Chapter Two: Real Estate Lending Decision in Kuwaiti Banks
Literature Review
The five Cs of credit model – character, collateral, capital, conditions and capacity, all serve as important indicators for gauging the inclination and aptitude of debtors in fulfilling the obligations they have to their respective creditors (Sraeel, 2005, p. 40, par. 5; Strischek, 2009, par. 2). It is thus advisable for creditors to make their decisions based on the five Cs of credit model in order for them to assess the creditworthiness of their respective debtors properly (Strischek, 2011, par. 1). The prominence of the five Cs of credit model resurged most recently during the 2008 global financial crisis, in which it emerged bankers have been using said model for evaluating the ability and willingness of various debtors to pay their debts (Strischek, 2011, par 1). However, the 2008 global financial crisis made too apparent one of its root causes – subprime lending (Romaine, 2008, p. 31, par. 1). As emphasized by Franzini (2007, pars. 1-3) and Romaine (2008, p. 31, par. 1), subprime lending, as it generally referred to the act of granting loans to debtors with little ability and willingness to pay, already proved too risky from the beginning. The disastrous consequences of its continued accumulation rapidly permeated several industries in the United States (US), particularly real estate (Romaine, 2008, p. 31, par. 1). As the effects of the 2008 global financial crisis spread throughout nations in Europe and other nations with investments in US financial institutions, may have come to emphasize – and criticize, the five Cs of credit model (Abraham & Buczynski, 2011, pars. 6-7).
This section - first of two, of the literature review aims to evaluate the existing literature on the five Cs of credit model through specific examination of each of its elements. Criticisms against the five Cs of credit model come from existing literature that have provided several expanded renditions of said model, most notably the 20 Cs of credit model – one that finds substantial coverage in the second section of the literature review.
Character. Perhaps the most crucial element of the five Cs of credit model, character pertains to the individual traits of the debtor in terms of his mental and moral faculties in relation to his obligation to his creditor (Craig, Jackson & Thomson, 2005, p. 2, par. 5; Strischek, 2009, par. 5). A creditor, in assessing the characters of all his potential debtors, must monitor their reputation, integrity and honesty, among many similar others, unless he wishes to expose himself to risks against assets he has allotted for loaning (Bryant, 2012, p. 121, par. 3). Typically, a creditor assessing the character of his potential debtor would investigate on records involving loans, business ventures, assets and the overall attitude (Strischek, 2009, par. 7). Strischek (2011, pars. 4-5) agrees that by default, the potential debtor should provide an express guarantee of repayment to the creditor. Otherwise, such lack of commitment on his end might cost him his chances of ever obtaining a loan grant (Strischek, 2011, pars. 4-5). Above all things, the creditor must ensure that his loanable assets are safe from risks related to the inability and unwillingness of his potential debtors (Strischek, 2009, par. 7). As Strischek (2009, par. 7) has consistently stressed, potential debtors may appear to have all the resources needed for them to fulfill their obligations to their respective creditors, but their character would not stand as credible if they are without the inclination to render payments. In assessing character, the focus is not so much on the ability of potential debtors to pay based on the resources and proficiencies they have, but more on their disposition in doing so – whether they are willing to fulfill their responsibilities to their creditors (Strischek, 2009, par. 8).
Collateral. Failure on the part of debtors to render payment should not stand as an instant bane to their respective creditors (Strischek, 2009, pars. 19-21). Rather, the collateral guaranteed by the debtors should serve as their last-resort compensation their creditors should receive from them in return for the loans they have received (Strischek, 2009, pars. 19-21). It is therefore the responsibility of creditors, as part of their background-check regimen, to check whether their debtors have endowments they are willing to name as collateral to the loans they plan to borrow (Strischek, 2009, pars. 19-21). Assessing endowments named as collateral for loans is an important procedure (Strischek, 2009, pars. 19-21). Endowments must, at the very least, match the market value of the loans before both the debtors and creditors agree to name those as collateral (Strischek, 2009, pars. 19-21). Moreover, it is important to choose the quality of endowments debtors plan on naming as collateral to their loans (Strischek, 2009, pars. 19-21). The greater the quality of endowments, the greater the chance of having their value retained for a long time, taking into consideration the duration of the loans (Strischek, 2009, pars. 19-21). In that case, debtors should try their best to provide collateral endowments with values inextinguishable by factors such as time, wear-and-tear and economic conditions, among many similar others (Strischek, 2009, pars. 19-21). However, an accepted reality with regard to collateral endowments is the fact that such may not find immediate liquidation, regardless of proper valuations (Strischek, 2009, pars. 19-21). Cases of fraud may arise in the event debtors present collateral endowments that are not of the same valuation as the loans they have borrowed from creditors (Strischek, 2009, pars. 19-21). Creditors, therefore, have a large role to fulfill in terms of investigating the kinds of collateral endowments presented to them by potential debtors (Strischek, 2009, pars. 19-21). Ideally, before debtors could have their loan requests approved, creditors must investigate the authenticity and adequacy of the endowments named as collateral (Strischek, 2009, pars. 19-21). Debtors, in that respect, must act in good faith in order for them to avoid further liabilities (Strischek, 2009, pars. 19-21).
Capital. One effective measure of the ability of debtors to pay loans is their possession of capital for their respective businesses (Strischek, 2009, pars. 13-15). Creditors highly disfavor debtors whose intent to borrow loans does not find support from their due possession of capital for their business (Strischek, 2009, pars. 13-15). After all, one of the main purposes as to why creditors hand out loans is for debtors to have supplementary funds assisting their business ventures (Strischek, 2009, pars. 13-15). With ownership of businesses being among the foremost considerations of creditors in assessing the ability of their debtors to pay for their loans, capital thus finds essence (Strischek, 2009, pars. 13-15). The presence of adequate capital serves as an important marker for creditors on the ability of their potential debtors to pay for their debts (Strischek, 2009, pars. 13-15). One could not establish business start-ups through loan injections alone (Strischek, 2009, pars. 13-15). People planning to enter into business ventures must gather adequate resources first for them to become credible in terms of productivity (Strischek, 2009, pars. 13-15). Creditors take such as a satisfactory impression convincing enough for them to entrust loans to potential debtors (Strischek, 2009, pars. 13-15). Furthermore, the presence of capital indicates that potential debtors have a sufficient cushion to supplement loans in the event particular valuations rise and fall, in return affecting the ability of debtors to render payment (Strischek, 2009, pars. 13-15). Given that loan agreements have specific time durations and usually require debtors to pay in either whole or installments, the presence of adequate capital on the part of potential debtors provides confidence to creditors in terms of affirming loan requests presented before them (Strischek, 2009, pars. 13-15). Potential debtors planning to start their businesses through loans alone would likely face rejection from creditors, given that the absence of capital stands as an important indicator of the lack of comprehensive business plans (Strischek, 2009, pars. 13-15). Therefore, for potential debtors to become more credible in the eyes of creditors, they must plan to generate capital first as a matter of supporting startup business operations (Strischek, 2009, pars. 13-15). Sheer reliance on loans for establishing businesses would only cause greater suspicion on the part of creditors against the real ability of debtors to render payments in a timely manner, effectively creating an impression of ineptitude on the part of debtors (Strischek, 2009, pars. 13-15).
Conditions. The market for lending requires a favorable economic setting that affects the integrity of both debtors and creditors (Strischek, 2009, par. 16). Loans, primarily coming in the form of currency, find inevitable exposure to economic circumstances (Bryant, 2012, p. 121, par. 3). Debtors whose assets – businesses, properties and collateral, among many others, become devaluated by poor economic conditions may find themselves disadvantaged over having to repay their obligations to their creditors (Strischek, 2009, pars. 16-17). At the same time, creditors also have risks related to poor economic conditions, in that they face the danger of debtor nonpayment due to their inability to do so, as well as the devaluation of the loans they have granted (Strischek, 2009, par. 17). Given that there are several variations on the kinds of conditions affecting the market for lending, it is therefore important for both creditors and debtors to create contingency measures related to averting such inevitable risks (Bryant, 2012, p. 121, par. 3). Real estate, for instance, has emerged as a particularly dangerous and virtually unprofitable investment, in that the bubble for said industry burst to contribute to the 2008 global financial crisis borne out of the accumulation of subprime lending (Strischek, 2009, par. 17; Romaine, 2008, p. 31, par. 1). One could adjudge subprime lending as virtually the failure of creditors to observe the five Cs of lending model, as it involves granting loans to debtors whose abilities and willingness to fulfill obligations are inferior at best (Sraeel, 2005, p. 40, par. 5; Strischek, 2009, par. 2). In the case of the 2008 global financial crisis, the accumulation of several nonpaying subprime borrowers cost several creditors their assets – mostly financial institutions, with some ultimately treading down the road to bankruptcy (Romaine, 2008, p. 31, par. 1). In that case, nonpaying subprime borrowers have affected not only their creditors, but also investors whose invested assets dissipated alongside those of the creditors (Romaine, 2008, p.31, par. 1; Strischek, 2009, par. 17). In effect, Romaine (2008, p.31, par. 1) noted that the burst real estate bubble has caused real estate prices to plummet down to rock-bottom levels, with many having gone down to below their original values due to oversupply, lack of buyers and the urgency felt by creditors to recoup their assets as soon as possible, despite the consequent losses. Given the compelling case of the 2008 global financial crisis, it is therefore important to consider conditions attendant to the market for lending (Strischek, 2009, par. 2). Political violence, policy regimes, the global economic output and the climate for business, among many others, may all affect the market for lending, which in turn may encourage or discourage lending activities, depending on the consequences of any given condition (Strischek, 2009, pars. 16-17).
Capacity. Debtors must have the inherent capacity to generate resources and fulfill their outstanding obligations to their creditors should they wish to enhance their credibility (Buczynski, 2013, par. 35; Zimmerman, 2011, p. 52, par. 4). For debtors to become qualified in the eyes of creditors, they should exhibit the ability to operate businesses, generate income and consolidate their assets in relation to repayment of debts (Strischek, 2009, pars. 9-10). Although typical of assessing capacity is the inclusion of the character of debtors, creditors differentiate capacity by merely looking at the manner in which debtors conduct business ventures and generate profit (Strischek, 2009, par. 10). The willingness of the debtors to pay debts falls under the character aspect of the five Cs of credit model; capacity stands for the credibility of debtors in terms of their expertise in their respective fields (Strischek, 2009, par. 11). Strischek (2009, par. 11) noted that creditors find debtors with deeper levels of experience more credible for lending, especially if they hold certain positions related to their profession. Yet, such positions also require due proof of action to convince creditors further (Strischek, 2009, pars. 11-12). In light of such, debtors with greater capacity tend to have stronger foundations in terms of establishing business operations and making those as profitable as possible (Bryant, 2012, p. 121, par. 3). Actions, combined with the proper credentials, duly characterize the capacity of debtors to fulfill their obligations to their creditors (Bryant, 2012, p. 121, par. 3; Strischek, 2009, pars. 11-12).
The Twenty Cs of Credit Model
The five Cs of credit model has found notoriety among actors within the financial industry, particularly those under the lending sector. Yet, there is an understanding that the five Cs of credit model stands as a fundamental one that may serve as a basis for other similar models. One such example is the twenty Cs of credit model introduced by Tim McCormick (2009, p. 18, pars. 1-2), which stands as an expanded version of the five Cs of credit model. McCormick (2009, p. 18, pars. 1-2) founded the twenty Cs of credit model on five questions pertaining to the nature of the lending process, particularly within the context of the real estate industry. The even distribution of all “twenty Cs” under the five questions suggests that McCormick (2009, p. 18, pars. 1-2) had in mind the effective elaboration of the five Cs of credit model, apparently emphasizing the importance of uniformity and symmetry in highlighting the equal importance of each question under the twenty Cs of credit model. The twenty Cs of credit model by McCormick (2009, p. 18, pars. 1-2) stands as perhaps the broadest of its kind within the existing literature on expanded models to the five Cs of credit model, yet many other models have also included, and complemented information on some of the twenty Cs. While the twenty Cs of credit model does not seek to deviate from the five Cs of credit model as it is merely an expansion, the manner in which it has expanded has fundamental roots from the five questions, which are as follows (McCormick, 2009, p. 18, par. 1):
- Who is the borrower?
- What kind of business?
- How much?
- Repayment?
- Terms and Conditions?
Summarily, the 20 Cs of credit model by McCormick (2009, p. 18, pars. 1-2) is unique, in the sense that no other model present in the existing literature provides the exact same structure of expanding the traditional five Cs of credit model. The fact that McCormick (2009, p. 18, pars. 1-2) emphasized on the case of the real estate market in Ireland makes the 20 Cs of credit model he has authored unique, although he does not discount the possibility the replicability of the model in other settings, such as Kuwait in this case. However, expanded models by DiCamillo (2009, p. 48, par. 3), Golden & Walker (2012, pars. 55-59), Khan (2009, pars. 49-50) and Reid (2009, par. 2) all complement some of the elements of the 20 Cs of credit model.
Question One: Who is the borrower?
Character or Culture. Similar to the model presented by Strischek (2009, par. 5), creditors tend to investigate the character of their potential debtors before they issue loans to them. McCormick (2009, p. 18, par. 3) extended the foregoing analysis to corporations, in which he deemed the importance of business culture in ascertaining whether a requesting corporation is worthy to receive loans. Recognizing the volatility of the real estate industry, McCormick (2009, p. 18, par. 3) noted that the approach of creditors to potential debtors that have the purpose to borrow loans for real estate have become highly careful. Proving the volatility of lending in the real estate industry is the fact that several creditors and debtors – individuals and businesses alike, have recorded massive earnings and losses, particularly during the 2008 global financial crisis (McCormick, 2009, p. 18, par. 3; Romaine, 2008, p. 31, par. 1). Most debtors who have failed to thrive in the real estate industry were those who have bought real estate properties that were not part of their original plans. Governments also played a crucial part in the demise of several real estate ventures, in that they have invested bonds that compelled real estate developers to complete more projects, to the extent of demand overestimation (McCormick, 2009, p. 18, par. 4).
Competence. For creditors to gain more confidence over issuing loans, their potential debtors should exhibit a degree of competence in terms of business strategies. Albeit being similar to capacity under the five Cs of credit model as discussed by Strischek (2009, pars. 11-12), competence as argued by McCormick (2009, p. 18, par. 5) refers to the ability of the debtor in terms of making the most out of his loans. In the case of the real estate industry, competence involves purchasing strategically located properties for practical prices, procuring the proper types of planning permissions, and exercising risk management, particularly in cases where there are instances of low sales in certain periods (McCormick, 2009, p. 18, par. 5). Real estate developers must have the competence to steer their developments away from the inevitable risks associated with the real estate industry in order for them to avoid posting losses disabling them to repay loans (McCormick, 2009, p. 18, par. 5).
Continuity. McCormick (2009, p. 18, par. 6) noted that stability is a key indicator for creditors in terms of issuing loans to potential debtors. Potential debtors, which are usually those with business ventures or corporations, have to prove to creditors that their respective management succession schemes are stable and amenable before they could receive favorable loan endowments (McCormick, 2009, p. 18, par. 6). Naturally, as McCormick (2009, p. 18, par. 6) stated, creditors would not expose themselves too much from risks involving management succession instabilities of their debtors. Power struggles within business ventures and corporations could become worse the more unstable the management succession schemes in question (McCormick, 2009, p. 18, par. 6). Therefore, creditors also investigate their potential debtors and see whether their management succession schemes are stable. In the real estate industry, management succession is highly crucial, in that its volatile nature requires stability, particularly in times of crisis (McCormick, 2009, p. 18, par. 6).
Corporate Constitution. Debtors tend to have a plethora of structures involving multiple businesses placed under clusters of corporate entities, McCormick (2009, p. 19, par. 1) has stated. Creditors, therefore, need to consider the nature of their potential debtors thoroughly, particularly in terms of their corporate constitutions (McCormick, 2009, p. 19, par. 1). A company belonging to a group of companies may not qualify as a debtor of a particular creditor if its fellow company has liabilities with said creditor (McCormick, 2009, p. 19, par. 1). As much as possible, creditors have to assess the nature of their potential debtors fully in terms of their corporate constitutions before they could approve loan grants confidently (McCormick, 2009, p. 19, par. 1). The more complicated the corporate constitution of a potential debtor, the greater the care the creditor must practice in terms of evaluating their decisions on granting loans (McCormick, 2009, p. 19, par. 1).
Question Two: What kind of business?
Customers and Competitors. In agreement to the same element within the eleven Cs of credit model by Khan (2009, pars. 49-50), a debtor that knows the pace of competition and market trends in the industry it is in has greater potential to become qualified under a fair selection of creditors (McCormick, 2009, p. 19, par. 2). Golden and Walker (2012, pars. 55-59), in the 10 Cs of credit model they have authored, have agreed in specifying under the “competition” element that creditors would not risk themselves to exposure towards risky ventures, for that would cost them outright losses in granting loans (McCormick, 2009, p. 19, par. 2). It is the responsibility of potential debtors to present their knowledge on their industries to justify that they are qualified to receive loans from particular creditors (McCormick, 2009, p. 19, par. 2). Otherwise, creditors would most likely see potential debtors as doubtful candidates for loan grants (McCormick, 2009, p. 19, par. 2).
Controls. According to McCormick (2009, p. 19, par. 3), debtors would most likely make the most out of their loans if they spend those in accordance to the trends involving costs and cashflows. In the case of the real estate industry, it is ideal for real estate developers to estimate areas of their expenditures where there would be greater or lesser costs involved (McCormick, 2009, p. 19, par. 3). DiCamillo (DiCamillo, 2009, p. 48, par. 3) raises the same point in his model, wherein he has specifically added controls as the sixth element to consider alongside the traditional five Cs of credit. A developer that knows the rising costs of land due to strong competition between different creditors in terms of providing lower interest rates on loans would most likely think twice in terms of spending on particular land locations (McCormick, 2009, p. 19, par. 3). A compromise between low interest rates and higher land costs, on one hand, and high interest rates and lower land costs, on the other hand, is something developers should consider in their plans before they present themselves as credible debtors (DiCamillo, 2009, p. 48, par. 3; McCormick, 2009, p. 19, par. 3).
Capacity to Contract. Reid (2009, par. 2) emphasized, under “contract” in his variation of the five Cs of credit model on counterparty credit risk that the ability of debtors to avert any impending crisis related to their respective industries through the effective generation of greater profits from the loans they have invested makes them highly qualified to borrow from creditors. Creditors always seek the capacity to generate repayment from potential debtors (Strischek, 2009, pars. 11-12), but more than that, they also look for the capacity of potential debtors to contract their operations through their surplus assets in order for them to avert any impending crisis (McCormick, 2009, p. 19, par. 4). Such is highly applicable in the case of the real estate industry, in which the market is volatile and risky due to irregular demands arising from the proliferation of subprime mortgage borrowers affecting the integrity of creditors (McCormick, 2009, p. 19, par. 4).
Credibility of Accounts. Creditors should make it a point to assess potential debtors in terms of the credibility of their audited accounts (McCormick, 2009, p. 19, par. 5). In the real estate industry, it is particularly difficult for creditors to assess the audited accounts of developers, in that they are involved in several projects in progress (McCormick, 2009, p. 19, par. 5). Such complication also provides for instances of tax anomalies arising from details vaguely detailed by developers (McCormick, 2009, p. 19, par. 5). Therefore, for developers to convince creditors properly for new loans, they must ensure that their accounts are credible enough and free from anomalies (McCormick, 2009, p. 19, par. 5).
Question Three: How much?
Cause. Before debtors could convince creditors to provide them with loan grants, they must provide a detailed plan first specifying their intended purpose and duration for loans (McCormick, 2009, p. 19, par. 6). Creditors reserve the right to know every detail behind the intention of debtors to borrow loans from them, given that they are lending part of their assets for a specific period (McCormick, 2009, p. 19, par. 6). Short-term loans, particularly in the real estate market, may prove unattractive propositions to creditors, unless borrowing developers prove that they have enough assets and forecasted profits to cover for repayments (McCormick, 2009, p. 19, par. 6).
Capital. Creditors also look into the total amount of capital required by potential debtors in lending out loans (McCormick, 2009, p. 19, par. 7). Given every industry has its share of rising costs and changing trends in profits, it is highly possible that creditors would deny loans to potential debtors who lack adequate knowledge in the financial aspect of their respective industries (McCormick, 2009, p. 19, par. 7). The real estate industry is such a volatile industry that requires developers to have an extensive layout of financial trends assuring their creditors of security in borrowing loans (McCormick, 2009, p. 19, par. 7).
Capital Contribution. Creditors should take into consideration the proceeds of the loans they grant contributing to the capital of their debtors (McCormick, 2009, p. 19, par. 8). Potential debtors planning to allot a large share of the loans they have obtained to their initial capital may stand as doubtful for creditors (McCormick, 2009, p. 19, par. 8). As creditors may stand to lose more the more the loans they grant go to large parts of the capital of debtors, they must set certain rules limiting the percentage of loans going to capital contributions (McCormick, 2009, p. 19, par. 8). Real estate developers, to that effect, must keep in mind the volatility of their market in using loans as capital contributions in order to protect their reputation before their creditors (McCormick, 2009, p. 19, par. 8).
Contribution to Bank Profits. Creditors – in the case of the real estate industry, banks, must consider the projected amount of profits they would gain before considering granting out loans to potential developers or taking equity positions in their projects (McCormick, 2009, p. 19, par. 9). The failure of developers to develop their projects into profitable ventures might hurt the position of creditors in terms of their objective to gain profits (McCormick, 2009, p. 19, par. 9).
Question Four: Repayment?
Commitments. Showing the commitment to issue repayments is a quality creditors look for in potential debtors (McCormick, 2009, p. 20, par. 1). Potential debtors should provide comprehensive lists of repayments they have issued and have yet to issue in order to present their credibility well to creditors (McCormick, 2009, p. 20, par. 1). While it is complicated to prepare repayment lists, especially in the case of real estate developers, the accomplishment of such stands as a strong mark of commitment before creditors (McCormick, 2009, p. 20, par. 1).
Contingencies. Golden and Walker (2012, pars. 49-54) specifically mentioned in elaborating the “contingencies” element in their 10 Cs of credit model that debtors should keep themselves aware of the kind of contingencies they face related to their industry in order for them to set repayment schedules for their loans properly (McCormick, 2009, p. 20, par. 2). In the real estate industry, developers need to face several contingent liabilities; they have to inform creditors on those possibilities in order for them to play their repayment schemes properly (McCormick, 2009, p. 20, par. 2).
Comprehensive Cashflow Projections. Forecasting the flow of profits is one area debtors need to develop before they could fully convince their creditors to grant loans to them (McCormick, 2009, p. 20, par. 3). Creditors should have access to data coming from their potential debtors containing comprehensive cashflow projections before they could become convinced to grant loans (McCormick, 2009, p. 20, par. 3). This is especially important in the real estate industry, in that it is a volatile industry requiring better security for exposed creditors (McCormick, 2009, p. 20, par. 3).
Current Trading. Creditors need to consider the performance of their accounts on good quality management over growing their loans in order to secure themselves from financial maladies of any industry to which they are exposed (McCormick, 2009, p. 20, par. 4). Granting too much loans could aggregately spell a massive financial crisis at worst, particularly if it involves those granted to subprime borrowers as in the case of the 2008 global financial crisis (Romaine, 2008, p. 31, par. 1).
Question Five: What terms?
Creditor Coordination. Coordinating creditors would result to greater stability in the lending market (McCormick, 2009, p. 20, par. 5). Although competition between creditors drives the creation of healthier options for potential debtors, creditors also face risks associated with lower interest rates and volatile demands leading to supply surpluses, thus affecting profitability on their end (McCormick, 2009, p. 20, par. 5). When creditors coordinate according to the different functions in which they specialize, they could create greater opportunities to stabilize the lending market away from erring debtors – potential and current alike (McCormick, 2009, p. 20, par. 5).
Conditions of Drawdown. There has to be restrictions on loan drawdowns to debtors coming from creditors in order to provide greater security in terms of relinquishing funds from loan facilities (McCormick, 2009, p. 20, par. 6). Debtors should not just arbitrarily commit loan drawdowns if they intend not to stick by the conditions set unto them by their respective creditors (McCormick, 2009, p. 20, par. 6). Such is to prevent instability against the assets of the creditors (McCormick, 2009, p. 20, par. 6).
Continuing Covenants. Debtors should prioritize its continuing covenants with their creditors for them to remain qualified in their future loan requests (McCormick, 2009, p. 20, par. 7). Such is to create security on the part of creditors, especially with their exposure to particularly risky industries (McCormick, 2009, p. 20, par. 7). Continuing covenants usually involve those related to the profitability and liquidity of debtors and their assets (McCormick, 2009, p. 20, par. 7).
Collateral. Creditors need to secure themselves from risks affecting their debtors by requiring the specification of endowments as collateral (McCormick, 2009, p. 20, par. 8). Given that collateral endowments serve as the last-resort payments of debtors to their creditors in the event they fail to render loan repayments, creditors should consider the quality of the endowments their potential debtors would name as their collateral to the loans they are asking to borrow (McCormick, 2009, p. 20, par. 8). Should a potential debtor present endowments not suitable enough as collateral under the loan agreement, or if it is unable to present any endowment for collateral at all, then the creditor should promptly disapprove or stall the loan request until a more potent offer for collateral comes from the potential debtor (McCormick, 2009, p. 20, par. 8).
Research Hypothesis
Without a proper lending structure, Kuwaiti banks stand to lose from borrowing real estate developers, given the volatile nature of the real estate industry.
Model – The SPAIN Credit Structure
The existing literature on two lending models reviewed in the foregoing sections – the five Cs of credit model and the 20 Cs of credit model, both provide the importance of securing the lending market from exposure to the volatility of the real estate industry. The SPAIN credit structure stands as a viable new model for securing the lending market of Kuwait from the volatile real estate industry of the nation, being a synthesis of the aforementioned models and as a matter of testing the research hypothesis. SPAIN is an acronym for the following – Settlement, Provisions, Amount, Industry and Nature.
Settlement
Settlement involves both the repayment process of the loans and subsequent proceedings in the event of any failure on repayment, duly characterizing the relationship of creditors and debtors in terms of repaying loans. Creditors must ensure that the debtor renders loan repayments subject to the provisions – a matter that finds further discussion in the next section. The importance of settlement in this case refers to the nature of loans being primarily a disadvantage on the part of the creditor. Whereas the creditor grants loans subject to earning interests, it is in a greater risk when lending, in that the debtor always faces risks related to non-repayment. The creditor may ensure that the debtor is in a secure industry and has a clean record of loan repayment. However, the debtor always faces risks related to the industry it belongs, alongside instances wherein misunderstandings arise from the understanding of provisions. Thus, for the volatile real estate industry, Kuwaiti banks should focus on compelling its borrowing real estate developers towards settlement.
Provisions
For debtors to comply with settlement fully, creditors should ensure that they understand the provisions stated in their loans. Each provision should not present any conflict of interest and must find compatibility with the industry within which the debtor belongs and the nature of the debtor itself – its record of loan repayment and preferences. Creditors should avoid specifying vague provisions, which might place debtors at peril due to miscommunication. Keeping provisions simple to understand and straight to the point yet detailed at the same time favors both the welfare and security of both creditors and debtors, particularly between Kuwaiti banks and real estate developers in Kuwait.
Amount
Both the creditor and the debtor must discuss amount details on loans, which include the rationale for borrowing particular amounts as loans, rates of profitability, percentage of loans used for capital and projected profits for banks. Kuwaiti banks must ensure that they are lending out the right amount to real estate developers for the right purposes – meaning to say, projections on profitability and stability is secure for justifying the use of loans and ensuring repayment. Otherwise, Kuwaiti banks stand to lose more from granting loans through non-justification by real estate developers of the amount taken as loans and subsequent failures in terms of posting profits and maintaining stability.
Industry
Creditors have to consider the kind of industry their debtors belong to in order to gain ideas on the degree of security they must expect on the loans they have granted. The real estate industry, being a volatile one, has led creditors to introduce stricter lending rules to real estate developers. Kuwaiti banks, in that respect, could prevent themselves from further exposure to the perils of the real estate industry; keeping borrowing real estate developers responsible could enable them to render repayments promptly.
Nature
Keeping a background check on debtors enables creditors to determine the ability and willingness of debtors in rendering repayments to loans. In observing that, Kuwaiti banks could secure themselves from erring debtors, particularly those with records of non-repayment, missed deadlines, burgeoning accumulated interest rates and indicators related to insolvency. The reputation of debtors – both in terms of their capacity and character, must stand as a crucial consideration of creditors.
Research Questions
- How could the SPAIN credit structure affect the creditor-debtor relationship between Kuwaiti banks and the real estate industry in Kuwait?
- What are the common problems faced by both Kuwaiti banks and the real estate industry in Kuwait with regard to the SPAIN credit structure, and how do those common problems inspire positive or negative changes in their creditor-debtor relationship?
- How rigid is the overall system of Kuwaiti banks – as they lend to real estate developers, in the face of the volatile real estate industry?
Research Problem and Objective
The problem this research intends to confront lies mainly on the decision-making agenda of Kuwaiti banks in granting loans to borrowing real estate developers in Kuwait. Given the volatile nature of the real estate industry, Kuwaiti banks face risks in terms of lending to real estate developers – their industry and nature generally characterized by uncertainties connected to the possibility of greater economic maladies, as in the case of the 2008 global financial crisis. Hence, the objective of this research is to encourage Kuwaiti banks to equip themselves with better safeguards to their exposure to the volatile real estate market – characterized by risks involving oversupply, subprime mortgages and subsequent failures to post profits. A comprehensive credit structure – SPAIN, may stand as a capable approach to securing Kuwaiti banks from the volatile real estate industry. Any negative repercussions from the volatile real estate industry caused by non-repayment of loans by real estate developers may severely harm Kuwaiti banks akin to that of the 2008 global financial crisis.
References
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