Solvency
Term in finance or business
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- 4 chapters
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Importance
A lender must assess a borrower’s solvency before granting credit. Loan conditions, including the interest rate, depend on the perceived risk. A highly solvent borrower usually receives better terms.
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Solvency of individuals
European Directive 2014/17/EU introduced a common framework for consumer and mortgage credit. Solvency assessment is now a clear legal requirement for lenders and intermediaries.
The analysis considers income, expenses, assets, and other financial factors. The independent valuation of the financed asset is also part of the process.
Solvency of businesses
Solvency is often evaluated through the gross operating surplus shown in the income statement. This indicator, minus expected loan repayments, should remain well above zero. A high level increases the company’s ability to obtain favourable rates.
The financial leverage ratio is another common measure.
Other borrowers and tools
For individuals, solvency models often use ratios and predictive scoring tools.
For businesses, lenders rely on financial statements and performance indicators.