Credit Appraisal is a knack of adapting certain precautions at the time of new sanction or renewal or enhancement of existing limit. Credit Appraisal revolves around the credit investigation to determine the economic and business environment in which prospective borrower is placed. The process involves assessment of honesty and integrity of the borrower, standing of the borrower, business capacity, experience in their line of business, managerial competence, financial resources in relation to size of the project.
Now let us look into simple 5 steps of credit appraisal.
Step 1: As a first step of appraisal, the work place of prospective borrower to be inspected by the Manager. From his visit to the factory or business place and residence of the borrower (in the cases of retail loans), Manager gets first hand idea of the business environment, technical, economic and financial viability of the proposition placed before the bank. Further it helps the Manager to familiarize himself the borrower’s business and attendant trade practices. The experienced bankers have the knack of measuring and ascertaining the standing of the borrower, his business capacity, experience in the line of business, managerial competence actual financial need of the borrower during his visit. He may also notice other adverse features or drawbacks in the project and may raise the relevant queries with regard to the project .The Manger has to be alert all the time and has to be diplomatic and tactful in raising queries. Loans are not sanctioned to any party unless the bank is satisfied with the replies received from the prospective borrowers.
Step 2: In addition to unit inspection, Bank Manager needs to conduct credit investigation of the prospective borrower. Credit investigation means, ascertaining the business reputation and creditworthiness of the borrower and guarantors. The sources of information available for credit investigation may be broadly classified as internal and external. Information available within the bank such as, length of the customer’s association with the bank, past history and conduct of current account, current or previous borrowing details and rating awarded to the account, deposit connection, Value and liquidity position of the security offered to the proposed loan etc. are internal sources of information. Experience with regard to dealings of the borrower with reference to co-operation extended in documentation and payment records of past and present obligations are quite useful in taking credit decisions.
Step 3: Information may be tapped from external sources like meetings with the borrower, present and past employees of the borrower, from third parties where references are given by the borrower. Information received during participation in informal and social get together or market gossip may be counter checked and make the record of it. Reports obtained from other banks and credit institutions, credit rating agencies, credit investigating entities like Dun and Bradstreet, CIBIL report on borrower or individuals behind the borrower company and guarantors to the loan, search report collected from ROC, report from CERSAI are import sources of credit investigations. News about the borrower or individuals behind Borrower’s Company published in newspapers and periodicals may alert the bankers..
Step 4: Analysis of financial statements for identifying the financial strength and weakness of a business establishment. It shows how the capital is distributed, how much of investment is identified with various accounts. The business trend can be examined by comparisons of various items in series of balance sheets that show changes in those items either increasing or decreasing. The successive increase of proportionate receivables to sales indicates that the company is relaxed period of credit to the customers.
Step 5: Along with appraisal of financial papers, the credit officer of the bank needs to examine the following non- financial papers while taking credit decisions.
(i).Individuals: In case of employed persons, normally loan will be considered only to confirmed employees. Employer’s no objection certificate/salary certificates are other requirements for retail loans. In case of self-employed, IT return for past 2-3 years would be verified to assess the repayment capacity of the applicant. No due certificate from existing banker, CIBIL report of the applicant (for a very small loan it is not necessary) will be verified. Proof of Residence like voter card/Telephone bill, Electricity Bills, Registered lease deed, Sale agreement etc. will be verified before entertaining borrower’s request for facility. In case, the applicant is operating his/her account with other banks, SB pass book and original statement of account is verified.
(ii). Sole Proprietor: Banks examine certified business account statement, Income Tax and Sales Tax Assessment Orders, VAT turnover statement, orders copy and other related papers. CIBIL report of the proprietor and the firm will be examined. The property offered as a security will be inspected and related documents are verified. No due certificate from existing banker, CIBIL report of the proprietor will be examined. Proof of residence like voter card/Telephone bill, Electricity Bills, Registered lease deed, Sale agreement etc. will be verified before entertaining borrower’s request for facility. In case, the applicant is operating his/her account with other banks, SB pass book and Current account original statement is verified. Property offered as security will be inspected and title records of security offered are investigated.
(iii). Partnership firms: Banks examine Partnership Deed, Certified statement of Accounts, copies of Income Tax assessments, wealth tax Assessment and Sales Tax assessments orders, VAT turnover statement for the reporting year etc. Reports obtained from CIBIL on partners and the firm will be verified. No due certificate from existing banker, proof of residence like voter card/Telephone bill, Electricity Bills, Registered lease deed, Sale agreement etc. will be verified before entertaining borrower’s request for facility. In case, the applicant is operating his/her account with other banks, Original statement of account is verified. Property offered as security will be inspected and title records of security offered are investigated.
(iv).Trust Accounts: Registered Trust Deed, profiles of the Trustees is examined by the bank before considering the loan proposal. The purpose and provisions to raise loans must be incorporated in the Trust deed. Financing bank would go through the trust deed to confirm who are the authorized person/ signatory to the loan documents to be executed. In case, the applicant is operating his/her account with other banks, Original statement of account is verified. Copy of Resolution passed CIBIL report of the trustees and the trust and also property offered as security will be inspected and title records of security offered are investigated.
(v). HUFs: Bank would first ascertain whether Karta or the Manager (major co-parceners, authorized by the Karta) of HUF, can create a charge against the joint family property for the loan availed. Banks should be cautious while considering a credit request from a HUF, as it is a legal necessity to prove that the loan for which the charge is created, is taken for a purpose necessary or beneficial to the family. The onus of proving, the purpose for which loan is taken, lies on the financer. The financer should keep a record that he made reasonable inquiries and he was satisfied that the loan is availed for the benefit of joint family, CIBIL report of the Karta and all major co-parceners of the joint family. Original statement of account is verified. Property offered as security will be inspected and title records of security offered are investigated.
(v). Clubs, Societies, and Associations: Registered Bye-laws of the Society/Association/club, Copy of resolution passed in the AGM to authorize managing committee to avail loan and pledge or mortgage the assets of the club or society or association as a security to the bank. Profile of Office bearers and CIBIL report on them will be called for. Banks also verify whether the purpose and provisions to raise loans is incorporated in the bye-laws of the entities and who are the authorized person/ Signatory to the Documents, Legal Opinion on creation of charge on assets of the clubs/association/society would be obtained. The property would be inspected by the bank officials.
(vi).Private Limited and Public Limited Companies: Certificate of Incorporation, Memorandum of Association, Articles of Association, Certificate for commencement of Business (for public limited companies), List of Directors, Share Holding pattern, Power of directors, common seal, Securities for Bank Advances, CIBIL report of the directors and the company, Search report of the company from the ROC to be verified by the bank to ensure that there is no prior charge on the assets to be offered to the bank as a security. Profile of directors of the company and CIBIL report on them will be called for. Banks also verify whether the purpose and provisions to raise loans is incorporated in the memorandum of the company and find out is the authorized person/ Signatory to the Documents, Legal Opinion on creation of charge on assets of the company would be obtained. The property of the company to be mortgaged to bank and factory and work place of the company should be inspected by the Bank Manager before evincing interest in credit proposal of the company. Public Sector Undertakings: The general documents/papers for loans, processed by banks for Public sector are as in case of PSUs. The bank may explore the possibilities of getting guarantee from the State or Central Governments for the advance made by the bank.
(vii). Consortium advances: A group of two or more banks join together and sharing the advance of large size loans to a borrower by means of an inter se (pari passu) agreement. Consortium lending helps banks in Joint appraisal of the project by different banks which will facilitate for exchange of valuable information among the Banks. It also helps the Banks to keep their exposure to the borrower within the desired limit and reduce the credit risk. Normally the bank with higher percentage of lending will lead the consortium completes joint documentation for total advance by all the members of consortium.