The Banking Tutor’s

Notes

Concepts for Credit Professional

For Certificate Examination of IIBF (2024)

Compiled by Sekhar Pariti

Book No 105 from The Banking Tutor

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 Introduction
Vide my Books No 37 and 41 I have shared Objective Points and Objective Notes
related to Certified Credit Professional examination of IIBF in June/July 2022.

However, IIBF has released revised Syllabus for its examination related to Certified
Credit Professional in the year 2024.

Many new chapters/topics are added in the syllabus of 2024. Hence I have
compiled this book based on syllabus, 2024. I have taken utmost care to furnish
updated information. If any one find any information need correction, they can
send a message duly furnishing correct message with proof, so that I can inform
others about the correct position.

Based on this Notes, I am going to compile covering Only Points. I am planning to

share next book No 106. CCP – Only Points by 31st May, 2024 positively.

I suggest the examinee to first study the CCP - Notes (Book No 105) twice or
thrice and then study CCP – Only Points (Book No 106). This plan of preparation
may help the examinee to clear the examination in first attempt.

This Book is compiled only for the purpose of the Examination. Any One wish to
get more knowledge about Credit, One has to study other books related to the
subject.

Sekhar Pariti
25-05-2024 +91 94406 41014

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 Certified Credit Professional
Syllabus 2024
Module A: Introduction & Overview of Credit

01. Principles of Lending

02. Credit Policy

03. Types of Borrowers & types of credit facilities

04. Credit Delivery

05. Credit Appraisal

06. Credit Rating

07. Capital Adequacy (Credit Risk- Standardised Approach & Advanced

Approaches)

# Probability of Default
# Exposure at Default
# Loss Given Default

08. Importance & Application of RAROC

Module B: Analysis of Financial Statements

09. Analysis of Financial Statements

10. Non-financial Risk Analysis & Macroeconomic Factors

11. Project Appraisal/Term Loan Appraisal

12. Credit Risk Analytics & Credit Scoring Models

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 Module C: Working Capital Management

13. Working Capital Assessment (including factoring, bill financing, etc. as sub-
limits)

14. Non-Fund based Credit Facilities

Module D: Other Credits

15. Export Finance

16. Priority Sector Lending/Government Sponsored schemes/NABARD Schemes

17. Retail Loans

18. Forward Exposure Limit & Pre-settlement risk

19. Structured Finance options

20. Alternative source of funding

21. Digital Finance-P2P lending via FinTech

22. Green Finance

Module E: Monitoring, Supervision/Follow Up &

Management of Impaired Assets

23. Documentation

24. Types of Charges

25. Follow up, supervision & credit monitoring u Periodical Scrutiny of Exception
Reports AI/ML based analytics tools to analyse the transactions to predict “likely
to default”

26. Resolution of Stressed Assets

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27. Fair Practices Code on Lender’s Liability

28. Insolvency & Bankruptcy Code (IBC), 2016 [including all amendments & top 5
judgments]

29. Fraud Risk Management in Credit

a. Early Warning Signals [Annexure 16/3 of current book]

b. Red Flagging of Accounts
c. Identification & Reporting of Fraud
d. Forensic Audit
e. Wilful Defaulters
f. Non-Cooperative Borrowers
g. Fugitive Economic Offender
h. Look Out Circular
i. Criminal Offenses and Investigative Agencies.

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 Index

Unit No Topics covered Page Nos

01 Principles of Lending 008-008

02 Credit Policy 009-014

03 Types of Borrowers & types of credit facilities 015-053

04 Credit Delivery 054-057

05 Credit Appraisal 058-067

06 Credit Rating 068-082

07 Capital Adequacy (Credit Risk- Standardised 083-088

Approach & Advanced Approaches)- Probability of
Default; Exposure at Default; Loss Given Default

08 Importance & Application of RAROC 089-093

09 Analysis of Financial Statements 094-130

10 Non-financial Risk Analysis & Macroeconomic 131-137

Factors

11 Project Appraisal/Term Loan Appraisal 138-142

12 Credit Risk Analytics & Credit Scoring Models 143-148

13 Working Capital Assessment 149-153

14 Non-Fund based Credit Facilities 154-185

15 Export Finance 186-216

16 Priority Sector Lending/Government Sponsored 217-263

schemes/NABARD Schemes + RBI Clarifications

17 Retail Banking 264-270

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18 Forward Exposure Limit & Pre-settlement risk 271-275

19 Structured Finance options 276-279

20 Alternative source of funding 280-283

21 Digital Finance-P2P lending via FinTech 284-288

22 Green Finance 289-291

23 Documentation 292-315

24 Types of Charges 316-321

25 Follow Up, Supervision & Credit Monitoring 322-327

26 Resolution of Stressed Assets 328-388

27 Fair Practices Code on Lender’s Liability 389-394

28 Insolvency & Bankruptcy Code (IBC), 2016 + 10 395-421

Court cases
29 Fraud Risk Management in Credit 422-430

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01. Principles of Lending
The lending process in any banking institutions is based on some core principles
such as safety, liquidity, diversity, stability and profitability.

Safety of funds - Safety is the first and foremost thing that the banker has to
consider, especially because he has to disburse depositors' money. As it is his
primary duty to safeguard the monies of others, he has to exercise caution,
prudence and tact.

Liquidity - Before providing loans to the borrowers, banks ensure that they have
sufficient liquid funds available. Therefore, they choose securities that can be sold
off without impacting their market price to meet urgent needs of their customers.
The securities usually belong to government, state and local government bonds.

Diversification - Banks follow the principle of diversity when giving out loans. A
banker is keen on mitigating the risks, by lending to a large number of borrowers
in a number of industries and areas and against different types of securities. If the
Bank has presence in large area , it gets a wide assortment of securities. A business
slump in particular sphere does not affect all these borrowers simultaneously.

Stability – Banks prefer investing in government bonds and debentures to

minimize risks and maintain a stable stance when there is a need for cash in the
middle of a financial crisis. The government debentures provide stability for the
market rate and interest rates are less likely to change in them.

Profits - Banks have to pay interest on deposits, incur expenses on establishment,

rent, stationery, make provision for depreciation of fixed assets and Non
Performing Assets. After meeting all these items of expenditure which enter the
running cost of banks, a reasonable profit must be made.

Due to liberalization measures initiated by the government, banks have to operate

in a competitive environment. More emphasis should therefore be given to aspects
of increasing market share of business, profitability, diversification of advance and
investment portfolio etc.

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[Link] Policy
RBI may issue directives restricting advances against commodities such as food
grains, cotton, oil etc. In the changing concept of banking, factors such as purpose
of the advance and national interest are also of greater importance like adequacy
of security.

Due to liberalization measures initiated by the government, banks have to operate

in a competitive environment. More emphasis should therefore be given to aspects
of increasing market share of business, profitability, diversification of advance and
investment portfolio etc.

Norms on credit exposure - The Norms of RBI have to be followed for ensuring
that the norms on Credit exposure for individuals, units and industry/Sector are
strictly followed.

Fair Lending Practices Code (FLPC)

Fair Lending Practices Code (FLPC) came into effect from 1st November 2003. FLPC
is put in place for retail credit facilities up to Rupees two lakhs. The purpose of
FLPC is to render courteous and speedy services to all the borrowal customers.

As per FLPC, all necessary information like range of loan products available,
securities, interest, service charges, other terms and conditions, the likely time
frame for sanction etc., should be furnished to a prospective borrowal customer.

The general Terms and Conditions for Advances and Schedule of service charges
as advised by Head Office from time to time should be furnished to the prospective
borrower along with the Application form.

The chart showing interest rate and service charges for advances to public should
be displayed by the branches on their Notice Board.

On receipt of loan application complete In all respects, branches should give an

acknowledgement. This is known as Token of Service.

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If any additional details are required while processing the application, the same
should be immediately intimated to the customer. In case of loan applications
under Priority Sector Advances upto Rs 2 lakh, the acknowledgement should also
indicate the time frame. for disposal of such applications.

On sanction of the loan, branches should obtain the customer's signature for
acceptance of the terms and conditions of the sanction in the copy of the sanction
ticket.

Statement of accounts should be regularly provided to the customers, unless the

borrower expressly states that it is not required.

In case of rejection of loan applications, branches should furnish reasons for the
same to the loan applicant through a letter.

FLPC provides for Grievance Redressal Mechanism by which any grievance of the
customer shall be attended to within the time frame stipulated. Branch Manager
will attend to the grievances during bank hours on any working day and inform
the customer within one week, if the customer is not satisfied with the reply, he
can approach the next higher level officers for redressal.

Bank's Loan Policy

The Loan Policy is formulated by Corporate Office with long term perspective to
achieve a wells structured Loan portfolio.

Bank’s Loan Policy enumerates strategies for branches/ will include to improve
advances, monitoring of Standard Assets and focus on recovery of NPA. The Policy
Document include the concept of Risk Management in loan administration.

Bank’s Loan Policy is based on the following factors:

a) RBI's Monetary and Credit Policy

b) RBI's new thrust on Risk Management

c) The Bank's strategy for profit through qualitative credit expansion

d) An analytical study of the industries- their present position and future prospects

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e) The views and suggestions are solicited and received from HO Executives and
the field level functionaries

f) The Enterprise Resources Plan (ERP) evolved by the Corporate Office

g) Comparative market forces emerging in the economy due to liberalization of

the market .

h) Targets prescribed by RBI in regard to social and other lending

i) The long term objective of the Bank to build up a loan portfolio which is both
qualitative and remunerative.

Pricing of Loan Products

Base Rate : Bench mark PLR has given way to Base rate. The banks have to follow
the RBI rules relating to Base rate calculation while determining the rates of
interest for different types of advances and loan products. As per RBI regulations,
barring the exceptions mentioned by RBI no loan product shall be priced below
the base rate.

Commercial Rate: Commercial Rate is the rate applicable for public or staff without
any relaxation. For staff, commercial rate means, the rate quoted for loans other
than concessional loans such as SRL, Conveyance Loan, etc., and shall be applicable
to public.

Penal Interest : lt is the penalty charged over the contracted rate, for the portion
of the loan which is overdue / irregular part as per guidelines issued from time to
time. It may be on account of financial irregularity or nonfinancial irregularity or
both.

Fixed Interest Rate: If the interest rate quoted at the time of

sanction/disbursement will not undergo any change despite change in base rate/
spread for the stated period, it is known as fixed rate.

Fixed rate can be offered only for the schemes/ products/ category for which it is
specifically permitted by RBI. EMI will not undergo any change throughout the
repayment period, unless there is a major policy change like periodicity of
charging interest.
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Fixed Interest Rates may also undergo change whenever Bank exercise the interest
reset option.

Variable Interest Rate : Unlike fixed rate, this rate of interest varies/ changes along
with the change in the Base Rate or Spread.

Finer Rate of Interest : Customers having high volume/hi-tech facilities may be

considered for finer rate of interest from card/commercial rate as per rating of
borrowal accounts, business consideration, value addition, cost of servicing the
advance and other internal parameters.

Bank Rate: lt is the rate at which RBI is prepared to lend to Banks or rediscount
Bills of Exchange or buy other Commercial Paper eligible for purchase under
Section 49 of RBI Act.

Call Money Rate: Prevailing interest rate for overnight/short duration borrowing
by banks in the interbank market.

Charging of Interest

As per RBI guidelines Banks switched over to charging of interest on loans /

advances at "Monthly Rests" with effect from April 01,2002. Accounts brought
under this system are all loans/advances such as loans on deposit, personal loan
products, structured loan products (for both of the schemes under variable rate of
interest and fixed rate of interest), Cash Credits, OD, Staff Loans, etc.

Bills Purchased: For all bill finance (DP/ DAI Supply etc.,) recovery of interest
should be on the date of purchasing/discounting the bill, for the specific/notional
number of days.

For Bills purchased/negotiated/discounted (Inland / Foreign), besides recovering

usual charges, the interest at applicable rate for the period from the date of
Purchase to the notional/committed due date (in supply bills) of the bill shall also
be collected as Up Front.

In case the bill is realised/ reversed after the notional due date, the interest for the
extended/delay period, at the penal rate, shall be compounded at monthly rests
and recovered.

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Exceptions from monthly compounding - Agricultural loans: As the agricultural
advances are linked to crop seasons, branches shall follow the periodicity of
charging/compounding of interest as per RBI/NABARD/HO guidelines.

Recovery of interest: The monthly interest debited has to be recovered

immediately as and when charged. Customers shall be informed well in advance
about the monthly charging of interest and to service the same.

However, on a case to case basis, Branch Managers can grant time as per HO
guidelines, for adjustment of the interest, from the date of debit.

Statutory Restrictions

Advances against banks' own shares: A Bank cannot grant any loan or advance on
the security of its own shares in terms of Section 20 (1) of the Banking Regulation
Act, 1949 either during the initial public offer or thereafter.

Lending should not be made against the shares of Bank’s own subsidiaries.

Advances to Banks' Directors: Banks are prohibited from entering into any
commitment for granting any loan or advance to or on behalf of any of their
directors or any firm/company in which any of their directors is interested as
Director or as Partner, Manager, employee or guarantor. However, the restrictions
shall not apply to Loans and Advances made against Govt. Securities, LIC polices,
Fixed Deposits. A Credit limit granted under credit card facility provided by a bank
to its Directors to the extent the credit limit so granted is determined by the bank
by applying the same criteria as applied by it in the normal conduct of the credit
card business.

Loans and Advances to Chairman and Managing Director/Executive Director for

the purpose of purchasing furniture, car, personal Computer or
constructing/acquiring house for personal use, Festival advance can be given with
the prior approval of RBI and on such terms & conditions as may be stipulated by
RBI.

The lenders must do a proper credit assessment of the borrower. They must
conduct due diligence.

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The lender must convey credit limits, terms and conditions and seek acceptance of
the borrower in writing for the same. The rules stipulate that lenders must timely
disburse the loan amount in their loan accounts. An intimation of all the terms and
conditions, changes (if any), interest rates, etc. must be communicated to the
borrower.

The lender should not engage in any sort of discrimination based on the sex, caste
and religion.

Lenders should not resort to undue harassment to recover loans such as bothering
borrowers at odd hours, use of muscle power for recovery of loans, etc.

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03. Types of Borrowers & types of credit facilities
There are several categories of bank debtors. Individuals, partnership firms,
private limited, public limited companies, huge corporations, public sector
undertakings, multinational corporations, and so on. The aforesaid consumers
demand several financial and non-financial credit facilities.

The primary function of a bank is to lend money or make a loan to a borrower who
has a specific need for it. Thus, the banker must be aware of the many rules that
apply to different types of borrowers.

A bank's approach to a loan offer will be influenced by the sort of borrower.

Different requirements are usually applied to different categories of borrowers.
Similarly, the sort of business or occupation will influence the bank's choice to
issue the loan.

Types of Borrowers
Individual

If a banker lends money to someone who is unable to contract, the money cannot
be reclaimed under the following situations:

● If an individual is a minor who has not reached the age of 18 under the
Indian Majority Act, or 20 if he is a child under the Guardian and Ward's Act.

● If a person is not of sound mind, he is unable to engage in a contract.

● If a person is barred from contracting due to a legislative disqualification.

Minor: A minor is someone who has not reached the age of eighteen. Whether the
guardian is natural or assigned by a court of law, a person becomes a major at the
age of eighteen. A minor is not competent to enter into a contract, according to
section 11 of the Indian Deal Act, 1872, and any contract entered into by him is
void ab initio.

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Guardians: There are three different categories of guardians.

● Father and mother are natural caretakers.

● A Testamentary Guardian is a person who is appointed by a will (Vasiyat).

By will, a natural guardian can select someone to function as a guardian after
his or her death. However, such a guardian will only appear when the natural
guardian has died (in the case of Hindus on the death of the father as well as
mother).

● A legal guardian is someone designated by the court. If there is no natural

or testamentary guardian, the court will appoint one.

When a Hindu minor's guardian stops being a Hindu or becomes a sanyasi, he loses
his status as a natural guardian.

As per Indian Majority Act (Section 3) a Minor is one who has not attained the age
of 18 years, in case no Guardian appointed by the Court.

Where a guardian is appointed by court (for person, property or both) or where a

court of ward is appointed by a guardian, a person attains majority on completion
of 21 years of age.

As per Section 11 of Indian Contract Act, Minor is not competent for contract and
contract with minor is void-ab-initio.

As per Section 183 of Indian Contract Act, a Minor cannot appoint an agent.

A Minor can not delegate powers to others.

A Minor can be appointed as an agent and bind his principal.

As per Section 26 of NI Act, a minor can draw, endorse or negotiate a cheque or

bill but he can not be liable. Other parties to that instrument are liable.

A Minor can not appoint Nominee. In the case of a deposit made in the name of a
minor, the nomination shall be made by a person-lawfully entitled to act on behalf
of the minor.

A minor can be appointed as nominee.

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A Minor can not become a partner but can be admitted for benefits of partnership
firm.

On attaining majority, within 6 months, Minor has to exercise his option to

continue in partnership. If he is silent, he is liable-ab-initio.

A minor can not stop payment of cheque issued by partnership firm.

On minor attaining majority, we should not pay cheques signed by guardian,

though the cheque is dated prior to attaining majority.

No deletion / substitution of Minor name be authorised except in the case of death

of Minor depositors.

As per Section 6 of the Hindu Minority and Guardianship Act, 1956, Father is the
natural guardian of a Hindu Minor boy or an unmarried girl and after him, the
mother.

As per the Hindu Minority and Guardianship Act, 1956, in case of married Hindu
minor girl, her husband is the natural guardian. If husband is minor or minor girl
becomes widow, her father in law and after him the mother in Law will be the
guardians though they are not natural guardians.

When a guardian of a Hindu minor ceases to be a Hindu or he becomes a hermit

or sanyasi, he ceases to be natural guardian.

Guardian appointed by father of a minor, is called as Testamentary Guardian and

testamentary guardian will come into picture only after death of father.

As per personal law applicable to Muslims, father is natural guardian.

A Muslim father can appoint a testamentary guardian (Even mother of a Muslim

child can be testamentary guardian), who can act as guardian after his death.

In case of Muslims, if father dies without leaving behind a will, father’s father i.e.
paternal grandfather is the guardian. (If father appoints testamentary guardian,
testamentary guardian will have priority).

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In case of Muslims, after death of paternal grandfather, testamentary guardian
appointed by Paternal grandfather will be guardian. If grandfather not appointed
any testamentary guardian and dies, then court will appoint testamentary
guardian.

In all schools of both the Sunnis and the Shias, the father is recognized as guardian
which term in the context is equivalent to natural guardian and the mother in all
schools of Muslim law is not recognized as a guardian, natural or otherwise, even
after the death of the father.

In case of Christian, Parsi & Jews, there is no specific law relating to Mother to be
treated as guardian. Only Father is the Guardian (except married daughter where
husband is competent to act as guardian) of a minor child. In absence of father,
mother has to get right through court.

In case of Hindu minor even if father is alive, mother can open and operate all
types of deposit accounts of minor (Permitted by Supreme Court)

Other than Hindu, where account is opened under guardianship of Mother, Mother
has no right to give nomination on behalf of Minor. Nomination is to be given by
person Lawfully entitled person.

A Minor can open and operate accounts on attaining 10 years age and he is literate.

Joint accounts of 2 minors can be opened provided both are at least 10 years age
and literates, belonging to same family and operation.

In case of Joint accounts with minor and guardian, we can accept either or survivor
operation condition. It will be in dormant till minor attains majority and on
attaining majority, he can also operate the account.

A bearer cheque presented for cash payment by minor may be paid as a minor can
give a valid discharge in the capacity of Payee.

When a loan has been raised on a term deposit in the name of major person, his
request for addition of the name of minor cannot be entertained.

Minor cannot be declared as insolvent.

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Declaration given by natural guardian is sufficient proof of date of birth.

Cheques issued by the guardian prior to the date on which the minor attains
majority, but presented after the above date, are to be treated as invalid.

Either or Survivor (other than illiterate customers) - It means, anyone can operate
the account till both are alive. After death of either of them, after obtaining Death
Certificate, the bank can delete the name of deceased depositor without any
formality. In case of death of all depositor claim is to be settled to Nominee/all
legal heirs of all deceased depositors.

In case of accounts where Operation condition is Either or Survivor, alteration of

cheque can be confirmed by any of the accountholders.

In case of accounts where Operation condition is Former or Survivor/s / No.1 or

Survivor/s (other than illiterate customers) - When both the depositors are alive,
former/No 1 alone can operate the account.

If the Former/No.1 expires after obtaining Death Certificate, the bank can delete
the name of deceased depositor without any formality.

In case of accounts Jointly Operated - Payable jointly till both are alive, if one or
the two expires, the bank would pay balance to survivor along with legal heirs of
deceased person. In case of death of all depositor claim is to be settled to
Nominee/all legal heirs of all deceased depositors.

In case of accounts Jointly Operated any one of account holders can stop payment
of cheque but revocation has to be done by all jointly.

Operation Condition and Repayment Condition

Operation Conditions are applicable to running accounts such as SB, CA and OD &
OCC. Normally they are applicable in case of Joint Accounts of Individuals and
Representative Accounts (Firms, Companies, Trusts, Societies).

In case of Single Individual accounts, such as Accounts of Minor, NRI etc

operations may be other than the Depositor and/or through Letter of Authority.

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‘Operation Severally’, ‘Operation Jointly’, ‘Operation by No 1 only’ are some of the
Operation Conditions.

‘Payable to No 1 only’, ‘Payable Jointly’, ‘Payment to by way of credit to SB

Account’….etc are some of the Repayment Options/Conditions.

Repayment Conditions apply in case of Term Deposits. This may include the mode
of payment of periodical interest (wherever applicable and/or Maturity Amount.

Partnership Firms
As per companies act 2013, the number of partners can be 100 (Earlier this number
was restricted to 10 for Banking Business and 20 for business other than banking.)

NBFC, HUF, Minor, Insolvent, Insane & alien enemy can not become a partner in
partnership.

Each partner is an agent of the firm and also agent for other partners.

Partners are jointly and severally liable for all the accounts.

Dissolution of the firm: Death, insolvency, retirement of a partner– causes

dissolution.

If account is having credit balance, the remaining partners can give a valid
discharge to the bank.

If the account is having debit balance, operations should be stopped to decide the
liability of the deceased /insolvent/retired partner. Otherwise, the rule in Clayton’s
case will apply.

A registered partnership firm can sue others to enforce its rights arising out of
Contractual obligations.

An unregistered firm can not sue others in its own name though others can sue it
in its name.(sec 69 of Indian partnership Act 1932)

Any partner including sleeping partner has authority to stop payment of a cheque
issued by another partner of the firm. However, revocation of stop order requires
signatures of all partners on revocation letter.

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A partner, being agent of partnership firm, cannot delegate his authority to an
outsider without the written consent of all other partners.

● The Indian Partnership Act of 1932 governs partnerships. A contract establishes

a partnership.

● A partnership is formed to manage a profitable business.

Legal Status of Partnership:

According to the Indian Partnership Act of 1932, which governs partnerships, a

lender dealing with a partnership firm must confirm whether the firm is registered
or not.

● Section 19 of the Partnership Act, 1932 addresses the implied authority of a

partner as an agent of the firm, whereas Section 22 addresses the way of executing
actions to bind the partnership.

● The minimum number of partners is two, with a maximum of ten for banking
and twenty for other businesses.

● Who is eligible to become a partner: A single person, a partnership, or a limited

business.

● Who is not eligible for partnership: Minors, insolvents, and insane people are
unable to become partners because they lack the legal capacity to contract.

● A minor cannot become a partner, but he can be permitted to share in the profits.

● According to a Supreme Court judgement, HUFs cannot become partners since

they are not accountable for the actions of others.

● Because partnership is designed for business, trust cannot become a partner.

● The registrar of businesses registers a partnership firm.

● It is not necessary to register a partnership firm. It is not essential to register the

company. However, an unregistered firm cannot sue others for the collection of
its debt, but others can sue the firm.

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Partner's liability: During his or her time as a partner, each partner is jointly and
individually accountable for all activities of the company. His legal responsibility
is limitless.

Insolvency of a Partner: If the firm's account is in credit at the time of the

insolvency of one of the partners, the other partner can continue to operate it, but
the banker must obtain a new mandate, and all previous checks issued by the
insolvent partner must be paid if the partner confirms the same.

Operational Authority: In partnership accounts, all partners have operational

power.

● Any change in operational power requires the approval of all partners.

● Every partner, including a sleeping partner, can halt payment of a cheque signed
by another partner of the firm, although revocation may only be done by the
operational authority.

● Partner is unable to delegate authority.

● Death of a Partner: Because the death of a partner dissolves the Partnership firm,
banks are obligated to cease the firm's transactions in a running credit facility such
as Cash credit and enable the transaction in a separate bank account so that the
firm's operation is not harmed.

● The remaining partners' approval will be obtained before the cheques signed by
the deceased, insane, or insolvent partner are paid.

● If the partner's account is in credit, operations are permitted for the firm's
closure.

● If the account is in debit, activities should be halted to preserve the obligation

of the deceased/insolvent partner or his/her estate and to prevent Clayton's rule
operations.

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Limited Liability Partnership (LLP) Account
LLP is a hybrid corporate form entity, combining the features of existing
partnership firms and limited liability companies.

LLP is a body corporate & legal entity separate from its partners.

It has to suffix “Limited Liability Partnership” or ‘LLP’ with its name.

It is liable to the full extent of its assets. The liability of the partners would be
limited to their agreed contribution to the LLP

Two or more persons can form a LLP. No upper limit on the number of partners in
an LLP.

A body corporate (including a LLP) can be a partner in LLP.

Change of partners will not affect existence, rights or liability of LLP.

Conversion of a partnership firm or a private limited company or an unlisted public

company into LLP is allowed.

HUF cannot become a partner in LLP.

A minor cannot be a partner in LLP.

LLP needs registration with Registrar of Companies (ROC).

In the name of LLP only Current account & Term Deposits can be opened.

Copy of LLP Agreement signed by all the partners. In case there is no LLP
agreement, Schedule I of the LLP Act signed by all the partners will prevail.

The authorized signatories of LLP are called as “Designated Partners”.

KYC norms are to be complied with in respect of each and every partner of LLP.

As per LLP Act, no resolution is required.

An LLP with more than two partners will continue to exist.

LLP cannot be converted into a company or partnership firm.

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A Private Company; A partnership firm and an Unlisted Public Company can be
converted into an LLP as per the provisions of the LLP Act.

There is no provision under LLP act for registration of charges with ROC.

Hindu Undivided Family

Hindu Undivided Family (HUF) Property, business or estate is ancestral and its
common possession, enjoyment and ownership are the basis of formation of HUF.

As per Hindu common law, the Hindus, Sikhs, Jains are the communities who can
form HUF.

Joint owners of HUF are known as coparceners.

There are two schools of Hindu Law i.e. Dayabehaga: applicable in Bengal and
Assam according to which father is absolute owner of property and Mitakshara:
applicable at other places and according to which all male members have a right
on joint family property by birth.

HUF consists of one common living ancestor and his male or female (w.e.f. Sep
2005) descendants up to 3 generation next to him.

The eldest coparcener including Female is Kartha. All male and female major
members are coparceners.

The eldest member will be Kartha even if he/she lives outside India. Kartha can
appoint any other coparcener or third party to conduct business of HUF.

Coparcener cannot stop payment of cheque unless he is authorized to operate the

account.

Kartha alone has the power to incur debts for family business and legal necessity
of the family.

As per Supreme Court’s judgment, “A HUF directly or indirectly cannot become

partner of a firm because the firm is an association of individuals.

Page 24 of 437
HUF is a floating body whose composition changes by births, deaths, marriages
and divorces.

A HUF not being a ‘legal person’ cannot enter into an agreement of partnership”

A banker working with a Hindu Undivided Family should be familiar with the
'Karta,' the family's senior member.

The banker should guarantee that the family 'Karta' does business with the bank
and only borrows for the benefit of the family company.

All members must sign the application to start an account, and all adult members
should sign it together.

HUF is neither a legal entity nor an individual. It is not the result of an agreement.

It is not a legal entity. Membership is through birth or adoption and is based on a

shared ancestor.

The Karta is the family's oldest member, and the others are co-parents.

Karta might also be a daughter.

Even if he or she resides outside of India, Karta remains the most senior member.

The account's operational power is in the hands of Karta

Karta has the authority to designate any other coparcener or third party to
perform HUF transactions and/or manage the account. Unless he is allowed to run
the account, Co parcener cannot halt the payment of the cheque.

Karta has personal responsibility.

A co parcener's responsibility is limited to his stake in the company. He is not

directly accountable.

According to a Supreme Court ruling, HUF cannot be a partner.

A joint family's manager or 'Karta' has the certain powers and duties:

Page 25 of 437
Powers

● Possession and administration of joint family property are both rights.

● Right to a share of the revenue from a joint family property

● Right to speak for the entire family

● Right to sell joint family property for a specific reason

Duties

● The responsibility of running the family company and managing the

property for the family's benefit.

● Accountability for revenue and property from a shared family company.

Companies
Private Limited Company

a) Number of members – maximum 200, minimum 2

b) General public can not contribute to the capital of the company

c) Number of Directors: min.2 maximum – No Ceiling

d) Minimum paid up capital – ₹ 1.00 lakh

Public Limited company

a) Affairs of the Public limited company will be managed by minimum 3

Directors & maximum no ceiling.

b) Companies Limited by Shares: Minimum 7 members. No maximum ceiling.

If number of Directors exceeds 15, they have to seek central government
permission.

c) Minimum paid up capital – ₹ 5.00 lakh.

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One Person Company Limited

a) Concept of One Person Company (OPC limited) Introduced by way of

Company Bill 2013.

b) Number of Director is 1.

Certificate of Incorporation is issued by Registrar of Companies

Certificate of Incorporation is birth certificate of company.

Certificate of Commencement of Business is issued by Registrar of companies after

it is satisfied that certain minimum capital has been subscribed by the public.

Certificate of Commencement of Business is not required in case of private limited

companies.

Memorandum of Association is the Constitution of the Company and it establishes

the relationship of the company with the rest of the world. Company can not go
beyond the memorandum. It contains:

a) Name of the Company with Ltd as last word, Registered Office address or State

in which the registered office of the company is situated.

b) Object/objectives of the company.

c) Authorised Capital/Issued capital of the company.

d) Limited liability clause.

e) Borrowing powers of the company.

f) For alteration of memorandum, special resolution with 3/4th majority in general

body meeting will be passed and approval from Central Government is required.

g) Any violation of memorandum is ultra-vires of the company and intra-vires of

the directories company is not responsible for violation and directors are
responsible.

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Articles of Association are by laws and internal rules and regulations of the
company. Articles are indoor management of the company.

Articles contain

a) Borrowing powers of directors, procedures for appointment and removal,

retirement and rotation of directors.

b) Articles can be amended by general body resolution. If the borrowing powers

are silent, still the company can avail the loan because every trading company has
the implied powers to borrow.

Private Limited Company’s Borrowing Powers are Unlimited

Borrowing Powers of a Public Ltd Company is restricted up-to paid up capital plus
free reserves of the company. If requires more than this, consent of shareholders
in general body meeting is required.

Death of a Director: does not affect the operations in the account.

The Directors of Company can not delegate their authority to any other person.

Common Seal in their account opening form is not a mandatory requirement.

Even in those cases, where the Memorandum of Association and Articles of

Association of the Company require affixing of Common Seal, the Company shall
be allowed to provide the same voluntarily and the account opening form of the
banks shall not have any such requirement for providing the Company Seal.

Charge creation is required to be registered when charge created on by way of

Hypothecation of stocks, book debts, mortgage of immovable properties, ship,
good will, uncalled share capital of the company.

Charge registration is not required in case of Pledge of goods or securities or

against Fixed Deposits.

Section 125 of Companies Act: Charges created on a company’s assets (except

pledge) have to be registered with Registrar of Companies within 30 days of
creation of the charge.

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ROC can grant extension of 30 days in filing particulars of charge under Sec 125.

Company required paying additional fees not exceeding 10 times of specified fees.
Beyond this period, permission from Company Law Board is required.

A person can not have more than 15 Directorship concurrently (Section 275 of
companies Act.)

Getting charge registered is company’s responsibility. If company getting failed to

register charge, as creditor, bank can register charge.

Non Filing of particulars/ non-registration renders the bank as unsecured creditor

And loan becomes payable immediately.

When charge in favour of two banks is registered, priority of charge is in favour

of bank, in whose favour it is created first i.e. date of documents.

For Registration of Charge or Modification Form CHG-1 to be filed with ROC.

For Satisfaction of Charge Form CHG-4 to be filed with ROC.

A company is another kind of borrower that a banker interacts with within his
lending business.

Basic laws governing companies: Companies in India are presently governed under
the Companies Act, 2013. Companies are needed to be registered under the
Companies Act of 1956.

Incorporation of Company: Section 12 of the Companies Act of 1956 states that

any seven or more people or where a business is known are known by two
documents called "Memorandum of Association" and "Articles of Association."

Memorandum of Association provides the name of the company, registered office,

its authorised capital, shareholders' liabilities, and the firm's purposes, among
other things.

Articles of Association are the rules and regulations that regulate the company's
internal management. For example, the number of directors, the company's
borrowing powers, the procedure for transferring and transmitting shares, and so
on.

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Statutory Corporations

Companies are registered under the Companies Act of 1956, and corporations may
be constituted by an Act of Parliament. These are referred to as Statutory
Corporations. The State Bank of India, for example, was created under the State
Bank Act of 1955. Statutory corporations are independent corporate organisations
established by a special Act of Parliament or a state legislature, with specific
functions, duties, powers, and immunities outlined in the Act of the legislature.
Statutory companies have financial autonomy and are accountable to the
legislation under which they were founded.

The following are the primary characteristics of the statutory corporation:

1. Corporate Body: It is a legal entity and an artificial person formed by law. The
government appoints a board of directors to administer such businesses. A
corporation has the authority to engage in contracts and do business in its name.

2. State-owned: The state assists such firms by totally or partially contributing to

their capital. The state owns it entirely.

3. Answerable to the Legislature: A statutory company is accountable to the

legislature or state assembly that established it. Parliament has no authority to
meddle with statutory corporations' operations. It can only address policy issues
and corporate performance.

4. Own Staffing System: Employees are not government employees, even though
the government owns and oversees a firm. The government provides balanced or
consistent pay and benefits to employees of diverse firms. They are hired,
compensated, and regulated by the corporation's regulations.

5. Financial Independence: A statutory company has financial independence or

autonomy. It is exempt from the budget, accounting, and audit controls. It can
even borrow funds within and outside the country with prior approval from the
government.

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Trusts
A Trust is a relationship created by a person (Testator) where a person (Trustee)
holds property for the benefit of another person (beneficiary) or some object in a
way such that the real benefit of the property accrues to the beneficiary or the
objects of the trust.

A Trust is generally created by a trust deed and all concerned matters are
governed by India Trusts Act, 1882.

Unless specifically provided for in the trust deed, No trustee or trustees can raise
loans against the security of the assets of trust.

Trustees can’t delegate powers to outsiders even with mutual consent.

Death or insolvency of trustee does not affect the trust property and the bank can
paycheques issued by the trustee prior to his death.

The account of the trust will have to be operated by persons authorized by the
resolution.

The responsibilities and obligations of the trustee are set down in the trust deed,
and they are also governed by the laws that apply to such trusts.

Private trusts have beneficiaries who are specific persons or groups, whereas
public trusts have beneficiaries who are the general public.

Private trusts are controlled by the Indian Trust Act of 1882, while public trusts are
overseen by the state's Public Trusts Act.

The document that establishes a trust is known as a "trust deed." The Charity
Commissioner oversees the registration of public trusts.

The bank account's operation and other features must be carried out by the Trust
Deed.

If the trust deed does not specify operational power, all trustees must jointly
manage the account.

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Payment will be stopped according to operational authorities. As per operational
authorities, the stop payment has been lifted.

Even by unanimous consent, trustees cannot assign their authority to an outsider.

Loans are permissible if they are approved under the Trust Deed and are for the
benefit of the Trust.

When a trustee dies, the trust property is handed on to the next trustee, although
the court can choose a trustee if the lone trustee or last living trustee dies.

The trust property is unaffected by a trustee's death or insolvency, and the bank
can cash checks made by the dead trustee before his death.

Clubs & Societies

Clubs, clubs, schools, and other non-commercial organisations that are not
incorporated under the laws that govern them are prohibited from transacting.
Companies Act or Co-operative Societies Act normally control these organisations.

The bank will require a Certificate of Registration, the Society's Byelaws, and a
decision from the Managing or Executive Committee to create a Clubs and
Societies account.

The Managing Committee will decide on operational authority.

The Managing Committee has decided to change the operational authority.

Operational Authority's stop payment and reversal of stop payment.

If everything else is in order, a cheque signed by the treasurer, secretary or

president of the society and given after his death can be paid.

Mandate and Power of Attorney

A mandate does not require witnessing or stamping.

Power of Attorney is stamped as per Stamp Act as applicable in concerned State.

It must be registered or notarized.

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Any cheque signed by agent and presented for payment after cancellation of
authority shall not be paid.

Power of Attorney or Mandate is revoked by death, insanity, insolvency of the

Principal.

In case cheque issued by the agent is presented for payment after his death, the
same can be paid so long as the principal is alive, provided the same is dated prior
to date of death of agent.

Types of Credit Facilities

In this chapter only fund based credit facilities are discussed. Non Fund based
credit facilities are discussed in a separate chapter.

Any enterprise whether industrial, trading or other acquires two types of assets to
run its business. It requires fixed assets which are necessary for carrying on the
production/business such as land and buildings, plant and machinery, furniture
and fixtures. For a going concern these assets are of permanent nature and are not
to be sold.

The other types of assets required for day to day working of a unit are known as
current assets which are floating in nature and keep changing during the course
of business. It is these 'current assets' which are generally referred to as 'working
capital'.

Big industrial projects may require substantial investment in fixed assets and also
large investment for working capital.

The trading units may not require heavy investment in fixed assets while they may
be carrying huge stocks in trade.

The service units may hardly require any working capital and all investment may
be blocked in creation of fixed assets.

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To make the things clear I am giving you following examples :

1. For one individual who has taken running Auto Service as his line of livelihood,
the Auto is a fixed asset, as by using the Auto, he is getting income. The Auto ,
though moving and fixed at a particular place, is a fixed asset to that particular
individual.

Suppose, there is a Dealer in Automobiles and buying Autos from Distributor /

Company is his business. In his case, the Auto is a current asset, as that is the
product in his business.

In both the above cases, Auto is common. In case of individual who is using the
Auto for long time, whereas, the Auto Dealer is not using the Auto, and he wants
to sell the same. For him the particular auto will be with him for short time (till it
is sold).

2. In case of individuals, a house/flat purchased is a fixed asset, whereas the same

house/flat is a current asset to the Builder who is in the line of selling houses.

Hoping the difference between Current Asset and Fixed Asset is clear, I am moving
further.

I have seen cases, where Managers sanctioned OD to purchase Machinery, which

is not correct. Since Machinery is a fixed asset, credit to be sanctioned by way of
Term Loan.

In another case, Manager had sanctioned Term Loan (not small amount, but a
considerable amount) to purchase raw material, which is not correct.

In case of small units (say upto Rs 2 to 3 lac only), we sanction Composite Loan to
enable the borrower to purchase both current assets and fixed assets. For example,
a person wants to purchase, Iron Racks, Tables (fixed assets) and also groceries
(current assets) to run Kirana (Groceries) shop. In such cases only we sanction
single loan (Composite Loan) to purchase both fixed assets and current assets.

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Please remember to sanction only Working Capital (OD/OCC/ODBD/SOD etc) to
purchase current assets and only Term loan (Machinery loan, Housing Loan,
Vehicle Loan etc) to purchase fixed assets, except in case of very small borrowers
as stated in previous para.

The credit facilities (finance) extended by Banks can be classified into different
Groups as under :

Working Capital & Term Loan : (based on nature of asset)

If Bank extend credit to enable the borrower to procure current assets – such type
of Credit is known as Working Capital Loan.

If Bank extend credit to enable the borrower to procure fixed assets – such facility
is known as Term Loan.

Fund Based & Non Fund Based : (basis: parting with Funds by Bank)

When Borrower approaches with a request to extend finance Credit to purchase

either Current Assets or Fixed Assets, Bank will open loan account (working capital
loan or term loan, depending on the nature of the asset) and the proceeds of the
loan will be sent to seller. In this case, Bank is parting with Funds. Hence such credit
facilities are known as Fund Based Credit Facilities. Examples – OD, OCC, Term
Loan, Housing Loan, Vehicle Loan.

In some cases, borrower may request Bank to give Guarantee or Under-taking

based on which they get goods without immediate payment to the seller. Banks
extend such facilities by way of Bank Guarantees and Letters of Credits. These
facilities are known as Non Fund Based Credit Facilities. Examples – Bank
Guarantees, Letters of Credit, Deferred Payment Guarantees and Bills Co-
acceptance Limits). In case of Non Fund Based (NFB) Limits, funds will be parted
by Bank only in case of eventuality and not immediately on receipt of goods by
borrower.

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Inland Credit & Forex Credit :

When we extend finance to meet the needs of the business done within borders
of India, it is known as Inland Credit. When Borrower is engaged in Export and
Import business (globally), even if we extend finance in Indian Rupees (such as
Packing Credit) it comes under Forex Credit.

In this chapter I am going to explain OD, OCC, Term Loans, Bill Finance.

Non Fund Based limits will be explained in another chapter.

Working Capital Facilities (Fund Based)

Banks extend support to entrepreneurs to meet working capital needs in two

forms – Fund Based and Non Fund Based.

In case of Fund Based facilities Bank part with money from the beginning.

However, in case of Non Fund Based facility, Bank will not part with funds but
assures payment in case of any eventuality. OD/OCC and Bills Purchased are
examples for Fund Based Credit facilities. Bank Guarantees for procurement of
Raw Material on credit basis etc and Letters of Credit for purchase raw material
etc on credit basis are examples of Non Fund Based W C facilities.

A working capital loan is a short term loan with the aim of financing the day to
day business operations of a company.

Working capital loans are not used to inject capital into the business or to purchase
long-term assets or investments.

Working Capital Requirement = Inventory+ Accounts Receivables – Accounts

payable

Term loan is a form of borrowing where the payments can be made over a
predetermined period of time in regular intervals.

Working capital loan is a loan taken out to finance routine business operations to
minimize shortfalls in working capital.

Term loans may be short, medium or long term.

Page 36 of 437
Working capital loans are short term loans.

Repayment of a term loan is done by many instalments.

Repayment of a working capital loan is done by a limited number of instalments.

Working Capital (WC) is the life blood of every business concern. Business firms
cannot progress without sufficient WC.

Inadequate WC for any entity denotes shortage of inputs, whereas excess of WC

results in extra cost. Hence, the quantum of WC in every business firm should be
neither more nor less than what is actually required. In this context, proper
assessment of WC requirement and monitoring of the functioning of the unit on
a regular basis play an important role.

Fixed Capital and Liquid Capital

For running an Industry or a Business, two types of capital – Fixed Capital and
Liquid Capital are needed.

Fixed Capital is utilised for acquiring the fixed assets such as land, building, plant
and machinery, etc. But by themselves, these fixed assets can not produce/earn
anything. They have to be run/worked for production. This requires enough liquid
sources, viz., working capital to keep the wheels moving.

WC represents the money that is required for purchase/stocking of raw materials,

payment of salary, wages, power charges etc, and also for financing the interval
between the supply of goods and the receipt of payment thereafter. In other
words, the working capital is the finance required to meet the costs involved
during the operating cycle or working capital cycle.

WC Cycle (Operating Cycle)

The process involved in the utilisation of WC is cyclic one. What is at one stage a
raw material, gets converted into goods-in-process in the next stage and then into
finished goods, then book debts and then cash and again back to the state of raw
materials.

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In respect of trading concerns, operating cycle represents the period involved from
the time the goods and services are purchased and the same are sold and realised.

In the case of manufacturing concerns, it is the time involved in the purchasing of

raw materials, converting them into finished goods and the same are finally sold
and proceeds are realised.

The Working Capital Cycle is fast in consumer goods industries and slow in capital
goods industries.

The Working Capital Cycle is short in case of perishables such as food articles,
fruits. Cycle is long in the case of tobacco, timber, steel.

Seasonal industries like manufacturers of umbrella, woollen fabrics require higher

stocks in some months and bare minimum in remaining months.

During the Working Capital cycle, funds are blocked in various stages of current
assets, viz., cash itself, inventory (consisting of raw materials, stock in process,
finished goods) and receivables. These require finance. Quicker the cycle, more is
the turnover normally and longer the cycle, the less is the turnover.

Management of WC means management of two things – Current Assets, Current

Liabilities.

Current liabilities are short- term liabilities which are repayable within a year.

They are normally raised for meeting the WC needs and to acquire current assets.

Current liabilities are the main source of finance for WC and are normally
identified with the operating cycle of the business.

While making assessment of WC needs, we keep Bank Borrowings away from total
CL and we denote the balance as Current Liabilities Other than Bank Borrowings
(CLOBB)

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Current Liabilities normally consists of:

a) Bank Borrowings for working capital (OCC, Bills)

b) Other short term borrowings like Unsecured Loans.

c) Sundry Creditors – (Purchase of goods on credit basis)

d) Term Loan instalments repayable within a period of one year

e) Other current liabilities and provisions.

Current Assets are also called convertible assets, liquid assets or floating assets.
They change their form every now and then and ultimately are converted into
cash. Current assets in the form of finished goods, are meant for sale and
conversion into cash in a period not exceeding one year.

Current Assets mainly consist of: (a) Cash (b) Inventory (c) Book debts; and (d)
Other loans and advances, etc.

Inventory means Raw Material, Work-in-process (also called Semi Finished Goods
or Stock-in process), Finished Goods, Stores, Packing Material.

Any asset held in excess, burdens the business with unnecessary interest and costs
on such borrowings.

In case of individuals, a house/flat purchased is a fixed asset, whereas the same

house/flat is a current asset to the Builder who is in the line of selling houses.

For individual who has taken running Auto Service as his line of livelihood, the
Auto is a fixed asset, as by using the Auto, he is getting income. The Auto , though
moving and not fixed at a particular place, is a fixed asset to that particular
individual.

Suppose, there is a Dealer in Automobiles and buying Autos from Distributor /

Company is his business. In his case, the Auto is a current asset, as that is the
product in his business.

Page 39 of 437
In both the above cases, Auto is common. In case of individual is using the Auto
for long time, whereas, the Auto Dealer is not using the Auto, and he wants to sell
the same. For him the particular auto will be with him for short time, till it is sold.

Working Capital Gap (WCG) represents excess of current assets over current
liabilities excluding bank borrowings. A part of the Current Assets are financed by
Current Liabilities (other than bank borrowings). The remaining portion of current
assets which requires financing is called as working capital gap.

General rule is that the Entrepreneur has to finance a part of working capital gap
out of either capital or long term sources. This part which is to be met from long
term own funds is called Margin.

WCG = CA – CLOBB (Where WCG is Working Capital Gap, CA is Current Assets and
CLOBB is Current Liabilities other than Bank Borrowings)

Net Working Capital (NWC) is the net surplus of long term sources minus long
term uses. ( Long Term Sources – Long Term Uses). This is known as technical
definition of NWC.

NWC also represents excess of current assets over current liabilities (including
bank finance). NWC = (CA – CL)

NWC indicates the margin or long term sources provided by the borrower for
financing a part of the current assets.

The ratio of current assets to current liabilities is known as Current Ratio.

Current Ratio indicates the liquidity position .

If the current ratio is less than 1, it is generally considered adverse.

Term Loans
Any enterprise whether industrial, trading or other acquires two types of assets to
run its business. It requires fixed assets which are necessary for carrying on the
production/business such as land and buildings, plant and machinery, furniture
and fixtures. For a going concern these assets are of permanent nature and are not
to be sold.

Page 40 of 437
The other types of assets required for day to day working of a unit are known as
current assets which are floating in nature and keep changing during the course
of business. It is these 'current assets' which are generally referred to as 'working
capital'.

Big industrial projects may require substantial investment in fixed assets and also
large investment for working capital.

The trading units may not require heavy investment in fixed assets while they may
be carrying huge stocks in trade.

The service units may hardly require any working capital and all investment may
be blocked in creation of fixed assets.

If Bank extend credit to enable the borrower to procure current assets – such type
of Credit is known as Working Capital Loan.

If Bank extend credit to enable the borrower to procure fixed assets – such facility
is known as Term Loan.

Debt Equity Ratio (DER) is the ratio between debt and equity. i.e., debt / equity. It
indicates the relation-ship between the loan capital and capital raised by way of
equity. In the numerator we take only Long Term Outside Liabilities as Debt.

The main difference between loan capital and equity is that the interest payable
on the loan capital has prior charge and has to be paid before any dividend can be
declared. While there can be no dividend without profits, interest may have to be
paid even if there is no profit.

In the calculation of the Debt Equity Ratio, debt is defined as the outside liabilities.

As per the definition, the debt would include debentures, current liabilities, and
loans from banks and financial institutions. However, the inclusion of current
liability is controversial because debt to equity ratio is all about long-term
financial solvency and current liability is a short-term liability and the amount of
current liability fluctuates far and wide over the year.

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Further, current liabilities are taken care of in liquidity ratios (such short-term
ratio and quick ratio) and the interest on them is not so huge. In view of the above
in calculation of DER, Debt represents long term outside liabilities.

'Equity' refers to tangible net worth.

As the debt to equity ratio expresses the relationship between external equity
(liabilities) and internal equity (stockholder’s equity), it is also known as “external
internal equity ratio”.

If a unit has more debt and less capital, it may be in a disadvantageous position as
the servicing of loan, i.e., payment of instalments and interest, may be a problem,
in the event of its failure to earn sufficient profit.

The optimal debt/equity ratio is 1:1.

A capital-intensive entity may have a high debt/equity ratio indicating that net
assets have been regularly maintained and financed through the debts obtained
which would increase returns in the future due to higher production.

Debt Service Coverage Ratio (DSCR) or Debt Coverage Ratio (DCR).

DSCR is a ratio of cash available to cash required for debt servicing. In other words,
it is the ratio of the sufficiency of cash to repay the debt. It measures a company’s
ability to service its current debts by comparing its net operating income with its
total debt service obligations.

DSCR indicates whether the earnings are adequate to meet the burden of fixed
financial charges. A borrowing concern is required to pay interest on the loan as
also to pay the stipulated instalments. It must, therefore, have sufficient earnings
to enable it to meet these financial commitments.

Debt service coverage ratio is calculated as follows :

Net profit after tax + depreciation + interest on term loans

DSCR = ----------------------------------------------------------------------------
Interest on term loans + principal repayment instalment

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Depreciation is a non-cash charge and it does not reflect any actual out go of
funds. It is generally entered in the books in order to satisfy certain accounting
conventions and sometimes to provide for replacement of the assets. Since
depreciation does not reflect any actual outgo of funds it is added back to the
operating profit in order to arrive at the real funds from operation. This would
apply to any other non-cash charge debited before the operating profit stage.

Interpretation of Debt Service Coverage Ratio :

Higher DSCR indicates better debt serving capacity.

If DSCR is less than 1, it indicates that the cash flows of the firm are not sufficient
to service its debt obligations.

The Ideal DSCR is the one which that is between 1.5 to 2.

DSCR Indicates adequacy of cash accruals to meet debt obligations. It is important

to know the following terms related to DSCR :

1. Average DSCR (ADSCR)

2. Minimum DSCR

Average DSCR : Apart from the DSCR calculated on every calculation period (say,
a year), the ADSCR is an important ratio.

There are two ways to arrive at ADSCR as under :

[Link] the average of the period-by-period (year by year) DSCRs over the life
of the loan.

2. Divide the total cash flow available for debt service (CFADS) over the life of the
loan by the sum of principal (P) and interest (I).

While processing the Proposal we have to study Overall DSCR (aka Average DSCR)
keeping the Minimum DSCR of each year (Year-to-Year DSCR) to come to a proper
conclusion. The yearly ratios are significant as they reflect the coverage available
for debt payments on a year to year basis.

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A debt service coverage ratio of 1 or above indicates that a company is generating
sufficient operating income to cover its annual debt and interest payments. As a
general rule of thumb, an ideal ratio is 2 or higher. A ratio that high suggests that
the company is capable of taking on more debt.

A ratio of less than 1 is not optimal because it reflects the company’s inability to
service its current debt obligations with operating income alone. For example, a
DSCR of 0.8 indicates that there is only enough operating income to cover 80% of
the company’s debt payments.

Net DSCR

Gestation Period & Repayment Holiday (Moratorium)

In any manufacturing unit there will be a time lag between commencement of the
project and commercial production. This period is known as gestation period.

While fixing Repayment holiday we have to take into account Gestation Period
and also some more period for realisation of sales made by the Unit, as during
initial stages of the Firm, Cash Sales may be difficult.

Promoter’s Contribution & Margin

Any Business owner or promoter should bring part of total project cost which is
called Promoter’s Contribution. Margin is part of Promoter’s Contribution. In
certain cases, both Promoter’s Contribution and Margin is one and the same, but
it is not so in all cases. Though, in certain cases both Margin and Promoter’s
Contribution is one and the same, they are different in many cases. Following
examples are furnished to make the concepts clear.

Example: When Applicant want to purchase a Car for Rs 10 lacs (inclusive of

Purchase Price, Registration Expenses and Cost of Insurance), we insist him to
bring 20% (i.e. Rs 2 lacs) and we extend finance to the extent of Rs 8 lacs. In this
case, both promoter’s contribution and Margin are one and the same (20% or Rs
2lacs)

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In case the Applicant approached for Loan to meet cost of construction of
residential building in the site purchased by him two months back for Rs 5 lacs.

Now he has approached for a loan of Rs 9 lacs to meet cost of construction and to
provide other amenities like electricity, which is estimated at Rs 12 lacs. In this
case, Total Project Cost is Rs 17 lacs (Cost of Site + Cost of Construction). Already
he has invested Rs 5 lacs (towards purchase of site from his own sources) and he
is ready to meet Rs 3 lacs ( difference between Cost of Construction and Amount
of the Loan sought) from his own sources. As such total amount brought by the
Borrower is Rs 8 lacs. This Rs 8 lacs is known as Promoter’s Contribution. Though
he had already invested his own funds of Rs 5 lacs towards purchase of site, we
will not sanction Rs 12 lacs to meet cost of construction. We stipulate minimum
percentage of estimated cost to be brought in by Applicant, which is known as
Margin. In the above case, Rs 3 lacs, which he is ready to bring-in from own sources
to meet the part of construction, is known as Margin.

Thus, Margin is different from the promoter's contribution. While the promoter's
contribution is calculated with reference to project as a whole, margin is in respect
of each asset acquired out of each loan.

Stages of Repayment by Instalments

The following are the stages, through which the loan accounts have to pass
depending upon the schedule selected at the time of opening.

Holiday / Moratorium Period - During this period neither instalment nor interest
is to be expected to be paid by the borrower (Holiday period for both principal
and interest – Example: Education Loan). However, during this period, interest is
calculated at monthly rests, compounded or simple as the case may be. The total
interest accrued during the entire holiday period will be charged to the account
only on completion of the holiday period by crediting to 'interest accrued' and
fresh schedule is drawn for the outstanding balance for the term of the loan. This
is called as 'Capitalization' of interest.

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Interest Only Instalment (IOI) Period - This is holiday period for only principal
instalments. During this period, Interest debited on calendar/ anniversary date
becomes due and principal instalments are not expected (for example – Housing
Loan to customers).

Interest Principal Instalment (IPI)– Principal in equal monthly instalments +

Interest as and when due) - During this period actual interest debited to the
account and fixed instalment amount will be payable by the borrower. For
example if a loan of Rs.1,00,000 has to be recovered within 10 months, then the
IPI will be Rs.10,000 + Actual Interest charged to the account for the month.

Equated Periodic Instalments (EPI/EMI) – During this period, equated instalment

will become due periodically (actual interest + principal recovery to match the EMI
amount. However, while appropriation, actual Interest charged to the account for
the month will be recovered, then any other dues and finally the remaining
amount will be appropriated towards principal.

Post Maturity Instalment Stage - If the loan is not cleared before the due date, on
maturity, the loan account slips in to PMI stage and the account will be governed
by the rates/rules defined under this stage for the given schedule.

Different Repayment Options

Bullet : With bullet repayment type we receive the monthly interest payment and
on the maturity date, we receive the whole chunk of the principal back.

Balloon : Here we lock away the investment for the fixed period of time. The
interest for the entire period will be paid out on the maturity date together with
the loan principle.

Step Up Repayment Facility (SURF) - The loan instalment is low in the initial stages.
As our income increases over the years, the loan instalment increases accordingly.

Flexible Loan Instalments Plan (FLIP) - The loan instalment is higher in the initial
years and decreases subsequently in proportion to the income.

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Tranche Based EMI - We can use this option when we purchase a property under
construction. We have the facility to repay the interest amount on the loan amount
drawn until the final disbursement. We can start paying our regular EMIs after
that.

Accelerated Repayment Scheme - We get the flexibility to increase our EMIs every
year in proportion to the increase in our income. It enables us to repay our loan
faster.

Telescopic Repayment Option - We get the benefit of extended repayment tenure

up to 30 years. Hence, we become eligible for a higher loan amount.

Bill Finance
Bills finance is a short term and self liquidating in nature.

There are 3 parties involved in a payment by bill of exchange:

a) Drawer is the party that issues a bill of exchange – the 'creditor'; (seller of the
goods)

b) Drawee is the party to which the order to pay is sent - 'the debtor'(Buyer of the
goods)

c) Payee is the party to which the bill of exchange is payable; (Bank) Bills can be
broadly classified as Demand Bills and Usance Bills.

Certain advances are classified under Bills Purchased for convenience and follow
up, even though no negotiable instrument is purchased or discounted.

A Demand Bill is a Bill of Exchange which is either so expressed as payable ‘on

demand‘ or ’at sight‘ or ‘on presentment‘ or when no time for payment is specified
in it.

A Demand bill does not attract stamp duty.

A Demand bill may either be a clean bill or a documentary bill.

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Clean Demand Bill (CDB) is a cheque or a clean bill of exchange (i.e., not
accompanied by a document of title to goods), drawn payable on demand, and
purchased by the branch.

A Clean Demand Bill is an unsecured bill.

A Secured Demand Bill (SDB) is a bill of exchange accompanied by documents of

the title to goods, drawn payable on demand at an outstation place and purchased
by the branch.

The bill financing facility as a part of working capital finance.

In the case of Railway Receipt, the goods should have been consigned to self or
order of the consignor and endorsed in favour of the Bank or order. This would
avoid the consignee taking delivery of the goods against an indemnity.

Lorry Receipt (LR) should be in the special form if issued by a Transport Operator,
recommended by IBA and approved by us. It need not be in the special form if
issued by transport operators who are not in the IBA list but approved by our Bank.
No other LR should be accepted.

In the case of bills of Lading, all the sets of the bills of lading should accompany
the bill. The bill of lading should be clean and on board and signed by the
authorized person and should not contain any adverse remarks about the
condition of the goods. Bills of Lading marked received for shipment should not
be accepted for discount / negotiation.

Post Parcels should have been addressed to the collecting branch/ bank and the
receipt should clearly indicate this.

Airway Bills are not negotiable and hence goods should be consigned to the
collecting branch / bank only.

Accommodation cheques / bills should not be purchased / discounted.

Some of the possible indications of Accommodation cheques / bills are :

a) Bills for round sums drawn regularly or often or Bills / Cheques with consecutive
numbers drawn on or issued in favour of the same parties regularly;

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b) Bills particularly clean bills, drawn on allied / associate firms;

c) Address of the drawee gives room for doubt or where the address is care of a
hotel, lodge etc.,

d) Where the business of the drawer is different as seen from the nature of goods
consigned;

e) Bills covering goods not being of exportable surplus at the place where the bills
are drawn or not having any relevance to the place from which they are consigned
or those which are not normally consigned to the place mentioned in the bill /
documents;

f) Custom of trade not requiring bills to be drawn (as there may be a custom of
settlement of accounts between parties);

g) Sales turnover of the party not being commensurate with the amount of bills
tendered till then;

h) Delay in payment of the bills or payment by parties other than the drawee /
frequent free delivery instructions / disproportionate rebates / frequent
instructions to deliver documents to parties other than the drawee.

i) Inward bills or cheques drawn or issued in favour of the drawer by the drawees
of bills;

j) Remittances made by the drawer to the drawee by drafts or otherwise

frequently;

k) Parties to the bills/cheques maintaining accounts at various branches / banks

and resorting to bilateral or multilateral kite flying; and

l) Over invoicing of bills.

Lorry Receipts of transport operators not placed in the approved list of the Bank
should not be accepted for discount / purchase.

Only the ‘consignee copy‘ of the Lorry Receipt should be accepted for discount.

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The Lorry receipt should be issued at carrier/s risk. The scheme has placed an
obligation on the part of the Transport operators regarding safe carriage and
delivery of the consignments to the consignee bank or to its order, if description
of consignment with value (exceeding Rs.100/-) is declared by the consignor.

In respect of consignment of perishable goods the transport operator has a right

to sell such goods after 48 hours after the time of arrival at the destination and to
notify and render accounts to the Bank later. Hence, such consignments should be
discouraged, unless special arrangements are made.

Kite flying operations are usually practiced by group of concerns/groups of

persons maintaining accounts with different banks. Such operations are
conducted by tendering cheques (drawn on another bank or branch of the same
bank) for purchase without arranging for funds at the drawee bank. This is done
on a round robin way. On the inevitable instance of return of cheques unpaid (due
to inadequacy of funds in account with drawee bank), a fresh batch of cheques will
be lodged in substitution of returned cheques. The cheques thus lodged are again
not covered by adequate funds. The cycle goes on till the chain is broken. This
practice has to be identified and avoided.

Cheques / Bills once returned unpaid should not be accepted for discount again.

Immediate credit (not exceeding Rs.15000/-) in respect of outstation cheques

should be extended to all eligible account holders without any request.

In respect of local cheques immediate credit of Rs.15000/- is to be extended only

to those eligible account holders who desire to avail of facility.

Affording of immediate credit for amount not exceeding Rs.15000/- can also be
extended in the case of dividend warrants / interest warrants to all eligible account
holders. It should, however, be ensured that the dividend warrants and interest
warrants against which such immediate credit is extended are drawn on banks and
payable on demand without any pre-conditions.

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Individual cheques/dividend warrants / interest warrants (both local and
outstation) for amounts exceeding Rs.15,000/-are not eligible under this scheme
for affording immediate credit.

Local Secured Demand Bills (Applicable to Commodities Covered under SCC

directives):

The selective credit control directives of the Reserve Bank of India have imposed
certain restrictions on advances against commodities stipulated in the directives.
However, advances granted by way of demand documentary bills drawn in
connection with movement of commodities covered by the directives are
completely exempted from the purview of the directives.

Advances could be considered to the buyers of such commodities, by purchase of

bills accompanied by documents of title to goods viz., Railway Receipts and Bills
of Lading. Such advances should be classified as Local Secured Demand Bills
(LSDBs) under Bills Purchased Account. Though such advances are classified under
Bills Purchased Account, the terms /guidelines applicable to them are the same as
those applicable to PL / KCC against documents of title to goods. Loans / LSDBs
cannot be sanctioned against lorry receipts covering any commodity.

LSDBs should be repaid by the party on arrival of the goods or within twenty one
(21) days from the date of discount, whichever is earlier.

A usance bill is one which is not payable on demand, but is expressed to be payable
after a specified period (usance) mentioned in the bill.

A usance bill attracts stamp duty. It should be drawn on Hundi paper of adequate
stamp value. A usance bill may be either a clean bill or a documentary bill. It may
be payable locally or outside the place on which it is drawn.

A bill of exchange may be either D/A (documents to be delivered against

acceptance) or D/P (documents to be delivered against payment). In a D/A Bill, the
accompanying documents are to be delivered to the drawee against acceptance of
the bill. In a D/P Bill the accompanying documents are to be delivered against
payment of the bill. A D/A Bill is treated as an unsecured bill. A D/P Bill is treated
as a secured bill.

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Remission of stamp duty on usance bill of exchange of not more than three
months -The Government of India has remitted the proper stamp duty chargeable
under Indian Stamp Act, 1899 in respect of usance bills of exchange where

a) such bills of exchange are payable not more than 90 days after date or sight

b) such bills of exchange are drawn on or made by or in favour of a Commercial

bank or a Co-operative bank, and

c) Such bills of exchange arise out of bona fide Commercial or trade transaction.

Remission in Stamp Duty does not apply to usance promissory notes.

As per RBI’s Bill Culture Norms , in respect of borrowers having fund based
working capital limits of Rs. 5 crore or more from the banking system, the extent
of finance towards inland credit sale is confined to -

a) Not more than 75% of the aggregate limits in respect of book debts and supply
bills etc. ,

b) The level of financing inland credit sales by way of BEs should not be less than
25% of aggregate limits.

Supply bills arise in relation to transactions with the Government and public sector
undertakings. A party might have taken a contract for execution, and he is entitled
to progressive payments based on work done, for which he has to submit bills in
accordance with the terms and conditions of the contract. Similarly, parties who
have accepted tenders for supply of goods over a period are entitled to payments
on the supply of goods, for which they submit bills in accordance with the terms
of the contract. These bills are known as supply bills.

Contract Bills arise in respect of work done or completed by Contractors.

Supply Bills are accompanied by either documents of title to goods or

acknowledgement from the concerned Department / Bodies for goods received by
them.

E-way bill is a mandatory document to be carried by a person in charge of the

conveyance carrying consignment of goods of value more than Rs 50000/-.

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Discount ; Purchase and Negotiation

The term discounting of bills is used for Usance bills, where the term purchasing
of bills is used for Demand bills. In both cases, the bank immediately credits the
account of the customer with the amount of the bill, less its charges.

The term ‘Negotiation’ is used for extending finance to bills (either demand or
usance) drawn under LC.

There are essentially two systems of bills, the drawer bill system and the drawee
bill system, which are explained blow:

Under the Drawer Bills System Bills being discounted or purchased at the instance
of the drawer of the bills (Seller of the Goods). The banker primarily taking into
consideration the credit of the drawer of bill, while discounting or purchasing
these bills.

Under Drawee Bills System the Buyer’s banker accept the bill drawn by the seller
at the instance of the buyer (the drawee). On the strength of Acceptance of Bill by
Buyer’s Bank, Seller’s Bank extend finance (by purchase or discount0 to the Seller
of the Goods.

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04. Credit Delivery
In this Issue I am covering points related to Credit Delivery

Credit Limits can be availed in any of the following methods as required by the
borrower:

(a) Sole Banking

(b) Multiple Banking Arrangement (MBA)

(c) Consortium arrangement.

(d) Syndication.

(e) Joint Lending Arrangement (JLA)

Sole Banking

Under Sole Banking, the entire credit requirements of the borrower are met by
one Bank only.

Consortium Advances

The necessity of consortium arises when the amount involved is very large and
beyond the permissible resources of a single bank or beyond what a bank would
like to risk under ordinary circumstances on a single borrower beyond the
prudential exposure norms.

Borrowers having multi divisions/multi product companies are to be treated as

one single unit, unless there is more than one published balance sheet for each
division/unit. Therefore, more than one bank financing each division of the
company with only one published balance sheet without the formation of
Consortium / MBA would not be in order.

Under the consortium arrangement, more than one lending institution including
banks may participate in consortium to share the advances upto the total assessed
requirement of a borrower, on agreed proportions.

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Multiple Banking Arrangement (MBA)

Borrowers can avail any credit facilities (both FB & NFB) from any number of banks
without a formal consortium arrangement.

So long as the total credit limits enjoyed by a borrower from the bank are within
the permissible resources of a single bank, or within the prudential exposure
norms, such facilities can be extended by the individual banks without a formal
consortium under MBA.

To strengthen the sharing information about the status of borrowers enjoying

credit facilities under MBA., following guidelines shall be adhered to:

a) Where the borrowers enjoy credit facilities from more than one bank, obtain
declaration about the credit facilities already enjoyed by them from other banks
from the borrower. Also, obtain declaration each time any fresh facilities/
enhancements are sought or limits are renewed.

b) Bank shall obtain full details of all credit facilities including temporary/adhoc
facilities availed by such borrowers from the banking system, duly certified by
their auditors every time the credit facilities are renewed/ fresh facilities/
enhancements are permitted.

Under Consortium financing, several banks finance a single borrower with a

common appraisal, common documentation, joint supervision and follow up
exercises, but in multiple banking, different banks provide finance and other
banking facilities to a single borrower without having a common arrangement.

Loan Syndication

A syndicated credit is an agreement between two or more lending institutions to

provide the borrower credit facility using common loan documentation.

Bank shall obtain a mandate from the project sponsor and act as a Lead Manager
/ Mandated Bank to arrange credit on its behalf.

Wherever Bank is appointed as Lead Manager / Mandated Bank, the Bank shall
follow the general guidelines laid down for syndication of loan.

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Wherever any Bank wants to participate in loan syndication, the information
memorandum prepared by the lead manager / mandated bank shall be evaluated
and the matter be placed before appropriate authority for decision.

While loan syndications typically work across borders and may handle financing
in different currencies, consortiums typically occur within the boundaries of a
given nation.

The managing bank in a loan syndication is not necessarily the majority lender, or
"lead" bank. Any of the participating banks may act as lead or assume the
responsibilities of the managing bank depending on how the Credit Agreement is
drawn up.

Under Consortium all the banks acts as a supervisor whereas under loan
syndication there is a lead bank or syndicate agent who looks after all the issues.

Consortium is within a country's boundary whereas under syndication institutions

from different countries pool their resources to provide for the required amount.

While a loan syndication also involves multiple lenders and a single borrower, the
term is generally reserved for loans involving international transactions, different
currencies, and a necessary banking cooperation to guarantee payments and
reduce exposure. A loan syndication is headed by a managing bank that is
approached by the borrower to arrange credit. The managing bank is generally
responsible for negotiating conditions and arranging the syndicate. In return, the
borrower generally pays the bank a fee.

Loan syndication is a process where borrower approach a single bank / financial

institution and that bank sanction a part of the loan and get the rest of the part
sanctioned from other banks. (Sometimes the bank may not provide the loan itself
and may get it sanctioned from other banks). Banks do this for a fee and also to
diversify the risk.

In case of consortium , borrower approach different banks and get them at one
platform, generally the bank having largest share of loan act as leader of
consortium.

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Joint Lending Arrangement (JLA)

With a view to inculcate the required financial discipline in the borrowers and to
enable financing banks to take informed decision on credit matters and as a risk
mitigant, the ground rules governing Joint Lending Arrangement (JLA) has been
introduced.

The JLA scheme shall be applicable to all lending arrangements, with a single
borrower with aggregate credit limits (both Fund Based and Non-Fund Based) of
150 Crore and above involving more than one Public Sector Bank.

Borrowers having Multiple Banking Arrangement (MBA) below 150 crore may also
be encouraged to come under JLA.

Banks/Consortia shall treat borrowers having multi-division/ multi-product

companies as one single unit, unless there is more than one published balance
sheet.

Loan System for Delivery of Bank Credit (LSDBC)

The Loan System for Delivery of Bank Credit (LSDBC) is applicable in the case of
borrowers enjoying fund based working capital facilities of Rs. 150 crore and
above from the banking system.

In respect of borrowers having aggregate fund based working capital limit of Rs

150 Crore and above from the banking system, a minimum level of loan
component of 60% with effect from 01.07.2019.

In respect of certain business activities, which are cyclical and seasonal in nature
or have inherent volatility, the strict application of loan system may create
difficulties for the borrowers. Banks may exempt such borrowers from the loan
system of delivery.

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05. Credit Appraisal
Appraisal means, based on the feedback obtained, you have to justify sanction of
credit limits to the applicant.

Please note that Banks have devised different formats of Applications based on
the category of activity (Agriculture, MSME, Retail etc). Note to Application in the
format suitable to the activity of the applicant as advised by the Bank.

For Appraisal (also known as Credit Report) also Banks have devised different
formats based on category of the proposed borrower and the amount. Select
applicable format and furnish data related in respective paragraphs. Normally,
these formats are user friendly and what is to be furnished may be indicated in the
format itself.

In Appraisal, normally, the following need to be furnished :

1. Basic information about Applicant, constitution (Individual, Proprietary,

Partnership or Pvt Ltd Company) – Name, Age (date of establishment in case of
Firms); location (both residential & business); experience in the line. Details of
their Net worth, with proof to be obtained and to be commented in the Appraisal.

2. Brief narration of proposed activity: The process involved in case of

manufacturing units to be furnished.

3. Make a comment on availability of permissions & licences , if applicable.

4. Comment on availability of power, water, labour (skilled and unskilled),

transport facilities, storage facilities.

5. Furnish your observations based on Pre Sanction Visit, Market enquiries about
the Applicant and the Activity to be financed.

6. Comment on present situation in the related Industry and prospects of the

proposed activity in near future.

7. Comment on securities offered – here you have to furnish your observations on

Legal Opinion and Valuation Report.

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8. Comment on probable risks involved in the activity which may affect our interest
adversely and also steps to mitigate risk.

9. Calculate eligible amount. Some proposals may be for only Term Loan and some
may be only to meet working capital. Some may be for both the facilities. (We
have already explained the concepts of working capital and Term Loan in previous
lessons.).

Term Loan Assessment

In case of Term Loan , two things are important – DER (Debt Equity Ratio) and
DSCR (Debt Service Coverage Ratio). If the amount of proposed loan exceed
certain amount (normally Rs 5 lacs in some Banks), obtain Cash Flows and Funds
Flows with DSCR calculations. Also we need to know concepts of Promoter‘s
Contribution and Margin. (Concepts of DER,DSCR, Promoter‘s Contribution and
Margin are explained in previous chapters).

Based on estimated cost, if the above indicators (DER,DSCR and Promoter‘s

Contribution are as per Bank‘s requirement , you may sanction eligible amount
(after stipulating the margin as per Bank‘s norms) duly stipulating following …

Suitable margin ; Security (it includes machinery to be purchased – which is called

Prime Security and additional security , if any, offered by the Applicant, which is
known as Collateral; Personal Guarantee , the Rate of Interest (Banks have
different sets of Rates of Interest based on the Category of the Borrower, Risk
Grade of the Borrower, Term of the loan, Securities available). Banks offer
concessions to some category of borrowers (women entrepreneurs etc.), the
conditions for disbursement (like remitting the loan proceeds along with the
margin directly to the Borrower).

In case the Applicant does not offer any collateral, you have to cover the loan
under suitable guarantee scheme such as CGTMSE, CGFMU.

While arriving at Repayment Holiday period, you have to take into account, the
total time taken for generation of income (time for completing the project,
commence commercial production and also some time for realisation of sale
proceeds by the Unit.

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(Many Banks are not doing this exercise and simply stipulate 6 months from the
date of first disbursement. This is one of the reasons for many first generation and
small units becoming sick).

I have seen some cases, without making available sanctioned working capital
limits, we have insisted Repayment of term loan instalments, as a result of which
the small entrepreneurs are put to hardships. Banks should think rationally.

We have to take all precautions at the entry level only. Once you accept the
Customer, sometimes, you should be pragmatic. Otherwise, you are increasing Bad
Assets to your portfolio. You have to deviate guidelines, with proper justification,
in the interest of the business of the borrower and Bank. Report the deviations
taken with justification to Appropriate Authority in a proper way to save your skin.

Working Capital Assessment

We have already seen that Working Capital Finance is to procure current assets. In
this regard we come across terms like, current assets, current liabilities, working
capital gap , net working capital, current ratio. These concepts are explained in
previous chapters).

There are 3 different methods of assessment of working capital – MPBF Method,

Turnover Method and Cash Budget System.

In MPBF and Turnover methods, the important point is ―Sales Accepted for
arriving at the ―Eligible Limit. Borrower will submit Sales Estimated (for current
financial year) and Projected Sales (for next financial year) along with Actual
Balance Sheets for last two Financial Years.

In case of already established Units, we may arrive at future sales, based on past
levels, the Unit‘s abilities, Market conditions. Even if we take inflation into account,
sales may increase by minimum 15% in normal conditions year to year.

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In case of established units, you may examine projected sales and if you feel that
the firm has projected sales on higher side, you may prune down the same and
you may accept lower level of sales and arrive at Permissible Bank Finance (PBF).

In case of Turnover method, Accepted Sales is basis for calculation of PBF. In case
of MPBF System also, taking accepted sales as the basis, we will accept level of
current assets and current liabilities and using the levels of current assets and
current liabilities we arrive at PBF.

However, borrowers can opt for Method which is beneficial to them and Bank can
employ it if the same is more suitable and appropriate for assessing their working
capital needs. Actual drawings will be based on drawing power computed as per
Bank’s guidelines on this.

Turnover method

The idea of the turnover method is originated in the P R Nayak Committee

Recommendations which was again reviewed by the Vaz Committee. Under this
method, the working capital limit shall be computed at 20% of the projected gross
sales turnover accepted by the Bank, ensuring maintenance of minimum margin
of 5% on the projected gross annual sales turnover accepted by the Bank.

If the available NWC in the system exceeds stipulated 5% minimum margin, the
same shall be reckoned for assessing the extent of Bank finance and limits will be
determined accordingly.

The Turnover method of assessment shall be applicable for the WC limits as under:

Classification of the Applicant Fund Based WC Exposure

MSME (Manufacturing & Services) Up to Rs. 5 Crore

Non MSME Up to Rs. 2 Crore

Traders, Merchants, Exporters, others Up to Rs. 2 Crore

etc., who are not having a pre-
determined manufacturing /trading
cycle

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Under this method, the eligible Fund based credit limit shall be computed at 20%
of the projected gross annual sales turnover accepted by the Bank ensuring
maintenance of minimum margin of 5% on the projected gross annual sales
turnover accepted by the Bank.

The minimum margin of 5% shall be by way of promoter’s contribution towards

working capital margin.

If the available NWC in the system exceeds stipulated 5% minimum margin, the
same shall be reckoned for assessing the extent of Bank finance and limits will be
determined accordingly.

Maximum Permissible Bank Finance (MPBF)

The maximum permissible bank finance (MPBF) is calculated by subtracting the

margin from the working capital gap. Tandon's Second Method: In this method,
the borrower must arrange 25% of the total current assets as margin. The MPBF is
calculated by subtracting the margin from the total current assets.

Under this method, the assessment of Working Capital finance requirement is

made based on the overall study of the borrower’s business operation, the
operating cycle of the industry which results in estimation of a reasonable build
up of current assets supported by Bank finance.

Here, proper classification of current assets and current liabilities shall be made
on the lines given in the CMA(Credit Monitoring Arrangement) data format and
Method II of lending will be applied .

Current ratio of 1.33 shall be insisted subject to specific relaxations.

The levels of inventory and receivables shall be based on past trend, operational
needs, ability to absorb the carrying costs, inter-firm comparisons, industry trend
and related market developments, etc.

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The MPBF method of assessment shall be applicable for the WC limits as under:

Classification of the Applicant Fund Based WC

Exposure

MSME (Manufacturing & Services) Above Rs. 5 Crore

Non MSME Above Rs. 2 Crore

Traders, Merchants, Exporters, others etc., who are not having a Above Rs. 2 Crore
pre-determined manufacturing /trading cycle

Limits over Rs. 25 crore can be assessed on the basis of MPBF system or cash
budget system at the option of the borrower.

However, borrowers can opt for MPBF/Cash budget system and Bank can employ
it if the same is more suitable and appropriate for assessing their working capital
needs.

The levels of inventory and receivables shall be based on industry trend and closely
related market developments. Projected level of inventory and receivables shall be
examined in relation to the past trend and based on inter-firm comparisons.

The tolerance level of 10% is permissible on the assessed MPBF.

I am explaining above two methods using common data hereunder.

Data common to both the examples :

To understand both Turnover Method and MPBF Method, I have selected a firm
which has submitted following data :

Sales during F Y 2016-17 Rs 840 lacs

Sales during FY 2017-18 Rs 900 lacs

Sales during FY 2018-19 Rs 1020 lacs

Sales during FY 2019-20 Rs 1000 lacs @@

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Sales Estimated for FY 2020-21 Rs 800 lacs @@

Sales Projected for FY 2021-22 Rs 1200 lacs

@@ The Firm informs due to Covid, Sales are low

The Firm has requested sanction of OCC Rs 240 lacs

Points taken into account for appraisal by me :

If we see past trend increase in sales is nominal and if we take into account normal
inflation rate, there is no real growth in sales. Between 2016 to 2019.

Further, in the present scenario of Covid-19,we may not expect much growth in
sales. In view of the same, I am not accepting sales projected at Rs 1200 lacs.

Keeping past trends and present scenario in view I am accepting Sales of Rs 1000
lacs only for FY 2021-22.

To achieve sales of Rs 1000 lacs in one year, the Firm need Normal Inventory of Rs
200 lacs. Basis for arriving Rs 200 lacs inventory holding is ―normally if one Rupee
makes 5 turns, it will earn normal profit in normal conditions‖ is the thumb rule in
business.

Based on this thumb rule, I accept the following levels of Current Assets for the
Firm to achieve sales of Rs 1000 lacs

Inventory (RM, Work-in-process & Finished Goods) 200 lacs

Book-debts (2 months‘ Sales) 167 lacs

Other Current Assets (cash etc) 13 lacs

Total Current Assets 380 lacs

The Firm‘s Current Liabilities (other than Bank Borrowings) 110 lacs

Bank Borrowings estimated 240 lacs

Total Current Liabilities 350 lacs

NWC available / projected (CA-CL) 30 lacs

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 Current Liabilities Current Assets

Creditors for purchase 80 Raw Materials 100

Other Current Liabilities 30 Stocks in process 30

Sub-Total (CLOBB) 110 Finished goods 70

Bank borrowings 240 Receivables 167

XXX XXX Other current assets 13

Total CL 350 Total CA 380

Basing on above data WC is assessed both in TOM & MPBFM which is furnished
hereunder.

Turnover Method :

Under this method, the eligible Fund based credit limit shall be computed at 20%
of the projected gross annual sales turnover accepted by the Bank ensuring
maintenance of minimum margin of 5% on the projected gross annual sales
turnover accepted by the Bank. The minimum margin of 5% shall be by way of
promoter’s contribution towards working capital margin. If the available NWC in
the system exceeds stipulated 5% minimum margin, the same shall be reckoned
for assessing the extent of Bank finance and limits will be determined accordingly.

Projected accepted annual Gross Sales Turnover - Rs. 1000 lakh (A)

25% of the above - Rs. 250 lakh (B)

Minimum margin to be provided by the party - Rs. 50 lakh (C)

(5% of Accepted Sales)

NWC available /projected (whichever is higher) Rs 30 lakh (D)

Permissible Bank Finance Rs. 200 lakh

(B-C (250-50=200) or B-D (250-30=220---- We have taken 200 since it is lower)

PBF is arrived at – (25% of Accepted TO – Minimum 5% or NWC whichever is more)

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Current Ratio Calculation:

If we sanction Rs 200 lacs, Current Ratio will be position of CA & CL will be as

under:

Total CA ---- 380 (M)

Total CL ---- CLOBB -- 110 + BB 200 = 310 (N)

Current Ratio - M/N = 380/310 = 1.23 (nearing 1.25%)

MPBF Method - The following is an example of arriving at Maximum Permissible

Bank Finance

(MPBF) as per Method II of lending :

Total current assets (CA) 380

Less: Total current liabilities other than bank borrowings 110

Working capital gap 270

Less: 25% of CA or actual / projected NWC whichever is higher

25% of CA is 95 and NWC is CA-CL is 30. (which is higher to be reduced) 95

Maximum permissible bank finance (MPBF) 175

Current Ratio Calculation: If we sanction Rs 175 lacs, Current Ratio will be position
of CA & CL will be as under:

Total CA ---- 380 (M)

Total CL ---- CLOBB -- 110 + BB 175 = 285 (N)

Current Ratio - M/N = 380/285 = 1.33

Conclusion :

In subject case, PBF is Rs 200 lacs in Turnover Method and in MPBF Method PBF is
Rs 175 lacs. Borrower has right to choose the method of calculation which is
beneficial to him.

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PBF is only outer limit. However, drawings in the OCC account to be monitored
based on the Drawing Power which is arrived based on actual inventory (Stock,
WiP , FG, Book debts etc) holding at monthly intervals, normally.

MPBF Method explained in this lesson is known as Method II. If we apply Method
I, customer will get more finance compared to that of Method II and if we apply
Method III, Customer will get very less amount (compared to that of Method II).

We may extend more or less (approx. 10% ) finance, with proper justification.

Some points to be noted :

1) If NWC is positive (Current Assets are more than Current Liabilities), then
Current Ratio will be more than 1.

2) If NWC is Negative (CA are less than CL), then Current Ratio will be less than 1.

3) If NWC is Zero (CA are equal to CL) then Current Ratio will be 1.

4) If limits are assessed in Turnover Method, Current Ratio will be near to 1.25%.

5) If limits are assessed in MPBF Method, Current Ratio will be near to 1.33%

Cash Budget System

Under this method, the Working Capital needs of the borrowers are assessed on
the basis of projected cash flow and the estimate of cash deficit.

Cash Budget Method is applicable to those ....

a) Borrowers seeking / enjoying Fund based credit facilities of over Rs. 25 crore.

b) Specific industries / seasonal activities such as software development,

construction, tea and sugar.

c) Traders, Merchants, Exporters, others etc., who are not having a predetermined
manufacturing / trading cycle if the same is found to be more appropriate.

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06. Credit Rating
Credit risk is defined as the possibility of losses associated with diminution in the
credit quality of borrowers or counterparties. In a bank’s portfolio, losses stem
from outright default due to inability or unwillingness of a customer or
counterparty to meet commitments in relation to lending, trading, settlement and
other financial transactions.

Credit risk management encompasses identification, measurement, monitoring

and control of the credit risk exposures.

Building Blocks of Credit Risk Management - In a bank, an effective credit risk

management framework would comprise of the following distinct building blocks:

a) Policy and Strategy

b) Organisational Structure

c) Operations/ Systems

Credit risk assessment involves estimating the probability of loss resulting from a
borrower's failure to repay a loan or debt. Traditionally, it refers to the risk that
the lender may not be able to receive the principal and interest.

Risk rating involves the categorization of individual loans, based on credit analysis
and local market conditions, into a series of graduated categories of increasing
risk. Risk ratings are most commonly applied to all loans other than personal and
residential mortgage/bridge loans.

The risk rating determines the credit approval process and pricing for the loan.

During the risk rating process, the lender is determining the borrower's ability to
repay the loan and assessing the potential volatility of future loan payments.

Loss given default (LGD) is a key metric used in quantitative risk analysis. It is
defined as the percentage risk of exposure that is not expected to be recovered in
the event of default.

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Credit risks are calculated based on the borrower's overall ability to repay a loan
according to its original terms. To assess credit risk on a consumer loan, lenders
look at the five Cs: credit history, capacity to repay, capital, the loan's conditions,
and associated collateral.

Credit risk is most simply defined as the potential that a bank borrower or
counterparty will fail to meet its obligations in accordance with agreed terms. The
goal of credit risk management is to maximise a bank's risk-adjusted rate of return
by maintaining credit risk exposure within acceptable parameters.

Different Types of Credit Risk

Rating agencies can establish credit scores for individuals that can be used by
banks to help determine default risk.

The two main types of default risk are investment grade and non-investment
grade.

Credit Spread Risk: Credit spread risk is typically caused by the changeability
between interest rates and the risk-free return rate.

Default Risk: When borrowers are unable to make contractual payments, default
risk can occur.

Downgrade Risk: Risk ratings of issuers can be downgraded, thus resulting in

downgrade risk.

Concentration Risk or Industry Risk: When too much exposure is placed to any one
industry or sector investors, or financial institutions can be at risk for
concentration risk.

Institutional Risk: If there is a breakdown in the legal structure, banks may

encounter institutional risk. Institutional risk may also occur if there is an issue
with an entity that oversees the contractual agreement between a lender and
debtor.

Organisation Structure - Organisation for credit risk management is created with

the objective of achieving compatibility in risk and business policies and to ensure
their simultaneous implementation in a consistent manner.

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It involves setting risk limits based on the objective measures of risk and
simultaneously ensuring optimum risk adjusted return keeping in view the capital
constraints. It is a question of bank’s policy in balancing risks, returns and capital.
Organisation for credit risk management should be able to achieve it.

Usually, Credit Risk Management Organisation would consist of:

a) The Board of Directors

b) The Risk Management Committee

c) Credit Policy Committee (CPC)

d) Credit Risk Management Department

The Board of Directors has the overall responsibility for management of risks. The
Board articulates credit risk management policies, procedures, aggregate risk
limits, review mechanisms and reporting and auditing systems. The Board decides
the level of credit risk for the bank as a whole, keeping in view its profit objective
and capital planning.

The Risk Management Committee is a Board level Sub-Committee. The

responsibilities of Management Committee with regard to credit risk management
aspects include the following:

a) Setting guidelines for credit risk management and reporting

b) Ensuring that credit risk management processes conform to the policy

c) Setting up prudential limits and their periodical review

d) Ensuring robustness of measurement of risk models

e) Ensuring proper manning for the processes Management

Credit Policy Committee (CPC), also called Credit Control Committee/Credit Risk
Management Committee (CRMC) deals with issues relating to credit policy and
procedures and to analyse, manage and control credit risk on a bank wide basis.

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The Committee formulates policies on standards for presentation of credit
proposals, financial covenants, rating standards and benchmarks, delegation of
credit approving powers, prudential limits on large credit exposures, asset
concentrations, standards for loan collateral, portfolio management, loan review
mechanism, risk concentrations, risk monitoring and evaluation pricing of loans,
provisioning, regulatory/legal compliance, etc.

Credit Risk Management Department (CRMD), which is independent of the Credit

Administration Department, enforces and monitors compliance of the risk
parameters and prudential limits set by the CPC/CRMC. The CRMD also lays down
risk assessment systems, monitors quality of loan portfolio identifies problems
and corrects deficiencies, develops MIS and undertakes loan review/audit.

Department undertakes portfolio evaluations and conducts comprehensives

studies on the environment to test the resilience of the loan portfolio.

Risk Identification - Credit risk arises from potential changes in the credit quality
of a borrower. It has two components: default risk and credit spread risk.

Default Risk is driven by the potential failure of a borrower to make promised

payments, either partly or wholly. In the event of default, a fraction of the
obligations will normally be paid. This is known as recovery the rate.

Credit Spread Risk or Downgrade Risk

If a borrower does not default, there is still risk due to worsening in credit quality.
This results in the possible widening of the credit-spread. This is credit- spread
risk.

Usually this is reflected through rating downgrade. It is normally firm-specific.

Default risk and downgrade risk are transaction level risks. Risks associated with
the credit portfolio as a whole are termed portfolio risks.

Portfolio risk has two components - Systematic or Intrinsic Risk and Risk .

Concentration Risk.

Systematic or Intrinsic Risk - Portfolio risk will be reduced due to diversification.

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If a portfolio is fully diversified, i.e. diversified across geographies, industries,
borrowers, markets, etc., equitably, then the portfolio risk is reduced to a
minimum level. This minimum level corresponds to the risks in the economy which
it is operating. This is systematic or intrinsic risk.

Concentration Risk- If the portfolio is not diversified that is to say that it has higher
weight in respect of a borrower or geography or industry, etc., the portfolio gets
concentration risk.

A portfolio is open to the systematic risk i.e., the risks associated with the
economy. If economy as a whole does not perform well, the portfolio performance
will be affected. That is why when an economy stagnates or faces negative or
reduced growth, credit portfolio of banking industry as a whole shows indifferent
performance. Credit portfolio having concentration in any segment would be
affected if the segment does not perform well.

The risk analysis can be performed either for stand-alone trades or for portfolios
as a whole.

Banks adopt the risk analysis in the following manner.

a) Standalone analysis for Corporate exposures.

b) Portfolio analysis for Retail lending exposures.

Credit Rating of an account is done with the primary objective to determine

whether the account, after the expiry of a given period, would remain a
performing asset, i.e., it will continue to meet its obligation to its creditors,
including Bank and would not be in default. In other words, credit rating exercise
seeks to predict whether the borrower would have the capability to honour its
financial commitment in future to the rest of the world.

A Credit Rating depicts the credit quality of the borrower and depicts his default.
A credit rating process normally would consist of the following parameters:

Financial Parameter.
Management Parameter.
Industry Parameter.
Business Parameter,

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Credit Risk Control and Monitoring

Risk taking through lending activities needs to be supported by a very effective

control and monitoring mechanism, firstly because this activity is widespread, and
secondly, because of very high share of credit risk in the total risk taking activity
of a bank.

An elaborate and well-communicated policy at transaction level that articulates

guidelines for risk taking, procedural guidelines and an effective monitoring
system is necessary.

Active portfolio management is required to keep up with the dynamics of the

economy.

Credit risk control and monitoring is directed both at transaction level and
portfolio level.

The instruments of Credit Risk Management at transaction level are:

Credit Appraisal Process

Risk Analysis Process

Credit Audit and Loan Review

Monitoring Process

Credit risk taking policy and guidelines at transaction level should be outlined for

Delegation of Powers

Powers Credit Appraisals

Rating Standards and Benchmarks (derived from the Risk Rating System)

Pricing Strategy

Loan Review Mechanism

Credit Approving Authority

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An appropriate credit information system is the basic prerequisite for effective
control and monitoring. A comprehensive and detailed MIS (Management
Information System) and CIS (Credit Information System) is the backbone for an
effective CRM System.

Bank should have a carefully formulated scheme of delegation of powers. The

banks should also evolve multi-tier credit approving system where the loan
proposals are approved by an ‘Approval Grid’ or a Committee’. The ‘Grid’ or
‘Committee’, comprising at least 3 or 4 officers, may approve the credit facilities
above a specified limit and invariably one officer should represent the CRMD, who
has no volume and profit targets.

Credit Appraisal - Credit appraisal guidelines include borrower standards,

procedures for analyzing credit requirements and risk factors, policies on
standards for presentation of credit proposals, financial covenants, rating
standards and benchmarks, etc. This brings a uniformity of approach in credit risk
taking activity across the organisation. Credit appraisal guidelines may include risk
monitoring and evaluation of assets at transaction level, pricing of loans,
regulatory/legal compliance, etc.

Prudential Limits - Prudential limits serve the purpose of limiting credit risk.

Aspects for which prudential limits may include:

a) Prudential limits for financial and profitability ratios such as current ratio, debt
equity and return on capital or return on assets, debt service coverage ratio, etc.

b) Prudential limits for credit exposure

c) Prudential limits for asset concentration

d) Prudential limits for large exposures

e) Prudential limit for maturity profile of the loan book.

Prudential limits may have flexibility for deviations. The conditions subject to
which deviations are permitted and the authority thereof should also be clearly
spelt out in the Loan Policy.

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Risk Pricing - The pricing strategy for credit products should move towards risk
based pricing to generate adequate risk adjusted returns on capital. The Credit
Spread should have a bearing on the expected loss rates and charges on capital.

Credit Control and Monitoring at Portfolio Level deals with the risk of a given
portfolio, expected losses, requirement of risk capital, and impact of changing the
portfolio mix on risk, expected losses and capital. It also deals with the marginal
and absolute risk contribution of a new position and diversification benefits that
come out of changing the mix. It also analyses factors that affect the portfolio’s
risk profile.

Some measures to maintain the portfolio quality are:

a) Quantitative ceiling on aggregate exposure in specified rating categories.

b) Evaluation of rating-wise distribution of borrowers in various industries,

business segments, etc.

c) Industry-wise and sector-wise monitoring of exposure performance. Where

portfolio exposure to a single industry is badly performing, the banks may increase
the quality standards for that specific industry.

d) Target for probable defaults and provisioning requirements as a prudent

planning exercise. For any deviation/s from the expected parameters, an exercise
for restructuring of the portfolio should immediately be undertaken and if
necessary, the entry-level criteria could be enhanced to insulate the portfolio from
further deterioration.

e) Undertake rapid portfolio reviews, stress tests and scenario analysis when
external environment undergoes rapid changes (e.g., volatility in the forex market,
economic sanctions, changes in the fiscal/monetary policies, general slowdown of
the economy, market risk events, extreme liquidity conditions, etc.). Based on the
findings of stress test, prudential limits, quality standards, etc., may be revised.

f) Introduce discriminatory time schedules for review of borrowers.

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Active Credit Portfolio Management

Motivation for active credit portfolio management comes from changing demand
of traditional products and new business opportunities. Change in demand of
traditional products has arisen due to

a) Less demand due to disintermediation

b) More supply due to capital mobility

c) Lower returns and increased importance of risk

The motivation for active credit portfolio management also comes from new
opportunities in the economy, such as:

a) Pass through certificates

b) Syndicated lending

c) Project/structured finance

Tools to manage credit portfolio such as:

a) Secondary loan trading

b) Securitisation

c) Credit derivatives

Controlling Credit Risk through Loan Review Mechanism (LRM)

LRM is also called as Credit Audit.

LRM an effective tool for constantly evaluating the quality of loan book and to
bring about qualitative improvements in credit administration.

Loan Review Mechanism is used for large value accounts with responsibilities
assigned in various areas such as, evaluating effectiveness of loan administration,
maintaining the integrity of credit grading process, assessing portfolio quality, etc.

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The main objectives of LRM are:

a) To promptly identify loans, which develop credit weaknesses and initiate timely
corrective action.

b) To evaluate portfolio quality and isolate potential problem areas.

c) To provide information for determining adequacy of loan loss provision.

d) To assess the adequacy of and adherence to, loan policies and procedures,

and to monitor compliance with relevant laws and regulations.

e) To provide top management with information on credit administration,

including credit sanction process, risk evaluation and post-sanction follow up.

The Loan Reviews are designed to provide feedback on effectiveness of credit

sanction and to identify incipient deterioration in portfolio quality. Reviews of
high value loans should be undertaken usually within three months of
sanction/renewal or more frequently when factors indicate a potential for
deterioration in the credit quality.

The loan reviews should focus on:

a) Approval process

b) Accuracy and timeliness of credit ratings assigned by loan officers

c) Adherence to internal policies and procedures, and applicable laws/regulations

d) Compliance with loan covenants

e) Post-sanction follow up

f) Sufficiency of loan documentation

g) Portfolio quality

h) Recommendations for improving portfolio quality

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Credit Risk Mitigation is an essential part of credit risk management. This refers to
the process through which credit risk is reduced or it is transferred to
counterparty. Strategies for risk reduction at transaction level differ from that at
portfolio level.

At transaction level banks use a number of techniques to mitigate the credit risks
to which they are exposed. They are mostly traditional techniques and need no
elaboration. They are, for example, exposures collateralised by first priority claims,
either in whole or in part, with cash or securities, or an exposure guaranteed by a
third party. Recent techniques include buying a credit derivative to offset credit
risk at transaction level.

Securitisation refers to a transaction where financial securities are issued against

the cash flow generated from a pool of assets. Cash flows arising out of payment
of interest and repayment of principal are used to service interest and repayment
of financial securities. Usually an SPV – special purpose vehicle is created for the
purpose. Originating bank – that is the bank which has originated the assets -
transfers the ownership of such assets to the SPV. The SPV issues financial
securities and has the responsibility to service interest and repayments on such
financial instruments.

Credit Derivatives (CDS) - A credit derivative is an over-the-counter bilateral

contract between two or more counterparties that provide for transfer of risks in
a credit asset or credit portfolio without necessarily transferring the underlying
asset from the books of the originator.

Generally, credit derivatives transfer risks in a credit asset without transferring the
underlying asset themselves from the books of the originator. Hence, they are off-
balance sheet financial instruments. All credit assets (loans, bonds, account
receivable, financial leases, etc.) are bundles of risk and rewards.

Credit Default Swaps (CDS) - A Credit default swap is a transaction in which a credit
hedger (PB) pays a periodic premium to an investor (PS) in return for protection
against a credit event experienced on a reference obligation, (i.e., the underlying
credit that is being hedged).

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Credit default swaps (CDS) are generally off-balance sheet items and are not
funded exposures.

Credit events are ISDA defined credit events and include following six events – (a)
bankruptcy (b) obligation acceleration (c) obligation default (d) failure to pay (e)
repudiation/moratorium; (f) restructuring.

A total return swap (TRS) is a swap agreement in which one party makes payments
based on a set rate, either fixed or variable, while the other party makes payments
based on the return of an underlying asset, which includes both the income it
generates and any capital gains.

In total return swaps, the underlying asset, referred to as the reference asset, is
usually an equity index, a basket of loans, or bonds. The asset is owned by the
party receiving the set rate payment.

A total return swap represents an off-balance sheet replication of a financial asset

such as a loan or bond, whereas credit default swaps capture only credit risk, total
return swaps involved the transfer of the total economic return of the asset (i.e.,
both credit and market risks.)

Credit Linked Notes (CLN) are on-balance sheet which combine credit derivatives
with normal bond instruments and thus convert credit derivatives (generally an
OTC instrument) into capital market instruments.

Credit Spread Option (also known as a "credit spread") is an options contract that
includes the purchase of one option and the sale of a second similar option with a
different strike price.

CRAs (Credit Rating Agencies) in India

A credit rating agency (CRA) provides independent evidence and research-based

opinion on the ability and willingness of the issuer to meet debt service
obligations.

In India, CRAs are regulated by SEBI. The Securities and Exchange Board of India
tightened disclosure standards for credit rating agencies while assigning ratings
to companies and their debt instruments.

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The regulator directed that rating agencies must now disclose the liquidity
position of a company being rated. If the rating is assigned on the assumption of
cash inflow, the agencies would need to disclose the source of the funding. Rating
agencies must disclose their rating history and how the ratings have transitioned
across categories. Credit rating firms will also have to analyze the deterioration of
liquidity and also check for asset liability mismatch.

The following are some of important CRAs registered under SEBI.

CRISIL (formerly Credit Rating Information Services of India Limited) is an Indian

analytical company providing ratings, research, and risk and policy advisory
services and is a subsidiary of American company S&P Global.

CARE (Credit Analysis and Research Limited Ratings) commenced its operations in
the year 1993 has established itself as the leading credit rating agency of India.
The company was promoted by major Banks/ FIs (financial institutions) in India.
In the global arena CARE Ratings is a partner in ARC Ratings, an international
credit rating agency.

SMERA (Small and Medium Enterprises Rating Agency) . It is a joint enterprise by

SIDBI, Dun & Bradstreet Information Services India Private Limited (D&B), and
some chief banks in India.

ONICRA (Onida Individual Credit Rating Agency of India) has been promoted by
well known ‘ONIDA’ group. It is also known as Onicra Credit Rating Agency.

Fitch (India Ratings & Research) – Ind-Ra –(India Ratings and Research) is a 100%
owned subsidiary of the Fitch Group. Fitch Group is a global leader in financial
information services with operations in more than 30 countries. Fitch Group is
majority owned by New York based Hearst Corporation. Fitch Ratings Inc. is an
American credit rating agency and is one of the "Big Three credit rating agencies",
the other two being Moody's and Standard & Poor's.

ICRA Limited (formerly Investment Information and Credit Rating Agency of India
Limited) was set up in 1991 by leading financial/investment institutions,
commercial banks and financial services companies as an independent and
professional investment Information and Credit Rating Agency.

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The ultimate parent company of international Credit Rating Agency Moody’s
Investors Service is the indirect largest shareholder of ICRA.

BWR (Brickwork Ratings) was established in 2007 and is promoted by Canara Bank.
It offers ratings for bank loans, SMEs, corporate governance rating, municipal
corporation, capital market instrument, and financial institutions. It also grades
NGOs, tourism, IPOs, real estate investments, hospitals, IREDA, educational
institutions, MFI, and MNRE. Brickwork Ratings is recognised as external credit
assessment agency (ECAI) by Reserve Bank of India (RBI) to carry out credit ratings
in India.

IVRPL (Infomerics Valuation and Rating Private Limited) is a full-service rating

agency. It provides rating services for the entire range of money market & capital
market instruments and borrowing programmes. Infomerics also rates various
schemes of Mutual Funds and Alternative Investment Fund.

Acuite Ratings & Research Limited is an institutionally promoted organisation with

a unique combination of country's leading public & private sector banks along
with a global data & analytics company as its shareholders.

Globally The following 3 known as “The Big 3 Credt Rating Agencies”.

a) Moody’s (b) Fitch and ( c) S&P Global Ratings

Moody’s - Moody's Investors Service, often referred to as Moody's, is the bond

credit rating business of Moody's Corporation, representing the company's
traditional line of business and its historical name.

Fitch - Fitch Ratings is a leading provider of credit ratings, commentary and

research. It provides value beyond the rating through independent and
prospective credit opinions, It offers global perspectives shaped by strong local
market experience and credit market expertise.

S&P Global Ratings (previously Standard & Poor's and informally known as S&P)
is an American credit rating agency (CRA) and a division of S&P Global that
publishes financial research and analysis on stocks, bonds, and commodities. S&P
is considered the largest of the Big Three credit-rating agencies.

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Credit risk assessment is primarily through the internal rating process.

The risk rating of eligible borrowers is a pre sanction exercise.

Bank have developed their own Model of Risk Rating wherever RBI allows.

In many Banks for borrowers with exposure of Rs 2 lakh and above are rated
individually and under the appropriate risk rating models developed for the
purpose. The rating will be based on financial reports as well as recent information
available with the Bank.

The individual borrower ratings are subjected to annual review.

Banks are using internal risk rating model based on the exposure, wherever
freedom is given by RBI or Basel Norms.

Small Exposures and Retail Loans (upto some limit) are rated on the basis of
portfolio model.

Risk Rating function and Loan Approval functions are delinked and are handled by
separate entities to get fair analysis.

Regulatory Aspect to Credit Rating

Credit rating is not mandatory under Basel II, for exposures (FB+NFB) up to Rs 25
Crores. But banks are likely to save capital if they get their loan portfolios rated. If
a bank chooses to keep some of its loans unrated, it may have to provide a risk
weight of 100% for credit risk on such unrated loans. Hence it is essential for banks
to get the loans rated.

Basel III norms emphasizes on banks to have a core capital ratio of 8% and a total
capital adequacy ratio of 11.5%.

Basel III norms concentrate on the capital adequacy framework of a bank and the
quality and quantity of capital held. As Finance to Externally Rated Units saves
pressure on Capital , Banks are going for External Rating of Credit Proposals.

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07. Capital Adequacy
Capital Adequacy Ratio (CAR) is the ratio of a bank’s capital to its risk. It is also
known as the Capital to Risk (Weighted) Assets Ratio (CRAR). In other words, it is
the ratio of a bank’s capital to its risk-weighted assets and current liabilities. This
ratio is utilized to secure depositors and boost the efficiency and stability of
financial systems all over the world.

The capital adequacy ratio (CAR) is an indicator of how well a bank can meet its
obligations. Also known as the capital-to-risk weighted assets ratio (CRAR), the
ratio compares capital to risk-weighted assets and is watched by regulators to
determine a bank's risk of failure. It's used to protect depositors and promote the
stability and efficiency of financial systems around the world.

The Basel II framework provides two broad methodologies to banks to calculate

capital requirements for credit risk, namely, Standardised Approach (SA) and
Internal Rating Based (IRB) Approach.

The Standardised Approach measures credit risk based on external credit

assessments.

The standardised approach assigns standardised risk weights to exposures. Risk

weighted assets are calculated as the product of the standardised risk weights and
the exposure amount. Exposures should be risk-weighted net of specific provisions
(including partial write-offs).

The term standardized approach (or standardised approach) refers to a set of

credit risk measurement techniques proposed under Basel II, which sets capital
adequacy rules for banking institutions.

Under this approach the banks are required to use ratings from external credit
rating agencies to quantify required capital for credit risk. The Basel II accord
proposes to permit banks a choice between two broad methodologies for
calculating their capital requirements for credit risk. The other alternative is based
on internal ratings.

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IRB Approach (to Calculate Capital Requirement for Credit Risk)

The IRB Approach allows banks to use their own internal estimates for some or all
of the credit risk components in determining the capital requirement for a given
credit exposure.

RBI will allow banks to adopt IRB approach if banks meet the requirements
decided by RBI.

IRB approach to capital calculation for credit risk is based upon measures of
unexpected losses (UL) and expected losses (EL).

The IRB approach relies on a bank's own assessment of its counterparties and
exposures to calculate capital requirements for credit risk.

Such an approach has two primary objectives -

•Risk sensitivity - Capital requirements based on internal estimates are more

sensitive to the credit risk in the bank's portfolio of assets

•Incentive compatibility - Banks must adopt better risk management techniques

to control the credit risk in their portfolio to minimize regulatory capital

To use this approach, a bank must take two major steps:

•Categorize their exposures into various asset classes as defined by the Basel II
Accord.

•Estimate the risk parameters—probability of default (PD), loss given default

(LGD), exposure at default (EAD), maturity (M)—that are inputs to risk-weight
functions designed for each asset class to arrive at the total RWA (Risk Weighted
Assets)

Advanced Internal Rating-Based (AIRB)

An advanced internal rating-based (AIRB) approach to credit risk measurement is

a method that requests that all risk components be calculated internally within a
financial institution. Advanced internal rating-based (AIRB) can help an institution
reduce its capital requirements and credit risk.

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In addition to the basic Internal Rating-Based (IRB) approach estimations, the
Advanced Approach assesses the risk of default using loss given default (LGD),
exposure at default (EAD), and the probability of default (PD). These three
elements help determine the risk-weighted asset (RWA) that is calculated on a
percentage basis for the total required capital."

Probability of Default (PD)

Probability of default is a financial term describing the likelihood of a default over

a particular time horizon. It provides an estimate of the likelihood that a borrower
will be unable to meet its debt obligations. PD is used in a variety of credit analyses
and risk management frameworks.

Loss Given Default (LGD)

Loss given default or LGD is the share of an asset that is lost if a borrower defaults.
It is a common parameter in risk models and also a parameter used in the
calculation of economic capital, expected loss or regulatory capital under Basel II
for a banking institution.

Exposure At Default (EAD)

Exposure at default or is a parameter used in the calculation of economic capital

or regulatory capital under Basel II for a banking institution. It can be defined as
the gross exposure under a facility upon default of an obligor.

Outside of Basel II, the concept is sometimes known as Credit Exposure.

Two types of capital are measured:

Tier-1 capital, core funds on hand to manage losses so that a bank can continue
operating and,

Tier-2 capital, a secondary supply of funds available from the sale of assets once a
bank closes down.

The CAR or the CRAR is computed by dividing the capital of the bank with
aggregated risk-weighted assets for credit risk, operational risk, and market risk.

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This is calculated by summing a bank’s tier 1 capital and tier 2 capitals and dividing
the total by its total risk-weighted assets. That is:

Tier 1 CAR = (Eligible Tier 1 capital funds) = (Market Risk RWA + Credit Risk RWA
+ Operational Risk RWA)

Total CAR = (Eligible Total capital funds) ÷ (Credit Risk RWA + Market Risk RWA
+ Operational Risk RWA)

CAR Formula:

CAR = (Tier 1 capital + Tier 2 capital)/risk weighted assets

Note that two types of capitals are measured here.

Tier 1 capital: This can absorb the losses without a bank being required to stop
trading. Also called core capital, this consists of ordinary share capital, equity
capital, audited revenue reserves, and intangible assets. This is permanently
available capital and readily available to absorb losses incurred by a bank without
it having to cease operations.

Tier 2 capital: This can absorb losses if the bank is winding-up and so gives
depositors a lesser measure of protection. This consists of unaudited reserves,
unaudited retained earnings, and general loss reserves. This capital cushions losses
if the bank is winding up and is used to absorb losses after a bank loses all its tier
1 capital.

Risk-weighted assets: These assets are used to fix the least amount of capital that
should be possessed by banks to lower the insolvency risk. The capital requirement
for all types of bank assets depends on the risk assessment.

The CAR is decided by central banks and bank regulators to prevent commercial
banks from taking excess leverage and becoming insolvent in the process. The CAR
is important to ensure that banks have enough room to take a reasonable amount
of losses before they become insolvent and, as a result, lose depositors’ funds.

In general terms, a bank with a high CRAR/CAR is deemed safe/healthy and likely
to fulfill its financial obligations.

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When a bank is winding-up, depositors’ funds are accorded a greater priority than
the bank’s capital, so depositors will lose their savings only if a bank has a loss
higher than the capital it has. So, the higher the CAR, the greater is the protection
for depositors’ funds with the bank.

The CAR helps keep an economy’s financial system stable by ensuring that the risk
of banks going insolvent is low.

The Basel III Norms have prescribed a CAR of 8%. In India, the Reserve Bank of
India (RBI) mandates the CAR for scheduled commercial banks to be 9%, and for
public sector banks, the CAR to be maintained is 12%.

The Benefits of CRAR are as follows:

To stop commercial banks from taking on more debt and going broke, central
banks and bank regulators set the CRAR in banking,

The CAR is required to ensure that banks have sufficient breathing room to take a
reasonable loss level before declaring bankruptcy and losing depositor money.

High CRAR/CAR banks are seen as safe, healthy, and able to fulfil their financial
obligations.

Depositors will only forfeit their deposits if the bank experiences a loss bigger than
its capital, which eventually ends up since depositor funds take priority over the
total cash and cash equivalents.

Therefore, the safety offered by the bank to customers’ funds depends on how
high the CAR becomes.

By reducing the risk of bank bankruptcy, the CRAR helps keep a country’s
economic banking markets healthy.

Limitations of Using Capital Adequacy Ratio

The Capital Adequacy Ratio’s failure to account for predicted losses during a bank
run or financial crisis, which can affect a bank’s capital and money costs, is just one
of its limitations.

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Many analysts and bank executives regard the economic capital measure as a more
precise and reliable indicator of a bank’s financial soundness and risk exposure
than the adequacy ratio.

Economic capital is measured by calculating the amount of money a bank should

have to ensure it can handle its current outstanding risk. This calculation is based
on the bank’s economic stability, credit rating, expected losses, and liquidity level.

This measure is said to provide a more accurate assessment of a bank’s actual

financial risk and health level because it considers basic economic realities as
expected losses.

Risk-Weighted Assets in CRAR

Assets or off-balance-sheet assets weighted according to risk are known as risk-

weighted or RWAs. This asset calculation calculates a financial bank’s capital
requirement or Capital Adequacy Ratio (CRAR).

The Committee on Banking Supervision explains why utilizing a risk-weight

approach is the preferred methodology banks should use for capital calculation in
the Basel I accord that was released either by the Committee:

It offers a simpler way to compare banks in various regions.

Calculating capital adequacy may be ready with off exposures.

Banks are not barred from keeping fluid, low-risk assets on their records

Varying asset types usually have different risk acts provided to them.

Whether the bank has taken the standardized or IRB method underneath the
Basel II framework will affect how risk weights are computed.

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08. Importance & Application of RAROC
Risk-Adjusted Return On Capital, commonly known by its acronym RAROC, is a
risk-based profitability measurement framework for analyzing risk-adjusted
financial performance and providing a consistent view of profitability across
businesses.

The concept originated in the late 1970s as part of the broader move towards the
incorporation of risk in valuation models.

The primary purpose of RAROC is to provide a firm with a clear picture of the risks
it undertakes compared to the returns it expects to receive.

By taking into account potential risks along with anticipated returns, RAROC
allows financial institutions to better evaluate their decision-making and to make
more informed decisions regarding capital allocation and risk management.

Key Components - The RAROC model consists of three main components:

expected returns, risk adjustment, and capital allocation.

Expected Returns

This refers to the profits a firm expects to receive from a given business unit or
investment. These expected returns are typically derived from the firm's own
projections or from analyst estimates.

Risk Adjustment

Risk adjustment in RAROC accounts for the fact that higher risk should be
associated with higher expected returns. This process involves identifying and
measuring the various risks that a firm faces and then adjusting the expected
returns based on these risks.

Capital Allocation

Capital allocation involves distributing the firm's capital across its various business
units or investments based on the risk-adjusted returns of these units or
investments. In essence, RAROC encourages the allocation of capital to those areas
that provide the highest risk-adjusted return.

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Key Components of Risk Adjusted Return on Capital (RAROC)

Calculation of RAROC

Risk Adjusted Return on Capital (RAROC) vs Other Financial Metrics

Practical Application of RAROC in Financial Decision Making

RAROC has a variety of applications in financial decision making. These

applications generally fall into three main categories: capital budgeting,
performance evaluation, and risk management.

Capital Budgeting

RAROC is used to evaluate the potential profitability of different investment

options or projects. By taking into account both the expected returns and the
associated risks, it helps firms decide where to allocate their capital in order to
maximize their risk-adjusted return.

Performance Evaluation

RAROC serves as a useful metric for evaluating the performance of different

business units within a firm. Since it adjusts for risk, it allows for a more fair
comparison between units that have different risk profiles.

Risk Management

RAROC plays an important role in identifying and managing risk. By taking into
account potential losses due to risk in its calculation of return, it incentivizes firms
to manage their risks more effectively.

Benefits of RAROC

Encourages Efficient Use of Capital

By taking into account the risk-adjusted return of different business units or

investments, RAROC encourages the efficient use of capital. It incentivizes firms
to allocate their capital to those areas that provide the highest risk-adjusted
return.

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Enhances Risk Management

RAROC helps firms identify and manage their risks more effectively. By including
potential losses due to risk in its calculation of return, it pushes firms to mitigate
their risks and to make decisions that align with their risk appetite.

Provides a Holistic View of Profitability

Traditional profitability measures, such as return on investment (ROI) or return on

equity (ROE), do not take into account the risk associated with an investment or a
business unit. By adjusting for risk, RAROC provides a more holistic view of
profitability.

Drawbacks of RAROC

Complexity and Data Requirements

The calculation of RAROC can be complex and requires detailed data on both the
expected returns and the associated risks of different business units or
investments. This can make it difficult for smaller firms or those with less
sophisticated data systems to effectively implement RAROC.

Risks of Misinterpretation

If not properly understood, RAROC can lead to misinterpretation and poor

decision-making. For example, a high RAROC does not necessarily mean that a
business unit or investment is "good" – it simply means that it provides a high
return for its level of risk.

Dependence on Model Assumptions

The accuracy of RAROC depends on the accuracy of the underlying assumptions

and models used to estimate expected returns and measure risk. If these
assumptions or models are flawed, then the calculated RAROC will also be flawed.

Comparing RAROC With Other Financial Metrics

RAROC is often compared to other financial metrics, such as Return on Equity

(ROE) and Economic Capital.

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Contrast with Return on Equity (ROE)

ROE is a measure of a firm's profitability that compares net income to

shareholders' equity. Unlike RAROC, ROE does not adjust for risk.

This means that while ROE can provide a useful snapshot of a firm's profitability,
it does not provide as comprehensive a view of the firm's financial health as
RAROC does.

Differences from Economic Capital

Economic Capital is a measure of the amount of capital that a firm needs to stay
solvent and meet its obligations. It is often used in conjunction with RAROC – the
firm aims to maximize its RAROC while maintaining an adequate level of Economic
Capital.

Bottom Line

Risk-Adjusted Return On Capital is a crucial measure for financial institutions,

enabling a comprehensive view of profitability by factoring in risk.

It serves as a pivotal tool for capital allocation, performance evaluation, and risk
management. Despite its complexity and data requirements, the insights gained
from RAROC make it a valuable instrument for decision-making.

However, as it is based on model assumptions, its accuracy can be affected by

flawed inputs.

It's also vital to remember that while RAROC offers a more encompassing
perspective than traditional metrics like Return on Equity (ROE), it should be
utilized alongside other financial metrics such as Economic

Capital for a complete financial analysis. In the continuously evolving financial

industry, RAROC remains a vital element in optimizing risk-adjusted returns and
robust risk management

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Importance of RAROC

RAROC, or Risk-Adjusted Return On Capital, is a risk-based profitability

measurement framework. It's important because it allows financial institutions to
evaluate the expected returns from a business unit or investment in relation to the
level of risk involved. This helps firms make more informed decisions regarding
capital allocation and risk management.

Users of RAROC

RAROC is primarily used by financial institutions due to its focus on assessing the
risk-adjusted profitability of investments. However, any business that needs to
evaluate investments or projects based on potential returns and associated risks
can benefit from using RAROC. It helps in making informed decisions regarding
capital allocation and risk management.

Benefits of using RAROC

RAROC offers several benefits. It encourages efficient use of capital by

incentivizing firms to allocate capital to areas providing the highest risk-adjusted
returns. It enhances risk management by factoring potential risk-related losses
into its return calculations. Furthermore, by adjusting for risk, RAROC provides a
more comprehensive view of profitability than traditional measures.

Limitations of RAROC

RAROC's limitations include complexity and significant data requirements, which

can challenge smaller firms or those with less sophisticated data systems. There's
also a risk of misinterpretation if RAROC is not well understood, potentially
leading to poor decision-making. Finally, the accuracy of RAROC depends on the
underlying assumptions and models used to estimate returns and measure risk,
meaning flawed inputs lead to flawed results.

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09. Analysis of Financial Statements
Financial statement analysis involves gaining an understanding of an
organization's financial situation. The results can be used to make lending
decisions.

Financial statements (or Financial Reports) are formal records of the financial
activities and position of a business, person, or other entity. Financial Statements
represent a formal record of the financial activities of an entity. These are written
reports that quantify the financial strength, performance and liquidity of a
company. Financial Statements reflect the financial effects of business transactions
and events on the entity.

Relevant financial information is presented in a structured manner and in a form

which is easy to understand. They typically include four basic financial statements
accompanied by a management discussion and analysis.

1) A Balance Sheet, (or Statement of Financial Position), reports on a company's

Assets, Liabilities and Owners’ Equity at a given point in time. The Balance Sheet
displays the company’s assets, liabilities, and Shareholders’ Equity. As commonly
known, assets must equal liabilities plus equity. The asset section begins with Cash
and Equivalents, which should equal the balance found at the end of the Cash Flow
statement. The balance sheet then displays the changes in each major account. Net
income from the Income Statement flows into the Balance Sheet as a change in
retained earnings (adjusted for payment of Dividends )

2) An Income Statement - or Profit and Loss Account (P&L report), or Statement

of Comprehensive Income, or Statement of Revenue & Expense—reports on a
company’s Income, Expenses and Profit (or Loss) over a stated period.

A Profit and Loss Statement provides information on the operation of the

enterprise. These include sales and the various expenses incurred during the stated
period.

Often, the first place an investor or analyst will look is the income statement. The
Income Statement shows the performance of the business throughout each
period, displaying Sales Revenue at the very top.
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The statement then deducts the cost of goods sold (COGS) to find Gross Profit.
From there, the gross profit is affected by other operating expenses and income,
depending on the nature of the business, to reach Net Income at the bottom - “the
bottom line” for the business.

3) Cash Flow Statement: The cash flow statement then takes net income and
adjusts it for any non-cash expenses. Then, using changes in the balance sheet,
usage and receipt of cash is found. The cash flow statement displays the change in
cash per period, as well as the beginning balance and ending balance of cash.

Cash Flow Statement, presents the movement in cash and bank balances over a
period. The movement in cash flows is classified into the following segments:

a) Operating Activities: Represents the cash flow from primary activities of a

business.

b) Investing Activities: Represents cash flow from the purchase and sale of assets
other than inventories (e.g. purchase of a factory plant).

c) Financing Activities: Represents cash flow generated or spent on raising and

repaying share capital and debt together with the payments of interest and
dividends.

4) Statement of Changes in Equity, also known as the Statement of Retained

Earnings, details the movement in owners' equity over a period. The movement in
owners' equity is derived from the following components:

a) Net Profit (loss) during the period as reported in the Income Statement

b) Share capital issued or repaid during the period

c) Dividend payments

d) Gains or losses recognized directly in equity (e.g. revaluation surpluses)

e) Effects of a change in accounting policy or correction of accounting error

A statement of changes in equity or statement of equity, or statement of retained

earnings, reports on the changes in equity of the company over a stated period.

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For large corporations, these statements may be complex and may include an
extensive set of footnotes to the financial statements and management discussion
and analysis. The notes typically describe each item on the balance sheet, income
statement and cash flow statement in further detail. Notes to financial statements
are considered an integral part of the financial statements.

Methods of Financial Statement Analysis

There are two key methods for analysing financial statements - Horizontal Analysis
and Vertical Analysis.

Horizontal Analysis is the comparison of financial information covering a series of

reporting periods. Horizontal analysis is also known as Trend Analysis.

Vertical Analysis is the proportional analysis of a financial statement, where each

line item on a financial statement is listed as a percentage of another item. This
means that every line item on an income statement is stated as a percentage of
gross sales, while every line item on a balance sheet is stated as a percentage of
total assets.

Thus, horizontal analysis is the review of the results of multiple time periods, while
vertical analysis is the review of the proportion of accounts to each other within a
single period.

Another method for analysing financial statements is the use of many kinds of
ratios. Ratios are used to calculate the relative size of one number in relation to
another. After a ratio is calculated, you can then compare it to the same ratio
calculated for a prior period, or that is based on an industry average, to see if the
company is performing in accordance with expectations.

Problems with Financial Statement Analysis

While financial statement analysis is an excellent tool, there are several issues to
be aware of that can interfere with the interpretation of the analysis results.

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These issues are:

Comparability between periods. The company preparing the financial statements

may have changed the accounts in which it stores financial information, so that
results may differ from period to period. For example, an expense may appear in
the cost of goods sold in one period, and in administrative expenses in another
period.

Comparability between companies. An analyst frequently compares the financial

ratios of different companies in order to see how they match up against each
other. However, each company may aggregate financial information differently,
so that the results of their ratios are not really comparable. This can lead an analyst
to draw incorrect conclusions about the results of a company in comparison to its
competitors.

Operational information. Financial analysis only reviews a company's financial

information, not its operational information, so you cannot see a variety of key
indicators of future performance, such as the size of the order backlog, or changes
in warranty claims. Thus, financial analysis only presents part of the total picture.

The Basics of Balance Sheet

In this Chapter an attempt is made to explain concepts related to Balance Sheet

which may be useful for a Banker who is in initial stages of learning Banking. To
make the things easy to understand, one Sample Balance Sheet is made use of.
Care is taken not to furnish lengthy definitions which may not be useful to
Practicing Bankers.

A Balance Sheet comprises Assets, Liabilities, and Equity. The three important
sections of any balance sheet are:

Assets – Anything that has value and owned by a company

Liabilities – This provides a list of debts a company owes to others

Capital or Equity- This is the amount invested by the Shareholders

In a Balance Sheet Assets are equal to the Sum of liabilities and equity.

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Assets are the tools with the help of which , income in a business is earned.

Assets are also known as Application or Use of Funds and these have debit balance.

They are the resources of the company that have future economic value.

The Assets are grouped into current and long-term assets to reflect the ease of
liquidating each asset.

The Assets are also categorized into tangible and intangible assets.

The tangible assets are further bifurcated into current, long term and other assets,
to reflect the ease of liquidating each asset.

The non-tangible assets are trademark, copyrights, goodwill to mention a few.

Current assets include the cash, accounts receivable, prepaid expenses and all that
can be converted into cash within a year.

Long term assets are also called fixed assets and include land, buildings,
machinery, that are used in connection with the business. These are also known as
Block Assets.

Liabilities are debts owed by the business. These are claims of the creditors against
the assets of the business.

Liabilities are classified into current and long term liabilities.

Current liabilities are accounts payable, accrued expenses, taxes payable, the
current due within one year portion of long term debt and any other obligations
due within a year.

Long term liabilities are debts that must be repaid by the business in more than
one year from the date of the balance sheet.

Net worth (Owner’s Equity): Owner’s equity (called when it’s sole proprietorship)
sometimes is also referred to as the book value of the company because owner’s
equity is equal to the reported asset minus the reported liability.

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Liabilities and owners' equity: This includes all debts and obligations owed by the
business to outside creditors plus the owners' equity. Often this side of the balance
sheet is simply referred to as "liabilities."

A Banker, basically, make use of Balance Sheet to know the following important
indicators:

Liquidity Group : Current Ratio ; Quick Ratio ; NWC (Net Working Capital);
Working Capital Gap (WCG).

Solvency (or Leverage ) Group : Debt Equity Ratio; Net Worth ; TNW (Tangible Net
worth) Activity Ratios : Stock TO Ratio; Debtor Velocity Ratio; Creditor Velocity
Ratio.

As our focus is restricted to tools related working capital assessment only and we
are not going to discuss other ratios such as Profitability Ratios, DSCR etc.

The above concepts are explained in layman’s language hereunder :

Current Ratio = Current Assets / Current Liabilities

Quick Ratio (also known as Acid Test Ratio) = Quick Assets / Current Liabilities

Net Working Capital (NWC) = Current Assets – Current Liabilities

( or Long Term Funds – Long Term Uses).

Working Capital Gap = CA – CLOBB (i.e. CL other than Bank Borrowings)

Net Worth = Capital + Reserves

Tangible Net Worth = Net Worth – Intangible Assets.

Stock Turnover Ratio = Net Sales / Stock Value

Debtor Velocity Ratio : Debtors x 12 (months) / Net Sales

Creditor Velocity Ratio : .Creditors x 12 (months) / Purchases

Debt Equity Ratio (DER) : . Long Term Debt / Tangible Net worth

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A Simple Sample Balance Sheet is furnished hereunder to explain the concepts .

Liabilities Assets

Capital 300000 Land & Building 192150

General Reserve 55000 Plant & Machinery 128600

P & L Account (Credit 6750 Total Fixed Assets (after 265000

Balance) Depreciation)

Term Loan from Bank 100000 Goodwill 15000

Liability in OCC 38000 Pre-operative Expenses 15000

Creditors (for goods) 26000 Cash 250

Provision for Tax 9250 Receivables (Book-debts ) 125050

Dividend Proposed 15000 Stock (Inventory) 128200

xxxx Pre-paid expenses 1500

Total 550000 Total 550000

Other Information :

Net Sales : 15,00,000/-

Purchases : 10,50,000/-

Depreciation 55,750/-

From the above Sample Balance Sheet we have arrived at following:

Current Assets (CA) = Cash + Receivables + Stock + Pre-paid Expenses

= 250 + 125050 + 128200 + 1500 = 255000

Quick Assets (QA)= Cash + Receivables = 250 + 125050 = 125300

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Current Liabilities (CL) = OCC + Creditors + Provision for Tax + Dividend Proposed
= 38000 + 26000 + 9250 + 15000 = 88250

Current Ratio = CA / CL = 255000 / 88250 = 2.89 : 1

Quick Raio + QA / CL = 125300 / 88250 = 1.42 : 1

Net Working Capital = CA – CL = 255000 – 88250 = 166750

Current Liabilities other than Bank Borrowings (CLOBB ) = CL – Bank Borrowings

for WC = 88250 – 38000 = 50250

Working Capital Gap (WCG) = CA – CLOBB = 255000 – 50250 = 204750

Net Worth = Capital + Reserves + Credit Balance in P&L Account = 361750

Intangible Assets = Good Will + Pre-operative Expenses = 30000

TNW = Net Worth – Intangible Assets = 361750 – 30000 - 331750

Debt Equity Ratio (DER) = Long Term Debt / TNW = 100000 / 331750 = 0.30 : 1

Stock Turnover Ratio = Net Sales / Stock = 11.70 (approximately 12 times)

Debtor Velocity Ratio = Debtors / Net Sales x 12 = 1 month

Creditor Velocity Ratio = Creditors / Purchases x 12 = 26000/1000000 x 12 = 0.3

month.

Other way of arriving at NWC = Long Term Funds – Long Term Uses

Long Term Funds are also known as Long Term Sources (LTF or LTS)

LTS = Capital + Reserves + P&L Credit Balance + Term Loan

300000 + 55000 + 6750 + 100000 = 461750

LTU = Fixed Assets after Depreciation + Intangible Assets

FA after Depreciation = Land & Building + Plant & Machinery – Depreciation

192150 + 128600 – 55750 = 265000

LTU = 265000 + 30000 = 295000

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NWC arrived at using Long Term Items = LTS – LTU = 461750 – 295000 = 166750.

Though arithmetically calculating NWC using CA-CL formula correct, as Margin

represents the borrower’s own funds, it is apt if we calculate NWC using Long Term
Items. (LT Sources - LT Uses).

Please note the difference between Pre-paid Expenses and Pre-operative

Expenses. We find both these on Assets side.

Prepaid expenses are future expenses that have been paid in advance. These are
treated as Current Asset.

Preoperative expenses are those expenses incurred by a company before

commencement of commercial operations; or before starting to earn income.
These are distinct from preliminary expenses or formation expenses.

Preliminary expenses (also known as Formation Expenses) are those that are
incurred before incorporation of a company or commencement of business.

Preliminary expenses (Formation Expenses) and Pre-operative expenses are

treated as Intangible Assets.

In Balance Sheet, Though original value of Fixed Assets is furnished (this is known
as Gross Block), while computing Value of Assets, we take into account Value of
Fixed Assets after deducting Depreciation. This Depreciated Value of Fixed Assets
is known as Net Block .

In the above example, total of Land & Building (192150) and Plant & Machinery
(128600) is known as Gross Block (320750). If we deduct Depreciation (55750)
from Gross Block we get Net Block (265000) which is taken into account while
computing Balance Sheet.

Current Ratio
Current ratio is a liquidity ratio which measures a company's ability to pay its
current liabilities with cash generated from its current assets. It equals current
assets divided by current liabilities.

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Current Assets are assets that are expected to be converted to cash within normal
operating cycle, or one year.

Please note that a Vehicle used by the Firm for transporting its goods is a fixed
asset, though it is mobile (not fixed).

We have to decide whether the Asset is current or fixed basing on its usage to
particular activity. Goods Vehicle used by a Firm is Fixed Asset as it helps the Firm
in its activity.

However, the same Goods Vehicle is a current asset to Automobile Dealer who is
in the business of trading in Goods Vehicles. So to decide whether the one is
current asset or fixed asset, we have to see the purpose for which it is used in the
related activity.

Further, in some cases, where operating cycle is very long (beyond one year), the
items used in the production process are treated as Current Assets, even if cash is
not generated within one year. For example, in case of Ship Building Activity, in
some cases it may take 2 to 3 years for completing the ship building. In such cases,
we can treat all items used in the production as current assets, even if they are not
converted into cash within one year.

Current Liabilities are obligations that require settlement within normal operating
cycle or next 12 months. Examples of current liabilities include accounts payable,
salaries and wages payable, current tax payable, sales tax payable, accrued
expenses, etc. Though, working capital limits are permitted with tenability more
than one year, we have to treat them as current liability as they are payable on
demand, though tenability of the limit is more than one year.

Current ratio compares current assets with current liabilities and tells us whether
the current assets are enough to settle current liabilities. There is no single good
current ratio because ratios are most meaningful when analyzed in comparison
with the company's competitors.

Interpretation of Current Ratios

If Current Assets > Current Liabilities, then Ratio is greater than 1.0 -> a desirable
situation to be in.
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If Current Assets = Current Liabilities, then Ratio is equal to 1.0 -> Current Assets
are just enough to pay down the short term obligations.

If Current Assets < Current Liabilities, then Ratio is less than 1.0 -> a problem
situation at hand as the company does not have enough to pay for its short term
obligations.

A current ratio of 1 is safe because it means that current assets are more than
current liabilities and the company should not face any liquidity problem.

A current ratio below 1 means that current liabilities are more than current assets,
which may indicate liquidity problems. In general, higher current ratio is better.

A rising current ratio is not necessarily a good thing and a falling current ratio is
not inherently bad.

A very high current ratio may indicate existence of idle or underutilized resources
in the company. This is because most of the current assets do not earn any return
or earn a very low return as compared to long-term assets. A very high current
ratio may hurt a company’s profitability and efficiency.

Please note the following relation between Current Ratio (CR) and NWC (Net
Working Capital) :

a) When CR is 1 – NWC is zero

b) When CR is above 1 – NWC is positive.

c) When CR is less than 1 – NWC is negative.

Current ratios should be analyzed in the context of relevant industry. Some

industries for example retail, have very high current ratios. Others, for example
service providers such as accounting firms, have relatively low current ratios
because their business model is such that they do not have any significant current
assets.

It is quite possible for two companies to have same current ratios but vastly
different liquidity position for example when one company has a large amount of
obsolete inventories.

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Current Ratio does not focus on the breakup of Assets or Asset Quality.

The Current Ratio in isolation does not mean anything. It does not provide an
insight. product profitability etc.

An equal increase in both current assets and current liabilities would decrease the
ratio and likewise, an equal decrease in current assets and current liabilities would
increase the ratio

Current Ratio – Comparative Analysis

Let us discuss which of the following companies is in a better position to pay its
short term debt.

Item Company A Company B Company C

Current Assets 300 160 400

Current Liabilities 200 110 180

Current Ratio 1.50 1.45 2.22

From the above table, it is pretty clear that company C has 2.22 of Current Assets
for each 1.0 of its liabilities. Company C is more liquid and is apparently in a better
position to pay off its liabilities.

However we have to investigate further. Let us see the breakup of Current Assets
and we will try and answer the same question again.

Item Company A Company B Company C

Cash ---- 160 ----

Receivables 300 ---- ----

Inventory --- ---- --- ---- 400

Total CA 300 160 400

Current Liabilities 200 110 180

Current Ratio 1.50 1.45 2.22

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Company C has all of its current assets as Inventory. For paying the short term
debt, company C will have to move the inventory into sales and receive cash from
customers.

Inventory takes time to be converted to Cash. The typical flow will be Raw Material
inventory -> WIP Inventory -> Finished goods Inventory -> Sales Process takes
place -> Cash is received. This cycle may take a longer time. As Inventory is less
than receivables or cash, the current ratio of 2.22 does not look too great this time.

Company A, however, has all of its current assets as Receivables. For paying off
the short term debt, company A will have to recover this amount from its
customers. There is a certain risk associated with non-payments of receivables.

However, if you look at Company B now, it has all cash in its current assets. Even
though it’s Ratio is 1.45 , strictly from the short term debt repayment perspective,
it is best placed as they can immediately pay off their short term debt.

Seasonality & Current Ratio

It should not be analyzed in isolation for a specific period. We should closely

observe this ratio over a period of time – whether the ratio is showing a steady
increase or a decrease.

Current ratios should be analyzed in the context of relevant industry. Some

industries for example retail, have very high current ratios. Others, for example
service providers such as accounting firms, have relatively low current ratios
because their business model is such that they do not have any significant current
assets.

Further, it is quite possible for two companies to have same current ratios but
vastly different liquidity position for example when one company has a large
amount of obsolete inventories.

We can sum up its limitations as under :

1) It does not focus on the breakup of Assets or Asset Quality. The example that
we saw earlier Company A (all receivables), B (all cash) and C (all inventory)
provide different interpretations.

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2) This ratio in isolation does not mean anything. It does not provide an insight on
product profitability etc.

3) This ratio can be manipulated by management. An equal increase in both

current assets and current liabilities would decrease the ratio and likewise, an
equal decrease in current assets and current liabilities would increase the ratio.

A more meaningful liquidity analysis can be conducted by calculating Quick Ratio

(also called Acid-test Ratio) and Cash Ratio. These ratios remove the illiquid
current assets such as prepayments and inventories from the numerator and are a
better indicator of very liquid assets.

Debt Equity Ratio

In this Chapter, we are going to discuss Debt Equity Ratio.

DER is included under gearing ratios. Gearing ratios are a metric used to
demonstrate the funding of an entity’s operations i.e. whether it was covered
through debt or the investment made by shareholders.

This is the ratio between debt and equity. i.e., debt / equity. It indicates the
relation-ship between the loan capital and capital raised by way of equity. In the
numerator we take only Long Term Outside Liabilities as Debt.

A company's capital structure refers to how it finances its operations and growth
with different sources of funds. Capital structure is sometimes referred to as
"financial leverage"

There are two main forms or sources of capital for a capital structure: equity capital
and debt capital (loan capital).

The main difference between loan capital and equity is that the interest payable
on the loan capital has prior charge and has to be paid before any dividend can be
declared. While there can be no dividend without profits, interest may have to be
paid even if there is no profit.

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In the calculation of the ratio, debt is defined as the outside liabilities. As per the
definition, the debt would include debentures, current liabilities, and loans from
banks and financial institutions.

However, the inclusion of current liability is controversial because debt to equity

ratio is all about long-term financial solvency and current liability is a short-term
liability and the amount of current liability fluctuates far and wide over the year.
Further, current liabilities are taken care of in liquidity ratios (such short-term ratio
and quick ratio) and the interest on them is not so huge. In view of the above in
calculation of DER, Debt represents long term outside liabilities.

'Equity' refers to tangible net worth. As the debt to equity ratio expresses the
relationship between external equity (liabilities) and internal equity (stockholder’s
equity), it is also known as “external-internal equity ratio”.

If a unit has more debt and less capital, it may be in a disadvantageous position as
the servicing of loan, i.e., payment of instalments and interest, may be a problem,
in the event of its failure to earn sufficient profit.

Debt/equity ratio may misguide the potential investors as well since a low debt to
equity ratio can be a result of the company not appropriately using technology
available. This is an indication of technical inefficiency which would result in lower
returns even if the debt/equity ratio is low.

Though, the optimal debt/equity ratio is 1:1, it cannot be applied to all situations.
In respect of traders, loans from friends and relatives received on a long term basis,
subordinated to the Bank can be treated as equity.

A capital-intensive entity may have a high debt/equity ratio indicating that net
assets have been regularly maintained and financed through the debts obtained
which would increase returns in the future due to higher production.

However, a low-capital industry doesn’t need to invest in factories and types of

equipment hence its optimal ratio should be around 1:1. This is one of the major
limitations of the debt/equity ratio since it can only compare similar companies’
financial performance.

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On the other hand, if the unit obtains all its needs of long term funds by floating
equity capital, it will have no worry as there is no legal need of payment of
dividends and the capital will be repaid only in the event of the liquidation of the
unit. Conversely, the shareholders of a unit stand to gain considerably if a part of
these funds is obtained by borrowings.

Turnover Ratios
In this Chapter, we are going to discuss Turnover Ratios and other important
concepts related to Balance Sheet Analysis. Turnover Ratios are also known as
Activity Ratios.

These ratios basically measure the efficiency with which assets are being utilized
or managed. This is why they are also known as productivity ratio, efficiency ratio
or more famously as turnover ratios.

These ratios show the relationship between sales and any given asset. It will
indicate the ratio between how much a company has invested in one particular
type of group of assets and the revenue such asset is producing for the company.

The following are the different kinds of Activity Ratios that measure the
effectiveness of the funds invested and the efficiency of their performance

1) Stock Turnover Ratio and Inventory Holding Level

2) Debtors Turnover Ratio and Debtors Holding Level

3) Creditors Turnover Ratio and Creditors Holding Level

Stock Turnover Ratio :

This ratio focuses on the relationship between the cost of goods sold and average
stock. So it is also known as Inventory Turnover Ratio or Stock Velocity Ratio.

It measures how many times a company has sold and replaced its inventory during
a certain period of time.

Inventory turnover ratio is computed by dividing the cost of goods sold by average
inventory at cost. The formula/equation is given below:

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 Cost of Goods Sold
Inventory Turnover Ratio = ----------------------------
Average Inventory at cost

Two components of the formula of inventory turnover ratio are cost of goods sold
and average inventory at cost.

Cost of goods sold is equal to cost of goods manufactured (purchases for trading
company) plus opening inventory less closing inventory. Average inventory is
equal to opening balance of inventory plus closing balance of inventory divided
by two.

If cost of goods sold is not known, the net sales figure can be used as numerator
and if the opening balance of inventory is unknown, closing balance can be used
as denominator. For example if both cost of goods sold and opening inventory are
not available in the data provided, the formula would be as follows:

Inventory turnover ratio = Sales / Inventory

It allows Management to figure out their inventory reordering schedule, by

indicating when all the stock will run out. It also helps them analyze how efficiently
the stock and its reordering is being managed by the purchasing department.

The inventory holding levels measure the average length of time required to sell
inventory.

Its usefulness lies in its comparison to past years or to similar companies.

Debtors Turnover Ratio

This Ratio measures the efficiency with which Receivable are being managed.
Hence it is also known as ‘Receivable Turnover ratio’.

Definition: Debtor’s turnover ratio or accounts receivable turnover ratio or

velocity ratio indicates the velocity of debt collection of a firm.

In simple words, it indicates the speed of collection of credit sales.

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It is computed by dividing the net credit sales during a period by average
receivables.

Accounts receivable turnover ratio simply measures how many times the
receivables are collected during a particular period. It is a helpful tool to evaluate
the liquidity of receivables.

Net Credit Sales

Accounts Receivable Turnover Ratio = -----------------------------------
Average Trade Receivables (Net)

Two components of the formula are “net credit sales” and “average trade accounts
receivable”. It is clearly mentioned in the formula that the numerator should
include only credit sales. In case this information not available in the data
provided, the total sales should be used as numerator assuming all the sales are
made on credit.

Average receivables are equal to opening receivables (including notes receivables)

plus closing receivables (including notes receivables) divided by two. But
sometimes opening receivables may not be available in the data provided. In that
case closing balance of receivables should be used as denominator.

The higher the value of debtor’s turnover the more efficient is the management
of debtors or more liquid the debtors are. Similarly, low debtors turnover ratio
implies inefficient management of debtors.

Average Collection Period : Debtors Holding Level

This ratio is significant in managing the debtors of a company. This is also known
as Debtors’ Velocity Ratio and it indicates the time it takes for a business to receive
payments owed by its clients in terms of accounts receivable. Companies calculate
the average collection period to make sure they have enough cash on hand to meet
their financial obligations.

The average collection period is calculated by dividing the average balance of

accounts receivable by total net credit sales for the period and multiplying the
quotient by the number of days in the period.

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Average collection periods are most important for companies that rely heavily on
receivables for their cash flows.

The Formula to arrive at Average Collection Period is .......>

Average Book-debts
------------------------------ x 365 (for days) or (12) for months
Net Sales

Creditors Turnover Ratio (also known as Accounts Payable Turnover Ratio)

Accounts payable turnover ratio indicates the creditworthiness of the company. A

high ratio means prompt payment to suppliers for the goods purchased on credit
and a low ratio may be a sign of delayed payment.

Accounts payable turnover ratio also depends on the credit terms allowed by
suppliers.

Companies who enjoy longer credit periods allowed by creditors usually have low
ratio as compared to others.

A high ratio (prompt payment) is desirable but company should always avail the
credit facility allowed by the suppliers.

It measures the number of times, on average, the accounts payable are paid during
a period. It is calculated by using the following formula :

Net Credit Purchases

Accounts Payable Turnover Ratio = -------------------------------------
Average Accounts Payable

In above formula, numerator includes only credit purchases. But if credit purchases
are not known, the total net purchases should be used.

Average accounts payable are computed by adding opening and closing balances
of accounts payable and dividing by two. If data related to opening balance of
accounts payable is not available , the closing balance of Creditors should be used.

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Creditors’ Velocity or Creditors’ Payment Period : Average Payment Period:
Creditors Holding Level

Average Creditors
------------------------------ x 365 (for days) or (12) for months
Purchases

The Account Payable turnover ratio shows the speed at which a company pays its
suppliers.

Investors can use the accounts payable turnover ratio to determine if a company
has enough cash or revenue to meet its short-term obligations.

Creditors can use the ratio to measure whether to extend a line of credit to the
company.

A decreasing Account Payable turnover ratio indicates that a company is taking

longer to pay off its suppliers than in previous periods.

When the Account Payable Turnover Ratio is increasing, the company is paying off
suppliers at a faster rate than in previous periods. An increasing ratio means the
company has plenty of cash available to pay off its short-term debt in a timely
manner. As a result, an increasing accounts payable turnover ratio could be an
indication that the company managing its debts and cash flow effectively.

However, an increasing APT Ratio over a long period could also indicate the
company is not reinvesting back into its business, which could result in a lower
growth rate and lower earnings for the company in the long term.

Other related concepts :

By “Gross Working Capital” or “Working Capital “ we mean investment in total

current assets.

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Working Capital Gap : This represents excess of current assets over current
liabilities excluding bank borrowings. A part of the Current Assets are financed by
Current Liabilities (other than bank borrowings). The remaining portion of current
assets which requires financing is called as working capital gap. Banks do not grant
advance to the full extent of working capital gap. It is a well established rule that
the borrower has to finance a part of working capital gap out of either capital or
long term sources.

Net Working Capital : Excess of current assets over total current liabilities is known
as Net Working Capital (NWC). Further, NWC represents promoters’ contribution
in the business which is brought-in from long term sources. As such, NWC also
represents excess of Long Term Sources over Long Term Uses. It indicates the
margin or long term sources provided by the borrower for financing a part of the
current assets.

Operating Cycle or Working Capital Cycle - The process involved in the utilisation
of working capital is cyclic one. The cycle starts from getting Raw Material either
on cash basis or on credit and ends with realization of sale proceeds and make
payment to creditors.

In respect of trading concerns, operating cycle represents the period involved from
the time the goods and services are purchased and the same are sold and realised.

In the case of manufacturing concerns, it is the time involved in the purchasing of

raw materials, converting them into finished goods and the same are finally sold
and proceeds are realised.

The Basics of Profit & Loss Account

In this Chapter we are going to discuss important concepts related to Profit and
Loss Account and Profitability Ratios, which are useful for Bankers

The P&L statement is one of three financial statements , other two are Balance
Sheet and Cash Flow Statement.

The profit and loss (P&L) statement summarizes the revenues and expenses
incurred during a specified period, usually a fiscal quarter or year.

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The P&L statement is also known as Income Statement, Statement of Profit and
Loss, Statements of Operations, Statement of Financial Results or Income Earnings
Statement or Expense Statement.

This Statement provide information about a company's ability to generate profit

by increasing revenue, reducing costs, or both.

Basic elements of the profit and loss report are:

1. Revenue (Net Sales) : This entry represents the value of goods or services a
company has sold to its customers. Commonly sales are presented net of different
discounts, returns, etc.

2. Cost of Goods Sold. This element measures the total amount of expenses,
related to the product creation process, including the cost of materials, labour, etc.
Costs of goods sold include direct costs and overhead costs.

Direct costs (materials; parts of product purchased for its construction; items,
purchased for resale; labour costs; shipping costs, etc.) are the expenses that can
be actually associated with the object and its production.

Overhead costs (labour costs, equipment costs, rent costs, etc.) are the expenses
that are related to the business running process, but cannot be directly associated
with the particular object of production.

3. Gross Profit. Gross profit is net revenue excluding costs of goods sold.

4. Operating Expenses. Operating expenses include selling and administrative

expenses.

Selling expenses are the expenses, which relate to the process of generating sales
by a company, including miscellaneous advertisement expenses, sales commission,
etc. All the expenses connected with company’s operation administration, such as
salaries of the office employees, insurance, etc., refer to the administrative
expenses.

5. Operating Income Operating income is gross profit excluding operating

expenses.

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6. Other income or expense. This entry contains all the other income or expense
values that weren’t included to any of the previous entries. It may be dividends,
interest income, interest expense, net losses on derivatives, etc.

7. Income Before Income Taxes. Income before income taxes is operating income
including (or excluding) other income or expense.

8. Income Taxes. This entry includes all state and local taxes, which are based on
the reported profit of an enterprise.

9. Net Income. Net income is the amount of money remaining after taking the net
sales of a business and excluding all the expenses, taxes depreciation and other
costs. In other words, this entry reflects the basic goal of an enterprise functioning
– its profit. It is also often referred as net profit or net earnings.

Interpretation of Profitability Ratios :

The income statement of the firm contains information that can be used for
computation of certain financial ratios, which measure firm’s performance and
position over the reporting period. Depending on the ratio, it can be a measure of
firm’s profitability or financial sustainability.

There are two types of profit ratios viz., gross profit and net profit ratio.

Gross Profit
GP Ratio = --------------------
Net Sales

Gross Profit = Sales - Cost of goods sold

When gross profit ratio is expressed in percentage form, it is known as gross profit
margin or gross profit percentage. The formula of gross profit margin or
percentage is given below:

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 Gross Profit
GP Margin = -------------------- x 100
Net Sales

This indicates the efficiency and competence with which the unit is being
managed. A high GP ratio implies that the cost of production is relatively low and
margin of profit consequently high.

GP ratio may increase due to the following :

a. A higher sale price while cost of production remaining constant.

b. Lower cost of goods sold while sale price remaining constant.

GP ratio may decline due to the following :

a. Fall in prices of products

b. Increase in input costs not compensated by matching price increase

c. Decline in efficiency in production

d. Idle capacity

Net Profit Ratio also known as Net Profit Margin ratio, it establishes a relationship
between net profit earned and net revenue generated from operations (net sales).

Net profit ratio is a profitability ratio which is expressed as a percentage hence it

is multiplied by 100.

Net Profit
Net Profit Margin = -------------------- x 100
Net Sale

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Net Profit = Operating Income – (Direct Costs + Indirect Costs)

Net Sales = (Cash Sales + Credit Sales) – Sales Returns

This ratio is the main indicator of a firm’s profitability, a trend analysis is usually
done between two different accounting periods to assess improvement or
deterioration of operations.

High – A high ratio may indicate low direct and indirect costs which will result in
a higher net profit of the organization. This ratio is the overall measure of the
firm's ability to turn each rupee of sales into profit.

A firm with a high net profit ratio would be in an advantageous position in the
face of fall in sale prices, rise in cost of production or decline in the demand for
the product as it would be able to absorb the market fluctuation to a certain
extent.

Low – A low ratio may indicate unnecessarily high direct and indirect costs which
will result in a lower net profit of the organization, thus reducing the numerator
to lower than the desired number.

The following contribute to a decline in net profit ratio :

(a) The incidence of fixed costs may lead to a decline in profit when turnover falls.

(b) Expenses not entirely pertaining to current year (c) Presence of idle assets,
accumulated inventory, debtors posing difficult of realization. (d) Expenses not
resulting in revenue.

(c ) Lack of control over fixed assets.

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I am furnishing a Sample P & L Account to explain above concepts.

Sample P & L Account

Operating Revenue

Product sales 12,000

Service sales 4,000

Sales Returns 1,000

Total Operating Income (Net Sales) (Total Sales – Sales Returns) 15,000

Operating Expenses

Cost of goods sold 7,000

Gross Profit (Net Sales - COGS) 8,000

Overhead

Rent 1,500

Insurance 250

Office supplies 150

Utilities 100

Total Overhead 2,000

Operating Income (GP-Overheads) 6,000

Other Income (Add) 500

Other Expenes – Interest on Loan (Deduct) 1000

Earnings Before Income Taxes 5,500

Income Taxes (Deduct) 500

Net Profit 5,000

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From the above data we calculate GP Ratio and NP Ratio hereunder :

Gross Profit = Net Sales - COGS

Gross Profit 8000

GP Ratio = --------------------- x 100 = ---------------- x 100 = 53.33 %
Net Sales 15000

Net Profit 5000

NP Ratio = --------------------- x 100 = ---------------- x 100 = 33.33 %
Net Sales 15000

Operating Income = GP – Overheads (also known as Operating Expenses)

Operating Expenses include wages & salaries, utilities such as power, water,
logistics, Rent, depreciation.

Net Profit = Operating Income – Interest – Taxes

P&L management refers to how a company handles its P&L statement through
revenue and cost management.

DSCR
In this Chapter we are going to discuss “DSCR” (Debt Service Coverage Ratio) or
simply DCR (Debt Coverage Ratio). We make use this Ratio in the Appraisal of
Term Loans.

DSCR is a ratio of cash available to cash required for debt servicing. In other words,
it is the ratio of the sufficiency of cash to repay the debt. It measures a company’s
ability to service its current debts by comparing its net operating income with its
total debt service obligations.

This ratio indicates whether the earnings are adequate to meet the burden of fixed
financial charges. A borrowing concern is required to pay interest on the loan as
also to pay the stipulated instalments. It must, therefore, have sufficient earnings
to enable it to meet these financial commitments.

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Calculation of DSCR is very simple. Debt service coverage ratio is calculated as
follows :

Net profit after tax + depreciation + interest on term loans

DSCR = --------------------------------------------------------------------------
interest on term loans + principal repayment instalment

To calculate this ratio, following items from the financial statement are required:

Profit after tax (PAT)

Noncash expenses (e.g. Depreciation, Miscellaneous expenses are written

off etc.)

Interest for the current year

Instalment for the current year

Lease Rental for the current year

Sometimes, these figures are readily available but at times, they are to be
determined using the financial statements of the company/firm.

Profit after tax (PAT)

PAT is generally available readily on the face of the Profit and loss account. It is
the balance of the profit and loss account which is transferred to the reserve and
surplus fund of the business. Sometimes, in an absence of the profit and loss
statement, we can also find it on the Balance Sheet by subtracting the current year
P/L account from the previous year’s balance, which is readily available under the
head of reserve & surplus.

Interest

The amount which is payable for the financial year under concern on the loan is
taken.

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Noncash expenses

Noncash expenses are those expenses which are charged to the profit and loss
account for which payment has already been done in the past years. Following are
the noncash expenses:

a) Writing off of preliminary expenses, pre-operative expenses etc,

b) Depreciation on the fixed assets.

c) Amortization of the intangible assets like goodwill , trademark, patent ,

copyright etc,

d) Provisions for doubtful debts,

e) Deferment of expenses like an advertisement, promotion etc.

Depreciation is added back to the operating profit in the funds flow analysis in
order to arrive at true funds from operations or real funds from operations.
Depreciation is a noncash charge and it does not reflect any actual out go of funds.
It is generally entered in the books in order to satisfy certain accounting
conventions and sometimes to provide for replacement of the assets. Since
depreciation does not reflect any actual outgo of funds it is added back to the
operating profit in order to arrive at the real funds from operation.

This would apply to any other non-cash charge debited before the operating profit
stage.

Principal amount - It is the amount payable on the loan for the financial year under
review. It includes the payment towards principal for the financial year.

Lease Rental - The amount of lease rent paid or payable for the financial year.

Interpretation of Debt Service Coverage Ratio - The result of a debt service

coverage ratio is an absolute figure. Higher this figure better is the debt serving
capacity.

If the ratio is less than 1, it is considered bad because it simply indicates that the
cash of the firm are not sufficient to service its debt obligations.

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The acceptable norm for a debt service coverage ratio is between 1.5 to 2.

Net DSCR

While calculating Gross DSCR (or simply DSCR) we are taking into account only
Operating Expenses and not taking Other Expenses into account. Unless we take
into account Other Expenses, the repayment ability may not be known correctly if
we take only Gross DSCR while appraising the proposal. In this context Net DSCR
help us.

Net DSCR indicates whether the entity would generate sufficient cashflows after
taking into account its other expenses also to service its debt.

Net DSCR = Revenue / Debt Service

A net DSCR > 1 shows that the entity is self sufficient whereas a net DSCR < 1
indicates that the entity cannot service its debt.

Gross DSCR = (Revenue - Operating Expenses) / Debt Service

While calculating Gross DSCR we are adding back Depreciation as it is a Non Cash
Charge. However, in the calculation of Net DSCR we are not taking Depreciation
so that we will be knowing correct cash inflow.

The gross DSCR only focuses on the ability of the entity to service its debt based
on its revenue generation potential.

Some entities may have significant revenue generation potential but may also
incur a large amount of other expenses - they would have a healthy gross DSCR
but a poor net DSCR.

Funds Flow Statement & Cash Flow Statement

Funds flow analysis is aimed at identifying the various sources and uses of funds.
It helps in analyzing the interaction between short term and long term funds.

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The following example may be useful to explain the concept :

Asset or Liability 2019 2020 Change

Capital 100 120 +20

Reserves 50 60 +10

Term Loan 50 40 -10

Creditors 10 10 ---

Cash Credit 100 130 +30

Total 310 360 50

Fixed Assets 100 90 -10

Investments 50 60 +10

Goodwill 5 5 ---

Stocks 80 110 +30

Book debts 65 85 +20

Cash 10 10 --

Total 310 360 50

The above table is prepared based on Balance Sheets of two years (i.e 2019 and
2020).

Increase in Reserves is due to profit earned and decrease in Fixed Assets is due to
depreciation. Decrease in Term Loan is due to repayment of instalments.

It compares the two balance sheets by analyzing the sources of funds (debt and
equity capital) and the application of funds (assets).

It helps to understand where the money has been spent and from where the money
is received.

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From the above data, the following funds flow statement is prepared.

Sources – Change in Long Term Sources

Increase in Capital 20

Net Profit 10

Depreciation 10

Change in Short Term Sources

Increase in Working Capital 30

Total Change in Sources 70

Uses – Change in LT Uses

Increase in Investments 10

Decrease in Term Loan 10

Change in ST Uses

Increase in Stocks 30

Increase in Book debts 20

Total Change in Uses 70

Increase in ST Sources 30

Increase in ST Uses 50

Change in Working Capital (-) 20

Analysis of movement of funds :

In order to find out changes in the funds flow pattern comparison of a minimum
of two financial statements is to be done. Any increase in a liability item would be
a source of funds and any increase in asset would represent use of funds. Any
decrease in liability would be a use and decrease in assets would be a source.

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For example, if sundry debtors have decreased between the dates of two balance
sheets it means that sundry debtors have been collected and therefore it is a
source. Similarly if sundry creditors have decreased between the dates of two
balance sheets, it means that the sundry creditors have been paid off which would
mean that the resources have been utilized i.e. a use.

The long term sources and uses are identified/bifurcated. If the long term sources
are found to be more than long term uses, it shows that the excess or difference
has gone to short term uses.

Where the short term sources are found to be more than the short term uses and
the difference being utilized for long term uses, this state would lead to a decline
in the current ratio and a decline in the net working capital. If a portion of the
current liabilities (short term source) is diverted to long term uses (investment in
fixed or non current assets), it would result in current liabilities going up, while
the current assets do not increase proportionately. This would mean a reduction
in working capital. Hence, whenever there is a diversion, there is a reduction in the
net working capital.

In the above example, ST Uses are more than the ST Sources and the shortfall is
20, which is compensated by LT Sources. As a Banker we accept such situation. If
the reverse position is observed (where ST Sources are more than ST Uses) it
implies that the Firm is making use of ST Sources to met LT Uses, which is not
acceptable to Banker as this situation may lead to Liquidity Crunch in near future
and once the Firm faces Liquidity Shortage, it is very difficult to come out of this
Liquidity Trap.

If the long-term source is not increased during the period and term liability is
reduced or non-current assets are increased it indicates that short-term source is
utilized for long term source. In bankers parlance using short-term source for long
term use is the diversion of funds which has the dire consequence towards the
operation of the entity.

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Bankers, normally, analyse Funds Flow Statement to see whether the Firm has
resorted to divert Short Term Funds to meet Long Term Uses. If such situation is
observed Banker has to initiate corrective steps.

Funds flow analysis is also useful in determining whether the unit has adopted a
wise policy in the matter of raising funds from various sources and whether the
funds so obtained are properly deployed.

Difference between Funds Flow and Cash Flow :

The Cash Flow Statement is prepared on a cash basis, whereas , The Fund Flow
Statement is prepared on an accrual basis. Funds flow would take into account all
the changes in the pattern of economic resources, whereas, a cash flow statement
would represent only the effect of cash transactions.

For example, One Individual has supplied machinery with a condition that the Sale
consideration of the said machinery will be paid to him by way of Share Capital in
the Firm. In the Balance Sheet of the Firm (who had purchased machinery) the
machinery representing an increase in assets would appear as a long term use and
capital would appear as a long term source in a funds flow statement. In a cash
flow statement this should not figure on either side because no transaction has
taken place in cash.

Basically, any change in the assets and liabilities may result in the inflows and
outflows of funds, but not always, as in case of depreciation or revaluation of
assets, there is no inflow or outflow of funds. Hence, only those assets or liabilities
will become a part of the statement, which actually leads to the flows of the fund
to/from the business.

Funds flow statement is also called by various other names such as “Sources and
Application of Funds”; “Where came in and Where gone out Statement”; “Where
got, Where gone Statement” ; “Movement of Funds Statement”; “Funds Generated
and Expended Statement”; etc.

For the purpose of appraisal of a term loan proposal, an analysis of funds flow is
made, as the funds flow takes into account all transactions whether they represent
cash transactions or not.

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Financial Statements – Residual Concepts
The following concepts are to be understood to analyse Financial Statements in a
proper way.

1. Return on Equity. (RoE)

2. Return on Investment (or Capital Employed - ROCE) (RoI)

3. Operating Profit Ratio

4. Fixed Asset Coverage Ratio.(FACR)

5. Loan Life Ratio.

Return on Equity (ROE) : is a measure of financial performance.

ROE is expressed as a percentage and is calculated as under:

Net Profit
Return on Equity = -------------------------------- x 100
Tangible Net Worth

Return on Investment (ROI) (aka ROCE) is the ratio of a profit or loss made in a
fiscal year expressed in terms of an investment. It is expressed in terms of a
percentage of increase or decrease in the value of the investment during the year
in question.

For example, if you invested Rs 100 in a share of stock and its value rises to Rs 110
by the end of the fiscal year, the return on the investment is a healthy 10%,
assuming no dividends were paid.

Net Profit
Return on Investment = ------------------------- x 100
Total Investment

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RoI vs RoE

Although both the metrics define the health of investment, result of both might
not always go in the same direction. It is possible that a company might have
higher ROE but poor ROI or vice versa. The main difference is Debt is included
while arriving at Return on Investment (ROI) and whereas outside debt is not taken
into account while calculating Return on Equity

(ROE).

Operating Profit Ratio : This Ratio indicates the margin of profit on the main
operations revealing the operational efficiency of the Unit. The Ratio is calculated
to see that the main activity remains viable for long time, as under

Operating Profit
Operating Profit Ratio = ----------------------------- x 100
Net Sales

Fixed Assets Coverage Ratio (FACR)

The asset coverage ratio determines a company’s capacity to pay its debt through
its assets.

The ratio indicates specifically how much of these assets will be needed for the
company to settle its debts.

To what extent do fixed assets provide protection for long term creditors is
assessed by calculating this ratio.

Net fixed assets (i.e., after providing for depreciation)

FACR = --------------- -------------------------------------------------------
Long term debts secured by fixed assets.

This ratio indicates number of times the value of fixed assets covers the amount
of the loan. Generally the ratio should be 1.33 : 1.

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Loan Life Ratio (LLR) (also known as Loan Life Coverage ratio (LLCR))

LLCR is similar to the Debt Service Coverage Ratio (DSCR), but it is more commonly
used in project financing because of its long-term nature. The DSCR captures a
single point in time, whereas the LLCR addresses the entire span of the loan.

Loan Life Ratio is a concept which is used in project financing activity.

Loan Life Ratio is a concept which is used internationally in project financing

activity. The ratio is based on the Available Cash Flow (ACF) and present value
principle.

Present value of Available Cash Flow during loan life period

LLR =------------------------------------------------------------------------
Maximum amount of Loan

The present value of available cash flow is arrived by discounting the annual cash
surplus (cash profit before interest) at a discount rate equal to weighted average
cost of borrowing, post restructuring.

LLR can be used to arrive at the sustainable debt in a restructuring exercise. A

benchmark LLR of 1.25, which would give a sufficient cushion to the amount of
loan to be serviced, may be considered.

Purpose of Analysis will be served only if the all the related statements are studied
(Balance Sheet, P&L Account and Funds Flow Statements) together. Further, the
results are to be compared with previous years’ results and also with that of
Industry. Then only One can arrive at correct decisions. Studying each Ratio
separately excluding other terms, may not yield desired results

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10. Non-financial Risk Analysis & Macroeconomic Factors
Financial risks originate from financial markets and might arise from changes in
share prices or interest rates.

Non-financial risks emanate from outside the financial market environment and
could be consequences of environmental or regulatory changes or an issue with
customers or suppliers.

Financial Risk

The three primary types of financial risks are:

Market Risk

Market risk arises from movements within the financial market environment. Such
movements include shifts in share prices, interest rates, exchange rates,
commodity prices, and other economic or industry market factors.

Currency risk is a form of market risk. It affects investors or companies that

operate across different countries. Currency risk arises due to a change in the value
of one currency relative to another. For instance, a non-US company that imports
some of its raw materials from the US will be affected by currency risk, i.e., a
change in the dollar relative to the company’s domestic currency will affect the
quantity of raw materials imported, thereby affecting the company’s value.

Credit Risk

Credit risk is the risk of loss due to the failure of one party to pay the other an
outstanding obligation. Credit risk may be defined as default risk or counterparty
risk. Defaults and bankruptcies have long-term implications for borrowers and
may be irrecoverable.

Liquidity Risk

Liquidity risk is the risk of a severe downward price revision when attempting to
sell a particular asset. In stressed market conditions, the seller may have to accept
a price well below their perception of value.

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Within financial markets, the typical transaction cost is measured by the bid-ask
spread, where the selling price is less than the buying price. When there is
uncertainty in the bid-ask spread, for example, if the spread widens significantly
during a stressful market period, it means the liquidation price (selling price) is far
lower than the seller believes it should be, and this creates a liquidity risk. Liquidity
risk does not just pertain to illiquid assets; market liquidity varies over time for
particular assets, and the size of the position and the uncertainty associated with
its sale or liquidation increases simultaneously.

Non-Financial Risk

There are a number of non-financial risks that an organization may face:

Settlement Risk

Closely related to default risk, it is the risk around the timing of payments between
counterparties. For example, while one party may observe the agreement of a
currency swap, the other party may not.

Legal Risk

This is the risk of being sued, particularly in litigious environments, or the risk that
a counterparty will not uphold a contractual obligation.

Compliance Risk

Compliance risk is made up of regulatory risk, accounting risk, and tax risk. An
update of laws and regulations may create the need for financial restatements,
back taxes, or other penalties.

Model Risk

This is the risk of valuation error when the valuation of a particular security is
based on a mis-specified price model.

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Tail Risk

The likelihood or probability of a material negative outcome is often understated

in financial models, and it is, in most cases, related to model risk. Financial markets
do not follow a normal distribution of returns but tend to have “fat tails.” In case
the internally selected model does not account for this, tail risk is introduced.

Operational Risk

This risk is related to the people and processes of an organization. The employees
of an organization can make errors that are financially costly or act fraudulently
due to a lack of proper oversight and control. Companies may also be subject to
business interruptions attributable to natural calamities or terrorism.

Solvency Risk

A company may not survive if it runs out of cash and becomes insolvent. In times
of solvency pressure, a company may be forced to liquidate assets at unfavorable
prices simply to raise the necessary cash. Solvency risk can easily be mitigated by
making use of less leverage, using more stable sources of funding, and
incorporating solvency measures at the governance level of the business.

Interactions Between Risks

There are numerous interactions between risks – both financial and non-financial
– and these interactions become more pronounced during times of market stress.
The combined risk is often far more than the “sum of the parts” in the sense that
risks may exacerbate one another to drive up the total enterprise risk.

An example of risk interactions may be the failure of a key counterparty to settle

an obligation on time. Settlement risk creates a solvency risk for the company
which was due to receive the proceeds. In turn, it may not be able to pay its
suppliers, which occasions legal risk. Or, it may not meet regulatory solvency
requirements, which creates compliance risk. It may also need to rapidly sell assets
to raise cash hence creating a liquidity risk.

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Often, risk models do not adequately account for risk interactions and understate
the overall risk. The governance board, company management, and financial
analysts should be aware of how consequential a combination of risks can be. This
awareness should motivate them to adopt holistic approach to risk management
instead of treating each risk in isolation.

Non-Financial Risks (NFR) emanate from outside the financial market environment
and could be consequences of environmental or regulatory changes or an issue
with customers or suppliers.

The latest focus in risk management seems to be "non-financial risk (NFR)".

NFR is a broad term that is usually defined by exclusion, that is, any risks other
than the traditional financial risks of market, credit, and liquidity.

Risk is the effect of uncertainty on objectives.

Risk is made up of three main parts

Impacts/consequences: This is the "effect" on objectives

Causes: These are the root causes of the risk.

Events: These are things that occur between the causes and the impacts.

If we focus on risk impacts first, these should be defined based on the objectives
of the organisation. For most organisations, they would typically include such
things as:

Profit (revenue and expense)

Financial stability (capital levels and cash-flow)
Stakeholder satisfaction (customer, supplier, employee, etc)
Employee safety and well-being
Compliance with regulatory and contractual obligations
Protection and enhancement of reputation and brand
Protection and enhancement of the environment
Protection and enhancement of society (corporate social responsibility - CSR)

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This usually reduces to a number of identified risk impacts typically including:

Financial (profitability and cash-flow); Customer; Employee; Environment; Legal

and compliance breaches; Reputation and brand ; CSR.

A typical classification of risk events at board level may include - Market risk;
Liquidity and funding risk; Credit risk ; Human resource risk (quality and quantity);
Culture and conduct risk; IT risk; Loss of confidential data and IP, including cyber;
Business disruption; Fraud; Legal and compliance; Infrastructure and physical
assets; Strategic, project and change risk.

At the highest level, these typically come back to four main causes, being – People;
Inadequate process; Systems and External events

From these taxonomies of Causes, Events, and Impacts, combinations will define
each tailored risk that the organisation faces. A common way of representing this
is using risk bow tie analysis:

The most risk causes and events will impact many, if not, all impact types including
financial impacts.

Virtually every risk has the potential for a financial impact. The truth is that all risk
ultimately has financial consequences.

Financial Risk covers market, credit and liquidity in the risk event taxonomy noted
above.

The rest must be examples of non-financial risks. Using a positive definition, "non-
financial risk" therefore covers Human resource risk (quality and quantity); Culture
and conduct risk; IT risk; Loss of confidential data and IP, including cyber; Business
disruption; Fraud; Legal and compliance; Infrastructure and physical assets;
Strategic, project and change risk.

Non-financial risk is operational and strategic risk

These can be summarised as operational risk (including HR, culture & conduct, IT,
data & cyber, business disruption, fraud, legal & compliance, assets, and
infrastructure), and strategic risk.

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Non-financial risks are risks other than those managed directly by the finance
department (or equivalent) being Market, Credit and Liquidity (and for an
insurance company, insurance Risk).

When we are talking about non-financial risk, be clear that we are talking about
operational and strategic risk.

Operational and Strategic are more difficult to manage compared to the "financial
risks". This is because for operational and strategic risk - there is less risk data
available and as a result, the use of quantitative techniques to measure the risk is
made more difficult. If you can’t measure it, it’s more difficult to manage. This
makes the risks more qualitative in nature and measurement.

The disciplines of operational risk management and strategic risk management are
younger and much less mature than for the "financial" risks.

Unlike financial risks, non-financial risks are not managed by a centralised team
but rather a broad range of front-line staff across every business area.

Non-financial risks (NFR) are all of the risks which are not covered by traditional
financial risk management. This negative definition resembles the initial definition
of operational risk, and it depends on the bank or corporation whether or not they
use the term operational risk synchronously with NFR. Since 2019, the new term
NFR became popular in the risk management sector.

Examples

Non-financial risks include:

Operational risk (Op risk). In case that Op risk is considered a part of NFR (and not
as equivalent), Op risk summarizes e.g. those risks which can be quantified by the
use of scenario models. Examples are pandemics, floods and other weather events.

Conduct risk means that the behaviour of the cooperation's employees leads to
losses

Cyber risk and IT risk are possible losses due to security breaches.

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Compliance risks are risks related to Governance, risk management, and
compliance. Managing the compliance risk means putting a price tag on potential
failures of adhering to self-given rules of the bank as well as Regulatory
compliance.

Regulatory risk are possible losses due to changes of the law and regulations.

Reputational Risk is potential loss caused by the damage to a firm's reputation.

All these risk types are closely related. In the case of a data leak (which is a cyber
risk incident), the reputation of the company as a whole might be at stake.

Environmental Risk is another NFR. Example is recent Covid 19. Environmental Risk
is the probability and consequence of an unwanted accident. Because of
deficiencies in waste management, waste transport, and waste treatment and
disposal, several pollutants are released into the environment, which cause serious
threats to human health along their way.

NFR and Macro Economic Factors

A Macroeconomic Factor is a phenomenon, pattern, or condition that emanates

from, or relates to, a large aspect of an economy rather than to a particular
population. Inflation, gross domestic product (GDP), national income, and
unemployment levels are examples of macroeconomic factors.

Though an individual firm can control its Financial Risks to some extent, it may
not control NFR as these are influenced by Government or RBI and sometimes
Global conditions. Macro Economic factors influence NFR very heavily.

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11. Project Appraisal/Term Loan Appraisal
Concepts related to Term Loan Appraisal.

To study aspects related to a project finance we need Operating Statement (also

known as Cost of production and profitability statement).

An operating statement is a statement showing the quantum of profit that would

be earned and how the same is generated. Also we need Cash Flow & Funds Flow
statements for entire period.

By studying the projected cost of production and profitability statement, it is

possible to know when and at which level the unit will break even. If there is
sufficient operating profit it helps the bank to decide whether there is adequate
debt paying capacity year by year as and when the production is stepped up.

I have explained the following concepts in Chapter No 3 and 9. To avoid

duplication I am not going to explain again in this chapter.

Debt to Equity Ratio

DSCR – Debt Service Coverage Ratio

Promoter’s Contribution vs

Margin

FACR – Fixed Asset Coverage Ratio

Profitability Ratios

Loan Life Ratio (LLR) (also known as Loan Life Coverage ratio (LLCR))

PERT/CPM

Capital Budgeting Techniques

Since the investment in any project will be huge and will have a long-term effect,
an organization uses a combination of various techniques of capital budgeting like
NPV, IRR and payback period to select the best project.

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Net Present Value (NPV)

Net Present Value (NPV) is a method used to determine the current value of all
future cash flows generated by a project, including the initial capital investment.
It is widely used in Capital Budgeting to establish which projects are likely to earn
more profit.

Accept a project only if its NPV is positive.

Reject it if its NPV is negative.

Accept the project with higher NPV.

Internal Rate of Return (IRR)

Capital budgeting is a function of management, which uses various techniques to

assist in decision making. Internal Rate of Return (IRR) is one technique of capital
budgeting. It is the rate of return at which the net present value of a project
becomes zero. They call it ‘internal’ because it does not take any external factor
(like inflation) into consideration.

The Internal Rate of Return (IRR) is a discounting cash flow technique which gives
a rate of return earned by a project. The internal rate of return is the discounting
rate where the total of initial cash outlay and discounted cash inflows are equal to
zero. In other words, it is the discounting rate at which the Net Present Value (NPV)
is equal to zero.

The rate at which the cost of investment and the present value of future cash flows
match will be considered as the ideal rate of return. A project that can achieve this
is a profitable project. In other words, at this rate the cash outflows and the present
value of inflows are equal, making the project attractive.

Payback Period

Payback period is the time required to recover the initial cost of an investment. It
is the number of years it would take to get back the initial investment made for a
project.

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Therefore, as a technique of capital budgeting, the payback period will be used to
compare projects and derive the number of years it takes to get back the initial
investment. The project with the least number of years usually is selected.

Break Even Point

The break-even point indicates the volume of sales which the unit must achieve in
order to cover its total costs.

Break-even point is calculated as follows : Example :

Sales 100 units // Selling price per unit Rs 6/-

Variable cost per unit Rs 4/- // Fixed costs Rs 150/-

Then, the break-even point should be arrived as follows:

Selling price per unit Rs 6/-

Variable cost per unit Rs 4/-

Contribution is difference of Selling Price (SP) and Variable Cost (VC). It is also
known as Marginal Income.

Contribution or marginal income (SP – VC) Rs 2/- is derived from one unit.

Therefore, contribution of Rs 150/- will be derived from 50/2.i.e.,75 units.

Break-even volume of sales is 75 units.

Break-even amount of sales is 75 x Rs 6 = Rs 450/-.

Fixed cost x sales

Sales (BEP) (In terms of amount) = ----------------------------
Sales - marginal costs

Fixed cost
BEP (in terms of volume) = ----------------------
Sales - marginal costs

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The costs are recovered from contribution of each unit. If the unit sells 50 units
only it recovers Rs 100 towards fixed costs and thereby incurs a net loss of Rs 50.

If it sells is only 75 units, it recovers the entire cost and the net working results at
this stage is neither profit nor loss.

Margin of safety is the percentage of excess sales over those at the break-even
point to the actual sales. It indicates as to what extent the sales may decline before
the unit starts incurring losses.

Return on Capital Employed (ROCE)

This ratio computes percentage return in the company on the funds invested in
the business by its owners. A high ratio represents better the company is.

Net Operating Profit

ROCE = --------------------------------- x 100
Capital Employed

Capital Employed = Equity share capital, Reserve and Surplus, Debentures and
long-term Loans

Capital Employed = Total Assets – Current Liability

Return on Assets (ROA)

This ratio measures the earning per rupee of assets invested in the company. A
high ratio represents better the company is.

Net Profit
ROA = -------------------------
Total Assets

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Return on Investment (ROI) (aka Earning Power Ratio) is a technique that is widely
used to measure the return from an investment. ROI is a simple ratio of the gain
from an investment relative to its cost.

Net Return on Investment

ROI = ---------------------------------------------- ×100%
Cost of Investment

The ROI calculation has "net return" rather than "net profit or gain" in the
numerator. This is because returns from an investment can often be negative
instead of positive.

Project Evaluation and Review Technique / Critical Path Method (PERT / CPM)

The functioning of planning, scheduling and controlling are essential for execution
of a project. The Project Evaluation and Review Technique, abbreviated as PERT
or Critical Path Method, abbreviated as CPM helps the management in performing
all these functions more efficiently.

PERT / CPM is a method of budgeting and scheduling resources so as to

accomplish a predetermined job. It provides a communication facility in the sense
that it can report developments both favourable and unfavourable to managers
and thus keep them posted and informed.

PERT / CPM is based on a simple concept called the `Network Logic'. The network
is drawn taking into account the sequencing and interdependence of various
activities that constitute the project. Such a network, then, becomes the basis for
planning and controlling the project.

PERT / CPM is concerned with two concepts - Event : (a) An event is a specific
accomplishment that occurs at a recognizable point in time. An 'Event' is an
accomplishment occurring at an instantaneous point in time but requiring none of
the resources itself. (b) Activity : An activity is the work required to complete a
specified event. An 'Activity' is a recognizable part of a project that requires
resources for its completion and it is defined by its beginning and ending events.

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12. Credit Risk Analytics & Credit Scoring Models
Credit Analyst conduct thorough analysis of financial statements and assessment
of credit requests, including new requests, changed requests, refinancing and
annual due diligence

Provide recommendations tied to analysis and assessment of credit risk Present

analysis, findings, and recommendations to managers, especially findings that
involve a borrower’s ability to repay Keep up to date with the company’s lending
protocols

Reconcile credit files and identify discrepancies and variances

Develop and prepare spreadsheets and models to support analysis of new and
existing credit applications

Credit analysis is a very particular area revolving around a firm’s financial risk
analysis. The procedure involves evaluating the risks that businesses involved in
loan financing are likely to experience by initiating background research on the
retail or commercial customer. In other words, a financier must perform due
diligence on rating the credit of the borrower.

A credit analyst is responsible for several tasks, which include providing guidance
on credit risks related to lending programs that involve massive amounts of
money. A bank, for example, will hire a credit analyst to help assess the different
firms and individuals it can offer loans to and, thus, generate a return on their cash
assets.

The following are just a few types of documents that credit analysts take
information from:

Annual reports

Financial statements

Profit and loss statements

Other critical components in credit analysis, aside from the direct analysis of
company performance, are:

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A credit analyst usually has at least a bachelor’s degree, with a background in
finance, accounting or other related fields. A solid financial background is
important for acquainting credit analysts with ratio analysis, financial statement
analysis, risk assessment, and economics. Naturally, a working knowledge of
accounting principles and financial techniques also comes in handy.

Credit Scoring Models

Availing of credit becomes easy when you have a good credit score. Your credit
score is a three-digit number between 300 and 900 that indicates a borrower’s
creditworthiness and repayment capacity. The higher a borrower’s credit score,
the better their chances of getting approved for a loan quickly as well as getting
it on beneficial terms and conditions.

In India, most lenders require borrowers to have a credit score of 750 or above to
be eligible for a loan.

Four credit information agencies are authorized by the Reserve Bank of India to
collect information on borrowers and how they use credit and assign credit ratings
or scores based on this information.

These credit rating agencies or credit information bureaus are Experian, Equifax,
CRIF Highmark and TransUnion CIBIL. Every credit information bureau works
closely with lenders and other financial institutions. However, every credit rating
agency also uses a different credit score model.

The improved access to diverse data sources paired with higher computing power
has changed the way lenders assess borrowers. Over time, credit scoring models
have become sophisticated, evolving from conventional statistical techniques
involving regression and discriminant analysis to artificial intelligence (AI) and
machine learning (ML)-led models.

Even the application of credit scores—the primary determinant of a borrower’s

creditworthiness–has expanded beyond the decision-making of extending a loan;
financial institutions factor in credit scores to price their financial products and
services, solicit prospective customers, determine minimum capital maintenance
requirements, and enhance relationship management.

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The advent of fin-techs, the greater demand for anytime, anywhere finance, and
the need for enhanced credit access have amplified the variety of credit scoring
models, resulting in efficiency gains, improved customer experiences, and
deepening financial inclusion.

Below, we elaborate on what credit scoring is and the various models used to
perform it.

Credit Scoring

Credit scoring is a statistical calculation to determine a borrower’s

creditworthiness. It predicts the probability of a loan applicant or an existing
borrower defaulting on payments or becoming delinquent. Lenders sanctioning
business loans, mortgage finance, and consumer credit are heavily reliant on credit
scores to make these decisions.

While technically, credit scores can be scaled to any numerical range, in India,
credit scoring companies have restricted their scores to 300-900. Having said that,
the higher the credit score, the more creditworthy the borrower is. In other words,
lenders prefer loan applicants with 750+ credit scores, as the likelihood of non-
payments and defaults is minimized. Check your CIBIL score for free on the
Protium App.

As a credit score is indicative of a borrower’s credit risk, lenders use it to perform

risk-based pricing, thus basing their interest rates and loan terms on it. This, in
turn, affects their relative profitability.

Types of Data Used in Credit Scoring Models

As credit scores provide a quick and effective way to evaluate borrowers, lenders
include a variety of data to develop and maintain their credit scoring models to
ensure a strong credit underwriting framework. Traditionally, loan providers
would consider the historical payment performance, including defaults and
outstanding amounts, the length of credit history, collateral, guarantees, and the
amount, type, and maturity of the loan sought to build a credit score.

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To substantiate this, one of the four leading credit bureaus in India, TransUnion
CIBIL (Equifax, Experian, and CRIF Highmark are the remaining three), uses four
major factors in its credit scoring models:

Payment History: Credit scoring companies maintain and update monthly

payment records related to bills and loan instalments. Their credit scoring models
keep track of the payment dues and the frequency and recency of payment misses
and delays over the past 24 months. Late payments reduce credit scores, with a
single late EMI payment resulting in a loss of over 100 points.

Credit Utilization Ratio (CUR): It is a measure of the proportion of credit used by

the borrower against their stated limits. High CUR signals high credit usage and
repayment burden, negatively affecting credit scores. Individuals and businesses
with a 30-40% CUR tend to have better credit scores.

Credit Mix: Credit bureaus mark a variety of loan types as positive for an applicant.
Keeping a history of availing of secured loans, such as home loans, auto loans,
business loans, and unsecured loans, including personal loans and credit cards of
different durations, positively affects credit scores.

Number of Hard Enquiries: Lenders also gauge the borrower’s credit burden from
the number of inquiries made by other lenders. This plays a minor role in credit
scoring as credit service providers (CSPs) tend to look over the loan applicant
profile at the time of approving business loans and credit cards.

However, the advances in digitalization have enriched the variety of data, enabling
lenders to develop more predictive models that provide deeper insights into the
applicant, which is particularly crucial for new to credit (NTC) customers without
a thick credit file.

Alternate data, such as real-time granular transactional data, mobile data, social
media interactions, biometrics, and psychometrics, is being increasingly used by
new-age fin-techs to better evaluate a borrower’s creditworthiness.

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For instance, Vantage Score 4.0, developed by Equifax, Experian, and TransUnion,
deploys machine learning to evaluate consumers with thin credit histories.
Consequently, this credit scoring model has reported a 2.4% performance
improvement, with its ability to capture defaulting accounts increasing by 6% over
previous credit scoring models.

Traditional vs Modern Credit Scoring Models

Historically, the foundation of the majority of credit scoring models was formed
by past payment history. These traditional models were developed using linear
regression, decision trees, logit modelling, and other statistical analysis methods
using limited structured data. Below, we outline two such traditional credit scoring
models.

Linear Regression: Regression analysis involves one of the easiest approaches to

predicting and explaining credit risk and the probability of default. In regression-
based credit scoring models, the labelled structured data (target outcome) is
projected on a set of independent variables to identify parameters that minimize
the sum of squared residuals.

Discriminant Analysis: A variation of the regression analysis model, discriminant

analysis has several sub-types, with the simplest model entailing the labeling of
data into default and non-default categories of applicants. It was initially applied
to systemic data to identify firms that were at risk of going insolvent based on
their financial ratios.

However, as more and more people transact online due to smartphones and cheap
data penetration, financial institutions have been transitioning to the use of
additional, semi-structured, and unstructured data in their credit scoring models.
They use open banking transactions and mobile digital data to capture a more
holistic and granular view of prospective borrowers’ creditworthiness. This data is
processed using AI and ML-driven algorithms, reducing reliance on prior payment
records and opening doors to affordable credit for previously financially excluded
sections of society.

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AI-based credit scoring models are heavily dependent on natural language
processing and deep learning. These models detect complex patterns from vast
sources of data, make predictions, and improve them based on previous outcomes,
also known as “learning from experience”. For instance, if a lender has already
labelled some data points “in default” and “not in default”, the AI will learn the
general rule and similarly classify other data observations.

Two popular modern credit scoring models are deep neural networks and
clustering.

Deep Neural Networks: These models train the algorithm to recognize data
patterns through several layers of processing instead of organizing data through
predefined equations. To illustrate, based on the previous layer’s output, the
model is trained again to generate new outputs, enabling it to detect nonlinear
patterns in unstructured data.

Clustering: In this descriptive credit scoring method, the aim is to classify data into
groups with significant differences between distinct groups. For instance, a
clustering algorithm may look for a cluster for a borrower who is difficult to assess.
On finding the appropriate cluster, its average default assessment can be applied
to calculate the borrower’s probability of default.

Empowering Growth and Inclusion through Credit Scoring Models

The growing adoption of innovative credit scoring models holds immense

potential to improve access to affordable credit, advance financial inclusion, and
propel economic growth. By processing diverse data, automating computations,
and enhancing consumer experiences, lenders can benefit from improved process
efficiencies while catering to a larger borrowers’ cohort, ensuring last-mile access.
However, lenders must ensure that their credit scoring models continue to provide
fair and transparent outcomes without perpetuating data biases or endangering
data security and privacy.

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13. Working Capital Assessment
I have explained working capital, related concepts and three methods of
Assessment of Working Capital in Chapter No 3 with examples. To avoid
duplication I am not going to discuss these points again in this Chapter. However,
I wish to explain precautions to be taken in case of Special Types of OCC Limits.

OCC to meet working capital of Petrol Stations:

Precautions to be taken while extending finance to Petrol Pumps/ Stations /Bunks

1. Ensure all permissions required from different statutory bodies are available and
the Station has equipped with all Safety equipment. Verify the Licences /
Permissions are in force.

2. Ensure that the Unit is not Own Outlet of any Oil Company. I have come across
a case where the Manager of the Petrol Station (employee of Oil Company) availed
finance from Bank mis-representing himself as the owner of the said station.

3. Some Oil Companies supply stock on credit based on the Bank Guarantee.
Normally, Customer avail BG from a one Bank (by offering separate security) and
approach other Bank for OCC (hiding the fact of availing BG from other Bank). By
resorting to this he is getting double finance - one on credit basis from the
Company and the other is from Bank showing the same as paid stock.

4. At the time of Appraisal, we can ascertain what is the maximum stock that can
be stored with available infrastructure (Petrol Storage Tanks). The Petrol Stations
have to obtain permission to have storage Tanks from The Petroleum and
Explosives Safety Organisation (PESO) formerly Department of Explosives. By
verifying such permissions, we will know dimension of each Tank permitted and
based on that we can arrive at the Maximum Quantity of Stock that can be stored.
This is one check to see that the Outlet is showing stock correctly or not.

5. In recent times, Petrol Bunks also extending credit to Transport Operators and
Education Institutions and Contractors. Before allowing credit against such
receivables, we have to see whether we can permit DP against such receivables, as
per your Bank‘s policy and as per delegated powers.

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6. Normally, Oil Companies supply the oils and lubricants within 48 hours.
However, in case of remote places, the supply may take some time. Unless the
Station submits remit funds, Oil Company will not supply.

In such cases, normally banks allow drawings against the stock-to be received
based on the proof of remittance (either DD or Reference of RTGS/NEFT),
however, within the Limit Sanctioned. The borrower has to submit the inventory
of stocks immediately on receipt of such supplies but within the maximum period
of 7 days from the date of remittance of funds. All remittances to the Oil
Companies concerned should be by debit to the borrower’s account.

Credit Limits to LPG Distributorships:

In case of LPG Distributors also Banks allow Drawing Power against Amount paid
(as stated in previous para) along with stocks-in-trade available on hand.

It is desirable that except for small drawings to meet the usual expenses connected
with the business of the borrowers, all drawings for purchase of products shall be
routed through this account. The borrower will be required to produce copies of
the invoice issued by the supplier company and sign a certificate thereon to the
effect that he has taken possession of relative goods.

For purchase of stock-in-trade i.e., petrol, diesel, lubricants, kerosene, light diesel
oil and liquefied petroleum gas. As the LPG cylinders are owned by the oil
companies no advance shall be given against the cylinders.

Precautions to be taken while extending finance against stock of Tobacco:

1. Ensure that the Borrower is a /Trader Registered with Tobacco Board and the
Registration/permission is in force.

2. When Tobacco is stored in Godown, normally, with a view to utilise maximum

space of the godown, they may keep stacks of tobacco bales almost touching the
roof of the godown . During summer, due to much heat, there is a possibility of
self-combustion within the tobacco bales due to which the tobacco may lose value
as it becomes ash due to auto-combustion (or self combustion).

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Insurance Companies cover that risk if we pay some extra premium. When you
extend credit against such stock which is subject to self-combustion , advise the
borrower to get insurance cover towards that risk also.

Precautions to be taken while extending finance against Medicines:

Ensure that the borrower (applicant) has got a valid licence to run the Medical
Stock and the same is in force.

I have come across some cases where treating the stock of Medicines only (without
any other collateral or Government Guarantee) sanctioning huge limits (of course,
personal guarantee of third party is taken). Please avoid such instances. Value of
Medicines with expiry date become Zero once the time limit crosses. Since it is not
easily saleable product, better to sanction such limits only against collateral or
with guarantee cover from Government. Treating value of stock of medicines for
security purpose is meaning less and not a prudent decision.

3. Precautions to be taken while extending finance against Iron Ore :

We may come across such cases rarely. However, better to keep the following
points in mind which may help in future.

Normally, Iron Ore (in the form of dust) be stored in open space which is exposed
to rain and sun. If it is not processed within a certain period, the Ore may lost the
content of iron and it becomes useless. In view of this, treating value of such stock
to decide security value, is not prudent.

4. Please be very careful in accepting certain stock as Security & for drawing
power purpose. Study the process involved in the activity undertaken by the
Applicant and permit only appropriate facility. In this regard, I wish to explain one
case.

The Applicant, a technocrat, has applied for limit of Rs 2 crores to meet the
working capital needs of the activity. He is involved in the activity of separating
sand from debris of Coal Mines. Coal Mining Corporation has allowed him to use
the debris at their Mining Sites, and separate Sand from the debris at the same
site and keep the sand there itself.

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In this case the process involved is only separation of sand from the debris which
is owned by the Mining Corporation. In this case, the Applicant need finance to
meet labour charges, salaries, diesel, petrol to run the machinery and expenses to
run the vehicles (to carry separated sand to a different place with the Mining Area).
He need not pay towards the debris.

In this backdrop, the Specialised Section at Controlling Office has sanctioned OCC
against hypothecation of the Stock. The borrower is declaring Stock of Debris (for
which he has not paid any amount to Mining Corporation) and Branch has allowed
DP against such Stock. User Section has also reviewing Stock Statements and no
comments are made in this regard.

In above case, instead of OCC against Stock, they should have examined sanction
of ODBD (against Book Debts) as the Mining Corporation has to pay Charges based
on Invoices raised by the borrower and receivables from Mining Corporation can
be accepted as Security.

Being a technocrat, borrower may not be knowing your banking. We should have
examined the proposal critically and sanction limit suitable to the Firm.

Permit drawings only against items permitted by Sanctioning Authority :

Please study Sanction Memo received from SA. Permit Drawing Power only
allowed Inventory & Raw Material. I have come across two cases, wherein SA
permits only Receivables for DP Purpose in case of OCC permitted to a Civil
Contractor, but Branch allows DP against stock of sand, iron and cement which are
stored at different locations. It has come out in Branch Inspection and the Auditor
opined there is a need to collect Penal Interest of about Rs 25 lacs as DP arrived
based on only receivables not covering the liability in full.

6. Please be alert in accepting Oils stored in Tanks. Ensure that the Tanks are having
calibrations for measuring the volume of oil stored in the Tank. Also test check the
contents. This is very old method of fraud. Instead of Oil, they may fill the Drums
with some thing else.

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7. When you finance against Gold Jewellery , better to take the help of experts
(jewel appraisers) to test check quality of Gold etc. at periodical intervals, to verify
genuineness of gold to be hypothecated.

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14. Non-Fund based Credit Facilities
In this chapter I am going to furnish points related Commercial Paper, Non Fund
Based facilities to meet Working Capital needs and Letters of Credit.

Commercial Paper

Commercial paper (CP) is a money-market security issued by large corporations to

obtain funds to meet short-term debt obligations (for example, payroll) and is
backed only by an issuing bank or company promise to pay the face amount on
the maturity date specified on the note. Since it is not backed by collateral, only
firms with excellent credit ratings from a recognized credit rating agency will be
able to sell their commercial paper at a reasonable price. Commercial paper is
usually sold at a discount from face value and generally carries lower interest
repayment rates than bonds due to the shorter maturities of commercial paper.

Typically, the longer the maturity on a note, the higher the interest rate the issuing
institution pays. Interest rates fluctuate with market conditions but are typically
lower than banks' rates.

On 27th March 1989, commercial paper in India was introduced by RBI in the
Indian money market. It was initially recommended by Vaghul working Group on
the basis of the following points.

a) The registration of commercial papers should only be granted to companies

having Rs. 5 cores and above net worth with excellent dividend payment record.

b) The market should follow the CAS discipline. The RBI should manage the paper
amount, entry of the market, and total quantum which can be upgraded in a year.

c) No limitation on the commercial paper market apart from the least size of the
note. However, the size of one issue and each lot should not be less than Rs. 1
crore and Rs. 5 lakhs respectively.

d) It should be eliminated from the provision of insecure advances in the state of

banks.

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e) The company using commercial paper should have minimum 5 cores as net
worth, a debt ratio maximum of 105, a debt servicing ratio closer to 2, current
ratio minimum 1033, and should be recorded on the stock exchange.

f) The paper can be made in terms of interest or at a discount rate to face value.

g) It should not be compelled to stamp duty while issuing and transferring.

Non Fund Based Working Capital Facilities

When Borrower approaches with a request to extend finance Credit to purchase
either Current Assets or Fixed Assets, Bank will open loan account (working capital
loan or term loan, depending on the nature of the asset) and the proceeds of the
loan will be sent to seller. In this case, Bank is parting with Funds. Hence such credit
facilities are known as Fund Based Credit Facilities. Examples – OD, OCC, Term
Loan, Housing Loan, Vehicle Loan.

In some cases, borrower may request Bank to give Guarantee or Under-taking

based on which they get goods without immediate payment to the seller. Banks
extend such facilities by way of Bank Guarantees and Letters of Credits. These
facilities are known as Non Fund Based Credit Facilities. Examples – Bank
guarantees, Letters of Credit, Deferred Payment Guarantees and Bills Co
acceptance Limits). In case of Non Fund Based (NFB) Limits, funds will be parted
by Bank only in case of eventuality and not immediately on receipt of goods by
borrower.

Inland Documentary Letters of Credit

A Letter of Credit (LC) is a written instrument issued by a banker (opening Bank),

at the request of a buyer (applicant) in favour of a seller (beneficiary), undertaking
to honour drafts drawn by the seller in accordance with the terms and conditions
specified in the letter of credit.

An Inland letter of credit is one, which is opened by a Bank at the request of its
customer (buyer) in favour of the seller within the same country.

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Inland Documentary Letter of Credit - An Inland Documentary Letter of Credit is
one in which the beneficiary should tender documentary bills i.e. bills
accompanied by documents of title to goods, apart from other documents, if any,
stipulated therein, for obtaining payment in terms of the letter of credit.

Inland LCs are governed by Uniform Customs and Practices – UCP 600.

UCP 600 contains 39 Articles of UCP600 are a comprehensive and practical working
aid to everyone involved in letter of credit transactions worldwide.

Inland Clean Letter of Credit - If the seller is not required to tender documents of
title to goods for obtaining payment under the terms of the letter of credit, such
letter of credit is termed as Clean Letter of Credit. Branches should not issue Clean
LCs.

LCs should stipulate drawings by sight / usance drafts accompanied by documents

of title to goods, such as railway receipts, bills of lading or lorry receipts of
approved transport operators, inland way bills, invoices and other documents.

In undertaking the responsibility to pay bills drawn under the LC, the opening Bank
assumes contingent liability.

Irrevocable Letter of Credit - An irrevocable letter of credit is one which cannot be

revoked, cancelled or amended without the consent of all the parties thereto.

The LC opening Bank irrevocably commits itself to pay the beneficiary upon
presentation of specified documents, provided the terms and conditions of the
letter of credit are complied with.

Revocable Letter of Credit - A Revocable Letter of Credit is one which can be

revoked or cancelled at any time by the opening bank.

Revolving Letter of Credit- A revolving letter of credit is one which provides that
the amount of drawings made under the credit will be reinstated after the bill is
paid and made available to the beneficiary again for further drawings during the
currency of the credit, subject to certain conditions specified therein. A revolving
letter of credit obviates the need to establish a fresh LC each time the credit is fully
utilized by negotiation.

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Confirmed Irrevocable Letter of Credit - The seller, for various reasons, may ask
for the Letter of credit to be guaranteed for payment by another Bank. In such
circumstances, the opening bank requests the some other bank to add its
confirmation to the credit.

When the confirmation is added to a Credit by confirming bank at the specific

request of issuing bank, it constitutes a definite, equitable undertaking on the part
of confirming bank in addition to the undertaking of the issuing bank.

In short confirmed credit is a credit to which another bank ( the bank other than
the issuing bank) has added its confirmation.

Transferable Letter of Credit is one that can be transferred at the request of the
original beneficiary to one or more second beneficiaries. Such Credits can be
transferred only if it is specifically stated as “transferable” in the LC.

Back to Back LC - Where the seller is not a manufacturer or producer of the goods
and does not wish to get transferable letter of credit due to various reasons, he
may request his bank to open a letter of credit in favour of his supplier on the
strength of the LC already received in his favour. Such a letter of credit is referred
to as a ‘Back to Back’ letter of credit.

Deferred Payment Credit - It is an usance Credit where payment will be made by

the designated bank on respective due dates as per the terms of the credit without
drawing of the Drafts. Under Deferred payment Credit, no draft will be called upon
but Credit must specify the maturity at which the payment is to be made and how
to arrive at the maturity.

Acceptance Credit - It is similar to Deferred Payment Credit, except for the fact
that in this credit drawing of the usance Draft is a must and the designated bank
will accept the Draft and honour the same by making the payment on due date.

LC with “without recourse” clause. should not be opened.

LCs with onerous clauses which will result in increasing the commitment of the
Bank beyond the LC amount should not be opened.

Parties to a Letter of Credit - A letter of credit has the following parties:

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a) Applicant (Opener / Buyer) -the party on whose behalf the letter of credit is
opened.

b) Opening Bank / Branch (Issuing Bank/Branch) - the Bank/branch which

establishes the letter of credit and undertakes to pay on behalf of the applicant.

c) Beneficiary (Seller) -the party in whose favour the letter of credit is opened .

d) Advising Bank / Branch-the Bank/branch whose services are utilized for

advising (transmitting) the letter of credit to the beneficiary.

e) Negotiating Bank / Branch - the Bank / branch which is designated in the letter
of credit, to negotiate the documents drawn under the letter of credit and to make
payment to beneficiary.

f) Reimbursing Bank / Branch - the Bank / Branch from which the Negotiating
Bank / Branch has to claim reimbursement as per LC.

LCs against guarantees of other Banks should not be issued.

Guarantees should not be issued to other Banks for opening LCs.

Limits should be sanctioned for opening LCs generally in favour of beneficiaries

who are creditworthy and acceptable to the bank. To ascertain this, status reports
/ OPL should be called for in case of all parties except Government / Semi Govt.
departments and PSUs from their Bankers and LCs should be opened only if such
reports are satisfactory. Such reports should not be more than one year old.

Since assessment of LC limits is akin to assessment of working capital limits,

guidelines on current ratio in respect of fresh sanctions / renewals / enhancements
are to be followed, as stipulated in Credit Risk Management Policy and Delegation
of Powers Booklet for the relevant period.

Original LC should be stamped with revenue stamps of requisite value.

The LC should be advised to the beneficiary through the negotiating branch.

Amendments to an irrevocable LC become effective only if the amendments are

acceptable to the beneficiary.

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LC should call for drafts drawn on the Bank (and not on the applicant) in terms of
Article 6 of UCP 600.

The expired LC can be revived / reinstated / extended only at the specific request
of the opener. It should not be extended / revived / reinstated at the request of
the beneficiary or any other party.

Liability in respect of expired LCs may be reversed after the period of three (3)
weeks from the date of expiry of LCs.

The following protective clause should invariably be incorporated in the Revolving

LC - “The amount utilised under this credit shall be again available for utilisation
only on receipt by the negotiating branch/bank of the advice that the draft already
drawn by the beneficiary has been reimbursed by the opener”.

As and when bills drawn under LCs are paid, LC liability of the party has to be
reduced / reversed.

Debiting to operative account without sufficient balance will not amount to

payment of bills and hence we should not reverse the contingent liability till the
bills are paid.

Bank Guarantees
According to Section 126 of the Indian Contract Act, a contract of guarantee is a
contract to perform the promise, or discharge the liability of a third person in case
of his default.

A bank guarantee is a contractual assurance that is given by the bank to a third

party creditor. By virtue of this commercial instrument, the concerned bank
undertakes liability on behalf of the principal debtor to fulfil his contractual
obligation in the event of default. This secures the transaction by ensuring that no
detriment is caused to the creditor.

A “Contract of guarantee” is also known as contract of surety ship. There are three
parties to a guarantee.

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The person who gives the guarantee is called the “Surety” or “Guarantor”, the
person on whose behalf the guarantee is given is called the “Principal Debtor” and
the person in whose favour the guarantee is given is called the “Creditor “ or
“Beneficiary”.

The nature of obligations of the principal debtor is primary while the obligations
of the bank are secondary.

By issuing a guarantee, a bank ordinarily undertakes to pay the amounts specified

in the guarantee agreement to the beneficiary on demand made by him in
accordance to predetermined terms and conditions.

The object of a bank guarantee is to ensure the due performance of certain works
contracts. It is an act of trust with full faith to facilitate free flow of trade and
commerce in domestic or international trade or business. It creates an irrevocable
obligation to perform the contract in terms thereof.

Suppose , you are manager of a Branch of “Our Bank”. One of your valuable
customers, M/s Venkateswara Engineers engaged in selling Electric Motors. M/s
Venkateswara Engineers purchase Electric Motors from M/s Nav Bharat Company.
Based on their previous experience, Nav Bharat Company agree to sell Motors
costing Rs 10 lacs on 90 days credit provided Venkateswara Enterprises arrange
for a Bank Guarantee of Rs 10 lacs. Suppose, at the request of Venkateswara
Engineers, complying with other guidelines, you have issued a Guarantee on behalf
of Venkateswara Engineers favouring Nav Bharat Company.

In this transaction “Our Bank” is called “Guarantor” or “Surety”. Venkateswara

Engineers are called the “Principal Debtor” and Nav Bharat Company is called
“Creditor” or “Beneficiary”.

As such, the three parties to a Bank Guarantee in above case – Guarantor – Our
Bank ;

Debtor - Venkateswara Engineers – Our Bank’s Customer

Creditor - Nav Bharat Company - The Beneficiary

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Nature of BG – Non Fund Based : While issuing Bank Guarantee, Bank is not parting
with money upfront. Only in case of any eventuality (invocation) only Bank parts
with money. Till such time, this facility is not having any cash disbursement from
Bank side. That’s why BGs are called Non Fund Based Credit Facilities.

The liability of the surety/guarantor is co-extensive with that of the principal

debtor, unless it is otherwise provided in the Agreement of Guarantee itself.

Bearing this in mind our guarantees are drafted in such a way that the guarantor
and the principal debtor are jointly and severally liable in the ordinary course at
all times.

Benefits to the applicant:

1) Small companies can secure loans or conduct business that would otherwise not
be possible due to the potential riskiness of the contract for their counterparty. It
encourages business growth and entrepreneurial activity.

2) Compared to loans and advances (where Bank parts with money) the interest
charged, the fee charged in respect of BGs is very less. As such, it is a cost saving
product for Applicant.

Benefits to the Beneficiary:

1) The beneficiary can enter the contract knowing due diligence’s been done on
their counterparty.

2) The bank guarantee adds credit worthiness to both the applicant and the
contract.

3) There is a risk reduction due to the bank’s assurance that they will cover the
liabilities should the applicant default.

4) There is an increase in confidence in the transaction as a whole.

Benefits to the Bank:

1) As it is a Non Cash Transaction at the time of Issuance, Bank need not worry
about availability of Funds. It is not affecting Bank’s Credit-Deposit Ratio.

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2) The fee earned (normally collected upfront) can be recognised as Income as
Income Recognition Norms are not applicable, even if the BG is invoked at a later
date.

Disadvantages of Bank Guarantees

1) The involvement of a bank in the transaction can bog down the process and add
an unnecessary layer of complexity and bureaucracy.

2) While Issuing B G, Bank is carrying Risk. So the bank may require assurance on
the part of the applicant in the form of collateral.

Instances where BGs are needed.

Normally, in following cases, need for BG arises.

1) Guarantees for due performance of a contract.

2) Guarantees for supply of materials (Current Assets) on credit.

3) Guarantees favouring Tax Authorities to clear goods pending payment of duty.

4) Bid bonds and tender guarantees in lieu of earnest money/security deposit.

5) Guarantees for supply of machinery (Fixed Assets)

6) Guarantees, for getting Advance for execution of Contract.

7) Guarantees to Banks/ Financial Institutions for extending guarantee facilities.

Now we will discuss above instances hereunder.

1. Guarantees for due performance of a contract –– Performance Guarantees These

guarantees are issued for the performance of a contract or an obligation. In case,
there is a default in the performance, non-performance or short performance of a
contract, the beneficiary's loss will be made good by the bank.

These are known as Performance Guarantees. Although these guarantees are for
performance, in the event of non-performance of the obligations, the Bank
assumes only monetary liability up to a specified amount, and for a specified
period and not due performance of the contracts like construction of a building.

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2) Guarantees for supply of materials (Current Assets) on credit Please see the
example given in Page 2 related to Our Bank issuing BG of Rs 10 lacs on behalf of
its customer M/s Venkateswara Enterprises in favour of M/s Nav Bharat Company
for sale of material on credit. These guarantees are classified as Financial
Guarantees.

3) Guarantees favouring Tax Authorities to clear goods pending payment of duty.

Customs and Central Excise Departments will insist Bank Guarantees to release the
Goods pending payment of tax/duty. In some cases, when the issue is in Court of
Law or under Arbitration, our customer may be required to submit Bank
Guarantee.

4) Bid bonds and tender guarantees in lieu of earnest money/security deposit.

While calling for / awarding Contracts, the Principal may insist on submission of
Bank Guarantees from the Contractors in lieu of EMD and Security Deposit.

Earnest Money Deposit (EMD) : To ensure that a Bidder does not submit a dummy
bid or back out at time of tender opening, Department collects a small refundable
fee from each bidder, which is called EMD.

EMD is returned when all Bids are opened & tender is awarded to other firm. In
case Tender is cancelled, the EMD is returned.

In case, a Firm is the winning bidder, the said EMD shall be returned to the said
Firm only after completion the supply or on submission security deposit.

After Bid is opened, if a Bidders refuses to take the contract, then his EMD is
forfeited. EMD is generally less than 5% of the Tender Value.

Security Deposit: Once it is decided that a Tender is awarded to a Bidder, he has

to deposit a Security Deposit with the Buyers such that if he does not complete
the task as per the work order, the Buyer can recover the loss by forfeiting his
Security Deposit. For e.g. If a Bidders gets Rs.10 Cr contract to construct a flyover
within 10 months , than he has to deposit a Security deposit of 10% i.e. Rs 1 Crore
with the Department. Now if he does not complete the bridge on time or leaves it
incomplete, the Department can forfeit his 1 Cr as penalty.

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Security Deposit can be in form of Bank Guarantee, National Saving certificates,
Cash, etc. Only when the Winning Bidders makes the Security Deposit, he gets his
EMD Back.

Guarantees for supply of machinery (Fixed Assets) -DPG & BCA

DPG is a Non-Fund Based Credit facility to acquire Fixed Assets, mainly machinery.
Issuance of deferred payment guarantees favouring suppliers arise where
machineries are supplied on credit and the payment is to be made by way of
instalments. The manufacturers will agree to supply the same only if such
instalments are guaranteed by the bank.

In the event of non-payment of instalment dues by the buyer, i.e., principal debtor,
banker issuing the deferred payment guarantee will have to make the payment.

Normally Banks hesitate to extend DPG facility for new units.

Guarantees for getting Advance for execution of Contract. – Advance

Payment Guarantees.

Such type of guarantees are issued where the Contractors (borrowers) seek
advance payment from their Principals to meet part of the expenses for execution
of contracts. In such cases, the Principal may insist guarantee from the Bank
against such advance payment and guarantees of this type are known as Advance
Payment Guarantees.

Guarantees to Banks/Financial Institutions for extending credit

facilities.
Bank provides guarantee favouring other Banks/Other lending agencies for the
loans extended by the latter. However, no guarantee to be issued on behalf of
corporate entities for issuing non-convertible debentures. This facility applies only
to the loans and not to bonds or debt instrument. This facility to be extended only
in respect of borrower constituents to enable them to avail of additional credit
facility from other banks /other lending agencies.

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Classification of Guarantees

Bank Guarantees are classified in three different ways based on

a) Purpose;

b) Security

c) Condition for Invocation

Based on purpose, Bank Guarantees are classified as under:

a. Financial Guarantees : All guarantees issued guaranteeing repayment

of a loan or a debt are considered as Financial Guarantees.

b. Performance Guarantees :

c. Advance Payment Guarantees :

d. Deferred Payment Guarantees :

2) Based on security Bank Guarantees are classified as under :

a) Secured Bank Guarantee means a guarantee made on the security of assets

(including cash margin), the market value of which will not at any time be less than
the amount of the contingent liability on the guarantee, or a guarantee fully
covered by counter guarantee/s of the Central Government, State Governments,
public sector financial institutions and / or insurance companies.

b) Unsecured Bank Guarantee

Unsecured Bank Guarantee is one where the realisable value of security, as

assessed by the Bank / approved valuers / the RBI is not more than 10% ab-initio,
of the outstanding guarantee exposure.

Conditions for Invocation -

a) The Guarantees which can be invoked by Beneficiary only after compliance with
certain conditions are called Conditional Guarantees.

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b) The Guarantees which can be invoked with in the period mentioned in the
Guarantee, however without compliance of any other condition are called
Unconditional Guarantees. These are also known as Demand Guarantees.

Assessment & Issue of Guarantees

I wish to discuss Assessment of BG requirement under two heads – Single

Transaction Bank Guarantee and Regular Limit to issue multiple guarantees over
a specified period.

Single Transaction BG

Suppose, your customer has got one Order of Rs 5 Crores from One Corporate. To
ensure timely completion of the project the Corporate may insist a Bank Guarantee
for the amount equivalent to 5% of the Contract, i.e. Rs 25 lacs for a period of 2
years.

In above case, obtain minimum margin 25% of the proposed BG (Rs 6.25 lacs).
Apart from Margin (by way of Cash or by way of Deposit), to secure your
commitment obtain suitable security approved by Bank like land & Building.

In above cases obtain following documents. and issue B G in the prescribed format.

1. Application for issuing Guarantee - signed by persons authorised.

2) Stamped counter indemnity.

3) In case of Margin is obtained by way of Deposits of your Bank, mark lien on the
said Deposit (in CBS also) and obtain Pledge Letter.

4) Based on Security, obtain all necessary documents at pre sanction as well as

post disbursement stage such as Search Report from CERSAI, Legal Report,
Valuation Report, Registration of Mortgage with CERSAI, Obtention of ECs etc.

Regular Bank Guarantee Limit :

Firms & Individuals who need Guarantees on regular basis to ensure smooth
functioning of the Business may request for a Limit within which you have to issue
BGs whenever they need.

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In such cases, the Requirement may be assessed as under :

Suppose the Applicant’s present Sales are at Rs 800 lacs. He has estimated Sales at
Rs 1200 lacs. Increase is estimated sales is Rs 400 lacs. He wants to participate in
Bids worth Rs 300 lacs in present FY . Requirement of raw material is 65% of Sales.
Length of Working Capital Cycle is 2 months.

a. BG in lieu of EMD

b. BG in lieu of Security Deposits

c. BG to get raw material on credit basis (60 days DA basis)

d. BG to get Advance from the Principals.

e. BG towards timely performance.

Now we will discuss requirement of B G Limit based on above data.

1) EMD: Value of Estimated Bids is Rs 300 lacs. Please note that all bids worth Rs
300 lacs not appear at once. This value of Rs 300 lacs is total of all bids over a
period of one year. On average it may be Rs 25 lacs per month. As the BG in lieu
of EMD is for very short period, we may take value of monthly average bid of Rs
25 lacs into account. If the value of Bid is Rs 25 lacs, BG may be required for 5% of
the said Bid Value i.e. Rs 1.25 lacs. To give a comfort, we may consider need for
BG towards EMD as Rs 2 lacs.

2) Security Deposit : Once our Customer gets the Contract of Rs 25 lacs, he may
need BG in lieu of Security Deposit. In this case, period may be more than one
month. For our understanding purpose, I am taking the period of BG needed
towards Security Deposit as 3 months. As such, we have to sanction BG towards
Security keeping 3 months value of Bids i.e. Rs 75 lacs. Normally, Principal may
insist for Security Deposit @ 10% of the Bid. In that case our Customer need Rs
7.50 lacs towards BG for Security Deposit. Rounding off this requirement we may
sanction Rs 8 lacs towards BG for Security Deposit.

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3) BG to get raw material on credit basis (60 days DA basis)

In above case we have agreed value of raw material is 65% of Sales and the Length
of Working Capital Cycle as 2 months. As such at any time he has to keep Raw
Material needed for 3 months’ sales (two months in Working Capital Cycle and raw
material for one more month’s sales as buffer). 3 months’ sales are Rs 300 lacs for
which he need raw material of Rs 195 lacs. Out of requirement of raw material
worth Rs 195 lacs, Customer may get raw material to the extent of Rs 100 lacs
(50% of requirement) on Credit, for which he has to submit BG to the Suppliers.
Supplier may insist for down payment of minimum 25% of the Invoice Value and
balance to be paid within 60 days. Customer need to submit BG for 75% of the
Invoice Value for 2 months. Keeping the above we arrive at BG Limit as under .

Value of Raw Material made available by Supplier Rs 100 lacs

Down payment made Rs 25 lacs

Material Supplied on Credit Rs 75 lacs

Based on past experience Supplier may insist BG for Rs 45 lacs (60% of credit) In
above case if we permit BG limit Rs 45 lacs towards getting raw material on credit
basis, the Unit runs smoothly.

Please note to reduce the MPBF arrived at for Working Capital Limits to the extent
of BG Limit for getting raw material on credit, to avoid double finance.

4) BG to get Advance from the Principals.

In some commercial transactions Principal may agree to extend some amount of

the Contract as Advance against Bank Guarantee. Such Guarantees are called APG.
In above case Sales estimated for present FY are Rs 1200 lacs. Out of Rs 1200 lacs,
there may be new clientele to the extent of Rs 300 lacs, who may be ready to
extend Advance. Advance, normally, be extended 10% to 15% of the Bid Amount.

Clients who are willing to extend are accounting for Rs 300 lacs and if Advance is
extended at 15% as the amount of Advance the Customer may receive will be Rs
45 lacs in one year and on average it is Rs 12 lacs for 3 months. To give more
relaxation, we may sanction Limit of Rs 15 lacs towards issue of APG.

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5) BG towards timely and due performance.

While awarding Contracts, the Principal may insist on Bank Guarantee towards
proper and timely performance of the Contract by the Contractor. In such cases,
the Guarantees issued by Bank on behalf of their Customer (in this case Contractor
to supply Finished Goods) favouring the Principal are called Performance
Guarantees. Normally the amount of such guarantees may be about 10% or 15%
of the Contract Value.

In above example, if we take Rs 300 lacs as the amount of contracts where

Principals may insist for Performance Guarantee, we may sanction Limit of Rs 15
lacs (calculations made as per para 4 above).

Assessment of Total Bank Guarantee Limit in above example is as under.

1. Towards EMD Rs 02.00 lacs

2. Towards Security Deposits Rs 08.00 lacs

3. For purchases on Credit Rs 45.00 lacs

4. For APG Rs 15.00 lacs

5. For Performance Guarantee Rs 15.00 lacs

Total Rs 85.00 lacs.

As such we may sanction BG limit of Rs 85 lacs to meet his various needs of Bank
Guarantee.

In above case obtain following documents and issue B G in the prescribed format.

1. Application for Full Limit of Rs 85.00 lacs

2. Stamped counter indemnity for full limit of Rs 85.00 lacs

3. Separate request letter should be obtained as and when guarantees are issued
under the regular limit.

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4. In case of Margin is obtained by way of Deposits of your Bank, mark lien on the
said Deposit (in CBS also) and obtain Pledge Letter. You may obtain Margin for
entire limit of Rs 85 lacs at once or you may obtain Margin for each BG as and
when issued, depending on the liquidity position of the Applicant.

5) Obtain nature of Charge in respect of Security, obtain appropriate

documentation. If the Charge is by way of Mortgage, ensure compliance with
guidelines such as obtention of Search Report from CERSAI, Legal Report,
Valuation Report, Encumbrance Certificate (before and after mortgage also).

6) Issue B G in appropriate approved format duly incorporating various clauses

which we will discuss in next Chapter. Ensure that the B G is issued on a Paper duly
stamped, it is numbered, It is dated and signed by appropriate
authority/authorities.

Assessment of DPG requirement:

DPG (Deferred Payment Guarantee) is a Non Fund Based Term Loan, which is
needed to procure heavy machinery etc. If Bank sanctions Term Loan and part
funds it is called Fund Based Term Loan. However, in case of DPG, Bank is not
parting funds, but assures timely repayment of instalments. So the assessment of
DPG is similar to Term Loan. All parameters such as DER, Margin, and DSCR are to
be seen as applicable to Fund Based Term Loans.

Other points to be kept in mind during Sanction of BG Limits :

1. Reserve Bank of India has imposed specific prohibition on issuance of

guarantees on behalf of non-banking companies for repayment of their
loans/deposits secured by them from other non-banking companies or from the
public in general. Banks should not execute guarantees covering inter-company
deposits/loans thereby guaranteeing refund of deposits/loans accepted by
NBFC/firms from other NBFC/firms.

2. The purpose of the Bank Guarantee should be incidental to the business of the
Constituent.

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3. Avoid issuing guarantees on behalf of customers who enjoy credit facilities with
other bank. However, for accounts under Consortium, MBA etc this is not
applicable.

4. Ensure that the customer would be in a position to reimburse the bank in case
the bank is required to make the payment under the guarantee.

5. The guidelines on liquidity norms (Current Ratio) shall be applicable to

borrowers provided with working capital limits assessed under any of the three
methods viz., Turnover method/ MPBF system/ Cash Budget system.

6. Generally Guarantees issued on behalf of building contractors should not cover

progress payments under contracts for building and/or other constructions.

7. 100% margin in Cash / Term Deposit of the Bank should normally be insisted
upon in respect of guarantees issued covering payment of dues such as (a)
Payment of Insurance premium (b) Payment of Sales Tax (c) Payment of Income
Tax (d) Guarantees issued in favour of DGS&D.

8. Banks should not execute guarantees covering inter-company deposits/ loans.

9. Guarantees should not be issued for the purpose of indirectly enabling the
placement of deposits with non-banking institutions.

Issuing Bank Guarantee – Precautions.

Important concepts (other than what is discussed in previous Issues) related to

Inland Bank Guarantees.

Guarantees must be for specific amounts and for specific periods.

Ensure that the BG issued is properly stamped (with stamp duty).

Ensure that the BG contains Standard Protective Clause. A protective clause is one
that determines and restricts the amount of guarantee and period of
enforceability of the claim against Bank. All the guarantees to be issued by the
branches shall invariably contain the following protective clause:

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“Notwithstanding anything contained herein:-

i. Our liability under this Bank Guarantee shall not Exceed Rs....................... (Rupees.
...................................only).

ii. This Bank Guarantee shall be valid upto ...............................

iii. We are liable to pay the guaranteed amount or any part thereof under this Bank
Guarantee only and only if you serve upon us a written claim or demand on or
before .....................( Date of expiry of Guarantee as stated in para ii above plus
claim period).

If the claim period is not mentioned in the protective clause after the words, on or
before...........‘ in the guarantee, the beneficiary will have right to claim the amount
by taking legal action within 3/30 years from the date on which the cause of action
arises.

As per RBI directives Bank guarantees issued for Rs.50,000/- and above should be
signed by two officials jointly. Such a system will reduce the scope for
malpractices/ losses arising from the wrong perception/ judgement or lack of
honesty/ integrity on the part of a single signatory.

Ensure that the BG is issued in the Format advised by respective Banks. If the BG
needs to be issued in a different format or with addition of new clauses or deletion
of existing clauses to Approved Format, get the draft of such modified format
Approved from appropriate authority before issuing BG.

Guarantees containing onerous terms should not be issued. Condition which is

difficult to comply or without any certainty are called Onerous Clause. Example: a
clause as per which the Guarantee may be invoked only on 1st day of the month,
if the day happens to be Thursday and also it is raining. It is difficult to comply
with such clauses as it put hurdles in making claims under the Guarantee, in case
of need.

All BGs should contain a separate Claim Period. The claim period is only a facility
to the beneficiary enabling him to claim, within a specified period, the
loss/damage caused to him during the validity period of the guarantee.

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Hence in the normal circumstances should not provide unduly long claim period.
Only a reasonable claim period, taking into account the purpose of the guarantee,
the nature of activity, availability of margin etc., should be permitted.

Normally, the claim period in the guarantees issued by the branches should not
exceed 6 months.

While computing the ―guarantee period, the claim period should be excluded.

The normal period of limitation for preferring the claims under guarantee is 30
years from the date of expiry of the guarantee in the case of Govt. and 3 years in
other cases.

In case of APGs ensure compliance with the following :

a) In case of APG, the goods covering such guarantees are to be pledged

/hypothecated to the Bank and in such cases guidelines relating to Fund Based
Working Capital limits such as PL/KCC/OCC is to be followed.

b) As the nature of commitment under APG is similar to performance of a contract

or an agreement, APG is to be treated as Performance guarantee and accordingly,
the commission as applicable to performance guarantee be charged.

Also APG may be treated as performance guarantee for the purpose of Balance
Sheet classifications.

c) If the party is already enjoying inventory limits like OCC/PC etc. the goods
received under APG is to be deducted for the purpose of arriving drawing limit.

d) If advance payment guarantees are issued on behalf of joint stock companies,

our charges on the hypothecated goods should be got registered under Section
125 of the Indian Companies Act.

In case of Performance Guarantees - Guarantee liability cannot be reduced in

proportion to the work carried out partially. However, this may be considered if
the beneficiary gives in writing that they are not having any claim on the bank and
the guarantee liability is reduced to that extent.

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In the case of guarantees covering contracts, it must be ensured that the clients
have the requisite technical skills, experience and means to execute the contracts.

Guarantees with interest clause is to be issued with the specific approval of the
appropriate sanctioning authority.

Interest should be ascertainable and quantified. Notional interest for the specified
period should be calculated and specified in the guarantee itself to avoid
ambiguity. Ex. ―interest @ ....% not exceeding a sum of Rs..........

While limiting the liability of the Bank in the protective clause, notional interest
should also be taken into account and commission should be charged on the
amount including the interest component specified in protective clause. For all
purposes guarantee amount and interest constitute guarantee liability.

Issue of guarantee with Automatic Renewal Clause. Automatic renewal clause is

considered to be onerous. Normally, guarantees containing automatic renewal
clause carry an additional risk of being required to be renewed at the request of
the beneficiary with or without specific request from the borrower. Guarantees
containing onerous clauses may be issued only after obtaining permission from
the competent authority. Automatic Renewal Clause also known as SRC – Self

Renewal Clause.

While issuing the guarantees in favour of Government Department / Public Sector

Undertaking, Arbitration clause need not be incorporated in the guarantee.
However, if the beneficiary specifically requests for inclusion of the arbitration
clause in the guarantee, the same may be incorporated.

An arbitration clause is a clause in a contract that requires the parties to resolve

their disputes through an arbitration process. Although such a clause may or may
not specify that arbitration occur within a specific jurisdiction, it always binds the
parties to a type of resolution outside the courts, and is therefore considered a
kind of forum selection clause. It is also known as the "Scott v. Avery clause."

As per the guidelines issued by Ministry of Finance, in case of disputes where the
amount involved is up to Rs.50,000/-, it should be settled by the concerned Banks
through Reserve Bank of India.
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Disputes involving amounts up to Rs.5,00,000/- should have the approval of
Chairman and Managing Director before referring the matter to the arbitration
and in respect of disputes involving amounts more than Rs.5,00,000/-, reference
should be made to the Government for appointment of an arbitrator after seeking
the approval of Bank‘s Board of Directors.

Jurisdiction Clause, we may include the same. Normally, such situations occur only
in international transactions. However, we may incorporate Jurisdiction Clause in
Inland Bank Guarantees also at the option of any party to the Guarantee.

The laws in India have prescribed certain set of rules by which an aggrieved party
can institute a suit in Court of law. The general scenario to refer the disputes to
the Courts is provided under Code of Civil Procedure, 1908 (CPC). One of the
provision is enumerated in section 20 of the CPC which provides that a suit may
be instituted either at the place where the defendant ordinarily resides or carries
on business or where any part of the cause-of-action-arises.

The parties to a contract may mutually agree to refer the disputes to a particular
Court or Courts. Such a clause in a contract is called as exclusive jurisdiction clause.
The parties agree to exclusively refer the disputes arising from the contract, if any,
to a particular Court or Courts.

A jurisdiction clause should be included where the parties want all disputes arising
under their agreement to be determined by a particular national court or courts.

In some cases , guarantees may be required in compliance with interim orders

issued by courts in favour of customs and central excise authorities to cover
differential duty amounts. In such cases, branches are bound to pay the amounts
as and when the courts vacate the relative orders, issuing final orders and the
guarantees are invoked. Hence , take note of the implications involved in granting
such guarantee limits without full cash margin.

In case of guarantees issued without expiry period, liability cannot be reversed till
the original guarantee bond is received. Guarantees without expiry period should
be issued only under exceptional circumstances and not as a matter of routine.

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Guarantee issued on behalf of Joint Stock Companies should be supported by
appropriate resolutions of the Board of Directors. It should also be verified that
the company has the necessary authority under its Memorandum and Articles of
Association to execute counter guarantees / indemnities. The counter guarantee /
indemnity obtained should be signed by the person/s authorised in the resolution.

As per RBI directives no bank guarantee should normally have a maturity of more
than 10 years. However, in view of the changed scenario of the banking industry
where banks extend long term loans for periods longer than 10 years for various
projects, it has been decided to allow banks to also issue guarantees for periods
beyond 10 years.

While issuing such guarantees, banks are advised to take into account the impact
of very long duration guarantees on their Asset Liability Management. Further,
banks may evolve a policy on issuance of guarantees beyond 10 years as
considered appropriate with the approval of their Board of Directors.

SFMS Clause – Confirmation of Issue of BG

In addition to sending Bank Guarantee in paper form, a separate advice of the

Bank Guarantee shall be sent to the advising bank through SFMS by interfacing
Flexcube Corporate through Middleware i.e. XMM package, after which the paper
Bank Guarantee could become operative.

While processing the Application to Issue BG, obtain the details of advising bank
(bank of beneficiary) to transmit BG Advice through SFMS to the advising bank.
As a fraud prevention method, we have to include the following clause in all the
Bank Guarantees as last para :

“this Bank Guarantee shall be effective only when the BG message is transmitted
by the issuing bank through SFMS to ...... bank ...........branch (bank of beneficiary)
and written confirmation to that effect is issued by bank of beneficiary."

Bank Guarantees - Ghosh Committee Recommendations

Banks should implement the following recommendations made by the High Level
Committee constituted in October 1991 (Chaired by Shri A. Ghosh, the then Dy.
Governor of RBI):
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a) In order to prevent unaccounted issue of guarantees, as well as fake guarantees,
as suggested by IBA, bank guarantees should be issued in serially numbered
security forms.

b) Banks should, while forwarding guarantees, caution the beneficiaries that they
should, in their own interest, verify the genuineness of the guarantee with the
issuing bank.

Ensure copy of the BG issued sent directly to the Beneficiary under Regd. Post with
acknowledgement due with a request to verify the genuineness of the guarantee
submitted by the Contractor.

Bank Guarantee Scheme:

The Government of India have formulated a scheme in consultation with the

Reserve Bank of India, in terms of which the guarantees furnished by Banks on
behalf of their customers will be accepted by Government Departments, State
Governments, Government Bodies, Public sector undertakings and others who
have adopted this Bank Guarantee Scheme.

Under this Scheme, contractors who take up contract work may furnish (towards
earnest money/security deposit) a Bank guarantee or tender deposit receipts
issued by the Banks to the concerned Government Department/Body, in lieu of
depositing with them cash or government securities.

Guarantees to be issued in favour of Central Government should be addressed to

the President of India. It must be noted that any correspondence with regard to
issuance of guarantee should be addressed to the concerned officer who accepted
the guarantee and not to the President of India or President‘s Secretariat. The
correct name and address of the beneficiary, wherever not known should be
ascertained from the party on whose behalf the guarantee is issued.

While issuing guarantees in favour of State Governments, they have to be

addressed to the Governor of the State, but while corresponding with the
concerned State Government, branches must mention the name of beneficiary,
department and purpose for which guarantee has been executed.

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Payment of invoked guarantees

Where guarantees are invoked, payment should be made to the beneficiaries

without delay and demur. There should not be any delay on the pretext that legal
advice or approval of higher authorities is being obtained.

Delays on the part of banks in honouring the guarantees when invoked tend to
erode the value of the bank guarantees, the sanctity of the scheme of guarantees
and image of banks. It also provides an opportunity to the parties to take recourse
to courts and obtain injunction orders. In the case of guarantees in favour of
Government departments, this not only delays the revenue collection efforts but
also gives an erroneous impression that banks are actively in collusion with the
parties, which tarnishes the image of the banking system.

Renewal / Extension of Bank Guarantees

The period of guarantee may be extended on the same terms and conditions, at
the request of the party on whose behalf the guarantee is issued. The request
should normally be made on or before the expiry date.

Do not to entertain extension of guarantees after the expiry of the guarantees as,
validity of such extension would be doubtful in view of the guarantee not being
in force as on the date of such extension. However, where the party insists to have
the guarantee renewed after expiry at the instance of the beneficiary for any
reason, branches may issue the guarantee afresh with an additional clause stating
―This guarantee is deemed to have come into force and effective from
.........(Date). After issuing fresh guarantee, the old guarantee has to be liquidated.

Monitoring of Bank Guarantees

In the case of all performance guarantees / advance payment guarantees, the Bank
undertakes an obligation towards the beneficiary to indemnify in case of non-
performance of the promise within a specific time on behalf of the borrower.

Therefore, it will be obligatory for the Bank to know the position of the
performance by the borrower at periodical intervals, especially where the
guarantees are issued for large value and for longer period.

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Therefore, especially in case of guarantees issued for construction work to large
machinery manufacturers for supply of machinery, etc., the Bank should ascertain
the status of the contract / supply schedule such as to what extent the contract is
completed and to what extent the work is pending etc.

In view of the above there is a need to monitor the progress of all performance /
advance payment guarantees of Rs. 5 lac or more and the period of the guarantee
is more than 6 months. The cut off limit of Rs. 5 lac is per guarantee and not the
limit.

The monitoring shall be done on an ongoing basis at half yearly intervals after
completion of 6 months from the date of issue of the guarantees. For this purpose,
we should diarise the due dates of the guarantees and due date on which progress
report has to be obtained. We should obtain the progress report from the
borrowers on due dates.

Reversal of Entries - BG with Protective Clause

All the expired guarantees to be reversed in the books of the bank against which
no claim is pending with the bank as non-reversal of such liability has an adverse
impact on the capital adequacy of the Bank.

IBA has suggested uniform procedure to be followed in respect of guarantees

issued with the protective clause. Comply with the following guidelines for
reversal of the liability in respect of expired guarantees.

a) The expiry period of the guarantee is to be diarised taking into account the
claim period, if any.

b) If no claim or demand is received from the beneficiary on or before the validity

period/ claim period of the guarantee on the due date, an intimation is to be sent
to the beneficiary by a registered AD letter to the effect that the guarantee has
expired and request them to return the origi

b) If no claim or demand is received from the beneficiary on or before the validity

period/ claim period of the guarantee on the due date, an intimation is to be sent
to the beneficiary by a registered AD letter to the effect that the guarantee has
expired and request them to return the original guarantee bond.
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c) In the letter itself it must be made clear that the beneficiary is not entitled to
invoke the guarantee as the guarantee has already expired.

d) If in spite of this notice the expired guarantee bond is not returned by the
beneficiary within one month from the date of notice, the liability under the
guarantee may be reversed (without waiting for original guarantee).

Reversal of Entries - BG without Protective Clause

In the cases of BG which do not contain Standard Protective Clause, the guarantee
can be reversed only after return of guarantee or a letter from the beneficiary
stating that the beneficiary has no claim under the guarantee.

Reversal of Entries - Guarantees issued in Judicial Proceedings

The Bank Guarantees issued in Judicial Proceedings are to be kept valid , subsisting
and alive till the disposal of the proceedings and till discharge by the Hon‘ble
Court.

Settlement of claims - Court Orders:

Wherever such claims are subject matter of court orders bank has to settle the
claim / make payment after the court delivers its final judgement/order directing
the Bank to pay or vacating the injunction order earlier granted.

Where the Bank is a party to the proceeding initiated by Government for

enforcement of the Bank Guarantee and the case is decided in favour of the
Government by the court, Bank should not insist on production of certified copy
of judgement as the judgement/order is pronounced in open court in the presence
of the parties/their counsels and the judgement is known to the Bank.

In case the Bank is not a party to the proceedings a signed copy of the minutes of
the order certified by the Registrar / Deputy or Assistant Registrar of the court or
the ordinary copy of the judgement /order of the court duly attested to be true
copy by Government counsel should be sufficient for honouring the obligation
under the Guarantees unless the Guarantor Bank decides to file any appeal against
the order.

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Bank Guarantee vs. Letter of Credit

Bank Guarantee and Letter of Credit – both are promises from a financial
institution that a borrower will be able to repay a debt to another party, no matter
what the debtor's financial circumstances.

By providing financial backing for the borrowing party (often at the request of the
other one), these promises serve to reduce risk factors, encouraging the
transaction to proceed. But they work in slightly different ways and in different
situations.

Both bank guarantees and letters of credit work to reduce the risk in a business
agreement or deal. Parties are more likely to agree to the transaction because they
have less liability when a letter of credit or bank guarantee is active. These
agreements are particularly important and useful in what would otherwise be risky
transactions such as certain real estate and international trade contracts.

Letters of credit are especially important in international trade due to the distance
involved, the potentially differing laws in the countries of the businesses involved,
and the difficulty of the parties meeting in person. While letters of credit are
primarily used in global transactions, bank guarantees are often used in real estate
contracts and infrastructure projects.

Another key difference between bank guarantees and letters of credit lies in the
parties that use them. Bank guarantees are normally used by contractors who bid
on large projects. By providing a bank guarantee, the contractor provides proof of
its financial credibility. In essence, the guarantee assures the entity behind the
project it is financially stable enough to take it on from beginning to end. Letters
of credit, on the other hand, are commonly used by companies that regularly
import and export goods.

Purpose of Letters of Credit is reducing the Risk involved, whereas the purpose of
Bank Guarantees work as buffer in case of failure of Contractual Obligations.

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Another distinctive difference between the two instruments is that Bank
Guarantees are more costly than Letter of Credit. This is due to its ability to protect
both parties in the transaction, and also due to the Bank Guarantee covering a
wider range of higher value transactions.

Bank Guarantee and Standby LC

After Second World War, Banks in the US were not allowed to issue guarantees.
Then they found that if they changed the format of the guarantee slightly they
could adapt a Letter of Credit in such a way it became de facto a “bank guarantee”.
Japanese Banks also issue Standby Credits for similar reasons. In short Standby LC
is a bank guarantee in LC format.

A Standby Letter of Credit (SBLC / SLOC) is a guarantee that is made by a bank on

behalf of a client, which ensures payment will be made if their client cannot fulfil
the payment.

SBLC covers the beneficiary (/seller) and offers financial compensation in case of
the applicant (/buyer) defaulting on its named obligation (financial or otherwise)
i.e. it guarantees financial compensation in case of a claim in conformity with the
instrument and the underlying rules. So contrary to a “normal” LC you would only
draw under the SBLC in case something goes wrong An SBLC is frequently used as
a safety mechanism for the beneficiary, in an attempt to hedge out risks associated
with the trade.

It is also perceived as a “payment of last resort” due to the circumstances under

which it is called upon.

Furthermore, the presence of an SBLC is usually seen as a sign of good faith as it

provides proof of the buyer’s credit quality and the ability to make payment.

Essentially, it is an insurance mechanism to the company that is being contracted

with.

Difference between SBLC and LC

A Standby Letter of Credit is different from a Letter of Credit.

An SBLC is paid when called on when conditions have not fulfilled.

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However, a Letter of Credit is the guarantee of payment when certain conditions
are fulfilled and documents received from the selling party. In the event that there
is non-payment, the seller will present the SBLC to the buyer’s bank so that
payment is received.

A letter of credit is a short-term instrument, where the expiry is usually 90 days.

A standby letter of credit is a long-term instrument, (validity is usually one year or

so)

Difference between SBLC and Bank Guarantee :

Level playing field - Bank Guarantees (except for those under UDRG 758 ) are
subject to a certain law and jurisdiction, which is either that of the applicant or the
beneficiary. However, in case of SBLC, the underlying rules are either UCP or ISP.

Expiry date - a guarantee can be open ended, a SBLC cannot be open ended.

ICC (International Chamber of Commerce) formulated a separate set of rules

relating to SBLC in 1998 known as International Standby Practices (ISP-98), ICC
Publication No 590 which has come into force on 01-01-1999.

ISP- 98 reflects the generally accepted practices, customs and usage of Standby
LCs.

Standby LC can perform the functions of various guarantees like Advance Payment
Guarantee, Performance Guarantee etc. by suitably amending the wordings.

Banks in India are allowed to issue only Commercial SBLCs for importing goods
into India.

DPG & BCA

DPG and BCA are normally involved in purchase of heavy plant and machinery
only. This system is also advantageous to the Bank as no outflow of funds is
involved. These two products are of much helpful to Banks in adverse Credit
Deposit Ratio (CD Ratio) situations.

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Deferred Payment Guarantees (DPG)

Issuance of deferred payment guarantees favouring suppliers arise where

machineries are supplied on credit and the payment is to be made by way of
instalments. The manufacturers will agree to supply the same only if such
instalments are guaranteed by the bank.

In the event of non-payment of instalment dues by the buyer, i.e., principal debtor,
banker issuing the deferred payment guarantee will have to make the payment.

Bills Co-acceptance

Bills Co-acceptance (BCA) means “an undertaking from the third party (Bank) to
make payment to the drawer of the bill (seller) on due date even if the buyer fails
to make the payment on that date”.

Thus, in the Co-acceptance of the bills, the bank which stands as co-accepter
undertakes to make timely payment to the seller even if the buyer fails to make
payment on due date.

In terms of RBI regulations, the co-acceptance limits should be sanctioned only to

the borrowers of the bank who enjoy other credit facilities with the bank.

Main Difference between DPG & BCA :

In case of both DPG & BCA, Suppliers are sure of receipt of payments. However,
Suppliers who are cash rich may prefer DPG as they may not in need of funds
immediately. In case of BCA, since Co-accepted Bill is available, Suppliers who are
in need of funds, can get them discounted with their Bank. As such, Cash Rich
Suppliers may prefer DPG and Suppliers who

In case of both DPG & BCA, Suppliers are sure of receipt of payments. However,
Suppliers who are cash rich may prefer DPG as they may not in need of funds
immediately. In case of BCA, since Co-accepted Bill is available, Suppliers who are
in need of funds, can get them discounted with their Bank. As such, Cash Rich
Suppliers may prefer DPG and Suppliers who need immediate funds may prefer
BCA.

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Co-acceptance of bills means “an undertaking from the third party (Bank) to make
payment to the drawer of the bill (seller/exporter) on due date even if the
buyer/importer fails to make the payment on that date”.

Co-acceptance is a means of non-fund based finance whereby a Bill of Exchange

drawn by an seller/ exporter on the buyer/ importer is co-accepted by a Bank. By
co-accepting the Bill of Exchange, the Bank undertakes to make payment to the
exporter even if the importer fails to make payment on due date.

The co-acceptance by the buyer’s/ importer’s banker acts as a guarantee for the
seller/exporter for timely receipt of proceeds from the buyer/ importer. For the
Bank, it is a non-fund based exposure on the buyer/importer.

Benefits to Customer:

a) For the importer, Co-acceptance works out cheaper as compared to opening

Import Letter of Credit (LC) since under LC, commission is payable from the date
of opening LC whereas in the case of co-acceptance commission is applicable after
shipment has taken place from the overseas exporter’s end.

b) Further, unlike in LC, the importer need not use up his non-fund based limit
until the goods are shipped by the exporter and documents are received at the
counters of the importer’s Bank.

c) It is a means of non-recourse finance for the exporter, thereby strengthening

the importer’s bargaining power.

Benefits to Bank:

a) Additional Avenue for fee income.

b) Customers, who do not use their LC limits with the Bank, can be encouraged to
make use of the Co-acceptance facility, which is cheaper.

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15. Export Finance
In this chapter I am covering points related to Export Credit

Export Credit

Foreign exchange is essential component of growth and development. To sustain

the accumulation of foreign exchange, growth of export sector is necessary for the
country. For this growth, roles played by Bank in extending timely credit to
exporters assumes significance.

Export Credit is broadly classified into two categories, depending on at which

stage of export activity finance is required, viz. :

1. Pre-shipment Credit

2. Post-shipment Credit

Financial assistance extended to the exporters prior to shipment of goods fall

within the scope of pre shipment finance and assistance extended after
theshipment of goods falls within the scope of post-shipment of finance.

Export Finance (both at pre shipment and post shipment stages ) in India is
governed by FEMA, directives issued by RBI from time to time, regulations of
Directorate General of Foreign Trade (DGFT), FEDAI rules and guidelines issued by
ECGC Ltd.

Pre Shipment Credit

Working capital finance extended by Bank to exporter for purchase, processing,

manufacturing or packing of goods prior to shipment on the basis of LC opened
in favour or exporter or some other person by an overseas buyer or on the basis
of a confirmed and irrevocable order or any other evidence of an order for export
placed on the exporter /some other person, unless lodgement of Export order/LC
has been waived.

Pre-shipment credit is governed by the regulations stipulated by the Reserve Bank

of India and is extended at concessional interest rates as per Reserve Bank of India
directives.

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Pre-shipment credit may be extended either in Indian Rupees or in designated
currencies (presently USD, GBP and EURO) at the option of the exporter.

PCs may be extended for domestic as well as for imported inputs.

The period of a PC will generally begin with the procurement of raw materials for
execution of a particular LC / Order and the credit gets liquidated once the goods
are shipped and shipping documents are presented to the Bank. The liability under
the PC shall stand converted as Post-Shipment liability upon negotiation /
purchase / discount of the export bill.

PCs are generally granted to Exporters who have export orders or a Letter of Credit
established by the overseas buyer in their favour. However, Packing Credit can also
be granted to suppliers or supporting manufacturers who do not have export
order/ LC in their own name and are exporting through merchant exporters or Star
Exporters who are the Export Order Holders ( EOH ) subject to observance of
requirements stipulated by the Reserve Bank of India in this regard.

Goods and services going into SEZ from Domestic Tariff Area (DTA) shall be
treated as exports. Supply of goods and services from domestic tariff area to
special economic zone would therefore be eligible for export credit facilities.

RBI has permitted banks to release / grant PCs to exporters having good track
record, on the basis of ―Letters of Indication‖ or in anticipation of Export orders
without insisting for lodgement of Export LC / confirmed order or contract at the
time of release of PC depending upon their judgement regarding the need under
Running Account Facility (RAF).

Packing Credit is normally extended as fund-based advance secured by way of

hypothecation or pledge of goods. However, non-fund based facility can also be
extended by way of opening inland LCs or back to back LCs in favour of the sub
suppliers for supply of goods to be exported or by way of opening import LCs for
import of raw materials, accessories etc., for manufacture of goods meant to be
exported.

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General guidelines applicable to Working Capital facilities viz., assessment,
preparation of Credit Report etc., are to be followed in addition to the following :

a) Applicant should not have been be placed in the Exporters Caution List issued
by Reserve Bank of India/ defaulters list by the Bank.

b) All exporters / Importers (unless specifically exempted by the Govt.) should

possess Importer- Exporter Code number ( IECN.) allotted by Directorate General
of Foreign Trade (DGFT) unless specifically exempted.

c) Exporter should not placed under Specific Approval List ( SAL ) by ECGC.

The maximum period for which PC can be granted at concessional rate of interest
as per Reserve Bank of India directives is 180 days. This period can be extended
further by additional 90 days i.e. up to an aggregate period of 270 days at a higher
concessional rate of interest as per Reserve Bank of India directive.

Running Account Facility

In the cases of exports, the exporters have to procure raw material, manufacture
the export product and keep the same ready for shipment, in anticipation of
export orders from the overseas buyers. This is in view of, seasonal availability of
raw materials or when the time taken for manufacture and shipment of goods is
more than the delivery schedule as per export contracts. Having regard to the
difficulties of the exporters in availing of adequate pre-shipment credit in such
cases, RBI has authorized the banks to extend packing credit running account for
commodity exports subject to the following conditions:

a) The facility can be considered only for existing established exporters having
good track record and classified under Standard Asset (S1 / S2 parties)

b) An undertaking has to be obtained from the Exporters to produce the Export

LC / Order within a reasonable time.

c) In respect of export of commodities subject to Selective Credit Control

directives, exporters should give an undertaking to produce the Export LC / Order
within a period of 30 days from the date of grant of PC.

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d) Commodity to be exported should be of uniform grade and not made to specific
order.

e) The liability may also be liquidated with proceeds of export documents against
which no PC has been availed by the exporter.

Liquidation of outstanding in running account:

In the case of ‘Running Account’, each export bill will be individually marked by
the bank to monitor the period of advance. When the bank receives the export bill
for negotiation or collection, the export proceeds will be marked against the
earliest outstanding in the account on ‘First-in-First-Out’ (FIFO) basis.

Running account facility should not be granted to sub-suppliers.

Clean Packing Credits (CPCs) are granted where the exporter is unable to procure
the material immediately on making payment or within a short transit period as
he has to procure the goods from the outstation market. The CPCs are to be
granted only in those cases where advance payments are to be made by the buyer
to the seller in terms of the contractual arrangement and there is a time gap
between the date of payment of advance and the date of delivery of the material.

As and when stock is received against the CPC, the CPC is to be re-designated as
PCs.

Deemed Exports

Deemed Exports are supplies made by units in Domestic Tariff Area (DTA) to a unit
in EOU / EPZ / SEZ / STP / EHTP / BTP AND against orders for supplies in respect
of projects aided / financed by bilateral or multilateral agencies / funds involving
World 50Bank, IBRD, IDA. Which are eligible for grant of normal export benefits
by Government of India.

The supplies made to projects in India as per FTP are also eligible for concessional
finance facility at both the pre-supply as well as post-supply stages.

Supplies made to other Multilateral agencies or others though may enjoy the
status of Deemed Exports for other purposes, are not eligible for Packing Credit
at concessive rates.

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PCs to projects financed by Multilateral or Bilateral agencies / funds can be
considered only to eligible suppliers on lines similar to physical exports subject to
certain additional terms and conditions which are as under:

a) The advance should be provided only on the basis of an order placed for supplies
under the Multilateral / Bilateral agencies treated as under Deemed Exports.

b) In cases where the Multilateral / bilateral agencies do not directly place the
order on the supplier but only through a Central Agency of the Government of
India like the Central Water and Power Commission etc., the PCs can be provided
on the basis of an authenticated copy of the contract between the project
authorities and the supplier together with a certificate issued by the Central
Agency to the party to the effect that they have been awarded a particular tender
under international competitive bidding for supplies to such aided project in India.

c) The supplies made by the Indian suppliers under bilateral / multilateral Fund are
used by the agencies only for its aid projects / programmes in India and are eligible
for the grant of normal export benefits by the Government of India.

d) As goods under the order are supplied to projects within India, the PCs granted
to Manufacturers / suppliers of goods to projects financed by bilateral or
multilateral agencies / funds have to be liquidated out of payments received from
the project authorities.

e) Post-supply credit under Deemed Exports can be extended at concessional rate

of interest for a maximum period of 30 days or upto the date of payment by the
Project Authority whichever is earlier.

f) The liability under such PCs can also be adjusted from free foreign exchange
representing payments for the supplies of goods made under such bilateral/
multilateral agency/fund.

g) The advance should normally be liquidated from free forex representing

payment for supplier of goods to these agencies; it can also be repaid / prepaid
out of balance in EEFC / rupee resources to the extent supplies have actually been
made.

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h) Maximum period permitted for post-supply credit is 30 days ( advance becomes
overdue after 30 days; overdues, if liquidated within 180 days from notional due
date, ECNOS for extended period, if not paid within 210 days, ECNOS – post
shipment from date of advance.

i) Eligible for refinance.

Duty Draw Back

The scheme of Duty Draw Back (DDB) allows the refund of Excise/Customs Duty
paid on indigenous/ imported raw materials, components etc., used in exported
products. means refund of duty chargeable on any imported materials or refund
of excise duty in case of indigenous raw materials used in the manufacture of
goods to be exported from India.

The Draw Back schedule contains the items eligible for Draw Back as well as the
Draw Back rates. The rates of Draw Back are classified as under :

a) All Industry Rates (AI)

b) Brand Rates/Special Brand Rates/

All Industry Rates are applicable in general to all exporters of the specified items
and these rates are published by the Government of India every year.

Where the duty expenses are higher than the All India Rate as published by the
Government of India, the exporter may opt for brand/special brand rate fixation
of which is done on a specific request to Draw Back Section, Department of
Revenue, Ministry of Finance, after effecting the shipment.

The Government Department concerned will process the claim and issue a letter
of authority confirming the rate of eligibility of the claim.

For availing the Duty Draw back facility, the exporter has to file the shipping bill
along with the customs documents at the time of shipment. In the shipping bill,
the exporter has to make the prescribed declaration and statements regarding the
Duty Draw Back claimed. The Draw Back shipping bill is itself treated as an
application for claiming Duty Draw Back.

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The Duty Draw Back entitlement as claimed by the exporters are certified by the
Customs Authorities and settlements will be made in due course.

Advances against Duty Draw Back Entitlements can be considered at

a) pre-shipment stage,

b) post-shipment stage.

Advances can be considered against Duty Draw Back Entitlements at the pre
shipment stage under the following circumstances :

Where the cost of product to be exported exceeds the FOB value of the goods and
where the borrower needs an advance to bridge the gap between the actual cost
and the export price. This is subject to the product in question being eligible for
the Duty Draw Back Entitlement.

The least of the limits indicated below are to be considered :

a) 50% over and above the FOB value of the shipment subject to a maximum of
100% of the domestic cost of the export product or ;

b) 75% over and above the FOB value of the shipment provided that the value of
the import content in the export product is not less than 40% of the FOB value of
the shipment and the rate of import duty paid on the import content of the export
product is not less than 100% or ; c) Upto an amount established to the satisfaction
of the bank on the domestic cost of the export product.

Margin should not normally exceed 10% of the eligible advance amount.

Special Conditions related to Advances against DDB

a) The advance should be on the basis of an irrevocable LC opened by a Bank of

standing abroad or on a firm export order.

b) As the shipment would not have taken place at the time of granting the PC, the
question of obtaining provisional customs certified shipping bill of the Duty Draw
Back claims will not arise. Hence, exporters should submit an application in the
prescribed form seeking advance from the branch.

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c) All advances to be considered against Duty Draw Back entitlements d) Advance
should be covered under the Export Production Finance Guarantee (EPFG) of ECGC.

e) The period of advance should not exceed 90 days and limitation if any placed
under EPFG.

f) The borrower should file with the appropriate disbursement authority – Customs
authority, a copy of the application submitted by him to the Bank for
disbursement of advance at the pre-shipment stage against Duty Draw Back
entitlements and execute in favour of the Bank an irrevocable Letter of Authority
empowering the Bank to receive amounts directly from the disbursement
authority.

Accounting procedure

1. Advance should be accounted under Packing Credit‖ only till the entire liability
is cleared. Each advance should be maintained as a separate account to be wiped
off by credits received from Customs authorities.

DDB Finance at Post-shipment Stage

a) Provisional certificate of Duty Draw Back entitlements of the Customs

Authorities as certified on the copy of the Shipping Bill or on the basis of
endorsements by the Customs authorities of the appropriate All Industry Rate
claimed by the exporter in the shipping Bill pending sanction of the branch/special
brand rate by the Government of India.

b) Extent of finance

i) Upto 50% of the FOB value of the shipment, or;

ii) Upto 75% of the FOB value of the shipment, provided that the value of the
import content in the export product is not less than 40% of the FOB value of the
shipment and the rate of import duty paid on the import content of the export
product is not less than 100% or ;

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iii) Upto the amount provisionally certified by the Customs authorities on the copy
of the shipping bill or upto the All Industry Rate claim amount endorsed by the
Customs authorities on the copy of the shipping bill pending sanction of brand
rate/special brand rate by the Government of India.

iv) Up to the value of drawback shown in the EDI shipping bill cum GR.

Margin should not exceed 10% of the amount worked out as above.

Period of advance should be restricted to 90 days.

Pre-disbursal Conditions (DDB)

a) Advance should be covered by the Export Finance Guarantee (EFG) of ECGC.

b) The amount of advance should be subject to further limitations if any stipulated

under the EFG of ECGC.

c) Where the liability outstanding under pre-shipment credit towards entitlement

is more than the DDB entitlement (as certified by Customs), the balance portion
should be recovered from domestic resources

DDB Settlement by Customs

The payment of the final amount of Duty Draw Back will be made directly by the
Customs authorities to the Bank by means of a cheque drawn on Reserve Bank of
India, furnishing therewith the details such as name of The exporter, Bank Code
No., GR Form No., date and amount of Duty Draw Back sanctioned provisionally,
as also the amount finally sanctioned.

If, for any reason the Duty Draw Back amount is partially settled by the Customs,
or not settled at all, even though provisionally certified by them earlier in the
shipping bill, the advance granted against such entitlements or the extent of
advance not cleared out of the settled amount is not to be treated as an Export
Advance and the advance to be got recovered. In such cases, domestic commercial
rate of interest as applicable to Inland Finance is to be charged

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Diamond Exports, Finance to EOH, Sub Suppliers

The Export trade of Diamonds depends almost entirely on the imported roughs.

Banker has to rely on the integrity of the borrower rather than security, as the
roughs are sent to various places for cutting and polishing, though Packing Credit
is granted against the hypothecation of stocks. Valuation of security requires
special skill. The market is highly volatile and requires close study of trends and
prospects, which is very difficult.

The Diamond trade/industry is highly localised i.e. in and around Bombay and
Surat.

Exports of diamonds from India should be accompanied by Kimberly process

certificate to the effect that no conflict rough diamonds have been used in the
process.

Gem and Jewellery export promotion council would be validating/ verifying the
Kimberly process certificates Diamond exporters can be broadly classified into 2
categories:

a) Sight holders

b) Non-sight holders

Sight holders normally get their requirements of roughs from DTC, London. In case
the diamond allocation from DTC London falls short, they purchase the balance
requirement from ―Antwerp.

Non sight holders can be of two categories:

(i) Exporters who purchase rough diamonds locally from ―Hindustan Diamond
[Link]. (HDCL) or MMTC and also from other DTC sight holders and from Antwerp.

(ii) Exporters who purchase finished goods locally for exporting.

Of the total exports, 60% is accounted for by sight holders and the balance by
non-sight holders. As such our emphasis should be for financing sight holders
only, though finance to non sight holders can be considered selectively depending
upon their past records and merits.

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Conflict Diamonds

As conflict diamonds play a large role in funding the rebels, UN has prohibited
direct/ indict import of all types of rough diamonds from Sierra Leone and Liberia
and banned trading in conflict diamonds. Our country has adopted UN mandated
Kimberley Process certification Scheme to ensure that no rough diamonds mined
and illegally traded enter the Country. Imports of diamonds into India should
therefore be accompanied by Kimberly Process Certificate (KPC) and exports of
diamonds from India should be accompanied by KPC to the effect that no conflict
or rough diamonds have been used in the process. KPCs would be
verified/validated by the Gem and Jewellery export promotion council.

RBI has therefore stipulated that Banks should obtain prescribed undertaking
from clients who have been extended credit for doing any business relating to
diamonds.

Diamond Dollar Account

Under the scheme of Government of India, firms and Companies dealing in

purchase/sale of rough or cut and polished diamonds/diamond studded Jewellery,
with track record of at least 3 years in import or export of diamonds and having
an average annual turn over of Rs 5 crores or above during preceding three
licensing years (licensing year is from April to March) are permitted to transact
their business through Diamond Dollar accounts with their banks.

Antwerp is a port city in Belgium. Antwerp is known as the diamond capital of the
world.

PCs to Export Order Holder & Sub Suppliers

PCs can be shared between an Export House / Trading House / Star Trading House
/Super Star Trading House or Manufacturer Exporter, referred to as Export Order
Holder (EOH) and his sub-supplier of raw-materials / components / manufactured
goods.

The guidelines for granting PCs in such cases are as under :

A) Inland LC (IELC)

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a) Inland LCs (IELC) can be opened in favour of the sub-supplier(s) only on the
basis of the Export Orders / Export LCs received by the EOH.

b) Inland LCs to be opened in favour of the sub-supplier(s) should specify the

goods to be supplied by them.

c) The validity of the Inland LC should be within the overall validity of the Export
LC / Order.

d) In cases where there are more than one sub-supplier, Inland LCs can be opened
in favour of all the sub-suppliers in which case the aggregate value of all Inland
LCs opened in favour sub-suppliers should be within the aggregate value of the
Export Orders / LCs received / eligible P C amount.

e) The latest date for supply of goods under Inland LC should provide sufficient
time for the EOH to receive the components from each sub-supplier / s under the
ILC(s), assemble, pack and effect shipment within the validity of the Export Order
/Export Letter of Credit.

f) Payment under the IELC should be to the debit of the Packing Credit Account of
the EOH . The period of the PC will have to be reckoned from the drawal of PC by
any one of the sub-suppliers and hence EOH may avail PC at concessional interest
rate only for the balance period subject to maximum period as per sanction terms
whichever is lower.

g) In cases where EOH desires to execute a portion of the export order/LC,

branches may grant PCs to EOH after excluding the portion of IELC opened
favouring sub-supplier(s).

h) The Inland Export LCs opened under the scheme should invariably provide for
sight payment and contain a clause that the supply of goods under the LC is for
execution of the export order held by the LC opener (EOH).

Packing Credit to Sub-Suppliers

Scheme covers LC / Export Order received in favour of Star Export Houses or

Manufacturer Exporter only.

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EOH opens ILC specifying goods to be supplied by sub-supplier; sub suppliers
banker will grant EPC as working capital to enable sub-supplier to manufacture
components; and the advance is to be liquidated from amount received from ILC
opening bank.

The scheme covers only first stage of production cycle and will not cover suppliers
of raw materials / components to such immediate suppliers of components to
EOH.

If EOH is mere Trading House, facility will be available to the manufacturer, to

whom the order has been passed on by the EOH.

EOU / EPZ / SEZ units supplying goods to another such unit for export will be
eligible for Rupee Packing Credit but the supplier unit will not be eligible for post
shipment credit as the scheme does not cover sale of goods on credit terms.

Sale on credit terms by sub-supplier to EOH/ manufacturer is not covered under

the scheme.

PCs will be eligible for concessional rate of interest.

PCs will be eligible to be covered under the WTPCG of ECGC.

The PCs (IELC) will have to be liquidated only out of payments received under IELC.
Once the sub-supplier supplies the goods to the EOH as per the IELC terms, his
obligation of performance under the scheme will be treated as complied with and
penal provisions for delay in export or non-export by the EOH will not be
applicable to the sub-supplier.

The Sub-supplier will not be eligible for pre-shipment advance in Foreign currency
(PCFC).

Financing Route Through Exports

As per the current Foreign Trade Policy a Star Export House (SEH) which shows an
annual growth of more than 25% in its turnover is entitled to additional incentive
of 10% of incremental growth in the export turnover.

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This additional incentive is given by way of exemption of import duties on goods
to be imported by Star Export House. This facility is given to SEHs only and not to
general exporters.

Consequent to the addition of this clause in Foreign Trade policy, general

exporters opt to route their exports through SEHs because the SEH passes on a
portion of the incentive it receives, to the manufacturer/shipper. Such transactions
which are routed though the SEH‘s are called Route Through Exports.

The method of operation is as follows:

The SEH is referred to as exporter and the supporting manufacturer as

manufacturer/shipper. Export order or LC is procured in the name of SEH, where
the LC is in favour of shipper/manufacturer it is transferred to SEH.

SEH places purchase order with shipper/manufacturer on back to back basis; no

back to back LC or inland LC in favour of manufacturer/shipper is opened by SEH.

SEH draws bill of exchange on overseas buyer or his banker as per LC terms.

SEH will give disclaimer in favour of supporting manufacturers making them

eligible for export incentives available under the Foreign Trade Policy. The
disclaimer is given because the special benefit of 10% of incremental export
turnover is specifically reserved for SEH and cannot be transferred to
shipper/manufacturer either in full or in part.

The fundamental requirement of route though exports is that the shipping bill
bears the name of the both the SEH and manufacturer/shipper.

The SEH will authorize the negotiating bank to transfer the proceeds of the
discount bill to the account of the manufacturer/shipper.

No recourse can be had to the export house for any default on the payment of the
export bill by the drawer.

The shipper/manufacturer who happens to be banks constituent, will undertake

to accept any liability arising out of the non payment of the export bill by the
drawee.

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The Bank realization certificate for the realization of export proceeds is to be made
out in the name of SEH only.

Sharing PCs

When a Merchant Exporter / STAR Export House receives a confirmed export order
or LC and he needs to procure the goods, or get the same processed/manufactured
by another supplier or manufacturer (who is normally referred to as supporting
manufacturer), he can share the PC with such supporting manufacturer.

Guidelines in this regard are:

a) Sharing of PCs is available only for goods exported and not for semi-finished
goods / components used for manufacture of goods to be exported.

b) Sharing of finance should not lead to double financing of the export order / LC.

c) As far as possible, merchant exporter must open a back to back LC / domestic

LC in favour of supporting manufacturer.

d) Wherever opening of back to back LC / domestic LC is not possible or

convenient, the merchant exporter / SEH must give a letter stating the particulars
of export order / LC and the portion of the order to be executed by the
manufacturer exporter.

e) Under an export order / LC, the manufacturer exporter can avail PC for
procuring raw materials / accessories / components for manufacturing the goods
meant for Export. On receipt of the goods meant for exports the Merchant
Exporter / SEH can also avail PC for packing the goods and / or for transporting
the goods to the port of shipment / airport. The aggregate period for which PC
can be given to both Manufacturer & Merchant Exporter / SEH at concessional
rates should not exceed 180 / 270 days.

Export/Trading/Star Trading/Super Star Trading Houses have been accorded

special status. When exporters achieve the specified level of exports over a period,
they may be recognized as EH/TH/STH/SSTH. Exports made both in free foreign
exchange and in Indian rupees shall be taken into account for recognition.

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The objective of this scheme is to recognize them as the respective houses” with a
view to building marketing infrastructure and expertise required for export
promotion. The exporters, registered with FlEO or EPC are, eligible for this
purpose. The export performance criteria may be based on either f.o.b. value of
exports or net foreign exchange earnings.

The Criteria to decide EH, Trading House, STH or SSTH is as under:

Category of Houses Average FOB value of FOB value of eligible

exports during the export during preceding
preceding 3 licensing licensing year in rupees
years, in rupees

Export House Rs. 15 crores Rs. 22 crores

Trading House Rs. 75 crores Rs. 112 crores

Star Trading House Rs. 375 crores Rs. 560 crores

Super Star Trading House Rs. 1125 crores Rs. 1680 crores

The manufacturing or merchandising units, who have achieved the following

targets can be accorded the status of above mentioned Export Houses.

Deemed exports are not counted for this purpose.

Export House is mostly home-based organization, located in the manufacturer’s

country, which is involved in the export of products that the manufacturer has
produced. These export houses carry out most of the export-related activities
overseas, via their own agents and distributors who are in place in the country
where the product is being exported.

Trading House is a business that specializes in facilitating transactions between a

home country and foreign countries. A trading house is an exporter, importer and
also a trader that purchases and sells products for other businesses.

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Export House and Export Broker

Export house is a company which deal directly in export of products manufactured

by others where as Export Broker act as facilitator or introductory party but deal
is done between manufacturer and buyer.

Export Order Holder

Export House; Trading House; STH; SSTH; Manufacturer Exporter are known as
Export Order Holder (EOH)

PC for Exports on Consignment Sale basis.

Exports on Consignment Sale basis essentially mean where the goods are
consigned to an agent/consignee for eventual sale and remittance of sale
proceeds. The goods sent thus are either auctioned or sold straight away as in the
case of cut flowers etc.

Liquidation of PC (Consignment Exports)

a) The goods are consigned to the agents/consignees who sell the same in an
auction/off the shelf. As such, there does not exist any letter of credit / firm order
for consignment exports. Hence, the value of the export proceeds will not be
known at the time of effecting the shipment.

However, for the purpose of Customs clearance and completion of GR formalities

a provisional Invoice is to be drawn on the agent and the same can be accepted as
the value of the goods exported.

a) Upon shipment of the goods & submission of the export documents the PC
amount may be liquidated as follows :

1. The bills may be purchased/discounted with suitable margin, or

2. The entire liability in the PC may be transferred to a special account Post-

shipment Rupee advance, or

3. By granting Rupee advance with suitable margin.

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c) The advance is to be liquidated in due course by the remittance received from
abroad in payment of the consignment sold duly ensuring that the remittance
received is towards the export of the commodities financed under the PCs.

d) The remittance received from abroad will be accompanied by Accounts sale by

the agent/consignee giving details of sale of goods sent on consignment basis viz.,
the price at which goods are sold on various dates, warehousing & transport cost,
his commission and handling charges etc. The net sale proceeds may differ from
the provisional Invoice amount on the above account. The GR/PP form may be
release to RBI duly enclosing this statement of account.

e) In case of short realisation with regard to Post-shipment advance the amount

short realised should be recovered immediately and interest should be charged on
the short realised amount at domestic rate from the date of granting Post-
shipment till recovery.

PC for Imports against Entitlements under Advance Licences

In the normal course, PCs are granted against Export Orders/LCs or under the
Running Account Facility taking into account past performance.

An Advance Licence is issued as a duty exemption scheme. A Duty Remission

Scheme enables post export replenishment/ remission of duty on inputs used in
the export product.

In the case of imports of raw-materials under advance licences for manufacture of

export items, branches may disburse PCs without insisting upon an export order/
LC since the imported materials will ultimately be utilised only for exports, subject
to the following conditions:

a) Bank has to satisfy itself that the imported raw materials will be utilised for the
items to be exported.

b) Firm export order/LC should be submitted by the exporter within 60 days from
the date of disbursal of PC, failing which, normal rate of interest will be charged.

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c) The Advance Licence is issued favouring the exporter. In other words, any
transferee of Advance Licence is not eligible for this facility. The above facility is
to be considered only on a case to case basis, and as special case only to parties
whose track record has been good and where the Bank is satisfied that the facility
is not likely to be misused.

PCs for Export of Goods meant for Exhibition and Sale

Firms/Companies and other organizations participating in Trade Fair/Exhibition

abroad are permitted to take/export goods for exhibition and sale outside India
without the prior approval of RBI. Unsold exhibit items may be sold outside the
exhibition/trade fair in the same country or in another third country. Such sales at
discounted value are also permissible. Exporters can Gift unsold goods up to the
value of USD 5,000 per exporter, per exhibition/trade fair. Branches can approve
GR forms for export items for display or display cum sale subject to the following

a) The exporter shall produce relative Bill of Entry within one month of re-import
of goods in to India.

b) The sale proceeds of the items sold are repatriated to India in accordance with
FEMA regulations.

c) The Exporter shall report to the branch the method of disposal of all items
exported, as well as the repatriation of proceeds to India.

Banks can extend Credit facilities for goods meant for exhibition and sale abroad,
at the first instance as a normal domestic credit. After the sale is completed and
the proceeds repatriated, they can allow the benefit of concessional rate of interest
for the stipulated/eligible period by way of refund.

PC for Consultancy Services

In case of Consultancy Services, exports do not involve goods. In such cases, pre-
shipment finance at concessional rate of interest can be extended to exporters for
meeting the expenses in connection with the technical and other staff employed
for the project and purchase of any materials required for the purpose as well as
export of computer software both standard and custom built software programs.

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While granting the PC facilities advance payments received if any, must be taken
into account.

PC for Software Exports

Packing Credit requirement can arise to meet the cash flow gaps of the exporter
undertaking programming services or manpower exports or development of
solutions to specific problems of the customers.

As per RBI guidelines the following are eligible for export credit a) IT Service – any
service which results from the use of any IT software over a system of IT products
for realizing value addition.

b) Manpower exports - deputation of professionals for delivering programming

services at customers location.

c) Project services – customized software development providing solution to

specific problems of customer which would be utilized by corporate main frame
and mini computer users

Liquidation of PC

PCs to be eligible for concessional rate of interest must be repaid from funds
received by the Exporter from either or combination of the following sources:

a) Proceeds of Export Bills Negotiated, Purchased or discounted in the case of

export bills presented by the exporter borrower (i.e., where relative GR/SDF form
is signed by the borrower or a shipper and or counter-signed by the borrower);

b) Proceeds of export bills negotiated by other banks under LCs restricted for
negotiation to them;

c) Proceeds of Advance payment received by the exporter through the permitted

method after the PC is released.

d) In the case of supplies made under an Inland Export LC opened by a EOH in

favour of the sub-supplier, by proceeds received from Issuing Bank of the IELC
being the payments received under the IELC.

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e) In the case of exports made through the STAR Export House, from the Inland
Bill proceeds received from the bankers of the STAR Export House supported by a
certificate.

f) Proceeds of advances granted against undrawn balances representing export

earnings under the relevant contract/LC.

g) By sale proceeds of residual/by-product oil in the case of PC granted to

exporters of HPS groundnut and de-oiled and defatted cakes, in excess of the FOB
value of the export order.

h) Proceeds of payments received in the form of Duty Draw Back where PC has
been granted against such entitlements due to the exporter.

i) In the case of PC against goods sent abroad for exhibition and sale, the PC would
have to be initially treated as an inland transaction. Only in case of goods sold and
remittances of such sale proceeds are received, the same should be treated as
export credit and interest rates as applicable to PC will have to be charged.

j) By granting Rupee Advance.

Under normal circumstances, liquidation of PCs shall be as follows:

(i) The PCs have to liquidated out of export bill proceeds of the relative export
order / LC

(ii) Under the Running Account Facility, PCs are to be liquidated out of export bill
proceeds relating to any other export order covering the same commodity or any
other commodity exported by the exporter applying First in First out principle.

Where exporter is enjoying running account facility no export bill should be sent
on collection basis.

If the PC is cleared by any source other than those indicated above, such PCs will
not be eligible for concessional interest.

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PCs should not remain outstanding once the relative goods are shipped and export
documents are tendered by the exporter to the bank. If the PC is allowed to remain
outstanding even after submission of relative export documents, by sending the
export documents on collection basis at the request of the exporter, the PC will
lose the cover under WTPCG of ECGC.

Where banks are not able to negotiate the discrepant export documents, branches
should grant Rupee advance against the export documents and get the PC liability
cleared.

Flexibility in Liquidation of PC

PCs should be liquidated from the proceeds of export bills by converting pre-
shipment to post-shipment credit. However, subject to mutual agreement
between the exporters and the banks the repayment or pre-payment of pre
shipment credit (whether in rupee or FC) from out of balances in EEFC or from
rupee resources may be permitted to the extent exports have actually taken place
as evidenced by relative GR form.

As per RBI guidelines, following relaxations may be permitted to exporters with

good track record –

a) liquidation with export documents relating to any other order covering same or
any other commodity exported by the exporter, after ensuring that such
substitution of contract is commercially necessary and unavoidable.

b) Liquidation with proceeds of export documents against which no PC has been

granted, after ensuring that exporter has not availed PC from another bank.

c) Such relaxations are not to be extended to transactions of sister/associate /

allied / group concerns.

d) PC availed by deemed exporters can also be repaid / prepaid out of balances in

EEFC or from rupee resources of the exporters to the extent of exports have
actually been made. .

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e) Banks should ensure that the goods have been actually shipped by the exporter
and current FEMA guidelines with regards to repatriation of export proceeds
within stipulated period are strictly adhered to by the exporter.

In order to provide further flexibility to exporters, Banks may, at their discretion

allow exporters to convert their rupee pre shipment credit into PCFC subject to
respective Bank’s norms.

The extent of export should be established by GR form or any other documents

considered essential by the AD as proof of shipment. If the shipping documents
have been sent by the exporter directly to the overseas buyer, copies of the same
and the GR form should be sufficient.

Exporters are eligible to prepay / repay their PC any time after the exports have
actually taken place.

Substitution of Contract

In cases where the exporter is not able to export against the original contract, he
may be permitted to clear the PC from the export bill proceeds pertaining to any
other export order covering the same or any other commodity exported by the
exporter without prior approval of RBI subject to the following conditions:

a) While allowing substitution, branches have to ensure that it is commercially

necessary and unavoidable. Branches may also satisfy themselves about the
genuineness of the reasons as to why the exporter could not ship the goods for
which the PC was disbursed.

b) The existing PC may be marked off with export proceeds of documents after
ensuring that no PC has been drawn by the exporter against the relative order
either with our bank or any other bank.

c) Substitution facility can be extended only to exporters of proven track record

and classified under S1 / S2 in order to ensure that the finance is utilised only for
the purpose of exports.

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PC - Interest related Points –

The charging of concessional rate of interest on PCs basically depends on

following factors:

(a) Originally permitted period of finance as per sanction terms

(b) Extension Period approved by appropriate authority

(c) Subject to maximum period of 270 days.

Concessional interest can be charged only if the export takes place ultimately but
within a reasonable period of availing the PC. This reasonable period is defined as
360 days from the date of grant of PC. In case disbursal against an Export
order/Export LC are made in two or three instalments, the 360 days period will
have to be reckoned from the date of disbursal of the first instalment.

In case of clean PCs, the period will have to be reckoned from the date of grant of
clean PC.

The concessional rates of interest are determined by RBI from time to time and
Rate of interest applicable to Export Credit Not Otherwise Specified is determined
by respective Banks.

No additional interest should be charged on ad-hoc PC limits.

Overdue PCs are those remaining outstanding beyond the period stipulated (i.e.,
where export does not take place within the period originally permitted as per
sanction terms or within the extended period approved For the overdue period
interest should be charged at the Rate specified for Export Credit Not Otherwise
Specified even if such overdue period falls within 180 days.

The interest accrued on PCs should be necessarily debited to an operative account

of the exporter and should not be debited to the PC account as ECGC cover is not
available to interest components.

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Pre Shipment Credit in Foreign Currency (PCFC)

The objective is to make available credit at internationally competitive rates linked

to LIBOR / EURIBOR / EURO LIBOR for domestic/ imported in puts. Under the
scheme, following options are available to exporter a) Avail PC in Rupees and post
shipment finance in Rupees or FC

b) Avail PC in FC and post shipment finance in FC

c) Avail PC in rupees and convert into PCFC at the discretion of bank.

Cross currency PCFC permissible. To enable the exporters to have operational

flexibility, it will be in order for banks to extend PCFC in one convertible currency
in respect of an export order invoiced in another convertible currency. For
example, an exporter can avail of PCFC in US Dollar against an export order
invoiced in Euro. The risk and cost of cross currency transaction will be that of the
exporter.

No separate limits required but to be carved out of normal PC limits sanctioned.

Rate of Interest should not to exceed 350 Basis points (3.5%) over applicable
LIBOR.

PCFC is available for standard period of 1 / 2 / 3 / 6 / 12 months. For nonstandard

periods, the ROI to be applied is the rate for the next / upper standard period .

Interest should be collected at monthly rests against sale of FC / out of balances

in EEFC or out of proceeds of export bill discounted.

If no export takes place within 360 days PCFC to be adjusted at TT selling rate.

For domestic output the PCFC should be converted into Rupees at Spot TT buying
rate.

Liquidation of PCFC shall be by adjustment of export bill proceeds / repayment or

prepayment out of balances in EEFC / rupee resources to the extent exports have
actually taken place.

PCFC would be only for exportable portion of produce.

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Running PCFC account may be permitted to exporters with good track record
subject to certain conditions:

PCFC to supplier to be liquidated by receipt of forex from receiver unit for which
receiver may avail of PCFC; hence no post-shipment credit is to be extended to the
supplier.

Under Deemed Exports PCFC may be granted only for supplies to projects financed
by multilateral / bilateral agencies / funds which is to be liquidated by FCL / BRD
at post supply stage for a maximum 30 days or up to date of payment by project
authorities whichever is earlier. Such advance may be prepaid or repaid from EEFC
or rupee resources to the extent supplies have actually been made.

Gold Card Scheme for Exporters

To simplify access to bank credit for exporters, the Reserve Bank of India has a
scheme that provides preference in providing packing credit in foreign currency
and term loan in foreign currency to deserving exporters.

Criteria for Issuing Gold Card - Exporters with a minimum track record of three
years, that is continuously standard with no irregularities or adverse features will
be treated as a good track record. Exporters black listed by the ECGC or included
in the RBI defaulters list or making losses for the past three years will not be
eligible for the gold card scheme.

Benefits of Gold Card Scheme - Gold card holders would be given preference by
the banks for granting of packing credit in foreign currency. Taking into account
the anticipated export turnover of the exporter, the bank can provide need-based
business loan limits with a liberal approach.

The in-principle limit will be sanctioned for a period of three years with a provision
for automatic renewal subject to fulfilment of loan terms and conditions.

Further, banks will also consider giving term loan in foreign currency for deserving
businesses out of the FCNR funds.

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Interest concession can also be given by the banks with a soft bias toward gold
card holders, through a transparent mechanism.

Processing charges on the loan granted to gold card holders should be lower than
those provided to other exporters. Service charge at a flat rate of 0.1% can be
charged on inter-bank foreign currency borrowing for lending to exporters.

Standby limit of not less than 20% of the assessed limit may be additionally made
available to the gold card holder to facilitate urgent credit needs for executing
sudden order.

All new proposals submitted by gold card holders need to be processed with 25
days for fresh proposals and 15 days for renewals and 7 days for ad-hoc limits.

Post Shipment Finance to Exporters

While handling Export Bills and/or granting post-shipment finance, the Foreign
Exchange Regulations of RBI, Interest Rate directives of RBI, EXIM Policy
guidelines of Govt. of India, FEDAI Rules and Rules of International Chamber of
Commerce are to be adhered to.

Purchase; Discount; Negotiation

The Export Bills could be either Sight Bills or Usance Bills.

When finance is made against Demand Bill, it is called Purchase.

When finance is made against Usance Bill, it is called Discount.

When finance is made against any Bill (either Demand Bill or Usance Bill) drawn
under LC, it is called Negotiation.

Providing finance in Indian Rupees without purchasing the foreign currency

element of the bill against exports documents is called Rupee Advance.

All Export Bills should necessarily be accompanied by relevant Export Declaration

Form viz., Shipping Bill/EDF/ SOFTEX Form.

OPL on the drawees of Export Bills can be called for through the service providers.

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OPL should not be older than one year.

Sight Export Bills are payable on "Demand" or "at sight". These are normally
accompanied by a Bill of Exchange/Draft drawn payable at sight or on demand.

The bills could be either covered under an Export Letter of Credit or against firm
contract/order.

Usance Export Bill is one which is not payable on demand but is expressed to be
payable after a specified period (usance) mentioned in the bill. These are normally
accompanied by a Usance Draft/Bill of Exchange such as payable ".... days after
sight" or ".... days after the date of shipment", etc. Usance Export Bills could be
either covered under an Export Letter of Credit or against firm contract/order.

In case of Usance Export Bills, the terms of delivery of documents would normally
be "D/A" (Delivery against Acceptance of the Draft).

There may also be instances of Usance Export Bills with "D/P" terms (Delivery
against Payment) where the collecting bank is instructed to deliver the shipping
documents to the drawee on the due date only against payment. In such cases, the
collecting bank presents the usance draft for acceptance, and delivers the relative
documents including B/L only upon payment by the drawee on the due date.

Export Bills are usually accompanied by a Bill of Exchange (Draft) drawn payable
either at sight or usance, as the case may be, Invoice, shipping document like Bill
of Lading/Airway Bill/Multimodal Transport Document/ Railway or Lorry Receipt,
etc., Insurance Policy or Certificate, Packing List, Certificate of Origin, and any
other document/s stipulated (if covered under LC) or as required by the buyer.

When intimation of non-acceptance of a usance bill or non-payment of a sight bill

is received from the collecting bank, through FD/FEX Cell, the exporter should be
immediately informed and his instructions to be sought. The date of
nonacceptance/non-payment advice received from the collecting bank and sent
to the exporter should be recorded.

Post Shipment export credit either in foreign currency or in rupees can be

liquidated out of the proceeds of any other export bill sent on collection basis or
from the balance available in the EEFC account of the exporter.
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Delinking/Crystallisation of Overdue Export Bills

Sight bills remaining unpaid beyond 15 days from the expiry of normal transit
period and usance bills remaining unpaid beyond a period of 15 days from the due
date should be delinked, in order to crystallize the liability of the exporter into
Rupees. TT Selling Rate ruling on the date of delinking should be taken into
consideration for arriving at rupee liability.

It is mandatory on the part of banks to delink unrealized Export Bills on the

ostensible date of delinking.

For delinking, if the TT Selling Rate as on the delinking date is higher than the
original Bill Buying Rate, the differential amount will be credited to Bank’s P&L
account by debiting party’s account.

In case if TT selling rate is lesser than the original bill buying rate, the bill
purchased liability will get reduced to the extent of differential amount by
debiting Bank’s P&L account for the same.

Dishonour of Export Bill

In the event of dishonor of a Bill, the advance given to exporter is to be recovered

as soon as the non-payment advice is received.

Wherever ECGC cover is available, steps may be taken to file our claim in the event
of dis-honour of bill.

Once the export documents are handled by Bank (whether Bank has advanced the
bills or not), Banks are accountable to RBI till the proceeds are realized and the
shipping bill/EDF/SOFTEX form is released.

Reduction in Value

If, after a bill has been negotiated or sent for collection, the amount thereof is
desired to be reduced for any reason, bank may approve such reduction, upto 25%
of invoice value in case of normal exporters and without such limit in case of
exporters with satisfactory track record, if satisfied about genuineness of the
request and subject to the eligibility conditions.

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Export Claims

Bank may remit export claims on application, provided the relative export
proceeds have already been realized and repatriated to India and the exporter is
not on the caution list of Reserve Bank of India and proportionate export
incentive, if any, received by the exporter is surrendered.

Agency Commission on Exports

Authorized dealers may allow payment of commission, either by remittance or by

deduction from invoice value, on application submitted by the exporter. The
remittance on agency commission may be allowed subject to the conditions.

Change of Buyer/Consignee

After the goods have been shipped, without the prior approval of RBI they can be
transferred to a buyer other than the original buyer in the event of default by the
latter, provided the reduction in value, if any, involved does not exceed 25% and
the realization of export proceeds is not delayed beyond the period of 9 months
from the date of export or time prescribed by RBI from time to time. Where the
reduction in value exceeds 25%, all other relevant conditions.

Miscellaneous

Where, Usance Bills discounted are realized before the due date, collect early
realization swap cost, if any and refund surplus interest collected to the customer.

Take into consideration the Normal Transit Period (NTP) for calculation of interest
on post-shipment finance while negotiating/purchasing/ discounting Export Bills.

Obtain specific instructions for delivery of documents against payment in local

currency, while handling documents payable at Restricted Cover Countries (Listed
Countries) for collection.

Where goods are exported from Inland container Depots or where transportation
of goods is by two or more modes, insist on submission of Multimodal Transport
Document in the prescribed format issued by a Regd. Multimodal Transport
Operator.

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Ensure that appropriate authorization/risk letter has been obtained from export
clients for dispatching the documents by courier service.

Where goods are exported to Listed Countries, advise the exporters that
repatriation of full proceeds of export bill is their responsibility though the Rupee
advance has been granted by our bank against said bills.

Ensure that Rupee Advance is granted whenever packing credit is outstanding/LCs

are restricted to other banks or when the documents submitted under LCs are
discrepant in nature or where bills are submitted in non-position currencies of our
Bank.

@@@

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16. Priority Sector/Government/NABARD Schemes
On 4th September, 2020, RBI has advised revised guidelines related to Priority
Sector Lending. These guidelines aim to encourage and support environment
friendly lending policies to help achieve Sustainable Development Goals (SDGs).

This Revision/Review took into account the recommendations made by the ‘Expert
Committee on Micro, Small and Medium Enterprises (Chairman: Shri U.K. Sinha)
and the ‘Internal Working Group to Review Agriculture Credit’ (Chairman: Shri M.
K. Jain) apart from discussions with all stakeholders.

“On-lending” means loans sanctioned by banks to eligible intermediaries for

onward lending for creation of priority sector assets. The average maturity of
priority sector assets thus created by the eligible intermediaries should be co-
terminus with maturity of the bank loan. Contingent liabilities/off-balance sheet
items do not form part of priority sector achievement. However, foreign banks
with less than 20 branches have an option to reckon the Credit Equivalent of Off-
Balance Sheet Exposures (CEOBE) extended to borrowers for eligible priority
sector activities for achievement of priority sector target, subject to the condition
that the CEOBE (both priority sector and non-priority sector excluding interbank
exposure) should be added to the Adjusted Net Bank Credit (ANBC) in the
denominator for computation of PSL targets.

Banks must ensure that loans extended under priority sector are for approved
purposes and the end use is continuously monitored. The banks should put in place
proper internal controls and systems in this regard.

The categories under priority sector are as follows:

(i) Agriculture ; (ii) Micro, Small and Medium Enterprises (iii) Export Credit (iv)
Education (v) Housing (vi) Social Infrastructure (vii) Renewable Energy (viii) Others

Targets /Sub-targets for Priority sector

The targets and sub-targets set under priority sector lending, to be computed on
the basis of the ANBC/ CEOBE as applicable as on the corresponding date of the
preceding year, are as under :

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 Categories Domestic Commercial Banks

Total Priority Sector 40% of ANBC or CEOBE whichever is higher

Agriculture 18% of ANBC or CEOBE, whichever is higher; out

of which a target of 10 percent# is prescribed
for Small and Marginal Farmers (SMFs)
Micro Enterprises 7.5% of ANBC or CEOBE, whichever is higher

Advances to Weaker Sections 12 % of ANBC or CEOBE, whichever is higher#

# Revised targets for SMFs and Weaker Section will be implemented in a phased
manner.

The term “all-inclusive interest” includes interest (effective annual interest),

processing fees and service charges.

For the purpose of priority sector computation only. Banks should not deduct /net
any amount like provisions, accrued interest, etc. from NBC.

Off-balance sheet interbank exposures are excluded for computing CEOBE for the
priority sector targets.

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Computation of Adjusted Net Bank Credit (ANBC)

For the purpose of priority sector lending, ANBC denotes the outstanding Bank
Credit in India and computed as follows:

Bank Credit in India as prescribed in the RBI Act, 1934 I

Bills Rediscounted with RBI and other approved Financial II

Institutions
Net Bank Credit (NBC) @ III= (I-II)

Outstanding Deposits under RIDF and other eligible funds IV

with NABARD, NHB, SIDBI and MUDRA Ltd in lieu of non-
achievement of priority sector lending targets/sub-targets +
outstanding PSLCs
Eligible amount for exemptions on issuance of long-term V
bonds for infrastructure and affordable housing.
Advances extended in India against the incremental FCNR VI
(B)/NRE deposits, qualifying for exemption from CRR/SLR
requirements.
Investments made by public sector banks in the VII
Recapitalization Bonds floated by Government of India
Other investments eligible to be treated as priority sector (e.g. VIII
investments in securitised assets)
Face Value of securities acquired and kept under HTM IX
category under the TLTRO 2.0 and also Extended Regulatory
Benefits under SLFMF Scheme
Bonds/debentures in Non-SLR categories under HTM category X

ANBC (Other than UCBs) III + IV-

(V+VI+VII)
+VIII - IX + X

The target for lending to the non-corporate farmers for FY 2021-22 will be 12.73%
of ANBC or CEOBE whichever is higher.

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The targets for lending to SMFs and for Weaker Sections shall be revised upwards
from FY 2021-22 onwards as follows:

Financial Year Small and Marginal Weaker Sections

Farmers target target
2020-21 8% 10%
2021-22 9% 11%
2022-23 9.5% 11.5%
2023-24 10% 12%

While calculating Net Bank Credit as above, if banks subtract prudential write off
at Corporate/Head Office level, it must be ensured that the credit to priority sector
and all other sub-sectors so written off should also be subtracted category wise
from priority sector and sub-target achievement. Wherever, investments or any
other items which are treated as eligible for classification under priority sector
target/sub-target achievement, the same should also form part of Adjusted Net
Bank Credit.

Agriculture –

The lending to agriculture sector will include Farm Credit (Agriculture and Allied
Activities), lending for Agriculture Infrastructure and Ancillary Activities.

Farm Credit - Individual farmers

Loans to individual farmers [including Self Help Groups (SHGs) or Joint Liability
Groups (JLGs) i.e. groups of individual farmers, provided banks maintain
disaggregated data of such loans] and Proprietorship firms of farmers, directly
engaged in Agriculture and Allied Activities, viz. dairy, fishery, animal husbandry,
poultry, bee-keeping and sericulture.

This will include:

i. Crop loans including loans for traditional/non-traditional plantations,

horticulture and allied activities.

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ii. Medium and long-term loans for agriculture and allied activities (e.g. purchase
of agricultural implements and machinery and developmental loans for allied
activities).

iii. Loans for pre and post-harvest activities viz. spraying, harvesting, grading and
transporting of their own farm produce.

iv. Loans to distressed farmers indebted to non-institutional lenders.

v. Loans under the Kisan Credit Card Scheme.

vi. Loans to small and marginal farmers for purchase of land for agricultural
purposes.

vii. Loans against pledge/hypothecation of agricultural produce (including

warehouse receipts) for a period not exceeding 12 months subject to a limit up to
₹75 lakh against NWRs/eNWRs and up to ₹50 lakh against warehouse receipts
other than NWRs/eNWRs.

viii. Loans to farmers for installation of stand-alone Solar Agriculture Pumps and
for solarisation of grid connected Agriculture Pumps.

ix. Loans to farmers for installation of solar power plants on barren/fallow land or
in stilt fashion on agriculture land owned by farmer.

Farm Credit –

a) Loans for the following activities will be subject to an aggregate limit of ₹2 crore
per borrowing entity:

(i) Crop loans to farmers which will include traditional/non-traditional plantations

and horticulture and loans for allied activities.

(ii) Medium and long-term loans for agriculture and allied activities (e.g. purchase
of agricultural implements and machinery and developmental loans for allied
activities).

(iii) Loans for pre and post-harvest activities viz. spraying, harvesting, grading and
transporting of their own farm produce.

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(b) Loans up to ₹75 lakh against pledge/hypothecation of agricultural produce
(including warehouse receipts) for a period not exceeding 12 months against
NWRs/eNWRs and up to ₹50 lakh against warehouse receipts other than
NWRs/eNWRs.

(c) Loans up to ₹5 crore per borrowing entity to FPOs/FPCs undertaking farming

with assured marketing of their produce at a pre-determined price.

Agriculture Infrastructure - Loans for agriculture infrastructure will be subject to

an aggregate sanctioned limit of ₹100 crore per borrower from the banking
system.

Ancillary Services - loans under ancillary services will be subject to limits

prescribed as under:

i. Loans up to ₹5 crore to co-operative societies of farmers for purchase of the

produce of members.

ii. Loans up to ₹50 crore to Start-ups, as per definition of Ministry of Commerce

and Industry, Govt. of India that are engaged in agriculture and allied services.

iii. Loans for Food and Agro-processing up to an aggregate sanctioned limit of

₹100 crore per borrower from the banking system.

Outstanding deposits under RIDF and other eligible funds with NABARD on
account of priority sector shortfall.

Small and Marginal Farmers (SMFs)

For the purpose of computation of achievement of the sub-target, Small and

Marginal Farmers will include the following:

i. Farmers with landholding of up to 1 hectare (Marginal Farmers).

ii. Farmers with a landholding of more than 1 hectare and up to 2 hectares (Small
Farmers).

iii. Landless agricultural labourers, tenant farmers, oral lessees and sharecroppers
whose share of landholding is within the limits prescribed for SMFs.

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iv. Loans to Self Help Groups (SHGs) or Joint Liability Groups (JLGs), i.e. groups of
individual SMFs directly engaged in Agriculture and Allied Activities, provided
banks maintain disaggregated data of such loans.

v. Loans up to ₹2 lakh to individuals solely engaged in Allied activities without any

accompanying land holding criteria.

vi. Loans to FPOs/FPC of individual farmers and co-operatives of farmers directly

engaged in Agriculture and Allied Activities where the land-holding share of SMFs
is not less than 75%, subject to loan limits prescribed.

Lending by banks to NBFCs and MFIs for on-lending in agriculture

(i) Bank credit extended to registered NBFC-MFIs and other MFIs (Societies, Trusts
etc.) which are members of RBI recognised SRO for the sector, for on-lending to
individuals and also to members of SHGs / JLGs will be eligible for categorisation
as priority sector advance under respective categories of agriculture subject to
conditions specified.

(ii) Bank credit to registered NBFCs (other than MFIs) towards on-lending for
‘Term lending’ component under agriculture will be allowed up to ₹ 10 lakh per
borrower subject to conditions specified.

Micro, Small and Medium Enterprises (MSMEs)

MSMEs should be engaged in the manufacture or production of goods, in any

manner, pertaining to any industry specified or engaged in providing or rendering
of any service or services. All bank loans to MSMEs conforming to the guidelines
qualify for classification under priority sector lending.

Factoring Transactions.

(i) ‘With Recourse’ Factoring transactions by banks which carry out the business
of factoring departmentally wherever the ‘assignor’ is a Micro, Small or Medium
Enterprise would be eligible for classification under MSME category on the
reporting dates.

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(ii) The ‘factors’ must intimate the limits sanctioned to the borrower and details
of debts factored to the banks concerned, taking responsibility to avoid double
financing.

(iii) Factoring transactions pertaining to MSMEs taking place through the Trade
Receivables Discounting System (TReDS) shall also be eligible for classification
under priority sector.

Khadi and Village Industries Sector (KVI)

All loans to units in the KVI sector will be eligible for classification under the sub
target of 7.5% prescribed for Micro Enterprises under priority sector.

Other Finance to MSMEs

(i) Loans up to ₹50 crore to Start-ups, as per definition of Ministry of Commerce

and Industry, Govt. of India that confirm to the definition of MSME.

(ii) Loans to entities involved in assisting the decentralized sector in the supply of
inputs and marketing of output of artisans, village and cottage industries.

(iii) Loans to co-operatives of producers in the decentralized sector viz. artisans,

village and cottage industries.

(iv) Loans sanctioned by banks to NBFC-MFIs and other MFIs (Societies, Trusts etc.)
which are members of RBI recognised SRO for the sector for on-lending to MSME
sector as per the conditions specified.

(v) Loans to registered NBFCs (other than MFIs) for on-lending to Micro & Small
Enterprises as per conditions specified.

(vi) Credit outstanding under General Credit Cards (including Artisan Credit Card,
Laghu Udyami Card, Swarojgar Credit Card and Weaver’s Card etc. in existence and
catering to the non-farm entrepreneurial credit needs of individuals).

(vii) Overdraft to Pradhan Mantri Jan-Dhan Yojana (PMJDY) account holders as

per limits and conditions prescribed by Ministry of Finance from time to time, will
qualify as achievement of the target for lending to Micro Enterprises.

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(viii) Outstanding deposits with SIDBI and MUDRA Ltd. on account of priority
sector shortfall.

Export Credit under agriculture and MSME sectors are allowed to be classified as
PSL in the respective categories viz. agriculture and MSME.

Export Credit (other than in agriculture and MSME) will be allowed to be classified
as priority sector as under

“ Incremental export credit over corresponding date of the preceding year, up to

2 per cent of ANBC or CEOBE whichever is higher, subject to a sanctioned limit of
up to ₹ 40 crore per borrower”.

Export credit includes pre-shipment and post-shipment export credit (excluding

off-balance sheet items).

Education

Loans to individuals for educational purposes, including vocational courses, not

exceeding ₹ 20 lakh will be considered as eligible for priority sector classification.

Loans currently classified as priority sector will continue till maturity.

Housing

Bank loans to Housing sector as per limits prescribed below are eligible for priority
sector classification:

(i) Loans to individuals up to ₹35 lakh in metropolitan centres (with population of

ten lakh and above) and up to ₹25 lakh in other centres for purchase/construction
of a dwelling unit per family provided the overall cost of the dwelling unit in the
metropolitan centre and at other centres does not exceed ₹45 lakh and ₹30 lakh
respectively. Existing individual housing loans of UCBs presently classified under
PSL will continue as PSL till maturity or repayment.

(ii) Housing loans to banks’ own employees will not be eligible for classification
under the priority sector.

(iii) Since Housing loans which are backed by long term bonds are exempted from
ANBC, banks should not classify such loans under priority sector.

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Loans up to ₹10 lakh in metropolitan centres and up to ₹6 lakh in other centres for
repairs to damaged dwelling units conforming to the overall cost of the dwelling
unit as prescribed.

Bank loans to any governmental agency for construction of dwelling units or for
slum clearance and rehabilitation of slum dwellers subject to dwelling units with
carpet area of not more than 60 sq.m.

Bank loans for affordable housing projects using at least 50% of FAR/FSI for
dwelling units with carpet area of not more than 60 sq.m.

Bank loans to HFCs (approved by NHB for their refinance) for on-lending, up to
₹20 lakh for individual borrowers, for purchase /construction/ reconstruction of
individual dwelling units or for slum clearance and rehabilitation of slum dwellers,
subject to conditions specified.

Outstanding deposits with NHB on account of priority sector shortfall.

Social Infrastructure - Bank loans to social infrastructure sector as per limits

prescribed below are eligible for priority sector classification

a) Bank loans up to a limit of ₹5 crore per borrower for setting up schools,

drinking water facilities and sanitation facilities including construction/
refurbishment of household toilets and water improvements at household level,
etc. and loans up to a limit of ₹10 crore per borrower for building health care
facilities including under ‘Ayushman Bharat’ in Tier II to Tier VI centres.

b) Bank loans to MFIs extended for on-lending to individuals and also to members
of SHGs/JLGs for water and sanitation facilities subject to the criteria laid down.

Renewable Energy

Bank loans up to a limit of ₹30 crore to borrowers for purposes like solar based
power generators, biomass-based power generators, wind mills, micro-hydel
plants and for non-conventional energy based public utilities, viz., street lighting
systems and remote village electrification etc., will be eligible for Priority Sector
classification. For individual households, the loan limit will be ₹10 lakh per
borrower.

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Others

The following loans as per the prescribed limits are eligible for priority sector
classification:

a) Loans not exceeding ₹1.00 lakh per borrower provided directly by banks to
individuals and individual members of SHG/JLG, provided the individual
borrower’s household annual income in rural areas does not exceed ₹1.00 lakh and
for non-rural areas it does not exceed ₹1.60 lakh, and loans not exceeding ₹2.00
lakh provided directly by banks to SHG/JLG for activities other than agriculture or
MSME, viz., loans for meeting social needs, construction or repair of house,
construction of toilets or any viable common activity started by the SHGs.

b) Loans to distressed persons [other than distressed farmers indebted to

noninstitutional lenders] not exceeding ₹1.00 lakh per borrower to prepay their
debt to non-institutional lenders.

c) Loans sanctioned to State Sponsored Organisations for Scheduled Castes/

Scheduled Tribes for the specific purpose of purchase and supply of inputs and/or
the marketing of the outputs of the beneficiaries of these organisations.

d) Loans up to ₹50 crore to Start-ups that are engaged in activities other than
Agriculture or MSME.

Weaker Sections

Priority sector loans to the following borrowers will be considered as lending

under Weaker Sections category:

(i) Small and Marginal Farmers

(ii) Artisans, village and cottage industries where individual credit limits do not
exceed ₹1 lakh

(iii) Beneficiaries under Government Sponsored Schemes such as National Rural

Livelihood Mission (NRLM), National Urban Livelihood Mission (NULM) and Self
Employment Scheme for Rehabilitation of Manual Scavengers (SRMS)

(iv) Scheduled Castes and Scheduled Tribes

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(v) Beneficiaries of Differential Rate of Interest (DRI) scheme

(vi) Self Help Groups

(vii) Distressed farmers indebted to non-institutional lenders

(viii) Distressed persons other than farmers, with loan amount not exceeding ₹1
lakh per borrower to prepay their debt to non-institutional lenders

(ix) Individual women beneficiaries up to ₹1 lakh per borrower.

(x) Persons with disabilities

(xi) Minority communities as may be notified by Government of India from time

to time.

Overdraft availed by PMJDY account holders as per limits and conditions

prescribed may be classified under Weaker Sections.

In States, where one of the minority communities notified is, in fact, in majority,
item (xi) will cover only the other notified minorities. These States/Union
Territories are Punjab, Meghalaya, Mizoram, Nagaland, Lakshadweep and Jammu
& Kashmir.

Investments by banks in securitised assets Investments by banks in ‘securitised

assets’, representing loans to various categories of priority sector, except 'others'
category, are eligible for classification under respective categories of priority
sector depending on the underlying assets provided:

(i) The assets are originated by banks and financial institutions and are eligible to
be classified as priority sector advances prior to securitisation and fulfil the
Reserve Bank of India guidelines on securitisation .

(ii) The all-inclusive interest charged to the ultimate borrower by the originating
entity should not exceed the investing bank’s MCLR + 10% or EBLR + 14%.

(iii) The investments in securitised assets originated by MFIs, which comply with
the guidelines in Paragraph 21 of these Master Directions are exempted from this
interest cap as there are separate caps on margin and interest rate for MFIs.

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(iv) Purchase/ assignment/investment transactions undertaken by banks with
NBFCs, where the underlying assets are loans against gold jewellery, are not
eligible for priority sector status.

Inter Bank Participation Certificates (IBPCs)

(i) IBPCs bought by banks, on a risk sharing basis, are eligible for classification
under respective categories of priority sector, provided the underlying assets are
eligible to be categorized under the respective categories of priority sector and
the banks fulfil the RBI guidelines on IBPCs.

(ii) IBPCs bought by banks on risk sharing basis relating to ‘Export Credit’ may be
classified from purchasing bank’s perspective for priority sector categorization.

However, in such a scenario, the issuing bank shall certify that the underlying asset
is ‘Export Credit’, in addition to the due diligence required to be undertaken by
the issuing and the purchasing bank.

Priority Sector Lending Certificates (PSLCs)

The outstanding PSLCs bought by banks will be eligible for classification under
respective categories of priority sector provided the underlying assets originated
by banks are eligible to be classified as priority sector advances and fulfil the
Reserve Bank of India guidelines on Priority Sector Lending Certificates.

Bank loans to MFIs (NBFC-MFIs, Societies, Trusts, etc.) for on-lending Banks are
allowed to extend credit to registered NBFC-MFIs and other MFIs (Societies, Trusts
etc.) which are members of RBI recognised SRO for the sector, for on-lending to
individuals and also to members of SHGs / JLGs.

Bank loans to NBFCs for on-lending

Bank credit to registered NBFCs (other than MFIs) for on-lending will be eligible
for classification as priority sector under respective categories subject to the
following conditions:

(a) Agriculture: On-lending by NBFCs for ‘Term lending’ component under

Agriculture will be allowed up to ₹ 10 lakh per borrower.

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(b) Micro & Small enterprises: On-lending by NBFC will be allowed up to ₹ 20 lakh
per borrower. The above dispensation shall be valid upto March 2022. However,
loans disbursed under the on-lending model will continue to be classified under
Priority Sector till the date of repayment/maturity.

Bank loans to HFCs for on-lending

Bank credit to Housing Finance Companies (HFCs), approved by NHB for their
refinance, for on-lending for the purpose of purchase/construction/
reconstruction of individual dwelling units or for slum clearance and rehabilitation
of slum dwellers, subject to an aggregate loan limit of ₹20 lakh per borrower.

Cap on On-lending

Bank credit to NBFCs (including HFCs) for on-lending will be allowed up to an

overall limit of 5% of individual bank’s total priority sector lending. Banks shall
compute the eligible portfolio under on lending mechanism by averaging across
four quarters, to determine adherence to the prescribed cap.

Co-lending by Banks and NBFCs to priority sector

All Scheduled Commercial Banks are permitted to co-lend with all registered Non
Banking Financial Companies (including Housing Finance Companies) for lending
to the priority sector.

Monitoring of Priority Sector Lending targets

To ensure continuous flow of credit to priority sector, the compliance of banks will
be monitored on ‘quarterly’ basis. The data on priority sector advances is required
to be furnished by banks to FIDD, Central Office at quarterly and annual intervals
as per the reporting format (quarterly and annual).

Non-achievement of Priority Sector targets

(i) Banks having any shortfall in lending to priority sector shall be allocated
amounts for contribution to the Rural Infrastructure Development Fund (RIDF)
established with NABARD and other funds with NABARD /NHB/ SIDBI/ MUDRA
Ltd., as decided by the Reserve Bank from time to time.

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(ii) While computing priority sector target achievement, shortfall / excess lending
for each quarter will be monitored separately. A simple average of all quarters will
be arrived at and considered for computation of overall shortfall / excess at the
end of the year. The same method will be followed for calculating the achievement
of priority sector sub-targets.

(iii) The interest rates on banks’ contribution to RIDF or any other funds, tenure of
deposits, etc. shall be fixed by Reserve Bank of India from time to time.

(iv) The mis-classifications reported by the Reserve Bank’s Department of

Supervision (DoS) (NABARD in respect of RRBs) would be adjusted/ reduced from
the achievement of that year, to which the amount of misclassification pertains,
for allocation to various funds in subsequent years.

(v) Non-achievement of priority sector targets and sub-targets will be taken into
account while granting regulatory clearances/approvals for various purposes.

Common guidelines for priority sector loans

(i) Rate of interest: The rates of interest on bank loans will be as per directives
issued by Department of Regulation (DoR), RBI from time to time.

(ii) Service charges: No loan related and ad hoc service charges/inspection charges
should be levied on priority sector loans up to ₹25,000. In the case of eligible
priority sector loans to SHGs/ JLGs, this limit will be applicable per member and
not to the group as a whole.

(iii) Receipt, Sanction/Rejection/Disbursement Register: A register/ electronic

record should be maintained by the bank wherein the date of receipt,
sanction/rejection/disbursement with reasons thereof, etc. should be recorded.
The register/electronic record should be made available to all inspecting agencies.

(iv) Issue of acknowledgement of loan applications: Banks should provide

acknowledgement for loan applications received under priority sector loans. Bank
Boards should prescribe a time limit within which the bank communicates its
decision in writing to the applicants.

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Priority Sector Lending – RBI’s Clarifications

01. Whether the deposits with DFIs viz., NABARD, SIDBI, MUDRA & NHB on
account of PSL shortfall can be counted towards achievement of PSL / targets/
sub-targets and ANBC?

Clarification: Banks can reckon outstanding deposits with NABARD under

Agriculture and overall PSL achievement, while deposits with SIDBI, MUDRA and
NHB can be reckoned only for overall PSL achievement. Banks should also add
these deposits to Net Bank Credit (NBC) for computation of Adjusted Net Bank
Credit (ANBC).

However, deposits with NABARD, SIDBI, MUDRA and NHB cannot be reckoned for
sub-target achievement viz. SMF, NCF, Micro and weaker section.

02. Are banks permitted to exclude bills purchased/ discounted /negotiated while
calculating the ‘Bank Credit in India’?

Clarification: The bills purchased/ discounted/ negotiated under LC is allowed to

be treated as Interbank exposure only for the limited purpose of computing
exposure and capital requirements. It should not be excluded from the
computation of ‘bank credit in India’ which allows for exclusion of interbank
advance. While exposure may be to the LC issuing bank, the bills purchased/
discounted amounts to bank credit to its borrower constituent. If this advance is
eligible for priority sector classification, then bank can claim it as PSL. Banks have
to take note of the above aspect while reporting Net Bank Credit in India as well
as computing the Adjusted Net Bank Credit for PSL targets and achievement.

03. What is the criteria for mapping credit to a particular district?

Clarification: For mapping a credit facility to a particular district, the ‘Place of

utilization of Credit’ shall be the qualifying criteria.

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04. Can bank loans against gold be classified under priority sector?

Clarification: The PSL guidelines are activity and beneficiary specific and are not
based on type of collateral. Therefore, bank loans given to individuals/ businesses
for undertaking agriculture activities do not automatically become ineligible for
priority sector classification, only on account of the fact that underlying asset is
gold jewellery/ornament etc. Banks may waive margin requirements for
agricultural loans upto ₹1.6 lakh. Therefore, bank should have extended the loan
based on scale of finance and assessment of credit requirement for undertaking
the agriculture activity and not solely based on available collateral in the form of
gold. Banks should ensure that the loans extended under priority sector are for
approved purposes and the end use is continuously monitored.

05. Can loans given to landless individuals engaged in allied activities be classified
under priority sector lending (SMF category)?

Clarification: Bank loans up to Rs 2 lakh to individuals solely engaged in allied

activities without any accompanying land holding criteria are entitled for
classification under SMF category of priority sector lending. Further, farmers
availing loans under SMF (based on land holding) are also eligible for loans under
allied activities upto Rs 2 lakhs and the same can be also be classified under SMF
category.

06. How should the banks ensure adherence to the credit cap of ₹100 crore from
banking system, while extending credit to activities under ‘Agriculture
Infrastructure’ or ‘Food & Agro-Processing’ categories?

Clarification: As per extant guidelines, loans for Agriculture Infrastructure or loans

for Food & Agro-processing activity are each subject to an aggregate sanctioned
limit of ₹100 crore per borrower from the banking system. In case aggregate
exposure across the banking industry exceeds the limit of ₹100 crore, then total
exposure will cease to be classified under PSL category.

The sanctioned limit of ₹100 crore has to be ascertained facility wise for a
particular entity and is exclusive of the other borrowings of the entity for PSL /
non-PSL purposes.

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However, it needs to be ensured that the bank has assessed and sanctioned
separate limits for the specific purpose of Agriculture Infrastructure or Food &
Agro Processing activities of the entity to qualify as PSL.

Banks should take a declaration from the borrower regarding loan sanctioned by
any other bank/s for the same activity and also independently seek confirmation
from those banks. In the scenario, where new sanction by the bank leads to overall
limit across banks to more than ₹100 crore, it needs to inform other banks too
about the same. Accordingly, all other banks need to declassify the same from PSL.

07. Loans are extended to Cargo Companies, Shipping Companies, Road lines Co.,
Transport Cos, Logistic Cos., Movers and Carriers etc. for purchasing Commercial
Vehicles. These transport and shipping companies act as a Carrier (‘Transporter’)
for such Enterprises which are into food and agro processing business. Whether
bank loans to such a transporter who acts as a ‘carrier’ and does not have any food
and agro processing set-up themselves, are eligible for classification under priority
sector.

Clarification: Transportation is an eligible activity under indicative list of

permissible activities under Food Processing Sector. However, while classifying
any facility to transporters for purchasing Commercial Vehicles under “Food &
Agro-processing” category, it needs to be ensured that the transporter is using the
vehicle exclusively for transportation of food & agro-processed products or is a
type of vehicle which is specifically used for “Food & Agro-processing” e.g. cold
storage trucks, vans etc. If the commercial vehicle is also used for transportation
of products other than those related to food & agro processing, the facility shall
not be eligible for classification under ‘Food & Agro-processing’ category. In such
cases, the same may be classified under MSME (Services), if it meets the conditions
prescribed for the same.

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08. Can bank loans extended to companies for buying commercial vehicles be
eligible for classification under “Agriculture Infrastructure” category of priority
sector?

Clarification: While classifying any facility to transporters for purchasing

Commercial Vehicles under “Agriculture Infrastructure” category, it needs to be
ensured that the transporter/ sub-contractor is using the vehicle exclusively for
activities that are ancillary to “Agriculture Infrastructure”. If the commercial
vehicle is also used for transportation for purposes under non-agriculture
infrastructure category, the facility shall not be eligible for classification under
‘Agriculture Infrastructure’. In such cases, the same may be classified under MSME
(Services), if it meets the conditions prescribed for the same.

09. Whether the continuity of the PSL status for 3 years is still applicable to
MSMEs that have breached the threshold limit as per the new definition of MSMEs?

Clarification: Govt of India has notified the new composite criteria of investment
in plant & machinery as well as turnover for classification of an enterprise under
MSME. Under the composite criteria, if an enterprise crosses the ceiling limits
specified for its present category in either of the two criteria of investment or
turnover, it will cease to exist in that category and be placed in the next higher
category but no enterprise shall be placed in the lower category unless it goes
below the ceiling limits specified for its present category in both the criteria of
investment as well as turnover. Based on the new definition, the earlier criteria
regarding continuity of PSL status for three years even after an enterprise grows
out of the MSME category concerned, is no longer valid.

10. What is the permissible cap for export credit under PSL ?

a) Bank lending to export credit under agriculture and MSME sectors is classified
as PSL under the respective categories viz, agriculture and MSME and there is no
cap on credit for the same.

b) In respect of Export Credit (other than in agriculture and MSME) Incremental

export credit over corresponding date of the preceding year, up to 2 % of ANBC
or CEOBE whichever is higher, subject to a sanctioned limit of up to ₹40 crore per
borrower is classified as priority sector.
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11. In the revised PSL guidelines, ₹20 lakh is referred to Outstanding Limit or
Sanctioned Limit?

Clarification: Only such loans that are within the sanctioned limit of ₹20 lakh shall
be eligible for priority sector classification.

12. If the same borrower is having multiple education loans with different opening
dates before and after 04-09-20, which value is required to be considered under
PSL (0/s of ₹10 lakhs per borrower or Limit of ₹20 lakhs per borrower). For
instance, Student had an education loan of ₹12 Lakhs prior to 04.09.2020, then
avails second education loan of ₹18 Lakhs after 04.09.2020, how PSL outstanding
will be calculated for this particular customer?

Clarification: For the loans sanctioned before September 4, 2020, outstanding

value up to ₹10 lakh, irrespective of the sanctioned limit, shall continue to be
classified under priority sector till maturity. However, while reckoning any fresh
loan under PSL to a borrower who had already availed education loan from the
bank prior to September 4, 2020, it needs to be ensured that the aggregate
sanctioned limit does not exceed ₹20 lakh for classification of the loans under PSL.

In the mentioned scenario, as the combined sanctioned limit becomes ₹30 lakh,
the ₹18 lakh loan extended after September 4, 2020 shall not be eligible for PSL
classification. However, with regard to the ₹12 lakh loan, which was already PSL
as per earlier guidelines, the outstanding value under the facility, up to ₹10 lakh
shall continue to be eligible under PSL till maturity.

13. Under revised PSL guidelines, sanctioned limit has been capped at ₹ 20 lakhs.
If a customer is sanctioned a loan of ₹20 lakhs and the outstanding amount
becomes ₹22 Lakhs, in such a scenario whether entire outstanding will be reckoned
for PSL?

Clarification: The outstanding value may exceed ₹20 lakh on account of accrued
interest due to moratorium on repayment during study period. Accordingly, the
entire outstanding amount shall be reckoned for priority sector provided the
sanctioned limit does not exceed ₹20 lakh.

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14. If a student avails two education loans after September 4, 2020 for ₹12 lakhs
and ₹18 lakhs, how PSL will be calculated for this particular customer?

Clarification: Post September 4, 2020, if the aggregate sanctioned limit of multiple

education loans either from a bank or across banks to a single borrower exceeds
₹20 lakh limit, all loans of the borrower sanctioned after September 4, 2020 shall
become ineligible for PSL classification. In this regard, banks should take a
declaration from the borrower regarding education loan sanctioned by any other
bank/s and also independently seek confirmation from those banks.

15. How is PSL classification considered for lending to Social Infrastructure

activities viz. Schools etc. (prescribed limit of ₹5 crore) and Health Care Facilities
(prescribed limit of ₹10 crore) which can also be classified as MSME (Service) based
on definition as per MSME Act.?

Clarification: As per Udyam Registration Portal- NIC Codes, under Services as

‘Major Activity’, ‘Education’ & ‘Health Activities’ are eligible activities for
classification under MSME (Services). Therefore, bank loans for above purposes
can be classified under MSME (Services), wherein no cap on credit has been
prescribed. However, banks can classify such activities either under MSME

(Services) or Social Infrastructure, and not under both. It may be noted that for
classification under Social Infrastructure, the associated cap on credit shall be
applicable.

16. In case of Partnership Firms/ Pvt. Limited, can the loan granted be tagged as
SMF and Weaker Section, if any of the Partner/ Director is holding Agriculture land
upto 2 hectares / 5 acres. ?

Clarification: SMF includes individuals, SHGs, JLGs, Farmers’ Producer Companies

(FPC) and Cooperatives of farmers with the accompanying criteria of membership
by number and land-holding. Therefore, loans to partnership firms/ co-borrowers
or any director of a Company holding Agriculture land upto 2 hectares / 5 acres
are not eligible to be classified under the Small and Marginal farmers category of
PSL

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17. In case of a Partnership firm, if majority of the partners belong to one or the
other of the specified minority communities, whether advances granted to such
partnership firms can be treated as advances granted to minority communities.
Further, in case of Private / Public Ltd. Company, if any of the borrowers belong
to Minority Community, can the loan be classified under weaker section category?

Clarification: In the case of a partnership firm, if the majority of the partners

belong to one or the other of the specified minority communities, advances
granted to such partnership firms may be treated as advances granted to minority
communities.

Further, if the majority beneficial ownership in a partnership firm belongs to the

minority community, then such lending can be classified as advances to the
specified communities.

A company has a separate legal entity and hence advances granted to it cannot be
classified as advances to the specified minority communities.

18. Can banks rely on customer’s declaration for Minority / SC / ST category to be

included under Weaker section?

Clarification: Our guidelines do not mandate banks to obtain documentary

evidence for classifying credit facilities to Minorities and SCs/STs under weaker
section. Therefore, declaration by the customer in the application form would
suffice. However, it needs to be ensured that for classification under weaker
sections, the loans should first be eligible for classification under priority sector
lending as per underlying activity.

19. What is the expiry date of PSLC?

Clarification: All PSLCs will be valid till end of FY i.e. March 31st and will expire on
next day i.e. April 1st.

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20. Whether PSLCs can be issued for a limited period i.e., for one reporting quarter
and multiples thereof?

Clarification: The duration of the PSLCs will depend on the date of issue with all
PSLCs being valid till end of FY i.e. March 31st and expiring on next day i.e. April
1st.

21. Whether service tax/ stamp duty/ transaction tax will be applicable while
paying fee for PSLC?

Clarification: PSLCs may be construed in the nature of 'goods' in the course of

inter-state trade or commerce, dealing in which has been notified as a permissible
activity.

Further, IGST is payable on the supply of PSLC traded over e-kuber portal. If a bank
which was liable to pay GST had already paid CGST/SGST or CGST/UGST, the bank
is not required to pay IGST towards such supply. Further, as per the extant
guidelines, no transaction charge/ fees is applicable on the participating banks
payable to RBI for usage of the PSLC module on e-Kuber portal.

22. Whether PSL – Weaker Sections or PSL – Export Credit can be traded as PSLCs?

Clarification: There are only four eligible categories of PSLCs i.e. PSLC General,
PSLC Small and Marginal Farmer, PSLC Agriculture & PSLC Micro Enterprises.

23. Whether Export Credit may form a part of PSLC 'General' and whether banks’
surplus in Export Credit can be sold as PSLC 'General’?

Clarification: 'Export Credit' can form a part of underlying assets against the PSLC
- General. However, any bank issuing PSLC General against 'Export Credit' shall
ensure that the underlying ''Export Credit' portfolio is also eligible for priority
sector classification by domestic banks.

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24. Are Foreign Banks with less than 20 branches permitted to buy PSLC-General
for achieving the target of 8% of lending to ‘other than exports’?

Clarification: Foreign banks with less than 20 branches are not allowed to buy PSLC
General for achieving their 8% target of lending to sectors other than exports.
However, such banks are allowed to buy PSLC Agriculture, PSLC Micro Enterprises
and PSLC Small and Marginal Farmer for the same.

25. Can a purchasing bank re-sell PSLCs? Will only the net PSLC position be
reckoned for ascertaining the underlying asset?

Clarification: A bank can purchase PSLCs as per its requirements. Further, a bank
is permitted to issue PSLCs upto 50% of previous year’s PSL achievement without
having the underlying in its books. This is applicable category-wise. The net
position of PSLCs (PSLC Buy – PSLC Sell) has to be considered while reporting the
quarterly and annual priority sector returns. However, with regard to ascertaining
the underlying assets, as on March 31st, the bank must have met the priority sector
target by way of the sum of outstanding priority sector portfolio and net of PSLCs
issued and purchased.

26. What happens if the RBI inspection team, at a later date, de-classifies a
particular PSLC (which has been already traded by the bank as PSLC) ineligible?

Clarification: The misclassifications, if any, will have to be reduced from the

achievement of PSLC seller bank only. There will be no counterparty risk for the
PSLC buyer, even if, the underlying asset of the traded PSLC gets misclassified.

27. The buyer would pay a fee to the seller of the PSLC which will be market
determined. Is there any standard/ minimum fee prescribed by the RBI, for
purchase of any PSLC?

Clarification: The premium will be completely market determined. No floor/

ceiling has been prescribed by RBI in this regard.

28. While lending to intermediaries for on-lending to priority sector, can the bank
reckon the total outstanding loan to the NBFCs / MFIs / HFCs towards its priority
sector achievement ?

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Clarification: In the case of bank’s lending to NBFCs / MFIs / HFCs for on-lending,
only that portion of the portfolio should be reckoned for PSL classification that
has been disbursed by the NBFC etc. to the ultimate borrower/s as on the reporting
date. The reckoning of residual portfolio, if any, can be done on subsequent
reporting dates, based on the disbursement of eligible loans and reported by the
NBFC etc. to the bank.

29. What is the cap for bank lending to NBFCs and HFCs for on-lending?

Clarification: Bank lending to NBFCs (other than MFIs) and HFCs are subjected to
a cap of 5% of average PSL achievement of the four quarters of the previous
financial year. In case of a new bank the cap shall be applicable on an on-going
basis during its first year of operations. The prescribed cap is not applicable for
bank lending to registered NBFC-MFIs and other MFIs (Societies, Trusts, etc.)
which are members of RBI recognised ‘Self-Regulatory Organisation’ of the sector.

Bank lending to such MFIs can be classified under different categories of PSL in
accordance with conditions specified.

30. Does the term "Mandatorily" in CLM guidelines means that the bank must take
all the loans originated by NBFC or a cap can be affixed on the number and amount
in the Master Agreement.

Clarification: Both entities, the bank & the NBFC shall be guided by the bilateral
Master Agreement entered by them for implementing the Co-lending Model
(CLM). The agreement may state any cap on the number and amount of loans that
can be originated by the NBFC under the Co-lending model.

31. Does the term back-to-back mean loan accounts will first be opened by NBFC
and thereafter bank will open loan accounts in its books or both will open loan
accounts and fund them simultaneously based on the loan agreement signed by
the borrower with the NBFC ?

Clarification: Back-to-back basis implies that the loans will be first opened by NBFC
and then bank will open loan accounts subsequently.

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32. Based on the loan documents executed, will the NBFC sanction and disburse
the whole amount and thereafter approach the bank for reimbursement or will it
sanction/ disburse its part of the loan and then approach the bank to sanction/
disburse its part.

Clarification: The bank and the NBFC can decide on this aspect as per the Master
agreement between them.

Govt Sponsored Schemes

PMEGP (Prime Minister’s Employment Generation Programme Government of
India introduced a new credit linked subsidy programme called Prime Minister’s
Employment Generation Programme (PMEGP) on 04-04-2008 by merging the two
schemes namely Prime Minister’s Rojgar Yojana (PMRY) and Rural Employment
Generation Programme (REGP), for generation of employment opportunities
through establishment of micro enterprises in rural as well as urban areas.

PMEGP is a Central Sector Scheme administered by the Ministry of Micro, Small

and Medium Enterprises (MoMSME).

Implementing Agencies:

National Level: Khadi & Village Industry Commission (KVIC).

State Level: In Rural Areas: Through State Directorates of KVIC , State Khadi &
Village Industries Boards(KVIB) and District Industries Center (DICs).

In Urban Areas: State District Industries Center (DICs) only.

Scheme is operational both in Rural and Urban Areas.

Rural & Urban Areas : Any area with population not exceeding exceeds 20000

persons is called as Rural area. Other Areas are classified as Urban Areas.

Quantum: Maximum Project cost Rs.25 lakhs for manufacturing sector and Rs.10
lakhs for service activities.

a) Self Help Group is eligible for getting financial assistance under PMEGP.

b) Without Capital Expenditure, Loan is not eligible.

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c) Finance under PMEGP is only for new projects.

d) Business/ Trading activities in the form of sales outlets may be permitted in

North-East Regions (NER), Left Wing Extremist (LWE) affected Districts and
Andaman & Nicobar Islands.

e) Retail outlets backed by Manufacturing (including Processing) / Service

facilities may be permitted (across the country).

f) Individuals, SHGs, Societies, Trusts are eligible. Only one person from
familyeligible. (Family includes, self and spouse)

Loan Amount : Upto 90% of project cost including subsidy (95% in case of special
category borrowers) without any Income Criteria.

Identification by task force consisting of KVIC/KVIB representative, DIC and banks

representatives.

Eligibility:

a) Above 18 years of age.

b) For setting project above Rs.10 lakhs in manufacturing sector and above Rs.5

lakhs in business/service sector, beneficiary should pass at least 8th standard.

c) Persons who have undergone at least 2 weeks Entrepreneurship Development

training can submit applications directly to Banks.

d) EDP training of 2 to 3 weeks compulsory before disbursement of loan.

e) Exempted for those who undergone training earlier.

f) The minimum limit of 12 months allowed for completion of EDP training after
release of first disbursement has been withdrawn by KVIC.

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Since Online EDP training has been introduced from October, 2019 through
Samadhan portal and PMEGP beneficiaries can opt for either pre-sanction EDP or
post-sanction EDP training either through online or offline mode, it is once again
reiterated that Pre-sanction EDP training completed by the PMEGP beneficiaries
through online EDP portal (Samadhan portal) is valid and should be considered at
par with post-sanction EDP training by Branches/Offices, as the content of syllabus
is one and the same.

Margin: General Category minimum 10% of project cost and Special category
beneficiary: 5% of project cost.

Project cost: Cost of land should not be included in the Project cost.

Project cost will include Capital Expenditure and one cycle of Working Capital.

Projects without Capital Expenditure are not eligible for financing under the
Scheme.

Projects costing more than ₹ 5 Lakh, which do not require working capital, need
clearance from the next higher authority.

Subsidy: General Category: Urban 15%, Rural 25%. Special category beneficiary (i.e
SC/ST/OBC/ Minorities /Women, Ex SM, OPH, NER, Hill & Border areas)

Urban:25%, Rural 35% of project cost.

The proportionate margin money to be refunded to KVIC for non-adherence of

scheme guidelines are as under:

If Bank finance working capital expenditure is in the form of cash credit, the
working capital component should be utilized in such a way that at one point of
time within three years of lock in period of margin money, the cash credit
availment touches 100% of the limit of the sanctioned cash credit and never falls
below 75% of the said limit.

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If it does not touch 100% limit, proportionate amount of the margin money
subsidy is to be recovered and refunded to KVIC at the end of the third year.

In case the account becomes NPA before the three year lock-in period, due to
reasons, beyond the control of the beneficiary, the Margin Money (subsidy) will
be returned to KVIC along with interest.

Repayment : 3 to 7 years, with repayment holiday up to 6 months.

Targets: 50% should be Rural Area Projects.

Social Target :SC-15%, ST-7.5 %,Women-30 % ,Minority -5 %

Village Industry: Fixed Capital Investment per Artisan/worker not to exceed Rs.1
lakh in plain areas and Rs.1.5 lakhs in Hill Areas.

Collateral Security :No collateral security/Third Party Guarantee for loans upto
Rs.10 lakhs to MSEs including units financed under the Prime Minister
Employment Generation Programme (PMEGP) of KVIC. However, such loans shall
invariably be covered under appropriate credit guarantee scheme, as per extant
guidelines, to safeguard the interest of the Bank. CGMSE coverage to be ensured
wherever applicable. Moreover, the PMEGP beneficiaries can also avail loans up to
Rs. 25 lakhs without furnishing collateral securities. However, such loans shall be
invariably covered under the credit guarantee scheme of CGTMSE.

Disposal of loan application

Disposal of loan applications under PMEGP scheme to be ensured within the

stipulated time frames of 30 days in respect of loan quantum above Rs. 5 lakhs
and within 15 days for loan quantum up to Rs. 5 lakhs.

Decision for rejection of credit proposals under the scheme shall be taken by
appropriate Authorities taking into account the guidelines as under:

a) Applications for credit facilities from SC / ST customers shall not be rejected at

branch level and such rejections shall be by the next higher authority.

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b) Whenever applications for loans under govt. sponsored schemes are rejected
by the Branch Manager for valid reasons, the same has to be recorded in a register
maintained to this effect.

c) Rejection of credit proposals from MSMEs is subject to concurrence of the next

higher authority.

d) Turn Around Time (TAT) within 30 days for loan quantum above Rs. 5 lakhs and
within 15 days for loan quantum uptoRs.5 Lacs .

e) Online applications will be mandatory and no manual applications will be

allowed.

f) There will be two separate online application forms for individuals and
institutional applicants available on the portal.

g) Sanction will be issued based on the online sanction letter and copies of the
sanction order will be sent to the applicant (by e-mail/hard copy) as well as to
KVIC/ KVIB/ DIC within 30 days from the receipt of District Level Task Force
committee (DLTFC) recommended application from the District Agencies.

h) The applicant will deposit his own contribution and copy of EDP training
certificate to the financing bank within 10 working days of receiving the
communication of sanction of loan.

Negative List of activities (Not to be financed under PMEGP):

Business activities like opening of grocery and stationery shops etc., involving no
manufacturing process and value addition; Farm related activities like Goatery,
Piggery, Poultry etc., Business connected with meat, intoxicated items, animal
husbandry; Manufacturing of polythene carry bags of less than 5 micron thickness
and manufacturing of carry bags/ containers of recycled plastic are not permitted.

Urban / Rural transport activities except: (a) Auto Rickshaw, Tourist boat and
house boat in A & N Islands. (b) The House boat, Shikara and tourist boat in J &
K. (c) Cycle rickshaw.

Any industry / business connected with cultivation of crops/plantation like Tea,

Coffee, Rubber etc., Sericulture (Cocoon rearing), Horticulture, and Floriculture.

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Value addition under these will be allowed under PMEGP.

Ministry of MSME has since discontinued the system of claiming PMEGP margin
money subsidy through nodal branches (Corporation Bank)/KVIC portal) and has
introduced an online system for quick disposal of the margin money subsidy
claims. The online system has come into effect from 01.07.2016.

The online claim form will be automatically checked for the fulfilment of two
conditions:

The date of release of first instalment is prior to the date of filing of Margin Money
subsidy claim and The amount of first instalment released is more than the Margin
Money subsidy amount claimed.

On receipt of Margin Money (subsidy) in favour of the loanee on the same day,
branch should keep it in Zero Interest Term Deposit for a period of three years
(Lock-in period) in the name of the beneficiary/Institution, duly noting Bank’s lien
on the deposit to the loan account in the CBS system.

PMEGP Second Loan

Objectives:-

To fulfill the need of additional financial assistance for upgrading and expansion
to the successful / well-performing units.

To cater to the need of the entrepreneurs for bringing new

technology/automation so as to modernize the existing unit.

To enhance the productivity of the existing units with the inclusion of additional
dose of funding.

To enhance the capacity of the existing unit with the additional financial assistance
assuring additional wage employment.

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Quantum and Nature of financial assistance: 2nd Loan for up-gradation of existing
PMEGP/MUDRA units:

Categories of Beneficiary Contribution Rate of Subsidy (Project

Beneficiaries Cost)
All categories 10% (of proposed 15% (20% in NER and Hill
expansion /up-gradation States)
cost)

The maximum cost of the project/unit admissible under manufacturing sector for
up-gradation is Rs.1.00 Crore, and the maximum subsidy would be Rs.15 lakhs
(Rs.20 lakhs for NER and Hill States).

b) The maximum cost of the project/unit admissible under Service/Trading sector

for up-gradation is Rs.25 lakhs, and the maximum subsidy would be Rs. 3.75 lakhs
(Rs. 5 lakhs for NER and Hill States).

c) For all categories), rate of subsidy (of project cost) is 15% (20% in NER and Hill
States).

Beneficiary’s contribution will be 10% for all categories.

d) The balance amount of the total project cost will be provided by bank as term
loan. The applicant can utilize the loan amount for investment on fixed assets i.e.
for construction of building/purchase of required new machineries/Installation of
machinery etc.

e) Under the term loan component (construction of building/industrial shed,

machinery & equipment etc.), the construction of own building may be included
and ceiling of construction should not usually exceed 25% of the total sanctioned
project cost.

f) The capital expenditure component including cost of construction should be

upto 60% of the total project cost. The working capital cost would be upto
40%.However, the financing bank can decide the criteria at the time of sanction of
loan based on the nature of the project.

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Eligibility conditions for the beneficiaries:

All existing units financed under PMEGP/MUDRA Scheme whose margin money
claim has been adjusted and the first loan availed should have been repaid in
stipulated time are eligible to avail the benefits.

a) The unit should have been making profit for the last three years.

b) Beneficiary may apply to the same financing bank, which provided first loan, or
to any other bank, which is willing to extend credit facility for second loan.

c) Registration of Udyog Aadhaar Memorandum (UAM) is mandatory.

d) The 2nd loan should lead to additional employment generation

Submission of ITR for last 1 year instead of 3 years, since the proof of making
profit by an enterprise for last three years could be worked out from the “annual
accounts certificate” issued by the Chartered Accountant for the last 3 years.

REGP units may also be considered for availing the facility of 2nd loans besides
PMEGP / MUDRA units.

Differential Rate of Interest Scheme

The DRI scheme was introduced by public sector banks in 1972 as per the
recommendation of the Hazari Committee (1971). Under this Scheme banks
provide loans to the weaker sections of both rural and urban areas, both directly
and indirectly through RRBs.

Maximum Quantum: Rs.15,000/- (For physically handicapped additional loan of

Rs.5000/- for artificial limbs/Braille typewriter.

Repayment Period:5-7 years fixed based on the income generation of the

borrower on installment or EMI basis.

Housing Loans under DIR Rs.20,000/- for SC/STs and Rs.15,000/- for others For EL,
as per Model IBA Educational Loan Scheme guidelines.

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Eligibility:

Annual family income Rs.18,000/- in Rural and Rs.24,000/- in Urban and Semi
Urban areas Individual whose land holding does not exceed 1 acre of irrigated and
2.5 acres of unirrigated land. No Ceiling for SC/ST engaged in Agriculture and
Allied activities.

Target:

1% of previous years Total Bank Credit.

2/3rd of DIR loans in Rural & Semi Urban.

Minimum 40 % to SC/ST beneficiaries.

DRI Scheme is operated through the following institutions:

Orphanage and Women’s home

Institutions for physically handicapped.

State Corporations for SC/ST.

State Minority Finance/Development Corporation.

Finance under DRI scheme for Solar Home Lighting System

Objective:

To be classified under Priority sector advances.

To Purchase / installation of brand new Solar Home Lighting System.

Eligibility Family Income:

Annual Family income of the borrower from all sources should not exceed
Rs.18000/- in rural areas and Rs.24000/- in Semi urban / Urban areas.

Eligibility Land holding SC/ST Borrowers: There is no ceiling on land holding but
the borrowers should satisfy the income criteria.

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Eligibility Land Holding - Other than SC/ST Borrowers: The borrower need not own
any land or the size of the land holding should not exceed one acre in case of
irrigated land and 2.5 acres in the case of un-irrigated land.

Quantum of Loan - The loan up to a maximum of Rs. 15000/- per unit.

Disbursement to be made directly to suppliers against authorization from the

borrower.

Post installation inspection to be conducted and report to be held on record.

No Margin to be insisted.

The assets purchased out of the bank loan are to be hypothecated to the Bank.

No co-obligation to be insisted.

Simple interest at 4 % p.a.

The loan is to be recovered within 60 months with a minimum repayment period

of 36 months.

Self Employment Scheme for Rehabilitation of Manual

Scavengers (SRMS)
The Objective of the SRMS Scheme aims at assisting the manual scavengers,
identified during various surveys, for their rehabilitation in alternative
occupations.

Manual Scavengers and their dependents, irrespective of their income, will be

eligible for assistance. National Safai Karmacharis Finance & Development
Corporation (NSKFDC) is the nodal agency.

Quantum - Loans up to a maximum project cost of Rs. 15 lakhs will be admissible

to identify manual scavengers and their dependents under the scheme. However,
for projects of Self Help Groups/ groups, the maximum project cost shall be
limited to Rs. 50 lakh. For sanitation related projects, apart from manual
scavengers, sanitation workers and their dependents would also be eligible for
assistance under the Scheme

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The beneficiaries have option to select any viable income generating self
employment project.

a) Term Loan- Up to a maximum project cost of Rs.15.00 lakhs for sanitation

related b) projects and up to Rs.10.00 lakhs for other activities.

Micro Financing - Up to a maximum project cost of Rs.25,000/- per scavenger.

Micro financing will be done through SHGs & NGOs.

Where the rate of interest chargeable by the banks on loans is higher than the
rates prescribed, interest subsidy to the extent of the difference will be given to
the banks by the respective State Channelising Agencies (SCAs)/ or NSKFDC.

a) For projects up to Rs.1,00,000/- @ 5% p.a

b) @ 4% per annum for women beneficiaries
c) For projects above Rs.1,00,000/- @ 6% p.a.

Interest Subsidy: As the applicable rate of interest is higher than the rate of interest
chargeable under the scheme, Interest subsidy to the extent of the difference in
rate of interest will be reimbursed to the bank by the Government / other agencies
identified by Government.

Cash Assistance: The identified manual scavengers, one from each family, would
be eligible for One Time Cash Assistance (OTCA) of Rs. 40,000/- or any such
amount as OTCA as revised from time to time Security: Only hypothecation of
assets created out of loans / subsidy in favour of the bank.

Repayment:

The period of repayment of loan, including moratorium period will be five years
for projects upto Rs. 5,00,000 and 7 years for projects above Rs. 5,00,000 with a
moratorium period to start the repayment of loan will be upto 6 months.

Projects up to Rs.5 Lakhs - 5 years after moratorium period

Projects above Rs.5 Lakhs - 7 years after moratorium period

The moratorium period/ repayment holiday allowed is up to 2 years.

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Since the subsidy is back ended, instalments to be fixed on the total loan quantum.

Training : Maximum training period increased up to 24 months, depending upon

trade and maximum stipend upto Rs.3000/- p.m. is provided.

The loans are to be disbursed only after receipt of upfront subsidy.

Disbursement process should commence immediately upon receipt of subsidy.

NRLM & NULM

Deendayal Antyodaya Yojana (DAY)-National Rural Livelihood Mission NRLM –
Aajeevika

DAY-NRLM earlier known as SGSY.

National Rural Livelihood Mission launched by the Ministry of Rural Development,

Government of India by restructuring Swarna Jayanthi Gram Swarozgar Yojana
(SGSY) w.e.f. 01.04.2013.

NRLM is the flagship programme of Government of India to promote poverty

reduction through building strong institutions for the poor, particularly women.

Objective: To bring assisted poor families above the poverty line over a period of
time.

NRLM supports around capacity building of SHGs (especially WSHGs).

The homogeneous group which comprises only women as group members in rural
areas only is eligible for coverage under NRLM scheme.

SHG can avail either TL or CC or both based on need.

SHGs should practice Panchasutra principles without fail, i.e., Regular Meetings,
Regular Savings, Regular inter-loaning, Timely repayment and maintenance of
proper up-to-date Books of Accounts.

Loan amount should be released in multiple doses and repayment linked to release
of such doses.

SHGs can avail either Term Loan or Cash Credit Limit or both based on need.

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Non-wilful defaulter is also eligible for availing loan.

Loan coverage should be: 50 % of beneficiaries from SC/ST, 15% to minorities and
3% to persons with disabilities.

Women SHGs under DAY-NRLM consists of 10-20 persons. In case of special SHGs,
ie., groups in difficult areas, groups with disabled persons, and groups formed in
remote tribal areas, this number may be a minimum of 5 persons.

DAY-NRLM promotes affinity based women self-help groups.

Only for groups to be formed with Persons with disabilities, and other special
categories like elders, transgenders, DAY-NRLM will have both men & women in
the Self-Help Groups.

Financial Assistance to the SHGs:

Revolving Fund under NRLM – Min Rs.10,000; Max Rs.15000 for a minimum period
of 3/6 months and follow the norms of good SHGs, ie., they follow “Panchasutra”.

Capital subsidy discontinued: No Capital Subsidy will be sanctioned to any SHG

from the date of implementation of NRLM.

Community Investment support Fund (CIF):

CIF would be provided by MoRD to the SHGs promoted under DAY – NRLM in all
blocks (intensive and non-intensive) and would be routed through the Village
level/ Cluster level Federations

The CIF would be used, by the Federations, to advance loans to the SHGs and/or
to undertake the common/collective socio-economic activities.

Introduction of Interest subvention:

NRLM has a provision for interest subvention, to cover the difference between the
Lending Rate of the banks and 7%, on all credit from the banks/financial
institutions availed by women SHGs, for a maximum of Rs.3,00,000 per SHG. This
will be available across the country in two ways:

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a) In 250 identified districts, Branches will lend to the women SHGs @7% up to an
aggregated loan amount of Rs.3,00,000/-. The Branches would be sub-vented to
the extent of difference between the Weighted Average Interest Charged and 7%,
subject to the maximum limit of 5.5%. An additional interest subvention of 3% is
also available on prompt repayment by the SHGs, reducing the effective rate of
interest to 4%.

b) In the remaining districts, the Branches may lend at their respective lending
rates applicable to SHGs. In these districts, all women SHGs under DAY– NRLM
would be eligible for interest subvention on prompt repayment.

The difference between the lending rates and 7% for loans up to Rs.3,00,000/-
subject to a maximum limit of 5.5%, would be sub-vented directly in the loan
accounts of the SHGs by the SRLMs. This part of the scheme would be
operationalized by the SRLMs.

c) ROI charged on SHG loans above Rs. 3.00 lakhs is as advised from time to time.

JLGs are not eligible for subsidy under NRLM scheme.

Interest Subvention Scheme is not applicable for the outstanding loans under
SGSY, where capital subsidy is already released.

Lending Norms to individual SHG members and SHGs:

Eligibility criteria for the SHGs to avail loans:

SHG should be in active existence at least since the last 6 months as per the books
of account of SHGs and not from the date of opening of S/B account and be
practicing ‘Panchasutras’.

Qualified as per grading norms fixed by NABARD

At the time of credit linkage, KYC verification of all members of the SHG is
mandatory

The existing defunct SHGs are also eligible for credit if they are revived and
continue to be active for a minimum period of 3 months.

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All banks should use the Common Loan Application Forms recommended by
Indian Bank’s Association (IBA) for extending credit facility to SHGs.

Loan amount: Emphasis is laid on the multiple doses of assistance under

DAYNRLM. This would mean assisting an SHG over a period of time, through
repeat doses of credit, to enable them to access higher amounts of credit for
taking up sustainable livelihoods and improve on the quality of life.

SHGs can avail either Term Loan (TL) or a Cash Credit Limit (CCL) loan or both
based on the need. In case of need, additional loan can be sanctioned even though
the previous loan is outstanding. The amount of credit under different facilities is
as follows:

Cash Credit Limit ( CCL): In case of CCL, to sanction a minimum loan of Rs.6 lakhs
to each eligible SHGs for a period of 3 years with a yearly drawing power (DP). The
drawing power may be enhanced annually based on the repayment performance
of the SHG. The drawing power may be calculated as follows:

DP for First Year: 6 times of the existing corpus or Minimum of Rs.1 lakh,
whichever is higher.

DP for Second Year: 8 times of the corpus at the time of review/enhancement or

Minimum of Rs.2 lakhs, whichever is higher.

DP for Third Year: Minimum of Rs.6 lakhs based on the Micro credit plan prepared
by SHG and appraised by the Federations / Support agency and the previous credit
History.

DP for Fourth Year onwards: Above Rs.6 lakhs based on the Micro credit plan
prepared by SHG and appraised by the Federations / Support agency and the
previous credit History.

Sanction of cash credit limit for the tenability of 3 years and renewal thereafter
will help to avoid repeated documentation which involves lot of activity for the
Group as well as for the Branches.

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Term Loan:

First Dose: 6 times of the existing corpus or Minimum of Rs.1 lakh, whichever is
higher.

Second Dose: 8 times of the existing corpus or Minimum of Rs.2 lakh, whichever
is higher.

Third Dose: Minimum of Rs.6 lakhs based on the Micro credit plan prepared by the
SHGs and appraised by the Federations / support agency and the previous credit
History

Fourth Dose: Above Rs.6 lakhs based on the Micro credit plan prepared by the
SHGs and appraised by the Federations/ Support agency and the previous credit
History

Banks should take necessary measures to ensure that eligible SHGs are provided
with repeat loans.

Corpus is inclusive of revolving funds, if any, received by that SHG, its own savings,
interest earning by SHG from on-lending to its members, income from other
sources, and funds from other sources in case of promotion by other
institutes/NGOs.

Purpose of Loan and repayment:

The loan amount should be distributed among members based on the Micro
Credit Plan prepared by the SHGs.

The loans may be used by members for meeting social needs, high cost debt
swapping, construction of toilets and taking up sustainable livelihoods by the
individual members within the SHGs or to finance any viable common activity
started by the SHGs.

Coverage: At least 50% of loans above Rs.2 lakhs and 75% of loans above Rs.4
lakhs and at least 85% of loans above Rs.6 lakhs be used primarily for income
generating productive purposes. Micro Credit Plan (MCP) prepared by SHGs would
form the basis for determining the purpose and usage of loans.

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Repayment schedule for Term Loans could be as follows:

The first dose of loan shall be repaid in 24 - 36 months in monthly/ quarterly

instalments.

The second dose of loan shall be repaid in 36 - 48 months in monthly/quarterly

instalments.

The third dose of loan shall be repaid in 48 - 60 months based on the cash flow in
monthly/ quarterly instalments.

The loan from fourth dose onwards has to be repaid between 60 – 84 months based
on the cash flow in monthly/ quarterly instalments.

Prompt Payment means:

For Cash Credit Limit: Outstanding balance shall not have remained in excess of
the limit/drawing power continuously for more than 30 days along with regular
credits and debits in the account.

Customer induced credit should be sufficient to cover the interest debited

duringthe month.

For the Term loans: Interest payments / instalments of principal are paid within 30
days of the due date during the tenure of the loan, would be considered as an
account having prompt payment

Security and Margin:

No collateral and no margin will be charged up to Rs.20.00 lakhs limit to the SHGs.
No lien should be marked against savings bank account of SHGs and no deposits
should be insisted upon while sanctioning loans.

Dealing with Defaulters:

The wilful defaulters should not be financed under DAY-NRLM. In case wilful
defaulters are members of a group, they might be allowed to benefit from the
thrift and credit activities of the group including the corpus built up with the
assistance of Revolving Fund.

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At the stage of accessing bank loan by SHG for financing economic activities by its
members, the wilful defaulters should not have the benefit of such bank loan until
the outstanding loans are repaid.

Wilful defaulters of the group should not get benefits under the DAY-NRLM
Scheme and the group may be financed excluding such defaulters while
documenting the loan. However, Branches should not deny loan to entire SHG on
the pretext that spouse or other family members of individual members of SHG
being a defaulter with the bank.

Further, non-wilful defaulters should not be debarred from receiving the loan. In
case default is due to genuine reasons, Branches may follow the norms suggested
for restructuring the account with revised repayment schedule.

Asset classification : All facilities will be governed by Asset Classification norms

issued by Reserve Bank of India from time to time.

Know Your Customer (KYC) verification of only the office bearers shall suffice for
opening of savings bank account.

Opening of SB accounts of all the members is not mandatory for credit linkage to
SHGs.

BCs can also open SB accounts of SHGs after verification / approval from base
branches; subject to adherence to extant BC guidelines of the Bank.

Should not insist on Permanent Account Number (PAN) of SHGs at the time of
opening of account or transactions and may accept declaration in Form No 60 as
may be required.

Supervision and monitoring of the Scheme

DAY-NRLM cells at Regional / Zonal office has to be set up. These cells should
periodically monitor and review the flow of credit to the SHGs, ensure the
implementation of the guidelines to the scheme, collect data from the branches
and make available consolidated data to the Head office and the DAY-NRLM units
the districts / blocks.

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Reporting to RBI: Banks may give a state-wise consolidated report on the progress
made on DAY-NRLM to RBI / NABARD at Quarterly intervals. The data may be
submitted within a month from the end of the concerned quarter.

Financial Literacy:

Financial Literacy is one of the important strategies to spread awareness on

financial behaviour and keep households informed about various financial
products and services.

DAY-NRLM has trained and deployed a large number of cadre called ‘Financial
Literacy Community Resource Persons (FL-CRPs)’ to carry out financial literacy
camps at village level.

Funding Pattern: DAY-NRLM is a Centrally Sponsored Scheme and the financing

of the programme would be shared between the Centre and the States in the ratio
of 60:40 (90:10 in case of North Eastern States including Sikkim; completely from
the Centre in case of UTs)

Deendayal Antyodaya Yojana (DAY)-National Urban Livelihoods Mission (NULM):

Self Employment Programme (SEP): Component 4

Name of NULM changed to DAY-NULM. Earlier this is known as SJSRY. Ministry of

Housing and Urban Poverty Alleviation (MoHUPA) has restructured the existing
Swarna Jayanti Shahari Rozgar Yojana (SJSRY) and launched the National Urban
Livelihoods Mission (NULM) in 2013.

NULM has been implemented in all district headquarters (irrespective of

population) and all the cities with population of 1 lakh or more.

NULM -Self Employment Programme (SEP) will focus on providing financial

assistance through a provision of interest subsidy on loans to support
establishment of Individual, including street vendors/hawkers of urban poor for
setting up gainful self-employment ventures/micro-enterprises, suited to their
skills, training, aptitude and local conditions. The programme also supports Group
Enterprises and SHGs of urban poor.

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Interest Subsidy, being interest charged over and above 7% rate of interest, will
be available for the term loans granted under Individual Enterprises (SEP-I) and
Group Enterprises (SEP-G)

Applicable Rate of Interest is to be charged to the account. Difference over 7% to

be claimed as interest subsidy with Urban Local Body (ULB).

Interest subsidy will be given only in case of timely repayment of loan.

An additional 3% interest subvention will be provided to all Women SHGs

(WSHGs) who repay their loan in time.

Loans granted under NULM (SEP-I, SEP-G and SHG) are eligible to be covered
under appropriate guarantee cover.

Finance can be extended to individuals for capital expenditure in the form of Term
Loan and Working Capital loans through Cash Credit. Composite Loans can also be
extended consisting of Capital Expenditure and Working Capital components,
depending upon individual borrower’s requirement.

Interest Subvention under DAY-NULM:

Identification of eligible accounts by the Ministry by way of uploading Master Data

in PaiSA Web Portal. Cases recommended by task force have to be processed by
the Bank with in a time frame of 15 days.

Up-dation of Mobile Numbers in all eligible accounts – mandatory field for

claiming interest subvention through the portal.

Loans to beneficiaries for carrying out Retail Trade activity can be permitted under
NULM, without insisting on collateral security, subject to fulfilment of the
eligibility conditions.

The percentage of women beneficiaries under Self Employment Programme (SEP)

shall not be less than 30 percent. SCs and STs must be benefited at least to the
extent of the proportion of their strength in the city/town population of poor. A
special provision of 5 percent reservation should be made for the differently abled
under this programme.

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At least 15 percent of the physical and financial targets under this component shall
be earmarked for the minority communities.

Educational Qualifications: For both components (Individual Enterprises - SEP-I

and Group Enterprises -SEP-G), no minimum educational qualification is required
for prospective beneficiaries under this component. However where the identified
activity for micro enterprise development requires some special skills appropriate
training must be provided to the beneficiaries before extending financial support
by linking for training under Employment through Skills Training and Placement
(EST&P). Financial assistance should be extended only after the prospective
beneficiary has acquired required skills for running the proposed microenterprise.

In addition to skill training of the beneficiaries, the ULB will also arrange to
conduct Entrepreneurship Development Programme for 3-7 days for individual
and group entrepreneurs.

Project Cost: The Maximum Project Cost for individual micro-enterprises cases is
Rs.2,00,000/- (Rupees Two Lakhs) and The Maximum unit Project Cost for a group
enterprise is Rs.10,00,000 /- (Rs. Ten Lakhs).

No collateral required. Only the assets created would be hypothecated /

mortgaged / pledged to banks for advancing loans.

Margin: For loan upto Rs.50000 Nil

For loan above Rs.50000 Minimum 5 % and maximum 10 %

The group enterprises (SEP-G) should have minimum of Three (3) members with a
minimum of 70% of the members from urban poor families. More than one person
from the same family should not be made a member of a group.

Repayment– 5 years inclusive of maximum moratorium of 6 months for Individuals

and for groups repayment schedule ranges between 5-7 years after initial
moratorium of 6 months.

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Under SEP-G, Loan can be extended either as a single loan to the group functioning
as one borrowing unit or each member of the group can be provided individual
loans upto 2 lakhs and an overall cap of 10 lakhs based on the principal of joint
liability of the group.

Lending to SHGs :

Opening of savings bank account of Self Help Groups (whether registered or

unregistered) which are engaged in promoting habit of savings among their
members as a starting point. Thereafter, the SHGs may be sanctioned Savings
Linked Loans (varying from a saving to loan ratio of 1:1 to 1:4) after due
assessment of grading.

However, in case of matured SHGs, loans may be given beyond the limit of four
times the savings as per the discretion of the bank.

Identification, selection, formation and monitoring of SHGs who are to get interest
subvention would be the responsibility of State/ULBs and Bank would not be
liable for wrong identification of SHGs who gets interest subvention.

SHGs can avail either Term loan or a Cash Credit Limit loan or both based on their
needs. In case of need, additional loan can be sanctioned even though the previous
loan is outstanding.

Prompt Repayment from SHGs: For Cash Credit limit to SHGs

a)Outstanding balance shall not have remained in excess of the sanctioned limit
/drawing power continuously for more than 30 days.

b) There shall be regular credits and debits in the account. In any case there shall
be at least one customer induced credit during the month which shall be sufficient
to cover the interest debited during the month.

For Term loan to SHGs- a term loan account where all of the interest payments
and /or instalments of principal were paid within 30 days of the due date during
the entire tenure of the loans would be considered as an account having prompt
payment.

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17. Retail Banking & Retail Loans
Retail Banking is a banking service that is geared primarily toward individual
consumers. Although retail banking is, for the most part, mass-market driven,
many retail banking products may also extend to small and medium sized
businesses.

In case of Retail Banking, Client base will be large and therefore risk is spread
across the customer base. In case of Retail Banking , Banking facilities targeted at
individual customers. Retail Banking offer different liability, asset and a plethora
of service products to the individual customers.

The delivery model of retail banking is both physical and virtual i.e. services are
extended through branches and also through technology driven electronic off site
delivery channels like ATMs, Internet Banking and Mobile Banking.

Channels for Retail Banking

The different channels for retail banking are physical branches, ATMs/Kiosks,
telephone/call centres/IVR, and internet mobile banking.

In case of Retail Banking , Customer Loyalty will be strong and customers tend not
to change from one bank to another very often.

In case of Retail Banking , attractive interest spreads since spreads are wide, since
customers are too fragmented to bargain effectively.

In case of Retail Banking , Credit risk tends to be well diversified, as loan amounts
are relatively small.

In case of Retail Banking there is less volatility in demand and credit cycle than
from large corporates.

In case of Retail Banking , large numbers of clients can facilitate marketing, mass
selling and the ability to categorize/select clients using scoring systems/data
mining.

Regulatory prescriptions are one of the major determinants of outsourcing in

Public Sector Banks.

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Business Approach (Domain Specific) in Retail Banking

The business strategies with regard to the domains targeted are approached in
different ways by different banks. The most common approaches are as follows:

a) Segmented Approach
b) Geography based approach
c) Classification based approach

Segmented Approach - Branches are classified as Resource Centres, Profit Centres,

Priority Centres and General Centres to have a clear business focus.

Geography based approach - where retail models are built based on geographies.

Classification based approach - where strategies are designed based on the type
of branch viz., Rural. Semi Urban. Urban and Metro. This strategy helps in better
product structuring for specific types of branches.

Other Products/Services

One set of these products are Credit Cards, Debit Cards. ATM Cards, Telephone
Banking. Mobile Banking, Internet Banking.

Depository Service and Broking Services. Distribution of third party products like
life and non life policies, mutual funds, retail sale of gold coins, bill payment
services, multi city cheques, payment gateway for rail, air ticket bookings, wealth
management services, portfolio management services and private banking are
some of the other services offered by banks.

These services are offered with twin objectives of customer multiple need
satisfaction and also to augment fee based income.

Distinction between Retail and Corporate/Wholesale Banking

Retail Banking and Corporate or Wholesale Banking differ in their basic approach
to banking. The major differences between the two segments are discussed as
follows:

a) Retail Banking targets at the individual segment while corporate banking deals
mainly with corporate clients.

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b) Retail Banking is a mass market banking model whereas wholesale/corporate
banking look at a relatively smaller segment of business/corporate client base as
compared to retail segment.

c) Retail Banking is a B2C approach (Business to Customer) whereas corporate

banking is a B2B approach (Business to Business).

d) The ticket size of loans in retail banking is low whereas the ticket size is high in
corporate loans.

e) Risk is widespread in retail banking as customer base is huge whereas in

Corporate Banking, the risk is more as the ticket size is big though customer base
is relatively small.

f) Returns are more in retail banking as the spreads are more for different asset
classes in retail. But in corporate banking, the returns will be low as corporates
bargain for lower rates due to higher loan amounts.

g) Monitoring and recovery in retail assets are more laborious because of the
larger customer base as compared to corporate banking.

h) In the liability side also, the cost of deposits is relatively less and mostly go
along with the card rates as the ticket size in retail deposits is small. In corporate
banking, as the ticket sizes of deposits will be large, the cost of deposits will be
high due to pressure from the corporates for higher rates and competitive forces
to garner the deposits.

i) The impact of NPA will be more pronounced in corporate banking than retail
banking as the ticket sizes in corporate loans are higher than retail loans.

Augmented products are those products which are developed from formal
products by combining two core products and adding value to the product in
terms of benefits and comforts to the customer. If it is availed by the customer it
will result in some value addition to the customer.

For Core Products there need not be much marketing orientation but for
augmented products there should be a concerted effort for the product to
succeed.

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Retail Loans
A retail loan can help you meet your need for funds instantly. The loan amount
can be used for anything and does not have any end usage restriction. Both big
ticket and small ticket purchases can be made using these loans, and they can then
be paid back in EMIs. There are many types of retail loans, and you can choose a
loan suitable to your specific needs.

A retail loan is a loan that is curated to meet the financial needs of individuals
rather than businesses. Both banks and NBFCs provide this loan. If you want to
make some immediate purchases but do not have the required funds for it, then
you can go in for retail loans. The loan terms and conditions depend on the
borrower’s creditworthiness, repayment capabilities, and income. The interest
rates that you will have to pay for these loans depend on the market conditions,
loan amount, tenure, and credit history of the borrower.

Types of retail loans are:

Personal Loans

Personal loans are unsecured loans and are not backed by any collateral. They are
the best loans one can get to fund their immediate financial needs. They don’t
have any end usage restriction and can be used for various purposes like medical
emergencies, home repairs, vacation expenses, etc.

Home Loans

A housing loan has flexible repayment options and reasonable interest rates.
Moreover, you can easily pay back your loan within a period of 20 to 30 years.

Vehicle Loans

Vehicle loans help you fund the purchase of your dream vehicle whether a new
car, used car, or a two wheeler. You will have to pay a certain amount as down
payment, and the remaining amount can be paid in EMIs. The interest rates offered
on vehicle loans vary across lenders. So, you must do a thorough research about
various lenders in the market and then proceed towards taking a loan.

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Education Loans

Expenditures made towards education can be quite expensive. It includes tuition

fees, accommodation, etc. If an education loan is taken , it will be easier for
individuals who want to pursue higher education in India or abroad. This loan can
either be secured or unsecured Compared to other loans like credit card loans,
personal loans, etc. education loans have a lower interest rate. Also, they have
lengthy repayment tenures giving students a lot of time to repay their loans.

Credit Card Loans

When you have an emergency, you can take a loan against your credit card i.e.
against the credit limit that has been assigned to you. After the approval of the
loan application by the bank, the amount gets credited to your bank account. This
loan can be repaid back in monthly instalments, and the components of the EMI
amount are the principal amount as well as the interest charged by the bank. The
interest charged by the bank varies with the terms and conditions of the loan.
Before taking a credit card loan, you should do a thorough research on the interest
rates offered by various banks. Banks charge a high-interest rate on credit card
loans, so it is better to shop around for the most feasible interest rate.

Advantages of Retail Loans

The application process is user-friendly and easy.

No Usage Restriction: You can repay the loan in monthly instalments and buy
anything that you wish to with the loan amount. The loan amount can be used for
anything and does not have any end usage restriction.

Retail loans offer finance for various purposes: Retail loans are of various types
like home loans, personal loans, credit card loans, educational loans, vehicle loans,
etc.

Retail loans are easy to obtain: Banks and other financial institutions have a simple
and straightforward application process. Many online lenders also have a quick
disbursal policy, and you will be able to receive the loan amount within 24 hours.
Further, retail loans usually have a lower interest rate compared to other forms of
credit such as credit cards and so on.
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Flexibility in Tenure: Retail loans have flexibility in tenure. So you can choose a
duration according to your repayment capacity.

It improves your credit score: Taking a retail loan can be a great way to build your
credit score. Making timely repayments shows that you can handle your finances
with discipline. This will be a good thing for obtaining future credit.

Disadvantages of Taking a Retail Loan

Higher Interest Rates and Additional Fees: The interest rates and additional fees
can spike over a time period, making the loan more expensive. It is essential to
carefully evaluate the terms and conditions of the loan before applying for it.

It could cause a Financial Strain: If you fail to make timely repayments of your
EMIs, then it will cause a financial burden.

Eligibility Criteria for Retail Loans

Age: For most lenders, borrowers must be 18 years and above

Income: Lenders usually require borrowers to have a minimum level of income.

This varies depending on the loan amount and credit history. Before applying for
the loan, applicants must check the income requirements of the lender.

Credit score: It is essential to have a good credit score for retail loans. A higher
credit score means higher chances of approval.

Employment: To be eligible for retail loans, borrowers must have a steady source
of income. They can be employed, self-employed, or have stable means of income.

Other factors: Other factors influencing the eligibility include the borrower’s
current financial obligations, debt-to-income ratio, and length of time at their
current residence or job. It is recommended to evaluate these factors before you
take a retail loan.

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Documents Required For a Retail Loan

Identity Proof

passport/driver’s license/PAN card

Residence Proof

Utility bill/bank statement/official document showing the borrower’s

current address

Income Proof

Salary slips, tax returns, bank statements, or other documents showing the
borrower’s salary

Collateral Documentation

Document proofs have to be submitted for the collateral such as a title or property
ownership certificate

Example of Retail Loans

Buy Now Pay Later or BNPL is the best example of a retail loan. For BNPL,
consumers can buy an item and pay for it in instalments over a specific period of
time. Payments can happen weekly or monthly. BNPL is an interest-free form of
credit, and may sometimes require an initial amount of deposit.

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18. Forward Exposure Limit & Pre-settlement risk
Forward Contracts - Exposure Limit

Forward contract is a binding agreement between two parties to purchase and sell
a specific quantity of foreign currency at a specified price but with delivery and
settlement at a specified future date.

Customers who need to hedge their foreign currency payables or receivables can
use forward contracts to protect themselves from adverse movements in the
exchange rate.

For example, forward enables the exporter who sells goods abroad in terms of
foreign currency to determine at once, the amount realizable in terms of Rupees
and the importer to determine at once the cost of his imports in terms of Rupees.

Benefits & Risks

The objective of this mechanism is to safeguard the customer from any probable
adverse movements or fluctuations in rates of exchange at a later date. At the
same time, even if the rate moves favorably (at the future date) the customer is
bound to settle the underlying transaction at the contracted rate. In other words,
by booking a forward contract, the customer has the obligation to acquire or
dispose off the foreign currency on a future date at the predetermined exchange
rate.

Types

Forward contracts can be classified into Forward Purchase Contracts (i.e., Exports,
Inward Remittances, etc.) or Forward Sale Contracts (i.e., Imports, Outward
Remittances, etc.) depending upon the nature of underlying transaction.

Terms

Forward Contract shall be strictly as per related provisions of FEMA and FEDAI
rules/ guidelines issued from time to time. Please refer to Application for booking
Forward Contract for other important terms and conditions applicable to this
product.

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Illustration (Bank: Purchase/Customer: Sale - i.e., Exports)

Parameters

Currency Pair USD/INR

Notional 1,00,000 USD

Spot Rate 73.50

Tenor 11 months

Swap Points (Premium) 3.50

Forward (Contracted) Rate 77

Settlement Scenarios

On maturity:

Customer would deliver 1,00,000 USD and shall take delivery of INR 77 Lakhs.

Early delivery:

Customer shall take delivery of the INR against the delivery of USD 1 Lakh or part
thereof, by paying back the prevailing swap points for the residual maturity,
subject to the recovery of swap cost. E.g., if the swap points to pay for the residual
period is at 1.00 on the date of early delivery, the INR notional for delivery would
be INR 77 Lakh and applicable swap cost of INR 1 Lakh will be recovered.

Termination/Cancellation of contract:

Customer may terminate the contract, during the tenor of contract, at the
prevailing market rate. The prevailing market rate shall constitute of the spot rate
and swap points for residual maturity of the contract.

Exchange Gain on such termination/cancellation shall be settled on maturity.

Exchange Loss shall be settled upfront.

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In the above example, if the spot rate on the date of termination/ cancellation of
the contract is at 72.50 and swap points for the residual maturity of the contract
is at 2.0 (premium), the net rate for cancellation shall be 74.50 (costs and fees
extra). Gain on such termination/cancellation of contract shall be ~ INR 2.50 Lakh
and the same shall be paid to the customer on the maturity date of the original
contract.

If customers fail to utilize/rollover/cancel the forward contract on or before the

maturity date, Bank shall cancel the contract and recover the loss and/or charges
arising out of the said cancellation by debiting customer’s account. Moreover,
customers are not eligible for any gain arising out of said cancellation.

Terms & Conditions

Anticipated exposure:

An exposure to the exchange rate of INR against a foreign currency on account of

current and capital account transactions permissible under FEMA, 1999 or any
rules or regulations made there under, which are expected to be entered into in
future.

Contracted exposure:

For contracts involving INR, customers may book forward contracts up to USD 100
million equivalent of notional value (outstanding at any point in time) without the
need to establish the existence of underlying exposure.

In case of contracted exposure Documentary evidence of underlying exposure

shall be submitted within 15 calendar days from the date of booking of contract.

In case of anticipated exposure - Gain, if any, arising out of cancellation/rollover

of the forward contract under Anticipated Exposure shall be payable only when
related cash flow takes place. Further, such gain, if any, shall not attract any
interest for the period from the date of accrual till the date of payment.

On cancellation or early delivery of a forward contract, the incidence of

cancellation / early delivery charges/gains occur which will be recovered from or
paid to the customer, as the case may be, in addition to applicable charges.

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 Margin Requirements:

Tenor of Contract Margin

Borrower Non Borrower

Up to 1 year 0.5% to 2% 3%

Above 1 year 2% to 5% 5%

In case of contracts booked under anticipated exposure, with maturity beyond one
year, for capital account transactions (as defined under FEMA), additional margin
of 10% to be obtained.

Mark-to-Market (MTM) margin:

Whenever MTM loss reaches the limit of 75% of available margin, the additional
Margin shall be maintained per contract wise. Such margin shall be kept under lien
marked for forward contracts. Margin can be considered by the way of earmarking
the Balances in Current Account/Term Deposit.

Authorised Dealers shall permit users to take position up to USD 100 million
equivalent of notional value (outstanding at any point of time), across all
Authorised Dealers, for hedging contracted exposure without the requirement to
establish the existence of underlying exposure.

Pre-Settlement Risk (PSR)

Any business operation involves a level of collaboration, co-operation, and
partnership with other parties. Put simply, counterparty risk measures how likely
it is that the other

A counterparty credit risk is simply a subtype of a credit risk. The term “credit risk”
covers all types of economic loss, including both counterparty and issuer credit
risks. It’s a term often used when talking about banks loaning money or corporate
bonds.

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Counterparty credit risk comes in two forms: pre-settlement risk and settlement
risk. The former applies during a transaction while the latter applies thereafter.

Settlement risk can then be further divided into default risks – i.e., a complete non-
fulfilment of an obligation – and settlement timing risks, such as late performance.

Pre-settlement risk is the possibility that one party in a contract will fail to meet
its obligations under that contract, resulting in default before the settlement date.
This default by one party would prematurely end the contract and leave the other
party to experience loss if they are not insured in some way.

Pre-settlement risk (PSR) is the risk that a counterparty to a transaction, such as a

forward contract, will not settle his/ her end of the deal.

PSR limits are based on the worst case loss that is likely to occur if the counterparty
defaults prior to the settlement of a transaction. The worst case loss assumes an
adverse movement in price/ rate, a client default and the subsequent cost of re-
covering the transaction again from the open market.

Therefore in setting a PSR Limit the following three factors need to be considered.

a) The credit worthiness of the counterparty in the same way as is done for
traditional credit lines,

b) The likelihood of a adverse market movement and,

c) The cost of covering the transaction from the market in case of a

counterparty default.

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19. Structured Finance options
The term “structured finance” is often used to explain the bundling of receivables,
although it is more generally applicable to the offering of a structured system to
help borrowers – and lenders – accomplish their end goal.

The primary goal is to facilitate financing solutions that don’t involve free cash
flow and to address different asset classes across various industries, making less
risky products available to clients that need them.

The Matter of Securitization

Securitization is the core of structured finance. It is the method by which those in

structured finance create asset pools and ultimately form complex financial
instruments that are useful to corporations and investors with special needs.

The specific reasons why securitization is valuable include:

Alternative funding formats for unique or complicated needs

Reduction of focus on credit

Managing risk through liquidity and interest rates

Efficient use of capital available, to capitalize on the potential for greater

earnings or profit

Less-costly funding options, which may be primarily important for borrowers

with a less-than-stellar credit rating

Transfer of risk away from investors

Examples

For large corporations looking to borrow substantial sums, a collected group of

assets and financial transactions may be necessary. There are lending transactions
that can’t be done with a traditional financial instrument. Therefore, structured
finance comes into play.

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Several structured finance products and combinations of products can be used to
accomplish the financing needs of large borrowers. Structured finance products
include:

Syndicated loans

Collateralized bond obligations (CBOs)

Credit default swaps (CDSs)

Hybrid securities

Collateralized mortgage obligations

Collateralized debt obligations (CDOs)

Syndicated loans

Syndicated loan is a form of loan business in which two or more lenders jointly
provide loans for one or more borrowers on the same loan terms and with
different duties and sign the same loan agreement. Usually, one bank is appointed
as the agency bank to manage the loan business on behalf of the syndicate
members.

Collateralized bond obligations (CBOs)

A collateralized bond obligation (CBO) is a structured product that pools several

junk bonds in order to create an investment grade security. Pooling several
securities that would be otherwise high-risk on their own creates diversification
such that the pooled security is far less risky for investors.

Credit Default Swaps (CDSs)

A credit default swap (CDS) is a financial derivative that allows an investor to swap
or offset their credit risk with that of another investor. To swap the risk of default,
the lender buys a CDS from another investor who agrees to reimburse them if the
borrower defaults.

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Hybrid Securities

It is a single financial security that combines two or more different financial

instruments.

Hybrid securities, often referred to as “hybrids,” generally combine both debt and
equity characteristics.

Preference shares are called hybrid securities, as these shares have the features of
equity shares and debentures. Like equity shares, preference shares receive
dividend only when the company is earning a profit; like debentures, preference
shares get a fixed rate of return.

The most common type of hybrid security is a convertible bond that has features
of an ordinary bond but is heavily influenced by the price movements of the stock
into which it is convertible.

They are bought and sold on an exchange or through a brokerage.

REITs and InvITs are classified as hybrid securities and they are relatively new
investment instruments in the Indian context but are extremely popular in global
markets.

A REIT comprises a portfolio of commercial real assets, a major portion of which

is already leased out, InvITs comprise a portfolio of infrastructure assets, such as
highways and power transmission assets.

Collateralized Mortgage Obligations

A collateralized mortgage obligation (CMO) refers to a type of mortgage-backed

security that contains a pool of mortgages bundled together and sold as an
investment. Organized by maturity and level of risk, CMOs receive cash flows as
borrowers repay the mortgages that act as collateral on these securities.

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Collateralized Debt Obligations (CDOs)

A collateralized debt obligation (CDO) is a complex structured finance product

that is backed by a pool of loans and other assets and sold to institutional
investors. A CDO is a particular type of derivative because, as its name implies, its
value is derived from another underlying asset.

Summary

Structured finance and its products are important. It provides the scaffolding and
space for major borrowers needing a capital injection or alternative source of
financing when other, more traditional borrowing options won’t work.

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20. Alternative Source of Funding
Alternative Investment Funds (AIF for short) are those funds created or established
in India as a privately pooled investment vehicle in order to collect funds from
specific investors as per a previously defined investment policy.

AIF does not include funds covered under the SEBI (Mutual Funds) Regulations,
1996, SEBI (Collective Investment Schemes) Regulations, 1999 or any other
regulations of the Board to regulate fund management activities.

Alternative Investment Funds consist of investment funds pooled in together

which is then used in investing private equity, hedge funds etc.

Regulation 2(1)(b) of the Regulation Act, 2012 of Securities and Exchange Board
of India (SEBI) lays down the definition of AIFs. Through a company, or a Limited
Liability Partnership (LLP) and Alternative Investment Fund can be established.

AIF does not include funds that are included in the regulations of the SEBI which
oversee fund management activities. Other exemptions include family trusts,
employee welfare trusts or gratuity trusts.

Types of Alternative Investment Funds

As per the Securities and Exchange Board of India, AIFS are divided into three
categories. They are as follows:

Category 1 AIFS

These funds are invested in businesses that are new or have the potential to grow
financially such as Start Ups, Small and Medium Enterprises. The government
encourages investments in these ventures as they have a positive impact on the
economy with regards to high output and job creation.

Examples of this category are as follows:

Infrastructure Funds
Angel Funds
Venture Capital Funds
Social Venture Funds

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Category 2 AIFS

Under this category, funds that are invested in equity securities and debt securities
are included. Those funds not already under Category 1 and 3 respectively are also
included. No concession is given by the government for any investment made for
Category 2 AIFS

Examples of this category are as follows:

Fund of Funds
Debt Funds
Private Equity Funds

Category 3 AIFS

Category 3 AIFs are those funds which give returns under a short period of time.
These funds use complex and diverse trading strategies to achieve their goals.
There is no known concession or incentive given towards these funds specifically
by the government

Examples of this category are as follows:

Hedge Funds
Private Investment in Public Equity Funds

Benefits of AIF

Alternative Investments may help in reducing volatility that is commonly

associated with traditional investments as their performances are not dependent
on the ups and downs of a stock market.

Helps in diversification in terms of markets strategies and investment styles

Strong potential in improving performance.

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Drawbacks of AIF

A high investment amount is required, something which is not possible for small-
scaled investors.

Alternative investment funds are complex funds and due diligence is needed
before deciding to invest in them.

Infrastructure Funds

An infrastructure fund is an investment scheme that invests primarily in facilities

and utilities that provide essential services to communities. These can include
airports, roads, seaports, railways, hospitals, education facilities, water supply, gas
and electricity and telecommunications facilities.

Angel Funds

“Angel fund” is a sub-category of Venture Capital Fund under Category I

Alternative Investment Fund that raises funds from angel investors and invests in
accordance with the provisions of Chapter III-A of AIF Regulations.

Venture Capital Funds

Venture capital funds are pooled investment funds that manage the money of
investors who seek private equity stakes in startups and small- to medium-sized
enterprises with strong growth potential. These investments are generally
characterized as very high-risk/high-return opportunities.

Social Venture Funds (SVF)

An SVF is a category 1 Alternative Investment Fund (AIF) that is already allowed

by SEBI to issue securities or units of social ventures to investors. These funds
invest in firms that have a social conscience and work to bring an impact to society.
These entities aim to make gains and, at the same time, solve social issues.

Fund of Funds

A fund of funds (FOF) is a pooled investment that invests in other types of funds.
It is also known as a multi-manager investment. An FOF is aimed at achieving
broad diversification and proper asset allocation.

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Debt Funds

A debt fund is a fund whose primary purpose is to be invested in debt or debt

securities.

Private Equity Funds

Private equity funds are pools of capital to be invested in companies that represent
an opportunity for a high rate of return. They come with a fixed investment
horizon, typically ranging from four to seven years, at which point the PE firm
hopes to profitably exit the investment.

Hedge Funds

A hedge fund is a limited partnership of private investors whose money is pooled

and managed by professional fund managers. These managers use a wide range
of strategies, including leverage (borrowed money) and the trading of non-
traditional assets, to earn above-average investment returns.

Private Investment in Public Equity Funds

Private investment in public equity (PIPE) is when an institutional or an accredited

investor buys stock directly from a public company below market price. Because
they have less stringent regulatory requirements than public offerings, PIPEs save
companies time and money and raise funds more quickly.

Corpus of an AIF

“Corpus’’ is the total amount of funds committed by investors to the AIF by way
of a written contract or any such document as on a particular date.

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[Link] Finance-P2P lending via FinTech
Digital finance is the term used to describe the impact of new technologies on the
financial services industry. It includes a variety of products, applications, processes
and business models that have transformed the traditional way of providing
banking and financial services.

The financial services sector is not new to digital transformation. But the
investments in digital finance and the extent to which digitalization is embraced
has definitely been accelerated in recent years.

Digital finance refers to the process of transforming traditional banking and

financial services through the use of new technologies. Specifically, using digital
products and tools to deliver financial services.

Examples of digital transformation in finance

Like with most industries out there, digital transformation has had a large impact
on financial services as well. Some examples of technologies and solutions that are
driving financial services digitization are mentioned below.

Increased use of online/mobile banking

Digital banking is not a new concept. In fact, it’s been quite popular with younger
audiences for a while. But recent events have significantly increased the use of
online banking. When visiting their local bank branch was no longer an option,
more and more turned towards digital banking. This has led to more people
getting comfortable with digital transactions, like online payments and transfers
– and have even started to prefer them.

The emergence of challenger banks

In the past years, more of the so-called challenger banks have emerged. These are
fully digital banks, with no physical branches. They challenge the traditional banks,
by making the customer experience smoother – from the ease of opening an
account to better functionality and more attractive fees and rates. Some examples
of such challenger banks are Revolut, Lunar, and Monzo.

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Fintech solutions

Fintech companies are also changing the financial services market. They provide a
variety of digital services, from spending tracking, budgeting, to customer service
chatbots and more. With more and more financial institutions relying on fintech
solutions, these companies have been essential in driving the digitalization of
financial services.

Digital investments companies

Algorithm-based investment management and digital financial advice platforms

are also increasing in popularity. Their ease of use and ability to offer more
attractive fees are just a few of the reasons why more consumers are preferring
them over traditional investment companies.

Blockchain technology

Another technology boosting digitalization in finance is blockchain. It provides

new opportunities to identify, record, and store assets digitally, as well as changes
the way people invest their resources and trade on markets. Blockchain
technology’s impact is still unfolding and is likely to play an even bigger role in
the future of financial services. If you’re eager to participate in its rollout, rather
than being a passive observer, you can learn Solidity and use this programming
language to work on blockchain projects, starting today.

Benefits of digital finance

More efficiency

Digital tools were created to help us work more efficiently, by removing the
manual time-consuming work out of the equation. Relying on such solutions
enables employees in financial institutions like banks, pension funds or insurance
companies to improve their productivity and focus more on value-adding tasks.

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Increased security

The finance industry is subject to security and compliance requirements and with
good reason. They often process and handle sensitive and confidential
information. Most finance automation tools are built with these requirements in
mind, making them a good choice for the needs of financial service providers.

Improved customer experience

Customers nowadays expect a digital, smooth experience by default. Their

interactions should be effortless and at their own convenience. With the market
becoming more competitive, financial institutions need to invest in digital tools to
keep their customers satisfied and provide the level of service they expect.

Insights & analysis

Financial services providers typically have access to and handle large amounts of
data, which comes with great potential. But without the tools to analyze it, that
data is not of much help. Digital solutions provide financial institutions with clean
data and actionable insights, which can be used to identify new business
opportunities and grow.

After digital payments and digital lending, the Reserve Bank of India is looking
closely at platforms that facilitate direct, or peer-to-peer (P2P), lending between
individuals. Peer-to-Peer (P2P) lending is done through a website that connects
borrowers and lenders directly.

Peer-to-Peer (P2P) lending

P2P lending is the popular type of crowd funding, whereby an internet platform
collects small amounts of funds from individuals in a crowd to finance collectively
a larger loan to individuals or businesses.

Websites that facilitate peer-to-peer lending have greatly increased its adoption
as an alternative method of financing.P2P lending is also known as social lending
and has only existed since 2005.

It is done through a website that connects borrowers and lenders directly.

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Those who want to lend money, open an account with a P2P platform as a lender.
And those who require a loan register themselves as a borrower.

It enables individuals to obtain loans directly from other individuals, cutting out
the financial institution as the middleman.

In 2017, the Reserve Bank of India brought this service under its regulatory
purview.

Only an NBFC can register as a P2P lender with the permission of RBI. Every P2P
lender should obtain a certificate of registration from the RBI.

The minimum capital requirement to set up a P2P platform is fixed at Rs. 2 Crores.

Risks associated with P2P lending

Lack of legal disclosure of risks for lenders: There are no legally defined disclosure
standards to ensure that lenders have a clear and accurate understanding of the
risks associated with using a specific P2P platform.

No uniform standards to calculate profit returns: The methods used for calculating
the risk-adjusted net returns differ considerably from platform to platform
because national laws and regulators have yet to define a common standard for
measuring the performance of P2P-loan investments.

Lack of disclosure about platforms and borrowers: There are no disclosure

standards for information about borrowers or platforms’ credit assessment
methods. This makes it impossible for investors to assess and compare the quality
of platforms and so make a careful selection of the “right” platform.

Lack of transparency regarding credit assessment: There is lack of transparency

about how platforms assess credit. Borrowers may not know what kind of data
their platforms are using and how credit ratings are calculated.

Lack of central regulation: Often platforms in countries without dedicated

crowdfunding regulation do not need any central authorisation from the national
financial regulator to start their business and do not have to fulfil minimum capital
requirements.

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Opportunities

Accessibility: Surveys of P2P borrowers reveal that the convenience of using a

web-base to get credit is the highest ranked benefit of P2P-lending.

Lower administration cost and enhanced efficiency: The advantages are seen
mainly as lower transaction costs in the loan application process and a much
shorter time span, when compared to bank loans, from first contact until the loan
pay-out is received. Lower transaction costs are a result of 24/7 accessibility of the
platform, reduced bureaucracy and documentation requirements, and a simple
and transparent application process.

No mandatory collateral: Corporate borrowers have the ability to obtain P2P-loans

without providing collateral.

Cheaper credit: Due to low administration cost, P2P is able to provide cheaper
credit than banks.

Extra flexibility that P2P offers over banks: Most platforms allow borrowers to
cancel loan contracts prematurely without paying a prepayment penalty

Conclusion

Web-based financial intermediation on a peer-to-peer basis will eventually prevail

as an economically superior form of organisation compared to the traditional
banking business model.

A uniform and dedicated regulation for crowdfunding through P2P is needed to

provide financial service platforms and their users with the necessary legal
confidence and certainty to expand their activities freely.

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22. Green Finance
Green Finance is a term which refers to financial investments for those projects
that support sustainable development.

Green financing is to increase level of financial flows (from banking, micro-credit,

insurance and investment) from the public, private and not-for-profit sectors to
sustainable development priorities. A key part of this is to better manage
environmental and social risks, take up opportunities that bring both a decent rate
of return and environmental benefit and deliver greater accountability.

Green financing could be promoted through changes in countries’ regulatory

frameworks, harmonizing public financial incentives, increases in green financing
from different sectors, alignment of public sector financing decision-making with
the environmental dimension of the Sustainable Development Goals, increases in
investment in clean and green technologies, financing for sustainable natural
resource-based green economies and climate smart blue economy, increase use of
green bonds, and so on.

Green investments include investments in biodiversity protection, water

sanitation, industrial pollution control, energy efficiency, climate change
adaptation, renewable energies, etc.

Green finance comprises of financing of public green policies, etc.

The terms ‘green finance’, ‘sustainable finance’, ‘climate finance’ is implicitly

known as an eclipsing territory of matters on environmental, social, economic and
governance.

Climate finance provides funds for addressing climate change adaptation and
mitigation and can be considered as a part of green finance, whereas green finance
has a broader scope as it also covers other environmental goals (e.g. biodiversity
protection/restoration).

Climate Finance can be defined as the emerging form of green finance which is
available for various projects in the developing countries. It is one of the growing
sectors in the field of international development and environmental finance.

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Climate Finance also helps in reducing emissions or for adapting to climate
changes. This can be achieved either by increasing the revenues that are available
to both public and private development projects namely: tariff support, carbon
finance. It can also be achieved through the improvement of project capital
structure, for example by reducing the costs of debt and equity.

Role of Green Finance

Green finance is responsible for the financing of both public and private green
investments along with the preparatory and capital costs. Some of the major roles
of Green Finance are as follows:

a) To provide financing for environmental goods and services such as water

management or protection of biodiversity and landscapes.

b) To prevent, minimize and compensate the damages to the environment

and to the climate.

c) To provide financing of public policies which will encourage the

implementation of environmental and environmental-damage mitigation
or adaptation projects and initiatives.

Green Investments majorly includes the following areas:

1. waste processing and recycling

2. biodiversity protection
3. climate change adaptation
4. renewable energies
5. energy efficiency
6. water sanitation
7. industrial pollution control
8. other climate change mitigation

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Green Bond

A green bond is a type of fixed-income instrument that is specifically earmarked

to raise money to invest in climate solutions. The top three green bond issuers are
the US, China and France.

Green Fund

Green Fund is an investment mechanism that will be invested in companies or

businesses deemed to be socially responsible towards the environment or promote
a sustainable responsibility towards it.

A green fund can come in the form of a focused investment vehicle for companies
engaged in environmentally supportive businesses, such as alternative energy,
green transport, water/waste management etc.

Sustainable Development Goals (SDGs) and Green Financing

UN Environment has been working with countries, financial regulators and finance
sector to align financial systems to the 2030 sustainable development agenda – to
direct financial flows to support the delivery of the Sustainable Development
Goals. At the core of today’s globalized economy are financial markets through
which banks and investors allocate capital to different sectors. The capital
allocated today will shape ecosystems and the production and consumption
patterns of tomorrow.

The main areas for the current work on green financing are:

Supporting public sector on creating enabling environment

Promoting public-private partnerships on financing mechanisms such as green

bonds

Capacity building of community enterprises on micro-credit.

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23. Documentation
Documentation is a set of documents that evidences and supports a banking
relationship. As per the Indian Contract Act, 1872, banking relationship is a
contract between the Bank and the Customer. Proper documentation has to be
ensured to capture the contracts of banking relationships appropriately so as to
create valid records of transactions and effective charges on securities in favour of
the Bank. The documents obtained from the customers will be the primary
evidence that can be produced in court of law to establish the Bank‘s right, claim
or interest in the security. Further, ensuring proper documentation can be the key
to avoid protracted litigation.

One of the foremost and major functions of Banks is lending money to

constituents. This results in contractual relationship between the banker and the
customer which needs to be supported by proper evidence. Besides, banks have to
get all their operations and transactions duly backed by requisite documents and
also maintain a proper record evidencing the fact of transactions. In this context,
obtention of correct ‘Documentation‘ assumes greatest importance.

Meaning and Purpose of Documentation

Documentation means any matter expressed or described upon any substance by

means of letters, figures or marks or by more than one of these means, intended
to be used or which may be used, for the purpose of recording that matter.
(Section 3, of the Indian Evidence Act, 1872 ). This means obtaining proper
documents in appropriate form in accordance with law, executed by relevant
party/ies.

The documentation establishes a legal relationship between the lending banker

and the borrower.

The terms and conditions of loans/advances, the securities offered and rights and
liabilities of the parties are reduced into writing which avoids ambiguity.

The documents are of primary importance in any litigation and proper

documentation not only helps the bank in litigation but also ensures that the
borrowers do not contest on technical grounds.
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Documentation is necessary to ensure due repayment of the loan by the borrower
and in case of default by him, entitles the Bank to legal recourse for recovery of
loans.

Documents are the primary evidence that can be produced in a court of law to
establish right, claim or interest of the bank in the security and unless these are
properly drawn/ executed, the bank may not be able to secure an order for decree.

Hence, the purposes of documentation are:

a) to create a record of transaction

b) to create a valid and effective charge on securities in favour of the bank.

Execution of Documents

Utmost attention and great care must be bestowed upon for proper execution of
the loan documents. Any discrepancy in the documentation adversely affects the
rights of the bank in the event of initiating legal proceedings to recover the dues.

Examples of defective documents:

a) Inappropriate documents;

b) Documents not in complete sets as prescribed by the Bank;

c) Documents which are left partially blank;

d) Obtention of photocopies of loan agreements as part of the prescribed

documentation.

e) Obtention of copies of Typed Agreements (other than the one originally typed).

f) Over writings/erasings without proper authentication by the borrower;

g) Unstamped or inadequately stamped or improperly stamped documents;

h) Documents executed wherein all the parties have not joined the execution;

i) the person has no proper authority. Example: Documents executed by agent in

the absence of power of attorney.

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j) the person does not have the capacity to enter into a contract. Example: Minor,
lunatic during lunacy etc.

Valid and Legally enforceable documents are necessary to have a recourse to Court
of Law to recover the dues in case of necessity.

Procedure to be followed whenever non-judicial stamp papers are to be used in

the absence of stamped/embossed agreement formats -

Preamble portion as appearing in the printed agreement should be hand

written/typed on the non-judicial stamp paper of requisite value. If more than one
stamp paper is used, care should be taken to see that the wordings of the said
preamble portion are spread over on all the stamp papers so used in order to avoid
scope for re-using.

After writing/typing the matter as stated above, the words ―continued in printed
NF............containing.................pages‖ should be written/ typed duly mentioning
the ―Form number and ―number of pages of the printed agreement so as to
ensure continuity.

The corresponding portion in the printed agreement should be cancelled under

full signature/s of the borrower/s / Executants without filling up.

The non-judicial stamp paper/s so used should be fastened to the printed

agreement and should be got duly executed by the borrower/s as a single
document.

Format:

After going through the sanction and ascertaining the nature of transaction, the
appropriate documents / agreement forms to be obtained are to be selected. In
cases where certain specified provisions / conditions of sanction are to be
incorporated, or where the documents to be accepted are not in the standard
formats generally obtained by the bank, the documents may be got drafted and
approval from the concerned Legal Sections.

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Date:

The date and place must be correctly mentioned in the document. If a document
is to be made effective retrospectively, a clause to that effect can be inserted in
the document.

The dates mentioned in the Pro-note and also on all other relevant documents
should be one and the same.

The importance of date mentioned in the document can be understood while

computing the period of limitation.

When different persons have executed the documents on different dates, they are
required to mention the date below their signature. In such cases, even though the
last date will be treated as the date of completion of documentation, for
computation of limitation, the date of first execution may be reckoned.

Filling up of particulars in the documents:

No space should be left blank in any document. The documents should be

complete in all respects. All blanks relating to details, such as, rate of interest,
nature, amount of advance, security etc., are to be carefully and accurately filled
up.

All loan papers should be filled up then and there before disbursing the loan
proceeds. The documents should be got completed in one sitting in the same
handwriting using the same ink and pen. Any infirmity in this regard may lead to
avoidable doubts regarding fair execution of the document.

The full name of the party, age and parentage (or husband‘s name) and full
address of the borrower and the co-borrower should be clearly mentioned failing
which in future there will be difficulty in locating the party. If there are
coobligants, they should not be named as co-obligants in the Pro-note. In law, a
coobligant is a co-borrower and there is no difference between the co-borrower
and the main borrower.

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If any document is filled up subsequent to its execution, it may be construed as
being at variance without the consent of the party, amounting to material
alteration.

The execution of all documents should always be done in the presence of

theofficer responsible for obtaining them.

The borrower should not be allowed to take away the documents for obtaining
the signatures of other co-borrowers/co-obligants/guarantors under any
circumstances.

Signature of Executants:

All loan documents should be signed on every page at the end by the executant
for having read the contents of the pages.

Initials must not be allowed to be put in place of full signature. This is the universal
practice with justifiable reasons. The obvious advantage of getting signature on
each and every page of an agreement is that a borrower will be fully and
completely bound by such execution. If it is not so signed, the borrower may allege
that the bank has substituted the relevant pages of the agreement and that the
documents executed by him contained some other matter or that the matter
contained in the pages not signed by him is not binding on him. In order to avoid
all risks and to safeguard bank‘s interest, the signature of the executant has to be
obtained on every page of the documents.

The borrowers must be asked to affix full signature in the same style throughout
the documents.

All types of additions, alterations, insertions, strikings, over writings, erasings,

interlining, deletions etc., in the documents must be authenticated by the
borrower under his full signature in the same style as he has signed elsewhere in
the documents.

All blanks must be filled in correctly as to spellings of the names of the borrowers,
the firm, company etc.

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Keeping the document blank or even one or more columns blank may invalidate
the whole document.

When a document is to be executed by an illiterate person, his/her Left Thumb

Impression should be obtained. If the Borrower is not having the left thumb or if
the practice in the area is to obtain the Right Thumb Impression, the same may be
obtained. Thumb impression of a person once affixed to a document cannot be
disputed as not belonging to him/her and therefore it can be treated as proper
mode adopted for binding a party to a document.

In case the borrower does not know the language of the document, it is necessary
to explain the contents thereof to him and obtain a declaration to the effect by a
person knowing the language of the document.

Wherever the loan documents are executed by illiterate person/s the narration
such as ―LTI / RTI of Mr/Mrs…………………………. has to be written wherever
thumb impressions are obtained/affixed.

While obtaining documents from Purdanishin ladies, Bank must ensure that the
lady executing the documents freely understands the nature and contents of the
documents. In such cases, a declaration is to be obtained by a person knowing the
language of the document.

Identification of the purdanishin lady and interpretation of the document should

be done by a female declarant not related to the borrower.

The Manager has to affix his signature wherever there is a provision in the
agreement for affixing the signature of Branch Manager.

Place of execution (Jurisdiction):

Generally documents mention the place of the branch where the advance is
disbursed and this will determine the jurisdiction within which the suit can be filed.

Sometimes one or more parties execute the documents in different States. In such
cases, the following points are to be noted.

a) No further stamps be affixed if the stamp duty is same in all States.

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b) Difference in stamp duty is payable if the documents travel to the higher stamp
duty area from lower stamp duty area.

c) If the document travels to the State of Jammu & Kashmir from another State or
vice versa, the full stamp duty as applicable in the State to which the document is
taken has to be paid in addition to the stamp duty already paid in the other State.

d) However, where a document which has been originally stamped in any State of
India other than Jammu and Kashmir, subsequently travels from J & K to another
State, not being the State where it was originally stamped, then only differential
stamp duty on the original stamp, if any, need be paid. This differential stamp duty
is to be paid irrespective of the stamp duty paid at J&K.

The borrowers should be asked to write the name of the place below their
signatures if they are executing the documents in different States.

Attestation: Essentials:

a) The attesting witness should sign in the presence of the executant.

b) He should sign to attest the signature of the executant.

c) The document must be executed first by the executant and then only it must be
signed by attesting witness.

d) He is not expected to be aware of the contents of the document. He is only

attesting the signature of the executant.

e) A person who is a party to the document/deed cannot be attesting witness.

f) Attestation of document should be done only on those documents which

compulsorily require attestation. In case a document not requiring attestation is
attested, the document attracts ad-valorem stamp duty

(Agreements should not be attested. A bond must be attested and it attracts

advalorem stamp duty). Example: Mortgage deed requires to be attested.

g) The attesting witness must have witnessed either the actual execution or
received an acknowledgement of execution from the executant.

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h) There must be minimum two witnesses. But it is not necessary that both should
be present at the same time.

i) If a document requiring attestation is not attested but executed by the

executant, the document will be treated as not duly executed.

j) If the attesting witness denies or does not recollect the execution of the
document, it‘s execution may be proved by some other evidence.

k) If no attesting witness can be found, it is enough if proved that the attestation

of at least one attesting witness is in his own handwriting and that the signature
of the person executing the document is in the handwriting of that person.

Stamping of the instruments:

All instruments chargeable with duty and executed by any person in India shall be
stamped before or at the time of execution as per the provisions of the Indian
Stamp Act or the State Stamp Act, as the case may be.

To be on the safer side, documents should be stamped before execution.

The primary duty of payment of stamp duty is that of the borrower.

Printed forms of documents generally used by bankers attracting stamp duty are
to be sent to stamp office who affix the stamps known as - Special Adhesive
Stamps. In certain States, Branch Managers of Nationalized Banks are empowered
to affix stamps, in which case affixing stamp on documents by stamp office is not
necessary.

Hypothecation agreements, power of attorney, Guarantee agreements etc., are

instances of documents affixed with special adhesive stamps. The executant need
not cancel these stamps. They are cancelled by the Treasury itself. Even if the
Treasury impress or emboss the stamp value on the documents, it would amount
to stamping the documents and no cancellation is required. In case of instruments
to which stamp is not affixed by stamp office or authorised official but affixed by
the executants (parties) the same shall be cancelled by the executants at the time
of execution

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It should be ensured that execution/dating of the instrument should be on or
subsequent to the issue of non- judicial stamp paper/affixation of special adhesive
stamps, as the case may be. Cutting of stamped portion from the non-judicial
stamp paper and pasting the same on the document should not be done as it
would be a violation of the Indian Stamp Act.

There is no bar in procuring revenue stamps from neighbouring States.

Further, the revenue stamps come under the purview of the Central Government
and unless Central Government issues any ban on the same there will be no
restriction on the usage of the same procured from other states. Postal stamps
cannot be used in place of revenue stamps.

Stamp Duty:

The stamp duties on the following instruments fall under the Union list of the
constitution of India (Indian Stamp Act) and duty is common throughout India
(except the State of Jammu & Kashmir). Reduction, remission or alteration with
regard to stamp duty on these instruments could be effected by the Central
Government only.

a. Promissory Notes ; b. Bills of Exchange (only on Usance bills. No stamp duty on

demand bills) ; c. Cheques (no stamp duty at present) ; d. Transfer of shares ; e.
Debentures ; f. Proxy ; g. Insurance Policy ; h. Letter of Credit i. Bill of lading ; j.
Receipts

Pronotes should be affixed with revenue stamps of correct value as follows:

If the loan amount is upto and including ` 250/- 10 Paise

Above ` 250/- and upto and including ` 1,000/- 15 Paise

And above ` 1,000/- 25 Paise

On all other documents such as Agreement, Power of Attorney, AOD, Mortgage

Bond etc., the appropriate State Government has a right to levy the stamp duty
(State‘s Stamp Act) because it falls under the State list of the Constitution of India.

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Therefore, duties on these instruments differ from State to State. In such of the
States where stamp duty is levied on pledge letters, branches should get the
pledge letters stamped accordingly.

Section 11 of the Stamp Act 1989 says that adhesive stamp may be used on the
pronote. Therefore, promissory note though written on an impressed paper of
requisite value will have to be taken in law as duly stamped.

Cancellation:

The criterion for determining whether a stamp has been effectually cancelled is
whether, on seeing the stamp, an ordinary prudent man would come to the
conclusion that the stamp has been used and cannot be re-used.

It is to be ensured that the signature starts on the document, goes over the stamp
and may extend beyond the stamp on the document. Getting the signature of the
borrower in this manner is the most effective method of cancellation.

If the entire signature of the party is on the stamp and not extending on to the
document or a single line drawn on the stamp, it may be treated as ineffective
cancellation and capable of being re-used as the stamp can be taken out and
pasted on another document.

When there are more than one borrower, it is enough if one of them signs across
the stamp. It is not necessary that all the borrowers should sign across the stamp.

Under stamping/Non-stamping:

An under stamped document cannot be the basis of a suit in a Court of Law as it

cannot be accepted in evidence.

Any documents including the Bills of Exchange and Promissory Notes not duly
stamped can be revalidated on payment of the due stamp duty along with penalty
imposed by the Concerned authorities thereon.

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Miscellaneous :

The Bank shall invariably furnish a copy of the loan agreement along with a copy
of all enclosures quoted in the loan agreement to all the borrowers at the time of
sanction / disbursement of loans, even in the absence of specific request from the
borrower

Before obtaining the full and complete set of documents, no loan should be
disbursed.

The date and place of execution of the documents should be correctly written.

The dates mentioned in the pronote and other relevant documents should be one
and the same. However, when different persons have executed the documents on
different dates, the signatories are required to mention the dates below their
signatures.

Branches/offices should ensure that all the documents indicated in the Legal
scrutiny report are obtained from the borrower at the time of putting through the
EMT itself.

Registration of Charges and CERSAI.

A Company registered under the Company‘s Act 2013 or under earlier Companies
Act, can raise a loan by creating charge on moveable/immoveable assets of the
company.

A charge means an interest or lien created on the property or assets of a Borrower

or related entity or both as security and includes a mortgage.

Thus, a charge is a right of a creditor in and over the property/assets existing or

coming into existence on a future date.

Charge includes lien as well as equitable charge created or evidenced by an

instrument in writing or by deposit of title deeds.

A charge created may be a fixed charge or a floating charge.

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A fixed charge is one which is fastened to an ascertainable property of the debtor
company. Such a property cannot be disposed off by the debtor company without
the specific permission from the creditor/bank.

A floating charge is a charge on the assets (present or future) of a debtor company.

In this case, generally the company can deal with the asset, (say, stock in-trade) in
the normal course of business till the charge is crystallised. Creditor may crystalise
he charge at his option when there are defaults or when he feels that all is not well
with the company.

Whenever charge is to be created and registered, the bank shall inspect the
register of charges to find out whether the proposed properties/ assets to be
charged to the Bank remain unencumbered or not. Register for applications
pending registration shall also be verified in this regard.

Section 81 of Companies Act 2013 requires the Registrar of Companies to maintain

a register in respect of each company containing the details of all charges
requiring registration. This register is kept open for inspection by any person
against payment of prescribed fee for each inspection.

Section 85 of the Companies Act 2013 requires every company to keep at its
Registered Office a Register of Charges and enter therein all fixed and floating
charges on the undertaking or any property of the company.

Copy of the instrument creating the charge shall also be kept at the registered
office of the company along with the register of charges.

The copies of instruments creating the charge and the Company‘s Register of
charges shall be open during the business hours for the inspection of any creditor
or members of the company free of cost at the Registered Office of the Company
(Section 85). This register is also open for inspection to any other person on
payment of prescribed fee for each inspection.

Under Section 77 of the Companies Act 2013, a charge created by a company

whether public or private must be registered with the Registrar of Companies
(ROC) having jurisdiction over Registered Office of the Company. The charges that
require registration are mentioned below:

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a) A charge for the purpose of securing any issue of debentures;

b) A charge on uncalled share capital of the company;

c) A charge on any immovable property, wherever situated or any interest therein;

d) A charge on any book debts of the company;

e) A charge not being a pledge, on any moveable property of the company;

f) A floating charge on the undertaking or any property of the company including

stock-in-trade;

g) A charge on calls made but not paid;

h) A charge on a ship or any share in a ship;

i) A charge on goodwill, on a patent or a licence under a patent on a trade mark

or on a copyright or a licence under a copyright.

j) Charge on pledge of shares or other valuable security by a Company.

These borrowings are made by a company, by executing anyone of the following

documents/records creating mortgage/ charge in favour of the bank, that
provides such assistance:

a) Hypothecation Agreement / Common Hypothecation Agreement

b) Hypothecation Letter

c) Letter evidencing deposit of title deeds creating equitable mortgages.

d) Deed of simple mortgage.

The Companies (Registration of Charges) Rules, 2014 prescribes the rules for
submission of forms relating to creation, modification (From No. CHG-1) and
satisfaction of charge (Form No. CHG – 4) with the ROC through the Electronic
mode (E-mode) on MCA – 21 platform.

With effect from 01.07.2006, it is mandatory for all the concerned including banks
to file the forms through E-mode under MCA 21.

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Particulars of all properties intended to be charged are to be furnished. Wherever
OCC agreement is taken, apart from stock particulars, book debts also should be
incorporated.

MCA 21 Forms filed with RoC through e Mode.

a) The format has to be filled in through the e-mode.

b) The formats (Form No CHG1 & CHG4) will have to be Digitally signed by the
Company, Bank and the Company secretary in whole time practice or by a
Chartered Accountant or by a Cost Accountant.

c) For signing the form digitally, the authorized person will have to obtain a Digital
Signature Certificate (DSC) from the appropriate authority.

The authorized officers of the Bank should use Digital Signature for authenticating
all relevant e-forms for the purposes of registration of charge with ROC.

The Director signing the form on behalf of the company will also be required to
have Director Identification Number (DIN) over and above the DSC.

Under MCA 21, Company Identification Number (CIN) and Director Identification
Number (DIN) is compulsory. Hence, in all the loan applications of corporates,
these details shall invariably be obtained and branches are required to incorporate
the same while filing the formats with ROC through E-mode.

The scanned documents (loan papers) creating / modifying the charge is also
required to be filed as an attachment to the e-form, while uploading the forms
electronically through scanning the same.

Certificate of registration of charge/modification of charge are sent to user as an

attachment to the mail on approval.

Modification of charge need not be filed for apportionment of limits (either at the
time of sanction or subsequently) among various branches of our Bank
irrespective of jurisdiction of the registered office. It is enough if our charge is
filed and registered with Registrar of Companies under whose jurisdiction the
registered office of the company is situated, for the entire limit sanctioned to the
company.

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In case of DALC/DPG/Co-acceptance also where goods/machinery covered under
such transactions are hypothecated to the bank, creation/registration of such
charge is mandatory.

Time limit for registration:

a) Section 77 of Companies Act 2013 specifies that any charge which requires
registration must be registered within 30 days of creation of charge, i.e., execution
of loan documents.

b) In cases where charge cannot be filed within 30 days of creation of charge, an

application should be made to the Registrar of Companies in Form-CHG-1 within
300 days of such creation. The Registrar may allow such registration on payment
of additional fees.

If the registration of charge is not made within 300 days of creation of charge, the
Central Government may on such terms and conditions as it may seem just and
expedient to Regional Director extend the time for such filing of charge.

However, any subsequent registration of charge done beyond 30 days is fraught

with its own set of dangers. Rights acquired by any person in respect of the
property which is subject matter of charge before such subsequent registration
shall not be prejudiced. Thus, the Bank may lose priority of charge in case of
subsequent registration of charge.

Therefore, registration of charge shall necessarily be done with 30 days of creation

of charge to avoid loss of priority.

Remedy available when charge created has not been registered:

The charge filed beyond 30 days with Registrar of Companies or the charge filed
beyond 300 days with the help of condonation order passed by the Regional
Director will not protect the interest of the Banker against a charge already filed
with the Registrar of Companies.

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As it is purely the discretion of Regional Director to allow such application, the
Bank cannot afford to make any omission/delay in the matter of Registration of
Charges. Therefore, all efforts should be made to get the charges registered with
the Registrar of Companies soon after creation of charge.

Penalty for default:

Any default made in complying with the provisions of Chapter VI pertaining to

Registration of Charges shall render the Company in contravention liable to
punishment with fine not less than one lakh rupees but which may extend to ten
lakh rupees.

Every officer of the Company who is in default shall be punishable with

imprisonment for a term which may extend to six months or with fine ranging
from twenty five thousand rupees to one lakh rupees or both imprisonment and
fine.

Whose duty it is to Register the Charge:

Even though it is the duty of the company to file with the Registrar of Companies
all the particulars of charge created, registration may also be effected on the
application of any other person interested therein, i.e., the bank which is interested
has a right to file charge created in its favour and have the same registered.

Effects of non-registration:

If a charge which requires registration is not registered with the Registrar of

Companies within the stipulated period, the security created by such charge
becomes void against the liquidator and creditors of the company.

Thus, the debt becomes unsecured and loses the priority if any other charge
intervenes in between.

Registration of charge under the following circumstances is also necessary:

a) For pledge (lock and key) facility and also for documentary LC facility where the
goods are in the effective possession of the Bank.

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b) In case of letter of credit and guarantee facilities wherever securities are
charged to the bank.

Modification of the charge

Modification of the charges is dealt by Rule 3 of The Companies (Registration of

Charges) Rules, 2014. The modification of charge is also required to be filed in
Form No. CHG-1..

The necessity to modify the charges registered earlier arises in the following
circumstances:

a) When the same asset is taken as collateral/additional security by way of

second/subsequent charges for limits granted subsequently; or

b) When additional limits are granted under a credit facility already granted and
the security covered in the original document is extended to the additional facility
sanctioned; or

c) When the original terms and conditions or the extent or operation of the
original charge registered is varied or modified/altered; or

d) Where loan facilities granted by one branch are transferred to another branch.

e) In respect of restructuring of Advances of Companies, modification of Charge

wherever applicable has to be registered.

Transfer of loans/advances from one branch to another:

Banks should file modification of charge in cases where credit facilities are granted
in a particular branch of bank and necessary charge has already been created and
subsequently if the entire credit limits along with the liability of the party are
transferred to another branch of bank either within the jurisdiction of the same
Registrar of Companies or entirely in a separate jurisdiction, modification is
required to be filed since the liability is transferred from one branch to another
branch.

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Whenever second charge/mortgage is created on movables and immovables, i.e.,
land and building, plant and machinery etc., modification of charge must be filed
with the registrar of companies accompanied by true copy of deed of creation of
second charge, extract of the memorandum of entry or LEDTD, as the case may be,
within 30 days from the date of creation of second charge/mortgage.

Wherever obtention of documents (loan papers) for main limit and the sub-limit
is done on different dates, modification of charge is to be filed. If all loan papers
are executed on the same day, charge may be filed in a single set of Forms itself
making due mention of all the securities on which charge is filed.

The provision as to filing of Forms, the period within which modification of charge
has to be filed and the mode of registration are the same as applicable to
registration of charge mentioned earlier.

Modification of charge is not necessary in cases where the rate of interest is

variable as per the terms and conditions specified in the loan agreement.

Satisfaction of Charge

When the amount of advance has been completely paid by the borrower company,
satisfaction of charge must be filed with the Registrar of Companies within 30 days
of satisfaction of dues (Section 82) in Form No. CHG- 4.

Generally the party who has filed for registration of charges must also file the
satisfaction thereof failing which the person shall be liable to pay the penalties
prescribed under Section 86 of the Companies Act 2013.

The Registrar on receipt of Form CHG-4 shall cause a notice to be sent to Bank to
show cause within time specified in such notice as to why satisfaction in full should
not be recorded. If no cause is shown by Bank, memorandum of satisfaction shall
be recorded in register of charges. No such show cause notice will be issued if
satisfaction is filed by Bank.

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Miscellaneous

Banks are to file the charges for registration / modification /satisfaction, as the
case may be, duly filling in the required form with correct particulars accompanied
by the instrument creating / modifying/ satisfying the charges.

Banks have to ensure correctness of the documents before the charge is filed with
the Registrar of Companies.

Limitation Act and other Miscellaneous Concepts.

The Law of Limitation specifies the limit for every dispute so as to put an end to
litigation. Without an end to litigation by means of limitation, disputes keep
pending for a lot of time hence decreasing the productivity of the Government
and the citizens. Old cases come to the court causing hardship to the judiciary.

Death of parties and witnesses, loss of memory / remembrance by witnesses etc.

will render the case to become waste.

This Law does not create a right nor causes any action. It is limited to just pointing
out the time frame till when a legal remedy is possible to be sought. It says that
after the particular period, the relevant suit or proceeding cannot be instituted in
a court of law.

Limitation Law suggests that all disputes/claims/remedies should be kept alive

only for a legislatively fixed period of time, for otherwise disputes would be
Immortal when Man is Mortal.

A lien is not impaired because the remedy is barred by limitation. However, in case
of private owners contesting inter se the title to lands, the law has established a
limitation of twelve years: after that time it declares not simply that the remedy is
barred, but that the title is extinct in favour of the possessor.

Objective of Limitation -The law assists those that are vigilant with their rights,
and not those that sleep there upon. Also to ensure..............>

That long dormant claims have more of cruelty than justice in them;

That the right not exercised for a long time is non-existence;

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That the rights in property and rights in ge

Objective of Limitation -The law assists those that are vigilant with their rights,
and not those that sleep there upon. Also to ensure..............>

That long dormant claims have more of cruelty than justice in them;

That the right not exercised for a long time is non-existence;

That the rights in property and rights in general should not be in a state of
constant uncertainty, doubt and suspense.

Limitation Act 1963, was passed to implement the Third Report of the Law
Commission on the Indian Limitation Act. The Limitation Act, 1963 specifies
certain prescribed period within which any suit appeal or application can be made.

A banker is allowed to take legal action by filing a suit, prefer an appeal and apply
for recovery only when the documents are within the period of limitation.

If the documents are expired or are time barred, the banker cannot take any legal
course of action to recover the dues. Banks should be careful to ensure that all
legal loan documents held are valid and not time barred.

Banks should ensure that all loan documents are properly executed and they are
within the required limitation period as per the limitation act.

Banks are expected to hold valid legal documents as per the provisions of the
limitation act.

Extension of Limitation Period :

The limitation period can be extended in the following manners:

Acknowledgement of debt (AOD) :

By obtaining acknowledgement of debt in writing from the borrower before

expiry of the prescribed period of limitation, limitation period is extended.

Part payment :

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Limitation period is extended when borrower of his duly authorized agent makes
part re- payment of the loan, before expiry of the documents. Evidence of such
payments should be under the signature of the borrower or his authorized agent.

If the limitation period expires it can be extended only by executing fresh set of
documents. Fresh limitation period will be available from the date of execution of
such documents.

Period of limitation for certain Documents

Nature of Documents Limitation Period

A Demand Promissory Note 3 years from the date of DP Note.

A Bill of exchange payable at sight or 3 years when the bill is presented

upon presentation.
An Usance Bill of exchange 3 years from the due date

Money payable for money lent 3 years from the loan was made.

A guarantee 3 years from the date of invocation of

the guarantee
A mortgage – enforcement of 12 years from the date the money
payment of money sued becomes due
A mortgage – foreclosure 12 years from the money secured by
the mortgage becomes due.
A mortgage – possession of 30 years when the mortgagee
Immovable property becomes entitled to possession.

If Courts are closed on the date of expiration of limitation period, suit, the suit
appeal or application may be made, on the day when the court reopens.

Borrower abroad : The stay of a borrower abroad is not taken into consideration
while calculating the period of limitation. But if the borrower makes a trip to India
and stays in the country for a while before returning, the number of the days that
he stayed in India is to be taken into account for determining the limitation period.

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Acknowledgement from a guarantor : Acknowledgment is to be obtained from a
guarantor within three years from the date of invocation of guarantee. Serving a
notice is a demand on guarantor, and hence, the banks should be very careful while
issuing such notices as limitation period starts running from the date of
invocation.

A normal guarantee agreement obtained by the banks from the guarantors is of a

continuing guarantee nature. Therefore, the period of limitation commences only
after a demand is made on the guarantor.

Cash Credit Accounts being mutual, open, running and continuous accounts, the
period of limitation will be further extended up to three years from the date of
last credit/debit entries (Article 1, Limitation Act 1963). However, a debit entry of
interest due on loans would not be considered for such purposes.

Balance Sheet Entries : A debit entry shown on the Liability side of a borrower‘s
balance sheet i.e., of a Limited Company, signed by its agents is considered an
acknowledgement of debt. If such acknowledgement is recorded within the
prescribed limitation period, it extends the limitation for a further prescribed
period.

AOS (Acknowledgement of Security) to be obtained to extend limitation period in

case of Mortgages.

Other Relevant Points :

A debtor may pay the time barred debt to the creditor. He cannot claim it back on
the plea that it was time barred.

A debtor who owes several debts to a creditor may pay a sum of money to the
Creditor. If there is no specific mention, then the creditor can adjust the payment
towards any of the debts, including the one whose recovery is barred by limitation.

An agreement in writing undertaking to pay a time barred debt is lawful and

binding.

Section 3 only bars the remedy but does not destroy the right which the remedy
relates to.

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The Court is under an obligation to dismiss a suit if it is filed beyond the time
prescribed by the Limitation Act. The provisions of Section 3 are mandatory and
the Court will not proceed with the suit if it is barred by time.

Under Section 19 of Limitation Act, where payment on account of a debt or of

interest on legacy- a fresh period of limitation will be computed when payment
was made.

Condonation of delay means that extension of time given in certain cases provided
there is sufficient cause for such delay. Section 5 talks about the extension of the
prescribed period in certain cases. It provides that if the appellant or the applicant
satisfies the court that he had sufficient cause to not prefer the appeal or
application within that period, such appeal or application can be admitted after
the prescribed time. However, If a party does not show any cogent ground for
delay then the application, suit or appeal will be rejected by the court.

General Rule that the law of limitation only bars the remedy but does not bar the
right itself. Section 27 is an exception to this rule. It talks about adverse
possession. Adverse possession means someone who is in the possession of
another‘s land for an extended period of time can claim a legal title over it. In
other words, the title of the property will vest with the person who resides in or is
in possession of the land or property for a long period. If the rightful owner sleeps
over his right, then the right of the owner will be extinguished and the possessor
of the property will confer a good title over it. Section 27 is not limited to physical
possession but also includes de jure possession. As per the wordings of this
Section, it applies and is limited only to suits for possession of the property.

For obtention of AOD from the legal heirs of guarantor in the case of the death of
the guarantor, the following guidelines may be referred to :

(i) Since the guarantee is obtained in the personal capacity, the question of binding
the legal heirs will arise only if the deceased guarantor has bequeathed property
asset to his legal heir and the bank is in a position to prove that a particular
property asset possessed by the legal heirs was the property of the guarantor at
the time of his death.

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In such cases, it is therefore advisable to obtain a fresh guarantee of a third party
adequate to cover the liability and acceptable to the Bank in consultation with the
sanctioning authority.

(iii) However, in the case of sticky accounts, where the borrower is not able to
provide alternate guarantee acceptable to the Bank, the Bank should obtain the
AOD from all the legal heirs of the deceased guarantor before the expiry of the
period of limitation.

Obtention of AOD / AOS /LOR from legal heirs of the deceased borrower /
cobligant:

i) On getting the information about the death of a borrower/ co-obligant, a

suitable condolence letter may be sent to the legal heirs. Indirect reference may
be made in the letter about the loan availed by the deceased borrower or
coextensive liability of the coobligant, as the case may be. However, detailed
particulars of the loan account need not be furnished in the letter.

ii) Immediately thereafter, within a week‘s time, a detailed letter regarding the
loan account has to be addressed to the legal heirs. This letter should be sent by
registered post AD.

Change in the Signature

In many cases signatures of the borrower/co-obligant undergo significant change.

Under such circumstances, banks are required to obtain a letter from the party to
the effect that his/her signature has undergone significant change.

In addition to this, LTI/RTI of the borrower may be obtained along with signature
in AOD so that it will be easier to substantiate it at a later date.

Wherever a letter as stated above is obtained, fresh specimen signature card

should also be obtained and kept with the loan papers.

The date of Acknowledgement of Debt and not the date on which it admits the
debt gives the fresh start to the limitation period.

@@@

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24. Types of Charges
By “Charge” we mean “transfer or creation of interest in the Asset”. Depending
on the nature of Asset and possession of the Asset, Charges are named differently
- Mortgage ; Hypothecation ; Pledge ; Lien ; Assignment.

Hypothecation : is transfer of interest in floating assets. Under hypothecation, the

possession of the security remains with the borrower itself. If the borrower
defaults on payments, the lender would have to first take possession of the
security (asset under hypothecation) and then sell the asset to recover dues. In
case of OCC, Kisan Credit Card (KCC), Vehicle Loans charge is created on assets by
way of hypothecation.

Pledge : Bailment of goods as security is known as the pledge. In case of KCC

(Keyshut Cash Credit), the stocks given as security will be stored in godown and
the godown keys will be with Bank. In such cases, the charge is known as Implied
Pledge. In case of loans against gold jewellery, the charge is known as Pledge.

Lien : Under a lien, the lender gets the right to hold up a property used as collateral
. However, unless the contract states otherwise, the lender doesn’t have the right
to sell the asset, if the borrower defaults . It is a right given to the creditor to
retain/possess the security until the loan amount is discharged. Since possession
is with the creditor, it is the strongest form of security. The words ‘under lien’ to
VSL/OD......’ should not be used since it may imply restriction on the Bank’s
paramount lien.

A Mortgage is a transfer of interest in specific immovable property for the purpose

of securing payment of money advanced by way of loan or any present or future
debt.

Assignment : Transfer of ownership of a property, or of benefits, interests, rights

under a contract (such as an insurance policy or Receivables), by one party (the
assignor) to another (the assignee) by signing a document called deed of
assignment.

The charge in case of loans against book debts (Receivables) and against amounts
covered under Insurance Policies, Shares known as Assignment.
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Fixed Charge is the kind of charge created on properties/assets the identity
/nature/ownership of which does not change.

For example, a fixed charge would be created on Land & Building, Plant &
Machinery.

Floating Charge is created on assets which undergo change of ownership – like

stocks of goods of a shop. A trading concern may take a loan, against its stock as
security. Such a stock may be used for business, i.e., it can be sold in the ordinary
course of its business. Thus the charge on the stock, which keeps changing, is
known as Floating Charge.

There are various types of mortgages as under:

a) Simple mortgage

b) Mortgage by conditional sale

c) Usufructuary mortgage

d) English mortgage

e) Equitable mortgage

f) Anomalous mortgage

Simple mortgage:

It is a transaction where without delivering possession of mortgaged property, the

mortgagor binds himself personally, to pay the mortgage money and agrees
expressly or impliedly that mortgagee shall have the right to sell the property
through court and adjust the proceeds as far as necessary.

Mortgage by conditional sale:

It is a transaction wherein the mortgagor ostensibly sells the mortgaged property

on the condition that -

a) The sale shall become absolute on default of the payment of the mortgaged
money on a certain date or

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b) shall become void on such payment being made or

c) that the buyer (mortgagee) shall transfer the property to the seller (mortgagor)
on such payment.

The process of transforming the ̳mortgage‘ into ̳sale‘ can be enforced by

foreclosure suit.

Usufructuary mortgage:

i) Usufructuary mortgage as the name implies, is one where the creditor is placed
in possession of the property to enjoy the rents and profits until his claim is
satisfied. There is transfer of one of the incidents of ownership viz., the right of
possession and enjoyment of the usufruct.

ii) The essence of a usufructuary mortgage is - rents and profits of the property
are appropriated in lieu of interest or they are applied in payment of mortgage
money or they are received in lieu of interest and partly in payment of mortgage
money.

English mortgage:

Under the English mortgage, the mortgagor personally binds himself to repay the
mortgaged money on a certain day. The property mortgaged is transferred
absolutely to the mortgagee. This transfer is, however, subject to the proviso that
the mortgagee will reconvey the property to the mortgagor upon payment of the
mortgage money on the date fixed for repayment.

Equitable Mortgage: (Mortgage by deposit of title deeds)

a) Mortgage by deposit of Title Deeds is one where a person in any one of the
metropolitan cities, namely Delhi, Kolkata, Chennai and Mumbai or in any other
town which the local government notifies in the Official Gazette, delivers to a
creditor or to his agent, documents of title to immovable property, with an
intention to create a security thereon.

b) By deposit of title deeds followed by registered memorandum of deposit: There

may be instances where the parties are in possession of only some of the material
documents of title to the property.

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In such cases, after satisfying about the creditworthiness of the borrower and that
the other material documents are not traceable in spite of best efforts put by the
borrowers, equitable mortgage by getting the Memorandum of deposit of title
deeds registered with the Registrar can be followed.

Anomalous Mortgage:

A mortgage which is not a simple mortgage, a mortgage by conditional sale,

usufructuary mortgage, an English mortgage, or a mortgage by deposit of title
deeds is called an anomalous mortgage.

An anomalous mortgage is a combination of various other mortgages, for

example, a usufructuary mortgage may be created and the mortgagee shall have
the right of sale.

Mortgage versus Charge

A mortgage is transfer of an interest in the property made by the mortgagor as a

security for the loan.

Charge is not the transfer of any interest in the property though it is security for
the payment of an amount.

Sub-Mortgage - Where the mortgagee transfers by mortgage his interest in the

mortgaged property, or creates a mortgage of a mortgage the transaction is
known as a sub-mortgage.

For example, where R mortgages his house to M for Rs. 10,000 and M mortgage
his mortgagee right to A for Rs. 8,000. M creates a sub-mortgage.

Puisne mortgage –Where the mortgagor, having mortgaged his property,

mortgages it to another person to secure another loan, the second mortgage is
called a puisne mortgage.

For example, where D mortgages his house worth Rs two lacs to M for Rs 90,000
and mortgages the same house to K for a further sum of Rs 50,000, the mortgage
to Mr. M is first mortgage and that to Mr. K the second or puisne mortgage. K is
the puisne mortgagee, and can recover the debt subject to the right of M, the first
mortgagee, to recover his debt of Rs 90,000 plus interest.

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Rights of Mortgagor –

a) Right of redemption – on repayment of loan, mortgagor can take the property

back.

b) Right against clog (obstruction) on equity of redemption – any condition which

stops the mortgagor from recovering property will be void and mortgagor and
take back.

c) Right of partial redemption

Foreclosure is the legal process by which a lender attempts to recover the amount
owed on a defaulted loan by taking ownership of the mortgaged property and
selling it.

Redemption- The mortgagor is entitled to get back his property on payment of

the principal and interest. This right of the mortgagor is called the Right of
Redemption.

Reversion – A reversion is the residue of an original interest which is left after the
grantor has granted the lessee a small estate. For example, Mr X the owner of a
land may lease it to Mrs B for a period of five years. Here after the period of 5
years the lease will come to an end and the property reverts back to the lessor.

The property which reverts back to him is called the reversion or the reversionary
interest.

Remainder – When the owner of the property grants a limited interest in favour of
a person or persons and gives the remaining to others, it is called a ―remainder.
For Example, Mr A , the owner of a land transfers property to B for life and then
to C absolutely. Here the interest in favour of B is a limited interest, i.e., it is only
for life. So long as B is alive B enjoys the property. B has a limited right since he
cannot sell away the property. B‘s right is only to enjoy the property. So, after B‘s
death the property will go to C. Interest of C is called a remainder.

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Mortgage by Conditional Sale Vs English Mortgage :

There are two major differences between Mortgage by Conditional Sale and
English Mortgage (Mortgage with condition of retransfer) as under :

1) In case of Mortgage by Conditional Sale , the existence of debt between seller

(mortgagor) and buyer (mortgagee) is necessary. However, in case of English
Mortgage (Mortgage with condition of Re-transfer) there is no relation of debtor
and buyer.

2) In the Mortgage by Conditional Sale, only some interest in the property is

transferred to the mortgagee while in case of English Mortgage (Motgage with
condition of retransfer) all the interest in the property is transferred except a
personal right of repurchase.

Reverse Mortgage

A Reverse Mortgage is a loan where the lender pays the monthly instalments to
the Borrower instead of the borrower paying the lender. The payment stream is
reversed. A reverse mortgage allows people to get tax-free income from the value
of their home. They are mainly to improve older people's personal and financial
independence.

Simple Mortgage & SARFAESI Act.

In case of Borrowal Accounts where Simple Mortgage is created, we cannot

proceed under SARFAESI Act. As such, please note to go for EMT with MODTD
wherever possible. However, in case of Agricultural Lands, we may go for Simple
Mortgage, as SARFAESI Act is not applicable.

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25. Follow Up, Supervision & Credit Monitoring
Monitoring and Follow-up

We use both the words “Monitoring” and “Followup” as synonyms. Though they
give similar meaning, there is subtle difference between the two words.

Monitoring gives more emphasis on ensuring proper end-use and follow-up gives
more emphasis on timely recovery of advances.

By Monitoring we mean to have a proper control over the borrowers’ operation to

ensure the end use of funds. Monitoring keeps track of the end-use of fund lent.
It includes adequate arrangement by bank for maintaining close contact with the
borrower and his activities in order to remain well informed about the position
and progress of the project financed and to offer appropriate guidance to the
borrower, where necessary. Monitoring starts right from the stage of selection of
a borrower.

Important Credit Monitoring Tools are -- Balance Sheet; Stock Statements, Unit
Visits, Monthly Select Operational Data (MSOD), QOS, HOS, Progress Reports in
case of Bank Guarantees; PIPR in case of Term Loans.

Follow-up starts soon after disbursement of the loan. Follow-up includes efforts
to ensure that the terms and conditions of the advance at different stages (Pre
disbursement, Disbursement, Post-disbursements and Recovery stages) are
complied with and money lent is repaid as per schedule of repayment. It also
includes efforts to regularize the irregular advances. Recovery of advances largely
depends on effective follow-up. Follow-up is the systematic process through
which these activities are carried out.

Important Follow up Tools are -- Unit Visits, Reminders for submission of feedback
data, for repayment, for compliance with Terms & Conditions.

Branches/Offices are obtaining these, but no proper review is done, they are being
used only for Attendance purpose. Please make use of these tools properly.

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Though, branches are contacting Borrowers (Co-obligant /Guarantors) frequently
no record is kept with respective files. If there is no proper record we may be
forced to conclude that there is no follow up action from Branch. Please keep a
record of your follow up action.

Importance of Turnover & Operations in OCC Account

Turnover in a running credit account - cash credit/overdraft account - is very

important for banks. Through this, we want to see whether the account is being
operated adequately or not. Lack of turnover in an account indicates that the
account is showing sticky tendencies.

Obtaining OPLs and studying the statement of accounts for at least the previous
two years , in case of takeover accounts, should be done sincerely at pre-sanction
stage, due diligence process and should not be treated just as a formality.

We have to examine transactions of high value to ensure that they are related to
the line of the business in which the Borrower is engaged. This will help in
detecting diversion of funds.

Review of Stock cum MSOD Statements

After going through queries from many young Bankers I felt that there is a need
to explain the following with examples wherever needed related to Monthly Stock
Statement cum SOD ( Monthly Select Operational Data)

Stock Statements are needed to be submitted by Borrowers enjoying Open Cash

Credit limits, normally. (In case of borrowers engaged in exports and enjoying
Packing Credit also Stock Statements are needed to enable Bank to arrive at
Drawing Power (DP).

When we say “Inventory limits” it represents credit facility against Inventory and
Receivables.

In case of Units engaged in Manufacturing Activity, Inventory means stock of Raw

Material, Work-in-process (aka Semi Finished Goods) , Finished Goods, Packing
Material and stock of spares.

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In case of Units engaged only in Trading Activity – inventory refers to Stock of
Finished Goods (items meant for Trading and some packing material).

Based on Estimates and Projections submitted by the prospective borrower we

Sanction the Credit Limit. However, Drawings are allowed based on Drawing
Power available for the unit (however within the Sanctioned Limit). Drawing
Power is arrived at based on actual position of Inventory and Receivables. To
enable the Bank to Calculate Drawing Power, Borrower has to submit Stock
Statement at the regular intervals as fixed by the Bank (normally it is one month,
in case of Inland Finance and 15 days in case of Export Finance – i.e. Packing
Credit).

Along with Monthly Stock Statements, units engaged in Manufacturing Activity

have to submit SOD (Select Operational Data). This is known as MSOD – Monthly
Select Operational Data.

MSOD need not be submitted by the Units engaged in Trading Activity.

Also, MSOD is not applicable for the Units enjoying W C Limit of less than Rs 10
lacs.

While Sanctioning the limits, Sanctioning Authority may stipulate same margin to
all types of Inventory or different margins in respect of different types of the
inventory. While calculating the Drawing Power , we have to keep the margins
stipulated in Sanction.

Further, based on risk perception, Sanctioning Authority (SA) may stipulate Sub-
limits to certain types of Inventory and Receivables. This aspect also to be kept in
mind while calculating the DP. Normally we use both the Terms “Drawing Power”
and “Drawing Limit” in the same meaning. However, there is a subtle difference
between these two.

Sometimes Drawing Power and Drawing Limit may be one and the same.

If Drawing Power is more than Drawing Limit, drawings will be restricted to

Drawing Limit (which is less) only.

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If Drawing Limit ls more than the Sanctioned Limit , drawings will be restricted to
sanctioned limit which is lower.

In this analysis we make use of data furnished both in stock statement and SOD
(Select Operational Data).

The terms “Bookdebts” and “ Receivables” are of the same meaning.

Similarly “Work-in-process (WIP) ; Stock in Process (SIP) and “Semi-Finished

Goods” are used in the same meaning.

Review of QOS & HOS

QOS stands for Quarterly Operating Statement and HOS stands for Half-yearly
Operating Statement.

The data under QOS /HOS gives information on the operational results of the
borrower enterprise, utilization of funds, liquidity position and can be used as an
important monitoring tool. Detailed analysis of QOS and HOS has to be conducted
to ascertain the movement of current assets, current liabilities, its impact on NWC
and also the trends in funds flow and profitability. In the case of borrowers having
multi-division activities, information should be sought for each line of activity
separately as also for company as a whole.

QOS contains the following information :

a) Para 1 - Estimates of Production, Gross Sales and Net Sales made for the CFY.
We have to verify whether the same are in conformity with CMA data used at the
time of appraisal.

b) Para 2 -Actuals of Production, Gross Sales and Net Sales will be furnished
Quarter-wise. Also cumulative amounts of Production, Gross Sales and Net Sales
will be furnished. In this regard, we have to counter-check the data with that of
MSOD related to respective quarter. In MSOD details of Production and Sales
related to related month are available. If wide variations are noticed , call for
justification.

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Compare Actual Production and Sales with that of Annual Estimates. If the actual
performance during the particular quarter and cumulative performance till the
end of latest quarter is not in tune with that of Annual Estimates, call for reasons
for such a poor performance (where shortfall is 15% or more) and also the Unit’s
plan of Action to bridge the shortfall. (This is not applicable to Units engaged in
Seasonal Activities).

We have seen some cases, despite poor performance, bank finance is utilised to
the full extent and also they approach for additional temporary limits, which may
not be utilised for the accepted activity and such funds may be diverted. In this
way, proper Analysis of QOS help Banker to take appropriate decision when
proposals for Adhoc or Temporary facilities sought by Borrowers.

c) Para 3 contains position of Current Assets and Current Liabilities. Compare each
item with that of stock statement and MSOD of respective period. If any wide
variation is noticed, call for justification.

Compare the levels of Current Assets and Current Liabilities with that of CMA data
which Bank has accepted at the time of Appraisal. While doing so, verify them
both in absolute terms and in terms of turnover/ holding periods. (days).

From QOS, we can observe the position of NWC. Compare NWC of current quarter
with that of previous quarter and in case the movement of NWC is not favourable,
call for steps taken by the Unit to improve NWC. You may advise them corrective
action to be taken such as induction of further capital or long term funds.

HOS contains two parts – Operating Statement related to respective Half year and
Funds Flow Statement.

In Operating Statement the following major items need to be analysed by us.

a) Gross Sales & Net Sales

b) Cost of Goods Sold
c) Operating Profit (or loss)
d) PBT (Profit Before Tax)

Compare them with data related to previous Year / quarter and also with CMA
data.

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Call for reasons, in case of wide variations and also plan of action to improve
profitability.

In Funds Flow part, how long term funds are generated (sources) and how they are
used will be available. From this we know whether Long Term Uses are funded only
by Long Term Sources or not. If the data tells that LT Uses are more than LT
Sources, it implies that Short Term Sources are used to meet Long Term Purposes,
which is not acceptable to Bank. This is known as Diversion of Working Capital.

Thus, from study of HOS we are able to know the following two important points

a) whether the Operations generate profits on estimated lines

b) whether the Unit is resorting to Diversion of WC funds to meet LT Uses.

While reviewing QOS the following points to be kept in mind :

Abnormal increase in Inventory (or accumulation of Inventory) may be due to

declining sales.

Abnormal increase in debtors may mean poor recovery steps adopted.

Compare receivables in proportion to sales. If the debtors share is increasing, it

may be due to declining demand for the Unit’s product and the Unit is forced to
sell the product on longer credits.

Creditors for purchase is not increasing in tune with purchases – may mean that
the Unit may be losing its creditworthiness. If share of Creditors is coming down,
make proper market enquiries regarding standing of the Unit in the Market.

Inconsistent Data – Units may be furnishing different data in different statements.

Value of Inventory what is stated in Monthly Stock Statements may differ from
what is stated in QOS. Sales furnished in MSOD may not agree with what is stated
in QOS. When the Unit is not consistent in furnishing data, we have to doubt the
quality of the Data itself. When we observe serious inconsistencies in the data
furnished, we should keep the Unit under scanner. Both QOS and HOS are beautiful
tools for monitoring Borrowers enjoying WC limits.

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26. Resolution of Stressed Assets
Norms on IRAC and Provisioning pertaining to Advances

In line with the international practices and as per the recommendations made by
the Committee on the Financial System (Chairman Shri M. Narasimham), the RBI
has introduced, in a phased manner, prudential norms for income recognition,
asset classification and provisioning for the advances portfolio of the banks so as
to move towards greater consistency and transparency in the published accounts.

Non-performing Assets - An asset becomes non performing when it ceases to

generate income for the bank.

A non performing asset (NPA) is a loan or an advance where;

a) interest and/ or instalment of principal remains overdue for a period of more

than 90 days in respect of a term loan,

b) the account remains ‘out of order’ in respect of an Overdraft/Cash Credit

(OD/CC),

c) the bill remains overdue for a period of more than 90 days in the case of bills
purchased and discounted,

d) the instalment of principal or interest thereon remains overdue for two crop
seasons for short duration crops,

e) the instalment of principal or interest thereon remains overdue for one crop
season for long duration crops,

In case of interest payments, banks should, classify an account as NPA only if the
interest due and charged during any quarter is not serviced fully within 90 days
from the end of the quarter.

‘Out of Order’ status - An account should be treated as 'out of order' if the

outstanding balance remains continuously in excess of the sanctioned
limit/drawing power for 90 days.

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In cases where the outstanding balance in the principal operating account is less
than the sanctioned limit/drawing power, but there are no credits continuously
for 90 days as on the date of Balance Sheet or credits are not enough to cover the
interest debited during the same period, these accounts should be treated as 'out
of order'.

‘Overdue’ - Any amount due to the bank under any credit facility is ‘overdue’ if it
is not paid on the due date fixed by the bank.

Income Recognition Policy has to be objective and based on the record of

recovery. Therefore, the banks should not charge and take to income account
interest on any NPA. This will apply to Government guaranteed accounts also.

However, interest on advances against Term Deposits, NSCs, IVPs, KVPs and Life
policies may be taken to income account provided adequate margin is available in
the accounts.

Reversal of income - If any advance, including bills purchased and discounted,

becomes NPA, the entire interest accrued and credited to income account in the
past periods, should be reversed if the same is not realised. This will apply to
Government guaranteed accounts also.

In respect of NPAs, fees, commission and similar income that have accrued should
cease to accrue in the current period and should be reversed with respect to past
periods, if uncollected.

Interest realised on NPAs may be taken to income account provided the credits in
the accounts towards interest are not out of fresh/ additional credit facilities
sanctioned to the borrower concerned.

On an account turning NPA, banks should reverse the interest already charged and
not collected by debiting Profit and Loss account and stop further application of
interest. However, banks may continue to record such accrued interest in a
Memorandum account in their books. For the purpose of computing Gross
Advances, interest recorded in the Memorandum account should not be taken into
account.

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Asset Classification - Categories of NPAs

Banks are required to classify non performing assets further into the following
three categories based on the period for which the asset has remained non
performing and the realisability of the dues

- (i) Substandard Assets (ii) Doubtful Assets (iii) Loss Assets

Substandard Assets - A substandard asset would be one, which has remained NPA
for a period less than or equal to 12 months. Such an asset will have well defined
credit weaknesses that jeopardise the liquidation of the debt and are characterised
by the distinct possibility that the banks will sustain some loss, if deficiencies are
not corrected.

Doubtful Assets - An asset would be classified as doubtful if it has remained in the

substandard category for a period of 12 months. A loan classified as doubtful has
all the weaknesses inherent in assets that were classified as substandard, with the
added characteristic that the weaknesses make collection or liquidation in full, –
on the basis of currently known facts, conditions and values – highly questionable
and improbable.

Loss Assets - A loss asset is one where loss has been identified by the bank or
internal or external auditors or the RBI inspection but the amount has not been
written off wholly.

Guidelines for Classification of Assets

The availability of security or net worth of borrower/ guarantor should not be

taken into account for the purpose of treating an advance as NPA or otherwise,
except to exempted categories.

The classification of an asset as NPA should be based on the record of recovery.

Bank should not classify an advance account as NPA merely due to the existence
of some deficiencies which are temporary in nature such as non-availability of
adequate drawing power, balance outstanding exceeding the limit temporarily,
non-submission of stock statements and non-renewal of the limits on the due
date, etc.

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In the matter of classification of accounts with such deficiencies banks may follow
the following guidelines:

a) Banks should ensure that drawings in the working capital accounts are covered
by the adequacy of current assets, since current assets are first appropriated in
times of distress. Drawing power is required to be arrived at based on the stock
statement which is current. However, considering the difficulties of large
borrowers, stock statements relied upon by the banks for determining drawing
power should not be older than three months. The outstanding in the account
based on drawing power calculated from stock statements older than three
months, would be deemed as irregular.

b) A working capital borrowal account will become NPA if such irregular drawings
are permitted in the account for a continuous period of 90 days even though the
unit may be working or the borrower's financial position is satisfactory.

c) Regular and ad hoc credit limits need to be reviewed/ regularised not later than
three months from the due date/date of ad hoc sanction. In case of constraints
such as nonavailability of financial statements and other data from the borrowers,
the branch should furnish evidence to show that renewal/ review of credit limits is
already on and would be completed soon. In any case, delay beyond six months is
not considered desirable as a general discipline. Hence, an account where the
regular/ ad hoc credit limits have not been reviewed/ renewed within 180 days
from the due date/ date of ad hoc sanction will be treated as NPA.

Upgradation of loan accounts classified as NPAs - If arrears of interest and

principal are paid by the borrower in the case of loan accounts classified as NPAs,
the account should no longer be treated as nonperforming and may be classified
as ‘standard’ accounts.

Asset Classification to be borrower-wise and not facility-wise - All the facilities

granted by a bank to a borrower will have to be treated as NPA/NPI and not the
particular facility/investment or part thereof which has become irregular.

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If the debits arising out of devolvement of letters of credit or invoked guarantees
are parked in a separate account, the balance outstanding in that account also
should be treated as a part of the borrower’s principal operating account for the
purpose of application of prudential norms on income recognition, asset
classification and provisioning.

The bills discounted under LC favouring a borrower may not be classified as a Non
performing assets (NPA), when any other facility granted to the borrower is
classified as NPA. However, in case documents under LC are not accepted on
presentation or the payment under the LC is not made on the due date by the LC
issuing bank for any reason and the borrower does not immediately make good
the amount disbursed as a result of discounting of concerned bills, the outstanding
bills discounted will immediately be classified as NPA with effect from the date
when the other facilities had been classified as NPA.

Advances under consortium arrangements - Asset classification of accounts under

consortium should be based on the record of recovery of the individual member
banks and other aspects having a bearing on the recoverability of the advances.
Where the remittances by the borrower under consortium lending arrangements
are pooled with one bank and/or where the bank receiving remittances is not
parting with the share of other member banks, the account will be treated as not
serviced in the books of the other member banks and therefore, be treated as NPA.
The banks participating in the consortium should, therefore, arrange to get their
share of recovery transferred from the lead bank or get an express consent from
the lead bank for the transfer of their share of recovery, to ensure proper asset
classification in their respective books.

In respect of accounts where there are potential threats for recovery on account
of erosion in the value of security or non-availability of security and existence of
other factors such as frauds committed by borrowers it will not be prudent that
such accounts should go through various stages of asset classification. In cases of
such serious credit impairment, the asset should be straightaway classified as
doubtful or loss asset as appropriate:

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a) Erosion in the value of security can be reckoned as significant when the
realisable value of the security is less than 50 % of the value assessed by the bank
or accepted by RBI at the time of last inspection, as the case may be. Such NPAs
may be straightaway classified under doubtful category.

b) If the realisable value of the security, as assessed by the bank/ approved valuers/
RBI is less than 10 % of the outstanding in the borrowal accounts, the existence of
security should be ignored and the asset should be straightaway classified as loss
asset.

Provisioning norms in respect of all cases of fraud:

a) Banks should normally provide for the entire amount due to the bank or for
which the bank is liable (including in case of deposit accounts), immediately upon
a fraud being detected.

b) Banks shall make suitable disclosures with regard to number of frauds reported,
amount involved in such frauds, quantum of provision made during the year and
quantum of unamortised provision debited from ‘other reserves’ as at the end of
the year.

Advances to Primary Agricultural Credit Societies (PACS)/Farmers’ Service

Societies (FSS)

In respect of agricultural advances as well as advances for other purposes granted

by banks to PACS/ FSS under the on-lending system, only that particular credit
facility granted to PACS/ FSS which is in default for a period of two crop seasons
in case of short duration crops and one crop season in case of long duration crops,
as the case may be, after it has become due will be classified as NPA and not all
the credit facilities sanctioned to a PACS/ FSS. The other direct loans & advances,
if any, granted by the bank to the member borrower of a PACS/ FSS outside the
on-lending arrangement will become NPA even if one of the credit facilities
granted to the same borrower becomes NPA.

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Advances against Term Deposits, NSCs, KVPs/IVPs, etc.

Advances against term deposits, NSCs eligible for surrender, IVPs, KVPs and life
policies need not be treated as NPAs, provided adequate margin is available in the
accounts. Advances against gold ornaments, government securities and all other
securities are not covered by this exemption.

Loans with moratorium for payment of interest

a) In the case of bank finance given for industrial projects or for agricultural
plantations etc. where moratorium is available for payment of interest, payment
of interest becomes 'due' only after the moratorium or gestation period is over.

Therefore, such amounts of interest do not become overdue and hence do not
become NPA, with reference to the date of debit of interest. They become overdue
after due date for payment of interest, if uncollected.

b) In the case of housing loan or similar advances granted to staff members where
interest is payable after recovery of principal, interest need not be considered as
overdue from the first quarter onwards. Such loans/advances should be classified
as NPA only when there is a default in repayment of instalment of principal or
payment of interest on the respective due dates.

Agricultural advances

A loan granted for short duration crops will be treated as NPA, if the instalment
of principal or interest thereon remains overdue for two crop seasons. A loan
granted for long duration crops will be treated as NPA, if the instalment of
principal or interest thereon remains overdue for one crop season. Depending
upon the duration of crops raised by an agriculturist, the above NPA norms would
also be made applicable to agricultural term loans availed of by him.

While fixing the repayment schedule in case of rural housing advances granted to
agriculturists under Indira Awas Yojana and Golden Jubilee Rural Housing Finance
Scheme, banks should ensure that the interest/instalment payable on such
advances are linked to crop cycles.

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Government guaranteed advances

The credit facilities backed by guarantee of the Central Government though

overdue may be treated as NPA only when the Government repudiates its
guarantee when invoked. This exemption from classification of Government
guaranteed advances as NPA is not for the purpose of recognition of income.

With effect from the year ending March 31, 2006 State Government guaranteed
advances and investments in State Government guaranteed securities would
attract asset classification and provisioning norms if interest and/or principal or
any other amount due to the bank remains overdue for more than 90 days.

Post-shipment Supplier's Credit

In respect of post-shipment credit extended by the banks covering export of

goods to countries for which the ECGC cover is available, EXIM Bank has
introduced a guarantee-cum-refinance programme whereby, in the event of
default, EXIM Bank will pay the guaranteed amount to the bank within a period of
30 days from the day the bank invokes the guarantee after the exporter has filed
claim with ECGC. Accordingly, to the extent payment has been received from the
EXIM Bank, the advance may not be treated as a non performing asset for asset
classification and provisioning purposes.

Export Project Finance

In respect of export project finance, there could be instances where the actual
importer has paid the dues to the bank abroad but the bank in turn is unable to
remit the amount due to political developments such as war, strife, UN embargo,
etc. In such cases, where the lending bank is able to establish through
documentary evidence that the importer has cleared the dues in full by depositing
the amount in the bank abroad before it turned into NPA in the books of the bank,
but the importer's country is not allowing the funds to be remitted due to political
or other reasons, the asset classification may be made after a period of one year
from the date the amount was deposited by the importer in the bank abroad.

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Credit Card Accounts

In credit card accounts, the amount spent is billed to the card users through a
monthly statement with a definite due date for repayment. Banks give an option
to the card users to pay either the full amount or a fraction of it, i.e., minimum
amount due, on the due date and roll-over the balance amount to the subsequent
months’ billing cycle.

A credit card account will be treated as non-performing asset if the minimum

amount due, as mentioned in the statement, is not paid fully within 90 days from
the payment due date mentioned in the statement.

Provisioning Norms

The primary responsibility for making adequate provisions for any diminution in
the value of loan assets, investment or other assets is that of the bank
managements and the statutory auditors. In conformity with the prudential
norms, provisions should be made on the non performing assets on the basis of
classification of assets into prescribed categories. Taking into account the time lag
between an account becoming doubtful of recovery, its recognition as such, the
realisation of the security and the erosion over time in the value of security
charged to the bank, the banks should make provision against substandard assets,
doubtful assets and loss assets as below.

Loss assets - Loss assets should be written off. If loss assets are permitted to remain
in the books for any reason, 100 % of the outstanding should be provided for.

Doubtful assets - 100 % of the extent to which the advance is not covered by the
realisable value of the security to which the bank has a valid recourse and the
realisable value is estimated on a realistic basis.

In regard to the secured portion, provision may be made on the following basis,
at the rates ranging from 25 % to 100 % of the secured portion depending upon
the period for which the asset has remained doubtful :

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 Period for which the advance has Provisioning requirement (%)
remained in ‘doubtful’ category

Up to one year 25

One to three years 40

More than three years 100

In cases of NPAs with balance of ₹5 crore and above stock audit at annual intervals
by external agencies would be mandatory in order to enhance the reliability on
stock valuation.

In cases of NPAs with balance of ₹5 crore and above Collaterals such as immovable
properties charged in favour of the bank should be got valued once in three years
by valuers.

Substandard assets

A general provision of 15 % on total outstanding should be made without making

any allowance for ECGC guarantee cover and securities available.

The ‘unsecured exposures’ which are identified as ‘substandard’ would attract

additional provision of 10 %, i.e., a total of 25 % on the outstanding balance.

However, in infrastructure lending, if Escrow mechanism is available loan accounts

which are classified as sub-standard will attract a provisioning of 20 % instead of
the aforesaid prescription of 25 %.

The provisioning requirement for unsecured ‘doubtful’ assets is 100 %.

Unsecured exposure is defined as an exposure where the realisable value of the

security, as assessed by the bank/approved valuers/Reserve Bank’s inspecting
officers, is not more than 10 %, ab-initio, of the outstanding exposure. ‘Exposure’
shall include all funded and non-funded exposures (including underwriting and
similar commitments). ‘Security’ will mean tangible security properly charged to
the bank and will not include intangible securities like guarantees (including State
government guarantees), comfort letters etc.
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Standard assets - Banks should make general provision for standard assets at the
following rates for the funded outstanding on global loan portfolio basis:

a) Farm Credit to agricultural activities, individual housing loans and Small and
Micro Enterprises (SMEs) sectors at 0.25 %;

b) advances to Commercial Real Estate (CRE)1 Sector at 1.00 %;

c) advances to Commercial Real Estate – Residential Housing Sector (CRE - RH) at

0.75 %

d) housing loans extended at teaser rates - the standard asset provisioning on the
outstanding amount of such loans has been increased from 0.40 per cent to 2.00
per cent in view of the higher risk associated with them. The provisioning on these
assets would revert to 0.40 per cent after 1 year from the date on which the rates
are reset at higher rates if the accounts remain ‘standard’.

e) restructured advances – as stipulated in the prudential norms for restructuring

of advances.

f) Advances restructured and classified as standard - at 5%.

g) All other loans and advances not included in (a) – (f) above at 0.40 %.

The provisions on standard assets should not be reckoned for arriving at net NPAs.
The provisions towards Standard Assets need not be netted from gross advances
but shown separately as 'Contingent Provisions against Standard Assets' under
'Other Liabilities and Provisions Others' in Schedule 5 of the balance sheet.

The Medium Enterprises will attract 0.40% standard asset provisioning.

Accounting

Floating provisions cannot be reversed by credit to the profit and loss account.
They can only be utilised for making specific provisions in extraordinary
circumstances as mentioned above. Until such utilisation, these provisions can be
netted off from gross NPAs to arrive at disclosure of net NPAs. Alternatively, they
can be treated as part of Tier II capital within the overall ceiling of 1.25% of total
risk weighted assets.

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Disclosures

Banks should make comprehensive disclosures on floating provisions in the “notes

on accounts” to the balance sheet.

Additional Provisions at higher than prescribed rates

For NPAs: The regulatory norms for provisioning represent the minimum
requirement. A bank may voluntarily make specific provisions for advances at
rates which are higher than the rates prescribed under existing regulations, to
provide for estimated actual loss in collectible amount, provided such higher rates
are approved by the Board of Directors and consistently adopted from year to
year. Such additional provisions are not to be considered as floating provisions.

The additional provisions for NPAs, like the minimum regulatory provision on
NPAs, may be netted off from gross NPAs to arrive at the net NPAs.

For standard assets: The provisioning rates prescribed are the regulatory minimum
and banks are encouraged to make provisions at higher rates in respect of
advances to stressed sectors of the economy.

Guidelines for Provisions under Special Circumstances

Advances against deposits/specific instruments Advances against term deposits,

NSCs eligible for surrender, IVPs, KVPs, gold ornaments, government & other
securities and life insurance policies would attract provisioning requirements as
applicable to their asset classification status.

Treatment of interest suspense account

Amounts held in Interest Suspense Account should not be reckoned as part of

provisions. Amounts lying in the Interest Suspense Account should be deducted
from the relative advances and thereafter, provisioning as per the norms, should
be made on the balances after such deduction.

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Advances covered by ECGC guarantee

In the case of advances classified as doubtful and guaranteed by ECGC, provision

should be made only for the balance in excess of the amount guaranteed by the
Corporation. Further, while arriving at the provision required to be made for
doubtful assets, realisable value of the securities should first be deducted from
the outstanding balance in respect of the amount guaranteed by the Corporation
and then provision made.

In case the advance covered by CGTMSE or CRGFTLIH guarantee becomes

nonperforming, no provision need be made towards the guaranteed portion. The
amount outstanding in excess of the guaranteed portion should be provided for
as per the extant guidelines on provisioning for non-performing assets.

Reserve for Exchange Rate Fluctuations Account (RERFA)

When exchange rate movements of Indian rupee turn adverse, the outstanding
amount of foreign currency denominated loans (where actual disbursement was
made in Indian Rupee) which becomes overdue, goes up correspondingly. Such
assets should not normally be revalued. In case such assets need to be revalued,
the following procedure may be adopted:

a. The loss on revaluation of assets has to be booked in the bank's Profit & Loss
Account.

b. In addition to the provisioning requirement as per Asset Classification, the full

amount of the Revaluation Gain, if any, on account of foreign exchange
fluctuation should be used to make provisions against the corresponding assets.

Provisioning for country risk

Banks are required to make provision for country risk in respect of a country where
its net funded exposure is one % or more of its total assets.

The provision for country risk shall be in addition to the provisions required to be
held according to the asset classification status of the asset.

In the case of ‘loss assets’ and ‘doubtful assets’, provision held, including provision
held for country risk, may not exceed 100% of the outstanding.

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Banks may not make any provision for ‘home country’ exposures i.e. exposure to
India. The exposures of foreign branches of Indian banks to the host country
should be included. Foreign banks shall compute the country exposures of their
Indian branches and shall hold appropriate provisions in their Indian books.
However, their exposures to India will be excluded.

Banks may make a lower level of provisioning (say 25% of the requirement) in
respect of short-term exposures (i.e. exposures with contractual maturity of less
than 180 days).

Provisioning Coverage Ratio

Provisioning Coverage Ratio (PCR) is the ratio of provisioning to gross

nonperforming assets and indicates the extent of funds a bank has kept aside to
cover loan losses.

From a macro-prudential perspective, banks should build up provisioning and

capital buffers in good times i.e. when the profits are good, which can be used for
absorbing losses in a downturn. This will enhance the soundness of individual
banks, as also the stability of the financial sector.

Banks should augment their provisioning cushions consisting of specific

provisions against NPAs as well as floating provisions, and ensure that their total
provisioning coverage ratio, including floating provisions, is not less than 70 %.

a) the PCR of 70 % may be with reference to the gross NPA position in banks as on
September 30, 2010;

b) the surplus of the provision under PCR vis-a-vis as required as per prudential
norms should be segregated into an account styled as “countercyclical
provisioning buffer”.

c) this buffer will be allowed to be used by banks for making specific provisions
for NPAs during periods of system wide downturn, with the prior approval of RBI.

The PCR of the bank should be disclosed in the Notes to Accounts to the Balance
Sheet.

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Writing off of NPAs

In terms of Section 43(D) of the Income Tax Act 1961, income by way of interest
in relation to such categories of bad and doubtful debts as may be prescribed
having regard to the guidelines issued by the RBI in relation to such debts, shall
be chargeable to tax in the previous year in which it is credited to the bank’s profit
and loss account or received, whichever is earlier. This stipulation is not applicable
to provisioning required to be made as indicated above. In other words, amounts
set aside for making provision for NPAs as above are not eligible for tax
deductions.

Therefore, the banks should either make full provision as per the guidelines or
write-off such advances and claim such tax benefits as are applicable, by evolving
appropriate methodology in consultation with their auditors/tax consultants.

Recoveries made in such accounts should be offered for tax purposes as per the
rules.

Write-off at Head Office Level

Banks may write-off advances at Head Office level, even though the relative
advances are still outstanding in the branch books. However, it is necessary that
provision is made as per the classification accorded to the respective accounts. In
other words, if an advance is a loss asset, 100 % provision will have to be made
therefor.

Banks are resorting to technical write off of accounts, which reduces incentives to
recover. Banks resorting to partial and technical write-offs should not show the
remaining part of the loan as standard asset. With a view to bring in more
transparency, henceforth banks should disclose full details of write offs, including
separate details about technical write offs, in their annual financial statements.

NPA Management – Requirement of Effective Mechanism and Granular Data

Asset quality of banks is one of the most important indicators of their financial
health. Banks should put in place a robust MIS mechanism for early detection of
signs of distress at individual account level as well as at segment level (asset class,
industry, geographic, size, etc.).
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The banks' IT and MIS system should be robust and able to generate reliable and
quality information with regard to their asset quality for effective decision
making.

There should be no inconsistencies between information furnished under

regulatory / statutory reporting and the banks' own MIS reporting.

Framework for Resolution of Stressed Assets

Recognise incipient stress in loan accounts, immediately on default , by classifying

such assets as Special Mention Accounts (SMA)

SMA Sub-categories Basis for classification – Principal or interest payment or any

other amount wholly or partly overdue between

SMA-0 1-30 days

SMA-1 31-60 days

SMA-2 61-90 days

In the case of revolving credit facilities like cash credit, the SMA sub- categories
will be based on outstanding balance remains continuously in excess of sanctioned
limit or drawing power, whichever is lower, for a period of:

SMA-1 31-60 days

SMA-2 61-90 days

The borrower accounts shall be flagged as overdue by the lending institutions as

part of their day-end processes for the due date, irrespective of the time of
running such processes.

Similarly, classification of borrower accounts as SMA as well as NPA shall be done

as part of day-end process for the relevant date and the SMA or NPA classification
date shall be the calendar date for which the day end process is run. In other words,
the date of SMA/NPA shall reflect the asset classification status of an account at
the day-end of that calendar date.

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Example: If due date of a loan account is March 31, 2021, and full dues are not
received before the lending institution runs the day-end process for this date, the
date of overdue shall be March 31, 2021. If it continues to remain overdue, then
this account shall get tagged as SMA-1 upon running day-end process on April30,
2021 i.e. upon completion of 30 days of being continuously overdue.

Accordingly, the date of SMA-1 classification for that account shall be April 30,
2021.

Similarly, if the account continues to remain overdue, it shall get tagged as SMA-
2 upon running day-end process on May 30, 2021 and if continues to remain
overdue further, it shall get classified as NPA upon running day-end process on
June 29, 2021.

It is clarified that the instructions on SMA classification of borrower accounts are

applicable to all loans , including retail loans, irrespective of size of exposure of
the lending institution.

Banks shall report credit information, including classification of an account as SMA

to Central Repository of Information on Large Credits (CRILC), on all borrowers
having aggregate exposure of ₹5 crore and above with them.

The CRILC-Main Report shall be submitted on a monthly basis.

Banks shall submit a weekly report of instances of default by all borrowers (with
aggregate exposure of ₹5 crore and above) by close of business on every Friday,
or the preceding working day if Friday happens to be a holiday.

In order to avoid any ambiguity regarding determination of ‘out of order’ status

of CC/OD accounts on a continuous basis, it is clarified that an account shall be
treated as ‘out of order’ if:

i) the outstanding balance in the CC/OD account remains continuously in excess

of the sanctioned limit/drawing power for 90 days, or

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ii) the outstanding balance in the CC/OD account is less than the sanctioned
limit/drawing power but there are no credits continuously for 90 days, or the
outstanding balance in the CC/OD account is less than the sanctioned
limit/drawing power but credits are not enough to cover the interest debited
during the previous 90 days period.

Implementation of Resolution Plan

Since default with any lender is a lagging indicator of financial stress faced by the
borrower, it is expected that the lenders initiate the process of implementing a
Resolution Plan (RP) even before a default. In any case, once a borrower is
reported to be in default by any of the lenders, lenders shall undertake a prima
facie review of the borrower account within thirty days from such default (“Review
Period”). During this Review Period of thirty days, lenders may decide on the
resolution strategy, including the nature of the RP, the approach for
implementation of the RP, etc. The lenders may also choose to initiate legal
proceedings for insolvency or recovery.

In cases where RP is to be implemented, all lenders shall enter into an Inter

Creditor Agreement (ICA), during the above-said Review Period, to provide for
ground rules for finalisation and implementation of the RP in respect of borrowers
with credit facilities from more than one lender.

The ICA shall provide that any decision agreed by lenders representing 75 % by
value of Aggregate Exposure and 60 % of lenders by number shall be binding upon
all the lenders. The ICA may provide for rights and duties of majority lenders,
duties and protection of rights of dissenting lenders, treatment of lenders with
priority in cash flows/differential security interest, etc. In particular, the RPs shall
provide for payment not less than the liquidation value due to the dissenting
lenders.

Aggregate exposure would include all fund based and non-fund based exposure,
including investment exposure with the lenders.

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In respect of accounts with aggregate exposure above a threshold with the
lenders, as indicated below, on or after the ‘reference date’, RP shall be
implemented within 180 days from the end of Review Period. The Review Period
shall commence not later than:

a. The reference date, if in default as on the reference date; or

b. The date of first default after the reference date.

The RP may involve any action / plan / reorganization including, but not limited
to, regularisation of the account by payment of all over dues by the borrower
entity, sale of the exposures to other entities / investors, change in ownership and
restructuring. The RP shall be clearly documented by the lenders concerned (even
if there is no change in any terms and conditions).

Implementation Conditions for RP

RPs involving restructuring / change in ownership in respect of accounts where

the aggregate exposure of lenders is ₹100 crore and above, shall require
independent credit evaluation (ICE) of the residual debt10 by credit rating
agencies (CRAs) specifically authorised by the Reserve Bank for this purpose.

While accounts with aggregate exposure of ₹5 billion and above shall require two
such ICEs, others shall require one ICE. Only such RPs which receive a credit opinion
of RP4 or better for the residual debt from one or two CRAs, as the case may be,
shall be considered for implementation. Further, ICEs shall be subject to the
following:

a) The CRAs shall be directly engaged by the lenders and the payment of fee for
such assignments shall be made by the lenders.

b) If lenders obtain ICE from more than the required number of CRAs, all such ICE
opinions shall be RP4 or better for the RP to be considered for implementation.

Restructuring is an act in which a lender, for economic or legal reasons relating to

the borrower's financial difficulty, grants concessions to the borrower.

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Restructuring would normally involve modification of terms of the advances,
enhancement of existing credit limits; compromise settlements where time for
payment of settlement amount exceeds three months.

A RP in respect of borrowers to whom the lenders continue to have credit

exposure, shall be deemed to be ‘implemented’ only if the following conditions
are met:

a) A RP which does not involve restructuring/change in ownership shall be deemed

to be implemented only if the borrower is not in default with any of the lenders as
on 180th day from the end of the Review Period. Any subsequent default after the
180 day period shall be treated as a fresh default, triggering a fresh review.

b) A RP which involves restructuring/change in ownership shall be deemed to be

implemented only if all of the following conditions are met:

i) all related documentation, including execution of necessary agreements

between lenders and borrower / creation of security charge / perfection of
securities, are completed by the lenders concerned in consonance with the RP
being implemented;

ii) the new capital structure and/or changes in the terms of conditions of the
existing loans get duly reflected in the books of all the lenders and the borrower;
and,

c) borrower is not in default with any of the lenders.

A RP which involves lenders exiting the exposure by assigning the exposures to

third party or a RP involving recovery action shall be deemed to be implemented
only if the exposure to the borrower is fully extinguished.

Delayed Implementation of Resolution Plan

Where a viable RP in respect of a borrower is not implemented within the timelines

given below, all lenders shall make additional provisions as under:

Timeline for implementation of viable RP Additional provisions to be made as a %

of total outstanding (funded + non-funded), if RP not implemented within the
timeline 180 days from the end of Review Period - 20%

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365 days from Commencement of Review Period 15% (i.e. total additional
provisioning of 35%)

The additional provisions shall be made over and above the higher of the
following, subject to the total provisions held being capped at 100% of total
outstanding:

a) The provisions already held; or,

b) The provisions required to be made as per the asset classification status of the
borrower account.

The additional provisions shall be made by all the lenders with exposure to such
borrower.

The additional provisions shall also be required to be made in cases where the
lenders have initiated recovery proceedings, unless the recovery proceedings are
fully completed.

The additional provisions may be reversed as under:

a) Where the RP involves only payment of over-dues by the borrower – the

additional provisions may be reversed only if the borrower is not in default for a
period of 6 months from the date of clearing of the over-dues with all the lenders;

b) Where RP involves restructuring/change in ownership outside IBC – the

additional provisions may be reversed upon implementation of the RP;

c) Where resolution is pursued under IBC – half of the additional provisions made
may be reversed on filing of insolvency application and the remaining additional
provisions may be reversed upon admission of the borrower into the insolvency
resolution process under IBC; or,

d) Where assignment of debt/recovery proceedings are initiated – the additional

provisions may be reversed upon completion of the assignment of debt/recovery.

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Supervisory Review

Any action by lenders with an intent to conceal the actual status of accounts or
evergreen the stressed accounts, will be subjected to stringent supervisory /
enforcement actions as deemed appropriate by the Reserve Bank, including, but
not limited to, higher provisioning on such accounts and monetary penalties.

During the period when the RP is being finalised and implemented, the usual asset
classification norms would continue to apply subject to additional provisioning
requirements of this circular. The process of re-classification of an asset should not
stop merely because RP is under consideration.

Disclosures

Lenders shall make appropriate disclosures in their financial statements, under

‘Notes on Accounts’, relating to RPs implemented.

Prudential Norms Applicable to Restructuring

A default, as per the definition provided in the framework, shall be treated as an

indicator for financial difficulty, irrespective of reasons for the default.

A borrower not in default, but it is probable that the borrower will default on any
of its exposures in the foreseeable future without the concession, for instance,
when there has been a pattern of delinquency in payments on its exposures.

a) A borrower’s outstanding securities have been delisted, are in the process of

being delisted, or are under threat of being delisted from an exchange due to
noncompliance with the listing requirements or for financial reasons.

b) On the basis of actual performance, estimates and projections that encompass

the borrower’s current level of operations, the borrower’s cash flows are assessed
to be insufficient to service all of its loans or debt securities in accordance with the
contractual terms of the existing agreement for the foreseeable future.

c) A borrower’s credit facilities are in non-performing status or would be

categorised as nonperforming without the concessions.

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Lenders need to complement the key financial ratios and operational parameters
which may include quantitative and qualitative aspects.

Financial difficulty can be identified even in the absence of arrears on an exposure.

Prudential Norms - Asset Classification - Restructured Accounts

In case of restructuring, the accounts classified as 'standard' shall be immediately

downgraded as non-performing assets (NPAs), i.e., ‘sub-standard’ to begin with.
The NPAs, upon restructuring, would continue to have the same asset
classification as prior to restructuring.

Conditions for Upgrade

For MSME accounts where aggregate exposure of the lenders is less than ₹25
crores - An account may be considered for upgradation to ‘standard’ only if it
demonstrates satisfactory performance during the specified period. ‘Specified
Period’ means a period of one year from the commencement of the first payment
of interest or principal, whichever is later, on the credit facility with longest period
of moratorium under the terms of restructuring package.

‘Satisfactory Performance’ means no payment (interest and/or principal) shall

remain overdue for a period of more than 30 days. In case of cash credit / overdraft
account, satisfactory performance means that the outstanding in the account shall
not be more than the sanctioned limit or drawing power, whichever is lower, for a
period of more than 30 days.

For all other accounts (Other than MSME with exposure below Rs 25 Crores) -
Standard accounts classified as NPA and NPA accounts retained in the same
category on restructuring by the lenders may be upgraded only when all the
outstanding loan facilities in the account demonstrate ‘satisfactory performance’
during the period from the date of implementation of RP up to the date by which
at least 10 % of the sum of outstanding principal debt as per the RP and interest
capitalisation sanctioned as part of the restructuring, if any, is repaid (‘monitoring
period’). Provided that the account cannot be upgraded before one year from the
commencement of the first payment of interest or principal (whichever is later) on
the credit facility with longest period of moratorium under the terms of RP.

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For accounts where the aggregate exposure of lenders is ₹100 crores and above at
the time of implementation of RP, to qualify for an upgrade, in addition to
demonstration of satisfactory performance, the credit facilities of the borrower
shall also be rated as investment grade (BBB- or better), at the time of upgrade,
by CRAs accredited by the Reserve Bank for the purpose of bank loan ratings.

While accounts with aggregate exposure of ₹500 crores and above shall require
two ratings, those below ₹500 crores shall require one rating. If the ratings are
obtained from more than the required number of CRAs, all such ratings shall be
investment grade for the account to qualify for an upgrade.

If the borrower fails to demonstrate satisfactory performance during the

monitoring period, asset classification upgrade shall be subject to implementation
of a fresh restructuring/change in ownership. Lenders shall make an additional
provision of 15% for such accounts at the end of the Review Period.

This additional provision, along with other additional provisions, may be reversed
as per the norms laid down.

Provisions held on restructured assets may be reversed when the accounts are
upgraded to standard category.

Any default by the borrower in any of the credit facilities with any of the lenders
(including any lender where the borrower is not in “specified period”) subsequent
to upgrade in asset classification as above but before the end of the specified
period, will require a fresh RP to be implemented within the above timelines as
any default would entail. However, lenders shall make an additional provision of
15% for such accounts at the end of the Review Period. Satisfactory performance
means that the borrower entity is not in default at any point of time during the
period concerned.

“Specified period” means the period from the date of implementation of RP up to

the date by which at least 20 % of the sum of outstanding principal debt as per the
RP and interest capitalisation sanctioned as part of the restructuring, if any, is
repaid.

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Accounts restructured under the revised framework shall attract provisioning as
per the general asset classification category.

Restructured Accounts - Additional Finance - Any additional finance approved

under the RP may be treated as 'standard asset' during the monitoring period
under the approved RP, provided the account demonstrates satisfactory
performance during the monitoring period. If the restructured asset fails to
perform satisfactorily during the monitoring period or does not qualify for
upgradation at the end of the monitoring period, the additional finance shall be
placed in the same asset classification category as the restructured debt.

Any interim finance extended by the lenders to debtors undergoing insolvency

proceedings under IBC may be treated as ‘standard asset’ during the insolvency
resolution process period. During this period, asset classification and provisioning
for the interim finance shall be governed by the general norms. Subsequently,
upon approval of the resolution plan by the Adjudicating Authority, treatment of
such interim finance shall be as per the norms applicable to additional finance.

Restructured Accounts - Income Recognition Norms

Interest income in respect of restructured accounts classified as 'standard assets'

may be recognized on accrual basis and that in respect of the restructured
accounts classified as 'non-performing assets' shall be recognised on cash basis.

In the case of additional finance in accounts where the pre-restructuring facilities

were classified as NPA, the interest income shall be recognised only on cash basis
except when the restructuring is accompanied by a change in ownership.

Conversion of Principal into Debt / Equity and Unpaid Interest into FITL,

Debt or Equity Instruments

An act of restructuring might create new securities issued by the borrower which
would be held by the lenders in lieu of a portion of the pre-restructured exposure.

The FITL / debt / equity instruments created by conversion of principal / unpaid

interest, as the case may be, shall be placed in the same asset classification
category in which the restructured advance has been classified.

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The provisioning applicable to such instruments shall be higher of:

a) The provisioning applicable to the asset classification category in which such

instruments are held; or

b) The provisioning applicable based on the fair valuation of such instruments as

provided in the following paragraphs.

Valuation of Debt/quasi-debt/equity instruments acquired by the lenders as part

of a RP shall be valued as under:

Debentures/bonds shall be valued as per the special instructions.

Conversion of debt into Zero Coupon Bonds (ZCBs)/low coupon bonds (LCBs) as
part of RP shall be subject to the following conditions :

i. Where the borrower fails to build up the sinking fund as required ZCBs/LCBs of
such borrower shall be collectively valued at Re.1

ii. Instruments without a pre-specified terminal value would be collectively valued

at Re.1.

Equity instruments, where classified as standard, shall be valued at market value,

if quoted, or else, should be valued at the lowest value arrived using the following
valuation methodologies:

i. Book value (without considering 'revaluation reserves', if any) which is to be

ascertained from the company's latest audited balance sheet. The date as on which
the latest balance sheet is drawn up should not precede the date of valuation by
more than 18 months. In case the latest audited balance sheet is not available the
shares are to be collectively valued at Re.1 per company.

ii. Discounted cash flow method where the discount factor is the actual interest
rate charged to the borrower on the residual debt post restructuring plus a risk
premium to be determined as per the board approved policy considering the
factors affecting the value of the equity. The risk premium will be subject to floor
of 3 % and the overall discount factor will be subject to a floor of 14 %.

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Further, cash flows (cash flow available from the current as well as immediately
prospective (not more than six months) level of operations) occurring within 85 %
of the useful economic life of the project only shall be reckoned.

Equity instruments, where classified as NPA shall be valued at market value, if

quoted, or else, shall be collectively valued at Re.1. Preference Shares shall be
valued on discounted cash flow (DCF) basis subject to the following:

i. The discount rate shall be subject to a floor of weighted average actual interest
rate charged to the borrower on the residual debt after restructuring plus a
markup of 1.5 %.

ii. Where preference dividends/coupons are in arrears, no credit should be taken

for accrued dividends/coupons and the value determined as above on DCF basis
should be discounted further by at least 15 % if arrears are for one year, 25 % if
arrears are for two years, so on and so forth (i.e., with 10 % increments).

The overarching principle should be that valuation of instruments arising out of

resolution of stressed assets shall be based on conservative assessment of cash
flows and appropriate discount rates to reflect the stressed cash flows of the
borrowers.

In case lenders have acquired unquoted instruments on conversion of debt as a

part of a RP, and if the RP is not deemed as implemented, such unquoted
instruments shall collectively be valued at Re. 1 at that point, and till the RP is
treated as implemented.

The unrealised income represented by FITL / Debt or equity instrument should

have a corresponding credit in an account styled as "Sundry Liabilities Account
(Interest Capitalization)".

The unrealised income represented by FITL / Debt or equity instrument can only
be recognised in the profit and loss account as under:

a) FITL/debt instruments: only on sale or redemption, as the case may be;

b) Unquoted equity/ quoted equity (where classified as NPA): only on sale;

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c) Quoted equity (where classified as standard): market value of the equity as on
the date of upgradation, not exceeding the amount of unrealised income
converted to such equity. Subsequent changes to value of the equity will be dealt
as per the extant prudential norms on investment portfolio of banks.

Change in Ownership

In case of change in ownership of the borrowing entities, credit facilities of the

concerned borrowing entities may be continued/ upgraded as ‘standard’ after the
change in ownership is implemented, either under the IBC or under this
framework. If the change in ownership is implemented under this framework, then
the classification as ‘standard’ shall be subject to the following conditions:

a) Lenders shall conduct necessary due diligence in this regard and clearly establish
that the acquirer is not a person disqualified in terms of Section 29A of the IBC.
Additionally, the ‘new promoter’ should not be a person/ entity/
subsidiary/associate etc. (domestic as well as overseas), from the existing
promoter /promoter group.

Lenders should clearly establish that the acquirer does not belong to the existing
promoter group as per SEBI Norms.

b) The new promoter shall have acquired at least 26 % of the paid up equity capital
as well as voting rights of the borrower entity and shall be the single largest
shareholder of the borrower entity.

c) The new promoter shall be in ‘control’ of the borrower entity as per the
definition of ‘control’ in the Companies Act, 2013 / regulations issued by the
Securities and Exchange Board of India/any other applicable regulations /
accounting standards as the case may be.

Upon change in ownership, all the outstanding loans/credit facilities of the

borrowing entity need to demonstrate satisfactory performance during the
monitoring period. If the account fails to perform satisfactorily at any point of
time during the monitoring period, it shall trigger a fresh Review Period.

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The quantum of provisions held (excluding additional provisions) by the bank
against the said account as on the date of change in ownership of the borrowing
entities can be reversed only after the end of monitoring period subject to
satisfactory performance during the same.

Exemptions from RBI Regulations

Acquisition of non-SLR securities by way of conversion of debt is exempted from

the restrictions and the prudential limit on investment in unlisted non-SLR
securities prescribed by the RBI.

Acquisition of shares due to conversion of debt to equity during a restructuring

process will be exempted from regulatory ceilings/ restrictions on Capital Market
Exposures, investment in Para-Banking activities and intra-group exposure.

However, these will require reporting to RBI and disclosure by banks in the Notes
to Accounts in Annual Financial Statements. Nonetheless, banks will have to
comply with the provisions of the BR Act, 1949.

Restructuring of frauds/wilful defaulters

Borrowers who have committed frauds/ malfeasance/ wilful default will remain
ineligible for restructuring. However, in cases where the existing promoters are
replaced by new promoters, and the borrower company is totally delinked from
such erstwhile promoters/management, lenders may take a view on restructuring
such accounts based on their viability, without prejudice to the continuance of
criminal action against the erstwhile promoters/management.

Wilful Defaulter/Non-Cooperative Borrower – Provisions

The provisioning in respect of existing loans

Wilful Defaulter/Non-Cooperative Borrower – Provisions

The provisioning in respect of existing loans/exposures of banks to companies

having director/s (other than nominee directors of government/financial
institutions brought on board at the time of distress), whose name/s appear more
than once in the list of wilful defaulters, will be 5% in cases of standard accounts;
if such account is classified as NPA, it will attract accelerated provisioning.

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Since the expected losses on exposures to wilful defaulters and non-cooperative
borrowers are likely to be higher, no additional facilities should be granted by any
bank/FI to the listed wilful defaulters.

With a view to discouraging borrowers/defaulters from being unreasonable and

noncooperative with lenders in their bonafide resolution/recovery efforts, banks
may classify such borrowers as non-cooperative borrowers, after giving them due
notice if satisfactory clarifications are not furnished. Banks will be required to
report classification of such borrowers to CRILC.

If any particular entity is reported as non-cooperative, any fresh exposure to such

a borrower will, by implication, entail greater risk necessitating higher
provisioning.

Dissemination of Information

In order to make the current system of banks/FIs reporting names of suit filed
accounts and non-suit filed accounts of Wilful Defaulters and its availability to the
banks by CICs as current as possible, banks have to forward data on wilful
defaulters to the CICs at the earliest but not later than a month from the reporting
date and they must use/ furnish the detailed information.

In case any falsification of accounts on the part of the borrowers is observed by

the banks / FIs, and if it is observed that the auditors were negligent or deficient
in conducting the audit, banks should lodge a formal complaint against the
auditors of the borrowers with the Institute of Chartered Accountants of India
(ICAI). Pending disciplinary action by ICAI, the complaints may also be forwarded
to the RBI and IBA for records.

A Non-Cooperative Borrower is one who does not engage constructively with his
lender by defaulting in timely repayment of dues while having ability to pay,
thwarting lenders’ efforts for recovery of their dues by not providing necessary
information sought, denying access to assets financed / collateral securities,
obstructing sale of securities, etc.

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Banks may seek explanation from advocates who wrongly certify as to clear legal
titles in respect of assets or valuers who overstate the security value, by negligence
or connivance, and if no reply/satisfactory clarification is received from them
within one month, they may report their names to IBA.

Bank Loans for Financing Promoters’ Contribution

The promoters' contribution towards the equity capital of a company should

come from their own resources and banks should not normally grant advances to
take up shares of other companies. It has been decided that banks can extend
finance to ‘specialized’ entities established for acquisition of troubled companies
subject to the general guidelines applicable to advances against
shares/debentures/bonds and other regulatory and statutory exposure limits. The
lenders should, however, assess the risks associated with such financing and
ensure that these entities are adequately capitalized, and debt equity ratio for such
entity is not more than 3:1.

In the context of Financing Promoters’ Contribution, a ‘specialized’ entity will be

a body corporate exclusively set up for the purpose of taking over and turning
around troubled companies and promoted by individuals or/and institutional
promoters (including Government) having professional expertise in turning
around ‘troubled companies’ and eligible to make investments in the
industry/segment to which the target asset belonged.

Banks should carry out their independent and objective credit appraisal in all cases
and must not depend on credit appraisal reports prepared by outside consultants,
especially the in-house consultants of the borrowing entity.

Banks should carry out sensitivity tests/scenario analysis, especially for

infrastructure projects, which should inter alia include project delays and cost
overruns. This will aid in taking a view on viability of the project at the time of
deciding on deferment of DCCO/restructuring.

Banks should ascertain the source and quality of equity capital brought in by the
promoters /shareholders. Banks have to ensure at the time of credit appraisal that
debt of the parent company is not infused as equity capital of the subsidiary/SPV.

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In order to ensure that directors are correctly identified and in no case, persons
whose names appear to be similar to the names of directors appearing in the list
of wilful defaulters, are wrongfully denied credit facilities on such grounds,
banks/FIs have been advised to include the Director Identification Number (DIN)
as one of the fields in the data submitted by them to Reserve Bank of India/Credit
Information Companies.

While carrying out the credit appraisal, banks should verify as to whether the
names of any of the directors of the companies appear in the list of defaulters/
wilful defaulters by way of reference to DIN/PAN etc. Further, in case of any doubt
arising on account of identical names, banks should use independent sources for
confirmation of the identity of directors rather than seeking declaration from the
borrowing company.

With a view to monitoring the end-use of funds, if the Banks desire a specific
certification from the borrowers’ auditors regarding diversion / siphoning of funds
by the borrower, the Bank should award a separate mandate to the auditors for
the purpose. To facilitate such certification by the auditors the banks will also need
to ensure that appropriate covenants in the loan agreements are incorporated.

Banks may engage own auditors for specific certification purpose to ensure proper
end-use of funds and preventing diversion/siphoning of funds by the borrowers,
without relying on certification given by borrower’s auditors. However, this
cannot substitute bank’s basic minimum own diligence in the matter.

Registration of Transactions with CERSAI

Banks are required to register, on an ongoing basis, the transactions relating to

securitization and reconstruction of financial assets on the CERSAI portal. Banks
also need to file, on an ongoing basis, the following types of security interest on
the CERSAI portal to secure any loans or advances:

a) Particulars of creation, modification, or satisfaction of security interest in

mortgage by deposit of title deeds & mortgage other than mortgage by deposit
of title deeds;

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b) Particulars of creation, modification, or satisfaction of security interest in
hypothecation of plant and machinery, stocks, debts including book debts or
receivables, whether existing or future.

c) Particulars of creation, modification, or satisfaction of security interest in

intangible assets, being know how, patent, copyright, trademark, licence,
franchise or any other business or commercial right of similar nature.

d) Particulars of creation, modification, or satisfaction of security interest in any

‘under construction’ residential or commercial or a part thereof by an agreement
or instrument other than mortgage.

The Board of Directors of banks should take all necessary steps to arrest the
deteriorating asset quality in their books and should focus on improving the credit
risk management system.

Early recognition of problems in asset quality and resolution envisaged requires

the Banks to be proactive and make use of CRILC.

The boards of banks should put in place a system for proper and timely
classification of borrowers as wilful defaulters or/and non-cooperative borrowers.

Further, Boards of banks should periodically review the accounts classified as such,
say on a half yearly basis.

Monitoring period in Restructuring

This period begins from the date of implementation of RP till the point in time
when the borrower pays back at least 10% of the residual debt. In case a borrower
is in default with any of the lending institutions during the monitoring period, a
review period of 30 days gets triggered.

NPA Provisioning – Numerical Examples

In this Notes, Doubtful Loans are indicated by following notations :

Doubtful upto 1 year – D1

Doubtful above 1 year upto 3 year – D2
Doubtful above 3 years – D3

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Advances covered by ECGC guarantee

In the case of advances classified as doubtful and guaranteed by ECGC, provision

should be made only for the balance in excess of the amount guaranteed by the
Corporation. Further, while arriving at the provision required to be made for
doubtful assets, realisable value of the securities should first be deducted from the
outstanding balance in respect of the amount guaranteed by the Corporation and
then provision made as illustrated hereunder:

Outstanding Balance Rs.4 lakhs

ECGC Cover 50 %

Period for which the advance has

remained doubtful More than 2 years remained

doubtful (say as on 31-03-2018)

Value of security held Rs.1.50 lakhs

Provision required to be made

Outstanding balance Rs.4.00 lakhs

Less: Value of security held Rs.1.50 lakhs

Unrealised balance Rs.2.50 lakhs

Less: ECGC Cover (50% of unrealisable balance) Rs.1

Less: ECGC Cover (50% of unrealisable balance) Rs.1.25 lakhs

Net unsecured balance Rs.1.25 lakhs

Provision for unsecured portion of

advance Rs.1.25 lakhs (@ 100 % of Unsecured portion)

Provision for secured portion of advance (as on 31-03-2016) Rs.0.60 lakhs (@

40 per cent of the secured portion)

Total provision to be made Rs.1.85 lakhs (as on 31-03-2018)

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Advance covered by CGTMSE or CRGFTLIH

In case the advance covered by CGTMSE or CRGFTLIH guarantee becomes

nonperforming, no provision need be made towards the guaranteed portion. The
amount outstanding in excess of the guaranteed portion should be provided for
as per the extant guidelines on provisioning for non-performing assets. An
illustrative example is given below:

Outstanding Balance Rs.10 lakhs

CGTMSE/CRGFTLIH Cover 75% of the amount outstanding or 75% of the

unsecured amount or Rs.37.50 lakh, whichever is the least

Period for which the advance has remained doubtful More than 2 years remained

doubtful (say as on 31-03- 2016)

Value of security held Rs.1.50 lakhs

Provision required to be made

Balance outstanding Rs.10.00 lakh

Less: Value of security Rs.1.50 lakh

Unsecured amount Rs.8.50 lakh

Less: CGTMSE/CRGFTLIH cover (75%) Rs.6.38 lakh

Net unsecured and uncovered portion Rs.2.12 lakh

Provision for Secured portion @ 40%

of Rs.1.50 lakh Rs.0.60 lakh

Provision for Unsecured & uncovered portion @ 100% of Rs.2.12 lakh

Rs.2.12 lakh

Total provision required Rs.2.72 lakh

03. The following is the data related to M/s Cunning Bank (related to its loans and
advance portfolio, as of March 31, 2021).(Rs in Crores) Total loans Rs 200000 Cr
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Standard

Direct Agriculture Rs 50000 Cr

Others Rs 140000 Cr

Total Standard Rs 190000 Cr

Unsecured Substandard Rs 1000 Cr

Secured Substandard Rs 3000 Cr

Total Substandard Rs 4000 Cr

D1 Rs 4000 Cr

D2 Rs.1000 Cr

D3 Rs 600 Cr

Total Doubtful Rs 5600 Cr (all doubtful loans are secured loans)

Loss Accounts Rs.400 Cr

Based on the above data the following are solved.

a) The provision of standard accounts

For provision for direct advance to agriculture or small and micro enterprise is
0.25%, for other standard assets 0.40%

140000 @ 0.40%= Rs 560 Cr, 50000 @ 0.25%= Rs 125 Cr

Ans.: Total Rs 560+125= Rs 685 Cr

b) The amount of provisions made on substandard loan accounts 15% of

outstanding amount in case of Secured loans, 25% of outstanding amount in case
of Unsecured loans.

Secured loans Rs 3000 Cr and Unsecured Rs.1000 Cr

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Rs 3000 Cr @ 15% + Rs 1000 Cr @ 25% = 450+250= Rs 700 Cr

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c) The Amount of provision on doubtful loan accounts (all doubtful loans are fully
secured)

D1 Rs 4000 Cr - Provision @ 25% = Rs 1000 Cr

D2 Rs1000 Cr @ 40% = Rs 400 Cr

D3 Rs 600 Crore @ 100% = Rs 600 Cr

Provision for Total Doubtful Advances Rs 2000 Cr

d) Provision for Loss Advances @ 100% = Rs 400 Cr Rs 400 Cr

e) Total provision on NPA =

Provision made on Substandard + Doubtful + Loss Assets

= Rs 700+2000+ 400= 3100 Cr

f) Total provision on Advances = Prov for Standard + Prov for NPA

= 3100+ 685= 3785 Cr

g) The Provision Coverage Ratio of the Bank (PCR)

Gross NPA= Total advance - Std assets = 200000 - 190000 = 10000

Total Provision for NPA 3100

PCR % = ----------------------------- x 100 = ----------- x 100 = 31%
Gross NPAs 10000

h) Net NPA = Total NPA- Total provision for NPA = 10000-3100= 6900 Cr

Net NPA 6900

i) The % of Net NPA = ---------------- = ------------ = 3.45%
Total Advance 200000

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04. The Nice Bank details of NPA accounts as at 31-03-2019 are as under.

Total Advances Rs 200000 Cr

Standard Advances Rs.190000 Cr (Standard Advances include Direct Agriculture &

SME loans of Rs 50000 Cr)

Substandard Rs 4000 Cr out of which Unsecured Advances amount to Rs.1000 Cr

D 1 - Rs.4000 Cr

D 2 - Rs.1000 Cr

D 3 - Rs 600 Cr

Loss advances Rs 400 Cr

a) The provision for D1 category accounts

Doubtful upto 1 year is Rs.4000 Cr

Secured Rs 3000 Cr

Unsecured Rs 1000 Cr

Provision for Secured D1 is 25% = 3000 x 25% = 750

Provision for Unsecured D1 is 100% = 1000 x 100% = 1000 Cr

Total Provision for D1 = Rs 750 Cr +Rs 1000 Cr= Rs 1750 Cr

b) If the security value is Rs.300 Crore in Doubtful -2 category account, the

provision will be as under.

D2 Rs 400 Cr , Secured Rs 300 Cr, therefore Unsecured Rs 100 Cr

Provision for D2 Secured - 300 @ 40%= 120 Cr

Provision for D2 Unsecured = 100 @ 100% = 100 Cr

Total Provision for D2 = Rs 120 + 100 = Rs 220 Crore

05. Outstanding of a loan account is Rs.10 lac, value of security held is Rs 4 lakh,
ECGC cover is 50%, the account remained doubtful for more than 2 years.

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Outstanding Rs 10 lac – Less Value of security held Rs. 4 lac = Rs.6 lac

Unrealisable balance Rs. 6 lakh Less 50% ECGC Cover Rs. 3 lakh = Rs 3 lac (this is
the net unsecured balance)

Provision for unsecured portion of advance Rs 3 lac (@ 100 percent of unsecured

portion = Rs 3 lakh

Provision for secured portion of advance Rs 4 lac @ 40% is Rs.160000/-

Total provision Rs.300000 + Rs160000= Rs.460000/-

Recovery Aspects - Corporate Debt Restructuring

Corporate Debt Restructuring (“CDR”) is a voluntary framework, under which

financial institutions and banks restructure the debt of companies facing financial
difficulties due to various factors, in order to provide support at the right time for
such businesses.

CDR is a process employed by companies facing cash crunch or financial distress

in order to avoid default risk. It can be done with:

Reducing interest rates on mortgage loans or extending the length of payment.

It may also include an equity swap arrangement where creditors of the company
may agree to cancel some or all of the debt in return for the company’s equity. It
may also require a “haircut” where the corporation may compromise with the
Financial Creditor to write off some interest or capital part.

The objects of the CDR mechanism as stated by the Reserve Bank of India, the
country’s central bank, are-

“To ensure a timely and transparent mechanism for the restructuring of corporate
debts of viable entities facing problems, for the benefit of all concerned.”

“To aim at preserving viable corporates that are affected by certain internal and
external factors”.

“To minimize the losses to creditors and other stakeholders through an orderly
and co-ordinated restructuring programme”.

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The intention behind the mechanism is to revive such firms and also to protect the
interests of the lending institutions and other stakeholders.

The CDR mechanism is available from more than one lending institution to
companies that enjoy the credit facilities. The mechanism allows these institutions
to restructure the debt for the benefit of all in a prompt and transparent manner.

Debt restructuring can be a mutually beneficial situation for both, as the

corporation escapes bankruptcy and the borrowers typically receive more than
they would have gained in an IBC bankruptcy proceeding.

The CDR system was framed almost 18 years ago, to restructure corporate debt
outside the purview of debt recovery tribunals (DRT) and the then Board for
Industrial and Financial Reconstruction (BIFR). It is a three-tiered structure,
consisting of the CDR Standing Forum followed by the CDR Empowered Group and
then the CDR Cell The CDR Standing Committee was responsible for setting all
debt restructuring rules and regulations, while the CDR cell was responsible for
scrutinizing both borrowers ‘ and lenders ‘ restructuring plans. The CDR
Empowered Group took the final decision to approve the restructuring package.

Under the rules of the CDR group, the resolution plan should be accepted by at
least 75% of creditors by the amount of outstanding financial debt.

The formal procedure for restructuring as stated above encompasses within its
scope scheme of reconstruction, takeover, mergers, demergers, transfer of
undertakings and restructuring of debts as provided Sections 230 and 231 of the
Companies Act 2013.

The structured restructuring process set out above includes, as provided for in
Sections 230 and 231 of the Companies Act 2013, the scope of rehabilitation,
acquisition, mergers, demergers, transfers of undertakings and debt restructuring.

Section 230 of the Companies Act, 2013 authorizes NCLT to make an order on the
application of the corporation or creditor/member, or in the case at issue. Many
CDR schemes are carried out by Compromise or Arrangement of Capital Therefore
it is important to understand the meaning of Compromise & Arrangement.

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Compromise is a term that usually suggests the presence of a rights dispute. A
compromise scheme may be drawn up when a corporation has a disagreement
with a member or a class of members, a borrower or a class of creditors.

Nonetheless, where there is no disagreement but there is a need to adjudicate the

member’s or a class of members ‘ rights or liabilities, the organization may resort
to the arrangement. A settlement can be made in the preparation or some
possibility of a conflict, while compromise is usually found at the close of a
dispute. Thus, Arrangement and compromise may take place for, the purpose of
amalgamation or reconstruction /merger/demerger of companies, or may involve
the reduction of share capital as the need be.

Recently, the Reserve Bank of India has abolished multiple loan restructuring
schemes that are prevalent among banks in order to restructure defaulted loans,
and has made the resolution of defaults subject to the Insolvency and Bankruptcy
Code (IBC) the key mechanism for dealing with defaulters.

The Adjudicating Authority, in this case, is also NCLT under the IBC. The resolution
process under IBC is well defined with specific timelines. The IBC enables initiation
of Corporate Insolvency Resolution Process (CIRP), immediately after the first
default has occurred. The Committee of creditors needs to act in the best interest
of all the stakeholders of the corporate debtor.

With growing litigation over insolvency cases, banks are increasingly opting for
loan settlement deals under IBC Section 12A from defaulting companies. Under
IBC section 12 A, borrowers are given the option of accepting these offers from
defaulting promoters.

CDR- Current MSME Focus

RBI has permitted a one-time restructuring of current MSME loans, which have
defaulted but are not non-performing as of January 1, 2019, in a huge step. Such
debt restructuring would still not result in a downgrade in the asset category.

To qualify for the debt restructuring scheme, the exposure mix together with the
bank’s total facilities must no longer exceed Rs. 25 crore to a borrower. The
restructuring of the loan must also be carried out by way of 31 March 2020.

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After the budget announcement by Finance Minister Nirmala Sitharaman, the
government has asked the Reserve Bank of India (RBI) to extend the debt
restructuring scheme beyond the deadline of March 31, 2020, the RBI extended
the scheme to December 31, 2020. This would help MSMEs tide over problems
following demonetisation and implementation of GST due to a lack of work
capital. Ms. Sitharaman had said in her budget speech that more than five lakh
MSMEs have benefited from the debt restructuring that RBI has allowed in the
past year.

Future of CDR Schemes

There is a lot of talk about “Pre-Packs” on CDR. A pre-packaged restructuring plan

is a pre-planned insolvency process in which a corporation arranges to sell its
assets to a bidder before filing for insolvency, promotes the sale and NCLT are
approached by creditors and shareholders with a pre-negotiated, pre-approved
corporate reorganization plan called the “pre-packaged.” This kind of corporate
rescue and reorganization plan reduces significantly the time taken in lengthy
court proceedings apart from the substantial costs for companies that are already
in financial distress. One of Pre-pack’s most significant benefit is that it is debtor
focused and not creditor-focused, as is typically the case under the IBC.

The purpose of the pre-pack procedure is to save the company, its financial and
intellectual property assets, and to ensure operational continuity while at the same
time moving towards getting the business out of the financial slump and
reclassifying it as a performing asset.

One-Time Settlement (OTS) (aka Compromise)

One-time settlement or OTS is a type of compromise settlement executed by the

banks in order to recover non-performing assets (NPAs).

OTS is a scheme where the borrower (the one who has defaulted) proposes to
settle all the dues at once, and banks agree to accept an amount lesser than what
was originally due. The banks settle the loan and waiver/write it off against a one
time instalment, thereby compromising on a portion of their profits.

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One-time Settlement (OTS) schemes are available in all banks as an effort to deal
with NPA levels. However, not every borrower is given this provision and whether
to settle a bad loan account through OTS is on a sole discretion of the concerned
bank based on some criteria and is not applicable in case of wilful defaults.

Impact of OTS on Banks Profitability

When a loan account becomes delinquent and turns into an NPA, banks are
required to settle it as per the RBI guidelines. This provision varies depending upon
the remaining due (principal and Impact of OTS on Banks Profitability

When a loan account becomes delinquent and turns into an NPA, banks are
required to settle it as per the RBI guidelines. This provision varies depending upon
the remaining due (principal and interest) and more such factors. In this scenario,
banks have to compromise on their profitability by agreeing upon an amount that
can be paid by the borrower on a one-time basis.

In order to recover NPAs, banks execute a recovery drive on a regular basis, where
borrowers can approach them and ask for settling their account through OTS. For
this, they need to justify themselves in order to get a rebate on the interest
charged or any other fee charged against the loan.

It is for the bank to decide if they have to extend this facility to the borrower or
not. In case the bank holds the borrower’s security/assets and is sure to recover
both the principal and interest in full, they may reject the borrower’s plea for OTS.

Conversely, when the assets or prime security is inadequate, they may choose to
grant a one-time settlement.

Benefits of OTS

1) Prompt and speedy recovery of loans and advances

2) Increase in liquidity

3) Easy flow of funds that promotes a continuous lending process

4) The health of the economy is maintained.

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The one-time settlement schemes of NPAs in different sectors vary. It is distinct
for agriculture, MSMEs and others. OTS also considers to settle bad loan accounts
on the grounds of security available with them, the current financial conditions of
borrower/company, their legal state etc., in case the borrower fail to offer the
principal amount.

OTS -Not applicable to Decreed Accounts

One Public Sector Bank has extended credit facilities to a Pharma Company to the
extent of Rs 12 crores and over a period of time the said borrowal account slipped
to NPA.

As recovery in normal course is not forth coming Bank has filed a Case in DRT.

After hectic negotiations, a settlement was arrived whereby, Bank agreed to settle
the case by accepting 80 per cent of the total dues. Subsequently, a consent decree
was obtained from the DRT.

In the meantime, the RBI came out with the guidelines on one-time settlement
(OTS) of NPA dues. Realising the benefits of the OTS scheme where the settlement
amount worked out to 40 per cent less than the original dues, the pharma
company approached the bank for an OTS. As value of collaterals is comfortable,
the Bank did not agree for the OTS proposal from the Borrower.

Following this, the Pharma Company filed a case in the High Court. The high court
sought the mediation of the RBI, which was made a third party to the case.

The RBI filed an affidavit supporting the Bank’s stand and stated that the OTS
should be made applicable to cases pending settlement and not to those where
settlement has been cleared with a consent decree obtained.

The decision is based on the premise that OTS is not meant to help defaulting
parties to settle their dues at lesser cost but to expedite the recovery process.

Following the affidavit, the court rejected the plea of the Pharma Company and
upheld that the OTS cannot be made applicable to cases where a decree has been
obtained but will be only valid for pending ones.

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OTS and Criminal Liability

A one-time settlement (OTS) of loan taken from banks by itself is not legally
sufficient to wipe out the criminal liability of the borrowers, particularly those who
fraudulently took loans and opted to settle those with meagre amounts. This
significant ruling has come from the Telangana High Court.

Lok Adalat (People’s Court)

Lok Adalat is one of the modes of Alternative Dispute Resolution.

The National Legal Services Authority (NALSA) along with other Legal Services
Institutions conducts Lok Adalat.

Lok Adalat Benches consisting of Judicial Officers, Advocates and social workers
deal with cases referred to them and help the parties in arriving at a settlement.

The Lok Adalat shall have jurisdiction to determine and to arrive at a compromise
or settlement between the parties to a dispute in respect of any case pending
before any Court or any matter which is falling within the jurisdiction of any Court
and is not brought before such Court that is pre-litigation.

In respect of cases pending before Courts, such cases can be referred to Lok Adalat
if the parties thereof agree or one of the parties thereof makes an application to
the Court or the Court is satisfied that the matter is an appropriate one to be taken
cognizance of by the Lok Adalat.

The Lok Adalat can deal with all Civil Cases, Matrimonial Disputes, Land Disputes,
Partition/Property Disputes, Labour Disputes etc., and non-compoundable
criminal Cases.

The Plaintiff/Petitioner is entitled to get refund of Court Fee that has been paid by
him at the time of filing a Suit before a Court and that suit has been settled before
the Lok Adalat.

The parties who wish to avail the Lok Adalat Mechanism can simply approach the
Court concerned or any of the Legal Services Institution.

No fee is required to be paid by the parties to settle their cases before Lok Adalat.

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Lok Adalat has been given statutory status under the Legal Services Authorities
Act, 1987. Under the said Act, the award (decision) made by the Lok Adalat is
deemed to be a decree of a civil court and is final and binding on all parties and
no appeal against such an award lies before any court of law.

If the parties are not satisfied with the award of the Lok Adalat though there is no
provision for an appeal against such an award, but they are free to initiate
litigation by approaching the court of appropriate jurisdiction by filing a case by
following the required procedure, in exercise of their right to litigate.

The persons deciding the cases in the Lok Adalat are called the Members of the
Lok Adalat, they have the role of statutory conciliators only and do not have any
judicial role; therefore, they can only persuade the parties to come to a conclusion
for settling the dispute outside the court in the Lok Adalat and shall not pressurize
or coerce any of the parties to compromise or settle cases or matters either directly
or indirectly.

The Lok Adalat shall not decide the matter so referred at its own instance, instead
the same would be decided on the basis of the compromise or settlement between
the parties.

The members shall assist the parties in an independent and impartial manner in
their attempt to reach amicable settlement of their dispute.

RBI guidelines on Lok Adalat

To make increasing use of the forum of Lok Adalat to settle banking disputes
involving smaller amounts, RBI during April 2001 advised bank and financial
institutions to follow the following guidelines for implementation:

1) Cases involving an amount up to Rs. 30 lakh may be referred to Lok Adalat.

2) All NPA accounts, both suit filed and non-suit filed which are in “doubtful” and
“loss” category. No cut off date is suggested since Lok Adalat is an on-going
process.

3) Settlement Formula - It would be flexible with following essential parameters

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a) A decree should be sought from the Lok Adalat for the principal amount and
interest claimed in the suit and after full payments of decree amount, a discharge
certificate should be issued by the bank/financial institutions.

b) Repayment period to be within 1-3 years - The negotiated agreement should

contain a default clause. If borrower does not pay due amount regularly, within
the repayment period, entire debt will fall due for payments and bank may initiate
legal proceedings

c) DRT Lok Adalat - Banks can take up matters where outstanding exceed the
ceiling of Rs. 20 lac, with Lok Adalat organised by the Debt Recovery Tribunals /
Debt Recovery Appellate Tribunals.

Supreme Court has suggested that personal loan cases up to Rs. 10 lac should
preferably settled through Lok Adalat.

Debt Recovery Tribunal (DRT)

The Debts Recovery Tribunals (DRTs) and Debts Recovery Appellate Tribunals
(DRATs) were established under the Recovery of Debts Due to Banks and Financial
Institutions Act (RDDBFI Act), 1993 with the specific objective of providing
expeditious adjudication and recovery of debts due to Banks and Financial
Institution.

DRT jurisdiction covers loans of Banks with outstanding of Rs 20 lacs or more.

Originally, the cutoff limit was Rs 10 lacs. The Central Government, in 2018, raised
the pecuniary limit from Rs 10 lakh to Rs 20 lakh.

The power of the tribunal is restricted to settling down the cases concerning the
recovery of the due amount from non-performing assets as affirmed by the banks
as per the RBI guidelines.

The Tribunal has the powers bestowed with the District Court. The Tribunal shall
have a Recovery officer who would be guiding towards executing the recovery
Certificates as passed through the Presiding Officers. DRT is required to follow the
legal process by stressing on prompt disposal of the matters and fast execution of
the final order.

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The Debts Recovery Tribunal (DRT) enforces provisions of the Recovery of Debts
Due to Banks and Financial Institutions (RDDBFI) Act, 1993 and also Securitization
and Reconstruction of Financial Assets and Enforcement of Security Interests
(SARFAESI) Act, 2002.

The Debts Recovery Tribunal (DRT) are fully empowered to pass comprehensive
orders and can travel beyond the Civil procedure Code to render complete justice.

A Debts Recovery Tribunal (DRT) can hear cross suits, counter claims and allow set
offs. However, a Debts Recovery Tribunal (DRT) cannot hear claims of damages or
deficiency of services or breach of contract or criminal negligence on the part of
the lenders. In addition, a Debts Recovery Tribunal (DRT) cannot express an
opinion beyond its domain, or the list pending before it.

The Debts Recovery Tribunal can appoint Receivers, Commissioners, pass ex-parte
orders, ad-interim orders, interim orders apart from powers to Review its own
decisions and hear appeals against orders passed by the Recovery Officers of the
Tribunal.

No court in the country other than the SC and the HCs and that too, only under
articles 226 and 227 of the Constitution have jurisdiction over this matter.

The Order passed by DRT is appealable , within 45 days from the date of receipt of
Order of DRT, to the Appellate Tribunal. No appeal shall be entertained by the
Appellate Tribunal unless the appellant deposits 75% of the due amount.

The Appellate Authority may, waive or reduce the amount of such deposit. The
Petitions against orders passed through DRT, are to be disposed off by the Debts
Recovery Appellate Tribunal (DRAT) within 6 months from the date of receipt of
the Appeal.

SARFAESI Act
The Securitization and Reconstruction of Financial Assets and Enforcement of
Security Interest (SARFAESI) Act, 2002 was framed to address the problem of NPAs
(Non-Performing Assets) or bad assets through different processes and
mechanisms.

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The SARFAESI Act gives detailed provisions for the formation and activities of
Asset Securitization Companies (SC) and Asset Reconstruction Companies (ARC).

Following are the main objectives of the SARFAESI Act :

1) The Act provides the legal framework for Securitization Activities in India.

2) It gives the procedures for the transfer of NPAs to Asset Reconstruction

Companies for the reconstruction of the assets.

3) The Act enforces the security interest without Court’s intervention .

4)The Act give powers to banks and financial institutions to take over the
immovable property that is hypothecated or charged to enforce the recovery of
debt. Empowers the Banks / FIs to enforce the securities against the borrowers and
realize their dues without intervention of the Court.

The Act provides following three methods for recovery of NPAs :

a) Securitization;

b) Asset Reconstruction; and

c) Enforcement of Security without the intervention of the Court.

Securitization is the process of pooling and repackaging of financial assets (like

loans given) into marketable securities that can be sold to investors.

In the context of bad asset management, securitization is the process of

conversion of existing less liquid assets (loans) into marketable securities. The
securitization company takes custody of the underlying mortgaged assets of the
loan taker.

Asset reconstruction is the activity of converting a bad or non-performing asset

into performing asset.

Enforcement of Security Interests

The Act empowers the lender (banker), when the borrower defaults, to issue
notice to the defaulting borrower and guarantor, calling to repay the debt within
60 days from the date of the notice.

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If the borrower fails to comply with the notice, the bank or the financial institution
may enforce security interests (means interest of the bank/creditor) by following
the provisions of the Act:

a) Take possession of the security;

b) Sale or lease or assign the right over the security;

c) Appoint Manager to manage the security;

d) Ask any debtors of the borrower to pay any sum due to the borrower.

Account Eligible to proceed under SARFAESI Act :

a) Account should be NPA.

b) Security interest should be created (right, title and interest of any kind upon
property such as mortgage, charge, hypothecation and assignment).

c) Amount claimable (including accrued interest) should be above Rs.1.00 lakhs.

d) Amount due should be more than 20% of the Principal and interest thereon.

Securities exempted from SARFAESI Act :

The following are outside purview of the SARFAESI Act.

a) Claim / liability upto Rs.1.00 lakhs.

b) Security interest (mortgage) created in agricultural land.

c) Where amount due is less than 20% of the principal amount & interest thereon.

d) Lien on any goods, money or security .

e) Pledge of movables .

f) Creation of any security in any aircraft.

g) Creation of security interest in any vessel.

h) Rights of unpaid seller.

i) Properties not liable to attachment or sale.

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Other Provisions :

- Suit to be filed as per procedure and as per the period of limitation.

- Action can be initiated in suit filed account without permission from Court/DRT.

- Action can be initiated pending any other litigation.

Important Points for a Prudent Banker :

1. Action under SARFAESI Act will not save Limitation.

2. In case of Borrowal Accounts where Simple Mortgage is created, we cannot

proceed under SARFAESI Act. As such, please note to go for EMT with MODTD
wherever possible. However, in case of Agricultural Lands, we may go for Simple
Mortgage, as SARFAESI Act is not applicable.

The National Company Law Tribunal (NCLT)

The National Company Law Tribunal is a quasi-judicial body in India that

adjudicates issues relating to Indian companies. The tribunal was established
under the Companies Act 2013 and was constituted on 1 June 2016 by the
Government of India based on the recommendation of the V. Balakrishna Eradi
committee on law relating to the insolvency and the winding up of companies.

All proceedings under the Companies Act, including proceedings relating to

arbitration, compromise, arrangements, reconstructions and the winding up of
companies shall be disposed off by the National Company Law Tribunal.

The NCLT bench is chaired by a Judicial member who is supposed to be a retired

or a serving High Court Judge and a Technical member who must be from the
Indian Corporate Law Service, ICLS Cadre. The tribunal has sixteen benches.

The National Company Law Tribunal is the adjudicating authority for the
insolvency resolution process of companies and limited liability partnerships
under the Insolvency and Bankruptcy Code, 2016.

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No criminal court shall have jurisdiction to entertain any suit or proceeding in
respect of any matter which the Tribunal or the Appellate Tribunal is empowered
to determine by or under this Act or any other law for the time being in force and
no injunction shall be granted by any court or other authority in respect of any
action taken or to be taken in pursuance of any power conferred by or under this
Act or any other law for the time being in force, by the Tribunal or the Appellate
Tribunal.

Major Functions of NCLT

The Areas of the Companies Act where NCLT plays a vital role and powers relating
provision of company law are Compromise arrangement and Amalgamation,
winding up, Oppression and mismanagement, Revival & Rehabilitation of sick
companies.

Registration of Companies

The Companies Act, 2013 has enabled questioning the legitimacy of companies
because of specific procedural errors during incorporation and registration. NCLT
has been empowered in taking several steps, from cancelling the registration of a
company to dissolving any company. The Tribunal could even render the liability
or charge of members to unlimited. With this approach, NCLT can de-register any
company in specific situations when the registration certificate has been obtained
by wrongful manner or illegal means.

Transfer of shares

NCLT is empowered to hear grievances of rejection of companies in transferring

shares and securities which were under the purview of the Company Law Board.

Deposits

The power to deal with deposits was transferred to the NCLT, (from Company Law
Board) the laws regarding this are also comparatively clearer. Depositors also have
an additional procedure of filing class-action suits for their grievances.

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Power to investigate

The NCLT can inquire about the workings of a company if more than 100 people
file an application against one company. They can freeze company assets, place
restrictions and temporarily halt distribution of products. They can ask a non-
member of the tribunal to investigate in India or anywhere else in the world.

Appeals – NCLAT

National Company Law Appellate Tribunal (NCLAT) was constituted under the
Companies Act, 2013 for hearing appeals against the orders of National Company
Law Tribunal(s) (NCLT), with effect from 1st June, 2016. Decisions of the tribunal
may be appealed to the National Company Law Appellate Tribunal (NCLAT), the
decisions of which may further be appealed to the Supreme Court of India on a
point of law.

NCLAT is also the Appellate Tribunal for hearing appeals against the orders passed
by Insolvency and Bankruptcy Board of India under Section 202 and Section 211
of IBC.

NCLAT is also the Appellate Tribunal to hear and dispose of appeals against any
direction issued or decision made or order passed by the Competition Commission
of India (CCI).

NCLT works on the lines of a normal Court of law in the country and is obliged to
fairly and without any biases determine the facts of each case and decide with
matters in accordance with principles of natural justice and in the continuance of
such decisions, offer conclusions from decisions in the form of orders.

The orders so formed by NCLT could assist in resolving a situation, rectifying a

wrong done by any corporate or levying penalties and costs and might alter the
rights, obligations, duties or privileges of the concerned parties.

The NCLT focuses only on corporate matters which results in a speedy

investigation.

The presiding judges are a combination of technical and judicial experts, which
will help in more sound and effective judgements.

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It will also remove the multiplicity of litigation before different forums and courts
thus time will reduce.

In cases of bankruptcy, the insolvency and revival of the body corporate are
handled by NCLT hence it will assist in a short and precise process.

Exclusive jurisdiction will remove ins Exclusive jurisdiction will remove instances
of ambiguity.

The grievance redressal mechanism has also drastically improved.

The Insolvency and Bankruptcy Board of India (IBBI)

Before discussing IBBA, let us understand the difference between Bankruptcy and
Insolvency. Often we tend to treat the terms ”Bankruptcy” and “Insolvency” as one
and the same, but they are very different. Insolvency is a problem that bankruptcy
is designed to solve.

Insolvency is often a state when a person, company or organization’s liabilities

exceeds its assets and is unable to pay off his creditors. One of the legal ways to

solve insolvency is through bankruptcy.

Insolvency is a financial state , whereas, Bankruptcy is a legal procedure to help

people facing insolvency resolves their financial state with help of government.

Showing that we are insolvent is necessary for establishing a bankruptcy claim.

One can be insolvent without being bankrupt, but one can’t be bankrupt without
being insolvent.

Insolvency is the inability to pay debts when they are due. There are solutions for
resolving insolvency, including borrowing money or increasing income so that we
can pay off debt. We also could negotiate a debt payment or settlement plan with
creditors.

Bankruptcy is usually a final alternative when other attempts to clear debt fail.

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A person facing insolvency needs to take corrective actions to rectify its situation
to avoid possible bankruptcy. This can be done in many ways like generating
surplus cash or by minimizing the overhead cost. This can also be done by
negotiating the repayment terms with lenders.

The Insolvency and Bankruptcy Board of India (IBBI) was established on 1st
October, 2016 under the Insolvency and Bankruptcy Code, 2016 (Code).

It is responsible for implementation of the Code that consolidates and amends the
laws relating to reorganization and insolvency resolution of corporate persons,
partnership firms and individuals in a time bound manner for maximization of the
value of assets of such persons, to promote entrepreneurship, availability of credit
and balance the interests of all the stakeholders.

It is a unique regulator: regulates a profession as well as processes.

It has regulatory oversight over the Insolvency Professionals, Insolvency

Professional Agencies, Insolvency Professional Entities and Information Utilities.

It writes and enforces rules for processes, namely, corporate insolvency resolution,
corporate liquidation, individual insolvency resolution and individual bankruptcy
under the Code. It has initiated steps to promote the development of, and
regulate, the working and practices of, insolvency professionals, insolvency
professional agencies and information utilities and other institutions, in
furtherance of the purposes of the Code. It has also been designated as the
‘Authority’ for regulation and development of the profession of valuers.

It attempts to simplify the process of insolvency and bankruptcy proceedings. It

handles the cases using two tribunals like NCLT (National company law tribunal)
and Debt recovery tribunal.

Asset Reconstruction Company (ARC)

The word "asset reconstruction" in India were used in Narsimham I report where
it was envisaged for the setting up of a Central Asset Reconstruction Fund with
money contributed by the Central Government, which was to be used by banks to
shore up their balance sheets to clean up their non-performing loans.

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However, this never saw the light of the day and later on Narsimham II Report
floated the idea asset reconstruction companies..

In last two decades or so the number of economies around the world have
witnessed the problem of non performing assets. A high level of NPAs in the
banking system can severely affect the economy in many ways. The high level of
NPAs leads to diversion of banking resources towards resolution of this problems.
This causes an opportunity loss for more productive use of resources.

The banks tend to become risk averse in making new loans, particularly to small
and medium sized companies.

Thus, large scale NPAs when left unattended, cause continued economic and
financial degradation of the country. The realization of these problems has lead to
greater attention to resolve the NPAs. ARCs have been used world-wide,
particularly in Asia, to resolve bad-loan problems. ARCs focus on NPAs and allows
the banking system to act as "clean bank".

The Narasimhan Committee Report mentioned that an important aspect of the

continuing reform process was to reduce the high level of NPAs as a means of
banking sector reform.

The Report envisaged creation of an "Asset Recovery Fund" to take the NPAs off
the lender's books at a discount.

ARC has been set up to provide a focused approach to Non-Performing Loans

resolution issue by:-

(a) Isolating Non Performing Assets from the Financial System.

(b) Freeing the financial system to focus on their core activities and

(c) Facilitating development of market for distressed assets.

Functions of ARC : As per RBI Notification ARC performs the following functions:

(i) Acquisition of financial assets as defined in SRFAESI Act, 2002

(ii) Change or take over of Management / Sale or Lease of Business of the Borrower

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(iii) Rescheduling of Debts

(iv) Enforcement of Security Interest as per SRFAESI Act, 2002

(v) Settlement of dues payable by the borrower

ARC functions more or less like a Mutual Fund. It transfers the acquired assets to
one or more trusts at the price at which the financial assets were acquired from
the originator (Banks/FIs).

Then, the trusts issues Security Receipts to Qualified Institutional Buyers. The
trusteeship of such trusts shall vest with the ARC. ARC will get only management
fee from the trusts. Any upside in between acquired price and realized price will
be shared with the beneficiary of the trusts (Banks/FIs) and ARC. Any downside in
between acquired price and realized price will be borne by the beneficiary of the
trusts (Banks/FIs).

ARCIL (Asset Reconstruction Company (India) Limited)

ARCIL is the first asset reconstruction company (ARC) in India to commence the
business of resolution of non-performing Assets (NPAs) acquired from Indian
banks and financial institutions. It commenced business consequent to the
enactment of the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 (Securitisation Act, 2002). As the first
ARC, ARCIL played a pioneering role in setting standards for the industry in India.

It has been spearheading the drive to recreate value out of NPAs and in doing so,
it continues to play a proactive role in reenergizing the Indian industry through
critical times

National Asset Reconstruction Company Ltd (NARCL) (Bad Bank)

Various studies suggest that in a couple of years, the proportion of stressed assets
in the banking system could jump to as high as 18 per cent from around 11 per
cent at present. To face this expected and imminent challenge, the banking
industry has proposed the setting up of a government-backed Bad Bank.

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This was based on an idea proposed by a panel on faster resolution of stressed
assets in public sector banks headed by Sri Sunil Mehta, former Chairman of
Punjab National Bank (PNB) two years ago.

There are many asset reconstruction companies already operating in the private
space. The government has significantly capitalised state-owned banks in recent
years and pursued consolidation in the PSU banking space.

In the last three financial years, the government has infused equity of Rs 2.65 lakh
crore into state-owned banks. These steps, along with insolvency resolution under
the IBC, are seen as adequate to the tackle the challenge of bad loans.

The high level of provisioning by public sector banks of their stressed assets calls
for measures to clean up the bank books.

No doubt IBC is available as fairly effective method in resolving bad loans. But the
delays and low realisation from assets under IBC is major worry for government
and other stakeholders.

As a one stop solution to increasing NPAs -National Asset Reconstruction

Company Ltd (NARCL), ( the name coined for the bad bank) announced in the
Budget 2021-22, has set up on 7th July 2021 with Rs. 100 Crore authorized capital
& Rs. 74.60 crore paid up capital.

Sri Padmakumar M Nair, Chief General Manager at State Bank of India, has taken
over the post of Chief Executive Officer.

The new entity is being created in collaboration with both public and private sector
banks.

The NARCL will be having ARC-AMC structure as announced by FM in Union

Budget 2021-22.

The ARC will buy NPA accounts and AMC will work on restructuring, turnaround
and resolution.

Asset Reconstruction Company (ARC) is a specialized financial institution which

get license from RBI and buys the Non-Performing Assets (NPAs) from banks and
financial institutions so that they can clean up their balance sheets.

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The Securitization and Reconstruction of Financial Assets and Enforcement of
Security Interest (SARFAESI) Act, 2002 provides the legal basis for the setting up
of ARCs in India.

NARCL different from existing ARCs. It operates differently. NARCL will have a
public sector character since the idea is mooted by the government and majority
ownership is likely to rest with state-owned banks.

At present, ARCs typically seek a steep discount on loans. With the proposed Bad
Bank being set up, the valuation issue is unlikely to come up since this is a
government initiative.

The government-backed ARC will have deep pockets to buy out big accounts and
thus free up banks from carrying these accounts on their books.

Benefits of NARCL

The biggest advantage of NARCL would be aggregation of identified NPAs.. This

is expected to be more efficient in recovery as it will step into the shoes of multiple
lenders who currently have different compulsions when it comes to resolving a
bad loan.

NARCL will consolidate and take over the existing stressed debt. It will then
manage and dispose-off the assets to alternate investment funds and other
potential investors for eventual value realization.

NARCL will take over identified bad loans of lenders. The lead bank with offer in
hand of NARCL will go for a 'Swiss Challenge', where other asset reconstruction
players will be invited to better the offer made by a chosen bidder for finding
higher valuation of an NPA on sale.

Swiss Challenge Method :

Under the Swiss Challenge method, a candidate makes a proposal for a project,
which the government puts before the public to seek more proposals. Once these
are received, the original candidate is allowed to match the best bid.

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Applied to the ongoing bankruptcy cases, a Swiss Challenge may entail two rounds
of bidding for a distressed company or its assets. Assume that Company A wins
the first round of bidding by a quoting a price of Rs 5,000 crore for a power plant.
This will be made public and a second set of bids invited. If Company B quotes Rs
5,500 crore, Company A will be offered a second opportunity to match it. If it
refuses, Company B would be declared the winning bidder. If Company A steps up,
then it will bag the power plant at Rs 5,500 crore.

NARCL, to be floated by the banking industry, will likely follow the Swiss Challenge
method for price discovery of assets. This means that even as an asset is
transferred to the new asset reconstruction company (ARC) at a pre-agreed price,
bids will be called later from others, and the highest bidder will get the asset.

The model also prevents the amendment of the Securitisation and Reconstruction
of Financial Assets and Enforcement of Securities Interest Act (SARFAESI Act),
which mandates a bidding process before the transfer of any asset from banks
books, while keeping the whole process less cumbersome and time consuming.

Other Relevant Points

The company will pick up those assets that are 100% provided for by the lenders.

NARCL will pay up to 15% of the agreed value for the loans in cash and the
remaining 85% would be government-guaranteed security receipts.

The government guarantee would be invoked if there is loss against the threshold
value.

The Reserve Bank of India has said that loans classified as fraud cannot be sold to
NARCL.

Revenue Recovery Act & Banks

In India, Central Government has enacted The Revenue Recovery Act, 1890. Apart
from this, each State has formulated it’s own Revenue Recovery Act of their own.

However, the Central Act covers land revenue (including water cess, sewerage fee)
dues only and not covering the dues to Banks.

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However, some States cover Dues to Banks also in their Acts on par with Land
Revenue. For instance, The A. P. Revenue Recovery Act 1864 enables the
Government to recover

[i] arrears of Public Revenues and certain other amounts due to the Government

[ii] dues to banks and notified public bodies

[iii] dues from persons from whom money is due by the defaulter by adopting the
following methods,. The costs awarded to the State Government by various courts
can also be recovered as arrears of land revenue under the provisions of the R. R.
Act.

As RR Act settles the dues by direct auction of the landed property of the defaulter,
it settles the issues early. In view of the speed with which the RR Act finalises the
cases, Bankers insist respective State Government to help their recovery efforts by
including the Bank Dues also under RR Act. Bankers in some States requested the
state government to invoke the Revenue Recovery Act for the agriculture and
allied sector to improve the loan recovery position in rural areas.

If all the State Governments help Banking Sector by including Dues to Banks on
par with Land Revenue, it improves Recovery position as the Act allows recovery
of loan by auctioning the properties of the defaulter.

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27. Fair Practices Code on Lender’s Liability
Fair Practices Code for Lenders

RBI advised the following Fair Practices for Lenders.

Applications for loans and their processing Loan application forms in respect of all
categories of loans irrespective of the amount of loan sought by the borrower
should be comprehensive.

Banks and financial institutions should give acknowledgement for receipt of all
loan applications.

Banks must transparently disclose to the borrower all information about fees /
charges payable for processing the loan application, the amount of fees
refundable if loan amount is not sanctioned / disbursed. Such information should
also be displayed on the website of the banks for all categories of loan products.

Levying charges subsequently without disclosing the same to the borrower is an

unfair practice.

Banks must inform ‘all-in-cost’ to the customer to enable him to compare the rates
charges with other sources of finance.

Such charges / fees are non-discriminatory.

Timelines for Credit Decisions

While banks are required to carry out necessary due diligence before arriving at
credit decisions, timely and adequate availability of credit is a pre-requisite for
successful implementation of large projects. Banks may also make suitable
disclosures on the timelines for conveying credit decisions through their websites,
notice-boards, product literature, etc.

Banks / financial institutions should verify the loan applications within a

reasonable period of time. If additional details / documents are required, they
should intimate the borrowers immediately.

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In case of all categories of loans irrespective of any threshold limits, including
credit card applications, the lenders should convey in writing, the main
reason/reasons which, in the opinion of the bank after due consideration, have led
to rejection of the loan applications within stipulated time.

Loan appraisal and terms/conditions

a) Lenders should ensure that there is proper assessment of credit application by

borrowers. They should not use margin and security stipulation as a substitute for
due diligence on credit worthiness of the borrower.

b) The lender should convey to the borrower the credit limit along with the terms
and conditions thereof and keep the borrower's acceptance of these terms and
conditions given with his full knowledge on record.

c) Terms and conditions and other caveats governing credit facilities given by
banks/ financial institutions arrived at after negotiation by lending institution and
the borrower should be reduced in writing and duly certified by the authorised
official.

A copy of the loan agreement along with a copy each of all enclosures quoted in
the loan agreement should be furnished to the borrower.

d) As far as possible, the loan agreement should clearly stipulate credit facilities
that are solely at the discretion of lenders. These may include approval or
disallowance of facilities, such as, drawings beyond the sanctioned limits,
honouring cheques issued for the purpose other than specifically agreed to in the
credit sanction, and disallowing drawing on a borrowal account on its
classification as a non-performing asset or on account of non-compliance with the
terms of sanction. It may also be specifically stated that the lender does not have
an obligation to meet further requirements of the borrowers on account of growth
in business etc. without proper review of credit limits.

e) In the case of lending under consortium arrangement, the participating lenders

should evolve procedures to complete appraisal of proposals in the time bound
manner to the extent feasible, and communicate their decisions on financing or
otherwise within a reasonable time.

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Disbursement of loans including changes in terms and conditions Lenders should
ensure timely disbursement of loans sanctioned in conformity with the terms and
conditions governing such sanction. Lenders should give notice of any change in
the terms and conditions including interest rates, service charges etc. Lenders
should also ensure that changes in interest rates and charges are effected only
prospectively.

Post disbursement supervision

a) Post disbursement supervision by lenders, particularly in respect of loans up to

Rupees two lakh, should be constructive with a view to taking care of any" lender
related" genuine difficulty that the borrower may face.

b) Before taking a decision to recall / accelerate payment or performance under

the agreement or seeking additional securities, lenders should give notice to
borrowers, as specified in the loan agreement or a reasonable period, if no such
condition exits in the loan agreement.

c) Lenders should release all securities on receiving payment of loan or realisation

of loan subject to any legitimate right or lien for any other claim lenders may have
against borrowers. If such right of set off is to be exercised, borrowers shall be
given notice about the same with full particulars about the remaining claims and
the documents under which lenders are entitled to retain the securities till the
relevant claim is settled/ paid.

General

a) Lenders should restrain from interference in the affairs of the borrowers except
for what is provided in the terms and conditions of the loan sanction documents
(unless new information, not earlier disclosed by the borrower, has come to the
notice of the lender).

b) Lenders must not discriminate on grounds of sex, caste and religion in the
matter of lending. However, this does not preclude lenders from participating in
credit-linked schemes framed for weaker sections of the society.

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c) In the matter of recovery of loans, the lenders should not resort to undue
harassment viz. persistently bothering the borrowers at odd hours, use of muscle
power for recovery of loans, etc.

d) In case of receipt of request for transfer of borrowal account, either from the
borrower or from a bank/financial institution, which proposes to take- over the
account, the consent or otherwise i.e. objection of the lender, if any, should be
conveyed within 21 days from the date of receipt of request.

The Fair Practices Code, which may be adopted by banks and financial institutions,
should also be put on their website and given wide publicity. A copy may also be
forwarded to the Reserve Bank of India.

Guidelines on Recovery Agents engaged by banks

Banks are advised to take into account the following specific considerations while
engaging recovery agents:

(i) ‘Agent’ in these guidelines would include agencies engaged by the bank and
the agents/ employees of the concerned agencies.

(ii) Banks should have a due diligence process in place for engagement of recovery
agents, which should be so structured to cover, among others, individuals involved
in the recovery process. Further, banks should ensure that the agents engaged by
them in the recovery process carry out verification of the antecedents of their
employees, which may include pre-employment police verification, as a matter of
abundant caution.

(iii) To ensure due notice and appropriate authorization, banks should inform the
borrower the details of recovery agency firms / companies while forwarding
default cases to the recovery agency.

(iv) The notice and the authorization letter should, among other details, also
include the telephone numbers of the relevant recovery agency. Banks should
ensure that there is a tape recording of the content / text of the calls made by
recovery agents to the customers, and vice-versa. Banks may take reasonable
precaution such as intimating the customer that the conversation is being
recorded, etc.
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(v) The up to date details of the recovery agency firms / companies engaged by
banks may also be posted on the bank’s website.

(vi) Where a grievance/ complaint has been lodged, banks should not forward
cases to recovery agencies till they have finally disposed of any grievance /
complaint lodged by the concerned borrower.

However, where the bank is convinced, with appropriate proof, that the borrower
is continuously making frivolous / vexatious complaints, it may continue with the
recovery proceedings through the Recovery Agents even if a grievance / complaint
is pending with them. In cases where the subject matter of the borrower’s dues
might be sub judice, banks should exercise utmost caution, as appropriate, in
referring the matter to the recovery agencies, depending on the circumstances.

Incentives to Recovery Agents

Banks are advised to ensure that the contracts with the recovery agents do not
induce adoption of uncivilized, unlawful and questionable behaviour or recovery
process.

Every agent will have to pass the examination conducted by IIBF all over India.

Taking possession of property mortgaged / hypothecated to banks The recovery

of loans or seizure of vehicles could be done only through legal means. It is
desirable that banks rely only on legal remedies available under the relevant
statutes while enforcing security interest without intervention of the Courts.

Where banks have incorporated a re-possession clause in the contract with the
borrower and rely on such re-possession clause for enforcing their rights, they
should ensure that the re-possession clause is legally valid and ensure that such
repossession clause is clearly brought to the notice of the borrower at the time of
execution of the contract.

The terms and conditions of the contract should be strictly in terms of the
Recovery Policy and should contain provisions regarding

(a) notice period before taking possession

(b) circumstances under which the notice period can be waived

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(c) the procedure for taking possession of the security

(d) a provision regarding final chance to be given to the borrower for repayment
of loan before the sale / auction of the property

(e) the procedure for giving repossession to the borrower and (f) the procedure
for sale / auction of the property.

Use of forum of Lok Adalats

Banks are encouraged to use the forum of Lok Adalats for recovery of personal
loans, credit card loans or housing loans with less than Rupees ten lakh

Utilisation of credit counsellors

Banks are encouraged to have in place an appropriate mechanism to utilise the

services of the credit counsellors for providing suitable counselling to the
borrowers where it becomes aware that the case of a particular borrower deserves
sympathetic consideration.

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28. Insolvency & Bankruptcy Code (IBC), 2016
The Insolvency and Bankruptcy Code, 2016 (IBC) is the bankruptcy law of India
which seeks to consolidate the existing framework by creating a single law for
insolvency and bankruptcy. It was introduced amidst various other reforms
introduced by the Government, with focused emphasis on the Ease of Doing
Business in India. Ease of Doing Business not only means speedy and easy entry,
and ease of carrying out operation of businesses; it also covers in its ambit, the
ease of exit.

The Code received the assent of the President of India on 28 May 2016. The Code
has been amended several times till June, 2020.

The bankruptcy Code is a one stop solution for resolving insolvencies which
previously was a long process that did not offer an economically viable
arrangement. It was done to consolidate all the existing laws related to insolvency
in India and to simplify the process of insolvency resolution.

This Code applies to a company registered under the Companies Act 1956, a
Limited liability partnership, Partnership firms and Individuals. Under the
Insolvency and Bankruptcy Code, any financial creditor or an operational creditor
can initiate corporate insolvency process against a corporate debtor when the
corporate debtor commits a default in repayment of debts.

Default involves non repayment of debt when it has become due and payable.
Hence, when any financial or operational creditor is not honoured duly, he can
initiate the insolvency proceedings against the corporate debtor.

IBC lays down strict time frame for each and every process for resolution process
right from admission of application, appointment of Interim Resolution
Professional, lodging of claim, formation of Creditors Committee, consideration
of resolution plan and submission of plant to adjudicating authority and its
approval thereof.

To effectively address the issues of participation of various stake holders, the Code
has divided creditors into two categories of Financial Creditors and Operational
Creditors.
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The IBC has 255 sections and 11 Schedules. IBC is divided into 4 parts i.e.

IBC resolve claims involving insolvent companies. This was intended to tackle the
bad loan problems that were affecting the banking system.

The IBC process has changed the debtor-creditor relationship.

The IBC envisages filing of Corporate Insolvency Resolution Process (hereinafter

referred to as CIRP) by the Corporate Debtor, Financial Creditor and Operational
Creditor.

Need of Insolvency & Bankruptcy Code

There was no single law dealing with insolvency and bankruptcy in India. The
liquidation of companies and individuals were handled under various Acts (around
12 in number). It led to an overlapping jurisdiction of different authorities like
High Court, Company Law Board, Board for Industrial and Financial Reconstruction
(BIFR) and Debt Recovery Tribunal. This overlapping jurisdictions and multiplicity
of laws made the process of insolvency resolution very cumbersome in India.

In India it was easier to start a business than to exit it. The new Insolvency and
Bankruptcy Code seeks to cut it to 1 year.

The new Code seeks to help banks and other creditors from recovering their loans
from the bankrupt companies in a timely and efficient way.

Aims & Objective of IBC

It provides for a time-bound process to resolve insolvency. When a default in

repayment occurs, creditors gain control over debtors assets and must take
decisions to resolve insolvency within a 180-day period. To ensure an
uninterrupted resolution process, the Code also provides immunity to debtors
from resolution claims of creditors during this period. The Code also consolidates
provisions of the current legislative framework to form a common forum for
debtors and creditors of all classes to resolve insolvency. Under IBC debtor and
creditor both can start recovery proceedings against each other.

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The main objective of this Code is:

Consolidate and amend all existing insolvency laws in India.

To simplify and expedite the Insolvency and Bankruptcy Proceedings in India.

To protect the interest of creditors including stakeholders in a company.

To revive the company in a time-bound manner.

To promote entrepreneurship.

To get the necessary relief to the creditors and consequently increase the credit
supply in the economy.

To work out a new and timely recovery procedure to be adopted by the banks,
financial institutions or individuals.

To set up an Insolvency and Bankruptcy Board of India.

Maximization of the value of assets of corporate persons.

Advantage to lenders for resorting to IBC

Creditors in control as most decision making with the lenders.

Time bound and quick solution for stressed and NPA accounts.

Change of management possible.

Brings financial lenders to a platform - enabling quick decision making and

arriving at consensus quickly.

Prepare and examine resolution plan by professionals appointed by creditors

ensuring fearless decision making.

Final approval by NCLT (a legal entity) which ensures accountability and vigilance.

Fair chance to viable and sustainable entities for time bound revival. In case of
unviable accounts, faster, transparent and smooth liquidation process.

Clear and fair distribution of funds in case of liquidation. Government / Statutory

dues do not get priority.

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Protection of assets of secured borrowers with maximization of realization.

Positive support from government for realization and resolution of NPAs.

Advantage to Borrowers to approach NCLT

There is no need to pay Court Fee in NCLT (which is 5% or more in courts)

In Courts generally it takes 3-4 years but not in NCLT because in NCLT we dont
approach for recovery of money.

Less chances for settlement in less amount.

Provides for time bound resolution forcing lenders to take a decisive action.

A Resolution plan approved by NCLT has legal sanction and is binding on all
stakeholders.

Transparent process under judicial supervision removes investigation and

vigilance fear from the lenders perspective which is expected to improve decision
making.

Pre-empt all creditors, legal cases and other recovery actions during moratorium
period.

Not only loans, but all types of debt, including operational creditors and
government dues can be restructured/realigned/reduced under the Code.

The Borrower has the option of applying himself under the code in which case
borrowers proposed IP would be appointed as IRP.

Company to work under the control of IRP/RP who are supposed to preserve the
economic value of the company as a going concern entity.

It can be used as a measure of last resort when other options like CDR, SDR, S4A
have been exhausted.

Attracting investor (financial / strategic/ JV Partner) would be easier particularly

in case of unlisted companies.

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The Possibility of raising additional finance as the same will have priority as it will
form part of CIRP cost.

Important Definitions & Concepts

Insolvency

Insolvency is a state where the liabilities of an individual or an organization

exceeds its asset and that entity is unable to raise enough cash to meet its
obligations or debts as they become due for payment. Technically insolvency could
be a financial state when the value of total assets of an individual or a group
exceeds its liabilities.

Insolvency is the inability of a person or companies to pay their bills as and when
they becomes due and payable. It is a situation where individuals or companies are
unable to repay their outstanding debt. If insolvency cannot be resolved, assets of
the debtor may be sold to raise money, and repay the outstanding debt.

The term Insolvency is a state whereas Bankruptcy is the effect of that act.

Bankruptcy

Bankruptcy is when a person or company is legally declared incapable of paying

their due and payable bills.

When an individual is unable to pay off his liabilities and debts then he generally
files for bankruptcy. He asks for help from government to pay off his debts to his
creditors.

Bankruptcy could of two types, namely, reorganization bankruptcy and liquidation

bankruptcy. Usually people tend to restructure the repayment plans to pay them
easily under reorganization bankruptcy. And under liquidation bankruptcy, the
debtor tends to sell of certain of their assets to pay off their debts for their
creditors.

Insolvency Vs. Bankruptcy

An individual or company can be insolvent without being bankrupt ,especially if

the insolvency is temporary and correctable, but not the opposite.

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Insolvency can lead to bankruptcy if the insolvent party is unable to successfully
address its financial condition.

Insolvent companies can reverse course by cutting costs, selling assets, borrowing
money, renegotiating debt or allowing themselves to be acquired by a larger
corporation that agrees to take over the insolvent companys debts in return for
control of its products or services.

Liquidation

Liquidation is the process of winding up a corporation or incorporated entity.

Default

Default means non-payment of debt when whole or any part or installment of the
amount of debt has become due and payable and is not repaid by the debtor or
the corporate debtor, as the case may be. In IBC, default means failure to pay
whole or any part or installment of amount of debt or interest due of minimum
Rs.1 Crore. Default amount under section 4 of IBC was Rs.1 Lakh, but after central
govt. notification dated 24.03.2020, minimum default amount raised to Rs.1 Crore.

Financial Creditor, Operational Creditor & Corporate Debtor

It means any person to whom a financial debt and operational debt respectively,
is owed and includes a person to whom such debt has been legally transferred or
assigned to.

Earlier, a homebuyer who had attained possession of the property was grouped
together with homebuyers who had not yet acquired possession, in the
circumstance of the builder encountering insolvency. In such a scenario, the sole
recourse available was to be eligible for a refund.

To eliminate this anomaly, the Insolvency and Bankruptcy Board of India has
introduced a recent amendment in 2024 in IBBI (Liquidation Process) Regulations,
2016 vide a notification dated 12.02.2024 which aims to exclude flats—where
possession has been granted but conveyance deeds have not been executed or
registered—from the liquidation estate.

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This measure is undertaken to alleviate the immense hardships and substantial
challenges faced by homebuyers and to offer relief to those who find themselves
in predicaments subsequent to the insolvency declaration of the builder or the
developer. By amendment in IBC, Homebuyers Recognized as Financial Creditors
giving them due to representation in the Committee of Creditors (CoC). Thus, now
home buyers will be an integral part of the decision making process.

The Code differentiates between both, financial creditors are those whose
relationship with the entity is a pure financial contract, such as loan or debt
security and therefore is debt, along with interest, if any, which is disbursed
against the consideration for the time value of money, whereas Operational
creditors are those whose liabilities from the entity comes from a transaction on
operations. Operational Creditors includes government & employees or workmen.
A corporate debtor is the Corporate Person who owes a debt to any person.

Corporate Applicant

Corporate Applicant means:

a) Corporate Debtor, or

b) A Member or the partner of the corporate debtor who is authorized to make

an application for the CIRP under the constitutional documents of the
corporate debtor, or

c) An individual who is in-charge of managing the operations and resources

of the corporate debtor, or

d) A person who has control and supervision over the financial affairs of the
corporate debtor;

Committee of Creditors (CoC)

The committee of creditor formed under section 21 of the code and shall consist
of all the financial creditors of the corporate debtor. The interim resolution
professional after collation of claims and assessing the information of the debtor
constitute a committee of creditors.

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There voting share shall be determined on the basis of the financial debt owed to
them. Otherwise provided in the code, all the decisions of the committee of
creditors shall be taken by a vote of not less than 51%. It shall require a resolution
professional to furnish any financial information in relation to the corporate
debtor during the resolution process.

Moratorium

The term Moratorium is nowhere defined in the Code, however, the term in basic
parlance means, a stopping of activity for an agreed amount of time. Under the
Code, Moratorium is actually described as a period wherein no judicial proceedings
for recovery, enforcement of security interest, sale or transfer of assets, or
termination of essential contracts can be instituted or continued against the
Corporate Debtor.

The Adjudicating Authority [National Company Law Tribunal], whilst admitting a

petition against the Corporate Debtor is required to declare the moratorium
period as described under Section 14 of the Code.

The main purpose of declaring the moratorium period is to keep the Corporate
Debtors assets intact during the CIRP, which otherwise may be attached by any
competent court of law during the pendency of proceedings against the Corporate
Debtor. In other words, the moratorium ensures that the time-bound completion
of the CIRP and also that the corporate debtor may continue as a going concern.

Apart from staying the pending proceedings, the moratorium also casts a bar upon
the directors of the company, who cannot use or take the amount available on the
date of declaration of the moratorium in the company. If the moratorium period
is not declared, the insolvency process will be frustrated which in turn will fail the
objective of the Code.

Punishment - Under Section 74 of the IBC, officials of the corporate debtor who
violate provisions of moratorium can be imprisoned for a minimum of three years,
which may be extended up to five years. Such officials will also be fined a minimum
of Rs 100,000 but not more than Rs 300,000.

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Officials of creditors who knowingly and willfully authorize or permit such
contravention can be jailed for a minimum of one year, with a maximum tenure of
five years. Such officials will also be fined a minimum of Rs 100,000, with the
maximum penalty of up to Rs 10 million.

Resolution Applicant

As per the Code, a Resolution Professional has to appoint a Resolution Applicant

who in-turn is required to prepare different resolution plans for different
stakeholders in corporate insolvency resolution process. The code defines the
resolution applicant under section 5(25) as a person who submits a resolution plan
to insolvency professional. A resolution plan specifies the details of how the debt
of a defaulting debtor can be restructured.

Corporate Insolvency Resolution Process (CIRP)

The creditors committee will take a decision regarding the future of the
outstanding debt owed to them. They may choose to revive the debt owed to them
by changing the repayment schedule or sell (liquidate) the assets of the debtor to
repay the debts owed to them. If a decision is not taken in 180 days, the debtors
assets go into liquidation.

The Insolvency & Bankruptcy Code ecosystem

Insolvency and Bankruptcy Board (IBBI)

IBBI is an apex body governing Insolvency and Bankruptcy Code. It consists of

representatives of Reserve Bank of India, and the Ministries of Finance, Corporate
Affairs and Law. It is setting up the necessary infrastructure and accredits
Insolvency Professionals (IPs) and Information Utilities (IUs). It manages and
controls Insolvency Professionals, Agencies and Information Utilities set up under
the Code.

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Insolvency Professionals (IPs)

IPs are licensed professionals registered with IBBI who act as Resolution
Professional/ Liquidator/ Bankruptcy trustee in an insolvency resolution process.
A Specialized category of officers is created to administer and enforce the
resolution process, manage the affairs of the corporate debtor and share
information with creditors to help them in decision-making. The adjudicating
authority shall appoint an interim resolution professional within 14 days from the
insolvency commencement date.

He shall collect the information relating to the debtors assets, finances and
operations, take its control and custody, receive and collate claims and constitute
a committee of creditors. The personnel i.e. managers and employees of the
corporate debtors shall extend cooperation to insolvency professional. He shall
make efforts to preserve the value of corporate debtors property and manage the
operations as a going concern. Within 7 days of the constitution of the committee
of creditors, they should by a vote of 66% resolve to appoint an interim resolution
professional as resolution professional or replace him by another one.

Some important duties and function of the Insolvency Professional:

a) To make public announcement of insolvency process in English and local

language newspaper.

b) To manage affair of the company as a going concern.

c) To collect information relating to the assets, finances and operation of

corporate debtor for determining the financial position

d) To collect all claims received from creditors and assess them.

e) To constitute a committee of creditors etc.

f) To appoint to registered valuers to evaluate the assets.

g) To coordinate with NCLT and IBBI.

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Information Utilities

Information Utilities would collect, store and distribute information related to the
indebtedness of companies. A person registered with the Board as Information
Utility i.e. a person to whom the creditors report the financial information of the
debt owed to them by the debtors which include debt, liabilities and default.

Insolvency Professional Agencies

Insolvency Professional Agencies (IPAs) are enrolling insolvency professionals as

members. These agencies conduct an examination and certify these insolvency
professionals as well as defines their code of conduct for their duties and
performance. Currently, there are three IPAs:

ICSI Insolvency professional Agency

Indian Institute of Insolvency Professionals of ICAI

Insolvency professional Agency of Institute of cost Accountants of India

Adjudicating Authorities (AA)

Adjudicating Authorities (AA) have the exclusive jurisdiction to deal with

insolvency related matters.

National Company Law Tribunal (NCLT) is the AA for Corporate and LLP
insolvency.

Debt Recovery Tribunal (DRT) would be AA for individual or partnership Firms

Insolvency.

A person aggrieved by the order of the Adjudicating Authority under Part III of
IBC (insolvency resolution and bankruptcy for individuals and partnership firms),
viz. DRT, may prefer an appeal to the Debt Recovery Appellate Tribunal (DRAT)
under Section 181.

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Thus, statutory forums in the form of NCLAT and DRAT have been designated as
the appellate authority under IBC for redressal of grievances arising out of an
order of the Adjudicating Authority under Part II and Part III of IBC respectively.

Further, any person aggrieved by an order of the NCLAT or DRAT may file an
appeal to the Supreme Court on a question of law arising out of such order.

Thus, IBC provides for a three-tier adjudicatory mechanism, for dealing with all
issues that may arise in relation to the insolvency resolution and liquidation for
corporate persons and insolvency resolution and bankruptcy for individuals and
partnership firms, namely:

NCLT/ DRT;

the NCLAT/ DRAT

the Supreme Court.

It shall be the National Company Law Tribunal (NCLT) having the territorial
jurisdiction over the place where the registered office of the corporate person is
located. Any insolvency resolution, liquidation or bankruptcy proceedings shall
stand transferred to NCLT.

Any person aggrieved by its order can prefer an appeal to the National Company
Law Appellate Tribunal (NCLAT) within 30 days of the NCLT order, which in turn
can be appealed to the Supreme Court within 45 days of NCLAT order on questions
of law arising out of such order. If both the Appellate courts are satisfied about
the sufficient cause they may extend the time for appeal by 15 days. No civil court
shall have jurisdiction over the matters of NCLT.

Applicability of code

Applies to whole of India including J&K and Ladakh.

Persons covered – Company; Limit Liability Partnership; An individual; A Hindu

Undivided Family; A Partnership; A Trust; Any other entity established under a
statute, and includes a person resident outside the India.

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Who can approach

Any person whose amount is due with the Company or LLP (minimum amount
1,00,00,000) can approach to NCLT (National Company Law Tribunal) under IBC
(Insolvency and Bankruptcy Code) 2016 for Liquidation of that Company / LLP.

Jurisdiction to file the application before NCLT

Jurisdiction as per the State in which Company (to whom we are filling a suit) is
registered. As per that state connected NCLT shall be the jurisdiction to file the
petition.

Applicability of Limitation Law

The Limitation Act is applicable to applications filed under IBC. The right to sue
accrues when a default occurs. If the default has occurred over three years prior to
the date of filing of the application, the application would be barred under Article
137 of the Limitation Act and Section 5 of the Limitation Act may be applied to
condone the delay in filing such application.

IBC (Amendment) 2020

Central Govt. notified on 24.03.2020 that Due to the emerging financial distress
faced by most companies on account of the large-scale economic distress caused
by COVID 19, it has been decided to raise the threshold of default under section 4
of the IBC 2016 to Rs 1 crore from the existing threshold of Rs 1 lakh;

Insolvency commencement date is now the date of admission of an application for

initiating CIRP;

IRP to be appointed on the date of admission of application itself;

IRP shall continue to manage the affairs of a Corporate Debtor till the time the
resolution plan is approved by the Adjudicating Authority or an order for
liquidation of Corporate Debtor is passed;

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Conclusion

The IBC has taken its first steps to regularize the insolvency process in India. It has
amended over 11 legislations in India, bringing about one of the most significant
change to commercial laws in India in recent times. It has also become a very
important tool for banks to regularize multitudes of non-performing assets
plaguing the country’s economy.

Insolvency and Bankruptcy Code brought quite a few changes in the big business
scenario in the country. Brought forward to reduce the time it takes to deal with
the issue of bankruptcy, the code has morphed into something that is driving this
country towards a new age of economy.

With more than 11% of all loans in India being terms as bad loans, the IBC has
become the need of the hour. The IBC has brought a plethora of changes to
insolvency laws in India and aims to reduce the amount of bad loans that has
saddled the economy over the last few years.

Court Cases related to IBC, 2016

I am furnishing 10 court cases related to IBC. The Gist of these cases is presented
hereunder:

Case 01. Wages/salaries of only those employees who worked during CIRP are to
be included in CIRP costs, rules SC

Case Details: Sunil Kumar Jain v. Sundaresh Bhatt

Facts of the Case

In the instant case of Sunil Kumar Jain v. Sundaresh Bhatt the NCLAT had
dismissed an appeal filed by the workmen/employees of ABG Shipyard Limited
against the impugned order of NCLT denying any relief to them with regard to
their claim relating to salary, which they claimed for a period involving CIRP and
the prior period. Appellants filed an appeal against the order of the NCLAT.

The question before the Court was whether the wages/salaries of those
workmen/employees who had not worked at all during CIRP shall have to be
treated and/or included in the CIRP costs?
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Supreme Court Held

The Court observed that the wages/salaries of the workmen/employees of the

corporate debtor for the period during CIRP could be included in the CIRP costs
provided it is established and proved that the Interim Resolution
Professional/Resolution Professional managed the operations of the corporate
debtor as a going concern during the CIRP and that the concerned
workmen/employees of the corporate debtor actually worked during the CIRP.

The Court held that in such an eventuality, the wages/salaries of those

workmen/employees who actually worked during the CIRP period when the
resolution professional managed the operations of the corporate debtor as a
going concern shall be paid treating it and/or considering it as part of CIRP costs
and the same shall be payable in full first as per Section 53(1)(a) of the IB Code.

The Court further held that even if RP has not submitted the claims towards the
wages/salaries as part of CIRP costs, still the claims submitted/to be submitted by
the appellant’s workers will have to be adjudicated upon and considered by the
Liquidator.

The Liquidator has to consider and adjudicate (i) whether the corporate debtor
was a going concern during the CIRP; (ii) how many workmen/employees actually
worked during the CIRP while the corporate debtor was a going concern.

Case 02. State is a secured creditor for tax purposes under GVAT Act.

Case Details: State Tax Officer v. Rainbow Papers Ltd.

Facts of the Case

In the landmark ruling, the Supreme Court held that the State is a secured creditor
for tax purposes under GVAT Act, and Section 53 of IBC doesn’t override Section
48 of the GVAT Act.

In the instant case, the following questions were placed before the Supreme Court:

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(a) Whether State is a secured creditor under IBC for tax purposes under Gujarat
VAT (GVAT Act)?

(b) Whether Section 53 of IBC overrides Section 48 of the Gujarat VAT (GVAT Act)
or not?

The Apex Court held that the State is a secured creditor under the GVAT Act.
Section 3(30) of the IBC defines the secured creditor as “Secured creditor means a
creditor in favour of whom security interest is created”.

The Court further held that such security interest could be created by the operation
of law. The definition of a secured creditor in the IBC does not exclude any
Government or Governmental Authority. Therefore, the State will be treated as
the secured creditor under IBC for tax purposes.

In view of the above, the Supreme Court concluded that State is a secured creditor
for VAT under GVAT Act, and Section 53 of IBC doesn’t override Section 48 of the
GVAT Act.

With regard to the overriding effect of Section 53 of IBC, it was held that Section
48 of the GVAT Act is not contrary to or inconsistent with Section 53 or any other
provisions of the IBC. As per Section 53, proceeds from the sale of the liquidation
assets shall be distributed in the order of priority and within such period as
prescribed in the provision.

Under Section 53(1)(b)(ii), the debts owed to a secured creditor, which would
include the State under the GVAT Act, shall rank equally with other specified debts,
including debts on account of workman’s dues for 24 months preceding the
liquidation commencement date.

The term “Secured Creditor”, as defined under the IBC, is comprehensive and wide
enough to cover all types of security interests, namely, the right, title, interest or
a claim to the property created in favour of or provided for a secured creditor by
a transaction, which secures payment or performance of an obligation and
includes mortgage, charge, hypothecation, assignment and encumbrance or any
other agreement or arrangement securing payment or performance of any
obligation of any person.

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In view of the statutory charge in terms of Section 48 of the GVAT Act, the claim
of the tax department of the State squarely falls within the definition of “Security
Interest” under Section 3(31) of the IBC, and the State becomes a secured creditor
under Section 3(30) of the Code.

Case 03. CIRP proceedings could be initiated against both corporate co-borrowers,
but the recovery of the same amount could not be made from both parties:

Case Details: Maitreya Doshi v. Anand Rathi Global Finance Ltd.

Facts of the Case

In the Instant case, an appeal was filed before the Supreme Court against the order
of the NCLAT, whereby the NCLAT ordered that CIRP proceedings under Section 7
could be initiated against both corporate co-borrowers.

The respondent was an NBFC (a Financial Creditor) that disbursed a loan to

Premier Limited (“Premier”) under three separate Loan-cum-Pledge Agreements.
According to the appellant (a director in Premier & Doshi Holdings), Doshi
Holdings pledged shares held by it in Premier, in favour of the Financial Creditor,
by way of security for the loan.

The Premier failed to make repayments in terms of the Loan-cum-Pledge

Agreements. The Financial Creditor filed a petition under Section 7 of the IBC to
initiate CIRP against Premier for default in repayment of the loan. The Financial
Creditor also filed a petition against Doshi Holdings, under Section 7 of the IBC,
for initiation of CIRP in respect of the same claim based on the same loan
documents.

The NCLT admitted both CIRP applications. An appeal lied against the order of the
NCLT admitting the CIRP application initiated against the Doshi holdings. The
NCLAT dismissed the appeal and upheld the order of admission of the petition
under Section 7 of the IBC. Thereafter, the appellant filed an appeal to the
Supreme Court against the order of the NCLAT.

Supreme Court Held

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After hearing both the parties, the Supreme Court dismissed the appellant’s plea
and upheld the order as passed by the NCLAT. The Court held that if two borrowers
or two corporate bodies fall within the ambit of corporate debtors, then CIRP can
be initiated against both the Corporate Debtors. However, the same amount
cannot be realised from both the Corporate Debtors. If the dues are partly realised
from one Corporate Debtor, the balance may be realised from the other Corporate
Debtor being the co-borrower.

Case 04. Bombay High Court has territorial jurisdiction to entertain a Writ plea if
Insolvency Professional has an assignment in Maharashtra

Case Details: Partha Sarathy Sarkar v. Insolvency & Bankruptcy Board of India
(IBBI)

Facts of the Case

In the instant case, the petitioner was an Insolvency Professional (IP). He was a
professional member of the ICSI Institute of Insolvency Professionals (ICSI and IIP)
and an Insolvency Professional (IP) registered with the IBBI.

A show cause notice was issued to the petitioner, and his registration as an IP was
suspended for three years under the impugned order in respect of the proceedings
against a company based in Delhi.

The petitioner assailed the order of registration suspension before the Bombay
High Court. The Respondents raised a preliminary objection of the territorial
jurisdiction to entertain the Writ Petition of this court as the order of suspension
was passed by the authority at Delhi.

The Respondent contended that the petitioner had already filed an application
before the Adjudicating Authority (NCLT), Delhi seeking a direction to hold a show
cause notice issued by the Respondent to be an attempt to interfere in the course
of proceedings qua the said application and issue appropriate directions. The said
application was pending adjudication before the NCLT, Delhi, and this fact had
been materially suppressed.

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The Respondent also submitted that the entire cause of action had arisen at Delhi,
and no part of the cause of action had arisen within the jurisdiction of the Bombay
High Court. As such, the Bombay High Court may not entertain the Writ Petition.

High Court’s Ruling

The High Court held that the petitioner already had assignments in the State of
Maharashtra as a Resolution Professional. Pursuant to the order of suspension, the
petitioner would not be in a position to work as a Resolution Professional with
assignments on hand in the State of Maharashtra.

The High Court further held that the petitioner would feel the effect of the
impugned order in the State of Maharashtra and it could safely be concluded that
part of the cause of action had arisen with the territorial jurisdiction of the Bombay
High Court.

Case 05. Section 33(5) of IBC doesn’t bar legal proceeding against a ship owned
by Corporate Debtor in liquidation:

Case Details: Angre Port (P.) Ltd. v. TAG 15

Facts of the Case

Angre Port Private Ltd filed an interim application under the provisions of order
XIII-A read with Order XII Rule 6 of the Code of Civil Procedure, 1908 seeking a
summary judgment against TAG 15 (IMO. 9705550), the ship owned by Tag
Offshore Ltd. for a sum of Rs.9,37,19,098 together with interest at the rate of 18%
p.a. from 18th December 2020.

Plaintiff said that the vessel was docked at its port on 13th February 2019, and
they had raised timely bills as berthing charges. The plaintiffs had also paid other
expenses to secure the ship during a storm. Meanwhile, the company that owned
the ship went into liquidation under the IBC and Defendant No. 2 was appointed
as the Liquidator. Plaintiff initiated the Admiralty suit to recover the berthing
charges and other costs.

High Court Held

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The High Court observed that Port authorities are not barred by Section 33(5) from
invoking the Admiralty jurisdiction of High Court to enforce their maritime claim
against a defaulting Ship/Vessel of a Corporate Debtor in liquidation and to
recover the amount of the claim from the vessel by an admiralty sale of the vessel
and for payment out of the sale proceeds. Section 33(5) only bars suit/legal
proceedings against the corporate debtor in liquidation and not any
suit/proceeding against vessel/ship of the corporate debtor under the Admiralty
Act as the vessel/ship is treated as a separate legal entity.

What sub-section 5 of Section 33 contemplates is that subject to Section 52, when

a liquidation order is passed against the Corporate Debtor, no suit or other legal
proceeding shall be instituted by or against the Corporate Debtor. Section 52 deals
with the rights of the secured creditor in liquidation proceedings. The proviso to
Section 33(5) stipulates that a suit or other legal proceeding may be instituted by
the Liquidator, on behalf of the Corporate Debtor, with the prior approval of the
Adjudicating Authority.

When one reads Section 33(5), it is ex-facie clear that the said provision prohibits
the institution of a suit or other legal proceeding against the Corporate Debtor
only. It does not in any way prohibit the institution of a suit or other legal
proceeding against a ship/Vessel owned by the Corporate Debtor when invoking
the Admiralty Jurisdiction of the High Court because under the Admiralty Act, the
vessel is treated as a separate juristic entity which can be sued without joining the
owner of the said vessel to the proceeding.

The action against the vessel under the Admiralty Act, is an action in rem and a
decree can be sought against the vessel without suing the owner of the said vessel.
Under the Admiralty Act, a ship, or a Vessel, as commonly referred to, is a legal
entity that can be sued without reference to its owner.

The purpose of an action in rem against the vessel is to enforce the maritime claim
against the vessel and recover the amount of the claim from the vessel by an
admiralty sale of the vessel and for payment out of the sale proceeds.

Page 414 of 437

It is the vessel that is liable to pay the claim. This is the fundamental basis of an
action in rem. The Claimant/Plaintiff is not concerned with the owner, and neither
is the owner a necessary or a proper party. In other words, the presence of the
owner is not required for adjudication of the Plaintiff’s claim.

For this very reason, there is no requirement to serve the writ of summons on the
owner of the vessel and the service of the warrant of arrest on the vessel is
considered adequate.

The action is a remedy against the corpus of the offending vessel. It is distinct from
an action in person am, which is a proceeding inter-parties founded on personal
service on the defendant within the jurisdiction of the Court, leading to a
judgment against the person of the defendant. In action in rem, no direct demand
is made against the owner of the res personally.

Case 06. Bar under Section 14 of IBC applies only to corporate debtors; Directors
being natural persons continue to be liable for cheque bounce

Case Details: Narinder Garg v. Kotak Mahindra Bank Ltd.

Facts of the Case

In the instant case, writ petitions were filed seeking:

(a) Directions to quash the criminal complaints filed against the corporate debtors
and its directors under Section 138 of the Negotiable Instruments Act, 1881 on the
ground that the resolution plan was approved by the Committee of Creditors (CoC)
under Section 30(4) of the IBC.

(b) Quashing the criminal complaint initiated after the order of moratorium passed
by the NCLT, as it cannot proceed even if the old management and its director take
over the corporate debtor.

The Supreme Court held that there is no bar under Section 14 of IBC for initiating
or continuing a cheque bounce case against natural persons mentioned in Section
141 of the Negotiable Instruments Act during the period of moratorium. Section
14 only bars initiating or continuing a cheque bounce case against the corporate
debtor during the moratorium period.

Page 415 of 437

Case 07. Unqualified acknowledgement of debt in the balance sheet extends the
period of limitation for filing of CIRP: Supreme Court

Case Details: State Bank of India v. Krishidhan Seeds (P.) Ltd.

Facts of the Case

In the instant case, the NCLT rejected an application filed by the State Bank of
India (the ‘appellant’) under Section 7 of the IBC against the Corporate Debtor
(‘the respondent’) initiating the Corporate Insolvency Resolution Process (CIRP).

The respondent had received credit facilities from the appellant, and the
outstanding amount under the credit facility totalled Rs. 102.4 crores. In place of
these credit facilities, the respondent (along with other persons) provided
securities in favour of the appellant.

However, the respondent failed to honour the terms of credit facilities and
defaulted on repayments. Hence, the respondent’s account with the appellant was
classified as a Non-Performing Asset on June 10, 2014.

Supreme Court Held

Then, the appellant aimed to seek recourse at various junctures to the SARFAESI
Act 2002 and Recovery of Debts Due to Banks and Financial Institutions Act, 1993
while continuing to engage in negotiations with the respondent.

Thereafter, a letter was issued by the respondent to the appellant dated January
19, 2016, offering a one-time settlement of Rs 61 crores in lieu of its debts, which
was conditionally accepted by the appellant. However, the respondent, by a letter
dated September 18, 2017, unilaterally revised the one-time settlement to Rs 40.6
crores, which was refused by the appellant.

In addition to this, an application for initiation of the CIRP was filed by the
appellant on the ground that there was a default on the part of the respondent in
paying a financial debt of approximately Rs 189 crores (calculated along with
interest as of June 30, 2018).

Page 416 of 437

While rejecting the application under Section 7 of the IBC on the grounds of
limitation, the NCLT observed that the respondent’s loan account was declared as
NPA on June 10, 2014, while the proceeding under Section 7 was instituted on
September 19, 2018, i.e. beyond a period of three years from the date on which
the right to apply accrued.

Referring to the decision given by NCLAT in case of “V Padmakumar v. Stressed

Assets Stabilisation Fund and Another”, the Appellate Tribunal held that a
statement contained in the balance sheet could not be treated as an
acknowledgement of liability under Section 18 of the Limitation Act 1963 and the
proposal for one-time settlement which was submitted by the respondent on
September 18, 2017 was also beyond three years from the date of default.

On appeal, the Supreme Court observed that an acknowledgement in a balance

sheet without qualification could be relied upon for the purpose of the
proceedings under the IBC.

The Supreme Court held that unqualified acknowledgement of debt in a Corporate

Debtor’s balance sheet within three years from the original date of default extends
the limitation for filing CIRP under Section 7 of IBC, as Section 238A of IBC makes
Section 18 of Limitation Act applicable to proceedings under IBC. Therefore:

(a) the provisions of Section 18 of the Limitation Act are not alien to and are
applicable to proceedings under the IBC; and

(b) An acknowledgement in a balance sheet without qualification can furnish a

legitimate basis for determining whether the period of limitation would stand
extended, so long as the acknowledgement was within three years from the
original date of default.

With the above clarification, the Supreme Court allowed the appeal and set aside
the impugned judgment and order of the NCLAT and the NCLT.

Case 08. SC resorts to Article 142 of the Constitution to cut short IBC technicalities
to benefit home-buyers

Case Details: Amit Katyal v. Meera Ahuja

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Facts of the Case

In the instant case in the matter of Amit Katyal v. Meera Ahuja – [2022] 136
[Link] 55 (SC) , the builder-(corporate debtor) came up with a housing
project in Gurgaon which could not be completed in eight years. On 06.12.2018,
three home buyers (original applicants) preferred an application under Section 7
of the IBC before the NCLT to initiate the CIRP process against the corporate
debtor. The application was admitted and a Resolution Professional was appointed
and the moratorium was declared.

The promoters of the corporate debtor challenged the admission of Section 7

application before the NCLAT, during the hearing before the NCLAT, the appellant
tried to settle the matter with the original applicants, however, the settlement did
not go through, the NCLAT dismissed the appeal and directed commencement of
CIRP. The IRP issued a public announcement and constituted the Committee of
Creditors (CoC). In the meantime, the promoters preferred the present appeal
before the Apex Court challenging the order passed by the NCLAT.

Supreme Court Held

The Apex Court allowed withdrawal of the Corporate Insolvency Resolution

Process plea filed against a builder filed by three homebuyers on being paid a
settlement amount along with applicable interest as agreed upon by the majority
of them. The Apex Court, in the larger interest of the homebuyers, exercised power
under Article 142 to permit withdrawal of the CIRP proceedings and set aside all
matters pending between the parties. The Court observed that under Section 12A
NCLT may allow withdrawal of the application admitted under Section 7 on an
application filed by the applicant with approval of 90% voting share of CoC.

Taking note of Swiss Ribbons Pvt. Ltd. And Anr. v. Union of India And Ors. (2019)
4 SCC 17, in which the Court had permitted the original applicants to withdraw the
CIRP proceedings in view of the settlement entered between parties, the Court
noted that the COC comprises 91 members, of which 70% are the members of the
Flat Buyers Association who are willing for the CIRP proceedings being set aside
subject to the appellant and the Corporate Debtor – company honoring its
undertaking given to this Court as per the settlement plan.

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The Court also observed that out of the total 128 home buyers of 176 units, 82
homebuyers are against the insolvency proceedings and the original applicants
have also settled their dispute with the appellant and corporate debtor. Even the
object and purpose of the IBC is not to kill the company and stop/stall the project,
but to ensure that the business of the company runs as a going concern.

Case 09. NOIDA isn’t a financial creditor under IBC as leasing a plot with a
restrictive clause didn’t amount to a finance lease: SC

Case Details: New Okhla Industrial Development Authority [Link] Sonbhadra

Facts of the Case

The appellant ‘NOIDA’ initially submitted Form ’B’ and claimed as an operational
creditor in regard to the dues outstanding under the lease. Subsequently, the
appellant filed a claim in Form ‘C’ and claimed as a financial creditor. Some
correspondence revealed that the appellant insisted upon being treated as a
financial creditor.

Finally, the matter was considered by the adjudicating authority (NCLT), which
held that there was no financial lease in terms of the Indian Accounting Standards
and there was no financial debt. By the impugned order, the NCLAT has affirmed
the view taken by the NCLT.

The dispute involves the question of whether the lease executed by NOIDA (lessor)
in favour of the lessee is a financial lease under Section 5 (8)(d) and 5(8)(f) of IB
Code?

Supreme Court Held

On appeal, the Apex Court observed that where NOIDA leased out a plot of land
for 90 years with a clause, the lessee builder will construct residential buildings on
it within 7 years with a maximum extension of 3 years with a penalty. If the lease
is cancelled due to non-fulfilment of conditions, the land with any building on it
to revert to NOIDA.

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Further, the lessee would require to take prior permission from NOIDA to create a
mortgage over it. It was clear that the lessee builder does not get substantial risks
and rewards of ownership as he is not free to do whatever he likes with the plot of
land. Therefore, the lease does not qualify as a financial or capital lease under
section 5(8)(d) read with Paras 61 to 67 of Ind AS 116 and will not qualify as
“financial debt”.

“A lease, which is not a finance or a capital lease under Section 5(8)(d), may create
a financial debt within the meaning of Section 5(8)(f),if, on its terms, the Court
concludes that it is a transaction, under which, any amount is raised, having the
commercial effect of the borrowing. The lease in question does not fall within the
ambit of Section 5(8)(f) as lessee has not raised any amount from the appellant
under the lease, which is a transaction. The raising of the amount, which, according
to the appellant, constitutes the financial debt, has not taken place in the form of
any flow of funds from the appellant/lessor, in any manner, to the lessee. The mere
permission or facility of moratorium, followed by staggered payment in easy
installments, cannot lead us to the conclusion that any amount has been raised,
under the lease, from the appellant, which is the most important consideration.”

Said Supreme Court

In view of the above, the Court held that NOIDA is not a ‘financial creditor’ and is
an ‘operational creditor’ under the provisions of IBC, 2016

Case 10. Provisions of IBC are intended to bring the corporate debtor to its feet
and are not of money recovery proceedings: SC

Case Details: Invent Asset Securitisation and Reconstruction (P.) Ltd. v. Girnar
Fibres Ltd.

Facts of the Case

In the instant case in the matter of Invent Asset Securitisation and Reconstruction
(P.) Ltd. v. Girnar Fibres Ltd. – [2022] 137 [Link] 462 (SC) , an application
was moved before the Hon’ble Supreme Court against the order of the Hon’ble
National Company Law Appellate Tribunal, Delhi Bench.
Page 420 of 437
An application was filed by the appellant under section 7 of the Insolvency and
Bankruptcy Code, 2016 against the corporate debtor.

Supreme Court Held

The corporate debtor defaulted on 28-02-2002. The applicant filed an application

before the Hon’ble National Company Law Tribunal (NCLT). The NCLT held that
right to sue accrued when the default occurred way back on 28-2-2002, and that
the material on record does not evidence any acknowledgment of liability in terms
of Section 18 of the Limitation Act, 1963. Therefore, the debt has become time-
barred now. No insolvency proceedings can be initiated against the corporate
debtor.

The applicant filed an appeal before the Hon’ble National Company Law Appellate
Tribunal against the order of the NCLT. NCLAT took the same view as that of the
NCLT.

On further appeal, the Supreme Court dismissed the plea and held that both NCLT
& NCLAT have rightly taken the view that the application as moved by the present
appellant under Section 7 of the Insolvency and Bankruptcy Code, 2016 (‘the
Code’) was barred by limitation.

Although the counsel for the appellant has attempted to refer to the documents
towards restructuring of the loan and the alleged revival letter etc. Court is
satisfied that the said documents cannot enure to the benefit of the appellant so
far as the application under Section 7 of the Code is concerned.

The provisions of the Code are essentially intended to bring the corporate debtor
to its feet and are not of money recovery proceedings as such. The intent of the
appellant had only been to invoke the provisions of the Code so as to enforce
recovery against the corporate debtor.

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29. Fraud Risk Management in Credit
Fraud risk management is a holistic and proactive fraud mitigation approach that
is embedded within an organization. A successful strategy requires robust internal
controls plus investment in anti-fraud technology. It also needs to consider the
current and future fraud landscape.

Importance of Fraud Risk Management

Industry professionals know that fraud cannot be ignored and will not disappear
on its own. To combat the rising risks, organizations should address fraud
strategically and benefit from taking a proactive approach rather than a reactive
one. This is where an effective fraud risk management strategy plays a crucial role.

By conducting thorough risk assessments, businesses can pinpoint potential weak

points where fraudulent activities may occur. Understanding these vulnerabilities
empowers companies to develop tailored control measures and implement
internal checks and balances to mitigate the risk effectively.

Additionally, effective fraud risk management enhances regulatory compliance

during a time when regulations are continually evolving and requirements for
reporting entities are becoming increasingly rigorous. Implementing
comprehensive fraud risk management strategies ensures adherence to these
regulations, reducing the chances of legal violations and associated penalties.

Steps to implement an effective fraud risk management program

Senior fraud and compliance professionals can refer to the following steps as a list
of best practices to enhance their firm’s fraud risk management programs.

1. Assess risk and vulnerabilities

Start by conducting a comprehensive risk assessment to identify potential areas

of vulnerability to fraud. Collaborate with key stakeholders across departments to
gain a holistic understanding of the organization’s operations, processes, and
systems. Analyze historical fraud incidents and review industry best practices to
inform your risk assessment.

Page 422 of 437

Questions to ask when assessing potential fraud risks include:

What does the firm’s past fraud detection performance look like?

What is the culture of the organization? Does it already demonstrate a risk-

based approach to fraud, anti-money laundering and counter-terrorist
financing (AML/CTF)? Are anti-fraud policies and attitudes embedded?

What technology is being used, and does it need to be upgraded?

Are recommendations from audits and assessments promptly actioned?

2. Establish clear policies and procedures

Develop clear and concise fraud prevention policies and procedures tailored to
your organization’s unique risks and requirements. These policies should outline
acceptable conduct, reporting mechanisms, and consequences for fraudulent
behavior. Ensure that all employees are aware of and understand these policies
through regular training and communication.

3. Implement internal controls

Internal controls play a crucial role in minimizing fraud risks. Segregation of

duties, access controls, and authorization mechanisms are essential components
of a robust control framework. Regularly review and update these controls to
adapt to changing business needs and emerging fraud threats.

4. Conduct regular fraud awareness training

Education is paramount to prevent fraud. Provide regular fraud awareness training

for all employees to recognize potential red flags, fraud indicators, and the
importance of reporting suspicions promptly. Tailor the training to different
departments, job roles, and levels of responsibility within the organization.

5. Establish monitoring and detection mechanisms

Deploy advanced fraud detection tools and analytics to monitor transactions,

behavior patterns, and anomalies that could indicate potential fraudulent activity.
Implementing AI-driven solutions can enhance the accuracy and efficiency of
fraud detection, aiding in timely intervention.

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6. Respond and investigate fraud incidents

Prepare a well-defined response plan for handling suspected fraud incidents. This
plan should include protocols for investigation, involving relevant internal and
external parties, and complying with legal and regulatory requirements. Swift
action is crucial to mitigate potential damages and prevent recurrence.

7. Continuously evaluate and enhance the program

Fraud risk management is an ongoing process. Regularly assess the effectiveness

of your program, seeking feedback from stakeholders, and making improvements
accordingly. Stay up-to-date with the latest fraud trends and technologies to
ensure your organization is prepared to face evolving threats.

Fraud risk management solutions

In the fight against fraud, the right tools can help equip firms to better detect and
prevent fraudulent activity. Artificial intelligence (AI) and machine learning (ML)
has been highlighted by the Financial Action Task Force (FATF) as able to help
firms detect abnormalities, provide alert prioritization to make remediation more
efficient, and intuitively set fraud transaction monitoring thresholds. Forensic and
behavioral analytics can connect seemingly unrelated data in a customer’s profile
– even among multiple accounts (known as identity clustering).

The key is to create a holistic, fraud-aware culture, reduce silos, and encourage
transparency. Businesses have the best chance of preventing fraud if they are
proactive, take fraud seriously and invest in a market-leading fraud detection
solution.

Credit risk and fraud risk are often discussed in relation to one another but in truth,
determining an individual’s fraud risk is not the same as determining their credit
risk.

An evolving fraud landscape with increasingly sophisticated methods requires new

tactics for mitigating fraud risk. This means moving away from the old, rigid credit
risk assessment tactics.

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In the 1980s and early 1990s, the traditional method for determining credit risk
was based on data tied to consumer credit histories, and only done for mature
credit markets. This information was used by the government to identify the
correct person for payments, such as welfare, social benefits, wages, and stimulus
checks. Banks and other financial institutions also leveraged this data to process
account openings and assess loan worthiness. Credit data was essential for
preventing mis-payments, flagging individuals who do not pay back their loans,
and more.

When the tech boom occurred in the mid-1990s and e-commerce began to take
off (as well as digital fraud), companies turned to a method they were already
using to determine credit risk and prevent fraud – using namely credit data.
However, the massive number of security breaches that occurred in the 2000s,
including Equifax in 2017, compromised much of this credit data. Non-fraudulent
customers trying to make valid purchases were often flagged as risky, even if they
were perfectly legitimate customers, leaving money on the table for businesses
and creating unnecessary friction for buyers. With this in mind, businesses are
finding new ways to determine creditworthiness.

Fraud Assessment to Determine Risk

Modern businesses are leaving behind old, rigid credit risk assessments, and are
turning their attention to new approaches for determining the probability of fraud
risk. This assessment leverages new types of Dynamic Personally Identifiable
Information (PII) to make a risk assessment, and new technologies (such as
machine learning) to help organisations anticipate the behavior of potential
fraudsters.

There are three ways this type of analysis is helpful for businesses:

It eliminates friction in the digital customer journey: Credit risk makes a

determination based on a set threshold. For instance, customers must meet a
certain credit score in order to be eligible. Fraud risk looks at the likelihood that a
bad actor is behind the digital interaction. Using a probabilistic approach to risk
assessment for digital fraud can help businesses move away from utilising rigid,
friction-filled deterministic methods to fight digital fraud.

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This creates a smoother process for good customers while also flagging suspicious
online activity and protecting the business.

It provides a more comprehensive assessment: The PII used for credit risk analysis
is based on static information (social security numbers, government IDs, phone
numbers, etc.) most of which has been compromised. While the information used
in probabilistic fraud risk analysis utilises dynamic PII and more importantly the
links between those attributes and how they behave online. Dynamic PII moves
beyond credit history determinations and instead looks at device ID, IP, emails,
consumer behavior, metadata, and biometrics, to get a better sense of the
customer risk. By evaluating the multiple dynamic linkages between these
elements, organisations can learn how consumers are behaving online and provide
a more comprehensive assessment of risk in fractions of a second.

Extends beyond border limitations: Another issue with using only a deterministic
approach with credit data is that it resides in country-based silos in only around
20 mature credit markets, making it difficult for businesses to evaluate risk
internationally or across borders. Dynamic PII elements can circumvent this issue
and be leveraged with a consistent data format around the world to assess risk.

A rigid, deterministic approach was useful for fraud detection when e-commerce
was in its infancy, but in today’s world, it simply isn’t sustainable. More than 70%
of consumers say account creation should be instantaneous. An overwhelming
majority also expect a fast, frictionless experience while also getting one that is as
trustworthy and secure as possible. As data breaches continue to compromise
customer’s credit information, it’s imperative that organisations move beyond
traditional risk analysis and shift toward new ways to protect themselves and their
customers.

Dynamic PII used through machine learning is the future of fraud analysis, and by
utilising a wider breadth of data, businesses can enable a quick and easy process
for their good customers while mitigating risk.

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Fraud Risk Management

Fraud risk management is the process of identifying, understanding, and

responding to fraud risks in an organization. It involves creating a program to
detect, stop, and/or prevent both internal and external fraud for an organization.

Proper fraud risk management reduces the risk of theft, corruption, conspiracy,
embezzlement, money laundering, extortion, bribery, and other forms of fraud. It
also closes security loopholes through which various threats and application
security risks can reach your business.

5 Fraud Risk Management Principles

Fraud risk management principles are established guidelines that provide

structure in an organization’s fight against fraud. Following the five principles
below will make it much harder for anyone inside and/or outside your
organization to commit an act of fraud against your business.

1. Fraud Risk Governance

Fraud risk governance is the structure of rules, practices, and processes for fraud
risk management in a company. A strong and transparent fraud risk governance
policy discourages fraudsters because it emphasizes C-level commitment to
reducing and controlling fraud risk. Some elements of a fraud risk governance
policy include:

1. Increasing fraud awareness among employees.

2. Ensuring the quality of each rule, practice, or fraud risk process.

3. Continuous fraud risk monitoring.

4. Research on market fraud prevention and mitigation technology.

5. Descriptions of the fraud investigation process.

As with all good governance, every element of a fraud risk governance policy
should be properly documented, delegated, and easily accessible. Ideally, one
person in the organization spearheads fraud risk governance.

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2. Fraud Risk Assessment

Fraud risk assessment is the process of identifying risks and categorizing them by
their likelihood and impact. The assessment allows a company to create a
straightforward risk quadrant that helps leadership decide the right solution for
each type of risk. Fraud risk assessment can be done with the following four
strategies:

Understand your company’s top risks. Which fraud risks are the most harmful to
your company? You can uncover the top risks with techniques such as workshops,
interviews, brainstorming sessions, questionnaires, and comparisons with other
organizations in your industry.

Review your existing controls. Do you already have fraud risk management
controls in place? How well do they work? Have they uncovered any fraud? Can
you cheat the controls? All fraud controls should be reviewed frequently and
thoroughly.

Identify risks and vulnerabilities. In addition to your top risks, you need to uncover
the remaining risks. Even risks that may not seem immediately harmful can cause
significant damage. For example, it is critical that companies prevent online fraud
in addition to focusing on offline fraud.

Integrate your fraud risk strategy across departments. No company department

should be a silo. To ensure everyone across all departments is on the same page
when it comes to fraud, you must encourage open communication, transparency,
feedback, and leading by example.

3. Fraud Prevention

Once you’ve written down a fraud risk governance policy and identified and
assessed the fraud risks in your organization, you need to implement policies,
controls, software, and procedures that will prevent (or reduce the chance of)
fraud.

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Focus on reducing all three aspects of the Fraud Triangle:

Motivation: What are the financial incentives that encourage people to commit
fraud?

Rationalization: How can someone justify committing fraud against your

company?

Opportunity: How easy is it for someone to commit fraud and walk away
unnoticed?

You may also wish to invest in a trustworthy online fraud prevention software.

4. Risk Detection Mechanisms

No matter how hard you try, it’s impossible to fully prevent fraud. Businesses need
fraud risk detection mechanisms to stop fraud before it does any damage. You
need reporting mechanisms that monitor anomalies, such as exception reporting,
data mining, trend analyses, etc.

5. Monitoring & Reporting Risk

Detecting fraud can put an innocent employee in a difficult position. There are
several reasons why someone may not report fraud: Fear of losing their job, not
realizing it’s fraud, not knowing how to report it, etc. To overcome whistleblowing
silence, your organization must provide fraud education, an anonymous hotline,
and a culture of transparency and openness.

You should perform frequent internal and external audits to ensure that your fraud
policies and controls are working. Even policies that do seem to work could stop
working as fraudsters find new ways around them, or as your organization grows
and changes.

Key Takeaways for Effective Fraud Risk Management

Companies of all shapes and sizes are at risk of fraud. Proper fraud risk
management will tighten security loopholes through which fraudsters and other
threats might otherwise reach your business.

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Effective fraud risk management means:

1. Creating a fraud risk governance policy.

2. Frequently assessing your organization’s fraud risks.

3. Implementing procedures to prevent fraud risk.

4. Implementing procedures to stop fraud before it does any damage.

5. Creating a culture where employees feel safe to report fraud.

Fraud Risk Management FAQ

What type of risk is fraud?

Fraud risk is the chance that an internal or external person will commit actions that
will result in the financial, material, or reputational loss of your organization.

What is the foundation of fraud risk management?

The fraud triangle (motivation, rationalization, and opportunity) is at the

foundation of fraud risk management, because it explains the reasons someone
might decide to commit fraud. Making the fraud triangle smaller will reduce your
risk of fraud.

What is the best way to do a fraud risk assessment?

It is recommended that every fraud risk assessment should start with a fraud risk
quadrant to categorizes fraud risks by their impact and their likelihood of
occurring. This allows an organization to create the right fraud risk prevention
rules for each type of fraud risk.

What strategy to mitigate fraud risk?

Automated fraud prevention software greatly reduces the possibility of external

fraud, while an anonymous hotline and a culture of transparency and trust will
significantly reduce the risk of internal fraud.

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 List of Books compiled by The Banking Tutor
So far the following Books are compiled by me which can be shared by any one
free of cost, without any permission from me or without any intimation to me,
without charging any amount.

Book No Book Name

001 Banking Jargon - Vol 01

002 Alerts - Vol 01

003 Forex - Vol 01

004 Banker and Legal Enactments - Vol 01

005 Banker and Financial Statements

006 Confusables – Vol 01

007 Banking Jargon - Vol 02

008 ABC (Awareness of Basics of Credit)

009 The Can Support_2020

010 The Core Support_2020

011 The Sundries_2020

012 The Soft Support

013 Management of W C Limits

014 The Notes_2021 (for Promotion Test)

015 Confusables - Vol 02

016 Banking Information

017 Banking Jargon - Vol 03

018 Bankers and Court Verdicts - Vol 01

Page 431 of 437

019 Inland Bank Guarantees

020 The Dirty Dozen

021 SPA (Not related to Banking)

022 Banks - Supporting Agencies - Vol 01

023 Banking Jargon - Volume 4

024 Banks - Supporting Agencies - Vol 2

025 Banks - Supporting Agencies - Vol 3

026 JAIIB Notes - PPB

027 JAIIB Notes - LRB

028 JAIIB Notes – AFB

029 CAIIB Notes – ABM

030 CAIIB Notes – BFM

031 Confusables - Vol 03

032 Banking Jargon - Vol 05

033 The Banking Regulations & Business Laws (BRBL)

034 Accounting & Finance for Bankers

035 Bank Financial Management

036 Retail Banking & Wealth Management

037 Concepts for Credit Professional - OT

038 Advance Business Management

039 Principles & Practice of Banking

040 Indian Economy & Indian Financial System - OT

Page 432 of 437

041 Concepts for Credit Professional - Notes

042 Less Known Forex Terminology

043 KYC & AML – Notes & MCQ

044 Treasury Management - Objective Type

045 Treasury Management - Notes

046 Indian Economy & Indian Financial System - Notes

047 MSME -Notes

048 MSME – Objective Type

049 Banking Jargon – Volume 06

050 50 Essays in Practical Banking

051 Promotion 2022

052 Basics of Bank Audits

053 The Shortens

054 Recap TIN 2022

055 NumLogEx

056 Basic Statistics for Bankers

057 JAIIB IE & IFS – All Modules

058 JAIIB IE & IFS - Mod B : Economic Concepts - Banking

059 JAIIB IE & IFS - Mod C : Indian Financial Architecture

060 JAIIB IE & IFS - Mod D : Financial Products and Services

061 Banking Jargon – Volume 07

062 JAIIB – PPB – All Modules

Page 433 of 437

063 JAIIB 2023 – IE & IFS – Objective Type

064 JAIIB Notes 2023 - PPB - Mod B - Functions of Banks

065 JAIIB 2023 - PPB Mod C - Technology & Mod D - Ethics

066 JAIIB 2023 – PPB – Objective Type

067 JAIIB 2023 – AFM - Notes

068 JAIIB 2023 – AFM – Objective Type

069 JAIIB 2023 – RBWM - Notes

070 JAIIB 2023 – RBWM - Objective Type

071 CAIIB 2023 – AFBM – Objective Notes

072 CAIIB 2023 – ABM – Objective Notes

073 CAIIB 2023 – BRBL – Objective Notes

074 CAIIB 2023 – BFM – Objective Notes

075 CAIIB 2023 – One Liners – BFM

076 JAIIB 2023 – One Liners – IE & IFS

077 CAIIB 2023 – One Liners – ABFM

078 CAIIB 2023 – One Liners – BRBL

079 CAIIB 2023 – One Liners – ABM

080 Risk Management – Objective Notes

081 Basics of Agri Lending & Essays in Rural Economy

082 IT Security – Objective Notes

083 HRM – Objective Notes

084 Rural Banking – Objective Notes

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085 Rural Banking – One Liners

086 Promotion 2023

087 CRAM 2023

088 Essays Related to Banking and Finance Volume 02

089 Material for Promotion Test from Sub-Staff to SWO

090 KYC AML CFT Notes

091 The Banking Jargon – Vol 8

092 Central Banking Notes (CAIIB Elective Subject)

093 Central Banking Only Points (CAIIB Elective Subject)

094 Digital Banking Notes (Certificate Course of IIBF)

095 Digital Banking Only Points (Certificate Course of IIBF

096 Cyber Crimes & Fraud Management - Notes

097 Foreign Exchange Operations Notes (Cert Course -IIBF)

098 Foreign Exchange Operations – Only Points

099 Court Cases related to Bankers Volume 02

100 MSME - Objective Notes (2024 Updation)

101 Confusables - Volume 04

102 MSME – Only Points (2024)

103 Foreign Exchange Facilities for Individuals (FEFI) - Notes

104 Foreign Exchange Facilities for Individuals (FEFI) – Only Points

105 Concepts for Credit Professional - Notes

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28 Books marked in Red are kept out of circulation as books based on latest
syllabus are shared/made available.

Book 37 and 41 (related to CCP) *(Book 105 with revised syllabus 2024 shared)

Book No 58, 59 & 60 are since merged with Book No 57.

Book No 64 and 65 are since merged with Book No 62

Book No 21 is not related to Banking

@@@

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 My Activity
I am sharing the following in my WhatsApp Groups (The Banking Tutor), Telegram
Group of The Banking Tutor and Blog (The Banking Tutor - TBT).

1. One Point related to Banking & Finance Daily (Daily Point). Started on 16-09-
2019, so far shared 1714 points without any break.

2. Once 3 days (on 3rd, 6th, 9th ,12th….) one Lesson on Banking & Finance
(Banking Tutor’s Lessons - BTL), started on 06-09-2018, so far shared 667 lessons.

3. Monthly First Day – Recap of Daily Points shared during the previous month.

My mail id – paritiss@[Link]

WhatsApp +91 94406 41014

Banking Tutor Blog – [Link]

25-05-2024 Sekhar Pariti

+91 9440641014

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