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Lending Criteria by Banks Featured

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Why a Firm’s Strategic Plan is important in Lending Money by Banks

The firm’s strategic plan is one of the factors that banks consider when making lending decision. The firm’s strategic plan is important in banks lending decision for various reasons. First, the strategic plan helps the bank to identify the aspiration and directions of a given entity. Vision, mission and goals are some of the vital elements of a strategic plan (Kaplan, 2010). A strategic plan increases the specificity in the operation of a given business. Examining these elements will enable the bank to determine the direction of the organization. This information will enable the bank to determine whether the borrowing firm is heading in the right direction, and whether the direction taken by the firm will enable it to repay the loan.  

A strategic plan also informs banks about the priorities of a given business. The prime intention of strategic planning is to establish the goals of a given business and translate these goals into actionable plans (Pirtea, Nicolesci & Botoc, 2009). Business can have different corporate goals such as expanding of market share, increasing employee satisfaction, increasing productivity, reducing costs, increasing customer satisfaction, or increasing revenues. Examining the firm’s strategic plan will enable the bank to determine the strategic priorities of a given firm and how these priorities are likely to affect the capacity of the firm to reimburse the funds. Similarly, the strategic plan will enable the bank to establish the capability of the organization to transform goals into actions. Examining the firm’s strategic plan will enable the bank to establish whether the plans of business are realistic and whether the firm has what it takes to realize its goals.  The strategic plan also enables the bank to establish the likelihood of success of a given firm (Chittithaworn, Islam & Yusuf, 2011)

Does the size of the firm matters in lending by banks?

            The size of the firm influences the lending-decision of banks because of several reasons. First large firm have higher value of tangible assets than small firms (Carrascal, 2010). A large value of tangible assets gives lender a sense of security as the lender can recover his funds by selling the asset in case the borrower defaults on the loan. Conversely, small firms have a small tangible asset value hence the lender cannot recover his fund by selling the asset in the event of default of the loan.

            Secondly, small firms are associated with a high level of income volatility than large firms. The capacity of a firm to repay loans is largely reliant on the capacity of the firm to generate income. Income volatility is a gauge of the firm’s ability to maintain a smooth flow of cash (Allayannis & Weston, 2003). High level income volatility is a significant threat to the credit rating of a given firm. Firms whose incomes are highly volatile are at high risk of experience cash flow problems since these firms experience significant variations in earning (Allayannis & Weston, 2003). Consequently, small firms have a high risk of bankruptcy than large companies.

Finally, large firms have are more likely to have effective corporate governance and reporting structure. Effective corporate governance and reporting structures reduce the level of information asymmetry between the bank and the borrower hence reducing moral hazard (Berndt & Gupta, 2009). Information asymmetry between banks and small institution is large; consequently, banks tend to avoid lending to small firms.

References

Allayannis, G. & Weston, J. (2003). Earning Volatility, Cash Flow and Firm Value. Retrieved from http://faculty.darden.virginia.edu/allayannisy/documents/EARNVOL0727.pdf

Berndt. A. & Gupta, A. (2009). Moral Hazard and Adverse Selection in the Model of Bank Credit. Retrieved from http://www.frbatlanta.org/filelegacydocs/seminars/seminar_berndt_041609.pdf

Carrascal, C. (2010). Cash holdings, firm size and access to finance. Social Science Research Network. Retrieved from http://dx.doi.org/10.2139/ssrn.1711142

Chittithaworn, C. Islam, A. & Yusuf, D. (2011). Factors that affect the success of SMEs in Thailand. Asian Social Science. 7 (5): 180- 190

Kaplan, R. (2010). Conceptual Foundations of the Balance Scorecard. Handbook of Management and Accounting Research. 3, 1-36

Pirtea, M. Nicolesci, C. & Botoc, C. (2009). The Role of Strategic Plans in Modern Businesses. Annales Universitatis Apulensis Series. 11 (2): 953- 957

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