the principles of lending and lending basics
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30/09/2014 978-0-7346-1164-2
Chapter One
The principles of lending
and lending basics
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Distinguish different types of borrowers and any speciaconsiderations in lending.
Explain how advances are structured.
Explain the importance of credit culture in a lending ins Understand how an advances portfolio is designed.
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Introduction
Lending evolved in real-world practice with supporting developed later.
Lending principles are universal in their application to lo
all sizes. Lending is both an art and a science.
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Principles of good lending
Safety of loan: Borrower should be of good character, financially sound with
and willingness to repay the loan.
Suitability of loan purpose: Loan applications may be accepted or rejected subject to ba
legality and ethical principles.
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Profitability: The risks and returns from lending activities must be carefull
considered to improve viability of loan portfolio.
Following the Lending Principles: Regardless of loan size, lending principles of varying levels osophistication must be rigorously adhered to.
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Five Cs
Character
Capacity
Capital
Collateral
Conditions
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Traditional methods of creditanalysis
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Modern approaches to creditrisk measurement
Econometric techniques
Optimisation models
Neural networks
Hybrid systems
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External factors affectinglending decisions
Legislation including common law, RBA Act, Banking AUniform Consumer Credit Code, ASIC Act and the ACCconsumer laws
Macroeconomic factors Industry-specific factors
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Lending Inst i tut ion-Speci f ic Factors :
Institution's lending policy, Loan Budget and Staff Availability
Bo rrower-Speci f ic Factors :
Meeting Five Cs requirements and compliance with legal
requirements such as common and black-letter law
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The lending process
Ten-Step Process :
Step 1: Use of prescribed application form
Step 2: Obtain required supporting documents such as income
financial statements
Step 3: Check loan application and supporting documents forinconsistencies
Step 4: If personal loan, loan decision can be made. If business
lender to gain better knowledge of proposed borrowers busines
Step 5: Appraise technical, commercial, financial and manageri
of the business 11
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Step 6: Assess financial requirements and determine most s
product
Step 7: Advise potential borrower whether loan application is
successful or not
Step 8: Ensure security and all other loan documents are sig
Step 9: Monitor borrowers financial position and repayment
Step 10: Ensure necessary steps are taken before loan in de
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Characteristics of differenttypes of advance
Tradit io nal Types of Advance
Loans Classified According to:
Security secured v. unsecured loans
Type of Borrower personal, business or government Term of Loan short, medium or long
Sector retail, manufacturing or mining
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Loans Classified According to:
Region rural, town or major city
Purpose personal, home, commercial, motor vehicles.
Overdrafts: Flexible form of fixed limit continuous loan with no fixed re
schedule and flexible drawdown characteristics.
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Traditional types of advance
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Modern forms of advance forbusiness
Equity Participation: where equity rather than debt f
provided
Loan Syndication: consortium of lenders provide fun
Equipment Leasing: financing v. operating
Factoring: sale of business debt
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Personal borrower
Unable to enter loan contract if: Minors borrower under 18 years
Persons of unsound mind
Insolvents bankrupts or insolvents who are either undispending proceedings
Joint Accounts: account held in the name of two or mpersons
Husband and Wife: see joint account
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Sole Proprietorship: Business operated by one pers
Partnerships: Business with more than one owner w
profits shared
Companies: Separate legal entity recognised under
Corporation Law
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Business borrower
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Special types of borrowers
Local authorities: e.g. local government entities such a
Councils
Clubs, Literary Societies and Schools: Generally regis
unincorporated associations or trusts Unincorporated Associations: e.g. arts, charities and r
organisations
Co-operatives: e.g. farming bodies
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Structuring of advances
Security/Collateral: Includes land, buildings, directors guarantees, shares and c
Debt Covenants: Outlines key loan conditions including fees, security, repaym
Pricing Issues: Risk premium over a benchmark rate
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Credit culture
Can be defined as:
The institutional priorities, traditions and philosophie
surround credit or lending decisions; and/or
The collection of principles, actions, deterrents and
that exist within a lending organisation Caouette, AltmNarayanan (1998)
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Banc One uses the principles of:
Strong customer orientation
A preference for small exposures
An understanding of the business to whom you are lendin
Understanding of the organisationsrisk tolerance and pr
when assessing proposals
Understanding that avoidance of problem loans is not nec
good sign
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Designing an advancesportfolio
Advances portfolio design requires decisionsincorporating:
What resources are available to invest?
Of these, what proportion should be invested in advances
What proportions should be invested in personal versus badvances?
Of those personal advances, what proportion should be iloans, credit cards and so on?
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Three main approaches:
Historical or recent loss experience
Standards based on risk tolerance to capital
Risk-adjusted return on capital, where risk is evaluarelative to the risk either at the transaction level or b
unit level.
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