The 5 Cs Of Credit Simplified! And Here’s Why They matter!

It’s what big businesses have been built on, it’s how the economy runs & it’s why you don’t have to wait 30 years to buy a home.

The above statements answer a fundamental question — what is credit?

You could travel back a thousand years and witness primitive forms of money-lending which has since evolved into a colossal section of the finance industry. Credit and loans ensure many local and global economic opportunities. They allow businesses to run their operations seamlessly.

In simplest terms, credit refers to a monetary agreement between a borrower and a lender. The person in debt agrees to a contract wherein he pays back the amount plus interest within a time frame. Banks, credit agencies and money-lending organisations have created different types of loans and credit systems. Whether you apply for home loans, car loans, student loans or a credit card, you take advantage of the ‘buy now pay later’ scheme and manage your finances to stay within your income.

Credit is one of the top professions in the finance field. As a professional, you get to understand how the markets work, study the economic trends and are also required to follow the 5 Cs of credit. They are appropriate guidelines in the credit process that minimise risks and ensure regular payments. If you are eyeing the credit industry for your future career, keep reading.

What are the 5 Cs of credit?

These five parameters help establish the terms of a loan and the financial stability of the borrower. There are risks to credit, many of which lending agencies and banks are determined to avoid. These 5 Cs of credit serve to safeguard the interests of both parties.

They are:

• Character
• Capacity
• Capital
• Collateral
• Conditions

1. Character

Before sanctioning a loan, credit analysts look into the loan applicant’s reputation and financial background. Someone with a poor track record of unpaid loans or repeated delays may not receive the funding from lending firms. Credit analysts will look into every potential borrower’s credit history to understand their ability to repay on time. They perform due diligence and careful analysis. Credit experts delve into the financial background of the customer to examine their payment patterns, debt, credit scores and losses. They may also check for any pending legal issues.

Some experts believe character is the most important of all the 5Cs of credit. Banks cannot play fast and loose with their money. You need a certain amount of guarantee that the borrower is a responsible and stable individual who can repay the loan within the stipulated time frame.

The lesser the risk, the more likely the person is granted credit.

Also Read – What Is Credit Analysis? Its Importance And Career Scope

2. Capacity

Your capability to repay a loan depends on certain financial factors. Are you commercially stable? Is there a guaranteed income every month? Do you have the financial means to make your due date? A credit analyst will take a good look at the numbers and figures, thereby determining your capacity to fulfil your financial obligations. Credit firms use a debt-to-income ratio to understand a borrower’s capacity better. They have a team of experts to review and investigate the availability of funds.

If an individual or organisation lacks the capacity, they are not considered a safe bet for repayment. Unstable cash flow can result in a request for credit getting denied. This is why capacity is a vital part of the 5 Cs of credit.

3. Capital

Credit teams pay close attention to the borrower’s investments, assets and equity to determine their total capital. Companies or individuals have various financial and non-financial assets such as savings, real estate or an investment portfolio. Credit analysts look into the value of these assets during the loan approval stage. The borrower’s net worth serves as an assurance against the credit. In non-payment or default, assets can be seized to cover the loan amount. As one of the 5Cs of credit, capital can help borrowers negotiate better loan terms and even impact interest rates.

Also Read – What are the various skills required to become a Credit Analyst

4. Collateral

One of the 5Cs of credit, the concept of collateral is fairly common during the loan application process. This term refers to any fixed asset or security that is used as a guarantee for credit approval.

A client or company can use valuables such as real estate, gold or investments as ‘collateral’ or assurance. These assets can be seized and kept by the lending company if the borrower runs out of money to repay the loan.

Every borrower may not have to put up collateral. However, it is mostly mandatory for high-risk borrowers or those individuals with a poor financial history of bad debt. Collateral can even get you better terms for your loan or a higher amount.

5. Conditions

What is the borrower’s financial condition? This is a highly significant question to ask before granting the loan. As a lender, you must understand the reason for the loan, the economic scenario, financial background and potential challenges. Companies applying for loans present their financial statements, cash flow statements and balance sheets to the credit team for deeper analysis. All these conditions are evaluated to understand the overall cost of credit.

Importance of the 5 Cs of Credit

Now that you know what the 5 Cs of credit are, it is time to understand why they are so important and relevant.

1. To evaluate the risks involved

Risk is the single biggest concern in any money-lending business. The one question every credit analyst has to try to answer to their best ability is, “Will we get our money back?”

It is a difficult query, and the answer is only possible when we apply the 5 Cs of credit.

Credit analysts do their due diligence to ascertain that the borrower is stable enough to repay the loan. Every potential risk is analysed with a fine-tooth comb, and the loan terms ensure that the lending company’s interests are secured.

2. Help to decide the terms of loans

No two loans are the same. No two borrowers’ have the same needs. Credit teams have to meet with the potential borrower to understand their requirements. They apply the 5 Cs of credit to reach a mutually beneficial contractual agreement, keeping the borrower’s and lender’s best interests in mind.

Also Read – Credit Analysis Essentials: Fundamentals, Importance & Techniques

3. Borrowers can improve their credit score

Applying the 5Cs of credit can help the borrowers too. Companies and clients can improve their credit scores, clear pending debts and improve their creditworthiness. This enables them to reach more favourable terms during the credit approval process. 

4. Determine creditworthiness

If you work as a credit analyst, you will face countless loan and credit applications regularly. If you use the 5Cs of credit as a checklist, it will help you sieve out the ‘good’ borrowers from the unreliable ones.

Proschool’s CFA course for Credit Analysts

If you want to be a credit analyst, then The CFA Program is the perfect certification for you. However, this rigorous and challenging program is best studied under expert tutelage at Proschool. As one of India’s top coaching institutes, IMS Proschool is nationally renowned for its experienced faculty and exceptional facilities.

The subjects are taught by finance gurus who have been a part of the industry for a long time. They use innovative learning methods and hands-on training tools to ensure students understand and appreciate the course material.

Why Proschool is perfect for you:

• Coaching centres are set up across India in major cities such as Mumbai, Pune, Chennai, Kolkata, Bangalore and Delhi.
• Online classes are also available for students unable to visit a coaching centre.
• The professors offer doubt-clearing sessions, customised study plans and personalised attention to all students.
• Students studying the CFA curriculum are given a deep understanding of the 5Cs of credit and other important credit-based concepts.
• Additional resources are available, such as over 2,000 practice papers, mock tests and learning videos.
• Proschool’s one-month online foundation module is perfect for students who come from a non-finance background.
• Students can access the placement program to apply for job openings in the finance and credit industry.

FAQs

• Why is credit so essential in finance?

Credit is a huge boon for our economy. It helps small businesses get off the ground, large companies to expand and individual customers can enhance the quality of their lives. It’s not always easy to access capital. Many people invest their excess funds or have to wait for payments. Credit enables people to proceed with their financial goals immediately.

• Which of the 5Cs is most important?

It is objectively tough to say which of the 5Cs of credit is the most important. It depends on the priorities of the lender and borrower. Some credit experts may feel character is the most significant while others may give more attention to capacity. Rest assured, all five points are equally important in the long run.

• What qualifications are needed to work in credit agencies?

A bachelor’s degree in commerce, finance or economics can help you gain an entry-level job. Finance certifications like CFA, CA or MBA can help you get noticed by the top companies and kickstart your career in credit.

• What are the benefits of using credit?

Whether you are an individual or a company, there are many advantages to using credit. You can make large purchases and pay off the loan in small pieces. Your business gets a cash boost needed to buy important equipment or pay off vendors. Your existing finances are not affected, your investment stays secure and you can even get access to better financial products.

• Does the CFA syllabus have a section on credit?

Yes, the CFA course offers several credit-based concepts such as the 5Cs of credit to help students receive a deeper understanding of how this industry works. Other topics include credit risk, default probability, calculation of financial ratios and corporate debt rankings.

• What are the 5Ps of credit?

The five Ps of credit are as follows — people, purpose, plan, protection and payment.

Conclusion

If you are still on this page, you understand the 5 Cs of credit by now. You may also have a good idea of how the credit industry operates. If you join this prestigious field and become a credit analyst, consider doing the CFA course with Proschool. This program offers an intensive education in finance and helps students grasp relevant concepts including the 5Cs of credit.