Lecture 2

Lecture outline:
Credit control mechanism of central bank
What is bank lending policy
Elements of sound lending policy
Areas for using banks funds

Credit Control Mechanism of Central Bank
Monetary policy refers to the control of credit and total money supply. This policy is also known as
the central banks policy in control of credit. Control of money supply is very important for the
economic growth of a country. If there is excess supply of money then the result will be inflation
whereas tight control over money may cause depression and unemployment. Therefore monetary
policy is implemented to achieve various objectives such as achievement of price stability, increase
employment opportunities, stimulate economic growth, achieve stable rate of the currency and
increase in investment. Monetary policy is implemented by the central bank and it uses different
methods for this purpose. These are classified into two types and are given below.
Quantitative Controls
Bank Rate
Bank rate refers to the rate at which central bank rediscounts bills of exchange. In other words it
is the rate of interest at which central bank advances loans to the commercial banks. In case of
inflation central bank increases the bank rate due to which commercial banks have to increase
the interest rate. Due to increase in the interest rate demand for the loans of commercial banks
reduces and the money supply in country shrinks. In this way inflation is controlled. On the other
hand bank rate is reduced in case of depression which results in the reduction of interest rate and
the money supply in country is increased.
Open Market Operations
When the central bank purchase or sale government securities in the open market such as stock
exchange it is called open market operation. If central bank wants to reduce the money supply in
country it sells government securities to the commercial banks and people. In this way the
amount of cash with people and commercial banks is reduced due to which commercial banks
decrease the number of loans whereas peoples demand for goods and services shrinks. Similarly
if the central bank wants to increase the money supply it purchases government securities due to
the amount of cash with commercial banks and people increases.
Changes in Reserve Ratio
Every member bank keeps a percentage of its total deposit with the central bank known as cash
reserve ratio. Central bank uses reserve ratio to increase or decrease the money supply in
country. For example if the central bank wants to decrease the money supply it raises the reserve
ratio due to which less amount of cash is left with the commercial banks to lend. Due to lower
lending the supply of money reduces along with the demand for goods and services which results
in the control of inflation. Similarly central bank can increase the money supply by lowering the
reserve requirements.
Credit Rationing
Central bank uses credit rationing to fix the credit ceiling allowed for each and every commercial
bank. It means that central bank fixes the credit limit for each commercial bank and does not
give credit to them beyond that limit. Whenever the central bank desires to decrease the money
supply it decreases the limit up to which it can give loans to the member banks. Similarly central
bank can increase the money supply by increasing the credit limit.
Qualitative Controls
Change in Margin Requirement
Every commercial bank has to keep a margin whenever it extends loans against the security. It
means that the amount of loan is lower than the actual value of security. For example actual
value of security is 100 and the amount of loan is 85, therefore margin requirement is 15%.
Central bank can increase or decrease the money supply by changing the margin requirements.
For example if central bank wants to decrease the money supply it can do so by increasing the
margin requirements. In this way amount of loans decreases.
Regulation of Consumers Credit
Consumer credit facility refers to the act of selling a consumer good on a credit basis to the
people. The method is used by government or central bank to implement certain regulations on
goods sold on credit. If the central bank wants to increase the money supply it can do so by
adopting a lenient policy about the credit for purchase of consumer goods. Similarly central bank
can reduce the money supply by putting restrictions on consumer credit.
Moral suasion
In some cases central bank morally persuades or requests the commercial banks not to indulge
themselves in such economic activities which are against the interest of country. It regularly
advises and guides the member banks to follow a particular policy for loans and refrain
themselves from giving loan for speculative purposes.
Publicity
Central bank also publishes details concerning its policies and important information about assets
and liabilities, credit and business situation etc of commercial banks. This helps to make
commercial banks as well as general public realize the monetary needs of country. Central bank
reveals some of the important information about the commercial banks so that the people know
about the various activities of commercial banks and can protect themselves from any potential
loss in the future.
Direct Action
Direct action is the last resort through which central bank takes a direct action against the bank
which does not act in accordance with the policy of central bank. In case of direct action the
central bank can impose fine and penalty and can refuse to give out loans to the commercial
bank. Such type of pressure keeps commercial banks away from undesired credit activities.

Commercial Bank Lending Policy
As lending is no doubt the core commercial banking activities, the bank is poised to the
formulation of efficient lending policy which will be flexible enough to meet the test of time, be
effective enough to ensure safe and shrewd lending and achieve the commercial and social
objectives of the bank.
The policy will take into account:
i) The need for diversified portfolio
ii) The mood and dictates of the economy
iii) The structure of deposits and cost of fund
iv) The central bank credit guidelines as may be modified from time to time, and
v) The need to maintain a competitive stance in the financial market
Any official of the bank who is designated in writing to do so or granted power by virtue of his
official designation and position may grant credit up to the limit of his lending power and subject
to the laid down procedure as may be modified from time to time.


Elements/Components for a Sound Lending Policy
The lending policy should require diversification within the portfolio and provide prudent
underwriting standards. There are certain components that form the basis for a sound loan policy
and should be addressed by every lending institution.
Aggregate Limits and Distributions by Category
In order to limit the total amount of loans outstanding, relationships with other balance sheet
accounts should be established. Branches usually express controls over the loan portfolio relative
to their total claims on nonrelated parties. In setting such limits, various factors, such as credit
demand, legal lending limit, borrower or industry concentration, the volatility of funding and the
credit risks involved must be considered. Additionally, limits on aggregate percentages of total
loans in commercial, real estate, consumer, or other categories are common. Such policies are
beneficial but should allow for deviations with the approval by the head office. This allows credit
to be distributed in relation to the changing needs of the target markets.
Geographic Limits
A branchs trade area should be clearly delineated and loan officers and senior management
should be fully aware of specific geographic limitations for lending purposes. Although many
branches will define their trade areas to include a number of states, frequently, the primary
calling efforts are focused on a narrower area. Certain types of lending, which require significant
knowledge of local market conditions or intensive monitoring of branch personnel, should be
carefully considered. Examples include commercial loans to large regional companies, loans to
finance commercial real estate projects, or asset based lending that requires regular monitoring of
accounts receivables. In addition, the branchs defined trade area should not be so large that,
given its resources, proper and adequate monitoring and administration of the branchs credits
cannot be reasonably determined.
Concentrations of Credit
The loan policy should recognize the need for diversification of risk and establish some
parameters on concentrations of loans to industries, related groups of borrowers, loans
collateralized by a single security or securities with common characteristics, and loans to
borrowers with common characteristics within an industry. Examiners should recognize that as a
part of a larger banking entity, individual branches may have concentrations that are well within
proper diversification in the context of the overall organization. Many branches specialize in
terms of the kind of business transacted and the types of credits extended. Many credits are trade
related and often reflect the economic makeup of the branchs home country. In addition, credits
at the branch are often booked at the direction of the head office and can reveal concentration by
industry, country, or borrower. Nonetheless, branches, as part of a sound risk management
system, must establish procedures for identify-ng and monitoring inherent risk resulting from
concentrations of credit. Institutions that have effective controls in place to manage and reduce
undue concentrations need not refuse credit to sound borrowers simply because of the borrowers
industry or geographic location. It is important to emphasize that this principle applies to loan
renewals, rollovers, and new extensions of credit.
Types of Loans
The lending policy should state the types of loans that the branch will make and should set forth
guidelines to follow in making specific loans. The decision about the types of loans to be granted
should be based on a consideration of the business plan, expertise of the lending officers and
support personnel, the funding structure of the branch, and anticipated credit demands of the
target markets. Credits involving complex structures or repayment arrangements or loans secured
by collateral that require more than normal policing should be avoided unless or until the branch
obtains the necessary personnel, policies, controls, and systems to properly administer such
loans. Types of credits that have resulted in an abnormal loss to the branch should be identified,
scrutinized, and controlled within the framework of stated policy.
Repayment Terms and Maximum Maturities
Loans should be granted with realistic repayment plans. Maturity scheduling should be related to
the anticipated source of repayment, the purpose of the loan, and the useful life of the collateral.
For term loans, a lending policy should state the maximum number of months over which loans
may be amortized. Specific procedures should be developed for situations requiring balloon
payments and modification of the original terms of a loan. If the branch requires a cleanup (out-
of-debt) period for lines of credit, the period should be explicitly stated.
Loan Pricing
Rates on various loan types established by the loan policy must be sufficient to cover the costs of
the funds loaned, of servicing the loan, including general overhead and of probable losses while
providing for a reasonable margin of profit. Policy makers must know those costs before
establishing rates that arise out of an effective risk management process. Periodic review allows
the rates to be adjusted to reflect changes in costs, competitive factors, or the risks associated
with the type of extension of credit. Specific guidelines for other relevant factors, such as
commitment fees, are also germane to pricing policy.
Documentation and Collateral
Trade financing often represents a significant amount of the branchs lending activity. In such
financing, the branch deals only in documents while its customer is responsible for the
merchandise under the terms of the contract. The branchs control of documents, especially title
documents, is crucial. There are significant differences between domestic loan agreements and
foreign ones. Nevertheless, the branch must ensure that it is adequately protected through loan
agreements with foreign borrowers. The loan agreement should also protect against adverse
changes in foreign tax rules, loan funding problems, and additional withholding and other types
of taxes. The branch should have policies for taking foreign collateral as security for a loan to
assure adherence with the local required procedures. For example, liens on fixed assets in many
countries must be registered with the local government.
Maximum Ratio of Loan Amount to Collateral Value or Acquisition Costs
The branchs ending policy should identify where the responsibility for appraisals or internal
evaluations lies and should define formal, standard appraisal, and evaluation procedures, and
procedures for possible reappraisals or reevaluations in the case of renewals or extensions.
Acceptable types of appraisals or evaluations should be listed. The policy should also include the
limits on the dollar amount and type of real or personal property that branch personnel are
authorized to appraise. Circumstances regarding the use of in-house appraisers versus a fee
appraiser should be identified. The ratio of loan amount to the value of the collateral, the method
of valuation, and the differences for various types of property should be detailed.
Financial Information
Extending credit on a safe and sound basis depends on complete and accurate information
regarding the borrowers credit standing. One exception is when the loan is predicated on readily
marketable collateral, the disposition of which was originally designated as the source of
repayment for the advance. Current and complete financial information is necessary not only at the
inception of the credit but also throughout the term of the credit. The lending policy should define
the requirements of financial statement information for various types of credit extended by the
branch. In addition, the lending policy should define the requirements for financial statements and
operating data for businesses and individuals at various borrowing levels and should include
requirements for audited, non-audited, annual, interim, income, cash flow and other financial
statements, tax returns, changes in owners equity and other supporting notes, schedules, and
management analyses. Financial statement requirements should include external credit checks
required at the time of periodic updates. The policy should define the financial requirements in
such a manner that any credit data exception in an examination report should be a clear
contravention of the branchs lending policy. Financial statements for foreign borrowers or
guarantors may present additional risks or problems not associated with domestic borrowers.
Foreign customers financial statements may be prepared in either U.S. dollar equivalents or in the
borrowers local currency. Most branches analyze the latter statements, particularly if that currency
is unstable, therefore figures stated in U.S. dollar equivalent amounts would be distorted by the
conversion rates used at various times. Sometimes, the branch may need to reconstruct a
borrowers financial statement in U.S. dollar equivalents to reflect the borrowers financial strength
and weaknesses more accurately. Since the financial information may not be reliable, the branchs
policies should enable it to determine by other means the capacity, integrity, experience and
reputation of the foreign borrower. While analyzing foreign borrowers financial statements,
examiners should take into consideration the differences in foreign accounting practices from the
generally accepted accounting principles (GAAP) in the United States.
Limits on Sectoral Exposures
The loan policy should define maximum exposures to specific sector other than the priority
sectors. All sizeable exposures should be supported by sector analyses and other supporting
information. Sectoral limits should be consistent with the creditworthiness of the respective
creditors.

Limits and Guidelines for Purchasing and Selling Loans Either Directly or Through
Participations or Swaps
If sufficient loan demand exists, lending within the branchs trade area is safer and less
expensive than purchasing paper from another bank. Direct lending promotes customer
relationships, serves the credit needs of customers, and develops additional business. In some
instances, however, a branch may not be able to make a loan to a customer for the full amount
requested because of prudential lending limitations or other reasons. In such situations, the
branch may extend credit to its customer for the full amount needed and sell or participate out
that portion that exceeds the branchs lending limit or the amount it wishes to extend on its own.
Generally, such sales arrangements are established before the credit is ultimately approved.
These sales should be on a nonrecourse basis to the branch and the originating and purchasing
institutions should share in the risks and contractual payments on a pro rata basis. Selling or
participating out portions of loans to accommodate the credit needs of customers promotes
goodwill and enables a branch to retain customers who might otherwise seek credit elsewhere.
Conversely, many branches purchase loans or participations in loans originated by other
organizations. The policy should require that loans purchased from another source be evaluated
in the same manner as loans originated by the branch itself. Generally, the branch should avoid
concentrations in purchasing loans from anyone outside source or concentrations in purchases of
loans to any one industry.
Purchasing and selling loans can have a legitimate role in a branchs asset and liability
management and can contribute to the efficient functioning of the financial system. In addition,
these activities can assist a branch in diversifying its risks and improving its liquidity. The policy
should state the limits for the aggregate amount of loans purchased from and sold to anyone
outside source and for all loans purchased and sold. Limits should also be established for the
aggregate amount of loans to particular types of industries that may be purchased. Guidelines
should be established for the type and frequency of credit and other information that should be
obtained from the lead institution in order to keep the branch continually updated on the financial
condition of the borrower and the status of the credit. Because of the inherent reliance on the lead
institution to administer and collect participated loans, the purchasing branch should evaluate the
lead institutions ability to properly carry out these responsibilities. Conversely, guidelines
should also be established for supplying complete and regularly updated credit information to the
purchasers of loans originated and sold by the branch.
Loan Authority
The lending policy should establish limits for all lending officers. In many branches of banks,
most lending authority remains with the head office. If lending policies are clearly established
and enforced, individual officer limitations may be somewhat higher, based on the officers
experience and tenure with the branch. Frequently, group lending limits are set, allowing a
combination of officers or a committee to approve larger loans than the members would be
permitted to approve individually. The reporting procedures and the frequency of committee
meetings should be defined.
Collections, Charge-Offs, and Specific Reserves
The lending policy should define delinquent obligations and contain guidelines for placing loans
on nonaccrual status and initiating foreclosure proceedings. Delinquency status is determined by
the contractual terms and defined as when the principal or interest on an asset becomes due and
unpaid for 60 days or more. For regulatory reports, branches must comply with the reporting
requirements for past due and nonaccrual loans. Additionally, the policy should dictate the
appropriate reports to be submitted to the head office concerning those obligations. The reports
should include sufficient detail to allow for the determination of the loss potential and alternative
courses of action. The policy should require a follow-up collection notice procedure that is
systematic and progressively stronger. Guidelines should be established to ensure that all
accounts are presented to and reviewed by the head office for chargeoffs or specific reserves in
accordance with applicable regulatory policy.
Legal Lending Limits
The lending policy may describe limitations on loans to one borrower, as are consistent with
head office and/or regulatory requirements. The Bank Companies Act, 1991 superseded banks
legal lending limits to the extent that exposures to a single borrower by a bank and branches of
the same bank must be aggregated and applied against the capital of the bank.
Other
The lending policy should be supplemented with other written guidelines for specific
departments of the branch. Written policies and procedures approved and enforced in various
departments should be referenced in the general lending policy of the branch.
Management should establish appropriate policies, procedures, and information systems to
ensure that the impact of the branchs lending activities on its interest rate exposure is carefully
analyzed, monitored, and managed. In this regard, consideration should also be given to the risks
associated with off-balance sheet instruments related to lending arrangements, such as loan
commitments and swaps.


Areas for using banks funds
FORMS OF ADVANCES
Over and above deposit taking function, there are two more important functions of commercial
banks. These are lending and investment. Banks, based on deposit resources, lend money to diverse
areas and people as well as invest their funds for many purposes. Advancing money to various types
of borrowers including traders, industrialists and other peoples. Banks, therefore, classify their
advances into various categories having their own features. These advances are as follows-
1. Loans:
A loan is a kind of advance made with or without security. In the case of a loan the bank makes a
lump sum payment to the borrower or credits his deposit account with the money advanced. It is
given for a fixed period at an agreed rate of interest. Repayments may be made in instalments or at
the expiry of a certain period. The customer has to pay interest on the total amount advanced whether
he withdraws the money from his account (credited with the loan) or not. A loan once repaid in full
or in part cannot be withdrawn again by the borrower unless the banker sanctions a fresh loan.
Banker can charge a lower rate of interest in the case of loans than cash credits and overdrafts
on account of the following reasons:
(i) It involves lower cost of maintenance as the accounts are not operated very frequently.
(ii) The bank gets interest on the total amount sanctioned whether the customer withdraws the
whole money or not.
Loan may be a term loan or a demand loan. Term loans payment is spread over a long
period. It includes a medium term loan (repayable within 3 to 5 years) and a long term loan
(repayable after 5 years). Demand loan is payable on demand. Thus, it is for a short period.
Advantages of loan:
A. Observance of the financial discipline by the borrower: In loan system, the time and amount
of repayment of installment is fixed in advance
B. Periodic review of loan account: The banker gets an opportunity to review the loan account
as and when a loan is granted or renewed.
C. Simple and profitable: The banker charges interest on the total amount sanctioned as a loan
to the borrower irrespective of the withdrawals by the borrower. Thus, there is no loss of interest
to the banker. Moreover the operation of the system is comparatively simple.
Limitations:
A. Inflexibility: The system is inflexible in the sense that every time a loan is required the banker
has to negotiate with the borrower.
B. More formalities: Sanctioning of the loan requires more documentation as compared to a
cash-credit system.
C. Frequent renewals: Though the loan is sanctioned only for a fixed period but in practice they
are continuously renewed period after period.
2. Cash credit:
Cash Credit or continuing credits are those that form continuous debits and credits up to a limit
and have and expiration date. A service charge that is effect an interest charge is normally made
as a percentage of the value of purchases. Cash credit arrangements are usually made against the
security of commodities hypothecated or pledged with the bank. In this case, the customer need
not borrow at once the whole of the amount he is likely to require but draw such amounts as and
when required. He can put back any surplus amount which he may find with him for the time
being. Interest has to be paid by the customer on the amount actually drawn at any time and not
on the full amount of the credit allowed.
CASH CREDIT (HYPO):
Under this arrangement a credit is sanctioned against hypothecation of the raw materials or
finished goods. The letter of hypothecation creates a charge against the goods in favor of the
Bank but neither the ownership nor its possession is passed on to it; only a right or interest in the
goods is created in favor of the Bank and the borrower binds himself to give possession of the
goods to the bank when called upon to do so. When the possession is handed over, the charge is
converted into pledge. This type of facility is generally given to the reputed borrowers of
undoubted integrity.
CASH CREDIT (PLEDGE):
Under this arrangement a cash credit is sanctioned against pledge of goods or raw materials. By
signing the letter of pledge, the borrower surrenders the physical possession of the goods under
the Banks effective control as security for payment of Bank dues. The ownership of the goods,
however, remains with the borrower. The pledge creates an implied lien in favor of the Bank on
the underlying merchandise. In the event of failure of the borrower to honor his commitment the
Bank can sell the goods for recovery of the advance. No collateral security is normally asked for
grant of such credit.
However, cash credit system runs with some limitations. Here the banker lays greater emphasis
on the security offered rather the end-use of funds. As a result the funds are diverted to other
purposes without bankers knowledge. Besides, this system it is not the banker but the borrower
who decides when and how much he will borrow. In other words utilization of credit limits
depends upon the discretion of the borrower.
Advantages of cash credit:
A. Flexibility: The borrower can withdraw the total amount or a part of the amount of cash
credit.
B. Convenience: Banks have to maintain only one account for all transactions of the customer
and hence repetitive documentation can be avoided. Thus, the system is quite convenient to
operate.
C. Charges of interest: The interest on cash credit is charges on the amount which is already
withdrawn.
Limitations of cash credit:
A. Under-utilization of credit limit: Cash credit limits are fixed once a year. Hence, it gives rise
to the tendency of fixing a higher limit than the amount of funds required by the customer
throughout the year.
B. No verification of end use of funds: The banker lays greater emphasis on the security offered
rather the end-use of funds.
C. Lack of proper management: In cash credit, utilization of credit limits depends upon the
discretion of the borrower. This may result in sufficient idle funds with the banker.
3. Overdrafts:
The customer may be allowed to overdraw his account, with or without security if he requires
temporary accommodation. This arrangement like the cash credit is advantageous from the
customer's point of view as he required to pay interest on the actual amount used by him. An
overdraft differs from a cash credit in the sense that the latter is used for long-term by
commercial and industrial concerns doing regular business, while the former is supposed to be a
form of bank credit for occasional use and for shorter durations.
It is an important segment of the credit portfolio of the commercial banks. This kind of advance in
the form of overdraft is always allowed on a current account to be operated upon by cheques. The
customer may be sanctioned a certain limit within which he can overdraw his current account within
a stipulated period. Here, withdraws or deposits can be made any number of times at the convenience
of the borrower provided that the total amount overdrawn does not, at any time, exceed the agreed
limit. Interest is calculated and charged only on the actual debit balances on daily product basis.
Advantages of bank overdraft:
A. This advance can be sanctioned without any security.
B. The money of this advance can be withdrawn partial amount.
C. The interest is charged on the amount is already withdrawn.
Limitations:
It is a very short term loan. So a borrower has a very little time to repay the advance.
4. Bills Discounted and purchased:
These advances are created when banks are to purchase bill of exchange of businessmen to
facilitate commercial transactions. In case of purchase and discounting of bills, the banker credits
the customer's account with the amount of the bill after deducting his charges or discount. The
bank may discount the bills with or without any security from the debtor in addition to the
personal security of one or more persons already liable on the bill. Besides bills, banks also
purchase cheques drawn by government and semi-government institutions, local authorities or
any first class parties for extending accommodation to the parties requiring funds. Purchasing of
foreign bills of exchange arising out of commercial transactions is called foreign bill purchased.
In this case, shipping documents for exports are treated as security.
5. Payment against documents (PAD): Payment against documents is associated with import
financing. The bank, opening letter of credit, is bound to honor its commitment to pay for import bills
when these are presented for payment provided that it is drawn strictly in terms of the letter of credit.
6. Loan Against imported merchandise (LIM): In these credit, bank has to clear the goods
imported under letter of credit at the request of the borrower.
7. Trust receipts (TR): This is an arrangement under which credit is allowed against trust
receipts and imported or exportable goods remain in the custody of the importer or exporter but
he has to execute a stamped on trust receipt in favor of the bank wherein a declaration is made.

Loan Review
All banks, including community banks, are expected to have loan review functions. To conserve
costs, many small community banks have chosen to outsource the loan review function, rather
than follow the route chosen by large multi-regional organizations and some larger community
banks, which have established internal loan review departments. Clearly, there are many benefits
to having an in-house loan review staff, but regardless of the structure, loan review should focus
on the following:
The accuracy of credit grades assigned by lenders.
The quality of credit underwriting.
Deviations from loan policy guidelines.
Loans not accompanied by adequate credit or collateral documentation.
Violations of banking laws and statutes.
Borrowers' compliance with loan covenants.
The method used for determining the adequacy of the allowance for loan and lease losses
(ALLL).
Loan review reports should be distributed to all senior officers involved in the lending function,
internal audit, the audit committee, and the board of directors. If any material weaknesses or
deficiencies are found in the reports, a written response outlining a plan of corrective action
should be addressed to the chief executive officer and the board of directors or a committee of
the board of directors.
Risk Ratings
Community banks are expected to have formal credit-grading systems that ultimately translate
into the pass, special mention, substandard, doubtful, and loss categories used by supervisory
agencies. Risk ratings should be developed for various credit types based on their unique features
and risk characteristics (e.g., credit scores, debt-to-income ratios, collateral type, and loan-to-
value ratios for consumer loans and debt service coverage, and financial strength of
management/major tenant and loan-to-value ratios for commercial real estate credits).
Ideally, grading systems should have several pass categories based on the borrower's
earnings/operating cash flow, leverage, and net worth. Collateral (quality and control), the
company's management, and the strength provided by any guarantors should also be considered.
Because grades reflect varying degrees of risk, they are expected to be major components for
determining the adequacy of the ALLL and loan pricing. An inaccurately graded loan may lead
to incorrect and uncompetitive pricing and over- or under-reserving.
Clear ownership for rating a borrower should be established and, in most cases, should reside
with the loan officer. An independent source, in most cases, loan review, should periodically
validate the accuracy of the rating.

Top Five Common Lending Mistakes
The following list outlines the top five mistakes lenders make:
Absent or inadequate cash flow analyses (debt service coverage and debt-to-income
calculations) that do not consistently validate a borrower's ability to repay debt.
Speculative real estate loans that are often extended to builders without adequate cash
flow and liquidity analyses to validate their capacity to carry unsold inventory for
extended periods.
Poorly specified risk ratings that do not accurately reflect the financial condition of, or
the risks posed by, borrowers.
Consumer loans that are made to customers with high debt-to-income ratios and
unfavorable credit histories, or credit decisions that are often based on proposed collateral
values rather than on debt service capacity.
Loan pricing that is not commensurate with risk.