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OBJECTIVE OF THE PROJECT:

  • To develop and understanding of the Non-Banking Financial Institutions (NBFIs) and their business operations in India.
  • To do a detailed research on SREI Equipment Finance Private Limited, its market share and the SWOT analysis.
  • To thoroughly review SREI's credit appraisal and credit management process.
  • To understand the risk management process of the company.
  • To gain a detailed knowledge of the parameters that affects various risks.

To determine weightages and scores for designing and developing risk assessment model based on market forces for assessing SREI's Customers.

METHODOLOGY:

  1. In order to achieve the said objectives, will be to go through the entire NBFs history, thrust areas; growth opportunities, present scenario. This will be the ongoing process and will be done using internet, news and books.
  2. To understand the functioning of SREI pertaining to credit risk management and appraisal process followed for financing large corporates (risk exposures more than Rs.5 crores). Factual data, credit appraisal memorandum prepared by the company and the credit risk policy of the company will be referred in this regard.
  3. Then comes the technical part of conducting Balance Sheet Analysis, Ratio Analysis and Cash Flow Analysis.
  4. To propose a statistical credit rating model, data have been collected from credit officers and the relationship managers in the institution. Financial ratios were used to measure the strength of the customer. Score model for assessing risk to convert responses to scores. Weighted average method applied to assign appropriate importance to various parameters.

LIMITATIONS OF THE STUDY:

  • The study will only be focusing on the LARGE CORPORATES (risk exposure more than Rs.5 crores) not the retail and SME sectors of SREI.
  • Study is on the basis of first-hand information collected from employees/head of the division of the company that might be incorrect or biased.
  • Duration of the internship imparts the pressure of covering this vast spectrum in a limit period of 14 weeks.
  • The accuracy of the Risk Assessing Model depends on the accuracy of information provided by the customer.
  • The risk rating model doesn't take into the consideration where in the company doesn't follow the rules & norms strictly. The relationships with the customers are given more importance.

INDUSTRY ANALYSIS:

Structure of India's Financial Services Industry:

The RBI, the central banking and monetary authority of India, is the central regulatory and supervisory authority for theIndian financial system. SEBI and IRDA regulate the capital markets and insurance sector, respectively. A variety offinancial intermediaries in the public and private sectors participate in India's financial sector, including the following:

  • Commercial banks;
  • NBFCs;
  • Specialised financial institutions like NABARD, EXIM Bank, SIDBI and TFCI;
  • Securities brokers;
  • Investment banks;
  • Insurance companies;
  • Mutual funds; and

Venture capital.

NON-BANKING FINANCIALCOMPANIES:

Non-banking financial companies (NBFCs) are fast emerging as an important segment of Indian financial system. It is an heterogeneous group of institutions (other than commercial and co-operative banks) performing financial intermediation in a variety of ways, like accepting deposits, making loans and advances, leasing, hire purchase, etc. They raise funds from the public, directly or indirectly, and lend them to ultimate spenders. They advance loans to the various wholesale and retail traders, small-scale industries and self-employed persons. Thus, they have broadened and diversified the range of products and services offered by a financial sector. Gradually, they are being recognized as complementary to the banking sector due to their customer-oriented services; simplified procedures; attractive rates of return on deposits; flexibility and timeliness in meeting the credit needs of specified sectors; etc.

The working and operations of NBFCs are regulated by the Reserve Bank of India (RBI) within the framework of the Reserve Bank of India Act, 1934 (Chapter III B) and the directions issued by it under the Act. As per the RBI Act, a 'non-banking financial company' is defined as:- (i) a financial institution which is a company; (ii) a non-banking institution which is a company and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner; (iii) such other non-banking institution or class of such institutions, as the bank may, with the previous approval of the Central Government and by notification in the Official Gazette, specify.

NBFCs VsBANKING SECTOR IN INDIA:

Non-Banking Finance Companies (NBFCs) are an integral part of the country's financial system complementing theservices of commercial banks. The main reason attributed to the growth of NBFCs is the comprehensive regulation of thebanking system. Other factors include higher level of customer orientation, lesser pre/post sanction requirements andhigher rates of interest on deposits being offered by NBFCs.

NBFCs have traditionally been extending credit across various parts of the country through their geographical presence,with NBFCs being a supplier of credit to segments such as equipment leasing, hire purchase, and consumer finance. Theseare areas which warrant infusion of financing due to the existing demand-supply gap. NBFCs have been a more flexiblesource of financing and have been able to disburse funds to a gamut of client, from the local common man to a varietyof corporate client. NBFCs are also able to accelerate the pace of decision making to disburse funds, customise andtailor their products according to the client needs and take on excess risks on their portfolio. NBFCs can be divided intodeposit taking NBFCs, i.e., which accept deposits from public and non-deposit taking NBFCs being those which do notaccept deposits from public.

The activities carried out by NBFCs in India can be grouped as under -

The types of NBFCs registered with the RBI are:-

§ Equipment leasing Company: is any financial institution whose principal business is that of leasing equipment or financing of such an activity.

§ Hire-purchase Company:is any financial intermediary whose principal business relates to hire purchase transactions or financing of such transactions.

§ Loan Company: means any financial institution whose principal business is that of providing finance, whether by making loans or advances or otherwise for any activity other than its own (excluding any equipment leasing or hire-purchase finance activity).

§ Investment Company: is any financial intermediary whose principal business is that of buying and selling of securities.

Now, these NBFCs have been reclassified into three categories:-

§ Asset Finance Company (AFC)

§ Investment Company (IC) and

§ Loan Company (LC).

Under this classification, 'AFC' is defined as a financial institution whose principal business is that of financing the physical assets which support various productive/economic activities in the country.

GOVERNMENT ROLE IN PROMOTING INFRASTRUCTURE FINANCE:

Infrastructure is expected to be a key area of growth in a developing country like India. The Government has been activelypromoting the country's infrastructure through a sustained focus on area like power, roads, ports and urbantransportation. Private sector participation through public private partnerships as well as privately funded projects isbeing encouraged in order to enable quick scale up of government's efforts and better management. As per PlanningCommission's estimates the investments in infrastructure during the Tenth Plan aggregated to Rs. 4, 52,900 crores whichis expected to increase to Rs. 11, 25,000 crores in the Eleventh Plan. The chart below describes the anticipated andestimated investments under the two plans respectively.

PROJECTED INVESTMENT IN INFRASTRUCTURE in the 11th FIVE YEAR PLAN:

COMPANY PROFILE:

A started operation in 1989, Srei is a leading infrastructure focused private sector Non-Banking Financial Company (NBFC) in India. It is currently the only institution in India offering holistic infrastructure solutions financing, advisory services & development.

Milestones Achieved:

1989 - Started operations and identified the infrastructure sector as its core

Business area.

1992 - Initial Public Offering with listing on all major stock exchanges.

1997 - IFC, FMO & DEG invested as strategic equity partners Promoters stake.

2002 - Conceived Quippo, India's first equipment bank.

2004 - All India presence, currently 63 offices.

2005 - First Indian NBFC to be listed on the London Stock Exchange.

2006 - Geographical expansion into Russia; equity partners EBRD, DEG, &

FMO.

2007 - Joint venture with BNP Paribas Lease Group, 100% subsidiary of BNP

Paribas.

2008 - Holistic Infrastructure Institution, financing, advisory services &

Development.

Services:

Ø Infrastructure Equipment Financing & Leasing

Ø Infrastructure Project: Financing, Advisory services and development

Ø Insurance Broking

Ø Venture Capital

Ø Capital market

Ø Sahaj e-village

Ø Quippo - Equipment Bank

GROUP STRUCTURE:

About Srei Equipment Finance Private Limited:

Srei BNP Paribas (Registered name: Srei Equipment Finance Private Limited) is a 50:50 joint-venture between Srei Infrastructure Finance Limited, India's leading and only private sector Non-Banking Financial Institution in the infrastructure space and BNP Paribas Leasing Solutions(BPLS), a wholly owned subsidiary of BNP Paribas, France.

Srei BNP Paribas started its operation from January 01, 2008 with the infrastructure and construction equipment financing and insurance businesses and has further plans to expand its business to new verticals.

Industry leader in the infrastructure and construction equipment financing, Srei BNP Paribas is aptly benefitting from the Indian expertise and insight of Srei and global leasing insight in diverse product classes of BNP Paribas.

Srei BNP Paribas has deep insight on diverse equipment used in the infrastructure and construction sector and acts a valuable advisor to its customers. It has tied up with all the leading equipment manufacturers. Over the years, Srei BNP Paribas has been innovating new marketing programs bringing together the manufacturers and customers on a single platform, creating immense value and sharing this value with all the stake holders. "Paison Ki Nilami" and "Srei BNP Paribas Partnership Week" are two such prominent programs.

Srei BNP Paribas has already started financing Technology Solutions (financing of IT equipment, software and services) and has effectively partnered with leading global IT vendors for financing their customers. It has also forayed into financing of new Equipment classes: Agriculture Equipment, Healthcare Equipment, Office Automation, and Equipment in Education sector etc. With its foray into new equipment classes, Srei BNP Paribas has become probably the one and only Company to offer complete Equipment Solutions.

With a customer base of over 20,000, Srei BNP Paribas has grown from strength to strength enjoying a strong national presence with a network of 86 offices across India.

VISION:

To be the most inspiring global holistic infrastructure institution.

MISSION:

To be an Indian multinational company providing innovative integrated infrastructure solutions.

CORE VALUES:

Customer Partnership:

At Srei, customer satisfaction is the benchmark for success. Srei delights its customers through a comprehensive range of financial services that are personalized, fast, reliable, convenient, quality driven, and yet cost - effective.

Integrity:

Business integrity is a way of life at Srei. The company strongly stands by integrity in all its dealings and ensures strict adherence to the highest standards of business ethics.

Passion for Excellence:

Srei's passion for excellence is instrumental in positioning the company as the most innovative infrastructure solution provider in India.

Respect for People:

Srei acknowledges the fact that its people are its most valuable assets and accordingly provides the best possible work environment and treats them like family members. The company rewards excellence and initiative.

Stakeholder Value enhancement:

Srei is committed to earning the trust and confidence of all its stake holders. Its growth focus, the ability to constantly enlarge its product basket while controlling risk and reducing the cost of its services have resulted in enhanced value for its stakeholders.

Professional Entrepreneurship:

Srei's in - depth knowledge of infrastructure financing business in India, coupled with its spirit of entrepreneurship, and helps the company to overcome the obstacles and complexities with professional expertise.

MANUFACTURING PARTNERS:

MARKET SHARE OF SREI BNP PARIBAS:

Source: Company.

MAJOR COMPETITOR'S:

1. MAGMA FINCORP LIMITED:

Magma Fincorp Ltd (Magma) is a Kolkata based asset financing company. The company is engaged in financingof commercial vehicles, cars, construction equipment, tractors and utility vehicles.The company's target customers are mostly first time users and small entrepreneurs.

The Company provides construction equipment finance across retail and strategic customer segments. In the retail segment, it focuses on first-time buyers and small customers. The Company has established contracts with large value vendors addressing multiple projects. It finances a range of construction equipment like excavators, backhoe loaders, compactors, compressors, cranes, tippers and drillers of prominent brands like JCB, Telcon, L&T, Ingersoll-Rand, Caterpillar, ECEL, Escorts and Atlas Copco etc.

Magma provides unsecured EMI-based loans to SMEs for working capital, business expansion and business maintenance. It has developed proprietary financial analysis tools to make safe credit assessments. The share of this segment is increasing in the total disbursements (5% in FY10). Going forward the company intends to maintain the proportion of these loans at 5% and would adopt a cautious approach while lending.

In Commercial Vehicle Finance Segment, Magma provides loans on used commercial vehicles and construction equipment. Magma refinanced popular models of Tata Motors and Ashok Leyland.

Magma Fincorp predominantly was engaged in financing of construction equipment and passenger cars, utility vehicles and commercial vehicles (CVs). These business verticals accounted for 90% of the company's disbursements in FY10. Recently the company has ventured into high-yield segments, viz; financing of used CVs, tractors and SME loans. Most of the loans disbursed are retail loans and have small ticket size except in the construction equipment segment. MFL has a concentrated focus on the under tapped semi urban and rural market to finance first time users, Small Road Transport operators, small contractors etc.

2. TATA CAPITAL:

The Company was incorporated on March 8, 1991 and actively commenced business operations since September, 2007. The Company is a wholly owned subsidiary of Tata Sons Limited, the apex holding company of the Tatas. Their fund based businesses comprise Corporate Finance, Infrastructure Finance and Retail Finance & fee based businesses comprise investment banking, broking and distribution, wealth management, private equity, treasury advisory, services relating to travel, forex and infrastructure.

With the wide array of products and customized service, the commercial finance business, helps small, medium and large corporates grow their business. The company's team of handpicked professionals offers in-depth expertise to help customers keep pace with the changing marketplace and offer them appropriate solutions to meet their ever-growing financial needs. The company's management structure enables them to leverage relationships across lines of our businesses. Their product knowledge and multi-channel delivery model enhances the ability to cross-sell the company's services. TATA Capital is in the advanced stages of setting up institutional broking, insurance broking and rural finance businesses which would supplement the aforementioned lines of business.

TATA Capital believes that the following are the key strengths:

  • Unified financial services platform;
  • Diversified and balanced mix of businesses;
  • Experienced management team;
  • Innovative solutions model;
  • Respected brand;
  • Controls, processes and risk management systems; and
  • Access to capital.

3. L&T FINANCE LIMITED:

L&T Finance Limited (LTF) is a subsidiary of Larsen and Toubro. It was incorporated as a Non-Banking Finance Company in November 1994. Through LTF, L&T aims at making a strong foray in the ever-expanding financial services sector.L&T Finance understands the intricacies of your business. We at L&T Finance offer financing for your Construction Equipment in the form of term loans, working capital loan and operating lease facilities. In 1996, L&T Finance had made a foray in financing of commercial vehicles. L&T Finance offers financing Commercial Vehicles of all makes and sizes. We also undertake funding of the body for the Commercial Vehicles. L&T Finance has an extensive network from where you can easily avail financing for your Commercial Vehicle.

Advantages of partnering with L&T Finance

  • Presence in more than 70 locations
  • Flexible repayment option
  • Competitive interest rates
  • Finance for used vehicles available
  • Faster loan approval and disbursement

A brief Comparison between SREI EQUIPMENT FINSNCE & its Competitors:

Magma Fincorp Ltd.

TATA Capital

L&T Finance

SREI

Product Profile

Commercial Vehicle Finance,Construction Equipment Finance,Car and Utility Vehicle Finance,Suvidha Loans (Refinance),Strategic Construction Equipment Finance,Tractor Finance,SME Loans,Insurance

Fund based businesses: Corporate Finance, Infrastructure Finance and Retail Finance. Fee based Businesses:Investment banking, broking and distribution, wealth management, private equity, treasury advisory, services relating to travel

Commercial Vehicle Finance,Construction Equipment Finance, Rural finance, microfinance, Working Capital Finance, Corporate Finance, Loan against Securities, Project Finance, Insurance & Mutual Funds

Fund based businesses:Equipment Financing, Project Financing. Fee based Businesses:Project Advisory, Investment Banking, Venture Capital / Fund Management.

Presence

PAN India Presence

PAN India Presence

PAN India Presence

PAN India Presence

Focus Segment

First Time Users & Small Entrepreneurs

Retail finance, small and mediumEnterprise finance and construction equipment and infrastructure finance.

Strategic Retail

Strategic & Retail

Branch Network

172

100

200

86

Credit Ratings

LAA+(ICRA)

LAA+(ICRA)

Date of Incorporation

1989

8th March, 1991 (commenced business operations since September,2007

November, 1994

1989

2008 - JV with BNP Paribas Leasing Solutions

REASON FOR THE JOINT VENTURE WITH BNP PARIBAS LEGAL SOLUTIONS:

Mr.HemantKanoria, Vice Chairman and Managing Director of SREI, termed this joint venture as a very significant step in the Indian Financial Services Market. “We are the largest player in the financing of infrastructure equipment and collaborating with BPLG will help in increasing our market share further and also expanding the product line into financing of agriculture, information technology, medical and other equipment.”

Speaking at the occasion Mr. Bertrand Gousset, member of the Executive Committee of BPLG, in charge of Corporate Development, said, “We are delighted to be associated with the SREI group, who are the leaders in the financing of infrastructure equipment and provide a wide range of equipment finance products to large strategic clients as well as to retail customers, with pan-India coverage. This joint venture is very significant for us and we look forward to a long and prosperous association with them.”

Mr. Sunil Kanoria said, “This joint venture signifies the coming together of two companies with the same shared values. Both SREI and BPLG are convinced that they are well positioned to build on the already strong platform established by SREI and that this will enable in reduction in cost of funds resulting in higher profitability.”

Mr.Amoudru, CEO of BNP Paribas India and Head of Territory, said "The acquisition of a 50% stake in this joint-venture with SREI - a highly recognised firm in equipment and infrastructure financing - further evidences the willingness of the BNP Paribas Group to expand its presence in India in activities where it has a strong expertise. It represents another substantial capital commitment from the Group- the largest so far- in this country and testifies our confidence in the long term prospects of the Indian economy".

SWOT ANALYSIS:

LITERATURE REVIEW:

FLOW OF THE PROCESS AT SREI:

CREDIT APPRAISAL:

Credit Appraisal is a process to ascertain the risks associated with the extension of the credit facility. It is generally carried by the financial institutions which are involved in providing financial funding to its customers.These financial institutions appraise the technical feasibility, economic viability and bankability including creditworthiness of the prospective borrower. Credit appraisal starts from the time a prospective borrower walks into the branch and culminates in credit delivery and monitoring with the objective of ensuring and maintaining the quality of lending and managing credit risk within acceptable limits.

Credit appraisal involves analysis of liquidity position/ financial soundness of the company. Although, the analysis also covers understanding growth trends in revenues and earnings, and profit margins, more emphasis is required to be placed on liquidity-both long term and short term.

There are basically two types of proposals that are received by the companies for funds. The first types of proposals are financing against new and first hand assets to be purchased (EQUIK) and the other proposals are financing against pre owned assets (REQUIK).

Asset finance is generally divided into three departments depending upon the risk exposure*:

  • Retail: Aggregate risk exposure not exceeding Rs.1 crore.
  • SME (Small & Medium Enterprises): Aggregate risk exposure between Rs.1 - 5 crores.
  • Strategic: Aggregate exposure more than Rs.5 crores.

*NOTE: Risk exposure to a client is determined by the summation of Net Finance Amount for the approval(s) being considered, together with all existing exposures to the client & all related concerns in aggregate and residual Net Finance Amounts under all previous valid approvals for the Client pending part or full disbursement.

SOME IMPORTANT TERMINOLOGIES:

ASSET FINANCE:

Asset Finance category includes secured business loan in which the borrower pledges as collateral an asset used in the conduct of its business. Asset finance also includes business in which a client takes an asset on lease for use in the conduct of his business for a defined period with or without right of onward sub - lease the asset.

ASSET COST:

  1. In case of Equik, the invoice values of the Asset including all duties and taxes which are not refundable or adjustable under drawback or otherwise any scheme. Spares, consumables, accessories & auxiliaries, consultancy fees, installation and erection charges, etc. shall not be considered as part of asset cost.
  2. In case of Requik, Asset cost will be determined by the lowest of:
    • Present Intrinsic Value of Asset as determined through a process by an expert approved by SREI.
    • Actual purchase price to be paid by the consumer
    • Current Insured Declared Value.

MARGIN:

Margin means the client's contribution on the Asset Cost payable upfront or any amount deposited with us as Security Deposit in relation to the transaction before the disbursement or release of facility.

AIRR:

Internal Rate of Return (IRR) by definition is the rate of return at which the Net Present Value of the stream of payments (repayment of installments and interest by the customer vis-à-vis the actual disbursement made by the company) become equal to zero.

FIRR:

Financial IRR (FIRR) shall mean the transaction IRR without factoring any benefit available to Srei - BNPP in terms of normal MOU entered into by srei - BNPP with concerned manufacturer. Management fees/ RTE/ Commitment Charges collected upfront, an extra credit period, subvention or other cash incentives extracted from the manufacturer over and above those available workings.

YIELD:

Yield means the rate of return to Srei-BNPP from the transaction, factoring all the benefits available to Srei-BNPP under normal MOU and otherwise from the manufacturers/vendors.

ETR (Excellent Track Record):

ETR means peak delay of not more than 30 days and average delay of not more than 15 days for payment of dues in all existing and past accounts of the proposed customer.

GTR (Good track Record):

GTR means peak delay of not more than 45 days and average delay of not more than 30 days for payment of dues in all existing and past accounts of the proposed customer.

PTR (Poor track Record):

PTR means peak delay more than 45 days and average delay of more than 30 days for payment of dues in all existing and past accounts of the proposed customer.

ANALYSIS OF CREDIT APPRAISAL MEMORANDUM:

Credit risk of each individual transaction is studied and managed from the five different perspectives:

  • Customer credit worthiness
  • Asset quality
  • Asset deployment
  • Collateral security
  • Facility type

Background of the proponent/ management:

The identification of the borrower is done properly through scrutiny of his antecedents, experience, competence, integrity, initiative etc. This may be done by obtaining status reports from previous bankers. In case of corporate, the management structure, the background of the top management needs to be scrutinized. KYC guidelines as framed by RBI are adopted by the company.

Commercial Appraisal:

The nature of the product, demand for the same, the existing and perceived competition in the segment, ability of the proponents to withstand the same, government policies governing the industry etc. need to be taken into consideration.

Technical Appraisal:

Technical appraisal of the project needs to be carried out for industrial activity proposals beyond the cut - off limits prescribed from time to time. Such appraisal may be carried out in - house by technical officers.

Financial Appraisal:

Apart from ascertaining the need based character of the limits requested for, the financial health of the proponents, ability to absorb unanticipated financial costs need to be looked into which would include scrutiny of the cost of the project, means of financing, financial projections etc. important performance indicators like profitability ratios, debt - equity ratio, operating profit margin etc. need to be within acceptable parameters for that industries/ activities.

INTRODUCTION TO RISK:

The interpretation of the word 'risk' will determine the approach to risk management. The word 'risk' is interpreted in three distinct senses namely risk as hazard, risk as opportunity and risk as uncertainty.

Risk as hazard is the most commonly used meaning of risk and it means likely financial losses arising from negative events such as control failures, bad publicity and loss of reputation. Risk management in this context would mean eliminating possibilities of losses from such negative events by putting in place adequate control systems.

Risk as an opportunity means, taking risks and earning adequate returns on them. This implies the trade-off between risk and return. Here risk management, becomes risk optimization meaning maximizing the upside potential and minimizing the downside. Here capacity and ability to manage risk is used to increase shareholders' value and achieve a competitive advantage.

Risk, as uncertainty is basically a statistical concept, which assumes a normal distribution for future outcomes. Here risk management means narrowing the difference between the expected outcomes and actual results. Banks and other similar financial institutions need to manage the risk inherent in the entire portfolio as well as the risk in individual credits or transactions. The effective management of risk is a critical component of a comprehensive approach to risk management and essential to the long-term success of any banking organization.

In simple words, risk is the possibility of losses associated with decrease in the credit quality of borrowers. In a financial institution, loss may stem from default due to inability or unwillingness of a customer to meet his commitments in relation to lending, trading, settlement and other financial transactions. A default reduces the present value of the loan and consequently the value of the bank's business. Thus, it is imperative that these institutions have a robust risk management.

MODEL BUILDING:

Need for Study:

A Risk Assessment Model (RAM) is necessary to avoid the limitations associated with a simplistic and broad classification of applicants into a "good" or "bad" category

The comapny currently uses a judgemental risk assessing model.

Grading System for Standardization of Risk:

The grades (symbols, numbers, alphabets, and descriptive terms) used in the internal credit-risk grading system represent, without any ambiguity, the default risks associated with an exposure. The grading system will enable comparisons of risks for purposes of analysis and top management decision-making. The grading system is therefore, be flexible and should accommodate the refinements in risk categorization.

STEPS IN DEVELOPING OF MODEL:

STEP- 1: Identification of all the key risk components in the principal business:

The first step in the development of the model was the identification of the various parameters to be taken into consideration. For this purpose, the various manuals and documents pertaining to appraisal were carefully studied. More factors were added to the list to make it comprehensive, effective and statistical. This was done through literature survey and scanning the company's appraisal system.

The following was the result..Risk assessment can be done from 2 aspects:

Quantitative aspect:

Quantitative aspect refers to managing the credit risk by using the quantitative tools and techniques such as ratio analysis, and reaching a concrete number for every loan which would indicate the magnitude of risk and expected returns, on a case by case basis.

Qualitative aspect:

Qualitative aspect is taking a holistic view by a financial institute at its overall portfolio, deciding the lending limits to a sector, setting up the broad policies and procedures, and so on.

Both quantitative and qualitative aspects need to be taken into consideration while computing the risk levels. In the case of corporate clients, post-mortem of the balance sheet is one of the main instruments. Ratio analysis helps us determine whether the loans have to be extended. But, past performance is not an ideal indicator of the future performance. This raises the necessity to consider other qualitative parameters such as technological status, reputation, repayment track with others and so on.

Classification of Risk:

The risk faced by financial institutions extending commercial vehicles or construction equipment finance has been regrouped as follows:

A. Liquidity Risk:

Liquidity risk is the non-availability of cash to pay a liability that falls due. A company is deemed to be financially sound if it is in a position to carry on its business smoothly and meet all the obligations - both long term as well as short term - without strain. Assessment of the efficiency with which the funds are put to use is very important for credit analysis.

The study of efficiency of debt-service management becomes essential to banks as the ratios reveal:

  • Whether the profit of the firm is enough to cover not only the interest payment, but also to provide a reasonable cushion against future uncertainty
  • Whether the profit is sufficient to provide enough coverage for repayment bligations
  • Whether the assets of the firm provide adequate security for loanssanctioned.

In short, the coverage ratios show the relationship between the debt servicing commitments and the sources for meeting these burdens.

Debt Equity Ratio:

The ratio brings out the extent to which the firm is dependent on outsiders for its existence and indicates the proportion of the owners' stake in the business. A high ratio means that claims of creditors are greater than owner's funds. Excessive liabilities tend to cause insolvency. This is the most unfavourable situation for a banker, as he may gain the position of just one among the many creditors of the company.

Current Ratio:

The current ratio is an index of the concern's financial stability since it shows the extent of the working capital, which is the amount by which the current assets exceed the current liabilities. A high current ratio indicates inadequate employment of funds while a poor current ratio is a danger signal to the management. It shows that business is trading beyond its resources.

Interest Coverage Ratio:

It tells the analysts the extent to which the firm's current earnings are able to meet current interest payments. When this ratio is high it shows that the business would earn sufficient profits to pay the interest charges periodically. A low interest coverage ratio may result in financial embarrassment.

Funded Debt Ratio:

The ratio of secured loans to turnover is known as Funded Debt Ratio. This ratio varies from sector to sector. A low Funded Debt Ratio is preferred.

B. Operations Risk:

In a competitive market, it is critical for any business unit to control its costs at all levels. To measure the operational efficiency, the turnover ratios and profitability ratios are used. They measure how efficiently the firm is employing the assets. They also represent the relationship between profit and sales, and between profit and investment.

Net profit margin:

The final profit figure arrived at after charging all the expenses of the firm against all its income is called net profit. A credit officer would look at the trend of net profit over the years. A company, which has been consistently achieving positive growth rates, reflects a healthy industry position and the management's commitment to the business, effective steps taken by the management to promote their sales in the market.

Fixed Assets Turnover Ratio:

This ratio measures the sales per rupee of investment in fixed assets or the efficiency with which fixed assets are employed. A high ratio indicates a high degree of efficiency in asset utilization and a low ratio reflects inefficient use of assets.

Total Assets Turnover Ratio:

This takes the total view of the business as a producing unit. It determines the produce ability of the assets of the business, which also indicates the managerial capacity of the entrepreneur in putting the assets to best use.

Free Assets to Total Assets:

This ratio is critical to firms employing commercial vehicles and construction equipment as it determines the level of assets available to a banker in case of default. The higher the ratio more secured the funding would be.

Construction Equipment / Vehicles Turnover Ratio:

This ratio measures the sales per rupee of investment in construction equipment and vehicles. In simple terms it measures the fleet strength of the clients.

Experience in the Industry:

Experience in the industry also helps in determining the operation risk. Basically it helps in measuring the work orders and the cost involved in the same. If it is a well-established industry the risk to finance them will be low and vice versa

C. Credit Risk:

Credit risk is risk resulting from uncertainty in a counter party's willingness to meet his contractual obligations. The business character of a borrower rests on traits as trustworthiness and commitment.

Repayment track with others:

The repayment track of the borrower with others determines how well they have carried out their business in the past years. A business with prompt payment has less credit risks than those whose reputation is a question mark in the market. Srei has its own different categories based on the repayment track i.e. ETR, GTR & PTR.

Percentage funding to total cost:

This helps us measure the level of financial commitment of the borrower in the proposal. Lower ratio means more contribution from the borrower and the risk on the banker's end is low.

Category of assets:

At Srei, there are basically two types of assets: Standard assets & Non-Standard Assets. The approvals, interest charged, and risk assessment is done on the basis of the category. Standard Assets are charged comparatively low interest rate with respect to Non-Standard Assets.

D. Market Risk

The factors influencing the relative competitive position of the customer are examined in detail. The result of these factors is reflected in the ability of the issuer to maintain or improve its market share. It may be mentioned that the customers, whose market share is declining, generally do not get favourable long-term ratings.

Net Worth to Net Sales:

The net worth of a business provides that important cushion to withstand shocks from adverse changes in external (economic, financial and legal) and internal environments of the business. Net worth is thus referred to as the risk capital. When compared to the sales of the business, it shows the efficiency with which the capital is rotated in the business.

Technology Status

Obsolescence is another problem that an industry faces. A firm's competitive position is decided based on the technological competence it possesses. Advances in technology can dramatically alter a firm's landscape.

The firm is at an advantageous position when it holds superior technology. The risk is more among the players in the industry when the technological competence is inferior. The risk of not keeping up with the progress of changing technology may affect the growth. Hence a firm with a good technological background is more attractive.

Competitions:

The competitions prevailing in the market also determines the risk involved while financing a client. If there is less competition & the customer is the major player then there is less risk involved and vice versa.

Geographical Factors Affecting the Industry:

The geographical factors where the customers are established are also taken into consideration while assessing the risk.

STEP - IV: ARRIVE AT THE RISK RATING ON THE RISK ASSESSMENT MODEL:

Based on the information on weights which was collected from the credit team of the company, a standard and comprehensive model was developed. Each of the customers will be rated on each of the parameters based on the key provided. The final score of the customer decides the risk involved in operating with him.

To aid the assessment process and to systematize the entire process, key for assessment has been developed in consultation with people well versed in this field. The key will not only quicken the assessment, but also standardizes it. The parameters in each risk category should be analysed based on the key and must be given a score. The scores should be multiplied with the weights assigned, in proportion to the importance of the parameter, to arrive at an aggregate for each risk category. Each risk category is measured separately and is also expressed as a percentage, which would help to measure the risk easily. After calculating the risks under each category, they must be summed up and the grand score will be on 1000. To get a single point indicator of the risks, it is divided by 10 and expressed as a score on 100. Based on the final score the company is given a rating by referring to the scoring guide of the model.

As mentioned earlier, the grades used in the internal risk grading system should represent, without any ambiguity, the default risks associated with an exposure.

Here, we employ a numeric rating scale. A numeric scale developed is such that the lower the risk, the lower is the rating on the scale. The rating scale consists of 6 levels, of which levels 0 to 2 represents various grades of acceptable credit risk and levels 3 to 5 represents various grades of unacceptable credit risk associated with an exposure. The scale, starting from "0" (which would represent lowest level credit risk and highest level of safety) and ending at "5" (which would represent the highest level of credit risk and lowest level of safety), is deployed to standardize, benchmark, compare and monitor credit risk associated with the bank's loans and give indicative guidelines for risk management activities.

The model, the key for assessment and the scoring guide along with the interpretation are illustrated below.

#

Parameters

Weight

Score

Weighted score

LIQUIDITY RISK

1

Debt Equity Ratio

8.5

2

Current Ratio

5

4

Interest Coverage Ratio

6

5

Debt Service Coverage Ratio

10

6

Secured Loans to Turnover Ratio

9

Sub Total

OPERATIONS RISK

6

Net Profit Margin

9

7

OperatingProfit Margin

9

8

Fixed Assets Turnover Ratio

6

9

Return on Capital Employed

7.5

10

Free Assets to Total Assets

7

11

Construction Equipment / Vehicles Turnover Ratio

8

12

Experience in the Industry

9

Sub Total

CREDIT RISK

18

%age Funding to Total Cost

7

19

Repayment Track with Others

10

22

Category of Assets

6.5

Sub Total

MARKET RISK 100

23

Geographical factors affecting the Industry

7

24

Net Worth to Net Sales

6

25

Promoters stake in the Industry

8

26

Technology status

5

27

Competitions

6.5

Sub Total

GRAND TOTAL

SCORE (in %ge)

The Risk Assessment Model

Table showing the key for assessment

#

Parameters \

Scores Ratings

Best Worst

5

4

3

2

1

1

Debt Equity Ratio

1 - 1.5

1.5 - 2

2 - 2.5

2.5 - 3

Above 3

2

Current Ratio

Above 2.5

2 - 2.5

1.33 - 2

1 - 1.33

Below 1

Interest Cov-erage Ratio

Above 4

2.5 - 4

1.5-2.5

1.5 - 1

Below 1

4

Debt Service Coverage Ratio

Above 2.5

1.5 -2.5

1.25 -1.5

1 -1.25

Below 1

5

Funded Debt Ratio

Very High

High

Moderate

Low

Very Low

6

Net profit Margin

Increasing sharply

Increasing

Constant

Inconsis-

tent

Decreasing

7

Operating Profit Margin

Increasing sharply

Increasing

Constant

Inconsis-

tent

Decreasing

8

Fixed assets turnover Ratio

Above 3.5

3 - 3.5

2.5 - 3

2.5 - 3

2 - 2.5

9

Return on Capital Employed

Very High

High

Moderate

Low

Very Low

10

Free Assets to Total Assets

Very High

High

Moderate

Low

Very Low

Construction Equipment/ Vehicles Turnover Ratio

Very High

High

Moderate

Low

Very Low

12

Experience in the Industry

More than 20 years

10 - 20 years

5 - 10 years

2 - 5 years

0 - 2 years

13

%age funding to Total Cost

Below 75 %

75 - 80%

80 - 85%

85 - 90%

More than 90 %

Repayment Track with Others

ETR

GTR

PTR

VPTR

Category of Assets

Standard

Non Standard

Geographical Factors Affecting the Industry

Most favourable

Favour-

able

Moderate

Less Favour-

able

Very Less Favourable.

Net Worth to sales

Very High

High

Moderate

Low

Very Low

Promoters Stake in the Industry

100%

80%

70%

60%

Less than 60%

26

Technology Status

Superior

Updated

Comfort

-able

Competitions

No Competitio-n

Very Less Competitio-n

Less Competitio-n

High Competito-n

Very High Competition

THE SCORING GUIDE

RISK SCORE (%)

RISK CATEGORY

EXPLANATION

NATURE OF CASE

100 -81

0

Very low risk

Excellent

80 - 71

1

Low risk

Very good

70 - 61

2

Comfortable risk

Good

60 - 51

3

Tolerable risk

Fair

50 - 41

4

High risk

Doubtful

Below41

5

Undesirable risk

Poor

Interpretation:

RISK CATEGORY 0 - Indicates fundamentally strong position. Risk factors are negligible. There may be circumstances adversely affecting the degree of safety but even such circumstances are not likely to affect the timely payment of principal and interest as per terms.

RISK CATEGORY 1 - The risk factors are more variable and greater in periods of economic stress. Any adverse change in circumstances may alter the fundamental strength and affect the timely payment of principal and interest as per terms.

RISK CATEGORY 2 - Considerable variability in risk factors. The protective factors are below average. Adverse changes in economic circumstances are likely to affect the timely payment of principal and interest as per terms.

RISK CATEGORY 3 - Risk factors indicate that obligations may not be met when due. The protective factors are narrow. Adverse changes in economic conditions could result in inability or unwillingness to service debts on time as per terms.

RISK CATEGORY 4 - There are inherent elements of risk. Timely servicing of debts could be possible only in case of continued existence of favourable circumstances.

RISK CATEGORY 5 - Extremely speculative. Either already in default in payment of interest and/or principal as per terms or expected to default. Recovery is likely only on liquidation or re-organization.

NOTE:

The above proposed risk rating Model will not be applicable in following situations:

  • When the financing is done on the basis of the SREI's Relationship with the clients.
  • When the financing is done to a new or recently formed company.
  • When financing is done to a Manufacturing Unit.

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