Professional Knowledge: Credit, Risk and Trade Finance
This section examines how a bank appraises, prices and monitors credit, and how it handles cross-border trade. Expect the 5Cs of credit, the credit assessment memorandum, working capital assessment, DSCR and coverage ratios, risk categories under Basel, and trade instruments such as letters of credit and bank guarantees.
Credit appraisal
- 5Cs: character, capacity, capital, collateral, conditions.
- Tandon Committee methods: Method I gives MPBF = 0.75 (CA - CL), Method II gives 0.75 CA - CL, Method III excludes core current assets. Drawing power follows from the stock statement, net of margin.
- DSCR: (PAT + depreciation + interest) / (interest + principal repayment); a benchmark near 1.5 is expected for term loans. TOL/TNW measures leverage.
Risk
Credit risk is default risk; market risk covers interest rate, forex and price movements; operational risk covers people, process, systems and external events. Basel rests on three pillars: minimum capital, supervisory review, and market discipline through disclosure.
Trade finance
A letter of credit substitutes bank credit for buyer credit and is governed by UCP 600; a bank guarantee covers performance or financial obligation; Incoterms 2020 fix cost and risk transfer (FOB at the ship's rail, CIF adds freight and insurance); ECGC covers export credit risk; FEMA governs the RBI/AD bank framework.
Worked example. PAT 120, depreciation 40, interest 60, principal repayment 100. DSCR = (120 + 40 + 60) / (60 + 100) = 220/160 = 1.375. That is below the 1.5 benchmark, so the proposal needs a longer tenor or higher margin.
Traps that cost marks
Substituting net profit for cash accruals in DSCR; forgetting that the denominator includes both interest and repayment; confusing a letter of credit with a guarantee; and misreading the Incoterms risk-transfer point.