New Thinking For Loan Risk Management By Nigerian Banks

By Akin Oladeji –Johnbrowne

Asset Management Corporation of Nigeria (AMCON) was established to resolve bad loan problems created by banks in Nigeria. The creation of AMCON was a political necessity to avert systemic credit crisis in the financial markets. In an ideal world, a borrower would be expected to keep to his promise of repayment of loan taken from a lender based on the terms agreed.

However, this has never been true even in most advanced economies, hence the need for Loan Risk Management (LRM). In Nigeria, bad loan is a systemic problem amongst banks, requiring new methods by banking institutions. Most banks appear to have been accustomed to the orthodox risk management processes known in finance and accounting. Meanwhile orthodox method has not solved the high non-performing loan problems. Unorthodox method appears to be most likely appropriate in risk management in our environment.

In spite of contractual obligation and penalty for failure to repay a loan, remedy available to lender is to sue for repayment or force the borrower into bankruptcy or liquidation. The business of loan creation by banks does not pre-suppose a loan failure or default, however loan default is a reality due to several factors. In Nigeria, as at December 2014 loan loss provision was 2.96% as against 11.4% in 2018.

The increase in loan loss between 2014 and 2018 represented 8.54% of total loan portfolio of the banking system. With the continuing growth in loan loss provision, credit creation will be a challenge in the economy and not surprising why banks mitigate the loan loss by high interest rates, fictitious and spurious charges. This article is an exploratory discussion on strategies on how loan risks can be mitigated in Nigeria and other similar jurisdictions of same status.

Loan risk arise because of the likelihood that a borrower will default in repayment and financial institutions invest a lot of resources for its measurement and management. In LRM, banks pay more emphasis on Information Technology (IT) and training of human resources. The bank adopts the internationally accepted methods based on Basel regulations, update risk measurement software at regular intervals and send staff for training. These loan risks management methods do not in most cases result in optimal loan book. In fact, loan loss provision in Nigeria was consistently on the increase from 2014 to 2017. The decline of loss provision to 11.4% between 2017 and 2018 was just marginal as compared to previous years.

Three rating agencies have been registered by Securities and Exchange Commission (SEC), which ordinarily should assist the banking system in ascertaining the credit worthiness of loan applicants, namely, Agusto and Co; Datapro Limited and Global Credit Rating. Depending on credit rating, the lending institution can categorise the borrower on a scale to form an opinion on their likely level of loan exposure and risk. One of the obvious constraints of the rating agencies is the poor infrastructure, which hinders the companies to do physical inspections of the assets and facilities of borrower. The dilapidating infrastructure makes inspection of borrower’s asset and location very tedious.

Some locations of borrowers have become urban ghettos, due to poor town planning and over population. At times the rating agencies will rely on inadequate data from banks, hearsay or any other available information at their disposal. In such circumstances the rating report becomes suspect for good credit evaluation and risk assessment. A new credit risk method that should be considered in Nigeria is what I term oracle banking. It is a variant adapted from Islamic banking principles. In oracle banking, the credit process shall be taken to religious sects like Church, mosques and other traditional worship places after approval of the subject loan by credit committees.

The religious sect will subject the loan approval to divination as is normally done in most churches and mosques. The divination result will determine whether the credit should be approved or likely go delinquent. With this approach the banks would have considered variables pertinent for the loan risk based on religious belief. The oracle banking should not be seen as strange or anomalous, it is a common knowledge that Nigerian believe in religion organization and their divination.

We are all aware that traditional religion divination is well accepted by first nations in Canada, Brazil, Columbia, India, Pakistan China etc. The bank may even set up the department of Oracle Banking to be headed by Pastors, Imams, Alfas, Priest or General Overseers for the purpose of risk management. It must be mentioned that religious loan is not new, it only became visible during the crisis of 2008 when household were negatively affected by financial crisis. For instance Oikocredit, of Netherlands ,a Church-backed microfinance agency, increased its loan book by over 32% in 2008, serving households in both rural and urban areas and focusing on regions where underdeveloped commercial banking sector excludes the poor.

Also Grameen Bank, set up by Mohammed Yunus, a Bangladeshi Muslim economist have been providing loan to peasants through micro-loan program amounting to nearly $6bn in the last 50 years. Nigeria is a country of religion and prayers. We have churches and mosques of varied denominations. Citizens belong to one or the other faith denomination. Catholic, Baptists, Redeemer, Cherubim and Seraphim, Christ Embassy, Mountain of Fire, Seven Day Adventists, Ansar Ud deen, Darul Islam, Jama’atu Nasril Islam, NASFAT, Kala Kato, Muslim Student Society and Kano State Hisbah Corps amongst others. These organisations are moral institution where lender can make enquiry from their trustees on character of borrowers without violating privacy treaty.

It should be noted that once a loan is granted, depending on the borrower’s religious inclination there is the norm to go to religious houses to pay tithes and offerings. The tithes sometimes is about 10% of the loan amount usually donated by the borrower to ‘appreciate’ God. Banks should therefore include religion attestation policy form in their loan approval process. A classical justification for this can be inferred from consolidation and CBN Stress test of 2010 in which some Chief Executive Officer of banks were observed to have granted loans to religious organisations and staff based on being in same faith with their bosses.

The banks even opened more branches in religious places than commercial business districts. A reference location is Lagos Ibadan expressway where we have varied religious groups and branches of all banks inclusive of Microfinance and Mortgage Banks. The use of local informant is a new potential tool that should be considered in loan risk evaluation in our environment. Most businesses in Nigeria are local. Hardly can you go to a community without knowing businesses that are bankable and their promoters. The opinion of local residents, Chiefs, Turaki, Emirs, Kings etc. should be one of the loan evaluation processes that should be adopted especially for small scale enterprises.

Successful business and entrepreneur have political sympathy and affiliation either direct or indirect. The political platforms can be used to access credible information about borrowers. Lenders can as a matter of new loan strategy request information from political parties on borrower. Although such information may not be one hundred percent credible, it will in no small way assist the lenders in knowing salient credit information. At least we have had rumours of how some big borrowers in the AMCON debtors list funded political course and diverted proceeds of loan for political and other activities which were not the original purpose of the loan.

Lenders should develop a politically exposed credit process form that can be adopted for risk appraisal. One of the orthodox methods worth mentioning for loan risk management is the adoption of netting clauses in loan contract. By netting, the lender will rely on the global exposure information of the customers from other institutions and the security provided. Once there is a default, the lender can close on the loan contract the borrower has with other parties to offset each other. This is where the role of the rating agencies like Augusto and Co and Datapro Limited will be relevant. The credit agencies must be able to provide robust data to assist the banks in this regard.

Collateralization and downgrade triggers are other orthodox methods that can be used in credit risk management. In collateralisation, interest is vested in property owned by the borrower where certain rights are made available to satisfy loan obligation owned to the lenders. The lenders must ensure that the collateral is fully secured and registered with relevant department of government prior to loan disbursement. Collateralisation became popular after the global financial crisis and the European Sovereign debt crisis and its use has increase significantly since then.

A downgrade is a negative change in the rating of a security or loan performance. This situation occurs when lenders is of the view that the prospects for the loan repayment have weakened from the original estimation, usually due to a material and fundamental change in the future outlook or industry. Loan downgrade should be adopted once there is one off default in repayment by borrower. Lenders does not need to wait before pulling the triggers. Many triggers are common in Nigeria. A typical one is the closure of land borders which might affect import finance related loans granted to companies whose imports are from neighbouring West African countries.

In conclusion the orthodox LRM tools cannot be fully adopted to improve loan loss in Nigeria. The banks must think outside the box and look beyond the methods known in banking literature by considering factors that are peculiar to our environment. Mentioned in the article are, local informant, political affiliation, oracle banking and religious inclination tools. All these combined with the orthodox tools will improve the loan loss and credit risk management in Banks.

*Oladeji-Johnbrowne, a Fellow of Institute of Chartered Accountants, Institute of Taxation Nigeria and Securities and Investment Institute wrote from United Kingdom.

Related posts