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Developing Examiner Guidelines: Commercial Bank Internal Control Evaluation

This session, presented by Robert Lyon, retired Credit Risk Officer from FRB Credit Risk Management, covers evaluating credit risk management in commercial banks. Topics include lending controls, lending process, key information, sampling of loan files, problem loans, internal loan review, credit grading systems, risk rating elements, and best practices to prevent fraud by insiders. The session also addresses controlling abuse through audits and monitoring insider transactions. Examiner conflict of interests and ethical standards are discussed to ensure integrity and objectivity in evaluations.

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Developing Examiner Guidelines: Commercial Bank Internal Control Evaluation

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  1. FINANCIALSERVICESVOLUNTEERCORPS 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

  2. Credit Risk Management • Do Loans Comply with the Loan Policy? - Approval process - Collateral valuation - Loan limits - Loan concentrations Industry Geographic Loan types

  3. Lending Controls • Lending Process • Key Information

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

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

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

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

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

  9. 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

  10. 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

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

  12. Credit Grading Systems • Problem Loans – quarterly • Large exposures – quarterly • Sampling size • Performed by • Loan Officer • Independent credit review specialist

  13. 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

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

  15. 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

  16. 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

  17. 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

  18. 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

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