BANK LENDING

1.0. INTORDUCTION

Lending is concerned with granting of credit facilities to customers. The term ‘credit’ is derived from the Latin word ‘credere’ meaning to trust. Credit is thereby defined as the ability to source goods and services in exchange for a promise to pay back later.
One of the Principal businesses of a bank is lending and the bulk of bank’s income comes from this source. The survival of a bank depends mostly on the efficient management of its lending portfolio.
Lending involves taking risks and assessing the risk of defaults and movements in interest rates. It is a key element in the creation and maintenance of depositor relationships particularly with business firms. Every bank lending aims at three principal objectives viz: growth, profitability and liquidity. Ana appropriate aand sound measurement of risk is required in lending since it involves risk taking. For this to take place a well-conceived lending policies coupled with careful lending practices are essential to facilitate credit creating function and minimise risk in lending. The bulk of technical training a banker receives is geared towards lending hence an astute banker is described as a shrewd banker. Students often misuse the two terms borrowing and ‘lending’ hence explanation of these two words will remove such confusion. Simply put borrowing means getting credit facilities from the bank while lending means
giving credit facilities to the customer. Thus while customer borrows, banker lends.
Funds mobilized from customers in form of deposit form the basis for the credit creation exercise by the bank which is achieved through lending. At this juncture, it is pertinent to explain the meaning of the two technical words ‘Banker’ and Customer’ coupled with relationship between them.

2.0. OBJECTIVES

After going through this unit, you should be able to:

1.  Evaluate the risks in Customers’ loan application. 
2.  Discuss the factors affecting prudent bank lending. 
3. Explain the basic principles of lending 
4. List the canons of good lending. 

3.0. MAIN CONTENT

3.1. LENDING DECISION

Decision to lend to customers in influenced by some factors and every prudent banker should consider them in evaluating any customer asking for loan/credit facilities. These include:

1. Internal policies of the bank. 
2. Credit guidelines of the Central Bank of Nigeria. 
3. The principles of bank lending. 

(i) Internal Policies of the bank 

evolve policy guidelines which provide the framework for dealing with loans and advances. Some of these policies are designed by each bank based on its peculiar internal constraints like sectoral performance, deposit base, existing exposure, risk exposure etc. Similarly, other policies of each bank are largely derived from the guidelines issued periodically by the Central Bank of Nigeria for control purposes like liquidity requirement, reserve requirement etc.

For example, deposit base (total amount mobilised as deposit) is the greatest constraint to lending in that if the deposit base of a bank increases more funds to meet various borrowing requests of the customers will be available thereby increasing the bank’s ability to grant more loans. On the other hand, if deposit base of the bank is low, new lending can hardly take place.
Similarly, liquidity ratios as earlier explained in chapter six prescribed in the Central Bank of Nigeria monetary circular is another form of limitation on banks ability to grant credit facilities. If the ratio is high, the bank’s ability to grant loans to customers will be reduced and the opposite holds when the
ratio becomes low.

(ii) Credit guidelines of the Central Bank of Nigeria.

Another important factor that exerts great influence on the decision of bank to lend to its customer is the Central Bank of Nigeria credit guidelines. These guidelines not only dictate the volume of loans but the direction of commercial banks lending. The annual credit guidelines of the Central Bank of Nigeria usually contains among others; the aggregate credit allowed, the sectoral distribution of loans and advances and penalties for non-compliance.

(iii) The principal of bank lending.

The principles of bank lending comprise of basic principles and general principles and these principles are explained as follows:

Self Assessment Exercise: 

How would you appraise a loan application by

1.  Customer of your bank? 

3.2. Basic principles of lending.

There are three basic principles of lending viz: safety, suitability and profitability of the loan.

3.2.1. Safety of the loan:

A loan is said to be safe if the borrower meets both interest and principal repayment of the
loan as at when due. This is determined by assessing the character, integrity and reliability of the borrower. The customer us considered credit worthy and qualified for the loan if the source(s) of repayment is/are certain and un-doubtful. Bank attaches more importance to the safety of the loan or advance. If loan granted is repaid promptly, more customers of the bank will benefit and the banking business will continue to grow and the survival of the bank is guaranteed.

3.2.2. Suitability of the loan: 

A loan is considered suitable if the purpose of the loan is lawful and does not contravene the credit guidelines of the Central Bank. Similarly, loan must satisfy all safety and risk considerations. Bank must satisfy itself that the advance sought by the customer is not meant for illegal purposes or for a purpose which is in conflict with the economic or monetary policies of the government as stated in the credit guidelines of the Central Bank. For example, a banker will turn down a loan request whose purpose is to gamble or bet because the loan is meant for a speculative purpose.

3.2.3. Profitability:

This refers to profits accruing to the bank or additional business generated as a result of the loan granted to a customer. Since commercial banks are established to maximize profit most of its activities are geared towards profit maximization. In doing this banks accept deposit from customers and pay interest on deposits and lend larger part of deposit mobilized to customers at a profit.
The rate of interest charged on its loan is higher than the rate interest paid to the depositor and the difference constitutes profits to the bank. More importantly banker is always eager to lend if such borrowing will create a good connection between him and the customer, thereby other businesses for
the bank.

3.3. Canons of good lending.

The following principles which are also known as canons of good lending must be followed by every lending officer before granting credit facilities to bank customers. Canon means the general standard or principle by which something is judged. If the following principles are strictly followed, a
potential borrower can be adjudged at the onset to determine his repayment ability.

3.3.1. The character and ability of the borrower.

The character and business ability of the prospective borrowers must be studied and known. The bank knows that character of his personal customers through his track record that is past operations on the account of the customer since the account is opened. What to look for includes: whether past advance
granted had been repaid as scheduled in accordance with arrangements, if and whether
the account has been operated satisfactorily or unsatisfactorily. Also the integrity and character of such customers must not be doubted. For business customer, apart from analysing and evaluating the past financial statements of the company, the bank must satisfy himself that the customer is capable of running the business well enough to enhance profitability and that a substantial part of the profits made are ploughed back into the business for future growth. The management of such business must be efficient. The ability of the business to have repaid past advances given coupled with its present performance will indicate whether or not the customer gas ability to repay the loan applied for.

3.3.2. Amount required by the customer.

Customer must state how much he wants to borrow and this must be confirmed by the
manager. The essence of confirmation is to ensure the actual amount needed by the
customer to carry out the project into completion is advanced to him. The rule is ‘do
not lend too little or too much’. In other to determine this, for a business customer bank
will demand for and analysed by considering notable ratios, the cash budget and financial statements of the customer for abut five years for an old customer of three years for a new
customer. Then the customer’s own contribution is then compared with the amount sought to see whether the bank is being asked to lend too much. Ideally, bank will be prepared to lend only a proportion of the total amount requested for customer is expected to provide at least one third of total
sum needed for the project. Any proposal to the bank to finance the whole project will be turned down because if customer has no stake in such project it is believed that customer will not be serious with the project and see to its successful completion. Banks prefer to see some of the customer’s money involved in the deal for this will be a sort of incentive for borrower to see the project to a profitable conclusion. For the project to be carried out successfully, bank must ensure that the
amount granted to the customer together with the customer’s own contribution is enough to carry out the project.

3.3.3. Purpose of the loan

The purpose for which the advance is sought must be revealed to the bank to determine
whether or not the loan will be granted by the bank. The purpose of the loan must be in line with the internal lending policies of the bank. Bank should not lend for illegal purpose or for
any purpose that is not in line with the Central Bank guidelines. For example, no bank will
lend for a speculative purpose or lend for gambling. Before a loan is granted to a
corporate customer, bank must ensure that the company has power to borrow and loan is
meant for legal purpose. This can be known by perusing the Memorandum and Articles of
Association of the company. Any loan granted by the bank to a corporate customer which is
later found to be illegal purpose cannot be recovered by the bank under the law.

3.3.4. Length of time for which the customer requires the loan.

Bank is expected to be liquid at all the time so that it can meet its customer’s cash
withdrawal on demand at all time. This is the reason why the commercial bank cannot
afford to lend on long term. Instead commercial bank prefers to lend on short term, medium term or grant self-liquidating loan. Such loans are mostly meant for working capital, to buy raw materials which will be used to repay the overdraft or loan granted.

3.3.5. Repayment Schedule

The lending banker would be interested in how the borrower intends to repay the loan
granted. If it is from his future earnings, the borrowing customer must be able to submit a simple cash budget. In a personal loan,the manager will ask for details of the customer’s
earnings now and in the future through his normal monthly expenditure. The statement
will incorporate his existing payments on a mortgage, insurance premium, hire purchase repayments, personal and house keeping expenses.