As is the case with the ficticious Insights Bank and Trust, inevitably there will be lending opportunities that are not covered by the bank’s loan policy. These are called policy exceptions. Policy exceptions are simply that – exceptions to policy. This doesn’t necessarily mean they pose any more credit risk than a loan that is not an exception to policy. Instead, they have unique features or special characteristics that require more attention than a loan that falls within policy bounds. Rather than immediately exclude these proposals from consideration, find out why they are exceptions to policy and determine if the basis for the exceptions present unacceptable risk. If loan exceptions do present unacceptable risk, there may be ways to mitigate the risk with more collateral or through third-party guarantees, for example, in order to bring the risk to an acceptable level.
Depending upon circumstances, however, policy exceptions can serve as a warning tool. Care should be used with approvals that are exceptions to policy. They should not be so numerous that they constitute a “de facto” standard. If, for example, the board is reviewing and/or approving a large number of policy exceptions, it may be an indication of other issues. It may be that the board’s risk tolerance has changed and the loan approvals reflect the need to update the loan policy to reflect the new risk view. It might also mean that the board is ignoring the loan policy, negating its effectiveness as a risk management tool.
To get a better understanding of how policy exceptions are used at your bank, review the Try This At Your Bank: Policy Exceptions exercise.
A useful report to help you track exceptions is one that shows the number or volume of loans (those above a certain dollar amount) approved as exceptions to policy versus the number or volume of loans that are not.
A large and growing number of exceptions can serve as a red flag prompting questions to senior management about exceptions and whether or not action is needed to deal with them. If exceptions are large or growing over time, consult with management to see if the loan policy should be updated or whether greater measures should be taken to adhere to policy.