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Assistance provided by Punjab national bank

Summer project report on Working capital management And introduction of Term loan financing

Project report submitted to the Bhai Parmanand Institute of Advanced Studies, Affilated to G.G.S.I.P University, Delhi. In the partial fulfillment For the award of the degree in Masters of Business Administration. Submitted by: - Himanshu Malhotra Company guide:Mr. Satish Puri (Sr. Manager, credit Administration division) PNB head office

PUNJAB NATIONAL BANK HO, PNB HOUSE, 7 BHIKAJI CAMA PLACE


Dated: ___________2011

CERTIFICATE
Certified that Himanshu Malhotra has successfully completed Summer Project Study entitled Working capital management And introduction of Term loan financing Under my guidance. It is her original work, and is fit for evaluation in partial fulfillment for the requirement of the Two Year Post Graduate Degree in Management (Full-time).

Mr. Satish Puri (Senior Manager, PNB, and HO)

Himanshu Malhotra

Declaration
I declare that the project entitled XYZ conducted at Punjab National Bank is a record of independent analysis work carried out by me during the academic year 2010-12 under the guidance of my project guide, Mr. Satish Puri (Senior Manager, PNB, HO). I also declare that this project is the result of my effort and has not been submitted to any other University or Institute for the award of any degree, or personal favor whatsoever. All the details and analysis provided in the report hold true to the best of my knowledge.

Date: ___________2011

HIMANSHU MALHOTRA BHAI PARMANAND INSTITUTE OF ADVANCED STUDIES

ACKNOWLEDGEMENT
I wish to express my gratitude to PUNJAB NATIONAL BANK for giving me an opportunity to be a part of their esteemed organization and enhance my knowledge by granting permission to do summer training project under their guidance. I am deeply indebted to my company guide, Mr. Satish Puri (Senior Manager, PNB, HO), of Punjab national bank, HO for their valuable and enlightened guidance. They provided me with the opportunity to learn in the bank and spare their valuable time to help me. He provided me with immense opportunity to learn about the working at Credit Administration Department (CAD), HO. I am also thankful to the employees of PNB for their support and coordination. I am also highly thankful to Library staff of PNB who provided me the study materials and helped me during training. Last but not the least I grant my heartiest thanks to my friends and colleagues for their help and support.
The learning during the project was immense and valuable. My work included the study of various aspects of Credit Administration.

Regards, Himanshu Malhotra Bhai Parmanand Institute of Advanced Studies, G.G.S.I.P University, Delhi

Executive Summary
This project explains various credit facilities and policies followed by one of the most reputed banks in the country, Punjab National Bank. Each bank has its own set of policies within the overall RBI guidelines that must be followed while sanctioning a loan and care must be taken that the money provided by the bank is being used up for the intended purpose only. The task ranging from acceptance of loan proposal to sanctioning of loan is carried out at Credit Division of the bank. Moreover, each loan proposal falls under powers at different hierarchical levels for adequate decentralization & faster decision making depending on the size of the proposal. The objective of the study is to analyze in depth, the Loan Policies and its sanctioning for corporate bodies. Different corporate bodies require funds for various functions & mainly for: To finance their new projects. To meet their working capital requirements. So this project is undertaken to understand the various aspects of processing/appraisal of Term Loan, working capital assessment and Credit Risk Management carried out at PNB. With a developing economy and many multinational companies coming up, new projects are being undertaken. These projects require huge amount of fund and thus banks come forward to finance these projects depending on the feasibility of the project. PNB carries out an extensive study of the project and checks for its feasibility such as Technical, Economic and Financial Feasibility and if the project seems to be feasible, a decision is taken. This process of carrying out the feasibility test of the project is called Project Appraisal. Various companies require fund for daily operations. In order to finance these needs, a company approaches bank for credit facilities. CD at PNB takes care of these facilities and based on the credit worthiness and other useful parameters, the bank sanctions it at a particular rate of interest. In order to understand this, one must be clear with basic topics such as working capital management, balance sheet analysis and forecasting, and cash budget. However in case of working capital financing the basic task for the bank and the company is to evaluate the Net Working capital, which is done through working capital assessment. Further, the project also covers the Credit Risk Rating carried out at Integrated Risk Management Department (IRMD) of the bank. Rating is done in order to find out the capability or the willingness of the company to pay its debt. PNB uses its own model to rate a company and this model is one of its kind in the country. Depending on the type of project, a suitable model is chosen and based on financials of the company and the track record of the management, rating is done. This rating also helps in determining the rate of interest at which the loan should be given. Generally, a company with good ratings is gives loan at a lower ROI since the risk involved is lower.
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In this report we shall discuss the various aspects that PNB took into consideration before granting term loan and enhancing working capital limits through 1 case studies how Working capital loan appraisal a PBF note based on the CMA data given by the company is prepared based on which the bank decides how much contribution is to be brought in by the borrower and how much is the permissible bank finance.

NOTE: Due to security/confidentiality reasons all the names in this report have been changed to fictitious.

OBJECTIVES
1) To gain insights into the Credit Administration processes of the banks.
2) To understand the intricacies of working capital assessment. 3) To understand the various appraisal system adopted by the banking followed by live studies. 4) To Analyze the balance sheet. case

SCOPE OF THE STUDY


With the opening up of the economy, rapid changes are taking place in the technology and financial sector, exposing banks to greater risks. Thus, in the present scenario efficient project appraisal has assumed a great importance as it can check and prevent induction of weak accounts to our loan portfolio. All possible steps need to be taken to strengthen pre sanction appraisal as prevention is better than cure.

CHAPTER-1 INTRODUCTION
Banking industry at a glance
Bank is the main confluence that maintains and controls the flow of money to make the commerce of the lend possible. Government uses it to control the flow of money by managing Cash Reserve Ratio (CRR) and thereby influencing the inflation level. The function of the bank include accepting the deposit from the public and other institutions and then to direct as loans and advance to parties for growth and development of industries. It extends loans for the purpose of education, housing etc and as a part of social duty, some percentage of agricultural sectors as decided by the RBI. The bank takes the deposit at the lower rate of interest and gives loan to the higher rate of interest. The difference in the transaction constitutes the main source of the income for the bank. This is known as Net Interest Margin. Banking in India has undergone starling changes in terms of growth and structure. Organized banking was active in India since the establishment of the General Bank of India in 1786. The Reserve Bank of India (RBI) was established as a central bank in 1995. The imperial bank of India, the biggest Bank at that time, was taken over by the Government to form State owned STATE BANK OF INDIA (SBI). RBI under took an exercise to reduce the fragmentation in the Indian Banking Industry post independence by merging weaker banks with stronger banks. The total number of banks reduced from 566 in 1951 to 85 in 1969. With the objective of reaching out to the masses and servicing credit needs of all sections of people, the government nationalized 14 large banks in 1969 followed by another six branch in 1980. This period saw the enormous growth in the number of branches and Banks branch network become wide enough to reach the weaker section of the society in a vast country like INDIA. The economic reforms unleashed by the government in the early nineties including banking sector too, to a significant extent. Entry of new private banks was permitted by RBI under specific guidelines. A number of liberalization and deregulation measures like efficiency, asset quality, capital adequacy and profitability have been introduced by the RBI to bring Indian banks in the line with the international best practices. With a view of giving the state owned banks operational flexibility and functional autonomy, partial privatization has been authorized as a first step, enabling them to reduce the stake of the Government to 51%.

Leading Indian Banks by Assets and Market Capitalization

Bank

Majority Shareholding Government Private Government Government Government Government Government Private Government Private

Asset Size (in $ Billions) 314 81 66 62 61 59 52 49 43 40

Market Capitalization (in $ Stock Listing Billions) 36.6 25.6 7.6 7.3 5.1 5.5 2.9 22.2 3.7 11.6 Mumbai, London Mumbai, New York Mumbai Mumbai Mumbai Mumbai Mumbai Mumbai Mumbai Mumbai, London

State Bank of India ICICI Bank Punjab National Bank Bank of Baroda Bank of India Canara Bank IDBI Bank HDFC Bank Union Bank of India Axis Bank

Market capitalization data based on full capitalization as on March 18, 2011 Bank Assets as on March 31, 2010; Source: Indian Banks Association

Major Banking Operations


The main operations of a bank can be segregated into three main areas: (i) Balancing Profitability with Liquidity Management (ii) Management of Reserves (iii) Creation of Credit.

Main Operations of a Bank

- Balancing Profitability with Liquidity Management Banks are commercial concerns which provide various financial services to customers in return for payments in one form or another, such as interest, discount fees, commission and so on. Their objective is to make profits. However, what distinguishes them from other business concerns is the degree to which they have to balance the principle of profit maximization with certain other principles. Banks in general have to pay much more attention in balancing the profitability with liquidity. Therefore, they have to devote considerable attention to liquidity management. Banks deal in other peoples money, a substantial part of which is repayable on demand. That is why, for banks unlike other business concerns liquidity management is as important as profitability management.

- Management of Reserves
Banks are expected to hold voluntarily a part of their deposits in the form of ready cash which is known as cash reserves and the ratio of cash reserves to deposits is known as Cash Reserve Ratio (CRR). The Central Bank in every country is empowered to prescribe the
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reserve ratio that all banks must maintain. The Central Bank also undertakes as the lender of last resort, to supply reserves to banks in times of genuine difficulties. Since the banks are required to maintain a fraction of their deposit liabilities as reserves, the modern banking system is also known as the fractional reserve banking.

- Creation of Credit
Unlike other financial institutions, banks are not merely financial intermediaries but they can create as well as transfer money. Banks are set to create deposits or credit or money or it can be said that every loan given by bank creates a deposit. This has given rose to the concept of deposit multiplier or credit multiplier. The importance of this is that banks add to the money supply in the economy and hence, banks become responsible in a major way for changes in the economic activities.

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Structure of Banking Industry

Scheduled banks

Scheduled commercial Banks

Scheduled cooperative Banks

Public sector banks

Regional rural Banks

Foreign Banks

Private sector Banks

Urban Cooperative Banks

State cooperative Banks

SBI & its subsidiaries

Nationalized Banks

Old private sector Banks

New private sector Banks

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COMPANY PROFILE

Punjab National Bank (PNB)

VISION
"To be a Leading Global Bank with Pan India footprints and become a household brand in the Indo-Gangetic Plains providing entire range of financial products and services under one roof"

MISSION
"Banking for the unbanked"

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Punjab National Bank, Head Office, Bhikaji Cama Place, New Delhi.

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PUNJAB NAIONAL BANK , SINCE 1985


Established in 1895 at Lahore, undivided India, Punjab National Bank (PNB) has the distinction of being the first Indian bank to have been started solely with Indian capital. The bank was nationalized in July 1969 along with 13 other banks. Today, PNB is a professionally managed bank with a successful track record over 110 years. The bank has the largest branch network In India, with 4497 branches including 454 extinction countries spread throughout the country. PNB was ranked as 515th biggest bank in the world by Bankers Almanac, London. Punjab National Bank is not the first bank to specialize in credit rating models in India but also the first one to launch image based cheque transaction system for collection of intra bank inter-city cheques thereby providing credit merely in 48 hrs in 13 cities. From the modest beginning; the bank ha grown in size and stature to become a front line banking institution in India at present. Based on its sound and prudent banking experience and consistent profit performance, PNB looks confidently to the future . The name you can Bank upon ..

Branches 5189

ATMs 5050

Customer Base 60 Million

PROFILE AND ACHIEVEMENTS:


The bank enjoys strong fundamentals and a good brand value. Besides being ranked as one of Indias top service brands, PNB has remained fully committed to its guiding principles of prudent banking. Apart from offering banking products, the bank has also entered the credit and debit card, life and non-life insurance business. PNB has always looked at a technology as a key facilitator to provide better costumer services and it has ensure that its IT strategy follows the business strategy so as to arrive at best fit. Along with 100% branch computerization, PNB covers all its branches under core business solutions (CBS) and thus providing anytime anywhere banking facility to all its customers. The has also been offering internet banking services and thus has used technology as a key for growth.

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Profile
With its presence virtually in all the important centers in the country, Punjab National Bank offers a wide variety of banking services which include corporate and personnel banking, industrial finance, agricultural finance, financing of trade and international banking. Among the clients of the bank are Indian conglomerates, medium and small industrial units, exporters, non- resident Indians and multinational companies. The large presence and vast resources base have helped the bank t built strong links with trade and industry.

The banks strength lies in corporate belief of growth and stability.

With over 38 million satisfied customers and 4688 offices, PNB has continued to retain its leadership position among the nationalized banks. The banks enjoys strong fundamentals, large franchise value and good brand image. Besides being ranked as one of indias top service brands, PNB has remained fully commited to products, the bank has also entered the credit card and debit card business; bullion business; life and non- life insurance business; gold coins and asset management business etc. Since its humble beginning in 1895 with the distinction of being the first Indian bank to have been started with Indian capital PNB has achieved significant growth in business which at the end of march 2009 amounted to Rs. 3,64,463 crore. Today, with assets more than RS.2,46,000 crore PNB is ranked as the 3rd largest bank in the country ( after SBI and ICICI Bank) and has the 2nd largest network of branches ( 4668 including 238 extenction counters and 3 overseas offices). During the FY 2008-09, with 39% share of low cost deposits, the bank achieved a net profit of Rs. 3,091 crore, maintaining its number ONE position amongst nationalised banks. Bank has a strong capital base with capital adequacy ratio as per basel II at 14.03% with tier I and tier II capital ratio at 8.98% and 5.05% respectively as on march09. As on March09, the Bank has the gross net NPA ratio of only 1.77% and 0.17% respectively. PNB has aways looked at technology as a key facilitattor to provide better consumer service and insured that IT strategy follows the business strataegy so as to arive at BEST FIT. The Bank has made a rapid strides in this direction. Alongwith the achivement of 100% branch computrisation, one of the major achivement of bank is covering all the branches of bank under Core Banking Solution (CBS), Thus coverin 100% of its business and providing Anytime Anywhere banking facility to all customers including cutomers of more than 2000 rural branches. The bank has also been ofering internet banking services to the cutomers of CBS branches like booking of tickets, payment of bills of utilities, puchasae of airline ticket etc. Towards developing a cost effective alternative channels of delivery, the bank with more than 2150 ATM networks amongest Nationalised banks. With the help of advanced technology, the bank has been a forntrunner in the industry so far as the inintiatives for financila inclusion is concerned. With its policy of inclusive growth in the indo-Gangetic belt, the bankers mission is Banking for Unbanked. The bank has launched a drive for biometric smart card based technology enabled financial inclusion with the help of business corespondents/ business faicilitators (BC/BF) so as to
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reach out the last mile customer. The BC/BF will address the outreach issue while technology will provide cost effective and transparent services. The Bank has started several innovative initiatives for marginal groups like rickshaw pullers, vegetable vendors, dairy farmers, construction workers, etc. The bank has already achieved 100% financial inclusion in 21,408 villages. Backed by strong domestic performance, the bank is planning to realize its global aspirations. In order to increase its international presence, the bank continues Its selective foray in international markets with presence in Hongkong, Dubai, UK, Shanghai, Singapore, Kabul and Norway. The second branch in hongkong at Kowloon was opened in the first week of April09. Bank has also in the process of establishing its presence in China, Bhutan, DIFC Dubai, Canada and Singapore. The bank also has a joint venture with Everest bank ltd (EBL) Nepal. Amongst top 1000 Banks in the world, The Banker listed PNB at 250 th place. Further , PNB is at the 1166th position among 48 Indian firms making it to a list of the worlds biggest companies compiled by the US magazine FORBES.

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FINANCIAL PERFORMANCE
Punjab National Bank continues to maintain its frontline position in the indian banking industry. In particular, the bank has retained its NUMBER ONE position among the nationalised bank in terms of branches, Deposit, Advances, total business, operating and net profit in the year 2008-09. The impressive operational and financial performance has been brought about by Banks focus on customer based business with thrust on SME, Agricultural, more inclusive approach to banking; better asset liability management; improved margin management; thrust on recovery and increased effeciency in core operatons of the Bank. The performance highlights of the bank in terms of business and profits as shown below:
Parameters Operating Profit Net Profit Deposits Advances March 2008 4006 2049 166457 119502 March 2009 5744 3091 209760 154703 March 2010 7382 3976 252458 247747 March 2011 9250 4575 316232 191111

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Organization structure : PNB


The bank has its corporate office at New Delhi and supervises 65 circle offices under which branches function. The delegation of powers is decentralized up to the branch level to facilitate quick decision making.

CMD Chief Managing Director ED Executive Director GM General Manager AGM Assistant General Manager DGM Deputy General Manager

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Delivery Channels in PNB:

Performance of PNB Bank as on 31 March 2010: CREDIT PORTFOLIO

Bank has a well diversified credit portfolio. Advances grew by 29.5% yoyo to Rs. 154702 Cr. (Mar10) from Rs. 119502cr. (Mar09). CD ratio increased to 73.8% (Mar10) from 71.8% (Mar09) Credit to SME increased to Rs. 23700cr. (Mar10) registering YOY growth of 30.2 % Credit to agricultural was rest. 24057 cr. In Mar;10 (19.72% of ANBC) Credit to direct agriculture increased by a robust 33% to rs. 18,908cr.

CREDIT ADMINISTRATION DIVISION (CAD)

CAD operations look after on the proposal for all type of loans which fall within the preview of GMs-HO/ED/CMD/MC/Board. Credit proposal goes through different level of sanctioning to enforce internal control and other practices to ensure that exception to policies, procedure and limits are reported in a timely manner to the appropriate level of management for action.
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The bank has introduced GRID/COMMITTEE system in credit and sanction process where in every loan proposal falling within the vested power of DGM and above is discussed in credit committee, which, on the merit of the case , recommends the proposal to the sanctioning authority. Such committees have been formed both at HO and ZO levels. The credit committee at HO includes GM-Credit and CGM/GM/RMD. For credit proposals falling within the credit powers of CGM/GM, the credit committee at HO includes DGM/AGM/CHIEF MANAGER-CAD and GDM/AGM/chief manager RMD. The credit administration division is assisted by RMD and industry desk for risk analysis and technical feasibility of credit proposals. Credit Risk Management Structure at PNB involves: Risk Management Division (RMD) Zonal Risk Management Department (ZRMD) Risk Management Committee (RMC) Credit Risk Management Committee (CRMC) Credit Audit Review Division (CARD)

TAXATION POLICY
Current tax is determined on the amount of tax payable in respect of taxable income for the year and accordingly provision for taxis made. The deferred tax charge on credit is recognized using the tax rate that have been enacted or subsequently enacted by the balance sheet date. In terms of accounting standard 22 issued by ICAI, provision for deferred tax liability is made on the basis of review at each balance sheet date and deferred tax assets are recognized only if there is virtually certainly of realization of such assets in future. Deferred tax assets/liabilities are reviewed at each balance sheet date based on developments during the year.

RISK MANAGEMENT DEPARTMENT (RMD)


Credit risk is the possibility of loss associated with changes in the credit quality of the borrowers or counter parties. In a banks portfolio, losses stem from outright default due to inability or unwillingness of a borrower or counter party to honor commitments in relation to lending, settlement and other financial transactions. PNB has an elaborate risk management structure in place. Credit Risk management structure at PNB involves - Integrated Risk Management Division (IRMD)

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RMD frames policies related to credit risk and develops systems and models for identifying, measuring and managing credit risks. It also monitors and manages industry risks. Circle Risk Management Departments (CRMDs) Risk Management Departments at circle level are known as CRMD. Their responsibilities include monitoring and initiating steps to improve the quality of the credit portfolio of the Circle, tracking down the health of the borrowal accounts through regular risk rating, besides assisting the respective Credit Committee in addressing the issues on risk. Risk Management Committee (RMC) It is a sub-committee of Board with responsibility of formulating policies/procedures and managing all the risks. Credit Risk Management Committee (CRMC) It is a top level functional committee headed by CMD and comprises of EDs, CGMs/GMs of Risk Management, Credit, Treasury etc. as per the directives of RBI. Credit Audit Review Division (CARD ) It independently conducts Loan Reviews/Audits.

The risk management philosophy & policy of the bank focuses reducing exposure to high risk areas, emphasizing more on the promising industries, optimizing the return by striking a balance between the risk and the return on assets and striving towards improving market share to maximize shareholders value. The credit risk rating tool has been developed with a view to provide a standard system for assigning a credit risk rating to the borrowers of the bank according to their risk profile. This rating tool is applicable to all large corporate borrower accounts availing total limits (fund based and non-fund based) of more than Rs. 12 crore or having total sales/ income of more than Rs. 100 crore. The Bank has robust credit risk framework and has already placed credit risk rating models on central server based system PNB TRAC, which provides a scientific method for assessing credit risk rating of a client. Taking a step further during the year, the Bank has developed and placed on central server score based rating models in respect of retail banking. These processes have helped the Bank to achieve fast & accurate delivery of credit; bring uniformity in the system and facilitate storage of data & analysis thereof. The analysis also involves analyzing the projections for the future years.

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CHAPTER- 2

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REVIEW OF LITERATURE
WORKING CAPITAL

Sagan in his paper (1955), perhaps the first theoretical paper on the theory of working capital management, emphasized the need for management of working capital accounts and warned that it could vitally affect the health of the company. He realized the need to build up a theory of working capital management. He discussed mainly the role and functions of money manager inefficient working capital management. Sagan pointed out the money managers operations were primarily in the area of cash flows generated in the course of business transactions. However, money manager must be familiar with what is being done with the control of inventories, receivables and payables because all these accounts affect cash position. Thus, Sagan concentrated mainly on cash component of working capital. He suggested that money manager should take his decisions on the basis of cash budget and total current assets position rather than on the basis of traditional working capital ratios. This is important because efficient money manager can avoid borrowing from outside even when his net working capital position is low.

Walker (1964) made a pioneering effort to develop a theory of working capital


management by empirically testing, though partially, three management. Walker studied the effect of the change in the level of working capital on the rate of return in nine industries for the year 1961 and found the relationship between the level of working capital and the rate of return to be negative. On the basis of this observation, Walker formulated three following propositions:

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Proposition I If the amount of working capital is to fixed capital, the amount of risk the firm assumes is also varied and the opportunities for gain or loss are increased

Proposition II The type of capital (debt or equity) used to finance working capital directly affects the amount of risk that a firm assumes as well as the opportunities for gain or loss.

Proposition III The greater the disparity between the maturities of a firms debt instruments and its flow of internally generated funds, the greater the risk and vice-versa.

Weston and Brigham (1972) further extended the second proposition suggested by Walker by dividing debt into long-term debt and short-term debt. They suggested that short-term debt should be used in place of long-term debt whenever their use would lower the average cost of capital to the firm. They suggested that a business would hold short-term marketable securities only if there were excess funds after meeting shortterm debt obligations. They further suggested that current assets holding should be expanded to the point where marginal returns on increase in these assets would just equal the cost of capital required to finance such increases.

Abramovitz (1950) and Modigliani (1957) highlighted the impact of capacity utilization on inventory investment. Existing stock of inventories is expected to take account of adjustment process to the desired levels. Thus the variable, existing stock of inventories, is postulated to be negatively related with the desired stock. The ratio of inventory to sales may affect inventory investment positively because a high ratio of stocks to sales in the past suggests the maintenance of high levels of inventories in the past and thus also calling for high investment in inventories in the current period

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NCAER, 1966 The first, small but fine piece of work is the

study conducted by National Council of Applied Economic Research (NCAER) in 1966 with reference to working capital management in three industries namely cement, fertilizer and sugar. This was the first study on nature and norms of working capital management in countries with scarcity of investible resources. This study was mainly devoted to the ratio analysis of composition, utilization and financing of working capital for the period 1959 to 1963. This study classified these three industries into private and public sector for comparing their performance as regards the working capital management. The study revealed that inventory constituted a major portion of working capital i.e. 74.06 per cent in the sugar industry followed by cement industry (63.1%) and fertilizer industry (59.58%). The study observed that the control of inventory had not received proper attention.

Appavadhanulu (1971) recognizing the lack of attention being given to investment in working
capital, analysed working capital management by examining the impact of method of production on investment in working capital. He emphasized that different production techniques require different amount of working capital by affecting goods-inprocess because different techniques have differences in the length of production period, the rate of outputflow per unit of time and time pattern of value addition. Different techniques would also affect the stock of raw materials and finished goods, by affecting lead-time, optimum lot size and marketing lag of output disposals. He estimated the ratio of work-in-progress and working

capital to gross output and net output in textile weaving done during 1960, on the basis of detailed discussions with the producers and not on the basis of balance sheets which might include speculative figures.

Chakraborty (1973) approached working capital as a segment of capital employed rather than a mere cover for creditors. He emphasized that working capital is the fund to pay all the operating expenses of running a business. He pointed out that return on capital employed, an aggregate measure of overall efficiency in running a business, would be adversely affected by excessive working capital.
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Similarly, too little working capital might reduce the earning capacity of the fixed capital employed over the succeeding periods. For knowing the appropriateness of working capital amount, he applied Operating Cycle (OC) Concept. He calculated required cash working capital by applying OC concept and compared it with cash from balance sheet data to find out the adequacy of working capital in Union Carbide Ltd. and Madura Mills

Co. Ltd. for the years 1970 and 1971. He extended the analysis to four companies over the period 1965-69 in 1974 study. The study revealed that cash working capital requirement were less than average working capital as per balance sheet for Hindustan Lever Ltd. and Guest, Keen and Williams Ltd. 61indicating the need for effective management of current assets. Cash working capital requirements of Dunlop and Madura Mills were more than average balance sheet working capital for all years efficient employment of resources. For Union Carrbide Ltd., cash working capital requirements were more in beginning years and then started reducing in the later years as compared to conventional working capital indicating the attempts to better manage the working capital.
Chakraborty emphasized the usefulness of OC concept in the determination of future cash requirements on the basis of estimated sales and costs by internal staff of the firm. OC concept can also be successfully employed by banks to assess the working capital needs of the borrowers.

CREDIT RISK

According to the Saraiya Commission, "the grant of credit is a business which involves a risk of increasing bad debts if proper care is not taken and banks therefore ascertain the creditworthiness of borrowers from time to time and Maintain credit reports on them. The process of grant of credit by banks comprise in the filing in of applications by the borrowers, scrutiny of the applications, assessment of creditworthiness and sanctions of

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limits by the branch manager or higher authority as well as the follow-up actions on the advances after they have been granted.

The modern rating system dates back to 1909 when John Moody started rating US railroad bonds. In India in 1962, a Credit Information Division was established in RBI with the view of collection of information from banks and other financial institutions regarding data relating to the prescribed limits sanctioned by RBI even the RBI Act was

amended into 1962 given powers to collect information in regard to credit facilities granted by individual banks and notified financial institutions to their constituents and to supply to these banks and institutions on application the relative information in a consolidated form. Apart from all the above steps, banks constantly keep a check on the customers by obtaining information from all the other sources pertaining to their customers in any form. The Saraiya Commission also suggested the formation of credit information bureaus on the lines of those prevalent in the US and the UK.

TELECOM INDUSTRY

Cygnus Business Consulting & Research Pvt. Ltd. (2008), in its Performance Analysis of
Companies (April-June 2008) has analyzed the Indian telecom industry in the awake of recent global recession and its overall impact on the Indian economy. With almost 56million subscribers are being added every month, and the country is witnessing wild momentum in the telecom industry, the Indian telecom industry is expected to maintain the same growth trajectory.

Internet service providers in India, Rao (2000), provide a broad view of the role of an
Internet service provider (ISP) in a nascent market of India. Building local content,foreknowledge of new Internet technologies, connecting issues, competitiveness, etc. wouldhelp in their sustainability.

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The role of technology in the emergence of the information society in India, Singh (2005), describes the role that information and communication technologies are playing for Indian society to educate them formally or informally which is ultimately helping India to emerge as an information society. According to a report by Gartner Inc., India is likely to remain the world's second largestwireless market after China in terms of mobile connections. According to recent data released bythe COAI, Indian telecom operators added a total of 10.66 million wireless subscribers inDecember 2008. Further, the total wireless subscriber base stood at 346.89 million at the end ofDecember 2008. The overall cellular services revenue in India is projected to grow at a CAGR of 18 per cent from2008-2012 to exceed US$ 37 billion. Cellular market penetration will rise to 60.7 per cent from19.8 per cent in 2007. The Indian telecommunications industry is on a growth trajectory with the GSM operatorsadding a record 9.3 million new subscribers in January 2009, taking the total user base to 267.5million, according to the data released by COAI. However, this figure does not include thenumber of subscribers added by Reliance Telecom.

BASIC CONCEPTS
WORKING CAPITAL: Working Capital is defined as the total amount of funds required for day to day operations of a business unit. It is often classified as gross working capital and net working capital. Gross Working Capital refers to the fund required for financing total current assets of a business unit. Net Working Capital (NWC), on the other hand, is the different between the current assets and current liabilities (including bank borrowings) which is nothing but surplus of long term sources over long term usage. We know that the liquid surplus available in a unit which can be either positive or negative. A positive NWC is always desirable because of the fact that it provides not only margin for the working capital requirement but also improves ability of borrower to meet its short term liabilities. 28

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DETERMINANTS OF WORKING CAPITAL


There are lot many factors that affect the quantum of working capital as desired by a business entity. Following are the main factors common to most of the conglomerates:

1. Nature of business - Need for working capital is highly depends on what type of business, the firm in. There are trading firms, which needs to invest a lot in stocks, ills receivables, liquid cash etc. Public utilities like railways, electricity, etc., need much less inventories and cash. Manufacturing concerns stands in between these two extends. Working capital requirement for manufacturing concerns depends on various factors like the products, technologies, marketing policies.

2. Production policies - Production policies of the organization effects working capital requirements very highly. Seasonal industries, which produces only in specific season requires more working capital. Some industries which produces round the year but sale mainly done in some special seasons are also need to keep more working capital.

3. Size of business - Size of business is another factor to determine the need for working capital.

4. Length of operating cycle - Operating cycle of the firm also influence the working capital. Longer the operating cycle, the higher will be the working capital requirement of the organization.

5. Credit policy - Companies following liberal credit policies need to keep more working capital with them. Efficiency of debt collecting machinery is also relevant in this matter. Credit availability from suppliers also effects the companies working capital

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requirements. A company that doesnt enjoy a liberal credit from its suppliers will have to keep more working capital.

6. Business fluctuation - Cyclical changes in the economy also influence the level of working capital. During boom period, to avail the advantage of rising prices, the management intends to pile up inventories of raw materials and finished goods. This creates demand for more capital. On contrary, during depression when the prices and demand for

7. manufactured goods constantly reduce, the industrial and trading activities show a downward trend. Thus the demand for working capital is low.

8. Current asset policies - The quantum of working capital of a company is significantly determined by its current assets policies. A company with conservative assets policy may operate with relatively high level of working capital than its sales volume. A company pursuing an aggressive amount assets policy operates with a relatively lower level of working capital.

9. Other factors Developed transportation and communication infrastructure help to reduce the working capital requirement. Effective co-ordination between production and distribution can further lower the need for working capital. OPERATING CYCLE:
It is very important to a company to manage its working capital carefully. This is particularly true where there is a substantial time lag between making the product and receiving the money for it. A short working capital cycle suggests a business has good cash flow. Every Business Unit has an Operating cycle which indicates a unit procures raw material (RM) from its funds, convert the RM into stock in process (SIP) which is again converted into Finished

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31 Goods (FG). FG can be sold cash and thus transforms into fund. Alternatively FG is converted into receivables, when sold on credit and on realization there of gets converted into Fund. Fig. 3: Operating Cycle

This cycle continues and in order to keep the Operating Cycle going on, certain level of assets are always required, the total of which gives the amount of total working capital required. Thus total working capital can be obtained by assessing the level of the various components of current assets in terms of time and value.

Table: 4 Parameters for various stages

Stage Raw Material

Time Holding period

Value Value of RM consumed during the period

SIP

Time Taken in converting the RM into FG

RM + mfg. exp. During the period (Cost of production) R.M + mfg. exp. +adm. Overheads for the period (cost of sales) RM + Mfg. Exp. Adm. Exp. + profit for the period (sales)

FG

Holding period of FG before being sold

Receivable

Credit allowed to buyer

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32 The working capital management policy of an enterprise is inextricably linked to its approach towards current assets funding. From the point of view of currency, the assets of an enterprise may be broadly divided into two categories i.e. current and non-current (fixed/capital) assets. The capital assets (fixed assets) are funded by long terms loans from banks/DFls and margin contributed by the promoters. On the other hand, current assets may further be classified into two components:

1. A Core Components 2. A Fluctuating Components

A manufacturing enterprise has to maintain minimum level of inventory at any point of time in order to run the production at a specified level. Fall of inventory below this level may trigger a discontinuity in production and the required synchronization between the various stages of production. We may call this minimum level of current assets as the permanent or core current assets (CCA) levels. The fluctuating current assets refer to the portion above this level that undergoes a change continually on account of change in demand, seasonality of product etc. during the various periods of the year. One may distinctly observe the behavior of the permanent and fluctuating components of currents assets. Only the fluctuating portion of the current assets should be funded by way of short term source of finance i.e. overdraft, cash credit etc. This policy is then opted by the commercial banks of most of the developed countries while funding working capital requirements.

Thus, working capital required (WCR) is dependent on:

i. ii.

The volume of activity (viz. level of operations i.e. Production and Sales) The activity carried on viz. manufacturing process, product, production program, and the materials and marketing mix. DATA REQUIRED FOR ASSESSMENT OF WORKING CAPITAL REQUIREMENTS:

For assessing the working capital needs of an organization banks follows CMA (Credit Monitoring Arrangement) which include analysis of following six documents: Existing and proposed banking arrangements
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Fund Flow statement Analysis of balance sheet

Operating statement

Build up of current assets and current liabilities Calculation of M.P.B.F. (Maximum Permissible Bank Finance)

About Project
1.1 OBJECTIVES OF THE STUDY

1. To gain insights into the Credit Administration processes of the banks. 2. To understand the different types of credit facilities and credit delivery mechanisms provided to industrial costumers viz. Overdraft, Cash Credit, Drawing Rights, Fund Based Credit, Non Fund Based Credit etc. 3. To understand the different methods available for risk vetting of lending proposals, different risk assessment models and the different credit rating procedures used in Punjab National Bank. 4. To understand the appraisal process of Term Loan and Working Capital Financing proposals 5. To understand the factors affecting rate of interest levied viz. risk assessment, bank guidelines, sectoral policies, business considerations etc. 6. To understand various norms like credit exposure limits etc., that influence credit disbursal for various sectors, companies and business groups.

1.2
1) 2) 3) 4) 5) 6) 7)

This report covers: Credit Administration at PNB Various types of Bank Finance Term Loans Financing Working Capital Financing Appraisal Process of Term Loans and Working Capital Post Sanction Processes Case Study describing actual appraisal of a Term Loan proposal and a Working Capital Financing Proposal

SCOPE OF THE STUDY

The study covered different aspects of assessing working capital loan from Bankers perspective. The evaluation of the loan proposal involved following:

1.3

RESERCH METHODOLOGY

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1. The management of the group and the company was evaluated on the basis of their reputation in the industry and any former defaults, their experience in the industry and their success. 2. The requested working capital is calculated based on methods of lending adopted, industry sector and the projected requirements of the company, past and current financial statements etc. 3. The industry to which the company belongs was studied from the point of view of current and future scenario and prospects. 4. Recruiting the financial statements of the company requesting for loan into CMA format. Then calculating and analyzing relevant ratios to study the past performance of the company and its current and future standing. The project financials of the project were also analyzed to ascertain the cash flows and return on the investment to service the debt principal and interest timely. Based on the above parameters recommendations were given to sanction or reject the proposal with certain terms and conditions.

3) BREAK EVEN ANALYSIS

Analysis of break-even point of a business enterprise would help in knowing the level of output and sales at which the business enterprise just breaks even i.e. there are neither profit nor loss. A business earns profit if it operates at a level higher than the breakeven level of break-even point. If, on the other hand, production is below this level, the business would incur loss. The break-even point in a =n algebraic equation can be put as under:

Break-even point = (Volume or units)

Total Fixed Cost (Sales price Per unit) (Variable Cost per unit)
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Break-even point = Sales (Sales in rupees)

Total Fixed Cost X

(Sales) (Variable Costs)

The fixed cost includes all those costs which tend to remain the same up to a certain level of production while variable costs which tend to change in proportion with the volume of production. As regards unit sales price, it is generally the same for all level of output. The break-even analysis can help in making vital decisions relating to fixation of selling price, make or buy decision, maximizing production of the item giving higher contribution etc. Further, the break-even analysis can help in understanding the impact of important cost factors, such as power, raw material, labor etc and optimizing product-mix to improve project profitability.

4) FUND FLOW STATEMENT


A fund-flow statement is often describes as s Statement of Movement of Funds or where got: where gone statement. It is derived by comparing the successive balance sheet specified dates and finding out the net changes in the various items appearing in the balance sheets. A critical analysis of the statement shows the various changes in sources and applications of funds to ultimately give the position of net funds available with the business for the repayment of the loans. A project Fund Flow Statements helps in answering the under mentioned points: How much funds will be generated by internal operations/external sources? How the funds during the period are proposed to be deployed? Is the business likely to face liquidity problem?

5) BALANCE SHEET PROJECTIONS


The financial appraisal also includes study of project balance sheet which gives the position of assets and liabilities of a unit at a particular future date. In other words, the
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statement helps to analyze as to what an enterprise owns and what it owes at a particular point of time. An appraisal of the projected balance sheet data of the unit would be concerned with whether the projections are realistic looking to various aspects relating to the same industry.

6) FINANCIAL RATIOS
While analyzing the financial aspects of project, it would be advisable to analyze the important financial ratios over a period of time as it may tell us a lot about a units liquidity position, managements sate in the business, capacity to service the debts etc. The financial ratios which are considered as important are disused below: Debt-Equity Ratio = Debt (Term Liabilities) Equity (Share capital, free reserves, Premium on shares, development rebate Reserve etc after adjusting loss balance)

There cannot be a rigid rule to a satisfactory debt-equity ratio, lower than the ratio higher is the degree of protection enjoyed by the creditors. These days the debt equity ratio of 1.5:1 is considered reasonable. It, however, is higher in respect of capital intensive projects. But it is always desirable that owners have a substantial stake in the project. Other features like quality of management should be kept in view while agreeing to less favorable ratio. In financing highly capital intensive project like infrastructures, cement, etc., the ratio could be considered at a higher level: Net Profit (After Taxes) + Annual interest on long term debt + Depreciation Annual interest on long term debt + Amount of installments of principal Payable during the year.

Debt- Service Coverage = Ratio

This ratio of 1.5 to 2 is considered reasonable. A very high ratio may indicate the need of lower moratorium period/repayment of loan in a shorter schedule. This ratio provides a measure of the ability of an enterprise to service its debts i.e. interest and principal repayment besides indicating the margin of safety. The ratio may vary from industry to industry but has to be viewed with circumspection when it is less than 1.5.
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Tangible Net worth (paid up Capital + Reserves and Tangible Net Worth = Outside Liabilities Ratio Surplus Intangible Assets) Total outside Liabilities (Total liability Net Worth)

This ratio gives a view of borrowers capital structure. If the ratio shows a rising trend, it indicates that the borrower is relying more on his own funds and less on outside funds and vise-versa. Profit Sale ratio = Income from other sources Sales This ratio gives the margin available after meeting cost of manufacturing. It provides a yardstick to measure the efficiency of production and margin on sales price i.e. the pricing structure. Sales- Tangible Assets = Ratio Sales Total Assets Intangible Assets

This ratio is of a primary importance to see how best the assets are used. A rising trend of the ratio reveals that borrower has been making efficient utilization of its assets. However, caution needs to be exercised when fixed assets are old and depreciated, as in such ratio tends to be high because the value of the denominator of the ratio is very low. Output- Investment = Ratio Sales Total Capital Employed (Infixed and current assets) This ratio I indicative of the efficiency with which the total capital is turned over as compared to other units in similar lines.
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Current ratio = Current liabilities

Current Assets

Higher the ratio greater the short term liquidity. This ratio is indicative to short term financial position of a business enterprise. It provides margin as well as it is a measure of business enterprise. It provides margin as well as it is measure of the business enterprise to pay-off the current enterprise to pay-off the current liabilities as they mature and its capacity to withstand sudden reverses by the strength of its liquid position. Ratio analysis gives indications, their interpretations has, however, to be made with the reference to overall tendencies and parameters in relation to the project.

WORKING CAPITAL ASSESSMENT

The objective of running any industry is earning profits. An industry will require funds to acquire fixed assets like land and building, plant and machinery, equipment, vehicles etc. and also to run the business i.e. its day to day operations. Working capital is defined, as the fund required carrying the required levels of current assets to enable the unit to carry on its operations at the expected levels uninterruptedly. Each business unit has an operating cycle which can be illustrated below:

Operating Cycle

This cycle continues and in order to keep the operating cycle going on, certain level of current assets are requires, the total of which gives the amount of total working capital required.
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i. ii.

Thus, working capital required (WCR) is dependent on: The volume of activity (viz. level of operations i.e. Production and Sales) The activity carried on viz. manufacturing process, product, production program, and the materials and marketing mix.

Working capital loan is of two types: a) Fund Based Working Capital (FBWC) include those where actual funds are proposed to be given. In FB earnings are in form of interest. Eg. Cash Credit (CC), Packing Credit (PC) etc. b) Non-Fund Based Working Capital (NFBWC) actual fund flow does not take place. In NFB earnings are in form of commission. Eg. Letter of Credit (LC), Bank Guarantee (BG) etc.

Assessment of Working Capital Limits (Fund based)

How much Working Capital loan should be given to the borrower is determined by evaluating the Working Capital Requirement and the Assessed Bank Finance (ABF). This is done by 3 methods:

A. Simplified Turnover Method/Nayak Committee:

The Reserve Bank of India constituted on 9 December 1991, a Committee under the Chairmanship of Shri P.R. Nayak, Deputy Governor to examine the difficulties confronting the small scale industries (SSI) in the country in the matter of securing finance. The representative of the SSI associations had earlier placed before the Governor, Reserve Bank of India, various problems, issues and the difficulties which the SSI sector had been facing. So for SSI with annual sales of less than Rs 1000 Cr the working capital requirement was set to 25% of the annual sales out of which 20% would be financed by the Banks and the rest 5% would be contributors margin.
Tandon or Chore Committee. In PNB, MPBF is assessed by using the method recommended by Chore Committee. Preparation of CMA data forms an integral part of CAD and it is based on this data that the further steps are taken. CMA consists of six Forms and they are:

FORM I: Break up of facility: This form give details regarding the different forms in which credit has been asked by company such as Cash Credit, Packing Credit, Letter of Credit, Bank Guarantee, etc. FORM II: Operating statement or Profit and Loss statement: This help banker to know about the expenses and tells about the expenses and income generated during the year.

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FORM III: Analysis of Balance sheet: This helps bankers to assess the financial health of an entity on date of documentation of the business entity FORM IV: Comparative Statement of Current assets and current liabilities: This form explains the operating cycle of the company. FORM V: Maximum permissible bank finance: This forms will show how much loan bank is eligible to give to company. FORM VI: Fund flow statement: Many companies do window dressing in their financial statements and fudge with their accounting figures. A profitable firm may have negative operative cash flows. Thus fund flow and cash flow analysis helps the bankers to check the sources of inflow and points of outflow.
The CMA is prepared by both the company as well as the bank. The bank uses the CMA prepared by the company to analyse the correctness of the working capital requirements and understand its validity. However, it must be noted that the entire CMA data is prepared using the balance sheet of the company and certain other documents submitted by the company to the banks. Here we explain the preparation of CMA data using a balance sheet of SAP TELECOM Ltd.

TYPES OF LENDING (Fund based and Non-Fund based limits)

After arriving at MPBF on the basis of current assets and current liabilities and appropriate method of lending, various Fund based and Non Fund based Limits have to be decided. The Fund based limits should not exceed MPBF in any case.
Working capital loan is of two types:

c)Fund Based Working Capital (FBWC) include those where actual funds are proposed to be given. In FB earnings are in form of interest. Eg. Cash Credit (CC), Packing Credit (PC) etc.

d) Non-Fund Based Working Capital (NFBWC) actual fund flow does not take place. In NFB earnings are in form of commission. Eg. Letter of Credit (LC), Bank Guarantee (BG) etc.
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a) FUND BASED LIMITS The inventory limits are set up in the shape of Cash Credit. The receivable limit either by way of C/C against book debts or by way of bills limit. Cash credit is the most popular credit system adopted in India and accounts for more than 70%of total bank credit. Under this system, banker specifies a limit, called the cash credit limit, for each customer up to which the customer can borrow money against the security of tangible assets or guarantees. The customer can withdraw money when he needs funds and deposit any amount of money that he finds surplus with him. The borrower is charged on the actual amount and tenure of the amount utilized. Under this system, banks prescribe the cash credit limit for each of their customer on annual basis. To avoid situations wherein customers seeking excessive cash credit limit, banks charge a nominal fees on the unutilized amount of cash credit limit. These nominal charges are known as commitment charges. Within the sanctioned limit, Drawing Power may be allowed on the basis of value of security. The concept of Drawing Power is explained as under:
Take for an example, a company ABC Ltd. which does not use any Non fund based facilities. This company takes cash credit advances from the bank. This cash credit limit is calculated using the value of current assets and current liabilities of the company. VALUE (RS. CRORE)

1. 2. 3. 4. 5. 6. 7. 8.

Chargeable current assets Other current assets Total current assets Other current Liabilities Net current assets Minimum stipulated working capital Permissible bank finance Cash credit limit

3000(stock=2000,receivables=1000) 600 3600 (1+2) 600 3000 (3-4) 900(arranged by the owner) 2100 (5-6) 2100

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42 The above table shows that the cash credit limit for the company is 2100 since it does not use the facility of letters of credit. So the entire working capital requirement is financed through the cash credit advances of Rs 2100 crores. However the company is not allowed to avail the above limit at once. The drawing power is calculated using its monthly stock statement which includes only the chargeable current assets such as stocks and receivables.

The table below shows the value of current assets of the company for a particular month which is used to calculate the drawing power. The bank maintains a margin of 25% on stocks and 30% on receivables which has to be arranged by the owner. As a result the total cash credit advance of 2000 crores has drawing power of 1050+700 i.e. 1750 crores.

Table: 8 Example- d STOCKS Amount (Rs. RECEIVABLES Crores) Value of stocks Less :Creditors Chargeable stocks Less : 25% margin CC for stocks 2000 600 1400 350 1050 Receivables Less: 30% margin CC for Receivables Drawing power Amount (Rs. crores) 1000 300 700 1750

Financing Fund Based Requirements


An exporter may require credit facilities for completion of export contracts at two stages:

1) Pre Shipment (Packaging credit) 2) Post Shipment


Pre Shipment credit means any loan/advance granted by a bank to an exporter for financing the purchase, processing, manufacturing or packing of goods prior to shipment on the basis of letter of credit opened in his favour by an overseas buyer. 42

43 Pre-shipment finance can be broadly classified into the following:

Packing Credit Advance against Duty drawback entitlements Packing Credit in foreign currency (PCFC)

Post Shipment credit means any loan/advance granted by a lending bank to an exporter of goods from India from the date of extending credit after shipment of goods to the date of realisation of exports proceeds. Post shipment credit facilities are as follows:

Export Bills purchased/discounted/negotiated Advances against bills for collection Advances against duty drawback receivables from government

NON FUND BASED LIMITS


The credit facilities given by the banks where actual bank funds are not involved are termed as 'non-fund based facilities'. These facilities are divided in three broad categories as under:

Guarantees Letters of credit Co-acceptance of-bills/deferred payment guarantees.

GUARANTEES
Definition Sec 126 of Indian Contract Act defines guarantee as a contract to perform the promise of discharge the liability of a third person in case of default. Parties to a Guarantee:

(a) Surety (Guarantor): Person, who gives the guarantee (b) Principal debtor : Person on whose behalf guarantee is given (c) Creditor : the person to whom guarantee is given (Beneficiary of LG)

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Types of Guarantees:

(a) Financial Guarantee: In financial guarantee , the guarantor is undertaking to pay damages in monetary terms on the happening of some defaults. In these cases the LGs are issued in Lieu of Financial transactions, e.g. (1) LG for payment of determined liabilities towards tax, excise duties, custom duties octroi etc. (ii) LG issued towards disputed liabilities. (b) Performance Guarantee: Under this head, the LGs are issued mostly to secure

performance of the contracts, the need to pay LG amount will arise only in the event of non-performance of the contractual obligation. For example performance with regard to construction of building installation of plant & machinery. - Performance of plant and machinery up to agree level. - Performance related to supply of goods/ materials - Securing Advance payment / in lieu of security money deposit, earnest money deposit/ tender deposit/ Bid bonds

(c) Deferred Payment Guarantee (DPG) Like term loans, deferred payment guarantees are also given for acquisition of fixed assets. Term loan involves payment in cash whereas in the deferred payment guarantee, the Bank commits to pay the beneficiary in case of default made by its customer (purchaser). Therefore, the issuance of deferred payment guarantees should be treated at par with the grant of term loans and the proposals for the two should be examined in the same manner. The proposal for issuances of a deferred payment guarantee can be entertained in either of the following two ways:

The Bank executes a guarantee deed on behalf of the customer (Purchaser) in favour of the manufacturer/supplier/financial institution.
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OR The Bank accepts/co-accepts usance bill on behalf of its customer (purchaser) drawn by manufacturer/supplier. LETTER OF CREDIT (L/C) Bank also provides companies with the facility of letter of credit, a type of non-fund based facility which enables the companies to purchase raw materials or other components at credit and paying them later. Letter of credit is issued by the bank at the request of the customer in favour of a third party informing him that the bank undertakes to accept the bills drawn on its costumer up to the amount stated in the LC subject to the fulfilment of conditions stipulated therein. In simple language, LC is a letter issued by the bank on behalf of the customers. The bank charges a particular fee from the customers for opening of an LC and at a suitable rate of interest. These LCs involve role of many bans such as buyers bank, sellers bank, negotiating bank, and reimbursing bank.

Fig. 4: Main parties to documentary credit

BUYER

SELLER

ISSUING BANK

ISSUING BANK

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1. The Buyer (Applicant for L/C) issuing bank at his request and instructions opens the L/C. He has liability to pay the issuing bank for the drafts drawn under the L/C. 2. Issuing or Opening Bank is the bank which opens/issues the L/C at the request of applicant (buyer) and undertakes to pay/ to accept bill drawn by the beneficiary 3. The Seller (Beneficiary of L/C) is in whose favour the L/C is opened and to whom the L/C is addressed. Beneficiary is entitled to obtain payment under L/C. 4. Advising Bank is the intermediary bank; advises the Letter of Credit to the beneficiary, Advising Bank undertakes the responsibility of providing the authenticity of L/C. 5. Confirming bank Confirming Bank is a bank who may be requested by the issuing bank to add its confirmation. If agreed to, the bank becomes a party to L/C and undertakes the responsibility to honour the bills, i.e., to pay, to accept or to negotiate the same. Generally the Advising Bank is asked to add confirmation to L/C. 6. Negotiating Bank is a bank to whom the seller is supposed to submit the documents for negotiation and get the payment as per the drawn bill 7. Reimbursing Bank is a bank who is authorized by issuing bank (normally one of its correspondent banks) to reimburse the paying or negotiating bank.

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a) vocable and Irrevocable L/Cs An irrevocable LC cannot be revoked, cancelled or altered without the consent of the parties concerned, but in case of revocable LC, the bank reserves the right to cancel or alter the credit unilaterally by giving notice to all the parties concerned. b) Transferable and Non Transferable L/Cs A transferable L/C is a credit under which the beneficiary (called as original/first beneficiary) may request the authorized bank to pay, to make credit available in whole or in part to one or more other beneficiary(ies)[called as second beneficiary(ies)].Such credit can be transferred subject only to the original terms and conditions of credit expecting the amount of credit, unit prices, percentage of insurance terms, period of validity and shipment. All other L/Cs, where the wording Transferable is not included by issuing bank are Non Transferable L/C. Thus Non transferable L/Cs are those L/Cs which cannot be transferred to any other beneficiary. c) Inland and Foreign L/Cs An inland LC is issued basically for domestic purchases where

both the parties are in the same country while a foreign LC is issued when one of the parties is in different country. d) Drawn against payment (DP) or drawn against acceptance (DA) LCs When a buyer pays the bank for opening an LC as soon as it receives the goals is called DP while if a buyer after a certain period upon receiving of goods, it is DA. This period can be 90 or 180 days and is called usance period. These terms and conditions are already defined in an LC. A variety of documents are required while using LC. These include bills, Railway receipts, motor transport receipts and others. These are called documents of title to goods which is sent to the buyer by the seller to claim for goods.

Calculation for LC limits Bank has its own procedure to calculate the limit for issuing LCs.This limit is calculated using the purchases made during the year by the company. Suppose the company XYZ Ltd. needs 1200 crores of raw materials for the current year. Then its LC require is calculated as shown below
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48 Assessment of Limit of Letter of Credit:

Table 9: Assessment of Limit of Letter of Credit


Assessment of Limit of Letter of Credit Annual Raw Material Consumption Annual Raw Material Procurement through ILC/ FLC Monthly Consumption Usance Lead Time Total Time LC Time Required A B C D E F=D+E G=F*C

LEAD TIME

is the time required to receive the goods which includes time taken during

transit of goods from seller to buyer. Thus for the company the LC requirement is Rs 350 crores at any point in time for a particular year.

B. C. Traditional Method/Tandon Committee/Chore Committee:

The Study Group to frame guidelines for follow up of Bank Credit (commonly referred to as the Tandon Committee) set up in July 1974, recommended radical changes in the system of bank lending. Besides shifting the basis of bank lending from the erstwhile security-oriented system to a production oriented one, it also recommended certain norms to facilitate meeting the genuine credit needs of industry while, at the same time, preventing pre-emption of scarce bank resources by the large industry. The major changes introduced as a sequel to the Working Groups recommendations consisted of (a) norms relating to inventory and receivables (current assets) and (b) method of lending. The Tandon Committee suggested norms for 15 major industries (norms have since been finalized for 45 industries) on the basis of various studies conducted earlier discussions with the representatives of industry. These norms represent the maximum levels for holding inventory and receivables in each industry for the purpose of sanctioning short-term credit limits to supplement the borrowing units own resources to carry an acceptable level of current assets. It, however, a borrowing unit has managed with lower levels of inventory and receivables in the past, banks are to finance the level of current assets on the basis of such reduced levels of holding unless warranted otherwise.
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Hence for Working Capital limit of greater than Rs 5 Cr the Maximum Permissible Bank Finance (MPBF) is calculated to assess the Assessed Bank Finance (ABF) and the contributors margin. CMA data is provided by the company in a prescribed format. This CMA data involves the analysis of balance sheet in order to find out the working capital requirements of the company and the maximum amount of permissible bank finance. This method is the most widely used method and requires a great deal of understanding in order to prepare a CMA data of the company. The Committee also suggested three ways to assess the maximum permissible level of bank finance (MPBF). These are:

Ist Method of lending (Tondon Committee)


Total Current Assets (TCA) Less: Other Current Liability (OCL) Working Capital Gap (WCG) Minimum stipulated NWC is 25% of the WCG Actual/Projected NWC WCG (1) WCG (2) Maximum permissible Bank Finance is Minimum of (3) or (4) Margin is (1) or (2) whichever is more (1) (2) (3) (4)

IInd Method of lending (Chore Committee)


Total Current Assets (TCA) Less: Other Current Liability (OCL) Working Capital Gap (WCG) Minimum stipulated NWC is 25% of the TCA Actual/Projected NWC WCG (1) WCG (2) Maximum permissible Bank Finance is Minimum of (3) or (4) Margin is (1) or (2) whichever is more & CR will be =1.33 or more
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(1) (2) (3) (4)

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IIIrd method of lending

Chargeable Current Assets (CCA) Add: Other Current Assets (OCA) Total Current Assets (TCA) Less: Other Current Liability (OCL) Working Capital Gap (WCG) Minimum stipulated NWC is 25% of CCA Actual/Projected NWC WCG (1) WCG (2) Maximum permissible Bank Finance is Minimum of (3) or (4) Margin is (1) or (2) whichever is more However this method is not into use. (1) (2) (3) (4)

D. Cash Budget System:

Cash Budget method, which is used specially for industries where seasonality is involved like availability of raw materials is seasonal such as sugar industry, cotton textiles and where sales is seasonal like AC, Woolens etc. In this method, a cash budget is estimated for the next 12 months. The cash requirements for each month are calculated and the highest value of cash required during any month becomes the working capital of the company.

Assessment of Working Capital (Non-Fund Based)

The credit facilities given by the banks where actual bank funds are not involved are termed as Non-Fund based facilities. These facilities are divided in three broad categories as under:

Letters of credit Guarantees Bills Co-acceptance Deferred Payment Guarantees

Letter Of Credit:
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Letter of credit (LC) is a method of settlement of payment of a trade transaction and is widely used to finance purchase of machinery and raw material etc. It contains a written undertaking given by the bank on behalf of the purchaser to the seller to make payment of a stated amount on presentation of stipulated documents and fulfilment of all the terms and conditions incorporated therein. Letter of credit is of two types: Delivery against payment (DP) SIGHT: The beneficiary is paid as soon as the paying bank or borrowers bank has determined that all necessary documents are in order. Delivery against acceptance (DA) USANCE: the borrower pays after certain due date of payment specified.

Buyer

Sales Contract Title of Goods

Buyers Bank

Good title +LC Negotiating Bank

LC

Forward

Seller

Sellers Bank Doc + Title of Goods

Letter of Credit Mechanism


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LC involves three types of pricing Basic Cost (C) + Insurance (I) + Freight (F) Further LC is categorized in various type which are: Letter of Credit: - Inland Letter of Credit (ILC) - Foreign Letter of Credit (FLC) Letter of Credit: - Transferable LC - Non-Transferable LC Letter of Credit: - Revocable LC - Irrevocable LC

Assessment of LC limit
Annual Raw Material Consumption (a) Annual Raw Material Procurement (through ILC/FLC) Monthly Consumption Usance (d) Lead Time Total Time [(d) + (e)] (f) LC limit required [(f) x (c)] LC limit recommended

(b) (c) (e)

Bank Guarantee:

A contract of guarantee can be defined as a contract to perform the promise, or discharge the liability of a third person in case of his default. Bank provides guarantee facilities to its customers who may require these facilities for various purposes. The guarantees may broadly be divided in two categories as under : Financial guarantees Guarantees to discharge financial obligations to the customers. Performance guarantees Guarantees for due performance of a contact by customers.

Assessment of BG limit
Outstanding BG as per Audited Balance Sheet Add: BGs required during the period Less: Estimated maturity/cancellation of BGs during the period Requirement of BGs Recommended BG limit

Bills Co-Acceptance:
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Bills co-acceptance is same as Letter of credit the difference is in Bills co-acceptance LC is accepted by buyer as well as by co-accepting bank.

Deferred Payment Guarantee (DPG):

DPG is a bank facility where the bank does not directly extend a loan. Instead, it extends a guarantee to the seller on behalf of its client that the financing extended by the seller (by himself or through its preferred financer) would be repaid as per the terms agreed upon. The advantage to the buyer here is that he benefits to the extent of savings in interest charges accruing on account of opting for equipment financing under installment payment system less the guarantee charges paid to the bank.

Key Working Capital Ratios: a) Current Ratio:


obligations. A liquidity ratio that measures a company's ability to pay short-term

Company has to maintain a current ratio of 1.33:1.The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health. b) Quick Ratio: An indicator of a company's short-term liquidity. The quick ratio measures a company's ability to meet its short-term obligations with its most liquid assets. Higher the Quick ratio better the position of the company. Quick ratio is effective in case stocks are obsolete, non-saleable or waste.

c) Debt Equity Ratio:

Represent the ratio between capital invested by the owners and the funds provided by lenders.

Higher the ratio greater the risk to a present or future creditor. Debt Equity Ratio should be less than 2:1. Too much debt can put your business
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at risk... but too little debt may mean you are not realizing the full potential of your business and may actually hurt your overall profitability.

d) Gross Profit Margin:

A financial metric used to assess a firm's financial health by revealing the proportion of money left over from revenues after accounting for the cost of goods sold. Gross profit margin serves as the source for paying additional expenses and future savings.

e) Operating Profit to Sales:

This ratio gives the margin available after meeting cost of manufacturing. It provides a yardstick to measure the efficiency of production and margin on sales price i.e. the pricing structure.

f) Return on Equity:

The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.

g) TOL/TNW:

This ratio gives a view of borrower's capital structure. If the ratio shows a rising trend, it indicates that the borrower is relying more on his own funds and less on outside funds and vice versa.

Where Tangible Net Worth = Paid up Capital Add: Reserves & Surplus Add: Compulsory Convertible Debenture Add/Less: Deferred Tax Liability/Assets Add: Share Application Money Less: Misc. exp. Not written off Less: Accumulated Loss
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A ratio showing how many times a company's inventory is sold and replaced over a period.

h) Inventory Turnover Ratio:

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Credit Risk Rating


An overview: An opinion offered by Rating Agency on the relative ability and willingness of an issuer of debt instrument to make timely payments on specific debt or related obligations over the lift of instrument. Relative ranking of credit quality of debt instrument. Not a recommendation to invest since it does not evaluate reasonableness of issue price, possibility of capital gains, liquidity in the secondary market, risk of pre-payment by issuer.

Various External Credit Agencies in India:


1. 2. 3. 4. CIBIL CARE FITCH ICRA

Factors determining credit risk: State of economy Wide swing in commodity prices Fluctuations in foreign exchange rates and interest rates Trade restrictions Economic sanctions Government policies Some company specific factors are: Management expertise Company policies Labor relations

The internal factors within the bank, influencing credit risk for a bank is: Deficiencies in loan policies/administration Absence of prudential concentration limits Inadequate defined lending limits for loan officers/credit committees Deficiencies in appraisal of borrowers financial position Excessive dependence on collateral without ascertaining its quality/reliability Absence of loan review mechanism

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Credit risk rating by PNB


Credit risk rating assigned to the borrower, based on the detailed analysis for their ability and willingness to repay the debt from the bank. Credit risk rating helps a bank in assigning as probability of default.

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Uses of credit risk rating


Whether to lend to a borrower or not: the credit risk rating of a borrower determines the appetite of the bank in determining exposure level. A bank would be willing to lend highly rated borrowers but would not like exposure to borrowers with very poor credit risk rating. 1. Pricing: The risk premium to be charged to a borrower should be determined by its credit risk rating. Borrowers with poor credit rating should be priced high to compensate for the higher probability of default. Credit rating is just amongst several inputs to pricing. 2. Risk Mitigants: relates to credit risk that is reduced by some means i.e. by collateral, credit derivatives, guarantees, netting agreements etc. risk may be mitigated by prescribing additional collateral security and also by stepping up the margin requirements. The higher the risk category of borrower, the greater should be the value of collateral and/or the margin needed. 3. Product mix: in case of high risk category, there is need to gradually shift from the present form of cash credit limit to term lending in working capital offering demand loan for shorter durations keeping in view the risk involved. Conversely, for those borrowers with low credit risk, bank may sanction predetermined limits for disbursals at short notice. 4. Level of decision making: the delegation of loan sanction/approval power can be linked to the credit risk rating of the borrowers higher power of approval can be at the branch level to facilitate faster sanctioning of loans thereby ensuring better customers service. For high risk borrowers, approval from higher levels may be considered. 5. Frequency of renewal and monitoring: renewal of facilities in case of high rated borrowers can be considered at longer intervals as compared to low rated borrowers. Further high risk rated borrowers should be monitored on a more frequent basis than a low risk ones.

Credit Rating at Punjab National Bank:

The credit risk rating tool has been developed with a view to provide the standard system for assigning a credit risk rating to the borrower of the bank according to their risk profile. The tool evaluated the credit risk rating of a borrower on 7 scales from AAA to D indicating AAA as minimum risk and D as maximum risk.
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The credit risk rating tool incorporates and includes possible factors of risk for determining the credit rating of borrower. This risk could be internal and specific to a company. Sources for Risk Evaluation: Signals of credit risk can be taken from number of sources such as Balance Sheet, Profit and Loss account, other financial data, business/industry information, market report etc. Credit risk rating structure of PNB The credit risk rating tool has been developed to capture credit risk under four areas: 1. Financials 2. Business/Industry 3. Management 4. Conduct of Account We also have a small weight age about the key risk factors. According to these head credit score is determined based on the following weight age:
S. No. 1 2 3 4 Total Factor affecting Credit Rating Factors Weight assigned Financial Business/Industry Management Conduct of Account 40 20 20 20 100

Usage of Credit Risk Rating Tool: The scores are assigned to each of the parameters on a scale of 0 to 4 with 0 being very poor and 4 being excellent. The scoring of some of these parameters is subjective while for some others it is done on the basis of predefined objective criteria. The score given to the individual parameters multiplied by allocated weights are then aggregated and a composite score for the company is arrived at, in percentage terms. Higher the score obtained by a company, better is its credit rating. Weights have been assigned to different parameters based on their importance. After allocating/evaluating scores to all the parameters, the aggregate score is calculated.
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The overall percentage score obtained is then translated into a rating on a scale from AAA to D according to the pre-defined range of credit scores. The credit rating according to the credit scores are:
Rating Category PNB-AAA PNB-AA Description Minimum risk Marginal risk Score (%) description Above Above 80.00 Above 77.50 Above 72.50 Above 70.00 Above 67.50 Above 80.00 77.50 upto 72.50 up to 70.00 up to 67.50 up to 62.50 upto 60 upto 62.50 Grade within the rating category PNB-AAA PNB-AA+ PNB-AA PNB-AAPNB-A+ PNB-A PNB-APNB-BB+ PNB-BB PNB-BBPNB-B+_ PNB-B PNB-BPNB-C PNB-D

PNB-A

Modest risk

PNB-BB

Average risk

PNB-B

PNB-C PNB-D

Above 57.50 upto 60.00 Above 52.50 upto 57.50 Above 50.00 upto 52.50 Marginally acceptable Above 47.50 upto risk 50.00 Above 42.50 upto 47.50 Above 40.00 upto 42.50 High risk Above 30.00 upto 40.00 Caution 30.00 and below Credit rating according to credit scores

Rating with AAA, AA, A and BB grade signifies Investment Grade. B rating grade is known as Marginally Acceptable Risk Grade and C and D rating grade are called High Risk Grade.

Important factors to be considered


1. The rating contains several qualitative parameters that are to be evaluated subjectively. It is therefore necessary to be adequately familiar with the company
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and the industry. Visiting the company and interacting with its management generally helps the rater in understanding the underline activity behind the financial data of the company being analyzed, the business prospects of the company from all possible sources to conduct this exercise completely, accurately and in an authenticate manner. 2. the data used to rate companies should be analyzed and compared before it is used for rating purpose. Similarly, the financials of the company should be made comparable with the peers in case of change in accounting policies, mergers, demergers, acquisitions, setoff etc. 3. while evaluating the company against the industry the following points should be kept in mind: a. The company value should be compared with the peers. b. Size/capacity /volume is indicative factor in selecting peers. c. The sample of the companies chosen for the industry comparison should be identical as far as possible for rating all companies under a particular industry having similar size/capacity/nature of activity. d. The number of companies in sample should be reasonable that it is neither too low nor too high. e. The sample size should be of at least 5 companies. f. For companies where industry data is not available, data for other comparable industry can be used. g. Wherever a particular parameter is not applicable no score should be given. The parameter should be made NA so that the weight assigned gets distributed among the other parameter in the section. h. For multidivisional companies which are involved in more than one industry, evaluation should be done separately for each business. i. The credit risk rating exercise should be done immediately after receipt of audited financial results of the company and should be delinked invariably from the regular renewal exercise. j. In case the latest data of peers is not available for industry comparison, then last available data, not more than one year old may be considered.

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k. The credit risk policy and risk management deptt, head office will provide the industry score to be used for all major industries, progressively, until such time industry score may be assigned as 50%. The factors stated above are only indicative and the account may be downgraded on any other crucial factor which affects the operating efficiency/viability of the unit. The applicability of various credit risk ratings models to different category loan accounts are given below:
Credit risk rating applicability Applicability Total Limit from our Bank Larger Corporate Mid Corporate Above Rs. 15 Crore OR Above Rs. 5 Cr and up to Rs. 15 Cr. OR Sales Above Rs. 100 Crore except Trading concerns Above Rs. 25 Cr. and up to Rs. 100 Cr.

Credit Risk Rating

Small Loans Small Loans II NBFC New Projects Rating Model Entrepreneur New Business Model

All trading concern falling in the Large Corporate category shall also be rated under this model. Above Rs. 50 lac and up to Up to Rs. 25 Cr. Rs. 5 Cr. AND Above Rs. 2 lac and up to Rs. 50 lac All Non Banking Financial Companies irrespective of Limit Above Rs. 5 Cr. Cost of Project above Rs. 15 Cr.

Borrower setting up new Cost of Project up to Rs. 15 Cr. business and requiring finance above Rs. 20 Lac upto Rs. 5 Cr AND However, all new trading business irrespective of limits shall be rated under this model. i. All listed companies rated on Large/Mid corporate rating models. ii. Other borrowal accounts rated on Large/Mid corporate rating models availing limits (FB + NFB) above Rs. 50.00 Cr from our bank. Assigning rating to facility sanctioned to the borrower based on default rating and securities available. All Banks and Financial Institution 60

Half Yearly Review of Rating

Facility Rating Framework Credit Risk rating Models for Banks/FI

61 NPA Model Future Lease Rental Model For making NPA accounts in on-line PNB Trac Credit risk Rating System. Advances to property owners against future lease rentals.

Security
Charging of a security means creating right of the creditor (bank) over the security so that in case of default by the borrower, creditor (bank) cab realize the security to recover its advance. A charge could be fixed charge or floating charge. Fixed charge is created on specific property like land, building etc whereas floating charge is an equitable charge over the assets of the company. A floating charge crystallizes when the company ceases to be a going concern or the charge holder (bank) initiates action to enforce security for recovery of the amount loan. 1st, 2nd and pari passu charge: When charge is created in favor of more than one creditor, then the creditor in whose favor the charge was created earlier will have the first charge and any subsequent charge will be called as 2nd charge and so on. If a charge is created on several creditors with the condition that all creditors will have equal priority in proportion to the amount of their advance it is called pari passu charge. When consortium advance is granted this type of charge is created by the borrower. In case of pari passu charge sale proceeds of the property are shared among creditors in the proportion of their outstanding within sanctioned limits. Two types of security: Primary Security Collateral Security

Primary Security:

A primary security is the security against which bank finance is made or the security (asset) which is created out of bank.

Collateral Security:

Security obtained in addition to prime security is known as collateral security. Properties or assets that are offered to secure a loan or other credit. Collateral becomes subject to seizure on default. Properties or assets that are offered to secure a loan or other credit. Collateral becomes subject to seizure on default. Collateral is a form of security to the lender in case the borrower fails to pay back the loan. Charge on securities can be created by various methods depending on the type of security charged.
Nature of Charge Pledge Nature of charge (Security) Type of Security Movable goods like stocks 61

62 Hypothecation Lien Mortgage Assignment Movable goods like stock, vehicles Assignment, hypothecation Immovable property Book Debts, LIP, NSC, FDR

Lien:

The right of a person to retain the possession of a property till dues are paid in full. A lien may be general of particular. TRANSFER OF OWNERSHIP OR PROPERTY: no TRANSFER OF POSSESSION OF SECURITY: yes POWER OF SALE: yes Remarks: a particular lien confers right to retain the property in which a particular debt arise. A general lien confers a right to retain all goods or any property (which is in possession of holder) of another until all the claims of the holder are satisfied. Banker has a general lien on all securities deposited by a customer. Negative lien is an undertaking in writing form the borrower not to encumber or deposit off his assets without banks permission as long as the banks advance is continued.

Pledge:

Bailment of goods as security for payment of s debt or performance of a promise. TRANSFER OF OWNERSHIP OR PROPERTY: no TRANSFER OF POSSESSION OF SECURITY: yes POWER OF SALE: yes, through intervention of court and after reasonable notice without intervention of the court. Remarks: the person delivering the goods as security is called pledger or pawer. The person to whom the goods are delivered is called pledge or pawnee. A pledge may be in respect of goods, stocks, shares or any other movable property.

Hypothecation:

When possession of the property and other movable offered as a security remains with the borrower and only constructive charge is created in favor of the lender, the transaction is called hypothecation. It is created by an instrument in writing viz, hypothecation agreement. TRANSFER OF OWNERSHIP OR PROPERTY : no TRANSFER OF POSSESSION OF SECURITY : no, but normally the creditor takes the right to obtain possession in certain circumstances. POWER OF SALE: yes, through intervention of court or after obtaining possession and giving reasonable notice without intervention of court. Remarks: in hypothecation advances, effectiveness supervision over the goods and possession is absolutely necessary. For, this purpose, period stock statements are obtained and the stocks are checked at regular intervals.
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A mortgageis a transfer of interest in specific immovable property for the purpose of securing the payment of money advance by the way of loan, an existing or future debt or the performance of an engagement which may give rise to a pecuniary liability.

Mortgage:

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FUND FLOW STATEMENT:


A fund-flow statement is often describes as s Statement of Movement of Funds or where got: where gone statement. It is derived by comparing the successive balance sheet specified dates and finding out the net changes in the various items appearing in the balance sheets.

A critical analysis of the statement shows the various changes in sources and applications of funds to ultimately give the position of net funds available with the business for the repayment of the loans. A project Fund Flow Statements helps in answering the under mentioned points:

How much funds will be generated by internal operations/external sources?

How the funds during the period are proposed to be deployed?

Is the business likely to face liquidity problem?

BALANCE SHEET PROJECTIONS:


The financial appraisal also includes study of projected balance sheet which gives the position of assets and liabilities of a unit at a particular future date. In other words, the statement helps to analyze as to what an enterprise owns and what it owes at a particular point of time. An appraisal of the projected balance sheet data of the unit would be concerned with whether the projections are realistic looking to various aspects relating to the same industry.

Analysis of balance sheet


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Balance sheet analysis is the process of identifying the financial strength and weaknesses of the firm by properly establishing relationship between the item of the balance sheet and profit and loss account. It is concerned with the following parties: Lender Managements Investors Trade Credits

FINANCIAL RATIOS:
While analyzing the financial aspects of project, it would be advisable to analyze the important financial ratios over a period of time as it may tell us a lot about a units liquidity position, managements sate in the business, capacity to service the debts etc. The financial ratios which are considered as important are disused below: 1. LIQUIDITY PARAMETER

Current ratio
This ratio is to assess the short term financial position of the enterprise. The relationship of current assets to current liabilities is known as the current ratio. Current assets mean that the assets are in the form of cash or cash equivalents or can be converted into cash or cash equivalents in a short time (say within a years time). Current ratio= current assets/ current liabilities Current assets = cash and bank balance + investments in government security + sundry debtors

+ bills discounted + inventories + loans and advances (other than group/associate/other companies)+ advances payment of tax + pre-paid expenses + other current assets.

Current liabilities = short term bank borrowings + commercial paper + loan from corporate bodies (including group / associate co) + bills discounted + Sundry creditors + int. accrued + un matured financial charges + advance against work in progress + inter office adjustment + provision for tax dividend + diminution in investment + other current liabilities.

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Company has to maintain a current ratio of 1.33:1. The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health.
It shows the number of times the current assets are in excess over the current liabilities. It is generally accepted that the current assets should be 2 times the current liabilities, then only will realization from current assets be sufficient to pay the current liabilities on time and enable the firm to meet the day to day expenses. A very high ratio will indicate idleness of funds and not a good sign. It thus indicates poor investment policies of the management and poor inventory control.

i) Quick Ratio:

An indicator of a company's short-term liquidity. The quick ratio measures a company's ability to meet its short-term obligations with its most liquid assets. Higher the Quick ratio better the position of the company. Quick ratio is effective in case stocks are obsolete, non-saleable or waste.

2. LONG-TERM SOLVENCY PARAMETER

j) Debt Equity Ratio:


Represent the ratio between capital invested by the owners and the funds provided by lenders.

Debt= Total borrowings + preference capital short-term bank borrowing commercial paperloans from corporate bodies (including group/associate co.). 65

66 Equity = Tangible net worth.

Higher the ratio greater the risk to a present or future creditor. Debt Equity Ratio should be less than 2:1. Too much debt can put your business at risk... but too little debt may mean you are not realizing the full potential of your business and may actually hurt your overall profitability.

3. PROFITABILITY PARAMETER

Return on Investment
The net result of a business is profit or loss. The sources used by the business to attain this (profit or loss) consists of both the shareholders funds and loans. The overall performance can be judged by working out a ratio between profit earned and capital employed. The resultant ratio usually expressed as a percentage is called the ROI, ROCE, Rate of Return , Net Profit to Capital Employed.

ROI = (Profit before interest, tax and dividend/ capital employed)* 100

Wherein , Capital Employed= share capital (both equity & preference) + reserves + long term loans fictitious assets non-operating assets like investments. Or, Fixed assets cost less depreciation + working capital

Since, non- operating assets are excluded while determining capital employed, profit should also exclude income from investment outside the business. Return on investment judges the overall performance of concern. It measures how efficiently the sources entrusted to the business are being used or what is the earning power of the assets of the business.


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Operating profit ratio:


OPBDIT Net sales OPBDIT (Operating profit before depreciation, interest and tax)=Profit before depreciation, interest and tax- extra ordinary income + extra ordinary expenses other income. 4. OPERATING EFFICIENCY PARAMETER

Operating Leverage

Sales revenue Variable cost =contribution -fixed cost =EBIT


The relation between sales revenue and EBIT is defined as operating leverage.

Operating leverage = % change in EBIT / % change in sales revenue

It means that for every increase or decrease in sales level, there will be more than proportionate increase or decrease in the level of EBIT. It may be noted that this is due to the existence of fixed cost. As long as DOL is greater than 1, there is an operating leverage. A positive DOL means that the firm is operating at a sales level above the break even level and EBIT will be positive. Once all fixed costs are recovered by the contributions, profits grow proportionately faster than the growth in volume.

A high DOL is considered a high risk situation and even a small decrease in sales can excessively affect the firms ability to record profits.

5. OTHERS Total outside liability to tangible net worth


TOL 67

68 TNW TOL (Total outside liabilities) = Total Borrowing + Preference Capital + Current Liabilities & Provisions + Bills Discounting.

TNL (Tangible net worth) = Equity capital + surplus Revolution reserve-Accumulated losses-Misc. expenses not written off intangible assets accumulated depreciation not provided for. This ratio gives a view of borrower's capital structure. If the ratio shows a rising trend, it indicates that the borrower is relying more on his own funds and less on outside funds and vice versa.

Interest coverage ratio


EBITDA Total Interest

EBITDA (Earnings before interest, tax, depreciation and amortization) = Profit before depreciation, interest tax and amortization + extra ordinary expenses extra ordinary income. Total interest = Gross interest + interest capitalized.

Debt-service coverage ratio:


It measures the number of times a companys earning cover its total long term debt, including interest and principal repayments in term debts, over a period of one year. A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1, say 0.95, it would mean that there is only enough net operating income to cover 95% of annual debt payments.

Debt-Service Coverage = Ratio

Net Profit (After Taxes) + Annual interest on long term debt + Depreciation . Annual interest on long term debt + Amount of installments of principal payable during the year.

For example, in the context of personal finance, this would mean that the borrower would have to delve into his or her personal funds every month to keep the project afloat. Generally, lenders frown on a negative cash flow, but some allow it if the borrower has strong outside income.

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CREDIT RISK RATING


An overview:
An opinion offered by Rating Agency on the relative ability and willingness of an issuer of debt instrument to make timely payments on specific debt or related obligations over the lift of instrument. Relative ranking of credit quality of debt instrument. Not a recommendation to invest since it does not evaluate reasonableness of issue price, possibility of capital gains, liquidity in the secondary market, risk of pre-payment by issuer.

Various External Credit Agencies in India: CISIL CARE FITCH ICRA Factors determining credit risk: State of economy Wide swing in commodity prices Fluctuations in foreign exchange rates and interest rates Trade restrictions Economic sanctions Government policies Some company specific factors are: Management expertise Company policies

The internal factors within the bank, influencing credit risk for a bank is: Deficiencies in loan policies/administration
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Inadequate defined lending limits for loan officers/credit committees Deficiencies in appraisal of borrowers financial position Absence of loan review mechanism Credit risk rating by PNB:
Credit risk rating assigned to the borrower, based on the detailed analysis for their ability and willingness to repay the debt from the bank. Credit risk rating helps a bank in assigning as probability of default.

Uses of credit risk rating:


Whether to lend to a borrower or not: the credit risk rating of a borrower determines the appetite of the bank in determining exposure level. A bank would be willing to lend highly rated borrowers but would not like exposure to borrowers with very poor credit risk rating.

6. Pricing: The risk premium to be charged to a borrower should be determined by its credit risk rating. Borrowers with poor credit rating should be priced high to compensate for the higher probability of default. Credit rating is just amongst several inputs to pricing.

7. Level of decision making: the delegation of loan sanction/approval power can be linked to the credit risk rating of the borrowers higher power of approval can be at the branch level to facilitate faster sanctioning of loans thereby ensuring better customers service. For high risk borrowers, approval from higher levels may be considered.

8. Frequency of renewal and monitoring: renewal of facilities in case of high rated borrowers can be considered at longer intervals as compared to low rated borrowers. Further high risk rated borrowers should be monitored on a more frequent basis than a low risk ones. Credit Rating at Punjab National Bank:
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The credit risk rating tool has been developed with a view to provide the standard system for assigning a credit risk rating to the borrower of the bank according to their risk profile. The tool evaluated the credit risk rating of a borrower on 7 scales from AAA to D indicating AAA as minimum risk and D as maximum risk. The credit risk rating tool incorporates and includes possible factors of risk for determining the credit rating of borrower. This risk could be internal and specific to a company.

Credit risk rating structure of PNB


The credit risk rating tool has been developed to capture credit risk under four areas:

1. Financials 2. Business/Industry 3. Management


4. Conduct of Account
We also have a small weightage about the key risk factors. According to these head credit score is determined based on the following weight age: Table: 10 Factor affecting Credit Rating S. No. 1 2 3 4 Total Factors Financial Business/Industry Management Conduct of Account Weight assigned 40 20 20 20 100

Usage of Credit Risk Rating Tool:

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The scores are assigned to each of the parameters on a scale of 0 to 4 with 0 being very poor and 4 being excellent. The scoring of some of these parameters is subjective while for some others it is done on the basis of predefined objective criteria.

The score given to the individual parameters multiplied by allocated weights are then aggregated and a composite score for the company is arrived at, in percentage terms. Higher the score obtained by a company, better is its credit rating. Weights have been assigned to different parameters based on their importance. After allocating/evaluating scores to all the parameters, the aggregate score is calculated. The overall percentage score obtained is then translated into a rating on a scale from AAA to D according to the pre-defined range of credit scores.

The credit rating according to the credit scores are:

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73 Table: 11 Credit rating according to credit scores Rating Category PNB-AAA PNB-AA Description Minimum risk Marginal risk Score (%) description Above 80.00 Above 77.50 upto 80.00 Above 72.50 up to 77.50 Above 70.00 up to 72.50 Above 67.50 up to 70.00 Above 62.50 upto 67.50 Above 60 upto 62.50 Above 57.50 upto 60.00 Above 52.50 upto 57.50 Above 50.00 upto 52.50 Above 47.50 upto 50.00 Above 42.50 upto 47.50 Above 40.00 upto 42.50 Above 30.00 upto 40.00 30.00 and below Grade within the rating category PNB-AAA PNB-AA+ PNB-AA PNB-AAPNB-A+ PNB-A PNB-APNB-BB+ PNB-BB PNB-BBPNB-B+_ PNB-B PNB-BPNB-C PNB-D

PNB-A

Modest risk

PNB-BB

Average risk

PNB-B

Marginally acceptable risk

PNB-C PNB-D

High risk Caution

Rating with AAA, AA, A and BB grade signifies Investment Grade. B rating grade is known as Marginally Acceptable Risk Grade and C and D rating grade are called High Risk Grade.

Table: 12 Credit risk rating applicability Applicability Credit Risk Rating Total Limit from our Bank 73 Sales

74 Larger Corporate Mid Corporate Above Rs. 15 Crore OR Above Rs. 5 Cr and up to Rs. 15 Cr. OR Above Rs. 100 Crore except Trading concerns Above Rs. 25 Cr. and up to Rs. 100 Cr.

Small Loans

Small Loans II NBFC New Projects Rating Model

All trading concern falling in the Large Corporate category shall also be rated under this model. Above Rs. 50 lac and up to Up to Rs. 25 Cr. Rs. 5 Cr. AND Above Rs. 2 lac and up to Rs. 50 lac All Non Banking Financial Companies irrespective of Limit Above Rs. 5 Cr. Cost of Project above Rs. 15 Cr.

Entrepreneur New Business Model

Borrower setting up new Cost of Project up to Rs. 15 business and requiring Cr. finance above Rs. 20 Lac upto Rs. 5 Cr AND However, all new trading business irrespective of limits shall be rated under this model. iii. All listed companies rated on Large/Mid corporate rating models. iv. Other borrowal accounts rated on Large/Mid corporate rating models availing limits (FB + NFB) above Rs. 50.00 Cr from our bank. Assigning rating to facility sanctioned to the borrower based on default rating and securities available. All Banks and Financial Institution For making NPA accounts in on-line PNB Trac Credit risk Rating System. Advances to property owners against future lease rentals.

Half Yearly Review of Rating

Facility Rating Framework Credit Risk rating Models for Banks/FI NPA Model Future Lease Rental Model

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CHAPTER- 3

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RESEARCH METHODOLOGY

In order to learn and observe the practical implementation of the concepts, the following sources of information have been used:

Primary Sources Meeting with the project guide Meeting with other staff members of various departments

Secondary Sources Material provided by project guide Study of proposal Annual report of company CMA of company

Techniques of Analysis Literature review Analysis of audited balance sheet Overview of Credit risk rating Live case studies (Based on CMA) On the job assessment of working capital requirement Interaction with appraiser and other senior official of the banks.

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CASE STUDY
Name of the Borrower BO & Controlling Office : M/s TVS-E Telecom Ltd : BO South Extension, New Delhi, CO : GK-1.

Proposal GIST OF THE PROPOSAL (Rs in Crore)

A. Sanction of Working Capital Limits Enhancement in working capital limits (both FB & NFB) from Rs 29.50 Cr to Rs 63.00 Cr, detailed as under: Existing 11.50 18.00 29.50 Proposed 23.00 40.00 63.00

FB NFB TOTAL B. For Term Loan : Not applicable.

Credit Risk Rating by Bank is BB indicating Average Risk

Rating Present Previous BB BB

Date of Rating 22.12.10 29.10.09

Score 52.60% 57.18%

ABS 30.06.10 30.06.09

Reasons for degradation NA NA

Rating Agency

from

External

Decline in score from 57.18% as at 30.6.09 to 52.60% as at 30.6.10 due to decline in score under Management Evaluation and Conduct Evaluation. Facility Rating Date of Rating Remarks rated rating Agency /Significance Long term Bank facilities Rs 27.50 Cr Short term Bank facilities Rs 51 Cr CARE, BBB(SO) 20.09.10 CARE Moderate safety for timely serving of debt obligation. Such facilities carry moderate risk. Moderate capacity for timely repayment of short term-debt obligation and carry higher

External Rating is mapped to internal rating of BB

PR3 (SO)

20.09. 10

CARE

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credit risk..

BRIEF HISTORY
M/S TVS-E Telecom Ltd was incorporated on 22nd June1995. The Company is engaged in the business of manufacturing, import, Distribution and Trading of consumer Electronic items like TV Games, DVD/MP3 Player, Hi-Fi Systems, Home Theaters and various accessories thereof. Presently the company is assembling the products at its plant located at Industrial Center in Barotiwala at Himachal Pradesh. This unit has Excise and Income Tax Exemption for a period of 10 years beginning from August, 2004. The Sales Tax is charged at concessional rate. Due to this reason, the Company has been able to work out very competitive rates for its products. The company is selling its products mainly on Original Equipments Manufacturers (OEM) basis, besides this the company also market its products independently through its Distributor network. This brings synergy of efforts and the company saves on the overhead expenses facilitating it to market its products competitively.

Diversification into Trading/ testing / branding / packaging of Mobile Hand Sets: The company has diversified into retail trade of mobile handsets. The company has tied up purchase of low cost mobile sets from China. The telecommunications industry has a very bright future in India and it is one of the fastest growing Industries.

The company has a professional team in place to run the Mobile Business. A consultant having more than 10 years of experience in this line has also been roped in. The company is in the process of recruiting the ground staff and sales teams for the project.

Presently the company is enjoying FB working capital limits of Rs.27.50 crore from consortium with PNB as lead bank wherein our share is Rs.11.50 crore. Considering the proposed expansion plans of the Company, the present proposal is submitted for sanction of enhancement in WC FB limit from 11.50 crore to Rs 23.00 crore and in NFB limit from Rs 18.00 crore to Rs 40.00 crore being our share out of the total assessed FB limit of Rs 76.00 crore &

78

79 NFB limit of Rs 125.00 crore for the consortium to be shared among member banks as per item 5D below under: Table: 14 Facilities Recommended Nature Fund Based CC(H) Fund Based Ceiling Non Fund Based ILC/FLC ILG FLG Non Fund Based Ceiling Term Loan TOTAL COMMITMENT Existing 11.50 11.50 18.00 NA NA 18.00 NA 29.50 Proposed (Rs. in Crore) Secured/Unsecured along with the basis thereof (As per RBIs guidelines) 23.00 Secured 23.00 Secured Secured

40.00 (5.00) (5.00) 40.00 NA 63.00

Secured Secured

Table: 15 Credit Rating by agencies {CRISIL/ICRA/CARE/FITCH INDIA} with purpose of such rating. Significance of Purpose Validity Date Rating CARE, BBB- 20.09.2010 Moderate safety for Long Term Upto (SO) timely serving of Bank facilities 31.08.2011 debt obligation. Rs 27.50 Cr Such facilities carry CARE moderate risk. PR3 (SO) 20.09.2010 Moderate capacity Short Term Upto for timely Bank facilities 31.08.2011 repayment of short Rs 51 Cr term debt obligation and carry higher credit risk as compared to facilities rated higher. Table: 16 Financial Position of the Company as on close of financial year for last three years and estimated for last year and projected for the next year 30.06.07 Audited 30.06.08 Audited 30.06.09 Audited 30.06.2010 Estimated Audited Projections for the current year 30.06.2011 542.78 542.78 Nil 93% 542.77 Agency Rating Date of Rating

Gross Sales - Domestic - Export % growth Net sales (net of excise duty etc.)

172.56 172.56 Nil -172.56

275.35 275.35 Nil 59.57% 275.35

241.23 241.23 Nil (12.38%) 241.23 79

277.42 277.42 Nil 15.00% 277.42

279.48 279.48 Nil 16.00% 279.48

80 Other Income Operating Profit/Loss Profit before tax Profit after tax Depreciation/ Amortization of expenses Cash profit/ (Loss) EBIDTA/PBIDTA Paid up capital Reserves and Surplus excluding revaluation reserves Misc. expenditure not written off Accumulated losses Deferred Tax Liability/Asset a) Tangible Net Worth b) Investment in allied concerns and amount of cross holdings c) Net owned funds/Adjusted TNW (a b) Share application money Total Borrowings Secured Unsecured Investments-others Total Assets Out of which net fixed assets Net Working Capital Current Ratio Debt Equity Ratio Term liability/ Adjusted TNW TOL/Adjusted TNW Operating Profit/Sales 0.06 3.14 3.20 2.69 0.02 0.07 1.27 1.34 1.09 0.02 0.10 1.36 1.46 1.00 0.02 0.11 11.83 11.94 10.15 0.04 0.10 1.99 2.09 1.40 0.03 3.10 36.40 39.50 26.07 0.29

2.71 4.18 2.52 10.23

1.11 2.97 2.52 11.32

1.02 2. 55 2.52 12.32

10.19 16.79 6.92 22.47

1.43 3.66 7.12 13.72

26.36 60.99 32.12 39.79

0.00 0.00 0.03 12.78 Nil

0.00 0.00 0.02 13.86 Nil

0.00 0.00 0.02 14.86 1.00

0.00 0.00 0.02 29.41 1.00

0.00 0.00 0.02 20.86 1.00

24.00 0.00 0.02 47.93 1. 00

12.78

13.86

13.86

28.41

19.86

46.93

Nil 4.11 4.11 0.00 0.05 24.37 0.22 11.53 1.99 0.00 0.00 0.91 1.81

Nil 4.59 4.59 0.00 1.05 27.08 0.20 11.53 1.87 0.00 0.00 0.95 0.46

4.40 4.53 4.53 0.00 0.05 31.75 0.17 12.61 1.74 0.00 0.00 0.65 0.56

Nil 28.00 28.00 0.00 0.05 88.02 0.63 21.76 1.37 0.00 0.00 2.10 4.26

12.39 8.35 8.35 0.00 0.10 69.16 0.45 28.50 1.78 0.00 0.00 2.51 0.71 Nil 120.00 88.00 32.00 0.10 276.91 3.97 59.27 1.34 0.00 0.00 4.90 6.70

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81 Long Term Sources Long Term Uses Surplus/ Deficit Short Term Sources Short Term Uses Surplus/ Deficit 12.78 1.25 11.53 11.60 23.13 -11.53 13.87 2.34 11.53 13.21 24.74 -11.53 14.85 2.24 12.61 16.89 29.50 -12.61 29.40 7.64 21.76 58.61 80.37 - 21.76 33.25 4.75 28.50 35.91 64.41 -28.50 103.93 44.66 59.27 172.98 232.25 -59.27

Key Financials up to last quarter: The company is not a listed company. However Key financials upto 30.09.2010 i.e. first quarter of the financial year and sales achieved up to 30.11.2010 are as under: Table: 17 Key Financials up to last quarter (Rs. in Cr) Upto 30.09.10 85.38 0.25 5.10 5.35 3.57

Particulars Net Sales Other Income Operating Profit PBT PAT Present Proposal Present proposal is for :

(Rs. in Cr) Upto 31.12.2011 203.89 Not Available Not Available Not Available Not Available

Approval of enhancement in FBWC limits from 11.50 crore to Rs 23.00 crore and in NFB limits

from Rs 18.00 crore to Rs 40.00 crore being our share out of the total assessed PBF of Rs 76.00 crore & NFB limit of Rs 125.00 crore from the consortium. Approval of 0.50% concession in ROI in line with existing consortium member Banks. Approval of 50% relaxation in Processing Charges and 25% relaxation in commission on NFB

limits .

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82 Issuance of NOC/ consent letter in favour of Punjab & Sind Bank for ceding pari passu charge on current assets of company and on collateral security i.e. EM of IPs

in the account for securing STL/WC limit of sanctioned/to be sanctioned by them.

a)Justification for working capital sanction:

Table: 18 Assessment of Fund Based Limits


S No 1 2 3 4 5 6 7 8 9 Item Chargeable current assets Other current assets Total current assets Other current liabilities Working capital gap Net Working Capital at 25% of Total Current Assets less Export Receivables Projected net working capital Permissible bank finance (5-6) Permissible bank finance (5-7)

(Rs. In crore)
Projected for 30.6.2011 202.49 29.76 232.24 84.98 147.27 58.06 59.27 89.21 88.00 Accepted for 30.6.2011 202.49 29.76 232.25 96.98 135.27 58.06 59.27 76.19 76.00

Justification for Fund based working capital limits proposed

The existing PBF of Rs.27.50 cr from the consortium was assessed on the projected sales of 277.42 cr for 30.6.2010 against which the company has achieved sales of Rs.279.47 cr.

Thus surpassing the target. Now, the company has projected sales of Rs.542.78 cr for 30.6.2011 due to diversification of its activity into trading of mobile handsets, besides continuation of the existing activity in trading of electronic goods. The projected turnover of Rs.542.78 cr, includes sales of

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Rs.151.98 cr on account of sales of DVD and other electronic items and Rs.390.80 cr due to sale of Mobile Hand Sets.

The mobiles sets are being got manufactured from China on the specifications and designs of the company. The Company is undertaking huge advertisement expenses to popularize their TVS-E brand in the market. Looking to the popularity of the existing brand product, vast market for mobile sets and companys existing marketing net work all across the country, the company is hope full of achieving the projected sales target. The company has achieved sales of Rs 203.89 Cr as at 31.12.2010, detailed as under:

a) b)

Telecom division

115.53 Cr 88.36 Cr : 203.89Cr

Electronics Division: Total

Sales achievement upto 31.12.2010 is 37.56% of the annual estimates. It is proposed that release of enhancement in limits should be in consonance with the sale performance

Further the Company is undertaking huge advertisement expenses to popularize its TVS-E brand in the market and has already spent Rs. 22.00 Cr on advertisement and further a sum of Rs.10.00 Cr is projected to be spent in next three to four months. As a result, sales of mobile handsets are growing day by day. Looking to vast market for mobile sets and also existing marketing net work of the company all across the country, coupled with availability of working capital funds from the consortium the company is likely to make considerable sales in second half year ending 30.06.2011. Hence proposed sales targets are considered feasible.

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84 The existing PBF for FB limits of Rs 27.50 Cr was assessed on the projected sales of Rs 277.42 Cr for 2009-10. Now, PBF of Rs 76.00 Cr has been assessed on projected sales of Rs 542.77 Cr for 2010-11, due to the following reasons:

a) The activity of sales of mobile handsets needs higher holding of Finished Goods and receivable. Hence the same have been estimated at 2.69 Months and 2.30 Months respectively compared to last accepted level of 1.59 Months and 1.87 Months .

b) Higher holding level of FG and receivable is justified and accepted as the company has to keep the inventory of finished goods comprising of various models/variants in different colours at all its 29 locations across the country.

c) All the mobile handsets are imported. The replenishment of the consignment does not take place very fast as the lead time is 50-60 days approximately. Due to these reasons, the finished goods inventory of 2.69 Months is justified.

d) With the diversification of activity into trading of mobile handsets the projected level of debtors has been made as per prevailing market trend. Hence the same is not comparable to past trend. The projected debtors level of Rs.104.09 Cr for 2.30 months is considered reasonable because in trading of Mobile Handsets the competition is very high from the international brands as well as national brands. It is a trade practice to provide 90 days credit to the distributors in this activity. Therefore, company has projected the average debtors holding period of 2.30 Months Due to increase in level of operations, particularly due to diversification in Mobile Hand Set business, requirement of the company for WC limits has increased. Hence the company has approached banks in the consortium for enhanced in working capital limits.

b) Justification for Non Fund based limits


The company imports DVD in knocked down condition, other electronics goods and mobile handsets against LC on usance basis. The company has projected import of goods worth Rs 510.21 Cr under LC during current financial year ending 30.6.2011. Accordingly the FLC 84

85 requirement from the consortium has been assessed as under : Table: 19 Non Fund based limits (Rs in crore) 1. i) ii) iii) iv) v) vi) vii) viii) ix) Letter of Credit Estimated purchase during 2010-11 Out of which, raw materials expected to be purchased under L/C. ( 100%) Time lag between date of opening L/C to date of shipment Time lag between dates of shipment to dates of receipt of material. Average Usance credit excluding the period mentioned under (iv) Total Lead period Maximum requirement of L/C = (ii X vi) / 365 Total requirement of LC say Amount of sundry creditors considered under L/C (DA) 510.21 510.21 19 Days 10 Days 61 Days* 90 Days 125.80 125.00 84.46

*The above calculation has been made on the following assumptions:Total purchases of Rs. 510.21 Cr will be made under LC and 70% of the total purchases will be under Letter of Credit having usance period ranging from 60-90 days and 30% of purchases will be under LCs having usance period of 30 days. Therefore o an average 61 days of usance period has been taken for assessment of NFB limits.

Table: 20 Limits Limits TL WC (FB) NFB Total/Ceiling Existing Nil 11.50 18.00 29.50

(Rs. in crore) Recommended Nil 23.00 40.00 63.00

Detailed Industry Scenario


Industry Scenario for Telecom Sector in India: a) The Indian telecommunications industry is one of the fastest growing in the world and India is projected the second largest telecom market globally by 2010. b) India added 113.26 million new customers in 2008, the largest globally. In fact, in April 2008, India had already overtaken the US as the second largest wireless market. To put this growth into perspective the countrys cellular base witnessed close to 50 per cent growth in 2008, with an average 9.5 million customers added every month. 85

86 c) According to Telecom Regulatory Authority of India (TRAI) the total number of telephone connections (mobile as well as fixed) had touched 385 million as of December 2008., taking the telecom penetration to over 33 per cent. This means that one out of every three Indians has a telephone connection, and telecom companies expect this pace of growth to continue in 2009-10 as well. It is projected that the industry will generate revenues worth US$ 43 billion in 2009-10. d) With the rural India growth story unfolding, the telecom sector is likely to see tremendous growth in Indias rural and semi urban areas in the years to come. By 2012, India is likely to have 200 million rural telecom connections at a penetration rate of 25 per cent. And according to a report jointly released by Confederation of Industries and Ernst & Young, by 2012, rural users will account for over 60 per cent of the total telecom subscriber base. e) According to Business Monitor International, India is currently adding 8-10 million mobile subscribers every month. It is estimated that by mid 2012, around half the countrys

population will own a mobile phone. This would translate into 612 million mobile subscribers, accounting for tele-density of around 51 per cent by 2012. f) On 29.05.2009 the Telecommunication Ministry, Government of India has announced the target of local rate of Rs.0.10 paise per call and STD at Rs.0.25 paise per call which will open a wide market for mobile telephony in India. Table: 21 Detailed Note on Assessment of Maximum Permissible Bank Finance (MPBF) Sales 2008-09 (AUDITED) Gross Sales Less Excise Net Sales %age increase 241.23 0.00 241.23 (12.39%) 2009-10 (Audited) 279.48 0.00 279.48 16.24% (Rs in Cr) 2010-11 2010-11 (PROJECTED) (ACCEPTED) 542.78 542.78 0.00 0.00 542.78 542.78 93.57% 93.57%

Particulars Total Sales Mobile Handset Consumer Electronic Business

Projections for the current year 30.06.2011 542.77 (390.80) (151.97) 86

Achieved %Achievement upto 30.11.2010 176.02 32.42% (90.36) 23.12% (85.66) 56.36%

Annualized

422.44 216.86 205.58

87 Justification:

The existing PBF of Rs.27.50 Cr from the consortium was assessed on the projected sales of 277.42 Cr for 30.6.2010 against which the company has achieved sales of Rs.279.48 cr.

thus surpassing the target. Now, the company has projected sales of Rs.542.70 cr for 30.6.2011 due to diversification its activity into trading of mobile handsets, besides continuation of the existing activity in trading of electronic goods. The projected turnover of Rs.542.78 cr, includes sales of Rs.151.98 cr on account of sales of DVD and other electronic items and Rs.390.80 cr due to sale of Mobile Hand Sets. Looking to the popularity of the existing brand product, vast market for mobile sets and companys existing marketing net work all across the country, the proposed sales targets are considered feasible.

In view of the increase in level of operations, particularly due to diversification in Mobile Hand Set business, requirement of the company for WC limits has increased. Hence the company has approached banks in the consortium for enhanced in working capital limits. Since the Company was already in assembly and sales of Electronics items and has established/proposed marketing network with dealers all across the country, the same can be economically and efficiently utilized for sales of Mobile Handsets also. Considering the vast potential for sales of Mobile handsets and their established marketing network and also the price range of products which they are getting manufactured from China on economic costs, the proposed sales targets are considered feasible.

Table: 22 Chargeable Current Assets 30.6.2010 Last accepted Raw Material (Holding per month) 1.30 (13.87) 30.6.2010 (Audited) 0.88 (26.00) 87 30.6.2011 (ESTIMATED) Nil

(Rs in Cr) 30.6.2011 (ACCEPTED) Nil

88 Finished Goods (Holding per month) Other Consumable spares (Holding per month) Receivables (Holding per month) Total 33.92 (1.59) 0.02 15.88 (0.69) 0.05 98.39 (2.69) 0.01 98.39 (2.69) 0.01

(1.48) 43.12 (1.87) 78.36

(18.67) 9.17 (0.39) 25.98

(1.48) 104.09 (2.30) 202.49

(1.48) 104.09 (2.30) 202.49

Comments on accepted level of holdings:Raw Materials:


Raw material was mainly comprised of miscellaneous electronic items, the value of which remained at Rs 0.88 cr as against estimated value of Rs 1.30 cr in the past as at 30.06.2010. However keeping in view holding of same being nominal compared to FG, it is now estimated at Nil for current FY and value as given in the CMA has been taken into finished goods as after purchase / receipts of CKD Kit (Complete Knocked Down) and SKD Kit (Semi Knocked Down) which was earlier treated as part of RM stocks, the same are taken into assembly process/FG, hence it is not accounted as RM now.

Finished Goods: Actual holding level of finished goods as at 30.06.2010 is Rs.15.88 Cr (0.69 months of cost of goods sold) which is lower than the accepted level.
The company has projected level of finished goods at Rs 98.39 Cr (2.69 months of cost of goods sold) because: The Company is marketing the Mobile Handsets all over the country and it has entered into

agreement with M/s DIESL (Tata Group Enterprises) for providing Warehousing and Logistics Services at 29 places all across the country. The company has transferred the goods to these warehouses and the sale billing to the distributors also takes place from these warehouses only. It helps in speedy delivery to the distributors as well as placement of the goods in the market and further sales. As such, the company has to keep the inventory of finished goods comprising of all the 88

89 models at all the 29 locations.

All the mobile handsets are imported. The replenishment of the consignment does not take

place very fast as the lead time is 50-60 days approximately. Due to these reasons, the finished goods inventory of 80 days is justified.

The company supply the items in lots as per order schedule and keep certain quantity readily

available for urgent orders also and added new line of trading business also for which core inventory is needed on certain locations, the projected holding of finished goods has been accepted.

Other Consumable spares :

The company has to keep spare parts in stock for assembling / manufacturing of DVD and Mobile Handsets. The company purchases the consumable spares in economical lot. Looking into the turnover of the company, the level of other consumable spares is reasonable and is being accepted. Debtors :
Actual holding level of receivables as at 30.06.2010 is Rs. 9.82 Cr (0.42 months of sales) which is lower than the accepted level. However with the diversification of activity into trading of mobile handsets the projected level of debtors has been made as per prevailing market trend. Hence the same are not comparable to past actual and accepted levels at the time of last assessment.The projected debtor level of Rs.104.09 Cr for 2.30 months is considered reasonable because in trading of Mobile Handsets the competitions are very high from the international brands as well as national brands. Therefore in order to brave the competition the company has to offer credit as per the market trend.

Table: 23 Other Current Assets 30.6.2010 30.06.2010 Last accepted (Audited) Cash & Balance Advance suppliers Bank to 0.14 0.25 0.14 16.48

(Rs in Cr) 30.6.2011 30.06.2011 (ESTIMATED) (ACCEPTED) 2.62 25.45 2.62 25.45

89

90 Other Current Assets Total Cash in hand, at Bank: 1.53 1.92 22.39 39.01 1.69 29.76 1.69 29.76

The level of cash in hands has been projected on higher side as compared to the past on account of introduction of business of trading of mobiles handsets wherein the company will be having approximately 30 sales points all across the country for its Mobile Handsets business and it has to maintain cash/current account balance (CA with member banks where our bank will not be having branch office) in all the locations to take care of day to day operating expenses of the marketing staff, logistics and other petty requirements. As such, due to nature of operations, the average holding of Rs. 8.00 lacs per location in cash/bank balances is justified.

Advance to suppliers: The company has to make advance payments to the suppliers of mobile manufacturers so as to enable them to take the job in hands. When material is ready for supply the suppliers than ask for opening of FLCs so that stocks are shipped as per terms of LCs. The advance payments are get adjusted against the supplies. The projected level of such payments are reasonable in view of the fact that the company has to purchase total stocks of Rs 510 Cr during the current fiscal. Looking into volume of operation, the level is reasonable and accepted.

Other Current Assets : Other current asset includes loans & advance to staff, prepaid expenses, advance payment of taxes etc. and the same has been projected as per past trends. Hence accepted.

Table: 24 Other Current Liability 30.6.2010 Last accepted

30.6.2010 (Audited)

(Rs in Cr) 30.6.2011 30.6.2011 (ESTIMATED) (ACCEPTED)

90

91

Trade Creditors (Months purchases) Advance from customers Provision for taxation Total Trade Creditors :

29.89 (1.30) 0.05 0.67 30.61

26.26 (1.14) 0.06 1.24 28.26

71.44 (1.68) 0.11 13.43 84.98

83.44 (1.97) 0.11 13.43 96.98

The level of sundry creditors is proposed to be increased from 0.27 months to 1.99 months considering the new line of business of mobile handsets and the same is as per trend in the market.

Advance from Customers: The company gets advance payment from dealers who are looking for ready delivery of goods and the level is reasonable and accepted.

Net Working Capital Projected NWC of Rs.59.27 Cr is acceptable as per 2nd method of lending. NWC buildup is as under: Table: 25 Net Working Capital Sr No. 1 2 Particulars Actual NWC as at 30.6.2010 ADD: Cash Accruals for 2010-11 Fresh Induction of Capital Increase in TL/STL Amount In CR 28.50 26.36 12.63* 32.00 -------------91

70.99

92 3 LESS: Increase in NCA/increase in FA/Repayment of STL etc. NWC to be available as at 30.6.2011 40.26

59.27

*It is stipulated that before release of enhancement the company to bring in amount of Rs 12.63 Cr on account of induction of fresh capital. Table: 26 Assessment of Permissible Bank Finance (Rs. in crore ) Item Projected for Accepted for 30.6.2011 30.6.2011 Chargeable current assets 202.49 202.49 Other current assets 29.76 29.76 Total current assets 232.24 232.25 Other current liabilities 84.98 96.98 Working capital gap 147.27 135.27 Net Working Capital at 25% of Total Current 58.06 58.06 Assets less Export Receivables Projected net working capital 59.27 59.27 Permissible bank finance (5-6) 89.21 76.19 Permissible bank finance (5-7) 88.00 76.00

S No 1 2 3 4 5 6 7 8 9

Recommendations: In view of forgoing CH has recommended for approval of: Enhancement in WC FB limit from 11.50 crore to Rs 23.00 crore and in NFB limit from Rs 18.00 crore to Rs 40.00 crore from our bank, being our share in the assessed PBF of Rs 76.00 crore for FB limits and Rs 125.00 crore for NFB limits from the consortium. (Rs. in crore) Limits TL WC (FB) NFB Total/Ceiling Existing Nil 11.50 18.00 29.50 Recommended Nil 23.00 40.00 63.00

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CHAPTER - 4

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94

ANALYSIS

- This section explains the analysis of CMA data submitted by the client and assessments of need based working Capital finance as per the prescribed methodology. - Companies approaching bank for working capital financing need to assess their working capital requirements. - This assessment forms the most basic part of working capital and companies must present a clear picture of this assessment to the banks for sanction of loan. - CMA data is one of the methods used to assess working capital for a company and is involves preparation of a number of forms. - These forms have a prescribed format in which they are presented these forms clearly define financial position of the company. - CMA data distinguishes current assets and current liabilities and determines the net working capital for the company for a particular period. This net working capital is then used to determinate one of the most important variables according to banker. This is called maximum permissible bank finance.

- The bank adopts a suitable method for the determination of MPBF using any of one method, Tandon or Chore committee.

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95

FINDINGS
The following are the ratios calculated using the CMA data: Table: 28 Ratios RATIOS 2008-09 2009-10 PROJECTED 2010-11 1.34 PROJECTED 2011-12 1.35

Current ratio DSCR TOL /TNW

2.37

1.78

1.96 0.65

1.96 1.10

2.24 4.28

2.04 2.19

Fig. : 6 Current ratio

1) Current Ratio of the company is 1.34 in 2010-11 which is acceptable as ideal ratio is 1.33. This shows that bank has a margin of safety of 37%. The current ratio can give a

95

96

sense of the efficiency of a company's operating cycle or its ability to turn its product into cash. Fig.: 7 DSCR

2) DSCR represents the debt repayment capacity of the firm. From the table and the graph we can see that DSCR is favourable in 2011 but it deteriorates further in the next year because of the higher instalments and interest amount. Minimum DSCR is in the years 2008-09 & 2009-10 when the PAT is quiet low. Although the DSCR is expected to be supported by higher PAT in the year 2011-12, itll decline because high repayment in the year. A DSCR of less than 1 would mean a negative cash flow. A DSCR of less than 1, say .95, would mean that there is only enough net operating income to cover 95% of annual debt payments. For example, in the context of personal finance, this would mean that the borrower would have to delve into his or her personal funds every month to keep the project afloat.

Fig. : 8 TOL/TNW

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97

2) TOL/TNW ratio tells us the capital adequacy of the firm to service its debts. The ratio in 2008-09 was low because of high amount of debt and no generation of profits but afterwards, the ratio improves quickly because of capitalization of profits and repayment of debts.

Table: 29 Net Sales & MPBF 2008-09 24123.45 452.70 2009-10 28040.53 819.53 2010-11 54277.77 8800.00 2011-12 59705.55 11000.00

Net Sales (in lacs) MPBF (in lacs) MPBF/Net Sales

1.87

2.92

16.21

18.42

Fig. : 9 MPBF to Net Sales

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98

MPBF/Net Sales
20 15 10 5
0 2008-09 2009-10 2010-11 2011-12 MPBF/Net Sales

3) MPBF to NET SALES Here we can see that, as the net sales is rising; the limit of MPBF is also increasing. The ratio was 1.87% in 2008-09 and is expected to increase to 18.42% in 2011-12. Reason for such an increase in MPBF/Sales is that raw material procurement (purchase) has increased/ expected to increase as the company is planning to diversify its business.

CONCLUSION & RECOMMENDATIONS

98

99

CONCLUSION
PNB has well researched and well defined credit appraisal systems which have been experimented over its standing of 116 years in the industry, however in order to increase the efficiency and faster decision making on credit on credit matters, bank may initiate following actions.

1) Banks should go for need based financing. 2) The assessment of working capital requirement is a dynamic process as the bank has to ensure the following things:
a) WC requirement is not over assessed, as it would give undue benefits to the company in the form of excess limits which is not commensuration with the business activity of the company and thus company would the excess limits to some other uses like long terms uses. b) WC requirement is not under assessed, as it would expose company to risk of lower funds and hence it would lead to access the other sources of short terms financing which would have which could have impact on the financials off the company and in some cases the viability of the company also.

3) Apart from this, different industries process different challenges in WC assessment as WC cycle varies from industry to industry. However, bank should ensure holding levels of various components of the MPBF are in consensus with the peer group of the industry. There should not be large variation from the market trend and if so, reasons for this must be sought from the company. 4) Assessment system should be transparent and easily understood by the borrowers. 5) To reduce appraisal time, banks should devise a suitable software.

RECOMMENDATIONS
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100

1) Bank should ask for Personal guarantee for credit enhancement as it creates a moral binding on the borrower. Hence it mitigates the risk of default by failure on repayment will lead to bad name of the promoter in the market and will have a spiral effect.

2) Credit rating of the company is done on subjective parameters and every person has its own point of view regarding these parameters and hence rating can differ. Therefore, there is a need to standardize the norms to minimize human bias.

3) Number of tiers: faster decision making and faster dispersion of credit is of paramount importance. There are 3 channels:i. ii. iii. Branch Office 3 touching points ( Officer, Manager, Chief Manager) Circle Office - 3 touching points ( Officer, Chief Manager, Circle Head) Head Office - 3 touching points ( Chief Manager, Deputy General Manager, General

Manager)
The bank at present has a 3 tier system with 9 touching points which need drastic reduction for faster decision making: -

This will curtail avoidable delays.


Improve efficiency besides reducing appraisal time as well as cost.

In order to expedite decision making besides qualitative improvement in credit appraisal system, it is suggested that the branches should:

Concentrate on marketing of credit Focus on improvement in customer service

4) Utilization of Funds
Major portion of Bank finance consist of short term credit to meet working capital requirements. It is therefore, necessary that it is utilized for acquiring inventories, to finance receivables etc. But it 100

101 has been observed from the balance sheet of various companies that fund raised (including bank Finance) to meet short term needs are diverted towards other requirements.

Post loan sanction, monitoring should be done.

5) The bank may consider the following that is in terms of preference is given to proposal/ projects which: Are least harmful for the environment are employment oriented encourage entrepreneurial work help in development of backward/ rural areas Promote and facilitate the concept of CSR.

LIMITATIONS OF THE STUDY


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102

All the information cannot be included as most of the information is confidential and not approachable.

The study is being done keeping in mind the policies of the head office.

The data availability is proprietary and not readily shared for dissemination.

The staff although are very helpful but are not able to give much of their time due to their own job constraints.

The data is used in the study is secondary which can lead to some kind of discrepancy, anomaly or biasness in the study.

Due to the ongoing process of globalization and increasing competition, no one model or method will suffice over a long period of time and constant up gradation will be required.

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CHAPTER- 5

103

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REFERENCE
WEBSITES http://en.wikipedia.org/wiki/Punjab_National_Bank rbi.org.in http://www.dogpile.com/dogpile_other/ws/index?_IceUrl=true DBOD/ RBI/ECGC/FEMA notification/policies http:// en.wikipedia.org/wiki/credit_appraisal http:// en.wikipedia.org/wiki/working_capital http://www.crisil.com/Ratings/RatingList/RatingDocs/megha-technicalengineers_02feb10.html http://www.mckinsey.com/locations/india/mckinseyonindia/pdf/india_banking_2010.p df http://www.slideshare.net/m9821735856/information-security-and-risk-managementfor-banks-in-india http://www.bankingindiaupdate.com/creditrisk.html http://www.bizresearchpapers.com/Kesseven.pdf http://www.journaloffinance.in/wp-content/uploads/2010/02/Credit-Rating-Agenciesin-India-final.pdf http://www.investopedia.com BOOKS, PUBLICATIONS & MAGAZINES Book of Instruction on Loan Accounts PNB, Internal Circulation. Project Appraisal by Prasanna Chandra. PNB Annual Report 2009-10. Internal Files of PNB. PNB Monthly Review January 2011.

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