A written loan policy is evidence that a bank has established a process to identify, measure and control risks in the lending arena. Therefore, an incomplete or inadequate policy may raise regulatory concerns with respect to the bank’s risk management practices. In the ever changing lending and regulatory climate that all banks are experiencing, it is of the utmost importance that each bank stay on top of its lending policy. A bank’s policy should be reviewed by the board of directors annually. However, in these ever changing times it may be necessary to constantly watch for regulatory and market changes which that may necessitate revising your loan policy. Also, having an up-to-date loan policy puts a bank in the best position to evaluate and capitalize on new opportunities.
Over the last couple of years the country saw many banks whose lending practices got out of control. Significant concentrations in real estate or other hot areas resulted in many banks finding themselves in a difficult situation. Many of these banks probably had a policy which set forth appropriate risk diversification levels which should have helped to avoid over concentrations, but practices did not mirror what was set forth in their policy. If a bank is unable to follow its own policy, what does it say about the safety and soundness of its lending practice?
Covering the Basics
It is important that a bank’s loan policy keep up with its lending practices so that there is a resource for the bank’s lending staff and other personnel to rely upon. There are significant benefits to having a comprehensive loan policy. These benefits include: (1) favorable reflection on the board and management during examinations; (2) better control of lending related risks; (3) better and more knowledgeable decisions; and (4) guidance for documentation personnel. All loan policies should, at a minimum, cover the following:
- General fields of lending in which the institution will engage and the kinds or types of loans within each general field;
- Lending authority of each loan officer;
- Lending authority of a loan or executive committee, if any;
- Responsibility of the board of directors in reviewing, ratifying, or approving loans;
- Guidelines under which unsecured loans will be granted;
- Guidelines for rates of interest and the terms of repayment for secured and unsecured loans;
- Limitations on the amount advanced in relation to the value of the collateral and the documentation required by the institution for each type of secured loan;
- Guidelines for obtaining and reviewing real estate appraisals as well as for ordering reappraisals, when needed;
- Maintenance and review of complete and current credit files on each borrower;
- Appropriate and adequate collection procedures including, but not limited to, actions to be taken against borrowers who fail to make timely payments;
- Limitations on the maximum volume of loans in relation to total assets;
- Limitations on the extension of credit through overdrafts;
- Description of the institution’s normal trade area and circumstances under which the institution may extend credit outside of such area;
- Guidelines, which at a minimum, address the goals for portfolio mix and risk diversification and cover the institution’s plans for monitoring and taking appropriate corrective action, if deemed necessary, on any concentrations that may exist;
- Guidelines addressing the institution’s loan review and grading system;
- Guidelines addressing the institution’s review of the Allowance for Loan and Lease Losses; and
- Guidelines for adequate safeguards to minimize potential environmental liability.
Growing Lending Expertise and Lending Policy
With all the recent turnover of bank personnel it is likely that many banks have made new and talented additions to their lending staff. Specifically, these additions may have brought new expertise which could grow a bank’s business. It is important that the loan policy grow with these changes. The expertise and reputation may have immediately expanded the bank’s geographic and industry reach, which can provide new and unique opportunities for a bank. If the bank’s loan policy does not keep up with these changes it will be difficult to capitalize on new opportunities as they arise. And obviously, lending and documentation staff need appropriate guidance to enable a strong and safe lending practice.