The Director's Role In Lending
by Dennis F. Ceklovsky

As published in Western Independent Banking Magazine

Do you remember the reasons outside board members were chosen for your bank? Are you one? If so, were you recruited for your lending underwriting acumen? The most common answer is, "no." So how can you effectively render correct decisions on your bank's most sophisticated loans?

Why are they here?

If you recall the reasons for outside director recruitment, the most important is the individual value they bring to the bank - something the regulators insist upon when approving de novo applications now. Their individual credit analysis and underwriting skills were probably not a major factor, so should they be expected to become credit "gurus" when they serve on the loan committee? The answer is obviously no. What, then, should their role be in the credit approval process of your bank?

The reality is, despite being responsible for the safety and soundness of the bank, outside directors will NEVER be able to match the skill level of the professional lenders at your bank. Sounds like an oxymoron, doesn't it?

What should be expected?

Well, let's review the board's primary lending responsibilities:

  • Safety and soundness of the bank's lending function
  • Establishing/maintaining loan policies and procedures
  • Delegating lending authorities
  • Approving/reviewing loans
  • If you're a director, remember that YOU, not THEY, are responsible for the safety and soundness of the bank.

Guidelines for loan committee's outside directors

Use your existing business talents. This can range from specific industry expertise to common sense. Generally speaking, directors are most valuable in seeing the big picture - having outside viewpoints regarding specific industry(s) and/or serving area economic conditions, as well as knowledge of individuals and companies.

Pricing issues should NOT be a part of the loan committee's responsibilities, period. The loan committee is charged with a credit risk function. Other board committees deal with profitability issues.

KISS (keep it simple syndrome) or get back to basics. Too often, we lose sight of this, particularly in larger, most complex commercial loan transactions. In this regard, it is highly recommended that directors remember the five C's of creidt (the five key elements a borrower must possess to obtain credit).

  • Character (integrity) - will they pay?
  • Capacity to repay - can they pay?
  • Collateral - assests pledged
  • Capital - borrower's investment
  • Conditions (loan and industry or economic)
  • If you are unable to ascertain answers to the above questions, ask the handling/presenting officer. Most importantly, if you do not feel completely comfortable in making a decision, DON'T. Yours is a weighty responsibility and not one of a follower, but one of a leader.

Stay engaged with your lenders. Your job doesn't end after approval of the loans, it's just the beginning. Saying yes is the easy part, collecting loans is always the challenge. Effective loan committees follow-up on previously approved loans to ensure they are performing as agreed. Regular management reporting is the most effective way to accomplish this. It also provides an ongoing scorecard of each lender's individual performance and how they rank among themselves. Reporting items typically include levels of criticized assets, past dues and loan losses ranked by lender.

Meet regularly with outside loan review consultants. These are the folks that see things the loan committee usually doesn't and they have no interest in the bank one way or the other. Review their recommendations, and more importantly, your bank's responses to them. Once again, if you do not understand something, this is your opportunity to ask.

Director training

The minimum requirement for a sitting member of any bank loan committee should include a working knowledge or understanding of credit underwriting at the institution. Should directors need to know how to make loans? No. There's a huge difference between making loans and approving them. Management hires professional loan officers to make loans; it's the director's job to satisfy him - or herself that they are made safely and soundly, conforming to regulatory standards and bank policy.

Outside directors with little or no lending experience or knowledge should be trained for their laon committee responsibilities. Attendance at national or accredited lending schools is great but not required to accomplish this, as other alternatives are readily available and discussed later.

At a minimum, directors need to be fully knowledgable with the bank's loan approval report format, as well as basic underwriting requirements. All reports shoud be systematized under a uniform format that is understood by all those involved in the lending function. New committee members should be instructed in the report format by management prior to their first meeting assignments.

Basic underwriting requirements should include the following:

  • Ability to assess the borrower's character
  • Analysis of primary and secondary repayment sources
  • Description, valuation and acceptability of collateral
  • Ability to assess the borrower's investment
  • Credit structure and conditions
  • The above requirements mirror the five C's of credit discussed earlier.

In conclusion

The bank is in business to make a profit, no different than any other company. The bank's core business is to accept deposits and rent them out for a profit. Therefore, managing risk is crucial to its success.

Directors are charged with the ultimate responsibility for successfully managing risk. However, outside directors are usually unfamiliar with the bank's lending function, beyond the generic sense. As mentioned earlier, this significant and most important requirement to oversee and monitor the lending operation can be successfully managed with proper training.

Accredited lending schools, professional consultants and outside loan review providers are a good source for directorate lending training. Professional consultants typically have substantial credit training and real-life experience. In addition, they usually interact regularly with other banks, as well as state and federal regulatory agencies. Accordingly, their industry horizon is wider than most community bank loan committees, which can be a significant advantage for the bank. Lastly, consultants can tailor their training content specifically to the bank's needs.

Whatever source is chosen, an investment in director training is money well spent, considering the possible consequences that are thrown in the lap of these individuals when problems arise in the loan portfolio.

Featured in Western Banking Magazine