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FOS Blog

03 Sep
2015

Steps to Mitigate Your Bank’s Credit Risk

Steps to Mitigate Your Bank’s Credit Risk

Loan portfolios typically have the largest impact on the overall risk profile and earnings of community banks.  A strong credit culture provides a platform for the Bank to compete successfully in its market.   Although credit risk is inevitable, banks can mitigate the risk by taking steps to strengthen its lending program.  The following steps can help assist in providing a framework for a sound lending program:

  • Written Credit Policies-A well-written and descriptive credit policy is the cornerstone of sound lending.  Credit policies should address the inherent and residual risks in lending.
  • Standardized Credit packages-Documented credit request packages should be uniform.  Most credit packages will consist of a request, required supporting documentation, and an analysis/financial review.
  • Experienced Underwriting/Decision Making-Underwriters should effectively apply the Bank’s credit policy and risk guidelines to determine the degree of risk involved in the credit request.  Too many exceptions to policy may suggest that current underwriting guidelines may not be in line with the Bank’s priorities or financial goals.  It is important to gather as much information as possible, both internally and externally in order to make informed decisions on credit requests.
  • Loan Approval Authority-The Bank should document loan approval authorities which are approved by the Board of Directors.  In order to maintain a balance between credit quality and profitable loan portfolio growth, appropriate lending authority controls must exist.  Each loan file should contain documentation of proper approval.
  • Well-Managed Credit Risk Rating System-Well- managed credit risk rating systems promote bank safety and soundness by facilitating informed decision making.  The Bank’s risk rating system should form the foundation for credit risk measurement, monitoring and reporting and should support the board’s objectives.
  • Accuracy of Loan Documentation-Properly executed loan documentation is necessary to ensure the bank has an enforceable claim for repayment, including liquidation of collateral or the right to demand payment.  Documentation must be properly drafted, completed, executed, filed and stamped. A secondary review of this documentation should be in place.
  • Monitoring/Reporting Loan Performance-It is important to identify trends within the loan portfolio and isolate potential problem areas.  Reports to senior management should provide sufficient information for an independent evaluation of risk and trends.
  • Problem Asset Management-When collection problems persist and risk ratings deteriorate, many banks find it beneficial to transfer problem loans to an independent work-out team.
  • Adequate Loan Loss Reserve-The ALLL exists to cover any losses in the loan (and lease) portfolio of all banks.  Adequate management of the allowance is an integral part of managing credit risk.
  • Independent Loan Review and audit-Periodic objective reviews of credit risk levels and risk management processes, as well as independent audits are essential to effective portfolio management.

Loan portfolio and risk management is not just about avoiding risk. It is also about balancing risk while seizing opportunities in your marketplace and serving your community well. So, go for the opportunities while balancing your risk management strategy. It can help make your organization even more successful.

For additional information contact the author Kay M. Scarselli at kscarselli@fosaudit.com.

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