Reading today’s (10th August 2020) Daily Monitor, page 36, left me with a sour mouth. Why are many businesses defaulting on bank loans? What is the work of the banks’ credit risk assessment before a facility is given? How come banks give loans with more emphasis on the value of the collateral at the expense of quality of the business model and its potential success?
Banks must invest more in risk assessment and review of the business models of prospective borrowers. Many young entrepreneurs have been turned down because they lack the much-needed collateral for that essential seed capital they seek. In the end, people with property (some of which is an inheritance) have been given loans only to fail to pay them due to a lack of business acumen. The result is banks fighting to recover money by attacking the collateral of their customers. Banks also wrongly apply the traditional 5Cs (character, capacity, capital, collateral, and conditions). Today’s business environment has changed. For example, during credit risk assessment, bank credit officers misinterpret character to mean the popularity of the business person instead of the business acumen and ethical business conduct of the applicant. For example, an outspoken politician or businessman is more likely to get a loan at the expense of a low-profile businessperson who is just starting but has a consistent history of making good on his obligations. Bank credit officers are more likely to approve a loan despite the record at the credit reference bureau! For this reason, we see many loans becoming bad.
The trend is giving a bad reputation for banks.
We need more success stories than court fights between banks and the customers they set out to help. Today, banks spend a lot of money and time in loan recovery instead of spending more time and energy on credit risk assessment, customer support, and business restructuring to grow with the customer. I understand the pressure to post profits, reduce non-performing assets, and allow depositors to access their money on time. And that is where the process should be focused – -reduce single exposure to a few people who take large facilities due to the collateral properties they daggle before the credit officers.
Many once profitable businesses are struggling due to over trading as a result of accessing money from banks for which they did not have a great strategy and business model to apply. Banks are set to fail to identify a business or borrower with more chances to win and therefore repay.
The focus of credit risk assessment is loan security, which weights over 80% during the on-boarding process at the expense of the ability to pay, which accounts for just 20% of the assessment. The result is giving a loan to someone with collateral security and rejecting folks with a sound business model.
To win, both banks and entrepreneurs must build for resilience. How you may ask? The following are the five ways to build resilience.
Set up a strong team of competent people with winning attitudes and ethics. Businesses are run by people. Folks with the right attitude and skills to make things happen. To innovate. To provide alternatives and keep pushing.
Every business needs people who don’t have to wait to be told what to do. But folks who anticipate the future of the business in which they operate, and provide recommendations of the changes needed. People who are willing to go the extra mile to deliver outstanding services to the customer because they know that is the right thing to do – and not folks who have to wait for approval from the boss, even for an obvious decision. In simple, people are the difference between outstanding companies and mediocre ones.
If you want to build resilience, hire the right people. Tell them the vision. Give them the tools needed and let them be at the driving seat. Next are the building blocks for sustainable growth.
Put governance structures in place
A governance structure together with a system of checks and balances over the critical processes — is critical for sustainability. How do you manage financial resources? One of the sins of entrepreneurship is the failure to separate profits from capital or loan. Many an entrepreneur, and surprisingly, even educated folks are blind about profits and revenue.
It is common for entrepreneurs to just put their hands in the cash till and say, “we shall balance tomorrow.” However, tomorrow is always a moving target. Before you know it, the business has been suffocated of working capital and it starts defaulting on salaries and supplier payments. The worst money to eat is the tax man’s 18% share which is usually paid by the clients on the invoice of the supplier.
Many businesses have been victims of eating the tax collector’s money. And that is never a good thing.
Effective governance systems promote the separation of power and trust after the controls principle. When it comes to business, even your son or daughter is a potential thief – innocent thieve or deliberate thief. Only the system of checks and balances can help stop the theft.
Above all, every businessperson needs a sounding board. Whether it is a formal board of directors or just a team of successful and exposed individuals you throw your challenges at for wise counsel, you need them before taking critical decisions like obtain bank financing. There is always some sort of excitement to entrepreneurs when they spot an opportunity before they fully attend to it in terms of the appraisal.
With a sounding board of high caliber people, someone, you can be guided to subject the potential opportunity to an expert appraisal or assessment. Instead of blindly obtaining a bank loan against your inheritance or family property, you learn the chances of success of the opportunity. Such guidance could be the difference between failure or success.
Effective building blocks
No house or construction stands without a firm foundation and the combination of several resources to erect it. Like a house, a business needs risk management intervention to anticipate the bad things that could happen and prevent them.
To be continued
Copyright Mustapha B Mugisa, 2020. All rights reserved.