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Define credit policy

Credit is the provision of resources (such as granting a loan) by one party to another party where that second party does not reimburse the first party immediately, thereby generating a debt, and instead arranges either to repay or return those resources (or material(s) of equal value) at a later date. It is any form of deferred payment. The first party is called a creditor, also known as a lender, while the second party is called a debtor, also known as a borrower. Movements of financial capital are normally dependent on either credit or equity transfers. Credit is in turn dependent on the reputation or creditworthiness of the entity which takes responsibility for the funds. Credit need not necessarily be based on formal monetary systems. The credit concept can be applied in barter economies based on the direct exchange of goods and services, and some would go so far as to suggest that the true nature of money is best described as a representation of the credit-debt relationships that exist in society. Credit is denominated by a unit of account. Unlike money (by a strict definition), credit itself cannot act as a unit of account. However, many forms of credit can readily act as a medium of exchange. As such, various forms of credit are frequently referred to as money and are included in estimates of the money supply. Credit is also traded in the market. The purest form is the credit default swap market, which is essentially a traded market in credit insurance. A credit default swap represents the price at which two parties exchange this risk - the protection "seller" takes the risk of default of the credit in return for a payment, commonly denoted in basis points (one basis point is 1/100 of a percent) of the notional amount to be referenced, while the protection "buyer" pays this premium and in the case of default of the underlying (a loan, bond or other receivable), delivers this receivable to the protection seller and receives from the seller the par amount (that is, is made whole).

What are the objectives of a credit policy?

Five (5) objectives of a credit policy are listed as follows: To ensure consistency in the processes and procedures used to manage all credit aspects of an organization. To ensure that the expectations of the management of an organization and the credit department are aligned and met consistently. To ensure that all customers are treated fairly when making credit decisions. To provide for succession management and training if credit personnel leave the business. To evaluate credit decision making and adjust as circumstances warrant.

As you create your policy, consider the link between credit and sales. Easy credit terms can be an excellent way to boost sales, but they can also increase losses if customers default. A typical credit policy will address the following points: Credit limits: You'll establish dollar figures for the amount of credit you're willing to extend and define the parameters or circumstances. Credit terms: If you agree to bill a customer, you need to decide when the payment will be due. Your terms may also include early-payment discounts and late-payment penalties. Deposits: You may require customers to pay a portion of the amount due in advance. Credit cards and personal checks: Your bank is a good resource for credit card merchant status and for setting policies regarding the acceptance of personal checks. Customer information: This section should outline what you want to know about a customer before making a credit decision. Typical points include years in business, length of time at present location, financial data, credit rating with other vendors and credit reporting agencies, information about the individual principals of the company, and how much they expect to purchase from you.

Documentation: This includes credit applications, sales agreements, contracts, purchase orders, bills of lading, delivery receipts, invoices, correspondence, and so on.

Credit Policy of BALMER LAWRIE & CO LTD

The credit policy for 2001-02 has disappointed Indian industry once again. As the policy has been set when serious lacunae have surfaced in some segments of the financial sector, the governor of the Reserve Bank of India (RBI) has, not surprisingly, adopted a safe path by not taking any controversial steps. He has not affected changes in key monetary instruments like cutting the interest rates further. At the same time, the RBI has indicated that the high government debt has reduced its ability to reduce interest rates. But the credit policy reiterates that "on present reckoning, the current interest rates can continue and some softening in the medium and long-term rates can be expected as and when economic conditions change." Watchfulness, caution and flexibility in the forex market continue to remain the RBIs mantra. The interest rates are, therefore, likely to dovetail the movements in the forex market. A silver lining for exporters and corporate houses with huge exports is the reduction in interest rates on export credit by 1 to 1.5 per cent, indicating a reduction from 10-10.5 per cent to 8.5-9 per cent, and rationalisation of export credit refinance. Thus, with effect from May 5, 2001, banks will be provided export credit refinance to the extent of 50 per cent of the outstanding export credit eligible for refinance. Industry may argue that an interest rate cut could have been on the anvil owing to the following factors: Major indicators pointing to a gathering global recession, prompting the US Fed to further cut interest rates for the second time inside a month. A softening of 10-year gilt rates from 11.57 per cent in September 2000 to 10.36 per cent in March 2001.

Comfortable liquidity position in the banking sector, thanks to the aggregate growth of deposits of scheduled commercial banks at 17.8 per cent (13.9 per cent last year) and the increase in net foreign exchange assets.

However, current economic conditions do not support a lower interest rate regime. Also, a unilateral cut in PLR sans a corresponding cut in the deposit rates cannot be undertaken. With the union budget effecting cuts in the rates of small savings, further cuts in the deposit rates as well would have serious political repercussions, without any beneficial effects on the economy. Given the widespread despondency in the air, the countrys political leadership will have to display considerable sagacity to revive the growth momentum of the economy. Time is of the essence here. The last month of the financial year gone by would have turned out much better if the good work of budget exercise were reflected in initiatives across various areas of policy-making, and in the framework of their implementation. But that is not to be. The wait-and-watch approach to getting the economy out of the current morass wont work. The aspirations are clear: secure healthy economic growth and become increasingly globalised. The budget as well as the exim policy reflects this perspective. How can the government then deal with the present predicament? By shoring up the confidence of consumers and investors. By according business and industry top priority over the next few months.

The budget did create a climate for growth. The first major task, therefore, is to work towards arriving at some kind of political consensus on the totality of the Finance Bills provisions. While doing so, finance minister Yashwant Sinha will have to take into account modifications suggested by many tax experts. The removal of unintended anomalies and inadequacies is imperative to enhancing the efficacy of an intrinsically sound budgetary strategy. The proposed changes are in respect to doing away with retrospective amendments (for example, insertion of the new section 14A to the Income-tax Act). They are also by way of enlarging the scope of various provisions for facilitating the process of business re-

organisation (among them the suggestion regarding a broader definition of industrial undertaking under section 72(A) to include telecom services, etc).

Secondly, as a part of the strategy to shore up confidence, a time-bound programme has to be launched on many other initiatives set out in the budget. These include the proposal to introduce the Electricity Bill 2001 to make state electricity boards (SEBs) financially viable; to review the Essential Commodities Act, 1955, to encourage free inter-state movement of foodgrains and agriculture produce; to make amendments to the Industrial Disputes Act as well as the Contract Labour Act that will ease the rigidities of the labour market; and to push the Fiscal Responsibility Bill. Responsibility for initiating action in these areas cannot just be passed on to the respective ministries. The success of these tough second-generation reforms depends on the top political leadership make concerted efforts. Thirdly, Indian industry, apart from probably being affected by the rationalisation and reduction of the tax structure, is also heavily influenced by the growth stimulus emanating from the plan expenditure in the budget. Over the last few years, the quest for fiscal deficit management has seen the essential push to the economy through incremental plan spending go missing. We, therefore, cannot afford shortfalls in the budgetary target of raising the central plan outlay by 19.9 per cent to Rs 130,181 crore in 2001-02. Incidentally, as much as Rs5,000 crore of the additional plan expenditure is linked to disinvestment receipts. This conditional provision creates some uncertainty about the actual plan spending. It is, thus, of vital importance that the government pursue the public sector disinvestment target more vigorously in the current year. Fourthly, It is essential to consolidate the various measures on softening interest rates. Domestic interest rates are high in real terms when compared with international figures. This undermines the viability of investment proposals, be they in the manufacturing or infrastructure areas. At the same time, we need to acknowledge the strong resistance that is building up against a further reduction in interest rates on bank deposits and in the administered system of contractual savings.

Surely the government cannot build up a cult of equity through a decline in interest rates on fixed interest-bearing financial assets. Similarly, the mutual fund industry cannot become an inspiring avenue of saving merely by promising tax concessions and incentives to savers. Therefore, policy-makers, whether in the finance ministry or the Reserve Bank, will have to provide a stable climate that ensures reasonable returns to the saving community. This is inevitable in the country where the maximum savings are channelised through banks or contractual savings like provident funds, small savings, etc. Outlook for 2001-02 While the credit policy explicitly states that a realistic projection of the overall growth rate for 2001-02 is presently difficult in view of uncertainties pertaining to industrial growth, certain growth assumptions have been indicated: GDP growth at 6-6.5 per cent. Inflation at close to 5 per cent. Money supply (M3) at 14.5 per cent. Aggregate deposit growth at 14.5 per cent (Rs1,34,000 crore). Non-food credit at 16-17 per cent.

Performance of key economic parameters in 2000-01 The macro-economic, monetary, price, and external sector developments remained, by and large, favourable in 2000-01 despite the lower performance of industry and some adverse developments in certain segments of the financial market. GDP growth (latest estimates) likely to be 6 per cent (6.4 per cent previous year). WPI lower at 4.9 per cent (6.8). CPI lower at 3 per cent (4). Money supply higher at 16.2 per cent net of IMD inflows growth works out to 13.9 per cent (14.6).

Aggregate deposit growth much higher at 17.8 per cent(13.9). Non-food credit falls to 14.3 per cent (Rs58,800crore;16.5).

Highlights of credit policy 2001-02 The recent credit policies have focussed on structural measures to strengthen the financial system and improve the functioning of various segments of the financial markets. The current policy continues in the same vein.

Review of Liquidity Adjustment Facility (LAF) Stage II Steps to move forward to the second stage of LAF, envisaging replacement of Collateralised Lending Facility (CLF) and Level I support to PDs by variable rate repo auctions. Changes in LAF operating procedures. Measures to reduce interest rates on export credit by 1-1.5 per cent below PLR, and rationalisation of export credit refinance. Moves to develop a pure inter-bank call money market; permission to corporates to route their call transactions through PDs would be available upto June 30, 2001. Shortening of minimum maturity period of term deposits from the present 15 days to seven with respect to wholesale deposits of Rs15 lakh and above. CRR made more flexible; the maintenance of daily minimum requirement by scheduled banks reduced from 65 per cent to 50 per cent for the first week of the reporting fortnight, while retaining it at 65 per cent for the second week. This is expected to reduce volatility in the money markets. Interest rate policy

PLR norms liberalised; requirement of PLR being the floor rate for loans above Rs2 lakh relaxed to provide further operational flexibility to commercial banks to decide their lending rates.

Banks allowed to offer higher interest on deposits held by senior citizens. Flexibility to banks to disallow premature withdrawal of large deposits. Interest rate on FCNR(B) deposits revised downward to LIBOR/SWAP rates from the current ceiling of LIBOR/SWAP rate, plus 50 Bps.

Prudential norms Revised norms on exposure of banks to stock markets with effect from May 2001. Prudential measures to strengthen co-operative banks, including no direct/indirect lending against security of shares; borrowings in the call/notice money market not to exceed 2 per cent of aggregate deposits; required to maintain their entire SLR assets of 25 per cent of NDTL only in government and other approved securities with effect from April 1, 2003. Revised guidelines for the recovery of NPAs; for one-time settlement extended upto June 30, 2001, from March 31, 2001. Prudential norms for financial institutions Assets to be treated as an NPA if interest and/or principal amount remain overdue for 180 days from the present 365 days, with effect from March 31, 2002. Debt recovery tribunals Seven more to be added to the existing 22 DRPs and five appellate tribunals to facilitate banks to quickly recover their dues. Adoption of 90-day norm for recognition of loan impairment, with a view to move towards international practices and ensure greater transparency. Method of computation of credit exposure

Exposure ceilings to be computed uniformly in relation to total capital as per international norms with effect from March 31, 2002. Non-fund based exposures to be reckoned at 100 per cent and banks to include forward contracts in forex and other derivative products with effect from April 1, 2003. Group exposure limits adjusted to 40 per cent of capital funds.