The rationale for determining the credit limit is among the most important problems of crediting an enlarged object within the credit line. This is due to the fact that the size of the credit line is due to two factors: the client’s need for borrowed funds and his ability to repay the loan debt in the required amount. In other words, the value of the client’s need for borrowed funds must be measured against the potential possibility of repaying the loan. To reconcile these values, it is advisable to calculate two indicators:
- the limit of the client’s need for borrowed funds and
- the borrower’s credit risk limit (loans).
Comparison of two types of credit limits
The first type of limit is best calculated on the basis of a feasibility study of the need for a loan. In this case, its value will be determined by the aggregate of the client’s costs associated with the object being credited.
The second type of limit, expressing an assessment of the borrower’s credit risk, it is advisable to calculate on the basis of an assessment of the possible sources of repayment of the loan. By comparing these limits, the bank can decide on the most rational limit of the credit line. In this case, in our opinion, it is important to choose the minimum value of one of the two specified limits. This can be a value either within the limits of a feasibility study, if the amount received is within the credit risk limit. It can also be a value within the credit risk limit, if this limit is less than the amount of the need for a loan, calculated on the basis of a feasibility study.
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Approaches to calculating credit limits
Techniques of calculating credit limits can be recommended to Filipino credit organizations. It is also important to pay attention to the method of assessing the borrower’s credit risk. Here, in principle, two approaches are possible. The first approach focuses on assessing the creditworthiness of the client based on the calculation of financial ratios. However, it does not provide an opportunity to determine the absolute amount of the limit. For this, a method of assessing the client’s creditworthiness based on analysis and assessment of cash flows is more suitable.
Unfortunately, this approach in the Philippines context can only be applied mainly to borrowers who have a stable business and have been placing their resources on current accounts with this bank for a long time. Here, however, it should be borne in mind that the definition of future flows, based on data from past years, is not entirely correct. In this regard, the degree of reliability of the forecast may be insufficient.
How to determine the limit of credit risk?
Therefore, to determine the limit of credit risk, you can use another approach – on the basis of assessing the secondary sources of loan repayment: discounting the assets of the borrower or the surety assets.
In this case, the calculation of the credit risk limit should be carried out in the following sequence:
- first, to assess the borrower’s creditworthiness based on the financial ratios chosen by the bank and the criteria levels;
- secondly, to carry out discounting of the borrower’s assets, taking into account the allocation of four groups of assets liquidity and the established discount rate, differentiated depending on the group of liquidity and the class of solvency of the borrower;
- thirdly, to compare the amount of the credit risk limit of the loan to be issued with the maximum value of “large loans”, based on the regulatory requirements of the Central Bank of the Russian Federation.
When calculating the size of the credit line, in our opinion, one should also take into account the particular circulation of the borrower’s funds – its uniform (off-season) or irregular (seasonal) nature. It is known, for example, that trade organizations are credited with their entire cumulative turnover, while the turnover of funds is non-seasonal. This means that a certain part of the loan debt will always be at the disposal of the borrower.