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Q.1. The Importance of Small and Medium Enterprises (SMEs) in Economic

Development

One of the significant characteristics of a flourishing and growing economy is a booming and
blooming small and medium enterprises (SMEs) sector. Small and medium enterprises play
an important role in the development of a country. SMEs contribute to economic
development in various ways by creating employment for rural and urban growing labor
force, providing desirable sustainability and innovation in the economy as a whole .In
addition to that, a large number of people rely on the small and medium enterprises directly
or indirectly.

One of the significant characteristics of a flourishing and growing economy is a booming and
blooming small and medium enterprises (SMEs) sector. Small and medium enterprises play
an important role in the development of a country. SMEs contribute to economic
development in various ways: by creating employment for rural and urban growing labor
force, providing desirable sustainability and innovation in the economy as a whole .In
addition to that, a large number of people rely on the small and medium enterprises directly
or indirectly.

Most of the current larger enterprises have their origin in small and medium enterprises.
SMEs are different from large scale enterprises in three main aspects; uncertainty, innovation
and evolution. The SME sector itself can be classified into micro enterprises, small
enterprises and medium enterprises. SMEs are the starting point of development in the
economies towards industrialization. However, SMEs have their significant effect on the
income distribution, tax revenue, and employment, efficient utilization of resources and
stability of family income. According to the United Nations Industrial Development
Organization UNIDO, for developing countries, integration into the global economy through
economic liberalization, deregulation, and democratization is seen as the paramount way to
triumph over poverty and inequality. Important to this process, is the development of an
animated private sector, in which small and medium enterprises can play a central role.
SMEs have a propensity to employ more labor-intensive production processes than large
enterprises. Consequently, they contribute significantly to the provision of productive
employment opportunities, the generation of income and, eventually, the reduction of poverty.
According to the statistics, in industrialized countries, SMEs are major contributors to private
sector employment. Empirical studies have shown that SMEs contribute to over 55% of GDP
and over 65% of total employment in high income countries .SMEs and informal enterprises,
account for over 60% of GDP and over 70% of total employment in low income countries,
while they contribute about 70% of GDP and 95% of total employment in middle income
countries. SMEs play significant contribution in the transition of agriculture-led economies to
industrial ones furnishing plain opportunities for processing activities which can generate
sustainable source of revenue and enhance the development process. SMEs shore up the
expansion of systemic productive capability. They help to absorb productive resources at all
levels of the economy and add to the formation of flexible economic systems in which small
and large firms are interlinked. Such linkages are very crucial for the attraction of foreign
investment. Investing transnational corporations look for sound domestic suppliers for their
supply chains. SMEs are the major growing force behind the fastest growing economy of
China, in terms of contribution to the national GDP (accounting for 40%), scale of assets,
diversification of products, and the creation of employment. Similarly, the role of SMEs is
well acknowledged in other countries such as Japan, Korea, and all other industrialized
economies in terms of creating employment, reducing poverty and increasing the welfare of
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the society. Experts and economists are unanimous about the role and importance of small
and medium enterprises in the development of Pakistan economy. The statistical data and
empirical studies about SMEs highlight the bulk share of SMEs in the economy. According to
the Small and Medium Enterprises Development Authority (SMEDA), "SMEs constitute
nearly 90% of all the enterprises in Pakistan; employ 80% of the non-agricultural labor force;
and their share in the annual GDP is 40%, approximately?.

Q. 2. SME Foundation

SMEs are recognized as engine of economic growth and employment generation for
sustainable industrialization in both developed and developing countries of the world. In
context of Bangladesh, there is no alternative of small and medium enterprises for rapid
industrialization and national economic growth through lower capital investment and
employment generation. The SME Foundation is playing its role in helping the SME
entrepreneurs including the women entrepreneurs by conducting various programs with an
aim to develop the SMEs of Bangladesh. One of the major aims of SMEF is to bring the
grassroots entrepreneurs into the main stream of economic development through employment
generation, reduction of social discrimination and poverty alleviation.

Legal base of establishing SME Foundation

Small and Medium Enterprise Foundation got registration from the Ministry of Commerce on
12-11-2006 and from the Registrar of Joint Stock Companies and Firms on 26-11-2006 under
the Companies Act (Act XXVIII), 1994 . A resolution (Gazette notification) was circulated on
30-05-2007 regarding the establishment of SME Foundation. It is an independent and unique
non-profit organization.

Vision
Fostering industrialization through SME promotion for employment generation, economic
development finally poverty alleviation of Bangladesh.

Mission
Undertake and implement multi sectorial action plan for proper growth of SMEs and make
them competitive in the free market economy.

Objective

1. Implementing SME Policy Strategy adopted by the Government of Bangladesh.

2. Recommending SME friendly policies to different government ministries and agencies.

3. Providing business support services to the SME entrepreneurs.

4. Providing information and proper guidance for establishing new SMEs.

5. Conducting sectoral study to ensure availability of latest information, identify challenges

and recommend preventing measures.
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6. Operating credit wholesaling programs for the SMEs through different banking and non-
banking financial institutions.

7. Conducting training programs to create skilled labor for different SME sub-sector based on
their demands.

8. Technology development, adopting new technology, conducting reverse engineering and

supporting SMEs to get quality certifications.

9. Supporting SMEs in marketing their products and promotion of services.

10. Bringing women entrepreneurs into the mainstream of development and helping them to
achieve economic self-dependency.

11. Assisting SMEs in creating institutional bondage with foreign companies for capacity
building, technology transfer and improving productivity.

12. Training up and motivating SMEs in using ICT tools for more productivity and improving
quality.

Q. 3.Types of Financial Institutions and Their Roles

A financial institution is an establishment that conducts financial transactions such as
investments, loans and deposits. Almost everyone deals with financial institutions on a
regular basis. Everything from depositing money to taking out loans and exchanging
currencies must be done through financial institutions. Here is an overview of some of the
major categories of financial institutions and their roles in the financial system.

Commercial Banks

Commercial banks accept deposits and provide security and convenience to their customers.
Part of the original purpose of banks was to offer customers safe keeping for their money. By
keeping physical cash at home or in a wallet, there are risks of loss due to theft and accidents,
not to mention the loss of possible income from interest. With banks, consumers no longer
need to keep large amounts of currency on hand; transactions can be handled with checks,
debit cards or credit cards, instead.

Commercial banks also make loans that individuals and businesses use to buy goods or
expand business operations, which in turn lead to more deposited funds that make their way
to banks. If banks can lend money at a higher interest rate than they have to pay for funds and
operating costs, they make money.

Banks also serve often under-appreciated roles as payment agents within a country and
between nations. Not only do banks issues debit cards that allow account holders to pay for
goods with the swipe of a card, they can also arrange wire transfers with other institutions.
Banks essentially underwrite financial transactions by lending their reputation and credibility
to the transaction; a check is basically just a promissory note between two people, but without
a bank's name and information on that note, no merchant would accept it. As payment agents,
banks make commercial transactions much more convenient; it is not necessary to carry
around large amounts of physical currency when merchants will accept the checks, debit
cards or credit cards that banks provide.
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Investment Banks

The stock market crash of 1929 and ensuing Great Depression caused the United States
government to increase financial market regulation. The Glass-Steagall Act of 1933 resulted
in the separation of investment banking from commercial banking. While investment banks
may be called "banks," their operations are far different than deposit-gathering commercial
banks. An investment bank is a financial intermediary that performs a variety of services for
businesses and some governments. These services include underwriting debt and equity
offerings, acting as an intermediary between an issuer of securities and the investing public,
making markets, facilitating mergers and other corporate reorganizations, and acting as a
broker for institutional clients. They may also provide research and financial advisory
services to companies. As a general rule, investment banks focus on initial public offerings
(IPOs) and large public and private share offerings. Traditionally, investment banks do not
deal with the general public.

Insurance Companies

Insurance companies pool risk by collecting premiums from a large group of people who
want to protect themselves and/or their loved ones against a particular loss, such as a fire, car
accident, illness, lawsuit, disability or death. Insurance helps individuals and companies
manage risk and preserve wealth. By insuring a large number of people, insurance companies
can operate profitably and at the same time pay for claims that may arise. Insurance
companies use statistical analysis to project what their actual losses will be within a given
class. They know that not all insured individuals will suffer losses at the same time or at all.

Brokerages

A brokerage acts as an intermediary between buyers and sellers to facilitate securities

transactions. Brokerage companies are compensated via commission after the transaction has
been successfully completed. For example, when a trade order for a stock is carried out, an
individual often pays a transaction fee for the brokerage company's efforts to execute the
trade. A brokerage can be either full service or discount. A full service brokerage provides
investment advice, portfolio management and trade execution. In exchange for this high level
of service, customers pay significant commissions on each trade. Discount brokers allow
investors to perform their own investment research and make their own decisions. The
brokerage still executes the investor's trades, but since it doesn't provide the other services of
a full-service brokerage, its trade commissions are much smaller.

Investment Companies

An investment company is a corporation or a trust through which individuals invest in

diversified, professionally managed portfolios of securities by pooling their funds with those
of other investors. Rather than purchasing combinations of individual stocks and bonds for a
portfolio, an investor can purchase securities indirectly through a package product like a
mutual fund. There are three fundamental types of investment companies: unit investment
trusts (UITs), face amount certificate companies and managed investment companies. All
three types have the following things in common:

 An undivided interest in the fund proportional to the number of shares held

 Diversification in a large number of securities
 Professional management
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 Specific investment objectives

Let's take a closer look at each type of Investment Company.

Unit Investment Trusts (UITs)

A unit investment trust, or UIT, is a company established under an indenture or similar

agreement. It has the following characteristics:

 The management of the trust is supervised by a trustee.

 Unit investment trusts sell a fixed number of shares to unit holders, who receive a
proportionate share of net income from the underlying trust.
 The UIT security is redeemable and represents an undivided interest in a specific
portfolio of securities.
 The portfolio is merely supervised, not managed, as it remains fixed for the life of the
trust. In other words, there is no day-to-day management of the portfolio.

Face Amount Certificates

A face amount certificate company issues debt certificates at a predetermined rate of interest.
Additional characteristics include:

 Certificate holders may redeem their certificates for a fixed amount on a specified
date, or for a specific surrender value, before maturity.
 Certificates can be purchased either in periodic installments or all at once with a
lump-sum payment.
 Face amount certificate companies are almost nonexistent today.

Management Investment Companies

The most common type of investment company is the management investment company,
which actively manages a portfolio of securities to achieve its investment objective. There are
two types of management investment company: closed-end and open-end. The primary
differences between the two come down to where investors buy and sell their shares - in the
primary or secondary markets - and the type of securities the investment company sells.

 Closed-End Investment Companies: A closed-end investment company issues shares

in a one-time public offering. It does not continually offer new shares, nor does it
redeem its shares like an open-end investment company. Once shares are issued, an
investor may purchase them on the open market and sell them in the same way. The
market value of the closed-end fund's shares will be based on supply and demand,
much like other securities. Instead of selling at net asset value, the shares can sell at a
premium or at a discount to the net asset value.

 Open-End Investment Companies: Open-end investment companies, also known as

mutual funds, continuously issue new shares. These shares may only be purchased
from the investment company and sold back to the investment company. Mutual funds
are discussed in more detail in the Variable Contracts section.
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Nonbank Financial Institutions

The following institutions are not technically banks but provide some of the same services as
banks.

Savings and Loans

Savings and loan associations, also known as S&Ls or thrifts, resemble banks in many
respects. Most consumers don't know the differences between commercial banks and S&Ls.
By law, savings and loan companies must have 65% or more of their lending in residential
mortgages, though other types of lending is allowed.

S&Ls emerged largely in response to the exclusivity of commercial banks. There was a time
when banks would only accept deposits from people of relatively high wealth, with
references, and would not lend to ordinary workers. Savings and loans typically offered lower
borrowing rates than commercial banks and higher interest rates on deposits; the narrower
profit margin was a byproduct of the fact that such S&Ls were privately or mutually owned.

Credit Unions
Credit unions are another alternative to regular commercial banks. Credit unions are almost
always organized as not-for-profit cooperatives. Like banks and S&Ls, credit unions can be
chartered at the federal or state level. Like S&Ls, credit unions typically offer higher rates on
deposits and charge lower rates on loans in comparison to commercial banks.

In exchange for a little added freedom, there is one particular restriction on credit unions;
membership is not open to the public, but rather restricted to a particular membership group.
In the past, this has meant that employees of certain companies, members of certain churches,
and so on, were the only ones allowed to join a credit union. In recent years, though, these
restrictions have been eased considerably, very much over the objections of banks.

Shadow Banks
The housing bubble and subsequent credit crisis brought attention to what is commonly
called "the shadow banking system." This is a collection of investment banks, hedge funds,
insurers and other non-bank financial institutions that replicate some of the activities of
regulated banks, but do not operate in the same regulatory environment.
The shadow banking system funneled a great deal of money into the U.S. residential
mortgage market during the bubble. Insurance companies would buy mortgage bonds from
investment banks, which would then use the proceeds to buy more mortgages, so that they
could issue more mortgage bonds. The banks would use the money obtained from selling
mortgages to write still more mortgages.
Many estimates of the size of the shadow banking system suggest that it had grown to match
the size of the traditional U.S. banking system by 2008.
Apart from the absence of regulation and reporting requirements, the nature of the operations
within the shadow banking system created several problems. Specifically, many of these
institutions "borrowed short" to "lend long." In other words, they financed long-term
commitments with short-term debt. This left these institutions very vulnerable to increases in
short-term rates and when those rates rose, it forced many institutions to rush to liquidate
investments and make margin calls. Moreover, as these institutions were not part of the
formal banking system, they did not have access to the same emergency funding facilities.
(Learn more in The Rise And Fall Of The Shadow Banking System.)
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Money lending in one form or the other has evolved along with the history of the mankind. Even in
the ancient times there are references to the moneylenders. Shakespeare also referred to ‘Shylocks’
who made unreasonable demands in case the loans were not repaid in time along with interest. Indian
history is also replete with the instances referring to indigenous money lenders, Sahukars and
Zamindars involved in the business of money lending by mortgaging the landed property of the
borrowers. Towards the beginning of the twentieth century, with the onset of modern industry in the
country, the need for government regulated banking system was felt.

Modern Day Role

Banking system and the Financial Institutions play very significant role in the economy. First and
foremost is in the form of catering to the need of credit for all the sections of society. The modern
economies in the world have developed primarily by making best use of the credit availability in their
systems. An efficient banking system must cater to the needs of high end investors by making
available high amounts of capital for big projects in the industrial, infrastructure and service sectors. At
the same time, the medium and small ventures must also have credit available to them for new
investment and expansion of the existing units. Rural sector in a country like India can grow only if
cheaper credit is available to the farmers for their short and medium term needs.

Future

Till a few years ago, the government largely patro-nized the small savings schemes in which not
only the interest rates were higher, but the income tax rebates and incentives were also in plenty. The
bank deposits, on the other hand, did not entail such benefits. As a result, the small savings were the
first choice of the investors. But for the last few years the trend has been reversed. The small savings,
the bank deposits and the mutual funds have been brought at par for the purpose of incentives under
the income tax. Moreover, the interest rates in the small savings schemes are no longer higher than
those offered by the banks.

Q.4. Eligibility for equity support from the Equity and Entrepreneurship Fund Unit
(EEF):

1. The project will have to be a new one and belong to either of the sectors viz., software industry
or food processing and agro-based industry.

2. The sponsors/entrepreneurs applying for EEF support will have to be a private limited company
registered under the Companies Act, 1994 and established old companies can also apply for EEF
support by setting-up a subsidiary new private limited company. But in case of a software
company registered on or after 01 January, 1997 will be treated as a new company.

3. The total project cost ( including net working capital ) of the proposed project will have to be of
minimum 0.50 (half) core for both IT and agro-based industries and that of the maximum is Taka
5.00 Crore for IT& Taka 10.00 Crore for agro –based industries . Project proposal with bank loan
is not allowed for agro –based industries but allowed for IT industries.

4. The project shall have to be viable technically & financially .It should be environment friendly.
Importance shall be given on the appraisal of the entrepreneurship such as educational
qualification in the relevant discipline, knowledge in the technology/ process operating such
project, track records in financial conduct specially with Banks/FI. In case of ratio analysis the
project has to offer minimum IRR (Internal Rate of Return) of 15%, Return on equity (ROE) of
15% Debt service coverage Ratio 1.50:1 Current ratio 1.50:1 and Fixed asset coverage ratio 1.50:
1 and SWOT analysis should have to be acceptable.4. The project shall have to be viable
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technically & financially .It should be environment friendly. Importance shall be given on the
appraisal of the entrepreneurship such as educational qualification in the relevant discipline,
knowledge in the technology/ process operating such project, track records in financial conduct
specially with Banks/FI. In case of ratio analysis the project has to offer minimum IRR (Internal
Rate of Return) of 15%, Return on equity (ROE) of 15% Debt service coverage Ratio 1.50:1
Current ratio 1.50:1 and Fixed asset coverage ratio 1.50: 1 and SWOT analysis should have to be
acceptable.

5. The non-resident Bangladeshis will be given preference subject to the fulfillment of the terms &
conditions mentioned in the above paragraphs.

6. Any defaulter (as defined by Bangladesh Bank) cannot apply for EEF.

7. Where a sponsor of a project needs term-loan and /or working capital loan from any Bank/FI and
also equity support form the EEF, he has to submit application to the Bank/FI concerned. The
Bank/FI will have to be satisfied that the project has fulfilled all the terms and conditions
required. Where the sponsors/entrepreneurs need only equity support from EEF without any bank
loan a Bank/FI will be nominated as representative of EEF for appraisal of the project by
Bangladesh Bank(EEF) . To nominate such Bank/FI, previous business relationship of
entrepreneur with the Bank/FI will be considered. The concerned Bank (which will also act as
monitoring bank) will make thorough appraisal of the project in accordance with EEF rules and
guidelines and if the bank is satisfied about the viability of the project they shall send the project
proposal with specific recommendation to Bangladesh Bank. The Bank/FI may determine their
project examination fee according to their existing rules. Bangladesh Bank, EEF Unit will re-
examine the project appraisal and perform pre-sanction visit if necessary. Then EEF Unit will
place it with specific recommendation before the Technical Advisory Committee (TAC). TAC is
a four member expert Committee under the chairmanship of the Governor of the Bangladesh
Bank. This Committee is the ultimate authority to approve the projects. When a project is
approved by the TAC, EEF Unit will issue a sanction letter to the concerned entrepreneur
instructing them to invest their portion of equity within a certain period of time.

Q. 5. Role of NGO

Non-governmental organizations (NGOs) have played a major role in pushing for sustainable
development at the international level. Campaigning groups have been key drivers of inter-
governmental negotiations, ranging from the regulation of hazardous wastes to a global ban
on land mines and the elimination of slavery.But NGOs are not only focusing their energies
on governments and inter-governmental processes. With the retreat of the state from a
number of public functions and regulatory activities, NGOs have begun to fix their sights on
powerful corporations - many of which can rival entire nations in terms of their resources and
influence. Aided by advances in information and communications technology, NGOs have
helped to focus attention on the social and environmental externalities of business activity.
Multinational brands have been acutely susceptible to pressure from activists and from NGOs
eager to challenge a company's labour, environmental or human rights record. Even those
businesses that do not specialize in highly visible branded goods are feeling the pressure, as
campaigners develop techniques to target downstream customers and shareholders. In
response to such pressures, many businesses are abandoning their narrow Milton Friedmanite
shareholder theory of value in favour of a broader, stakeholder approach which not only seeks
increased share value, but cares about how this increased value is to be attained. Such a
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stakeholder approach takes into account the effects of business activity - not just on
shareholders, but on customers, employees, communities and other interested groups. There
are many visible manifestations of this shift. One has been the devotion of energy and
resources by companies to environmental and social affairs. Companies are taking
responsibility for their externalities and reporting on the impact of their activities on a range
of stakeholders. Nor are companies merely reporting; many are striving to design new
management structures which integrate sustainable development concerns into the decision-
making process. Much of the credit for creating these trends can be taken by NGOs. But how
should the business world react to NGOs in the future? Should companies batten down the
hatches and gird themselves against attacks from hostile critics? Or should they hold out hope
that NGOs can sometimes be helpful partners? For those businesses willing to engage with
the NGO community, how can they do so? The term NGO may be a ubiquitous term, but it is
used to describe a bewildering array of groups and organizations - from activist groups
'reclaiming the streets' to development organizations delivering aid and providing essential
public services. Other NGOs are research-driven policy organizations, looking to engage with
decision-makers. Still others see themselves as watchdogs, casting a critical eye over current
events. They hail from north and south and from all points in between - with the contrasting
levels of resources which such differences often imply. Some are highly sophisticated, media-
savvy organizations like Friends of the Earth and WWF; others are tiny, grassroots
collectives, never destined to be household names. Although it is often assumed that NGOs
are charities or enjoy non-profit status, some NGOs are profit-making organizations such as
cooperatives or groups which lobby on behalf of profit-driven interests. For example, the
World Trade Organization's definition of NGOs is broad enough to include industry lobby
groups such as the Association of Swiss Bankers and the International Chamber of
Commerce. Such a broad definition has its critics. It is more common to define NGOs as
those organizations which pursue some sort of public interest or public good, rather than
individual or commercial interests. Even then, the NGO community remains a diverse
constellation. Some groups may pursue a single policy objective - for example access to
AIDS drugs in developing countries or press freedom. Others will pursue more sweeping
policy goals such as poverty eradication or human rights protection.

Q. 6. What are the assumption of of BEP analysis.

The Break-even Analysis depends on three key assumptions:

1. Average per-unit sales price (per-unit revenue):

This is the price that you receive per unit of sales. Take into account sales
discounts and special offers. Get this number from your Sales Forecast. For non-
unit based businesses, make the per-unit revenue $1 and enter your costs as a
percent of a dollar.
2. Average per-unit cost:
This is the incremental cost, or variable cost, of each unit of sales. If you buy
goods for resale, this is what you paid, on average, for the goods you sell. If you
sell a service, this is what it costs you, per dollar of revenue or unit of service
delivered, to deliver that service.

3. Monthly fixed costs:

Technically, a break-even analysis defines fixed costs as costs that would
continue even if you went broke. Instead, we recommend that you use your
regular running fixed costs, including payroll and normal expenses (total monthly
Operating Expenses). This will give you a better insight on financial realities. If
averaging and estimating is difficult, use your Profit and Loss table to calculate a
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working fixed cost estimate—it will be a rough estimate, but it will provide a
useful input for a conservative Break-even Analysis.

Q. 7. Methods of BEP

Equation Method:The equation method centers on the contribution approach to the

income statement. The format of this statement can be expressed in
equation form as follows:Profit = (Sales − Variable expenses) − Fixed
expenses

Rearranging this equation slightly yields the following equation, which is widely used in
cost volume profit (CVP) analysis:Sales = Variable expenses + Fixed expenses + Profit

According to the definition of break even point, break even point is the level of sales
where profits are zero. Therefore the break even point can be computed by finding that
point where sales just equal the total of the variable expenses plus fixed expenses and
profit is zero.

Contribution Margin Method:The contribution margin method is actually just

a short cut conversion of the equation method already described. The
approach centers on the idea discussed earlier that each unit sold provides a
certain amount of contribution margin that goes toward covering fixed
cost. To find out how many units must be sold to break even, divide the total
fixed cost by the unit contribution margin.

This approach is particularly suitable in situations where a company has multiple

products lines and wishes to compute a single break even point for the company as a
whole.

Q. 8. Break Even point Analysis and its importance.

Break even point is the level of sales at which profit is zero. According to this
definition, at break even point sales are equal to fixed cost plus variable cost. This
concept is further explained by the the following equation:[Break even sales = fixed
cost + variable cost]

The break even point can be calculated using either the equation method or contribution
margin method.The main advantages of break even point analysis is that it explains the
relationship between cost, production, volume and returns. It can be extended to show how
changes in fixed cost, variable cost, commodity prices, revenues will effect profit levels and
break even points. Break even analysis is most useful when used with partial budgeting,
capital budgeting techniques. The major benefits to use break even analysis is that it indicates
the lowest amount of business activity necessary to prevent losses.

Q.9. Capital budgeting techniques.

The Major Capital Budgeting Techniques

A variety of measures have evolved over time to analyze capital budgeting requests. The
better methods use time value of money concepts. Older methods, like the payback period,
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have the deficiency of not using time value techniques and will eventually fall by the wayside
and be replaced in companies by the newer, superior methods of evaluation.

1. Payback Period : Alright, let's get this out of the way up front: the Payback Period isn't a
very good method. After all, it doesn't use the time value of money principle, making it the
weakest of the methods that we will discuss here. However, it is still used by a large number
of companies, so we'll include it in our list of popular methods. What is the payback period?
By definition, it is the length of time that it takes to recover your investment.

2. Net Present Value: Using a minimum rate of return known as the hurdle rate, the net
present value of an investment is the present value of the cash inflows minus the present
value of the cash outflows. A more common way of expressing this is to say that the net
present value (NPV) is the present value of the benefits (PVB) minus the present value of the
costs (PVC) NPV = PVB - PVC

3. Internal Rate of Return: The Internal Rate of Return (IRR) is the rate of return that an
investor can expect to earn on the investment. Technically, it is the discount rate that causes
the present value of the benefits to equal the present value of the costs. According to surveys
of businesses, the IRR method is actually the most commonly used method for evaluating
capital budgeting proposals.

4. Discounted Cash Flow : The discounted cash flow method takes into account the time
value of money by discounting an investment's future return to a present value. The
premise of the time value of money is that a dollar in-hand today is worth more than the
same dollar in the future. In more sophisticated capital budgeting valuations, this
discount is taken into consideration when the present value of the future return is
assessed against the present value of the cash outflows on an investment.

Q. 10 . What is the purpose of the cash flow statement?

The purpose of the cash flow statement or statement of cash flows is to provide information
about a company’s gross receipts and gross payments for a specified period of time. The
gross receipts and gross payments will be reported in the cash flow statement according to
one of the following classifications: operating activities, investing activities, and financing
activities. The net change from these three classifications should equal the change in a
company’s cash and cash equivalents during the reporting period. For instance, the cash flow
statement for the calendar year 2010 will report the causes of the change in a company’s cash
and cash equivalents between its balance sheets of December 31, 2009 and December 31,
2010. In addition to the cash amounts being reported as operating, investing, and financing
activities, the cash flow statement must disclose other information, including the amount of
interest paid, the amount of income taxes paid, and any significant investing and financing
activities which did not require the use of cash. The statement of cash flows is to be
distributed along with a company’s income statement and balance sheet.

Q.11. Define working capital and its significance for a firm.

Net liquid assets computed by deducting current liabilities from current assets. The amount of
available working capital is a measure of a firm's ability to meet its short-term
obligations.Sources of working capital are (1) net income, (2) long-term loans, (3) sale of
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capital assets, and (4) injection of funds by stockholders. Ample working capital allows
management to take advantage of unexpected opportunities, and to qualify for bank loans and
favorable trade credit terms. In the normal trade cycle of a company, working capital equals
working assets. Also called net current assets. A measure of both a company's efficiency and
its short-term financial health. The working capital ratio is calculated as:

Positive working capital means that the company is able to pay off its short-term
liabilities. Negative working capital means that a company currently is unable to meet its
short-term liabilities with its current assets (cash, accounts receivable and inventory). Also
known as "net working capital", or the "working capital ratio". If a company's current assets
do not exceed its current liabilities, then it may run into trouble paying back creditors in the
short term. The worst-case scenario is bankruptcy. A declining working capital ratio over a
longer time period could also be a red flag that warrants further analysis. For example, it
could be that the company's sales volumes are decreasing and, as a result, its accounts
receivables number continues to get smaller and smaller.
Working capital also gives investors an idea of the company's underlying operational
efficiency. Money that is tied up in inventory or money that customers still owe to the
company cannot be used to pay off any of the company's obligations. So, if a company is not
operating in the most efficient manner (slow collection), it will show up as an increase in the
working capital. This can be seen by comparing the working capital from one period to
another; slow collection may signal an underlying problem in the company's operations.

Importance of Working Capital: Working capital is very important concept in finance.

Working capital represents the funds available with the company for day to day operations.
working capital finances the cash conversion cycle. company cannot survive with negative
working capital which represents that the company has no funds for day to day operations
Essentially working capital is the answer to the question: "How much short term funding do
you need to operate this business?". Short term funding is important because, with long term
funding already in place, the business still needs short term funding to operate. Without the
short term funding, the business will go bankrupt. Another concept is net working capital
which means surpuls of current assets over current liablities. a positive NWC is good for a
company.
 13

Q.12. Project appraisal

Meaning and definition

•Assessment of a project in terms of its economic, social and financial viability
•A lending financial institution makes an independent and objective assessment of various
aspects of an investment proposition
•It is defined as taking a second look critically and carefully at a project by a person who is in
no way involved or connected with its preparation. He is able to take independent,
dispassionate and objective view of the project in totality, along with its various components.

Steps for project appraisal/ Aspects of project appraisal

•Economic Aspects
•Technical Aspects
•Organizational Aspects
•Managerial Aspects
•Financial Aspects
•Market/Commercial Aspects

Economic Aspects
•Analyses if the benefits will justify the project cost/ investment done
•A successful project gives following benefits:
–Increased output
–Enhanced services
–Increased employment
–Larger government revenue
–Higher earnings
–Higher standard of living
–Increased national income
–Improved income distribution

Technical Aspects
•Site and Location: RM supply, proximity to markets, transportation facility, power supply,
manpower, water, government policies, labour laws, climate, taxes
•Size of plant/scale of operations: Technological capacity is standardized for achieving
economies of scale, low demand or less resource availability result in economies of scale
•Technical feasibility: Technology selected, availability of infrastructure, plant layout, project
implementation schedules etc.

Organizational Aspects
•Organization structure, recruitment and training aspects are studies
•Appraisal done to see if project is adequately staffed, initial recruitment is done.
Managerial Aspects
•Financial institutions check if promoters are competent and have business sense
•They can appoint nominee directors on board
•The Companies Act and Industries Act empower government to exercise control over
management
•They can also take over the management in case it is needed.
Financial Aspects
•Cost analysis: Finding out the cost of production
 14

•Pricing: Deciding price of the product after considering demand, profit and competition
•Financing: Raising funds and efficient use of the same
•Income and Expenditure: Concerned with predicting profit and costs involved

Market/Commercial Aspects
•Analysis of market opportunities
•Specification of marketing objectives
•Planning and organizing of marketing process
•Controlling of implementation of marketing plan.
 15

Q.13. Essentials of Business Plans.

When you're about to embark on developing a business plan, remember this: Form follows
function, so you want a plan that fits your exact business needs. The emphasis should change
depending on whether it's a plan for starting a company, raising investment money,
supporting a business loan or managing an existing business. In most cases, your plan will be
a 20- to 30-page document written in simple business language so it's easy to read with the
main points highlighted and lots of bullets, and some tables and charts to highlight the most
important financial projections. A standard plan includes seven sections:

1. The Executive Summary. Write this summary last, and make sure it contains the
highlights of your plan. Assume your most important readers will read only this section.

2. The Company. A plan for a startup describes your strategy for creating the legal entity and
how the initial ownership will be divided among the founders. It should also include a table
that lists startup costs and initial funding. A plan for an ongoing or already existing company
should describe the legal form of the business, the company history and the business's past
performance.

3. What You Sell. Describe the products or services you offer. Emphasize why buyers
purchase those things, what benefits they get, and what pain points they have before they buy.
Show how much it costs to deliver what you're selling.

4. Your Market. Describe your target market, including market demographics, market
growth and trends. Include a table that shows a market forecast. Describe the nature of your
industry and the competition you have.

5. Strategy and Implementation. Strategy is all about focus. So focus on certain target
market segments, certain products or services, and specific distribution avenues. Forecast
your sales and the cost of sales. Define your milestones with dates, budgets and specific
responsibilities.

6. Management Team. Name and describe the key members on your team. Include a table
that shows personnel costs. List the gaps in the management team--if any--and show how
they're being addressed.

7. Financial Projections. Describe your financial strategy and how it supports your projected
growth. Include a break-even analysis that shows risk as a matter of fixed vs. variable costs.
Include projected profit or loss, cash flow and balance sheets.

1. Specific milestones, with deadline dates, spending budgets and a list of the people
responsible for them. I've seen this called "weaving a MAT," with MAT standing for
"milestones, assumptions and tasks." That normally goes into Section 5, Strategy and
Implementation. Make the responsibilities specific for specific people, and make sure every
task gets assigned to a single person with a name and a face. This section must describe how
these different milestones are going to be tracked and measured.

2. Real cash flow. Your plan should show cash flow--either projected or actual or both--
month by month for at least 12 months. Show where you're getting money and how much,
and show what you're spending the money on. This is cash flow, not just profit and loss, and
 16

you have to understand how different cash flow is from profits. Profitable companies go
under all the time, but companies with positive cash flow can pay their bills.

3. Focus. A business plan should establish your company's priorities. Don't try to do
everything, and don't try to please everybody.

Q. 14. Asset based financing.

A specialized method of providing structured working capital and term loans that are secured
by accounts receivable, inventory, machinery, equipment and/or real estate. This type of
funding is great for startup companies, refinancing existing loans, financing growth, mergers
and acquisitions, and management buy-outs (MBOs) and buy-ins (MBIs). An example of
asset-based finance would be purchase order financing; this may be attractive to a company
that has stretched its credit limits with vendors and has reached its lending capacity at the
bank. The inability to finance raw materials to fill all orders would leave a company
operating under capacity. The asset-based lender finances the purchase of the raw material,
and the purchase orders are then assigned to the lender. After the orders are filled, payment is
made to the lender, and the lender then deducts its cost and fees and remits the balance to the
company. The disadvantage of this type of financing, however, is the high interest typically
charged - which can be as high as prime plus 10%. In the simplest meaning, asset-based
lending is any kind of lending secured by an asset. This means, if the loan is not repaid, the
asset is taken. In this sense, a mortgage is an example of an asset-backed loan. More
commonly however, the phrase is used to describe lending to business and large corporations
using assets not normally used in other loans. Typically, these loans are tied to inventory,
accounts receivable, machinery and equipment. This type of lending is usually done when the
normal routes of raising funds, such as the capital markets (selling bonds to investors) or
normal unsecured or mortgage secured bank lending is not possible. This is usually because
the company was unable to raise capital in the normal marketplace or needs more immediate
capital for project financing needs (such as inventory purchases, mergers, acquisitions and
debt purchasing). It is usually accompanied by higher interest rates, and can be very lucrative
for the parent company. For example, the bank Wells Fargo made more money from asset-
based lending business than it did the rest of its corporate business (both lending and fee
based services). Many financial services companies now use asset-based lending package of
structured and leveraged financial services. Most banks, both national investment banks
(Goldman Sachs, RBC) and conglomerates (i.e. Citigroup, Wells Fargo), along with regional
banks, offer these services to corporate clients.

Q. 15. Factoring.

Factoring is a financial transaction whereby a business sells its accounts receivable (i.e.,
invoices) to a third party (called a factor) at a discount. In "advance" factoring, the factor
provides financing to the seller of the accounts in the form of a cash "advance," often 70-85%
of the purchase price of the accounts, with the balance of the purchase price being paid, net of
the factor's discount fee (commission) and other charges, upon collection from the account
client. In "maturity" factoring, the factor makes no advance on the purchased accounts; rather,
the purchase price is paid on or about the average maturity date of the accounts being
purchased in the batch. Factoring differs from a bank loan in several ways. The emphasis is
on the value of the receivables (essentially a financial asset), whereas a bank focuses more on
the value of the borrower's total assets, and often also considers, in underwriting the loan, the
value attributable to non-accounts collateral owned by the borrower. Such collateral includes
 17

inventory, equipment, and real property, That is, a bank loan issuer looks beyond the credit-
worthiness of the firm's accounts receivables and of the account debtors (obligors) thereon.
Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable).
Third, a nonrecourse factor assumes the "credit risk" that a purchased account will not collect
due solely to the financial inability of account debtor to pay. In the United States, if the factor
does not assume credit risk on the purchased accounts, in most cases a court will
recharacterize the transaction as a secured loan.

Q.16. Leasing

Leasing is a process by which a firm can obtain the use of a certain fixed assets for which it
must pay a series of contractual, periodic, tax deductible payments. The lessee is the receiver
of the services or the assets under the lease contract and the lessor is the owner of the assets.
The relationship between the tenant and the landlord is called a tenancy, and can be for a
fixed or an indefinite period of time (called the term of the lease). The consideration for the
lease is called rent. A gross lease is when the tenant pays a flat rental amount and the landlord
pays for all property charges regularly incurred by the ownership from lawnmowers and
washing machines to handbags and jewelry.

Under normal circumstances, a freehold owner of property is at liberty to do what they want
with their property, including destroy it or hand over possession of the property to a tenant.
However, if the owner has surrendered possession to another (the tenant) then any
interference with the quiet enjoyment of the property by the tenant in lawful possession is
unlawful.

Similar principles apply to real property as well as to personal property, though the
terminology would be different. Similar principles apply to sub-leasing, that is the leasing by
a tenant in possession to a sub-tenant. The right to sub-lease can be expressly prohibited by
the main lease.
 18

Q. 17. Documentation and creation of charges on securities.

CHARGING OF SECURITIES AND DOCUMENTATION

Security for bank advance has no doubt been reduced to secondary importance in the present
context particularly for priority sector advances but it is still very important to influence the
decision of banks in conventional advances. Reserve Bank of India has also stipulated certain
quantitative restrictions on the banks' power to grant clean advances. Banks have prescribed
their own formats for documentation for various types of advances and the borrowers in
almost all the cases have to execute those documents without any choice. It would never be
advantageous to know the general characteristics of securities, methods of their charging and
documentation procedures adopted by the banks.

The securities may primarily be divided in two categories as under

 Primary security.

 Collateral security.

The assets created by the borrower from the credit facilities granted by the bank form the
primary security for the bank advance as a matter of rule. The bank invariably obtains a
charge over those assets. Similarly, other assets on which the advance is primarily based even
if it is not created from the credit facilities granted by the bank will also be taken as primary
security. In some cases where primary security is not considered adequate or the charge on the
security is open the bank may insist on an additional security to collaterally secure advances
granted by it. Such securities are termed as collateral securities. Collateral security may either
be tangible or third party guarantees may also be accepted. Bank now grant need based
advance after proper assessment and should not normally insist for collateral security in most
of the cases.1bip matter needs to be discussed at die time of sanctioning of limits. Reserve
Bank, of India has advised the banks not to obtain any collateral security in case of all priority
sector advances upto Rs. 25,000. In other cases, it is left to the mutual agreement of the
borrower with the bank.

BASIC CHARACTERISTICS OF SECURITIES AND CONCEPT OF MARGIN

The securities acceptable to banks either as primary or collateral must have certain, basic
characteristics as under:

 Ascertainment of value. A security will be considered good and will be acceptable

to the bank only if its value can be ascertained with a definite degree of
correctness. Certain articles may be valuable but may not be accepted as
security if the value cannot be ascertained such as paintings/antiques etc.

 Marketability. A good security must have a ready market. Raw materials, articles of
necessity, other primary commodities are easily marketable and are considered good
security. Semi-finished goods may be more valuable than raw material for the
borrower but may not be marketable at all and will thus be considered inferior to raw
material in as much as its acceptance as a security is concerned.

 Stability in value. A good security should have a stable value over along period. If the
value of a security fluctuates violently over a short period, it may not be considered a
 19

good security and may be accepted by the bank only after keeping a very high
margin.

 Ascertainment of title and transferability. An asset can be accepted as security by the

bank only when the title over that asset can be ascertained. Furthermore, the title
should be easily transferable. The purpose of obtaining a security is to apply the sale
proceeds of the security if the customer fails to repay the advance. But if the security
is not easily transferable the very purpose of obtaining a security may be defeated.
Immovable property located at a prime location may be very stable in value has a
ready market and the value can also be ascertained but may still not be considered as
a good security due to difficulty in ascertaining the title and elaborate legal process
involved for effecting its sale through a court of law.

 Durability. The security accepted by the Bank must be durable. No bank advance is
granted against perishable commodities.

 In case loan or advances to Muslims offering their property as primary or collateral

security, it should be ensured, before accepting property as security that such property
has not been alienated under the Muslim Law like 'waqf-ul-ulad' and/or 'Haq-rnehr' in
favour of their wives or for the benefit of their heirs since it will jeopardise the
interest of the banker as lender.

TYPES OF CHARGES

Security is obtained by the bank as an additional cover against default by the borrower in
repayment of bank's dues. Charging of security means making such security available to the
bank and involves certain formalities. Charging should be legal and perfect so that it is
possible to realise the security if such a need arises. There are six different modes of charging
a security as under:

 Pledge. Pledge is bailment of goods by the debtor to the creditor with an intention
to create a charge thereon as security for the debt. It has a legal backing as per the
Indian Contract Act, 1872 wherein the definition of pledge and bailment and also the
rights and liabilities of all the parties to pledge have been clearly spelt out. Important
conditions to be complied with for constitution of a valid pledge are:

 There should be bailment of goods which implies that goods should be delivered
the debtor (pledger) to the creditor (pledgee). The delivery may nevertheless be
actual physical delivery or constructive delivery as in case of documents of title to
goods.

 The bailment must be by the debtor or on behalf of the debtor.

 The delivery of goods must be with an intention of the parties to create security for
die debt or performance of a promise.

In pledge the ownership of the goods remain with the borrower whereas physical control over
these goods will be exercised by the bank. The borrower has a right to get the goods returned
to him after payment of debt created here against. In case of default by die borrower the bank
can sell the goods after giving a reasonable notice of sale as required under Section 176 of
the Indian Contract Act,1872. Notice must clearly indicate the intention of the pledgee to sell
the security and is compulsory before the sale can be effected. If the bank realises more than
its dues by such sale, the excess realised will have to be returned to the borrower. However, if
 20

there is any shortfall, die bank can proceed against the borrower in a court of law for recovery
of the balance.

 Hypothecation. Pledge takes away control over the goods from the borrower which
may not be practicable as the borrower would require certain goods under his control
to continue its manufacturing and/or trading activities. An equitable charge in favour
of the bank over the goods is created in such cases without parting with the
possession of the goods. A charge on a property for a debt where neither ownership
nor possession is passed on to the creditor is known as ‘hypothecation charge’
Hypothecation agreements obtained by banks generally have a clause under which
hypothecation can be converted into a pledge at, a later date.

 Assignment. Assignment means transfer of a right, property or debt by one person to

another person. The person transferring the right is known as assignor and the person
to whom the right is transferred is known as assignee. The assignment may be legal in
which case the assignor must give a written notice of the assignment stating the name
and address of the assignee to the debtor or may he equitable where no such notice is
sent. This form of charge is generally adopted for charging of book debts, monies due
from Government (supply bills) and life insurance policies etc. Banks generally go in
for legal assignment and insist for obtaining an acknowledgement of assignment from
the debtor.

 Mortgage. Mortgage is a mode of charge associated with immovable property.

Immovable property has been defined by Section 3(26) of General Clauses Act, 1887
as under:

Immovable property shall include land, benefits to arise out of land and things
attached to the earth or permanently fastened to anything attached to the earth".

Section 4 of General Clauses Act, 1887 further provides that the above definition of
immovable property shall hold good under the Transfer of Property Act, 1882 as well.

Section 3 of Transfer of Property Act, 1882 provides that immovable property does
not include standing timber, growing crops or grass. It also provides explanation to
the term "attached to the earth" which means:

(a) rooted in the earth, as in case of trees and shrubs,

(b) imbedded in the earth, as in case of walls or buildings, or

(c) attached to what is so imbedded for the permanent enjoyment of that to

which it is attached.

Immovable property' includes land, buildings, hereditary allowances, rights to ways, lights,
ferries, fisheries or any other benefit to arise out of land and things attached to the earth or
permanently fastened to anything which is attached to the earth but not standing timber,
growing crops nor grass".

Mortgage by deposit of title deeds or equitable mortgage. Section 58(f) of the Transfer
of Property Act, 1882 defines equitable mortgage as mortgage created by depositing
title deeds of an immovable property to secure a debt, existing or future. Three basic
conditions to constitute a valid equitable mortgage are
 21

(i) Delivery of title deeds (original) by the mortgagor to the bank.

(ii) Existence of a debt, existing or future.

(iii) Intention of the mortgagor to create a mortgage on that property to secure the
debt.

No equitable mortgage can be created if any of the above three conditions' is not complied
with.

This form of mortgage is very popular because it does not require finalisation of any
mortgage deed and its subsequent registration which requires payment of heavy stamp duty.
Mortgage is created simply by depositing the title deeds with the bank with an intention to
create a security and no other agreement etc. is strictly required. Equitable mortgage can,
however, be created only at places as notified by government in this regard.

 Simple Mortgage. Section 58(b) of Transfer of Property Act, 1882 relates to simple
mortgage in which the mortgagor personally binds himself to pay the debt and agrees
that in the event of non-payment by him, the mortgager may cause the mortgaged
property to be sold and the proceeds of sale be applied in repayment of debt. The
possession of mortgaged property, however, still remains with the mortgagor. The
mortgagee does not have an absolute right to sell the property in case of default but
has to seek intervention of the court.

A formal mortgage deed will have to be executed for creation of a simple mortgage
which will also be required to be registered after payment of necessary stamp duty
which is quite substantial and in all the cases will have to be borne by the borrower.
All efforts should, therefore, be made to convince the bank to accept equitable
mortgage. Simple mortgage may be resorted to only when equitable mortgage cannot
be created as in cases where title deeds are not available,

 Lien. Lien means the right of the creditor to retain the goods or securities of the
debtor, which are in his possession until the debt due from the debtor is paid. It does
not require any specific agreement to support this right. The lien may be general
which confers the right to retain any goods for a general balance of account or it may
be particular lien where goods can be retained by the creditor for a particular debt
only. The person exercising general lien has only a right to retain the goods till the
dues are paid and may not be able to sell those goods.

The right of the banks to general lien is however, considered on a different footing and banks
have a general lien on all securities deposited with them as bankers by a customer, unless
there be an express contract or circumstances that show an implied contract, inconsistent with
lien. A banker’s lien is thus more than a general lien, it is an implied pledge. The bank,
therefore, has a right to sell the goods in his possession after giving a reasonable notice. The
lien can be exercised on bills and cheque deposited for collection, dividend warrants received
by the banker as a mandatee from the customer, securities left with the banker after a
particular loan has been paid. The bankers lien however, does not extend to:

(i) Securities or valuables lying in the locker rented to the customer.

(ii) Securities deposited upon a particular trust.

(iii) Securities deposited to secure a specific loan.

 22

(iv) Securities left with the banks after an advance against them has been adjusted.

(v) Securities left inadvertently with the bank.

No specific letter of lien agreement is necessary as the banks enjoy the right of lien under the
Contract Act. However, in some cases the bank may obtain a specific letter of lien so that the
borrower is not able to contend later that the securities were deposited by him for a specific
purpose inconsistent with the lien.

Negative Lien

The borrower may sometime be having non-encumbered assets which are not charged to the
bank as security. The borrower is thus free to deal with these assets and may even sell them if
he so desires. To restrict this right of the borrower, bank may sometimes request him to give
an undertaking to the effect that he will neither create any encumbrance on these assets nor
sell them without the previous permission of the bank so long as the advance continues. This
type of an undertaking obtained by the bank is known as 'Negative Lien'. Negative lien is in
the form of a personal assurance or undertaking which has binding effect but confers no right
on the bank to proceed against the property itself and thus creates no encumbrance or charge
on the property.

 Set Off. Set off is the right of combining of accounts between a debtor and a
creditor so as to arrive at a net balance payable to one or the other. Set off in relation
to bank means his right to apply the credit balance in customer's account towards
liquidation of debit balance in another account of the customer provided both the
accounts are maintained by him in the same capacity. The right may not be
considered as absolute and the bank may be required to give a notice for exercising
his right of set off. The right of set off can be applied by the bank only if the
following conditions are met:

(a) The liability of the borrower is for a sum which is certain,

(b) The repayment of debt is due, and

(c) Both the accounts are held by the customer in the same capacity.

The right of set off should, however, not be exercised arbitrarily and a notice for combining
the accounts must invariably be served by the bank on the customer.

DIFFERENT TYPES OF BORROWERS/EXECUTION OF DOCUMENTS

Banks generally grant advance to persons having legal capacity to enter into a contract.
Minors/lunatics/drunken persons etc. who cannot enter into a valid contract may not be
favoured as borrowers and no credit facilities may be sanctioned to such persons.

The borrowers may have different constitution conferring on themselves various legal rights
and responsibilities and banks as creditors will be interested to know the exact constitution of
the borrower. Banks may also require additional undertakings information in some cases. This
information is very essential for the banks while getting the documents executed from the
borrowers. The documents can be executed only by the persons who can validly bind the
borrower. The position regarding obtaining of undertaking/information may differ from bank
to bank. Chart given on the next page gives details of various types of borrowers, the
 23

additional undertakings required by banks and the persons who are authorised to execute the
documents which is based upon the common practice of most of the banks.

S.NO. Constitution of Additional papers required Persons authorised to

execute the document
Borrower
1. Individual ---- Individual in his personal capacity
2. Joint ---- All the borrowers in their personal
capacity binding themselves jointly and
severally.
3. Sole Declaration regarding his soleSole proprietor in his capacity as sole
interest in theproprietor. He is, however, personally
Proprie- business. liable for all the dealings and
torship obligations in the name of business.
4. Joint Hindu 1. Letter of Joint Hindu FamilyAll documents to be signed by Karta of
Family giving details of all the maleHUF and all major coparceners in their
members includingcapacity as Karta & coparceners and
minors also in their individual capacity.

2. Declaration to the effect that

the advances will be
utilised only for the family
business to be signed

by Karta & all other major

coparceners.
5. Trusts 1. Copy of trust deed. All the trustees in their representative
2. Legal opinion regarding thecapacity or as per trust deed and
power of trustee tosupported by the legal opinion.
borrow.

6. Partnership 1. Copy of partnership deed. All partners in their representative

firm capacity i.e. as partner and also in their
2. Declaration from allindividual capacity.
partners to inform
the bank of any change in
constitution.
7. Limited 1. Articles and MemorandumDocuments to be signed by authorised
Companies Association persons in terms of board resolution in
their representative capacity. The
2. Copy of Certificate of common seal of die company is also
incorporation. required to be affixed wherever
necessary.
3.Copy of Certificate ofThe charge created by the company
commencement of businessover its assets will also require
(only in case of public limitedregistration under Section 125 of
companies) Companies Act, 1956.

4.Copy of Board Resolution

empowering the company to
borrow from the bank and also
authorising managing
director/ directors/other
 24

officers to execute the

documents as required by the
bank.

5.Copy of the resolution of

general body meeting of the
company under Section 293
(1) (D) authorising the
company to borrow in excess
of its own paid up capital and
free reserve.

6.Declaration from the company

that borrowings will remain
within the powers conferred
on it as in (5) above

DOCUMENTATION

Banks have their own standard forms for promissory notes and other documents and no
deviations are normally permitted. The borrowers are expected to execute these documents as
required by the bank. Banks also do not generally give copies of these documents to the
borrower which sometimes creates difficulty when these documents become subject matter of
a legal dispute. The following points must be kept in mind while executing the documents as
required by the Bank.

Precautions while executing loan documents

The following are the precautions, in nutshell, which should be taken care of both by the
borrower as well as banker, at the time of preparation, execution and registration of loan
documents etc.:

(a) Person, executing the loan documents must be competent to enter into a
contract i.e., he or she should have contractual capacity. Thus, minor,
insolvent person, lunatic etc. are not competent persons to execute
documents.

(b) The loan documents should bear proper type of stamps i.e. adhesive,
embossed etc. Further value of stamp duty should be adequate, keeping in
view the laws of the State in which the documents are executed. The
Non-Judicial Stamp papers, if used, should bear the date, prior to its
execution and also the date should not be earlier than six months. The text of
the agreement may be written on the Stamp papers itself and plain papers
(additional sheets) may be used, if required in addition to Stamp papers.

(c) No column of the loan documents should be left blank. While executing the
documents, the borrower must sign in full and in the same flow in which his
signatures are available in the bank. The cuttings & over writings must be
avoided and if at all, they become unavoidable, they should be authenticated
by the borrowers by signing in full.
 25

(d) Sometimes the borrower does not understand the language of the loan
documents. In such a case, a separate letter, in the language of the borrower
should he taken from him stating that the contents of the loan documents
have been well understood by him, including the terms and conditions of the
loan sanctioned. The letter should be got witnessed by another person.

(e) In the case of an illiterate borrower who puts his thumb impression on the
loan documents, the bank official in whose presence the documents are
executed, should give a certificate on a separate paper that the contents have
been fully explained to the borrower in a language which he speaks and
understands. This certificate should be got witnessed by independent persons.

(f) Similarly, in case of a blind person, such a certificate should be obtained from
lawyer or notary public in whose presence the borrower executes documents.

(g) In case the borrowers reside at different places, the loan documents should he
got executed through the branches of the bank situated at those stations, after
properly verifying the identity of the borrowers. As

regards stamp duty, it should be according to the state which attracts highest
value of stamp duty. The borrowers while signing the documents must put
date and place of execution after their signatures.

(h) In the case of a partnership firm where a minor is admitted as partner to the
benefits of partnership, he should not be allowed to execute any loan
document. This is so because a creditor i.e. lending banker cannot proceed
against the minor in person. However, minor's share in the firm can be
proceeded against, as the major partners of the firm have executed loan
documents, thereby binding each other by their act of execution. After the
minor attains majority and elects to remain as partner in the firm, the bank
should proceed to obtain an undertaking from him stating that he (minor
attaining majority) stands fully liable for the dues of the bank against the
partnership firm.

(i) Sometimes loan documents are executed by the holder of power of Attorney
on behalf of a trading concern, partnership firm, Hindu undivided family
(HUF), company, individual etc. In such a case, a notice should be sent to the
principal, stating that the attorney has executed the documents on their
behalf. A certified copy of Power of Attorney should be kept along with main
loan documents. And also the letter/confirmation received from the principal
in this regard, in response to the notice should be preserved.

(j) The borrowers must obtain a copy of the sanction and ensure that documents
only for those facilities which are sanctioned in their favour are executed.

(k) All the documents must be completely filled in before their execution.

(l) The guarantee form should be executed if so agreed and stipulated as a term
of sanction.

(m) Copies of all the documents executed must be obtained and kept on record for
any future reference.
 26

Q.18. Non-performing loan

A sum of borrowed money upon which the debtor has not made his or her scheduled
payments for at least 90 days. A nonperforming loan is either in default or close to being in
default. Once a loan is nonperforming, the odds that it will be repaid in full are considered to
be substantially lower. If the debtor starts making payments again on a nonperforming loan, it
becomes a reperforming loan, even if the debtor has not caught up on all the missed
payments. Institutions holding nonperforming loans in their portfolios may choose to sell
them to other investors in order to get rid of risky assets and clean up their balance sheets.
Sales of nonperforming loans must be carefully considered since they can have numerous
financial implications, including affecting the company's profit and loss, and tax situations.

A Non-performing loan is a loan that is in default or close to being in default. Many loans
become non-performing after being in default for 90 days, but this can depend on the contract
terms.

“A loan is nonperforming when payments of interest and principal are past due by 90 days or
more, or at least 90 days of interest payments have been capitalized, refinanced or delayed by
agreement, or payments are less than 90 days overdue, but there are other good reasons to
doubt that payments will be made in full” (International Monetary Fund).

By Bank regulatory definition non-performing loans consist of:

 other real estate owned which is taken by foreclosure or a deed in lieu of foreclosure,
 loans that are 90 days or more past due and still accruing interest, and
 loans which have been placed on nonaccrual (i.e., loans for which interest is no longer
accrued and posted to the income statement).

Q.19. Procedure for loan recovery.

Necessity of recovey of loan amounts

We are familiar about the working of Urban Co-op. Banks. The Urban Co-op. Banks
mobilise deposits from the members of the public. The banks have introduced various
deposits schemes which induce the common man to save more money. The Urban Co-op.
Banks accept deposits for the purpose of lending. One of the most important functions of
the banks is to create credit. Except in a few cases like interest on savings bank deposits and
interest on export credit and interest on small loans upto Rs2 lakh which are administered

( under the control of the RBI), most of the interest rates on deposits as well as loans &
advances can now be freely set by the banks themselves.

It is the primary duty and function of the Urban Co-op. Banks to safeguard the interest of
depositors. Whenever deposits are accepted, the bank agrees and undertakes to repay the
amount of deposits with interest to the depositor on maturity. The ownership of the deposit
amount vests with the customer and the custody of the deposit amount is with the Banker.
So whenever Advances and Loans are sanctioned to shareholders / members of the Bank,
the Banker has to take utmost care to see that the Borrower repays the amount of loan with
interest so as to enable the Banker to repay the amount of deposit with interest to the
 27

customer.

It is with background, it will be clear that the banker must be vigilant about the utilization
of the amount of advances and loans made to be shareholders/nominal member. If the
Banker is reluctant and negligent towards recovery of loan amounts and advances, it will be
very difficult for the bank to repay the amount of "DEPOSIT AMOUNTS" to the customers
on maturity.

What is meant by overdues

The Urban Co-op. Banks should exercise caution, necessary checks and adopt detailed
scrutiny measures to process loan applications, received from the different shareholders.

This is necessary to ensure that every borrower has a proper repaying capacity for
repayment of the amount of loans and advances that would be sanctioned. Securities are
also taken to ensure that in case the borrower fails to repay the amount of loan, the
securities can be attached and sold out and the debts can be liquidated.

Even with this background, though there is a detailed scrutiny of loan application, it is
observed that there are very few cases, where the judgment of the bankers fail. In such 'Fail
Cases' the borrowers are not ready and willing to repay the amount of loan, the securities
can be attached and sold out and the debts can be liquidated.

We have also studied that whenever loans and advances are sanctioned, the borrowing
shareholders nominal members and sureties etc.are required to execute Demand Promissory
Note and other allied Loan Agreements such as Deed of Hypothecation, Deed of Mortgage
and immovable properties, Deed of pledge etc.

On careful reading the Loan agreements, we observe the following points are stipulated in
each Agreement/Bond.

 a) Date of sanction of loan

 b) Amount of loan sanctioned.
 c) Rate of Interest that would be charged.
 d) Last date of repayment of loan.
 e) Period for which loan is granted.
 f) The mode of repayment of loan, i.e on monthly basis / on quarterly
basis etc.
 g) Rate of penal interest in case there are defaults committed by the
borrower in respect of repayment of loan amount.
 h) Details regarding securities offered.

Normal measures to be adopted by bank officials for recovery of dues

Whenever, a borrower commits breach of agreement in respect of repayment of schedule of

the amount of loans with interest etc., we safely say that there are 'OVERDUES ' in the
Loan Account.
 28

Once the Loan A/c is an overdue A/c i.e. the borrower has committed default in repayment
of loan amount as per the dates specified in the Agreement, then the Banker has necessarily
to adopt measures which will result into recovery of overdue amounts.

We now proceed to suggest certain measures to be adopted by Urban Co-op. Banks for
effecting recovery of overdue amounts.

Whenever the borrower commits default in repayment of loan amount, immediately the
bank should serve ' Preliminary Notices' on the principal borrower and the sureties advising
them to repay the amount of overdues with interest etc. Such Preliminary Notices should
invariably mention information which is of factual nature relating to (i) amount of loan
sanctioned (ii) date of sanction of loan (iii) Names of the sureties (iv)amount of the loan
sanctioned (v) amount of over dues with interest etc. on a particular date. In addition to the
above it must also be communicated the bank shall proceed to take further action against the
principal borrower and sureties in case of failure to repay the amount of loan/over dues. It
has been often said 'A' stitch in time saves nine'. Thus, the banker must be vigilant, right
from the disbursement of loan amount till the recovery of the entire loan amount. There
should be effective supervision over the amount of loan sanctioned.

Recovery through salary / wages

After issue of such preliminary notices, there may be a positive response from the principal
borrower and he may repay the amount of defaulted loan installment, or the principal
borrower and the surety may approach the authorities of the bank and may explain their
genuine difficulties regarding repayment of loan amount or there may offer to repay the
dues partially. There may be cases where there is no response from the borrower / sureties.

With this background, the bank should proceed further to devise such steps which will result
in recovery of dues. Under various State Cooperative Acts (e.g. Section 49 of M.C.S. Act
1960) it has been provided that if a member of a society./Bank authorises his Employer to
make deduction from his salary/wages, in order to satisfy the claims of the society/Bank,
then on receipt of requisition letter from the concerned Bank, the Employer shall proceed to
make deduction from the salary/wages from the concerned employee/member to meet the
claims of the Bank. The Employer must remit the amount so deducted immediately to the
Bank concerned.

Non-compliance of these provisions under the State Cooperative Act shall be constructed as
'offence' and further Civil and Criminal action can be instituted against such Erring
Employer.

In addition to the above, there are provisions under the Indian Payment of Wages Act 1936
(vide Section 7(2) and Section 7(2)(j) which stipulates that the Employer shall make
deduction from the salary/wages of an Employee to satisfy the claims of the Cooperative
Society / Banks.

Settlement of Disputes

Based on the noting of the Management, the Board of Directors may pass a Resolution
 29

authorizing the Manager/or such other officer to file "Dispute Application” in the Co-
op.Court against the defaulting principal borrower and his sureties. Section 91 of the MCS
Act empowers the co-operative courts to decide on ‘Disputes’ and Section 95 further
empowers the court to direct attachment of property before announcement of the award
which is called Attachment before award or order and interlocutory order if it is satisfied
that the parties to the dispute are likely to remove/ dispose off whole or part of his property.
Section 95 similarly empowers the Registrar / Officer authorised by him to take the above
measures in case of disputes referred to him.

Under Section 96 of the MCS Act, the Co-operative courts after giving reasonable
opportunity to the parties to the dispute may make an award on the dispute. The related
procedures and documents needed have been detailed below:

The Dispute Application shall consist of following papers/documents etc.

A. A copy of the plaint- the plaint should mention the date of

Loan Application

 The date of Promissory Note & other loan agreements, bonds executed in favour of
the Bank.
 Description of the securities offered.
 Details regarding sanction of loan.
 Details regarding recovery effected.
 Details of the loan amounts outstanding together with interest, penal interest etc.,
 Date of issue of notice requesting the borrowings & sureties to repay the entire
amount of loan with interest.

In the concluding para of the plaint we have to mention about the 'Prayer Clause' requesting
the Hon. Court to grant an Award/Decree in favour of the Bank.

The prayer clause normally consists of following important points -

 The opponents may be held responsible to repay the entire amount of loan with
interest.
 If the opponents fail to pay the amount of loan, the disputant may be entitled to
attach the movable and immovable property of the opponents.
 The disputant may be entitled to sell the attached property and recover the amount
due from the opponents.
 Any other orders to meet the ends of justice.

Along with the copy of the plaint, the Bank is required to enclose 'Certified True Copies' of
the following documents i.e.

o Copy of the Resolution passed by the Board of Directors for filing the
dispute in the Co-op. Court.
 30

o Copy of the notices issued to the principal borrower and the sureties.
o Acknowledgement receipts received from the postal authorities regarding
service of notices.
o Copies of the promissory note and loan agreement /Bond etc.
o A copy of Deed of Mortgage, if any.
o Statement of loan account.
o Any other papers relevant to the dispute.
o A copy of the Treasury challan indicating the amount deposited to meet the
Arbitration cost.
o On receipt of "Dispute Application" the Court shall issue summons to all the
opponents mentioned in the application.
o After serving the summons, the opponents are directed to file their ' Written
Statement' or 'Say' or ' Reply ' to the ' Dispute Application'.
o After carefully reading the plaint and ' Written statement' filed by the
opponents the court shall proceed to frame issues ' involved in the dispute'.
o The courts shall direct the disputant and the opponents to produce
documentary evidences in support of their say or claims etc.
o After this, the authorized officer of the Disputant shall stand in the 'Witness
Box' and explain the circumstances which led to filing of dispute against the
opponents.
o The advocates for the opponents are at liberty to do 'Cross-Examination' of
the Bank officials.
o The opponents are subsequently required to stand in the 'Witness Box' and
explain their stand to Hon. Court.
o The Bank official or the Advocate is also at liberty to do a cross examination
of the opponent.
o After this, the Advocate for the disputant and Advocate for the opponent are
to make 'Arguments' before the court in support of their claims.
o After hearing both sides, the court shall deliver a judgment in the open court.
o On the basis of the judgment, a final award / decree shall be passed.

Under section 97 of the MCS Act, an appeal against the decision under Section 96 or order
under Section 95 can be made by the aggrieved party to the Co-operative Appellate Court
within 2 months from the date of the decision or order.

It is observed that there has been often delay in the Co-op. Court for getting an Award and
the leading Cooperators & representatives of Urban Coop. Banks vehemently pressed the
State Government to carry out certain amendments for early disposal of cases of Urban Co-
op. Banks. In Maharashtra State, the State Government has amended the provisions of
section 101 of the Maharashtra State Co-op. Societies Act, 1960.

Power of the Registrar to issue Recovery Certificate: Under the provisions of Section
101 of M.C.S. Act 1960, the Registrar of Co-op. Societies is competent to make an enquiry
on the merits of the application made to him by an Urban Co-op. Bank for grant of
'Recovery Certificate' against the borrowers and sureties.

As provided under section 101 of the M.C.S. Act 1960 the Urban Co-op. Bank is required to
file an application for grant of 'Recovery Certificate' against the borrower in the office of
 31

Registrar of Co-op. Society.

The Registrar of Co-op. Societies shall serve summons to the opponents requesting them to
appear before him and explain to him why 'Certificate of Recovery' should not be granted
against them.

The Registrar shall apply 'The Principles of summery procedure' for disposal of such
cases/applications.

Before issue of 'Certificate of Recovery' the Registrar has to satisfy about following
important aspects -

 I) The opponents are members/Nominal Members of the Society / Bank.

 II) That the opponents have borrowed money from the Society / Bank.
 III) That the opponents have committed defaults in repayment of loan
amounts and that they are in 'ARREARS'
 IV) The Registrar, shall grant a Certificate that the opponents are in arrears
and are responsible to pay the amount to the society with interest, cost of recovery
etc.

Once, 'The Certificate of Recovery' is issued it becomes 'Final'. The word 'Final' denotes
that it is not appealable in any Court of Law.

Thus, in short the application under Section 101 is similar to that of 'dispute application'.
We are required to enclose all the papers relevant to documents etc., alongwith the
application under Section 101.

The Urban Co-op. Banks, after obtaining awards are required to execute the same so as to
recover the decreetal amount from the opponents.

In Maharashtra, there are special provisions under the Maharashtra Co-op. Societies Act,
1960. Under Section 156 of the M.C.S. Act 1960 the Registrar or a person empowered by
the Registrar, is Competent to execute the awards against the opponents.

There are following broad methods / measures by which an award can be executed.

 By issue of Demand Notice to opponents directing them to repay the entire amount
as mentioned in the award.
 By attachment of movable property.
 By sale of movable property.
 By attachment of immovable property.
 Without attachment, in case of Mortgage Decree, immovable property can be sold
out.

The Registrar of Co-op. Societies in Maharashtra State, has also empowered the officials,
not below the rank of Branch Manager of Urban Co-op. Banks, to exercise the powers
under Section 156 of M.C.S. Act 1960 read with Rule 107 of M.C.S. Rules 1961.
 32

Debt Recovery Tribunal – The Debts Recovery Tribunals were established by the
Government of India under an Act of Parliament (Act 51 of 1993) for expeditious
adjudication and recovery of debts due to banks and financial institutions. Accordingly the
DRTs were set up in different parts of the country as per the Recovery of Debts due to banks
and Financial Institutions Act, 1993 and Debts Recovery Tribunal (Procedure) Rules, 1993.

As per the provisions ( Section 19) of the DRT Act , banks and financial Institutions could
apply to the Tribunal for recovery of debts of Rs 10 Lakh or more by making an
application called Original application to it. The Tribunal has powers to pass an interim
order preventing the borrower from selling/ disposing off / tampering with the property and
can pass orders for attaching the properties of the borrower in case it is satisfied that the
latter may sell/ dispose off whole or part of the property. Further the Tribunal has powers to
appoint a receiver for taking care of the property.

Issue of Decree under section 19(20) of the Act- The Tribunal, after giving opportunities to
both the parties, issues an order directing the borrower to pay a specific amount to the bank.
Based on the order, the Tribunal then issues a certificate of recovery to the Recovery
Officer. The RO can then proceed to recover the amount by attachment & sale of property
or by appointment of receiver for management of the property in terms of section 25 of the
Act. As per Section 20 of the Act, the aggrieved party can file an appeal against the order of
the DRT before the Appellate Tribunal within 45 days.

Recent Judgement of a three member bench of the Supreme Court:

The Supreme Court held that Cooperative banks can recover outstanding loans only
through the mechanism provided in State cooperative laws and need not approach the Debts
Recovery Tribunal. The Bench pointed out that the reason for excluding cooperative banks
from the purview of the RDB Act seemed to be that they had comprehensive, self-contained
and less expensive remedies available under the State Co-operative Societies Acts, while
commercial banks and financial institutions had to file suits in civil courts. The RDB Act
was, therefore, designed to deal with other banks and financial institutions, which had to
have recourse to the time-consuming process of civil courts. The bench held that If
cooperative disputes also went to the tribunals, they would be overburdened and the whole
object of speedy recovery of debts due to banks and financial institutions would be
defeated. In conclusion, unless this decision of the bench is revised, the co-operative banks
can not recover their loans through the DRTs.

SARFAESI Act, 2002

There are 3 objectives of the Act viz., to regulate:

o – Securitization and
o – Reconstruction of financial assets and
o – Enforcement of security interest.

From the point of view of the UCBs, the ‘Enforcement of security interest’ is of particular
importance and use for recovery of their bad loans. The specialty of the Act is that the
security interest can be enforced without intervention of the courts subject to procedures
 33

being followed as per provisions of the Act and the related Rules.

Procedure to be followed:

o Under Section 13(2) of the Act, a 60 days notice has to be served by the bank
on the borrower with a request to discharge the loan liability
o The notice must contain details of :
 amount payable by the borrower;
 ecurity interest intended to be enforced.
 on receipt of notice, if the borrower makes a representation or raises
an objection, the secured creditor must consider such representation
or objection.
 if the secured creditor comes to the conclusion that the said
representation or objection is not acceptable or tenable, he must
communicate the reasons for non-acceptance of representation or
objection within one week of receipt of the above.
 MODES OF RECOVERY AVAILABLE (S.13(4))

If borrower fails to discharge the liability, secured creditor has the following options

 Take possession of secured asset

 Take over the management of the business of the borrower including
 The right to transfer by way of lease, sale, assignment, etc.
 The said rights must be exercised only where substantial part of
business of borrower is held as security for the debt.
 Appoint a manager to manage the security asset taken over.
 Issue notice to persons who acquired the secured asset from the
borrower or from whom money is due.
 The CMM( chief metropolitan magistrate)or DM

(district magistrate)is empowered even to use

force necessary for taking steps towards

securing compliance

Non-application under the Act- Section 31 -The exemptions under this Act i.e. properties
which can not be attached have been detailed in the schedule to the Act. Some of the
important ones relevant for the UCBs are:

 Any security interest securing repayment of any financial assistance

not exceeding Rs.1 lakh.
 Security interest not registered under this Act.
 Any security interest created in agricultural land.
 A lien on any goods, money or security given under the Indian
Contract Act, 1872
 A pledge of movables u/s 172 of the Indian Contract Act
 Any conditional sale or hire-purchase or lease or any other contract in
 34

which no security interest has been created.

 Rights of unpaid seller u/s 47 of Sale of Goods Act.
 Properties not liable to attachment under s.60 of cpc 1908 excluding
properties specifically charged for raising the loan.
 The amount due is less than 20 per cent of the principal and interest
 RIGHT TO APPEAL: Under the Act, the borrower can appeal before DRT by
paying the fee within 45 days (S.17). The appeal can be entertained only when the
borrower deposits fifty per cent of the amounts claimed in the notice.
 DRT can consider the legality of action taken by the bank. If it finds it wrongful, it
can restore the business or management to the borrower. If , however, the DRT finds
that the action taken by the bank is as per the provisions of the law , then the bank/
secured creditor can proceed to take action under Section 13(4) of the Act. The
application has to be disposed of by the DRT within 60 days and if its pending for
four months, either the bank or the borrower can appeal to the Appellate Tribunal for
expeditious Tribunal.
 An application for recovery of balance amount, if any, by secured creditor can be
presented to the debt recovery tribunal by the authorised officer (AO)of the bank or
can be sent by registered post addressed to the registrar of debt recovery tribunal.
 Appeal to the APPELLATE TRIBUNAL under Section 18:
 Persons aggrieved by the order of DRT to prefer an application before the appellate
tribunal within 30 days.
 The appellate tribunal is vested with power to reduce the deposit amount to not less
than 25 percent.

Miscellaneous aspects: No civil court has any jurisdiction under this Act.