Corporate Banking

By
Prof. Santosh Kumar
 Enough is enough
• This time agricultural farmers’ loan will be
waived...........populist or really
• NPA is all time high requiring massive
haircuts.....................what to do? No one
knows?..............conundrum
• Banks are not skilled enough in credit
evaluation.......all are fools........or only Govt.
one.........no idea...........stop credit...........stop project
finance..............stop development.........OMG
 Learning Objectives
• The RBI’s regulatory aspects to expand, monitor,
supervise, and control the credit to corporate sector
• The types of loans and advances and other credit
facilities being extended to the corporate sector
from the banking system
• The concept of consortium lending and syndicated
loans
• And to analyse a term loan proposal of a corporate
firm
 Cont.
• The working capital requirement of a firm
and its various approaches
• The concept of MSMEs and an assessment of
their financial requirements
• The corporate banking policies and process at
the bank level
 Regulatory policy and procedures
• RBI controls the flow of credit to corporate covering the
following areas.
1. Credit allocation
2. Exposure limits and group approach
3. Interest regulations
4. Prudential norms for loans and advances ( industrial
loans, SME financing, agricultural loans, asset quality,
terms of repayment, indicators of performing and non-
performing assets)
5. Margin money requirement..
 Credit allocation

Targets and Sub-targets

Helps in achieving
Credit allocation for various priority and
financial inclusion
other sectors
 Exposure limits and group approach

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 Cont.
• 5% and 10% additional exposure permitted in
infrastructure sector for individual exposure
and group exposure respectively.
• Exposure of a bank to a single NBFC and NBFC-
AFC should be less than 10 and 15 %
respectively. 5% additional relaxation for
infrastructure sector.
 One moment...........
• Capital funds: last day of the March of previous year
( Tier 1 and tier 2)
• AFC............asset finance companies
• NBFC...........Non banking finance companies
• Tier 1 capital....shareholder’s equity and retained
earnings

• Tier 2 capital ..revaluation reserves, undisclosed

reserves, hybrid capital instruments, subordinate debt
Interest Regulations
 Cont.
• Interest is also subsidized by way of refinance
to the banks by the RBI or the other apex level
organizations.
• Sometimes interest cap is also fixed by RBI e.g
priority sectors, export finance
 Features of Bank Credit
• Maintaining healthy assets (quality and performance)
• Generation of income
• Risk control ( Mandatory reserves or provisions for
unforeseen situations)
• Managing liquidity ( adequate asset liability management)
• Search for innovations
• Basis for credit creation ( primary deposits are used)
• Driving force for economic growth ( Capital formation and
working capital requirements)
• Function to demand creation ( house, assets, business)
 Process of credit creation

Deposits Cash reserve

in banks deducted

Producers And buy

Remaining so
on ......money
machinesmultiplies
and
amount lent pay to supplier
 Principles of lending
Principles Desirables

Safety •Decentralized and diversification approach

•Reputation of borrower in the market
•Market value of securities
•Adequate interest on loan
Liquidity •Asset liability management
•Less gap between inflows and outflows pattern
•Scattered time schedule of repayment

Profitability Interest income and non-interest income should be sufficient

Purpose •More to production

•Less to consumption and
•No to speculative reasons
 cont.
Principles Desirables

Security Primary and Collateral security

Personal security

Marketability Freely marketable

Value Stability Security should have a stable price pattern

National Interest Credit must flow to agriculture, MSME, infrastructure, strategic

requirements, small borrowers, entrepreneurs, tribal
developments, export oriented industries
Process of lending to corporate sector

1 •Prepare loan policy document for corporate with detailed procedures and lend for different needs and different time

2 •Close monitoring and follow up mechanism of loan accounts to ensure the utilization of loan proceeds for the known purposes and the project runs
successfully.

3 •No resort to undue harassment for recovery reasons

Retail banking vs. Corporate banking
Parameters of Retail Banking Corporate Banking
difference

Nature of Loan Consumer needs, personal Industrial and commercial loans

finance and small loans

Size of Negligible Large

exposure

Purpose Individual needs Project diversification or

expansion

Monitoring Pre sanction monitoring only Regular monitoring and end to

and follow up end fund utilization
by banks
 Retail banking vs. Corporate banking
cont.
Parameters of Retail Banking Corporate Banking
difference

Additional loan rare Often

requirement

Nature of Principal and borrower Principal and borrower along with

relationship commercial relationship

Credit simple Complicated

appraisal

Interest rates Decided by corporate office Lot of bargaining

 Retail banking vs. Corporate banking
cont.
Parameters of Retail Banking Corporate Banking
difference

Loan simple Mortgage and other legal

documentation formalities

RBI role less Exhaustive guidelines

Sanctioning Branch managers Higher level officials

authority

Bank’s expertise No specific skills Specialized skills in corporate

credit appraisal
 Loans vs. Advances
Loans Advances

Lump sum or in parts but after the Regular limit and can operate continuously
withdrawal of sanctioned amount no
further debits other than interest and
other charges
Long term Short term

Against security With or without security

Need not to carry enough cash as it is Banks has to carry enough cash as
one time disbursement customers can withdraw any time the
sanctioned limit.
 Loans vs. Advances
Loans Advances

Lower rate of Higher rate of interest

interest
Not frequent Periodic review and continuance depends on performance
review
Not too Banks have to comply the RBI guideline regarding maximum
much permissible bank finance, margin money, ceiling on the amounts of
restrictive credit for certain purposes
Advances without any security are clean advances e.g personal loan.
They are guaranteed on the basis of promissory note signed by the
borrower. Advances are also extended again tangible and marketable
securities which are pledged or hypothecated with the bank.
e.G cash credit
 So what is cash credit?
• Most common form of advances
• It is an arrangement under which banks allows
the borrower to raise funds up to a certain limit
against securities generally the receivables or
inventories.
• The banks sanction a particular limit and
borrower can withdraw and make other
transactions any number of times but within
the overall permitted limit.
 Then what is overdraft?
• Customer is permitted for a temporary period to
withdraw from the account exceeding the permitted
arrangement.
• Treated as loans and repayable with interest in a short
period.
• Overdrawn amount should be paid within time
otherwise legal action can be taken.
• Sometimes regular overdraft is also permitted
depending on the security or the financial worth of
the customer.
 Types of lending
Fund based lending ( most common,
direct, prime or collateral
securities).......actual outflow of the
cash to the borrower
Non fund based lending (initially no
fund outflow but cash outflow if
customer fails to fulfil the
obligations. ( letter of credit, bank
guarantee
Asset based lending..........looks for future
cash flows and earning capacity of the asset
being financed. Bank will have limited or no
recourse to the borrower. E.g securitization
or project finance
 Types of loans and advances
• Short term loans ( < than 3 years)
1. Financing working capital resulting from
temporary build up of inventories and
receivables
2. Seasonal lines of credit subjected to seasonal
sales cycle
3. Other term loans of repayment schedule with
less than 3 years
 Cont.
• Medium term loans
1. Purpose : creating or acquiring of assets
2. Repayment period: 3-7 years
 Cont.
• Long term loans ( 7-20 years)
1. Repayments = f( future CF arising out of asset
financed)
2. Purpose: Fixed assets acquisition, expansion,
modernisation and diversification
3. Substitute of equity or for financing permanent
working capital needs
4. Securities for the term loans are banks’ claim on
assets purchased from the term loan proceeds or the
collaterals obtained by the bank.
Other forms of loans and advances
• Clean advances
1. Loan without any security purely on personal
guarantee or third party guarantee.
2. Given to individuals or professionals with salary
account with sound financial health and good
history with banks.
3. Common parley ....personal loans ...will be used
for consumption, marriage any thing.
4. Repayable over short period
 Cont.
• Bills purchased or discounted
1. Banks discount genuine commercial or treasury bills.
2. Loan amount constitutes the face value of the bill
minus the discount charges.
Discount constitutes the income earned by the bank.
Investment in these bills is generally referred to as
the third line of defence for the banks.
3. The banker gets back the money lent on or before
the bill period.
 Cont.
• Consumer credit
It meets the personal and consumption
requirement like purchase of cars,
refrigerators, televisions, and other durable
articles.
Given to customers with good financial record
with banks and repayable by instalments in
the short medium duration.
 If loan amounts are exceptionally high
• Loan syndication
• Consortium finance
Both are same or different. Let us see.

RBI also advises that the credits higher than 1.5% of

individual’s bank deposits should normally be extended
on a participation basis.
In case of working capital financed by many banks,
appraisal, follow-up and exchange of information may
be adopted
Process under direct consortium finance
• Several banks finance a single
borrower with common
1 documentation, common appraisal,
joint supervision and follow –up
exercises.
• Lead bank will take initiative and
approach client and collect all
2 information. Client will fixes up the
loan with each participating bank.
Lead bank will do follow up and
other jobs.

• Loans are disbursed through lead

3 bank
• In case of disputes in recovery, lead
bank will take the legal action.
 Direct Consortium finance cont.
• The exposure to a single borrower < 25% of the net
worth of the banking system.
• The lead bank will charge suitable fee for the services
rendered within the RBI guidelines.
• Participating banks may offer different interest rates.
• Borrower of consortium finance should not avail any
other non fund based credit facility outside the
consortium.
• Share of participating bank should be minimum of 5 % of
the fund based credit limit or 1 crore whichever is more.
 Advantages of direct consortium loan

• Risk is pro rata and diversified

• Credit appraisal becomes effective due to
expertise from various banks
• Smaller banks also get the benefit of
consortium finance
• Less competitive, less cost and more profits to
the bank
• Banks have pro rata right in the shares
 Indirect consortium loan
• Lead bank will directly grant loans to the
borrower and then splits the stocking credit
assets by way of share or repayment time.
Thus the lead bank transfer proportionate
credit assets to the other banks known as
assignee. Then, assignor and assignee form a
bank consortium to manage the entire loan
portfolio
 Now “ Loan Syndication” process

Lead manager
Borrower
Borrower approaches a prepares the will inform
bank known as lead
manager to arrange
information
memorandum and
about the
credit and offers the share with loan
credit terms participating banks and
fixes the T&C
requirement
to lead bank
 Cont.

Fee consists of
Syndicate members arrangement fee,
may consist of senior legal charges,
If any credit deficit, it is underwriting
and junior members. It
to be borne by lead
is not essential for lead
bank.
commissions,
bank to take credit participating
share fees, facility fee,
agency fee etc.
 Term Loan
• Loan for particular time period ( payments may
in lump sum or instalments)
• Mostly for acquiring movable or immovable
assets. Such assets are charged to the bank by
way of mortgage as prime securities.
• Drawdown may be lump sum or progress linked (
construction linked)
• Appraisal = f (technical, economical and financial,
legal viability)
 Working Capital Assessment
• Capital required for day to day activities or
complete a working cycle of a product or
service.
1. Capital for inventory
2. Amount involved in receivables
3. Cash required to meet day to day expenses
• Net working capital or liquid surplus = CA-CL
 You may be aware of
• Current ratio...........2:1
• Quick ratio................1:1
• Operating cycle.............as low as possible
• Let us learn “ Maximum Permissible Bank
Finance ( Nov 1975)
• Tandon committee suggested 3 methods to
compute working capital requirement ( MPBF)
 Method 1 (Tandon Committee)
• Total current assets= 1850
• CL less bank borrowings= 750
• Working capital gap = 1850-750= 1100
• 25% margin from long term sources= 275
• Max permissible bank finance= WCG-margin= 1100-275=
825
• Bank borrowings= 1000
• Excess borrowings= 1000-825=175
• Current ratio = CA / ( 750 + MPBF) = 1850/(750+825)=
1.17
 Method 2
• Total current assets= 1850
• 25% from long term funds ( owned funds +term
borrowings)=462.5
• Working capital gap = 1850-462.5= 1387.5
• CL other BB= 750
• Max permissible bank finance= WCG-CL other than bank
borrowings= 1387.5 -750=637.5
• Bank borrowings= 1000
• Excess borrowings= 1000-637.5=362.5
• Current ratio = CA / ( 750 + MPBF) = 1850/(750+637.5)= 1.33
 Method 3
• CA= 1850
• Core assets from long term sources= 475
(assume)
• Real CA= 1850-475= 1325
• Then the entire process as method 2
 Cont.
• As per RBI directions, bank can use their own
method for MPBF
• Concluded
• Method 1= (CA-CL less BB)*0.75
• Method 2= 0.75*CA –CL less BB
• Method 3= 0.75* Core CA-CL less BB
 Turnover method
• Used in small scale industries
• Example
1. Estimated sales = 100
2. Min WC= 25% of 100= 25
3. Borrower’s contribution= 5% of estimated
sales= 5
4. Minimum bank finance for WC= 25-5=20
( 20% of estimated sales)
 Projected Balance Sheet Method
• F ( operating cycle, projected level of
operations, nature of projected current ratio,
profitability and liquidity
• Benchmark CA for liquidity: 1.33.......if lower
than this, it should be examined.
 Cash Budget Method
• Working capital limits = f ( cash gap projected
on monthly or quarterly basis)
• No strict norms for inventory or receivables
 Classification of WC
1. Permanent WC:
• Minimum amount of investments in CA required to
continue with operations of the firm.
• Met through long term sources
2. Fluctuating WC: to fulfil seasonal requirements
3. WC term loan: Usually for WC margin money in the form
of term loan.
4. WC margin through long term sources: WC margin raised
from equity and debt instruments.
 Working Capital and Commercial Bills
• RBI ....Bill rediscounting scheme in 1975 to promote
advances against discounting of commercial bills.
• Commercials bills are short term instrument and known as
bills of exchange.
• Usually supplier of goods draws the bill of exchange on the
buyer for the value of goods supplied. Buyer after accepting
the bill send to supplier.
• After supply of goods, supplier will approach bank by
endorsing on the documents like bills of exchange along with
shipment documents. Bank will give advance against it. Bank
will send it to buyer or the other bank at buyer place.
 Cont.
• Buyer will receive transport documents through
bank and take the possession of goods
supplied. Buyer will make payment to the bank
which again remits to supplier bank.
• Here payment is received in advance rather
than waiting for credit period. The chances of
dishonour of the bills are minimized as the
banks become intermediary in the process.
• Cost of funds for the supplier is also lower.
 Types of commercial bills
• Foreign bill: Drawn on a person residing outside India
and may be payable outside India
• Inland bills: Drawn on person residing in India
• Demand bill: Payable on demand. No time mentioned.
• Usance bill: Specifies time duration for payment.
• Clean bill: Drawn on the party after supply the goods to
discharge the payment.
• Documentary bill: Drawn to claim the payment along
with documents like bill of lading, railway receipts, lorry
receipts,
 Commercial papers
• Short term negotiable instrument
• Corporate use it for raising resources from money market.
• Unsecured promissory note issued by corporate
• Issuing corporate should have min credit rating of P2 or equivalent.
Min tangible net worth 4 crore. Total WC issued including commercial
papers should be less than MPBF.
• Issued for 7 days to 360 days.
• Min size is Rs 5 Lakhs and multiple of 1 Lakh
• It can be transferred number of times till maturity by way of
endorsement and delivery
• On maturity, holder will receive the payment from the issuer.
• Issued at discount and redeemed at face value.
 Certificate of Deposit
• Short term instrument used to meet the requirement of WC of
corporate
• Secured instrument by Banks or FIs
• Issued at discount and redeemed at face value.
• Negotiable and traded in market by endorsement and delivery.
• Individuals, corporate, companies, trust funds can invest in this
instrument
• Min size is Rs 1 Lakh and maximum multiple of Rs 1 Lakhs
• Time: 7 days to 360 days and in few cases 3 years.
• Issuing bank pays interest as per the market demand.
• Pre-mature of CD is not allowed.
 Benchmark financial ratios for SMEs
Ratios Desired
Current ratio 1:1
Debt equity ratio ( WC limits <Rs 5 lakh crore for micro and small 4:1
enterprises
Debt equity ratio ( WC limits > Rs 5 lakh crore for micro and small 3:1
enterprises

Debt equity ratio (medium enterprises) 3:1

Interest service coverage ratio 1.5

Debt service coverage ratio 1.25

 Please focus on
• Ability to meet short term obligations
• Debt load
• Debt bearing capacity
• Ability to convert the inputs into outputs
efficiently
• Market perception
• Savings for various stakeholders
 Rate of interest
• Varies with amount (directly proportional)
• Varies with risk (directly proportional)
• Varies with credit rating ( inversely
proportional)
• Priority sector has different norms
 Types of services in Corporate Banking
• Exclusive corporate client services
• Forex business management
• Cash management services
• Customize business solutions
• Trade and channel finance
• Supply chain finance
• Trade finance
• Letter of credit
• Project finance and advisory services
• Lease finance
• Insurance services
• Consultancy services