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3 Common Loan Review Weaknesses

Kylee Wooten
December 10, 2021
Read Time: 0 min

Avoiding common loan review process obstacles

Three common weaknesses within the loan review process can prevent a loan review department from being fully effective.

 

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This article is substantially updated from a 2015 blog post.

Loan review is a periodic review of bank and credit union loan portfolios in order to gauge their overall risk profiles. The assessment of loan portfolio quality is then provided to senior management and the board of directors. This assessment often provides an early warning of deterioration(s) in credit quality and allows management to take steps to mitigate the risks.

The scope of the review and the way it is performed will vary from institution to institution. However, there are a few fundamental principles that should be followed within every loan review. As highlighted in a recent Abrigo whitepaper, Effective Loan Review, the following components should be included in their loan review function:

  • Review for accuracy of credit grades assigned by lenders
  • Review of the quality of credit underwriting
  • Identification of any deviations from loan policy guidelines
  • Confirmation of borrowers’ compliance with loan covenants

Unfortunately, loan review departments often have weaknesses that can prevent them from being fully effective. Ancin Cooley, CIA CISA, Principal and Founder of Synergy Bank Consulting and Synergy Credit Union Consulting, outlines three common loan review weaknesses: a lack of independent assessments, poor documentation and reporting, and a lack of talent development.

 
Remain Objective

Lack of independent assessments.

According to Cooley, when an examiner criticizes loan review, the source of scrutiny usually involves risk rating discrepancies. It often concerns the samplings, the depth of review, and any differences found in risk ratings between loan review and examiners. Unfortunately, when examiners are studying loan review, they aren’t always looking at the same information. Cooley explains that an independent assessment will pull the current files and compare them against the original information for any discrepancies.

As stated in the 2020 Interagency Guidance on Credit Risk Review, “An independent assessment of risk is achieved when personnel who perform the loan review do not have control over the loan and are not part of or influenced by individuals associated with the loan approval process.”

The independent assessment should include an evaluation of your processes and procedures. Cooley recommends an independent assessment occur every two to three years. This helps you be better prepared for examinations.

 
Documentation

Detailed reports supported by data

Cooley often sees loan review reports with risk rating changes, issues with ticklers, or a general lack of updated financial statements. However, one of the most pressing issues is a lack of proper documentation for the root cause of the issue. Financial institutions should include a synopsis that is supported by data and provides the board with enough information to make informed decisions. Board members should be able to see more than just a loan moving from pass to substandard – they should know the drivers behind it. “You have to tell the story of how the credit risk in your institution is changing from one period to another,” says Cooley.

Information challenges are a significant issue for many banks and credit unions, even beyond the loan review function. The loan review process requires loan-level information that often needs to be pulled from different sources within the institution, including the core processing system, third-party software solutions, and usually a number of manually maintained spreadsheets. Getting current data to the appropriate parties and reporting on the loan portfolio from these various stovepipe systems can prove difficult and can make the loan review process more cumbersome.

Given the volume of loans that a typical financial institution has, it’s no surprise that many banks and credit unions find getting the necessary data to be the biggest challenge related to loan review. In Abrigo’s survey, getting data was cited most frequently by respondents (37%).

Invest in Staff

Lack of talent development

Within loan review and other areas of your institution, you’re often only as strong as your weakest link. Not properly investing in your talent can lead to issues like turnover, errors, or inefficiencies. But “investing” goes beyond compensation.

Financial institutions must invest in the time (and expense) of properly training your loan review department, Cooley explains. An effectively trained loan review staff can detect issues before they become costly. This saves money in the long run – often many times more than the initial training investment. Retaining the employees you invest in is also important, according to Cooley. In addition to proper compensation, he recommends walking employees through the organizational chart to demonstrate internal growth potential. It is often easier to organically grow individuals within your institution’s culture than it is to continuously hire from the outside. Particularly for internal loan review departments, personnel must have the skills to understand the loan portfolio and the overall credit culture of the institution, skills on par with their counterparts on the lending side.

Considerations for staffing the loan review function:

  1. Education and formal training
  2. Knowledge of all loan types in the portfolio
  3. Familiarity with the loan review process, including work paper standards 
  4. Understanding of the bank’s credit policy and pertinent regulations
  5. Diversity of experience among loan review personnel
  6. Esteem within the organization

The loan review process is important for the overall health of the bank or credit union. Financial institutions that address these common areas of loan review weaknesses can bolster their loan review departments' effectiveness and ensure its safety and soundness.

Learn more about effective loan review with this blog,
"3 Keys to Effective Loan Review."

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About the Author

Kylee Wooten

Media Relations Manager
Kylee manages and writes articles, creates digital content, and assists in media relations efforts

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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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