LENDING OPERATIONS AND RISK MANAGEMENT

Area 1 - Finance facilities

• Fund-based facilities for finance of domestic business, import, export
• Contingent facilities for supporting both domestic and foreign trade businesses

Mark-up rates:

• Basic formula for working out weighted average cost of deposit funds
• Structuring floating mark-up rates and their impact during changing of interest rates
• The bases for floating mark-up rates using (i) Karachi Inter-bank Offer Rates (KIBOR), (ii) SBP Discount Rate and (iii) PIB Rates matching the facility tenor
• Bank’s spread over cost of deposits relating to customer and transaction risks
• Methods and frequency of mark-up recovery and their impact on income recognition

The other service tariffs

Regulations prescribing supervision and control of financing operations:

· Borrower classification in terms of micro, SME or Commercial/Corporate entities

· Essential requirements for opening borrower accounts

· Prevention of criminal use of banking channels by borrowers

· Certification of customer accounts by external auditors - types and quantum of their proposed or actual fund-based and non-fund-based borrowings

· Existing borrowings from the financial services sector and the methods for verifying 

· Maintenance of debt-equity ratio & permissible limits of unsecured financing

Regulations prescribing internal control measures for banks:

· Reporting under Automated Performance Appraisal System (APAS)

· Internal control issues raised by APAS

The concepts of re-scheduling and re-structuring of borrower accounts

· Circumstances permitting re-scheduling of an account

· Circumstances permitting re-structuring of an account

Loan Loss Provisioning:

· Timing for classifying accounts and loss provisioning there for

Area 2 - Loan & Charge Documentation

Ownership structures

· Sole Proprietorships to Trusts

Ownership of financed assets – the concept in Anglo-Saxon Law and NIB

· Arrangements to establish bank’s ownership/control over financed goods/collateral:

· Stated and implied lien over customer’s assets

· Hypothecation of stocks and rights vested in the bank  

· Assignment of receivables and rights vested in the bank  

· Pledge of paper securities and rights vested in the bank

· Pledge of goods and rights vested in the bank  

· Mortgage of immovable assets rights vested in the bank  

Understanding the basic differences in contract types

(i)   The finance agreement, (ii) Security documents and (iii) Charge documents

Contractual nature of bank financing in Anglo-Saxon Law and NIB 

· Contracts and obligations of financing bank and its customer under these contracts

Perfection of financing contract

Establishing the charge – verification and valuation of asset being charged

Safe-keeping of documents

· In-house arrangements and the way they work

· Ex-house arrangements and the way they work

· Arrangements for storage of documents and the system for recording 

· Procedures to be followed for depositing and retrieving documents

Area 3 - Account, Asset & Collateral Monitoring

Facility Account monitoring – internally generated account status signals:

· Frequency of peak/low facility utilization, swing in account balances

· Frequency of irregularities in, or misuse of, facility accounts

· Difficulties in operating within present limits

· Meeting facility turnover requirement and quantum of business booked

· Indications of unauthorized passage of business to competitors

Financed assets monitoring:

· Bank’s ownership of financed assets – Islamic Banking point of view

· Customer obligations under hypothecation of assets

· Bank’s risk under various arrangements of hypothecation of assets

· Appointment and role Muccudums

· Obligations of the custodial services under the arrangement for pledge of goods

· Bank’s risk under various arrangements of pledge of goods

Collateral Monitoring:

· Collateral types

· Salient aspects of monitoring Marketable Securities under lien/pledge

· Monitoring Guarantees – issuer’s status, guarantee validity, conditions for           claims 

· Monitoring Insurance Policies – issuer’s status, policy validity, conditions for         claims          

· Monitoring Immovable Assets:

Monitoring systems

• Significance and configuration of reports on activity in facility account
• Significance and configuration of computer-generated/manually maintained Due Date Diaries for retrieval of due amounts or settlement of facilities     
• Significance and configuration of accounting reports highlighting:
• Proper system for tracking reports  of borrowers and independent custodians
• Proper formants for the reports to be filed by the borrowers and independent custodians to assist the bank in knowing on a prompt basis the correct status of financed assets
• Proper system and credible sources for monitoring prices of financed assets and collateral

Post-monitoring procedures

• Activating remedial action
• Customer contact modes depending on severity of failure in meeting commitments
• Determining net exposure and status of financed assets and collateral 
• Reporting defaults for in-house remedial action i.e. fulfilling any inter-bank commitments that can’t be met anymore out of borrower’s repayment

Area 4 - Financing Risk Assessment

Sources of Risk in financing operations:

· Business and industry risk – cycles, price trends of major commodities and their impact on: (i) trade flows, (ii) balance of trade, (iii) balance of payments, and  (iv) inflation

· Transaction failure Risk, Customer Integrity Risk

· Approach to business – capability of production, selling, recovery units

· Loss sustaining capacity of the borrower

Finance facilities required by customer types and sources of risk therein:

· Large manufacturing/processing units

· Small and medium scale manufacturing/processing units

· Commodity traders

· Construction and supply contractors

· Service organizations

Understanding customer’s business – nature, size, and inherent risks:

· Nature – processing/manufacturing, wholesaling/trading, retailing

· Sourcing of goods dealt with – origin, brands, makes, product lines

· Physical and sale/distribution arrangements for conducting business

· Customer’s competitive position – strengths and weaknesses

· Terms of payment to suppliers and buyers – gap in trading cycle that needs financing

Transactions to be financed – identification and capturing repayment sources

· Transaction mechanics and risk stages – reliability for timely completion of transaction

· Terms of payment to suppliers and buyers – determining financing gap

· Primary & secondary sources of repayment, amount, reliability and methods for capturing

· Quantification of net bank risk

· Collateral requirements – quantification and determining collateral type and mix

Assessing customer Integrity and capability – market sources:

· Tapping market intelligence – reliability of sources

· Bank references and their deficiencies 

· Informal bank inquiries

· Visit to customer’s premises – the things to observe

· Customer interview and Visit Report 

Examining customer’s risk taking capacity – salient aspects of financial statements

· Authenticity of reported assets/liabilities – who are customer’s auditors?

· Critical indications provided by their trends:

· Assets already pledged to other financiers and nature of their charge

· Free assets of the borrower

· Realizable value of reported free assets – prospects of their sale in distress

· Nature of current and contingent liabilities – total debt servicing burden

Recommended Readings

1.         Siddiqi Dr. Israr H.                               Practice & Law of Banking

2.         Sinkey                                                  Commercial Bank Management

Supplementary Readings

1.         Pakistan, Institute of Bankers                Selected Essays on Banking & Finance

2.         Sinkey, Joseph F.                                 Credit Risk Management in Banks

3.         Pond, Keith & Lipsombe,                     The Business of Banking

            Geoffery

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