual inventory
and sales levels remain constant.
One example of manipulated inventory was Laribee Wire Manufacturing Co., which
recorded phantom inventory and carried other inventory at bloated values. This helped
the company borrow some $130 million from six banks by using the inventory as
collateral. Meanwhile, the company reported $3 million in net income for the period,
when it really lost $6.5 million.
Investors can detect overvalued inventory by looking for telling trends, such as
inventory increasing faster than sales, decreases in inventory turnover, inventory rising
faster than total assets and falling cost of sales as a percentage of sales. Any unusual
variations in these figures can be indicative of potential inventory accounting fraud.
Subsidiaries and Joint Ventures

When public companies make large investments in a separate business or entity, they can
either account for the investment under the consolidation method or the equity method
depending on their ability to control the subsidiary. Unfortunately, this leaves the door
open to companies that want to conceal and manipulate the true performance of their
subsidiaries or joint ventures. Under the equity method, the investment is recorded at
cost and is subsequently adjusted to reflect the share of net profit or loss and
Page 54
dividends received. While this is reported on the balance sheet and income statement,
the method does limit the information available for investors. For example, a company
could overstate interest coverage in order to change the leverage ratios of the
subsidiary.
Undervaluing Liabilities
Pension Obligations
Pension obligations are ripe for manipulation by public companies, since the liabilities
occur in the future and company-generated estimations need to be used to account for
them. Companies can make aggressive estimations in order to improve both short-term
earnings as well as to create the illusion of a stronger financial position.
Companies can make themselves appear in a stronger financial position by changing a few
assumptions to reduce the pension obligation. Because the pension benefit obligation is
the present value of future payments earned by employees, these accounts can be
effectively controlled via the discount rate. Increasing the discount rate can
significantly reduce the pension obligation depending on the size of the obligation.
Meanwhile, companies can also use pension accounting in order to manipulate short-term
earnings by artificially changing the net benefit cost, or the expected return on pension
plan assets, on the income statement. While the estimate should be roughly the same as
the discount rate, companies can make aggressive estimates that will then affect the
income statement. An increase in the expected return on plan assets will reduce the
pension expense in the income statement and boost net income.
Contingent Liabilities
Contingent liabilities are obligations that are dependent on future events to confirm the
existence of an obligation, the amount owed, the payee or the date payable. For example,
warranty obligations or anticipated litigation loss may be considered contingent
liabilities. Companies can creatively account for these liabilities by underestimating
their materiality.
Companies that fail to record a contingent liability that is likely to be incurred and
subject to reasonable estimation are understating their liabilities and overstating their
net income or shareholders' equity. Investors can avoid these problems by carefully
reading a company's footnotes, which contain information about these obligations.
What a Banker can do?
Inculcate reading beyond the Profit & Loss Account and the Balance Sheet:
(1) Study (a) the "notes" to the Balance Sheet / Profit & Loss account; (b) directors' report;
(c) Chairman's report; (c) Auditors' report more immaculately than the care shown in
analyzing the figures appearing in Profit & Loss Account and Balance Sheet; they carry
more revealing information than what the Profit & Loss Account and / or the Balance
Sheet depict. Particularly, work out the following nine ratios: Current ratio, Debt Equity
ratio, Operating profit margin, Net profit margin, Retained profit ratio, Inventory turn

Page 55
over ratio, Debtors turn over ratio, Return on capital employed and DSCR. Compare all
these ratios with the accounts with the branch/bank.
(2) Watch the Cash Flow; if profits are going-up, but the cash in-flow is flat, it is clear
indication of imminent tornado.
(3) Check Sundry Debtors / Receivables; if the level is rising disproportionate to the rise in
sales and especially if their amount outstanding for more than 6 months is steadily
rising, it spells trouble since the company is not realizing what is owed to it.
(4) Do not blindly rely on any "analyst"; - the experts don't commit mistakes; they commit
blunders! Always have a self-check / re-look.
(5) Get alarmed of frequent / big-ticket mergers /acquisitions; they may camouflage the
shit. In such a situation, first disaggregate the merged balance sheet and than read
them individually.
(6) Ensure that authorized capital, shown in the Balance Sheet, is in conformity with the
Memorandum of Association (amended up to date) and the relevant Form No.5 & 23 filed
with Registrar of Companies.
(7) In case the company has made any recent issue of shares, peruse the details of
allotment and compliance with the Registrar of Companies; - remember, bonus shares can
not be issued out of revaluation reserves.
(8) Have a look on the annual return filed with Registrar of Companies regarding
promoters' contribution;
(9) Remember that application money can be retained for a maximum of 3 months as current
liability only and during this period, this should not be treated as part of capital / NOF.
(10) Capital Reserves and Revaluation reserves are not to be treated as part of TNW.
(11) Investments in associate / group concerns is to be ensured to be genuine, strategic, and
are to be accounted for at present real value;
(12) No company is permitted to borrow in excess of 30% of its NOF nor is permitted to
invest by way of deposits / advances in another company in excess of 30% of Its NOF or
30% of NOF of the investee company whichever is lower unless Permitted by annual
general meeting of the company.
(13) Always ensure that the Balance Sheet that you are relying on is audited by a
chartered accountant and the auditors' report is an integral part of the balance sheet
perused by you. Simply certifying a balance sheet by a chartered accountant without use
of the word "audit" has no value and it is nothing but a compilation of accounting data by
a accounting professional without any onus / responsibility. Such certified balance sheet
or certificate needs to be viewed more skeptically. Further, audit of a balance sheet
should not be a pretext to abandon a re-look on the balance sheet and financials by the
lender.
(14) If the auditor of the company's balance sheet is also a tax consultant / financial
consultant of the borrower, beware of the auditor's vested interests in the company's
published financials. Remember the saga of Arthur Anderson!
CASES:
1. Satyam Computers
On 7 January 2009, company Chairman Ramalinga Raju resigned after notifying board
members and the Securities and Exchange Board of India (SEBI) that Satyam's
accounts had been falsified.
Page 56
Raju confessed that Satyam's balance sheet of 30 September 2008 contained:
 inflated figures for cash and bank balances of 5,040 crore (US$1.09 billion) as
against 5,361 crore (US$1.16 billion) crore reflected in the books.
 an accrued interest of 376 crore (US$81.59 million) which was non-existent.
 an understated liability of 1,230 crore (US$266.91 million) on account of funds was
arranged by himself.
 an overstated debtors' position of 490 crore (US$106.33 million) (as against
2,651 crore (US$575.27 million) in the books).
Raju claimed in the same letter that neither he nor the managing director had benefited
financially from the inflated revenues. He claimed that none of the board members had
any knowledge of the situation in which the company was placed.
He stated that "What started as a marginal gap between actual operating profit and the
one reflected in the books of accounts continued to grow over the years. It has attained
unmanageable proportions as the size of company operations grew significantly
(annualised revenue run rate of 11,276 crore (US$2.45 billion) in the September
quarter of 2008 and official reserves of 8,392 crore (US$1.82 billion).
As the promoters held a small percentage of equity, the concern was that poor
performance would result in a takeover, thereby exposing the gap. The aborted ‗Maytas‘
acquisition deal was the last attempt to fill the fictitious assets with real ones. It was
like riding a tiger, not knowing how to get off without being eaten.‖
2. Enron
Enron Corporation (former NYSE ticker symbol ENE) was an American energy company
based in the Enron Complex in Downtown Houston, Texas. Before its bankruptcy in late
2001, Enron employed approximately 22,000 staff and was one of the world's leading
electricity, natural gas, communications and pulp and paper companies, with claimed
revenues of nearly $101 billion in 2000. Fortune named Enron "America's Most
Innovative Company" for six consecutive years.
At the end of 2001, it was revealed that its reported financial condition was sustained
substantially by institutionalized, systematic, and creatively planned accounting fraud,
known as the "Enron scandal". Enron has since become a popular symbol of willful
corporate fraud and corruption.
The scandal also brought into question the accounting practices and activities of many
corporations throughout the United States and was a factor in the creation of the
Sarbanes–Oxley Act of 2002. The scandal also affected the wider business world by
causing the dissolution of the Arthur Andersen accounting firm.
Enron filed for bankruptcy protection in the Southern District of New York in late 2001
and selected Weil, Gotshal & Manges as its bankruptcy counsel. It emerged from
bankruptcy in November 2004, pursuant to a court-approved plan of reorganization,
after one of the biggest and most complex bankruptcy cases in U.S. history. A new
Page 57
board of directors changed the name of Enron to Enron Creditors Recovery Corp., and
focused on reorganizing and liquidating certain operations and assets of the pre-
bankruptcy Enron.
On September 7, 2006, Enron sold Prisma Energy International Inc., its last remaining
business, to Ashmore Energy International Ltd. (now AEI).
WorldCom
WorldCom has engaged in what could be one of the biggest financial frauds in history
and will restate earnings for the past five quarters.
It said it overstated cash flow by $3.9 billion for 2001 and the first quarter of 2002 by
booking ordinary expenses as capital expenditures — which dressed up the books.
Otherwise, WorldCom says, it would have posted a loss last year instead of net income
of $1.4 billion, and a loss for the first quarter of 2002 instead of net income of $130
million. Telecom analyst Tom Lauria estimates WorldCom's loss for 2001 could top $1.5
billion.
The Securities and Exchange Commission, already reviewing WorldCom's accounting, has
launched a high-level probe. Executives found guilty could face civil and criminal
penalties, say people familiar with the situation. "Our senior management team is
shocked by these discoveries," said CEO John Sidgmore in a statement. He replaced
ousted CEO Bernard Ebbers in April.

Page 58
8-TYPES OF CREDIT FACILITIES
Quick bites:
This chapter deals with types of credit facilities which are sanctioned to
borrowers/customers i.e. Overdraft, Cash Credit, Demand Loan, Term Loan, Packing
Credit, Bills Purchase/Discounted, Guarantee, L/C etc.
Various types of credit facilities that are generally available to the borrowers may be
now categorized in two segments-
i. Traditional Credit Facilities
Traditional credit facilities extended by bank can be classified into two categories viz.
fund based and non-fund based. When bank places certain funds at the disposal of
borrowers and borrowers avail these funds, such types of credit facilities are known as
fund based. However, there are certain types of advances which do not involve
deployment of funds at least at the initial stage though in contingencies funds are also
involved. These are called non-fund based advances.
Salient Features of these facilities are as under:
Loan: The loan is disbursed by way of single debit/stage-wise debits (wherever sanction
so accorded) to the account. The amount may be allowed to be repaid in lump sum or in
suitable installments, as per terms of sanction. Loan is categorized Demand Loan if the
repayment period of the loan is less than three years, in case the repayment of the loan
is three years and above the loan be considered as Term Loan.
OVERDRAFT
When a customer is maintaining a current account, a facility is allowed by the bank to

draw more than the credit balance in the account, such facility is called an
'overdraft' facility. At the request and requirement of customers temporary
overdrafts are also allowed. However, against certain securities, regular overdraft limits
are sanctioned.
Salient features of this type of account are as under
i. All rules applicable to current account are applicable to overdraft accounts mutatis
mutandis.
ii. Overdraft is a running account and hence debits and credits are freely allowed.
iii. Interest is applied on daily product basis and debited to the account on monthly
basis. In case of temporary overdraft, interest should be applied as and when temporary
overdraft is adjusted or at the end of the month, whichever is earlier.
iv. Overdrafts are generally granted against the security of government securities,
shares & debentures, National Savings Certificates, LIC policies and bank's own deposits
etc. and also on unsecured basis.

Page 59
CASH CREDIT: A cash-credit is an arrangement to extend short term working capital
facility under which the bank establishes a credit limit and allows the customers to
borrow money upto a certain limit. Under the system, bank sanctions a limit called the
cash-credit limit to each borrower upto which he is allowed to borrow against the
security of stipulated tangible assets i.e. stocks, book debts etc. The customer need not
draw at once the whole of the credit limit sanctioned but can withdraw from his cash-
credit account as and when he needs the funds and deposit the surplus cash/funds
proceeds of sale etc., into the account. Besides this, the facility of frequent and
unrestricted transactions is available.
Types of cash-credit limits : Depending upon the type of security against which cash-
credit limit is sanctioned, following types of cash-credit limits are sanctioned :-
1. Cash-Credit (Pledge) against pledge of goods

2. Cash-Credit Combo- Limit against hypothecation of stocks cum book debts
3. Cash-Credit (Hypothecation) against hypothecation of stocks
4. Cash-Credit (Book Debts) against hypothecation of receivables
5. Cash-Credit (Government Supply Bills) against Hypothecation of government supply
bills
6. Cash-Credit (Imports) against hypothecation of imported goods
7. Cash-Credit (Clean) against trust receipts
In terms of the bank‘s guidelines, all the authorities are now required to sanction a
combo-limit of Cash Credit (Hypothecation of stock-cum-book debt) even if the
borrower requests for only Cash Credit (Hypothecation of stock) facility or only Cash
Credit (Hypothecation of Book-debts) facility. An authority in JMGS-I to MMGS-III
can sanction a combo-limit even if there is sufficient tangible collaterals (i.e. tangible
collateral security at least 75%).
Salient features of cash-credit system are as under:
Sanction of limit: Bank sanctions the cash-credit limit after taking into account several
features as detailed in the foregoing chapters. The drawings are restricted up to the
sanctioned limits.
Calculation of drawing power: Based on the value of security charged to the bank, the
stipulated margin is reduced and the advance value is calculated subject to overall limits.
Branches should not allow drawings in cash-credit accounts beyond the drawing power.
However, interest and other charges may be debited exceeding drawing power. Drawing
power is calculated on monthly basis.
Actual drawings in cash credit accounts will be allowed lower of sanction limit or drawing
powers.
Bill Finance: Pre-sales activities from procuring raw material to manufacturing of
finished goods are financed by extending cash credit facility whereas the post sales
requirement are financed either by way of granting facilities against bills or against the
book debts. Bankers prefer to grant bill finance which provides an excellent medium for
settlement of a trade transaction.

Page 60
Under bills finance mechanism a seller of goods draws a bill of exchange (draft) on
buyer (drawee), as per payment terms for the goods supplied. Such bills can be routed
through the banker of the seller to the banker of the buyer for effective control.
(i) Clean & Documentary bill :
a) When documents to title to goods are not enclosed with the bill, such a bill is called
Clean Bill. When documents to title to goods along with other documents are attached to
the bill, such a bill is called 'Documentary Bill'.
b) Documents, the due possession of which give title to the goods covered by them such as
RR/MTR, bill of lading, delivery orders etc. are called documents to title to goods.
c) Cheques and drafts are also examples of clean bills.
(ii) Demand & Usance bill :
When the bill of exchange either clean or documentary is made payable on demand or
sight, such a bill is called Demand Bill. The buyer is expected to pay the amount of such
bill immediately at sight. If such a demand bill is a documentary bill, then the
documents including document to title to goods are delivered to the buyer only against
payment of the bill. (Documents against payment-DP Bills).
When a bill, either clean or documentary is drawn payable after certain period or on a
specified date, the bill is called Usance Bill. Such bill is presented to the buyer once for
Acceptance, when he accepts to pay the bill on due date and on due date the bill is
presented again for Payment. In case of documentary usance bill, the documents are
delivered to the buyer (drawee/acceptor) against his acceptance of bill (Documents
against acceptance - DA Bills).
Finance against bills of exchange: Difference between BP/BD
Banks consider working capital finance to meet the post sale requirements of borrowers
through Bill finance either by 'Purchasing' bills or 'Discounting' them.
a) Bill Purchase facility is extended against clean demand bills like cheques /drafts/bills of
exchange/hundies & demand documentary bills, whereby the bank lends money to the
payee of the cheque/draft and to the drawer of the bills by purchasing the same against
tendering of such bills by the payee/drawer. The bank in turn sends the bills for
collection, preferably to its own branch at the place of drawee or to its correspondent
bank or to the buyers (drawee's) bank.
b) Bills Discounting facility is extended against usance bills. In such cases, the seller
tenders the usance bill drawn by him usually alongwith documents to title to goods,
to his banker who discounts the bill i.e. levies discount charges for the unexpired
portion of the duration of the bill and credits the balance amount to the seller's
account. Thereafter the drawer's bank sends the bill to collecting bank at the centre of
drawee either to it's own branch or drawee's bank, with instructions to release the
documents to title against acceptance and thereafter, to recover the bill amount on due
date. Sometimes the accepted usance bills are also tendered and discounted by the
bank.
EXPORT FINANCE
It is Endeavour of the government of India to give all possible encouragement for
promoting exports from the country. Apart from other benefits offered by the
Government of India, banks grant export credit on very liberal terms to meet all the

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financial requirements of exporters. The export credit can broadly be divided into two
groups as under-
1. Pre-shipment advances/ Packing credit advances
Financial assistance sanctioned to exporters to enable them to manufacture/ procure
goods meant for exports and arrange for their eventual shipment to foreign countries is
termed as ‗pre-shipment/ packing credit advance‘. In fact all facilities granted to
exporter upto shipment stage will be grouped under this category. Following forms of
pre-shipment facilities are available to the exporters-
 Packing credit in Indian rupees
 Packing credit in foreign currency (PCFC)
2. Post Shipment Advances
After completion of shipment of goods for exports, the exporters in almost in all cases
require to draw a bill on foreign buyer for submission to his banker for collection. The
bill purchase/discount facility granted to the exporter is covered under post-shipment
credit. The exporter has to raise his claim of duty drawback etc. on various government
agencies after completion of export and may approach his banker to sanction him credit
facilities against these claims. Following facilities of post-shipment facilities are
available to the exporters-
a) Post-shipment credit in rupees
b) Foreign Currency Bills Purchased (FCBP)/ Discounted (FCBD)
c) Post-shipment Demand Loan (PSDL)
ECGC COVER:
Bank has opted for the following two whole turn over guarantees of Export Credit
Guarantee Corporation of India Ltd. :
(i) Whole Turnover Packing Credit Guarantee. (WTPCG)
(ii) Whole Turnover Post-shipment Guarantee. (WTPSG)
Under these guarantees all the advances at pre-shipment stage and post-shipment stage
are automatically covered. The branch has to ensure the prompt remittance of monthly
premium within the stipulated time, at the stipulated rate on daily product basis for
advances outstanding under pre-shipment and post-shipment heads, to the debit of
borrower's account.
 The WTPSG opted by the bank also covers the shipments under letters of credit.
 The claim if any, shall be considered by ECGC only if all the stipulations under
the whole turn over guarantees are fulfilled like :
a. All the sanctions/review/deviations etc. are to be reported to ECGC in the prescribed
format in a prescribed time limit.
b. The terms of the sanction should be fulfilled and for deviations if any, proper
confirmation from competent authority should have been obtained.

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Sources other than the Traditional Lending
Type
# of the Purpose/Meaning Eligibility Cost Security Tenure
Product
Bridge
( To meet Corporate with Available Current Assets Matching
Loans/
A temporary cash good credit at MIBOR with Cash
Short-term
) flow mismatches rating / LIBOR Flows
Loans
Commercial
( Short-term Highly rated depending Unsecured 7 days to
Paper
B borrowing corporate on rating one year
) Denomination of having minimum
CP Note - Rs.5 net worth of
Lakhs or Rs. 4.00 crores
multiples thereof & Credit rating
of P2 or
equivalent of
credit rating
agencies
approved by
RBI, Primary
Dealers,
Satellite
Dealers & FIs
Factoring
( Outright sales of Corporate Nominal Receivables Continuous
C the receivables having large service process
) of a firm to numbers of charges
another agency debtors compensat
specializing in ed by
the management saving in
of trade credit managing
called the factor receivable
s
in-house
Forfeiting Discounting Exporters Fixed rate Bills of Medium to

( export basis Exchange long -term
D receivables discount maturities
)
Securitisation
( Discounting Continuity of depending Quality of Continuous
of
E Future certain or near specific on rating receivables process
Receivables
) certain cash business and
flows borrowers‘
ability to
perform

Page 63
consistently
Channel
( Purchase bill Distributors depending Bill of Continuous
Financing
J discounting who purchases on rating Exchange, Post process
) wherein Bills of goods from dated cheque
exchange reputed (PDC), Invoice
(BoE) drawn by a corporate & Transport
Corporate on its proof
distributors is
discounted by
the Bank &
proceeds are
directly paid to
the seller
(Corporate).
Cash
( Cheque collections deposited in banks are credited on the date of deposit or
Management
K prior to the date of clearing as per the arrangement with the bank. This is
Products
) done at a nominal fee for the service provided but it improves the cash flows
considerably when collections against sales are spread over remote locations.
External
( For investment in Corporate As per Choice of More than 3
Commercial
L real/ industrial registered RBI security to be years
Borrowings/Tr
) sector and under the guidelines provided to
ade Credit infrastructure Companies Act –Linked the lender/
(Buyers except with supplier is left
Credit/Sellers financial LIBOR to the
Credit intermediaries borrower
(such as banks,
financial
institutions
(FIs), housing
finance
companies and
NBFCs)
FCNR-B
( Loans Loans against Generally to LIBOR + Fixed/Current
M FCNR Deposits Corporate who Assets
) (Foreign have natural
Currency) hedge due to
exports
The above-mentioned products are mainly to meet the shortfall in working capital and
working capital requirements of the business and are offered by Nationalised Banks,
Private Banks and Foreign Banks (depending upon the credit rating of the borrower).
Venture Capital Financing

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Venture Capital Financing refers to financing of new high-risk venture promoted by
qualified entrepreneurs who lack experience and funds to give shape to their ideas. In
broad sense, under venture capital financing venture capitalist make investment to
purchase equity or debt securities from inexperienced entrepreneurs who undertake
highly risky ventures with a potential of success. Some common method of venture
capital finance is as follows:
 Equity financing
 Conditional loan
 Income Note
 Participating Debenture
Presently there are 80 Foreign Venture Capital Investors (FVCI) and 90 Venture Capital
Funds (VCF) registered with SEBI (Securities Exchange Board of India). For details
please visit http://www.sebi.gov.in/investor/venturecap.html
International Financing
There are various avenues available to raise funds from the international market. Euro
Issues, Global Depository Receipts (GDR), American Depository Receipts (ADR) and
Foreign Currency Convertible Bonds (FCCB) are more popular in India.
Euro Issues
Euro Issues are listed on a European Stock Exchange. Finance can be raised by Global
Depository Receipts (GDRs), Foreign Currency Convertible Bonds (FCCBs) and pure debt
bonds.
Euro Convertible Bonds

A Convertible bond is a debt instrument, which gives the holders of the bond an option
to convert the bond into predetermined number of equity shares of the company. The
bonds carry a fixed rate of interest. Such bonds may carry 2 options viz.
(i) Call Option (Issuer‘s Option)
(ii) Put Option (Holder‘s Option)
Global Depository Receipts (GDR)

GDR is negotiable certificate, denominated in US dollar that represents a non-US
company‘s publicly traded local currency (Indian Rupee) equity shares.
American Depository Receipts (ADR)

Depository receipt issued by a company in the USA is known as ADRs. Such receipts
have to be issued in accordance with the provision of Security and Exchange Commission
of USA.
Foreign Currency Convertible Bonds (FCCB)

FCCB means bonds issued in accordance with the scheme and subscribed by a non-
resident in foreign currency and convertible into ordinary shares of the issuing company
in any manner, either in whole, or in part, on the basis of any equity related warrants
attached to debt instruments.

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Private Equity Funding
Private Equity is also known as equity finance, equity loans, venture capital or private
venture capital. PE can be defined as investment in unlisted companies not quoted on a
stock exchange and is usually seen as an alternative (or an addition) to the more
traditional forms of finance such as bank debt. It includes forms of venture capital and
MBO financing. PE can be derived from a number of areas such as superannuation funds,
overseas investors, other companies, high net worth investors, a venture capitalist or
venture capital firms.
PE enables entrepreneurs to achieve success that may otherwise have been beyond
reach by providing resources over and above money. Success of PE Fund is dependent on
success of the venture. PE funds make sure that their star entrepreneurs are helped
with all the resources and learning which can be mustered by the fund to help them
realise their dream.
Typically if a private equity investor agrees to invest in a company, they will require
some kind of representation on the board and hold a shareholding in that company.
Normally these investments lack security and as a consequence a venture capitalist will
be looking for high returns on their investment which means they will be aiming to
identify companies with high growth potential.
The private equity investor or venture capitalist aims to exit the business usually 3 to 7
years after the investment through the company listing on the stock exchange, selling
the business or through a management buyout. Accordingly, the primary return on
investment from equity funding is usually through capital gain at the exit stage. Private
equity finance is suitable for less mature companies with developing or under developed
concepts or revenue as well as for more mature established companies to finance
expansion or turnaround strategies.
Private equity investors will examine the following key areas when considering a loan
investment:
 Strength of Management
 Business Strategy
 Target Market
 Competition
 Innovation
Whether the business is a start up or an existing company, any period of forecasted
growth will bring additional risks which may also stretch the financial requirement
beyond the current capabilities of the company. Bank debt may prove to be too
restrictive on cash flow or even impossible to obtain. In these circumstances equity
funding may provide the much needed capital base as well as the support to achieve
goals.
Bank Guarantee:
Bank guarantee is ‗a guarantee given by a bank to a third person, to pay him a certain
sum on behalf of the bank‘s customer, on the customer failing to fulfill any contractual
or legal obligations towards the third person.‘
Types of Guarantees:
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Though as per law Bank guarantees have not been classified, by the nature of the
underlying contract entered into by the customer, in practice such classification has
been made. There are various types of guarantees the important ones which a banker
would be regularly required to issue are as follows: -
1. Financial Guarantee
2. Performance Guarantee
3. Deferred Payment Guarantee
Guidelines
 The following should be complied with:
 Except in case of Deferred Payment Guarantee, normally Bank guarantee with
maturity of more than –5- years should not be issued and any guarantee beyond –5-
years can be issued with prior approval of next Higher Authority.
 Guarantees executed on behalf of any individual constituent or a group of
constituents should be subject to prescribed exposure norms.
 Section 20 of The Banking Regulation Act, 1949, prohibits banks from granting loans
or advances to any of their directors or any firm or company in which any of their
directors is a partner or guarantor.
Permitted Deviations
Bank guarantee/s with maturity of more than –5- years can be issued subject to
Discretionary Lending Powers of the sanctioning authority, for the purpose which is
incidental to the business of the constituent, when the cash margin is 100% or
guarantee/s issued are against indemnity / counter guarantee of another bank, if the
exposure on the other bank is within ASL (Aggregate Settlement Limit).
Other Precautions
While issuing guarantees on behalf of customers, the following safeguards should be
observed:
i. The purpose of Bank Guarantee should be incidental to the business of the
constituent.
ii. Issuing bank guarantees on behalf of constituents who do not enjoy regular credit
facilities with us for their main business activities should not be normally considered.
In an exceptional cases when such guarantee facility is to be considered for
constituents who do not enjoy regular credit facilities with us a proper justification is
to be recorded.
iii. No guarantee to be issued on behalf of constituents enjoying main credit facility with
other banks without the prior consent of the latter.
iv. While extending guarantee against export advances it is to be ensured that no violation
of FEMA Regulations takes place and bank is not exposed to various risks. Guarantees
to be issued in favour of overseas buyers should be only on account of bonafides
export from India, observing laid down norms of the customer and his capacity.
v. Guarantees should not be issued in respect of caution-listed exporters without prior
approval of Reserve Bank of India.
vi. Guarantees with ‗Assignment‘ clause are not to be issued at all.

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vii. No guarantee should be issued containing, in any form, ‗auto renewal clause‘ as it would
tantamount to issuing guarantee for indefinite period.
viii. Bank guarantees be issued serially numbered.
ix. Guarantees beyond Rs. 50,000/- should be issued under two signatures one of whom
should be a Power of Attorney holder.
Extension / Renewal / Amendment of Bank Guarantee
If a request is received from the applicant (our client) ‗only for extension in the period
of guarantee‘ already issued such requests may be entertained, subject to satisfactory
conduct of the account and provided there is no change in the amount and other terms
and conditions of the guarantee.
The delegated authorities, who have sanctioned guarantee limit to the borrower, may
allow renewal of existing guarantee in NPA / SF accounts from time to time on selective
basis.
Letter of Credit
A letter of credit (LC) is a written but a conditional undertaking given by the issuing
bank on behalf of its customer, to the beneficiary that it will pay him the amount stated
in the credit provided documents specified in the letter of credit are drawn and
presented in strict conformity with the terms and conditions of the credit.
Types of Letter of Credit

Letter of credits are classified into various categories depending upon the nature and
the functions of the credit. Some of these types are as under:-
i. Revocable Letter of credit
ii. Irrevocable letter of credit
iii. Confirmed and unconfirmed letter of credit
iv. Transferable credit
v. Revolving credit
vi. Back to back credit
vii. Stand-by letter of credit.
Banks normally deal in Import (foreign) letter of credit, Inland letter of credit and
export letter of credit.
GUIDELINES
Import (foreign) Letter of credit
The Opening of Import L/C involves compliance of —
i. Trade control requirement
ii. Exchange control requirement
iii. Credit norms prescribed by RBI
iv. FEDAI and UCP ICC 600 guidelines
v. Banks internal procedures
Trade control requirements
Trade control lays down the policy and regulations relating to physical movement of
goods into India, therefore a person who wishes to open an import letter of credit must
have the basic authorization for import of goods.

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The applicant must possess an Importer Exporter Code Numbers (IEC) allotted by DGFT
(unless they belong to an exempted category). If import is covered under license he
must submit exchange control copy of the same.
The opening of letter of credit automatically falls under the purview of exchange
control and payment authorized or committed under the letter of credit must be within
the scope of exchange control guidelines.
As per extant guidelines, AD Banks may freely open letter of credit and allows
remittances for import of goods permitted under OGL.
OTHER GUIDELINES
Opening of Revolving Letter of Credit against import of goods into India can be allowed
in exceptional cases with adequate safeguards/conditions particularly with reference to
aggregate drawings under such Letter of Credits and shipment dates etc.
Opening of Deferred Payment Letter of Credit, where remittances against imports are
to be completed beyond 3 years and above from date of shipment require prior approval
from Reserve Bank of India.
Issuing guarantees for import remittances requires Reserve Bank‘s specific approval.
Standby credits for a period ‗less than 3 years‘ can be approved by the Authorized
Dealer.
FEDAI and UCP ICC 600 Guidelines

Import letter of credit being one of the important areas of Forex operations, fall within
the scope of FEDAI guidelines. In 1984, on the eve of introduction of 1983 Revision of
UCPDC, FEDAI issued detailed guidelines for the opening of Import letters of Credit by
banks in India. Standard formats of credit application and letter of credit to be opened
by banks was circulated for the information and adoption by banks. With a few
modifications/additions these guidelines are still in vogue and are to be followed by the
authorized branches.
Inland Letter of Credit:

The procedure for opening the Inland Letter of Credit is similar to that for opening
import letter of credit except that of exchange control and trade control regulations.
Inland letter of credit transactions are also guided by UCPDC ICC 600 guidelines.
Besides guidelines incorporated in book of instruction/circulars issued from time to time
the following guidelines be followed:
i. While opening the L/C, it should be ensured that the applicant will be able to retire the
bills under the L/C without resorting to any adhoc funded facility.
ii. In case the L/C applicant is not able to provide required cash margin at the time of
opening of the L/C, a condition of stepping up of margin gradually may be stipulated.
iii. Care should be taken to ensure that no finance is allowed against the stocks received
under a usance LC, which is yet outstanding / under AB. Such goods should however, be
charged / hypothecated to the bank and shown in the periodical stock, statements being
submitted by the borrowers. However, the value of stocks under LC should be
separately shown by way of footnote, and these stocks should be excluded for the
purpose of calculating advance value/drawing power.
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iv. For the purpose of lending powers DA LC is treated as clean fund based facility.
v. Limits sanctioned under DP basis cannot be converted to DA basis without the

permission of sanctioning authority. However, conversion of DA limits to DP LC limits can
be done as per guidelines issued from time to time.
Other precautions:
Interchangeability between guarantees and LCs While interchangeability between
guarantee facility and LC facility is permissible for similar purposes, automatic
interchangeability between all types of guarantee facilities and LC facilities should not
be allowed.
Precautions for tie-up of funds required for LC for import / purchase of capital goods
LC facility for purchase of capital goods should be normally on case-to-case basis to
cover specific capex programme and not as a regular facility.
LC limit sanctioned for acquiring current assets should not be allowed for acquiring
capital assets.

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9-WORKING CAPITAL FINANCE
Quick Bites:
This handout deals with the rationale behind need of assessing working capital for smooth
conduct of economic activities in a business/ manufacturing unit. This chapter deals in depth
various components of current assets, methods used to assess the working capital
requirement of a unit along with promoting bill culture in the system.
Any business enterprise whether engaged in manufacturing or purely trading activity, has to
have sufficient capital to finance both, its fixed assets, viz. land, building, machineries, etc.
and current assets for smooth conduct of day to day business activities/ production schedule.
The amount of current assets required for a smooth conduct of business is dependent on the
nature of the activity, availability of the raw materials, level of production, storage capacity
and funds available. So the funds/capital actually required to maintain this required level of
current assets, is called the gross working capital.
Out of the level of gross working capital, required as above, the borrower raises the
necessary funds from many sources, viz.: Share Capital, Retained Profits, Bank Borrowings,
Trade Creditors, Advance from Purchasers
Out of the above, credit available in the form of trade creditors and advance from
purchasers etc., are sources of finance which are short term in nature and are available as per
trade practices and market conditions. The remaining resources are, therefore, to be raised
from own capital or through bank borrowing. Such short-term credits available to the firm are
called current liabilities and the difference of gross working capital and the current liabilities
is called the 'Net Working Capital'.
Net Working Capital:
Diagrammatically the above can be shown as per exhibit.
LIABILITIES ASSETS
CAPITAL FIXED ASSETS
+ RESERVES
+ INVESTMENT
= Net Worth
+ NON CURRENT
+ LONG TERM BORROWINGS ASSET
NWC from LTS for total WC

requirement
CURRENT ASSET
CURRENT LIABILITIES

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The firm requires an amount of capital to maintain its level of assets comprising of fixed
assets and current assets. The level of current assets is partially met by capital raised
through current liabilities. The total current assets are called the gross working capital. If
the borrower has no bank borrowings then the total current assets - current liabilities will be
called his Working capital Gap. The borrower is required to raise the resources equivalent to
Working Capital Gap either from long term sources or through short term bank borrowings.
Out of this, if he brings in some amount, from long term sources, viz. capital, long term debts,
etc., the remaining amount is the amount required to be financed by the Bank. So the
appraisal of working capital finance by the bank requires computing the required level of
current assets and current liabilities besides the amount to be brought in by the borrower
from long term resources. The share of the borrower which comes from long term sources is
also known as Net Working Capital.
In other words,
TOTAL CURRENT ASSETS – TOTAL CURRENT LIABILITIES = NET WORKING CAPTIAL
Appraisal of Bank Finance:
The appraisal of bank finance for working capital thus involves the following steps:
A) Estimation of the Level of Gross Working Capital (GWC)
B) Estimation of the Level of Current Liabilities (OCL other than Bank)
C) Computation of Net Working Capital Gap (WCG)
D) Computing the share of NWC Gap required to be brought by the borrower as Margin.
(NWC)
E) Computation of the Level of Bank Finance. (PBF)
Estimation of Gross Working Capital:

For a systematic and proper estimation of the gross working capital requirements of a firm,
it is essential to identify its various components and analyze them in detail.
Operating Cycle Theory:
To estimate the gross working capital requirements, the understanding of the operating cycle
of manufacture/production is very important.
The function of any manufacturing unit is to procure raw materials, process the same to
produce finished goods, sell the finished goods and realize money and utilize the money so
received, to procure raw material again and to continue the cycle all over again.
Besides, the cost of raw material, labor charges, electricity, water, rent etc. are also incurred
during the period of processing. All this requires funds/capital.
Once the goods are produced, it may not be sold immediately and it may have to be stored in a
godown for some days before they are sold. Storing of such finished goods involves cost of
raw material used in such finished products, labour and other manufacturing expenses
incurred in producing them, etc.
It is not necessary that all the goods will be sold in cash. Some goods will be sold on credit.
Till such time sale proceeds are not realized, funds are blocked in such receivables.
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Finally, when the sales proceeds are realized, the funds are again used to procure raw
material, etc. as above and the whole process/cycle starts all over again.
The total time taken from the purchase of raw material, till realization of sale proceeds is
called the operating cycle and the amount of capital/funds required to sustain this cycle is
called the gross working capital. This is also called Cash to Cash Cycle or Working capital
cycle.
(1) Components of Gross Working Capital:
In any typical manufacturing unit, the components that constitute the gross working capital or
current assets are as under: Raw materials , Consumable stores and spares, Stock in process,
Finished goods, Receivables, Cash and bank balance, Other current assets.
(a) Raw Materials:
For a systematic assessment of the level of raw material requirements, following factors
are to be considered:
Types of raw materials required,
Sources of raw material,
Availability of raw materials,
Mode of transportation of the raw material,
Period for which the raw materials are required to be stored before they, are
taken out for processing,
Terms of purchase of raw materials,
(b) Consumable Stores and Spares and packing material:
All the aspects covered in above are applicable for estimating the amount of consumable
stores, spares and packing material required in the manufacturing process also. The average
stock in terms of number of days to be worked out. Usually this level of holding is expressed
in number of months by dividing it by 30.
(c ) Stock in Process:
Once the raw material is taken up for processing, it goes through various stages of
production. The time taken for such conversion depends upon number of operations and time
taken for each operation, etc. Further, additional expenses like wages, salary, fuel, power,
water, depreciation etc., are also incurred during the manufacturing process. When these
expenses are added to the cost of raw material and locked up in various stages of production,
it will form the cost of stocks in process.
Cost of production: Raw material consumed in a year + spares consumed + depreciation +
manufacturer expenses + overheads + opening stocks in process - closing stock in process.
Average stock in process: Opening stock in process + Closing stock in process) / 2
Stock in process (No. of days): Average stock in process x 365/ Yearly cost of production.
(d) Finished Goods

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Depending upon the demand and market for the product, the finished goods may be
required to be stored for some period before they are finally sold. This involves blocking
of capital on these finished goods. The quantum and value of these finished goods will be
determined by:
Physical characteristic, i.e. perishable, hazardous, loses weight on storage, types and
varieties of finished goods, demand for the product, location of the market and
dispatch time, seasonality of the product etc.
Cost of sales = Cost of production + opening stock of finished goods + purchase of
finished goods - closing stock of finished goods
No. of days of Finished Goods = Average stock of finished goods x 365/ Yearly Cost
of sales
(e) Sundry Debtors/Receivables

The nature and period of credit to be given to the customers depends upon various
factors, viz.
Nature of the product, Demand for the product, Credit worthiness of purchasers ,
Reputation of the seller, Competition in the market and trade practices.
The period of such credits varies from industry to industry and area to area.
No. of days of debtors: Average Sundry Debtors x 365
Annual sales
No. of days of Export Receivables: Average export receivables outstanding x365/ Annual
export sales
No. of days of domestic Receivables: Average domestic receivables outstanding X 365
/Annual domestic sales
(f) Cash and Bank Balance:
Every unit requires some liquid cash and balance in current account with bank to meet
urgent day to day requirements. Such requirements should be minimum. Estimation of the
level of cash and bank balances is dependent upon the policy of purchases, sales, past
holding, etc. As such past trends and trends in similar units would be the bench mark for
determining such levels.
(g) Other Current Assets:
Usually the following items are included in the "Other Current Assets:
Advance payment to suppliers of raw material, etc.
Advance payment of taxes, excise duties. Cash etc.
The level of these items can be generally gauged from past figures and requirements of
the unit.
(2) Estimation of Level of Current Liabilities:
Once the gross working capital or current assets are computed as above, it is essential
to find out the amount of credit available to the borrowers in purchase of raw materials,
Page 74
advance payment received from buyers, deposits from dealers, provisions for statutory
liabilities, etc.
If usance letter of credit facility is proposed, the period of credit available due to
availment of such letter of credit facilities should be reflected in the level of sundry
creditors.
Projected level of sundry creditors should be reasonable with reference to the quantum
of purchases, market practice and past trends.
(3) Computation of Net Working Capital :
Net working capital is defined as gross working capital minus total current liability.
Total Current Liability is Short Term Bank Borrowing + Other Current Liabilities.
If short term bank borrowings is NIL, then the gross working capital is financed entirely
by other current liability. Normally it is not the case.
So the difference between gross working capital and other current liabilities (excluding
bank borrowings) is called the working capital gap. The question is how much of this gap
is to be financed by the bank and how is the borrower required to make up the remaining
amount.
(4) VARIOUS METHODS OF LENDING :
Various committees have been set up by RBI to suggest the methods of lending.
Following are some of the methods of lending introduced in banks from time to time:
Tandon / Chore committee recommendations
First method of Lending
Second Method of Lending
Nayak Committee Recommendations for SSIs
Vaz Committee Recommendations for Non-SSIs
OUR BANK‘S PERMISSIBLE BANK FINANCE SYSTEM
(a) First Method of Lending (I METHOD) :

Under the first method of lending, the borrower is required to contribute a minimum of
25% of the working capital gap from the long term sources. The balance amount i.e. 75%
of the working capital gap represents the maximum permissible bank finance (MPBF).
Where the net working capital is more than the amount required to be provided by the
borrower, the maximum permissible bank finance would get reduced to that extent. To
ensure compliance under this method of lending, the current ratio of the concern should
not be less than 1.17:1.
(b) Second Method of Lending (II METHOD) :
The second method of lending stipulates that the borrower is required to contribute a
minimum of 25% of the total current assets from the long term sources(Net Working
Capital) irrespective of the working capital gap. The maximum permissible bank finance
will, therefore, be working capital gap less the amount to be so contributed by the
borrower. Where the net working capital is more than the stipulated minimum
contribution, the maximum permissible bank finance would get reduced to that extent. To
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ensure compliance under this method of lending, the current ratio of the concern should
not be less than 1.33:1. The above two methods can be illustrated by an example given
hereunder:
Current Liabilities Current Assets

Creditors for purchases 100 Raw materials 200
Other current liabilities 50 Stock-in-process 20
Total Current Liability other than 150 Finished goods 90
Bank Borrowings
Bank borrowings including bills 200 Receivables including bills 50
discounted with bankers discounted with bankers
Other current assets 10
Total Current Liabilities 350 Total Current Asset 370
1st Method 2nd Method
Total Current Asset 370 Total Current Asset 370
Less: Current Liabilities other than 150 Less: 25% of Current Asset 92
bank borrowings
Working Capital Gap 220 278
Less: 25% of Working Capital Gap 55 Less: Current Liabilities other 150
than bank borrowings
Maximum Permissible Bank Finance 165 Maximum Permissible Bank 128
Finance
Excess borrowing 35 Excess borrowing 72
Current Ratio 1.17:1 Current Ratio 1.33:1
In the example, it is observed that under the first method of lending the borrower is entitled
for an MPBF of 165 only, whereas he has availed bank borrowing of 200, thus resulting in an
excess borrowing of 35.
Under the second method the MPBF works out to 128 only and the excess borrowings
increases to 72. The borrower is thus, required to bring in additional long term funds of Rs.
35/- and 72/- under first and second method of lending respectively.
Nayak Committee Method:

Under this method originally proposed for SSI borrowers and later made applicable for all
borrowers with Fund based Working Capital limits upto Rs.5/- crore, the computation is made
at 20% of projected gross sales as under.
The gross working capital is uniformly assumed to be a minimum of 25% of projected gross
sales. On this, the borrower is required to maintain a margin equivalent to 20% of gross
working capital computed as above. The bank finance on projected sales of Rs. 100/- would be:
Projected Sales Rs.100/- (a)
Gross Working Capital Rs. 25/- (b)
Minimum margin required Rs. 5/- (c)
(20% of b)
Minimum bank finance Rs. 20/-
(b-c) or 20% of projected sales

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Inventory/Receivable Norms:
As per the original recommendations of the Tandon Committee and Chore Committee, norms
were prescribed for maintaining levels of inventory and receivables by selected types of
industries. All appraisal by banks for credit facilities to these industries, were required to
conform to these norms with relaxations/ deviations allowed upto 20%. However, as per
existing guidelines, banks can henceforth assess the credit requirements of borrowers based
on total study of borrowers' business operations i.e. taking into account the
production/processing cycle of the industry, as well as the financial and other relevant
parameters of the borrowers. Accordingly, banks can decide the levels of holding of each item
of inventory as also of receivables, which in their view would represent a reasonable build up
of current assets for being supported by bank finance.
The bank had earlier circulated the suggested norms for levels of inventory/receivables
under MPBF system for different industries. However, these norms are no more mandatory as
explained later. Under PBF system the above norms are no more applicable. Now the bank is
circulating industry reports published by Risk Management Department, Baroda Corporate
Centre, which contain inter-alia inventory/ receivable norms for various industries The
branches are advised to assess the working capital requirement taking into account these
norms as guiding factors.
However, there may be instances, when the borrowers may request for allowing them to
exceed the norms in circumstances beyond their control like:
a. Bunched supply of materials both indigenous and imported.
b. Power cuts, strikes and other interruptions in operations.
c. Transport delays and bottlenecks.
d. Accumulation of stocks due to non-availability of shipping space.
e. Build-up of stocks of finished goods (machinery), due to delay in taking delivery by the
purchaser for whom they were specifically manufactured.
(It is normal practice to obtain substantial advance/ progress payment in respect of
such tailor-made orders to preclude, inter-alia, the possibility of failure on the part of
the purchaser to take delivery).
To cover material required for executing large export orders during short duration (i.e. not
anticipated in the annual projections assessed by the bank). Such requests for exceeding the
norms maximum upto 20% of the standard norms/past trends may be acceded to in all genuine
cases, provided, the bank is satisfied that:
a. The requested deviation is justified;
b. The borrower is not habitually exceeding the standard/past trends levels, when they
are not warranted;
c. The borrower will make every effort to bring down the levels within a reasonable
period.
d. Where the financing of the unit is also subject to additional controls like Selective
Credit Controls directives, or control by other authorities, viz. Textile Commissioner,
Jute Commissioner, etc., the inventory/receivable levels reckoned for calculating MPBF
should be the lowest among all the levels (including prescribed/past levels) permitted.

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Computation of the Level of Bank Finance:
After ascertaining the margin or NWC to be brought by the borrower appropriate to the
method of lending applied, the level of Bank Finance should be assessed.
Computation of Bank Finance also depends upon the Method of Lending
(d) Computation of the Level of Bank Finance :
After ascertaining the gross working capital, other current liabilities and available
margin or NWC to be brought by the borrower appropriate to the method of lending
applied, the level of Bank Finance should be assessed as under:
Total Current Assets (GWC)
Less : Total Current Liabilities other than bank borrowings (OCL)
= Working Capital Gap (GWC – OCL)
Less: (a) Actual Projected Net Working Capital (NWC) or
(b) Minimum margin required
I method - 25% of Working Capital Gap (WCG)
II method - 25% of (TCA) Total Current Assets
Out of (a) or (b) above whichever is higher is to be considered as margin
= Maximum permissible bank finance (MPBF)
(e) Working capital assessment of SSI/SMEs units
(BCC:BR:98/301 of 28.10.2006)
As per the revised guidelines the assessment of WC finance upto a limit of Rs. 5 crs.
should be done on turn over method as recommended by Nayak Committee (20% of the
projected turn over method) or Ist method of lending as recommended by Tondon
committee whichever is higher. No counter check method under format B.
WC limits above Rs. 5 crs is to assessed as per PBF method of lending .
PERMISSIBLE BANK FINANCE (PBF) SYSTEM:
BACKGROUND:
Reserve Bank of India has directed that Working capital credit may be determined by banks
according to their perception of the borrower and the credit needs. Banks should lay down,
through their boards, transparent policy and guidelines for credit dispensation in respect of
each broad category of economic activity.
In the above said context, our Bank has decided to replace the system of assessment of
working capital finance, based on MPBF-computations, i.e. the Tandon Committee
recommendations by a new system of assessment of working capital finance called Permissible
Bank Finance (PBF) System.
As a consequence of the withdrawal of the existing system of working capital finance based
on "MPBF-system", a large leeway is available to the bank to adopt a new method/system. The
PBF system has retained, with appropriate modifications, the strengths, and removed the
Page 78
weaknesses, of existing MPBF-system simultaneously doing away with its rigidities as regards
computation of working capital bank finance, and supervision & monitoring of the credit
dispensed by the banks thus, the new system ensures faster credit delivery with INHERENT
need & merit based flexibilities.
CASH REQUIREMENT LENDING (Cash Budgeting Method)
By projecting future cash receipts & disbursements, the cash budget enables the corporate
to determine its cash needs. We, therefore, shift emphasis from the "Security Obsessed
Lending to the "CASH REQUIREMENT LENDING" which is envisaged to be a need based
lending. Cash flow financing, thus, conceives self-liquidating finance during various time-zones
unlike the present MPBF system.
THE CASH REQUIREMENT LENDING is aimed at to perceive the borrower's requirement,

rather than to monotonously assess with arithmetical rigidities, after the necessary risk-
analysis and risk-perceptions on case to case basis with perusal of the acceptability of the
borrower's estimated Cash Flow-position as per his overall financial status, projected level of
liquidity & activity, market reports, industry/activity profile and the economic strata which a
particular borrower belongs to.
This information is readily available in the financial newspapers & periodicals, for example,
―CMIE‖ and ―Capitalole‖ industry - analysis software. In case of need, the branch manager
/other authorities may take assistance /guidance from higher authorities. Cash requirement
financing imposes its own discipline, such as, sound resource planning, receivables management,
purchase planning and management of inventory. Working Capital finance on the basis of
future cash flows facilitates a more holistic view of the company‘s earning capacity rather
than on the basis of its capacity to maintain a particular asset holding level.
If there is Cash Deficits under all the three Heads, viz., from trading operations, from non-
trading operations and from Balance Sheet items; then, the Working Capital finance shall be
eligible only upto the extent of Cash Deficit from Trading Operations. However, at the same
time, the borrower shall be required to explain as to how the deficits in other two Heads shall
be taken care off.
APPLICABILITY:
The PBF system shall be applicable for all borrowers engaged in legally permitted economic /
financial activities. Following categories of borrowers shall not be covered under PBF system
excepting the following:-
1. NBFCs (Non banking Finance Companies)

2. Construction Companies/Contractors
3. Tea Companies Working Capital finance
4. Ship breaking companies
5. Diamond Industry
6. Sugar, Gur & Khandsari Companies
7. Software Companies (Existing separately set out guidelines to be in force)
8. Other specific industries: Industry specific guidelines, if provided, to apply.

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CATEGORISATION OF BORROWERS ACCORDING TO SIZE OF WORKING CAPITAL
FINANCE:-
In respect of SSI-borrowers, requiring Working Capital Finance upto Rs 500.00 lac (Rupees
Five Crore), the turnover method, as propounded by the Nayak Committee, shall be followed.
In respect of Non-SSI borrowers, requiring Working Capital Finance upto Rs 2.00 lac (Rupees
Two lac), it is already stated hereinbefore, that most of such borrowers are usually covered
under one or the other SCHEMES SPONSORED by various Government / local bodies.
Therefore, financing requirement of such borrowers shall be catered as per the directives of
the relevant scheme. Yet, if any borrower, requiring Working Capital finance upto Rs 2.00
lac (Rupees Two lac) is not covered under any of sponsored scheme and / or under the
directed lending, then, his Working Capital requirement shall be catered in accordance with
the Turnover Method propounded by Nayak Committee.
In the chart furnished hereunder, wherever the phrase ―.... all the borrowers .... ―is used, it
should be inferred to be referring to the borrowers excluding the borrowers mentioned
under para (iii)-(1) to (11) hereinbefore.
The categorization of the borrowers on the basis of size of LINE OF CREDIT (which
includes working capital limit) is given below.
Size of the Line of Credit / the REMARKS

borrower
1. All non-SSI borrowers (including Considering the present level of the economy
traders) requiring Working Capital and ongoing liberalization, this size of the limit
finance above Rs 2.00 lacs (Rupees Two is not very substantial, yet, the en mass
lacs) but upto Rs 200 lacs (Rupees Two contribution by the borrowers, enjoying this
crores) from the banking system. size of the limit, to the national economy is
considerable. Further, these borrowers are
more constrained to face operational vagaries
in the business cycles. Therefore, simplified
TURNOVER BASED method of perceiving
Working Capital credit requirement for such
borrowers has been proposed.
2. All non-SSI borrowers, (including Consequent upon the enhancement in

traders) requiring Working Capital investment ceiling in Plant & Machinery for
finance above Rs 200 lacs (Rupees Two SSI-borrowers to Rs 100 lac (or as the
crores) but upto Rs 500 lacs (Rupees Government of India may fix it from time to
Five Crores) from the banking system time), and the fundamentals of the economy
prospecting growth & expansions, this size of
the limit is expected to cover a large number
of those borrowers who may feel more
comfortable to plan their business activities
according to some envisaged turnover-scales.
Therefore, for this segment too, TURNOVER
BASED method of perceiving Working Capital

Page 80
credit requirement has been proposed.
However, since these borrowers are pre-
supposed to have a better data base of their
financials, the TURNOVER BASED method in
this segment is proposed to be a bit more
analytical.
3. All borrowers requiring Working Capital The borrowers, requiring this size of the limit,
finance above Rs 500 lacs (Rupees Five are either corporates or likely to graduate to
crores) but upto Rs 1000 lacs (Rupees corporate-status shortly. Further, the
Ten Crores) from the banking system. aggregate of the limits under this segment is
to be very substantial for the bank. However,
since planning out the limit-requirement a la
the Cash Flow is still in nascent stage in our
country, such borrowers, for the time being,
may not find comfortable to develop
adaptability for perceiving the Working Capital
finance requirement from the banking system
on the basis of Cash Requirement Lending /
Cash Budget basis.
Working Capital finance to these borrowers is
to be made on the basis of permissible holding
levels of the current assets / current liabilities
(MPBF Method II) and later on, switch over to
Cash Requirement Lending can be effected.
4. All borrowers requiring Working Capital The borrowers, requiring this size of the limit
finance above Rs 1000 lac (Rupees Ten :-
Crore) from the banking system. are in upper strata of the economy;
are predominantly corporates;
are required to maintain their financials in
accordance with the statutorily laid down
formats and procedures;
have established system to retrieve their
financials along with in-depth analysis to cater
to heterogeneous demands;
normally do not lack in holding of the assets
but usually suffer from and require Working
Capital finance due to the distortions in Cash
Flow;
Bank has, therefore, proposed to introduce &

to induct CASH REQUIREMENT LENDING for
this segment of the borrowers. However, since
perceiving the Working Capital finance on the
basis of the Cash Requirement Lending is a new
concept as far as the banking system in India is
Page 81
concerned, we also propose to satisfy upon the
veracity of the ―perceptions‖ based on the
Cash Requirement Lending for the time being
with the help of financial indicators.
regulated through periodical statements of stock, book debts etc., subject to observance of
the assumed / relevant parameters under the PBF-method. This periodicity may be fixed by
the sanctioning authority as quarterly, monthly or of lesser periodicity. The operative limit
for next quarter (s) shall be fixed from the relevant quarter‘s projected Cash Budget.
Further, In respect of allowing drawings against Book-Debts, the terms of sanction and the
bank‘s extant guidelines in this regard shall be the guiding factors to include or exclude book-
debts exceeding 90 days.
RISK FORCASTING:
Detailed risks-analysis carried out with the intra-firm comparison, and also inter-firm comparison
if necessary, of the borrower‘s financial & operational statements and projections;
Risk-perceptions based on the interface with the borrowers, the market reports, industry /
activity profile, managerial components, government policies and cross-country risks as applicable.
In this regard, a Risk-score sheet may be drafted according to the case specific merits till some
standardized format (s) are circulated by our bank.
CURRENT RATIO
A query may arise that if Current ratio is to be 1.17, then, how minimum margin can be @ 10%
proposed in the new system. In this regard, it is stated that the Current Ratio is calculated with
reference to Current Assets and Current Liabilities.
Under the Turnover Method, the borrower‘s own margin / contribution towards Working Capital is
fixed @ 5% or 10% on the acceptable projected turnover, as the case may be. Therefore, both
are different.
Further, in addition to the borrower‘s own contribution / margin and the bank borrowings, there
may be Sundry Creditors for purchases, liabilities for expenses, liabilities for payment of term
loan instalments maturing within the year etc. All these affect the Current Ratio.
Another query may be whether the existing benchmark current ratio of 1.33 for borrowers,
enjoying Working Capital limits of & more than Rs 50 lac is reduced from 1.33:1 to 1.17:1 for the
borrowers, covered under the segments number Rs.1‘ & Rs.2‘, i.e., the borrowers enjoying Working
Capital limits of Rs 2.00 lac and upto Rs 500.00 lac, then, the answer is ―Yes‖; but this dilution has
to be on case-specific merits and without diversion of funds. In other words, the dilution is
permitted to help needy borrowers on genuine merits.
DEBT EQUITY RATIO

Generally, the acceptable Debt Equity Ratio does not normally go beyond 2:1 except under the
lending to export sector, priority sector, core sector, infrastructure sector etc. Therefore, it
is advisable to have benchmark level of Debt Equity Ratio as 2:1.

Page 82
Wherever, the Sanctioning Authority is satisfied about a higher Debt Equity Ratio taking into
consideration nature of the business / industry etc., the same may be allowed on case-specific
basis. The judiciousness of the sanctioning authority may not be questionable provided his
decision is based on the recorded & factual justifications & merits.
In all cases, Debt Equity Ratio is to be calculated with reference to Net Owned Funds only. In
other words, Debt Equity Ratio calculation shall be the division of total outside liabilities
including quasi-owned funds by Net Owned Funds. However, in case of non-corporate
borrowers, an additional Debt Equity Ratio may be calculated with reference to Total Owned
funds also. However, in both type of calculations, Revaluation reserves, shall be excluded
totally.
FUNDS INVESTED OUTSIDE BUSINESS
The funds invested outside business can be considered excessive when, for example:
It is not under statutory / mandatory / obligatory requirements; or,
It is made otherwise than to acquire or to retain controlling interests in associate/ group
concerns; or,
It is made with sole intention to derive returns on surplus funds without reducing/ liquidating
Working Capital borrowings from the banking system.
It is in disproportionate percentage to Tangible Net Worth, say, in excess of 50% of the
Tangible Net Worth as per last audited Balance Sheet. However, the aforesaid 50% is not
meant to be a benchmark and the ―disproportion‖ is to be reckoned with after considering
overall financials, purpose & tenor of the investments etc.
LINE OF CREDIT
Under the PBF-method, a Line of Credit (i.e., the outer limit for entire working capital
finance) shall be fixed, within which, the borrowers shall be given freedom to select, for full
one year or for a part of the year, sub-limits in one or more out of the various existing types
of credit facilities.
DRAWING POWER
The disbursal of the operative / sanctioned Fund Based limits shall be regulated through
periodical statements of stock, book-debts etc. subject to observance of the assumed /
relevant parameters under the new PBF-method.
The fixation of the "margin" to arrive at the Drawing Power against the value of the
inventory / receivables shall be done after looking to the track record & nature of the
borrower‘s business. As a broad guidelines, and subject to other features remaining
satisfactory, if conversion of stock into debtors and realization of debtors are fast, then,
there should be no hesitation in fixing the margin at, say, 10% or so to match with the amount
of the Line of Credit approved / limit sanctioned to the borrowers.
Periodicity of submission of stock / book-debts statements and of carrying out periodical
inspections / verifications by the Bank‘s Officials, and the certifications by the Chartered
Accountants etc. are to be as per the Bank‘s extant guidelines. This periodicity may be fixed
by the sanctioning authority as quarterly, monthly or of lesser periodicity.

Page 83
Further, In respect of allowing drawings against Book-Debts, the terms of sanction and the
bank‘s extant guidelines in this regard shall be the guiding factors to include or exclude book-
debts exceeding 90 days.
QUARTERLY MONITORING REPORTS
The Quarterly Monitoring Reports, as prescribed under PBF System have replaced the
existing Quarterly Information Systems.
The QMR will be different for different categories i.e. the borrowers requiring Working
Capital finance upto Rs.500 lacs, more than Rs500 lacs but upto Rs1000 lacs and more than
Rs1000 lacs.
Regulation of drawings shall continue to be based on stock /book-debts statements etc
FIXATION OF OPERATING LIMIT.

For fixing the operative limit, instead of present QIS, the proposed quarterly monitoring
reports shall be obtained.
For the borrowers financed under the cash budget, the Cash Budget shall be obtained on
quarterly basis to fix the operative limits and also to monitor it.
INSPECTION OF SECURITIES
The periodical verification / inspection of the Current Assets and Current Liabilities is to be
carried out periodically (preferably once in every month) by the bank‘s officials. The
periodicity of inspections / verifications is to be as per the prevailing guidelines (Domestic
Loan Policy Guidelines) or as stipulated by the Sanctioning Authority after considering the
case specific merits.
For the purpose of the periodical inspections, in accordance with the existing guidelines, the
inspection-report may comment upon how the inspecting officer(s) has satisfied himself
about the correctness of quantitative details of stocks; and Valuation of Stocks; proper
safety, security and movement of stock; how the inspecting officer(s) has satisfied that
stock is not overly unpaid vis-a-vis the assessed level of credit, old age receivables, further
turnover therein and whether they are considered good of recovery; and which are the
registers / records perused to specifically comment whether the unit is having proper system
of inventory management and control.
AD HOC / EXCESS
Before sanction of any adhoc / excess over the sanctioned limit (whether funded or non-
funded facility), the borrower shall be asked to submit a .proper Cash Flow statement so
as to satisfy timely adjustment/liquidation of the adhoc/excess. The adhoc/excess
may be subjected, at the discretion of the sanctioning authority, to a levy of additional
interest upto 2.00 % p.a. to meet the cost of arranging uncommitted & suddenly needed
funds / obligations for the adhoc / excess.
Commitment Charge
There shall ordinarily be no commitment charge on unutilised portion of working capital
finance. However, when during the two consecutive quarters, the availment of the limits is
unsatisfactory, say, less than 70% of the sanctioned / operative limit, as the case may be,
Page 84
appropriate corrective measures shall be endeavoured including drawing this fact to the
attention of the sanctioning / reviewing authority. (The Bank has in the year 2004 re-
introduced levy of Commitment Charges, details of which are given separately).
BILL CULTURE
The Reserve Bank of India has advised that in the interest of developing ―bills-culture‖ in the
system, out of the total inland credit purchases of the borrowers, not less than 25% should
be through bills drawn on them by concerned sellers. Accordingly, the Reserve Bank of India
had again urged to ensure that, out of the total credit purchases of the borrowers, not less
than 25 % , should be through bills drawn on them by concerned sellers. The aforesaid
instruction of Reserve Bank of India has to be observed scrupulously.
GENERAL GUIDELINES
Wherever any of our borrower is having multi-division activities/businesses, the
working capital credit requirement shall be perceived/assessed separately for each of the
division as is done at present.
For the Post-shipment export credit limits, the borrower has some pre-plans / orders for the
export-turnover. This can be accounted for while working out PBF. However, wherever, the
requirement arises due to sudden opportunity, it can be dealt with on the line of consideration
of adhoc / specific limit requirement.
In case the unit is doing only job work, the unit incurs only conversion / value addition cost
and earns a margin on the same. The conversion / value addition cost + margin represents the
turnover which can be taken into account for perceiving the Working Capital requirement on
turnover method. Under Asset based method, the value addition material and receivables
etc. require Working Capital finance and accordingly be considered. Under Cash Requirement
lending, the peak level cash deficit can easily be worked out to perceive Working Capital
finance. A similar treatment can be given for the units which are getting the job-work done
by other units.
Whenever there is wide variation of the Working Capital finance assessed under the new
PBF-method with the Working Capital finance assessed under the existing system based on
MPBF, it should be noted that the sanction of the limits is to be as per the methods
suggested under the new guidelines. But, regulation of the drawings shall continue to be based
as per the existing practice.
Working Capital Term Loan (WCTL):
While implementing the norms for inventory and receivables and applying the prescribed
method of lending, borrowings of the concern from the bank for working capital, may be more
than the maximum permissible bank finance resulting in excess borrowing. Such excess
borrowings occur basically due to excessive holding of current assets and shortage of net
working capital. It should be regularised by realising the current assets held above the
permitted levels and by augmenting long term sources, which would improve the net working
capital. However, where such excess borrowings, due to shortage of net working capital, could
not be regularised in time, they should be transferred to a separate account styled as
"Working Capital Term Loan (WCTL)". This account should be repaid over a period, not
exceeding five years, depending upon the projected cash generation and in suitable
instalments.
Page 85
WCTL is not a separate facility, but only a portion of the existing excess borrowings
segregated and set apart for better control and repayment over a period of time. The balance
in the WCTL should continue to be covered by the advance value of stocks as in the case of
cash credit.
WCTL once granted, should not be increased or fresh WCTL granted to the same party for
any reason and effective steps should be taken to recover the amount as originally envisaged.
It should be ensured that the WCTL component is not enhanced at the time of increase in WC
limit and the additional limits are considered on the basis of incremental current ratio of
1.33:1 or 1.17:1 as the case may be.
Excess drawings due to excess inventory or receivables, should be liquidated by
consuming/disposing off such excess stocks or recovery of the receivables. A time bound
programme, not exceeding six months, should be drawn up for this purpose in consultation
with the borrower. Genuine reasons or difficulties, if any, should be taken into account while
determining the period for adjusting the excess drawings. Such cases should be referred to
the higher authorities with full particulars, as to the reasons why the inventory cannot be
reduced to the permissible level within six months and instructions sought.
WCTL should not be considered where the deficit in the net working capital is due to cash
losses suffered by the undertaking.
Where the borrowing unit exports a substantial part of its production and the WCTL has to
be carved out of the existing packing credit limit, the bank may identify the WCTL on a
notional basis in view of the concessional rate of interest applicable to such packing credit
(i.e. the amount of excess borrowing may be identified, but not transferred to a separate
WCTL, so that concessional rate continues to be available for the permissible time). It may,
however, be impressed upon the borrowers that they should bring in the required contribution
within the stipulated period of five years.
Ad-hoc Facilities:
Ad-hoc facilities over and above the sanctioned limit or MPBF can be considered by branches
on a case to case basis, subject to administrative guidelines issued from time to time and
within their delegated discretionary powers.
Such facilities are not to be granted for a period exceeding 2 months.
Additional interest of 2% per annum over sanctioned rate should be charged on the ad-hoc
limit.
Borrower falling under compliance of Demand Loan Delivery system of RBI, ad hoc facilities
should not be considered unless the Demand Loan portion is fully utilised by the borrower.
Guidelines for Allocation of Sub-Limits :
Where a borrower requires allocation of sub-limits at different branches, branch should
examine the request carefully and satisfy itself that such a request is warranted in the
interest of the concern. The guidelines in this regard are as under:
The request should be referred to the Regional Authority with full details and comments on
the conduct of the account.

Page 86
Zonal Authorities are authorised to consider allocation of sub-limits at branches located
within the zone. In other cases, reference should be made to the Central Office and their
approval obtained.
The branch to whom the sub-limit is transferred should not grant any excess in the account
without the written consent of the base branch. Details of all excesses allowed should be
reported to the base branch.
The branch, to whom the sub-limit is transferred, should inform the base branch, once in a
month, the outstanding balance in the account. Any other information or adverse features
noticed should promptly be advised to the base branch.
As the stock statement/position of other securities will only be available at the base branch,
they should advise, once in two months, the branches, to whom the sub-limits are transferred,
about the available security and advance value with suitable instructions to regulate the
drawings within the available advance value.
Base branch should forward copies of renewal sanction advices to the branches, to whom the
sub-limits are transferred.
Slip Back in Current Ratio:
Generally, current ratio of any borrowing unit should improve over the years and it should not
deteriorate. In other words, the net working capital of the borrower in absolute terms as well
as in relation to the working capital gap should improve.
Guidelines under MPBF System :
However, relaxation in the above may be permitted, as a special case, for the following
purposes in the case of units which have a good past performance record and which have built
up a sound current ratio over a period of time.
For undertaking either expansion of the existing capacity or for diversification. For fuller
utilization of existing plant capacity.
For meeting a substantial increase in the unit's working capital requirements on account of
abnormal price rise.
For investment in allied concerns with the concurrence of the bank, if such an investment is
considered necessary in the business interest of the borrowing unit e.g. for procuring of raw
materials etc.
For bringing about a reduction in the level of deposits accepted from the public for complying
with the statutory requirements.
For repayment of the installments due under foreign currency loans and other term loans.
For rehabilitation/reviving weaker units in the 'Group' by allowing flow of funds from cash
rich units in the group subject to the condition that no amount is lent to a healthy unit of a
'Group' for its working capital requirement is transferred to another unit within the group so
as to reduce the Current Ratio of the transferor unit to a level below 1.33:1.
While permitting relaxation, it should be ensured that the current ratio of at least 1.33:1 is
maintained. In other words, the relaxation should not result in reducing the unit's
contribution from the long-term sources below a minimum of 25% of its current assets.

Page 87
Borrowers who are in the first method of lending stage (i.e. whose contribution from the long
term sources of funds is less than 25% of the current assets) should not normally be allowed
to expand their activities without bringing in additional equity or raising term loans, so as to
ensure that their financial structure is not weakened as a result of expansion. However, in
exceptional cases, relaxation may be permitted for temporary period in regard to the units
which can reasonably be expected to make good, the gap out of cash generation within a short
period. Cases of such units should be constantly reviewed.
The slip back in the current ratio should not normally be allowed except under the
circumstances indicated in the foregoing paragraphs. It should particularly be noted that
units which have diverted their funds outside the business, by giving loans and advances not in
the nature of advance payments for raw materials, etc. and units which seek to enlarge their
investments in other concerns not approved by the bank/s, should not be allowed diminution in
their current ratio under any circumstances.
Slip back in the current ratio in respect of 100% export oriented units and sick units should
be examined on merits on case to case basis.
WORKING CAPITAL FACILITIES UNDER CONSORTIUM:
In the case of borrowers to whom working capital limits are financed by consortium of banks,
it will be the responsibility of the Lead Bank for preparation of appraisal note, its circulation,
arrangement for convening meetings, documentation etc.
The Lead Bank is also vested with the responsibility of arranging for sanction and disbursal of
credit, monitoring of the borrowal account, advising share of member banks in the
monthly/quarterly operative limits.
The Lead Bank will also be responsible for submitting prescribed data/information to the RBI
on behalf of the consortium.
Given below is the gist of guidelines pertaining to operational aspects of financing working
capital under a consortium :
The appraisal of credit proposals will be done exclusively by the Lead Bank, if its share in the
consortium exceeds 50% of the fund based limits. In other cases, the appraisal will be done
by a team comprising the Lead Bank and the bank having the next largest share in the limits.
On submission of all the necessary papers and data by the borrower to the Lead Bank
regarding appraisal of the limit, the Lead Bank will prepare the necessary appraisal note and
circulate the same to other member bank for their perusal and observations/objections if
any.
The entire work relating to appraisal should be completed by the Lead Bank within 2 months
of submission of proposal by the borrower.
The member banks are required to study the appraisal note prepared by the Lead Bank and
communicate their observations/objections etc. to the appraisal note to the Lead Bank within
a specified time.
After receiving the observations from the member banks the Lead Bank will call a consortium
meeting to approve the appraisal note, sharing of limits, charging securities, inspection of
securities, etc.

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At the above meeting the member banks discuss the appraisal note and the company is given
an opportunity to explain the queries of the member banks/Lead Bank. After discussion the
consortium may approve the limits, sharing pattern etc. and decide about the modality of
disbursing the facilities after proper documentation.
The ancillary and non-fund based business, should be shared by the member banks in the same
proportion in which, fund based limits are shared.
The inspection/verification of securities may be done by the Lead Bank or members in
rotation as per arrangement finalised at the consortium.
The quarterly operating statement will be submitted to the Lead Bank who will fix the
quarterly operative limits and communicate it to the member banks.
Normally the Lead Bank will have the authority from other member banks to make available
their share/enhanced limits, if latter's decision is not conveyed to the Lead Bank in time.
However, after first disbursement as above, the borrower will be allowed to operate his
accounts with member banks, subject to limits allotted to them. The Lead Bank should ensure
that the borrower does operate his accounts with all the member banks proportionately.
Working capital facilities under multiple banking:
Normally bank does not finance the working capital requirements of a borrower, who is
enjoying some working capital limits with other banks. The bank would like to take over the
account in total, rather than share the facilities without a formal consortium.
However forming of a consortium is mandatory in case of borrowers enjoying fund based
working capital limits of Rs. 50/- crores and above and in cases, where such limits are less
than Rs. 50/- crores, it is optional. Therefore, in respect of new borrowers whose fund based
working capital requirements are less than 50/- crores, they are free to avail various working
capital credit facilities from different banks. In such cases, the borrower is said to
undertake 'Multiple Banking'.
The financing bank should obtain full details of the credit facilities availed of by such
borrowers from the banking system duly certified by their auditors, each time any fresh
facility/enhancement is sought. Financing banks should ensure the timely exchange of
information and co-ordinated approach in the interest of overall credit discipline.
The documentation will be separate for each financing bank and charges should be registered
on assets to cover their exposure. In case of multiple banking arrangement reporting under
CMA is to be done by each bank separately.
Quarterly operating statements should be submitted to all financing banks and operative
limits fixed separately by the individual banks. The individual banks will be free to fix their
rate of interest and other conditions.
Due to inherent risks involved and many operational problems in control monitoring and follow-
up of credit facilities, 'Multiple Banking' should not be encouraged and should be avoided.
Wherever possible a formal consortium should be formed.

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10-NON FUND BASED WORKING CAPITAL FACILITIES
Quick Bites:
Non-fund based limits do not included immediate cash outflow and it is a very good
source of income for Bank. The limits include Bank Guarantees – Financial, Performance
and Deferred Payment Guarantees, Letter of Credit – Import/Inland, DP/DA and Co-
acceptance.
The material provided discusses/explains, methods of assessment of limits, charging of
commission etc.
The major non-fund based facilities that are considered as a part of the regular credit
facilities are:
1. Bank Guarantee.
2. Letters of Credit.
3. Co-acceptance.
While sanctioning regular limits, a detailed appraisal is required to be done to take care
of the need-based requirements of the borrower for one year. However, in the case of
ad-hoc facilities, the appraisal is done on a case-to-case basis and looking to the
immediate requirement of the borrower. As the above facilities are distinct and
separate, the appraisal is also to be made separately.
BANK GUARANTEE
A "Contract of Guarantee" under the Indian Contract Act is a contract to perform the
promise or discharge the liability of a third person in case of his default.
The different types of Bank guarantees which a borrower may require, can be broadly
classified into 3 categories:
i. Financial Guarantee: Guarantees issued in respect of constituents liability, such as
guarantees favouring tax/ customs/excise/court authorities in respect of disputed
claims, payment of taxes, customs and excise etc. will come under the classification of
financial guarantees. While issuing such guarantees the branches should be satisfied
about the financial strength/liquidity of the party.
ii. Performance Guarantee: Performance guarantees are issued on behalf of constituents

guaranteeing their performance as per the contracts entered into, performance of
machineries supplied, due discharge of other contractual obligations undertaken etc. In
such guarantees, Bank does not undertake to perform the obligations undertaken by
the customer under the contract, but only to fix the financial responsibility in the
event of default or failure on the part of the customer to perform the obligations
undertaken by him. Hence, in the event of default of the customer and on being
notified to that effect, the Bank will make payment under the guarantee.

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iii. Deferred Payment Guarantee : Although a Deferred Payment Guarantee is essentially a
Non- fund based facility, it is similar to a Term Loan. As such for the purpose of
Discretionary Lending Powers, a DPG is treated as a Fund Based facility.
A DPG is essentially a guarantee in favour of a supplier of a plant and machinery to a

buyer on Deferred Payment basis, for payment of installment on the due date if the
buyer fails to pay the same. It is, therefore, another method of financing of fixed
assets. Even though bank would be parting with funds only on the failure of the
borrower to honour its commitments, nevertheless the banks guarantee requires it to
treat it as a liability.
Assessment of Bank Guarantee Limits:
The assessment of regular Bank Guarantee Limits would depend upon the nature of
activity of the borrower, the nature, purpose and type of guarantees required in such an
activity and the duration of such guarantee.
i) The first step is to note down in detail the types of guarantees required in the line of
activity and classify them into financial and Performance guarantees.
ii) Secondly identify and segregate those guarantees which are likely to be required on a
fixed basis and will be outstanding as long as the unit is in operation or the bank finance
is outstanding e.g. guarantee in favour of State Electricity Boards in lieu of security
deposit/for regular payment of Electricity Bills etc.
iii) Guarantee in favour of suppliers of raw material or stock in trade for ensuring regular
supply of goods on credit. Such guarantees are essential for the normal operation of the
unit and hence the value of such guarantees can be assessed. e.g. in case of Electricity
dues it is related to the connected load & the optimum power utilisation by the firm.
iv) Next, the assessments of other types of guarantees that may be required are to be
made. It depends upon the volume of activity proposed & the duration of such
guarantees. e.g. earnest money guarantee will depend upon the No. & value of tenders to
be applied by the company and the percentage of success in getting the tender awarded
and the duration of each such guarantee. In case of guarantees issued favouring Apparel
Export Promotion council for release of Garment export quota, the guarantee amount is
related to the value of quota applied and allotted, which in turn will depend upon the
level of exports proposed in the ensuing year and other factors.
v) Further, the borrower may require guarantees to be issued favouring Excise, Income-
Tax authorities against disputed liabilities. Requirement of such guarantees can be
easily ascertained based on the level of such disputed liabilities and the demand made by
the concerned departments.
vi) The borrower may also require guarantees for import of capital goods on concessional
import duty under various schemes of Government, whose requirement can be
determined on a case to case basis.
vii) Wherever the borrower is accepting advance payment from purchasers & is required to
furnish bank guarantees in lieu thereof, the amount of such guarantees will be
proportional to the amount of such advance payments that will be outstanding which in
turn will be dependent on the level of sales.

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The cumulative requirements as enumerated in points (i) to (vii) above will decide the
amount of Bank Guarantee limits and the nature of such limits.
The Bank Guarantee limits once sanctioned should be reviewed every year along with all
other fund based and non-fund based limits. At that time, the level of utilisation of the
limits in the past year and the current year would be a guiding factor for the limits to
be renewed.
When bank guarantee is issued for procurement of raw material on credit, care should
be taken to ensure that no finance is allowed against such stocks. It should be
understood that the sanctioning of a Bank Guarantee limit does not automatically mean
that the borrower has the right to get any type of Bank Guarantees issued. Every
guarantee to be issued within the limit should be need based, justifiable from the
business point of view and within the purview of guidelines of RBI and the bank issued
from time to time. At the cost of repetition following points are to be kept in mind while
sanctioning Bank Guarantee limits:
1. As per RBI guidelines, no guarantee should be given covering a loan raised by a client
from third parties including from a bank or financial institution, guaranteeing the
repayment of the loan.
2. As per the RBI guidelines, banks are precluded from issuing guarantees favouring the
financial institutions or other banks or lending agencies for the latter's loan/s as these
institutions should do their own assessment of the credit risk and take the risk
themselves (if justified) and not seek a bank guarantee: the only exception to this is
where a bank cannot take its additional share in a consortium account, due to liquidity
strain, and temporarily transfers the share to another bank in the consortium, along
with issuing a guarantee in its favour. The above instructions will also apply equally to
Technical Development Fund Scheme (TDF) loans given by IDBI and HUDCO loans to
State Housing Boards etc., except in very exceptional circumstances as may be stated
by IECD of RBI. It is reiterated that the bank should take extreme care while issuing
guarantees and desist from issuing them rather freely, purely motivated by the earning
of commission.
3. Guarantees favouring Government Departments/ courts in regard to disputed amounts
like Excise/customs duty etc. enable the customer to defer the payment of particular
sum of money pending the clarification /judgement. These types of guarantees are in
the nature of money guarantees and hence should be fully secured as under :-
4. Guarantees in respect of disputed duty/taxes should be secured by 100% cash margin,
particularly in all cases where the party has preferred an appeal against the judgement
of a court or tribunal.
5. If a customer is not immediately able to pay the full cash margin and if the liability
under the guarantee accrues over a period of time, then cash margin may be provided in
stages matching with the accruing liability with the permission of sanctioning
authorities.
6. In respect of the disputed amounts in litigation like in family disputes, compensation
money etc. the guarantee should be backed by 100% cash margin without exception.
7. Where a guarantee is invoked, no attempt to delay the payment or facilitate party to
bring injunction restraining the payment be made. However, the branches should satisfy

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themselves that the guarantee has been invoked properly and as per the terms specified
therein.
8. If any credit facility is to be granted to a party on the strength of a guarantee issued
by another bank, the under noted points should be kept in mind:
a. The credit proposal should be subjected to usual thorough scrutiny and appraisal.
b. The reasons why the other Bank is not granting the facilities itself should be thoroughly
gone into and examined.
c. Ensure that the officials of the other bank issuing the guarantee are empowered to do
so and the power of attorney is registered with the Bank.
d. No guarantee is executed for the purpose different than the usual and regular
business/vocation of the customer.
e. Care should be exercised to have the expired guarantees redeemed expeditiously.
DEFERRED PAYMENT GUARANTEE (DPG)
Although a Deferred Payment Guarantee is essentially a Non- fund based facility, it is

similar to a Term Loan. As such for the purpose of Discretionary Lending Powers, a DPG
is treated as a Fund Based facility.
A DPG is essentially a guarantee in favour of a supplier of a plant and machinery to a

buyer on Deferred Payment basis, for payment of instalment on the due date if the
buyer fails to pay the same. It is, therefore, another method of financing of fixed
assets. Even though bank would be parting with funds only on the failure of the
borrower to honour its commitments, nevertheless the banks guarantee requires it to
treat it as a liability.
CO-ACCEPTANCE FACILITIES
When a borrower intends purchasing of goods and machineries on deferred credit basis,
the seller usually requires the buyer to provide a Deferred Payment Guarantee from his
bankers or get the usance Bills of Exchange, drawn by the seller for the deferred sale,
co-accepted by the buyer's bank. This will give the seller an assurance of payment by
the buyer on the due date and in case of such a default, the co-accepting bank would
make the payment.
Such proposals, therefore, should be subjected to thorough scrutiny and appraisal as in

the case of any proposal for bank Guarantee of Letter of Credit Facilities.
The accounting entries and rates of commission in respect of co-acceptance facilities

are the same as applicable for Bank Guarantees.
Co-acceptance of bills covering supply of goods
Proposals for co-acceptance should be examined thoroughly and the need thereof should
be well established. Such facilities should be only to those who enjoy other credit
facilities with the Bank. Since this facility enables the party to avail/enjoy credit
facility from the suppliers, the same should be considered as a part of working capital
and hence the fund based working capital facilities should be correspondingly reduced.

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Only genuine trade bill should be co-accepted. The goods covered by such bills should be
hypothecated to the Bank, but no advance should be granted against these goods as to
avoid double financing. This is generally done by earmarking in market/advance value of
stocks (as the case may be) and the limit, if the co-acceptance facility is not taken into
account while assessing the credit limit. Periodical inspection of the stocks should be
done.
It is to be ensured that adequate arrangement is made by the parties out of their own
resources or through existing borrowing arrangements to honour the bills on due dates.
For this purpose, the party's cash generation should be examined. Valuation of goods
covered under the bills should be verified to ensure that there is no hidden
accommodation or this credit of the suppliers of goods is not exorbitantly high. No
house bill, i.e., bills drawn by sister/associated concerns be co-accepted without specific
sanction of higher authorities. Bills should be co-accepted within the sanctioned limit
only. No officer without proper Power of Attorney should co-accept bills. Proper records
of all bills co-accepted should be maintained and due liability entries should be passed in
the books of the branch. Due date of the bills co-accepted should be diarised and action
in advance should be initiated to ensure that the bill is honoured on due date by the
party. Periodical returns as laid down relating to the bills co- accepted should be
submitted to the controlling authority. Co-acceptance facility is treated as a fund based
facility for the purpose of exercising Discretionary Lending Powers.
Co-acceptance of bills covering supply of machinery under deferred payment guarantee

arrangement
This facility covers acquisition of capital equipment on long-term credit with provision
for payment of installments in a deferred manner. Such proposals should be processed in
the same manner as the proposals relating to Term Loan. Particularly care should be
exercised for evaluating the additional benefits/viability of the project and the cash
flow during the deferred period of credit to ensure that the customer will be able to
make periodical payment of the bill on due date. In addition to taking the machinery
purchased under D.P. financial guarantee, extension/charge on other fixed assets should
also be taken as security for the facility, wherever applicable.
No co-acceptance of bills with short usance period (say 90/180 days) covering supply of
capital goods/machineries/ equipment should be considered, particularly for a new
project, as our experience shows that the parties are seldom able to generate adequate
funds within such short duration for retiring the bills on due dates.
Discounting/purchase of bills co-accepted by other banks (other than IDBI schemes)
Before discounting/purchasing bills co-accepted by other banks for the value exceeding
Rs. 2/-lacs for a single party, branches should obtain written confirmation of the
Regional/Zonal authority of the co-accepting bank. Similarly, when the total amount of
such bills discounted/purchased exceeds Rs. 20/- lacs for a single borrower, prior

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approval of the Head Office of the co-accepting bank must be obtained in writing and
kept on record.
LETTER OF CREDIT
Ideally any seller of goods/services would like to receive payment before the delivery of
goods/services to a buyer. Similarly the buyer would also like to ensure that the
goods/services bought are as per his specifications and deliveries are effected in time,
before parting with the money. If the buyer and seller are at two different, far away
stations, both the factors can not be satisfied simultaneously.
As a compromise, services of third party as an intermediary are utilised. This

intermediary is usually a bank who issues a letter of assurance to a seller at the request
of a buyer for payment of cost of goods / services sold on certain terms and conditions.
Such an assurance letter is named as a "Letter of Credit".
A letter of credit is a written instrument issued by a banker at the request of a buyer

(applicant) in favour of the seller (beneficiary) undertaking to honour the documents or
drafts drawn by the seller in accordance with the terms and conditions specified in the
credit, within a specified time.
Different parties to a Letter of Credit
i. Applicant : The buyer of the goods/services (borrower)

ii. Opening Bank : The Bank/Branch which lends its name/credit.
iii. Advising Bank : Opening bank's branch or another bank at beneficiary's place to
whom the Letter of Credit is sent for onward transmission to the beneficiary.
iv. Seller/Beneficiary : The party to whom the credit is addressed (seller or supplier
of the goods/services)
v. Negotiating Bank : Opening bank's branch or another bank who negotiates the
documents.
vi. Confirming Bank : The bank adding confirmation to the letter of credit, which
undertakes the responsibility of payment by the issuing bank and on his failure to
pay.
vii. Reimbursing Bank : The bank who make the payment of document on behalf of the
opening bank to the negotiating bank
Different Types of Letter of Credit
(a) Inland L/C : An L/C where all the parties to an L/C are located within the country.
(b) Foreign L/C : An L/C where either the opener or the beneficiary is located outside
the country of issue and arising out of export or import of goods/services out
of/into the country of issue.
(c) Revocable : A credit that can be cancelled or amended at any time without the prior
knowledge of the beneficiary.
(d) Irrevocable : It is a definite undertaking of the issuing bank to honour documents
strictly drawn as per terms and conditions of credit which cannot be amended or

Page 95
cancelled without the agreement of all the parties to the credit, in particular the
beneficiary.
(e) Confirmed : Where credits carry the confirmation of the advising bank. It
constitutes a definite undertaking of such confirming bank in addition to that of the
opening bank.
(f) Transferable : A transferable credit is a credit under which the beneficiary (first
beneficiary) may request the bank authorised to pay, incur a deferred payment
undertaking, accept or negotiate (the "Transferring Bank"), or in the case of a freely
negotiable credit, the bank specifically authorised in the credit as transferring bank,
to make the credit available in whole or in part to beneficiary(ies) second
beneficiary/beneficiaries
(g) Acceptance : Where the payment is to be made on the maturity date calculated
on/after in terms of the credit.
(h) Revolving : Which provide that the amount of drawings made thereunder would be
reinstated and made available to the beneficiary again and again for further
drawings during the currency of credit, upto a certain sum subject to certain
conditions specified therein.
ASSESSMENT OF LETTER OF CREDIT LIMITS
For assessing the Letter of Credit limit requirements of a borrower followings points
are to be considered:
(i) The necessity for opening L/C:
The necessity may arise due to the fact that a particular raw material or a fixed asset
or consumable stores are to be imported and the overseas seller is willing to sell only
against L/C.
In case of inland sales also the seller may be willing to sell the goods against L/C only.
The same may be verified by the original terms of sale offered by the seller.
The quantity of goods to be purchased under L/C: Once the necessity is established the
requirement of L/C limit would depend on the quantity of goods required for productions
annually that are to be purchased against L/C.
1. Terms of L/C Whether DP or DA.
2. Periodicity of supply by the seller.
3. Lead Time: The time taken to receive goods after opening an L/C.
4. Minimum level of stocks to be kept at all times.
5. Storage facility.
6. Quota allotment.
7. Minimum size of each consignment.
8. Freight cost.
9. Insurance charges.
Assessment of DP-LC limit

Assume a borrower purchases raw material worth Rs. 48/- lacs in a year. Out of the
above Rs. 24/- lacs worth of raw material are purchased through L/c. Further out of
this Rs. 24/- lacs worth of raw material purchased through L/C, Rs. 12/- lacs worth of
raw materials are imported. The indigenous raw material purchased through L/C takes
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about 2 months to be delivered after opening of L/C and in the case of imported ones it
takes about 4 months and the minimum import consignment is Rs. 3/- lacs.
In the above case the monthly consumption of indigenous raw material is Rs. 12/12 - Rs.
1/- lac and the monthly consumption of imported raw material is Rs. 12/12 = 1/- lac. The
amount of the limit for indigenous raw material will be computed as under :
Monthly consumption X (Lead Time + A weeks cushion)

= 1 X (2 + 0.25 months)
= Rs. 2.25 lacs
The amount of LC limit for imported raw material will be
Monthly consumption X (Lead time + A month's cushion)
= 1 X (4 + 1) = Rs. 5/- lacs.
The total L/C limit would then be Rs. 2.25 + 5.00 = Rs. 7.25
lacs say Rs. 8/- lacs.
Assessment of DA-LC limits

If in the above example both the L/C's are to be on 2 months DA basis then 2 months
should be added to the Lead Time subject to adjustment of transit period already
covered under the Lead Time. Assuming such transit period is 15 days or 1/2 month then
the requirement will be
Indigenous = 1 x (2 + 0.25 + 1.5) = 3.75 lacs
Imported = 1 X (4 + 1 + 1.5) = 6.50 lacs
---------
9.25 lacs
---------
Say Rs. 10/- lacs
Adjustment of duty paid on imported raw material

While assessing the import LC limit the value of imported raw material annually obtained
from the balance sheet includes the import duty paid and transportation charges.
However, the LC limit is to be assessed on the basis of the C.I.F value of the imported
raw materials. As such from the value obtained from the balance sheet customs duty
paid should be subtracted. Example : A company engaged in manufacture of
pharmaceutical products has projected, total imported raw material and consumable
spares consumption as under :
Total Imported raw material = Rs. 9,000/-

consumption
Total Imported raw material = Rs. 9,900/-
purchase
Total Import of consumable = Rs. 200/-
stores
------------
Total Purchase = Rs. 10,100/-
------------

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The company has further informed that the total imported goods as above will be
utilised as under:
a. Rs. 4,500/- lacs worth of raw materials will be imported for manufacturing of goods to
be exported through a division which is 100% EOU which shall be duty free.
b. Remaining will be used for their own manufacturing which will attract 100% customs
duty.
So out of the total raw material import of Rs. 10,100/- lacs Rs. 4,500/- lacs worth of
raw material is duty free. Therefore, Rs/ 10,100/- - 4,500/- = Rs. 5,600/- lacs worth of
raw material attracts 100% customs duty. In that case the CIF value of such goods
would be approximate Rs. 2,800/- lacs.
Therefore, the total C.F value of goods imported will be Rs. 4,500/- + 2,800/- lacs = Rs.
7,300/- lacs.
Monthly requirements will be (Rs. 7,300/-)/12 = Rs. 610/- lacs (Approximately)

Considering a Lead time of 2 months and assuming that average holding level of 2 months
the limit requirement will be 7300 X 2 X 2/12 = Rs. 2433/- lacs, say Rs. 2500/- lacs. If
the same is imported under 2 months DA L/C the limit would go up proportionately.

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11- TERM LOAN APPRAISAL
Quick Bites:
Term Loan appraisal includes Borrower Appraisal, Technical Appraisal, Financial
Appraisal, Economic Appraisal. It explains Cost of Project, Sources of Finance, Debt
Equity Ratio, DSCR, IRR, Break Even Point analysis, Sensitivity Analysis, Project
Implementation Schedule (PERT chart), Moratorium Period, and Fixing Repayment
Schedule ,T.E.V study etc.
The term loan appraisal and processing of the application requires very careful
scrutiny in view of the complexities involved and as such we should devote sufficient
attention to all the aspects covering such an appraisal.
The essence of the term loan appraisal is in assessing the ability of the unit to repay the
loan and interest thereon, from surplus generated by utilizing the fixed assets acquired.
For this purpose, all the techniques of project appraisal should be employed in all cases,
irrespective of loan amount or whether it is considered for the purpose of one item or
for setting up entirely a new unit.
Project Appraisal:
1. The term 'Project Appraisal' includes a detailed study of the various aspects of
implementation of a project viz. Production, financing and marketing.
2. For this purpose, the entire appraisal process can be segregated into following sections.
 Borrower Appraisal
 Management Appraisal
 Technical Appraisal
 Financial Appraisal
 Economic Appraisal
 Market Appraisal
 Environmental Appraisal
Technical Appraisal of the project:

Availability of Basic Infrastructure:
Land:
Land is the most basic requirement for setting up any project. The land should be freely
marketable and its title deed free and clear of all encumbrances Title Opinion report of
our approved advocate should be very clear and as per Bank‘s format. Further the size
of the available land should not only meet the present requirements but also take care
of the future expansion plans. Care should be taken about the nature of land i.e.
agriculture, industrial, freehold, leasehold etc.

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Location:
1. Mere availability of land would not be sufficient. Its location should be such that it is
near to the market for sale of goods produced, availability of raw materials and other
inputs like power, water, fuel, skilled manpower, infrastructure support (developed
roads, railway lines, schools, hospitals etc.).
2. Climatic conditions also have a bearing on the location of land. Investigations of the
history of earthquake and flood in the area may also be useful in locating an industrial
unit in an industrially backward district has some advantages also in the form of
incentives and subsidies granted by Central/State governments.
3. A proper inspection of the land would help in deciding its appropriateness. A wrong site
selection may result in flooding of factory, difficulties in input procurement, sinking of
heavy machines, difficulties in marketing of produces etc.
Power:
1. For setting up industrial units availability of regular and adequate amount of power is
very important.
2. If it is not so, arrangement for installation of a captive power plant/ generator etc.
should be made which would result in escalation of project cost and thus affect
profitability.
3. Some units are power intensive while some are labour intensive. So a careful study of
the process of manufacture would reveal the extent of power requirement and can be
evaluated accordingly.
4. Proper arrangements should have been made for supply of adequate power by State
Electricity Boards etc. If not, till such time such an arrangement is made some stand-
by arrangement in the form of hiring a diesel generator set should be made.
Water:
1. Many projects involve consumption of large amount of water either in the
manufacturing process as a raw material or as a cooling agent or for use in generating
steam.
2. Availability of adequate supply of water either through regular connection or through
sinking bore wells is very vital for appraisal of the project.
3. Reports of Ground Water Board may be obtained regarding the ground water level and
the quality of water.
Licensing/Registration Requirements:
1. Wherever necessary obtaining of valid licenses from the Central, State Government,
Municipalities etc. for setting up the unit should be ensured.
2. Even for establishment of a shop, registration under shop and establishment act, or
other provisions of local authorities, may be mandatory.

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3. Such licenses should be obtained and produced before actual disbursement of the
advances sanctioned.
4. It should be ensured that all the licenses/ approvals/ consents/ clearances/ NOC/
patents etc. for the items/ products are kept current at the time of appraisal.
Selection of Technology:
An important aspect of technical appraisal of a proposal is the critical examination of
the technology/technical process selected for the project. The main points to be
considered in this regard are:
(a). Availability:
1. The technical process/technology selected for the project must be
readily available either indigenously or necessary arrangements for
importing it or for a foreign collaboration must be finalised.
2. The technical process selected is to be critically compared with other technical
processes in operation for manufacture of similar products to establish superiority
over other process.
3. Similarly if the process selected is already in use in other similar units, a certificate
from such units regarding its performance etc. should be obtained to satisfy its
suitability.
4. Some plants may require longer time for delivery which may affect the implementation
schedule resulting in cost over run.
5. Necessary arrangements for servicing of the machinery, supply of spare parts and
consumables are also to be examined, so that there are no production bottlenecks due
to failure of plant and machinery in the long run.
(b) Application:
1. In case of foreign technology, the selected technology must find a successful
application in Indian environment and the management should be capable of fully
absorbing the technology.
2. It should also be appropriate from the point of view of local, social and cultural
conditions.
3. It should be ensured that the technology is neither obsolete nor out of date.
4. Encouragement should be given to process/technology conforming to ISO 9000
specifications/certifications
c) Plant Size and Production Capacity:
1. The selection of plant size and production capacity is mainly dependent on the total
capital outlay by the promoter and also on the desired level of quality and quantity
determined by the market.
2. Further the plant size has broad economic connotations, as creation of over capacity
may increase the cost of capital and affect the working of the project.
3. Underutilization of plant capacity also results in reduced profitability.

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(d) Availability of Skilled Technical Personnel/ Training Facility:
1. Availability of a sophisticated technology or machinery would not make the process
more productive.
2. It requires skilled and technically qualified personnel to run these machines efficiently
and to carry out preventive maintenance and regular repairs.
3. So availability of such technically qualified/competent persons either indigenous or
foreign has to be ensured.
4. Further the agreement regarding foreign collaboration should be carefully studied
regarding transfer of technology, selection of plant and machinery, role of foreign
collaborations in plant installation and project commissioning
(e). Continuous updating:
1. The selected technology should not only be modern, state of the art and of proven
track record but it should also be ensured that a provision is made for the technology
to be constantly upgraded.
2. The R & D (Research & Development) facilities should be provided for absorption and
continuous updation of technology.
(f). Availability of suitable raw materials and consumables:

1. The easy and regular availability of raw materials and consumables should be a pre-
condition for successful operation of a project.
2. If the suppliers are few, necessary firm tie-up arrangements with them should be
ensured.
3. In case of import of raw material, licensing requirements should be looked into.
4. Further, in case of imported raw materials, their import in a bunch or bigger lots may
sometime become necessary resulting in excess inventory for a long time and the unit
will have to incur additional working capital cost.
Determination of the Cost of the Project:
1. A realistic assessment of project cost is necessary to determine the source for its
availability and to properly evaluate the financial viability of the project.
2. It is desirable to provide for sufficient cushion into costs for any inflationary increase
expected during the course of implementation.
3. The major items of the cost of the project and the various sub items which are to be
included in each of these items and their method of appraisal is given hereunder :

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A. Land and Cost of-Land, Legal Charges of Ascertain from the plant layout
Site Registration, Leveling, Laying whether proposed construction
Development roads, Fencing and Gates will cater the present and future
expansion need.
Agreement for sale, land
description, area etc.
Legal/registration charges
B. Building Main/ ancillary factory Building, Design/ construction type/
administrative building and requirement of the proposed
godown. building
Canteen and guest House etc.
Staff quarters
Soil tanks, walls, sewerage,
drainages etc.
Garages etc.
Architect fees
C. Plants and 1. Imported 1. Necessity of imported plant
Machineries 2. Necessary stores/spares also
2. FOB Value of the plant to be
imported
imported
3. Quotation/orders (if already
3. Shipping, Freight and
placed) of the plant.
Insurance
4. Import licence
4. Import Duty
5. In case second hand plant is
5. Clearing, loading unloading
imported- report of
and transportation charges
independent/registered/
6. Foundation & Installation
approved engineer to be
charges
obtained
6. Warranty
Indigenous Plants Quotations received from various
Main Plant and other machines machinery suppliers
Machinery stores and spares Cross- check with some
Sales Tax reputable suppliers
Transportation charges List of main items of machinery
Foundation and Installation to be purchased
charges Orders, if already placed
Terms of contract entered
between supplier and purchaser
(borrower)
Basis of selection of supplier of
proposed machinery
D. Engineering Expenses of - foreign Contract between the company,
and technicians/training for Indian foreign collaborator and
Consultancy technicians/ drawings consultant
Fees Fee for- Technical know-how/ Past record of consultant
preparing project report Relationship; if any between
promoter and consultant
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E. Misc. Furniture Details of various items of
Office machinery, equipment & furniture, office machinery, and
computers laboratory equipments etc.
Vehicles-cars, trucks etc. Comparative study of
Cost of electric installation transportation cost of hired
Equipment and pipes for vehicles vis-à-vis investment in
distribution of water vehicles
Laboratory equipments Contract regarding electric
Fire fighting equipments installation, drainage system etc.
Effluent collection treatment
and disposal arrangement Pollution control measures, if
Pollution control equipments required
F. Preliminary Expenses relating to share Capital to be raised and charges
and capital Issue thereon
Preoperative Interest on term loans during Interest during the Construction
Expenses construction period period of the project
Mortgage expenses Other expenses during the
Misc. Expenses construction period
Cash losses, if any
G. Provision and Probable increase in cost due to Make 5-15% provision for
Contingencies new additions, rise in prices, contingencies for non-firm cost
taxes, transportation cost and items (where firm agreement not
fluctuation in foreign exchange entered into for acquiring the
rates assets)
H. Margin Current assets comprises stock, Calculate total requirement of
Money for book-debts, spare and working capital on the basis of
Working consumable stores expected production. Generally
Capital 25% of working capital
requirement is to be brought as
margin.
Fixing Of Means of Financing:

Once the cost of the project is finalised the next step is to identify and finalize the
sources from where resources for financing the cost of the project will be raised.
Various sources from which a project is generally financed are –
Issue of share capital
Issue of debentures/bonds
Term loan from financial institution
Unsecured loan from friends, relatives, etc.
Deferred payment credit from suppliers
Central/State capital subsidy/developmental loans/sales tax, loans etc.
Internal cash accruals

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Although various sources as above are available, the extent of tapping a particular
source such as stock / debt market will depend upon regulatory framework applicable in
the market with regard to -
Debt-equity ratio
Promoters' contribution
Security margin
SEBI and stock exchange regulations
Difficulty in raising external financing
Out of the total resources required, the quantum of equity financing and debt
financing will be regulated by the debt-equity norm stipulated by financial institutions.
Out of the equity component, the amount of equity to be brought in by the

promoter is regulated by norm for "Promoters Contribution" prescribed by
financial institution. Further the external equity component can be in the form of
equity share or preference share (redeemable within 10 years). Further, if the equity
issue is not fully subscribed to, the amount not subscribed would have to be contributed
by the promoters only.
The term loan from financial institution is restricted to the cost of fixed assets to
be financed by them less security margin.
All borrowings in the form of debentures, bonds, unsecured loans etc. involve payment of
interest usually fixed. The decision to raise resources by way of debt or equity would
not only depend upon the cost of such resources, but also the impact of income-tax
laws in force at that time. While interest paid on debentures etc. are allowed as
deductible expenses for tax purpose, dividend on equity shares is not.
Therefore, the decision to raise resources from any source would require careful
planning and cost benefit analysis.
Where capital subsidy from Central/State Government is included as a source of
finance, bankers should note that normally such subsidy takes a long time to be
released by the concerned Government Department. As such, borrower should give
an undertaking to bring in an equivalent sum from his own sources till the actual
receipt of the subsidy amount. The branch may, however, stipulate a condition that in
such cases, they will allow the subsidy amount to be withdrawn by the borrower,
provided he has already brought an equal amount from his sources. Branches should
ensure to stipulate the above in the detailed terms and conditions.
Similarly, if 'cash accrual' is shown as a source of finance, it should be noted that
such funds are available only gradually over the year/period of the project, subject to
satisfactory performance and achieving the estimated cash flow. Branches,
therefore, should verify whether the ‗cash accrual‘ amount shown is in consonance with
the expected cash flow. Further, the borrower should be advised to bring in an
additional amount as his contribution equal to the 'cash accrual' component till such time
the cash is actually accrued. An undertaking to this effect should be taken and it

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should be ensured that bank loan is released only after ensuring that the borrower has
brought in an equal amount, as above, to make the project viable.
Estimation of Cost of Production and Profitability

As already stated the purpose of term loan appraisal is to ensure that the unit will be
in a position to generate sufficient surplus/profit to repay the loan and interest
thereon, by utilising the fixed assets acquired from bank's loan. Thus, the repayment
capacity of the borrower to repay the loan is not linked to the value of security etc.
but it is linked to its ability to generate sufficient surplus from its operations. The
method by which this is done is by estimating the profitability of the project over the
entire project period or the proposed repayment period of the loan, which ever is
higher.
The proforma is essentially a statement of income and expenditure indicating the sales
value, cost of various inputs and profit margin at a level of production and under a
given set of operating conditions.
The aim in the estimation of cost of production and profitability is primarily to assess –
the earning capacity of the project
 the capacity of the unit to amortize and service the borrowed cost
 the capability of the unit to service the share capital
 the surplus available with the unit to finance its future growth.
The growth estimates also help in deriving the operating budgets, financial analysis such
as break even analysis, internal rate of return etc. inter-firm comparison Indicating
areas of strengths and weaknesses of the unit cost control and cost reduction, selecting
optimum plant capacity to achieve desired rate of return, choosing the best product
mix if the unit is multi product oriented
Estimating Cost of Production:

For estimating the cost of production, several factors have to be considered. They are
briefly discussed below:-
Installed capacity:
Since the cost of production is estimated at a particular level of production, it is
essential to assess the installed capacity of the plant.
For assessing the installed capacity, it is essential to know the rated capacity of the
entire plant and the capacity guaranteed by the supplier for each equipment. Such
guaranteed capacities are indicated in terms of number of units/tones per unit of
time say hour, day etc.
The installed capacity is determined by the capacity of that section of the plant which
has the lowest capacity and is calculated in terms of output per hour/day and per
year, which in turn is dependent on the number of shifts, number of hours in a shift,
number of operating days in a year etc.

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The installed capacity can change according to the direct inputs, product mix etc.
Capacity utilisation:
Normally the installed capacity is not fully utilised. The capacity utilisation is low in the
initial years due to following reasons:-
Teething problems in the plant & machinery
Time taken in the development of product of satisfactory quality.
Development of operating skills.
Technological constraints etc.
Gradually the plant is generally expected to achieve higher capacity utilisation.
However, 100% capacity utilisation is generally not achieved due to various factors and
is not taken for estimation of cost of production. The average capacity utilisation of
the industry over the past few years, capacity utilisation of similar units etc. would
be the guiding factor in accepting the level of capacity utilisation.
It is normally assumed that the maximum capacity utilisation is achieved in the 3rd/4th
year of production and is assumed to remain so thereafter.
Product mix:
When the plant with a specific installed capacity can produce various types of
products with different input costs and sales realisation, the profitability estimate
varies with change in product mix. The decision on the product mix would, therefore,
generally depend upon the contribution of each product towards profitability,
demand for the product and the adequacy of the plant and utility facilities.
Selling price:
In the case of produce, whose prices are controlled by the government, assuming the
selling price would not be a problem.
In the case of a product, which is presently not manufactured in the country,
but is being imported, the selling price would be near to the landed cost of the
imported product.
In the case of products whose price is not controlled, it is to be decided on the basis
of current market prices and price trends in the past.
In the case of variation in selling price, the lowest selling price is assumed.
Unit cost of production:
The elements of costs that make up the unit cost of production are the cost of
raw materials, chemicals, components, consumables, power, fuel, water, etc.
These are calculated on the basis of actual consumption pattern in the industry
and the consumption pattern indicated by the plant / machinery / technical know-
how suppliers, based on their experience.

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The consumption shall also include losses during transportation, handling, loss of
weight due to mixture etc.
The cost would include cost at site i.e. loading, transportation, unloading expenses
etc.
The cost of raw material depends upon its quality, source of supplies, volume of
purchase etc. If the cost of raw material is very important to the economics of the
process, it is essential to negotiate a contract price on the basis of volume of
purchase.
The costs assumed here are current costs without considering any likely/future cost
escalation due to inflation etc.
The cost of power shall include demand charges, energy charges, taxes etc.
Labour:
The labour requirement would depend upon the sectional and shift requirements with
provision for leave reserves etc.
The cost of labour will be guided by the wages prevailing in the location of the plant.
Besides salaries, a provision of around 25% would need to be considered to cover PF,
ESI, and Bonus etc.
Repairs and maintenance:
The cost incurred on repairs and maintenance would include cost of material required,
manpower and overheads for supervision and services. Generally, it is provided on the
basis of a certain percentage of fixed investment say 2% to 5% depending upon the
industry.
Plant overheads:
All costs in the plant which are not chargeable to any specific operation are
considered as plant overheads and charged to the manufacturing cost of the product.
The above includes factory supervision, light, rent, taxes and insurance on factory
assets.
The factory supervision includes salaries of supervisory staff and also additional
provision to the extent of 25% to cover PF, ESI, Bonus, etc.
While the taxes would include local taxes, the insurance cost would depend upon types
of risks covered and value of assets covered. Normally, risks of fire, explosion, storms,
floods, earthquakes, etc. are covered.
Administrative expenses:
These include administrative salaries, remuneration to directors and other office
expenditure.
Packing cost:
This includes the cost of the container as also expenses involved in packing, besides the
cost of packing materials.
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Sales expenses:
These include salaries of sales personnel, expenses on warehousing, advertising,
technical services, customer service, as also the commission payable to the selling
agents. The commission generally varies from 2 to 25% depending upon the product.
Financial expenses:
These include interest on bank borrowings for term loans, working capital, unsecured
loans, guarantee commission etc.
The interest on term loan is calculated on the basis of disbursing schedule, schedule
of repayment, mode of charging interest. The reducing balance method is to be
adopted for such calculation. Interest tax, if applicable, has to be included.
The interest on working capital would depend on average level of working capital
finance utilised, which in turn is dependent on the level of holding of
inventories, receivables, margin prescribed by the bank, rate of interest etc.
The interest rate of unsecured loans would depend upon the rate of interest
allowed to be paid as per terms of appraisal. It should not be too high.
While computing the interest cost, it is assumed that the borrower will repay the
instalments and service the interest promptly.
The interest rate assumed is the contracted rate as on date of proposal and no increase
or decrease are assumed over the years.
Depreciation:
The calculation of depreciation provision is done on the basis of depreciation rates
provided under the Companies Act on straight line method for financial projections. The
same is computed under written-down-method at rates prescribed by income tax
authorities for computation of tax liability.
For computing the depreciation for financial projections following adjustments in the
cost of fixed assets is to be made
The pre-operative costs, preliminary expenses & contingencies which are allowed
to be capitalised are to be added to the cost of land, building, plant & machinery
etc. in proportion to the share of these costs in the total capital expenditure. To
illustrate -
Assume that pre-operative expenses, preliminary expenses and contingencies which
can be capitalised is Rs.10 lacs. The cost of land, building etc. are required to be
restructured as under:-
Original % Share Proportionate Revised
Cost share of cost on
expenses to be which
provided depreciation
is to be

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provided
-------- ------- --------- --------
1) Land 2.00 2% 0.20 2.20
2) Building 20.00 20% 2.00 22.00
3) Plant &
Machinery 60.00 60% 6.00 66.00
4) Misc.Fixed
Assets 18.00 18% 1.80 19.80
------------------------------------------------------------------------------------------
100.00* 100% 10.00 110.00
------------------------------------------------------------------------------------------
* Including contingencies as per cost of project.

No depreciation is provided on land.
It is assumed that the entire capital expenditure is incurred during the
construction period itself and full year depreciation is provided irrespective of actual
date of incurring the cost.
Income tax:
The computation of income tax liability is a complex matter which varies from company
to company and is dependent upon various concessions available under the act. A banker
may not be in a position to compute the same. For this, the opinion given by the
statutory auditor/tax consultant may be accepted.
Project life:
The estimation of the cost of production is usually done for the entire project life or
the proposed repayment period of the term loan. In the case of new unit, it should be
done for a minimum of 5 years from date of commercial production.
Sales:
It is always assumed that all the products manufactured are sold and sale proceeds
realized. No provision for bad debts etc. is assumed.
Price rise and inflation:
All costs and sales realizations are valued at rates applicable on date for the entire
repayment period/project cycle.
Financial and Economic Appraisal
Debt – Equity Ratio (DER)
This ratio indicates relationship between the external term borrowings and the own
funds of the concern. Bank takes total term liabilities as Debt i.e. total liabilities minus
net worth and total current liabilities. Equity means net worth of the concern minus
intangible and fictitious assets. However, the subordinated funds (i.e. long-term
unsecured loans from friends and relatives, etc.) may be considered as quasi-

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equity, generally for non-corporate borrowers, and included in equity while arriving at
ratio, if the borrower retains the same at the existing level/ projected level during the
currency of Bank Loan. The subordinated debt however should not exceed borrower‘s
tier I capital i.e. capital plus free reserves less intangible assets.
Debt-Equity Ratio = Total Term Liabilities (TTL)/Tangible Net Worth (TNW).
A ratio of 3:1 is considered satisfactory. However, higher ratio may be allowed keeping
in view the activity of the borrower, industry, sect oral classification such as SME units,
other priority sector advances etc.
Apart from DER (TTL/TNW), bank assesses the Debt Equity Ratio as Total outside
Liabilities (TOL) to Tangible Net worth (TNW) also. Total outside Liabilities (TOL) will be
calculated as total of all liabilities of a company/firm on liability side of balance sheet
MINUS the net worth. A ratio of 4.5:1 of DER (TOL/TNW) may be considered
satisfactory.
Fixed Assets Coverage Ratio
This ratio shows the number of times the value of Net fixed assets (after
providing depreciation) covers term liabilities.
Fixed Assets Coverage Ratio = Net Fixed Assets/ Term Debts (Medium & Long)
Fixed Assets Coverage Ratio of more than 1 is considered reasonable.
Debt Service Coverage Ratio (DSCR)
Once the estimation of cost of production and profitability is made, it will usually
reveal that the operations during the initial years may show a low profitability or even
losses due to high initial cost or low capacity utilisation. In subsequent years, it
should improve and should show sufficient profit.
Ability of a concern to service its term liabilities can be assessed from this ratio,
which is applied while appraising all term loans proposals, studying rehabilitation/
reschedulement / restructuring proposals, etc. DSCR measures whether interest and
installments can be paid out of internal generation of funds. A ratio of 1.75 would
indicate that the concern‘s internal generation of funds would be 1.75 times of its
commitments towards term loan obligations and interest thereon. It works out as
under: -
DSCR = (Profit after tax + Dep.+ Int. on TL) / (Int. on TL+TL Installments).
The average DSCR (i.e. the sum of numerator divided by the sum of denominator of
DSCR formula as stated above for entire repayment period of the loan) of 1.75 is
considered reasonable. However, in any year it should not be less than 1.25. The
sanctioning authority may consider lower average DSCR depending upon the nature
of project / Industry after recording the reasons for the same.
Break Even Point
The Break-Even Point (BEP) is the point where Total Costs equal Sales value. The BEP is
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the point at which, cost or expenses and revenue are equal: there is no net loss or
gain, and the unit has "broken even". The ratio is extremely useful in analysis of
Term Loan proposals.
BEP is calculated in order to determine at what level of sales the unit will be able to
recover the costs and will be generating profit at the sales level above BEP.
The BEP is calculated as per below mentioned formulae:-

Break Even Point (No. of unit) = fixed cost / contribution per unit
Contribution (per unit) = selling price (per unit) - variable cost (per unit)
Break Even Point (sales) ={fixed cost/ contribution (per unit)} * sales price (per unit)
Branches should calculate BEP in all credit proposals involving sanction of fresh
term loan of Rs. 20 Crore and above to part fund setting up of new units or expansion
of existing facilities. A lower BEP suggests that unit has adequate margin of
safety. Margin of safety is computed as 1 minus BEP and indicates the proportion of
sales which is available as cushion for any increase in variable costs and is
considered as profitability zone of the unit. The sanctioning authority should assess
the viability of unit in terms of BEP and justification of accepted BEP should be
recorded in the proposal.
Internal Rate of Return and Net Present Value (Applicable For Term Loan of Rs. 20
Crore & Above)
The internal rate of return (IRR) is used to measure and compare the profitability of
investment in financing a large project. It is also called the discounted cash flow
rate of return (DCFROR) or simply the rate of return (ROR). The internal rate of
return on an investment or potential investment is the annualized effective
compounded return rate that can be earned on the invested capital. The IRR of
an investment is the interest rate at which the investment has a zero net present
value.
A project is considered viable if it is generating an IRR greater than cost of capital.

Branches can compare the project IRR with the weighted average cost of funds
proposed to be invested in the project. The projects with an IRR greater than cost of
funds should be considered for funding.
Net present value (NPV) is the total present value (PV) of the project cash flows. It is
a standard method for using the time value of money to appraise long-term projects.
NPV measures the excess or shortfall of cash flows, in present value terms, once
financing charges are met.
Borrower‘s weighted average cost of capital (after tax) can be used to discount
back the cash flows of the project to arrive at the Present Value. Alternatively the
discount rate could be the rate, which the capital needed for the project could
return, if invested in an alternative venture. When analyzing projects, it will be
appropriate to use the applicable interest rate as the discount factor.

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The following sums up the NPVs in various situations.
If... It means... Then...
the investment would add

NPV > 0 value to the firm The project may be accepted
the investment would

subtract value from the
NPV < 0 firm The project should be rejected
the investment would We should be indifferent in the decision whether to

NPV = 0 neither gain nor lose valueaccept or reject the project. This project adds no
for the firm monetary value. Decision should be based on other
criteria, e.g. strategic positioning or other factors
not explicitly included in the calculation.
However, NPV = 0 does not mean that a project is only expected to break even, in
the sense of undiscounted profit or loss (earnings). It will show net
total positive cash flow and earnings over its life.
Interest Coverage Ratio
Interest Coverage Ratio indicates the number of times a firm's income in an accounting
period can pay off (cover) the interest on term debt during the same period.
Since it measures the ability to pay interest-due from the earnings of the firm,
this ratio is used in computing the firm's borrowing capacity and in assessing the
risk of servicing of debt.
Formula: Earnings before Interest and Tax (EBIT) / Interest expense.
The Interest Coverage Ratio is also calculated as Earnings before Interest, Tax,
Depreciation and Amortisation (EBITDA) / Interest expense. This is a measure of
calculating the company‘s operating cash flow coverage of interest expenses.
The higher the Interest Coverage Ratio, more secure the Bank is in respect of the
interest servicing ability of the borrower. An Interest Coverage Ratio of 5 may be
considered satisfactory. The sanctioning authority may consider lower interest
coverage ratio depending upon the nature of project / Industry after recording the
reasons for the same.
Sensitivity Analysis :
The DSCR and IRR, as explained above have been computed after assuming certain
values for various variable parameters like capacity utilisation, cost of raw material,
sales price per unit, sales volume etc. Any adverse variation in the values of these

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parameters may alter the values of DSCR and IRR so drastically that the proposal
may become unviable and unacceptable.
The variations in the values of these parameters does not affect the profitability
estimates uniformly. For some, the effect may be more drastic and for some it may not
have appreciable effect.
So, as a prudent banker it is advisable to compute the values of DSCR and IRR by
altering the values of following parameters by +10% or -10%.
Capacity utilisation
Sale price per unit
Sales volume
Cost of raw material, Labour etc.
If the values of DSCR and IRR computed as above get altered dramatically to a -
10% change in the value of any of the above variable so as to make it unviable, we may
state that the project is sensitive to variations in that parameter. This is called the
sensitivity analysis. This provides an opportunity to the Bank to analyse the financial
viability even in adverse situations.
Fixing up of repayment schedule

The usual repayment period of a term loan varies from 3 years to 7 years (including
moratorium period i.e. repayment holiday ). In case of capital intensive projects, it may
be higher.
The repayment period of a term loan is, therefore, fixed taking into account the DSCR
and the IRR.
In cases, where DSCR is more than 2, branches may consider reducing the
repayment period suitably after considering all aspects.
Moratorium period
Moratorium period is the initial repayment holiday allowed to the borrower i.e. the
time gap allowed between the date of disbursement and the due date of first
instalment. However, borrower will continue to service interest during moratorium
period. The interest cost during moratorium period should be included in Cost of Project
under preliminary and preoperative expenses which is to be entirely financed by
Borrower. The due date should be so fixed that repayment does not fall during the
period when the unit is incurring cash loss or cash accruals are very poor. However,
the moratorium period should not exceed 6 months in the case of transport operators,
12 months in the case of term loans covered under Automatic Refinance Scheme of
IDBI and 18 months in all other cases. Moratorium period should be fixed considering
Project implementation period and Operating Cycle of the unit.
Payment of Interest
Normally interest on term loan is to be paid with quarterly rests from the date of
disbursement.

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However, in the case of new projects under implementation and in other deserving
cases, moratorium on payment of interest may be considered depending upon cash
generating capacity of the unit.
In respect of borrowers enjoying total credit limits of Rs.2 lacs and over from the
bank, rate of interest on all facilities including term loans are linked to credit rating
and PLR.
Security
The term loan should be secured by way of hypothecation/ mortgage of fixed assets for
which the loan is sanction.
Besides, the bank should normally be further secured by first charge on the assets of
the firm by way of hypothecation/mortgage of other fixed assets and hypothecation of
movable assets. Where the existing block of fixed assets/movable machineries are
already charged to other banks or financial institutions, their specific permission
should be obtained for creating a charge in bank's favour on any specific item of
machinery etc. financed by us in the absence of a pari-passu charge. All such charges
should be registered with the Registrar of Assurances and Registrar of Companies,
wherever necessary.
Wherever possible additional collateral securities in the form of equitable mortgage
of landed property in the personal name of partners / directors / guarantors should
be obtained.
Before stipulating such securities, branch should ensure that the consent of the
property holder has been obtained and that the title of the property is clear and
marketable.
Wherever possible obtaining pledge of shares, government securities, units of
UTI, mutual funds etc. could also be explored to further securities the facility.
Branches should maintain Plant & Machinery Register (borrower- wise) for recording
the following particulars of machineries charged to us and also to facilitate physical
verification.
Date of purchase
Details of machinery with identification numbers/marks
Name of the supplier with address
Invoice number and purchase price
Depreciated value of machinery indicating the basis of calculating depreciation
Condition of machinery (new or second hand)
The valuation should be based on the acquisition price Depreciation should be
charged periodically as per any of the approved methods and should be consistent. The
method followed should be mentioned in the register. In no case should the
borrower be allowed to revalue the machinery or any other fixed assets to provide
the requisite margin. In the case of second hand machinery, valuation should be done
by Bank's technical officers or approved valuers and the report be retained on

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record. Any addition or sale of machinery should properly be recorded in the above
register.
Pre-Sanction Inspection
Before sanctioning the proposal, a pre-sanction inspection of the unit is essential to
ensure the purpose and end use of the funds.
In case of an existing unit, a visit to the factory/site of production would give an
idea about the operations of the unit, the actual use of the machinery proposed to be
acquired, its location etc. It will also give an idea about the existing plant & machinery
and other fixed assets which are to be charged to the bank.
Such an inspection would also enable the branch to verify that the unit is genuine, it is
in operation and the name, address and other details furnished are correct.
It will also enable the branch to physically verify the collateral securities offered
as security and ensure its location, valuation, sale ability etc.
After inspection, a pre-sanction inspection report should be submitted along with
the proposal in the prescribed format The report should contain specific reference
to the following :-
Particulars regarding industrial licence and registration with the relevant
authorities like DGTD, Textile Commissioner, Drugs Controller etc., as the case may
be.
Arrangements made for import of machineries.
Details of collaboration agreement, if any, including the name of the collaborators,
nature of collaboration, royalty/ fees payable. In the case of foreign collaboration,
details of Government approval should be indicated.
Government/RBI clearance in respect of FERA/MRTP companies and NRI investment.
Particulars of land and terms of purchase/ lease.
Permission of use of land for industrial purpose and under Urban Land Ceiling laws.
Permission from municipal/ local authorities, if required.
Position and availability of power.
Time schedule for implementation of the project and progress made so far with
reference to :
Land development
Construction of buildings
Purchase and erection of machinery
Development works like construction of roads, extending electricity lines etc.
Steps taken for raising the resources including arrangements made for issue of shares.
Clearance from Pollution Control Board
Arrangements made for recruitment of labour and other staff.

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Other basic information.
The likely period by which trial/commercial production is expected to commence etc.
A certificate from the auditors of the company regarding promoters'
contribution/investment made on date.
A list showing details of existing fixed assets and others should be enclosed with the
inspection report.
Documentation and Disbursement
Loan amount should not be disbursed before the completion of documentation and
other formalities.
Prior to documentation, full details of the terms and conditions of sanction should be
conveyed to the borrower and his concurrence obtained in writing.
As per extant guidelines, all documents of borrowers with credit facilities above Rs.10
lacs, have to be approved by Legal Department at Zonal Office or by Bank's
approved advocate, wherever permitted.
Wherever mortgage of land and buildings are stipulated, branches should ensure the
following :-
Absolute ownership/clear title/lease rights of the borrower free from all
encumbrances.
Marketability/transferability of the title.
There are no legal restrictions for creating the mortgage of the property.
In the case of leasehold properties, the unexpired lease period should be
sufficiently longer than the period of loan. There should not be any restrictions in the
lease deed for creation of the mortgage or sub-lease by the lessee.
Advocate's opinion confirming the above aspects should be obtained and kept on
record before the creation of the mortgage. If the advocate's opinion contains
any qualifications, the same should be set right and a fresh opinion certifying
the clear and marketable title to the properties should be obtained before the loan
amount is disbursed.
Branches should strictly ensure compliance of all the terms and conditions of the
sanction in toto before disbursing the facilities.
Wherever direct payment to the suppliers or contractors is to be made, the relative
bills or invoices should be approved by the borrower and the latter's specific
authority to make payment be obtained. Photocopies of all such bills/invoices should be
kept on record.
Schedule of Implementation
The project report should contain the schedule of implementation of the project
which shall be supported by a PERT (Project Evaluation and Review Technique) chart,
where feasible. In case the PERT chart is not submitted, a time schedule for
implementation of the project should be drawn up before disbursement of loan.

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The progress of implementation of the project should continuously be monitored.
Wherever the terms and conditions stipulate disbursement of loan in stages, it
should be ensured that the work is complete upto the desired level before making
further disbursements. For this purpose, spot inspection should be carried out by
the Branch Manager or the officer authorised at each stage. Where considered
necessary, technical officer of the Bank or consultants should also be associated
with such inspections.
Where the progress of the project is not satisfactory, the reasons for the delay
should be ascertained and analysed. Any such delay would entail cost over-run. It may
also result in larger commitment by way of foreign exchange, wherever imported
machinery or equipment is involved, adding to the cost. In case of seasonal industries,
the delay in implementation may result in loss of business for the season. Where
contractual obligations are involved, the unit may be called upon to pay penalty for not
maintaining delivery schedule.
All the above situations have serious financial implications. Branches should,
therefore, be extremely vigilant in monitoring the progress of the project.
The developments should periodically be advised to the Regional Authority and
instructions/guidance sought for taking remedial measures.
In the case of a term loan for purchase of a particular equipment either for
replacement or for expansion, even though a close supervision of the entire working
of the unit may not be warranted, branches should ensure that the machinery is
installed in time and operating satisfactorily to give the desired results.
Margin requirement in Term Loan Appraisal:
In case of Factory Land & Buildings - overall margin of 30%
In case of Plant & Machinery and Equipment - 25%
In exceptional cases, finance for 2nd hand machinery may be considered with a minimum
margin of 40% at the discretion of the Sanctioning Authority.
Guidelines for TEV Study based on Project Cost:
While appraising term loans of large amount TEV (techno economic viability) study is
required ,the latest guidelines for TEV study in our bank are as under.
Project Cost Applicable Guidelines.
Upto Rs. 10 crores No TEV Study may be insisted upon.
Above Rs. 10 crore and The TEV Study should be carried out by Bank‘s
up to Rs. 30 crore Technical Officer posted in the zone or empanelled
consultant.
From Rs.30crores to Rs. For all the zones, where bank‘s technical officers are
300 crores not available or are in scale I/ II, such zones should
refer all theproposals having project cost over Rs. 30
crore to our Project Finance Division, BCC for carrying
out TEV study.
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Above Rs.300crores In case of such large projects, the TEV study may
generally be done by our Project Finance Division. In
case, the TEV study of the project has been done by
some other Bank/ FI subject to conditions/ stipulations
,the same maybe accepted by our Bank, subject to
vetting of the TEVstudy being done by our Project
Finance Division.

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12-Documentation
Quick Bites-
Documentation is process of formalizing the terms of agreement basis on which
credit facilities are granted between bank and borrower and creation of bank‘s
enforceable charge on various securities through documents.
WHAT IS "DOCUMENTATION"?
"Documentation" means obtaining of RELEVANT documents as per terms of sanction for
creation of charge on security/es. Nature of documents varies with nature of advance,
terms and conditions, nature of security and nature of the legal status of the borrower.
Mode of execution of documents also varies with the legal status of the borrower.
SIGNIFICANCE OF DOCUMENTATION :
Appropriate documents properly executed, signify and incorporate the following :-
a) The contractual relationship between the Bank and the constituent such as creditor -
debtor, agent-principal etc.,
b) The nature and description of the security, if any, offered for the advance, and
c) The terms and conditions of the advance.
IMPORTANCE OF DOCUMENTATION:
Documents obtained by the Bank form the basis upon which a suit, as and when found
necessary, may be filed by the Bank in a competent Court of Law against the defaulting
borrower. In the absence of such properly executed documents, the onerous burden of
proof is on the banker.
CERTAIN IMPORTANT POINTS TO BE OBSERVED WHILE OBTAINING

DOCUMENTS FOR ADVANCES:
1. To obtain acceptance of all terms and conditions of sanction in totality of borrower/s

and guarantor/s of terms and conditions.
2. All relevant documents as stipulated in the sanction or as per the Bank‘s practice,
should be obtained in respect of different kinds of facilities granted to the borrowers.
3. Documents must ordinarily be executed in the presence of the Branch Manager/
Accountant.
4. Attestation Memo (LDOC-1) should be filled in and kept along with the documents.
However, where a document is required to be witnessed as in the case of a Mortgage
Deed, it may be witnessed and the name, description and address of the witness should
be given.
5. Where a document is executed by an illiterate or by a person not knowing the language
in which the document is written/printed, a letter as per LDOC-53 (Letter of
Attestation) should be obtained duly signed by a person conversant with English
language as well as the language of the executant and also known to the Bank. In

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addition, the officer in whose presence the documents are executed should prepare a
note as per LDOC-1 and keep it along with the documents.
6. Documents should be complete in all respects and not to keep any blank space or
column.
7. Each page of document, the executants should sign invariably and overwriting must be
authenticated.
8. All documents should state the date, month and year of execution (for determining the
period of limitation)
9. Normally, all documents should bear a uniform date of execution, unless a particular
document is of necessity required to be executed on a different date.
10. Document must mention place of execution (for determining the jurisdiction of courts
in case of disputes and for purpose of payment of proper stamp duty )
11. All details are to be filled up as per terms of sanction i.e. amount, rate of interest,
name of the borrower/s etc.
12. All documents should be properly and adequately stamped at or before the time
of their execution as per law in force.
13. The documents should be executed by the borrowers/ guarantors themselves.
However, if it is decided for valid and justifiable reasons to permit the Power of
Attorney holder to execute the documents
14. The documents should state full names of the parties. Initials /short names or
abbreviated names of the parties should not be written.
DEFECTIVE DOCUMENTATION - ITS CONSEQUENCES:
a) What is meant by "defective documentation"?

i. Inappropriate documents, i.e. documents not relevant to the advance.
ii. Incomplete set of documents.
iii. Documents not filled in / partially filled in / incorrectly filled in.
iv. Documents with unauthenticated over-writings / erasures / cancellation/ corrections /
insertions.
v. Unstamped or inadequately stamped or improperly stamped documents.
vi. Documents not executed properly or not executed by all the persons who are required
to execute such documents.
vii. Documents executed by person/s incompetent to contract, i.e. by persons who have no
legal capacity to contract and hence to borrow.
viii. Documents executed by persons not authorised to so execute, e.g. by agents who do not
have necessary power to borrow and execute the documents.
Consequences of Defective Documentation:
Defective documentation may lead to a situation where the Bank may either lose the
legal remedy against the borrower and/or the guarantor or may not be able to enforce
its rights and the advance may become irrecoverable.

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1. CREATION OF MORTGAGE BY DEPOSIT OF TITLE DEEDS
1.1 Practice and Procedure:
A. Deposit of all the material Title-Deeds by the mortgagor to the Bank at the Notified
Place.
B. Recording the act of Deposit of Title-Deeds either by way of a Memorandum of Deposit
of Title Deeds or recording Oral Assent of the mortgagor in the Banks' book, to show
the intention to create security by way of mortgage for particular advance or advances.
C. Obtaining confirmation letter from the mortgagor regarding such deposit of title deeds.
D. Registering the memorandum of deposit, in cases when such registration is required.
1.2 Delivery of Title-Deeds:
a. There should be delivery of all the material and relevant title deeds relating to the
property, by the mortgagor/s to the Branch Manager of the Bank, who will be acting
for and on behalf of the Bank.
b. The delivery of the title deeds should be made by the authorised persons, who
have the right and the capacity to create such mortgage.
1.3 What are Title Deeds / Documents of title :
a) Title deeds mean the documents relating to the property and which are material
evidence of title. The documents must not only relate to the property but must also be
such as to show prima facie title of the mortgagor.
b) Mortgage by deposit of title deeds is created by deposit of only ORIGINAL title-deeds,
such as Sale Deed, Conveyance Deed, Lease Deed, Gift Deed, Trust Deed, Will, Sale
Certificate, Share Certificate or Membership Certificate with Allotment Letter in case
of Society or Non-Trading Association etc.
c) Copies of these material deeds / documents are not the title deeds and should not be
accepted in normal course.
d) Agreements of Sale or of Lease are not Title Deeds. The copies of the Government
Records or Revenue Records are also not the documents of title.
e) Mortgage of agriculture land to secure non - agriculture advance requires permission of
the Land Revenue Authorities and encumbrance should be got noted in the land records.
For any activity other than agriculture on agricultural land, conversion of agriculture
land into non – agriculture usage is must.
1.4 Places where it can be created :
A mortgage by deposit of title deeds can be created only at the places which are
notified by the State Government for purpose, from time to time. A list of such notified
places will be available from the Government Gazette.
2.0 MEMORANDUM OF DEPOSIT OF TITLE DEEDS:

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2.1 Such Memorandum records the fact of the mortgagor/s (stating their names)
delivering the title deeds to the Bank with an intent to create a mortgage on his / their
property (which is described) as security for the repayment of the advances (giving
nature of facilities, amount, rate of interest, etc. ) granted by the Bank to him / them.
2.2 Such Memorandum contains two Schedules. One Schedule shall give full details of the
mortgaged property. The other Schedule gives a list describing the title deeds which
are deposited.
2.3 The Memorandum is signed by the mortgagor/s and two witnesses. All the particulars
such as, the names of the persons attending the branch and depositing the tittle deeds,
the date of such deposit, amount/s of limit/s to be covered under the mortgage security
and the rate of interest for each facility etc., are required to be duly filled in and
completed before execution.
2.4 The Schedules should be correctly completed. All the title deeds which are deposited
should be included in the List of Title deeds. In the Schedule of mortgaged property,
full description and details with boundaries should be described so as to give proper
identification of such property.
2.5 Description of Property :-
a) A mortgage is a transfer of interest in a specific immovable property. Hence, great care

should be taken to ensure that full and correct description of the property mortgaged is
given such as, Revenue Survey Number, Plot Number, House/Tenament Number, Location
or Number of Road/Street, Area, Village, Taluka, District, etc., giving the particulars of
the boundaries.
b) If the description of property is too general or vague, it could lead to difficulties at the
time of enforcement of mortgage.
c) If the property is wrongly described, it would mean taking a mortgage of some other
property, not belonging to the mortgagor. In that case, the Bank may not be in a position
to execute the mortgage decree even when it is obtained against the party.
2.6 Stamping of Memorandum:-
a) Any instrument evidencing an Agreement or Memorandum of Agreement relating to the

deposit of title deeds attracts stamp duty under Article 6 of the Indian Stamp Act and
under the corresponding Article in the Schedule of the Local/State Stamp Law. Hence,
the Memorandum should be got stamped accordingly.
b) Normally, the Stamp duty for a Memorandum of Deposit of Title Deeds is comparatively
less than the stamp duty prescribed for a Mortgage Deed.
c) However, it may be noted that in order that such Memorandum is considered as an
Agreement relating to deposit of title deeds should merely contain the bargain between
the parties in relation to deposit of title deeds and conditions ancillary to such deposit.
If it contains all the provisions which contain the contract between the parties which
are normally found in a Mortgage Deed, then it would not make it an 'Agreement for
deposit of Title Deeds.'
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d) Mortgage by deposit of title deeds can be created at any notified place. In some states
the Memorandum of deposit does not attract stamp duty. Such an opportunity though
can help in avoiding payment of stamp duty for some time but it should not result in
evasion of stamp duty. At any later date the Memorandum may have to be brought back
for the purpose of enforcing the mortgage and at that point of time the stamp duty will
become payable.
4. MEMORANDUM OF ENTRY OR ORAL ASSENT.
4.1 The Memorandum of Entry is recorded accepting deposit of title deeds not on the
same day on which mortgage by deposit of title deeds was created but on any day
subsequent thereto, preferably the next day. This is done with a view to establish that
entry is simply a recital of earlier transaction.
4.2 In the Memorandum of Entry, the time, date and place of deposit of title deeds are
clearly recorded and it is dated on a subsequent day.
4.3 The Entry is signed only by the authorised official of the Bank, who has accepted the
deposit of title deeds and witnessed by one or more witnesses.
4.4 No signature of the Mortgagor is taken on the Memorandum of Entry or Oral Assent.
4.5 The Entry records that the mortgagor/s had deposited the title deeds with intent to
create mortgage on the property (description is given) in favour of the Bank, as
security for the advances (facilities, limits, rates of interest, etc., are described)
granted by the Bank to the mortgagor/s. It also contains declaration that the property
is absolutely owned by him and that he has clear marketable title; that there is no
charge, lien, encumbrance, attachment etc., on the property; that the mortgage shall be
the continuing security for the advances etc.
4.6 Such entry serially numbered is generally made in handwriting in a bound Register
with pages serially numbered. It should never be in loose leaf form. The list of the title
deeds and the Schedule of Property over which mortgage is created should be written
as part of such Entry.
4.7 Whenever a Confirmation Letter is obtained, it should not be on the same date but
should be on the next day of the Date of Entry.
4.8 The record of Entry of deposit of Title deeds thus made in the Bank's books is
admissible in evidence in the court of law as primary evidence of transaction under
Section 4 of the Banker's Book Evidence Act.
5. NO PARTING OF TITLE DEEDS
5.1 At no point of time during the continuance of mortgage, the title deeds or any of the
title deeds should be parted with or delivered to the mortgagor or his representative.
The parting of title deeds even for a temporary period may create complications

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affecting the continuity of the mortgage. Section 78 of the Transfer of Property Act
states that where through the fraud, misrepresentation or gross neglect of a prior
mortgagee, another person has been induced to advance money on the security of already
mortgaged property, the prior mortgagee shall be postponed to such subsequent
mortgagee.
5.2 In the event of inspection of title deeds is requested, it may be allowed to be done in
the presence of a Bank's official at the Bank premises only.
5.3 The title deeds should be kept in a separate file in a fire proof cabinet under the
duel control of responsible officials.
6. PRIORITY OF MORTGAGE BY DEPOSIT OF TITLE DEEDS
6.1 A validly created mortgage by deposit of title deeds shall stand on the same footing
and has the same legal force as that of any other form of mortgage. Therefore, a
mortgage created by deposit of title deeds at a prior date shall have priority over any
other mortgage executed at a later date.
6.2 As per Section 48 of the Registration Act, a mortgage by deposit of title deeds
shall take effect against any mortgage deeds subsequently registered though relating
to the same property.
7. MORTGAGE FROM A GUARANTOR
1. Under Section 58 of the Transfer of Property Act, a mortgage can be for the purpose
of securing the payment of money advanced or to be advanced by way of loan or for any
existing or future debt or for the performance of an agreement which may give rise to a
pecuniary liability. Thus, a mortgage can be created by a guarantor to any advance on his
property.
2. The procedure for creating a mortgage of the guarantor's property will be the same as
in case of creating a mortgage of the borrower's property, except that the relative
recital in the Memorandum of Deposit of Title deeds or in the Memorandum of Entry will
mention the name of the guarantor as mortgagor depositing the title deeds for the
facilities sanctioned to the borrower whose name will appear at appropriate place along
with the facilities.
3. The third party mortgage can only be from a guarantor.
8.0 PRECAUTIONS FOR CREATION OF MORTGAGE:
Following steps are to be followed for creation of valid and enforceable mortgage:
8.1 Before creation of a mortgage by deposit of title deeds, branches to ensure that the
title deeds are verified and report on title obtained from Advocate on the panel after
they conduct searches in the appropriate records of the Sub – Registrar of Assurance
and Revenue / Municipal records, upto the nearest date of creation of mortgage. The
advocate to certify that the title deeds relating to concerned property are original, duly
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stamped and wherever required duly registered and title is clear, marketable and free
from encumbrances.
8.2 Branches to insist on opening of bank account as per ‗ KYC‘ norms by owners of the
property who offer the same as mortgage security against the loan given to third
parties. Copies of House Tax receipts / Electricity Bills etc. are to be obtained as proof
of possession / residence.
8.3 In case property proposed to be mortgaged is under tenancy / leased to a third

party, the same will reduce the marketability and value thereof. It is necessary to take
this aspect into consideration while accepting such property as security.
SAFE CUSTODY OF ORIGINAL SECURITY DOCUMENTS AND TITLE DEEDS
Instances have come to the notice of the Bank that original documents and /or original
title deeds are found missing either after lapse of considerable time / period from the
date of security creation or after filing of recovery suits etc. Many times it happens
that branches hand over the original security documents and title deeds to the
Advocate for filing of suit / DRT application etc. but do not collect/obtain the same
back promptly and properly. No record is maintained at the branch that original
documents are handed over to the Advocate which have not been returned by him. As a
result, as and when it is required to present the original documents etc. in court/
Tribunal the same are not found or not traceable.
To overcome this situation, given below are the guidelines for safe custody of original
documents, title deeds, etc.,
1. While going to the Advocate/s for preparation to file suit, etc., the concerned branch
officials may carry with them and deliver to the Advocate/s a photocopy of the
originals, and the original documents, after perusal by the Advocate/s, may be brought
back intact and kept in the safe custody of the branch. This course of action is designed
to avoid any possible loss / misplacement of security documents/title deeds.
2. Alternatively, as far as possible, our advocates may be requested to call on the branch,
peruse the documents, etc., at the branch premises itself and do the needful further so
as to obviate the need for the branch to keep track of the original documents and title
deeds.
3. It is the Bank's recognised practice to send documents, etc., - originals or even photo
copies to advocates / other branches along with a forwarding letter and to obtain the
Advocate's / the other branch's acknowledgment of receipt thereof, and this practice
should be strictly followed by all the branches.
4. According to the practice prevailing at the particular place of filing suit, etc.; the
Advocate may file security documents and title deeds -- original or copies as per the
requirement -- in the court or other legal forum. In either case, advocate's written
confirmation has to be obtained.

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5. Branches should never part with the originals without retaining the copy thereof with
themselves.
6. Safekeeping of documents and records is the sole responsibility of the branch officials
concerned, the same being an operational matter, and utmost care is expected of the
personnel handling the same. It is, therefore, necessary that the factual position as to
the availability of the originals is verified by the concerned officials even at the time of
every change over on transfer or job rotation involving key officials of the branch.
PERIODICITY OF RENEWAL OF DOCUMENTS
1. In case of all advances the renewal documents should be obtained before the end of the
fourth year calculated from the date of the documents on hand. But a letter of
acknowledgment of debt signed by all the signatories who have signed the original
documents, should be obtained at the end of every second year, calculated from the
date of documents on hand for all types of advances whether the advance is to limited
companies, firms or individuals.
2. In respect of advances to limited companies, as also documents involving payment of
substantial stamp duty, the matter regarding obtaining fresh documents, should be
referred to the Regional Authority for necessary guidance. Along with the letter of
reference, a copy of the last search report taken from the records of the Registrar of
Companies should be sent to the Regional Authority.
3. In case of secured advances (mortgages) the following procedure should be followed:
a) A letter of acknowledgment of debt should be obtained every two years from the date
of documents on hand.
b) As the period of limitation for mortgage is 12 years, the branch should obtain only a
letter of acknowledgment of debt for about ten years, at the end of which each such
case should be referred to the Zonal Legal Department through the Regional Authority
for further advice.
4. In case of Bills Purchase/ Discounting facility (Inland/Foreign) fresh B.P. Undertaking

letter should be obtained every two years from the date of existing documents.
5. In all letters of acknowledgment of debt subsequent to the first one (relating to the
same set of documents) reference to all the previous letters of acknowledgment of debt
should be made in addition to the reference to the documents.
6. Signatures of each of the borrowers and guarantors to an advance should be obtained on
the letter of acknowledgment of debt, on separate revenue stamps of appropriate value
in case revenue stamp is affixed.
7. In respect of advance account wherein a letter of guarantee is obtained, same letter of
acknowledgment of debt should be got signed by the principal borrower/s as well as by
the guarantor/s.
8. In case of change in the constitution of a borrower's firm, fresh sanction and
documents should be obtained and a fresh account should be opened.

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9. When the limit in an existing account is subsequently increased, supplemental set of
documents should be obtained for the amount by which the limit is enhanced.
For example, if a limit is increased from Rs.1 lac to 2 lacs or from Rs. 5 lacs to Rs. 10
lacs, the supplemental set of documents to be taken will be for Rs. 1 lac and Rs.5 lacs
respectively.
As regards obtaining of the renewal documents in such cases, the renewal documents
should be taken for entire limit (including the enhanced limit).
10. If security by way of pledge/ hypothecation/ mortgage/ to secure a facility by way of
loan or overdraft or cash credit has already been created and the same is to be either
extended for enhanced limit or otherwise a fresh additional advance is to be made, then
the documents required to be obtained in such a case will be full set of documents as
may be appropriate to the type of advance and the amount of the facility in the
document should be limited to the extended or a fresh additional advances, as the case
may be.
11. Memorandum of Entry made in connection with mortgages by deposit of title deeds
should not be renewed, as otherwise any mortgage / charge or lien created in the
meantime would take priority over the Bank's mortgage / charge and lien. However, a
letter of acknowledgment of debt should be obtained in standard form.
12. It should be carefully seen that the advance documents do not become time-barred due
to omission to obtain in time renewal documents, confirmation/ revival letters or letters
of acknowledgment of debt from the borrowers/guarantors.
13. Usual debit balance confirmation letters should invariably be obtained every half-year.
CHARGES REQUIRING REGISTRATION WITH THE REGISTRAR OF COMPANIES

UNDER SECTION 125 OF COMPANIES ACT, 1956
In the case of all companies including private limited companies, certain charges on the
assets have compulsorily to be registered with the Registrar of Companies under
Section 125 the Companies Act, 1956. The charges which require compulsory
registration are given hereunder.
Sr.No Description of charge
a. A charge for the purpose of securing any issue of debentures.

b. A charge on uncalled share capital of the company.
c. A charge on any immovable property, wherever situate, or any interest therein.
(This will include all types of mortgages)
d. A charge on any book debts of the company.
e. A charge, not being a pledge, on any movable property of the company. (e.g. a
hypothecation)
f. A floating charge on the undertaking or any property of the company including
stock-in-trade.
g. A charge on calls made but not paid.
h. A charge on a ship or any share in a ship.
i. A charge on goodwill, on a patent or license under a patent, on a trade mark, or
on a copyright or a license under a copyright.

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In terms of Section -135 of the Companies Act, whenever the terms and conditions, or
the extent or operation of any charge registered as aforesaid are or is modified,
particulars of such modifications are also required to be registered with the Registrar
of Companies. Modification of such charges may be by way of enhancement in limits or
fresh advances granted against the same security or obtaining of additional securities
for the existing or enhanced limits or any other modification in the terms and conditions
of advance like revision in rate of interest other than change in PLR of the Bank,
arrangement for sharing of securities with other creditors, change in the ranking etc.
It should be noted that the charge has to be filed for registration within 30 days of its
creation i.e. from the date of execution of document, if any. In case it is not so filed
within the stipulated period, the Registrar has the discretion to extend the period by a
maximum of thirty days if sufficient cause is shown. No prudent banker would, however,
depend on the discretionary powers of the Registrar which may or may not be exercised
in his favor.

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13-CHARGING OF SECURITIES
Quick bites: This chapter deals with The charge on the Security offered,
depending on the nature of the security, is created by way of Pledge,
Hypothecation, Mortgage, Assignment etc., subject to registration with
competent authorities wherever mandatory under the law.
Various types of securities:
Before going to the topic – Charging of Securities, let us understand the types of
securities we deal with – (1) Primary Security (2) Collateral Security.
The assets created by the borrower from the credit facilities granted by the bank form
the primary security for the bank advance as a matter of rule. The bank invariably
obtains a charge over those assets. Similarly, other assets on which the advance is
primarily based even if it is not created from the credit facilities granted by the bank
will also be taken as primary security.
In some cases where primary security is not considered adequate or the charge on the
security is open the bank may insist on an additional security to collaterally secure
advances granted by it. Such securities are termed as collateral securities. Collateral
security may either be tangible or third party guarantees may also be accepted.
BASIC CHARACTERISTICS OF SECURITIES
The securities acceptable to banks either as primary or collateral must have certain,
basic characteristics as under:
Ascertainment of value: A security will be considered good and will be acceptable to the
bank only if its value can be ascertained with a definite degree of correctness. Certain
articles may be valuable but may not be accepted as security if the value cannot be
ascertained such as paintings/antiques etc.
Marketability: A good security must have a ready market. Raw materials, articles of
necessity, other primary commodities are easily marketable and are considered good
security. Semi-finished goods may be more valuable than raw material for the borrower
but may not be marketable at all and will thus be considered inferior to raw material in
as much as its acceptance as a security is concerned.
Stability in value: A good security should have a stable value over a long period. If the
value of a security fluctuates violently over a short period, it may not be considered a
good security and may be accepted by the bank only after keeping a very high margin.
Ascertainment of title and transferability: An asset can be accepted as security by the
bank only when the title over that asset can be ascertained. Furthermore, the title
should be easily transferable. The purpose of obtaining a security is to apply the sale
proceeds of the security if the customer fails to repay the advance. But if the security
is not easily transferable the very purpose of obtaining a security may be defeated.
Immovable property located at a prime location may be very stable in value has a ready
market and the value can also be ascertained but may still not be considered as a good
security due to difficulty in ascertaining the title and elaborate legal process involved
for effecting its sale through a court of law.
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Durability: The security accepted by the Bank must be durable. No bank advance is
granted against perishable commodities.
Other Characteristics:
 In case loan or advances to Muslims offering their property as primary or collateral

security, it should be ensured, before accepting property as security that such
property has not been alienated under the Muslim Law like 'waqf-ul-ulad' and/or
'Haq-rnehr' in favour of their wives or for the benefit of their heirs since it will
jeopardise the interest of the banker as lender.
 There are circumstances when securities given to the bank as security to cover the
loan, have become void as against income tax dues/arrears of land revenues. To avoid
such an unpleasant situation, the borrower should be asked to furnish income tax
clearance certificate/clearance from local authorities.
 There are few other characteristics such as controllability of an asset as a security
and securities having a yield which will enhance their value etc. which are critically
analysed by the bank while accepting any security.
CONCEPT OF MARGIN
The percentage of margin which is kept by the bank as a cushion for any unforeseen
drop in the value of security is directly linked to various characteristic as discussed
above. Lower margin may be prescribed for those securities which have a stable value
and easy marketability whereas higher margins are prescribed for those securities
where fluctuations are wide. Margin fixed on raw material may be lower as compared to
margin on stocks-in-process as the marketability has been affected in the latter case.
The fixation of margin may also depend on the credit worthiness of the borrower and in
some cases even Reserve Bank may issue directives to the banks.
Fixed assets:
Assets like land & building, plant & machinery, which are called fixed assets, are taken
as security by the bank. Bank finances the borrowers to acquire these fixed assets and
takes such acquired assets as primary security or it can grant working capital limits
against stocks/debtors as primary security and take fixed assets acquired by the
company as collateral security.
Current assets:
Stocks: Stocks are generally goods in trade. A manufacturing unit purchases raw
material processes it and produces final product. In this process, stocks of raw
material, semi- finished goods, and finished products are lying with the unit. These
stocks are offered as security for the working capital limits. In case of manufacturing
unit besides the security of raw material, work-in-process, finished goods, security of
stores and spares, packing material and goods in transit can also be accepted.
Debtors/Book-debts/Receivables:
Any trading/manufacturing concern in its business will have to sell some of its products
on credit to its customers. In this process debtors are created. Funds of the company
get locked up in these unrealised debtors and its cash flow gets affected. However,
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these trade debtors are current assets and could be taken as security. Bank lends
against the security of debtors by way of cash credit (hypothecation) against book
debts. When the company draws and holds bills of exchange, it can offer these bills with
or without title to goods to the bank as security and bank can finance by way of bills
purchase (in case of demand bills) and bill discounting (in case of usance bills).
Bank's own deposits:

Bank grants credit to its customers against its own time deposits. Demand
loan/overdraft facilities can be sanctioned to the depositors holding
short/fixed/recurring deposits and other types of term deposits by following Bank's
usual norms.
The advance can also be granted in exceptional cases against security of third party
deposit. However, no advance can be sanctioned against deposit held at another branch
even in case of the depositor himself.
Other types of securities:

Bank finances against various other types of securities in the nature of movable assets
like government bonds, postal / national saving certificates, shares & debentures of the
companies, units of Unit Trust of India and other mutual funds, LIC policies, public
sector undertakings' bonds or gold/silver and jewelry. Loan facilities are granted
against these types of securities, which are covered separately.
Methods of Charging of Securities:

Charging of securities means to create coverage over the security – which will be like a
cushion to ensure the repayment by the borrower in usual course and through legal
recourse, if necessary. Selection of security should be appropriate depending upon the
type of credit facility, type of borrower and purpose. Once the appropriate security is
selected, bank's charge on the security should be ensured by observing necessary
formalities, so that in case of default by a borrower, the security will be available to the
bank to recover its dues.
The important six methods of charging of securities are given below with brief
explanation.
Pledge:
Section 172 of the Indian Contract Act, 1872 defines 'Pledge' as 'the bailment of goods
as security for payment of debt or performance of a promise is called 'pledge'. The
bailor is, in this case, called the 'pledger' and the bailee is called the 'pledgee'.
Above definition reveals that: Pledge means bailment of goods, its purpose is to secure
payment of a debt or to secure performance of a promise. Any movable property can be
pledged. Delivery (actual or constructive) is necessary to complete a pledge. In case of
Bank's advance against the pledge of goods, customer is called the 'pledger' and the
bank is called the 'pledgee'. Where pledged securities or goods are indivisible, the
pledgee can sell the securities or goods only to that extent by which the loan amount will
be satisfied.

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Hypothecation:
The term 'hypothecation' is described as "Charge against property for an amount of
debt where neither ownership nor possession is passed on to the creditor."
Hypothecation is defined in SARFAESI Act, 2002.
In case of pledge, the borrower's goods are placed in the bank's possession under its
own locks whereas in case of hypothecation, goods remain in the possession of the
borrower.
If the borrower fails to liquidate the advance granted to him against hypothecated
goods, under agreement, he has to give the possession of the goods to hypothecatee
(bank). At this stage, hypothecation converts into pledge and the banker as
hypothecatee enjoys the powers and rights of a pledgee.
On borrower's default in repayment of advance, if the banker prefers to file a civil suit,
it is held that the banker ranks as an unsecured creditor, at par with other unsecured
creditors, of the borrower. Hence, by creating the charge of Hypothecation, banker can
have direct and first charge/claim over the goods hypothecated to him.
Mortgage:
It is the transfer of an interest in specific immovable property for the purpose of
securing the payment of money advanced or to be advanced by way of loan, an existing or
future debt or the performance of the agreement which may lead to a pecuniary
liability. The borrower is called the 'mortgagor' and the lender the 'mortgagee'.
Forms of mortgage: As per Sec. 58 of the Transfer of Property Act, there are six types
of mortgages:
(1)Simple mortgage
(2) Mortgage by conditional sale
(3) Usufructuary mortgage
(4) English mortgage
(5)Anomalous mortgage
(6) Mortgage by deposit of title deeds/ equitable mortgage
Generally only two types of the mortgage are preferable by the banks
Simple Mortgage; according to section 58 (b) of the Transfer of Property Act, a simple
mortgage is a transaction whereby without delivering the possession of the mortgaged
property, the mortgagor binds himself personally to pay the mortgage money and agrees,
expressly or impliedly, that in case of default the mortgagee shall have a right to cause
the mortgage property to be sold by a decree of the court.
Equitable mortgage or Mortgage by deposit of title deeds:
According to section 58(f) of Transfer of Property Act, where a person delivers the
documents of title to the immovable property to the creditors with an intention to
create a security thereon, the transaction is called equitable mortgage.
The essential features of the equitable mortgage are as under:
 Delivery of the documents title to the immovable property to the creditor

 Intention of the mortgagor to create a security thereon in favour of the creditor.
 The delivery of the title deeds must be by the owner of the property or his / her
authorized agent only.
 The owner of the property must be either our borrower or a guarantor.

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 Mortgage to be created in our usual memorandum for equitable mortgage as given in
Book of Instruction Vol 9
 Proper records of the title deeds deposited must be recorded in the mortgage
register with serial number.
 Photo/s of the person who is/are depositing the title deeds should be on records duly
signed by him/them
 A registered letter to be sent to the mortgagor mentioning the fact that he/she
attended the office on a particular date for depositing the title deeds as security
against the credit facility/ies and acknowledgement thereof to be kept with the
memorandum of the equitable mortgage
Establishment of Central Registry
Government of India has made it compulsory that mortgages created by way of deposit
of title deeds are to be registered with the Central Registry of securitization Asset
Restriction & Security Interest of India (CERSAI) within 30 days from the date of
creation of the mortgage.
Such a Central Registry has come into force with effect from 31st March 2011 and
Government notification establishing the Central Registry has been issued on 31st
March 2011.
Accordingly, Branches are required to enter details in CBS using menu CERSAI and all
creation of mortgages by deposit of title deeds are to be filled in property-wise and
verified as per menu CERSAI in CBS.
Assignment
Assignment means transfer of a right of an actionable claim, existing or future.
'Actionable claim' means a claim to any debt, other than a debt secured by mortgage of
immovable property, by hypothecation or pledge of movable property, or to any
beneficial interest in movable property in possession, either actual or constructive, of
the claimant, which the Civil Courts recognise as affording grounds for relief, whether
such debt or beneficial interest be existent, accruing, conditional or contingent.
Section 130 describes the manner in which actionable claims can be transferred, as
follows:
The transfer of an actionable claim, whether with or without consideration, shall be
effected only by the execution of an instrument in writing signed by the transfer or his
duly authorised agent, shall be complete and effectual upon the execution of such
instrument, and thereupon all the rights and remedies of the transfer, whether by way
of damages or otherwise shall vest in the transferee, whether such notice of the
transfer is hereinafter provided be given or not.
Lien:
Lien is the right of a creditor to retain in his possession the goods and securities owned
by the debtor until the debt has been discharged, but has no right to sell the goods and
securities so retained. Lien is of two types, particular and general.
Banker's right of lien: Banker has a right of general lien against his borrowers. Section
171 of the Indian Contract Act, 1872 confers the right of general lien on the bankers as
"Banker may, in the absence of a contract to the contrary, retain as a security for a
general balance of account, any goods bailed to them."

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Bank's right of general lien includes Right of sale. Therefore, it is said that banker's
lien tantamount to an implied pledge.
The banker's right of lien is not barred by law of limitation. The Limitation Act only
bars the remedy and does not discharge debt. As such, banker has a right of lien against
time barred debt also. When banker exercises this right, property of goods remains
with owner even though the same is in possession with the bank.
Negative Lien
The borrower may sometime be having non-encumbered assets which are not charged to
the bank as security. The borrower is thus free to deal with these assets and may even
sell them if he so desires. To restrict this right of the borrower, bank may request him
to give an undertaking to the effect that he will neither create any encumbrance on
these assets nor sell them without due permission from the bank so long as the advance
continues. This type of an undertaking obtained by the bank is known as 'Negative Lien'.
Negative lien is in the form of a personal assurance or undertaking which has binding
effect but confers no right on the bank to proceed against the property itself and thus
creates no encumbrance or charge on the property.
Right of set-off:
Right to apply the credit balance in customer's account towards liquidation of debit
balance in another account of the customer provided both the accounts are maintained
by him in the same capacity.
The right of set-off is a statutory right which enables bank to combine several accounts
of a customer in his own right unless there is any agreement expressed or implied to the
contrary. Before exercising the right of set-off a reasonable notice should be given to a
customer to avoid dishonouring of cheques drawn by the customer being unaware of the
situation. Though the right of set-off is available to a banker as a legal right, banks take
letter of set-off from customer. It helps the bank to overcome future legal
complications and it dispenses with the need for notice.
The right of set off can be applied by the bank only if the following conditions are met:
(a)The liability of the borrower is for a sum which is certain.

(b)The repayment of debt is due.
(c)Both the accounts are held by the customer in the same capacity.

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14- MICRO, SMALL AND MEDIUM ENTERPRISES(MSME) : AN
OVERVIEW
MSMED Act was operationalized with effect from 2nd October 2006, which defines an
―enterprise‖ instead of an ―industry‖ to give recognition to service sector and also
defines a ―medium enterprise‖ to facilitate technology up gradation and graduation.
Section 7 of the Act protects the sector by restricting the investment in Plant &
Machinery in case of Industries and investment in equipments for service enterprises as
below with effect from 2nd Oct. 2006:
Activity Micro Small Enterprises Medium

Enterprises Enterprises
Manufacturing Not Exceeding Above Rs.25lakh Above Rs.5cr to not
(investment in P&M Rs. 25lakh up to Rs. 5cr exceeding 10cr
Service (investment Not Exceeding Above Rs10lakh up Above Rs.2cr to not
in Equipments) Rs.10lakh to Rs.2cr exceeding Rs.5cr
MICRO ENTERPRISES: Units engaged in manufacturing, processing, preservation of

goods, mining, quarrying, servicing & repairing of specified type of machinery and
equipment, agro service units – Investment in P&M upto Rs.25 lacs in manufacturing units
and investment in equipments upto Rs.10 lacs in Services sector
SMALL ENTERPRISES: Units engaged in manufacturing, processing or preservation of

goods or is a servicing and repair workshop undertaking repairs of machinery used for
production, mining, quarrying or custom service units (except water service units) –
investment in P&M >Rs.25 lacs and upto Rs.5 cr. In Services Sector – investment in
equipment >Rs.10 lacs upto Rs.2 cr.
MEDIUM ENTERPRISES: Units engaged in manufacturing, processing or preservation

of goods or is a servicing and repair workshop undertaking repairs of machinery used for
production, mining or quarrying or Custom Service unit (except water service units) –
Investment in P&M - >Rs.5 cr. upto Rs.10 cr,. In Services Sector – investments in
equipment >Rs.2 cr. upto Rs.5 cr.
SME Business Segment will not include the following:
 Financial Institutions including banks, RRBs and all types of NBFCs.

 Central & State Governments.
 Associate/sister concerns of Wholesale Banking customers, irrespective
 of their annual sales/income turnover.
 Micro Finance.
Computation of value of Plant & Machinery:

Original price of every productive item, irrespective of whether new or second hand,
acquired and proposed to be acquired, whether on lease or hire purchase or on ownership
basis. Items to be included: Original cost of P&M (price paid by the owner / hirer/
lessor), Cost of control panel, starters, electric motors, other electrical accessories
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mounted on individual machine) and Cost of only those testing and quality control
equipments which are used for/in process testing. In case of Imported machinery:
i- Import duty.
ii- The shipping charges.
iii- Custom clearance charges.
iv- Sales Tax.
Our Bank‘s approach - MSME sector for internal purpose:

(BCC/BR/98/324 dt.28.11.06)
SMEs are growth engines and there are many advantages in financing SME. The Act
provides the regulatory definition of MSME which will be used for all the reporting and
classification purposes in all the banks.
A large number of organizations (Micro, Small & Medium sized service sector companies
and Trading Enterprises without any Plant & Machinery investment, Club, Trust etc) are
left out from the MSME sector, under the regulatory definition.
Our bank considering vital role being played by such organizations in Economic
development of the Nation and in order to capture the business, has expanded the
coverage of MSMEs well beyond the Regulatory definition as under:
All Banking business (Assets & Liabilities) with Companies / entities with annual gross
sales turnover / income from Rs.1 Cr up to Rs 150 crores and new Infrastructure and
Real Estate projects where the Project Cost is less than Rs.50 Crores in case of Real
Estate and less than Rs.100 Crs in case of other than Real Estate projects are to be
covered under MSME ambit.
The new/extended definition will only be used internally for promotion of business
across these segments. All the proposals falling beyond the ambit of regulatory
definition shall be covered by the Loan Policy Document and will attract all provisions of
C & I sector, if not specified otherwise.
In this regard, Bank has set up SME loan factories based on the Assembly Line
principles as a Centralised hub for processing. We have -51- SME Loan Factories as of
August, 2012.
SME Banking business will thus include the following across the Bank –
 Micro, Small and Medium Enterprises – as per Regulatory definition irrespective

of geographical location.
 All other entities with their annual Sales Turnover of Rs.1 Crore to Rs.150 Crores
and new Infrastructure and real estate projects, where Project cost is less than
Rs.50 Crores in case of Real Estate and less than Rs.100 Crs in case of other than
Real Estate projects.
 SMEs which are Associate/Sister concerns of Wholesale Banking Customers.
 Clubs, Trusts etc.
 Financing under various Govt schemes launched for MSME Sector.
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However, such Units, which are outside the purview of regulatory definition will not
form part of Priority Sector lending.
COMMON GUIDELINES:
1)Simple Standardized Application form for various credit limits (BCC:BR:101/13 dt.
03/01/09). There is a separate format for Adhoc basis requests vide BCC:BR:100:11
dated 01.01.2008.
2)Receipt and acknowledgement of application – Date of receipt, date for discussion,
decision within prescribed period, reasons for rejection; rejection to be referred to
next higher authority
3)Register for application received
4)Submission of Credit proposals to BCC – All credit proposals irrespective of its
classification, whether it is SME as per regulatory guidelines or SME as pr expanded
coverage, with gross turnover / income upto Rs.150 cr. will be processed by the SME
Dept. at BCC, if it is beyond ZH powers.
All proposals falling under SME sector as per Regulatory guidelines with gross turnover
/ income exceeding Rs.150 cr. will also be processed by SME Dept., if it is beyond ZH
powers.
5) Time norms for disposal of loan applications:
Upto Rs.2.00 lacs - 2 weeks; Above Rs.2.00 lacs - 4 weeks;
SME LF – 14 days (without TEV) and 21 days (with TEV).
6) Types of Facilities:
TL, DL, DPG, CC, OD, BP/BD, PC, FBP/ UFBP, DA L/C, DP L/C and BG.
TAKE OVER A/CS.
Ratio Norms
Micro & Small Medium Enterprises Others
Enterprises
CR Min. 1.17 & above Min. 1.20 & above Min. 1.33 &
above
DER Max.4:1 Max.3:1 Max.3:1
(TTL/TNW)
DER Max.4.5:1 Max.4.5:1 Max.4.5:1
(TOL/TNW)
Average 1.75 (anyone yr. 1.75 (anyone yr. 1.75 (anyone
DSCR should not be should not be below yr. should be
below 1.25) 1.25) <1.25)
GUIDELINES FOR TAKEOVER OF ADVANCE ACCOUNTS:

 profit making (PBT) concerns only as per latest audited balance sheet
 Minimum BOB 6 Credit Rating
 No reschedulement / restructuring in the existing a/c. for last -2- years

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 {in a, b & c deviation can be allowed by ZH for accounts with exposure up to Rs.3 cr.;
in other cases – GM(SME) for proposals up to powers of DGM; ED for proposals up
to powers of GM (ZH or BCC) & CMD in all other cases}
 Satisfactory report/Statement of Account from existing bankers.
 ―STANDARD ASSET‖ with existing banker
 All other existing norms , guidelines to be scrupulously followed
REHABILITATION OF SICK UNITS / DEBT RESTRUCTURING SCHEME FOR SMEs /
SCHEME FOR OTS FOR SMEs:
Separate policies are approved by the Board and guidelines are conveyed from time to
time by various circulars.
Assessment of Working Capital:

For the aggregate fund based working capital limits required up to Rs.5.00crores from
banking system, assessment of WC should be done as per the Nayak Committee
recommendation i.e.20% of the projected annual turn over. The assessment under
counter check method as per format ―B‖ has been discontinued for credit limit up to
Rs.500lacs. Instead, limit will be assessed under Tandon Committee 1st method (WCG-
25% of WCG as minimum NWC = PBF) of lending or as per Turn Over method of Nayak
Committee, which ever has the higher assessed limit.(Ref: BCC/BR/98/301 dt. 28.10.06)
For the assessment of the working capital required above Rs.5.00crores PBF method
(asset based) of assessment should be adopted.
Margin: TL – L&B – 30%; P& M – 25% (in exceptional cases, 40% on 2nd hand P & M)
WC – 25% uniform; Export Credit – 10%
(Deviation – Next Higher Authority by 5% on L&B and P&M.
ED & CMD – beyond 5%)
ROI: Statutory Guidelines – SME rates to be applied.; Others – as per Cr. Rating –
pricing – Separate guidelines. (Latest Circular BCC/BR/101/352 Dt. 26.11.2009)
Penal Interest – 1 to 2%
Credit Rating : As per new Scoring model (manual) for accounts having exposure of
Rs.25.00 lacs to Rs.200.00 lacs. BOBRAM (CRISIL) model is applicable to MSME
accounts having exposure of above Rs.200 lacs. (only for Regulatory)
External Rating : External Credit Rating should be carried out in all SME loan accounts
with Credit limits of above Rs.5 Crores by any one of the RBI approved external Credit
Rating agencies. The exposure to SME borrower rated by any of these Rating agencies
will be recognized as rated exposure for the purpose of computation of Risk Weighted
Assets under Standardized Approach of Credit risk.
TEV Study : As per guidelines
Collateral Free Loans :
Collateral free loan will be provided to all new loans upto Rs.10.00 lacs (enhanced from
Rs.5 lacs) to the Micro & small Enterprises Sector (both Manufacturing and Service

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Sector) of MSME vide cir. No. BCC/BR/102/149 dated 02.06.2010. All such loans should
invariably be covered under Credit Guarantee Scheme of CGTMSE.
The extant guidelines for extending collateral free loans (including 3rd party guarantee/
security) up to Rs.100 lacs to existing MSE Units based on the good track record and
financial position of the units will continue to be in force.
SME PRODUCTS:
Baroda SME Loan Pack

SME Short Term Loans
SME Medium Term Loans
Baroda SME Gold Card
Baroda Laghu Udhyami Credit Card
Baroda Artisans Credit Card (BACC)
Baroda Overdraft Against Land and Building
Baroda Vidyasthali Loan
Baroda Arogyadham Loan
Collateral Free Loans under Credit Guarantee Fund Trust Scheme for Micro & Small
Enterprises
Loans under National Equity Fund (NEF) Scheme
Scheme for Financing Energy Efficiency Projects
Margin Money Scheme under Rural Employment Generation Programme of KVIC
Scheme for Financing Existing Borrowers for Purchase of New Vehicles
Financial Ratios:(Existing and new a/cs.)
Ratio Norms
MS Regulatory ME Regulatory SME Non Regula-
guidelines guidelines tory/expanded
definition
CR (Min.) 1.17 1.20 1.33
DER(Max.)(TTL/TNW) 3:1 3:1 3:1
DER(Max.)(TOL/TNW) 4.5:1 4.5:1 4.5:1
FACR (Net FA/ LTL) Not below 1.25 Not below 1.25 Not below 1.25
Average DSCR 1.75 (anyone yr. 1.75 (anyone yr. 1.75 (anyone yr.
should not be should not be should be <1.25)
below 1.00) below 1.25)
The above ratios are indicative and deviations can be allowed by sanctioning authority /
competent authority on case to case basis, industry specific problems of unit, etc.

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15-CERDIT RATING
1. CREDIT RATING
Evaluation of credit risk is a primary tool of appraisal of advance based on credit risk rating.
Bank use a frame work by name ―credit scoring‖ to evaluate the proposal. Under this, marks
are assigned to various parameters/ attributes that a find a place in the proposal and using
varying weights for different parameters, an aggregate score, otherwise called ―credit score‖
is advised.
If the credit score is more than the minimum threshold acceptable to Bank, the proposal is
accepted, if it is less than the minimum threshold then the concerned proposals stands
rejected. Credit scoring model works as decision support system
The credit rating in respect of the borrower enjoying credit facilities above Rs. 2 lacs but
less than Rs. 25 lacs and loan under various retail lending schemes , irrespective of credit
limit , shall continue, even though the pricing is de-linked, for determining the credit risk
perception.
As per RBI guidelines, all credit exposures need to be rated. However in case, models for
rating of any kind of exposure to be taken up are not available, the exposure may be
considered as unrated. While taking up such unrated exposure bank's extant guidelines
including financial, non-financial parameters etc. are to be followed.
(i) When Rating to be done

The credit rating exercise must be completed before taking credit decision .It includes
validation of rating also.
(ii) Based on the rating of the account followings decision are being taken
1. Loan should be consider if:

a) Cut off grade for investment (BOB-6 and above and BOB-7 for Green Field
Projects/Infrastructure Projects at Build phase stage with annual exposure cap) under
BOBRAM Model.
b) for considering exposure to borrowers with rating of MSMEBOB6/CR 7 and below, under
MSME SCORE CARD model, the account is to be referred to next higher authority
c),Baroda Housing Loan-HL8 & ABOVE, clean loan CL7etc
2) Pricing - based on rating , wherever applicable.

3) Discretionary Lending Power for sanction / review - based on rating.
4) Sanction of Adhoc /Excess/DAUE - based on obligor rating/rating.
5) Inspection of securities - based on rating
6) Rating based exposure ceiling - based on rating.
(a) Pluses:
1. Render credit decision-making totally unbiased
2. Assessed on the basis of certain quantifiable parameters and support in credit decision

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(b) Minuses:
No check of willful omission or commission of information. The Bank has evolved rating
models revised from time to time applicable for advance.
2. TYPE OF CREDIT RATING –
(1) Internal Credit Rating System:

(a) Off line / Score Card Module –
1. Credit rating System (old)- Advance Proposal Rs. 2.00 Lacs but less than Rs. 25.00 Lacs (
except Retail Loan/SME Loan). In case of commercial lending below Rs. 25 lacs (which are not
covered under BOBRAM Rating Models) the existing guidelines will continue for the present.
2. SME Advance Accounts Rs. 2 lac and above up to Rs. 2crore- Please refer circular No.
BCC/BR/101/194 dt 13.07.09 ( BOI –SME )
3. Retail Loan: As per CRISIL Rating Models –Off line (BCC/BR/101/311
dt 12.10.09,102/201/29.07.10).(BOI- RETAIL LOAN)
Note:
Advance under Baroda Traders Loan with a limit of Rs. 25.00 Lacs & above will be rated under
BOB RAM
(b) BOBRAM / On line Module-
(i) The Rating models are based on two dimensional rating methodologies specified under
Basel- II requirements wherein –4- types of risks viz. Industry Risk, Business risk, Financial
Risk and Management Quality Risk are assessed pertaining to the characteristics of an obligor
(borrower) while facilities proposed / sanctioned to a company are assessed separately under
second dimension of rating i.e. Facility Rating. Thus, three ratings are worked out under
CRISIL solution viz. Obligor Rating, Facility Rating and Composite Rating.
(ii)The credit risk rating models as stated above cover 13 categories under 13 model are as
under;
Sr. No. Model Applicable for Rating of

1. Large Corporate 1. Manufacturing units with Annual Net Sales of over
Rs. 150 Crore and Investments in Plant & Machinery of
Rs. 10 Crore & above and for infrastructure projects
which have started cash generations from the project
operations with part / full implementation.
2.Service sector units with net annual sales over Rs.
100 Crore and / or investment in equipments of over Rs.
5 Crore.
2. SME (Manufacturing Manufacturing units with Annual Net Sales of Rs. 150
Sector) incl.Commercial Crore & below and / or Investments in Plant &
Enterprises Machinery less than Rs. 10 Crore.
3. SME (Services) Service Sector units with Annual Net Sales of Rs. 100

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Crore & below and / or Investment in Equipment of Rs 5
Crore & below.
4. Traders Units engaged in trading activities irrespective of sales
turnover.
5. Banks Organisations engaged in banking activities.
6. NBFCs Organisations registered with RBI / NHB for carrying
out non-banking financial activity / housing finance
activity.
7. Brokers Entities engaged in broking business in shares /
securities.
8. Infrastructure (Power) Infrastructure-Power Projects (Generation &
Distribution) - Build stage i.e. implementation stage
where cash generation from the project is not yet
started.
9. Infrastructure (Roads & Infrastructure-Roads & Bridges Projects - Build stage
Bridges) i.e. implementation stage where cash generation from
the project is not yet started.
10 Infrastructure (Ports) Infrastructure-Ports Projects - Build stage i.e.
implementation stage where cash generation from the
project is yet not started
11 Infrastructure (Telecom) Infrastructure-Telecom Projects - Build stage i.e.
implementation stage where cash generation from the
project is yet not started.
12 UAE Rating model for UAE territories
13 UK Rating model for UK territories
(iii) CREDIT RATING METHODOLOGY
The Rating Models for Commercial Advances are based on two dimensional rating methodology
specified under Basel -II Accord requirements. The credit risk rating process as per
BOBRAM Rating Models involves three types of ratings for each credit facility viz. 1) Obligor
( Borrower) Rating - for credit worthiness indicating the Probability of Default (PD), 2)
Facility Rating - representing the Loss Given Default (LGD) and 3) Composite Rating - which is
indicative of the Expected Loss (EL).
(iv) STEPS INVOLVED IN CARRYING OUT THE CREDIT RATING OF COMMERCIAL

ADVANCES:
Step 1: Selection of Appropriate Model

Based on the criteria narrated above, the applicable model is to be selected for rating
exercise.
Step 2: Data Sheet Preparation (off-line mode)

Having selected one of the applicable models for the rating purpose, only the prescribed CMA
data based input sheet and / or project profitability data input sheet downloaded from Bank's

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INTRANET or provided through Compact Disc (CD) during the training is to be used. This
sheet is to be filled in by the credit officers in the off-line mode after due diligence of the
CMA / Project financials etc by the appropriate authority, for that particular borrower.
Please note that only the prescribed data input sheet has to be used for the purpose of data
entry and subsequent uploading during the rating process. Any other data input sheet except
the one as stated above is not suitable for uploading during the rating process.
Step 3: Rating Exercise
1. The server is available on INTERNET site with the IP address:

http://prmcl001.bankofbaroda.co.in/bobram
2. Use the login name and password allotted by the IT Officer / Risk Officer at Regional
Office / Zonal office to enter the rating pages as explained at Para XV -(a).
3. Detailed methodology for the rating process has been released by way of circular No.
BCC/RM/CRC/98/12 dated 01/03/2006. The said circular also contains the manual for
operating instructions (OMRAM06) - a PDF file, which contains step-by-step instructions
for carrying out the rating process, may be kept at the branch / regional / zonal
office(Copy of the circular is already available on intranet-Corporate-Risk Management),
4. A credit officer is supposed to have done prior study of company's operations and should
have analysed rating parameters which are to be rated / scored for that particular
company under different modules. Prior study is essential, as the allotted score for a
particular parameter has to be supported with proper justification at the space provided
for the said purpose on the computer screen. For the illustrative purpose, a complete set
of parameters which are to be scored under different modules for Large Corporate Model
(LCM) appears as Annexure - IV.
5. Other data input requirements for rating of different modules under obligor rating is
already made available as under:
Rating of Industry Risk Score (except for SME / trading) - The credit rating officer has to
select the relevant industry sub sector at the activity page during the rating process.
Industry Risk score for all applicable parameters are already uploaded on the server for all -
118- industry sub sectors and the same is automatically filled in for the selected industry sub
sector at the industry risk module during the rating process. The credit risk rating officer or
the validator will not be able to change the industry risk score.
 Rating of Industry Risk Score (for SME / trading) - The credit Rating officer has to
carry out the rating of all parameters after selecting the dependent industry and the
risk scores under various parameters are not made available as in the case of other
models.
 Financial Risk Assessment: Data sheet for that particular borrower (refer step 2
above) is to be uploaded at appropriate prompt (Please refer the OMRAM06 which is a
step-by-step guide for this process). While most of the parameters are scored
automatically, only certain subjective parameters like comments on Obligor's
(Borrower's) ability to raise debt / equity etc. are required to be scored with proper
justification.

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 Business Risk / Management Quality Risk assessment: Necessary information / data
input required by way of Industry Profiles/ Updates etc. is already circulated as well
as uploaded on INTRANET at the Risk Management page. Please note that only the
parameters relevant to the industry of operations of the Obligor (Borrower) are
automatically made available for scoring. The other subjective parameters are required
to be scored by credit officer with proper justification.
Step 4: Facility Rating:
After completing the obligor rating as above, facility rating is to be carried out. For this
purpose, the security value is to be appropriated first against the respective facilities and
thereafter the excess security over the outstanding amount of facility enjoyed is to be
worked out. This excess security is distributed over the remaining facilities in proportion to
the availment.
The Limit amount of each of the facilities considered / under consideration and the amount of
securities, existing/ proposed, are to be worked out by above stated method by allocation of
excess security and then filled in at appropriate pages during the facility rating process as
the case may be. After filling up the data as stated above the facility rating, separate for
each facility, is automatically worked out by the system.
Step 5: Composite Rating (CR Rating):
This rating is automatically worked out, once the obligor rating and the facility rating are in
place.
With the completion of above five steps, the credit risk rating process is over.
Step 6: Submission of the credit rating to the Validator:

The credit rating officer is required to comply with the following steps:
a) Get -2- hard copy print outs of the "Interim Company Report" from the reports
section in the on-line mode. The relevant PDF file for "Interim Company Report" has
also to be saved in the system by the credit rating officer on his computer for any
reference.
b) One copy of the above stated "Interim Company Report" is to be sent to the
appropriate validator (Refer point No.1 of step -7). A credit officer has also to submit
the hard copies of the financial data (audited or provisional) along with the relevant
records, which have been used during the risk rating process to the validator for
further processing. The second copy of the "Interim Company Report" has to be kept
by the credit rating officer for records.
c) Credit risk rating done on software has to be submitted online to the validator (located
at the office of sanctioning authority) for further processing
d) Whenever a proposal for certain credit facilities is submitted to the sanctioning
authority, one hard copy of the latest validated 'Interim Company Report' received
from the validator is required to be sent to the sanctioning authority.

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Step 7: Validation
Credit Rating of borrowal accounts carried out under BOBRAM RAM (Risk Assessment
Models) Model are required to be validated and finalised by the respective authorities as per
extant guidelines
The validator is required to comply with the following steps:
a) The validator is required to validate the credit risk rating based on the financial data
(audited or provisional) & other relevant records, which have been used during the
credit risk rating process by the rating officer. However, all proposals falling under
the powers of branch Manager are to be validated at Regional Office Level or the
reporting authority level as the case may be.
b) After due validation, the validator is required to take out -3- hard copy print outs of
the 'Interim Company Report' and send one copy to the credit rating officer, the
other copy to the sanctioning authority and the third copy may be kept on records.
c) Validator is required to submit the validated credit rating to the appropriate
sanctioning authority through the system.
With the completion of seven steps as described above, the credit risk rating and validation
process stands completed.
Step 8: Submission of Validated Credit Risk Rating Report and other MIS Reports to the
Sanctioning Authority
The sanctioning authority has no role during the process of credit risk rating as also during
the process of validation.
After the completion of validation process, the concerned credit officer at the office of
sanctioning authority will receive a hard copy of the validated rating from the validator as
also a soft copy through the system. A copy of the validated rating report is to be attached
to the proposal.
The following reports could also be generated through the system.

a) Company Comparison Report
b) Financial Reports (All Labels) viz. CMA financials, Project Financials, Ratios
c) MIS reports like ASCROM Industry wise, Borrower group wise etc. as desired by the
authority.
d) Strengths & Weaknesses Report
3. PERIODICITY OF THE RATING EXERCISE
a) Rating exercise for advance accounts will be carried out on yearly basis
b) Credit rating on BOBRAM models based only on annual audited financials in all eligible
advance accounts as per existing guidelines. Only in case of any adverse situation
faced by the relevant industry/ company/ management which may come to the notice
of the Bank, either by the borrower or from any other source, rating may be reviewed
immediately in all such accounts with exposure (fund based +Non fund based) of Rs. 5
Crore and above.
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c) The rating exercise is not to be linked with the review of the account and it is to be
carried out in specified fixed periodicity (annual) based on accounting year of the
borrower.
Assuming that the financial year end of a borrower is March, the date of effect of the
interest rate arrived at based on credit rating will be 1st October.
Where the financial year end is other than March, the periodicity of rating exercise and the
date of effect of the revised interest rate will get shifted suitably, keeping the time gap
constant.
4. EXTERNAL CREDIT RATING:
i. All unrated advance accounts in respect of exposures on corporate in excess of Rs 5.00

crore will attract a risk weight of 100%. In view of the fact that bank will be required to
maintain additional capital against operational risk as per BASEL guidelines .It is
extremely important for the bank to reduce capital requirement against credit risk. Thus
the immediate need is to credit rate the large borrowers with exposure above Rs 5.00
crore by the approved ECAI (External Credit Assessment Institutions) [viz. CRISIL,
ICRA, CARE or FITCH for resident corporates both for Rupee Exposure and Foreign
currency and S & P, Moody‘s or FITCH for Non-Resident Corporate(overseas)
ii. External credit rating is relevant only with respect to credit exposure to four risk
categories namely (i) ‗Foreign Sovereign‘, ‗Foreign Banks‘ and ‗Non-resident Corporate‘ (ii)
‗Corporate‘ (iii) ‗Public Sector Entities‘ (PSE) (iv) ‗Primary Dealers‘ (PD)
The branch should NOT require the borrower to obtain external rating if the credit exposure
is classified in to any of the categories as under:
 Domestic Sovereign
 Direct Housing Loan to Individuals
 Commercial Real Estate
 Capital Market Exposure
 NBFC (excluding Asset Finance Company, which is to be treated as‗Corporate‘)
 Staff Loans
 Consumer Credit
 Non Performing Assets
 Regulatory Retail (where borrower wise aggregate credit exposure does not exceed Rs.
5 crore OR the borrowers average annual turnover does not exceed Rs. 50 crore)
Example: A partnership firm with FB limit of 3.00 crore and NFB limit of Rs. 2.5 crore and
average annual turnover of Rs. 40 crore will be classified as a corporate exposure as the
aggregated exposure of the borrower of Rs. 5.5 crore exceeds the threshold limit of Rs.
5crore
iii. The rating agency is required to review the rating at least once during a period of 15
months. Hence the ratings assigned to the borrower (Issuer Rating) or our exposure
(Issue Rating), as the case may be, may be due for review during the current year.
iv. Now as per notification no DBOD.No.BP.BC. 39/ 21.06.007/ 2011-12 dated 13.10.2011
issued by Reserve Bank of India, Credit Rating Agencies will henceforth use common
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rating symbols and rating definitions which will be applicable to all the new ratings
and rating reviews by them. Under the revised system the long term rating symbols
will henceforth display the name of the rating agency and the short term rating
would be denoted by ‗A‘ on a scale of ‗1‘ to ‗4‘ (i.e. A1, A2, A3 and A4) and ‗D‘. e.g.
CARE AAA, CRISIL AAA, Fitch AAA , ICRA AAA
v. Branch can also obtain the external credit rating sheet from respective rating agency
site e.g htpp://www.icra.in/

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16-CREDIT AUDIT
 Bank has established a Credit Audit Cell which is attached with Central Inspection &
Audit Division.
Objectives of Credit Audit
 Improvement in quality of credit portfolio

 Review of sanction process and compliance status of large loans
 Feedback on regulatory compliance
 Independent review of credit risk assessment
 Pick up of early warning signals and suggest remedial measures
 Recommend corrective action to improve credit quality, credit administration and credit
skills of staff etc.
 Coverage
All fresh sanctions / increase in limits where FB+NFB limit is Rs.5.00 crores and
above.
All existing accounts with FB + NFB limit of Rs.10.00 crores and above.
5% accounts (number) of Region on random selection basis with FB + NFB limit of
Rs.1 crore to below Rs.10.00 crores (FROM REST OF THE PORTFOLIO).
 Salient features of Credit Audit
 Credit audit should be conducted within 3 to 6 months of sanction / review.

 Credit audit of eligible accounts of one Region is to be carried out by Officers of
another Region within the same Zone.
 Zonal Office shall do the identification of Credit Auditors and eligible accounts.
 Accounts of CFS / Specialised branches shall be treated as accounts of the Regions to
which these branches are reporting for admin. Purposes.
 Identified Credit Auditors shall submit the Credit Audit Report in the prescribed
format within a period of 15 days to Credit Audit Department with a copy to the
concerned Branch and Region.
 A groomed credit officer / officer with good exposure in credit is normally appointed at
the Credit Auditor.
 Allotment of eligible accounts is done on quarterly basis within 15 days from the end of
previous quarter.

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17-MMR : MONTHLY MONITORING REPORT
 MMR is one of the tools of credit monitoring of advance accounts.
Objective of MMR is :-
 To prevent asset quality slippage
 To take timely corrective steps
 Improve the quality of credit portfolio
 MMR is to be submitted to respected authority within 5 days of the reporting date i.e.
15th of each month :-
Exposure (FB+NFB) WHO will monitor

Upto Rs.1 cr Branch Manager to monitor the --
account.
Above Rs.1 cr upto Rs.5 Regional Manager to monitor RO to forward the same to ZO
cr the account. for further monitoring.
Above Rs.5 cr upto Zonal Manager to monitor the ZO to forward the same to
Rs.10 cr account BCC for further monitoring.
Above Rs.10 cr BCC to monitor the account --
 HIGH RISK accounts : Exposure BOB 6 and below. BCC will monitor all such HIRG RISK
accounts where exposure is above Rs.1 cr through summary reports received from
RO/ZO.
 RO to further monitor all advance accounts with exposure from Rs.1 lacs to Rs.25 lacs
based on ASCROM scrutiny and all adv accounts with exposure above Rs.25 lacs upto
Rs.1 cr based on both ASCROM scrutiny and QMR.

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18- PSR : Post Sanction Reporting
 Bank follows a Post Sanction Reporting System replacing the erstwhile Post Sanction
Scrutiny.
 PSR is to be submitted to the next higher authority.
The features of PSR are:
 Covers all sanctions and credit decisions viz., Fresh / Increase / Renewal / Rejection
/Adhoc / Excess / Modifications / Waivers / restructuring / rescheduling etc.,
excluding sanction of staff advances, LABOD (i.e. post sanction reporting of LABOD and
staff loans is not required).
 Broad parameters relating to sanction are only examined by the PSR authority whereas
the sanctioning authority shall take care of all procedural details on credit appraisal,
adequacy of security, documentation etc.,
 Observations of PSR authority are to be attended immediately, which shall also serve as
guide to the sanctioning authority for future.
 Disbursement of credit facility/ies is not to be withheld merely for want of

observations of the competent authority on PSR.
 PSRs upto following exposure are to be submitted in single line statement format on
monthly basis to PSR Authority alongwith a common covering letter :-
Branches in Area Sanction Threshold Retail

(FB+NFB) Other than
Retail,
Excl LABOD & Staff
Loan
Metro & Urban Rs.25 Lakhs Rs. 5 Lakhs
Semi Urban & Rural Rs.10 Lakhs Rs.5 Lakhs
 For decisions involving exceeding above limits the following things to be individually
submitted within 3 days of date of sanction to PSR authority :-
 Copies of Credit Proposal

 Appraisal Note
 Latest financials with necessary comments by the sanctioning authority
 Latest credit rating sheet
 Gist of major adverse features and noncompliance of stipulated terms and conditions
and the sanctioning authority‘s comments thereon.

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 The PSR authority is required to clear the proposal from PSR angle within a period of –
30- days from the date of receipt of proposal by the PSR Authority. If the PSR
authority has not made any observation within the said period, it will be presumed that
the PSR authority has no observation to make and the proposal is cleared from PSR
angle.
 PSR authority :
Sanctioning Authority PSR Authority

Branch Manager Regional Manager
Regional Manager Zonal Manager
GM at Zone Corporate GM at BCC
Corporate GM at BCC Executive Director
Executive Director & CMD MCB

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19- PREVENTIVE VIGILANCE
 Non compliance of KYC norms

 Pre sanction inspection either not carried out or carried out in casual manner
 Photocopies of the documents submitted by the borrowers are not verified from the
originals
 Further genuineness of the same is not verified from independent sources
 Not obtaining credit reports from previous bankers of the borrowers/customers
 Accepting projections submitted by the borrowers without having/mentioning proper
justification
 Sanction of loans without preparing proposal in prescribed format
 Recommending credit facilities for sanction to higher authorities without incorporating
the relevant facts/information or without disclosing the adverse features
 Non observance of four eye principle
 Exceeding lending powers
 Allowing disbursement of credit facilities without compliance of all the terms &
conditions of sanction
 Seeking authority for disbursement of credit facilities from higher authorities by
submitting false/wrong confirmation of compliance of all the terms & conditions of
sanction
 Non/late submission of proposals of loans sanctioned to higher authorities for PSR
 Not responding immediately to the PSR queries/observations made by the higher
authorities
 Allowing disproportionate excesses immediately after sanction of credit facilities
without having sufficient drawing Power
 Allowing excesses even beyond the discretionary lending powers
 Not reporting immediately to higher authorities the excesses/TODs sanctioned
 Not conducting timely post sanction inspections so as to ensure end-use of funds
 Recommending take over of the accounts from other banks without compliance of the
requirements as per Bank‘s guidelines
 Proper verification and cross checking of information / papers submitted by the
borrower. Noting should be made on the documents for having verified with originals
 Income related papers should be got verified through Practicing Chartered Accountants
empanelled for the purpose
Let us draw a Lakshman Rekha
 Extra care and caution while granting loans where mortgage of immovable property is
involved. It is difficult to distinguish fake document from the genuine ones. For this
purpose knowledge about the customer is a must. Personal visits to the property site
and verifying the Title Deeds should be ensured in all cases.
 Select the panel advocate by experience and enquiry with your colleagues. Counter check
his work by personal verification at Sub-Registrar‘s office occasionally.
 Cash Credit and other Working Capital Limits can be entertained only after gaining
sufficient experience and after ascertaining antecedents of the borrower by way of
market enquiry, scrutiny of statement of accounts maintained with other banks etc.

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 Working Capital limits should be assessed with adequate care by following norms
prescribed. Adhoc limits should not be sanctioned / recommended without sufficient
additional evidence / justification.
 By experience you know the nature of Bills which can be purchased / discounted. If you
know that a particular Bill / cheque is accommodative in nature, party‘s request should
not be entertained despite any pressures from any corner.
 Inspection of stock as per norms should be conducted with diligence and intelligence. If
you are unable to assess the quantity, quality or value due to specific nature of the
commodity, recommend for the assistance of experts in the line. Borrower should know
that you are serious about the task.
 The mantra for granting working capital limits continues to be – need based, purpose
oriented and timely.
 Operation in the account is an indicator of health of the unit. Fall in turnover, slow down
in manufacturing / trading activity are signs of incipient sickness
 Officers should be weary of target oriented lending such as Tractor Loans. Involvement
of Dealers, dilution of minimum land holding stipulation to facilitate large number of
loans etc., are clear signs of short sightedness.

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20-MAJOR TIPS/ CHECK POINTS
Pre – disbursement/Sanction:
a. Pre sanction inspection done, including that of immovable property. Report attached (
in fresh/review with increase ,both cases)
b. Receipt of Financial statements of last 2 years, current FY(estimated) and next F.Y.
projected. In case of TL, Projections for the repayment period.
c. Analysis of Financial statements (calculations of Ratios etc, Ratios are as per bench
mark. ( Refer Ann )
d. Credit Rating is done & validated.
e. ROI – Stipulated as per Bank‘s guidelines/Rating, ( Refer Ann )
f. Concession – Whether approved by appropriate Authority.
g. Whether continuation of the same got approved.If credit rating is declined ,
concessions cancelled .( BCC:BR:99:325 DATED 29.10.07)
h. Mortgaged property – valuation & legal opinion i.e. NEC for 30 years.
i. Deviation/modification got approved by higher authorities.
j. Borrowing Power & Common Seal Clause (in case of Company) to be ensured based on
Memorandum & Articles of Association.
k. CIBIL Reports generated/verified.
l. Assessing working capital: Proper Method applied. ( Refer Ann )
m. Conduct of A/C verified from Credit Report/account statement.
n. TEV study is based upon project cost only and not linked to size of exposure.
 Up to Rs.10/-crores-Not required.
 By agency empanelled : upto 30/- crore.
 From Rs30/- crores to Rs 300/- crores : In Zone where bankRs.s technical
officers are not posted or are in scale I /II , such zones should refer the
matter to PFD for carrying out TEV study.If Technical officer , posted in zone,
is of scale III / IV , he can carry out TEV study up to Rs 200/- crores.TEV
study of project of cost of more than above ceilings to be referred to PFD.
 For above Rs300/- crores, TEV study by PFD OR if already done by other bank
then vetting by PFD.
 ZOCC are authorized to waive projects due for TEV study where project cost
is upto Rs.15/- crores and the proposal falls up to DLP of the ZOCC.
 For projects with the cost above Rs15/- crores , the power to waive TEV study
shall rest with Credit Approval Committee (CACB) of Board.
 BY BCC project cell : up to Rs300/- crore
 Vetting of project reports by PFD is mandatory only where the cost exceeds
Rs.300/- crores
 No TEV study is required for appraising Real estate projects, General
Hospitals and Baroda Vidya Sthali
 In case of extension of project, only incremental project cost will be considered
for TEV study
o. Terms and conditions got acknowledged by borrower/guarantors.

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p. Take Over norms followed. ( Refer Ann )
q. Activity Clearance obtained. ( Refer Ann )
r. Whether under DLP. ( Refer Ann )
s. Charge with ROC noted.
t. ROC search & Status report obtained. (Satisfaction of charge also )
u. Legal Compliance Certificate.
v. All Sanctions in respect of Fund-Based and Non Fund-Based credit limits (excluding
LABOD & Staff Loans) up to Rs. 10 lacs (Rs. 5 lacs for Retail Loans) are only to be
reported to PSR authority on monthly basis in the prescribed format. ( Rs25/- lacs for
metro & urban).Proposals of credit facilities above Rs 10/- lacs ( retail above Rs5/-
lacs) for rural /semi urban & Rs25/- lacs for metro /urban areas are to be sent to RO
for PSR within 3 days from the date of sanction. RO to clear the proposal within 30
days.
II. DOCUMENTATION:
a. All documents are properly filled in and duly signed by

borrowers/guarantors/firm/company and supported by Board Resolution, where
necessary. LDOC-I DULY SIGNED.
b. All documents are adequately duly stamped.
c. List of P/M attached with Hypo Agreement./LDOC-19/17B.
d. Equitable Mortgage:
 Chain of documents complete. No laminated title deed.
 Permission/NOC/Noting of lien from appropriate authority obtained
 Mutation obtained.
 Memorandum properly prepared and signed.
 Owners‘ signatures on mortgage confirmation/attendance sheet Obtained.
 Noted under CERSAI.
e. Succession Clause – D.P.Note,LDOC-5 (6),LDOC 7 ,Hypo etc in case of enhancement of
facilities (Personal guarantee for full amount)
f. Power of Attorney in respect of Book Debt facility got notorised & registered with
Sundry Debtors as per sanction. Documents executed by POA holder – norms
followed, permission from higher authority obtained, POA got vetted from legal
cell.etc.
g. Vetting – Done, discrepancies rectified.
h. Doc. To be obtained on enhancement.
i. Documentation where credit facilities are changed : OD → CC → OD.
III. Disbursement & Post Disbursemant :
 Authority for disbursement obtained. (If applicable).Amt disbursed as per sanction. End
use verified.
 In case of Company – No disbursement without Charge Registration
 Proposal sent to R.O. for PSR.
 Conduct of A/C, returning of cheques ( Below Rs one crore –six times & above Rs one
crore four times matter to be taken up with higher authority for immediate review) ,
unusual transactions.
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 Turnover.
 A/C opened in Correct Menu & Correct ROI being applied.
 DP – Sundry Creditors are deducted from DP, Sundry Debtors o/s for prescribed period
only are taken into account, CA certified statement of Book Debt(Qty.) being received
or not.
 QMR/QIS – whether being received & processed.
QIS I : One week before commencement of quarter.
QIS II: With in 6 weeks of close of quarter.
QIS III: With in 8 weeks of close of H.Y.
 MMR – whether being sent. Rs one crore and above on monthly basis Rs25/- lac to Less
than Rs100/- lac on QTY basis to RO
 Godown Inspection/Periodical Inspection of securities charged to Bank. Now linked with
credit rating :
BOB 1 TO 3 : H.Y, BOB 4 TO 5 : QTY, BOB6 & below :Bimonthly
Fixed assets ( DL/TL/DPG) : H.Y ( JAN &JULY) Collateral : yearly
 Insurance of primary & collateral securities charged : Agreed Bank clause, average Bank
clause.
 Excesses/overdrawing/TODs are allowed as per norms. ( Refer Ann )
 Adhoc – whether sanctioned by Competent Authority, Documents obtained, Mort.
Extended, ROC charge created, Adhoc adjusted within time, ROI 2% over applicable
ROI is to be charged.
 Repayment schedule/status to be monitored
 Facilities to be reviewed /LAD to be obtained with in stipulated time. ( Refer Ann )
 Latest ROC search report to be obtained on annual basis.
 A/C properly classified in ASCROM & FINACLE. In NPA A/C – whether intt. Application
stopped and unrealized income reversed.
 Formalities – change in constitution of firm.
 Zonal Heads, up to the designation of Deputy General Manager, are authorized to
waive/relax levy of penal/ additional interest in respect of accounts falling up to the
powers of Regional Managers.
 GMs (including GMs as Zonal Head) are authorized to waive / relax levy of penal /
additional interest in all other cases.
 COMMITMENT CHARGES :Accounts with fund based working capital limits of Rs.10
Crore and above.
-To be levied on quarterly basis @ 0.50% p.a.plus service tax in case of accounts where
the average utilization is below 60% of the Limit OR indicated in the QIS/ QMR
statements. It is to be charged on the amount of under utilization below 60% in all
working capital facilities of Rs.10/- crores and above.
 ADV to a/c where HUF is a partner:
a. No credit facility to be granted to firm.
b. Existing a/c –letter of consent from major members of HUF declaring
themselves as partners of firm. Total no. of partner max 20.
c. No HUF property to be obtained as security for any facilities given to any other
individual/firm/co unless and otherwise Karta /all major coparceners/guardian of
minor coparceners claim that such offering is for the benefit of HUF.

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21-PREPARATION, SANCTION & SUBMISSION OF CREDIT PROPOSALS
PREPARATION OF PROPOSALS
When a decision has been taken by the Branch Manager to consider favorably the
borrower's request for sanctioning / recommending of various credit facilities, the
branches should prepare a formal proposal in writing.
The proposal should be prepared for all borrowers irrespective of size of the credit
facilities.
The preparion of proposal is based on Application forms submitted by the prospective
borrowers.
LOAN APPLICATION FORM:
a. Loan application form duly filed and signed by borrower / constituent is the prime
loan document.
b. Documents obtained by the Bank, form the basis upon which the Bank may file a suit
as & when found necessary, in a competent Court of Law against the defaulting
borrower. In the absence of properly executed documents, the onerous burden of
proof is on the Banker
c. Application form not filled in / partially filled in / incorrectly filled in should not be
accepted.
Types of Application Form:
(a) Govt. Sponsored Scheme : As per scheme.

(b) BKCC : As per BKCC Mater Circular
(c) Retail Loan : Refer BOI IV
(d) SME : Refer Cir BCC/BR/101/13 dt 03.01.09
i. Standard schedule of fee / charges relating to the loan application depending on the
segment, to which the accounts belong, will be made available to all the prospective
borrowers in a transparent manner, along with the loan application, irrespective of the
loan amount. Likewise, amount of fee refundable in the event of non-acceptance of the
application, prepayment options and any other matter which affects the interest of the
borrower will also be made known to the borrower at the time of application.
ii. Receipt of completed application forms will be duly acknowledged.
iii. The acknowledgement would also include the approximate date by which the applicant
should call on the Bank for preliminary discussions, if deemed necessary.
iv. All loan applications will be disposed of within a period of 4 weeks from the date of
receipt of duly completed loan applications i.e. with all the requisite information/papers.
v. In case of rejection of loan application, irrespective of category of loans or threshold
limits, the same would be conveyed in writing along with the main reason(s), which led to
rejection of the loan application. The time frame for conveying the reason/s of

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rejection will be as per Schedule contained in circular BCC: BR: 103: 291 14th October
2011
vi. When a prospective borrower submitted a loan application for sanction, the appropriate
authority may either sanction or reject the proposal.
vii. The decision to sanction or reject the proposal has to be based on a careful analysis of
various facts and data presented by borrower. The sanctioning authority should
convinced that the money lent to the borrower for the desired purpose will be safe and
it will be repaid with interest over the desired period. To arrive on conclusion KYC norms
should be satisfied by pre sanction inspection.
Formats for preparation of credit proposals :
1. Various types of formats are prescribed for preparing credit proposals for different
activities.
2. For Agricultural & Retail Advances specific formats are prescribed. Similarly for
SME borrowers, separate formats are prescribed for borrowers
3. For other
a. types of borrowers, there are following types of formats prescribed :
a. For overdraft/demand loan bank‘s own time deposit receipts/recurring deposits form
no. 117C as given in Appendix –VIII
b. For Retail Lending prescribed formats for various schemes are given in Book of
Instruction on Retail Lending Schemes.
c. For credit facilities upto Rs. 50/- lacs.( 12 page Proposal Format)
d. For credit facilities exceeding Rs. 50/- lacs.(New MCB Format- Subject to approval
from the Competent Authority )
Annexures to be enclosed to credit proposals
After the proposal has been prepared in prescribed format the following annexures
are invariably to be attached to the same :
i. Application/Letter of request duly signed by the borrower.Copies of latest financial

statements like balance-sheet,
ii. profit & loss account and also for previous 1 to 2 years.
iii. (iii)Copies of credit reports on guarantors, partners, directors etc. in Form- 135 &
117A as per format given in Appendix-XIA & XIB.
iv. Copies of wealth tax, income tax and sales tax returns, wherever applicable.
v. Other enclosures, as may be relevant to the credit facility to be sanctioned.
Guidelines for preparation of credit proposals :
(i)The detailed guidelines for preparation of various proposals in respect of financing

of agriculture, SME & Small Borrowers are given in respective chapters in BOI
Volume 6 & 7.

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(ii)Given below are some guidelines for filling in following two types of proposal
formats used for submission of credit proposals in general & Whole sale proposals in
particular.
(a) Format for credit proposals upto Rs. 50/- lacs.
(b) Format for credit proposals exceeding Rs. 50/- lacs.
Format for credit proposals upto Rs.50/- lacs :
 The format contains 14 pages divided into 3 parts :

 First part containing 33 items (Pages 1 to 9) eliciting the important information
about the borrower's financial parameters, details of the proposal, branch's
commendations etc.
 Annexures A & B giving the computation of working capital
 assessment and various financial ratios.
 Supplementary information sheet (To be used in case of review of existing
accounts).
 While most of the information‘s sought will be readily available at the branch,
the following points may be kept in mind while filling in following items :
Item No. Particulars Remark

1(b) Borrower No. As per extant guidelines each borrower has
to be given a unique Borrower number which will
be common for all the facilities to the same
borrower
2(a) Is it a subsidiary If the unit is a subsidiary of another Co/unit,
the name of the parent Co/unit to be mentioned.
5 Date of If the unit has been reconstituted after first
incorporation incorporation, such date of reconstitution &
nature of reconstitution to be mentioned
8 Net Worth/ In case of partnership firms, credit/debit
Share/Partners' balance in capital partners current a/c with the
Capital firm is to be added/subtracted to/from the
share capital a/c.
14 Yield To be mentioned as %age & also in absolute

amount (Rs.)
15 Date of Last Please specify whether it is Regular Review/
Sanction/ Review Short Review
16 Commitments with 1. Latest credit report should be obtained
other Banks from the bank and be enclosed
2. The latest asset classification should be
mentioned
3. Branches should obtain credit Report from
the other banks and The information such as
Outstanding, overdues, if any,. should be

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incorporated in the proposal. Credit report
obtained may be kept on branch's record.
17 Details of Sister/ 1. Copy of latest balance sheet to be enclosed.
Associate Concerns 2. Latest credit report should be obtained from
the bank and be enclosed.
3.Their asset classification should be
mentioned. Whether any overdues in their
accounts. If yes, since when & steps taken
for adjustment of the same.
20 Adverse comments Here the branch should not only give the
of Inspecting adverse comments of RBI Inspecting Officers
Officers/Auditors / Bank's Inspecting Officers / Auditors /
Concurrent Auditors, but also the branch's
comments on the remarks & the status of
rectification
20A Compliance of terms Only conditions not complied with in full should
& conditions of be stated with reasons for noncompliance,
sanction present position and action plan to comply with
the same.
21 Operational Details a) Each Term Loan, Demand Loa to be shown
separately.
b) Each facility to be shown separately.
c) If bills have been returned unpaid, state
specifically whether they are promptly
adjusted or not. If not adjusted, reasons
thereof, are given.
d) Data to be given separately for guarantees &
L/C's. In case of L/C's, state whether it is on
DA basis or DP basis
31 Appraisal Note 1. The note should be precise and logical
2. It should give justification for sanctioning
various credit limits based on facts & figures.
32 Specific 1. The branch should specifically recommend for
Recommendations sanctioning of credit facilities proposed. It
should avoid using ambiguous terms
2. It should be recommended by the Branch
Manager
Annexure As per extant guidelines for fund
Rs.A' based working capital limits upto Rs. 5/- crore,
the limit is to be assessed as per Tandon
st
Committee 1 Method norms or20%of Projected
turnover whichever is higher. As such, limits
should be worked out as per both the criteria
& then fix the limit for sanction.

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Supplementary Information Sheet -This should be used only for
review of existing facilities.
Format for credit proposals exceeding Rs.50/- lacs (fund
based) MCB Format- Subject to approval from the competent
Authority
(i) The MCB format divided into two parts :Section I- Details of
Proposal & Section II- Financial Performance
(ii) Part-I contains Gist of Proposal / Issue for consideration ,Modifications, Adhoc /
excess data in case of existing account ,Basic Data, Name and back ground of Promoters
, Share holding pattern in case of Company ,Conduct of Account ( existing as well as in
case of take over account) ,Major inspection irregularities ( existing account)
,Compliance of Search from RBI Willful defaulter list, ECGC defaulter list , CIBIL &
other approved credit information companies incorporated under CICA Act,2005 & Take
over norms etc , Justification , Recommendation , Sanction & Legal Compliance
Certificate ( advance account for the exposure of Rs.1 crore & above )
(iii) Part-II contains Financial Performance , Assessment of Credit Facilities &
Annexures A to O analysing the financial statement of the company in various forms.
(iv) The format should be used for all proposals exceeding Rs.50/- lacs, whether
fresh/review/review with increase.( Proposed )
(v) Given below are some of the important guidelines/instructions that should be
kept in mind while filling up the format :
General :
Ensure that :
a) the proposal is in the prescribed format; duly filled in full, leaving no room for
ambiguity.
b) classification of the proposal, viz. new, review, etc. is indicated.
c) the authority to whom the proposal is to be submitted ultimately is indicated.
Please refer to Circular on DLP / Chapter on DLP /Domestic Loan Policy /RBI Circulars
for lending powers and detailed special provisions regarding restricted powers for
granting advances/facilities in respect of the following :
Advances against bank's own shares /against approved shares & debentures.
Restrictions on Holding Shares in Companies
Restrictions on Credit to Companies for Buy-back of their Securities
Money Market Mutual Funds
Advances against Fixed Deposit Receipts (FDRs) Issued by Other Banks
Grant of Loans for acquisition of Kisan Vikas Patras (KVPs)
d) to senior officers of the bank, their relatives or concerns in which such relatives
are interested.
e) Advances to bank's Directors -to directors of our bank, of other banks including Co-
operative banks, their relatives or to concerns in which they or their relatives
are interested as proprietors, partners, directors or guarantors.

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f) to leasing/hire purchase companies.
g) Restrictions on Grant of Financial Assistance to Industries Producing / Consuming
Ozone Depleting Substances (ODS)
h) Restrictions on Advances against Sensitive Commodities under Selective Credit
Control (SCC)
i) against hypothecation of book-debts/by way of co- acceptance of bills.
j) Advances against Bullion/Primary gold
k) against pledge of gold/silver jewellery/ ornaments to dealers or under priority

sector.
l) Gold (Metal) Loans
m) Advances to Agents/Intermediaries based on Consideration of Deposit Mobilization
n) Loans against Certificate of Deposits (CDs)
o) Bank Finance to Non-Banking Financial Companies (NBFCs)
p) Loans and advances to Commercial Real Estate Sector
q) Working Capital Finance to Information Technology and Software Industry .
r) bank finance for PSU disinvestments of Government of India
s) Bridge Loans against receivables from Government
New MCB Format :
(A) Section 1- Details of the Proposal:
(1.0) Gist of Proposal/Issue for consideration - This section contain following parameters:
(1.1)
a. Purpose , existing limit, proposed limit , Present O/s bal Overdue if any in existing
account as on date to be incorporated and overdue in term loan/DPG
installments/interest, if any will be discussed under head Justification :
 Amount and period for which they are overdue to our bank, other banks and
financial institution should be mentioned.
 Reasons for overdue will be mentioned.
b. Details of existing / proposed Concession i.e. ROI , Commission, TEV & processing
charges etc to be reported and justification for the same be reported under head
Justification.
c. Deviation in any parameter e.g. Current ratio in case of ME enterprises should be 1.33:1
as per bank‘s extant guidelines /norms where in in proposed proposal it is below 1.33:1.
In that situation it is a matter of deviation and must be incorporated and note to that
effect be given.
d. Modification; Any modification in terms and condition in context with existing sanction
will be incorporated

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1.Detailed terms & conditions of sanction, existing/ proposed and that to be modified with
reference to proposal should be stated herein, in respect of each of the facility. This
would include :
1. Nature of facility.
2. Limits existing and proposed, sub-limit under the limit as well as at various
branches and restrictions/ interchangeability, etc. for drawings under the limit.
3. securities.
4. Repayment schedule for term loan/demand loan, clearly specifying the date
on which the recovery of instalment/interest to commence, the amount of
instalment and the date of last recovery of instalment.
2. Any release in securities / gurarntee wherever dilution is taking place to be referred to

next higher authority for approval before considering sanction.
e. Confirmation ; Any unconfirmed action during the review period will be incorporated here
for confirmation of the action from the sanctioning authority ,e.g. An unreviwed
account from due date of review requires confirmation for continuing the existing
facilities till date of review from the sanctioning authority as the existing sanction was
for a period of 12 months only.
(1.2) Reference of existing sanction and dure date of review will be incorporated along with
sanction no & authority
(1.3) Adhoc / excess sanction during the review period . The Appraisal contain Sanction no.,
date of sanction , authority and gist of such adhoc/excess
(2.0 ) Basic Data :-It includes following data
(2.01) : Asset classification / Credit Rating along with previous 02 rating / external credit
rating (where ever applicable) ,constitution , Risk weight age , group , nature of activity ,
banking arrangement , security available,
Details of securities and securities coverage ,FACR ( in case of Term Loan only ) will be
clearly mentioned with full details and the same must be cross verified with Advocate
report as well as with Title deed , Valuation report .
Address of each unit need not be indicated. Location of each unit will suffice etc
will be looked into.
In case of Export Oriented Unit (EOU) ,State specifically if the unit is

predominantly export oriented or 100% EOU.

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(2.02) Banking Arrangement -facilities with us & other banks (existing limit)
1. The information should be given bank-wise/institution-wise.
2. Asset classification of these facilities should be stated.
3. Brief comments about utilisation, overdues in a/c,securities and its value etc. should
be given.
(2.03 ) Any restructuring in last 03 years will be incorporated and will be commented in
brief under bullet points
(2.04 ) Name of Promoters/ Proprietor/guarantors etc : The name of Promoters/ guarantors

and their updated net worth will be furnished here . We have to look into whether it
has undergone any changes since last review due to reasons such as merger,
amalgamation, etc. or for any other reasons. If yes, details should be indicated. DIN Of
Directors to be furnished here and to be satisfied upon
(2.05) Share holding pattern in case of corporate to be furnished and cross verified upon.
(3.0) Back ground of Firm / Company : An informative brief note should be incorporated in
view of taking credit decision
(4.0) Conduct of account and other information e.g. compliance of exiting terms and condition
, yield in the account, licenses and approvals , utilisation of limits etc be incorporated
.Following points to be observed :-
a. Please state clearly about the conduct of the account.

b. If the conduct is not upto the mark, the same should be indicated clearly without
any ambiguity and the reasons for such unsatisfactory conduct should be
mentioned.
c. Similarly, the authorities at various levels below the sanctioning authority should
state unambiguously whether each one of them recommends the proposal or
not.
d. Please state clearly about the non compliance of earlier terms & conditions if any
with specific reasons .In addition to indicate about :
(i) regularity of submission of QMR/QIS statements, please indicate whether penal
interest is charged for non/ submission of statements. Whether quarterly review
meetings are held regularly and operative limits are fixed (applicable if aggregate of
fund based limits is Rs. 100/- lacs or above.)
(ii) compliance of the terms & conditions of the sanction by the borrowers, state clearly
whether penal interest is charged for the non-compliance of any of the terms. If
the borrower is non-cooperative on any score, it should be brought to the attention of
the higher authorities invariably.

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(a) Please state clearly whether . documentation is complete in all respect, please also
indicate whether the same is verified / vetted by the empanelled advocate / legal
department of Regional/Zonal Office in the case of advances with aggregate limit
of Rs. 10/- lacs & above and deficiencies if any noticed in the verification including
that of the inspecting officers/auditors are rectified. If not, specific steps taken
for the rectification should be stated.
(b) Yield its details, viz. percentage, and amount in absolute terms and the period to
which it pertains (i.e. the preceding year) If the yield is abnormally low or high, the
reasons therefore should be stated in brief.
(c) Please state clearly whether clearance / approval have been obtained from the
competent authority e.g. Pollution clearance from Pollution control board.
(4.01) Major Inspection / Audit irregularities /Auditors remarks will be incorporated

such as Concurrent audit /RBIA/RBI/Statutory Audit/Credit audit /Stock audit
wherever applicable and any observation of Credit Monitoring Department
(4.02 ) Auditors Remark of the Company /firm – Qualification remark, Contingent

liabilities and whether statutory dues have been paid or not should be looked into and be
incorporated here.
(5.0) Compliance of credit information norms e.g.

(i) RBI defaulters list/Willful defaulter list/ECGCcaution list /CIBIL Report etc be satisfied
upon and incorporated herein
(ii) Whether take over norms have been complied with, wherever applicable
(iii) Whether directors of Company / borrower are relative of any member of the Bank‘s
board /senior officer of the bank or member of the any other Bank‘s board be
incorporated .As per RBI guidelines there is regulatory Restrictions on Granting loans
and advances to relatives of Directors / senior officer of the bank or member of the
any other Bank‘s board
(iv) In case to exposure to BOB- 7 accounts-The financial parameters to be indicated and
commented . As per extant guidelines , accounts with BOB-7 or below as per BOBRAM
(CRISIL) rating model or C rating or below, as per old rating model, falling under the
normal delegated lending powers of any authority below Zonal Head, additional exposure
is not to be taken by such authority. If the exposure, including the increase portion is
upto Rs.25 lacs, the proposal may be considered by Zonal Head on merits
(v) Exposure to industry be incorporated e.g. Sectoral Cap,NPA at Bank and Zone Level and
the same can be obtained from ACROM Cell BCC/ZO/RO
(6.0) Details of associate/subsidiaries/group concerns to be incorporated here in e.g.

The DLP of Assistant General Manager for Fund based & non fund based advance in
context with Single party is Rs.9 crore and for a group is Rs.18 Crore only.
M/S ABC has applied for a Fund based limit of Rs.6 Crore where in M/S CAB the
associate of M/S ABC is enjoying a limit of Rs.14 crore from us ( Bank of Baroda) , the

Page 166
instant proposal does not fall under the DLP of an Authority up to the rank of Assistant
General Manager
(7.0) Justification : The most important portion of appraisal note is justification . This
section contain only and only justification for recommending the proposal preferably in
bullet points and no praise letter or rosy justification should be given
Under justification the recommending officer gives plausible explanations to why

sanctioning authority think these recommendations are justified. When the Credit
Officer gives a justification , he/she basically want to let the Sanctioning authority
know why he/she should agree to your opinion.
Basically, why does what Credit officer comments under this head matter? It should be
used to defend opinion of recommending authority
(i) Existing as well as Proposed Fund based / Non Fund based – Justification must be in
bullet point facilities wise that why we are recommending to accord sanction or
recommending to continue the facilities e.g. Term Loan , Working Capital .
(ii) any concession/ waiver etc requires justification in plausible manner .
8.0 – Legal Compliance Certificate – In case of an advance having exposure of Rs.1 Crore
and above the certificate will be signed by the sanctioning authority.
B. Section II – Financial parameters and Assessment along with brief comments on

financial , Assessment , Industry scenario , SWOT analysis along with annexures A to O
will be looked into
a. State briefly the percentage improvement / deterioration in the performance

parameters, like sales, cash profit, net profit during the last year (for which
audited results or provisional figures are available) compared to its previous
year.
b. Whether the actual result as above was in alignment with the projections
earlier made or not should be indicated spelling out the reasons for any mis-
match.
c. How the financial position of the company improved/ deteriorated during
the year due to its operations?
d. What is the percentage of operational surplus retained in the business ?
e. What is the level of fresh injection of funds into the business to take care of the
depletion of owned funds due to losses or reduced liquidity position due to
delayed realisation, etc. ?
f. How the position is expected to change/improve in the years for which
estimates/projections are given should be indicated in brief.
g. State in brief your comments on the variations of the ratios with reference to the
above points.
h. Full details of funds invested outside business should be incorporated and
branches should certify that the same are not included for the purpose of
calculation of MPBF. In short, funds invested outside business should not be
treated as current assets.

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All the borrowers enjoying working capital facilities funded limit of Rs. 1/-
crore and above, should submit a certificate from their Chartered Accountant
regarding the position of funds invested outside business.
(9 ) Other General Points :-
(i)Production capacity :
a. Licensed and installed capacities (in quantity or numbers, etc.) for the years
last audited and next successive two years (i.e. estimates and projections)
should be given for each of the products.
b. If the product is not subject to control of licensing, it should be stated clearly.
c. Following check-points may be answered briefly :
1. Is/are the installed and/or production capacity/ies in excess of licensed capacity.
2. If yes, is it within the permissible level.

3. If not, whether requisite specific permission therefore is obtained.
4. In the case of installed capacity lower than the licensed capacity, is the
company going in for any expansion.
5. If the production is lower compared to installed capacity, what are the reasons.
6. It should be ensured that the estimated/projected capacity based on which
assessment is done, is in tune with the licensed and/or the approved expansion
programme of the company.
(ii) Raw materials, etc. and market for finished products, marketing set-up
Special features like availability of raw material, marketing organisation, capacity

etc. concerning the above should be indicated stating constraint, if any.
Major suppliers of raw-materials/customers of company's products :
(a) Names of 4/5 major suppliers/customers need be mentioned.

(b) Separate sheet therefor, need not be attached.
(c) In the case of opening of LCs, execution of guarantees, please
indicate the validity period of the same (and in the case of LC, expiry date
for shipment/negotiation, tenor of the bill), cash margin, security etc.)
Annexure A
Details of Major share holders of susidaries /group concern
Annexure B
Name and business experience of director / promoters ,NUp dated net worth & ,DIN
etc
Annexure C
Page 168
Brief Back ground of the Company will be discussed here . Branch to ensure search of
company details through their CIN
Annexure D
Please check up to ensure that all facilities detailed in appraisal note & Annexure-D
are same.
ANNEXURE-E
1. Form II, Operating Statement of the revised CMA format corresponds to
the Annexure-E of the proposal.
2. This form gives the operational data relating to gross sales, excise duty, net
sales and also data for arriving at the cost of production and cost of sales.
Profit position is also shown in this form.
3. The operating statement, which shows the projections, is the starting point of
the whole exercise of assessing the working capital requirements. So, the
assumptions made have to be studied in depth. It should be ensured that -
 The data furnished are strictly in the prescribed format. For instance, in some
cases it has been observed that the borrower has classified excise duty as
an item of expenditure, whereas in the prescribed format excise duty is to
be deducted from the gross sales to arrive at net sales. Similarly the tendency
to combine the items in the format or adding new items is also not to be
permitted. The data should invariably conform to the prescribed
format.Clarifications where necessary may be given by way of notes to the
relative format.
 The assumptions based on which projections are made are valid & realistic and
the consumption of raw materials, various items of expenses,cost of
production,cost of sales, operating profit, etc. are comparable and in tune with
the past rends/estimates/projections of the sales. If there are any significant
variations say due to product- diversification, change of technology, shift in
production in favour of items of higher value etc. such larifications and
comments are to be furnished.
 Whenever the borrower is having more than one division, evaluation of
performance of various divisions/product range is to be made so as to assess
viability of operations of each division/product. Branches should endeavour
to collect, wherever available Division wise/productwise Balance Sheet of the
concerned companies.
 The valuation of the sales projections should be based on the current ruling
prices. Similarly the valuation of various inputs of cost of sales in the
projections should also be based on current costs. It should be ensured that
price escalations are not built into the projections. Where the projections
relating to production show wide variations in mparison with the past trend,
information in regard to the physical quantity of goods produced/to be
produced, their unit price, etc. should also be furnished. Where the number of
items anufactured is large, the information be classified under three or four
broad categories.

Page 169
ANNEXURE-F
This annexure corresponds to analysis of balance sheet .
1. Short Term Bank Borrowings
(a) Ensure that bills purchased/discounted and excess borrowings placed on repayment
basis (WCTL) are included in short term borrowings.
(b) The quantum of BP/BD facility should be shown separately against 1 (iii)
Following points are also to be noted :
1. What is the percentage of BP/BD facility to aggregate limits for financing inland
credit sale.
2. If it is below 25%, what are the reasons for not increasing it to 25%.
3. Are they justified and the facility is allowed to be continued at less than 25% of
the total post-sale limit.
4. If so, it should be stipulated to charge additional interest @ 2% p.a. on the

portion of the drawings against book-debts in excess of 75% of limits allocated
for financing inland credit sale.
(c) What is the percentage increase/decrease in short term bank borrowings annually ?
 Is it in tune with increase/decrease in sales turnover?
 Estimated/projected bank borrowings should be tallied with PBF/MPBF & Excess
borrowings as per Form V.
 If it is not tallying, the details/reasons for proposing fund based working
capital limits other than as per the assessment should be indicated.
(d) Compare the actual bank borrowings and limits earlier sanctioned by the banks.
 Large variance, if any should be explained.
 Verify the outstanding with the bank/s as shown in the balance sheet/this format
with the relative actuals.
 Ensure that party is not availing banking/credit facilities without the
knowledge of the bank/consortium.
2. Short Term Borrowings from Others :
a. Is it increasing or decreasing ?
b. Estimated decrease from actuals would mean repayment.
c. Ensure that bank facilities are not increased for the diversion of short term
borrowings usually available as per the business practice or for the repayment of
the inter corporate deposits raised earlier as per the stipulation of the bank.
d. Ensure that the terms upon which these are raised are not detrimental to the
interest of the business/our Bank.
e. Ensure that under the guise of interest payment through the medium of this
account, business profits are not diverted outside the business.
Page 170
3. Deposits (Maturing in one year) :
(i) Includes Fixed Deposits from public maturing within a year. Deposits from
dealers etc. should be classified in item 19.
(ii) Deposits in respect of margin on L/C/Guarantee should not be included under
this item and the same should be classified as current assets for the purpose
of MPBF.
4. Sundry Creditors :
 Check up with the balance sheet to ensure that all trade creditors are classified
correctly under this head.
 Liability for payment to be materialised after the date of balance sheet and
treated as contingent liability should be classified as current liability under this
head.
 For example, bills accepted under LC, the payment of which is outstanding as of the
date of balance sheet.
 Whether the estimated/projected level is in tune with the actuals thereof and
purchase turnover.
 Whether the level shows normal trade credit available and that under non-funding
limits sanctioned.
 What percent of non-funding limit whereby credit is obtained is taken for arriving
at sundry creditors level ? Normally it should be in the range of 50-80%.
 What are the reasons for the level if decreasing or not increasing proportionally
to the business volume. Are they acceptable ?
 Lower creditor's level would increase the bank borrowing level and hence ensure
that they are at a realistic level.
5. Unsecured Loans :
Loans from friends, relatives, directors should be shown here irrespective of maturity.
6. Advance payments from customers/deposits from dealers :
a. Whether rate of increase/decrease under this head is proportionate to the

business volume.
b. Verify whether any claim for refund etc. under this head not honoured by the party
is outstanding.
c. If yes, whether it will crystallise into pecuniary liability in the current/ensuing year.
d. If yes, what provision/arrangement the company has made.
7. Interest and other charges accrued but not due for payment.
8. Provision for taxation :
a. The tax assessment is completed for what period.

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b. Has the company paid the tax as demanded by the departments?
c. In case of disputes, what is the stage at which the same rest ?
d. Has adequate provision in the books of the company or payment under protest
made for discharging the disputed liability on its materialisation ?
e. Has netting of tax provision and advance tax paid (vide item 36), been made ?
(This can be effected for all the years uniformly. Netting as above will reduce the
requirement of net working capital to certain extent, which is permitted)
a. Whether bank guarantee facilities are extended to cover disputed tax liabilities.
b. What is the arrangement made for liquidating the liability under the guarantee, if
the borrower's dispute fails ? Is the arrangement acceptable to the bank ?
9. Dividend Payable :
(i) Is there any restriction in the terms of sanction for payment of dividend ?
(ii) If yes, whether it is complied with.
(iii) Whether provision in full is made for this liability, to the extent known to the
bank.
10. Other statutory liabilities (due within one year) Ensure that :
(i) position regarding statutory dues of the borrower is incorporated in the proposal
and suitable conditions are stipulated in the sanction for the clearance of the dues
within a reasonable period. in the case of item (5) above, whether adequate provision or
arrangement for liquidity is made in respect of disputed items covered by bank
guarantee.
(ii) Whether the position shows accumulation necessitating resort to bank borrowing at a
future date under this head.
(iii) If yes, whether company will have adequate drawing power for the same or will be in
a position to offer tangible collaterals for such borrowings.
11. Instalments of term loans, DPGs, Debentures, etc. (due within one year)
(a) Verify the correctness of above (term liabilities as per balance sheet) treated as
current liabilities for the purpose of CMA data.
(b) Cross-check as under
1. Term liabilities as on the date of balance sheet of the previous accounting year and
that contracted during the year should be split into –
(i) payable within one year, grouped under current liabilities against item 11 &
(ii) payable beyond one year shown against the appropriate item under term liabilities
(item 14 to 21).

Page 172
(i) In case of capitalisation of whole of the interest on term loan for the entire period of
loan, instalment as well as interest payable within one year should be classified as
current liability.
(ii) Whether the provision made for the above payment can be considered reasonable
considering the long term sources and position of net working capital of the company.
(iii) If adequate long term sources are not available to meet the instalment/interest
payment, whether action in advance is taken for strengthening the long term source
inter-alia by deferring the above payment.
(iv) Care should be taken to ensure that the payment under this head does not dilute the
current ratio below 1.33 under MPBF method. Under PBF method, the dilution should not
be below 1.17 for borrowers requiring working capital finance upto 200 lacs from the
banking system and below for other borrowers.
(v) Has suitable stipulation to ensure current ratio atleast at 1.33 is made in the
terms of sanction in respect of borrowers with working capital limits above Rs 500/-
lacs under MPBF method? Under PBF method the minimum stipulation for Current
Ratio should be 1.17 in respect of borrowers with working capital limits upto Rs.200/-
lacs from the banking system and 1.33 for other borrowers.
(vi) Under PBF/MPBF system of working capital assessment instalment of Term Loan/DP
Guarantee payable within one year to be treated as current liability for all the
purposes
12. Other Current Liabilities & Provisions
(i) Major items should be specified.

(ii) Ensure that these are not shown below realistic levels.
13. Total Current Liabilities

(a) What is the increase/decrease in quantum terms & percentage annually ?
(b) Do you consider the same in tune with build up of current assets and stipulated net
working capital requirements ?
(c) If not, what are the reasons and whether they are accepted.
(d) Ensure that this is tallied with aggregate of item 14 in Form IV and items 8 & 9 in
form V.
14. to 20 Term Liabilities
 Whether necessary debenture/preference share redemption reserve or fund is

created, if the company is subject to it.
 Whether fresh term loans/deferred payment credits contracted are in consonance
with the existing stipulations of sanction as regards capital expenditure and
security to the existing facilities from the bank.
 Whether reduction in unsecured loans brought in by the promoters and
subordinated to bank's advance (earlier classified as term liability) is proposed.
 If yes, whether prior approval for the same is obtained from the bank.
 Do you consider that increase/decrease in term liabilities is reasonable
considering repayment obligations, capital expenditure programme and net working
capital requirements ?
Page 173
21. Total Outside Liabilities
(i) What is the increase/decrease in quantum terms and percentage,
annually ?
(ii) Do you consider the same satisfactory, considering the net worth and
business volume of the company ?
22. Ordinary Share Capital

a. Is it increasing or decreasing
b. (In the case, particularly, of borrowers other than joint stock companies)
c. If increasing, is it due to fresh cash subscription or due to capitalisation of
reserves.
d. Whether stipulation for increasing the capital base of the company is complied
with.
e. In cases where equity is very low compared to very large reserves position, an
attempt should be made to capitalise a part of the reserves.
f. If it is projected to increase, whether the company will be able to mobilise the
expected amount without much difficulty.
g. In the case of public issue, whether industrial, economic & stock market situations
as well as previous record of the promoters/ group are conducive for making
the issue a success.
h. Whether under-writing/stand by support for the fresh issue is arranged.
24. Reserves (General, Revaluation & others)
Reserves which have not resulted or arisen out of the operations of the concern (i.e.
where no cash generation has taken place)
e.g.
(i) revaluation reserves.

(ii) capitalisation of whole of the interest for the amortisation period of the
loan.
(iii) due to change in the method of depreciation.
Find out the effect of above in the reserves position i.e. Had it not been given effect
to, What would have been the actual position.
27. Profit & Loss Account

Accumulated Profit/Loss balance.
28. Net Worth

a. Observe the movement of net worth position year to year.
b. Is net worth improving ? If yes, is it on account of fresh cash subscription in
shares or due to surplus retained in business ?
c. Whether the level/quantum of increase of net worth is adequate considering
the requirement for long term uses and working capital ?

Page 174
d. If it is inadequate, whether suitable arrangement/ stipulation in the terms of
sanction, is made to increase net worth adequately.
e. In the case of a firm, partners or proprietor's debit balance in the firm's
account, should be deducted from the net worth to arrive at the actual stake of
the owners in the business.
f. If net worth is decreasing, what are the factors responsible for the same ?If due
to losses, since when ?
g. What is the trend regarding quantum of losses year to year ? i.e. whether
increasing/decreasing ?
h. Whether the factors responsible for the losses analysed and
corrective/preventive actions were taken for reversing the trend.
i. Whether such actions yielded positive results.
j. What is the quantum of accumulated cash loss, as well as loss before interest and
depreciation ?
k. To what extent it has affected the security to and borrowings from bank ?
l. Has the borrower continued to pay interest/instalment on term loans to
institutions or to other banks as well as on unsecured loans from others, during
the period of loss/when adequate surplus thereof was not available ?
m. If net worth position is at unsatisfactory level, when at the earliest will it be
made up and what are the reasons/grounds for expecting so ?
29. Total Liabilities

Ensure that this is tallied with total assets (item 47).
30. What is percentage of the cash & bank balance holding level to the current asset?
Normally it will depend on the nature of business, branch net work, collection
procedure etc.
(a) Ensure that the projected level is not excessive.

(b) Confirm that the bank balances are with the banks financing the borrower exclusively.
(c) In certain cases, it is found that cash & bank balances are large as on the date of
balance sheet compared to average holding through out the year. Ensure that
average minimum olding level is only reckoned for the purpose of working capital
assessment.
31. Investments constitute a very small component of total current assets ordinarily
and hence the projection thereof at an unreasonable level should never be
permitted.
If the actuals are at a higher level than what was projected earlier, such excess
portion should be projected to be realised. In general, it should be ensured that –
a. investments pertain to normal day to day operation of the borrower like securities
to be offered to the Government for licences and permissions etc.
b. What is the purpose of creating fixed deposit with the bank?

Page 175
c. Such fixed deposits should be created to an extent of mpany's need for the
day to day operations like cash margin with the bank for short duration covering
guarantees and LC facilities.
d. The deposits of a long term nature and/or in respect of capital expenditure or
deposits with the banks not approved by the bank/consortium are not included
under this head. These types of deposits should be met from long term sources
and hence should be classified under non-current assets.
e. Investment in the nature of short term or long term should not be included as a
part of the current assets for the purpose of calculation of MPBF.
f. As regards margin on L/Cs and Guarantees held by the branch in fixed deposits
should not be included as a part of current assets for the purpose of calculation
of MPBF.
32 to 33. Receivables and Instalments of Deferred Receivables.
a. Ensure that permitted level of receivables is only taken into account.

b. Bad debts, debts doubtful of recovery or debts of age exceeding the
approved period are excluded from this head; and shown against item 42 under
non current assets.
c. Receivables in respect of goods sent on consignment basis or credit sales to
associate concerns or bills transactions relating to the same and not pertaining
to genuine tradetransactions should not be included under this head.
d. Cross check the following :
i. Domestic receivables(including bills purchased/discounted by banks) are only shown

against item 28 (i).
ii. This should be tallied with A 5 in Form IV.
iii. Export receivables including foreign bills purchased/discounted by banks) are only
shown against item 32 (b).
This should be tallied with A 6 in Form IV.
i. Instalments of deferred receivables due within one year are shown separately
against item 33. It should not be included in 32(a) or 32(b).
ii. Check up whether borrowings raised against above instalments are outstanding.
iii. If yes, such borrowings should be shown under 'other current liabilities' against item
9.
34. Inventory
i. Ensure that the basis of valuation is in accordance with that adopted for
statutory balance sheet.
ii. Current cost/current ruling prices are only taken for valuation.
iii. Obsolete/unusable/non-marketable items, i.e. dead inventory are not included.
iv. Non-consumable spares should be excluded from this head; but the same should be
shown against item 43.

Page 176
v. Projected levels of spares on the basis of past experience, but not exceeding 12
months consumption for imported items and 9 months consumption for indigenous
items should only be classified under this head. Levels in excess of the above
should be classified under non-current assets and shown against item 44.
34. Advances to Suppliers of Raw Materials & Stores and Spares
i. Check up the relative item in balance sheet (often referred to as advance

recoverable in cash or in kind)
ii. Ensure that advances given to other than the above suppliers are not included. For
example like advances given to sister concerns (other than for genuine purchase
of raw materials from them, etc.), advances against purchase of capital
equipments, debts due from directors/owners of the concern, etc. should be
excluded.
iii. How many months purchase do the above advances constitute ?
iv. Considering the average purchase/consumption and permitted holding level of raw
materials, stores & spares, whether the level of advances, actual/projected are
reasonable.
v. If unreasonably high, what are the justifications given? Are they acceptable ?
vi. Take care to curb the tendency to inflate the projections with a view to
circumvent the norms prescribed for raw materials, etc.
vii. What is the creditors level in the suppliers' industry ?
viii. Is it in tune with the level reckoned for advances under this head ?
ix. If deviation is wide, convincing justification should be given.
x. Take care to ensure that through the medium of this account, business funds are
not diverted/siphoned off to interested parties.
35. Advance payment of taxes could be netted against provision for taxation, as
explained against item (8) above.
Other current assets would include items like money receivable during the next 12
months as in the case of contracted sale of fixed assets etc.
Ensure that realistic level thereof is only taken into account.
38. Total Current Assets
This should match with item A 9 in Form IV.
39. Gross Block.
(a) This includes capital work in progress.

(b) Check up the relative schedule in the balance sheet to find out the additions &
deletions during the year.
Ascertain the price realised from the sale of fixed assets and correctness of the
accounting thereof.

Page 177
(c) If the assets sold were subject to the charge of bank thereon, whether
requisite permission of the bank is obtained and the realisation was routed through
the bank for liquidation of the outstanding thereagainst.
(d)
1. What is the increase in Gross Block after taking into account deletion, if any ?
2. Whether restrictive clauses concerning capital expenditure, if any, in the
terms of sanction are complied with.
3. What was the source for financing capital expenditure ?
4. Are they on the approved lines ?
5. Is there any diversion from working capital ? If yes, whether it has gone to the
extent of diverting working capital limits sanctioned by the bank/s for long term uses
a. If yes, how it is to be re-couped and what action is taken/proposed for avoiding
its recurrence.
b. Was the capital expenditure programme appraised by any financial institution/bank.
If not, do you consider the capital expenditure incurred/proposed reasonable ?
40. Depreciation
(a) Is method of charging depreciation as per the relevant rules and consistent from year to
year ?
(b) If change in method of depreciations effected in any year, what is the effect of the
same on net worth, reserves, P/L account, Debt-equity ratio and security
margin/assets coverage ratio.
(c) Are there any arrears of depreciation remained to be charged ?
When is it expected to be fully charged ?

Whether the depreciation provision during the current year includes adjustments relating
to prior years.
If yes, details of adjustments and its effect on the profit during the current year should
be examined.
41. Net Block
(a) Whether the position from year to year is in tune with term commitments there
against.
(b) Is the security margin/assets coverage ratio maintained/ decreased/increased ?

If it is below the stipulated level, how is it proposed to comply with the terms of
sanction ?
42. "Investments" with associates/other companies, Unapproved/Non- permissible

portion of book debts, Advances to suppliers of capital goods and contractors,
Deferred receivables maturing after one year.

Page 178
43. Non-Consumable Stores & Spares
44. Other Non-Current Assets.
i. All the above items are non-current assets which should be financed without
resorting to bank borrowing thereof, i.e. mostly out of own funds.
ii. Hence, special care should be taken to ensure that none of the above items is
classified under current assets.
iii. Please refer to the points given against items 32, 33 & 34 for details.
45. Total of Other Non-Current Assets
i. These are non-chargeable as securities to cover the facilities from the bank/s.
ii. Hence it should not be disproportionate to the total of current assets/chargeable
current assets.
iii. This is with a view to ensure that the quantum of chargeable current assets
available as securities to cover the facilities is in consonance with the
percentage of margin stipulated under various facilities.
46. Intangible Assets (patents, goodwill, preliminary expenses, bad/doubtful debts not
provided for, etc.)
(a) Barring patents and goodwill, other items above referred are cash outflows that have
already taken place.
(b) Patents and goodwill also remain as mere book entries till they are realised.
(c) As these are not really assets as such and are in fact erosion from the net worth,
the same should be deducted from the net worth to arrive at the tangible net worth.
Hence net worth (28) Minus Intangible assets (46), which should be shown against
item 48 as tangible net worth.
47. Total Assets
(a) This is the aggregate of current assets (38), fixed assets (41), non-current assets
(45) and intangible assets (46) Tangible assets would be Total assets (47) Minus
tntangible assets (46).
48. Tangible Net Worth
(a) Please refer 46 as above.

(b) Ensure that for the purpose of computing ratios of debt to equity and net profit to
tangible net worth, tangible net worth as above should only be taken into account.
(c) Please tally it with tangible net worth position shown in proposal page nos. 2 & 7.
49. Net Working Capital

Page 179
(a) This is the excess portion of the long term sources (i.e. Total term liabilities (20)
+ net worth (28) over long/medium term uses (i.e. fixed assets (41) + other non-
current assets (45) + intangible assets (46).
(b) This should be equivalent to excess of current assets (38) over current liabilities (13).
(c) Hence ensure that it is tallied as under :
(20 + 28) = (41 + 45 + 46)
(d) Tally it with NWC shown against item V in Form V.
50. Current Ratio = 38 divided by 13
51. Debt/Equity Ratio :
Total Outside Liabilities 21

------------------------- = --
Tangible Net Worth 48
52. Additional Information
(a) Arrears of depreciation Please refer 40 above.

(b) Contingent liabilities.
(i) Arrears of cumulative : Please refer Annexure F item 7
dividends.
(ii) Gratuity liability not : Please refer Annexure F item 7
provided for.
(iii) Disputed excise/customs/ : Please refer Chapter III
tax liabilities
(iv) Other liabilities not : Please refer Chapter III
provided for
ANNEXURE-G
This form shows cost of project and the details of means of financing of the project.
ANNEXURE-H
This form shows net position of funds available from long term & short term sources and
its disposition into long & short term uses.
I. Long term sources (1) Minus Long term uses (2)

= Long term surplus (+) or Long term deficit (-)
Note :
Long term deficit shows diversion of short term sources for long term purposes,
which is not permissible, except under certain circumstances, as explained
earlier.

Page 180
II. The difference between the increase/decrease of current assets (4) & current
liabilities, other than bank borrowing (5) will amount to the increase/decrease of
working capital gap (6).
III. Working capital gap Minus Long term surplus (or plus deficit in long term surplus) will be
the increase/decrease in bank borrowings.IV.
IV. Net increase/decrease in bank borrowings should be related to increase/decrease

in net sales to ensure that they are in tune with the business volume.
General :
1. Increase in cost of various items of inventory which is disproportionate to

percentage rise in sales turnover should be explained in detail separately.
2. Similarly, a decrease in current liabilities which is not commensurate with percentage
rise or fall in sales turnover should be explained in detail separately.
3. In case the increase in working capital gap is not commensurate with the increase in net
sales, the position should be explained in detail separately.
ANNEXURE – I
This shows the record of business turnover & operational details of the account. The
details are to be furnished facility-wise & data to be collected from the Ledgers,
Registers etc. The yield should be mentioned in percentage & in absolute terms
stating the period for which it pertains. Reasons for low yield should be specified.
ANNEXURE – J
This shows the details of group/associate concerns & their banking arrangements. In
this proforma, asset classification of each credit facility/account should be given.
Specific mention as to whether there are any overdues in the account should be
made. In case there are any overdue, the date when it became overdue and steps
initiated for its adjustment should be given.
General Guidelines :
1. Figures against each item in the form should tally with the relative item or group in
Form
2. Check up the norms in Col. 1.
Ensure that the norms applicable to the industry to which the unit belongs are stated
correctly.
3. If the norms are not prescribed, the relative past trend be specified in Col.1. stating
that norms are not prescribed.

Page 181
4. Ensure that holding level of each item (wherever specified should be given) is shown
below the relative quantum.
5. In case of borrowers having seasonal activity, where the working capital limits are
required to be sanctioned based on the peak level requirements (not coinciding with
balance sheet date) the corresponding data for the previous/preceding year(s)
should also be indicated separately. In such case, the corresponding build up of
balance sheet position as on the date of peak requirement should also be indicated.
6. Current Assets
i. Compare the norms with the levels of holding; actual, estimated and projected.
ii. The level of holding for the year for which the assessment is to be made should
not be more than the norms or the past trend, whichever is lower.
iii. If the level is higher than above, find out the percentage deviation
iv. What are the justification for the deviation ?
v. Are they genuine and acceptable ?
vi. Normally, the deviation should not be more than 20%.
vii. Where deviation has to be permitted, whether suitable stipulation to conform to
the prescribed norm/past trend in a phased manner within a reasonable time is
made.
viii. Whether special guidelines (where deviation is not permissible at all) such as level
of holding of imported raw materials should not exceed three months and
minimum security margin there against should not be less than 50% are complied
with ?
ix. If not, the same should be reported/highlighted specifically stating compelling
grounds therefor, for enabling the appropriate authority to consider the same
and obtain concurrence of RBI thereto, where necessary.
x. Was the deviation permitted earlier brought in order as stipulated ? If not,
why it should not be considered that the borrower is not treating the deviated
norms as his entitlement, which is not permissible.
xi. Ensure that total of current assets (9) is tallied with item 34 in Form III & item
38 of Annexure-F.
7. Current Liabilities (other than bank borrowing)

(i) The level of creditors should be shown below the relative quantum.
(ii) Ensure that the projected level is compared with the past trends and prevailing
market conditions and significant/abnormal variations, if any, are explained.
Ensure that current liabilities (other than bank borrowing) are tallied with
aggregate of items 2 to 6 in Form III.
Ensure that following are matched :

Page 182
ITEM(S) WITH ITEM(S)
1. Current assets 38 in Annexure F & I in proposal

page No. 7.
2. Current liabilities other Aggregate of 2 to 12 in Annexure F.

than bank borrowings.
3. Actual/Projected 49 in Annexure F & 3 in proposal

net working capital page No. 7.
Note :
Minimum stipulated NWC should normally be not less than 25% of current assets.
However it could be reduced to the extent of 25% of export receivables and other
exemptions discussed in Chapter - III.
8+9. MPBF & Excess Borrowings in Form III.
(a) Maximum Permissible Bank Finance is reckoned as under :
Working capital gap (1-2) Minus (Actual/Projected net working capital or minimum
stipulated NWC whichever is higher).
(b) Where minimum stipulated NWC is lesser than actual projected NWC, the difference
thereof will be the quantum of excess borrowings to be considered for placing on
repayment basis.
General
For detailed instructions on computation of MPBF refer to Chapter - III.
ANNEXURE – K
All major adverse features pointed out by auditors/internal inspectors/RBI

inspectors should be incorporated as per latest reports & comments on action taken
& specific time frame within which, deficiencies to be rectified, should be stated.
This should also be touched upon in the detailed appraisal note.
ANNEXURE – L
Minutes of Consortium Meeting
ANNEXURE – M
Appraisal note for sick units. In case of Sick/Weak units:

Page 183
Check-up with reference to the following definitions, whether the unit is a sick
or weak one; and indicate the same specifically.
(a) Definitions :
Sick unit:
An industrial company, which is registered under Companies Act for not less than 5
years and which has accumulated losses, at the end of any financial year, equal to or
exceeding its entire net worth, is a sick industrial company. Net worth means sum total
of the paid up capital and free reserves. Free reserves means all reserves credited out
of the profits and Share Premium Account but do not include reserves credited out of
revaluation of assets, write back of depreciation provision and amalgamation.
All the Sick Industrial companies which are –
a) engaged in manufacturing/processing activity, employing –50- workers or more,

b) registered for 5 years or more,.
c) whose net worth has completely been eroded as at the end of any financial year,
Weak unit :
A weak unit is one which has at the end of any accounting year, accumulated
losses equal to or exceeding 50% of its peak net worth in the immediately
preceding five accounting years.
Explanations :
 Net worth is the sum of the paid-up capital and free reserves.
 Free reserves means all reserves credited out of the profits and share premium
account, but does not include reserves created out of revaluation of assets,
write back of depreciation provisions and amalgamation.
ANNEXURE – N
DSCR: The calculation chart for DSCR is as under:
( Rs. in Crore)
Particulars 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14
Profit after Tax 0.99 54.47 58.95 63.28 57.58 61.65
Depreciation 17.30 34.59 34.59 34.59 34.59 34.59
Term Loan Interest 26.11 30.49 25.90 19.89 13.48 6.38
Sub-Total 44.40 119.55 119.44 117.76 105.65 102.62
Term Loan 0.0 30.00 46.00 48.00 54.00 56.00
Installment
Term Loan Interest 26.11 30.49 25.90 19.89 13.48 6.38
Sub-total 26.11 60.49 71.90 67.89 67.48 62.38
DSCR 1.70 1.98 1.66 1.73 1.57 1.65
Av DSCR 1.72

Page 184
ANNEXURE – P
Project Details should contain :
Details about project including location ,Technical Consultant , Project coordinator , Man
power , Power supply, Infrastructure available , Contingency plan in case of inordinate
delay of project , Marketing strategy etc.

Page 185

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FOREWORD

This Handbook presents a composite of information about the evaluation and

I wish all users‘ great success in their endeavors.

Baroda Academy Inventing Methods for Igniting Minds

3 PRE SANCTION APPRAISAL

4 ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS

5 RATIO ANALYSIS & INTERPRETATION

6 BREAKEVEN POINT ANALYSIS

7 DOCTORING OF BALANCE SHEET - CREATIVE ACCOUNTING

8 TYPES OF CREDIT FACILITIES

9 WORKING CAPITAL FINANCE

10 NON FUND BASED LIMITS

11 TERM LOAN APPRAISAL

14 OVERVIEW OF SME POLICY

17 CREDIT MONITORING - MMR

18 POST SANCTION REPORTING

20 IMPORTANT TIPS / CHECKPOINTS

Baroda Academy Inventing Methods for Igniting Minds

3 Due Diligence Report format

4 Credit Information Report

5 Information disclosure by borrowers to banks for Multiple Banking

7 Format for Agreement – in – principle

8 Adhoc Sanctions / Concessions / Modifications in terms and conditions

9 CMA data format

10 Proposal format upto 20 lacs

11 Proposal format above 20 lacs upto 50 lacs

12 Proposal format above 50 lacs-MCB Note format

13 General Terms and Conditions

14 Scorecard based Credit Rating for SMEs

15 Pre-sanction inspection reports

16 Sharing of Credit Information for takeover MMR Format

17 Credit Audit Format

Note: These are available in electronic form in CD attached with this.

Baroda Academy Inventing Methods for Igniting Minds

Principle of Safety of Funds :-

 It is a major concern of a Banker.

 It deals with Bankers ability to get advance liquidated expeditiously.

 Lending should be for an approved purpose.

Baroda Academy Inventing Methods for Igniting Minds

 You should not keep all eggs in one basket.

5 ‗C‘s of the borrower = Character, Capacity, Capital, Collateral, Conditions

(2) Character of a borrower is constituted by honesty, sobriety, good habits, personality,

It deals with the ability of the borrower to manage an enterprise or venture

Baroda Academy Inventing Methods for Igniting Minds

Sources of information available to assess the borrower

 Primary & collateral security should be ‗MASTDAY‘

External factors affecting borrowers business :

Changes in Government policy.

Scrutiny of Loan Proposal

Cash Credit Monitoring

Any Credit Proposal must answer the following key questions

Baroda Academy Inventing Methods for Igniting Minds

2. SOLE PROPRIETORSHIP FIRMS

As far as signing or execution of loan documents is concern, it is a common practice to

A Partnership is an association of two or more persons to do a business for profit, like a

Baroda Academy Inventing Methods for Igniting Minds

 No partner should be a lunatic or un-discharged insolvent and no other partnership

Action on the part of Lending Bank in case of reconstitution of the firm

PRIVATE LIMITED COMPANIES

 Such companies have minimum 2 and maximum 50 shareholders.

PUBLIC LIMITED COMPANIES

Baroda Academy Inventing Methods for Igniting Minds

Section Description of the matter