Insider lending is a process where a Savings and Credit Co-operative Society (Sacco) or a financial services institution advances loans to its officers or directors.
However, in some developed countries, such as the United States, it is a requirement that such loans are charged at the same interest rate, repayment terms and credit evaluation criteria similar to that of outside borrowers.
More often than not, financial experts argue that in financial institutions, particularly Saccos, lending to insider is more or less like lending to oneself, hence compromising the essence of a banking obligation whose purpose is to extend credit to those who need it most, keeping in mind its profitability and risk concerns.
Any Sacco or financial institution that engages in lending to its associates or its officers and management is behaving irrationally and contrary to the objective of financial services business economy.
Based on business ethics and code of conduct, it is prudent for the Saccos alongside other financial services providers to embrace a manageable level of insider lending, since excessive levels might lead to losses that often might threaten continued existence of that particular institution.
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In this case, a financial risk refers to the likelihood that a firm could fail or encounter difficulty in honouring its financial obligations as and when they fall due.
Proven banking practice reports from across the world, point out that, it is a common practice to find those customers who are well connected with top level management executives, not tend to flout the banking laws to access favourable credit conditions, with such favours bound to increase through the banking hierarchy as the customers’ contacts and references rise through the banks’ governance structures.
It is important to note that, banking is one critical industry where one’s character is considered a crucial requirement in the repayment analysis of the borrower, making it necessary for any professional and ethical banker to have interaction with the customer to assess their character.
On matters good corporate governance, financial experts have advised not once that, lending to close associates and business enterprises are and should be reported in the financial statements and made public.
However, in certain circumstances, lending to the customers who have links inside the management is a different issue and a financial institution cannot publicly disclose such sensitive information based on the rule of banker-customer confidentiality.
In most cases, insider lending and fraud, tend to have serious consequences not only for the banking sector, but for the entire financial system.
And these fraudulent activities expose the banking and the financial services system to numerous risks, including operational, credit, liquidity, reputation, and compliance risk.
There have been serious cases where insider lending has been linked to the high volume of toxic assets or bad and irrecoverable loans that endanger the financial institutions’ corporate survival.
However, at the back of every manager’s mind, they must remember that the primary responsibility for preventing and detecting any type of fraud, not just loan fraud, rests with the financial institution and the system of internal controls it has in place.
It is important that financial institutions and insiders should carefully review any potential insider transaction and if necessary, seek legal advice before engaging insider lending activities.
Poor lending policies, on the other hand, stand out as one of the leading causes of financial crises, particularly within financial institutions with poor corporate governance and weak enforcement of regulations systems.
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OPINION: How Saccos should manage risks to ensure financial stability
It is crucial to note that, a financial institution can make loans to a variety of insiders, including major shareholders, subsidiaries, affiliated companies, directors, executive officers and board of directors.
And when insiders receive loans with favourable terms and conditions, there is always a probability of a risk of abuse.
Another critical concern on insider loans is that insiders may have less incentive to repay a loan on time or at all than outsiders.
This is to say the least, financial institution executives may simply roll over the bad debts of insiders with whom they have close ties in some cases, much to the disadvantage of the institution’s ethical financial practices.
While the majority of dangers are quantifiable, insider misuse has the potential to harm a financial institution’s reputation far beyond any financial loss, since inappropriate insider activity can basically erode the public’s trust in a financial institution.
It is obvious that the financial health and long-term viability of any given financial institution are directly correlated to the market’s assessment of the insiders’ integrity.
However, in order to keep the public’s confidence and trust, a financial institution needs to be known for its honesty, integrity and high ethical standards in all of its dealings, more particularly with insiders.
By Ben Okoth
The Writer is a Communications Practitioner and Correspondent based in Kisii.
benoroko2000@yahoo.co
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