A study on the effectiveness of credit appraisal process for working capital loans at the Mauritius Commercial Bank Ltd

By Vimal Ramgoolam ID: 1018197

BSc (hons) Banking and finance Faculty of Law and Management University Of Mauritius

Submitted to Mr. Ushad Subadar Agathee

13 APRIL 2012

Project Summary
Credit the lifeline of a business
Of all the elements that that go into a business, credit is perhaps the most crucial one. The best of the plans can come to naught if adequate finance is not available at the right time. Entrepreneurs need credit support not only for running the enterprise but also for diversification, modernization of facilities, capacity and expansion. Banking and financial system should ensure that the supply of timely and adequate amount of credit should be provided to the entrepreneur in order to develop the economy. Development in the banking system Due to rapid growth of the economy, banks can expect to see rapid increase in disbursement; this challenges the credit appraisal system followed by banks. Hence the adoption of global best practices under these circumstances is necessary. Moreover, the Mauritian Banking System has seen various improvements during the last few years, including, improves solvency, better risk management and greater access to capital. However, due to greater complexities of the corporate and lending business, the need for stronger risk management assessment is required. A well developed and implemented credit appraisal system will result in: Growth in the volume of credit disbursement Reduce the non-performance assets of banks and improves the quality of asset portfolio Improves the bottom line of banks Ensures timely and adequate supply of credit to the industry.

Hence, this study is carried out to understand the credit appraisal process carried out by a bank. Moreover the customer satisfaction level will also be reviewed.

Contents
Introduction .................................................................................................................................................. 1 Objectives of the study ................................................................................................................................. 2 Limitations of the study ................................................................................................................................ 2 Problem statement ....................................................................................................................................... 2 Literature review........................................................................................................................................... 3 Previous researches concerning credit appraisal. .................................................................................... 3 Banking in Mauritius ................................................................................................................................. 4 Overview of the Mauritius commercial bank ........................................................................................... 4 Small and medium enterprises in Mauritius ............................................................................................. 4 International findings ................................................................................................................................ 4 Proposed Methodology ................................................................................................................................ 5 Primary data.............................................................................................................................................. 5 Secondary data ......................................................................................................................................... 5 The research approach ............................................................................................................................. 5 The Gantt chart ............................................................................................................................................. 6 Budget analysis ............................................................................................................................................. 6 References .................................................................................................................................................... 7

Research proposal 2012

Introduction
The title of the project is A study on the effectiveness of the credit appraisal process for working capital loans at the Mauritius Commercial Bank Ltd. The company is the market leader in the banking sector of Mauritius and is engaged in all type of banking services. The study will be conducted to identify the effectiveness of credit appraisal process of MCB for small and medium enterprises. It must be noted that the project will be carried out on small and medium enterprises (SME). I will proceed with a comparative study with other banks for products associated with working capital loans. Here, I will do a case study in which I will select a small enterprise which will be a customer of MCB and analyse its financial statement to get familiar with the appraisal system follows by the bank. Then, I will approach 5 banks, which will be the main competitors of MCB on the market, with a questionnaire to identify the techniques followed by them to appraise their borrowers and compare it with the MCB. In addition, it is good to know that customers perception also place an important role in judging the overall effectiveness of appraisal. To find out, I will meet 50 customers of the MCB with a questionnaire and find out their level of satisfaction after taking a working capital loan. The data collected will be then analyse with statistical tools like chi-square test and interval estimation. Traditionally, banking is defined as the process of accepting deposits from surplus unit with the objective of lending these funds to the deficit units. Currently, the banks are offering a wide range of loans such as car loans, educational loans, housing loans, business loan and so on. Moreover, banks are also concentrating on the segment of business enterprises and are offering working capital loan to SME. However, before providing such loans, the banks must appraise thoroughly the credibility of borrowers based on financial ground and non-financial grounds. Credit appraisal process is a technique by which a bank or any financial agency including financial institutions estimates the soundness of a credit proposal. The credit appraisal for SME starts with understanding the need of loan to the borrower, that is, for which purpose the loan is required. The next step is to analyse the financial statement of the company to whom the loan is to be sanctioned. The main things which are taken into consideration while analyzing the financial statement are type of statement, nature of activity ,accounting policy, qualities of assets and liabilities , unit wise performance result of the company & directors report.

Research proposal 2012

Objectives of the study

To find out the effectiveness of credit appraisal system of MCB by comparing it with other banks appraisal system for working capital loans. Carry out customer satisfaction survey to find out the perspective of the customer towards the appraisal process. To study the procedure adopted in evaluating credit proposal using case analysis and working out and interpreting the financial ratios in case of working capital loans.

Limitations of the study

Coverage: The study aims at covering the MCB only. There might be tendencies among the personals of banks to amplify or filter their responses due to time limitation. Credit appraisal for working capital finance is a study that needed specialized knowledge of the area, so there might be a chance for interpretational error on my behalf.

Problem statement
Commercial lending is the mainstay of Mauritian banking, its bread and butter activity. Therefore many banks wish to maximize market share in commercial lending. However, banks should also concentrate about controlling and reducing its non-performing loans. This highlights the importance of risk management system in commercial lending so that banks do not go bankrupt. We will try to benchmark the credit appraisal process of MCB in regards to SME with other banks to know the reliable variables to include in a credit appraisal. Moreover, the study will try to collect information among existing customers to know about their satisfaction level with regards to various aspects of MCB service. This can be helpful to address the problems of customers to the bank and to find ways to improve their satisfaction level.

Research proposal 2012

Literature review
Previous researches concerning credit appraisal.
Banks manage a wide range of assets, liabilities and equity capital that support their activities. Proper risk management is therefore a vital and integral part of effective bank operations. During the past 20 years, banks used different tools such as credit scoring system to evaluate certain types of loans more objectively and effectively. Nowadays, the banking industry started to implement credit rating as a mechanism to better manage its credit rating and to improve its overall portfolio performance. It helps banks to reduce default risk, increase liquidity and so on. Moreover, Treacy and Carrey (2000) suggest that in designing a credit rating system, banks should consider numerous factors, including cost, efficiency of gathering information, consistency of rating produced, staff incentives, nature of banks business and uses to be made of the internal ratings. They notice that the proportion of grades use to distinguish among riskier pass credits tend to differ with the business mix of a bank. A rating system with more categories is better than a system with just a few categories. Furthermore, they have also found that despite various advances in the risk assessment program, human judgment is still important. According to, Treacy and Carrey (2000), the rating process almost always involve the exercise of human judgment because factors to be considered in assigning a rating and weight given to each factor can differs significantly between borrowers. In addition, Crouhy et al. (2000) suggest that banks should analyze 3 different categories of variable when assigning a loan applicant to a particular grade which is: qualitative, quantitative and legal. Quantitative analysis concentrates mainly on financial analysis based on a firms financial statement. It is the process of calculating ratios of a firm. Qualitative analysis is based on a borrowers management. That is, it reviews the firms competitiveness in the industry. And finally, legal analysis refers to the capacity to borrow. The banks must make sure that a customer has the authority and the legal standing of signing a binding agreement.

Research proposal 2012

Banking in Mauritius
In the late 1980s and early 1990s, the Mauritian financial sector was marked by the process of financial liberalization to modernize the financial sector. The Mauritian banking industry comprises of 20 banks, of which 7 are local banks, 8 are foreign owned subsidiaries, 1 is a joint venture and 4 are branches of foreign banks. All the banks are licensed by the Bank of Mauritius. There is a good and strong regulatory framework for banks in Mauritius. Since 31st March 2009, banks have fully adopted the Basel II Framework. As at November 2011, banks in Mauritius had a total asset value of Rs 924.2 billion. As at March 2011, banks in Mauritius had a regulatory capital to risk-weighted assets of 17.2%, a regulatory Tier 1 capital to risk-weighted assets of 14.6% and non-performing loans net of provisions to capital of 8.2%.

Overview of the Mauritius commercial bank

Mauritius Commercial bank (MCB) started its operations in 1838 and has always been active within the Mauritian economy. The bank has played a catalyst role in the sugar and textile industry and today is still responsible for 60% of the financing of the Export Processing Zone and finances almost 50% of the tourism sector. It holds the number one position among the banks of the island; with nearly 45% of the market share in terms of "savings" that is 700,000 savings accounts for a population of 1.2 million. The bank also has some 40 branches throughout the country as well as ten bureau de change. Services they provide are: working capital loan, term loan, cash credit and overdraft, bill discount, letter of credit, internet banking and so on.

Small and medium enterprises in Mauritius

A Small Enterprise is defined as an enterprise which has an annual turnover of not more than 10 million MUR and a Medium Enterprise is defined as an enterprise which has an annual turnover of more than 10 million MUR but not more than 50 million MUR.

International findings
It has been found that the worldwide size of the largest 1000 banks grew by 15.5% to reach $60.5 trillion in 2005. Moreover, banking crises have developed many times in history. Prominent examples are: US saving and loan crisis in 1980s, Japanese banking crisis in the 1990s and the great depression and more recently the financial crisis in 2007.

Research proposal 2012

Proposed Methodology
A research design is purely and simply the framework for the study that guides the collection and analysis of data. Basically, the study will be divided into 3 methods. Case study analysis Comparison analysis with other banks Customer satisfaction analysis

Since the research carried out will be descriptive in nature, we will require both primary and secondary data to make our analysis.

Primary data
Primary data will be the first hand information collected from the five banks, which are the main competitors of MCB in the industry for benchmarking of credit appraisal by using unstructured

questionnaire. Moreover, to find out the perspective of customer towards credit appraisal, the data will be collected through a structured questionnaire. This will help me to understanding the credit rating and assessment of working capital loans of the company.

Secondary data
The secondary data will be collected through various documents and official files like the annual report which would be required for understanding the methodology used by the banks. Moreover, related articles, newspapers, magazines, in-house journals of banks etc. will be used to collect secondary data. This will enable me to calculate financial ratios and do the case analysis.

The research approach

Surveys will be used for collect primary data from different banks and customers. It is important to know about the way to choose a sample. The sample will be taken to be 50 for customer survey and 5 for benchmarking of appraisal. Simple random sampling technique will be adopted to collect required data by interviewing credit managers from various banks for benchmarking credit appraisal. The data will be analysed with statistical tool like percentage analysis and interval analysis.

Research proposal 2012

The Gantt chart

The Gantt chart will enable me to make a time plan so that the research will end on time.

Budget analysis
The research work will require the following expenses and efforts Cost of making photocopies of the questionnaires The cost to print the research work Cost of travelling to meet different people in banks and to collect data

The total cost which will be incurred for this project is estimates to be at least RS 2000.

Research proposal 2012

References
Altman, E.I. (1968), Financial ratios, discriminant analysis and the prediction of corporate bankruptcy, Journal of Finance, Vol. XXIII No. 4, pp. 589-609.

Banasik, J., Crook, J. and Thomas, L. (2003), Sample selection bias in credit scoring models, Journal of the Operational Research Society, Vol. 54 No. 8, pp. 822-32.

Ayyagari, M., Beck, T. and Demirguc-Kunt, A. (2003), Small and medium enterprises across the globe: a new database, Policy Research Working Paper No. 3127, The World Bank, Washington, DC, August

Patricia J. Marshall (1992). The Role of the Appraisal Industry in the US Savings and Loan Crisis

http://www.sehda.org/

http://www.wikipedia.org/

http://scholar.google.com/

http://www.scribd.com/doc/27255237/A-REPORT-ON-CREDIT-APPRAISAL-OF-INDUSTRIAL-FINANCEFOR-SME