Retail products of bank or in layman language loans which are introduced by banks to fulfill the needs of people ranging from basic desires like owning a dream home or children’ education to augmented needs like summer holidays & fancy cars by paying easy installments has come a long way since its inception. What was introduced as supplementary product has now become one of major revenue earner for the bank. These retail products which are boon for banks have turned into major nightmare when people begin to default or delay their loan installments. These incidences led to the establishment of procedure of checking the creditworthiness of applicant now known as credit appraisal.
Credit Appraisal is the process by which a lender appraises the technical feasibility, economic viability and bankability including creditworthiness of the prospective borrower. Credit appraisal process of a customer lies in assessing if that customer is liable to repay the loan amount in the stipulated time, or not. Here bank has their own methodology to determine if a borrower is creditworthy or not. It is determined in terms of the norms and standards set by the banks. Being a very crucial step in the sanctioning of a loan, the borrower needs to be very careful in planning his financing modes. However, the borrower alone doesn’t have to do all the hard work. The banks need to be cautious, lest they end up increasing their risk exposure. All banks employ their own unique objective, subjective, financial and non-financial techniques to evaluate the creditworthiness of their customers.
What is credit appraisal? The word ‘credit appraisal’ garners a lot of meaning when you talk of personal loans. It looks a complicated word, but it is assessing a particular loan application in a thorough manner, to check or gauge your loan repayment ability. The lender or the bank does credit appraisal to check if you can repay the loan.
Credit appraisal assesses two major factors. Ability and willingness to repay the loan. The bank checks:
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Lenders check the fixed obligation to income ratio (FOIR): This gives banks an idea on how much debt you have and how regular you are with repayments. FOIR gives the fixed obligations a bank has to meet each month. Banks frown on customers having loan EMIs of 50% or more vis-à-vis monthly income. Banks assume that you require at least 50% of income for living expenses. If more than 50% of monthly salary goes in loan EMIs, you could struggle with repayments.
You have an income of Rs 60,000 a month. (Take home salary). You have availed a car loan where you pay Rs 9,500 a month in EMIs. You also have a personal loan where you pay Rs 6,500 a month. Banks believe that if loan EMIs are within 50% of monthly income, you can safely repay loans.
Take home salary = Rs 60,000.
Car loan = Rs 9,500
Personal loan = Rs 6,500
Total loan EMIs = Rs 16,000.
Banks are happy to give you a loan as long as loan EMIs are within Rs 14,000. (This is 50% of Rs 60,000 – Rs 16,000).
FOIR = Sum total of loan EMIs / Monthly Income.
FOIR = 16,000 / 60,000 = 27%.
Installment to Income Ratio: This is loan EMIs to income you earn.
Loan to Cost Ratio: This helps to gauge how much of a loan you must be given. A bank will sanction a personal loan based on requirement. Banks would sanction a home loan based on 80-90% of the cost of the property. Banks would sanction 70-80% of the cost of the car.
Identification of the customer:
Banks check identity proof like PAN and Passport, Employment proof like appointment letter/experience letter or office address proof. CIBIL score of 700 and above. Investment proof required for collateral like LIC Policy, Mutual Funds, Shares, FD or PPF.
The bank wants to know who you are, where you live, how much you earn and your reputation in society. Banks want to know the ability and willingness to repay the loan.
Banks want to understand the business model, before sanctioning credit. They enquire on the nature of business, the industry you operate and peers in the business, and do research on the performance of the business and the sector.
Banks need an accurate estimate of funds you need to run the business. If they sanction too high a loan amount, the businessman will use the money for other purposes. Too low an amount means money would not be sufficient to run the business.
Banks slot you in a scheme based on the line of business. This could be a unique scheme for traders, professionals, car dealers, travel agents and so on. Banks check eligibility, collateral, margins, rate of interest, before slotting you in a scheme.
You have to fill the loan application in the prescribed format. The bank collects crucial information on you through loan application.
Banks go through the credit information report (CIR) and the CIBIL score. There are two types of credit reports.
Banks check for settlements, defaults, dues and written off amounts.
The defaulter list can be got from the CIBIL website. Borrowers, proprietors, promoters, partners, guarantors must not be on the list.
Banks check the CERSAI website to find out if property is mortgaged to another lender.
While assessing a customer, the bank needs to know the following information: Incomes of applicants and co-applicants, age of applicants, educational qualifications, profession, experience, additional sources of income, past loan record, family history, employer/business, security of tenure, tax history, assets of applicants and their financing pattern, recurring liabilities, other present and future liabilities and investments (if any). Out of these, the incomes of applicants are the most important criteria to understand and calculate the credit worthiness of the applicants. As stated earlier, the actual norms decided by banks differ greatly. Each has certain norms within which the customer needs to fit in to be eligible for a loan. Based on these parameters, the maximum amount of loan that the bank can sanction and the customer is eligible for is worked out. The broad tools to determine eligibility remain the same for all banks. We can tabulate all the conditions under three parameters.
|Technical feasibility||Field Investigation, Market value of asset|
|Economic viability||LTV(Loan to Value), IIR|
|Bankability||Past month bank statements, Asset and liabilities of the applicant|
Besides the above said process, profile of the customer is studied properly. Their CIBIL (Credit Information Bureau (India) Limited) score is checked.
Parameter components & How bank asses your creditworthiness through it.
|Technical Feasibility||What bank is looking for|
|Living standard||Decent living standard with some tangibles like T.V. & fridge will provide assurance to bank regarding your residential status.|
|Locality||Presence of some undesirable elements like local goons or controversial areas adversely affects your loan appraisal process.|
|Telephonic Verification||At least one response is need from person to establish the identity of the person from contact point of view.|
|Educational Qualification||Not an essential barrier but essential to understand the complex terms & conditions of bank loan.|
|Political Influence||An interesting reference point in the sense that they are one of major category of loan defaulters.|
|References||To establish the residential identity of person from human contact point of view & cross check of their loans.|
This ratio is generally expressed as a percentage. This percentage denotes the portion of the customer's monthly installment on the home loan taken. Usually, banks use 33.33 percent to 40 percent ratio. This is because it is has been observed that under normal circumstances, a person can pay an installment up to 33.33 to 40 per cent of his salary towards a loan.
Example: If we consider the installment to income ratio equal to 33.33 per cent, and assume the gross income to be Rs 30,000 per month, then as per the ratio, the applicant is eligible for a loan with the maximum installment of Rs 10,000 per month.
This ratio signifies the importance of the regularity in the repayment of previous loans. In this calculation, the bank considers the installments of all other loans already availed of by the customer and still due, including the home loan applied for. In other words, this ratio includes all the fixed obligations that the borrower is supposed to pay regularly on a monthly basis to any bank. Statutory deductions from salary like provident fund, professional tax and deductions for investment like insurance premium, recurring deposit etc. are exempt from these fixed obligations.
Example: Assume that monthly income of an applicant is Rs 30,000 and the applicant has a car loan installment of Rs 4,000 per month, a TV loan installment of Rs 1,000 per month. In addition to this his proposed housing loan installment is Rs 10,000 per month. Numerically, the ratio is equal to Rs. 15,000 or 50 percent (i.e. 50 percent of the monthly income). If the bank has decided on the standard of 40 per cent of ratio as the criteria, then the maximum total installments the person can pay, as per the standard, would be Rs 12,000 per month. As he is already paying Rs 5,000 for the car and TV, he only has Rs 7,000 left out. Hence, the customer would be given only that loan for which the EMI would be equal to Rs 7,000, keeping in mind the repayment capacity of the applicant.
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This ratio is used by banks to calculate the loan amount that an applicant is eligible to pay on the basis of the total cost of the property. This ratio sets the upper limit or the maximum loan amount that a person is eligible for, irrespective of the loan eligibility under any other criteria. The maximum amount of loan the borrower is eligible to pay is pegged as equal to the cost or value of the property. Even if the banks’ calculations of eligibility, according to the above mentioned two criterions, turns out to be higher, the loan amount can't exceed the cost or value of the property. This ratio is set equal to between 70 to 90 per cent of the registered value of the property.
Hence, while deciding on the maximum amount of loan a customer can be given, the banks use these three parameters. These parameters help in computing loan eligibility, which is crucial in calculating the creditworthiness of a customer. It also acts as a guide to determine the loan amount.
|Installment to income ratio||
IIR for salaried cases would be capped at 60% of Net income in general.
-Pension Income cases IIR to be restricted to 40%
|Fixed obligation to income ratio||FIOR kept at 55%|
|Loan to cost ratio||LTV amount to 80%|
|Bank Statements||6 months bank statements need to be furnished||To check the average amount client is maintaining in the account is sufficient to pay the installment amount or not.|
|Business continuity proof||Two year IT returns made compulsory||To enquire primary source of income|
|Credit interview||For the big loan amount credit interview is necessary.||To check the general attitude of customer along with efforts are put in to understand their needs better.|
|Profile of customer||Salaried professionals get an edge over business income people.||Secured source of income give them a edge|
|Security||Asset of value equal to or more than loan amount taken has to be put as pledge or collateral.||To safeguard bank interest against any future default.|
|Ownership title||To be on the name or blood relative of applicant.||To establish the ownership claim of the loan applicant.|
|CIBIL Report||To check the credit history of the bank applicant.||Bank tool to check any default incidence in loaning history of applicant.|
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These are the parameters which help banks in deciding your creditworthiness & help them in granting the loan to the seekers.
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