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By Sudam Chandima Kaluarachchi, Union Bank of Colombo Ltd

Lending is one of the major activities of a bank. The core business of banking is to mobilise deposits from public who have surplus to save and lend same back to public who are in need of money, keeping a margin as profit. In this task, banks are acting as financial intermediaries and they match their lending portfolio with the maturity pattern of the deposits mobilised.

Banks mobilise deposits as short, medium and long-terms. According to the rules and regulations of the Central Bank of Sri Lanka (CBSL), a certain percentage of the mobilised deposits should be reserved to maintain the reserve requirement imposed by the CBSL and a considerable amount of liquid assets should be maintained to meet the demand for money by the customers. After fulfilling the statutory requirements, the balance is available for banks to lend or invest as they wish.

The people who fall into one of the following categories may apply for advances/loans.

Individuals, sole proprietorship, partnership, limited liability companies (private and public), unincorporated societies and clubs, government institutions, trustees and executors and administrators. Once the Lending Proposition (LP) for a loan/advance is received by the bank from a prospective borrower, the assessment of the applicant/borrower is begun to determine the credit worthiness of the applicant/borrower. The objective of this evaluation process is to ascertain whether the LP is; acceptable in its original form, acceptable with some amendments or not acceptable.

The LP should come from the prospective borrower himself and the decision to lend or not is taken by the bank. The requests for loans/advances received by banks will be finally categorised under one of the above criteria after evaluating the LP. Therefore some of the LPs are accepted in its original form while some are accepted with some amendments to its original form.

A considerable percentage of LPs are declined due to various reasons. The LP should conform to the principles of good lending as well as the bank's lending policy. This clearly shows that the banks are not willing to lend anyone who applies for a loan/advance.

We will now discuss the important factors examined by the commercial banks when they evaluate the LP received from a prospective borrower for a loan/advance, emphasising on personal lending.

Character

Banks are willing to lend money to people who have an excellent character. This feature is judged by banks in two ways. Banks consider credit applications favourably, received from their customers who have maintained their accounts with the bank at least for six months. Recommendations received from the existing customers will be given preference in the evaluation process.

Therefore, if the customer maintains a Current Account (CA) with the bank, it is considered as a plus point since a CA is necessarily be introduced by an existing customer of the bank and the monthly statement derived from the CA is useful as a mirror of the financial discipline of the customer.

If the applicant does not maintain an account with the bank, then the bank is interested in finding out why the applicant does not demand for the advance/loan from his/her present banker. Banks carry out a thorough study on the past records of the loans obtained from the bank by the customer, repayment pattern of such loans, reports of Credit Information Bureau (CRIB), cheque returns, stop payments of cheques, behaviour of the CA (highest, lowest and average balances) and the expenses over income i.e. debits over credits in the account. Banks also give weight age to those who have any other relationships with the bank like investments with the bank and holding other products of the bank such as Fixed Deposits (FDs), Certificate of Deposits (CDs) and Saving Accounts.

Conducting a personal interview

This technique is adopted by the banks to determine the integrity and trustworthiness of the prospective applicant/borrower. Banks assess the financial standing and genuineness of the financial need by meeting the borrower personally. It is important to examine whether the borrower is clear on his plans, objectives and the return on the investment made by him.

Through a personal interview, banks recognise the special skills, leadership qualities, relevant experience, know-how and the knowledge on financial matters of the borrower.

Credit Officers of the Bank study the LP, gather the market, technical and industrial information and identify the strengths and weaknesses of the LP before they meet the applicant/borrower.

They take this opportunity to discuss with the borrower about the weaknesses of the LP, propose alternatives, make amendments if required and suggest improvements. This opportunity is also used to build a strong and friendly relationship with the prospective borrower.

Ability

Banks are willing to lend money to people who have special ability to do things. This means the ability of the prospective borrower to manage the financial affairs properly and efficiently.

Banks take into account the relevant experience and skills, academic and professional qualifications along with the knowledge on the relevant field and also the knowledge on principles of marketing and basics of finance. The overall assessment about the ability of the borrower will help the Credit Officer to ascertain the borrower's capacity to meet the financial commitments proposed in the LP. If the application is for a loan for a consumption purpose the bank is mainly interested in assessing his\her ability to generate the cash flow (liquidity) to repay the loan.

Margin

Banks are willing to lend money to people who are capable to repay a certain percentage of interest as the return for the money disbursed by the bank. This quantum should be adequate to cover the administration cost of the bank and keep a margin as profit to the bank. Banks make profits from their lending activities in three different ways such as interest margin, fees and commission. Borrowers have to pay an interest as the cost of money they borrowed from the bank along with the capital.

Purpose

Banks are willing to lend money to people who have a clear idea of what they are going to do with the money they borrow. Banks do not lend for illegal purposes. It is a banking practice to inquire from the borrower the actual reason for the advance/loan to be taken from the bank. The propose is an important aspect of lending since it will decide:

Whether to lend or not;The amount of the loan; The period of repayment and the grace period (if any); The type of security to be taken.

Though the purpose is legal some banks do not lend for some purposes as a policy of that particular bank and due to technical and practical limitations. Refraining from granting advances to new ventures by new commercial banks is a good example for this point.

Amount

Banks are willing to lend money to people who clearly stipulate their financial need in the LP. This is one of the crucial factors and the exact amount of the loan should clearly be indicated.The amount of the loan is very closely related with the purpose of the loan. It must not be a qualitative statement or a quantitative range. Banks consider several important points in relation to the amount of the loan.

* Whether the borrower's contribution/stake is sufficient with the amount to be lent; * Whether the borrower has asked for more than the real requirement; * Whether the borrower has asked for less than the real requirement; * Whether the borrower wants his/her bank to suggest the amount.

Generally banks do not decide or suggest the amount of the loan. Further, they do not lend more than the quantum necessary to fulfil the purpose of the loan to avoid the possibility of using the excess money for other purposes. Banks also do not lend less than the real requirement since the borrower will go for other sources of funds to fill the gap. This may deteriorate the repayment capacity of the borrower.

Repayment

Banks are willing to lend money to people who have a strong repayment capacity (net worth). This factor is very important and ranked after the character of the borrower. Even though the borrower has adequate quantity of assets to be lodged as a security for the advance, banks do not lend him if he does not have the capacity of repayment of the loan along with the interest. Therefore banks request the prospectus borrower to produce the all possible document evidences which will enable him to prove his repayment capacity. Banks in general perform a proper analysis of the cash flow of the borrow to determine the repayment capacity.

Security/collateral

Banks are willing to lend money to people who can provide the bank with some sort of asset as security or a guarantee as a collateral for the loan applied to cover the event of an unfortunate inability to repay. Banks consider the security as an insurance against the non-payment and realise same as the last resort in case of default to recover the outstanding along with the interest accrued.

In brief, banks are willing to lend money to people who: * Have a good character, high degree of integrity and trustworthiness; * have ability to meet the financial commitments; * Are willing to provide a margin to the bank; * Have come with an acceptable purpose; * Have a clear idea about the financial requirement; * Have documented evidences for the repayment capacity; * Are willing to provide some sort of security/collateral. The judgement will be taken in the following manner.

* Identify the issues in the proposition; * Consider the risks involved; * Decide the measures necessary to make the risks acceptable; * Weigh the available evidence; * Make the judgement.

It is accepted that any Credit officer should grant credit facilities prudently and judiciously weighing the risk involved in and the benefits derived from that particular credit transaction. On one hand lending is a science, on the other hand it is a matter of common sense. Credit officers are ruled by their heads and not by their hearts. Therefore the lending Proposition (LP) should be prepared comprehensively, providing all possible facts and figures by the prospective borrower and presented it to the bank as early as possible after deciding to borrow, to enable the credit officer to evaluate the same properly and favourably.

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