For some years now non-performing loans continue to pose a serious threat to the health of the country's financial institutions. The problem of lending money has assumed new dimension on account of sluggish demand for loans on the one hand and stiff competition in the banking sector, on the other. It has driven many banks to the corridor of uncertainty fraught with potential risks. Nine new commercial banks thrown in the fray have added to the intensity of the competition. The latent danger implicit in the heavy load of idle funds accumulated in the banking system is the tendency seen in many banks to lower their guards for lending money. This article is intended to serve as a warning against cavalier attitude in lending money even when competition gets very tough.
BALANCE THE COSTS AGAINST THE PERCEIVED RISKS: A balance must be maintained between increasing loan volume and the quality of loans. There are practical cost limits on how much investigation, analysis and documentation can be devoted to a loan. On the other hand, a loan with poor credit quality imposes a different kind of cost: loan loss, salary and allowances of officers working on problem loans, cost of litigations etc. The key to success is to address these conflicting objectives by maintaining a balance between the perceived risks and potential rewards while dealing with a loan proposal.
ONLY CASH REPAYS LOANS: A loan can be repaid from future cash flow of the borrower from his or her business or conversion of other assets to cash, or contracting a new loan from another source. A bank should generally make loans only after ensuring that the anticipated cash flow would enable the borrower to repay the loan. It should not, for example, make home loans to consumers where the bank will have to go through the hassles of foreclosing on the home to collect the dues.
STAY CLEAR OF SPECULATIVE LENDING: The banks should be very cautious about financing aggressive stock market investment, speculation in commodities, foreign exchange or other futures. Years of experience in many countries have taught us that the sharp increases in value (in stocks, real estate, and other assets) are often followed by sharp decline in value. The bankers in Bangladesh learned this lesson the hard way in 1996 and again in 2009-10 when the country's bourses witnessed unprecedented bullish fervour before the onset of inevitable bust of the inflated bubbles. Many bankers are still licking the wounds for misjudging the boom as the real thing.
ACCOUNTABILITY: Someone who recommends a credit is fully responsible for that credit decision even though the final authority to approve that credit rests elsewhere. Recommendations for action on credits should be accurate, clear, concise, candid, and complete. Material risks should be identified and highlighted as should the purpose of the credit. The basis for conclusions should be given so that the approving officers themselves have an analytical task (not a rubber stamp function) but are spared the job of sifting through masses of raw data for the important facts.
DO NOT LOWER YOUR GUARD EVEN UNDER PRESSURE: Executives and Directors of the bank and other influential people refer prospective clients to credit officers sometimes as a genuine effort to promote the bank's business but more often for doing a favour to their friends and relations or as a trade-off for a favour they received from the applicant. These references must be subject to normal scrutiny standards to ensure that the credit decision is prudent. Because, if the loan turns bad Hall-Mark-like, the loan officer will be among those who will face the unpleasant music from the Board of Directors or the Government's anti-corruption watchdogs and spend sleepless nights at home or prison while the sponsors of the borrowers, whose signatures do not feature in the memorandum, will sleep in the comfort of his or her home.
BASIC CREDIT STANDARDS: The following five basic standards will eliminate most problems from a bank's commercial lending portfolio:
I. Officers recommending approval of a credit must be satisfied that the credit will be reasonably free of risk by gathering information on the borrower's businesses and analysis of the credit risks.
II. The credit officers must ensure that the borrowers must be people of integrity and posses relevant business experience. The character of the borrower is the single-most important determinant of his credit quality. No amount of analysis, loan structuring, or legal documentation can protect a bank from the excessive costs and risks of loss that come from dealing with a fly by night character.
III. Ownership equity or net worth of the borrower must be significant in relation to the credit granted. Someone who has only the bank's money at risk is less likely to be a prudent user of that money than one who also has a significant amount of his or her own money at stake.
IV. The primary source of repayment should be the reasonably expected cash flow from the borrower's operations. Collateral supporting the loan may be considered as an alternative source but it is not a substitute for a primary source of repayment because of the legal and practical difficulties to convert collateral into cash. Special care must be taken before accepting real estate as collateral because land record in Bangladesh is in complete disarray and unscrupulous people prowl all over the places with fictitious documents to offer these on rent for use as collateral for bank loans.
V. A LENDER SHOULD BRAND THE PHRASE "ONLY CASH REPAYS LOANS" ON HIS OR HER MEMORY: In loans to individuals, lenders sometimes make the mistake of looking to assets (for example, a large, beautiful house), rather than the individual's cash flow. The writer of this piece had a bizarre experience of encountering a particularly solicitous borrower who claimed to have had the most beautiful house west of Padma in Faridpur town. With such a beautiful house as collateral, who would imagine that he would turn into a defaulting borrower? He did.
ANALYSIS: Creditworthiness is a function of capacity to repay and willingness to repay. The first step in analysis is to understand the environment in which the company operates. Political, economic, technological, and sociological trends in the country or countries where the borrower operates can all have an impact on the borrower's business. The availability of multiple sources of supply and the company's labour relations are also important factors impinging on the long-term success.
GOOD CREDIT ANALYSIS GOES BEHIND THE NUMBERS: A spreadsheet showing five years of financial figures that include many analytical ratios is a beautiful tool in analysis, but it is a tool only. It is not historical cash flow but future cash flow that will repay the loan. Companies that exist or thrive on political favours are particularly vulnerable when the people who dispense those favours are no longer in government. So be careful when providing finance to a project with a political overtone, particularly, in Bangladesh where politics is not free from personal or collective vendetta.
END USE: A loan must be sanctioned for a productive purpose capable of generating enough cash to service the debt. Repayment of loan shall match the time-frame of the cash generation capacity of the venture for which the loan has been sanctioned. If the credit amount is diverted, the purpose of the credit is defeated and turns sour before the ink dries in the charge documents executed by the borrower. If a banker has a close look, he can naturally find some reasons for this diversion.
There are a few identifiable reasons for diversions. Most common is the ease with which the borrower can access the credit. As the saying goes 'easy comes, easy goes'. Wherever a borrower gets the credit on a silver platter without much efforts or formalities or sometime even without 'asking', that money shall in all probability be frittered away on conspicuous consumptions or speculative ventures. We know of bankers who enjoy impressing others with their power and dispense favours by giving loans to their friends or acquaintances with carefree abandon. We have also seen some financing agencies coming in the open with a more formal 'Rin Mela' (loan fair) as well. Let's not forget that all 'easy' loans granted under the influence of alcoholic beverages or showcasing of dynamic lending practice end up as non-performing ones.
FOLLOW-UP: The commercial lender's job is not done when the loan is disbursed. The lender should stay in touch with the customer and sources of information about the customer so as to understand what is happening in the customer's business. This allows the lender to know whether there is some deterioration that requires action to protect the bank's interest. It is also a source of marketing information leading to new opportunities to do business.
Credit Rating: Banks lend funds to clients having high or acceptable creditworthiness. An effective way of judging the creditworthiness of a borrower is to ascertain CAMEL rating. 'CAMEL' stands for Capital, Assets, Management Earning ratio and Liquidity. These parameters serve as a handy tool to assess the creditworthiness of a borrower.
Collection of Credit Information: For assessing the creditworthiness of a borrower, the options available to a bank include Bangladesh Bank's Credit Information Bureau which maintains a data base on the indebtedness of the borrowers of banks and other financial institutions. The banks also try to find out the creditworthiness of the party by making enquiries from the brokers, traders and businessmen in the same locality, especially in the same trade or industry. An analysis of the Balance Sheet and Profit and Loss Account of the borrower for the last few years will reveal the trend of his true financial position.
NEVER MAKE HASTE: There is a saying 'Act in haste, lament at leisure'. A hasty decision may miss vital points affecting the quality of the decision. To approve a credit, a banker must evaluate the purpose, the viability of the business venture and also make assessment of the capability of the entrepreneur regarding the implementation of the project. It is always advisable that a reasonable time is spent to reach a rational decision. Remember that Almighty God who could just create the universe in a flash did not take that short-cut route. He took six days to do it, perhaps to remind the ordinary mortals to avoid hasty action. Regardless of how strong the pressure is from the borrower or one who walks in the corridor of power, take your time to ponder over the merits of the proposal to take a rational decision. Otherwise, you might really end up lamenting for the rest of life for the decision taken in haste.
The author is a former central banker and Chief Executive of a commercial bank. [email protected]
© 2024 - All Rights with The Financial Express
