A cardinal rule in banking is the concept of “Know your client”. This means exactly what is says. The banker will do all he can to find out as much as he can about the company and the client. In this no information is too small or too immaterial since they will fit into a larger picture and the fate of the facilities extended may depend upon it. It has to be always remembered that the project may appear sound, the documentation perfect and the financials impeccable. However, if the intent is to cheat, it could cause severe losses to the Bank. Banks are always aware that a dishonest man is also a very clever person. Additionally the dishonest person has the advantage in that the innocent banker believes him to be a good, honest soul. He knows he is not; he knows he intends to cheat the banker and he has a scheme to cheat him.
- Case 1: A few years ago an apparently wealthy businessman approached the Bangkok branch of a large foreign bank to open a letter of credit to import certain items from Hong Kong. The amount was large. The person appeared respectable. The young banker, in his eagerness to capture additional business to meet the demands of a very tough budget, complied with his request. The banker convinced himself that the risk was small as the goods would not be handed over till it had been paid for. Additionally the facility was short term and self liquidating. The seller from Hong Kong exported the goods and on his presenting the documents was paid (as the Hong Kong branch had confirmed the letter of credit). The documents arrived in Bangkok and when the client was sought, he was nowhere to be found. Inquiries revealed that he had left the country a day after the exporter had been paid. It was further found that the businessman had no business any longer. The bank took possession of the goods and when the cartons were opened, it was found that the goods were not what they were purported to be. In fact, they were of practically no value at all. The Bank suffered a significant loss. It was later discovered that the “businessman of Bangkok” and the “exporter from Hong Kong” were in fact brother in law and partners in crime.
This incident reveals the importance of knowing to whom monies are lent. A person intent on cheating a Bank can do so however tight or foolproof the documentation appears to be. Bankers therefore, quite rightly, follow a simple rule. If there is a doubt – even a very slight doubt on the integrity and the honesty of a client they will not lend. The risks are too great.
It is because of this crying need of knowing the client that Banks insist on a client being introduced. The banker works on the supposition that if the prospective client has been introduced by another whose credentials are above reproach then by extension the prospective client’s credentials are also by extension, above reproach.
In addition a banker will always attempt to verify facts and try to find out more. This is to establish the credibility of the client. A prospective borrower, optimistic of his future, may give information that may be too ambitious or hopeful. Conversely, with the intent of defrauding the Bank the information given may be totally false. The banker will check all statements made. The acceptance of an unverified statement destroys the credibility of the analysis and bankers are aware that such an action can put the entire exposure at risk.
- Case 2: Several years ago a well spoken gentleman approached the Manager of a large branch of a private sector bank and informed him that a mutual friend had recommended the bank to him for a loan to finance working capital. This was not checked because the person appeared so genuine and respectable. The facilities were arranged securing them to the hypothecation of stocks, book debts and fixed assets. There appeared to be adequate cover. A few years passed. The demand for the Company’s goods fell. The inventory became obsolete. The client became bankrupt. When the Bank took steps to seize the inventory and fixed assets it was found that another bank had a first charge on the fixed assets. The Manager was not aware of his inferior collateral as he accepted the clients word without verifying. It was later found that the client was not a friend of the person the Manager knew. He had merely dropped a name and the Manager had bitten the bait. In this case failure to verify facts lad the Bank to lose a large sum of money.
Bankers verify facts and information given by:
- Bank checkings – the opinion of the bank where the new customer is known and the dealings he has had. Banks asked for this information are often non committal as they expose themselves to law suits and the like if they reveal more than they should. However, the wordings used are usually enough to give the querying banker adequate information.
- Trade checkings – the person’s standing among his peers and his reputation.
- Customer checks – the opinion customers of the prospective borrower has of him.
- On site visits and asset verification – does the factory/ plant/ business actually exist and the value of the assets.
- Collateral Audit – does the collateral actually exist and can it be pledged (has it been pledged to someone else).
- Verification of other statements made by whatever means.
Good bankers will always “keep their ears to the ground” to listen to information and gossip because this can be very valuable as it is sometimes surprisingly accurate. Bankers will invariably react quickly to negative news as it often is the harbinger of very very bad news. A good banker will not however react without checking the information that he has received because it may be untrue.
As borrowers clients must always tell the truth. Even one small inexactitude puts the whole relationship in jeopardy as it would make the banker doubt the integrity and honesty of the client.