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CHAPTER ONE

INTRODUCTION
1.1 Background of study
Credit-Risk analysis and evaluation is an extremely difficult and essential information
mining issue in the area of monetary investigation. One of the key choices financial
institutions need to make is to choose whether or not to grant loan to a customer. This
choice essentially comes down to a double arrangement issue which goes for recognizing
great payer from terrible payers. Up to this point, this qualification was made utilizing a
judgmental methodology by simply assessing the application form and details of the
applicant. The credit master then chooses the financial soundness of the candidate,
utilizing all conceivable important data concerning his/her socio-demographic status,
monetary conditions and intensions. The coming of data storage technology has
encouraged financial organizations capacity to store all data in regards to the attributes
and reimbursement conduct of credit applicants electronically. This has persuaded the
need to robotize the credit-granting decision by using machining-learning algorithm or
artificial neural networks.
Various techniques have been proposed in the literature to create credit-risk analysis
and evaluation models, these model include Neural network models. The greater part of
these studies concentrate essentially on creating classification models with high prescient
precision without giving careful consideration to clarifying how the classification are
being made. Clearly, this assumes a crucial part in credit-risk analysis and evaluation, as
the evaluator might be required to give a legitimization for why a specific credit
application is affirmed or rejected. Capon (1999) was one of the first authors to argue that
credit-risk analysis and evaluation system should focus more on providing explanations
for why customers default instead of merely trying to develop score cards which
accurately distinguish good customers from bad customers.
Financial institutions such as banks, renting organizations, venture and annuity assets are
liable to money related danger. The fundamental dangers are: Credit, Market, Liquidity
and Operational risk. To diminished credit risk, financial institutions play out a financial
investigation of every potential borrower.
In this exploration work, I provide details regarding the utilization of Artificial Neural
Network standard extraction technique to develop intelligent and self-explanatory credit-
risk analysis and evaluation system. Although manufactured artificial neural network has
been utilized before for this reason, there is still no accord on their prevalence with
deference over more conventional measurable calculations, for example, logistic
regression. This alludes to the way that they don't permit formalization of the relationship
between the output and the inputs in an easy to use, understandable way.

1.2 Statement of the problem


Traditionally, credits are granted based on a judgmental concept using past experiences
of the credit officers. This approach suffers, however, from: High cost of training credit
officers; frequent incorrect decisions made by credit officers; the long period of time that
is required to evaluate the risk category of the client and to make the credit granting
decision; and different decisions (made by different credit officers) for the same case.
These numerous difficulties suggest the need to automate credit management decisions.
Against this background, Artificial Neural networks intelligence technologies have been
employed for the development of credit-risk analysis and evaluation software system that
can meet the emerging needs and requirement.

1.3 Aim and Objectives of the study


The aim of this project is to use artificial neural network in analyzing and evaluating
credit risk of financial institutions. This is to be achieved by the following objectives:
1. To design and build a financial loan granting application.
2. To design an algorithm to minimize risk in credit facilities.
3. To develop a database for loan granting model.
4. To help the bankers make decision more quickly and cheaply compared with old
style judgmental underwriting.
1.4 Significant of the study
The ability to predict good clients and bad clients will reduce credit risk of financial
institutions. It will also enable the financial institution to determine the strengths and
weaknesses of their clients as this will enable them identify good and bad customers.
With predictive ability, this will reduce probability of non-repayment of loans and
financial institutions will be more successful in performing their duties and have greater
effect on economic growth of the country

1.5 Scope of study


In the field of computing today, there are essentially diverse sorts of strategies or methods
used in solving different kinds of problems. However, this project is designed mainly to
deal with credit-risk problem in financial institutions utilizing Artificial Neural Networks
to evaluate or calculate the credit-worthiness of an applicant in other to grant loan to that
individual. And finally, to formalize the setting in which this technique could be applied.

1.6 Limitation of the Study


During the time of this research work, there were many impediments I encountered, and
such impediments are:
Time: The researcher will simultaneously engage in this study with other academic work.
This consequently will cut down on the time devoted for the research work.
Finance: Insufficient fund tends to impede the efficiency of the researcher in sourcing
for the relevant materials, literature or information and in the process of data collection
(internet, questionnaire and interview).
1.7 Definition of terms
CREDIT: Credit is borrowed money that you can use to purchase things you need when
you need them and then repay the funds back at an agreed on time.
RISK: A state of uncertainty where some of the possibilities involve a loss, catastrophe,
or other undesirable outcome. Or it is the quantifiable likelihood of loss or less-than
expected returns.
LOAN: Loan is a certain amount of money given for a certain period of time. It is repaid
according to the set schedule.
EVALUATION: The process of determining whether an item or activity meets specified
criteria.
COLLATERAL: It is any asset that is pledged, hypothecated, or assigned to the lender
and that the lender has the right to take possession of, if the borrower defaults.
NEURAL NETWORKS: in information technology a Neural Network is a system of
programs and data structures that approximates the operation of the human brain.
CHAPTER TWO
LITERATURE REVIEW

2.1 Introduction
This chapter reviews what other people have done on this topic and related topics. In this
chapter also the concept of neural network shall be discussed including how neural
network will be applied in a loan evaluation. It is now an unarguable fact that all well-
structured organizations: businesses co-operate bodies, government agencies etc. are all
information technology (I.T) based. This has brought about a rapid increase in demand
for neural network developers

2.2 Analysis and evaluation of the risk of credit


Analysis and evaluation of risk is the main issue for concession of credit. If the risk is
poorly evaluated the company will certainly lose money, be it because of acceptance of
clients who will generate losses to the business or because of the refusal of good clients
who would generate profits for business. Financial institutions that have a better
evaluation than their competitors in the concession of credit have an advantage over the
others as they are less vulnerable to the consequence of the wrong decision when
providing credit (Arminger. 1997). Analysis and evaluation of risk of a potential client
can be carried out in two ways as follows:
1) By judgment, a more subject way involving a more qualitative analysis.
2) By classifying the taker by means of evaluation models, involving a more
quantitative analysis. The models called credit sunning are used for the analysis
and evaluation risk of credit by classification of the applicant. They permit
measurement of the credit applicants risk, to support the decision taking
(concession or not of credit). Thomas (2000)
2.2.1 Credit scoring models

The pioneer of credit models was Henry Wells, executive of the Spiegel Inc. who
developed a credit-scoring model during the Second World War (Lewis, 1992). Wells
needed tools that would allow experienced analysts to perform credit evaluation, because
many of its qualified employees had been recruited for the War. During the fifties the
scoring models were disseminated in the American banking industry. The first models
were based upon pre-established or eights for certain given characteristics, summing the
points to reach a classification score. More extensive use of the models in the sixties
transformed business only companies in the financial area, but also the large retailers
began to use credit scoring models to carry out credit sales to their consumers. Retailers
Such as Wards, Blooming dales and J. C. Penney were some of the pioneers in this
segment.
Currently, about 90% of the American companies that offer some kind of consumer credit
utilize models of credit scoring. Other countries like Brazil, Portugal, and Nigeria etc.
their financial institutions started to make an intensive use of credit scoring models only
in the Mid-nineties.
Credit scoring is perhaps one of the most "classic" applications for predictive modeling
(Chen, 2002), to predict whether or not credit extended to an applicant will likely result
in profit or losses for the lending institution. Credit scoring is the set of decision models
and their underlying techniques that aid lenders in the granting of consumer credit. These
techniques determine who will get credit, how much credit they should get, and what
operational strategies will enhance the profitability of the borrowers to the lenders.
Further, they help to assess the risk in lending. Credit scoring is a dependable assessment
of a persons credit worthiness since it is based on actual data.
A lender commonly makes decisions: whether to grant credit to a new applicant, it is
critical that there is a large sample of previous customers with their application details,
behavioral patterns, and subsequent credit history available. Most of the techniques use
this sample to identify the connection between the characteristics of the consumers
(annual income, age, number of years in employment with their current employer, etc.)
and their subsequent history.

Scoring is a mathematical or statistical model, by means of which, based on the credit


history of customers who have used the services of the bank, the latter tries to determine
what the probability is of that a customer returns in determined term, i.e. diagnosis of the
probability of bankruptcy of the potential borrower, when considering his credit. Total
client assessment using scoring becomes appropriation to the customer exact rating that
could allow delay. The main tool for scoring is a scorecard - a mathematical model that
allows comparing the characteristics of the borrower with numerical values and
eventually scoring rates. There is a credit (or questionnaire), scoring (an English
equivalent - application scoring), i.e. getting credit indicator of the potential borrower
based on some of its characteristics, primarily contained in the application of the
borrower; behavioral scoring (behavior scoring) - a dynamic estimation of the expected
behavior of the client to repay the loan, based on transactions history data on his account
and used, in particular, for prevention of debt. In addition, there is a collector scoring
(scoring penalties, collection scoring), for selecting the priority of "bad" borrowers in
arrears, and areas of work to collect their debt, as well as scoring among persons applying
for a loan. The latter type of scoring in domestic practice is often referred to as the vetting
of potential borrowers Andreeva, G. (2003).
Scoring models are used in economic practice in evaluating the creditworthiness of
individuals and legal entities, the risk of bankruptcy and other tasks. In general, the
mathematical model of the scoring is as follow

S= + +. +

where S - the value of a generalized estimate of the object; , , , - normalized


values of the factors that affect the analyzed characteristics of the evaluated object; ,
,..., - weights that characterize the significance of the relevant factors for the
experts.

There are some steps to be followed to construct a credit scoring models such as:
I. Survey of a historical background of the clients.
The basic supposition to construct a model of credit evaluation is that the clients
have the same behaviour pattern over time; therefore, models are constructed based
upon past information. The availability and quality of the data bank are
fundamental for the success of the model (Trevisani, 2004).
II. Classification of clients according to their behaviour pattern and definition of the
dependent variable. In practice, institutions consider only the good and bad clients
to build the model because it is much easier to work with binary response models.
This tendency to work only with good and band clients is also noticed in academic
works started by (Rosa, 2002).
III. Descriptive analysis and preparation of data. This consist of analyzing, according
to static criteria, each variable the will be utilized in the model.
IV. And finally choice and application of techniques to be used in the construction the
model, Neural Networks will be used in this work. Hard and Henley (1997) further
stress Discriminant Analysis, Regression and Decision Tress as methods that can
be used in practice. Recently some scholars have also used survival Analysis
(Harrison and Ansell: 2002). There is no method that is clearly better than the
others, everything depends upon how the elected techniques the data.
V. Selection and implementation of the best model. The best model is design using
the previously defined criteria. As such the implementation of the model must be
programmed. The institution must adjust its systems, to receive the final algorithm
and program its utilization in coordination with the other areas involved.

2.3 Functions of credit risk rating system


A well-managed credit risk rating systems promote financial institutions safety and
soundness by facilitating credit risk and differentiate individual credits and groups of
credits by the risk they pose.
This allows financial institutions management and examiners to monitors changes and
trends in risk levels. The process also allows financial institutions management to manage
risk to optimize returns. (Crook and Hills: 1999)

2.3.1 Development in financial institution risk rating systems


Many financial institutions are developing more robust internal risk rating processes in
order to increase the precision and effectiveness of credit risk measurement and
management. This trend will continue as financial institutions implement advanced
portfolio risk management practices and improve their processes for measuring and
allocating economic capital to credit risk. Further, expanded risk rating system
requirements are anticipated for financial institutions that assign regulatory capital for
credit risk in accordance with the Based committee on financial institutions Supervisions
proposed internal- ratings based approach to capital. More and more financial institutions
are:
i) Expanding the number of they use, particularly for pass credits.
ii) Using two rating systems, one for risk of default and the other for expected loss;
iii) Linking risk rating systems to measurable outcomes for default and loss
probabilities, and
iv) Using credit rating models and other expert systems to assign ratings and support
internal analysis. (Zan and Hung: 2000)

2.4 The credit risk evaluation process


The risk rating starts with a thorough analysis of the borrowers ability to repay and the
support provided by the structure and any credit risk mitigants. He said, when analyzing
the risk in a credit exposure, examiners will consider:
i) The borrowers current and expected financial condition, cash flow, liquidity,
leverage etc.
ii) The borrowers ability to withstand adverse or stressed conditions.
iii) The borrowers history of servicing debt, whether projected and historical
repayment capacities are correlated, and the borrowers willingness to repay.
iv) Underwriting elements in the loan agreements, such as loan covenant, amortization
and reporting requirements
v) Collateral pledged (amount, quality and liquidity) control over collateral, other
credit risk mitigants; and
vi) Qualitative factors such as the caliber of the borrowers management, the strength
of its industry, and the condition of the economy. (Soushan and Wu: 1999).
2.5 Credit risk mitigation

Credit risk can be moderated by enhancing the loan structure. Parties to a loan can arrange
for mitigants such as collated, guarantees, letters of credit, credit derivatives, and
insurance during or after the loan is underwritten.
Although these mitigants have similar effects there are important distinctive, including
the amount of loss protection, that must be considered when assigning risk ratings. For
example, a letters of credit may affect a loans risk rating differently than credit
derivative.
Credit miligants primarily affect loss when a guarantees, generally do not lessen the risk
of default. Therefore, their impact on a rating should be negligible until the loan is
classified. (Chia-Jung Hsu: 1999).

2.5.1 Collateral for granting loan

Collateral, the most human form of credit risk mitigation, is any asset that is pledged,
hypothecated, or assigned to lender and that the lender has the right to take possession of
it if the borrower defaults.
The lenders rights must be perfected through legal documents that provide a security
interest, mortgaged, deed of trusts, or other form of lien against the asset. The process of
perfecting the lenders interest varies by types of assets and by locality.
Once the lender has taken possession of the collateral, loan losses can be reduced or
eliminated through sale of the assets. The level of loss protection is a function of the
assets value, liquidity, and marketability. Realistic collateral valuation is important at
loan inception and throughout the loans life, but it becomes increasingly important as
the borrowers financial condition and performance deteriorate (Van-Zak:2001).
According to Van-Zak, collateral valuations should include analysis will the collateral be
with when it must be liquidated. The appropriate value may be a fair market, orderly
liquidation, or forced liquidation valuation, depending on the borrowers circumstances.
(Bishop and Watt: 2001).

2.5.2 Loan guarantors

Loans may be guaranteed by related or unrelated businesses and individuals. Guarantor


strength is often a major consideration when deciding whether to grant a loan, especially
to start-up businesses. A guarantors financial statement should be analyzed to ensure that
the guarantor can perform as required, if necessary, and that the statement acknowledges
the guarantee.

Guarantee agreements should be precise as possible, stating the specific credit


facilities being guaranteed, under what circumstances the guarantor will be
expected to perform, and what benefit the guarantor received for providing the
guarantee.
Guarantees can be unconditional or conditional. An unconditional guarantee
generally extends liability equal to that of the primary obligor in other words; the
guarantor assumes the full responsibilities of the borrower.
A conditional guarantee as stated by Swales requires the creditor to meet a
condition before the guarantor becomes liable.
According to him, guarantee can also be limited to a specific transaction, in
amount, to interest a principal, and in duration. (Guimares, 1999).
2.5.3 Credit derivatives in financial institutions

Credit derivation can be used to manage capital manage loan portfolios. And mitigate
risk in individual transactions. Only credit derivatives for individual transactions have a
bearing on risk rating.

According to (Soushan and Wu: 2000) credit derivatives for individual loan transactions
are usually written. Credit derivatives have unique structural characteristics and
complexities that can diminish or eliminate their ability to reduce credit risk. In
determining how much a derivative enhances a credits rating (if indeed it does so at all),
examiners should determine whether the derivatives protection is compromised by any
of the following circumstances:

i) The event that triggers payments is tied to a reference asset that may have different
forms and conditions than the loan held by the financial institutions. The residual
exposure in this transaction is known as basis risk.
ii) The financial institutions have forward credit exposure because the derivative has
a shorter maturity than the financial institutions loan. A timing mismatch can also
occur when the protection does not take effect until some future date.
iii) The derivative has a materially clause that limits protection to amount over a
designated threshold. In other words, the financial institution retains the first loss
position.
iv) The definition of default or any other credit event that triggers the sellers payment
is less rigorous for the swap or the reference assets than for the financial institutions
loan. This is known as contract basis risk.
v) The protection seller is materially at risk of default. If this seller and the reference
asset are correlated (that is, if they are subject to many of the same economic and
market forces), the risk to the protection buyer increases.
Finally, language in credit derivatives contracts is complex and can be subjected to
different interpretations. (Soushan and Wu : 2000)

2.5.4 Credit insurance


Credit insurance, a recent innovation for commercial loans, is not yet used extensively.
Examines should look for coverage- limiting insurance underwriting specifications such
as deductible amounts and exclusion of certain loss events. Additionally, the insurers
financial strength and default risk should the insurer is strong; insurance can enhance a
credits risk rating in much the way an L/C does. (Soushan and Wu: 2000).

2.6 Artificial intelligence in risk analysis

In this project among other credit risk system discussed earlier. It will be pertinent if a
brief review of the model that will be use in this work be looked into very shortly i.e.
(The artificial Neural Networks model).
Artificial Neural Networks (ANN) is computational techniques that represents a
mathematical model based upon the neural structure of intelligent organisms and who
acquire knowledge through experience. It was only in the eighties that, because of the
greater computational power, neural networks were orderly studied and applied.
(Faulsett: 1994) underlines the development of back propagation algorithm as the turning
point for the popularly of neural networks.
An artificial neural network model processes certain characteristics and produces replies
like those of the human brain.
Artificial neural networks are developed using mathematical model in which the
following suppositions are made.

(i) Processing of information takes place within the so-called neurons.


(ii) Stimuli are transmitted by the neurons through connective
(iii) Each connection is associated to a weight which, in a standard neural network,
multiples itself upon receiving a stimulus;
(iv) Each neuron contributes for the activation function to determine the output
stimulus (response of the network). The pioneer model by McCullough and Pitts
form 1943 for one processing unit (neuron) can be summarized in
a. Signals are presented upon input:
b. Each signal is multiplied by a weight that indicates its influence on the output
of the unit.
c. The weighted sum of the signals which produces a level of activity is made.
d. If this level exceeds a limit, the unit produces an output.

Fig 2.6. Structure of Artificial neural network .Haykin (1999).


Each i unit is represented by its activation state xi propagating to other neurons
through connexions wi that slows down or accelerates the signal passage. When the
activity states reach at a particular unit; they are combined together to form one value
expressing the total quantity of signal reached. If this value exceeds a determined
threshold (related to the neuron), then the unit is activated, otherwise inhibited. In the
artificial neuron the activation state xi is a number value and the connexions wi are
mathematical weights. The only value of total activation is the linear combination of
activation states xi for correspondent weights wi.
The net activation state is equal to the total activation state minus the threshold value.
The net state is elaborated by a non- linear function f (.) and the output value y is the
activation state of single neuron. There are neurons receiving signal x from the external
environment (input units or input layer), and propagate the signal through w connexions
to other internal units (hidden units or hidden layers) that elaborate the sending of the
signal, through other w connexions to the units specialized in the signal communication
(output units or output layer). The activation state of input units is determined by the
external, whereas the output activation state is dictated by the modeled environment. The
connexion links have a feed forward framework, that is, the signal can be propagated only
in one direction. The mathematical weights have an important role because they
determine the connexions and represent what the system knows. The network is able to
generate a good answer (output unit) because it has training phases, which are regulated
by training laws for updating the network weights. Despite the tremendous benefits
offered by knowledge discovery for businesses, neural networks are not free from
criticism.
Most neural networks are of the "black box" kind. This means that the tool can only
produce conclusions without explanations and justification of the reasons behind such
conclusions. This makes accountability and reliability issues difficult to address. That is
why one of the main interests in knowledge discovery research is to find ways to justify
and to explain the knowledge discovery result. Other limitations concern the high
computational requirements of neural networks, usually in the form of computer power
and training time, and the scarcity of experts in the field, which makes some businesses
avoid their use. Choosing which neural network model to use is not trivial. There are
several criteria that can be followed in order to choose a suitable model. These criteria
include data type and quantity, training requirements and functional requirements. A
comprehensive introduction to neural networks can be found in. Nowadays neural
networks are important tools used for pattern classification, financial crime detection,
process automation, time series prediction, data mining, etc.
2.6.1 Neural architecture
The system architecture of the proposed credit risk evaluation system using neural
networks are shown in Figure 2.6.1

Figure 2.6.1: The neural network layers for credit risk analysis and evaluation. Bakpo and
Kabari,( 2009).

The input units of the system have connexions starting but not in arriving, contrary to,
the output neurons that have connexions arriving and not starting. The hidden units have
connexions arriving from the input layer and continuing to the output neurons. The
proposed neural network architecture works in this way:
i. In the input layer, balance sheet data are inserted;
ii. In the hidden layer, it calculates the activation state of each neuron;
iii. The output layer expresses a result which is easy to interpret.

The most important quality of neural networks is the capacity to Learn according to the
environment and thereby improves their performance as stated by (Castro 2003).
There are essentially three type of learning.
(i) Supervised learning: In this type of learning the expected reply is indicated to the
network. This is the case of this work, where a priori it is already known whether
the client is good or bad.
(ii) Non- supervised learning: In this type of learning the network must only rely on
the received stimuli; the network must learn to cluster the stimuli;
(iii) Reinforcement learning: In this type of learning, behaviour of the network is
assessed by an external reviewer.
(Berry And Linoff: 1997) Point out the following positive points in the utilization of
neural networks:

1) There are versatile: neural networks may be used for the solution of different type
of problems such as: prediction, clustering or identification of patterns.
2) They are able to identify non-linear relationships between variables.
(iii)They are widely utilized, can be found in various software. As for the
disadvantages the authors state:
(iv)Results cannot be explained: no explicit rules are produced, analysis is performed
inside the network and only the result is supplied as the output.
(v)The network can converge towards a lesser solution: there are no warranties that
the network will find the best possible solution; it may converge to a local maximum.
(Fausett 1994).
CHAPTER THREE

ANALYSIS AND DESIGN

3.1 Introduction
System analysis can be defined as the process of breaking down a whole entity into parts
or components for proper understanding. It involves studying a problem area and
constructing an improved way of handling it. It adopts a perspective approach to
information system development in that it specifies in advance the modules, stages and
tasks which have to be carried out the deliverables to be produced and furthermore the
techniques used to produce the deliverables.it can also be referred to as a process through
which an existing system is examined with the intention of improving it or creating a better
new system through better procedures and methods, An analysis is done by the designer in
order to better understand why computerization is necessary. It helps the designer to
breakdown complex topics to simpler form in order to get a better understanding of it. In
this chapter, the analysis of the old system of credit risk evaluation and analysis shall be
discussed. Also, the problem inherent in the old system shall be identified with the aim of
developing a new and better system. Finally, a new system which will solve the problems
identified in the old system will be designed

3.2 Methodology

We have many methodologies for software development; some of the most popular
software development methods include rapid application development, structured system
analysis and design method, integrated methodology, the prototype and others. The
methodology employed in the development of the proposed system is the object oriented
analysis and design method which is a model-driven technique that integrates data and
process into construct called object. OOADM also has the potential for object reusability.
Object models are diagrams that document a system in terms of its objects and their
relationships. During this phase, the class objects and the interrelationships of these
classes are translated and actually coded using the programming language decided upon.
The databases are made and the complete system is given a functional shape. The
complete OO methodology revolves around the objects identified in the system.

3.3 Investigation and Analysis of the present System

The researcher carried out a study of the present system with the IT supervisor of the
financial institution and found out that the present system that was being used by the
institution was the manual loan system.

3.3.1 Loan process in the present system


Below is a summary of the loan process of the present system

Initial conversation

This is the first contact you will have with your Loan officer. We use this
stage to discuss your situation, your needs and objectives behind getting a loan.

Returning your applications and documents

Once you have agreed to apply for loan, you will be asked to compete our paper
application which contains data ranging from name, age, sex, marital status,
nationality, state of origin, Local government identification, email, annual income,
reason for loan, property type and name etc. We will also require supporting
documents such as your income details, documents. By giving us all supporting
documents in one go allows us to give you a quick and accurate assessment.

Preliminary assessment
After we have your application and supporting documents we are able to do a
preliminary assessment of your situation. The preliminary assessment is a very
detailed process where we identify any possible problems from a lending point of
view, also identify if there will be risk in the customer paying back the loan. If no
risk is identified the loan is granted.

3.3.1 Managers
Critical issues for the present system
According to the interviews carried out on Financial institution, it was found out that
most of the managers had been in the institution for a period of 3-4 years. When asked
about the number of loan given out, it was revealed that the institution gives out 3
categories of loans. These include Personal, Household equipment, commercial loans.it
was also paramount for the researcher to know the potential loan applicants. These are
people with good accounts, clients who get salaries through business community. When
asked about how they decide whom to give loan and whom not to give, it was revealed
that age of customers were considered, if his or her age falls below 20 they cannot risk
giving out loan to such customer, it was reviewed in the case of repeated customers, they
looked at their repayment history. If a client has ever defaulted the cannot risk giving a
loan but if he or she has been servicing the loan well, then the give the loan. For the case
of new customers, it is those ones with good performing businesses and good income,
work with a reputable establishment. In order for the researcher to get the requirements
for the proposed system, a question was asked about the features that are missing in the
existing system. 75% of the financial institution managers interviewed reviewed that that
the existing system makes work tiresome on the side of the manager who has to compute
them moreover after being computed by credit officers to check accuracy. If it is error
free, then a decision has to be taken on which is based on the result of the computations.
3.3.2 Credit Officers
Critical issues Registered by Loan officers

An interview with the loan officers regarding whether customers have ever complained
about the existing system, was answered with 100% response yes and the following are
some of the complaints raised.
I. Officers takes a lot of time (usually 1-2 months) right from the time a customer
applies up to the time a loan is approved.
II. Customer make unnecessary trips to the institution. This normally comes in if a
credit officer is not knowledgeable about the loan requirement where he tells a
customer to provide for example land title as security and when he brings it, again
he is told to pledge chattels. This disgusts customers as they have to make so many
trips because of failure of the officer to provide full and accurate information in
first meeting.
III. Amount of loan approved is far below the amount applied for and yet there is no
proper justification for that.
IV. No grace for business loan.
Out of many officers interviewed. Some were of the view that the existing system is
cumbersome as it contains repetitive fields and some particulars are irrelevant.
The same percentage also revealed that, there is a lot of bias in the existing system
because once you have a perception that someone is likely not to pay, then you do not
even bother to appraise. Among the solutions suggested were a Proper system to put in
place and the following policy and procedures

3.3.3 Critical issue raised by customers


As far as the customer were concerned, the researcher sought to know whether they had
ever applied for loans. To this, interviewees agreed that they had ever applied for loans
and this was simply because business demands which sometimes cannot be settled out of
their little savings. According to the research findings, among the 60 percent who had
ever applied for loan, only 30 percent loans were approved. Reasons for failure are so
many and these include the following.
I. Business being at premature stages.
II. Not having worthwhile security.
III. Unsounding reasons like failure of a client to pay a tip to a loan officer.
From the above reasons raised, almost 80 percent were focusing on tips which calls
for a computerized credit risk evaluation system, those who loans were approved
revealed that, the period in which the loan is approved is too long and at times it may
even be approved when the customer has lost interest and it is no longer valuable and
used for the purpose it was intended for. To this, they added that if a loan was to be
approved in normal circumstances without tipping officers, it could take a period of
2months but since a customer needs money for a specific purpose in a particular time,
he ends up paying something for quick processing.

3.3.3 Observation

Various activities ranging from the distribution of reports, managers behavior in the
office, credit officers behavior in loan department and customer behavior with loan
officers were observed. This was to help the researcher become familiar with financial
institution operations. Observation further enabled the researcher crosscheck for the
validity and accuracy of the information that was gathered through interviews and also
acted as a foundation in designing an appropriate system.
3.4 Strength of the Present System:
i) Data loss is less of a risk, particularly if records are stored in a fire-proof
environment,
ii) It enhances personal relationship between the giver and the receiver.
iii) The risk of corrupted data is much less.
iv) The cost of establishing the system is cheaper

3.5 Weaknesses of the Present System:


i) it is labour intensive.
ii) Much paper work is involved and writing therefore the work can be very
tedious and tiring.
iii)Accessing information is slow and not very accurate
iv)Poor record information

3.6 Analysis of the proposed system


The new system is designed in a way it solves the problems that was detected in the
existing system and this will be implemented with an automated computer system to
detect the credit risk before granting loan to customer.

3.6.1 Solving the issue with the Proposed System


This will be solved by getting rid of the old manual loan and credit risk evaluation
system by building a computerized system that will perform better than the old system
Neural network model with the Proposed system

Artificial neural networks can be placed among those of dynamical systems with
processing the experimental data, knowledge beyond transmits data to the network.

Input1 Hidden1

Input2 Hidden2 Output

Input k Hidden k

Figure 3.6.1 Neural network architecture



Y(k) = F (=0 (k) . () )

Where
() is the hidden value.
() is the input value.
is the transfer function.
Y(k) is the output value.
(i) The input layer: This represents the loan data attributes that will be inserted into
the proposed computerized system. Financial institution used different attribute
in processing credit data.

No Attribute Name
1 Age
2 Terms
3 Annual income
4 Number of years employed
5 Job
6 Property type
7 Reason for loan
8 Property name
9 Repayment period
10 Phone no
11 Present employment
12 Credit history
13 Loan amount
14 Loan date

(ii) The hidden layer: The hidden layer is a bridge between the input layer and the
output layer. The neurons in this layer are fundamentally hidden from view, and
their number and arrangement can typically be treated as a black box to those who
are carrying out the system. The function of the hidden layer is to process the input
variables. This is achieved by summing up all weighted inputs, checking whether
the sum meets the threshold value and applying the transformation function. The
weights between the input neuron and hidden neurons determine when each unit
in the hidden layer may fire or not and by modifying these weights, the hidden
layer may fire or not in other words, the hidden layers learn the relationship
between inputs and outputs in a way similar to that of the human brain by adjusting
the weights during the training process. It is in the hidden layer that neural network
rules are set that detects fraudulent customer base on under age, with low income
rate, to check credit history with institution, to check types of job be done by the
customer etc. this is done in order to minimize credit risk in loan granting

(iii) The output layer This layer expresses the result of the Process layer by
bringing out result from the decisions and rules being set in the hidden layer
determining if to grant loan to customer or not to grant loan.
Start

Loan form
application

ANN PARAMETER SETTING


-Number of hidden layers
-Number of neurons
-Learning rate

Processing & Training Phase

No Accepted
perfomance

Yes
Loan grant

End

Figure (3.6.1) Flow Diagram of the Proposed Model


3.6.2 Advantages of the proposed system
i. It is accurate and reliable and also provides quick access to complete and critical
information.
ii. Improved data security: This new system guarantees maximum security of
information; only registered or authorized users are granted access to the
database.
iii. Greater data integrity: This means data cannot be altered or changed by
unauthorized users or hackers
iv. Reduced or minimized redundancy
v. Time efficiency: The time spent in searching manually for information is
reduced.
vi. It can be accessed simultaneously by several users unlike the manual where
files are held up by a department causing a possible stop of operations.
3.7 Description of Input and Output Documents
The description sections of this project is targeted towards discussing how the system
interface is designed for taking in data and how the data is displayed or outputted to
the end users.
Register Page: The register page shown in the figure below. The register page is
designed with a Php backend. This enables the customer to register in the loan portal to
enable he/her access into the Portal.

Enter Username

Enter Email-id

Enter Password

Sign-Up

Login page: The login system is shown in the figure below. The login page is designed
with a Php backend. The User enters his username and password and clicks on the sign
in button, the system processes the data entered and the result is to grant access into the
loan portal homepage.

Username

Password

Sign-in
Loan application page: The loan application page form is designed with a Php backend
that enables the client details to be collected and processed with neural network principles
before determining if he/her is credit worthy or not.

Firstname Last name Surname


Name
Age Sex Male Female Marital status

Nationality State of Origin Lga

Phone no Email

Annual income Reason for loan

Job Years employed

Property type Property name

Loan amount Repayment period

Employment Loan date

Submit
3.8 Information and product flow diagram

User

Loan application form

Loan neural network


processing

View Data Save data Database

Figure 3.8 information and product flow diagram


3.9 Specification and Design

System should have a Provision for client to contact help desk by contact form or
email.
System should have a facility for client and financial institution administrators to
view all loan application
System should have the provision for client to access knowledgebase which details
problem and solutions.
System should provide facility for client to give feedback.

Non-functional Requirements
The users of the system should be provided user id and password along with well-
defined access privileges.
24X7 internet connectivity should be provided for well-functioning of the system.
System should be provided with proper backup media and resources to handles
data crash scenarios.
3.10 High level model of the proposed system

User

Program interface

Login Sign-up

Homepage

Loan
View loan
Application

Database

Fig 3.10 high level model of the proposed system