Fundamentals of the loan decision
As part of loan processing in banks, savings banks and other lending organizations (credit institutions), the loan decision represents a particularly important sub-step for the lender. The loan decision is based on the internal lending guidelines of the respective bank, which reflect the institution's orientation in lending business and its risk policy.
In addition, the "minimum requirements for risk management" (MaRisk) issued by the Federal Financial Supervisory Authority (BaFin) must be observed. A loan decision is necessary not only at the time of the initial granting of a loan. Loan decisions are also made when collateral is changed, in the case of overdrafts (exceeding established credit lines) and when a credit exposure is expanded. The back office (market follow-up) must also be taken into account because of BaFin requirements.
Individual creditworthiness as the basis of every loan decision
The basis of loan decisions is a creditworthiness check, in which the probability of default of a particular borrower is usually determined using rating and scoring systems. The individual credit risk is expressed by a rating or creditworthiness class in which each borrower is classified. Rating and scoring systems help the lender make a decision regarding the granting of credit.
"Creditworthiness" (worthiness of credit) comprises, on the one hand, the economic ability of a borrower to repay a loan granted by a lender (repayment ability/economic creditworthiness) and, on the other hand, the borrower's willingness to repay (willingness to pay/personal creditworthiness). As part of the assessment of personal creditworthiness before a loan decision, in addition to willingness to pay, the personal reliability of the borrower is also examined. Creditworthiness is therefore a prerequisite for granting a loan.
Criteria for the creditworthiness check before the loan decision
For private individuals, professional and occupational qualifications are relevant in the creditworthiness check prior to a loan decision. For companies, the qualifications of the management are evaluated. Economic creditworthiness includes a borrower's ability to repay a loan (debt service capacity), where the borrower's past economic development is taken into account and a forecast for the future is made. Data sources for assessing debt service capacity include, for example, proof of income and financial statements.
Important factor in the loan decision: the Schufa report
Information from credit reporting agencies is also included when creditworthiness is checked before a loan decision. For private customers, data from Schufa Holding AG (Schutzgemeinschaft für allgemeine Kreditsicherung) is used, and for commercial customers, information from specialized corporate credit agencies such as Bürgel or Creditreform as well as bank references are used. A Schufa report provides the lender with information on whether there is sufficient assurance that the borrowed money will be repaid.
A Schufa report contains details about income situation, the proper handling of previous credit arrangements, any irregularities in account management and loan repayments, the debt and asset situation, and the matrimonial property regime.
Obtained company reports include information on the legal form of the company and data from annual financial statements, such as cash flow, equity capital ratio, profit or loss, and management quality.
What are "hard" and "soft" negative indicators?
So-called "negative indicators" are data that indicate poor creditworthiness of the borrower. "Hard" negative indicators are facts that can be proven with the quality of a court judgment. These include, for example, an opened insolvency proceeding, a sworn affidavit of inability to pay, or enforcement measures. "Soft" negative indicators, such as the filing of a lawsuit or an applied-for payment order, do not have conclusive significance.
Before a loan decision the creditworthiness check must be completed without fail, because not only does its result determine whether the loan will be granted. The amount of the loan interest rate as well as the scope and type of collateral required are also influenced by the results of the creditworthiness check. The creditworthiness check is therefore an indispensable prerequisite for the lender and thus for granting a loan.
Scoring or rating are included in the loan decision
The result of the creditworthiness check is the assignment of the borrower to the individually applicable creditworthiness class, which is expressed in a scoring or rating value. These rating levels provide information about the probability of default. The assignment to a creditworthiness class is based on historical experience with other borrowers, but also on demographic, sectoral and macroeconomic data. That means every borrower has a score that indicates creditworthiness.
Therefore, the particular value of the score — and thus the basis for future loan decisions — can change over time due to circumstances that are outside the individual borrower.
Technology and procedures in loan decisions
Loan decisions in retail banking are made fully automatically. The relevant data for the applicant's loan request (e.g. desired loan amount, purpose of the loan, the customer's creditworthiness, term, installment amount and repayment type) are compared in electronically executed verification procedures that reflect the institution's internal lending policy. This data matching leads in most cases to an immediate loan decision.
Only in borderline cases ("gray area"), which normally affect at most 10% of all loan applications, is a final decision made by qualified specialists. However, the majority of loan decisions fall into the (machine-determined) approving "white" or rejecting "black" area.
By contrast, in lending to commercial customers and affluent private clients, credit specialists are involved in the loan decision. Although rating and scoring systems are also used here, the credit specialists have wider decision-making scopes that allow consideration of "soft criteria" such as management quality and special circumstances in start-ups and product launches. In corporate lending to large companies, loan decisions are made by special credit committees established within a bank.
Documentation of the loan decision and loan agreement
In mass retail business, electronically made loan decisions are archived electronically. For individual loan decisions, the person who made the decision, the reasons for the decision and the conditions imposed on the borrower are also documented. After an approving loan decision, a loan agreement is drawn up, which may also contain conditions and requirements and lists the agreed collateral.
The minimum requirements for risk management (MaRisk) of the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin)
In December 2005, BaFin issued MaRisk administrative instructions for the first time, which represent a specification of § 25a of the German Banking Act (Kreditwesengesetz, KWG). MaRisk regulations implement in German law the provisions of the "Basel II" agreement concerning banks' own funds that have applied in the European Union since January 1, 2007.
MaRisk are to be applied to all credit decisions made by credit institutions. The general part of MaRisk contains requirements regarding the principles to be observed in banks' risk management. The special part sets out more detailed rules on management organization and on the treatment of risks such as credit default risks.