An effective consumer lending proposition

Lending is one of the major and traditional activities of a bank. It is responsible for a large portion of the asset side of a bank’s balance sheet.
The core business of a bank is to mobilise deposits from public who have surplus funds to save and lend same back to public who are in need of money, keeping a margin as profit.

In this task, banks are acting as financial intermediaries and they match their lending portfolio (assets) with the maturity pattern of the deposits (liabilities) mobilised.
Banks mobilise deposits for short, medium and long-terms. It can vary from overnight to several years. According to the rules and regulations of the Central Bank of Sri Lanka (CBSL), a certain percentage of the mobilised deposits should be set aside to maintain the reserve requirement imposed by the CBSL and a considerable amount of liquid assets to meet the demand for money (withdrawals) by the customers. After meeting the statutory requirements, the balance is available for banks to lend or invest as they wish.
Banks can lend the mobilised or borrowed money to consumers for personal requirements or corporate for business requirements. The people who fall into one of the following categories may apply for advances/loans.
Individuals, sole proprietorship, partnership, limited liability companies (private and public), unincorporated societies and clubs, government institutions, trustees and executors and administrators.
The aim of this article is to discuss the matters related to personal/ consumer lending by giving special reference to banks.
Once the Lending Proposition (LP) for a loan/advance is received by the bank from a prospective borrower, the assessment of the applicant/borrower is started to determine the credit worthiness/ suitability of the applicant/borrower for the applied loan/ advance. The objective of this evaluation process is to decide whether the LP is acceptable in its original form, acceptable with some amendments or is not acceptable.
The LP should come from the prospective borrower himself and the decision to lend or not is taken by the competent bank officers. The requests for loans/advances received by banks will be finally categorised under one of the above criteria after evaluating the LP. Therefore, some of the LPs are accepted in its original form while some are accepted with some amendments to its original form.
A considerable percentage of LPs are declined due to various reasons. The LP should conform to the principles of good lending as well as the bank's lending policies and procedures. Further, it should be in line with the bank’s credit culture. This clearly proves that the banks would not be willing to lend to everybody who applies for a loan/advance.
There are important factors/ aspects examined by the banks when they evaluate the LP received from a prospective borrower for a loan/advance for a consumer loan. Those factors can be described using the mnemonic ‘CAMPARI’. C – Character, A – Ability, M – Margin (Profit), P – Purpose, A – Amount, R – Repayment Capacity and I – Insurance/Collateral/Security.
Character
Banks would be willing to lend money to people who have an excellent character. This cause is established by banks in two ways. Primarily, banks can use their own records if the applicant is an existing customer of the bank.
Most probably, banks may more comfortably consider the loan applications received from their own customers who have already maintained their accounts at least for six months. Moreover, recommendations received from the existing customers will add value to the evaluation process.
Therefore, if the customer maintains a Current Account (CA) with the bank, it will definitely support the evaluation process since a CA should necessarily be introduced by an existing customer of the bank and the monthly statement generated from the CA is useful to be used as a mirror image of the financial discipline of the customer.
Secondly, if the applicant does not maintain an account with the bank, then the bank would be interested in finding out why the applicant does not apply for the advance/loan from his/her present banker.
Banks may carry out a thorough study on the past records of the loans obtained from the bank by the applicant, repayment pattern of such loans, reports of Credit Information Bureau (CRIB), cheque returns, stop payments of cheques, behaviour of the CA (highest, lowest and average balances) and the expenses over income i.e. debits over credits in the account.
Banks would also give weightage to those who hold any other relationships with the bank like investments with the bank and holding other products of the bank such as Fixed Deposits (FDs), Certificate of Deposits (CDs) and saving accounts.
Conducting a personal interview
This technique is adopted by the banks to determine the integrity and trustworthiness of the prospective applicant/borrower. It will also help the bank officer to meet the client and estimate his/ her competencies and skills.
Banks would assess the financial standing and genuineness of the financial need of the borrower by meeting him personally. It is important to examine whether the borrower is clear on his plans, objectives, strategies and the return on the investment made by him or the benefits of his expenditure.
Through a personal interview, banks would recognise the special skills, leadership qualities, relevant experience, know-how and the knowledge on financial matters of the borrower.
Credit officers of the bank study the contents of the LP, gather the market, technical and industrial information and identify the strengths and weaknesses of the LP before they meet the applicant/borrower. This will help them to conduct a structured interview to gather the maximum information required for a proper analysis and clarify any doubts about the information provided and the nature of the transaction.
Credit officers would take this opportunity to discuss with the borrower about the strengths and weaknesses of the LP, propose alternatives, make amendments if required and suggest improvements. This opportunity would also be used to build a strong and friendly relationship with the prospective borrower. This may explore the opportunities for cross selling of other products immediately or in the future.
Ability
Banks would be willing to lend money to people who have special ability to perform duties/tasks. This means the ability of the prospective borrower to manage the financial affairs properly and efficiently.
Banks would take into account the relevant experience and skills, academic and professional qualifications along with the expertise on the relevant field and also the knowledge on principles of marketing and basics of finance. The applicant’s knowledge, understanding and capacity to apply the acquired knowledge to situations are important.
The overall assessment about the ability of the borrower will help the credit officer to establish the borrower's capacity to meet the financial commitments proposed in the LP. If the application is for a loan for a consumption purpose the bank is mainly interested in assessing his/her ability to generate the cash flow (liquidity) to repay the loan.
Margin
Banks would be willing to lend money to people who are capable and willing to pay a certain percentage of interest as the return for the money disbursed/lent by the bank while repaying the capital borrowed. Basically, banks make profits from their lending activities in three different ways such as interest margin, fees and commission.
Borrowers have to pay an interest as the cost of money they borrowed from the bank along with the capital. This quantum should be adequate to cover the administration cost of the transaction and keep a considerable margin as the profit to the bank. More commonly, banks may charge a lump sum as the processing fee at the time of disbursing the loan.
The interest rate varies from bank to bank, product to product and based on the estimated risk involved in the transaction.
Purpose
Banks would be willing to lend money to people who have a clear idea of what they are going to do with the money they borrow. Banks do not lend for illegal purposes. It is a banking practice to inquire from the borrower the actual reason for the advance/loan to be taken from the bank. The purpose of the loan is an important aspect of lending since it will decide:

• Whether to lend or not
• Amount of the loan
• Period of repayment and grace period (if any)
• Applicable interest rate
• Type of security/collateral to be taken.

Though the purpose is legal some banks may not lend for some purposes as a policy of that particular bank or may be due to technical, practical or operational limitations. Refraining from granting advances to new ventures by new commercial banks is a good example for this point.
Amount
Banks would be willing to lend money to people who clearly stipulate their financial need (quantum) in the LP. This is one of the crucial factors and the exact amount of the loan should clearly be indicated in the loan application.
The amount of the loan is very closely related with the purpose of the loan. There should be supporting documents to prove that the loan amount is in line with the purpose. The amount must not be a qualitative statement or a quantitative range.
Banks may consider several important factors in relation to the amount of the loan:

• Whether the borrower’s contribution/stake is sufficient with the amount to be lent
• Whether the borrower has asked for more than the real requirement
• Whether the borrower has asked for less than the real requirement
• Whether the borrower wants his/her bank to suggest the amount

Generally banks may not decide or suggest the amount of the loan. Further, they do not lend more than the quantum necessary for the purpose of the loan to avoid the possibility of using the excess money for other purposes. Banks also do not lend less than the real requirement since the borrower will go for other sources of funds to fill the gap. This may deteriorate the repayment capacity of the borrower.
Repayment
Banks would be willing to lend money to people who have a strong repayment capacity (net worth). This factor is very important and ranked after the character of the borrower since wilful defaulters may not repay their financial commitments even though they have the sufficient repayment capacity.
Despite the fact that the borrower has adequate quantity of assets to be lodged as security for the advance, banks do not lend him if he does not have the capacity of repayment of the loan together with the interest. Therefore banks request the prospective borrower to produce the all possible document evidences which will enable him to prove his repayment capacity. Banks in general perform a proper analysis of the cash flow of the borrower to determine the repayment capacity.
These statements will include but not limited to salary slips, tax certificates, income statements from businesses, bank statements, etc.
Security/collateral
Banks would be willing to lend money to people who are capable of providing the bank with some sort of asset as security or a guarantee as collateral against the loan applied to cover the consequences of an event of unfortunate inability to repay.
Banks may consider the security as an insurance against the non-payment and may realise same as the last resort in case of a default of the loan to recover the outstanding capital lent along with the interest accrued base on the best practices of recovery, the policies and procedures of the bank and applicable law.
Conclusion
In brief, banks would be willing to lend money to people who:

• Have a good character, high degree of integrity and trustworthiness
• Have ability to meet the financial commitments
• Are willing to provide a margin to the bank
• Have come with an acceptable purpose
• Have a clear idea about the financial requirement
• Have documented evidences for the repayment capacity
• Are willing to provide some sort of security/collateral

The judgment will be made by the bank officers in the following manner:

• Identify the issues in the proposition
• Consider the risks involved
• Decide the measures necessary to make the risks acceptable/mitigate the risks
• Evaluate the available evidences
• Sanction or decline of the loan

It is expected that any credit officer should grant credit facilities prudently and judiciously, weighing between the risks involved in and the benefits derived from that particular credit transaction.
On one hand lending is a science and on the other hand it is a matter of common sense. Necessarily, credit officers are ruled by their heads and not by their hearts. Therefore, the Lending Proposition (LP) should be prepared comprehensively, providing all important facts and figures by the prospective borrower and presented to the bank as early as possible after deciding to borrow, to enable the credit officer to evaluate the same professionally and favourably.
(The writer – MBA (Finance)(UK), Chartered Marketer, MCIM (UK), MICM (UK), B.Sc (Agri) Hons, AIB (SL), MSLIM, MAAT – is Director of the College of Banking & Finance, Institute of Bankers of Sri Lanka.)