Bank Loans, Credits, and Guarantees

Posted on Nov 28, 2024 in Economy

Bank Debt and Asset Operations

Bank debt is the source of funds that banks and other financial institutions invest in their assets.

Factors Affecting Asset Operations

Banks’ core business is taking deposits and lending money to customers through various asset operations (loans, credits, discounts, etc.).

This financial intermediation involves the risk of borrowers defaulting. Therefore, institutions must assess the creditworthiness of customers—their capacity to repay the borrowed amount plus interest.

To counterbalance risks, entities may require customers to purchase additional products or services.

The provision of asset operations depends on the risk involved and the potential return.

The Risk of Asset Operations

Lenders carefully assess the applicant’s ability to repay by consulting internal and external sources.

Internal information includes data the bank already possesses or information provided in the loan application (income, assets, personal circumstances).

External information comes from agencies like the Property Registry, the Bank of Spain’s Risk Information Center, credit reporting agencies, other financial institutions, and even suppliers.

The repayment period also influences risk. Longer periods increase uncertainty and the potential for unforeseen circumstances.

Trade Discount and Discounted Notes

Commercial transactions often involve deferred payments, creating credit claims materialized in documents like bills and receipts.

Trade discount involves transferring these documents to a bank, which anticipates the amount minus interest and commissions. The bank then recovers the loan upon maturity.

This carries the risk of non-payment, requiring the customer to refund the bank.

The Bill of Exchange

A bill of exchange is a negotiable instrument where the drawer orders the drawee to pay a sum to the payee at maturity.

The Risk in Discounting Bills

Banks consider the number of endorsements and the drawee’s creditworthiness. Acceptance by the drawee increases security.

Endorsements reduce risk, but excessive endorsements may indicate a saturated drawer.

A high ratio of bad debts (e.g., over 20%) is alarming and may deter banks from discounting.

To increase security, banks often use a policy to discount bills of exchange and other operations, ensuring an executive path for reclaiming unpaid amounts.

Discount of Documents

Discount Bills

Companies in intensive sectors often use discount bills to improve cash flow. These are similar to bills of exchange but cannot be endorsed or accepted, increasing the bank’s risk.

Discount Certificates of Work

Certificates of work are used for phased payments in large projects. Delays in payment pose the main risk for the discounting bank.

Forfeiting

Banks offer forfeiting for deferred payments, similar to discounting bills of exchange. Companies also issue their own promissory notes, often with longer maturities.

Banks assess the issuer’s creditworthiness and may require guarantees from the customer.

The Discount of Remittances: Negotiating Bills

Remittances involve discounting multiple documents simultaneously. Banks use various calculation methods, including applying a single interest rate, charging fees per letter, or treating each document individually.

Loans and Credits

While both involve providing funds, loans and credits have distinct characteristics.

A loan is a contract where a lump sum is disbursed, and repayment follows a predetermined schedule.

A credit allows the client to access funds up to a limit, repaying the used amount at the end of the period.

Loans are suitable for situations requiring the full amount upfront (e.g., property acquisition). Credits are used by businesses needing flexible access to funds.

The Risk in Loans and Credits

The risk is non-repayment. Banks mitigate this through customer assessment, guarantees, and proper documentation.

Evaluation Scoring

For high-volume, low-value loans, banks use scoring systems to assess risk quickly. Points are assigned based on factors like occupation, age, income, etc.

Loans on Personal Guarantee

Based on the principle of universal liability, borrowers are responsible for repayment with all their assets.

Unsecured loans carry higher risk for the lender, requiring careful assessment of the borrower’s reliability.

Secured Loans

For high-risk loans, banks require collateral, such as pledges or mortgages.

A pledge involves using an asset (securities, goods, etc.) as security. A mortgage uses real estate or specific chattels.

In both cases, the creditor can sell the collateral upon default.

Collateral Loans

Less frequent, these involve a possessory pledge, often of securities or investment funds.

Mortgage Loans

Commonly used for property purchases, these loans typically have long terms (10-20 years) and often include insurance.

Credit Accounts

These are current accounts with a credit limit. Borrowers access funds through checks, transfers, etc.

Interest is charged on the drawn amount. Overdrafts are penalized with high interest and fees.

Current Account Overdrafts

Overdrafts are essentially undocumented loans granted based on trust. They are restrictive and penalized due to the higher risk.

Bank Guarantees

Also known as signature loans, these involve a bank guaranteeing a client’s obligations. The bank doesn’t disburse funds unless the client defaults.

Profitability comes from fees charged on the guaranteed amount.

Guarantees can be for a specific period or indefinite, depending on the situation.

They are documented through letters or forms and a counter-guarantee policy.

Differences Between Loans and Credits