2 Principles+of+Lending

8/3/2019 2 Principles+of+Lending

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Principles of Lending

Presented by


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General Lending principlesGeneral Lending principles

A lender does lend money and does notA lender does lend money and does not

give it away.give it away.

Lenders must seek to arrive at anLenders must seek to arrive at anobjective decision.objective decision.

The approach of the true professional isThe approach of the true professional is

to resist outside pressures and to insistto resist outside pressures and to insiston sufficient time and information toon sufficient time and information to

understand and evaluate the proposition.understand and evaluate the proposition.


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Professional lending principlesProfessional lending principles

Get full information from the customer and notGet full information from the customer and notmake unnecessary assumptions or fill inmake unnecessary assumptions or fill inmissing details.missing details.

Do not take a customers statements at faceDo not take a customers statements at facevalue and ask for evidence that will providevalue and ask for evidence that will provideindependent corroboration.independent corroboration.

Distinguish between facts, estimates andDistinguish between facts, estimates and

opinions when forming aopinions when forming a judgementjudgement.. Think again when the gut reaction suggestsThink again when the gut reaction suggests

caution,evencaution,even though the factual assessmentthough the factual assessmentlooks satisfactory.looks satisfactory.


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TRADITIONAL METHODSOFTRADITIONAL METHODSOF

CREDITANALYSISCREDITANALYSIS Anyone can lend, but lending money andAnyone can lend, but lending money and

ensuring it repayment distinguishesensuring it repayment distinguishesbetween a good banker and a bad banker.between a good banker and a bad banker.

When you are dealing with people, it isWhen you are dealing with people, it isalmost impossible to predict howalmost impossible to predict howsomeone will behave in the future.someone will behave in the future.

It is important therefore that lendersIt is important therefore that lendersexercise sound judgment while grantingexercise sound judgment while grantingloan.loan.


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Means of gathering informationMeans of gathering information

Credit check of internal bank records or otherCredit check of internal bank records or otherfinancial institution.financial institution.

Documentary evidence such as salary/incomeDocumentary evidence such as salary/income

statements, drivers license, utility billstatements, drivers license, utility bill For business borrowers, character assessmentFor business borrowers, character assessment

involves assessing the character of the businessinvolves assessing the character of the businessowners or, in the case of companies, theowners or, in the case of companies, themembers of the board.members of the board.

Confidential reports from credit rating agenciesConfidential reports from credit rating agenciesare another source.are another source.


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ProfessionalProfessional

lending principleslending principles

The purpose of any creditThe purpose of any credit

assessment or analysis is theassessment or analysis is the

measurement of credit risk.measurement of credit risk.

Borrowers credit assessment isBorrowers credit assessment is

done using the following criteria,done using the following criteria,popularly known as the six Cs ofpopularly known as the six Cs of

lending.lending.


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Evaluation of

Borrowers

CharacterCharacter

CapacityC

apacity CapitalCapital

ConditionsConditions

CollateralCollateral

ComplianceCompliance


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CHARACTERCHARACTER

Character is the sum total of humanCharacter is the sum total of humanqualities of honesty , integrity, moralityqualities of honesty , integrity, moralityand so on.and so on.

Character is perhaps the most importantCharacter is perhaps the most importantand at times the most difficult criterion toand at times the most difficult criterion toassess.assess.

Character assessment involves collectingCharacter assessment involves collectinginformation about the borrowers trackinformation about the borrowers trackrecord of integrity, repayment ability andrecord of integrity, repayment ability andspending habits.spending habits.


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CAPACITYCAPACITY

Capacity is the ability to repay the loan togetherCapacity is the ability to repay the loan togetherwith interest as per the prewith interest as per the pre--determined schedule.determined schedule.

A borrowers capacity depends on two factors:A borrowers capacity depends on two factors:

first, the borrowers financial position should befirst, the borrowers financial position should besound; and second, the borrower must be able tosound; and second, the borrower must be able togenerate sufficient net income to service the loangenerate sufficient net income to service the loanrepayment, after meeting the sustenance.repayment, after meeting the sustenance.

In the case of businesses, lenders usually askIn the case of businesses, lenders usually askfor audited financial statements and projectedfor audited financial statements and projectedcash flow to determine the financial soundnesscash flow to determine the financial soundnessor creditworthiness of the business borrower.or creditworthiness of the business borrower.


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AbilityAbility

This aspect relates to the borrowers ability inThis aspect relates to the borrowers ability inmanaging financial affairs and is similar tomanaging financial affairs and is similar tocharacter as far as personal customers arecharacter as far as personal customers are

concerned.concerned. Is there a good spread of skill and experienceIs there a good spread of skill and experience

among the management team in, foramong the management team in, forexample,production,marketing and finance.example,production,marketing and finance.

Are they committed to making the companyAre they committed to making the company

successful?successful? Where the finance is earmarked for a specific areaWhere the finance is earmarked for a specific area

of activity, do they have the necessaryof activity, do they have the necessaryexperience/expertise in that area.experience/expertise in that area.


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CAPITALCAPITAL

Capital refers to the capital contribution that theCapital refers to the capital contribution that theborrower proposes to make in the totalborrower proposes to make in the totalinvestment.investment.

An investment is usually financed partly byAn investment is usually financed partly bybank loan and partly by the capital contributionbank loan and partly by the capital contributionof the owner.of the owner.

The owners contribution is called the ownersThe owners contribution is called the ownersmargin.margin.

The greater the owners contribution to a projectThe greater the owners contribution to a projectthe greater is the lenders confidence in thethe greater is the lenders confidence in theventure. Banks usually expect usually a 25venture. Banks usually expect usually a 25percent input from the borrower.percent input from the borrower.


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CONDITIONCONDITION

An analysis of conditions coversAn analysis of conditions covers

external and internal factors.external and internal factors.

It also covers the conditions andIt also covers the conditions and

terms of the loan.terms of the loan.

The riskier the advance theThe riskier the advance thestricter are the terms andstricter are the terms and

conditions.conditions.


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EXTERNAL CONDITIONSEXTERNAL CONDITIONS

Recession, SlowdownRecession, Slowdown

Interest rate shockInterest rate shock

High InflationHigh Inflation Threat of warThreat of war

CrimeCrime

Internal DisturbancesInternal Disturbances

EmergencyEmergency


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Other Conditions

PoliticalPolitical

EconomicEconomic

SocialSocial

TechnologicalTechnological

EcologicalEcological

LegalLegal


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INTERNAL CONDITIONSINTERNAL CONDITIONS

Lending policiesLending policies

Lending budgetLending budget

Availability of expert staff to monitor loan.Availability of expert staff to monitor loan.

A financial institution may decide to followA financial institution may decide to followrestrictive lending policies, the lending budgetrestrictive lending policies, the lending budgetand the availability of a funds constraint, or toand the availability of a funds constraint, or toexpand lending business in particularexpand lending business in particularsegments of the market.segments of the market.

Credit analysis should take such aspects intoCredit analysis should take such aspects intoaccount.account.


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COLLATERALCOLLATERAL

Collateral is also known asCollateral is also known as

secondary source of repayment.secondary source of repayment.

When a loan cannot be paid out ofWhen a loan cannot be paid out ofprimary source, lenders usually takeprimary source, lenders usually take

possession of collateral and disposepossession of collateral and dispose

of it and use the proceeds to set offof it and use the proceeds to set offthe outstanding loan amount.the outstanding loan amount.


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QUALITIESOFGOODQUALITIESOFGOOD

COLLATERALCOLLATERAL The price of the security should be stable, orThe price of the security should be stable, or

not subject to wide fluctuations.not subject to wide fluctuations.

The marketability of the security should beThe marketability of the security should be

rated good.rated good. The security should be easily valued.The security should be easily valued.

The security should not deteriorate rapidly overThe security should not deteriorate rapidly overtime.time.

If security is quickly transportable or portable,If security is quickly transportable or portable,then the lender can sell it in another market. Ifthen the lender can sell it in another market. Ifthe security is not portable then, the lender maythe security is not portable then, the lender mayfind it hard to sell that security in the localfind it hard to sell that security in the local

market.market.


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Compliance

According to rules and regulationsAccording to rules and regulations

Meeting all the formalitiesMeeting all the formalities

Guidelines from GovernmentGuidelines from Government

Regulatory agency instructionsRegulatory agency instructions


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AmountAmount

Is the customer asking for either tooIs the customer asking for either too

much or too little?.much or too little?.

There are dangers in both and it isThere are dangers in both and it isimportant therefore to establish that theimportant therefore to establish that the

amount requested is correct and that allamount requested is correct and that all

incidental expenses have beenincidental expenses have been

considered.considered.

The good borrower will have allowed forThe good borrower will have allowed for

contingencies.contingencies.


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RepaymentRepayment

The real risk in lending is to be found in theThe real risk in lending is to be found in theassessment of the repayment proposals.assessment of the repayment proposals.

It is important that the source of repaymentIt is important that the source of repayment

is made quite clear at the outset and theis made quite clear at the outset and thelender must establish the degree of certaintylender must establish the degree of certaintythat the promised funds will be received.that the promised funds will be received.

Where the source of repayment is income/Where the source of repayment is income/

cash flow , the lender will need projections tocash flow , the lender will need projections toensure that there are surplus funds to coverensure that there are surplus funds to coverrepayment after meeting other commitments.repayment after meeting other commitments.


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Fair Practices Code Loan application forms in case ofPSLoan application forms in case ofPS

advances up to Rs.2 lakhs, shouldadvances up to Rs.2 lakhs, shouldinclude information such as fee/ chargesinclude information such as fee/ charges

payablepayable

Acknowledge receipt of all loanAcknowledge receipt of all loanapplicationsapplications

Main reason for rejection to be conveyedMain reason for rejection to be conveyedto small borrowers/applicants up toto small borrowers/applicants up toRs.2lakhs, in writing within the stipulatedRs.2lakhs, in writing within the stipulatedtimetime


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Fair Practices Code

No interference by the lender inNo interference by the lender in

the affairs of the borrower,the affairs of the borrower,

except in case of Terms andexcept in case of Terms and

conditions complianceconditions compliance

Consent/ objection on requestConsent/ objection on request

for transfer of loan to befor transfer of loan to be

conveyed within 21 daysconveyed within 21 days


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Fair Practices Code -US Equal Credit Opportunity ActEqual Credit Opportunity Act

No discrimination on the basis ofNo discrimination on the basis of

AgeAge

SexSex

Marital statusMarital status

Dependence on income fromDependence on income from

public assistance programmepublic assistance programme


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Fair Practices Code -US In case of denial the applicant must be notifiedIn case of denial the applicant must be notified

within 30 days with statement of reasonwithin 30 days with statement of reason

If discriminated on any of the stated groundsIf discriminated on any of the stated groundsCheck with state attorney generalCheck with state attorney general

State may prosecute the bankerState may prosecute the banker

Applicant can claim damages /compensationApplicant can claim damages /compensation

for attorneys fees, Court costsfor attorneys fees, Court costs

File a class action suit along with other suchFile a class action suit along with other such

personspersons


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Thanks for your attentionThanks for your attention

Dr. S. C. BihariDr. S. C. Bihari

Tell:Tell:0841708417--236660 to 65(Extn: 6214)236660 to 65(Extn: 6214) Mail:[email protected]:[email protected]

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