Practical Approach to Bank Lending

By ROSELINE OLUWATOYIN OLUITAN

The book discusses about the methods and approaches used by banks in granting credits to their customers. The material covers the various types of lending and the processes involved in detail. It goes beyond the normal classroom rhetoric as it adopts a practical approach similar to having a hands-on-experience in lending. It is an ideal material for students of finance who need to understand the core rudiments for financial activities and to succeed in professional examinations. It is also useful for bank staff and researchers in the subject area to keep abreast of the banking procedure. I strongly recommend the material for finance students and lecturers in the field.

• Language: English
• Publisher: AuthorHouse UK
• Release date: Jul 29, 2011
• ISBN: 9781456787721

ROSELINE OLUWATOYIN OLUITAN

Roseline ia a professional banker with about two decades of practical banking experience. She holds Bachelor and Master’s degree in Banking & Finance and recently obtained doctoral degree in Economics & Finance from Brunel University, West London. She is an Associate of the Chartered Institute of Bankers of Nigeria and is currently a lecturer in the Department of Accounting & Finance, Lagos State University in Nigeria. She brings her wealth of experience both in the industry and as a lecturer to bear in the writing of this book.

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© 2011 by Roseline Oluwatoyin Oluitan. All rights reserved.

No part of this book may be reproduced, stored in a retrieval system, or transmitted by any means without the written permission of the author.

First published by AuthorHouse 07/15/2011

ISBN: 978-1-4567-8771-4 (sc)

ISBN: 978-1-4567-8772-1 (ebk)

Printed in the United States of America

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and such images are being used for illustrative purposes only.

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Because of the dynamic nature of the Internet, any web addresses or links contained in this book may have changed since publication and may no longer be valid. The views expressed in this work are solely those of the author and do not necessarily reflect the views of the publisher, and the publisher hereby disclaims any responsibility for them.

Contents

PREFACE

INTRODUCTION

CHAPTER 1

TYPES OF CREDIT

CHAPTER 2

CREDIT APPRAISAL TECHNIQUES

CHAPTER 3

LOAN SYNDICATION AND MANAGEMENT

CHAPTER 4

LENDING POLCY

CHAPTER 5

CREDIT GUIDELINES

CHAPTER 6

CREDIT PORTFOLIO

CLASSIFICATION SYSTEM

CHAPTER 7

DEBT RECOVERY

CHAPTER 8

SERVICE BANKING

CHAPTER 9

CAPITAL AND DEBT ISSUES

CHAPTER 10

CREDIT RISKS

CHAPTER 11

SECURITIES FOR BANK LENDING

CHAPTER 12

FRAUD AND FORGERIES

BIBLIOGRAPHY

PREFACE

Bank Lending which is concerned principally with matching deposit liability with the asset counterpart can be described as both an art and a science. The art lies in the concept of adopting efficient and scarce resources to satisfy certain wants. The science relates to the use of computational methods in analyzing credit proposals. Thus the book will take us through both concepts.

The book is divided into twelve chapters following a sequential order from Types of Credit, Credit Analysis, Loan Syndication., Lending Policy, Credit guidelines, Classification System, Service banking,’ Capital and Debt Issues, Credit Risks, Collateralization and Fraud and Forgeries.

I believe that the utilization of this book will provide succor to Academicians, Students and Professionals who want expand their scope of knowledge or for examination purposes.

At this point, I wish to, express my appreciation to the Dean of the Faculty of Management Sciences Lagos State University and my colleagues in the Department of Accounting & Finance, Lagos State University for bits of comments while this piece was a work-in-progress. I remain grateful everybody. Also I wish to express my gratitude to Professor S. I Ajayi and Professor Adedoyin Soyibo , both of Department of Economics, University of’ Ibadan for their continued support assistance.

Finally, I appreciate my husband Mr. J.A. Oluitan for his understanding and Bimbo Oluitan for keeping up with household chores whenever I am not around. Lastly, to God is the glory for the grace and power that saw me through this publication.

OLUITAN ROSELINE OLUWATOYIN

INTRODUCTION

One of the major functions of the banking industry is that of availing their customers with credit facilities to aid their financial position. Granting credit is not peculiar to banks alone as various other organizations or persons do practice this function. However, we are focusing on the banking industry that assists their customers in the process of financial intermediation to distribute funds to the needing clients/ customers. This is necessitated due to their stock in trade which is money that is garnered together in form of deposits by the banking populace. These funds do attract fee called interest which are paid to the depositors hence the need for the banks to give out such funds to the needing sectors of the economy through customers demand for same.

In the process of performing this credit function, banks do make profit as they do not lend at the same rate they collected the funds for deposit, however, some level of margin is applied to create the profit effect thereby enhance the status of such a bank. In essence the more the deposit, the more credit to be created and the more the profit, provided necessary impetus were taken into consideration. This presupposes credit portfolio but with little or no return to show for it. It is the aim of this book to examine this and also analyze the means by which the banking industry performs this task.

Also it is a widely accepted norm that banks are agent for socioeconomic development. This implies that banks are catalysts for national development thus Nigeria’s case is not different.

Lewis (1976) in the theory of economic growth opined that The advantage of economic growth is not that wealth increases the range of human choice. Similarly, Ayida (1971) in development objectives stated that The basic objective of development policy in Nigeria is not to widen the range of effective choice of the ‘have nots’ in the foreseeable future: but to satisfy their basic wants for food, shelter and living wage. In the same vein, Aboyade (1971.) in the development process noted that three basic measures were core to a development planning model.

"The first prong of the operational strategy is the achievement of increased productivity per man acre and per man hour in agriculture and especially in the sector of food and raw material production for domestic consumption without prejudice to continued benefits from agricultural export. This result needs to be brought about by a higher marginal physical productivity per unit of land, labour inputs without a fall in the revenue product. Its purpose will not raise agricultural output and hence national income for higher and diversified consumption within the period, but also particularly to create a large social surplus for the much needed capital formation.

The second element of the growth determinant is to be found in a greater structural shift of resource use towards more manufacturing industries, guided by more industries consideration of social profitability.

The third but not the least important is the powerful stimulus for growth which could come from the maximum possible expansion of petroleum production to generate some of the enormous foreign exchange and government revenue required to sustain the difficult process of reconstruction and development in an underdeveloped economy that has been over stretched by a long wasting war. The above exerts reinforce other economist views about growth parameters in a developing economy to include the following four indices:

¾ Agriculture and Agro-Allied Industry

¾ Manufacturing

¾ Mineral Resources (Mining, Quarrying & Petroleum)

¾ Exportation.

1t is imperative to state that there is no specific theory of growth, whose element are best suited to the nature and extent of underdevelopment typified by Nigeria, hence whichever model will be adapted, it will have to note the peculiar problems which the country is entrenched in. This view is in fact upheld by the financial supervisory authorities in Nigeria to the extent of issuing guidelines on sectoral allocation of credit which is detailed hereunder.

Table 1

However, though the parameters of’ growth show positive signals, the sectors of a nation’s development such as Manufacturing, Mining Agriculture still shows signs of financial malnourishment depicting inadequate/improper funding. While the fund that is channeled in my view is relatively adequate, the method adopted may call for review so that fund channeled into these sectors are done subject to thoroughly and proper analysis that will ensure safely of the funds and creation of the desired impact on the populace and the banking sector in particular. This will ensure wealth increase that will assist to achieve the desired banking populace confidence in the industry and also avert banking failures as a result of weak institutions in the country.

CHAPTER 1

TYPES OF CREDIT

DEFINITION

Presentation of lending proposal can be defined as the body of processes involved in analyzing and granting of credits to customers. In other words it can be termed as the medium employed by Financial Institution in the management of financial resources available them for the provision of fee based services to their numerous customers.

The business of banking involves taking of risks while ability to effectively manage these risks is Credit Administration. The effectiveness of credit depends on the level of efficiency employed in the presentation of credit proposals among others. It is an integral of Credit Administration of the bank which determines its Survival, Solvency, Profitability and Public Confidence. In essence, Credit Administration is the business of banking as it covers the basic duty of granting credit and recovering same.

However this book will dwell basically on the mode or parameters employed in granting credit and also ensure prompt repayment.

In order to properly harness the topic for discussion, it is essential to appreciate the numerous forms of credit available.

TYPES OF CREDIT

There are a number of terms used in granting credits to customers. The aim is to reduce risk in the portfolio while the criteria used in appraising each proposal depends largely on its form/type.

LOAN

i)   Short Term

   This type of facility is usually used to meet sudden/unforeseen expenditure for projects that can easily repay itself soonest. Their duration is usually not more than 12 months.

ii)   Medium Term Loan

   These are facilities of less than 5 years project maturity or repayment of the proposal.(some schools of thought advocate 3 years for medium term loan; and any proposal of longer maturity is classified as long term)

iii)   Long Term Loan

   This is usually used to acquire fixed assets with repayment period above 5 years.

Loans are granted for specific purpose and repayment is spread over a specific period.

Advances

Unlike overdraft which is continuing in nature, an advance is a short-term credit extension which is granted for a definite period and repayable in lump sum.

Advances are normally granted for specific purposes e.g. Bridging finance, Refinancing of Letters of credit, Payment of collections, Refinancing of matured loans, etc.

Overdraft

These are for recurrent expenses and working capital of a concern or entity. Overdraft is normally granted for working capital purposes and the amount outstanding is expected to fluctuate over the life of the facility. These are for recurrent expenses and/or working capital of a concern or entity.

Overdraft facilities are normally reviewed every year. However, in accordance with general banking practice, overdraft is repayable on demand and can be cancelled at the bank’s option without prior notice.

Some other classifications are:

Leasing

A medium to acquire usage of the required equipment without parting with the total cash required or purchasing such equipments.

Trust Receipt

Part financing of raw materials and goods imported pending sales. If a client imports goods and is unable to pay for clearing fees, the bank can assist and clear the goods to the bank’s warehouse. However, to allow the client to repay the facility availed, the goods have to be sold before payment could be effected. The bank will then release the goods to the client on trust, having executed a Trust Receipt so that when sales are made, payment could be effected.

Bridging Loan

This is used to bridge the gap between when funds are needed and when it can be available.

Venture Capital

For new projects which the promoter believes has the potentials of survival, profitability and growth.

Direct Credit Facility

This is also called cheque discounting. It is a form of facility in that money is advanced on the discounted face value of a cheque and instrument pending actual receipt of fund or when the cheque will be cleared. Customers to enjoy this facility must have negligible incidence of returned cheques and amount to be recommended must relate to the volume of transaction on the account.

Product Advance

These are facilities given to produce customers for the purpose of acquiring stock for their trade. It is usually part financed.

BILL DISCOUNTING

This is when the face value of a bill/credit note is discounted. It is similar to Direct Credit. While Direct only credit relates to bank cheques only, bill discounting is more encompassing. It includes Bills and Notes. Essentially, financing receivables involves accepting the customer’s accounts receivable as pledge for credit facilities. This pledge is done either on a notification basis to our customer’s debtor or by domiciliation of bills drawn by the customer on his debtor {discount or trade bills}. However, the bank will accept discounting only on recourse basis.

Interest on bills discounted is charged in advance, with the net proceeds being credited to the customer’s current account. Because interest is debited in advance, bills discounting normally carries a lower interest rate than overdraft or advances.

Warehousing and Advance Against Warrants

This is an advanced to an exporting customer backed up by goods warehoused awaiting shipment. This does not relate to any warehouse but of specialized agent such as SGS, Decacia etc:

Contingent Facilities etc

i)   Share Issue

   Specialized Credit e.g. NERFUND, NEXIM, SME, etc Loan Syndication etc.

ii)   Bonds, Guarantees and Indemnities

   These are required by clients to give assurance of action/ payment on a particular event or transaction.

iii)   Bonds and Guarantees are basically contingent liabilities issued on behalf of customers to specific contracts. The common types are:

a.   Public works Bond, such as:

   i.   Bid Bond or Tender Bonds

   ii.   Advance payment Guarantees

   iii.   Performance Bonds

b.   Customs and Excise Bonds

c.   Bill of Landing indemnities

d.   Bank Guarantees

Credit officer should note that contingent liabilities are credit facilities in themselves and as such, must be duly appraised with approval obtained from the appropriate authority.

a)   Public Works Bonds

I.   Bid Bonds or Tender Bonds

   The essence of Bid Bonds is normally to ensure that the party to whom a contract is awarded will indeed accept the award and proceed with the execution of the contract. The Bid Bond can be called by the employer when the contractor fails to accept the contract award. The money realized from the bank is used to defray the cost of re-awarding the contract. The Bid Bond is usually for a small percentage (between 1%-3%) of the contract. Bid Bonds, if successful, are usually followed by Advance Payment Guarantees and Performance Bonds.

II.   Advance Payment Guarantees

   Advance Payment Guarantee is required in contracts whereby the employer undertakes to pay a certain percentage of the contract sum to the contractor prior to commencing execution of the contract. In order to guarantee the subsequent performance of the contractor, the employer requires a bank to guarantee the contractor (our customer) for the initial payment. This guarantee is issued in all cases subject to the funds being made payable directly to the bank. Acceptable collateral must be obtained to support the Guarantee from the customer.

III.   Performance Bonds

   This type of Bond is issued to a customer who has been awarded a contract to guarantee the employer of the customer’s capability in terms of financial standing and technical ability to handle contracts of such magnitude. Usually, the bank is able to perceive the customer’s ability to handle such contracts from our past association with the customer. The performance Bond therefore guarantees the employer of the customer (usually governments or parastatals) that the customer (contractor) is capable of executing the contract. With this guarantee, the bank will be liable to employer for a breach of the contract agreement by its customer. It is usually for a percentage of the contract sum (5%-.10%) and has to be fully cash-covered.

b)   Customs and Excise Bonds

This type of bond is issued to guarantee the customer for payment of