Credit Monitoring

By
maintaining
good
communication with the borrowers,
by providing advisory services at
the time of adverse situation and
by collecting information from
outside
such
as
clients
competitors, suppliers, customers,
and regulators and also from
published reports in the daily
newspapers, magazines and trade
publications, a credit officer can
prevent the problem loan before
happening.

Monitoring program should

include
A periodic review of all or selected loans to
ensure that they are consistent with bank
loan policy, documentation requirements,
profitability requirements, and so forth;
A grading of loan quality as measured by
key indicators; and
External and internal audit that consider
not only the quality of banks portfolio, but
may also encompass the entire lending
function from bank loan policy on down.

Scope of Review
Decisions about which loans to be reviewed and
how often largely depends on loan size,
complexity, and the credit review policy of the
institution.
Credit review policy of the institution set
guidelines which area of lending, what maximum
amount of credit, what percentage of total credit
and the circumstances of review. Some institutions
determined that all loans or commitments of over
certain amount or more, regardless of location,
lending area, are eligible for review.
Credit review policy might include large loans and
collateral that could rapidly deteriorate in value
for regular reviews, while loans that fall bellow a
certain amount threshold might not be reviewed
at all.

Approaches of Loan
Review
In passive approach, of loan review, credit
reviewers review the credit files and other loan
documents available to them with or without
discuss with the lending officers, even the
problem loans cases.
In active approach, the reviewer reviews up to
date credit file, comments, appraise value of
equipment or real estate, examine receivables,
payables, inventory, personal statements, more
recent financial statements and so forth in
addition to passive approach

Goal of Loan Review

Function
Prime goal of loan review is to detect problem
loan to reduce loan losses.
Credit reviewer prepares a review report for the
credit officer and for the top management to take
necessary actions. Credit report should includes
the following:
(a)Soundness of loan portfolio, its liquidity and
profitability;
(b) Evaluation of loan officers, loan officer
supervision, adherence to laws and regulations,
loan policy, and loan approval procedures;
(c) Note and collateral departments operations.

A Loan Review Checklist

A loan reviewer should concentrate his/her attention to the
following areas:
Purpose: The reviewer should consider whether the
borrowers use the loan stated for the purpose,
Loan repayment sources and term: Both repayment
sources and term are stated in the loan documents. The
reviewer should evaluate whether loan repayment and sources
are in conformity with the terms and condition stated in the
loan documents,

Financial condition of the borrowers: Loan reviewer

reviews the key elements of the financial statements of the
borrowers and makes comment on whether any improvements
or deterioration in the borrowers cash flow, key ratios, and so
forth,

A Loan Review Checklist

Documentation: By physical inspection of
documents, the borrowers compliance with the
agreements
affirmative
and
negative
covenants should be verified,
Collateral: Many loan losses are a direct result
of collateral that was lost, improperly
documented or in such poor condition that it
had little liquidation value. The loan review
should include physical inspection of collateral
and an examination of collateral records,
Credit checks,
Profitability, and
Regulatory compliance.

Loan Review Systems

Automated reporting, banks use a software
package which ensures the automated reporting of
new and renewed loans, loans over certain limit,
past due loans, loans by rate level, participation
relation analysis, officers portfolio profile, loans over
bank limit. Banks make these reports available
periodically
at
various
places
within
the
organization. The intent of this review is not only to
monitor individual position of credit but also to
detect trends which may require in-depth analysis
and possible management action.
In actual system there are three tier loan review
system. In three tier systems, all loans are classified
as first tire, second tire, and third tire on the basis of
loans volume and some other selected criteria.

Risk Coding/ Loan Grades

Types of loan

Substandard

Doubtful

Bad and loss

Continuous loans

Non payment/ Renewal Classified

as Classified as doubtful
within 3 moths or 6 substandard for 6 to 12 for 12 months or more
months after expiry months
date

Demand loans

Non payment within 3 Classified

as Classified as doubtful
months or 6 months substandard for 6 to 12 for 12 months or more
after expiry date
months.

Fixed term loans

(Up-to five years)

Installment default for Classified

as Classified as doubtful
more than 6 months.
substandard more than more than 18 months
12 months

Fixed term loans (more Installment

default Classified
as Classified as doubtful
than five years)
more than 12 months
substandard more than more than 24 months
18 months
Short- term Agriculture Overdue more than 12 Overdue more than 36 Overdue more than 60
and Micro-Credit
months
months
months

Risk Coding/ Loan Grades

Types
Loan

of Classified

Substandard Doubtful

Bad and Loss

Classified
Classified for
Continuous On the expiry Classified
of due date or more than 6 more than 9 12 months and
Loan
not renewal

Demand
Loan

months
but months
but more
not more than not
over12
9 months
months

On the expiry Classified

of due date or more than 6
not renewal.
months
but
less than 9
months

Classified
Classified
more than 9 more than 12
months
but months
and
less
than12 more
months

Key Ingredients in the Loan

Review System
A good loan policy is a guide line for the credit
officers. A good credit policy, a good
administrative system, accurate information
and, of course, a savvy senior management
are key for success in loan review. Reviews are
made on the basis of information, and the
success of review greatly depends on the
accuracy of information. To ensure its
accuracy, information must be tested from an
independent, unbiased perspective. For making
loan review accurate, a separate loan review
department headed by one man with
commercial lending experience and common
sense is needed.

Principles of Effective
Loan Review
Avoid the gotcha approach in words and
actions,
Communicate in timely way. Do not spring
surprises, touch base with the involved
parties, and get the full story,
Give
credit
where
credit
is
due;
acknowledge when the line initiates action.
Use the team approach. Ask How can we
fix this? versus How did this get broken?

Principles of Effective
Loan Review
Avoid sharp and prickly adjectives,
Keep materiality in mind: Nice to have versus
need to have; and underwriting oversight on an
isolated basis should not be a cause for a public
humiliation; an issue on a $10,000 loan probably
is not an important issue on a $10 million loan,
Avoid jumping to conclusions, especially when
you have not discussed the issue with all parties
involved,
Recognize signals you may be giving; dont start
out with we are right and you are wrong body
language and verbal cues. After all, you may be
wrong. Listen at least as much as you talk,

Principles of Effective
Loan Review
Make sure your constituents know
that you recognize risk grading is as
much art as it may be science and
that you are equally open to
upgrading as downgrading, and
If it does not make sense, it is
probably wrong.

Which System is best?

A loan review system is the best for a bank
is dependent on the risk tolerance and
credit culture of the bank. System which is
best suited in one bank may not be
completely applicable to another bank. In
some
respect
it
also
takes
into
consideration the overall financial condition
of the bank, its size, and its geographic
footprint, the mix of the banks portfolio
among consumer loans, small-business
loans. Large commercial loans may
influence the direction and scope of a loan
review process.

Problem
Identification
Resolution

loans
and

Loan losses can be

minimized
by
early
detection of problem
and
its
efficient
handling.

Definition of Problem
Loan
Behrens (1998) defines problem loan
as:
A problem loan can also be defined as
one in which there is a major
breakdown in the repayment agreement
resulting in an undue delay in collection,
or one in which it appears legal action
may required to effect collection.

Banking Company (Revised)

Act 2001

(1) In case of continuous loan or call loan:

On the expiry of due date, (2) Term loan
(Maturity less than 5 Year): On the expiry
of installment due date, (3) Term loan
(Maturity more than 5 years): On the
expiry of 6 month of the installment date,
(4) Agriculture and small loan: On the
expiry of 6 month of the due date, and
(5) Any overdue loan should be treated
as problem loans. (BRPD Circular No.10
May 14, 2001)

Early Sign of Problem

loans
(1) Lack of profitability, (2) High/rising
leverage, (3) Low/decreasing liquidity, (4)
Low collection of accounts receivables, (5)
Slow
turn
of
inventory,
(6)
Weak/decreasing equity, (7) Increase in
accounts payable, (8) Loans to officers
and stockholders, (9) Fraudulent of
financial information, (10) Delinquency or
other default, (11) Failure to provide
information, (12) Family and marital
problems, (13) Rapid business expansion,

Early Sign of Problem

loans
(14) Changes in management, (15) Change
in accountants, (16) Declining sales, (17)
Change in product mix, (18) Loss of key
employees, (19) Collateral problems, (20)
Large/Rising insider transactions, (21)
Changes in accounting methods or auditors,
(22) Re-negotiations of loan covenants, (23)
Cancellation of insurance, (24) Investment
in non-related venture, (25) Judgments and
tax liens, (26) Concentrations, and (27)
Changes in customer mix.

Causes of Problem Loans

(1) Not paying attention to written loan

policy, (2) Having no real initiative to
determine the purpose of the loan, (3)
Doing improper credit work, (4) Not
understanding
the
business
being
financed, (5) Failing to address repayment
realistically, (6) Relying too heavily on
collateral, (7) Refusing to admit a problem,
(8) Being lax with borrowers who are past
due, (9) Procrastinating, and (10) Failure in
to the renewal/reduction syndrome.

Handling Problem loans/

Loan work-out
The following techniques are usually
used for handling problem loans:
(1) Providing advisory/counseling
services,
(2)
Deputing
representatives in the management
position of borrowers organizations,
(3) Rescheduling of credit, and (4)
Waiver of interest.

Alternatives to Collect
Problem Loans
Usually loan recovery drives can be: (1)
Compromise settlement, (2) Creditors
arrangement, (3) Involuntary bankruptcy,
(4) No action, (5) Voluntary liquidation, (6)
Legal action for repossession and sale of
collateral, (7) Legal action against
borrowers, (8) Legal action against
guarantor, (9) Sale of loan to independent
organization (Behrens 1998, 253-258),
and (10) Appointment of an organization
for recovery of default loan.

Recovery of Credit
Banks are using many alternatives for
recovery of problem loans. Some banks
are using moral persuasion to recover
problem credit, some banks sale the loan
to other party, some appoint third party
to recover loan. If all these techniques
come in to failiure to recover credit then
lenders have no alternative rather taking
legal action against borrower to recover
loan.