After a number of years of repeated examiner criticism about not having a loan policy, the board of directors of a small rural bank adopted a written loan policy. The examiners, upon arrival for the next examination, found an impressive leather-bound volume that described the full range of the bank’s lending guidelines. In addition to sections on commercial, agriculture, small business and consumer lending, there was a section on how to make aircraft loans. There was also a section on international loans even though the bank didn’t make loans outside the county. As examiners read through the policy, they realized it had been borrowed from another bank. The board of directors didn’t know what was in the policy and the bank’s loan officers hadn’t read it. The policy was worthless as a legitimate guide for the bank’s lending function.

Another illustration comes from a $250 million bank in a metropolitan area where examiners found a 25-page loan policy, written by the board of directors. The policy addressed the terms and conditions of the loans the bank was willing to make and every loan officer had a copy and had read it. It wasn’t elaborate and in some instances wasn’t grammatically correct. It was, however, a solid working document developed by the bank to meet its individual needs and provide lending guidance to its staff

Which illustration best describes your bank’s loan policy?

The reason for presenting these two stories is simple. No two banks face the same economic environment and have the same tolerance for risk. Policies should be tailored to a bank’s specific characteristics and needs. Loan policies exist to benefit the bank and its shareholders by helping the bank make sound credit decisions. A loan policy is not adopted to merely satisfy banking supervisors.

If a policy doesn’t exist, doesn’t adequately address the inherent risk in a bank’s lending or isn’t used, poor asset quality and low earnings are likely results. For example, a 1988 Comptroller of the Currency study found that 86 percent of failed banks had inappropriate loan policies. These banks lacked the necessary systems and controls to guide their staffs in building a consistently performing loan portfolio in good and bad economic times.