Chapter 1 - Foundations of Bank Lending PDF

FIN367 1.1.1 Introduction to Bank Credit 1.1.1.1 Bank definition and scope...

FIN367 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... FIN367 Introduction to Bank Credit (Cont.) 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 “the word “bank” unless such person is licensed under this Act to carry on banking business or investment banking business” Business: Financial Services Act 2013 “banking business” means— (a) the business of— (i) accepting deposits on current account, deposit account, savings account or other similar account; (ii) paying or collecting cheques drawn by or paid in by customers; and (iii) provision of finance; and (b) such other business as prescribed under section 3;  FIN367 Introduction to Bank Credit (Cont.) 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, certificates of deposit, debentures or other negotiable instruments; and (e) the acceptance or guarantee of any liability, obligation or duty of any person;. FIN367 Introduction to Bank Credit (Cont.) 1.1.1.2 Bank lending business (cont.) Typically a universal banking operations are divided into five areas: 1. Wholesale and corporate banking, responsible for providing financial services to large enterprises (public firms) 2. Business/SME banking, responsible for Or Investment banking providing financial services to medium to SME/Business large SMEs (private firms) Banking 3. Retail and consumer banking, responsible for providing financial services to individuals and small businesses Focus of this course 4. Treasury, responsible for managing the bank’s funding and liquidity needs 5. Asset management, responsible for investing funds on behalf of customers. Sample of Bank Structure Source: Adapted from Golin and Delhaise (2013).  FIN367 Introduction to Bank Credit (Cont.) 1.1.1.2 Bank lending business (cont.) Balance Sheet Profit & Loss Account Credit to SMEs is an important business of the Loans Equity Interest income……….……[+] bank andC contributes large part to the bank Deposit Fee-based income…..…...[+] credit portfolio. Interest paid………………….[-] Loan losses (Loss).………..[-] Total Assets Total Liabilities Expenses……………………….[-] Granting more loans to SMEs will 3exposed(the and Equities bank to(high credit risk3 that is directly impacting Net Profit……………….[+/-] the bank’s profitability. Bank Lending to SMEs Credit risk impacts to bank’s Credit to SMEs profitability Hence, SME credit analysis need to be properly undertaken to Cmitigate credit risk( following internal credit analysis process, credit policy, compliance to laws and regulations. Bank Project Borrower a FIN367 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 Regulations, Bank credit policy Guidelines, Notices Internal regulations and guidelines and Directions Issued by Bank Negara Malaysia Financial Services Act 2013 National Land Agency Theory > Agency problem Code Act 828 The “marketing phase” of credit process cycle.  FIN367 Introduction to Bank Credit (Cont.) 1.1.1.3 Bank operation is highly regulated (cont.) The Basel Framework bes The Basel Framework is the Cfull set of standardsSof the Basel Committee on Banking Supervision, which is the primary global standard setter for the prudential regulation of banks. External Laws & Regulations The external laws and regulations affecting bank credit functions including: ✔ 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. - dokumen yg tetapkan guidelines ↳ to make lending decision The “marketing phase” of credit process cycle. FIN367 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  FIN367 The Credit Process Cycle -marketing 1 Origination creditation Principles of lending 2 Approval applies (in Chapter ?) atk ment flow repay 3 Administration What is credit process cycle? ~ lending- loahdocumentationa It is the operational flow of credit lending, from loan origination to full loan repayment. Monitoring info 4 provide responsibility Why credit process cycle is important? ~ after loan disburse It provides vital information to the lender in the process Settlement/ Read More.origination, of loan.. data and information for 5 Recovery upon loan verification of borrowers, and credit evaluation based maturity period on internal and external parameter. FIN367 The Credit Process Cycle (Cont.) 1.1.2.1 Origination ~ promoteemer The “marketing phase” of credit process cycle. Lender will : Initiate the contact with customer Discuss business requirements Evaluate credit risk relative to the acceptance criteria This phase is conducted based on Bank’s internal lending policies and in compliance with external regulations such as CBank 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 onCage, minimum loan amount, employment( tenure, income, payment history etc.  FIN367 The Credit Process Cycle (Cont.) - tak credit application dr financial info 1.1.2.2 Approval lik tentukan kita mampu ke tak byr balik 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 orderC to determine borrower’s repayment ability.S 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 allow 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 borrower for acceptance. FIN367 The Credit Process Cycle (Cont.) 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 and security agreement( documentation department will Shandle the execution and perfection of loan agreement3( Cbetween the borrower and the lender.( Alternatively, they may instruct the Bank’s panel of solicitor toChandle the legal documentation() depending on the complexity of security arrangement.C 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. C They are to ensure that all approved terms and conditions are duly complied with, and legal documentation duly perfected before the loan is disbursed for borrower’s utilization. This is also to ensure Bank’s right is protected with good enforceability over collateral taken as security for the loan.  FIN367 The Credit Process Cycle (Cont.) 1.1.2.4 Monitoring Loan monitoring covers the following: This stage involve activities, roles and responsibilities of credit officers Monitor facility utilization in orderCto generate profitabilityIto after the loan is disbursed. the bank. i The lender must monitor the loan account to ensure borrower meets all Monitor loan repayment to(ensure satisfactory conduct and repayment obligation in a timely manner, and actively utilize the (( prompt payment, and to detect any potential warning signal/ red C facility in order to generate profitability for the Bank. flag.C The loan monitoring also includes tracking of all post-drawn down previous terms and conditions for compliance by borrower. Tracking of antecedent (post draw dawn) conditions to ensure In addition, credit officer is required to carry out review of borrowing full compliance e.g.(placement of sinking funds, quarterly account of C at least once a year(C to revisit borrower’s credit risk profile submission of financial accounts, certified progress billing C and to assess the need to and financing needs, before loan draw dawn.( restructure/modify/renew or wind down the banking facility. Site visitation to Cverify business visibility and management Proactive loan account management and loan monitoring is important competency.C for lender toCidentify potential warning signals or red flags ( that would 2weaken the borrower’s loan repayment and increase risk of loan C Interim or annual review to Srevisit borrower’s risk profile, default,1) and take pre-emptive action to protect bank’s interest and Cfinancing requirement(C or the need to restructure facility terms ( mitigate loan losses. according to borrower’s operating cycle.C FIN367 The Credit Process Cycle (Cont.) 1.1.2.5 Settlement/Recovery The final phase of the credit process cycle involves repayment and settlement of loan owing to lender by borrower upon the maturity of loan period. In the event where borrower encounters problem in meeting the loan repayment or unable to make full loan settlement, lender is required to undertake loan rehabilitation which involves(loan rescheduling and restructuring to prevent loan from turning into non-performing.( Loan recovery will be the last resort for the lender. It is applicable in situation where 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 proceeding and sell the asset held as collateral to settle the loan outstanding owed by the borrower.