Management continuously strives to balance credit quality with their bank’s need for income. This enables them to build capital and provide shareholders with a competitive return on their investment. One of the most important jobs of the board of directors is to evaluate management’s effectiveness in achieving this balance. At many banks, the board assigns this oversight duty to the loan committee.

Although the board can delegate tasks to others, the board ultimately remains responsible for the bank and the effectiveness of its risk management. Here are a few points to keep in mind when reviewing loans brought before the board and loan committee:

• The borrower knows more about his or her finances and the reasons behind his or her loan request than the bank. It’s what the bank does not know, or doesn’t take the time to find out, that can leave it with loan losses. Do not be pressured into quick decisions, especially if crucial information on which to base your decision is not available.
• Regardless of how good the bank’s loan evaluation process is, there is always the possibility of some unknown or unanticipated event that can trigger a loan loss. Consider all possibilities – negative and positive – and act accordingly. This may result in additional loan covenants, more reporting requirements and increased monitoring.
• The lending decision can be driven by many things – profit, growth plans, prestige. Ask yourself why the loan is being made. Is it because the loan represents a profitable opportunity that is consistent with the bank’s lending philosophy, risk tolerance and management capabilities? Or, is it being motivated by something else – to help out a bank insider, to keep a customer from moving their business elsewhere or to promote someone’s own version of Insights Bank and Trust’s “Visions for Success” program?

These and other matters are embodied in the Red Flags of Lending, practices that experience has proven increase credit risk exposure and can, in extreme cases, lead to a bank’s failure.