Customer Acquisition  Strategies - Due Diligence

 Learning  Objectives

• Pre-Sanction  Inspection
• Bank  Statement Analysis
• Credit report -  CRILC & CIBIL
• Defaulters  List
• CERSAI
• ROC
• Market Diligence
• Large Exposure Framework

 “Finding skeletons in the closet before the deal, is better than finding them later”

 MSME Lending - Unique challenges

Business Risk

1. Key-Man  Risk
2. Attrition  Risk
3.  Exposure Risk

Credit Risk 

1. High volume,  Low ticket size
2. Poor financial data, and reporting 
3. Weak internal process

Operational Risk

1. Green field Project
2. Heterogeneous Business Sectors
3. Poor data representation

Due Diligence Process

Verify the internal bank’s database

↓

Scrutinize external database

↓

Check any unstructured/random information

↓

Analyze the docs submitted

↓

Conduct reference checks/market feedback

↓

Available Sources of Information

Internal Sources (ETB-Past track, personal credit history of promoters

↓

External Databases (CRILC, CIBIL, ROC, CERSAI etc)

↓

Documents submitted by the client (Annual report/Bank statements/GST)

↓

Market Feedback

 Notes

• Having a checklist & being methodical, helps in preventing lapses due to oversight or inexperience
• The comprehensive process helps in detecting fraud
• Standardized process positively impacts TAT
• Improvement in asset quality due to all of the above

 Internal sources

 Internal Databases

BORROWERS

1. Repayment history
2. Interest Servicing  delays
3. Documentation incomplete
4. Security creation  delays

 PROMOTERS 

1. CIBIL Scores-Delays  or defaults in EMI  payments on loans

2. Inward Cheque  returns from personal accounts due to inadequate balance

3. Frequent use of unsecured personal loans

 GST Returns – An Statement of Business  Performance

• Validation of the borrower’s business performance
• Confirmation of identity and business continuity
• Reveals important business details useful to the bank
• Name, address and GST registration number 
• List & classification of goods supplied/sold by the borrower
• Gross sales & Purchases
• Freight and installation costs incurred
• Sales returns
• GST paid
• Any interest and penalty paid

 Pre-Sanction Inspection

• Visiting the office and factory premises as well as the properties mortgaged with the bank as a collateral security is essential & should be stipulated as a pre-sanction or pre-disbursement condition for all the borrowers.
• Inspection at the pre sanction stage itself can prevent booking of a bad asset. 
• Ensures that the business of the prospective borrower is being run in a satisfactory manner and in line with that stated by the borrower. 
• Enables ascertaining the level of activity (whether it commensurate with that as given in the financials)
• The information gathered from employees on the conversation during factory/godown inspection can be of early warning signals.
• An independent visit of the collateral properties is also essential at the pre sanction stage
• General tempo of operations
• Level of stocks, orders in hand, licenses available, products being manufactured, presence of obsolete stock or unused machinery ,  Quality of fixed assets 
• Process of storage/recording stocks/hypothecation board, maintenance of registers
• Accessibility of location, transport etc, power failures
• Insurance policies 
• Payment of utility charges, taxes statutory dues
• SAP/ERP/Fire safety
• Project implementation stage, future business plans etc. 

 Collateral Properties Inspection is critical 

To validate the address/location, nature of the property, the demarcation, area and the estimated valuation. 

Demarcation & identification is crucial in case of vacant plots. In case of residential properties; availability of free passage /entrance needs to be verified.

 Checklist

Prepare a checklist and keep it handy prior to proceeding on inspection.

Report

A detailed Inspection Report in the prescribed format needs to be prepared and form the part of the Sanction/Recommending Note.

Highlight

Any adverse observation or irregularities seen at the time of visit need to be highlighted to the Sanctioning Authority.

Bank Statements

• A very critical source of information is the Borrower's Bank statement. But before analyzing the same, the bank must verify the genuineness of the bank statement submitted.
• If banks are aware of the early warning signs of otherwise hidden liquidity pressures that are building up, they can protect themselves from bad exposures.
• An analysis of the bank statement can reveal & validate:
  • The reported revenues and cash collection
  • The key suppliers and customers matches with that reported
  • Any suspicious transactions, high value transaction or fraudulent ones
  • Any unusual pattern or trends in credit /debit entries
  • Concern areas such as cheque returns, penal charges levied, instances of overdues or over drawings
  • Liquidity concerns in case of sudden reduction in credit summations
  • LC Devolvement
  • Inter-party /related party transactions

 Warning Signs

Credit Summations Not In Line With Reported Revenues:

• More than revenues : Underreporting or infusion/disbursement
• Less than revenues (deviation>15%): Possibility of diversion of funds

Bank statement accounts for less than the reported sales:

• All sales are not routed through the account
•  Sales are directly settled in cash.
•  Going through the borrower’s account in another bank

Suspicious Or High Value Transactions Not In Line With Business

• Large transactions with related parties
• High value transfer to another bank 
• Frequent withdrawal of amount of Rs 49000

Cheque Returns Due To Insufficient Funds

• Signal poor liquidity issues
• Cheque returns > 3 every quarter should be investigated.

 External Sources

CRILC

Central Repository of Information on Large Credits (CRILC) -  set up by RBI to collect, store & disseminate credit data to lenders.

Experian

REPORTS  from Credit Bureaus  CIBIL, Experian.

Top Defaulters In RBI List

RBI Defaulters’ List/Caution Listed Exporters

Credibility Reports

Structured Data Providers   –  PROBE D&B

Unstructured Data

Unstructured Public data - Market news reports etc

 Credit Information Company (CIC)

• Credit Information Company (CIC) is an independent third-party agency that collects financial data of individuals pertaining to their loans, credit cards and other related information and shares with its members, who generally happen to be banks and other financial institutions
• All the CICs in India are licensed by Reserve Bank of India (RBI) and are governed by the provisions under Credit Information Companies Regulation Act (CIC Act), 2005 and other RBI regulations and guidelines.

CIC operating in India are:

• Transunion CIBIL
• Equifax Credit Information Services Private Limited.
• Experian Credit Information Company of India Private Limited.
• CRIF High Mark Credit Information Services Private Limited

 Trans-union Cibil

• Established in 2000, TransUnion CIBIL Limited (formerly known as Credit Information Bureau (India) Limited) is India’s first Credit Information Company. Initially set up by SBI.
• The credit bureau does not make any lending decisions. It only provides data to banks and other financial institutions, who use it to filter applications for loans and credit cards.
• CIBIL scores are assigned on a scale of 1- 900. The score is seen as a direct indicator of your credit health.

‘ The number of loans and types of loan accounts, outstanding debt, and length of credit history also play a major role in determining your score. If you maintain a good track record backed by a solid credit score, lenders will be very comfortable lending to you”

 Central Repository of information on large Credits

• The Central Repository of Information on Large Credits (CRILC) Set up by RBI  in 2014 to collect, store, and disseminate credit data to banks.
• For preventive monitoring of large loans from banks. The list includes non-performing assets as well as performing accounts that are
• RILC captures information on borrowers with aggregate exposure, both fund and non-fund based, of ₹5 crore or above. 

Cirilic report

• The borrowers’ current exposure & outstanding position in other banks 
• The borrowers’ asset classification (Standard or substandard)
• Any stress in the borrowers’ accounts (SMA)
• ‘Non Cooperative”, “Red Flagged” or “Fraud” status by any bank
•  Current accounts maintained with other banks
• Moved to Default’ & ‘Moved Out of Default’ status- weekly reporting
• Reconciliation of Exposure levels with that reported by the borrower and the historical trend 

 RBI Defaulter’s List

• Every six months Banks share information on all defaulters of ₹1 crore and above with the RBI. 
• Every quarter banks share information on wilful defaults of Rs 25 lacs and above.
• The RBI compiles this information into the RBI Defaulters List and the RBI Wilful Defaulters List.
• The RBI lists include information about the amount of exposure, present status and reasons for default. 
• RBI has recently instructed banks to send information about defaulters and wilful defaulters to Credit
• Information Companies (CICs) like CIBIL on a monthly basis.
• Banks may refer to CICs as th e comprehensive source of information on wilful defaulters is in the future
• Banks should scan the Defaulters Lists to see if any of the following are listed as defaulters or wilful defaulters:
  • The borrower
  • The Director/Partners/Proprietor of the borrowing entity (Director Identification  Number (DIN). 
  • The guaranteeing company or individuals

“If the borrower or its promoters are found to be wilful defaulters, the borrower should be automatically disqualified”

 CERSAI(Central Registry of Securitisation Asset Reconstruction and Security Interest of India)

• Central Registry of Securitisation Asset Reconstruction and Security Interest (CERSAI)  is a central online security interest registry of India set up in 2011 under Section 20 of the SARFAESI Act, 2002, under Section 25 of the Companies Act 1956. 
•  Incorporated with majority shareholding of the Central Government, Public Sector Banks and National Housing Bank, for the purpose of operating a Registration System  under SARFAESI Act.  Later, was entrusted with the responsibility of operating and maintaining a KYC Registry, governed under PML Rules 2005 (Maintenance of Records).
• information on checks against fraudulent multiple lending against the same property. Information be accessed online for a fee  by financial institutions and the general public  (only  equitable mortgages)

“ RBI is all set up to take 51% stake  (currently held by Central Government) in CERSAI”

• This allows prospective lenders to check that the property against which they are extending a loan is not encumbered by a pre-existing security interest created by another lender. 
• Lenders can examine if the value of the collateral is sufficient for them to extend another loan, given the existing liability on the property. 
• General public, especially for home buyers, can ensures that the  property they are planning to purchase, is free of any loan/security interest created by a lender

AMENDMENT W.E.F January 2020

Section 23 Amended:

• Removal of the timeline of 30 days, within which a secured creditor is required to file certain types of SI.
• To provide a right to the Central Government to notify types of transactions which require registration with the CERSAI.

Chapter VI A Introduced

• permission to person or creditor who has obtained an attachment order for attachment of property, to file such orders with the CERSAI and gives priority to the claims of such person or creditor
• disallows any secured creditor from exercising the right of enforcement if the same has not been duly registered with the CERSAI
• gives priority to the dues of secured creditors over all other dues including statutory dues and taxes, after registration with the CERSAI; subject to IBC provisions

 Securitisation  and  Reconstruction  of Financial  Assets  and  Enforcement of   Security Interest (SARFAESI Act, 2002) 

• Under section 13 of SARFAESI Act, 2002 secured creditors (banks or financial institutions) have many right for enforcement of security interest   The first asset reconstruction company (ARC) of India, ARCIL, was set up under this act.
• This law allowed banks to sell their non-performing assets to Asset Reconstruction Companies (ARC). Banks are allowed to take possession of the collateral property (except agricultural land) and sell it without the permission of a court. Enables banks to reduce their NPAs by adopting measures for recovery and reconstruction.

PRE CONDITIONS: 

• The debt is secured;
• The debt has been classified as an NPA by the banks ;
• The outstanding dues are one lakh and above and more than 20% of the principal loan amount and interest there on.
• The security to be enforced is not an Agricultural land.

TWO MAIN METHODS OF RECOVERY 

• Securitization: The process of issuing marketable securities backed by a pool of existing assets such as auto or home loans. 
• Asset Reconstruction: By either proper management of the business, or by taking over it or by selling a part or whole of the business or by rescheduling of payment of debts.

“In Mardia Chemicals Ltd. v. ICICI Bank the Supreme Court of India declared the SARFAESI Act to be constitutionally valid.”

Register of Companies  (ROC)

• The Registrar of Companies (ROCs) is an office under the Ministry of Corporate Affairs. At present, 25 ROCs are operating in India across all the major states/UT’s
• There are two categories of MCA filings – one is periodical and another is based on events like incorporation, change of situation of registered office, resolutions, the appointment of directors and auditors etc. 
• The prefix to the form number provides some kind of meaning about the type of form and the purpose of filing. For example, forms with the prefix INC refer to filings related to incorporation, AOC to annual filing, DIR to directors, MGT to management, ADT to audit, and so on. 

 Possible checks from MCA Records

• Whether the company has filed the annual returns or not? Investigate there reason for delay if any.
• Reconciliation of financials: Cross check/Verify the financials submitted to the bank with that filled in the MCA records
• Reconciliation of charges: Check the index of charges and reconcile the same with the debt profile submitted  by the borrower
• ROC Search Report for verification of charges, details regarding modification & amount and securities
•  Director’s details can also be verified / any change in directorship
  •   Details of the signatories

 Market Feedback

• One of the very reliable sources of feedback is that obtained from the peers and those dealing with the company.  
• The list of key suppliers, customers, debtors and creditors can be obtained and information about the borrower can be sought regarding length of relationship and satisfaction levels of dealings, information about the promoters, any family feud etc. Some of these may be the bank’s existing customers also.
• Past credit history of the borrower may be obtained from earlier bankers of the company
• Employees also serve as a good source of feedback especially wrt the promoters.

 Third Party Due Diligence

Banks subscribe to many third-party databases that can provide valuable information about borrowers and their promoters.

Sources - Third Party Due Diligence

Credit Reports-

Probe 42, Save Risk, Zauba , Owler etc. They contain details such as financials as per ROC, Charges, Directors & their other directorships, rating history, legal cases by & against the company etc. Wherever Probe report is not available, Banks can take help of external agencies for verifying the authenticity of the  Audited Balance Sheets and Bank Statements submitted by the borrower

Caution List Exporters:

The RBI maintains a caution list of exporters in the Export Data Processing and Monitoring System (EDPMS). Banks can access the EDPMS on a daily basis. If a company or individual is present on the exports made by the company or individual or the company promoted by the individual has not been received even six months after the export was completed. In such cases, banks must exercise caution and ascertain reason for non receipt/delay in receipt of export proceeds list, it means that payment for.

World Checklist /D&B report

Can be obtained in case the borrower is an exporter or has other businesses abroad.

Banks must thoroughly scrutinize the name of the borrower & the directors/promoters for blacklisted companies, shell company list, fraud, pending legal cases or scam in the internet and any other available database.

Also, in case of MSMEs, the names of the key suppliers, customers, debtors and creditors should be searched and validated to ensure that the names & dealings are genuine as reported.

Unstructured Market Intelligence

News in Public Domain

News related to the company, promoters, group companies and the industry can be used to assess the company’s future prospects and verify information received from the borrower. (eg: Tax raids, CBI inquiry or any ban on the core activity of the company)

Social media

Social media platforms like Facebook and LinkedIn can reveal valuable information about key-man and promoters. Their contacts and peers  in the market, social standing and areas of interest.

Employee Review/ Feedback 

Feedback from ex or present employees on portals such as Glassdoor can also be a useful source of information on the operations of the company. 

Delays/Default in Payment Dues

Delay or default in the payment of statutory dues, utility bills or credit card bills can signal financial stress or delinquent character of the promoters.

Signal of Cash Crunch

Any indication of stretched market creditors can also signal cash crunch.