Question

2. What are the five C’s involved in a bank’s decision to make a loan. Please provide a brief explanation of each.

Answer 1

The 5 C's are used by bank to measure the credit worthiness of the borrower. It takes in to account both quantitative and qualitative factors. They are:

1. Character or credit history
2. Capacity
3. Capital
4. Collateral
5. Conditions

Let’s look everything in details here:

Character or credit history:

It measures the borrower’s reputation and track record for repaying debts. This is available in the borrower’s credit report prepared by Experian, Trans union or Equifax. It provides credit scores to all borrowers. The minimum credit score requirement varies from lender to lender and from one loan to another. But the general rule is, higher the credit score, more possibility of receiving a loan.

Capacity:

It refers to the ability of borrower to repay the loan. Capacity is measured by calculating borrower’s debt to income ratio. It is calculated by adding together total monthly debt payment and dividing it by gross monthly income. Lower the debt-to-income ratio, higher is the chance of getting a loan.

Capital:

Capital refers to how much of your money you have invested in your business. This shows your commitment, courage and energy for your business. Lenders measure capital by looking your balance sheet or wealth statement. More the asset you possess in your business, more the possibility of getting a loan.

Collateral:

Collateral is a form of security. It helps lenders to secure a loan thus helps the borrower to secure a loan. It gives the lender an assurance that even if a borrower makes default in repayment of loan, the lenders face no loss. In the event of default, lender can repossess the collateral. A loan secured with collateral generally carries low interest rate.

Conditions:

Condition of the loan generally includes its interest rate, principal and terms of payment, etc. Conditions refer to how a borrower intends to utilise the loan amount. Thus specific loan is more preferred by lenders than general loan which can be used for any purpose.