Chapter – 13 Credit Function of Banks


• There are various reasons why banks should lend money. Firstly, Bank lends money to earn income and fulfill the legal requirement of Banking Regulation Act, 1949, second, in order to meet its liabilities arising out of interest and non-interest paid expenses, and third, as a partner to economic development process, e.g. lending to trade, commerce, industry, agriculture etc.

• Bankers have liability on them as a part of Fair Practices Code set by IBA/RBI. These are:

Develop simplified and comprehensive loan application forms containing all important information like interest rate, manner of charging interest, etc.
Develop system of giving acknowledgement for receipt of all applications indicating any fee taken for processing fee, etc.
As a lender to ensure that there is proper assessment of credit requirement of borrowers.
Keep the record of duly signed sanctioned letter containing amount, interest charged and installment amount to be paid at specified intervals.
• As a part of Fair Practices Code, banks are further required to:

Apprise the borrower of the state of their accounts from time to time.
Ensure that any change in interest rate, charges, etc. should be brought to the notice of the borrower.
Give reasonable notice to borrowers before taking decision to recall /accelerate payment as agreed.
• Sources of funds (liability) available to lending banker for making advances are:

Paid-up capital
Reserve funds retained by bank out of profits
Deposits mobilized from public in various deposit accounts.
Borrowing from other banks / market etc.
• Uses of funds by banks(assets) is either in the form of Fund based lending and /or Non-fund based lending

What is Lending?

• Lending by banks means giving credit to borrowers for a particular purpose at a rate of interest pre-agreed rate of interest and repayable within specified period of time, as per terms and conditions agreed by both parties.

Principles of Lending

• While lending to other parties bank has to ensure that the money lent will come back in the form of principal and interest. For this bank has to follow certain principles of lending that are based on the guidelines from the RBI and also practical experience of bankers over years. These principles of lending are given below:

1. While considering application for any loan or advance, bank must look into the following aspects:

• That the lending is going to be profitable.

• Borrower is acceptable to the bank in terms of his honesty, integrity, skills, business acumen etc.

• Safety and liquidity aspects of Lending.

• Purpose for which loans and advances are being given is productive and desirable. Purpose should be legitimate and as per law of the land.

• Borrower has good repaying capacity, etc.

2. Profitable lending is a function of many aspects. All loans and advances must yield profit to bank. Principles to be followed will cover the following aspects:

• Borrower must be trustworthy and of good character.

• Borrower should have intention and willingness to repay loan.

• Borrower’s goods and services have market demand.

• Bank should diversify the credit portfolio and choose the most profitable venture to lend money.

3. Business Acumen of Borrower: Since business is promoted and managed by borrower, it is necessary that bank must as a principle look into the following aspects of management:

• Borrower has trade knowledge

• Borrower has business acumen like organizational capacity, labour management, environment management, market management etc.

• Borrower shows strong financial soundness. He has ability to repay the loan.

• The most common aspect that bank looks into is its borrower’s 3’C (character, capacity and capital).

4. Safety of loan is another important principle. It depends upon factors like right purpose, right use, honest and sensible borrower, taking adequate security to cover risks, productive business etc. Safety of loan is critical to bank lending system. For this banks follow two level appraisal, viz.

• Pre-sanction appraisal

• Post-sanction appraisal

5. Pre-sanction Appraisal: While doing pre-sanction appraisal important aspect is preparation of credit report to ascertain risk factor(s), identification of strong and weak areas of loan proposal, credit need identification, etc. As a principle bank has to ensure that there is neither underfinancing nor overfinancing, since both are damaging to the bank and the borrower.

6. Post-sanction Appraisal: This aspect of banking principle covers proper documentation, post sanction supervision and follow-up, inspection of securities etc. besides upgrading the credit report and renewals and reviewals.

Distinction between Loans and Advances

• In loans no frequent debits are allowed. There is one debit entry of the principal amount in the loan account. Subsequent debits relate to bank charges, if any, interest charged, etc.

• Withdrawal of amount in loan may be in stages as per the need of the borrower.

• In case of advances, the amount sanctioned is placed at the disposal of the borrower with a condition that he cannot draw beyond the limit sanctioned.

• In case of advances, account is running account and borrower can draw money as and when required for genuine sanctioned trade / business transaction.

• However in common usage, both these words are being used as interchangeable.

TYPES OF CREDIT FACILITIES

Banks extend Credit facilities in mainly two forms. These are:

(a) Fund Based, and

(b) Non-fund based facilities.

• Fund based: In this form of credit delivery, funds are made available to the borrower immediately for his use for the purpose for which sanctioned. Fund based lending is further given in the form of either:

Term Loan, and / or
Working Capital
In case of Term loan, the loan amount is given to the borrower for the purchase of fixed assets like plant and machinery, construction of building, purchase of commercial vehicle etc.
In case of working capital funds are used for day-to-day expenses of the business like purchase of raw material, processing of raw material to get finished goods, salaries and wages of the employees etc.
• Non-fund Based: in this form, release of funds is deferred for period temporarily till the happening of an event. It is also classified as contingent liability by banks.

• Banks may also sanction working capital in the form of non-fund based facility. Many a time in business, sellers may sell the goods on credit basis (say 1 month credit) to the buyer (borrower). As a security, sellers insist for Bank Guarantee or ask the buyers (borrower’s) bank to open a irrevocable letter of credit. In other words, instead of disbursing loan for buying goods, bank will issue a guarantee or open a Letter of Credit.

Most common and preferred fund based facilities

• Term Loans

• Overdraft

• Cash credit

• Bill finance

Similarly, following non-fund based facilities are common with banker and borrowers

• Letter of Credit

• Bank Guarantee

• Deferred Payment Guarantee

(Note: Discussed elsewhere in the book)

TERM LOANS

Term Loans are sanctioned mainly for two major purposes, viz.

(i) Business purposes for productive use, like Capital investments for purchase of Plant and Machinery, Vehicles, Furniture & fixtures, etc.

(ii) The term loans sanctioned for productive purposes are for Capital investments like purchase of Plant and Machinery, Vehicles, Furniture & fixtures, etc.

Special Features of Term Loans

• Bank disburses the entire sanctioned loan amount to the borrower in one go.

• As far as rate of interest is concerned, banks and borrowers have two options.

(i) One Fixed Rate of Interest, and

(ii) Floating Rate of Interest.

• In the fixed interest basis, the same rate of interest is charged throughout the period of loan. However, in case of Floating rate of interest which means, as and when there is change in the link rate (say Base Rate, Prime Lending Rate (PLR) of a bank), the rate of interest will change.

• Charging of Interest: Banks charge Interest on the balance outstanding (i.e., daily reducing balance method or ba ance outstanding at the beginning of the month/ quarter, as per the terms and conditions agreed upon between bank and borrower.

• Repayment Period: Term loans normally have a period of repayment ranging between say 3 years to 5 or even 7 years.

• Security of Loans: Loans are secured by some tangible assets purchased and charged to banks (Hypothecation / Mortgage, etc). Additional or Collateral securities can be obtained where necessary which can be in the form of Pledge/mortgage or by 3rd parties Guarantees.

Moratorium of Term Loan

In terms of loans, a moratorium period refers to a period of time that is agreed on between the lender and the borrower in which the loan and the interest is to be repaid.The main principle of having a moratorium is so an individual who has taken out a loan has some extra time to pay it back to the lender. However, each moratorium period is different depending on each individual circumstance. Some people may be awarded a longer period of time than others depending on the amount they have borrowed or the reasons why they are not available to pay it back straight away. This is usually the process that is agreed on before the creditor makes official demands for the repayment.

Debt Moratorium

This method is used quite a lot when it comes to debt repayment. In this case, the creditor gives the debtor a later date to begin paying back the required amount; however there is no specific date used in these circumstances either. It is simply judged depending on the situation and how much debt needs to be repaid. If the debt is not paid back within this time period then the creditor will take additional measures to claim back the debt from you.

What is reverse mortgage Loan Scheme?

In simple terms, a reverse mortgage is the “opposite” of a conventional home loan. A reverse mortgage enables a senior citizen to receive a regular stream of income from a lender (a bank or a financial institution) against the mortgage of his home. The borrower (i.e. the individual pledging the property), continues to reside in the property till the end of his life and receives 206 Credit Function of Banks a periodic payment on it.

How does a reverse mortgage work?

When the home is pledged, its monetary value is arrived at by the bank, on the basis of the demand for the property, current property prices, and the condition of the house. The bank then disburses a loan amount to the borrower in the form of periodic payments, after considering a margin for interest costs and price fluctuations. The periodic payments also known as reverse EMI are received by the borrower over fixed loan tenure. With each payment, whether monthly or quarterly, the equity or the individual’s interest in the house decreases.

A reverse mortgage is an ideal option for senior citizens who require regular income, or if the property is of illiquid nature for some reason.

WORKING CAPITAL–Important Features

• Working capital is granted to borrower either as cash credit, overdraft or bill finance. Important features of working capital are given below along with features of mode of financing.

• It is finance granted for meeting borrower’s day-to-day expenditure required to produce/manufacture the goods or sale of goods (in case of traders).

• Commonly working capital finance is based on operating cycle of the business. Operating cycle is defined as the time taken for conversion of cash into cash. For instance, with sanctioned cash borrower purchases raw material and convert raw material into finished goods. While converting raw material into finished goods borrower spends many overheads etc. as expenses. The finished goods are then sold in the market on cash basis or finished goods are converted directly into cash. If sold on credit basis, the finished goods are replaced by debtors and conversion into cash is only on realization as per the terms of settlement between seller and buyer. This process is called Operating cycle. It is also called “working capital cycle”. In simple words, operating cycle is:

• Cash —Raw Material—Stock-in-Process—Finished goods—sales —Cash (Receivables). Duration of operating cycle is equal to the sum of the holding periods of all current assets forming part of the operating process.

• Duration of operating cycle normally depends upon order period for raw material, time taken during processing, time period for packing etc. and demand, supply and technology use.

• Current assets are those that can be converted into cash within 1 year and these include finished goods, cash, claims receivables in one year, etc.

• Current liabilities include liabilities that are payable within 1 year from the date of balance sheet, liabilities representing sources of funds etc.

• Gross Working Capital (GWC) means funds required to finance total current assets.

• Net Working Capital (NWC) means difference between current assets and current liabilities.

OVERDRAFT

• The main purpose of overdraft is to meet immediate needs or shortfall of funds with the borrower.

• Overdraft is a mode of finance where a borrower is

• Sanctioned a limit in his, say, current account, to draw as many times as required in a day but up to the limit sanctioned.

• It is a fluctuating account wherein the balance sometimes may be in credit or sometimes in debit.

• Normally drawings are permitted through cheques only except under very special circumstances where cash drawing is needed and allowed by bank.

• The security in an Overdraft account may be either personal or other tangible like insurance policies, fixed deposit receipts, shares and debentures, book debts etc.

• Overdrafts allowed are normally for short periods. Banks have the discretion either to allow or refuse overdraft facility.

• Banks go by past record of the borrower and only when satisfied about the need, repayment aspects and intention where money will be used etc. banks may allow overdraft facility.

CASH CREDIT

A cash credit is a drawing account against credit guaranteed by the bank and is operated in the same as overdraft account. The bank will sanction limit based on the working capital cycle of the business and the borrower has to operate within the limit so fixed. The balance outstanding in the account should be within the limit or drawing power. The drawing power means the value of securities less margin stipulated by the bank. The borrower can save interest by reducing the debit balance whenever he is in a position to do so. The borrower will provide securities as stipulated from time to time. Cash credits are generally allowed against pledge or hypothecation of goods or sometimes against book debts and / or bill purchase and discounting.

Cash credit as working capital is provided by the banks either on operating cycle basis, turnover method (recommended by Nayak Committee), or cash budget method.

First (operating cycle) and second (turnover method) methods are mostly used in India.

BILL FINANCE

• An entrepreneur may finance his trade through (a) long term loans, (b) cash credit, (c) bill discounting. Bill finance involves (i) purchase of bills, and (ii) discounting of bills.

• Bill finance through bill discounting system as compared to other modes has some advantages like (i) certainty of payment on due date, (ii) liquid assets can be easily discounted with banks, (iii) better control and better resource planning is possible, and (iv) easily identifiable transactions.

• Bill discounting system comprises of (i) clean bills, (ii) Documentary bills, (iii) bills drawn under credit.

• Bills basically means ‘Bills of Exchange’ as defined and governed by negotiable Instruments Act, 1881, section 5 which provides that bill is an instrument in writing containing an unconditional order signed by maker, directing a certain person to pay certain sum of money only to or to the order of a certain person or to the bearer of the instrument.

• Bill of exchange in International Trade acts as a means of collecting payments as well as receipt of payment, demanding payment, acts as a promise of payment like bills drawn on acceptance basis. It is means of extending credit, e.g. sight bill or tenor bills.

• Bill finance comes into play when sale is done on credit basis by the seller to borrowers. Otherwise borrowers i.e., sellers of the goods, who supply the goods on credit basis will have to wait for a specified period – say 3 months. This would help the borrower increase his business, as his working capital cycle is reduced. As the bank directly recovers the money advanced from the buyer of goods, bill finance is also known as self-liquidating finance.

• Bills are further classified as Sight bills and usance bills. Sight bills have to be paid by the purchaser of goods immediately sight bills are purchased.

• Usance bills are payable by the purchaser of goods after a specified period of time (say 3 months, etc). Usance bills are discounted. In the case of usance bills, bank will deduct the discount amount (say 20 or 25%) and pay the balance to the borrower and pay the discount amount on realization of the bill.

Essential feature of a bill that a banker normally sees when bill is presented to him are:
Essential details like date of instrument, place of payment, principal amount payable and interest payable as well as maturity of bill.
Dishonour of bill if unpaid on maturity.
Rate of interest applicable at the material time and payment of bill.
Validity, authentication of material alteration, if any and stamp duty payable has been properly paid.
• In bill purchased bank negotiates bills payable on demand, whether clean or documentary; bank pays the face value of the bill to the holder; bank after purchasing acts as a holder in due course of the bill and inherits all rights of the ownership.

• Crocka Bill: It is a bill of lading covering goods carried by road issued by sea carrier. Crock a bill of lading cannot be deemed as Ocean Bill of Lading.

LETTER OF CREDIT (L/CS)

LCs are the guarantee given by a bank to the seller of goods that on the due date he will receive the sale amount (LC amount). In this case, LC opening bank (i.e., buyer’s bank) will not provide any fund based facility to the buyer. LCs are issued for trade both within the country and for trade internationally. This chapter has been discussed earlier in detail.

BANK GUARANTEE

Banks issue guarantee on behalf of customers in favour of third parties undertaking to pay the guaranteed sum of money to the third parties (beneficiary) in the event of the (his) customer failing to perform the agreed obligations. Guarantees are classified as financial guarantee and performance guarantee. Performance guarantee is an undertaking by a bank that in the event of a failure by the applicant, the guarantor bank will complete the original contract. In India, however, performance guarantee (as also financial guarantee) will obligate the guaranteeing bank to pay the fixed amount only. Similar to LC, there is no fund based credit facility sanctioned.

DEFERRED PAYMENT GUARANTEE (DPG)

Deferred Payment Guarantee is a financial guarantee issued by banks that have a currency period in excess of twelve months. This type of guarantee is generally issued by banks in favour of importers who import raw materials and other store inventories, or plant and machinery from a foreign country. The payments to be made by the importers are made in installments. If any installment is defaulted or any terms of guarantee is violated, the guarantee is invoked.

BANK ADVANCES WHICH ARE SELF LIQUIDATING

Banks lend money against certain documents / securities in which case the loans are liquidated easily by the primary security at the time of maturity of the document or security or just after repayment period is over. These loans are provided against liquid securities or maturity period of the primary security whichever is earlier.

Some of the common self-liquidating loan schemes of banks are:

• Loan against Bank’s own Deposits- FDR.

• Loan against KVP/ NSC.

• Loan against LIC Policy.

Loans against Bank’s own FDR

• Bank can provide loan up to 90% of present value of its own deposits like FDR etc. for the period not exceeding the maturity date of the deposit. The facility can be provided in the form of Term Loan and Overdraft limit.

• Bank’s lien marked on the FDR.

• Interest rate charged by banks varies from bank to bank but normally it is 1-2% above the FDR rate. In some banks, lending against/ for third party deposit, ROI is 3% over the deposit rate.

Loans against NSC/KVP

• Banks provide loans against NSC and KVP as personal loans against deposit certificates. Bank can provide loan varying from 75% to 90% of face value of NSC/ KVP depending upon the age and maturity period of the security. The facility can be provided in the form of Term Loan and Overdraft limit.

• For security banks ask borrower to pledge the certificate in favour of the Bank.

• Rate of interest normally varies from bank to bank but usually is at bank’s PLR.

Personal Loans

A personal loan is a kind of unsecured loan which can be used for any purpose that the borrower deems necessary. An unsecured loan is an umbrella term used for loans which do not require collateral. Banks, credit unions, and other financial institutions offer personal loans on an ongoing basis.

There are two kinds of personal loans:

1. A secured loan sometimes called personal bad credit loans, which are typically offered toa person that has a lower credit score or a credit history that has a record of delinquent or missed payments. A secured personal loan needs some collateral, (like house or car), to recover some of the money lent in case of default in payments.

2. An unsecured loan is generally offered to people that the lender considers a low credit risk, meaning that they have a higher credit score, a long record of on time payments in their credit history, and make enough money to be able to pay the loan off easily.

IMPORTANT TERMINOLOGIES

Loan Proposal: It means a written request made by the prospective borrower to the bank for a credit facility. It is done on the bank’s application form. This request application is also called loan proposal or loan application.

Limit: The dictionary meaning of the word ‘limit’ is boundary or last line or point, which a person is required not to cross. In banking the word limit is used in case of Cash Credit / overdraft accounts and means the amount sanctioned by the bank. Limit before sanction can be of different types. These can be:

• Proposed limit

• Recommended limit

• Authorized limit or sanctioned limit or overall limit

• Sub-limit

• Drawing Limit

• All these words are used mainly in case of working capital advances (cc a/c or OD a/c)

Proposed limit: This is the amount which the borrower has requested the bank to sanction.

Recommended limit: This is the amount which the manager or bank recommends to the sanctioning authority for sanctioning.

Authorized limit: This is the amount that the sanctioning authority sanctions after going through the complete proposal. This amount is also called sanctioned limit.

Sub-limit: Sometimes borrower wants credit facility sanctioned as per his specific needs against bills, hypothecation, pledge etc. The overall (authorized limit) is then sub-divided into need based requirements of the borrower.

For example, a borrower requests for a credit facility for Rupees 3 lakh (proposed limit). The branch manager after calculating the needs recommends to the sanctioning authority an amount of Rupees 2.50 lakh (recommended limit). The sanctioning of the bank after critical appraisal sanctions 2.00 lakh rupees. (sanctioned or authorized limit). After sanctioning the overall limit (authorized limit), it is sub-divided into sub-limit based on borrower’s requirement. He may be allowed, say

Against pledge Rupees Rupees 60,000
Against hypothecation Rupees 75,000
Against bills Rupees 40,000,
Against book debts Rupees 25,000

This shows that despite sub-limits being sanctioned against various activities, overall amount drawn does not exceed Rupees 2 lakh. The interpretation of this is that borrower can draw money against pledge only up to Rs.60,000 and against hypothecation up to Rs.75,000 only. Drawings against bills and book debts is only up to 40,000 and 25,000 rupees respectively. Total debit balance should not exceed Rupees 2 lakh.

Drawing Power (DP): It means residual value of current assets minus margin. In other words it is value of security minus amount of margin.

Margin: It is the amount contributed by the borrower to run his business. It represents borrower’s risk involvement in the business.

Loan Syndication: Loan syndication means multiple banking, i.e. banking with more than one bank for meeting his business financial requirements. Here each bank makes its own independent evaluation of the borrower, project and offer credit. It is flexible and convenient approach for banks and borrower.

J.V. Shetty committee to review system of consortium lending, had suggested following methods alternative to consortium loans and advances.

• Inter-bank participation

• Commercial Paper

• Debentures and securitization of debts

• Syndication of Credit

RETAIL LENDING BY BANKS

Why Retail Lending by banks?

Banks are opting for more retail lending activities due to following various reasons:

• Increase in purchasing powers and desire to improve standard of living has led retail lending activities to grow.

• Consumer needs are ever changing resulting in more buying of consumer goods.

• Convenience of obtaining bank loans and easy operation of accounts due to technological improvements.

• Slow growth of Industrial sector has led banks see their slow credit off take thus, affecting its profit. Retail sector is a growing sector and hence bank’s natural option shall be retailsector.

• Loans to retail sector are safe and lending rates are competitive.

Need of Retail Lending

Further need of retail lending by banks arose because of the following factors:

• Retail is a developing market,

• It is assumed that retail market is assured market for doing business.

• Easy to handle and overhead costs being very less, it becomes a profitable venture.

• Competitive products are available off the shelf for consumers to choose from hence, no delays in decision making.

• Since it is a compact loan, supervision and monitoring is nominal. Loan is safe and NPAs level is less.

• It also adds to the diversification of bank’s credit portfolio thus providing a new growing channel of lending.

Drivers of Retail Lending

• More Income Tax Rebate in various categories of citizens has led to rising savings and thus giving higher disposable income in hand.

• Couples earning has led to more row of income and double income.

• Young generation makes a lot of change in the consumer behaviour. An estimate shows that 65% population in India is less than 35 yrs. of age.

• Government of India has taken many steps to allow people to buy homes through bank loans. For incentive purpose, government has allowed interest rebate up to Rupees 1.50 lakhs from 2015-16 financial year increasing the level from Rupees 1.00 lakh during 2014-15 F.Y.

• Alternate investment opportunity offering good return

• With increasing urbanization, consumerism concept is growing and hence providing a positive boost to retail sector.

Various Retail Lending Products

• Home Loans

• Vehicle Loans

• Consumer product loans

• Repair & maintenance of home loan

• Education loans

The RBI guidelines for Recovery Agents:

Banks and other financial institutions hire recovery agents in order to recover debts from clients on their behalf. These recovery agents are responsible for collecting outstanding payments from the bank’s customers. Recovery agents have been accused of using inappropriate measures to collect money from people. Their recovery practices have recently come under the scrutiny of the law and justice keepers in the country.

Arm-twisting tactics

The common notion is that recovery agents use threat or ‘goonda-gardi’ practices and harass clients to collect debts due. The RBI has recently issued draft guidelines that recovery agents and banks will have to abide by when collecting debts from their customers. The idea is to streamline the practices used by recovery agents and keep a tab on them.The gist of the guidelines

• Banks should approach Lok Adalats for small cases of outstanding consumer debts less than around $25,000 in the form of personal loans, credit card debts or other loans.

• Banks are responsible for the actions of the recovery agents. Hence banks have to ensure that the recovery agents they hire follow RBI guidelines and the rules of the Banking Codes and Standards Board of India throughout the recovery process.

• In cases where customers default on payments, banks are obligated to inform them about the details of recovery agents hired by the bank.

• The Indian Banks’ Association (IBA) and the Indian Institute of Banking & Finance (IIBF) should conduct training courses for recovery agents in order to educate them about the preferred recovery practices.

• Customers should not be harassed or abused during the recovery process. For example, customers may be contacted only on telephone numbers provided by them and not on any other number.

RBI will take strict action against banks not complying with these guidelines.

MICRO, SMALL AND MEDIUM ENTERPRISES

What is the meaning of Enterprises?

An “enterprises” means an Industrial undertaking or a business concern or any other establishment, by whatever name called, engaged in the manufacture or production of goods pertaining to any industry specified in the First Schedule to the Industries (Development and Regulation) Act 1951 or employing plant and machinery in the process of value addition to the final product having a distinct name or character or use or engaged in providing or rendering of any service or services.

Importance of MSME

• Most significant sector after Agriculture.Employs 60 million persons spread over 30 million enterprises. Creates one million jobs every year.

• Accounts for about 45% of the total industrial output.

• Contributes 40% of the total exports.

• 94.9% are Micro enterprises, 4.9% are small and only o.2% are medium enterprises.

Micro enterprises (Manufacturing)

• Enterprises engaged in the manufacture/ production, processing or preservation of goods and whose investment in Plant and Machinery (Original cost excluding Land and Building and the items specified by the Ministry of Small Scale Industries (vide its notification no. S.O.1722 (E) dated October 5, 2006) does not exceed Rs. 25 lakhs.

Micro Enterprises (Service)

(i) Enterprises engaged in the providing / rendering of services and whose investment in Equipment (Original cost excluding Land and building and furniture, fittings and other not directly related to the service rendered or as may be under the Micro, Small and Medium Enterprises Development, Act 2006) does not exceed Rs.10 lakhs.

(ii) The Micro Enterprises (Service) shall include Small Road & Water Transport Operator (SRWTO), Professional and Self Employed (PSEP), Small Business, Retail Trade and all other service enterprises whose investment in equipment does not exceed Rs.10 lakhs.

Small Enterprises (manufacturing)

• Enterprises engaged in the manufacture/ production, processing or preservation of goods and whose investment in Plant and Machinery (Original cost excluding Land and building and the items specified by the Ministry of Small Scale Industries vide its notification no. S.O.1722 (E) dated October 5, 2006) is above Rs.25 lakhs to Rs.5 crore.

Small Enterprises (Service)

• Enterprises engaged in providing /rendering of services and whose investment in Equipment (Original cost excluding Land and building and furniture, fittings and such items as per 1.2.2.) is above Rs.10 lakhs to Rs.2 crore.

• The Small Enterprises (Service) shall include Small Road & Water Transport Operator (SRWTO), Professional and Self Employed (PSEP), Small Business, Retail Trade and all other service enterprises, whose investment in equipment is above Rs.10 lakhs to Rs.2 crore.

Medium enterprises (Manufacturing)

Enterprises engaged in the manufacture/ production, processing or preservation of goods and whose investment in Plant and Machinery Original cost excluding Land and building and the items specified by the Ministry of Small Scale Industries vide its notification no. S.O.1722 (E) dated October 5, 2006) is more than Rs.5 crore but does not exceed Rs.10 crore.

Medium Enterprises (Service)

• Enterprises engaged in providing/rendering of services and whose investment in Equipment (Original cost excluding Land and building and furniture, fittings and such items as per 1.2.2.) is more than Rs.2 crore but does not exceed Rs.5 crore.

• The Medium Enterprises (Service) shall include Small Road and Water Transport Operator (SRWTO), Professional and Self Employed (PSEP), Business and all other service enterprises, whose investment in equipment is above Rs.2 crore to Rs.5 crore.

Classification of MSME

• The Micro and Small Enterprises (manufacturing and service) will be classified under Priority Sector irrespective of whether the borrowing entity is engaged in export or otherwise.

Acknowledgement

• Each branch will issue an acknowledgement for loan applications received from the borrowers towards financing under this sector and maintain the record of the same.

Disposal of Applications

• In case of Loans up to Rs.25000/- : Within 2 weeks

• In case of Loans above Rs.25000/- : Within 4 Weeks

(Provided the loan applications are complete in all respects and accompanied by a ‘check list’ enclosed to the application form).

CREDIT GUARANTEE TRUST FOR MSME (CGTMSE)

The Government of India and SIDBI created CGTMSE for helping banks to help small enterprises which are unable to give security to the Banks and are denied loans. The Trust guarantees certain amount of loan if given as per the terms laid down by the Trust. Banks also need not take any security as per the CGTMSE scheme.

• Main contributors to the capital corpus of CGTMSE are Government of India and Small Industrial Development Bank of India (SIDBI).

Eligible Borrowers

• New and existing Micro and Small Enterprises engaged in manufacturing or service activity excluding ‘Retail Trade’.

• As of now, all activities that come under service sector as per RBI’s guidelines on ‘Lending to Priority Sector’ and MSMED Act, 2006 except retail trade are eligible for coverage under the scheme.

Whether loans given to Small Road Transport Operators are eligible for coverage under the Scheme?

• Yes. Small road and water transport loans are eligible for guarantee cover.

• Under the Guarantee Scheme, a borrower is required to obtain IT PAN number prior to availing of credit facility from the eligible lending institution. Also it is a mandatory requirement under section 139A(5) read with section 272(C) of the I.T Act 1961 to indicate IT PAN on all tax documents which include returns, challans, appeals, etc.

• However, in respect of loans up to Rs. 10 lakh, CGTMSE is presently not insisting that the IT PAN be obtained at the time of availing of the guarantee cover. IT Pan No. is to be indicated in respect of credit facility above Rs.10 lakh.

What Guarantee Fee required to be paid

• 1.50% of the total limit sanctioned, maximum to Rs 100 lakhs (0.75% in case of North Eastern Region including state of Sikkim & Jammu and Kashmir )

Annual Fee

• 0.75% of the total amount outstanding as on 31st of March of the preceding financial year.

Whether the rates of guarantee fee and annual service fee can be varied after the commencement of guarantee cover?

• Guarantee fee will not be changed with retrospective effect.

• Since the guarantee fee is payable only once at the time of seeking guarantee cover, so any change in rate will have only prospective effect on the future proposals to be covered under the Scheme.

• As regards Annual Service Fee,it is payable on the guaranteed credit facilities as on March 31, the prevailing rate at that time will apply.

THIRD PARTY PRODUCTS (TPP)

Why TPP?

It is non-fund business for banks and is very lucrative business without lending any funds. Bank’s profit normally is based on net interest margin. Due to squeezing of interest rates and higher cost of products, manpower, infrastructure and competitive scenario, burden on banks has increased and spread reduced. Net Interest Margin has been reduced considerably.This factor worried the banks and they looked for non-fund based business in TPP.

Advantages of TPP to Banks

• Immediate Return

• No risk of N P A or loss due to frauds

• Bulk business

• Good publicity

• Cross selling of bank’s products

• Access to new market potential

• Reach to new business

Therefore the banks have targeted their focus on sell of Third Party Products with following points in their minds.

• Hassle free

• Low cost

• High profit (comm./brokerages)

• Easy marketing

• No follow up

• No Risk Involved

BANC ASSURANCE

What is Bank Assurance?

Fully exploiting the synergies between banking and insurance, so as to manufacture and distribute cost effective banking and insurance products to a common customer base. In simple words banc assurance is a linkage of insurance and bank products and distribution channel.

Why Banc Assurance?

Major reasons why banks should go for bank assurance are:

Falling interest rates, reducing spreads and stiff competition.
Alternative avenues of fee-based income for banks.
Insurance business in India accounts for a mere around 3% of GDP and as such bright chance of expansion of business of insurance through alternative channels like banks.
Provides under one roof all banking and insurance product / services and promotes insurance linked banking products / services.
• Banks act as Corporate agents of Insurance Companies under the Amended Corporate Agents Act.

To promote bank assurance business, banks may look into the following promotional aspects:

Bank assurance should play proactive role in properity of Insurance industry.
Bank should promote more product / services linked with insurance.
Bank assurance should develop brand image to stand tall.
Bank assurance model available in the market are:

Referral Model
Deposit linked Insurance Schemes
Corporate Agency Model
Referral Model of bank assurance means:

Bank will identify customers interested in insurance products whose names will be referred to Insurance company.
Insurance company sends its representative to customers for sales.
Deposit linked Insurance Schemes Models means:

Deposit schemes are insurance linked through group insurance.
Special deposit schemes are promoted.
Nominal premium is charged from customers on special deposits-insurance linked schemes.
Salient features of Corporate Agency Model are:

Popular model having more involvement of banks.
Banks appoint specially licensed insurance trained executives/managers to meet customers and sell bank assurance products / services.
Licensed executives / managers provide single window service for all the insurance requirements.
Following are the benefits of bank assurance to the banks:

It offers fee based non-interest income to banks which does not require banks to maintain capital adequacy ratio on commission business. Bank’s comfort level is improved.
Bank assurance increases non-interest income which helps to increase total income without necessitating increase in capital or total assets. Thus balance sheet of banks improves by improved returns on assets and return on equity.
Surplus manpower can be used for marketing of bank and banc assurance products without additional cost and efforts.
Loan linked assurance products like most priority sector loans and others like home loans, vehicle loans, etc. can be marketed by banks through banc assurance and get commission.

SECURITIES FOR BANK LOANS:MODES

• Hypothecation: Banker has right over goods but physical possession of goods is not with him, e.g. Car Loan, Vehicle loan, CC Limit, Book Debts, Stock / Inventory. Hypothecation creates a transfer of interest in favour of hypothecate (Bank). It creates a charge in or upon any movable property, existing or future, created by the borrower in favour of secured creditor (Bank) without delivery of possession. The charge is floating charge and crystallizes at the time of maturity.

• Pledge: Banker has right over goods as well as their physical possession. In case of non-payment, Bank has the right to sell. e.g. marketable securities like shares, Gold. Section 172 of the Indian Contract Act, 1872 defines pledge as bailment of goods as security for a debt or performance of a promise.

• Mortgage: When an immovable property, the security is created by way of Mortgage; e.g. for Home Loan, Loan against Property.

• Lien: It is a charge on the specific asset (Specific Lien) or general assets (General Lien) of the borrower. It is a creation of right in favour of the lender for payment of dues.

PRIME LENDING RATE (PLR)

• After the deregulation of interest rate structure with regards to banking operations by banks, the concept of creating bank’s own bench mark lending rate arose. There as a result of this banks started fixing their bench mark rate of interest which was called Prime Lending Rates. It is a rate at which banks would lend to their prime customers.

• As a general practice, banks mark up (add) 2.5 to 3.5% on the PLR to make it as commercial rate of lending to the customers of various credit rating.