Factors involved in consideration of credit
proposals
Factors involved in consideration of
credit proposals
• Proper assessment of a credit proposal, taking into account all the
relevant and important factors forms the basis of a banker’s sound
financing decisions.
• The following factors must be taken into consideration.
–
–
–
–
–
–
–
–
–
–
Diversification
Safety/security
Liquidity
Profitability
Desirability
Customer’s character
Customer’s management capability
Customer’s capital
Project viability
Credit risk and return
Diversification
• The principle of diversification is the key
method for managing credit risks.
• Banks apply this concept by setting exposure
limits on several criteria such as industry
exposure limits, counter party limits and per
party limits.
diversification
• According to prudential regulation R1
– The total outstanding exposure (fund based and
non-fund based) by a bank/DFI to any single
person shall not at any point in time exceed 30%
of the bank’s/DFI’s equity as disclosed in the latest
audited financial statements, subject to the
condition that the maximum outstanding against
fund based exposure does not exceed 20% of the
bank’s/DFI’s equity.
Diversification
• The total outstanding exposure (fund based and nonfund based) by a bank/DFI to any group shall not
exceed 50% of the bank’s/DFI’s equity as disclosed in
the latest audited financial statements, subject to the
condition that the maximum outstanding against
fund based exposure does not exceed 35% of the
bank’s/DFI’s equity.
Safety / Security
• Safety of bank’s exposure is one of the most vital
aspects of affording any credit facility.
• The bank should be certain that the credit
facilities allowed are well secured and can be
recovered through realization of such securities.
• Security held should be considered a second way
out, as bank’s financing should normally be
liquidated from customer’s business cash flows.
Safety / security
• From a banker’s point of view prime / collateral securities should
posses the following attributes before such securities could be
termed as acceptable.
–
–
–
–
Readily realizable and of steady increasing value.
Marketability/ storability of the goods offered as security.
Durability of the assets charged to the bank.
Transportability / transferability (where applicable) of the nature of
assets charged.
– Bank has unhindered access to security.
– Special care is required in case security is previously encumbered.
– All security documentation should be perfect in all respects.
• However security collateral offered should not be taken as sole
justification for sanctioning of facilities and other factors such as
viability of the project, etc should be given due consideration.
Liquidity
• It would require the banker to ensure that the customer remains in
a position to repay on demand, or at least within a reasonable time
after the demand for payment is made.
• The banker should also ensure that funds invested are not locked
up for any unduly long or indefinite period.
• The banker should ascertain whether the transactions of the
project being financed would generate necessary cash to repay the
finance and mark up, as per the agreed schedule.
• In case of large projects feasibility study and cash generation
statement should also be examined minutely.
• Bankers usually prefer granting of short term finances. The longer
the period of repayment, the greater the unforeseen risks in future,
due to factors such as change in the global / national economic
situation or changes in government policies.
Profitability
• The major source of a bank’s income is through financing of viable
projects generally on a short term basis and this important
profitability factor should be kept in constant view.
• However in the process of such profit making considerable risk is
often involved as among several unforeseen factors the borrowing
firm may at some point in time, not be able to operate successfully,
thus risking the bank’s finances.
• Hence the banker should avoid investment in such projects where
although the profit is high, a much greater risk is involved.
• to maintain a proper balance the bank should keep in its
investment portfolio, three types of investments i-e liquid semiliquid & income earning investments.
• In a nut shell the bank while employing funds in the most profitable
channels, should not ignore important aspects of safety and
liquidity.
Desirability
• While providing facilities to customers the banker
must ensure that the funds are utilized for
productive, bonafide business purpose and not
for speculative undesirable activities such as
hoarding, black marketing or for purposes other
then the customer’s normal sphere of business.
• It should be ensured that the purpose of
borrowing is clearly spelt out indicating useful
and productive application of funds for a specific
purpose, which should be in line with the
regulatory requirements.
Customer’s character
• The customer’s previous records must be
looked into to ascertain the degree of their
honesty and integrity.
• Information should be obtained as to whether
they have been known to keep their
commitments or have been defaulters in
respect of any facility allowed in the past by
any bank.
Customer’s management quality
• It is important to gauge the customers’ ability to
manage their business efficiently and in manner
that they conserve their resources and meet their
obligations on time.
• This ability can be judged from their qualities of
effective management and necessary experience
in their particular line of trade .
• The banker must have a clear picture of this
aspect, as facilities allowed without carefully
weighing these aspects may lead to partial or
total loss of funds lent by the bank.
Customer’s capital
• The customer should have sufficient funds as
his own stake in the business.
• Prudent bankers are reluctant to finance
borrowers who do not invest enough funds of
their own in the business.
• It should be ensured that the customer has
sufficient stake in the business to remain
committed even in the difficult circumstances.
Project viability
• An applicant having a viable project and
possessing other favorable attributes may be
financed.
• A customer may have a well balanced
proportions of character, capacity and capital, yet
the credit proposal may still be lacking in the
aspects of project viability, marketability of goods
produced, conduct of the account and operation/
utilization of previous limits granted, the
fulfillment of commitments etc. Thus all these
factors must be kept in mind.
Credit risk and return
• The reward that the bank receives for bearing the risks which are
inherent in its customer base and the products which it offers are
determined by a number of factors, the most powerful being the
risk/ reward criteria and market competition.
• The product offered by the banks in the same market generally
posses similar characteristics. It is therefore difficult to demand a
return which is substantially different from that prevailing in the
market place.
• The ultimate objective of the bank is to maximize the return, but
this must be done with in acceptable risk parameters.
• The principle risk parameters are the strength of the business, cash
flows, and the ease with which the security can be realized.
• However while deciding on the rate of return, both probability of
default and that of loss, must be carefully analyzed.
• Strict compliance with State Bank of Pakistan
regulations