Credit Monitoring

In such circumstances, the sanctioning authority prescribes to the branch that the account needs close monitoring. Very often the operating staff may not be able to understand what exactly the sanctioning authority has meant by the stipulation that the account now requires close monitoring than before. Even if they appreciate the statement they may not know the modalities as to how to go about exercising close monitoring of the account than before.

A few illustrative cases are collected to explain how such close monitoring is to be conducted and what exactly was the thought process of the sanctioning authority while sanctioning such additional limits. These cases are only illustrative in nature and may not cover the different types of circumstances arising in all the borrowal accounts. Nevertheless, a close study of these cases and underlying process in decision making would enable the reader to exercise such judgement on accounts falling under his own discretionary powers and also really exercise close monitoring in cases of sanctions made by higher authorities.

The purpose of this communication is to highlight that if the sanctioning authority has some hesitancy in meeting the additional/adhoc needs of the borrower, such hesitancy is based on certain happenings in the account in the past. Keeping this in view "close monitoring" is stipulated in certain circumstances.

It is not a simple condition or a vague statement to be ignored. The attention of Branch Manager/Regional Manager is drawn to take special care of the administration of the existing outstanding as also adhoc release.

In the entire gamut of Credit Administration, monitoring of advances after their release assumes crucial importance. Bank credit is sanctioned for a definite purpose to be repaid on a definite date from an indicated and agreed source. Therefore, it becomes necessary for the banks to follow up the credit after disbursement so as to ensure that all the conditions which were prescribed at the time of sanction have, infact, been compiled with and the monies are utilised for the purposes for which they were originally sanctioned and released. Thus, Credit Monitoring assumes vital role in the gamut of Credit Management.

It is the common experience of banks that requests are received for considering adhoc sanctions so as to get over certain situations which were not originally contemplated at the time of sanction of the limits. The sanctioning authority takes into account the present position of the account, the nature and extent of irregularities, if any, in the account, whether the circumstances that have arisen are beyond the borrowers control and whether it is safe for the bank to lend further amounts by way of adhoc advances or to make modifications in any of the terms of sanction and then sanction such adhoc/additional limits/modifications in the terms of sanction.

1) Fixing of Quarterly Operative Limit - Consortium

2) Adhoc Facility extended during the middle of the financial year.

Fine Chemicals Ltd. is engaged in manufacture of synthetic and alcohol based chemicals with an annual turnover of around Rs. 180 crores. For the current year beginning from April'94 to March'95, the company has projected a sales turnover of Rs. 200 crores which was found achievable by the consortium of banks (led by 'A' bank with 'B' bank and 'C bank as members) extending working capital fac ilities to the company. The appraisal committee of the consortium assessed the working capital requirement as below :

The PBF is to be made available as below

The sharing pattern of the limits among the consortium is given below :

The forms received under Quarterly information system for the quarter ended June and Septem - ber revealed almost a pro-rata performance of the respective quarters ie. the company has achieved nearly Rs. 100 crores turnover.

During the first week of October, the company approached the leader bank representing that,

1) there is acute shortage of indigenous raw material.

2) the company has represented to the Government requesting permission for importing alcohol and they have obtained the same.

3) they have negotiated for a bulk supply of alcohol with a foreign supplier who is prepared t o supply at 180 days credit terms against bank's letter of credit and,

4) they require a DALC limit urgently as well as reassessment of their credit requirements.

The LC is requested to be opened on DA terms for USD ten million (approximate I.Rs. 32.50 crores) and with 35% import duty and other charges, the landed cost would be Rs. 44 crores. It was also indicated that the differential cost due to import shall be off-set by increase in the selling price.

The consortium met on an emergent basis and considered the company's request as per the following assessment, which is based on the following assumptions and quarterly projections for December'94.

1) Out of the projected other current liabilities of Rs. 12 crores nearly Rs. 7 crores represents supplier credit and to the extent of additional suppliers credit now available drawing power will get reduced

2) Though 180 days credit from date of shipment is extended by the supplier, it takes nearly 1.5 months for the goods to reach the company's factory and as such the company would get only 4.5 months credit. Hence current liabilities other than bank borrowing is estimated at Rs. 40 crores and,

3) The company shall not approach the consortium for any additional facility.

In view of availability of additional supplier's credit against banks LC, PBF has undergone a change and stands reduced by Rs. 10 crores.

The operative limit of Rs. 60 crores for the quarter ending December'94 is to be extended as follows : (Rs. in crores)

Accordingly the share of limits among the consortium members will be as under

The letters sent to member banks advising operative limits is given below

We refer to the QIS form - I submitted by the captioned company for the quarter ending 31.12. 1994. As decided in the consortium meeting held on.............. we have fixed the quarterly operating limit for the quarter ending 31.12.1994 and accordingly your share will be as follows.

Total limit fixed Rs. 62.00 crores.

Please note not to exceed the limit fixed to your bank at any time. We request you to submit the outstanding under various limits once in every fortnight without fail.

Yours faithfully,

MANAGER

FIXATION OF QUARTERLY OPERATIVE LIMIT WHEN HOLDING LEVEL OF CREDITORS CHANGES

Beta and company is textile unit. The working Capital requirements of the Company are being taken care of by A bank leader in consortium with B Bank on 75:25 basis. The annual review of the account was made in September when the company was sanctioned aggregate working capital limit of Rs. 14 crores to support the sales turnover of Rs. 80 crores for the ensuing year January to December. The basis of assessment of aggregate working capital limit of Rs. 14 crores is furnished below :

The Form II under Quarterly Information System for the quarter ended March submitted by the company in May was analysed. It was observed that the levels of production and sales were in line with the annual plan. Level of current assets were comparable with the projected levels at the time of review. The inventory position at the end of the quarter was also in conformity with the stock statement for the month of March submitted by the company. But the level of trade creditors has increased by 100% i.e., from the assessed level of one month's purchase to two months. Consequently, the reduction in Bank Borrowings was almost equal to the increase in the level of trade creditors.

In respect of Form I received for the quarter ending September the operating limit was fixed as under adopting the actual level of credit i.e., 2 months extended by the trade creditors though the company has estimated only the level as envisaged in the original plan i.e. 1 month.

Consequent upon the higher credit available from Trade creditors, the permissible Bank Finance stands reduced from Rs. 14 crores to Rs. 11 crores for the quarter ending September. Letter addressed to other member of the consortium viz. "B" Bank fixing the quarty operating limit is enclosed.

We refer to Form I for the quarter ending September submitted under Information System. On the basis of increase in the level of Trade Creditors to 2 months purchases as against the assessed level of 1 month's purchases as revealed by Form II for the quarter ended March, we have reduced the operating limit to Rs. 11 crores as against the sanctioned level of Rs. 14 crores as indicated below

Please note not to exceed your share of operating limits notwithstanding higher level of sanctioned limits. Also, please arrange to furnish outstandings under working capital limits on fortnightly basis without fail.

Yours faithfully,

(MANAGER)

DETERMINATION OF CREDIT FACILITIES BASED ON QIS DATA

DEF Ltd. is engaged in manufacture of fancy fire works, crackers and explosives for Defence Department. The unit is banking with ABC bank for decades and their dealings are satisfactory. The performance of the company is also satisfactory.

The unit was sanctioned a fund based credit facility of Rs. 280 lacs based on the following assessment for the year 1993-94.

The company has estimated an annual sales of Rs. 800 lacs. The company was sanctioned the following limits :

Full interchangeability between the above limits is also permitted.

The company submitted its QIS Form I being estimates for the quarter ending June'93, during last week of March'93 and important details are given below.

The company has projected a Net sales of Rs. 160 lacs for the first quarter:

Based on the above, the company's quarterly operative limit was fixed as follows :

(Bills limit of Rs. 35 lacs has been fixed to maintain 25% margin on receivables)

The reasons for the fixation of above operative limits are

1. The cracker industry is seasonal in nature where the sales reach a peak in third quarter (i.e. October to December) though sales begin to pick up by middle of second quarter (July to Sept.)

2. The sales projection of Rs. 160 lacs though represents only 20% of the annual projection, the same appears to be in line with trend of the trade.

3. Raw Material holding is high during first quarter to facilitate availability of required quan tity of finished goods during peak season. Hence cash credit limit is fixed at a higher level.

The company submitted Form II on 10.8.93. The important observations on the same are as follows :

Based on the above the operative limits were fixed as follows :

As per Form II submitted at the end of the second quarter, the company achieved a sales of Rs. 267 lacs during the second quarter and level of current assets and current liabilities were in line with the projection.

In the meantime, during the last week of September'93, the company had submitted its Form I for the third quarter and the details are as follows :

Estimated sales for the III quarter - Rs. 320 lacs

The operative limits fixed for the third quarter are :

As per Form II submitted by the company it had achieved an actual sales of Rs. 338 lacs and other details are given below :

Earlier during the last week of December'93, Form I for last quarter was submitted and the details are given below :

Estimated Sales for the last Quarter - Rs. 80 lacs

Operative limits fixed for the fourth quarter is

To sum up

1. The company had achieved a net sales of Rs. 850 lacs as against the estimates of Rs. 800 lacs

2. Though PBF assessed was Rs. 280 lacs it was effectively made available to the com pany according to its requirement.

3. During the last quarter, the bank borrowing has come to Nil as sufficient Net workigng Capital to finance working capital gap was available due to retention of profits earned through the year.

4. Being a seasonal industry flexibility between cash credit and bill limit was allowed.

QIS helps as an effective tool to monitor the account and fix operative limit.

NEED TO VERIFY DATA SUBMITTED WITH DETAILS AVAILABLE WITH BANK

Data based on which limits were fixed are as under:

Working Capital assessment for the year 1988

The company submitted Form II for the quarter ended 30th June 1988 containing following particulars.

A. Estimates for the current accounting year indicated in the annual plan sales

B. Actual production and sales during the current accounting year (data for completed quarters)

C. Data relating to the latest completed quarter ended 30.6.88

D. Current Assets and Current Liabilities for the quarter ended

Some time after the above form was submitted, the company called on the bank and requested for sanction of an adhoc limit of Rs. 50 lacs under the cash credit limits, stating that they have been lucky to bag a big order not anticipated earlier and therefore they require additional credit limit to enable them to increase their performance of the year.

From the form II submitted it was seen that the actual bank borrowing was only Rs. 50.00 lacs as against the sanctioned limit of Rs. 125 lacs and so it was suggested that the company can very well avail of Rs.5O lacs that they want from the unutilised portion of the limit. The representative from the company, however maintained that they have already drawn the limits to the full and that is why they had to approach the bank for an increase in the limit on a temporary basis.

It was at that point the bank realised that the figures shown as bank borrowing was less though the limit was fully drawn. The representative of the company who came for negotiating the adhoc limit was enquired as to how the company could show a figure in Form II as bank borrowing which was totally at variance with the actual outstandings, and, further how did they manage the drawing. According to the Form II submitted the Permissible Bank Finance works out to Rs. 52.50 lacs and the actual drawing of Rs. 50.00 lacs shown in the form is well within the Permissible Bank Finance. Therefore when the actual drawing is Rs. 125 lacs the questions are :

i) Where from did they get the goods which they have pledged/hypothecated and drawn the funds?

ii) What did they do with the money drawn from the bank?

iii) Why did they conceal the actual position while submitting the Form II ?

Slowly the Company representative came out with full facts. What they had done was they had taken possession of the goods covered by the inward bills outstanding in the branch, from the lorry company without production of the relative lorry way bills (and therefore unauthorisedly) and pledged/ hypothecated the same for purposes of drawing from the credit limits to the full.

The company did not account for the stocks so taken possession of from the lorry company in their books, since, if they had done so the value of stocks of raw materials on hand would go up, and correspondingly the creditors for purchases would also go up. Consequently, the actual drawing of Rs. 125 lacs will be higher than the maximum permissible finance, and the company knew that bank would

AUDITING OF QIS DATA FURNISHED BY THE BORROWER - ITS IMPACT

Details of credit facilities

Nature of financial arrangement: Sole banking.

An analysis of Form I and II reveal the following position -

I. Production details :-

The company had projected a production of 7500 tons of value Rs. 547.09 lakhs in the CMA forms given earlier while negotiating the credit requirements. As against this the company had given quarterly details in each Form I and a comparison of actual performance vis-a-vis the quarterly projections showed that the company could achieve only 83% of the projection for the first quarter and 78%for the remaining three quarters. The total production for the year was only 5847 tons. Total sales during the year was 5600 tons as against indicated level of 7400 tons. Further the net sales was of value Rs. 552 lacs as against the earlier indication of Rs. 703 lacs.

II. Permissible levels of holding of inventories and receivables were as follows -

As against the permissible levels the company's actual holding were found to be far less except in the case of finished goods stores and spares and also receivables.

The data relating to quarterwise estimate and actual current assets are as under

A close scrutiny of the figures given in the above analysis reveals the following

a) The production has been only around 80% although the company had drawn the limits to the full.

b) Consequently, the gross sales and net sales have also been below the estimates given at the time of credit negotiation.

c) The prescribed norm for the holding of receivables is 1.5 months of sales. The quarterwise position of sales and the receivables outstandig rare as follows :

Inference : It is surprising to note that there is no relationship between the permitted levels and the actual level of receivables. Even presuming that there could be some overdue bills in every quarter such overdue bills could not be to this extent. As a corollary to this question, the application of funds is also to be ascertained.

This is how the bank that received the Form I should have analysed and probed into it even when the first quarter form was received. As far as the bank is concerned whenever they purchased bills under the DBP limit they should have ascertained whether there are any large overdues before they agreed to purchase further bills, apart from scrutinising the bills from various other angles. They had enough opportunity even in the absence of QIS forms to regulate the advance.

A questioning mind would have picked the bubble before it was too late.

Action taken

A thorough investigation was initiated into the bills purchase portfolio of the branch and also to inspect the position of stocks at various destinations on which the bills were drawn. It revealed the following information

a) the branch has been allowing large excesses under the bills purchase limit even when there are overdues and some of the excesses have not been reported at all.

b) there was no such lorry company at the places on which the bills had been drawn and so the lorry way bills turned out to be bogus ones. The entire outstanding under the bills portfolio thus turned out to be a clean advance without backing of any security.

c) Party had diverted the funds raised through such bills to other activities.

Conclusion

When the banker insists upon furnishing of information by the borrower in return for the credit that is sanctioned to him, if such information is not made proper use of, then the process of getting the QIS forms would only peter down to a ritual. There is one more danger viz. that the customer may turn round and contend that he had already put the banker on notice and the banker cannot pretend he was not.

MONITORING THROUGH FORM III

In the previous five cases, we have seen the importance of QIS Form I and Form II in monitoring of a borrowal account. Form HI, submitted once in every half year, is useful in analysing the half yearly performance of the company as well as funds flow.

This case study is in continuation of the one given in the Page 8 of our earlier circular No. 10 dated 18.11.94. The revised CMA data reproduced in the said circular is taken as the basis for this case study.

M/s. ABC Ltd. submitted QIS I for the quarter ending 30.6.93 on 25.3.93 containing estimates of Current Assets and Current Liabilities. The estimates were in line with the projections given in CMA data submitted by the company earlier and accepted by the bank for working capital assessment. ABC Ltd. submitted QIS II for quarter ended 30.6.93 on 13.8.93 which showed that the company's current ratio was better than the estimates as a result of improvement in Net Working Capital. Form I and II are reproduced below:

For the next quarter ending 30.9.93, QIS I was received on 24.7.93 estimating a lower NWC of Rs. 1485 lacs and current Ratio of 1.83 : 1. But the QIS II for the quarter ended 30.9.93 showing the actuals, revealed a totally different picture. The form I and form II for the quarter ended 30.9.93 are reproduced below :

The company was asked to submit Form III received from the company is reproduced below :

HALF YEARLY OPERATING AND FUNDS FLOW STATEMENTS

FORM III (to be submitted within two months from the close of the half year)

Name of Borrower : ABC Ltd.

Scrutiny of the half yearly operating statement reveals the following:

1. The Net Sales of Rs. 2190 lacs have fallen short of Rs. 2639 lacs estimated.

2. The cost of production has reduced due to reduction in overheads.

3. There is disproportionate decrease in other manufacturing expenses which includes depre ciation. It should be ascertained whether-the company has provided for depreciation or not and if they have provided for depreciation, the reason for the decrease in other manufactur ing expenses.

The company explained as follows :

1. The sales have decreased due to certain political distrubances for a month in North India and with improvement in the situation, the sales have started picking up. The company expects better performance in the next half year.

2. Due to certain cost reduction methods adopted by the company, the cost of production has shown a decline. Depreciation has been provided for the half year.

Scrutiny of Fund Flow Statement reveals the following :

1. During the half Iyer ended 30.9.93, the company had diverted Rs. 938 lacs of short term funds for long term uses. The company had invested Rs. 1016 lacs in Fixed assets as reflected in "Increase in Fixed Assets" under "Use of Funds". For this investment, matching long term funds should have been brought in additionally, either in the form of induction of additional capital or increase in Term Loans or Unsecured Loans from long term sources. This has not happened. On the other hand, the company had funded the acquisition of fixed assets by short term funds such as, decrease in receivables, increase in other current liabilities and decrease in other current assets, which should have gone to fund working capital requirement.

2. The fall in sales during the half year ended 30.9.93 may not be entirely due to political disturbances in some part of country. It may be partly due to shortage of working capital arising out of diversion of short term funds for acquisition of fixed assets.

REMEDIAL ACTION TAKEN :

It could be seen that the divertion of funds was detected immediately and in time, by scrutiny of QIS forms and Fund Flow Statement.

The divertion of funds was internal in the sense that the money has not gone out of the company but invested within the company in fixed assets.

Now, to correct the imbalance, long term funds have to be inducted, at least to the extent of bringing up the current ratio from 1.23:1 to 1.33:1. the current position of current assets and current liabiities as on 30.9.93 was as under:

As envisaged earlier the company may be asked to raise fixed deposits/debentures from public to strengthen the NWC position.

Alternatively a term loan of Rs. 157 lacs can be considered against the security of fixed assets of the company (under Asset Credit Scheme) which will improve the Net working Capital position. The term loan can be repaid by the company in two years time as the company has cash generation of more than Rs. 100 lacs per year.

Conclusion :

This case study reveals the usefulness of detecting diversion of funds with the help of Quarterly information system. While we can not approve diversion of funds, internal diversion may be tolerated in certain cases and remedial action by infusion of long term funds in the form of term loan may be thought of. However remedial action is also possible only if the going is good for the company. Also early detection alone will help in rectifying the situation. In any case, if there is any external diversion, the situation demands strict action by bank to safeguard its interest.

The "Statement of outstandings and operations under various credit facilities" more popularly known as "Continuous Surveillance Statement" is another vital tool available with us to detect the diversion at the very initial stage, not to speak, of monitoring of the account at the branch level which alone can prevent diverison of funds.

Obtaining and scrutinizing Stock Statements and conducting periodical godown Inspections are age old practices for monitoring of advances related to Inventory financing and related to block assets such as machinery, land, building etc. In fact, the returns submitted by branches to the controlling offices will have to be compiled based on stock statements and godown/factory inspection reports. This is an effective tool through which the movement of stock is followed up closely. This has also got the advantage of ensuring that the level of raw materials, goods in process and finished goods are not only maintained but are also physically available.

While stock statements are required to be submitted weekly/fortnightly or monthly as per the sanctioned terms, the periodical site Inspections have to have an element of surprise. Shortage of stock, stoppage of work in the factory, presence of other bank's board indicating financing against the same security, existence of non usable redundent or unpaid Inventory being included to compute drawing power etc. can be noticed through such inspections and remedial action taken then and there.

In the case of Pledge form of advances, the bank will have symbolic delivery of the Inventory and the bank will also be accountable for loss, if any. Absence of our Bank's name board, presence of some other bank's name board, non availability of independent access, availability of clandestine access to other banks, loss'of goods by fire etc. can be ascertained and remedial action taken then and there. Over a period, experienced bankers have established clear guidelines to inspect different types of godowns depending upon the nature of the activity of the borrower.

There are clear guidelines available for Inspection of say, a rice mill or a chemical factory where r aw materials or finished goods are stored in huge storage vessels. Banks ascertain the value of stock by measuring the length, breadth and height of the containers. They have also developed expertise to assess the value of goods in process by looking into the log sheets and noting down the issues and deliveries. They can even ascertain the value and volume of production by computing the consumption in the eiectric meter and relating it to the annual electric bill and number of units required for a certain levei of production.

We also have to have the knack of ascertaining valuable information affecting or prejudicing bank's interest by carrying on intelligent conversation with the technical and other employees of the unit during such visits.

Purchase and Sales Invoices are to be verified to ascertain not only the cost of goods sold and purchased but also to ensure that the goods were paid for and receivables properly accounted. With some intelligent approach, banks could also identify rejected/returned goods being received and once again included in the stock statement for Drawing Power. In other words through such inspections the bankers were almost upto date with whatever relevant information that was required to ensure safety of the money lent by them.

Over these years, it is seen that this effective monitoring tool is slowly being forgotten. Borrowers have not been submitting / are irregular in submitting stock statements. Returns on advances are being accepted without insisting on stock statements and godown inspection reports. The verification of Inventory as declared in the stock statement and as indicated in the financial statement (Balance Sheet) are not being cross verified. Entire credit limits meant for a particular assessed level of activity is being utilised without reaching even 50% of the levels assessed. Presence of another bank / other lenders comes to the bank's knowledge as a rude shock. Crores worth of Inventory shortage are announced as a matter of routine, thus indicating that for several months Inspection has not been conducted. Machineries hypothecated to the bank are being removed or sold without bank's consent and subsequent forced Inspection reveals the fact that these vanished months back. Bills for huge amounts are purchased within the sanctioned limit when it is established that the factory was under lock out and no goods were produced which could have resulted in a bills transaction.

Even today investigating into the causes of irregularities in the account reveal that a proper systematic and periodical godown inspection would have prevented such situations or would have unearthed some serious happenings as and when they occured.

We have learnt only to reckon drawing power shortage as a fait accompli and are forced to fund them. The banking industry has not developed a substitute monitoring tool to this useful stock statement scrutiny or godown inspection procedure. While monitoring through quarterly data which was explained at length in our last circular or through the monthly surveillance data etc. are useful ahd required, they can only be supplementary to the rigorous and meaningful godown/factory inspections conducted periodically.

A few caselets explaining and emphasising the above are given in the annexure. Our Bank's Book of Instructions has stipulated the drill for obtaining and scrutinising the Stock Statements and for conducting periodical factory / godown inspections. Bankers can neglect these only at their peril.

1. GODOWN/FACTORY NOT VISITED AT ALL

In one of the Steel Rolling Mills at Nagpur, the factory site, where entire current assets are supposed to be Hypothecated to the bank were stored, was not visited at all by the branch. The Company produced goods out of working capital and used up almost 90% of the finished goods for construction of the tresses in their own associate Unit where term loan had been obtained for factory construction. It so happened that when the bank came to know about the acute shortage of drawing power, it was too late and a s usual panic button was switched on at a much later stage when the unit's default to not only the bank but also to lot more people who had all given advances and bankers who had given guarantees came to light. The invoked guarantees, Bank's dues and interest became too large. Subsequently when the unit asked for concession in rate of interest claiming" sick" status they announced that the stocks were not there to cover the OCC dues from that date. It was exactly 1V2 years later that the bank has come to know about this shortfall and the customer confirmed that during this period nobody from the Bank had cared to visit the factory.

2. EMBARASSING ABSENCE

In another Unit, branch had not been making its periodical visits. It so happened that one of the Executives from Centra! Office had accepted the persistent invitation from the customer to visit the unit. The manager also accompanied him. During the visit to the factory it was noticed that one new block had come up adjoining the main floor where the stocks hypothecated to the Bank were stored. Unaware of the consequence, the manager remarked that he had not seen the new block so far, to which the customer replied that new block had been in existence for the last six months, thereby exposing the Manager of his failure to visit the factory durig the last six months.

3. SHOCKING SHORTFALL

One of the leading Electrical parts manufacturing Company in Madras was assessed for their Working Capital requirement in the year 1986 and was awarded Health Code 1 - Satisfactory with current ratio more than 1.33 : 1. The proposal was recommended by the branch with the review along with financial statements. Exactly 12 months later, the company announced that there is an acute drawing power shortfall in account amonting to Rs. 1 crore owing to cash losses. This collosal shortfall in drawing power forced a separate stock audit being conducted and this stock audit revealed several things, which interalia pointed out that the drawing power shortage had been built up over a period of 2 to 3 years and did not occur in less than an year's time. There were visible symptoms of stock level being depleted without matching reduction in outstanding. Surprisingly, during the same period, the branch had recom - mended for higher limits and meanwhile granted excesses all of which had contributed only to fund the cash losses. The account became irrecoverable and hypothecated assets had to be sold and balance dues were partly waived. The prolonged absence from godown inspection encouraged depleti on of stock, the sale proceeds of which were used by the company to make preferential payment for supplies made by the Directors of the company and that of their family and friends.

4. BILL FINANCE LINKED TO GODOWN INSPECTION

We had sanctioned some bill puchased limit to a Vanaspathy manufacturing unit in Gujarat in Consortium. Being only a bill finance, it was not customary to visit the factory except by way of an annual inspection along with other financial Institutions and banks.

When the Unit became bankrupt, our bank's bill outstanding was upto the full limit. When the affairs of the unit were probed into, the bankers were taken by surprise to learn that the unit was closed for nearly 4 months prior to their announcing their default to their creditors. Being an edible vanaspathy making unit this unit never used to have finished goods for more than 4 to 5 days. That being so, eye brows went up as to from where the unit was producing bills when the factory was remaining closed and there was no production for the last 4 months. In fact this case is an eye opener for emphasising the need for godown inspeciton even where our working capital limit is in the form of bills finance only.

5. DUSTY CURRENT ASSET

In one of the units financed by us in Orissa, godown inspection was conspicuously absent for a long time. Customers explanation was accepted for shortfall in production and excesses were recommended on the basis of full support of current asset to cover existing and future drawings. Subsequently when a detailed qodown inspection was organised by Zonal Office it turned out to be quite a dusty affair, as nearly Rs. 8 crores worth of stocks supporting a total drawing power of Rs. 22 crores was comprising of dust. When a detailed probe was conducted, it was indicated that such a dust accumulation is unavoidable processing and that it does contain 20 to 30% of the prime ore. Starting with Rs. 50 lacs worth of such inclusion of dust in the stocks, subjects were encouraged to build it up to a level of Rs. 8 crores as no questions were raised by the bank and no godown inspection pointed this out. In fact during the closure of one or two furnaces of the unit the inevitable liquidity shortfall owing to loss of production and sales was made qood by building up drawing power based on such stocks of dust. It was our good fortune that this was noticed in good time when the unit's going was still good and remedial action for the time bound removal of such stocks from the drawing power could be worked out.

6. LOCKOUT AND EMPTIED OUT

In one of the units in Madras, Branch Manager could not inspect the stock under the pretext that the factory was under lockout. He was shown some stock through the window and being s atisfied, he forwarded the godown inspection report with the remarks that the stocks could not be inspected because of lock out however looking through the window "I am satisfied that there are adequate stocks to cover the dues" Not being satisfied, a few technical people were deputed to the premises where accounts department and others were functioning. This visit was followed by another visit 15 days later and during the second visit they made discreet enquiries in and around. During the earlier visit by the technical staff they were able to note down the reading in the electric meter. In the subsequent second visit similar reading was taken which revealed enormous consumption of electricity which was dispropotionate to run only the office premises. There was no satisfactory reply from the people concerned but the enquiries with neighbours revealed that at night the factory used to carry on production and the finished goods were being removed by 3.30 to 4.00 a.m. outside the godown. With the information so collected, a regular stock inspection was conducted and it was noticed that more than Rs. 40 lacs worth of stocks of billets were converted into finished goods and sold clandestinely without any operation in the CC a/c. The account became a problem account for recovery.

7. FOR CONVERSION

It is customary to relate stock shortfall to job work assigned in favour of somebody else. In one of the Export Packing Credit advance, the forced godown inspection revealed totally inadequate stocks to which the customer replied that bulk of the goods were given for job work. We insisted upon knowing the place where such job work was being carried out. Though it was quite a distance from the main unit, a visit to such "job site" was made. To our surprise it was found that there were no such activity and the address given was a closed old house. The front portion of the corridor was occupied by hawkers who confirmed that atleast for the last 6 months during which they were having their business they had never seen the buying opened and they were not aware of any activity inside. The so called job work was only a hoax and there was really no stock. Due to timely detection and forcing the issue, bank could recover Its dues though with some delay.

8. WITH A PINCH OF SALT

A chemical manufacturing unit was given hypothecation limit covered by stocks of chemicals. Inspecting this godown was reduced to a mere ritual. The factory was visited and some stocks pointed out were accepted as cover for the outstandings in the account. It was noticed that not only the hypothecated stocks did not move, the operations in the account also did not reflect sales made. The company officials wanted more facility and confirmed availability of stocks to the extent declared in the stock statement. To our surprise we found that the quantum of current assets declared in the stock statement was sufficient to carry on the level of activity undertaken and proposed. They could not explain the need for more stocks to carry out the already reckoned volume of production. Discreetly organised factory visit revealed that the godown containing chemical contained mere common salt in a semi molten condition. The godown inspection conducted previously were reduced to a ritual and never aroused any suspicion which could have occured to any new credit officer. Bank had to launch recovery drive to adjust the dues.

9. ALCOHOL

One of the raw materials used by the Stainless steel unit financed by the bank had to hold a minimum level of alchohol for their process. In fact with the help of the bank, quota was obtained for supply of alchohol for their manufacturing activity. The account showed healthy fluctuations and CC a/c. was well conducted. Normally during such periods inspecting the stocks or visit to the factory is considered superfluous and such units' godowns are not in the list of godowns to be visited normally. Consequently when abnormal features were noticed in the account like interest debits not being absorbed, frequent return of cheques both inward and outward and then stoppage of operations in the account for some time a factory visit was organised. It was gathered during such visit that the factory visit by the officials were conducted in a routine manner and that too at very infrequent intervals. While the operations were good, it turned out that the company did not really manufacture the end product but was selling alcholhol in the black market at exhorbitant price. The turnover in the account was only due to such sale proceeds and there was prosperity so built up. It was revealed that at no point of time the allotted alchohol was found in the factory though included in the stock statement, the value being almost V3 of the total value of stocks. This was never physically verifed as it was never available. It appears that due to detection by the authorities further supply of alchohol was stopped and the unit was in a real crisis. Bank had totally ignored to see the end use of funds and verification of total current assets. We learned that due to availability of the alchohol quota several other manufacturers were interested in taking over the unit and bank could recover its dues with minor injury.

10. DOUBLE COUNTING

Wherever pledge form of securities are offered to the bank the bank used to have a sense of comfort. In fact due to this form of security, a reduction of V2 to 1% interest benefit used to be given besides which the customers used to offer deposit support to the bank. Bank sustained injury more in pledge advance than hypothecation advance due to the fact that mere physical verification of goods under pledge was not correlated with financial statements.

1. Unpaid stocks were offered under pledge.

2. Goods offered for job work were used for raising funds.

3. Market credits or advance payments received were not related to total inventory position and eligible paid for stocks are not often reckoned before granting pledge. In several pledge ad vances granted under clearing agents warehouse certificates, it was observed after discreet enquiries that these stocks were being rotated from one bank to the other and that the clearing agents used to change the name of the banks and issue fresh storage certificates after collecting their rent.

11. NO INSURANCE FOR FAILURE

There was a major fire accident in one of the chemical factories. Branch never used to pay attention to periodical visits. In one particular area, during year end closing, the borrowers declared as low a stock as he could manage and brought down the dues under OCC to the minimum. Under compulsion, godown inspection had to be conducted by the Manager along with the Statutory Auditors. Three months later, a major fire accident occured and the borrowers filed hefty insurance claim. They could not produce any stock register nor were there evidence of godown insepction by bank. Though the stock statements were produced they were inconsistent with what was available in branch records. No copy of godown inspection report during the three months was available. ESank outstandings were not supported by other stocks, unless the stocks declared as consumed by fire were also included. Insurance company, in the absence of proper stock records and purchase invoices, offered to settle the amount only to the extent of what was declared as on 31st December, which stock had been duly inspected by the branch. Due to the huge shortfall in drawing power and acute liquidity problems cash credit with lower margin had to be administered as part of a rehabilitation package, till normalcy was restored.

12. PRE SANCTION / PRE DISBURSAL

It becomes necessary to visit the factory site even in cases where bank has not provided Term Loan. Generally this is not done. It is absolutely necessary to ensure that the unit has created necessary infrastructure, as it is necessary to identify source of funds, ensure availability of margin for working capital not yet eroded by cost overrun.

In fact in one of the units financed by us in Bangalore where the term loans were provided by State Level Financial Institutions, block assets were manufactured by one of the associates of this borrower on whom no satisfactory credit reports were held. This unit failed within 12 months of commencement. The subsequent investigations revealed that the machinery suppliers were borrowers own associates and had not manufactured any machinery beyond Rs. 10 lacs p.a. for the past several years and are known to have delivered machinery worth nearly a crore of Rupees to this project. When our bank appointed a tyre technologist from a reputed tyre manufacturing company to study the matter, it was revealed that the installed machinery was capable of producing only cycle tyres and tyres for two wheelers, whereas the project was for car tyre manufacturing. In the name of supply of machinery and civil construction the borrowers syphoned the entire funds and their intention was bad abinitio. The borrowers abandoned the unit and for nearly 2 decades finaficjal institutions and banks were stuck with the unit. This case very amply illustrates need for our presanction factory visit and verification of assets created even where we as a commercial bank had given only working capital facility.

13. SOLD IN WEIGHT

A unit financed by the bank at Bombay had their factory and current assets stored at Pune. While occasional factory visit used to be conducted by the Bombay branch, periodical factory visit was conducted by Pune branch. On one such visit undertakan by the then Manager of Bombay branch he was informed that no one had so far come from Pune branch (except to call for godown ins pection register and copy of the stock statement) to the branch premises. The borrowers representative was instructed to organise a real factory visit. During the visit to the unit the stocks shown to cover OCC advance were declared in the stock statement in Kilos, whereas number of household articles stocked were shown to represent those declared in the stock statement. When this anomoly of accounting the number in lieu of reckoning weight in Kilos were pointed out and a sample weighrnent was sought, the borrowers protested that never such a thing has taken place and that they were being humiliated with such a request. A detailed report on this account was sent and yet no \ serious action was taken.

At that stage the going was good and imported Stainless Steel sheets sold as rawmaterials at a premium was sufficient to ensure adequate operations and turnover in the account. When this unit failed, traditional shortage in drawing power was indicated as one of the weaknesses in recovery prospects and with huge concessions bank had to launch their recovery process.

14. THOUGHTFUL INSPECTION - TRUTH AT A STONE'S THROW

We had financed a unit set up by a well reputed group, manufacturing wheat products like atta, maida etc. This flour mill had been gainfully progressing over the years and bank facilities were increasing. The operations of the company were subject to selective credit control regulations. The godown used to be visited periodically by the branch Manager. The Inspection of stock was rather simple and less cumbursome, as bulk of the stocks were raw materials such as wheat stacked in gunny bags and neatly stocked. There were negligible stocks of finished goods and goods in process, as process involved was very simple. The promoters of this unit chose to divert their business to film making. Large sums were invested and completion and release of the movie was delayed and the success of the venture was anybody's guess. As more and more investment was required and amounts already invested got stuck up, recourse to flour mill working capital funds became inevitable. The depleted stock was not noticed by the branch manager who was satisfied with stock statement and random godown visits.

This unit was visited by Food Corporation of India officials along with the branch Manager one day, as they suspected that wheat stocks released under quota were not being properly utilised. However, even during the visit of this official, there were visible stocks stored length and breadthwise packed in a room almost to the roof level. The extent of declared inventory would have passed off as genuine, but for the thoughtful approach of the inspecting team to physically count each gunny bag. The team was almost closing the Inspection and when the door was about to be closed, F.C.I, official picked up a stone and threw it high over the room. To their surprise it was found that the stone landed on the floor making a noise, giving room for suspicion that there is a total empty space in between. This suspicion regarding heavy shortage of stock was later confirmed by verification of individual bags. It is here, that the wisdom of an outside agency was able to reveal the true position which our routine inspection could not.

15. AN EYE OPENER

Sometimes periodical visit to the factory also serves as an eye opener to the bank officials and helps them to change their rigid opinions. In Ahmedabad, one of the Textile Mills, whose limits were fully drawn, wanted to retire one inward bill which was turned down on account of inadequacy of balance/limit. For about three days, the unit could not discount fresh bills owing to delay in realisation of the bills discounted and the CC limit was full. In view of the strict instructions not to grant any excess, subject's request for additional drawing was turned down. Four days later, the factory was visited. The factory visit was not confined only to inspecting the stocks. An inspection of the entire manufacturing operations in all the floors was undertaken. During such a visit, it was noticed that a large section of a floor was not active and the machinery was not used in production. The workers gathered around in a corner and were chit chatting. When enquired about the inaction in that floor it was clarified that due to break down of one of the main parts of the major machinery, all related machineries and workers could not be fed with sufficient work. For a meagre excess of Rs. 10000/- required for retiring inward bill covering L/R (carrying the vital machine part) to be replaced, the unit was forced to suffer loss of production, idle machinery time and loss of man hours. Perhaps if such a grim sad situation had been envisaged by the branch, the manager would have mustered the courage to grant the excess and convince the higher authorities.

At times borrowers' problems are better understood by personal visits to the unit and interaction with the borrowers and their technical staff than coming to conclusions based on letters / correspondence.

In respect of large borrowa! accounts, failures have occured mainly on account of total neglect in monitoring them. BIFR while disposing off several cases that came up before them and RBI in their Annual Financial Review have often observed that there were enough symptoms which threw up clear signals for a prudent banker to identify problems and difficulties at an early stage itself and take r emedial action thereby ensuring the safety of advances. Not only branches do not ensure compliance with our stipulation of obtaining stock statements, conduct of godown Inspections and inspection of securities, they do not even care to know what is happening in these accounts.

When a business fails and loss of money to the bank occurs, it is probably possible that the Management may take a lenient view in respect of non malafide/simple acts of ommission and commission. But gross negligence in safeguarding the bank's interest cannot go unpunished. For any branch manager, irrespective of the size of the branch, an advance of Rs. 50 lacs and over for Working Capital is fairly a significant credit line to bring such accounts under closer supervision as prescribed. Total stoppage of production, production well below the level of activity for which sanctions were made, heavy shortage in drawing power, prolonged over dues in bills portfolio and continued irregularities in servicing the term loan interest and instalments etc. are required to be put under close monitoring.

With a view to ensuring that the failures of advances do not come like a bolt from the blue, our bank has introduced a system called Monthly Surveillance of large borrowal accounts as an additional tool in the armoury of credit monitoring instruments.

The form of the statement is given in the annexure. It can be seen that the return can be compiled without the borrower's assistance and from the available records from the branch itself. The statemnet, inter alia, contains details of the following and reveals the features as explained below :

1. Turnover: A look at the turnover will indicate the volume of business routed through us. In addition, a careful manager can also ensure whether the turnover for the current month along with those for the previous two statements for the quarter can be considered as commensurate with reasonable segment of the annual turnover accepted at the time of assessment of the credit.

2. The details of debits contained in the statement can also help us to ensure that the monies are drawn for business purposes only. Diversions for other activities can be identified and borrowers sufficiently cautioned against such diversions. In the case of Consortium advances we can verify whether the business passed on through us bears a reasonable proportion to the size of our limit. Details of cash withdrawals can be examined with a view to ensuring that they are related only to wages salary payment etc. and for other minimum cash requirements.

3. In the case of bills : Though the outstandings may be indicated to be well within the limit, the turnover details called for, such as the number of bills purchased during the month, number of bills and amount paid during the month and outstandings, number of the bills and amount during the end of th e month will amply indicate the activity in that portfolio. Out of the outstanding bills, bifurcated details of overdues can enable the manager to take up with borrowers then and there before they become difficult of recovery.

4. The regularity in the payment of instalments under DPG/ Term Loans will indicate the position and give reasonable signals whether or not the account is heading for the non performing sub standard status.

We have also noticed in a few instances that the details of debits obtained indicate unrelated payments which can be deemed as diversions. Cash withdrawals for large amounts should be closely monitored. The branch should have an idea of their monthly cash requirements for payment of wages and sundry expenses. Any abnormal withdrawal should provoke the suspicion of the branch and branch should make further enquiries. If large payments are made month after month to a set of beneficiaries it is possible that they represent periodical payment for raw material and Misc. supplies. The branch may obtain a list of such recurring beneficiaries and take note of only payments to new parties.

Similarly, abnormal credit summation also requires suitable explanations. Borrowers resorting to any market borrowings may bank these proceeds through the CC a/c. These are not related to our assessment. They are not in any case a source of comfort as it can not be treated as a healthy fluctuation.

We give below an interesting case.

A unit manufacturing Electrical components was enjoying substantial Working Capital facilities aggregating to nearly Rs. 400 lacs. This level of credit was given after their decade of existence and consistent growth in the past.

The Directors who are family members had some difference of opinion among themselves and were contemplating settlement among themselves. As a sequel, large amounts had to be paid off to some of the Directors. The turnover also fell leading to operations well below break-even and profit projections nosedived. These developments were unknown to the bank. In addition, during this period, the unit had purchased four new cars for the use of the Directors by resorting to Hire Purchase from an outside firm. In order to carry out diversions the fully drawn Cash Credit limit was not adequate. The unit convinced the bank to open L/cs on DA terms for six months and through this they were in possession of large inventory. The lead time for conversion of these inventories was not large. Well before due data the unit converted these imported stocks into finished goods sold them and realised the sale proceeds. The y were recycled without any amortisation programme.

At this stage the unit and the Directors knew that the crisis was round the corner. Each one of the Directors wanted to take out as much as possible before announcing the state of affairs to bank. They promoted four partnership firms. These partner ship firms had current account with our own branch and large transactions were carried ouf in these accounts by a debit and credit to the main borrowal account. These four partnership firms were supposed to be selling raw material to the company and were also buying finished goods from them. The branch was satisfied with this explanation. Lots of sums paid out through our CC a/c. to these firms subsequently turned out to be diversions and withdrawal of own funds.

During the same period large cheques were passed by the branch representing interest payments at the rate of 24% p.a. towards the Director's unsecured loan in the business.

When all these things were happening, the company produced an estimated financial statement and a 10 forecast of CMA data and enlarged credit facilities were considered based on Health Code 1 status. It so happened that the outstandings were already close to the fresh limits sanctioned due to unabsorbed interest debits during the last few quarters. When everything was over, the unit chose to announce "sick" status and a massive drawing power shortfall of Rs. 1 1/2 to 2 crores. Curious to note such a shortfall in drawing power and huge cash loss in such a short time, a stock audit was ordered for and this audit revealed some of the undue occurrences mentioned above. This case very clearly reveals continued absence of monitoring at different levels. The branch did not inspect the stock for several months, huge drawing power shortfall was not noticed. Absence of profitable operations escaped the bank's attention. DA Letters of Credit enabled further withdrawals and diversions. Belated submission of financial statements and that too estimates were used as basis for according satisfactory status. Partnership firms of the Directors purpotedly supplying substantial stocks were not even enquired into, as to what their plans are and how, without any working capital facility they could manufacture and supply materials of this magnitude.

This case is sighted to explain that it is possible to detect the undue occurence with the help of the systems and procedures already obtaining in the bank. A careful scrutiny of the Monthly Surveillence data prescribed together with meaningful study of the Quarterly Information System and carrying basic appraisal standards and observing the prescribed godown inspection formalities could have saved the bank from a massive waiver and write off. This case is sighted to drive home the importance of close monitoring needs through the combination of monthly Surveillance data, Quarterly Information System and meaningful godown inspection.

3. Bills Purchased and Discounted (Inland)

OPERATIONS UNDER WORKING CAPITAL FACILITIES

PART - B

I. Fund - based

(I) Cash Credit Hypothecation :

Outstandings at the beginning of the month

ADD : Total debits during the month

LESS : Total credits during the month

Outstanding at the close of the month

Break up details of debits during the month under cash credit facility :

Large payments over Rs. 2 lacs (other than debits to internal appropriation towards Term Loan, LCBR payments, etc,: (PI. attach a Separate sheet, if the space is not adequate)

Other debits

Total debits during the month

(5) Export Finance :

(6) Pre - shipment (Packing Credit)

(b) Post - shipment

Fund based :

There are three types of reviews that a Bank can make as listed below:

(a) A short renewal cum review.

(b) A review of the account cum renewal of the existing credit limits extended to it.

(c) A review of the account with enhancement of credit facilities extended to it or modification of the credit facilities extended.

Whatever may be the type of review any review should highlight the health of the account, security position for the advances given the yield and margin on the security which should have been maintained. A review should also throw light on the status of the account like whether it is performing, standard etc., and details relating to level of sales and profit achievements in comparison with estimates/targets accepted, based on which the limits were fixed at the time of earlier review. Another important aspect of r eview is to ascertain whether there are any major changes in the ownership and management team of the borrowing unit which would adversely affect the interest of the bank.

In other words, a review of the account should encompass the following aspects :

I. Income Recognition, Asset classification and achievement of projected figures :

1.1 Eligibility or otherwise of Income Recognition and Asset classification of the account.

1.2 Credit rating awarded to accounts as per Bank's guidelines in force.

1.3 The extent of achievement of the company with reference to sales and build up of Net Working Capital. Actual Holding level of inventory, receivables and sundry creditors in comparison to the estimates accepted at the time of earlier assessment of working Capital to that company. This could be done by comparing the actuals available based on QIS data with the Annual / Quarterly estimates submitted by the company earlier.

1.4 Financial Structure :

As regards financial structure whether,

(a) there is any change in capital structure or owned funds position of the company.

(b) the unsecured loans that have been reckoned by us as Quasi Equity in the earlier assessment continue to remain in the business.

(c) the same has been withdrawn fully or to some extent and if so, what are the implications to the bank for continuing / enhancing the limits.

1.5 Production:

Whether the Unit continues to produce the same product or it has gone in for any diversification, expansion, modernisation or addition of new product. The level of utilisation of capacity installed should be dealt in brief.

1.6 Working Capital finance :

Were the limits extended adequate or excessive or short of their requirements. If any adhoc limit has been extended during the period under review or any modification of the credit limits was permitted, the reasons for permitting the same should be detailed. The utilisation of the limit and the present position of the particular adhoc or modification should be furnished. Also, whether the need for such an adhoc limit, like unanticipated sales orders in addition to the estimated sales, which was considered acceptable by the bank to consider the adhoc, have been fulfilled. If not, the present position of execution of such orders etc.

II. Management and Major events :

2.1 Management:

In regard to the management of the company.

(a) whether there is any change in constitution,

(b) whether there is any change in the partners/ Directors and key personnel in Technical, Financial, Marketing etc. The review should deal with.the impact of any such change that has occured during the period under review.

2.2 Major events:

All the important events which has affected the utilisation of the Working Capital limits extended to the unit should be covered in the review. This may include, among others :

(a) Product diversification plan undertaken by the company, the impact of the same on company's financial position and will it sustain its position with the diversificaiton.

(b) The competition faced by the company in selling its product. Whether the company offers a discount and its ability to collect from the debtors.

2.3 Working Capital is a dynamic element of any unit's working which is liable to be affected by

1. various events happening in the environment

2. various decisions taken by the management and

3. occurences beyond the control of the management (such as Lockout, strike etc.)

Hence, a proper watch on the impact on unit's performance as a result of such an event is an important function in monitoring of the account and that should be stated in detail in review of the account.

III. Cash Flow and Liquidity :

3.1 This depends on series of decisions taken by the company with regard to production, marketing and future expansion plans. A comment on such decisions should be given. This is to ensure that the assets which are secured to us for the limits extended remain in bankable quality. This would also in a way ensure that the end use of funds is verified.

3.2 To understand cash flow let us take a simple case of the trader in apples who buys @ Rs. 3/- per apple and sells @ Rs. 5/- thereby making a profit of Rs.2/- per apple. The volume of transaction viz. the quantity purchased and sold determines his total profit. It may be seen that for a given turnover the total amount of "Profit" remains unaltered but "cash flow" can vary on account of the following decisions taken by the trader such as

1. to buy and sell for "cash"

2. to buy for cash and sell on credit

3. to buy on credit and sell for cash

4. to buy on credit and sell on credit.

Under situation 2 there is virtual "Bankruptcy" (Negative cash in-flow i.e. Rs. 3/- per apple) and under situation 4 the cash inflow is "nil". "Buy on credit and sell for cash" situation results in excellent cash inflow. Such a situation may not always exist since the availability of suppliers credit is not entirely in the hands of the trader and the goods traded may be in buyers or sellers market. The example given below, illustrates, position of cash flow and profitability assuming buying and selling situation for cash. It can be seen that net "cash flow" depends upon the "inventory held" under closing stock, though "profit" may remain unaltered.

IV. Major decisions taken by the company influencing Working Capital and liquidity of the Unit.

4.1 Details of decision taken by the unit affecting working capital limits, for example credit period extension, procurement of materials on credit, increase / decrease in holding levels of inventories, new market developed, repayment of unsecured loans from Partners / Directors / Promoters, capital expenditure on account of backward / forward integration which will have an impact on the Net Working Capital should be elaborated. The impact of such decisions should be commented. This is a very important area which the review / renewal should touch upon and the implicaitons on the safety of the advance should be analysed and spelt out.

4.2 While most of the major decisions taken by the company may be good in the long term interest of the company many a time several decisions taken by the company result in impairment of the Net Working Capital (NWC), liquidity and profitability. In order to highlight the importance an illustration is given which deals with the renewal / additional facility proposal received from the branch :

ABC Ltd. was engaged in manufacture of tooth brushes and selling them through a well reputed wholesale distributor with a very well established brand name. The sale was on 120 days credit terms, the hundies were accepted by the company and co-accepted by another bank. The unit was a Small Scale Unit and has six tooth brush filling machine and separate equipments for packing etc., in addition to brushes manufacturing machine. Their progress was steady and the turnover was increasing from Rs. 50 lacs to Rs. 120 lacs and then to Rs. 200 lacs during the last 3 years.

They were buying raw materials namely nylon bristles from one company on 3 months credit basis and tooth brush handles on 2 months credit terms. Sales realisation and creditor payments were regular.

Summary of financial statement is given below :

Net Working Capital (NWC) available = Current Assets - Current Liabilities

40 - 25 = 15 lacs

When the unit gave their applicaion for renewal / enhancement they had applied for a term loan of Rs. 35 lacs to purchase Windsor Machine, an extruder plant for manufacture of nylon bristles and for making handles.

The unit pointed out that by installing these machines they will be able to increase the total turnover by Rs. 50 lacs and save the profit outflow on these bought out items thereby increasing the profits and profitability. In other words they thought of manufacturing the two items that they were till then buying from two other manufacturers.

The company had also mentioned that on account of undependable erratic supply of raw materials earlier viz. the bristles and tooth brush handles, they suffered on many occasions resulting in delayed supply and distributors getting annoyed.

Existing accounts were regular and the interest on bills, cash credit and term loans with instalments were serviced promptly.

There appeared no difficulty in taking up the request. Considering the company's past satisfactory dealings term loan was sanctioned along with renewal of existing working capital limits.

Six months after installing the machine when the factory visit was held, it was noticed that the newly purchased machines were found to lie idle, neatly closed with tarpaulins after erection. During the same period, operations in the account were erratic and cheques issued by thenf were asked to be re-presented.

General liquidity strain was felt and the first instalment of term loan falling due in the six months also remained overdue.

What went wrong ?

No doubt this proposal would be taken up by most of us considering the satisfactory dealings in the past, progressive growth in turnover and promptness of the company in keeping up its commitments like repayment of term loans etc. However it can be noticed that:

1. The unit's surplus Net Working Capital was hardly sufficient to pay 25% margin on the term loan disbursed.

2. Required margin for term loans worked out to Rs. 11 lacs of which hardly Rs. 5 lacs were available and remaining Rs. 6 lacs paid created corresponding working capital shortage in the existing activity.

3. It transpired that in the bristle making activity, there was no credit available from the supplier of basic raw materials. This basic raw material could be had only on cash payment.

4. Considering the liquidity angle the erstwhile supplier of bristle was giving him 3 months credit which-works out to Rs. 13 lacs.

5. Similarly tooth brush handle supplier was giving 2 months credit which approximately works out to Rs. 4 lacs.

6. When the above credits were no more available the entire working capital requirement of the integrated unit underwent a change.

7. Due to this the unit deprived itself of the availably of Rs. 17 lacs credit on purchases and had to lay down cash for purchase of basic raw materials amounting to nearly Rs. 8 to 9 lacs.

8. This non availability of Rs. 17 lacs of their credit together with the amount diverted towards meeting margin requirements for acquiring capital equipments amount to severe liquidity short age.

The bank could have considered a total Working Capital package for the integrated unit provided the unit had margin paying capacity for the term loan. Since the borrower had no recourse to long term funds he could not have availed such working capital even if offered.

As a cumulative result of all this it was worthwhile for him to operate by resuming purchases of the 2 materials viz. bristles and handles from outside. It took the company about 3 years to service the capital assets by straining the profits generated and by disposing off one of the machineries purchased.

This is the case in point to highlight that the unit's decision to diversify and to go for backward integration from profitability angle was a good one, but the timing of the plan was not correct. The unit did not visualise the impact of the position on the existing working capital position and future working capital requirement.

The banker could have counselled him about possible areas of pitfalls. Instead of encouraging him to push through diversification plan at that stage, bank could have persuaded him to undertake the expansion at a later date when they could have sufficient owned long term funds.

Another case where one of the major decisions of a good borrowing unit turned out to be a wrong one is given below :

DEF Ltd. was engaged in manufacture of Plastic buckets and was selling at Rs. 18/- per bucket in the local market.

The market for the unit was well defined and the company was able to cater to the requirements of its distributors in time. The reputation of the company was very good and it had also earned a good brand name with the consumers.

The company received an order for 1 lac buckets from a reputed washing powder manufacturer as a one time order with 10% advance payment. To execute the order within the stipulated time, the unit had to create infrastructure facilities like some Plant & Machinery and some balancing equipments.

The unit approached, with a copy of the order, their existing bankers for term loan as well as adhoc working capital facility to execute the order. It was also assured to the bankers by the company that such order would be repetitive in future.

Considering the satisfactory dealings of the unit in the past as well as its financial strength and also being convinced by the fact that repeat orders would be forthcoming from the reputed washing powder manufacturer, the bank sanctioned the required term loan and adhoc working capital limits. The company executed the order in time and made good profits. However, while the adhoc working capital limits were repaid the repayment of term loan instalments began to be irregular.

While probing the reasons for irregularity the following points came to light to the banker.

1. The washing powder manufacturer had declared a scheme by which if any one puchases two 500 gms. Packets of washing powder they would be given one bucket free. So this order was meant for effective marketing of washing powder. Once the scheme came to an end there was no need for the washing powder manufacturer to repeat the order.

2. To the dismay of the unit it was later realised that the area in which the unit was marketing its products a majority of the households had received a bucket under the sales promotion scheme of the washing powder manufacturer. As a result existing market for the unit itself had shrunk.

3. Non repetition of the order from the washing powder manufacturer coupled with steep fall in the existing market of the unit had resulted in lower turnover and profits of the unit, which had its effect on the ability to repay bank's term loan.

What went wrong?

1. The huge order was accepted by the unit from the washing powder manufacturer at a selling price which carried nearly 20% discount over the normal market price at which the unit was selling the buckets. So the profit earned was less than the normal profit it could earn through direct sales in the same market.

2. The company had created infrastructure for meeting the orders without ensuring whether repeat orders would be definitely forthcoming.

3. With the free buckets being offered in huge quantities to the market the demand for company's buckets fell sharply resulting in lesser turnover.

The company had to reorganise itself to overcome this problem. One of the methods followed by it was to offer more attractive and different shapes of buckets. To manufacture such an attractive bucket the company had to first make a die. It took nearly 12 months for the unit to make a die of an attractive model of the bucket. Hence, the operation of the unit suffered for more than 17 years.

However, the new model buckets were well accepted in the market and the company could come out of the troubles in course of time but not before making cash losses for a couple of years.

This is another illustration of major decision taken by a company which might result in jeoparadising its existing operations itself and provides for additional thoughts for bankers counselling wisdom.

V. Restructuring the limits :

It is not out of place to mention that the limits sanctioned at times appears large and disproportionate to the level of operations in the account. A careful look at utilisation will reveal that bulk of the limits are unutilised either because some of them remain as a standby or some of the conditions stipulated could not be complied with.

By and large limits are sanctioned only for availment after taking into account the borrower's credit worthiness and his credit needs. If there are impediments in utilising the need based credit extended they should be thoroughly discussed and sorted out before recommending the renewal.

Certain conditions such as

1. bringing long term funds towards margin.

2. pegging unsecured loans

3. getting the acceptance of major buyers for supply bill / usance bills.

4. completing the mortgage formalities etc., may not be waived

Also, while it may not be possible to go back on all the conditions stipulated considered relevant to the safety of the advance some impediments can be removed by proper discussions particularly where the renewal proposal is received with visible incipient sickness. To illustrate the above the following case study is quoted.

A pharmaceutical shop situated in a thick market place was sanctioned cash credit limit Rs. 50000/-against stock of numerous pharmaceutical items and with collateral security of shop valued at Rs. 1 lac.

This account suffered continuously from cash crunch. Though the daily cash collections were remitted, not a day passed without inward clearing cheques being referred for funds. The conduct of the account was a perennial source of nuisance to branch staff at all levels starting from clearing Dept. to the branch Manager.

During one of the review undertaken it was noticed that their daily sales amounting to around Rs. 2500/- (all in cash) used to be remitted. Their daily drawings were also of the order Rs. 2000/- to Rs. 2500/-by way of inward clearing cheques. The CC a/c. used to fluctuate between outstanding of Rs. 47000/- to 50000/- always. When the monthly interest used to be debited in CC a/c the cheques issued by the company used to be returned for re-presentation.

A careful study revealed that whatever profits generated by the company was hardly sufficient to meet interest liabiity. Borrowers were sincere and honest and yet could not get out of the embarrassment.

What was the cause?

The structuring of the limit abinitio was wrong. They should have had a repayable term loan, and a small operating cash credit of say Rs. 5000 to Rs. 6000 instead of an omnibus CC limit of Rs. 50000/-. The bank interest for Rs. 50000/- level and the carrying cost of slow moving high value items like expensive tonics etc., swallowed the profits. The borrower worked day and night to service bank interest. When it was pointed out to the borrower that they could never get out of this impasse, particularly when their sales were adversely affected due to declaration of one way traffic in the road where the shop was situated, the borrower realised that continuation of business was harmful to himself and to the banker.

The thought provoked by bank at the time of renewal worked in his mind and he quickly decided to dispose of the shop and took it on monthly lease basis from the purchaser. The sale proceeds were used to liquidate the CC outstanding which was brought down to Rs. 7500/-. Thereafter the operations in the account was conducted only through their messenger staff. There was no problem thereafter.

Yet another case was the proposal before the branch to review a CC limit of Rs. 10000/- and a term .loan of Rs. 50000/- for a delivery van extended to a sweet meat shop. The entire term loan was irregular and CC limit was used in full and for last one year there was no operation in the account. Bank had a choice either to recall the advance and call it day or probe into the causes for the default.

A visit to borrower's premises was undertaken before renewing the existing limits along with a letter threatening to recall the advance. During the visit it was noticed that production of cheaply priced toffee was in full swing. There was also enough sugar bags to cover the bank dues. The entire production was lift ed and sold to retail shops almost on same day.

This unit was situated in the border of Tamilnadu and Kerala and the sweet meat / toffee found its place in more than 150 to 200 retail shops.

When the borrower was asked as to

1. why the account is not being operated

2. why daily sales are not remitted and

3. why term loan instalments default exists

he politely replied that daily collections and expenses have almost been matching.

A few cheques were earlier returned by the branch, which scared the customer from again remitting daily cash for fear of bank appropriating such remittances towards overdues.

Though the level of sales generated adequate surplus to service the term loan, they were used to finance larger volume of sales.

A careful analysis of subjects case revealed that the unit did suffer for want of long term funds (which the bank could have provided) to finance hard core current assets.

It is interesting to note that the stock held by the numerous retail shops were hardcore not because they cannot be sold, but the payment to borrower will be made only after he replenishes the stock. In other words after delivering fresh stock, company representative would be in a position to realise payment for previous supplies.

At all times, borrowing company had Rs. 10000/- worth of stock at various shops which could be fully recovered only when unit goes out of business. This amount could have been sanctioned by the bank as a repayable term loan.

As there were enough collateral by way of mortgage of residential house of the borrower, with a little bit of additional exposure by way of term loan and a slight reduction in CC limit to commensurate with daily collection, the borrower bounced back to a well operated CC a/c. and started servicing term loan for delivery van also.

It would have been a harsh decision if bank had forced the issue and closed the business. There was enough profit margin in the business and so the limits were only to be restructured.

VI. Operation of the account:

Critical analysis of the operations in the account would reveal the extent of utilisation of the limits 10 with our bank, whether the utilisation was in tune with the sales achieved, whether the sales proceeds were routed through our medium as prescribed, whether ancillary business such as L/C, L/G etc. were routed through us, whether payment of bills was within the time limits prescribed in our sanction and assumed in our assessment, percentage of return of bills to the total bills purchased / discounted, age of book debts hypothecated etc. These are some of the areas to be commented in review.

VII. Monitoring of commitments :

Various conditions are laid down at the time of sanction of facilities and for sanction of adhoc limits. The review should also comment whether the unit has fulfilled all the commitments given / undertaken (for example payment of bills under LVC, payment of term loan /DPG instalments, regularisation of adhoc limits within the time stipulated, creation of charges etc.)

VIII. Income earned :

The income earned comprising interest, exchange, commission etc. during the period under review, any concession shown on account of the above charges and reasons for the same are to be commented.

Conclusion:

A review / renewal should not confine itself to financial parameters alone. Financial statement can not throw light on certain factors like changes in management and Key Personnel, impact of major decision taken on the unit's functioning as well as on availability of Net Working Capital and Working Capital requirement.

Hence, the review / renewal exercise should be made based on various data given above. Such an action would enable the bank to recover maximum out of non performing and doubtful assets and in many occasions identify such accounts in the early stages itself.

It can also be seen that review / renewal process can be used as a tool for detecting incepient sickness and removing the same. Knowledge, experience and wisdom of the banker, should always come into play in reviewing / renewing as well as enhancing the credit facilities extended to an existing borrowal unit.

Lending is thus an art and a science. There is no substitute for banker's wisdom which must be fully employed and constantly sharpened.

PALS Electronics has been enjoying working capital limits to the order of Rs. 3 crores. The limits, interalia, include Cash Credit Hypothecation, supply bills and import LC.

While assessing the credit requirements the sales level was accepted at Rs. 10 crores. Certain levels of creditors and unsecured loans were assumed to justify the permissible bank finance and the long term funds necessary for an acceptable current ratio of 1.33.

DEVELOPMENTS

The account came for subsequent review seeking enhancements based on Rs. 15 crores sales projection. The financials submitted confirmed the existence of the accepted current ratio and full drawing power to cover all the outstandings including Bills received under Usance LC.

However, the company had achieved the sales level of Rs. 6 crores as against Rs. 10 crores projected earlier and the proposal at CO was under correspondence seeking justification for use of entire limits when the actual sales had fallen below the target mark. The enhanced sanction was kept in abeyance though there was pressure from party. Adhoc sanction was made to the extent of Rs. 50 lacs with a stipulation that the account should be "closely monitored".

Within three months of the adhoc sanction there were physical evidences of bad performance.

WHAT WENT WRONG

1. The operations in the Cash credit account were not commensurate with the limits and sales level

2. Bills under Usance LC were not taken up on due dates.

3. It was reported that overall drawing power to cover the funded dues of Rs. 350 lacs was a meagre Rs. 100 lacs.

Acute Drawing Power shortfall of over Rs. 2.50 crores took the bank by surprise. When queried the reply came casually that the shortfall was on account of Cash loss.

For a unit of this size it was not possible to sustain a cash loss of Rs. 2.50 crores in one year. The deterioration could not have occurred overnight. There was progressive deterioration which went unnoticed. The panic that was created resulted in detailed investigation cum stock audit by a professional Chartered Accountant, His report, interalia, revealed that

1. The data given in CMA form based on which assessment was made and the financial forecast accepted were themselves fudged.

2. The unaudited financials literally hid the true position.

3. The unit had acute shortfall in drawing power even during assessment period.

4. The unit's Directors had Partnership/Proprietory accounts in the name of their family members in the same branch.

5. These firms including that of the Finance Executive had reportedly sold goods to the unit or bought goods from the unit.

6. Supply Bills drawn on these firms have been purchased.

7. The so called supplies made by these companies to the borrower were fraudulently preferred by payment by cheque through our own branch out of the adhoc limits released. It is quite interesting to observe that the aggregate of supplies purportedly received by the unit was much more than that stated in the financials and sales made to these firms were much more than the production capacity of the borrower unit during those period.

8. During the same period there were genuine creditors for the goods supplied who were overdue for settlement.

9. Some of the payments made during the period related to instalments made for hire purchase of cars given to the Directors.

10. The other payments that were made include heavy interest payments on unsecured loans purportedly brought in by the Directors and during the same period the Bank's quarterly interest debits remained unserviced for more than 5 quarters.

The Branch did not bother to recover its own interest but was willing to pass cheques resulting in outflow for preferential interest payments.

Whatever adhoc that was released by the bank and some sales realisation were systematically syphoned off leaving the core and unsaleable inventory to cover the bank outstanding with a drawing power shortage of Rs. 2.50 crores.

After several years of prolonged negotiations and recovery oriented efforts and with the help of collateral securities held, bank could recover part of its dues.

This experience of the bank would certainly reveal that the account was not subject to "Close monitoring" as also "Ordinary monitoring". One and half years of periodical go down inspections/ factory visits did not reveal any inventory shortage leaving the impression that the go down/factory inspection was done in a casual way or has not taken place at all.

The sanctioning authority while handling cases revealing near similar situations would certainly be tempted to stipulate close monitoring as one of the conditions.

Central Office may not be able to envisage all such attempts to syphon off the funds as it is not functioning at the grass root level. Such monitoring mechanisms could be thought of in a situation like this only at Branch/Regional Office level and scrupulous observance of stipulated terms and conditions and guidelines laid down.

ABC Ltd had requested the bank to consider a term loan of Rs. 100 lacs to part finance its expansion project. The project was implemented 5 years back. The Bank had earlier sanctioned a term loan of Rs. 400 lacs.

The performance of the company in the last couple of years has shown marginal improvement. In the interest of the company and to ensure its continued viability as well as to secure the bank stake already given, it is prudent that fresh Term Loan is considered. This Term Loan is for acquiring certain balancing equipments which would have a bearing on reducing cost of production and widen the "Cash Generation Base".

Bank therefore felt that there was need for considering the Term Loan in its own interest but yet the sanction was made available with the condition that the account especially the drawals should be subject to "close monitoring".

WHY?

Earlier, Term Loan was sanctioned for a project cost of Rs. 600 lacs which included Working Capital Margin of Rs. 50 lacs and preliminary and pre-operative expenses of Rs. 25 lacs. There was a delay in commencement of commercial production and hence there was a consequent cost over run.

There was also significant cash loss during the initial period, when the original project was supposed to be generating positive cash surplus. The first casualty, in meeting cost overrun which was not independently funded, was evaporation of margin money provided towards Working Capital needs and unfunded remaining portion of Cash loss.

The poor monitoring mechanism also did not reveal part withdrawal of unsecured loan (brought in by the promoters during the implementation stage.)

Somehow the company managed to draw working capital limits to the full and the drawing power shortfall was hidden.

It is in this background the term loan of Rs. 100 lacs requested for acquiring balancing equipments was sanctioned in order to retain the viability of the unit. However, in order to ensure that the past monitoring flaws do not creep in again "close monitoring" was stipulated.

Close monitoring here includes

1. restrictions regarding cash disbursement out of term loan account and direct payment to machinery suppliers.

2. credit report on machinery suppliers and invoice verification.

3. disbursal of term loans only on matching contribution of promoter's stake

4. release of additional working capital limits to cater to the enhanced production as a result of installing balancing equipment to be done only after ensuring that the said equipments are brought into the factory and installed.

5. post inspection is a must at different stages to ensure end use as well as the correctness of the value of the equipment installed.

6. as far as possible relating the term loan component to tangible asset creation such as machinery purchased and level of civil work portion if any to be completed out of owned funds and

7. if actual and projected NWC is just sufficient to cover the existing working capital, no diversion even towards margin be permitted and/or on the contrary the promoter's contribution be brought in cash from outside the business.

When everything is alright or appears to be alright we tend to loosen our grip particularly in the observance of basics. It is during this period of slackening certain unscrupulous borrowers tend to take advantage of the bank. Close monitoring some time involves critical monitoring accompanied by strict observance of stipulated conditions and adherence to laid down guidelines.

Any commission or omission deliberately done during this period normally surfaces only after one year on receipt of Balance Sheet and it will be too late to do anything if the unit slips beyond normal recovery process.

At times it so happens that during this period credits are generously recommended and get sanctioned to enable the borrower to implement his evil scheme of things. When noticed it is not always the case with banks to recall the advance as the units are still going concerns. Need based limits are being extended but not without reservation. Need for close monitoring gets mentioned and the same should be read with the incident that had occurred.

Given below are a few more cases to highlight the close monitoring aspect.

OPERATIONAL INSTRUCTIONS

The cases given as illustrations are only a few glaring examples highlighting the level of business prudence.

Fund is expected from Bankers. Needless to point out that the Branch Management which is close to the place where things are happening is most advantageously placed to notice these as they happen and go all out to protect the bank's interest. A stitch in time verily saves nine.

Branches and Regional Office should bring into operation a high level of control over the borrowal accounts so as to ensure that all our assets are in tact and, at all times, really remain Performing.

BACKGROUND

HONEST STEELS LTD enjoys working capital credit facilities to the extent of Rs. 5 crores. The limits were sanctioned for a projected turnover of Rs. 20 crores for the year 1990-91.

After 1 1/2 years of original sanction, a proposal was submitted for renewal/enhancement of credit facilities to Rs. 6 crores. It was observed that against the projected sales of Rs. 20 crores, the actual sales were only Rs. 13 crores. The limits, however, were fully utilised.

The reasons attributed for lower level of sales were delay in commencement of commercial producton, sluggishness in market and delay in appointing dealers at different centres. Considering the various factors involved and the unit being in infant stage it was decided to renew the limits for the year 1991-92 and watch the units performance for another year.

During 1991-92, the company achieved a turnover of Rs. 19.6 crores and projected a turnover of Rs. 24 crores for 1992-93. The bank was impressed and enhanced the limits to Rs. 6 crores accepting the projected turnover of Rs. 24 crores. The limits were fully utilised.

DEVELOPMENTS

For 1993-94, the unit submitted a renewal proposal for enhancement in credit facilities to Rs. 9.00 crores. The unit had projected a turnover of Rs. 36 crores for 1993-94. The company had submitted an unaudited financial statement for 1992-93 which revealed a turnonver of Rs. 28.00 crores during the year. Based on past performance, Branch/Regional Office were convinced of the need to enhance the limit and so duly recommended enhancement of limits to Rs. 9.00 crores for 1993-94.

Central Office called for audited financial statements for 1992-93. Regional Office obtained the same and forwarded it to Central Office. While scrutinising the schedules attached to Balance Sheet, it was observed that Receivables to the extent of Rs. 5.95 crores were due from Honest Traders. On probing, like seeking credit reports etc., it was ascertained that they are the associates of the subjects.

Central Office called for audited financial statements for 1992-93. Regional Office obtained the same and forwarded it to Central Office. While scrutinising the schedules attached to Balance Sheet, it was observed that Receivables to the extent of Rs. 5.95 crores were due from Honest Traders. On probing, like seeking credit reports etc., it was ascertained that they are the associates of the subjects.

It was really of interest to note that for a turnover of Rs. 5.95 crores profit was a meagre Rs. 1.00 lac. More importantly the entire sales figure of Honest Traders tallied with receivables level of Rs. 5.95 crores shown in Balance Sheet of Honest Steels Ltd.

The unit was inspected to explore the strange coincidence observed. The closing stock level in Honest Steels Ltd was at very high level of Rs. 8.50 crores. On the same day the premises of Honest Traders was visited and it was found that the level of stock was NIL. It transpired that this unit had sold back the entire stock to subjects in April '93.

It was obvious that in order to camouflage the sales figure, the Company has routed the transaction through one of its associate firms. Thus finished goods held during March 1993 became receivables and got converted back to finished goods in April 1993 though inwarded back as purchases - raw materials.

Well. Subjects had understood that higher working capital eligibility is basically based on sales and sales projections. Non existent sales were booked in the year to make projected level acceptable. When their game stood clearly exposed, they settled down for realistic working capital limits against realistic projections. Diversion possibilities/efforts were thwarted.

Close monitoring in this case is not merely observance of laid down norms/guidelines, but is beyond this. Integrating physical features with actual financial and forecast and meaningful study thereof could reveal ugly intentions to take bankers for a ride. This case study, it is hoped, will link close monitoring to critical monitoring through extraneous tools.

1. relating the commodity to the nature of activity in which borrower is engaged and for which limit is sanctioned.

2. credit report on drawees and finally

3. verification of infrastructure capabilities to produce Rs. 50 lacs extra goods by a company, whose annual turnover was less than Rs. 1.5 crores.

The Bank may have to show a prolonged tolerance to fully recover the limits. Certainly there is a need for continuation of credit facility for both banks and borrowers mutual co-existence.

The renewal/enhancement in present proposal in the light of what had happened will certainly carry the message that the account should be "closely monitored".

ABC Ltd. established in 1978 is engaged in manufacture of conductors. The unit enjoyed working capital limits of Rs. 80 lacs which interalia include Key Cash Credit, Supply Bills and Usance Bills facilities. The unit also enjoyed non fund based limits of Rs. 30 lacs.

Upto 1992, the performance of the unit was satisfactory. By mid 1992, there was a labour strike in the unit which resulted in the unit being closed down. The account was not operated during the strike period.

DEVELOPMENTS

After a prolonged and continued negotiation for over an year, the strike was withdrawn and production commenced.

During the strike period the following events took place.

a) As stated earlier the account was not operated and interest debited was not serviced.

b) The unit's main buyer viz. State Electricity Board (SEB) invoked a Letter of Guarantee for Rs. 10 lacs due to non performance. The unit could not supply to SEB due to strike. The invocation was honoured by making payment to the debit of TOD account.

Though the unit was closed for an year, the materials being non perishable were in good condition. The overall indebtedness to the bank was Rs. 125 lacs which was not covered by Drawing Power.

The unit requested permission to operate the account as follows.

Rs. 125 lacs being the overall indebtedness of the borrower.

Branch/Regional Office recommended favourable consideration of unit's request considering the long standing association and the unit is now commencing operations.

To consider the request the following details were called for.

1. How the labour dispute was settled?

2. What was financial outlay to the unit to settle the dispute?

Latest Balance Sheet.

The unit informed that a negotiated settlement was reached with the labour union in the presence of the Labour Officer. As per the settlement the company had to make an exgratia payment of Rs. 75 lacs to the labourers.

The unit had purchased the materials with its own funds and had started functioning on 3.6.93.

The latest audited balance sheet revealed the following.

The enhancement in working capital was justified on the following

Regional Office had recommended a MPBF of Rs. 100 lacs considering that the company is coming out of troubled times and needs support. In the process bank's interest would also be protected.

WHAT IS THE MISSING LINK?

For the year 93-94 the value of fixed assets has gone up by Rs. 50 lacs. How was the same funded?

The level of creditors and other current liabilities have also come down substantially during the same period (93-94). Inventory and sundry debtors value have come down as on 31.3.93.

Regional Office reply indicated that the unit had revalued the assets during June '93 and hence the value of fixed assets was projected higher as on 31.3.94. The point that was missed was that if assets are revalued, reserves level should have gone up, whereas in this case there has been a marginal increase only.

Further enquiries / investigations revealed that

a. the revaluation amount has been utilised to justify the payment to the labourers to settle the dispute.

b. To fund the cash flow, inventories were disposed and debtors were collected privately. These current assets were charged to the bank (the bank was left with drawing power shortage even at the time strike surfaced).

c. Investments were disposed off to pay all pressing creditors.

Bank threatened action for 'conversion' of its rights and the unit agreed to settle the issue with the bank and requested for sanction of proposed facilities to tide over the present crisis. The company offered collateral security for the proposed enhancement, a building valued at Rs. 250 lacs in a busy business centre.

Considering that it was preferable to ensure the quality of asset and the unit should be given an opportunity to correct itself, the request was considered as follows.

For the balance Rs. 25 lacs shortfall in working capital sanction, the unit was advised to look upto creditors. The unit expressed confidence to get market credit for purchases upto Rs. 25 lacs.

Subsequently, unit's performance improved. The WCTL is regular and operations in the account are more or less in line with the projections.

But what is important is that the borrower had conveniently fudged the balance sheet and hid the payment made to labourers and creditors to the bank. A cursory scrutiny of the Balance Sheet at branch/Regional office level itself would have exposed the systematic syphoning of funds to meet labour payments under dispute. It was funds legitimately due to the bank which was used to pay the labourers. Diversion of funds, withdrawal of materials and direct collection of sale proceeds were unnoticed by the branch. Worse scenario was that proceeds of inventory sold and book debts that were collected were put through current account opened at the same branch.

If at all branch had been vigilant in this account, the proceeds collected could have been used to reduce dues to us. Since a part of the loan was funded as WCTL, the asset was classified as 'Substandard' for 2 years and attracted 'Provision' which could have been avoided if branch was 'closely monitoring' the account. After all monitoring should be very close in the rehabilitated units as well as in units under stress from Labour/market/Govt. Policy, pressing creditors, fall in demand, rejections etc.

The preceding sections dealt elaborately on the importance of close monitoring and critical monitoring. Discussion on close monitoring highlighted the need for very close attention to the operations in the account and correct inferences thereon for the operations whenever adhoc/additional limits are sanctioned or wherever modifications of the terms of sanctions are made. Critical monitoring highlighted the tendency to loosen our grip particularly in the observance of basics when everything is alright or appears to be alright.

Intensive monitoring stems from interaction with borrower. Such monitoring is also necessitated when a unit gets rehabilitated from sickness.

There are accounts which give a sense of overall satisfaction though the operations in the account bristles with regular signs of lack of liquidity, margin paying capacities, inabilities to meet commitments in time etc. Such signs may be indications of impending trouble which may lead to sickness.

Interaction with the borrower will throw light on certain hidden plans of the Company/recurring problems faced by it/over enthusiastic plans to expand or over trade etc, which are otherwise not advised to the Bank through the regular MIS submitted to the Bank. Such hidden facts might be detrimental to the Bank's interest.

Especially when the unit is showing signs of sickness or well ahead in its route to being sick there will always be a tendency on the part of the creditors to recover their dues, with least expenses and time spent. It is the general experience that the unsecured creditors are both quick and smart to recover their dues in full first. Government machineries have both the power and wherewithal to recover the dues to the full. Trade creditors can sqeeze the Company's operation and recover their dues. Even the owners take their money back by more ingenious methods (example -diversion etc).

It is generally the Bank which is left to hold the borrowers dues, sometimes, to eternity. But bankers are also to blame for their lackadaisical approach to monitoring these situations.

OPERATIONAL INSTRUCTIONS

Two case studies to highlight the importance of probing interactions with the borrower while monitoring a borrowal account are given. Another case study on monitoring a sick unit is also enclosed.

It is once again reiterated that Branch management which is close to the place where things are happening is most advantageously placed to notice changes that are happening. Thus Branch Management is best placed to protect Bank's interest by taking appropriate necessary immediate steps. It may not be out of place to menti on that it is the human tendency to recover whatever they can from a burning house. But to do this also you need mental alertness and physical ability. The situation is no different for a Banker whenever a unit becomes sick.

Picking up unintentional - unconjcious disclosures from the borrower on things like developing liquidity stress etc. calls for mental alertness which the Branch management should develop to become an alert/prudent Manager. Otherwise we will be one among host of bankers trying salvage out of ruins like rag pickers.

A burnt house needs to be rebuilt brick by brick and In every stage Its ability to bear the stress has to be assessed. Necessary corrective actions has to be taken as and when required. The situation is the same while rehabilitating sick unit. The enclosed case study will give a broad guidelines for monitoring a sick unit under rehabilitation.

Monitoring tools, methods and approach needs the same ingenuity in lending. It is an ongoing exercise to be developed and nurtured. No manual or guidelines to monitoring should have a back page to indicate conclusion. So will be these "Return to Basics" series. I hope that some day, some one will keep this updated.

PSI. Ltd, Is an chemical unit enjoylng working capital credit facility from the bank to the extent of Rs 300 IACS FOR the projected turnover of Rs. 900 lacs. The unit belongs to a well known group with good means.

Though the unit has been performing to an extent satisfactorily, achieving a turnover In the region of about Rs. 750 lacs continuously for the last couple of years there has been net working capital shortfall and current ratio was hovering around 1.25.

DEVELOPMENTS

During the course of one of the discussions with the branch, the officials of PSL indicated that they are planning to set up a textile unit at a cost of Rs. 800 lacs and they had obtained in principle sanction from financial institutions for extending a Term Loan of Rs. 600 lacs for the proposed project. Subsequently the company informed that the loan has been sanctioned by the Institutions and the project implementation is under brisk phase. After 6 months the company came with a request for working capital limit of Rs. 600 lacs for their Textile Mill.

Branch obtained the details from the unit and submitted a proposal for sanction of the limits requested. Regional Office also recommended for sanction of limits considering the long standing connection and past satisfactory dealings.

The means of finance, which included internal generation of Rs. 200 lacs for the proposed project threw a spark to the sanctioning authority. After all the company's current ratio was lower than required 1.33 and how the company proposed to invest Rs. 200 lacs from internal generation. The units present net working capital is itself around Rs. 80 lacs only. A query on the above lines was raised on the branch proposal.

The unit took serious objection to this. The company officials called on the Sanctioning Authority to discuss the issue. They explained that they were trying to dispose off a house property worth Rs. 50 lacs to augment the internal generation.

The financial institutions had made part releases on matching contribution basis. Ever after the disposal of the property there will still be substantial shortfall to meet the required Rs. 200 lacs from internal generation.

It was decided to investigate the case.

HOW DID THE REQUIRED FUNDS COME IN?

Investigation revealed that the sundry creditors level was substantially higher than the one estimated at the time of sanction of limits. The company has got very high credit period and utilise the available period to process the material, sell and collect the sale proceeds. Declaring these as paid stocks for DP calculation, the company has been getting the sanctioned limits from the banks. The funds have been utilised as unit's contribution towards the textile unit.

When the matter was explained in detail the company officials were convinced of the bank's stand and agreed to rectify this situation by liquidating substantial investments they held plus one more property at their disposal.

The financial institution were also advised that while accepting the means of finance for a project they should have taken care to see that the promoter's contribution are truly and solely promoter's own. If promoters try to divert bank funds towards their contribution to finance the project there is every possibility of conversion. Financial Institutions realised the need to consult the bankers on such sensitive issues. The means of finance was revised by the institutions and internal generations was replaced by capital.

If at all the branch managomont had been smart enough to take the lead when the company Initially advised of the plan to set up the textile mill such situation could have been avoided. After all it should have struck to the branch management that there is no long term surplus available in the unit to embark on diversification. At least when the company submitted the proposal for working capital limits, the branch should have seen that the sum of Rs. 200 lacs from the unit is proposed to be invested in the textile mill.

Even our earlier circular No. 4 discuss In detail the need for discussions with the party. The periodical discussion with the party will throw light on various future plans of the borrower. Such future plans may also have an important impact on a security cover. It may either strengthen or weaken the security cover. But in most cases the security cover only gets further weakened. Such discussion can also pave way for unconscious disclosure from the borrower on developing liquidity stress, weakening market share etc. Alert/prudent branch managers pick up the lead and put the unit into normal discipline at the initial stage itself and safeguard bank's interest.

CL engaged In manufacturing of dice/casts enjoys working capital advance of Rs.300 lacs (comprising cash credit Rs. 150 lacs and supply bills Rs. 150 lacs). The facilities were sanctioned to enable the company to achieve a turnover of Rs. 700 lacs. The unit achieved a turnover of Rs. 730 lacs and had projected a turnover of Rs. 900 lacs for the next year. To achieve their target, the unit requested for enhancement In working capital limits to Rs. 350 lacs (cash credit limits Rs. 200 lacs and supply bills Rs. 150 lacs)

Two years back, the unit had wanted to increase the usance period for supply bills from 90 days to 120 days which was sanctioned. The reason attributed by the unit for a modification of sanction was delay in realisation of bill proceeds.

Considering the past satisfactory performance and current ratio which was nearly 2:1, branch/Regional Office had recommended for enhancement of Rs. 50 lacs proposed in CC limit.

Afterall, very large portfolio in receivables and a large period of credit expended explains the ills of the unit. While current ratio is good, the quality of current assets that go to make up such a ratio perhaps is not good.

Scrutiny of operations in the account revealed that the company's liquidity position remained tight inspite of good current ratio. Unit attributed the reason as funds locked up in receivables. There were substantial overdues in bills. It was decided to undertake a unit visit and inspect the stocks.

It was observed during the visit that huge quantity of stocks were piled up. A vast majority of such stocks appear old.

All the drawees of the bills were contacted and requested to give an indebtedness certificate certifying their dues to the unit. Most of the drawees advised that goods represented by overdue bills were returned back by them for rectification/correction.

Thus there are huge overdues in bills limit in branch books, most of the goods representing the bills were already received back by the unit and were lying in their godown.

These goods require rectification and it may take a long period of say over six months, to despatch the goods back to the buyers. This situation has led to the liquidity crunch and to overcome the same, the unit has requested for enhancement.

Led by satisfactory turnover achieved and a comfortable current ratio, branch-Regional Office has recommended for enhanced limits. Actually the stated turnover of Rs. 730 lacs was not achieved by the unit. It had gone ahead to vouch as sales even goods which were sent back to their buyers after rectification. The actual sales was only Rs. 560 lacs.

Even the current ratio had to be revised as most of the inventories returned as well as long overdue bills will qualify only as non current asset. The actual current ratio when reworked was low at 1.18:1.

The remedy to the situation was only extending a short term loan of Rs. 50 lacs since we have our interest in the unit as financiers and the unit has to overcome the liquidity crisis.

This situation could have been avoided if the interactions which the branch had during periodical unit inspections were purposeful. Branch had failed to identify the old stocks, which it could have atleast done when talking to lower level functionaries of the unit. There is no scope for picking up signals relating to the rejections and the goods being returned for rectification. Branch has not identified such statements and given due credence to it for nearly 2 years.

Close monitoring thus also takes shape of picking up leads during casual discussions with unit officials about the unit's performance.

FRDI was involved in manufacturing of automobile components. It was established in 1983. It was supplying the components to various Original Equipment Manufacturers (OEMs). The affairs of the Company were satisfactory until 1985. In order to cater to the increased needs of the OEMs, the Company went for expansion of capacity in 1985. Most of The OEM had Japanese collaboration and due to heavy appreciation of Japanese Yen vis a vis Indian Rupee, the OEMs could not generate profits to repay the Foreign Currency loans taken by them and they had become sick.

FRDL found that their orders had slowed down and they could not generate funds to repay the term loans for investments made in their expansion project. FRDL ultimately became sick.

At the time when the company became sick, it was enjoying the following credit limits :

The financial position of the FRDL at the time when it became sick was as under:

REASONS FOR SICKNESS

The bank conducted a review of the account and visited the unit's manufacturing facilities. It also gathered information about the status of the company and the industry in general from market sources. The bank found that the following were the main reasons for sickness:

1. The product range of the Company was not suitable for the present demand conditions of the market.

2. The Company had surplus labour force which was affecting the profitability.

3. Part of the working capital was used for the expansion project.

4. The expansion project was funded partly by Hire Purchase Finance which was high interest bearing.

5. The production facilities were poorly organised resulting in criss crossing of material flow which has contributed in lower efficiency in manufacturing operations.

6. The creditors level was high. Pressing creditors were not paid in time with the result timely supply of material could not be obtained.

REHABILITATION PLAN

The Company Officials were called for a detailed discussion and the bank's observations were revealed to them. The Company was advised to come out with their plan for rehabilitating the Unit. As the management was sincere and were co-operating with the bank, it was decided in principle to rehabilitate the unit.

Tho Company submittnd and rehabilitation plan, salient features of which are BS under:

1. The plan envisaged the following expenditure and the means of finance.

2. The automobile industry was showing signs of recovery and it was widely expected that it will witness a boom in the very near feature. FRDL will be able to capitalise on the changing scenario. Two existing and well performing truck manufacturing companies and a leading car manufacturer were keenly interested in sourcing the components from FRDL. They offered tie up arrangements for the company's products. The capital expenditure envisaged included certain balancing equipments and for re-arranging the production facilities.

3. The production, sales and profits after implementation of the scheme was estimated as under:

4. Restructuring of liabilities

a) Out of cash credit outstandings of Rs. 440 lacs, an amount of Rs. 230 lacs was converted into Working Capital Term Loan repayable in 4 years at concessional interest rate. Balance of Rs. 210 lacs representing the drawing power available, was allowed as operative cash credit.

b) Term loan and Hire purchase finance of Rs. 190 lacs was restructured as follows :

5. Company was advised to submit every month a detailed Monthly Performance data to the bank as per the formats enclosed.

Month-wise performance of the company was monitored by the bank to ensure that its performance is in line with the rehabilitation plan envisaged.

The monitoring efforts taken by the bank is given below.

UNIT VISIT

Initially the Branch Manager visited the unit on a weekly basis to get a first hand information on the progress made. It was observed that the unit was performing more or less in line with the monthly projection.

Being satisfied, later on, the periodicity of the unit visit was relaxed to fortnightly considering the satisfactory performance of the Company.

A discussion with the unit's employees was also held during the visit. Initially the employees response was some what lukewarm as they had apprehensions about the unit's revival.

The promoters were sincere in their efforts.

The market was favourable and there was no rejections upto the end of the third month evidencing that the quality of unit's product was acceptable to the buyers.

Officials of the bank in a branch nearer to the buyers was requested to call on the buyers to ascertain buyers opinion on quality of the unit's products. Buyers confirmed that the unit's products were acceptable and found satisfactory.

For the promoters, the approach of the bank as detailed above is indicative of bank's seriousness and involvement in rehabilitation scheme.

The bank analysed the Monthly Performance Data submitted for June as given below :

Percentage of sales achievement upto I quarter - 24.87% which is in line with the annual estimates.

COST OF PRODUCTION

This increasing trend in raw material cost as a percentage of sales was advised to the Company. The unit's officials had a meeting with the workmen and it was agreed to effect a cut in overhead expenses by 10% from July onwards in order to offset the increase in raw material cost.

[A reference to the enclosed Monthly Performance Data will give the details of the issues to be looked into by the bank constantly for monitoring]

PERFORMANCE AFTER REHABILITATION

The rehabilitation plan proved to be a success as the Company was able to market the products under the new tie up arrangements with the truck and car manufacturers. The promoters were sincere in their approach. But the most important factor was the close monitoring of the account carried out by the bank which helped in keeping a close watch on the monthly production, sales, overheads, profits, repayment obligations etc. Initial teething problems were identified in time due to close monitoring and remedial action was taken promptly. The format designed for the purpose (which is enclosed) took care of all aspects of the working of the Company. It is also a very simple and lucid format which facilitates monitoring of an account effectively.

The illustration is a case of successful rehabilitation. One of the reasons for the success was the close watch maintained by the bank, though sincerity of promoters, co operation of workers, favourable market conditions were also equally important.

There are also cases where assumptions of rehabilitation may not be achieved. It may happen in cash flow projections or in demand level or in build up of current assets or in delays in implementation of project resulting in higher interest cost etc. In such cases branch should take up with Regional Office / Central Office for further guidance for monitoring.

CONCLUSION

Assessment of credit needs (both long term as well as working capital) are made based on future projections. Again projections are made on certain assumptions. Unless the projections are achieved (may be with a tolerable extent of +/-5%) the assessment may go away. As a result the credit facilities may become too less or too much. Both the cases are detrimental to bank's interest. If the credit extended is too less, unit's working will be greatly affected. If the credit limits are too much, there is always a possibility of diversion.

To safeguard the bank's funds lent and ensure it is utilised only for the purpose for which it was lent, close monitoring becomes an important tool for a banker.

A sick unit has all the problems. They experience a variety of pressures, like

1) Production levels falling

2) Volume per worker remaining below standards.

3) Workers anticipating one more "lay offs" - 'lock outs".

4) Unabated demands despite operations below break-even levels and management meeting the same despite losses.

5) Creditors demanding cash payments for supplies and remaining alert and ever ready to collect their dues.

6) Financial Institutions threaten recovery of dues by resorting to Revenue Recovery Channels.

7) Statutory payments claiming priority.

8) Power disconnection threats.

9) Buyers stretching payments and resorting to rejections for claiming huge discounts.

10) Dishonour of bills.

11) Unit trying to dump their goods only to register "Book Sales".

12) Invocation of guarantees issued.

13) Promoters themselves losing hopes and pulling back their existent or non-existent stake by operating bank accounts for realising the collections. and lastly

14) Siphoning off funds in ingenious methods as had happened in a recent case where the lending bank also acted as reimbursing agents for deposit interest warrant payments. The desperateness with which the promoters have reportedly pulled back funds by getting interest warrant payments for huge amounts on huge non-existent deposits, swept away their own bankers.

A combination of one or more of the above should be anticipated by the rehabilitating bank and monitoring mechanism should adequately cover these possibilities.

Monitoring not only helps in ensuring safety of funds lent but also in initiating necessary timely and corrective action.

MONTHLY PROFIT & LOSS ACCOUNT

PRODUCTION & ORDER BOOK POSITION

CASH FLOW STATEMENT

DEBTORS AND INVENTORY DATA

AGEWISE ANALYSIS OF CREDITORS

PERSONAL DATA