Bank Credit Management Course

Dr. Ra’fat Jallad

First Semester (20-21)
Chapter 1
The Principles of Lending and Lending Basics
Learning Objectives
• Identify the basic principles governing bank lending and explain their
importance.
• Understand the framework within which credit and lending decisions are
taken.
• Understand the lending process.
• Explain the characteristics of various types of bank advance.
• Distinguish different types of borrowers and any special considerations in
lending.

Chapter 1 Credit Analysis and Lending Management

 Learning Objectives
• Explain how advances are structured.
• Explain the importance of credit culture in a lending institution.
• Understand how an advances portfolio is designed.

Chapter 1 Credit Analysis and Lending Management

Introduction
• Lending evolved in real-world practice with supporting principles developed
later.

• Lending principles are universal in their application to loans of all sizes.

• Lending is both an art and a science

Chapter 1 Credit Analysis and Lending Management

Principles of Good Lending
Principles of Good Lending
• Safety of Loan:
– Borrower should be of good character, financially sound with the ability and willingness
to repay the loan.

– The Lender should account for meeting unexpected emergencies.

– Back up in the form of collateral security. Collateral serves as a safety valve or insurance
against unforeseen developments.

Chapter 1 Credit Analysis and Lending Management

Principles of Good Lending
• Suitability of Loan Purpose:
– Loan applications may be accepted or rejected subject to bank policy, legality and
ethical principles (valid purpose).

• Profitability:
– The risks and returns from lending activities must be carefully considered to improve
viability of loan portfolio.
Following the Lending Principles: Credit
analysis
• Regardless of loan size, lending principles of varying levels of sophistication
must be rigorously adhered to.
• Traditional Methods of Credit Analysis — the “Five Cs”:
– Character
– Capacity
– Capital
– Collateral
– Conditions

Chapter 1 Credit Analysis and Lending Management

• Modern Approaches to Credit Risk Measurement:
– Econometric techniques
– Optimisation models
– Neural networks
– Hybrid systems

Chapter 1 Credit Analysis and Lending Management

A Framework For Credit and Lending
Decisions
• External Factors Affecting Lending Decisions:
– Legislation including common law, RBA Act, Banking Act, Uniform Consumer Credit
Code, ASIC Act and the ACCCs consumer laws
– Macroeconomic factors
– Industry-specific factors

• Lending Institution-Specific Factors:

– Institution's lending policy, Loan Budget and Staff Availability

• Borrower-Specific Factors:
– Meeting “Five Cs” requirements and compliance with legal requirements such as
common and ‘black-letter’ law

Chapter 1 Credit Analysis and Lending Management

The Lending Process
• Ten-Step Process:
– Step 1: Use of prescribed application form
– Step 2: Obtain required supporting documents such as income and/or financial statements
– Step 3: Check loan application and supporting documents for inconsistencies
– Step 4: If personal loan, loan decision can be made. If business loan, lender to gain better
knowledge of proposed borrower’s business
– Step 5: Appraise technical, commercial, financial and managerial aspects of the business
– Step 6: Assess financial requirements and determine most suitable product

Chapter 1 Credit Analysis and Lending Management

 – Step 7: Advise potential borrower whether loan application is successful or not
– Step 8: Ensure security and all other loan documents are signed
– Step 9: Monitor borrower’s financial position and repayment position
– Step 10: Ensure necessary steps are taken before loan in default.

Chapter 1 Credit Analysis and Lending Management

Characteristics of Different Types of
Advance
• Traditional Types of Advance
– Loans Classified According to:
– Security — secured v. unsecured loans
– Type of Borrower — personal, business or government
– Term of Loan — short, medium or long
– Sector — retail, manufacturing or mining

• Traditional Types of Advance

– Loans Classified According to:
– Region — rural, town or major city
– Purpose — personal, home, commercial, motor vehicles.
– Overdrafts:
– Flexible form of fixed limit continuous loan with no fixed repayment schedule and flexible
drawdown characteristics.

Chapter 1 Credit Analysis and Lending Management

• Modern Forms of Advance for Business:
– Equity Participation: where equity rather than debt finance is provided
– Loan Syndication: consortium of lenders provide funding
– Equipment Leasing: financing v. operating
– Factoring: sale of business’ debt

Chapter 1 Credit Analysis and Lending Management

Different Types of Borrower
• Personal:
– Unable to enter loan contract if:
– Minors — borrower under 18 years
– Persons of unsound mind
– Insolvents — bankrupts or insolvents who are either undischarged or
pending proceedings
– Joint Accounts: account held in the name of two or more persons
– Husband and Wife: see joint account

Chapter 1 Credit Analysis and Lending Management

• Business Borrowers:
– Sole Proprietorship: Business operated by one person
– Partnerships: Business with more than one owner where profits shared
– Companies: Separate legal entity recognised under Corporation Law
• Special Types of Borrower:
– Local authorities: e.g. local government entities such as City Councils
– Clubs, Literary Societies and Schools: Generally registered as
unincorporated associations or trusts
– Unincorporated Associations: e.g. arts, charities and religious
organisations
– Co-operatives: e.g. farming bodies

Chapter 1 Credit Analysis and Lending Management

• Special Types of Borrower:
– Local authorities: e.g. local government entities such as City
Councils
– Clubs, Literary Societies and Schools: Generally registered as
unincorporated associations or trusts
– Unincorporated Associations: e.g. arts, charities and religious
organisations
– Co-operatives: e.g. farming bodies

Chapter 1 Credit Analysis and Lending Management

Structuring of Advances
• Security/Collateral:
– Includes land, buildings, directors’ guarantees, shares and crop liens

• Debt Covenants:
– Outlines key loan conditions including fees, security, repayments

• Pricing Issues:
– Risk premium over a benchmark rate

Chapter 1 Credit Analysis and Lending Management

Credit Culture
• Can be defined as:
– The institutional priorities, traditions and philosophies that surround credit or lending
decisions; and/or
– “The collection of principles, actions, deterrents and rewards that exist within a lending
organisation” Caouette, Altman and Narayanan (1998)

Chapter 1 Credit Analysis and Lending Management

Designing an Advances Portfolio
• Advances portfolio design requires decisions incorporating:
– What resources are available to invest?
– Of these, what proportion should be invested in advances?
– What proportions should be invested in personal versus business advances?
– Of those personal advances, what proportion should be in housing loans, credit cards and so
on?

• Three main approaches:

– Historical or recent loss experience
– Standards based on risk tolerance to capital
– Risk-adjusted return on capital, where risk is evaluated relative to the risk either at the
transaction level or business unit level.

Chapter 1 Credit Analysis and Lending Management

Summary
• basic principles governing bank lending
• framework within which credit and lending decisions are made
• various steps involved in the lending process
• characteristics of various types of bank advance
• different types of borrower
• Structuring loans and advances
• importance of credit culture
• designing loans and advances portfolios

Chapter 1 Credit Analysis and Lending Management