Allocating ₹1,000 Lakh of Refinance Across Three Portfolios
The planning cell of a rural bank has ₹1,000 lakh of refinance for the next quarter. The bank's board has fixed three policy floors and caps: crop loans must receive at least ₹400 lakh; dairy and allied activities cannot exceed ₹200 lakh; agri-processing and MSME cannot exceed ₹350 lakh. The treasury cell estimates net interest margins after all operating costs at 2.8% for crop loans, 4.2% for dairy and 5.6% for agri-processing. Expected credit loss over the life of the loans is estimated at 1.5%, 2.5% and 4.5% respectively. A board member has proposed allocating ₹500 lakh to agri-processing because its gross margin is highest. The branch network can disburse at most ₹450 lakh of crop loans in the quarter because of staff and season constraints; the dairy and processing caps are binding only by policy. The bank must also report a risk-adjusted income figure to the board.
1. Compute the risk-adjusted margin for each product and the allocation that maximises total risk-adjusted income. Show your working.
Read the worked answer
Risk-adjusted margin = gross margin − expected loss.
| Product | Gross margin | Expected loss | Risk-adjusted |
|---|---|---|---|
| Crop | 2.8% | 1.5% | 1.3% |
| Dairy | 4.2% | 2.5% | 1.7% |
| Agri-processing/MSME | 5.6% | 4.5% | 1.1% |
Dairy has the highest risk-adjusted margin, so fill its ₹200 lakh cap first: ₹3.40 lakh. Crop has the next highest, and the floor is ₹400 lakh: ₹5.20 lakh. MSME is lowest but still positive, so fill its ₹350 lakh cap: ₹3.85 lakh. That uses ₹950 lakh. The residual ₹50 lakh goes to crop, which is above the floor and within the ₹450 lakh staff constraint: ₹0.65 lakh. Total risk-adjusted income = ₹13.10 lakh. Crop ends at ₹450 lakh, so the staff cap is satisfied.
The board member's ₹500 lakh MSME proposal breaches the ₹350 lakh cap and would shift money from a 1.3% product to a 1.1% product, reducing income.
2. The board demands ₹15 lakh. Evaluate (a) a 10 bps cut in cost of funds on the whole ₹1,000 lakh and (b) raising the dairy cap to ₹300 lakh with refinance raised to ₹1,050 lakh. Which is feasible and what is the residual gap?
Read the worked answer
(a) 10 bps on ₹1,000 lakh = 0.10% × ₹1,000 lakh = ₹1.00 lakh. Income rises to ₹14.10 lakh; residual gap ₹0.90 lakh. This is within treasury discretion but compresses margin permanently for a one-quarter target.
(b) New mix: dairy ₹300 lakh, crop ₹400 lakh, MSME ₹350 lakh = ₹1,050 lakh. Income = ₹5.10 + ₹5.20 + ₹3.85 = ₹14.15 lakh; gap ₹0.85 lakh. It needs a board cap change and ₹50 lakh more refinance, and it still misses ₹15 lakh.
Evaluation: (b) is marginally better in income but is not feasible in the quarter without policy and funding approvals; (a) is feasible but still leaves a gap. Neither should be used to justify loosening credit standards. The honest recommendation is to report a ₹0.85–0.90 lakh shortfall and close it through fee income or lower expected loss (collateral, guarantee, collection), not by pushing the lowest-margin product.
3. Crop disbursement may fall to ₹380 lakh because of staff constraints. Quantify the income loss and recommend a response.
Read the worked answer
Crop at ₹380 lakh instead of ₹450 lakh is a ₹70 lakh reduction at 1.3%, i.e. ₹0.91 lakh. If the ₹70 lakh stays undeployed, income is ₹12.19 lakh. Even if the MSME cap were relaxed to absorb it at 1.1%, income would be ₹12.96 lakh, still below ₹13.10 lakh.
Response: protect the ₹400 lakh crop floor, because crop is seasonal and priority-sector linked; a shortfall cannot be made up after the season. Use mobile camp mode, redeploy two staff from the MSME desk for three weeks, and use business correspondents for documentation. If the floor still cannot be met, seek a one-quarter board waiver with a written explanation and a compensating recovery plan, rather than silently reallocating to a lower-margin product. Do not count the unutilised ₹70 lakh as income.