Credit Appraisal Processes Followed by Banks

Contents

Click to expand Contents

1. INTRODUCTION & OBJECTIVE OF THE STUDY

2. Role of Bank in economic growth

3. OBJECTIVES

4. CREDIT APPRAISAL & ITS NEED

I. NEED FOR CREDIT APPRAISAL:

5. Types of Credit and Loan facility

(A) Fund based bank facilities:

(B) Non-fund based bank facility

II. Process followed by Kotak Mahindra Bank for Credit Appraisal

III. RBI Guidelines for banks’ lending

6. BRIEF DESCRIPTION OF THE CONCEPTS/MODEL INTRODUCED IN THE STUDY

Turnover method:

MPBF (Maximum permissible bank finance) method:

Illustration of MPBF method:

7. COMPANY OVERVIEW

8. CASE INTRODUCTION

9. CASE ANALYSIS

Financial Analysis:

10. INTERPRETATION AND CONCLUSION

11. RECOMMENDATIONS

12. LIMITATIONS OF THE STUDY

1. INTRODUCTION & OBJECTIVE OF THE STUDY

This project report explains through different chapters the process of credit appraisal followed by the banks and its importance with respect to current economic scenario. It also explains different methodologies used for assessment of loans by the banks.

Through the years we have noticed that the main cause of the economic and financial crisis has been credit default of big companies and individuals which has severely impacted the world economy.

If we look at the process of creation of money by the banks, we would see that each time the bank makes a loan, new money is created. When banks create huge sums of new money it apparently increases debt in the economy and eventually these debt becomes unpayable and hence banks find themselves in danger of bankruptcy and also triggers the financial crisis in the economy.

Hence the process of credit appraisal becomes important to assess credit worthiness of an individual or organization and to safeguard an economy from financial crisis due to credit default and thereby adding to economic development of a country.

Figure 1: RBI industrial deployment of bank credit[1]

		Outstanding as on
Sr.No	Industry	Jun.26, 2015	Mar.18, 2016	Jun.24, 2016	Mar.31, 2017	Jun.23, 2017
2.1	Mining & Quarrying (incl. Coal)	358	390	338	345	327
2.2	Food Processing	1609	1501	1460	1455	1450
2.2.1	Sugar	395	400	372	327	297
2.2.2	Edible Oils & Vanaspati	195	199	194	184	183
2.2.3	Tea	30	36	33	35	39
2.2.4	Others	989	866	861	909	930
2.3	Beverage & Tobacco	183	181	166	173	166
2.4	Textiles	1982	2058	1992	1963	1927
2.4.1	Cotton Textiles	978	1035	977	964	971
2.4.2	Jute Textiles	22	22	20	23	22
2.4.3	Man-Made Textiles	210	208	199	204	216
2.4.4	Other Textiles	772	793	796	773	718
2.5	Leather & Leather Products	101	105	105	107	106
2.6	Wood & Wood Products	97	95	103	105	101
2.7	Paper & Paper Products	339	355	341	326	319
2.8	Petroleum, Coal Products & Nuclear Fuels	492	512	523	596	525
2.9	Chemicals & Chemical Products	1516	1645	1558	1724	1536
2.9.1	Fertilizers	233	285	251	335	272
2.9.2	Drugs & Pharmaceuticals	499	535	522	464	427
2.9.3	Petro Chemicals	342	365	336	507	436
2.9.4	Others	443	461	448	419	401
2.10	Rubber, Plastic & their Products	363	374	366	392	389
2.11	Glass & Glassware	88	89	84	79	76
2.12	Cement & Cement Products	563	543	548	542	506
2.13	Basic Metal & Metal Product	3829	4160	4195	4211	4154
2.13.1	Iron & Steel	2846	3115	3139	3192	3213
2.13.2	Other Metal & Metal Product	983	1046	1056	1018	941
2.14	All Engineering	1528	1542	1529	1496	1463
2.14.1	Electronics	387	382	377	336	318
2.14.2	Others	1141	1159	1152	1160	1146
2.15	Vehicles, Vehicle Parts & Transport Equipment	686	690	686	736	706
2.16	Gems & Jewellery	705	727	695	690	689
2.17	Construction	724	745	755	822	849
2.18	Infrastructure	9339	9648	9140	9064	8915
2.18.1	Power	5731	5799	5288	5254	5203
2.18.2	Telecommunications	892	913	910	851	827
2.18.3	Roads	1675	1775	1840	1800	1721
2.18.4	Other Infrastructure	1041	1161	1102	1160	1164
2.19	Other Industries	1800	1945	1884	1973	1981
	Industries	26301	27307	26469	26800	26185

From the data it can be seen how vital role a bank plays in lending activity and economic development by funding different industries for its functioning & from this data given by RBI in above table it can be concluded that:

• On a year-on-year basis, non-food bank credit increased by 4.8 per cent in June 2017 as compared with an increase of 7.9 per cent in June 2016.
• Credit to agriculture and allied activities increased by 7.5 per cent in June 2017, lower than the increase of 13.8 per cent in June 2016.
• Credit to industry contracted by 1.1 per cent in June 2017 in contrast with an increase of 0.6 per cent in June 2016. Credit growth to major sub-sectors such as ‘infrastructure’, ‘basic metal & metal products’, ‘textiles’, ‘chemicals & chemical products’, ‘all engineering’ and ‘food processing’ contracted. However, credit growth to ‘construction’, ‘vehicles, vehicle parts & transport equipment’ and ‘rubber, plastic & their products’ accelerated.
• Credit to the services sector increased by 4.7 per cent in June 2017, lower than the increase of 9.2 per cent in June 2016.
• Personal loans increased by 14.1 per cent in June 2017, lower than the increase of 18.5 per cent in June 2016.

2. Role of Bank in economic growth

• The banks play important role in mobilizing savings via network of banks and thereby promotes investments
• finally the savings of people helps in formation of capital which again helps in economic development
• The banks provide loans for the industrial sector and not only they finance industries but also help in growing Indian capital market.
•  Banks helps in promoting entrepreneurship by underwriting the shares of new and existing companies
• Banks help poor people by providing education loans and also this activity promotes higher education and thus help in human capital formation which eventually helps in economic growth of the nation

3. OBJECTIVES

The objective of my project on “Working Capital Assessment” in Kotak Mahindra Bank was to study different steps involved in the process of assessment of loan by the concerned organization and explain the same with the help of a case analysis.

The main objective can be bulleted into different objectives as follows:

• To study and understand various loan product and credit facilities of the bank.
• To study the sources and uses of working capital.
• To study the liquidity position through various working capital related ratios.
• To study the working capital components such as receivable accounts, cash management, inventory management
• To understand the principle for bank lending process
• To learn the process of making a FAT Report
• To make suggestions based on the findings of the study
• To understand the process of making detailed appraisal note
• To study the checklist of the required documents of the process flow
• To study the documentation and disbursement process
• To understand the different types of risks associated in lending decisions and the methods for minimizing such risks.

4. CREDIT APPRAISAL & ITS NEED

Credit appraisal is the process by which various risks which can impact repayment of loans are assessed by the lending body or banks in order to define the credit worthiness of the loan applicant.

4.1. NEED FOR CREDIT APPRAISAL

As mentioned earlier, if bank starts lending money to everyone in order to create money it might lead to huge debts and thus may lead to inability of borrowers to pay back the loan and also it would increase the chances of bank going bankrupt.

Thus credit appraisal is important to identify the risks involved in sanctioning of loans and hence mitigate the credit risk.[2]

There are 3C’s of credit appraisal which are to be kept in mind while assessing the borrower:

• Character
• Capacity
• Collateral

Character refers to the personality traits of the applicant and gives an insight on how the applicant has handled his past debts and if he would be reliable or not.

Capacity refers to the strength of the applicant to repay the loan amount or how much of loan he can handle.

Collateral refers to the capital strength of the applicant which is to be verified in order to make sure no losses occur in situation of default in the pay back process.

5. Types of Credit and Loan facility[3]

There are different types of credit and loan facilities available in each banks as discussed below:

(A) Fund based bank facilities

Credit facilities which involve actual outflow of funds by banks are generally termed as fund based bank facilities.

1. Working capital loan: it is a facility provided by banks to finance day to day operations requirement of a business entity and is used to clear up account payable, wages etc. it includes:
   • Cash credit facility: It is a fund based facility which caters to working capital requirement such as inventory book debt etc. every business entity needs to make a match between the time period for which the funds are raised and the manner in which they are utilized. This is necessary to ensure that there is some sort of asset and liability mismatch and there are no problems in paying back the amounts borrowed. Every business has a short term need to meet working capital requirements and one of the way to tackle this is through the use of cash credit facility.
   • Overdraft facility: it is a facility provided by bank in which it allows an account holder of the bank to draw funds in excess of the amount deposited. This type of financing is most commonly used by businesses to make there working capital more flexible.
2. Term Loan: These are generally sanctioned for project loan or non-project loan. Project loans are sanctioned for setting up a new unit or for expansion of existing units whereas non-project loans are extended for the purpose of acquisition of fixed assets. Viz., building, plant and machinery etc. it is generally granted for creation of fixed assets required for long term use.
3. Export Finance: It is the facility provided by banks to the exporters for financing their export activities generally at lower rate of interest.

(B) Non-fund based bank facility

It is an arrangement done by bank where there is no outflow of funds by the bank but help in obligation to obtain certain facilities from third parties. Some common non fund based products are letter of credit and bank guarantee.

II. Process followed by Kotak Mahindra Bank for Credit Appraisal

The banks’ credit process is divided into three steps based on RBI guidelines:

• Pre sanction
• Sanction
• Post sanction

At the pre sanction stage, the independent credit function within respective businesses conduct credit appraisal and assign a credit rating based on internal rating model.

Based on the independent credit risk assessment, appropriate credit decisions are taken by the sanctioning authorities. The bank has a tiered credit sanction process where credit approvals are reported to the next higher level.

As part of the post sanction process, the credit administration team processes documentation, on the completion of which, credit is disbursed.

III. RBI Guidelines for banks’ lending

Pre sanction stage: [4]

1. Loan application form is secured from the client along with following documents:
   • Last 3 years audited balance sheet along with current year estimation and next 2 years projection
   • Credit monitoring arrangement report
   • Papers of collateral and securities & latest evaluation done by a valuation officer
   • IT returns and other documents like VAT returns/sales tax, excise duty return, sales tax return.
   • Pollution board clearance and electricity connection details (In case of manufacturing unit)
   • Credit rating report by external agency like CRISIL
   • Asset-liability statement of promoters, directors, guarantors and associate companies
2. CIBIL report is secured which provide details regarding following:
   • Firm &guarantors default status &financial history
   • Firm’s business details
   • Loan amount availed, disbursement and repayment details
   • Details of proprietors financial history
   • Bank account and cash balance details
3. If the proposal is for renewal/ enhancement/ reduction of term loan for existing customers, then summary of serious irregularities report and review of account is done by the branch
4. Confidential reports are obtained from other banks from where the client has availed bank facility for getting the information about satisfactory conduct
5. Market standing of company is evaluated by site visit
6. A CMA report is prepared. The CMA report is vetted at the office which has sanctioning authority
7. A CA note is prepared for the detailed appraisal
8. Lastly proposal is accepted if found satisfactory according to bank policy and regulations

Post Sanction Stage: [5]

At this stage following reports are prepared

1. Quarterly monitoring system report is to be submitted on quarterly basis. It gives company’s last quarter performance
2. Legal compliance certificate
3. Stock audit is done by the bank or bank approved CA’s annually
4. Bank’s auditor prepares an annual inspection report
5. Company has to submit annual audited report along with asset-liability statement of promoters, directors, and guarantors.
6. Legal confidential reports are obtained
7. If the client has availed facility of consortium, then report regarding consortium meeting held and key decisions taken.

6. BRIEF DESCRIPTION OF THE CONCEPTS/MODEL INTRODUCED IN THE STUDY

Turnover method:

Turnover method was initially introduced by Nayak committee for SSI units in order to ensure proper flow of credit to small borrowers

According to this method, working capital requirements are estimated at 25% of the projected turnover and of this 25% banks can only finance 20% and rest 5% is to be financed by the borrower himself as his margin.

Method for calculation of working capital requirements and amount to be financed by bank using turnover method can be explained as follows:

Figure 2: working capital requirement calculation method

Annual gross turnover as projected by borrower	1
Turnover as accepted by bank	2
Working capital requirement (25% of 2)	3
Minimum margin required (5% of 2)	4
Actual margin available (current assets – current liabilities)	5
Item 3 – item 4	6
Item 3 – item 5	7
Minimum working capital ( minimum of 6 or 7)	8

MPBF (Maximum permissible bank finance) method:

As per Tondon committee maximum permissible bank finance score is calculated which is the maximum amount a bank can finance. According to MPBF method net working capital should be at least 25% of the total current assets and remaining 75% should be first financed by other current liabilities and rest or the working capital gap can be financed by the bank.

Working capital: working capital is the cash used by organizations for day to day operating expenses.

Working capital gap: working capital gap can be calculated by current assets less current liabilities other than bank borrowings. Here a part of current assets are financed using current liabilities other than bank borrowings and rest which remains is working capital gap.

Illustration of MPBF method:

Figure 3: MPBF method

1st  step	Calculation of total current assets
2nd step	Calculation of Current liabilities other than bank borrowings
3rd  step	Calculation of Working capital gap (Step 1 – step 2)
4th  step	Calculation of minimum stipulated net working capital that is 25% of (step 1)
5th step	Calculation of net working capital i.e. current assets – current liabilities
6th step	Step 3 – step 4
7th step	Step 3 – step 5
8th step	MPBF (minimum of step 6th or 7th )

7. COMPANY OVERVIEW

Kotak Mahindra bank ltd was established by Mr. Uday Kotak as Kotak Mahindra finance ltd. in 1985, since when it started to commence its business. It started with bill discounting but expanded to become a financial services conglomerate.

In 2003 RBI granted Banking license to Kotak Mahindra finance ltd. and hence KMFL became the first non-banking finance company which was converted into a commercial Bank, today known as Kotak Mahindra Bank Ltd.

Kotak Mahindra Bank Ltd. caters to all banking needs at one place. It caters to personal finance solutions of various kinds like credit cards, saving accounts, distribution of mutual funds, life insurance products etc. It also deals with transaction banking, operates lending verticals, manages IPOs and cater to working capital requirements of organizations.

Kotak has one of the largest and most respected wealth management teams in India, providing the widest range of solutions to high net worth individuals, entrepreneurs, business families and employed professionals.

Various Departments at Kotak Mahindra Bank:

• Credit Department
• Risk management department
• Investment and fund management
• Treasury department
• Govt. transaction department
• Credit monitoring, recovery and NPA management, IT, ADC and MIS department
• Priority sector MSME RRB, PMJDY, FI lead bank and SLBC department
• Legal, DRT, Compliance, RTI department
• Planning and development, IRM, fraud monitoring cell
• HRM and training department
• Marketing, retail cell, retails liabilities, Bank assurance, publicity and corporate brand Building department etc.

8. CASE INTRODUCTION

Introduction

The case which as a part of my summer internship study I went through was about a CC limit for working capital. The original name of the company cannot be disclosed as a legally binding letter of secrecy, signed prior to joining the bank which prevents interns from declaring sensitive bank data to outside world.

The case study is about XYZ pvt Ltd. and the brief assessment is as follows:

The company is a private limited company that deals in manufacturing of pharmaceutical products and medicines.

At present most of their products are sold in some of northern parts of the country and now they are planning for expanding market base with an aim to cover the entire northern parts of the country.

The proposal of the company involves fresh issue of CC (cash credit) of Rs. 300 lakh.

The process involved in credit appraisal of working capital loan are as follows:

• Know your customer/ credit login check list (Annexure- A)
• Preparation of FAT/CPA report
• Preparation of gap sheet and query sheet
• Obtain secondary data and conduct other due diligence
• Personal discussion/ customer visit
• Preparation of CRAN (credit risk assessment note)
• Scrutiny of CRAN report
• Sanctioning or rejecting of the proposal
• Terms and condition
• Loan agreement
• Disbursement of loan
• Monitoring

Know your customer / credit login check list:

According to bank policies all the documents and information is collected from the customer who is required to login the request for loan and its processing.

Preparation of CPA (credit processing assistant) report

It is made mandatory by RBI to analyze balance sheets and income statement of the company or the firm. The pattern illustrated here can be different from the one given by company law board (CLB).

This illustration gives us more clear insight of the situation of a company:

Figure 4: CPA illustration

Form	Purpose and contents
LOS UPLOAD	Details of borrower
LOS 1	Profit and loss account and balance sheet
FAT 1	Ratio analysis and ITR details
BOM	Banking plotting
LOAN,DSCR,LTV	Loan details, DSCR calculations, LTV calculations
Assessment of limit	MPBF calculation

Obtain secondary data and conduct due diligence:

In this step we conduct due diligence of secondary data such as-

• Industry outlook
• CIBIL check
• CRILIC check
• RBI default check list
• Information on account status received by other banks
• Company detail verification from MCA website

Preparation of GAP sheet and Query sheet:

GAP sheet is to prepare the list of documents that are yet to be submitted by the customer as per checklist while query sheet records all the doubts and queries related to the case after analyzing financial data and other documents and further same is discussed with the customer while personal discussion.

Personal discussion / customer visit:

PD is conducted by the relationship officer and credit manager in order to verify the reason for loan taken by the customer and if it is justified or not.

While the discussion, officers try to get in detail knowledge about the company and also take down notes about various technical and financial conditions.

9. CASE ANALYSIS

Preparation of credit risk assessment note i.e. CRAN:

In CRAN (credit risk assessment note) for every loan document a memorandum is prepared which consists of the details about the company, proposal and financial parameter.

Here a detail note of the borrower along with the working credit facilities existing and required is mentioned.

Figure 5: CRAN

Promoters background, Family background and group companies	XYZ pvt ltd.   XYZ pvt ltd. was Incorporated on 5-09-1992 And has three directors on board as follows: Pramod Aggarwal Praveen Aggarwal Suresh Aggarwal Details of the directors are as follows: Name Age Qualification Experience Pramod Aggarwal 61 B.com Over 30 yrs. Praveen Aggarwal 52 B.com Over 25 Yrs. Suresh Aggarwal 45 B.com Over 20 Yrs.
Business background	The company is into manufacturing of pharmaceutical products and medicines since 1992 when they started to manufacture fine chemicals for the pharmaceuticals and allied industries. In 1994 XYZ Pharmaceuticals received FDA approval. In 1996 the production of metallic stearates was started utilizing home grown technologies. In 2000 they exported to USA for the first time and in 2003 received ISO 9001:2000 from bureau Veritas quality international S.A London In 2005 the company started building the plant as per WHO-GMP and US-FDA requirements
Market reference	Top 3 customers: 1 Name can’t be disclosed Positive feedback 2 Name can’t be disclosed Positive feedback 3 Name can’t be disclosed Positive feedback

Financial Analysis:

Ratio analysis	Prov. March- 2017	31-Mar-16
current ratio	1.10	1.12
Interest Coverage Ratio	4.66	2.32
DSCR	3.8	2.13
quick ratio	0.95	0.85
NCFO	1.92	0.44
TOL/TNW	4.68	3.8
DER	0.79	0.53

Liquidity analysis

Net Working Capital (NWC):

The net working capital should be compared with the “current liability” to find out whether the

Concerned company would be able to survive the financial downturn or not.

NWC in 2017 is more than NWC in 2016 as in 2017 it is 2.24 crores whereas in 2016 it is 1.36

Crores.

Also from balance sheet we can see that the total current assets as well as total current liability in

2017 is more than 2015 which implies that extent of long term funds deployed in the operating

Assets in 2017 is more than 2016.

Net working capital as a percentage of the total current liabilities:

• In 2017 – (2.24/18.68)*100 = 11.99%
• In 2016 – (1.36/13.13)*100 = 10.36%

Thus in 2017, NWC is 12% of the current liability , which is more than that in the year 2016 and

This implies that the company would be able to survive financial downturn better in the year 2017.

Current Ratio : Benchmark for current ratio as per KMBL guidelines is 1.33

• In 2017 – 1.12
• In 2016 – 1.10

As we can see here the value of current ratio for both the years are slightly higher than 1, which shows that current liabilities can be paid off faster out of the proceeds of the current assets. This indicates a good coverage for current liability as it helps create additional cushion against any difficulties in future.

Quick Ratio: quick ratio indicates short term liquidity of a company and measures a company’s ability to meet its short term obligations.

• In 2017 – 0.85
• In 2016 – 0.95

Thus we can see that company’s ability to meet its short term obligations in 2016 is better than in 2017.

NCFO i.e. Net cash flow from the operating cycle:

• In 2017 – 1.92
• In 2016 – 0.44

The increase in net cash flow from operating cycle in 2017 is a good remark for the company

from investment point of view.

Profitability analysis

PBDIT / Net sales (%) – The increasing trend in this value from 2016 to 2017 indicates good health of the company as the profit before depreciation interest and tax makes good contribution to percentage of net sales.

Retained Profits / Net profits (%) – For both the years 100% of the net profit is retained by the company and this indicates good financial health for the firm.

Solvency Analysis

TOL / TNW – This is a critical ratio in ensuring the extent of the external debt funds, a company relies on. Higher the value lower would be the capacity of company to withstand shocks and downturns.

• In 2017 – 4.68
• In 2016 – 3.80

As we can see the value is higher in 2017 and hence we can conclude that company is more susceptible to shocks and downturns in 2017 but it is higher in both the years and so we can conclude that, company has low capacity to withstand shocks.

Comments based on few important ratios:

Debt to equity ratio (DER): This value indicates how much debt a company uses to finance its assets relative to the amount of value represented in shareholders’ equity.

• In 2017 – 0.79
• In 2016 – 0.53

Since for both the years the value is less than 1, it indicates that company doesn’t finance much of its assets using debts and this is a good sign.

Debt service coverage ratio i.e. DSCR: This value indicates that how much cash flow is available to pay current debt obligations to the company.

• In 2017 – 2.13
• In 2016 – 3.80

Here we can see that for both the years cash flow is positive which is a good sign but in 2016 more debt can be financed from the cash flow generated in comparison to 2017.

Assessment of the current proposal:

Here working capital assessment of the company is done. The assessment of working capital is

Done by two methods and lower of the two eligible working capital loan amount is considered

For providing loan subject to other policies and norms of the bank.

Turnover method:

Figure 6: Turnover method

Sr no.	Particulars	Amt. (Rs. In crores)
		FY 2016	FY 2017
1	Projected accepted annual gross sales / turnover	29.70	23.22
2	Working capital – 25% of the above (1)	7.4	5.8
3	Minimum margin to be provided by the borrower – 5% of 1st	1.48	1.16
4	Bank finance – (2nd-3rd )	5.92	4.64
5	Limit requested by applicant	5	5
6	Limit recommended – lowest of 4th or 5th	5	4.64

MPBF method:

Figure 7: MPBF method

Sr no.	Particulars	Amt. (Rs. in crores)
		FY 2016	FY 2017
1	Total current assets	20.92	14.49
2	Total current liability	18.68	13.13
3	Bank borrowings	9.92	6.10
4	Current liability excluding bank finance	8.76	7.03
5	Working capital gap i.e. (2nd – 4th )	9.92	6.10
6	Margin i.e. 25% of 5th item	2.48	1.52
7	MPBF i.e. (5th – 6th )item	7.44	4.58
8	Existing bank borrowing	9.92	6.10
9	Excess bank finance is( item 8th – item 7th )	2.48	1.52

As per our analysis working capital requirement for XYZ pharmaceuticals of 5 Crores is beyond the limit of amount he can borrow from the bank and hence part of the amount can be financed by the bank as per result of the analysis and rest has to be arranged by the borrower himself as per MPBF method but if we look at turnover method then applicant may borrow up to 4.6 crores from the bank but rest he will have to manage.

Verification Process:

• Prior to sanctioning the loan residential FI is to be done.
• Personal discussion is done to verify minute details.
• ITR Verification is done before sanctioning of loan
• Internal Depude Checks (NCIF & BCIF): Done as mentioned above.
• External Depude Checks (Consumer & Commercial CIBILs, PAN* & CA verifications): Done as mentioned above.

Security Details:

Property details are recorded for security purpose as it can be used as collateral. It consist of following:

• Address of the mentioned property: *Can’t be disclosed
• Name of the owner: *Can’t be disclosed
• Type of property: *Can’t be disclosed
• Market value of the property: *Can’t be disclosed

Rating Report

In Kotak Mahindra Bank each proposal for loan is rated using the kotak rate assessment model i.e. KRAM .This report generated by KRAM helps in analyzing the credit worthiness of the organization. There are other several agencies and institutions like CIBIL, CRISIL etc. which performs credit rating.

LOAN DOCUMENTATION

It is an internal part of lending by banks by which a legal relationship is established between the bank and the borrower and for bank’s legal resort in the court of law. It helps to recognize the nature and level of security which is required in order to provide evidence of the transactions, for deciding the terms and conditions and for enforcing the rights under the documents.

DOCUMENTATION PROCESS

Following are the steps involved in process of documentation:

1. Pre sanctioning safety measures are to be taken before the documentation process starts:

There are certain precautions depending upon the type of borrower which are to be considered before the documentation is done.

2. Execution of documents – following are the steps involved in execution of documents:
   • Proper documentation is required by the borrower which means all the documents should be as per terms and condition declared for sanction and it should be executed by proper sanctioning authority. Also relevant details are needed to be filled up before signing of the documents by the concerned parties.
   • Proper stamping: Documents must be properly stamped as per the stamp law for them to be legally enforceable, failing which those documents would not be considered as valid evidence in court of law.
   • Proper execution: Execution of documents should be done in presence of authorized officials or some representatives from the bank and in any case if it has to be executed outside the bank premises, in such case it has to be approved by the bank itself.

SAFE CUSTODY OF DOCUMENTS

Documents have to be maintained and kept safe based on the guidelines issued under Document handling policy.

POST SANCTIONING INSPECTION OF THE BORROWER TO MAKE SURE LOAN IS PROPERLY UTILIZED

Following methods are implied by the banks to ensure the sanctioned loan would be used for justified reasons:

Make sure the interest payment made by the borrower is always on time.

Always visit the borrower on quarterly basis.

Make assessment of the borrower on quarterly basis.

Checking the stipulated EOD (Annual) of the borrower Scrutiny of the CC account.

10. INTERPRETATION AND CONCLUSION

On the basis of detailed appraisal of the firm XYZ Ltd., we can conclude that the company is in a sound financial condition and looking at past trends it was concluded that the organization is creditworthy. It has a satisfactory credit rating with good grades and also there was no such prior incidences of default reported for the concerned organization. The pharmaceutical industry to which the company belongs seems to have a good future in terms of growth and development and hence we may conclude that the organization will have no difficulty in expansion and growth.

The proposal is recommended to sanctioning committee.

This means the case has to be referred to credit committee which is a group of credit managers of Kotak Mahindra Bank. After the approval of the case by credit committee, the Cash Credit of working capital limit will be sanctioned accordingly.

This project helped me in learning the concepts of working capital needs along with a detailed understanding of how credit appraisal is done and why it is important.

11. RECOMMENDATIONS

Following are the recommendations which I would put forward as per my opinion:

• Bank must always try to verify if the data obtained is authentic or not as it is very crucial for any credit appraisal process.
• Banks must incorporate use of more advanced technologies to avoid delay in information gathering processes as any such delay may lead to certain assumptions made by credit officers in order to carry forward the case.
• Rating models are needed to be of standard norms and also these models should be updated on time to time basis as the credit model used by bank give the rating on different parameters but in some cases credit manager has to make assumptions which leads to variation in ratings.

12. LIMITATIONS OF THE STUDY

Following are the limitations which I had to face while my summer internship:

It was a difficult task for me to understand and apply my learnings on credit appraisal in a short span of 2 months.

As per bank policies revealing of name of the clients or any information/data related to client should not be disclosed because of the confidentiality and hence it was a challenging task to get all the data from bank officials.

Also due to busy schedule at times it was difficult to convince bank officials to guide me through the process and hence I had to depend on internet for my learnings and thus the process was slow.

13. ANNEXURE

Balance sheet

		Name of Company –										XYZ Ltd
																						(Rupees in Crores)
			II. BALANCE SHEET LIABILITIES									Year 1						Year 2						Year 3						Year 4
		CURRENT LIABILITIES (CL) :
		Short Term borrowings from banks (including bills purchased / discounted)
		1. from applicant bank								0.00								0.00				0.00						0.00
		2. from other banks								6.10								9.92				13.11						20.17
		(Out of total bank borrowings – BP & BD								0.00								0.00				0.00						0.00
			SUB-TOTAL									6.10						9.92						13.11						20.17
		1.			Short term borrowings from other incl. CPs					0.00								0.00				0.00						0.00
		2.			Sundry Creditors (Trade)					5.25								7.27				6.68						7.18
		3.			Advance Payment from Customers / Deposit from dealers
										0.00								0.00				0.00						0.00
		4.			Provision for taxation					0.29								0.50				0.62						1.24
		5.			Dividend payable					0.00								0.00				0.00						0.00
		6.			Other Stat. liabilities (due within 1 year)					0.00								0.00				0.00						0.00
		7.			Instalments of TLs/ Debentures/ Pref. Shares/ DPGs/Deposits/ Unsecured Loans etc. (due within 1 yr.)
										0.00								0.00				0.68						0.76
		8.			Other CL and Provisions (due within 1 year)					0.00								0.00				0.00						0.00
		9.			Interest accrued but not due					0.00								0.00				0.00						0.00
		10. Dues to Directors								0.20								0.00				0.00						0.00
		11. Security Deposit  – Suppliers & Contractors								0.00								0.00				0.00						0.00
		12. Other Current Liabilities								1.29								0.99				0.00						0.00
			SUB-TOTAL									7.03						8.76						7.98						9.18
			TOTAL- CURRENT LIABILITIES
												13.13						18.68						21.09						29.35
		TERM LIABILITIES
		1.			Debentures (not maturing within 1 year)					0.00								0.00				0.00						0.00
		2.			Preference Shares (redeemable with residual tenor for
		> 1yr & < 5 yrs.)								0.00								0.00				0.00						0.00
		3.			Term Loans ( excluding instalments payable within 1
		yr.)								0.07								1.41				0.44						1.68
		4.			Term Deposits (repayable after 1yr)					0.00								0.00				0.00						0.00
		5.			Unsecured Loans (repayable after 1 yr.)					2.04								2.18				2.17						2.17
		6.			Mobilization Adv. (repayable after 1yr)					0.00								0.00				0.00						0.00
		7.			Sundry Creditors for Capital goods					0.00								0.00				0.00						0.00
		8.			Deferred Sales Tax					0.00								0.00				0.00						0.00
		9.			Deferred tax liabilities					0.02								0.22				0.21						0.21
			TOTAL TERM LIABILITIES									2.13						3.81						2.82						4.06
		1.			Ordinary Share Capital					2.13								2.13				2.13						2.13
	2.					Pref. Share Cap. (Residual tenor > 5 yr)					0.00								0.00										0.00
	3.					General Reserve					1.89								2.68				3.90						6.38
	4.					Capital Reserve					0.00								0.00				0.00						0.00
	s					Surplus (+) or Deficit(-) in P&L Account					0.00								0.00				0.00						0.00
	6.					Share Application Money					0.00								0.00				0.00						0.00
	7.					Share Premium					0.00								0.00				0.00						0.00
	8.					Capital Redemption Reserve					0.00								0.00				0.00						0.00
	9.					Quasi Equity					0.00								0.00				0.00						0.00
	10.						Less : Revaluation Reserve				0.00								0.00				0.00						0.00
				NET WORTH									4.02						4.81						6.03						8.51
				TOTAL LIABILITIES
													19.28						27.30						29.94						41.92
	III. ASSETS
	Name of Company –												XYZ Ltd
																							(Rupees in Crores)
				II. BALANCE SHEET – ASSETS									Year 1						Year 2						Year 3						Year 4
	CURRENT ASSETS
	Cash And Bank Balance										0.04								0.02				0.39						2.02
				Short Term Unencumbered Investments (Other than
				long term)									0.01						0.00						0.00						0.00
	1.					Government and other Securities					0.00								0.00				0.00						0.00
	2.Fixed deposits with banks										0.01								0.00				0.00						0.00
				Receivables									11.03						11.15						11.89						16.62
	3.					Domestic Sales					11.03								10.22				3.57						4.98
	4.					Export Receivables (incl. contingent B/P & discounts
	by banks)										0.00								0.00				8.32						11.64
	INVENTORY
													2.08						4.96						9.01						12.68
	7.					Raw Material – Indigenous					0.98								1.62				3.48						4.82
	8.					Raw Material – Imported					0.00								0.00				0.00						0.00
	9.					Consumable Spares- Indigenous					0.00								0.00				0.00						0.00
	10.						Consumable Spares – Imported				0.00								0.00				0.00						0.00
	11.						Stocks in process
													0.20						0.62						1.13						1.96
	12.						Finished goods
													0.90						2.72						4.40						5.90
	13.						Goods in transit				0.00								0.00				0.00						0.00
	14.						Closing stock of traded goods				0.00								0.00				0.00						0.00
				OTHER CURRENT ASSETS									1.33						5.72						3.77						3.97
	16.						Deposits				0.00								2.06				0.00						0
	17.						Duties and taxes paid in advance				0.99								2.25				2.61						2.71
	18.						Others (receivables within 1 year)				0.27								1.35				1.16						1.26
	19.						Advance to suppliers of raw material				0.07								0.06				0.00						0.00
				TOTAL CURRENT ASSETS									14.49						20.92						25.06						35.29
				GROSS FIXED ASSETS (GFA)
													4.45						5.52						3.80						5.55
	1.					Land					0.04								0.47				0.47						0.47

2.		Building		0.75			0.75			0.53			1.56
3.		Plant and Machinery		2.55			2.98			2.5			3.27
4.		Furniture and fixtures		0.08			0.09			0.05			0.04
5.		Other fixed assets		1.03			1.23			0.25			0.21
6.		Capital works in progress		0.81			1.08			1.08			1.08
Less : Accumulated Depreciation on FA				0.49			1.17			0.00			0.00
Less : Revaluation Reserves , if any				0.00			0.00			0.00			0.00
	NET BLOCK				4.77			5.43			4.88			6.63
NON CURRENT ASSETS
1.		Investments in Subsidiary/ Affiliates Cos.		0.00			0.00			0.00			0.00
2.		Other Investments		0.00			0.02			0.00			0.00
3.		Loans & Advances to Subsidiary / Affiliates /
Associates Cos.				0.00			0.00			0.00			0.00
4.		Advance to supplier of Capital Goods / Contractors		0.00			0.00			0.00			0.00
5.		Deferred receivables (maturity > 1 yr.)		0.00			0.00			0.00			0.00
6.		Margin money kept with banks		0.00			0.00			0.00			0.00
7.		Debtors exceeding six months		0.00			0.93			0.00			0.00
8.		Short Term Deposits with Bodies Corporate		0.00			0.00			0.00			0.00
9.		Non-Consumables Stores & Spares		0.00			0.00			0.00			0.00
10. Other Non-current assets including dues from
Directors				0.02			0.00			0.00			0.00
	TOTAL NON CURRENT ASSETS				0.02			0.95			0.00			0.00
Intangible Assets ( deferred tax assets, patents, goodwill,
preliminary expenses, bad / doubtful expenses not
provided for, etc. to the extent not written off
				0.00			0.00			0.00			0.00
	TOTAL ASSETS				19.28			27.30			29.94			41.92
	TOTAL LIABILITIES less TOTAL ASSETS				0.00			0.00			0.00			0.00

I. Operating Statement
.
Name of Company –				XYZ Ltd
											(Rupees in Crores)
I. PROFIT AND LOSS ACCOUNT				Year 1				Year 2			Year 3			Year 4
Sales
1.		Domestic Sales		9.42			9.90			10.39			18.42
2.		Export Sales		13.80			19.80			24.26			43.00
	GROSS SALES				23.22			29.70			34.65			61.42
Less : Excise Duty/ Sales tax				0.00			0.00			0.00			0.00
Add : Other Operating Income				0.00			0.00			0.00			0.00
	NET SALES :				23.22			29.70			34.65			61.42
	Increase in Net Sales (%)
								27.91%			16.67%			77.26%
	COST OF SALES :
1.		Raw Materials		10.30			15.70			19.81			38.53
A. Imported				0.00			0.00			3.96			7.70
B.  Indigenous				10.30			15.70			15.85			30.83
2.		Other  Spares		0.10			0.20			0.00			0.00
A. Imported				0.00			0.00			0.00			0.00
B.  Indigenous				0.10			0.20			0.00			0.00
3.		Power & Fuel		1.60			1.71			2.07			2.45
4.		Direct Labor		1.70			1.80			2.16			2.41
5.		Other Manufacturing expenses		1.50			1.60			2.60			3.07
6.		Depreciation / Amortization		0.45			0.67			0.52			0.75
7.		Repairs and Maintenance		0.44			0.40			0.00			0.00

Profit & loss Statement

	SUB TOTAL :				16.09			22.08			27.16			47.21
Add : Opening Stock in Process				0.78			0.20			0.62			1.13
Less :  Closing Stock in Process				0.20			0.62			1.13			1.96
	COST OF PRODUCTION :				16.67			21.66			26.65			46.38
	COP as % of Gross Sales
					71.79%			72.93%			76.91%			75.51%
Add : Opening Stock of finished goods				1.00			0.90			2.71			4.40
Less :  Closing Stock of finished goods				0.90			2.72			4.40			5.90
	COST OF SALES :				16.77			19.84			24.96			44.88
	Cost of Sales as % of Gross Sales
					72.22%			66.80%			72.03%			73.07%
Selling. General and Admin. Expenses				4.57			7.21			6.48			10.68
	PROFIT BEFORE INTT. & TAX(PBIT)				1.88			2.65			3.21			5.86
	PBIT as % of Gross Sales
					8.10%			8.92%			9.26%			9.54%
Interest & Other Financial Charges				0.50			1.43			1.58			2.53
	Intt. & Fin. Charges as % of Sales				2.15%			4.81%			4.56%			4.12%
	OP. PROFIT BEFORE TAX (OPBT)
					1.38			1.22			1.63			3.33
	OPBT as % of GROSS SALES
					5.94%			4.11%			4.70%			5.42%
Add : Other Non-Operative Income
1.		Interest & Dividend		0.00			0.01			0.25			0.40
2.		Exchange Profit/ Export Incentives		0.00			0.15			0.00			0.00
3.		Excess Provision written back		0.00			0.00			0.00			0.00
4.		Profit on Sale of Assets		0.00			0.00			0.00			0.00
5.		Sale of scrap / other misc. income		0.10			0.09			0.00			0.00
	SUB TOTAL (INCOME)				0.10			0.25			0.25			0.40
Less : Other Non-operating expenses
1.		Loss on Investment		0.00			0.00			0.00			0.00
2.		Loss on forex		0.00			0.00			0.00			0.00
3.		Loss on sale of fixed assets		0.00			0.00			0.00			0.00
4.		Bad debts written off		0.00			0.00			0.00			0.00
5.		Misc. expenses written off		0.00			0.00			0.00			0.00
	SUB-TOTAL (EXPENSES)				0.00			0.00			0.00			0.00
	PROFIT BEFORE TAX/ LOSS
					1.48			1.47			1.88			3.73
Tax Paid				0.24			0.01			0.00			0.00
Deferred Tax liability/ (deferred tax asset)				0.02			0.21			0.00			0.00
Provision for taxes				0.29			0.51			0.62			1.22
	NET PROFIT / LOSS (PAT)				0.93			0.74			1.26			2.51
	PAT as % of Gross Sales
					4.01%			2.49%			3.64%			4.09%
Equity / Preference Dividend  Paid :
1.		Equity Dividend		0.00			0.00			0.00			0.00
2.		Preference Dividend		0.00			0.00			0.00			0.00
	RETAINED PROFIT				0.93			0.74			1.26			2.51

14. BIBLIOGRAPHY

• www.Investopidea.com
• www.kotak

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[1] Source: www.rbi.org.in

[2] Credit risk: it is the risk of default on a debt that may arise from a borrower failing to make required payments. Source: http://ir.kotak.com/downloads/pillar3_disclosures_%20june_15.pdf

[3] Source: www.investopedia.com/terms/c/creditfacility.asp

[4] Source: https://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?Id=5146&Mode=0#B & Kotak Mahindra bank document

[5] Source: https://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?Id=5146&Mode=0#B & kotak Mahindra bank documents