Final Exam Flashcards
is the systematic assessment of an individual’s or entity’s creditworthiness, considering financial data, payment history, and other relevant factors.
Conducted by lenders, it informs decisions on loan approvals, interest rates, and credit limits. This ensures prudent risk management and responsible lending practices.
Credit Evaluation
defined as the process in which an entity (a bank or a business) determines, based on analysis, whether to advance funds, extend credit, or lend money to another party.
It’s a result of careful evaluation that involves risk assessment, credit scoring, and careful scrutiny of financial statements
Credit Decision
- Lenders assess a borrower’s capacity to repay a loan by examining their ability to meet the proposed terms and amount.
- For businesses, cash flow statements are reviewed, while individuals provide income and employment stability information.
- Lenders use specific formulas, such as the debt-to-income ratio, to evaluate capacity.
- A higher ratio is seen as higher risk and may result in loan rejection or adjusted repayment terms with increased costs
Capacity
- Lenders evaluate a borrower’s capital to determine their creditworthiness
- Capital represents the borrower’s personal investments and serves as a backup for loan repayment in case of income disruptions
- Higher capital demonstrates commitment and reduces the risk of default.
Capital
- Lenders assess the conditions of a loan, including its terms and the economic context
- This applies to both business and individual borrowers
- While conditions are predominantly evaluated subjectively, some quantitative factors such as interest rates and repayment terms are also considered
Conditions
- Plays a vital role in credit evaluation
- Lenders consider a borrower’s financial reputation and track record, utilizing various qualitative and quantitative methods.
- Credit history and scores are often reviewed to gain insights into a borrower’s character
Character
- Represents the assets pledged by borrowers to secure a loan
- Lenders favor secured loans as they have the right to claim the collateral if the borrower fails to repay
- Collateral is assessed based on its value and ease of liquidation
Collateral
These phases help businesses to minimize risk, increase profits and foster stronger customer relationships.
Phases in the Credit Decision Process
- In this initial phase, prospective borrowers submit an application to request credit.
- Applications are typically comprehensive and include details about the applicant’s personal information, employment status, financial data, and the purpose of the loan
Application Phase
- After receiving an application, lenders gather information to verify the details provided by the borrower.
- This phase often includes credit checks and scrutinizing public and private records
Data Gathering and Verification Phase
- this critical phase, lenders assess the creditworthiness of the applicant using evaluation methods like credit scoring model or application scoring.
- Financial statements are analyzed, and key ratios are calculated to decide the applicant’s ability to repay
Assessment Phase
The final decision is made at this stage.
If the applicant meets the lender’s criteria and is considered creditworthy, the loan application is approved. If not, it is rejected
Approval or Rejection Phase
For approved credits, a legal agreement is drafted highlighting the terms and conditions of the loan. The borrower needs to accept these terms before the loan is disbursed
Documentation Phase
- includes the information and/or verifications used to analyze and support the loan decision and any subsequent loan servicing decision.
- Documentation needs will vary given the loan size, risk, and complexity. Documentation must provide adequate support for the decision made.
Credit Decision Documentation
- Loan Officer judgment is essential in determining the degree or extent of documentation necessary to support the loan decision.
- Therefore, the required documentation is differential and commensurate with the size, complexity, history, and credit quality of the applicant.
Credit Documentation Guidelines
These involve the formal authorization of extending credit to individuals or entities based on their creditworthiness.
Lenders assess financial information and risk factors to make informed decisions on granting credit, determining credit limits, and setting terms.
Efficient credit approval processes are crucial for maintaining a healthy balance between risk management and facilitating responsible lending.
Credit Denial/Disapproval: the rejection of a credit application by a prospective lender.
Credit Approval and Disapproval
One of the most important aspects of credit decision making is to continuously monitor and review the credit decisions that have been made.
This is because credit decisions are not static, but dynamic, and they need to be adjusted according to the changing circumstances of the borrowers, the lenders, and the market
MONITORING AND REVIEW OF CREDIT DECISIONS: CONTINUOUS MONITORING AND REVIEW OF CREDIT DECISIONS
CONTINUOUS MONITORING AND REVIEW OF CREDIT DECISIONS CAN HELP TO ACHIEVE THE FOLLOWING OBJECTIVES:
- To ensure that the credit decisions are aligned with the credit policy and the risk appetite of the lender.
- To identify and mitigate any potential credit risks or issues that may arise during the credit life cycle.
- To evaluate the performance and profitability of the credit portfolio and the individual loans.
- To provide feedback and learning opportunities for the credit decision makers and the credit analysts.
- To enhance the communication and relationship with the borrowers and the stakeholders
Regularly review this process to ensure that it is thorough and accurate. This includes evaluating the borrower’s financial stability, credit history, and ability to repay the loan
Credit Risk Assessment
Ensure that credit decisions comply with internal policies, industry regulations, and legal requirements. Regular audits and reviews can help identify any non-compliance issues
Compliance
Monitor the performance of the credit portfolio to assess the quality of loans and identify any potential risks. This involves tracking key metrics such as delinquency rates, default rates, and loss ratios
Portfolio Performance
Utilize credit monitoring tools and systems to track borrower behavior, detect early warning signs of financial distress, and manage credit exposure effectively
Credit Monitoring Tools
Establish a systematic ______ that includes regular evaluations of credit decisions, risk assessments, and portfolio performance. This helps in identifying areas for improvement and mitigating risks
Review Process
Establish a systematic ______ that includes regular evaluations of credit decisions, risk assessments, and portfolio performance. This helps in identifying areas for improvement and mitigating risks
Review Process
Provide ongoing training to credit officers and staff to ensure they have the necessary skills and knowledge to make informed credit decisions and conduct effective monitoring
Training and Development
Maintain comprehensive __________ of credit decisions, risk assessments, and monitoring activities. This serves as a record of the rationale behind credit decisions and helps in audits and reviews
Documentation
Develop these to address potential credit risks and uncertainties. This may include setting aside provisions for loan losses, diversifying the loan portfolio, and implementing credit enhancement measures
Risk Mitigation Strategies
This should include the frequency, scope, criteria, methods, and responsibilities for the monitoring and review process.
For example, the lender may decide to monitor and review the credit decisions on a monthly, quarterly, or annual basis, depending on the type, size, and complexity of the loans.
The lender may also use different tools and techniques for monitoring and review, such as credit reports, financial statements, site visits, audits, surveys, etc.
Establish a clear and consistent framework for monitoring and review
The KPIs are the quantitative and qualitative measures that indicate the success and effectiveness of the credit decisions, such as the repayment rate, the default rate, the recovery rate, the return on assets, the customer satisfaction, etc.
The EWS are the signs and symptoms that indicate the deterioration or potential problems of the credit decisions, such as the late payments, the covenant breaches, the negative cash flows, the declining credit scores, the complaints, etc.
Define and track the key performance indicators (KPIs) and the early warning signals (EWS) for the credit decisions
The lender should collect, organize, and interpret the data and information from the monitoring and review process, and generate meaningful and actionable insights and recommendations.
The lender should also prepare and present the reports of the monitoring and review to the relevant parties, such as the senior management, the board of directors, the regulators, the auditors, the borrowers, etc.
Analyze and report the results of the monitoring and review
Based on the results of the monitoring and review, the lender should take the necessary steps to address any issues or gaps that have been identified, and to enhance the quality and efficiency of the credit decisions.
For example, the lender may revise the credit policy, adjust the credit terms, restructure or write off the loans, provide additional support or guidance to the borrowers, train or coach the credit staff, etc.
The lender should also monitor and evaluate the impact and effectiveness of the corrective actions and the improvement plans, and make further adjustments if needed.
Implement and follow up the corrective actions and the improvement plans
These are the specific steps taken to implement the credit practices.
Credit Procedures
These are the general policies a business or lender follows in regards to credit
Credit Practices
What are the key components of credit practices and procedures?
- Credit Policy
- Application Process
- Credit Analysis & Approval
- Credit Terms & Conditions
- Credit Monitoring & Reporting
- Collections Process
- Reporting & Review
A credit policy is a set of guidelines a company uses to decide how it will extend credit to customers and collect outstanding debts. It’s like a rulebook that ensures responsible lending and helps the business run smoothly.
Establishing Credit Practices
encompasses the establishment of strategies to effectively handle and diminish credit risks. Taking proactive steps to manage your credit health
This involves the continual assessment of credit-related aspects such as credit scores and payment records. Use to assess your creditworthiness.
Credit Monitoring and Control
the process of assessing a customer’s financial stability and ability to meet obligations.
Customer Credit Evaluation
It refers to evaluating a borrower’s loan application to determine the financial health of an entity and its ability to generate sufficient cash flows to service the debt. In simple terms, the credit process begins with a thorough analysis of the borrower’s creditworthiness, or capacity and willingness to repay the loan.
Credit Process
Collecting information about the applicant
Collecting information about the business for which a loan is required
Collecting information about the recovery process
Collecting information about the security
Information Collection
- Analyzing the accuracy of information
- Analyzing the financial ability of the applicant
- Analyzing the effectiveness of the project
Information Analysis
The final stage in the credit analysis process is this. After obtaining and analyzing the appropriate financial data from the borrower, the ender makes a decision on whether the assessed level of risk is acceptable or not.
decision-making stage
conducted on all credit applications to immediately ascertain the applicant’s credit worthiness.
Credit Investigation
Requires full disclosure of credit terms to consumers.
Truth in Lending Act
Protects against deceptive, unfair, unconscionable credit practices.
Consumer Act of the Philippines
Governs the establishment and operations of lending companies.
Lending Company Regulation Act
It is the process by which a financial business, or lender, gathers past-due principle, interest, and escrow payment.
Banks were traditionally responsible for creating and servicing loans until changes in the industry made it less profitable to engage in the business.
Loan Servicing
a set of legal and financial documents that outline the terms, conditions, and agreements of a loan, serving as a binding contract between the lender and borrower, ensuring a clear understanding of their rights and obligations.
It is crucial for transparency and legal binding in the lending process, protecting lender-borrower interests. It’s essential to consult legal professionals and industry experts for compliance with regulations and best practices
Loan Documentation
a written promise from a borrower to repay a loan, detailing the amount borrowed, interest rate, repayment terms, and penalties for late payment or default , serving as evidence of the borrower’s debt
Promissory Note
a legally binding contract between the lender and borrower, outlining the term and conditions of the loan, such as principal amount, interest rate, repayment schedule, and collateral requirements
Loan Agreement
It is crucial for secured loans, outlining the collateral pledged be the borrower, allowing the lender to seize the collateral if the borrower defaults
Security Agreement
the systematic process of collecting, recording, preserving, utilizing, and disposing of official documents, such as bills, vouchers, letters, circulars, files, books, of accounts, financial statement, reports, contracts, and order written documents.
Record Keeping
A loan is disbursed when the agreed-upon amount is paid into the borrower’s account and is available for use. When the loan is disbursed, the cash has been debited from the lender’s account and credited to the borrower’s account.
Loan Disbursement and Monitoring
The process of keeping track of a borrower’s creditworthiness and financial stability during the life of a loan. It is a critical aspect of lending that enables lenders to mitigate risks and ensure that borrowers are meeting their obligations.
Loan Monitoring
the act of paying back a lender the money you’ve borrowed. Typically, it consists of periodic payments toward the principal- the original amount borrowed- and interest, a fee for the “privilege” of being lent the money. Some loans even allow you to repay the full amount at any time, though there might be early repayment fees
Managing Loan Repayments
Involves changes to existing loan terms to aid borrowers facing financial hardship
Common adjustments include reducing the interest rate, extending the loan term, or reducing the principal balance
Aimed at making monthly payments more affordable to avoid default and foreclosure
Acts as a tool for loss mitigation
Loan Modification
A broader process that includes loan modifications and other complex changes.
Can involve consolidating multiple loans, changing loan types, or altering debt terms significantly.
Designed to improve the borrower’s financial situation or make debt more sustainable in the long run.
Loan Restructuring
- tool that helps organizations plan and schedule their collection activities
- It outlines specific dates and tasks related to collections
- important actions are taken
Collection Calendar
What are the collection strategy
- Payment Incentives
- Payment Plans
- Automated Reminders
- Customer Self-Service Portals
- Customer Segmentation
- Dispute Resolution
- Proactive Communication
is the means by which negotiators can achieve objectives, build relationships, and resolve disputes
Communication in negotiation
Collectors serve as the primary point of contact between the organization and customers with outstanding balances. They communicate with customers through various channels such as phone calls, emails, and letters to discuss payment status, resolve disputes, and negotiate payment arrangements
Customer Communication
Collectors follow up with customers who have not made timely payments, sending reminders and past-due notifications to prompt payment. They monitor payment due dates, identify delinquent accounts, and initiate appropriate collection actions based on established protocols
Payment Follow-up
Collectors aim to maintain positive customer relationships while pursuing payments. They utilize effective communication skills to build rapport, understand customer circumstances, and work towards mutually beneficial solutions. This approach helps preserve customer loyalty and long-term business relationships.
Relationship Management
Collectors negotiate with customers to establish payment plans or resolve any disputes related to outstanding balances. They may offer flexible payment terms or explore alternative arrangements that align with the customer’s financial capabilities while ensuring the organization’s interests are protected.
Payment Negotiation
It analyzes consumer data to deliver forecast, actionable information on the risk of borrower repayment, giving collections teams the knowledge they need to make wise decisions, which improves the collections process more efficient, personalized, humane, and productive.
Artificial Intelligence and Machine Learning
It helps to achieve higher operational efficiencies by using analytics to automate low-priority interactions based on segmentation and classification of large volumes of borrower data
Data Analytics
It includes several techniques, such as AI and ML-based data mining and statistical modelling, to predict pre-delinquencies, the likelihood of resolution and the borrower’s propensity to pay.
Predictive Analytics
a service that uses AI-based algorithms can filter out busy signals, inoperative phone numbers, and voicemails and pass on the calls to live agents when the borrower answers the call.
Predictive Dialer
handle basic questions about early-stage arrears, freeing up agents to handle more advanced or complex queries.
Self-service chatbots
Voice-bots are proving to be a successful medium to achieve efficiency in the debt collections industry. They are also able to handle a large volume of calls and help lenders achieve efficiency and employee productivity.
AI-based Voice Bots
These include techniques that allow lenders toe stablish non-intrusive contact with debtors, such as SMS-based repayment reminders, email or text messaging-based payment links or QR codes, or the availability of a selfservice platform for consolidated and simplified repayments.
SELF-SERVICE REPAYMENT OPTIONS
Collectors maintain accurate and detailed records of all collection activities, including communication logs payment arrangements, and dispute resolutions. Proper documentation helps track progress, provide reference for future interactions, and support legal actions if necessary
Account Documentation
When standard collection efforts prove unsuccessful,collectors may escalate delinquent accounts to higherlevel management or engage external collection agencies. They may also collaborate with legal counsel to pursue legal actions, such filing lawsuits or initiating debt recovery proceedings, to recover outstanding
debts
Escalation and Legal Action
Collectors generate regular reports on collection activities, delinquency rates, aging of accounts, and other key performance indicators. These reports help management assess the effectiveness of the collection process, identify trends, and make informed
decisions to optimize collection strategies.
Reporting and Analysis
