Term Loans: Caiib Paper 1 (Module D), Unit 4
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CAIIB exams are conducted twice in a year. Candidates should have completed JAIIB before appearing for CAIIB Exam. Here, we will provide detailed notes of every unit of the CAIIB Exam on the latest pattern of IIBF.
So, here we are providing “Unit 4: Term Loans” of “Module D: Credit Management” from “Paper 1: Advanced Bank Management (ABM)”.
♦Important Points about Term Loans
- Working capital loans are normally sanctioned for one year but are payable on demand. Term loans are payable as per the agreed repayment schedule, which is stipulated in the terms of the sanction. Therefore, for the purpose of matching assets and liabilities of the bank, term loans are considered long term assets while working capital loans are considered as short term assets.
- Banks provide term loans normally for acquiring the fixed assets like land, building, plant and machinery, infrastructure etc., (personal loans, consumption loans, educational loans etc. being exceptions)
- As a term loan is expected to be repaid out of the future cash flows of the borrower, the D S C R assumes great importance while considering term loans, while for working capital loans, the liquidity ratios assume greater importance.
- In exceptional cases, banks provide term loans for current assets This is called Working Capital Term Loan (WCTL)
- There is no uniform repayment schedule for all term loans. Each term loan has its own peculiar repayment schedule depending upon the cash surplus of the borrower.
Deferred Payment Guarantees (DPGs)
- When the purchaser of a fixed asset does not pay to the supplier immediately, but pays according to an agreed repayment schedule, and the bank guarantees this repayment, the guarantee is called DPG. This is a Non-fund based method for financing purchase of fixed assets.
Difference Between Term Loan Appraisal And Project Appraisal
The differences can be summarized as under:
- In project finance all the financial needs of the enterprise, including working capital requirements, are appraised. This is because the total requirement of long term funds includes margin money for working capital. After assessing the total requirement of long term funds, the banks decide upon the amount of term loan to be sanctioned and the contribution of the promoters.
- If an existing enterprise wants to purchase a few machineries, which are not going to have a major impact on the volume or composition of the business, it will serve little purpose to have a detailed examination of techno- economic feasibility, managerial competence, I R R etc. It may be enough for the bank to examine the projections for next 2 to 3 years to find out that D S C R is at satisfactory level. In case of loans to individuals also, like housing loans, educational loans etc., it may be enough to examine the projected D S C R to judge the viability. However, the basic principles of appraisal of a project or a standalone term loan are not different and if one is clear about project appraisal, the appraisal of a standalone term loan proposal is even simpler.
Project appraisal can be broadly taken in the following steps:
- Appraisal of Managerial Aspects
- Technical Appraisal
- Economic Appraisal
Appraisal of Managerial Aspects: The appraisal of managerial aspects involves seeking the answer to the following questions:
- What are the credentials of the promoters’?
- What is the financial stake of promoters in the project? Can they bring additional funds in case of contingencies arising out of delay in project implementation and changes in market conditions?
- What is the form of business organization? Who are the key persons to be appointed to run the business?
Technical Appraisal: The technical feasibility of a project involves the following aspects:
- products to be manufactured, production process
- availability of infrastructure
- provider of technology
- details of proposed construction
- contractor for project execution
- waste-disposal and pollution control
- availability of raw materials
- marketing arrangements
Economic Appraisal: The economic or financial feasibility of a project involves the following aspects:
- Return on Investment: The usual methods used are the NPV, IRR, payback period, cost benefit ratio, accounting rate of return etc.
- Break-even Analysis: A project with a high break-even point is considered more risky compared to the one with lower break-even point.
- Sensitivity Analysis: As market conditions are uncertain, a small change in the prices of raw materials or finished goods may have a drastic impact on the viability of a project. Sensitivity analysis examines such impact.
Appraisal and Financial of Infrastructure projects
- Water & Sanitation
- Social and Commercial Infrastructure
Types of Financing by Banks
- Take-out Financing
- Financing Promoter’s Equity
- In respect of financing of infrastructure projects undertaken by Government owned entities, banks or Financial Institutions should undertake due diligence on the viability of the projects. Banks should ensure that the individual components of financing and returns on the project are well defined and assessed. State government guarantees may not be taken as a substitute for satisfactory credit appraisal and such appraisal requirements should not be diluted on the basis of any reported arrangement with the Reserve Bank of India or any bank for regular standing instructions or periodic payment instructions for servicing the loans or bonds.
- Infrastructure projects are often financed through Special Purpose Vehicles. Financing of these projects would, therefore, call for special appraisal skills on the part of lending agencies. Identification of various project risks, evaluation of risk mitigation through appraisal of project contracts and evaluation of creditworthiness of the contracting entities and their abilities to fulfill contractual obligations will be an integral part of the appraisal exercise.
- In this connection, banks or Financial Institutions may consider constituting appropriate screening committees or special cells for appraisal of credit proposals and monitoring the progress or performance of the projects.
- Prudential Credit Exposure Limits
- Assignment of Risk Weight for Capital Adequacy Purposes
- Asset Liability Management
- Administrative arrangements
Take-out Financing or Liquidity Support
- Take-out Financing or Liquidity Support
- Liquidity support from IDFC
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