— By Mr Jayant Tandon
The onslaught of COVID-19 has created a ripple effect across industries and geographies, resulting in a downturn in the economic landscape. The slowdown from the pandemic has disrupted the demand and supply chain globally. Furthermore, consumer behaviour is experiencing a paradigm shift, with people being more mindful of their expenses.
The banking sector is no exception to the changing market dynamics. With the financial pressure surmounting in the corporate world and household incomes fluctuating, there has been a significant rise in demand for all loan types. However, the current economic situation has made financial institutions more cautious. The banks are more wary about lending as individuals and corporates grapple with the effects of the pandemic.
What Can Banks Do to Maintain Asset Quality?
Banks are anticipating a deterioration in their asset quality. Credit risk defaults and lower recoveries are also a cause of serious concern for the banks. To weather this storm, banks must implement a foolproof and agile strategy for risk mitigation. Banks need a non-traditional framework to manage risk, the treatment for which will vary based on the flexibility, soundness, and adaptability of the customers’ business models.
Banks must identify and assess every client on the following three parameters before issuing loans to maintain asset quality and ensure loan repayment:
1. Business Parameters
Before issuing credit to a client or a business, ask the following questions:
• What is the type of business of the client (large, medium, or small enterprise)?
• How severely have the demand and supply for their products or services been disrupted, and what are the reasons for the same?
• What is their expected turnaround time to restore operations?
• What is their operational efficiency ratio and breakeven point? Is there a cause for concern here?
The answers to the aforementioned questions can help a bank evaluate the strengths and weaknesses of their prospective clients.
2. Management Parameters
From a managerial perspective, it is critical to review a prospective client on the following:
• Keenness to Embrace Technology – Technology adoption can be a crucial driver in today’s context. Collaborative tools and a digital-first approach can facilitate remote work and ensure business continuity. Additionally, a robust low code digital automation platform can help translate business needs into applications
• Business Adaptability – Enterprises need to think beyond the pandemic and future-proof their operations with the help of scalable and agile solutions. Continually adapting to the ever-evolving business environment by leveraging the right technology is the only way to achieve the desired busines outcomes
• Management Outlook – It has never been more critical to have a strategic and resilient business continuity plan. Clutching to legacy processes and functions will do more harm than good in the long run. The management should innovate for continuous process improvement and review frameworks to survive and thrive in a challenging environment
3. Financial Parameters
Enterprises are facing financial pressures and witnessing rise in costs and reduction in revenues, thereby impacting their overall performance. Banks need to consider the following financial parameters while assessing a prospective client:
• Cash reserve should be set to meet future operational expenses
• Stress testing should be done on a consecutive basis with different scenarios
• The ability to meet certain covenants should be viable
• The level of cash/loan infusion required vs length of recovery should be financially viable
• Projected current ratio, cash flows, and debt service coverage ratio should be favourable
Additionally, analyse the client’s liquidity, net worth, and critical financial ratios, compared over the previous three months, to understand their financial stability and debt repayment potential.
The Way Forward
Banks require a strong re-design and recalibration for their risk models and portfolio testing based on how a client performs against the business, management, and financial parameters.
With the gradual navigation towards economic re-establishment, the banks and financial institutions that prioritize their technological investments and modernize their business models are more likely to emerge out stronger and more resilient through these testing times.
(The Author is Head, Banking COE, Newgen Software)
