Invoice Bazaar Blog

What Do Banks Check while Assessing the Credit Risk of Loans to SMEs?

By Invoice Bazaar | July 7, 2020

Banks and other financial institutions across the world generally have little inclination to lend money to the SME sector as there is a lack of precise methods for assessing or measuring the credit risk associated with such loans. Furthermore, the process of determining and evaluating the likely risk of lending to the SMEs is very time-consuming and expensive.

On the other hand, no bank can afford to keep its surplus funds idle as that would adversely affect its overall performance and impact its bottom line. Furthermore, SMEs in the UAE play a very significant role and contribute more than 50 per cent of the non-oil GDP. Hence, despite their reluctance, banks sometimes get tempted to consider loan applications received from the SMEs favourably.

In such situations, while assessing the credit risk of loans to be given to SMEs, obviously, banks and other financial institutions will invariably check the following points and related aspects before approving and releasing the loan.

  • repayment capability of the SMEs and their readiness to service the debts
  • whether those SMEs operate transparently
  • whether they maintain proper and comprehensive accounting & financial records
  • whether they have a sound credit history
  • timing and frequency of likely cash inflows after the loan is released
  • the size of their markets
  • their vulnerability to market fluctuations and economic downturns
  • do those SMEs have any tangible or real assets that can pledge as collaterals
  • have they ever defaulted on loan repayments in the past

After thoroughly analyzing the above-collated data and related information, some banks may design very effective and useful credit scoring models or other sophisticated techniques that will enable them to rate and determine the creditworthiness of different SMEs. Based on such analysis and conclusions, banks are in a position to distinguish the good borrowers from the bad and thereby take appropriate decisions related to lending money to the SMEs. Hence, SMEs which need bank loans should strengthen their bankability on the above counts.