Importance of Identifying Problem Loans Early for Banks

Detecting Problem Loans is for loan officers and other credit professionals who need to understand the ways to minimize problem loans and to deal with them once they surface.

The course is appropriate for junior to mid-level commercial lenders, credit review and credit policy officers, and junior workout officers.

Maintaining Profitability of Bank

Problem loans must be identified early because they can affect profitability. Repayments with interest are the primary income source of lending institutions. If repayments are not made regularly, then ability to make a profit is severely affected.

Providing Client Support

If the bank can identify a problem loan early it will be able to take steps to support a client to pay. For instance, banker may call them and offer them the option of paying part of the repayment immediately and part later.

Saving Lending Institution Image

If the bank is slow to identify and follow’ up on late repayments it sends a specific message to borrowers.

The bank sends the message that it is ‘soft’, that it will not take immediate action, and that late payment or non-payment is a viable option for them. To work towards zero delinquency the bank must avoid this image at all costs”.

What are the Indications of Problem Loans

If loan can be identified earlier as problem loans before it actually happens, regulating monitoring along with some other measures can prevent the loans from being problems loans.

For identifying the “potential” problem loans, we have to know the symptoms of problem loan.

The symptoms of problem loans can be classified in the following way:

Quantitative Indicators

  1. Preparation of irregular and delayed financial statements.
  2. Refusal of large insurance claim.
  3. Creating hindrances to the main source of income
  4. Diminishing deposit balance.
  5. Inability to pay the debt of creditors other than the bank.
  6. Non-repayment of the loan installments as repayment dates.
  7. Entering into big loan contracts frequently with institutions and persons other than the existing bank.
  8. Continuous decline in the market price of the shares of the borrowing company.
  9. Sudden rise or fall of large size deposit withdrawals.
  10. Excessive cash dividend payouts from reserve fund or even from capital.
  11. Al the end of the cycle, creditors are not completely paid out.
  12. Concentration changes from a major well-known customer to one of lesser stature.
  13. Loans are made to or from officers and affiliates.
  14. Unable to clean up bank debt, or cleanups are affected by rotating bank debt.
  15. Investment in fixed assets has become excessive.

Qualitative Indicators

  1. Sudden death or accident of chief executive of the business
  2. Avoiding communication with the lending bank.
  3. The borrowing organization is not operating smoothly due to some conflicts among the executives and among the board members.
  4. Bitter relationship between borrower and lending bank.
  5. Occurrence of theft, fraud, robbery and/or hijacking in the organization of the borrowers.
  6. Conflicts among the heirs of the owners of the borrowing organization.
  7. Pretending in the manner that payable are paid.
  8. Financial reporting is frequently “down-tiered” due to changes in financial management.
  9. Delayed responses of financial transaction.
  10. Suppliers cut back terms or request cash on Delivery (COD).
  11. Distribution or production methods become obsolete.
  12. The company has grown dependent on trouble customers or industries.
  13. The board of directors is no longer active in making crucial business decisions.
  14. Lack of depth in managerial decision making.
  15. Financial control mechanisms are weak.

Qualitative indicators as well as quantitative indicators provide valuable information to the bank about the problem or make repeat requests of increasing or deferring the installment date.

After getting this preliminary indication, banks may seek information regarding the above -mentioned qualitative and quantitative factor. Then, the bank can be certain about the problem loan.