Ashwin Menon K.P

RISK MANAGEMENT IN MSME FINANCING
REPORT ON A Study on Risk Management in MSME Financing at Union Bank of India
Project Report Submitted to Christ University Institute of Management, Bangalore

In partial fulfillment of the requirement for the award Of MASTERS DEGREE IN BUSINESS ADMINISTRATION
By
ASHWIN MENON K.P
(Reg no.1020209) Under the guidance of Faculty Guide Prof.Anand Aivalli Dept. of MBA, Christ University, Bangalore. Company Guide Mr. Suresh Kumar Senior Manager Union Bank of India
CHRIST UNIVERSITY INSTITUTE OF MANAGEMENT BANGALORE -560 029

1|Page
DECLARATION
I, Ashwin Menon K.P ,hereby declare that the project report titled A Study on Risk Management in MSME financing at Union Bank of India submitted for the partial
fulfillment of the requirements for the award of Master of Business Administration is my original project work and has been carried out under the guidance of Prof.. Anand Aivalli, Faculty Guide, Christ University Institute of Management, Bangalore and Mr. Suresh Kumar , Senior Manager, at Union Bank of India, Calicut.
Place Date:
Ashwin Menon K.P 1020209 CUIM, Bangalore
2|Page
CERTIFICATE
This is to certify that the Summer Internship Project work titled A Study on Risk Management in MSME Financing at Union Bank of India is a bonafide record of research work done by Mr Ashwin Menon K.P bearing Reg. No 1020209 under the guidance of Prof. Anand Aivalli for the partial fulfilment of the course of Masters in Business Administration (Finance) from Christ University Institute of Management, Bangalore.
Place: Bangalore Date:
Prof. Anand Aivalli (Faculty Guide, CUIM)
Prof. Dr Jeevananda S Campus Co-ordinator CUIM
3|Page
ACKNOWLEDGEMENT
The successful completion of this project has been the result of the help extended to me by a number of people; hence I would like to place on record my acknowledgement. First of all I would like to thank Lord Almighty giving me the strength and wisdom to complete this project successfully. I extend my heartfelt gratitude to my project guide, Prof.Anand Aivalli, Faculty Guide, Christ University Institute of Management for his immense help, timely guidance, unstrained attention and inspiration at all stages to make this project successful. I also express gratitude to my company guide Mr.Suresh Kumar, Senior Manager, Union Bank of India and the staff for their invaluable suggestions and encouragement. I thank my friends for having encouraged me in one way or the other in the successful completion of this work. Without the constant encouragement, support and prayers of my parents, this work would not have been a reality.
4|Page
TABLE OF CONTENTS
CHAPTER TITLE PAGE NO.
Chapter I
1.1- INRTRODUCTION 1.2 - INDUSTRY PROFILE
8-25 26-29
Chapter II Chapter III
RESEARCH DESIGN
30-33
COMPANY PROFILE
34-44
Chapter IV
RISK MANAGEMENT OF MSME AT UBI ANALYSIS & INTERPRETATION
45-61
Chapter V
62-88
Chapter VI
FINDINGS, SUGGESTIONS AND CONCLUSION
89-93
BIBLIOGRAPHY
94
5|Page
LIST OF CHARTS
Chart No
TITLE
1. 2 Chart showing growth in MSME business for the last 5 years Chart showing distribution of SME business under Kozhikode Region
Chart showing the Growth in Advances of the Bank
Chart showing percentage of MSME on total advances
Chart showing percentage of NPA on Net Advances
Chart showing percentage of Capital Adequacy Ratio
7.
Chart showing growth in Net interest income of bank
Chart showing the change in Current Ratio 8
9.
Chart showing the change in Debt Equity Ratio
6|Page
10.
Chart showing change net construction receipts of the company
11.
Chart showing Net profit of the company
7|Page
Executive Summary
Micro, Small and Medium enterprises play a very crucial role in the development of the Indian industrial sector. Banks are giving higher priority for MSMEs and are provided with adequate funds and finance for the purpose of its development. The importance of providing sustainable development for this sector is of one of the major priorities of bank. The advances of Banks mainly comprises of financing of MSMEs and as a result banks are required to control and manage risk in its financing.
This study mainly focus the area of risk management in SME financing which the banks are now trying to segregate from its overall risk management architecture. Banks are required to assess the risk involved in proposals of SMEs on the basis of financial, market, industrial and other business considerations based on which the proposal is rated and ranked according to its risk potential. They will primarily try to reduce this risk through an effective risk management system and thereby making the accounts live for the benefit of the bank.
8|Page
CHAPTER 1
INTRODUCTION
9|Page
1.1 INTRODUCTION
INDIAN SME SECTOR

In India, the enterprises have been classified broadly into two categories: (i) Manufacturing; and (ii) Those engaged in providing/rendering of services. Both categories of enterprises have been further classified into micro, small and medium enterprises basedon their investment in plant and machinery (for manufacturing enterprises) or on equipment (in case ofenterprises providing or rendering services). The present ceiling on investment to be classified as micro, small or medium enterprises is as under:
Classification
Investment Ceiling for Plant, Machinery or Equipments*@ Manufacturing Enterprises Service Enterprises
Micro Small
Medium
Upto Rs.25 lakh ($50 thousand) Above Rs.25 lakh ($50 thousand) &upto Rs.5 crore ($1 million) Above Rs.5 crore ($1 million) &upto Rs.10 crore ($2 million)
Above Rs.10 lakh ($20 thousand) Above Rs.10 lakh ($20 thousand) &upto Rs.2 crore ($0.40 million) Above Rs.2 crore ($0.40 million) & upto Rs.5 crore ($1 million
These enterprises can be rightly called as the backbone of the GDP of India. The SME sector in India is growing at an exceptionally fast rate due to which it is proving to be beneficial to the
10 | P a g e
Indian Economy. The current figures and statistics shows how important are this sector to the overall growth of the Indian economy.The contribution of the SME sector to the entire output of the country is 40 %. Currently, there are over 11 million SME units in India that produces more than 8000 products. 90 % of the Industrial Units in India belong to the SME sector.These SME units contribute 35 % to the Indian Industrial Export. The Indian economy is firmly on a recovery path. Exports have been expanding since 2009, a trend that is expected to continue. The industrial sector recovery is increasingly becoming broad based and is expected to take firmer hold going forward on the back of rising domestic and external demand. According to the Reserve Banks quarterly industrial outlook survey, although the business expectation index(BEI) shows seasonal moderation from 120.6 in Q4 of 2009-10 to 119.8 in QI of 2010 -11, it was much higher in comparison with the level of 96.4 a year ago. The improved performance in the industrial sector is also reflected in the improved profitability in the corporate and sme sector.
PRESENT POLICY FRAMEWORKS AND FOCUS AREAS

P Micro, Small and Medium Enterprises Development Act, 2006
The Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 seeks to facilitate the development of these enterprises as also enhance their competitiveness. It provides the firstever legal framework for recognition of the concept of enterprise which comprises both manufacturing and service entities. It defines medium enterprises for the first time and seeks to integrate the three tiers of these enterprises, namely, micro, small and medium. The Act also provides for a statutory consultative mechanism at the national level with balanced representation of all sections of stakeholders, particularly the three classes of enterprises; and with a wide range of advisory functions. Establishment of specific Funds for the promotion, development and enhancing competitiveness of these enterprises, notification of
schemes/programmes for this purpose, progressive credit policies and practices, preference inGovernment procurement to products and services of the micro and small enterprises, more effective mechanisms for mitigating the problems of delayed payments to micro and small
11 | P a g e
enterprises and assurance of a scheme for easing the closure of business by these enterprises are some of the other features of the Act.
Foreign Direct Investment (FDI) Policy
With the promulgation of the MSMED Act, 2006, the restrictive 24% ceiling prescribed for equity holding by industrial undertakings, whether domestic or foreign, in the MSEs has been done away with and MSEs are defined solely on the basis of investment in plant and machinery (manufacturing enterprises) and equipment (service enterprises). Thus, the present policy on FDI in MSE permits FDI subject only to the sectoral equity caps, entry routesand other relevant sectoral regulations.
Credit/Finance Credit is one of the critical inputs for the promotion and development of the micro and small enterprises. Some of the features of existing credit policy for the MSEs are:
Priority Sector Lending
Credit to the MSEs is part of the Priority Sector Lending
Policy of the banks. For the public and private sector banks, 40% of the net bank credit (NBC) is earmarked for the Priority Sector. For the foreign banks, however, 32% of the NBC is earmarked for the Priority Sector, of which 10% is earmarked for the MSE sector. Any shortfall in such lending by the foreign banks has to be deposited in the Small Enterprise Development Fund (SEDF) to be set up by the Small Industries Development Bank of India (SIDBI).F Institutional Arrangement - The SIDBI is the principal financial institution for promotion, financing and development of the MSE sector. Apart from extending financial assistance to the sector, it coordinates the functions of institutions engaged in similar activities. SIDBI's major operations are in the areas of : (i) refinance assistance (ii) direct lending, and (iii) development and support services. Commercial banks are important channels of
12 | P a g e
credit dispensation to the sector and play a pivotal role in financing the working capital requirements, besides providing term loans (in the form of composite loans). At the State level, State Financial Corporations (SFCs) and twin-functional State Industrial Development Corporations (SIDCs) are the main sources of long-term finance for the MSE sector.
To ensure betterflow of credit to MSEs, the Ministry of MSME is also implementing the following major schemes: AS
Credit Guarantee Scheme

To ensure better flow of credit to micro and small enterprises by minimizing the risk perception of banks/financial institutions in lending without collateral security, the Government launched Credit Guarantee Fund Scheme for Micro and Small Enterprises in August 2000. The scheme covers collateralfree credit facility extended by eligible lending institutions to new and existing micro and small enterprises for loans up to Rs.100 lakh ($250,000) per borrowing unit. The guarantee cover is up to 75 per cent of the credit sanctioned [85% in respect of loans up to Rs.5 lakh ($12,500) and 80% for loans provided to MSEs owned/operated by women and all loans in the North-East Region].PRE
Performance & Credit Rating Scheme The Performance & Credit Rating Scheme for manufacturing MSEs was launched in April, 2005 with the objective of assisting the MSEs in obtaining performance-cum-credit rating which would help them in improving performance and also accessing bank credit on better terms if the rating is high. Under the scheme (implemented by the National Small Industries Corporation in conjunction with reputed rating agencies), 75% of the fee charged by the rating agency is reimbursed by the Government subject to a maximum of Rs.40,000 ($1,000).
13 | P a g e
RISK MANAGEMENT IN BANKS
Emergence of Risk management in Banks
The banking environment consists of numerous risks that can impinge upon the profitability of the banks. These multiple sources of risk give rise to a range of different issues. In an environment where the aspect of the quantitative management of risks has become a major banking function, it is of lesser importance to speak of the generic concepts. The different types of risks needs to be carefully defined and such definitions provide a first basis for measuring risks on which the risk management can be implemented. There have been a number of factors that can be attributed to the stabilization of the banking environment in nineties. Prior to that period, the industry was heavily regulated. Commercial banking operations were basically restricted towards collecting resources and lending operations. The regulators were concerned by the safety of the industry and the control of its money creation power. The rules limited the scope of the operations of the various credit institutions and limited their risks as well. It was only during the nineties that banks experienced the first drastic waves of change in the industry. Among the main driving forces that played a crucial role in the changes were the inflating role of the financial markets, deregulation of the banking sector and the increase in the competition among the existing and emerging banks. On the foreign exchanges front, the floating exchanges rates accelerated the growth of uncertainty. Monetary policies favouring high levels of interest rates and stimulating their intermediation was by far the major channel of financing the economy, disintermediation increased at an accelerated pace. Those changes turned into new opportunities and threats for the players. These waves of changes generated risks. Risks increased because of new competition, product innovations, the shift from commercial banking to capital markets increased market volatility and the disappearance of old barriers which limited the scope of operations for the various financial institutions. There was a total and radical change in the banking industry. Here it is
14 | P a g e
worth mentioning that this process has been a continuous one and has taken place in an orderly manner. Thus it is no surprise that risk management emerged strongly at the time of these waves of transformation in the banking sector. Banks Risks As stated, risks are usually defined by the adverse impact on profitability of several distinct sources of uncertainty. Risk measurement requires that both the uncertainty and its potential adverse effect on profitability be addressed. Let us now try to focus on the risk framework purely from the perspective of a bank Risk Framework The various risks associated with the banking may be defined as below and these definitions have the advantage of being readily recognizable to bankers. i)Credit Risk: Risk of loss to the bank as a result of a default by an obligatory. (ii) Solvancy Risk: Risk of total financial failure of a bank due to its chronic inability to meet obligations. (iii) Liquidity Risk : the risk arising out of a banks inability to meet the repayment requirements. (iv) Interest Rate Risk : Volatility in operation of net interest income, or the present values of a portfolio, to changes in interest rates. (v) Price Risks: Risk of loss/gain in the value of assets, liabilities or derivative due to market price changes, notably volatility in exchange rate and share price movements. (vi) Operational Risk : Risks arising from out of failures in operations, supporting systems, human error, omissions, design fault, business interruption, frauds, sabotage, natural disaster etc.
15 | P a g e
Credit Risk: Credit risk with respect to bank is most simply defined as the risk of a borrowers payment default on payment of interest and principal due to the borrowers unwillingness or inability to service the debt. The higher the credit risk an institution is exposed to, the greater the losses may be. For banks and most other credit institutions, credit risk is considered to be the form of risk that can most significantly diminish earnings and financial strength. The effective management of credit risk is a critical component of acomprehensive approach to risk management and essential to the long-term success ofany banking organization. Banks should also consider the relationships between creditrisk and other risks. Need to Manage Credit Risk For most banks loans are the largest and most obvious source of credit risk; Loans and advances constitute almost sixty per cent of the assets side of the balance sheet of any bank. As long as the borrower pays the interest and the principal on the due dates, a loan will be a performing asset. The problem however arises once the payments are delayed or defaulted and such situations are very common occurrences in any bank. Delays/defaults in payments affect the cash forecasts made by the bank and further result in a changed risk profile, as the bank will now have to face an enhanced interest rate risk, liquidity risk and credit risk. Banks are increasingly facing credit risk in various financial instruments other than loans, which include interbank transactions, trade financing, foreign exchange transactions, financial futures, swaps, bonds, equities, options, and in the extension of commitments and guarantees, and the settlement of transactions. Importance of Credit Risk Assessment Effective credit risk assessment and loan accounting practices should be performed in a systematic way and in accordance with established policies and procedures. To be able toprudently value loans and to determine appropriate loan provisions, it is particularly important that banks have a system in place to reliably classify loans on the basis of credit risk. Larger loans should be classified on the basis of a credit risk grading system. Other, smaller loans, may be classified on the basis of either a credit risk grading system or payment delinquency status. Both accounting frameworks and Basel II recognize loan classification systems as tools in
16 | P a g e
accurately assessing the full range of credit risk. Further, Basel II and accounting frameworks both recognise that all credit classifications, not only that reflecting severe credit deterioration, should be considered in assessing probability of default and loan impairment. A well-structured loan grading system is an important tool in differentiating the degree of credit risk in the various credit exposures of a bank. This allows a more accurate determination of the overall characteristics of the loan portfolio, probability of default and ultimately the adequacy of provisions for loan losses. In describing a loan grading system, a bank should address the definitions of each loan grade and the delineation of responsibilities for the design, implementation, operation and performance of a loan grading system.
Credit risk grading processes typically take into account a borrowers current financial condition and paying capacity, the current value and reliability of collateral and other borrower and facility specific characteristics that affect the prospects for collection of principal and interest. Because these characteristics are not used solely for one purpose(e.g. credit risk or financial reporting), a bank may assign a single credit risk grade to a loan regardless of the purpose for which the grading is used. Both Basel II and accounting frameworks recognise the use of internal (or external) credit risk grading processes in determining groups of loans that would be collectively assessed for loan loss measurement. Thus, a bank may make a single determination of groups of loans for collective assessment under both Basel II and the applicable accounting framework. Credit Rating is the main tool to assess credit risk, which helps in measuring the credit risk and facilitates the pricing of the account. It gives the vital indications of weaknesses in the account. It also triggers portfolio management at the corporate level. Therefore, banks should realize the importance of developing and implementing effective internal credit risk management. It involves evaluating and assessing an institutions risk management, capital adequacy ,and asset quality. Risk ratings should be reviewed and updated whenever relevant new information is received. All credits should receive a periodic formal review (e.g. at least annually) to reasonably assure that credit risk grades are accurate and up-to-date. Credit risk grades for individually
17 | P a g e
assessed loans that are either large, complex, higher risk or problem credits should be reviewed more frequently. To ensure the proper administration of their various credit risk-bearing portfolios the banks must have the following: a. A system for monitoring the condition of individual credits, and determining the adequacy of provisions and reserves, b. An internal risk rating system in managing credit risk. The rating system should be consistent with the nature, size and complexity of a banks activities, c. Information systems and analytical techniques that enable the management to measure the credit risk inherent in all on- and off-balance sheet activities. The management information system should provide adequate information on the composition of the credit portfolio, including identification of any concentrations of risk, d. A system for monitoring the overall composition and quality of credit portfolio. In addition while approving loans, due consideration should be given to the integrity and reputation of the borrower or counterparty as well as their legal capacity to assume the liability. Once credit-granting criteria are established, it is essential for the bank to ensure that the information it receives is sufficient to make proper credit-granting decisions. This information will also serve as the basis for rating the credit under the banks internal rating system. Internal credit risk ratings are used by banks to identify gradations in credit risk among their business loans. For larger institutions, the number and geographic dispersion of their borrowers makes it increasingly difficult to manage their loan portfolio simply by remaining closely attuned to the performance of each borrower. To control credit risk, it is important to identify its gradations among business loans, and assign internal credit risk ratings to loans that correspond to these gradations. The use of such an internal rating process is appropriate and indeed necessary for sound risk management at large institutions. The long-term goal of this analysis is to encourage broader adoption of sound practices in the use of such ratings and to promote further innovation and enhancement by the industry in this area.
18 | P a g e
Internal rating systems are primarily used to determine approval requirements and identify problem loans, while on the other end they are an integral element of credit portfolio monitoring and management, capital allocation, pricing of credit, profitability analysis, and detailed analysis to support loan loss reserving. Internal rating systems being used for the former purposes. As with all material bank activities, as sound risk management process should adequately illuminate the risks being taken and apply appropriate control allow the institution to balance risks against returns and the institutions overall appetite for risk, giving due consideration to the uncertainties faced by lenders and the long-term viability of the bank. Based on the historical data which is both financial and non-financial a score is arrived at.The borrower is then classified into different classes of credit rating based on the score which is used to determine the rate of interest to be charged. The borrowers credit rating method used above is only one such model. Based on the information available, a detailed and more comprehensive model can be developed by banks. Banking organizations should have strong risk rating systems. These systems should take proper account of the gradations in risk and overall composition of portfolios in originating new loans, assessing overall portfolio risks and concentrations, and reporting on risk profiles to directors and management. Moreover, such rating systems also shouldplay an important role in establishing an appropriate level for the allowance for loan and lease losses, conducting internal bank analysis of loan and relationship profitability, assessing capital adequacy, and possibly performance-based compensation. Credit risk ratings are designed to reflect the quality of a loan or other credit exposure, and thus explicitly or implicitly- the loss characteristics of that loan or exposure. In addition, credit risk ratings may reflect not only the likelihood or severity of loss but also the variability of loss over time, particularly as this relates to the effect of the business cycle. Linkage to these measurable outcomes gives greater clarity to risk rating analysis and allows for more consistent evaluation of performance against relevant benchmarks. In documentation their credit administration procedure, institutions should clearly identify whether risk ratings reflect the risk of the borrower or the risk of the specific transaction .The rating scale chosen should meaningfully distinguish
19 | P a g e
gradations of risk within the institutions portfolio, so that there is clear link age to loan quality (and/or loss characteristics). To do so, the rating system should be designed to address the range of risks typically encountered in the underlying businesses of the institutions. Prompt and systematic tracking of credits in need of such attention is an element of managing credit risk. Risk ratings should be reviewed by independent credit risk management or loan review personnel both at the inception and also periodically over the life of the loan. In view of the diverse financial and non-financial risks confronted by banks in the wake of the financial sector deregulation, the risk management practices of the banks have to be upgraded by adopting sophisticated techniques like Value at Risk (VaR), Duration and simulation and adopting internal model- based approaches as also credit risk modeling techniques. When making credit rating decisions, banks review credit application and credit reports with respect to financial risk. Once lenders make a yes decision, they review the credit reports of their customers on a regular basis as they continue to manage their financial risk. This process scans credit reports for certain risk characteristics as defined by the lender. Some lenders, for example, monitor whether or not all of a consumers payments are on time. Others look at account balance in relation to the total credit limit. Some lenders review their accounts frequently. Others review accounts once a year. Account monitoring also allows lenders to manage the business risk of extending credit in a better way. Banks pool assets and loans, which have a possibility of default and yet provide the depositors with the assurance of the redemption at full face value. Credit risk, in terms of possibilities of loss to the bank, due to failure of borrowers/counterparties in meeting commitment to the depositors. Credit risk is the most significant risk, more so in the Indian scenario where the NPA level of the banking system is significantly high. The management of credit risk through an efficient credit administration is a prerequisite for long-term sustainability/ profitability of a bank. A proper credit administration reduces the incidence of credit risk. Credit risk depends on both internal and external factors. Some of the important external factors are state of economy, swings in commodity prices, foreign exchange rates and interest rates etc. The internal factors may be deficiencies in loan policies and administration of loan portfolio
20 | P a g e
covering areas like prudential exposure limits to various categories, appraisal of borrowers financial position, excessive dependence on collaterals, mechanism of review and post-sanction surveillance, etc. The key issue in managing credit risk is to apply a consistent evaluation and rating system to all investment opportunities. Prudential limits need to be laid down on various aspects of credit viz., benchmarking current ratio, debt-equity ratio, profitability ratio, debt service coverage ratio, concentration limits for group/single borrower, maximum exposure limits to industries, and provision for flexibilities to allow variation for very special features. Credit rating may be a single point indicator of diverse risk factors. Management of credit in a bank will require alertness on the part of the staff at all the stages of credit delivery and monitoring process. Lack of such standards in financial institution would increase the problem of increasing loan write-offs. How can an institution be sure that its collateral is totally protected in the event of bankruptcy by the borrower? The bank can ensure this through efficient credit rating and loan documentation.
BASEL NORMS The process of implementing Basel II norms in India is being carried out in phases. Phase I has been carried out for foreign banks operating in India and Indian banks having operational presence outside India with effect from March 31,2008.
In phase II, all other scheduled commercial banks (except Local Area Banks and RRBs) will have to adhere to Basel II guidelines by March 31, 2009. With the deadline of March 31, 2009 for full implementation of Basel II norms fast approaching, banks are looking to maintain a cushion in their respective capital reserves. The minimum capital to risk-weighted asset ratio (CRAR) in India is placed at 9%, one percentage point above the Basel II requirement. All the banks have their Capital to Risk Weighted Assets Ratio (CRAR) above the stipulated requirement of Basel guidelines (8%) and RBI guidelines (9%). As per Basel II norms, Indian
21 | P a g e
banks should maintain tier I capital of at least 6%. The Government of India has emphasized that public sector banks should maintain CRAR of 12%. For this, it announced measures to recapitalize most of the public sector banks, as these banks cannot dilute stake further, as the Government is required to maintain a stake of minimum 51% in these banks. Indian banking companies are required to ensure full implementation of Basel II guidelines by March 31, 2009. The first phase of Basel II was implemented in India with foreign banks operating in India and Indian banks having operational presence outside India complying with the same effective end of March 2008. With Basel II norms coming into force in 2009, maintaining adequate capital reserves will become a priority for banks.
Basel II mandates Capital to Risk Weighted Assets Ratio (CRAR) of 8% and Tier I capital of 6%. The RBI has stated that Indian banks must have a CRAR of minimum 9%, effective March 31, 2009. All private sector banks are already in compliance with the Basel II guidelines as regards their CRAR as well as Tier I capital. Further, the Government of India has stated that public sector banks must have a capital cushion with a CRAR of at least 12%, higher than the threshold of 9% prescribed by the RBI.
- Failure to adhere to Basel II can attract RBI action including restricting lending and investment activities. Since fund raising has been difficult in the recent turbulent times, the question was whether the full implementation of Basel II norms would be deferred. However, the implementation is unlikely to be deferred with the Government taking steps to recapitalize some public sector banks.
- Further for public sector banks, the Government prescribed CRAR of at least 12%. The Terminology
Capital to Risk Weighted Assets Ratio (CRAR) is also known as Capital Adequacy Ratio
22 | P a g e
which indicates a bank's risk-taking ability. The RBI uses CRAR to track whether a bank is meeting its statutory capital requirements and is capable of absorbing a reasonable amount of loss. CRAR = (Tier I capital + Tier II capital) / Risk-Weighted Assets
Capital funds are broadly classified as Tier 1 and Tier 2 capital. Two types of capital are measured: Tier one capital, which absorbs losses without a bank being required to cease trading, and Tier two capital, which absorbs losses in the event of winding-up and so provides a lesser degree of protection to depositors.
Tier I capital (core capital) is the most reliable form of capital. The major components of Tier I capital are paid up equity share capital and disclosed reserves viz. statutory reserves, general reserves, capital reserves (other than revaluation reserves) and any other type of instrument notified by the RBI as and when for inclusion in Tier I capital. Examples of Tier 1 capital are common stock, preferred stock that is irredeemable and non-cumulative, and retained earnings.
Tier II capital (supplementary capital) is a measure of a bank's financial strength with regard to the second most reliable forms of financial capital. It consists mainly of undisclosed reserves, revaluation reserves, general provisions, subordinated debt, and hybrid instruments. This capital is less permanent in nature.The reason for holding capital is that it should provide protection against unexpected losses. This is different from expected losses for which provisions are made. What are Basel I and Basel II norms?
While Basel I framework was confined to the prescription of only minimum capital requirements for banks, the Basel II framework expands this approach not only to capture certain additional risks in the minimum capital ratio but also includes two additional areas, viz. Supervisory
23 | P a g e
Review Process and Market Discipline through increased disclosure requirements for banks. Thus, Basel II framework rests on the following three mutually- reinforcing pillars:
Pillar 1: Minimum Capital Requirements prescribes a risk-sensitive calculation of capital requirements that, for the first time, explicitly includes operational risk along with market and credit risk.
Pillar 2: Supervisory Review Process (SRP) envisages the establishment of suitable risk management systems in banks and their review by the supervisory authority.
Pillar 3: Market Discipline seeks to achieve increased transparency through expanded disclosure requirements tor banks.
24 | P a g e
Basel Committee The Basel Committee on Banking Supervision was established in 1974, by the Bank of International Settlements (BIS), an international organization founded in Basel, Switzerland in 1930 to serve as a bank for central banks.
- Basel Committee on Banking Supervision is a committee of bank supervisors consisting of members from each of the G10 countries. It is represented by central bank governors of each of the G10 countries. The Committee's members are from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Spain, Sweden, Switzerland, UK and US. The present Chairman of the Committee is Mr. NoutWellink, President of the Netherlands Bank.
- The Committee is a forum for discussion on handling of specific supervisory problems. It coordinates the sharing of supervisory responsibilities among national authorities in respect of banks' foreign establishments with the aim of ensuring effective supervision of banks' activities worldwide. It meets regularly 4 times a year.
With a view to adopt Basel Committee on Banking Supervision (BCBS) framework on capital adequacy which takes into account the elements of credit risk in various types of assets in the balance sheet as well as off-balance sheet business and to strengthen the capital base of banks, RBI decided in April 1992 to introduce a risk asset ratio system for banks in India as a capital adequacy measure. Essentially, under the above system the balance sheet assets and other offbalance sheet exposures are assigned prescribed risk weights and banks have to maintain minimum capital funds equivalent to the prescribed ratio on the aggregate of the risk weighted assets and other exposures on an ongoing basis. Basel 1 The first accord was the Basel I was issued in 1988 and focused mainly on credit risk by creating a bank asset classification system.
25 | P a g e
The Basel Capital Accord is an Agreement concluded among country representatives in 1988 to develop standardized risk-based capital requirements for banks across countries. The Accord was replaced with a New capital adequacy framework (Basel II), published in June 2004. Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. The purpose of Basel II, which was initially published in June 2004, is to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face. Advocates of Basel II believe that such an international standard can help protect the international financial system from the types of problems that might arise should a major bank or a series of banks collapse. In practice, Basel II attempts to accomplish this by setting up rigorous risk and capital management requirements designed to ensure that a bank holds capital reserves appropriate to the risk the bank exposes itself to through its lending and investment practices. Generally speaking, these rules mean that the greater risk to which the bank is exposed, the greater the amount of capital the bank needs to hold to safeguard its solvency and overall economic stability.
Basel II is based on 3 pillars that allow banks and supervisors to evaluate properly the various risks that banks face. These three pillars are: (i) Minimum capital requirements, (ii) Supervisory review of an institution's capital adequacy and internal assessment process; (iii) Market discipline through effective disclosure to encourage safe and sound banking practices.
26 | P a g e
1.2
INDUSTRY PROFILE
Banking in India
Banking in India originated in the last decades of the 18th century. The first banks were The General Bank of India which started in 1786, and the Bank of Hindustan, both of which are now defunct. The oldest bank in existence in India is the State Bank of India, which originated in the Bank of Calcutta in June 1806, which almost immediately became the Bank of Bengal. This was one of the three presidency banks, the other two being the Bank of Bombay and the Bank of Madras, all three of which were established under charters from the British East India Company. For many years the Presidency banks acted as quasi-central banks, as did their successors. The three banks merged in 1921 to form the Imperial Bank of India, which, upon India's independence, became the State Bank of India. Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as a consequence of the economic crisis of 1848-49. The Allahabad Bank, established in 1865 and still functioning today, is the oldest Joint Stock bank in India. It was not the first though. That honor belongs to the Bank of Upper India, which was established in 1863, and which survived until 1913, when it failed, with some of its assets and liabilities being transferred to the Alliance Bank of Simla. When the American Civil War stopped the supply of cotton to Lancashire from the Confederate States, promoters opened banks to finance trading in Indian cotton. With large exposure to speculative ventures, most of the banks opened in India during that period failed. The depositors lost money and lost interest in keeping deposits with banks. Subsequently, banking in India remained the exclusive domain of Europeans for next several decades until the beginning of the 20th century.
27 | P a g e
Foreign banks too started to arrive, particularly in Calcutta, in the 1860s. The Comptoired'Escompte de Paris opened a branch in Calcutta in 1860, and another in Bombay in 1862; branches in Madras and Pondichery, then a French colony, followed. HSBC established itself in Bengal in 1869. Calcutta was the most active trading port in India, mainly due to the trade of the British Empire, and so became a banking center. The Bank of Bengal, which later became the State Bank of India. The first entirely Indian joint stock bank was the Oudh Commercial Bank, established in 1881 in Faizabad. It failed in 1958. The next was the Punjab National Bank, established in Lahore in 1895, which has survived to the present and is now one of the largest banks in India. Around the turn of the 20th Century, the Indian economy was passing through a relative period of stability. Around five decades had elapsed since the Indian Mutiny, and the social, industrial and other infrastructure had improved. Indians had established small banks, most of which served particular ethnic and religious communities. The presidency banks dominated banking in India but there were also some exchange banks and a number of Indian joint stock banks. All these banks operated in different segments of the economy. The exchange banks, mostly owned by Europeans, concentrated on financing foreign trade. Indian joint stock banks were generally undercapitalized and lacked the experience and maturity to compete with the presidency and exchange banks. This segmentation let Lord Curzon to observe, "In respect of banking it seems we are behind the times. We are like some old fashioned sailing ship, divided by solid wooden bulkheads into separate and cumbersome compartments." The period between 1906 and 1911, saw the establishment of banks inspired by the Swadeshi movement. The Swadeshi movement inspired local businessmen and political figures to found banks of and for the Indian community. A number of banks established then have survived to the present such as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central Bank of India.
28 | P a g e
The fervour of Swadeshi movement lead to establishing of many private banks in Dakshina Kannada and Udupi district which were unified earlier and known by the name South Canara ( South Kanara ) district. Four nationalised banks started in this district and also a leading private sector bank. Hence undivided Dakshina Kannada district is known as "Cradle of Indian Banking.
In the early 1990s, the then NarsimhaRao government embarked on a policy of liberalization, licensing a small number of private banks. These came to be known as New Generation techsavvy banks, and included Global Trust Bank (the first of such new generation banks to be setup), which later amalgamated with Oriental Bank of Commerce, Axis Bank(earlier as UTI Bank), ICICI Bank and HDFC Bank. This move, along with the rapid growth in the economy of India, revitalized the banking sector in India, which has seen rapid growth with strong contribution from all the three sectors of banks, namely, government banks, private banks and foreign banks. The next stage for the Indian banking has been setup with the proposed relaxation in the norms for Foreign Direct Investment, where all Foreign Investors in banks may be given voting rights which could exceed the present cap of 10%,at present it has gone up to 74% with some restrictions. The new policy shook the Banking sector in India completely. Bankers, till this time, were used to the 4-6-4 method (Borrow at 4%;Lend at 6%;Go home at 4) of functioning. The new wave ushered in a modern outlook and tech-savvy methods of working for traditional banks. All this led to the retail boom in India. People not just demanded more from their banks but also received more. Currently (2007), banking in India is generally fairly mature in terms of supply, product range and reach-even though reach in rural India still remains a challenge for the private sector and foreign banks. In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its region. The Reserve Bank of India is an autonomous body, with minimal
29 | P a g e
pressure from the government. The stated policy of the Bank on the Indian Rupee is to manage volatility but without any fixed exchange rate-and this has mostly been true. With the growth in the Indian economy expected to be strong for quite some time-especially in its services sector-the demand for banking services, especially retail banking, mortgages and investment services are expected to be strong. One may also expect M&As, takeovers, and asset sales. In March 2006, the Reserve Bank of India allowed Warburg Pincus to increase its stake in Kotak Mahindra Bank (a private sector bank) to 10%. This is the first time an investor has been allowed to hold more than 5% in a private sector bank since the RBI announced norms in 2005 that any stake exceeding 5% in the private sector banks would need to be vetted by them. In recent years critics have charged that the non-government owned banks are too aggressive in their loan recovery efforts in connection with housing, vehicle and personal loans. There are press reports that the banks' loan recovery efforts have driven defaulting borrowers to suicide Currently, India has 96 scheduled commercial banks (SCBs) - 27 public sector banks (that is with the Government of India holding a stake), 31 private banks (these do not have government stake; they may be publicly listed and traded on stock exchanges) and 38 foreign banks. They have a combined network of over 53,000 branches and 49,000 ATMs. According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75 percent of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively.
30 | P a g e
CHAPTER II
RESEARCH DESIGN
31 | P a g e
TITLE OF THE STUDY
A study on risk management in SME financing with special reference to Union Bank of India
OBJECTIVES
To study on msme financing of the bank To study on risk management policy of the bank To understand the risk management architecture on msme financing To measure the credit risk through risk rating. To study the instruments for credit risk management.
SCOPE OF THE STUDY
The study mainly focuses on the risk management policies and procedures adopted by Union Bank of India for assessing the risk of various sme proposals financed by the bank. The study covers the area under Kozhikode Region of the bank. I attempted to have a detailed study on how the bank is assessing each and every proposal and the various tools used by it for effective risk management.A sound credit rating is used for credit appraisal of the project which should be
32 | P a g e
done for all the projects to determine whether bank would get their money back. A good rating system ensures that their NPAs are less.
The research is based on credit risk rating of Union Bank of India. The study helps to understand various aspects of risk rating like financial risk, market risk, technology risk etc., the project might be useful to management students and others who may want to broaden their horizon on this topic.
METHODOLOGY
The methodology used for the study is by collecting various data and figures from the bank officials and websites through personal interview and secondary data collection methods.
COLLECTION OF DATA
Risk management policies and procedures followed by the bank for effective assessment and rating of various sme proposals are collected by taking the four internal rating models of the bank. Both primary and secondary data are collected for the study.
Primary data Primary data was collected by way of personal interview with bank officials and records of performance of sme business of the bank for the past 2 years. Secondary Data
33 | P a g e
Secondary data was collected from bank website, various circulars and journals of the bank, official website of ministry of MSME and text books on risk management of banks.
ANALYTICAL TOOLS The financial performance and growth of the bank is analyzed using various percentage diagrams and trend charts.
LIMITATIONS OF THE STUDY
The period of the study was only for two months The study is confined to a particular region only. The performance of the bank was studied only based on past audited figures. The study is affected by the lack of financial information required for further analysis which was not given by the bank.
34 | P a g e
CHAPTER III COMPANY PROFILE
35 | P a g e
UNION BANK OF INDIA
THE BANK The dawn of twentieth century witnesses the birth of a banking enterprise par excellenceUNION BANK OF INDIA- that was flagged off by none other than the Father of the Nation, Mahatma Gandhi. Since that the golden moment, Union Bank of India has this far unflinchingly traveled the arduous road to successful banking........ a journey that spans 88 years. We at Union Bank of India, reiterate the objective of our inception to the profound thoughts of the great Mahatma... "We should have the ability to carry on a big bank, to manage efficiently crores of rupees in the course of our national activities. Though we have not many banks amongst us, it does not follow that we are not capable of efficiently managing crores and tens of crores of rupees." Union Bank of India is firmly committed to consolidating and maintaining its identity as a leading, innovative commercial Bank, with a proactive approach to the changing needs of the society. This has resulted in a wide gamut of products and services, made available to its valuable clientele in catering to the smallest of their needs. Today, with its efficient, valueadded services, sustained growth, consistent profitability and development of new technologies, Union Bank has ensured complete customer delight, living up to its image of, GOOD PEOPLE TO BANK WITH. Anticipative banking- the ability to gauge the customer's needs well ahead of real-time - forms the vital ingredient in value-based services to effectively reduce the gap between expectations and deliverables.
36 | P a g e
The key to the success of any organization lies with its people. No wonder, Union Bank's unique family of about 26,000 qualified / skilled employees is and ever will be dedicated and delighted to serve the discerning customer with professionalism and wholeheartedness.
Union Bank is a Public Sector Unit with 55.43% Share Capital held by the Government of India. The Bank came out with its Initial Public Offer (IPO) in August 20, 2002 and Follow on Public Offer in February 2006. Presently 44.57 % of Share Capital is presently held by Institutions, individuals and others.
Over the years, the Bank has earned the reputation of being a techno-savvy and is a front runner among public sector banks in modern-day banking trends. It is one of the pioneer public sector banks, which launched Core Banking Solution in 2002. Under this solution umbrella, all Branches of the Bank have been 1135 networked ATMs, with online Telebanking facility made available to all its Core Banking Customers - individual as well as corporate. In addition to this, the versatile Internet Banking provides extensive information pertaining to accounts and facets of banking. Regular banking services apart, the customer can also avail of a variety of other value-added services like Cash Management Service, Insurance, Mutual Funds and Demat..
The Bank will ever strive in its endeavour to provide services to its customer and enhance its businesses thereby fulfilling its vision of becoming THE BANK OF FIRST CHOICE IN OUR CHOSEN AREA BY BUILDING BENEFICIAL AND LASTING RELATIONSHIP WITH CUSTOMERS THROUGH A PROCESS OF CONTINUOUS IMPROVEMENT.
37 | P a g e
VISION
CORPORATE MISSION
A logical extension of the Vision Statement is the Mission of the Bank,which is to gain market recognition in the chosen areas.
To build a sizeable market shares in each of the chosen areas of business through effective strategies in terms of pricing, product packaging and promoting the product
38 | P a g e
in the market.
To facilitate a process of restructuring of branches to support a greater efficiency in the retail banking field.
To sustain the mission objective through harnessing technology driven banking and delivery channels.
To promote confidence and commitment among the staff members, to address the expectations of the customers efficiently and handle technology banking with ease.
Management - Union Bank

Name M V Nair S Raman B M Sharma M S Sriram S Ravi MeenaHemchandra B N Bhattacharjee Name S C Kalia K V Eapen N Shankar Arun Kumar Nanda GulfamMujibi S SMundra Designation Chairman and Managing director Executive Director Non Official Part-time Director Director Director Director Employee Director Designation Executive Director Nominee Director Director Director Director Executive Director
BANK'S INITIATIVES AND ACHIEVEMENTS
Union Bank of India, which has the vision to become one of the top three Nationalized Banks in India by 2012, has identified funding MSME business as one of its thrust areas. The bank has taken several initiatives to ensure credit growth in this segment.
39 | P a g e
Initiatives: Bank has launched its ambitious Project Navnirman for transforming itself from a Banking Organization to a Sales Oriented Financial Service Organization. With this strategic initiative in mind, a separate vertical named as MSME Vertical has been carved out to oversee the growth of MSME finance in the Bank across the country.
As part of the organizational restructuring exercise for improving credit flow to MSMEs, bank has streamlined its processes to increase efficiency. Central Processing Centers (CPCs) have been established at key locations to:
a. accelerate the credit flow to MSMEs through focused sales and marketing b. enhance customer service through quick Turn Around Time c. reduce NPAs in MSMEs through efficient supervision and monitoring d. lower cost and build expertise The Bank has implemented Loan Automation Solution for its Retail, MSME and Corporate Asset portfolios. It is designed with the aim of straight through processing of all credit proposals with capabilities to interact / interface with existing data. This will usher in paperless credit proposals for processing, sanctioning and simultaneously taking care of areas like credit ratings, monitoring, NPA Management and MIS in an integrated manner. The solution is expected to further reduce the Turn-around-Time (TAT) in sanctioning of credit facilities and support key requirements like monitoring and reporting. Bank has entered into MoU with
a. SIDBI: for joint processing of loan applications and WC limits
40 | P a g e
b. SMERA: for rating of MSME clients only c. CGTMSE: for extending guarantee cover d. NSIC: for financing around 250 training institutes e. ONICRA agency specialized in credit rating of MSMEs f. and leading manufacturers of Commercial Vehicles The Bank also set up a research chair at the prestigious Indian Institute of Management, Ahmedabad. The chair will fund research in MSME sector and findings will be shared with the Bank. On an ongoing basis and as per RBI directives, meetings of Standing Committee on Customer Service were held with the active participation of customers of the Bank. The bank has broad based the invitees to cover various segments of customers viz., pensioners, women entrepreneurs, young generation Annual Report 2008-2009 119 customers and MSME customers. To solicit the MSME clients, bank has launched a web based information channel i.e., SME Helpline and all the Regional offices of the Bank have been designated as the MSME Care Centers and the details of the same have been placed on the banks website. The MSME entrepreneurs/clients can contact any of the centers across the country and get their queries satisfied.
Performance:-
The MSME credit growth of the bank has been driven by focusing on assured Turn around Time (TAT), Credit Delivery at affordable prices, customized products, and enhancing the base of MSME clientele. MSME portfolio of the Bank recorded a growth of 31.91% for the year ended March 2009.The outstanding under MSME segment as on March 31, 2009 was Rs.16,149 Crore as against
41 | P a g e
Rs.12,242 Crore as on March 31, 2008 and Rs.8833 Crore as on Mar 31, 2007. The share of the MSME lending constituted 16.60% of the total advances of the Bank as on March 31 2009 as compared to 16.13% in the previous year. Priority Sector Advances registered the growth of 21.02% and stood at Rs.36,341 Cr as on March 31, 2009. Small Enterprises segment comprises of 26% of its total priority sector advances. Achievements: -
Union Bank was awarded the National Awards for Excellence in Lending to Micro Enterprises 2008-09 on 29th August, 2009. The Bank attained Second Rank based on its excellent performance in lending to micro enterprises during the year 2008-09.
The Bank was also adjudged as the Best Bank in West Zone for extending institutional finance in propagating KVI programs under Interest Subsidy Eligibility Certificate scheme during 2008-09.
MSME Loan Schemes of Union Bank of India
Union Bank of India has adopted a policy package for stepping up credit to Small & Medium Enterprises [SME] .the following loan schemes are provided by UBI.
UNION HIGH PRIDE
Term Loans for purchase of Machineries/equipments, construction of industrial shed/Gala for industrial units Working Capital needs of mid segment industrial firms
Purpose
42 | P a g e
Working Capital/Term Loans in case of Trading units/Business Enterprises/ Service units
Quantum
Above Rs. 5 cr to Rs. 25 cr
Nature of facility
Working Capital / Term Loan
Eligibility
Companies / Trading firms / Business Enterprises/ Service units requiring credit facilities above Rs. 5.00cr up to Rs. 25.00cr OR Mid Corporate Enterprises with Investment in Plant & Machinery above Rs. 1 cr up to Rs. 10 cr Credit Rating of unit should be CR-4 or above
UNION PROCURE
Purpose
Financing of receivables through bills discounting relating only to the products supplied by vendor to the concerned Corporate
Quantum Nature of facility
Minimum Rs. 25 lac and Maximum Rs. 5 cr Bill Discounting Scheme i.e. UBD
Eligibility
Selected vendors supplying to identified large Corporate borrowers of the bank
UNION SUPPLY
43 | P a g e
Purpose
Financing purchases of dealers through buyers bills discounting relating only to products supplied by the concerned corporate
Quantum
Minimum Rs. 25 lac and Maximum Rs. 5 cr Bills Discounting Scheme in the account of the dealer (Buyers UBD) drawn by the corporate
Nature of facility
Eligibility
Selected authorized dealers of identified large Corporate borrowers of the Bank
UNION CYBER
Purpose
Term Loan for setting up internet/cyber caf for purchase of Computers/PCO Equipments, furniture etc. at rural, semi urban and urban centers
Quantum
Maximum Rs. 3 lac
Nature of facility
Term Loan Minimum Qualification Minimum S.S.C. passed
Eligibility
Age between 18 to 30 years, should possess a certificate having completed a basic computer knowledge course * Women entrepreneurs are given preference
44 | P a g e
UNION SME PLUS
All kind of genuine credit needs of temporary nature to tide over liquidity crunch Repayment of high cost short term borrowings Temporary delay in shipment / realization of book debts Sudden increase in raw material cost Mismatch in Cash Flow
Purpose
Quantum
Adhoc Working Capital limit up to 20% of the existing overall Fund based credit facilities in respect of unit having over-all fund based credit facilities up to Rs. 10 cr
Nature of Facility
Working Capital
Borrower Accounts belonging to Small Scale entrepreneurs / Medium Enterprises Eligibility Earned profits consistently for the preceding three years and who have not defaulted in any of their commitments Borrowers with existing overall Fund-Based credit facilities up to Rs.10 cr
45 | P a g e
CHAPTER iV
RISK MANAGEMENT IN SME AT UBI
46 | P a g e
Risk Management in union bank Risk Management Risk is inherent part of Banks business. Effective Risk Management is critical to any Bank for achieving financial soundness. In view of this, aligning Risk Management to Banks organizational structure and business strategy has become integral in banking business. Over a period of year, Union Bank of India (UBI) has taken various initiatives for strengthening risk management practices. Bank has an integrated approach for management of risk and in tune with this, formulated policy documents taking into account the business requirements / best international practices or as per the guidelines of the national supervisor. These policies address the different risk classes viz., Credit Risk, Market Risk and Operational Risk.
Oversight Mechanism: The Board of Directors has the overall responsibility of ensuring that adequate structures, policies and procedures are in place for risk management and that they are properly implemented. Board approves our risk management policies and also sets limits by assessing our risk appetite, skills available for managing risk and our risk bearing capacity.
Board has delegated this responsibility to a sub-committee: the Supervisory Committee of Directors on Risk Management & Asset Liability Management. This is the Apex body / Committee is responsible for supervising the risk management activities of the Bank. Further, Bank has the following separate committees of top executives and dedicated Risk Management Department:
Credit Risk Management Committee (CRMC): This Committee deals with issues relating to credit policies and procedure and manages the credit risk on a Bank-wide basis.
47 | P a g e
Asset Liability Management Committee (ALCO): This Committee is the decision-making unit responsible for balance sheet planning and management from the angle of risk-return perspective including management of market risk. Operational Risk Management Committee (ORMC): This Committee is responsible for overseeing Banks operational risk management policy and process.
Risk Management Department of the Bank provides support functions to the risk management committees mentioned above through analysis of risks and reporting of risk positions and making recommendations as to the level and degree of risks to be assumed. The department has the responsibility of identifying, measuring and monitoring the various risk faced the bank, assist in developing the policies and verifying the models that are used for risk measurement from time to time.
Credit Risk Credit Risk Management Policy of the Bank dictates the Credit Risk Strategy. These Polices spell out the target markets, risk acceptance / avoidance levels, risk tolerance limits, preferred levels of diversification and concentration, credit risk measurement, monitoring and controlling mechanisms. Standardized Credit Approval Process with well-established methods of appraisal and rating is the pivot of the credit management of the bank. Bank has comprehensive credit rating / scoring models being applied in the spheres of retail and non-retail portfolios of the bank. The Credit rating system of the Bank has eight borrower grades for standard accounts and three grades for defaulted borrowers. Proactive credit risk management practices in the form of studies of rating-wise distribution, rating migration, probability of defaults of borrowers, Portfolio Analysis of retail lending assets, periodic industry review, Review of Country, Currency, Counter-party and Group exposures are only some of the prudent measures, the bank is engaged in mitigating risk exposures. The current focus is on augmenting the banks abilities to quantify risk in a consistent, reliable and valid fashion, which will ensure advanced level of
48 | P a g e
sophistication in the Credit Risk Measurement and Management in the years ahead.
Market Risk Bank has well-established framework for Market Risk management with the Asset Liability Management Policy and the Treasury Policy forming the fulcrum for procedures, processes and structure. It has a major objective of protecting the banks net interest income in the short run and market value of the equity in the long run for enhancing shareholders wealth. The important aspect of the Market Risk includes liquidity management, interest rate risk management and the pricing of assets and liabilities. Further, Bank views the Asset Liability Management exercise as the total balance sheet management with regard to its size, quality and risk. The ALCO is primarily entrusted with the task of market risk management. The Committee decides on product pricing, mix of assets and liabilities, stipulates liquidity and interest rate risk limits, monitors them, articulates Banks interest rate view and determines the business strategy of the Bank.
Bank has put in place a structured ALM system with 100% coverage of data on both assets and liabilities. To measure liquidity and interest rate risk, Bank prepares various reports such as Structural Liquidity, Interest Rate Sensitivity, Fortnightly Dynamic Statement etc. Besides RBI reporting many meaningful analytical reports such as Duration Gap analysis, Contingency Funding Plan, Contractual Maturity report etc. are generated at periodic intervals for ALCO, which meets regularly. Statistical and mathematical models are used to analyze the core and volatile components of assets and liabilities. The objective of liquidity management is to ensure adequate liquidity without affecting the profitability. In tune with this, Bank ensures adequate liquidity at all times through systematic funds planning, maintenance of liquid investments and focusing on more stable funding sources. The Mid Office group positioned in treasury with independent reporting structure on risk aspects ensure compliance in terms of exposure analysis, limits fixed and calculation of risk sensitive parameters like VaR, PV01, Duration, Defeasance Period etc. and their analysis.
49 | P a g e
5.0 Operational Risk Operational Risk, which is intrinsic to the bank in all its material products, activities, processes and systems, is emerging as an important component of the enterprise-wide risk management system. Recognizing the importance of Operational Risk Management, Bank has adopted a Comprehensive Operational Risk Management Policy. This would entail the bank to move towards enhanced level of sophistication in the years ahead and to capture qualitative and quantitative measures of Operational Risk indicators in management of operational risk. Bank has comprehensive system of internal controls, systems and procedures to monitor and mitigate risk. Bank has also institutionalized new product approval process to identify the risk inherent in the new product and activities. The Internal audit function of the Bank and the Risk Based Internal Audit, compliments the banks ability to control and mitigate risk.
Risk Management Policy of the bank 2010-2011 The policy is designed with the following major objectives: To enhance the risk management capabilities to ensure orderly and healthy credit growth. Adhere to minimum credit standards across the bank uniformly. Maintain asset quality Maintain credit risk exposure within acceptable parameters/prudential exposures. Maintain reasonable risk adjusted return on credit exposures. Mitigate and reduce risk associated with lending by fine tuning the systems and control.
Principles of Credit Risk Management Banks Credit Risk Management policy is based on the following principles: Establishing an appropriate credit risk environment. Operating under a sound credit granting process.
50 | P a g e
Maintaining an appropriate credit administration, measurement and monitoring process Assuring adequate control over credit risk.
Overall Credit Risk Management Architecture of UBI

Organizational Structure A sound organizational structure is designed by the bank for effective implementation of risk management process. Organizational structure in the bank for credit risk management covers the following: The Board of Directors shall have the overall responsibility for management of credit risk. The Board shall approve the credit risk management policy of the bank and various prudential limits. A supervisory committee is established which acts as an interface between the Board of Directors and Credit Risk Management Committee. Credit Risk Management Committee, which is headed by Credit Risk Management Department (CMD), shall oversee the risk management process in entire lending functions. Independent Credit risk Management Cell is in place at Central Office Risk Management Department to carry out day to day functioning, which covers the following. o Formulating policy on Credit Risk Management o To measure, control and manage credit risk on bank wide basis within the limits set by the Board and also based on MIS available o To carry out Portfolio Analysis covering exposure under retail sector, Single/Group borrower, Sensitive sector, Industry etc. based on available MIS o To prepare Risk Profile Templates for Credit Risk along with other risk templates o To introduce / refine credit risk rating or scoring models o To be a member of Credit Grid o Calculation of capital under both Basel 1 and Basel 2 guidelines which is subject to compliance to minimum prudential floor.
51 | P a g e
o To initiate steps on an ongoing basis for migration to Internal Rating Based (IRB) approach
Independent Risk management Cell established at RO/FGMOs by posting risk officers to carry out the above said functions at the regional level and also functions like: o Assigning independent Obligor Credit Rating to all accounts falling under DA of ROs/FGMOs by using banks rating models as well as IRB module in Lending Automation Solution o To carry out Internal Loan Review Mechanism (ILRM) for the branch sanctions on a random sample basis. o To conduct mini CRMC meetings at periodic intervals etc.
Risk Management Approach Credit risk management approach encompasses all processes right from loan origination till the logical conclusion of the exposure. CRM covers: 1. Credit approval process 2. Low priority exposures 3. Credit Grid Approach to sanction 4. Takeover code 5. Credit Risk Rating 6. Hurdle Rate of new accounts. 7. New Capital Adequacy Framework(NCAF) 8. System driven rating 9. Pricing 10. Monitoring and control 11. Internal Loan Review Mechanism (ILRM)
52 | P a g e
Credit approval process consists of credit origination and appraisal: Credit investigations on borrower or guarantor including KYC(AML) compliance and verification of CIBIL reports, RBI defaulters list, ECGCS Specific Approval List(SAL) Asking for /obtaining all relevant /necessary credit related information from the borrower preferably at one go. Synchronizing Annual reviews to pre decided time of submission of annual renewal data or information through discussion with each borrower. Structured or systematic credit appraisal with a view to upgrading credit quality or plugging deficiencies if any. Documentation Credit delivery Adhoc requests
Low Priority Exposures / Negative List: The list of Low Priority Exposures and Negatives are finalized by Corporate Credit Department taking into account the business potentials and this list shall form part of loan policy.
Credit Grid Approach to sanction In line with guidelines issued by Reserve Bank of India and Basel, Bank has established Credit Grid Approach with the approval of Board of Directors at Central Office/ FGMOs/ROs to examine all credit exposure through a minimum Six Eye principle with at l east one representing Risk concerns exclusively who is having no business/ profit targets.
53 | P a g e
All the credit sanctions or renewal of proposals including new proposals and adhoc sanctions shall be routed through the Credit Approval Grid. All other miscellaneous proposals such as modification in sanction terms, interest rate modifications, NOCs, FCL conversion etc. is to be performed by the sanctioning authorities. All new connections above Rs.50 lacs which were earlier being routed though NBG, are now required to be placed before the Appropriate Grids at these offices. Credit Risk Rating Risk rating is not a substitute to any professionalized lending experience but arises due to a need to standardize or uniformly communicate the judgement. Rating involves the following. Individual obligor reviews Periodic credit calls that are documented Quarterly management reviews of troubled exposures/ weak credits Standardization or benchmark for risk ratings Interaction with External Credit Assessment Institutions(ECAI) Rating grades will represent unambiguously the default risks associated with the exposure Bank has Credit Rating Models for commercial advances covering the following different ranges of exposures. MODEL I- For advances above Rs. 2.00 lacs and up to Rs.10.00 lacs MODEL II- For advances above Rs. 10.00 lacs and up to Rs.1.00 Crs MODEL III- For advances above Rs. 1.00 cr and up to Rs.10.00 Crs MODEL IV- For advances above Rs. 10.00 crs
Bank has credit rating models for Union Trade Scheme as under:
54 | P a g e
MODEL I: For advances above Rs.2 lacs and up to Rs. 50 lacs MODEL II: For advances above Rs.50 lacs and up to Rs. 5 crores \
The rating models cover the following 4 aspects: Borrower Rating Covering financial, Industrial and Management aspects Facility Rating Covering compliance part, operations in the accounts and repayment experience Risk Mitigators Business Aspects Covering value and quality of collaterals Covering relationship and income value
Grading system for calibration of Credit risk: Various grades are introduced to indicate different credit qualities. The grading system adopted by the bank for calibration of Credit risk as under
INVESTMENT GRADE CREDIT QUALITY Lowest risk Minimal risk Moderate risk Satisfactory risk Acceptable risk Watch List RATING NUMERIC CR 1 CR 2 CR 3 CR 4 CR 5 CR 6 AGGREGATE SCORE >90 81.90 76-80 71-75 66-70 61-65
NON INVESTMENT GRADE CREDIT QUALITY Risk Prone High Risk Sub-Standard Doubtful Loss RATING NUMERIC CR 7 CR 8 CR 9 CR 10 CR 1 1 AGGREGATE SCORE 56-60 55 & below Default- N P A -
55 | P a g e
Rating scale starts from CR-1 to CR-8 in standard loans. It will represent lowest credit risk or highest safety and comfort at CR-1 and highest credit risk or lowest safety and comfort at CR8.
Rating will primarily be used for the purpose of Individual credit selection Pricing and deciding on the terms that can be offered on a credit facility Surveillance, monitoring and internal MIS Portfolio level analysis at operating/control units Assessing the aggregate risk profile of bank Hurdle Rate of new accounts Within the 8 grades in Standard Account category, Investment and Non-Investment grades are fixed, thereby indicating the minimum level of score at entry point below which no new proposal. Thus investment grades for all new proposals are from CR-1 to CR-5. Rating CR-6, CR-7 and CR-8 will be treated as Non-Investment grade and bank shall not take a new exposure in this category. External Credit Assessment Institutions (ECAIs) RBI accredited four external rating agencies i.e, CARE, CRISIL, FITCH India and ICRA Ltd, and the bank also approved these external rating agencies for rating of borrowers of the bank. System Driven Rating As a part of Lending Automation Solution (LAS) implementation, bank is in the process of introducing System Driven Rating and such system shall cover: Rating assignment Preparation of Rating Migration Matrix
56 | P a g e
Computation of Probability of Default(PD) Computation of Loss Given Default(LGD) Computation of Exposure At Default(EAD)
Pricing Risk return pricing for loan products is a fundamental tenet of risk management. General dictum shall be Higher the risk higher the price, Lower the risk lower the price. Presently as per RBI guidelines, banks are required to calculate their benchmark PLR, taking into account their actual cost of funds, operating expenses and a minimum margin to cover regulatory requirement of provisioning or capital charge and profit margin. All the lending rates except those specifically exempted by RBI are to be determined with reference to the benchmark PLR. BPLR needs to be seen as a reference rate around which banks lending shall take place. Presently the Bench Prime Lending Rate w.e.f. 07/05/2011 is 14.25%. The following tables state the current rates of interest for Micro, Small & Medium Sector Enterprises.
(A) Interest Rate On Advances to Micro Enterprises

Working Capital Advances Rs.25.00 lacs and above
Rating CR-1 CR-2 CR-3 CR-4 CR-5 CR-6 CR-7 CR-8 CR-9
Score > 90 81-90 76-80 71-75 66-70 61-65 56-60 55 & below NPA
Rate of Interest BPLR-0.50 BPLR-0.25 BPLR BPLR+0.50 BPLR+0.75 BPLR+1.25 BPLR+1.75 BPLR+1.75 BPLR+1.75
Loans Repayable in installments beyond 1 year Rs.25.00 lacs and above
57 | P a g e
Rating Score Rate of Interest CR-1 > 90 BPLR CR-2 81-90 BPL;R+0.25 CR-3 76-80 BPLR+0.50 CR-4 71-75 BPLR+1.00 CR-5 66-70 BPLR+1.25 CR-6 61-65 BPLR+1.75 CR-7 56-60 BPLR+2.75 CR-8 55 & below BPLR+2.75 CR-9 NPA BPLR+2.75 Note: For advances above Rs.2.00 lacs covered under CGTMSE, rate of interest applicable will be 0.50% more the usual rate
(B) Interest Rate on Advances to Small Scale Enterprises (SSE)

Working Capital Advances Rs.25.00 lacs and above
Rating CR-1 CR-2 CR-3 CR-4 CR-5 CR-6 CR-7 CR-8 CR-9
Score > 90 81-90 76-80 71-75 66-70 61-65 56-60 55 & below NPA
Rate of Interest BPLR-0.25 BPLR BPLR+0.25 BPLR+0.75 BPLR+1.00 BPLR+1.50 BPLR+2.00 BPLR+2.00 BPLR+2.00
Loans Repayable in installments beyond 1 year Advances Rs.25.00 lacs and above
Rating Score Rate of Interest CR-1 > 90 BPLR+0.25 CR-2 81-90 BPL;R+0.50 CR-3 76-80 BPLR+0.75 CR-4 71-75 BPLR+1.25 CR-5 66-70 BPLR+1.50 CR-6 61-65 BPLR+2.00 CR-7 56-60 BPLR+3.00 CR-8 55 & below BPLR+3.00 CR-9 NPA BPLR+3.00 Note: For advances above Rs.2.00 lacs covered under CGTMSE, rate of interest applicable will be 0.50% more the usual rate
58 | P a g e
(C) Interest Rate On Advances to MEDIUM SCALE ENTERPRISES (MSE)
Working Capital Rating Score CR-1 > 90 CR-2 81-90 CR-3 76-80 CR-4 71-75 CR-5 66-70 CR-6 61-65 CR-7 56-60 CR-8 55 & below CR-9 NPA Rating Score CR-1 > 90 CR-2 81-90 CR-3 76-80 CR-4 71-75 CR-5 66-70 CR-6 61-65 CR-7 56-60 CR-8 55 & below CR-9 NPA *Inclusive of Term Premium of 1%
Rate of Interest BPLR BPL;R+1.00 BPLR+1.50 BPLR+2.50 BPLR+3.50 BPLR+3.50 BPLR+3.50 BPLR+3.50 BPLR+3.50 Rate of Interest* BPLR+1.00 BPLR+2.00 BPLR+2.50 BPLR+3.50 BPLR+4.50 BPLR+4.50 BPLR+4.50 BPLR+4.50 BPLR+4.50
Loans Repayable in installments beyond 1 year
Besides above penal interest rates are levied wherever applicable as per extant guidelines of the bank, The bank reserves the rights to change / alter the interest rates under any head at any point of time based on its internal policies decided by the Corporate Management from time to time.
Monitoring and Control
59 | P a g e
Bank has in place a separate Credit Monitoring Policy and the credit monitoring exercise such as EAS/SMA documentation, review of credit limits, follow up and scrutiny of control returns etc. shall be governed by the same.
Credit Guarantee Fund Trust for Micro & Small Enterprises

This scheme was setup by Government of India and SIDBI with an aim to provide for the growth of MSME sector in India and to generate more employment opportunities in this sector. All Scheduled Commercial Banks, Regional Rural Banks and other approved institutions by the Ministry of SSI and GOI are eligible for availing this scheme. All types of firms/ companies or other legally constituted bodies, individual borrowers, small businesses in the MSE sector other than Trade, Hospitals & Educational Institutions are eligible for this scheme. Features The major features of the scheme include the following: Facilitates availment of credit by MSE including units engaged in IT based activities from formal banking channel. Maximum loan guaranteed is Rs. 100 lakh per borrowing unit, extended without any collateral security or third party guarantee to a new or existing micro and small enterprise. It covers the risk of banks in case of NPA. Both term loans and working capital can be covered under this scheme. Non fund based limits are also covered.
60 | P a g e
Cost of Guarantee Fee (payable within 30 days from the date of 1st disbursement of term loan or 30 days from the date of demand advice of Guarantee Fee whichever is later) 1.00% for credit facility up to Rs. 5 lakh 1.5% for credit facility above Rs. 5 lakh. Annual Service Fee 0.50% of credit facility up to Rs. 5 lakh 0.75% in case of credit facility above Rs. 5 lakh as on March 31st each year. The guarantee cover shall run through the tenure of the term credit/ composite credit. Working capital alone is financed 5 years or block of 5 years. EXTENT OF COVERAGE Micro Enterprises: Upto Rs. 5.00 lacs Rs. 5.00 to 50.00 lacs Rs. 50.00 to 100 lacs 85% of amt in default (max Rs.4.25 lacs) 75% of amt in default (Max Rs. 37.50 lacs) Rs. 37..50 lacs+ 50% of amt in default above Rs.50 lacs (Max Rs. 62.50 lacs)
Women Entrepreneurs: (other than micro) Rs. 5.00 lacs to Rs. 50.00 lacs Rs.50 to 100 lacs 80% of amt in default (max Rs.40 lacs) Rs. 40 lacs + 50% of amt in default beyond Rs.50 lacs (Max Rs.65 lacs)
All other category of borrowers Rs. 5.00 lacs to Rs. 50.00 lacs Rs.50 to 100 lacs 75% of amt in default (max Rs.37.50 lacs) Rs. 37.50 lacs + 50% of amt in default beyond
61 | P a g e
Rs.50 lacs (Max Rs.62.50 lacs)
Amount in Default means: Term loan: Principal and Interest o/s in the account on the date of classification of the account as NPA or on the date of lodgment of claim whichever is lower. Working Capital: O/s in the account, including interest, on the date of classification of the account as NPA or on the date of lodgment of claim whichever is lower, subject to maximum of amount guaranteed.
Advantages
TO BANKS: Zero capital adequacy ( to the extent of coverage) Zero Provision ( to the extent of coverage) No hassle for managing collaterals. Enhances comfort level Improves quality of their assets Builds better client relationship In case off default, major portion of amount realizable through claim.
62 | P a g e
CHAPTER V
ANALYSIS AND INTERPRETATIONS

63 | P a g e
Growth in MSME Advances for the last 5 years in Union Bank of India (Rs in cr)
Year 2006-07 2007-08 2008-09 2009-10 2010-11 Amount 8833 12242 16149 22685 24735 Trend (%) 100 127.85 182.83 256.82 280.03
64 | P a g e
30000 280.03 25000 20000 15000 10000 5000 0 2006-07 2007-08 2008-09 2009-10 2010-11 100 127.85 182.83 Trend (%) Amount 256.82
INTERPRETATION
The advances given for MSME for the last 5 years by the bank shows a descent growth. The amount of advances increased from Rs.8833 crs to Rs 24735 crs from 2006-07 to 2010-11 which is almost twice in figures. The extensive customer friendly policies introduced for MSMEs for the last five years helped the bank to make a good growth in these advances.
District wise figures of MSME business under Kozhikode region of Union Bank of India
Year Trichur 200910 2010-11 1845200 2587000 Kannur 6247300 9868800 Districts Palakkad 4051200 6352233 Kozhikode 1684700 2569200 Malappuram 1892100 968700
65 | P a g e
18000000 16000000 14000000 12000000 10000000 8000000 6000000 4000000 2000000 0 Trichur Kannur Palakkad Kozhikode Malappuram 2010-11 200910
INTERPRETATION
The district wise figures of sme under Kozhikode region for the year 2009-10 and 2010-11 is showed in the diagram. There has been a considerable growth in the sme business in almost all districts. Palakkad and Kannur showed more growth in the total amount of sme advances than other districts. The no.of branches in these districts are more compared to other places. Prospective entrepreneurs are encouraged by Central and State Government policies supporting the growth of sme sector in the country also paves the way for increased demand in loans for smes.
Growth in Advances for the last 5 years in Union Bank of India

Year 2006-07 2007-08 2008-09 2009-10 Amount(in cr) 63658 75878 98265 121249
66 | P a g e
2010-11
153022
Advances(in cr)
160000 140000 120000 100000 80000 60000 40000 20000 0 2006-07 2007-08 2008-09 2009-10 2010-11 Advances(in cr)
INTERPRETATION Advances of the bank showed a steady growth over the last 5 years. The bank has achieved more no.of customers over the past years with its new attractive loan products and improved customer centric business. Affordable interest rates attracted more no.of accounts over the years.
Percentage of MSME advances on total Advances

Rs in crs
Particulars Total Advances MSME % of MSME on total adv. 2006-07 63658 8833 13.86 2007-08 75878 12242 16.13 2008-09 98265 16149 16.43 2009-10 121249 22685 18.71 2010-11 153022 24735 16.16
67 | P a g e
% of MSME on Total Advances

20 18 16 14 12 10 8 6 4 2 0 2006-07 2007-08 2008-09 2009-10 2010-11
% of MSME on total adv.
INTERPRETATION Banks Micro, Small & Medium Enterprises (MSMEs) portfolio has increased from ` 8833 crore from2006-07 to ` 24,735 crore during the current fiscal 2010-11, registering a growth of 180.02% over a period of 5 years. But the percentage increase on MSME on total advances decreased from 18.71% to 16.16% from 2009-10 to 2010-11. The lower growth is on account of higher base as category reclassification of some accounts was done as per RBI guidelines in the year 2009-10.
Percentage of NPA on Net Advances

Rs in crs Year 2006-07 2007-08 2008-09 Net Advances 62386 74267 96534 NPA 601 108 326 Percentage 0.96 0.15 0.34
68 | P a g e
2009-10 2010-2011
119315 150986
965 1803
0.81 1.19
Percentage of NPA on Net Adv.

1.4 1.2 1 0.8 0.6 0.4 0.2 0 Percentage of NPA on Net Adv.
INTEERPRETATION
The percentage of NPA on net advances was well maintained under control for the last 5 years. During the financial year 2007-08, the bank has managed to keep the NPA to Net advances ratio to a very low percentage by way of efficient loan management and recovery system.
Percentage Increase in Banks Capital Adequacy Ratio

Year 2007-08 2008-09 2009-10 2010-11 CAR 12.51 13.27 12.51 12.95 Tier-1 Capital 7.45 8.19 7.91 8.69 Tier -2 Capital 5.06 5.08 4.60 4.26
69 | P a g e
Capital Adequacy Ratio

14 12 10 8 6 4 2 0 2007-08 2008-09 2009-10 2010-11 CAR Tier-1 Capital Tier -2 Capital
INTERPRETATION Bank has always maintained a fair level of Capital Adequacy Ratio for the last 4 years under monitoring. The CAR of the Bank is well above the regulatory benchmark of 9% across the years. Effective implementation of Basel II norms and management of funds for efficient risk management helped the bank to maintain the level of Tier 1 and Tier 2 capital above the benchmark level.
Growth in Net Interest Income of UBI
Year 2008-09 2009-10
Amount(in cr) 3813 4192
70 | P a g e
2010-11
6216
Amount(in cr)
7000 6000 5000 4000 3000 2000 1000 0 2008-09 2009-10 2010-11 Amount(in cr)
INTERPRETATION Net Interest Income has grown by 9.94% from 2009 to 2010 and by 48.28% from 2010 to 2011. The growth in NII from 2010 to 2011has been driven mainly due to increase in yield on funds at 8.33% as against 8.04% in the previous year and reduction in cost of funds to 5.19% from 5.51% in the previous year.
CASE STUDY
Name of the organization: M/s Ernad Constructions Pvt ltd. Nature of business: Civil contractors Nature of organization: SME
71 | P a g e
The company is engaged in civil contract business for the last 5 years. The company has undertaken and completed 5 major works so far. They are mainly doing small government construction projects like construction of roads and bridges through bidding process. Construction industry is a potential business having demand at all times. At present the company is having work in 5 different sites. At present there are no adverse policies affecting this sector. The company approached the bank for a loan amount of Rs.2.80 crs by Rs. 2.00 crs as fund based and Rs. 80 lacs non fund based.
Evaluation of Business Risk The company is mainly undertaking construction work of different government departments. Even though the company is incorporated in 2004, Mr.Ali, the Managing Director is in this line of business for the last 20 years. Building materials are locally available. They process all the necessary machinery used in construction and transportation of materials to different locations.
FINANCIAL ANALYSIS
(1) Key Financials 31.03.09 Particulars Audited 31.03.10 Audited 31.03.11 Projection
Rs. In lacs 31.03.12 Projection
72 | P a g e
Paid up capital Reserves and Surplus Loan from Directors/ Relatives Intangible assets Tangible net worth Long term liabilities Capital employed Net block Investments Net working capital Current assets Current liabilities Current Ratio Debt Equity Ratio DER(TOL/TNW) Net sales/construction receipts Net Profit After Tax Depreciation Cash accruals
1.00 1.66
1.00 4.72
50.00 19.97
50.00 47.64
8.24 0.21 10.90 _ 10.69 0.06 _ 10.92 27.17 16.55 1.64 0.00 1.55 _
19.96 0.46 25.68
19.96 _ 89.93 6.68
19.96 0.35 117.60 2.69 119.94 9.89 _ 110.04 411.04 301.00 1.37 0.02 2.59
25.22 12.50 _ 12.72 179.27 166.55 1.08 0.00 6.60
96.61 11.64 _ 84.97 360.72 275.75 1.31 0.07 3.14
45.47 2.40 _ 2.40
50.46 3.06 0.43 3.49
250 15.25 2.05 17.30
450 27.68 1.74 29.42
The ratios used for financial risk analysis is shown below:
Graph showing the change in Current Ratio

73 | P a g e
Current Ratio
Current Ratio
1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 2009 2010 2011 2012
Current Ratio
Interpretation: Current ratio: This ratio is mainly used to give an idea of the company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the more capable the company is of paying its obligations. Here it has decreased from 2009 to 2010 but projects an increase in the coming 2 years which shows that the enterprise has a good liquidity position and the repayment capacity of the enterprise is good.
Change in DER (TOL/TNW)
74 | P a g e
DER
7 6 5 Axis Title 4 3 2 1 0 2009 2010 2011 2012 DER
INTERPRETATION
DER for the year 2010 is 6.60 which are beyond the bench mark levels. Projected TOL/TNW is at acceptable levels of 3.14 and 2.59 respectively. The company is projecting a favorable level of DER which will enable them to cover all their debts without much difficulty.
Graph Showing growth in Net Sales
75 | P a g e
Year 2009 2010 2011 2012
Net Sales (Rs. In lacs) 45.47 50.46 250 450
Net Construction Receipts

500 450 400 350 300 250 200 150 100 50 0 1 2 3 4
Net Sales
INTERPRETATION The net sales/ net construction receipts are expected to rise in the year 2011 and 2012 The company has committed 5 new projects in 5 different sites and expected to earn a good amount of revenue.
Growth in Net Profit
Year
Net PAT (Rs. In lacs)
76 | P a g e
2009 2010 2011 2012
2.4 3.06 15.25 27.68
Net PAT
30 25 20 15 10 5 0 1 2 3 4 Net PAT
INTERPRETATION The Net PAT is expected to go up in 2011 and 2012 because of receipts from new projects. Expenses are managed well to increase the net profit level of the company.
Borrower Rating
No. Parameter/Criterion Parameter/Criterion A. FINANCIAL RISK f as per last audited financial statement 1 (static) I 1.50 and below DEBT EQUITY RATIO
Score 3
Max
77 | P a g e
[Term Liability to Tangible Net Worth] 2.00 and below 2 2
2.50 and below
Above 2.50
II
Ratio of Total Outside Liability to Tangible Net Worth
3.00 & below
Above 3.00-4.00
Above 4.00-5.00
Above 5.00
III.
CURRENT RATIO - Liquidity Ratio Current Assets Current Liabilities
1.33 and above 1.25 and above 1.17 and above 1.10 and above. 1.00 and above Less than one
5 4 3 2 1 0 4
IV
Return on Capital Employed Net Profit after Taxes Capita! Employed Capital Employed means = TNW + Long Term Liabilities
15% and above 12% and above 10% and above
4 3 2 3
78 | P a g e
7% and above Less than 7%
1 0
NET SALES Actual vis-a-vis Projections Indicates achievement level
100% and above
> 80% < 100%
>60% <80%
Below 50%
VI
Interest Service Coverage Ratio Measures firm's ability to pay interest Profit before Interest, Depreciation, tax - Interest
More than 2.5 2.00 to 2.5 1.99 to 1.50 Less than 1.50
3 2 1 0 2
VII
Debt Service Coverage Ratio Measures firm's ability to pay interest & instalment
>2
79 | P a g e
Net Profit Interest on TL + Depreciation > 1.50 TO 2.00 2 2
>1.10 TO 1.50
Installment + Interest on TL
< 1.10
VIII Growth in net sales As compared to previous year
>20%
>15%<20% >10%<15% Less than 10% SUB TOTAL
2 1 0 30 18 1
B.MANAGEMENT RISK I Hands on experience of the management personnel in the industry The management/proprietor's understanding of the business environment the borrower operates in. (If an experienced management of well-managed company/firm undertakes a new industry/business sector, they may be given the marks for managerial competence, as per rating of the existing account provided the industry/business sector they propose to start is related to their existing one.) Very High >5 years High (2 to 5 yrs) Moderate (<2 years) Absent (0 yrs) 3 2 1 0 3
80 | P a g e
II
Management Initiatives The initiatives of the management to stay ahead of the competitors are a clear indication of management quality. The pointers are quality certification, collaborations and marketing alliances, awards etc.
High Moderate Low
2 1 0
III
Honouring financial commitments
(to our bank Honoured on time
3 2
and other banks & Financial Institutions and Govt, Honoured but delayed within and other creditors). Consider the following to judge acceptable period (say 10 to 15 days business) the payment of practices: Not honoured - Payment of interest/instalment Retirement of bills Return of cheques A/c within limits Creditors velocity ratio - in line with the projections/acceptable level
1 0
VI
Affiliate concerns performance Absent In case there are affiliates of the same management of the borrower then this criteria to be applied, as to whether these concerns are classified as NPAs by banks/FIs. Present
2 2
81 | P a g e
VII
Market reputation of the promoters / management. (In case of adverse report on the promoters /directors, proposal will not be entertained)
Excellent image No adverse factors
2 I
VIII
Ability of the promoters / management to bail out the company in case of crisis
Yes
No
. 0
IX
Succession planning in key business areas
Yes No
1 0
Balance Sheet Practices Consider those qualifications having adverse impact on Net Profit &TNW
Unqualified Report for the past 3 years Unqualified Report for the past 2 years
2 1
Other cases
XI
Statutory Compliance Compliance with the following (a) Pollution Board (b) Environmental clearance (c) Sales Tax - Income Tax No. (d) Export/Import code (e) (list only illustrative)
Complied with
Not complied with
82 | P a g e
Sub Total
22
17
C MARKET- INDUSTRY RISK Market potential/Demand I situation Consider die following : Assessment of the market/demand for the j product being or proposed to be sold by the 1 borrower in the area of operation, | Compare demand / supply scenario. Say ! supply is short of demand can be classified I as a "good' scenario. I f supply more or less j matches demand, it can be classified as 1 "neutral' scenario. Good Neutral Unfavourable 2 1 0 2
II
Diversification among different consumer segments/geographical spread Consider the following Diversification among consumers and geographical spread of the products sold. Say whether highly diverse set of customers or products or fairly diverse set of customers / products
High Moderate Low
2 1 0
Competitive Situation Every business unit is III exposed to competitive pressures, except in monopoly. With the available information, an approximate assessment of the competitive situation should be arrived at after considering the following aspects :
Monopoly situation Favourable Neutral Unfavourable
3 2 1 0 2
83 | P a g e
a)
Number of Competitors
b) Presence of big competitors with inherent strength c) Existence of parallel Markets d) Competitive advantages enjoyed by the borrower such as cost efficiencies, superior technology, brand loyalty, etc. e) f) Market share of key products Impact of WTO liberalization
IV
Inputs/Raw materials availability The availability, quality of key inputs/raw materials is having bearing on the quality and price of the final product/services Consider the following : a) Continuous availability of quality inputs/raw materials b) Availability materials of substitutes for inputs/raw
High Moderate
2 1
Low
c) Affordability of quality inputs/raw materials
Locationa! Issues Locationai advantage might provide a borrower with a competitive advantage visa-vis competitors like availability of infrastructure, favourable government policies, nearness to raw materials/markets, etc. a) b) c) Infrastructure facilities Proximity to Inputs Proximity to markets
Favourable Neutral Un Favourable
2 1 0
84 | P a g e
d)
Presence in a state with favourable policies
VI
Technology tT.O. findings) Consider the following factors :
Superior Adequate
2 1
Availability of R&D facilities Low Proven Technology,(i.e. not subjected to changes in the immediate future) Technology likely to undergo changes (i.e. Company capable of surviving the changes.) Outdated technology
VII
Manufacturing efficiency/capacity utilisation. Consider the following : More than 90% - Good Between 75% to 90% - Satisfactory Between 50% to 75% - Average Below 50% - Below Average Provided unit is working above the breakeven point, otherwise score of 0 to be given
Good Satisfactory Average Below Average
3 2 1 0
VIII
Cyclicality/Seasonality
Not affected by cyclical x fluctuations Favourable industry cycle with long term prospects
2 1
Susecpetible to unfavourable changes in the markets/ Industry cycle Sub- total Rating of the Facility A. Compliance of Sanction Terms
18
17
85 | P a g e
Compliance of Sanction terms
All sanction terms complied with and legally enforceable documentation held on records
Only 2nd Charge not registered
EM not completed
II
Submission of Stock Statements/QPR
Timely Submission Submitted within 30 days from due date
2 1
Belated Submission beyond 30 days
III
Submission of Audited Balance Sheet & Profit & Loss A/c & Financial Data in CMA forms
Submitted within 5 months from the closure of the account Submitted within a period of > 5months < 8 months from the closure of the account
Delay > 8 months
IV.
Repayment schedule for Term Loans only
UptoS years > 5 years
2 1
V.
Operations in the account- - Turnover Commensurate with sales - Turnover > 70% to < 90%
3 2
86 | P a g e
- Turnover > 60% to < 70%
- Turnover < 60%
VI.
Operations in the account Top Pass No occasion of excess and return of cheques Satisfactory Rare occasions of excess and returns of cheques
3 2
Average Occasional excesses and return of cheques
Below Average Frequent excess and return of cheques
VII
Commitments under DPGL/Term Loan and payment of interest on cash credit/overdraft, etc.
Timely payment
Irregular/overdue upto one month from due date
Irregular/overdue beyond one month upto 2 months
Delayed beyond 2 months
VIII
Margin given on Term loan
> 40% Margin 25% to < 40%
3 2
20% < 25%
< 20%
87 | P a g e
TOTAL
21
19
III RISK MITIGATORS Availability of Collateral Security and quality of collaterals. Note: Marks to be allotted only if the formalities documentation / creations of securities are of More than75% to 100% of the total Exposure 3 3
completed in all respects. Between 50% to 75% of the exposure. 2
Less than 50% of the exposure
No Collateral Security
Availability of Guarantee Promoter' - Directors' Guarantee Third Party Guarantee Means of the Guarantor = Total Exposure (FB + NFB) TAKEN
Guarantee available
Guarantee not available
Sub- total IV Business Considerations I Length of Relationship Under "length of relationship , it Is now clarified that marks can be allotted if any group/ associate concern dealing with the bank is floating a new venture,
1
Having satisfactory relationship with the Bank for 2 > 5 years
88 | P a g e
the relationship value of the group/ associate concern can be taken in to account. Having satisfactory relationship with the Bank between 1 - 5 years 1 1
Having satisfactory relationship with the Bank for < 1 year
II
Income Value to the Bank (Merest, commission, exchange, etc.) from the account as percentage to total fund based limits SUB TOTAL
> 10% > 8% -10% < 8%
2 1 0
Rating Analysis Total Borrower rating awarded for this proposal is 58/70, which is a good score. The Financial and Management aspects are pretty good for the company. The expected Debt Equity Ratio and Current Ratio are above the benchmark level. The company has committed 5 new projects and they are expecting a net construction receipt of Rs.250 and Rs.450 lacs in the coming years which will enable them to pay back the loan without much delay. The market potential and availability of raw materials help the company to carry out its operations. Facility rating has also got a good score of 19/21. The company is prompt in submitting stock statements and audited Balance Sheet and Profit and Loss Account to the bank and it has fair operations in its account.
89 | P a g e
Other scores for Risk mitigators and Business aspects are 5/5 and 2/4 respectively. The company has provided quality collateral security which will reduce the risk factor of the bank. The current availability of funds and market conditions for the business are favorable for them and they can easily payback their liabilities with projected level of profits and capital. FINAL RATING
Parameters Borrower rating Facility rating Risk mitigators Business aspects Total marks with grade
Marks obtained 58/70 19/21 5/5 2/4 84/100
Total score obtained Grade
84% CR-2
The proposal is given a final score of 84% and obtained a grade of CR-2 which is favorable to the bank. The proposal is seen well to finance and the bank can get back the advance without much risk factor. The interest rate proposed is BPLR+ 0.25%. The bank can operate this account without having a fear of NPA. The track record of the company assures the liquidity position and repaying capacity of M/S Ernad Constructions Pvt ltd.
90 | P a g e
CHAPTER VI
FINDINGS, SUGGESTIONS AND CONCLUSION
FINDINGS
91 | P a g e
Union Bank of India is one of the premier public sector banks in India and has a deep routed customer relationship and tradition of trust that spans over years. UBI has performed extremely well during these years by committing itself to achieve complete customer satisfaction through best industrial practice. From the analysis and interpretation of data, the summary of finding is as follows: Advances of the bank have increased which is proportional to the increase in the volume of banks business. The percentage of MSME advances on Net advances also increased drastically registering a growth of 180.02% from 2006 to 2011. A good growth is seen in the overall MSME business by the bank throughout the country for the last 5years. The district wise figures of MSME also showed smart growth for the last 2 years which is mainly supported by less interest bearing loan products and favorable State and Central Government policies for MSMEs. CAR is 12.95% for the previous year which is above the industry standard of 12% Ratio of NPA to Net Advances is controlled and maintained near to the bench mark level. The credit risk rating of the UBI consists of rating for financial risk to find out the financial viability and then followed by market risk and managerial risk and track record. Financial strength of the unit to be financed is determined by debt equity ratio, debt service coverage ratio, PAT / Net sales and PAT / TNW. Financial analysis is done based on the balance sheet and P&L a/c for two years, and projections for two years. The total marks allotted are 30.
92 | P a g e
Separate and detailed rating of Financial , Management , Market , Industry ,Risk and other business factors are performed in banks Internal Rating Model External Agencies rate the proposals with a limit of over Rs.1 lakh The banks risk management architecture is well defined and structured that it will enable them to rate each and every proposal exactly and helps them to mitigate the risk accordingly.
SUGGESTIONS
93 | P a g e
A pre-requisite for an effective risk management system is the existence of a robust, Management Information System (MIS), consistent in quality. The existing MIS requires substantial up-gradation and strengthening of data collection machinery to ensure the integrity and reliability of data. The rating model should also take into consideration the capacity and efficiency of the unit for grading purpose. Bank must ensure the authenticity of the documents provided by the borrower to reduce the risk. So that if further complication arises, the bank will be safe Internal Loan Review Mechanism should be strengthened so as to reduce and ease the work of Credit Grid team Banks should always take measures to maintain and improve their CAR above 12%. Cost of NPA should be controlled by efficiently using the scheme of Credit Guarantee Fund Trust for MSMEs. Banks should release to the public, information on the level of risk and policies for risk management. This will attract more customers for UBI, having a better risk profile.
CONCLUSION
94 | P a g e
SMEs are playing a major role in the development of Indian industrial sector. The country is having 128.44 lakh SMEs as per present statistics. 39% of the total manufacturing output of India is from SMEs. More than 309.11 lakh persons are employed in this sector which shows how fast this industry is growing and their considerable contribution to the Indian economy. Risk management in financing these SMEs is one of the major areas of credit risk management in banks. The percentage of MSME advances to total advances are growing drastically year after year which shows the importance of having an efficient credit risk management in its financing. The banks shall look into the potentiality of each proposal and rate them with different criteria for an efficient risk management system in this field. The management of credit risk is possible only with its measurement. Models are the tools to effectively measure the risk exposure of various financial institutions. With the correct measure of the credit risk, its management will become effective and efficient. This research work concentrates on developing an approach to measure the credit risks associated with various MSME borrowers of the bank. I hope this work will help us to get a brief idea of how the banks are doing its risk management activities and the perfectly designed architecture in implementing this in practice.
95 | P a g e
BIBLIOGRAPHY
Books 1. Macmillan Risk Management Indian Institute of Banking and Finance Bank Reports 1. Annual Reports of Union Bank of India 2. Master Circulars and policy documents of bank
Web resources 1. www.unionbankofindia.co.in 2. www.msme.gov.in 3. KPMG report on Basel II 4. www.investopedia.com
96 | P a g e
97 | P a g e

Ashwin Menon K.P

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ashwin Menon K.P

Uploaded by

Copyright:

Available Formats

RISK MANAGEMENT IN MSME FINANCING

REPORT ON A Study on Risk Management in MSME Financing at Union Bank of India

Project Report Submitted to Christ University Institute of Management, Bangalore

CHRIST UNIVERSITY INSTITUTE OF MANAGEMENT BANGALORE -560 029

RISK MANAGEMENT IN MSME FINANCING

Ashwin Menon K.P 1020209 CUIM, Bangalore

RISK MANAGEMENT IN MSME FINANCING

Place: Bangalore Date:

Prof. Anand Aivalli (Faculty Guide, CUIM)

Prof. Dr Jeevananda S Campus Co-ordinator CUIM

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

1.1- INRTRODUCTION 1.2 - INDUSTRY PROFILE

Chapter II Chapter III

RISK MANAGEMENT OF MSME AT UBI ANALYSIS & INTERPRETATION

FINDINGS, SUGGESTIONS AND CONCLUSION

RISK MANAGEMENT IN MSME FINANCING

Chart showing the Growth in Advances of the Bank

Chart showing percentage of MSME on total advances

Chart showing percentage of NPA on Net Advances

Chart showing percentage of Capital Adequacy Ratio

Chart showing growth in Net interest income of bank

Chart showing the change in Current Ratio 8

Chart showing the change in Debt Equity Ratio

RISK MANAGEMENT IN MSME FINANCING

Chart showing change net construction receipts of the company

Chart showing Net profit of the company

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

INDIAN SME SECTOR

RISK MANAGEMENT IN MSME FINANCING

PRESENT POLICY FRAMEWORKS AND FOCUS AREAS

RISK MANAGEMENT IN MSME FINANCING

Foreign Direct Investment (FDI) Policy

Priority Sector Lending

Credit to the MSEs is part of the Priority Sector Lending

RISK MANAGEMENT IN MSME FINANCING

Credit Guarantee Scheme

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN BANKS

Emergence of Risk management in Banks

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

RISK MANAGEMENT IN MSME FINANCING

TITLE OF THE STUDY

SCOPE OF THE STUDY

RISK MANAGEMENT IN MSME FINANCING