Leveraging opportunityEffective loan structuring is an important aspect of prudent lending practices.
Prudent regulatory directives in place for banks and financial institutions (BFIs) mandate ensuring appropriate structuring and monitoring of loans and making sure that they are utilised for the intended purposes. Due to tough competition, banks find it tough to ensure that loans are utilised for the stated purpose in case of certain good borrowers. The books often exhibit a mismatch in working capital loans vis-à-vis current assets as a result of the use of working capital loans to fund long-term assets. It is the primary responsibility of banks and other financial institutions to ensure that the short-term loans issued to create current assets are utilised only for meeting working capital requirements. Similarly, long-term loans are to be utilised for financing only those assets that have a longer life. Reputed auditors also advise their clients to utilise the debts only for the intended purpose. Banks at times rework the structuring of loans to manage the mismatches.
In recent years, the central bank has been closely monitoring loans to identify any siphoning off of funds or utilisation of loans for unintended purposes, and if deemed required, firms have had to make additional loan loss provisioning. But how appropriate is it to have BFIs maintain additional loan loss provisioning even if the borrowed funds match the values of the assets created, and only surplus funds have been used elsewhere.
Facts and trends
While the top management, with the intent of risk diversification, has been vying to expand loan portfolios in the small and medium-sized enterprise (SME) category, most banks have not been able to lure distributors and retailers of hardware goods, processed food, medicines manufactured in Nepal to take such loans. A major portion of the loan portfolios of many commercial banks comprises of large corporate, retail and real estate loans.
There are several reasons why banks are finding it hard to increase their share of loans to small enterprises. Some SMEs are still upgrading their bookkeeping system to the level desired by banks, and there is a high demand for loans from large corporates to procure raw materials or trade goods in bulk. Provided there is political stability and the economy rebounds from Covid-19 in the near future, large corporates are what propel economic growth in an underdeveloped country. So banks jump to grab the opportunity to lend to such corporates that not only provide interest income, but also additional income like fees, commission and exchange profits related to international trade.
Large corporates sell their products to distributors and wholesalers on credit, and they depend on bank loans to provide credit terms to their customers. In certain sectors, distributors pay their arrears only after a new consignment of goods is supplied, again on credit. In such a scenario, distributors and even retailers would not need to borrow from banks as they can procure goods on credit. Thus, the cash cycle of large borrowers is generally longer requiring long-term bank financing.
As manufacturers or importers revolve their receivables on a continuous basis, it becomes pertinent for them to have in place a revolving working capital credit limit from banks, assuming that they have to import goods in bulk. When distributors make part payment to corporates and demand continuous supply on credit terms, the corporates will only be able to make part payment to their banks and will need to have the loans extended.
Should this kind of rolling over of loans be construed as ‘ever-greening’ while there are corresponding active receivables against such loans, there are deposits of sales proceeds in part in current accounts, and such deposit inflows in aggregate exceed or match credit outflows? The central bank must ensure that BFI credit policies allow them to meet the requirements of all kinds of businesses. Restrictions on credit period or inventory holding period invariably for businesses of all kinds can lead to mismatches. Effective loan structuring is an important aspect of prudent lending practices. Efficient monitoring of accounts to control the diversion of funds is all the more important.
While there can be no denying that exceptionally weaker businesses tend to resort to ever-greening their loans, there is a trend, in general, to revolve the loans within the drawing powers to match the revolving of receivables by borrowers. Instead of calling the phenomena ever-greening of loans, it is apposite to bring out a mechanism to secure the credit transactions of businesses to strengthen the security of loans and advances of BFIs against receivables. This will go a long way in capital creation and employment generation contributing to economic growth.
Impact due to the pandemic
Disruptions owing to Covid-19 are going to have an adverse impact on economies and businesses in varying degrees. An interesting development in Nepal is that manufacturers and wholesalers have begun to control credit terms because of a short supply of materials which they say will not last long. But if this phenomenon were to persist, we will see a rise in demand for loans from small and medium enterprises, meaning that it will open up further opportunities for banks and other financial institutions for value-chain financing.
As businesses grow, markets and business practices tend to rationalise and attain maturity; in this aspect, Nepal’s market is still at a nascent stage. In this context, the receivables of businesses need to be secured in order to protect the loans issued by banks. As banks have been registering their charges over the current assets of their borrowers as per the provisions of the Secured Transaction Act (2006), arrangements should be made to allow businesses to register their credit transactions too. This will not only encourage entrepreneurs in the unorganised sector to come into the tax bracket and grow, but also allow transactions that were not taken into account while computing the GDP to be recorded, thereby attracting additional foreign investment and encouraging further participation from multilateral and developmental organisations.