Recent headlines around rising Non Performing Assets (NPAs) have brought a myriad of challenges faced by banks and financial institutions into the spotlight. The sector still seems to be struggling with the constant issue of inadequate collaterals against loans. So what could be the primary reasons behind this occurrence?
The issue of collateral evaluation and review can be demystified by segregating it into the various stages of the loan cycle:
There are times when loans are sanctioned without adequate due diligence to confirm authenticity and valuation of the collaterals being provided. This becomes even more relevant for loans sanctioned especially at period ends where there is significant pressure on TATs.
In some instances, it has been observed that the ‘market value’ of the collateral is considered while preparing the sanction documents instead of taking a rather conservative approach and considering ‘distressed value’ which allows a ‘cushion’ to the lending institution.
Another case could be when the evaluation of collaterals is often performed by independent agencies that are later identified as being linked to the borrower (being appointed by the borrower) thus defeating the purpose of independent assessments.
- Loan documentation
Documents submitted by the borrower are often taken at face value without adequate diligence and sceptical review. Some common occurrences in this case would be unavailability of requisite insurance cover or just photocopy of ‘no objection certificate’ obtained from other lenders. Others could be gaps or significant caveats in the title search reports, vague collateral valuation reports, use of non-empanelled verification agencies, and absence of registered mortgage.
- End use monitoring
Financial institutions often take post disbursement monitoring of accounts as a formality. Steps such as,
- Surprise visits to factory premises to verify the existence of collateral (stocks in case of running loan) or
- Regular monitoring of information available in the public domain around the borrower and the collateral provided can serve as a sound indicator and act as early warning signals. Gaps in monitoring the loan leave a window open for the borrower to manipulate with the collateral and their valuations.
Challenges in doing businesses will continue to be sector agnostic – the banking industry will also see either the same or new issues as their carry on with day to day operations. However, a proactive approach will also prove beneficial in protecting the interests. To elaborate, these include,
- Conducting independent background checks on the promoter and key management personnel of the borrower entity
- Watchful scrutiny of documents provided by the borrower including leveraging information available in public domain to validate the documents provided
- Performing mystery shopping and conducting surprise visits, etc. at key customers or suppliers sites of the borrower entity
Measures such as these can assist financial institutions in reducing their concerns around to collateral security and valuation.