Posts Tagged ‘credit analysis’

What is 5C Credit Analysis?

June 25, 2009

New officers who join the bank as a credit officer will learn about 5C. What is 5C? 5 C stands for:

(1) Capacity (2) Capital (3) Collateral (4) Conditions, and (5) Character

1. Capacity

Is is an evaluation of the customer ability to repay the loan. This is the most important C to the bank. Because, at the end of the day, the bank wants back its money it lends to customers.

Capacity is evaluated by several components. There are:

  • Cash Flow: It refers to the income a business generates versus the expenses it takes to run the business. For example, if a company generates RM10,000 a month of revenue, and it has expenses of RM8,000 a month, the lender would determine that there is RM2,000 a month in cash flow that could be used to repay the loan. A bank will normally takes the most 70% of the net cash flow (70% x RM2,000) to repay the loan. So, if the net cash flow (total inflow-total outflow) is low, the lender or borrower would have reason to be concerned about how the company plans to repay the debt.
  • Payment history. It refers to the timeliness of the payments that have been made on previous loans. This situation is for existing customers. But, for a new customer, the bank can check his payment history from other banks through CCRISS or CTOS the worst.
  • Contingent sources for repayment are additional sources of cash flow that can be used to repay a loan. These include personal assets, savings, current account and other investments.

2. Capital

Typically, a company’s owner must have his own funds invested in the company before a bank will be willing to risk their own investment. Capital is an owner’s personal investment in his business which could be lost if the business is a failure. There is no fixed ringgit amount or percentage that the owner must be vested in his own company before he is eligible for a business loan.

However, most banks want to see at least 25% of a company’s funding coming from the owner before they apply a loan. Nevertheless, in the past 10 years, banks are willing to take more risk where margin of financing goes up to 95% of the total project cost. And lately, a bank is willingly to finance 100% of the asset cost. From risk management side point of view, banks who are ready to finance 100% of the project cost are considered ‘risky banks’ and to the shareholders too, indirectly.

3. Collateral

Lands, landed properties, machinery, shares and other assets that can be sold if a borrower fails to repay the loan are considered collateral. Collateral always is an issue between a bank and a borrower, especially to the first time customer.

4. Condition

Conditions refer to overall evaluation on the proposed business or project. Analysis includes business objectives and purpose of the loan. We need to analyse that the loan can help the business to grow and not a burden to the borrower. Other conditions that we should consider are marketing, technical aspects of the project, economic and overall business conditions such as laws and regulations. These information you get from customers when they apply for a loan.

As a banker, you should not have a problem to get these information as customers will provide you all documents before a bank approves a loan.

5. Character

Basically it is an evaluation of business owner’s personal history and his background. For a company, it is the history of the owners, the boards and the key management. As a banker, character is the most important C compares to other Cs. The reason is simple: a man make things done or happened no the others. He is a mastermind to make a project succesfull and pays the bank money! Do you agree?

Banks have to believe that a business owner is a reliable individual who can be depended on to repay the loan. Background information such as credit history, education, work experience are the factors in credit analysis.  These information you get from customers when they apply a loan and it is normally a part of the bank’s loan presedures.