Business — Banking — Management — Marketing & Sales

1. Legal and regulatory framework

Western civil and trade laws require every corporation to exercise proper care in their business transactions. Banks are regulated in more specific and detailed ways because they operate with other people’s money. In contrast to most non-banking business operations, most of the funding that banks provide belongs to third parties, which are mainly individual members of the public. A large amount of every western country’s citizens wealth rests with banks in the form of bank deposits. This requires governments to set particular regulatory standards for banking. So, European banking laws regulate the gearing or leverage ratio that measures the extent to which a bank’s funding is provided by third parties (that is, deposits) and by shareholders. Banks are allowed to lend only 12.5 times their equity. Credit decisions have to be signed by two authorized bank officers. A proper documentation of all credit transactions must be maintained. In Germany, one of the most important regulations is § 18 KWG (Banking Act): Banks must take special care to be informed about their credit clients financial situation. They comply with this law by reviewing and thoroughly analyzing their corporate clients annual financial statements.

Every banker involved in the credit decision is therefore expected to:

—          exercise proper care in following the legal rules at every point

—          understand, assess and monitor the risks involved in the transactions undertaken with his clients

—          ensure that adequate internal policies, guidelines and procedures are in place

—          oversee the performance of his credit portfolio

—          delegate responsibility  and monitor its competent management.

2. Factors influencing the bank‘s lending decision

A study conducted by the University of Frankfurt, Germany, has shown the relevant factors that play a part in forming a lending decision. Bankers still rely heavily on analyzing the annual financial statements of a corporation. With 31 %, this was the most influential factor on credit decisions. Although lending decisions ought not to be based solely on the annual financial statements but ought to include further information, no credit decision must ever be made without looking at the borrower’s financial statements. Banks follow this rule: further information about markets, the client’s customers and suppliers, its other borrowers and creditors and so on account for 16 % in the lending decision making process. Next comes collateral with 15 %. Management quality contributes only 11 % to the credit decision. Its importance should increase, however, since management failure has proved to be the key reason for corporate bankruptcies. Astonishingly, financial planning and industry sector analysis are considered less important factors with only 8 % each. Sophisticated tools like account data analysis seem to be almost unknown (3%), although both, experience and scientific tests, have shown that an impending business crisis is foreshadowed in the development of a company’s bank account.

3. Elements of a credit reports

An impressive number of factors and considerations are reflected in a thorough credit decision. The lending officers making such decisions must write down a memo in their credit files showing which factors have influenced their decision. This credit report must contain at least the following information:

—          Name of the corporate client

—          A «SWOT»-Analysis of its business and industry sector

—          The annual reports at least the last 3 years

—          An in-depth analysis and appraisal of the annual reports

—          The business plan / outlook for the next year(s)

—          The members of its management team

—          The financing provided to the client

—          Collateral

The bank’s lending officers have to meticulously evaluate the creditworthiness of each corporate borrower in order to safeguard the bank’s assets and to comply with the legal regulations. This evaluation is to answer two crucial questions:

— Does the borrowing company have the ability to regularly pay interest and repay principal as agreed in the loan contract?

— Would the collateral be sufficient to make up for the losses in case of the borrowers insolvency?