Uni 2: Trade Credit Risk

 Sole Banking Arrangement

Feature	Details
Meaning	Borrower takes loan or credit facility from only one bank.
Control	One bank handles all financial needs of borrower.
Suitable For	Small to medium-sized businesses or individuals.
Advantages	Simple process, strong relationship with bank, easy monitoring.
Disadvantages	Limited fund availability, higher risk for bank.

Example: A small business takes a working capital loan of ₹10 lakh from only Bank A.

Multiple Banking Arrangement

Feature	Details
Meaning	Borrower takes separate loans from different banks, independently.
Control	Each bank has no knowledge of borrower’s exposure to other banks.
Suitable For	Medium to large businesses needing higher funds.
Advantages	More funds available, reduced risk concentration.
Disadvantages	No coordination among banks, possible misuse of credit.

Example: A company borrows ₹10 lakh from Bank A and ₹15 lakh from Bank B independently.

Consortium Lending

Feature	Details
Meaning	Group of banks lend together to one borrower under a common agreement.
Lead Bank	One bank acts as leader, manages the loan, and coordinates others.
Control	Joint control; all banks share loan amount, risk, and security.
Suitable For	Large loans (₹150 crore or more), infrastructure projects, big companies.
Advantages	Shared risk, unified monitoring, large loan possible.
Disadvantages	Time-consuming, requires agreement and coordination.

Example: 4 banks form a consortium to give ₹500 crore loan to a power project. Bank A is lead bank.

Loan Syndication (Syndicated Loan)

Feature	Details
Meaning	Similar to consortium, but mostly for international or large corporate loans.
Lead Arranger Bank	One bank arranges the deal, negotiates terms, and invites other banks.
Control	Lead bank manages, others join after syndication agreement.
Suitable For	Cross-border loans, multi-currency loans, mega-projects.
Advantages	Access to global capital, large fund availability, shared risk.
Disadvantages	Complex structure, expensive arrangement fees.

Example: An Indian company gets a $200 million syndicated loan arranged by HSBC, joined by other foreign banks.

Comparison Table

Criteria	Sole Banking	Multiple Banking	Consortium Lending	Loan Syndication
Number of Banks	One	Multiple (independent)	Multiple (jointly)	Multiple (organized)
Control	Single bank	No coordination	Joint, with lead bank	Lead arranger manages
Loan Size	Small to medium	Medium to large	Large	Very large/global
Risk Sharing	No	No	Yes	Yes
Monitoring	Easy	Difficult	Coordinated	Coordinated
Cost to Borrower	Low	Medium	Medium	High (fees involved)

Credit Thrust 

Credit Thrust refers to the focus or emphasis given by banks or governments to specific sectors or purposes while extending loans or credit facilities.

Purpose	Details
Support Key Sectors	Banks may focus on agriculture, MSMEs, exports, housing, etc.
Promote Economic Growth	Thrust on sectors that drive employment, GDP growth, and social welfare.
Government Directions	Thrust areas may be defined under priority sector lending norms by RBI.

Examples of Credit Thrust Areas:

• Agriculture and allied activities.
• Renewable energy and green projects.
• Affordable housing.
• Startups and MSMEs.

Credit Priorities

Credit Priorities refer to the order of importance given to various sectors by banks and regulators (like RBI) for allocating credit.

Types of Priority Sectors (as per RBI in India):

Sector	Details
Agriculture	Loans to farmers, agri-processing units.
MSME	Micro, Small, and Medium Enterprises.
Education	Loans for studies in India or abroad.
Housing	Affordable housing loans.
Export Credit	Loans to exporters to promote foreign trade.
Weaker Sections	Scheduled Castes, Scheduled Tribes, women, etc.
Renewable Energy	Solar, wind, and other green energy projects.

RBI Mandate:

• 40% of adjusted net bank credit (ANBC) must be lent to priority sectors by commercial banks.

Credit Acquisitions 

Credit Acquisitions refer to the process by which banks acquire loan accounts or portfolios from other banks or financial institutions.

Forms of Credit Acquisition

Type	Details
Loan Takeover	One bank takes over a borrower’s loan from another bank (usually at better terms).
Securitization	Purchase of loan portfolio (e.g., housing loans, auto loans) from another lender.
Merger/Acquisition	When banks merge, their loan books are acquired together.
Asset Purchase Deals	Buying Non-Performing Assets (NPA) from other banks.

Objective

• Expand loan portfolio, increase interest income, and balance risk exposure.

Statutory & Regulatory Restrictions on Advances

Banks are bound by certain laws and regulations when giving loans (advances), to ensure financial safety and soundness.

Major Restrictions

Regulation Type	Details / Example
Exposure Norms	RBI sets limits on loan amount to a single borrower/group (e.g., 20% of capital funds).
Sectoral Limits	Certain sectors (like real estate) may have loan limits or extra monitoring.
Capital Adequacy (Basel Norms)	Banks must hold enough capital before advancing high-risk loans.
Provisioning Norms	Banks must make provisions for bad loans/NPA, reducing profits.
Loan Pricing Restrictions	Interest rates must follow MCLR or external benchmark rates, not arbitrary.
No Loan to Bank Staff	Restrictions on self-dealing or granting unsecured loans to directors/staff.
Priority Sector Lending Rules	Banks must lend a set % to priority sectors (e.g., 40% of net credit).
End-Use Restrictions	Loans must be used only for approved purposes; banks can audit usage.

Summary Table

Concept	Key Idea
Credit Thrust	Focus on specific sectors for credit growth.
Credit Priorities	RBI-defined sectors that get loan priority.
Credit Acquisitions	Acquiring loan assets from other banks/FIs.
Statutory Restrictions	Legal rules by RBI/Regulators limiting how and to whom banks can lend.

Credit Appraisal

Credit Appraisal is the process by which a bank or lender evaluates a loan proposal to determine the creditworthiness and repayment capacity of a borrower before sanctioning a loan.

Validation of Proposal

This is the first step of credit appraisal where the bank checks whether the loan request is genuine, feasible, and aligns with lending policies.

Key Aspects of Validation

Validation Point	Explanation
Loan Purpose Check	Whether the loan purpose is legitimate and allowed by bank policy.
Borrower Profile Check	KYC verification, credit history, business background.
Financial Viability	Will the project/business generate enough income to repay the loan?
Security/Collateral	Is there adequate collateral or guarantee to cover the loan?
Compliance with Law	Does the loan comply with RBI norms, sectoral limits, exposure norms?

Dimensions of Credit Appraisal

Credit appraisal has multiple dimensions to ensure holistic evaluation of the borrower and the loan request.

Dimension	Details
Financial Appraisal	Analyze borrower’s balance sheet, income statement, cash flow, ratios (e.g., Debt-Equity, DSCR).
Technical Appraisal	For project loans: evaluate project cost, technology, implementation plan.
Economic Appraisal	Evaluate economic feasibility, market demand, cost-benefit analysis.
Managerial Appraisal	Evaluate borrower’s management capability, experience, past performance.
Risk Appraisal	Identify risks (credit risk, market risk) and assess how to mitigate them.
Environmental & Social	For large projects, check impact on environment and community.

Structuring of Loan Documents

Once the loan is approved, loan documents are structured to legally bind the borrower and protect the lender’s interest.

Key Components of Loan Documentation:

Document / Structure	Purpose
Loan Agreement	Main contract specifying terms (amount, interest, repayment, security).
Sanction Letter	Bank’s approval with specific conditions (signed by borrower).
Promissory Note	Borrower promises to pay loan on demand or as per terms.
Hypothecation Deed	For movable asset security (e.g., stock, machinery).
Mortgage Deed	For immovable property security (land, building).
Guarantee Agreement	Guarantor agrees to pay if borrower defaults.
Repayment Schedule	Detailed schedule of EMI or installment payments.
Disbursement Letter	Terms and timing of fund release by bank.
Security Document	Details of collateral, valuation report, legal ownership proof.
Covenants Clause	Conditions borrower must follow (e.g., maintain minimum balance, submit reports).

Summary Table

Component	Key Point
Validation of Proposal	Initial screening of loan feasibility, borrower profile, and policy match.
Dimensions of Appraisal	Financial, technical, managerial, economic, and risk assessment.
Loan Document Structure	Legal framework to protect bank’s interest and define borrower’s obligations.

Credit Risk 

Credit Risk is the possibility that a borrower may fail to repay the loan or interest on time, causing financial loss to the lender.

Key Points	Details
Risk for Lender	Non-repayment leads to Non-Performing Assets (NPA).
Causes	Poor financial health, business failure, fraud, external shocks.
Credit Risk Management Tools	Risk rating models, credit analysis, collateral, and insurance.

Credit Risk Rating

A Credit Risk Rating is a score or grade given to borrowers based on their ability to repay loans, used by banks to assess risk.

Types of Credit Ratings

Internal Rating (by Banks)	Based on in-house models – e.g., AAA to D rating system.
External Rating (by Agencies)	Given by credit agencies like CRISIL, ICRA, CARE in India.

Rating Grade	Meaning
AAA / A1	Highest safety, very low credit risk.
BBB / B	Moderate safety, higher risk.
C / D	Poor safety, very high credit risk.

Creditworthiness of Borrower

Creditworthiness means the borrower’s ability and willingness to repay the loan.

Key Factors to Assess Creditworthiness

Factor	Explanation
Credit History	Past loan repayments, credit score (e.g., CIBIL in India).
Income Level	Ability to repay based on salary, business income.
Financial Ratios	Debt-to-Income, Debt-to-Equity, DSCR (Debt Service Coverage Ratio).
Character	Honesty, reputation, and intent to repay.

Purpose of Loan

The loan purpose helps the lender understand the reason for borrowing and its feasibility.

Loan Purpose Examples	Impact on Risk
Working capital, machinery	Productive use – generates income, lower risk.
Personal loan, luxury items	Non-productive, no income generation, higher risk.
Business expansion	Feasible plan can reduce risk, supported by projections.

Source of Repayment

Banks need to verify how the borrower will repay the loan. This is critical in credit appraisal.

Sources	Examples
Business Income	Revenues/profits from business or project.
Salary	Regular monthly income for salaried borrowers.
Rental Income	Income from leased property.
Sale of Asset	Repayment planned from sale of property/shares (carefully analyzed).

Cash Flow

Cash Flow is the actual inflow and outflow of money in a business or individual’s finances.

Importance	Explanation
Positive Cash Flow	Indicates ability to repay loan on time.
Negative Cash Flow	Warning sign – loan repayment may be difficult.
Cash Flow Statement	Used in credit analysis to assess liquidity and repayment capacity.

Collateral

Collateral is an asset pledged by the borrower to secure the loan. It reduces lender’s risk.

Types of Collateral	Examples
Movable Assets	Vehicles, machinery, gold.
Immovable Assets	Land, buildings, houses.
Financial Assets	Fixed deposits, shares, insurance policies.
Guarantee (Personal/Corporate)	Third-party guarantee also acts as collateral.

Importance	Explanation
Reduces Risk	Bank can recover dues by selling collateral if borrower defaults.
Loan-to-Value (LTV) Ratio	% of loan amount given against collateral value (e.g., 75% of property value).

Summary Table

Term	Key Point
Credit Risk	Risk of borrower not repaying the loan.
Credit Risk Rating	Score given to assess borrower’s repayment capacity.
Creditworthiness	Borrower’s ability and intent to repay loan.
Purpose of Loan	Determines loan feasibility and risk.
Source of Repayment	Income or revenue used for repayment.
Cash Flow	Shows borrower’s liquidity and repayment ability.
Collateral	Security for loan, reduces risk for lender.