This document discusses the nature of credit and the credit process. It begins by outlining the key concepts around credit intermediation and how financial institutions bridge the gap between depositors and borrowers. It then describes the various instruments used by governments and central banks to regulate credit activity, such as statutory reserve requirements, interest rates, and capital adequacy ratios. Finally, it outlines the four main stages of the credit process: business development, credit evaluation, credit monitoring, and credit recovery.

1. CHAPTER 1 :
NATURE OF CREDIT

2. LEARNING OUTCOMES
 Basic concepts in credit
 Intermediation process
 Risk and return
 Various instruments in government regulations
affecting credit activity
 Determine factors influencing credit activities
 Identify various stages in credit process

3. INTERMEDIATION PROCESS
 Introduction
 The financial services industry touches the lives
of every individual, household and business
within the economy.
 Individuals and households provide savings to
financial institutions which transform them into
financial assets.
 In this content, financial institutions act as
financial intermediaries bridging the distance
between depositors and borrowers.

4.  Process of Intermediation
**The players in this Financial Services Industry are known
as Financial Services Firms and they consists of the
following:
 Commercial Banks;
 Merchant Banks;
 Finance Companies
 Scheduled Institutions
DEPOSITORS (with surplus units)
Financial Services Industry (FSI)**
BORROWERS (with deficit units)

5. INSTRUMENTS IN GOVERNMENT
 In a conventional banking system, Central Banks
usually employ six primary methods for
implementing monetary policy :
 Statutory Reserve Requirement
 Minimum Liquidity Requirement
 Interest Rate Regulation
 Selective Credit Control
 Capital Adequacy Ratio
 Base Financing rate / Cost of Financing
 These instruments have a similar effect on the
quantity of money and credit in the economy.

6. STATUTORY RESERVE REQUIREMENT (SRR)
 SRR is one of the oldest monetary instrument
deployed by BNM to control the liquidity situation in
the banking system.
 SRR is a powerful instruments available to BNM
because it affects the level of deposits and loans that
a bank can legally support.
 Any increment in the SRR ratio will:
 Reduce the level of reserve available to the banking
institutions
 Decrease the lending ability of the banking institutions
 Any decrement in the SRR ratio will:
 Increase the level of reserves available to the banking
institutions.
 Increase the lending ability of the banking institutions.

7. MINIMUM LIQUIDITY REQUIREMENT (MLR)
 Under 38(1) of the BAFIA 1989, the banking
institutions are required to observe a minimum
liquidity ratio.
 The ratio is also expressed as a percentage of the
EL based on the banking institutions.
 The current definition of liquid assets are:
- Cash - Cagamas Bond
- Money at Call - Treasury Bills
 It operates in the same manner as the SRR.
Therefore when the liquidity ratio is raised, the
amount of deposits and loans suppled by the
reserves will decrease.

8. INTEREST RATE REGULATION
 An important instrument which BNM can control
including the bank’s liquidity and cost of bank
credit through the interest rates charged on bank
loans as well as the rates of interest offered for
deposits.
 Increment of the interest rate will :
 Increase the level of cost of funds for the banks loans
 Decrease the demand for bank loans
 Decrement of the interest rate will :
 Decrease the level of cost of funds for the banks loans
 Increase the demand for bank loans

9. SELECTIVE CREDIT CONTROL
 Credit facility is important to all economic
sectors but due to certain consideration, some
sectors need special protection.
 Guideline on lending to these priority sectors are
issued by central bank in order to achieve the
target loans to these sectors.
 This priority sectors comprise of small and
medium industry, Bumiputra community,
agricultural sector and low and medium house
buyers.

10. CAPITAL ADEQUACY CONTROL (CAR)
 Capital Adequacy Ratio (CAR) is a ratio that
regulators in the banking system use to watch
bank's health, specifically bank's capital to its
risk. Regulators in the banking system track a
bank's CAR to ensure that it can absorb a
reasonable amount of loss.
 Regulators in most countries define and monitor
CAR to protect depositors, thereby maintaining
confidence in the banking system.
 Capital adequacy ratio is the ratio which
determines the capacity of a bank in terms of
meeting the time liabilities and other risk such
as credit risk, market risk, operational risk, and
others. It is a measure of how much capital is
used to support the banks' risk assets.

11. BASE FINANCING RATES (BFR) / COST OF
FINANCING
 is the cost and interest and other charges
involved in the borrowing of money to purchase
assets.

12. FACTORS INFLUENCING CREDIT ACTIVITIES
 Credit activities will be affecting by several
factors which will resulting the fluctuation based
financing rate, demand for credit and profit rate.
The several factors are known as:
1.Economics conditions
 During the economic growth, demand for
financing will be increase rather than during
recession. Credit activities based on economic
condition will be affected through investment
spending and consumer spending which will
increase growth domestic product (GDP).

13. 2. Supply of money and interest rate
 Supply of money and interest rate also affected
the credit activities. But it depends on the
economic situation. For example, during
economic growth supply of money from depositors
will increase. Many people will invest and saving
to the financial institutions.
 So, the supplies of money are increase resulting
demand for financing increase. With the
competitive profit rate offer by financial
institution encouraged customer to demand for
financing also. But, during the recession it will
be supply of money decreased and profit rate for
financing increased resulting decreased demand
for financing.

14. 3.Government regulations and policies
 Bank Negara Malaysia is a Central Bank of
Malaysia. Act as a protector of depositors and
deposits almost to the safety. BNM also act as to
maintain stability of financial system and to
structures financial system with intention to
avoid customer from the monopoly power of
banks.
 So, in order to resembling BNM roles, Bank
Negara Malaysia has comes with the regulatory
framework which is the BNM Garis Panduan
GP5, BAFIA (Banking and Financial Institution
Act 1989 and Capital Adequacy Guidelines 1989.
In 2011 BNM has state the new pre-requirement
to financial institution in Malaysia where is
credit assessment must be done by evaluating
customer’s net income.

15.  This regulation and policies will change time to
time depending on the economic situation. When
the economic are stable, the regulation and
policies would be more flexible to increase
business activities but different in the recession.
4. Competition among banks
 Competition among financial institution always
happens in order to achieve higher market share
in financial portfolios and all together affected
credit activities. Hence, anywhere of financial
institutions offers the best and better facilities to
customer will get attentions form customers.

16. STAGES IN CREDIT PROCESS
 Credit process is the basic concepts in the credit
environment. There are four main stages of credit process.
First, credit officer will market bank’s facilities to the
potential customer (STAGE 1: BUSINESS
DEVELOPMENT). After having a potential customer, he
will ask for customer details (job, income, address, identity
number and the others requirement) to do a credit
analysis. Hence, credit officer must know the sound
lending principle or known as a credit analysis (STAGE 2:
CREDIT EVALUATION). Once the financing has
approved, credit administration and monitoring will be
required (STAGE 3: CREDIT MONITORING). If the
borrower default or failed to fulfil the payment in the right
time, credit officer must study the remedial actions
suitable to the customer (STAGE 4: CREDIT
RECOVERY).

17. STAGES IN CREDIT PROCESS
STAGE 1: BUSINESS DEVELOPMENT
BUSINESS DEVELOPMENT CAN BE DONE
THROUGH THE SELLING CYCLE

18.  PROSPECTING
 Involve the opportunities to find out the business require
financing. During this process, credit officer must identity
and aware of the credit risk and business condition because
different company has different business condition and
credit risk towards financial institutions. If credit officer
failure to identify the credit risk there will potentially
negative impact to bank’s portfolio.
 DATA COLLECTION
 Credit officer will collect preliminary information with
respect to the background and nature of the business and
industry that it’s operates from, the pricing of the
financing based on market conditions and the type and
value of security offered.

19.  ANALYSIS AND MEETING
 Credit officer should arrange to meet the prospective
customer for the purpose of making a site visit to the
premises to gather more facts about the business. This site
visit is normally recorded into a Call Report and submitted
to the bank management for further comments.
 SELLING AND NEGOTIATION
 During the meeting and if there is sufficient information to
make proposal, the credit officer may proceed to discuss the
financing structure to ensure that the prospect is able to
make repayments. This negotiation with the prospect
involves bank’s willing to sell his financial products at the
highest level of profit rate and the prospect hoping to gain
the lowest possible profit rate.

20.  CREDIT MEMORANDUM
 If the selling negotiations appear accommodative to both
parties, then the credit officer will proceed to prepare a
credit memorandum or application for Accommodation
(AA) to recommend the proposed financing to the finance
committee for their approval.
 APPROVAL OF OFFER
 Upon the approval of committee by endorsing the Credit
Memorandum, the officer will proceed to prepare a Letter
of Offer and to forward to the prospect for his acceptance.
In the event the offer is not accepted by the prospect,
renegotiations will have to commence. Once the offer has
met with acceptance, the officer will proceed to initiate the
selling cycle with another new prospect.

21. STAGE 2: CREDIT EVALUATION
 Credit analysis covers the following:
i. Quantitative aspect
ii. Qualitative aspect
iii.Documentation process
iv. Security and other legal aspects
v. Profitability and relationship
vi. Capital adequacy ratio compliance

22. STAGE 3: CREDIT MONITORING
 Follow up aspects on the financing account
includes:
i. Annual or interim reviews
ii. Reassessment of existing terms and conditions
iii.Renewal of financing facility
iv. Re-establishment of borrowing relationship with
issuance of a fresh Letter of Offer and Customer’s
acceptance of the renewed facility

23. STAGE 4: CREDIT RECOVERY
 Comprises the following actions:
i. Winding-up proceeding by means of legal action
on the company
ii. Enforcement of guarantees against guarantors as
individuals
iii.Receivership via appointment of Receivers and
Managers (R&M)
iv. Foreclosure by way of auctioning a landed
property
v. Turnaround of restructuring by salvaging the
company to generate cash flow.