The three basic principles that guide lending decision are :
-Safety of loan
-Suitability of loan purpose
-Profitability
Safety of Loan
-Good character
-Financially sound
-Has the ability
-Willingness to repay the loan
-Collateral security
Suitability of loan purpose
-Legal and conforms to the lending policy of the bank
-Lending to gambling????
-If the bank giving a loan for an illegal activity, then the lender may not be able to recover the money.
Profitability
-Financial institution are in the business of lending to earn profits.
-Interest on loan
-Lending institution must carefully weigh the risks and return from a possible loan.
Credit Analysis
Credit analysis can be done by
Traditional methods:
The judgmental method (also called the expert systems method)
The rating method
The credit scoring method
Modern methods:
Modern methods use technology and thus facilitate faster processing of proposals.
Expert Systems Method
The purpose of any credit assessment or analysis is the measurement of credit risk. Borrowers’ credit assessment done using the following criteria, popularly known as the Six Cs of lending:
-Character
-Capacity
-Capital
-Collateral
-Condition
-Control
The Rating Methods
Rating Agencies
Moody’s
Standard & Poor’s
Ex: AAA, AA, A+ or B
Credit Scoring Systems
Credit scoring systems are to be found in all types of credit analysis whether personal credit or business credit.
These system identify and weigh certain key factors that determine the probability of repayment default.
A framework for credit and lending decisions
-External factors affecting lending decisions
-Lending institution – specific factors
-Borrower – specific factors
External factors affecting lending decisions
General law
-Macro economic factors
-Industry specific factors
-The Banking Act
Lending institution – specific factors
-The lending policy of the institution
-The loan budget
-Staff availability
Borrower – specific factors
6 Cs of lending :
-Character
-Capacity
-Capital
-Collateral
-Condition
-Control
The lending process
Step 1: obtain the prescribed loan application form.
Step 2: obtain required document/financial statement.
Step 3: check the loan application form and documents/financial statements for any obvious inconsistencies.
Step 4: if all the information has been received and is in order,
Step 5: appraise detailed technical, commercial, financial and managerial aspects of the proposed business borrower.
Step 6: assess the financial requirements of the borrower (personal or business).
Step 7: If the proposal is approved, then send a letter conveying the approval to the borrower.
Step 8: if the proposal is approved, then ensure that security and other documents are duly signed before disbursing the loan.
Step 9: monitor the account periodically.
Step 10: where the operations in the loan account are not satisfactory
Modern Credit Approach
