The International Monetary Fund (IMF) defined a non-performing loan as follows: ‘A loan is said to be non-performing and problematic when payments of interest and principal are past due by 90 days or more, or at least 90 days of interest payment have been capitalised, refinanced or delayed by agreement; or payments are less than 90 days overdue, but there are good reasons to doubt payment will be made in full’.
What is the situation in our country?
At the end of 2015 financial year, the World Bank report put Ghana’s Non-Performing Loan (NPL) position at 11.2%. If we compare Ghana’s performance with some selected countries so that we can have good understanding of how well we performed — particularly countries like Nigeria, South Africa, Kenya and Sierra Leone — we can situate the problem appropriately.
The World Bank Report on Bank Non-Performing Loans to Total Gross Loans (%) (Extract)
A Five-year comparative analysis of Ghana’s non-performing loan report shows a downward trend in percentage of non-performing loans to total gross loans granted; but the rate is still dangerously high compared to other countries listed in the report — the only country Ghana bettered in performance is Sierra Leone. Sierra Leone’s case is quite understandable because of the country’s long spell with an Ebola crisis that crippled the economy for a three-year period.
Why it is that Ghana’s NPL ratio is very high, about twice or three times that of Nigeria and South Africa? Are there immediate causes or there are other environmental factors that make loans granted in Ghana highly susceptible to payment default.
likely reasons for high level of credit default in Ghana
One may want to ask the following questions to get an idea of what the issues are. Is it the per capita income of individuals that is low relative to other countries or state of the country’s economy? Weak regulatory framework on the part of the regulators; lack of credit culture among the people; No proactivity and/or passivity of lenders; lack of traceability f borrowers? High interest rate regime in the country; Connivance between lender’s staff or and borrowers? Inadequate risk management skills, Weak corporate governance? Or Ineffective regulations and Lack of good credit policies.
Can it be over-zealousness on the part of lending officers, over-reliance on collateral and absence of a sound credit culture all contribute to creating Problem Loans? Defectiveness in selection of potential borrower; Mistakes in selection of business where to finance/not to finance? Long-drawn appraisement/approval process; Poor appraisal technique; End use/purpose not properly tracked? Defective structuring of credit; Under/over-financing of projects; Inconsistent and erratic government fiscal policy — the list of likely causes for the issue that has become an albatross for bankers and regulators in the country is endless.
However, no matter what may be responsible, the practical and reasonable thing to do is find some lasting solutions to the problem and ensure we return the country’s credit performance ratio to a more sound and respectable position within the shortest possible time.
Credit Appraisal Techniques to Avoid Bad Loans
For most players in the banking industry, the five canons of credit or lending still remain unchanged. Traditionally they are Character, Capacity, Collateral, Condition and Capital. But beyond these generally accepted Five Cs of commercial lending there is a need for bankers to understand that credit management like any other area of banking require continuous innovative thinking in order to outsmart dubious bank customers and prevent unprofitable lending. Thinking strategically and being two steps ahead of the borrowing public is what make, a good lender.
Additional Cs which easily come to mind that can strengthen bank’s credit appraisal processes include appraisal of the applicant Cash flow position, both past and future performance. Insider Connections with officers of the bank must be properly investigated; either their past relationship with previous employment or correspondences exchanged before and after the disbursement should be monitored. And, above all, the approving officer must apply his/her discretionary powers reasonably well. The other name for that is ‘application of Commonsense’.
The important thing to remember is not to be overwhelmed by marketing or profit-centred reasons to book a loan, but rather take a balanced view when booking a loan while taking into account the risk-reward aspects.
Generally, banks remain optimistic during the upswing of a business cycle, but tend to forget to check how the borrower will manage during the downturn — which is a shortsighted approach. Furthermore, banks tend to place greater emphasis on historic financials…which are usually outdated; this is further exacerbated by the fact that a descriptive approach is usually taken to the credit, rather than an analytical approach.
Resolving Non-performing Loans
Broadly speaking, there are three main methodologies to deal with excessive NPLs.
These can be done by creation of an Assets Management Company (AMC) to take over all bad loans in the balance sheet of banks — Securitisation of non-performing loans and Debt restructuring.
Banks on the other hand can resolve their non-performing loans problem more intensively by applying some of the already-known measures of debt restructuring. The most commonly used measure by banks is loan rescheduling — that is, modification of the maturity date and rarely changing interest rates (write off of default interest rate) or reducing the debt principal.
Beyond the traditional approach that has been tried and did not prove quite successful, we want to look at some other options that are open to banks in Ghana which are not currently being used.
Adopting World Bank ‘Podgorica approach’
The ‘Podgorica approach’ was developed by the World Bank Financial Sector Advisory Centre (FinSAC), which aims to achieve greater stability for the banking sector as well as revitalise lending activity to economically viable companies.
After the analysis of the borrowers’ financial situation, creditors should consider the possibility of financially restructuring debt or the entire corporation. The restructuring plan must show whether the creditors have real possibilities for the settlement of their claims, and borrowers the ability to service their debts regularly. Financial restructuring should be based on:
A well-designed restructuring plan for each individual loan, which should contain: financial information about the borrower, its business activities and the guarantor; collateral valuation, defined appropriate measures of financial restructuring; and adequate legal documentation that enables a change of deadlines for loan repayment.
Corporate restructuring involves changing some of a company’s structures (assets, capital, management, costs and organisation) in order to relax and reduce restrictions and improve the company’s performance.
Formulation of well-structured NPL management strategy is an essential requirement of sound credit policy. No compromise with due diligence in the sanctioning process: we must keep in mind that “Prevention is better than cure”.
Assets Management Method
Asset management is a process that involves identification of non-performing loans; taking specific decisions to resolve them, and implementing the decisions so the problem is corrected.
This can be achieved by setting up a special-purpose vehicle (company) as an Asset Management Company to facilitate restructuring viable financial institutions which are burdened with NPLs — by legally, financially and operationally separating and taking over bad loans from the financial institution. This is what government should do through the instrumentality of legislative acts to be championed by the Bank of Ghana. The benefits of this arrangement to the banks and government cannot be quantified in changing the face of banking in Ghana.
The other two methods that time may not permit us to discuss fully are the Balance Sheet Management approach and Cost Volume Profit Analysis approach.
There are two main methods of exiting a bad loan arrangement. Each method strictly depends on the position you are in at the time of taking that decision. If the bank is operating from a weak security position — that is, low convertibility of security — relationship viability is required; Collection success is not time-sensitive; Maintain customer creditworthiness while exiting. In this situation you have to use the cooperative exit method. The reason is simple: the bank position is weak relative to that of the borrower.
In a situation where you have strong security position we advise that you can go forcefully to recover your debt because the hand of the debtor is right is your mout; you can chew it as much as you want. Once you established that your security position is strong (full perfection of legal mortgage documents), you notice low management integrity; fraud highly suspected or proven; and security realidation and value deteriorating. You must move in fast and with force.
It is common knowledge among the players in the industry that diversion of funds is one of the identified causes of loan default. So it becomes very imperative to keep a close watch on the borrower’s business operations and the movement of its financial indicators in an empirical manner. Banks have to play the role of business partner rather than conventional lender. A bank has to ensure that utilisation of credit is in accordance with the purpose for which it is lent — i.e. end-use of the lending has to be ensured.
The bank has to monitor the borrowing unit’s performance to verify whether the assumptions on which the loan was sanctioned continue to hold good with regard to operation and environment. It is also to be observed whether the promoters are adhering to the terms and conditions of sanction, and this is done by devising a mechanism for obtaining information at regular intervals from the borrowing units. The bank will review the unit’s performance from the broader perspective by having better insight, so that it can extend meaningful advice to the promoters for overcoming any business hurdles.
It is an admitted fact that a bank’s financial health is largely dependent upon the extent and size of performing assets. Credit losses are equivalent to capital losses. An increase in non-performing loans (NPL) has multi-pronged adverse impacts on a bank’s balance sheet; having the consequential effect of eroding capital — thus impairing earning streams, profitability, liquidity and solvency. Any compromise with the quality of assets at the sanctioning process will be a contributing factor toward the enhancement of NPLs. The bank management has no choice but to stay focused on the issue of keeping the credit portfolio performing to its maximum extent.
Published in the Business & Financial Times on 2/2/2016