Banking Operations and Risk Assessment

Posted on Nov 25, 2024 in Economy

Bank Debt and Asset Operations

Factors Affecting Asset Operations

Banks primarily take money from customers as deposits and offer it to others through various asset operations like loans and discounts. This financial intermediation involves the risk of borrowers defaulting, so banks must assess the creditworthiness of customers—their capacity to repay—before lending.

To counterbalance risks, banks may require customers to purchase additional products or clear payroll and bills.

In essence, providing asset operations depends on the risk involved and the potential return.

Risk Assessment in Asset Operations

Lenders carefully evaluate applicants’ repayment ability using internal and external information sources.

Internal information comes from previous interactions with the bank or data provided in the loan application, including income, assets, and personal circumstances.

External information is gathered from agencies like the Property Registry, the Bank of Spain’s Risk Information Center, and credit reporting agencies.

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

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 by charging the obligated party.

This process carries the risk of non-payment at maturity.

Bills 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. Its negotiable nature provides legal protection for collection.

Risk in Discounting Bills

Banks consider the number of parties involved and creditworthiness when discounting bills. More parties increase the chances of recovery.

Acceptance, where the drawee agrees to pay, increases security. Banks prefer accepted bills.

Endorsements (guarantees) also reduce risk, as the bank can claim payment from the guarantor.

A high ratio of bad debts (returned effects) indicates unreliable business relationships and significant risk for the lender. A ratio above 20% is considered alarming.

To increase security, banks often use a policy to discount bills of exchange to ensure a legal path for reclaiming unpaid amounts.

Discounting Other Documents

• Discounting Receipts: Used for deferred sales, but unlike bills of exchange, receipts are not securities and cannot be endorsed or accepted, increasing the risk for the bank.
• Discounting Certificates of Work: Used for phased payments in large projects, with delays being the main risk factor.
• Discounting Promissory Notes: Notes are securities where the issuer promises to pay a certain amount at maturity. Banks assess the issuer’s creditworthiness and may require endorsements.
• Discounting Remittances: Multiple documents discounted simultaneously, with various calculation methods for interest and fees.

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.

Credits are often used by businesses needing flexible access to funds, while loans are suitable for specific purchases or investments.

Risk in Loans and Credits

The risk lies in the possibility of non-repayment. Banks mitigate this by assessing creditworthiness, requiring guarantees, and documenting the transaction.

• Scoring: A risk assessment system used for consumer loans, assigning scores based on applicant characteristics.

Unsecured Loans

Based on the principle of universal liability, borrowers are responsible for repayment with all their assets. The risk is higher for unsecured loans due to the lack of collateral.

Secured Loans

When the risk is high, banks may require collateral, such as pledges or mortgages.

A pledge involves using an asset as security. A mortgage is a security right on specific movable or immovable property.

• Collateral Loans: Less frequent, involving possessory pledges, typically securities or investment funds.
• Mortgage Loans: Common for real estate purchases, with terms ranging from 10 to 20 years, often accompanied by insurance.

Credit Accounts

Credit accounts are current accounts with a credit limit. Borrowers can access funds through checks, transfers, etc. Interest is charged on the drawn amount, and various commissions may apply.

Overdrafts or exceeding the limit are penalized with high interest and fees.

Current Account Overdrafts

Overdrafts are essentially undocumented loans granted based on trust. They are restrictive and penalized with high interest and fees. The law limits interest rates for overdrafts to individuals.

Bank Guarantees

Banks may guarantee obligations on behalf of clients, known as signature loans or guarantees. These transactions don’t involve immediate funds but carry risk. Profitability comes from fees charged on the guaranteed amount.

Guarantees are documented through letters or forms and secured by a counter-guarantee policy notarized by a notary.