Persistent inflation which has increased the cost of funding and made repayment difficult [for consumers] has affected the margins of most lending operations, forcing them to explore alternative ways to grow their profit. Exploring measures to drive up profits is commendable but some of the measures lenders adopt achieve the opposite. An example is lower interest rates and non-adherence to the stipulations of the lending policy in order to get more customers. There are measures lenders can adopt to increase profitability, especially in an uncertain economy. In this article, we’ll share two of them which are reduced PAR and strategic cost-cutting.
Before we share practical ways to run a profitable lending operation in an austere economy, let’s briefly share how economic, social and political factors affect the ability of lenders to thrive.
Political Factor: In some countries, the government (or party in power) set up and manage microfinance banks. This is not surprising as microfinance banks are vehicles the government utilize to extend credit and other financial services to underserved communities. However, most microfinance banks are not used for this purpose. Instead, they are used to advance the agenda of the administration in power, which more often than not, is contrary to how an MFB should operate. For instance, a state may have thirty non-functional MFBs. These banks remain in operation because they intend to sell their licenses.
Economic Factor: Economic factors like high and prolonged inflation make it difficult for borrowers to repay their loans. This prolonged economic hardship combined with the lack of consequence for default increases NPLs (Increased NPLs threaten the continuity of lending business. This is because the lender will run out of money to lend and may not be able to pay for operational costs). It is common industry knowledge that borrowers are unwilling to pay their loans. But this unwillingness to repay a loan is addressed through severe consequences that force the borrower to repay. Unfortunately, these consequences and their enforcement are absent in emerging economies. This emboldens serial borrowers who devise different ways to defraud borrowers.
Social factors: When borrowers use the loan for the agreed or specified purpose, they can easily repay the loan. But most times, the reverse is the case. Borrowers divert the loans, going as far as using them for frivolous activities like hosting parties.
As mentioned previously, one of the drivers of this behaviour is the lack of consequences for default. For instance, in developed economies [which operate primarily on credit], the ability to access loans and other forms of credit relies on a good credit score. This being the case, borrowers are careful and avoid situations that will put a dent in their credit scores. Another factor that points to a lack of consequence is the absence of legal actions. Nigeria for instance set up a small claims court to address issues like loan default. But these courts are not decisive in their rulings and borrowers seldom abide by the rulings of the court.
P.S. Another way lenders can thrive is to reconsider their approach to portfolio management. In most organizations, loan officers manage the portfolio. When these officers leave, the bank or lending business loses the portfolio because there’s no one managing the portfolio. Once a customer knows that the account officer is not in charge of the loan, they lose the willingness to repay. Therefore, every lending business needs to restructure the process so that in the event that a loan officer is unavailable, someone else takes charge of the loan. The loan should not be the responsibility of the loan officer, but that of the business.
Now that we’ve shared some of the challenges that impede the progress of lenders, here are some actionable strategies you can adopt to grow the profitability of your lending business.
1. Create loan products you’re knowledgeable in. To succeed, you need to become tactical. This means creating loan products you have deep expertise in so that you can recover the loans easily. For instance, some lenders may offer business loans because they heard it’s lucrative even though they don’t have the required skills nor sufficient understanding of the SME sector.
Creating loan products that you’re experienced in is important because the economy is unstable. Inflation is currently at 21% up from the usual 10%. This is an indicator that people may not have money in the near future. So creating loan products for sectors you’re familiar with is a way to minimize risk as you’re sure of a high recovery rate and the interest will cover the losses. In a period of economic uncertainty, it is inadvisable to explore new markets or unfamiliar loan products. Instead, create a plan that ensures that your risk criteria can accommodate unexpected losses.
2. Strict monitoring of portfolio performance. We cannot overemphasize the importance of loan monitoring. Have a process for identifying high-risk portfolios as well as an action plan to mitigate this risk. In addition to portfolio monitoring, ensure you have an experienced collection team that constantly follows up with customers. This is necessary because most borrowers are unwilling to repay their loans.
3. Increase your risk appetite. Analyse your portfolio to uncover trends. With these insights, you can adopt new strategies that address areas of weakness or strengthen the areas where you’re exceeding expectations. Still on risk appetite, identify viable sectors to lend to. For instance, if you offer salary loans, bankers and telecoms workers are believed to be less risky. Continuously use data to analyze the risks in a given sector, and use this data to make your business decision. Increasing risk appetite is not the same as taking on excessive risks. Rather, it is close and continuous monitoring of how you lend and use these insights to make decisions.
Loan repayment is critical to the success of any lending business. This is because a high repayment rate reduces PAR, increasing your profits and giving you more money to disburse. Therefore, the first step to increase profits is to keep NPLs to a minimum. Here are some ways to do that.
1. Enforce strict adherence to your credit policy. This is important because in order to meet targets, some credit officers ignore the stipulations of your credit policy, forgetting the credit policy defines risks that they can take and ensures that the business or bank can recover disbursed loans.
2. Another way to reduce your NPL, also known as PAR is to look beyond bank statements during the decisioning stage as they are insufficient in determining a borrower’s character. In addition to bank statement analysis, conduct further research to ensure that the information in the bank statements reflects the true state of the business. Most times, this investigation will reveal that contrary to the bank statement, the borrower is overleveraged and will be unable to repay the loan.
If your lending policy requires physical visits as part of its process, ensure that you have easy access to the borrower’s building. If a borrower lives in a gated community where you require security clearance before gaining access, recovering the loan in case of a default will be difficult as the borrower can easily rescind your access to their residence.
3. Outsource recovery. In the absence of a recovery team, outsource delinquent loans to a collection agency.
4. Don’t assume collaterals guarantee repayment. When collateral seems solid, you’re prone to ignore other checks because you feel that the collateral can cover the loan in the case of a default. This is not always the case. Your primary responsibility is to ensure that the customer does not default and that there’s never any reason to resort to collaterals to recover the loan. To do this, check the customer’s credibility, capacity, income and financial statement. Collateral does not render these processes irrelevant.
Any lending business regardless of its size can increase its profits and ensure business continuity. The primary way to do this is to reduce non-performing loans drastically and create strategies that save costs for the business.