Credit risk is one of the most vital risks which is pertinent to the Banks worldwide. Every Bank, however small or big is working upon ways to minimize or curtail credit risk. Credit risk basically constitutes of two major stages: – pre sanction and post sanction. Pre-sanction measure includes distinguishing the right borrowers, the reasons for the advance, quantum of advance, the timing of advance, genuine requirements of reimbursement (if any), security available for advance, feasibility, pre-sanction, unit examination, evaluation of credit proposition and proper sanction of limits on the basis of afore mentioned requirements. The post-sanction stage incorporates appropriate documentation, stamping and execution as per constitution and Memorandum and Article of Association of the company, registration of records with Registrar of assurances, ROC, CERSAI and other statutory and quasi government bodies as governed by rules in that State. It also involves timely and adequate disbursement and proper end use of the funds. It can be ensured by proper follow up, supervision and monitoring better known as FSM in banking parlance.
As the security of the assets financed by the Bank is of utmost importance to them, while granting new sanction, defaulter lists of RBI/ECGC, alert by CIBIL, CRIF and other credit data organizations and Credit Opinion reports (CIR) from different banks are checked. Apart from the same, Banks also look out for any adverse news or publication in mass or online media regarding potential borrowers.
While sanctioning loan to the potential borrowers, credit officials must ensure that they abide by internal loan policy of the Bank. They are also required to fully cross check credentials of the promoters and the directors through the Director’s Identification Number (DIN) and Permanent Account Number (PAN) for any default or adverse feature.
Fundamental parts of credit examination:
The sanctioning committee has set up different benchmarks for proposal assessment. For example, there are different benchmark for ratios pertaining to profitability, liquidity, debt, solvency etc. Similarly, there is a fundamental risk in lending a bulk of our resources to a single borrower or in a single industry as it is fraught with risk of concentration in one segment only, which may or may not yield positive results.
The bank must curtail this danger by enhancing the borrower pool. Henceforth, banks need to have a defining instrument to assess the fresh sanction and to ensure that their exposure is within prudential norms recommended by Reserve Bank of India.
Banks normally put cap on lending to risky ventures like infrastructure and other likely ventures which have long gestation period and realization of yield is time consuming.
The credit assessment includes an assessment of all accessible data about the borrower, including borrower’s previous experience and fitness to actualize the current/proposed business action. Monetary sufficiency and capacity to support duties significantly under unfriendly conditions, business ethics and culture, consistence, grievances, security and internal control, business congruity, the board members etc. will have an effect on decision making.
Pledges in underwriting:
The terms and conditions of underwriting should be properly recognized by the borrower/s and underwriter/s will specify that (I) the borrower element intermittently report its monetary condition to the bank. (ii) Unsecured advances from companies and family members of the borrowers which are treated as par with contribution within promoters quota ought not be pulled back during the tenure of the loan and a guarantee to that extent must be taken from the stakeholders (iii) The organization will avoid declaring dividends, repurchasing shares and acquiring extra shares from the market and so forth which may unfavorably influence the organization’s budget.
Documentation:
The loan related documents executed by the borrower ought to be enforceable by law which should adequately cover our exposure and allow banks to hold a proper degree of power over the functioning of the borrower. Documentation ought to likewise give the bank, the option to intercede with proper measures to meet legitimate and administrative commitments as desired by the borrower.
Risk based estimating:
The actual credit risks within the Bank’s framework contrasts from one bank to another depending upon the type and value of their exposure to different industries and segments depending upon their risk appetite.
Banks need to break down credit risk at the individual client and portfolio levels and choose to charge the higher pace of premium (credit spread) on borrowers where probability of default is more. This act of banks is called risk based evaluation.
The risk based evaluation includes FICO assessment/scoring (outside/inside) of clients after assessing values like shares pledged to us, Land, Building and machinery mortgaged or hypothecated to us. It doesn’t include the capacity of the borrower based on nature of business, credit scores, monetary adequacy and capacity to support responsibilities significantly under unfavorable condition. It though depends upon coverage of insurance of our security and coverage under Govt. schemes such as CGTMSE/ECGC and so on.
Post payment Monitoring:
Financial institutions need to guarantee the correct end-use of funds delivered to the borrower, inspection of borrower’s unit/site at regular intervals is a perquisite to ensure that the unit is functioning as per the requirements of the business.
Through a proper visit of borrower’s unit/industrial facility, lenders can get the early warning signals like deficiency of stocks, stoppage of work in the production line, presence of other Bank’s name in hypothecation board in lieu of theirs and so forth.
Industrial facility units can be guilty of classifying the old stock/dismissed/returned merchandise as the goods and present one. Stock registers needs to be properly verified in order to calculate proper drawing power of the unit.
Another significant risk is that the lenders must be cautious about preoccupation of assets obtained by the borrower or multiple financing on the same assets.
As per the guidelines laid by the RBI; new lender Banks need to be suitably informed by the Present Bankers of any prior charge on the assets of the Borrower. The same also holds true for the borrower who must be transparent in the dealing with the present and potential Banks.
Credit Review Mechanism:
To check and control the slippage of advances from Standard to sub standard, Banks utilize Loan Renew/Review Mechanism (LRM) framework. The advance audit system is intended to assess the viability of approval cycle and status of post sanction position of the high-value advances. According to RBI rules, at any rate 30-40% of the credit portfolio ought to be exposed to LRM in a year in order to ensure that all the significant credit risk in assets have been sought after.
Arrangements to assimilate misfortunes:
The vital obligation of a Bank is to screen every borrower consistently, measure the danger and make adequate arrangements to assimilate any normal and sudden surprising misfortunes which might impact the business cycle of the borrower.
Vipul Parikh
Manager (Faculty),
State Bank Institute of Learning & Development, Bhavnagar.
