Bank Loan Committees and Credit Policies

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Questions and Answers

What is the primary role of Loan Committees?

To review major loan proposals and loan delinquencies (correct)

To approve all loan applications regardless of size

To manage the day-to-day operations of the bank

To provide financial advice to customers

What is the benefit of a bank utilizing a system with smaller loan limits and relying heavily on loan committees for approval?

Reduced administrative burden

Greater control and safety (correct)

Greater flexibility and efficiency

Increased customer satisfaction

Which of the following is NOT a duty of a Loan Committee?

Reviewing loan renewals

Determining the interest rate for all loans (correct)

Reviewing new loan applications

Determining the cause of delinquent loans

What is the main purpose of a bank’s credit policy?

To define the bank's lending culture and guidelines (B) Signup and view all the answers

According to the Comptroller of the Currency (USA), a written loan policy should achieve which of the following outcomes?

Produce sound and collectible loans, provide profitable investment of funds, and encourage lending that meets market needs (B) Signup and view all the answers

What is the initial cash deposit received by Bank A?

$100,000 (D) Signup and view all the answers

What role does a credit policy play in ensuring the quality of a bank's loan portfolio?

It provides a framework for lending activities, ensuring sound lending practices and the creation of a quality portfolio. (A) Signup and view all the answers

Why is it important for a credit policy to be in written form?

To provide clarity and ensure that all relevant parties are aware of the lending guidelines. (A) Signup and view all the answers

What is the ratio of cash to total deposits that banks are aiming to maintain?

10% (C) Signup and view all the answers

What is the amount of the loan granted by Bank A to a customer?

$90,000 (A) Signup and view all the answers

What is the ultimate decision-making body regarding the approval of major loan proposals?

The Board of Directors (A) Signup and view all the answers

After the loan is granted, what is the amount of cash remaining in Bank A's balance sheet?

$10,000 (C) Signup and view all the answers

After the customer withdraws the loan amount, how does it affect Bank A's liabilities?

Liabilities remain unchanged (D) Signup and view all the answers

What is the type of asset that Bank A exchanges when granting a loan?

Loan for a claim against the borrower (D) Signup and view all the answers

Why is it assumed that the customer withdrawing the loan will spend it?

Customers only borrow money if they need it for expenditures (B) Signup and view all the answers

What happens when the recipient of the cheque deposits it into their account at Bank B?

The funds are transferred from Bank A to Bank B (D) Signup and view all the answers

What are the three general parts of a credit policy outline?

General policy statements, technical principles, and detailed procedures (D) Signup and view all the answers

What is the main purpose of a written credit policy, according to Michael Dennis?

To prevent problems and minimize the loss of customer goodwill. (A) Signup and view all the answers

Which of the following is NOT a type of loan mentioned in the text?

Mortgage loans (B) Signup and view all the answers

What is the role of a credit policy in lending decisions?

To guide the lending decision and specify certain clauses. (C) Signup and view all the answers

Which of the following is NOT a strategy for mitigating risks associated with credit/lending?

Offering competitive interest rates on loans (D) Signup and view all the answers

What is the main objective of a credit department within a bank?

To ensure the safety and soundness of the bank's loan portfolio. (C) Signup and view all the answers

Why is it important to have a credit policy and procedures manual updated regularly?

To reflect changes in market conditions and lending practices. (C) Signup and view all the answers

Which of the following areas is NOT directly related to the management of a loan portfolio?

Marketing and advertising of loan products (D) Signup and view all the answers

What is a key element that lenders consider when assessing a potential borrower's character?

The borrower's past record (C) Signup and view all the answers

Why is the margin of profit important to a lender?

It represents the financial gain from lending activities (A) Signup and view all the answers

Which of the following is NOT considered a principle of good lending?

The borrower's industry expertise (A) Signup and view all the answers

What is a primary purpose of a personal interview when assessing a borrower's character?

To determine the borrower's willingness and financial sense (C) Signup and view all the answers

For business customers, what is crucial in addition to the character of the borrower?

The borrower's ability to manage business affairs (A) Signup and view all the answers

What is a potential red flag when evaluating a business borrower's ability to repay?

A lack of expertise in crucial areas like finance or marketing (D) Signup and view all the answers

Why might a lender require security for a loan?

To protect the lender in case the borrower defaults on the loan (B) Signup and view all the answers

Which of the following is NOT a common component of a lender's margin of profit?

Insurance premiums (B) Signup and view all the answers

What is the primary source of risk in a lending context?

The borrower's inability to pay the loan (B) Signup and view all the answers

Which of the following is NOT a factor that contributes to inherent risk level?

The bank's marketing strategy (B) Signup and view all the answers

What does a secured credit arrangement specify?

An alternative asset to be seized in case of default (D) Signup and view all the answers

Which of the following describes the concept of 'credit risk'?

The probability that the borrower will not meet its debt obligations (D) Signup and view all the answers

What is the significance of a bank's strategic business objectives in relation to inherent risk?

They help determine what level of inherent risk is acceptable (C) Signup and view all the answers

How does the level of inherent risk impact the risk strategies and control measures employed by a bank?

It determines the monitoring and control procedures implemented (D) Signup and view all the answers

What is the key feature that distinguishes unsecured credit from secured credit?

The absence of a collateral asset (D) Signup and view all the answers

Which of the following best describes the concept of 'default risk'?

The risk of a borrower failing to meet their financial obligations (A) Signup and view all the answers

What consideration should a banker prioritize when evaluating a borrower's overdraft facility request?

Whether the requested amount is sufficient for the intended purpose (C) Signup and view all the answers

If a borrower requests a smaller loan amount than what is seemingly necessary, what action should a lender take?

Assess whether there's an alternative funding source or if additional funds might be required later (B) Signup and view all the answers

What type of financial commitment is considered crucial for borrowers, particularly in business scenarios?

A significant personal financial stake in the venture (B) Signup and view all the answers

When assessing a business borrower's request for a loan, what financial document(s) should a banker analyze to determine if the requested amount is appropriate?

The business's budget and cash flow projections, and its balance sheet (A) Signup and view all the answers

Why should a banker be wary of providing risk capital to a borrower?

It exposes the bank to significant financial risk and potentially large losses (B) Signup and view all the answers

Suppose a banker is evaluating a loan request from a small business owner. What should the banker consider if the owner later requests additional funds, suggesting an initial underestimation of costs?

Thoroughly revisit the initial loan application and ensure the borrower's financial viability (A) Signup and view all the answers

In what scenario might a lender be required to provide additional funding to a borrower after the initial loan?

The borrower's initial needs were underestimated, leading to a shortfall in funds (C) Signup and view all the answers

How does a borrower's significant financial stake in a venture typically influence their commitment?

It often leads to greater personal commitment to the venture's success (B) Signup and view all the answers

Study Notes

Unit 1: Credit and its Inherent Risks

Banking's core business is lending/credit.
Over $1 trillion in outstanding bank loans globally.
Interest and fees on loans comprise two-thirds of banks' total operating income.
The course explores the credit function in financial institutions, particularly banks.
Two sessions cover credit risks and sound lending practices.

Session 1.1: Credit and Its Inherent Risks

Lending is a critical function for financial institutions.
Bank lending is crucial, and its quality can make or break a financial institution.
Credit is important for the community, clients' relationships, and cross-selling services.
Lending programs help banks generate revenue via interest, fees, and investment income.
There are inherent risks in lending, regardless of management control.
Key risks include economic changes, check fraud, bank robberies, mortgage defaults, and business choices (e.g., subprime mortgages).
A high level of risk does not necessarily equate to negative outcomes, nor is low risk necessarily positive.
The bank's strategic objectives influence acceptable risk levels.

Key Terms

Credit: A deferred payment arrangement where a benefit is received now and paid for later.
Secured Credit: A credit agreement with an alternative if the borrower defaults.
Unsecured Credit: A credit agreement without a specified alternative in the event of default.
Collateral: An alternative asset that can be seized in case of default.
Risk: The likelihood of loss due to a borrower's inability to repay a loan.
Credit Risk: The probability that a borrower will fail to meet agreed-upon debt obligations (also known as default risk).
Credit Policy: Clearly defined guidelines for providing credit: terms, customer qualification criteria, collections procedures, and handling delinquencies.
Default Risk: A borrower's failure to meet their debt obligations.

Session 1.2: Cannons of Lending and the Basic Principles of Sound Lending Practice

Profitable lending balances income with the risk of non-repayment.
Essential for banks to establish requirements for growing their credit portfolio.
Lending involves several key principles:
- Character of the borrower
- Ability to repay the loan
- Profit margin for the lender
- Reason for seeking the loan
- Amount of the loan request
- Terms of repayment
- Secondary source if loan repayment fails
Character of borrower is assessed with past records and personal interviews.
Determining the appropriate loan amount involves considering borrower needs and their ability to repay.
Important to consider the borrower's purpose for the loan, whether it's for working capital, a new business, or other purposes.
Establishing security for the loan is vital to mitigate default risk and ensure recovery if repayments fail,
Loans related to speculations might be rejected.
The 5 C’s of credit (character, capacity, capital, collateral, conditions) are important factors to consider for a successful lending proposition.
A comprehensive process for loan assessment includes introduction, application review, specifics of the request, guiding principles, and securing repayment.

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Description

This quiz explores the functions and responsibilities of loan committees within banks, as well as the importance of credit policies in managing a bank's loan portfolio. Test your knowledge on key terms and practices related to bank lending and credit decision-making processes.