Business Credit Essentials Chapter 2 PDF

Home About FIN367 BUSINESS CREDIT ESSENTIALS CHAPTER 2 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 ...

Home About FIN367 BUSINESS CREDIT ESSENTIALS CHAPTER 2 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  FIN367 BUSINESS CREDIT ESSENTIALS CHAPTER'S OUTLINE Principles of Lending Credit Evaluation Credit Information and Loan and Securities 9 Principles Framework Verification Documentation Loan Agreement The 5Cs Model Property Security The CAMPARI Model Other Security Guarantee and Indemnity More Info More Info More Info More Info  FIN367 Learning Objectives: Upon completion of this chapter, students should be able to: 1. Apply key lending principle in credit risk assessment 2. Use 5Cs and CAMPARI framework in credit risk assessment 3. Understand the credit information acquisition and verification 4. Describe the loan agreement and security documentations Read More...  Home About FIN367 Principles of Lending Sub-topic 2.1 Next Slide  RECAP: Bank Process Insights FIN367 By Department By Process Marketing/Sales Marketing/Sales leads Department Head Office Origination Submission of application C r e d i t Credit Risk information and Management form and other required In the bank process, the documents verification Department credit analysis, the Credit Committee Credit Analysis Principles of Assessment and approval of Credit Analysis principles of lending, and ! 5Cs Approval Approval Department Lending facilities requested ! CAMPARI verification of information are occurring Issuance of letter of offer/ in the approval process. Compliance to rejection to borrower rules and regulations Borrower declines (internal and Borrower accepts offer L o a n a n d offer or appeal against securities external) facilities Borrower comply to legal documentation Loan and securities requirement and pre- Administration documentations are Appointed disbursement conditions occurring in the Solicitor administration process. Credit (perfection of legal Disbursement of credit Administration documentations) facilities Department Panel Solicitor Credit facilities Monitoring monitoring Credit Rehabilitation & Credit facilities recovery Recovery Recovery Department Business Banking / Business Center  FIN367 Principles of Lending Every extension of credit facilities involves risk. It is important for Credit Officer to understand and apply the fundamental credit principles in their credit evaluation in order to make a sound credit judgement, and manage the credit risk effectively. Principle of Risk Taking Principle of Control Principle of Prioritizing the Principle of Risk Diversification Quality of Credit Principle of Proportionate Principle of Appropriate Stake Tenure of Financing Principle of Pari-PASSU Principle of Purposeful and Principle of Protection Productive Lending In the process of assessment and approval, credit officer need to ensure that al3 of these lending principles are complied. Principles of Lending (Cont.) 1. Principle of Risk Taking in Credit and Lending An effective risk management involves: Identify risks that can cause the credit to be vulnerable Mitigate risks with lending covenants, terms and conditions, control measures and / or appropriate structuring of credit facilities Under this principle, the bank is required to adopt a credit culture that guides the Bank’s Management and its officers to practice effective risk management and quality first policies in all credit decisions with little exception Principles of Lending (Cont.) 1. Principle of Risk Taking in Credit and Lending (Cont.) A strong credit culture: Promotes good corporate governance that govern the business strategies and administrative actions of the bank management and its officers. Discourage irresponsible lending practice Minimize Fraud Develop positive recognition from the market Promote confidence among depositors, investors, and shareholders. Lender must also be mindful or risk return concept. The Bank provides debts financing at a fixed return therefore should not take on excessive equity risk like business owners which have the potential of unlimited return.  Home About FIN367 Principles of Lending (Cont.) 2. Principle of Prioritizing the Quality of Credit In the course of pursuing loan Illustration of the impact of Loan Loss growth and account profitability, If a loan of RM1 million earns an interest the lender may inadvertently 10% p.a. defaulted with no chance of compromise the loan assets recovery, total loss for the lender would quality without realizing the be: material financial implication RM1 million (loan principle) + caused by loan impairment. RM100,000 (interest lossess p.a.) = It is imperative to note that for RM1.1 million (total loan loss) every one ringgit of loan losses, If average loan size for the bank is RM1 lender may need to extend 50 to million with an interest spread of 2% p.a., 100 times of new credit in order the bank must get 55 new loans totaling to compensate the loan losses.Next Slide up to RM55 million to cover the loss from this bad loan. New loan to cover loss = RM1.1 million / 2% = RM55 million  Home About FIN367 Principles of Lending (Cont.) 3. Principle of Risk Diversification Lender is required to have a well spread /diversified lending portfolio to mitigate the concentration risk. Over concentration in any particular borrower group, industry sector or market segment may adversely be affecting the Bank’s financial condition in the event of downturn of any particular single counterparty, industry, or market segment. Bank Negara Malaysia had imposed the Single Counter Party Exposure restriction on financial institutions to mitigate risk concentration. Next Slide Principles of Lending (Cont.) 3. Principle of Proportionate Stake In credit risk evaluation, it is important for Credit Officer to assess the financial and capital commitment of owner/shareholder of a company towards the company’s business and debts obligation. Reason - lenders are only debt creditors with fixed return for the lending risk they underwrite unlike the shareholders who participate in the unlimited growth potential of the company. A low capital commitment by business owner/ shareholder or borrower increase the risk of loan default in time of economy adverse as the potential losses suffered by borrower is relatively low as compared to lender prompting borrower to walk away from their debts obligation. Principles of Lending (Cont.) 3. Principle of Proportionate Stake (Cont.) For retail lending, a Higher Loan to Value (LTV) of assets financed, led to higher lending risk due to lower margin of contribution by borrower relative to lender in assets financing. For business lending, Debts to Shareholders Equity of