RETAIL BANKING (Advances)

Why bank should extend loan for Retail Segment: Retail loans give better yield It improves bottom line of bank. Retail segment is growing avenue for funds deployment. Retail loans are presumed to be of lower risk and NPA perception. It helps in economic revival of nation through increased production activity. Improves life-style and fulfils aspiration of people through affordable credit. Innovative product development. In a demand-driven economy Retail segment requires minimum marketing efforts.

Whom should Bank extend loan in retail segment: EVALUATION OF THE BORROWERTHE 6Cs of INDIVIDUAL - PROFILE ASSESSMENT (A) CHARACTER: Appraise personal characteristic of the borrower- honesty, attitude, willingness and commitment to repay debts. Banker needs to be careful and will have to use all his diligence and resources to find out the true character of the borrower. Banker should be familiar with the reputation of the borrower. Character also includes responsibility, integrity and consistency, which shall form the basis, on which borrower s willingness to repay loans can be determined. (B) Capacity: An assessment of whether the borrower has the potential to repay the loan from his resources - Annual Income, Stability of income , competence etc.

(C) Collateral: The prime principle of the banker in credit management is safety of funds. This can be achieved by obtaining proper security i.e., collateral should have adequate value, marketability so that in case it is required to be enforced the same can be sold with least effort, cost & sufficient to cover the defaulted amount. The bankers at the time of appraisal may require the valuation of collateral offered be valued by

an approved valuer. (D) Capital: The banker has to assess the financial strength of the borrower or his Net Worth . It may require compilation of an opinion report on the borrower/guarantor Existing Assets and Liabilities. (E) Conditions: Banker needs to evaluate family and other enviornmental conditions of the borrower. His future prospects, Total Family income, Number of dependents etc. (F) Compliance: The banker needs to assess that loans granted are in conformity with the guidelines as specified from time to time by the Government, other regulatory authorities and as per the Loan Policy of the Bank. In the absence of compliance ,

it will be difficult for the Banker to recover the loan in case of default.

 Some of the distinct features of lending to Psegment are: Appraisal/Assessment: The appraisal is normally based on the repayment capacity of the borrower. Unlike in other segments, only the present verifiable income of the borrower is reckoned (except to some extent in Educational Loans). A Credit Scoring Model has been devised for assessing/rating the borrowers. The pricing could be either on floating rate or fixed interest rate basis. If on floating rate, the pricing will be linked to PLR. Further, the spread will be higher in case of clean loans and loans which carry higher risk due to relatively illiquidity of security. Some flexibility in pricing is provided for bulk loaning under tie-ups with corporate/institutions on case to case .

 The option for Fixed rate is available, within maximum limits prescribed for the purpose. Maturity: While the maturity of term loans is not to normally exceed 8 years, in case of Housing Loan repayment is now permitted up to 20 years(30 years). Repayment: The repayment in personal segment term loans may be on the basis of EMI Pre-payment: Pre-payment is freely permitted on penalty basis (discretionary power to waive) Security: This differs from scheme to scheme depending on nature of loan Take over : is not generally encouraged, except in cases of Housing Loans The Risk Management Dept. to review Risks in lending to personal segment on periodical basis

CREDIT FACILITIES EXTENDED BY THE BANKS to Retail Sector: RETAIL : Risk Assessment on Scoring Model Personal Loans: Amount sanctioned: Multiple of Monthly Income/Annual Income, Repayment 3-7 years, Documentation- Loan Application, Loan Agreement, Demand Promissory Note (DP Note) Check-off facility (if available), PDCs for EMIs or mandate to debit the account through ECS for monthly repayments.

Consumer loans: To buy consumer goods, Margin Nil to 25%, Repayment 3-7 years, documents as in personal loan additionally Hypothecation agreement Vehicle Loans: Cars/Scooters Margin 5% to 25%, Period 5-7 years, Documents as above, Charge to be registered with RTO, Comprehensive Insurance to include Bank clause Home Loans: Home Loans against mortgage of property, Equitable Mortgage is preferred, Credit extended may be 60% to 85% of the cost of house/cost of construction, Period may range

from 10 to 30 years depending upon income and age of the borrower. Title Documents relating to property are called for verification of ownership. Photocopies of these documents are sent to Bank s Legal Advisor to seek his opinion regarding ownership of the customer and also to know if the valid registered/equitable mortgage can be created against the property. Sometimes, if necessary technical report from approved valuer to know the market value of the property is also called for. Documentation: Home Loan application, Loan agreement, personal guarantee agreements from the acceptable guarantors, Personal guarantee of the

spouse/ legal heirs, Deposit of titles of the property for equitable mortgage, independent letter to be sent by the customer to the bank detailing the details of the property and his independent acceptability to equitable mortgage the property, Recital to be prepared by the Banker, PDCs or ECS mandate for EMIs. Construction of house : Inspection, progressive payments on the basis of architects certificate, if title deed is not available, obtain any other acceptable security for the intervening period. Education Loan: Admission must be granted by a Recognised Institution, good academic track record of the student, Family financial position, scoring model

MARGIN : Upto Rs 4 lacsNilAbove Rs. 4 lacs : Studies in India5%Studies Abroad15%- Scholarship/ assistantship to be included in margin. - Margin may be brought-in on year-to-year basis as and when disbursements are made on a pro-rata basis. SECURITY : Upto Rs 4 lacsCo-obligation of parents. No securityAbove Rs.4 lacs and upto Rs7.5 lakhsCo-obligation of parents together with collateral security in the form of suitable third party guarantee. The bank may, at its discretion, in exceptional cases, waive third party guarantee if satisfied with the net-worth / means of parent/s who would be executing the document as joint borrower .Above Rs.7.5 lakhsCo-obligation of parents together with tangible collateral security of suitable value, along with the assignment of future income of the student for payment of instalments Loan application, Loan agreement to be signed by the student and parents, personal guarantee agreements (if applicable)

Loan repayment to start as soon as the student gets employment or within 6 months of the completition of the course. LOAN AGAINST SHARES OF THE LISTED COMPANIES: Sanctioned both as demand loan or Limit/DP in Current Account. Facility should be extended only in case of listed companies. Amount sanctioned should not be more than 50% of the average market price of the share. Documents: Application form, DP Note, Transfer deed duly signed by the shareholder. If EMIPDCS/ECS, Bullet Payment. LOAN AGAINST BANKS OWN FDRS/NSCs etc. Sanctioned both as demand loan or Limit/DP in Current Account. Margin 25% Lien of Bank is

noted (in case of NSCs/ KVPs with the issuing Post Office) Documents: FDR/NSCS/KVPs duly discharged by the customer along with security delivery letter, Application for loan, DP Note. Credit Cards or Revolving Credit Lines: An overline Revolving credit is not as yet a popular product in India. It is a pre-arranged loan to cover overdraft in checking accounts. Customers pay a faction of monthly overdrawn loan and incur finance charges on the remainder. Credit cards are also a form of revolving credit and are very popular world-wide. Limits are sanctioned by the issuer to individual customers depending upon their credibility. Credit cards usually have two type of limits sanctioned to customer one for purchases

 And the other for cash-withdrawal. The bills of the merchandisers are settled by the Credit card issuer directly and after the prescribed credit period, customer can avail of two options one to make payment of full amount of the bills to credit card issuer or to pay partially the minimum amount payable and incur finance charges on the remainder. Card issuer earns income from three sources Charging card-holders annual fee, Charging interest on outstanding loan balances, discounting the charges that merchants accept on purchases. Overdraft Protection and Open Credit Lines: Revolving credit also takes the form of overdraft protection in a checking account (normally a CA)

 Where a clean overdraft limit can be sanctioned to a high net-worth credible customer. The customer must pay interest on overdrawn amount. The overdrawn amount than can be recovered by periodic payments or by a bullet payment. Credit Lines -Present innovations of the banks is to provide special cheques to high value customers, specifying therein a specific amount or a limit within which they can draw the cheque and present it to bank to activate their loan account. The interest is charged by the Bank on the outstanding balance and repayment of loan amount can be either through periodic payments or bullet payment.

 REVERSE MORTGAGE:  It is a contract between the Home owner and the financier/bank, which enables the Home owner to receive a stream of income (monthly/quarterly), from the future realizable value of home.  It enables senior citizens/Old age to get independent income and live honourably  Normally banks will provide the stream of income to couple, till the last of two live but may put maximum tenure to 15 years  The recovery of loan amount is effected through sale of house after the death of last of couple  Even if maximum tenure of income stream is fixed for 15 years, couple can continue to live in the house till last of two is alive

 Legal heirs after death of couple can also pay the loan amount along with interest and can acquire the house  In case if sale of house takes place, any surplus amount after clearing loan balance is passed on to the legal heirs  In case if the sale amount falls short of the loan amount, loss is borne by the bank  Valuation of the property is got done and equity value on which annuity is paid to the couple may range from 60% to 90% of the property valuation  Property valuation is revisited periodically and if couple requires annuity value can be increased

 Amount of annuity paid to the couple is based on factors like current valuation, projected appreciation, age of applicant, current interest rates  Higher the age, valuation, more is amount available  Benefit to the Bank:  Bank will be able to get expected return on the principal invested  No risk of account becoming NPA  Provisioning and capital adequacy norms still not defined by RBI  More profitable to offer mortgage to older people because of less life expectancy

 Risk factors for Bank:  Life expectancy/mortality risk: May have to pay annuity for longer period, if borrower or spouse live longer. Risk is mitigated by fixing tenure to 15 years  Interest rate risk: When interest rates move up: Can be mitigated by entering into floating rate contract  Real Estate market risk: Depreciation in valuation: Real Estate values seldom depreciate in long run Benefits to Borrower:  Supplement retirement income  Remain economical independent  With real estate values increasing, better equity left over for heirs

 No age prescribed. In fact more the age, more easy to get loan  It is a non recourse loan. Bank can recover the amount only when last of couple dies Disadvantage:  Non convential retirement tool  May disturb emotional attachment  Pricing is complex; based on future value, life expectancy, interest rate risk  Closure and servicing cost is high upfront cost, servicing cost (Insurance etc), closure cost (Margins due to life expectancy& others) Recommendations go only for 15 years or fixed annuity period

 If borrower have two or more spouses, reverse mortgage agreement will include only one and bank will be entitled to sell property accordingly. An undertaking to this effect should be taken.  Borrower may be required to give an undertaking to the effect that spouse dies, he/she will not remarry. In case if remarriage occurs, loan account may be foreclosed.

 Non installment loans/Bridge Loans : Sometimes customers require a loan facility for a short time say for medical expense or for purchase of a new flat etc. pending receipt of well defined cashinflows, say selling a house, receipt of a large tax refund etc. In such cases, customer can be accommodated by providing him loan facility with or without intervening securities, as the case may be. Customer repays the loan amount along with accrued interest by making a bullet payment. Sub-Prime Loans : These are the loans sanctioned to lower-income borrowers with high credit risk. The interest rate charged on these loans is generally higher, taking

 Into account high risk exposure of the bank on such type of loans. Characteristic of Retail Loans: Small amount loans, need large staff to handle them (Cost factor) Higher spreads than commercial loans Free from exposure limits Encourage loyalty of depositors, by extending credit facilities These loans are cyclically sensitive and interest inelastic (depend upon future salaries/earnings/ employment conditions of customers). In making decisions about terms of consumer credits to borrowers, lenders take into account credit scores

 And their qualitative judgment with respect to four basic terms: Interest Rates Maturity Amount of Finance Loan to value (Margins) Banks top priority remains on retaining the existing customers by deepening their sense of loyalty, providing them with variety of financial products & services, innovating products to suit their requirement yet the pressure is there to market aggressively to acquire new customers. Thus for Banking institutions, the mantra is to cut cost by

 Increasing operational efficiencies and launch new revenue generating products & services to meet customer s desires. ILLUSTRATION : Calculate monthly EMI payable by a borrower on vehicle Loan of 5 years duration when the loan amount is Rs. 4 lac and interest rate is 12% p.a. Note : As per present instructions, interest on loan accounts is being charged at monthly rest (Previously it was at quarterly rests) Effective annual interest rate = (1 + k/m)^m -1= (1+.12/12)^12 -1 = (1.01)^12 -1 = 1.127-1 = 12.7% Monthly interest rate 12.7%/12 = 1.0583%

Therefore, 4,00,000 = A x PVIFA (1.0853%, 60) A = 4,00,000/PVIFA (1.0853%,60) PVIFA = [1 {1/(1+r)^n}]/r

A = (4,00,000)/ [1 {1/(1+0.010853)^60}]/0.010853 Or A =Rs.9106/-

 Add on interest: In this method interest is calculated at Simple interest rate on full amount and added to principal amount. The total amount is then divided by the repayment terms to work out the instalments. It results in effective rate more than the nominal interest rate. ILLUSTRATION: What is effective annual interest rate on a loan of Rs.3000 for 1 year, 12% add on rate, repaid in 12 equal monthly instalments. Annual interest = 3000 x 0.12 = Rs.360/ Total amount payable = 3000 + 360 = Rs.3360/ Monthly instalment = 3360/12 = Rs.280/- p.m.

Let i be the effective monthly rate, then Rs.3000 = 280 x PVIFA (i%, 12) PVIFA(i%,12) = 3000/280 = 10.7143 From PVIFA table and interpolating i = 1.788% Therefore, effective annual rate = 12 x 1.788 = 21.46% Discount rate Let us say, that in the above case interest is payable upfront i.e. loan amount is disbursed to the borrower at 12% discount. As such loan disbursed to the borrower by the bank

 Bank will be = 3000 360 = Rs.2640, and after a year amount repayable by the borrower to the bank will be Rs.3000/-. Thus if i is the annual effective rate, then Rs.2640 = 3000/(1+ i) i = 3000/2640 1 = 0.1364 = 13.64%

 ILLUSTRATION: Mr. Himesh a HNI customer enjoys an overdraft limit of Rs.30 lacs in his Current Account against his Term Deposits amounting to Rs.40 lacs at your branch. The interest rate applicable to the account is 12% p.a. and the interest is applied by the bank to the account at monthly rests. The ledger account for the month of November shows undernoted entries. You are required to calculated interest applicable to the account for the month of November.

Date 01-11-09 05-11-09 08-11-09 09-11-09 11-11-09 17-11-09 20-11-09 22-11-09 26-11-09 28-11-09 28-11-09

Particulars To balance By Clg To Clg By S/C To Clg To Cash By clg To S/C By Clg To Clg By clg

Dr

Cr

Balance

14,50,000(Dr) 1,30,000 13,20,000(Dr) 2,80,000 3,30,000 50,000 20,00,000 16,00,000 5,20,000 16,00,000(Dr) 90,000 15,10,000(Dr) 18,40,000(Dr) 18,90,000(Dr) 1,10,000(Cr) 14,90,000(Dr)

85,000 14,05,000(Dr) 19,25,000(Dr) 3,00,000 16,25,000(Dr)

Balance 14,50,000 13,20,000 16,00,000 15,10,000 18,40,000 18,90,000 Cr Balance 14,90,000 14,05,000 16,25,000 TOTAL:

Days 4 3 1 2 6 3 2 4 2 3 30

Products=Bal x Days 14,50,000 x 4 13,20,000 x 3 16,00,000 x 1 15,10,000 x 2 18,40,000 x 6 18,90,000 x 3 0x2 14,90,000 x 4 14,05,000 x 2 16,25,000 x 3

=Products 58,00,000 39,60,000 16,00,000 30,20,000 1,10,40,000 56,70,000 0 59,60,000 28,10,000 48,75,000 4,47,35,000

Interest to be applied on 30/11/2009 = Product X Interest Rate 365 = (4,47,35,000 x .12) /365 = Rs. 14,707.40

 Credit Analysis It is done on scoring pattern as also judgemental approach. The objective is to assess the risk associated with lending to individuals. Scoring pattern is worked out to assess 6 C s Character, Capacity, Collateral, Capital, Conditions & Compliance. Among these most important thing to be assessed is character, which depicts the consumers desire to repay the loan. If the borrower is not current customer, bank may solicit information from local credit bureau or other business that have extended credit to the individual. Banks can also rely on the subjective appraisal of the borrower s character by obtaining personal reference, verify employment, check accuracy of application etc.

Risk Management and Retail lending: Risk in Retail lending may emanate from: Deficiencies in lending policies Incorrect product structuring Inadequate loan documentation Deficiencies in credit appraisal Absence of Post sanction surveillance and monitoring Inadequate risk pricing Inadequately defined lending limits Weak collection strategy The sound credit scoring model should not be limited

 To assessing creditworthiness but also be used to predict bankruptcy, revenue response, profitability attrition and fraud. Banks are required to move from mass marketing where one size fits all to targeting specific customers based on their individual behaviour, needs and value. The customer data-base maintained by each bank would be handy to study customer behaviour, needs etc. to respond with the right product at the right time through right delivery channel; conveniently, effectively and efficiently.