When I attend a banking forum, junior executives often ask me, “What have I learned from so many credit checks around the world? How can we avoid loan defaults?”
I tell you that loans typically fail for the following reasons: (1) improper or weak needs assessment; (2) improper structuring of facilities; (3) collateral or collateral breach; (4) poor internal company cash generation, resulting in recurring overdue charges; (5) lending based on borrower names or future potential or even succession; (6) ignorance of competition or emerging competition; and (7) economic downturns or investments in business areas other than core business areas relevant to the future or the economy.
Add to this, of course, weak credit ratings, a lack of understanding of foreign exchange risk in cross-border exposures, corruption or loan officer failures, weak or no approval requirements, or weak compliance or oversight. Sometimes pressure from above is also to blame.
We saw a textile customer endure recurring back payments due to an incorrect loan repayment structure. A large borrower from a state-owned bank defaulted immediately after disbursing the term loan because its project costs skyrocketed because it had not hedged against exchange rate fluctuations.
A major distributor of a global consumer brand defaulted because all of its money borrowed from the bank was invested in buying land rather than in the distribution business.
Loan officers are often captured by large clients because of their perceived “brawn or business prowess” or sometimes even “emotional blackmail”. In most cases, these large customers dictate the conditions. If we lend more than the client needs, he or she must withdraw the excess money from the business.
Regardless of who the customer is or what their business is, a loan officer must conduct a thorough needs analysis, ie how much the customer needs to run their business and in what form. You have to look at the business model. What is the forecast turnover? What is the term of an end-to-end transaction?
Then the loan officer has to come up with a number for structuring the facility. Even when you come up with a number, you need to know how much of it would be banked and how much by the owners. The collateral or collateral provided must be valued by an appropriate agency or subject to a mark-to-market valuation process on a regular basis. Amounts outstanding can also be checked against collateral or collateral held in the same way.
Incorrect land titles and the confiscation of school or prayer sites also led to problems in the construction of plants, forced companies to relocate and increased project costs. The business, which is not relevant to the core strength of entrepreneurs, also did not help many repayments.
Many banks in Bangladesh do not have their own risk policy or structured approach to credit appraisal, disbursement and repayment. Many financial institutions have large numbers of employees in their credit departments, but are entirely dependent on the board for almost any credit approval.
Many banks lack an appropriate security or collateral valuation culture. Facilities are granted without acknowledgment of the business or trade circuit. The resulting effects are credit defaults, foreclosures, capital depletion, reduced profitability and ultimately falling stock prices.
The author is a business analyst.