Bank Own Record (9)
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Transcript of Bank Own Record (9)
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Factors considered in credit analysis
Ownership of assets
Ownership of assets is similar to capital and collateral in the cs of the
credit . Manufacturer must have modern machinery and equipment if they
are to be competitive producers.
Retailers must have a stock of merchandise and attractive buildings and
fixtures if they are to attract customers Credit will not be supplied to business concerns unless capital has been
supplied by the owners to support the debt . The net worth of a firm is
one measure of its financial strength
It is often one of the principal determinant of the amount of credit a bank
is willing to make available to a business borrower Consumer loans are frequently secured by assets of the borrower .
If the value of the pledged assets has not depreciated below the unpaid
balance of the loan , the borrower has a strong incentive to continue
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Economic conditions Economic conditions affect the ability of the borrower and the
lender. borrower may have good character , an apparent ability to
create income , and sufficient assets , but economic
conditions can render the extension of credit unwise
The economy is subject to short and long run fluctuations thatvary in intensity and duration
A knowledge of what is happening in the industry is very
important changes in competitive conditions , technology,
the demand for the product , and distribution methods
If a loan applicant is not performing a function basic to the
operation of the economy , the lender will less likely to act
favorably on credit application
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Character The concept of character ,as it relates to credit
transactions , means not only the willingness to repaydebt but also a strong desire to settle all obligations
within the term of contract
A person of character usually possesses attributes
such as honesty , integrity , industry , and morality ,
but character is a difficult to evaluate
The past record of a borrower in meeting his or her
obligation is usually weighted heavily in evaluating hisor her character for credit purposes
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Capacity
It refers to the ability of the potential borrower to repay the
debt when it falls due , and is indicative of the borrowerscompetence to utilize the loan effectively and profitability
This is a very important variable of credit analysis , for the
customer s ability to repay is primarily dependent upon his
earning capacity . The repayment of loan may be made by the sale of the assets
, by borrowing funds from others , and by earning s. banks are
always interested in loan repayment out of earnings because
the repayment of the debt by sale of assets is an expensiveand time consuming process, and may strain the banks
relations with the borrower
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Capital
It represent the general financial position of the potential
borrowers firm , with special emphasis on tangible net worth
and profitability . The net worth figure of the business
enterprise is the key factor that would determine the amount
of credit that would be made available to the borrower
The lending officer has to determine the amount of
immediate liabilities liabilities that are due for retirement and
the relation these bear to the firms available assets
A true estimate of capital can be made if the market value
rather than the book value of assets is taken into account
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Collateral it is represented by the assets that may be offered as
a pledge against the loan . Collateral , thus , serve as
a cushion or shock absorber if one or several of the
first three c s are insufficient to give a reasonable
assurance of repayment of the loan on maturity . The collateral in the form of pledged assets serves to
compensate for a deficiency in one or several of the
fisrt three c
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Condition
It refers to the economic and business conditions which affect
the borrower s ability to earn and repay the debt and which
are , or may be , beyond the control of the borrower
Economic conditions include all those factors which have a
bearing on the economic processes of production ,
distribution and consumption .
Borrowers may have a high credit character and potential
ability to produce income ; but the existing or ensuring
conditions may be such as to render the extension of credit
imprudent
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Ability to create incomeIf a loan is to be repaid from earnings , it is essential to evaluate
the borrower ability to earn a sufficient amount to make the
payment
Debt are paid from 4 sources : income , sale of assets , sale of
stock , and borrowing from another source
An individual power to generate income also depends on such
factors such as education , health and energy , skill , stability of
employment and resourcefulness
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Relative importance of the credit
factors
Although all the factors mentioned earlier are important incredit analysis , most bankers agree that the collateral
available for a loan is generally the least important
Security is taken in most instances to strengthen a weakness
found in one or more of the credit factors , such as ability tocreate income
Over the entire spectrum of credit analysis , however ,
character emerges as the most important factor
If the borrower is of poor character , the probability is highthat at some time he or she will not comply with the terms of
a loan agreement
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Scope of credit investigation
The scope of credit investigation will vary depending on the suchdeterminant as the size and maturity of the loan , the operatingrecord of the business ,the security offered , and previous relation swith the borrower.
The objective is to accumulate information that can be used toevaluate the applicant character , ability to create assets andincome , and the probable economic environment for his or herbusiness
Banks should know about the nature and operations of the business: what types of products are handled or produced , what type ofservices are rendered
Bank also want information on concerns financial condition . Thetrends of sales and profits may be of considerable importance inevaluating the firms future
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Sources of credit information
Interview of loan applicant
If the interview with the applicant , the lendingofficer learns the reason for the loan and whether
the loan request meets various requirementsestablished in the loan policies of the bank .
From the interview , the lending officer can also getsome idea as to an applicants honesty and ability
and may form an opinion as to whether security
In the interview , the lending officer will also advise
the applicant as to what additional financialinformation will be needed for evaluating theproposed loan
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Inspection of applicants places of business
Businesses applying for loans should be willing to allow a loanofficer to visit and tour their places of business . An
experienced loan officer will learn a significant amount about
how productive and well managed a business is from a tour of
facilities
The loan officer should note how well the business is
organized and whether or not employees seem to be
performing effectively
If a firm is a retailer , a visit during a normally busy period
may indicate the strength of the firms business as well as the
proficiency of the sale staff
In the case of visiting a manufacturing firm , particular note
should be made of the equipment and the production layout
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Gathering credit information
The credit department of a bank gathers from differentsources the requisite information on which customer
evaluation must necessarily be based
Two important factors should be kept in mind while searching
for credit information cost and time .
A bank cannot afford to spend a lot of money in the
investigation of some loan applicants, particularly the smaller
ones
Spending a lot of time on investigation may be justified in
cases of new and large credit customers
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Interview
An interview with the applicant enables the bank to secure
the information about the history of the borrowers business
its record of growth , types of product made the services
rendered , the competitive position of the firm and its market
and check it against other sources
In an interview, the lending officer discovers the purpose of
the loan sought and the applicants plan for repayment
If the applicant does not sastify the credit norm , the lending
officer ay stop making a further probe into hiscreditworthiness.
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Financial statements
the financial statements , including the balance sheet and theprofit and loss account of the prospective borrower , are
invaluable sources of credit information .
Such statements are most readily available from the applicant
himself . An analysis of these financial statements wouldprovide an insight into the borrowers financial position , fund
management capacity , liquidity , profitability and loan
repaying capacity.
The balance sheet enable the banker to judge the
creditworthiness of the borrower;
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Reports of credit rating agencies
Commercial bank can gather information on thecreditworthiness of the applicant by procuring financial
reports from credit rating agencies , wherever they exist
These agencies collect information on the financial ,
managerial and other aspects of a large number of businessconcerns and keep it up- to- date
This will provide individual as well as corporate investor a
useful tool in making investment decision
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Credit analysis
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Credit decision
After determining the creditworthiness of the applicant , the
lending officer has to decide whether or not credit facilitiesshould be provided to him .
The creditworthiness of the applicant should be matchedagainst the credit standard set out in loan policy
The difficultly in taking a credit decision arises where the
applicant is marginally creditworthy against the cost of thedebt loss.
The applicant who does not satisfy the standard ofacceptability may be told of the banks helplessness in view of
its loan policy
The bank may advise such firm to approach term financing
institutions whose terms and conditions might be fulfilled bythe firm