The standard early-warning system monitors financial ratios: DSCR, current ratio, debt-to-equity, interest coverage. These ratios are calculated from the borrower’s financial statements, which arrive quarterly or annually. By the time a ratio deteriorates visibly in the financial statements, the underlying business has been deteriorating for months. The ratio reports what has already happened. It does not signal what is happening now.
The Borrower Deterioration Test monitors 15 leading indicators across three categories, each of which typically deteriorates before the financial ratios move. The indicators are “leading” because they reflect changes in the borrower’s operating behaviour, competitive position and governance discipline before those changes translate into the financial metrics the lender normally tracks.
Banking behaviour indicators (signals 1 through 5)
These are observable from the borrower’s bank account data, which the lender has access to in real time or near-real time.
1. Credit summation declining. The total credits into the borrower’s bank accounts are declining month-over-month without a seasonal explanation. Credit summation is the most direct proxy for cash collections. Declining credits mean the borrower is collecting less cash, which means its ability to service debt from operating cash flow is weakening.
2. Cheque return ratio increasing. The number of cheques deposited by the borrower that are returned unpaid (bounced by the borrower’s customers) is increasing. This indicates that the borrower’s customers are themselves under financial stress or that the borrower is booking revenue from customers who cannot pay.
3. Facility utilisation persistently above 90%. The borrower is operating with no headroom in its working capital facility. Any unexpected cash requirement (a delayed collection, an unplanned expense, a tax demand) cannot be accommodated. The borrower has no buffer.
4. Frequency of temporary overdrawing increasing. The borrower is exceeding its sanctioned limit more frequently, suggesting that the facility is undersized for the borrower’s actual cash needs or that the borrower’s cash management is deteriorating.
5. Inward remittances from unusual sources. Credits from personal accounts, group entities or unrelated parties that are not consistent with the borrower’s normal operating receipts. These may indicate fund infusions to service the facility or to maintain the appearance of operating activity: the promoter is injecting personal funds to keep the account looking active, which suggests the business is not generating sufficient cash on its own.
Operational indicators (signals 6 through 10)
These are observable from periodic monitoring, site visits and industry intelligence.
6. Inventory turnover declining. Stock is sitting longer in the godown. The borrower is either producing more than it can sell (demand has weakened), or the product mix has shifted to slower-moving items, or the borrower is accumulating inventory to inflate the stock statement and maintain drawing power. Each explanation has different implications, but all indicate that the working capital cycle is stretching.
7. Receivable concentration increasing. The borrower’s revenue is becoming dependent on fewer customers. If the top 3 customers represent 70% of revenue (up from 50% a year ago), the loss of any one customer would be catastrophic. Concentration also increases the impact of a single customer’s financial difficulty on the borrower’s receivable quality.
8. Key employee departures. The CFO resigns. The operations head leaves. Two senior engineers depart within a quarter. Key employees leave when they perceive that the business is weakening, when they receive offers that suggest the market values their skills more highly than the borrower can, or when they disagree with management decisions they believe will damage the business. The departures are a signal. The reasons behind the departures are the information.
9. Supplier behaviour changes. Suppliers reduce credit terms (from 45 days to 15 days), demand advance payment, or issue legal notices for overdue balances. Suppliers interact with the borrower daily and have granular, current information about the borrower’s payment behaviour. When suppliers tighten terms, they are expressing a credit judgment about the borrower based on information the lender may not have.
10. Customer quality shift. The borrower’s customer base is shifting toward smaller, less creditworthy, more price-sensitive customers. This may indicate that the borrower’s product or service quality has declined (it can no longer attract premium customers), that the competitive landscape has shifted (a new entrant is capturing the premium segment) or that the borrower is pursuing revenue growth at the expense of customer quality (accepting orders from customers who will pay slowly or not at all).
Governance and compliance indicators (signals 11 through 15)
These are observable from public filings, regulatory databases and the borrower’s engagement with the lender.
11. Auditor change. The borrower changes its statutory auditor, particularly mid-term or to a significantly smaller firm. An auditor resignation, especially if it follows a qualification or an emphasis-of-matter paragraph, is a serious signal. The incoming auditor’s willingness to accept the appointment without addressing the outgoing auditor’s concerns is a second signal.
12. Statutory filing delays. ROC annual returns filed late. GST returns filed after the due date. TDS returns delayed. Each delay may have an administrative explanation. The pattern of delays across multiple filings suggests that the borrower’s compliance infrastructure is weakening, which correlates with operational and financial stress.
13. Management unresponsiveness. Delayed responses to lender queries. Missed review meetings. Requests to postpone site visits. Incomplete submissions of periodic reports. Each individually is a minor issue. The pattern is a signal that the borrower does not want the lender to look closely at the current position.
14. Related-party transaction growth. The volume or value of related-party transactions is increasing. The growth may be genuine (the borrower’s group is expanding). It may also indicate that the borrower is routing facility funds through connected entities, using related-party transactions as the mechanism for extraction.
15. Contingent liability growth. The contingent liabilities disclosed in the financial statements (pending litigation, guarantees, disputed demands) are growing. Each contingent liability has a probability of crystallising into an actual liability, and the aggregate exposure may be material to the borrower’s net worth.
How the framework operates
Each indicator is monitored at a defined frequency: banking indicators weekly or monthly (from account data), operational indicators quarterly (from site visits and industry sources), governance indicators continuously (from public databases and borrower engagement). Each indicator has a defined threshold that triggers an alert. Three or more simultaneous alerts across different categories trigger an escalation to the credit review team.
The framework is designed to detect stress 6 to 12 months before the financial ratios show it, giving the lender response time while options remain: enhanced monitoring, restructuring, additional security, facility reduction or exit.