The stakes of recovery
In a context of crisis, companies' delays of payments have never been so long in Europe during the last 4 years. These delays cost 90 billions euros per year and represent 10.8 billions euros of lost interests. In addition, the increase in the number of files in litigation generates a loss of almost 24 billions euros of non recovered debt . This raise is accompanied by an augmentation of provisions, penalizing banks' financial results. In 2009, the main French banks have noticed an average increase by 40% of the risk cost compared to 2008.
In order to limit the risk cost, banks should improve their efforts regarding the management of risky files or doubtful ones. To do so banks should act on the whole credit process:
- Pre-default process: credit granting and management (administrative management, credit follow-up). Banks should prevent the default and avoid it as much as possible.
- Post-default process: recovery and provisioning. Banks should set up measures allowing then to strengthen their recovery function in order to optimize the amount of recovered debt in case of default.
Improvement of the pre-default process
Basel II reform defines the default as the moment when the debtor exceeds 90 consecutive days of unpaid debt or when the bank must take appropriated measures such as guarantees application. So unpaid debt does not necessarily mean an entry in the recovery process.
But these delays in credit settlements are expensive for banks. The cost is mainly linked with fixed capital. So client monitoring appears to be an essential stake for banks which lend a lot of money. But CIB and retail banks are not equal on this matter.
CIB has access to documents and information based on official publications which allow them to analyze a company's situation in a much better way and more regularly. They also act as soon as the credit is granted in order to facilitate the monitoring and to ensure an optimal coverage of risks. This is why the credit contract often includes specific protection clauses (covenants) expressed as financial ratios which must not be exceeded. The non respect of these clauses can force the client to refund the whole credit. This allows a regular monitoring of the debtor by the lender.
Retail banks have more difficulties to act upstream of debtor's default because they generally don't have access to the same risk management tools. In addition, the number of clients does not allow a systematic and performing individualized follow-up. Finally, because financial stakes of each operation are more important for CIB, KYC (Know Your Client) tools are more efficient.
Thus the reinforcement of counterparties risk prevention should be addressed first in retail banks. In order to be more efficient in clients monitoring, banks should improve their KYC tools and adapt the information systems in order to guarantee a better understanding and traceability of the client.
To monitor clients in difficulty, banks should also be able to decide in a more dynamic way on the solution to apply on pre-default files: repurchase of credit, transfer of receivables...
When, despite these arrangements, the client becomes doubtful, banks recovery process should be managed at best in order for them to be paid back.
Reinforcement of the recovery function
Today banks have recourse to 3 different recovery methods: internal recovery, external recovery and transfer of receivables. Depending on the amounts to be recovered, the number of files to process and the profitability, banks prioritize one method or the other.
Internal recovery is used when the debt to be recovered is a large amount. This method allows banks to keep a close relationship with their clients (fidelity) and to propose adapted solutions regarding individual situations. Banks should be able to identify different types of debtors, especially to distinguish bad debtors from clients facing temporarily difficulties. In this case, a good knowledge of the client is mandatory in order to propose to the good ones a debt rescheduling.
External recovery is prioritized by banks when they want to treat an important number of homogenous files representing less money. External companies are mandated by banks to recover their debt in return of a commission on paid back amounts. This externalization requires optimized internal information systems to manage transferred files, to facilitate exchanges between the bank and the company and to keep an audit trail for each file.
When banks estimate that profitability of recovery is negative (recovery costs are more important than estimated recovered amounts), they transfer their receivables to specialized companies. These companies buy back the debt in order to industrialize their treatment and improve their profitability.
Whatever recovery mode is chosen, banks prefer an amicable way in order to limit legal procedures which can be long and expensive. By this way, banks also preserve at best their commercial relationship.
Due to the raise of contentious files, recovery should now be considered as an extension of the client relationship. It should be executed in a way allowing to protect this relationship and to guarantee future business acquaintances.
This way of thinking implies to take into account the potential end of contract at the moment of credit granting, and also to connect recovery tools with CRM and KYC systems.
Beyond mid-term regulatory capital savings, the stakes of recovery are long-term ones. Only banks which have set up a global and flexible process will be able to keep contact with their clients and claim proximity values.
2009 European Commission study regarding companies payments behaviors in Europe.