Project on credit risk in indian banking system

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CREDIT RISK ANALYSIS OF INDIAN BANKING SECTOR FOR MBA FINANCE 1

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RESEARCH METHODOLOGY

CORPORATE BANKING

STATEMENT OF PROBLEM:
To study the emergence and evolution of the corporate banking as an
important division of the commercial banking and also to study the credit
appraisal models supporting the increased activities of corporate lending by
banks.

In today’s global Banking arena, Corporate Bankers are facing a string of
unprecedented and sweeping challenges in the areas like Treasury
Management, Trade Finance, Risk Management, Compliance Management,
Electronic Trading and Derivatives Markets. Compounding this are the
mounting complexities from ongoing regulatory changes, decreasing
margins and fierce competition

NEED FOR STUDY:
Over the period of time, with the tremendous increase in the growth pattern
of industrial development, the need for the corporate loans have increased
more than ever. So, the increasing trend urges the banks and financial
institutions to focus on corporate banking as a separate division. So, the
researchers have preferred to study the concept of corporate banking and all
the operational aspects attached to it in the entire process.

OBJECTIVE OF THE STUDY:


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To study the banking industry, as a whole with the help of various
analysis including SWOT analysis, PEST analysis and Porter’s Five Force
analysis.

To acquire basic knowledge about the corporate lending in India and
its relevance with respect to banks.

To analyze the credit risk models of both public bank and private bank
and bring out its comparative picture on the basis of various
parameters.

To study credit risk management strategies of bank.

RESEARCH DESIGN:
A research design is the arrangement of the condition for collection and
analysis of data. Actually it is the blueprint of the research project. The
research type is descriptive research. The main objective of this design is
search primary and secondary data.

The research primarily focuses on the secondary sources and first hand
information through focus group interviews.

DATA COLLECTION:
As the research type is descriptive, the method of data collection was
informal.

SOURCES:
The relevant information were collected from both primary and secondary
sources like follow up with bank managers web search, newspaper articles


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TOOLS:
Focus group interviews with the managers of banks.

BENEFICIARIES:

For the banks:
It will give them the in depth review of the various aspects involved in the
corporate banking with emphasis on the credit risk management.

For the corporates:
The report shows the comparative study of the credit appraisal and
sanctioning procedure involved in the credit lending by banks as well as
financial institutions. Secondly, they will also get the relevance of the
corporate lending by the banks and its various relevant aspects.

For the management students:
The report studies the entire banking industry from various aspects using
different analytical tools. Secondly, it introduces into the world of credit
lending and its trend in India. Moreover, it also shows the operational
procedures involved in the corporate lending with emphasis on risk
modeling and credit risk management.

LIMITATIONS OF THE STUDY:
The scope of the report is mainly depends on the information extracted from
secondary sources and the information given by the managers of banks. So,
lack of the availability of the first hand information may act as a limitation to
the project report.


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CHAPTER: 1

AN OVERVIEW ON BANKING INDUSTRY

In recent years, the banking industry around the world has been undergoing
a rapid transformation. In India also, the wave of deregulation of early 1990s
has created heightened competition and greater risk for banks and other
financial intermediaries. The cross-border flows and entry of new players
and products have forced banks to adjust the product-mix and undertake
rapid changes in their processes and operations to remain competitive. The
deepening of technology has facilitated better tracking and fulfillment of
commitments, multiple delivery channels for customers and faster resolution
of miscoordinations.

Unlike in the past, the banks today are market driven and market responsive.
The top concern in the mind of every bank's CEO is increasing or at least
maintaining the market share in every line of business against the backdrop
of heightened competition. With the entry of new players and multiple
channels, customers (both corporate and retail) have become more
discerning and less "loyal" to banks. This makes it imperative that banks
provide best possible products and services to ensure customer satisfaction.
To address the challenge of retention of customers, there have been active
efforts in the banking circles to switch over to customer-centric business
model. The success of such a model depends upon the approach adopted by
banks with respect to customer data management and customer relationship
management.

Over the years, Indian banks have expanded to cover a large geographic &
functional area to meet the developmental needs. They have been managing


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a world of information about customers - their profiles, location, etc. They
have a close relationship with their customers and a good knowledge of their
needs, requirements and cash positions. Though this offers them a unique
advantage, they face a fundamental problem.

During the period of planned economic development, the bank products
were bought in India and not sold. What our banks, especially those in the
public sector lack are the marketing attitude. Marketing is a
customer-oriented operation. What is needed is the effort on their part to
improve their service image and exploit their large customer information
base effectively to communicate product availability. Achieving customer
focus requires leveraging existing customer information to gain a deeper
insight into the relationship a customer has with the institution, and
improving customer service-related processes so that the services are quick,
error free and convenient for the customers.

Furthermore, banks need to have very strong in-house research and market
intelligence units in order to face the future challenges of competition,
especially customer retention. Marketing is a question of demand (customers)
and supply (financial products & services, customer services through various
delivery channels). Both demand and supply have to be understood in the
context of geographic locations and competitor analysis to undertake
focused marketing (advertising) efforts. Focusing on region-specific
campaigns rather than national media campaigns would be a better strategy
for a diverse country like India.

Customer-centricity also implies increasing investment in technology.
Throughout much of the last decade, banks world-over have re-engineered
their organizations to improve efficiency and move customers to lower cost,
automated channels, such as ATMs and online banking.
As is proved by the experience, banks are now realizing that one of their
best assets for building profitable customer relationships especially in a


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developing country like India is the branch-branches are in fact a key
channel for customer retention and profit growth in rural and semi-urban set
up. However, to maximize the value of this resource, our banks need to
transform their branches from transaction processing centers into
customer-centric service centers. This transformation would help them
achieve bottom line business benefits by retaining the most profitable
customers. Branches could also be used to inform and educate customers
about other, more efficient channels, to advise on and sell new financial
instruments like consumer loans, insurance products, mutual fund products,
etc.
There is a growing realization among Indian banks that it no longer pays to
have a "transaction-based" operating model. There are active efforts to
develop a relationship-oriented model of operations focusing on
customer-centric services. The biggest challenge our banks face today is to
establish customer intimacy without which all other efforts towards
operational excellence are meaningless. The banks need to ensure through
their services that the customers come back to them. This is because a major
chunk of income for most of the banks comes from existing customers,
rather than from new customers.
Customer relationship management (CRM) solutions, if implemented and
integrated correctly, can help significantly in improving customer satisfaction
levels. Data warehousing can help in providing better transaction
experiences for customers over different transaction channels. This is
because data warehousing helps bring all the transactions coming from
different channels under the same roof. Data mining helps banks analyse
and measure customer transaction patterns and behaviour. This can help a
lot in improving service levels.
It must be noted, however, that customer-centric banking also involves
many risks. The banking industry world over is being thrust into a wild new
world of privacy controversy. The banks need to set up serious governance
systems for privacy risk management. It must be remembered that customer


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privacy issues threaten to compromise the use of information technology
which is at the very center of e-commerce and customer relationship
management - two areas which are crucial for banks' future.

The critical issue for banks is that they will not be able to safeguard
customer privacy completely without undermining the most exciting
innovations in banking. These innovations promise huge benefits, both for
customers and providers. But to capture them, financial services companies
and their customers will have to make some critical tradeoffs. When the
stakes are so high, nothing can be left to chance, which is why banks must
immediately begin developing comprehensive approaches to the privacy
issue.

The customer centric business models based on the applications of
information technology are sustainable only if the banks protect client
confidentiality in the process - which is the basic foundation of banking
business.

1.1 EVOLUTION OF BANKING IN INDIA

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Banking in India has its origin as early as the Vedic period. It is believed that
the transition from money lending to banking must have occurred even
before Manu, the great Hindu Jurist, who has devoted a section of his work
to deposits and advances and laid down rules relating to rates of interest.
During the Mogul period, the indigenous bankers played a very important
role in lending money and financing foreign trade and commerce. During
the days of the East India Company, it was the turn of the agency houses to
carry on the banking business.

The General Bank of India was the first Joint Stock Bank to be established in
the year 1786. The others which followed were the Bank of Hindustan and
the Bengal Bank. The Bank of Hindustan is reported to have continued till
1906 while the other two failed in the meantime. In the first half of the 19th
century the East India Company established three banks; the Bank of Bengal
in 1809, the Bank of Bombay in 1840 and the Bank of Madras in 1843. These
three banks also known as Presidency Banks were independent units and
functioned well. These three banks were amalgamated in 1920 and a new
bank, the Imperial Bank of India was established on 27th January 1921. With
the passing of the State Bank of India Act in 1955 the undertaking of the
Imperial Bank of India was taken over by the newly constituted State Bank of
India.

The Reserve Bank which is the Central Bank was created in 1935 by passing
Reserve Bank of India Act 1934. In the wake of the Swadeshi Movement, a
number of banks with Indian management were established in the country
namely, Punjab National Bank Ltd, Bank of India Ltd, Canara Bank Ltd, Indian
Bank Ltd, the Bank of Baroda Ltd, the Central Bank of India Ltd. On July 19,
1969, 14 major banks of the country were nationalized and in 15th April
1980 six more commercial private sector banks were also taken over by the
government.


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The Indian banking can be broadly categorized into nationalized
(government owned), private banks and specialized banking institutions. The
Reserve Bank of India acts a centralized body monitoring any discrepancies
and shortcoming in the system. Since the nationalization of banks in 1969,
the public sector banks or the nationalized banks have acquired a place of
prominence and has since then seen tremendous progress. The need to
become highly customer focused has forced the slow-moving public sector
banks to adopt a fast track approach. The unleashing of products and
services through the net has galvanized players at all levels of the banking
and financial institutions market grid to look anew at their existing portfolio
offering.

Conservative banking practices allowed Indian banks to be insulated partially
from the Asian currency crisis. Indian banks are now quoting a higher
valuation when compared to banks in other Asian countries (viz. Hong Kong,
Singapore, Philippines etc.) that have major problems linked to huge Non
Performing Assets (NPAs) and payment defaults. Co-operative banks are
nimble footed in approach and armed with efficient branch networks focus
primarily on the ‘high revenue’ niche retail segments.

The Indian banking has finally worked up to the competitive dynamics of the
‘new’ Indian market and is addressing the relevant issues to take on the
multifarious challenges of globalization. It has come a long way from being a
sleepy business institution to a highly proactive and dynamic entity. Banks
that employ IT solutions are perceived to be ‘futuristic’ and proactive players
capable of meeting the multifarious requirements of the large customers
base. Private banks have been fast on the uptake and are reorienting their
strategies using the internet as a medium The Internet has emerged as the
new and challenging frontier of marketing with the conventional physical
world tenets being just as applicable like in any other marketing medium.


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This transformation has been largely brought about by the large dose of
liberalization and economic reforms that allowed banks to explore new
business opportunities rather than generating revenues from conventional
streams (i.e. borrowing and lending).

The banking in India is highly fragmented with 30 banking units contributing
to almost 50% of deposits and 60% of advances. Indian nationalized banks
(banks owned by the government) continue to be the major lenders in the
economy due to their sheer size and penetrative networks which assures
them high deposit mobilization. The Indian banking can be broadly
categorized into nationalized, private banks and specialized banking
institutions.

The Reserve Bank of India acts as a centralized body monitoring any
discrepancies and shortcoming in the system. It is the foremost monitoring
body in the Indian financial sector. The nationalized banks (i.e.
government-owned banks) continue to dominate the Indian banking arena.
Industry estimates indicate that out of 274 commercial banks operating in
India, 223 banks are in the public sector and 51 are in the private sector.
The private sector bank grid also includes 24 foreign banks that have started
their operations here. Under the ambit of the nationalized banks come the
specialized banking institutions. These co-operatives, rural banks focus on
areas of agriculture, rural development etc., unlike commercial banks these
co-operative banks do not lend on the basis of a prime lending rate. They
also have various tax sops because of their holding pattern and lending
structure and hence have lower overheads. This enables them to give a
marginally higher percentage on savings deposits. Many of these
cooperative banks diversified into specialized areas (catering to the vast
retail audience) like car finance, housing loans, truck finance etc. in order to
keep pace with their public sector and private counterparts, the co-operative
banks too have invested heavily in information technology to offer high-end


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computerized banking services to its clients.

Complementing the roles of the nationalized and private banks are the
specialized financial institutions or Non Banking Financial Institutions
(NBFCs). With their focused portfolio of products and services, these Non
Banking Financial Institutions act as an important catalyst in contributing to
the overall growth of the financial services sector. NBFCs offer loans for
working capital requirements, facilitate mergers and acquisitions, IPO
finance, etc. apart from financial consultancy services. Trends are now
changing as banks (both public and private) have now started focusing on
NBFC domains like long and medium-term finance, working cap
requirements, IPO financing etc. to meet the multifarious needs of the
business community.

1.2 STRUCTURE OF BANKING INDUSTRY:

Banking system plays an important role in a country’s economy. It promotes
growth and development of the country. Indian money market comprises
organized and the unorganized institutions. The organized and unorganized
institutions in the Indian banking system serve a source of short term credit
to agriculture, industry, trade and commerce.


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In the Indian banking structure the Reserve Bank of India is the central bank.
It regulates, direct and controls the banking and financial institutions in the
country. There are three high banking institutions, namely, RBI, NABARD and
EXIM Bank. There are separate financial institutions catering to the needs of
different sectors of the economy. Development Banks, Investment Banks,
Co-operative Banks, Land Development Banks, Commercial Banks in public
and private sectors, NABARD, RRBs, EXIM Bank, etc. The indigenous bankers
and moneylenders dominate unorganized sector.

The Indian banking structure can be seen from the chart shown under:

Apex Banking Institution

RBI IDBI NABARD EXIM Bank SIDBI
NHB IRBI

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Banking Institutions

Commercial Regional Rural Co- operative Land
Development Development
Banks Banks Banks
Banks Bank

Public Private Foreign PAC’s CCB’s SCB’s PLD’s
SLDB
Sector Sector exchange
Banks Bank Banks

All India State

Level Level

SBI and Nationalised
Subsidiaries Banks
IDBI
ICICI SIDBI

SFC’s SIDC

Foreign Indian Non –
Schedule
Bank Scheduled Bank Bank


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The chart reveals that there are several apex banking institutions working at
the national level. RBI is the highest banking authority regulating, directing
and controlling all the banking and financial institutions in the country.
There are development banks, namely IDBI, SIDBI, ICICI at the national level
and State Financial Corporations and State Industrial Development
Corporations which have been set-up.

There are 29 public sector banks. Co-operative banks have three tier system.
At the village level there is Primary Agriculture Co-operative Society(PACs), at
the district level there is Central Co-operative Bank and at the state level
there is State Co-operative Bank. Co-operative banks provide short term and
medium loans to the agriculture sector. Land Development Banks provide
long term agriculture credit. It comprises Primary Land Development
Bank(PLDB) at ht district level and State Land Development Bank(SLDB) at the
state level. RRBs provide loans and advances to the rural poor and NABARD is
an apex body regulating, directing and controlling the financial and banking
institutions providing finance for the agriculture and rural development.

TYPES OF BANKS

Modern age is the age of specialization with the changing situation
worldwide, bank functions have also undergone a major change. Economic
conditions and financial needs of a country are different than those of other
countries throughout the world. Some financial institutions deal in accepting
deposits and making loans and advances to different sectors of the economy.
Some institution makes loans and advances for medium and short term,
while others are meant for long term advances. Some are financing industrial
sector and foreign trade while others are advancing loans to agriculture
sector.


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In broader sense of the term banks may be classified into following
categories:

Central Bank
Commercial Banks
Development Banks
Investment Banks
Co-operative Banks
Foreign Exchange Banks
Savings Banks
Export-Import Bank
Specialized National Banks
Indigenous Bankers
International Financial Institutions


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1.3 GROWTH OF BANKING SECTOR
(DECADE WISE)

Pre-Liberalization: The growth of the Banking Sector in the pre
liberalization period can be analyzed as under.

1971-80:
This was the decade immediately following the Nationalization of 14
commercial banks. Also the banking sector grew at the fastest pace in this
decade.

1. Assets:
The assets of the sector grew at 21.58 % CAGR 1 . They increased from
RS.82.52bn to Rs.582.33bn. This kind of growth was achieved due to
massive increase in the number of branches resulting in a spurt in deposit
mobilization.

2. Deposits:
The deposits grew from Rs.64.79bn to Rs.439.87bn. at a CAGR 21.11 %. The
growth was higher in later part of the decade. This growth rate would have
been higher had the current accounts grown at a rate higher than 18 %. This


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indicates people’s preference for using bank as place to keep their savings.
The bank was not used as a place to keep money to be used for transaction
motive. This is further clarified by the poor ratio of average current deposits
to total deposits at 23.45 %.

3. Advances:
The advances grew at 19.26 % CAGR from Rs.46.85bn to Rs.272.67bn. Also
the growth was higher in the later part of the decade. Thus the advances
grew at a pace slower than the deposits due to decreasing credit deposit
ratio, which reduced from 72.30 % in 1970 to 61.99 % in 1980.

4. Net worth:
The Net worth increased from Rs.1.16bn to Rs.5.33bn at a CAGR of 16.48 %.
The Capital of the banks remained flat throughout the decade growing at
just 8.54 % and also the growth came in the later part of the decade. The
capital increased form Rs.470.2mn to Rs.1.07bn.
However, the Reserves grew at a healthy pace of 20 % CAGR from Rs.690mn
to Rs.4.27bn. Thus the banks in this decade did not raise capital and funded
their growth from internal accruals. This resulted in a wide gap between
Reserves and Capital indicating the banks’ hunger for Capital.

1981-90:

1. Assets:
The growth of the sector was significantly subdued since the last decade.
The assets grew at just 16.30 % CAGR compared to 21.58 % in the previous
decade. The total assets increased from Rs.582.33bn to Rs.2636.93bn.


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2. Deposits:
Deposits increased from Rs.439.86bn to Rs.1820.46bn at a CAGR of 15.26 %.
The current accounts remained the usual laggards in terms of growth
growing at just 12.67 % CAGR. The term and saving deposits grew at a
slightly faster pace of 16.17 % and 15.5 % CAGR.

3. Advances:
Advances grew at a CAGR of 16.79 % from Rs.272.67bn to Rs.1287.85bn.
This is due to the fact that the banks have stepped up their credit-deposit
ratio from 62 % to 70.74 %. This indicates higher investment than saving in
the economy.

4. Net worth:
The Net worth increased from Rs.5.33bn to Rs.47.1bn. Thus the net worth
grew at a whopping 24.33 % CAGR.
The capital hungry banks went on capital raising spree in the latter half of
the decade. Thus the capital grew at a CAGR of 34.53 %. In absolute terms,
the capital soared from Rs.1.06bn at the beginning of the decade to
Rs.20.73bn at the end of the decade.
The Reserves however grew at more or less constant pace of 19.97 % CAGR
throughout the decade.
At the end of the decade the Capital had kept pace with the Reserves and the
gap between them had significantly narrowed down.

Post-Liberalization: The growth of this sector after 1991 can be
represented as under.
1991-2000:

1. Assets:


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The rate of the sector further slowed down during this decade. The assets
grew at a CAGR of 15.24 % from Rs.2636.93bn to Rs.11103.68bn. The
growth rate however, was greater in the later part of the decade indicating
future prospects of increase in growth.

2. Deposits:
The deposits grew from Rs.1820.47bn to Rs.9003.06bn at a CAGR of
16.69 %. There was a spurt in the last 3-4 years of the decade indicating
improving trend. In this decade however, the savings accounts were the
laggards in terms of growth at 13.34 % CAGR. The term deposits grew at
18.38 % and current deposits grew at 15.23 %. This reversal of trend in
growth rates shows that the people are increasingly using banks to deposit
money to be used for transaction motive.

3. Advances:
The advances increased from Rs.1287.85bn to Rs.4434.69bn at a CAGR of
12.46 %. The lower growth in advances is due to the decline in credit-deposit
ratio from 70.74 % in 1990 to 49.26 %. This shows there was a marked
decline in investment in this decade with savings exceeding investment.

4. Net worth:
The Net worth grew at a feverish pace of 36.60 % CAGR, the highest in last
three decades. This was mainly because the RBI opened the Banking sector
to Private sector. As many as 9 New Private Sector Banks started their
operations in this period. They brought a lot of capital in the period 1993-95.
However in the later half of the decade, capital growth was virtually nil.
The Reserves grew at 37.54 % CAGR from Rs.26.36bn Rs.438.34bn. However,
contrary to Capital the Reserves recorded exceptional growth in the later half
of the decade due to improving profits of private as well as public sector
banks. However the gap between reserves and capital is once again widening.


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1.4 FUTURE LANDSCAPE OF INDIAN BANKING


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Liberalization and de-regulation process started in 1991-92 has made a sea
change in the banking system. From a totally regulated environment, we
have gradually moved into a market driven competitive system. Our move
towards global benchmarks has been, by and large, calibrated and regulator
driven. The pace of changes gained momentum in the last few years.
Globalization would gain greater speed in the coming years particularly on
account of expected opening up of financial services under WTO. Four trends
change the banking industry world over, viz. 1) Consolidation of players
through mergers and acquisitions, 2) Globalisation of operations, 3)
Development of new technology and 4) Universalisation of banking. With
technology acting as a catalyst, we expect to see great changes in the
banking scene in the coming years. The Committee has attempted to
visualize the financial world 5-10 years from now. The picture that emerged
is somewhat as discussed below. It entails emergence of an integrated and
diversified financial system. The move towards universal banking has already
begun. This will gather further momentum bringing non-banking financial
institutions also, into an integrated financial system.

The traditional banking functions would give way to a system geared to meet
all the financial needs of the customer. We could see emergence of highly
varied financial products, which are tailored to meet specific needs of the
customers in the retail as well as corporate segments. The advent of new
technologies could see the emergence of new financial players doing
financial intermediation. For example, we could see utility service providers
offering say, bill payment services or supermarkets or retailers doing basic
lending operations. The conventional definition of banking might undergo
changes.

The competitive environment in the banking sector is likely to result in
individual players working out differentiated strategies based on their
strengths and market niches. For example, some players might emerge as


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specialists in mortgage products, credit cards etc. whereas some could
choose to concentrate on particular segments of business system, while
outsourcing all other functions. Some other banks may concentrate on SME
segments or high net worth individuals by providing specially tailored
services beyond traditional banking offerings to satisfy the needs of
customers they understand better than a more generalist competitor.

International trade is an area where India’s presence is expected to show
appreciable increase. With the growth in IT sector and other IT Enabled
Services, there is tremendous potential for business opportunities. Keeping
in view the GDP growth forecast under India Vision 2020, Indian exports can
be expected to grow at a sustainable rate of 15% per annum in the period
ending with 2010. This again will offer enormous scope to Banks in India to
increase their forex business and international presence. Globalization
would provide opportunities for Indian corporate entities to expand their
business in other countries. Banks in India wanting to increase their
international presence could naturally be expected to follow these corporates
and other trade flows in and out of India.

Retail lending will receive greater focus. Banks would compete with one
another to provide full range of financial services to this segment. Banks
would use multiple delivery channels to suit the requirements and tastes of
customers. While some customers might value relationship banking
(conventional branch banking), others might prefer convenience banking
(e-banking).

One of the concerns is quality of bank lending. Most significant challenge
before banks is the maintenance of rigorous credit standards, especially in
an environment of increased competition for new and existing clients.
Experience has shown us that the worst loans are often made in the best of
times. Compensation through trading gains is not going to support the

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banks forever. Large-scale efforts are needed to upgrade skills in credit risk
measuring, controlling and monitoring as also revamp operating procedures.
Credit evaluation may have to shift from cash flow based analysis to
“borrower account behaviour”, so that the state of readiness of Indian banks
for Basle II regime improves. Corporate lending is already undergoing
changes. The emphasis in future would be towards more of fee based
services rather than lending operations. Banks will compete with each other
to provide value added services to their customers.

Structure and ownership pattern would undergo changes. There would be
greater presence of international players in the Indian financial system.
Similarly, some of the Indian banks would become global players.
Government is taking steps to reduce its holdings in Public sector banks to
33%. However the indications are that their PSB character may still be
retained.

Mergers and acquisitions would gather momentum as managements will
strive to meet the expectations of stakeholders. This could see the
emergence of 4-5 world class Indian Banks. As Banks seek niche areas, we
could see emergence of some national banks of global scale and a number
of regional players.

Corporate governance in banks and financial institutions would assume
greater importance in the coming years and this will be reflected in the
composition of the Boards of Banks.

Concept of social lending would undergo a change. Rather than being seen
as directed lending such lending would be business driven. With SME sector
expected to play a greater role in the economy, Banks will give greater
overall focus in this area. Changes could be expected in the delivery
channels used for lending to small borrowers and agriculturalists and


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unorganized sectors (micro credit). Use of intermediaries or franchise agents
could emerge as means to reduce transaction costs.

Technology as an enabler is separately discussed in the report. It would not
be out of place, however, to state that most of the changes in the landscape
of financial sector discussed above would be technology driven. In the
ultimate analysis, successful institutions will be those which continue to
leverage the advancements in technology in re-engineering processes and
delivery modes and offering state-of-the-art products and services
providing complete financial solutions for different types of customers.

Human Resources Development would be another key factor defining the
characteristics of a successful banking institution. Employing and retaining
skilled workers and specialists, re-training the existing workforce and
promoting a culture of continuous learning would be a challenge for the
banking institutions.

1.5 BANKING INDUSTRY REFORMS AND VISION 2010

“A vision is not a project report or a plan target. It is an articulation of
the desired end results in broader terms” - A.P.J.Abdul Kalam

Vision is of an integrated banking and finance system catering to all financial
intermediation requirements of customers. Strong market players will strive
to uncover markets and provide all services, combining innovation, quality,
personal touch and flexibility in delivery. The growing expectations of the
customers are the catalyst for our vision. The customer would continue to be
the centre-point of our business strategy. In short, you lose touch with the

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customer, and you lose everything.

It is expected that the Indian banking and finance system will be globally
competitive. For this the market players will have to be financially strong and
operationally efficient. Capital would be a key factor in building a successful
institution. The banking and finance system will improve competitiveness
through a process of consolidation, either through mergers and acquisitions
through strategic alliances.

Technology would be the key to the competitiveness of banking and finance
system. Indian players will keep pace with global leaders in the use of
banking technology. In such a scenario, on-line accessibility will be available
to the customers from any part of the globe; ‘Anywhere’ and ‘Anytime’
banking will be realized truly and fully. At the same time ‘brick and mortar’
banking will co-exist with ‘on-line’ banking to cater to the specific needs of
different customers.

Indian Banking system has played a crucial role in the socio-economic
development of the country. The system is expected to continue to be
sensitive to the growth and development needs of all the segments of the
society. The banking system that will evolve will be transparent in its
dealings and adopt global best practices in accounting and disclosures
driven by the motto of value enhancement for all stakeholders.

Financial Sector Reforms set in motion in 1991 have greatly changed the face
of Indian Banking. The banking industry has moved gradually from a
regulated environment to a deregulated market economy. The market
developments kindled by liberalization and globalization have resulted in
changes in the intermediation role of banks. The pace of transformation has
been more significant in recent times with technology acting as a catalyst.
While the banking system has done fairly well in adjusting to the new market
dynamics, greater challenges lie ahead. Financial sector would be opened up


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for greater international competition under WTO. Banks will have to gear up
to meet stringent prudential capital adequacy norms under Basel II. In
addition to WTO and Basel II, the Free Trade Agreements (FTAs) such as with
Singapore, may have an impact on the shape of the banking industry. Banks
will also have to cope with challenges posed by technological innovations in
banking. Banks need to prepare for the changes. In this context the need for
drawing up a Road Map to the future assumes relevance. The idea of setting
up a Committee to prepare a Vision for the Indian Banking industry came up
in IBA, in this background.

Managing Committee of Indian Banks’ Association constituted a Committee
under the Chairmanship of Shri S C Gupta, Chairman & Managing Director,
Indian Overseas Bank to prepare a Vision Report for the Indian Banking
Industry. The composition of the Committee is given at the end of the report.

The Committee held its first meeting on 23rd June 2003 at Mumbai. Prior to
the meeting the members were requested to give their thoughts on the
future landscape of the banking industry. A discussion paper based on the
responses received from members was circulated along with a questionnaire
eliciting views of members on some of the specific issues concerning
anticipated changes in the banking environment. In the meeting, which
served as a brainstorming session, members gave their Vision of the future.
A second meeting of the Committee was held at Chennai on 7th August 2003
to have further discussions on the common views, which emerged in the first
meeting, and also to examine fresh areas to be covered in the study.


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The Vision Statement prepared by the Committee is based on common
thinking that crystallized at the meetings. In the Chennai meeting it was
decided to form a smaller group from among the members to draft the
report of the Committee. The group met thrice to finalize the draft report.
The report was adopted in the final meeting of the Committee held at
Mumbai.

When we talk about the future, it is necessary to have a time horizon in
mind. The Committee felt, it would be rather difficult to visualize the
landscape of banking industry say, 20 years hence due to the dynamic
environment. While Government of India brought out India Vision 2020,
the Committee is of the view that the pace of changes taking place in the
banking industry and in the field of Information Technology would render
any attempt to visualize the banking scenario in 2020, inconceivable.
The entire financial services sector may undergo a dramatic
transformation. It was, therefore, felt that we should set our goals for the
near future say, for 5-10 years hence and appropriately call this exercise
“Banking Industry – Vision 2010”. The three main aspects focused in
the banking vision includes product innovation, process re-engineering
and technology.

PRODUCT INNOVATION AND PROCESS RE-ENGINEERING

With increased competition in the banking Industry, the net interest
margin of banks has come down over the last one decade. Liberalization
with Globalization will see the spreads narrowing further to 1-1.5% as in
the case of banks operating in developed countries. Banks will look for
fee-based income to fill the gap in interest income. Product innovations
and process re-engineering will be the order of the day. The changes will


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be motivated by the desire to meet the customer requirements and to
reduce the cost and improve the efficiency of service. All banks will
therefore go for rejuvenating their costing and pricing to segregate
profitable and non-profitable business. Service charges will be decided
taking into account the costing and what the traffic can bear. From the
earlier revenue = cost + profit equation i.e., customers are charged to
cover the costs incurred and the profits expected, most banks have
already moved into the profit =revenue - cost equation. This has been
reflected in the fact that with cost of services staying nearly equal across
banks, the banks with better cost control are able to achieve higher
profits whereas the banks with high overheads due to under-utilisation of
resources, un-remunerative branch network etc., either incurred losses or
made profits not commensurate with the capital employed. The new
paradigm in the coming years will be cost = revenue - profit.

As banks strive to provide value added services to customers, the market
will see the emergence of strong investment and merchant banking
entities. Product innovation and creating brand equity for specialized
products will decide the market share and volumes. New products on the
liabilities side such as forex linked deposits, investment-linked deposits,
etc. are likely to be introduced, as investors with varied risk profiles will
look for better yields. There will be more and more of tie-ups between
banks, corporate clients and their retail outlets to share a common
platform to shore up revenue through increased volumes.


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Banks will increasingly act as risk managers to corporate and other
entities by offering a variety of risk management products like options,
swaps and other aspects of financial management in a multi currency
scenario. Banks will play an active role in the development of derivative
products and will offer a variety of hedge products to the corporate
sector and other investors. For example, Derivatives in emerging futures
market for commodities would be an area offering opportunities for
banks. As the integration of markets takes place internationally,
sophistication in trading and specialized exchanges for commodities will
expand. As these changes take place, banking will play a major role in
providing financial support to such exchanges, facilitating settlement
systems and enabling wider participation.

Bancassurance is catching up and Banks / Financial Institutions have
started entering insurance business. From mere offering of insurance
products through network of bank branches, the business is likely to
expand through self-designed insurance products after necessary
legislative changes. This could lead to a spurt in fee-based income of
the banks.

Similarly, Banks will look analytically into various processes and practices
as these exist today and may make appropriate changes therein to cut
costs and delays. Outsourcing and adoption of BPOs will become more
and more relevant, especially when Banks go in for larger volumes of
retail business. However, by increasing outsourcing of operations
through service providers, banks are making themselves vulnerable to
problems faced by these providers. Banks should therefore outsource
only those functions that are not strategic to banks’ business. For
instance, in the wake of implementation of 90 days’ delinquency norms


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for classification of assets, some banks may think of engaging external
agencies for recovery of their dues and in NPA management.

Banks will take on competition in the front end and seek co-operation in
the back end, as in the case of networking of ATMs. This type of
co-opetition will become the order of the day as Banks seek to enlarge
their customer base and at the same time to realize cost reduction and
greater efficiency.

TECHNOLOGY IN BANKING

Technology will bring fundamental shift in the functioning of banks. It
would not only help them bring improvements in their internal
functioning but also enable them to provide better customer service.
Technology will break all boundaries and encourage cross border banking
business. Banks would have to undertake extensive Business Process
Re-Engineering and tackle issues like a) how best to deliver products and
services to customers b) designing an appropriate organizational model
to fully capture the benefits of technology and business process changes
brought about. c) how to exploit technology for deriving economies of
scale and how to create cost efficiencies, and d) how to create a customer
- centric operation model.

Entry of ATMs has changed the profile of front offices in bank branches.
Customers no longer need to visit branches for their day to day banking
transactions like cash deposits, withdrawals, cheque collection, balance


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enquiry etc. E-banking and Internet banking have opened new avenues in
“convenience banking”. Internet banking has also led to reduction in
transaction costs for banks to about a tenth of branch banking.

Technology solutions would make flow of information much faster, more
accurate and enable quicker analysis of data received. This would make
the decision making process faster and more efficient. For the Banks, this
would also enable development of appraisal and monitoring tools which
would make credit management much more effective. The result would
be a definite reduction in transaction costs, the benefits of which would
be shared between banks and customers.

While application of technology would help banks reduce their operating
costs in the long run, the initial investments would be sizeable. With
greater use of technology solutions, we expect IT spending of Indian
banking system to go up significantly.

One area where the banking system can reduce the investment costs in
technology applications is by sharing of facilities. We are already seeing
banks coming together to share ATM Networks. Similarly, in the coming
years, we expect to see banks and FIs coming together to share facilities
in the area of payment and settlement, back office processing, data
warehousing, etc. While dealing with technology, banks will have to deal
with attendant operational risks. This would be a critical area the Bank
management will have to deal with in future.

Payment and Settlement system is the backbone of any financial market
place.
The present Payment and Settlement systems such as Structured Financial
Messaging System (SFMS), Centralised Funds Management System (CFMS),


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Centralized Funds Transfer System (CFTS) and Real Time Gross
Settlement System (RTGS) will undergo further fine-tuning to meet
international standards. Needless to add, necessary security checks and
controls will have to be in place. In this regard, Institutions such as
IDRBT will have a greater role to play.

CHAPTER: 2

STRATEGIC ANALYSIS OF BANKING INDUSTRY

2.1 PORTER’S FIVE FORCE ANALYSIS:

Prof. Michael Porter’s competitive forces Model applies to each and every
company as well as industry. This model with regards to the Banking
Industry is presented below:


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(2)
Potential Entrants
is high as
Development
Financial
Institutions as well
as Private and
foreign banks
have entered in a
(5) big way.(1) (4)
Organizing Power Rivalry among Bargaining Power
of the Supplier is Existing Firms of Buyers is high
high. With new has increased with as corporate can
financial liberalization. New raise funds easily
instruments they products and due to high
are asking higher improved competition.
return on customer services
investment. is the focus.
(3)
Threat from
Substitute is high
due to
competition from
NBFCs & Insurance
companies as they
offer a higher rate
of interest than
banks.

Rivalry among existing firms
With the process of liberalization, competition among the existing banks
has increased. Each bank is coming up with new products to attract the
customers and tailor made loans are provided. The quality of services
provided by banks has improved drastically.


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Potential Entrants
Previously the Development Financial Institutions mainly provided project
finance and development activities. But they have now entered into retail
banking which has resulted into stiff competition among the existing
players

Threats from Substitutes
Banks face threats from Non-Banking Financial Companies. NBFCs offer a
higher rate of interest.

Bargaining Power of Buyers
Corporates can raise their funds through primary market or by issue of
GDRs, FCCBs. As a result they have a higher bargaining power. Even in
the case of personal finance, the buyers have a higher bargaining power.
This is mainly because of competition.

Bargaining power of Suppliers
With the advent of new financial instruments providing a higher rate of
returns to the investors, the investments in deposits is not growing in a
phased manner. The suppliers demand a higher return for the
investments.

Overall Analysis
The key issue is that how can banks leverage their strengths to have a
better future. Since the availability of funds is more and deployment of
funds is less, banks should evolve new products and services to the
customers. There should be rational thinking in sanctioning loans, which
will bring down the NPAs. As there is expected revival in the Indian
economy banks have a major role to play. Funding corporate at a low cost
of capital is a major requisite.


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2.2 SWOT ANALYSIS:
The banking sector is often taken as a proxy for the economy as a whole.
The performance of bank should therefore, reflect “Trends in the Indian
Economy”. Due to the reforms in the financial sector, banking industry
has changed drastically with the opportunities to the work with, new
accounting standards new entrants and information technology. The
deregulation of the interest rate, participation of banks in project
financing has changed in the environment of banks.

The performance of banking industry is done through SWOT Analysis. It
mainly helps to know the Strengths and Weakness of the industry and to
improve will be known through converting the opportunities into
strengths. It also helps for the competitive environment among the banks.

STRENGTHS

1. Greater securities of Funds

Compared to other investment options banks since its inception has been
a better avenue in terms of securities. Due to satisfactory implementation
of RBI’s prudential norms banks have won public confidence over several
years.

2. Banking network
After nationalization, banks have expanded their branches in the country,
which has helped banks build large networks in the rural and urban areas.


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Private banks allowed to operate but they mainly concentrate in
metropolis.

3. Large Customer Base
This is mainly attributed to the large network of the banking system.
Depositors in rural areas prefer banks because of the failure of the NBFCs
.

4. Low Cost of Capital
Corporate prefers borrowing money from banks because of low cost of
capital. Middle income people who want money for personal financing
can look to banks as they offer at very low rates of interests. Consumer
credit forms the major source of financing by banks

WEAKNESSES

1. Basel Committee

The banks need to comply with the norms of Basel committee but before
that it is challenge for banks to implement the Basel committee standard,
which are of international standard.

2. Powerful Unions
Nationalization of Banks had a positive outcome in helping the Indian
Economy as a whole. But this has also proved detrimental in the form of
strong unions, which have a major influence in decision making. They are
against automation.

3. Priority Sector Lending


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To uplift the society, priority sector lending was brought in during
nationalization. This is good for the economy but banks have failed to
manage the asset quality and their intensions were more towards
fulfilling government norms. As a result lending was done for
non-productive purposes.

4. High Non-Performing Assets
Non-Performing Assets (NPAs) have become a matter of concern in the
banking industry. This is because of change in the Accounting Standards
(Prudential Norms). Net NPAs increased to large extent of the total
advances, which has to be reduced to meet the international standards.

OPPORTUNITIES

1. Universal Banking
Banks have moved along the value chain to provide their customers more
products and services. For example: - SBI is into SBI home finance, SBI
Capital Markets, SBI Bonds etc.

2. Differential Interest Rates
As RBI control over bank reduces, they will have greater flexibility to fix
their own interest rates which depends on the profitability of the banks.

3. High Household Savings
Household savings have been increasing drastically. Investment in
financial assets has also increased. Banks should use this opportunity for
raising funds.

4. Overseas Markets
Banks should tap the overseas market, as the cost of capital is very low.


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5. Internet Banking
The advances in information technology have made banking easier.
Business transactions can effectively carried out through internet banking.

THREATS

1. NBFCs, Capital Markets and Mutual funds
There is a huge investment of household savings. The investments in
NBFCs deposits, Capital Market Instruments and Mutual Funds are
increasing. Normally these instruments offer better returns to investors.

2. Change in the Government Policy
The change in the government policy has proved to be a threat to the
banking sector.

3. Inflation
The interest rates go down with a fall in inflation. Thus, the investors will
shift his investments to other profitable sectors.

4. Recession


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Due to the recession in the business cycle the economy functions poorly
and this has proved to be a threat to the banking sector. The market
oriented economy and globalization has resulted into competition for
market share. The spread in the banking sector is very narrow. To meet
the competition the banks have to grow at a faster rate and reduce the
overheads. They can introduce new products and develop the existing
services.

2.3. PEST ANALYSIS

POLITICAL/ LEGAL ENVIROMENT

Government and RBI policies affect the banking sector. Sometimes
looking into the political advantage of a particular party, the Government
declares some measures to their benefits like waiver of short-term
agricultural loans, to attract the farmer’s votes. By doing so the profits of
the bank get affected. Various banks in the cooperative sector are open
and run by the politicians. They exploit these banks for their benefits.
Sometimes the government appoints various chairmen of the banks.
Various policies are framed by the RBI looking at the present situation of
the country for better control over the banks


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ECONOMICAL ENVIROMENT

Banking is as old as authentic history and the modern commercial
banking are traceable to ancient times. In India, banking has existed in
one form or the other from time to time. The present era in banking may
be taken to have commenced with establishment of bank of Bengal in
1809 under the government charter and with government participation in
share capital. Allahabad bank was started in the year 1865 and Punjab
national bank in 1895, and thus, others followed

Every year RBI declares its 6 monthly policy and accordingly the
various measures and rates are implemented which has an impact on the
banking sector. Also the Union budget affects the banking sector to
boost the economy by giving certain concessions or facilities. If in the
Budget savings are encouraged, then more deposits will be attracted
towards the banks and in turn they can lend more money to the
agricultural sector and industrial sector, therefore, booming the economy.
If the FDI limits are relaxed, then more FDI are brought in India through
banking channels.

SOCIAL ENVIROMENT

Before nationalization of the banks, their control was in the hands
of the private parties and only big business houses and the effluent
sections of the society were getting benefits of banking in India. In 1969
government nationalized 14 banks. To adopt the social development in
the banking sector it was necessary for speedy economic progress,
consistent with social justice, in democratic political system, which is free
from domination of law, and in which opportunities are open to all.


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Accordingly, keeping in mind both the national and social objectives,
bankers were given direction to help economically weaker section of the
society and also provide need-based finance to all the sectors of the
economy with flexible and liberal attitude. Now the banks provide various
types of loans to farmers, working women, professionals, and traders.
They also provide education loan to the students and housing loans,
consumer loans, etc.

Banks having big clients or big companies have to provide services
like personalized banking to their clients because these customers do not
believe in running about and waiting in queues for getting their work
done. The bankers also have to provide these customers with special
provisions and at times with benefits like food and parties. But the banks
do not mind incurring these costs because of the kind of business these
clients bring for the bank.

Banks have changed the culture of human life in India and have
made life much easier for the people.

TECHNOLOGICAL ENVIROMENT

Technology plays a very important role in bank’s internal control
mechanisms as well as services offered by them. It has in fact given new
dimensions to the banks as well as services that they cater to and the
banks are enthusiastically adopting new technological innovations for
devising new products and services.

The latest developments in terms of technology in computer and
telecommunication have encouraged the bankers to change the concept
of branch banking to anywhere banking. The use of ATM and Internet
banking has allowed ‘anytime, anywhere banking’ facilities. Automatic


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voice recorders now answer simple queries, currency accounting
machines makes the job easier and self-service counters are now
encouraged. Credit card facility has encouraged an era of cashless society.
Today MasterCard and Visa card are the two most popular cards used
world over. The banks have now started issuing smartcards or debit cards
to be used for making payments. These are also called as electronic
purse. Some of the banks have also started home banking through
telecommunication facilities and computer technology by using terminals
installed at customers home and they can make the balance inquiry, get
the statement of accounts, give instructions for fund transfers, etc.
Through ECS we can receive the dividends and interest directly to our
account avoiding the delay or chance of loosing the post.

Today banks are also using SMS and Internet as major tool of
promotions and giving great utility to its customers. For example SMS
functions through simple text messages sent from your mobile. The
messages are then recognized by the bank to provide you with the
required information.

All these technological changes have forced the bankers to adopt
customer-based approach instead of product-based approach.


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CHAPTER: 3

CORPORATE BANKING: AN OVERVIEW

3.1 INTRODUCTION:

According to American author and humorist Mark Twain: ”A banker is a
fellow who lends his umbrella when the sun is shining and wants it back
the minute it begins to rain.”
Many troubled businesses seeding credit in recent years might agree with
Mr. Twain. Indeed securing the large amounts of credit that many
businesses require can be a complicated and challenging task loan
requests. Moreover, business loans, often called commercial and
industrial loans, rank among the most important assets that commercial
banks and their closest competitors hold.

Corporate finance is an area of finance dealing with financial decisions
business enterprises make and the tools and analysis used to make these
decisions. The primary goal of corporate finance is to maximize
[1]
corporate value while managing the firm's financial risks. Although it is
in principle different from managerial finance which studies the financial
decisions of all firms, rather than corporations alone, the main concepts
in the study of corporate finance are applicable to the financial problems
of all kinds of firms.
The discipline can be divided into long-term and short-term decisions
and techniques. Capital investment decisions are long-term choices
about which projects receive investment, whether to finance that
investment with equity or debt, and when or whether to pay dividends to
shareholders. On the other hand, the short term decisions can be
grouped under the heading "Working capital management". This subject


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deals with the short-term balance of current assets and current liabilities;
the focus here is on managing cash, inventories, and short-term
borrowing and lending (such as the terms on credit extended to
customers).
The terms corporate finance and corporate financier are also associated
with investment banking. The typical role of an investment bank is to
evaluate the company's financial needs and raise the appropriate type of
capital that best fits those needs.

Corporate banking is a part of commercial banking but the part that
average depositor with deposits account never sees. It is a division of
commercial banking which extends the financial support to the corporate
for helping them achieve their organizational goals and objectives. While
banks hold money and mortgages, lend money, extend or open up a line
of credit for the average depositors, it is business that needs major
financial services to build plant, erect buildings, make structural
improvements on old ones and start new business ventures. This is one
of the most competitive, risky and financially lucrative areas of doing
business in today’s world.

Commercial loans were the earliest form of lending banks did in their
move than 2000 year old history. Later in the 20th century finance
companies, insurance firms, and thrift institutions entered the business
lending field. Today loan officers skilled in evaluating the credit of
businesses are usually among the most experienced and highest paid
people in the financial services field, along with security underwriters.

As a part of commercial banking, corporate banking is focused on
analyzing and assessing the risk of the business, establishing the
creditworthiness of the business and trying to predict the likelihood of
success or failure of business endeavour. These are the professionals


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who help decide what business initiatives will be taken and when,
whether or not to expand the existing businesses, help develop new
markets so that new clients can be found and help develop new products
for e-commerce, the internet and the international markets.

Corporate Banking represents the wide range of banking and financial
services provided to domestic and international operations of large local
corporate and local operations of multinationals corporations. Services
include access to commercial banking products, including working capital
facilities such as domestic and international trade operations and funding,
channel financing, and overdrafts, as well as domestic and international
payments, INR term loans (including external commercial borrowings in
foreign currency), letters of guarantee etc.

The Investment Banking and Markets division of various bank brings
together the advisory and financing, equity securities, asset management,
treasury and capital markets, and private equity activities to complete the
CIBM structure and provide a complete range of financial products to our
clients. Increasingly, ECA financing is being considered by customers and
we work closely with our project export finance teams, both onshore and
offshore, to provide structured solutions.

The Corporate Bank in India was ranked 2nd overall in the 2004
Greenwich Survey.

This portfolio is largely spread within 9 sector teams divided as under :

Consumer Brands
Industrials
Energy and Utilities
Telecommunications
Automotive


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Healthcare
Transport and Logistics
Metals and Mining
Media

3.2 STRUCTURE OF CREDIT LENDING (CORPORATE) IN
INDIA:

Banks, finance companies, and competing business lenders grant many
different types of commercial loans. Among the most widely used forms
of business credit are the following:

SHORT-TERM BUSINESS LOANS:
Self-liquidating inventory loans
Working capital loans
Interim construction financing
Security dealer financing
Retailer and equipment financing
Asset-based loans (accounts receivable financing, factoring, and
inventory financing)
Syndicated loans

LONG-TERM BUSINESS LOANS:


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Term loans to support the purchase of equipment, rolling stock,
and structures
Revolving credit financing
Project loans
Loans to support acquisitions of others business firms

SHORT-TERM LOANS TO BUSINESS FIRMS:

Self-Liquidating Inventory Loans

Historically, commercial banks have been the leaders in extending short
term credit to businesses. These loans were used to finance the purchase
of inventory, raw materials or finished goods to sell. In this case the term
of the loan begins when cash in needed to purchase inventory and ends
when cash is available in the firm’s account to write the lender a check
for the balance of its loan.

Working Capital Loans

Working capital loans provide businesses with short run credit, lasting
from few days to about one year. Working capital loans are most often
used to fund the purchase of inventories in order to put goods on shelves


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or to purchase raw materials; thus, they come closest to the traditional
self-liquidating loan described previously.

Frequently, the working capital loan is designed to cover seasonal peaks
in the business customer’s production levels and credit needs. Normally,
working capital loans are secured by accounts receivable or by pledges of
inventory and carry a floating interest rate on the amounts actually
borrowed against the approved credit line. A commitment fee is charged
on the unused portion of the credit line and sometimes on the entire
amount of funds made available.

Interim Construction Financing

A popular form of secured short term lending is the interim construction
loan, used to support the construction of homes, apartments, office
buildings, shopping centers, and other permanent structures. The finance
is used while the construction is going on but once the construction
phase is over, this short term loan usually is paid off with a longer term
mortgage loan issued by another lender, such as insurance company of
pension fund. Recently, some commercial banks have issued
‘minipermanent’ loans, providing funding for construction and the early
operation of a project for as long as five to seven years.

Retailer and Equipment Financing

Banks support installment purchases of automobiles, appliances,
furniture, business equipment, and other durable goods by financing the
receivables that dealers selling these goods take on when they write
installment contracts to cover customer purchases. In turn, these
contracts are reviewed by banks and other lending institutions with whom
the dealers have established credit relationships. If they meet acceptable


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credit standards, the contracts are purchased by lenders at an interest
rate that varies with the risk level of each borrower, the quality of
collateral pledged, and the term of each loan.

Asset-Based Financing

An increasing portion of short-term lending by banks and other lenders
in recent years has consisted of asset based loans, credit secured by the
shorter term assets of a firm that are expected to roll over into cash in
the future. Key business assets used for many of these loans are accounts
receivables and inventories of raw materials or finished goods. The lender
commits funs against a specific percentage of the book value of
outstanding credit accounts or against inventory.

In most loans collateralized by accounts receivable and inventory, the
borrowing firm retains title to the assets pledged, but sometimes title is
passed to the lender, which then assumes the risk that some of those
assets will not pay out as expected. The most common example of this
arrangement is factoring, where the bank actually takes on the
responsibility of collecting the accounts receivable of one of its business
customers. It typically assesses a higher discount rate and lends a smaller
fraction of the book value of the customer’s accounts receivable because
the lender incurs both additional expense and additional risk with a
factored loan.

Syndicated Loan

A type of large corporate loan that is increasingly used today is the
syndicated loan. This is typically a loan or loan package extended to a
corporation by a group of banks and other institutional lenders. These


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loans may be “drawn” by the borrowing company, with the funds used to
support business operations or commercial expansion, or “undrawn”,
serving as lines of credit to back a security issue or other venture. Banks
engage in syndicated loans both to spread the heavy risk exposures of
these large loans, often involving hundreds of lakhs or crore of rupees in
credit for each loan, and to earn fee income.

LONG-TERM LOANS TO BUSINESS FIRMS:

Term Business Loans

Term loans are designed to fund long and medium term business
investments, such as the purchase of equipment or the construction of


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physical facilities, covering a period longer than one year. Usually the
borrowing firm applies for a lump sum loan based on the budgeted cost
of its proposed project and then pledges to repay the loan in a series of
installments.

Term loans normally are secured by fixed assets e.g. Plant and Equipment
owned by the borrower and may carry either a fixed or a floating interest
rate. That rate is normally higher than on shorter term business loans
due to the lender’s greater risk exposure from such loans.

Revolving Credit Financing

A revolving credit line allows a business customer to borrow up to a pre
specified limit, repay all or a portion of the borrowing, and re borrows as
necessary until the credit line matures. One of the most flexible of all the
forms of business loans, revolving credit is often granted without specific
collateral to secure the loan and may be short term or caver a period as
long as three, four, or five years. This form of business financing is
particularly popular when the customer is highly uncertain about the
timing of future cash flows or about the exact magnitude of the future
borrowings needs.

Loan commitments are usually of two types namely,
1. Formal Loan Commitment, and
2. Confirmed Credit Line.

Formal Loan Commitment is a contractual promise to lend to a customer
up to a maximum amount of money at a set interest rate or rate markup
over the prevailing base loan rate. Whereas, Confirmed Credit Line is a
looser form of loan commitment where the banks indicate its approval of


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customer’s request for credit in an emergency, though the prices of such
a credit line may not be set in advance and the customer may have little
intention to draw upon the credit line.

Long-Term Project Loans

The most risky of all business loans are project loans, credit to finance
the construction of fixed assets designed to generate a flow of revenue in
future periods. Prominent examples include oil refineries, pipelines,
mines, power plants and harbor facilities. Project loans are usually
granted to several companies jointly sponsoring a large project.

Project loans may be granted on a recourse basis, in which the lender can
recover funds from the sponsoring companies if the project does not pay
out as planned. At the other end, loan may be extended on a non
recourse basis, in which no sponsor guarantees; the project stands or
falls on its own merits. Many such loans require that the project‘s
sponsors pledge enough of their own capital to see the project through
to completion.


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Term Loan / Deferred Payment Guarantees

In case of term loans and deferred payment guarantees, the
project report is obtained from the customer, who may have
been compiled in-house or by a firm or consultants/ merchant
bankers.

Term loan is provided to support capital expenditures for
setting up new ventures as also for expansion, renovation etc.

The technical feasibility and economic viability is vetted by the
Bank and wherever it is felt necessary.

Banks normally expects at least 20% contribution of Promoter’s
contribution. But the promoter contribution may vary largely in
mega projects. Therefore, there cannot be a definitive
benchmark.

The sanctioning authority will have the necessary discretion to
permit deviations.


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3.3 EMERGENCE OF CORPORATE BANKING IN INDIA

The bank lending has expanded in a number of emerging market
economies, especially in Asia and Latin America, in recent years. Bank
credit to the private sector, in real terms, was rising at a high rate.
Several factors have contributed to the significant rise in bank lending in
emerging economies such as strong growth, excess liquidity in banking
systems reflecting easier global and domestic monetary conditions, and
substantial bank restructuring. The recent surge in bank lending has
been associated with important changes on the asset side of banksí
balance sheet. First, credit to the business sector - historically the most
important component of banksí assets – has been weak, while the share
of the household sector has increased sharply in several countries.
Second, banksí investments in Government securities increased sharply
until 2004-05. As a result, commercial banks continue to hold a very
large part of their domestic assets in the form of Government securities -
a process that seems to have begun in the mid-1990s.

There has been a sharp pick up in bank credit in India in recent years.
The rate of growth in bank credit which touched a low of 14.4 per cent in
2002-03, accelerated to more than 30.0 per cent in 2004-05, the rate
which was maintained in 2005-06. The upturn in the growth rate of bank
credit can be attributed to several factors. One, macroeconomic
performance of the economy turned robust with GDP growth rates
hovering between 7.5 per cent and 8.5 per cent during the last few years.
Two, the hardening of sovereign yields from the second half of 2003-04


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forced banks to readjust their assets portfolio by shifting from
investments to advances. While the share of gross advances in total
assets of commercial banks grew from 45.0 per cent to 54.7 per cent that
of investments declined from 41.6 per cent to 32.1 per cent in the last
few years.

However, the credit growth has been broad-based making banks less
vulnerable to credit concentration risk. The declining trend of priority
sector loans in 2001-02 in the credit book of banks was due to
prudential write offs and compromise settlements of a large number of
small accounts which was reversed from 2002-03 on the strength of a
spurt in the housing loan portfolio of banks. Even though credit to
industry and other sectors have also picked up, their share in total loans
has declined marginally. Retail loans, which witnessed a growth of over
40.0 per cent in 2004-05 and again in 2005-06, have been the prime
driver of the credit growth in recent years. Retail loans as a percentage of
gross advances increased from 22.0 per cent in March 2004 to 25.5 per
cent in March 2006. The cyclical uptrend in the economy along with the
concomitant recovery in the business climate brings with it improved
abilities of the debtors to service loans, thereby greatly improving banks
asset quality. Despite the sharp rise in credit growth in recent years, not
only the proportional levels of gross non-performing loans (NPLs) have
declined, but the absolute levels of gross NPLs declined significantly.
Several factors have contributed to the marked improvement in the Indian
banksí asset quality. One, banks have gradually improved their risk
management practices and introduced more vigorous systems and
scoring models for identifying credit risks. Two, a favourable
macroeconomic environment in recent years has also meant that many
entities and units of traditionally problematic industries are now
performing better. Three, diversification of credit base with increased
focus on retail loans, which generally have low delinquency rates, has


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also contributed to the more favourable credit risk profile. Four, several
institutional measures have been put in place to recover the NPAs. These
include Debt Recovery Tribunals (DRTs), Lok Adalats (peopleís courts),
Asset Reconstruction Companies (ARCs) and corporate debt restructuring
mechanism (CDRM). In particular, the Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest (SARFAESI) Act,
2002 for enforcement of security interest without intervention of the
courts has provided more negotiating power to the banks for resolving
bad debts.


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Sectoral Deployment of Gross Bank Credit

During 2008-09 total deployment of gross bank credit increased to
Rs.1.87,515 crores from Rs.1,69.536 crores in 2008-07
Non-food bank credit increased sharply during 2005-06. The credit
growth was broad based. Credit to services (including personal loans and
other services) increased by 52.8 per cent in 2005-06, accounting for
58.3 per cent of incremental non-food gross bank credit (NFGBC).
Personal loans increased sharply in recent years mainly on account of
housing loans. Real estate loans more than doubled. Other personal loans
such as credit card outstanding and education loans also recorded sharp
increases of 59.3 per cent and 96.5 per cent, respectively.

Priority Sector Advances

Credit to the priority sector decreased to 34.1 per cent in the previous
year against 39.5 in 2008. In terms of revised guidelines on lending to
priority sector , broad category of advances under priority sector include
agriculture, micro and small enterprises, retail trade, micro-credit,
education and housing.

The agriculture and housing sectors were the major beneficiaries, which
together accounted for more than two-third of incremental priority sector
lending. Credit to small scale industries also accelerate. Several
favourable policy initiatives undertaken by the Central Government and
the Reserve Bank including, inter alia, the policy package for stepping up
of credit to small and medium enterprises (SMEs) announced on August
10, 2005, have had a positive impact. At the individual bank-level, all the
nationalised banks, and all but two of the State Bank group (State Bank of
India and State Bank of Patiala) were able to meet the priority sector
target of 40 per cent of NBC. However, only ten PSBs (Allahabad Bank,


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Andhra Bank, Bank of India, Indian Bank, Indian Overseas Bank, Punjab
National Bank, Syndicate Bank, State Bank of Bikaner and Jaipur, State
Bank of Indore and State Bank of Saurashtra) were able to achieve the
subtargets for agriculture, while the sub-target for weaker sections was
met by eight PSBs (Allahabad Bank, Andhra Bank, Bank of India, Indian
Bank, Indian Overseas Bank, Punjab National Bank, Syndicate Bank and
State Bank of Patiala).

Lending to the priority sector by foreign banks constituted 34.6 per cent
of net bank credit as on the last reporting Friday of March 2006, which
was well above the stipulated target of 32 per cent. The share of export
credit in total netbank credit at 19.4 per cent was significantly above the
prescribed sub-target of 12.0 per cent. Foreign banks, however, fell a
little short of the sub-target of 10.0 per cent in respect of lending to SSIs.

Special Agricultural Credit Plans

The Reserve Bank had advised public sector banks to prepare Special
Agricultural Credit Plans (SACP) on an annual basis in 1994. The SACP
mechanism for private sector banks was made applicable from 2005-06,
as recommended by the Advisory Committee on Flow of Credit to
Agriculture and Related Activities from the Banking System
(Chairman:Prof. V.S. Vyas) and announced in the Mid-term Review of
Annual Policy for 2004-05. Public sector banks were advised to make
efforts to increase their disbursements to small and marginal farmers to
40.0 per cent of their direct advances under SACP by March 2007. The
disbursement to agriculture under SACP by public sector banks
aggregated Rs.94,278 crore during 2005-06, which was much above the
target of Rs.85,024 crore and the disbursement of Rs.65,218 crore
during 2004-05. The disbursement by private sector banks during
2005-06 at Rs.31,119 crore was above the target of Rs.24,222 crore.


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3.21 Public sector banks were advised to earmark 5.0 per cent of their
net bank credit to women. At end-March 2006, aggregate credit to
women by public sector banks stood at 5.37 per cent of their net bank
credit with 22 banks achieving the target. A consortium of select public
sector banks was formed, with the State Bank of India as the leader of the
consortium, to provide credit to the Khadi and Village Industries
Commission (KVIC). These loans are provided at 1.5 per cent below the
average prime lending rates of five major banks in the consortium. An
amount of Rs.322 crore was outstanding at end-July 2006 out of Rs.738
crore disbursed by the consortium under the scheme.
Micro-finance

The Reserve Bank has been making consistent efforts to strengthen credit
delivery, improve customer service and encourage banks to provide
banking services to all segments of the population. Despite considerable
expansion of the banking system in India, large segments of the country’
s population do not have access to banking services.

Expanding the outreach of banking services has, therefore, been a major
thrust area of the policy of the Government of India and the Reserve Bank
in recent years.

The self-help group (SHG)-bank linkage programme has emerged as the
major micro-finance programme in the country and is being
implemented by commercial banks, RRBs and co-operative banks. As on
March 31, 2008 3.6 million SHGs had outstanding bank loans of
Rs.17,000 crore, an increase of 25 per cent over March 31, 2007 in
respect of number of SHGs credit linked. During 2007-08, banks
financed 1.2 million SHGs for Rs.8,849 crore. As at end-March 2008,
SHGs had 5 million savings accounts with banks for Rs.3,785 crore.


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Retail Credit
Continuing the strong growth in recent years, retail advances increased
by 40.9 per cent to Rs.3,75,739 crore in 2007-08, which was significantly
higher than the overall credit growth of 31.0 per cent. As a result, their
share in total loans and advances increased during the year. Auto loans
experienced the highest growth, followed by credit card receivables,
other personal loans (comprising loans mainly to professionals and for
educational purposes) and housing finance. Loans for consumer durables
increased by 17.3 per cent as against the decline of 39.1 per cent in the
previous year.

Major steps earlier taken by the Reserve Bank of India were somewhat
more oriented towards price stability and the related monitory
instruments like the bank rate, reverse repo rate, repo rate and CRR were
adjusted to rein in the price instability. Naturally, the priority was
inflation control for overall growth of the economy and we must
congratulate the RBI for a wonderful job done. The inflation today is at a
moderate level and in line with a developed economy.With these steps
taken by RBI, the latest scenario is that the non-food credit growth got
moderated, agricultural and service sector credit went up but the retail
credit growth actually took a beating due to northbound interest rates.
Such positive impact on inflation helped the economy for price stability
and we feel what is important for India now is to ensure that there is
sufficient focus on growth of the economy along with price stability.

Lending to the Sensitive Sectors

Lending by SCBs to the sensitive sectors (capital market, real estate and
commodities) increased sharply during 2005-06 mainly on account of a
sharp increase in exposure to the real estate market. Total exposure of
SCBs to the sensitive sectors consituted 18.9 per cent of aggregate bank


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loans and advances (comprising 17.2 per cent to real estate, 1.5 per cent
to the capital market and 0.3 per cent to the commodities sector). During
2008-2009 total lending to sensitive sector increased by 19.1 percent in
capital market.

Among bank groups, new private sector banks had the highest exposure
to the sensitive sectors (measured as percentage to total loans and
advances of banks) mainly due to the increase in exposure to the real
estate market, followed by foreign banks, old private sector banks and
public sector banks.

MEASURES BY SIDBI

SIDBI has developed a Credit Appraisal & Rating Tool (CART) as well as a
Risk Assessment Model (RAM) and a comprehensive rating model for risk
assessment of proposals for SMEs. The banks may consider to take
advantage of these models as appropriate and reduce their transaction
costs.
.


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Public Sector Banks are advised to follow a transparent rating system
with cost of credit being linked to the credit rating of the enterprise.

SIDBI in association with Credit Information Bureau (India) Ltd. (CIBIL)
expedited setting up a credit rating agency.

SIDBI in association with Indian Banks’ Association (IBA) would collect
and pool common data on risk in each identified cluster and develop an
IT-enabled application, appraisal and monitoring system for small
(including tiny) enterprises. This would help reduce transaction cost as
well as improve credit flow to small (including tiny) enterprises in the
clusters.

The National Small Industries Corporation has introduced a Credit Rating
Scheme for encouraging SSI units to get themselves credit rated by
reputed credit rating agencies. Public Sector Banks will be advised to
consider these ratings appropriately and as per availability, and structure
their rates suitably.

ROADMAP BY RBI

The Reserve Bank of India (RBI) has worked out the roadmap for the
Indian banks to graduate from the simpler approaches of the Basel II
framework to more advanced ones.


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Basel II is the second among Basel Accords, which are primarily,
recommendations on banking laws and regulations issued by the Basel
committee on banking supervision.
It sets up rigorous risk and capital management requirements aimed at
ensuring that a bank holds capital reserves appropriate to the risk it
exposes itself to through its lending and investment practices.

Since March 2008, foreign banks operating in India and Indian banks
having presence outside the country have migrated to simpler
approaches under Basel II framework. Other commercial banks are
required to migrate to these norms by March 31, 2009.
These include standardised approach for credit risk which arising from
default by borrowers, basic indicator approach for operational risk
(arising from day to operations of the banks such robbery or power
failure) and standardised duration approach for market risk (arising from
fluctuations in interest rate and share prices) which affects the
investment and market portfolio of the banks.

In the framework, the RBI had earlier specified the date by which banks
may file application for approvals and the the likely date by which
approvals can be obtained from the central bank.

While banks have the discretion to adopt the advanced approaches, they
need to seek prior approval.

Under market risk, banks may apply to RBI for graduating to more
advanced method of internal models approach (IMA) by April 1, 2010 and
then, RBI may approve it by March 31, 2011. IMA sets out a framework
for applying capital charges to the market risks (both on balance sheet
and off-balance sheet) incurred by banks by an internal model. The


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current standardised duration approach specifies a specific average
duration of the banks at large, which the banks follow and make it a basis
for applying capital charges to only open positions.

Similarly, for operational risk, banks may graduate to standardised
approach by April 1, 2010 and RBI can approve the plan by September 30,
2010. After that, they can graduate to advanced measurement approach
for operational risk by April 1, 2011 and get RBI approval by March 31,
2013.

While advanced measurement approach (AMA) sets the framework for
banks to develop their own empirical model to quantify required capital
for operational risk, it can be used after they get regulatory clearances.

Under the standardised approach, a bank's activities are divided into
eight business lines: corporate finance, trading and sales, retail banking,
commercial banking , payment and settlement, agency services, asset
management and retail brokerage. Within each business line, gross
income is a broad indicator for the scale of business operations and so,
the scale of operational risk exposure within each of these business lines.
The capital charge for each business line is calculated by multiplying
gross income by a factor .

Currently, banks are using the basic indicator approach as per which they
must hold capital for operational risk equal to the average over the
previous three years of a fixed percentage of positive annual gross
income.

For credit risk, banks can use internal ratings-based approach which
allows them to develop their own model to estimate the probability of
default for individual clients or groups of clients. Currently, banks use


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standardised approach where they are required to use ratings from
external credit rating agencies to quantify the required capital for credit
risk.

CHAPTER: 4

CRM STRATEGIES FOR CORPORATE BANKING

4.1 RAROC

Risk-Adjusted Return on Capital –– RAROC–– is a measure of the
expected return on
Economic Capital over the life of an investment. This prospective measure
of risk-adjusted profitability allows for apples-to-apples comparison of
activities across risk types of business.

RAROC helps senior management maximize shareholder value by
addressing strategic business questions such as:
How much capital is needed to support the company’s
enterprise-wide risks?
Is the company over or under capitalized?
Are individual business units creating or destroying shareholder
value?
What opportunities for growth or diversification exist within the
company?
How should the economics of the business be managed within
regulatory and rating agency capital constraints?


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