THE INSTITUTE OF FINANCE MANAGEMENT

BANKING AND FINANCE DEPARTMENT

BF 07406: CREDIT AND LENDING DECISIONS
MODULE GUIDE

MODULE DESCRIPTION:
The module sheds light on fundamental issues related to the core business of banks i.e.
lending. It gives students an overview of the lending environment and how best loans
can be processed professionally while observing risks of various borrowers both
individual and institutional. It avails students with an understanding of different
techniques of good credit assessment.

THE MODULE TEAM

Module Instructor – Mr. Hussein Mbululo and Selestin Christopher. They will be assisted
by Tutorial Leaders.

TEACHING AND LEARNING STRATEGY

Module Instructor will introduce student key concepts. Students will apply them in
readings and tutorial classes to expand their knowledge. In case of any problem regarding
lecture, student may consult the lecturer.

There will be tutorials classes in which student will be provided with questions that are to
be discussed in details after doing further reading apart from lecture materials.

ASSESSMENT.
Module assessment will involve Final exam, semester tests, assignments and tutorial
participation.
FINAL EXAM………………………………………..60%
COURSEWORK
Tests.………………………………………………...30%
Unannounced Quiz & Assignments & Tutorials.…….10%
Total ………………………………………………….100%

LEARNING OUTCOME
At the end of the module a successful student will be able to:
 Apply good principles of lending in dealing with loan/credit applications.
 Apply lending policies and framework for assessment (methodical approach) of
lending to screen creditworthiness of prospective borrowers.
 Analyze and interprete various financial statements for lending purposes.
 Understand procedures for securities documentation, registration, release and
realization.
 Understand various type of borrowers and their financing needs (credit facilities).

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TOPICS AND REQUIRED READINGS
1. Lending Environment
Required Readings:
i. Satta, T.A. (2003), Banking Operations, TIOB (Unit 3)
ii. CIB Study Text (1996) Lending, BPP Publishing (Chapter 1)
2. A Framework for Assessment of Lending/Methodical Approach to
Lending
Required Readings:
i. Satta, T.A. (2003), Banking Operations, TIOB (Unit 4 and 5)
ii. McGregor, P. (1996), Lending Bankers Workbook, CIB
3. Credit Facilities and Types of Borrowers
Required Readings:
i. CIB Study Text (1996) Lending, BPP Publishing (Chapter 14)
ii. Satta, T.A. (2003), Banking Operations, TIOB (Unit 6,7 and 8)
4. Credit Risk Protection: Securities
Required Readings:
i. CIB Study Text, Banking Operations: UK Lending and International Business,
BPP Publishing (Chapter 4,5 and 6)
ii. Satta, T.A. (2003), Banking Operations, TIOB (Unit 12,13 and 14)
5. Financial Analysis for Lending Consideration
Required Readings:
i. CIB Study Text, Lending, BPP Publishing (Part B: Chapter 3 and 5)
ii. Satta, T.A. (2003), Banking Operations, TIOB (Unit 11)
iii. Chijoriga, M.(2008), Lending, TIOB (Unit 3)
6. Uses of Management Accounting to Bankers
Required Readings:
i. Pitcher, M.A. (1985), Management Accounting for the Lending Banker, The
Institute of Bankers.
ii. McGregor, P. (1996), Lending Bankers Workbook, CIB.
iii. CIB Study Text, Lending, BPP Publishing (Chapter 14)
7. Bridging and Mortgage Finance
Required Readings:
i. McGregor, P. (1996), Lending Bankers Workbook, CIB (Unit 3)
ii. Checkley, K. (1997), Lending, CIB (Unit 1)
iii. CIB Study Text, Lending, BPP Publishing (Chapter 14)
8. Agricultural Finance and Probate Finance
Required Readings:
i. McGregor, P. (1996), Lending Bankers Workbook, CIB (Unit 11)
ii. Checkley, K. (1997), Lending, CIB (Unit 7)
iii. CIB Study Text, Lending, BPP Publishing (Part C: Chapter 10)

9. Business Financing
Required Readings:
i. CIB Study Text, Lending, BPP Publishing (Part C: Chapter 7 and 12)

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 I. TOPICS TO BE COVERED
1 LENDING ENVIRONMENT
1.1 An Overview of Lending (Concept & Philosophy)
1.2 Importance of Lending Operations to Banks
1.3 Local Environment Affecting Lending Activities in TZ
1.4 (Credit Process
1.5 Credit Facilities
2 TYPES OF BORROWERS & FUNDAMENTAL PRINCIPLE OF LENDING
2.1 Types of Borrowers
2.1.1 Personal Borrowers
2.1.2 Sole Traders
2.1.3 Partnership
2.1.4 Unincorporated Bodies
2.1.5 Limited Companies
2.1.5 Trustees
2.1.6 Retailers
2.1.7 Wholesalers
2.1.8 Manufacturers
2.1.9 Financial Businesses
2.2 Fundamental Principles of Good Lending Practices
2.2.1 CAMPARI
2.2.1.1 Character
2.2.1.2 Ability
2.2.1.3 Margin
2.2.1.4 Purpose
2.2.1.5 Amount
2.2.1.6 Repayment
2.2.1.7 Insurance
2.2.2
4 Cs stands for:
2.2.2.1 C – Character
2.2.2.2 C – Capability
2.2.2.3 C – Capital
2.2.2.4 C – Connections
2.2.3 PARSER stands for:
2.2.3.1 P – Principal or customers’ characteristics
2.2.3.2 A – Amount requested considerations
2.2.3.3 R – Repayment considerations
2.2.3.4 S – Security considerations
2.2.3.5 E - Expediency considerations
2.2.3.6 R- Remuneration considerations

2.3 Handling a credit Application

2.4 Documentation for a Lending Proposition

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 3. CREDIT RISK MANAGEMENT (SECURITIES)
3.1 Attributes/ Features of ideal (Need for Security and Attributes of a Good Security)
3.2 Types of Charges (Forms of Security (Mortgage, pledge, lien, etc))
3.3 Commonly acceptable Securities (Items commonly Accepted by Lenders as Security)
3.4 Standard Form Security Clauses
3.5 (Procedure for Taking Security)
3.6 (Procedure for Security Realization)

4. INTERPRETATION OF FINANCIAL INFORMATION

4.1Financial Statement Analysis
4.1.1 Generation of Financial Statements
4.1.2 Calculation of Ratios
4.1.3 Interpretation of ratios
4.2 Cash flow Forecast Analysis
4.2.1 Preparation of CFF
4.2.2 Interpretation of the CFF
4.3 Bank Account Operations
4.3.1 Preparation of Bank Account
4.3.2 Preparation of the Statistical Return
4.3.3 Interpretation of Statistical Return
2.1 PROCEDURE FOR HANDLING CREDIT APPLICATION (WRITING A LENDING
PROPOSITION)
TEST 1
BUSINESS FINANCE (FINANCING OF BUSINESSES

The Purpose of an Advance for Day to Day Trading (Lending for Normal Trading Finance)
(Lending for New Ventures or Business Purchase)
Agricultural Finance and Probate Advances (Lending for Farming)
Bridging and Mortgage Finance (Lending for Building)
ALTERNATIVE WAYS OF RAISING FINANCE
10.2 Leasing and Hire Purchase, Factoring, Invoice Discounting
10.3 Forfaiting, Acceptance Credits

10.4 Use of Management Accounting to a Banker

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 INSTITUTE OF FINANCE MANAGEMENT
FACULTY OF ACCOUNTING, BANKING AND FINANCE
DEPARTMENT OF BANKING AND FINANCE

BFU 07406: LENDING AND CREDIT LENDING DECISIONS: 2019/2020

LENDING ENVIRONMENT

1. AN OVERVIEW OF LENDING:
1.1 BRIEF HISTORY OF LENDING

Evolution of commercial banking and lending is related to the practice of safe-keeping of

gold and other valuables by the people with merchants/goldsmiths
• In the seventeenth century many people in London held their wealth in gold.
• They usually looked around for someone who had vaults and safes to look after their
wealth.
• Gold and silver smiths had such vaults/safe.
• Goldsmiths took these precious metals deposits for safe keeping, issuing a receipt;
acknowledging the deposit for the metals and incorporating a promise to return them
on demand. The depositors paid a fee to the goldsmith for the service of safe keeping
of gold.
• The goldsmiths were rich people. Therefore people around them used to ask for loans
from them and the goldsmiths gave the loans from their own money
• It so happened that there were occasions when the demand for loans was greater than
what the goldsmiths would provide from their own funds
• It also happened that the goldsmith noticed that the demands of repayment by the
depositors was often less than the total deposits. The goldsmith often had some cash
in hand
• The goldsmith started to lend this out to meet the excess demand for loans, charging
interest.
• The goldsmiths realised that the business of keeping the valuables and then lending
was profitable
• So they began to offer interest on deposits, so as to get more money deposited, which
they could then profitably lend.

1.2 CONCEPT OF CREDIT/LENDING

Lending involves two main parties whose basic interests differ and are sometimes
antagonistic
The main parties are the borrower and the lender
The main interest of the borrower is to get funds to spend now in anticipation of
future income
The main interest of the lender is to ensure repayment of borrowed money and
make profit
Hence there is a gap between borrowers and lenders

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 Concept of Credit – Borrower’s View
The borrower wishes to spend expected income now
Most often they are under pressure to spend now and their main concern is to get
the money now; nothing else
Hence they will press for the release of funds and everything else will a way to
convince the lender to release those funds
Indeed borrowers have come to know what it takes to convince lenders

Borrowers know that they must indicate that:

 Their character and integrity is undoubted

 They can to generate income to repay the credit facility

 The purpose of the borrowing is within the lender’s lending policy and
government policies

 The amount of funds requested is not too much

 There is a reliable source of repayment

 The lender will generate profits from the lending; and

 There is a property that can be used as a security, whose value is adequate to

compensate the lender

Hence applicants do prepare themselves for these questions

Concept of Credit – Lender’s View

• Lender’s main concern is loan repayment and profits

• Whenever banks lend they know that they are lending depositors’ money

• Therefore banks must lend where they know repayment is most likely; or risk is
low

• Banks are criticized for not lending enough, but high risk will deter banks from
lending more freely even if the highest interest rates will be charged

• In addition to critically analyzing the lending request, banks must properly

administer the lent funds to ensure that they are repaid.

• Remember: repayment is not the borrower’s priority!!

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1.3 PHYLOSOPY OF LENDING

Successful lending is about getting the balance correct, between the financial return the
lender expects to receive, and the risk that the borrowing may not be repaid as
anticipated. Above all, there must be a balance between, the need for the bank to obtain
more lending business, against the risk that the proposition may not end up being unpaid.

1.3.1 A Philosophy for Lending:

 A lender ‘lends’ money and does not give it away. There is a judgment that at
some future date repayment will take place.
 The lender needs to look into the future and ask, will the customer repay by the
agreed date?
 The lender objective will be to assess the extent of the risk and to try to reduce the
amount of uncertainty that will exist over the prospect of the repayment.

1.3.2 Handling the Credits

• The fact that the interests of the borrowers and lenders are never the same; means
that the lender must independently decide on what to take into account in making
a lending decision

• The lender must also make independent search for information that enables him to
make decisions

• Therefore lenders should never completely rely on what the credit applicant tells
them.

• They should ask for information from credit applicants, but

• Independently ensure correctness of that information and make independent

decisions

• In addition to critically analyzing the lending request, banks must properly

administer the lent funds to ensure that they are repaid.

• Remember: repayment is not the borrower’s priority!!

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 1.4 IMPORTANCE OF LENDING OPERATIONS TO BANKS

Lending is important to banks because it is the main source of income for most banks.
Banks get income from lending

The primary objective of any commercial bank is to make profits so that the owners
realize a return on their investment. Lending is the main source of income to the bank.
For most banks about 60% of their income is generated by lending operations.
Income from lending is in 2 main forms
(a) Interest Income. This is paid as the cost of utilizing the funds by the borrowers
(b) Service charges such as:
(i) Commissions on processing the credit facilities such as loans, overdrafts,
letters of credits and guarantees
(ii) Other services required by the borrowers in the process of borrowing such
as legal documentation fees

The income generated from lending activities is ultimately used to pay interest on
deposits, to meet operating expenses, dividends to the owners, and also for expansion
purposes.

1.5 THE LOCAL ENVIRONMENT AFFECTING LENDING

ACTIVITIES IN TANZANIA:

The local environment affecting lending activities in Tanzania is characterized by the

following factors:

a) Political aspects
b) Legal aspects
c) Social aspects
d) Economic aspects
e) Technological aspects
f) Level of competition/the market
g) High default rate
h) Poor security (collateral) perfection
i) Lack of discipline on the borrowers’ side

1.5.1 Political aspects:

Politics have often affected banking processes; from the beginning to the end of the end.
For example during the product formation stage banks might be required to follow
government inclinations towards the type of customers and kind of activities to finance.
Banks might also be affected by government decisions on the marketing aspects of their
customers, when for example the government barns exportation of goods produced by
bank customers.

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1.5.2 Legal framework aspects:
The lending function is also affected by legal aspects. In Tanzania for example, recovery
of bank loans is facing problems when banks attempt to enforce their rights of selling the
borrowers mortgaged houses. The defaulting customers have been asking for injunctions
from the courts to the banks not to sell the houses.
With a strong and supportive legal system, the enforcement of the contractual
relationship between banks and borrowers becomes easier. The absence of this is likely
to result into a number of defaults by borrowers.

1.5.3 Social attitude aspects:

The repayment of borrowed money to some extent is dependent on the social attitudes
and commitments of both the borrower and the credit officer. On the borrower’s side this
includes the commitment to use the borrowed money for the purpose it was granted for,
the moral responsibility and commitment to make all efforts to repay the borrowed
money, and possibly more important is the ability to realize that the borrowed money is
not an income for consumption to the borrower.

The social attitude problem also lies on the side of credit officers and bank management.
The success of the lending function also depends on the moral responsibility of these staff
and management to apply the good principles of good lending, otherwise this could result
into high default rate among other problems.

1.5.4 Economic development aspects:

Lending is affected by the state of the economy in many ways. A substantial level of
economic growth over a period of time is likely to lead to an increased level of
investment opportunities, which in turn encourages investors to look for investment funds
from banks

When there is a decline in investment opportunities banks are affected and they find
themselves with huge amount of deposits with little lending activities forcing them to
invest in government securities.
Another problem of a decline in economic growth makes it difficult for the borrowers to
repay due to the resulting decline in economic returns, from their investments.

1.5.5 Technological aspects:

The level of technological development certainly has an impact on both lenders and
borrowers. To the bank, not only the lending function becomes more efficient and faster
but also all the delivery of all other banking services improves. To the borrowers the
level of technological development has an influence on the performance of their
operations. This in turn has an indirect influence on the repayment of the borrowed
money.

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The level of technology has a significant effect on the delivery of all services offered by
banks. For example customers had to spend long hours waiting for bank services in
banking halls. Similarly the borrowing process takes a long time

1.5.6 Competition/the market aspects:

The level of competition among lenders also affects the lending function. The presence
of more banks into the market results into increased competition. Prior to the
liberalization of the banking sector in Tanzania, the lending function was dominated by a
few banks.
This partly resulted into a bureaucratic lending process by few lending institutions and
this worked to the detriment of the borrowers. The liberalization of the banking sector in
1991 led to increased competition not only on the lending function but also on the
delivery of all other banking services.

Under an ideal situation, increased competition is expected to improve efficiency in terms

of delivery, costs of lending (interest rate), terms and conditions, and the types and
number of credit facilities.

1.5.7 High default rate:

Default rate is high in Tanzania

There are a number of reasons that could result into a high default rate, these include:
 Poor appraisal/analysis of lending propositions
 Poor credit/loan application decisions
 The existence of untrustworthy bank employees who collude with loan applicants
to conceal some relevant information
 Un-conducive economic conditions for investment activities
 The existence of high lending rates which lead to the failure of borrowers to meet
the repayment obligations.

1.5.8 Poor security (collateral) perfection:

This is another factor which characterize the local lending environment in Tanzania
whereby most of the securities which were accepted by banks against lending were not
perfected according to the legal requirements of the country.

As a result it became very difficult for most banks to realize the securities when
borrowers default. Reasons for such behaviour include ignorance, incompetence as well
as untrustworthy on the side of some borrowers and employees. Other reasons include
the types of securities taken and the valuation methods employed by banks.

1.5.9 Lack of discipline on the borrowers’ side:

For so many reasons most of the borrowers have had an attitude of borrowing and not
paying back. Some of the reasons have been the presence of un-conducive investment

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environment, diversion of borrowed funds to activities other than the purpose of the
loans.

2 CREDIT PROCESS
There are several stages in a lending process
2.1 The credit product development - Features of the product in policies
and manuals

2.2 The credit product marketing (Issue of brochures, visiting,

advertisements)

2.3 The Application: Indicate basic issues (Amount, repayment source,

repayment period, purpose, security offered)

2.4 Procedure for handling a Loan Application (Review of the application)

2.5 Approval of the credit facility while also giving terms and conditions

2.6 Disbursement: (after fulfillment of terms and conditions)

2.7 Monitoring and Control (to ensure the lending remains good)

2.8 Repayment

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 INSTITUTE OF FINANCE MANAGEMENT
FACULTY OF ACCOUNTING, BANKING AND FINANCE
DEPARTMENT OF BANKING AND FINANCE
BFU 07406: LENDING AND CREDIT LENDING DECISIONS: 2019/2020
TYPES OF CREDIT FACILITIES
1. LOANS
1.1 By Duration
1.1.1 Short Term
1.1.2 Medium Term
1.1.3 Long Term
1.2 By Borrowers
1.2.1 Personal Borrowers
1.2.1.1 Education Loans
1.2.1.2 Holiday Loans
1.2.1.3 Car Loans
1.2.1.4 Consumer Loans
1.2.1.5 Mortgage Loans
1.2.1.6 Bridging Loans
1.2.1.7 Budget Accounts
1.2.2 Business Borrowers
1.2.2.1 Agricultural Loans
1.2.2.2 Building Loans
1.2.2.3 Industrial Loans
1.2.2.4 Commercial Loans
1.2.3 Microfinance Loans
1.2.3.1 Microfinance Loans
1.2.3.2 SME Loans
1.2.3.3 MSE Loans

2. OVERDRAFTS
Definition:
It is a facility whereby a customer is allowed to overdraw his ordinary current account up to a
specified amount within a given period. The account is operated on a fluctuating basis.
It is used by businesses to finance working capital requirements.
It is also used by salaried people.
It is usually short term, lasting for not more than a year.

Comparison of Loans and Overdrafts

Loans
1 Normally involves two accounts;
Loan A/c and an ordinary account
2 Given in one lump sum at once
3 The balance of account reflects the
amount of the whole loan
Overdrafts
Only one account is involved. The ordinary
current account is allowed to overdraw
The account is overdrawn on withdrawal
The balance of account reflects actual
withdrawals

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 4 Interest is paid on the full amount of Interest is paid on the actual balance overdrawn
the loan given
5 Borrower has less room to manage Borrower can easily manage interest payment
interest payment
3. BILLS DISCOUNTED
 Bills discounted facility is an ‘after sales’ facility involving the discounting of trade
bills by the bank for the bills drawn by a customer on his trade debtors
 The bank practically purchase the bills from the beneficiary of those bills which are
payable in future
 The bank pays the face value of the bill less bank charges and interest
 The bank recovers the money on due date from the drawee

4. INVOICE DISCOUNTED
 This is also an ‘after sales’ facility, which involves discounting invoices
 It enables the seller of goods to sell invoices of buyers who do not sign bills
 It works in the same way as the ‘bills discounted’ facility

5. BILLS NEGOTIATED
 These are foreign bills purchased by banks from exporters (drawers)
 The drawers in international trade are mainly exporters drawing bills on their
importers of their products
 The bank collects the bills for onward transmission to the foreign importers for
payment
 On negotiation the bank pays the exporter immediately on presentation of the bills
without waiting for the foreign buyer to pay
 The bank will receive the payment from the foreign importer on its own and will
thereby recover the funds paid to the exporter.

6. ACCEPTANCE CREDITS
 Banks offer this facility to exporters and importers
 When an exporter presents the trade bill drawn on the foreign importer the exporter
may ask his bank for an acceptance facility. The exporter draws a bill on the bank,
who, accepts it and gives it back to the exporter. The exporter then can discount the
accepted bill in the market.
 When a foreign bill is due for payment by the importer, and the importer is unable to
pay it, the importer can ask for an acceptance facility from the bank. The importer
draws a bill on the bank for an amount equivalent to the amount of the trade bill. The
bank accepts the bill and gives it back to the importer. The importer can then
discount the bill in the market and get funds to pay the foreign trade bill.

7. GUARANTEES AND INDEMNITIES

These are credit facilities issued by banks on request from their customers to ‘third parties’
 Examples of guarantees are ‘bid or tender’ guarantees, Performance guarantees,
Advance payment guarantees and Retention funds guarantees

8. LETTERS OF CREDIT
 Letters of credit are useful instruments in facilitating trade settlements between local
importers and foreign exporters and vice versa.

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  A letter of credit is a set of instruction by a bank, acting on behalf of its customer
(importer) to another bank to pay the beneficiary (exporter) if the exporter fulfils
stipulated conditions (normally production of specified documents).
 The letter of credit enables the exporter to receive payment before payment is made
by the importer

9. CREDIT CARD
 They allow the card-holders to buy now and pay latter and so take credit from the
card company. A card-holder is given a credit limit. He can use the card to purchase
goods or services, provided he does not exceed the limit. It is a revolving facility.
10. MICROFINANCE LENDING
11. MORTGAGE LENDING
12. SYNDICATED LENDING

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 INSTITUTE OF FINANCE MANAGEMENT
FACULTY OF ACCOUNTING, BANKING AND FINANCE
DEPARTMENT OF BANKING AND FINANCE
BFU 07406: LENDING AND CREDIT LENDING DECISIONS: 2019/2020
TYPES OF BORROWERS

1. PERSONAL BORROWERS
1.1 Personal Loans
These are formalized, packaged facilities, usually credit scored, agreed over a fixed
period of time and with fixed interest and repayments on a monthly basis. They are easy
to monitor, and as long as the customer can afford the repayments usually cause little
trouble. They come in various guises (car loans, holiday loans etc) and can be secured if
necessary.
As with all borrowings, monitoring is necessary, in addition to the usual annual review.
Circumstances can change at short notice. Some warning signals to watch out for are:
i. Increasing or earlier anticipation of salary
ii. Reduction or loss of salary
iii. Irregular funds through the account
iv. Evidence of cheques to pay gambling debts
v. New outgoings to other providers of finance
vi. Advance not used for agreed purpose
Credit Scoring
Most of personal lending is done on a credit score basis whereby a numerical
score is calculated by allocating points to various characteristics of the borrower.
Statistics have shown that customers with different characteristics have different
probabilities of default; hence a system has been devised to award points to the
various characteristics of borrowers. A certain minimum score must be achieved
if borrowing is to be approved. The most common characteristics scored are
i. type of job,
ii. address,
iii. frequency of income,
iv. age,
v. marital status
vi. and several other factors,
The system is often used in conjunction with credit reference agencies.
The credit reference agencies keep a record of names, addresses and
whether there is any adverse credit information recorded against them.
The bank’s credit scoring systems, do vary. The system is reliable and this has
enabled banks to lower the level of sanctioning authority; provided that the

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 system is strictly followed. It is essential that staff handling such applications do
so sensibly and watch out for discrepancies on the application forms which may
indicate that the customer is not telling the truth. For example:
- Mortgage repayments do not match size of the mortgage
- Salary seems too high for the type of job
- Length of time in the job does not fit with age of customer

1.2 Overdraft
Overdrafts should, by their nature be temporary and self-liquidating, otherwise
the borrowing should normally be taken on a loan account
These are usually short term for a specific purpose for example:
(a) A student anticipating his next grant or parental contribution
(b) A worker expecting his annual bonus soon and wishing to book a holiday

In all cases the source and timing of the funds to repay the borrowing should be
confirmed.
On a slightly different tack, more and more revolving credit facilities, with a pre-
set limit are now on offer from the banks. These are obviously not payable on
demand, but some liquidity in the borrowing would be expected, and regular
monthly payments try to ensure the borrowing does not become ‘hard core’. In
any case all such facilities are reviewed at least once a year and action can be
taken if solid maximum borrowing is seen.

1.3 Bridging loans:

Home bridging loans are granted to allow a borrower to go ahead with the
purchase of a new home before the sale of his old home is complete. It is often
difficult to synchronize the purchases and sales in a ‘chain’, an individual might
be required to go ahead with the purchase of a new home before he has sold his
old one. This means that he needs money to pay for the new house before he has
received his funds out of the sale of the old house. The bank may be requested
to lend at various stages of the process so that the purchaser can pay for the new
home pending receipt of sale proceeds from the previous property and the new
mortgage proceeds.

There are three types of bridging finance generally seen in connection with house
sales/purchases:

a) 10% deposit loans (loan to a purchaser so that he can pay 10% deposit on
exchanging contracts for a property). These are not usually for more than four
weeks, this being the normal interval between exchange and completion of
contracts.
b) Closed bridging finance – the borrower must complete the purchase of his new
home before completing the sale of his old one but after exchanging contracts on
the sale. Again therefore the loan is for a certain period – up until the completion
of the sale.

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 c) Open bridging finance – to complete the purchase of a new house without having
exchanged contracts on the old one. It is an open-ended transaction. There is no
certain period when the sale will be complete. Clearly there is a high risk that the
sale will not go ahead and so often a bank will refuse such an advance

1.4 Hire purchase:

Hire purchase (HP) is a form of instalment credit whereby an individual or business
purchases goods on credit and pays for them by instalments. The HP contract is arranged
by the vendor of the goods but is usually between the customer and a finance house of
finance company. It works like this:

a) The supplier sells the goods to the finance house; but

b) Delivers the goods to the customer who will eventually purchase them; and
c) The hire purchase arrangement exists between the finance house and the
customer.

With other forms of credit, such as a loan or credit card, the goods bought belong to the
buyer straight away, while under HP:

 The buyer does not legally own the good until he has paid back all the money he
owes. This means that he cannot modify or sell them without the lender’s
permission.
 The buyer’s contract is with a finance company (not the retailer) who will own the
goods until the final payment is made.
 The finance company can take the goods back if the buyer does not keep up his
repayments.
 The buyer will be liable for any damage caused to the goods during the contract
period.

In most cases, under an HP agreement, the buyer pays an initial deposit followed by
monthly payments (a portion of the money borrowed plus interest) over an agreed period.

The finance house will nearly always insist that the hirer should pay a deposit towards the
purchase price – perhaps as low as 15% or even less, or as high as 33%. The size of the
deposit will depend on the finance company’s policy and assessment of the hirer, and
also on any government regulations in force.

1.5 Credit cards:

In recent times credit cards have become very popular to both customers and banks.
Reasons being today’s customers do not want to carry cash or cheque books. Also
interest rate has gone down because of high competition and some customers receive
interest-free credit. On the part of banks, this product is highly profitable and also due to
reduction in processing costs.

17
 1.6 Mortgages:
A mortgage loan is simply a loan to purchase or build a house.
The bank will usually not finance 100% of the purchase price hence the customer will
have to put his/her equity in the first place. Tenure of the facility will vary between 10 –
25 years. The source of repayment will come from the customer’s steady income and in
most cases his/her salary. The bank will take mortgage as security for the facility.
1.7 Budget Account
2. Sole traders:
A sole trader is the simplest form of commercial enterprise. The sole trader is an
individual running a business with a view to profit – such as a shopkeeper, a farmer, or a
photographer.

When a lending proposition is received from a sole trader, it is important for the bank to
point out to a prospective sole trader that:

 He is personally liable for all the business’s debts since the business is not a
separate legal entity as is the case for companies.
 A high degree of commitment is required, in terms of time and worry, in order to
be able to generate a sufficient level of income.
 The bank expects the owner to contribute both a substantial personal stake and
security, usually in the form of a mortgage over the individual’s home – failure of
the business will therefore greatly risk his capital.

In addition to that banks should check carefully at the character of the sole trader and the
soundness of the venture. Ideally the sole trader should be known to the bank already.

At all times the canons of good lending – CAMPARI – should be remembered.

3. Partnerships:
Partnerships are a fairly common form of association among professional people. It is
defined as ‘a relation which subsists between persons carrying on a business in common
with a view of profit’. Like a club or society, the partnership is not a legal entity separate
from its members.

When lending to a partnerships, banks in addition to normal lending requirements have to

make reference to the partnership deed. A joint and several liability must accompany any
lending to a partnership to all partners.

The fact that many partnerships are those of professional people has implications for the
bank. Here is why:

a) Goodwill may be a major part of the partnership’s assets but is difficult to value.
This may cause problems when deciding how much to lend the business, but can
usually be estimated by looking at the partnership’s earning capacity.
b) Personal assets are usually charged to the bank as security rather than partnership
assets because, as seen above, often the biggest shared asset is goodwill.

18
 Charging the partners’ personal assets gives security in addition to the fact that
they have joint and several liability anyway (unless one or more are limited
partners). Such a ‘belt and braces’ approach may be deemed unnecessary if the
partners are persons of very good financial standing.

At all times the canons of good lending – CAMPARI – should be remembered.

3.3.1 Companies:
Companies are the most important form of business organization, since they are often
very large and are also very numerous. The most important point to remember
concerning companies is that a corporate body is a legal entity separate from its members
with its own rights and responsibilities.

As a separate legal entity a company can do anything subject to the limitations of its own
rules, legislation and the fact that it is not a physical being. Though it cannot talk or sign
documents – these functions are performed, in the company’s name, by its agents. It can
enter into a contract, have a bank account, give security, borrow money, sue and be sued,
own a property and so on.

A company must have certain documentation which the banker will need to see:

(a) Certificate of incorporation:

This is the company’s ‘birth certificate’ issued by the Registrar of Companies. It shows
that the company has been properly formed and can function as a legal entity.

(b) Company seal:

In order to create a deed (a contract signed by the company itself, such as a loan) the
company seal must be affixed. This may be a stamp or a sticker denoting the old-
fashioned red sealing wax.

(c) Memorandum of association:

This document sets out the constitution and purpose of the company and regulates its
relations with the outside world.

A company’s capacity to contract is limited to the purposes of the company listed in the
objects clause of its Memorandum of Association. An act performed outside those
objects (or a loan agreement for a purpose outside those objects) is in theory void.
Hence, a banker who lends to a company for a purpose which is beyond the company’s
powers will not recover its monies.

This was the situation in Re Introductions Ltd 1972. The company had objects stating it
was to run tours etc for overseas visitors. Later it gave up tourists and took to pig-
breeding. Because the company had the express power to borrow in its Memorandum,

19
the bank lent it money to finance pig-breeding. It was held that the purpose of the
borrowing was ultra vires and hence the loan could not be recovered.

Memorandum also express if the company is allowed to borrow. If not, a bank should
not lend its money.

(d) Articles of association:

This document sets out the internal relations in the company. It defines the powers of
directors which a banks need to be aware. Any act performed outside these powers may
not be binding. Therefore the banker needs to determine the borrowing powers of the
Directors of the company.

At all times the canons of good lending – CAMPARI – should be remembered.

3.3.2 Unincorporated borrowers:

Unincorporated borrowers include clubs, associations and societies. It is merely a group
of people who are associated by agreement. A club or society often has a large
membership which is constantly changing. It will have an income, for example from
membership subscriptions or charges for goods and services supplied to members. It may
have premises such as a clubhouse or a sports ground and incur expenditure on upkeep.
Sometimes it trades: in clubs, for example, the bar profits are an important element in its
finance.

But because an unincorporated club or society does not have an existence in the eyes of
the law in the same way that an incorporated company does, it cannot normally be sued
for recovery of a debt. Because of this fact, the bank needs to safeguard its position by
looking to individual members to provide it with assurance that advances will be repaid.

The procedure on considering lending to an unincorporated borrower is as follows:

a) Check the rules. Most established clubs and similar organizations have a written
constitution which set out whether borrowing can be undertaken in the club’s
name and how far offices are authorized to take such a power. Legal advice may
also be sought.

b) Take personal guarantees. While a bank may give short-term lending without
any form of security, regular borrowing or longer-term borrowing should be
secured in some way. The most common method is to take the personal
guarantees of the club’s officers that they will repay the debt if the club fails to do
so.

c) Identify assets and liabilities. If the lending is made in order to purchase assets
for the club (this is the most common reason) the bank should ensure that it
identifies the asset and the trustees who hold it on the club’s behalf. Against this
the bank should match the loan account (so that the term of the lending is less

20
 than the life of the asset) and should ensure that the trustees are aware of the
repayment schedule.

The bank should also consider whether there is a prescribed method (perhaps by passing
a resolution at a general meeting of members) by which the members, under their own
rules or by-laws, approve and accept responsibility for the loan. If there is a prescribed
procedure the bank should insist on obtaining evidence (for example a certified copy of
the resolution) that proper authority has been given.

The bank can then probably assert a claim against the assets of the club or society and
against its members individually, since on becoming members they have accepted that
liability can be imposed on them in this way.

At all times the canons of good lending – CAMPARI – should be remembered.

3.3.3 Trustees:
A trustee is a person who holds property for the benefit of another person.

Therefore a trustee may be appointed when a wealthy person dies and leaves money to
specified beneficiaries who may include young children who cannot manage the property
themselves. So trustees hold the legal title to the property but all the benefit belongs to
the beneficiaries. When they reach the age of majority, the legal ownership of the trust
property passes to them.

In addition to that, trusts may also be created:

 By individual whilst still alive;
 For charitable purposes;
 For the benefit of employees; and
 By clubs or societies as a way for property to be owned.

When trustees ask for loans a bank should check the trust deed to see whether the trustees
have the authority to borrow. In addition, a bank has to be satisfied that:
 The loan is to be used for a specific purpose
 The security given is to enable trustees to exercise their power of applying capital
funds for a specific purpose
 The beneficiaries consent to the lending.

It will be necessary for all the trustees to sign the loan agreement with the bank because
such an agreement is made using powers (to pay capital and so forth) which cannot be
delegated.

At all times the canons of good lending – CAMPARI – should be remembered.

21
3.3 DOCUMENTATION FOR LENDING PROPOSITIONS

When prospective borrowers submit their lending propositions, there are a number of
documents that lenders demand for various reasons. These documents are:

a) Certificate of registration and incorporation:

These are documents to be submitted by business customers to provide evidence that they
are legally operating entities.

b) Partnership deed:
This is written agreement used when a partnership is being formed. It is intended to
outline the basis on which the partnership is being formed. This document indicates who
is who inside the firm. For the bank it is important as it can be used to identify the
borrowing powers of the partners.

c) Memorandum and Articles of Association (MERMATS):

This is a document that comes from companies. Lenders are required to review this
document to ensure that the reasons for borrowing are within the company’s objects and
that the company is allowed to borrow and pledge its assets. Banks will also be able to
determine the borrowing powers of the Directors.

d) Constitution:
This is a very important document as far as unincorporated bodies are concerned as it
provides the set up and the organization of the institution. It is likely to indicate the
powers of the office bearers in terms of borrowing on behalf of the body.

e) Trustee deed:
A trustee is a person who holds property for the benefit of another person. A trustee deed
is a document, which governs the way the trustee manages the property of the trust.
When trustees ask for loans a bank should check the trust deed to see whether the trustees
have the authority to borrow.

f) Financial statements:
Any lending proposition coming from a prospective borrower must be accompanied with
audited financial statements for at least past three years. It should however, be noted that
this condition applies to businesses that are already in operation for many years. These
documents are balance sheets, income statements, and cash flow statements. In addition,
projected financial statements (management accounts) should be submitted.

These financial statements are useful in assessing the borrowers ability to repay the loan
if granted by looking at the past performance and the projected financial outlook in the
future.
g) Company’s resolution:
Borrowing companies have to provide a resolution by Board of Directors allowing the
management to borrow.

22
 h) List of current Board of Directors:
This applies to borrowing companies.

i) List of Management team:

This is a condition for borrowing businesses.

j) Security documents for perfection:

The perfection of security is an integral part of the taking of security and is usually made
a condition for disbursing approved funds. The documentation process of security varies
from one type to another. The following procedures are relevant in relation to the
respective types of security detailed bellows:

i. Legal Mortgages:
In addition to the Certificate of Title, the borrower is required to submit to the lender
the following documents:
 Valuation report on the property to be mortgaged prepared by an approved
valuation expert e.g. Government valuation officer.
 Memorandum by the borrower addressed to the Commissioner for Lands
or Regional Land Development Officers giving reasons for the proposed
mortgage and requesting consent to create a mortgage.
 Land rent and service charges clearance certificate evidencing that rent on
the property is paid up to date.

ii. Debenture:
A prospective borrower executes a standard form of debenture drawn by the lender.
Duly authorized officials of the company or a corporate body empowered to issue a
debenture must execute the documents under the company’s common seal. The
debenture is then submitted to the lender together with the following documents:
 Certificate of incorporation;
 Certified resolution of the Board authorizing the borrowing;
 Copies of annual returns;
 Memorandum and Articles of Association;
iii. Chattels Mortgages:
A chattel mortgages is a security charging on movable properties such as motor
vehicles, machineries etc. In case of vehicles the borrower has to surrender the
vehicle registration card to the lender and is in return required to execute a chattel
mortgage.

Recommended Reading
1. Rouse, C.N (1995), Applied Lending Techniques, CIB.
2. McGregor, P. (1996), Lending Bankers Workbook, CIB.
3. BPP (1996), Lending Study Test, BPP Publishing.
4. Satta, T.A. (2003), Banking Operations, TIOB.
5. BPP (1992), Banking Operations: UK Lending & International Business,
CIB.
6. BPP (1995), Lending, CIB

23
 INSTITUTE OF FINANCE MANAGEMENT
FACULTY OF ACCOUNTING, BANKING AND FINANCE
DEPARTMENT OF BANKING AND FINANCE
BFU 07406: LENDING AND CREDIT LENDING DECISIONS: 2019/2020

CRITICAL FACTORS IN LENDING TO DIFFERENT TYPES OF

BUSINESSSES:
A. RETAILING
Retailing ranges from the corner shop to the large store
The purpose of the borrowing is to finance working capital requirements.
Profitability of the retailing business is dependent on the rapidity of the
turnover and the size of the stocks
The main risk is competition and demand for sales
The critical factors to be considered in the appraisal of the business
operations include:
(i) Type of goods sold (Basic goods or fashionable goods)
(ii) Quality of purchasing or purchasing skills. This includes product
knowledge, where to source the products and which goods sell best
to minimize unsold goods.
(iii) Profit margins
(iv) Is there local market? There should be indigineous customers
(v) Competition
(vi) Niche product reduces the impact of location, competition and
profit margins. However new entries are likely if the niche product
is successful
(vii) Strategy. Do they plough back profits or do they withdraw profits
(viii) Forecasted sales and profit
(ix) Stock control. Where the retailer’s books of accounts provide an
analysis of purchases and sales by gross profit margin, it will be
possible to estimate stock movement each month.

B. WHOLESALING

The critical factors to determine profitability and risk of wholesaling are:

(i) Certainty of sources of supply. Possibly have 2
suppliers
(ii) Reliance of customers’ demand to avoid unsold stocks
(iii) Skills to match demand with supply

24
 (iv) Availability of resources to complete the supply chain

C. MANUFACTURING
This can either be:
(a) Building the Product from raw materials to finished goods
(b) Build a small amount and buy other components
(c) Supply labor to tailor a bespoke article with minimum
manufacturing
The critical factors in manufacturing the complete product involve the
awareness of the characteristics of the production line that may halt or
delay the product:
(a) Are there any raw materials whose delivery could be open to doubt
(b) Are raw materials adequate stocks to ensure production is not delayed
(c) Has due regard been taken of any planned management programs like
plant stoppage for maintenance and repair
(d) Operating efficiency of the production line like capacity slacks
(e) Efficiency of the plant layout: Under the same roof
(f) Is production and quality control adequately supervised
(g) Are individual machine records maintained for replacement purposes
(h) Are finished product stock levels monitored
(i) Are financial records satisfactory to calculate accurately cost of
production when tendering for future contracts
The risks of ‘buying in other components’ are mainly:
(a) Delivery of the items may be interrupted. This can be mitigated by
having more than one supplier
(b) Possible loss of know-how. This can be mitigated by entering into
exclusive agreements with confidentiality clause

D. FINANCIAL BUSINESSES
These are independent financial businesses offering specialized banking
services (intermediaries). These may require bank finance.
The lending banker will judge each application on:
(a) The type of borrowing risks undertaken by the intermediary
(b) The conditions the intermediary sets out for its customers to sign
(c) The typical period of the loans that are offered by the
intermediary
(d) The quality of the security the intermediary will accept
(e) The lending margin required relative to the loan outstanding
(f) The track record of the intermediary with respect to this type of
lending
(g) The management capabilities as a financial intermediary
(h) Previous bad and doubtful debt experience in good times and bad
times
(i) The regulatory controls the intermediary will be operating under
(j) The stability of the profits of the intermediary

25
 (k) The ownership of the intermediary and whether there is recourse
thereto.

INSTITUTE OF FINANCE MANAGEMENT

FACULTY OF ACCOUNTING, BANKING AND FINANCE
DEPARTMENT OF BANKING AND FINANCE
BFU 07406: LENDING AND CREDIT LENDING DECISIONS: 2019/2020

A. PRINCIPLES OF LENDING

In credit analysis a number of mnemonics have been developed to simplify the analysis
process.
(a) CAMPARI.
(b) PARSER.
(c) 4 Cs

(a) CAMPARI stands for:

C – Character
This refers to the willingness to pay. Lending bankers can get information related to
the character from interview and from records
A – Ability
This refers to the ability of the borrower to pay. There are various issues which enable
a borrower to pay. Some of them are:
 Technical
 Marketing
 Management
 Financial
M – Margin
The borrower should be able and willing to pay bank charges and interest
P – Purpose
The purpose of the overdraft should fall within the lending policy of the bank. It
should also legal
A – Amount
The amount requested should be just right for the purpose. The amount should not be
too little, nor too much. If it is too small it will not accomplish the assignment, and
when it is too much it may be misused.
The borrower should produce a cash-flow statement for this purpose

26
 R – Repayment
There should be a clear source of repayment which should be sufficient to repay the
overdraft. The sources of repayment should be reliable.
The customer should produce a cash-flow statement for this purpose
I - Insurance
The customer should provide security as a last resort by the bank in case the expected
sources of repayment fail. The property offered should have a value which is
sufficient to repay the overdraft with a margin. The value should also be stable. The
item offered should also have documents of title of ownership
The customer should produce documents of title, insurance documents and valuation
reports to support him for this purpose
(b) 4Cs stands for:
C – Character
C – Capability
C – Capital
C – Connections

(c) PARSER stands for:

 P – Principal or customers’ characteristics
 A – Amount requested considerations
 R – Repayment considerations
 S – Security considerations
 E - Expediency considerations
 R- Remuneration considerations

What is noted is that in each of the acronyms the criteria concerning the character and the
personality ranks high whereas security ranks low. This is what it should be. Bad loans
do not become good just because of the availability of security.

PROCEDURE FOR HANDLING A LOAN APPLICATION

Applications will take many forms, but inherent in all of them should be some sort of
plan for repaying the borrowing, an assessment of the contingencies which might
reasonably arise and how they would be dealt with.

In many instances the initial introduction to the application will not be in written form
and where this is the case the interviewer will have to draw out sufficient information to
enable the risks in the proposition to be assessed.

Most of lending decisions are based on experience or feeling of credit officers that the
credit will fulfill the basic attributes of good lending. However, experience should come
when one has learnt thoroughly and is able to apply the basic principles of good lending.

Once the bank receives the specific lending/borrowing proposition from the customer, a
decision has to be made whether:

27
 a) The proposition is acceptable the way it has been presented;
b) The proposition would be acceptable if it were amended; or
c) The proposition should be rejected

Therefore, the following are procedures for handling a loan application:

1. Receipt of application/inquiry
2. Interview of the customer
3. Visit business premises and proposed security
4. Customer identification
5. Documents from the customer

The application:
Applications will take many forms. However, usually the customer will put his/her
application in writing. After introducing himself/herself, it is expected that he/she will
specify:

 Amount needed
 Purpose of the loan
 Proposed credit period
 Sources of repayment

Some customers may attach business plan, cashflow projections and other documents
which are deemed necessary for credit procession.

Interviewing the customer:

After receiving loan application, the next step should be interviewing the customer to
establish if the application has merit at all. The bank will determine whether the
applicant qualifies for credit.

If the applicant does not qualify for starting the loan processing, the officer shall advise
the customer immediately. In case the application is substantive, the bank officer will
arrange to visit the customer business premises to clear/confirm some of the information
given during the initial interview.

The interview of the customer should cover the following points to ensure that the bank
gets a clear picture of the customer:

1. Business information:
Here the bank will seek to know the following:
 Nature of the business
 Years in business
 Main suppliers
 Main buyers
 Current bankers
 Annual business turn-over

28
 2. Particulars of the application:
The following are useful information to the bank:
 Proposed amount of the loan
 Purpose of the loan
 Proposed loan/credit period
 Source(s) of loan repayment
 Particulars of proposed security and use.
 Ownership of the proposed security (own/third party)
 Estimated value of the security.
 Other assets owned by the applicant other than the proposed security.

3. Particulars of the Customer:

(a) Corporate Customer

For corporate customers, the bank should seek to know about:
 Corporate name
 Registration number
 Date of registration
 Law under which the corporate body has been registered
 Authorised share capital
 Issued share capital
 Paid up share capital
 Information about owners of the company which will include
nationality, number of share allotted and shares paid up by each
shareholder.

(b) Individual Customers

For individual borrowers, the bank ought to know about:
 Name of the customer
 Nationality of the customer
 Trade name
 Business address
 Residential address
 Age
 Marital status
 Number of wives
 Number of children
 Occupation/professional

Information to Customer:
During the interview the bank also has a duty to inform the customer about the following
conditions:
 The prime lending rate;
 The applicable commission, fees and charges;

29
  The business plan requirement;
 The required documents;
 Customer equity contribution where applicable;
 Securities acceptable to the bank and valuation arrangement;
 The need for having a business account through which all transactions shall be
conducted;
 Deadline for submission of information/documents.

Visit business premises and proposed security:

In case the loan application has any merit, the next step is visitation of business premises
and proposed security (if landed property) by bank officials. The aim is to clear/confirm
some of the information given during the initial interview.

At the business premises, the bank will verify:

- the type of business the customer is dealing with;

- if the level of operation is in line with loan application and adequate to
service the loan once granted;
- the customer is authorized to deal with the type of business he/she is
dealing;
- working environment is conducive and meet the required standard to avoid
closure by relevant authorities;

If the customer has offered a landed property as a security for the loan, it is necessary for
the bank to look at it in order to judge whether:

- the property does exist;

- the property is valuable and adequate enough to provide cover for the loan
applied;
- the property meet standard of the bank hence suitable.

Customer identification:
The purpose of customer identification is to establish the legitimacy of the credit
applicant.

If the borrower is an existing customer of the bank, the bank will go through the
customer’s file to check available documents and will also assess if his/her account has
been conducted satisfactorily.

If the prospective borrower is a new customer, he/she must be introduced by:

i. Officials of the bank

ii. Existing customer who is well known to the bank.

He/she should provide a bank statement from his current bank and authorize the bank to
seek more information about him/her from the current bank.

30
The following documents may also be used to identify the new customer:

a) A valid passport
b) Letter from employer accompanied with a valid identification card issued by the
employer
c) Voters registration card
d) If the borrower is a foreign investor check with the respective embassy and/or
correspondent bank
e) Company search done by bank officials.

Credit procession should always depend on satisfactory customer identification. While

waiting for required documents and further information the application including all
enclosures must be filled in customer file opened. Each customer file should have a
checklist of information and documents submitted. If the required information is not
received within agreed time schedule the application should be stopped on the basis of
lack of information and the customer should accordingly be informed.

Precaution:
The following persons should are not eligible for credit facilities:
i. Minor
ii. Undischarged bankrupts or a person whom bankruptcy proceeding has been
instituted against him/her
iii. A person with unsound mind
iv. Blacklisted persons
v. A company which petition for winding up has been signed or a notice for
receivership has been served.
vi. A person giving false information
vii. External auditors of the bank.

Documents from the Customer:

After being satisfied that the application has merit and worth to be evaluated/appraised,
the bank will ask the customer to submit various documents which will necessitate that
evaluation/appraisal. The documents will vary in accordance to the:
- type of the customer
- type of the credit facility applied
- amount of the loan
- risk involved e.t.c.
The following documents must be with the bank before the application is processed:
 Business license;
 Certificate of registration of business name and extract from the registrar;
 Annual audited accounts for at least past three years;
 Draft/Management accounts;
 Certificate of incorporation (for companies);
 Annual returns (for companies);
 Business plan

31
  Budget and cash flow projections including the repayment plan;
 Bank statements (if new customer) etc.
The list of documents required as intimated before will vary depending on the
circumstances

INSTITUTE OF FINANCE MANAGEMENT

FACULTY OF ACCOUNTING, BANKING AND FINANCE
DEPARTMENT OF BANKING AND FINANCE
BFU 07406: LENDING AND CREDIT LENDING DECISIONS: 2019/2020

SECURITIES
Meaning of Security

It is a safety net in case things go wrong, and the borrower cannot repay the credit
facility as planned

Need for Security

Lenders will demand for security for 4 main reasons namely:
1. Safety Net: To rely on it in case the borrower cannot repay the credit facility as
planned.
2. To determine the borrower’s confidence in his ability to repay the credit facility
3. To instill a sense of seriousness in the borrower because he will then know that
there is something to lose if he does not pay
4. To comply with the regulatory requirement
What a Security is Not
• A security is not a replacement of a critical evaluation of a borrower’s credit
worthiness.
• A borrower will not be credit-worthy by simply having a very good security.
• A security is considered as a last resort after failing in everything, and when
bankers resort to security realisation there are number of problems such as:

32
 - Expenses like legal costs
- Bad publicity
Qualities of a good security
• Value
- Sufficiency. The value of the property being offered should have a value sufficient to
repay the advance in full, preferably with a margin
- Ease of determination
- Stability of value, preferably increasing

• Ownership
- Evidence of ownership such as a certificate of occupancy
- Ease of confirmation of ownership
- Ease of Transfer of ownership
- Absence of encumbrances

• Realization.
- It should be easy to convert the property as cash in case of need

TYPES OF SECURITIES
1. MORTGAGE
It is the conveyance of an interest in the property as security for a payment of debt
or discharge of some other obligation.
It is the conveyance of a right to a claim against the property of another less than
a claim to actual possession
Possession of the property remains with the borrower (mortgagor) while the
lender (mortgagee) obtains some or all of the rights to obtain ownership if the
borrower defaults
The lender obtains rights which border that of ownership.
Ownership of the property remains with the borrower
Land is the form of property most commonly mortgaged but choses of action like
life insurance policies and stocks and shares can be mortgaged.

33
 Types of Mortgages
Mortgages can be legal or equitable.
A legal mortgage is one that is created by the deposit of the title of ownership of
the property with the mortgagee and the registration of the lender’s interest with
the Land Registry.
The mortgagee obtains rights on the property itself in addition to the rights on the
borrower
It is the conveyance of rights against the property itself (rights in rem) and are
therefore enforceable against the whole world.
Thus whoever acquires the land is bound by any legal interest which exists over it
whether or not he had knowledge of it before acquisition.
The lender gets what is called ‘legal estate in the property’ and is endowed with
all sorts of rights and remedies, which can, for the most part be exercised by his
own initiative without seeking the aid of the court,

Remedies of a Legal Mortgagee:

 A right to sue the debtor
 A right to sale the property
 A right to appoint a receiver of rents
 A right to enter into possession

Equitable Mortgage
An equitable mortgage is created by a mere deposit of the title deeds with the lender
(mortgagee),
It is created by a mere deposit of the certificate of occupancy with the lender
(mortgagee), often evidenced by a ‘memorandum of deposit’,
• It gives the mortgagee no rights against the property, only against the borrower
• Hence an equitable mortgage is a weak security, and should only be accepted on
rare occasions and only for borrowers of undoubted integrity

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Second Mortgage.
• It is a mortgage made on a property already mortgaged elsewhere.
• The first mortgage will have been made for a value that leaves room for further
mortgages being made.
• A lender who takes a second mortgage must notify the first mortgagee

2. PLEDGE
A pledge is a deposit by a borrower to a lender of goods or documents or negotiable
instruments as security for a debt or discharge of some other obligation, on the
understanding that the goods or documents or negotiable instruments will be returned to
the borrower upon repayment of the debt
Possession of the property remains with the lender (pledgee) while ownership remains
with the borrower (pledgor)
It is an express agreement, whereby the deposit of the property is expressly made as a
security from the beginning

Possession of the property can be actual or constructive.

Actual possession is the physical possession of the property (goods, documents or
negotiable instruments)
Constructive possession is the transfer of title deeds of the goods to the pledge.
On arrival of the goods, documents are released to the pledgor, and the pledgor issues a
trust letter to the bank, himself as the bank’s trustee to the goods.
The goods are warehoused in the bank’s name.
The pledgor undertakes to insure the goods and to deposit all sales proceeds with the
bank
The pledgor has rights to sell the goods in case the borrower defaults
A pledge differs from a mortgage in that with a mortgage possession of the property
remains with the borrower, while with a pledge possession remains with the lender

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Letters of pledge are used by banks when they lend against produce which has been
bought or sold especially in international trade. They usually hold shipping documents

3. LIEN
A lien is a right to hold a debtor’s property until an amount due from the owner of
the property to the holder is paid.
The possession of the property remains with the creditor while ownership remains
with the debtor.
A lien is an implied arrangement whereby the debtor does not deposit the
property with the creditor as a security. A lien will arise out of usual business
between a debtor and a creditor when the debtor is unable to discharge his
obligations. The creditor then acquires the right to retain the property until the
obligation is discharged.
The creditor has no right of sale.

Types of Liens
Liens can be general or particular
(a) General lien
It is the right to retain the property of, which has come into the possession of
the creditor because of a particular transaction until he recovers all the moneys
due from the debtor arising out of general dealings between them.
(b) Particular lien
It is the right to retain the property of, which has come into the possession of
the creditor because of a particular transaction until he recovers debts
pertaining to that particular transaction.
It gives the right to retain possession of the property only to secure payment of
money owing in respect of the particular property over which the lien is
exercised
(c) Banker’s Lien
A banker’s lien is special in that it confers powers of sale on the bank. By
merchantile custom banker’s lien is a general lien, which confers the valuable
right of sale and recoupment after reasonable notice to the customer over
property of the customer, which has come into the hands of the bank in the
ordinary cause of business. Examples of such transactions are cheques, other
bills of exchange, promisory notes and coupons.
However the lien does not apply where the property has been handed over to
the bank for a specific purpose such as safe custody or for securities handed to
them for a specific advance or specific obligation.
When a bank takes securities from a customer to back an advance, it will
avoid any possible dispute as to the purpose of depositing securities by taking
its usual form of charge in which the right of lien is incorporated. Furthermore
it will include a right of sale.
Possession of the property remains with the creditor while ownership remains
with the debtors

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 Possession of the property is the essence of the lien. Thus a bank which has
the possession of an article, which it has a lien must not let it out of its
possession because in doing so it will lose its lien.

4. HYPOTHECATION
This is a legal transaction by which goods or documents of title are made
available as security without transferring possession, nor ownership. It is usually
taken when it is impossible for the banker to take over goods or documents
because they are have not yet been received (from overseas or produce not yet
harvested) It is a promise that the goods will be pledged when they are available.
It is granted by means of a letter of hypothecation, sometimes called a letter of
lien
Since the borrower retains both ownership and possession of the goods, the lender
has little control over the documents and the goods themselves and there is always
the possibility that the borrower may fraudulently deal with them and thereby
deprive the lenders of their security

5. GUARANTEES
A guarantee is the undertaking by one person to be responsible for another’s
debts, when the principal debtor fails to discharge his obligations
If bankers take guarantees as third party securities they must ensure that the
following points receive attention:
1. They must ensure that the guarantor fully understands the nature and
extent of the liability
2. The guarantor must be given the opportunity to take independent legal
advise, particularly if there is any chance of ‘undue influence’ being
exerted
3. If security forms are to be signed at another bank branch, ensure that
the nature of the liability is fully explained
4. If heavy reliance is placed on a large guarantee, supporting tangible
security should be sought

6. DEBENTURES
A debenture is an acknowledgement of debt by a company.
Secured Debentures can be either:
 Fixed charge, or Floating charge
Fixed Charge is a charge on fixed assets, such as:
 Freehold and leasehold
 Plant and equipment
 Fixtures and fittings
It attaches on specific assets.
A floating charge is a charge on circulating assets. The assets normally charged are:
 Debtors, and Stocks
Disadvantages of a debenture:
1. A debenture is the most difficult security to value

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  Almost without doubt the balance sheet values of assets will bear no resemblance
to their break-up values
 Freehold property can be sold at market value
 Market value of leasehold property depends on the unexpired period of the term
 Plant and machinery, if old may have only scrap value
 Specialised machinery may have limited market
 Fixtures and fittings would probably sell for very little
 Debtors may be doubtful, bad, inter-group or there may be counter-claims, claims
sub-standard delivery of goods, or the debtors may be too small to pursue
 Socks may be have, very low break-up value because finished goods may be out
of date or unsaleable and work in progress may probably be abandoned.
2. It may be invalid if the company is wound up within a year
3. Raw materials may be covered by Romalpa clause
Banks take debentures because there is the advantage of the bank becoming secured,
while taking the necessary precautions against the disadvantages
Precautions:
1. Considerable margin above the credit
2. The company giving the debenture should covenant not to create any further
mortgage
3. Debenture formula – maintenance clause for:
 Minimum holding of stocks or minimum holding of debtors or both
 Minimum ratio of current assets to the bank debt
4. Certificate of compliance with the maintenance clause (Debtors and stocks
statements)
5. Physical stock verification
6. Standing instructions for land rent and insurance
7. Personal guarantee of the directors of the company

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 INSTITUTE OF FINANCE MANAGEMENT
FACULTY OF ACCOUNTING, BANKING AND FINANCE
DEPARTMENT OF BANKING AND FINANCE
BFU 07406: LENDING AND CREDIT LENDING DECISIONS: 2019/2020

4. ITEMS COMMONLY TAKEN AS SECURITY BY BANKS

Items commonly accepted by lending bankers as security for borrowing and their
advantages and disadvantages are as follows:
(a) Bank Deposits
Advantages:
(i) Easy to determine its value
(ii) Value is stable and indeed grows with interest being paid on them
(iii) Easy to determine ownership

Disadvantages:
Few people have these deposits
(b) Land and Buildings
Advantages:
(i) The value of land tends to be stable in normal times
(ii) Unlike other securities, land can always be used productively
(iii) It is tangible and immovable
Disadvantages
(i) It is difficult and expensive to determine its value
(ii) Property prices can rise as well as fall, such that their values may now be
less than the amount loaned to purchase them
(iii) It difficult, cumbersome and expensive to establish its ownership
(iv) Even in a healthy market a reduction in price below market value may be
needed for a quick sale
(v) The bank will incur legal costs and estate agents’ costs in selling any
property
(vi) Property is not an easy security to realize, especially if it is:
 A domestic home occupied by the mortgagor and his family
 A specialized property like industrial premises

(c) Life Policies

Advantages:
(i) They are simple and cheap to charge
(ii) When a legal mortgage has been taken, they are easy to realize
(iii) Provided the premiums are paid the surrender value grows

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 (iv)A policy has a readily ascertainable value in form of cash figure, which can be
supplied upon its surrender
Disadvantages
(i) If the premiums are not paid accordingly there is the risk that the policy may lapse
(ii) The insurance company may not pay if there was non-disclosure of material facts
(iii) The insurance company may refuse to pay if there is a breach of conditions by
the assured
(iv) Where a person insures his life and commits suicide while sane, his personal
representatives cannot recover the proceeds of a life policy from the assurance
company even if the policy provides for payment in the event of suicide
committed while the person was sane
(v) Adverse Publicity, which might be occasioned to the bank needs to surrender
the policy, so depriving the beneficiary of death cover
(vi) The proposer might have an insurable interest in the life of the assured and if
not for any reason this did not exist, then the policy would have been wrongly
issued
The precautions lending bankers take to minimize risks are:
(i) The bank ensures that the assured’s age has been admitted
(ii) The bank ensures that there are no restrictive clauses
(iii) The bank checks the type of life policy
(iv) The bank checks the integrity of the insurance company
(v) The bank notifies the insurance company
(vi) The bank ascertains the surrender value
(vii) The bank ensures that premiums are paid up to date; by asking the assured to
issue instructions to the bank to pay the premiums

1. Stocks and Shares

Advantages:
(i) They can be handled quickly and simply
(ii) Bearer securities are fully negotiable
(iii) If shares are quoted and trading is active, valuation can be made easily
(iv) Shares can easily be realized
(v) Shares can be realized with minimum cost
Disadvantages
(i) The value is not stable
(ii) For equitable mortgages there may be a prior equitable interest in existence,
which will take precedence over the bank’s interests
(iii) For equitable mortgages the borrower remains the registered shareholder in
the company’s register and communications by the company is made to him

2. Goods
Advantages:
(j) They are self-liquidating
(iii) It is rare to find any problems with ownership
(iv) The charging formalities are few and simple

Disadvantages:
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(i) Control on on-going basis can be quite involving
(ii) Where a warehouseman’s charges have been paid, he will be entitled to a lien
over the goods and that charge will be superior to a bank charge
(iii) Accurate valuation of goods is difficult
(iv) Some goods may be perishable
(v) The value of goods fluctuate quite widely
(vi) The actual physical possession of the goods will move out of the control of the
bank
(vii) Rights of unpaid suppliers may be superior to those of the bank (Romalpa)
(viii) It may be difficult to identify goods for bank security if they are mixed with
other goods

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 INSTITUTE OF FINANCE MANAGEMENT
FACULTY OF ACCOUNTING, BANKING AND FINANCE
DEPARTMENT OF BANKING AND FINANCE
BFU 07406: LENDING AND CREDIT LENDING DECISIONS: 2019/2020

WRITING A CREDIT MEMORANDUM

THE LENDING PROPOSITION REPORT
• Introduction
- Nature and history of the borrower
- Loan details, like purpose amount and repayment period
• Markets and Products
• Physical and Production Resources
• Assessment of the Management
• Trading Performance
• Projected financial position
• Bank account operations
• Security and conditions
• Remunerations
• Summary and Recommendations

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