This topic is designed to educate lenders on what should be considered before advancing credits to an individual, groups or business outfits. Borrowers are also expected to know that lenders always assess them using the 5 Cs of borrowing.
At the end of this, lenders should know whether to disburse credit facility and what the should look out for before disbursements.
Lenders (financial institutions and people) attempt to mitigate the risk of lending to unworthy borrowers by performing a credit analysis on individuals and businesses applying or demanding for a new credit facility.
The 5 Cs are mechanisms put in place to determine creditworthiness of the borrower.
Therefore, before you lend out funds, consider the five (5) Cs explained below;
Lenders always analyze the borrower’s capital level when determining creditworthiness.
Capital is the difference between your assets (what you own) and your liabilities (what you owe). It is very vital for lenders to consider a borrower’s capital, which is the equivalent of the borrower’s net worth. Capital means what you are worth.
Here, lenders must consider the ability of the borrower to pay the amount intended to be borrowed. You also look at the debt load of the borrower (existing loan(s) as the case maybe), or all of your monthly obligations divided by your income for the same period. This question is cardinal for the lender to ask; does the person or business has enough to pay the new credit facility?
Capacity here is different from capital because it is not about preexisting ownership; but your ability to keep earning money to paying off your financial obligations (debts).
This is key and a fallback in the case of default but when lenders ask of collateral, they are not aiming to make your life miserable, but you having collateral on loan reduces their risk and make them likely to hand the cash you need.
Lenders must insist on collaterals (which could be assets-including intangible assets, salaries domiciliation etc)from borrowers before advancing credit facilities to them which they can fall back to in case of default on the part of the borrower.
As a more subjective factor in creditworthiness, lenders analyze the condition under which the loan is being made. Lenders also need to review condition such as the purpose of the loan.
The conditions of the loan such as the interest rate, the amount of principal, repayment schedule and tenor of the loan influence the lender’s desire to finance the borrower.
The character of the borrower is a very important and essential factor to be considered when disbursing credit facility. It tells you if the borrower will repay the loan or not.
Character is sometimes called “credit history” and refers to the borrower’s reputation or track records for repaying debts.
There are people or businesses who no matter how financially buoyant see it as a taboo to repay debts or loan disbursed to them.
The character (reputation and past track records towards debt repayments) must be considered before disbursing credit facility.
Borrowers may have the capital, collateral, conditions and capacity all in place but may lack the character towards loan repayments.
Therefore, lenders must deal with borrowers with integrity and clean track records (antecedence) of loan repayment. There are many people and businesses that have fallen short of this factor which has made their integrity and creditworthiness questionable. Not all persons or businesses will borrow with the intention to repay. That is why financial institutions (especially Banks) make huge provisioning for loss assets which affects their end of year net Profits and in some cases throw them to loss positions.
Lenders must desist from borrowing people without the character attribute because default is imminent and inevitable.
With this, when next you intend to lend to any person or business, bring the aforementioned factors into consideration. This will help you not to take
uninsurable risks and cases of your debts deteriorating from bad debt, doubtful debt to becoming loss asset(s) which you maybe written off.
These are the factors to be considered when you are thinking of advancing credit facilities to any potential borrower (whether an individual or business).
Written by Dr. David Charima