The recent financial crisis has resulted in loan defaults and Non-Performing Loans (NPLs) for a large number of businesses. Unfortunately, these businesses are unable to access banking finance until all their discrepancies are settled. At present, Cyprus and Greece have the largest proportion of NPLs in Europe. The solution of the NPL problem is critical for both the businesses and the economy of Cyprus and Greece.
This criterion refers to the capacity of the borrower to repay its financial obligations. Banks cannot lend their clients’ money (depositors) unless they can be relatively certain that the borrowers will be able to repay the money back on time.
This basic criterion was often disregarded by the banks in the years prior to the financial crisis and it is one of the main reasons behind the large number of NPLs now.
The borrower needs to demonstrate that the business can repay the loans requested. The tools required to demonstrate this repayment ability are the Business Plan of the company or as a minimum, a Cash Flow Forecast. The use of independent business experts to prepare these tools can add to the credibility of the report and assist in the approval process.
Collateral refers to the cash and assets a business owner pledges to secure a loan. It is more commonly known as loan security. In addition to having good credit, a proven ability to make money, and business assets, banks will often require an owner to pledge his or her own personal assets as security for the loan.
Banks require collateral because they want the business owner to suffer if the business fails. If an owner didn't have to put up any personal assets, he or she might just walk away from the business failure and let the bank take what it can from the assets. Having collateral at risk makes the business owner more likely to work to keep the business going, as banks reason it.
At present, many banks require a floating charge on the business, personal guarantees from the shareholders and asset backing to secure the loans.
Capital refers to the capital assets of the business such as property, fixtures & fittings, machinery, stock and cash. Banks consider these assets so that in case of loan default they can sell the property, machinery etc. However, these assets depreciate so for the banks cash is considered to be the best asset.
It is important to emphasize that these are only some of the criteria that banks use to provide finance and this list is by no means exhausting. Additional criteria will be covered in future articles.