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How to monitor Rate of Interst on your Loan

MANAGE THE RATE OF INTEREST ON YOUR LOAN
 
At the initial stages of the project the small & medium scale entrepreneurs are enthusiastic, particularly in coordinating the funds for the project.  by and large they run around with the loan proposal for getting “Best Rate of Interest”, meaning Lowest Rate of Interest and also for lowest Processing Costs.  Their Financial and non financial consultants also push them for such bargain. These probable entrepreneurs have tendency to approach more than one bank for such bargains. Entire focus is on keeping the cost of borrowings at the minimum level.  However, the rate of interest at the time of sanction is subject to change in future and it is possible to get the Rate of Interest reduced in subsequent years after the commercial production starts. 
 
Similar is the case with the existing units in SME Segment.  Many of the entrepreneurs are ignore about the process of what is known as “Risk Assessment “at branch leve”l and therefore do not pay attention to the process of getting interest rates reduced during the Risk Appraisal by the bank at regular interval, generally a year or at the time of “renewal of the existing Cash Credit Limits” and thereby reduce the cost of borrowings instead of bargaining or “Shopping” for it in the initial stages. I am discussing this subject from the Borrower’s perspective in the following paragraphs
 
Lending money involves risk for banks.  Therefore RBI has also issued various circulars for risk management by banks.  Risk management exercise is also vital function for the bank to estimate and monitor its Loan Assets.
 
Every individual Loan Account is a unique asset carrying specific degree of risk.  Therefore banks try to assess the risk involved in each account in a systematic method by giving least scope for subjectivity.  Accounts showing higher risk factor are closely monitored, or higher interest rates are applied to risky accounts as compared to the accounts carrying lower risk or higher comfort level.  Therefore it is possible to get the originally sanctioned interest rate reduced in subsequent “risk review” by the branches.
 
The Risk Assessment
 Process involves answering a structured questionnaire.  Various questions are generated under each category of risk with Multiple Options for answers.  Predefined marks are given to the answers of each option. Therefore the officers assessing the risk do not have any Discretion or Discriminating Power. For example, following options and respective mark structure can be designed for Stock statements:
All statements are regular  in a year    12 Marks
Upto 2 defaults  in a year                     9 Marks
Upto 4 defaults  in a year                   8 Marks
More than 4 defaults in a year            6 Marks
In this case, the Risk Assessing Officer can not give 10 or 7 marks to any borrower even if he chooses to do so.
Various types of Risk areas attached to a Loan accounts can be classified as under

 

  1. Financial Risks
  2. Performance and Profitability
  3. Security Risks
  4. Management Risks
  5. Technology Risks
  6. Regulatory risks
  7. Industry Specific Risks

Financial Risks
While assessing the degree of Financial Risk in relation to any Loan account, the bank relies on the various financial ratios.  Important of them are TOL/TNW,  Retained Earnings (%), DSCR, DE Ratio for Term Loans and Current Ratio, Age of Debtors, Age of Creditors,  Working Capital Turnover Ratio etc are considered for assessing the risk of Working Capital Facilities.  Needless to say lesser is the risk if the ratios are favourable.
 
Security Risks
Bank reviews the value of security to ensure that market value of the Securities offered is adequate to cover the Loan outstanding through out the tenure of loan.  Situations like downward trend in the market value, Non Payment of installments, litigations if any after the disbursement, inadequate Insurance Cover etc may increase the risk of the bank.  Some times there can be a possibility of erosion of the Margin also and in that case risk is the maximum.  In respect of Stocks and Debtors, factors like realizable value of stocks, Shelf life of the stock, slow movement of finished goods, slower recovery of debtors, bad debts etc are important parameters to assess the risk relating to Securities.

 
 
Performance Risk
 
Bank also considers the performance of the borrower unit.  This is done by comparing the ratios of two consecutive periods.  Ratios and information like Change in Sales, Changes in GP and NP Ratio, Achievement of Sales and Net Profit vis-à-vis Projected Figures are considered first.  In the cases of units who achieve more than 80 % of the projections, comfort level is rated high. Similarly in the cases of borrowers showing improvement in ratios like TOL/TNW, NP Ratio, PAT/Sales (%) are considered less risky.   
Instances like timely regularization of temporary enhancements, Income generation from the account in the form of Commission, frequency of cheque-returns, timely retiring of L/c documents etc are also considered at the time of risk appraisal.  Punctuality in repaying all the installments during the year is another important factor deciding the degree of risk in the account.  Deposit patronage of the account is also an important parameter in assessing the Performance Risk
 
Management Risk
Factors such as background of the promoters, their experience in the field of business of the unit, this is very important aspect when the group of promoters have diverse business activities.  
Capability of raising additional finance, Succession Plan, Constitution of the borrower unit, Degree of professional approach, Organization chart and delegation of powers within the organization etc throw light on the degree of risk associated with the loan account.  Here more the professional approach of the management, safe succession plan, core competence of the management in the same line of business etc give higher comfort level to the bank.  Therefore such units are less risky.
 
Technology Risks
Up-gradation of technology is a continuous process, therefore, while assessing the degree of risk relating to technology of the borrower unit bank considers other sophisticated technology available, possibility of the existing machinery getting obsolete or useless.  Bank can also consider the plans of the borrower unit to upgrade its technology.   Technology used by the other competitors of the borrower unit will also influence the assessment of the bank.  Possibility of unit running successfully with the existing technology through out the tenure of loan is very important.   
 
Industry specific Risks
Each type of industry is exposed to specific risks attached to it.  Degree of consistency in the market to ensure profitability, liquidity, stability etc defers from industry to industry.  Some industries are more vulnerable to global changes;  in some cases industries are also complementary to each other and therefore sensitive to the developments in other dependant industries for example, upward trend in auto industry will boost many small contractors, ancillary or allied industry in Engineering, Petroleum Paint industry etc.,.  Therefore banks consider industry specific risks also. 
 
Regulatory Risks
Risks are also attributable to the changes in government policies and decisions.  For example, changes in Export-import policy, changes in customs duty, other indirect tax structure etc also play important role in the business of the borrower unit.  Risks associated with these are too considered in overall risk appraisal.
 
 
How gradation of a borrower account is made?
After allotting marks to the questions in the Risk appraisal questionnaire, grades are fixed on the basis of percentage of the marks obtained by that account  Borrower accounts scoring more than 90% marks are generally classified as Safe, degree of risk increases with decrease in the Marks. Accordingly, lesser the percentage of marks, bank manager classifies that account as risky or more risky.  This classification is nothing to do whether the account is  regular in payment or is classified as NPA for the purpose of finalization of the balance sheet of the bank.   Needless to say, all NPA Accounts are risky, but many of the Performing accounts can be classified as risky.
 
Here comes the challenge to the borrower.  During the year, he has to continuously monitor his account on the above lines.  The promoter must have regular watch on the operations of the account.  He must be vigilant about the audit objections raised by the bank auditors and rectify the errors found by him.  Promoter may not be able to show good performance every time developments in the economy and the market can be  beyond his control  but, he can score good marks by operating the account with strict discipline as regards

 

  1. regularization of temporary advances, if possible avoiding favours like withdrawals against clearing etc
  2. Not giving unrealistic projections
  3. Retiring L/c documents in time
  4. Timely compliance of Renewal, Stock statement submission, renewing Insurance policies
  5. Timely submission of Balance sheet and Income Tax papers to the bank even if his CC Renewal is not due.
  6. Complying terms of sanction
  7. Rectifying the lapses  in the account which are pointed out by the Bank Auditors immediately preferably before the audit of the bank is completed.
  8. Keeping account within the drawing powers
  9. Maintaining good track records of installments of term loans

 
While finalizing the Balance Sheet, many of the promoters concentrate only on the Income Tax aspect.  But decisions to  maintain minimum Income tax liability  many times lead to adverse financial ratios.  Therefore he should consider various financial ratios also.  Some factors like maintaining profitability, maintaining good Current Ratio etc (1.33:1 is expected by the bank) may not be under control due to market pressures, but he should be alert in avoiding deteriorations in those ratios so that  he does not lose marks on it.
 
When Borrowers are successful in getting upward credit grades, banks do come forward and lower the rate of interest on the loans.  Safer the assessment of the account, more comfortable is the branch manager.
 
Incidentally many a times it is experienced that Credit appraisal work is pending with the branch manager for a long time.  Borrower should in his own interest get his Risk appraisal done periodically.

 

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