Verifying and determining the creditworthiness of a potential client by looking at their financial state, credit reports, and business cash flows
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Written byCFI Team
In bank credit analysis, banks consider and evaluate every loan application based on merits. They check the creditworthiness of every individual or entity to determine the level of risk that they subject themself by lending to an entity or individual.
Clients with a high level of risk are less desirable since they present with a high likelihood of defaulting on their loan obligations. Low-risk clients are more likely to get their loan applications approved since the lender considers them creditworthy.
Summary
- Bank credit analysis involves verifying and determining the creditworthiness of a potential client by looking at their financial state, credit reports, and business cash flows.
- The goal of credit analysis is to determine the level of default risk that a client presents to the company and the losses that the bank will suffer if the client defaults.
- The risk level that a client presents determines whether the bank will approve or reject the loan application, and if approved, the amount to be awarded.
How It Works
One important consideration that banks make is the collateral provided for the loan. The collateral must be of equal or higher value than the debt amount. In case of default, the bank can repossess the collateral to compensate for the inability of the borrower to service the debt as per the agreed terms.
A credit analyst can use software to analyze data available about the financial history of the client. The software provides financial and creditworthiness reports that provide information on the level of risk of the borrower, which helps the lender make the appropriate decision.
The credit analyst is the final decision-maker based on the reports and issues at hand. Issues mostly considered include the financial history of the client, whether payments are always made on time, the amount of income generated by the client, and the potential of similar businesses in the same location. The lender may also request credit reports from credit agencies to assess the credit health of the borrower.
Information Gathering
When filling in the loan application form, the borrower is required to provide their personal information and physical address. The borrower should also submit copies of their identification documents alongside the loan application form. The credit analyst or the bank official at the point of information gathering should verify the original documents and ask for copies of the documents to be deposited with the bank as part of the loan application documents.
Verification of the applicant’s identification documents helps the bank prevent cases of fraud. Unverified persons may be imposters or non-existent individuals, which, if not detected, may result in loss of money. A background check should also be done on the client to check for criminal records and to curb money laundering.
In summary, the bank checks credit repayment history, the character of the client, financial solvency, the client’s reputation, and the ability to work with the amount granted as a loan. Part of the information is provided in credit reports obtained from reputable credit bureaus. The bank checks against its records and against other lenders. It helps the bank determine the credit risk and, consequently, the amount of credit that the client can afford at the lowest probability of default.
The Creditworthiness of a Borrower
A borrower’s creditworthiness is ascertained by evaluating and verifying the information provided by the client. The loan requested by the client should be reasonable and adequate to undertake the purpose of the loan to completion. A loan that is below the amount required to perform the intended purpose comes with a high risk of default.
The bank should also confirm that the borrower possesses the required experience and industry knowledge in the field that they are about to invest in. In most cases, the bank may require the borrower to provide a feasibility report of the project they are about to undertake. It is to ascertain if the borrower is able to enough cash flows to service the debt, provide for staff salaries, and meet the operating expenses of the business.
Credit Security
The loan officers assigned to review a loan application should gather as much information on the collateral provided and the general credit security. The client is asked to submit the collateral or their documentation to the bank. The collateral can be in the form of vehicle logbooks, land title deeds, and other forms of documentation that act as proof of ownership. It must be of the same value as the loan or more at the most recent valuations.
The collateral should also be verified by the loan officers as existent and of the value as declared by the client. The client should be informed on the recovery process of a defaulted loan, and they should be aware that the collateral will be seized in the event that they default on the loan.
Banks undertake all the risk analysis steps to make sure that the risk of default is reduced to close to zero. However, if the default is imminent, the bank can be left with no option but to seize the collateral.
Credit Bank Analysis Decision-Making
The credit analysts and loan officers base their decision on the entire analysis. The analysis helps in reaching a decision on whether the risk level is acceptable or not and to what extent. The amount of loan to be awarded to the borrower will depend on whether the lender is convinced that the loan will be repaid within the agreed terms and duration.
The bank can either approve the total amount of loan requested or decide on a specific amount of loan that is below what the borrower applied for. Whatever the decision, the lender must communicate to the borrower its decision before the disbursem*nt is made.
Related Readings
CFI offers the certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:
- Credit Rating
- Credit Report Analysis
- Probability of Default
- Quality of Collateral
- See all commercial lending resources
As a seasoned financial analyst with extensive experience in credit analysis, I have been actively involved in evaluating the creditworthiness of potential clients for several years. My expertise is grounded in a deep understanding of financial statements, credit reports, and business cash flows—the very components central to the article on verifying and determining the creditworthiness of clients.
In the realm of bank credit analysis, the article accurately emphasizes the importance of considering and evaluating every loan application based on its merits. This involves a comprehensive assessment of the client's financial state, credit reports, and business cash flows to determine the level of risk associated with lending to them.
The article highlights the critical role of credit analysts in making informed decisions based on the available data. I can attest to the significance of assessing a client's creditworthiness to mitigate the risk of default, which is a core objective of credit analysis. The meticulous examination of a client's financial history, payment patterns, income generation, and industry potential is essential for gauging their credit risk.
The mention of collateral as a crucial factor in the credit analysis process aligns with industry best practices. Drawing from my experience, I can confirm that collateral serves as a risk mitigation strategy for banks. The requirement for collateral of equal or higher value than the debt amount provides a safety net for the lender in the event of default.
The utilization of software for data analysis, as discussed in the article, is a practical approach that I have employed in my professional career. Analyzing financial and creditworthiness reports generated by specialized software aids credit analysts in making well-informed decisions.
The article rightly underscores the importance of information gathering, emphasizing the verification of identification documents to prevent fraud. My experience aligns with the necessity of conducting background checks on clients to detect potential issues such as criminal records and money laundering risks.
The detailed explanation of how the creditworthiness of a borrower is ascertained, including the evaluation of the loan amount requested and the borrower's experience in the relevant industry, reflects the thoroughness required in credit analysis. A borrower's ability to generate sufficient cash flows to service the debt is a crucial aspect that I have consistently assessed in my role as a credit analyst.
Lastly, the article appropriately addresses the decision-making process in credit bank analysis. The final decision, whether approving the total loan amount or a specific lesser amount, hinges on the lender's confidence in the borrower's ability to repay within agreed terms.
In conclusion, my comprehensive knowledge and hands-on experience in credit analysis align closely with the concepts presented in the article. From assessing credit reports to evaluating collateral and making informed decisions, I am well-versed in the intricacies of ensuring sound credit risk management.
