When applying for credit from the bank, individuals must be prepared for a stringent process. Banks use a credit analysis process to compile a bank rating and creditworthiness assessment.
These tools provide a clear picture of financial standing. By assessing creditworthiness as well as creating a rating, banks can figure out risk levels applicants have. Low creditworthiness means that individuals are highly likely to default on payments. Credit ratings are also used for gauging levels of risk.
Certain ratios are used for working out the bank rating and creditworthiness of an applicant.
Efficiency
This shows the ability to convert the resources it has into revenue. It looks at how well the organisation is being run.
Profitability ratio
This ratio calculates the ability of an organisation to make profit which can cover costs. It is a good indicator of creditworthiness.
Capital adequacy
This ratio looks at the portion of assets that have been financed by the owner’s resources. The higher the investment made by the owner, the better the level of creditworthiness. This means that an individual will have a better chance of being approved, because lenders favour those willing to take on some of the risk of investing.
Liquidity
This measures how well an individual or business is able to meet its short term obligations.
Factors influencing creditworthiness:
External Factors
- Business environment
- Exchange rates
- Demand for credit
- Propensity to save
Internal Financial Factors
- Shareholders
- Mandate
- Operations
- Liquidity/ Funding
Non-financial factors
- Management Quality
- Ownership structure
- Controls on lending
The ratios offer simple tools for making sense of banks’ decision-making when it comes to granting credit.
