Preface

Motivation to write this book came from my experience as a banker from 1991 to 2003, during which I rose to the positions of divisional director (corporate banking) and member (executive management). I observed, studied, appreciated, and plugged loopholes in lending practices and decisions. I also saw firsthand the agony associated with bank failure, much of which could have been averted with sound credit policy, institutionalized lending culture, and responsible management of the risk assets portfolio. The problem was really overwhelming. I thought of writing a book that would chronicle the events leading to particular bank failures and the lessons they held for stakeholders in banking. Though that made sense, on second thought, I was loath to write a book with a heavy heart. Yet I had an overwhelming urge-which I could no longer resist-to write the book. The dearth of textbooks that solely documented the intricacies of this topic boosted my zeal for the book. The fact that seminars, workshops, conferences, and other such in-house and ad hoc training arrangements that banks use as fallbacks imparted only fleeting knowledge added to the boost. So I mustered confidence and started writing to fill the observed gap. Ironically, I tinkered with the original concept of the book when I eventually made up my mind to write. This book, which addresses thorny issues in bank lending and credit risk control, is the eventual outcome of the tinkering. Two of my popular bestsellers made the precursors of this book. In 2004, I published the first of the two books entitled Analyzing and Managing Risks of Bank Lending. The success of this 17-chapter book was overwhelming. It was reprinted in 2005 and 2006 before its 30-chapter second edition was published in 2008 - with a reprint in 2009. The resounding market acceptance of the second edition was remarkable. Then I was convinced that the market needed more than a broadbrush book on the subject. So I decided to write a companion to it. The companion - Credit Risk: Taming a Hotbed of Reckless Banking - published concurrently with the third edition of the first book in 2013 was no less well received by the market. However, there was a compelling need - soon after the companion was published - to merge the two books. That need was for an entirely new book that would combine the contents of the aforesaid precursors into one strong, unparalleled, revised volume - covering emerging markets in Africa, Asia, Eastern Europe, and Latin America. The idea came to fruition with the publishing of Emerging Market Bank Lending and Credit Risk Control. I imagine that bankers, practitioners, analysts, academics, and students around the world who have read and used the two books will sorely miss them. I advise them not to mourn the books' passing. The new book that supplants them, Emerging Market Bank Lending and Credit Risk Control, is superior and offers obvious gains as reflected in this preface.

Overview of the Book

Bank lending and credit risk control can be likened to the American-type presidential system of government, one powered by strong democratic values. In a presidential democracy, power is shared among three tiers of government and protected by clearly defined separation principles. The three tiers of government-executive, legislative, and judicial-function independently but under a checks-and-balances arrangement. Similarly, the crux of bank lending is usually three-pronged. This is depicted as the three Pillars of credit risk management-credit analysis (Pillar 1); credit policy and control-also referred to as credit administration or credit compliance (Pillar 2); and loan workout, remediation, and recovery (Pillar 3). I summarize the purposes of the Pillars as follows: Credit analysis institutionalizes processes for assessing lending risk and structuring a credit facility. This implies that credit risk must be properly identified, appraised, and effectively mitigated. This methodological framework, and the analytical functions it embodies, paves the way for efficient structuring of a credit facility. Credit administration ensures that the lending portfolio is of high quality, profitable, and effectively managed. This Pillar subsumes issues involved in enforcing credit control and compliance. Regular portfolio review, loan loss provisions, and internal credit ratings are some of the critical assignments implied in credit administration functions. Loan recovery seeks, regularizes, and adopts measures to ensure that a bank always has efficient processes for loan workouts, remediation of nonperforming loans, and the recovery of classified or lost risk assets. Each of these functions in Pillar 3 helps to improve the quality of and returns on the credit portfolio. The approach to and methodology for dealing with issues implied in the Pillars have witnessed dramatic changes over time. Yet, the goal of credit risk control remains immutable. The goal in question is addressed and largely fulfilled in the content of and expatiation on Pillar 1. An effective process in the pursuit of risk identification, risk analysis, and risk mitigation-all of which Pillar 1 subsumes-holds the key to successful lending. Striving to perfect these lending criteria has been, and will continue to be, the superstructure on which credit risk management hinges. One reason is that it defines a methodology that has become commonplace. Another reason is that it builds on the hallowed lending principles commonly referred to as the five Cs. The third reason is that the so-called five Cs of lending also underlie credit risk management in practical terms. A fourth reason is that Pillars 2 and 3 are simply postmortems on Pillar 1. Besides, Pillar 1 informs actions lending officers take in pursuit of Pillars 2 and 3. Yet in order to build a quality lending portfolio, the three Pillars should function in independent capacities within the dictates of checks-and-balances rules. However, working relationships among the Pillars are scarcely well ordered in banks in emerging economies, thus leaving room for avoidable lapses. In drawing the analogy between a presidential democracy and credit risk control in banking, I make a case for the institutionalization of oversight of lending as a means of attaining quality portfolios in emerging economies.

Defining the Problem

It is bad enough that regulators try-but all to no avail-to tame the excessive risk appetites of banks. It is worse that reckless lending persists in banks and keeps the financial system on the edge of a precipice. Sadly, global financial crises in recent history originated in inefficient lending and failed risk management. More worrying yet is that this quirk has become a recurring phenomenon. Most disturbing is that the problem is unlikely to give way without a serious overhaul of the methodology for risk management. Ironically, the pursuit of this goal-a foolproof credit risk management methodology-has been an absolute nightmare for bank management and regulators. Today, many see credit risk as a hotbed of reckless banking. More than ever before, the attention of banking and finance experts around the world is now focused on credit risk. The Basel Committee has led this cause with Basel I (1988), Basel II (2004), and Basel III (2010). While Basel I dealt exclusively with credit risk-to underscore its importance-Basel II and Basel III advanced the cause even as they also focused on market, operational, and liquidity risks. Regrettably, crises in the global financial system have never been well ordered. The financial crises of the 1970s and 1980s were not anticipated, as was also the case for those of the 1990s. They caught regulators and bank management completely unawares. Some of the emerging markets and regions that experienced crises included Latin America (1980s), Mexico (1994-1995), and Asia (1997-1998). In each case, the crisis left bitter lessons of experience for government, economists, and financial experts, especially bank managements. The banking systems in the emerging markets of Africa, Europe, and the Middle East have suffered similar fates at one time or the other. In most cases, the crises became a contagion and had practical and compelling lessons. But for the large stock of nonperforming risk assets within these banking system portfolios, the tempo of the crises and magnitude of national economic losses incurred by the countries would have been manageable. Unfortunately, an unmanageable volume of nonperforming risk assets tends to cause liquidity pressure for banks and make them vulnerable to such systemic crises. The financial crisis of 2007-2009 was the most embarrassing and lingered on for too long. The main culprit whenever financial crisis rocked the industry, especially in the 2007-2009 case, was usually credit risk. On each occasion of crisis, regulators found ways to rationalize a flawed supervisory framework in the wake of a crisis, while bank management prevaricated reckless lending. The public tends to distrust regulators and bank managements when authorities make hollow excuses for avoidable crisis. Besides, failure to anticipate crises impinges on the soundness of the financial system. Often, as would be expected under the circumstances, a postmortem on each crisis triggered some regulatory response. Basel I addressed findings from the postmortem of the 1970s and 1980s crises. The postmortem of the 1990s crises informed enactment of Basel II. In the manner of its predecessors, Basel III originated in the 2007 to 2009 financial crisis. Now, hopes are high...