As a business model, banks are involved in the borrowing and lending of money, for the sake of generating a profit. But this business model does have its own inherent risk, due to economic conditions and the lending practices utilized by a bank. In the course of this article, we shall endeavor to look at the various factors banks consider to lend money to various individuals and organizations. So if you are looking to access a loan, or are would like to gain some familiarity on the factors in banking that affect how they lend money, then this should act as a guide for that very purpose.
Lending activity in the banking system is driven mostly by the need to generate a reasonable rate of return, according to prevailing market conditions. You will often that in periods of high economic growth and confidence, banks prefer to lend to the private sector and individuals, while charging a reasonably low interest rate. Therefore, you will often find that during period of high economic growth, there is a high access to credit facilities to those interested in taking up a loan. On the contrary, during recessive economic conditions, banks will typically have a lower risk appetite, and may use stricter criteria to access those individuals or corporations that are interested in taking up a loan.
Banks will normally weigh the risk of lending to a particular party, against the return achieved. Banks will often perform a background check on the borrower’s financial history, to determine whether they pose any risk, in regards to default paying on the loan. Once the necessary checks have been performed, they will lend money at a rate of interest that corresponds to the borrower’s credit worthiness. Government legislation also has an effect on the lending activities performed by banks. Governments can affect lending activity in the banking system by raising or lowering the level of interests, which affects the amount of interest banks will charge for loans. On top of that, banks are bound to follow the regulations stipulated by financial regulators, such as the Federal Reserve Bank or the European Central Bank, which may raise or lower the reserve requirements banks are required to maintain at any given point. The higher the levels, the lesser amounts they can loan, and vice versa.
Tips and comments:
If you are considering taking up a loan through a bank, it would be wise to shop around for different interest rates. The point differences may not be so much, but if you can manage to reduce the cost of the loan by just a few points, they benefit will to your advantage in the long term. Also make sure to read the fine print, so as to ensure you are fully conversant with the terms and conditions you are bound to follow, in the loan period. Either way, banks will always make the best effort to lend money at a reasonable rate of return, but with a given amount of risk taken into consideration, so as to safeguard capital.
