Part of the credit process is the bank's evaluation of credit risk on a loan.  Credit risk arises from the potential that a borrower will fail to meet their obligations under the terms of the loan.  Naturally, banks try to avoid or minimize any credit risk in their loan portfolio, and have numerous ways to evaluate the credit worthiness of a borrower. 

Banks can use a variety of methodologies to evaluate business loans, depending on the bank's commercial lending philosophy.  For example, the financial strength of a business as depicted by its financial statements, the nature and quality of assets used as collateral for the loan and the character of the borrower are all part of a typical evaluation. The importance of these and other factors will vary from bank to bank depending on the bank's strategy and the marketplace.

Advances in the U.S. commercial banking industry through financial engineering, telecommunications and information processing have led to credit scoring models to determine loan viability.  Credit scoring models may include the business owner's monthly income, outstanding debt, financial assets, employment tenure, home ownership and previous loan defaults or delinquencies.  Most banks use a blend of credit scoring with one of the traditional types of lending to determine the credit worthiness of a business loan.

The 5 C's

Bankers have traditionally used the "5 C's" of lending to help in the determination of risk in a business loan.  The 5 C's are the basic components of credit analysis.

Capacity to repay a loan is the most critical of the factors considered.  The prospective lender will want to know your ability to repay the loan, and will consider your business' cash flow, the timing of repayment, and the probability of successful repayment of the loan. 

Capital, or the amount of money you have personally invested in the business, indicates how much risk you have if the business fails. Lenders will want to see that you have contributed from your own assets, undertaking personal risk to establish the business, before asking for outside funding.

Collateral means you pledge an asset you own, such as your home, to the lender with the agreement that it will be the source of repayment in the event that you cannot repay the loan.

Conditions describe the intended purpose of the loan:  will it be used for working capital, equipment or inventory?  The lender will consider economic conditions, local and global, if appropriate, within your industry and other industries that may impact your business.

Character is your honesty and integrity, and your experience and expertise in your industry. 

Reducing Risk

Banks seek to minimize risk in their loan portfolios. While a bank is not required to disclose their criteria for commercial lending, furnishing complete information with your credit request is important to insure the likelihood of your loan being approved.  A good relationship with your banker is also helpful so that they understand your business and industry.  Ultimately bankers want to evaluate your credit worthiness accurately, to help you and your business be successful.

June M. Webre is Regional President for Team Capital Bank, Lehigh Valley.  Reach her at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it or 610-297-4040.