Understand loan structuring or perish
Posted Tuesday, February 26 2013 at 00:00
I once had the opportunity of visiting and traversing two districts of Busoga; Mayuge and Bugiri. When we drove from Mayuge through a back road to Bugiri I noticed that in virtually all the trading centres there were shops with “For Sale” signs written on the doors.
In some trading centres the concentration of the “For Sale” sign was so high accounting for a third of the shops.
When I inquired who was selling these shops and why they were doing it, I was told that the sale was due to failed loans. This was what apparently happened.
The main economic activity of the communities in those parts of Mayuge and Bugiri is crop farming which includes rice, sugar cane and maize. Now rice and maize take between four and five months from planting to selling on the market.
Some microfinance institutions came into the area and offered financing to the farmers so that they could expand their enterprises. With the loan a farmer who previously managed 1.5 acres could now hire labour and buy inputs to expand to say three acres. The math was done on paper and there was every indication that the farmers would end up richer after selling their harvest and paying the loan.
The microfinance institutions structured the loans in such a way that the borrowers were required to make weekly payments. This is a longstanding practice of many microcredit organisations and the aim is to encourage regular saving on the part of the clients as well as use of group persuasion to foster good loan repayment.
It is in the weekly payment structure that the farmers got done in. Week after week the farmers had no money to bring to the lenders because their crops were still growing in the fields.
As weeks passed and turned into months, the lenders started labelling the loans as bad loans and in some cases the unpaid interest was capitalised meaning that the interest due to be paid was calculated on both the principal amount borrowed and the unpaid interest.
When eventually the farmers were able to sell their crops, the money realised from the sale was not sufficient to pay the loans and that is when the lenders put up their securities for sale.
Poorly structured loans are not only found in rural areas but even in urban areas such as Kampala City.
For the elite borrowers the kinds of loan that have usually burned them are those obtained for infrastructure projects and equipment.
There was the businessman who took a loan to finance the construction of a hotel. The lending bank started calculating interest one month after the loan was disbursed.
Note that the hotelier drew the money over a period of time to either buy materials or pay his contractor but even when the money was on his bank account, the lender kept charging interest. That was problem number one.
Problem number two was that building and equipping a medium sized hotel took at least three years.
So after two years the bank was breathing hard on the neck of the hotelier because the interest was accumulating and the project was still far from complete. Eventually the banked pulled the plug and declared the hotelier a defaulter.