As Bad loans pile up again let's revisit the role of cash-flow audits before lending to MSMEs
With the bad loans piling up again, cash-flow audits before lending to MSMEs make more sense than ever before.
On the contrary, the growth of MSMEs narrates the overall growth story of the world economy. MSMEs represent more than 90% of all business establishments around the globe, and as per the estimates, additional funding of $5.2 trillion would be required for MSMEs to grow.
This makes reliable Loan Origination Systems (LOS) a notable component in all financial organizations.
What makes Loan Origination Systems (LOS) important?
Credit Analysis through a LOS determines the risk associated with the entity and tags a risk rating. Diving deeper, a credit analysis allows lenders to estimate the Probability of Default (PD), Exposure at Default (EAD), and other important parameters to assess the negative impact it may have in the future.
Simply put, LOS as a system helps financial organizations assess the risk involved in approving credit to a particular entity. This helps in avoiding bad loans in the future.
To take a step further, lenders can now use LOS systems to accurately picture cash flow analysis, trend analysis, and ratio analysis. These parameters help calculate the risk involved in the journey. When coupled with Early Warning Systems (EWS), LOS helps to detect loan defaults at very early stages.
These factors consistently ensure that benchmarking MSMEs loans play a vital role for banks and allow them to maintain a healthy loan portfolio.
LOS and the 5 Cs of Commercial Credit Analysis
In an advanced LOS system, the entire process goes through a series of checkpoints, with applications getting rejected at any interval. These metrics and parameters vary with the banks. However, here are the 5 Cs that every commercial credit assessment processes:
While this may sound unusual but the character does play a vital role in loan origination. Most banks dig previous and current reputations to understand the nature and the characteristics of the business.
Some of the factors that enable banks to assess the business are credentials, past credit reports, and reputation in the industry. The background verification ensures that the company lends to better eligible businesses. Capacity
The next very crucial aspect of credit analysis is capacity. Capacity refers to the monetary aspect of an organization. This involves paying expenses, present cash flow, credit score, and other important factors like current debts.
If the banks find that a business is hardly meeting its expenses, in most scenarios the bank won’t lend the sum.
Capital refers to investment made by the core team into the business. A higher capital value represents the seriousness of the founders and is often perceived as a positive sign. This helps banks move forward in the LOS cycle.
Collateral is the security against the loan. It could be an equal or higher value asset that ensures that the bank holds the right to sell it and recover the default value. Collateral could reduce the risk factor greatly and, hence, is preferred by banks.
Finally, the application ends with terms and conditions of repayment. Conditions are mutually accepted and ensure a projected track of repayment. This also ensures established customer categorization and risk profiling from the bank’s end.
Being the largest chunk in the business ecosystem, MSMEs need capital to sustain and grow. However, it is due diligence from the bank’s end to verify all the information and take a calculated risk. This is where a reliable LOS comes in place and cannot be ignored at all costs.