Journal of Business Management & Social Sciences Research (JBM&SSR)          ISSN No: 2319‐5614   

Volume 2, No.7, July 2013                                                                                                                                 
_________________________________________________________________________________
 
Credit Is Inevitable In Banking: A Case Study Of Premier
Bank On Credit Appraisal & Assessment
 
Dr. Ram Jass Yadav, Assistant General Manager & Vice-Principal at Staff College, Bank of Baroda, Ahmedabad

Introduction Credit risk assessment and appraisal has been

Credit risk simply means the risk of default being
made by a customer owing to non repayment of the
credit obtained by him from a bank. Proper
evaluation of the customer measures the financial
condition and the ability of the customer to repay
loan in future. Credit appraisal is a process of
collecting related information of customers and
projects to undertake risk assessment exercise by the
bank prior providing any loans & also checks the
technical, economical & financial viability of the
project proposed. It also includes verification of
primary & collateral security available for recovery
of such funds being lent to the customer. Credit
Appraisal thus ascertains the risks associated with
lending functions in banks. It is generally carried out
by the banks which are engaged in providing finance
to its customers. In the present case, process used in
studied taking SME credit account in sample to
observe various parameters and stages in risk
assessment and appraisal process exist in one of the
largest public sector banks in India. The bank has
been named ‘Premier Bank (PB)’ in the study to keep
original identity of the bank undisclosed.
Credit Risk Assessment & Appraisal – An
Overview
Risk is inability or unwillingness of borrower-
customer or counter -party to meet their repayment
obligations/ honor their commitments, as per the
stipulated terms. Numerous tasks and activities
associated with risk assessment are summarized
below in the matrix –

Lender’s task Credit & Risk are Twins

1. Both are two sides of the same coin.
1. Identify the risk factors
2. All credit proposals have some inherent
2. Measurement of Risk
risks
3. Mitigate the risk
3. Go hand in hand
Probable reasons of risk Factors for good credit
1. Managerial ability
1. Deficiencies on the part of the management
2. Favorable business & industrial
2. Uncertainties in the business & industrial
environment
environment
3. Adequate financial strength
3. Weaknesses in the financial position
4. Proper due diligence & hedging of risk
4. Un-hedging market risks etc.

Lending being the core banking function, banks
should not deter from financing merely because of
risks in credit. A banker’s task is to identify the risk
parameters & to mitigate them on a continuous basis.
It is prudent to have some idea about the degree of
risk associated with any credit proposal and banker
should take calculated risk, based on risk-absorption
& hedging capacity of the Bank.
Credit risk assessment models adopted by the
Premier Bank take into account all possible factors
which go into appraising the risks associated with a
loan. For assessment of risk, the rating structure
evaluates four major risks such as Industry Risk,
Business Risk, Financial Risk and Management
Quality / Risks. To arrive at the overall risk rating,
the parameters are duly weighted & calibrated to
arrive at a single point indicator of risk associated
with the credit decision.
Industry Risk
The characteristics of an industry which pose varying
degrees of risk are built into Bank’s risk assessment
model such as competition, industry outlook,
regulatory risks, contemporary issues. The
assessment of this part is external to the borrower and
is done through assessment of Industry related macro

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Journal of Business Management & Social Sciences Research (JBM&SSR)          ISSN No: 2319‐5614
Volume 2, No.7, July 2013                                                               
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- economic parameters like demand supply gap,
capacity utilization level, financial ratios like ROCE /
OPM etc. applicable to the specific Industry and
having different risk weights.
Business Risk
The assessment of this factor is based on internal
working of the borrower and relates to parameters
such as after sales service, distribution set up etc. The
parameters, which are only relevant to a particular
industry, are selected for scoring having different risk
weights.
   
                                                                  
the parameters related to the management such as
integrity (corporate governance), track record,
managerial competence / commitment, expertise,
structure & systems, experience in the industry,
credibility - ability to meet sales projections, ability
to meet profit (PAT) projections, Payment record,
Strategic initiatives, Length of relationship with the
Bank and many more. Thus, internal being the factors
to assess this parameter the score would base on
internal working of the Borrower’s management and
relates to parameters such as past repayment record,
quality of information submitted, group support etc.

Financial Risk Taking above broad parameters into account, the

The assessment of financial risk includes appraisal of
the financial strength of the borrower based on
performance & financial indicators. The overall
financial risk is assessed in terms of static ratios,
future prospects & risk mitigation (collateral security
/ financial standing). The assessment of this
parameter is based on internal working of the
borrower and relates to parameters such as past (not
in case of a green field / infrastructure company
under implementation stage) and projected financials.
The CMA based data input sheet is uploaded into the
software and the same allows computation of
financial rating automatically based on the
computation of financial ratios like Net Profit
Margin, Current Ratio, DSCR, Interest Coverage etc.
Management Quality
The management of an enterprise / group is rated on
bank assesses the risk under three dimensions such as
obligor rating to determine investment grade and
worthiness of the customer based on the assessment
of past and projected cash flows of the borrower and
it indicates probability of default (PD). It’s grading
range from PB-1 to PB-10. Facility rating evaluates
the riskiness of facilities assessed on the basis of
security coverage for a given facility indicating the
Loss Given Default (LGD) and its grades range from
FR-1 to FR-8. The composite rating is the
combination of PD and LGD indicating the expected
loss (EL) in case the facility defaulted which is
worked out automatically by the software based on
the matrix of obligor & facility rating. The rating
grades and their description for credit risk assessment
is tabulated below-

Obligor Rating Facility Rating Composite Rating

PB-1 Highest Safety FR-1 Highest Safety CR-1 Lowest Expected Loss
PB -2 High Safety FR-2 Higher Safety CR-2 Lower Expected Loss
PB-3 High safety FR-3 High Safety CR-3 Low Expected Loss
PB-4 Adequate Safety FR-4 Adequate Safety CR-4 Reasonable Expected Loss
Adequate Coverable expected
PB-5 Moderate Safety FR-5 Reasonable Safety CR-5
Loss
PB-6 Moderate Safety FR-6 Moderate Safety CR-6 Moderate Expected Loss
PB-7 Inadequate Safety FR-7 Low Safety CR-7 Extra Expected Loss
PB-8 High Risk CR-8 High Probability of Loss
Lowest Safety /
Default Substantial
PB-9 FR-8 Clean Loans / Totally CR-9 Higher Probability of Loss
Risk
Unsecured
PB-10 Default CR-10 Highest Expected Loss
Note – Obligor rating from PB-1 to PB-6 are considered to be investment grade

Besides the above risk assessment module (RAM) exposure of INR 20 Mn. Applicability and grading
applicable for loan exposure of INR 2.5 Mn and under this module is tabulated below-
above, the Premier Bank has also separate risk
assessment model for SME customers with

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Journal of Business Management & Social Sciences Research (JBM&SSR)          ISSN No: 2319‐5614   
Volume 2, No.7, July 2013                                                                                                                                 
_________________________________________________________________________________
 

Exposure Level (FB+NFB) Credit Module Rating Grade

Obligor Facility Composite
INR 0.2 Mn to INR 20 Mn MSME Score type CR 1 / MSME 1 to 10
Over INR 20 Mn PBRAM PB 1-10 FR-1 to 8 CR 1 to 10

For new borrowers of SME segment with new
projects, scoring to be done based on parameters of
Financial Performance and Adequacy of tangible
security of the module. The interest rate applicable
will be based on actual rating subject to the
applicable rate to the rating worked out actually or
applicable to CR 3 – whichever is higher. This
parameter of adequacy of Tangible collateral security
is not applicable to the existing advance accounts, if
not stipulated in sanction specifically. This parameter
is also not applicable in case of accounts covered
under credit guarantee fund trust for micro & small
enterprises (CGTMSE) scheme and Government
sponsored schemes wherein obtaining of collateral
security is not permitted.
Credit appraisal process begins from generating the
business lead and ends while lead is closed i.e.
amount is disbursed. Numerous layers of credit
appraisal are depicted in appendix -1 which explains
the flow of activities involved in proposal appraisal.
Both credit risk assessment and appraisal have been
studied taking a real case of SME client M/s
Hindustan Industries which was processed by SME
Loan Hub (SMELH) of the Premier Bank.
Credit Appraisal & Assessment – A Case of
SME unit: M/s Hindustan Industries
M/s Hindustan Industries is a proprietorship firm
constituted in April 2012 engaged in manufacturing
of Lead Acid Batteries. Firm is registered with
District Industries Center (DIC) Jaipur as Small
enterprises (manufacturing) and it is also registered
with Central Sales Tax department for the purpose of
manufacturing & trading of Cell, Batteries,
Invertors, Electric transformers, Lead Plates,
stabilizers etc. Firm has power connection of 50HP
from State Electricity Board. NOC from Pollution
Control Board has been obtained to set the unit. Firm
has commenced its operations from May 2012 and its
product is largely consumed by the associate concern
M/s Indian Batteries Private Limited which is already
in the field of trading of batteries for last 10 years.
Besides, other important clients of the firm are M/s
New Super Power House, Jaipur; M/s Bharat Battery
House, Jaipur; M/s Pawan Battery House, Jaipur thus
the firm has no problem for marketing its products.
Main raw materials of the firm is Lead, Lead Oxide,
Red Oxide, Acid, Tub Bag 115 MM, Tub Bag 250
MM, Battery P P Container, Peg Separator, I T
separator, Indicator. Some of the main suppliers of
raw material to the firm are M/s Manoj Metal,
Kanpur; M/s Luxmi Industries, Ghaziabad; M/s
Siddharth Traders; M/s Accum Bags, Delhi; M/s j G
Exports, Delhi, M/s Associated Traders, Delhi.
Proprietor of the firm has rich experience of this line
of activity and she will be closely assisted by her
husband Mr. K S Jha who along with the proprietor
of the borrowing firm is director of associate concern
M/s Indian Batteries Private Limited. Firm is
maintaining current account with our Jaipur Branch
& the conduct of account is satisfactory. Factory
land value of INR 7 Mn is in name of the firm and
would be available for the security in loan from bank.
Besides firm is eligible to be covered under collateral
free lending scheme of finance under CGTMSE
Scheme and customer is agreed for the same.
Customer has requested for a term loan of INR 7 Mn
and working capital limit of INR 3 Mn for purchasing
plant & machines and cash credit to run her unit
successfully. SMELH needs to take decisions on the
proposal (received 17.02.2013) to adhere to
turnaround time (TAT) which is 14 days at present.
The cost of project and means of finance for the
proposed term finance is given below: -

INR Mn
Cost of Project Amount Means of Finance Amount
Land Development & Building 3.00 Promoters Contribution 9.50
Plant & Machinery 11.65 Term Loan 7.00
Margin Money of Working Capital 1.85
Total 16.50 Total 16.50
1. DE ratio of the project works out 0.74, which is favorable for bank finance.
2. Firm has requested Term Loan only for Plant & Machinery as other items of the project would be self

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Volume 2, No.7, July 2013                                                                                                                                 
_________________________________________________________________________________
 
financed by the firm.
3. Overall margin on cost of project is 57.57% as against normally acceptable margin between 25-30%.

The firm proposed to repay the term loan amount of

INR 7 Mn in 80 monthly installments on ballooning moratorium) and ending in January 2020. The
pattern commencing from June 2013 (after 4 months implementation schedule is given below:

Particulars Date of Commencement Date of Completion

Land Already acquired from RIICO
Building Construction Already Completed
Order for Plant & Machinery Orders already placed March 2013
Installation of P & M March 2013 March 2013
For Additional power Load (existing February 2013 March 2013
Load is 50 KVA)
Trial Run March 2013 March 2013
Commercial Production April / May 2013
The synopsis of estimated / projected financial has been depicted in appendix -2

Findings of the Case
1. Proprietor of the firm has rich experience of this
line of activity and she will be closely assisted
by her husband Mr. K S Jha who along with the
proprietor of the borrowing firm is director of
associate concern M/s Indian Batteries Private
Limited which is in the business of trading of
batteries for last 10 years.
2. Firm has commenced its operation from May
2012 and its product is largely being consumed
by the associate concern M/s Indian Batteries
Private Limited besides firm has tied up with
good number of buyers of its product thus the
firm has no problem for marketing its products.
5. Being the first year of its operation firm has
estimated to achieve sales of INR10.65 Mn for
the period ending 31.03.2013. Firm has so far
achieved sales of INR5.33 Mn till January
2013(as per sales VAT/Tax returns, & firm’s
book of accounts) which is over 50% of the total
estimated sales. Firm has also mentioned that
summer season commences from last week of
March thus demand of batteries will be high
from current month and firm has confirmed
orders of batteries for February & March 2013
for INR2.57 Mn & INR 2.78 Mn respectively
from M/s Indian Batteries Private Ltd well in
advance hence the firm will easily surpass the
estimated sales target.

3. Firm has all necessary infrastructure including 6. Firm has installed capacity of manufacturing
power connection, water, manpower to meet the 1250 batteries per month i.e. 50 batteries per day
demand of the market & after installation of but to be on conservative side it has projected
following capacity which is reasonable
4. proposed additional plant& machinery the
capacity of the firm will further increase to 150
batteries per day.

Year 2014 2015 2016 2017 2018 2019 2020

Installed capacity 50 50 50 50 50 50 50
(No. of batteries per day)
Capacity utilization (%) 28% 32% 36% 40% 44% 48% 52%
Projected capacity 14 16 18 20 22 24 26
(No. Of batteries per day)
Sales price per battery (INR) 5050 5050 5050 5050 5050 5050 5050
Total Sales (INR in Mn) 21.21 24.24 27.27 30.30 33.33 36.33 39.39
(assuming 300 working days in a year)

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Volume 2, No.7, July 2013                                                               
_________________________________________________________________________________
7. With the increase in capacity after proposed
installation of additional machines firm has
estimated to increase capacity from 7 batteries
per day to 14 batteries per day in first year of its
operations after installing the new machines i.e.
year 2014 and hence projected to achieve sales
of INR21.21 Mn for the year ending 31.03.2014
based on the assumptions that average sales price
per battery is INR5050. Looking to the high
demand of the product in the market, reputed
name of the associate concern in this field, rich
experience of the proprietor the
estimated/projected sales is reasonable & thus
acceptable.
8. Being the regulatory manufacturing MSE Unit,
guarantee cover of INR 6.25 Mn is available
under CGTMSE Scheme besides bank’s charge
on primary securities.
9. Firm has already acquired the land situated at
D-2, Industrial Area, Sitapura, Distt- Jaipur
admeasuring 2110.50 sq. mtrs standing in the
name of M/s Hindustan Industries through its
proprietor taken on 90 years lease from RIICO,
Jaipur
10. Firm has already constructed the building on it
and had commenced its operation of
manufacturing of batteries from May 2012. Also
orders of proposed machines have been placed so
that their supply could take place in time.
11. All necessary approvals & licenses/ registration
have already obtained by the firm to run the unit
successfully.
12. Project has been assessed from financial point of
view and repayment capacity gauged in terms of
DSCR & ICR of the project assessed over the
bank’s norms of average DSCR of 1.75 (not
below 1.25 in individual year) and ICR of 5
times thus proposal is financial and
economically viable.
13. Minimum margin towards working capital and
capital goods to be kept at least 25%. Also
SMELH to observed policy guidelines of the
bank for working capital financé to SMEs.
14. Rate of Interest would be @ 3.25% over
Base Rate i.e.13.50 % p.a. at present with monthly
rest subject to change in Base Rate and MSME Score
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Card type Credit rating from time to time as per
Bank’s extant guidelines
Conclusion
Credit appraisal is done to assess the technical,
economical and financial viability of the project.
Loan policy of Bank contains various norms for
sanction of different types of loans under SME
segment and all these norms do not necessarily apply
to each & every case. The credit risk assessment
models adopted by the bank take into account all
possible factors which go into appraising the risk
associated with a loan. These have been categorized
broadly into financial, business, industrial, and
management risks. Rating of the account is being
worked out under three dimensions such as Obligor,
Facility and Composite rating to determine
investment grade and also to charge rate of interest.
The assessment of financial risk includes appraisal of
the financial strength of the customer based on
performance & financial indicators. Non financial
parameters are also being considered in person
appraisal and credit scores of the credit information
bureau / companies are also given due weight age in
appraisal of credit business. Credit risk arising from
lending business in banks is therefore, two sides of a
coin and bankers should never deter from financing.
Banks need to strengthen their credit risk assessment
mechanism and appraisal process for qualitative
growth in credit and also to mitigate risks effectively.
References
[1] Gombola, M. J, and Ketz, J. E., 1983, A note on
cash flow and classification patterns of financial
ratios, The Accounting review LVIII, 105-14
[2] Hsiu-Kwang W. (1969), “Bank Examiner
Criticisms, Bank Loan Defaults, and Bank Loan
Quality” The Journal of Finance, Vol. 24,
September, 697-705.
[3] I.M.F (International Monetary Fund) (1997),
“Banking Soundness and Monetary Policy in a
World of Global CapitalFlows", Proceedings of
the Seventh Central Banking Seminar, Jan. 27-31
Washington D.C.
[4] Martin Omara – Credit assessment process and
repayment of bank loans in Barclays Bank
Uganda Ltd, A research report submitted to
Makerere University Business School (MUBS)
in Partial fulfillment of the requirements for the
award of a degree of Masters of Business
Administration (MBA) of Makerere University,
June, 2007
[5] Nancy Arora – ‘Credit Appraisal Process of SBI
– A Case Study of Branch of SBI in Hissar’ :
 
Journal of Business Management & Social Sciences Research (JBM&SSR)          ISSN No: 2319‐5614
Volume 2, No.7, July 2013                                                               
_________________________________________________________________________________
Arth Prabhand: A Journal of Economics and
Management, Vol.2 Issue 1, January 2013, ISSN
2278‐0629
[6] Sathya Varathan & others- ‘Credit policy and
credit appraisal of Canara bank using ratio
analysis’ - International Multidisciplinary
Research Journal 2012, 2(7):19-28, ISSN: 2231-
6302
[7] SIDBI Report on MSME Sector – 2010. Extract
of studies / survey on Contemporary studies
taking 200 MSMEs (42 Micro, 114 Small & 44
Medium Enterprises) into its sample from all
over India.
[8] Sun, J., & Li, H, (2008).Data mining method for
listed companies’ financial distress prediction.
Knowledge-Based Systems, 21(1), 1–5.
[9] Thorsten Beck, Asli Demirgüç-Kunt,María
Soledad Martínez Pería, Policy Research
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Working Paper 4785 on “Bank Financing for
SMEs around the World Drivers, Obstacles,
Business Models and Lending Practices; The
World Bank, Development Research Group,
Finance and Private Sector Team, November
2008
[10] Yadav Ram Jass (Dr) – Issues in SME
Financing, Macro Research Project, Indian
Institute of Banking & Finance, Mumbai, June
2012
[11] Yadav Ram Jass (Dr) – MSME Finance :
Viability study from Bankers’ perspective,
International Journal of Advanced Research in
Management and Social Sciences ISSN: 2278-
6236 Vol. 1 | No. 1 | July 2012 www.garph.co.uk
IJARMSS | 50
 
Journal of Business Management & Social Sciences Research (JBM&SSR)          ISSN No: 2319‐5614   
Volume 2, No.7, July 2013                                                                                                                                 
_________________________________________________________________________________
 
Credit Appraisal Process Appendix -1
1. Generating Business Leads

2. Receipt of application from applicant

3. Receipt of documents (Balance sheet, KYC papers, Different govt.

registration no., MOA, AOA, and Properties documents)

4. Due diligence of Loan Arranger & customer

5. Pre- sanction visit by bank officers

6. Check for RBI defaulters list willful defaulters list CIBIL data, ECGC
caution list etc.

7. Title clearance reports of the properties to be obtained from empanelled

advocates

8. Valuation reports of the properties to be obtained from empanelled valuer

/engineers

9. Activity & Industry Analysis –Viability assessment

10. Verify authenticity of Financial statement from various sources –

MCA21, diligence report etc.

11. Preparation of financial data (CMA Data)

12. Risk Assessment – Credit Rating

13. Proposal preparation (MCB Note)

14. Assessment of Limit – Quantum of loan

15. Sanction / approval of proposal by appropriate sanctioning authority –

Also PSR note

16. Documentations, agreements, mortgages

17. Disbursement of loan

18. Post sanction activities such as receiving stock statements, review of

accounts, renew of accounts, etc
Synopsis Of Balance Sheet Appendix-2

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(INR in Mn)
Particulars 31.03.13 31.03.14
Estimated Projected
Period (months) 11 12
Paid up Capital - Firm’s Capital 9.26 9.37
Reserves & Surplus (Excl. Revaluation reserves and net 0.35 0.27
of intangible assets)
Tangible Net worth 9.61 9.64
Term Liabilities of which. Unsecured loan 6.50 5.78
Capital Employed 16.11 15.42
Net Block 14.41 13.54
Current Assets 5.42 6.04
Current Liabilities 3.71 4.16
b) Operational Data
Net Sales 10.61 21.21
Manufacturing expenses 9.27 17.05
Adm. & Selling expenses 0.52 1.06
Depreciation 0.25 1.57
Interest 0.21 1.25
Profit before tax 0.36 0.28
Net Profit After Tax 0.35 0.27
Profitability Ratio
Net Profit/Sales (%) 3.30 1.27
NP/capital employed (%) 2.17 1.75
PAT/TNW (%) 3.64 2.80
Current Ratio 1.46 1.45
DE Ratio (TTL / TNW) 0.68 0.60
  DE Ratio (TOL / TNW) 1.06 1.03
 
Profitability and Repayment Trend of Term Loan
                      (INR in Mn) 
Year 31st March 2014 2015 2016 2017 2018 2019 2020
PAT 0.27 0.76 1.33 1.72 2.23 2.73 3.13
Depreciation 1.57 1.41 1.26 1.23 1.12 1.00 1.00
Interest on T/L 0.87 0.81 0.72 0.60 0.45 0.30 0.15
T/L installments 0.50 0.72 0.96 1.20 1.20 1.20 1.22
  3. To list various items of due diligence while
Suggestive Notes for the Case appraising the borrower and proposal
4. To get acquaintance of methods of lending for
Administrator in Class working capital finance prevailing in the Bank
Trainees should be given adequate time to thoroughly and based on the understanding of methods need
read the case with basic objectives – based working capital limit to be worked out for
1. To be aware of the flow of credit appraisal and funding
various parameters associated with the credit risk 5. To know various norms of term lending such as
assessment. margin, verification of project cost envisaged in
2. To understand modalities how the credit risk the proposal, important factors to be kept in
assessment module (RAM) functions in the mind during pre-sanction visit of the site.
Bankto determine investment grade of the 6. To recommend ways for making the credit risk
proposal and also to ascertain pricing (ROI) in assessment & appraisal more effective at
account operating units of the branches. 

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