The Procedure of Lending Money
In order to execute a loan, a bank must have funds to lend. This comes from paid-in capital, retained earnings of previous years, borrowed funds, and the largest, most important, resource – the bank’s customers’ deposits. The banker must always remember that the money he lends is not his bank’s own money. It is money deposited by the bank’s customers, whether in a demand or time account.
To evaluate the risk, the domestic or international banker must first obtain certain basic information that usually is forthcoming in a meeting with the potential borrower. The banker must learn how much money is being sought, the purpose of the loan, how long it is needed for, and how it will be repaid.
Each part of this information must bear a reasonable relationship to the other parts. For example, a businessman seeking credit to finance the importation of coffee should need financing for only ninety days, the normal period of time for the shipment to arrive, undergo processing, and be sold to a coffee company. It would be unreasonable for him to seek a five-year loan when he expects to sell within three months. On the other hand, it would be impractical for a businessman to borrow money to construct a new manufacturing plant and expect to repay the loan in six months.
Banks make loans only for worthwhile purposes: financing trade, expanding business, and so on. Once the banker has obtained the desired information from the applicant, he considers the risk involved. This means evaluating the three C’s of credit: character, capacity, and capital – the integrity of the borrower, his ability to repay, and the soundness of his financial position.
A potential borrower’s credit-worthiness is determined by previous loans and by his standing with credit rating bureaus or other banks. In the United States, as well as elsewhere, banks exchange credit information with each other.
The loan applicant’s ability to repay the loan depends to some degree on the purpose of the loan. If the source of repayment is from the sale of imported merchandise, the transaction is said to be self-liquidating. If the loan is for plant expansion, usually called capital expansion, the source of repayment is the income from increased sales.
Capital, the financial position of the borrower, is determined by examining the borrower’s financial statement. This usually consists of a detailed balance sheet and a profit and loss statement. The bank credit officer requests a company seeking credit to provide audited financial statements covering the previous three years.
The international credit officer must consider the economic and political outlook of the foreign country before loaning money to a foreign borrower. This, of course, involves an evaluation of the country’s balance-of-payments outlook. The credit officer then decides whether the bank will extend credit to the borrower. If the decision is negative, the credit applicant is entitled to a prompt acknowledgment by the bank so that he may either seek alternate financing or defer the proposed business transaction.
If a bank decides to make the loan, then the credit officer must first select an interest rate, which is the price for renting the money to the borrower. In computing the interest rate, the banker must consider the cost of the money to his bank. This includes the average interest rate his bank is paying its depositors, the bank’s operating costs, and the normal return that the bank expects. The bank must be able to cover possible loan losses and provide dividends to the bank’s shareholders.
The credit officer must charge amounts to compensate for risks greater than those assumed to prime-rate borrowers. The prime rate assumes a short-term loan. If the loan is a term loan, the risk is greater and must be compensated for in a higher interest rate. A bank usually considers the maximum term to be five years for normal commercial loans, although there has been competitive international pressure to extend this to as long as ten years.
If the borrower is foreign, the country risk may be greater than making a loan to a domestic borrower, and therefore the credit officer expects extra interest.
The credit officer must determine the most appropriate credit instrument to use. A promissory note is most customary. Generally, the bank wants partial payments at least semi-annually, but a promissory note can also be payable "on demand", rather than a certain period after the date of the note. "On demand" means that the note will have to be paid at such time when the bank demands this. Banker’s acceptances can be used for only certain types of transactions, involving international trade, United States domestic trade, and the storage of commodities. The maximum loan period is 270 days.
Another means of extending credit may involve advances, the discounting of accounts receivable, overdrafts (not usually done in the United States), or advances against collections. The credit officer must also decide whether to make an unsecured loan or a secured loan (secured by collateral assigned to the bank, such as securities or precious metals), or whether the unsecured loan should be guaranteed.
The banker makes an offer to the customer, who may or may not agree to all of the terms and conditions. After the bank and the borrower reach an agreement, the banker arranges for the borrower to sign the necessary documents and then disburses the funds to him.
For large loans, banks often form a syndicate, a device whereby one or more major banks form a consortium of banks, each of which disburses a portion of the loan. Often, one bank puts the deal together and carries the administrative burden during the life of the loan. This is the "lead bank". A syndicate may be desirable because of legal lending limits on banks, the general relationship of the total demand for credit compared to the supply of loanable funds, or the prudent banker’s desire to spread the risk.
Assignments
I. Answer the questions.
1. Where do bank’s lendable funds come from?
2. What are the three C’s of credit?
3. What is a potential borrower’s credit-worthiness determined by?
4. What does the loan applicant’s ability to repay the loan depend on?
5. What does a bank usually consider to be the maximum term for normal commercial loans?
6. What is the "lead bank"?
7. Why is a syndicate desirable for large loans?
II. Translate the following sentences into Ukrainian. Put questions to any two of them.
1. In order to execute a loan, a bank must have funds to lend.
2. Banks make loans only for worthwhile purposes: financing trade, expanding business, and so on.
3. Capital, the financial position of the borrower, is determined by examining the borrower’s financial statement.
4. This usually consists of a detailed balance sheet and a profit and loss statement.
5. The bank credit officer requests a company seeking credit to provide audited financial statements covering the previous three years.
III. Translate the following sentences into English.
1. Банкір завжди має пам’ятати, що гроші, які він надає у позику, не є власними грошима його банку.
2. Здатність того, хто звертається по позику, виплатити її залежить певною мірою від мети позики.
3. Перш за все слід вивчити економічні та політичні перспективи іноземної країни перед тим, як надати позику іноземному позичальнику.
4. Якщо банк вирішує надати позику, перш за все слід обрати відсоткову ставку, що є ціною за одержання грошей позичальником.
IV. Name the following definitions.
1. A type of lending whereby individual disbursements are not evidenced by notes, but by a master agreement.
2. A company’s financial condition on a stated date as viewed by independent auditors.
3. The part of a company’s overall statement that lists what the company owns and owes.
4. Money transferred to a person or company in return for a signed promise to return the money, with interest, by a stated future date.
5. The negative balance in a checking account that occurs when a bank pays checks for an amount greater than that which the customer has in the account.
6. The amount of money actually contributed to a company by its owners for the company’s use.
7. A loan not supported by collateral.
(Keys: unsecured loan, overdraft, paid-in capital, profit and loss statement, collateral, audited financial statement, loan)
V. Make a scheme to the procedure of lending money by the bank.
VI. Find in the text and translate all sentences with Infinitives; define functions of the Infinitives (a subject, attribute, object, adverbial modifier, part of a predicate).
VII. Make sentences with the Complex Subject / Complex Object basing on the text.
VIII. Sum up what the text says about commercial bank lending.
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