Question

Can an exceptionally high value of one of the “5 C’s of Credit” compensate for a low value of one of the others?

Answer 1

The five C's of credit are used by lenders to determine the creditworthiness of potential borrowers. After allocating appropriate weights to the individual C's the chance of default is estimated.

The five C's of credit are:
i)Character
ii)Capacity
iii)Capital
iv)Conditions
v)Collateral

i)Character: It refers to the opinion of a lender regarding the trustworthiness, credibility of the borrower, this is important because banks lend to borrowers who are trustworthy and keep commitments.
ii)Capacity : It refers to the capacity of a borrower to repay the loan. It is important because, the lenders needs to be assured that the borrower has enough cash flows (may be through salary or business) to repay the loan
iii)Capital: Banks consider the funds a person invests towards a potential business or project. If the contribution is large compared to the loan taken, then it reduces the chances of defaulting
iv)Conditions: It refers to the condition of the business like whether it is growing up or seeing downturn. To ensure that the loan amount are paid back by the borrower, banks prefer to lend for the business that are operating in favorable conditions, banks also take into consideration the state of economy.
v)Collateral: These are the assets that are used to secure a loan, in case if a borrower fails to pay off the loans, the lender can sell off the collateral to recover the loan amount.

Yes, exceptionally high value of one of the 5 C’s can compensate for a low value of one of the others.

Example:Exceptionally high value of collateral can compensate for a low value of capacity (or cash flows) or conditions. In case if the business closes due to capacity or economic conditions then the lender can sell of the collateral and recover the loan amount.