William Chittenden edited and updated the PowerPoint slides for this edition.
CREDIT POLICIES AND
PROCEDURES: MANAGING
CREDIT RISK
Chapter 5
Key topics
1. Types of loans banks make
2. Factors affecting the mix of loans made
3. Regulation of lending
4. Creating a written loan policy
5. Steps in the lending process
6. Loan review and loan workouts
16-2
Types of loans made by banks

Real estate loans

Commercial and industrial loans

Loans to individuals

Financial institution loans

Agriculture loans

Miscellaneous loans

Lease financing receivables
16-3
Loans outstanding for U.S. Banks (2007)
16-4

Regulation of lending: CAMELS rating system

Capital adequacy

Asset quality

Management quality

Earnings record

Liquidity position

Sensitivity to market risk
16-7
Asset quality

Criticized loans: performing well but lender
have minor weakness

Scheduled loans: containing significant
weakness or showing dangerous
concentration of credit in a borrower/industry
16-8
Asset quality

Adversely classified loans: carrying risk of not
paying out as planned

Substandard loans: margin of protection is
inadequate due to weakness in collateral of the

interest, taking into account net realisable value of collateral.
5. Loss: Loans that are considered uncollectable after all collection
options (such as the realisation of collateral or the institution of legal
proceedings) have been exhausted.
Establishing a good written loan policy
1. Goal statement for bank’s loan portfolio
2. Specification of lending authority of each loan
officer and committee
3. Lines of responsibility in making assignments
and reporting information
4. Operating procedures for soliciting, evaluating
and making loan decisions
5. Required documentation for all loans
6. Lines of authority for maintaining and
reviewing credit files
16-13
Bank’s written loan policy (cont.)
7. Guidelines for taking and perfecting collateral
8. Procedures for setting loan interest rate
9. Statement of quality standards for all loans
10. Statement of upper limit for total loans
outstanding
11. Description of the bank’s principal trade area
12. Procedures for detecting, analyzing and
working out problem loans
16-14
Steps in the lending process
1. Finding prospective loan customers
2. Evaluating a customer’s character and sincerity
of purpose


Reasons for taking collateral:

Proceeds of collateral sale is to cover loans

Collateralization gives lenders a psychological
advantage over the borrower

The lender’s perfected claim: a lender holds
claim standing superior to claims of other lenders
and the borrower’s own claim.

Procedures for establishing a perfected claim
depends on the nature of assets and laws of the
place where the asset reside.
16-18
Common types of loan collateral

Types of collateral:

Accounts receivables

Factoring

Inventory

Real property

Personal property


Copies of board of director’s resolutions or
partnership agreements

Credit ratings – Dun & Bradstreet, Moody’s,
Standard & Poor’s

New York Times, Wall Street Journal, other
business publications

Risk management associates (RMA), Dun &
Bradstreet industry averages

The world wide web
16-22
Information about governments

Government budget reports

Credit ratings assigned to government
borrowers by Moody’s, Standard & Poor’s,
Fitch

Web
16-23
Lending the old fashioned way? (box)

Traditional lending model

Deregulation of the 1980s and 1990s
