c
 

 

A Comprehensive Loan Policy

Rather than incorporating everything into a single loan policy document,

many banks find it is better to divide their loan policy into a series of
documents. For example, a bank may have separate policies related to
lending for:

V Loan administration.
V Loan categories (such as commercial, real estate, consumer
installment and agricultural).
V anvironmental risk.
V Collections, charge-offs, and recoveries.
V Loan review and loan grading.
V Loan loss reserves.
V Fair lending (for example, ensuring loans are made to all credit-
worthy applications regardless of the race, age, or gender of the
borrower).

Because a bank¶s lending practices can have implications for its other risk
exposures, it is important that the loan policy take into account these
risks as well. For example, loans are not a very liquid asset. When a bank
makes loans, all else equal, it becomes less liquid, meaning it has fewer
funds available to make more loans and to meet its other operating needs.
The loan policy, in addition to addressing lending, must also address the
bank¶s other needs. For instance, your bank¶s loan policy may have a
statement that limits the proportion of its assets in loans (perhaps loans
are limited to 60 percent of bank assets). The intent of this limit may be
to preserve the bank¶s liquidity position.

These policies can be written by the board, a board committee or

delegated to senior management. Regardless of who drafts the policies,
directors are required to review and approve the contents of the final
policy statement because the board is ultimately responsible for the bank.
Once approved and put into operation, these policies should be reviewed,
revised as experience dictates and approved at least annually by the
board.

By establishing effective policies, directors determine the parameters

within which the bank¶s lending function operates. This is important
because directors often are not involved in individual credit decisions,
except in their roles as members of the loan committee or when they are
examining loans involving more than the normal credit risk that come to
the board for approval.
Although policies differ from bank to bank, a loan or loan administration
policy will often address the following issues:

Th 
    h
   including the proportion

of the bank¶s funding sources that may be used for lending, the types of
loans that may be granted, and, if appropriate, the maximum percentage
of the overall portfolio allowable for each loan category. These
considerations affect liquidity, asset and liability management and
concentration issues.

Th
    h
   
h

  such as procedures for loan approval and the booking of loans,
including documentation requirements.




 
 

 







 
 . The heart of the bank¶s
lending business is granting sound, collectible loans. Therefore, these
standards should be set so that they result in a portfolio of sound loans,
but shouldn¶t be so stringent that they screen out legitimate borrowers or
inadvertently discriminate against a class of potential borrowers that is
protected by antidiscrimination laws.





 
. This is an

essential element for the ongoing monitoring of the lending function.

h    
h


 h
 
 



  and the resulting reserves. Normally,
management will calculate and recommend the provisions and reserves
for loan losses, but the directors are ultimately responsible for its
adequacy.


 
    (amount of funds and, hence,

bank capital committed) to individual borrowers, related borrowers or to
specific types of industry (agricultural, auto, real estate or aircraft
manufacturers, for example). With respect to these concentrations, banks
often establish an in-house lending limit, an amount less than the legal
lending limit. Some banks adopt this limit to diversify risk, but then
include in their policy a procedure for approving larger loans on a case-by-
case basis.

 
h


hhh
. Many banks

define their trade area as the area from which a high percentage, such as
75 or 80 percent, of their loan and deposit business is derived. In defining
the trade area, it is important the bank ensures that no low or moderate-
income areas are excluded.

c
 h


. Out-of-territory loans inherently carry
higher risk than do comparable loans closer to home, if for no other
reason than their physical remoteness and the resulting servicing
difficulties. There can be a sound and logical reason for an out-of-territory
loan, however, and, as a result, policies often include a procedure for
consideration and approval of such loans.

c  
h

 . Factors often considered include asset and
liability management (liquidity and market risk exposures), concentration
of credit issues and credit quality matters such as whether purchased
loans meet the bank¶s underwriting and servicing standards.

c
  
  . Bank insiders are directors, officers and

principal shareholders. Loans to insiders are the subject of specific
regulatory restrictions, examiner scrutiny and restrictive legal limits. They
therefore require special attention by the board of directors. Some banks
choose to impose even stricter in-house limits that go beyond legal limits
on loans to any one insider and to his or her related interests, as well as
on the aggregate of loans to all insiders. Violations of the loans to insider
rules can result in fines and penalties.

 


h 

 
 




  
. This also includes the manner and
degree of involvement of the directors, through their loan committee or
comparable function. The objective is to delegate authority to loan
officers, commensurate with safety and soundness considerations, for the
sake of efficiency, while retaining director involvement for unusual or
large credits. Individual officer's lending approval limits should be geared
to his or her experience: The senior commercial lending officer may have
an approval limit that approaches the bank¶s legal or in-house lending
limit in size, while the junior installment officer may have a limit of only a
few thousand dollars. Some banks permit two or more loan officers to
approve a loan jointly and ³pool´ their individual lending limits. Many
banks require loans over a certain size to be approved by a loan
committee consisting of senior lending officers and one or more outside
directors.

c

 
 . Loan administration covers all aspects of individual

loans and the overall loan portfolio, including loan applications and
documentation, approval, servicing, collection and loan review.

c


  . To meet the needs of larger borrowers and to

increase loan income, many community banks utilize loan participation
agreements in which two or more banks share in the ownership of a loan.
Because these arrangements can present unique risk issues, banks
involved in participations should have policy guidelines for participation
agreements. The policy should require a complete analysis of the credit
quality of obligations to be purchased, evaluation of the collateral and the
maintenance of full credit information for the life of the participation.

 


 . Loans to be sold in the secondary market,

such as 1-4 family residential loans, also have a unique set of
requirements and must follow strict standards. Banks involved in this type
of lending should have policy guidelines that address such matters as
originating, underwriting, and servicing of secondary market loans.

j
. Fair lending has come to the forefront of regulatory

concern. It is to the benefit of all banks to address fair lending issues in
the loan policy, both to ensure that the bank does not accidentally violate
the fair lending regulations and to demonstrate that it is committed to the
principles of fair lending.

Other miscellaneous issues included are such matters as nonaccrual loans,

collections and charge-offs, concentrations of credit, credit file
maintenance, financing of other real estate, lender liability, loan pricing,
maximum maturities, maximum ratio of loan amount to collateral value,
appraisal guidelines and off-balance-sheet activities.

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