Credit Policy and Credit Planning

Credit Policy and Credit Planning:

 

The word "policy” covers matters ranging from high order strategy to administrative detail. It provides guidance for managerial thinking as well as action.

A policy is a deliberate plan of action, usually based on certain principles indicating the priorities of decision makers about allocations of resources for achieving rational outcome. It is a written statement that communicates management’s intent, objectives, requirements, responsibilities, and or standards.

Lending is one of the core activities of banks. Banks earnings, profitability, reputation, net asset value etc., depend on its credit portfolio. A sound and healthy lending portfolio is must for bank’s survival.

Reserve Bank of India issues guidelines from time to time relating to flow of credit and directives about credit discipline by the borrowers and banks.

Keeping in view the economic conditions, fiscal deficit position of the country Government of India/ Ministry of Finance too issue directives to banks about credit. RBI announces monetary and credit policy in April and October each year keeping in view the significant changes in the regulatory framework for financial markets. The policy has direct impact on the lending policy of banks. 

 Why Credit Policy?

In the process of financial intermediation banks are confronted with various kinds of financial and non-financial risks. These risks are highly inter-dependent.  One area of risk can have ramifications for a range of other risk categories. Banks are attaching considerable importance to improve the ability to identify, measure, monitor and control the overall level of risks undertaken. To mitigate the risk, banks prepare credit policy which contains guidelines for the entire credit process, from credit origination to problems in loan management and covers areas like mechanism for loan review, interbank exposure, country risk, credit rating framework, portfolio management and risk adjusted return on capital. Credit policy gives valuable guidance to the operational units in credit dispensation, building up a diversified portfolio of quality assets and credit monitoring. The policy also contains prudential limits to individual borrowers, non-corporate borrowers, entry-level exposure norms, substantial exposure limits, benchmark financial ratios, borrower standards, exposure limits, ceilings to industries, sensitive sectors, rating categories etc.  For effective implementation of credit policy banks have also put in place a multi-tier credit approving system wherein an “Approval Grid” clears the loan proposals before being placed to the respective sanctioning authorities.

 

Objectives of credit policy:

The main objectives of a credit policy are:

• To comply with national priorities in achieving planned growth in various productive sectors of the economy.
• To see that credit portfolio has a balanced mix from different viewpoints.
• To regulate and streamline the financial resources of the bank in an orderly manner for achieving objectives of the bank and to instill a sense of credit culture in the operating staff.
• To provide need based and timely availability of credit to borrowers.
• To strengthen the credit management skills, supervision and follow up measures for maintaining a healthy and quality credit portfolio in the bank for ensuring overall profitability.
• To minimize credit risk.
• To comply with various regulatory requirements, pertaining to exposure norms, priority sector norms, income recognition and asset classification guidelines, capital adequacy, credit risk management guidelines, etc., of Reserve Bank of India and other authorities.
• To decide discretionary lending powers of various authorities

 

Aspects kept in view while preparing Credit Policy:

(a) Regulatory Restrictions issued by RBI:

While preparing lending policy, banks keep into consideration Regulatory Restrictions issued by RBI on lending, the power derived from the Banking Regulation Act, 1949. The regulatory restrictions include:

• Statutory Restrictions
• Regulatory Restrictions
• Restrictions on other loans and advances   and contains
• Guidelines on Fair Practices Code for Lenders

(i) Statutory Restrictions: In terms of Section 20(1) of the Banking Regulation Act, 1949, a bank cannot grant any loans and advances on the security of its own shares Banking Regulation Act, 1949. Section 20(1) of the Banking Regulation Act, 1949 also lays down the restrictions on loans and advances to the directors and the firms in which they hold substantial interest.

(ii) Regulatory Restrictions:

RBI has put restrictions on granting of loans and advances to:

• Relatives of Directors
• Officers and Relatives of Senior Officers of Banks
• Industries Producing / Consuming Ozone Depleting Substances (ODS)

RBI has also put certain restrictions on advances against Sensitive Commodities under Selective Credit Control (SCC) and payment of commission to staff members including officers under Section 10(1)(b)(ii) of Banking Regulation Act, 1934,

(iii) Restrictions on other loans and advances:

     RBI has issued guidelines to banks in respect of:

• Loans and Advances against Shares, Debentures and Bonds
• Advances against Fixed Deposit Receipts (FDRs) Issued by Other Banks
• Advances to Agents/Intermediaries based on Consideration of Deposit Mobilisation
• Loans against Certificate of Deposits (CDs)

• Bank Finance to Non-Banking Financial Companies (NBFCs) in respect of certain activities undertaken by them
• Bank Finance to Equipment Leasing Companies
• Financing Infrastructure/ Housing Projects

(iv) Guidelines on Fair Practices Code for Lenders:

It is basically disclosure guidelines. Commercial banks and other lenders are required to state plainly the terms of the contract and provide a copy of the lending agreement to the borrower.  RBI has advised all banks and financial institutions to display on their web sites “Fair Practices Code for Lenders.”

Preparing Credit Policy:

Credit policy differs from bank to bank.  Banks prepare their credit policy keeping in view RBI guidelines, directives of Government of India, Ministry of Finance, banking scenario, provisions
of Banking Regulations Act, position of assets and liabilities,
traditions, inherent expertise, strengths and weaknesses, emerging market, economic trends,
and banks’ priorities, thrust areas, innovative products and above all
most profitable deployment of resources by way of lending. The credit
policy also contains guidelines for risk identification, measurement,
risk grading, risk reporting and risk control. Credit policies are
periodically reviewed keeping in view the ever-changing economic and
socioeconomic conditions.  Credit policy
duly approved by board of directors is circulated to branches and
controlling offices along with detailed instructions and guidelines.

As
per RBI directives all commercial banks operating in India are required
to give 40 percent of their net adjusted credit to priority sector. RBI
regulates rate of interest on priority sector advances up to a limit of
Rs. 2 laks.  RBI announces credit policy twice a year. Credit policy
specifies bank’s exposure in different segments of economy.

(i) Assessment of Needs:

Assessing the credit needs of different sectors help in budgeting the quantum of funds to be lent in to that sector.

(ii) Assessing Resource position:

Deposits are the main resource for banks. Bank deposits are held in different maturity buckets as under

1 to 14 days

15 to 29 days

29 days and up to 3 months

Over 3 months and up to 6 months

Over 6 months and up to 1 year

Over 1 year and up to 3 years

Over 3 years and up to 5 years

Over 5 years

While deciding credit policy deposits in different maturity buckets are considered, as a bank cannot afford to lend for longer period if major portion of deposits is held in short period maturity bucket.

(iii) Sectoral Diversification:

Credit policy should not have leaning towards a particular sector, as deployment of resources towards one particular sector may be suicidal for the bank.  It is not advisable to keep all eggs in one basket. Therefore size of the loan portfolio for different sectors of economy needs to be determined.

iv) Retail lending or bulk (wholesale) lending:

While preparing credit policy bank also decides whether it wants to go for retail lending or bulk lending. While retail lending involves higher cost of supervision and control the element of credit risk is less. In case of bulk lending cost of supervision and control is less but risk of default is high.

(v) Loan Pricing:

Bank has to decide the benchmark Prime Lending Rate for different types of loans and advances. It also decides whether to have fixed rate of interest or floating rate of interest or both and its applicability on different asset products. The advantage in charging fixed rate of interest is that the revenue can be worked out well in advance. The disadvantage is that in the event of interest rate going up and in the event of declining rate regime (unless bank falls in line) borrowers desert bank and migrate to other banks having lower interest rate. In case of floating interest rate it automatically gets adjusted as per market forces, however it become bit difficult to project revenue. Banks also permit borrowers to switch over from fixed to floating rate and vice versa by levying migration fee.

(vi) Market intelligence:

With a view to enabling them to face competition, while preparing credit policy, banks take in to account the credit policy of other banks. They find out-processing fee, charges for non-utilization of sanctioned limit and other incidental charges and reducing risks arising from lending operations.

(vii) Risk assessment:

Banks also undertake portfolio review / industry studies in order to assess the risks lying in the portfolio / industries financed and impact of concentration of exposures to certain borrowers, sectors or industries for improving quality of the portfolio and reduce the potential adverse.

(vii) Exposure limit:

In terms of powers conferred by the Banking Regulation Act, 1949, RBI issues statutory guideline to Scheduled Commercial Banks relating to credit exposure limits for individual / group borrowers , credit exposure to specific industry or sectors, and the capital market exposure of banks.

 

Preparing Budget:

Once the bank decides its lending policy, budgeting for lending is done. Controlling offices are asked to prepare their lending budget keeping in view the potential in their area of operations and priorities mentioned in district credit plan.

 

References:

• Crosse. Howard D. and George H. Hempel “ Management Policies for Commercial Banks”, Prentice-Hall, Inc. Englewood Cliffs, New Jersey, 1973
• Banking Regulation Act, 1949
• Master Circular RBI/2008-09/78 DBOD No. Dir. BC. 17/13.03.00/2008-09 dated July 1, 2008 ‘Loans and Advances –Statutory and Other Restrictions’
• Master Circular RBI/2009-10/71 DBOD No. Dir. BC.15/13.03.00/ 2009-10 dated July 1, 2009 about Exposure Norms

 

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