Chapter : 16

Bank Lending: Policies & Procedures

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Objectives of Lending Policies

a) b) c) d) e) f) g) h)

Resource planning to match lending outlay. Strategy to win over the nearest competitors. Augment good lending base with moderate risk involvement. Increased profitability. Ensure balanced loan portfolio. Quick disposal of loan cases. Development of efficient & capable loan personnel. Building up market reputation & goodwill by satisfactory services to the loan customers &

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Steps Required in Framing a Lending Policy

1) 2)

3)

4)

5)

Demarcate market area, market share & define profit goals. Determine the types of loans that will best serve the bank in realizing set market area, market share & profit goals. Arrange due legal sanctions from the appropriate authorities, i.e. central bank or others. Arrange proper & effective communication of the lending policy decision to loan officers & others & others likely to be interested, i.e. existing & potential loan customers. Arrange regular periodic review, updating & improvement of the policy to suit the demand of time & situations.
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Contents of a Bank Lending Policy

1)

Lending Budget
Total amount for a particular period. Maximum amount for a single case Average amount of lending to be made per case. Types of loan By areas By economic sectors & sub-sectors & industry mix Investment loan Productivity loan

2)

Composition

3)

Periodicity
Call loans Short-term working capital loan Intermediate-term investment loan Long-term investment loan.
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Contents of a Bank Lending Policy----Contd

4)

Documentation Standard
Application Evidences of Security Loan agreement. Credit reports

5)

Acceptable Securities
Criteria of acceptable security Listing of acceptable security Allowable margins to be made Qualifications of becoming guarantors

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Contents of a Bank Lending Policy----Contd

6)

Evaluating Credit Worthiness

Acceptable records, data, & other useful information Personal interview Credit investigation Accepts to be covered personal, financial, market, management etc.

7)

Pricing: Lending Cost + Profit

Lending Cost = Cost of fund + Cost of lending operation + Liquidity of the advance + Risk. Rate of Interest or Profit Scale of Interest Rates/Profit.

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Contents of a Bank Lending Policy----Contd

Customer Category
Excellent Satisfactory

Rate of Interest/Profit
Base Rate/Prime Rate (PR) PR +0.5 %

Average
Below Average Unsatisfactory

PR + 1%
PR + 1.5% PR + 2%

Table: Banks Interest Rate Charges to Customer

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Contents of a Bank Lending Policy----Contd

8)

Lending Authority
Sanctioning limits of various types of loans Branch Manager Regional Manager Deputy general Manager General Manager Managing Director Board of Director Authorization of the Central Bank where required.

9)

Compensating Balance
Right of offsetting deposit balance for an outstanding loan Method of computation of compensating balance.

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Contents of a Bank Lending Policy----Contd

10)

Risk Average
Types of risk involved Insurable risk

11)

Supervision & Control

Who supervises? When & how? Loan installments release process. Reports & Actions

12)

Collection Procedure
Repayment schedule Remainders & circular letters Personal visits Collection through cheques
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Contents of a Bank Lending Policy----Contd

13)

Loan Accounting & Record

Recording procedure to be followed. Loan/project profiles to be maintained Statements to be provided Possible competitors Their strengths & weakness. Methods of winning competition Avoiding unhealthy competition. A= Top grade loan, B= Good loan, C= Marginal Loan, D= Doubtful loan, E= Likely to be bad loans.

14)

Competition

15)

Loan Grading System

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Contents of a Bank Lending Policy----Contd

16)

Procedures of handling problem loans

Criteria if identifying problem loans. Methods to be used for identification Steps to be taken Setting up loan reserves. Loan-man ratio to be ideal. Training on the various aspects of loan processing. Credit evaluation, follow up, retirement, etc. In bank, on the job, on-hand, & foreign training are necessary. Methods of policy review. Periodicity of policy review Personnel responsible for policy review.
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17)

Development of Efficient Loan Personnel

18)

Policy Review & Improvement in new policy

How to Measure the Credit Worthiness of Borrower?

A.

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.

B.

PARSAR
P = Purpose, A = Amount R = Reason, S = Sources of Payment A = Ability, R = Risk

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How to Measure the Credit Worthiness of Borrower?---Contd

C.

Seven Cs
C = Character C = Capacity C = Cash C = Collateral C = Conditions C = Capital C = Control

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Regulation of Lending

Uniform Financial Institutions Rating System has introduced the following rating system for the banks:
1= 2= 3= 4= 5= Strong Performance Satisfactory Performance Fair Performance Marginal Performance Unsatisfactory Performance

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Regulation of Lending-----Contd

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

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
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Loan Committee

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 committees are as follows:
1. 2. 3. 4. 5. 6. 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.

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Loan Approval Process

1. 2.

3.

The three fundamental elements of the loan approval process: Delegation of Authority Uniform Presentation Format & Standards i. Descriptions of the client ii. Assessment of management iii. Purpose of the loan request. iv. Repayment schedule & source of repayment v. Secondary sources of repayment including collateral values & guarantors. vi. History of past borrowing with the bank vii. Required monitoring steps, including timing of submissions of financial statement. viii. Sponsoring officers comments, including consistency with policy. The loan Decision.
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Pricing Policy

Interest rates charged on loans may depend on considerations, such as the following: 1. The banks cost of funds. 2. The riskiness of the borrower. 3. Compensating balances & fees. 4. Interest rates charged by competitors. 5. Other banking relationships with the borrower

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Twenty Common Reasons for Loan Losses

1) 2) 3)

4) 5)

6)

Collateral overvalued, improperly margined; failure to get appraisal. Dispersal of funds before documentation finished. Officer making good ole boy loans, bypassing the loan committee, personal friendship of loan officer with borrower. Loan to a new business with an inexperienced ownermanager. Renewing a loan for increasing amounts, with additional collateral taken. Repeatedly rewriting loan to cover delinquent interest due.
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Twenty Common Reasons for Loan Losses--Contd

7) 8) 9) 10) 11) 12)

Not analyzing borrowers cash flows & repayment capacity. Failure of officer to review loans status frequently enough. Funds not applied as represented; diverted to borrowers personal use. Funds used out of the banks market area: poor communications with the borrower. Repayment plan not clear or not stated on the face of the note. Failure to receive or infrequent receipts of borrowers financial problems.
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Twenty Common Reasons for Loan Losses--Contd Failure to realize on collateral because borrower raised nuisance legal defenses. 14) Banks failure to follow its own written policies & procedures. 15) Bank president too dominant in pushing through loan approval. 16) Ignoring overdraft situations as a tip-off to borrowers major financial problems. 17) Failure to inspect borrowers business premises. 18) Lending against fictitious book net worth of business, with no audit or verification of borrowers financial statement.
13)
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Twenty Common Reasons for Loan Losses--Contd

Failure to get or ignoring negative credit bureau reports or other credit references. 20) Failure to call loan or to move against collateral quickly when deterioration becomes obviously hopeless.
19)

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Common Types of Collateral

Accounts Receivables Factoring. Inventory Real Property. Personal Property Personal Guarantees.

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Components of Typical Loan Agreement

The Note: A credit document that spells out how much a borrower must repay & on what terms. Loan Commitment Agreement: Pledges by lenders to make credit available to borrowers in the future for a stipulated time under specific terms. Collateral: Assets or pledges of value that can be turned into cash to support the repayment of a loan. 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.
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Components of Typical Loan Agreement----Contd

Warranties: A written stipulation by a borrower that information supplied in a loan application is true. Events of Default: Portion of a loan agreement describing what action or inaction by a borrower would violate the terms of a loan.

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Indicators of a Weak or Troubled Loan

Irregular or delinquent loan payment. Frequent alterations in loan terms. Poor loan renewal record. Unusually high loan rate. Unusually or unexpected buildup of the borrowing customer's account receivable &/or inventories. Rising debt-to-net-worth ratio. Missing documentation. Poor quality collateral. Reliance on reappraisals of assets to increase the borrowing customers net worth. Absence of cash flow statements or projections. Customer reliance on nonrecurring sources of funds to meet loan payments.
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