Will History Repeat Itself Because of Weak Credit Administration?

During the recent economic expansion, profits have soared, organizations
have consolidated and many community banks have quickly built their loan portfolios with the proceeds of borrowed money. While examiners have not yet detected a material up-tick in asset classifications, many of these "growth" loans are not aged, and few of the new banking entrepreneurs have experienced an economic slowdown.

A frequent result is poor credit-administration practices, similar to what contributed to the failures of the late '80s and early '90s. With a few exceptions, there is little evidence of evil intent—simply situations where risk management is sidelined while bankers focus on the next deal.

• What are the common deficiencies cited by regulators?
• Failure to analyze the borrowers' repayment ability.
• Absence (or lack of) adequate real estate appraisals.
• Legal lending limit and insider-lending violations.
• Nonexistent or ineffective internal loan rating/review programs.
• Inaccurate internal "watch lists."
• Deficient loan-loss reserves.

Although the Fed does not want to discourage lending, we do want to encourage financial institutions to follow prudent risk-management practices. Banks with serious deficiencies are often surprised by the size of the losses they incur. So, the time to fix these problems is now, before financially weak borrowers "shake out" and history repeats itself.