The 5 Cs of a Good Loan
The 5 Cs of a Good Loan
USAID – Workshop on
agricultural sector financing
THE 5Cs OF A GOOD LOAN
Workshop on July 22 and 23, 2011
Being an analyst requires the following different roles:
• A borrower is always optimistic
The credit analyst must defend the Bank, but not the borrower
• Verify, verify, always verify...
THE SCIENCE vs. THE ART
The science consists in:
• Considering the facts
• Analyzing the information in order to know the “real story”
• Preparing the financial analysis
The art consists in:
• Issuing credit judgments based on incomplete data
• Understanding the borrower’s motivations
• Building trust
IN ALL CASES, WE REPRESENT THE BANK, NOT THE BORROWER
WHAT IS THE MAIN RISK IN TERMS OF
• The main risk is that the borrower is not able to repay and that its
guarantees do not fully cover the unpaid amounts
• However, it is interesting to take the risk if you think that it is profitable for
your bank and your analysis concludes that it is a good opportunity to
build a partnership with the client
• Before making the decision, be sure not to have forgotten to analyze all
the aspects. Use a checklist called FIVE Cs
WHICH BUSINESS PRESENTS THE
• invests in printers
• already in operation for 5 years
• creates high-quality graphic presentations for advertising companies, etc.
• invests in bottling equipment
• operational for 2 years
• sells nationwide
• invests in 4 sewing machines
• in activity for 3 months
• Lubumbashi local market
The 2 main Cs:
• Character - the person and the family
• Capacity/Cash-flow - technical, economic and financial feasibility and past
history of the activity
The 3 secondary Cs:
• Capital - funds invested in the business plan
• Conditions - the loan terms (amount, rate, repayment terms)
MEANING OF THE 5 Cs
• CHARACTER: does the borrower WANT to repay?
• CAPACITY: CAN the borrower repay?
• “COLLATERAL” or GUARANTEE: are there SUFFICIENT secondary
• CAPITAL: up to what level does the borrower PARTICIPATE in the risk of the
• CONDITIONS: what is the company’s ENVIRONMENT?
• Honesty and integrity
• Family situation
• Skills for managing an economic activity
• Family assets (net worth)
• Reputation in the community
• Openness and conformity with the market and the community
• Ability and habit of repaying previous credits
QUESTIONS ABOUT CHARACTER
Evaluation of the moral and financial responsibility of the individual
requesting a loan may be made by considering questions such as:
• Are the individual and his family worthy of trust - demonstration of trust,
but also honesty, responsibility and work habits?
• How did the individual and his family arrive at their current economic
• How did he resolve difficult situations in the past?
• What do the people and the leaders around him say about him/them?
• What do the suppliers and the buyers say about him/them?
• How do (does) his (their) habitual style of life and his (their) habitual
expenses compare with his (their) income level?
• How are the family relationships and family considerations that might
affect the activity and the loan?
• What does the business plan indicate about the revenue generation and the
profitability of the industrial and commercial activity?
• Can the individual/business produce enough money to honor the loan
repayments with interest, including a safety margin?
• When will the loan be repaid?
• What are the family needs?
• What are the consequences of seasonal fluctuations and production
• How does the entrepreneur/farmer fare compared with others in the same
sector or the same activity?
• Is there a successor?
Management questions include:
• How does he manage his business, farm or structure compared with
• How does he manage his money and his expenses?
• How have their assets/net worth increased or decreased over time and
• How do they manage, do they have relationships with people?
HUMAN AND WORK CAPACITY
• What are the age and the health of the person in question?
• How does the family cooperate?
• How does the individual cooperate with other farmers in the community?
• Is labor available when necessary?
• How does work capacity influence the economic feasibility of the activity?
(This is particularly important when a specific competence or person is
Technical capacity is closely connected with the analysis of feasibility and
must be analyzed with other parameters:
Has the client had loans in the past?
• How were they repaid?
• How were they managed?
• Were they late in repayment and, if so, what were the reasons?
• What is the evaluation of their previous credit managers?
Does the client have savings?
• What is the level of savings compared with the loan?
• What is the savings history?
• How are the assets invested in the business (activity)?
• What is their value?
• What is the quality of the assets (are they well maintained)?
• What are the family contributions to the business (activity)?
The secondary sources for repayment of the loan:
• Are they personal guarantees from trustworthy individuals?
• Are the business’ assets and the personal guarantees enough to cover the
repayment of the loan if necessary?
But PLEASE NOTE – the guarantee is not a primary source of
• Is there an adequate and stable market to support the business?
• Are the terms of the loan (duration, interest rate, etc.) well defined in
relation to the capacity for repayment?
• What are the price and production risks?
• What are the general trends of the sector market?
• Additional risks such as illness, etc.
The 5Cs = 5 factors for analyzing the loan risk
• “The art” is much more than knowing how to calculate! It’s the sense of
smell, the intuition and the emotional intelligence!
• Proper risk management depends on knowing what, when and how to
apply the analysis indicators and also how to analyze the borrower’s social
and personal factors.