Lending, an effective consumer proposition
Sudam Chandima Kaluarachchi Director - College of
Banking and Finance Institute of Bankers of Sri Lanka
Lending is one of the major and traditional activities of a bank. It
is responsible for a large portion of the asset side of a bank’s balance
sheet.
The core business of a bank is to mobilize deposits from public who
have surplus funds 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 (assets) with the maturity pattern of the
deposits (liabilities) mobilized.
Banks mobilize deposits for short, medium and long-terms. It can vary
from overnight to several years. According to the rules and regulations
of the Central Bank of Sri Lanka (CBSL), a certain percentage of the
mobilized deposits should be set aside to maintain the reserve
requirement imposed by the CBSL and a considerable amount of liquid
assets to meet the demand for money (withdrawals) by the customers.
After meeting the statutory requirements, the balance is available
for banks to lend or invest as they wish.
Banks can lend the mobilized or borrowed money to consumers for
personal requirements or corporate for business requirements. The people
who fall into one of the following categories may apply for advances and
loans.
Individuals, sole proprietorship, partnership, limited liability
companies (private and public), unincorporated societies and clubs,
government institutions, trustees and executors and administrators.
The aim of this article is to discuss the matters related to personal
and consumer lending by giving special reference to banks.
Once the Lending Proposition (LP) for a loan or advance is received
by the bank from a prospective borrower, the assessment of the applicant
or borrower is started to determine the credit worthiness or suitability
of the applicant or borrower for the applied loan or advance.
The objective of this evaluation process is to decide whether the LP
is acceptable in its original form, acceptable with some amendments or
is not acceptable.
The LP should come from the prospective borrower himself and the
decision to lend or not is taken by the competent bank officers. The
requests for loans and advances received by banks will be finally
categorized 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 policies and procedures. Further, it should be in line
with the bank’s credit culture.
This clearly proves that the banks would not be willing to lend to
everybody who applies for a loan and advance.
There are important factors/aspects examined by the banks when they
evaluate the LP received from a prospective borrower for a loan/advance
for a consumer loan.
Those factors can be described using the mnemonic “CAMPARI”. C -
Character, A - Ability, M - Margin (Profit), P - Purpose, A - Amount, R
- Repayment Capacity and I - Insurance/ Collateral/ Security.
Character
Banks would be willing to lend money to people who have an excellent
character. This cause is established by banks in two ways. Primarily,
banks can use their own records if the applicant is an existing customer
of the bank.
Most probably, banks may more comfortably consider the loan
applications received from their own customers who have already
maintained their accounts at least for six months.
Moreover, recommendations received from the existing customers will
add value to the evaluation process.
Therefore, if the customer maintains a Current Account (CA) with the
bank, it will definitely support the evaluation process since a CA
should necessarily be introduced by an existing customer of the bank and
the monthly statement generated from the CA is useful to be used as a
mirror image of the financial discipline of the customer.
Secondly, if the applicant does not maintain an account with the
bank, then the bank would be interested in finding out why the applicant
does not apply for the advance or loan from his/her present banker.
Banks may carry out a thorough study on the past records of the loans
obtained from the bank by the applicant, 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 would also give weightage to those who hold 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 or borrower. It will also
help the bank officer to meet the client and estimate his or her
competencies and skills. Banks would assess the financial standing and
genuineness of the financial need of the borrower by meeting him
personally.
It is important to examine whether the borrower is clear on his
plans, objectives, strategies and the return on the investment made by
him or the benefits of his expenditure.
Through a personal interview, banks would recognize 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 contents of the LP, gather the
market, technical and industrial information and identify the strengths
and weaknesses of the LP before they meet the applicant or borrower.
This will help them to conduct a structured interview to gather the
maximum information required for a proper analysis and clarify any
doubts about the information provided and the nature of the transaction.
Credit Officers would take this opportunity to discuss with the
borrower about the strengths and weaknesses of the LP, propose
alternatives, make amendments if required and suggest improvements.
This opportunity would also be used to build a strong and friendly
relationship with the prospective borrower. This may explore the
opportunities for cross selling of other products immediately or in the
future.
Ability
Banks would be willing to lend money to people who have special
ability to perform duties and tasks. This means the ability of the
prospective borrower to manage the financial affairs properly and
efficiently.
Banks would take into account the relevant experience and skills,
academic and professional qualifications along with the expertise on the
relevant field and also the knowledge on principles of marketing and
basics of finance.
The applicant’s knowledge, understanding and capacity to apply the
acquired knowledge to situations are important.
The overall assessment about the ability of the borrower will help
the Credit Officer to establish 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 would be willing to lend money to people who are capable and
willing to pay a certain percentage of interest as the return for the
money disbursed/ lent by the bank while repaying the capital borrowed.
Basically, 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.
This quantum should be adequate to cover the administration cost of
the transaction and keep a considerable margin as the profit to the
bank.
More commonly, banks may charge a lump sum as the processing fee at
the time of disbursing the loan.
The interest rate varies from bank to bank, product to product and
based on the estimated risk involved in the transaction.
Purpose
Banks would be 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 or loan to be taken from the bank.
The purpose of the loan is an important aspect of lending since it
will decide:
* Whether to lend or not
* Amount of the loan
* Period of repayment and grace period (if any)
* Applicable interest rate
* Type of security or collateral to be taken.
Though the purpose is legal some banks may not lend for some purposes
as a policy of that particular bank or may be due to technical,
practical or operational limitations. Refraining from granting advances
to new ventures by new commercial banks is a good example for this
point.
Amount
Banks would be willing to lend money to people who clearly stipulate
their financial need (quantum) in the LP. This is one of the crucial
factors and the exact amount of the loan should clearly be indicated in
the loan application.
The amount of the loan is very closely related with the purpose of
the loan. There should be supporting documents to prove that the loan
amount is in line with the purpose.
The amount must not be a qualitative statement or a quantitative
range.
Banks may consider several important factors in relation to the
amount of the loan.
* Whether the borrower’s contribution or 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 or her bank to suggest the amount
Generally banks may not decide or suggest the amount of the loan.
Further, they do not lend more than the quantum necessary for 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 would be 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 since willful defaulters may not repay their financial
commitments even though they have the sufficient repayment capacity.
Despite the fact that the borrower has adequate quantity of assets to
be lodged as security for the advance, banks do not lend him if he does
not have the capacity of repayment of the loan together with the
interest. Therefore banks request the prospective 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 borrower to determine the repayment capacity.
These statements will include but not limited to salary slips, tax
certificates, income statements from businesses, bank statements etc.
Security or collateral
Banks would be willing to lend money to people who are capable of
providing the bank with some sort of asset as security or a guarantee as
collateral against the loan applied to cover the consequences of an
event of unfortunate inability to repay. Banks may consider the security
as an insurance against the non-payment and may realize same as the last
resort in case of a default of the loan to recover the outstanding
capital lent along with the interest accrued base on the best practices
of recovery, the policies and procedures of the bank and applicable law.
In brief, banks would be 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 or collateral
The judgment will be made by the bank officers in the following
manner.
* Identify the issues in the proposition
* Consider the risks involved
* Decide the measures necessary to make the risks acceptable and
mitigate the risks
* Evaluate the available evidences
* Sanction or decline of the loan
It is expected that any Credit Officer should grant credit facilities
prudently and judiciously, weighing between the risks involved in and
the benefits derived from that particular credit transaction. On one
hand lending is a science and on the other hand it is a matter of common
sense. Necessarily, credit officers are ruled by their heads and not by
their hearts.
Therefore, the lending Proposition (LP) should be prepared
comprehensively, providing all important facts and figures by the
prospective borrower and presented to the bank as early as possible
after deciding to borrow, to enable the credit officer to evaluate the
same professionally and favourably.
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