II. Problem loan management
When the time for repayment comes, two scenarios may occur:
1. the loan is repaid (principal and interest) under the pre
agreed terms and conditions
2. the borrower fails to make the repayment of both or part
principal and interest. In such case the loan then becomes a problem loan and a
new process is then triggered. A loan
32 MBA in Banking and Finance
can become a problem loan before its maturity due to the
disclosure of any information questioning the borrower's ability to repay (case
of cross default for example).
In respect of the GCPPM, three main stages can be
defined in the bank's dealing with problem loans:
- the early warning systems
- the classification and provisioning
- the remedial management
1. Early Warning Systems
They refer to the ability of the Bank to anticipate, detect,
recognize and report problems as
early as possible so that prompt corrective actions can be taken
to avoid problem loans. In order to achieve this objective, the Bank has built
three main internal rating systems:
- Obligor Risk Rating (ORR): The rating attributed to the obligor
applying for a credit.
- Portfolio Risk Rating (PRR): The rating attributed to a
group of related companies, which has stakes in other companies. The PRR of
a group is derived from the ORR of
the companies in its portfolio.
- Facility Risk Rating (FRR): the structure, security and
tenor of a facility inform the assignment of an appropriate risk rating. Then
the FRR refers to rating given to the facility the obligor is applying for.
The GCPPM insists on the importance of continuous
gathering of information on the customer, market, industry and reporting to
the Credit Committee and Management.
Among the warning signs that may draw the Bank's
attention on the borrower, we can mention:
- Recurring casual overdrafts or line excesses that take a long
time to clear.
- Frequent delays in repayment of principal or interest
payments.
- Inability to communicate with customer and failure to disclose
information.
- Major management changes especially in financial area
people and key decision makers.
- Negative market trends, Government directives, Legal suits
and/or bankruptcy threats
by other creditors.
- Deterioration of economic environment.
- New competition in industry.
33 MBA in Banking and Finance
2. Credit classification and provisioning
There are four main objectives attributed to the Bank's credit
classification system to:
1. Highlight those credits that represent an above-normal
credit risk.
2. Evaluate the degree of risk involved.
3. Develop a strategy or action plan for the
elimination of weakness and the ultimate collection of outstandings.
4. Assist the calculation and reserving of appropriate loan
loss provisions.
|
Category
|
Loan classification system
|
Provision
|
|
Class I :
"Uncriticized" (Current)
|
Credits that are fully current and the orderly payment
of which is without
|
1%
|
|
Class IA : Other Assets Especially Mentioned
("OAEM")
|
Credits with evidence of weakness in the borrower's
financial condition or credit worthiness, or which are subject to
an unrealistic repayment programme, or which are lacking adequate
collateral, credit information or documentation. If sufficiently severe or
advanced, these or other conditions would warrant a worse classification.
Early attention, including substantive discussions with borrowers, is
required to correct deficiencies
|
10%
|
|
Class II :
Substandard
|
Credits for which the normal repayment of principal and interest
may tee, or has been, jeopardized by reason of severely adverse trends or
developments
of a financial, managerial, economic, or political
nature, or by important weaknesses in collateral. No loss is foreseen, but a
protracted work out is a possibility. Prompt corrective action is required
to strengthen the Bank's position as a lender, to reduce its
exposure, and to ensure that adequate remedial measures are taken by the
borrower.
|
25%
|
|
Class III :
Doubtful
|
Credits, full repayment of which appears questionable
on the basis of available information, and which therefore suggest a degree
of eventual loss not yet determinable as to amount or timing. Vigorous action
is required to avers or minimize losses. Non accrual of interest is required
and previously accrued and unpaid interest must be reversed. The
principal should be reversed or written off to the extent deemed
necessary. Any such credits should be reported to the local Board of
Directors and the ETI Board.
|
50%
|
|
Class IV :
Loss
|
Credits that are regarded as uncollectible. Any amount
so classified by account management, should be fully reserved, and
previously accrued and unpaid interest must be reversed. A classification
to IV does not mean that there is no potential for eventual recovery.
Responsible units are expected to continue a vigorous collection effort
until it is decided that no further repayment or recovery is possible.
Any such credits must also be reported to the local Board of Directors as well
as to the ETI Board.
|
100%
|
doubt.
It is important to underline that some assets, though
not worth classifying require special
attention. These are put in a "watch list" category. The watch
list is not a requirement but it is done in the aim to attract the bank's
attention to them. There is no provision made on them.
34 MBA in Banking and Finance
Another aspect of the classification is that an asset
can move from class I to IV without passing through classes IA, II or
III. On the other hand, an asset classified III can become I within a short
period. This is quite understandable because the overdue period of the loan
is
not the only criterion taken into account for loans
classification. A company can move from a healthy situation to very bad one and
vice versa.
| 
