1. 6 BANK LOANS 6.1 Consumer Loan Theory 6.2 Consumer Loans
Banking
5/27/2018
BANK LOANS 6
6.1 Consumer Loan Theory
6.2 Consumer Loans
6.3 Granting and Analyzing Credit
6.4 Cost of Credit
6.5 Bank Loans and Policy
Chapter 1

2. GOALS Explain asset transformation and modern portfolio theory.
Banking
5/27/2018
6.1 CONSUMER LOAN THEORY
GOALS
Explain asset transformation and modern portfolio theory.
Describe components of consumer lending.
Explain nonloan sources of bank revenue.
Chapter 1

3. TERMS Asset transformation Modern portfolio theory (MPT)
Adverse selection
Captive borrower
Moral hazard
Credit rationing

4. MANAGING A BANK’S PORTFOLIO
Loan categories include
Consumer loans
Mortgage loans
Commercial loans

6. ASSET MANAGEMENT Asset transformation
Using deposits to generate revenue by putting deposits to work via loans
When banks transform liabilities (deposits) into assets (loans), asset transformation has occurred.

7. MODERN PORTFOLIO THEORY
Modern portfolio theory (MPT)
Within any portfolio of investments, diversification should be used to spread out risk
Variation by industry
Variation by maturity dates

8. checkpoint
What is asset transformation?

9. CONSUMER LENDING THEORY
Loan selection
Adverse selection
Borrowers who are most willing to accept a high interest rate are the same borrowers who are most likely to default on their loans
Captive borrower
When borrowers with certain credit characteristics are more likely to prefer one type of lender to another

10. Moral hazard Credit rationing
When a borrower takes greater risks if they think the harm they will incur from those risks will somehow be minimalized
Credit rationing
When banks refuse to provide a loan, or when they lend less than the customer requested

11. DOWNSTREAM LOAN PROFIT
Securitization
When individual loans are pooled together and sold as securities

12. checkpoint
What is adverse selection?

13. ADDITIONAL SOURCES OF BANK REVENUE
Banks generate revenue from
Astutely managing loan portfolios
Charging a variety of fees

14. OFF-BALANCE SHEET ACTIVITIES
A brief summary that lists the net profit, owner’s equity, assets, and liabilities for a company
Public companies have public balance sheets.
Seen by investors
Off-balance sheet activities are not seen by investors.

15. Off-balance sheet activities include
Overdraft protection
Letters of credit
Flex line
When overdraft protection is linked to a home equity line of credit

16. OTHER REVENUE SOURCES
Account service charges
Safe deposit box rental
ATM charges
Insurance sales fees
Trading fees

18. checkpoint
What are three methods of providing overdraft protection?

19. GOALS Define major terms associated with consumer lending.
Banking
5/27/2018
6.2 CONSUMER LOANS
GOALS
Define major terms associated with consumer lending.
Explain the difference between installment loans and open-end loans.
Chapter 1

20. TERMS Installment loan Secured loan Collateral Lien Unsecured loan
Open-end loan
Grace period

21. INSTALLMENT LOANS Consumer loans Installment loan Installment loans
Open-end loans
Installment loan
A loan for which the amount of the payments, the rate of interest, and the number of payments (or length of term) are fixed
Repaid on a periodic basis

22. Personal loans
Vehicle loans
Home equity loans
Education loans

23. SECURED AND UNSECURED LOANS
Some item of value backs the loan in case the borrower defaults on the loan
Collateral
An item of value that secures a loan

24. Unsecured loan (signature loan)
Lien
A legal claim to the property to secure the debt
Unsecured loan (signature loan)
A loan backed only by the reputation and creditworthiness of the borrower

25. LENDING TERMINOLOGY Principal Interest The amount borrowed
The amount you pay to use the principal
Fixed rate
Variable rate
Indexed rate

26. It is important to know how interest is calculated.
Calculated on the declining principal balance as payments are made Or
Payments go toward the interest first, then toward the balance

27. Fees Finance charge Total payments Other charges for the loan
The total dollar amount to be paid for the loan
Total payments
The total amount a consumer must repay

28. Payment Acceleration clause
The amount the borrower repays each specified period
Acceleration clause
Brings the entire loan due if payments are missed

29. checkpoint
What is the difference between a secured loan and an unsecured loan?

30. OPEN-END LOANS Open-end loan The amount owed is flexible
The longer you use the money, the more you pay
The term is flexible

31. Credit cards are a form of consumer loan. Grace period
An amount of time you have to pay the bill in full and avoid any finance charges

32. LINES OF CREDIT Line-of-credit plans Home equity reserve
Overdraft protection plan
Consumers can draw upon this credit as needed

33. checkpoint
What is an open-end loan?

34. 6.3 GRANTING AND ANALYZING CREDIT
Banking
5/27/2018
6.3 GRANTING AND ANALYZING CREDIT
GOALS
List steps in the credit-approval process.
Identify major criteria in a person’s credit rating.
Chapter 1

35. TERMS Underwriting Subprime rates Consumer reporting agency (CRA)
FICO score

36. GRANTING CREDIT
Every borrower represents a potential risk to the lender.
Banks use a well-defined policy of risk management to minimize the risk associated with loans.

37. Credit-related risk management policies include consideration of
The bank’s overall financial position
Reserve requirements
Cash flow
Ratio analyses of liabilities and assets

38. CREDIT-APPROVAL PROCESS
Application
Documentation
Processing
Underwriting
Reviewing the loan for soundness
Making sure the loan is a prudent use of bank funds

39. The three Cs of underwriting
Collateral
Capacity
Credit reputation
Subprime rates
Higher than normal rates set to offset the increased risk represented by a less-than-perfect borrower

40. Closing
Funding

41. checkpoint
What is underwriting?

42. A key factor underwriters review is credit history.
ANALYZING CREDIT
A key factor underwriters review is credit history.
The best way to predict the future is to see how a person has done in the past.

43. CONSUMER REPORTING AGENCIES
Consumer reporting agency (CRA)
A company that compiles and keeps records on consumer payment habits and sells these reports to banks and other companies to use for evaluating creditworthiness

44. Three Major Reporting Agencies

45. Most credit reports contain the following types of information:
Personal data
Accounts history
Delinquent accounts
Public records
Inquiries
Consumers are entitled to a free credit report each year.

46. Example of Credit Report

47. CREDIT-SCORING SYSTEM
A credit-scoring system can provide an efficient and unbiased method of evaluating credit.
These scores place a numerical value on the performance or status of an applicant in various categories.
The points in each category are added for a total score.

48. FICO
FICO score
A three-digit number that credit granters can use in making a loan approval decision
Payment history (35 percent)
Amounts owed (30 percent)
Length of credit history (15 percent)
New credit (10 percent)
Types of credit (10 percent)

49. Credit Score Makeup

50. FICO Score Breakdowns

51. When To Request Your Copy?

52. Creditkarma.com

53. FICO Credit Score Alternative Resource

54. checkpoint
What is a consumer reporting agency?

55. GOALS Identify key factors in the cost of credit.
Banking
5/27/2018
6.4 COST OF CREDIT
GOALS
Identify key factors in the cost of credit.
Explain the impact of negative credit ratings on consumers.
Chapter 1

56. TERMS Revolving credit Sum-of-digits method Previous balance method
Adjusted balance method
Average daily balance method
Predatory lending

57. Credit cards are an example of revolving credit.
WHAT CREDIT COSTS
Revolving credit
A line of credit that has a maximum limit
Can be used on an ongoing basis until the limit is reached
When the balance (or a portion of the balance) is paid off, the credit can be used again until the next time the maximum is met.
Credit cards are an example of revolving credit.

58. REVIEWING APR AND FINANCE CHARGE
The amount of interest charged on the loan principal expressed as a yearly figure
Understanding the total finance charge depends on how interest charges are applied.
Lenders can calculate interest in many different ways, as long as they explain clearly what they are.

59. If interest is paid first Sum-of-digits method
Paying ahead saves the consumer no money
Sum-of-digits method
Takes the total finance charge, divides it by the number of months in the loan term, and assigns a higher ratio of interest to the early payments
Rule of 78

61. PREVIOUS AND ADJUSTED BALANCE METHODS
Previous balance method
Taking the amount owed at the beginning of the billing cycle and calculating interest on that figure
Regardless of payments or charges
Adjusted balance method
Subtracting payments made during the billing cycle
Usually not counting purchases

62. AVERAGE DAILY BALANCE METHOD
The balances for each day of the billing cycle are added and then divided by the number of days in the billing cycle to yield an average figure on which the finance charge is calculated.

63. MINIMUM PAYMENTS
Lower minimum payments increase bank profits, but contribute to greater consumer debt.
Although paying the minimum payment keeps the account in good standing, it doesn’t reduce the principal much.

64. TERM
For installment loans, length of term also affects the total finance charge.
Lenders must disclose the total payments.

65. Based on individual circumstances, consumers should choose between
Taking a shorter loan
Higher monthly payments
Lower total payments
Taking a longer loan
Lower monthly payments
Higher total payments

67. checkpoint
Why is it a good idea for consumers to pay more than their minimum balances on open-ended credit accounts?

68. THE IMPACT OF CREDIT
Healthy economic growth depends upon healthy use of credit.

69. Overextension can result in
A ruined credit rating
Notations of bad credit in your credit record for a seven year period
A more difficult daily life
With disposable income going to service debt

70. Excessive consumer debt is not in banks’ interest.
THE ROLE OF BANKS
Predatory lending
When lenders create problems for consumers by making credit too easily available without regard to the borrower’s ability to pay
Excessive consumer debt is not in banks’ interest.

71. Credit counseling agencies can help consumers
Reorganize debt
Renegotiate terms
Consumers should use counseling agencies with caution.
Some agencies want to make a profit

72. checkpoint
Why do consumers become overextended?

73. GOALS Explain how loans affect a bank’s income.
Banking
5/27/2018
6.5 BANK LOANS AND POLICY
GOALS
Explain how loans affect a bank’s income.
Describe the purpose of a bank’s loan policy committee.
Chapter 1

74. TERMS
Liquidity risk
Credit risk
Market risk

75. LOANS, THE “BOTTOM LINE,” AND LIQUIDITY
Loans and income
Loans are a major income source.
The loan policies a bank sets must protect its income.
Default
Failure to repay a loan as called for in the loan contract

76. Loan factors that affect the lending bank’s liquidity include
LOANS AND LIQUIDITY
Liquidity
Having the funds to meet obligations when required
Loan factors that affect the lending bank’s liquidity include
Loan term
Interest rate
Loan type
Collateral

77. Liquidity risk
The risk that a bank will have to sell its assets at a loss to meet its cash demands

78. CREDIT AND MARKET RISK Credit risk Market risk
The bank’s estimate of the probability that the borrower can and will repay a loan with interest as scheduled
Market risk
The risk that an investment will decrease in price as market conditions change

79. LOAN DECISIONS AND TRADE- OFFS
Making loan decisions is a difficult process that generally requires weighing one factor against another.
Short-term loan
Low risk, relatively quick liquidity, low interest rate
Relatively low profit
Long-term loan
More risk and liquidity concerns, higher interest rate
Higher profit

80. checkpoint
How do credit risk and market risk differ?

81. LOAN POLICY COMMITTEE Lending policy Loan policy committee
A written statement of the guidelines and standards to follow in making credit decisions
Loan policy committee
Sets a bank’s lending policy

82. Five factors are reviewed when administering commercial loans.
Cash flow
Liquidity
Leverage
Collateral
Management

83. Community Reinvestment Act (CRA)
The federal law requiring banks to meet the credit needs of the entire communities they serve, including those with low and moderate income

84. checkpoint
What is the function of a loan policy committee?