My entire banking experience has proven time and again– the importance of cash-flow based lending, in driving asset quality.
This move by the central bank, encouraging cash-flow based lending vis-a-vis asset-based lending is being greeted with immense pleasure. Assets and tangible collaterals can act as insurance to tide over any crisis or irregular behaviour of the customer. But future projections of income or cash-flow can function as a strong indicator for regular repayments when backed by past income trends and the credibility of the borrower. Banks and/or NBFIs also need to consider seasonality, cyclicality of the business, fluctuation of income, where weather, season, harvesting, festivals, etc. play a significant role in defining the cash flow of the customer. Thus, financial institutions need to be mindful of the same while structuring repayments, without going for a one size fits all approach. It is often seen that structuring repayments through step-up, step-down, or bullet payments (with interest-only) for the tenor of the facility, offers convenience to customers. Similarly, banks can protect themselves from unwanted provisioning by aligning the repayment of the borrowers with their cash flows.
The system of monitoring loans based on, meeting credit covenants in terms of financial ratios often prove inadequate and possibly pushes an MSME borrower to resort to accounts management. Today there are various technology solutions (AI based) for analysing Bank statements to gain big insights in understanding the cash flow of the customer. Customer account statements across banks can be facilitated by the proposed account aggregators model. For that matter understanding the nature of the business in the starting point. An underwriter can also assume the amount of cash received in the business (which may be used for direct payments) by asking a few questions to the prospect.
A technology-driven analysis can throw up more interesting insights beyond cash-flow, otherwise time-consuming, and prone to slippages if carried out manually.
Past financial crises have led to great learnings in terms of technology adoption, change in accounting and financial methodology and better governance. The shift of focus into cash-flow based lending is a welcoming move to drive behaviour amongst borrowers and strengthen the future asset quality of financial institutions.