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 client’s 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 agreement’s
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 Installment default for Classified as Classified as doubtful
(Up-to five years) 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 of Classified Substandard Doubtful Bad and Loss
Loan
Continuous On the expiry Classified Classified Classified for
Loan of due date or more than 6 more than 9 12 months and
not renewal months but months but more
not more than not over12
9 months months
Demand On the expiry Classified Classified Classified
Loan of due date or more than 6 more than 9 more than 12
not renewal. months but months but months and
less than 9 less than12 more
months 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; don’t 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 bank’s portfolio among consumer
loans, small-business loans. Large commercial
loans may influence the direction and scope of a
loan review process.
Problem loans Identification and
Resolution
• 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) Creditor’s
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.