MANAGING THE LENDING PORTFOLIO OF BANKS

After studying this chapter, the student should be able to:

 Define loan policy, loan policy statement and the Cs of credit.
 Describe trends in the loan portfolio
 Discuss the factors involved in evaluating a loan
 Compare the characteristics and profitability of different types of loans.
 Identify financial ratios used in loan evaluations.

Introduction
The principal reason why banks are chartered by the state is to meet the legitimate credit needs of
their customers. Banks are expected to support their local communities with an adequate
supply of credit for all legitimate business and consumer financial needs and to price that
Credit reasonably in line with competitively determined interest rates. Indeed, making loans is
the principal economic function of banks –to fund consumption and investment spending by
businesses, individuals and unit of governments. How well a bank performs its lending
function has a great deal to do with the economic health of its region, because bank loans
support the growth of new businesses and jobs within the bank’s trade territory and promote
economic vitality.
Not only do loans represent the largest commitment of funds for depository financial institutions,
they also produce the greatest share of the total revenue generated from all earning assets.
Moreover, it is in the lending function that depository financial institutions generally accept the
greatest risks. The failure of individual financial institutions is usually associated with problems
in the loan portfolio and is less often the result of shrinkage in the value of other assets. Most
bank funds as well as funds of other depository financial institutions are committed to loans, the
bulk of their revenue is generated by loans, and bulk of risk is central around the loan portfolio.
When a bank gets into serious financial problems, it trouble usually springs from loans that have
become uncollectible due to mismanagement, illegal manipulation of loans, misguided loan
policy or unexpected economic downtown.
Management must appraise the return and risk characteristics of loans and compare to securities
and must evaluate relative attractiveness of different types of loans. This appraisal is complex for
the loan function is central to the basic credit-granting role of financial institutions and loans
differ widely in degrees of risk. Lending is the basic reason to be for the commercial bank and
other deposit – type financial institution. Most financial intermediaries (especially the deposit
type) are local in nature; their funds are drawn from a relatively local market area. Local
consumers and businesses, depend essentially on local financial institution’s credits. The
fulfillment of this credit need by commercial banks and other depository financial institutions
may be received as a social commitment or obligation of the institution, subject of course to the
constrains of profitability and liquidity or risk. This social function performed by lending is
perhaps even more significant for the other depository financial institutions which for the most
part have been mutual organizations designed to proof the funds of individuals with a common
bond or purpose and make loans to these same individuals.

The Loan Portfolio

Types of Loans
Banks make a wide variety of loans to a wide variety of customers for many different purposes –
for the purchase of automobiles, buying new furniture, taking dream vocations, pursuing college
education, construction of homes and office building. An order can be brought to the diversity of
bank lending by grouping bank loans according to their purpose- what the customer plans to do
with the proceeds of his loan. Bank loans may be divided into seven categories delineated by
their purposes.
1. Real estate loans- secured by real property – land, buildings and other structures and include
short-term loans for construction and land development and long –term loans to finance the
purchase of farmland homes, apartments and commercial structures and foreign property.
2. Financial institution loans – including credit to banks, insurance companies, finance
companies and other financial institutions.
3. Agricultural loan – Extend to farm and ranch operations, to assist in planting and harvesting
crops and to support the feeding and care of livestock.
4. Commercial and industrial loans- granted to businesses to cover such expenses as
purchasing inventories, paying taxes and meeting payrolls.
5. Loan to individuals- including credit to finance the purchase of automobiles, mobile homes,
appliances and other retail goods, to repair and modernize homes ,cover the cost of medical
 care and other personal expenses either extended directly to individuals or indirectly through
retail dealers.
6. Miscellaneous loans. Include all those loans not classified above such a securities’ loans.
7. Lease financing receivables. Where the bank buys machines or equipment and leases them
to its customers.
Of the loan categories shown, the largest in terms of FCFA is real estate loans, accounting for
about 2/5 of all loans from bank.NB. in the case of America

FACTORS DETERMING THE MIX OF LOANS

Banking industry has different kinds of loans and this mix differ markedly from one
institution to another. One of the key factors in shaping an individual bank’s respond to the
particular demand for credit arising from customers in its own area. A bank serving a suburban
community with large number of single family homes and small retail stores will normally have
mainly residential real estate loans, automobile loans and credit for the purchase of home
appliances and for meeting household expenses.
In contrast, a bank situated at the central city surrounded by office buildings, department stores
will devote the bulk of its loans to business loans designed to stock shelves with inventory
purchase equipment and meet pay rolls.
Bank size is also a key factor shaping the loan portfolio of banks, especially the size of the
bank’s capital which determine the legal lending limit to a single borrowing customer. Larger
banks typically are wholesale lenders while smaller banks are retail lenders.
The experience and expertise of management in making different types of loans also shapes the
bank’s loan portfolio mix. Of course delinquency which is the inability of the borrower to repay
both the principal and interest as they become due most often is management responsibility when
it occurs, it can eat away at a portfolio without anyone realizing it and then suddenly explodes
out of control like a ‘’hidden beast’’. It negatively affects a program in the following ways
- Shows the rotation of portfolio
- Delays earnings
- Increases collection cost
- Decreases operation spread
- Can cause the bank to lose credibility
- Leads to ever increasing repayment problems and threaten long term institution’s viability.
Loan mix at any particular bank depends heavily as well on the expected yield to the bank that
each loan offers compared to the yields in all the other assets the bank could acquire.

Trends in the Loan Portfolio

Changes: The loan portfolio of commercial banks has changed drastically in recent years. In
general, there has been a decreasing relative emphasis on business lending and an increasing
concentration on consumer and real estate lending. This drastic change reflects shifts in the
economy and the financial system as well in the relative rates shifts in the economy and the
financial system as well in the relative rates of return on different types of loans. Bank liabilities,
once primarily demand deposits, are now mostly time and savings accounts. Reflecting the
longer term nature of bank liabilities and also the more costly aspects of these sources of funds,
banks have lengthened their loan portfolios and have increased their emphasis on real estate
related loans. Example, term loans for the purchase of equipment and building are now of great
significance at many banks. Also of considerable importance is the shift from fixed rate to
variable rate lending. Many banks today have almost their entire loan portfolio on a variable rate
(floating-rate) basis.

Consumer Lending
There has been a revolution in the attitude of the financial system towards meeting the borrowing
needs of consumers. At one time, consumer credit was viewed as socially unproductive use of
funds by a commercial bank with the post-world war II emphasis on the consumption of durable
goods and the need to finance these purchases have made the behavior of banks to change.
Commercial banks now actively solicit consumer accounts, both for the purchase of durable
goods and for other uses. This change in the loan portfolio has brought commercial banks into
active competition with a new group of financial institutions (particularly finance institution) and
has tended to blur the distinction amongst different kinds of financial institutions.

Regional Variable in Loans

The loan portfolio of banks has reflected variations in geography. Banks located in rapidly
growing portions of the Republic of Cameroon and having substantial amounts of time and
savings deposits place more emphasis on real estate lending than banks that operate in more
mature economic environments and depend more heavily on demand deposits as a source of
funds. Thus to some extend the loan mix of an individual financial institution must reflect the
nature of the economic base of the market area served by that institution.

Securitization:
The composition of the loan portfolio at commercial banks and other depository institutions has
been greatly affected by the growth of securitization. This refers to the transformation of non
marketable loans into marketable securities. It often occurs through pooling a large number of
small loans and selling securities that represent interest in the cash flows that come from those
loans.
The process of securitization began in the early 1970s in America with the creation of
Government National Mortgage Association(GNMA) pass-through certificates, by which
individual government insured (FHA) or guaranteed(VA) residential mortgage loans were placed
in pools and certificates have passed through to them all interest and principal
payments(including prepayments) on the mortgage. With a good secondary market and relatively
high yield, the GNMA passed through certificates became very attractive to investors. Following
the success experienced by securitization or non guaranteed mortgages were securitized. By
1987 most residential mortgage loans were securitized. The securitization of assets spread to
nonresidential mortgage loans, commercial loans, and even some consumer loans. The
securitization movement has contributed to a decline in the growth rate of loan portfolios at
commercial banks and other depository financial institutions and to a loss of market share for
these lenders. Moreover, because in many cases the more credit worthy assets are securitized, the
assets quality of loan portfolio at commercial banks and other depository financial institutions
has been negatively affected. Although the securitization phenomenon is to new to make any
long-run projections of ultimate effects, it seems likely that it will produce a significant increase
in the credit risk of the loan portfolio at commercial banks and other depository institutions.

LENDING REGULATION
The loan portfolio of any bank is heavily influenced by regulation because the quality of a bank’s
loan portfolio has more to do with risk and safety than any other aspect of the banking business;
some loans are restricted or prohibited by law. For example, Banks are frequently prohibited
from making loans collaterised by their own stock. Real estate loans granted by a national bank
cannot exceed the bank’s capital and surplus or 70% of its total time and savings deposits, which
ever is greater. A loan to a single customer normally cannot exceed 15% of the national bank’s
capital and surplus account.
The Community Reinvestment Act (1977) requires all banks to make ‘’an affirmative effort’’ to
meet the credit needs of individuals and businesses in their trade territories so that no area of
the local community are discriminated against in seeking access to bank credits. More over,
under the Equal Credit Opportunity Act (1974),no individual can be denied credit because of
race, sex, religion, age or receipt of public assistance.
In the field of international lending spcial regulations have appeared in recent years in an
effort to reduce the risk exposure associated with granting loans overseas. In this field banks
often face significant political risk, when foreign governments pass restrictive laws or seize
foreign own property as well as substantial business risk due to lack of information and
knowledge.
The quality ofa bank’s loan portfolio and the soundness of its lending policies ar the areas
bank examiners look at most closely when examining a bank. Under the Uniform Finance
Institution Rating System, used by examiners, each bank is assigned a numerical rating based on
the quality of its assets portfolio including its loans. The possible ratings are:
1 strong performance
2 satisfactory performance
3 fair performance
4 marginal performance
5 unsatisfactory performance
The higher a bank’s asset quality rating, the less frequent it will be subject to review and
examination.
Examiners generally look at all the bank loans above a designated minimum size
and at a random sample of small loans that are performing well but have minor weaknesses
because the bank had not followed its own loan policy or has failed to get full documentation
form the borrower are called criticized loans. Loans that appear to contain significant
weaknesses or that represent what the examiner regards as a dangerous concentration of
 credits in one borrower or in one industry are called scheduled loans. A schedule loan is a
warning to bank management to monitor that credit carefully and to work toward reducing a
bank’s concentrated risk exposure from it.
When an examiner finds some loans that carry an immediate risk of not paying out as
planned, these credits are adversely classified. Examiners will place adversely classified loans
into one of three groupings
1 Substandard loans – where the bank margin of protection is inadequate due to weaknesses
in collateral or in the borrower’s repayment abilities.
2 Doubtful loans – which carry a strong probability of loss to the bank.
3 Loss loans – which are regarded as uncollectible. A common procedure is just for
examiners to multiply all substandard loans by 0.20, the total of all doubtful loans by 0.50
and all loss loans by 1.0, then sum these weighted amounts together and compare their
totals with the bank’s sum of loan loss reserves and equity capital.
If the weighted sum of all adversely classified loans appear too large relative to laon loss
reserves and bank equity, examiners will demand changes in the bank’s policies and procedures
or possibly require conditions to the bank’s loan loss reserves and capital.numerical ratingsare
also assigned based on examiners judgement of the bank’s capital adequacy, management
quality, earnings records, liquidity position and sensitivity to market risk exposure. This is
popularly referred to as CAMELS Rating

Loan Policies: Development

In view of the importance of lending to the financial health of the individual financial institution
and to the community it serves, every financial institution must carefully plan its lending
operations. Careful consideration should be given to at least two major factors. The lending
institution needs some general guidelines or loan policies to assists those involved in making
loan decisions. Without such guidelines, individual loan officers are likely to make judgments
inconsistent with the goals of the organization and inconsistent internally from loan officer to
loan officer. Moreover, the development of a loan policy forces senior management to grapple
with a number of complicated issues and face significant concerns such as how much risk the
institution is prepared to assume in its loan portfolio. A loan policy can be an indispensable aid
in the training of now employees. Beyond establishing a loan policy the institutions needs to be
concerned about how individual loan applications are evaluated. Here, the most common
approach is to establish a set of criteria for evaluating each application. These criteria are usually
referred to as the 5Cs of credit. The number of Cs varies from lender to lender but the following
three are commonly used.

Example of Credit Analysis

The type of analysis used to evaluate capacity might best be explained through an example based
on the procedures followed at a particular multi-million-CFA commercial bank in handling
commercial loan applications. The credit department of the bank received a request the financial
characteristics of a particular loan application. The credit analyst then seeks information from a
variety of sources. Financial statements of the applicant are essential but insufficient. Additional
information comes from tax statements, news papers and related sources. It is important to have
information available on the industry in which the applicant operates in order to make good-bad
evaluations. Many such sources are readily available. Government publications and industry
trade periodicals are relatively easy to obtain. Financial ratios of various industries can be found
in a number of places. One excellent source is the annual statement studies. Published by a group
of commercial loan officers working for commercial banks. In addition, some published lists of
financial ratios, it is important for the analyst to keep up with local business conditions,
especially if the applicant is heavily dependent on the local community for sales.

Sources of Credit Analysis Data

One of the most comprehensive sets of industry standard is provided by the annual statement
studies and includes industry information on liquidity, coverage of fixed charges such as interest,
and the current portion of long-term-debt, leverage, including both operating leverage (as
measured by the ratio of net fixed assets to tangible net worth) and financial leverage (as
measured by the ratio of total liability to total worth); various operating ratios that are designed
to measure profitability and efficiencies in the use of assets and expense ratios.
After the data have been obtained, it is possible to proceed with the credit analysis, which
will culminate in a report to the loan officer. Such a report should include at least the following:
a) The purpose of the analysis (whether the request is for short term working capital loan or for
long –term capital loan).
b) The previous relationships of the customer with the lending institution (of substantial
operating importance because management is interested in profitability and not simply of one
loan).
c) The business history of the firm
d) The financial operating factors relevant to the firm.
Analysis of financial operating factors is especially important in determining the ability of
the borrower to repay the loan. Both income statement and balance sheet ratios are calculated,
sources and application of funds are examined; the liquidity and leverage ratios are incorporated
into the analysis. The report concludes with the summary of findings of the analyst.

Character:
Character refers to the personal traits of the borrower (completely apart from financial standing)
which may be significant in credit decision. Terms such as ethical, honesty and integrity are
important in this regard. It is often said that character is the most important of the Cs of credit,
for a dishonest borrower can always find a way to avoid the restrictions imposed by the lender on
a loan agreement. Certainly, character should be one of the first factors examined by a loan
officer. Given acceptable character, the other Cs of credit can be explored, but if this C is found
to be inadequate, further analysis is not warranted. No matter how good the collateral or the
financial position of the borrower, the lending institution should not provide a loan to anyone
who does not meet its character stand.

Capacity:
Capacity to generate income refers to the ability of the borrower to generate sufficient funds
either through liquidation of assets or earnings to repay the loan. Relevant to this question is the
quality of management of the organization as distinct from the character of the individuals
involved. In a long-term commitment, the lender would be inclined to look towards the earning
potentials of the borrower for repayment of interest and principal. Funds would be invested in
permanent assets, and the cash flow generated from the operation of these permanent assets
would be used to retire the debt. In contrast, funds for short-term loan repayment would come
from liquidation of current assets, and hence, the liquidity position of the firm would be crucial.
For long-term loans, focus would be on the interest coverage ratio (profitability related to interest
payments); on short term loans however, liquidity ratios would take on more importance. The
financial analysis associated with loan applications concentrates on this C of credit.

Collateral –
This is the third C of credit. This refers to the ability of the borrower to pledge specific assets to
secure the loan. These assets may be fixed in nature, such as land and buildings, or working
capital such as inventory and account receivable. While collateral is important in reducing risk, it
should not be viewed as a substitute for adequate earning potential. Indeed collaterized business
loans usually carry high interest rates than uncollateralized. Higher risk is frequently offset to
some extent by requiring collateral as well as by rising interest charged. However, especially
high risk loans should not be viewed as being made acceptable by collateral requirements. Such
loans should not be made, regardless of collateral possibilities. Collateral should be viewed as a
second line of defend (second to the ability of the borrower to generate cash flow from
operations to repay the lender).
The usefulness of collateral in the credit granting process is affected by the nature of the
collateral acceptable to the lender. Example the lender may establish a policy of not accepting
precious metal or collateral because of their frequently high price volatility as well as difficulty
of determining the true composition of the metal. If so, the lender may have to seek alternative
collateral.

Capital:
It is mainly composed of retained earnings and proceeds received from issuing stock.
Capital is measured by the general financial position of the firm as indicated by a financial
statement and ratio analysis, with special emphasis on the tangible networth of the bank. Capital
is best assessed through financial statement and security analysis. This usually starts with project
analysis or evaluation. With the tools and techniques acquired through environmental analysis,
the banker equips himself with integrity and competence. There are three aspects of this analysis:
financial statement analysis, security analysis and management evaluation. The essence of the
financial statement analysis is to establish that, all things being equal, the loan will be safe,
property used, and repaidon schedule. He must ask for and take adequate collateral/securities as a
manisfestation of the customer’s confidence in his own project and as something upon which the
banker can fall if things go wrong and expected results are not achieved.
Condition:
Refers to the general economic condition beyond the control of the borrower that may affect the
ability of the borrower to repay the loan. It has to o with the impact of the general economic
trends in the firm or special developments in certain areas of the economy that may affect the
customer’s ability to meet the obligations.
The 5 Cs of credit represent the factors by which the credit risk is judged. Information on these
items is obtained from the firms previous experience with the customer supplemented by a well
developed system of information gathering – Two major sources of external information are
available. The first is the credit association. By periodic meetings of local groups and by
correspondence, information on experience with debtors is exchanged. More formally credit
interchange, a system developed by the national association of credit management for
assembling and distributing information on debtors past performance, is provided. The
interchange reports show the paying record of the debtor, the industry from which he or she is
buying and the trading areas in which the purchase are being made.
The second source of external information is the credit reporting agencies, the best known of
which is the Dum and Bradstreet Agencies in the US that specialized in the coverage of a limited
number of industries.

BANK LENDING
One of the basic functions of a bank is lending of surplus deposits to those who wish to borrow.
For most customers, both personal and business, the banks represent one of the cheapest and
most flexible sources of finance available for the small business in particular, the bank is often
the only source of advice and additional funds.

Regulated Agreements.
The bank must also take into account the requirements of the consumer credit Act (1974). This
Act controls regulated agreements which are any form of credit up to $15,000 (including O/Ds
and credit cards), granted to individuals and partnerships.
 The Act requires the disclosure of the true cost of the credit to the customer on all regulated
agreements. This is the (APR) annual percentage rate charged. This Act prohibits canvassing for
a regulated agreement outside what are called ‘’trade premisses’’ without having received a prior
invitation for that purpose. It is not unusual for a bank manager to visit his customer at home and
chance meetings occur on many a social occasion. The Act means that the manager would
commit and offence if the question of credit was discussed in these circumstances.

Credit Scoring
Nowadays most personal loan applications are credit scored. This is defined as the measurement
of the statistical probability that credit will be repaid. The technique involves awarding its to
answers given to questions listed on an application form. Questions such as:
1 marital status and dependants
2 age
3 number of years at present address
4 nature of property occupied-whether it is owned or rented
5 occupation
6 length of time with employer
7 previous credit experience
It is no longer necessary to see the bank manager or other bank officers in order to arrange a
personal loan. Instead, and application form is completed which canbe handed into the branch or
sent by post upon receipt by the bank. The application is credit scored to assess whether or not
the loan should be granted.
However, despite the use of credit scoring, most lending does still rely upon the judgement of the
bank manager, or other officers who will interview the customer and make a decision based on
the interview and other information available in the bank.
BASIC QUESTIONS
The manager faced with a request for loan or overdraft facility must remember the four basic
questions
1 How much does the customer wants?
2 What does he wants it for?
3 How long does he wants it?
 4 How is it tobe repaid?
HOW MUCH?
The manager should bear in mind the customer’s own resources and whether the bank is being
asked to lend too much in comparison with these resources. Most managers agree that if a
customers of his own money invested in the project is high he will have plenty of incentives to
see it through to a profitable conclusion. The bank should not have more invested in the business
than the customer. This rule does not necessarily apply to personal borrowing, but the customer
must contribute. When a personal loan is being granted to buy goods, manager must bear in mind
any current government restriction. E.g minimum deposits, maximum repayment period.
WHAT FOR?
The purpose for which the advance is required must be known.
HOW LONG?
High proportion of the deposits of the bank is repayable on demand or at 7 days notice
HOW TO BE REPAID?
Repayment of every advance will normally come from the customer’s future earnings.
THE CUSTOMER:
The highly variable factor in any lending proportion is the customer. Manager must know though
most often only those who come for loans. References are created for every customer who shows
details of lending tele-conversation summary interviews held.
SECURITY FOR ADVANCES.
The manager will often ask of a suitable security from the customer in case the advance should
go wrong. There are 03 main requirements of a security accepted by banks
a. it should be easy to value
b. easy for the bank to obtain a good legal title
c. should be readily marketable or realizable
d. value should increase as time goes on
Security maybe either direct or collateral. Direct when deposited by the customer to secure his
own account. Collateral deposited by another person to secure a customer’s account. Four main
securities are often taken.
1 a mortgage of stock and shares
2 an assignment of a life policy
 3 a mortgage over land
4 a guarantee
a mortgage is the conveyance or transfer of an interest in land or other assets as security for a
debt. Where a bank takes a legal mortgage of property and can sell or do anything it likes with it
under an equitable mortgage the bank does not have such powers and the mortgage deed merely
establishes a clain on the land or other assets. Upon repayment of the advance, the mortgage is
reconveyed and ownership of the land or property revert to the ‘’true owner’’. A legal mortgage
is taken where the bank wants to make absolute certain that in the event of a force sale of the
security it will receive all the sale proceeds- an equitable mortgage is taken where the bank is
prepared to rely less on the security concerned, because it could happen that others might have
had similar equitable claims on the property.
Whereas a mortgage transfers an interest in assets, an assignment is the transfer to another
person of the right to receive a sum of money or some other benefits. Other ways in which banks
acquire rights over security taken include: lien, pledge, hypothencation.
1 LIEN- This is the right to retain the property of another until legal demands against the
owner – such as settlement of a debt have been satisfied. There are many types of lien eg.
A hotel proprietor has a lien over a ghest luggage until the hotel bill is paid. In banking if
a customer is overdrawn, a bank has a general lien over the property belonging to the
customer that comes into its hands during the ordinary course of business.eg cheques id
in ore credit of the customer’s account. Items held safe custody are not covered by the
lien of the bank as they are considered to have been deposited by the customer for a
purpose.
2 PLEDGE. - This is the delivery of goods or document of tittle to the lender as security
for a debt. It differs from a lien in that it is security that derives from an express
agreement between the borrower and the lender. Whereas a lien arises independently by
the operation of common law. A pledge differs from a mortgage in that the lender obtains
possession while the borrower retains legal ownership. With a mortgage, possession
generally remains with the mortgagor (while the right to tittle pass to the morgagee
eg the bank ,the lender). It is impotant for the lender to keep the pledge until the debt is paid.
The lender has the right to sell the goods if the debt is not repaid.
 3 Hypothencation - This is an agreement to give a charge over goods or document of tittle
to goods. It is used when the goods (documents) have not yet been received by the
customer, and is a legal agreement to give a pledge once the goods or documents are
available. Unlike the mortgage, the lender does not obtain ownership of the good and
unlike the pledge the lender does not obtain possession.
A letter of hypothencation often known as trust letter is taken when a pledgor of
goods or documents of title seeks the release of the goods to him so that they maybe sold
and the loan repaid. Thus if the bank has the customer’s goods wharehoused in the bank’s
name, the bank will give authority for the goods tobe released to the customer, so
enabling them tobe sold. Under the terms of the letter, the customer agrees to account to
the bank for the proceeds of the sale of the goods. The latter may cover one transaction
only or where trading customers are concern, may cover future transactions in which the
baki is involved in progidinjgt finance.

Loan Pricing and Profitability

Since interest revenue and fees on loans represent the bulk of the total revenue for most banking
organizations, it is vital that loans be properly priced and an evaluation made of the different
profitability of different types of loans. In order to do this, management must evaluate the
following three factors.
1. The interest rate charged on the loan.
2. The cost of making different types of loans.
3. The expected loan loss ratio on different types of loans.
Setting a sustainable interest rate. This is what a financial institution will need to realize on its
loans, if it wants to fund its growth primarily with commercial funds at some point in the future.
The model here presented is simplified and consequently imprecise. However, it yields an
approximation that is useful for financial institution. This model was established by CGAP
(consultative Group to Assist the poorest) through IFIDS in Bamenda July 2005. The pricing
formula is

R = AE + LL + CF + - 11
I – LL
Where R = effective interest charged on the loans which will be a function of 5 elements each
expressed as a percentage of average outstanding loan portfolio.
AE = Administrative expertise
CT = Loan Loss
CT = Cost of Funds
K = Desired capitalization Rate
II = Investment Income
NB: For an elaborate and rigorous calculation using this method, consult the topic on
microfinance in this volume II of the Banker.

Operating Costs of Lending

The operating (as opposed to the funding or money) costs of making different types of loans vary
widely. These loans usually made in small denominations and involving large amount of time of
clerical and management personnel for the bank, are generally high cost per FCFA of loans
expended. Installment lending in general and credit and loans in particular are high-cost types of
loans, while large – volume commercial lending are low- cost types of lending.

Profitability of Loans.
The profitability of loans or class of loans is also affected by the loss experienced on loans.
Unfortunately, as many banks found out in the early 1980s, the actual default experienced on
their loan portfolio sometimes is much higher than expected. But of particularly importance to
the loan allocation decision is the different default loss for different types of loans. The actual
default rate on credit card loans is often two or three times the default rate on commercial loan.
Hence when making or evaluating the desirability of making consumer, as contrast with
commercial loans, management should adjust (reduce) the interest return on the loans for the
expected loan loss for each type of loan.
The profitability of loans is, of course determined by the interaction of the cost of loans, the
expected default loss, and the interest rate that the bank can charge. The interest rate that is
possible for the bank to charge is determined by competition. For large commercial loans to
high-quality national and international borrowers, there is a single rate for credit determined by
competition amongst a large number of potential lenders. The individual lender for that loan is a
price taker, not price maker. The bank can look at it cost of funds, its operating costs of making
the loan, the expected default loss, and the potential interest return on the loan and then
determine whether or not it wishes to make the loan. In contrast, in most local and less
competitive loan markets, the bank is a price maker, that is, the bank can set the price of loans. In
doing so, of course, the bank must recognize the “`law of downward sloping demand curve” it
may set a high price, but if so, it will reduce the amount of funds that it may loan, and any excess
funds will have to be disposed of in the securities markets, generally with a smaller return. The
bank must also recognize that while all loan markets in which it is price maker have a downward
slopping demand curve, the elasticity of the demand curve may vary unsubstantially from one
type of loan to another. The quality of some loans may be highly sensitive to changes in the
interest rate while others (most with less elastic demand curves) may not be sensitive. The
profitability of different types of loans may be evaluated as: P= I – 0 – F - D
Where I = Interest return (including fees associated with making the loan)
O = Operating cost associated with making the loan
F = The cost of funds
D = Expected default loss

Government Restrictions
It should also be recognized that lenders are increasingly constrained in their credit decisions by
a variety of government regulations designed to assure equal access for all to sources of funds.
While the impact of these restrains is greatest in the consumer credit area, they affect a variety of
types of loans. Although usury regulations (limits on the maximum rates charged on loans) have
been common for sometimes, the decades of the sixties (1960s) and 1970s have resulted in a
large increase in the types of regulations applicable on loans made by financial intermediaries.
These regulations have included disclosure requirements on interest rates.
Truth – In –Lending
The truth –in – lending law imposes substantial restrictions on lenders. The principal purpose of
this legislation is to provide consumers accurate information on the cost of credit in a uniform
way, thereby allowing borrowers to move readily compare the charges fro, different credit
sources.
The law requires the lender to provide the total finance charged the total amount of FCFA paid
by the borrower over the life of the loan and the annual percentage rate (APR). The APR
provides a means for the borrower to compare credit costs, regardless of the amount of the costs
or the length of time over which payments are made. Both the total finance charged (include the
APR must be displayed prominently on the credit terms must also be included in advertising by
the lender (provided any credit information is include).
The truth in lending law also affects the relationship between the lender and borrower
through the use of credit cards. Example the law provides that consumer liability for lost or
stolen credit cards is limited to $50. Moreover for the lender to hold the borrower responsible
even for that amount, the unauthorized use of credit card must have occurred before the card
issuer has been notified by the cardholder, who is not liable for any unauthorized use occurring
after such notifications. The law equally prohibits card issuers from mailing a card to a potential
customer unless the customer requested or applied for it.

Components of Loan Policy

A number of important procedures are involved in the establishment of a loan policy as well as
several components of a loan policy. The policy may be a function of size of the financial
institution. The term to be incorporated in the loan policy (loan policy statement), are many but
some of the most important are:
Loan Volume: The policy should provide some general guidelines concerning the desired
volume of lending. As lending is a principal function of commercial banks, we would expect the
loan portfolio to dominate the asset structure. However, bank management must allocate funds to
meet reserves requirement as well as satisfy anticipated liquidity needs caused by deposit
withdrawals. In addition management may decide to hold a substantial amount of long-term
securities to achieve assets diversification as well as minimize tax payments through municipal
security investment. The size of the loan portfolio will also be affected by the credit needs of the
community as well as the ability of the financial institution to meet those needs. For example, an
intermediary may be located in an area with strong deposit potential but a weak loan demand.
Also management of an institution may not have the expertise to service the particular type of
loan demands provided by the local community. For example petroleum loans require the skill of
petroleum engineers at some faces of the decision process.
Mix of Loans:The loan policy should contain some references to the mix of credits that the
institution must emphasis and what must be an appropriate balance of each type of loan portfolio.
Such specifications should be made with regard to the demand for credit in the local economy as
well as the size of its management. If the local community is based on agriculture the loan
portfolio should weigh heavily towards loans to farmers and ranchers and business firms serving
the needs of farmers and ranchers.

Charges for Loans

A loan policy should include reference to customer charges and fees for loans and related terms
associated with the loan contract. This generally is referred to as loan pricing. A number of
aspects of the interest rate issue are important. The institution must appraise the degree of credit
risk and other factors that should affect the interest rate charged. An important issue concerns
how to adjust the rate charged as the perceived risk of the loan varies. One possibility is to group
the loans into risk categories and vary the interest rate form category to category. The lending
institution also must decide if it is to set a fixed rate or floating rate on its loan. If the institution
desires to establish a floating rate it must decide to what interest rate the loan contract rate should
be related. Short-term loans are more likely to have floating rates; although the decision to
establish any of the rates depends on other factors besides the maturity of the loan, such as the
strength of loan demand. Traditionally, floating rate loans have been tied to the prime interest
rate (the rate charged to the highest – quality customers for short term loans). For example, the
loan contract may specify that the loan rate will be equal to the prime plus 2% points (200 basis
points), in order to reflect credit risk considerations. This provision may run into the problem
that in some periods of high interest rates, lenders especially commercial banks are under
political pressure to hold down increase in the prime rate. In recent years, it has become common
to tie loan rate to the London interbank offered rate (LIBOR) on Eurodollar deposits. In is not
uncommon to tie the loan rate to more than one market index with the borrower having the
option to switch from one index to the other (through the frequency is usually limited).
Other factors: A number of other factors are relevant in the development of the loan –policy.
Compensating balance : This refer to the non interest bearing deposit (some commercial bank
allow timed deposit to be used) that the borrower is required to maintain at the lending institution
as a condition of the loan. Management must decide on the amount of compensating balance
required and on which types of loan compensating balances will be needed. Moreover decision
about the majority of different kinds of loan must be made.
Alternative structures for the loan. Additional issues in the formulation and implementation
of a loan policy involve the extent to which the lender will accept different kind of credit
arrangement.
Are there certain kinds of collateral that the lender will not accept? If so, under what condition?
How is the bank to decide the terms of this credit line?
Another important aspect of the laon portfolio that bank management faces is structuring the
administrative contract between the bank and the customer. Traditionally, loan officers have
been assigned to certain types of loans. For example, a loan officer might be assigned to
installment loans, real estate loans, or commercial lending; an increasingly popular arrangement
in installment lending is that of the personal banker. With this arrangement, all retail customers
of the bank are assigned their own personal banker; that personal banker then handles all the
relationships (not just loans) between the bank and the customer.
There are only a few of the issues that must be dealt with in his formulation of loan policy.
However, some of these policies may differ from institution to institution and from region to
region depending on the local government regulation.

Loan Policies and Elements of a Written Loan Policy

A sample loan policy for commercial banks has been provided by the American Bankers
Association in its pamphlet “A guide to development a written loan policy”. It lists the following
elements of a written loan policy.
The most important way a bank can make sure its loans meet regulatory standards and are
profitable is to establish a written loan policy. This will give loan officers and bank management
specific guidelines in making individual loan decisions and in shapping the banks’ overall loan
portfolio. The actual makeup of a bank’s loan portfolio should reflect what it loan policy says.

1 Bank objectives: The development of a written loan policy must begin with the objectives
of the institution. Development and re-examination of an opportunity to evaluate the role of the
bank or other lending institution) in community economic development; its support of small
business; and other important issues. The objectives must be established. In fact, one of the
major problems facing financial institutions’management is reconciling different ( and, to some
extent, conflicting) objectives. Internal objectives such as earnings, liquidity and acceptable risk
levels must be specified. After these goals have been determined, the board of directors must
establish policies or rules consistent with the objectives. In doing this, it must be recognized that
under both state and federal law, as well as common law estabilished by judicial decisions, the
board of directors remains ultimatel responsible for the activities of the institution.
1 Administration: It is vital that procedures be established for efficient administration of
lending function. The responsibility for administration of the lending function should be
clear. Lending authority for each individual and for various committees in the institution
should be specified. Most commercial banks for example, have specific dollar limits or
authority for different personnel. These limit general increase as the responsibility and
experience of the loan officers advance until at some point-certain official of the bank may
have loan authority equal to the legal lending limit of the institution. A delicate balance
must be reached between establishing loan authorities for individual officers that are to low
or too high. Loan limit that are too low will discourage the progress of individual loan
officers, force senior management (including the board of directors) to review an excessive
amount of small-quantity loan, and perhaps drive away larger customers. Conversely loan
limit that are too high add risk to the institution’s loan portfolio in that in an inexperienced
loan officer may commit the institution to undesirable loans. Certainly it would be
expected that the distribution of loan amongst individual loan officer vary with the sixe of
the lending institution.
2 Loan committees: The loan policy should also describe the function of the loan
committee organization. While they are no definite patterns for the organization of a loan
committee, loan committees generally meet weekly or more frequently to consider loans in
excess of some particular amounts or outside the normal credit standard of the
organization. The loan committee should be supported by a credit analyst or analysis group
that has regular contact with the loan officers and also has access to all relevant credit files.
At smaller commercial banks, for example, the size of the organization precludes setting up
a separate credit analysis group and loan officers must do their own investigations and
analysis. At a few large banks where a credit analysis department is feasible, operating
 policies still call for individual loan officers to perform their own credit investigation as a
means of maintaining closer knowledge of the prospective borrowers.
3 Trade areas: A loan policy should make reference to the trade area of the lending
institution. This will vary with size of the institution. The smaller the trade area and the
larger the institution the larger the trade area.
One important deficiency at many financial institutions in the past had been the maintenance of
records of credit files of borrowers. The exact credit requirements for different kinds of loans
should be specified in the written loan policy. Certainly the lender should have credit files for
every borrower and infact may face serious difficulties with examiners if the credit files are not
maintained properly. While the file may be large or small, depending on the particular
characteristics of each loan, such as size and collateral, the file should provide all the important
information necessary for the credit decisions, including complete financial statementsfor the
prospective borrower. It is particularly important that the credit file contain information
sufficient to justify the institution’s decision on the loan application, whether that decision is
positive or negative.
4 Substandard loans. Commercial banks as the most important lending institutions have had
substantial difficulty in recent years with the quality of their loans. Following the 1973-74
recessions, loan losses at commercial banks mounted to particularly high levels and at
some banks, exceeded by a substantial margin the reserve for bad debts that the bank had
amassed over a considerable period. Moreover, there was some evidence during this period
that loan losses were not simply associated with the business cycle but also reflected
improper lending standards of some institutions. Similar problems surfaced during the
1980-82 economic decline. The virtual depression in agriculture and energy in the mid
1980s also caused substantial problems. Given these problems, it is vital that the individual
financial institution include in the written policy some procedures for handling substandard
loans. While no financial intermediary makes loans that before the fact, it knows to be
substandard after the fact. At large lending institution, the number of such loans may
warrant the creation of a special department staffed with seasoned loan officers and other
specialists available to consult with other loan officers on problem cases or possible
assume responsibility for problem loans (in which case the loans would be transferred from
the loan officer to the specialized department). Such a transfer policy does have the
 advantage of shifting problem loans to those with specialized knowledge (frequently the
legal problem involved with these loans are great), but It has the disadvantage of not
forcing the loan officer to live with prior mistakes. While such a policy is impractical for a
small intermediary, it is essential for every financial institution to have some established
procedures for handling substandard loans and investments.
Loan Policies Implementation
It will be insufficient just to state a general lending policy. Those involve in the lending
function must also take this guidelines and apply them to specific loan situation, making the final
accept or reject decision based on both quantitative and qualitative factors. The type of analysis
that lies behind the loan decidson varies from institution to institution. At relatively small
commercial banks located in rural areas, for example, great importance is often placed on
personal relationships between borrower and lender, and less significance is attached to financial
statements and other objective sources of information. In contrast, in urban areas, where personal
relationships are frequently less stable, more reliance necessarily must be placed on hard
evidence regarding the creditworthiness of different individuals and businesses.
1 A goal statement for the bank’s loan portfolio (ie statement of the characteristics of a
good loan portfolio for the bank in terms of types, maturities, size and quality of loans)
2 Specification of lending authority given to each loan officer and loan committee.
3 Lines of responsibility in making assignments and reporting information within the loan
department
4 Operating proceduresfor soliciting, reviewing, evaluating and making decisions on
customers’ loan applications.
5 The required documentation to accompany each loan application.
6 Lines of authority within the bank detailing who is responsible for maintaining and
reviewing th bank’s credit files
7 Guidelines for taking, evaluating and perfecting loan collateral
8 A presentation of policies and procedures for setting loan interest rates and fees and the
terms for repayment ofloans.
9 A statement of quality standards applicable toall loans
10 A stamenent of the preferred upper limit for total loans outstanding (ie the maximum
ratio oftotal loans to total assets allowed).
 ADVANTAGES OF A WRITTEN LOAN POLICY
1 It communicates to employees working in the loan department what procedures
they must follow and what their responsibilities are.
2 It helps the bank move toward a loan portfolio that can successfully blend multiple
objectives such as promoting the bank’s profitability, controlling its risk exposure
and satisfying regulatory requirements. Any exception to the bank’s loan policy
should be fully documented and reasons why a variance from the loan policy was
permitted. While any written loan policy must be flexible due to continuing
changes in economic conditions, violations of a bank’s loan policy should be
infrequent.

FRAUDS IN BANKING

DEFINITION /CAUSES OF FRAUDS

The United Kingdom Financial Service Act (1986) defines fraud as “an irregularity involving the
use of criminal deception to obtain for instance an unjust or illegal advantage. Fraud is only
established as having been committed following a verdict to that effect in the court” fraud turns
to mean different things to different people. It is seen as the number one enemy in the business
world today with no company been immune to it. It is in all walks of life-in government on the
export trade, in football, in banking and so on. Attempts have been made to combat it both at the
national and international levels but it has not and cannot be eradicated completely. The
magnitude of fraud is not known because much of it is unnoticed and not all that is detected is
published. It is obvious therefore why the management of fraud, like that of risk is crucial for the
financial health of banks.
Fraud occurs when a person in a position of trust and responsibility in defiance of prescribed
norms, breaks the rule to advance his personal interest at the expense of the public interest he has
been entrusted to guard and promote. It also occurs when a person through deceit, trick or highly
intelligent cunning, gains an advantage he could not otherwise have gained through lawful, just
or normal processes. Seen in this perspective, fraud is a matter of individual choice and
opportunity and is reasonably convinced he can get away with it; and society provides such
opportunities in abundance.
One of such opportunity is that fraud is a big business. People are simply discovering and
being more aware that fraud is a fairly easy way of making big money. For the successful
fraudster, the reward can be enormous and risk small. Even if caught, the chance of been
publicly published are rare and the punishment is usually much lighter than the punishment
meted out to ordinary robbers.
Fraud is also a big business because it is a means of buying power and influence. As the
internal Chambers of Commerce emphasize the growth of organized crimes, influence and power
in the world’s financial market is one of the must serious problems facing both the developed
and developing countries today. Political and economic institutions have been significantly
weakened and corrupted by fraudsters engaged in international economic crimes.
Another factor that has facilitated the increase in fraud is the increasing internationalization
of financial markets. This has offered the frauds men new opportunities. Money laundering with
funds laundered through offshore banking centers run into billions of dollar each year.
Laundering techniques are complex, involving the manipulation of banks, brokerage houses,
lawyers, trust accounts, and exchange rate transactions and so on. The criminals are aided by
accountants, lawyers and banks that show little interest in identifying either the original source or
ultimate destination of the money. To the above is added the impact of new technologies.
These open up a new avenue and more opportunities for fraud. Nowhere is this more
pronounced than in computers and information technology. The volume and value of payment
traffics carried through the international bank payment system, the increase and modernization of
computer network, the use of automatic teller machine (ATM) and the electrical funds transfer
systems (EFTS) have resulted in big increases in frauds. This has been greatly assisted by the
banks reluctance to admit, much more report the fraudster. Worried about adverse publicity and
the thought of having squads of policemen delving through their files, the banks report only a
tiny percentage of fraud to the authorities. So the perpetrators escape persecution and the
banking community is left without opportunities to learn from the misfortune of others.
The absence of social sanctions or misplaced civil values and in many cases lack of ultimate
discovery is almost certainly the strongest deterrent to fraud. However, under the law, no citizen
has the right to report any crime to the authorities except treason or terrorism. Anyone who
reports other crimes does so voluntarily without the defense that he is fulfilling a statutory duty.
Even then, the costs and inconveniences of “come today”, “come tomorrow” in police
investigation act as a strong inhibition against reporting or attempting to arrest or restrain
criminals. Beside, many recent being branded deviants and outcast by acting otherwise in society
where wealth (no matter how acquired) is worshipped more than any other human attainment.
Inadequate internal control system within the organization has also contributed immensely to
fraud in banking. Others would include weak management and board lack of knowledge and
skills appropriate to have a firm grip of the bank’s operations.

Classification of Fraud
Fraud can be classified in three ways:
 By flow
 By victim
 By the act
1. The flow fraud : There are two types
I) Smash and Grape
Usually ‘’one off’’, small in number, high in value and occurs over a very short period of
time. They usually take the form of EFTS. Security and funds transfer, theft through vault
break-ins.
Ii) Drip- occurs through by passing of routine controls and employs a large number of
fraudulent acts each of relatively low value. Each fraud is repetitive in nature and may be done
successfully for many years without detection. For example payroll pudding through which
“ghost” workers receive salaries, “salami” operation where fraudulent programs are used to
credit small rounding differences to a favored account.
2. Victim Fraud: These are those identified by the victim of the fraud. For example in terms
of those committed against the company by bank itself and those against parties outside the
company. The former include frauds committed by employees, individual directors or board
of directors collectively. In the three cases, the appropriate plaintiff in any action for recovery
is the company or bank itself. The later, against parties outside the company or bank
 committed by employees, Directors, board of directors against share holders, other investor,
in this case the plaintiff for action is the aggrieved third part.
3. The Act Fraud :- This is in three categories:
A) Perpetrator fraud: There are those classified as such by the group or individual
committing the fraud. These include employee’s fraud that is fraud committed by the
employee, corporate fraud:- those committed by the institution itself through the board of
Directors and /or executive management. They also include those perpetrated by individual
directors and those committed by outsiders such as direct theft by outsiders or armed robbers.
a. Employees fraud: A great majority of fraud especially computer frauds is carried out
by employees in many cases by managers themselves.
i) Direct and indirect embezzlement and /or misappropriation of cash or equivalent by
theft of cash or bearer securities, using company funds to meet personal expenses or setting
personal indebtedness, making false wage / over time claims and claiming reimbursement of
expenses never incurred.
ii) Theft of non – monetary asset – furniture, equipment either for personal use or resale.
iii) Unauthorized personal used of company’s asset including secretariat and computer
services.
iv) Commercial sale of company’s unused computers and expropriating the proceeds.
v) Apparent legitimate activity entered into on the banks behalf but from which a wide
variety of unauthorized personal benefits may arise as for example in many party
transactions.

b) Corporate Frauds: This occurs when the company itself or executive management
become an instrument of fraud. This is the most serious type of fraud and usually causes the
collapse of companies. An example is the Pinnock finance Ltd in the United Kingdom, which
accepted deposits from the public, largely induced by offering excessive favorable interest
rates and then use the deposits themselves, to make up the inevitable short fall when meeting
interest rates expectations. Most of the corporate frauds have common features. One being
the obvious need for the perpetrators to falsify the company’s records to conceal the
fraudulent acts.
c) Third Party Frauds: committed by third parties ie those other than the company or
employees. Example is armed robbery or theft by outsiders –perhaps in collution with
insiders.
B) Fraud by Method
It takes many forms
1) EFTS Frauds: - These are mainly “one off” “Smash and grab” frauds and have been
facilitated by the increase in the volume and value of the payment traffic passing through
the interbank transmission payment systems by new technology particularly the
computer. Automatic Teller Machines (ATMs) which have made the financial system
more vulnerable to a wide variety of vandalism and fraud.
2) Fraudulent loans: -Banks are victims of defaulting and fraudulent loans may be made to
fictitious or ghost entities or entities to which the lending officer has and interest.
3) Demand Deposit and savings Account manipulation: - This is the manipulation of
customers’ demand deposits and savings account to conceal theft of bank funds.
4) Cheque Fiddling: - This is the use of stolen cheque to obtain cash and goods. Cheque
cross – firing is another form of cheque fiddling, in this case A draws a cheque for B
who draws a cheque for the same amount to A. The bank may then pay against a cheque
which has not yet been cleared.
5) Payrol, Paddling and Ghost Workers: - This involves payment of salaries and pension
to ghost and fictitious workers.
6) Counterfeiting: These include currency and commodity counterfeiting.
7) Investment Fraud: Promising generous rewards to investors and paying the first
investors’ dividend out of money received from later investors.
8) Theft embezzlement and bribery are all forms of fraud by method.
C) Instrument Frauds: Fraud identified by the instrument used can be described as
instrument fraud: They include the following.
1) Marine Fraud: scuttled ships, varnishing cargoes, marine theft and chartered party
swindles: Others are inflated insurance claims for ship and the cargo.
2) Documentary Credit Fraud: Occurs when one or more parties to an internal transaction
are deprived of the goods and /or the purchase price. This arises because in most international
trade transactions, documents such as bills of laden are treated as if they are goods
themselves.
3) Stock Exchange Fraud: Fraudsters may include investors to buy securities; they may
manipulate the market to influence the price of shares to their advantage or indulged in
buying and selling upon the basis of inside knowledge not available to outsiders.
4) Bankruptcy Frauds: business operates on the basis of funds obtained with no prospect
or intention to repay. When pushed, goes into liquidation and reemerges, trading in another
name.

Control of Frauds
As seen from the analysis above fraud is right in the fabric of the society and cannot be
eliminated totally. As long as society exists, the banking system will always experience fraud
as in the other sectors of the society. What had been done in terms of control is to minimize
its incidence and losses there from. These controls will differ from bank to bank depending
on the size, location and the general environment – national and international. The procedure
for control will and should normally involve identification, prevention, detection and
management.
Fraud Identification
Every bank should be aware of and identify the types of fraud prevalent in the society,
including the international society, the causes and modalities of the fraud and the potentials
and prospects for the fraud or some of them occurring in the bank. This will normally depend
on the volume, types and concentration of the bank’s operations, methods of operation, the
management control system, including internal checks and balances and an appreciation of
the wider macro-economic and political environment under which the bank operates. For
example a bank that deals in international trade finance must take into consideration the risk
of marine and documentary fraud. Those in mortgage finance are most likely to experience
mortgage fraud.
Fraud Prevention
The next stage after identification of the fraud would be to involve measures to prevent the
occurrences of the frauds. Some institutions have set up high ethical standards by
management to influence the rest of the workforce. Others warn their employees about the
 consequences of committing fraud as a way of minimizing or preventing the incidence of
frauds.
Despite this, no amount of warning or high ethical standard can prevent fraud. It is rather the
opportunity. If staff do not have the opportunity or freely exposed, they will not commit
fraud.
The preventive measures are general and specific.
General measures should appreciate the main features of fraud. One is that fraud is rapidly
and highly profitable industry and that the computer technology facilitates and accelerates the
growth. Others are that it involves misappropriation of assets and data and that most frauds
occur from basic failures or inadequate controls. Management should therefore evolve
policies toward safe guarding the banks assets and ensure that staff do not exploit weaknesses
in internal control. The policy can stress the principle of separation of duties to ensure that
one person does not originate and complete an assignment or entry.
- It should emphasis dual control of areas such as strong rooms of the bank and vault chamber
be opened by more than one person.
- Need for compliance with established policies, rules and procedures and employees
awareness of risk and fraud.
- Responsibilities of directors be clearly spelt out and formally explained to them. They must
ensure that suitable security exists and adequate account record and internal control measures
and precautions to prevent falsification of account record.
- External auditors should be incorporated.
- Specific preventive measures address particular sensitive sections of the bank’s operations.
For example EFTS operations’ preventive measures should start from the design of the
system, including back-up system.
- Protective service to prevent attackers from denying access to legitimate users.
- Rotation of employees in sensitive post
- Proper use of password
- Staff recruitment should emphasis quality, skills, integrity, motivation and dedication of
staff.
General Measures
On devising the general preventive measures the bank should appreciate the main features of
fraud. One is that fraud is a rapidly expanding and highly profitable industry and that the
computer technology facilitates and accelerates the growth. Other features are that fraud
involves misappropriation of assets and manipulation or distortion of data and that most
frauds result from basic failures and inadequacies in internal controls. Most frauds are
committed by insiders usually collusion with outside third parties, and most are discovered
by accident or by tip-offs rather than internal or external auditors.
From the above explanation on fraud, management should evolve positive policies
towards safeguarding the banks’ assets, and ensuring that staff do not exploit weaknesses in
internal control. The policy should stress the cardinal principles of separation of duties to
ensure that one person does not originate and complete an assignment or entry. It should also
emphasis dual control of sensitive areas such as strong- rooms and locks to security
documents. Other preventive measures to be enshrined and emphasized in the policy include
the separation of life and dormant accounts, the treatment of overdrawn and dormant
accounts, the need for daily balancing and periodic reconciliation of accounts including
necessary references, for opening accounts. Others include the need for full compliance with
established policies, rules and procedures, with expceptional deviations duly and
appropriately authorized, and employees’ wareness of the risks of attempting to defraud the
bank and the action expected if caught. Finally, the policy should incorporate and emphasis
expeditious reporting, investigation and possible prosecution of suspected frauds, defining
procedures and assigning responsibilities accordingly.
The responsibilities of the BODs should also be clearly spelt out and formally
explained to them. Generally these include directing the overall policy and management of
the bank, fiduciary duty to act honestly and with utmost good faith, and the exercise of skill
and care in discharging the statutory obligations of the bank. In particular the Board has the
collective responsiblility of the members to ensure that suitable security system exists there
are adequate precautions to prevent falsification of accounting records, and facilitate the
discovery of any falsifications. While board and management should be aware of the
existence and responsibilities of the external auditors, the fact should be emphasized to them
that it is not the responsibility of the external auditors to detect frauds unless when they are
serious enough to impinge on the truth and fairness of the financial statements. Board and
 management must understand that they have the primary responsibility for the prevention and
detention of errors and irregularities and that this can be achieved by an adequate internal
control system.
Specific Preventive Measures
Having specified and assigned responsibilities for general preventive measures, specific
preventive measures should be evolved to address particular sensitive sections of the bank’s
operations. One such area is EFTO operations. Preventive measures should start from the
design of the system and the parapherinalia of protecting it, including a back up system to
allow for machine failure, cryptographic facilities to protect the computers, data network and
terminals from illicit access or tampering; or protection services to prevent attackers denying
access to legitimate users. Other areas include the payment process, key management,
recovery and contingency arrangements, software and data integrity and security
responsibilities. Each measage must be authenticated end –to –end with the relevant keys
which must be appropriately secured. Power failures must be guarded against by providing
uninterrupted power supplies through stanby generators.
As amount of security technology can totally eliminate the abuse of computer
data, particularly by employees, other supplementary preventive measures are necessary. The
most crucial of these is simply to raise employees’ security awareness through effective pre-
employment screening, the rotation of personnel in sensitive posts, enforcement of periodic
or annual holidays , the proper use of passwords and user logs, access limitation based on job
related necessity as opposed to convenience, encryption, and log-on audit trails, Employees
who understand management concern and alertness will usually respond much more
favourably than those who show unawareness or even ambivalence.
Security technology is important but it just not be allowed to obscured the far more fundatmental
threat from authorized users. In this regard, administrative routines, established codes of ethics
and effective audit trails are more important. Policy must make it clear that data is just as much
corporate property as tangible assets. Anyone stealing or unlawfully using either mut be dealt
with in the dame way. There is not much point erecting fences and prosecuting the late night
burglars if employees are allowed to steal data with impunity in broad dalylight. As with other
forms of business risk, recognizing the fundamental nature of electronic theft will go a long way
to defeat it.
 Two other operational areas require specific preventive measures. One is lending and the
other deposits. The objective is to prevent falsification of records, making phony or ghost loans
and collution with customers. Other objectives include avoindign demand deposit and savings
account manipulation through, amongst other things, creating false and off –setting entries
concealedentries and suppressing incoming cash, credits and cheques on customers’ accounts
etc.
To achieve the above, preventive measures must start with and emphasis the quality, skill,
integrity, motivation and dedication of staff. Accordingly staff recruitment and other personnel
policies should emphasize appropriate qualifications, merit and reward for special merit and
achievements. It should not in any way undermine the authority and integrity of board and
managemtn and must avoid courting widespread disloyalty amongst staff and management , as
this would engender staff alienation and encourage collusion with debtors to frustrate effective
lending and debt recovery. Other preventive measures include regular dispatch of statements and
rendition of reports coding and testing of branch instructions, surprise checks and expenditious
handling of customers’ dcomplaints by persons other than those complained about; Encouraging
expeditiousreport of suspected frauds and other malpractices, motivating staff to a state of full
satisfaction and commitment to the objectives of the bank; and installing electronic devices as
surveillance TV systems, on the spot photographing of customers etc.
Detective Controls
This is an after event phenomenon and less conventional approach to fraud control. This is by
following up the detection of fraud symptoms with conventional investigation, sanction,
disciplinary, criminal or civil and publicity. Detective measures are versatile. They can be built
into the bank’s management system to form part of the routine controls, used in a serious or non-
routine special exercise or take the form of fraud audit.
Fraud audit has a number of advantages. It is covert in nature and can be used to detect fraud
without affecting employees’ moral or damaging industrial relations by making employees feel
they are under suspicion. They are effective in detecting frauds where established systems of
control have been bypassed. Even when there is no suspicion of fraud, they can be used to
identify areas where hither-to unsuspected frauds may be operating. The power and speed of the
computer can be exploited to permit techniques which would not have been practicable.
Complete examination of the files can be performed and sophisticated statistical techniques can
be employed to discover patterns, relationships and deviations from the norms. It is possible to
control the extent of the action taken and thus minimize business disruption. In the detective
approach, it is not necessary to catch and apply sanctions to all wrongdoers in the bank, and the
publicity following a successful operation will create a considerable deterent effect. Finally
many of the tests and checks performed may also highlight inefficient operations and accounting
errors; their elimination provides an additional spin-off benefit to the bank and they can be
incorporated into the routine reports to assist management in improving operational efficiency.
Investigation: This is designed to resolve the fraud system or suspicion so that they can be either
dismissed or acted upon. It may include undercover surveillance and investigation, detailed
examination, witness and suspects.
Action: The resulting action may be Internal/External to the organization or both. The choice
will depend upon circumstances and for the individual organization. Internal action can range
from improving system to prevent the reoccurrence through normal disciplinary procedures to
dismissal. External action would include criminal prosecution and also civil action for restitution.
Publicity: This is the final key element and may be achieved informally by means of the
“grapevine” or formally through direct briefing of employee, home journal or local, national or
trade press. Care should be taken that publicity does not prejudice any legal action.
Monitoring: The result is to create a temporary fraud free period which should reflect the true
performance of the operation. This can then be used to determine under performance or fraud.
Fraud insurance: As in risk generally one can shoulder it or shift it to someone else - an
insurance company.
Treatment of suspect: Banks are generally reluctant to report fraud because it may tarnish the
reputation of the bank(s) involved.
CHAPTER QUESTIONS
1a. Define fraud in relation to banking and what can be the possible causes of fraud.
b. Suggest the possible means of control of fraud in banking.

ACCOUNTING AND FINANCE

Subsection 1
FINANCIAL MARKETS.
1 A money market is a market where..
a) Money is bought and sold
b) Money can be exchanged
c) A market for short –term securities
d) None of the above
2 What is a capital market?
a) Market for capital goods
b) A market for long term securities
c) A marker for beginners in business
d) None of the above
3 A primary market is ...
a) A market for first entrants
b) Facilitator of the issuance of new securities
c) A market for newly created companies
d) None of the above
4 A secondary market is ...
a) One that facilitates the trading of existing securities
b) A market for first hand securities
c) A market for second world securities
d) None of the above
5 A surplus unit is ...
a) A unit which supplies loanable funds
b) A unit with surplus capital
c) A unit with excess income
d) None of the above
6 What is a stock in relation to securities ?
a) Goods in a shop Page 2 of 7
b) Certificate representing partial ownership in a corporation
c) There are government income
d) None of the above
7 What are derivative instruments?
a) Risk-free securities
 b) Securities of future markets
c) Securities whose values are determined by the values of the underlying assets
d) None of above
8 What is market efficiency ?
a) When security prices fully reflect all available information in the market
b) When target markets are fully made
c) When quality services are performed in the market
d) None of the above
9 Exchange rates are .....
a) Rates at which securities are sold in the foreign exchange market
b) Rates at which one currency can be exchanged for another
c) The price of securities when converted to cash
d) None of the above
10 Name any two theories used in determining interest rates
a) Loanable and Keynesian theories
b) Liquidity and pure expectation theories
c) Fisher and Fisher Effects Theories
d) None of the above

Subsection 2 Decentralise Financial Systems (MFIs)

1 A microfinance institution is..
a) An institution with little capital
b) A bank for the poor
c) A bank most often found in the rural areas
d) None of the above
2 What is the minimum capital for category 2 microfinance institutions in Cameroon? Page 3of 7
a) less than 50 million FCFA
b) Greater or equal to 50 million FCFA
c) Any amount of money
d) None of the above
3 For category 1, MFIs the minimum capital shall be fixed at..
a) Less or equal to 50 million FCFA
 b) More than 50 million FCFA
c) Equal to 50 million FCFA
d) None of the above
4 Category 3 MFIs collect savings from members
a) True
b) False
c) At times when need arises
d) None of the above
5 COBAC stands for..
a) Bank of Central African States
b) Commission of Banking Commissions
c) Commercial bank of Cameroon
d) None of the above
6 What is a target market for MFIs?
a) A market that is always available
b) A group of potential clients who share certain characteristics
c) A market that always meets its targets
d) None of the above
7 One of the most common collateral substitutes for MFIs is peer pressure. What is peer pressure
a) Loans given to more than one person
b) Loan given to groups not individuals
c) Loans granted on the basis of large collaterals
d) None of the above
8 What is a delinquent loan in a MFI?
a) Loan which is one day past due Page 4 of 7
b) Loan which had not been paid for more than one month
c) Loan which had not been paid for more than six months
d) None of the above
9 Name any adjustment which must be made on the financial statements of MFIs
a) Accounting for inflation
b) Accounting for total deposits
c) Accounting for total loan portfolio
 d) None of the above
10 The following are performance indicators in a microfinance institution.
a) Leverage and capital adequacy
b) Credit methodology
c) Markets and clients
d) None of the above

Subsection 3 ISLAMIC FINANCE

1 Islamic banking is based on non-interest bearing.
a) False
b) True
c) Indirectly
d) None of the above
2 One characteristic common to Sukuk and Conventional banks is ..
a) Both provide investors with payment streams
b) Bonds at Sukuk are not initially issued to investors
c) Both are considered not to be safe investors than equities
d) None of the above
3 One main difference between Islamic finance and Conventional banking is that..
a) Conventional banks charged interest but Islamic banks do not
b) Islamic banks can move to areas that Conventional cannot
c) Conventional banks mostly found in urban areas but Islamic banks can be found in rural areas
d) None of the above
4 What is an investment vehicle? Page 5 of 7
a) Vehicles used by investors
b) Investors that move across national boundaries
c) A product used by investors to gain positive returns
d) None of the above
5 Islamic banks do not invest in bonds
a) False
b) True
c) At times
d) None of the above

SECTION B: ACCOUNTING
Subsection 1:Accounting for Banking Operations
1. Awacam contracted a loan of 20 000 000FCFA on the 31/12/2020 from Gift Bank to be
reimbursed within 5years by constant amortization at a compound interest rate of 12%.
Considering the VAT rate to be 19.25%.
a) Present the amortization schedule of the loan .
b) Record the loan and the payment of the first and 4 th payments in the books of Gift Bank.
(10-5=15kms).

2. Record the following transactions in the books of Gift bank.

1/1/2020 started the microfinance with a capital of 50 000 000FCFA
2/1/2020 paid ENEO bills by cash 100 000FCFA .
31/1/2020 paid salaries 2000 000FCFA
2/2/2020 opened a savings account for peter 10 000 000FCFA cash deposit
3/2/2020 paid business license 400 000FCFA
4/2/2020 paid NSIF contribution of 5000 000FCFA
5/2/2020 JIG LTD opened a current account with 40 000 000FCFA ( 10 000 000FCFA was from his
savings account while the rest was paid cash). (10mks)

Subsection 2: Financial Accounting

A sole proprietor realised the following transactions during the month of January 2021
1/1 started business with cash 20 000 000FCFA
2/1 Transfered 15000 000FCFA cash to the bank
3/1 bought goods on credit 2000 000F
4/1 sold goods costing 500 000F for 1200 000FCFA on credit to Bih
5/1 Bought goods and paid by cash 100 000FCFA
6/1 Bih completely settled her account amounting to 1150 000FCFA cash
7/1 contracted a loan of 8000 000FCFA from NFC
8/1 paid interest on loan 20 000FCFA
9/1 paid salaries by cheque 1500 000FCFA
10/1 sold goods costing 200 000FCFA for 1000 000FCFA. Page 6 of 7
11/1 sold goods costing 300 000F to Peter for 1000 000F cash after offering a trade discount of 10% and
a cash discount of 5%. The goods were delivered in containers consigned at 20 000FCFA and the
transport invoiced was 15000FCFA.
Required:
a) Record the transactions in a journal.
b) Post the Journal to the ledger and present a six column trial balance.
c) Present a simple income statement to determine the profit/loss for the period. (25mks)
 SECTION C STRATEGIC MARKETING MANAGEMENT IN BANKING
1 Define marketing and give its role in a bank.
2 Who is a marketing manager?
3 What is market segmentation and of what relevance is it to banking?
4 a) Define marketing
b what is marketing strategy?
5 What is market segmentation? Why is it important in banking?

SECTION D Banking Environment

1 Discuss the impact of the LePEST factors in banking (12.5mks)
2 How can you account for the numerous changes that have taken place within the Cameroon
banking system for the past years (12.5mks)

SECTION E
LOAN PORTFOLIO MANAGEMENT

Question 1 How can you assess the credibility of a potential loan recipient using the 5cs of credit?
(4mks)
Question 2 A loan policy has components, discuss any five of such components that you know. (4mks)
Question 3 list and explain the various types of loans in a loan portfolio (4mks)
Question 4 what can you suggest could be the main reason(s) behind loan defaults in banks? (4mks)
Question 5 Why do banks invest in securities. (4mks)

SECTION A – MCQs (monetary and banking Economics)

1 What is financial intermediation?
a) Process of moving finances across borders
b) Movement of funds from surplus unit to deficit unit
c) Bankers’ opinion being exhibited
d) None of the above
2 A treasury bill is?
a) Bill from the government treasury
b) Short term government security
 c) Lending instrument of corporations
d) None of the above
3 bankers’s acceptance is?
a) Banks accept to do a service
b) Short term security issued by banks on behalf of their customers guaranteeing payment and it becomes
a liability of the bank
c) Acceptance to pay cheques by a bank
d) None of the above
4 what is a commercial paper?
a) Short term government security
b) Short-term security of corporation usually 6 months
c) Paper of commercial institutions
d) None of the above
5 Define a bond.
a) Government long term security
b) Non interest bearing security of government
c) Security of private companies
d) None of the above
6 define a stock
a) securities of government that are long term in nature
b) short term securities of companies
c) coupon bearing securities of the state page 2 of 5
d) none of the above
7 what is interest rate ?
a) Reward for investment.
b) Price for changing money
c) Gains from banks
d) None of the above
8 What is money supply?
a) It is all money in circulation
b) It is demand deposits,
c) It is demand deposits, currency and checking deposits held by the public
 d) None of the above
9 What is a financial asset?
a) An I O U paper
b) Document of value to shareholders
c) Money in disguise
d) None of the above
10 How are financial assets created and transferred?
a) Created by banks and transferred to individuals
b) Created by surplus units and transferred to deficit sector
c) Created by deficit sector and transferred to surplus units
d) None of the above
11 a money market is /
a) market where money is bought and sold
b) market for securities
c) market for short-term securities
d) none of the above
12 What is a primary market?
a) Market for short term securities
b) Market for second hand securities
c) Market where securities are sold for the first time
d) None of the above ` page 3 of 5
13 Who are the main participants in financial markets?
a) Government and private companies
b) Households, businesses and governments
c) The government treasury, companies and businesses
d) None of the above
14 What are derivative instruments?
a) Securities whose value is determined by value of underlying assets
b) They are integral instruments
c) Instruments whose derivatives are still to be found.
d) None of the above
15 Four examples of derivative instruments are?
 a) Options, warrants, future and forward markets
b) Future market, forward markets spot and CDs
c) Commercial paper, bankers acceptance, futures and forward markets
d) None of the above
16 Three theories that can be used to determine interest rates are?
a) Loanable funds theory, market segmentation and pure expectation theory
b) Liquidity preference theory, loanable funds theory and market segmentation theory
c) Keynesian theory, loanable funds theory and liquidity preference theory.
d) None of the above
17 Three examples of capital market instruments are?
a) Stocks, bonds, mortgage
b) Mortgage, bonds , commercial paper
c) Bonds, CDs, and securities
d) None of the above
18 Three examples of money market instruments are?
a) Treasury bills, CDs, bonds
b) CDs, treasury bills and commercial paper
c) Eurodollar notes, bonds and acceptances
d) None of the above
19 Does printing more money increase the money supply? Page 4 of 5
a) Yes
b) Sometimes
c) No
d) None of the above
20 Examples of non-depository institutions are?
a) Insurance companies, credit unions and investment banks
b) Investment banks, insurance companies and commercial banks
c) Credit unions, consortium banks, representative offices
d) None of the above

Monetary and Banking Economics

SECTION B subsection 1
QUESTION 1 ‘’Central bank actions affect interest rates, amount of credits and the money
supply all of which has a direct impact not only financial markets but also on aggregate output’’.
Explain briefly (5mks)
QUESTION 2 Name and explain four types of risk showing clearly how there can be
minimised. (5mks)
QUESTION 3 list any four sources of finance available to an investor. (5mks)
QUESTION 4 Access the reason(s) for portfolio investment by commercial banks . (5mks)
QUESTION 5 what three things can the Cameroon government do to fight a recession?
(5mks)
Subsection 2 monetary and banking economics
QUESTION 1 briefly explain four factors that determine exchange rates (5mks)
QUESTION 2 How can the Cameroon government control the supply and demand of loanable
funds in the country? (5mks)
QUESTION 3 What factors limit the bank’s ability to create credits?(5mks)
QUESTION 4 what is the job of the central bank in Cameroon? (5mks)
QUESTION 5 What three things can the government do to fight inflation? (5mks)