WBB 3023 LENDING MANAGEMENT

TOPIC 1: INTRODUCTION BASIC CONCEPT OF LENDING

CONCEPT OF LENDING
Definition of lending: is the giving of an asset with the expectation that an equivalent value will be returned at a future point in time (Nirmala Lee,2008) Loan become an asset to the lender while it is a liability to the borrower Loan is sold to borrower at a price called interest; computed based on costs and risks of lending.

CONCEPT OF LENDING
BORROWER TO REPAY THE INTEREST AND PRINCIPAL (LOAN AMOUNT) AT A FUTURE POINT IN TIME Lending involves the creation of credit When a credit/loan is given, the lender becomes a creditor while the borrower become a debtor

Concept of Lending
A primary business function of bank is lending Loans and advances constitute 70% to 80% of a banks assets which provide the major sources of earnings and profits Lending is a risky business. No guarantee that a borrower will repay. Thus, losses on loans can quickly erode the bank net worth and encroach on its ability to meet depositors demand for funds

Concept of Lending
Due to the general rule of risk return function, a loan officer must take into consideration all risks associated with the loan and apply the principles of good lending. A loan portfolio refers to the diversified loan base of financial institutions. A portfolio that is well spread with good loan products and industry mix will minimise risks.

Credit Vs Lending
Material
Raw material supplier Goods Inventory Final Goods

Manufacturer

Distributors

Retail outlet

Consumer

BUSINESS CREDIT

CONSUMER CREDIT

Credit Vs Lending
Business credit business credit describes the credit relationships involved in purchasing good for resale, or obtaining funds to operate, using credit as the medium of exchange. Consumer credit Consumer credit is the use of credit as a medium of exchange for the purchase of finished goods and services by the ultimate users.

Direct vs Indirect Lending

The financial system offers two different ways to lend: (1) direct lending through financial markets, and (2) indirect lending through financial intermediaries, such as banks, finance companies, and mutual funds.

Direct Lending
Direct lending is best defined as the transfer of funds without any change of ownership of the funds during the process. In other words, the owner of the funds transfer those funds directly to those who required them. Example of bank lending to other financial institutions in money market.

Indirect Lending
Funds are gathered from a large number of sources and pooled together for lending. The relationship is different from that of direct finance. A bank is a classics example. It collects surplus funds from a large number of sources (the depositors). The bank then lends the depositors funds to creditworthy organizations or persons.

Indirect lending is lending by the ultimate lender to a financial intermediary who pools the funds of many lenders in order to re-lend at a markup over the cost of the funds. The ultimate borrowers are normally unknown to the ultimate lenders. A lender faces less risk in indirect lending because, as a specialist in the field, the intermediary normally has a well-established credit standing. Of course, lower risk usually means less gain for the lender.

Comparison of Risks
The two types of lenders face different problems with borrowers in financial difficulty. With direct lending, rescheduling a loan is problematic because the relationship is generally at arms length and legalistic. The risks are often unknown to the lender. With indirect lending, the intermediary is usually in a much better position to know whether the problem is permanent or temporary. As the sole lender, the intermediary can alter the terms without having to obtain the agreement of others.

Sources of finance and its uses

In examining bank lending in relation to another sources of finance, we will consider the extend to which bank lending is used compared to other sources of commercial finance and how these sources are generally utilised by commercial borrowers. In finance theory it is convention to categorize sources of finance into long term, medium term and short term. The needs of business differ over these time horizons and the nature of the funding to support the business activity will also differ in character.

Sources of finance and its uses

Another important source of funding is funds retained in the business, which have been derived from operating profits. Although, the exact proportion of each type of finance used is not known, some information is available relating to banks.

Interest Vs Profit
Interest Income Interest and fees generated from loans account for most bank revenues (normally 2/3 or more of the total) as well as most of the revenues received by savings and loan associations. The relative income items fluctuates from year to year with shifts in interest rate and loan demand, though loan income is nearly always the dominant revenue source.

Interest Vs Profit
Interest expenses The number one expense item for a bank normally is interest on deposits. Interest on deposits accounted almost 60% of banks total interest costs.

Interest Vs Profit
Net interest income (NIM) Total interest expenses are subtracted from total interest income to yield net interest income (NIM). This important item is often referred to as the interest margin (profit). It is usually a key determinant of profitability.