BANKING TIPS: The cause of NPLs in banking industry

The upward trend in non-performing loans (NPLs) in Tanzania is a cause for concern. According to the International Monetary Fund (IMF), a loan is non-performing if it is at least 90 days (3 months) overdue.

By the end of 2017, the NPL ratio was above 10 percent while the Bank of Tanzania (BOT) regulatory requirement for NPL ratio is five percent.

The level of NPLs always raised concerns among policymakers and the BOT took various measures to reduce the NPLS and ensure the stability of the banks.

In my article two weeks ago, I argued that stability of the banking sector is important to our economic welfare since it is an important sector for the stabilization of the entire financial systems and also plays a critical role in the whole economy of our country.

Hence the performance of the financial sector depends on the performance of the banks.

It is well known that the NPLs shrink the profitability of banks since the banks do not earn interest income from those loans which can cause low-capital base problem to the banks. In addition, the NPLs decrease the ability of the banks to extend additional loans to private sector hence affecting the growth of our economy because NPLs affect the ability of the banks to play their role in the development of the economy.

It has been argued that NPLs are the one of the major causes of the economic stagnation so it is not surprising that currently our economy is struggling as the banks struggle to make profits due to high NPLs on their balance sheets.

To improve our economic status, we need to lower our NPLs levels in our banking industry and to do that we need to understand the causes.

So what are the reasons for high ratio of NPLs in our banking industry? In this article, I will share what I think are the various possible causes of NPLs in our banking industry.

• Non-supervision and monitoring of the loans – One of the main causes of NPLs in the banking industry is the lack of supervision and monitoring of loans which is called post disbursement monitoring.

Banks should have a dedicated department that will monitor their loans portfolio instead of leaving the task to relationship managers who are occupied with chasing sales most of their times, making it more challenging for them to follow and supervise the credits provided.

The main objective of supervising a loan is to verify whether the basis on which the lending decision was taken continues to hold, and to ascertain that the loan funds are being properly used for the purpose they have been sanctioned for.

Also, the other objectives of supervising the loan are: to evaluate the performance of the borrower to see if he/she is in line with the original plan, and detecting early signs of distress from the borrower in order to take corrective actions to avoid the loan to turn into a NPL.

Banks often are not losing money solely because the initial decision to lend was wrong rather they are losing money because they do not pay attention to their borrowers and monitor their activities, hence failing to recognize warning signs early enough to put measures in place to prevent the loan loss.

A majority of the banks in the industry do not monitor their loans performance effectively hence missing the opportunity to prevent the loans from turning into NPLs. The behavior of majority of the borrowers in our market has been well documented; many borrowers tend to have more than one loan from different banks which make it hard for them to make loan repayment timely, and many borrowers after securing loans, use the funds for other social activities that are not part of their loan agreements.

Hence, it is imperative for the banks to change their operational model and create a dedicated unit within the credit department to monitor the borrower and performance of the loan.

Next week, I will share other possible causes of NPLs in our banking industry.

Kelvin Mkwawa, MBA is a seasoned banker.