Your business customer’s account is always overdrawn and near to the limit that you agreed. Deposits are still being made so the account is not inactive, but you have a feeling that something’s not quite right. What’s going on and what should you do about it?
The situation that you’re seeing is called “hardcore”. This is where the monthly deposits into the account are much lower than expected and never make much of a dent in the overdrawn balance. Often, in these situations, when deposits are made into the account, the funds are withdrawn again very soon afterwards – probably to pay a pressing creditor or buy some inventory for cash as credit lines have been fully utilized or maybe even withdrawn.
The problem is serious and requires your quick attention. One of the two things is happening. Either;
- The business has lost its customers (or one main customer) and revenues have fallen to much lower levels than they were when the overdraft facility was agreed, or
- The business is now split-banked and some revenues are going into another bank account where there may also be some debt.
To avoid this problem in the first place it’s sensible to make sure that this type of fluctuating short-term facility is limited to about 10% of the business’ annual revenue. As long as those revenues are maintained and the business only banks with you, that should see the overdrawn balance swing into credit (or very close to it) sometime during the month.
When the customer is known to be split-banked, the temptation is to provide an overdraft facility limited to 10% of the revenues being deposited into your bank account so that the balance should fluctuate during the month. The problem here of course is that you have no control on what proportion of total revenues the customers puts through your account from month to month, so you could still find yourself with a hardcore overdraft if the customer deposits a higher proportion of revenues into another account somewhere else.
What some banks do is to have the customer confirm that he or she is not split-banked at the time of agreeing the facility and then writing a clause into the facility letter or agreement for the customer to sign which says that the customer will not open a bank account at another bank while the overdraft facility is in place. It doesn’t mean that the customer will adhere to that but at least it gives the bank some legal grounds for withdrawing the facility in those circumstances.
So, what to do if a hardcore situation is already evident? Not easy unfortunately. The first thing is to have a conversation with the customer to find out exactly what has happened to cause the problem. Generally, you’ll find that the customer cannot repay the whole debt in one go or even in a short period of time so there’s often no option but to re-schedule the overdraft into a term loan that the customer will repay in instalments.
It might be useful at that stage to see if any collateral is available for the debt, but it’s unlikely. In practice, depending on the reason for the hardcore situation, these re-scheduled debts are not repaid and the bank is simply kicking the can down the road. Eventually the debt will become the subject of a legal process or be written-off.
The important things here are to, firstly, spot the warning sign of the hardcore situation and then, secondly, to take quick action to try to reduce the bank’s exposure to the customer.