This lesson provides a step-by-step overview of the commercial lending process, from initial contact with a borrower to loan structuring and documentation.

3.1 The Commercial Lending Lifecycle

A key role of the Relationship Manager (RM) in commercial banking is to identify, originate, and manage a portfolio of commercial loans. The process includes business development, portfolio planning, and client acquisition, as well as managing a pipeline of lending opportunities . The commercial lending process encompasses several key stages:

3.2 The 6 Elements of Loan Structure

Effective loan structuring is a critical step for mitigating risk and ensuring the loan meets the borrower’s needs. The loan structure typically includes six key elements :

  1. Loan Purpose: Clearly define why the borrower needs the funds and what they will be used for.

  2. Sources of Repayment: The primary source of repayment (typically operating cash flow) must be identified and validated.

  3. Adequate Amount: The loan amount must be sufficient to achieve the stated purpose.

  4. Appropriate Term: The loan tenor must match the economic life of the asset being financed.

  5. Adequate Support: This includes the secondary and tertiary repayment sources (collateral, guarantees, and loan agreements).

  6. Framework for Monitoring: The bank must establish a monitoring framework (including financial covenants and reporting requirements) to track the borrower’s ongoing performance.

3.3 Key Documentation

Proper documentation is the bedrock of a legally enforceable loan . Key documents include :

  • Term Sheet / Commitment Letter: The initial offer letter outlining the key terms and conditions.

  • Loan Agreement: The master contract outlining the loan’s terms, covenants, and representations.

  • Promissory Note: A formal, legally binding document in which the borrower promises to repay the debt.

  • Security Documents: Documents creating a legal claim on collateral, such as a mortgage, a security agreement (for personal property, under UCC Article 9), and control agreements for deposit accounts .

  • Guarantees: An agreement where a third party (e.g., the business owner) promises to repay the loan if the borrower defaults.

  • Subordination Agreements: Documents that establish the priority of the bank’s claim over other creditors.

3.4 Types of Commercial Loans

Commercial banks offer a variety of loan products to meet different business needs. The main categories include :

  • Working Capital Loans: Used to finance a company’s day-to-day operations (e.g., inventory, accounts receivable).

  • Term Loans: Used for capital expenditures (e.g., purchasing equipment, property).

  • Project Finance: Used to finance major capital-intensive projects (e.g., infrastructure, energy).

  • Trade Credit and Export Finance: Used to facilitate international trade transactions.

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