Objectives

Understand credit appraisal, credit risk, and its components.

Introduction

Credit appraisal assesses borrower creditworthiness based on character, collateral, capacity, income, dependents, expenditure, and employment history.

Credit Appraisal

Critical evaluation to ensure safety, liquidity, and profitability. Aims to avoid NPAs by analyzing financials, business viability, and market prospects.

Validation of the Proposal

• Get all relevant data before making a decision
• Verify KYC, registration, approvals
• Visit factory/office premises
• Ensure legal borrowing capacity via resolutions or documents

Cardinal Principles of Lending: 7Cs

• Creditworthiness
• Character
• Capacity
• Capital
• Collateral
• Conditions
• Cash Flows

Creditworthiness of Borrower

Checked via CIBIL, financial statements, defaulter lists, etc. Loan request details scored via template.

Purpose of the Loan

Should align with bank policy and reflect seriousness and competency. Must not be speculative.

Source of Repayment

Primarily from business cash flows. Profits should be sufficient to service the loan and strengthen finances.

Cash Flow Analysis

Analyze through Direct or Indirect Method. Focus on operations-based cash flow rather than asset sales or borrowing.

Collateral

Collateral is an exit option in case of default. Must be enforceable and valuable over time.

Risk Measures

• Standard Deviation: Measures investment volatility.
• Coefficient of Variation: Risk per unit of return.
• Value at Risk (VAR): Quantifies maximum expected loss.
• Beta: Market/systematic risk.
• Alpha: Active return over market benchmark.
• Drawdown: Magnitude, duration, and frequency of losses.

Portable Alpha

Separating alpha (manager value) from beta (market return) to optimize fee and performance.

KMV Model for Default Risk

Default Point = Short Term Debt + 1/2 Long Term Debt

Let Us Sum Up

Credit appraisal is a comprehensive evaluation from proposal to sanction, focusing on technical, financial, commercial, and economic aspects to ensure viability and minimize risk.