UNIT 3 - Banking Lending and Monitoring Process

Principles of Sound Lending

• Safety - Safety means that the borrower should be able to repay the loan and
interest in time at regular intervals without default. Bank’s deposits are always
payable on demand. Bank has to maintain trust of depositor forever. As such
the first and foremost principle of lending is to ensure safety of funds lent. The
repayment of the loan depends upon the borrower's (a) capacity to pay, and (2)
willingness to pay. The former depends upon his tangible assets and the success
of his business; if he is successful in his efforts, he earns profits and can repay
the loan promptly. Otherwise, the loan is recovered out of the sale proceeds of
his tangible assets. The willingness to pay depends upon the honesty and
character of the borrower. The banker should, therefore, take utmost care in
ensuring that the enterprise or business for which a loan is sought is a sound one
and the borrower is capable of carrying it out successfully.
• Liquidity: The term liquidity refers to the extent of availability of funds with
the banker for providing credit to borrowers. It is to be seen that money lent is
not going to be locked up for a long time. The money should return to the bank
as per the repayment schedule. This schedule that is drawn up by the banker has
to adhere to the requirement that at any point of time the banker should possess
liquidity to meet the withdrawals of the depositors. It is to be kept in mind that
various deposits have various maturities and some of it would also be payable
on demand. The banker should possess liquidity to meet the withdrawals of the
depositors – both demand and time. Hence the banker has to always monitor the
cash flows and carry out the exercise of ensuring liquidity with the borrower as
this in turn means liquidity with the banker. Thus, the concept of liquidity entails
the banker to look for easy salability and absence of risk of loss on sale of asset,
which has been taken as collateral.
• Profitability - Commercial banks are profit-earning institutions; the nationalized
banks are no exception to this. They must employ their funds profitably so as to
earn sufficient income out of which to pay interest to the depositors, salaries to
the staff and to meet various other establishment expenses and distribute
dividends to the shareholders (the Government in case of nationalized banks).
This difference between the receipts and payments will be the bank’s gross
 profit. Banks further incur various expenses as any organization does. After
accounting for all such expenses and provisions, banks have to earn reasonable
amount as net profit (NIM) so that dividends can be paid to its shareholders.
Hence it is important that whatever the business the bank engages itself with,
the business be profitable enough not just to cover its costs but to ensure
generation of surplus funds or margin. It is prudent for the banker to consider
overall profitability of the entire business that is undertaken rather than the
profitability against each component of business or service offered.
• Purpose: The purpose should be productive so that the money not only remain
safe but also provides a definite source of repayment. Banks do not grant loans
for each and every purpose—they ensure the safety and liquidity of their funds
by granting loans for productive purposes only, viz., for meeting working capital
needs of a business enterprise. It is very difficult to ensure that the loan has been
utilized for the purpose for which it was sanctioned. Banker should take follow-
up measures to ensure end use of fund exactly for the same purpose for which
it is borrowed.
• Security - The security offered by a borrower for an advance is as like as the
insurance to the banker. It serves as the safety valve for an unforeseen
emergency. So, another principle of sound lending is the security of lending.
Security offered against loan may be various. It may be a plot of land, building,
flat, insurance policies; term deposits etc. There may even be cases where there
is no security at all. The security and its adequacy alone should not form the
sole consideration for judging the viability of a loan proposal. It is the duty of
the banker to check the nature of the security and assess whether it is adequate
for the loan granted.
• Diversification - Tangible assets are no doubt valuable and the banker feels safe
while granting advances on the security of such assets, yet some risk is always
involved therein. An industry or trade may face depression conditions and the
price of the goods and commodities may sharply fall. To safeguard his interest
against such unforeseen contingencies, the banker follows the principle of
diversification of risks by lending funds to different sectors, so that it can save
itself from the slump in some sectors by way of prosperity in the others.
 • Nature of Business – The repaying capacity of a borrower depends on the nature
of the business. Thus, while considering the repayment ability and borrowing
limit, the bank should also consider the nature of business.
• Margin – The security offered under underlying advance must be judged from
economic value and legal aspect. Its book value and market value must offer
enough margins to market price volatility and interest rate fluctuations.
• National Policies - Government policies and national interests impose certain
social responsibilities on commercial banks. Sometimes to cater social
responsibility, advances are given at concessional rate to the weaker and
neglected sectors.

AML/CFT Guidelines

The objective of KYC/AML/CFT guidelines is to prevent Bank from being used, intentionally
or unintentionally, by criminal elements for money laundering or terrorist financing activities.
KYC procedures also enable Bank to know/ understand the customers and their financial
dealings better and manage the risks prudently. The PML Act was enacted by the Indian
parliament in 2002 and came into force in 2005. Under the PML Act, financial institutions and
intermediaries, non-banking financial companies (NBFCs), stockbrokers and payment system
operators, are required to maintain records of transactions of a prescribed nature and above
certain thresholds. The procedure and manner for providing such information is prescribed by
the RBI in consultation with the central government. Under the PML Act, fines ranging from
10,000 rupees to 100,000 rupees for each failure can be imposed on the banks, financial
institutions and intermediaries if the bank, financial institution or intermediary has failed to
maintain records or furnish information in the manner prescribed under the PML Act and the
PML Rules.

KYC Policy

Banks should frame their KYC policies incorporating the following four key elements:

a. Customer Acceptance Policy;

b. Customer Identification Procedures;
c. Monitoring of Transactions; and
 d. Risk Management.

Customer Acceptance Policy (CAP)

a) Every bank should develop a clear Customer Acceptance Policy laying down explicit criteria
for acceptance of customers. The Customer Acceptance Policy must ensure that explicit
guidelines are in place on the following aspects of customer relationship in the bank.

o No account is opened in anonymous or fictitious/benami name.

[Ref: Government of India Notification dated June 16, 2010 Rule 9, sub-rule
(1C) - Banks should not allow the opening of or keep any anonymous
account or accounts in fictitious name or account on behalf of other persons
whose identity has not been disclosed or cannot be verified].
o Parameters of risk perception are clearly defined in terms of the nature of
business activity, location of customer and his clients, mode of payments,
volume of turnover, social and financial status etc. to enable categorisation of
customers into low, medium and high risk (banks may choose any suitable
nomenclature viz. level I, level II and level III). Customers requiring very high
level of monitoring, e.g. Politically Exposed Persons (PEPs) may, if considered
necessary, be categorised even higher;
o Documentation requirements and other information to be collected in respect of
different categories of customers depending on perceived risk and keeping in
mind the requirements of PML Act, 2002 and instructions/guidelines issued by
Reserve Bank from time to time;
o Not to open an account or close an existing account where the bank is unable to
apply appropriate customer due diligence measures, i.e., bank is unable to verify
the identity and /or obtain documents required as per the risk categorisation due
to non cooperation of the customer or non reliability of the data/information
furnished to the bank. It is, however, necessary to have suitable built in
safeguards to avoid harassment of the customer. For example, decision by a
bank to close an account should be taken at a reasonably high level after giving
due notice to the customer explaining the reasons for such a decision.
o Circumstances, in which a customer is permitted to act on behalf of another
person/entity, should be clearly spelt out in conformity with the established law
 and practice of banking as there could be occasions when an account is operated
by a mandate holder or where an account is opened by an intermediary in
fiduciary capacity and
o Necessary checks before opening a new account so as to ensure that the identity
of the customer does not match with any person with known criminal
background or with banned entities such as individual terrorists or terrorist
organisations etc.

b) Banks should prepare a profile for each new customer based on risk categorisation.
The customer profile may contain information relating to customer’s identity,
social/financial status, nature of business activity, information about his clients’ business
and their location etc. The nature and extent of due diligence will depend on the risk
perceived by the bank. However, while preparing customer profile banks should take
care to seek only such information from the customer, which is relevant to the risk
category and is not intrusive. The customer profile is a confidential document and details
contained therein should not be divulged for cross selling or any other purposes.

c) For the purpose of risk categorisation, individuals (other than High Net Worth) and
entities whose identities and sources of wealth can be easily identified and transactions in
whose accounts by and large conform to the known profile, may be categorised as low
risk. Illustrative examples of low risk customers could be salaried employees whose salary
structures are well defined, people belonging to lower economic strata of the society whose
accounts show small balances and low turnover, Government Departments and Government
owned companies, regulators and statutory bodies etc. In such cases, the policy may require
that only the basic requirements of verifying the identity and location of the customer are to be
met. Customers that are likely to pose a higher than average risk to the bank should be
categorised as medium or high risk depending on customer's background, nature and
location of activity, country of origin, sources of funds and his client profile, etc. Banks
should apply enhanced due diligence measures based on the risk assessment, thereby
requiring intensive ‘due diligence’ for higher risk customers, especially those for whom
the sources of funds are not clear. In view of the risks involved in cash intensive businesses,
accounts of bullion dealers (including sub-dealers) & jewelers should also be categorized by
banks as 'high risk' requiring enhanced due diligence. Other examples of customers requiring
higher due diligence include (a) nonresident customers; (b) high net worth individuals; (c)
trusts, charities, NGOs and organizations receiving donations; (d) companies having close
family shareholding or beneficial ownership; (e) firms with 'sleeping partners'; (f) politically
exposed persons (PEPs) of foreign origin, customers who are close relatives of PEPs and
accounts of which a PEP is the ultimate beneficial owner; (g) non-face to face customers and
(h) those with dubious reputation as per public information available etc. However only
NPOs/NGOs promoted by United Nations or its agencies may be classified as low risk
customers.

d) In addition to what has been indicated above, banks/FIs should take steps to identify
and assess their Money Laundering/Terrorist Funding risk for customers, countries and
geographical areas as also for products/ services/ transactions/delivery channels,
Banks/FIs should have policies, controls and procedures, duly approved by their boards,
in place to effectively manage and mitigate their risk adopting a risk-based approach. As
a corollary, banks would be required to adopt enhanced measures for products, services
and customers with a medium or high risk rating. In this regard, banks may use for
guidance in their own risk assessment, a Report on Parameters for Risk-Based
Transaction Monitoring (RBTM) dated March 30, 2011 issued by Indian Banks' Association
on May 18, 2011 as a supplement to their guidance note on Know Your Customer (KYC)
norms / Anti-Money Laundering (AML) standards issued in July 2009. The IBA guidance
also provides an indicative list of high risk customers, products, services and geographies.

e) It is important to bear in mind that the adoption of customer acceptance policy and its
implementation should not become too restrictive and must not result in denial of banking
services to general public, especially to those, who are financially or socially disadvantaged.

Customer Identification Procedure

• Customer identification means identifying the customer and verifying his/her identity
by using reliable, independent source documents, data or information. Banks need to
obtain sufficient information necessary to establish, to their satisfaction, the identity of
each new customer, whether regular or occasional, and the purpose of the intended
nature of banking relationship. Being satisfied means that the bank must be able to
satisfy the competent authorities that due diligence was observed based on the risk
profile of the customer in compliance with the extant guidelines in place. Such risk-
 based approach is considered necessary to avoid disproportionate cost to banks and a
burdensome regime for the customers. Besides risk perception, the nature of
information/documents required would also depend on the type of customer
(individual, corporate etc.). For customers that are natural persons, the banks should
obtain sufficient identification data to verify the identity of the customer, his
address/location, and also his recent photograph. For customers that are legal persons
or entities, the bank should (i) verify the legal status of the legal person/entity through
proper and relevant documents; (ii) verify that any person purporting to act on behalf
of the legal person/entity is so authorized and identify and verify the identity of that
person; (iii) understand the ownership and control structure of the customer and
determine who are the natural persons who ultimately control the legal person.
• The Unique Customer Identification Code (UCIC) will help banks to identify
customers, track the facilities availed, monitor financial transactions in a holistic
manner and enable banks to have a better approach to risk profiling of customers. It
would also smoothen banking operations for the customers. While some banks already
use UCIC for their customers by providing them a relationship number, etc., other
banks have not adopted this practice. Banks were therefore, advised to initiate steps for
allotting UCIC to all their customers while entering into any new relationships for
individual customers to begin with. Existing individual customers were required to be
allotted UCIC by end-May 2013.
• Whenever there is suspicion of money laundering or terrorist financing or when other
factors give rise to a belief that the customer does not, in fact, pose a low risk, banks
should carry out full scale customer due diligence (CDD) before opening an account.
When there are suspicions of money laundering or financing of the activities relating
to terrorism or where there are doubts about the adequacy or veracity of
previously obtained customer identification data, banks should review the due
diligence measures including verifying again the identity of the client and obtaining
information on the purpose and intended nature of the business relationship.
• Banks may transfer existing accounts at the transferor branch to the transferee branch
without insisting on fresh proof of address and on the basis of a self-declaration from
the account holder about his/her current address, subject to submitting proof of address
within a period of six months. Banks should introduce a system of periodical updation
of customer identification data (including photograph/s) after the account is opened.
 The periodicity of such updation should not be less than once in five years in case of
low risk category customers and not less than once in two years in case of high and
medium risk categories.
Special Cases of CIP –

• Walk-in Customers

In case of transactions carried out by a non-account based customer, that is a walk-in customer,
where the amount of transaction is equal to or exceeds rupees fifty thousand, whether
conducted as a single transaction or several transactions that appear to be connected, the
customer's identity and address should be verified.

• Trust/Nominee or Fiduciary Accounts

There exists the possibility that trust/nominee or fiduciary accounts can be used to circumvent
the customer identification procedures. Banks should determine whether the customer is acting
on behalf of another person as trustee/nominee or any other intermediary. If so, banks should
insist on receipt of satisfactory evidence of the identity of the intermediaries and of the persons
on whose behalf they are acting, as also obtain details of the nature of the trust or other
arrangements in place.

• Client accounts opened by professional intermediaries

When the bank has knowledge or reason to believe that the client account opened by a
professional intermediary is on behalf of a single client, that client must be identified. Banks
may hold 'pooled' accounts managed by professional intermediaries on behalf of entities like
mutual funds, pension funds or other types of funds. Banks also maintain 'pooled' accounts
managed by lawyers/chartered accountants or stockbrokers for funds held 'on deposit' or 'in
escrow' for a range of clients. Where funds held by the intermediaries are not co-mingled at the
bank and there are 'sub-accounts', each of them attributable to a beneficial owner, all the
beneficial owners must be identified. Where the banks rely on the 'customer due diligence'
(CDD) done by an intermediary, they should satisfy themselves that the intermediary is
regulated and supervised and has adequate systems in place to comply with the KYC
requirements. It should be understood that the ultimate responsibility for knowing the customer
lies with the bank.
 • Accounts of Politically Exposed Persons (PEPs) resident outside India

Politically exposed persons are individuals who are or have been entrusted with prominent
public functions in a foreign country, e.g., Heads of States or of Governments, senior
politicians, senior government/judicial/military officers, senior executives of state-owned
corporations, important political party officials, etc. Banks should gather sufficient
information on any person/customer of this category intending to establish a relationship
and check all the information available on the person in the public domain. Banks should
verify the identity of the person and seek information about the sources of funds before
accepting the PEP as a customer.

• Small Accounts - In terms of Rule 2 clause (fb) of the Notification 'small account' means
a savings account in a banking company where-
o the aggregate of all credits in a financial year does not exceed rupees one lakh;
o the aggregate of all withdrawals and transfers in a month does not exceed
rupees ten thousand; and
o the balance at any point of time does not exceed rupees fifty thousand .

In a money mule transaction, an individual with a bank account is recruited to receive cheque
deposits or wire transfers and then transfer these funds to accounts held on behalf of another
person or to other individuals, minus a certain commission payment. Money mules may be
recruited by a variety of methods, including spam e-mails, advertisements on genuine
recruitment web sites, social networking sites, instant messaging and advertisements in
newspapers. When caught, these money mules often have their bank accounts suspended,
causing inconvenience and potential financial loss, apart from facing likely legal action for
being part of a fraud. Many a times the address and contact details of such mules are found to
be fake or not up to date, making it difficult for enforcement agencies to locate the account
holder. The operations of such mule accounts can be minimised if banks follow the guidelines
on opening of accounts and monitoring of transactions contained in this Master Circular. Banks
are, therefore, advised to strictly adhere to the guidelines on KYC/AML/CFT issued from time
to time and to those relating to periodical updation of customer identification data after the
account is opened and also to monitoring of transactions in order to protect themselves and
their customers from misuse by such fraudsters.
Monitoring of Transactions

Ongoing monitoring is an essential element of effective KYC procedures. Banks can

effectively control and reduce their risk only if they have an understanding of the normal and
reasonable activity of the customer so that they have the means of identifying transactions that
fall outside the regular pattern of activity. However, the extent of monitoring will depend on
the risk sensitivity of the account. Banks should pay special attention to all complex, unusually
large transactions and all unusual patterns which have no apparent economic or visible lawful
purpose. Banks may prescribe threshold limits for a particular category of accounts and pay
particular attention to the transactions which exceed these limits. Transactions that involve
large amounts of cash inconsistent with the normal and expected activity of the customer
should particularly attract the attention of the bank. Very high account turnover inconsistent
with the size of the balance maintained may indicate that funds are being 'washed' through the
account. Accounts of Multi-level Marketing (MLM) Companies were misused for defrauding
public by luring them into depositing their money with the MLM company by promising a high
return. Such depositors are assured of high returns and issued post-dated cheques for interest
and repayment of principal. So long as money keeps coming into the MLM company’s account
from new depositors, the cheques are honoured but once the chain breaks, all such post-dated
instruments are dishonoured. This results in fraud on the public and is a reputational risk for
banks concerned. Banks should exercise ongoing due diligence with respect to the business
relationship with every client and closely examine the transactions in order to ensure that they
are consistent with their knowledge of the client, his business and risk profile and where
necessary, the source of funds. Banks should, therefore, ensure compliance with the regulatory
guidelines on KYC/AML/CFT both in letter and spirit. Accordingly, banks are advised to
complete the process of risk categorization and compiling/updating profiles of all of their
existing customers in a time-bound manner, and in any case not later than end-March 2013.

Risk Management –

The Board of Directors of the bank should ensure that an effective KYC programme is put in
place by establishing appropriate procedures and ensuring their effective implementation. It
should cover proper management oversight, systems and controls, segregation of duties,
training and other related matters. Banks should, in consultation with their boards, devise
procedures for creating risk profiles of their existing and new customers, assess risk in dealing
with various countries, geographical areas and also the risk of various products, services,
transactions, delivery channels, etc. Banks’ internal audit and compliance functions have an
important role in evaluating and ensuring adherence to the KYC policies and procedures. As a
general rule, the compliance function should provide an independent evaluation of the bank’s
own policies and procedures, including legal and regulatory requirements. Banks should ensure
that their audit machinery is staffed adequately with individuals who are well-versed in such
policies and procedures.

Documents required for KYC –

Individual - Passport/ driving licence/ Permanent Account Number (PAN) Card/ Voter's
Identity Card issued by the Election Commission of India/ identity card with applicant’s
Photograph issued by Central/State Government Departments, Statutory/Regulatory
Authorities, Public Sector Undertakings, Scheduled Commercial Banks, and Public Financial
Institutions/ ) letter issued by a gazetted officer, with a duly attested photograph of the person.

Company - Certificate of incorporation, resolution from the Board of Directors and power of
attorney granted to its managers, officers or employees to transact on its behalf, such other
documents including the ones related to the nature of business and financial status of the client,
as may be required by the banking company.

KNOW YOUR EMPLOYEE POLICY

Traditionally, banks have concentrated on identifying their customers. Know your customer
(KYC), doubtless, is an essential precaution, but it is not sufficient. It must be coupled with
know your employees (KYE). An organization implementing and maintaining a robust internal
control system and with a moral and ethical value system would, in most cases, prevent any
perversion of rules and regulations. If banking organizations do not go down that road, it is
inevitable that they will be more prone to violations and resultant reputational risk. Where
weak KYE and internal control measures abound, corporate losses due to employee theft and
embezzlements increase. Policies, procedures, internal controls, job descriptions, code of
conduct or ethics, levels of authority, compliance with personnel laws and regulations,
accountability, dual control, and other deterrents should be firmly in place. Background
screening of prospective and current employees, especially for criminal history, is essential to
keeping out unwanted employees and identifying those to be removed. Just as management
verifies the identity of customers, it should verify the identity of job applicants. Once the person
is hired, an ongoing approach to screening should be considered for specific positions, as
circumstances change, or for a comprehensive review of departmental staff over a period of
time. Solid KYE (Know your Employee) policies and procedures should form part of a sound
compliance program, on the anti-money laundering, ethics, and fraud fronts. All relationships
between an organisation's clients, employees, and third-party service providers carry a level of
risk; however the risks posed by employees may ultimately be the greatest risk an organisation
faces. Once a business relationship has been established with an employee, banks must
conduct enhanced on-going monitoring of the business relationship. Management should also
have a policy that addresses appropriate actions when a pre-employment or subsequent
screening detects information contrary to what the applicant or employee provided. However,
absent of an effective screening process, a bank may incur significant expenses from recruiting,
hiring and training unqualified individuals based upon their skill sets or backgrounds.

Secured Vs Unsecured loans

Secured Loan - In the case of default in repayment, the lender has the right to seize and sell
the security to recover the amount lent. Here one thing should be kept in mind that the
borrower need not transfer the asset for getting the loan amount approved instead he can
possess the property until and unless he fails to pay the loan amount. Under secured loan, the
amount of debt sanctioned by the lending institution will be based on the collateral. Interest
rates are low as the loan is protected by the property. The types of Secured Loans are:

• Mortgage Loan
• Foreclosure
• Repossession
• Non-recourse loan

Unsecured Loan - The loan agreement, in which an asset does not protect the loan amount, is
Unsecured Loan. In this type of loan, there is no obligation of the borrower to pledge an asset
as security. The loan is known as unsecured because there is no guarantee regarding payment
and if the borrower defaults payment the financial institution can only sue him for the money
but cannot recover the amount forcefully or by selling his property. The risk is very high as the
property does not support the amount. The loan amount will be approved on the basis of
creditworthiness, financial status, character and ability to pay, of the borrower. This also
becomes one of the criteria for deciding the rate of interest. For availing such loans, the
borrower must possess high credit ratings.

Loans against Securities.

Banks provide loans against security of shares/debentures/bonds to individuals, share and stock
brokers and market makers.

Loans against shares and debentures can be given to individuals

 ✓ For meeting contingencies and needs of personal nature
✓ For subscribing to rights or new issue of shares/debentures against the security of
existing shares/debentures
Loans will not be sanctioned
✓ To Trusts and Endowments against the security of shares and debentures.
✓ For speculative purposes, inter corporate investments and acquiring controlling interest
in companies.
✓ Against the equity shares of the banking company to its directors.
✓ Banks will not extend advances to their employees/ Employee Trusts set up by them
for the purpose of purchasing their (banks’) own shares under ESOP/ IPO or from the
secondary market. This prohibition will apply irrespective of whether the advances are
unsecured or secured.

The amount of loan generally does not exceed Rs.20 lakh per borrower. As per RBI guidelines
loans against security of shares, convertible bonds, convertible debentures and units of equity
oriented mutual funds should not exceed the limit of Rs.10lakh if the securities are held in
physical form and Rs.20 lakh per individual if the securities are held in demat form. For
subscribing to IPOs, loans given to individuals will not exceed Rs.10 lakh. Banks may extend
finance to employees for purchasing shares of their own companies under ESOP to the extent
of 90% of the purchase price of the shares or Rs. 20 lakh, whichever is lower. The ceiling of
Rupees ten lakhs / Rupees twenty lakhs for advances against shares/debentures to
individuals will not be applicable in the case of share and stock brokers / commodity
brokers and the advances would be need based.

Banks stipulate a minimum margin of 50% of the market value of equity shares/debentures.
These are minimum margin stipulations and banks can stipulate higher margins. Banks avail
the facility of Pledge of the dematerialized shares/debentures in the depository system, whereby
the securities pledged by the borrower get blocked in favour of the lending bank. The loan limit
depends on the valuation of the security, applicable margin and ability to service and repay the
loan. Loan is normally given in the form of overdraft facility against the pledge of the securities.
Interest has to be paid for the amount and period for which the overdraft facility is utilized. A
declaration is obtained from the borrower indicating the details of the loans / advances availed
against shares and other securities, from any other bank, in order to ensure compliance with
the ceilings prescribed for the purpose.
While granting advances against shares held in joint names to joint holders or third-party
beneficiaries, banks normally ensure that the objective of the regulation is not defeated by
granting advances to other joint holders or third party beneficiaries to circumvent the limits
placed on loans/advances against shares and other securities.

A declaration is obtained from the borrower indicating the details of the loans / advances
availed against shares and other securities, from any other bank, in order to ensure compliance
with the ceilings prescribed for the purpose.

As stated in RBI circular, banks’ capital market exposures would include both their direct
exposures and indirect exposures. The aggregate exposure of a bank to the capital markets
in all forms (both fund based and non-fund based) should not exceed 40 per cent of its net
worth, as on March 31 of the previous year. Within this overall ceiling, the bank’s direct
investment in shares, convertible bonds / debentures, units of equity-oriented mutual funds and
all exposures to Venture Capital Funds (VCFs) [both registered and unregistered] should not
exceed 20 per cent of its net worth.

Loans against units of mutual funds are granted only to those units that are listed in the stock
exchange or for those units for which repurchase facility is available. If there is a lock in period
in the scheme then the scheme should have completed the minimum lock in period stipulated.
The amount of advance is linked to the net asset value/repurchase price or the market value
whichever is less and not to the face value. Banks ensure that the advance should not be granted
for subscribing to or boosting up the sales of another scheme of mutual funds or for the
purchase of shares/debentures/bonds. Compared to loans against shares, the extent of funding
against mutual funds is generally lower at 40-50% of the base NAV.

Banks normally follow certain guidelines while sanctioning advances against

shares/debentures
✓ The advance should be purpose oriented, taking into account the credit
requirements of the investor
✓ The normal procedures for the sanction, appraisal and post sanction follow up
is followed
 ✓ Advances against the primary security of shares/debentures/bonds are not
combined with any other advance.
✓ Banks satisfy themselves about the marketability of the shares/debentures and
the net worth and working of the company whose shares/debentures/bonds are
offered as security.
✓ Shares/debentures/bonds are valued at prevailing market prices when they are
lodged as security for advances.
✓ Advances against partly paid shares are not granted.

The advantages to customers obtaining loans against shares/debentures is

✓ It enables instant liquidity against shares without selling them
✓ It takes care of all investment as well as personal needs.
✓ It is ideal for short term funding.

Securitisation of Standard Assets

Securitization is the financial practice of pooling various types of contractual debt such as
residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or
other non-debt assets which generate receivables) and selling their related cash flows to third
party investors as securities, which may be described as bonds, pass-through securities, or
collateralized debt obligations (CDOs).
Importance of Asset Securitization - First, asset securitization increases banks’ liquidity and
reduces banks’ funding needs in the event of monetary tightening; second, it allows banks to
transfer a part of their credit risk to the markets (including institutional investors such as hedge
funds, insurance companies and pension funds) and thereby reduce their regulatory
requirements on capital. This capital relief seems to cause, ceteris paribus, a further increase in
supplied lending
Securitization is a process by which assets are sold to a bankruptcy remote special purpose
vehicle (SPV) in return for an immediate cash payment. The cash flow from the underlying
pool of assets is used to service the securities issued by the SPV. Securitization thus follows a
two-stage process. In the first stage there is sale of single asset or pooling and sale of pool of
assets to a 'bankruptcy remote' special purpose vehicle (SPV) in return for an immediate cash
payment and in the second stage repackaging and selling the security interests representing
claims on incoming cash flows from the asset or pool of assets to third party investors by
issuance of tradable debt securities. Banks’ exposures to a securitisation transaction are referred
to as "securitisation exposures". Securitisation exposures include, but are not restricted to the
following: exposures to securities issued by the SPV, credit enhancement facility, liquidity
facility, underwriting facility, interest rate or currency swaps and cash collateral accounts.

Process of Securitization –

Securitization is a complex and lengthy process since it is the conversion of the receivables
into bonds; it involves multiple parties.
Origination Function: The borrower approaches a bank or other financial institution
(originator) for a loan. The respective financial institution allows a certain sum as debts in
exchange for any collateral.

Pooling Function: The originator then sells off its receivables through pledge receipts to the
special purpose vehicle.

Securitization: The SPV transforms these receivables into marketable securities, i.e., either
Pay Through Certificate or PTC (Pass-Through Certificate). These instruments are then
forwarded to the merchant banks for selling it to the investors. The investors buy these
instruments to benefit in the long run.

Credit Appraisal Process –

It involves determining the loan applicant’s creditworthiness and reducing the default between
the lenders as principals and the borrowers as agents through the process of gathering,
processing and analyzing of quality information about the borrower. The credit assessment
process is usually guided by the Banks credit policy, procedures and directives. Character,
Capacity, Capital, Collateral and Conditions are the various principles of lending which banks
base their credit appraisal.
Character - It is basically a paradigm for ascertaining the type of borrower and whether he/she
can be trusted to repay the loan in full within a specific time period.
Capacity - This indicates how strong the borrower is financially when it comes to paying back
your loan. If a lender observes that the borrower will not have enough income to repay the loan,
then loan will not be sanctioned.
Capital - Lenders want to see borrowers who invest money into their own businesses for future
growth. This may include the money pumped in for establishing the business, how long the
borrower has been doing business, does the borrower have ample assets as collateral for other
debts and so on.
Conditions - For business loan applicants, this factor means the bigger aspects that surround
the growth and future of the business, i.e. social, economic, political and industry aspects.
Collateral - The fifth and final C of any credit appraisal process pertains to collateral, i.e. the
quantum of assets or securities that can be pledged against the loan.

CIBIL –
The full form of CIBIL is Credit Information Bureau (India) Limited. Also known as
TransUnion CIBIL, it is India’s oldest Credit Information Company (CIC) and provides credit
related services to its members nationwide. Since its establishment in 2000, CIBIL has been
collecting and maintaining credit information of Indian residents. TransUnion CIBIL receives
details of its loans and credit cards from all NBFCs and banks operating in India which is then
used to generate the CIBIL credit report and CIBIL Score.
CIBIL Score is calculated using the credit history found in your CIBIL Report. It reflects a
person’s credit behaviour which includes frequency of applying for loans/credit cards, credit
repayment history, mix of secured and unsecured credit, etc. Generally, a score closer to 900
is considered to be a good score. Some factors which affect a person’s CIBIL score are given
below:
• Repayment history
• Credit utilization history
• Simultaneous Credit card applications
• Lack of credit history

Though CIBIL score is not the only thing that lenders look at when considering a loan or credit
card application, it is arguably one of the most important ones. Some advantages of maintaining
a good CIBIL score may include:

• Greater chances of loan applications being approved, as a high credit score indicates
higher credit worthiness and lower risk for the lender
• You are more likely to receive lower interest rate loans
• Loans and credit cards are approved quickly and easily
• Access to pre-approved loans
• Ability to avail higher credit card limit
• Discount on processing fees and other charges

Non-Performing Assets and Classification -

Reserve Bank of India defines NPA as any advance or loan that is overdue for more than 90
days. “An asset becomes non-performing when it ceases to generate income for the bank,” said
RBI in a circular form 2007. Banks are required to classify NPAs further into Substandard,
Doubtful and Loss assets.
• Substandard assets: Assets which has remained NPA for a period less than or
equal to 12 months.
• Doubtful assets: An asset would be classified as doubtful if it has remained in
the substandard category for a period of 12 months.
• Loss assets: As per RBI, “Loss asset is considered uncollectible and of such
little value that its continuance as a bankable asset is not warranted, although
there may be some salvage or recovery value.”

Loan Syndication
A syndicated loan is offered by a group of lenders who work together to provide credit to a
large borrower. The borrower can be a corporation, an individual project, or a government.
Each lender in the syndicate contributes part of the loan amount, and they all share in the
lending risk. One of the lenders acts as the manager (arranging bank), which administers the
loan on behalf of the other lenders in the syndicate. The syndicate may be a combination of
various types of loans, each with different repayment terms that are agreed upon during
negotiations between the lenders and the borrower.

A syndication agreement is reached between a borrower and a bank (or a financial institution),
which arranges the syndication. The arranger bank identifies one or more banks or financial
institutions that pool funds to meet the borrowing requirements. These banks or institutions are
known as participants. The arranger bank actually disburses the loan, after receiving the
contributions of the other participants. The participants in the syndication share the interest and
other income accruing from the loan, in the ratio of their participation that was agreed upon at
the time of drawing up the Loan Syndication agreement.

Parties to a syndicate loan –

o Arranging bank - The arranging bank is also known as the lead manager and
is mandated by the borrower to organize the funding based on specific agreed
terms of the loan. The bank must acquire other lending parties who are willing
to participate in the lending syndicate and share the lending risks involved.
o Agent - The agent in a syndicated loan serves as a link between the borrower
and the lenders and owes a contractual obligation to both the borrower and the
lenders. The role of the agent to the lenders is to provide them with information
that allows them to exercise their rights under the syndicated loan agreement.
o Trustee - The trustee is responsible for holding the security of the assets of the
borrower on behalf of the lenders. Syndicated loan structures avoid granting the
security to the individual lenders separately since the practice would be costly
to the syndicate.

Credit Recovery –

Credit recovery is when a loan—such as a credit card balance—continues to go unpaid, and a

creditor hires a third party, known as a collection service, to focus on collecting the money.

Credit recovery is important because it is directly correlated to your credit score. If you are
being contacted by a debt recovery service, it means there is a record that you have defaulted
on a loan and currently have delinquencies. These delinquencies get reported to the credit
bureaus, damaging your credit score, which can potentially hurt any future loan opportunities.

Credit recovery may include:

• Referring the matter to a specialist debt recovery team within the bank
• Employing an external debt collection agency to act on its behalf
• Selling property over which the bank holds security
• Seeking a judgment from the courts to enforce the debts