Demographic & Psychographic variables pertaining to the customer seeking a personal loan would be different. Many times documents collected or submitted to banks are only for the sake of RBI compliance, than assessment or thorough review and several instances, banks are more interested in achieving targets than having a quality portfolio.
Potential to repay the loan cannot be determined only by present/ historical income, the existing traditional appraisal model practiced by banks is not plugged with the new more robust method. The practice of robust loan processing and credit appraisal will assist in the long term quality portfolio of loans and reduce the bad loans.
It is extremely important in analyzing one’s credit worthiness before providing the same to banks/financial institutions. In order to assess the repaying capacity, various financial institutions follow different techniques. From the lender’s perspective, there are majorly 6 steps involved in loan processing which includes: prospecting, pre-approval and documentation, loan processing, underwriting/credit appraisal, disbursal and post disbursal evaluation.
Credit appraisal is an assessment of the various risks associated with repayment of the loan and analysis of credit worthiness of prospective customers.
A personal loan is a form of debt given to an individual by the banks or financial institutions without security or collateral by the borrower for the purpose of personal needs, such as durable goods, education, medical care, marriage and other expenses.
It is important from the borrower perspective of banks or financial institutions to analysis the loan proposal. The borrower believed that banker does not understand his/her credit requirements. From the banker’s perspective, the banker may have a bad experience with similar type of borrowers who defaulted and would follow more stringent lending policy. It is most critical to mitigate risk by the banker, to lend the loan to the right customer through proper assessment or appraisal of the proposed loan.
- Who is the customer?
- How much amount they need and when?
- How will the loan amount will be utilized and what specific purpose?
- How will the borrower service the debt obligation?
- What protection can the borrower provide the bank in the event of him/her unable to meet the agreed obligation?
- What is the key metrics and how well are they measured, monitored and comprehend?
5 C’S OF CREDIT:
5 c’s are basic components of credit appraisal or assessment. It is a method used by a lender to determine the credit worthiness of the potential borrower in order to mitigate the risk of default.
Capacity: Capacity to repay is the most critical of all 5 factors, it is the primary sources of repayment of the loan. Banker or financial institutions will estimate the borrowing capacity by considering the cash flow of applicant, timing of repayment and the probability of successful repayment of the loan. By evaluating the existing credit relationships- personal or commercial is considered an indicator of future payment performance. Other sources of income are also providing the capacity to serve the loan.
Capital: Capital is the money borrower personally invested in his/her intended personal expenses and is an indication of how much banks or financial institution at risk. The lender always expected the prospective borrower to have contributed from own asset and to have undertaken personal financial risk which depicts the seriousness in repaying the loans.
Collateral or guarantee: Although the personal loan is an unsecured loan, collateral or other personal guarantee or providing postdated cheque become collateral for lending banks or financial institution. This gives comfort to the lender in case of non-repayment and can be considered as another source of repayment.
Character: General impression by lending banks/financial institution on the prospective customer. The lender will form a selective opinion as to whether or not a borrower is trustworthy to repay the loan or intention of repayment. Education qualification, background, quality of references, banking habits, and residential status provides a view on the character. Access to social media to get an insight of career progression, experience. Sentimental insight to analyze characters.
Common sense: By analyzing the 4 major criteria along with hybrid analysis, the lender will provide the basis for making a decision.
Prospecting: Prospecting is identifying the right customer/borrower who is in need of a loan is the first phase of the loan process.
Pre-approval and documentation: Sales team will be assessing the applicant details, to check whether it is meeting the basic requirements and he/she is eligible for a loan. Documentation includes loan applications, KYC documents, income documents, employment documents, residential details and other supporting documents as per the lender’s requirements.
Loan processing: In processing stage, the applicant details will be confirmed, the risk team will be checking the authenticity of documents submitted, residential, employment and reference verification will be completed. Credit report CIBIL request to check credit history, internal and external verification will be completed before sending the file for credit appraisal.
Credit appraisal: Loan officer/credit officer will evaluate the applicant documents based on 5C’s on credit and render a decision of approval or rejection with valid reason.
Disbursal: Once the loan is approved by credit officer, the operations teams prepares the final documents and this document goes through the verification process. Then the loan amount on agreed basis is disbursed to the customer.
Post disbursal evaluation: Auditing and post disbursal evaluation will be conducted through the centralized system to verify all the systems, process, documentation and other policy related aspects are covered under each stage of loan processing.
The root cause of non-performing asset in India is non-adherence to credit system, especially unsecured personal loan. It is extremely important to follow stringent credit processing and credit appraisal system which assist in risk mitigation and reduction in non-performing assets. 5 C’s – capacity, capital, character, collateral and common sense will assist in determining the credit worthiness of a prospective borrower. 6 major loan processing methods are critical to the success of banks/financial institutions in maximizing their return on investment.