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Lending unit 2
1. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
1
Module 3: Lending
2. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
LEARNING OUTCOMES
After completion of this study you should be
able to:
• Articulate the role of lending in the banking business
• Discuss the various aspects of a typical bank lending
cycle and highlight the key issues at each stage
• Explain the meaning of insolvency, bankruptcy and
receivership from the viewpoint of the lender.
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3. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
Lending in the Banking Business
General Principles of Good Lending
Types of Advances to Customers
The Practice of Lending
Securities for Advances
Corporate, Retail and Mortgage Lending
MODULE COVERAGE
3
Typical remedies for Defaulting Borrowers
Insolvency, Receivership and its Effects
4. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
The principles of good lending can be broadly
categorized into these main areas;
• Prudence
• Good internal processes and
• Efficient service.
• Viability oriented instead of security oriented.
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5. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
Prudence: refers to the due care, diligence and carefulness
that a lender must exercise in the lending process so as
to avoid losses or asset impairment.
Regulatory compliance forbids lending when:
• Liquid assets are not sufficient
• Lending against own shares and debt instruments
• Lending will create credit concentration
• There is inter institutional placements and loans
• Lending is for insider transactions
• Lending is for purchase of certain loans
• There is restriction on externalization of assets
• Engaging in trade, commerce, industry
• Investments in immovable property
• Engaging in securities activities
6. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
• Limited insider lending
Referred to above as insider transactions, insider lending
must be expressly limited by all regulated financial
institutions. This is partly to ensure that owners, directors
and other persons in banking institutions do not unfairly
lend money to themselves in ways and amounts that
would put the bank at the risk of loss.
• Asset-Liability maturity matching
The bulk of bank lending is financed through customer
deposits and one key principle of such intermediation is
that the maturity profile of the loans (assets) should be
matched by the maturity profile of the deposits
(liabilities) funding them.
7. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
• Risk spreading (diversification
To reduce the likelihood of default, the lender should
spread the loans over different borrowers, sectors,
geographical locations and lending instruments. By doing
this, the risks are reduced or even eliminated.
• Triggers and red flags
As part of the loans/ advances management system in a
financial institution, there should be automatic flagging
systems to alert management or whoever is concerned
that things are not going the right way in the lending
function. These systems therefore act as triggers and red
flags to management of an institution as soon as
incidences start to or show signs of occurring.
8. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
• Security
There should be adequate
security for both the
loans/advances and
assets pledged to
secure them. Ideally,
most loans should be
secured and the
collateral pledged to
secure them,
adequately insured.
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9. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
• Choice of borrowers
Although we talk of loans
going bad, in reality
there is seldom such a
thing as a loan going
bad. The fact is that in
most of the cases in
which loans turn bad,
the bank just made a
bad lending decision in
choosing the borrower.
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10. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
Good internal processes
Supportive internal processes, which are clear and adhered to, are
necessary for any banking function. This is critical for lending. Among
the aspects of these are;
1. Consistent and enforced credit policy
Many of the bank failures of the late 1990s in Uganda happened mainly
due to bad lending, often with a weak credit policy or one that was
not followed in lending.
2. Independence of credit control from client relationship management
To ensure impartiality in credit processing, credit control should be
separate from account/ customer relationship management.
3. Active loan portfolio management
There should also be a very active, preferably well automated loan
account management system. Any amounts falling due and not
serviced should be shown and acted on immediately.
11. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
Efficient service and customer care
Lending banks should at all times maintain customer responsiveness, balance of
speed and diligence, and communication.
• Customer responsiveness
A bank needs to develop, through experience, diverse loan products to suit
different needs of its customers. Additionally, these should be a certain level
of flexibility so that the bank can adopt lending conditions to customer’s
realities without affecting normal prudence.
• Balance of speed and diligence
The timing of credit processing should be convenient and reasonably satisfactory
to the borrowing customer.
• Communication
Clear and regular communication between the bank and the customer is
necessary. Although banking relations are seen mainly as being financial,
comfort is added into the relationship between the bank and its customer if
there is clear and regular communication.
12. THE UGANDA INSTITUTE
OF BANKING &
FINANCIAL SERVICES
UIBFS
ISO 9001:2008 CERTIFIED
Viability oriented instead of security oriented
Advances should be granted with due regard to profitability of the business and
looking into the character, capacity and capital of the borrower. Security
mainly acts as a “psychological support” to the banker and pressure to the
borrower, and should be ideally be considered as insurance or cushion to a
fallback position. This is because the primary focus of a bank is to lend money
and receive deposits, and anything such as disposal of securities is time
wasting and in most cases counterproductive.
To be prudent in their lending, banks must ensure the following;
Regulatory compliance in all lending activities
All the lending activities must comply with the relevant policies, laws and regulations. For example, the T FIA 2004 and MDI Act 2003 put restrictions on lending under the following circumstances;
Persons considered to be insiders are the shareholders, their spouses, family members, directors, managers, staff and all their companies and other persons or organizations that are closely related to them.
A well matched asset-liability portfolio reduces the likelihood of cash crises arising from maturity mismatches.
Bankers should take both primary and secondary security and incentive value should be high on the agenda. The security should be “MASTDAY” i.e
M= marketability
A= ascertain with ease its title, value, quantity and quality
S= stability of value
T= Transferability of title
D= Durability, not perishable
A= absence of contingent liability i.e the bank may not have to spend more money on the security to make it more marketable or even to maintain it.
Y= yield. The security in some cases should provide some ongoing income to the borrower or bank to cover interest and/ or partial repayment.
Every bank should have a Credit Policies and Procedures Manual, by whatever name they might call it. The stipulations in this manual should reflect regularity compliance issues as well as the institution’s own need for prudence in lending. Among the areas that should be very clear in the policy are adequate screening and appraisal of credit proposals, security requirements and action in cases of delinquency or default.
While ensuring that lending operations are safe and sound for the bank, care should be taken that good and high-worth borrowing customers are retained. Balance of speed and diligence is perhaps one of the aspects in which Ugandan banks have not done very well. Often, the customer is promised that the banks would make a lending decision within a week or two after the customer submits all things required to process the loan. A month after submission, it is common to find that the bank has still given no firm response to the customer due to long and sometimes uncoordinated internal processes.
