Chapter 16 Bank Lending Policies Procedures M Morshed

Chapter : 16 Bank Lending: Policies & Procedures M. Morshed 1

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 & M. Morshed 2

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 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. M. Morshed 3

Contents of a Bank Lending Policy 1) Lending Budget n n n 2) Composition n n 3) 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 Periodicity n n Call loans Short-term working capital loan Intermediate-term investment loan Long-term investment loan. M. Morshed 4

Contents of a Bank Lending Policy----Contd 4) Documentation Standard n n 5) Application Evidences of Security Loan agreement. Credit reports Acceptable Securities n n Criteria of acceptable security Listing of acceptable security Allowable margins to be made Qualifications of becoming guarantors M. Morshed 5

Contents of a Bank Lending Policy----Contd 6) Evaluating Credit Worthiness n n 7) Acceptable records, data, & other useful information Personal interview Credit investigation Accepts to be covered – personal, financial, market, management etc. Pricing: Lending Cost + Profit n n n Lending Cost = Cost of fund + Cost of lending operation + Liquidity of the advance + Risk. Rate of Interest or Profit Scale of Interest Rates/Profit. M. Morshed 6

Contents of a Bank Lending Policy----Contd Customer Category Rate of Interest/Profit Excellent Base Rate/Prime Rate (PR) Satisfactory PR +0. 5 % Average PR + 1% Below Average PR + 1. 5% Unsatisfactory PR + 2% Table: Bank’s Interest Rate Charges to Customer M. Morshed 7

Contents of a Bank Lending Policy----Contd 8) Lending Authority n n n n 9) 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. Compensating Balance n n Right of offsetting deposit balance for an outstanding loan Method of computation of compensating balance. M. Morshed 8

Contents of a Bank Lending Policy----Contd 10) Risk Average n n 11) Supervision & Control n n n 12) Types of risk involved Insurable risk Who supervises? When & how? Loan installments’ release process. Reports & Actions Collection Procedure n n Repayment schedule Remainders & circular letters Personal visits Collection through cheques M. Morshed 9

Contents of a Bank Lending Policy----Contd 13) Loan Accounting & Record n n n 14) Competition n n 15) 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. Loan Grading System n A= Top grade loan, B= Good loan, C= Marginal Loan, D= Doubtful loan, E= Likely to be bad loans. M. Morshed 10

Contents of a Bank Lending Policy----Contd 16) Procedures of handling problem loans n n 17) Development of Efficient Loan Personnel n n 18) 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. Policy Review & Improvement in new policy n n n Methods of policy review. Periodicity of policy review Personnel responsible for policy review. M. Morshed 11

How to Measure the Credit Worthiness of Borrower? A. CAMPARI • • B. 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. PARSAR • • • P = Purpose, A = Amount R = Reason, S = Sources of Payment A = Ability, R = Risk M. Morshed 12

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 M. Morshed 13

Regulation of Lending n “Uniform Financial Institutions Rating System” has introduced the following rating system for the banks: 1= Strong Performance 2= Satisfactory Performance 3= Fair Performance 4= Marginal Performance 5= Unsatisfactory Performance M. Morshed 14

Regulation of Lending-----Contd n All five dimensions of bank performance are combined into one overall numerical rating, known as “CAMELS” rating. • • • n 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 M. Morshed 15

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: 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. M. Morshed 16

Loan Approval Process n 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 officer’s comments, including consistency with policy. The loan Decision. M. Morshed 17