Lecture 1 - Concepts and Principals of Credit Lending Flashcards
What is the purpose of Credit Analysis?
It is to evaluate an applicant’s loan request to determine his/her ability to meet the debt obligation
How to do Credit Analysis?
- Identify - risks in lending situations
- Draw - conclusions as to the likelihood of repayment
- Make - recommendations as to the type and structure of the loan facility
What is Credit Policy?
- 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
What are the objectives of Credit Policy?
- 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
What are the characteristics of a good Credit Policy?
- Clear and concise
- Specific enough to provide guidelines
- Ensure consistency in credit decisions
- Not too restrictive
- Should not stifle initiative and judgement
- In written form
- Ensure guidelines are clear and communicated to all
What are the factors that influence Credit Policy?
- State of the economy
- State of the stock market
- State of the property market
- MAS regulations
- Competition
- Stability of deposits
- Capital position
- Profitability objective
What are the 5Cs of Credit?
- Character
- Capital
- Capacity
- Condition
- Collateral
What is Character?
- Ascertain type of borrower
- Deal with integrity, reliability and co-operative
- Business experience & knowledge of financial matters
How to judge on Character?
- Conduct of account
- Past repayment history
- Personal interview
- Factual information
- Connections
- Unresolved legal judgement
- Track record
What is Capital?
- 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
How to judge on Capital?
Secured loans:
- Valuation of the asset
- Depreciation policy
- Credit Policy
Unsecured loans:
- Compute net worth of borrower
What is Capacity?
Borrower’s ability to generate regular cash flow to:
- Make loan repayments
- Service interest
Clear repayment source e.g. payslips, P&L statement
How to judge on Capacity?
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
What is Condition?
- Purpose of loan
- Amount of loan
- Term of loan
What is the definition of purpose of loan?
- What the loan is meant to finance
- Purpose must be acceptable, legal and non-speculative in nature
- In accordance with Bank’s policy
State and elaborate on the 3 types of loan purposes
- Rejected outright:
- Illegal activities
- Gambling and speculative activities
- Loans disallowed under Bank and Govt - Proceed with caution:
- New venture
- Repay existing debts
- Repay other types of debts(?) - Proceed
- Purchase of fixed assets
- Working capital financing for normal business activities
What is the definition of amount of loan?
- Borrower did not over/under request for loan
- Amount is in accordance with MAS
- As much documentary evidence as possible
What is the definition of term of loan?
4 guiding principles:
- Customer’s repayment ability - matched with repayment source as per loan purpose
- Risk of non-payment - the higher the risk, the shorter the term of the loan
- Retirement age - existing age + tenure < retirement age
- Useful life of asset - existing life + tenure < useful life
What is Collateral?
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
What is a good collateral?
- Easy to value
- Readily marketable or realizable
- Stable, preferably increasing value
