The Best Loan Policies Consider a Bank's Community

The final exam of a credit administration course I once taught consisted of the usual multiple questions. To test what the students had learned, I added an extra, challenging assignment: Draft the loan policy for a newly chartered bank about to commence business in a trade area of the student's choice.

The importance of a well-thought-out loan policy cannot be emphasized enough, because a loan policy is like a compass helping bank officers navigate the sea of commerce.

Many major banks have deviated from their main function of serving their community, and have engaged instead in speculative operations, which do not provide any benefit whatsoever to the local economy.

A loan policy should reflect the business available in a bank's trade area, because it stands to reason that if a bank is located in a retail commercial area, its policy should underwrite credit to retail merchants.

The loan officers should be experienced in retail commercial credits at the minimum. If they should happen to know real estate and international credits, better yet. A merchant may one day want to finance the purchase of a commercial property for use in his business, or may want to import merchandise from another country. In such an event, the banker should be prepared to talk about real estate or import financing with at least a modicum of competence, lest he lose his customer to another bank.

Lending officers' loan limits should be set at adequate levels and according to the officers' experience.

A conservative policy sets the lending authority of every officer, up to and including the president of the bank and the chairman, at a low level, and increases progressively by combining the authority of two or more officers.

Such conservative policy tends to effectively reduce loan losses and prevent major credit debacles.

A bank's loan policy should also be guided by its board of directors, who, in turn, should be knowledgeable about the business of the trade area of the bank. In this respect, a community bank has an advantage over a megabank in drafting an adequate loan policy, since to a certain extent, its board of directors are prominent and respected citizens of the community and, moreover, intimately familiar with the make-up of the community and its members.  

A long time ago there were big banks with limited branching-out possibilities in states like New York, no branching at all in states like Illinois and statewide branching in states like California. There was a good reason for limiting the expansion of a bank beyond the limits of a reasonable trade area, because it is doubtful that management and directors of a megabank may be familiar and competent with the entire gamut of credits available from coast to coast. As such, loan policies at these institutions may be too general and simply prove inadequate.

Ill-advised considerations, however, prevailed over prudent banking practice with the passage of the Riegle-Neal Act of 1994. The final knell to sound banking practice was tolled with the repeal, in 1999, of the Glass-Steagall Act of 1933.

That reminds us of Oliver Hardy's famous line: "Here's another fine mess you've gotten me into!"

Over his 50-year career in banking, Ugo Nardi worked his way up from a teller to an auditor, lending officer, state bank examiner and a bank president. He retired in 2000.