What is solvency?

Definition: The customer's ability and willingness to fulfil his/her future payment obligations in full and on time.

The question "What is solvency?" is closely connected with the granting of loans. Banks only grant loans to customers if they can provide proof of sufficient solvency. Moreover, mail-order companies and online shops also use credit checks before they send out goods with an invoice.

In principle, solvency corresponds to creditworthiness or financial standing. Before establishing a business relationship, a bank or mail-order company checks whether a new customer is creditworthy. The credit assessment covers various criteria used by banks to check for certainty of repayment. During a credit assessment, suppliers obtain information on how likely a customer is to pay invoices during the payment term. 

 

What is solvency?
the preconditions

The personal and the commercial creditworthiness constitute the most important criteria to assess solvency. In this context, the current situation and payment history are considered in the assessment. However, banks' and suppliers' preconditions for creditworthiness differ in this respect. Mail-order companies primarily consider payment discipline: They do not consider the current income and regular payment obligations. On the other hand, these criteria are very important for a bank before it gives a loan. Thus, banks and suppliers carry out credit checks based on different criteria. 

What is solvency?
The credit assessment

Banks that grant loans over a term of several years check solvency on the basis of commercial and statistical procedures. Through a systematic assessment of the solvency criteria, this results in an individual credit rating. On the one hand, the credit assessment constitutes a reliable basis for lending decisions for banks. On the other hand, banks are also obliged to carry out regular credit assessments under the German Banking Law. Therefore, the bank requests current proof of income if you apply for a loan. At the same time, you are obliged to provide information on your regular payment obligations, for which you should be able to give proof on demand. In the framework of a credit assessment, the bank determines whether the difference between your income and expenses is sufficient for the regular payment of a loan instalment. In this process, it also considers your costs of living and possible assets which can be used as collateral. Moreover, the bank obtains information from credit agencies to determine your payment history. This information includes, e.g., data regarding loans, banking accounts, customer accounts at mail-order companies, online shops and mobile-phone contracts. Since vendors cannot request proof of income for every order, they focus their credit assessment on information obtained from credit agencies.

What is solvency?
Effects of the credit rating

The question "What is solvency?" can be answered as: The borrowers' financial ability to repay their debts and the customers' ability to pay their invoices. The credit assessment is followed by a credit rating based on a rating score. Banks base their lending decisions on the credit rating. In addition, the credit rating can also influence the interest level. An increased credit risk might lead to a higher interest rate. Suppliers will only carry out a delivery on invoice if the credit assessment has a positive result. If this is not the case, vendors will frequently only deliver goods against prepayment or cash-on-delivery.