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There is a consensus among banking experts that the greatest source of bank profitability is credit extension. This belief , though factual is based on the assumption that the customers to whom the credit is extended will repay both the principal and the interest on the loan. Experience of many bankers over the years show that this assumption has failed to holding many instances.

The borrower may be able to repay the loan but unwilling to do so in some cases. Alternatively , he may be willing but unable to pay. Either of these situation gives rise to what is called credit risk.

Credit risk is thus the risk that the principal or the interest, or both or part thereof of the credit extended to a customer will not be repaid by him in accordance with the loan agreement.

When this happens the bank will end up classifying the credit as a bad debt , and in due cause will be written off. The long run effect of this on the bank can be very detrimental.

This is exactly what happened to many banks in Cameroon banks were recently classified as distressed by the central Bank ( BEAC).

These risks arise from a non payment of capital an interest; in this case the borrower fails to pay the capital or the interest or both. Some of the non-payment may be deliberate or as a result of misappropriation of the loan. It can also be because of financial weakness of the borrower or adverse business conditions. Instances abound of borrowers who have diverted bank loans and use them to organize death celebrations of their grandparents or marry more wives. Some even assume the loan to be their own share of the ‘national cake’ and therefore , refuse to pay.

Another risk maybe a case where the borrower repays the loan , but not according to the agreed repayment dates. He may deliberately delay the payments so that he can continue to enjoy the use of the fund and repay it at any future date when the value of such money would have been reduced. This , unknown to such a borrower , causes him to lose his credit worthiness in the sight of the bank. The bank can also deny him further credit. The impact of delayed payment on the bank’s liquidity can be very adverse where the amount involved is substantial.

Loan rescheduling is similar to delayed payment except that in this case it is made formal. That is, the customer approaches the bank to allow him repay the loan on a later date. In many cases , the customer lives up to his expectation by repaying on the rescheduled date proposed. However, it is possible that he will still come for another rescehedulement and the loan may eventually remain unpaid and lost.

Restructuring entails the overall review of the nature of the loan. The borrower can request that the debt owed by the bank be converted to equity investment in the firm. If this is acceptable to the bank , the debt will no longer be paid. But the bank will now enjoy the returns from such security investments or sell the security if it is marketable to recover its funds.

Tags: Assumption, Bad Debt, Bank Loans, Bank Profitability, Banks, Belief, Borrowers, Business Conditions, Celebrations, Consensus, Credit Risk, Financial Weakness, Grandparents, Instances, Interest On The Loan, Loan Agreement, Loan Experience, Misappropriation, National Cake, Risk Credit