TOPIC 8:

Principles of
Lending & Credit
Facilities
 Lending Money as a Business
• Major traditional role of banks –Lending
money
• The basic principles of good lending are
safety of the loan, suitability of the loan
purpose and profitability.
 Principles of good lending
Purpose of loan
– reflecting the government policy
– consistent with the present business activity
– working capital, purchase of fixed assets, speculative

The amount of loan

– adequate; determined financing requirements

The duration of loan

– commensurate with nature of the business proposal

The repayment of loan

– sources of repayment: present income, future income and sale of
assets.
 Principles of good lending
Know-how
– knowledge to carry out the project
– past performance of the borrower
– market reputation of the borrower

Market stability
– how stable is the demand for the borrower’s product?
– borrower in sunset or sunrise industry?

Financial position
– short term and long term financial position
– fund flow position
 Principles of good lending
Bank’s position
– vis-à-vis the borrower or shareholders
– vis-à-vis other banks
– vis-à-vis the industry

Security
– is secondary in making a decision whether to
underwrite a loan
– because the bank is not in the business to realize the
security to pay off the loan.

Monitoring
– repayment schedule must be drawn up so that the
loan can be paid off.
 Credit Evaluation
There are 7Cs in credit proposal
i) Character
- quality that makes borrower intend to pay
debt
honesty, reasonableness, responsibility, correct attitude,
virtuous
ii) Capacity
- legal status of the borrower to enter into a
contract.
- minor (under 18 years old); unsound mind?
- if company, has it been properly incorporated
-is the person bankrupt?
 Credit Evaluation
iii) Capability
– ability of borrower to pay loan
– determined by borrower’s salary, wealth,
qualifications, business acumen, health and
industriousness.
iv) Capital
– the borrower’s money that he puts into a
project
v) Condition
– economic condition, industry outlook and
government policy
 Credit Evaluation
vi) Collectivity
- how easy to collect from “going concern
“ premises?
- how much would be collected back in a
“gone concern “ premises?
vii) Collateral
- assets which may be charged or pledge
to the bank as security for the loans.
Relative importance of the 7 Cs:
Suggested weightage
– Capacity (should not be given loans if
have no capacity, therefore most
important)
– Character (25%)
– Capability (25%)
– Capital (18%)
– Collectivity (18%)
– Condition (9%)
– Collateral (5%)
 Financial Analysis (FA)

• Use ratios to analyze or determine the financial

health of borrower.

• Usually, several ratios have to be considered to

get better picture of company.

• Nowadays, the accounts presented to banker

are much improved compared to 20 years ago.
 Common Ratio used in FA
• Profitability
• Liquidity
• Leverage
• Activity
• Trend Analysis
• Peer Group
a) Profitability – Measure the borrower’s ability
to earn profits

(i) Return on Equity (ROE) = Profit After Tax

Capital Employed
(ii) Return On Assets (ROA) = Net Profit Before Tax
Total Assets
(iii) Net Profit Margin = Net Profit After Tax
Sales
(iv) Gross Profits Margin = Gross Profits x 100
Sales
b) Liquidity – Indicate the ability of a company to
have cash in hand

(i) Current Ratio = Current Assets

Current Liabilities

(ii) Quick/Acid Test Ratio = Current Assets-Stock

Current Liabilities
c) Leverage –Show the relationship of debt and
equity

(i) Gearing Ratio = Debt

Equity
(ii) Debt Ratio = Total Liabilities
Total Assets
(iii) Time Interest covered = EBIT
Interest
(iv) Days Payable = Accounts Payable x 365
Cost of Goods Sold
d) Activity – Evaluate the efficiency of a company
and its management of its assets

(i) Total assets Turnover = Sales

Total Assets
(ii) Fixed Asset Turnover =Sales
Fixed Assets
(iii) Inventory Turnover = Cost of Goods sold
Inventory
(iv) Av Collection Period = A/c Receivable x 365
Sales
 TOPIC 9
Credit
Facilities
 Type of Credit Facilities
(i) Overdraft
(ii) Term Loan
(iii) Trust Receipts
(iv) Banker’s Acceptance
(v) Letter of credit (off balance sheet item)
(vi) Shipping Guarantee
(vii)Bank Guarantee (off balance sheet item)
 Overdraft
• Is a credit facility operated through a current account

• The borrower applies to the bank for the facility and once
approved, his credit limit is maintained in the current
account system.

• Interest-charge for the amount overdrawn in the account.

This interest is calculated every day.

• Interest: Principal (P) X Time (T) X Rate Quoted

Where : P=overdrawn balance at the end of each day,
T = 1/365
 Overdraft
• Commitment Fee – Charged on the unutilised portion of
the overdraft facility. The present fee is 1% p.a
Exception :
(i) Overdraft facilities with interest prescribed by
BNM e.g : loan to small scale enterprise
(ii) Personal overdraft facilities with limit up to RM
250k in total
 Term Loan
• Loan with a regular repayment date
• The purpose of a term loan is normally to finance expenditure
of capital nature (e.g Purchase of Fixed Assets)
• Interest
– Depend on repayment schadule
– once a month (monthly basis) based on amount o/stding end of
previous month
• Interest on term loans, personal loan simple interest formula :
Principal x Time x Rate
• Where
• P= amount of loan o/stding end of previous month
• T= no. of the days in the month/365
• R= Rate quoted for the loan
 Interest on Housing loan shall be calculated using the
simple interest formula : Principal x Time x Rate
Where
(i) During the period until the loan is fully drawn down
• P= balance of loan outstanding at the end of each
day
• T= 1/365
• R= Rate quoted for the loan

(ii) During period after the loan has been fully drawn down
• P=Amount of loan outstanding at the end of the
previous month
• T= Number of days in the month /365
• R= Rate quoted for the loan
 Trust Receipts
• Trust Receipt allows to take possession of the
goods and convert the goods into cash prior to
maturity of the Trust Receipt.

• Trust Receipt is an agreement signed by the buyer

and the bank, which states that the buyer will hold
the goods in trust as the agent of the bank.

• The buyer will sell the goods and use the proceeds
of sale to settle the advance made to the bank.
 Trust Receipts
Benefits
• Allows to take possession of the goods without
having to use your own funds immediately

• Improves cash flow by having additional time to

convert your goods into cash

• Flexibility in payment as partial repayment and

early repayment is allowed without penalty
 Trust Receipts
Interest On Trust Receipts
• According to ABM Rules Section B,B3 (iv)(d)
Principal (P) X Time (T) X Rate quoted
Where :
P= Amount advanced
T=number of days as stipulated in the TR/365
 Banker’s Acceptance (BA)
• Bankers Acceptance (BA) is a usance Bill of
Exchange drawn by the customer on and
accepted by bank for financing trade
transactions on specific future date
• A Bankers Acceptance may only be drawn on
and accepted by bank, subject to availability of a
Bankers Acceptance facility.
 Banker’s Acceptance (BA)
• By accepting a BA,
– the bank is guaranteeing payment of the BA on the
specified due date.
– The purchaser or holder will look to the accepting
bank for payment on the maturity date.
– The accepting bank shall charge the drawer a
commission for accepting the BA:-

Commission for BA = FV X R/100 XT/365

Where:
FV = Face value of BA
R= Rate quoted in percent per annum
T= tenor of BA in number of days
 Settlement of BA
• a) On Maturity Date – the accepting bank shall
pay to the bearer of BA , the Face Value of the
BA
• b) Before maturity date – the BA can be re-
discounted. The redemption amount shall be
calculated as follows:
• RA =FV X (1- (r x t))
36500
Where :
RA= Redemption value
FV=Face Value
r= mutually agreed redemption rate (in % pa)
t= no of days remaining to maturity
 Letter of Credit
• Letter of credit (L/C) is the bank's guarantee that
they will pay the exporter in the event of the
importer becoming insolvent. The bank's
guarantee is provided by issuing a L/C to the
exporter.

• L/C serves to facilitate smooth transaction in

international trade. Therefore, it is extensively
used around the world. Exporters are
recommended to do business on L/C basis
particularly when doing business with foreigners
with whom the exporter has little knowledge of
their financial standing.
 What is the mechanism of L/C?
• The parties connected with L/C are:
(A) Applicant/importer,
(B) L/C issuing bank on the side of importer,
(C) Advising bank
(D) Beneficiary/exporter
(E) Confirming bank
(F) Negotiation bank on the side of exporter)
(G) Reimbursing bank
 The mechanism of opening a L/C is as
follows:-
• When a sales contract is made between the exporter
and the importer, both sides agree to do business on an
L/C basis.
• The importer requests the issuing bank to issue an L/C.
• If the issuing bank determines that the importer's
financial standing is acceptable, the bank will issue the
L/C to the exporter (beneficiary of L/C). The bank may
request the importer to make a deposit (security) in order
to guarantee themselves.
• The issuing bank notifies the exporter through the
correspondent bank (notifying bank ) by telegram first
and then sends the original L/C to the exporter.
 The mechanism of opening a L/C
• The exporter executes the shipment according to the
conditions of the L/C.
• The exporter presents the Bill of Exchange (Draft) based
on the condition of the L/C together with a full set of the
shipping documents and applies for negotiation of the
documentary bill at the exporter's bank (negotiating
bank).
• The negotiating bank checks the conditions of L/C and
shipping documents.
• If the conditions of L/C are found to be consistent with
the shipping documents, the bank pays the exporter.
• If there is any discrepancy between the conditions of L/C
and the documents attached.
• The exporter has to inform the importer and request the
issuing bank for an amendment to the L/C accordingly.
 Types of LC
• Revocable
– A revocable LC is one that maybe cancelled or
amended by the issuing bank or the applicant. This
type is seldom used in international trade.
• Irrevocable
• A definite undertaking by the issuing bank to pay to the
beneficiary, provided the beneficiary complies with all the
terms and conditions of the credit. Form:
– Red clause L/C
– Revolving L/C
– Transferable L/C
– Back-to-back L/C
– Standby L/C
 Shipping Guarantee (SG)
• A shipping guarantee is an indemnity given by the
consignee to a shipping company or its agent,
• the shipping company may release the
merchandise to the consignee named in the SG,
without presentation of the relevant bills of lading.
• A bank countersign the SG, making it liable, to
assist the importer to take delivery of the goods
(which arrive before the transport documents).
• The bank charges commission 0.1% of the invoice
value or a minimum of RM10.
 Bank Guarantees (BGs)
• A BG is an irrevocable obligation of a bank
to pay a sum of money in the event of a
non-performance of contract by a 3rd party
(bank’s customer).
 Features of BGs
• The sum guaranteed
• The period of the guarantee
• The name of the beneficiary
• Commission charged:
– Not less than 0.5% per transaction subject to
a minimum of RM10 shall be charged for the
full liability period (inclusive of the claim
period) of the guarantee issued.