CHAPTER 1 :

NATURE OF CREDIT
 LEARNING OUTCOMES

 Basic concepts in credit

• Intermediation process
• Risk and return
• Various instruments in government regulations
affecting credit activity
• Determine factors influencing credit activities
• Identify various stages in credit process
INTERMEDIATION PROCESS
 Introduction
 The financial services industry touches the lives of
every individual, household and business within the
economy.
 Individuals and households provide savings to
financial institutions which transform them into financial
assets.
 In this content, financial institutions act as financial
intermediaries bridging the distance between
depositors and borrowers.
 Process of Intermediation

DEPOSITORS (with surplus units)

Financial Services Industry (FSI)**

BORROWERS (with deficit units)

**The players in this Financial Services Industry are known as

Financial Services Firms and they consists of the following:
 Commercial Banks;
 Merchant Banks;
 Finance Companies
 Scheduled Institutions
INSTRUMENTS IN GOVERNMENT
 In a conventional banking system, Central Banks
usually employ six primary methods for implementing
monetary policy :
 Statutory Reserve Requirement
 Minimum Liquidity Requirement
 Interest Rate Regulation
 Selective Credit Control
 Capital Adequacy Ratio
 Base Financing rate / Cost of Financing
 These instruments have a similar effect on the
quantity of money and credit in the economy.
 STATUTORY RESERVE REQUIREMENT (SRR)

 SRR is one of the oldest monetary instrument deployed by

BSP to control the liquidity situation in the banking system.
 SRR is a powerful instruments available to BSP because it
affects the level of deposits and loans that a bank can legally
support.
 Any increment in the SRR ratio will:
 Reduce the level of reserve available to the banking institutions
 Decrease the lending ability of the banking institutions
 Any decrement in the SRR ratio will:
 Increase the level of reserves available to the banking institutions.
 Increase the lending ability of the banking institutions.
 INTEREST RATE REGULATION
 An important instrument which BSP can control
including the bank’s liquidity and cost of bank credit
through the interest rates charged on bank loans as well
as the rates of interest offered for deposits.
 Increment of the interest rate will :
 Increase the level of cost of funds for the banks loans
 Decrease the demand for bank loans
 Decrement of the interest rate will :
 Decrease the level of cost of funds for the banks loans
 Increase the demand for bank loans
SELECTIVE CREDIT CONTROL
 Credit facility is important to all economic sectors but
due to certain consideration, some sectors need special
protection.
 Guideline on lending to these priority sectors are
issued by central bank in order to achieve the target
loans to these sectors.
 This priority sectors comprise of small and medium
industry, agricultural sector and low and medium house
buyers.
CAPITAL ADEQUACY CONTROL (CAR)
 Capital Adequacy Ratio (CAR) is a ratio that
regulators in the banking system use to watch bank's
health, specifically bank's capital to its risk. Regulators
in the banking system track a bank's CAR to ensure that
it can absorb a reasonable amount of loss.
 Regulators in most countries define and monitor CAR
to protect depositors, thereby maintaining confidence in
the banking system.
 Capital adequacy ratio is the ratio which determines
the capacity of a bank in terms of meeting the time
liabilities and other risk such as credit risk, market risk,
operational risk, and others. It is a measure of how much
capital is used to support the banks' risk assets.
BASE FINANCING RATES (BFR) / COST OF
FINANCING
 is the cost and interest and other charges involved in
the borrowing of money to purchase assets.
 FACTORS INFLUENCING CREDIT ACTIVITIES
 Credit activities will be affecting by several factors
which will resulting the fluctuation based financing rate,
demand for credit and profit rate. The several factors are
known as:

1.Economics conditions
 During the economic growth, demand for financing
will be increase rather than during recession. Credit
activities based on economic condition will be affected
through investment spending and consumer spending
which will increase growth domestic product (GDP).
2. Supply of money and interest rate
 Supply of money and interest rate also affected the
credit activities. But it depends on the economic
situation. For example, during economic growth supply
of money from depositors will increase. Many people
will invest and saving to the financial institutions.
 So, the supplies of money are increase resulting
demand for financing increase. With the competitive
profit rate offer by financial institution encouraged
customer to demand for financing also. But, during the
recession it will be supply of money decreased and
profit rate for financing increased resulting decreased
demand for financing.
3.Government regulations and policies
 BSP is a Central Bank of PI. Act as a protector of
depositors and deposits almost to the safety. BSP also act
as to maintain stability of financial system and to
structures financial system with intention to avoid
customer from the monopoly power of banks.

 This regulation and policies will change time to time
depending on the economic situation. When the
economic are stable, the regulation and policies would
be more flexible to increase business activities but
different in the recession.

4. Competition among banks

 Competition among financial institution always
happens in order to achieve higher market share in
financial portfolios and all together affected credit
activities. Hence, anywhere of financial institutions
offers the best and better facilities to customer will get
attentions form customers.
STAGES IN CREDIT PROCESS

 Credit process is the basic concepts in the credit environment.

There are four main stages of credit process. First, credit officer will
market bank’s facilities to the potential customer (STAGE 1:
BUSINESS DEVELOPMENT). After having a potential customer,
he will ask for customer details (job, income, address, identity
number and the others requirement) to do a credit analysis. Hence,
credit officer must know the sound lending principle or known as a
credit analysis (STAGE 2: CREDIT EVALUATION). Once the
financing has approved, credit administration and monitoring will
be required (STAGE 3: CREDIT MONITORING). If the
borrower default or failed to fulfil the payment in the right time,
credit officer must study the remedial actions suitable to the
customer (STAGE 4: CREDIT RECOVERY).
STAGES IN CREDIT PROCESS
STAGE 1: BUSINESS DEVELOPMENT

BUSINESS DEVELOPMENT CAN BE DONE

THROUGH THE SELLING CYCLE
 PROSPECTING
 Involve the opportunities to find out the business require financing.
During this process, credit officer must identity and aware of the
credit risk and business condition because different company has
different business condition and credit risk towards financial
institutions. If credit officer failure to identify the credit risk there
will potentially negative impact to bank’s portfolio.

 DATA COLLECTION
 Credit officer will collect preliminary information with respect to
the background and nature of the business and industry that it’s
operates from, the pricing of the financing based on market
conditions and the type and value of security offered.
 ANALYSIS AND MEETING
 Credit officer should arrange to meet the prospective customer for
the purpose of making a site visit to the premises to gather more
facts about the business. This site visit is normally recorded into a
Call Report and submitted to the bank management for further
comments.

 SELLING AND NEGOTIATION

 During the meeting and if there is sufficient information to make
proposal, the credit officer may proceed to discuss the financing
structure to ensure that the prospect is able to make repayments.
This negotiation with the prospect involves bank’s willing to sell
his financial products at the highest level of profit rate and the
prospect hoping to gain the lowest possible profit rate.
 CREDIT MEMORANDUM
 If the selling negotiations appear accommodative to both parties,
then the credit officer will proceed to prepare a credit memorandum
or application for Accommodation (AA) to recommend the
proposed financing to the finance committee for their approval.

 APPROVAL OF OFFER
 Upon the approval of committee by endorsing the Credit
Memorandum, the officer will proceed to prepare a Letter of Offer
and to forward to the prospect for his acceptance. In the event the
offer is not accepted by the prospect, renegotiations will have to
commence. Once the offer has met with acceptance, the officer will
proceed to initiate the selling cycle with another new prospect.
STAGE 2: CREDIT EVALUATION

 Credit analysis covers the following:

i. Quantitative aspect
ii. Qualitative aspect

iii. Documentation process

iv. Security and other legal aspects

v. Profitability and relationship

vi. Capital adequacy ratio compliance

STAGE 3: CREDIT MONITORING

 Follow up aspects on the financing account

includes:

i. Annual or interim reviews

ii. Reassessment of existing terms and conditions

iii. Renewal of financing facility

iv. Re-establishment of borrowing relationship with

issuance of a fresh Letter of Offer and Customer’s
acceptance of the renewed facility
STAGE 4: CREDIT RECOVERY

 Comprises the following actions:

i. Winding-up proceeding by means of legal

action on the company
ii. Enforcement of guarantees against guarantors as
individuals
iii. Receivership via appointment of Receivers
and Managers (R&M)
iv. Foreclosure by way of auctioning a
landed property
v. Turnaround of restructuring by salvaging
the company to generate cash flow.