What lenders consider before approving and pricing your loan

Bank loans are a ready way to raise money for your various needs, such as purchasing an asset, paying school fees, starting a business, refinancing debt or dealing with an emergency such as a hospital bill. It is thus necessary to know the requirements for your loan application to be approved.

Besides approval, accessing a loan that is not the right fit for you can have a potentially negative impact on one’s finances. For instance, taking a loan that carries a very high interest rate can affect your ability to repay it.

It is, therefore, important to be as informed as you possibly can before making the decision to borrow. One of the primary considerations is how the options available in the sector compare.

To ease this process, the Kenya Bankers Association (KBA) provides you with a ‘shopping window’ for bank loans in the form of a total cost of credit website that the association co-hosts with the Central Bank of Kenya (CBK). The website, whose link is accessible via both the KBA and CBK websites, provides a comparison across all banks of the charges that customers would face for similar products. So, on matters interest rate and other charges, you can easily decide which institution to approach for a loan.

Once your decision has been made on the particular bank to approach for the loan, it is equally important to understand how banks assess loan eligibility. The bank assesses the loan request to assure itself of the likelihood of the money being repaid, as it lends out money that belongs to depositors – who, on the other hand, have a right to access their money on demand.

Minimum qualifications

To unpack this, I parade four common features that banks apply, that can be categorised as ‘the four Cs’, that is, character, capacity, collateral and conditions. The application of these features, which can be regarded as the minimum qualifications for a bank loan, vary from one bank to another depending on internal credit policies.

The first C is Character of the borrower. Here, a demonstration of the past record with handling loan obligations is critical, particularly for repeat customers. Most lenders in the banking sector will require you to submit a credit history report from a Credit Reference Bureau (CRB) showing that you do not have a loan in arrears with any other financial institution, or if you do, the reasons for default are provided. It would also matter for some banks how long you have had an account with them. Long-term customers would be able to demonstrate long-term stability and ably provide confidence on their future relations with the bank.

As such, it matters to build a relationship with your bank. A good credit history can also be used as a basis for negotiating for a lower interest on your loan since it reflects a lower risk. We have seen borrowers who approach the bank for a loan with the intention of not repaying it back. The bank has to have the right processes to weed out such and protect depositors’ money.

The second C is Capacity to repay, which is largely assessed through the cashflow analysis. This is an indicator of your ability to service a loan. Here, most lenders will require you to provide some documents to prove that you have a stable income. Having a stable income is not enough if the same income is not banked. It matters to keep all your incomes in a bank. This would be shown in payslips for the salaried and bank statements for all. For project financing, a cashflow analysis would entail projection of cash inflows (from the sale of goods or services) and the cash outflows and ensure there is sufficient balance to meet the obligations to the lender.

The third C is Collateral. There is a perception that banks lend on the basis of the collateral, which is not entirely true. The collateral is a fallback if for any unforeseen reasons, the cashflows do not materialise, in which case as a last resort, the lender can exercise its powers and liquidate the assets pledged to repay itself. This is important for secured loans. Examples of collaterals include land and buildings, fixed deposits in banks, and cars. The options for assets to pledge as collateral have been widened under the Moveable Assets Collateral Registry. Use of a collateral by a customer shows commitment to repay the loan. Being a cover for a particular value of a loan, banks typically value the collateral and establish that the collateral is adequate to cover the risk occasioned by advancement of the loan.

In practice, the use of a collateral to secure a loan is a legally binding contract, and thus its realisation in the event of a default depends to a great extent on the level of development of the legal and judicial frameworks in the country. As such, whenever there is a risk in the collateral realisation process, banks place a smaller weight on the collateral in the determination of loan approval. In most cases, you may be required to provide a security of a higher value than the loan you are seeking.

Tangible assets

As part of the collateral structure, some banks require a guarantor, who can either be personal or corporate; the strength of which depends on the assets backing the guarantee. The quality of the collateral depends largely on the ease of realisation in the event of default, with cash collateral being the highest and a guarantee not backed by any tangible assets ranking towards the lowest.

Finally, the last C stands for Conditions which a lender puts in the loan agreement to safeguard priority of repayment for the loan. Conditions like non-payment of dividends until loan is fully repaid would be contained in this section.  So would conditions pertaining to utilisation of equipment financed to ensure good working condition during the life of the loan to continue generating the projected cashflows.

In summary, there would be slight variations across banks on the extent to which these four Cs are applied. It is always worthwhile for customers to spend a little time to either check on the bank’s website or make a phone call, or possibly visit a branch of their preferred lender.

 At all times, there are benefits in repayment terms that accrue from a customer’s investment in a good character of repaying loans, being able to demonstrate strong cashflows and for secured lending, presenting strong value collaterals.

Dr Olaka, EBS, is the CEO of the Kenya Bankers Association