Chapter 1

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Lim Chhayada
Learning objective
• Identify the basic principles governing bank lending
and explain their importance
• Understand the framework within which credit and
lending decision are taken
• Distinguish different types of borrowers
• A framework for credit and lending decisions

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The principles of good lending
The three basic principles that guide lending
decision are :

 Safety of loan
 Suitability of loan purpose
 Profitability

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Safety of loan
 Good character

 Financially sound

 Has the ability

 Willingness to repay the loan

 Collateral security
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Suitability of loan purpose

 Legal and conforms to the lending policy of the

bank

 Lending to gambling????

 If the bank giving a loan for an illegal activity, then

the lender may not be able to recover the money.
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Profitability

 Financial institution are in the business of lending to

earn profits.

 Interest on loan

 Lending institution must carefully weigh the risks

and return from a possible loan.
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Credit Analysis
Credit analysis can be done by

 Traditional methods
The judgmental method (also called the expert
systems method)
The rating method
The credit scoring method

 Modern methods.
Modern methods use technology and thus facilitate
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faster processing of proposals.
SELECTION RISK ANALYSIS

 Credit selection is the process of assessing the risk of

lending to a business or an individual.
 Selection risk has both qualitative and quantitative
dimensions.
 Qualitative: financial responsibility, true purpose for
borrowing funds, economic conditions, degree of
commitment.
 Quantitative: analysis of historical financial data
and the projection of future financial results.
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Sources of Credit Information

1.Customer Interview:
Despite the possible lack of objectivity, the loan customer ordinarily provides
the most important information needed in a credit investigation.
2.Internal Bank Sources:
If a loan customer has existing relationships with the bank, a great deal of
information is internally available to the bank about the customer’s
willingness and capacity to service the proposed loan.
3.External Sources of Information:
Local, regional and national credit bureaus provides information about the
credit history and business operations of the loan applicants.
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The Rating Methods

Rating Agencies
• Moody’s
• Standard & Poor’s
Ex: AAA, AA, A+ or B

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Credit Scoring Systems

 Credit scoring systems are to be found in all

types of credit analysis whether personal credit
or business credit.
 These system identify and weigh certain key
factors that determine the probability of
repayment default.

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Lending banks deal with a variety of
different categories of borrower. In order to
operate effectively within the lending
market, it is essential to understand the
distinct borrowing needs and risks
associated with each category of borrower.

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 Personal borrowers
 Sole proprietors
 Partnerships
 Companies
 Clubs and societies
 Government organization
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Legal borrowing Capacity

 An individual obtains the legal capacity to borrow at the age of 18.

 In Malaysia, BNM stipulates that an individual must be at least 21 to obtain
a credit card
 An individual adjudicated bankrupt does not have the legal capacity to
borrow

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 A sole proprietorship is a simple type of business to
establish in which the individual owner of the
business becomes the sole proprietor
 The borrower can choose to borrow credit facilities in
their own personal name or in the name of the
business. The sole proprietor remains responsible for
any outstanding amount
 The sole proprietor is responsible for all business
liabilities
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 A partnership is an association of two or more
persons to conduct a business with a view to making
a profit
 A partnership is a firm with no separate legal identity
from its partners
 A partnership may not have more than 20 partners
unless it is a legal firm or professional practice

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A partnership changes its status each time a partner is admitted or retires. A
lending bank must reassess the new risks and legal liabilities between partners
whenever a new partner is admitted or retires from the partnership

Incoming partners Outgoing partners

It is common for new partners to be admitted, to add
expertise or to increase capital in the firm.
An incoming partner is only liable for debts created
after their admission to the firm
A lender should obtain a letter of undertaking or
personal guarantee from an incoming partner to
admit liabilities of the firm’s existing debts.
An outgoing partner may have become deceased, or
have retired/resigned from the firm.
Such a partner’s liabilities are determined from the
date they died or left the firm
The outgoing partner is not liable for any debts
incurred after said date
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 A company is an organization of people with common intent and interests who
bind themselves an organization, contributing capital and sharing joint
responsibility for the organization
 Individuals who own shares in the company for the capital they contributed
are know as shareholders
 Companies can be classified as either public limited companies or private
limited companies

 A limited company has separate legal status from its owners and has the legal
capacity to act on behalf of its owners
 A limited liability company allows shareholders to limit their liability in the
company and protect their private assets from unpaid creditors or the
company
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 Private limited companies
 This category of company is  Public companies have no  Listed companies
restricted in the amount of
shares which can be
transferred to any one
shareholder
 This restriction exists to
ensure that the company
shares remain limited to a
private group of shareholders
 Private companies cannot be
listed companies
Public limited companies Listed companies
such restrictions and are have their shares
free to raise funds from the listed on a recognized
public stock exchange
 Shares are freely  No all public
transferable among companies are listed
shareholder and non companies as they
shareholders must meet exchange
listing requirement
before they can be
listed
 Private companies
cannot be listed
companies
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 The Memorandum of The Articles of Supporting
Association Association documentation
This document represents This document details: Bank much check:
the company constitution  The directors’ powers  Details the company
The following clauses  How meetings are to shareholder
must be checked: be called  Details the company
 The name  The passing of director
 The address resolutions  Resolutions
 The objects  Affixing the company
 The limited liability seal etc
 Authorized share capital
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 Clubs and societies are unincorporated bodies with no legal
status of their own
 They are formed by persons grouping themselves together and
forming a club and society at general meeting
 The members draw up the rules and by law of the society
 A registered society may be used in the name of any member
registered with the registrar of society as a public officer of the
society

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All borrowings by a club or society must be supported by a resolution
passed by its committee members. As a club/society has no legal status,
loan must be extended in the name of a committee member.

Assets acquired by a club/society will be registered in the name of the

trustees who may be committee members

In taking assets as security form a club/society, a lending bank must ensure:

 The power for the society to borrow on behalf of its members is detailed in the
constitution
 The signatories to the charge document are authorized, and
 The purpose of borrowing is within the authority granted to the trustees, committee or
board

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 Government organizations are bodies created by the
government to undertake a specific function
 Government organizations are restricted in their borrowing by
the Ministry of Finance. Borrowing are subject to the
provision of general orders issued by Treasury
 It is highly unlikely that a statutory body would seek a loan
without the clearance of Ministry of Finance, however lending
banks should bear in mind that any borrowing requiring credit
support must be approved by the Treasury

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A framework for credit and lending
decisions

 External factors affecting lending

decisions
 Lending institution – specific factors

 Borrower – specific factors

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 General Law

Lending policy

Strategic consideration

Loan portfolio design

Macro economic
6Cs of Lending

Banking Act
BORROWER
SPECIFIC FACTORS

INTERNAL FACTORS

EXTERNAL FACTORS
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