The Principles of Lending

and Lending Basics

BFS 3001 S. Parkes
LENDING

UNIT 1

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 Objectives: In this Unit, the
students will do the following:
• Identify the basic principles governing lending and
explain their importance.
• Understand the frame work 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 the
special considerations that apply to them when giving
loans.
• Explain how advances are structured.
• Explain the importance of credit culture in a lending
institution.
• Understand how an advances portfolio is designed.
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 LENDING?

• Lending constitutes on of the most important

functions of any Financial Institution. In a
typical bank nearly 70% of assets are
invested in only one type of asset: Loans and
advances.
• If the lending function is not managed
properly, it could lead to credit quality
problems and eventually threaten the
existence of the financial institution.

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 The principles of good
lending
1. Safety of loan – Loan granted only to that
borrower who is considered safe.
- A safe borrower is one who is of good
character, is financially sound and has
the ability and willingness to repay the
loan.
2. Suitability of loan purpose – A loan can
be given for any valid purpose. A valid
purpose is one that is legal and conforms
to the lending policy of the bank.
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 The principles of good
lending

3. Profitability – Financial institutions are in

the business of lending to earn profits.
Lenders will compare the cost and benefit
of a loan before granting it. Interest on
loans and advances are a major source
of income for any bank. Lending
institutions must weigh the risks and
returns from a possible loan.

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 Following the lending
principles – Credit Analysis

Credit analysis can be done by

traditional methods and/or modern
methods.
 Modern methods – Use technology and
thus facilitate faster processing of
proposals.
 Still rests on the foundation provided by
traditional analysis.

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 Credit Analysis

 Modern approaches-
 Econometric Technique – involve the
modeling of probability of default.
 Optimisation models – Use mathematical
programming techniques to minimise
lender error and maximise profits.

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 Credit Analysis

• Traditional methods of credit analysis

• Five Cs
- Character - Most important and at the same
time, the most difficult criterion to assess. It is
the sum total of human qualities of honesty,
integrity, morality etc.
- Capacity – The ability to repay the loan together
with interest. (The financial capacity to repay
loan). It depends on two factors:
- The borrower’s financial position should be sound;
- The borrower must be able to generate sufficient net
income to service the loan repayment.

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 Five Cs cont.

- Capital – refers to the capital contribution that the

borrower proposes to make in the total
investment.
- Collateral – Also known as the secondary source
of repayment. When a loan cannot be repaid out
of the primary source, lenders usually take
possession of the collateral.
- Conditions – covers the conditions and terms of
the loan which includes external and internal
factors – such as condition of economy, relevant
industry and lending policies of the bank.

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 Credit Analysis

CAMPARI :
– Character - It is the sum total of human qualities
of honesty, integrity, morality etc.
– Ability – The borrower’s ability in managing
financial affairs.
– Margin – The interest margin is a reflection of the
risk involved in the lending.
– Purpose – The lender will want to verify that the
purpose is acceptable. (legal and in the
customer’s best interest.

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 CAMPARI :
– Amount – Is the customer asking for too much or
too little? There are dangers in both and it is
important to establish that the amount requested
is correct and that all incidental expenses have
been considered.
– Repayment – The real risk in lending is to be
found in the assessment of the repayment
proposals. It is important that the source of
repayment is made clear from the outset and the
lender must establish the degree of certainty that
the promised funds will be received.

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 CAMPARI :

– Insurance/Security - Ideally, the cannons

of lending should be satisfied irrespective
of available security, but security is often
considered necessary in case the
repayment proposals fail to materialize.

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Other traditional methods
of credit analysis

• Rating Systems – Moody’s, Standard &

Poor’s Fitch among others. – The rate
bonds that are floated in the capital
market.
• Credit Scoring Systems – found in all
types of credit analysis. These systems
identify and weigh (on a quantitative
scale) certain key factors that determine
the probability of repayment default.

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 Framework for credit and
lending decisions

• Credit and lending decisions are made

in the light of certain factors that have
an impact on such decisions.
• Credit analysis is not just financial
statement analysis – it is a much
broader concept.

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External factors affecting
lending decisions

• General law of the land

• Macroeconomic factors
• Industry specific factors
• The Banking Act
• Bank of Jamaica
• FSC

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 Lending Institution –
specific factors

• The lending policy of the Institution.

• The loan budget
• Staff availability

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 The lending process

• Step 1: obtain the prescribed loan application

form. – At this stage the lending officer
checks compliance with external and internal
requirements.
• Step 2: obtain required documents/financial
statements.
• Step 3: check the loan application form and
the documents/financial statements for any
inconsistencies.
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 The lending process

• Step 4: if all the information has been

received and is in order, then the decision on
whether to grant a personal loan would be
made at this stage. In case of a business
loans, the lender needs to take a few more
steps. An important step is to visit the
business site of the borrower to gain first
hand knowledge of the borrower’s business.
• Step 5: Appraise detailed technical,
commercial, financial and managerial aspects
of the proposed business borrower.

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 The lending process

• Step 6: assess the financial requirements of

the borrower – The exact financial needs of
the borrower and the type of finance required.
• Step 7: If the proposal is approved send a
letter conveying the approval to the borrower.
If rejected, inform the borrower, giving
suitable reasons.
• Step 8: If approved, ensure that security and
other documents are duly signed before
disbursing the loan.
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 The lending process

• Step 9: Monitor the account periodically, to

ensure loan conditions are being met.
• Step 10: Where the operations of the loan
account are not satisfactory – be very
cautious and take steps before the account
turns into a problem loan.

By following the ten step approach, a lending

officer can be certain that nothing has been
missed in the process of lending.

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 Credit Culture

• Culture means a stratum of linked attitudes,

responses, and behavioural patterns within
an organization.
• Credit culture means the institutional
priorities, traditions and philosophies that
surround credit or lending decisions.
• A cultural attitude towards credit risk
assessment is critical in any credit-granting
organisation.
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