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Basis For Bank Lending
An alternative approach to evaluating creditworthiness and determining loan quantum in modern banking.
Need for Bank Credit
Every business enterprise, trading or manufacturing needs liquidity. Bank lending is either by way of short term loans (STL) or by way of long Term Loans (LTL).
STLs: provide seasonal liquidity to build current assets or to take advantage of attractive suppliers credit. STLs are highly desirable in terms of providing liquidity.
LTLs: are meant for funding non-current assets carrying higher risks. As the liquidity diminishes, repayment has to come from non-asset conversion sources which extends the time frame.
"The ultimate conversion of assets into cash to repay the loans is what **CREDIT IS ALL ABOUT**."
Understanding Credit Risks
Lenders should be willing to take risks but credit analysis should identify and monitor them carefully. Risks are bi-lateral:
Overly Conservative
Insufficient credit extended on excessively conservative terms. This is seldom recognized but leads to production levels below potential.
Overly Generous
Extending too much credit on generous terms to unreliable and unproductive borrowers, leading to systemic instability.
Evolution of Credit Quantum
The history of Indian Banking has seen various approaches to credit dispensation:
Creditworthiness Related
Negotiated Approach
Bargained Approach
Committees like Daheja, Tandon, and Chore laid down qualitative and quantitative measures, including:
- 01 Inventory Receivable norms
- 02 Minimum margins (Current ratio - NWC)
- 03 Maximum Permissible Bank Finance (MPBF)
- 04 Consortium discipline and bill culture
Financial Sector Reforms & Liberalization
With an accent on industrial growth and competitiveness, several reforms necessitated the withdrawal of rigid concepts:
Prior Credit Authorisation
Prescribed Inventory Norms
Mandatory Consortiums
MPBF Concept Formulas
"RBI now advises Banks to evolve their own methods for assessing and determining the quantum of loans."
What Our Bank's Approach Should Be?
Our credit decisions emanate out of **good common sense, judgement, and scrupulous providence**. We utilize quantitative info to arrive at qualitative judgement.
Character
Evaluation of character and managerial ability.
Cash Flow
Review of historical cash flow and financial policies.
Balance Sheet
Analysis of assets, leverage, and gearing.
Borrower Evaluation Framework
Introduction of Borrower Evaluation Sheets helps predict behavior across business cycles (Recessions, Recoveries, Booms, and Busts).
Key Assessment Factors:
Determination of Quantum
Adequacy of bank credit is linked to production facility and sales. Modern tools used:
Current Ratio (1.33:1)
Retaining the yardstick for measuring working capital finance while leaving current asset levels to customer discretion.
Receivables Handling
Exclude receivables from assets qualifying for CC limits, preferring suitable Bill Limits for greater flexibility.
Trade Creditors
Leave it to the customer to forecast levels, giving flexibility to operate limits based on market credit availability.
Other Sources
Align evaluation with cash forecast systems for Equity, NCDs, Commercial Paper, and Foreign Loans.
Case Illustration: Rs. 60.00 Crores Project
A manufacturing unit projecting annual sales of Rs. 60 Crores with 3 months inventory requirement.
Limit Bifurcation
Suggested Flexibilities
- Give up DP based on "paid for stock" concept.
- Evolve simple cash flow statements for monitoring.
- Permit QIS data + Cash Budget for A+ rated borrowers.
Segment Specific Norms:
- SMEs (Rs 2 Cr & below)
Adopt Nayak Committee norms for simplified assessment.
- SSI (Rs 10 Lacs & below)
Use "Line of Credit" without complex bifurcation of limits.