Credit Planning and Term Loan.

Credit Planning and Term Loan's Substance

Credit planning is to set out procedures for defining and measuring the credit-risk exposure within the Group and to assess the risk of losses associated with credit extended to customers, financial investments and counter party risks with respect to derivative instruments. Term loan refers to asset based loan payable in a fixed number of equal installments over the term of the loan, usually for 1 to 5 years.

Credit Planning

A credit planning is to set out procedures for defining and measuring the credit-risk exposure within the Group and to assess the risk of losses associated with credit extended to customers, financial investments and counter party risks with respect to derivative instruments. The main aspects of a credit planning are- 

1) the terms and conditions on credit, 

2) customer qualification criteria, 

3) procedure for making collections, and 

4) steps to be taken in case of customer delinquency.

Important Factors / Components are to be taken in consideration by a bank in formulating a credit planning or lending operational policy of a bank.

An effective Credit planning should include the following considerations:

 Objectives of the credit function

 Opening procedures and obtaining information for new accounts

 Assessing & evaluating the proposals

 Terms and conditions

 Authority levels and responsibilities

 Invoicing procedures

 Monitoring borrowing and paying behavior of customer

 Procedure relating to complaints and disputes

 Targets, benchmarks, and deadlines for the credit function

 Defining & collecting of dues, overdue and bad debts

The credit planning should be considered by internal and external factors and should be reviewed on an ongoing process. These are:

 Customer’s buying patterns, needs and requests

 Type of industry

 Competitors’ offers

 Type of products or services provided to customers

 Production and warehouse management

 Distribution systems

 Credit terms from trade suppliers and the bank’s overdraft limits

 Costs of third parties involved, such as factoring, debt collection agencies, etc

.

The components that should consider when formulating a lending policy that should influence to extend credit are discussed below:

A. Terms of Sale

The conditions under which a firm sells its goods & services-

1. The period for which credit is granted: The factors that influence the credit period are

a) Predictability

b) Consumer Demand

c) Cost, profitability and standardization

d) Credit risk

e) Size of the account

f) Completion

2. The type of credit instrument

3. Credit Function

a) Running a credit department

b) Chose to contract all or part of credit to a factor

c) Manage internal credit operations are insured against default

B. Credit analysis

Refers to the process of deciding, it usually involves two steps:

1. Relevant information

a) financial statements

b) credit agency

c) banks credit

d) market good will

2. Credit Worthiness

a) Character

b) Capacity

c) Capital

d) Collateral

3. Credit scoring: 

The process of quantifying the probability of default when granting consumer credit

C. Collection Policy

Collection policy is the final factor in credit policy. Collection policy involves monitory receivables to spot trouble and obtaining payment on past due accounts.

List down the minimum eligibility criteria to be fulfilled by borrower to obtain loan

1. Credit-worthiness: 

These will be treated on behalf of applicant’s credit history, capacity to repay, collateral value as eligibility criteria.

2. Business and Credit history: 

The eligibility may be judged by business track records and also qualifying for the different types of credit history like type of credit facility, credit limit, repayment records, etc.

3. Working capital: 

The present working capital may be considered that can be thought of as cash at hand and bank.

4. Collateral:

Collateral securities which are assets will be evaluated as secured assets and pledge or hypothecation of inventory.

5. Keen money management skills: 

This includes a solid cash flow, the ability to live, and skills of keeping accurate and timely financial records.

6. Earning power: 

The earnings of borrower to be given out as loan are some of the determining factors in granting the loans.

7. Ability to repay: 

The borrower should have to ability to repay the loans from his business and personal income. 

8. Experience and character: 

The borrower should have experience in business to run that should have business skills and managerial experience.

Term Loan Definition

Term loan refers to asset based loan payable in a fixed number of equal installments over the term of the loan, usually for 1 to 5 years. Term loans are generally provided as working capital for acquiring income producing assets like machinery, equipment, inventory that generate the cash flows for repayment of the loan. Banks have term-loan programs that can offer small businesses the cash they need to operate from month to month.

Why the private commercial banks discourage to consider long term loans

Most of the time the private commercial banks discourage to finance the long term loans due to some relative risky and problems. These are:

1) Lower Rates: 

Long-term loan normally have lower interest rates than short-term credits.

2) Slow Cash Inflow: 

A long-term debt obligation also prevents the faster cash inflow.

3) Risk Involvement: 

Generally, the level of the interest rate is depends upon the risk involved with making the loan. In case of default, long-term loan includes a greater span of time.

4) Credit turn-over loss: 

The long-term loan will be paid over a loan period. So the lender get recovered the amount by a long period as the lender has missed the rapid credit turn over. 

5) Long term debt is often costly to service.

6) The cost of capital is higher in case of long term debt.

Distinguish between Term credit and Short-term credit.

SL	Description	Term Credit	Short Term Credit
1.	Definition	A form of finance that have a small, mid or long repayment  schedule.	A form of finance that have a short repayment schedule.
2.	Maturity period	1 to 5 years, in some cases it may be 20 years.	1 or less than 1 year.
3.	Competitive  interest rate	Competitively high rate.	Competitively marginal or low rate.
4.	Lending complexity	Some complex to lending except.	short-term lending Easy to lending.
5.	Profitability	Marginal profit.	High margin of profit
6.	Risk	Marginal or high risk.	Low risk.
7.	Loan limit	Loan limit is more.	Small Loan limit.

Advantages of Short-Term Financing. or, Why do the private commercial banks prefer short term lending.

There are various advantages of short term financing and this is why private commercial banks prefer short term lending. Those advantages of short term financing are given below with detail -

1. Easier to provide:

Banks can provide short–term credit more easily within the minimum functionality than long-term credit.

2. Higher interest: 

Banks may impose the higher interest rate due to small amount of credit with the minimum or security less financing.

3. Rapid turn-over of capital: 

The capital investment is turning over rapidly and it make chance to further investment.

4. Minimum cost of capital: 

Whether, the short-term credit makes the rapid turn-over of capital investment, thus it may reduce the cost of capital.

5. Minimum risks: 

Due to minimum time frame, the repayment of loan may cover in earlier. Thus, the risk is lesser than the long term credit.

6. Easy control over the customers: 

Banks can overlook more easily to the short-term borrowing customers than the long-term borrower. 

7. Flexibility to lend: 

It is more flexible in the sense that the banks lends as the borrowers are needed and repay then in due time.

8. Minimum complexity: 

The maintenance and supports of further credit procedures is simple than long-term finance.

9. Fund availability: 

In many cases, commercial banks prefer to maximize the fund availability particularly small enterprises.