The 5 C's of Credit in the Lending Industry

33 Pages Posted: 26 Jun 2011

Date Written: June 26, 2011


Credit underwriting is the practice of analyzing structuring, approving and documenting extensions of credit. This practice constitutes the lending process. Lenders need ‘tools to guide them through this process. The well known Five C’s of Credit, Character Capacity, Capital, Collateral, Conditions, are the ‘tools’ or framework used for credit analysis.

Character represents the customers’ willingness and determination to meet a loan obligation. Character is generally discovered through interview and investigation into the customers’ payment habits, the way they manage their business affairs and the way they respond to adversity. Capital, also called equity or net worth, represents reserves a business has in the event of unforeseen problem. The lender attempts to investigate capital adequacy of the enterprise. Capital is also indicative of level of commitment by stakeholders of the company. This mitigates moral hazard.

Collateral is the assets or assets pledged to secure a loan. Collateral provides the lender a secondary or tertiary source of repayment if the primary source of repayment is not available. Conditions are the external variables that can affect credit and credit quality. This refers to national, international and local economy, the industry and the bank itself.

In assessing conditions, the lender determines whether the prevailing conditions are conducive for not only lending but also for borrowers ability to repay the loan. All the five C’s are fundamental tenets of lending and credit. Some have tried to rank the five C’s in order of importance. A typical ranking in order of importance is Character, Capacity, Capital, Conditions, and Collateral. Some also rank capacity and capital as the most important, because capacity gives the lender comfort in seeing how the loan will be repaid and Capital shows commitment of owners as pre-emption to moral hazards. Regardless of arguments proffered for the ranking, a lender prudentially must use all the five C’s comprehensively for prudence while staying competitive, because they are inter-related for the purpose of risk mitigation and enhancement of shareholders’ value.

Suggested Citation

Baiden, John E., The 5 C's of Credit in the Lending Industry (June 26, 2011). Available at SSRN: or

John E. Baiden (Contact Author)

Central University College ( email )

P.O. Box DS 2310

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