Banks are unique businesses. The value of their largest assets is determined entirely by the performance of their customers. A bank’s loan book is typically its most significant asset. When customers fail to service interest or repay principal, the bank must make provisions for impairment.
In Nigeria, these prudential guidelines are strictly set by the Central Bank of Nigeria (CBN).
The uncertainty of the banking business
During my time at NAL Merchant Bank (NAL), the bank’s chief credit officer was Michael Pimley, a representative of our technical partners, the American Express Bank. He is one of the best credit analysts anywhere.
After exiting the bank, Mr. Pimley collaborated with Biodun Dabiri, Clem Baiye, and me to found the International Credit Consulting Group (ICCG). Our mission was to teach credit analysis to officers in the many new banks then being licensed, including Guaranty Trust Bank (now GTBank). At the time, ICCG was a leader in that training space. A company called DC Gardner was our only real competitor then.
During training sessions, Mr. Pimley would often pose a riddle: “Which business has the most uncertain balance sheet because it knows neither its true assets nor its true liabilities?”
The answer, he revealed, was banking. He illustrated this with a scenario — Bank executives might review their positions in the morning and find everything in order. By lunch, news breaks that their biggest customer’s factory and warehouses — full of raw materials financed by the bank, have burnt down. Despite insurance mitigation, the business will be offline for months, rendering them unable to service their loans.
This dilemma of sudden, and dramatic change in the status of credits and liabilities, is a reality for banks.
In the past couple of weeks, the market was surprised by reports of several systemically important banks making large impairment provisions. These provisions will prevent them from paying dividends this year.
The stock market was spooked. Investors and traders reacted immediately, marking down share prices. Some bank stocks plummeted by more than 20 percent in a single week.
Impairments stem from various sources: poor credit decisions, sudden shifts in economic policy, or broader recessions. While credit analysis isn’t an exact science, robust policies must be in place to ensure loans remain recoverable.
The NAL Merchant Bank model
In my time in banking, NAL Merchant Bank maintained the highest standards of credit quality and was consistently among the most profitable banks.
Our process was transparent and governed by credible rules. Every credit request had input from every credit officer in the credit department. At our Monday morning Credit meetings, there were over 20 credit officers in attendance, including an assistant general manager and a general manager, presiding. Each credit proposal was presented by the team responsible for that specific industry segment. The credit proposal was openly debated. If a proposal did not receive a “Yes” at this meeting, it went no further. Even if it came from a friend of the CEO.
This “wisdom of the crowd” allowed for information sharing that a single team might lack. If a credit was deemed unviable, a rejection letter was sent immediately, allowing the customer to seek funding elsewhere.
This differs sharply from what happens in many banks today, where credit memos go all the way, until they reach the Board Credit Committee, only to be rejected after weeks of wasted effort.
The NAL approach also eliminated undue influence; if a senior executive contacted an analyst regarding a loan, it had to be officially recorded.
Collateral vs. viability
Contrary to popular belief, banks should not lend based solely on collateral. The best loans are those that do not require it.
At NAL, we frequently used a “Negative Pledge” for top-tier customers. This was a legal commitment by the customer not to pledge their fixed assets to any other lender without our permission. This simple documentation preserved the company’s assets and avoided the extensive and costly full blown mortgage legal documentation, while still allowing the bank to rely on these assets, if liquidation became necessary.
It also prevented multiple banks from fighting over the same assets, a common sight today.
In a NAL loan, the viability of the transaction was the primary consideration. Collateral was merely the “back way out” if the transaction failed on its merits.
Monitoring and the “Watch Loan” Committee
Granting a loan is only the beginning. Monitoring is what ensures recovery. At NAL, teams conducted quarterly reviews to ensure customers met “covenants” specific ratios of liquidity or assets to liabilities. These reviews were sometimes learning moments for officers.
In the pharmaceutical industry that was one of our team’s coverage, we had to understand tamper-proof packaging because it was a critical defense against fake medicines. We also learned that “slow-moving” inventory wasn’t always a weakness; in an environment with scarce foreign exchange, smart companies hoarded raw materials to ensure continuous production.
Despite best efforts, some loans inevitably go bad. NAL managed this through a high-powered Watch Loan Committee. A committee that included senior management, department heads, and the CEO.
Serving as secretary for this committee was one of my most valuable learning experiences. We reviewed every deteriorating credit to understand why it was failing and what could be done.
New practices
Lately, we hear of practices that undermine credit standards. I was recently told of a developer who was asked by bank officials to inflate a loan request from N1 billion to N1.5 billion. The extra N500 million was intended as a kickback for approving officers and board members. The developer, out of desperation, agreed. The first N1 billion was disbursed, N500 million went to the bank officials, and the remaining balance was never released. The project failed, the bank officers relocated abroad, and the developer was left with the debt and an EFCC investigation.
Loans made under such conditions are never recovered.
A better way forward
There is also a growing haste to involve insolvency lawyers and the courts rather than restructuring loans. When a default results from a poor economy, effort should be made to help the customer repay over a longer timeline.
A bank’s business is to make loans. In a bad economy, even loans made in good times will come under stress.
However, we must ensure quality at the point of creation and maintain rigorous monitoring. Recovering loans through court battles and media fights ultimately fails everyone: the bank, the customer, and the economy.
Victor Ogiemwonyi, a retired investment banker, is a former Governing Council member of the Nigerian Stock Exchange (NSE), now Nigerian Exchange Group (NGX Group). He sent this contribution from Ikoyi, Lagos. He can be reached via comment@businessamlive.com and marketconversations.substack.com
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