Rising bad debt: Businesses urged to review risk management procedures

The South African financial service industry’s reputation took a knock recently as a result of events such as African Bank being placed under curatorship after experiencing high levels of bad debts, as well as the downgrade of four of the largest banks by Moody’s. While risk management practices may have been in place within these businesses, these incidents highlight that even the most stringent procedures cannot protect a business against financial risks and liabilities should the warning signs be ignored by management.

This is according to Gillian Wolman, Head of Litigation Risks at Risk Benefit Solutions (RBS), who says that tough economic conditions place enormous strain on local companies, both small and large, and require that businesses make a greater effort to ensure profitability, as well as act in the organisation’s best interests.

“South Africa closely avoided a technical recession in the second quarter of 2014 with the gross domestic product (GDP) increasing by 0.6%, following a 0.6% contraction in the first quarter. Despite the economy improving slightly, it remains weak, and it is likely that the increase in bad debt and delicate financial conditions will continue as individuals and companies continue to recover.”

The on-going strikes, increases in commercial crime, the recent Africa Bank collapse and downgrades all indicate that despite risk management processes being implemented, these procedures are not always sufficient, says Wolman.

“Companies need to ensure their risk management protocols are revised and adhered to on an ongoing basis, and ensure that these policies are effective and in line with the economic environment the business finds itself operating in. If not utilised appropriately, and warning signs are ignored, even the most sophisticated and active risk management processes can be defective, thereby creating a huge financial loss for the company, as well for those who manage and own it.”

She says that effective management control is necessary to ensure that all risks and uncertainties within the business are recognised, quantified and analysed.

“Continuous monitoring by management should enable the business to anticipate issues, therefore allowing the correct parties to attend to warning signs. This not only promotes job and financial security, but also supports ethical and responsible behaviour. In addition, this control will also reduce the frequency and severity of possible claims, which will ultimately maximise benefits for the business and its shareholders.”

Wolman says that it is vital that directors actively engage with the business’ risk management procedures. “While a directorship may come with great perks, the position also comes with an enormous and onerous responsibility. These responsibilities do not only include the running of the business, but also monitoring of all employees and visitor activity on the business’ premises.

“Failure to adhere to a company’s risk management procedure can be linked to shareholder claims or activism against delinquent directors, and this liability will fall within the director’s personal capacity and assets. Third parties, shareholders, employees, creditors and liquidators will have no empathy and look to direct actions against negligent directors, which will in turn increase the upward trend of litigants seeking compensation for losses.”

Risk management therefore requires directors to deal with the unknown and the risks associated with the unknown, says Wolman. “A comprehensive and appropriate risk transfer, through insurance for example, is a means of providing a safety net for those unforeseen events. The requirement and value of liability cover is by all means no longer a frill for a business, but a necessity and cannot be emphasised enough,” concludes Wolman.