By Eisenhower Mkaka (WAS first published on 04/03/2015)
Some weeks ago we looked at the principles of lending in the light of glaring violation of these canons of lending by the erring MSB and the role of the Central Bank (RBM) in the whole saga.
Briefly we said any prudent lender will assess a potential borrower on the basis of 3 Cs – Capital, Capacity and Character.
Today we will look at other salient features of lending that might have been ignored in the matter of MSB’s delinquent assets/ non-performing loans.
Critical to any lender is the knowledge that even if a potential borrower passes the test of the 3 Cs, there are 3 inherent risks that would turn an apparentlyy good deal into a sour one. The 3 inherent risks are: Information assymmetry, adverse selection and moral hazard.
This, simply put, means that the information you have on your desk will not be able to give you a mirror image of the potential borrower; you do not have all the information you need to make an informed decision. For example when all the 3 Cs may be positive, the potential borrower may have successfully hidden a contingent liablity as a result some suit (some case lost in court resulting in pay out that will eventually affect the business). Conversely, while all (or one or two) the 3 Cs may be negative, the documents you have, as an assessor, may not reveal a potential deal the potential borrower will land in the short to medium term, that will be a “gold mine”. Thus an assessor needs to be carerful to avoid overly dependence on submitted documents. The assessor should also be able to hear what the sixth sense is saying.
Simply put, a lender may not choose a potentially successful deal because of information assymmetry. Some times a lender will also choose to lend to Mr X just because he is connected to a Mr Z who performed well thinking consciously or unconsciously that the good performance of a Mr Z could be generalised to Mr X. This, therefore calls for avoidance of generalisations and treating each case as a unique one.
This refers to the risk that a potential borrower when given a loan would not use the loan for intended purpose. For example a potential borrower may say in their application letter/form that the loan is intended for acquisition of a particular plant in the business’ quest for expansion and yet apply the same towards some political activity etc. Knowledge of this calls for the lender to wirk closely with the borrower. In that regard the lender need not stop at releasing funds but closely follow the goings-on at the borrower’s place of business.
All in all knowledge of these inherent risks of lending should equip a lender with the tools he needs to grow a healthy loan book. This is not to say that a lender will not goof here and there, but failure is kept to a minimum possible where the lender is well equiped!