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Revisiting key issues in loan delinquency governance

Loan delinquency is still an issue in the banking sector; especially in the microfinance subsector. The concept of governance has a checkered history. With a Greek origin and a meaning that conveys the idea of steering or piloting, Plato amplified its metaphorical connotations and use in his early works. It was then up to William Tyndale, the English scholar and champion of the Protestant Reform, and the Royals of Scotland and England, to occasionally apply the concept of governance to the specific activity of ruling a country. Overtime, governance has become a very general term applicable in a wide variety of phenomena, including public governance, corporate governance and even project governance.

 

From an abstract conceptual viewpoint, governance may refer to all the actions and processes that coalesce to create and institutionalize stable entities and practices. This is why we can talk of risk governance, crisis governance, project governance and for those interested in the health of financial institutions, credit risk governance, and such. Delinquency governance is a generic economic term, designating the aggregate of rules, regulations, processes and procedures that seek to control and minimize bad loans in any financial institution.

 

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As economic conditions change, and they do so more often now than ever, many of the underlying variables that guide lenders in the creation of risk assets also change. And that’s not the only thing that happens at times like these. The changing times have also introduced new variables in the equation of loans contracted before it. Among such new variables is what we call loan shortage. Many lending institutions, apart from delaying disbursement of loans, which has its own complications in the life of a credit, sometimes find that they are no longer in a position to continue funding some projects, part of which loans the clients have already drawn down. This is usually a recipe for loan delinquency, which is now one of the real and present dangers of our current predicament. Uncompleted projects cannot yield the projected revenue requisite for loan repayment.

 

Furthermore, every transaction with foreign exchange component is thwarted once the exchange rate goes against the local currency. The recent devaluation of the naira had this effect. Most corporate consumers of the services of MSMEs have also either shut down (a technical term used by economists to designate the stoppage of production when revenues barely cover average variable costs and there is no motivation for continuing production) or contemplating outright exit of their industries to cut their losses. The combination of a deteriorating exchange rate, high and rising inflation and a contracting national output is one of the acknowledged “clusters of disability” that cause loan default around the world. It has led to a further serious deterioration of the already poor loan portfolio quality in the microlenders’ books. Realising that our microfinance institutions are not famous for their ability to effectively manage loans, we see the need to return to the subject of effective delinquency governance.

Without doubt, the present situation calls for the stepping up of delinquency management and risk control capabilities of all lenders.

A clear understanding of clients’ cash flow pattern is one of the first delinquency governance measures in a credit good process. Unfortunately, cash flow analysis skills are not exactly common these days

It is therefore important for operators in the microfinance sector to stop for one moment and analyse key aspects of their operations. In particular, such analysis should establish the extent of deterioration in their loan portfolios, since the present crisis. It should also analyse the rate of loan collection over the same period, and assess the general health of their loan portfolios. I believe this is not the time to pursue new interest income. They should use this period to sharpen their skills and improve their understanding, particularly of effective risk and delinquency governance. These skills will become more important as the economy grinds slowly along, and hopefully, ultimately bounces back.

 

Delinquency is like a pregnancy. It takes a process to happen. Loans do not just go bad. It is like child birth. Nobody around a pregnant woman can claim not to be aware that “somebody is on the way”, as one Nigerian musician put it. It is never a sudden flight. Loan delinquency follows a process. Indeed, it does not just follow a process, it follows a due process; one of the abundantly scarce attributes of our polity.

 

The first challenge in delinquency management is that some operators hardly know what the best practice demands in this matter. It may be necessary to refresh our minds as to the meaning of these related words – delinquency and default. As a result of this weakness, what some operators call delinquency is actually a default – a higher degree of the failure to keep to loan repayment terms. A loan becomes delinquent when the borrower fails to bring in the money on due date. If a payment is due today and fails to come, the loan is delinquent by tomorrow. Default is when delinquency persists on the subsequent due dates. Owing to the close connection between delinquency and default, and by extension, loan loss, effective delinquency governance is an antidote to bad loans. Precisely, by best practice, a borrower who has not made three consecutive principal payments has defaulted on the loan. It does not matter that he is meeting interest payments, provided these three principal repayments remain outstanding, either in part or in full.

 

In microfinancing, the principal amount of loans outstanding is usually the most important and largest asset of the organization.  It is the main product on sale and the most important income stream, hence the need to protect it. Besides, delinquency can unravel a lending programme. First, it postpones earnings and eventually reduces them. Second, it affects the lender’s cash flow and may damage reputation when lenders can no longer serve clients. These may ultimately damage sustainability and outreach potentials.

 

Having made these clarifications, we may now outline some of the key attributes of an effective delinquency governance strategy. Delinquency control must begin from the design of the loan products. The Board and Management should produce a clear and written policy on credit facilities that leaves no one in doubt as to what should be done, especially where the possibility of unsecured lending exists. Sometimes we congratulate ourselves for beginning our delinquency control efforts from the day an application is made for a facility. That is old school. We should up the ante now and realise that this is no longer the practice. Control now begins from the product and policy design stages.

Operators must also be familiar with cash patterns, as they affect the ability of clients to meet their obligations. Lenders must therefore take account of clients’ cash pattern in designing loan facilities, failing which payment may become difficult. They must equally understand the impact of seasonality as a factor in such cash patterns, and by extension, clients’ ability to meet obligations.

 

A clear understanding of clients’ cash flow pattern is one of the first delinquency governance measures in a credit good process. Unfortunately, cash flow analysis skills are not exactly common these days.

The other important yet downgraded activity in this regard is loan collection. Constant and consistent collection activity is critical to successful delinquency superintendence. Collection activity must be active, consistent and internalised. It should not abate just because a loan has been written off. Last but not the least; operators should take advantage of loan protection insurance, which pays the loan if the client dies and or take disability insurance, which pays the loan if the client is disabled by accident. These strategies, I believe, have the potential of improving aggregate collection, sustainability and profitability.

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