Important Elements of a Written Loan Policy

Important Elements of a Written Loan Policy

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1)     One of the most important ways a bank can make sure its loans meet regulatory standards and are profitable is by establishing a written loan policy. A loan policy gives loan officers and the bank’s management specific guidelines in making some loan decisions and in shaping the over all portfolios of the bank. The following are the most important elements of a Written Loan Policy;
     1.     Statements of Lending: A statement that defines the type of loan, its maturities, quality and the size of loans.
     2.     Establish a Lending Authority: It should clearly define who is authorized to a loan
     3.     Establish Lines of Responsibility: It is making sure that all the information is reported to its department.
     4.     Operating Procedure: There should be appropriate operating procedures for soliciting, reviewing, evaluating, and making decisions on customer loan application.
     5.     Required Documents: All the required documents should be obtained for every loan application and must be filed properly.
     6.     Lines of Authority: Responsibility for maintaining and reviewing the bank’s credit files should be well defined.
     7.     Guidelines: Proper guidelines must be given as to how you can take a loan, evaluate it and perfect a loan.
     8.     Policies’ & Procedures: Policies’ & Procedures for establishing interest rates, payments, fees and repayments must be present.
     9.     Establish Quality Standards: A statement of quality standards applicable to all loans. That is, if a person does not meet the standards then the loan should be denied.
     10.     Establishing Upper Limit to Loans: A statement defining the upper limit to a loan beyond which a loan cannot be allowed
     11.     Define its Community: A description of the bank’s principal trade area, which most loans should come from.
     12.     Trouble Loan: A discussion of the preferred procedures for detecting, analyzing, and working out problem loan situations.
               
     For loan to be good three conditions should be fulfilled, ie. First that the borrower should be creditworthy. Which could be known by a detailed study of the following six aspects:
     •     Character: The loan officer must know the purpose of the loan and make sure that the customer will be able to make the repayment of the loan. He should also determine that the borrower has a responsible attitude towards using borrowed funds, is truthful in answering the bank’s questions and willing to make every effort to repay what is owned.
     •     Capacity: The loan officer must make sure the borrower has the authority to request a loan and the legal standing to sign a loan agreement.
     •     Cash: The loan officer should make sure that the borrower has a stable stream of income and the ability to repay the loan.

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     •     Collateral: The loan officer should see to it that the borrower posses adequate net worth or own enough quality assets to provide adequate support for the loan.
     •     Conditions: The loan officer must be aware of the recent trends in the borrower’s line of work or industry and how economic trends might affect the loan.
     •     Control: The loan officer must see that the loan request meets the bank’s and the regulatory authorities’ standards for loan quality. And also make sure whether changes in law and regulation would adversely affect the borrower
Secondly a loan agreement should me properly structured and documented to satisfy the needs of both borrower and the bank.
Thirdly is to perfect a loan. That is getting a pledge of certain borrower assets as collateral behind a loan, which serves two purposes. First that the bank has the right to seize and sell the assets if the borrower is unable to repay the loan. Secondly, collateralization of a loan gives the lender a psychological advantage over the borrower. Because specific asset is important to the borrower and he feels more obligated to work hard to repay the loan.

2)     For most banks, ,business loans rank among the most important loans made. Banks lend short as well as long term loans to business, but usually prefer short term loans as it involves less risk involved. On the other hand consumer loans are also getting popular these days, but are considered costly and risky for a bank as the financial situations of individuals and families can change quickly due to illness or loss of employment. For lending a business loan the following things are taken under consideration
     •     Control over expenses: A firms ability to control their expenses is observed closely by the bank. Management of the firm also plays am important role in this as it shows how efficient the management is.
     •     Liquidity Position: The firms liquidity position reflects its ability to raise cash in timely fashion at reasonable cost, including the ability to meet the loan payment when they are due.
     •     Coverage Ratio: Ratios indicating that the firm as enough cash inflows to repay the loan is measured.
     •     Market share distribution: In order to generate adequate cash flows to repay a loan, the business customer must be able to market its goods, services or skills successfully. A bank often assess public acceptance of what the business customers has to sell by analyzing such factors as the growth rate of sales revenue, change in business customer’s share of the available market and the gross profit margin of the firm.
     •     Debt Equity Ratio: A bank has to make sure of the firm will be legally allowed to take more debt. And also that the borrower can generate earnings that exceed the cost of debt, thereby increasing the potential returns to a business.
     •     Operating Efficiency: The bank has to see how effectively are the assets being utilized by the business to generate sales and cash flows and how effectively are sales converted into cash.
     •     Nature of Contingent Liabilities: The bank must be aware of the potential claims against the borrower which do not appear on the balance sheets, for example taxes owed but unpaid, unfunded pension funds etc.
     Where as the following thing s are taken under considerations while approving for a consumer loan:
     •     Character & Purpose: The loan officer must be assured that the borrower feels keen sense of moral responsibility to repay a loan fully and on time. Moreover his income level and valuable assets must be sufficient to reassure the loan officer that the customer has the ability to repay the loan with a comfortable margin of safety.
     •     Income Level: The size and stability of an individual’s income are considered important by a consumer loan officers.
     •     Employment and Residential Stability: An individuals duration of employment is also taken in to consideration. Usually loan officers do not grant sizable loans to someone who has held his or her present job for only a few months. Length of residence is also frequently analyzed because the longer a person stays at one address, the more stable his or her personal situation is considered.
     •     Pyramiding of Debt: The loan officer are usually sensitive to evidence that debt is piling up relative to a consumer’s monthly or annual income.
     •     Deposit Balances: An indirect measure of income size and stability is the daily average deposits balance maintained by the customers, which the loan officer normally verify with the bank involved.
     
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