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example, a competitor has a similar credit limit at its disposal, or because the borrower wishes
to make capital out of the size of its credit limit.
The problem of inventory limits is at its most conspicuous with construction loans. By
their very nature these are only utilised fully at the end of the term, i.e. prior to consolidation.
If a construction loan deteriorates from the point of view of credit-worthiness during the
construction period whether it be owing to the client s financial standing or to the quality
of the construction project in hand it is usually pointless for the bank to call in the loan, as
during the term of such a loan there is only an unfinished building to show for it. In this situation
the bank has no alternative but to complete the building at its own expense and therefore in
practice, de facto, to pay the loan off. As invoices for works completed are in each case settled
as late as possible, the extent to which any construction loan is taken up is equivalent to an
average utilisation of about one-third. Under equation (4.26) this leads to a shortfall risk charge
three times higher than that for full utilisation. We permit ourselves at this point the conjecture
that construction loans, seen in isolation, have historically been under-priced. Attractively
priced construction loans may, however, be a means of canvassing new mortgage business,
and therefore be justified on marketing grounds, but this presupposes a matching degree of
customer loyalty.
As already mentioned the problem of only partial utilisation, particularly in the case of
current account loans, may also be solved by arrangement fees on credit limits granted. This
would also be a solution in relation to the billing of profit contributions that might not otherwise
be obtained. Furthermore the difficulty of inventory limits could be effectively countered, as
presumably only a very few borrowers are prepared to pay an arrangement fee for a credit limit
that may hardly ever be utilised. If the price elements p and r (see equation (1.1)) are billed in
the form of an arrangement fee, then on the other hand it is still only the price element f that
40 Risk-adjusted Lending Conditions
rises in proportion to the loan being taken up. In practice this may, for example, lead to a current
account credit priced today with interest at 5% per annum and with a fee of 0.25% per quarter
being demanded, being charged in future at 4% per annum on the amount of loan actually
taken up and at a fee of 0.5% per quarter on the amount of credit granted. Such an arrangement
fee should not, however, be forced upon the Swiss market for credit at the moment.
If cases of exceeding limits are ignored, it may be said that the following always applies:
Luk
From this it may be concluded that the following always applies:
rck > 1 (4.28)
This allows us to note, purely qualitatively, that any current account credit facility for the
same borrower is always associated with a higher loan interest rate than fixed advance credit,
providing the risk-free rate of interest is is identical in both cases. But even if is is not identical,
then it may be emphasised that current account credit must, on the strength of the expositions
in this section, tend to be more expensive than fixed advance credit.
So a lending policy could consist in only granting fixed advances that are fully utilised at any
one time and operating current accounts only on the basis of credit balances. The advantage of
being able to give immediate notice on current account facilities in cases indicating that those
facilities should be withdrawn is in many cases illusory anyway. Moreover the qualifying time
until maturity in the case of fixed advances, of three or six months, would not be excessively
long. If winding up such advances does occur, one may always fall back on current account
lending. This is no arithmetical problem here, as experience shows that current account credit
facilities are fully utilised in such situations and therefore are tantamount to de facto fixed
advances.
One further problem in current account lending is the tiresome subject of current account
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