Unformatted text preview: 5/20/2020 Bank Management - Formulating Loan Policy - Tutorialspoint Bank Management - Formulating Loan Policy Basically, loan portfolios have the largest effect on the total risk profile and earnings performance. This
earning performance comprises of various factors like interest income, fees, provisions, and other factors
of commercial banks.
The mediocre loan portfolio marks approximately 62.5 percent of total centralized assets for banking
organizations with less than $1 billion in total assets and 64.9 percent of total centralized assets for
banking organizations with less than $10 billion in total assets. In order to limit credit risk, it is compulsory that suitable and effective policies, procedures, and practices
are developed and executed. Loan policies should coordinate with the target and objectives of the bank,
in addition to supporting safe and sound lending activity.
Policies and procedures should be presented as a layout for all major credit decisions and actions,
enclosing all material aspects of credit risk, and mirroring the complexity of the activities in which a bank is
engaged. Policy Development
As we know risks are inevitable, banks can lighten credit risk by development of and cohesion to efficient
and effective loan policies and procedures. A well-documented and descriptive loan policy proves to be
the milestone of any sound lending function.
Ultimately, a bank’s board of directors is accountable for flaying out the structure of the loan policies to
address the inherent and residual risks. Residual risks are those risks that remain even after sound
1/2 5/20/2020 Bank Management - Formulating Loan Policy - Tutorialspoint internal controls have been executed in the lending business lines.
After formulating the policy, senior management is held accountable for its execution and ongoing
monitoring, accompanied by the maintenance of procedures to assure they are up to date and compatible
to the current risk profile. Policy Objectives
The loan policy should clearly communicate the strategic goals and objectives of the bank, as well as
define the types of loan exposures acceptable to the institution, loan approval authority, loan limits, loan
underwriting criteria, and several other guidelines.
It is important to note that a policy differs from procedures in which it sets forth the plan, guiding
principles, and framework for decisions. Procedures, on the other hand, establish methods and steps to
perform tasks. Banks that offer a wider variety of loan products and/or more complex products should
consider developing separate policy and procedure manuals for loan products. Policy Elements
The regulatory agencies’ examination manuals and policy statements can be considered as the best place
to begin when deciding the key elements to be incorporated into the loan policy.
In order to outline loan policy elements, the bank should have a consistent lending strategy, identifying the
types of loans that are permissible and those that are impermissible. Along with identifying the types of
loans, the bank will and will not underwrite regardless of permissibility. The policy elements should also
outline other common loan types found in commercial banks.
The major policy elements for a bank are −
A statement highlighting the features of a good loan portfolio in terms of types, maturities, sizes,
and quality of loans. In short, a goal statement for entire loan portfolio.
Stipulation of lending authority prescribed to each loan officer and loan committee. The main task
of loan officers and loan committee is to measure the maximum amount and types of loan
approved by each employee and committee and what signatures of approval are needed.
Boundaries of duty in making assignments and reporting information.
Functioning procedures for soliciting, examining, accessing and making decisions on customer
The documents required for each loan application and all the necessary papers and records to
be kept in the lender’s files like financial statements, pass book details, security agreements, etc.
Lines of authority and accountability for maintaining, monitoring, updating and reviewing the
institution’s credit files.
Loan policies vary significantly from one bank to another. It is completely based on the complexity of the
activities they are engaged in. The policy elements of a private bank may slightly differ from the
government bank. Anyhow, a general loan policy incorporates specific basic lending tenets. 2/2 ...
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