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Credit Appraisal

INTRODUCTION
Credit appraisal means an investigation done by a bank before providing any advances, loans or project finance. Banks also check the financial, commercial & technical viability of the project proposed its funding pattern & further checks the primary & collateral security cover available for recovery of such funds.
Credit Appraisal is a process to ascertain the risks associated with the extension of the credit facility.

WHAT IS CREDIT?
Service credit

  • Utilities such as gas, telephone and electricity which are paid monthly.
  • Generally a deposit is paid
  • A late charge needs to be paid if payment is not done on time

Loans

  • Burrowing cash which can vary
  • According to borrowing amount (small or large)
  • According to time (few days or several years).
  • Repayment can either be done in one lump sum or in several regular payments
  • Loans can be secured or unsecured
  • Secured loans are the loans where the borrower has to provide a collateral against the loan
  • Unsecured loans don’t have a collateral against the loan

Installment Credit

  • The borrower takes the goods home and promises to pay the same later.
  • Cars, furniture and major appliances are purchased mostly in installments.
  • A Down payment is made during the purchase
  • Balance payment is paid with a specified number of equal payments called installments. Payments include financial charges.

Credit Cards

  • Issued by individual retail stores or banks
  • Equivalent of an interest-free loan
  • Payment for the use of it in full at the end of each month or 90 days as per the agreement.

WHAT IS THE RISK INVOLVED IN CREDIT ?

  • Risk of non repayment of the credit obtained by the customer of a bank
  • Important to check or appraise the credibility of the customer in order to lessen the risk involved in providing credit.

CREDIT APPRAISAL
Credit Appraisal is a process to find out certainly the risks involved when the credit facility is extended. Financial institutions carries these tasks and they are involved in providing financial funding to its customers
CREDIT APPRAISAL PROCESS
Applicant fills up the application and sends it to bank –
Documents are received  –
(KYC papers, Government. registration no.,balance sheet from previous banks, Memorandum of agreement, Articles of association, and Properties documents) –
Pre-sanction visit by bank officers  –
Check wilful defaulters list, CIBIL data, ECGC caution list.-
Clearance reports of properties from enlisted advocates are obtained
Valuation reports of properties from enlisted valuer or engineer are obtained
Financial data is prepared
Proposal is prepared
The proposal is assessed
Approval from the appropriate authority is obtained
Documentations, mortgages, agreements
Loan is disimbursed
After sanctioning loan, activities such as stock statements, review & renew of accounts on regular basis is received
CREDIT INFORMATION COMPANY
A Credit Information Company (CIC) (also called as Credit Bureaus) collects and maintains records of an individual’s or organisation’s payments for all the previous loans and other forms of credit taken from various credit institution (banks etc). Based on these records CIC gives a Credit Information Report(CIR) to various financial institutions on a monthly basis. These CIRs are used to evaluate an individual’s or organisation’s capability to repay loans and other credits without defaults
The 3 Credit Information Company(CIC) in India are:-

  • Credit Information Bureau (India) Ltd (CIBIL)
  • Experian Credit Information Company of India Pvt. Ltd
  • Equifax Credit Information Services Pvt. Ltd

The range for credit score for these CICs are:-
CIBIL: 300 to 900
Experian:  -35 to 1005
Equifax: 1 to 999

CREDIT INFORMATION
CICRA Act, 2005 was enacted to provide adequate, comprehensive and reliable information about the borrowers through a database that contains the data of the borrowers.
The Act came into effect on December 14, 2006 and provides the rules and regulation of CIC by the Reserve Bank of India.
In terms of Section 2(d) of CICRA, “credit information” is any information related to:

  • the amounts and the nature of loans and advances, outstanding amounts under credit cards and other credit facilities granted by a credit institution to any borrower;
  • Type of security taken/proposed to be taken by a credit institution from any borrower for credit facilities granted to him;
  • the guarantee available or any other non-fund based facility granted or proposed to be granted by a credit institution for any of its borrowers;
  • the credit worthiness of borrower of a credit institution;
  • any other matter which the Reserve Bank of India may consider necessary for inclusion in the credit information to be collected and maintained by CIC (credit information companies), and, specify, by notification;

 
Types of Credit Information:
Credit information could be of various types:
Negative information Any defaults or arrears in payment is recorded.
Positive information Any outstanding credit, amount of loan and repayment patterns is recorded.
 
CICs in India while preserving information about the borrower keep note that they store both positive as well as negative information about him/her. This gives a more comprehensive data about the borrowers.
Past evidences have suggested that information sharing increases access to credit. It has been observed that while sharing of only negative information results in high default rates , sharing a combination of both positive and negative information lowers the default rates.
In India, RBI has adopted such best practice (like comination of different types of information) quite early as compared to other developing economies like Brazil and Australia. RBI has been seen to be quite proactive while taking instances from the best global practice.
SCOPE OF CREDIT INFORMATION
Borrower, client and Credit Institution in CICRA Act can be defined as
Borrower is a person who has been granted credit facility by a credit institution
Client is a person who is

  • a guarantor/person who is ready to provide security/guarantee for a borrower of the credit institution
  • a person has obtained financial assistance from a credit institution, by way of advances, loans etc. or by providing credit cards or any other credit form
  • a person who has raised money by issue of security as per the Securities Contracts (Regulation) Act, 1956 or by issue of depository receipt, commercial paper or any other instrument
  • a person whose financial standing has been assessed by a credit institution or any other notified institution, as per the direction of the Reserve Bank of India

 
Credit Institutions is an institution which can receive deposits, make loans, and provide current and savings accounts
Credit Institution may include –

  • a national or subsidiary or co-operative or rural bank
  • a financial company which is not involved in banking as per the Reserve Bank of India Act of 1934
  • a public financial institution as per the Companies Act of 1956
  • a financial corporation established by a State as per the State Financial Corporation Act of 1951
  • a housing finance institution as per the National Housing Bank Act of 1987;
  • a company engaged in the business of credit cards and other companies engaged in distribution of credit in any manner;
  • any other institution specified by the Reserve Bank of India for a particular period for the purposes of this clause;

Rules and Regulations for Credit Institutions

  • Each credit institution has to be atleast a member of one of the Credit Information Companies
  • Credit Institution can provide credit information only to the CIC’s they are member of
  • Credit Institution must take this into account while sanctioning loans that a borrower who has taken a CIR from a CIC has the rating of only that CIC and hence the previous data from only its member credit institutions

CREDIT SCORES
Once a borrower approaches a Credit Information Company (CIC), it provides a Credit Score based on its Credit Information Report(CIR).
Credit Scores are given depending on 3 historical data:

  • Defaults on past credit transactions
  • Positive payment behaviour
  • Prior inquiries

In certain circumstances, other types of data are also included : –

  • Court judgments and Bankruptcies
  • Demographics (like age of the borrower)
  • Geographic level
ParameterComment
History of credit lengthLonger the better.
Number of defaultsLess is better.
Severity of defaultsLess is better.
Recent repayment trends/Repayment patternsOlder the last default the better.
No. of accounts which are overdueLesser number of negligence in repaying the credit results in a better credit score
Current Outstanding or Amount overdueLess the better.
Presence of charge off/write-offCharge off or Loan defaults and loan repayment delinquencies negatively impact the credit score.
Mix of credit, i.e.,  credit cards, unsecured & personal loans,
Number of loan enquired recentlyHigh credit score for less number of enquiries
Occupation, Income and length of time in current addressNot used in credit score.

 
The aggregate numbers of new loans sanctioned as per the CIBIL TransUnion Score is
WILFUL DEFAULTERS
The Reserve Bank of India have taken certain initiatives for putting in place information on defaulters and “wilful defaulters” in the public domain.
The timline for the same is :

1990Half-yearly reporting by banks to the Reserve Bank of India on wilful defaulters enjoying fund-based aggregate credit limits of Rs. 2 crore and above from the banking system.
1994Scheme of half-yearly disclosure of information on defaulting borrowers (doubtful and/or loss and suit filed accounts) of banks and FIs (Rs. one crore and above of fund-based and non-fund based accounts) for collection/dissemination of information from/to banking companies.
1999Banks/FIs advised to collect and disseminate information on cases of wilful default of Rs. 25 lakh and more.
2003Defaulters and wilful default cases where banks have filed suit to be reported to CIBIL which would in turn publish on their website. Reserve Bank to continue disseminating such information on non-suit filed cases.
2011Defaulters for whom Suit is filed and wilful default cases to be reported to the other CICs also, where banks are members, which were required to publish the information on their websites.

 
As per RBI, a wilful defaulter can be said so in case of any one of the following:

  • The borrower has defaulted in meeting its payment obligations though he/she has the capacity to honour the obligations.
  • The borrower has defaulted in meeting its payment obligation and he/she has not utilised the availed the fund for the specific purposes which was cited but has utilised the funds for other purposes.
  • The borrower couldn’t make its default payment obligations on time and has siphoned off the borrowings so that the borrowings could not be utilised for the given purpose for which finance was availed of, nor are the funds available with the borrower in the form of any other property.

The borrower couldn’t make its default payment obligations on time and he/she has disposed off the fixed assets or property given by him/her as a collateral for securing a term loan without the knowledge of the lender

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