Rajkumar Singh 06/05/2023

1 UNIT - 1

•FINANCIAL CREDIT
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2 MEANING
• Financial Credit means a letter of credit used directly or
indirectly to cover a default in payment of any financial
contractual obligation of the Company.
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3 OBJECTIVES
 It aims to establish proper financial institutions to cater to the needs of the weaker sections of the
society.
 It intends to help people secure financial products and services at affordable prices. These
include deposits, loans, insurance, payment services, etc.
 It aims to build and maintain financial sustainability so that the poor individuals are assured of the
required funds.
 It intends to bring in mobile banking and/ or financial services to reach the weaker sections of the
society living in remote areas of India.
 It intends to have numerous institutions that would offer affordable financial assistance, giving
rise to adequate competition so that the clients have myriad options to choose from.
 It plans to improve financial awareness and financial literacy across the nation.
 It aims to bring in digital financial solutions for the economically weaker sections in the country.
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4
CREDIT RISK
A credit risk is risk of default on a debt that
may arise from a borrower failing to make
required payments. In the first resort, the risk is
that of the lender and includes lost principal
and interest, disruption to cash flows, and
increased collection costs.
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5
LOSSES CAN ARISE
A consumer may fail to make a payment due on a mortgage loan, credit card, line of credit,
or other loan.
A company is unable to repay asset-secured fixed or floating charge debt.
A business or consumer does not pay a trade invoice when due.
A business does not pay an employee’s earned wages when due.
A business or government bond issuer does not make a payment on a coupon or principal
payment when due.
An insolvent insurance company does not pay a policy obligation.
An insolvent bank won’t return funds to a depositor.
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6 TYPES

• Credit default risk: The risk of loss arising from a debtor being unlikely to pay its
loan obligations in full or the debtor is more than 90 days past due on any material
credit obligation; default risk may impact all credit-sensitive transactions, including
loans, securities and derivatives.

• Concentration risk: The risk associated with any single exposure or group of
exposures with the potential to produce large enough losses to threaten a bank’s
core operations. It may arise in the form of single-name concentration or industry
concentration.

• Country risk: The risk of loss arising from a sovereign state freezing foreign
currency payments (transfer/conversion risk) or when it defaults on its obligations
(sovereign risk); this type of risk is prominently associated with the country’s
macroeconomic performance and its political stability.
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7 CREDIT ANALYSIS

• Credit analysis is the method by which one calculates the creditworthiness of a

business or organization. In other words, It is the evaluation of the ability of a
company to honour its financial obligations. The audited financial statements of a
large company might be analyzed when it issues or has issued bonds. Or, a bank
may analyze the financial statements of a small business before making or
renewing a commercial loan. The term refers to either case, whether the
business is large or small. A credit analyst is the finance professional undertaking
this role.
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8 SEVEN C’S
• Capital: Indicates your level of seriousness. What you have personally invested in the company. The net worth figure in the business enterprise is
the key factor that governs the amount of credit made available to the borrower.
• Condition: The purpose and details of your loan. The loan officer and credit analyst must be aware of recent trends in the borrower’s work or
industry and how changing economic conditions might affect the loan.
• A loan looks very good on paper, only to have its value eroded by declining sales or income in a recession or by high-interest rates occasioned by
inflation.
• Capacity: How you plan of to repay the loan. For example, in most areas, a minor cannot legally be held responsible for a credit agreement; thus,
the lender would have difficulty collecting on such a loan.
• Similarly, the loan officer must be sure that the representative from a corporation asking for credit has proper authority from the company’s board of
directors to negotiate a loan and sign a credit agreement binding the company.
• Collateral: A form of security that guarantees repayment. The loan officer is particularly sensitive to such features as the borrower’s assets’ age,
condition, and degree of specialization.
• Technology plays an important role here as well. If the borrower’s assets are technologically obsolete, they will have limited value as collateral
because of the difficulty finding a buyer for those assets should the borrower’s income falter.
• Character: A look at your credit history, demonstrated responsibility and the integrity of your actions.
• Control: The last factor in assessing a borrower’s creditworthiness status is control
• Cash: This feature of any loan application centers on the question.
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9 CREDIT ANALYSIS PROCESS

• The credit analysis process involves a thorough review of a business to determine its perceived ability to
pay. To do this, business credit managers must evaluate the information provided in the credit application
by analyzing financial statements, applying credit analysis ratios, and reviewing trade references. In
addition to the information requested in the application, it is important to consult a business credit report
from a reputable third party. The information gathered during this process allows companies to decide
whether or not to offer the customer credit, and if so, precisely how much credit to extend.

• Cash flow = Net profits + Noncash expenses.

• This is often called traditional cash flow and can be further broken down into

• Cash flow = Sales revenues – Cost of goods sold – Selling, general, and administrative expenses-
Taxes paid in cash + Noncash expenses.
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10 STAGES IN THE CREDIT ANALYSIS PROCESS

• Information collection :- Specifically, the lender is interested in the past repayment record of the
customer, organizational reputation, financial solvency, as well as their transaction records with
the bank and other financial institutions.
2. Information analysis :- The information collected in the first stage is analyzed to determine if the
information is accurate and truthful. Personal and corporate documents, such as the passport,
corporate charter, trade licenses, corporate resolutions, agreements with customers and
suppliers, and other legal documents are scrutinized to determine if they are accurate and
genuine.

3. Approval (or rejection) of the loan application :- The final stage in the credit analysis process
is the decision-making stage. After obtaining and analyzing the appropriate financial data from
the borrower, the lender makes a decision on whether the assessed level of risk is acceptable or
not.
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11 CREDIT PROCESS
“FIVE C’S OF CREDIT.”

• Character: It involves a review of your personal honesty, integrity, trustworthiness and management skills. A banking officer also
makes a judgment of character based on your business plan, credit history and the quality of your presentation.

• Capitalization: The capital structure of your company is important to Bank of Ann Arbor because it helps determine the level of risk
associated with your loan request. An analysis of capitalization includes a review of equity, total debt, the value of assets and
permanent working capital.

• Cash Flow: This is the cash your business has to pay the debt. A cash flow analysis helps us determine if you have the ability to
repay the loan.

• Collateral: This provides a secondary source of repayment, thereby minimizing the risk for Bank of Ann Arbor. The amount and
type of collateral required depends on the type and purpose of the loan.

• Conditions: This refers to outside conditions that may affect the ability of your business to repay the loan. Factors such as general
economic conditions or a large concentration of sales to a single customer are evaluated during our review of your loan application.
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12 DOCUMENTATION
CREDIT DOCUMENT

• Credit Document means any of this Agreement, the Notes, if any, the Collateral
Documents, any documents or certificates executed by Company in favour of Issuing Bank
relating to Letters of Credit, and all other documents, instruments or agreements executed
and delivered by a Credit Party for the benefit of any Agent, Issuing Bank or any Lender in
connection herewith.
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13 LOAN PRICING AND PROFITABILITY ANALYSIS, REGULATIONS

• Loan pricing is the process of determining the interest rate for granting a loan, typically as
an interest spread (margin) over the base rate, conducted by the book runners.  The pricing
of syndicated loans requires arrangers to evaluate the credit risk inherent in the loans and to
gauge lender appetite for that risk
• For market-based loan pricing, banks incorporate credit default spreads as a measure of
borrowers’ credit risks.  It is standard procedure in loan pricing to benchmark a loan against
recent comparable transactions (“comps”) and select the base rate on which the financing
costs are pegged.  A comparable deal is one with a borrower in the same industry, country
and of the same size with the same credit rating, for which a certain market rate of return is
required.
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14 BENEFITS OF LOAN PRICING

• This methodical approach can help ensure the best loan and terms are matched to the
borrower so that the financial institution makes the sale and keeps the customer.
• One overall benefit of effective loan pricing is that it is one of the many ways a financial
institution can optimize capital.
• Another benefit of having a loan-pricing policy or model is that it provides the institution
with defensible measures for justifying pricing changes and for avoiding charges of
discriminatory pricing, which some lenders have faced in recent years.
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15 CONSIDERATIONS OF LOAN-PRICING MODELS

• loan origination system (LOS)

• According to James L. Adams, supervising examiner at the Federal Reserve Bank of Philadelphia, pricing is a
key underwriting factor that should be addressed as part of a sound loan policy. A simple cost-plus loan pricing
model is one method of pricing loans, he wrote in a newsletter for community banks that cites the Fed’s
Commercial Bank Examination Manual (CBEM).  A cost-plus pricing model requires that all related costs
associated with extending the credit be known before setting the interest rate and fees, and it typically considers
the following:

 Operating costs associated with servicing the loan or loans

 Cost of funds
 Risk premium for default risk
 A reasonable profit margin on capital.
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16 TYPES OF CREDIT FACILITIES: VARIOUS TYPES OF CREDIT FACILITIES-

CASH CREDIT, OVERDRAFTS, DEMAND LOAN

• The different types of Credit Facilities can be broadly classified into two parts:

 Fund Based Credit

 Non-Fund Based Credit

• Short-Term Credit Facilities

• Cash credit and overdraft

• In this type of credit facility, a company can withdraw funds more than it has in its deposits. The borrower would then be
required to pay the interest rate which is applicable only to the amount that has been overdrawn. The size and the interest
rate charged on the overdraft facility is typically a function of the borrower’s credit score (or rating).

• Short-term loans

• A corporation may also borrow short-term loans for its working capital needs, the tenor of which may be limited to up to a
year. This type of credit facility may or may not be secured in nature, depending on the credit rating of the borrower. A
stronger borrower (typically of an investment grade category) might be able to borrow on an unsecured basis.
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17 PROFITABILITY ANALYSIS

1. Probability of default
• Probability of default is defined as the probability that the borrower will not be able to make scheduled principal and
interest payments over a specified period, usually one year. The default probability depends on both the borrower’s
characteristics and the economic environment.

2. Loss given default

• Loss given default is defined as the amount of money that a lender stands to lose when a borrower defaults on the debt
obligations. While there is no accepted method for quantifying the loss given default per loan, most lenders calculate
loss given default as a percentage of total exposure to loss in the entire loan portfolio.
• For example, if ABC Bank lends $1,000 to Borrower A and $10,000 to Borrower B, the bank stands to lose more money
in the event that Borrower B defaults on repayments.

3. Exposure at default
• Exposure at default measures the amount of loss that a lender is exposed to at any particular point, due to loan defaults.
Financial institutions often use their internal risk management models to estimate the level of exposure at default.
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18 TRADE FINANCE

• Credit from suppliers: A supplier is typically more comfortable with providing credit to its
customers, with whom it has strong relationships.

• Letters of Credit: This is a more secure form of credit, in which a bank guarantees the
payment from the company to the supplier.

• Export credit: This form of loan is provided to the exporters by government agencies to
support export growth

• Factoring: Factoring is an advanced form of borrowing, in which the company sells its
accounts receivables to another party (called a factor) at a discount (to compensate for
transferring the credit risk).
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19 LONG-TERM CREDIT FACILITIES

• Now, let’s look at how long-term credit facilities are typically structured. They can be borrowed
from several sources’ banks, private placement, and capital markets, and are at varying levels
in a payment default waterfall.

• Bank loans

• The most common type of long-term credit facility is a term loan, which is defined by a specific
amount, tenor (that may vary from 1-10 years) and a specified repayment schedule. These
loans could be secured (usually for higher-risk borrowers) or unsecured (for investment-grade
borrowers), and are generally at floating rates (i.e a spread over LIBOR or EURIBOR).
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20 MEZZANINE DEBT

• debt is a mix between debt and equity and rank last in the payment default waterfall. This debt is completely
unsecured, senior only to the common shares, and junior to the other debt in the capital structure. Owing to the
enhanced risk, they require a return rate of 18-25% and are provided only by private equity and hedge funds,
which usually invest in riskier assets

• Securitization

• This type of credit facility is very similar to the factoring of receivables mentioned earlier. The only difference is
the liquidity of assets and the institutions involved. In factoring, a financial institution may act as a “factor” and
purchase the Company’s trade receivables; however, in securitization,

• Bridge loan

• Another type of credit facility is a bridge facility, which is usually utilized for M&A or working capital purposes. A
bridge loan is typically short-term in nature (for up to 6 months), and are borrowed for an interim usage, while the
company awaits long-term financing
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21 BILL FINANCE: DRAWEE BILL SCHEME, BILL DISCOUNTING

• It is a binding short-term financial instrument that mandates one party to pay a specific
sum of money to another at a predetermined date or on-demand. Also known as a bill of
exchange, it essentially denotes, in writing, that one person (debtor) owes money to
another (Creditor).

• Businesses predominantly use bill finance during international trade, since the degree of
uncertainty concerning the payment is considerable in that regard. However, there’s no set
law as such, and companies can use a bill of exchange for intra-border trade as well.
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Bill Finance Working
The practice of bill of exchange issuance involves three parties primarily: 06/05/2023
Drawer: This person issues a bill of exchange, usually before undertaking credit sales. A drawee is obliged to pay the
due amount to a drawer. This entity must sign a bill of exchange during issuance.
22 Drawee: This is the person or entity on which a bill of exchange is issued, also referred to as the debtor. A drawee
needs to accept the bill, which legally binds it to pay a specific sum.
Payee: The payment ultimately goes to a payee. In most cases, a drawer, and payee are the same entity. However, in
some cases, a drawer can transfer bill finance to a third-party, in which case that person becomes the payee.

Types Explanation 

Demand bill Also known as sight draft, this type of bill finance comes with an on-demand payment stipulation. 

Bills of exchange that feature the clause of payment by a specific date and time. These are also
Usance bill
known as time draft. 

A type of bill of exchange that requires the presentation of supporting documents attesting to the
Documentary bill
legitimacy of a transaction(s). 

It involves no supporting documents, and therefore, the interest that one needs to pay, if any, is
Clean bill
much higher. 

Inland bill This is issued for transactions within national borders. 

As opposed to the inland bill, a foreign bill of exchange is issued to debtors beyond national
Foreign bill
borders. 

When a bank issues a bill of exchange, it’s called a bank draft. In this case, a bank enforces bill
Bank draft
payment as per terms. 

Trade draft Bill finance issued by an individual is called a trade draft. 

Accommodation bill It refers to the unconditional bill finances. 

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23 FUNCTIONS OF A DRAWEE

• In a financial transaction, a drawee typically serves as an intermediary. The primary purpose of

the drawee is to channel and direct funds from a payer’s account (also known as a drawer or
depositor) to the account of the payee (the receiver of the funds or the natural person to whom
the funds are payable).

• In most instances, the drawee is a financial institution. In such a situation, the drawee holds the
funds from the payer in an account that it manages

• Apart from banks, other entities that can serve as a drawee can be wire transfer and money
order companies and companies that provide check-cashing services
• A bill of exchange is a binding agreement by one party to pay a fixed amount of cash to another
party as of a predetermined date or on demand.
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24 Drawee. this party pays the amount stated on the bill of exchange to the payee.
Drawer. this party requires the drawee to pay a third party (or the drawer can be paid by the drawee).
Payee. this party is paid the amount specified on the bill of exchange by the drawee.

• Bill Discounting

• Discounting is a financial mechanism in which a debtor obtains the right to delay payments to a creditor,
for a defined period of time, in exchange for a charge or fee. Essentially, the party that owes money in the
present purchases the right to delay the payment until some future date. This transaction is based on the
fact that most people prefer current interest to delayed interest because of mortality effects, impatience
effects, and salience effects. The discount, or charge, is the difference between the original amount owed
in the present and the amount that has to be paid in the future to settle the debt.

• The discount is usually associated with a discount rate, which is also called the discount yield. The
discount yield is the proportional share of the initial amount owed (initial liability) that must be paid to
delay payment for 1 year.

• Discount Yield = Charge to delay Payment for 1 Year / Debt Liability

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25 STAKEHOLDERS IN BILL DISCOUNTING

• Bill Discounting is made possible by multiple parties working together for a scenario to enable movement of goods.

• There are 3 main stakeholders:

1. Seller
• Seller is the one who is selling the goods and expects the payment. in case of bill discounting, seller takes the
payment from bank earlier than the credit period and gets funds immediately but after a discount which is charges as
fee by the bank.

2. Buyer
• Buyer is the one who is buying the goods and is supposed to make or initiate the payment to the seller through letter
of credit. In case of bill discounting the payment is made in full to the bank instead of the seller.

3. Bank
• Bank acts as the intermediary in the bill discounting scenario by providing funds immediately to the seller on behalf of
buyer within the credit period and collects the full amount from buyer as per LOC terms.
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26 ADVANTAGES OF BILL DISCOUNTING

 It also helps the bank earn some revenue.

 Bill Discounting is a major trade activity. It helps the seller’s get funds earlier on a small fees or discount.

 The borrower or (seller’s) customer can pay money on the due date of the credit period.

• Disadvantages of Bill Discounting

1. Bill Discounting is not available to everyone especially new businesses.

2. It is good for short term financing but is not a long term finance option.
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CASH DELIVERY: TYPES OF FACILITIES, MODES OF DELIVERY

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• Cash Credit (CC) is a source of short-term finance for businesses and companies. Cash
credits are also called working capital loans as they fund the instant cash requirements of
the organizations, or to purchase current assets. Borrowing limits on the amount of cash
available for credit for the company varies between commercial banks. The interest
charged is on the daily closing balance instead of the upper borrowing limit, so the
repayment is only on the amount spent from the available limit. Because it is taken for a
short term, the repayment of the amount taken on credit is also set at 12 or less months.
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28 IMPORTANT FEATURES OF CASH CREDIT

• Interest on running balance

• In contrast with other traditional debt financing methods such as loans, the interest charged is only on the running balance
of the cash credit account and not on the total borrowing limit.
• Borrowing limit
• A cash credit comes with a borrowing limit determined by the creditworthiness of the borrower. A company can withdraw
funds up to its established borrowing limit.
• Minimum commitment charge
• The short-term loan comes with a minimum charge for establishing the loan account regardless of whether the borrower
utilizes the available credit
• Credit period
• Cash credit is typically given for a maximum period of 12 months, after which the drawing power is re-evaluated.
• Collateral Security
• The credit is often secured using stocks, fixed assets, or property as collateral.
•