What Does A Bank/Financial Lender Look For When Giving A Business Loan?

Today, the business world market dynamics are rapidly changing and expanding. Serious considerations are to be made by businesses to expand their reach to catch up with these changes. A business loan is an essential tool businesses employ to infuse capital for growth and maintain consistent cash flow. In today's world, one can easily secure a business loan online within a few minutes. However, sometimes it becomes difficult for businesses to secure a business loan online from a bank or personally from a financial lender. 

One main reason for unsuccessful attempts to secure a business loan is unawareness of factors banks, or financial lenders consider before business loan approvals. 

Generally, there are five (5) fundamental factors on which a business loan application is assessed. These factors are commonly known as the "Five Cs" of credit: capacity, collateral, capital, character, and conditions. As most business loans are unsecured, banks/financial lenders tend to consider these factors seriously. 

This article aims to discuss each fundamental factor of credit in detail. 

Capacity

The capacity of the business to repay is an important factor considered by bank/financial lenders before granting a business loan. The credit score is a widespread criterion to assess the repaying capacity. While applying for a business loan online, the credit score is automatically calculated after filling necessary information. It mainly considers the past repayment history of loans and current debt owed by the business. Credit Information Bureau India Limited (CIBIL) is a credit information company in India authorised by the Reserve Bank of India (RBI). It provides a three (3) digit credit score between 300 to 900, indicating creditworthiness: the higher the score, the higher the creditworthiness, and the higher probability of repayment of the loan. Bank/financial lenders generally grant loans on a credit score above 700, which shows good credit history and higher money management skills. Thus, businesses with higher credit scores and higher creditworthiness (capacity to repay) are more likely to get a business loan than others with a lower score and lower creditworthiness. 

Collateral 

Collateral is an immovable property pledged as a security with a bank/financial institution to secure the repayment of a loan, and on default, fortified by the lender. Collateral could be property, business assets, or vehicles, etc. However, as mentioned earlier, a business loan is generally unsecured, so collateral is not required, but collateral gives the lender a sense of assurance and increases the chances of loan approval. In some cases, a bank/financial institution particularly requires collateral before sanctioning a business loan. Collateral is assessed to determine its current and future value. A bank/financial institution generally never grants a loan of an equal or higher value than collateral value. For this purpose, they determine the loan-to-value ratio. Hence, collateral becomes crucial to get secured loans from banks/financial institutions.

Capital

Capital in business refers to assets owned by a business for its fixed expenditure, day-to-day expenses, future expansion, and other things. It could be anything that generates value for a business. Capital is divided into three types when financial planning for a business, namely working capital, equity capital, and debt capital. Banks/financial institutions tend to evaluate capital to assess whether the return from the sold-off assets will suffice to make good their loss due to a default on a loan. 

To a bank/financial institution, the more capital invested in a business, shows higher commitment to a business's success. The lower the capital, the harder it is for a bank/financial institution to recoup its losses. It gives a sense of assurance to lenders that in case of default, at least capital invested would be there to minimise their losses. Thus, capital is one of the critical factors banks/financial institutions consider when granting a business loan. 

Character 

The character or reputation of the business in the market is of important consideration for banks/financial institutions. Although character is not black or white, many factors like past repayment records of debts, business references, business products quality, and other financial factors contribute to building a business reputation. Banks/financial institutions will hesitate to grant loans if a business has a bad repayment history because of fear of default. Good character shows resilience and integrity and customers’ faith in a business. A good reputation in the market and amongst customers reflects a business's commitment towards delivering satisfactory products and its potential to achieve higher milestones. Hence, a business must showcase stability, consistency, and reliability to banks/financial institutions to repay their loans on time. 

Conditions

Conditions of the market are a factor outside the control of businesses, yet a lender places reliance on it while granting a business loan. The market conditions of an economy depend on various factors like sectoral growth, growth of GDP, repayment history of previous loans, industry prospects, state of various financial ratios released by RBI, etc. All data and factors influence banks/financial institutions decisions’ to grant a business loan. The lender might refrain from extending a loan for a business operating in a high-risk or seasonal business sector, while they might grant a business loan to a business operating in a high-growth industry. 

Lastly, different banks/financial institutions have different eligibility criteria for granting a business loan. However, a few standard documents are required by most. These include identity proof, address proof, financial statements, income tax documents, business ownership certificates, and such. Thus, verify and confirm important documentation necessary before applying for a business loan online. 

Conclusion

Although factors taken into consideration vary with each lender, the above-discussed are common when granting business loans. Therefore, anyone applying for a business loan must ensure that their Five Cs of credit are strong enough in the opinion of banks/financial institutions.