Investments, Corp. Finance and Financial Markets Essay - 1

Investments, Corp. Finance and Financial Markets - Essay Example This has adverse effects on the financial institution such as insolvency and therefore banks employ the 5 C’s of Credit Scoring to evaluate whether or not a person should be entitled to a loan. The 5 C’s are based on the characteristics of the borrower and are explained in detail as follows. Character- The bank seeks basic information from the borrower such as his trustworthiness, integrity, work, reputation based on previous history with lenders, any defaults. Some of this information could be accessed easily through credit reports. A credit report is a report generated by the Credit Reference Bureau detailing information on a person’s credit history including identifying information, credit accounts and loans, bankruptcies, late payments and enquiries. Because credit history shall make up the biggest percentage of a borrower’s eventual credit score, it makes sense that he focuses his attention on that factor. This helps evaluate whether he is credit worthy. Capital- The borrower’s equity or net worth is checked in comparison to the amount he so wishes to borrow. If the capital invested is way below the amount borrowed, then that could raise red flags in his ability to repay the loan. Capacity- The borrower is gauged on his sufficiency of yielding positive cash flows during the loan repayment period and the amount is pre-calculated using different analysis criteria such as the Net Present Value, Profitability Index. If he passes this stage, he has to provide a credible plan on his willingness to repay his loan when it’s due. Conditions- Economic conditions dictate whether a loan should be granted to a borrower. For instance, in periods of economic recovery or boom, it is safe for a borrower to be granted a loan because chances of him defaulting are minimal. However, in the recession period, it’s most likely that the borrower will not be in a position to fully settle his obligations and therefore banks