Credit Appraisal Questions for Bank Exam

Financial ratios translate raw balance sheet numbers into signals a credit officer can act on. The Current Ratio (CA/CL) has a PSB benchmark of ≥ 1.33; below 1 signals technical insolvency. The Quick Ratio ((CA − Inventory)/CL) strips out inventory illiquidity; ≥ 1 is preferred.

Leverage ratios matter for term loans: Debt-Equity Ratio (TL/TNW) should be ≤ 2:1 for most term loans; infrastructure and priority-sector lending allow higher leverage. TOL/TNW (Total Outside Liabilities / Tangible Net Worth) measures overall leverage; PSB norm is ≤ 4:1.

The Debt Service Coverage Ratio (DSCR) is the most exam-critical formula: DSCR = (PAT + Depreciation) ÷ (Principal repayment + Interest on TL). Minimum 1.5x for project finance in most PSBs. Interest Coverage Ratio = EBIT / Interest; ≥ 2x preferred. Profitability ratios — Net Profit Margin (PAT/Net Sales × 100) and ROCE (EBIT / Capital Employed × 100) — round out the assessment.

Credit risk assessment goes beyond numbers. The classic 5 Cs framework covers: Character (integrity and track record), Capacity (ability to repay from cash flows), Capital (own funds and net worth), Collateral (security offered), and Conditions (macroeconomic and industry environment). An alternative mnemonic is the 5 Ps: Purpose, People, Payment, Protection, and Perspective.

Assessment combines qualitative factors — management quality, industry outlook, regulatory environment, market position — with quantitative analysis of financials, ratios, and cash flows. CIBIL scores guide retail and MSME lending: 750+ is good; 650–749 acceptable with conditions; below 650 warrants caution.

FOIR (Fixed Obligation to Income Ratio) applies mainly to retail loans: a ceiling of 40–50% means total monthly EMI/fixed obligations cannot exceed 40–50% of gross monthly income. MSME FOIR varies by turnover and loan purpose.

The type of charge created over an asset determines the bank's enforcement rights. Pledge: possession transferred to the bank (gold, FDs, shares) — bank has right of sale on default. Hypothecation: possession remains with borrower (stock, vehicles, plant); only a charge is created. Most working capital loans use hypothecation.

Mortgage creates a charge on immovable property. Equitable mortgage (deposit of title deeds) is most common in banking. Legal mortgage requires a registered deed. Assignment transfers rights to intangible assets (LIC policy, book debts) — the standard charge for receivables financing. Lien is the right to retain goods until debt is paid (e.g., bank lien on fixed deposits).

A Fixed Charge is on a specific identified asset (e.g., a particular machine); the asset cannot be sold without the bank's permission. A Floating Charge is over a class of assets (e.g., all current assets); it crystallises on default. Primary security is the asset financed (machinery for a machinery loan); Collateral security is the additional top-up (a property mortgaged to supplement the primary charge).

Under the SARFAESI Act, Section 13(2) requires the bank to issue a 60-day demand notice to the borrower. If dues remain unpaid, Section 13(4) empowers the bank to take possession of secured assets — without a court order. SARFAESI applies for loans ≥ ₹1 lakh in NPA accounts where security value ≥ loan amount. DRT (Debt Recovery Tribunals) handle debt recovery for dues above ₹20 lakh.

An account becomes a Non-Performing Asset (NPA) when interest or principal is overdue for more than 90 days (term loans / CC/OD). Agricultural loans follow a different clock: 2 crop seasons, effectively ~180 days. The moment an account becomes NPA, the bank must stop recognising interest income in the P&L — any interest received or accrued goes into the Interest Suspense Account.

The IRAC asset classification waterfallis: Standard → Sub-Standard (up to 12 months as NPA) → Doubtful D1 (12–24 months) → Doubtful D2 (24–36 months) → Doubtful D3 (>36 months as D1+D2 combined) → Loss (irrecoverable; fully written off/provided). Restructured accounts attract an additional 5% provision over the normal requirement.

Before an account becomes NPA, it passes through SMA (Special Mention Account) buckets: SMA-0 (1–30 days overdue), SMA-1 (31–60 days), SMA-2 (61–90 days). SMA-2 is the final warning — the account is still Standard but the clock is ticking toward NPA classification.

Priority Sector Lending (PSL) mandates that domestic scheduled commercial banks direct 40% of their ANBC (Adjusted Net Bank Credit) to priority sectors. Sub-targets include: Agriculture 18% of ANBC (with 10% specifically for small and marginal farmers), Weaker Sections 12%, and Micro Enterprises 7.5% of ANBC. Foreign banks with fewer than 20 branches also have a 40% ANBC target but with different sub-target structures.

The MSME definition revised in 2020 uses a dual criterion of investment in plant & machinery AND annual turnover. Both thresholds must be satisfied simultaneously. The Mudra Yojana caters to micro enterprises: Shishu (loans up to ₹50,000), Kishor (₹50K–₹5L), Tarun (₹5L–₹10L). Stand-Up India supports SC/ST and women entrepreneurs for greenfield enterprises in the ₹10L–₹1Cr range.

Large project loans require a TEV Study (Techno-Economic Viability)conducted by an independent expert or consultant — not the bank's own credit team (to avoid conflict of interest) and not the borrower's CA. The TEV assesses both technical feasibility and financial viability. Cost is typically borne by the borrower.

Means of Finance for project funding: Promoter equity + Term Loan + Internal Accruals. D:E ratio benchmarks are 2:1 for general projects and up to 3:1 for infrastructure and priority sectors. The Moratorium Period — the post-disbursement window before repayments begin — is typically 1–2 years for large projects. DSCR is not tested during the moratorium; banks calculate DSCR for the full repayment period only.

BEP (Break Even Point)expressed as percentage of installed capacity is a key viability metric. BEP at 45% means the project covers all costs when operating at 45% capacity — well below full utilisation. PSBs prefer BEP < 60%. A higher BEP signals a riskier project with less cushion against demand shortfalls.

Sensitivity Analysis stress-tests the project by changing key assumptions: typically a 10% fall in revenue, a 10% rise in input costs, or a 1% rise in interest rates. This reveals which variable the project is most sensitive to. Finally, if the project's IRR exceeds WACC, the project creates value for the promoter — a fundamental hurdle for sanction.