Foundations of Bank Lending PDF

# FOUNDATIONS OF BANK LENDING ## Chapter 1: Fundamental Principles of Bank Credit ### Module Authors: - Jasman Tuyon, PhD - Rapheedah Musneh, PhD - Siti Julea Supar - Nurziya Muzzawer Faculty of Business and Management Universiti Teknologi MARA, Sabah Branch, Kota Kinabalu Campus ## Chapter's O...

# FOUNDATIONS OF BANK LENDING ## Chapter 1: Fundamental Principles of Bank Credit ### Module Authors: - Jasman Tuyon, PhD - Rapheedah Musneh, PhD - Siti Julea Supar - Nurziya Muzzawer Faculty of Business and Management Universiti Teknologi MARA, Sabah Branch, Kota Kinabalu Campus ## Chapter's Outline - **1.1 Fundamental Principles of Bank Credit** - 1.1.1 Introduction to Bank Credit - 1.1.2 The Credit Process Cycle - 1.1.3 Lending Decision Framework in Business Banking - **1.2 Rules and Regulations Governing Bank Credit in Malaysia** - **1.3 Ethics and Corporate Governance in Bank Credit** ## Learning Objectives: Upon completion of this chapter, students should be able to: 1. Define bank credit. 2. Clarify the importance of bank credit to the bank business. 3. Understand the flow of the credit process cycle. 4. Understand major provisions of the Financial Services Act 2013 and BNM guidelines affecting credit function. 5. Explain ethics and governance in financial institutions. ## Fundamental Principles of Bank Credit ### Sub-topic 1.1.1: Introduction to Bank Credit #### 1.1.1.1 Bank definition and scope of business **Definition:** - **Central Bank of Malaysia Act 2009 [Act 701]** > "financial institution” means a person carrying on a financial business regulated under the laws enforced by the Bank and in addition includes any- > (a)person who operates any payment system or issues any payment instrument; - **Financial Services Act 2013 [139]** > "the word "bank” unless such person is licensed under this Act to carry on banking business or investment banking business" #### 1.1.1.2 Bank lending business - **Financial Services Act 2013** > "provision of finance" includes: > (a) lending of money; > (b) leasing business; > (c) factoring business; > (d) purchase of bills of exchange, promissory notes, of deposit, debentures or other negotiable instruments; and > (e) the acceptance or guarantee of any liability, obligation or duty of any person;. #### 1.1.1.3 Bank operation is highly regulated Bank operation is highly regulated at both the **international level** (Basel Framework) and the **domestic level**. **External Regulations:** - Regulations - Guidelines - Notices - Directions Issued by Bank Negara Malaysia - Financial Services Act 2013 - National Land Code Act 828 **Internal Regulations:** - Bank Credit Policy and Guidelines **External Regulations:** - Shareholder Theory/Stakeholder Theory - Agency Theory > Agency problem #### 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. #### External Laws & Regulations - Regulations, Guidelines, Notices and Directions Issued by Bank Negara Malaysia - Financial Services Act 2013 - National Land Code Act 828 (for land charges and lien as collateral) #### 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. ### Sub-topic 1.1.2: The Credit Process Cycle #### 1.1.2.1 Origination The "marketing phase" of credit process cycle. **Lender will:** - Initiate the contact with the customer - Discuss business requirements - Evaluate credit risk relative to the acceptance criteria This phase is conducted based on the Bank's internal lending policies and in compliance with external regulations such as Bank Negara Malaysia guideline and Financial Services Act 2013. At this stage, the credit officer will identify the target market and key customer group for retail and business lending in accordance with lending Bank's Risk Assets Acceptance Criteria (RAAC). The RAAC can be set for business lending and individual or consumer lending. - For business lending, - the RAAC can be set based on minimum sales, profitability, net worth, and account profitability to the lender. - For individual or consumer lending - the RAAC can be based on age, minimum loan amount, employment tenure, income, payment history etc. #### 1.1.2.2 Approval This stage involves credit evaluation/credit risk analysis. At this stage, the credit officer will review and analyse the credit application based on the available financial information (audited financial statement, income tax, financial forecast) and non-financial information (borrowing track record, litigation status, business background etc) in order to determine borrower's repayment ability. The credit evaluation can be carried out based on principles of lending, and using tools such as 5Cs basic credit factors, qualitative, and quantitative financial analysis. The Bank's credit officer will submit the credit proposition to Credit Approval for consideration and the loan will be approved/modified/declined with status (outright reject due to poor bankable credit, approved with or without conditions, refer to borrowers for more information, approved with reduce limit, recommend to higher approval authority) based on the Discretionary Approving Authority of the Credit Approval (Credit Approval Committee, Bank's BOD). The Bank's credit officer has the responsibility to recommend a quality credit proposition with acceptable credit risk that allows the lender to maximize their risk-weighted return. Upon approval, the Letter of Offer (LO) will be issued in the Bank's standard format incorporating all approved facility terms and conditions and presented to the borrower for acceptance. #### 1.1.2.3 Administration This stage involves loan documentation and disbursement. Once the borrowers accept the LO incorporating the approved terms and conditions, the Bank's legal documentation department will handle the execution and perfection of loan agreement and security agreement between the borrower and the lender. Alternatively, they may instruct the Bank's panel of solicitors to handle the legal documentation depending on the complexity of the security arrangement. To ensure effective check and balance and to minimize risk of conflict of interest and fraud, another independent unit of the Bank known as loan disbursement department will handle the release of loan/ banking facilities. They are to ensure that all approved terms and conditions are duly complied with and the legal documentation duly perfected before the loan is disbursed for the borrower's utilization. This is also to ensure Bank's right is protected with good enforceability over the collateral taken as security for the loan. #### 1.1.2.4 Monitoring This stage involves activities, roles and responsibilities of credit officers after the loan is disbursed. - The lender must monitor the loan account to ensure the borrower meets all repayment obligations in a timely manner, and actively utilizes the facility in order to generate profitability for the Bank. - The loan monitoring also includes tracking of all post-drawn down terms and conditions for compliance by the borrower. - In addition, the credit officer is required to carry out a review of the borrowing account of at least once a year to revisit the borrower's credit risk profile and financing needs, and to assess the need to restructure/modify/renew or wind down the banking facility. - Proactive loan account management and loan monitoring is important for the lender to identify potential warning signals or red flags that would weaken the borrower's loan repayment and increase the risk of loan default, and to take pre-emptive action to protect the bank's interest and mitigate loan losses. **Loan monitoring covers the following:** - **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 down) conditions** to ensure full compliance e.g. placement of sinking funds, quarterly submission of financial accounts, certified progress billing before loan draw down.. - **Site visitation** to verify business visibility and management competency. - **Interim or annual review** to revisit the borrower's risk profile, financing requirement, or the need to restructure facility terms according to the borrower's operating cycle. #### 1.1.2.5 Settlement/Recovery The final phase of the credit process cycle involves repayment and settlement of loan owing to the lender by the borrower upon the maturity of the loan period. In the event where the borrower encounters a problem in meeting the loan repayment or is unable to make full loan settlement, the lender is required to undertake loan rehabilitation which involves loan rescheduling and restructuring to prevent the loan from turning into non-performing. Loan recovery will be the last resort for the lender. - It is applicable in situations where the borrower's business cash flow and repayment ability is permanently affected and is unlikely to recover to meet its loan obligation. - The bank will commence legal proceedings and sell the asset held as collateral to settle the loan outstanding owed by the borrower.