What are the discouraged business areas of Trust Bank Ltd.?
Ans. Bank will not grant any facilities to the following business types:
i). Bridge loan relying on equity/debt issuance as a source of repayment.
ii). Counter parties in counties subject to UN sanctions.
iii). Finance of speculative investments.
iv). Finance of military equipments/weapons.
v). Highly leveraged Transactions.
vi). Lending to holding companies.
vii). Lending to slow moving items.
viii). Logging, Mineral extraction/mining or other activity that is ethically or environmentally sensitive.
ix). Lending to companies listed by CIB as defaulters or known defaulter/habitual defaulter.
x). Highly perishable goods stored in godown.
xi). Share lending.
xii). Taking an equity state in borrower etc.
What do you mean by cross border risk?
Ans. Borrower of a particular country may be unable or unwillingly to fulfill principle and interest obligations. Difficulty may be raised in following situations:
i). Suspension of external payments.
ii). Synonymous with political & sovereign risk.
iii). Third world debt crisis, for example, export documents negotiated for countries like Nigeria.
As per section 126 of the Indian Contract Act 1872, “A contract of guarantee is a contract to perform the promise or discharge the liability of a third person in case of his default”
The person who gives the guarantee is called ‘surety’ or ‘guarantor’. The person in respect of whose default the guarantee is given called the ‘principal debtor’ & the person to whom the guarantee is given called ‘creditor’ or ‘beneficiary’.
A contract of guarantee thus a secondary contract, the principal contract being between the creditor and the principal debtor themselves to which guarantor is not a part. If the promise or liability in the principal contract is not fulfilled or discharged, only than the liability of the guarantor arises.
From Banks point of view Guarantee may be two kinds:
i). Guarantee taken by the bank as security against the advance.
ii). Guarantees required by customers from banks in the course of their normal trading.
In other sense Guarantee may be two kinds:
i). Specific guarantee: Specific guarantee means a guarantee for one specific transaction.
ii). Continuing guarantee: A continuing guarantee is that which extends to a series of transactions. (Sec.129)
As per section 124 of the Indian Contract Act 1872, indemnity is “ A contract by which one party promises to save the other from loss caused to him by the conduct of the promisor himself or by the conduct of any other person”
Rights of indemnity holder:
- Indemnity holder is entitled to recover all damages.
- Indemnity holder is entitled to recover all costs.
- Indemnity holder is entitled to recover all sums paid under any compromise.
Banks & letter of indemnity:
i). Loss of Term Deposit Receipt.
ii). Issue of a duplicate draft.
iii). Loss of Travelers Cheque.
iv). Loss of safe custody receipt.
v). Loss of gift cheque.
Revocation of continuing guarantee:
i). By Notice: A continuing guarantee may at any time revoked by the guarantor as to future transactions, by giving a distinct notice to the creditor.
ii). By death: Death of the guarantor will operate as a revocation of the continuing guarantee with regard to the future transactions unless the contract provides otherwise.
When Guarantee will be invalid? What are the distinguish between ‘Guarantee’ & ‘Indemnity’?
Ans. a). Guarantee given by misinterpretation/misunderstanding.
b). Guarantee obtained by concealment.
c). In cases co-surety does not join.
Distinguish between ‘Guarantee’ & ‘Indemnity’:
|There Are three parties to the contract of guarantee, namely, the debtor, the creditor and the guarantor||There are two parties to the contract of indemnity, namely, the indemnifier & the indemnified.|
|Liability under guarantee, principal debtor has primary liability. If he fails than surer have to fulfill his obligation.||Under indemnity, indemnified is primarily & independently liable if the loss occurs.|
|In the case of guarantee, there is an existing debt or obligation, the performance of which is guaranteed by the surety.||In a contract of indemnity, the liability of the indemnified arises only on the happening of a contingency.|
|Guarantors undertakes his obligation at the request of the third person(Principal debtor).||Indemnity is given or obligation is undertaken without any request, expressed or implied of the debtor.|
|A guarantor can file a suit in his own name against the debtor, if he pays the debt or perform the obligation.||The indemnified cannot sue third parties in his own name unless there is the assignment.|
What are the essential elements for a contract of guarantee?
Ans. i). Oral or in writing: A contract of guarantee may be either oral or written. Banks invariably like to have a written contract of guarantee to avoid uncertainty in future and to bind the security by his words.
ii). Implied guarantee: A contract of guarantee is sometimes implied from the circumstances or nature of the transactions.
iii). Consideration: A guarantee must be supported by lawful consideration between parties. i.e. Creditor, Principal Debtor and surety.
iv). Not a contract of utmost good faith: As a general rule, a guarantee is not a contract of utmost good faith. The banker is therefore no obligation to disclose to the surety the past conduct of the debtor or full facts relating to his state of affairs.
v). Effect of misinterpretation or concealment of material facts: Since a guarantee is not contract of utmost good faith, there is no duty upon the bank to disclose the details relating to the customers account. But if the prospective guarantor asks for some specific information, the banker is under obligation to make statements which are accurate and not capable of being misconstrued.
FINANCIAL STATEMENT ANALYSIS
When a borrower approaches a banker for a loan, the banker usually take the five “Ps” into account. These are People, Purpose, protection, Prospects & Payment.
People: Caliber of the people can be judged with reference to their know how of their business as reflected in their production, purchase, sales, financial & personal policies.
Purpose: Can be ascertained by interviewing the borrower.
Prospects: Prospects of the borrowing concern can be judged by looking to both the person and future profitability of the concern.
Payment: The capacity of payment has to be judged on the basis of present & prospective liquidity of the concern.
Protection: Protection has to be judged on the basis of the tangible asset backing which the company enjoys.
Analysis of financial statements greatly helps a baker in studying particularly the last three “Ps” i.e. Prospects, Payment & Protection.
Financial Statements: Financial statements show the financial position of the entity at the time of the report and also the operating results by which the entity arrived at this position. The basic purpose of financial statements is to assist decision makers in evaluating the financial strength, profitability and future prospects of a business entity.
Income Statement: This is also termed as profit & loss statement. The purpose of income statement is to determine the operating result or net income of a business entity for a specific period of time. Net income is equal to revenue minus expenses.
Balance Sheet: A balance sheet consists of the assets, liabilities and the owners equity of a business entity. A fundamental characteristics of a balance sheet is ASSET=LIABILITIES +OWNERS EQUITY. The purpose of balance sheet is to show the financial position of a business entity at a specific time.
What are the basic nature of financial statements?
Ans. a). Recorded facts: The terms recorded facts means facts which have been recorded in the accounting books.
b). Accounting conventions: Accounting conventions imply certain fundamental accounting principles which have been sanctified by long usage.
c). Personal judgment: Personal judgments have also an important bearing on the financial statements.
- What things bankers wants to find out by interpretation & analysis of financial statements?
Ans. i). Financial strength & weakness of the company.
ii). Status of Sales or production.
iii). Companies profitability & earning position.
iv). Companies liquidity.
v). Credit policy of the company.
vi). Extent of profit retained.
vii). Companies long term loan.
viii). Extent of over trading.
What are the distinguish between “Analysis” & “Interpretation” ?
Ans. The term ‘Analysis’ means methodical classification of the data given in the financial statements. The figures given in the financial statements will not help one unless they are put in a simplified form. The term ‘interpretation’ means explaining the meaning and significance of the data so simplified.
Both ‘Analysis’ & ‘interpretation’ are complimentary to each other. Interpretation requires analysis, while analysis is useless without interpretation. Most of the authors have used term ‘Analysis’ only to cover the meaning of both analysis and interpretation, since analysis is largely a study of the relationship among the various financial factors in a business as disclosed by a single set of statement and study of the trend of these factors as shown in a series of statements.
What are the limitations of financial statements?
Ans. 1. Financial statements are essentially interim reports.
- Accounting concepts and conventions.
- Influence of personal judgment.
- Disclose only monetary facts. What do you mean by common size financial statements?
Ans. Common size financial statements are those in which figures reported are converted into percentages to some common base. In the income statement the sale figure is assumed to be 100 and all figures are expressed as a percentage of this total.
- What is cash flow statement? What are the major parts of cash flow statement? What are the purposes of cash flow statement?
Ans. The statement of cash flows reports the cash receipts, cash payments and net changes in cash resulting from the operating, investing and financing activities of an enterprise during a period in a format the reconciles the beginning and ending cash balances.
The cash flow classifies cash receipts and cash payments from following three activities:
a). Operating activities: Include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income. Generally operating activities involve income determination (Income statement) items.
b). Investing activities: Include- i). acquiring and disposing of investments and productive long lived assets, and ii). Lending money and collecting the loans. Generally investing activities involve cash flows resulting from changes in investment and long term asset items.
c). Financing activities: Include – i). Obtaining cash from issuing debt and repaying the amounts borrowed, and ii). Obtaining cash from stock holders and providing them with a return on their investment. Generally financing activities involve cash flows resulting from changes in long term liability and stock holders equity items.
Purposes of cash flow statement:
The information in a statement of cash flows should help investors, creditors and others assess various aspects of the firms financial position:
- The entities ability to generate future cash flows.
- The entities ability to pay dividends and meet obligations.
- The reason for the difference between net income and net cash provided by operating activities.
- The cash investing and financing transactions during the period.
- What do you mean by Fund flow statement? What are the benefits of fund flow statement?
Ans. The fund flow statement is a report that shows how the activities of the business have been financed and the financial resources have been generated during a particular period.
Benefits of fund flow statement:
i). The fund flow estimate helps a banker to fix up a well timed repayment schedule. If in the earlier years funds accrual is less, a higher installment can not be stipulated.
ii). Fund flow statement helps to know whether there is need for funds for operation of the business.
iii). It informs the banker the investing and financing policies pursued by the company in the year under review.
iv). In details it shows why the company is not in a position to meet the obligations such as taxes, wages, bonus, dividend etc. in spite of profits. It also suggests the ways in which the position of working capital can be improved.
v). It indicates how dividends are distributed in excess of current earning i.e. whether dividends are paid out of profits or out of capital itself or borrowed funds.
vi). Fund flow helps the banker to know how the borrowing have been repaid. From the existing behavior, bankers may able to receive an overall idea on client’s repayment behavior.
- What are the distinguish between ‘Fund flow’ & ‘Cash flow’ statement?
Ans. Fund flow analysis reveals/disclose the changes in working capital position. It tells us about the sources from which the working capital was obtained and purposes for which it was used. It brings out the open the changes which have been taken place behind the Balance Sheet. Working capital being the life blood of the business, such an analysis is extremely useful.
Cash flow analysis tells about the sources and application of cash. It emphasis is on short term liquidity of the firm.
- What do you mean by ‘capital budgeting’ & ‘capital structuring’?
Ans. Capital Budgeting: The process of planning & managing of a companies long term investment is called capital budgeting. Loosely speaking this means that the value of cash flow exceeds the cost of that assets.
Capital Structuring: A firms capital structuring or financial structuring is the specific mixture of long term debt and equity the firm uses to finance it’s operation.
- Write short notes on the followings:
a). Corporation: A business created as a distinct/separate legal entity composed of one or more individuals on entities. A corporation is a legal ‘person’ separate & distinct from its owners and it has many of the rights, duties & privileges of an actual person.
b). Agency problem: The possibility of conflict between stockholders & management is called agency problem.
c). Agency cost: Agency cost refers to the cost of the conflict of interest between stock holders & management.
d). Stakeholder: Stakeholder is someone other than a stockholder who potentially has a claim on the cash flow of the firm. Employees, Customers, Suppliers & even a Government all have a financial interest in the firm.
- Write down the classification of credit needs in a business?
Ans. The credit needs of a business can broadly be classified into two categories. These are:
i). Short term credit needs: They are for meeting the working capital requirement of a business. They are usually meant for a period up to one year. Such advances may be in the form of loans, cash credit, overdrafts, bills discounted & purchased.
ii). Medium term credit needs: It includes credit needs for a period between one year and five years.
iii). Long term credit needs: It includes credit needs for a period exceeding five years.
- What is working capital? What are the different categories of working capital? What do you mean by operating cycle?
Ans. The term working capital means capital required by a business to carry out its day to day operations in particular to complete the operating cycle of the business. In the course of running a business, payments have to made for raw materials, wages, manufacturing and other expenses. However, money on account of sale for goods or services is not immediately realized. It may take time depend upon the credit terms prevailing in the business. The business must have sufficient fund for this period.
Working Capital can be divided into two categories on the basis of time. These are:
i). Permanent working capital: This refers to that minimum amount of investment in all current assets which is required at all times to carry out minimum level of business activities. This is also known as ‘core current capital’. (Characteristics: i). Amount of permanent working capital remains in the business in one form or another ii). It also grows with the size of the business).
ii). Temporary working capital: The amount of such working capital keeps on fluctuating from time to time on the basis of business activities. In other words, it represents additional current assets required at different times during the operating year.
Operating cycle: In the course of running a business, payments have to made for raw materials, wages, manufacturing and other expenses. However, money on account of sale for goods or services is not immediately realized. It may take time depend upon the credit terms prevailing in the business. From the above it is clear that working capital is required because of the time gap between the sales & their actual realization in cash. This time gap is technically termed as Operating cycle of the business.
CREDIT RISK GRADING MANUAL
- Under which changes is going on? GLCDC
- what are the steps of CRM to select good credit risk? IAGPM
- Risk identification
- Risk assessment
- Risk grading
- Risk pricing
- Risk monitoring
- What are the factors of risk identification?
a). Risk factors internal banks and financial institutions.
b). Risk factors external on account of borrower.
a). Risk factors internal banks and financial institutions: PEMFM
- Risk in planning
- Risk in execution/implementation
- Marketing risk
- Financial risk
- Managerial risk
b). Risk factors external on account of borrower:
- Input/Utility availability
- Natural calamities
- Technological obsolescence
- Political situation
- Write down the definitions of Credit Risk Grading?
- Credit risk grading is a collective definition based on pre specified scale and reflects the underlying credit risk for a given exposure.
- A credit risk grading deploys/arrange a number/alphabet/symbol as a primary summary indicator of risks associated with a credit exposure.
- Credit risk grading is the basic module to develop a credit risk grading management.
- What are the functions of credit risk grading?
Ans. Credit risk grading system promote bank safety & soundness by facilitating informed decision making. It helps us to differentiate individual credit & group credit on the basis of risk they possess. This helps banks management to monitor changes and trends in risk level. The process also helps the management to manage risk & optimize return.
- Write down number & names of grade used in the CRG?
|GOOD||GD||2||85 OR MORE|
|BAD & LOSS||BL||8||LESS THAN 35|
- Define different categories of credit risk grading?
|Superior (sup) – 1||Fully secured credit by cash collateral or by the guarantee from Govt. or Int’l bank.|
|Good (GD) – 2||Strong repayment capacity of the borrower with excellent liquidity & leverage.|
|Acceptable (Accpt) – 3||Consistent earnings, cash flow with good track record, adequate liquidity and earnings.|
|Marginal/Watchlist (MG/WL) – 4||Greater attention required & have an above average risk due to strained liquidity, higher than normal leverage & thin cash flow.|
|Special Mention (SM) – 5||Potential weaknesses deserve management close attention, if left uncorrected, these may result in a deterioration of the repayment prospect.|
|Sub Standard (SS) – 6||Weak financial condition|
|Doubtful (DF) – 7||Full repayment is unlikely & possibility of loss is extremely high.|
|Bad & Loss (BD) – 8||Long outstanding with no progress & prospect of recovery is poor & legal option have been pursued.|
- Write down the distribution of weight age of risk components?
|Broad Risk head||Sub Risk areas with %||Total weighted %|
|Financial Risk||Leverage – 15%, Liquidity – 15%, Profitability – 15%, coverage -5%||50%|
|Business Risk||Size of business-5%, Age of business- 3%, Business outlook-3%, Industry growth-3%, Market competition – 2%, Barriers in business-2%||18%|
|Management Risk||Experience – 5%, Succession – 4%, Team work – 3%||12%|
|Security Risk||Security coverage – 5%, Collateral coverage -3%, Support – 2%||10%|
|Relationship Risk||Account conduct-5%, Limit Utilization – 2%, Compliance of covenants-2%, Personal deposit – 1%||10%|
- What are the papers required to consist with during credit risk grading ?
Ans. All credit proposals whether new, renewal or specific facility should consists of a) Data collection checklist b). Limit utilization form c). Credit risk grading score sheet and d). Credit Risk Grading Form.
- What do you mean by Early Warning Signals? Which categories of risk grading may fall into Early Warning Signals?
Ans. Early Warning Signals: Early Warning Signals indicates risks or potential weaknesses of an exposure requiring monitoring, supervision, or close attention by management. If these weaknesses are left uncorrected, they may result in deterioration of the repayment prospect in the banks assets at some future date with a likely prospect of being downgraded to classified assets.
Irrespective of credit score obtained by any obligor as per the proposed risk grade score sheet, the grading of the account highlighted as Early Warning Signals (EWS) accounts shall have the following risk symptoms:
a). Marginal/Watchlist (MG/WL-4):
- If any loan is past due/overdue for 60 days and above.
- Frequent drop in security value or shortfall in drawing power exists.
b). Special Mention (SM – 5):
- Any loan is past due/overdue for 90 days and above.
- Major document deficiency prevails
- A significant petition or claim is lodged against the borrower.
- What are the exceptions of credit risk grading?
- Head of CRM may also down grade/classify an account in the normal course of inspection of a branch or during the periodic port folio review.
- Recommendation for upgrading of an account has to be well justified by the recommending officers. Essentially complete removal of the reasons for downgrade should be basis of any upgrading.
- Marginal/Special mention/Unacceptable credit risk may be accepted if additional collateral exists – Exceptionally approved by the appropriate authority.
- Independent assessment of CRG may be conducted by the head of CRM or Internal Auditor.
- Bank may exercise option to continue with own CRG if equivalent or stricter.
- What are the prescribed period for credit risk grading review?
|Risk Grading||Frequency of Review|
|Bad & Loss||Quarterly.|
- What are the difference between Primary versus Secondary markets?
Ans. Primary Markets: In a primary market transaction, the corporation is the seller, and the transaction raises money for the corporation. Corporation engage in two types of primary market transactions: Public Offering and private placements. A public offering, as the name suggests, involves selling securities to the general public, whereas a private placement is a negotiated sale involving a specific buyer.
Secondary market: A secondary market transaction involves one owner or creditor selling to another. It is therefore the secondary markets that provide the means for transferring ownership of corporate securities.
Balance sheet: Financial Statement showing a firms accounting value on a particular date.
Income Statement: Financial statement summarizing a firms performance over a period of time.
Non cash items: Expenses charged against revenues that do not directly affect cash flow such as depreciation.
Average Tax Rate: Total taxes paid divided by total taxable income.
Marginal Tax Rate: Amount of Tax payable on the next dollar earned.
Operating cash flow: Cash generated from a firms normal business activities.
Cash flow to creditors: A firms interest payment of creditors less net new borrowings.
Cash flow of stockholders: Dividends paid out by firm less net new equity raised.
Financial Ratio: Relationships determined from a firms financial information and used for comparison purposes.
i). Current Ratio = Current Asset/Current Liability (Ideal ratio = 2:1)
ii). Quick or Acid Test Ratio = Current Assets-Inventory/Current Liabilities (Ideal Ratio = 1:1)
iii). Cash or other liquidity Ratio = Cash/Current liabilities
iv). Net Working capital to total Assets = Net Working Capital/Total Assets
v). Total Debt Ratio = Total Assets-Total Equity/Total Assets.
vi). Debt Equity Ratio = Total debt/Total equity
vii). Times interest earned = EBIT/Interest
viii). Cash coverage ratio = EBIT + Depreciation/Interest
ix). Inventory turnover Ratio = Cost of goods sold/Inventory
x). Days sales in Inventory = 365 days/Inventory turnover
xi). Receivable turnover = Sales/Accounts Receivable
xii). Days sales in receivables = 365 days/Receivable turnover
xiii). Profit margin = Net Income/Sales
xiv). Return on Assets = Net Income/Total Assets
xv). Return on Equity = Net Income/total equity
- What do you mean by Leverage? What is financial leverage?
Ans. Leverage: Leverage means risk associated relationship between debt & equity.
Financial leverage: Financial Leverage refers to the extent to which a firm relies on debt. The more debt financing a firm uses in its capital structure, the more financial leverage it employs/use.
CONTRACT OF INDEMNITY & GUARANTEE(Continuation of previous chapter)
* Types of Guarantors:
- Minor, person of unsound mind and insolvents: A minor has no capacity to contract. A guarantee given by him is void. He cannot even ratify such a contract after attaining majority. Person of unsound mind or an un-discharged insolvent cannot give valid guarantee.
- Guarantee by married woman: It should always be borne in mine that the guarantee of a married woman can only be enforced against her separate estate. It does not bind her husband. In case of obtaining guarantee from a woman it must be ensured that:
- She has separate estate.
- A confirmation must be obtained separately, if possible through her solicitor that the nature of the liability she is assuming has been explained to her and she has signed the guarantee on her own will and without compulsion.
- Husband/Wife: A guarantee given by wife in respect of her husbands debt is valid, but a court of law scrutinizes such case more closely and ascertain whether the wife has exercised a will on her own or alternatively, received independent legal advice before she executed the guarantee. In such cases banker should carefully explain the nature of the transaction to avoid the plea of influence.
- Joint or several Guarantors:
i). Release of any one of the joint and several guarantors should not release the other from
ii). Notice by sureties or in the event of death of one or more of them, notice by the surviving guarantors, along with the legal representatives of the deceased guarantors, is necessary before guarantee can be determined.
In case of joint guarantee, the banker would have to sue guarantors jointly and obtain a decree against them in order to make them responsible, because if he chooses one or two in the first instances and fails to get satisfaction for the whole debt out of the decree, he cannot sue the others for the balance.
- Guarantee by Partners:
A partner has no implied authority to bind his co-partners by guarantee. As such any guarantee executed by the operating partner is not binding on the firm. The operating partner can bind the firm upon a guarantee only in case when the giving of guarantee is part of normal business of the firm and when the co-partners definitely authorizes him to give such a guarantee.
While obtaining guarantee from partnership firm, it should in order to avoid the risk of any future trouble, be signed by all partners individually and in the name of the firm and thereby undertaking liability jointly and severally. In case of death, insolvency or retirement of any of the partners, admission of a new partner, the advance account which is guaranteed should be closed and a new account to be opened.
- Limited company as Guarantors: Before a guarantee executed by a public limited company is accepted by a banker, it is necessary to examine its Memorandum & Articles of Association to verify whether it has specific authority to enter into a contract of guarantee. The implied power to borrower in the case of a trading company does not extend to giving of guarantees. Where the Memorandum & Articles of Association permit the company to give a guarantee, resolution should be passed by the Board of Directors of the company authorizing the giving of the specific guarantee by the company. The guarantee should be signed by the persons authorized by the resolution on behalf of the company under its seal.
- Directors personal guarantee in the case of advances to limited company: Bank should obtain such guarantee on their standard form duly executed by the directors on their personal capacity.
- What are the liabilities of guarantors? What are the rights of the guarantors?
Ans. Liabilities of the Guarantors:
i). Extent of the liability: The liability of a surety or guarantor is co-extensive with that of the principal debtor, unless otherwise provided by the contract. (Section 128). Liability of the guarantors cannot, in any circumstances, exceed that of the principal debtor.
ii). The time liability arises: The liability of the guarantor arises as soon as the principal debtor defaults. If the liability become due, it is not necessary for him to proceed against the debtor first. He may sue the guarantor without suing the principal debtor.
iii). Liability of co guarantors: In case more than one person guarantee a debt, all of them called co guarantors and are liable to pay the debt of the principal debtor.
Rights of the guarantors:
i). Against the Principal debtor:
a). Right of subrogation: when the principal debtor has committed default in fulfilling his promise and the guarantor meets his liability to the creditor, the guarantor steps into the shoes of creditor, and acquires all rights of the creditor against the principal debtor. This right is called the “right of subrogation”
b). Right to claim indemnity: In every contract of guarantee, there is an implied/indirect promise by the principal debtor to indemnify the guarantor and the guarantor is entitled to recover from the principal debtor.
c).Right to revoke continuing guarantee: The guarantor has the right to revoke at any time a continuing guarantee by giving a notice of such revocation to the creditor. The guarantor may revoke a continuing guarantee as future transaction only, he remains liable in respect of transactions which have already taken place.
ii). Against the creditor: A surety is entitled to the benefit of every security which the creditor has against the principal debtor at the time when the contract of surety ship is entered into, whether the surety knows of the existence of such surety or not and, if the creditor loses or without the consent of the surety, parts with such security, the surety is discharged to the extent of the value of the benefit of the security.
iii). Against the co sureties:
a). Co sureties liable to contribute equally. B). Liability of co sureties bound in different sums.
- When Guarantor discharge from his liability?
i). By notice of death.
ii). Variations in the terms of the original contract between the principal debtor and the creditor without the consent of the guarantor.
iii). If principal debtor is released by the creditor.
iv). If there is any act or omission on the part of the creditor, the legal consequences of which discharge of the principal debtor.
v). Compounding by creditor with the principal debtor.
vi). If the creditor does act which is inconsistent with the rights of the guarantor.
vii). A contract of guarantee becomes invalid if guarantee was obtained by fraud or concealment etc.
viii). Loss of security.
- What are the precautions to be taken by the bank prior accepting of guarantees?
Ans. i). The guarantor should be high creditworthy.
ii). Financial position of the guarantor must be ascertained.
iii). Borrower would approach any person to be his guarantor not the bank.
iv). The guarantee should always be taken on the banks approved form in the presence of a bank official.
v). In case of joint or several guarantee, no advance should be made until all the proposed guarantors sign the letter of guarantee.
vi). Periodical confirmation of guarantee to be obtained from the guarantor to avoid the guarantee becoming time barred.
vii). The suit against the guarantor must be instituted within three years from the date of execution of the guarantee.
- When a guarantee is terminated/finished?
Ans. A guarantee is terminated and cease to apply to future transactions on the happening of any of the following points:
i). Death of the principal debtor.
ii). Death of guarantor.
iii). Change in the constitution of the borrower.
iv). Change in the creditors constitution.
v). Demand by creditor.
vi). Notice by guarantor.
CREDIT RISK MANAGEMENT
- What is Credit risk Management?
Ans. Credit Risk Management is a robust process to enables banks to proactively manage it’s loan port folios in order to minimize losses and earn an acceptable return for it’s shareholders.
- What are the objectives of Credit risk Management guideline?
Ans. The purpose of credit risk management guideline is to provide directional guideline to the banking sector that will improve the risk management culture, establish minimum standards for segregation of duties and responsibilities, and assist in the ongoing improvement of the banking sector in Bangladesh.
- How many sections in Credit risk Management guideline?
Ans. The Credit risk Management guideline categorized into three broader categories. These are:
a). Policy Guideline b). Preferred organizational structure & c). procedural guideline.
a). Policy Guideline: LCASI
- Lending guideline.
- Credit assessment & Risk grading.
- Approval Authority.
- Segregation of Duties.
- Internal Audit.
b). Preferred organizational structure:
2.1. Preferred Organizational Structure.
2.2. Key Responsibilities.
c). Procedural Guideline: ACCC
- Approval process.
- Credit Administration.
- Credit Monitoring.
- Credit Recovery.
a). Policy guideline:
1.1. Lending Guideline: The lending guideline should provide the key foundations for Account Officers/Relationship Manager (RM) to formulate their recommendations for approval and should include the following:
- Industry & business segment focus.
- Type of loan facilities.
- Single Borrower/Group Limits/Syndication
- Lending caps
- Discouraged business types.
- Loan facility parameter.
- Cross Border risk.
1.2. Credit Assessment & Risk Grading: A thorough credit & risk assessment to be conducted prior to the granting of loans and annually thereafter for all facilities. It is essential that RM’s know their customers and conduct the diligence on new borrowers, principals and guarantors to ensure such parties are in fact who they represents themselves. Following Risk areas should be addressed:
B I S H P A M L S N
i). Borrower Analysis: Majority shareholder, management team and affiliate companies.
ii). Industry Analysis: SWOT analysis of the particular industry.
iii). Supplier/Buyer analysis: Concentration on particular seller or buyer
iv). Historical financial analysis: Analysis of minimum 3 years historical financial statement.
v). Projected Financial Performance: Borrowers projected financial performance should be provided.
vi). Account conduct: Historic performance in meeting repayment obligations should be assessed.
vii). Adherence to lending guidelines: Credit should be in adherence with the bank’s lending guidelines.
viii). Mitigating factors: Margin sustainability/volatility, high debt load(leverage/gearing), overstocking or debtor issues, repaid growth, acquisition of expansion, new business line/product expansion, management changes or succession issues, customer or supplier concentration, and lack of transparency or industry issues.
ix). Loan Structure: Amount and tenors of proposed should be justified based on the project repayment ability and loan purpose.
x). Security: Current valuation of collateral should be obtained & assessed. Adequate insurance coverage should be assessed.
xi). Name lending: Credit should not be influenced by an over reliance on the sponsoring principals reputation.
Risk Grading: All banks already introduced Credit Risk Grading as per Bangladesh Bank’s prescribed guideline.
1.3. Approval Authority: The authority to sanction/approve loan must be clearly delegated to senior credit executives by M.D./CEO & Board based on the Executives knowledge & experience. An Executive charged with approving loans should have followings:
- At least 5 years experience in working in Corporate/Commercial banking as a relationship manager or account executive.
- Training & experience in financial statement, cash flow and risk analysis.
- A through working knowledge of accounting.
- A good understanding of the local industry/market dynamics.
- Successfully completed an assessment test demonstrating adequate knowledge on the following areas:
- Introduction of accrual accounting.
- Industry/Business Risk Analysis.
- Borrowing clause.
- Financial Reporting and full disclosure.
- Financial Statement Analysis.
- The Asset conversion/Trade Cycle.
- Cash Flow analysis.
- Loan Structure & Documentation.
- Loan Management.
1.4. Segregation of Duties: Segregate the following lending functions:
- Credit Approval/Risk Management.
- Relationship management/marketing.
- Credit Administration.
2.1. Preferred Organizational Structure:
Head of CRM Head of Corporate/Commercial Banking Other Direct Reports
(Internal Audit, etc.)
Credit Administration. Relationship Management/Marketing (RM)
Credit Approval. Business Development.
2.2 Key Responsibilities:
2.2. 1. Responsibility of CRM:
- Oversight/mistake of the bank’s credit policies, procedures and controls relating to all credit risks arising from corporate/commercial/institutional banking, personal banking & treasury operations.
- Oversight of the banks asset quality.
- Directly manage all Sub-Standard, Doubtful & Bad and Loss accounts to maximize recovery and ensure that appropriate and timely loan loss provision have been made.
- To approve or decline, within delegated authority, credit applications recommended by RM. Where borrower exposure is in excess of approval limits, to provide recommendation to MD/CEO for approval.
- To provide Advice/Assistance regarding all credit matters to line management/RMs.
- To ensure that lending executives have adequate experience and or training in order to carry out job duties. Effectively.
2.2. 2. Responsibility of Credit Administration:
- To ensure that all security documentation complies with the terms of approval and is enforceable.
- To monitor insurance coverage to ensure appropriate coverage is in place over assets pledged as collateral and is properly assigned to the bank.
- To control loan disbursements only after all terms and conditions of approval have been met and all security documentation is in place.
- To maintain control over security documentation.
- To monitor borrowers compliance with covenants and agreed terms and conditions, and general monitoring or account conduct/performance.
2.2.3 Responsibility of Relationship Management/marketing (RM):
- To act as the primary bank contact with borrowers.
- To maintain through knowledge of borrowers business and industry through regular contact, factory/warehouse inspections etc. RM’s should proactively monitor the financial performance and account conduct of borrowers.
- To be responsible for the timely and accurate submission of credit applications for new proposals and annual reviews, taking into account the credit assessment requirements.
- To highlight any deterioration in borrowers financial standing and amend the borrowers risk grade in a timely manner. Changes in risk Grades should be advised to approved by CRM.
- To seek assistance/advice at the earliest from CRM regarding the structuring of facilities, potential deterioration in accounts or for any credit related issues.
2.2.3 Responsibility of Credit Monitoring:
- Past due principal or interest payments, past due trade bills, account excesses and breach of loan covenants.
- Loan terms and conditions are monitored, financial statements are received on a regular basis, and any covenant breaches or expectations are referred to CRM and the RM team for timely follow up.
- Timely corrective action is taken to address findings of any internal, external or regular inspection/audit.
- All borrower relationships/loan facilities are reviewed and approved through the submission of a credit application at least annually.
- What do you mean by Loan facility parameters?
- Maximum size, maximum tenor, covenant and security requirements.
- Banks should not grant facilities where the banks security position is inferior to that of any other financial institutions.
- Valuations of property taken as security should be performed prior to loans being granted. A recognized 3rd party professional valuation firm should be appointed to conduct valuations.
- What do you mean by Cross border risk?
Ans. Borrowers of a particular country may be unable or unwilling to fulfill principal and interest obligations. Distinguished from ordinary credit risk because the difficulty arises from a political event, such as suspension of external payments.
- What do you mean by custodial duties?
- Loan disbursements and the preparation and storage of security documents should be centralized in the regional credit centers.
- Appropriate insurance coverage is maintained (and renewed on a timely basis) on assets pledged as collateral.
- Security documentation is held under strict control, preferably in locked fireproof storage.
- What is compliance requirements?
- All required Bangladesh Bank returns are submitted in the correct format in a timely manner.
- Bangladesh Bank circulars/regulations are maintained centrally, and advised to all relevant departments to ensure compliance.
- All third party service providers (valuers, lawyers, insurer, CPAs etc.) are approved and performance reviewed on an annual basis. Banks are referred to Bangladesh Bank circular outlining approved external audit firms that are acceptable.
- What are the discouraged business areas as per Credit Risk Manual?
- Military equipments/Weapons Finance.
- Highly leveraged Transactions.
- Finance of speculative investments.
- Logging, Mineral Extraction/Mining, or other activity that is ethically or environmentally sensitive.
- Lending to companies listed on CIB black list or known defaulters
- Counterparties in countries subject to UN sanctions.
- Share lending.
- Taking an equity state in borrowers.
- Lending to holding companies.
- Bridged Loans relying on equity/debt issuance as a source of repayment.
- What is Early Alert Account? Write down different stages of early alert signals?
Ans. An early alert account is one that has risks or potential weaknesses of a material nature requiring monitoring, supervision, or close attention by management. If these weaknesses left uncorrected, they may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date with a likely prospect of being downgraded to classified as “Special Mentioned Account” within the next twelve months.
Different stages of early alert signals:
EA 1: Industry & competition: Position within industry rapidly eroding & industry in a cyclical downturn.
EA 2: Ownership/Management: Inability of management & lack of commitment to support business
EA 3: Balance sheet: Continued weakness, deteriorating working capital cycle, highly geared etc.
EA 4: Cash flow/repayment source: Liquidity strained, cash flow is unlikely to cover debt service.
EA 5: Performance: Interest & or principal remain overdue.
EA 6: Expired limit/Incomplete documents: Facilities expired & documentation pending after 30 days.
- Define Merchant Banking? What is the distinguish between merchant banking & commercial banking?
Ans. Securities & Exchange commission defines Merchant Banking as :
“ Merchant banking means a person who is engaged in the business of issue management either making necessary arrangements regarding selling, buying, underwriting, or subscribing to the securities underwriter, manager, consultant, adviser or rendering corporate advisory services in relation to such issue management.”
Distinguish between merchant banking & commercial banking:
Commercial bankers are financiers but merchant bankers are engineers or architects. A commercial banker strives most of his time on his financial muscle. A merchant banker has to strain his grey cells and has to think of new ideas in order to anticipate & innovate. The activity of merchant banking is equity and equity related finance or more broadly funds raised through money & capital markets.
- What are the different areas of merchant banking?
Ans. i). Issue Management.
iii). Portfolio Management.
i). Issue Management: Issue management function of merchant banking helps capital market to increase the supply of securities. The securities & exchange commission stipulates that the issuer must float the shares/debentures through a separate institution licensed by them(SEC) as issue manager or merchant banker. The bank being a licensed merchant banker has an ample opportunity to operate in this area.
ii). Underwriting Operation: Underwriting operation is one of the important functions of a merchant banker by which it can increase the supply of stock/shares and debentures in the market. It is an arrangement whereby the underwriter undertakes to subscribe the un-subscribed portion of shares/debentures offered by any public limited company. This encourages the prospective issuers to offer shares/debentures to the public for subscription and they can raise funds from the public for implementation of their undertakings.
iii). Portfolio Management Service: The two broad function outlined above are from the supply side of capital market. A merchant banker has also the responsibility of creating demand for securities. Through portfolio management this task can be accomplished. Bank being a merchant banker and portfolio manager wants to build an institutional investors base by managing portfolio of investment in shares and debentures on behalf of individual & institutions.