What happens to a loan agreement after the borrower and the bank have endorsed it?
Should it be filed away and forgotten until the loan falls due and the borrower makes the final payment?
Obviously, that would be a foolish thing for a bank because the conditions under which each loan is made are constantly changing, affecting the borrower’s financial condition and their ability to repay a loan.
Fluctuations in the economy weaken some businesses and increase the credit needs of others. At the same time, individuals may lose their jobs or contract serious health problems, imperiling their ability to repay any outstanding loans.
The bank’s loan department must be sensitive to these developments and periodically review all loans until they reach maturity.
Loan review refers to examining outstanding loans to make sure borrowers adhere to their credit agreements and the bank follows its loan policies.
While banks today use various loan review procedures, a few general principles are followed by nearly all banks.
These include:
- Carrying out reviews of all types of loans periodically – for example, every 30, 60, or 90 days.
- Structuring the loan review process carefully to make sure the most important features of each loan are checked, including:
- The record of borrower payments to ensure that the customer is not falling behind the planned repayment schedule.
- The quality and condition of any collateral pledged behind the loan.
- The completeness of loan documentation ensures the bank has access to any collateral pledged and possesses the full legal authority to take action against the borrower in the courts if necessary.
- An evaluation of whether the borrower’s financial condition and forecasts have changed may have increased or decreased the borrower’s need for bank credit.
- Examiners from the regulatory agencies will assess whether the loan conforms to the bank’s lending policies and the standards applied to its loan portfolio.
- Reviewing most frequently the largest loans, because the default on these credit agreements could seriously affect the bank’s financial condition.
- Conducting more frequent reviews of troubled loans, with the frequency of review increasing as the problems surrounding any particular loan increase.
- Accelerating the loan review schedule if the economy slows down or if the industries in which the bank has made a substantial portion of its loan develop significant problems.
A loan review is not a luxury but a necessity for a sound bank lending program. It helps management spot problem loans more quickly and acts as a continuing check on whether loan officers are adhering to the bank’s loan policy.
For this reason, and to promote objectivity in the loan review process, many of the largest banks separate their loan review personnel from the loan department itself.
Loan reviews also aid senior management and the bank’s board of directors in assessing the bank’s overall exposure to risk and its possible need for more capital in the future.