Loan Classification in UAE
Any bank’s primary objective is to take deposits from customers and lend the money to individuals & companies. Once a bank has lent or loaned money to anybody, it is the person or companies responsibility to repay the money according to the repayment schedule. For a personal loan, the repayment could be monthly, whereas for a company it may be quarterly or bi-annually.
Not all clients repay the loan on time! Some of them default meaning they are not able to repay the amount borrowed due to various reasons. Banks have to regularly report about their customers’ loan repayment report to Central Bank and make provisions for the bad debts that arise. However, prior to that, they need to classified into various types depending on the age of the bad debt.
There are 5 classification as per UAE Central Bank:
- OLEM-Other Loans Exceptionally Mentioned (Criticisable);
- SUB STANDARD;
NORMAL (Performing or Current)
If a loan is classified as Normal, that means everything with the loan account is OK. These accounts have favourable credit rating within the banks and the banks enough financial information to assure repayments within the time frame of repayment. Most of the time the loan accounts that have never defaulted are classified as Normal. Any loan account that is current with repayment and the repayment has never been delayed beyond the date of repayment are classified as Normal. Usually the days past due is ZERO in this case, meaning loans that have never repaid late.
Loans and Advances are deemed to be Performing(Normal) if the payments of both principal and interest are up-to-date in accordance with the agreed terms. An overdraft would be regarded as current if there were regular activity on the account with no sign of a hard core of debt developing.
Loans and Advances in this category are currently protected by adequate security, both as to principal and interest, but they are potentially weak and vulnerable to credit risk, although not to the point of justifying the classification “ Substandard”. The credit risk may be relatively minor yet constitute an unwarranted risk in the light of circumstances surrounding a specific case. Usually loans with some past dues between 1 to 30 days are called as OLEM.
The weaknesses, may, if not checked or corrected, weaken the asset or inadequately protect the bank’s credit position at some future date.
This category would include loans and advances that are unusual due to their nature, the customer or project; loans in respect of which financial information is lacking; the Loan Officer (Relationship Manager) may be unable to supervise the loan properly because of lack of expertise; an inadequate loan agreement; the condition of and control over collateral; or any other deviations from prudent lending practices. Banks are required keep such loans and advances in the Watch List so as to properly and closely monitor them.
Non- performing loans and advances for which the principal and/or the interest remain outstanding for ninety (90) days but less than one hundred and eighty (180) days are classified as Substandard.
Overdrafts and other credits without pre-established repayment program are considered substandard when the advances exceed the customer’s borrowing line for ninety (90) consecutive days but less than one hundred and eighty (180) days; or the borrowing line has expired for ninety (90) days but less than one hundred and eighty (180) days; or interest is due and unpaid for ninety (90) days but less than one hundred and eighty (180) days; or the account has been inactive for ninety (90) days but less than one hundred and eighty (180) days and deposits are insufficient to cover the interest capitalised during the period. The principal balance outstanding (and not the unpaid amounts) is used in determining the aggregate amount of past – due obligations.
Substandard loans and advances show clear manifestations of credit weaknesses that jeopardize the liquidation of the debt. Substandard loans and advances include loans to borrowers whose cash flows are not sufficient to meet currently maturing debts, loans to borrowers, which are significantly under capitalised, and loans to borrowers lacking sufficient working capital to meet their operating needs. Substandard loans and advances are not protected by the current sound worth and paying ability of the customer. In this respect, the bank will need to rely on the secondary sources of repayment such as collateral, or fresh capital to service the debt.
Non- performing loans and advances for which the principal and /or the interest remain outstanding for one hundred and eighty (180) days but less than three hundred and sixty (360) days shall be classified doubtful.
Doubtful loans and advances display all the weakness inherent in loans and advances classified as sub-standard but with the added characteristics that they are not well secured and the weaknesses make collection or liquidation in full, on the basis of currently available information, highly questionable and improbable.
The possibility of loss is extremely high, but because of certain mitigating circumstances, which may work to the advantage and strengthening of the facility, its classification as an estimated loss is postponed until its more defined status is ascertained.
Non- performing loans and advances for which the principal and / or the interest remain outstanding for three hundred and sixty (360) days or more shall be classified as loss. Usually loans and advances which the bank is unable secure and the repayment is beyond 360 days is classified as LOSS.
Loans and advances shall be classified as loss where they are considered uncollectible and of such little value that their continuation as recoverable facilities is not defensible. This classification does not imply that the facility has absolutely no recoverable value, but rather it is not practical or desirable to defer making full provisions for the facility even though partial recovery in future may not be entirely ruled out. Loans and advances classified as loss include those to bankrupt companies and insolvent firms with negative working capital and cash flow or those to judgement debtors with no means or fore-closable collateral to settle the debts. Licensed banks should not retain such facilities on their books while pursuing long-term recoveries. Losses should be taken in the period in which they surface as uncollectible.
What about Rescheduled Loans?
Once loans and advances are classified as Substandard, Doubtful or Loss, they shall not be reclassified or upgraded merely on the ground of rescheduling or roll-over of payment of interest and principal. Consequently, the loans and advances shall only be upgraded if the borrower repays the delinquent interest from his own funds prior to the roll- over such that the outstanding unpaid interest does not exceed ninety (90) days.
It is important that you understand these things to be knowledgeable. If you are a banker, you will appreciate the fact that these are mere basic requirements to be known if you work in this area within a bank.