Lending unit 2

THE UGANDA INSTITUTE OF BANKING & FINANCIAL SERVICES

UIBFS

ISO 9001:2008 CERTIFIED

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Module 3: Lending


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LEARNING OUTCOMESAfter 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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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

Typical remedies for Defaulting Borrowers

Insolvency, Receivership and its Effects


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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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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


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• Limited insider lendingReferred 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 matchingThe 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.


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• Risk spreading (diversificationTo 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 flagsAs 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.


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• SecurityThere 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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• Choice of borrowersAlthough 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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Good internal processesSupportive 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 managementTo ensure impartiality in credit processing, credit control should be separate from

account/ customer relationship management. 3. Active loan portfolio managementThere 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.


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Efficient service and customer careLending banks should at all times maintain customer responsiveness, balance of speed and

diligence, and communication.• Customer responsivenessA 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 diligenceThe timing of credit processing should be convenient and reasonably satisfactory to the

borrowing customer. • CommunicationClear 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.


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Viability oriented instead of security orientedAdvances 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.


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END

Lending unit 2

Business

Transcript of Lending unit 2