CREDIT PROCESS AND CREDIT

APPRAISAL OF A COMMERCIAL
BANK

Submitted By-
Debeeka Pathak(17)
Evolina Deka(24)
Sabnam Sultana Ahmed(54)
Smritirekha Sarma(58)
Sunit Kumar Pathak(60)
 CREDIT PROCESS

 Credit evaluation and approval is the process a

business or an individual must go through to
become eligible for a loan or to pay for goods and
services over an extended period.

 It also refers to the process businesses or lenders

undertake when evaluating a request for credit.
 The risks involved in lending render it
imperative that banks should have systems and
controls that enable bank managers to take
credit decisions after objectively evaluating risk-
return trade offs. Whether it is consumer or
commercial lending, credit decisions impact the
profitability of banks, and ultimately their
competitiveness and survival in the industry.
 CREDIT APPRAISAL

 Credit Appraisal is the process by which a

lender appraises the technical feasibility,
economic viability and bankability including
creditworthiness of the prospective borrower.

 Credit appraisal process of a customer lies in

assessing if that customer is liable to repay
the loan amount in the stipulated time, or not.
IMPORTANCE OF CREDIT APPRAISAL
 It is absolutely important for a lender to carry out
a credit appraisal process in order to ensure that
the borrower has the capacity to repay the entire loan
amount on time without missing any payment
deadlines.
 This is very crucial for a bank as this determines the
interest income and the capital of the bank.
 A credit appraisal is an important part of
determining the eligibility for a home loan, and the
quantum of the loan.
 A prospective borrower has to go thorough the various
stages of the credit appraisal process of the bank.
 Each bank has its own criteria to satisfy itself on
the credit worthiness of the borrower.
Constituents of the Credit
Process
THE LOAN POLICY

To ensure alignment of individual goals of credit

officers to the bank's overall goals, banks
formulate 'loan policies' . These are written
documents , authorized by individual bank's
Board of Directors, that formalize and set
guidelines for lending to be followed by decision-
makers in the bank.
BUSINESS DEVELOPMENT

Within the broad framework of the loan policy of

the bank, and based on the bank's goals in
building its loan asset portfolio, credit officers
seek to reinforce the relationship with existing
customers. Though every employee of the bank,
from the front office personnel to the top
management, is responsible for overall business
development, credit development requires a
more focused approach.
CREDIT DELIVERY AND
ADMINISTRATION

Depending on the size of the bank, the loan size

and type of exposure planned, the final decision
to lend may be taken by an authorized layer of
the bank. Typically, banks fix "discretionary
limits" - monetary ceilings up to which personnel
at each level can take credit decision - for each
layer of authority starting from credit officers
themselves to branch heads to senior and top
management at the corporate office, including
the Board of Directors.
CREDIT REVIEW AND MONITORING

Banks that have succeeded in credit

management, and hence reduction of credit risk,
are those that have separated credit review and
monitoring from credit analysis, execution and
administration.
BROAD STEPS OF CREDIT
ANALYSIS
STEP 1: BUILDING THE “CREDIT FILE”

 The first step of effective credit analysis is

gathering information to build the credit file.
 The preliminary information so obtained would
throw light on the borrower’s antecedents, his
credit history and track record.
 The credit file is an important tool box for the
credit officer.
STEP 2: PROJECT AND FINANCIAL
APPRAISAL
 In this step the internal and external factors such as
management integrity and capacity, the company’s
performance and market value and the industry
characteristics are evaluated.
 One of the important activities at this stage is
financial analysis.
 An illustrative list of inputs and activities is as
follows-
 Past financial status.
 Cash flow statements.
 From the above data the credit officer analyze the
liquidity position of the borrower.
 The financial risk of an entity is measured.
 The projections are examined.
 Evaluation of the collateral securities.
STEP 3: QUALITATIVE ANALYSIS

 Integrity is the most important quality that the

banker looks for in a borrower and the most
difficult to measure.
 Lenders will have to make qualitative
assessment of the borrower .
 Many poor credit decisions have been the result
of not knowing enough about the customer.
STEP 4: DUE DILIGENCE

 Bypassing due diligence can be very costly for a

bank.
 Many loans have run into problems since
bankers did not take this step seriously.
 It includes checking on borrower’s address, pre
– approval inspections of the borrower’s
workplace, an interview with the borrower’s
competitors. Suppliers, customers and
employees.
 A comprehensive due diligence can also include
reviews of technology used by the borrowers,
planned capital expenditure, other obligations to
outsiders, credit reports from other debtors, the
internal management control and information
system, industrial relations, employee
compensation and benefits and environmental
audit.
STEP 5: RISK ASSESSMENT

 A key function of the credit officer is to identify

and analyze the key risks associated with the
proposed credit.
 All potential internal and external risks are to be
identified and their severity assessed in terms of
how these risks would impact the borrowers
future cash flows and hence the debt service
capacity.
 The risk assessment would form an important
input for structuring the credit facility and the
terms of the loan agreement.
STEP 6: MAKING THE
RECOMMENDATION

 Based on a thorough analysis of the project , the

borrower and the market, and after examining
the “fit” of the credit with the “loan policy”, the
credit officer makes his recommendations to
consider the loan favourably or reject it outright.
CREDIT APPRAISAL
FINANCIAL APPRAISAL FOR CREDIT
DECISIONS

Though several qualitative factors play a role in a

credit decision, a major influencing factor is the
financial health of the borrower as brought out
by the financial appraisal. The credit officer uses
techniques , such as financial ratio analysis, cash
flow analysis and sensitivity analysis to assess
the achievability of the projections.
FINANCIAL RATIO ANALYSIS

 A standardized spreadsheet or format ,where the

balance sheet and income statement data , past
and future, are rearranged in a consistent format
to facilitate comparison over time and benchmark
with industry standards.
 Most credit analysis are five broad categories of
ratios – Liquidity, Profitability, Leverage ,
Operating and valuation .
 Liquidity ratios indicate the borrower’s ability
to meet short-term obligations, continue
operations and remain solvent.
 Profitability ratios indicate the earning potential
and its impact on shareholder’s returns.
 Leverage ratios indicate the financial risk in the
firm as evidenced by its capital structure and the
consequent impact on earnings volatility.
 Operating ratios demonstrate how efficiently the
assets are being utilized to generate revenue.
 Finally , valuation ratios extend beyond historical
accounting measures to depict a realistic ‘value’ of
the borrower.
COMMON SIZE RATIO COMPARISONS

 These comparisons are valuable since they are

independent of firm size, thus facilitating inter-
firm comparisons in the same industry or line of
business.

 The analysis should be able to spot the outliers,

such as firms whose financial structure is vastly
different from the typical firm in the industry.
CASH FLOW ANALYSIS

 While the income statement of the borrower

provides vital information, it also contains
accounting adjustments and non cash expenses.
To get a clearer picture of the borrowers capacity
to repay, the bank will have to convert the
income statement into a cash flow statement or
call for a cash flow statement from the borrower.
 The statement of cash flows is divided into four
parts – Cash from operating activities, Cash
from investing activities, Cash from financing
activities and Cash.
CONCLUSION