Bank Own Record (9)

7/28/2019 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

Documents

Bank Own Record (9)