what+is+credit+appraisal

7/31/2019 What+is+Credit+Appraisal

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What is Credit Appraisal....?

(Source: Post by Anshul Saxena on 26/9/09 at Indianmoney.com)

What is credit appraisal?

Credit Appraisal is the process by which a lender appraises the technicalfeasibility, economic viability and bankability including creditworthiness of theprospective borrower. Credit appraisal process of a customer lies in assessing ifthat 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 creditworthyor 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 bevery careful in planning his financing modes. However, the borrower alonedoesnt have to do all the hard work. The banks need to be cautious, lest theyend up increasing their risk exposure. All banks employ their own uniqueobjective, subjective, financial and non-financial techniques to evaluate thecreditworthiness of their customers.

Components of Credit Appraisal Process

While assessing a customer, the bank needs to know the following information:Incomes of applicants and co-applicants, age of applicants, educationalqualifications, profession, experience, additional sources of income, past loanrecord, family history, employer/business, security of tenure, tax history, assetsof applicants and their financing pattern, recurring liabilities, other present andfuture liabilities and investments (if any). Out of these, the incomes of applicants

are the most important criteria to understand and calculate the credit worthinessof the applicants. As stated earlier, the actual norms decided by banks differgreatly. Each has certain norms within which the customer needs to fit in to beeligible for a loan. Based on these parameters, the maximum amount of loan thatthe bank can sanction and the customer is eligible for is worked out. The broadtools to determine eligibility remain the same for all banks. We can tabulate allthe conditions under three parameters.Parameter DOCUMENTS

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 applicantBesides the above said process, profile of the customer is studied properly. TheirCIBIL (Credit Information Bureau (India) Limited) score is checked.

Parameter components & How bank asses your creditworthiness through it


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Technical Feasibility What bank is looking for

Living standard Decent living standard with some tangibles like T.V. & fridge willprovide 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 majorcategory of loan defaulters.

References To establish the residential identity of person from human contactpoint of view & cross check of their loans.

The 3 methods used to arrive at Eligibility

Installment to income ratio Fixed obligation to income ratio Loan to cost ratio

Installment to income ratio

This ratio is generally expressed as a percentage. This percentage denotes theportion 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 beenobserved that under normal circumstances, a person can pay an installment upto 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 permonth.Fixed obligation to income ratio

This ratio signifies the importance of the regularity in the repayment of previousloans. In this calculation, the bank considers the installments of all other loansalready 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 issupposed to pay regularly on a monthly basis to any bank. Statutory deductionsfrom salary like provident fund, professional tax and deductions for investmentlike insurance premium, recurring deposit etc. are exempt from these fixedobligations.Example: assume that monthly income of an applicant is Rs 30,000 and theapplicant has a car loan installment of Rs 4,000 per month, a TV loan installment


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of Rs 1,000 per month. In addition to this his proposed housing loan installmentis Rs 10,000 per month. Numerically, the ratio is equal to Rs. 15,000 or 50percent (i.e. 50 percent of the monthly income). If the bank has decided on thestandard of 40 per cent of ratio as the criteria, then the maximum totalinstallments 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 Rs7,000 left out. Hence, the customer would be given only that loan for which theEMI would be equal to Rs 7,000, keeping in mind the repayment capacity of theapplicant.

Loan to cost ratio

This ratio is used by banks to calculate the loan amount that an applicant iseligible to pay on the basis of the total cost of the property. This ratio sets theupper limit or the maximum loan amount that a person is eligible for, irrespectiveof the loan eligibility under any other criteria. The maximum amount of loan theborrower 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 mentionedtwo criterions, turns out to be higher, the loan amount can't exceed the cost orvalue of the property. This ratio is set equal to between 70 to 90 per cent of theregistered 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 loaneligibility, which is crucial in calculating the creditworthiness of a customer. It alsoacts as a guide to determine the loan amount.

Economic viability

Installment to income ratio IIR for salaried cases would be capped at 60% of Net incomein general Pension Income cases IIR to be restricted to 40%a

Fixed obligation to income ratio FIOR kept at 55%

Loan to cost ratio LTV amount to 80%

Bankability Parameters


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Parameter Norms Checkpoints

Bank Statements 6 months bank statements need tobe furnished

To check the average amountclient is maintaining in theaccount is sufficient to pay theinstallment amount or not.

Business continuity proof Two year IT returns madecompulsory To enquire primary source ofincome.

Credit interview For the big loan amount creditinterview is necessary.

To check the general attitude ofcustomer along with efforts areput in to understand their needsbetter.

Profile of customer Salaried professionals get an edgeover business income people.

Secured source of income givethem a edge

Security Asset of value equal to or more thanloan amount taken has to be put aspledge or collateral.

To safeguard bank interestagainst any future default.

Ownership title To be on the name or blood relativeof applicant. To establish the ownership claimof the loan applicant.

CIBIL Report To check the credit history of thebank applicant.

Bank tool to check any defaultincidence in loaning history ofapplicant.

These are the parameters which help banks in deciding your creditworthiness &help them in granting the loan to the seekers.

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