Course Instructor:

Md. Nazmul Hasan

Associate Professor
Department of Banking and Insurance
University of Dhaka
Email: [email protected]

Chapter-9: Lending Policies and

Procedures
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 Types of Loans Made By Banks
• Banks make a wide variety of loans to a wide variety of
customers for many different purposes—from purchasing
automobiles and buying new furniture, taking dream
vacations, or pursuing college educations to constructing
homes and office buildings.

• Fortunately, we can bring some order to the diversity of

lending by grouping loans according to their purpose—what
customers plan to do with the proceeds of their loans.

• At least once each year, the Bangladesh Bank require each

bank to report the composition of its loan portfolio by
purpose of loan on a report form known as Schedule A,
attached to bank’s balance sheet.

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 Types of Loans Made By Banks
• Commercial and Industrial Loans- Purchasing
inventories, Setting new industry, paying taxes, meeting payrolls.
• Real Estate Loans- To purchase homes, apartments,
commercial structures, land, and buildings.
• Agriculture Loans- Granted in planting, harvesting crops and
supporting the feeding & care of livestock. (Poultry Farming, Beef
Fattening, Agri farming, duck farming, Aggregate Farming.)
• Lease Financing Receivables- Lender buys equipment or
vehicles and lease items. NBFIs do the same in BD.
• Financial Institution Loans- Credit to retail banks,
insurance and finance companies. (Wholesale Banks in USA, EU)
• Miscellaneous Loans- Securities loans
• Loans to Individuals-Credit to finance automobiles, homes,
appliances, repair homes, and cost of medical care, financing
education and vacations as well.
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 Factors Determining the Mix of Bank Loans
• Characteristics of Principal Loan Area: - Each lender must respond to
the demands for credit arising from customers in its own areas. Such as branch at EPZs
(Export-import financing), branch at Old Dhaka (small-businesses, Islampur for clothing),
branch at Rural Areas (Agro-based financing such as poultry, beef fattening, and fish
farming).
• Lender Size: Retail Bank Vs. Wholesale Banks:
Lender size determines the legal lending limit. Wholesale banks devote bulk of their credit
portfolios to large-denomination loans to businesses while Retail Banks concentrates to
cash loans, personal credits, and agricultural loans.
• Experience and Expertise of Management:
Credit policy sets the direction of the lending concentration and the management
philosophies and priorities for particular loans. Highly skilled management usually
prefers corporate banking and syndicated/participatory lending, selling advisory services.
• Yield/Return of Each Type of Loan: High yield on personal credit, credit
card loans, installment loans and Real-estate Loans.

• Type and Nature of Lending Institution-Bank/FIs: FIs lends

mostly in inventory and equipment, purchase appliances automobiles, and leases. Such as BDBL
sanctions industrial loan, RAKUB-agro-based loan, HBFC-House Loan.
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 Banking Regulations: BD & Beyond
• Lending institutions are among the most closely regulated of all financial-
service institutions. Not surprisingly, the mix, quality, and yield of the loan
portfolio are heavily influenced by the character and depth of regulation. Any
loans made are subject to examination and review and many are restricted or even
prohibited by law.

• Banks are prohibited from making loans collateralized by their own stock. (BD)
• Real estate loans granted by bank cannot exceed that bank’s capital or 70
percent of its total time and savings deposits, whichever is greater (USA).

• A loan to a single customer normally cannot exceed 15 percent of a bank’s

capital. The lending limit may be further increased to 25 percent of capital if the
loan amount exceeding the 15 percent limit is fully secured by marketable
securities. (USA)

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 Banking Regulations: BD & Beyond
• While in Bangladesh, in a similar fashion, A bank can grant only 15% of
funded credit to a single borrower and 25% non-funded credit to a single
customer.

• Lending to directors is strictly prohibited which is also known as connected

party lending.

• In the field of international lending, special regulations have appeared in

recent years in an effort to reduce the risk exposure associated with
granting loans overseas. In this field lenders often face significant political
risk from foreign governments passing restrictive laws or seizing foreign-
owned property, and substantial business risk due to lack of knowledge
concerning foreign markets.

• The quality of a loan portfolio and the soundness of its policies are the areas
central bank authority looks at most closely when examining a lending
institution. The better a bank’s asset-quality rating, the less frequently it will
be subject to examination by banking agencies, other factors held equal.

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 Bank’s Written Loan Policy
• Goal Statement for Bank’s Loan Portfolio
– i.e., types, maturities, sizes, quality
– Fixing the credit portfolio matrix i.e., RMG-grow, Agro-
maintain, Real-estate: decline.
• Specification of Lending Authority of Each Loan Officer
and Committee (Manager of Motijheel vs. Comilla Br.)
• Lines of Responsibility in Making Assignments and
Reporting Information
• Operating Procedures for Soliciting, Evaluating and
Making Loan Decisions (Who will accept loan application, who will appraise it,
who will manage documentation, and who maintain the customer relationship)

• Required Documentation for All Loans: Documents must be

acquired and creating charge in bank’s favour.
• Lines of Authority for Maintaining and Reviewing
Credit Files 16-7
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 Bank’s Written Loan Policy (cont.)
• Guidelines for Taking and Perfecting Collateral:
Perfecting means making security flawless in terms legal perspective
• Procedures for Setting Loan Interest Rate (Deciding the
loan pricing mechanism)

• Statement of Quality Standards for All Loans

• Statement of Upper Limit for Total Loans
Outstanding (
• Description of the Bank’s Principal Trade Area
(Real-estate, Pharmaceuticals, manufacturing, RMG, Personal Loan)
• Procedures for Detecting, Analyzing and Working
Out Problem Loans (How to detect a problem loan and what to do when it
becomes bad loan?)

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McGraw-Hill/Irwin 16-9
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 Steps in the Lending Process
• Receiving loan application/Finding Prospective
Loan Customers
• Evaluating a Customer’s Character and Sincerity
of Purpose
• Evaluating a Customer’s Credit Record &and
Making Site Visits
• Evaluating a Customer’s Financial Record
• Assessing Possible Loan Collateral and Signing
the Loan Agreement
• Monitoring Compliance with the Loan
Agreement and Other Customer Service Needs

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 Six Basic C’s of Lending

• Character – Specific Purpose of Loan and Serious

Intent to Repay Loan
• Capacity – Legal Authority to Sign Binding Contract
• Cash – Ability to Generate Enough Cash to Repay
Loan
• Collateral – Adequate Assets to Support the Loan
• Conditions – Economic Conditions Faced By Borrower
• Control – Does Loan Meet Written Loan Policy and
How Would Loan Be Affected By Changing Laws and
Regulations
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McGraw-Hill/Irwin 16-12
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 Common Types of Loan Collateral

• Accounts Receivables
• Factoring
• Inventory
• Real Property
• Personal Property
• Personal Guarantees
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 Factoring Vs. Discounting
Credit Control: With Factor Vs. Business
• With Factoring, the provider takes the role of managing the sales ledger, credit control and chasing
customers for settlement of their invoices.
• With Invoice Discounting, your business retains control of its own sales ledger and chases payment in
the usual way.

Confidentiality: No Confidentiality vs. confidential

• With Factoring, the customer settles their invoice directly with the Factoring company; so customers
are more likely to be aware of your Factoring arrangement.
• With Invoice Discounting, your customers still pay you directly; there is no need for them to know that
a third party is involved.

Size of Business: Small Firms Vs. Large reputed business

• Without credit control, the lender has less control over whether your customers will pay on time (or
pay at all), which means they’re taking on more risk by advancing you cash based on these invoices.
Thus, factoring is slightly more expensive than invoice discounting
• For this reason, discounting is traditionally used by bigger companies with higher turnover and
creditworthy customers, whereas invoice factoring is commonly used by smaller firms.

Flexibility: More flexibility vs. less flexibility

• There’s also a form of invoice finance called selective invoice finance or ‘spot factoring’, which allows
you to choose single invoices, specific clients, or specific projects to fund only applicable in Factoring.
• With invoice discounting, the lender will usually require you to finance your entire debtor book (i.e. all
of your current outstanding invoices).
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 Information About Consumers

• Consumer-Supplied Financial Statements

• Credit Bureau Reports (CIB/Online CIB)
• Experience of Other Lenders
• Verification of Employment
• Verification of Property Ownership
• Reviewing the Personal tax files
• The Web/Business Newspaper/Magazine
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 Information About Businesses
• Financial Reports Supplied by the Borrowing Firm

• Copies of Board of Director’s Resolutions or Partnership

Agreements (MOA, AOA, Partnership deed)
• Credit Ratings –Fitch, Moody’s Int’l , Standard & Poor’s
– Commercial data & Analytics: Dun & Bradstreet Corp.

• New York Times, Wall Street Journal, Other Business

Publications
• Risk Management Associates, Dun & Bradstreet
Industry Averages
• Online & Web Sources

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 Parts of a Typical Loan Agreement

• The Note: When a lending institution grants a loan to one of its customers, such an
extension of credit is accompanied by a written contract with several different parts. First,
the note, signed by the borrower, specifies the principal amount of the loan. The face of
the note will also indicate the interest rate attached to the principal amount and the
terms under which repayment must take place (including the dates on which any
installment payments are due).
• Loan Commitment Agreement: In addition, larger business and home
mortgage loans often are accompanied by loan commitment agreements, in which the
lender promises to make credit available to the borrower over a designated future
period up to a maximum amount in return for a commitment fee (usually expressed as a
percentage—such as 0.5 percent—of the maximum amount of credit available).

• Collateral: Secured loan agreements include a section describing any assets pledged
as collateral to protect the lender’s interest, along with an explanation of how and when
the lending institution can take possession of the collateral in order to recover its funds.
For example, an individual seeking an auto loan usually must sign a chattel mortgage
agreement, which means that the borrower temporarily assigns the vehicle’s title to the
lender until the loan is paid off.

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• Covenants: It means the terms and conditions of the loan.
Most formal loan agreements contain restrictive covenants, which are usually one of two
types: affirmative or negative.
– Affirmative: require the borrower to take certain actions, such as periodically filing financial
statements with the lending institution, maintaining insurance coverage on the loan and on any
collateral pledged, and maintaining specified levels of liquidity and equity.
– Negative: restrict the borrower from doing certain things without the lender’s approval, such
as restricting of taking on new debt, acquiring additional fixed assets, participating in mergers,
selling assets, or paying excessive dividends to stockholders.

• Borrower Guaranties and Warranties: In most loan agreements, the

borrower specifically guarantees or warranties that the information supplied in the loan
application is true and correct. The borrower may also be required to pledge personal
assets—a house, land, automobiles, and so on—behind a business loan or against a loan
that is consigned by a third party. Whether collateral is posted or not, the loan agreement
must identify who or what institution is responsible for the loan and obligated to make
payment.

• Events of Default: Finally, most loans contain a section listing events of default,
specifying what actions or inactions by the borrower would represent a significant
violation of the terms of the loan agreement and what actions the lender is legally
authorized to take in order to secure recovery of its funds. The events-of-default section
also clarifies who is responsible for collection costs, court costs, and attorney’s fees that
may arise from litigation of the loan agreement.
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 Loan Review
• What happens to a loan agreement after it has been endorsed by the
borrower and the lending institution? Should it be filed away and
forgotten until the loan falls due and the borrower makes the final
payment?
• Obviously that would be a foolish thing for any lender to do because
the conditions under which each loan is made are constantly changing,
affecting the borrower’s financial strength and his or her ability to
repay .
• Fluctuations in the economy weaken some businesses and increase the
credit needs of others, while individuals may lose their jobs or contract
serious health problems, imperiling their ability to repay any
outstanding loans.
• Examination of Outstanding Loans to Make Sure Borrowers are
Adhering to Their Credit Agreements and the Bank is Following Its
Own Loan Policies.
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 Loan Review Procedures

• Carrying Out Review of All Types of

Loans on a Periodic Basis
• Structuring the Loan Process
– Record of Borrower Payments
– Quality and Condition of Collateral
– Completeness of Loan Documentation
– Evaluation of Borrower’s Financial Condition
– Assessment as to Whether Fits with Lender’s
Loan Policies

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 Loan Review Procedures (cont.)

• Reviewing Largest Loans Most Frequently

• Conducting More Frequent Reviews of

Troubled Loans

• Accelerating the Loan Review Schedule if

Economy or Industry Experiences
Problems
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 Warning Signs of Problem Loans

• Unusual or Unexpected Delays in Receiving Financial

Statements
• Any Sudden Changes in Accounting Methods
• Restructuring Debt or Eliminating Dividend Payments
or Changes in Credit Rating
• Adverse Changes in the Price of Stock
• Losses in One or More Years
• Adverse Changes in Capital Structure
• Deviations in Actual Sales from Predictions
• Unexpected and Unexplained Changes in Deposits
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McGraw-Hill/Irwin 16-23
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 Loan Workouts

• What should a lender do when a loan is

in trouble?
• Experts in loan workouts—the process
of recovering funds from a problem
loan situation—suggest the following
steps:
• The purpose is to resolve a ‘Troubled
Loan’ so the Bank can recover its funds
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 Loan Workout Process
• Goal is to Maximize Full Recovery of Funds
• Rapid Detection and Reporting of Problems is
Essential
• Loan Workout Should Be Separate From Lending
Function
• Should Consult With Customer Quickly on Possible
Options
• Estimate Resources Available to Collect on Loan
• Conduct Tax and Litigation Search
• Evaluate Quality and Competence of Management
• Consider All Reasonable Alternatives
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McGraw-Hill/Irwin 16-26
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 Review Questions
• Explain the different categories of loan based on purpose.
• What is loan mix? What are the factors play crucial role in deciding the mix of loan?
• What is single-borrower exposure? Identify and enlist the major forms of banking
regulation.
• What is credit policy? Why is it important? Identify the crucial elements of a bank credit
policy.
• Describe the steps involved in a lending procedure.
• What is CIB? What avenues of information should a banker explore to assess a customer?
• How would you assess a prospective loan client based on the six C’s of lending? Why are
they important?
• What is a fully-securitised loan? Describe the commonly accepted bank collateral.
• What is loan agreement? Identify and explore the different parts of the loan agreement?
• What is loan review? Discuss the process of loan review.
• How a poor lending policy may affect the quality of loan? What are the warning sings of
the problem loan?
• What is loan work-out? Why each bank should have a plan to settle the problem loan?
Describe the usual loan workout process for a bank.

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 Thanks for your patient
hearing!

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