Credit appraisal is the evaluation process conducted by financial institutions, such as banks or lenders to assess the creditworthiness and risk associated with extending credit to a borrower. It involves analyzing various aspects of the borrower’s financial health, including their income, assets, liabilities, credit history, and repayment capacity. The aim of credit appraisal is to determine whether the borrower is likely to repay the loan or credit facility as agreed. 

What Are The Steps involved in Credit Appraisal?

The process of credit appraisal consists of the following steps

Step 1: Credit Processing: All applications and necessary information are gathered by the bank and processed. The application provided by the customer must provide the explanation clearly for why the credit is required. Further, all the information provided must be authenticated. 

Step 2: Documentation: The borrower has to provide supporting documents, such as income statements, bank statements, property documents, tax returns, and identity proofs according to the lender’s requirements. 

Step 3: Credit investigation: The lender runs a thorough investigation to verify the borrower’s credit history, employment details, income stability, and any outstanding debts. This may involve contacting employers, references provided by the borrowers, and the credit bureaus. 

Step 4: Financial assessment: The lender analyzes the borrower’s financial statement including income, expenses, assets, and liabilities. This helps the lender to evaluate the borrower’s repayment capacity and financial stability. 

Step 5: Risk Assessment: The lender evaluates the risk associated with lending to the borrower based on factors like credit history,  collateral (if applicable), market trends and conditions,  and the purpose of the loan.

Step 6: Loan Structuring: After doing the investigations on credit, finance, and risk, if the results are satisfactory, the borrower will give a structure to the loan based on loan amount, repayment tenure, interest rate, and additional charges. 

Step 7: Decision to Grant Credit: The lender makes the decision to approve the loan application based on the credit appraisal. The application will get approved if the results are satisfactory. He/she may also ask for additional details and collateral if required. 

Step 8: Administration: The final step of the credit process is to ensure that financial institutions are administering their credit portfolios meticulously. These include writing out proper loan agreements, renewal letters sent out in a timely manner, and ensuring that records are up to date. Most large organizations have a committed administration department that overlooks the administration. 

What Is The Eligibility Criteria For Credit Appraisal?

Eligibility for credit appraisal varies across financial institutions. However, here are some common eligibility criteria. 

  • A good credit history: A good credit history and a good repayment track record increase the borrower’s eligibility. 
  • Loan To Cost Ratio: This ratio is computed for the lender to understand how much the borrower can pay based on the total loan amount requested. Actually, this ratio calculates how much can be lent to the customer. 
  • Income and Stability: Lenders assess the borrower’s income level, employment stability, and capacity to repay the loan. 
  • Debt-to-Income Ratio: Lenders evaluate the borrowers based on their debt to income ratio. This is the ratio of their monthly debt payments to their monthly income. The lower the ratio, the higher the repayment capacity. 
  • Collateral (If applicable): The value and quality of the collateral provided by the borrower are considered for secured loans. 

What Are The Benefits of Credit Appraisal?

The benefits of doing pre-sanction appraisal are as follows:

  • Risk Analysis: This analysis is done to help banks understand the risk involved in lending money to an employee. The lower the risk, the more ready banks are to lend money to individuals. 
  • Confidence Among Banks: The creditworthiness of the individual is determined through credit appraisal. So, it gives a sense of confidence to the lenders about the repayment capacity of the borrower. He/she will be sure that the installments are paid on time. 
  •  Helps Determine Loan Amount: Credit appraisal helps in determining the loan amount that can be lent to the borrower. This way, the borrower will repay the loan on time and the banks will not incur a loss. 

What Are The Factors Evaluated During Credit Appraisal?

  •  Credit history: The borrower’s past credit behavior and credit score are reviewed to determine their reliability in repaying debts. 
  • Income and employment stability: The borrower's income level and stability of employment are assessed to ensure their ability to meet repayment obligations.
  •  Assets Owned: This information is analyzed and kept with the bank. It will be used as collateral if the borrower is not able to repay the amount borrowed
  • Liabilities Owned: This ensures that the borrower has not defaulted on any previous payments and has minimum liabilities that they can afford to pay off. 

Parameters involved in The Credit Appraisal Process

  • Industry and Market Analysis: An assessment of the industry and market conditions helps in evaluating the applicant's ability to generate sufficient cash flow for loan repayment.
  • Bankability: It is a very important parameter that is involved in doing credit appraisal. It refers to what will be accepted by a particular bank. A lender will evaluate if a loan given to a certain person will lead to cash flow and profitability in the future.
  • Business Plan: Start-ups and new businesses have to present a complete business plan that shows their strategy, market analysis, financial projections, and repayment plan. These parameters can vary depending on the specific requirements of the lender or the financial institution you are dealing with.
  • Technical Feasibility: The bank verifies the living conditions and the standard of living of the borrower. This is an important factor in determining whether the individual is creditworthy or not. 
  • Economic Viability: This is where factors such as LTV and FIOR are taken into consideration. The borrower’s credit history is checked to ensure that the individual will be able to repay the funds that were provided as credit

Conclusion

Credit appraisal is an important process for financial institutions in order to ensure that borrowers are creditworthy and that they can afford to repay the amount. This should be done meticulously by financial institutions in order to make sure that there is no financial loss and bad debts. 

FAQS

  • What are the documents required to be submitted to prove your bankability?

The documents required to be submitted to prove your bankability are, income proof documents which include most recent bank statements for 3 to 6 months, most recent salary slips, most recent income tax returns, and audited financials for the previous 2 years. Address proof documents which include leave and license agreement, latest electricity bills or utility bills, aadhaar card, driving license, and passport. Identity proof documents that include aadhaar card, PAN card, voter ID, driving license, and passport size photographs. Employment proof documents which include a letter from your employer, offer letter or appointment letter provided by your employer, office address proof, employment certificate from your present employer, and Certificate of experience or relieving letter from your previous employer(s) to display your overall work experience. 

  • What are the 5 key C’s that shape the credit appraisal process?

The 5  key C’s are, character, capacity, conditions, collateral, and capital.