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Lending & Credit Risk Portfolio Risk & CECL Loan Review and Due Diligence

Credit review systems: Does yours make the grade?

Dev Strischek
April 12, 2023
Read Time: 0 min

Building a strong credit review process

A critical element of monitoring is an organization’s credit risk rating system. This blog will examine credit review in more detail. 

You might also like this whitepaper: "2022 Loan Review Benchmark Survey Results."

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Takeaway 1

Loan review, or credit review, must be timely, thorough, and accurate to meet regulatory requirements.

Takeaway 2

Proper credit grading should not only involve loan officers, but also an independent reviewer. 

Takeaway 3

Abrigo staff can partner with your institution to present a customized business case for loan review automation.

Introduction

Regulatory expectations for credit review systems

Financial institutions work hard to make sure their credit review systems have been perfected to meet regulatory expectations. And regulatory expectations for an effective loan review system often include objectives such as: 

  • identifying promptly loans with well-defined credit weaknesses so that timely action can be taken to minimize credit loss
  • reporting essential information for determining the relevant trends affecting the collectability of the loan portfolio and isolate potential problem areas 
  • evaluating the activities of lending personnel 
  • assessing the adequacy of, and adherence to, loan policies and procedures
  • providing the board of directors and senior management with an objective assessment of the overall portfolio quality 
  • providing management with information related to credit quality that can be used for financial and regulatory reporting purposes 

The first objective’s call for prompt identification of weak loans infers that these loans are being monitored regularly, and a critical element of monitoring is an organization’s risk rating system, so let’s examine credit grading in more detail. 

Roles and responsibilities

Risk rating systems: Who picks the numbers?

Accurate and timely credit grading is a primary component of an effective loan review system. Credit grading usually integrates the assessment of credit quality, identification of problem loans, and the assignment of risk ratings. An effective system gathers data for use in setting an allowance based on the aggregation of individual loans’ credit risk estimates for loans and leases, as appropriate. 

Credit grading systems often place primary reliance on loan officers for identifying emerging credit problems because they are typically the closest to the borrowers. The initial credit grade may change as it moves through the approval process, but many organizations hold the account officer, relationship manager, or the lender responsible for the initial rating. However, given the subjective nature of credit grading, a loan officer’s judgment regarding the assignment of a specific credit grade should generally be subject to review. Reviews may be performed by peers, superiors, loan committee(s), or other internal or external credit review specialists. 

Independent loan review

Lenders write numbers, independent loan reviewers review them

Credit grading reviews performed by individuals independent of the lending function are preferred because they can often provide a more objective assessment of credit quality. A loan review system builds on the credit grading system and typically includes the following: 

  • A formal credit grading system that can be aligned with the framework used by federal regulatory agencies, especially the criticized (special mention) and classified (substandard, doubtful, non- accrual, and loss) categories 
  • An identification of loans or loan pools that warrant special attention, particularly in terms of watchlist loans (usually the loans in the lowest pass grade), concentration concerns (largest individual borrowers, industry, geography), specialized lending needs (agricultural lending, asset-based lending, commercial real estate, energy lending) 
  • A mechanism for reporting identified loans, and any corrective action taken, to senior management and the board of directors (consider a monthly problem loan-loan review credit quality report to management and the board 
  • Documentation and reporting by credit risk management or other appropriate organizational function of an institution’s credit loss experience for various components of the loan and lease portfolio (information needed for maintaining and calibrating loan loss reserve, anyway) 

Conclusion

A checklist for ensuring objective credit review

Groucho Marx once said, “Those are my principles, and if you don’t like them . . . well, I have others.” Despite Groucho’s flexible standards, we need a loan’s credit grades to sum up its current credit condition as consistently and objectively as possible. So, to ensure your own organization’s objective assessment of credit quality, consider this checklist: 

An effective independent loan review system has always been critical for managing a financial institution’s credit risk and accurately estimating the allowance for loan and lease losses. Remember, loan grading is more than picking number; those numbers add up to big payoffs in monitoring and managing your loan portfolios. 

 

Learn more: Develop or enhance your risk rating system.

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About the Author

Dev Strischek

Principal
A frequent speaker, instructor, advisor and writer on credit risk and commercial banking topics and issues, Dev is principal of Devon Risk Advisory Group and engages in consulting, speaking and training on a wide range of risk, credit, and lending topics. As former SVP and senior credit policy officer at

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About Abrigo

Abrigo enables U.S. financial institutions to support their communities through technology that fights financial crime, grows loans and deposits, and optimizes risk. Abrigo's platform centralizes the institution's data, creates a digital user experience, ensures compliance, and delivers efficiency for scale and profitable growth.

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