TUTORIAL 4

Q1. What is consumer lending? What are its various types?

Ans. Consumer lending or credit refers to the loans required by individuals or households to
meet personal needs such as travel or the purchase of furniture, household appliances,
motor vehicles, boats or homes. However, confusion prevails about what constitutes
consumer lending. The Uniform Consumer Credit Code, Australia Bureau of Statistics
and others have their own definitions. For all practical purposes, consumer lending
includes personal loans and credit card loans. Home loans are also given to individuals
and households. If they are owner occupied, they should actually be included under
consumer loans. However, given the large magnitude of such loans, these loans are
treated distinct from personal and credit card loans.

Q2. What factors have led to rapid growth of consumer credit in Australia?
Ans. There are several factors that have contributed to rapid growth of consumer credit in
Australia. These include:
 Continuing economic expansion: Australian economy is steadily growing over the
years. During the period from 1995 to 2000, Australian economy grew by 4.4 per
cent (compound average annual growth). In a growing economy the demand for all
types of credit including consumer credit is naturally high.
 Low inflation regime: The rate of price rise or inflation is moderate in Australia. As
per the monetary policy of the Reserve Bank of Australia the inflation was targeted
to move in the band of 2 to 3 per cent per annum. It has remained so in recent years.
Low inflation spurs buying and hence higher demand for credit.
 Low interest rates: The structural decline in inflation and interest rates explains
much of the rise in consumer credit and buying by owner-occupiers. The effects of
the gains in wealth on their behaviour are still working their way through the
economy.
Thus due to the rise in personal income and household expenditure, the demand for
consumer credit is rapidly growing. That demand indicates consumer confidence and is
carefully watched by the government and central bank of the country.

Q3. What are credit-scoring models?

Ans. Credit scoring models is a credit assessment tool used by many lending institutions. They
have several advantages over the traditional judgemental system of credit risk
assessment. These include the ability of the credit scoring models to handle a large
volume of credit applications, fast processing of applications, lower operating cost,
saving in training cost and customer convenience. These models are developed using
statistical models. In these models, several variables are simultaneously used to arrive at
a credit score or ranking for each applicant. If the score exceeds the pre-determined cut
off score, then application is automatically approved. The variables used in credit scoring
models include age, marital status, number of dependents, home ownership, income
bracket, credit rating, time in current employment, number of bank accounts held, the
type of accounts held and telephone ownership. These models attempt to segregate the
good loans from bad loans based on the past experience of the bank. The bank collects
data of loans that have proved to be sound and those that have proved to be risky against
 each of the above parameters, then runs a statistical model like a regression or
discriminant analysis that gives the relative weights or points for each of the above
variables. These weights are then used for constructing a credit-scoring model against
which all applications are evaluated. The scoring models are dynamic, that is, they are
tested and re-tested periodically and revised if necessary.

Q4. What are the important provisions of the Uniform Consumer Credit Code?
Ans. The Uniform Consumer Credit Code (UCCC), now known as the National Credit
Code (NCC) standardises the practices relating to consumer credit in Australia. The
UCCC is very comprehensive in scope and includes all transactions where ‘credit’ is
granted. Thus, even where goods or services are brought on credit, the UCCC will apply.
The code provides for the redress of consumer grievances if the credit provider fails to
comply with provisions of the Code. The UCCC provides that all credit contracts must
include information about:
 The amount of credit provided;
 The annual percentage rate or rates;
 Details regarding calculation of interest;
 Credit charges and fees to be paid;
 If there is a change in terms of the contract then how should the consumer be
informed;
 How is default interest to be calculated;
 How and at what interval account statement is sent to customer;
 Information about whether a mortgage or guarantee applies; and
 The details of any credit-related insurance financed under the contract.
 Provisions relating to registration of credit providers’ and disciplinary procedures;
 The establishment of the Consumer Credit Fund, a statutory fund for payment of
civil penalties for Code breaches.
 In Victoria, the Code provides that there will be maximum interest rate ceilings of
48 per cent.
 Finance brokers who negotiate consumer credit on a client’s behalf are also
regulated by the Code.
 Non-compliance with the Code could lead to criminal fines and civil penalties (e.g.
$500,000 fine for breaching one of the Code’s key requirements, for example);
 Payment of compensation to consumers suffering loss as a result of the behaviour of
credit provider;
 Personal liability of officers of the credit provider.

Q5. Changing demographics in Australia are expected to have substantial effects on a bank’s
consumer credit programs. Outline the changes taking place in demographics in Australia
and how these may have an impact on consumer credit programmes.
Ans. According to Financial System Inquiry Final Report (popularly known as the Wallis
Report, 1997), the important developments that are changing customer needs include the
following:
 Ageing of the population: As per report of Australian Bureau of Statistics
approximately 17.5 per cent of the Australian population will be ‘old’, that is, above
65 years of age compared to 11.9 percent in 1995 and 8.3 percent in 1970. As a
 result, governments have started superannuation schemes to reduce the dependence
of retirees on age pension. Hence, retirement products will have greater demand.
There could be demand for credit to meet medical expenses, travel and leisure etc.
 Changes in work patterns: There is a trend towards early retirement and
percentage of people in full time employment after the age of 55 has declined from
33 per cent to 22 per cent between 1966 to 1996. Similarly, many people are in part-
time employment and may like to used their free time to undertake certain activities.
It is possible that these people may like to start some small business requiring bank
credit.
 Increasing value awareness: Consumers will seek those financial products that
offer best value for money. They are becoming more price sensitive to transaction
fees as well as interest rates. Credit products will have to be competitive to take care
of this value awareness among consumers.
 Willingness to adopt technology: Consumers are becoming more technology savvy
and electronic banking products are like to see a surge in demand. The convenience
and low cost that electronic banking offers makes it very attractive for consumers.

Q6. What are the three main principles applied to corporate lending proposals?
Ans. 1) Safety
2) Suitability
3) Profitability
Do not forget to always have “ways out” in any loan that is approved.

Q7. The five Cs is one method of structuring a loan approval process. What fundamental
piece of information does it ignore or fail to highlight?
Ans. The purpose of the loan is not implicitly discussed or demanded / domestic issues by
borrower.

Q8. What are the three components of a corporate loan?

Ans. 1) Origination – who are the borrower?, purpose?
2) Funding – type of loan / bond
3) Managing – frequency of repayments, default trends, collaterals, timeliness

Q9. Do you think that an understanding of the three components noted in question 3 would
allow for a correct segmentation of loan duties and functions within a financial
institution?
Ans.
 Allows for the segmentation of duties into the stated functions
 Allows for limited training to be effective across functions
 Synergy can be applied to management practices as centralisation can occur
 Corporate governance is strengthened because there is less potential to manage the
whole loan process and potential for fraud is lessened
  The audit process can be strengthened because of the separation of responsibilities
and duties
Q10. In recommending approval of a loan, how does a loan officer reconcile the needs of the
borrower with the bank’s objective of making a profit?
Ans.
 Attention to a prudent lending process will allow a loan officer to identify good
loans that meet the needs of the institution and assist the client to grow their
businesses.
 As the loan portfolio is usually the major asset of a lending institution quality is
paramount to sustainability of profit and growth (RAROC > ROE).
 Care here that type one and type two errors do not occur.

Q11. Discuss the veracity and value of the lending cycle.

Ans. It is a structured and progressive cycle that allows for a loan to be declined or approved
at any stage. The cycle ensures that during the analysis and approval process the loan
officer considers the following aspects, some of which are directly related to the loan and
some are related to the strategic thrust of the financial institution.
a. Target market – is the loan within the parameters of the institution.
b. Origin – the meeting of client and institutional needs.
c. Evaluation – formal processing of the loan for veracity (accuracy).
d. Negotiation – the imposition of the terms and conditions. This is the old rule "Yee
who has the gold writes the rules".
e. Approval – or decline, the time in the cycle when the ownership of the funds
changes hands.
f. Documentation – finalisation of the necessary paperwork.
g. Disbursement – the passing of the funds (timeliness of disbursement).
h. Administration – The ongoing monitoring of the performance of the loan.
i. Orderly payment and finally repayment – the successful completion of the life of a
loan.
j. Unforeseen events – loss – workout – and write-off – the actions undertaken to save
a loss or the most efficient method of minimum loan write-off.

Q12. An evaluation of the worth of the three ways out of a loan may lead to a modification of
the loan approval process. What changes may occur? What additional information may
be needed?
Ans. The analysis of the three ways out of a loan demonstrates that there is only one
successful outcome and that is the full repayment of the principle and interest due over
the life of the loan.
Rigorous lending principles need to be applied and loans must be given on the basis of
ability to repay, i.e. cash flow rather than the amount of security available. In addition,
the granting of a loan must be based on the purpose of the loan rather than the value of
and the amount of available lending capacity.

Q13. Attempt to overlay the five Cs and PARSER on the formalised lending cycle shown in
figure 8.1.
Ans. Five "C"
i. Character
ii. Capacity
iii. Collateral
iv. Conditions
v. Capital
"PARSER"
i. Personal element
ii. Amount required
iii. Repayment
iv. Security
v. Expedience
vi. Remuneration
The lending cycle and the commercial lending decision making process forces a loan
officer to analyse all the factors in either the five "C" or PARSER.

Q14. Refer to the lending products listed in this chapter to meet the needs of corporates. Are
any of them practical to offer as a replacement for a large corporate’s interaction in the
direct market?
Ans. Facilities as offered by a financial institution are designed to either meet the borrowing
needs of the client or to manage risks incurred by the client. An entity will enter the
direct money market if their credit rating allows and will do so for commercial reasons.
These reasons may involve the lending of or the raising of money at a cheaper rate or at
differing terms than available through the indirect institutions.
It is important that a lending officer understands the needs of their clients and be able to
offer products that meet those needs. A properly organised corporate entity that has the
ability to interact in the short-term money markets will do so regardless of the products
available from a financial institution. Smaller corporate entities that cannot access the
direct markets will need a financial institution to supply replacement products.
Care must be exercised as to the credit rating and size of the borrower as it is the
responsibility of the loan officer to ensure correct discussions and negotiations take place
with the borrower. A corporate will view continued harassment by a loan officer as
unprofessional if it demonstrates that he or she does not understand the business.

Q15. Should a loan officer be involved in the cross-selling of various institutional products or
should this be the function of other parties employed by the financial institution? In your
discussion, define and develop what is meant by a ‘full relationship with the client’
Ans. A full client relationship can also be termed a 'one stop shop'. This does not mean that the
loan officer must do all; indeed it may mean that the loan officer is one of the services
offered by the client relationship manager along with all the other services offered.
It is the responsibility of the loan officer to ensure correct analysis has been made of any
loan proposal and that a recommendation is made independent of the overall needs of the
institution.
A loan officer must balance the needs of the bank or financial institution against that of
the need for absolute loan quality. Segregation of responsibilities and reporting channels
for various products and processes within the financial institution should ensure no
contradictions are allowed to downgrade the quality of the loan portfolio.