Internal Lending – Getting Headaches Out of the Treasury Department

Internal Lending Programs

With financial technology and treasury management sophistication taking treasury to new heights, every year treasury departments are inclined to adopt internal lending programs. Adoption of an internal lending program allows treasuries to issue local debt for internal purposes, such as project financing for regional departments and business divisions.

An internal lending program makes internal loans to entities within an umbrella organisation and supervises repayments in accordance with financing agreements between the internal borrower and the organisation. The treasury department in turn bundles those internal loans in portfolio buckets based on the type of a loan, probability of default and other parametres in order to borrow externally to secure the funds for those loans.

A correctly organised and managed internal lending program allows lower borrowing costs and stabilises borrowing rates making financial flows predictable and controllable for treasury department managers.

The internal lending program streamlines initiative and innovation for business units and secures a better bottom line for the organization.

How to organise internal lending

Despite the fact that internal lending means issuing loans only to the entities, which form a part of the organisation or a holding, there is always a risk of a loan default. The more numerous the company’s divisions are, the less sure its management is about every business project or entity, which want to get a loan.

To reduce the risk of default, it is highly recommended to use a credit risk rating system with its formal approach to any potential borrower. It helps to exclude a possible payment delinquency rejecting the lending requests, that do not match certain lending criteria, and thus lowering the risk level. Any credit risk assessment or credit risk scoring tool is based upon real data from different sources, which reflect the reality of lending. Such data helps to create an assessment system, which rejects potentially risky loan requests. The credit risk evaluation rules include many aspects: internal policy, credit bureau, anti-money laundering measures, internal fraud scoring and others upon demand. Even though this is internal lending, these rules are not redundant.

An appropriate lending system with embedded decision making and a credit risk scoring module automates the lending process, making it less expensive and prolonged. It helps to get a trustworthy assessment result with maximum automation of efforts and often within several minutes after the loan request is submitted.

Internal lending program process

Loan Requests

Internal borrowers and separate business units send their loan requests to a centralised loan requests repository.

Credit Analysis

Treasury department managers have to perform credit risk analysis, assess the risk of the borrower or a business project and its impact on institutional debt capacity. There are five stages of this process:

1. Start with base case scenario writing.
2. Identify main financial risks. A company that is better aware of its internal entities than other banks will have lower credit risk, if credit risk assessment is properly organised.
3. Underline scenarios with the main risks in various combinations.
4. Prepare a risk mitigation procedure.
5. Evaluate the influence of this project on the company’s debt capacity.

Loan/Project Approval

The treasury department should make decisions on loans for small amounts within a specified credit limit for each type, purpose, and sector. The financial director (or board of directors) should approve loans for business units and company projects for an amount over a definite threshold limit or loans that lead to a high concentration risk.

Financing Agreement

This is the key document, which establishes terms. It provides authorisation, loan term, first payment date, covenants and disclosure requirements.

Expenditure Funding

Treasury reviews and funds loan with debt proceeds or reserves.

Debt Repayment

Upon repayment, the treasury department transfers debt service from a unit to the internal lending program. Since such lending is internal in nature and should serve strategic purposes of the organisation rather than be used purely for profit purposes, the loan can be prepaid in part or completely any time.

Important aspects

Additionally, the following important aspects should not be forgotten when arranging the internal lending program.

Reporting

The treasury office sends quarter or annual reports to the board on internal lending program activities, with an overview of the organisation’s external debt portfolio, the status of internal loans and institutional loan capacity.

Annual Bond Resolution

The annual bond resolution, which authorises both the issuance of new debt during the next year and the refunding of existing bonds, should be presented to the board for approval. The annual bond resolution is limited for debt that is supposed to be issued over the next 12 months.

Rate Stabilization

The internal lending program offers a uniform internal lending rate to all internal borrowers. The internal lending rate includes a reserve component for rate stabilisation that is used to subsidise the internal lending rate if it increases in external borrowing rates that puts upward pressure on the internal rate. The rate stabilisation reserve has to be large enough to offset considerable growth in external borrowing rates – otherwise, the internal lending rate will have to be raised in order to assure the solvency of the internal lending program.

Internal lending program structure

Below you can find a high-level schema of internal lending program that can be improved or adapted to organisation needs and historically inherited business processes.

Obstacles to overcome

These are the main obstacles and difficulties that are faced by a company that intends to arrange an internal lending program:

• “Cultural” resistance of management and financial staff to a new improvements in doing business
• No experience in lending within organisation
• No experience in credit risk management
• No software/hardware in place to automate credit risk evaluation, loan portfolio management and reporting.
• Absence of costly experts to manage the program properl
• Unclear monitoring and reporting process to manage internal lending efficiently

Is it really possible to surpass these obstacles properly without lengthy and painful transformation inside the treasury department?

Thanks to advances in financial technology and standardisation of lending processes, complex lending technology (previously used by banks only) has been made available for everyday usage by any organisation.

Arranging it without headaches for the treasury department

Internal lending has become more and more popular nowadays among organisations because the period of SME lending “know-how” and technologies descending from banking heights to small alternative lending startups is now over. These days, cloud-based lending software is available on the market and such software is affordable and at the same time, easy-to-learn by new entrants.

To arrange the internal lending program properly, without costly procedures, a treasury department needs a tool that will be able to:

• Automate the internal lending process with minimum inclusion of manual operations
• Provide the best lending practices embedded into the workflow
• Provide automated credit risk assessment
• Provide automated loan schedule calculation
• Facilitate automatic portfolio reporting and alerts

One of the proven examples of such technology development, that is suitable for internal lending without hassle, is the Turnkey Lender software that has proven that lending and credit risk assessment practices, embedded within its workflow and interface, is able to deal correctly with SME loans and project loans in the way that is acceptable for a non-banking organisation.

There is one more important point in arranging the program smoothly. Start it step by step, do not dive into it at once. Once the treasury department has adjusted its process, selected a software solution and got approval from their board, it will need to start its internal lending program in a pilot phase. Use this pilot phase experience to adjust to its established business processes and internal priorities and then start reaping benefits ahead of the competition at full steam ahead.

For twenty years, Elena Visser has worked in senior level positions in corporate finance, investment, treasury and lending areas. She possesses a broad experience in all aspects of finance and corporate governance requirements, including Pan-European treasury projects. Throughout her career, Elena has been involved in financial innovation projects for multi-national corporations, working not only in EU and US, but active in the developed markets of Eastern Europe and Asia. Elena’s main areas of expertise lie in financial strategy, alternative lending, information technology innovation, corporate lending, corporate investments, corporate restructuring, private equity, M&A, management reporting and analysis implementation. Elena holds MBA from Webster University.