3. THE BANKING SECTOR AND LENDING PRACTICES

Like corporate management, the position and conduct of the banking sector and the lending practices of banks are not areas in which a traditional corporate insolvency law system might or should have any direct influence or involvement. It may, for example, be argued that if the banking sector engages in non-commercial or illegal practices, if banks provide loans and credit to corporations without engaging in proper credit analysis or if banks make loans for which collateral is the only consideration, those are problems for the banking sector and not for an insolvency law system.
However, that overlooks the fact that in practically all cases of corporate financial difficulty or insolvency a bank or banks will be the major, influential creditors. There is a well founded expectation that in most cases the banks will play a lead role in determining the fate of the corporation. Other creditors will look to the banks for information, guidance and possible support (they will also, no doubt, have a healthy regard for the fact that the banks may endeavour to promote their own interest in the outcome). If the banks are in disarray as a result, for example, of loan and credit control mismanagement, one may expect that this will filter down and attempts to resolve some commercial settlement of the problems of the insolvent corporation will likely flounder.
But there is another reason why attention should be further directed at the banking sector in the context of this project. This is because of the exceptional situation that confronted the banking sector as a result of the economic crisis in the region.
In summary, that situation was attributable to three factors.
First, the problem of an over-extended banking and financial sector with non-performing loan portfolios, and extensive unhedged foreign currency debt that was made worse by deep currency devaluation, resulted in systemic problems in the banking and financial sectors in the region.
Secondly, there was evidence of significant political and government involvement and interference in lending policies and practices. This had an effect on the availability of funds for lending and also distorted debt recovery and enforcement policies. It also considerably affected the application of insolvency laws and practices.
Thirdly, the banking crisis in the region exposed some extraordinary failings in bank lending practices and credit monitoring, which can also affect the application of insolvency laws and practices.
It was necessary in four of the five economies to address those issues and to conduct a concerted program of repair to their respective banking sectors. The ADB report noted that such systemic problems cannot be addressed by traditional insolvency laws and the application of traditional insolvency methods and processes.
But the need for this repair had a 'knock on' effect into the corporate sectors of those economies because a significant part of the problem in the banking sector was due to non-performing loans for which the corporate sector was liable. This repair and the flow on effect into the corporate sector are continuing processes in those economies.

3.1 Relevance to insolvency processes
The two main areas of interest are:
-First, the economic crisis has resulted in the emergence of many useful and important precedents for dealing with systemic insolvency caused by an economic crisis. This required the adoption of measures to repair the banking sector. That exposed non-performing loans for which corporate debtors were liable and led, in some of the RETA economies, to the employment of complimentary insolvency related measures to deal with those corporate debtors in the form of structured informal work out processes. Those are reviewed in a later part of this report.
-Secondly, now that many of the lending and loan monitoring practices of the banking sector have been laid bare, the weaknesses may be better analysed. This is important for insolvency law purposes. The ADB report noted, for example, that dependence on collateral based lending often means that a lender does not take proper or any account of the ability of the borrower to meet interest payments or to repay the loan generally; does not monitor the financial position of the borrower; and, if insolvency of the borrower occurs, has little knowledge of the business and financial position of the borrower. This can result in the bank being either unwilling or unable to take an active and positive role in a possible corporate rescue or attempt at rehabilitation. Accordingly, this part of the report seeks to identify the main problems relating to bank lending practices and to suggest proposals for their solution.
A review of developments in relation to lending practices in the five economies follows:
3.2 Philippines
The Philippines was less affected by the crisis than its neighbours. Nonetheless, the opportunity has been taken by the Bangko Sentral to place greater protective controls in place within the commercial banking sector. Enforcement of banking regulations concerning loan documentation has been tightened. If an audit by the central bank reveals deficient or non-performing loan accounts, the bank is required to provide reserves. Measures like this have encouraged banks to require far better information and financial statements from actual and prospective borrowers.
Problems still exist however. The chief of these are in the areas of proper loan documentation, loan administration/monitoring policies (many banks are fundamentally weak in monitoring the business performance of corporate debtors) and in remedial management (banks do not have sufficient officers with experience and skill in handling formal or informal work-out processes).
In the Philippines it is considered that education and training of bank officers would be valuable, particularly in areas such as risk acceptance criteria, understanding and assessing the business of borrowers, proper loan documentation, loan administration and monitoring, and formal and informal insolvency processes.
3.3 Malaysia
In Malaysia the problems centre on four areas:
-Excessive enthusiasm for property based lending;
-Failure to make informed credit evaluations and to conduct adequate credit screenings;
-Failure to monitor collateral adequacy; and
-Over-emphasis on relationship lending. This poses problems because of the close ties over a long period of time between a lender and a borrower. The result can be that the lender pays less attention to and fails to appreciate the current debt servicing capability of the borrower.

The Malaysian consultant considers that officers and employees of banks would benefit from education programs that should include training in:
-Evaluation of loan applications and, in particular, evaluation of on going debt servicing capability;
-Critical analysis of adequacy of collateral;
-Scrutiny of corporate governance procedures of the corporate borrower;
-Formal insolvency practices and informal work-out techniques and practices.
3.4 Korea
The Korean report observes that domestic banks and other lending institutions have been heavily dependant on secured lending and are weak in analysing the borrowing strength of borrowers based on financial data. However, the Korean government has recently encouraged domestic banks to base lending practices on proper credit analysis without dependence on secured financing.
3.5 Thailand
In Thailand it seems apparent that both lending and reporting rules were deficient, as was compliance with them. For example, many cases have come to light in which banks had reported secured loans as 'performing' even though no interest had been paid for over one year.
Banks also failed to properly examine financial risks and failed to properly evaluate collateral.
The chief of the Financial Sector Restructuring Authority of Thailand has said that much of the banking and financial institution financial crisis in that country may be attributed to 'profligate lending', 'fraud' and 'dishonesty' (the number of bad or restructured financial sector debts being handled in June 1999 was 76,000). That officer also observed that the work of clearing up the bad debt portfolio was greatly hampered by the failure of the government to put 'a legal framework in place for creditors to force debtors to make good'.
3.6 Indonesia
Detailed credit policies that banks are obliged to follow have been in force since 1995. The credit policies regulate fundamental matters, including prudence in credit affairs, organisation and management of credit, credit approval policies, documentation and administration of credit and the settlement of credit problems. Despite these regulations, in practice only a few banks have complied. The amount of non-performing loans in commercial banks is well over 50%. Banks have violated legal lending limits and credit requirements.
There is also evidence that private banks have been used by their owners to obtain funds to finance their other businesses. In many cases this has occurred in breach of legal lending limits to affiliate parties.
State banks have channelled loans to particular corporate groups, often as a result of the urgings of government officials. This type of abuse invariably results in little or no security for a loan and no real assessment of the ability of the borrower to repay.
The operation of internal bank credit and other control committees is also poor. There are numerous examples of credit committee approvals for loans that are in direct contravention of prohibitions.
Credit analysis is fundamentally unsound. For example, the practice of 'marking up' the value of assets (particularly the value of property projects) to obtain loans secured against the 'value' of those assets is said to be rampant in the banking industry. In addition, banks lack specialisation in understanding the industries in which corporations engage.
An extensive system of internal bank auditing and monitoring of credits is required by regulations issued in 1995. However, many banks have failed to conduct such audits and have even issued false financial reports. Non-performing loans are not disclosed and are sometimes covered up by the grant of other loans to repay previous loans.
The Indonesian consultant considers that the central bank must perform a greater regulatory and disciplinary role and educate Indonesian bankers to become more professional. The fact that there have been no prosecutions for the many breaches of banking regulations indicates the lack of any law enforcement in the banking sector. It may be, however, that the new central bank law, enacted in May 1999, will help to stem and prevent abuses. That law provides that the central bank is an independent institution, free from government intervention, and that one of its key functions is to regulate and supervise banks.
The Indonesian consultant considers that education and training in informal work out practices is essential. There are many corporate debtors in Indonesia that have cash flow and other financial difficulties, but few banks have officers with any experience of using informal workout techniques and practices.
3.7 Conclusions and proposals
Although, as mentioned in the introduction to this section, this is not an area that is appropriate for any regulation by an insolvency law, it is necessary (as with the issue of corporate management) to draw attention to particular problems that weaknesses in this area cause for insolvency law and insolvency processes. The main problems are these:
-The provision of 'easy' credit by a bank to a borrower because either the borrower is an affiliate or the lending is made as a result of government or political pressure will almost certainly breach sound credit policies and will result in the borrower having considerable leverage regarding recovery. If the corporate debtor becomes insolvent, the actions (or inaction) of the creditor bank will be dictated by other than appropriate objectively assessed commercial motives. If the bank is a major creditor, the prospect of structuring a commercially based rescue or rehabilitation becomes quite remote.
-An over concentration by banks and other financial institutions on secured lending, particularly lending on the security of land and shares of the borrower or related corporations, means that cash flow and profitability, which gives a reasonable guide to the ability to repay, is often ignored or treated as a secondary consideration in lending decisions. When analysis and decisions must be made concerning the prospect of corporate rescue, these banks can bring very little help or assistance to the negotiating table.
-Poor loan and monitoring practices are inevitably carried through into both formal and informal insolvency processes. The more that these can be improved the earlier that financial difficulty of a corporate borrower may be detected and remedial action taken (often for the benefit of both the lender and borrower).
Comprehensive education and training courses for bank and other financial institution officers and employees are necessary. These might cover loan practices, loan management and monitoring, loan enforcement and recovery practices and formal and informal insolvency processes.