What happens to a loan agreement after it has been endorsed by the borrower and the bank? 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 to do because the conditions under which each loan is made are constantly changing, affecting the borrower’s financial condition and his or her ability to repay a loan.
Fluctuations in the economy weaken some businesses and increase the credit needs of others, while 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 examination of outstanding loans to make sure borrowers are adhering to their credit agreements and the bank is following its own loan policies.
While banks today use a variety of different loan review procedures, a few general principles, are followed by nearly all banks.
- Carrying out reviews of all types of loans on a periodic basis – 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, to make sure 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 which may have increased or decreased the borrower’s need for bank credit.
- An assessment of whether the loan conforms to the bank’s lending policies and to the standards applied to its loan portfolio by examiners from the regulatory agencies.
- Reviewing most frequently the largest loans, because default on these credit agreements could seriously affect the bank’s own 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.
Loan review is not a luxury but a necessity for a sound bank lending program. It not only helps management spot problem loans more quickly but also 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.