In preparing financial statements a loan is recognized as impaired when it is probable that principal and/or interest are not collectible in accordance with the loan’s contractual terms. In banks “loss” is often the result of failed repayment of loans or facilities advanced to customers.
Failure to repay loans can be related to any of the following:
- Disruptive changes in the market or industry which results in financial difficulties for the borrower e.g. new environmental regulations on forestry, new food packaging standards, among others.
- Missed market opportunities due to delays in the borrower’s planned investment or productive activities, consequently delaying income realization thereby delaying loan repayment.
- Missed market opportunities due to delays in loan disbursement subsequently delaying income realization and thus delaying loan repayment.
- Misuse or misallocation of funds by the borrower.
- Mismanagement of the borrower’s business.
- Miss-selling or issuing the wrong loan product for the customer’s intended use, e.g., issuing a commercial loan for the purchase of a new home instead of a home loan.
However, the underlying root cause of some of the above factors is the lack of sound banking/financial literacy. Both bank staff and prospective borrowers should be able to assess the level of borrowing the business or prospective business can sustain. This requires good business and financial analysis of the prospective business. Experience has shown that very often financial projections presented to banks to support loan applications are not credible. Unfortunately this fact is frequently missed by bank staff. It is therefore important for banks to ensure that their staff is well trained to be able to discern unreliable projections.
An important factor for any business to consider is that the borrowing exposes the business to the risk of financial distress in times of economic/business downturn. However, businesses that have predominantly cash sales (e.g. mobile phone companies) or have very short working capital cycles are able to take on higher levels of borrowing than those with long working capital cycles (e.g. a sisal plantation). The important factor here is to understand the sector in which the borrower operates and to avoid creating overdependence on borrowing.
The type of borrowing should also match its potential use. For example, it is a serious mistake to use an overdraft meant for working capital purposes to fund capital expenditure (e.g. construction of office premises). Banks often experience this kind of diversion of funds, which means their credit monitoring personnel need to keep close tabs of their borrowers.
In 2016 as well as in 2017, we have witnessed a fast rising trend of non-performing loans (NPL). The NPL as a percentage to total borrowing for the industry increased from 7% at the end of 2015 to 9% at the end of 2016. The state of the economy is to blame for much of this. However, individual banks have suffered to a lesser or greater extent, depending on the sector spread of their borrowers and how well they have managed their lending portfolios. The deterioration in respect of CRDB Bank made headlines because of its size, but there are several banks that were similarly adversely impacted.
Going forward, with the introduction of International Financial Reporting Standard (IFRS) 9, with more stringent impairment requirements, we expect to see further deterioration in impairment levels in financial statements for 2018.
Meanwhile recent data on lending activity has shown evidence of impressive growth. Total assets of the banking sector grew from less than TZS20 trillion in 2013 to more than TZS30 trillion in 2016 of which more than 50% consisted of loans to various sectors of the economy.This has gone hand-in-hand with growth in financial inclusion, whereby the population with access to financial services has grown from 11% in 2006 to 62% currently, albeit mostly through mobile services (World Bank Economic Update April 2017). With several national outreach programmes being implemented by various members of both the private and public sector to uplift the struggling and poor segments of the population who have largely been excluded from the formal financial system, bankers could play a critical role in reinforcing the knowledge, discipline and confidence of the new upcoming members of the various productive sectors of the Tanzanian economy.
Unfortunately, the professional development of bankers in their role of promoting the sound administration of bank products and services has not kept pace with the growth in use of banking services. The fact that the banking sector is becoming increasingly regulated in order to maintain national financial stability means this gap needs to be addressed sooner rather than later. Best practices for the recognition of losses from lending activity have continuously evolved since the Global Financial Crisis of 2008 during which the US and other western economies witnessed a rapid deterioration of sub-prime mortgages that had quickly become the biggest cash-cow of several big lenders. Since then strict rules on loan loss recognition have been introduced through global financial reporting standards and continued reviews of these standards have also made detailed disclosures on financial statements mandatory. Similarly, the management of banks’ credit risk has become a critical part of doing business.
As a result regular financial education programmes to banks’ clients and customers are quickly becoming the norm in Tanzania as banks are being forced to consider anything ranging from proactive to near-predictive approaches to managing their loans before they start to underperform. But the jury is still out on how far banks are willing to reinforce the right skills and behaviours in their employees through shared training programmes and best practices in their respective roles as both ambassadors of financial literacy and gate keepers against the economic shocks of credit risk.
Patrick Mususa is Executive Director, The Tanzania Institute of Bankers (TIOB).