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BANK LOANS

BANK LOANS. 6. 6.1 Consumer Loan Theory 6.2 Consumer Loans 6.3 Granting and Analyzing Credit 6.4 Cost of Credit 6 .5 Bank Loans and Policy. 6.1 CONSUMER LOAN THEORY. GOALS. Explain asset transformation and modern portfolio theory. Describe components of consumer lending.

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BANK LOANS

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  1. BANK LOANS 6 6.1 Consumer Loan Theory 6.2Consumer Loans 6.3Granting and Analyzing Credit 6.4Cost of Credit 6.5Bank Loans and Policy

  2. 6.1CONSUMER LOAN THEORY GOALS Explain asset transformation and modern portfolio theory. Describe components of consumer lending. Explain nonloan sources of bank revenue.

  3. TERMS • Asset transformation • Modern portfolio theory (MPT) • Adverse selection • Captive borrower • Moral hazard • Credit rationing

  4. MANAGING A BANK’S PORTFOLIO • Loan categories include • Consumer loans • Mortgage loans • Commercial loans

  5. ASSET MANAGEMENT • Asset transformation • Using deposits to generate revenue by putting deposits to work via loans • When banks transform liabilities (deposits) into assets (loans), asset transformation has occurred.

  6. MODERN PORTFOLIO THEORY • Modern portfolio theory (MPT) • Within any portfolio of investments, diversification should be used to spread out risk • Variation by industry • Variation by maturity dates

  7. checkpoint What is asset transformation?

  8. CONSUMER LENDING THEORY • Loan selection • Adverse selection • Borrowers who are most willing to accept a high interest rate are the same borrowers who are most likely to default on their loans • Captive borrower • When borrowers with certain credit characteristics are more likely to prefer one type of lender to another

  9. Moral hazard • When a borrower takes greater risks if they think the harm they will incur from those risks will somehow be minimalized • Credit rationing • When banks refuse to provide a loan, or when they lend less than the customer requested

  10. DOWNSTREAM LOAN PROFIT • Securitization • When individual loans are pooled together and sold as securities

  11. checkpoint What is adverse selection?

  12. ADDITIONAL SOURCES OF BANK REVENUE • Banks generate revenue from • Astutely managing loan portfolios • Charging a variety of fees

  13. OFF-BALANCE SHEET ACTIVITIES • Balance sheet • A brief summary that lists the net profit, owner’s equity, assets, and liabilities for a company • Public companies have public balance sheets. • Seen by investors • Off-balance sheet activities are not seen by investors.

  14. Off-balance sheet activities include • Overdraft protection • Letters of credit • Flex line • When overdraft protection is linked to a home equity line of credit

  15. OTHER REVENUE SOURCES • Account service charges • Safe deposit box rental • ATM charges • Insurance sales fees • Trading fees

  16. checkpoint What are three methods of providing overdraft protection?

  17. 6.2CONSUMER LOANS GOALS Define major terms associated with consumer lending. Explain the difference between installment loans and open-end loans.

  18. TERMS • Installment loan • Secured loan • Collateral • Lien • Unsecured loan • Open-end loan • Grace period

  19. INSTALLMENT LOANS • Consumer loans • Installment loans • Open-end loans • Installment loan • A loan for which the amount of the payments, the rate of interest, and the number of payments (or length of term) are fixed • Repaid on a periodic basis

  20. Personal loans • Vehicle loans • Home equity loans • Education loans

  21. SECURED AND UNSECURED LOANS • Secured loan • Some item of value backs the loan in case the borrower defaults on the loan • Collateral • An item of value that secures a loan

  22. Lien • A legal claim to the property to secure the debt • Unsecured loan (signature loan) • A loan backed only by the reputation and creditworthiness of the borrower

  23. LENDING TERMINOLOGY • Principal • The amount borrowed • Interest • The amount you pay to use the principal • Fixed rate • Variable rate • Indexed rate

  24. It is important to know how interest is calculated. • Calculated on the declining principal balance as payments are made Or • Payments go toward the interest first, then toward the balance

  25. Fees • Other charges for the loan • Finance charge • The total dollar amount to be paid for the loan • Total payments • The total amount a consumer must repay

  26. Payment • The amount the borrower repays each specified period • Acceleration clause • Brings the entire loan due if payments are missed

  27. checkpoint What is the difference between a secured loan and an unsecured loan?

  28. OPEN-END LOANS • Open-end loan • The amount owed is flexible • The longer you use the money, the more you pay • The term is flexible

  29. CREDIT CARDS • Credit cards are a form of consumer loan. • Grace period • An amount of time you have to pay the bill in full and avoid any finance charges

  30. LINES OF CREDIT • Line-of-credit plans • Home equity reserve • Overdraft protection plan • Consumers can draw upon this credit as needed

  31. checkpoint What is an open-end loan?

  32. 6.3GRANTING AND ANALYZING CREDIT GOALS List steps in the credit-approval process. Identify major criteria in a person’s credit rating.

  33. TERMS • Underwriting • Subprime rates • Consumer reporting agency (CRA) • FICO score

  34. GRANTING CREDIT • Every borrower represents a potential risk to the lender. • Banks use a well-defined policy of risk management to minimize the risk associated with loans.

  35. RISK MANAGEMENT • Credit-related risk management policies include consideration of • The bank’s overall financial position • Reserve requirements • Cash flow • Ratio analyses of liabilities and assets

  36. CREDIT-APPROVAL PROCESS • Application • Documentation • Processing • Underwriting • Reviewing the loan for soundness • Making sure the loan is a prudent use of bank funds

  37. The three Cs of underwriting • Collateral • Capacity • Credit reputation • Subprime rates • Higher than normal rates set to offset the increased risk represented by a less-than-perfect borrower

  38. Closing • Funding

  39. checkpoint What is underwriting?

  40. ANALYZING CREDIT • A key factor underwriters review is credit history. • The best way to predict the future is to see how a person has done in the past.

  41. CONSUMER REPORTING AGENCIES • Consumer reporting agency (CRA) • A company that compiles and keeps records on consumer payment habits and sells these reports to banks and other companies to use for evaluating creditworthiness

  42. Three Major Reporting Agencies

  43. Most credit reports contain the following types of information: • Personal data • Accounts history • Delinquent accounts • Public records • Inquiries • Consumers are entitled to a free credit report each year.

  44. Example of Credit Report

  45. CREDIT-SCORING SYSTEM • A credit-scoring system can provide an efficient and unbiased method of evaluating credit. • These scores place a numerical value on the performance or status of an applicant in various categories. • The points in each category are added for a total score.

  46. FICO • FICO score • A three-digit number that credit granters can use in making a loan approval decision • Payment history (35 percent) • Amounts owed (30 percent) • Length of credit history (15 percent) • New credit (10 percent) • Types of credit (10 percent)

  47. Credit Score Makeup

  48. FICO Score Breakdowns

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