As with other bank matters, the board of directors is responsible for establishing the bank’s loan policy. It is important that you are familiar with the purpose and basic components of loan policy as a key credit risk control tool. In addition, you should be able to judge whether a loan policy is adequate for ensuring good asset quality at your bank.

Although policies should be tailored to a bank’s individual needs, they tend to contain certain common elements. Loan policies almost always include an objective statement describing what is to be accomplished. For example, the basic objectives of the loan policy are for the bank to:

• Make sound loans on a collectible basis.
• Invest funds profitably to benefit shareholders and protect depositors.
• Serve the legitimate credit needs of the community.

Policies may also include provisions that address questions of "Who," "What" and "When" which directly relate to the lending function.

“Who” refers to the board, loan committee, senior lending officer and other lending officers and their lending authority.

“What” pertains to the considerations in making a loan:

• What are acceptable loan purposes and types of credit the bank will extend? (For example, general fields or types of lending such as consumer, small business or residential real estate.)
• What kind of information must the bank have from the borrower and other sources before a loan can be made?
• What is to be considered or what analysis must be done before making a loan?
• What are prohibited types of loans and what practices are unacceptable or undesirable?
• What are the limits set on lending – to an individual borrower or to an industry/government unit?
• What are the geographic limits on where the bank will make loans?
• What process is used to handle exceptions to policy?
• What should be considered in loan purchases and sales?
• What loans should be brought to the board for a decision?
• What reports does the board need to have in order to evaluate the condition of the loan portfolio and the bank’s adherence to policy?

“When” refers to time frames for completing actions covered by loan policy.

• When are loan reports to be made?
• When should loan review be done?
• When should loans be charged off?
• When should the policy be reviewed to ensure it reflects the board’s risk appetite, current conditions and the bank’s status?

To compare some of your policy elements with those at other small banks, review the Common Practices at Small Banks.