It can be regarded as an essential concept to decide the … Expand. This study examines the effects of the various risk components like credit risk, interest rate risk and operational risk on the financial performance of Deposit Money Banks in Nigeria. The study is … Expand. Highly Influential. View 3 excerpts, references background. This study attempts to reveal the relationship between credit risk and profitability of some selected banks in Ghana.
A panel data from six selected commercial banks covering the five-year period … Expand. The study was meant to find the relationship between the credit risk and bank performance as measured by return on asset.
Regression model was used to develop the relationship between the indicators … Expand. View 1 excerpt. Pakistan is a developing country and its financial sector consists of different types of institutions.
In the economic development of … Expand. View 1 excerpt, references background. Using an autoregressive distributed lag model, this paper examines the factors that influence the credit risk of the Bulgarian banking system over the decade —, as measured by non-performing … Expand. The documents are both signed by the loan officer of the bank and the customer who benefits the loan facility. There is also the need for the guarantors to sign the documents before the final seal.
In carrying out this business the banks would source for funds from various members of the public. The funds of the customers are held in safekeeping of the banks and therefore, such funds must be made available to the depositors whenever they demand for them.
The implication is that banks strive to ensure that the funds are available for payments to the depositors on periodic basis for their needs and commitments. In the process of performing the other aspect of financial intermediation, the commercial banks usually keep the interest in uppermost consideration so as to discharge their delicate function efficiently.
In performing such function of lending funds to customers the banks usually take necessary steps to protect the interest of the depositors. In the process of trying to maintain a delicate balance between recovery of loans and advances and periodic payments to the depositors, the banks usually institute appropriate measures to safeguard their position with regards profitability and survival.
Based on this discussion, it is possible to identify the basic reasons for the management of lending and credits by the banks, which are critical to their operations. And since such depositors are entitled to their funds as often as they so desire, banks lend money for a short time in most cases. The administration of lending and credits by the banks is managed in such a manner that the funds are repaid at agreed regular intervals without defaults.
The repayment of loans by the beneficiaries depends on their capacity to generate enough funds from their projects, besides the fact that their character which are normally evaluated before loan approval. In essence, the banks lend funds to the customers based on the financial standing of their business in terms of regularity of cash inflows with which to repay the loans.
The banks also take into consideration a less risky business for loans to ensure the safety of the funds and their prompt recovery from the borrowers. In the case of new business ventures, the banks would also grant loans for those enterprises whose owners command good character and have adequate capacity to repay the loans.
The new business venture should have sound financial projections in relation to the technical feasibility and economic viability of the project for which the loan is granted. This means that in the process of granting loans and credits to customers, the banks consider the composition of the loan portfolio so as to maintain balanced diversity of the assets. This is view of the fact that the spread goes a long way to guarantee the safety of the banks funds.
It implies that the loans and credits being granted to customers are not concentrated in a particular sector but in diverse sectors of the economy. This is in conformity with the policy of the apex bank in terms of extending loans to various productive industries and businesses for balanced growth and development of the economy. The spread of the loan portfolio to various productive sectors of the economy is also imperative towards minimizing risks that are always associated with lending of funds.
In this regards, commercial banks take appropriate measures to spread the risks of investment in loan and advances portfolio by considering various trades and industries.
In order to ensure constant inflows of funds from loans and advances, the banks normally put in place some administrative measures towards assessing that such credits are the types that would generate stable incomes with which to repay the funds.
It is the responsibility of the credit officers and the committee to also evaluate new projects using their technical feasibility and economic viability reports to determine the nature of cash inflows in terms of their nature of earnings. Such assessment will be used for the selection of the projects that can generate enough funds for repaying loans and credit facilities. In the case of existing business, the usual practice is for the bank to request for financial reports of the business which incorporate relevant data for five years.
This will be used in evaluating the regularity of generation of earnings. And the assessment is used to determine the stability of income from the business for the repayment of loan facility. Loans and advances are usually granted to customers with the intention of earning some income for the banks.
The income from lending facilities comes mainly from the interest charges being made from loans advances being granted to customers by the banks. The rate of interest being charged on loans and advances by the banks is normally determined in consideration to the prevailing interest rate and the ruling bank rate sanctioned by the apex bank in the economy.
Such bank rate is called the monetary policy rate in the country, as determined by Central Bank of Nigeria. The interest rate being charged on loans by the commercial banks is normally determined in relation to the bank rate being charged by the apex bank, the former being higher than the later.
In addition, the banks incorporate some other charges as may be determined by the lending officers or the credit committee. In order to ensure that lending operations are proper supervised, the banks normally set administrative policies on loan supervision. In this regards, administrative policies are established on supervision of credit facilities, their recovery drives, and personal visits by bank officials to the loan beneficiaries.
The relevant supervision policies are normally established in relation to the past strategies and those methods being used by the other banks in the industry.
In order to ensure effective loan supervision, these policies are used: supervisory teams, reports and evaluation, time line for periodic reviews of loan recoveries, loan recovery visits, procedures for compliance with banking regulations, appropriate pricing of loans and credits, and loan recovery methods.
In this regard, administrative measures are established by the banks for management of the credit risk in respect of grave problems which can arise from loan recovery by the bank. The objective is to eliminate or minimize the hazards and perils that loans and advances can present to the operations of banks. The measures for controlling loans and advances in order to manage their risks may differ from one bank to another.
The banks do formulate administrative measures for the management of credit risks by assigning responsibilities for: a branch managers in preventing credit risks; b senior officers in credit risk management; c loan officers in recommending only loans with minimal risks; d credit committee for assessing and handling credit risks; e effective supervision to minimize defaults in loan repayment; f managing accounts of loan beneficiaries; g constant visits to loan beneficiaries; and h actions necessary in managing difficult loan beneficiaries.
Administrative policies are normally formulated for managing difficult loan beneficiaries. Banks formulate administrative policies and assign them to relevant bank officials for managing problem loans.
These policies are used to specify the necessary actions to be taken by relevant bank officials to handle loan beneficiaries that are proving difficult and problematic. Lending and Credit Administration Essentially, the back business of commercial banks revolves around financial intermediation activities. Therefore, they source for funds from the members of the public, corporate organizations and other institutions through various forms of deposit accounts. Such funds are then used for the purpose of lending and credit facilities.
The depositors are entitled to the funds whenever they so desired. The banks are invariably under legal obligations to honour the demands of the depositors. The banks therefore, are constantly under obligation to evolve ways of maintaining delicate balance between the recoveries of funds loaned out and the demands of the depositors.
In essence, the funds which are loaned out to customers have to be managed in such a manner that such funds can be available from the customers whenever they are needed to meet the demand of the depositors. The delicate balancing of demands for funds by depositors and recoveries of loans and advances from customers is predicted on the necessity for the commercial banks to survive in business and generate reasonable returns for the shareholders. It implies that lending and credits should be managed in such a way that generating funds from loan repayments is tailored towards meeting periodic demands of the depositors.
In order to manage loans and credits effectively for adequately meeting the demands on the deposit accounts of customers, there are operational modalities normally put in place by the banks for administering loans and advances right from inception to the time when they totally liquidated.
Such modalities of managing loans and advances are identified and discussed below. Hence the banks determines total amount of loans and advances for a particular period, maximum amount for a single case, and average amount of lending to be made per case. In terms of composition of loans and advances that will be granted to customers, the banks consider issues such as types of loan and advances, sectors, sub-sectors and industry mix, investment or equity participation, and productivity sector favoured by the government.
There are some responsibilities which the loan committee is expected to perform. Therefore, the basic considerations are call loans, short- term working capital loan, intermediate-term investment loan, and long-term investment loan. A typical grading system for loans and advances is as presented below, which indicates classification of loans in terms of their likely performance. Factors that are taken into consideration, among others, include financial statements, other required information, personal interview and credit investigation, information on operations; personnel, financial, market, etc.
The other important contemplation is the concern of collateral security which is very critical for loan consideration. In this regard, the critical issues to consider are criteria of acceptable security, listing of acceptable security, allowable margins to be made; and qualifications of becoming guarantors. The interest chargeable on loan is normally considered in relation the bank rate of the apex bank; the former being above the latter.
This calls for determining the risk average in relation to previous loans that are similar to the loan under consideration, the types of risk involved, and the insurable risk that should be insured by the bank.
It is always necessary for the bank to retain some funds in the loan account of the customer which is regarded as the compensating balance. More considerations can be included in the above list for effective loan approval process. The documentation starts from the time that the customer applies for the loan. Therefore, the documents to be kept bank include application form filled by the customer, evidence of security, loan agreement, credit reports, referee forms, and financial statements, among others.
The procedures for managing problem loan problems and their beneficiaries involved the following considerations: a Criteria to be used for identifying problem loans; b Methods to be used for identification problem loans; c Steps to be taken in managing the loans and their beneficiaries; and d The issue of setting up loan reserves for managing such risk 8.
Such evaluation is very critical because it provides the basis for the engagement in credit analysis of the request. The relevant issues to be considered in the initial evaluation are identified and discussed below. Therefore, the bank would assess that the reason for the loan is not related to; speculative business; illegal business transaction; fruitless venture; self-aggrandizement; failed venture; money laundering; dealing in arms or weapons; political agendas, etc Once the loan request is not connected to any of the above subject or business, the request will be qualified for consideration by the bank.
The assessment of the amount in relation to the above issues will make the bank either to grant the whole amount or decrease it. The reason for the loan will enable the bank to classify the request in relation to broad-based categorization as shown below. The categorization of the loan request will enable the bank to determine the appropriate amount to grant for the demand.
This consideration is related to the cash inflows from the business, which will be used by the beneficiary to meet the periodic repayments of the principal amount and the interest charges to the bank.
This is based on the fact that the capital base of the business determines its ability to carry out its operations efficiently. In the case of a new project, the financial projections for a period of five years will be assessed to determine the ability of the business to generate enough income to meet its cost of operation and meeting the loan repayment.
These credit risks include: default in repayment; delays in repayment; diversion of the funds; failure of the project; mismanagement of the funds; and total loss of the funds. Once most of these risks are perceived to the inherent in the loan request, the bank officials may not advance further on the analysis of the request. Nevertheless, if the bank is satisfied with above elements of assessment, it will proceed to credit analysis, which is the next area of discussion below.
All these considerations are discussed below. The bank officers or loan officers would take steps to determine the character of the customer to ensure that they are convinced that the customer has a well-defined purpose for requesting bank credit and a serious intention to repay the funds appropriately. Therefore, the bank always takes steps to ensure that the customer requesting credit has the authority to do so.
The bank will also consider the approval of the board of directors and the legal standing of the person to sign a binding loan agreement on behalf of his firm.
This customer characteristic is known as the capacity to borrow money. The assessment also applies to the quality of the assets in providing adequate collateral support for the loan.
To assess industry and economic conditions, most banks maintain files of information newspaper clippings, magazine articles, and research reports-on the industries represented by their major borrowing customers. This is important because in the absence of any appreciable contribution or the capital base of the business, the customer will not feel that the firm has any stake in the scheme of things. Therefore, the project may be allowed to fail and the bank will lose its funds. There are three main sources of income from a business to repay the funds of the loans.
These sources include: The cash flows generated from sales or turnover of the business; the sale or liquidation of operating assets of the business; or funds to be raised by way of issuance of debt or equity securities. The net cash inflows is the net profits from the operations of the business, indicative of total revenue less all expenses, and combined with non-cash expenses such as the amount of depreciation of capital assets.
The other of looking at the cash inflows is that the net cash inflows is the net profits plus non-cash expenses plus additions to accounts payable less additions to inventories and accounts receivable. The relevant information for such assessment involves the data which are embedded in the financial statements of the business operations in the past five years.
The relevant financial statements are the income statement and the balance sheet. A simple approach to the assessment involves the use of financial ratios. Therefore, the commercial banks normally make use of an assessment technique called CAMPARI, an acronym from other relevant considerations in loan assessment. Such considerations for assessing the creditworthiness of customers seeking for loan facilities are as follows. Character: This is a review of the management of the business, the products of the company, and the past performance of the business for which a loan is being requested.
Ability: This refers to the ability of the business to generate enough income from cash inflows with which to repay the loan facility. Amount: This refers to the value or amount of funds that is being requested by the customer, which will be considered in relations to issues such as available funds for lending, the liquid position of the bank, regulation of the apex bank, amount of loan already committed to loan, pace of loan recovery, trend in volume of withdrawals, etc.
More so, the bank will also consider the past performance of the business in relation of its ability to meet periodic repayments of the funds in relation to the liquidity plan of the bank.
Insurance: — this refers to the issue of collateral security which is available to secure the loan by the customer.
This is very important to the bank because in the event of defaults or inability to repay the loan the bank will use the collateral security for generate funds to settle the loan. The analysis above indicates that it represents a broad-based evaluation of the loan request compared to the earlier consideration in this unit. These considerations are important in terms attributes which coalesce to form the basis of the lending decision.
Among these considerations, there are five attributes that are linked to the accounts and finances of the prospective borrowers. The interests charged only for the amount drawn and not for the whole amount sanctioned. In this case both the ownership and physical possession remain with the borrower. The borrower binds himself to surrender the hypothecated goods to the bank as and when called upon to do so.
The bank only acquires a right over the goods. Therefore, the band insists upon the borrower to give other secondary securities. Overdraft facility against hypothecation of goods is allowed go only trustworthy and prudent clients. In this matter the borrower surrenders the physical possession of the goods, under effective control of the bank.
The ownership of the goods however, remains with the borrower. In case of default by the borrower in repayment if the credit, the bank has the authority to sell the pledged goods and realize the due loan with interest. But the bank has to give a notice to the borrower before attempting to sell the goods.
The following thing must be considered while allowing O. The branch shall also obtain letter of undertaking and indemnity from the customer before getting goods cleared through L. Clearing should be taken by approved clearing agent of the bank. Merchandise should be insured with specific risk clauses. The following matters must consider while allowing L.
This type of facility is given only to first class and reliable clients. The customer holds the goods or their sale proceeds in trust for the bank till the loan allowed against Trust Receipt is fully paid off. The period of Trust receipt may be 30, 45, 60, 90 days.
The loan is adjustable within the period. Sale proceeds of goods held in trust must be deposited in the bank by the borrower irrespective of the period of the trust receipt.
Post- shipment. Through negotiation of documents; Through purchase of foreign bill. Generally, for the movement of goods from hinterland areas to the port of shipment, the bank provided interim facilities by way of packing credit.
In this system, after the shipment of goods the export presents the relative documents to the Negotiating bank for negotiation. Here the bank extends financial accommodation to the concerned exporter by allowing him to enjoy F. P Foreign Bill Purchase limit with prior approval of Head office, where necessary. The bank allows the export taka equivalent of the foreign bill amount after deducting its discount, commission and charges as per existing rule. An export bill may be drawn either at sight or usance basis.
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