RESOLVING THE PROBLEM OF NONPERFORMING CREDITS (LOANS)
In RF banking and finance, nonperforming loans are the result of sudden changes in the economic conditions that may be out of control of the customer and the bank. In an RF bank, the challenge becomes not how to take the customer to court in order to recover as much as the bank can of the balance of its credit (loan), but rather to work with the customer in order to help him or her in meeting his or her commitments without destroying the future of that honorable customer. The reason the customer is described here as honorable is the fact that the relationship between the customer and the RF bank was developed after a thorough evaluation of that customer's ethical and moral values, character, and professional capabilities. This approach can be challenging because the accounting standards and the regulators have set rules and regulations to go by. For example, if a customer stops making the monthly payments for six months, this credit must be charged off. The challenge faced by an RF banker is immense because the banker has to comply with the laws and regulations and, at the same time does not want to destroy the future of the customer who has gotten into problems because of factors that are in most cases in an RF platform outside his control and not of his own doing.
The strategy used in our RF banking practice consists of the following steps:
1. Reserve enough funds to meet unexpected nonperforming loans. The allowance for loan and lease losses (ALLL) is not only evaluated as a percentage of the size of the loan portfolio, usually taken as 1.5 to 2 percent of the loan portfolio, but by using historical loss experience of the RF bank plus a probabilistic approach to the changing factors that may impact the different types of political, economic, and environmental factors and the loan sectors in the loan portfolio. The probabilistic approach lists all environmental parameters that may impact the loan portfolio like the direction of the economy, energy price projections, expected levels of unemployment, occupancy expectations of commercial buildings, and so on. Executives, credit managers, private bankers, and credit analysts are supplied with a critical analysis and review of the economic factors and how they may unfold. The economic salient features report is based on reviewing economic research by specialized research institutions, respected publications like the Financial Times, the Economist, the Wall Street Journal, and other, similar publications. Each member of the group is asked to fill out a matrix that includes his or her expectation of the direction of change of each economic parameter. These matrixes are integrated and a weighted average is obtained, with weights allocated based on the experience of each group member. These probabilistic values are applied to calculate the projected loss factor and subsequently a conservative estimate of ALLL is calculated. In an RF bank, ALLL can be as high as 3.5 percent of the loan portfolio. This has been a real important factor in sailing our RF bank through the financial meltdown of 2008 — the most difficult economic downturn since the depression of 1929.
2. Maintain a civil and family-based relationship with the customer, and never treat that customer as a bad person because he or she cannot make the monthly payments. The issue of character in an RF setting is moot because it was settled during the thorough evaluation process that preceded the granting of the credit. The problem here is to continue to discover ways and means to help the customer to come back to his normal life as an honorable and respected citizen while insisting on recovering the bank's credit. When good and sincere will is expressed and implemented, and the customer is treated as an honorable family member, that customer will cooperate and return that goodwill with sincere cooperation to recover the credit fully.
3. Offer help to resolve customer's chronic needs especially in cases when the customer is laid off or the customer loses a major contract that may be the reason for nonperformance. In an RF bank setting, a special fund called the M-fund (M stands for miskeen, which means “the needy”), which is an assistance organization, may be able to offer interest-free loans to the needy. This fund is capitalized from donations by members of the community, unavoidable interest income that is earned by the RF institution, and late payment fees and penalties charged to chronic abusers of RF facilities.
4. Exercise extreme patience, sympathy, and understanding. Resolving a nonperforming credit can take two to three years because that is the time needed for the economic cycle to start an upturn.
5. Do not resort to a lawyer unless all efforts fail and the customer tries to get away from meeting his or her commitment. Attorneys are expensive and lawsuits are difficult and time consuming, drain the valuable time of the bank's staff, and usually the return on that investment is negligible except in cases that involve intentional fraud or bad faith.