ABUBAKAR TAFAWA BALEWA UNIVERSITY, BAUCHI

FACULTY OF MANGEMENT SCIENCES

DEPARTMENT OF ACCUNTING AND FINANCE

16th April, 2017

COURSE: MAFS 616 (Bank Lending and Credit Administration)
CREDIT HOURS: 3 Credits
CLASS: Masters in Accounting and Financial Studies
SEMESTER /SESSION: 1st Semester, 2016/2017 Session
LECTURER: Kabir Tahir Hamid, PhD
CONSULTATION: Saturday 11.30-1.00pm
OFFICE: Department of Accounting Finance, ATBU

A. COURSE DESCRIPTION
This course is designed to introduce the meaning of bank lending and its objectives, principles
of good bank lending and credit administration, lending appraisal decisions, types of loans and
constraints on bank lending, pricing of loans, loan supervision and security problems, defaults
and bad debts.

B.COURSE OBJECTIVES
The main objective of this course is to introduce students to accounting information
system. It is expected that on completion of this course, the students should be able to:
i) understand the meaning of bank lending and its objectives;
ii) identify and explain the principles of good bank lending and credit administration;
iii) discuss lending appraisal decisions and types of loans
iv) identify and explain the constraints on bank lending,
v) explain the models of pricing of loans;
vi) highlight the procedure of loan supervision;
vii) explain the meaning of defaults and bad debts; and
viii) highlight and discuss Decision Criteria Credit Administration;

C. COURSE CONTENTS
1. Introduction to Bank Lending
2. Bank Policies on Lending
3. Credit Extension By Banks
4. Credit Protection Methods
5. Lending Procedure
6. Objectives of Lending & Credit Administration
7. Lending and Credit Administration
8. Lending Appraisals & Decisions
9. Loan Monitoring & Supervision
10. Pricing of Loans

D. RECOMMENDED TEXT BOOKS

Fraser, D. R., Gup, B. E. and Kolari, J. W. (1995). Commercial Banking: The
Management of Risk, Minneapolis/St Andrew: Western Publishing Company.
Jessup, P. F. (1980). Modern Bank Management, New York: West Publishing Company.
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Jhingan, M. L. (2008). Money, Banking, International Trade and Public Finance, 7
Edition, Delhi: Vrinda Publications (P) Ltd.
Luckett, D.G. (1984). Money and Banking, Singapore: McGraw-Hill Book Co.
International Edition.
Uremadu, S. O. (2004). Core Bank Management: Concepts and Application, Enugu:
Precision Publishers.
Uzoaga, W.O. (1981). Money and Banking in Nigeria, Enugu: Fourth Dimension
Publishers.
Uremadu, S. O. (2000). Bank Management: Basic Issues in Money, Bank Lending and
Credit Administration, Benin City: Precision Publishers.

E. COURSE REQUIREMENTS
Every student is required to attend the class regularly and participate actively in group
discussions and study group activities. Attendance at lecture is compulsory and at least
75% attendance record is mandatory for a student to qualify to sit for the end of semester
examination. Students are also expected to sign up for an email account for effective e–
discussions.

F. COURSE DELIVERY STRATEGIES/METHODOLOGY

Face to face lectures, class discussion, group work, and online interaction. The course
outline along with the complete lecture notes would be made available to the class and
would be posted onto the internet. Students are expected to photocopy (and or
download) and read the notes before each lecture for better understanding and effective
participation during class discussion.

G. BREAK-DOWN OF GRADING

S/No. Type Scores (%)

1 Assignments 20
2 Continuous Assessment 20
(Tests)
3 Final Examination 60
Total Score 100

The continuous assessment marks are to be absorbed through snap test (s) to be given
without notice, scheduled test (s) and/or paper presentation.

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11. Introduction to Bank Lending
In 1906, Italian economist Vilfredo Pareto created a mathematical formula to describe
the unequal distribution of wealth in his country, observing that twenty percent (20%) of
the people owned eighty percent (80%) of the wealth. This principles of 80/20, later
came to be known as Pareto principles. Uneven distribution of wealth in the society
necessitated the need for banks to intermediate between the surplus and deficit units for
economic growth and development. Lending is thus central and fundamental to the
financial intermediation role of banks, making banks to granting different types of loans,
with different periods of moratorium, rate of interest and repayment terms to their
customers. The lending function of banks is equally ingrained in the need to generate
maximum return for the shareholders and maximum liquidity for the depositors, as well
as achieve their objectives.

A bank is a financial intermediary for the safeguarding, transferring, exchanging, or

lending of money. When customers deposit their money with a bank, they are giving the
bank permission to borrow the money. This borrowed money is what is used for the
loans to the bank customers. The bank pays a smaller amount of interest to the customer
who allowed them to borrow the money and charges a larger amount of interest to the
customer they lent the money to. The bank makes money from the difference in the
interest. If too many depositors run to withdraw their money like in a time of depression,
backup systems like a consortium of banks and the Central Bank and other systems
intervenes to get money to the banks to meet their obligations to depositors and save the
bank from collapsing.

1.1 The Concept of Bank Lending

Bank lending is the granting of credit facilities to borrowers (individuals and
organizations) at an interest rate, based on collateral security to be repaid after a period
of time. An effective lending therefore is one that maximized profit to shareholders and
liquidly to depositors, as well as, ensure societal economic development.

1.2 Objectives of Bank Lending

The Objectives of bank lending include:
(i) Stimulate economic growth and development: This is done by lending money
to businesses to purchase assets with that will grow their business, which will in
turn produce more goods, create more sales, and stimulate the economy, while at
the same time making enough profit off of the new assets to be able to pay the
money back in a timely fashion with interest thereby making the bank to earn
profits and deliver returns to its shareholders.
(ii) Encourage savings and investment: Bank lending encourage savings by
individuals and organizations which are taking to the bank for safe keeping or
eventually give the money as loans and overdrafts to their customers.
(iii) Maintain maximum profitability to shareholders and liquidity to investors:
Bank lending enable banks to earn profit through the difference between the
interests paid on savings and fixed deposits and that charged on loans and
overdrafts. Part of the profit earned is given as dividend to shareholders while the
remaining part is retain in the bank to enhance liquidity and provide for expansion
and growth in the business,
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(iv) Realize government policy objectives: Banking is used as a vehicle for driving
government monetary policy through expansion and contraction in the amount of
credit facilities due to the economic situation of a country.

12. Bank Policies On Lending

Commercial banks are business entities which are established for the purpose of carrying
out banking operations with the aim of earning reasonable returns for the shareholders.
This implies that such organizations cannot be operated effectively and efficiently
without internal laws, regulations and procedures for transacting banking business.
Hence the need for operating policies by commercial banks cannot be overemphasized.
2.1 Nature of Bank Policies on Operations
The bank policies are normally derived from the objectives of their operations which are
products of their mission statements. The bank policies are formulated with the intention
of ensuring that the operations of the banks are established on sounding footing which
conforms to the best practices of banking operations. This is because bank operations are
basically embedded in financial intermediation; sourcing for funds from surplus areas
and lending such funds to areas of needs. Bank policies affect the organizational
structure and by extension also influence the employment of the personnel. Bank
policies are also used to shape the bank personality and for shaping the desired course of
action in terms of the operational direction of the banks. Bank policies are normally
formulated on operational areas such as follows:
(i) organizational structure
(ii) employment of the personnel
(iii) modalities of operations\
(iv) lending procedures
(v) investment of funds
(vi) strategies for hedging risks in operations
(vii) sectorial allocation of loans and advances
(viii) remuneration of personnel
(ix) appointment of external auditors, etc.

The formulation of bank policies can be the responsibility of the board of directors. The
policies can also be formulated by the chief executive officers and tabled before the
board for consideration and approval before their implementation. In some instances, the
policies can be formulated by committees constituted by the management for such
purpose.
The formulation of bank policies in unit banks with their operations being restricted to
specific areas, such as the microfinance banks in the country, can be easily
accomplished. This is because of such banks’ nearness to their personnel and the
understanding of the particular areas where they operate. For instance, a microfinance
bank would have distinct operational policies given the peculiar socio-economic
conditions as compared to the operational policies for a microfinance banks which
engage in business in an area like Lagos. These are also different from the operational
policies of microfinance banks that are doing business in Bauchi.
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The operational policies of the branch banks do differ from those of the unit banks. This
is because of the fact that their operations spread over a large geographical areas.
Therefore, the branch managers are expected to make some inputs into the overall
corporate policies necessary for successful operations. Furthermore, the branch manager
of each area may like to initiate a different policy on a particular matter which is dictated
by the peculiar environment in issues such economic growth, economic activities, socio-
economic needs, and people’s attitudes towards banks generally.
The operational policies of the banks, be they unit banks or branch banks, should be
couched on the basis of flexibility due to the changing patterns of environmental
conditions. Hence banking policies should be subjected to review on periodical basis
because of the changing economic condition and other environmental dictates which
shape banks’ operations. Therefore, the need for the formulation and constant review of
the bank policies becomes very relevant in the areas of sourcing for deposits from the
public, investment of funds on marketable securities, hedging against risks in operations,
managing credit risks, and above all lending or granting credits, loans and advances to
customers.
2.2 Principles of Bank Lending Policies
There are basic principles which normally come into play when the commercial banks
consider the establishment of lending policies for their operations. Such principles of
bank lending are as identified and discussed below.
(i) Safety: This is the most important principle of good lending. When a banker lends
that the borrower is going to repay. If for example the borrower invest the money
in unproductive and speculative venture or the borrower himself is dishonest the
advance would be in jeopardy. Similarly if the borrower or suffer losses in his
business due to incompetence the recovery would be difficult. The bank ensures
that the money advanced by him goes to the right type of borrower and is utilized
in such a way that it will not only be safe at the time of lending but remain so
throughout the period, and after serving a useful interest purpose in the trade or
industry where it is employed to repaid with interest.
(ii) Liquidity: It is not enough that the money will be repaid back, it is also necessary
that it must be repaid back on demand or in accordance with agreed terms of
repayment. The borrower must be in position to repay within a reasonable time
after demand for repayment is made and the source of repayment must be
definite. This is because bulk of the bank deposits are repayable on demand or
short notice and liquidity of the borrower can affect the ability of the bank to
repay its depositors on demand in spite of the safety.
(iii) Profitability: Loans and advances are not just granted customers for the fun of it.
They are usually granted with the intention of earning some income for the
banks. This income can only be earned by the bank through the interest charges
being made from the loans granted to customers. The interest on loans from the
banks to customers are normally established taking into consideration the
prevailing market rate and the established bank rate by the apex bank in the
economy, which is called the monetary policy rate. The interest rate being
charged on loans by the commercial banks is normally higher than the bank rate

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 being charged by the apex bank, and building into it other charges as may be
determined by the banks.
(iv) Diversification: In the process of granting loans to customers, the banks consider
the composition of the loan portfolio so as to strike the desired diversity of the
investment. The loans being granted to customers are not normally concentrated
in a particular type of sector but in different types of sectors, which will have to
conform to the policy of sectorial distribution of loans as demanded by the apex
bank. The distribution of the loan portfolio is also imperative towards minimizing
risks that are always inherent in lending of funds. The principle of diversity is
also applicable to spreading loans to various industries, firms, businesses and
trades. Hence, commercial banks do strive to spread of risks of investment in
loan portfolio by giving out credits to various trades and industries.
(v) Stability: Commercial banks only advance loans to customers whose businesses
generate stable incomes. For instance, a customer who applies for a loan facility
should have his project or business evaluated to determine the possibility of such
ventures generating constant income with which to serve the loan and make
repayment on regular basis. Therefore, for a new project the technical feasibility
and economic viability report will be evaluated to determine the nature of cash
inflows in terms of stability of earnings, which will be used for repaying the loan
and servicing it. The regularity of the earnings is very important and this will
depend on the prudent management of the project. In the case of existing
business, the financial reports for a period of not less than five years on
consecutive basis will be evaluated to determine the regularity and quantum of
earnings. Such assessment is used to evaluate the stability of such earnings
towards definite repayment of loan facility.
(vi) Purpose: The purpose should be productive so that the lending would not only
remain safe but would provide definite source for repayment. It would be
important if the purpose is short and the risk is small and the money be applied
for the purpose intended.

2.3 Major Areas of Bank Policies on Lending

There are critical areas relating to lending that the banks do not normally take for grant
in the formulation of bank policies. Such areas for policy formulation on bank lending
are as identified and discussed below.
(i) Loan Limit: Policies are normally set for the granting of loans by the various
officers of the bank that are directing involved in lending. In setting the magnitude
of loan that can be approved by the officers in charge of credits, certain factors are
usually taken into consideration. In terms of policy on loan limit for the officers, the
factors taking into account may include the position of the officer, e.g., a branch
manager, senior loan officer, the experience of the officer, e.g., 10 years in loan
administration, the level of expertise in sector of the economy, e.g., estate,
agriculture, etc,, the performance of the officer in handling loans in the past; and
understanding of the customers’ product markets.
In terms of the loan limit for the customers, the following factors, among others, are
taken into consideration; creditworthiness of the customer; performance on the
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 previous loans, for old customer; performance of the business in the last five years,
at least, for new customer, his market share in the industry, e.g., 5%, 10%, 25%,
35%, 45%, 60%, geographical area of operations, e.g., a town, city, suburb, village,
farm settlement, his operational capacity, e.g., medium-scale, large-scale
operations;, level of demand for his product or service in the economy; magnitude
of cash inflows on periodic basis; and customer’s character and other personal
qualities. Furthermore, grading system can be used for setting the policies on loan
limit such as portrayed by the Table 1.
Table 1: Categorization of Customers for Loan Limit Grad
Comments Loan Limit (N)
A Blue chip company 50,000,000
B Government Agency 10,000,000
C Large Company 5,000,000
D Medium Company 3,000,000
E Small Company 1,000,000
F Individualized Business 500,000

However, there is no hard and fast rule in the categorization of customers for the purpose
of loan limit. A grading or categorization system being used by any bank for setting loan
limits on customers depends on choice. In related terms, such categorization of loan
limits can be also be used to set loan mandate for the officers of the bank when it comes
to approval of loans for the customers. In the case of the branch manager, the usual
policy on loan limit is for the bank to set the amount of funds that he or she can lend out
to a customer. The limit is regarded as his or her authority in lending, and any loan
request in excess of such lending authority will have to be communicated to the head
office for advice. A loan request in excess of the branch manager’s authority in lending
can as well be communicated to the area manager who may have the authority to
sanction it without recourse to the head office for the necessary approval.
(ii)Loan Supervision: It is very important for the bank to set policies on loan
supervision. The policies on granting of loans, their supervision, and recovery drive
are normally established taking into consideration the relevant strategies used in the
past and those ones being utilized by other banks. Bank policies on loan supervision
are used to address responsibilities such as:
(a) Teams to be constituted for checks and balances;
(b) Superior officer(s) to be in charge of reports and evaluation, e.g., an Executive
Director at the head office, a Senior Manager at regional office;
(c) Time line for periodic reviews of loan portfolio for compliance on laid down
regulations;
(d) Number of loan recovery visits to customers who are loan beneficiaries in a
period.
(e) Charting out procedures for compliance with extant banking laws and
regulations on loan facilities;
(f) The rate of interest to charge in line with prevailing market rate and bank rate;
(g) Spread of available funds for different sectoral allocations; and
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 (h) Repayment drive to keep pace with liquidity needs.

(iii) Credit Risk Management: A policy should usually be established for the
management of the credit risk in terms of the problems that can emanate from loan
recovery by the bank. The policy is on the following areas of responsibilities:
(a) Manager’s responsibility in preventing credit risks;
(b) Assistant Manager’s responsibility in credit risk management;
(c) Loan officers’ responsibility in preventing credit risks;
(d) Hierarchical authority for handling credit risks; and
(e) Actions necessary in managing difficult beneficiaries of loans.

There are other areas of responsibilities for the management of credit risks by
various bank officials, which are not covered by above list. Therefore, the list is by
no means exhaustive for the purpose of credit management of credit risks by the
banks.

(iv) Managing Difficult Loan Beneficiary: There should be policy on how a difficult
loan beneficiary can be managed by relevant bank officials. Such policy should be
used to specify the necessary actions to be initiated and taken by the bank officials to
recover the amount of loan involved in the transaction. The necessary directives in
managing difficult account involve the following considerations:
(a) The use of committee for the recovery of the funds;
(b) Discussion with the difficult customer by the bank officials;
(c) Visit to the business premises of the customer for assessment;
(d) The use of subtle pressure on the customer, e.g., threat of legal action;
(e) Constant visits for help in managing the affairs of the customer;
(f) Threat of disposing off the collateral security pledged for the loan; and
(g) Legal letter on the status of the customer and the plan to take action on the
business for the recovery of the outstanding amount of loan.

In addition to the above, there are other areas for policy actions on difficult
customers, which various banks can formulate to manage them. More so, necessary
responsibilities for the management of the difficult customers are formulated and
assigned to various bank officials, which are not covered by above list. Therefore,
the list is by no means exhaustive for the purpose of managing difficult customers
by the banks.
(v) Controlling Customer Accounts: Policy on controlling the account of the
customer who is a loan beneficiary is also necessary for consideration in
establishing banking policies. The control of customer account is necessary because
of the fact that a customer can be playing pranks on the repayment of loan and
payment of interest on such funds. The policy on control of customer account
always emphases the following considerations:
(i) Constant monitoring of repayment status;
(ii) Periodic statement being issued to the customer;
(iii) Constant reminder on outstanding balance of the loan;
(iv) Computer alert sent to the customer whenever any payment is made;
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 (v) Any discrepancy such as delay or amount less than expected in repayment be
communicated to the customer immediately;
(vi) Computer alert on due date for next payment be sent to the customer on
monthly basis;
(vii) Monitoring of withdrawals from the customer account as not to jeopardize
repayment of funds loaned to him or her.

The above list is by no means is exhaustive, and therefore, it is left for individual
banks to decide on the necessary considerations in this respect.
(vi) Monitoring and Review of Customer Case: This is done to evaluate the
performance of a customer’s account. It is necessary in the management of the
bank’s liquidity particularly in the case of big time customers of the bank. In
addition, there is every likelihood that such customers will use their accounts to
demand for overdraft or loans in the course of their operations. There are areas on
which policies can be established for such purpose.
The account turnover, trends in account balance with the bank, amount in cheques
drawn and customer’s performance in standing order can be used to monitor the
account of such customer who are known for keeping large amount of funds in their
account:
13. Credit Extension By Banks
Commercial banks operate business that is woven around financial intermediation
activities. In fundamental terms, banks are institutions which evolve for the business of
keeping, lending and exchanging of money. Therefore, banks are organizations whose
principal operations are entrenched in accumulation of idle funds from the general public
with the purpose of lending such funds to business entities and individuals as well as the
government institutions. The position of the commercial banks is that of retail banking
institutions that accept deposits from the public and in turn lend such funds to some
members of the public.
3.1 Nature of Commercial Banking Operations
Banks generally owe their operations in financial intermediation activities. Historically,
the goldsmiths that pioneered the realm of banking business evolved the operations by
accepting valuables such as bullions, money and ornaments for safekeeping. For the care
of the valuables, the goldsmiths started charging some fees for the safekeeping of the
money and the bullions. In the process of the safekeeping of money, bullion and other
valuables, the goldsmiths started lending the money to other people for fees. This serves
as the precursor of the modern banking business operations. In conceptual terms, banks
are institutions which evolve for the business of keeping, lending and exchanging of
money. In broad terms, there are other views banks in economics discipline which offer
succinct explanation on the essence of banking business

There is the view that banker’s business is to take the debts of other people to offer his
own in exchange, and in the process create money. Another view posits that banks are
organizations whose principal operations are embedded in the accumulation of
temporarily idle funds of the general public for the purpose of advancing to others for
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expenditure. Hence, commercial banks as retail banks are institutions that accept
deposits from the public and in turn advance loans by creating credit. The commercial
banks, are the banks that perform all kinds of banking functions such as:
a) accepting deposits;
b) advancing loans;
c) credit creation;
d) financing foreign trade;
e) discounting bills of exchange;
f) agency functions;
g) keeping of valuables;
h) issue credit instruments; and
i) serve as underwriters for shares and debentures.

The commercial banks are known for granting short-term loans, in most cases, to
customers. Nevertheless, in recent years, they have included medium–term and long
term loans in their loan portfolios. In terms of ownership, commercial banks are joint
stock banks in the sense that they are just like the joint stock companies whose
ownership cuts across many strata of the society; and therefore the shareholders of each
of such corporate banking entities run into millions.
3.2 Advancing Loans from Deposits
The commercial banks give out loan facilities to the members of the public particularly
their customers who are into one form of business undertaking or another. The situation
may be different in advanced climes where there are some other forms of loans or credits
which can be advanced to customers. Advancing loans or credits out of the deposits
constitutes one of the fundamental functions of the commercial banks. In the process of
banking operations, the commercial banks lend out certain percentage of the cash in
deposits on a higher rate of interest than they pay on such deposits. The various forms of
loans and credits being granted to customers by the commercial banks are identified and
discussed below.
(i) Term Loans: The commercial banks advance this type of loans to customers who
are businessmen against specified securities. The amount of loan is normally
credited to the current account of the borrower. In the case of a new customer, a loan
account for amount of loan is normally opened for the facility. The customer who is
the beneficiary of the loan facility is then free to withdraw money with cheques,
from the loan account in the case of the new customer and the current by the existing
customer of the bank. The beneficiary of the loan has to pay the specified or agreed
interest rate on the full amount of the loan and necessarily the loan principal would
also be repaid back to the bank.
(ii)Call Loans: These loans are short-term facilities that can be granted to the bill
brokers for not more than a fortnight or fifteen days. Such loan facilities are
normally advanced against first class bill or securities. Such loans can be recalled at
a very short notice and can also be renewed. These are similar to money at calls and
short notices normally advanced by banks to other banks in the money market
operations in the economy.

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(iii) Overdraft: This is the facility which is designed for the businessmen and
corporate entities for which they are allowed to cheques for sums greater than the
balance in their current accounts. The facility is effected by providing the overdraft
up to a specific amount to the customers against their future deposits, which would
be used to offset the amount involved by the bank. The commercial banks normally
charge interest only on the amount by which the current account is overdrawn and
not by the amount of the full amount of the overdraft approved for the customer by
the bank.
(iv) Discounting of Bills of Exchange: This facility is available for use by the
creditor who holds a bill of exchange. It is meant for immediate access to the funds
in the bill but at a discounted amount which is lower than the face value of the
instrument. The commercial banks through this facility provide the customer who is
a holder of a bill of exchange immediate cash by discounting the bill. The banks
would deposit the amount of the bill in the current account of the bill holder after
deducting their rate of interest for the period of the loan, which is not more than 90
days.
It is instructive to note that the bill of exchange is normally drawn by the creditor
and sent to the debtor for acceptance, and then given back to the creditor making it
payable after 90 days. At the maturity of the bill of exchange, the bank that
discounts it recovers its payment from the banker named by the debtor who accepted
the bill.
3.3 Credit Creation from Credit Facility
This function of the commercial banks is associated with granting of loan facilities to
their customers. By implication, the commercial banks cannot create credits without
engaging in granting loans to their customers. The credit creation by the commercial
banks, unlike other financial institutions that cannot create credits, arises out of their
quest to generate profits in their operations. For this rationale, the commercial banks
accept deposits and advance loans out of such funds by keeping small cash in reserve for
day-to-day transactions. In this operation, whenever the bank advances a loan, it opens
an account in the name of the customer as the beneficiary but does not pay cash to the
customer. The bank would allow the customer to draw the funds through the use of
cheques according to his needs. Hence, by granting loan to a customer, the commercial
bank creates credit or deposit.
14.Credit Protection Methods
The following are the methods being adopted by banks to ensure the protection of the
funds they usually commit into loans and advances.
(i) Retention of Title to Assets: One of the prominent methods of protecting bank
credits is retention of title to ownership of goods until the funds invested in the
articles are recovered. This is an important way of eliminating credit risk. The
retention of the articles by the bank does not involve any cost. This is relevant in the
case of leasing of items of equipment that involves acquiring these productive
assets and make them available to manufacturers for use on rental basis. The title to
the ownership of the assets is normally retained by the banks until they are paid for
by the users called lessee at the end of lease period. In essence, the bank that
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 financed the purchase of the assets has the right to retain ownership of the
equipment until they are paid for by the users. It implies that such arrangement
gives the bank the right to recover the items of equipment which are not paid for by
the users.
(ii) Establishment of a Separate Bank Account: This form of agreement is designed
to forestall the problem that can arise out of the conversion of the raw materials
funded by loan into finished without the fund being paid for by the manufacturer.
The requirement is that the customer as the loan beneficiary should establish a
separate bank account into which the proceeds from the sale of the finished goods,
arising from the conversion of the raw materials, be lodged on periodic basis. Such
lodgments will be used to repay the funds that have been advanced as loan to the
manufacturer by the bank.
(iii) Collateral Security: Another method of ensuring the protection of the funds being
granted as loans to customers is by way of collateral security. Therefore, the usual
practice by banks in the process of lending funds, is to request for some form of
collateral security. In the event of customer’s default or insolvency, the collateral
security can be possessed and sold by the bank to offset the loan or repay any
outstanding debt. The commercial banks normally consider certain categories of
property or assets as well as valuable for the purpose of securing collateral from a
loan beneficiary. The various forms of collateral security that can be considered by
the banks for the purpose of loans include the following debenture, mortgage and
guarantee/indemnity.
(iv) Taking Possession of Letters of Credit: The document embodies a payment term
in exporting, which is a means of transferring the final responsibility for payment
from the customer to a bank. The bank advancing loan to the exporter of goods will
have to demand for the irrevocable letter of credit to hold it as mortgage for the
loan.
15.Lending Procedure
The lending of loans and advances to the customers of banks goes through a rigorous
events. Such events or procedures are normally initiated by both the bank and the
customers who are seeking for credits with which to run their business operations. The
process involves contact between the bank and the applicant for loan, during which the
bank would initiate necessary actions to conduct a thorough investigation on the loan
applicant and his business or the project for which the funds would be utilized.
5.1 Loan Request from Customer: In the process of lending of credits, it is the normal
practice that a request be put forward by an applicant who is customer of the bank for a
credit facility for the operations of a business entity or to prosecute a certain project
which is expected to be self-liquidating. Nevertheless, some customers of the bank may
be approached by the bank managers or credit officials of the bank to convince them to
apply for credit facilities. The bank officials normally take into consideration certain
factors before initiating the move in drawing the attention of some customers that they
are entitled and qualified for credit facilities. Such move by the bank officials is
normally based on the following considerations:

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 a) performance of such customers in the operations of their bank accounts;
b) the size of their business undertakings;
c) the nature of their business operations;
d) their market share in the industry;
e) the personal integrity of the customers;
f) level of liquidity of the bank;
g) business focus of the bank; and
h) type of banking operations, e.g., investment banking.

In general terms, therefore, the request for loan facility of a customer can be initiated
by both the customer and the bank. This is often based contacts and good banking
relationships between the bank and their customers. Hence, it is not uncommon for
the bank’s loan officers and the managers to solicit new accounts from individuals
and firms operating in the bank’s market area with the idea of convincing them with
offer of loan facilities.

(ii) Interview with Loan Officer: The scheduled interview of personal interaction
between the loan officer and the applicant for loan facility is considered necessary in
lending procedure. The interview is very critical in view of the fact that there is need to
confirm the necessary claims by the customer who is seeking for the credit facility. The
interview is normally conducted on the strength of the loan form filled and the analysis
of same by the loan officer or loan committee as the case may be. The loan interview is
desirable because it can be used to extract some additional information from the loan
applicant, which can go a long way to help in giving favourable consideration, or
otherwise, to the loan request. The loan interview provides an opportunity for the bank’s
loan officer to assess:
a) the customer’s character and sincerity of purpose;
b) planned utilization of the funds;
c) actual amount of funds sufficient for the project involved;
d) applicant’s business acumen in utilization of the funds;
e) nature of applicant’s business operation;
f) means of ensuring prompt repayment of the loan; and
g) applicant’s understanding of the implications of loan obligations.

(iii) Site Visit by Bank Officials: It is desirable that the bank officials, and not only the
loan officer, pay schedule visit to the business premises of the loan applicant. The visit
of a team of bank officers to the customer’s business is imperative because the applicant
for the loan facility may not supply the necessary information upon which a decision
will be taken. The visit to the customer’s business becomes inevitable for the following
reasons:
a) If a business loan or mortgage loan is applied for;
b) When a mortgage loan is involved;
c) To verify the claims of the customer;
d) To assess personally the nature of customer’s business
e) To determine the actual scale of the customer’s operations;
f) Assessment of the location of landed property for security;
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 g) Assessment of organizational setup of the customer’s business; and
h) Determine supplementary information for decision on the request.

(iv) Evaluation of Loan Request: The final aspect of the lending procedure is the
evaluation of the loan request before a decision is taken on whether or not to grant the
request. In order to evaluate the loan request, the following considerations are assessed.
a) Financial Statements and Documentation
b) The financial statements and documentation needed for loan evaluation include:
c) Income statement of the business for some years;
d) Balance sheet of the business for some years; and
e) Board of directors’ resolutions authorizing the loan with the bank.

In the case of a new business, the necessary financial projections on income generation
and statement of affairs for some years, which are incorporated in the feasibility study
report, will have to be used for evaluation.
The bank will have to carry out the following:
(a) Credit Analysis: The credit analysis is used for determining whether the
customer’s business will be generating sufficient amount of cash inflows for the
regular repayment of the loan. In addition, the backup assets of the business will
also be assessed for the purpose of the business’ capacity to generate needed funds
with which to repay the loan.
(b) Reference Checks: The loan officer will have to assess the references made and
received on the loan applicant in addition to information form contact with other
creditors who have previously loaned money to this customer. In the case of the
new loan applicant, there is the need to crosscheck the guarantors’ background
information to ensure that such people are credible. This is necessary in order to
guarantee that people who are being used as guarantors are not loan defaulters in
other banks who, therefore, cannot be trusted for such responsibility,
(c) Perfecting the Bank’s Claims to Collateral: There is the need for the bank
officials to ensure that the bank will have immediate access to the collateral or can
acquire title to the property involved if the loan agreement is defaulted by the
customer.
(v) Preparing A Loan Agreement: Once the loan and the proposed collateral are
satisfied after the evaluation, the necessary loan agreement form and other
documents that make up the agreement are prepared. The documents are both signed
by the loan officer of the bank and the customer who benefits the loan facility. There
is also the need for the guarantors to sign the documents before the final seal. The
necessary documents, such as financial statements, security agreements, etc, that
must accompany each loan application, must be kept in the bank’s credit files with
loan agreement and guarantors’ forms signed by them. The principal components of
a loan agreement include the following:

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 a) Loan Commitment Agreement: This refers to pledges entered into by the bank
as lender to make credit available to borrowers in the future for a stipulated time
under specific terms.
b) Collateral Security: This refers to the assets or pledges of value that can be
turned into cash to support the repayment of a loan.
c) Covenants: These are restrictions in the loan agreement that require a borrower to
do or not do certain things while the loan agreement is in force without first
receiving lender approval.
d) Warranty: It refers to a written stipulation or assurance by a borrower that
information supplied in a loan application is true.
e) Events of Default: There is always a portion of a loan agreement which describes
or spells out what action or inaction by a borrower would violate the terms of a
loan.

16.Objectives of Lending & Credit Administration

The major operational business of commercial banks revolves around financial
intermediation. In carrying out this business the banks would source for funds from
various members of the public. The funds of the customers are held in safekeeping of the
banks and therefore, such funds must be made available to the depositors whenever they
demand for them. The implication is that banks strive to ensure that the funds are
available for payments to the depositors on periodic basis for their needs and
commitments. In the process of performing the other aspect of financial intermediation,
the commercial banks usually keep the interest in uppermost consideration so as to
discharge their delicate function efficiently. While lending depositors’ funds to
customers, the banks normally ensure that their recoveries from loans and advances
granted out to customers must be managed in such a manner that their operations would
not run into murky waters. In performing such function of lending funds to customers
the banks usually take necessary steps to protect the interest of the depositors.
In the process of trying to maintain a delicate balance between recovery of loans and
advances and periodic payments to the depositors, the banks usually institute appropriate
measures to safeguard their position with regards profitability and survival. Based on
this discussion, it is possible to identify the basic reasons for the management of lending
and credits by the banks, which are critical to their operations. Such reasons for effective
management of lending and credits by the banks include the following:
a) Safeguarding the funds of the depositors;
b) Generating enough funds to meet depositors’ demands;
c) Ensuring their profitable operations;
d) Protecting the interest of their shareholders;
e) Ensuring efficient administration of lending and credits;
f) Ensuring positive capital base for their operations;
g) Protecting the values of the shares in the capital market;
h) Properly aid the growth of industrial undertakings; and
i) Creating conducive environment for economic development.

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6.1 Objectives of Lending & Credit Administration
(i) Ensure the Liquidity of the Bank: One of the objectives of lending and credit
administration is to ensure that the bank is always in liquid position to meet the demands
of the depositors. This is the uppermost objective in bank lending because banks only
make use of depositors’ money for business. And since such depositors are entitled to
their funds as often as they so desire, banks lend money for a short time in most cases.
(ii) Guarantee Prompt Repayment of Loans: Another objective of lending and credit
administration is to ensure that the funds committed into loans and advances are
promptly repaid by the beneficiaries. Banks always ensure that the depositors’ money is
safe in the sense that the borrower should be able to repay the principal amount and the
interest charges involved in loans. The administration of lending and credits by the
banks is managed in such a manner that the funds are repaid at agreed regular intervals
without defaults. The repayment of loans by the beneficiaries depends on their capacity
to generate enough funds from their projects, besides the fact that their character which
are normally evaluated before loan approval.
In essence, the banks lend funds to the customers based on the financial standing of their
business in terms of regularity of cash inflows with which to repay the loans. The banks
also take into consideration a less risky business for loans to ensure the safety of the
funds and their prompt recovery from the borrowers. In the case of new business
ventures, the banks would also grant loans for those enterprises whose owners command
good character and have adequate capacity to repay the loans. The new business venture
should have sound financial projections in relation to the technical feasibility and
economic viability of the project for which the loan is granted.

(iii) Ensure Balanced Loan Portfolio: An objective of lending and credit

administration is the need to ensure that there is a balanced portfolio in terms of the
composition of loans and credits being granted to customers. This means that in the
process of granting loans and credits to customers, the banks consider the composition of
the loan portfolio so as to maintain balanced diversity of the assets. This is view of the
fact that the spread goes a long way to guarantee the safety of the banks funds. This is
important for the banks’ profitable operations and liquidity so as to protect the interest of
the depositors as well as that of the shareholders. It implies that the loans and credits
being granted to customers are not concentrated in a particular sector but in diverse
sectors of the economy. This is in conformity with the policy of the apex bank in terms
of extending loans to various productive industries and businesses for balanced growth
and development of the economy.
The spread of the loan portfolio to various productive sectors of the economy is also
imperative towards minimizing risks that are always associated with lending of funds. In
this regards, commercial banks take appropriate measures to spread the risks of
investment in loan and advances portfolio by considering various trades and industries.
(iv) Guarantee Constant Stream of Cash Inflows: Another objective of loan and credit
administration is to guarantee constant stream of cash inflows from loans and advances
for the banks’ liquidity. Therefore, commercial banks will only grant loans and advances
to customers whose business ventures have the potential of earning enough funds with

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which to repay the principal amounts and the interest charges. In order to ensure
constant inflows of funds from loans and advances, the banks normally put in place
some administrative measures towards assessing that such credits are the types that
would generate stable incomes with which to repay the funds.
For effective management of lending and credits, customers’ loan applications are
normally scrutinized by appropriate loan officers and committees in charge of credit
facilities so as to choose those ventures that are capable of generating constant income
with which to service the loan and make repayment on regular basis. It is the
responsibility of the credit officers and the committee to also evaluate new projects
using their technical feasibility and economic viability reports to determine the nature of
cash inflows in terms of their nature of earnings. Such assessment will be used for the
selection of the projects that can generate enough funds for repaying loans and credit
facilities. In the case of existing business, the usual practice is for the bank to request for
financial reports of the business which incorporate relevant data for five years. This will
be used in evaluating the regularity of generation of earnings. And the assessment is
used to determine the stability of income from the business for the repayment of loan
facility.
(v) Earn Adequate Returns from Lending: An objective of loan and credit
administration is to generate adequate earnings from lending and credits, which are very
important to the operations of commercial banks. Loans and advances are usually
granted to customers with the intention of earning some income for the banks. The
income from lending facilities comes mainly from the interest charges being made from
loans advances being granted to customers by the banks.
The rate of interest being charged on loans and advances by the banks is normally
determined in consideration to the prevailing interest rate and the ruling bank rate
sanctioned by the apex bank in the economy. Such bank rate is called the monetary
policy rate in the country, as determined by Central Bank of Nigeria. The interest rate
being charged on loans by the commercial banks is normally determined in relation to
the bank rate being charged by the apex bank, the former being higher than the later. In
addition, the banks incorporate some other charges as may be determined by the lending
officers or the credit committee.
(vi) Ensure Effective Supervision of Lending: Another objective of loan and credit
administration is to ensure effective supervision of lending by the banks. In order to
ensure that lending operations are proper supervised, the banks normally set
administrative policies on loan supervision. In this regards, administrative policies are
established on supervision of credit facilities, their recovery drives, and personal visits
by bank officials to the loan beneficiaries.
The relevant supervision policies are normally established in relation to the past
strategies and those methods being used by the other banks in the industry. In order to
ensure effective loan supervision, these policies are used: supervisory teams, reports and
evaluation, time line for periodic reviews of loan recoveries, loan recovery visits,
procedures for compliance with banking regulations, appropriate pricing of loans and
credits, and loan recovery methods.

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(vii) Efficient Management of Credit Risk: An objective of loan and credit
administration is to ensure efficient management of risks associated with loans and
advances. In this regard, administrative measures are established by the banks for
management of the credit risk in respect of grave problems which can arise from loan
recovery by the bank. The objective is to eliminate or minimize the hazards and perils
that loans and advances can present to the operations of banks. The measures for
controlling loans and advances in order to manage their risks may differ from one bank
to another. The banks do formulate administrative measures for the management of
credit risks by assigning responsibilities for:
a) branch managers in preventing credit risks;
b) senior officers in credit risk management;
c) loan officers in recommending only loans with minimal risks;
d) credit committee for assessing and handling credit risks;
e) effective supervision to minimize defaults in loan repayment;
f) managing accounts of loan beneficiaries;
g) constant visits to loan beneficiaries; and
h) actions necessary in managing difficult loan beneficiaries.

(viii)Effective Management of Difficult Loan Beneficiary: Another objective of loan

and credit administration is to ensure effective management of difficult loan beneficiary.
Administrative policies are normally formulated for managing difficult loan
beneficiaries. Banks formulate administrative policies and assign them to relevant bank
officials for managing problem loans. These policies are used to specify the necessary
actions to be taken by relevant bank officials to handle loan beneficiaries that are
proving difficult and problematic. Examples of such administrative measures for
managing difficult beneficiaries of loan facilities include the following:
a) Committee’ s actions for the recovery of difficult loans;
b) Mutual discussion with the beneficiary of the loan;
c) Planned contact for assessment of beneficiary’s premises;
d) Threat of legal action against the beneficiaries
e) Offer of restructuring of beneficiaries’ operations;
f) Threat of sale of securities for the loan; and
g) Representation to beneficiaries on plan to take over their business operations.

7. Lending and Credit Administration

Essentially, the back business of commercial banks revolves around financial
intermediation activities. Therefore, they source for funds from the members of the
public, corporate organizations and other institutions through various forms of deposit
accounts. Such funds are then used for the purpose of lending and credit facilities. The
depositors are entitled to the funds whenever they so desired. The banks are invariably
under legal obligations to honour the demands of the depositors. The banks therefore,
are constantly under obligation to evolve ways of maintaining delicate balance between
the recoveries of funds loaned out and the demands of the depositors.

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This is where the issue of lending and credit administration comes into play. In essence,
the funds which are loaned out to customers have to be managed in such a manner that
such funds can be available from the customers whenever they are needed to meet the
demand of the depositors. The delicate balancing of demands for funds by depositors
and recoveries of loans and advances from customers is predicted on the necessity for
the commercial banks to survive in business and generate reasonable returns for the
shareholders. It implies that lending and credits should be managed in such a way that
generating funds from loan repayments is tailored towards meeting periodic demands of
the depositors.
In order to manage loans and credits effectively for adequately meeting the demands on
the deposit accounts of customers, there are operational modalities normally put in place
by the banks for administering loans and advances right from inception to the time when
they totally liquidated. Such modalities of managing loans and advances are identified
and discussed below.
7.1 Modalities for Lending & Credit Administration
i) Loan Budget and Composition: It is an ideal practice for commercial banks to
determine the amount of funds which will be devoted for loans and advances in a
given period of time taking into consideration the requirements of the regulatory
agency. Hence the banks determines total amount of loans and advances for a
particular period, maximum amount for a single case, and average amount of lending
to be made per case. In terms of composition of loans and advances that will be
granted to customers, the banks consider issues such as types of loan and advances,
sectors, sub-sectors and industry mix, investment or equity participation, and
productivity sector favoured by the government.
ii) Loan Committee and Authorisation: It is also a common practice for commercial
banks to institute a loan and advances committee to deal with major credit decisions.
There are some responsibilities which the loan committee is expected to perform.
Such responsibilities or duties of the loan committee may, among others, include the
following:
a) To review major new loans;
b) Review major loan renewals;
c) Ascertain the reasons for renewal;
d) Assess delinquent loans & determine the cause of delinquency;
e) Ensure compliance with established lending policy; Ensure full documentation of
loans before disbursement; and
f) Ensure consistency in the treatment of loan customers.
(iii) Periodicity and Loan Grading System: In terms of periodicity, the duration of loan
composition is very critical. Therefore, the basic considerations are call loans, short-
term working capital loan, intermediate-term investment loan, and long-term
investment loan. A typical grading system for loans and advances is as presented
below, which indicates classification of loans in terms of their likely performance.
The classification is as follows:

Table 2: Grading of Loans and Advances Grade Classification

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 A Top Grade Loan
B Good Loan
C Marginal Loan
D Doubtful Loan
E Likely Bad Loans

The grading will be used to allocate funds accordingly in terms of the magnitude of
money that will be assigned to each grade.
(vi) Evaluating Credit Worthiness & Securities: There is issue of the evaluation of the
creditworthiness of the customer that is prospecting for loan facility. Factors that are
taken into consideration, among others, include financial statements, other required
information, personal interview and credit investigation, information on operations;
personnel, financial, market, etc. The other important contemplation is the concern of
collateral security which is very critical for loan consideration. In this regard, the critical
issues to consider are criteria of acceptable security, listing of acceptable security,
allowable margins to be made; and qualifications of becoming guarantors.
(v) Expected Revenue from Loan: The expected revenue from any loan facility to the
bank is referred to as the pricing of the loan, which is the lending cost plus the profit
inherent in the facility. It is expressed formula wise as:
Lending Cost = Cost of fund + Cost of lending operation
Liquidity of the advance + Risk.

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The rate of interest in relation to the cost of the fund to the bank definitely partly
determines the amount of profit that can be earned from a loan facility. The interest
chargeable on loan is normally considered in relation the bank rate of the apex bank; the
former being above the latter. The interest rates being charged on loans by the banks
may depend on factors, which are in the following areas:
a) The bank’s cost of funds;
b) The riskiness of the borrower;
c) Compensating balances & fees;
d) Interest rates charged by competitors;
e) The ruling bank rate in the economy; and
f) Other banking relationships with the borrower

(vi)Assessment of Credit Risk & Compensating Balance: It is always a practice for

the bank to assess the risk involved in the loan being granted to a customer. This calls
for determining the risk average in relation to previous loans that are similar to the loan
under consideration, the types of risk involved, and the insurable risk that should be
insured by the bank. It is always necessary for the bank to retain some funds in the loan
account of the customer which is regarded as the compensating balance. This is
considered in line with the bank’s right of offsetting deposit balance for an outstanding
loan and the method of computation of compensating balance.
(vii) Loan Approval, Documentation & Accounting Record: The process of the loan
approval refers to the necessary considerations which are taken cognizance of towards
the final decision on loan request. Such considerations include the following issues:
a) Sanctioning limits of various types of loans;
b) Delegation of Authority;
c) Uniform Presentation Format & Standards;
d) Descriptions of the client;
e) Assessment of management;
f) Pricing Policy;
g) Purpose of the loan request;
h) Repayment schedule & source of repayment;
i) Secondary sources of repayment including collateral values & guarantors;
j) History of past borrowing with the bank;
k) Required monitoring steps;
l) Timing of submissions of financial statement;
m) The loan Decision; and
n) Loan officer’s comments including consistency with policy.

More considerations can be included in the above list for effective loan approval
process. The documentation starts from the time that the customer applies for the loan.
Therefore, the documents to be kept bank include application form filled by the
customer, evidence of security, loan agreement, credit reports, referee forms, and
financial statements, among others. The necessary considerations for the accounting
records include recording procedure to be followed, loan and project profiles to be

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maintained, statements to be provided by the customer, and loan recovery recording,
among other accounting records to be maintained by the bank.
(viii) Collection Procedure & Handling Problem loans: In terms of collection
procedure, there are critical considerations which include repayment schedule as
prepared by loan officers, remainders & circular letters to be sent out on periodic basis,
constant personal visits by the credit officers, and collection the principal payment and
interest charges on the loan necessarily through cheques. The procedures for managing
problem loan problems and their beneficiaries involved the following considerations:
a) Criteria to be used for identifying problem loans;
b) Methods to be used for identification problem loans;
c) Steps to be taken in managing the loans and their beneficiaries; and
d) The issue of setting up loan reserves for managing such risk

8. Lending Appraisals & Decisions

(i) Initial Evaluation of Loan Request: The commercial banks, at the instance of loan
request from a customer, have to engage in initial evaluation of the application in
relation to relevant areas, which constitute part of the lending procedure. Such
evaluation is very critical because it provides the basis for the engagement in credit
analysis of the request. The relevant issues to be considered in the initial evaluation are
identified and discussed below.
a) Purpose of the Loan: The bank will be interested in determining the purpose of
the loan so that the funds from the loan would not be used for illegal business
activities or unproductive project. Therefore, the bank would assess that the
reason for the loan is not related to; speculative business; illegal business
transaction; fruitless venture; self-aggrandizement; failed venture; money
laundering; dealing in arms or weapons; political agendas, etc Once the loan
request is not connected to any of the above subject or business, the request will
be qualified for consideration by the bank.
b) Amount of the Loan: It is also the practice for the commercial banks to take into
consideration the amount funds that a customer is prospecting for. The amount of
funds that is incorporated in a customer’s loan request will be assessed by a
commercial bank in relation to: available funds for lending; the liquid position of
the bank; regulation of the apex bank; amount of loan already committed to the
industry; pace of loan recovery; trend in volume of withdrawals; pattern of
deposits; and quality of deposit accounts. The assessment of the amount in
relation to the above issues will make the bank either to grant the whole amount or
decrease it.
c) Reason for the Loan: The banks will also be interested in determining the main
reason which informs the customer’s request for loan. The reason for the loan will
enable the bank to classify the request in relation to broad-based categorization as
shown below. Real estate loans (short-term loans for construction and land
development and longer-term loans for the purchase of farmland, homes,
apartments, commercial structures, and foreign properties), financial institution
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 loans (loans to other banks, insurance companies, finance companies, and other
financial institutions) agricultural loans (loans to finance farm and ranch
operations, mainly to assist in planting and harvesting crops and to support the
feeding and care of livestock), commercial and industrial loans (to businesses to
cover expenditures on inventories, paying taxes, and meeting payrolls) loans to
individuals (credit to finance the purchase of automobiles, appliances, and other
consumer goods, equity lines for home improvements, and other personal
expenses) and lease financing (to corporate firms on equipment or vehicles). The
categorization of the loan request will enable the bank to determine the
appropriate amount to grant for the demand.
d) Sources of Payment: The means of repayment will also be considered by the
banks in assessing any loan request by the customer. This consideration is related
to the cash inflows from the business, which will be used by the beneficiary to
meet the periodic repayments of the principal amount and the interest charges to
the bank.
e) Ability of the Beneficiary to Repay: This issue will be assessed in relation to the
capital and assets of the business for which the loan is being requested. This is
based on the fact that the capital base of the business determines its ability to carry
out its operations efficiently. In the case of a new project, the financial projections
for a period of five years will be assessed to determine the ability of the business
to generate enough income to meet its cost of operation and meeting the loan
repayment.
f) Risk Inherent in the Loan; The loan request will also be assessed in relation to
the risks inherent in the facility in the event that it is granted. These credit risks
include: default in repayment; delays in repayment; diversion of the funds; failure
of the project; mismanagement of the funds; and total loss of the funds. Once most
of these risks are perceived to the inherent in the loan request, the bank officials
may not advance further on the analysis of the request. Nevertheless, if the bank is
satisfied with above elements of assessment, it will proceed to credit analysis,
which is the next area of discussion below.
(ii) Credit Analysis: The credit analysis is based on the popular considerations such as
the character of the applicant, capacity of the customer to repay the loan, capital in
relation to contribution of the customer to the project funding, collateral security being
offered by the customer for the loan, condition of the economy, cash generation from the
project for repayment, and lastly control of the bank over the loan facility. All these
considerations are discussed below.
a) Character: This consideration is the personal integrity of the customer requesting
for the loan, which is relation to his business dealings with the bank and other
banks. The bank officers or loan officers would take steps to determine the
character of the customer to ensure that they are convinced that the customer has a
well-defined purpose for requesting bank credit and a serious intention to repay
the funds appropriately.

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b) Capacity: This involves the authorization of the person making the request to
make a demand for loan facility, which is normally defined by virtue of his
position. Therefore, the bank always takes steps to ensure that the customer
requesting credit has the authority to do so. The bank will also consider the
approval of the board of directors and the legal standing of the person to sign a
binding loan agreement on behalf of his firm. This customer characteristic is
known as the capacity to borrow money.
c) Collateral: The bank will also assess the borrower’s security in terms of whether
or not it possesses adequate networth. The assessment also applies to the quality
of the assets in providing adequate collateral support for the loan. The bank
officials will be interested in evaluating the assets of the firm particularly in
relation to such considerations as the age, condition, and degree of specialization
for the firm’s operations.
d) Conditions: This has to do with the assessment of the economic conditions and
the industry in which the firm operates. The bank officials or credit analysts are to
consider the recent trends in the borrower’s line of work or industry and the
dynamics of the changing economic conditions might impact on the usage of the
funds and the repayment. To assess industry and economic conditions, most banks
maintain files of information newspaper clippings, magazine articles, and research
reports-on the industries represented by their major borrowing customers.
e) Capital: This refers to the contribution of the customer’s business to the financing
of the project for which the loan request is desired. This is important because in
the absence of any appreciable contribution or the capital base of the business, the
customer will not feel that the firm has any stake in the scheme of things.
Therefore, the project may be allowed to fail and the bank will lose its funds.
f) Cash Inflows: The expected cash inflows from the business or the project that
may affect the repayment of the loan will be evaluated by the bank. There are
three main sources of income from a business to repay the funds of the loans.
These sources include: The cash flows generated from sales or turnover of the
business; the sale or liquidation of operating assets of the business; or funds to be
raised by way of issuance of debt or equity securities. The net cash inflows is the
net profits from the operations of the business, indicative of total revenue less all
expenses, and combined with non-cash expenses such as the amount of
depreciation of capital assets. The other of looking at the cash inflows is that the
net cash inflows is the net profits plus non-cash expenses plus additions to
accounts payable less additions to inventories and accounts receivable.
g) Control: The issue of control is focused on such consideration as to the
assessment of the effect of any changes in government rules and regulations on
business. Furthermore, the consideration is on the possible adverse effect on the
borrower’s ability to repay the funds on the loan. The other issue in the control
consideration is relating the loan request to the bank’s and the regulatory
authorities’ standards for loan quality.

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(iii) Evaluation of Past Performance of Loan Applicant: This involves assessing the
performance of the business of the customer who is prospecting for a loan facility. The
relevant information for such assessment involves the data which are embedded in the
financial statements of the business operations in the past five years. The relevant
financial statements are the income statement and the balance sheet. A simple approach
to the assessment involves the use of financial ratios. The important ratios are:

Page 25 of 33
Page 26 of 33
(vi) Considerations for Decisions on Loan Request: The use of the data in the income
statement and the balance sheet is not considered enough to assess the creditworthiness
of the customer. Therefore, the commercial banks normally make use of an assessment
technique called CAMPARI, an acronym from other relevant considerations in loan
assessment. Such considerations for assessing the creditworthiness of customers seeking
for loan facilities are as follows.
Character: This is a review of the management of the business, the products of the
company, and the past performance of the business for which a loan is being requested.
Ability: This refers to the ability of the business to generate enough income from cash
inflows with which to repay the loan facility.
Margin: This refers to the profit or reward of engaging in the lending facility which will
determine the bank’s consideration in committing funds.
Purpose: This relates to the reason which informs the customer’s request which should
not be connected with abnormal business operations such as speculative business, illegal
business transaction, fruitless venture, self-aggrandizement, failed venture, money
laundering, dealing in arms or weapons, etc.
Amount: This refers to the value or amount of funds that is being requested by the
customer, which will be considered in relations to issues such as available funds for
lending, the liquid position of the bank, regulation of the apex bank, amount of loan
already committed to loan, pace of loan recovery, trend in volume of withdrawals, etc.

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Repayment: – this refers to the possibility of the repayment schedule being appropriate
to the bank’s liquidity management plan. More so, the bank will also consider the past
performance of the business in relation of its ability to meet periodic repayments of the
funds in relation to the liquidity plan of the bank.
Insurance: – this refers to the issue of collateral security which is available to secure the
loan by the customer. This is very important to the bank because in the event of defaults
or inability to repay the loan the bank will use the collateral security for generate funds
to settle the loan.
The analysis above indicates that it represents a broad-based evaluation of the loan
request compared to the earlier consideration in this unit. These considerations are
important in terms attributes which coalesce to form the basis of the lending decision.
Among these considerations, there are five attributes that are linked to the accounts and
finances of the prospective borrowers. The remaining two considerations are character
and margin, which are related to the customer and the bank’s profit contemplation.
In the case of character, the issues are management of the business, which represents
subjective assessment, and the others in the areas of the products of the company, and
the past performance of the business, the latter which can be specifically quantified from
the balance sheet data. The banks will therefore, be interested in seeing financial
information for the past five years before lending any money to the customer. These are
the balance sheet and the income statement of the business which incorporates the past
data relating to five years consecutively.
9. Loan Monitoring & Supervision
Lending as you have understood from earlier discussions in this study unit, involves the
use of depositors’ funds. This is an important aspect of financial intermediation that
commercial banks perform in the economy. In the process of lending funds, some
measures are normally instituted by the banks to ensure that customers, who are the
beneficiaries of the loans and advances, are being monitored so as to recover the funds.
Hence supervision of lending is critical to the operations of the banks.
9.1 Nature of Loan Monitoring & Supervision
The administration of lending and credits by the banks is managed in such a manner that
the funds are repaid at agreed regular intervals without defaults. In order to ensure that
the customers perform up to expectation, the banks normally institute concrete measures
towards monitoring them. The repayment of loans by the beneficiaries depends on the
appropriate administrative measures which are initiated and implemented by the banks
to keep such customers on track. The administrative measures for monitoring prompt
repayment of loans by the customers are embedded in loan supervision. In essence, the
issue of monitoring of loans is very critical in keeping watch over the performance of the
customers in loan repayment so as to prevent defaults. In order not to toy with the funds
of the depositors, commercial banks normally supervise the repayment of loans and
advances using appropriate strategies. Therefore, there are obvious reasons which inform
loan supervision. Such reasons for monitoring loan repayment include the following:
a) Ensure regular repayment of loans and advances;
b) Generate enough funds to meet depositors’ demands;
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c) Prevent loan defaults from the customers;
d) Ensure liquidity for the banks’ operations;
e) Generate reasonable amount of returns on operations;
f) Protect depositors’ interest;
g) Guide against financial distress in operations;
h) Ensure regularity of cash inflows from investment in loans;
i) Minimize risks inherent in loans and advances;
j) Ensure safety of the funds committed into loans;

The reasons as enumerated above inform the monitoring of repayment of loans and
advances by the banks using appropriate administrative measures. Such administrative
measures which are necessary for monitoring and supervision of loans are identified and
discussed.
9.2 Methods of Loan Monitoring & Supervision
(i) Supervision & Control: Supervision and control of loans and advances is very
critical to lending management in the operations of the commercial banks. The
repayment of loans and advances should be supervised and controlled in such a manner
that the interest of both the bank and the depositors whose funds are committed in these
investments is protected. The effective supervision of loans and advances requires that
the banks institute appropriate to ensure the following operational actions:
a) Assigning responsibilities for supervision to appropriate staff;
b) Determining time line for periodic contacts and visits with loan beneficiaries
c) Provision of logistics for facilitating supervision by the staff;
d) Determining modalities for contacts with loan beneficiaries;
e) Constituting supervision team from experience staff;
f) Modalities of releasing funds on loans and advances;
g) Process and actions for dealing with problem loan accounts;
h) Periodicity of supervision reports from relevant staff; and
i) Determining necessary actions for handling logistic bottlenecks.

There other administrative actions necessary for effective supervision and control of
repayment of loans and advances that must be instituted by the banks. Therefore, the
above list on operational actions is not exhaustive.
9.2 Collection Procedure: It is always necessary for the banks to institute relevant
measures for the collection of funds involved in loans and advances which are granted to
the customers. The collection procedure is normally determined at the stage of granting
the loans and credits to customers of the bank. The collection procedure involves the use
of the following administrative measures.
a) Schedule of Repayment: In most cases the repayment for any loan by the
customer is normally effected with a prepared schedule showing the frequency
and amount of principal and interest involved. The schedule is prepared to show
the number of repayment installments, the magnitude of principal repayment, and
the interest charges to be met by the customer on periodic basis.
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 b) Reminders and Circulars: Another important responsibility of the credit officers
of the bank is the preparation of the periodic reminders and circular letters which
are normally sent out to the loan beneficiaries. The reminders and circular letters
are normally prepared to incorporate the total loan commitment of the customer,
the repayment that has been made, the outstanding payments and their due dates.
c) Personal Visits: Personal visits are very imperative for effective supervision of
the repayment of loans and advances by the banks. The visits may be scheduled or
on the basis of surprise contacts by the relevant bank officers. The personal visits
by bank officers to loan beneficiaries are normally facilitated by the evaluation
visit which is made during the assessment of the loan request from the customers.
In the process of loan evaluation, the premises of the customers’ business would
be visited, and this eliminates problem of difficulty in accessing the loan
beneficiaries. The personal contacts by the bank officers to the customers are on
periodic basis and therefore, not reserved for solving problem loan accounts when
the beneficiaries might not be forthcoming in terms of meeting regular loan
repayment. It implies that the personal visit to customers who are holding the
funds of the bank is a regular action, which can be used to forestall repayment
defaults.
d) Mode of Collection of Funds: The mode of collection of funds from the loan
beneficiaries is normally determined and made known to them at the instance of
granting the facilities. The mode of collection can either be cash payment or
payment by cheques by the loan beneficiaries. The collection of repayments in
cash by the bank officials is not normally encouraged. The non-repayment of
loans and advances by the customers in cash to bank officials is to prevent frauds
and fraudulent practices by the staff when handling cash outside the premises of
the bank. Therefore, the customers are encouraged to make repayments in cheques
directly to the bank and not to the bank officials unless they are crossed cheques.
9.3 Loan Accounting & Record: Another important consideration in loan supervision is
keeping appropriate accounting records on the release of funds to the loan beneficiaries
and the repayments of the funds to the bank. This is important for the bank because such
accounting record will be used in monitoring the performance of the repayment by the
customers. The bank may have to create separate loan accounts for large of amount of
loans while the customers’ existing accounts would be used for the records of release of
funds as well as the repayments on the facilities.
Furthermore, the customers would be required to be supplying interim financial
statements to the bank for evaluating the performance of the business or project for
which the bank’s funds have been committed. The financial statements are valuable in
assessing the income position of the loan beneficiaries’ business operations or project
performance in terms of their prudent management. One of the financial statements
required from the customers who are the beneficiaries of loans and credits is the income
statement, which reveals the returns from operations and how profitable such operations
is to the customers’ business ventures.
The other important financial statement is the balance sheet which reveals the statement
of affairs of the customers’ business operations. The balance also reveals outstanding
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financial commitments to outsiders, position of the capital, magnitude of the assets,
which are to be used for running the business and generating revenue from operations.
9.4 Loan Repayment Monitoring: The loan repayment agreement is always monitored
continuously by the bank officials. This is to ensure that the terms of the loan are being
followed and that all required payments of principal and interest are being made as
promised.
The loan officers normally visit the customer’s business periodically to check on the
firm’s progress and to see what professional services the customer may need. The loan
officer or other staff member places information about a new loan customer in a
computer file known as a bank customer profile. The customer file shows what bank
services the customer is currently using and contains other information required by bank
management to monitor a customer’s progress and financial-service needs.
9.5 Repayment Evaluation; In most cases the repayment schedule for any loan by the
customer is normally used to assess the progress of repayment based prepared schedule.
The evaluation is based on the frequency and amount of principal and interest being
repaid by the customers. It is normally easier for the bank officials to use the repayment
schedule for evaluating customers’ performance since it is prepared to show the number
of repayment installments, the magnitude of principal repayment, and the interest
charges to be met by the customer on periodic basis. Hence, the details of the repayment
schedule would be compared with the records of the actual repayment of the funds
involved in the loan in order to assess any discrepancies which may require actions on
the part of the bank.
Another important aid to evaluation of loan repayment is the appropriate accounting
records maintained by the bank on the release of funds to the loan beneficiaries and the
repayments of the funds to the bank. This is important for the bank because such
accounting record will be used in evaluating the performance of the loan repayment by
the customers.
The evaluation of repayment of loans process also affects the assessment of the entries in
the separate loan accounts that have been created for large of amount of loans. The
customers’ existing accounts used for accounting records of release of funds and the
repayments on the facilities would also be evaluated to determine the performance.

10. Pricing of Loans

The commercial banks normally base their pricing or interest rate charges primarily
on risk grade, which is adjusted by the level and quality of collateral security being
pledged in respect of the facility. The risk grades used by the banks, as pointed out
earlier, are normally correlated to statistical data available to the banks, which is used
to estimate the probability of default and likely loss on default.

Nevertheless, due to bank-customer relationship and competitive reasons, it is quite

feasible that two companies or corporate entities in the same risk grade with equivalent
facilities and collateral security may pay different interest rates. By the same token or
consideration, two corporate entities with different risk grades may pay the same rate
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of interest.

There could be some variation regarding interest rates and margins with respect to the
nature of business and peculiar loans generally and with respect to loan type and
nature of security. Therefore, the variation can arise because of the consideration for
the promotion of small and medium enterprises and peculiar regulation of the apex
bank on loans and advances for favoured sectors of the economy.

The various commercial banks may use different methodologies for pricing which are
consistent with their business strategies. In general terms, interest charges are
combinations of fees and margins in terms of the interest rate charges. In related
terms:

fees are normally charged to cover the costs incurred by the banks for
establishing and servicing loan facilities; and margins are normally charged by the
banks to provide a commensurate return based on the risk inherent in the loan and the
cost of capital faced by banks.

The cost of capital reflects the cost of financing the banks’ deposit liabilities. In
respect of small businesses, the banks may likely charge a uniform rate of interest
with little or no variation in interest rate between micro-business customers).

A number of banks use a matrix in terms of methodology, by setting out risk and
security, as well as customer need or product type to ascertain an appropriate base for
interest charges. And then adjustments are made to reflect the relative risk of the
business entity. This may increase or decrease the base pricing. The relationship
managers or credit managers may be granted some discretion to change interest
charges as necessary.
There may be consideration by the banks that the risk-reward relationship in respect of
the small and medium enterprises is attractive for loan facilities due to the following
reasons.

The profitability of the small and medium enterprise sector is perceived to be

higher than personal banking.

Lending to the small and medium enterprises may be regarded as the most
profitable sector for the banks. The small and medium enterprise market may have a
higher risk of default, but it has a lower loss on default, and therefore, it is normally
priced accordingly.

In terms of lending generally to the small and medium enterprises, the factors
considered for charging interest rates include; inherent risk element, competitive
pressures, target return on equity, future potential, level of patronage of products, and
government regulations.

i) Competitive Pressures
These constitute a potent influence on margins. This can affect the margins of the
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banks and therefore, tends to erode the risk-return relationship, notwithstanding the
profitability of lending to the small and medium enterprise sector. The banks
may consider the fact that the industry is highly volatile but they tend to be unwilling
to lose a customer primarily due to price.

ii) Target Return on Equity

This factor is a high level consideration in setting interest charges. Nevertheless, other
factors are more important on a case-by-case basis. The target margins are normally
used to ensure the desired level of profitability is achieved by the bank. Nevertheless,
banks tend to match rates or negotiate charges to win new business, or more
importantly to attempt to retain business under threat from competing banks.

iii) Future Potential Earnings

The future earning potential of businesses is a consideration when banks price
facilities in terms of charging interest on loans. For a small and medium enterprise with
good growth prospects, a bank may provide loans at discounted rates or margins, in
order to secure a long-term profitable customer. This is considered to be beneficial for
both the business and the bank; the SME can access the funds at very competitive
rates to enable its growth, and the bank secures a profitable client.

iv) Level of Cross Subsidization

This factor is also important in charging interest on loan facility. The consideration
encompasses the fees received from the customer from other accounts held within the
bank. Certain banks have more sophisticated pricing models that are based on the
overall relationship between profitability, collateral and other factors.

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