Synopsis: In the booming business loan market, disclosure statements are essential for reducing risk and ensuring a smooth loan process for both borrowers and lenders. Learn about their importance, types and applications from the perspective of lenders and borrowers in a business loan.  

In India, an estimated 63 million MSMEs are operating in the current fiscal year. With this thriving entrepreneurial ecosystem, the value of total business loans increased by 10% from FY21 to FY22. However, a lack of transparency in loan applications can pose significant risks for both lenders and borrowers. This is where paying close attention to disclosure statements becomes important.  

What is a Disclosure Statement? 

A disclosure statement is a written description of the rules of a financial transaction in simple, non-technical language. In terms of business loans, a disclosure statement is an official record of documents provided by one party to another that clearly outlines the facts and figures that should be mentioned for the loan procedure. This document serves the purpose of bringing transparency into the transaction by offering details on crucial aspects like:  

• Loan amount and interest rates 
• Any initial origination or upfront charges 
• Late payment penalties 
• Repayment terms and options  
• Collateral requirements and their type (optional) 
• Borrower’s right to early payoff or loan modification  
• Borrower’s responsibilities against timely payments  

According to the law, lenders must provide the disclosure statement to borrowers within a reasonable amount of time before loan approval.  

Types of Disclosure Statements

There are two different types of disclosure statements for business loans, each tailored to a specific purpose and industry.  

1. Financial Disclosure Statements:  

When borrowers apply for business loans, lenders analyze their financial disclosure statements to get a snapshot of their business’s financial health. These documents detail an individual’s financial health with details such as assets, liabilities, income, and expenses. They are often required for:  

• Loan applications:  

Based on the borrower’s financial standing, lenders decide if the business qualifies for the loan. If the financial statement is strong, it increases the likelihood of loan approval.  

• Interest rates and loan terms:  

The borrower’s financial health directly impacts the interest rate offered by the lender. For instance, if a business has a solid financial track record, it typically qualifies for lower interest rates and favourable loan terms with longer repayment periods.  

2. Loan Disclosure Statements  

Loan disclosure statements are provided by the lender to the borrower that outlines specific terms and conditions of the loan offer in detail. According to the Truth in Lending Act (TILA), lenders are under obligation to furnish such details to ensure transparency and informed consent from borrowers.  

A loan disclosure statement includes:  

• Loan amount and interest rates 
• Upfront origination fees 
• Processing charges and late fees 
• Repayment terms 
• Collateral requirements 
• Borrowers’ rights and requirements  

What is the purpose of a disclosure statement? 

A disclosure statement serves several key purposes in business loan applications, such as:  

1. Transparency: Lenders communicate about the loan’s details to build trust and help borrowers make informed decisions 

2. Informed consent: By knowing all terms, fees, and repayment details, borrowers offer their genuine consent to the loan agreement  

3. Fair comparison window: Borrowers can use the disclosure statements to compare loan offers from different lenders on an apples-to-apples basis  

4. Reduced risk: A clear understanding of loan obligations helps borrowers manage expectations and avoid potential misunderstanding or defaults  

5. Compliance with legal requirements: Disclosure statements are mandatory under consumer protection regulations to ensure the ethical operation of lenders 

6. Protection against liability: A clearly written disclosure statement protects lenders from potential legal disputes resulting from misunderstandings  

7. Improves reputation: As lenders commit to transparency practices, it helps build trust and enhance their company’s reputation in the market  

Applications of Disclosure Statements in Business Loans  

Let’s understand the application of disclosure statements from the perspective of lenders and borrowers.  

For Borrowers  

Disclosure statements become important during loan application and loan evaluation.  

During loan applications:  

While applying for loans, borrowers are requested to furnish a disclosure statement that details their financial health, also known as a financial disclosure statement. This statement provides the following financial details of the borrower:  

Balance Sheet: 

The balance sheet contains the list of total assets, liabilities, and shareholder equity of the borrower at a specific point in time. This data shows the financial position of the borrower’s company and the probability of loan default in the future.  

Income Statement:  

Income statements show a business’s revenue and expenses over years. They help lenders evaluate the profitability and cash flow of the business, which indicate its capacity to make loan payments.  

Tax Returns: A borrower’s ITR verifies its business’s financial health. Typically, lenders ask for the ITRs of the past 2-3 years in your disclosure statements to gauge the  business’s stability and growth trajectory. Lenders often use ITR data to calculate net income and thereby assess the risk involved in lending loans in the first place.  

During loan evaluations:  

After reviewing the financial disclosure statement of the borrower, the lender issues a loan disclosure statement, as we have already discussed before. It clearly outlines the specific terms and conditions of the loan offer.  

For Lenders 

For lenders, disclosure statements are highly useful for:   

Measuring creditworthiness:  

Lenders take the help of the financial disclosure statements of the borrower to see what they own and what they owe. A borrower with high assets compared to liabilities is generally considered less risky. The disclosure statement might include a history of past loan repayments. Lenders consider borrowers with an excellent track record of managing debt responsibly.  

Calculate Loan-to-value ratio (LTV): 

Financial disclosure statements can indirectly influence the LTV assessment in a couple of ways. For instance, if the statement shows that the borrower has a significant amount of liquid assets, the lender might be able to put down a larger down payment on a loan. A higher down payment lowers the LTV ratio.  

Loan restructuring:  

The disclosure statement reveals the borrower’s updated financial situation compared to when the loan was initially issued. It shows changes in income, expenses, assets, and liabilities. This helps the lender understand why the borrower needs restructuring and assess their current liability to repay the loan.  

FAQs 

What is a disclosure requirement? 

A disclosure requirement is a rule or regulation that mandates involved parties in any transaction to reveal certain information. The specific requirements can vary for laws, industry regulations, and internal company policies. The purpose is to ensure transparency, fairness, and informed decision-making in various situations.  

What is a disclosure form? 

This is a standard document, physical or electronic, used for collecting and organizing disclosure information. These forms contain predefined questions or sections that individuals must fill out to comply with the disclosure rules.