CREDIT POLICY

Lending is an indispensable aspect of banking, and a banker earns bulk of his income through
lending. The other major reason of the lending function is to add value to the bank. By lending
the funds mobilized, a bank will be in a position to earn spreads to sustain profitability.
Profitability through lending will be attained if the bank is in a position to take and manage
credit risk that arises on account of the quality of the borrower and liquidity risk that may arise
by borrowing short and lending long in order to attain greater spreads. The lending decisions of a
bank are guided by its loan policy or credit policy.

The credit policy outlines the crucial lending decisions of a bank. It lays down the rules and
regulations that guide the sanctioning of loans. However, to sustain profitability, prudent
decisions need to be taken both prior to and after sanctioning the credit. These rules generally
relate to the amount of credit to be extended during a financial year, the industries to focus on,
the geographical spread, the type of credit to offer, the type of proposals to finance, the disbursal
mechanism, the collateral value, the method of pricing, the repayment schedule, the monitoring
process, etc. These macro and micro level considerations of the lending activity contribute to the
achievement of the bank's objectives. The bank's management should thus, ensure that lending
decisions fall in line with the bank's overall objectives.

The credit policy of a bank is primarily aimed at accomplishing this mission. It is a byword of
the bank's approach to sanctioning, managing and monitoring credit risk. Its main aim is to make
the bank's systems and controls more effective. The policy applies to the entire bank's domestic
lending.
The policy is laid down by the top management and deals with the following:
 Exposure levels
 Credit risk assessment
 Credit appraisal standards
 Documentation standards
 Delegation of powers
 Pricing
 Review and renewal of advances
 Takeover of advances.

Besides the above, the policy deals with credit facilities to companies whose directors are in the
defaulters list of the RBI. The policy also lays down the norms of major and minor deviations
and the authority for sanctioning/approving them. The policy also discusses different kinds of
advances such as personal loans, export credit, advances to priority sector and maturity period of
bank's advances. In the final pages, the policy details the strengths, weaknesses and the prospects
of the bank.

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NEED FOR CREDIT POLICY

The credit policy document is a document that carefully specifies the do's and dont's while
sanctioning the loan proposals. As loan proposals differ widely from each other, there cannot be
a strict methodology for accepting or rejecting the proposals.

Instead, guidelines can be given within the credit policy for the decision makers to enable them
to screen out loans, which can be out rightly rejected, loans that can be sanctioned without any
reference to the top management and proposals that require a certain amount of top-level
decision-making. The credit policy of a bank consists of five major components

a. General policies
b. Specific loan categories
c. Miscellaneous loan policies
d. Quality control
e. Other specific issues

The process of appraisal remains the same with regard to any proposal - analyzing,
selecting, sanctioning and monitoring. The top management sets the exposure
limits for individual/company/industry, credit quality of the borrowers, lending
rate, and risk level, etc., and enable decentralized decision-making by the lower
level functionaries.

A bank should apply due diligence and look out for the purpose of the loan,
identity the primary and secondary sources of repayment, assess the business and
industry risks that could inhibit repayment, and analyze the applicant's financial
statements before granting a loan.
Discussed below are a few components that the credit policy may contain.

COMPONENTS OF CREDIT POLICY

While developing a credit policy, a bank needs to address certain significant issues
that are to be incorporated in the policy. A few considerations that the loan policy
may address are:

OBJECTIVES

The first step in framing a credit policy is the formulation of objectives of the
proposed policy. With diverse objectives like profitability, liquidity, volume of
business, risk factors, etc. being present, there is a need to prioritize these
objectives. In the wake of emergence of conflicting objectives, reconciliation

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between different objectives has to be done. Essentially, the credit policy should fit
within the framework of regulatory norms e.g., capital adequacy norms.
Considering the importance of adherence to the regulatory prescriptions, it will be
appropriate to state the related regulatory aspects within the policy. This step
would enable the loan officers to be aware of such requirements.

VOLUME AND MIX OF LOANS

The policy should specify the targeted composition of the loan portfolio, such
composition being in terms of industry/location/size/interest rate/security. Decisions
regarding the loan portfolio will depend on the size of the bank, the credit
requirements in its operational areas and the expertise available with the bank. In
an agrarian type of economy, most of the loan demands may come from the
farmers. Likewise, if the bank's size is small, it may have to put a limit to
individual loan proposals to be in proportion to its total loan portfolio. Generally,
the apex regulatory body gives exposure levels, which the banks can have for
various types of borrowers. While fulfilling the regulatory prescription it is
desirable to develop more detailed limits within the bank.

GEOGRAPHICAL SPREAD

There will be various locations from where a bank conducts its operations. Of
these locations, some may be weak credit demand areas with a considerably high
deposit potential and vice versa. While operating in any area, the bank should have
the requisite funds and expertise to meet the credit demands. The policy should thus,
state the key trade areas of the bank for extending credit. Further, within the trade
areas, there may be certain areas with a primary focus and a few others, which may
be given the secondary focus. Such a classification may also enable the bank to
switch on to the secondary trade areas when the chief trade areas are not active.

LOAN EVALUATION PROCEDURES

The policy document shall specify a process for evaluation of loan proposals,
which will enable uniform evaluation across areas/people. Evaluation involves a
careful selection of the borrowers by understanding their creditworthiness. While
evaluating the proposal, banks should not only assess the ability of the client to
pay back the loan but also their willingness to repay. Banks need to consider the
following variables while evaluating a loan proposal:

Industry Prospects: To study the prospects of the industry, an industry level

credit analysis needs to be performed which most importantly includes a study of
the following:
 Industry cycles
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  Threat from substitutes
 Shifts in consumer demands
 Regulatory environment.

Operational Efficiency: The company level credit rating is conducted to assess

the operational efficiency of the client company. The critical aspects that are to be
evaluated in this process fall into the following categories:
 Operating margins
 Stability and growth of market share
 Access to key raw materials
 Benefit from economies of scale.

Financial Efficiency: Repayment of the loan by the clients depends greatly on

their financial soundness. Hence, financial analysis becomes an imperative part of
credit risk analysis. It includes an analysis of the following:
 Financial leverage
 Coverage ratios
 Cost of capital
 Ability to raise funds
 Working capital management
 Interest rate risk management.

Management Evaluation
While the above mentioned factors assess the ability of the client to repay, the
management evaluation to a certain extent, throws light on the willingness of the
client to repay. Thus, evaluation of management includes a study on the performance
of the promoter, top management and also the performance of group companies under
the same management.

FUNDAMENTAL ANALYSIS
The fundamental factors that influence the working of the client company are
analyzed. These factors are listed below:
 Capital structure
 Asset/liability position
 Asset quality
 Profitability
 Sensitivity to interest rate structures, tax policies, etc.

Above is the broad classification of the various parameters used to evaluate a loan proposal. The
parameters used for evaluating will vary depending on the type of
the borrower, the nature of the project and the purpose of funds. The list provided
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above is not an exhaustive one and depending on the loan proposal, the bank will
select the evaluating variables. Once a broad list of such parameters is identified,
the loan policy may also specify benchmarks so that uniform evaluation be
ensured.

Loan Administration: Efficient administration is the key to the success of the

lending policy. And for improving its efficiency, the authority of the loan
executives should be clearly stated as also their responsibilities. The loan policy
should state the sanctioning powers of the loan officers regarding the credit limits.
The credit limits, which are generally set, based on the responsibility and the
experience of the loan officer should be done diligently. Too lower limit will lead
to a situation where a major part of the senior management's time is spent on
smaller quantum of loans. In contrast to this situation, the risk of the bank may
increase when loan sanction powers are too high. Inexperienced officers may
commit the bank to undesirable loans.

Credit Files: The details regarding the borrower are not only essential during the
loan appraisal time but they are also required throughout the tenor of the loan. This
is essential especially since there may always be a probability of default or a
change in the risk-return profile of the customer. Continuous evaluation is possible
with the help of a credit file, which keeps track of the historical record of the
borrower. In this context, the loan policy can specifically mention the inputs
required for maintaining the credit files for varying types of loans. The credit file
maintained for a borrower should reveal all the parameters considered while
accepting the proposal. It is useful to keep a record of any specific events/experiences
which indicate whether the decision taken for granting such a loan was sound or
not. The contents of the credit file should include all details of the borrower
including detailed financial statements and analysis, collateral provided and the value of the
same, details of compensating balances, etc. Moreover, since most of
the customers are not one-time borrowers, it will be more necessary for the bank to
maintain such credit files.

Lending Rates: The interest charged should reflect the credit risk present in the
credit disbursal. The major issue will thus be to adjust the rate charged to the risk
perception. For this, the loans can be classified into different risk groups based on
the risks involved. Having done this, the policy should then state the returns a
particular loan generates at a particular level of risk. The policy should also state
the risk level at which no credit can be extended. In addition to this, the policy
should also give guidelines for selecting a floating or a fixed rate of interest.

A loan policy is actually a function of the size of the bank. Hence, apart from the

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above mentioned considerations, depending on the banks' own requirements, there
may be several other issues/parameters that may be included in its loan policy.
Given below are some of the other issues/parameters that the loan policy may
contain:
 Type and extent of collaterals
 Compensating balances / margin
 Statutory limits for different types of loans
 Monitoring mechanism
 Loan-Deposit ratio
 Incentive schemes for the loan officers
 Loan repayment pattern
 Communication practices
 Extension of renewals of past-due installment loans (rescheduling the loan)
 Loan-loss reserves
 Consumer laws and regulations
 Role of credit department
 Role of recovery department.

A model credit policy of XYZ Bank is given under Appendix I of this chapter.
Having drafted the loan policy, adequate measures should also be taken to ensure
that the policy is being referred while granting loans. For this, there need to be
loan committees, which review the loan policy from time to time and also, assess
the performance of the credit departments. These committees should meet frequently
to assess the loan policy, the loan proposals beyond a threshold limit and also
those loan proposals that do not comply with the normal credit standards. It has to
suggest measures to cope with certain grey areas and find a solution to the critical
questions relating to a bad loan before it drifts into an undesirable and
uncontrollable situation.

Appendix-I
Salient Features of the Model Loan Policy of XYZ Bank Ltd.
Capital Market Exposure

The Bank's aggregate exposure to capital markets covering direct investment by a

bank in equity shares, convertible bonds and debentures and units of equity-
oriented mutual funds; advances against shares to individuals for investment in
equity shares (including IPOs), bonds and debenture and units of equity-oriented
mutual funds etc., and secured and unsecured advances to stockbrokers and
guarantees issued on behalf of stockbrokers and market makers should not exceed
5 percent of the total outstanding advances (including Commercial Paper) as on
March 31 of the previous year. This ceiling of 5 percent prescribed for investment
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in shares would apply to total exposure including both, fund based and non-fund
based to capital market in all forms. Within this overall ceiling, banks investment
in shares, convertible bonds and debentures and units of equity-oriented mutual
funds should not exceed 20 percent of bank's net worth. Adherence of this ceiling
is on an ongoing basis.

Takeover of accounts from other Banks

Powers to permit takeover of accounts from other banks falling under the powers
of heads at various administrative levels are referred to H.O. For the accounts
falling under H.O. powers, the respective sanctioning authority shall permit
takeover of accounts from other Banks.

Any deviation in takeover norms is to be permitted by ED/CMD/Board.

Discretionary Powers

Discretionary powers will be delegated to Branches/Zonal Offices/Department at

Head Office basing on the credit limits for each sector. For example, Real Estate,
Trade finance, Export accounts, SSI units, Conventional advances. Discretionary
powers will be varying from bank to bank.

Maximum Exposure

The overall exposure for the above category of advances for the sanctions made by
the Head at Zonal level (in many banks) during the year shall be given.

Extending Credit Facilities to Restructured Standard Accounts with Other Banks

Credit facilities to Restructured Accounts with other banks may be considered
while complying with the following conditions:

1. The account shall be a standard asset.

2. Satisfactory financial position and performance shall be ensured by obtaining
Latest Audited balance sheet of the company. The entry level norms as
applicable to takeover of accounts shall be ensured.
3. The following ratios shall be ensured.
Current ratio shall be above unity (above 1).
Maximum Permissible Total Debt-Equity ratio i.e., TOL/TNW shall be 6.
Maximum permissible Capital Gearing Ratio is 10 (Term Liabilities +
Current Liabilities + Non-Fund Based Limits (divided by) Tangible Net
Worth - (Non-Current Assets excluding advances given for capital goods for
business purpose).
Minimum DSCR is 1.50.
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 Sensitivity Analysis and IRR (for TLs of Rs.50 lakh and above).
4. Eligibility of limits shall be as per our bank norms and policy guidelines.
5. The rating as per CRS/CRAS shall be worked out basing on all the relevant
parameters excluding operational parameters (being a new account for our
bank).
6. Financial statements of the group/associate concerns shall be obtained and
satisfactory financial performance and position should be ensured.
7. The limits shall be fully secured by tangible collateral securities and personal
guarantee of the promoter directors.

ASSESSMENT METHODS
Turnover Method
1. The working capital eligibility shall be arrived based on 25% of turnover or
turnover projected less 5% turnover or actual NWC available whichever is
more, as per latest audited balance sheet. If actual NWC is less than required
NWC, the borrower has to bring in the shortfall and sanctioning authority has
to ensure the same.

2. In case the borrower requires LC (DA), BG (for procurement of stocks) the

same shall be considered as sub-limit within the fund based limits sanctioned
under Turnover Method.

Inventory/Projected Balance Sheet Method

(Limit up to Rs.6 crore)
1. If the borrower opts for assessment of limits under inventory method in place
of Turnover Method, the same shall be considered for working out MPBF.
However, it shall be ensured that
2. The borrower brings in a margin of 13% of current assets as required NWC
to maintain minimum current ratio of 1.15 as per policy guidelines.
3. The build up of current assets and other current liabilities shall be in the light
of past actuals and justification shall be given wherever deviations are
accepted.
4. Where LC (DA), BG (for procurement of stocks) is considered outside
MPBF, it shall be ensured that in addition to creditors for direct purchases
and expenses, the proposed LC (DA)/BG (for procurement of stocks) limit is
fully reflected under build up of Sundry Creditors.

Inventory Levels
The past inventory levels shall be the basis for future projections for accepting the
buildup of current assets and other current liabilities. However, the sanctioning
authority will have flexibility to accept higher level provided there is enough
justification on a case to case basis.

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Corporate Loans
Corporate loan shall not be permitted for meeting financial commitments of
subsidiary/associate concerns.

Sensitivity Analysis
Sensitivity Analysis is made mandatory in respect of all Term Loans of Rs.50 lakh
and above. The percentage of reduction in variables like sales, costs, occupancy
rates, etc., shall be based on a case to case basis taking into account industry trend
with rationale.

Processing Charges
Processing charges shall be collected for processing of fresh/renewal/enhancement
of limits and it is not related to any specific period. Hence, for overdue period no
processing charges need to be collected.

Stock and Receivable Audit

The following advances are also brought within the purview of Stock and
Receivable Audit.
1. Non-Performing Assets with balance of Rs.5 crore and above.
2. New/Takeover accounts which are less than 3 years old where working
capital limits enjoyed are Rs.2 crore and above irrespective of Credit Rating.

Fine Rates
Powers are delegated to appropriate authorities for quoting finer rate of interest in
respect of Advances/Overdrafts against domestic/NRE/FCNR(B) deposits.

Prohibited Loans
Bridge Loans/Interim Finance are generally prohibited at Branch level.

Applicability of Credit Rating Systems

CRS is extended for all fund based limits of Rs.5 lakh and above but less than 50
lakh. Interest as per the credit rating finalized by the sanctioning authority shall be
charged for all advances of above Rs.10 lakh. For advances between Rs.5 lakh to
Rs.IO lakh, the fixed slab interest rate as specified for the type/category of advance
will continue.

CRAS is extended for all fund and non-fund advances ofRs.50 lakh and above.

Audited/Provisional Financial Statements-Rating

1. The rating at the time of renewal/sanction shall be done basing on audited
balance sheet of the latest financial year. If the audited balance sheet of the
latest financial year is not available then the least of rating arrived based on
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 the latest provisional balance sheet or last audited balance sheet shall be
awarded to the constituent.
2. In all such cases as in above, the sanctioning authority shall obtain audited
balance sheet for latest financial year within a reasonable period of time not
exceeding 6 months and finalize credit rating and re-fix interest accordingly.
If this process is not completed within 6 months from the date of closure of
the financial year, an additional I % interest shall be charged from 1st
October onwards till submission of audited balance sheet. This additional
interest will be applicable for all funds based on advances of Rs.100 lakh and
above. The overall penal interest (chargeable for non-submission of stock and
book debt statements Monthly select operation data (MSOD)/Quarterly
Information System (QIS) etc., including the said additional interest shall not
exceed 2% to the borrower.
3. However, in the event of slippage based on provisional/half-yearly/quarterly
balance sheet, QIC etc., CRAS/CRS should be reviewed immediately.

Minimum Entry Level Scoring under CRS/CRAS

In case of new borrowal accounts, the party shall secure a minimum of 40% under
each parameter i.e., Industry/Management and Financial Risks and also minimum
overall score of 40% for taking up exposure.

Consortium Lending
Credit facilities shall not be extended outside the consortium without permission
from the consortium. The process notes shall contain details of limits enjoyed by
the constituent with consortium/group concerns from banking system, Regulatory
Classification by member banks and details of meetings held. For this purpose,
efforts should be made to obtain information as expeditiously as possible and
however the proposal shall not be delayed for want of the same.

Concurrent Audit
Borrowers in respect of large advances say Rs.1 crore and above shall be advised
to appoint concurrent auditors to this effect a condition shall be incorporated in the
sanction letter following Ghosh Committee recommendations.

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