A Study on Credit Appraisal System in India with Special Reference to South Indian Banks

1. International Journal of Trend in International Open Access Journal International Open Access Journal | www.ijtsrd.com International Journal of Trend in Scientific Research and Development (IJTSRD) Research and Development (IJTSRD) www.ijtsrd.com ISSN No: 2456 ISSN No: 2456 - 6470 | Volume - 3 | Issue – 1 | Nov 1 | Nov – Dec 2018 A Study on Credit Special Reference to South Indian Banks Special Reference to South Indian Banks Special Reference to South Indian Banks A Study on Credit Appraisal System in India with Appraisal System in India with Mrs. P. Dhanya1,Dr. K. Vanaja2 Mrs. 1Assistant Professor Assistant Professor, 2Professor and Head Department of B.Com (PA), Dr. N. G. P. Arts and Science College (Autonomous) Coimbatore, Tamil Nadu, India Department of B.Com (PA) Arts and Science College (Autonomous) ABSTRACT This study helps in understanding the credit appraisal system of Banks in India and to understand how to reduce various parameters, which are broadly categorized into financial risk, business risk, industrial risk and management risk associated in providin loans or advances or project finance. The research design was analytical in nature. Only secondary data was collected to this project. Using this collected data; analysis work was done in the area of Micro and Small enterprises. After the analysis of this study, it was found that the following are the factors that will be considered by the Banks in credit appraisal process. They are financial performance, business performance, industry outlook, quality of management and conduct of account. In the factor of financial performance, the operating and financial viability of the proposal was found. This study helps to know the credit appraisal process and understand the operating and financial viability of the proposal. KEY WORDS:Credit Appraisal, Financial Risk, Business Risk, Industrial Risk, Management Risk, Financial Viability 1. INTRODUCTION Credit appraisal means an investigation/assessment done by the Banks prior before providing any loans & advances/project finance commercial, financial & technical viability of the project proposed its funding pattern & further checks the primary & collateral security cover available for recovery of such funds. This study helps in understanding the credit appraisal system of Banks in India and to understand how to reduce various parameters, which are broadly categorized into financial risk, business risk, industrial risk and management risk associated in providing any the primary & collateral security cover available for 2. MAIN THEME OF THE PROJECT AIN THEME OF THE PROJECT 2.1 STATEMENT OF THE PROBLEM 2.1 STATEMENT OF THE PROBLEM The study is to examine credit appraisal system based on the three enterprises and the problems identified by the researcher related to Micro and Small enterprises and the factors responsible for their infrastructure, limited financial resources, obsolesce technology, financial problems, low quality image. This study is to compare the three enterprises with financial viability and to find out the conclusion viability and to find out the conclusion. credit appraisal system based The research design was analytical in nature. Only secondary data was collected to this project. Using this collected data; analysis work was done in the area on the three enterprises and the problems identified by the researcher related to Micro and Small enterprises and the factors responsible for their sickness are infrastructure, limited financial resources, obsolesce technology, financial problems, low quality image. of this study, it was found that the the three enterprises with following are the factors that will be considered by the Banks in credit appraisal process. They are financial performance, business performance, industry outlook, quality of management and conduct of actor of financial performance, the operating and financial viability of the proposal was 2.2 OBJECTIVES To study the Credit appraisal system in Micro and Small enterprises sector the following objectives are framed dit appraisal system in Micro and the following objectives are This study helps to know the credit appraisal process and understand the operating and financial viability of To Study about the Credit appraisal process. To Study about the Credit appraisal process. To Study about the factors of operating and financial viability. To Study about the factors of operating and Credit Appraisal, Financial Risk, Business Risk, Industrial Risk, Management Risk, To Study about how they are giving rating’s to the sectors. To Study about how they are giving rating’s to the To provide necessary findings based on the given data. To provide necessary findings based on the given Credit appraisal means an investigation/assessment re providing any loans & advances/project commercial, financial & technical viability of the unding pattern & further checks finance & & also also checks checks the the @ IJTSRD | Available Online @ www.ijtsrd.com www.ijtsrd.com | Volume – 3 | Issue – 1 | Nov-Dec 2018 Dec 2018 Page: 126

2. International Journal of Trend in Scientific Research and Development (IJTSRD) ISSN: 2456 International Journal of Trend in Scientific Research and Development (IJTSRD) ISSN: 2456 International Journal of Trend in Scientific Research and Development (IJTSRD) ISSN: 2456-6470 models, the Risk Metrics Group's Credit Metrics and models, the Risk Metrics Group's Credit Metrics and Credit Suisse Financial Produc Credit Suisse Financial Product's Credit Risk+. 2.3 SCOPE AND LIMITATION 2.3.1 SCOPE Michael B Gordy (July 2014) Credit Risk+ is an influential and widely implemented model of portfolio credit risk. As a close variant of models long used for insurance risk, it retains the analytical tractability for Michael B Gordy (July 2014 influential and widely implemented model of portfolio credit risk. As a close variant of models long used for insurance risk, it retains the analytical tractability for which the insurance models were designed. odels were designed. The study will help in understanding the credit appraisal system at Banks and to understand how to reduce various risk parameters associated in providing any loans or advances or project finance. any loans or advances or project finance. The study will help in understanding the credit and to understand how to reduce various risk parameters associated in providing 2.3.2 LIMITATION eter Krahnen, Martin Weber (2015) Banks internal ratings of corporate clients are intended to quantify the expected likelihood of future borrower defaults. It develops a comprehensive framework for evaluating the quality of standard rating systems. It suggest a number of principles that ought to be met by Jan Pieter Krahnen, Martin Weber (2015 internal ratings of corporate clients are intended to quantify the expected likelihood of future borrower defaults. It develops a comprehensive framework for evaluating the quality of stan suggest a number of principles that ought to be met by ``good rating practice''. 1.The credit appraisal is one of the crucial areas for any Banks, some of the technicalities are not revealed. This system includes various types of detail studies for different areas of analysis, but due to time constraint, the analysis was in the area of Micro and Small enterprises only. The credit appraisal is one of the crucial areas for , some of the technicalities are not revealed. This system includes various types of detail studies but due to time constraint, the analysis was in the area of Micro and Seth B. Carpenter, William Whitesell, Egon A researcher evaluates the potential cyclical effects of the "standardized approach" to risk evaluation in the new Accord, which involves the ratings of external agencies. Researchers find that the level of required capital against business loans would be noticeably lower under the new Accord compared Seth B. Carpenter, William Zakrajsek (2016) A researcher evaluates the potential cyclical effects of the "standardized approach" to ri evaluation in the new Accord, which involves the ratings of external agencies. Researchers find that the level of required capital against business loans would be noticeably lower under the new Accord compared with the current regime. 2.4 RESEARCH METHODOLOGY 2.4.1 RESEARCH DESIGN Research type: The study is based on analytical research. Analytical research describes to use facts or information already available and analyze these to make a critical evaluation of the material. make a critical evaluation of the material. The study is based on analytical describes to use facts or already available and analyze these to 3. ANALYSIS AND INTERPRETATION TERPRETATION 2.4.2 TOOLS INTRODUCTION TO CREDIT TOOLS has developed tools for better credit risk management. These focus on the areas of rating of sanctioning) of loans and monitoring of sanctioning). The focus of this manual is to familiarize the user with the credit rating tool. PARAMATERS USED IN CREDIT RATING 3.1 INTRODUCTION TO CREDIT TOOLS The Banks has developed tools for better credit risk management. These focus on the areas of rating of corporate (pre-sanctioning) of loans and monitoring of loans (post-sanctioning). The focus of this manual to familiarize the user with the credit rating tool. 3.2 PARAMATERS USED IN CREDIT RATING OF SME The tools used in Credit Appraisal System are The tools used in Credit Appraisal System are Pre-sanction sanctioned only before analyzing various details of the enterprises is pre-sanction process. process- The loan will be The loan will be sanctioned only before analyzing various details sanction process. Post-sanction process-After analyzing various details of the enterprises in pre-sanction process the loan will be sanctioned. After analyzing various sanction process The rating tool for Small and Micro Enterprise borrowers assigns the following weightages to each one of the four main categories one of the four main categories as in the table 1. The rating tool for Small and Micro Enterprise borrowers assigns the following weightages to each 2.5 REVIEW OF LITERATURE Allen N. Berger, Gregory F. Udell(2012 the inner workings of relationship lending, the implications for Banks organizational structure, and the effects of shocks to the economic environment on the availability of relationship credit to small businesses. (2012) illustrates p lending, the Parameter Weightage (%) organizational structure, and Financial performance Operating performance Quality of management Industry outlook Various parameters under each of the above stated parameters 40 22.5 22.5 40 22.5 22.5 15 15 the effects of shocks to the economic environment on the availability of relationship credit to small Michael B Gordy (2014) illustrates that within the past two years, important advances have been made in modelling credit risk at the portfolio level. Researchers offer a comparative anatomy of two especially influential benchmarks for credit risk especially influential benchmarks for credit risk illustrates that within the ant advances have been made in Various parameters under each of the above stated modelling credit risk at the portfolio level. a comparative anatomy of two @ IJTSRD | Available Online @ www.ijtsrd.com www.ijtsrd.com | Volume – 3 | Issue – 1 | Nov-Dec 2018 Dec 2018 Page: 127

3. International Journal of Trend in Scientific Research and Development (IJTSRD) ISSN: 2456 International Journal of Trend in Scientific Research and Development (IJTSRD) ISSN: 2456 International Journal of Trend in Scientific Research and Development (IJTSRD) ISSN: 2456-6470 3.3 PERFORAMCE AND ITS WEIGHTAGE PERFORAMCE AND ITS WEIGHTAGE PARAMETERS PARAMETERS OF OF FINANCIAL FINANCIAL 3.4 PERFORMANCE AND ITS WEIGHTAGE PERFORMANCE AND ITS WEIGHTAGE PARAMETERS PARAMETERS OF OF OPERATING OPERATING S.No Sub Parameters Weightage (%) 10 7 10 10 10 S.No Sub Paramete Sub Parameters Weightage (%) 10 10 20 10 10 10 10 10 10 100 F1 F2 F3 F6 F7 Net sales growth rate (%) PBDIT growth rate (%) PBDIT/Sales (%) TOL/TNW Current ratio B7 B8 B9 B10 B13 B14 B15 B20 B21 Credit period allowed Credit period availed Working capital cycle Credit period allowed Credit period availed Working capital cycle Tax incentives Production related risks Product related risks Price related risks Client risk Fixed asset turnover TOTAL Production related risks F8 F9 F12* Foreign exchange risk F13 Expected values of D/E, if 50% of NFB devolves(Corrected for margin) F24 Reliability of Debtors F27* State of export country economy F28* Fund repatriation risk TOTAL *Applicable for export units Operating cash flow DSCR 8 8 10 5 Expected values of D/E, if 50% of NFB credi credit 12 5 5 100 State of export country economy CASE - 1 M/s Sivakumar Spinner Name of the Company Present proposal Nature Limit Proposed 100 lakhs Purpose Cash Credit Open Loan(CCOL) 100 lakhs Working capital Term loan 90 lakhs 90 lakhs To machinery purchase Fully Security Loan (FSL) 120 lakhs 120 lakhs To import machinery valued Euro 1,80,000 Security details a)Primary Particulars of asset Value / Margin Mode of change Cash Credit Open Loan 25% for stock and 50% for debtors 25% for stock and 50% for debtors Hypothecation Hypothecation Fully Security Loan 25% Hypot Hypothecation @ IJTSRD | Available Online @ www.ijtsrd.com www.ijtsrd.com | Volume – 3 | Issue – 1 | Nov-Dec 2018 Dec 2018 Page: 128

4. International Journal of Trend in Scientific Research and Development (IJTSRD) ISSN: 2456 in Scientific Research and Development (IJTSRD) ISSN: 2456 in Scientific Research and Development (IJTSRD) ISSN: 2456-6470 b)Collateral Nature Owner Present valuation 13.1.17 year dated Previous valuation 23.3.16 118.61 75.49 us year dated dated year Expert valuation 18.1.17 valuation Unit property The mill Sivakumar spinners Sivaswamy, Rajkumar Sukumar Sivakumar spinners 255.04 302.00 329.18 219.78 Rajkumar and and Purpose of loan : To purchase machinery To purchase machinery Validity of limits Term loan (OD) Ratings by Banks Unit Visit The unit was visited and the overall operations of the unit were found to be satisf The unit was visited and the overall operations of the unit were found to be satisfactory. : : : 12 months 1 year AA with 76% (High safety) AA with 76% (High safety) 12 months actory. CASE - 2 M/s Rajsanthi Spinners Name of the Company Present proposal Nature Limit Proposed Purpose 150.00 lakhs 150.00 lakhs 200 (of which 50.00 lakhs Working capital 200 (of which 50.00 lakhs seasonal Cash Credit Open Loan(CCOL) 22.00 lakhs 22.00 lakhs 22.00 (reduced to 19.23 lakhs) to 19.23 lakhs) Continuance Fully Security Loan (FSL) Security details a)Primary Particulars of asset Stock and Book debts Value / Margin Mode of change 25% for stock and 50% for debtors 25% for stock and 50% for debtors Hypothecation Hypothecation Machines WDV Rs.211.91 lakhs WDV Rs.211.91 lakhs Hypothecation Hypothecation b)Collateral Nature Owner Present valuation 20.12.17 year dated Previous valuation Previous valuation 03.01.16 year dated dated year Expert valuation 25.12.17 Mr.M.Thankaraj 398.82 317.03 318.24 Land Factoring with Mr.M.Thankaraj 144.70 99.00 99.80 Vacant Land @ IJTSRD | Available Online @ www.ijtsrd.com www.ijtsrd.com | Volume – 2 | Issue – 6 | Sep-Oct 2018 Oct 2018 Page: 129

5. International Journal of Trend in Scientific Research and Development (IJTSRD) ISSN: 2456 International Journal of Trend in Scientific Research and Development (IJTSRD) ISSN: 2456 International Journal of Trend in Scientific Research and Development (IJTSRD) ISSN: 2456-6470 Purpose of loan Validity of limits Term loan (OD) Ratings by Banks Unit Visit The unit was visited and the overall operations of the unit were found to be satisfactory. 4. FINDINGS Credit appraisal is done to check the technical and financial viability of the project proposed its funding pattern and checks the primary or collateral security cover available for the recovery of such funds. is the core activity of the Banks and important source of their earnings which go to pay interest to depositors, salaries to employees and dividend to shareholders. Banks main function is to lend funds or provide finance but it appears that norms are taken as guidelines not as a decision making. 5.CONCLUSION Banks loan policy contains various norms for sanction of different types of loans. These all norms do not apply to each and every case. Banks providing loans are flexible and it may differ from case to case. Usually it is seen that credit appraisal is basically done on the basis of fundamental soundness. But, after different types of cases studies, the conclusion was such that the credit appraisal system is not only looking for financial wealth. : : : : To purchase machinery 12 months 1 year A with 68% (Adequate safety) A with 68% (Adequate safety) To purchase machinery 12 months REFERENCES 1)Altman, E.I., Saunders, A., measurement: Developments over the last 20 years. Journal of Banksing and Finance 21, 1721 1742. The unit was visited and the overall operations of the Altman, E.I., Saunders, A., 2007. Credit risk rement: Developments over the last 20 ing and Finance 21, 1721- ck the technical and 2)Allen N. Berger, Gregory F. Udell., 201 business credit availability and relationship lending: the importance of structure, Finance and Series with number 2001- of the Federal Reserve System (U.S.) of the Federal Reserve System (U.S.) . Berger, Gregory F. Udell., 2011. Small business credit availability and relationship lending: the importance of Banks organizational Economics Discussion -36. Board of Governors financial viability of the project proposed its funding pattern and checks the primary or collateral security cover available for the recovery of such funds. Credit s and important source gs which go to pay interest to depositors, salaries to employees and dividend to s main function is to lend funds or provide finance but it appears that norms are taken as 3)A.J. Murphy., 2012. Appraisal and the small company. Personnel Review Personnel Review-Volume: 9 Issue: 4. . Appraisal and the small 4)Carey, M., Treacy, W., 2012 rating systems at large Banks Bulletin 84 (11), 897-921. Carey, M., Treacy, W., 2012. Internal credit risk Bankss. Federal Reserve 5)Cantor, R. Packer, F., 2013 opinion and selection bias in the credit industry. Federal Reserve Journal of Banksing & Finance 1395 ing & Finance 1395-1417. Cantor, R. Packer, F., 2013. Differences of opinion and selection bias in the credit rating industry. Federal Reserve Banks of New York. licy contains various norms for sanction of different types of loans. These all norms do not Banks norms for providing loans are flexible and it may differ from case to case. Usually it is seen that credit appraisal is ly done on the basis of fundamental soundness. But, after different types of cases studies, the conclusion was such that the credit appraisal system is 6)English, W.B., Nelson, W.R., 2015 rating of business loans. Working paper, Board of Governors of the Federal Reserve System. Washington, DC. nglish, W.B., Nelson, W.R., 2015. Banks risk rating of business loans. Working paper, Board of Governors of the Federal Reserve System. 7)Michael B Gordy., 2016. A comparative anatomy of credit risk models. Journal of Finance 24 (1/2), 119-149, this issue. 149, this issue. . A comparative anatomy of credit risk models. Journal of Banksing and @ IJTSRD | Available Online @ www.ijtsrd.com www.ijtsrd.com | Volume – 3 | Issue – 1 | Nov-Dec 2018 Dec 2018 Page: 130