CHAPTER-10
The bank Credit Organization
-The main objective of the bank is not to making deposit and
making loans, but to minimize risk in collection them. Thus the
true core of business of banking is the profitable management of
risk.
-Banking crisis have occurred when a group of banks create loans
of poor quality. Banks might get in trouble because of insufficient
liquidity, unexpected interest rate movements, and so forth. But
when banks fail, they do so because of poor-quality loans.
-Lending is based on the two fundamental products of banking:
money and information.
- The trick is to create loan management packages and
management systems that maximize banks’ chances of getting the
money back.
The bank Credit Organization
- Bank loans finance diverse group in the economy,
manufacturers, farmers, builders, etc. which assist the
society to grow, so the bank operations grow as well.
-Every bank bears a degree of risk when it lends to
private borrowers such as business and consumers with
out exceptions, so banks experiences some loan losses
when certain borrowers fail to repay their loans as
agreed.
Loan Risk and Losses
-Lending opportunities have been declined
among low risk borrowers. Many conditions; such
as high competition, have pushed banks toward
riskier classes of borrowers. Most bank shift from
large and stable corporate borrowers who
engaged in the financial markets, to business
with small, less stable borrowers.
-poor quality loan was the main factor in the
large number of faileures banks
Loan Risk and Losses-con
It was noted that several faults in lending procedures include the
followings:
1. Inattention to loan policies.
2. Overlay generous loan terms and lack of clear standards.
3. Disregards of banks’ own policies.
4. Unsafe concentration of credit.
5. Poor control over loan personnel.
6. Loan growth beyond the banks’ ability to control quality.
7. Poor systems for detecting loan problems.
8. Lack of understanding of borrowers’ cash needs.
9. Out-of- market lending.
Managing Credit Risk
Credit Philosophy and Culture
-Managing credit risk requires a clear credit
philosophy in order to set management's
priorities with respect to the marketplace.
-Bank credit philosophy may range from an
emphases on consistent performance of the
highest quality loan portfolio based on highly
conservative underwriting standards to an
emphasis on aggressive loan growth and market
share with highly flexible underwriting standard.
Managing Credit Risk-con.
-Credit philosophy and loan policy must be
supported by credit culture.
An effective credit culture exist when the
actual behavior of every individual in the loan
organization is closely aligned with
management’s priorities.
- Credit culture is reflected in the loan
organization’s system and procedures that
implement management’s priorities and
minimize errors and poor lending decisions.
Managing Credit Risk-con.
Credit Risk management Strategy
Bank must design its credit risk management strategy. Figure 10.3P.393, illustrates the structure of bank credit risk. Overall credit risk is
divided into two basic parts:
1. Transaction risk.
2. Portfolio risk.
-Transaction risk includes selection risk, underwriting risk, and
operations risk.
-Portfolio risk is divided into intrinsic risk and concentration risk.
Operation risk is considered in this chapter. The main objective is to
explain the need for and the formulation of a loan policy to
steer bank toward the desired makeup and control of their loan
portfolios
The Credit Organization
The organizational structure of the lending
function varies with a bank’s size and type of
business.
-An officer of a small bank may perform all of
the detailed work associated with making a
loan.
-in a large banks, individual officers specialize in
consulting and negotiating with customers.
Figure 10.4- P.394.
The Credit Organization-con.
Loan Division
Figure 10.4 shows the various loan divisions. They perform the
basic functions of generating loan business and supporting
customers.
Credit department
-The primary mission of the credit department is to evaluate
the creditworthiness and debt payment capacity of present
loan customers and new loan applicants.
-The department is an excellent place to train new loan officers.
-the department may be responsible for loan review.
-also, it is responsible for collection of past-due loans.
The Credit Organization-con.
Collateral and Note Department
The main loan function is the perfection of the
bank’s security interest in collateral offered in
support of a loan.
-the department also performs the discount
function: monitoring and crediting of payments
received on outstanding notes.
Loan committees and the Loan
Approval Process
Loan Committees
Among several committees, two or three committees are
involved with major credit decisions, they are:
1. An officers’ loan committee
2. Director’ loan committee
3. Special assets committee
The above committees are commissioned to approve only those
loans that confirm to loan policy. Loan above certain minimum
sizes are examined by individual loan officers before the officers’
loan committee:
Loan committees and the Loan
Approval Process-con.
this committee’s duties are:
1. Review major new loans
2. Review major loan renewals and ascertain the reasons for
the renewal.
3. Review delinquent loans and determine the cause of
delinquency.
4. Ensure compliance with stated bank policy.
5. Ensure full documentation of loans
6. Ensure consistency in the treatment of loan customers.
Loan committees and the Loan
Approval Process-con.
1-The officer’ committee meet frequently- daily in large
banks, and weekly in small banks.
-the committee serve as check on of loans not as a
substitute for the individual loan officer’s judgment.
2-The directors’ loan committee reviews major loans
approved by the officers’ committee.
•The committee makes the final judgment on the officers’
loan committee decisions.
•It is concerned with conformance to bank loan policy and
avoidance of violating law and policies control insider loans.
Loan committees and the Loan
Approval Process-con.
3- a special assets committee: it is special committee.
It is created in banks that have experienced a significant
increase in regulator-criticized loans.
It monitor the progress of problem loans, and try to find the
best way to collect such loans.
Loan Approval Process
The loan approval process requires three elements:
1. Delegation of authority.
2. Uniform presentation format and standard.
3. The actual loan decision.
Loan committees and the Loan
Approval Process-con.
Some bank adopt decentralization process, which
permits large loan limits to the loan officers, and
possible for the officers to combine their limits
with other officers. This system results in greater
customers responsiveness and productivity.
Some other banks grant smaller loan limits, do not
permit combining of loan limits. This system has
the advantage of greater consistency and safty.
Loan committees and the Loan
Approval Process-con.
Uniform presentation format and standards.
Loan committee use a single standardized cover sheet
that summarizes the key elements of the loan
decision.
Attachments to cover sheet include spread sheets,
balance sheet and other projections, credit analysis
and comment by the loan officer.
The cover sheet should present brief comments on the
following:
Loan committees and the Loan
Approval Process-con.
1. Description of the client’s business and position in its market
and industry.
2. Assessment of management.
3. Purpose of the loan request
4. Repayment schedule and source of repayment.
5. Secondary sources of repayment including collateral values
and guarantors.
6. History of past borrowing with the bank
7. Required monitoring steps, including timing of submission of
financial statements
8. Sponsoring officer’s comments, including consistency with
policy.
Loan committees and the Loan
Approval Process-con.
The Loan Decision
Most loans presented to the loan committee
receive approval, because officer submits all
required information and job has been
carefully studied.
Loan committees frequently can improve the
transaction by discussing the loan merit.
Loan Policy and Procedures
Formulation
Loan Policy
All loans should reflect the bank’s policy loan. Such
policy should reflect the bank lending philosophy and
culture, indicating:
• Priorities
• Procedures
• Means of monitoring lending activity.
Bank policy must be written in a written form.
From the comptroller’s point of view, a written policy
should obtain three results:
Loan Policy and Procedures
Formulation-con.
1.
2.
3.
Produce sound and collectible loans.
Provide profitable investment of bank funds.
Encourage extensions of credit that meet the legitimate
needs of the bank’s market.
-Loan policy may change over time (different kind of loans may
be lend according to environment of the market, such as
consumer goods or capital goods.
-loan policy vary over time; i.e.., in recession and boom
periods. In periods of tight money, banks are able to
expand lending rapidly and may have to restrict their loan
growth. In contrast, when funds are plentiful and the
economy is weak, banks may require their borrowers to
show greater balance sheet and earnings strengths than
during boom periods.
Loan Policy and Procedures
Formulation-con.
Loan Policy Outline
The elements of written loan policy are as follows:
1. Introduction
2. Objectives
3. Strategies
4. Lending authorities and approvals
5. Credit standards
According to the credit standards, the written policy
states the desirable loans as following:
Loan Policy and Procedures
Formulation-con.
1. Short term credit which include short-term loans to business
customers such as working capital loans (30-90 days a year)
2. Undesirable loans such as loans of acquiring a business or to buy
out stockholders in the borrower’s present business. Such lending
is considered as replacing equity with debt. Bridge loans are cited
as a contrary to bank policy.
3. Speculative loans are proscribed by policy unless the borrowers
can qualify independently on the base of his normal business
performance.
4. Trade area. Primary and secondary area should be stated by the
loan policy; such as the area be served, limits on loans
participation out of the bank area, and exception of some loans.
5. Acceptable collateral
6. Appraisals.
Loan Policy and Procedures
Formulation-con.
Principles and Procedures
They are organized into two parts: (p. 401)
1. Technical procedures
2. The detailed procedures and parameters.
Some considerations are given her to some of the first part:
Insurance protection
The ability of borrowers to repay the loan is associated with risk.
Life insurance on key personnel is necessary to protect against
loss caused by death or any reason (flood, natural disasters,
which destroy loan collateral.
Loan Policy and Procedures
Formulation-con.
The procedures policy should indicate:
1. The types of the borrowers who must be insured.
2. Designating the bank as loss payees.
Documentation Standards
Standards documentation must be followed in terms if uniform
credit files. These standards are not the sale all sizes of the
banks. Such requirements are routine for medium and large
sized banks. Small bank might adopt what is preferred by the
individual loan officers. The uniform loan documentation
checklist is required for each file. They are; (see page 402) 12
requirements.
Controlling Loan Losses
Securing Collateral
Collaterals are used to protect the debit, so the bank has a right to
sell the collaterals assets and use the money to repay the loan as
agreed.
Short run loan of high-quality borrowers are not secured, while
most long-run loans are secured.
Different kinds of collaterals are used to secure loans such as:
-Real estate property (land and improvements, including
structures).
-Personal Property in the bank’s Possessions.
-Personal Property in the customer’s possession (collateral
property held by the borrower with a public filing of general
security agreement, which grant the bank a security interest.
Figure 10.5 p.404
Controlling Loan Losses-con.
The Loan review Function
-Bad loan may occur in the process of making loans. Most banks
conduct loan reviews to reduce losses and monitor loan quality.
-Credit analysis in loan review occurs after the loan is on the
book.
•To reduce loan losses, the following points should be
emphasized in loan review:
•To detect or actual or potential problem loans as early as
possible.
•To provide an incentive for loan officers to monitor loans and to
report deterioration in their own loans.
•To enforce uniform documention.
•To ensure that loan policies, banking laws, and regulations are
followed.
•To inform management and the board about the overall
condition of the loan portfolio.
•To aid in establishing loan loss reserves.
Loan Review Procedures
These procedures should be in written form in the loan policy.
Large size bank establish separate staff for loan review which
independent from loan personnel.
In midsize bank, such review is the responsibility of credit
department or audit department.
Small banks often they do not have review program or they
depend on loan officers to do the job.
Conducting loan review required to cover the following points:
Financial condition and repayment ability of the borrower.
Completeness of documentation
Consistency with the loan policy
Perfection of the security interest on collateral
Legal and regulatory compliance
Apparent profitability
Correcting Problem loans
Some borrowers experience some difficulties to repay the loans, such
difficulties describe the problem loans. The best way to conduct such
problem is that individual loan officers can deal with such environment,
because they have special rapport with their borrowers. Business
deterioration can be noted by loan officers. Bad attitude toward loan
officer is another clue of problem loans. Late payment of principal and
interest and abnormal delay in submitting financial statements as required
is another clue of problem loan (indicators of trouble p.407).