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September 2010
Clients who pay promptly are not a problem. But those who can’t pay or won’t pay, cause trouble for themselves and for your business. For this reason, an efficient lending institution needs a simple but effective system to identify problem loans quickly and to deal with them early on.
Identifying Problem Loans Early
1. Why is it Important to Identify Problem Loans Early?
1.1. Profitability
Problem loans must be identified early because they can affect your profitability. Repayments with interest are the primary income source of lending institutions. If repayments are not made regularly, then your ability to make a profit is severely affected.
1.2. Client Support
If you identify a problem loan early you are able to take steps to support a client to pay. For instance, you may call them and offer them the option of paying part of the repayment immediately and part later. Or you may arrange to take double repayment next month. If you only identify problem loans when they have been in arrears for a few months, it will be much more difficult to make a supportive arrangement with the client. They will have much more to pay back and will be even less likely to make arrangements to pay.
1.3. Lending Institution Image
If you are slow to identify and follow up on late repayments you send a specific message to borrowers. You send the message that you are ‘soft’, that you will not take immediate action, and that late payment or non-payment is a viable option for them. To work towards zero delinquency you must avoid this image at all costs.
2. Cost / Benefit Analysis of Regular Vs Irregular Payments
This table gives you a useful comparison of the benefit to your lending institution and your borrowers of regular payments – and the cost associated with irregular payments.
| Cost / Benefit Analysis of Regular Repayment Vs. Default |
| Benefits of Regular Payment |
Cost of Irregular Payment |
- The client can predict his / her monthly costs in accordance with the loan repayment schedule
- A second loan is processed more easily
- Better interest rates on second loan
- A good credit history helps the client access better financial products.
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- More interest charged
- More administration charges
- Processing of a second loan is unlikely
- A poor credit history will keep other financial facilities beyond the client’s reach
- Possible judgement / liquidation of client’s assets
- Listing on credit bureau.
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| Benefits of regular payment |
Cost of irregular payment |
| To lender: |
To lender: |
- The lender can predict its income and plan its operations better.
- The lender can operate on a more sustainable basis and support clients on a more professional level as a result.
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- Overheads and administration costs remain high
- Irregular income hinders the organisation’s effectiveness and efficiency
- Lender business would not be sustainable
- The ability to support other clients is reduced
- Loan loss provision reduces surplus
- Written off loans require decapitalisation of the institution
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3. Ways to Identify Problem Loans
Since identifying problem loans early is so important, what are some ways that loan management staff can use to identify problem loans?
Some ways are:
Checking age analysis (the amount owed by debtors, classified by age of debt) daily
Checking month end status
Use credit bureau data and tools to monitor account - Get up to date credit bureau reports in batch format on your accounts or use tools like Compuscan’s CompuWatch to monitor your borrowers’ movements within the credit industry.
Dealing with Problem Loans
There is no point in identifying problem loans if you have no intention of doing something about them. Problem loans cause delinquency and loss to your lending institution. Having identified which loans are problematic, you need to do the following:
1. Create Policies and Procedures for Dealing with Problem Loans
A policy is set of decisions about how your company operates. Policies are written guidelines that help operations. Policy informs the procedures you develop. Procedures are written instructions that tell staff how to implement policies. Just as each lending institution must have policies and procedures for maintaining information, each lender must have its own policy for:
Identifying problem loans
Dealing with problem loans
You need to spend time with the management team deciding on the policy that will guide you. Then you need to translate those policies into a set of instructions to staff. These instructions are the procedures that will tell staff what to do to identify problem loans early. Sound policies and procedures protect you from loss. It is advisable that you treat every repayment that is one day past due as a cause for concern and the beginning of loss to your company.
2. Distinguish Between Can’t Pay Versus Won’t Pay
It is important to distinguish between borrowers who won’t pay, and those who can’t pay. If borrowers can’t pay you are wasting time and resources sending letters. If borrowers won’t pay, you are wasting time offering soft options, when in fact a more assertive approach would be more effective.
For borrowers who can’t pay consider the following:
- Find out whether they have relatives or children who can pay
- Be assertive in finding a source of repayment
- Be firm and unshakeable – borrowers must feel it is not worth missing a repayment
For borrowers who won’t pay consider the following:
- Put in place procedures that protect you from these types of borrowers from the beginning of the loan process
- Get a list of assets up front so you have some collateral to fall back on if the borrower won’t pay
- Avoid lending to ‘won’t-payers’ if at all possible
- Do not get trapped in a cycle of sending letters with no intention of following up
- Take legal action earlier rather than later
- Make quick use of garnishee orders and emolument attachment orders
| Emolument Attachment Order |
An emolument attachment order is a court order obtained by the lender / any creditor, which instructs an employer to make deductions from the borrower’s salary on a monthly basis until the debt has been settled. |
| Garnishee Order |
A garnishee order allows the lender to attach money from the debtor’s bank accou |
3. Develop a Relationship with the Client Up-Front
It is worth taking the time at the beginning of the loan process to establish a good relationship with the borrower. You need to make it part of your procedure to sit down with the borrower and explain what she / he must do to be accepted by your institution.
This sets the tone for future relations. You need to establish from the beginning that no late payments will be tolerated and that your lending institution will take swift and firm action to deal with late-payers. If you leave an explanation like this to the point where the borrower has already defaulted, then you will most likely ruin the relationship, lose the client, and lose any future payments you were expecting from him / her.
4. Prompt and effective follow-up is key
The trick in identifying and dealing with problem loans is when you choose to take action, and what action you choose to take. As soon as a repayment is one day past due some action needs to be taken. That action needs to be effective in securing the repayment. You need to make sure you do not devise procedures that waste your resources without securing payment. For example, sending a letter to a rural client, who cannot read, is not an effective procedure. It would be more effective to identify someone who lives nearby to visit the non-payer and secure payment.
Compuscan Academy has developed a learning programmes on this subject, called Credit Control & Collections and Effective Debt Collections Under the NCA! If you want to learn more about this topic, please contact Compuscan Academy at Tel: 021 888 6000 or e-mail us at
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