“When we are no longer able to change a situation – we are challenged to change ourselves.” – Viktor Frankl
Segregation of Duties in The Traditional Lending Process
The fourth revolution has made utmost use of digitalization to ensure seamless delivery of all operations and services. However until banking software applications are updated to make the best of digitalized credit delivery which can take only a few minutes to make a decision, (mostly in the case of personal lending), many financial institutions have to contend with manual loan processing.
Lending as a core banking operation
Lending is one of the core businesses that banks are licensed to do. There can never be a return on customers’ deposits held in banks if they are not invested in one way or another. Of course, lending is one of the most profitable operations of a bank business if conducted well enough for the monies to be repaid.
We still read publications on financial institutions going bust and customers invading their premises for their money. A bank can have all the structures in place in credit delivery, with all the principles of lending being applied. However, we admit that “to err is human” and the segregation of duty is one basic rule that reduces the operational risk in the process of lending.
The Lending Process
With the proliferation of financial institutions, the lending process remains the lifeblood of their business. Lending is a straightforward series of activities involving two parties which involves loan requests, loan approval, its disbursement and loan repayment. Most of these functions are interdependent in the value creation chain, and therefore segregation should be the must-have during the whole credit delivery and administration process. The challenge of achieving good segregation of duty is typically more acute in the small and medium-sized financial institutions due to the lack of advanced tools or the expertise to manage this risk effectively.
Let us look at the typical personal or sole proprietorship lending processes: It starts at the branch. An officer or relationship manager has to ensure the Know Your Customer (KYC) issues are complied with. This involves proof of identity, proof of residence, employment, confirmation of collateral submitted etc. In the case of account receivables and payables, the loan department expects confirmation of the ageing analysis of inventory and receivables. Where approval is granted at the head office, the appraisal staff also require some additional checks, to be convinced about the genuineness of the loan request.
This simple and straight-line process can still be fraught with problems if one person performs all these tasks. It becomes easy to lend to ghost or fictitious names and non-existent businesses. With loan administration, an increase in fictitious or unauthorized loans result when both the approval and the disbursement are handled by the same employee. To minimize exposure, banks must separate the loan approval and the disbursement functionaries.
Some loan officers use the advantages of technology as another outlet to commit fraud. Sometimes, data processing facilities are made easily accessible to unauthorized persons. Although the truth can be traced through an audit trail and to the individual data entry personnel, they are sometimes detected too late.
In bigger financial institutions, the loan process involves credit administration staff who ensure the various steps are confirmed, the amount granted are set up in the computer system, and all such prior approval conditions are met. Credit monitoring teams also come in to ensure that disbursement conditions are abided by and the loan is used for the intended purpose.
A Case of Breakdown in Segregation of Duty during Credit Delivery
- Kwame Donkor is a Loans officer who is asked to process a loan for Adwoa Enterprise, an SME in the central business district of Accra.
- The owner of the enterprise, Madam Adwoa is a thirty-five-year old lady, semi-literate who is supposed to have experience in the “buy and sell” business for about five years.
- She needed an overdraft of GHc50,000, to expand her business.
- Her main stock-in-trade is cosmetics.
- She does not perform any book-keeping, recording of transactions such as sales, purchases and other expenses. She mixes the business funds with her personal funds.
- She has a savings account in the same bank, where she places part of her profits.
- Kwame Donkor visited the shop, the residence and prepared his own statement of affairs of Adwoa Enterprise, as well as a cashflow projection; he manipulated the figures to window dress the business operations.
- Kwame overstated the stocks and receivables to make the business look very credit worthy.
- The appraisal was sent to the Head office for further appraisal and eventually an amount of GHC50,000 was approved for the business.
- Kwame kept the documents covering Madam Adwoa’s landed property, for which a search was not conducted at the Lands Department for authentication.
- Disbursement of the funds was made by Kwame through the set-up in the banking software system.
- Madam Adwoa received the credit in her account, withdraws GHC49,000 and travelled out of the country the following day.
- A search at the Lands Department shows that the documents are fake. Madam Adwoa is only a girlfriend of the main business owner, who is a drug dealer, currently in jail in Thailand. All the business registration documents submitted to the bank were fake!
- A regular review of data processing and nonfinancial reports can help discover any discrepancies.
- Avoidance of fictitious or unauthorized loans when loan approval and disbursement are handled by the same employee.
- Changes in an interest rate or a payment due date should not be done by one official without authority.
- A compulsory ten –day block leave forces staff to relinquish their duties to someone else at which time irregularities or unauthorized manipulations may surface.
- A rotation of duties, to prevent the exclusive power over some accounts by Relationship Managers.
- Annual audits, both internal and external personnel help verification of facts and objectivity in the process.
- With its benefits of speed and accessibility, technology can still be another outlet to commit fraud. Therefore, prevent data processing facilities from becoming easily accessible to unauthorized persons and create more internal control problems.
- Loan documents and custody of collaterals for loans should be maintained by staff not involved in the loan process.
- Staff responsible for disbursing loan payments should not initiate and authorize loan transactions.
- Activity in loan accounts should be reviewed and approved by someone other than the staff responsible for recording transactions in this account.
Perhaps sudden changes in lifestyle of some staff may be red-flags and managers need to stay in tune with all staff to see if their behaviour, personal situations or other red–flags are being waved. In fact, if managers take enterprise risk management to heart and implement credit policies and procedures that include SoD, it will reduce the risks of losses in credit delivery and administration. A country’s people and businesses cannot do without credit facilities, so financial institutions should take good care of their depositors’ funds and keep the economy alive.
ABOUT THE AUTHOR
Alberta Quarcoopome is a Fellow of the Institute of Bankers, and CEO of ALKAN Business Consult Ltd. She is the Author of Three books: “The 21st Century Bank Teller: A Strategic Partner” and “My Front Desk Experience: A Young Banker’s Story” and “The Modern Branch Manager’s Companion”. She uses her experience and practical case studies, training young bankers in operational risk management, sales, customer service, banking operations and fraud.