ending is the principal business activity for most commercial banks. The loan portfolio is typically the largest asset and the predominate source of revenue. As such, it is one of the greatest sources of risk to a bank’s safety and soundness. Whether due to lax credit standards, poor portfolio risk management, or weakness in the economy, loan portfolio problems have historically been the major cause of bank losses and failures.
Effective management of the loan portfolio and the credit function is fundamental to a bank’s safety and soundness. Loan portfolio management (LPM) is the process by which risks that are inherent in the credit process are managed and controlled. Because review of the Loan portfolio management (LPM) process is so important, it is a primary supervisory activity. Assessing Loan portfolio management involves evaluating the steps bank management takes to identify and control risk throughout the credit process. The assessment focuses on what management does to identify issues before they become problems. This paper, written for the benefit of both examiners and bankers, discusses the elements of an effective Loan portfolio management process. It emphasizes that the identification and management of risk among groups of loans may be at least as important as the risk inherent in individual loans.
Effective loan portfolio management begins with oversight of the risk in individual loans. Prudent risk selection is vital to maintaining favorable loan quality. Therefore, the historical emphasis on controlling the quality of individual loan approvals and managing the performance of loans continues to be essential. But better technology and information systems have opened the door to better management methods. A portfolio manager can now obtain early indications of increasing risk by taking a more comprehensive view of the loan portfolio.
To manage their portfolios, bankers must understand not only the risk posed by each credit but also how the risks of individual loans and portfolios are interrelated. These interrelationships can multiply risk many times beyond what it would be if the risks were not related. Until recently, few banks used modern portfolio management concepts to control credit risk. Now, many banks view the loan portfolio in its segments and as a whole and consider the relationships among portfolio segments as well as among loans. These practices provide management with a more complete picture of the bank’s credit risk profile and with more tools to analyze and control the risk.
All banks need to have basic loan portfolio management principles in place in some form. However, the need to formalize the various elements discussed in this paper, and the sophistication of the process, will depend on the size of the bank, the complexity of its portfolio and the types of credit risks it has assumed. For example, a community bank may be able to implement these principles in a less formal, less structured manner than a large bank and still have an effective loan portfolio management process. But even if the process is less formal, all banks should address the risks to the loan portfolio discussed in this paper. The examiner assigned Loan portfolio management is responsible for determining whether the bank has an effective loan portfolio management process. This includes determining whether the risks associated with the bank’s lending activities are accurately identified and appropriately communicated to senior management and the board of directors, and, when necessary, whether appropriate corrective action is taken. The purpose of loan portfolio management is to ensure that the bank is able to meet fully its contractual commitments. Loans comprise the most important assets as well as the primary source of earning for the banking financial institutions. On the other hand, this (loan) is also the major the major source of risk for the...