Foundations of Bank Lending PDF

FOUNDATIONS OF BANK LENDING CHAPTER 1 Module Authors Jasman Tuyon, PhD Rapheedah Musneh, PhD Siti Julea Supar Nurziya Muzzawer Next Slide Faculty of Business and Management Universiti Teknologi MARA, Sabah Branch, Kota Kinabalu Campus ...

FOUNDATIONS OF BANK LENDING CHAPTER 1 Module Authors Jasman Tuyon, PhD Rapheedah Musneh, PhD Siti Julea Supar Nurziya Muzzawer Next Slide Faculty of Business and Management Universiti Teknologi MARA, Sabah Branch, Kota Kinabalu Campus  FOUNDATIONS OF BANK LENDING CHAPTER'S OUTLINE 1.1 Fundamental Principles of 1.2 Rules and 1.3 Ethics and Bank Credit Regulations Corporate 1.1.1 Introduction to Bank Credit Governing Bank Governance in Bank 1.1.2 The Credit Process Cycle Credit in Malaysia Credit 1.1.3 Lending Decision Framework in Business Banking Learning Objectives: Upon completion of this chapter, students should be able to: 1. Define bank credit. 2. Clarify the important of bank credit to the bank business. 3. Understand the flow of credit process cycle. 4. Understand major provisions of Financial Services Act 2013 and BNM guidelines affecting credit function. 5. Explain ethics and governance in financial institution. Read More...  Fundamental Principles of Bank Credit Sub-topic 1.1 Next Slide 1.1.1 Introduction to Bank Credit 1.1.1.1 Bank definition and scope of business 1.1.1.2 Bank lending business 1.1.1.3 Bank operation is highly regulated Read More...  Introduction to Bank Credit (Cont.) 1.1.1.1 Bank definition and scope of business  Introduction to Bank Credit (Cont.) 1.1.1.2 Bank lending business  Introduction to Bank Credit (Cont.) 1.1.1.2 Bank lending business (cont.) Or Investment banking SME/Business Banking Focus of this course Sample of Bank Structure Source: Adapted from Golin and Delhaise (2013).  Introduction to Bank Credit (Cont.) 1.1.1.2 Bank lending business (cont.) Balance Sheet Profit & Loss Account Loans Equity Interest income……….……[+] Fee-based income…..…...[+] Deposit Interest paid………………….[-] Loan losses (Loss).………..[-] Total Assets Total Liabilities Expenses……………………….[-] and Equities Net Profit……………….[+/-] Bank Lending to SMEs Credit risk impacts to bank’s Credit to SMEs profitability Bank Project Borrower 1.1.1.3 Bank operation is highly regulated Financial System Stability International Level [Key regulatory – BASEL Framework] Domestic Level External regulations External regulations Shareholder Theory/Stakeholder Theory Internal regulations Ø Regulations, Ø Bank credit policy Guidelines, Internal regulations and guidelines Notices and Directions Issued by Bank Negara Malaysia Ø Financial Services Act 2013 Agency Theory > Agency problem Ø National Land Code Act 828  Introduction to Bank Credit (Cont.) 1.1.1.3 Bank operation is highly regulated (cont.) Ø The Basel Framework The Basel Framework is the full set of standards of the Basel Committee on Banking Supervision, which is the primary global standard setter for the prudential regulation of banks. Ø External Laws & Regulations The external laws and regulations affecting bank credit functions including: ü Regulations, Guidelines, Notices and Directions Issued by Bank Negara Malaysia ü Financial Services Act 2013 ü National Land Code Act 828 (for land charges and lien as collateral) Ø Internal Policies and Guidelines The credit policy is a document that determines all the guidelines which allow these lending companies to make these critical lending decisions. These guidelines are important for risk management and provide necessary guidelines to the staff to effectively manage clients' portfolio. 1.1.2 The Credit Process Cycle 1.1.2.1 Origination 1.1.2.2 Approval 1.1.2.3 Administration 1.1.2.4 Monitoring 1.1.2.5 Settlement/Recovery  The Credit Process Cycle 1 Origination Principles of lending 2 Approval applies (in Chapter ?) 3 Administration What is credit process cycle? It is the operational flow of credit lending, from loan origination to full loan repayment. Monitoring 4 Why credit process cycle is important? It provides vital information to the lender in the process of loan origination, data and Settlement/ information Read More... for verification of borrowers, and 5 Recovery credit evaluation based on internal and external parameter.  The Credit Process Cycle (Cont.) 1.1.2.1 Origination  The Credit Process Cycle (Cont.) 1.1.2.2 Approval  The Credit Process Cycle (Cont.) 1.1.2.3 Administration  The Credit Process Cycle (Cont.) Loan monitoring covers the following: 1.1.2.4 Monitoring Monitor facility utilization in order to generate profitability to the bank. Monitor loan repayment to ensure satisfactory conduct and prompt payment, and to detect any potential warning signal/ red flag. Tracking of antecedent (post draw dawn) conditions to ensure full compliance e.g. placement of sinking funds, quarterly submission of financial accounts, certified progress billing before loan draw dawn. Site visitation to verify business visibility and management competency. Interim or annual review to revisit borrower’s risk profile, financing requirement or the need to restructure facility terms according to borrower’s operating cycle.  The Credit Process Cycle (Cont.) 1.1.2.5 Settlement/Recovery 1.1.3 Lending Decision Framework in Business Banking 1.1.3.1 Overview of the bank lending decision process 1.1.3.2 Lending approaches 1.1.3.3 Credit decision operation in business banking Read More...  By Department By Process Marketing/Sales Marketing/Sales leads Department 2 Head Office Origination Credit Risk Management Submission of application 1.1.3.1 Overview of the Department form and other required documents bank lending decision Credit Analysis Credit Committee Principles of Assessment and approval of The 5Cs of process Approval Department Lending facilities requested Credit Analysis Approval Issuance of letter of offer/ Compliance to rejection to borrower rules and regulations Borrower declines (internal and offer or appeal against Borrower accepts offer external) facilities Borrower comply to legal requirement and pre- Administration Appointed disbursement conditions Solicitor Credit Administration (perfection of legal Department Disbursement of credit documentations) facilities 3 Panel Solicitor Credit facilities Monitoring monitoring Credit Rehabilitation & Recovery Credit facilities recovery Department Recovery Source: Adapted from Bank Negara Malaysia (2003) https://www.bankinginfo.com.my/pdf/sme_loans.pdf 1 Business Banking / Business Center  Introduction to Bank Credit (Cont.) 1.1.3.2 Lending approaches Bank Credit Analysis Credit scoring only apply to small business financing. Reasons: 1 Standard Process Individual Process 2 ü small amount of credit request (Credit Scoring) (Credit Judgement) and low probability of default. (System approach) (Judgement approach) Credit judgement apply to SMEs and corporate financing. Score Board The 5Cs of Credit Reasons: Analysis ü Information asymmetry is higher that need to be assessed manually by the credit officer. ü Higher amount of credit request Apply to Apply to and high probability of default. Small Business Medium & Large SMEs  Introduction to Bank Credit (Cont.) 1.1.3.2 Lending approaches (Cont.) Documents required: Annual financial statements or the business plan. A typical rating process consists of two components: 1. financial rating (or quantitative rating) ü Financial rating comprises an analysis of the financial data available for the credit applicant (focus on debt service capacity) 2. qualitative rating ü Borrower characters – knowledge, experience, and past credit conducts ü Business characteristics - profitability, competitiveness, and survival. Using a weighting function, financial and qualitative ratings are combined, with the Source: Adopted from Oesterreichische Nationalbank (2004). result usually referred to as base rating.  Introduction to Bank Credit (Cont.) 1.1.3.2 Lending approaches (Cont.) Conceptual presentation of the credit judgement process Source: Oesterreichische Nationalbank (2004).  Introduction to Bank Credit (Cont.) 1.1.3.3 Credit decision operation in business banking Business banking/Business center Head Office Economic Recommend/ Economic analysis Credit Officers Revision q Information Credit Risk Committee Industry asymmetry Industry analysis q Adverse selection Credit Files feedback SME Compliance to laws q Moral hazard and regulations Business & (internal and Credit Managers Revise/ Financial external) Approve/ analysis Reject Analysis and recommendation Approval Internal Credit Audit (Bank Auditors) SME credit application External Credit Audit (BNM Auditors)  Introduction to Bank Credit (Cont.) 1.1.3.3 Credit decision operation in business banking (Cont.) Shareholder Theory/Stakeholder Theory ØThe asymmetric information problem in a bank–customer relationship. Bank assessments of SME applications for loan finance are examples of decision making under uncertainty, incorporating asymmetric information for the provider and the client. ØDue to information asymmetry, banks face the twin problems of moral hazard (monitoring problem) and adverse selection (risk assessment problem) when dealing with small firm lending. Agency Theory > Agency problem Reference: Deakins and Hussain (1994); Behr, P., & Güttler, A. (2007); Tupangiu (2017).  Introduction to Bank Credit (Cont.) 1.1.3.3 Credit decision operation in business banking (Cont.) q Information asymmetry Asymmetric information means that the lender does not have information that is symmetric with that of the borrower, i.e. there is (or could be) a discrepancy between the information provided by the borrowing Shareholder Theory/Stakeholder Theory company (or person) and the actual state of affairs (financial and otherwise) of the company (or person). q Adverse selection The lenders are at a major disadvantage in terms of information about the borrower and, coupled with the fact that bad credit risks are more inclined to borrow than are good credit risks, the lenders are more likely to select borrowers with dubious projects (i.e. projects that have an adverse outcome) than borrowers with projects that will succeed. q Moral hazard Moral hazard means that after a loan is granted, there is a high probability that the borrower may engage in activities that do reflect the information gathered by the lender in connection with the borrower and his/her Agency Theory > Agency problem planned projects. There are countless examples where borrowers borrow with good intentions, but when the access to funds becomes a reality, they take on higher risk projects. Reference: https://ebrary.net/765/economics/credit_risk  Introduction to Bank Credit (Cont.) 1.1.3.3 Typical set-up of credit decision in business banking Credit application will be received from SMEs. In the process of analyzing the proposal, credit officer is exposed to information asymmetry and moral hazard risk. Credit analysis and recommendation will be performed by the credit officer using in-house credit review format. The analysis will be based on credit judgement applying 5Cs of credit analysis and respecting principles of lending. As part of credit risk control, every credit proposal is to be reviewed by the credit risk committee which will have the final decision (i.e. revise, approve, or reject) The credit files will be audited by internal credit auditor (i.e. Bank auditors) and external credit auditors (i.e. BNM auditors). CREDIT LENDING ASSESSMENT AND MANAGEMENT CONTINUE TO PART B…. THANK YOU Back To Home