Best Practices in Loan Review: Loan Review Governance (Part 1)
This post is first of a three-part series. [Printer friendly version]
The loan portfolio is the largest asset on a financial institution’s balance sheet and the largest driver of income. It can also be the greatest source of risk. Oversight and management of the loan portfolio ultimately rests with the Board of Directors, although many financial institutions have adopted the practice of loan review to provide an additional level of assurance around the institution’s largest asset.
The Board of Directors plays a crucial role in the development and oversight of a loan review program. The process begins with the policies that have been adopted by the Board of Directors to set the tone and the credit culture of the organization. The loan review policy should identify the objectives of the loan review program. For example, the objective of the loan review could state to provide assurance that credit policies and processes are being followed and that the risk of the loan portfolio is properly identified. Per the Office of the Comptroller of the Currency (OCC), “The board and senior management must ensure that a suitable framework exists to identify, measure, monitor, and control credit risk. Board-approved policies and procedures should guide the risk rating process.”
Responsibilities of the Board of Directors are to:
- Adopt polices
- Enforce policies
- Assign responsibility and accountability for the risk rating process
- Monitor the loan portfolio
- Maintain and adequate Allowance for Loan and Lease Losses (ALLL)
Appropriate oversight from the Board of Directors with direction from the Audit or Supervisory Committee is a critical component to an effective loan review program. This is true regardless if the loan review function is the responsibility of an internal department or provided through a third-party vendor. The loan review manager or designee should ideally report both functionally and administratively to the Audit or Supervisory Chairperson who then reports to the Board of Directors. This structure provides for independence in the loan review process and creates separation from the influences of the loan origination and underwriting process. If the loan review process is outsourced, the service agreement should be addressed to and reviewed, approved and signed by the Audit or Supervisory Chairperson.
More and more community-based financial institutions are outsourcing their loan review needs as they find it to be a more efficient, effective, and independent approach. Voids can exist in the communication process in this vendor/customer relationship if a direct link between the audit committee designee and the loan review contact is not made early in the relationship. This void can provide for a lack of clarity with the observations from the loan review engagement, thereby reducing the effectiveness of the money spent on risk management. So, clarifying expectations and setting up clear channels of communication are vital in a successful engagement with a third-party vendor.
The loan review policy should also incorporate key components of the loan review program to provide a framework and clear understanding and expectation of what will be accomplished. The Audit Committee should be actively involved with input into the scope and provide communication of results and findings to the board of directors.
Proper oversight at the board level for appropriate policies, scope, and independence in the loan review and reporting process will create the transparency and visibility at key levels of the organization to better evaluate the state the organization. Without this level of transparency and independence, the Board of Directors, the Audit Committee, and Senior Management may be disadvantaged in their efforts to monitor the loan portfolio.
Is your loan review process structured appropriately to maximize the benefit for the critical risk management function? The following are a few questions to consider when determining if your loan review process is structured appropriately:
- Is the Board of Directors appropriately engaged?
- Is the Audit or Supervisory Committee a significant component to the oversight of the loan review function?
- Is there sufficient independence in the loan review process?
- Are appropriate loan review policies in place?
- Are the results of the loan review engagement filtered through senior management?
- Is there an appropriate scope for the loan review procedures?
If your answer is no to any of these questions, we can help.
Please give us a call to determine how we can enhance the value to your institution of the loan review function.
Enlighten Financial is a specialized consulting firm that focuses on loan review and risk management services to community banks and credit unions. Enlighten Financial has made it our business to shed light on the complex financial landscape, and lead clients in the right direction. We work with financial institutions and other providers to mitigate risk. To talk to us directly, please call: (920) 445-8881.