An adequate lending policy is fundamental to achieve greater efficiency in resource allocation and to implement an outward-looking development model. The principles we delineate in here should be helpful to design an annual business plan for your institution that adequately reflects the strategy approved by the General Assembly.
Generally speaking, an appropriate lending policy should define the following processes:
- The target group selection of products and borrowers which will outline your institution’s portfolio, such as individuals from farming communities, agribusiness firms, agro-tourism companies, local resources processing initiatives, commercializing and marketing subjects, etc., respecting lending eligibility criteria.
- Poverty alleviation. low-income level applicants must remain the prominent norm. Nevertheless we will provide a flexible lending policy as to expand the eligibility criteria on local contexts.
- Women empowerment, which is primarily because of their better repayment records. This also makes them a particular target group for microfinancing activities. It is recognized that women play an important role in business communities, encompassing social and economic responsibilities and duties, both within and outside their households. In many poor communities women are often involved in productive activities to make up for the seasonal nature of their husbands’ incomes.
- Loan size requirements. Successful lending products usually start with small loans, gradually increasing based on repayment history. The annual lending policies approved by the General Assembly of your institution should define the loan size per borrower.
- Loan pricing. Pricing loans according to market parameters has proved to be financially much more efficient than subsidized interest rates. In principle, all loans are based on adjusted interest rate referring to:I) LIBOR+ for loans in USD; II) EURIBOR+ for loans in Euro.
- Disclosures. For example, to comply with regulations by the National Central Bank of the country you operate in, the lending contract must disclose the effective interest rate and respective calculations. Interest rates should reflect the following costs: I)Financing and capital costs – the actual cost of your institution’s funds. Capital costs fluctuate according to the market rate of interest and the inflation rate. In this context, the manual enhances adjustable rate loans instead of fixed ones; II)Operating costs – the annual recurrent costs incurred to run the credit service and include salaries, rents, utilities, depreciation and other administrative expenses; III) Loan loss provision – the amount provided to cover expected defaults of the loan portfolio.
- Defining the loan term and the frequency of loan repayments. Both of them should be based on the borrower’s cash patterns. The repayments may be made on installment basis (monthly or quarterly) dependent on borrower’s business operational cycle and activities that generate ongoing revenues; the seasonal pattern of the business is significant to avoid unduly debt burden of the borrower; the design of repayment periods also depends on the ability of the institution to face liquidity risk; whatever the design of the repayment schedule, the basic rule is that it should correspond to the income derived from the activity financed by the loan and therefore loan terms and repayment periods must be flexible enough to meet the client’s needs.
- The allocation of loan approval competences. The lending limits per each credit officer should be defined as well as the rules to proceed for large loans.
The credit policy is closely implemented with credit risk policy. They represent the operational target of credit department/structure with risk department/structure and are an integral part of the budgeting process. It has to include the planned trend in overall credit business, taking into account the nature and scope of business.
An adequate attention must be paid to limiting the cumulative concentration of exposures irrespective of its nature, i.e. industry concentration, size concentration, rating concentration, etc.
In our next post we will delve into the details of lending approval and monitoring.
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