Transcript MCF 304: Bank Management Lecture 4.2 Credit Analysis Credit Analysis • • Credit analysis is the most important activity in the lending process of any commercial.

MCF 304: Bank Management
Lecture 4.2
Credit Analysis
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Credit Analysis
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Credit analysis is the most important activity in the
lending process of any commercial bank. This
activity involves a network of task which are based
on theoretical model to ascertain the credit standing
of loan applicants
At the end of credit analysis process, a credit
decision proposal will be presented to the bank’s
management for final decision making
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Credit Analysis
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The credibility of a credit decision is very
much dependent on the credibility of the
credit analysis.
Credit analysis is greatly influenced by ratio
analysis because of the availability of
financial information
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Credit Analysis
• Determine the credit standing of potential
borrower
• However the issue of asymmetric information
often arise because borrowers certainly have
more information than banks on their future
• Credit analysis is practiced to determined the
repayment capacity of prospective borrowers &
their attitude towards loan repayment
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Credit Analysis
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Banks desire borrowers not only with repayment
capacity but also posses the sense of responsibility
towards loan repayment
The 5C model is used in credit analysis to determine
credit risk related to non-repayment of loans
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5 C’s
Character
- Evaluation on the applicant willingness to
make payment
- Historical credit records & character reference
from third party
- Image, good standing, reputation, business
prospects, etc.
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5 C’a
Capacity
- Evaluate the applicants both from the legal &
finance point of view
- Is the borrower have legal capacity to enter
into a contract?
- Main objective is to determine the borrowers
capacity to repay the loan
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5 C’s
Collateral
- Any asset pledge by borrower to secure a loan
- Need to know the age, condition &
specialization level of the pledged assets
- Banks however is more interested in loan
repayment rather than the collateral
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5 C’s
Conditions
- Evaluate the economic
conditions that may
effect the borrowers
capacity to repay the
loan
- Forecast the exposure of
borrower’s business to
economic and interest
rate changes
Capital
- Applicant’s net worth
because its symbolize
success & commitment
- Higher net worth
indicates higher loan
repayment capacity
- Net worth encompasses
accumulated earnings
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Scope of credit Analysis
• Depends on the size & maturity period of the
loan, the track records of the company, the
collateral involved and the past relationship
between the applicant & the bank
• Does not mean that credit analysis can be
forgone even if the collateral value exceeds the
loan amount
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Source of Credit Information Source of
Credit Information
Loan applicant interviews – to collect
information on the character of applicants
ii. Bank records – factual & highly reliable
credit information
iii. Business premises – to verify the existence of
business & understand the structure and
operations of the company
i.
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Credit Analysis
iv. Financial statements – to performed trend
analysis on credible (audited) financial
statements
v. Credit bureau – CCRIS / CTOS / RAM
vi. Inter bank references – cross checks from
other banks
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Evaluation of Financial Statements
Assets Evaluation
- Review the accounts receivables / debtors for
possible bad / doubtful debts disaster
- Ageing analysis, trade debtors, factoring
- Determine the age, liquidity & stability of
inventories and the efficiency & effectiveness
of the company asset management
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Evaluation of Financial Statements
Liability & Net Worth Evaluation
Determine the status of creditor’s on clients balance
sheet to protect the interest of the bank in the event
of loan default
Creditors can be categorized as secured, preferential
& general creditors
The amount & maturity of short / long term debts
must be taken into consideration in determining the
financial risk of applicants
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Evaluation of Financial Statements
Income Statement Evaluation
- Information on the profitability & stability
level of the company
- Will reveal the effectiveness of the company
credit, operations & debt utilization policy
- The sensitivity of each expenditure level to
change in sale
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Evaluation of Financial Statements
Statement of Changes in Financial Position
- Reflect the change in liquidity of the
company
- Determine the source & uses of funds to
determine the balance between financing &
investment policy
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Ratio Analysis
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Trend analysis is used to find out if the financial
performance & position have improved /
deteriorated / remain unchange over a period of
time
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Four groups of ratio analysis
i. Liquidity ratio
ii. Asset management ratio
iii. Financial leverage ratio
iv. Profitability ratio
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Liquidity ratio
Current Ratios.
Measure the ability of the company to fulfills
its long term loans using its current assets.
current assets
current liabilities
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Liquidity ratio
Quick Ratios
Measures the ability of the company to pay its
short terms loans quickly.
Current assets – (inventory + prepayments)
current liabilities
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Assets management ratios
Average collection period
Measure the average days taken by the
company to collect accounts receivables
Account Receivables x 365 days
Annual Credit Sales
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Assets management ratios
Inventory turnover
Measures the efficiency of inventory
management
Sales
Average Inventory
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Assets management ratios
Fixed assets turnover
Measures the efficiency of the company in
using its fixed assets to generate sales.
sales
fixed assets
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Assets management ratios
Total assets turnover
Measures the efficiency of the company in
using its assets to generate sales
sales
total assets
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Financial Leverage ratios
Debt ratio
Measures the percentage of total assets that are
financed by debts
total debts
total assets
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Financial Leverage ratios
Fixed Charged Coverage Ratio
- Measure a company capacity to pay fixed
charges such as interest on loans
Net Income
Fixed Charges
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Profitability ratio
• Return on assets
Measures the effectiveness of the company in
using its assets in generating profit
after tax earnings
total assets
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Profitability ratio
Return on equity
Measures the efficiency of the company in
generating profits for its ordinary shareholders
after tax earnings
shareholder's equity
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Profitability ratio
Net profit margin
Measure the ability of a company to generate
net profit from each dollar of sale after
deducting all expenditure
after tax earnings
sales
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Thank You!
Izdihar Baharin @ Md Daud
Post Graduate Centre
HP: 006019-5170817
Email: [email protected]
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