CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND
OF THE STUDY
Virtually, every business has a
credit relationship with a financial institution, especially banks. Some rely
on periodic short term loans to finance temporary working capital needs. Others
primarily use long-term loans to finance capital expenditure, new acquisitions
or permanent increases in capital. Regardless of the type of loan, all credit
request mandate a systematic analysis of the borrower‟s ability to repay as at
when due.
Commercial banks carry on ordinary
banking business with the general public, changing cash for bank deposits and
bank deposits for cash, transferring bank deposit from one corporation to
another, giving bank deposit in exchange of bills of exchange, providing of
trustees and executor’s services, providing safe custody of funds and valuables
as well as foreign exchange remittance. Though commercial banks differs from
country to country, their profit and banking motives are the same. Their
activities are of interest to their customers, workers (staff), and above all,
shareholders.
The commercial objective of the
bank is to maximize profit, though other social and economic functions tends to
deflect banks from profit maximization. The aims and objectives of commercial
banks have therefore paved way for their customers to make and obtain credits,
in form of loan of which the researcher is interested in. Lending has become a
vital function on operation because of its direct effect and impact on economic
growth and business development.
In a market oriented economy, there
are two main participants that move the economic growth; these are the
suppliers of invisible funds and the users of the funds for productive
purposes. These two participants are spread widely in the economy and may not
have direct relationship with each other. For this, there is the need to have
an intermediary to link them up. The banking sector mobilize surplus funds from
small and big savers who have no immediate need for such funds. The users of
these funds are the business entrepreneurs and investors who have brilliant
ideas on how to create additional wealth in the economy but lack the necessary
capital to execute their ideas. These groups of people approach banks to obtain
loan.
Subsequently, lending is a risky
venture which banks only engage on after a rigorous and satisfactory analysis
of the project for which lending is being made. The main preoccupation of banks
is extending loans to their customers. Thus, the formulation and implementation
of such lending policies are some of the important responsibilities of the
management of the bank. The lending policy of a bank must be specific on how
much loan will be made available to whom, what period and for what reason. For
this reason, lending policies should be well documented so that lending
officers will be able to know the areas of prohibition and the area of where
they can operate. Also, such policies should be subjected to periodic review to
make the banks keep abreast with the dynamic and innovation nature of the
economy as well as competing with other changing economic sector.
Therefore, the basic objectives of
credit analysis is to assess the risks involved in extending loans to bank
customers. In financial circle, risk typically refers to the volatility in
earnings. Lenders are particularly concerned with adverse fluctuation in net
income or cash flows, which hinder the borrower’s ability to service a loan.
Some risks can be measured with historical and projected financial data, while
others such as those associated with borrower’s character and willingness to
repay a loan are not directly measurable.
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