Another common issue with financial institutions’ credit policy is the tendency to combine policy, guidance, procedures, and reference materials in one unwieldy document, Kirby said.
For example, when an institution’s credit policy doesn’t have a clear and accessible section on commercial real estate, lenders might have to jump between underwriting, collateral, and financial analysis sections to gather the necessary information.
"You keep these sections self-contained, succinct, and separate so that people can go pull the loan policy for commercial real estate or the credit policy for risk rating or the guidance for construction lending,” Kirby advised. “If you have these things set up in a library format, it makes it a lot easier for people to actually go look at what it is they need to do."
Often, documents' sheer size and complexity mean they often do not get updated as needed. As a result, policies can fail to reflect current practices or regulatory changes, leading to outdated guidelines and unnecessary policy exceptions.
The core of effective credit policy management is having a distinction between policy, guidance, procedures, and reference material, according to Kirby.
- Policy should consist of fundamental principles that are unbreakable. In Kirby’s view, there should be no such thing as a policy exception because policies are foundational statements that apply universally across the enterprise. Policies should be approved at the highest levels, often by the board, and should not be subject to frequent changes.
- Guidance, on the other hand, is more granular and articulates the institution's risk appetites. While a loan policy might dictate that only experienced developers are eligible for construction lending, guidance would delve into the specifics of monitoring and other details. This level of detail mirrors the institution's risk appetite but does not require the same level of approval as policies. Instead, guidance is typically approved at a managerial or enterprise level, such as by a credit policy or executive committee.
- Procedures focus on day-to-day operations. These are the steps a department manager would follow to ensure tasks, like closing a loan, are completed correctly. Banks and credit unions may change procedures often as operational needs evolve, and procedures and changes to procedures do not require the high-level approvals necessary for policies or guidance.
Kirby said a common problem for banks and credit unions is that these procedures often get unnecessarily blended into policy, raising them to a level of scrutiny and approval that isn’t needed.
For instance, requiring financial statements within 120 days as a hard policy is problematic because it creates exceptions for common scenarios, like late tax filings, that are perfectly legal. Such detailed requirements should be categorized as guidance rather than policy to avoid tying the policy framework too tightly. Another example is a credit or loan policy that mandates the inclusion of irrelevant information in a credit approval process, such as requiring a profitability analysis for a loan secured by sufficient collateral from an estate. “This kind of unnecessary detail complicates the approval process and invites unnecessary scrutiny from regulators,” he said.
Keep policies simple, succinct, and focused on unbreakable principles, leaving detailed procedures and reference materials to more flexible and appropriate documents, such as user manuals or guidance.
