Interagency Guidelines Establishing Standards for Safety and Soundness
12 CFR part 30, Appendix A (OCC); 12 CFR part 208 Appendix D–1 (Board); 12 CFR part 364 Appendix A (FDIC); Part 723 of the NCUA Rules and Regulations
By: Stephen Rountree
During Q4 2019, Regulatory agencies published a notice for comments on proposed credit risk review. The existing & proposed guidance is to ‘Establish and highlight the need for credit risk review and establish safety and soundness standards regarding the establishment of an independent and ongoing credit risk review’. A review of existing and proposed regulatory guidance follows.
To be effective, the loan review system should:
Whether internal or third party review is utilized, the reviews should align with the bank’s overall credit risk and loan portfolio complexity. To quote the guidance “effective reviews cover all segments of the loan portfolio that pose significant credit risk or concentrations, and other loans that meet certain institution-specific criteria”. Proper, accurate, and timely loan grades are to be internally assigned. Loan / credit grades are to be reviewed by qualified & independent individuals or departments and can be performed by internal staff. The review process & grade assignment should be independent of the lending process. For smaller, more rural, institutions, if internal review is to be utilized, the staff should not be involved with originating or approving the specific credit(s) being reviewed. To ensure in-house independence, if bank staff are to be used for credit review, their compensation should not be ‘influenced’ by any grade changes.
An adequate scope typically includes:
An integral part of the loan review process is assigning accurate loan grades. The review should include procedures for resolving any differences between the internally assigned grades and those recommended during the credit review process. The Regulatory guidance generally indicates the recommended lower credit rating should be assigned unless “internal parties identify additional information sufficient to obtain the concurrence of the independent reviewer or arbiter on the higher credit quality classification or grade”. The guidance clearly indicates the bank’s board of directors, or a committee, is responsible for ensuring an adequate loan review scope and ensuring sufficient review frequency.
Source: https://www.occ.gov/news-issuances/federal-register/2019/84fr55679.pdf
To be effective, the loan review system should:
- Promptly identify loans with actual and potential credit weaknesses
- Appropriately validate and, if necessary, adjusts risk ratings
- Identify relevant trends that affect the quality of the loan portfolio
- Assess the adequacy of and adherence to internal credit policies and loan administration procedures
- Evaluate the activities of lending personnel
- Provide management and the board of directors with an objective, independent, and timely assessment of the overall quality of the loan portfolio.
- Provide management with accurate and timely credit quality information
Whether internal or third party review is utilized, the reviews should align with the bank’s overall credit risk and loan portfolio complexity. To quote the guidance “effective reviews cover all segments of the loan portfolio that pose significant credit risk or concentrations, and other loans that meet certain institution-specific criteria”. Proper, accurate, and timely loan grades are to be internally assigned. Loan / credit grades are to be reviewed by qualified & independent individuals or departments and can be performed by internal staff. The review process & grade assignment should be independent of the lending process. For smaller, more rural, institutions, if internal review is to be utilized, the staff should not be involved with originating or approving the specific credit(s) being reviewed. To ensure in-house independence, if bank staff are to be used for credit review, their compensation should not be ‘influenced’ by any grade changes.
An adequate scope typically includes:
- Loans over a predetermined size
- Sampling of smaller loans, new loan originations, and new loan products
- Loans with higher risk indicators (i.e. credits approved with exceptions to policy)
- Sampling of portfolios with high concentration risk and/or portfolio segments experiencing rapid growth
- Past due, non-accrual, renewed, and restructured loans
- Loans adversely rated and loans designated as warranting special attention
- Insider Loans
An integral part of the loan review process is assigning accurate loan grades. The review should include procedures for resolving any differences between the internally assigned grades and those recommended during the credit review process. The Regulatory guidance generally indicates the recommended lower credit rating should be assigned unless “internal parties identify additional information sufficient to obtain the concurrence of the independent reviewer or arbiter on the higher credit quality classification or grade”. The guidance clearly indicates the bank’s board of directors, or a committee, is responsible for ensuring an adequate loan review scope and ensuring sufficient review frequency.
Source: https://www.occ.gov/news-issuances/federal-register/2019/84fr55679.pdf