Delinquency, bad loans and a stitch in time

Lenders must ensure that they lend only to those that value them and their funds. They are more likely to want to pay back if they can afford to do so. Lenders should also not be shy of stepping back to correct errors detected in the loan structure. This error may be in the client selection process or the size, interest rate or repayment timing

During the last few weeks, we tried to make the point that bad loans constitute a tear in the fabrics of the well-being of a financial institution. Naturally, wear and tear is an unavoidable consequence of the use, effluxion of time and the operation of any system. What is not natural is the courage to tackle the wear and tear in a timeous manner to restore the object on which the tear is inflicted. Overtime, the wise men of the ages past have given us a hint as to the possibilities that follow our action or inaction whenever a tear occurs. According to them, we ought to very quickly mend the object of any tear. They summarized the wisdom in the adage: a stitch in time saves nine. Truly, this adage is of general application. A stitch made in time will surely save much trouble, whether it is on a piece of cloth or on the human body. Are we not told that early detection of cancer is fundamental in the survival of the patient?

Essentially, there are two steps to effectively resolve any challenge. The first thing is to identify the challenge and accept that it does exist. This is the work of research, or diagnoses if the challenge is of the medical dimension. When we have identified the issue, the next step is to apply whatever recommended or approved solutions to the challenge. After a cancer has been discovered, chemotherapy follows. According to medical reports, chemotherapy has three possible outcomes that may follow its administration. First, it could shrink the cancer completely out of existence.The treatment of cancer by chemotherapy sometimes destroys the cancer cells, so much so that doctors can no longer detect them anymore in the patients’ body. At that point, the cancer has lost its power to regenerate. Second, the cancer may be kept from spreading by slowing the growth of the tumours. The third scenario is that the cancer is not cured or slowed but continues to spread. Here chemotherapy fails. In all of these, the key determinant of the efficacy of the chemotherapy, or the lack of it, is the time the treatment started and the stage of the cancer. The earlier the cancer is detected and treated, the more efficacious the administration of chemotherapy.

So it is with bad loans. They must be determined, acknowledged and properly managed, if they are to be controlled and prevented from destroying the institution. The action must be timeous. Pretending that a bad delinquent loan is good is self-deceit. It may even create more problems, particularly for those who may decide to earn and accrue interest on loans that waved them goodbye. We had elsewhere shown how such acts could damage the repayment rate and enhance delinquency ratio.

There are a number of steps that an effective microfinance institution must take to avoid the destructive effects of toxic loans. First, we have to recall that delinquency is almost always a result of poorly designed and implemented loan making procedures. Let us begin by assuming that the loans are procedurally and technically sound. Thereafter, all delinquency must be managed along the following strategic lines:

There is one important point that lenders tend to miss when granting loans. That point is whether the client really values the loan granted him. Many factors drive a man to pay back a loan. One of them is how much he values the loan for the immediate benefit it brings and the fact that the lender remains a source of future loans. The hope of borrowing again is a tonic for repayment. It means the loan is valued. The main driving force behind loan repayment by clients is the hope that they may get future loans from the lender. This means they value the loan service as to keep the channel open. Clients do not value loans that are ill-timed or poorly delivered. Elements of poor packaging include ill-timing, insufficiency for the felt need and generally poor terms of the loan. This implies that a loan must be made to suit the needs of the client to enhance its value and therefore repayment possibility by the borrower.

The foregoing is the reason we advise microfinance institutions (MFIs) to desist from granting loans to the wrong people. These are the non-poor enterprises that borrow from MFIs just to meet emergencies but which the lenders now mistake for their core clients. Granted that these clients allow MFIs to make large loans to a single obligor, which is more attractive than the myriads of small loans for several reasons, the clients have the deposit money banks as alternative loans sources. They therefore do not value the loans very much. Lenders must ensure that they lend only to those that value them and their funds. They are more likely to want to pay back if they can afford to do so.

Lenders should also not be shy of stepping back to correct errors detected in the loan structure. This error may be in the client selection process or the size, interest rate or repayment timing. Borrower selection is an important instrument for preventing bad loans from happening. Naturally, every lender must have a target market that is clearly defined. This helps to eliminate and streamline the borrowers. Once clients have been properly selected, the lender must ensure that the loan structure is repayment-friendly. Certain loans are not repaid because they are not so structured. They just cannot be paid unless restructured. But lenders must accept the possibility of restructuring loans as a matter of course in their trade. Work Out arrangements are a fact of the lending life.

Poor management information system among the MFI has acted as energizer the growth of bad loans. It is impossible to manage loans away from delinquency, or out of it, if we are not fed with the most precise of information on our loans. Poor financial capacity has served as a brick wall against appropriate investment in this strategic resource. The quicker loan officers become aware of due and uncollected payments the better they can deal with the issues promoting such a situation. We have written quite a bit on the subject of Portfolio Reports. Suffice it to say that loan officers are duty bound to review their portfolios on a daily basis to throw up delinquent and potentially delinquent relationships. Because beliefs become thoughts which become words that become actions and then habits, it is important that lenders set out very early to educate clients on what standards they intend to keep in relationships. They must be told in clear language that delinquency is not acceptable and they should respect their contracts with the lender.

Loan review meetings are usually some of the worst places loan officers can find themselves. However, the regular and open discussion of delinquent accounts should be encouraged across the industry.