BANKS LENDING:
POLICIES &
PROCEDURE
Reference: Peter S. ROSE
1
Why Credit Management:
Making loans is the principal economic
function of banks. For most banks, loans
account for half or more of their total assets
and about half to two-thirds of their revenues.
Risk in banking tends to be concentrated in the
loan portfolio. Uncollectable loans can cause
serious financial problems for banks.
2
Loan Vs Advance
• Many people think that loan and advance is almost same .
Both means when a person borrows the money from other ,
it is called loan or advance . Both Loan and Advance are to
be repaid in installments for example: monthly installments
of equal amounts. But , In true sense, it has many
differences.
• loan is against a security but advance is not against any
security but based on relationship, for example vehicle loan
given to employees is against the security of the vehicle and
if advance is given for travel then it is not against any
security
• There is a sense of debt in loan, whereas an advance is a
facility being availed of by the borrower.
3
• Banks grant advances largely for short-term purposes, such as
purchase of goods traded in and meeting other short-term trading
liabilities. But loan could be for any period.
• Interest terms and structure is different.
• Example: Advance: Consumer loan(Car, Refrigerator), Personal loan,
Staff loan, Loan against FDR.
a. Advances to allied concerns of Directors
b. Advances to Chief Executive
c. Advances to Other Senior Executives
d. Advances to Customer's Group:
Agriculture loan
Commercial lending
Export financing
Consumer credit scheme
Special Program Loan (SME)
Staff loan
Source: Annual repot-2009, Dhaka Bank Ltd. Page: 98
4
Types of Loans Made By Banks:
Bank loans can be grouped according to their
purpose.
1. Real Estate Loans: secured by real property (land
,building, and other properties).can be both short term (land
development & construction) long term ( for purchase of
farmland, homes, apartments, commercial structures)
2. Financial Institution Loans: credit to banks, insurance
company, finance company and other FI
3. Agricultural Loans: planting and harvesting crops and
to support feeding and care of livestock
5
• 4. Commercial and Industrial Loans:
Purchasing inventories, paying tax, meeting
payrolls, factory infrastructure
• 5. Loans to Individuals: consumer loan, auto
mobile, home loan, medical expense, other
personal expenses
• 6. Miscellaneous Loans: Securities loan,
other loan which is not categories here including
• 7. Lease Financing Receivables: buy
equipment/ vehicle and lease them
6
Table 16.1 Loans Outstanding for US
Banks
1996
Loans by Purpose
All Banks
< 100 Mill. > 1 Bill.
$
%
%
%
Real Estate Loans
Loans to Fin. Inst.
Agriculture Loans
Commercial loans
Loans to Individuals
Misc. Loans
Lease Finance Rec.
1,140.0
114.2
41.3
709.9
560.9
171.7
78.4
40.5
4.1
1.5
25.2
19.9
6.1
2.8
55.8
0.1
10.9
16.3
15.4
1.0
0.4
35.6
5.0
0.6
27.4
20.7
7.4
3.4
Total
2,816.3
100.0
100.0
100.0
7
Factors Determining the Growth and
Mix of Bank Loans:
• Characteristics of Market Area Served: sub
urban surrounded by household , central city surrounded
by office
• Size of the Bank: large-Wholesales credit,
small-retail credit
• Experience and Expertise of Management
• Expected Yield of Each Type of Loan: credit
card loan, installment loan(household and SME
loan),real estate loan.
• Regulations: from govt. and central bank
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Regulation of Lending
• The loan portfolio of any bank is influenced by regulation.
For example, in the USA, real estate loans cannot exceed
the banks capital, or 70% of its total time and savings
deposits. Also, a loan to a single customer cannot exceed
15 % of banks capital.
– Asset Quality
– Maintain ace of Provision
– Eligible Securities
– Determination of Security Value
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i) Asset Quality
•Criticized Loans:
Loans that are performing well but
have minor weaknesses because the bank has not followed its
own loan policy or has failed to get full documentation from
the borrower are called criticized loans
–Unclassified
–Special Mention account
•Scheduled Loans:
Loans that appear to Contain
significant weaknesses or that represent what the examiner
regards as the dangerous concentration of credit in one
borrower or in one industry are called scheduled loans. A
scheduled loan is a warning to a bank’s management to
monitor that credit carefully and to work toward reducing the
bank’s concentrated risk exposure from it
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Scheduled/Classification of Loan
When an examiner finds some loans that carry an
immediate risk of not paying out as planned, these
credits are adversely classified.
– Sub-standard:
– Doubtful
– Bad debt/ loan losses
Sub-standard:
where the bank’s margin of protection is
inadequate due to weaknesses in collateral or in
the borrower’s repayment abilities; if it remains
past due/overdue for 6 months or beyond but less
than 9 months
Doubtful:
which carry a strong Probability of an uncollectible
loss to the bank; if it remains past due/overdue
for 9 months or beyond but less than 12 months
Bad debt/ loan losses
which are regarded as uncollectible and not suitable
to be called bankable assets. it remains past
due/overdue for 12months or beyond.
ii) Maintenance of Provision
• a) (i) Banks will be required to maintain General Provision in the following
way
:
(1) @ 1% against all unclassified loans (other than loans
under
Small Enterprise and Consumer Financing and
Special Mention Account.)
(2) @ 2% on the unclassified amount for Small
Enterprise Financing.
(3) @ 5% on the unclassified amount for Consumer
Financing whereas it has to be maintained @ 2% on the
unclassified amount
for (i) Housing Finance and (ii)
Loans for Professionals to set up business under Consumer
Financing Scheme.
(4) @ 5% on the outstanding amount of loans kept in
the 'Special Mention Account' after netting off the amount of
Interest Suspense.
(Source: BRPD Circular No. 16 , effective from January 01.1999.)
Maintenance of Provision
–b) (i) Banks will maintain provision at the following rates in
respect of classified (Continuous, Demand and Fixed Term)
Loans:
(1) Sub-standard 20%
(2) Doubtful 50%
(3) Bad/Loss 100%
(ii) Provision in respect of Short-term Agricultural and
Micro-Credits is to be maintained at the following rates:
(1) All credits except 'Bad/Loss'(i.e. 'Doubtful', 'Sub-standard',
irregular and regular credit accounts) : 5%
(2) 'Bad/Loss' : 100%
(Source: BRPD Circular No. 16 , effective from January 01.1999.)
Length of Overdue
Status of
Classification
Rate of
Frequency of
Provision Classification
Less than 3 month
Unclassified
1%
Loans overdue for 3 but less
than 6 months
Special Mention
Account (SMA)
5%
Loans overdue for 6 but less
than 9 months
Substandard
20%
Loans overdue for 9 to 12
Doubtful
50%
Loans overdue for 12 or more
Bad loan
100%
At
least
quarterly
usually
monthly
Eligible Securities
% to be
considered
Market value of gold or gold ornaments
pledged with the bank.
100
Duly discharged financial instruments like
FDR,PSP, Government bonds etc.
100
market value of easily marketable
commodities
market value of land and building
mortgaged
the shares traded in stock exchange.
50
50
50% of the
average market
value for last 06
months or 50% of
the face value,
whichever is less
CAMELS Rating System
•
•
•
•
•
•
Capital adequacy
Asset quality
Management quality
Earnings record
Liquidity position
Sensitivity to market risk
Banks whose overall CAMELS rating is toward the low,
riskier end of the numerical scale ( and overall rating of 4 or
5 ) are examined more frequently than the highest rated
banks, those with ratings of 1,2,or3.
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Steps in the Lending Process
• The customer fill out a loan application
• An interview with a loan officer usually follows right away
• If a business or mortgage loan is applied for, a site visit is
usually made by an officer of the bank to assess the property
• The customer is asked to submit several crucial documents,
such as financial statements
• The credit analysis division of the bank analyses the
application and prepares a brief summary and
recommendations.
• Recommendation goes to the loan committee for approval
• If the loan is approved, the loan officer check on the
property that is pledged as collateral in order to ensure that
the bank has immediate access to the collateral if the loan
agreement is defaulted. This is often referred to as
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perfecting the bank’s claim to collateral.
Credit Analysis:
The division of the bank responsible for analyzing and
making recommendations about loan applications is the
credit department.
Is the Borrower Creditworthy?
This usually involves a detailed study
of six aspects of the loan application:
character, capacity, cash, Collateral,
conditions, and control.
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The Six Basic C’s of Lending
1. Character—Specific Purpose For Loan and Serious
Intent to Repay Loan
2. Capacity—Customer Has Legal Authority to Sign
Binding Contract
3. Cash—Does the Borrower Have the Ability to
Generate Enough Cash to Repay the Loan
4. Collateral—Does the Borrower Have Adequate
Assets to Support the Loan
5. Conditions—Must Look At the Industry and
Changing Economic Conditions to Assess
Ability to Repay
6. Control—Does Loan Meet Written Loan Policy and
How Would Changing Laws and
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Regulations Affect Loan
Common Types of
Collateral/Security
•
•
•
•
•
•
Accounts Receivable
Factoring
Inventory
Real Property-mortgage
Personal Property
Personal Guarantees
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iii) Eligible Securities:
• In the definition of 'Eligible Securities' as
mentioned in the above paragraph the
following securities will be included as
eligible securities in determining base for
provision:
-100% of deposit under lien against the loan
-100% of the value of government
bond/savings certificate under lien.
-100% of the value of guarantee given by
Government or Bangladesh Bank
(Source: BRPD Circular No. 16 , effective from January 01.1999.)
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Eligible Securities contd.:
-100% of the market value of gold or gold
ornaments pledged with the bank.
-50% of the market value of easily marketable
commodities kept under control of the bank
-Maximum 50% of the market value of land and
building mortgaged with the bank
-50% of the average market value for last 06
months or 50% of the face value, whichever is
less, of the shares traded in stock exchange.
(Source: BRPD Circular No. 16 , effective from January 01.1999.)
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iv) Determination of Market Value of
Eligible Securities
• In determining market value of easily marketable commodities, land
and building, banks are advised to follow the instructions mentioned
below:
(a) Easily marketable goods will mean pledged, easily en-cashable
/saleable goods that remain under full control of the bank. However,
while the concerned bank branch official will conduct periodic
inspection to verify as to whether issues such as the suitability of
goods for use, expiry period, appropriateness of documentary
evidences, up to date insurance cover, same will have to be assessed by
the professional assessor from time to time.
(b) For land and building, banks will have to ensure whether title
documents are in order and concerned land and building will have to
be valued by the professional valuation firm along with completion of
proper documentation in favor of the bank. In absence of professional
valuation firm, certificate in favor of such valuation will have to be
collected from the specialized engineer. Nevertheless, temporary
houses including tin-shed structure shall not be shown as building.24
Determination of Market Value of Eligible
Securities contd…
c) In order to facilitate the on-site inspection by our Department of
Bank Inspection, banks are also advised to maintain complete
statement of eligible securities on a separate sheet in the concerned
loan file. Information such as description of eligible securities, their
assessment by recognized firm, marketability of the commodity,
control of the bank, and reasons for considering eligible securities etc.
will have to be included in that sheet. In terms of the above policies,
the banks will conduct their classification- activities on quarterly basis.
Detailed statements in respect of classification, provision and
'Interest suspense‘ accounts will have to be submitted to
Bangladesh Bank within 30 days from the reference date.
(Source: BRPD Circular No. 16 , effective from January 01.1999.)
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Loan Review (Loan Monitoring)
• After the loan is granted, the loan
department must periodically review
all loans until they reach maturity.
Loan review helps bank management
to spot problem loans quickly. This
increase the chance to recover the
loans and reduce the bank losses.
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Warning Signs of Problem Loans
• Unusual or Unexpected Delays in Receiving Financial
Statements
• Changes in Accounting Methods
• Restructuring Debt or Eliminating Dividend Payments
or Changes in Credit Rating
• Adverse Changes in Price of Stock
• Net Earnings Losses in One or More Years
• Adverse Changes in Capital Structure
• Deviations in Actual from Predicted
Sales Amounts
• Unexpected or Unexplained Changes in Deposit
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Balances
Topics for home work
(Consult with the Referred Book, especially
pages:528-531)
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• Under which of the six C’s of credit
discussed in this chapter does each of the
following pieces of information belong?
i.
First national bank discovers there is already a lien against
the fixed assets of one of its customers asking for a loan.
ii. Xron Corporation has asked for a type of loan the bank
normally refuse to make.
iii. John Selman has an excellent credit rating.
iv. Smithe Manufacturing Company has achieved higher
earnings each year for the past six years.
v. Commerce National Bank is concerned about extending a
loan for another year to Corrin Motors because a recession
is predicted in the economy stating within the next quarter
of the year.
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• Wes Velman needs an immediate cash loan and has gotten his
brother ,Chrles to volunteer to cosign the note should the loan
be approved.
• The bank checks out Mary Earl’s estimate of her monthly takehome pay with Mary’s employer, Brayan Sims Doors and
Windows.
• Hillsoro Bank and Trust Would like to make a loan to Pen-Tab
Oil and Gas company but fears a long term decline in oil and
gas prices.
• First State Bank of Jackson seeks the opinion of an expert on
the outlook for sales growth and production in Mexico before
granting a loan to a Mexican manufacturer of auto pars.
• The history of Members Manufacture and Distributing
Company indicates the firm has been through several recent
changes of ownership and there has been a substantial shift in
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its principal suppliers and customers in recent years.
Please identify which of the six basic C’s of lending –Character,
capacity, cash, collateral, conditions, and control- applies to each of
the loan factors listed here:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Insurance coverage
Competitive climate for
customers product
Credit rating
Corporate resolution
Liquid reserves
Asset Specialization
Driver’s license
Expected market share
Economist’s forecasts
Business Cycle
Performance of comparable
firms
Guarantees/ Warranties
Expense controls
Inventory Turnover
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Projected cash flow
Experience of other lenders
Social Security Card
Price-Earnings ratio
Industry outlook
Future financingg needs
Asset liquidation
Inflation outlook
Adequate documentation
Changes in accounting
standards
Written loan policy
Coverage ratios
Purpose of Loan
Banking laws and
regulations
•
•
•
•
•
•
•
•
•
•
•
•
Changes in technology
Obsolescence
Liens
Management Quality
Leverage
History of firm
Customer identity
Payment record
Partnership agreement
Accounts receivable
Turnover
Account Payable
Turnover
Wages in the labor
market
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