7
7.1
7.2
7.3
7.4
7.5
Bank Loans
Consumer Loan Theory
Consumer Loans
Granting and Analyzing Credit
Cost of Credit
Bank Loans and Policy
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
7.1
Consumer Loan Theory
Learning Objectives
7.1.1 Explain asset transformation and
modern portfolio theory.
7.1.2 Describe components of consumer
lending.
7.1.3 Explain nonloan sources of bank
revenue.
Slide 2
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Key Terms
asset transformation
modern portfolio theory (MPT)
adverse selection
captive borrower
moral hazard
credit rationing
Slide 3
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Managing a Bank’s Portfolio
Loan Balances in the United States
Asset Management
Asset transformation is the use of deposits to
generate revenue by putting them to work via
loans.
Modern portfolio theory (MPT) states that
within any portfolio of investments, diversification
should be used to spread out risk.
Slide 4
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Loan Portfolio Composition
Slide 5
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
 checkpoint
What is asset transformation?
The process of using deposits to generate
revenue by putting deposits to work in the
marketplace in the form of loans
Slide 6
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Consumer Lending Theory
Loan Selection
Adverse selection is the concept that the
borrowers who are most willing to accept a high
interest rate are the same borrowers who are
most likely to default on their loans.
Captive borrower is a consumer with a weak
credit history and limited options for securing a
loan.
Slide 7
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Consumer Lending Theory
(continued)
Loan Selection (continued)
Moral hazard occurs when borrowers take
greater risks if they think the harm they will incur
from those risks will somehow be minimalized.
Credit rationing occurs when banks refuse to
provide a loan, or when they lend less than the
customer requested.
Downstream Loan Profit
Slide 8
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
 checkpoint
What is adverse selection?
The concept that the borrowers who are most
willing to accept a high interest rate are the same
borrowers who are most likely to default on their
loans
Slide 9
The U.S. Banking System, 3e
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Additional Sources of Bank
Revenue
Off-Balance Sheet Activities
Other Revenue Sources
Slide 10
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
 checkpoint
What are three methods of providing overdraft
protection?
A checking account can be linked to either a
savings account, a credit card, or a home equity
line of credit (flex line).
Slide 11
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
7.2
Consumer Loans
Learning Objectives
7.2.1 Define major terms associated with
consumer lending.
7.2.2 Explain the difference between
installment loans and open-end loans.
Slide 12
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Key Terms
installment loan
secured loan
collateral
lien
unsecured loan
open-end loan
grace period
Slide 13
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Installment Loans
Installment loan is a loan for which the amount
of the payments, the rate of interest, and the
number of payments (or length of term) are fixed
and repaid on a periodic basis.
Personal Loans
Vehicle Loans
Home Equity Loans
Education Loans
Slide 14
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Installment Loans (continued)
Secured and Unsecured Loans
Secured loan is a loan in which some item of
value backs the loan in case the borrower
defaults on it.
Collateral is an item that secures a loan.
Lien is the legal claim to the property to secure a
debt.
Unsecured loan is a loan backed only by the
reputation and creditworthiness of the borrower.
Slide 15
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Installment Loans (continued)
Lending Terminology
Principal
Interest
Fees
Finance charge
Total payments
Payment
Slide 16
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
 checkpoint
What is the difference between a secured loan
and an unsecured loan?
A secured loan uses some item of value as
collateral for the loan, while an unsecured loan is
based solely upon the borrower’s
creditworthiness.
Slide 17
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Open-End Loans
Open-end loan is a loan that is flexible, as is the
term; the longer the loan is used, the more will
be paid.
Credit Cards
Grace period is the amount of time a consumer
has to pay a credit card bill in full and avoid any
finance charges.
Lines of Credit
Slide 18
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
 checkpoint
What is an open-end loan?
An open-end loan is a loan with no fixed principal
and no fixed term.
Slide 19
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
7.3
Granting and Analyzing
Credit
Learning Objectives
7.3.1 List steps in the credit-approval
process.
7.3.2 Identify major criteria in a person’s
credit rating.
Slide 20
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Key Terms
underwriting
subprime rates
consumer reporting agency (CRA)
FICO score
Slide 21
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Granting Credit
Risk Management
Credit-Approval Process
Underwriting is the process of reviewing a loan
for soundness.
Subprime rates are rates that are higher than
normal to offset the increased risk represented
by a less-than-perfect borrower.
Slide 22
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
 checkpoint
What is underwriting?
Underwriting is the process of evaluating loan
applications for soundness and making a
recommendation for approving or denying the
loan.
Slide 23
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Analyzing Credit
Consumer reporting agency (CRA) is a
company that compiles and keeps records on
consumer payment habits and sells these
reports to banks and other companies to use for
evaluating creditworthiness.
Credit-Scoring Systems
Slide 24
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Analyzing Credit (continued)
FICO score is a three-digit number that credit
granters can use in making a loan approval
decision.
Slide 25
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
 checkpoint
What is a consumer reporting agency?
A consumer reporting agency, or credit bureau, is
a company that compiles and sells data on
consumer debt and payment records.
Slide 26
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
7.4
Cost of Credit
Learning Objectives
7.4.1 Identify key factors in the cost of credit.
7.4.2 Explain the impact of negative credit
ratings on consumers.
Slide 27
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Key Terms
revolving credit
sum-of-digits method
previous-balance method
adjusted-balance method
average-daily-balance method
predatory lending
Slide 28
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
What Credit Costs
Revolving credit is a line of credit with a
maximum limit that can be used on an ongoing
basis until the limit is reached.
Reviewing APR and Finance Charge
Sum-of-digits method is the method of
calculating finance charges that takes the total
finance charge, divides it by the number of
months in the loan term, and assigns a higher
ratio of interest to the early payments.
Slide 29
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
What Credit Costs (continued)
Reviewing APR and Finance Charge (continued)
Previous-balance method calculates interest on
the amount owed at the beginning of the billing
cycle, regardless of payments or charges.
Adjusted-balance method subtracts payments
made during the billing cycle but usually doesn’t
count purchases.
Slide 30
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
What Credit Costs (continued)
Reviewing APR and Finance Charge (continued)
Average-daily-balance method adds balances
for each day of the billing cycle and then divides
by number of days in the billing cycle to yield an
average figure on which the finance charge is
calculated.
Minimum Payments
Term
Slide 31
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
 checkpoint
Why is it a good idea for consumers to pay more
than their minimum balances on open-ended
credit accounts?
Payment of minimum balance does little toward
reducing the principal balance, maximizing the
cost of credit.
Slide 32
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
The Impact of Credit
Overextension
Responsible Lending
Predatory lending occurs when lenders create
problems for consumers by making credit too
easily available without regard to the borrower’s
ability to pay.
Credit Counseling
Slide 33
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
 checkpoint
Why do some consumers become
overextended?
Consumers may become overextended because
they do not fully understand the costs of credit.
Other answers may vary.
Slide 34
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
7.5
Bank Loans and Policy
Learning Objectives
7.5.1 Explain how loans affect a bank’s
income.
7.5.2 Describe the purpose of a bank’s loan
policy committee.
Slide 35
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Key Terms
liquidity risk
credit risk
market risk
Slide 36
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Loans, the “Bottom Line,” and
Liquidity
Loans and Income
Loans and Liquidity
Liquidity risk refers to a risk that a bank will
have to sell its assets at a loss to meet its cash
demands.
Credit and Market Risk
Credit risk is a bank’s estimate of the probability
that the borrower can and will repay a loan with
interest as scheduled.
Slide 37
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Loans, the “Bottom Line,” and
Liquidity (continued)
Credit and Market Risk (continued)
Market risk is a risk that an investment will
decrease in price as market conditions change.
Loan Decisions and Trade-Offs
Slide 38
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
 checkpoint
How do credit risk and market risk differ?
Credit risk refers to the possibility that a borrower
will not repay a loan.
Market risk refers to whether an asset will sell for
full value.
Slide 39
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
Loan Policy Committee
All banks must have a lending policy, which is a
written statement of the guidelines and
standards to follow in making credit decisions.
A bank’s board of directors sets its lending
policy.
The lending policies must be fairly administered
and standardized for all applicants in a category
Bank policy must meet the provisions of the
Community Reinvestment Act (CRA).
Slide 40
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.
 checkpoint
What is the function of a loan policy committee?
It sets the policies the bank will use in
determining whether to accept or reject loan
applications.
Slide 41
The U.S. Banking System, 3e
© 2017 Cengage Learning®. All rights reserved.