Sunday, December 9, 2012


The writer joined the business of banking in 1979 when most of us were not born of course… He stumbled into Credit by default. We had an Industrial Estate branch in a city known for small and medium scale industry, mainly textile and steel related. There were thousands of working capital limits awaiting annual ‘renewal’ due to some branch management issues. Thanks to a round of musical chairs in the HR section, we landed at the branch for clearing up the arrears and the label of  ‘Credit’ stuck to us for good. The last commercial bank branch we headed had a fund based credit portfolio of around Rs. 13,000 crores and non-fund based limits of even amount. Those are the credentials.
The first human issue that confronted us as a dealing officer in 1980 was phobia of business people. We were from a ‘service-class background’. Nobody in our family had a business, and our parents were both in the teaching profession. In fact we were always taught that you study hard, you get a good job, else you have to do ‘business’. On the top of that, we had studied Science, and had no inkling of the subject of Commerce or Company Law. So whenever our branch manager summoned us to meet a businessman, our mouth would run dry. The primary fear was like this: this man has been in business for such a long time, and we know nothing about business, so how are we to assess or appraise his proposals and his business needs. We couldn’t afford to reveal our ignorance, for that would mean conceding his or her demands. Would he sort of ‘prevail’ upon us? How would we do justice to the fiduciary responsibility that our role demanded? It is now alleged that the author is a consummate credit person, and whether it is correct or not, the learning our stints generated was quite useful and it affected not only our appraisal skills, but also broadened our perspective and the way we looked at the world. We developed sympathy for the business of business. Now our elder son has a small but excellent business and we have supposedly rendered him advice that has always stood him is good stead. 
The precious ‘learning’ we imbibed, and upon which we shall try to elaborate below, is
(i)           There are businesses and businesses. But over a period of time, the credit analyst is in a unique position to grasp the common threads, and apply the common sense to judge any situation.
(ii)           The credit analyst, when he is new to the role, should realise that the knowledge the client has about his business is distinct from the knowledge that the analyst needs in order to protect the interest of his organisation, or his own interests. This should be made clear to the client also. Once he is equipped with his part of the mental software, he can hold his fort. Then of course to an extent it will also depend upon your own personality. But you have to be prepared to abandon you shyness if any, if you are to do justice to your Job.
(iii)          The businessman’s world, his compulsions are quite different from those of people hailing from the salaried middle class. We bet anybody will behave in identical fashion if born on the ‘other’ side of the fence. They are good people, we can assure you!
Let us start with papers. Once you are thorough and confident about your part of the paperwork, the borrower or the client can be told about the difference in concerns in so many words, and then he will respect you and, hopefully, seek your advice (loosely we refer to the other party as ‘borrower’, but he is an ‘applicant’ till his loan is released- no, not ‘supplicant’!).
Lot of learning comes by observing the best persons in the line. We recall an experience, when we were relatively new to the field, and RVJ, our expert from the technical cell came to assess the needs of a steel unit that was in some kind of trouble, and the interest was not getting serviced. RVJ happens to be an engineer in the technical cell, and the position is not subject to periodic transfer in the name of CVC requirements or statutory requirements of job rotation. Thus he had the opportunity to observe hundreds of units over a couple of decades, and being a curious, inquisitive and extremely capable officer, made the best of the opportunity. Analytical skills of course came to him from his study of engineering.
The unit was a steel rolling mill, manufacturing mild steel rods, angles, channels etc., mainly for use in construction. As you know, these are low tech industries, and the process is basically like making doughnuts or jalebis or murukku, you know? Passing molten stuff through holes of different shapes, and after a while the material solidifies. Technology being rudimentary, and the plant being relatively easy and cheap to assemble, there are few entry barriers. Construction demand is universal, so markets are usually available, except maybe when the commodities cycle is adverse, or there is a recession in capital goods. Margins being low, the units thrive on unscrupulousness, and unscrupulousness can be said to be a basic raw-material. As the process is quick, lots of stolen steel finds its way into the industry. There is a whole industry in a state which decency prevents us from naming, but we can give a ‘hint’- it’s a 5 letter word, starting with B and ending with R! They pilfer rails from railway and industrial yards, which are usually part of defunct rail networks, and once they are converted into rods, the evidence of theft is naturally lost, not even God can catch the theft. Then there is power theft, fake VAT claims, and naturally suppressing sales figures, for the buyer of rods usually pays cash, in India that is. We have always been wary of financing rolling mills due to the regulatory hazard, and the propensity for ‘number 2 sales’.
So RVJ came to our branch to examine one ‘A’ Rolling Mills, which was a partnership concern, in the month of August. The audited statements were not yet ready and the provisional ones showed a capital of Rs. 10.00 lacs or so, Unsecured Loans (‘quasi-equity’) of around a crore, and sales around Rs. 5.00 crores. The Cash Credit limit was around a crore and the borrower had applied for a term loan of Rs. 3.00 crores, as they planned to foray into structurals like rails, what they call ‘mota maal’ in Marwari parlance. Now we are referring to point (ii) made above: the timing of audit and contents of the statements reflected the needs of the businessman. As a novice we would not have appreciated the point, but RVJ launched into a full-scale attack on the promoter, and his weapon was what we called the ‘other’ side’s, that is the lender’s concerns about ‘financials’. He said something like this:
 “You people will never learn…still your financials are not audited and you have called me here…whaaat is this?? With one and half crore working funds, you have sales of Rs. 5.00 crores only- one rotation in three months…bah..nobody can believe that.! Your sale is actually at least Rs. 15.00 crore, it’s a rolling mill nooo.??...and that is the root cause of your audits being so late. The CAs first do the clean work..look at TNPL- audits over by 15th April! You want the CA to release all bogus vouchers and things like that to save on tax and to show your own money as Unsecured Loans by buying this entry and that entry etc. etc. etc., and that’s why the audits get delayed, then you change the auditor who is averse to these things…look you have changed you auditor twice in the last 5 years…I don’t appreciate that etc.etc.etc. Sethji, mend your ways if you want to enter the big league, this year I warn you our bank will not tolerate this .05% net profit, it should at least be 2%. You have to do that if you have to survive in the changing world, and our Bank will never like to finance people who are not prepared for the future…you’ll be extinct in no time and we’ll lose our money…etc.etc.etc.
So this the second part of point no (ii)- RVJ made known the lender’s position on the same financials which we normally accept believing that the owner knows the best and write inane, pedestrian comments like ‘the debt-equity ratio becomes satisfactory if we treat the Unsecured Loans at par with equity…’ isn’t it?  In the present case, the promoter hastily called the CA and told him to ‘show’ more profit. We could almost hear his head thinking “…saala, some kharcha has to be made to get this bloody loan sanctioned..okay, some fee we’ll pay to the Bank and some tax we’ll pay to the Government, that we’ll treat as kharcha for getting the sanctions, and I hope this man will not demand much..!”  RVJ is squeaky clean, by the way…
Having learnt this nice lesson from RVJ,  we always find is a good point to make, to let such a borrower know you mean business.
Then you have to know the difference between the financial statements the auditor produces, and the ones the FIs or Banks use. Here again the differences reflect differing concerns. The CA-produced financials are in the Company Act format, which reflects the requirements of Law, share-holders, tax authorities, etc., whereas the CMA formats reflect the concerns of the WC lender, whose attention is focussed on projected sales, the quantum of current assets required for achieving that, and what part of the current assts should be financed by the lender, keeping in view the quality with regard to liquidity. Thus you will find the heads with greater permanency at the top in the CA produced balance sheet, and in the CMA format, the other way round. Also, current liabilities cannot be netted out of current assets if the liquidity is assessed by the bank, and hence that is another point of difference. Likewise, bills purchased by the Bank/others have to be added back on both sides of the balance sheet. Often the CA’s balance sheet will show this figure under ‘contingent liabilities’. Note that deducting an identical amount both from the current assets and current liabilities will boost the current ratio. Then, the CMA format will enable you to readily compute the ‘net inventory’ in case of manufacture, as this figure is required from the point of view of the ‘matching concept’, for without making adjustment for the net inventory, ratio analysis on the P & L cannot be carried out. Finally there is the question what is a current asset and what is not. In the case of the working capital lender, more than the duration, what matters is whether or not it is a part of the working cycle- a ship may for example may require two years to build, but for the shipyard, it’s still a current asset. There could be more differences, we leave the technical part to you.
Whew…that’s a lot for one instalment we suppose. Once you are able to master the CMA and appreciate that the bread of the FI/Bank and that of the borrower is buttered on different sides, you can make it plain to the borrower or client. You’ll emerge a more confident credit analyst thereafter, and in a better position to negotiate.
The above dissertation may appear a bit crude or desi, sorry, but you can’t afford to appear too sophisticated in the Indian business world, or for that matter in any business world, ask Vikram Pandit…!
We plan to write about point (i) and (iii) later this week. Till then happy lending! A few friends have suggested we write with some regularity, so that they know when to expect the next edition. We shall try to make it a Sunday affair.
Why do people always begin an official letter with  “ with reference to your letter such-and-such, we have to advise that…”? That’s what you are actually doing, advising!Beating about the bush! Reminds us of Basanti in Sholay “ youn humen befazool bolney ki aadat to hai nahi par dekhna yeh hai key etc. etc. etc. “Just cut those words out, and look how nice and direct it looks. Come straight to the point…

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