MAS flags some riskier practices in bank lending here

THE Monetary Authority of Singapore (MAS) on Monday warned banks to watch their credit underwriting standards, with particular reference to shifts in trade finance.

In an MAS review that pinpointed heightened competition in a low-interest-rate environment, the central bank noted two "emerging trends" - that of substituting trade-finance facilities with working capital facilities, and that of pricing loans below the hurdle rate, a benchmark that captures the amount of return a bank seeks as compensation for taking lending risks.

"The protracted low-interest-rate environment and increased level of liquidity over the past years have resulted in a very competitive market and compressed interest margins for banks," MAS said, but added that there was no notable weakening of underwriting standards. "In this environment, some banks may relax loan structures and covenants, and under-price risks in their corporate lending activities."

Based on its inspection of unidentified Singapore banks, MAS said it has observed increasing examples of banks granting general-purpose working capital to companies, instead of trade finance matched against these borrowers' specific trading requirements. It said: "This trend could reflect the pressure on banks to accommodate the demands of borrowers to ease documentary requirements because of market competition."

Banks need to rely on trade documentation to ensure that the funds are backing real trades, and are not used for money-laundering.

Working capital loans are broadly more risky than trade finance. With trade loans, banks can structure the lending according to short-term trading cycles and associated cash flows from the trades. Such lending is also typically backed by collateral.

In contrast, working capital loans are not secured against an asset, and are held up by the borrower's credit standing. With these loans, banks would not know how the funds are used, or have proper control over the cash flows. Lenders must then be more vigilant in analysing such the borrower's financial position, especially if the borrower's results are volatile.

MAS also warned that some banks were granting "bullet loans" without due diligence. These are loans for which payment of the principal is due only at the end of loan term. (Most other loans are amortised so that borrowers pay down the principal over time.) On top of this, some banks are granting bullet loans with relatively long tenures of at least three years.

MAS noted certain banks are taking on riskier loans than they would otherwise reject, in hope that the fee income would make up for the risk. But some are not actively tracking that fee incomes adequately compensate for the overall risk borne, or are not managing banking relationships that have a poor risk-adjusted return, MAS said.

This article was first published on March 1, 2016.
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