The System of Credit Worthiness Finance Essay

In addition, the creditworthiness may be affected by a variety of other factors, such as residence, place of work, property ownership, number of persons in the household, etc. The analysis of the creditworthiness involves preliminary study of the factors and prerequisites which can affect adversely the duly repayment of the creditor. Thus, it is of high importance that bank specialists demonstrate competence and conscientiousness. Bank shave at their disposal various ways for choosing suitable borrowers to be financed and for exercising control over the special purpose of the credit resources and their expedient and efficient spending. The in-depth study of the financial situation of the loan applicant does not harm the good relations between him and the bank. Establishing firm grounds for the credit relations is seen as an inherent characteristic element of the credit activity. The study of the financial situation, which is carried out by qualified and experienced bank experts, may disclose a number of shortcomings which until that moment have been unknown to the administrative and managerial staff and in this way the study can turn out to be extremely useful for the loan applicant too. The last twenty years has seen a revolution in consumer credit, with more and more people borrowing on an increasing scale. The explosion in demand for consumer credit could probably not have been met successfully without the development of better and more efficient techniques for handling a key decision. This decision -whether or not to lend money to a prospective borrower - underpins all credit operations. The well-being of a credit institution, and ultimately its survival, depends on the ability to make this fundamental lending decision correctly. Reasons Why People Apply For A Loan One of the main reason for borrowing is to purchase a home or for home renovation. Shelter is one of the basic human needs. But acquiring a home might take you longer years to save for the amount of money it requires. The easiest way to have it is to apply for a loan. Furthermore, people also request loan to buy car. Vehicle nowadays becomes necessary. The last but not the least of the reasons for applying loan is to pay for educational balances to give your children a brighter future. Education is also expensive which demand bigger amount of money for tuition fees, books, allowances, and a lot more. (Burton, n.d.) Problem statement In the sixties and seventies, Mauritius was dependent on sugar production; but since then the island has developed itself into a diversified economy with important pillars in financial services, business process outsourcing, tourism and information technology. Like many other developing countries, Mauritius is now facing acute challenges arising out of the changing global environment arising from the process of liberalization, globalization, and technological advances. With a population of around 1.3 million, the figures below clearly indicate that the whole population lives on debts. That is, they are spending more than they earned. Jun-11 Sept-11 Dec-11 Credit cards 210,572 213,247 217,135 Outstanding Advances on credit cards(Rs M) 1673.4 1756.8 1863.3 Table (Statistics Office, Year 2011 source [https://www.gov.mu/portal/goc/cso/mif11/mif2011.pdf]) Table 1 show that there in a constant increase in amount due in credit cards from June 2011 to December 2011. Aim Research objectives The study will be carried out by selecting two main banks in Mauritius namely, Mauritius Commercial Bank and State Bank of Mauritius Ltd to analyze whether they are conducting proper credit assessment before granting any credit facilities to its customers The research objectives of this study are: To determine the effectiveness of a proper credit analyst; To identify the psychological factors which compel a person to request a loan; To assess the impact of loan repayment on borrowers income; To recommend a credit counseling session to client upon a request for credit facilities The following research questions are as follows: Why people request for (more) credit facilities (than they can afford)? What are the steps taken by a bank before granting credit facilities? What are the advices given by the bank officer to the client upon a request for credit facilities? What measures can be taken for improving the actual system of credit assessment Benefits of the study This study will be beneficial primarily to Bank of Mauritius in assessing whether commercial banks are acting in favor of the borrower when granting credit facilities to borrowers. Additionally, it will help in identifying some gaps in the system and it will determine whether the Borrower Protection Act which was introduced in 2007 is really protecting the borrowers or the act need to be reviewed

Literature Review

Mid loan relationships between bank-lenders and borrowers An investigation done by Gottesman and Roberts(2005) on the nature of mid-loan relationships between bank-lenders and borrowers, to test whether firms borrow from banks to signal quality. Using the LPC Deal Scan, CRSP, and Wall Street Journal databases, they test whether borrower abnormal returns are related to bank during the duration of the loan. They also demonstrated that borrower abnormal returns are related to mid-loan bank events, defined as an event resulting in bank abnormal returns beyond a specified threshold. The results suggest that borrowers are affected by bank events mid-loan, even when the event is not directly related to bank default. (Aron A. Gottesman, Gordon S. Roberts, 2005) Lending procedures Ralston and Wright (2003, p.6) elaborate on sound lending procedures in retail financial institutions involve identifying high-risk applicants, modifying loan conditions such as security requirements, and monitoring repayments post-loan approval. For managers of credit unions, this procedure is complicated by the need to achieve balance between the institution's social objective of improving loan accessibility so members can attain lifestyle goals and the possibility of reducing the institution's viability through loan default. The results of this survey of Australian credit unions, in which 70% of respondents reported experiencing some bankruptcy-related default on personal loans, indicate managers do not impose more stringent lending conditions on high-risk borrowers. However, social and viability objectives could be better balanced through careful loan monitoring and timely arrears practices. (Ralston, 2003) Bank lending and the environment Bankers have come to realise that banking operations, especially corporate lending, affect and are affected by the natural environment and that consequently the banks might have an important role to play in helping to raise environmental standards. Although the environment presents significant risks to banks, in particular environmental credit risk, it also perhaps presents profitable opportunities. Stricter environmental regulations have forced companies to invest in environmentally friendly technologies and pollution control measures and in turn generated lending opportunities for bankers. This article examines the lending policies of a sample of UK banks with respect to the environment, focusing on issues of environmental risk management, market segmentation and the exploitation of marketing opportunities. The research found that while the banks are placing considerable emphasis on environmental risk management in their corporate lending operations, there is little evidence of them harnessing the opportunities presented by the "greening" of industry.

Numerical Points Systems in Credit Screening

A study of Barry (1977, p.36) has shown how the development of numerical points systems, or credit scoring systems, have become increasingly important in this country as aids in the credit screening process. Most of the initial research on these techniques has been undertaken in the US, but in the last decade the principles have been used in this country, particularly by financial institutions operating in the consumer credit field. In broad terms, numerical points systems attempt to discriminate potentially bad from potentially good credit risks and offer an alternative to a purely subjective assessment of a credit applicant. The systems are particularly relevant in the consumer credit field where most of the information needed can be obtained from a credit application form. Under the system, numerical weights are assigned to certain types of information given (e.g. occupation, income, marital status, etc.), the total of the scores then being used as a measure of payment potential: the higher the score, the more likely is the applicant to possess characteristics which indicate a prompt payment disposition. In this article, it is emphasised that the construction of a numerical points system fits into the overall credit screening process, and it is important to appreciate the principles of the latter before full use can be made of any system. The empirical research is summarised both in the US and in the UK with a view to assessing the effectiveness of the systems, and a survey amongst UK financial institutions is also summarised to evaluate the extent of the use of the techniques in the UK. Emphasis throughout has been placed on the consumer credit field but the principles can also be applied to trade credit. (Savery, 1997) Small businesses and risk contingent credit A more recent study (Turvey et al. 2012, p 491) has shown that firms facing significant income volatility can often suffer from downside risk such that return on assets is insufficient to meet fixed financial obligations. The purpose is to provide a prescriptive credit solution for small businesses facing exogenous income risk. Formulas for risk-contingent operating and collateralized loans are developed and simulated in the context of a specific business sector. The Findings demonstrates that a structured credit product with an imbedded option can reduce or eliminate financial risks by providing payouts that decrease the amount of principal and/or interest that firms must repay under low income states. The overall objective is to provide a means to mitigate exogenous income risk faced by firms through the design and application of a risk-contingent credit product that is tied to primary markets and simple to implement. In this context, risk contingency credit refers to a suite of financial products with payoff schedules (loan principal) that are linked to specific commodities or indices. The authors are in fact unaware of any commercial financial products of the type considered in this paper and thus their approach is a prescriptive solution to the identified problem. (Turvey C. G., 2012) The impact of attitude variables on the credit debt behavior The present research attempts to address what kinds of attitude variables influence individuals' debt behavior. Although credit card debt has been extensively documented recently, the main focus is on the pure amount of debt. Little research is concerned with the source of credit card debt. This research tries to investigate how different attitude variables affect revolving credit card use and petty installment use which are two main sources of credit card debt. It is generally accepted that attitude variables are one of the causes of credit card misuse. But there is no research to compare the differential effect of each factor in one model. The present research tries to use statistical method to find out the distinctive effect of each attitude factor. The study was conducted by using mail-in questionnaires, which were sent to credit card holders who were using or had used either revolving credit or petty installment plans. After reliability and validity tests, stepwise regression model has been used to test the differential effect of each attitude variable. According to regression functions, it was found that attitude variables had a wonderful explanatory power in accounting for revolving credit use and petty installment use. Specifically, it was found that revolving credit use and petty installment use were closely related to attitudes about credit card, money, and debt. Risk attitude efficiently predicted petty installment use; however, it did not correlate with revolving credit use. Meanwhile, it was found that all of the attitude factors account for 82.1 percent of variance for revolving credit use. In contrast, they account for 41.6 percent of variance for petty installment use. The findings shed light on the role of attitude variables in debt behavior. Moreover, the paper identifies the specific role of different attitude variables, which has great implications for practice. Existing research has significantly clarified credit card debt issues, but there are still some gaps to fill in. For one, although the previous literature tests both separate effects and joint effects, it ignores some important variables, such as attitude variables. Meanwhile, previous research focuses on single variables most of the time, such as credit card attitude and debt attitude, and little research has simultaneously considered a bunch of attitude factors simultaneously. In summary, further exploration of the attitude factors is necessary. Additionally, previous researchers have focused only on the final consequences of credit usage - the outstanding balance or credit card debt rather than the behavior which triggers credit card debt. The present research aims to address these two questions. Fashion orientation, credit card use, and compulsive buying In 2005, a study by Park & Burns, to examine fashion orientation, a fashion-related variable, as a direct antecedent of compulsive buying and as an indirect antecedent of compulsive buying through credit card use. Using a convenient sampling method, women aged over 20 years living in the Seoul metropolitan area were selected as the sample. Out of 380 distributed, 267 useful questionnaires were returned. Confirmatory factor analysis and path analysis were conducted using structural equation modeling. (Park, H. J. & Burns, L. D. , 2005) The results of this study showed that fashion interest significantly influenced compulsive buying directly and also indirectly by influencing credit card use. This study has significance in terms of being the first one to explore the relationship between fashion orientation variables and compulsive buying, offering a new perspective on compulsive buying. Importance of credit counseling in the Mauritian Banking sector Credit counsel is very helpful because it would assist you toward not only improved understand the financial situation; however you would also discover how to evade accumulating overpowering debt within the future. Credits counseling is particularly useful for peopled suffering as of huge debt burden and opposite a monetary and individual crisis. As you gather with credit counselors as of the reputable credits counseling corporation, you would learn the finest way to doggedness the crisis also regain manage of the life. Professional credit counselor has the knowledge and qualifications within debt management toward helping you improve the finances. They would educate you how headed for manage the household finances; assist you comprehend how you obtain into such overpowering debt, also how you be able to avoid declare insolvency. They will evaluate your personal monetary situation and counsel you at the best alternative and come about with habits to develop into debt-frees. They would help you graph your route to financial free will. Normally a credit assessment is undertaken to see whether the borrower has the repayment capacity for amount loan being requested That is, a proper analysis must be performed. For instance, a person "A" requests a loan of 1million rupees to be paid over 10 years. The bank will normally determine his monthly installments; then the banker will check his monthly income net of his existing liability (any loan taken before) and including the new request. If the amount remaining is enough for a normal household expense taking into consideration of his status (If he is married and have children) then the loan will be provided to him. (Anon., 2011)

METHODOLOGY

Overview

The target population for this study will be the credit analysis department of the two main banks in Mauritius, namely Mauritius Commercial Bank and State Bank of Mauritius. It is to be noted that raw data will be collected through questionnaire filled by banking officers of credit analysis department and another questionnaire will target client who already have credit facilities. Moreover, data concerning the great disparities of customers will be analysed accordingly through various statistical method. Appropriate hypothesis will formulated to model the impact of the different physiological factors leading a person to apply for credit facilities.

Survey

Questionnaire will be distributed among a selected clients and banking officers through the help of friends. The questionnaire will be set to obtain from target audiences detail concerning the system of credit analyst and their impact on borrowers.

Planning

October November December Introduction Literature review Data collection and sorting Analysis Report writing Table

Ethical considerations

The research will be conducted in a professional way and abides to all ethics. That is, any information gathered during our research will not be disclosed to any individual.

Limitations of study

The main concern to this study is confidentiality of data. Banks will not give us access to personal data on their customers, in particular, when we are assessing on how they are evaluating credit worthiness. In other words, we will be able to determine loophole in their system and hence this may affect their reputation.

Expected result

A thorough analysis of how the system of credit analysis impacts on borrowers and the degree of importance it imposes upon the borrower; this will help us to reduce the overdebted population. Consequently, this will lead to a better social life.

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