Thesis on "Principles and Practices of Consumer Credit"

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Credit policy not only varies from bank to bank but within the same bank through different time periods. The bank to bank variation is expected, as credit policy can be a form of competitive advantage. A loose (riskier) credit policy can expose the bank to higher risk but higher returns; a tight (less risky) credit policy provides greater stability of income flows. Although in theory banks should be rational actors with respect to credit policy, evidence shows that they often follow money supply stimulus and the lead of other banks. This results in banks supporting negative NPV projects during market upswings and rejecting positive NPV projects during market downswings (Rajan, no date).

Banks execute their credit policies by a number of means. As noted earlier, most banks have a wide range of products at their disposal. Credit officers must assess the client's need and find the right product. Choosing the right product should result in maximizing the profit for the bank and the benefit for the consumer. There can be significant differences between consumer credit products. Thus it is critical that banking officers understand each different product, the circumstances for which it is best used and the needs of the individual customer so that the recommended solution is the best one available for that customer.

The decision to grant credit is often based on programs that weigh a number of factors. At the core of these factors are the Five Cs of credit analysis: capacity, capital, collateral, conditions and character (Penwell, 2009). Capacity refers to the consumer's ability to repay the loan (i.e. income level). Capital refers to the degree to which the consumer has to back the loan -- the down payment, for example. Collateral refers to physical assets, such as a house, car or boat, that can be used to back the loan. Conditions refer to the purpose of the loan. This especially refers to mortgages, since they are subject to a slightly different set of rules. Character refers to the perceived integrity of the borrower. Credit score is typically used as a proxy for character.

To each variable a score will be assigned, and a weighting. When these scores are combined, the program will yield a recommendation with respect to the bank's acceptance or lack thereof. The precise inputs for each variable -- and the weightings -- will be different at each bank, within the bounds set by law.

When the decision is made to accept a loan, the next step is to close… READ MORE