Bank Lending Policies & Procedures

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.