Lessons learned from credit failures
Thursday, 5 May 2011
Mamun Rashid
My posting to corporate banking division at ANZ Grindlays bank made me a credit initial holder in 1992. I became a certified credit professional in 1996, after passing all the 14 module exams organized by the OMEGA, London. During my professional banking career, I did attend many basic, intermediate and advanced credit as well as risk management courses, incidentally all abroad. However, I faced the real test as a credit officer, while I was made the restructuring and recovery head at the Standard Chartered Bank as well as while undergoing some audit assignments, following the Asian meltdown in 1997, and afterwards in East Africa. Younger bankers do often ask me, why does a credit go bad? Do we learn enough from the credit failures? My background as a Risk Officer for almost 14 years, taught me, credit usually go bad due to following reasons: 1) improper need assessment, 2) wrong structuring of the facilities, 3) security or collateral shortfall, 4) weak internal cash generation in the business leading to recurring past dues, 5) lending on the basis names of the borrowers without looking into their business fundamentals, 6) ignorance about competition, 7) economic downturn or investment in the business segments other than the core ones having relevance to the future or to the economy. Added to these are, of course, weak credit assessments, failure to understand foreign exchange risk where cross border exposures are required and corruption of the lending officers. I have seen many credits going bad in Indonesia due to the failure of the lending officers to understand the foreign currency conversion or fluctuation risks. Many loans in Malaysia went bad due to working capital being used to finance projects, a development almost similar to that of Bangladesh. In Taiwan many middle market loans went bad, because tenor provided was less than the trade cycle. Serious competition in India forced banks to keep their eyes shut with regard to security or collateral shortfall. Most East African credits went bad due to failure in facility structuring and thereby borrowers were taking away huge sum of money for unrelated purposes. Even in Bangladesh we have seen recently how industrial credits were diverted to stock market. In Pakistan 'name lending' or 'influenced lending' pushed the banks to go `belly up'. In Latin America cases were more related to taking over exposure in foreign currency, while in Europe and even North America, it was drastic reduction in underlying asset value, thereby making the exit impossible. One needs to do a `deep dive' need assessment, that is how much the client needs to run hisher business and in what form. There is a saying- if you push out too much paste from a toothpaste tube, you won't be able to take this back, and similarly if some water enters your ear, you need to put in some more water to take the same out. One has to look at the business model- how much is the projected turnover, what is the tenor of an end to end transaction and then derive a figure. Even if one derives a figure, one has to know, how much of that would be bank financed and how much by the owners. I have also seen credit going bad, because the borrower needed the facility for 150 days, whereas the facility the bank offered was only for 120 days. Facility structure must accommodate the trade cycle plus some grace period. We have often seen, marketing managers or relationship managers marketing a credit under some agreed security and collateral parameters and disbursing the facility by keeping some documentation pending. If there is no `approval covenant' monitoring system, security perfection may remain pending for years and ultimately going bad. One should always try to take best of the securities or even `nearest to clients' heart' properties or even household mortgages. Regular benchmarking of the security value vis a vis outstanding, should be part of the credit culture. I have also seen loans going bad due to non compliance with regulatory imperatives like waste treatment plant, river pollution or even neighborhood pollution in India. The social activist groups forced the agencies to close down the plants. Faulty title of land, grabbing of school or prayer places also created problems in erection of plants, thereby forced the companies to relocate and thereby increasing the project costs. Death of the key person without any proper succession also puts many loans into jeopardy. Business being not relevant to the core strength of the key entrepreneurs also didn't help many repayments. Most importantly one has to be with the winners in each of the business segment, not with the losers. If one would want to penetrate further into the client segment with some securitycollateral or even inadequate cash generation with some compromises, in that case pricing must be reflective of the inherent risk or government must subsidize to encourage money flowing to those hungry segments. Banking sector in Bangladesh has been a victim of constant loan defaults. Despite corrective measures taken, loan default continued to trouble the banks and financial institutions in Bangladesh. Until September 2010, such bad loans stood at around Taka 121 billion. According to Bangladesh Bank, until September 30, 2010, a total of 21,029 cases relating to recovery of loans remained pending with the courts. Borrowers owed Taka 118 billion to the state owned banks only. On December 31, 2010, the non-performing loans of the banks stood at Taka 227.09 billion. A year ago, it was Taka 224.82 billion. The volume of total such loans increased by Taka 2.27 billion or 1.0 per cent last year compared to that of the previous year. Bank loans in Bangladesh turned non-performing mainly due to -1) weak assessment of the loan or weak facility structuring, 2) failure of the lending officers to understand the inherent risks of the specific industry or business segment, 3) turning working capital loans to term loans, 4) 'name lending' or 'push lending' due to severe competition, 5) dictated loans or managed loans in the state owned or even some large private banks, and most importantly, 6) lack of timely monitoring and thereby failure in taking timely action to salvage the situation. Here I must give due credit to our regulatory agency and financial sector reform project driven by the World Bank. Both have significantly helped our financial sector to intensify loan monitoring, need assessment, interest rate differentiation on the basis of underlying risks and also core risk management guideline delineated by them to improve risk management culture in banking sector. However, we need to develop further a strong risk management culture in every financial institution to avoid surprises for our seniors, sponsors and also regulators. (The writer is a banker and economic analyst. He can be reached at: mamun1960@gmail.com)
My posting to corporate banking division at ANZ Grindlays bank made me a credit initial holder in 1992. I became a certified credit professional in 1996, after passing all the 14 module exams organized by the OMEGA, London. During my professional banking career, I did attend many basic, intermediate and advanced credit as well as risk management courses, incidentally all abroad. However, I faced the real test as a credit officer, while I was made the restructuring and recovery head at the Standard Chartered Bank as well as while undergoing some audit assignments, following the Asian meltdown in 1997, and afterwards in East Africa. Younger bankers do often ask me, why does a credit go bad? Do we learn enough from the credit failures? My background as a Risk Officer for almost 14 years, taught me, credit usually go bad due to following reasons: 1) improper need assessment, 2) wrong structuring of the facilities, 3) security or collateral shortfall, 4) weak internal cash generation in the business leading to recurring past dues, 5) lending on the basis names of the borrowers without looking into their business fundamentals, 6) ignorance about competition, 7) economic downturn or investment in the business segments other than the core ones having relevance to the future or to the economy. Added to these are, of course, weak credit assessments, failure to understand foreign exchange risk where cross border exposures are required and corruption of the lending officers. I have seen many credits going bad in Indonesia due to the failure of the lending officers to understand the foreign currency conversion or fluctuation risks. Many loans in Malaysia went bad due to working capital being used to finance projects, a development almost similar to that of Bangladesh. In Taiwan many middle market loans went bad, because tenor provided was less than the trade cycle. Serious competition in India forced banks to keep their eyes shut with regard to security or collateral shortfall. Most East African credits went bad due to failure in facility structuring and thereby borrowers were taking away huge sum of money for unrelated purposes. Even in Bangladesh we have seen recently how industrial credits were diverted to stock market. In Pakistan 'name lending' or 'influenced lending' pushed the banks to go `belly up'. In Latin America cases were more related to taking over exposure in foreign currency, while in Europe and even North America, it was drastic reduction in underlying asset value, thereby making the exit impossible. One needs to do a `deep dive' need assessment, that is how much the client needs to run hisher business and in what form. There is a saying- if you push out too much paste from a toothpaste tube, you won't be able to take this back, and similarly if some water enters your ear, you need to put in some more water to take the same out. One has to look at the business model- how much is the projected turnover, what is the tenor of an end to end transaction and then derive a figure. Even if one derives a figure, one has to know, how much of that would be bank financed and how much by the owners. I have also seen credit going bad, because the borrower needed the facility for 150 days, whereas the facility the bank offered was only for 120 days. Facility structure must accommodate the trade cycle plus some grace period. We have often seen, marketing managers or relationship managers marketing a credit under some agreed security and collateral parameters and disbursing the facility by keeping some documentation pending. If there is no `approval covenant' monitoring system, security perfection may remain pending for years and ultimately going bad. One should always try to take best of the securities or even `nearest to clients' heart' properties or even household mortgages. Regular benchmarking of the security value vis a vis outstanding, should be part of the credit culture. I have also seen loans going bad due to non compliance with regulatory imperatives like waste treatment plant, river pollution or even neighborhood pollution in India. The social activist groups forced the agencies to close down the plants. Faulty title of land, grabbing of school or prayer places also created problems in erection of plants, thereby forced the companies to relocate and thereby increasing the project costs. Death of the key person without any proper succession also puts many loans into jeopardy. Business being not relevant to the core strength of the key entrepreneurs also didn't help many repayments. Most importantly one has to be with the winners in each of the business segment, not with the losers. If one would want to penetrate further into the client segment with some securitycollateral or even inadequate cash generation with some compromises, in that case pricing must be reflective of the inherent risk or government must subsidize to encourage money flowing to those hungry segments. Banking sector in Bangladesh has been a victim of constant loan defaults. Despite corrective measures taken, loan default continued to trouble the banks and financial institutions in Bangladesh. Until September 2010, such bad loans stood at around Taka 121 billion. According to Bangladesh Bank, until September 30, 2010, a total of 21,029 cases relating to recovery of loans remained pending with the courts. Borrowers owed Taka 118 billion to the state owned banks only. On December 31, 2010, the non-performing loans of the banks stood at Taka 227.09 billion. A year ago, it was Taka 224.82 billion. The volume of total such loans increased by Taka 2.27 billion or 1.0 per cent last year compared to that of the previous year. Bank loans in Bangladesh turned non-performing mainly due to -1) weak assessment of the loan or weak facility structuring, 2) failure of the lending officers to understand the inherent risks of the specific industry or business segment, 3) turning working capital loans to term loans, 4) 'name lending' or 'push lending' due to severe competition, 5) dictated loans or managed loans in the state owned or even some large private banks, and most importantly, 6) lack of timely monitoring and thereby failure in taking timely action to salvage the situation. Here I must give due credit to our regulatory agency and financial sector reform project driven by the World Bank. Both have significantly helped our financial sector to intensify loan monitoring, need assessment, interest rate differentiation on the basis of underlying risks and also core risk management guideline delineated by them to improve risk management culture in banking sector. However, we need to develop further a strong risk management culture in every financial institution to avoid surprises for our seniors, sponsors and also regulators. (The writer is a banker and economic analyst. He can be reached at: mamun1960@gmail.com)