FINANCIAL SERVICES VOLUNTEER CORPS

Developing Examiner Guidelines for Evaluating Commercial Bank Internal Control(Credit Risk Management)

Banque d’Algerie (BdA)June 14-18, 2009

Presented by:Robert Lyon, Retired Credit Risk Officer FRB

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Credit Risk Management• Do Loans Comply with the Loan Policy?

- Approval process- Collateral valuation- Loan limits- Loan concentrations

IndustryGeographicLoan types

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Lending Controls• Lending Process

• Key Information

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Lending Process• Request• Presentation• Approval• Documentation• Funding• Review• Monitoring

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Key Information• Amount• Purpose• Yield• Term• Collateral• Agreement / Documentation• Repayment schedule

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Sampling of Loan files• Purpose• Disposition of proceeds• Repayment schedule• Financial statements• Memoranda of discussions with

borrower

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Problem Loans• Definition – past due or restructured• Action plan for remediation• Loan loss reserve allocation• Identification and Migration analysis• What did management learn?

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Does the Board Know• Total credit exposure• Lending activities• New credit extensions• Overdrafts• Past due loans• Watch list loans• Insider loans• Anticipated charge-offs

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Internal Loan Review• Internal Loan review thoughts• Loan Review / Rating Objectives• Characteristics of Loan Review

Program• Risk Rating / Credit Grading Systems• Personnel involved Risk Rating

System• Risk Rating Elements

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Loan Review – Loan Rating Objectives

• Consistent application• Are weak loans promptly identified?• What are the trends?• Are internal Credit policies followed?• Provide management with accurate

information– Financial and regulatory reporting– Adequacy of loan loss reserve

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Characteristics of Loan Review• Responsibilities defined• Explicit description and definitions• Capacity for judgment• Freedom to communicate• Performed by skilled personnel

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Credit Grading Systems• Problem Loans – quarterly• Large exposures – quarterly• Sampling size• Performed by

– Loan Officer– Independent credit review specialist

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Credit Grading Systems (continued)

• Assessment independent of the lending function preferred

• If loan officer used for grading, review by:– Peers, superiors, or loan committee– Independent department– External third party consultant

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Risk Rating Elements• Scope of reviews• Depth of reviews• Review of findings• Follow-up – correction action• Report Distribution

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Loans to Directors, Officers, Employees, and Shareholders

• Can be the best loans• Can be the worst loans• Best Practices

– No preferential treatment– Same terms as other borrowers– Annual reporting to the Board and

Supervisor

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Fraud by Insiders• Also called White collar crime• Results from weak internal controls• Dominant insider misuses position• Fails to disclose interests• Diverts bank assets and income• Accepts bribes and gratuities

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Controlling Abuse• Regular internal/external audits• Review of all insider transactions• Follow-up on exceptions• Pre-screening of new officers and

directors• Follow the money

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Examiner Conflict of Interests• Purpose – ensure integrity and

objectivity• Restrictions

– No gifts or gratuities from any bank– Reporting of indebtedness– For EIC, 18 month window for employment– May not participate in an examination where

• A family member employed• A loan from• Previous employment held• Other