BANKING SERVICES

Ch. 7.3Granting & Analyzing Credit

Banks Must be Careful When Granting Credit

Bad loans are the #1 reason banks get into financial trouble.

Banks need to make sound decisions about loans, and they need a defined method of granting loans.

Net Charge-Off

The total of loans & leases removed from a balance sheet because they are uncollectible minus any funds from prior charge-offs that were collected.

Banks Must Minimize Risk

Banks take a number of steps to minimize making bad loan decisions.

These steps are part of well-defined policies of risk management.

Risk Management

Banks face risks in: 1. operations 2. credit 3. liquidity 4. legal 5. regulatory compliance 6. marketing

These factors all influence the credit-granting process

Risk Management Policies under Scrutiny

A bank’s risk management policies are carefully scrutinized by bank examiners during an audit.

Sometimes legal requirements complicate things.

Banks must document that they comply with the law in extending credit fairly & equally

Credit-Approval Process

1. Application2. Documentation3. Processing4. Underwriting5. Closing6. Funding

Step 1: Application

All information must be correctBank representative helps consumer with this

step as part of a loan analysis or a needs analysis.

Helps consumers decide what type of loan they need.

Step 2: Documentation

Credit reportEmployment verificationBank account informationAppraisal of properties (for secured loans)

Step 3: Processing

The bank builds a loan fileThe loan officer verifies statements on the

application & checks info on all documentation

Loan officer may ask for explanations or seek further info during this step

Step 4: Underwriting

When all required info has been gathered and verified, the loan officer forwards the loan file for underwriting.

Underwriting – reviewing the loan for soundness

The underwriter’s job is to make sure the loan is a prudent use of bank funds.

Underwriters Evaluate the 3 Cs

3 Cs that Underwriters Evaluate: 1. Collateral 2. Capacity (the ability to repay based on income, job

history, & amount currently owed) 3. Credit reputation (how well they’ve repaid in the

past)

Based on these factors, the underwriter approves or disapproves the loan.

Automated Underwriting

Today, underwriting is increasingly automated.

Software programs provide statistical analyses & models based on vast quantities of data.

Banks may sometimes offer a loan at “subprime rates”

Subprime rates- rates that are higher than normal to offset the increased risk represented by a less-than-perfect borrower

Step 5: Closing

At the closing, a bank representative discusses & explains the terms of the loan, & the borrower signs the documentation that has been prepared.

Step 6: Funding

When the documents are signed, the bank either adds the funds to the borrower’s account or issues a check.

CRAs

Consumer reporting agency – a company that compiles & keeps records on consumer payment habits & sells these reports to banks to use for evaluating creditworthiness

Sometimes called “credit bureaus”

CRAs

CRAs report whether a person has been sued, arrested, or has had financial judgments issued against them by a court

3 Main Credit Bureaus: Equifax Experian TransUnion

Credit Reports Contain:

Personal data – name, ss#, addresses, employment

Accounts history – detailed history of active credit accounts

Delinquent accounts – past due accounts or late payments (often utilities, doctors, landlords)

Public records – bankruptcies, judgments, liens, divorces, child-support, criminal records

Inquiries – everyone that has requested a copy of the credit report within the last year

Check Your Credit Report

At least once a year (free)Check for errors, identity theft, etc.The Fair Credit Reporting Act guarantees

consumers the right to review & dispute information in the reports.

Be persistent if you find errors.

Credit-Scoring System

Scores that place a numerical value on the person’s creditworthiness

Various categories are rated and weighted: Income Debt Age Years on the job

FICO

FICO Score – a 3-digit number that credit granters can use in making a loan approval decision

It weighs all categories of informationExcludes income & the type of credit for

which the applicant has appliedAlso excluded are: race, ethnic background,

religion, gender, & marital status

Criteria Used for FICO Score: Payment History (35% of score)

track record on accounts such as credit cards, installment loans, mortgages

Also includes info about public records of collection, bankruptcies, judgments & wage attachments

Details on late payments & how many accounts have no late payments appear

Amounts Owed (30% of FICO score)

Total amounts owed on all accounts, the types of accounts that are open, how many of those accounts have balances, how much of a credit line is in use, how much is still owed on installment loans compared to the original loan value.

Length of Credit History(15% of score)

Considers how long accounts have been established & how long it has been since each was in use

A long, solid credit history increase the FICO score

New Credit(10% of score)

Often sought by people in financial troubleToo much new credit is a sign of

overextensionFICO considers how many new accounts

exist, how long they’ve been open, how many recent requests for credit have been made

Types of Credit(10% of score)

Shows what types of accounts exist & how many there are of each

A “healthy mix” of credit yields a higher score than a dependence on a single type of credit account.

FICO Scores

Range between 300 to 900, with about 620 being the point below which consumers may be regarded as high-risk

FICO scores can vary by as much as 50 points between credit reporting agencies

Book Work

“Checkpoints” Pg. 201 & 205

Ch. 7.3 Assessment Pg. 206 #1-4

Dave RamseyCredit Bureaus

Test&

Sample Credit Report Activity