Credit checks that reveal a borrowers’ capacity and creditworthiness are part of every decisioning process. However, sometimes, borrowers are unable to repay the loan and default on their payments. Loan default can have serious consequences for the lender. 

With a higher potential of non-performing loans [NPL] and a huge amount of portfolio at risk [PAR] leading to loss of business profits, it is important to know how to recover the loan from defaulters. In this article, we will discuss how lenders can recover loans from defaulters.

What is loan default?

Loan default occurs when a borrower is unable to repay the loan according to the terms agreed upon in the loan agreement. 

It is important for the lender to take prompt action to recover the loan because the longer the default continues, the harder it becomes to recover the loan.

How to prevent a loan default

Preventing a loan default is essential to maintain the stability of the business. It is also important to prevent incurring additional costs from hiring loan recovery officers or hiring a debt recovery company.

Some steps to prevent a loan default include: 

1. Provide loans to borrowers who are likely to repay. 
2. Lenders should carry out thorough credit analysis  to judge the credit risk.
3. Banks should scrutinise borrowers to determine how risky a borrower potentially is for loan monitoring, loan repayments and loan renegotiation.
4. Micro finance institutions should create a monitoring system that highlights loan repayment problems quickly and clearly.
5. Lenders should conduct thorough appraisals to minimise defaults and ensure a high quality portfolio.
6. Before making a lending decision, the lender should consider the borrower’s proposition [that is the borrower’s work experience, references, credentials, overall reputation] and subsequent repayment in isolation from security.
7. Lending businesses should reinforce zero tolerance to default to account and collection officers.

Pre-recovery steps

Before taking legal action, the lender should take some pre-recovery steps to ensure that they have a solid case and to try to resolve the matter. Some of these steps include:

• Verifying the default: The first step is to verify the default by reviewing the loan agreement and the borrower’s payment history. A default only happens when the borrower fails to make repayments according to the initial agreement. This can be ascertained if the borrower has missed several payments in a row. If the borrower is in default, the lender should try to contact the borrower to understand their financial situation and to try to reach a resolution. The borrower should be aware that defaulting on a loan is a civil charge for which they can be charged to court, reported to the credit bureau or even blacklisted.
• Reviewing the loan agreement: A loan agreement is between borrower and lender but the burden of the terms of the agreement falls on the lender. In reviewing the loan agreement, you need to understand transaction information [exact amount owed to the lender, what borrower receives after promising to repay], payment information [frequency of repayments, acceptable payment methods], interest information [simple interest, compound interest or fixed interest rate]. If you accept prepayment in your lending business, state it under the loan agreement terms to be reviewed including all the clauses.
• Trying to contact the borrower: The nature of the agreement will determine how you contact a borrower who has defaulted on a loan, either as a written agreement or not. Provided that all borrowers have written loan agreements, you need to follow the steps laid out in your loan recovery policy. Otherwise, contact the borrower through phone calls or SMS. If the borrower fails to respond, then the borrower can be served a letter that needs to be acknowledged to the registered address. Alternatively, you can make a report to the credit bureau and blacklist an unrepentant borrower.

Legal action

The second step is to serve the defaulters with a legal notice. This should include details of the loan amount and the timeframe for repayment. It should also clearly specify the consequences of defaulting on the loan.

• Filing a lawsuit: The first step in the legal process is to file a lawsuit. If the court finds in favour of the lender, a court order will be issued for the borrower to repay the loan. However, if the borrower still fails to repay the loan, the lender can garnish their wages to repay the loan. To file a lawsuit, a lender will need a lawyer to obtain a writ of summons or originating summons along with its paperwork. A lawyer will consider the court with jurisdiction to hear the case. In Nigeria, loans less than ten million Naira are treated at the magistrate court. For matters exceeding ten million Naira, the high court will preside. 
• Obtaining a court order: The second step is to obtain a court order. The court order is obtained if the borrower fails to appear in court or if the borrower does not dispute the debt claim by the lender. To obtain a court order, the lender must be directly affected and must have the capacity to sue. Proper lending business registration affords the lender a right to sue a debtor. However, there is no standard time frame to get a final order from the first application date.
• Garnishing wages: This is the last step when legal action has been taken and a lawsuit has been filed. A garnishee order is an option that the lender has to enforce a court judgement that mandates the borrower to pay. If the borrower still fails to repay the loan, the lender can garnish their wages to repay the loan. By enforcing a garnishee order, money is taken out of the borrower’s accounts by the banks so that the lender recovers his money.

Alternative methods

Legal action can be time-consuming and expensive, so the lender may consider alternative methods to recover the loan. Some alternative methods to recover loans include:

• Negotiation and mediation: Negotiation is an important step to recover loan from defaulters. It is essential to listen to their grievances and payment plan before coming to a compromise. It is important to remember that the defaulters are in financial distress, making it necessary to negotiate in good faith. If negotiation fails, then mediation can be the next step. This involves bringing in a third-party mediator who can help both the parties reach an agreement. This can help the borrower come to terms with the lender and come up with a payment plan that is suitable for both.
• Debt settlement: Debt settlement, where the borrower and lender agree on a reduced amount that the borrower will repay, can also be an option. Also called debt adjustment, it is the process where a delinquent debt is resolved for far less than the original amount owed. This means that the borrower agrees to pay a substantial amount of money to the lender as a lump sum. A lender can choose to hire a debt settlement firm to act on their behalf.
• Selling the debt: A lender can sell the debt to a collection agency or debt buyer, who will then try to collect the debt on their behalf. Debt collectors can be hired to recover loans from defaulters. They have the expertise and knowledge to handle such cases, and can often be successful in recovering loans. It is important to ensure that the debt collection agency is certified and abides by the rules and regulations of the country.
• Loan restructuring: Occurring in only when customers are unable to meet their debt obligations, the borrower negotiates with the lender to extend the loan tenure for the payment of the principal. Restructuring happens to alter an existing loan agreement. When a borrower is under financial distress which prevents them from timely loan repayment, debt restructuring is used to ease the borrower’s financial difficulty. 

GSI Mandate as a loan recovery tool

GSI means Global Standing Instruction and it is a term used in relation to financial institutions. The Central Bank of Nigeria [CBN] introduced a GSI mandate as a way to ensure financial stability, extending its dragnet against loan defaulters.

The GSI mandate is a set of instructions carried out by a borrower who is a bank account holder which authorises the recovery of a loan amount specified by a lending institution across the borrower’s bank accounts. Commercial banks who are participating financial institutions benefit from this mandate since they can collect money across a borrower’s account linked by BVN.

According to the guidelines, the aim of the policy is to reduce non-performing loans, improving the credit repayment culture, watchlisting incorrigible debtors, enhancing loan recovery from all eligible accounts and wallets across the banking industry.

This policy applies to individuals and not to corporate entities. It should therefore be noted that the GSI policy is used as a last resort to recover loans from defaulters. When a bank has done all it can to recover a bad debt, then the policy authorises that checks across banks can be conducted to ascertain whether the borrower has money available in other bank accounts. It is at this point that a garnishment is carried out – after legal action to enforce the payment of an outstanding loan.

However, while the circular makes mention of “implementation by all banks and other financial institutions”, it does not appear to apply to micro finance institutions, Microfinance banks and other alternative lenders. 

Conclusion

Loan recovery is an important process for lenders to ensure that they receive the funds that they are owed. By following the steps outlined in this article, lenders can recover their loans from defaulters and protect their financial interests. Prompt action is advisable as it ensures that the recovery process is smooth and effective.