Credit - Introduction L1

Credit – Introduction
Credit analysis
• Assessing the ability and willingness of the

counterparty to meet interest and principal
payments when due.
• If the borrower can meet these obligations easily,
the risk is considered low. If difficulty to meet
these payments, the risk is high.
• Higher the risk – higher the possibility of loss.
Purpose of credit
Revenue
Cover COF
Operating expenses
Return on equity
Diversify asset base
Economic development
Purpose of Credit _ revenues
• Poor revenue stream will lead to losses
• Examine US sub-prime crisis.
• If RBL has a poor credit portfolio – then declining performance is
expected
• Therefore, to reduce losses and promote continued growth- sound
credit decisions should be made.
Sub-prime credit crisis
Major banks have suffered significant losses
Shareholders have lost a huge part of their investments
Confidence in the sector has declined.
Markets are unstable
Citigroup
Bear Sterns
Funding the Bank’s credits
Depositors
Borrowings
Equity
others
Banks – financial intermediation
BANK
SAVERS BORROWERS
$$$$$
Credit
Risk is
Embedded
here
Banks – financial intermediation
Lending exposes the bank to many risk.
Worst case? Lose the principal and interest?
What are the risk exposures and how can the be reduced and
managed.
Risk in lending
Credit risk - affects
Income
Asset value
Capital (eroded)
Liquidity risk
Risk in lending
Legal risk
Operational risk
Reputation risk
Currency risk
Risk management system in lending
Establish RMS over lending
Identify
Measure
Report
monitor
Risk management system in lending
• Credit analysis – integral part of the RMS
Rational for credit analysis
• Risk in lending – all loans have risks
• Banks seek to reduce/manage risk through credit analysis.
• Identify acceptable from unacceptable risk
• Identify changes in risk profile over time
• pricing
Credit analysis
Willingness to pay and
Ability to pay
Analysis of the 6 Cs of credit
Willingness to pay
Character
Historical experience
References
Ability to pay
Financials
Source of CF
Stability of CF
Risk associated with CF
Credit environment- institutions
Banks
NFIs
Credit Unions
Insurance
Retailers
Credit environment
• Growth in credit cards – banks and non banks
• Growth in credit
• Shorter processing time
• Target oriented
• Telephone, computer application
• Pre-approved limits – debit cards
• Paucity of credit skills
• fraud
Credit environment
Poor risk assessment
Accept undesirable customer
Reject desirable customer
Subjective lending practices
Inadequate monitoring
Poor recovery
Credit – low quality
Loss of income
Loss of principal
Erosion of capital
Regulations
• CBTT – FIA
• Company act
• Proceeds of crime act
Regulations
• Adequate governance over all areas of operations – credit
• Documented policy and procedures approved by BOD
• Statutory limits
• Prohibitions (FIA)
• Directors/officers
• Borrowers
• Borrower group
Regulations
• Risk adjusted asset/ capital
• Ratio is influenced by loan portfolio
• Reporting of delinquent loans – CB20
• Combating money laundering and terrorist financing
• Suspicious activities
• KYC, CFATF
Policy
• Types of loans
• Limits – individual, aggregate
• Maturity
• Requirements
• Application
• Approvals
• Criteria for lending
Credit assessment
credit scoring
credit analysis
credit metrics models.
Judgmental
Credit analysis
Reduce/manage risk
Financial performance
Regulatory compliance
Credit analysis
Quantitative analysis
Qualitative analysis
Credit analysis - quantitative
• financial analysis
• Financial position – balance sheet
• Performance – income statement
• Cash flows – statement of CF
Introduction to Financial Statements
Purpose is to measure and communicate
Financial performance
Financial position
Cash flows
Of an entity
Introduction to Financial Statements
Three statements
Balance sheet
Income statement
Cash flow statement
Introduction to Financial Statements -Balance
sheet
• Schedule of assets, liabilities and owner’s equity
• Shows financial position as at a specific date
• Definition- assets, liabilities, owner’s equity.
• Identify assets, liabilities and owner’s equity from examples.
Introduction to Financial Statements -Income
statement
Schedule of revenues, expenses and net income (loss) over a specific
period, usually the financial year.
Define revenues, expenses.
Introduction to Financial Statements -Statement of
cash flows
Schedule of cash inflows and outflows over a specific period
Cash flows divided into three activities
Operating
Investing
financing
The balance sheet
• Fundamental accounting equation
Assets = Liabilities + owner’s

equity
The balance sheet
Assets
Liabilities
$1,500,000
$2,000,000
Owner’s
equity
$500,000
The balance sheet
What effect will a loan of $200,000 have on the balance sheet?
The balance sheet
Cash Loan
Assets Liabilities
$2,000,000 + $1,500,000+
$200,000 $200,000
Owner’s
equity
$500,000

Credit - Introduction L1

Uploaded by

Copyright:

Available Formats

Credit - Introduction L1

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Credit - Introduction L1

Uploaded by

Copyright:

Available Formats

Credit – Introduction

• Assessing the ability and willingness of the

Assets = Liabilities + owner’s

You might also like