No good bank enjoys foreclosing properties pledged to it by clients. A bank which constantly sells clients’ properties pays a huge price as it will have its reputation damaged, due to the negative perceptions that people will have of it thereafter. That is why underwriting of credit is never principally based on the collateral pledged, but rather on the capacity of the borrower to have access to enough funds to repay what is borrowed, either from their business, employment or other legitimate enterprise.
Strictly speaking, the credit analysis process should be satisfactory enough, to show that the client will be able to pay the borrowed funds without the bank having to resort to selling pledged items. If a bank finds out that the client will be unable to repay the loan and of necessity their property will have to be sold to recover funds, the client’s loan application should be rejected. Without observing this principle, a bank degenerates into a property seller, which is ordinarily the business of real estate firms. In such a scenario the bank fails the cardinal function of partnering with the citizenry in their socio-economic advancement initiatives but rather always leaves them financially damaged. Bank of Uganda flags the above as reckless lending.
Collateral pledged for a loan is the fallback position, to be sold off as a last resort, if the borrower totally fails to return the borrowed monies. It is what secures savers’ funds, assures a return on investment for bank shareholders, remuneration for bank staff and the bank’s ability to meet other financial obligations and continue in business. Without being able to utilize this last resort when necessary, banks cannot be sustained.
When pledged properties have to be taken over by banks, the process is distressing for both borrowers and banks. Upon sale, and rightly so, the borrower would wish the property to fetch as much proceeds as possible. The bank is only entitled to the outstanding balance owing from the borrower. The lower the price, the easier it would be for a bank to find a willing buyer but due to high property values banks are often stuck with properties. If a property holds a value of for example Shs100m, the bank does not just decide to sell it off at Shs20m, if this is the only amount that remains outstanding as owed by the client.
Banks have to exercise fairness to dispose the properties at reasonable prices, even under the circumstances of a forced sale that follows after a bank repossesses a property. The forced sale value is a sum arrived at, based on the assumptions that the disposal of the property happens in a manner reflecting the position of an unwilling seller under duress without an adequate period of marketing for the sale of such property.
Forced sale value is commonly stated in bank’s valuation of the property which happens before the borrower is given a loan, and can always be referred to in times of disagreement between the bank and the borrower about the selling price. It is important for the borrower to fully read the relevant pre-disbursement documents and pick out such details and others in their loan agreements that will apply to them during the tenure of the loan. They need to discuss and negotiate their loan terms around the details.
In the unfortunate instance that the loan recovery process sets in, the borrower will also normally be required to pay recovery costs. In Uganda, banks are barred from charging unreasonable costs of recovery and they have to provide the customer with a detailed breakdown of those costs and expenses.
Also when loans become difficult to pay off, changes in interest rates that have happened can arouse contention. Banks price their loans based on an index, with the final loan price coming out as the index plus what is added to it for credit risk, profit mark-up and other relevant elements of the lending transaction. The index rate is provided by the central bank based on their market assessments and as it changes along with other factors, the interest paid by borrowers may change. Ugandan banks are required to notify borrowers immediately of such changes. From a business perspective, a borrower can relocate their loan to another bank if they feel disfavoured.
Though the lending process runs on general financial principles, it is a normal buyer-seller process. Because of the pressure to get their loans approved, clients are hesitant to be seen as so keen about getting concessions from lending banks and do not negotiate favourable terms. This might however work to disadvantage them, therefore, clients should explore what favours them in the bank’s capacity to exercise flexibility in lending and negotiate for it.
Raymond is a Chartered Risk Analyst and risk management consultant