BASIC PRINCIPLES OF BANK LENDING

Daily Champion April 25, 2001

The recent distress in the financial system, witnessed more importantly in the banking sector, did wreak havoc on the economy. Depositors lost billions of Naira for no fault of theirs to greedy, selfish and corrupt banking officials.

For some time, the public wondered what could have caused the dismal performance of the banks in our economy. This resulted greatly in the lack of confidence by Nigerians in financial institutions. The major cause of distress, as witnessed in the banking sector, is the lack of proper coordination, mismanagement and deliberate greed on the part of the management, connivance of banking officials with fraudsters, among others.

From my humble point of view, we can rightly say that the major instrument used to defraud banks of deposits is uncoordinated lending without following the basic considerations as contained in banking lending principles.

It is widely held that a bank is an institution that accepts deposits from customers and looks after their money, offers cheque books to customers to enable them make payments to others and provides some other financial services which include lending. In a nutshell, a bank’s major operation is the acceptance of deposits and granting of loans to different kinds of customers.

In Nigeria today, we have two different types of banks, commercial and merchant banks, operating under the regulation of the Central Bank of Nigeria. The commercial banks engage in retail banking services through branch networks and operate with a broad deposit base consisting of demand and time deposit – they provide short term lending. On the other hand, merchant banks are licensed to provide wholesale banking, take deposit and arrange syndicated loan facilities for long terms by pooling, sometimes, a consortium of banks, including other financial institutions, to finance capital intensive projects. From the foregoing, it is realized that banks are generally debtors; they borrow money in order to lend them out to make profit. No bank can ever survive by just being a custodian of deposit, but they exist by lending from the deposit on fixed interest charged. Money lent on interest is always supposed to be secured on some guarantees or security.

Since banks depend largely on lending, the need to adhere to the basic principles of lending is quite inevitable. The principles, if strictly followed, will guarantee depositors and shareholders’ funds, increase profitability and make a healthy turn over. Such advances in turn assist in the transformation of rural environment, promote rapid expansion of banking habit and improve and boost the nation’s economy.

The basic considerations in bank lending are the character of the client seeking loan from the bank. The client must be an honest, upright customer whose record of transaction with the financial institution or in the society is remarkable. The information on the character of the borrower could be obtained through a completed form of his guarantor or his statement of account.

The capital base of the borrower and the amount of money injected into the project must be considered before granting any credit facilities. A customer who expects a bank to fund an entire project should not be considered, unless he provides clear evidence of his injection of initial capital into the project before consulting the bank. Ability and capability to repay the money sought should also be considered. The method of repayment period and collateral put forward to the bank, in addition to a strong recommendation from a highly respected guarantor from the society, are basis for major lending to avoid default and abscondment after approval. Not all projects may be profitable to the customer seeking loan. In that case, the bank should examine and study the purpose of such loans. Some projects may be against cardinal government policies like money-laundering, drug trafficking, smuggling, among others, while others may just be a kind of charitable project, which may not yield any profitable result. This is why the lending should be known and the amount required for it should be vividly stated for the bank to judge its merit. After all, banks are not established as charitable organizations.

For effective credit administration, the bank must assign functioning lending officers, properly trained on lending, to be responsible for evaluation of reports and collection and reporting findings to relevant senior schedule officers, for further consideration and final approval or rejection. Monitoring and supervision of the projects after the loan has been granted should be religiously pursued by the relevant departments in the bank like legal, security, supervision and any other such relevant units of the banks. Experience has shown that once a customer realizes that he is not being monitored, he easily diverts the fund for other unworthy projects.

An internal credits/lending policy should be formulated, implemented and pursued vigorously by the bank to minimize the risk of default from borrowers. The successful banks operating within the financial system are those that consider and coordinate basic principles of lending and monitor the activities of borrowers regularly.