credit analysis process.pptx

KMBNFM05 financial-and-credit-risk-analytics

1. Credit Analysis (According to AKTU SYLLABUS) Presented By Vikash Barnwal Assistant Professor Kashi Institute of Technology

2. Credit Analysis process Credit Analysis is a process adopted by any Bank and any financial institution to assess, evaluate and analyse about the potential borrower’s Identity, Financial Position, – Repayment Capacity, Integrity Etc. 

3. Information collection process: The very first step towards credit analysis is collecting every possible information about the applicant. The character, the reputation of the person, financial stability, credit history, ability to repay debt, the actual purpose of seeking debt etc. Example: If the loan is for a project then the loan officer must understand the objective of the project, financial feasibility of the project, importance of the project as compared to others, the cash burn in it and mainly the amount of loan that can be reasonably disbursed for the loan. Many times banks do it through its special third party inspection agencies which carry out the inspection on the field on behalf of the bank. Based on the risk associated with the profile as depicted by the agency, the bank decides whether to move forward in the proposal or not.

4. Analysing accuracy of the information : The individual borrower or the organisational project may submit all the information as demanded by the loan officer, but it is for the lender to verify if the given information is accurate and authentic. The credit analyst or the loan officer would verify the valid identity card of the borrower or in case of the organisation , the business license, the partnership deed, the legal document, the certificate of incorporation, etc At this phase, the financial solvency of the potential borrower the feasibility of the project, are important factors in credit analysis. The analyst performs ratio analysis from the past and projected profit and loss statements, balance sheets, cash flow statements, and other financial statements of the project and analyzes each of them to arrive at a conclusion before assessing the financial viability of the project. He then makes a comparison of his own analysis and that provided by the applicant.

5. Decision-making process The credit analyst tries to understand what impact the proposed loan will have on enhancing the income and liquidity position of the proposed borrower.  A good indicator for this is the net cash flow of the proposed borrower to pay back the loan and the interest component along with other expenses within due time. The credit analyst may also check the existing interest burden and fixed charge liability of the proposed borrower .

6. Credit Process 5 c`s Model or Credit process 1. Character : its involve a review of personal honesty, integrity, trustworthiness and managerial skills. A banking officer also makes a judgment of character based on your business plan, credit history and the quality of your presentation. 2. Capacity / Cash flow: this is the cash your business has to pay the debt. A cash flow analysis helps us determine if you have the ability to repay the loan Character Capacity/Cash flow Capital Conditions Collateral

7. Capital: The capital structure of your company is important to Bank because it helps determine the level of risk associated with your loan request. Analysis of capitalization includes a review of equity, total debt ,the value of Assets and permanent working capital . Condition: this refers to outside conditions that may affect the ability of your business to repay your loan request. Factor such as general economic condition or a large concentration of sales to a single customer are evaluated during our review of your loan application Collateral: this provide the secondery source of repayment, thereby minimizing the risk for bank. The amount and type of collateral required depend on the type and purpose of the loan

8. Documentation It  means the Bank Credit Agreement, the other “Loan Documents” as defined in the Bank Credit Agreement and any other document or agreement entered into for the purpose of evidencing, governing, securing or perfecting the obligations in respect of the Bank Debt, as each such  agreements or instruments may be amended or instruments may be amended, supplemented , modified, restated, replaced,  renewed  refunded, restructured, increased or refinanced from time to time.

9. Loan Pricing Loan pricing means determining the interest rate for granting loan to creditors, be it individuals or business firms. It is one of the most important, however difficult task in lending funds to business firms & other customers. Because it is always very difficult to exactly know what the actual loan risk a particular loan application is. Generally the lender wants to charge a high enough rate to make sure that the loan will be profitable as well as it will covers enough compensation against the default risk. On the other hand loan price must be set low enough that helps the customers to find it easy for successful repayment of loan. Loan pricing is the process of determining the interest rate for granting a loan, typically as an interest spread (margin ) over the base rate , conducted by the bookrunners  .  Loan Pricing Learning Objectives Identify loan types and their relative degree of profitability Define risk-adjusted return, and risk-adjusted return on capital Calculate and interpret an example risk rating Recommend pricing structures based on risk rating and loan type

10. ESSENTIAL ELEMENTS OF PROFITABLE LOAN PRICING  There are (3) broad considerations in formulating an appropriate loan pricing strategy. These are  costs ,  risk , and  profit . Cost Risk Profit

11. Costs Cost of Funds  – As with each attribute, there are different ways this can be measured. The simplest is to consider the institution’s interest expense.  Capital Costs  – To the extent a loan may impair capital, and this should be a consideration . Overhead  – Overhead is the institution’s cost to operate. Again, with all of the elements, this can be measured in different ways and can vary over time.  Fixed Costs  – Fixed costs are the fixed portion of the expense of origination, processing, and servicing an additional loan. Variable Costs  – Variable costs are the variable portion of the expense of origination, processing, and servicing an additional loan.

12. Risk Loan products carry varying degrees of risk, as do the credit characteristics to which they are underwritten. Higher risk loans are more costly because of the higher probability of default but they also have more carrying costs due to servicing. Loans should have a risk premium assigned as part of the pricing structure.  Profit Finally, loans should have a margin above the aforementioned factors. This represents the actual profit to the institution above its cost and taking into account risk. 

13. Profitability analysis the process of systematically analyzing profits derived from the various revenue streams of the business . Profitability analysis is part of enterprise resource planning and helps business leaders to identify ways to optimize profitability as it relates to various projects, plans, or products. It is the process of systematically analyzing profits derived from the various revenue streams of the business.  P rofitability refers to the profits or gains a business makes in relation to its expenses. Therefore, profitability analysis refers to  the process of calculating or analyzing the profits of a business . It helps businesses identify their revenue streams and where they can reduce their expenses to generate maximum gains.