Bad loans surge, threatens the future of banks

Following the recently published financials, banks reported increasing non-performing assets, a lot of which is attributed due to declining commodity prices on the world market, especially tea. DFCU Bank alone registered Ugx71.3b in 2015 compared Ugx47.7 in 2014 non-performing assets.  At Stanbic Bank, the loan book grew 18.5% to Ugx1.9 trillion from Ugx1.6 trillion in 2014.

A write-off is a reduction of the recognized value of something. In accounting, this is a recognition of the reduced or zero value of an asset. In income tax statements, this is a reduction of taxable income, as a recognition of certain expenses required to produce the income.

In business accounting, the term write-off is used to refer to an investment (such as a purchase of sellable goods) for which a return on the investment is now impossible or unlikely. The item’s potential return is thus canceled and removed (“written off”) from the business’s balance sheet. Common write-offs in retail include spoiled and damaged goods. In commercial or industrial settings, a productive asset may be subject to write-off if it suffers failure or accident damage that is infeasible to repair, leaving the asset unusable for its intended purpose.

Similarly, banks write off bad debt that is declared non collectable (such as a loan on a defunct business, or a credit card due that is in default), removing it from their balance sheets. A reduction in the value of an asset or earnings by the amount of an expense or loss. Companies are able to write off certain expenses that are required to run the business, or have been incurred in the operation of the business and detract from retained revenues

Sample scenarios

Absa, listed as Barclays Africa [JSE:BGA], indicated in their results for the year to December 2013 that the bank had to write off R5.88bn(Ugx 1.25 trillion) in bad debt (net of recoveries of R926m(Ugx 196 bn)) in its financial year. In the previous year, the impairment losses amounted to R8bn (Ugx 16.96 tn).

First National Bank, part of the FirstRand Group [JSE:FSR], said in its latest annual report that non-performing loans increased to a total of R17bn (Ugx 35 tn).at the end of its financial year to June 2013 after another R4.8bn (Ugx 996 bn). were set aside for losses due to non-payment by debtors. A massive R5.3bn (Ugx 1 tn).was finally written off during the year.

Nedbank [JSE:NED] said in its results for the year to December 2013 that an increase in losses associated with personal loans forced it to increase provisions by R5.6bn (Ugx 1.16 tn).to a total R14.7bn (Ugx 32 tn)..

Written off vs provision for bad debts

In reality, there is very little distinction between writing off bad debt and making provisions for bad debt. When banks’ management decides that it is prudent to make a provision, they are fairly sure that the debt will not be collected and eventually it will have to be written off. There is simply no benefit in throwing more money on legal fees and such to try to squeeze blood from a stone.

Most banks follow a simple process: The bank will classify a loan as “non-performing” once a client is three or four months in arrears. The bank knows it is very difficult for any client to catch up missed payments and will take into account that a certain percentage of these non-performing loans will not be repaid.

After legal steps and exhausting other options – now a few months down the line, with more missed instalments – it is obvious that most of the debt amount will not be collected. It will be classified as bad debt and the bank will be responsible for writing it off. If some of the debt is repaid, for instance if assets are repossessed and sold, these recoveries are netted off against the balance of provisions for bad debt.

Why write off

Collapsed business.

Many businesses individuals get credit to boost their business. Make them bigger but sometimes it doesn’t pay off. A re-known Business man borrowed money from a bank to buy more produce supply for his export to Juba. However the recipients never paid. He had pledged his hotel building as collateral. Money was just not coming through as anticipated to the business and hence the bank after exhausting all available means had to write off the loan as a bad debt.

Inexistent collateral security

With increased number of lenders some of whom don’t use the credit bureau to ascertain the credit worthiness of the clients being given credit combined with the pressure to perform at work. Bank officials have not taken due diligence to scrutinize security or collateral being pledged in the Banks. It’s after failure of clients to remit monthly settlements that eyes now open and attention is focused on the security that was pledges only for find out it was forged.

There’s a story of fraudsters who forged ownership documents for a house that was not theirs to obtain a loan from a reputable bank. Upon failing to pay their installments, the bank advertised the property for sale. The real owner was shocked to see his house being put on sale. He immediately contacted the bank to find out what was going on. It turned out the fraudsters had once posed as people who wanted to buy his house. They asked for his documents which they forged and presented to the bank. It was a bad loss to the bank, and hence they had to write off.

This leaves the financial institutions at the mercy of clients who later fail to pay

Staged business.

Staging business is a major phenomenal in urban areas .clients are using other people’s business to access credit from financial intuitions .if thorough appraisals are not done. Alongside due diligence prior to loan disbursement. The bank is likely to see more provisions for bad debts hence loan write off as a result of staged businesses

Survival of banks in credit business after write-offs

In a write-off, the bank includes a bad debt as an uncollectible loss on its tax return. This write-off is also called a “charge-off.” The write-off reduces the bank’s earnings and thereby reduces its taxable income. This accounting procedure may reduce the bank’s overall tax liability, which is the goal of a write-off. The designation of the debt as uncollectible doesn’t mean the bank will never collect on it — just that it hasn’t been able to collect on it until that point.

Collections

When a bank writes off a bad debt, that write-off does not constitute a waiver of the bank’s right to collect on it. The bank can still pursue you for its payment. Many banks turn bad debt accounts over to a collection agency. Either the bank hires the agency to collect on its behalf, or the bank sells the debt to the agency outright. The agency then has the right to attempt to collect that debt from you.

Consequences

If you have funds in an account with the same bank you owe money to, the bank can seize those funds in your bank account as payment of the debt. This is called the right of offset. Depending on how much you owe in bad debt, the bank, or the collection agency, may decide to sue you in civil court. A successful lawsuit will result in the court issuing a judgment against you for the unpaid debt. A judgment then gives the bank or collection agency the legal right to collect by seizing your assets. This may involve a wage garnishment or a lien being placed on your property.

Credit Reporting

If you owe bad debt to a bank and the bank writes it off, the bank may report that charged-off debt to the credit bureaus. The charged-off account will appear on your credit report and it will state how much you owe and how late the payments are. If a collection agency is attempting to collect on the debt, the agency may place the collection account on your credit report. Charged-off accounts and collection accounts remain on a credit report for up to seven years.

March 20th, 2018 | by

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