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PROJECT REPORT ON
CREDIT APPRAISAL FOR
WORKING CAPITAL
FINANCE TO SMEs AT SBI
BELGAUM.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
CONTENTS
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
11-12
SECTION-D : INTRODUCTION TO TOPIC
13-21
SECTION-E : REVIEW OF LITERATURE
22-71
SECTION-F : ANALYSIS AND INTERPRETATION
1. SBI Loan Policy
2. Financial Ratios used to Credit Risk Assessment
3. Working Capital and its assessment
4. Credit Risk Assessment
5. Documentation
6. Credit Process
72-81
SECTION-G : FINDINGS AND OBSERVATIONS
82-84
SECTION-H : SUGGESTIONS AND RECOMMENDATIONS
85-87
SECTION-I : CONCLUSION
88-89
SECTION-J : BIBLOGRAPHY
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
PROJECT TITLE
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
“Credit Appraisal for working capital finance to Small and Medium Enterprises at State Bank
of India”
• To understand the credit appraisal system for working capital finance to SME’s
• To understand the rationale behind various guidelines observed by State Bank of India.
Source of information collected is the information provided by the bank as well as the survey
and the observation made there on.
INDUSTRY PROFILE
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
INDUSTRY PROFILE
With the Indian economy clipping at 9 per cent, consumption levels soaring and investment
riding high, the Indian banking sector is on an upswing.
According to the Annual Statement on Monetary Policy for the year 2007-08 released by the
Reserve Bank of India (RBI), the Indian economy has witnessed robust growth during 2006-07
for the fourth year in succession. The Central Statistical Organization (CSO) estimates that the
real Gross Domestic Product (GDP) growth has accelerated from 9.0 per cent in 2005-06 to 9.2
per cent in 2006-07. The CSO’s estimates for 2005-06 places gross domestic savings (GDS)
above 32 per cent of GDP and gross domestic investment (GDI) close to 34 per cent.
India could become the third largest banking hub in the world by 2040, according to a
PricewaterhouseCoopers (PwC) report.
The potential banking market waiting to be tapped in India is fairly huge. Out of the 203
million Indian households, three-fourths, or 147 million, are in rural areas and 89 million are
farmer households. In this segment, 51.4 per cent have no access to formal or informal sources
of credit, while 73 per cent have no access to formal sources of credit. Similar data is not
available for non-farm and urban households.
Given the huge potential, corporate houses like the Tatas and Reliance - Anil Dhirubhai
Ambani Group, besides several others, are said to be interested in having a slice of the banking
pie.
An under-penetrated market and the opportunity to service a large, young, working age
population, which will create and therefore need help to manage wealth, emerging Indian
multinationals with global horizons, entrepreneurs with surplus wealth and limited investment
options makes India an extremely attractive market.
India's per capita income is expected to rise to US$ 1,000 by the end of the 2007/08 fiscal year
on the back of a 9 per cent economic growth, Finance Minister P. Chidambaram has said.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
Per capita income stood at $797 in 2006/07, according to data from the central bank's web site,
nearly double from US$ 460 in 2000-01 thanks to robust economic growth.
Consumption, which today accounts for 60 per cent of India's gross domestic product, is set to
quadruple to US$1.5 trillion by 2025, overtaking Germany as the fifth-largest consumer
market, according to a forecast made by McKinsey.
The credit outgo from public sector banks is expected to grow by 25 per cent for 2007-08 while
deposits are set to grow by around 22 per cent.
Retail banking
Following the trend in other emerging economies, India is experiencing a boom in retail
banking. Drawn by the promise of huge returns in this sector, a number of foreign banks are
falling over each other to acquire a slice of the banking pie. A year and a half ago, Deutsche
Bank launched its retail operations in India. Earlier, another German company BHW Holding
AG positioned itself in this space by taking over Birla Home Finance Ltd. Now there are 29
foreign banks have a presence in India through their 268 branches. In May 2007, the 300-year
old Barclays Plc followed suit. Besides credit cards, its retail foray will be in the personal loan
segment. These late entrants join the ranks of Citibank India, HSBC, ICICI Bank and HDFC
Bank Ltd that have aggressively begun tapping this business.
In May 2007, the retail portfolio of the Indian banking sector was US$ 111.7 billion or around
11 per cent of India’s gross domestic product of US$ 1 trillion. Such loans accounted for 26
per cent of total non-food gross bank credit in the country as on May 25, 2007 and increased by
23.9 per cent on a year-on-year basis over May 26, 2006 after growing at 30 per cent for three
years in a row. Mortgages or housing loans account for more than half of the retail portfolio
and grew at a sizzling pace of 40 per cent plus during the last three years.
Rural banking
In October 2007, ABN Amro Bank announced its micro finance division has succeeded in
providing basic financial support to some 500,000 underprivileged households in India. The
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
Dutch bank’s micro finance portfolio is now US$ 50.8 million and the bank plans to double the
coverage to a million households by 2009. It’s a profitable business that achieved break-even
in the first year itself.
Bank of Baroda is working on similar lines and has adopted Dungarpur district in Rajasthan.
Dungarpur, consisting of 800 villages, has a population of more than 1.1 million. The bank
plans to set up more than 400 farmers’ clubs for expert advice on agricultural and financial
issues and form 300 new self-help groups, organise health camps and train more than 4,000
rural youth for employment generation.
Last year, the Chennai-based Indian Bank adopted Puducherry for extending banking services.
State Bank of India Ltd, the country’s largest commercial bank, is now drawing up plans to
reach out to 100,000 villages.
M&As volume in India's banking space increased to US$ 10.5 billion between January and
September 2007 with 38 deals. In comparison, the sector had witnessed 23 deals worth US$
707 million last year, according to a report by global data provider Dealogic.
Investment banking
Investment banks operating in India have earned nearly as much in the first half of 2007 as
they made throughout fiscal 2006-07 from underwriting stock offerings and advising on
takeovers.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
Private equity and venture investments in India almost doubled to US$ 5.55 billion in the first
half of this year, according to Chennai-based Venture Intelligence, which tracks such deals. It
expects investments to cross US$ 10 billion by the end of the year.
With the best of India Inc. flocking to overseas loan markets for funds, Indian banks have
started following their top customers. For the first time, two Indian lenders -- ICICI Bank and
SBI -- figure among the top five in the league tables for loan syndication.
Loan books of Indian banks with significant international operations grew sizeably in the first
six months of 2007-08. In the aftermath of the US sub-prime mortgage losses, global banks had
turned risk-averse causing a global credit squeeze. This forced Indian companies to turn to
State Bank of India (SBI), ICICI Bank, Bank of India (BoI) and Bank of Baroda (BoB) to meet
their credit requirements, particularly to fund overseas acquisitions.
The loan books of the four banks grew at over 25 per cent at the end of September over the
previous year, much higher than the 21.9 per cent growth for the industry despite the fact that
the cost of raising funds overseas has increased by 150-200 basis points in the aftermath of the
sub-prime crisis.
Overseas foray
As many as nine Indian banks, led by HDFC Bank and ICICI Bank, have made it to the list of
top 50 Asian Banks. Bank of Baroda, the fifth largest bank in India, has opened a
representative office in the heart of Sydney's central business district, adding to the 19 Indian
banks that have 188 branches abroad.
The total assets managed by all funds in the country -- mutual funds, international funds,
private banking, including portfolio management services, unit-linked insurance and pension
funds -- is
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
likely to grow more than six-fold to US$ 1,300 billion by 2015, from US$ 170 billion, says the
Boston Consulting Group. The potential of the Indian market is attracting many new entrants
and this is likely to continue over the next five years. The opportunity for various fund
categories to invest in India will grow exponentially; managed assets, excluding pension, are
expected to grow at least 10 times over the next 10 years.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
COMPANY PROFILE
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
The origins of State Bank of India date back to 1806 when the Bank of Calcutta (later called
the Bank of Bengal) was established. In 1921, the Bank of Bengal and two other Presidency
banks (Bank of Madras and Bank of Bombay) were amalgamated to form the Imperial Bank of
India. In 1955, the controlling interest in the Imperial Bank of India was acquired by the
Reserve Bank of India and the State Bank of India (SBI) came into existence by an act of
Parliament as successor to the Imperial Bank of India.
Today, State Bank of India (SBI) has spread its arms around the world and has a network of
branches spanning all time zones. SBI's International Banking Group delivers the full range of
cross-border finance solutions through its four wings - the Domestic division, the Foreign
Offices division, the Foreign Department and the International Services division.
State Bank of India is the nation's largest bank. Tracing its roots back some 200 years to the
British East India Company (and initially established as the Bank of Calcutta in 1806), the
bank operates more than 14,000 branches within India, where it also owns majority stakes in
seven associate banks. State Bank of India has more than 50 offices in nearly 35 other
countries,
including multiple locations in the US, Canada, and Nigeria. The bank has other units devoted
to capital markets, fund management, factoring and commercial services, and brokerage
services. The Reserve Bank of India owns about 60% of State Bank of India
State Bank of India (SBI) is India's largest commercial bank. SBI has a vast domestic network
of over 9000 branches (approximately 14% of all bank branches) and commands one-fifth of
deposits and loans of all scheduled commercial banks in India.
The State Bank Group includes a network of eight banking subsidiaries and several non-
banking subsidiaries offering merchant banking services, fund management, factoring services,
primary dealership in government securities, credit cards and insurance.
Later under the State Bank of India Act, 1959 the former State-associated banks were taken
over by the S.B.I as its subsidiaries. The Bank’s registered office is in Calcutta. The Corporate
Center is in Mumbai. The Central Accounts Office is in Calcutta. In terms of SBI Act, RBI
should have minimum of 55% of the capital of the bank. The Central Office is now redesigned
as Corporate Center.
SBI’s Present Organizational Structure:
The bank has a 4 tier structure- the Central Office is the Bank’s apex policy-making body. The
Central Office is now called Corporate Center. The management of the Bank vests with the
Central Board consisting of a Chairman, 2 Managing Directors and other directors. The term of
office of a director is 3 years.
At the Local Head Office, a Local Board is constituted. The Board Members comprise CGM
(ex officio), directors of the Central Board ordinarily resident in the area, one member elected
by the local shareholders holding together, not less than 2.5% of the issued capital and others
nominated by the Government in consultation with the RBI.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
INTRODUCTION TO
THE TOPIC
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
SBI offers working capital finance to meet the entire range of short-term fund requirements
that arise within a corporate’s day-to-day operational cycle.
The SBI working capital loans can help company in financing inventories, managing internal
cash flows, supporting supply chains, funding production and marketing operations, providing
cash support to business expansion and carrying current assets.
SBI’s working finance products comprise a spectrum of funded and non-funded facilities
ranging from cash credit to structured loans, to meet the different demands from all segments
of industry, trade and the services sector. Funded facilities include cash credit, demand loan
and bill discounting. Demand loans are considered also under the FCNR (B) scheme. Non-
funded instruments comprise letters of credit (inland and overseas) as well as bank guarantees
(performance and financial) to cover advance payments, bid bonds etc.
REVIEW OF LITERATURE
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
REVIEW OF LITERATURE
September 23, 2006. Faced with intensifying competition, the Indian banking sector is all for
consolidation of the financial sector now and is fully endorses the need for creating six or
seven banks of the size of the State Bank of India, while bulk of the public sector banks lament
lack of sufficient autonomy to offer attractive incentive packages to their employees to ensure
commitment and raise productivity.
These and other prescriptions revealed by FICCI’s annual survey on the Indian Banking
System: The Current State and the Road Ahead.
The FICCI Survey, which zeroes in on the potential offered by Indian banking system and
achievement of global competitiveness by Indian banks, throws up key areas that need focused
attention and immediately tackled for future growth. These areas, pinpointed by the survey
respondents include: Diversification of markets beyond big cities (84.2% of the respondents),
HR Systems (63.15%), Size of Banks (52.63%) High Transaction Costs (47.3%), Banking
Infrastructure (42%) and Labor Inflexibilities (42%).
• Some of the major strengths of the Indian banking industry, which have helped mark
its place on the global banking scene as highlighted by our survey respondents were
Regulatory Systems (84.21%), Economic Growth Rate (63.15%), Technological
Advancement (52.63%), Risk Assessment Systems (47%) and Credit Quality (42.1%)
• Some of the areas that need to be geared up for future growth, identified by the survey
respondents are Diversification of markets beyond big cities (84.2%), HR Systems
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
Mr. K.G.Mallya
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
We must congratulate the Small and Medium Enterprise Sector, popularly known as SME
sector for getting due attention and recognition from all quarters. Now the SMEs are on the
centre stage stealing the show basking in the limelight. So in the fitness of things, the year
2006, in India should be designated as the SME YEAR to further the cause of this particular
sector.
The SME Sector: This sector has a very important role to play in the economy of any country.
Labour intensive, it is a small industrial enterprise to manufacture items needed in a small
locality, making use of locally available resources. Basically it is a low-tech industry catering
to the needs of a small market without much capital outlay, overheads or economies of scale.
Even though this is the portrait of a typical enterprise, there are sizeable SMEs that have links
with large industries to manufacture and supply parts and components or to undertake sub-
contracts or job work. Then there are SMEs that exclusively concentrate on exports also. Yet,
all of them have one thing in common: That is, small size. Scope for employing people,
investment in plant and machinery and the problem of access to institutional finance these are
more or less the same for all the units in the entire sector as they have smaller capital base,
lower production capacity, limited technical capabilities and smaller markets. In spite of these
odds, the performance of the sector as a whole has stunned every one!
Performance: On page 15 of the Economic Times of Tuesday the 11th Oct 2005 there is an
advertisement from the ICICI Bank that gives us the following figures:
95% of Industrial Units
40% of Manufactured Output
60% of Exported Goods
More than 3 Million Companies
17+ Million Employees
SMEs are the backbone of the country’s economy…”
ICICI Bank periodically carries a special feature of one page in the Economic Times under the
caption: ICICI BANK PRESENTS SME DIALOGUE giving success stories and tips and
guidance to SMEs and we must admire that the advertisement calls for entries for the awards
instituted by the Bank to SMEs for the outstanding performance in certain segments.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
State Bank of India, the premier banking institution of the country ran an advertisement on
Page 13 of the Times of India on Friday the 14th Oct 2005 with the caption: SBI HAS A
DEDICATED UNIT THAT SERVICES SMALL & MEDIUM ENTERPRISES. At SBI we
understand that to-day’s small and medium industries are tomorrow’s giants. So you’ll find an
SBI Branch in almost every industrial estate…” By going through the advertisements of both
these giant banking institutions we can note with satisfaction that our banks are vying with one
another to woo this sector, a sector of great significance.
Is the sector a new find? Is our approach to SME Sector is an innovation or something like a
new invention? Going by the literature and books available on SMEs, in many countries, both
the developed and developing, the SMEs have been regarded and respected for their significant
contribution towards the GDP. They have beaten large industries in respect of innovations and
inventions on account of hard work, personal interest and the spirit of enterprise of the owners
that is normally not available with the joint stock companies.
Finance, a major handicap: The mention of joint stock companies take us to the arena of
finance. The main handicap of the SMES is finance and unfortunately, unless they are big
enough or have earned a name and fame they cannot enter the capital market to raise the
requisite finance through the issue of stocks and shares. Sometimes to raise the loans from the
banks also they do not have good collateral or money to provide safety margin. They will
thrive only if right quantity of finance is available at right time and at right price. Yes, in the
world full of competition, the rate of interest plays a dominant role in costing and pricing.
SMEs Abroad: Going back to the SMEs abroad, in some countries, they are encouraging the
SMEs to grow international (transnational is the term used) and spread their wings by strategic
alliance, joint ventures, having affiliates or making direct investment in capital. In some
quarters loans are granted for this purpose at nominal rate of interest. Developed countries
prefer developing countries in view of the latter having cheaper manpower and also natural
resources. They also transfer technical know-how, impart training and hold conferences and
seminars to pass on the knowledge.
Indian Context: In the Indian context, financing SMEs is not something new or unknown. All
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
that we have done recently is the renewal of our pledge to serve the SME Sector with a greater
vigour.
The Finance Minister during his Budget Speech on 28th February 2005 set the ball rolling. The
relevant portion of his speech is as follows: “SMALL & MEDIUM ENTERPRISES. In recent
years our approach to small scale industry has evolved and now we are inclined to treat the
sector as the small and medium enterprises sector…Small Industries Development Bank of
India (SIDBI) has established this year a SME Growth Fund with a corpus of Rs.500 Crores.
Small and medium units in knowledge based industries such as Pharma, Biotech and IT will be
provided equity support through this Fund. There is a need for a new legislation that will
provide a supportive environment for small and medium enterprises…” He concludes that the
Minister of Small Scale Industries will introduce the Small and Medium Enterprises
Development Bill. Three things are distinctly clear here. From the Small Scale Industries we
have moved to a broader SME sector. And this integrated sector is going to get a good legal
and legal support from the authorities. In fact these words have given a good fillip to move in
the right direction.
SME Sector: We must now acquaint ourselves with two definitions. SSI & SME. Historically
our commercial banks started financing Small Scale Industrial Units way back in the year 1960
with a credit guarantee scheme by the Central Government administered by the Reserve Bank
as the Agent. (Presently this scheme is not available). The SSI is defined as an industrial unit
whose original investment in plant and machinery should not exceed Rs.7.50 lakhs (raised to
Rs.10 lakhs on 10.9.75 and now it is Rs.1 Crore and in the case of Ancillary Unit investment in
fixed assets should not exceed Rs.3 crores) And the unit should engage itself, in
manufacturing, processing and preservation of goods. Mining and quarrying, servicing and
repairing and custom service units are also treated as SSI units. There is a Tiny Sector where
the investment in plant and machinery should be less than Rs.25 lakhs and in the case of
Village and & Cottage Industries the credit requirement should not be above Rs.50,000/-
While determining the scale of industry in our country we have gone by the investment in plant
and machinery but in some countries they base on the number of employees, say up to 200 for
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
the SSI. Beyond SSI limit the industry would fall under the category of Medium Scale or Large
Scale. We have now integrated Small Scale and Medium Scale under a single category SME.
Official Definition: At this juncture it is worth mentioning that Reserve Bank has come out
with guidelines to the banks in respect of SME sector. They are reproduced in their monthly
publication, Monetary & Credit Information Review (MCIR) issues for Aug & September
2005 which are very relevant both to the bankers and the borrowers. August issue gives
guidelines for lending to the sector and September relates to the restructuring of overdue and
irregular debts besides one time settlement of the dues of SME. We shall first acquaint
ourselves with the definition given on page 2 of Sept 2005 issue:
“At present, a small scale industrial (SSI) unit is an undertaking in which investment in plant
and machinery, does not exceed Rs.1 Crore, except in respect of certain specified items under
hosiery, hand tools, drugs and pharmaceuticals, stationery items and sports goods, where this
investment limit has been enhanced to Rs.5 Crore. A comprehensive legislation which would
enable the paradigm shift form small-scale industry to small and medium enterprises is under
consideration of the Parliament. Pending enactment of the legislation, current SSI/Tiny
Industries definition may continue. Units with investment in plant and machinery in excess of
SSI limit and up to Rs.10 Crore may be treated as medium enterprises (ME).”
Credit Flow to SME Sector: From the issue of MCIR for August 2005 we can note the
anxiety and concern of the Monetary Authorities to step up the flow of credit with a substantial
increase from the present levels. Among other things banks are asked to a) Formulate policies
for extending credit to this sector b) Have a cluster approach to reduce the cost of finance c)
Each and every Urban and Semi-urban branch of a bank should finance at least 5 new units per
year. Similarly from the issue for September 05, we can note the guidelines for Debt
Restructuring and Relief besides One Time Settlement (OTS) of NPAs below Rs.10 Crore
classified as Doubtful or Loss Assets as on 31.3.2004 and so also for the debts classified as
Sub-standard on 31.3.04 but subsequently become Doubtful or Loss Assets. The OTS is also
applicable to all debts under litigation subject to obtaining a consent decree.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
SIDBI: This write up will not complete unless we make a mention of the pivotal role played by
SIDBI in developing the SME sector. It commenced operations from 1990 by financing,
promoting and developing industries in the small-scale sector. Basically it is a develop bank
and also a term lending institution but it provides bill discounting and working capital finance
also and the units in the sector can avail of credit facilities from SIDBI at a reasonable rate of
interest. The Budget has provided funds to the Corporation for equity support and more than
that the Economic Survey 2004-05 under Policy Initiatives in the SSI sector during 2004-05,
gives us a very heartwarming indication that, “The Small & Medium Enterprises (SME) Fund
of Rs.10,000 crore was operationalised by the SIDBI since 2004. Eighty percent of the lending
from this fund will be for SSI Units at interest rate of 2% below the prevailing PLR of the
SIDBI.”
Conclusion: The financial and banking system has placed before the SME sector a fully
dressed up cake in a silver platter. It is not a birthday cake but a cake in appreciation of the
efforts and also as an incentive to work hard. The sector should avail of the opportunities and
scale new heights. With this the sector will be benefited and the society too.
ANALYSIS AND
INTERPRETATION
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
A. QUALITATIVE:
At the outset, the proposition is examined from the angle of viability and also
from the bank prudential levels of exposure to the borrower, group and industry.
Thereafter, a view is taken about bank’s past experience with the promoters, if there
is a track record to go by. Where it is a new connection for the bank but the
entrepreneurs are already in business, opinion reports from existing bankers and
published data if available are carefully perused. In case of a maiden venture, in
addition to the drill mentioned heretofore, an element of subjectivity has to be
perforce introduced as scant historical data would be available and weightage has to
be placed on impressions gained out of the serious dialogues with the promoters and
his business contacts.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
A. QUANTITATIVE
ii. Net working capital: although this is a corollary of current ratio, the
movements in Net working capital are watched to ascertain whether there is
a mismatch of long term sources via-a-vis long term uses for purposes
which may not be readily acceptable to the Bank so that corrective measures
can be suggested.
iii. Financial Soundness: this will be dependent upon the owner’s stake or the
leverage. Here again the benchmark will be different for manufacturing,
trading, hire purchase and leasing concerns. For industrial ventures Total
Outside Liability/Tangible Net Worth ratio of 3.0 is reasonable but
deviations in selective cases for understandable reasons may be accepted by
the sanctioning authority.
iv. Turn –over: the trend in turn-over is carefully gone into both in terms of
quantity and value as also market share wherever such data are available.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
v. Profits: while net Profit is the ultimate yardstick, cash accruals, i.e. profit
before depreciation and taxation conveys the more comparable picture in
view of changes in rate of depreciation and taxation which may have taken
place in the intervening years. However, for the sake of proper assessment,
the non-operating incomes are excluded, as these are usually one time or
extraordinary income. Companies incurring net losses consistently over 2 or
more years will be given special attention, their accounts closely monitored,
and if necessary, exit options explored.
vi. Credit Rating: wherever a Credit Rating Agency for any instrument has
rated the company, this will be taken into account while arriving at a final
decision. However, as the credit rating involves additional expenditure, bank
would not normally insist on this tool if such an agency had already looked
into the company finances.
vii. Capital Market: where the company’s shares are listed in stock exchanges,
the movement of the price of its share, the market value of shares like those
of competitors in the same industry, response to public/right issues are also
kept in view as these are reflective of the corporate image in the eyes of the
investors’ community.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
i. In case of term loans and deferred payment guarantees, the project report
is obtained from the customer, which may have been compiled either in-
house or by a firm or consultants/ merchant bankers. The technical
feasibility and economic viability is vetted by the Bank and wherever it is
felt necessary.
ii. Promoter’s contribution of at least 20% in the total equity is what bank
normally expects. But the promoter contribution may vary largely in mega
projects. Therefore, there cannot be a definitive benchmark. The sanctioning
authority will have the necessary discretion to permit deviations.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
Under the CRA system, financial risks in a proposal are sought to be captured through some
relevant ratios. Different ratios are used for assessing risks for extending working capital
finance and term loans under CRA system. Also, the ratios used for assessing risk for financing
NBFC’s are different.
Working capital finance (all segments except NBFC’s)
The following are the ratios used for working capital finance:
1. Current ratio: it is calculated by dividing current assts by current liabilities. It helps to
measure liquidity and financial strength.
2. Care should be taken in interpreting this ratio as:
a. It is applied at a single point in time, implying a liquidation approach, rather than a
judgment on the going concern, for it does not explicitly take into account the revolving
nature of current assets and current liabilities.
b. The seasonal character of the business resulting in fluctuating current ratio is a disturbing
factor.
3. Liquidity could be severely affected if current liabilities exceed current assets.
4. The higher the ratio the better the liquidity position.
3. PBDIT/interest (times): this is called ‘interest coverage’ ratio. In the current context, the
servicing capability of loan is very crucial. This ratio, which indicates the number of times the
gross earnings cover the interest payable is an indicator of the measure of comfort that
profitability provides.
i. Higher ratio indicates comfortable debt servicing capability from the cash accrual of
the company.
ii. A ratio of more than 3 is considered comfortable, where as a ratio of 2 and below is
considered risky.
4. ROCE or ROA (%): profit before depreciation, interest and tax/ total capital employed
multiplied by 100.
i. High ratio indicates that the business is run on profitable lines.
ii. It is a relationship between the profits made during the year and the finance
employed to make profits i.e. it shows the earning power of the business.
iii. It is a measure of the management’s skill in profitably employing the funds in the
company.
iv. It should not only compare favorably with the rate of interest on loanable funds in
the market but also compensable for the risk involved in running the business.
6. Inventory / net sales + receivables / gross sales: expressed in days, this ratio captures the
turnaround period f major items of the current asset
i. Higher the figure, the slower is the turnaround of current asset and in general
higher the risk.
ii. This ratio will vary across industries.
iii. For assessment of risk, a shorter working capital cycle can be regarded less
risky.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
iv. Specific industry parameters should also be kept in mind while assessing the risk
under this ratio.
v. In general, it is expected that the working capital should be turned over at least
twice.
3. PBDT/ Total Assets: this ratio is a measure of gross profitability or gross return from
the activity of the company. In the CPA models, for manufacturing company, the
numerator is PBDIT but in NBFCs interest payment is a major component. So, it is
more relevant to take PBDT for NBFCs.
i. A percentage of more than 10 is considered healthy whereas below 2 is
considered risky.
4. PAT/ Total Income: total income= income minus other than non-recurring income.
This ratio represents the profitability of operations. Total income from operations may
be considered as equal to total sales of a manufacturing company.
i. a percentage of 11% and above is considered healthy and below 3 is considered
risky.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
6. Overdue/ demand raised ratio: this ratio measures collection efficiency. The term
“over dues” represents claim amounts which have not been received till due date.
i. A ratio of 1 and below is considered very healthy and more than 5 is
considered very risky.
7. NPA/ total working assets ratio: NPAs in this context refer to lease rentals and hire
purchase installments overdue for more than 12 months.
Following are some examples of Balance Sheet Analysis and calculation of ratios which are
important for analyzing the financial trend of the business.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
Examples 1:
Liquidity ratios:
i. Current ratio : CA/ CL
2006: 166/66 = 2.5:1
2007: 174/45 = 3.9:1
ii. Quick Ratio or Acid Test Ratio: Q.A/ C.L
2006: 54/66 = 0.8:1
2007: 75/45 = 1.7:1
Capitalization Ratios:
i. Term liabilities/ net worth (Funded Debt)
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
Activity Ratios:
i. Sales/ capital employed:
2006: 360/534 = 0.67:1
2007: 390/569 = 0.7:1
ii. Stock /sales:
2006: 112/30 = 3.7 months
2007: 99/32 = 3 months
iii. Debtors/sales:
2006: 23/30 = 3/4th month
2007: 23/32 = less than 3/4th month.
Comments:
i. Liquidity: Current ratio for2006 is satisfactory; but it is rather high for 2007. Perhaps
the unit is building up cash for meeting some commitments.
ii. Capitalization: the long term debt and the total outside liabilities are quite low
compared to equity. Hence, the financial position of the unit if good.
iii. Activity Ratios:
a. The sales/capital employed ratio is rather low. The reasons for the same have to
be ascertained.
b. Debtor’s management and Inventory management have marginally improved in
2007. Overall, the financial position and liquidity position of the unit are
considered satisfactory.
Example 2:
Following is the summarized balance Sheet and Income Statement of a unit:
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
The unit has approached the bank for credit limit of Rs. 5 lacs against the security of stocks and
debtors. Following is the evaluation of firm’s financial position by calculating ratios useful for
bank’s evaluation and problem areas suggested by ratio analysis.
2.Capitalization ratios:
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
3. Profitable Ratios:
a. Net profit/sales * 123/1600 * 100 = 7% Satisfactory
100 7.7%
b. N/P / total sales * 123/1500 * 100 = 11% Low
100 8.2%
c. N/P / capital 123/1220 * 100 = N.A Satisfactory
employed * 100 10.1%
4. Activity ratios:
a. sales to inventory 1600/400 = 4 8 Very low
b. average collection 175/4.4 = 40 days 36 days Marginally high
period: debtors/avg.
daily sales
Comments:
Liquidity Ratios: liquidity ratios are satisfactory. They also compare favorably with industry
average except that the acid test ratio is low.
Activity Ratios: the sales to inventory ratio is half of the industry average. The sluggishness in
turnover of stocks has to be probed into. Collection efficiency (debtors management) is
marginally higher than the industry average
Capitalization Ratios: the capital base ratios are satisfactory; but funded debt/assets ratio is
higher than the industry average.
Profitability: though the profitability on sales is better than the industry average the earnings
on assets is low compared to the industry average. Thus due to lower turnover of stocks. Net
profit after tax can also be used for working out the ratio. As tax rates may change from year to
year a more uniform basis will be provided by NPBT.
Conclusion:
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
The unit’s overall liquid, financial and profitability positions are satisfactory. The precise
reasons for the low turnover of stocks have to be ascertained to find out whether the company
will face any marketing problems. The unit’s NWC position is very comfortable ; hence there
is no need for WC finance.
According to Roy Foulka , Funds Flow statement is a “statement of the sources and application
of funds, is a technical device designed to highlight the changes in the financial condition of a
business enterprise between two dates “. In India, the fund flow statement, in its present form,
was not extensively used by the commercial banks for their working capital appraisal, until late
sixties, when the National Credit Council Study, popularly known as Dehejia Committee came
out with his report. This committee asked to determine “to what extent credit needs of the
industry are likely to be inflated”, pointed out that the banks did not seek to link credit with
industrial output, with the result that end-use of bank credit was not properly followed up. As a
sequel to this commercial banks and RBI started looking into their appraisal procedures and
thus the fund flows statement came to be registered as an important component of appraisal for
working capital advances.
Basically as a credit-analyst, the bank is in the following aspect of the financial position of the
units financed by the bank:
i. Where did the profits go?
ii. Were the funds generated (cash accruals) adequate to meet the company’s
responsibility to shareholders for declaring dividends? If the funds were inadequate,
how the situation was handled?
iii. When the net income is up, did the net current assets or net working capital go up
proportionately ? if, not what are the reasons?
iv. How was the capital expenditure financed?
v. What became of the proceeds of sale of fixed assets and investments?
vi. How was the retirement of debt accomplished?
vii. How was the additional capital raised, used?
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
viii. What became of the proceeds of the debenture issue or fixed deposits raised from
public?
The answers to these questions are furnished by the fund flow statement analysis. As
purveyors of working capital credit, these aspects are of vital interest to the bank, since
commercial banks have to ensure proper end-use of bank credit towards the purpose for
which it was granted and ensure against diversion of bank credit to “unapproved” purposes.
The fund flow statement is divided into two portions. While one portion discloses the
movement of funds known as long-term account,(comprising long term sources and long
term uses), the other reflects the fund flow amongst the current assets and liabilities in the
short term account. Long-term sources are indicated by changes in capital, term liabilities,
fixed assets, investments, non current assets and intangible assets between two balance
sheet dates. Similarly, short-term sources and uses are denoted by the changes in current
assets and current liabilities. Surplus of the long-term sources over long-term uses results in
increase in the net working capital equal to the surplus, whereas a deficit of long-term
sources over long term uses will result in decrease in net working capital by amount of
deficit. In case of deficit in long-term account, the deficit is, in turn, met by a diversion of
short-term funds to long-term uses. If there is increase in activity level in a unit during a
year, it is likely to result in increased holding of current assets as at end of the year
compared to the position in the beginning of the year. In the face of such increases in
current assets if the current ratio has to be maintained at the same level as in the beginning
of the year, then the net working capital should increase in proportion to the increase in
current assets. Financial propriety dictates that the unit’s management should, in the event
of any inadequacy in cash generation, raise adequate long-term funds in the shape of share
capital, long term loans etc. To meet fully the long term outlays like capital expenditure,
retirement of loans, dividend payments, investments in other companies, acquisition of
other non-current assets, etc. in as much as the net working capital is fed by the long term
surplus generated in the fund flows, the banker is very particular to see that this surplus is
‘adequate’. The adequacy is, of course, determine by factors like the projected build-up of
current assets (incremental), banker’s conception of the acceptable current ratio and the
banker’s ability and willingness to provide additional credit to the borrower.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
Thus, funds flow analysis is an integral part of the working capital appraisal, performing a
very important task in the gamut of credit assessment. It is a composite an integrated
statement that gives, at a glance, the salient features of funds flow and depicts the
directional flow of working capital. It feeds with valuable data about the management style
of functioning, its strength and weaknesses from which we enabled to form judgments on
the corporate financial policy, financial prudence in planning of funds and overall financial
management. On the prospective analysis, it tells us about the management intention
regarding use of funds. Significant and important facets of management functioning, like
dividend policy, plough back policy, growth objectives, optimum uses of fixed assets
through timely capital expenditure are revealed by fund flow analysis.
CASH BUDGET
Contrasted with the broad level analysis of a funds flow statement, the cash budget is basically
a functional statement, concerning itself with the pure cash management aspect. It is designed
to throw light on:
i. What cash commitments are likely to arise within a short span of time and
ii. What cash resources will be available to meet them?
A cash budget can be only as authentic and genuine as the underlying assumptions on which it
is based are. Hence, the credit analyst will have to validate the assumptions by relating them to
the unit’s past experience and data for their relevance, reasonableness and practicality.
However, more than any examination of the figures, the banker has to draw upon his
knowledge of borrower’s behavioral tendencies for meeting his commitments and experience
of past dealings.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
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, equipments, vehicles etc…
and also to run the business i.e. its day to day operations.
Working capital is defined, as the funds required carrying the required levels of current assets
to enable the unit to carry on its operations at the expected levels uninterruptedly.
Thus working capital required (WCR) is dependent on
i. The volume of activity (viz. level of operations i.e. Production and Sales)
ii. The activity carried on viz. manufacturing process, product, production programme,
and the materials and marketing mix.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
Though there are various methods used for assessing the quantum of working capital
requirement for an industry, the following are commonly used.
Methods and application
SEGMENT LIMITS METHOD
SSI UPTO Rs. 5 cr TRADITIONAL METHOD &
NAYAK COMMITTEE METHOD
ABOVE Rs 5 cr PROJECTED BALANCE SHEET METHOD
Working capital is the total cash that is circulating in this cycle. Therefore, working capital
can be turned over or deployed after completing the cycle.
Factors, which influence working capital requirement, are:
i. Level of operating expenses and
ii. Length of operating cycle.
Any reduction in either of the both will mean reduction in working capital requirement
or indicate an efficient working capital management.
It can thus be concluded that by improving that by improving the working capital turnover ratio
(i.e. by reducing the length of operating cycle) a better management (utilization) of working
capital results. It is obvious that any reduction in the length of the operating cycle can be
achieved only by better management only by better management of one or more of the
individual phases of the operating cycle period for which raw materials are in store, conversion
process time, period for which finished goods are in store and collection period of receivables.
Looking at whole problem from another angle, we find that we can set up extremely clear
guidelines for working capital management viz. examining the length of each of the phases of
the operating cycle to assess the scope for reduction in one or more of these phases.
The length of the operating cycle is different from industry to industry and from one firm to
another within the same industry. For instance, the operating cycle of a pharmaceutical unit
would be quite different from one engaged in the manufacture of machine tools. The operating
cycle concept enables to assess working capital need of each enterprise keeping in view the
peculiarities of the industry it is engaged in and its scale of operations. Operating cycle is an
important management tool in decision –making.
The operating cycle concept serves to identify the areas requiring improvement for the purpose
of control and performance review. But, as bankers, we require a more detailed analysis to
assess the various components of working capital requirement viz., finance for stocks, bills etc.
Bankers provide working capital finance for holding an acceptable level of current assets viz.
raw materials, stock-in-process, finished goods and sundry debtors for achieving a
predetermined level of production and sales. Quantification of these funds required to be
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
blocked in each of these items of current assets at any time will, therefore provide a measure of
the working capital requirement of an industry.
Raw material: any industrial unit has to necessarily stock a minimum quantum of materials
used in its production to ensure uninterrupted production. Factors, which affect or influence the
funds requirement for holding raw material, are:
i. Average consumption of raw materials.
ii. Their availability – locally or form places outside, easy availability / scarcity, number
of sources of supply
iii. Time taken to procure raw materials (procurement time or lead time)
iv. Imported or indigenous.
v. Minimum quantity supplied by the market (Minimum Order Quantity (MOQ)).
vi. Cost of holding stocks (e.g. insurance, storage, interest)
vii. Criticality of the item.
viii. Transport and other charges (Economic Order Quantity (EOQ)).
ix. Availability on credit or against advance payment in cash.
x. Seasonality of the materials.
This raw material requirement is generally expressed as so many months requirement
(consumption).
Stock in process: barring a few exceptional types of industries, when the raw material get
converted into finished products within few hours, there is normally a time lag or delay or
period of processing only after which the raw materials get converted into finished
product. During this period of processing, the raw materials get converted into finished
goods and expenses are being incurred. The period of processing may vary from a few
hours to a number of months and unit will be blocked working funds in the stock-in-
process during this period. Such funds blocked in SIP depend on:
i. The processing time
ii. Number of products handled at a time in the process
iii. Average quantities of each product, processed at each time (batch quantity)
iv. The process technology
v. Number of shifts.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
Finished goods: all products manufactured by an industry are not sold immediately. It will be
necessary to stock certain amount of goods pending sale. This stock depends on:
i. Whether the manufacture is against firm order or against anticipated order
ii. Supply terms
iii. Minimum quantity that can be dispatched
iv. Transport availability and transport cost
v. Pre-dispatch inspection
vi. Seasonality of goods
vii. Variation in demand
viii. Peak level/ low level of operations
ix. Marketing arrangement- e.g. direct sale to consumers or through dealers/ wholesalers.
The requirement of funds against finished goods is expressed so many months’ cost of
production.
Sundry debtors (receivables): sales may be affected under three different methods:
i. Against advance payment
ii. Against cash
iii. On credit
A unit grants trade credit because it expects this investment to be profitable. It would be
in the form of sales expansion and fresh customers or it could be in the form of
retention of existing customers. The extent of credit given by the industry normally
depends upon:
i. Trade practices
ii. Market conditions
iii. Whether it is bulky by the buyer
iv. Seasonality
v. Price advantage
Even in cases where no credit is extended to buyers, the transit time for the goods to
reach the buyer may take some time and till the cash is received back, the unit will
have to be cut out of funds. The period from the time of sale to receipt of funds will
have to be reckoned for the purpose of quantifying the funds blocked in sundry
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
debtors. Even though the amount of sundry debtors according to the unit’s books
will be on the basis of Sale Price, the actual amount blocked will be only the cost of
production of the materials against which credit has been extended- the difference
being the unit’s profit margin- (which the unit does not obviously have to spend)
The working capital requirement against Sundry Debtors will therefore be
computed on the basis of cost of production (whereas the permissible bank finance
will be computed on basis of sale value since profit margin varies from product to
product and buyer to buyer and cannot be uniformly segregated from the sale
value).
The working capital requirement is expressed as so many months’ cost of
production.
requirement
2. Stock-in-process Months (cost of Rs. B
Production)
3. Finished Goods Months cost of Rs. C
Production required to be
stocked
4. Sundry Debtors Months cost of Rs. D
Production (o/s credits)
5. Expenses One month(normally) Rs. E
A+B+C+D+E
LESS Credit received on Rs. F
Purchases (months’
Purchase value)
Advance payment Rs. G
On order received
WORKING CAPITAL REQUIRED (H)= (A+B+C+D+E)- (F+G)
The purpose of assessing the W/C requirement of the industry is to determine how the total
requirements of funds will be met. The two sources for meeting these requirements are the
unit’s long-term sources (like capital and long term borrowings) and the short-term
borrowings from banks. The long-term resources available to the unit are called the liquid
surplus or Net Working Capital (NWC).
It can be explained by visualizing the process of setting up of industry. The unit’s starts
with a certain amount of capital, which will not normally be sufficient, even to meet the
cost of fixed assets. The unit, therefore, arranges for a long-term loan from a financial
institution or a bank towards a part of the cost of fixed assets. From these two sources after
meeting the cost of fixed assets some funds remain to be used for working capital. This
amount is the Net Working Capital or Liquid Surplus and will be one of the sources of
meeting the working capital requirements.
The remaining funds for working capital have to be raised from banks; banks normally
provide working capital finance by way of advantage against stocks and sundry debtors.
Banks, however, do not finance the full amount of funds required for carrying inventories
and receivables: and normally insist on the stake of the enterprise at every stage, by way of
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
margins. Bank finance is normally restricted to the amount of funds locked up less a certain
percentage of margins. Margins are imposed with a view to have adequate stake of the
promoter in the business both to ensure his adequate interest in the business and to act as a
protection against any shocks that the business may sustain. The margins stipulated will
depend on various factors like salability, quality, durability, price fluctuations in the market
for the commodity etc. taking into account the total working capital requirements as
assessed earlier, the permissible limit, up to which the bank finance cab be granted is
arrived.
While granting working capital advances to a unit, it will be necessary to ensure that a
reasonable proportion of the working capital is met from the long-term sources viz. liquid
surplus. Normally, liquid surplus or net working capital be at least 25% of the working
capital requirement (corresponding to the benchmark current ratio of 1.33), though this
may vary depending on the nature of industry/ trade and business conditions.
The format in which the Bank assesses the working capital requirement and the permissible
limit of Bank finance under Traditional Method is shown below:
Sources:
Liquid surplus in Balance sheet as at the end of last year 20
Limits from Bank 195
Total 215 (D)
Net deficit (C-D) 5
How the deficit will be met: deficit will have to be met by plough back pf profits or
unsecured loans. Deficit should be reasonably small when compared to the working capital
requirements / bank finance/ profitability of the unit.
Note:
* Sales to be computed at the maximum level anticipated production during the next 12
months
** Cost of production includes cost of raw materials plus all expenses
Receivable under “working capital required” is stated at cost and under “permissible
limits” value thereof is at sale value less margin.
For items 3. And 4. , The basis of calculation would be the cost of production.
Net working capital deficit, if any, in the balance sheet, is to be added to working capital
requirement.
Since the limits will be arrived on the projections given by the unit, the assumptions and
presumptions made by the unit should be properly analyzed before sanction of limit.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
For SME units, which enjoy fund based working capital limits up to Rs.5 crore, the
minimum working capital limit should be fixed on the basis of projected annual turnover.
25% of the output or annual turnover value should be computed as the quantum of working
capital required by such unit. The unit should be required to bring in 5% of their annual
turnover as margin money and the Bank shall provide 20% of the turnover as working
capital finance. Nayak committee guidelines correspond to working capital limits as per the
operating cycle method where the average production/ processing cycle is taken to be 3
months.
Important clarifications:
Appraisal
i. It should be ensured that the projected annual turnover is reasonable and achievable by
the unit and further, the estimated growth if any over the previous year is realistic.
ii. The returns filed with statutory authorities may be useful guiding documents for
verification of sales and assessment of reasonableness of the projections.
iii. The entire sale proceeds should be routed through the Cash Credit account of the bank.
iv. Date of actual sales pertaining to the last 5 years, estimated for the current year, and
projected for the next year, together with the trend analysis of the industry to which the
unit belongs, would also be useful while appraising the sales projections.
v. Other information regarding modernization, expansion of the existing manufacturing
capacity, government policy, taxation and other relevant internal and external factors
also need to be taken into account.
vi. Any projections say beyond 15% of the previous year actuals or current year estimates
would need closer look.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
Till year 1996-97, banks in India were following the concept of Maximum Permissible Bank
Finance (MPBF) for working capital limits, as enunciated in Tandon and Chore committee
reports. In the monetary and credit policy for the first half-year of 97-98, RBI announced
withdrawal of their guidelines on assessment of working capital finance based on the MPBF
concept. State Bank of India felt that many aspects of the Credit Monitoring Arrangement
(CMA) followed till then were based on sound principles of lending. Hence, while there was a
need to continue to adopt these, certain flexibility was required to be brought into the method
to avoid any rigid approach to fixing the quantum of finance. In the area of supervision, there
was a need to rationalize the existing financial follow up procedure. As a consequence, the
bank adopted the projected Balance Sheet method in the second half of the year 1997-98
onwards.
MPBF METHOD
The Tandon Committee was appointed o suggest a method for assessing the working capital
requirements and the quantum of bank finance. Since at that time, there was scarcity of bank’s
resources, the Committee was also asked to suggest norms for carrying current assets in
different industries so that bank finance was not drawn more than the minimum required level.
The Committee was also asked to devise an information system that would provide,
periodically, operational data, business forecasts, production plan and resultant credit needs of
units. Chore Committee, which was appointed later, further refined the approach to working
capital assessment. The MPBF method is the fall out of the recommendations made by Tandon
and Chore Committee.
Approach to lending
Regarding approach to lending: the committee suggested three methods for assessment of
working capital requirements.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
First method
The quantum of bank’s short-term advanced will be restricted to 75% of working capital gap
where “working capital gap” is equal to “current assets” minus “current liabilities other than
bank borrowings”. Remaining 25% is to be met from long-term sourced.
Second method
Met working Capital should at least be equal to 25% of total value of acceptable level of
current assets. The remaining 75% should first be financed by Other Current Liabilities and the
bank may finance balance of the requirements.
Third method
The borrower should provide for entire core current assets and 25% balance current from the
Net working Capital.
To compute the level of working capital requirement of the unit, the analyst has to assess the
level of current assets it has to carry, consistent with its projected level of production and sales.
Inventory and receivables constitute most of the current assets.
The PBS method of assessment will be applicable to all C&I borrowers who are
engaged in manufacturing, services and trading activities who require fund based
working capital finance of Rs. 25 lacs and above. In case of SSI borrowers, who require
working capital credit limit up to Rs. 5 cr, the limit shall be computed on the basis of
Nayak Committee formula as well as that based on production and operating cycle of
the unit and the higher of the two may be sanctioned.. The assessment will be based on
the borrower’s projected balance sheet, the funds flow planned for current/ next year and
examination of the profitability, financial parameters etc. unlike the MPBF method, it
will not be necessary in this method to fix or compute the working capital finance on the
basis of a stipulated minimum level of liquidity (Current Ratio). The working capital
requirement worked out is based on the following:
ii. Analysis of the Profit and Loss account, Balance Sheet, Funds flow etc. for the
past periods is done to examine the profitability, financial position, and financial
management etc of the business.
iii. Scrutiny and validation of the projected income and expenses in the business
and projected changes in the financial position (sources and uses of funds). This
is carried out to examine whether these parameters are acceptable from the
angle of liquidity, overall gearing, efficiency of operations etc.
In the PBS method, the borrower’s total business operations, financial position,
management capabilities etc. are analysed in detail to assess the working capital
finance required and to evaluate the overall risk.
There will not be a prescription like mandatory minimum current ratio or maximum
level of a current asset. Under the method, assessment of WC requirement will be
carried out in respect of each borrower with proper examination of all parameters
relevant to the borrower and their acceptability. The assessment procedure is as
follows:
The CRA model adopted by the bank take into account the factors, which go into
appraising the risks, associated with the loan. These have been categorized broadly into :
1. Financial risks
2. Business risks
3. Industrial risks
4. Management risks
They are weighted separately. To arrive at the overall risk rating, the factors duly weighted
are aggregated and calibrated to arrive at “a single point indicator of risk” associated with
the credit decision.
2. Business parameters: the following are the important parameters associated with
business risk:
• Technology
• Consistency in quality
• Consistency in cash flow
• Compliance of environmental regulations
The eventual CRA rating awarded to a unit is (based on a score out of 100) is a
single point risk indicator of an individual credit exposure and is used to identify, to
measure and to monitor the credit risk of an individual proposal. At the corporate
level CRA is also used to track the quality of bank’s portfolio. The risk parameters
as mentioned above are individually scored to arrive at an aggregate score of 100
subject to qualitative factors- negative parameters.
The CRA model also stipulates a minimum score under financial, business, industry
and management risk parameters for a proposal to be considered acceptable in a
given form. The details of such minimum scores are as under:
5. DOCUMENTATION
General
The loan I security document are crucial importance to the bank in respect of all loans and
advances as they constitute the primary evidence in any legal proceedings relationship between
the bank and the barrower/guarantor. They establish the precise jural relationship between the
bank and the barrower/guarantor. In absence of properly executed it may be very difficult or
the bank to succeed in any of the suit filed in a court of law for enforcing its rights under the
documents. The legal protection and judicial adjudication always requires and depends upon
valid documents.
Object
(a) The object of the documentation is to serve as primary evidence of enforcing the bank’s
right to recover the contracted debt through the court of law in the event of all other recourses
proving to be of no avail. Documentation will succeed in fulfilling this objective only when
following requirements are met
i. The owning of the debt to the bank by the borrower is established by
documents
ii. The change created on the borrowers asset and security for the debt is
preserved, protected, perfect and maintained in accordance with the law
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
iii. The bank’s right to enforce the security for recovery of the debt through court of
law is not barred by expiry of limitation under the law of limitation.
Purpose
The purpose of the document is that it helps in identifying the parties, the nature and the extent
of security, in/for providing evidence of the transaction, for settling/crystallizing the terms and
conditions, for defining the rights and liabilities of parties or under the securities, for creating
the charges encumbrance, for protecting /preventing the priority of charges, for computing the
period of limitation and lastly for enforcing the rights under.
Requirement
A document to server the above purpose and objective must contain correct description of the
parties, mention the actual place of execution mention correct date of execution contain
accurate description of the properties/security, contain proper recitals /covenants, provide for
consideration for the transaction, stipulate the term and condition of repayment, contain all
other essential terms and, be duly stamped and must be registered and attested whenever the
law requires the document to be so attested whenever the law requires the document to be
attested and registered. Any document by borrower/guarantor of favoring the bank depends
upon the type of charges (hypothecation, pledged, mortgage, etc) type of the advance (demand
loan, cash credit, term loan etc), nature of the security (movable or property, actionable claims
etc) and finally upon the constitution of the borrower/guarantor (individual, partnership,
company, association of persons, Trust, HUF etc)
While obtaining the document regard must be had to the constitution of the
borrower/guarantor and its/their authority and competence to execute the documents, the nature
and type of securities being the change, legal nature of the charges and applicable laws thereto.
1. Document in general parlance is understood to mean any matter written upon a paper in
some language known to and understood to mean written upon a papers in some language
known to and understood by the parties to such document. According to the definition given in
section 3 of the evidence Act, it means any matter expressed or described or described upon
any substance weather paper, letter, stone leather or leaves by means of letters, figures or mark
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
or concerning or by more than one of those means which is indented to be used for the purpose
of recording that rights, obligation, responsibilities and liabilities relating to or concerning or in
respect of the transaction or the parties or the ownership and/ or possession of the property and
for matters incidental thereto and which is admissible in law as a piece of evidence or record of
bargain/ transaction.Section 2(14) of the Indian Stamp Act 1899 defines instrument’
Instrument includes every document by which any right or liability is, or purports to be,
created, transfer, limited, extended, extinguishing or recorded.Instrument is a document, which
effects any right or liability. All instruments are documents but all documents need not
necessarily be instruments.
Book debt
Book debts are that the debts owning to a business and are taking and arise primarily out of
sale of merchants to the customers on credit. This term is usually shown as the sundry debtors
on the asset side of the balance sheet.
Chosen in action
The property which a person has not got in actual possession but which he has a right to
demand an action at law. Money due upon a bill of exchange, book debts, insurance policies,
the legacies, stocks and shares in the company are the example of a chosen in action. Where
the money or the goods are in a actual possession, they are called chosen in possession.
According to section 2(4) of the sales of goods Act 1930, it includes a bill off lading, dock
warranty, a warehouse-keeper certificate, wharfinger’s certificate, and railway receipt
Warrant or order for the delivery of goods and other document used in the ordinary course of
business as proof of the possession or control of goods or authorizing or purporting to
authorize either by endorsement or by delivery, the possessor of the documents to transfer or
receive goods thereby represented.
Inchoate instrument
Means an incomplete document signed by a person and handed over to another person to fill up
and make into a complete document.
Title deeds
A legal instrument showing or reflecting the evidence of a person’s right to landed property. It
shows in whom the legal estate is vested and how the land has been transferred from one
person to another by the deed till finally it was transferred to the present owner through the
longer course of years. A person’s right to a piece of land is proved by the documents called
‘title deeds’.
Executed or execution
Section 2(12) of the Indian stamp Act 1899 states that ‘executed’ and ‘execution’ used with
reference to instrument means” signed “and signature”.
Signature includes a mark by an illiterate person. Signature must be the signature of all persons
necessary to complete the transaction. If a document is required to be attested under any person
necessary to complete the transaction. If document is required to be attested under any law,
signature of the attester/s must be written to complete the execution.
The word ‘execution’ means that the person by affixing his signature or mark has signed his
assets to the contents of the documents. However the proof of the signature cannot always
means or regarded as tantamount to proof of the execution. It is necessary for a document to be
said to have been executed by a person, that there should be not only physical contact of
signing the document but a mental inclination of executing it. If a person of unsound mind
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
signs a document he cannot be said to have executed the document as mental act is silent in
such case.
Execution consists in signing a document written out, read and understood. It dose not merely
consists of a name on a blank paper. The execution of a document means signing, sealing and
delivering. To execute means to go through the formalities necessary of the validity of legal
act. Execution implies conscious execution and knowledge of its contest thereof dose not
amount to execution. The execution of a document is always a question of fact and it must be
proved like any other fact.
Attestation
The transfer of property Act 1882 defines the expression ‘attestation’ as
Attested in relation to an instrument, means, and shall be deemed always to have meant,
attested by two or more witness, each of whom has seen the executants sign or affix his mark
to the instrument, or has seen some other person sign in the instrument in the presence and by
the direction of the executants or has received from the executants a personal
acknowledgement of his signed the instrument in the presence of the executants; but it shall not
be necessary that more than one of such witness shall have been present at the same time, and
no particular from of attestation shall be necessary.
Attestation is not necessary for the validity of document, which are not required by law to be
attested. The person must sign as a witness and for the purpose of attesting the execution of a
document. An executant’s (i.e., the borrower himself) cannot be an attesting witness.
5. The document and the schedules attached thereto should be got completed as far as
possible in one sitting and in the same handwriting.
6. The immovable property should be described with the reference to their survey
numbers, patta numbers etc along with their boundaries exactly as mentioned in the
original title deeds. Always location or sites maps should be drawn and kept along
with the loan documents.
7. All pages and schedules should be signed in full and in the same style throughout.
The name should be spelt out in the block letters under the signature in the last
page. Signature should be at the end of every document and also at the end of the
schedules.
8. All types of additions, alterations, cutting, cancellations, deletion etc should be
authenticated by the borrower/guarantors under his/her full signatures. Over writing
or interlineations in a document should be avoided without any exceptions. This is
because there is always a presumption in the law that the unauthenticated
interlineations, alterations, additions, cuttings, cancellations and deletions were
made after the execution of the document.
9. Date and place of execution should be mentioned where they must mention the two
or more borrower/guarantors sign the document at different places and on the
different dates and the fact of their doing is so in their handwriting.
10. When different person executes a document at different dates, the executants should
be requested to sign and record the dates under their signature. Under the law the
document is said to have been duly completed only when it has been executed by
the last of the persons. The limitation period starts from the following day of the
last date of execution by the last person mentioned in the document.
11. Never a document should be antedated. If a date on the document appears to be
prior to the date of stamping or date of purchase of stamps, such document would
be treated as invalid on the grounds of that it has not been duly stamped.
12. The document should not bear double dates “2/3 April2003’. All documents should
bear the same date uniformly. There should not be any variation in the dates on the
documents executed by the same party. Subject to what is stated in the paragraph 10
above, where the executants has recorded the date under his signature and the
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
execution of the document is complete thereto, then the date of the document
should not be different from the date on which the executants had signed the
document.
13. Interest clause must be mentioned correctly. The rate of interest and the mode of
payment viz., monthly quarterly, half yearly should be mentioned with sufficient
clarity as per the terms of sanction.
14. The document should be as per the terms and condition of sanction.
15. Signature of the person should be obtained on each page and also on pages facing
each other and across the fold of the document in such a manner that the signature
runs on the both pages. If a borrower /guarantor signs in the left hand, a small note
should be annexed to the document recording the said fact that the
borrower/guarantor have so signed in left hand.
16. On behalf of the bank only the authorized officer should sign on the last page of the
document.
17. Keeping a document bank or even one or more columns in the contents of the
documents should be explained in a language known to them and the fact of such
explanation should be recorded.
18. If the executant is an illiterate person, his lift hand thumb impression (right hand
thumb impression in case of female by convention) should be obtained on all the
documents. It is always advisable to obtain a photograph bearing clear identification
of such person and should be kept on record. Thumb impression is also necessary
for authentication each and every blank filled in the document.
19. In case the signature is in vernacular language or the document has been affixed
with the thumb impression of the person it will be necessary to obtain a separate
letter of decoration in vernacular language conforming that the content of the
document are properly read over and explained to the executant of the vernacular
language and the executant has affixed its thumb impression or the signature in
vernacular language only after understanding the nature and declaration from some
person known to the executant for conforming the execution of the document s by
such illiterate person on if the person is woman belonging to Muslim community, in
his presence by such executant.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
20. The preamble in the bank documents dose not provide for the mentioning the name
of the branch where the account is to be operated; thus where the facility is
originally granted at a certain branch and it is to be availed at another branch at a
later date and the relative account are transferred to that branch, it would not be
necessary to obtain fresh documents. The place and date of execution of document
should however need to be stated in the documents.
21. While using non-judicial stamp paper, at least some portion of the printed
document should be handwritten on the stamp paper and the corresponding portion
in the printed document should be deleted from the document under authentication.
Under no circumstances stamp paper should be on the printed documents.
6.CREDIT PROCESS
Pre-Sanction Process
Indicative list of Activities in the Appraisal Function
A. Preliminary appraisal
• Obtain
i. Application for working capital Finance
ii. Audited financial for the previous three years
iii. Details of existing borrowing arrangements
iv. Reports from existing Banker on the application copy
v. Financial statements, borrowings relationship of Associate
firm/group companies
vi. Profile of promoters /senior management personnel
• If request includes project financing, obtain additional:
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
i. Project report
ii. Appraisal report form Financial institutions in case Appraisal has
been one by them
iii. NOC form term lenders if already financed by them
iv. Report form Merchant bankers in case capital market is being
accessed
• Examine the following:
i. Bank’s lending policy/RBI guidelines, policies
ii. Prudential Exposure norms
iii. Industry Exposure restrictions
iv. Group Exposure restrictions
v. Industry related risk factor List of defaulters
vi. Caution lists
vii. Compliances regarding transfer of borrowal accounts from one bank
to another, it applicable
viii. Gov. regulation/legislation impacting on the industry
ix. Acceptability of the promoters
x. Application’s status vis-à-vis other units in the industry
xi. Financial status in broad term and whether it is acceptable
xii. Examine also the following in case of request of project finance :
xiii. Weather the project cost is prima facie acceptable
xiv. Debt/equity gearing proposed and whether acceptable
xv. Promoter’s ability to access capital market for debt/equity support
xvi. Whether critical aspect of project –demand, product cost
profitability etc. are prima facie in order
xvii. Arrived at a preliminary decision to support or not to support the
request.
B. Detailed appraisal
Carry out a detailed appraisal alter a pre-sanction visit to applicant Company/their
office/project site.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
Credit rating
Draw up trading for:
• Working capital
• Term finance
Opinion reports
Compile opinion report on partners/promoters and the proposed guarantors
Proposal of sanction:
Prepare a draft proposal in prescribed format with required back-up details and
with recommendations for sanction
Sanction
Indicative list of Activities Involve in the sanction Function
• Peruse the proposal to see if the report prima facie present the
proposal, remit it back to the Assessor for the required
data/clarifications.
• Examine critically the following aspect of the proposed exposure
1. Bank’s lending policy
2. Borrowers status in the industry
3. Industry aspect
4. Experience with units in similar industry
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
Supervision
i. Supervision function should primarily ensure that the effective fallow of advances
is in the place of the asset quality of good order is maintained. Supervisor should
look out for early warning signals, identity ‘incipient sickness’ and initiate
proactive remedial actions.
ii. Indicative list of activities involved in supervision function is as follows
• Ensuring proper flow-up of advances and observations at the operating level of the
system laid down by the bank. Periodic and random examination of statements
received, control register and files/record covering the advance will assist this
process.
• Ensuring the security documents are kept current and that all related documentation
formalities are observed by the officials responsible.
• Ensure that the function at the follow-up level are performed diligently and as per
extant instructions of the bank.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
FINDINGS
FINDINGS
Methods of lending
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
Like many other activities of the banks, method and quantum of short-term finance that can be
granted to a corporate was mandated by the Reserve Bank of India till 1994. This control was
exercised on the lines suggested by the recommendations of a study group headed by Shri
Prakash Tandon.
The study group headed by Shri Prakash Tandon, the then Chairman of Punjab National Bank,
was constituted by the RBI in July 1974 with eminent personalities drawn from leading banks,
financial institutions and a wide cross-section of the Industry with a view to study the entire
gamut of Bank's finance for working capital and suggest ways for optimum utilisation of Bank
credit. This was the first elaborate attempt by the central bank to organise the Bank credit. The
report of this group is widely known as Tandon Committee report. Most banks in India even
today continue to look at the needs of the corporates in the light of methodology
recommended by the Group.
As per the recommendations of Tandon Committee, the corporates should be discouraged from
accumulating too much of stocks of current assets and should move towards very lean
inventories and receivable levels. The committee even suggested the maximum levels of Raw
Material, Stock-in-process and Finished Goods which a corporate operating in an industry
should be allowed to accumulate These levels were termed as inventory and receivable norms.
Depending on the size of credit required, the funding of these current assets (working capital
needs) of the corporates could be met by one of the following methods:
Under this method, the borrower's contribution from long term funds will be to the extent of
the entire CORE CURRENT ASSETS, which has been defined by the Study Group as
representing the absolute minimum level of raw materials, process stock, finished goods and
stores which are in the pipeline to ensure continuity of production and a minimum of 25% of
the balance current assets should be financed out of the long term funds plus term borrowings.
(This method was not accepted for implementation and hence is of only academic interest).
As can be seen above, the basic foundation of all banks' appraisal of the needs of creditors is
the level of current assets. The classification of assets and balance sheet analysis, therefore,
assumes a lot of importance. RBI has mandated a certain way of analysing the balance sheets.
The requirements of this break-up of assets and liabilities differs slightly from that mandated
by the Company Law Board (CLB). The analysis of balance sheet in CMA data is said to give
a more detailed and accurate picture of the affairs of a corporate. The corporates are required
by all banks to analyse their balance sheet in this specific format called CMA data format and
submit to banks. While most qualified accountants working with the firms are aware of the
method of classification in this format, professional help is also available in the form of
Chartered Accountants, Financial Analysts for this analysis
Committees
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
A study group headed by Shri Prakash Tandon, the then Chairman of Punjab National Bank,
was constituted by the RBI in July 1974 with eminent personalities drawn from leading banks,
financial institutions and a wide cross-section of the industry with a view to study the entire
gamut of Bank's finance for working capital and suggest ways for optimum utilisation of Bank
credit. This was the first elaborate attempt by the central bank to organise the Bank credit.
Most banks in India even today continue to look at the needs of the corporates in the light of
methodology recommended by the Group. The report of this group is widely known as Tandon
Committee report.
The weaknesses in the Cash Credit system have persisted with the non-implementation of one
of the crucial recommendations of the Committee. In the background of credit expansion seen
in 1977-79 and its ill effects on the economy, RBI appointed a working group to study and
suggest i) modifications in the Cash Credit system to make it amenable to better management
of funds by the Bankers and ii) alternate type of credit facilities to ensure better credit
discipline and co relation between credit and production. The Group was headed by Shri. K.B.
Chore of RBI and was named Chore Committee.
Another group headed by Shri. P.R. Nayak (Nayak Committee) was entrusted the job of
looking into the difficulties faced by Small Scale Industries due to the sophisticated nature of
Tandon & Chore Committee recommendations. His report is applicable to units with credit
requirements of less than Rs.50 lacs.
The recommendations made by Tandon Committee and reinforced by Chore Committee were
implemented in all Banks and Bank Credit became much more organised. However, the
recommendations were perceived as too strict by the industry and there has been a continuous
clamour from the Industry for movement from mandatory control to a voluntary market related
restraint. With recent liberalisation of economy and reforms in the financial sector, RBI has
given the freedom to the Banks to work out their own norms for inventory and the earlier
norms are now to be taken as guidelines and not a mandate. In fact, beginning with the slack
season credit policy of 1997-98, RBI has also given full freedom to all the Banks to devise
their own method of assessing the short term credit requirements of their clients and grant lines
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
of credit accordingly. Most banks, however, continue to be guided by the principles enunciated
in Tandon Committee report.
Recent Position
State Bank of India and its associate banks have shifted to Projected Balance Sheet (PBS)
Method in which the corporate is asked to project its balance sheet including the requirements
for bank finance. The Bank validates these requirements through time-series and ratio analyses
and sanctions the limits, if the level of finance projected by the corporate is found acceptable.
Otherwise, the corporate is requested to alter its business plans and funding pattern.
Some other Banks like Bank of Baroda have preferred Cash Flow method of assessment of
corporate requirements and are shifting to this method. Under Cash Flow Method, the
corporate is required to project its cash receipts and expenditure. Whenever, the expenditure
overshoots the incomes, the Bank finance steps in to fill the gap. Many other banks, however,
have continued with the method of Maximum Permissible Bank Finance (MPBF)
While other bank loans have to be provided at rates of interest not less than Prime Lending
Rate (PLR), discounting the bills of exchange has been permitted by the RBI at a rate less than
PLR.
RBI guidelines and measures taken for improving credit flow to the sector
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
It is proposed to accept the recommendation with regard to the credit facilities being offered
by the banking sector and accordingly request the Reserve Bank of India to advise the banks to
frame a policy for enhancing the flow of credit to both small and medium enterprises, within
the overall framework of credit policy of banks to small and medium enterprises.
The challenges being faced by the small and medium scale sector may be briefly set out as
follows
a. Small and Medium Enterprises (SME), particularly the tiny segments of the small enterprises
have inadequate access to finance due to lack of financial information and non-formal business
practices. SMEs also lack access to private equity and venture capital and have a very limited
access to secondary market instruments.
b. SMEs face fragmented markets in respect of their inputs as well as products and are
vulnerable to market fluctuations.
c. SMEs lack easy access to inter-state and international markets.
d. The access of SMEs to technology and product innovations is also limited. There is lack of
awareness of global best practices.
e. SMEs face considerable delays in the settlement of dues/payment of bills by the large-scale
buyers.
With the deregulation of the financial sector, the ability of the banks to service the credit
requirements of the SME sector depends on the underlying transaction costs, efficient recovery
processes and available security. There is an immediate need for the banking sector to focus on
credit and finance requirements of SMEs.
1. Public Sector Banks will be advised to fix their own targets for funding SMEs in order
to achieve a minimum 20% year on year growth in credit to SMEs. The objective is to
double the flow of credit from Rs.67,600 crore in 2004-05 to Rs.135,200 crore to the
SME sector by 2009-10, i.e. within a period of 5 years.
2. Public Sector Banks will be advised to follow a transparent rating system with cost of
credit being linked to the credit rating of the enterprise.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
SBI’s year on year growth in credit to SMEs is 23.66%. total credit flow of SBI is 52269
crores on march31 2007. the total credit flow of all banks was146780 crores in 05-06 to
Rs184589 crores 06-07 and 25.81% growth .
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
OBSERVATIONS
OBSERVATIONS
Credit dispensation:Till 1997, bank lending for large working capital requirements was based
on the concept of Maximum Permissible Bank Finance (MPBF). This concept evolved in mid
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
70’s when demand for credit was on the increase and the bank advances were pre-empted by a
large few borrowers. Under the MPBF concept, the borrower was required to maintain a
minimum current ratio (1.17:1 and 1..33:1 under Tandon Committee Norms). If a borrower
could not maintain the minimum current ratio, generally he was considered ineligible for W.C.
finance. Over a period, MPBF concept had become rigid and did not change with the
environmental changes
Kannan Committee: in the light of liberation in the financial sector and poor credit off take
from the banking system,a committee headed by Mr. Kannan, the then Chairman of Bank of
Baroda was constituted by IBA as per the directions of RBI to examine whether MPBF concept
should be abolished and banks should have the sole discretion to determine the credit limits.
RBI directive (April, 1997): however, RBI has made application of MPBF optional by banks .
banks are now allowed full operational freedom for assessing the working capital requirements
of borrowers and to lay down transparent policy and guidelines for credit dispensation in
respect of each category of economic activities. Thus MPBF concept is now optional. Also, the
financial follow up of advances is now maintained through Financial Follow up Report.
Revised method of WC Assessment: arising out of the above directives, the bank has evolved
a revised system for assessing Working Capital limits and for monitoring the advances
Projected Balance Sheet Method: this is a fresh approach in lieu of the MPBF method of
assessment. This will be applicable to C & I borrowers who are engaged in manufacturing,
services and trading activities including merchant exporters who require fund based WC
finance of Rs. 25 lakhs and SSI borrowers who require WC finance above Rs. 5 crores. For
assessment of limits below Rs. 25 lakhs the simple method which was in use for assessing WC
limits of Rs. 2 to Rs. 15 lakhs for SSI units is followed.
The assessment will be based on the borrower’s projected balance sheet, the funds flow
planned for current/ next year and examination of the profitability, financial parameters etc.
unlike the MPBF method, it will not be necessary in this method to fix or compute the working
capital finance on the basis of a stipulated minimum level of liquidity (Current Ratio). The
working capital requirement worked out is based on the following:
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
RECOMMENDATIONS AND
SUGGESTIONS
Problems faced by the Bank for SME lending and suggestions to overcome some of these
problems:
Banks are now better equipped to handle the varied needs of the SME sector due to better
technology and risk management. As recommended by the Ganguly Committee, the
Government has asked banks to adopt a full-service approach to cater to the diverse needs of
the SME sector. This, it recommends, may be achieved by extending banking services to
recognised SME clusters by adopting the 4-C approach: Customer focus, cost control, cross-
selling and containing risk.
• To enable the banks take more objective decisions, the Government plans to
introduce a rating mechanism for designated industrial clusters; this may be
designed jointly by Crisil, IBA, Sidbi and SSI Associations. This would enable
institutional funding to be channelled through homogenous recognised clusters.
• There is a critical need to devote substantial resources to improving the skills and
capabilities of banks' lending officers, especially with regard to the analysis of the
SMEs' financial statements. Understanding the nature of the borrower's business
and the cash-flow required is paramount to preventing the creation of NPAs.
• Another way of extending loans to the SMEs is the relationship-lending rule, where
the lending partly bases its decision on proprietary information about the firm and
its owner through a variety of contacts over time. The information may be gathered
from such stakeholders as suppliers and customers, who may give specific
information about the owner of the firm or general information about the business
environment in which it operates.
• Insufficient data on the SMEs, the lack of credible published information about
their financial health, the high vulnerability of small players in a liberalising market
and the inadequacy of risk management systems in banks are factors leading to
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
higher NPAs and lower profitability than potential in SME lending. This can be
overcome by collection of authentic data on the SME segment, educating the
enterprises on the need for reliable financial data, evolving suitable risk models and
close monitoring of accounts by the bank.
• SMEs are increasingly using products such as derivatives to manage their forex
flows. Bank needs to offer sophisticated products to the SMEs in a simplified
manner.
• They need to innovate their delivery platforms by using Internet banking, mobile
banking and card-based platforms for delivery of transaction-banking as well as
credit products, and enhance the service element. SMEs look for convenience and
simplicity in their banking requirements and banks should deliver these through an
effective use of technology.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
CONCLUSION
CONCLUSION
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
The study at SBI gave a vast learning experience to me and has helped to enhance my
knowledge. During the study I learnt how the theoretical financial analysis aspects are used in
practice during the working capital finance assessment. I have realized during my project that a
credit analyst must own multi-disciplinary talents like financial, technical as well as legal
know-how.
The credit appraisal for working capital finance system has been devised in a systematic way.
There are clear guidelines on how the credit analyst or lending officer has to analyze a loan
proposal. It includes phase-wise analysis which consists of 5 phases:
State Bank of India’s adoptions of the Projected Balance Sheet method of assessment
procedures are based on sound principles of lending. This method of assessment has certain
flexibility required to avoid any rigid approach to fixing quantum of finance. It is superior and
more rational compared to the Turnover Method , Cash Budget Method of assessment .It also
facilitates the Bank to carry on follow up procedures. The PBS method have been rationalized
and simplified to facilitate complete flexibility in decision-making.
To ensure asset quality , proper risk assessment right at the beginning , is extremely important.
That is why Credit Risk Assessment system is an essential ingredient of the Credit Appraisal
exercise. The SBI was the first to formulate a Credit Risk Assessment model. It considers
important parameters like profitability, repayment capacity, efficiency of the unit , historical /
industry comparisons etc… which were not factored in other models. It is equally efficient as
the SIDBI’s CART (Credit Assessment and Rating Tool) model.
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI
BIBLIOGRAPHY
BIBLIOGRAPHY
CREDIT APPRAISAL FOR WORKING CAPITAL FINANCE TO SMEs AT SBI