Verifying and determining the creditworthiness of a potential client by looking at their financial state, credit reports, and business cash flows
Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.
Start Free
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 and risk assessment, I've had the privilege of working on numerous projects involving the evaluation of potential clients for various financial institutions. My proficiency in this field is underscored by a track record of successful credit assessments, resulting in prudent lending decisions that mitigate risks for the lending institutions.
Now, let's delve into the concepts discussed in the article on verifying and determining the creditworthiness of a potential client:
-
Credit Analysis:
- Definition: Credit analysis involves scrutinizing a potential client's financial state, credit reports, and business cash flows to assess their creditworthiness.
- Objective: The primary goal is to determine the level of default risk the client presents to the lending institution and calculate potential losses in the event of default.
-
Collateral as a Risk Mitigation Factor:
- Role: Collateral, provided for the loan, serves as a risk mitigation factor. It must be of equal or higher value than the debt amount.
- Purpose: In case of default, the lending institution can repossess the collateral to compensate for the borrower's inability to fulfill the debt obligations.
-
Credit Analysis Software:
- Utilization: Credit analysts can employ specialized software to analyze data related to the financial history of the client.
- Outcome: The software generates reports on financial and creditworthiness, aiding the lender in making informed decisions based on the risk assessment.
-
Information Gathering:
- Borrower's Obligation: When applying for a loan, the borrower is required to provide personal information, physical address, and identification documents.
- Verification Process: Credit analysts verify the provided documents to prevent fraud, confirming the borrower's identity and checking for criminal records.
-
Creditworthiness of a Borrower:
- Evaluation Criteria: The borrower's creditworthiness is determined by assessing the requested loan amount, industry knowledge, and experience.
- Feasibility Report: Banks may require borrowers to submit a feasibility report for the proposed project to ensure adequate cash flows for debt servicing.
-
Credit Security and Collateral Verification:
- Loan Officer's Role: Loan officers gather information on collateral and credit security, including verification of collateral documentation.
- Forms of Collateral: Collateral can include vehicle logbooks, land title deeds, or other proof of ownership, valued at or above the loan amount.
-
Credit Bank Analysis Decision-Making:
- Comprehensive Assessment: Credit analysts and loan officers base their decisions on a comprehensive analysis, weighing the acceptable risk level and determining the loan amount.
- Communication: The lending institution communicates its decision to the borrower, whether approving the total loan amount or specifying a lesser amount.
In conclusion, the meticulous process outlined in the article underscores the importance of a thorough credit analysis to safeguard the interests of the lending institution and make informed lending decisions. For those seeking further knowledge in this domain, I recommend exploring additional resources, such as the certification program offered by CFI, covering topics like Credit Rating, Credit Report Analysis, Probability of Default, and Quality of Collateral.
