Corporate Credit Appraisal & Monitoring

Lending to corporate clients involves careful analysis and ongoing oversight. Credit Appraisal is the upfront evaluation process a bank undertakes before sanctioning a loan or credit facility to a company.

Credit Monitoring is the continuous review of the account and the borrower’s performance after the loan is disbursed, to ensure that the loan remains safe and the borrower adheres to terms. Both are critical in managing credit risk and preventing loans from turning into NPAs (Non-Performing Assets).

Credit Appraisal (Corporate Loans)

When a company applies for a bank loan—whether for working capital or a term loan—the bank undertakes a detailed credit appraisal. The objective is to assess risk and ensure that the loan is safe, liquid, and profitable. This appraisal covers both qualitative and quantitative factors and is commonly explained through the 5 Cs of Credit: Character, Capacity, Capital, Collateral, and Conditions.

Management Evaluation (Character)

• The bank evaluates the promoters and management to assess trustworthiness and competence. This includes their background, experience, track record in the industry, integrity, reputation, and quality of corporate governance.
• For large corporates, ownership structure and past performance of the management team are closely reviewed. Strong and credible management significantly reduces credit risk.

Business and Industry Assessment (Capacity and Conditions)

The bank examines the borrower’s business model and operating environment.

• Industry Analysis: The nature of the industry is analyzed to understand growth prospects, cyclicality, competition, and inherent risks. Lending to cyclical or volatile industries requires higher caution and stronger risk buffers.
• Market Position of the Company: Banks assess market share, competitive advantages, product diversification, customer concentration, and order book strength. Firms with diversified revenues and strong market positions are considered more stable.
• Regulatory Environment: For regulated sectors such as power, telecom, or infrastructure, compliance requirements and potential regulatory changes are factored into the appraisal.
• Purpose of the Loan: The bank ensures the loan is for a legitimate and productive purpose. For projects, feasibility and profitability are evaluated. For working capital, the scale of operations must justify the limits sought. Lending for speculative or loss-covering purposes without a clear turnaround plan is generally avoided.

Financial Analysis (Capital and Capacity)

This is the most extensive part of credit appraisal.

Analysis of Historical Financials

Banks typically analyze 3–5 years of audited financial statements to assess trends and stability.

• Profitability ratios such as operating margin, net margin, ROCE, and ROE indicate earning capacity.
• Leverage ratios like debt–equity, debt–EBITDA, and interest coverage measure financial risk.
• Liquidity ratios such as current and quick ratios, along with the working capital cycle, show short-term solvency.
• Efficiency ratios reflect asset utilization and operational effectiveness.

Cash Flow Analysis

Banks focus strongly on operating cash flows, since debt is repaid from cash, not accounting profits. Consistent positive operating cash flows strengthen creditworthiness.

Growth and Stability

Trends in revenue and profits are examined. Volatility or past losses are investigated to understand underlying causes.

Contingent Liabilities

Off-balance-sheet items such as guarantees, legal disputes, or pending claims are reviewed, as they may crystallize into actual liabilities.

External Credit Rating

If available, ratings from recognized agencies provide an independent assessment of credit risk and influence pricing and comfort levels.

Projected Financials and Sensitivity Analysis

Since loans extend into the future, banks evaluate projections carefully.

• For term loans, projected income, expenses, and cash flows are scrutinized, with special emphasis on the Debt Service Coverage Ratio (DSCR). Banks typically require a minimum and average DSCR to ensure repayment capacity.
• For working capital, future sales and current asset levels are projected to assess required bank finance.

Banks also conduct sensitivity analysis by stress-testing key assumptions, such as lower revenues or higher costs, to judge whether the borrower can still service debt under adverse conditions.

Collateral and Security (Collateral)

While cash-flow lending is important, collateral provides additional comfort. Banks assess the type, value, and enforceability of security such as land, buildings, machinery, inventory, receivables, deposits, or shares. Independent valuations are often obtained. Margins or loan-to-value ratios are applied to account for price volatility and distress sale risk. If collateral is inadequate, personal or corporate guarantees may be required.

Banking History and Credit Conduct

For existing customers, past repayment behavior, account operations, and limit utilization are examined. For new customers, credit bureau reports and references from other banks are obtained to assess credit discipline.

Compliance with Regulatory and Internal Norms (Conditions)

The proposal is checked against regulatory and internal policies.

• Compliance with RBI exposure norms and sectoral limits is ensured.
• Prohibited end uses of funds are ruled out.
• Necessary regulatory approvals, if any, are verified.

Sanction Terms and Approval Process

If the appraisal is satisfactory, the bank proposes sanction terms covering:

• Type and amount of facility
• Interest rate and fees based on risk rating
• Tenure and repayment schedule
• Financial and operational covenants
• Security and documentation requirements

The proposal is placed before the appropriate sanctioning authority based on the loan size, ensuring separation between credit origination and approval.

Rejection or Modification

If risks are excessive, the bank may reject the proposal or seek modifications such as reduced limits, higher equity contribution, or additional security. Negotiations may occur before a final decision.

Credit Monitoring: Concept and Importance

After loan sanction and disbursement, banks shift from appraisal to credit monitoring. Banks cannot follow a “lend-and-forget” approach because business conditions, cash flows, and risks can change over time. Continuous monitoring helps detect early signs of stress and protects the bank from potential defaults.

Regular Financial Monitoring

Banks require borrowers, especially large corporates, to submit periodic financial information.

Periodic Financial Statements

Borrowers submit quarterly or half-yearly financials and annual audited accounts. Banks compare actual performance with projections and focus on:

• Trends in sales, profitability, and margins.
• Changes in working capital components such as inventory and receivables.
• Increase in leverage due to additional borrowings.
• Adequacy and sustainability of operating cash flows for servicing debt.

A deterioration in operating cash flow is treated as a major warning sign, even if accounting profits appear stable.

Monitoring of Working Capital Data

For working capital facilities, banks insist on frequent operational data.

Stock and Debtors Statements

Monthly stock and receivables statements are used to compute Drawing Power (DP). Banks ensure that outstanding borrowings remain within DP. Persistent shortfall in DP or frequent overdrawals indicate stress or diversion of funds.

Ageing Analysis

Banks review ageing of receivables to identify slow-moving or doubtful debts and ageing of payables to see whether the borrower is delaying payments to suppliers due to liquidity pressure.

Account Conduct and Transaction Behaviour

The way the borrower operates the bank account provides real-time signals.

• Cash credit accounts should show healthy turnover, not remain constantly at the maximum limit.
• Frequent excess drawings, unpaid interest, or overdue installments indicate strain.
• Cheque or ECS bounces due to insufficient funds are serious red flags.
• For term loans, timely payment of installments is crucial. Delays beyond 30 days lead to classification as Special Mention Accounts (SMA), which precede non-performing asset (NPA) status.

Site Visits and Inspections

Banks conduct regular and sometimes surprise inspections.

• Physical verification of inventory, plant, and machinery.
• Monitoring construction progress for project loans.
• Interaction with management and staff to assess operational health.

Discrepancies between physical verification and reported data may indicate misreporting or fund diversion.

Covenant Compliance Monitoring

Banks track compliance with financial and operational covenants.

• Ratios such as debt–equity or interest coverage are reviewed.
• Restrictions on additional borrowing, dividend payments, or routing of cash flows are enforced.
• Periodic certifications from auditors or company officials may be required.

Any covenant breach increases the perceived risk and triggers corrective action.

Early Warning Signals (EWS)

Banks maintain structured Early Warning Signal frameworks. Common EWS include:

• Sharp deterioration in financial ratios.
• Frequent management or auditor changes.
• Adverse market or media information.
• Credit rating downgrades or falling stock prices.
• Defaults with other lenders (cross-default).
• Evidence of diversion or misuse of funds.

Early identification allows banks to intervene before defaults occur.

Corrective Actions on Irregularities

When issues are detected, banks act promptly.

• Discussions with management to understand causes and corrective plans.
• Increased monitoring frequency and data requirements.
• Demand for additional collateral, higher margins, or guarantees.
• Restriction or suspension of further drawals.
• Loan restructuring under regulatory guidelines if the problem is temporary but the business remains viable.

Recovery and Legal Measures

If stress worsens and payments remain overdue, banks escalate actions.

• Classification of the account as SMA and then NPA (90 days overdue).
• Invocation of guarantees.
• Enforcement of security through legal mechanisms.
• Initiation of insolvency or recovery proceedings.
• Negotiation of settlements where recovery through normal means is unlikely.

These measures are last resorts; effective monitoring aims to avoid reaching this stage.

Annual Review and Renewal

Working capital limits undergo annual review.

• Updated financials are analyzed.
• Credit ratings and working capital needs are reassessed.
• Limits may be renewed, enhanced, reduced, or restructured based on performance.
• Pricing and covenants may be revised to reflect changes in risk profile.

Summary

Credit monitoring is a continuous process focused on early detection, timely intervention, and risk containment. It is not limited to tracking repayments but involves close scrutiny of financial health, cash flows, operations, and compliance. Effective monitoring protects banks and borrowers alike by preventing minor liquidity issues from escalating into serious defaults.