1. Credit and Lending

2. Loan types
Lending process
Credit (Default) risk

3. What is a bank loan?
It is the purchase of an asset (the borrower’s indebtedness) that is typically an illiquid and highly customized financial claim against the borrower’s future cash flows. The bank’s claim is the present value of borrower’s future obligations, assuming no extraordinary profit for the bank.

4. Business loans Transaction Loans Working Capital Loans Term Loans
Combinations

5. Loan types Consumer loans (excluding mortgage loans):
A direct consumer loan
Bank credit card
Mortgage loans:
Residential mortgage loans
Construction loans
Commercial mortgage loans

6. Lending process
Origination
Funding
Lending
Servicing
Risk processing
Credit culture

7. Loans vs Securities Securities are traded in the secondary markets
• Loans are private debt placement
• Difference is in relative liquidity
But, difference is narrowing down because of loan sales/securtization that has 2 forms:
Direct sales
Syndication

8. A loan agreement specifies:
Specifies the obligations of borrower
Specifies the obligations of the lender
Makes certain warranties
Places certain controls and restrictions on the borrower
States the amount to be borrowed, or the principal
States the maturity:
States the pricing formula,
Fixes the interest rate (fixed or floating), if floating, it may be :
States the fees to be paid to the bank
States penalties in case of default

9. Default risk
The root of credit default risk is information problems. If there were no informational problems in loans, there might not be any profits for banks in lending.
Information (or agency) problems are:
– Adverse selection
– Moral hazard

10. Default risk

11. Credit risk measures Interest rate spread Provision for loan losses
Net interest spread after provision
Non-performing loans/reserves
Net charge offs/average loans

12. Diversification Diversification but limitations are a) geography
b) uneven and uncertain arrival of lending opportunities
c) regulations
d) cross-sectional use of information

13. Credit analysis: 5c

14. Benefits of Secured Lending
Risk Reduction: Provides the lender with greater protection against loss in the event of default.
Signaling Instrument: Collateral can also convey valuable information to the bank.
Moral Hazard: Using collateral can help resolve a variety of moral hazard problems.

15. Sources of credit information
Internal sources
Interview with applicant
Bank’s own records
External sources
Financial statements
Credit information brokers
Other banks

16. Thank you.