Problem loans cause delinquency and loss to lending institution. Having identified which loans are problematic, the banker needs to do the following:
Create Policies and Procedures for Dealing with Problem Loan
A policy is set of decisions about how your company operates. Policies are written guidelines that help operation’s.
Procedures are written instructions that tell staff how to implement policies. Each lender must have its own policy for identifying problem loans and dealing with problem loans.
These instructions are the procedures that will tell staff what to do to identify problem loans early. Sound policies and procedures protect lenders from loss.
Distinguish Between Can Pay versus Won’t Pay
To is important to distinguish between borrowers who won’t pay, and those who can’t pay. If borrowers can’t pay, bankers are wasting time and resources sending letters. If borrowers won’t pay offering soft options is wastage of time, when in fact a more assertive approach would be more effective.
For borrowers who can’t pay consider the following:
- Find out whether they have relatives or children who can pay.
- Be assertive in finding a source of repayment.
- Be firm and unshakable – borrowers must feel it is not worth missing a repayment.
For borrowers who won’t pay consider the following:
- Put in place procedures that protect you from these types of borrowers from the beginning of the loan process.
- Get a list of assets up front so you have some collateral to fall back on if the borrower won’t pay.
- Avoid lending to ‘won’t-payers’ if at all possible.
- Do not get trapped in a cycle of sending letters with no intention of following up.
- Take legal action earlier rather than later.
- Make quick use of garnishee orders and emolument attachment orders.
- Emolument Attachment Order: An emolument attachment order is a court order obtained by the lender / any creditor, which instructs an employer to make deductions from the borrower’s salary on a monthly basis until the debt has been settled.
- Garnishee Order: A garnishee order allows the lender to attach money from the debtor’s bank account.
Develop a Relationship with the Client Up-Front
It is worth taking the time at the beginning of the loan process to establish a good relationship with the borrower. This sets the tone for future relations. Lenders need to establish from the beginning that no late.
Prompt and effective follow-up
As soon as a repayment is past due, some action needs to be taken. That action needs to be effective in securing the repayment. Procedures should not be devised that waste resources without securing payment.
For example, sending a letter to a rural client, who cannot read, is not an effective procedure. It would be more effective to identify someone who lives nearby to visit the non-payer and secure payment.
Periodic stress testing of loans
Lenders should conduct Periodic stress testing of their loan portfolios to better understand the potential risks. The objective here is to identify those scenarios which, if they did actually occur, could result in severe losses and jeopardize the financial stability of the bank.
Stress testing individual loans can serve as a valuable early-warning system to identify those customers most likely to experience financial stress under adverse economic conditions. Stress testing can give valuable insights into potential future losses; identify key areas of risk exposure within the portfolio.