Lecture 1 - Concepts and Principals of Credit Lending

Question 1

What is the purpose of Credit Analysis?

Answer 1

It is to evaluate an applicant’s loan request to determine his/her ability to meet the debt obligation

Question 2

How to do Credit Analysis?

Answer 2

1. Identify - risks in lending situations
2. Draw - conclusions as to the likelihood of repayment
3. Make - recommendations as to the type and structure of the loan facility

Question 3

What is Credit Policy?

Answer 3

• It is an approved written documentation within the bank
• It outlines lending principles, guidelines and parameters to facilitate the decision making process
• Provides guidelines for sales and credit officers, on bank’s risk appetite

Question 4

What are the objectives of Credit Policy?

Answer 4

• Produce good quality loans that contribute to profitability of the bank
• Limit the risk of having bad debts i.e. non-performing loans
• Allow bank management to adapt to changing conditions

Question 5

What are the characteristics of a good Credit Policy?

Answer 5

1. Clear and concise
   
   • Specific enough to provide guidelines
   • Ensure consistency in credit decisions
2. Not too restrictive
   
   • Should not stifle initiative and judgement
3. In written form
   
   • Ensure guidelines are clear and communicated to all

Question 6

What are the factors that influence Credit Policy?

Answer 6

• State of the economy
• State of the stock market
• State of the property market
• MAS regulations
• Competition
• Stability of deposits
• Capital position
• Profitability objective

Question 7

What are the 5Cs of Credit?

Answer 7

1. Character
2. Capital
3. Capacity
4. Condition
5. Collateral

Question 8

What is Character?

Answer 8

• Ascertain type of borrower
• Deal with integrity, reliability and co-operative
• Business experience & knowledge of financial matters

Question 9

How to judge on Character?

Answer 9

1. Conduct of account
2. Past repayment history
3. Personal interview
4. Factual information
5. Connections
6. Unresolved legal judgement
7. Track record

Question 10

What is Capital?

Answer 10

• The amount of net worth of borrower to justify the loan
• For secured loans: use Margin of Advance
• For unsecured loans: loan amt < borrower’s contribution

Question 11

How to judge on Capital?

Answer 11

Secured loans:

• Valuation of the asset
• Depreciation policy
• Credit Policy

Unsecured loans:
- Compute net worth of borrower

Question 12

What is Capacity?

Answer 12

Borrower’s ability to generate regular cash flow to:

1. Make loan repayments
2. Service interest

Clear repayment source e.g. payslips, P&L statement

Question 13

How to judge on Capacity?

Answer 13

Individual:

• IR8A (Income Tax Returns form) [Income]
• Credit Bureau report [regular debts]

Corporate:

• Last 3 years Financial Statements
• Projected P&L Statements [forecasted P&L]
• Projected CF Statements [forecasted cash]
• Declaration of other bank’s facilities

Question 14

What is Condition?

Answer 14

1. Purpose of loan
2. Amount of loan
3. Term of loan

Question 15

What is the definition of purpose of loan?

Answer 15

• What the loan is meant to finance
• Purpose must be acceptable, legal and non-speculative in nature
• In accordance with Bank’s policy

Question 16

State and elaborate on the 3 types of loan purposes

Answer 16

1. Rejected outright:
   - Illegal activities
   - Gambling and speculative activities
   - Loans disallowed under Bank and Govt
2. Proceed with caution:
   - New venture
   - Repay existing debts
   - Repay other types of debts(?)
3. Proceed
   - Purchase of fixed assets
   - Working capital financing for normal business activities

Question 17

What is the definition of amount of loan?

Answer 17

• Borrower did not over/under request for loan
• Amount is in accordance with MAS
• As much documentary evidence as possible

Question 18

What is the definition of term of loan?

Answer 18

4 guiding principles:

1. Customer’s repayment ability - matched with repayment source as per loan purpose
2. Risk of non-payment - the higher the risk, the shorter the term of the loan
3. Retirement age - existing age + tenure < retirement age
4. Useful life of asset - existing life + tenure < useful life

Question 19

What is Collateral?

Answer 19

Collateral is an asset which the bank has the legal right to sell should a borrower default

It is taken when:

• Amount of loan is large
• Higher level of risk

Question 20

What is a good collateral?

Answer 20

• Easy to value
• Readily marketable or realizable
• Stable, preferably increasing value