Lending Criteria / Parameters that effect credit decision …

By | March 10, 2019

Lending Criteria / Parameters that affect credit decision …

The lending policy is broadly defined by the RBI. The policy broadly says about macro issues. ex: exposure to a particular individual / company / Group should not exceed certain percentage of the Bank’s capital. The exposure of the bank should not exceed certain percentage to a particular industry etc. Thus the broad guidelines are devised the RBI. Within the broad guidelines, each Bank / FI has devised its own lending policies / lending criteria. These policies / criteria more or less may be same for the banks.

Once the project report / Business plan is submitted to the banks along with the loan application, usually banks assess the proposal on the following parameters. These are the crucial parameters that affect a credit decision of the Banks /FIs. 

Usually Banks assess the proposal based on the following broad categories. These are:

  • Management risks

  • Financial risks

  • Operational risks

  • Industry risk

  • Credit history

 

Details of each risk parameter: 

Management risks :

  • Some of the important parameters under this area are:

    • Capital of the unit

    • Key person(s) / Promoters

      • ability to contribute to their share

      • ability to raise the required share capital

      • ability to market their products / services

      • ability to run the unit with profits, ultimately

      • ability to generate adequate cash flows

      • reputation in the market

      • experience in the activity

      • credit rating of the unit

      • viability of the activity

      • security that you offer for the proposed loan.

  • Ability to contribute to their share and ability to raise the required share capital: the entrepreneur should be ready with the share of capital and also should have acceptable promises from the proposed shareholders. i.e. there should not be any doubt regarding generating adequate capital. This is primary thing that banks expect generally.

  • Key person(s) / Promoters abilities: Next thing that banks generally go through is the key person(s) / promoter(s) abilities. The future of the unit depends heavily on the key person(s) / promoter(s) abilities. Therefore, this criteria plays very crucial role in the credit decision of the bank /FI. Generally, banks look for the ability to market their products / services, reputation of the promoter(s) in the market, experience in the activity etc. As all these factors lead to run the unit with profits, ultimately. Finally, they will assess the ability to generate adequate cash flows based on the estimated and projected financials of the unit.

  • Before, going for a final decision they will also consider their internal Risk Management Department’s advise on the particular industry. Also they will go through the credit rating of the unit. The Credit rating may be the respective bank’s internal rating or may be of external rating. Sometimes they may consider both internal as well as external ratings.

  • Security that you offer for the proposed loan: Finally, they will go through the security that you offer. Security is of two types:

      • Primary Security: Assets for which the loan is advanced are classified as primary security.

      • Collateral Security: Additional assets that are mortgaged / hypothecated in addition to the primary security is called collateral security. however, unders specific schemes Collateral security can not be accepted by the banks. In such cases Credit guarantee may be accepted.

Financial risks :

Banks assess the financial risks associated with the enterprise / unit are assessed by calculating certain ratio. These ratios are calculated on the projected financials of the enterprise. Some of the important ratios / parameters are:

  • Current ratio : which denotes liquidity of the enterprise
  • Debt – equity ratio:Which denotes the level debt vis-a-vis equity
  • Debt Service Coverage Ratio: which denotes repayment capacity of the unit.
  • TOL / TNW ratio: denotes the units total outside liabilities to tangible net worth of the unit
  • Cash accruals: projected cash accruals of the unit.
  • Average turnover ratio: which denotes turnover of the enterprise
  • Net profit: Estimated / projected net profit of the enterprise.
  • Collateral Security: Finally collateral security offered by the unit to fall back in case of default of the loan.

These are some of the financial ratios / parameters banks look into to assess the Financial risk of the unit.

Operational risks:

Banks assess the operational risks and this plays a vital role in the credit decision of the lending bank. Some of the important areas / parameters banks assess under operational risk are:

  • Location of the unit– whether there is any advantage for the unit availability of raw material and proximity of the market for finished product.
  • Availability of technology for processing the products.
  • Availability of Human resources for the unit and the cost of skilled employees
  • Quality: Maintenance of quality

Some of these are the important areas / parameters that banks examine under operational risk.

Industry risk :

Under this category, Banks evaluate the risks associated to the industry. Some of these parameters are:

  • Nature of the industry – i.e. whether the industry is cyclical industry or seasonal industry.
  • Competition – what is the existing competition for the unit, whether the unit can sustain facing the existing industry majors.
  • Growing industry – Whether the industry is a growing industry or not.

Credit History :

Under this category Banks examine the past repayment history of the key person(s) / promoters / directors. This information is available in various credit information company reports ( ex. CIBIL, CRIF highmark, Equifax etc.) In these reports, these companies give information on various loans availed by the applicant. the repayment history i.e. whether the installments paid in time or not; if not paid in time the delay in payment. These reports also disclose whether there were any other loans which were totally defaulted etc. Thus these reports plays a very crucial role in taking the credit decision. If any applicant is defaulted in the repayment of existing loans are with not so good repayment history,then normally the credit decision will be negative. Therefore maintaining a clean repayment history is very important.

These are some of the important parameters that bankers consider while taking a credit decision. Therefore, thinks and assess in these areas before finalising the project .

All the best

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