Have loan assessment formula at fingertips before rushing to bank
An I&M Bank branch in Nairobi: Lenders are always keen on risk exposure and use discretion to decide what amount to give as loans. Photo/File
Have you ever applied for a business loan from a commercial bank and got a rejection letter after a long silence?
When that happens — and it is usually painful — do not complain but use the occasion to reassess your application on the bank’s scale of lending before trying again.
Banks evaluate applications on the basis of 5Cs of credit: character, capital, condition, capacity and collateral.
Of all these, character does not have a formula because it is a reflection of your personal qualities, reputation and habits. It is determined by your credit history, which is about how you have handled repayments previously.
Character
Each time you walk into a banking hall to ask for a loan -- perhaps to start a business -- before determining the amount, the bank will enquire from the credit reference bureau to know your risk level.
They use the information so gathered to decide whether to reject your application outright or process it under the other Cs of credit.
Capital
The bank will underwrite your application based on capital, which is the measure of your financial strength. This is captured from assessment and analysis of financial statements by the credit manager.
The capital you have invested in the business venture will indicate to the bank how much risk you would face should the business collapse.
The credit manager will expect you to have raised capital from personal sources to establish the business. This is where most requests to flop.
Capacity
Those who pass the financial-strength test, face another on whether one has the means to meet financial obligations throughout the repayment period -- it is called capacity.
You need to demonstrate how you plan to meet the financial obligation of prompt monthly repayments throughout the period.
Again, the credit manager will rely on the financial statements to assess your ability to generate sufficient funds to meet the current business obligations and in the future. The ability is demonstrated by your cash flow.
If in doubt, the lender will consider reducing the size of loan to a sizeable amount with eyes on repayment. But those who do not meet the threshold get the REJECT verdict.
Condition
But more importantly, the bank will be interested in how the business is performing under certain conditions in the industry or sector.
Although the prevailing economic or market dynamics such as competition and inflation are beyond your control or influence, lenders take note and consider the intended use of the requested loan to read the impact of the condition on your repayment.
Where the bank feels that the prevailing market condition could hurt ability to sufficiently meet the repayment obligations, the credit manager will be more cautious as this would serve as a signal of potential risk of default.
Collateral
Lastly, requests that pass these tests above are also subjected to cushion in form of a collateral to stay safe if, for some reasons, you may default.
This is where your credit report will be instrumental. Remember that this is your reputation collateral and it could help you to negotiate for a cheaper credit with the bank.
A good credit history is equivalent to a good character and can save you from the stress of looking for collateral to secure your loan facility.
