Term Loan Appraisal — Complete Guide for Bank Promotion Exams

Term Loan Appraisal is one of the most heavily tested topics in bank promotion exams — Scale I to Scale III. Questions appear on DSCR norms, BEP formula, cost of project components, and the distinction between TEV and financial appraisal. This article covers the full appraisal framework with worked examples and exam-ready ratios.

What Is a Term Loan?

A term loan is a credit facility extended for a fixed period to finance capital expenditure (capex) — such as purchase of land, construction of factory buildings, acquisition of plant and machinery, or setting up an entirely new production unit. Unlike working capital loans (which finance the operating cycle), term loans finance the creation or expansion of productive assets.

Repayment is structured in installments — monthly, quarterly, or half-yearly — over the agreed tenure, and the primary source of repayment is the future cash-generating capacity of the unit being funded, not its existing assets.

The Five Pillars of Term Loan Appraisal

A complete term loan appraisal examines five dimensions of the project. Exam questions frequently test whether candidates can distinguish between them.

1. Management Appraisal

The first step is evaluating the promoters and key management personnel. The appraisal must establish:

• Educational qualifications, technical expertise, and industry experience of promoters
• Track record — whether the promoter has successfully run a similar unit before
• Integrity and credit history of promoters (RBI defaulter lists, CIBIL, CERSAI searches)
• Quality of the management team in key functional areas: production, finance, marketing, and administration
• Succession plan for critical positions

A technically sound project with weak promoters is a higher credit risk. Many banks explicitly weight management quality at 20–25% in internal credit-rating scorecards.

2. Technical Feasibility

Technical feasibility examines whether the project can be physically implemented as proposed:

• Technology: Is the technology proven and suitable for the scale of operations? Is it imported or indigenous?
• Raw material: Availability, sources, proximity, price stability, and seasonality of inputs
• Infrastructure: Power, water, road connectivity, labour availability at the project site
• Location: Proximity to markets and raw material sources; regulatory approvals (environmental clearances, SPCB NOC)
• Capacity: Installed capacity, achievable capacity utilisation in Year 1/Year 2/stabilised year, and whether projections are realistic
• Plant & machinery: Whether equipment is from reputed suppliers; whether technical quotes have been obtained

For large projects, a bank may commission an independent Techno-Economic Viability (TEV) study by a technical consultant before sanctioning.

3. Economic Viability (Market Appraisal)

Economic viability assesses whether there is a sustainable market for the output:

• Demand-supply analysis for the product — current demand, projected growth, import substitution potential
• Competitive landscape: number of existing players, market share of promoter, threat of substitutes
• Pricing: Whether the proposed selling price is realistic given competition; sensitivity to price changes
• Distribution and marketing arrangements — existing channels vs. proposed
• Regulatory and export-import policy risks (anti-dumping duties, GST changes, etc.)

Sales projections that cannot be defended by market data are a red flag. Unrealistic revenue estimates cascade into inflated DSCR and misleading viability conclusions.

4. Financial Viability

Financial viability is the quantitative core of the appraisal. This is where most exam questions are set.

4a. Cost of Project

The total capex requirement of a project — the “Cost of Project” — must be carefully estimated and verified. Components include:

4b. Means of Finance

The “Means of Finance” must balance the “Cost of Project” to the rupee. Sources include:

• Promoters’ equity (share capital, internal accruals)
• Term loans from banks and financial institutions
• Government subsidies (PMEGP, CGTMSE, PLI scheme, state subsidies)
• Unsecured loans from promoters/relatives (treated as quasi-equity)
• Bonds and debentures (for larger companies)

The Debt : Equity ratio (also called Debt-Equity ratio or DER) measures the proportion of borrowed funds to promoter funds. Most banks apply a norm of 2:1 for MSME projects and up to 3:1 for large industrial projects. Infrastructure projects may be permitted up to 4:1.

4c. Key Financial Ratios for Term Loan Appraisal

5. Repayment Schedule and Debt Service

Repayment instalments must be aligned with the cash accruals of the project — not with profit alone. The cash available to repay debt is:

Net Cash Accruals = Net Profit After Tax + Depreciation + Other non-cash charges

The repayment schedule is prepared after projecting year-wise cash accruals for the entire loan tenure. A moratorium (holiday) period is granted equal to the construction period plus typically 6 months, during which only interest is serviced and no principal repayment is due.

DSCR — The Most Tested Concept

The Debt Service Coverage Ratio (DSCR) is the single most important metric in term loan appraisal. It measures the project’s ability to meet its debt obligations from its own earnings.

DSCR Formula

DSCR = (Net Profit After Tax + Depreciation + Interest on Term Loan) ÷ (Annual Term Loan Instalment + Interest on Term Loan)

Or equivalently:

DSCR = Net Cash Accruals + Interest on TL ÷ Debt Service (Principal + Interest on TL)

DSCR is calculated year-by-year over the repayment period, and the average DSCR is compared against the bank’s minimum benchmark.

Break-Even Point (BEP)

The Break-Even Point is the minimum level of output or sales at which the project covers all its costs — fixed and variable — and makes neither profit nor loss. It is expressed either in units of production or as a percentage of installed capacity.

BEP Formulas

Net Present Value (NPV) and Internal Rate of Return (IRR)

For large or long-tenure projects, banks may also assess investment viability using discounted cash flow techniques.

• NPV: The sum of present values of all projected cash inflows minus the initial investment, discounted at the cost of capital. A positive NPV indicates the project generates returns above the cost of funds.
• IRR: The discount rate at which NPV = 0. If IRR exceeds the bank’s hurdle rate (or WACC), the project is financially acceptable.
• IRR > Cost of Capital → Project viable; IRR < Cost of Capital → Project unviable.

Data Required from Borrower for Term Loan Appraisal

Security for Term Loans

Term loans are typically secured as follows:

• Primary security: Hypothecation / mortgage of the fixed assets created out of the term loan (land, building, plant & machinery)
• Collateral security: Mortgage of additional immovable property owned by promoters or third parties
• Personal guarantee: Of promoters and directors
• Corporate guarantee: From parent or group companies where applicable
• Charge registration: Equitable/legal mortgage registered with CERSAI and charge filed with ROC (for companies)

The Asset Coverage Ratio (ACR) measures the security cover: ACR = (Net Realisable Value of Securities) ÷ (Outstanding TL). Minimum ACR of 1.25× ensures a 25% buffer over the loan outstanding.

Moratorium Period

During construction, the project generates no revenue. The moratorium period (also called gestation period or holiday period) is the initial phase during which only interest is collected — no principal repayment. Interest accrued during this period is either:

• Funded as Interest During Construction (IDC) — capitalised and added to the Cost of Project, then repaid over the loan tenure; or
• Serviced by the borrower from own funds during construction

Typical moratorium = construction period + 6 months. Total loan tenure = moratorium + repayment period.

RBI Project Finance Framework

The RBI released a Draft Master Direction on Prudential Framework for Project Finance (May 2024) proposing revised IRAC norms for project loans. Key proposals include:

• Provisioning of 5% during construction phase for standard project loan accounts (compared to 0.40% for regular standard assets)
• Reduced to 2.5% once commercial operations begin, and 1% after 2 years of commercial operations without NPA classification
• Tighter norms for date of commencement of commercial operations (DCCO) extensions
• Uniform treatment across all lenders in consortium for stressed project loans

These proposals, once finalised, will significantly increase provisioning costs for project finance portfolios and are relevant for JAIIB/CAIIB and promotion exam questions on credit risk management.

Common Exam Questions on Term Loan Appraisal