Journal of Applied Finance & Banking

Bank Lending To Corporations: Scenario Analysis as an Alternative to Traditional Metrics

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  • Abstract

    For most financial institutions today, lending is a multi-step process that often is separated from credit review. In an ideal situation, the credit proposal delineates the inherent risks to the transaction. However, the thrust of the credit approval is more often the internal selling of the deal. As such, the credit proposal, if it does err, errs in overselling the strengths of the credit and in underestimating the risks in the transaction. The author examined some twenty loan agreements, and in every company or industry that was analyzed, the problems experienced could not have been discovered by traditional credit analysis. There can be no substitute for the initial step of appropriate due diligence of past and expected results. Bankers should run scenario testing of pro forma financials, which applies probabilities to various future states, and a joint expected value is then calculated. The concept can only be effective if research is conducted to determine the causal factors that affect loan repayment. There is a gap in the literature in analyzing the behavior of corporate borrowers. The author suggests that non-performing loan experience should be studied over several years to develop regressions on various independent variables.