When I attend a banking forum, junior bank executives often ask me: "What did I learn out of so many credit inspections across the world? How could we avoid loan losses?"

I tell them loans usually go bad due to: (1) improper or weak need assessment; (2) wrong structuring of the facilities; (3) security or collateral shortfall; (4) weak internal cash generation in the business leading to recurring past dues; (5) lending on the basis of names of the borrowers or future potentials or even succession; (6) ignorance about competition or emerging competition; and (7) economic downturn or investment in the business segments other than the core ones having relevance to the future or to the economy.

Added to these are, of course, weak loan appraisal, failure to understand foreign exchange risk where cross-border exposures are taken, corruption or failure of the lending officers, weak or no approval condition, or weak compliance or monitoring. At times, even pressure from the top is also to blame.

We have seen how a textiles client went through recurring past dues due to a wrong repayment structure of the loan. A large borrower of a state-owned bank became a defaulter right after the disbursement of the term loan due to his project cost going through the roof for his failure to cover himself against the foreign exchange rate fluctuation.

A large distributor of a global consumer brand became a defaulter because all his money borrowed from the bank was invested in purchasing land, not in the distribution business.

The lending officers often become captive to large clients due to their perceived "muscle power or business power" or at times even "emotional blackmailing". In most cases, these large clients dictate the terms. If we lend more than the client needs, he or she is bound to divert the excess money out of the business.

No matter who the client is or what his or her business is, a loan officer must do an in-depth need assessment, that is how much the client needs to run their business and in what form. One must look at the business model. How much is the projected turnover? What is the tenure of an end-to-end transaction?

Then the loan officer will have to arrive at a figure for facility structuring. Even if one arrives at a figure, one must know, how much of that would be bank financed and how much by the owners. The security or collateral provided must be valued by a proper agency or put up on a mark-to-market valuation process regularly. In the same way, outstanding can also be reviewed against security or collateral held.

Faulty titles of land and the grabbing of school or prayer places also created problems in the erection of plants, thereby forcing companies to relocate and increasing the project costs. The business being not relevant to the core strength of the entrepreneurs also didn't help many repayments.

Many banks in Bangladesh don't have a risk policy of their own or any structured approach to loan appraisal, disbursement, and repayment. Many financial institutions have a large pool of people in their credit departments, yet totally dependent on the board for almost each of loan approval.

Appropriate valuation culture of the security or collateral is absent in many banks. Facilities are granted without recognising the business or trade cycle. The resultant effect is loan losses, forced provision, capital erosion, profitability drops, and ultimately fall in share prices.

The author is an economic analyst.