While working in a bank in Bangladesh, we frequently noticed that there were some borrowers who personally came to the branch, waited in the Manager's chamber, spent some time in chatting and finally presented a cheque for his initial. His initial was needed to draw money from his/her loan account because there was not adequate balance to withdraw in normal course of business. It may be mentioned here that the cheque itself, if drawn properly by the account holder, is good enough to draw money provided the account remains in good standing i.e. either the deposit account has adequate balance or loan account has enough room within the approved limit. So no special initial or sign-off from the Manager is required to draw money from the account.
When the approved loan limit is fully utilised leaving no available balance to draw, the Manager's sign-off is required enabling the teller to honour the cheque which results in excess drawing over regular limit and this practice is commonly known as Excess over Limit (EoL). This EoL was, in fact, a regular phenomenon in some loan accounts and we were tired of preparing statements and providing explanation justifying EoL. Subsequently, most of these borrowers went default and thus outstanding loans became non-performing. This is obvious: allowing EoL is identified as one of the main reasons of creating Non-Performing Loan (NPL).
During the last two decades, the country's banking sector has achieved tremendous development bringing about many qualitative changes in the industry; yet this malpractice continues unabated.
Some banks have centralised their loan limit administration system which is definitely a remarkable improvement. This centralised limit administration may restrict the Manager's authority to allow drawing over regular limit but will not eliminate the practice of allowing EoL.
WHY EXCESS OVER LIMIT: The scope of EoL cannot be stopped if the reasons behind this practice are not properly identified. There are various reasons from the borrower's perspective to demand for allowing EoL. However, overtrading, under-financing, mismanagement of working capital, fund diversion, abnormally rising debts, rise in bad debts, inventory piling, enhancing production capacity without proportionate increase of OD/CC (overdraft/cash credit) limit lead to the recourse to EoL. Among these factors, overtrading and fund diversion are the consequences of the borrower's deliberate attempts. Besides, these are very common practices in our country. People always tempt to conduct more business and generate more revenue which invites danger for him and the bank as well.
Similarly, people are not careful in using fund assigned for particular purposes. Business loans are indiscriminately used for personal consumption what results in shortage of fund in business compelling the borrower to draw EoL. Mismanagement of working capital, rise in debt, increased bad debt and inventory piling are the result of the borrower's inefficiency and lack of proper supervision. Deterioration of business performance also results in shortage of fund requiring EoL from the bank. However, under-financing and increasing production capacity without proportionate increase of working capital come from bankers because when they take conservative approach in meeting the requirement of businessman, such situation arises and the borrower approaches for EoL in order to temporarily resolve the problem.
ANALYSIS OF REQUEST FOR EOL: Request for EoL from the borrower must be viewed with serious care because this primarily signals that the health of the loan approved by the bank is not in good condition. Under CRM (Credit Risk Management), a system was developed in all banks to introduce EWA (Early Warning Account) of the borrowers. One of the important parameters for identifying the borrower as EWA is the request for EoL. Whenever any request for EoL is submitted, the loan account should be immediately taken under the Special Account Team (SAT) which will thoroughly investigate the reason of EoL and closely monitor the account. Of course, there may have obvious reasons of excess drawing but this must be identified, analysed, justified and addressed first. If proper justification can be established, the account may be returned to regular form.
It may be mentioned here that if astaggering loan account is timely identified and appropriate measures are taken before it is too late, most of the probable NPLs can easily be prevented. So properly handling of EoL request from the borrower will keep the loan in good standing and thus contribute much in preventing loan from being NPL. If we make the borrower aware in the name of centralisation of loan limit administration that bank's computerised system does not permit EoL, the borrow will then find some other alternative means and thus the lending bank will be deprived of the opportunity to know the actual situation of the borrower. In spite of introducing centralised limit control, the avenues of EoL should be kept open as effective tools for monitoring purposes and even for entertaining when the request for EoL can be substantiated.
PROPER ASSESSMENT REQUIREMENT: In our country's loan operation, there is lack of proper analysis and assessment of borrower's funding requirement while sanctioning loan. Even there is a common practice of trimming of loan amount at different levels from branch Manager to the Board of Directors. Borrower's request is first curtailed at the branch level and then at the Credit Committee level and finally trimmed off at the Board level and thus the approved loan amount in most of cases falls short of actual requirement. This practice of approving loan by the bank is well-known to the business community and therefore, they always submit request for loans more than their actual requirement. Submission of higher amount and reduction thereof at different adjudicating level of the bank are not desired at all because this results in either over-financing or under-financing. However, neither over-financing nor under-financing is conducive for the borrower to keep the loan in good standing all the time. Over-finance allows the borrower to overtrade or divert fund for some other purposes including personal consumption. Fund diverted from the business operation hardly comes back and therefore, in spite of having strong will, the borrower may not repay the loan on time, so the loan will go for default.
Similarly under-financing causes mismanagement of working capital in the business and thus does not allow the borrower to perform at optimum level. Capacity utilisation cannot be maximised due to shortage of working capital likely to be arisen from under-financing by the bank. Because of working capital mismanagement, revenue generated from business operation is not good enough to service debt and thus the loan is most likely to turn NPL. In the developed world, all business firms maintain a strong Finance Department where a group of competent financial analysts work under the leadership of professional CFO (Chief Financial Officer). Even a small business employs CFO or Controller whose prime responsibility is to manage the company's finance including loans from the bank. The company's funding requirement is calculated and determined by the CFO and his team and then submitted to the bank.
BANKERS' EXTENSIVE HOMEWORK NEEDED: Analysts and CFO working in commercial firms are so competent that bankers are required to do extensive homework in order to prepare themselves for negotiating with the CFO of the borrower. The banker and the borrower discuss on the basis of requirement and accordingly funding decision is finalised. Unfortunately, this practice has not been developed among members of our business community. Even they have not yet started considering their finance as an important area although business turnover has increased manifold. So the credit officer in the bank has to play a dual role of banker as well as CFO of the borrower. Therefore, every banker must exercise in-depth analysis and apply his prudence and judgement so that accurate funding requirement can be assessed and determined. Of course, selection of borrower is exclusively the bank's own decision but once borrowers are selected, their total funding requirement will have to be satisfied so that neither over-financing nor under-financing arises at all.
AN OBSOLETE FORM OF CREDIT FACILITY: In our banking industry, Overdraft (OD) or Cash Credit (CC) is the most popular form of bank loan. Except project finance, all kinds of bank loans are sanctioned in the form of OD/CC limit. To speak the truth, all working capital financing is approved in the form of Overdraft limit. This OD/CC facility technically sets a maximum drawing limit in the borrower's account within which they can freely transact by withdrawing and depositing money. There is no restriction, control or any monitoring mechanism on OD/CC limit operation. This is not purpose-based lending and a banker can hardly ensure the end-use of the sanctioned loan. Therefore, business community mostly prefers this OD/CC limit to any other form of credit facility. Loan sanctioned for running business can easily be used for personal consumption or can easily be channelled to highly risky investment.
So the free flow of money in the form of OD/CC limit carries loopholes of easy fund diversion what eventually causes NPL. Besides, the nature and scope of working capital management of a business unit has changed significantly. Even component of working capital and its contribution to the production process has also changed. OD/CC limit for working capital finance has lost its effectiveness. Therefore, the banking industry in developed world and even many developing countries has discarded this form of credit facility long ago. Unfortunately, this OD/CC limit is still a very popular means of credit facility in our country's banking industry leaving wide scope of fund diversion and eventually turning NPL.
The writer is a banker based in Toronto, Canada
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