Understanding how banks analyse your business loan application

Credit analysis is a complete analysis of the client’s overall performance and the specific project to be financed with a loan in order to assess the credit risk, i.e. the creditworthiness of the loan applicant.

The credit analysis is a component of the credit process, during which the bank must undertake a detailed examination of the enterprise’s operations and the reason for the loan-financed project. Moreover, the processing of the loan application consists of a variety of qualitative and quantitative factors.

The first concern is the borrower’s previous work, legal standing, management, loan security, competition, etc.

The quantitative analysis includes analysis of the financial statements of the company, as well as analysis of certain financial indicators. The ultimate purpose of the bank’s credit analysis is to evaluate the credit risk, or creditworthiness, of the loan applicant.

For qualitative analysis, banks have a variety of tools at their disposal, including CAMPARI, PEST, SWOT, etc.

Lending is a constant worry for banks and financial institutions because it is the primary operation that permits them to invest their resources and it is also their most profitable endeavour.

Through lending, banks assist, on the one hand, to the production of resources for businesses that need to finance investment initiatives, and, on the other, they encourage fund holders to invest for profit (interest).

To attain a high rate of profitability, banks must take on some risks. In recent years, particularly following the global financial crisis, and the banking sector clean-up in Ghana, the focus has been on changing business models to enable financial institutions to build an effective risk assessment methodology without compromising profitability.

Consequently, performance and risk in loan activities become essential market mechanism, especially given Basel II requirements.

Credit risk is one of the primary risks a bank faces, and it is generated through client lending (individual or corporate). Investors are reimbursed by the borrower or issuer of a debt obligation in the form of interest payments for incurring credit risk. Credit risk is strongly related to the prospective return of an investment, therefore, the rate of interest that investors will demand in exchange for loaning their capital is proportionate to the perceived credit risk.

Developing and applying credit risk management techniques has been a concern for many years, and it has progressed from traditional techniques, such as exposure assessment, to limiting excessive concentration on the debtor, business sector or industry level, to new management techniques, such as transactions with swaps and options, tailored to this type of risk.

Credit Evaluation or Analysis

The credit analysis is a method that evaluates the client’s or the borrower’s, creditworthiness. A creditworthiness refers to the borrower’s ability to get cash, i.e. credit, to utilise it, and to repay it under precisely and stringently outlined circumstances.

This definition of credit analysis and creditworthiness demonstrates the necessity of completing a thorough and impartial credit analysis, which will provide a realistic picture of the borrower’s creditworthiness and allow the bank to avoid potentially problematic loans.

The credit analysis of a client who is a legal entity includes an evaluation of past business success, the current market position, the available human resources, the industry in which the client operates, the financial statements, the justification for the project (to be financed), and information regarding the borrower’s credit history. This is in the direction of evaluating the borrower’s financial readiness and capacity to meet the responsibilities that would result from the approval of the proposed loan amount.

A shallow and insufficient review of the borrower’s creditworthiness exposes the bank to a greater credit risk than was anticipated in its credit policy.

Credit analysis requires further information and data analysis. Given that some of them have a quantitative nature and others a qualitative one, credit analysis can be viewed from two perspectives, such as:

• Qualitative analysis – includes an analysis of information related to the industry in which the company operates, its market position, its management, the manner in which the loan is secured, etc.

• Quantitative analysis – comprises an examination of the data extracted from the company’s financial statements.

Qualitative analysis

The qualitative study provides a clearer picture of the company in terms of its historical evolution, its primary business, the situation of the market in which it operates, the condition of the branch, and its customers and suppliers.

The advantage of this study is that it provides a chance with the qualitative components to uncover the potential risks of the business in the future.

Each type of credit analysis addresses the same challenges. In this regard, the qualitative analysis of the loan application can be characterised by the abbreviation 5C or 6C (5Cs, 6Cs), which is derived from the initial letters of the regions considered during the study:

• character, which reveals whether the debtor is responsible, honest, and whether there is a serious purpose to repay the loan in time.

• capacity; assessment of the financial status of the borrower and its ability to adequately repay the loan.

• capital or cash, i.e., the borrower’s ability to earn sufficient funds to repay the loan.

• collateral, as a true cover for the loan.

• Macroeconomic conditions, i.e., the macroeconomic or sectorial situations that impact the borrower’s capacity to timely repay the loan.

• Quality control, i.e., evaluation of whether changes in legal and regulatory rules may have a negative impact on the creditworthiness of the borrower and whether the loan application meets the quality criteria established by the regulatory body, Bank of Ghana.

The credit analysis also considers external elements over which the company has no control, but which might have a significant impact on the loan’s timely repayment. In actuality, this is about studying the borrower’s business environment. The following would be evaluated: developments in the borrower’s industry, technical trends in the industry, the borrower’s market position, the stability of his relationships with suppliers and customers, the phase of the economic cycle, and the future movement of interest rates. Long-term lending places a premium on an analysis of the borrower’s industry’s features, as well as its strengths and weaknesses in relation to the competitors.

Analysis of Qualitative Factors

Structure of the company’s ownership

During his visit to the company, the credit officer would examine the borrower’s ownership structure to detect any probable relationships with other businesses. “statement of connection and credit obligations.” The finding of a possible relationship with other businesses is an indication that they should also undergo a financial analysis in order to form a complete picture of the borrower.