Decoding the Five C’s of Credit in the Lending Process


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Capital: How Much Will You Invest?

Stacks of Cash image by 401(K) 2012

How much capital can you invest in your venture?Image by 401(K) 2012

Most lenders require a certain amount of capital (“skin in the game”) contributed by the borrower in relationship to the debt incurred. Otherwise known as a down payment for a new venture or purchase, outside capital helps to minimize the overall risk profile. For a business loan, the equity on a borrower’s balance sheet will be looked at as a key part of the overall capital structure.

Collateral: Property The Bank Can Take if You Default

Even hut-dwellers in N’djamena, Chad understand the concept of collateral. When the economy is growing strongly, collateral values tend to rise commensurately. Thus, not only does a favorable economy keep fewer loans from going bad, but those that do are often collected in full by liquidation of their collateral.

Conversely, during distressed times, the opposite is the case: loan losses skyrocket as collateral values plummet. Vetting of a borrower’s capacity and other factors will help offset the risk, but cannot completely eliminate it.

During the Great Recession, income for many borrowers in hard-hit areas of the country fell between 10-50%, with some industries seeing even bigger declines. Collateral was generally unable to compensate for such an extraordinary event.

Conditions: Unique Factors Surrounding the Loan

Conditions include not only how the loan proceeds are being utilized, but market factors within and outside of the borrower’s control. These considerations include the overall economy, local conditions, industry-specific issues, and perceived overall volatility. Speculation is considered much more risky than feeding steady growth.

Speculative lending was a business line that helped fuel the skyrocketing housing market of the late 1990’s/mid-2000’s. In and of itself, the risk can generally be controlled; however, when combined with lax regulatory oversight and a charged political climate during the recent recession, the scenario became a perfect storm that swept over the economy like a tidal wave.

Character: Will You Repay the Loan?

Character matters when it comes to applying for credit: Image by Brosen

Although enumerated at the bottom of this list, it may be the single most important credit criteria when making a loan. As implied by its very name, a promissory note contains a promise to pay the loan on scheduled dates and, ultimately, in full. If the borrower has flawed character, they may choose not to pay the loan on time or in full, even when they maintain the ability to do so. Background checks, credit reports, character references, and other third-party resources are utilized to quantify the borrower’s character.

The Loan Decision

Very few borrowers are letter-perfect on paper. As such, there will always be risk inherent within the lending process. Whether or not the borrower can fully demonstrate capacity, has a large capital injection, proper collateral coverage,  excellent conditions, and/or flawless character will be ascertained during the underwriting process. Most lenders are willing to consider loans with a marginal element or two, as as long as the additional risk is sufficiently minimized by strengths in other areas — depending, of course, on what they are and how they are mitigated. In years’ past, collateral was the great equalizer; today, it is almost an afterthought, as too many losses were taken trying to collect the remainder of a loan from the sale of assets worth far more when the loan was originated than at the time of foreclosure.

Regardless of the changing dynamics, the five C’s of credit remains the most well-rounded methodology to determine the credit worthiness of a borrower, and shoring them up is the surest way to achieve a favorable loan decision. That, or having your rich Uncle Joe co-sign your loan.


Ministry of Planning and Development. The Five C’s of Credit: Capacity, Collateral, Capital, Conditions and Character. (2012). Accessed on September 12, 2012.

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