By John Oyuke
Borrowers will have to grapple with stringent lending rules if new proposals are implemented by Central Bank of Kenya (CBK).
The rules, intended to clamp down on poor lending practices, are set to be implemented on August 1.
Though the guidelines have not been finalised, and are still open for comment by stakeholders and the public, they could be have broad implications for borrowers if implemented as scripted.
According to the guidelines, any sign of potential default on a loan would subject concerned borrowers to additional oversight and monitoring, for example, through more frequent visits from credit officers, and inclusion on a watch list that is regularly reviewed by senior management.
Other indicators to be monitored keenly by banks are borrower‘s principal and interest repayments, account activity, as well as instances of excesses over credit limits.
Banks are also expected to monitor borrower‘s ability to adhere to pledges and financial covenants stated in the loan agreement and any breaches of the loan covenant detected would trigger prompt action.
In addition to monitoring the above risk indicators, CBK requires that banking institutions should also monitor use of funds to determine whether credit facilities are drawn down for their intended purposes.
Acted upon
“Where a borrower has utilised funds for purposes not shown in the original proposal, the bank should determine the implications on the creditworthiness of the obligor,” CBK says in its memorandum to banks.
Exceptions noted during the monitoring process should be promptly acted upon and reported to management.
According to the CBK Director, Bank supervision Department, Fredrick Pere, under the new legal dispensation commercial banks would have to operate under sound and well-defined credit-granting criteria.
“These criteria should include a thorough understanding of the borrower or counterparty, as well as the purpose and structure of the credit, and its source of repayment. Banks must receive sufficient information to enable a comprehensive assessment of the true risk profile of the borrower or counterparty,” he says.
Credit risk rating system, considered an important tool in monitoring the quality of individual credits, as well as the total portfolio, should be able to verify the financial position and business condition of the borrower, conduct of the borrower‘s accounts, adherence to loan covenants and value of collateral.
Purpose
At a minimum, the factors to be considered and documented in approving credits must include the purpose of the credit and source of repayment and the integrity and reputation of the borrower or counterparty.
Banks should also look for the current risk profile (including the nature and aggregate amounts of risks) of the borrower or counterparty and its sensitivity to economic and market developments and the borrower‘s repayment history and current capacity to repay, based on historical financial trends and cash flow projections.
Other documents to be looked at before a loan is approved are the borrower credit rating/report from licensed credit Reference Bureau, a forward-looking analysis of the capacity to repay based on various scenarios, the legal capacity of the borrower or counterparty to assume the liability in case of default.
For commercial credits, the borrower‘s business expertise and the status of the borrower‘s economic sector and its position within that sector will also be a key factor to be looked at before a loan is approved.
In addition, Bank must have checks and balances in places that ensure credit is granted on arms-length basis. “Extension of credit to directors, senior management and other influential parties, for example shareholders, should not override established credit granting and monitoring processes,” Pere says in an introduction the new guidelines.
CBK also wants financial institutions to reconstitute their boardrooms by next month in response to the new regulations requiring that half of non-executive board seats to be held by independent directors.
Revenue generator
Credit is the main revenue generator for banks and is raised by two types of borrowers, individual borrowers and corporate borrowers.
Though retail loans consisting of individual borrowers generally follow less stringent processes to verify credibility of borrowers compared to corporates, under the proposed risk management guidelines, banks will follow various methods and credit agency’s rating to establish the credibility of both.
According to managing director of Metropol East Africa, a credit reference bureau (CRB), Sam Omukoko, banks have been demanding that all loan applications be accompanied by findings of the individual’s or business report.
“Banks been more cautious passing every application through CRBs when appraising customers for loans as reflected in increased credit reports enquiries and this can only increase with new laws,” he told Business Weekly.
Omukoko welcomed decision by CBK to insist that borrowers adhere to the pledges and financial covenants stated in loan agreements, though he acknowledged this could not work out easily with personal loans.
He said personal loans are listed as consumer credit (for consumption) hence tracking any diversion of use could prove herculean task.
“It is important that people stick to agreement once they receive credit as this helps especially when filing reports with the Central Bank, which uses the data to show the levels of credit received in each sector,” he said.
Under the new set of guidelines the value of security should be updated periodically to account for changes in market conditions.
More valuations
For example, where security is property or shares, an institution should undertake more frequent valuations in adverse market conditions.
“If the facility is backed by an inventory or goods purportedly on the obligor‘s premises, appropriate inspections should be conducted to verify the existence and valuation of the collateral,” CBK has pointed out.
