|5. Allowance for Loan & Lease Losses|
|What you need to know||Join the meeting||Review the Reports||The board's response|
|Is There An
|ALLL Written Policies
|The ALLL is a reserve maintained to cover possible future losses in
the bank's loan and lease portfolio at the time the portfolio is evaluated for credit risk. An
appropriate reserve is one that will cover these potential losses.
Did you notice the exchange between Mike and his sister Madison? Basically, Madison believes that simply replacing what was charged off is not enough. She sees that loan volume has grown rapidly and that problem loans (delinquent loans) are increasing. She believes Insights Bank will need additional reserves in the future, based on trends in the bank's loan performance. Simply replacing what was charged off, as Mike wants to do, doesn't address these trends and isn't positioning the bank to deal effectively with the losses it is likely to face.
Madison's analysis is right on target, but she still voted for Mike's recommendation. Her unwillingness to vote "no" is instructive. As an outside director, you are an independent voice on the board. If you've considered all of the information presented and you feel that something is not in the best interest of the bank, don't vote for it!
Sometimes this can be difficult, especially if others on the board strongly support what is being proposed. However, serving your bank well may mean occasionally taking an unpopular position. And remember, if everyone votes the same way on every issue, board members may not be exercising independent judgment which is an important part of your responsibilities as a director. In this case, Madison appears to be more concerned with not rocking the boat than with standing up for what she believes to be right. How are Disagreements Among Board Members handled at your bank?
To determine an appropriate reserve, a bank must be able to recognize its loan problems. The bank's loan review process is an essential tool in identifying problem loans. A basic objective of the loan review is to identify loans with weaknesses that could jeopardize their collectibility so that the bank can take action to minimize loss. Another important objective of a loan review is to identify possible future losses in the loan portfolio and to determine whether the ALLL balance can absorb these losses.
Banks use two calculations FAS 114 and FAS 5 to estimate an appropriate ALLL balance. The FAS 114 component consists of the estimated loss on impaired loans that are reviewed individually. The FAS 5 component is the estimated loss in homogenous groupings of loans with similar risk characteristics. The sum of the FAS 114 and FAS 5 components constitute management's best estimate of an appropriate reserve balance.
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