Chapter 1: Overview of commercial banks' loans

1. Overview of commercial banks

1.1. Definition
A commercial bank is a type of financial institution that accepts
deposits, offers checking account services, makes various loans, and offers
basic financial products like certificates of deposit (CDs) and savings
accounts to individuals and small businesses.
It is a profit making company, which pays interest at a low rate to the
depositors and charges higher rate of interest to the borrowers and in this
way, the bank earns the profit.
1.2. Basic Functions
a. Accepting deposits:
The most significant and traditional function of commercial bank is
accepting deposits from the public. The deposits may be of three
types: Saving deposits, Current deposits and fixed deposits.
b. Providing loans:
The second important function of the commercial bank is to provide
loans to the public to fulfill their needs of money. Loans can be
granted in the form of cash credit, demand loans, short- term loan,
overdraft, discounting of bills etc.
c. Credit Creation:
This is a function performed by the commercial banks. A bank has
sometimes been called a factory for the manufacture of credit. In the
process of acceptance of deposits and granting of loans, commercial
banks are able to create credit.
d. Transfer of funds:
Commercial banks are able to transfer funds of a customer to other
customer’s account through the cheques, draft, mail transfers,
telegraphic transfers etc.
e. Agency functions:
 In modern time, commercial banks also act as an agent of the
customer. However, banks charge fee or commission for these
functions.
2. Theoretical basis for lending of commercial banks
2.1Definition
Lending is a form of credit extension whereby the lender gives the customer
a sum of money to be used for a certain purpose and time as agreed with the
rule of repayment of both principal and interest. This definition is applied by
other banks and credit institutions as a basic premise for their lending
activities.
2.2Classify
a. Based on loan period
- Short-term loans
- Medium-term loans
- Long-term loan
b. Based on the purpose of using
- Consumer loans
- Business loans
c.Based on trust in customer
- Asset based loans
- Non asset based loans
d. Based on the lending method
- Direct loan each time
- Lending by credit line
- Overdraft loans
- Revolving loans
- Installment loanIndirect lending
- Lending to investment projects
3. Overview of business loans

3.1 Definition
 Business loans of commercial banks is a form of credit extension by banks
for businesses, whereby the bank assigns an amount of money to the
business to use for a certain purpose and time as agreed with the principle of
repayment of both principal and interest.
3.2 Basic features
Business loans of commercial banks have the following characteristics:
- Diversified customer base because businesses operate in many different
fields. Therefore, the demand for loans to meet is also diverse and abundant
- The purpose of using capital of enterprises is to meet production and
business needs, expand production scale such as borrowing capital to buy
raw materials for production, purchase of fixed assets, building workshops,
equipment innovation
- Business lending procedures and processes are more complicated because
the legal status of the business is much more complicated than that of an
individual. In addition, the value of large loans and collaterals is often more
complex and difficult to value because most of the corporate assets often
mortgage their own factories and production tools ...
- Compared to lending to individual customers and business households,
corporate customers have better and tighter information systems because
they all have accounting information systems, financial statements.
Financial information provided by customers from financial statements, tax
reports, etc. Depending on whether the financial statements are audited or
not, the credibility of the auditing organization, the quality of financial
information Customer offers high or low.
- Risks from business loans often cause big losses for commercial banks.
Therefore, the leaders of commercial banks are very interested in managing
the risk of business loans.
3.3 Classification
a. Based on loan term
People are divided into 03 categories: short-term loan, medium-term loan
and long-term loan.
- Short-term loans: A type of loan with a term of up to 12 months and is
used to offset the shortage of working capital for businesses and short-term
spending needs of individuals.
 This type of credit is characterized by low risk because the quick payback
period reduces the risks of interest rates, inflation as well as the instability of
the macroeconomic environment. Therefore, this type of loan often has lower
interest rates than other types of credit.
- Medium-term loans: are loans with a term of over 12 months to 60 months.
Medium-term loans are mainly for procurement of fixed assets,
improvement or renewal of equipment, technology, expansion of production
and business, construction of new small-scale projects and fast payback
time, form regular working capital of enterprises, especially newly
established enterprises ...
- Long-term loan: This type of loan has a term of over 60 months and the
maximum term can be up to 20-30 years. Long-term lending aims to fund
basic construction projects such as housing construction, airports, bridges,
equipment, large-scale transport means, new factory construction ...
Because long term and effective investment is expected, this type of loan
often carries a high level of risk. Because of such a high level of risk, it has a
higher interest rate than short-term lending
b. Based on trust in customer
- Asset based loans: This type of loan is based on a security such as pledge,
mortgage, or must be secured by the property of a third party. In many cases,
banks require customers to have collateral when receiving credit. The reason
is that customers have to face risks in business, possibly losing their ability
to pay debts to banks. Unexpected events can cause big losses for the bank.
Currently, most loans must have collaterals.
- Non asset based loans: means lending based on the reputation of the
borrower itself without collateral, mortgage or guarantee with the third
party's assets. Lending without collaterals is usually for high-reputed
customers, traditional customers, healthy financial situation, regular business
with profits ... However, this is a form of lending with many risks for banks,
banks need to carefully evaluate customers before deciding to lend.
c. Based on the lending method
- Direct loan each time: As a relatively popular form of lending by the bank
to customers who do not have regular loan needs, do not have conditions to
be granted overdraft limits. According to each loan term, the bank will
collect principal and interest. In the process of using loan customers, the
bank will control the purpose and efficiency. If there is a sign of breach of
 contract, the bank will collect debt before maturity or transfer overdue debt.
The interest rate may be fixed or floating according to the time of interest
calculation.
- Lending by credit line: This is a credit operation whereby the bank agrees
to grant customers a credit line, the credit line can be calculated for the
whole or the end of the period. It is the maximum balance at the time of
calculation.Credit limits are granted on the basis of production and business
plans, capital needs and loan demands of customers.
+Lending within the limit: The balance is less than or equal to the limit.
Customers can borrow many times in a period but the loan balance does not
exceed the limit.
+ Loans outside the limit: The balance is larger than the limit. The bank
regulates the credit limit at the end of the period. The outstanding balance in
the period may be larger than the limit but at the end of the period, the
customer must pay the debt to reduce the loan balance so that the ending
balance does not exceed the limit.
For each loan, customers only need to present the plan to use the loan,
submit documents proving that they have purchased goods or services and
state loan requirements. After checking the validity of bank documents will
issue loans.
- Overdraft loans: A form of lending whereby the bank allows the borrower
to exceed the balance of its payment deposits to a specified term and for a
specified period of time. This limit is called an overdraft limit. Overdraft is a
short-term, flexible credit, simple procedure, most of which is unsecured, can
be granted to both businesses and individuals for several days a month,
several months a year to pay salaries, payables, purchases ... This form is
generally used only for customers with high reliability, regular income and
short-term income.
- Revolving loans: Lending operations based on the movement of goods,
applicable to commercial or manufacturing enterprises with short-term
consumption cycles, with regular loan repayment relations with banks.
Businesses may lack capital when purchasing goods, banks can lend to
purchase goods and will collect debt when selling goods. Lending to
customers is very convenient. The loan procedure only needs to be done
once for many loans. Customers are able to meet capital promptly, so
payment to suppliers will be short.
- Installment loan: A form of credit whereby the bank allows the customer to
pay the principal many times within the agreed credit line. Installment loans
are usually used for medium and long-term loans, financing for fixed or
long-term assets. The one-off payment is calculated to suit the debt
repayment capacity. This is a form of credit financing to buyers to encourage
consumption of goods. Installment loans are high risk as customers often
mortgage mortgaged goods. The ability to repay depends on the regular
income of the borrower. If borrowers lose their jobs, get sick, their income
declines, their debt collection capacity will be affected. Therefore, the risk of
installment payments is usually the highest in the bank's lending rate.
- Indirect lending: The majority of bank lending is direct lending. Besides,
the bank develops indirect forms of lending. This is a form of lending
through intermediaries. Banks provide loans through groups, teams,
associations and groups such as production groups, farmer associations, war
veterans' associations, women's associations, youth unions, etc.
- Lending to investment projects: This method is applicable to customers
who need to borrow capital to implement investment projects to develop
production, business, services and projects for life. Borrowers must have
investment capital to participate in the project. Project capital can be money
or assets put into use for the project, including the value of land use rights,
factory ownership, land rent paid, expenses invested by customers. into the
project. The capital of the investor must be put into the project before the
bank lends it after or in proportion to its participation.
3.4 Procedure
Step 1: Guidance for business to prepare credit record (for enterprises
borrowing for the first time)
This is the first step, the basic step of the credit process. Credit record is
made right after the teller contacts with the business that needs a loan.
Establish credit record is an important step as it is the information gathering
stage to perform the following steps, especially the credit analysis and
lending decision-making steps.
Depending on the relationship between the business and the bank, the type of
credit required and the size of the credit, teller will guide the business to set
up records with the required information and credit scale. Typically, a set of
credit application requests will need the following information from the
business:
- Information on legal capacity and behavioral capacity of enterprises
- Information about the ability to use and repay the capital of the business
- Information on credit guarantees
To collect such basic information, the bank requires businesses to prepare
and submit to the bank the following documents:
-Loan request form
- Papers proving legal status of enterprise such as establishment license,
decision to appoint director, operation charter, ...
- Business plan and repayment plan or investment project
- Financial statements of the latest period
- Papers relating to mortgaged, pledged or guaranteed loans
- Other relevant papers if necessary
Step 2: Document evaluation and credit analysis
After gathering the necessary information about the business, the banker
began moving the second stage - appraising loan documents and analyzing
credit. This is the most important and difficult stage, which requires the
qualifications and ability to judge and analysis of the employees.
Bussiness credit analysis is the analysis of current and hidden potentials of
business in terms of loan use, ability to repay and recover capital. The goal
of credit analysis is to identify situations that may lead to risks for the bank,
thereby finding ways to prevent and limit such risks. In addition, credit
analysis also involves verifying the authenticity of the information provided
by the business, thereby assessing the attitude and reputation of the business
to make a loan decision.
The credit analysis process includes the evaluation of the legal status, the
purpose of capital use, the current financial capacity of the enterprise, the
appraisal of the loan plan, the evaluation of investment target.
Step 3: Credit decision making
After completing the credit analysis, the banker will make a credit decision.
A credit decision is a decision to lend or refuse a loan application. This is
also an extremely important stage in the credit process because it greatly
affects the following stages, reputation and efficiency of the bank's credit
operations. To make a credit decision, employees need to make the following
required documents:
- Appraisal report
- Statement of the director
- A record of collateral security
- Request for notarization
- Credit agreement
However, this is also the most difficult stage to handle and most often make
mistakes. There are two basic types of mistakes that occur in this stage:
- Agree to lend to bad customers
- Refuse to lend to a good customer
Both types of mistakes lead to significant losses to the bank. In order to limit
mistakes, banks in the credit decision period often focus on two issues:
- Collect and process credit information fully and accurately as a basis for
making decisions
- Giving decision power to a credit council or those with analytical and
judgmental capacity.
Step 4: Disbursement loans
Disbursement Loan is the next step after the credit agreement has been
signed. Disbursement loans is the loan distribution to businesses based on the
credit limit committed in the contract. Of course, disbursement is not just a
matter of giving loans to businesses, it also involves monitoring and
checking whether the capital is used for the committed purpose. However,
disbursement must also follow the principle of ensuring convenience to
avoid causing difficulties and troubles for businesses. The bank's
disbursement needs documents such as:
- Bill of Debt
- Payment Order
- Facility Agreement
- Business Plan,..
Step 5: Credit Monitoring
Credit monitoring is an important step in ensuring that loans are used for the
right purpose, controlling credit risk, detecting and promptly addressing
errors that may affect the ability of credit to be monitored. ability to recover
debt later. Some methods of credit monitoringmay apply:
- Supervise the account activities of businesses at the bank
- Analyzing the financial statements of enterprises periodically
- Monitoring enterprises through periodic interest payment
- Surveying actual locations of production and business activities of
enterprises
- Check loan guarantee form
- Monitor the activities of the business through relationships with other
customers
- Monitoring business loans through other sources
Step 6: Credit Liquidation
This is the end of the credit process. This step includes:
- Collect both principal and interest
- Review of facility agreement.
- Liquidation of facility agreement.
Debt collection: The bank collects debts from bussiness in accordance with
the terms committed in the facility agreement. Depending on the nature of
the loan and the financial situation of the business, the two parties may agree
and select one of the following forms of debt collection:
- One-time interest payment, principal collection upon maturity
- Periodic interest collection, principal payment upon maturity
- Collect both principal and interest upon maturity
- Periodic interest and principal collection
If the loan is due and the enterprise is unable to pay the debt, the bank may
consider extending the debt or transferring it to overdue debt to later take
appropriate measures to ensure debt recovery.
Review facility agreement
The facility agreement review is essentially a credit analysis in the condition
that the loan has been granted for the purpose of assessing the quality of
credit, detecting risks in order to timely guide them.
Liquidation of credit contracts
If the credit contract expires and the bussiness has completed both principal
and interest repayments, the bank and the enterprise will carry out
procedures for liquidation of the credit contract, mortgage of assets and loan
documents. The capital of the business into the warehouse.