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Optimization of Profitability Vis-A-Vis reinforcement of financial health of Banks/Financial Institutions

Bankers now-a-days because of growing awareness prioritize to extend purpose oriented credit facilities with required security/ collateral support. So it becomes of imperative need to exercise due diligence in the process of credit assessment focusing on the borrower’s business dynamics and operational aspects to ensure optimal credit flow to the borrowing concern matching their requirements avoiding the incident of over or under financing. Lending institution has to ensure that utilization of credit is in accordance with the purpose for which it is lent i.e. end use of the lending has to be secured. The bank has to monitor the performance of the borrowing unit 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 performance of the unit from the broader perspective for having better risk perception so that they 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 in other words performance of the counter party borrower’s and how far they can pare down the size non-performing credit loans (NPLs).

Credit losses are equivalent to capital losses. An increase in NPL has the multi-pronged adverse impacts on bank’s balance sheet as expressed through key performance indicators having consequential effect of erosion of capital impairing earning streams, profitability, liquidity and solvency. Any compromise with the quality of asset at the sanctioning process will be a contributing factor towards enhancement of NPLs so the bank management has no choice but to stay focused on the issue of keeping credit portfolio performing to the maximum possible extent weathering both internal barrier and externalities.

Strategies, way outs for restraining NPL:

Formulation of well-structured NPL management strategy covering following areas:

 No compromise with due diligence in the sanctioning process. Keeping in mind “prevention is better than cure.”

 Action plan for potential NPLs.

 Identification of highly risk sensitive borrowers in the credit portfolio.

 Identification of geographical area wise risk sensitivity.

 Targeting high value end NPL accounts (having exposure Tk. 5.00 crore and above) depending upon the state of condition of portfolio.

 Prompt action on credit reports.

 Capacity building of officers and executive posted both had head office and branches.

Goals of monitoring and follow up:

 To ensure that funds are utilized for the purpose for which they were sanctioned.

 To see that the terms and conditions are complied with.

 To monitor the project implementation for avoiding time lag and consequential cost over-runs.

 To evaluate the performance in terms of production, sales, profits on a periodic basis for ensuring that the borrower is keeping to the original plan and is having sufficient profits to service the debts as well as for the sake of maintaining normal business momentum.

 To assess the impact of negative externalities on the performance of the company.

 To detect the symptom of sickness at the early stage for initiating measures at the opportune moment.

 To keep check on the movement of financial position.

Supervisory process:

Supervisory process may be activated meaningfully in a following manner:

 Off-site Monitoring:

  •  Periodic Reports on the risk sensitive clients/ borrowers.
  •  Analysis of financials as portrait in the balance sheet, income statement cash flow and fund flow statement etc. to shot out the weaknesses in the business.
  •  Risk grading in right perspective.

 On-site Monitoring:

  •  Physical visits to the business venue of the clients.
  •  Direct interaction/ discussion meeting

Preventive Measures:

 Understand client’s business.

 Analyze client’s financials.

 Frequent visits to client.

 Ensuring perfection of legal documentation.

 Investigation on market rumors.

 Use Credit Bureau checking.

Supervision and follow up of advances can be divided into three main control groups:

1. Legal control

2. Physical control

3. Financial control

Legal Control:

 Proper execution of documents.

 Keeping the documents constantly in force.

 Complying with various legal formalities like:

I. Registration of charges.

II. Creation of mortgage.

III. Complying with the directives of the central bank and internal policy guidelines.

Physical Control:

I. Inspection of the physical securities charged in favor of the Bank.

II. Verification of books of accounts.

III. Cross checking with the physical securities.

IV. Inspection of factory and go down sites/premises to ascertain the activity levels and stock levels respectively.

Financial Control:

I. Evaluate the performance of the company on the basis of periodic financial statements.

II. Monitoring the utilization of limits through quarterly information statement and monthly select operational data.

III. The credit inspection and supervision pertaining to the account could be off-site or on-site.

a. Off-site supervision is generally done at bank’s desk level.

b. On-site supervision is done at the borrower’s place of business.

Basic Indicators of non-performance requiring awareness by the Bankers:

Bankers are required to remain vigilant over the status of their credit portfolio and if any indication of deterioration of performance of the particular borrower is found in that case immediate measure of retrieval should be initiated, some of the indication are enumerated as under:

 Apparent stagnation in the business as reflected by slow/negligible turnover in the account.

 Frequent request for overdrawing or issue of cheques without ensuring availability of funds in the account.

 In case of term loan nonpayment of overdue installment.

 Unexplained delays in submission of stock statement.

 Slow movement/stagnation of stocks observed during inspection.

 Diversion of fund to sister units/acquiring capital assets not relevant to the business /large personal withdrawals.

 Non-adherence to project schedules cause time over-run having consequential effect of cost over-run requiring additional funding.

 Pressure on liquidity leading to non-payment of wages to workers /statutory dues/rents of office and factory premises.

 Current liabilities exceeding current assets.

 Basic weakness found in the financial statement.

 The borrower is not traceable

 The borrower does not have any property to be proceeded against or the particulars of the borrower’s properties are not available.

 Although the matter of non-repayment of banks debt has been brought to the notice of the borrower but he/she expressed inability to pay or do not respond.

 The borrowers business has suffered a setback and he/she has asked for further loan for reviving the business.

 The borrower is an influential person/ (PEPS) and maintains political clout that hinders the banker to progress with the issue of recovery.

 The borrower has died and the responsibility of repayment of the loan cannot be fixed up easily/involves wrangle of legal procedures.

 Documentations are irregular or securities are insufficient or not properly charged.

 Unusual or unexplained delays in receiving promised repayments or in communicating with bank personnel.

 For business loans, restructuring outstanding debt or experiencing a change in credit rating.

 Unusual build up of the borrowing customers’ accounts receivables /inventories

 Rising debt to net worth ratio (leverage ratio)

 Reliance on reappraisal of assets to increase the borrowing customer’s net worth.

 Adverse changes in the price of a borrowing customer’s stock.

 Net earnings losses in one or more consecutive years especially as measured by returns on borrower’s assets (ROA), or equity capital (ROE) or earnings before interest and taxes.

 Adverse changes in the borrower’s capital structure (equity/debt ratio) , liquidity (current ratio or activity levels (ratio of sales to inventory)

 Deviations of actual sales or cash flow from those projected when the loan was sanctioned.

 Sudden unexpected and unexplained changes in deposit balance maintained by the customer.

Causes of growth of Non-Performing Loans:

Pre-approval phase (Controllable Variables):

 Defectiveness in selection of potential borrower.

 Mistake in selection of business – where to finance/not to finance.

 Long drawn appraisement / approval process.

 Poor appraisal technique.

 End use/ purpose not identified.

 Defective structuring of credit.

 Under/over financing.  Mismatch of Asset (NWA).

 Imprudent Judgment/wrong conception about sectoral viability/ volatility.

 Unusual attachment of importance on collateral security.

 Wrongly conceived projections and not supported by adequate assumptions.

Causes of growth of Non-Performing Loans:

Post-approval phase:

 Poor Monitoring.

 Improper/ inadequacy in loan documentation.

 Poor IMS.

 Un-favorable Investment Climate.

 Economic Recession.

 Inconsistent and erratic govt. fiscal policy.

 Credit Culture promote loan default.

Steps for recovering bank’s funds from a problem loan:

 Bankers must always keep the goal of loan workouts firmly in mind.

 The rapid detection and reporting of any problem related to borrower or business is essential as delay often worsens a problem loan situation and the situation thereby spins out of control.

 The loan workout responsibility should be separate from the lending function to avoid possible conflict of interest.

 The concerned credit officer should confer/discuss with the troubled borrower quickly on possible options especially for cutting expenses, increasing cash flow and improving management control. Develop a preliminary plan of action after determining the bank’s risk exposure and sufficiency of loan documents, especially any claim against customer’s collateral other than that held by the bank.

Indicators of poor lending policies:

 Poor selection of risks among borrowing customers.

 Lending money contingent on possible future events.

 Lending money because a customer promises a large deposit.

 Failure to specify a plan for the liquidation of each loan.

 High proportion of loans made to borrowers outside the bank’s territory/ beyond the common measure.

 Incomplete credit file.

 Tendency to overreact to competition (making poor loans to keep customers from going to other banks.

 Lending money to support speculative purchase.

 Lack of sensitivity to changing economic conditions both domestic and world economic.

Concluding Remarks:

It is of imperative need to work out as to what resources both in value and quality are available to clear cobwebs of the troubled loans of the portfolio including the estimated liquidation values of business and non-business assets of the borrower/group. The credit personnel of the lending institutions must evaluate the quality, competence and integrity of the current management of the borrowing concern and making visit the site of the business to assess the borrower’s property and operations as part of due diligence for having better risk perception/insight. The concerned credit specialist must consider all reasonable alternatives for cleaning up the troubled loans on the basis of diagnosis of the financial health of the borrower’s capacity and capability to cope with the emerging situation for overcoming the financial hurdles with the ultimate objective to deliver sustainable financial solution.

Bangladesh Bank has expressed overriding concern over the quantum lift of NPLs and the propensity among the lending institutions to make prolongation without justifiable ground by even renewal of term loan/extension of validity arbitrarily which has been termed as ever greening may sometime result in over statement of capital, higher end maintenance of provisions than required though having low probability of repayment but carries inflated value on bank’s balance sheet. This kind of practice eventually weakens the financial foundation of the Bank and consequentially dented the financial health of the lenders and eventual enlistment as problem lending institution. The professional management of the lending institutions in the category of banks and financial institutions requires matured prudence level, clear-cut perception on different core risk areas of banking operations, leveraging of revenue drivers/forecasting of emerging business prospects which will ultimately prove to be instrumental for navigating the concerned lending institution in the right direction by overcoming the hurdles on the path ahead.


The author, Mohammad Masoom is currently working as AMD in Midland Bank Limited and the former Managing Director and CEO of BD Finance.  

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