The Board’s Vital Role in Lending

Submitted by Vince Van Nevel, June 27, 2017

 

We have all heard this mantra time and again. “The board is responsible for safely directing the business and affairs of the institution in the best interest of shareholders, customers, the community, and in accord with the law.”

Heaven forbid, should these four interests diverge, the path should be chosen that is in the best interest of shareholders. The interests of shareholders and regulators are not always aligned. In the worst case scenario, the FDIC as Receiver succeeds to all rights and privileges of a failed bank, including claims against former directors and officers, and sues officers and directors for “gross negligence,” usually related to loan underwriting and approval.

This article spells out five key requirements and regulatory expectations for the board to implement in carrying out its duties and vital role in lending.

First, it is clear that the FDIC and other regulators expect boards to provide a clear governance framework that incorporates sound:

  1. Objectives;
  2. Policies; and
  3. Risk Limits.

Equally important, the Board should monitor the extent to which officers and employees comply with this framework.

Second, if directors are involved in approving loans, they must attend and participate in board and assigned committee meetings regularly to fulfill their responsibilities. This is critical to sound corporate governance. Why? Because almost every state has set standards of conduct for corporate and/or financial institution directors that require directors to discharge their duties in good faith, with prudent care and in a manner the director reasonably believes to be in the best interest of the corporation. These standards are harder to meet if you don’t attend and participate.

Third, the board’s role in lending begins with the loan policy. Without a written policy (one that is written for and appropriate to the institution) it will be more difficult for the board to properly monitor the loan portfolio.

It is not suggested here that board members sit down with pen in hand and draft the loan policy. However, it is expected that board members have reviewed the loan policy and have an understanding of it and, hopefully, a satisfactory comfort level with the policy.

Fourth, a director does not routinely make decisions regarding individual loans. However, board approval for some loans is required by law. Others are submitted to the board for advance or after-the-fact review due to policy requirements or the need for legal action which the board must approve in advance.

When directors are involved in the approval process, it is because the loan involves special considerations or the borrower’s total indebtedness is of a size that poses greater-than-normal risk to the institution.

In such cases, the information provided should be consistent with the established governance framework (i.e. your loan approval process) in place.  It should also be sufficient enough that each director is satisfied, consistent with their knowledge of the borrower and lending market, that he or she has prudently investigated the merits of management’s recommended credit decision. Here directors should ask questions and seek explanations as appropriate.

Fifth, the board or its designated committee must monitor compliance with lending policies, regulatory requirements and portfolio quality trends and expectations. Monitoring reports can be both from internal and external sources, and must be independent. Independent audits and loan reviews are the eyes and ears of the board.

Directors must maintain ongoing knowledge of the overall performance of the loan portfolio as well as significant individual credits exhibiting performance problems. Such a perspective allows board members to get a feel for the quality and diversification of the portfolio, or the lack thereof.

As in the loan approval process, individual distressed credits should be brought to the board’s attention only when their size or ancillary issues, such as litigation, require the board’s attention as the ultimate decision-maker.

In summary, in fulfilling duties in the credit area directors must first establish a clear governance framework (a “process”) and then follow it. The framework should include being familiar with and approving policy, attending and participating in meetings, asking questions and seeking explanations, monitoring compliance with policy while considering and approving exceptions where warranted, monitoring loan quality and regulatory requirements, exercising independent judgment and being loyal to the institution’s interests.

Such actions should assist the board in fulfilling its responsibility for safely directing the business and affairs of the institution in the best interest of shareholders, customers, the community, and in accordance with the law.

 

ProBank Austin offers risk management and strategic consulting services to the financial services industry. We would be pleased to partner with you as you work to establish or improve these important functions.

 

 

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