Comprehensive and Effective Loan Policies Involve Annual Review
Bank loan policies vary in content, length, style and quality as determined by each individual financial institution. Each bank has its own tolerance for risk, product mix, and economic conditions can vary by geographic location. An effective loan policy should reflect the size and complexity of the bank and lending operations should be tailored to each banks needs and characteristics. An effective loan policy should be a living document, and revisions should occur as lending circumstances change. The policy should be flexible enough to accommodate new lending activity without a major overhaul. Loan policies are typically reviewed by senior management and the bank’s Board of Directors on an annual basis.
During risk management examinations bank examiners determine the adequacy of a financial institution’s loan policy. They want to make sure that the policy is up to date and key lending areas are addressed. Some of these key points are:
- Types of lending
- The bank’s business area
- Lending authority
- Responsibility of the Board of Directors in loan approvals
- Guidelines for portfolio mix
- Risk diversification
- Appraisal requirements
- Unsecured lending guidelines and pricing
- Advance rates and loan to value limits and aggregate
- Credit and collateral documentation standards
- Collection requirements
- Guidelines addressing loan review/grading systems and review for adequacy of the loan allowance
- Safeguards to minimize potential environment liability
The loan policy should include detailed guidelines for each lending department and or function. Each area should include specific guidelines.
A sound loan policy that is established and overseen by the bank Board of Directors reflects favorably on the Board as well as senior management. Clear expectations in writing show that senior management is better positioned to control lending risks, ensure safety and soundness, and fulfill oversight responsibilities. An up-to-date loan policy shows that actual loan documentation and underwriting practices will satisfy the Board’s expectations. Additionally, a clear and comprehensive loan policy describes management’s system of controls.
Some areas that could indicate that a loan policy is not current are:
- The policy has not been reviewed annually
- Multiple versions are in circulation
- The policy is disorganized or has information that is outdated
- Business area has not been reviewed
- Discontinued products are still included
- New regulations are not addressed
Other areas of concern may be that actual lending practices vary significantly from what the loan policy says, numerous exceptions to loan policy requirements have been approved and policy limits have been ignored.
A comprehensive annual review of the loan policy in addition to ongoing limited reviews will ensure that the policy does not become outdated and ineffective. The updating process should include identifying obsolete or irrelevant sections of the policy. Compliance testing by a third party review can also help senior management determine if staff is adhering to provisions of the loan policy. A current and effective loan policy is a tool to help senior management ensure that the bank’s lending function is operating within established risk tolerances. The purpose is to have an updated loan policy for staff to follow and that contributes to a uniform and consistent board-approved practices.