The loans which cannot easily be recovered from borrowers are called Problem loans. When the loans can’t be repaid according to the terms of an initial agreement or in an otherwise acceptable manner, it will be called problem loans.
The key to a successful lending program is the early identification of problem loans and the proper structuring of each credit. First “red flags” can alert the lender to a change in the borrower’s situation or a deterioration of the underlying credit. These red flags are typically early symptoms warranting further investigation. The earlier a potential problem is spotted, the more options are available to the lender. Some common “red flags” include:
(i) High growth – High growth usually results in strained cash flow. Term debt payments may be jeopardized by cash being used to support higher accounts receivable and inventory levels.
(ii) Revenue loss
(iii) Slowdown or Accounts Receivable and Inventory turnover
(iv) Major variations from budget
(v) Restatement of Financial Statements
(vi) Change in Accountants
(vii) External factors: changes in laws, weather, supply issues, etc.
Recovery of problem loans
Banks have a three-pronged job ahead of them when it comes to dealing with the prevalence of non-performing loans. They need to
(a) Use credit risk assessments to plan ahead, and avoid damaging credit risks later.
(b) Evaluate existing processes and their inefficiencies to improve both regulatory standing and shareholder expectations.
(c) Re-think and embrace modern loan repayment procedures and best practices, including collection scoring, segmentation, and specialized collection software.