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USAID – Workshop on agricultural sector financing

USAID – Workshop on agricultural sector financing. THE 5Cs OF A GOOD LOAN Workshop on July 22 and 23, 2011. PRELIMINARIES. Being an analyst requires the following different roles: Diplomat Detective Salesman Accountant Negotiator Area specialist. BASIC RULES.

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USAID – Workshop on agricultural sector financing

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  1. USAID – Workshop on agricultural sector financing THE 5Cs OF A GOOD LOAN Workshop on July 22 and 23, 2011

  2. PRELIMINARIES Being an analyst requires the following different roles: • Diplomat • Detective • Salesman • Accountant • Negotiator • Area specialist

  3. BASIC RULES • A borrower is always optimistic • The credit analyst must defend the Bank, but not the borrower • Verify, verify, always verify...

  4. THE SCIENCE vs. THE ART The science consists in: • Considering the facts • Analyzing the information in order to know the “real story” • Preparing the financial analysis The art consists in: • Issuing credit judgments based on incomplete data • Understanding the borrower’s motivations • Building trust IN ALL CASES, WE REPRESENT THE BANK, NOT THE BORROWER

  5. WHAT IS THE MAIN RISK IN TERMS OF GRANTING CREDIT? • The main risk is that the borrower is not able to repay and that its guarantees do not fully cover the unpaid amounts • However, it is interesting to take the risk if you think that it is profitable for your bank and your analysis concludes that it is a good opportunity to build a partnership with the client • Before making the decision, be sure not to have forgotten to analyze all the aspects. Use a checklist called FIVE Cs

  6. WHICH BUSINESS PRESENTS THE MOST RISKS? Printing shop • invests in printers • already in operation for 5 years • creates high-quality graphic presentations for advertising companies, etc. in Kinshasa Water-bottling plant • invests in bottling equipment • operational for 2 years • sells nationwide Tailor • invests in 4 sewing machines • in activity for 3 months • Lubumbashi local market

  7. THE 5Cs The 2 main Cs: • Character - the person and the family • Capacity/Cash-flow - technical, economic and financial feasibility and past history of the activity The 3 secondary Cs: • Capital - funds invested in the business plan • Collateral/Guarantees • Conditions - the loan terms (amount, rate, repayment terms)

  8. MEANING OF THE 5 Cs • CHARACTER: does the borrower WANT to repay? • CAPACITY: CAN the borrower repay? • “COLLATERAL” or GUARANTEE: are there SUFFICIENT secondary repayment sources? • CAPITAL: up to what level does the borrower PARTICIPATE in the risk of the business • CONDITIONS: what is the company’s ENVIRONMENT?

  9. CHARACTER • Honesty and integrity • Family situation • Skills for managing an economic activity • Family assets (net worth) • Reputation in the community • Openness and conformity with the market and the community • Ability and habit of repaying previous credits

  10. QUESTIONS ABOUT CHARACTER Evaluation of the moral and financial responsibility of the individual requesting a loan may be made by considering questions such as: • Are the individual and his family worthy of trust - demonstration of trust, but also honesty, responsibility and work habits? • How did the individual and his family arrive at their current economic situation? • How did he resolve difficult situations in the past? • What do the people and the leaders around him say about him/them? • What do the suppliers and the buyers say about him/them? • How do (does) his (their) habitual style of life and his (their) habitual expenses compare with his (their) income level? • How are the family relationships and family considerations that might affect the activity and the loan?

  11. CAPACITY • What does the business plan indicate about the revenue generation and the profitability of the industrial and commercial activity? • Can the individual/business produce enough money to honor the loan repayments with interest, including a safety margin? • When will the loan be repaid? • What are the family needs? • What are the consequences of seasonal fluctuations and production variations? • How does the entrepreneur/farmer fare compared with others in the same sector or the same activity? • Is there a successor?

  12. MANAGERIAL CAPACITY Management questions include: • How does he manage his business, farm or structure compared with others? • How does he manage his money and his expenses? • How have their assets/net worth increased or decreased over time and trends? • How do they manage, do they have relationships with people?

  13. HUMAN AND WORK CAPACITY • What are the age and the health of the person in question? • How does the family cooperate? • How does the individual cooperate with other farmers in the community? • Is labor available when necessary? • How does work capacity influence the economic feasibility of the activity? (This is particularly important when a specific competence or person is required)

  14. TECHNICAL CAPACITY Technical capacity is closely connected with the analysis of feasibility and must be analyzed with other parameters: • Equipment • Services/maintenance • Externalization • Land • Storage • …

  15. LOAN HISTORY Has the client had loans in the past? • How were they repaid? • How were they managed? • Were they late in repayment and, if so, what were the reasons? • What is the evaluation of their previous credit managers? Does the client have savings? • What is the level of savings compared with the loan? • What is the savings history?

  16. CAPITAL • How are the assets invested in the business (activity)? • What is their value? • What is the quality of the assets (are they well maintained)? • What are the family contributions to the business (activity)?

  17. COLLATERAL The secondary sources for repayment of the loan: • Are they personal guarantees from trustworthy individuals? • Are the business’ assets and the personal guarantees enough to cover the repayment of the loan if necessary? But PLEASE NOTE – the guarantee is not a primary source of repayment

  18. CONDITIONS • Is there an adequate and stable market to support the business? • Are the terms of the loan (duration, interest rate, etc.) well defined in relation to the capacity for repayment? • What are the price and production risks? • What are the general trends of the sector market? • Additional risks such as illness, etc.

  19. CONCLUSION The 5Cs = 5 factors for analyzing the loan risk • “The art” is much more than knowing how to calculate! It’s the sense of smell, the intuition and the emotional intelligence! • Proper risk management depends on knowing what, when and how to apply the analysis indicators and also how to analyze the borrower’s social and personal factors.

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