Understanding the science and art of business lending credit risk

May 01, 2019
Noel McArdle, Financial Services Educator, talks about the appropriate approach to the business lending credit risk assessment section of the financial services elective.

It has long been said that business lending credit assessment is both a science and an art. A sound knowledge of the canons of lending is an essential foundation on which to build a framework to carry out a business lending credit risk assessment. Time spent by students in studying the canons is time well spent.

Business theory

In terms of the science, students bring excellent knowledge and skills of financial analysis and business theory from their previous studies. This is a real strength. It’s important for students to remember to use the knowledge they have acquired on business strategy and business leadership as they assess the lending proposal in the case study. In particular, they should revise their knowledge on SWOT analysis which is used in this elective to assess the economic, industry and business risks faced by a business borrower.

Financial analysis

Financial analysis is also key part of business lending credit assessment. The level and extent of analysis is influenced by the complexity of the borrower’s proposal and the value the lender will have at risk if the proposal is sanctioned. Students will have an excellent knowledge on the preparation of trading accounts and in using tools, such as ratio analysis, to get behind the figures, benchmarking performance and spotting trends. A look back over the work they have done in these areas will aid students in honing their analytical skills to complete a financial analysis of a business lending proposal.

Business products

The science in business lending requires a knowledge of financial products from the common overdraft facility to more complex corporate bonds. Students will need to study these areas in the manual to be prepared for direct questions on products/debt structuring and to  know when a proposal would benefit from the introduction of a particular  product.

Security

Security is quite specific to business lending and is quite technical in nature. Security theory is a topic which will most likely be new to students. The level of detail required is not that of a student of law but is aimed at giving the student a working knowledge of the key instruments used to secure a business lending request. For example, what is the role of the security instrument and how can it be used to mitigate the credit risks of a proposal so that it is feasible for the lender to assist in providing the finance needed to the borrower? As you study this section, think more as a business person rather than a lawyer.

Strategy and operations

A unique aspect of this elective is that it introduces students to the strategic and operational approaches used by financial institutions to manage risk and, in particular, credit risk. These are topics with which students will already have a knowledge as they have been debated quite widely since the financial crises began in 2008. It is important for students to study the handouts provided to support these topics and follow the debate in the media. Reading the annual report of one of our significant financial institutions would be time well spent in getting an appreciation of these topics.

Experience

The art of business lending is polished by experience and, quite obviously, students will not have opportunities in this area quite yet. And so, it is important they come to the workshops which will afford them opportunities to discuss business lending case studies with me and to debate their views on credit risks with their colleagues. 

The  examination will  require students to express their own views on key areas of business risk, financial position, historic/projected trading positions, ability to repay and the identification and management of credit risks. Students will be asked to give their views on strategic and operational challenges faced by financial institutions in the management of risk in particular credit risk.

Good luck.