Borrower Selection Process in Banks

Md. Nehal Ahmed

Professor, BIBM

A bank usually has procedural guidelines indicating list and sequence of several activities
associated with its credit operation. The procedural guideline is prepared in the light of Credit
Risk Manual given by Bangladesh Bank. However, bank’s own credit policy, vision, mission
as well as guidelines and policies given by Bangladesh Bank from time to time are also
reflected in procedural guidelines. The activities of credit operations start with discussion
between bank and client and end with recovery of loan. Credit operations in banks may be
centralized or decentralized. However, the overall activities of the credit operations of a bank
are outlined in the Flow-Chart 1 whereas decision flow chart of borrower selection is
presented in Flow-Chart 2.

1. Origination of Credit
Each year the head office prepares a credit budget indicating the amount of credit to be
sanctioned and disbursed in different areas, categories, products and sectors. Credit
committee/CRM is entrusted to sanction and disburse the budgeted amount prudently.
Generally, there is a credit committee /CRM in every region, area, division and head office of
each bank which reviews every aspect of a loan proposal to be considered in approving and
sanctioning loan. Relationship Management/ Marketing (RM) unit acts as a primary bank
contact with a borrower. At first, the banker and the customer discuss with each other about
the credit facilities offered by the bank and required by the customer. Through discussion,
RM is to ensure that proposed credit is from expected business segment/sector and for
permissible and expected credit facility. He also ensures that there is a scope of lending to the
client. After a successful discussion, customer is to apply for credit in a prescribed format
provided by the bank. After receiving loan application from the prospective borrower, RM
scrutinizes the submitted information and collects all other required information from
different parties including Credit Information Bureau (CIB) report.

For selecting the right type of borrower and business, credit appraisal is a must. For this
purpose, RM is to conduct appraisal of managerial, organizational, marketing, technical,
socio-economic and environmental aspects. Besides, the bank assesses the credit worthiness
and risk profile of the borrower. By and large, this assessment covers loan proposition and

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purpose, borrower analysis, industry analysis, supplier/buyer analysis, historical financial
analysis, projected financial performance analysis, etc. Security offered by the customer
against the proposed loan should also be considered for credit decision. Moreover, bank
should grade the borrower by completing Credit Risk Grading Score Sheet (CRGS). In case
of large loan, banks refer to External Credit Assessment Institution (ECAI) for credit rating
according to the direction of Basel II. The assessments are mostly done based on the
information collected from the borrower. Besides, market reports, study of accounts, financial
statements, on line CIB, external rating and personal interview are also worked as source of
inputs for decision making. In case of corporate credits where the borrower is a group of
companies, banks conduct credit assessment on a consolidated or group basis. In case of loan
syndication, besides the lead bank, all participatory banks also perform their own independent
assessment, analysis and review of terms of the syndicate loan. On the basis of appraisal, RM
recommends the application for approval to the appropriate authority mentioning amount and
type of loan proposed, purpose of loan, loan structure, security arrangement, etc.

2. Approval of the Loan Proposal

The authority to sanction/approve loans is clearly delegated to senior credit executives by the
Managing Director (MD)/Chief Executive Officer (CEO) and Board of Directors (BOD).
Approval authority is required to be delegated to individual executives based on the
executives’ knowledge and experiences. The recommending/ approving executives should
take responsibility for and be held accountable for their recommendation/ approval.
Delegated authority including capacity of approval must be reviewed annually and the
pooling or combining of authority limits of different executives should not be permitted.
Considering the size and strategy of the bank, approval function is centralized in some banks.
However, approval functions are generally decentralized in zonal, divisional, and branch
level. In case of centralized system, irrespective of amount, there is an approval authority in
the head office level. In case of decentralized system, delegation of approval limits should be
such that all proposals where the facilities are up to 15% of the bank’s capital should be
approved at the CRM level, facilities up to 25% of capital should be approved by CEO/ MD,
facilities in excess of 25% of capital to be approved by the Executive Committee (EC)/ Board
only after recommendation of CRM and MD/CEO according to the CRM guideline. In
addition, a monthly summary of Zonal Credit Officer (ZCO) approvals is sent to Head of
Corporate Banking (HOCB)/Head of SME (HOSME)/ Head of Consumer Credit (HOCC).
The head office supposes to review at least 10% of ZCO approvals to ensure adherence to
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lending guidelines and bank policies. Approval authority may approve or decline the
recommended proposal. Approval process more or less uses the following line of approval
(Flow-Chart 3) depending on the loan amount and internal policy of the bank. Before
approval, the Head of CRM forward the loan proposal to Risk management Unit (RMU) for
their observation regarding risk. After getting observations from RMU, the Head of CRM
process for approval. Following due process, the loan proposal will be approved/ rejected and
send back to RM.

3. Documentation and Disbursement of Credit

Getting the approval for the loan proposal, RM makes two copies of the proposal and sends
one copy to RMU and the other to Credit Administration Department (CAD) for
documentation. Then, CAD issues sanction /offer letter to the customer through RM.
Customer should agree with the terms and conditions incorporated in the offer letter.
Subsequently, RM completes the Loan Documentation Check List (LDCL) and forwards the
acceptance to CAD. A typical CAD performs the activities relating to disbursement,
custodian, monitoring and compliance. Main responsibilities of CAD are: ensuring that all
security documentations comply with the terms of approval and are enforceable, examining
insurance coverage to ensure appropriate coverage in place over assets pledged as collateral,
and is properly assigned to the bank, disbursing loan only after all terms and conditions of
approval have been met, and all security documentations are in place; maintaining control
over all security documentations and monitoring borrower’s compliance with covenants and
agreed terms and conditions. After ensuring full compliance, CAD takes necessary steps for
disbursement of the loan amount.

4. Monitoring and Follow-up of Credit

After disbursement, RM regularly follows-up the credit. Monitoring unit under CAD
alongside of zonal office monitors credit based on due-date-diary. Identification of early alert
account and reporting the same to CRM are responsibility of RM. Through close monitoring,
the quality of early alert account may improve but conversion of this account to regular
account status is under the discretion of CRM. As per credit policy, RM is to classify the
accounts and maintain required provisions.

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5. Recovery of Credit
There is a separate Recovery Unit (RU) in each bank as per CRM manual. This unit should
directly manage accounts with continuous deterioration. Its primary responsibilities are to
determine recovery strategy, pursue all options to maximize recovery, ensure adequate and
timely loan loss provisioning, etc. The management of Non Performing Loan (NPL) must be
a dynamic process, and the associated strategy together with the adequacy of provisions
should be reviewed regularly. All NPLs should be assigned to an Account Manager within
the RU, who is responsible for coordinating and administering the action plan and should
serve as the primary customer contact after the account is downgraded to substandard or
worse. Account manager should review all documents, meet the customer and prepare a
Classified Loan Review Report (CLR). The head of credit should approve the CLR for NPLs
up to 15% of the bank’s capital, and excess of 15% be approved by MD/CEO according to
CRM guideline. As per CRM guideline, the CLR’s for NPLs above 25% of capital should be
approved by the MD/CEO, with a copy received by the Board. Bank may wish to introduce
incentive program to encourage RU to bring down the NPLs. RU should take legal action
against the defaulted borrower as a last resort to recovery the credit.

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 Flow-Chart 1: Credit Flow-Chart of Bank
By Whom to be Done What to be Done
Origination of Credit
1. Discussion with Client about Credit Facilities
2. Ensuring Expected Business Segment/Sector and Expected
Types of Loan Facilities
3. Reviewing Lending Target-Disbursement in the Industry
and Single Borrower/ Group Limit

Relationship Manager/Marketing (RM) 4. Receiving Request for Credit from the Client along with
Related Papers, Documents, etc.
5. Scrutinizing/Verification of Submitted Documents and
Information
6. Collection of all Other Required Information
7. Appraisal of Managerial, Organizational, Marketing,
Technical, Socio-Economic &Environmental Aspects
Relationship Manager/Marketing (RM)
8. Collection of Client’s CIB
through Credit Administration (CAD)
9. Analysis of Loan Structure, Purpose of Loans, etc.
10. Financial Analysis (Historical &Projected Data)
11. Analyzing Security Offered by Client
12. Completing Credit Risk Grading (CRG) Score Sheet
Relationship Manager/Marketing (RM)
13. Collection of Credit Rating Done by ECAI of Client, if
Possible
14. Finalization of Loan Structure and Security Arrangement
15. Recommendation of the Credit Proposal and Placing for
Approval to HOCB or Head of CRM
Approval of Loan Proposal
The Head of Credit Risk Management 16. Forward to Risk Management Unit (RMU) for their
(CRM) Observation
Risk Management Unit (RMU) 17. Send back to CRM after Putting Observations
The Head of CRM 18. Forward to Processing Unit (PU) under CRM
Processing Unit (PU) under CRM 19. Forward to Approval Unit (AU) under CRM
The Head of CRM
20. Forward to Managing Director (MD)/CEO for Approval
(if beyond his power)
Managing Director (MD)/CEO
21. Forward to Executive Committee (EC)/Board for Approval
(if beyond his power)
Executive Committee (EC)/Board 22. Returned Proposal on Approval/Rejection to CRM
The Head of CRM 23. Forward Approved/ Rejected Proposal to RM

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 Documentation and Disbursement
Relationship Manager/Marketing 24. Making 2 Copies of Approved Proposal and Send one to
(RM) RMU and the other to CAD
25. Issue Sanction /Offer Letter along with Loan
Credit Administration (CAD)
Documentation Check List (LDCL) to RM
26. Advise Sanction/Offer Letter to Client
Relationship Manager/Marketing
27. Collection of Client’s Acceptance with all Documents
(RM)
28. Completing LDCL and Forward to CAD
29. Documentation and Stepping towards Disbursement
Credit Administration (CAD) 30. Disbursement of Credit ensuring Compliance with all
Terms and Conditions of Sanction Letter

Monitoring and Follow-up

Relationship Manager/Marketing (RM) 31. After Disbursement, Regular Follow-up of the Credit
CAD/Zone 32. Monitoring Credit based on Due-Date-Diary
Relationship Manager/Marketing (RM) 33. Identification of Early Alert Account & Reporting to CRM
The Head of CRM
34. Conversion of Early Alert Account to Regular A/c Status
(for positive change)
Relationship Manager/Marketing (RM) 35. Classification and Making Provision as per Policy

Recovery of Credit
36. Transfer of all accounts of Sub Standard (SS) or Worse to
Relationship Manager/Marketing (RM)
A/c Manager within RU
37. Determination of Recovery Strategy
38. Pursue All Options of Non-Legal Measures to Maximize
Recovery
39. Making Loan Loss Provisioning based on Actual and
Expected Losses
Account Manager within RU
40. Regular Review of Grade 6 (SS) or Worse A/c
41. Preparation of Classified Loan Review (CLR) on a
Quarterly Bases
42. Recovery of Credit Through Legal Action against
Defaulted Clients
Source: Banerjee et al (2014)

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 Flow-Chart 2: Decision Flow Chart of Borrower Selection

Loan 1. Expected Business Yes 2. Expected Types of

Application Segment/Sector Loan Facilities

No No

Yes
Reject Reject

5. Managerial,
Gap 4. Single Borrower/ Gap 3. Lending Target
Organization,
Marketing and Group Limit and Disbursement in
Technical Aspects the Industry

Negative Exceed Exceed

Positive

Reject Reject Reject

Satisfactory
6. CIB, Bank
Clean 7. Financial Analysis 8. Financial Analysis
Statements and Contact
Based on Historical on Projected Data
Point Verification
Data

Unsatisfactory

Satisfactory
Adverse Unsatisfactory
Reject Reject Reject
Satisfactory

Expected

11. Socio-Economic 10. Security 9. Loan Structure:

and Environmental Arrangement: Nature, Price, Tenure,
Aspects Amount, Quality, etc. Nature, etc.

Unexpected
Compliance

Non-Compliance Unsatisfactory
Reject Reject Reject
Accordingly

13.
12. Sanction and Disbursement
Documentation of Loan Borrower
Non-Compliance
Reject

Flow-Chart 3: Line of Credit Approval

Source: Siddique et al (2014)

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Reference
Bangladesh Bank. (BB) (2003), Credit Risk Management: Industry Best Practice, Dhaka.
Bangladesh Bank. (BB) 2005), Credit Risk Grading Manual, Dhaka
Siddique, Md. Mohiuddin, Karmaker, Dhana Ranjan, Alamgir, Md. And Hossain, Md. Mahabbat.
(2014). “Loan Quality Management in Banks: Problems of Selecting Right Borrowers”,
Banking Research Series 2013, BIBM, Dhaka (upcoming).
Banerjee, Prashanta Kumar, Karmaker, Dhana Ranjan, , Pandit, Atul Chandra, Hossain, Md.
Mahabbat and Kibriya, Faisal, Nur Al and Talukder, Akhtar Kamal. (2014). “Credit
Operations of Banks – 2013”, Review Series 2014, BIBM, Dhaka (upcoming).