CIBN Lending and Credit Management Study Notes

CHAPTER ONE: OVERVIEW OF LENDING CONCEPTS, PRINCIPLES, POLICIES AND PRACTICES

• Introduction: Lending and credit management are the heart of banking. While lending involves subjectivity (an art), it requires an organized methodology and sound professional judgment to ensure principal and interest are paid as and when due.

• Rationale for Bank Lending: Granting loans is a bank's most important function. Banks earn income by accepting deposits and lending to customers at a "spread" (the difference between interest charged and interest paid). Banking is a margin business; protecting this margin is vital for survival. If loans go bad, it can lead to systemic distress, requiring Central Bank of Nigeria (CBN) intervention.

• Objectives of Lending:

  • Profitability: Delivering value to customers while maximizing shareholder wealth. Profit is necessary to pay deposit interest, staff salaries, and operating expenses.

  • Growth: A performing loan portfolio creates capital for re-investment, new products, and long-term sustainability.

  • Competitiveness: Successful mobilization and deployment of funds help a bank stay ahead in the market.

  • Economic Development: Banks act as agents of change by lending to strategic sectors (Agriculture, SMEs, Manufacturing) as directed by the CBN.

• Principles of Lending:

  • Safety: Ensuring funds are protected through compliance with Credit Policy and regulatory guidelines.

  • Liquidity: Adhering to the "matching principle" where the maturity structure of deposits aligns with the maturity structure of loans to avoid insolvency.

  • Profitability: Generating returns to cover the cost of funds, loan loss provisions, and dividends.

  • Purpose: The loan must be for a legal, specific, and clear reason that generates sufficient cash flow for repayment.

  • Risk Diversification: Avoiding concentration risk by spreading loans across sectors, industries, and geography. This minimizes impact from volatility (e.g., oil price drops) or localized issues (e.g., insurgency in the North East).

  • Security/Collateral: Acting as "insurance" or a secondary repayment source. Realizable value should typically exceed the loan amount (e.g., $120\%$ coverage).

• Reasons for Borrowing: Paying bills (wages, taxes), purchasing raw materials, acquiring plants/equipment for expansion, property development, or management buyouts.

• Asset Conversion Cycle (Trading Cycle): Measures the turnover rate of working capital. It starts with cash and ends with cash.

  • Example 1 (Bar): Trading cycle is one day (purchase stock in morning, sell for cash by evening).

  • Example 2 (Chocolate Company): Cycle may be 65 days (30 days for raw material arrival, 20 days for conversion, 15 days for debtor collection).

  • Implications: Shorter cycles are less risky. Working Capital is defined as $\text{Current Assets} - \text{Current Liabilities}$.

• Canons of Lending (The 5Cs):

  1. Character: Integrity, credit history, and track record. Assessed via Credit Bureaus (CRC, CR Services, XDS).

  2. Capacity: Ability to generate profits and cash flow to repay. Assessed via financial metrics like debt and liquidity ratios.

  3. Capital: The owner's equity or "skin in the game."

  4. Conditions: External factors including macro-economic trends (PESTLE analysis), industry framework (Porter’s Five Forces), and internal business health (SWOT analysis).

  5. Collateral: Assets pledged to offset weaknesses in other areas. Qualities include simplicity of title, stability of value, and realisability.

• CAMPARI Mnemonic: An alternative framework covering: Character, Ability, Margin, Purpose, Amount, Repayment, and Insurance.

• Credit Policy: A formal document approved by the Board detailing underwriting standards, credit memorandum requirements, and risk management procedures. It is a dynamic document managed by the Risk Management Department.

• Credit Culture: The system of behaviors and values regarding lending. Types include: Value-Driven (focus on asset quality), Immediate Performance Driven (focus on earnings/stock price), Production Driven (focus on market share/volume), and Unfocused (no clear priority, reactive).

CHAPTER TWO: OVERVIEW OF BUSINESS AND RETAIL LENDING

• Business Lending: Targeted at meeting the immediate and long-term financial needs of companies. Products include overdrafts, leases, project finance, and mezzanine financing.

• Retail Lending: Targeted at individuals. Includes personal loans, mortgages, and credit cards. Uses standardized product programs and credit scoring.

• The Banking Environment (PESTLE):

  • Global: International oil prices, pandemics (COVID-19), and exchange rate movements.

  • Political: Government policy shifts, tax rates, and the Treasury Single Account (TSA).

  • Economic: GDP growth, inflation, and Monetary Policy Rates.

  • Social: Demographics, labor unions, and social issues like kidnapping or banditry.

  • Regulatory: BOFIA 2004, CBN Act 2007, and Money Laundering acts.

  • Institutional: Interaction between deposit money banks, merchant banks, and regulators like CBN/NDIC.

  • Technological: Innovations in Fintech, Agency banking, and risk of product obsolescence.

• Financing Options:

  • Overdraft: An open-ended, short-term, "swinging" facility enabled through current accounts. Cheapest since interest is daily on outstanding balances.

  • Term Loan: Closed-end credit for expansion or fixed assets. Repayment is in installments over a fixed period (3-10 years).

  • Bridging Loans: Interim financing provided on a temporary basis (usually up to 1 year) until permanent funding is secured.

  • Equipment Leasing: The bank (Lessor) owns the asset; the customer (Lessee) pays rentals.

    • Operating Lease: Short-term, cancellable, lessor maintains the asset.

    • Finance Lease: Full cost recovery, non-cancellable, lessee maintains the asset.

  • Factoring: Selling account receivables to a third party (Factor). Can be "with recourse" or "non-recourse."

  • Hire Purchase: Installment agreement with the intention to own the asset upon completion of payments.

  • Project Finance: Financing large-scale infrastructure via a Special Purpose Vehicle (SPV); non-recourse or limited recourse.

  • Mezzanine Financing: Subordinated junior debt that is partly loan and partly equity.

CHAPTER THREE: RETAIL, COMMERCIAL AND CORPORATE BANKING

• Market Segments:

  • Retail Banking: Services individuals (current accounts, savings, personal loans).

  • Public Sector Banking: Deals with Federal, State, and Local governments (revenue collection, bonds).

  • Private Banking: Wealth management for High Networth Individuals (HNIs).

  • Corporate Banking: Services for large conglomerates and multinationals handled at headquarters.

  • Commercial Banking: Services mid-tier businesses, local corporates, and emerging SMEs.

• Commercial Lending Customer Life Cycle:

  1. Prospecting and Origination: Sales and data gathering.

  2. Underwriting: Appraisal against eligibility criteria.

  3. Credit Approval: Sanctioning per the Credit Policy Manual.

  4. Due Diligence and Documentation: Perfecting collateral and executing agreements.

  5. Loan Closing and Funding: Disbursement and start of repayment monitoring cycle.

• Challenger Banks: Small retail banks (e.g., in the UK context including Barclays, HSBC, Lloyds competitors) that leverage technology to fill gaps left by big banks.

CHAPTER FOUR: EFFECTIVE LOAN PRICING

• Pricing Philosophy: Determined by demand/supply of credit and specific borrower characteristics. The "Monetary Policy Rate" (MPR) is the base rate in Nigeria.

• Models:

  • Price to Competition: Matching what others charge.

  • Cost-Plus Pricing: $\text{Loan Price} = (\text{Direct Cost} + \text{Indirect Cost}) + \text{Risk Premium}$.

  • Components of Cost: Interest expense, administrative cost, and cost of capital.

• Basis of Interest Rates:

  • Fixed vs. Variable: Variable rates are tied to the bank's base rate or reference rates (LIBOR/NIBOR).

  • Prime Lending Rate: The lowest rate offered to highest-rated (low risk) customers.

  • Non-Interest Banking (Islamic): Uses Profit-and-Loss Sharing (Musharakah) and Leasing (Ijarah).

• Weighted Average Cost of Funds (WACF): Total expected interest payable divided by total deposits. Banks lower this through digitization, branch expansion, and capturing "free float" from public sector accounts.

• Value Propositions: Bankers sell more than money; they sell market knowledge, speed of execution, ease of use, and continuity of relationship.

• ALCO (Assets and Liabilities Management Committee): Oversees market risk, liquidity, and funds management policy.

CHAPTER FIVE: CREDIT RISKS: TYPES, MEASUREMENT AND MITIGATION

• Definition: The probability of default where a borrower fails to meet contractual payments.

• Essential Formula: $\text{Credit Risk} = \text{Default Probability (PD)} \times \text{Exposure (EAD)} \times \text{Loss Rate (LR)}$.

• Risk Types:

  • Default Risk: Failure to pay after 90 days.

  • Concentration Risk: Excess exposure to a single entity or industry.

  • Country Risk: Sovereign state freezing currency or defaulting.

• Management Process: Identification -> Classification -> Quantification -> Decision -> Control.

• Quantification Matrices: Expected value is likelihood multiplied by consequence (High, Medium, Low).

• Specific Industry Risks:

  • Agriculture: Post-harvest loss, pestilence, bad weather.

  • Oil & Gas: Dry wells, price fluctuations, production strikes.

  • Hotels: Low occupancy, health/safety issues (pandemics).

  • Manufacturing: Adulteration, regulatory sanctions (NAFDAC/SON), fire accidents.

• Mitigation: Risk-based pricing, covenants, credit insurance (Credit Default Swaps), risk tightening, and diversification.

CHAPTER SIX: CREDIT ANALYSIS AND INVESTIGATION PROCESS

• Introduction: Analysis involves breaking down data to determine the prospect of repayment. It asks "Why is revenue down?" or "Is the borrower responding to problems?"

• Processes: Gathering info -> Interview -> Analysis -> Presentation -> Approval -> Documentation -> Disbursement -> monitoring -> Recovery.

• Information Types:

  • Qualitative: Subjective judgment on management skill, expertise, and industry cycles.

  • Quantitative: Ratios, trends, common-sizing (vertical analysis), and percentages.

• Loan Presentation (O-PARTS/C-PARTS): Obligor, Purpose, Amount, Repayment, Terms/Conditions, Security.

• Credit Reporting: Central Bank of Nigeria mandates the use of at least two Credit Bureaus. In Nigeria: CRC Credit Bureau, CR Services, and XDS.

• Rating Agencies: Professionally evaluate debt issues. Approved by SEC in Nigeria: Agusto & Co Ltd, Datapro Ltd, and Global Credit Ratings.

CHAPTER SEVEN: ENVIRONMENTAL AND SOCIAL RISKS MANAGEMENT

• Sustainability: Meeting current needs without compromising future generations. Three pillars: Planet (Environment), People (Social), and Profit (Economic).

• Equator Principles (EP): Applied to project finance. Categorizes projects into High, Medium, or Low risk to support responsible risk decisions.

• IFC Performance Standards: Eight standards ranging from Labor (PS2) and Resource Efficiency (PS3) to Indigenous Peoples (PS7) and Cultural Heritage (PS8).

• Nigerian Sustainable Banking Principles (NSBP): Nine principles approved in 2012, including Principles 1 & 2 (lending and operational footprint), Women's Empowerment (4), and Financial Inclusion (5).

• ESMS (Environmental and Social Management System): A system to conduct due diligence before disbursement and monitor compliance throughout the loan term.

• Sector Specific Guidelines: Targeted guidance for Power, Agriculture, and Oil & Gas sectors.

CHAPTER EIGHT & NINE: FAM PREPARATION AND PROJECT FEASIBILITY

• FAM (Facility Approval Memorandum): The actual written application to a credit committee. Contains: Facility summary, environmental scanning, obligor profile, financial analysis, profitability, and justification.

• Project Feasibility: An analysis taking economic, technical, legal, and scheduling factors into account. A good study includes: Project Scope and Current Position Analysis.

• Structure of Feasibility Report: Introduction, business description, market evaluation (most important part), technical plan, and financial/economic plans (Break-even analysis).

CHAPTER TEN & ELEVEN: FINANCIAL STATEMENT ANALYSIS (RATIOS)

• Tools: Trend Analysis (horizontal), Common-sizing (vertical), and Ratio Analysis.

• Liquidity Ratios:

  • Current Ratio: $\frac{\text{Current Assets}}{\text{Current Liabilities}}$ (Ideal: 2:1).

  • Quick Ratio: $\frac{\text{Current Assets} - \text{Inventory}}{\text{Current Liabilities}}$ (Ideal: 1:1).

• Solvency/Leverage Ratios:

  • Total Debt to Assets: $\frac{\text{Total Liabilities}}{\text{Total Assets}}$.

  • Interest Coverage: $\frac{\text{EBIT}}{\text{Interest Expense}}$.

• Activity/Working Capital Ratios:

  • Receivable Days (ARDOH): $\frac{\text{Receivables} \times 365}{\text{Turnover}}$.

  • Inventory Days (IDOH): $\frac{\text{Inventory} \times 365}{\text{Cost of Sales}}$.

  • Operating Cycle: $\text{IDOH} + \text{ARDOH}$.

  • Cash Conversion Cycle: $\text{Operating Cycle} - \text{Payable Days (APDOH)}$.

CHAPTER THIRTEEN: REMEDIAL LOAN MANAGEMENT

• Problem Loan: A credit where interest or principal installments are more than 90 days past due.

• Early Warning Signs: Excessive overdraft use, returned checks, evasive communication, and mass staff resignations from the obligor.

• Borrower Quadrants: Willing and Able (Ideal), Unwilling and Able (Strategic default), Unable but Willing (Downturn victim), Unable and Unwilling (Double jeopardy).

• Recovery Steps: Demand letter -> Litigation -> Receiver appointment -> Debt-Equity Swap -> Sale to AMCON (Asset Management Corporation of Nigeria).

• CBN Provisioning Guidelines:

  • Substandard: 90 days overdue ($10\%$ or $20\%$ provision).

  • Doubtful: 180 days overdue ($50\%$ provision).

  • Lost: Over 365 days overdue ($100\%$ provision).

CHAPTER FIFTEEN: LOAN SYNDICATION

• Definition: Multiple lenders funding portions of a large loan for a single borrower. Necessary when the request exceeds the Single Obligor Limit.

• Parties: Arranger (structuring), Underwriter (guaranteeing availability), Agent (intermediary), Participating Banks (fractional lenders), Security Trustee (holding collateral for all).

• The Process: Preliminary evaluation -> Information Memorandum preparation -> Marketing to partners -> Offer letter -> Funding.

• Paris Club: Informal group of official creditors helping debtor countries with rescheduling and debt treatment solutions. Operating principles include: Solidarity, Consensus, Sharing Information, Case by Case, Conditionality, and Comparability of Treatment.