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TitleCredit appraisal techniques
TagsLoans Securities (Finance) Banks Credit (Finance) Market Liquidity
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Page 3

Following items should be noted when assessing management:

• Quality and depth of management, particularly the CEO.
• Experience, qualifications, and capability.
• Succession and back up plans.
• Management style i.e. conservative, centralized/ decentralized approach,

Organization Culture, Corporate strategy.

• Career progression, training and development policies.
• Staffturnover/personnel policies.
• Training, motivation, morale, besides staff quality.

The CEO sets the pace for the Company and can determine its success with the necessary
teamwork e.g. Jack Welch of General Electric, who has been enormously successful as CEO.

People are the most important resource a Company has and are crucial for its successful
running. Those Companies are successful which treat and recognize its talent properly and have
a clear, careful and thought out business strategy, formalized in a Business Plan which is then
followed accordingly. Besides this they have a organized change culture, solid customer
relationships and a strategic brand management / differentiation.

Above items are not found in the Balance Sheet, and should be analyzed by the lending officer,
after careful scrutiny and discussion with management.

Risk Areas: The lending order should review all risks officer relating to the lending point wise
along with the mitigants and justified why lending is warranted, i.e. can the risks be covered or
are these acceptable risks. Each borrower will have different risk profiles and therefore it is
important to ensure there are adequately understood and addressed.

Checkings: Written checkings from other lenders should be obtained. Trade/market checkings
can be obtained from various sources e.g. suppliers, etc. Talking to suppliers and other market
information can give updated input on the company's financial position, e.g. if company is
delaying payment to suppliers this could indicate liquidity problems. Also checks should be made
from the market how the company's product is selling in the market or if it suffers from quality
problems - these items are important since they impact sales and ultimately cash flow.

Loan Profitability: Again this is an important area which helps evaluate the risk / reward aspects
of a transaction. It is important to earn an acceptable spread on a loan, and therefore to arrange
necessary funding, to compensate for the credit risk. Apart from this the Bank should make an
adequate return on the loan to help build the up net worth which is a cushion to absorb loan
losses. The Bank should maximize return on assets not only through spread income but other
non funds income such as commissions, exchange etc. which are generated from contingent risk
and do not involve the use of Bank funds.

There is no insurance against loan losses or problems, nor is lending a rocket science. The
lending officer must therefore exercise common sense and follow basic lending rules when
analyzing a credit. There is no short cut to this - after disbursement it is also essential to maintain
contact with the company and remain abreast of its financial position. A lending officer must not
only have requisite credit skills, but develop problem recognition abilities to enable him to take
necessary and timely action, as and when required.

Page 8

Only HDFC Bank was able to perform this way over four years, that is, from
2000-01 to 2003-04. Jammu & Kashmir Bank and IDBI Bank have been in this
category for three years.

Banks with high credit expansion followed by high levels of NPAs cannot
perform consistently and they invariably fall behind; it is an unsustainable
approach. Banks such as Development Credit Bank fall in this category.

Aggressive credit expansion along with non-recovery till 2001-02, forced it to
substantially curtail its operations, ending up with low advance growth during
2003-04. Lord Krishna Bank has been in this category since 2001-02.

Banks with low credit expansion and low NPAs adopt a cautious approach
towards credit expansion. And those that consistently belong to this category
have low growth in advances, despite low levels of NPAs.

As per Table 2, only State Bank of India has been in this category consistently.

Perhaps, the credit market in India does not have the capacity to absorb the
funds available. Sangli Bank, one of the old private sector banks, has been in
this category for three years. Banks with comparatively larger balance-sheets,
such as State Bank of Saurashtra and Bank of Baroda, were also members of
this group for two years.

As mentioned, banks with low credit growth and high NPAs are the ones to be
monitored. These banks may have to review their credit assessment and
monitoring systems. Based on the four years, the banks commonly in this group
are Dena Bank, Ganesh Bank of Kurundwad and SBI Commercial & International.

Further, for the last three years, Punjab & Sind Bank has been in this category.
United Western Bank and erstwhile Global Trust Bank were in this category for
two years. It is worth mentioning that United Western Bank had extended high
credit despite having high NPAs during 1997-98 to 2000-01.

The common perception that listing of a bank in the stock market improves
quality of management may not be always correct, as illustrated in the Dena
Bank, United Western Bank and Global Trust Bank cases.

Also, ownership pattern does not necessarily have a bearing on performance
of banks. Both private and government entities have appeared in the important
categories discussed.

To conclude, higher than average credit expansion can further strengthen banks
if there is a good credit appraisal systems, strict recovery procedures and overall
checks and balances by the top management.

(The authors are in the Division of Banking Studies, RBI, Mumbai.)

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