Here is the witty strategy of a credit manager I know. He dashes to hospital to ward off the pressure from a higher authority to approve loan requests which he feels fall short of other necessary considerations. “My eyes, my eyes”. Mr. Eyes’ eyes don’t like seeing those loans. They give him temporary cataracts. Alright! We can now look far and near without any cataracts and have a discussion on what has always been around us – Cash-for-cash.
Credit administration is considered as the major activity around which the banking business revolves. It is the core part of banking through which banks earn or lose income. Therefore, much attention is given to it. When a bank (financial institution) wants to decide whether to give a loan to a borrower – be it an individual or a registered business – the conventional practice has always been to use appraisal techniques. These methods are in many forms by way of questions which largely provide the framework for soliciting the necessary information from the applicant.
Indeed, the appraisal techniques are situated within the financial institution’s credit policy which by itself provides the overall direction for arriving at a decision to approve or decline a loan request. Since banks mobilise deposits from the public and turn these around as loans to borrowers, they therefore seek collateral from the borrowers to serve as a fallback (security) against default. As has been the practice, banks usually provide a list of valuable items which are acceptable for the collateral. It may not be worth citing all these collaterals, but landed property is one of them.
The basic understanding is that the collateral(s) will be disposed of and the proceeds used to offset the loan if the borrower fails to honour their obligations without any reasonable cause under the terms and conditions of the loan agreement. The Lenders and Borrowers Act has given a legal blessing for lenders to dispose of collaterals without necessarily using the court process.
In Ghana’s banking industry, it is a common knowledge that disposing of collaterals in the form of landed property can be daunting and frustrating. In that respect, bankers find it worthwhile accepting Certificates of Deposit (usually referred to as fixed deposit) if any, or cash (including other instruments which are easily convertible) from borrowers for collateral because they are already liquid. These alternates can be described as cash-backed or cash-secured. We can literarily call it ‘cash-for-cash’ since the borrowers bring in cash and take more cash from their bankers.
Cash-for-cash – how safe is this kind of seat to support a banker’s back when the need arises? By its nature, the bank demands that the borrower place a cash-percentage of the loan amount in an interest-bearing account. In extreme cases, some lenders ask borrowers to deposit 100% cash of the loan amount.
In fact, the borrower is not allowed to access the funds until the loan is fully paid off. This provides an avenue for the bank, as part of its financial intermediary role, to create more money and trade with the funds it has ‘mobilised’ by way of collateral from the borrowers. Convenient as it may be to the lender, however, it’s not a bed of roses.
More often, borrowers who do not have the ready cash from their personal resources to support the loan request but are compelled by the circumstances to resort to mobilising it at the bank’s blind-side through ‘door-to-door’ borrowing from informal sources (friends, family-members, business associates etc.) until they get the required ‘cash-backed’ collateral to secure the loan. In some cases, borrowers agree and authorise the lender (financial institution) to withhold a percentage of the loan amount for the security (cash-backed).
But in doing the ‘bring in cash for more cash’ with the loan applicants, a lender could lose sight of the adequacy of the remaining balance to execute the project. The open secret is that after the loan is disbursed, borrowers use part of it to defray their indebtedness to the individuals who supported them to raise the cash-backed (collateral). Hence, they are left with insufficient funds to carry out the project, and therefore cause it to delay.
Meanwhile, the cash from the informal sources is also not captured on the Credit Bureau to provide a reliable credit history on the borrower. In situations where periodic (monthly) repayment of the loan is directly dependent on the investment returns of the project (the purpose of the loan), the borrower is unable to repay the loan until the bank advances additional funds toward remediation of the initial transaction’s pitfalls.
For instance, we can consider the case of a typical scrap-dealer who won a contract for scrap-metal from a blue-chip company and has approached his bankers for a loan facility to pay for the consignment – including hiring trucks to haul them from Bogoso (Western Region) to Tema Steel. After raising money through ‘kpakpakpa movements’ to win the contract and later using a portion of the loan to settle his intermediaries, he was left with insufficient funds for the job. The underlying fact is that a banker will advance the loan based on the total contract cost and the hiring (trucks cost) while oblivious to the contract facilitation fees.
From inference, the bank ends up ‘under-financing’ the project and then finds itself in a merry-go-round transactional relationship with the borrower when the loan account is in default. On the expiry (termination) of the loan contract, the cash-backed security is virtually insufficient to settle the total indebtedness – principal, interest and the penal (default) charges build-up on the loan -especially when there is no additional security supporting the credit agreement. At this stage, it becomes evident that the lender’s fallback position is weak and vulnerable to increasing non-performing loans. Consequently, can we admit that the banker’s fallback (security) is a misnomer?
It is worth reiterating that competition in the banking sector is keen in the face of external factors (economic indicators) which have an impact on banks’ operations. As a result, deposit mobilisation exercises are increasingly putting stress on many bankers. But since deposits stimulate the lending process, the banks tend to find ways and means of mobilising more funds to sustain the business. In this regard, it has become a conventional practice for some financial institutions to adopt the wholesale strategy of cash-backed collateralisation in their credit policies.
What this means is that borrowers’ specific peculiarities are not considered, even though that should have been the case regarding other collateral options. Even when other security alternatives are thought-through, accepting them is secondary to the cash-backed security. While admitting the fact that the practice will always be on banker’s score-sheet, it is the blanket application which is worrying. On many occasions, the borrowers’ retort when requested to make the cash available has been: “If we have that much to give you as a collateral, why then approach you for the loan?”
It is often said that “desperate times call for desperate measures”. Thus, it is very convenient for the lender to use this mechanism during the loan underwriting stage when he/she is constrained and desperate for more liquidity(cash). When the borrowers, in the same vein, resort to desperate means of raising the funds by robbing Peter to pay Paul, the whole credit transaction backfires into non-performing loans with inadequate collaterals. These incidents happen when other variables necessary for prudent credit decisions are not well-considered. At this final point, would it be out place to say that cash-for-cash is indeed a misnomer – defeating its primary purpose as a fallback seat to cushion the banker’s back at the time it is most needed?
Blessed Times, God is with us. Thank You. It’s bye for now.