Educating The Borrower

by Jeffrey K. Bagby, Regional Examiner, Oklahoma State Banking Department

Making loans is easy. Getting the borrower to pay it back is the hard part. Or so the old saying goes. It is a true proverb, but from my vantage point, lenders aren't completely at the mercy of the borrower when collecting a loan.

It can be as simple as educating the borrower. I know Pavlov experimented with a dog, but two legged animals are not all that different. Once a financially needful individual understands what they need to do to avoid the punishment or gain the benefit, they will comply with the established guidelines presented. The level of need, the size of the benefit, and the severity of punishment can manipulate this equation, but the application is generally consistent.

I know of a bank that inflicts a late fee of 10% of the PAYMENT amount for commercial loans ten days late. The majority of their loan portfolio is monthly amortizing notes. You immediately think they have a loan to deposits ratio of 30% or less, right? Not so, their loan portfolio is growing vigorously. The past due ratio is out of sight? Nope. It's one of the lowest in the state.

So what's their secret? They lend aggressively and they collect efficiently. The borrower knows what to expect and since they pay every 30 days, the lender discovers quickly if a problem is forming. You're thinking to yourself, my bank would never get away with something like that. Why?

Response: The bank has always loaned money a particular way and our borrowers would have a conniption if we changed.

Translation: We've educated our borrowers a certain way and now we're stuck.

Lenders can educate their clientele negatively as well. I've been in banks that had customers lined up in the lobby waiting to visit with a loan officer. I walked around looking for the guy in the big red suit and white beard. Small loans or big loans. Everyone walked out with something. They weren't handing out free toasters, but essentially the bank was giving away money. The underlying lending philosophy was to put loans on the books. Don't worry about documentation or collecting, just book the loan.

It's ironic how fast all the townsfolk knew management's lending approach. Skeptics that believe "word of mouth" marketing is dead should think again. The bank was educating their local market without uttering a word. "Come on in for some money, and we won't bother to collect it".

Their loan portfolio expanded dramatically, but it finally began falling in on itself once the loan officers couldn't defer and renew the loans anymore. When new management began collecting the loans, some borrowers were shocked and offended the bank now required repayment. The "new" word was getting out. The reeducation process had begun.

Educating the public isn't solely the loan officers' responsibility either. Most loan officers are going to do what they must to keep their job. The Board of Directors might be better named the Board of Education. The philosophy that eventually reaches the public in the form of cash money starts with the Board.

Enter the Loan Policy. Officially, the Board will prepare nice thick loan policies to convey their intent to the lending staff. By the way, remember to change "Your Bank's Name Here" to your bank's NAME in the policy. But examiners also look at how the bank staff lends in actual practice. This is the true lending policy for the bank. For example, no Board is going to write a loan policy that says, "Lend all the money you want to individuals with multi-million dollar net worth, and don't set the principal up on a repayment program, because we don't want to lose their business". Occasionally it happens.

Education is truly an ongoing process. Even regulators need to get in the act. If we educate bankers to spend all their time and effort appeasing examiners and complying with the latest designer regulations, we are not doing our job and they aren't able to do theirs. Our mission is to support and protect the banking industry; however, it's kind of like a loan policy. It sounds good on paper, but is it happening in real life. I believe we are getting there. And every day is a learning experience.

Jeff Bagby is a Regional Examiner with the Oklahoma State Banking Department. He has spent 17 years in bank regulation which includes a wide spectrum of knowledge and experience. In the early part of his career, the banking industry in the central region of the United States endured its most devastating era since the FDIC was established bringing with it numerous bank closures. In addition to writing examination reports and working with bank management, Jeff teaches Loan Officer Seminars which is aimed at revealing to bank lenders how and what an examiner looks for when reviewing loans.

Jeff received a B.B.A. from the University of Oklahoma in 1985 and is a graduate of the Conn Graduate School of Community Banking.

First published on BankersOnline.com 10/14/02