Chapter two

CREDIT MANAGEMENT IN BANKS

Credit management; is a process of granting credit, the terms it's granted on and
recovering this credit when it's due. This is the function within a bank or company to
control credit policies that will improve revenues and reduce financial risks.

The Credit Management function ensure that all a commercial bank’s activities aimed
at ensuring that customers pay their loans within the determined payment terms and
conditions.

The Effective Credit Management serves is try to prevented late payment or non-
payment, the two being the greatest risks commercial banks face when conducting
their operations.

CREDIT MANAGEMENT POLICY

The Credit management policy is defined as the principles and systems set up by top
administration that oversee the organization's credit division and investigates
execution in the growth of credit benefits against set down procedures.
How to make an Effective credit policy?

1. implemented through appropriate (suitable) procedures

2. monitoring it.

3. periodically reviewed to consider the changing of internal and external

circumstances.

CREDIT RISK

Credit risk is the probability of a financial loss resulting from a borrower's failure to
repay a loan. Essentially, credit risk refers to the risk that a lender may not receive the
owed principal and interest, which results in an interruption of cash flows and
increased costs for collection.

Despite the other risks, credit risk make the biggest threats to the banks and financial
organizations.

SOURCES OF CREDIT RISK

There are two main sources of credit risk factors. These are external and internal risk
factors.

1- The external factors are the state of the economy, equity prices, foreign exchange
rates and interest rates , trade restrictions, economic sanctions, Government
policies, etc.

Any changes in national income and the level of unemployment will have an impact
on credit risk because of the change in exchange rate, interest rate and credit quality.

2- The internal factors are deficiencies in loan policies, ineffective administration,

absence of wise credit limits, inadequately defined lending limits for Loan
Officers/Credit Committees, lacks in assessment and evaluation of borrowers’
financial position, excessive dependence on collaterals, absence of loan review
mechanism…etc.

Risk will increase if management does not regularly receive accurate and timely
reports on credits. The reports shall comprise important information relating to
underwriting process such as economic trends, market share, commodity prices,
exchange rates, including past due credits, credit concentrations, and analysis of
problem loans.
CREDIT ANALYSIS

- What do banks look at when deciding approved or decline to grant a loan to a

borrower?

Credit analysis is the primary method in reducing the credit risk on a loan request.
This includes determining the financial strength of the borrowers, estimating the
probability of default and reducing the risk of non repayment to an acceptable level.
In general, credit evaluations are based on the loan officer's subjective assessment.

The Five C’s of Credit are key factors that lenders use to evaluate a borrower’s
creditworthiness. They help determine the risk of lending money and the likelihood of
repayment.

The system weighs five characteristics of the borrower, attempting to measure the
chance of default.

The Five C’s are:

• Character

• Capacity

• Capital

• Collateral

• Conditions

1- Character (aka: Credit history) Will You Repay the Loan?

It refers to a borrower's reputation. The applicant’s record of meeting past

obligations, financial, contractual, and moral. Past payment history as well as any
pending or resolved legal judgments against the applicant would be used to evaluate
its character. which is a borrower’s reputation or track record for repaying debts.

Credit score information appears on the borrower’s credit reports. which are
generated by the three major credit bureaus. Credit reports contain detailed
information about how much an applicant has borrowed in the past and whether they
have repaid loans on time.

2- CAPACITY Can you repay the loan?

The applicant’s ability to repay the requested credit with interest. We can analyze
capacity by calculating Debt to Income ratio, were DTI ratio calculated by adding a
borrower’s total monthly debt payments and dividing that by the borrower’s gross
monthly income.

3- CAPITAL What are your Assets and Net Worth?

The financial strength of the applicant as reflected by its ownership position. Lenders
also consider any capital that the borrower puts toward a potential investment. A
large capital contribution by the borrower decreases the chance of default.

4- COLLATERAL What if you Don’t Repay the Loan?

The amount of assets the applicant has available for use in securing the credit. The
larger the amount of available assets, the greater the chance that a firm will recover
its funds if the applicant defaults.

A review of the applicant’s balance sheet, asset value evaluations, and any legal
claims filed against the applicant’s assets can be used to evaluate its collateral.

collateral-backed loans are sometimes referred to as secured loans or secured debt.

They are generally considered to be less risky for lenders to issue. As a result, loans
that are secured by some form of collateral are commonly offered with lower interest
rates and better terms compared to other unsecured forms of financing.

5- CONDITIONS

lenders look at the general conditions relating to the loan. This may include the length
of time that an applicant has been employed at their current job, how their industry is
performing, and future job stability. Conditions can refer to how a borrower intends
to use the money. Business loans that may provide future cash flow may have better
conditions than a house renovation during a slumping housing environment. lenders
may consider conditions outside of the borrower’s control, such as The current
economic and business climate as well as any unique situations affecting either party
to the credit transaction. Analysis of the general economic and business conditions,
as well as special situations that may affect the applicant or firm is performed to
assess conditions.

CREDIT REPORT
A credit report is a statement that has information about your credit activity and
current credit situation such as loan paying history and the status of your credit
accounts.

Most people have more than one credit report. Credit reporting companies, also
known as credit bureaus or consumer reporting agencies, collect and store financial
data about you that is submitted to them by creditors, such as lenders, credit card
companies, and other financial companies. Creditors are not required to report to
every credit reporting company.

What kind of information appears on a credit report?

1- Personal information:

• Your name and any name you may have used in the past in connection with a
credit account, including nicknames

• Current and former addresses

• Birth date

• Social Security number

• Phone numbers

2- Credit accounts:

• Current and historical credit accounts, including the type of account

(mortgage, installment, revolving, etc.)

• The credit limit or amount

• Account balance

• Account payment history

• The date the account was opened and closed

• The name of the creditor

3- Collection items:

• Missed payments

• Loans sent to collections

 • Information on overdue child support provided by a state or local child
support agency or verified by any local, state, or federal government agency

• Public records

CREDIT SCORE

A credit score is a numerical representation of a borrower's creditworthiness,

indicating how likely they are to repay borrowed money. It is used by banks, lenders,
and financial institutions to assess loan applications and determine interest rates.

It is a credit score is a numerical summary of credit report.

Who Issue CREDIT SCORE?

Credit scores are issued by credit bureaus (credit reporting agencies) and financial
institutions. These organizations collect and analyze credit-related data to generate
a credit score for individuals and businesses.

Who Issue CREDIT SCORE?

• Experian

• Equifax

• TransUnion

• CRIF (Italy and multiple European countries)

• Schufa (Germany)

• Creditsafe (Europe-wide)

• Al Etihad Credit Bureau (AECB) – United Arab Emirates (UAE)

• SIMAH – Saudi Arabia

• Qatar Credit Bureau – Qatar

Factors Affecting CREDIT SCORE

• Payment History (35%) – On-time vs. late payments.

• Credit Utilization (30%) – The percentage of available credit used.

 • Credit History Length (15%) – How long credit accounts have been active.

• New Credit (10%) – The number of recent credit inquiries and new accounts.

• Credit Mix (10%) – The variety of credit accounts (e.g., loans, credit cards,
mortgages).

The range (FICO)

• Excellent: 750–850

• Good: 700–749

• Fair: 650–699

• Poor: 600–649

• Very Poor: 300–599 .

Who uses credit score?

• Banks & Financial Institutions: To evaluate loan and credit card

applications.

• Mortgage Lenders: To determine home loan eligibility.

• Insurance Companies: To assess risk for policyholders.

• Landlords: To check tenant reliability.

• Employers (in some cases): To assess financial responsibility in sensitive

jobs.

Why It Matters?

• Most Banks and financial organization depend on it to make credit decisions

(credit analysis)

• Higher credit scores mean better loan offers and lower interest rates.

• Lower scores may result in loan rejections or higher borrowing costs.