Bank Lending: Policies & Procedures
Objectives of Lending Policies
n Resource planning to match lending outlay.
n Strategy to win over the nearest competitors.
n Augment good lending base with moderate risk involvement.
n Increased profitability.
n Ensure balanced loan portfolio.
n Quick disposal of loan cases.
n Development of efficient & capable loan personnel.
n Building up market reputation & goodwill by satisfactory services to the loan customers &
Steps Required in Framing a Lending Policy
n Demarcate market area, market share & define profit goals.
n Determine the types of loans that will best serve the bank in realizing set market area, market share & profit goals.
n Arrange due legal sanctions from the appropriate authorities, i.e. central bank or others.
n Arrange proper & effective communication of the lending policy decision to loan officers & others & others likely to be interested, i.e. existing & potential loan customers.
n Arrange regular periodic review, updating & improvement of the policy to suit the demand of time & situations.
Contents of a Bank Lending Policy
n Lending Budget
n Total amount for a particular period.
n Maximum amount for a single case
n Average amount of lending to be made per case.
n Composition
n Types of loan
n By areas
n By economic sectors & sub-sectors & industry mix
n Investment loan
n Productivity loan
n Periodicity
n Call loans
n Short-term working capital loan
n Intermediate-term investment loan
n Long-term investment loan.
Contents of a Bank Lending Policy—-Contd
n Documentation Standard
n Application
n Evidences of Security
n Loan agreement.
n Credit reports
n Acceptable Securities
n Criteria of acceptable security
n Listing of acceptable security
n Allowable margins to be made
n Qualifications of becoming guarantors
Contents of a Bank Lending Policy—-Contd
n Evaluating Credit Worthiness
n Acceptable records, data, & other useful information
n Personal interview
n Credit investigation
n Accepts to be covered – personal, financial, market, management etc.
n Pricing: Lending Cost + Profit
n Lending Cost = Cost of fund + Cost of lending operation + Liquidity of the advance + Risk.
n Rate of Interest or Profit
n Scale of Interest Rates/Profit.
n Lending Authority
n Sanctioning limits of various types of loans
n Branch Manager
n Regional Manager
n Deputy general Manager
n General Manager
n Managing Director
n Board of Director
n Authorization of the Central Bank where required.
n Compensating Balance
n Right of offsetting deposit balance for an outstanding loan
n Method of computation of compensating balance.
Contents of a Bank Lending Policy—-Contd
n Risk Average
n Types of risk involved
n Insurable risk
n Supervision & Control
n Who supervises? When & how?
n Loan installments’ release process.
n Reports & Actions
n Collection Procedure
n Repayment schedule
n Remainders & circular letters
n Personal visits
n Collection through cheques
Contents of a Bank Lending Policy—-Contd
n Loan Accounting & Record
n Recording procedure to be followed.
n Loan/project profiles to be maintained
n Statements to be provided
n Competition
n Possible competitors
n Their strengths & weakness.
n Methods of winning competition
n Avoiding unhealthy competition.
n Loan Grading System
n A= Top grade loan, B= Good loan, C= Marginal Loan, D= Doubtful loan, E= Likely to be bad loans.
Contents of a Bank Lending Policy—-Contd
n Procedures of handling problem loans
n Criteria if identifying problem loans.
n Methods to be used for identification
n Steps to be taken
n Setting up loan reserves.
n Development of Efficient Loan Personnel
n Loan-man ratio to be ideal.
n Training on the various aspects of loan processing.
n Credit evaluation, follow up, retirement, etc.
n In bank, on the job, on-hand, & foreign training are necessary.
n Policy Review & Improvement in new policy
n Methods of policy review.
n Periodicity of policy review
n Personnel responsible for policy review.
How to Measure the Credit Worthiness of Borrower?
n CAMPARI
• C = Character of the borrowers.
• A = Amount of loan sought (justification)
• M = Means of Financing
• P = Purpose for which the asked for loan to be utilized.
• A = Accountability of the borrowers to be ensured.
• R = Risk Extent
• I = Insurance to cover risk of default.
n PARSAR
• P = Purpose, A = Amount
• R = Reason, S = Sources of Payment
• A = Ability, R = Risk
How to Measure the Credit Worthiness of Borrower?—Contd
n Seven Cs
• C = Character
• C = Capacity
• C = Cash
• C = Collateral
• C = Conditions
• C = Capital
• C = Control
Regulation of Lending
n “Uniform Financial Institutions Rating System” has introduced the following rating system for the banks:
Regulation of Lending—–Contd
n All five dimensions of bank performance are combined into one overall numerical rating, known as “CAMELS” rating.
• C = Capital Adequacy
• A = Asset Quality
• M = Management Quality
• E = Earnings
• L = Liquidity
• S = Sensitivity to Market Risk
n Banks whose overall CAMELS rating is toward low, riskier end of the numerical scale – an overall rating of 4 or 5 – are examined more frequently than the highest-rated banks, those with ratings of 1,2 or 3
Loan Committee
n Two or three committees deal with major credit decisions: an officers’ loan committee, a directors’ loan committee, & for banks with an excessive number of troubled loans, a “special assets” committee. The duties of the committee’s are as follows:
– Reviews major new loans.
– Review major loan renewals * ascertain the reasons for renewal.
– Review delinquent loans & determine the cause of delinquency.
– Ensure compliance with stated bank policy.
– Ensure full documentation of loans.
– Ensure consistency in the treatment of loan customers.
Loan Approval Process
n The three fundamental elements of the loan approval process:
n Delegation of Authority
n Uniform Presentation Format & Standards
n Descriptions of the client
n Assessment of management
n Purpose of the loan request.
n Repayment schedule & source of repayment
n Secondary sources of repayment including collateral values & guarantors.
n History of past borrowing with the bank
n Required monitoring steps, including timing of submissions of financial statement.
n Sponsoring officer’s comments, including consistency with policy.
n The loan Decision.
n Pricing Policy
n Interest rates charged on loans may depend on considerations, such as the following:
– The bank’s cost of funds.
– The riskiness of the borrower.
– Compensating balances & fees.
– Interest rates charged by competitors.
– Other banking relationships with the borrower
Twenty Common Reasons for Loan Losses
n Collateral overvalued, improperly margined; failure to get appraisal.
n Dispersal of funds before documentation finished.
n Officer making “good ole boy” loans, bypassing the loan committee, personal friendship of loan officer with borrower.
n Loan to a new business with an inexperienced owner-manager.
n Renewing a loan for increasing amounts, with additional collateral taken.
n Repeatedly rewriting loan to cover delinquent interest due.
Twenty Common Reasons for Loan Losses–Contd
n Not analyzing borrower’s cash flows & repayment capacity.
n Failure of officer to review loan’s status frequently enough.
n Funds not applied as represented; diverted to borrower’s personal use.
n Funds used out of the bank’s market area: poor communications with the borrower.
n Repayment plan not clear or not stated on the face of the note.
n Failure to receive or infrequent receipts of borrower’s financial problems.
Twenty Common Reasons for Loan Losses–Contd
n Failure to realize on collateral because borrower raised nuisance legal defenses.
n Bank’s failure to follow its own written policies & procedures.
n Bank president too dominant in pushing through loan approval.
n Ignoring overdraft situations as a tip-off to borrower’s major financial problems.
n Failure to inspect borrower’s business premises.
n Lending against fictitious book net worth of business, with no audit or verification of borrower’s financial statement.
Twenty Common Reasons for Loan Losses–Contd
n Failure to get or ignoring negative credit bureau reports or other credit references.
n Failure to call loan or to move against collateral quickly when deterioration becomes obviously hopeless.
Common Types of Collateral
n Accounts Receivables
n Factoring.
n Inventory
n Real Property.
n Personal Property
n Personal Guarantees.
Components of Typical Loan Agreement
Ø The Note: A credit document that spells out how much a borrower must repay & on what terms.
Ø Loan Commitment Agreement: Pledges by lenders to make credit available to borrowers in the future for a stipulated time under specific terms.
Ø Collateral: Assets or pledges of value that can be turned into cash to support the repayment of a loan.
Ø Covenants: Components of loan agreement that require a borrower to do or not do certain things while the loan agreement is in force without first receiving lender approval.
Components of Typical Loan Agreement—-Contd
Ø Warranties: A written stipulation by a borrower that information supplied in a loan application is true.
Ø Events of Default: Portion of a loan agreement describing what action or inaction by a borrower would violate the terms of a loan.
Indicators of a Weak or Troubled Loan
v Irregular or delinquent loan payment.
v Frequent alterations in loan terms.
v Poor loan renewal record.
v Unusually high loan rate.
v Unusually or unexpected buildup of the borrowing customer’s account receivable &/or inventories.
v Rising debt-to-net-worth ratio.
v Missing documentation.
v Poor quality collateral.
v Reliance on reappraisals of assets to increase the borrowing customers’ net worth.
v Absence of cash flow statements or projections.
v Customer reliance on nonrecurring sources of funds to meet loan payments.