Plan of Action on Track to Restore Credit Scenario; 5 Cs of Loan Lending

The credit crunch caused by coronavirus pandemic has created widespread havoc, with credit crunch, tumbling equity markets, panic sell-off and travel bans. Central Banks across the world are trying to support their economies with rate cuts and open market operations, supported by fiscal and health packages.

Analysts are anticipating a wave of corporate bankruptcies with soaring funding costs on foreign money markets, crumbling travel/leisure sector, disturbed energy sector amidst oil price war. Companies are exposed to profitability/revenue risks amidst demand crunch, supply chain disruption and debtors’ default with inability to refinance existing debt.

Efforts On Track To Support Credit Availability

In its attempt to boost liquidity and ease funding availability and affordability, RBA slashed cash rate to 0.25%.

The RBA, in its first intervention in the government bond market today, successfully purchased $5 billion of government bonds (maturities 2-8 years), intending to lower the three-year government bond rate towards targeted 0.25 % and restore order to disruptive fixed income markets.

With the aim to lower funding costs for the banking system on the whole to mitigate credit costs for businesses and households, a $90 billion term funding facility has been extended to banks.

According to RBA, the robust financial system seems to be well positioned to offer the required assistance to households and businesses. As per APRA, the current huge capital buffers and liquidity will be supporting business lending.

Besides, as per Australian Banking Association, small businesses can utilize six months loan payments deferral amidst Covid credit crunch scenario. The package will be benefitting more than ~100 billion of existing business loans of small businesses.

In this context, businesses may look at below 5 Cs of Business Lending, banks and private lenders are expected to follow even more strictly in current market turmoil.

Casting Eye on 5Cs of Business Lending

Although a "C" might sound below average on an academic scale, the foundation of getting funds for your business from banks and other financial institutions is to be a master of the five C's of credit.

Although each lender employs its own methodology to access soundness and creditworthiness of the borrowers, most financial players put heavy weight on a borrower's capacity.

Capacity

Capacity refers to the willingness of the company to take on extra debt. This is calculated by looking at company's various financial metrics, cash flow statements and cash flow projections. The bank takes a decision basis whether the company has the potential to perform beyond its capacity to fulfill all of its debt obligations both financially and operationally.

The repayment potential is the most important of the five variables. The prospective lender would want to know your plans and ability of repaying the loan. Your current Debt- Equity ratio also depicts your ability to fulfil your debt obligations.

In the current market volatility, lenders would be closing looking at the cash flow of the company along with other factors like the repayment timing and the probability of the loan being repaid successfully.

Conditions

You might require additional funds for working capital, asset acquisition or project expansion. So the conditions for which you require liquidity support along with the current economic conditions do impact the loan extending capacity of the lender.

The current monetary policy stance to ingest greater liquidity in the system and reduce borrowing costs is bound to play a crucial role in the coming days.

Character

The term character in this context refers to the clean credit history of the company, quality of its management and the creditors who guarantee the loan. This category is very subjective in nature and depends on the risk-taking capacity and goals of the lender.

Lenders consider your reputation, honesty and integrity from the references as these qualities are factors in your ability to perform your duties.

Apart from looking at credit report and credit scores, lenders would be looking at your personal character to decide whether you have the intention, financial strength, robust loan repayment history and attributes that will help you to pay back the loan.

Capital

Capital is the money that you have directly invested in the company. In simple terms it is an indicator of how much you are at risk if your business fails. Interested lenders and investors would expect you to have invested from your own funds and taken personal financial risk to set up the company, given them additional incentive to not default.

Lenders would look at how much the owner’s money in invested and for what all purposes the capital is utilized.

Collateral

By allowing you to secure the loan with collateral, lenders protect themselves against future losses. When you borrow money, in case of a default, you will be forced to grant the lender the right to take specific business properties.

Lenders are expected to measure collateral qualitatively by its perceived ease of liquidation and quantitatively by its value.

Bottomline

Amidst current volatile credit market, households and businesses must keep faith on RBA’s QE initiatives, Morrison Government’s fiscal package, banks extending rate cuts and payment deferral plans to borrowers, while some lenders like American Express, Capital One and Apple card are offering assistance to people in terms of increasing credit line and not charging interest for skipping a month’s payment.


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