5 Cs of Credit

Banks must do a credit analysis before giving the loan, and the 5 Cs of Credit is a good way to understand the potential of a loan application.

Credit analysis covers analyzing the borrowers’ character, capacity to use loan amount, capital condition, objectives of taking the loan, planning for uses, probable repayment schedule, etc.

Loan activity is one of the risky functions of a bank. This is risky because a major portion of the loanable fund is the depositors’ money.

5 Cs of Credit

5 Cs of Credit are;

  1. Character
  2. Capacity
  3. Capital
  4. Collateral
  5. Conditions


Character (credit character) refers to the prospective borrower’s reputation in meeting the bank’s obligations upon maturity. This includes certain moral and mental qualities of integrity, fairness, responsibility, temperance, trustworthiness, industry, and the like credit character is a relative matter.

The character will the potential borrower repay the loan according to the loan contract;

  • Past track record of loan transactions with this bank.
  • Information from other lenders.
  • Examining the accuracy of the information provided in the loan application.


Capacity refers to the ability of the potential borrowers to repay the debt when it falls due. It indicates the borrower’s competence to utilize the loan effectively and profitably.

This is a significant variable of credit analysis as the customers’ ability to repay depends on their earning capacity.

Here, the bank must check the loan applicants’ capability of repaying the loan;

  • Monthly cash inflow over monthly cash outflow.
  • Stability and certainty of the source of income.
  • Stability of the financial condition.
  • Positive liquidity condition.


Capital represents the general financial position of the potential borrower’s firm with a special emphasis on tangible net worth and profitability, indicating the ability to generate funds continuously over time.

The net worth figure in the business enterprise is the key factor that governs the amount of credit that would be made available to the borrower.

The bank must find out whether the loan applicant can collect funds from alternative sources to repay and face adverse situations;

  • Amount of net assets
  • Amount of personal assets in case of proprietorship or partnership business.
  • The uncalled portion of capital from the shareholders.


Collateral is represented by assets that may be offered as pledges against loan extension. Collateral in pledged assets compensates for a deficiency in one or several of the first three ‘Cs.’ Collateral thus serves as a cushion or shock absorber if one or several loans are on maturity.

Bank needs to check whether the sale proceeds of the collateral will be sufficient to satisfy the full loan obligation.

  1. Loan to collateral ratio.
  2. Easy marketability.

Questions When Evaluating Collateral

The Commercial Bank Examination Manual suggests that lenders ask the following questions when evaluating collateral:

  1. Is negotiable collateral held under joint custody?
  2. Has the customer obtained and filed for released collateral sign receipts?
  3. Are Securities and commodities valued and margin requirements reviewed at least monthly?
  4. When the support rests on the cash surrender value of insurance policies, is a periodic accounting received from the insurance company and maintained with the policy?
  5. Is a record maintained of entry to the collateral vault?
  6. Are stock powers filed separately to bar negotiability and deter abstraction of both the security and the negotiating instruments?
  7.  Are securities out for transfer, exchange, and so on controlled by pre-numbered temporary vault-out tickets?
  8. Has the bank instituted a system that ensures that security agreements are filed, collateral mortgages are properly recorded, title searches and property appraisals are performed in connection with collateral mortgages, and insurance coverage (including loss payee clause) affects the property covered by collateral mortgages?
  9. Are acknowledgments received for pledged deposits held at other banks?
  10. Is an officer’s approval necessary before collateral can be released or substituted?
  11. Does the bank have an internal review system that reexamines collateral items for negotiability and proper assignment, checks values assigned to collateral when the loan is made, and at frequent intervals after that, determines that items out on temporary vault out tickets are authorized and have not been outstanding for an unreasonable length of time, and determines that loan payments are promptly posted?
  12. Are all notes assigned to consecutive numbers and recorded on a note register or similar recorded? Do numbers on notes agree with those recorded on the register?
  13. Are collection notices handled by someone not connected with loan processing?
  14. In mortgage warehouse financing, the bank holds the original mortgage note, trust deed, or other critical documents, releasing only against payment.
  15. Have standards been set for determining the percentage advance to be made against acceptable receivables’’
  16. Are acceptable receivables defined?
  17. Has the bank established minimum requirements for verifying the borrower’s accounts receivable and minimum documentation standards?
  18. Are accounts receivable financing policies reviewed at least annually co-determine if they are compatible with changing market conditions?
  19. Have loan statements, delinquent accounts, collection requests, and past due notices been checked to the trial balances used to reconcile subsidiary records of accounts receivable financing loans with general ledger accounts?
  20. Have inquiries about accounts receivable financing loan balances been received and investigated?
  21. Is the bank receiving documents supporting recorded credit adjustments to loan accounts or accrued interest receivable accounts? Have these documents been checked or tested subsequently?
  22. Are terms, dates, weights, descriptions of the merchandise, and other particulars, shown on invoices, shipping documents, delivery receipts, and bills of lading? Are these documents scrutinized for differences?
  23. Were customer payments scrutinized for differences in invoice dales, numbers, terns, and so on?
  24. Do bank records show, on a timely basis, a first lien on the assigned receivables for each borrower?
  25. Do loans granted on the security of the receivables also have an inventory assignment?
  26. Does the bank verify the borrower’s accounts receivable or require independent verification periodically?
  27. Does the bank require the borrower to provide aged accounts receivable schedules periodically?


Conditions imply economic and business conditions that affect the borrower’s ability to earn and repay debt beyond the borrower’s control. Economic conditions include all these factors affecting production, distribution, and consumption processes.

Bank must find out if problems in repaying the loan may arise under the business’s current financial position.

  1. Forecasting of general economic condition during the loan period.
  2. The possibility of the stability of the forecasted source of income of the loan applicant.
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