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MBA – PM0012 : what is credit risk appraisal? Explain the 5C’s of credit analysis.

Posted on: March 2, 2012

MBA – PM0012 :  what is credit risk appraisal? Explain the 5C’s of credit analysis.

Answer: – credit risk appraisal:-

Credit Appraisal is a process to determine the risks associated with the extension of the credit facility. It is generally carried out by the financial institutions which are involved in providing financial funding to its customers. Credit risk is a risk associated to non repayment of the credit acquired by the customer of a bank. Thus it is necessary to evaluate the credibility of the customer in order to mitigate the credit risk. Proper evaluation of the customer is performed and this measures the financial condition and the ability of the customer to repay back the loan in future. Generally the credits facilities are extended against the security know as collateral. But even though the collaterals return back the loans, banks are normally interested in the actual loan amount to be repaid along with the interest. Thus, the customer’s cash flows are ascertained to ensure the timely payment of the principal and the interest.

5C’s of credit analysis:- Capacity to repay is the most critical of the five factors, it is the primary source of repayment – cash. The prospective lender will want to know exactly how you intend to repay the loan. The lender will consider the cash flow from the business, the timing of the repayment, and the probability of successful repayment of the loan. Payment history on existing credit relationships – personal or commercial- is considered an indicator of future payment performance. Potential lenders also will want to know about other possible sources of repayment.

Capital is the money you personally have invested in the business and is an indication of how much you have at risk should the business fail. Interested lenders and investors will expect you to have contributed from your own assets and to have undertaken personal financial risk to establish the business before asking them to commit any funding.

Collateral, or guarantees, are additional forms of security you can provide the lender. Giving a lender collateral means that you pledge an asset you own, such as your home, to the lender with the agreement that it will be the repayment source in case you can’t repay the loan. A guarantee, on the other hand, is just that – someone else signs a guarantee document promising to repay the loan if you can’t. Some lenders may require such a guarantee in addition to collateral as security for a loan.

Conditions describe the intended purpose of the loan. Will the money be used for working capital, additional equipment or inventory? The lender will also consider local economic conditions and the overall climate, both within your industry and in other industries that could affect your business.

Character is the general impression you make on the prospective lender or investor. The lender will form a subjective opinion as to whether or not you are sufficiently trustworthy to repay the loan or generate a return on funds invested in your company. Your educational background and experience in business and in your industry will be considered. The quality of your references and the background and experience levels of your employees will also be reviewed.


1 Response to "MBA – PM0012 : what is credit risk appraisal? Explain the 5C’s of credit analysis."

Very much helpful in preparing assignment for time starved person like my self, Great job Thanks

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