Business Credit Essentials Chapter 2 PDF

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  BUSINE...

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  BUSINESS CREDIT ESSENTIALS CHAPTER'S OUTLINE Principles of Lending Credit Evaluation Credit Information Loan and Securities Framework and Verification Documentation Principles of Lending Sub-topic 2.1 Next Slide  RECAP: Bank Process Insights By Department By Process Marketing/Sales Marketing/Sales leads Department Head Office Origination Submission of application Credit Credit Risk Management information and In the bank process, the form and other required Department documents verification credit analysis, the Credit Analysis principles of lending, Credit Committee Credit Analysis Principles of Assessment and approval of ▪ 5Cs Approval and verification of Approval Department Lending facilities requested ▪ CAMPARI information are Issuance of letter of offer/ occurring in the approval Compliance to rejection to borrower process. rules and regulations Borrower declines (internal and Borrower accepts offer Loan and 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 Administration (perfection of legal Disbursement of credit Department documentations) facilities Panel Solicitor Credit facilities Monitoring monitoring Credit Rehabilitation & Recovery Credit facilities recovery Department Recovery Business Banking / Business Center 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 Principle of Risk the Quality of Credit Diversification Principle of Proportionate Principle of Appropriate Stake Tenure of Financing Principle of Pari-PASSU Principle of Purposeful Principle of Protection and 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 with 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 of 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.  Principles of Lending (Cont.) 2. Principle of Prioritizing the Quality of Credit Illustration of the impact of Loan Loss In the course of pursuing If a loan of RM1 million earns an interest loan growth and account 10% p.a. defaulted with no chance of profitability, the lender may recovery, total loss for the lender would inadvertently compromise be: the loan assets quality RM1 million (loan principle) + without realizing the material RM100,000 (interest lossess p.a.) = financial implication caused RM1.1 million (total loan loss) by loan impairment. If average loan size for the bank is RM1 It is imperative to note that million with an interest spread of 2% for every one ringgit of loan p.a., the bank must get 55 new loans losses, lender may need to totaling up to RM55 million to cover the extend 50 to 100 times of newNext Slide loss from this bad loan. credit in order to New loan to cover loss = RM1.1 million / compensate the loan losses. 2% = RM55 million 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