Bank Loan Policy: Meaning, Structure, Elements

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In many countries, improper and inefficient loan operations contribute mostly to the failure of banks.

What is Bank Loan Policy?

For proper loan management, a clear and detailed administrative framework and clear-cut policy detailing are required, through which bank executives involved in loan activities will know what they are supposed to do and to whom they are accountable.

And for efficient loan management, a proper loan administrative framework is required through which the concerned persons in loan management become aware of their duties and responsibilities.

Besides, before evaluating a loan application, the loan officer needs to consider identifying the necessary sources and collecting relevant information.

The loan activities will be difficult if the loan officer does not know how to analyze different loans in different ways and use financial ratios to judge the loan applicants’ creditworthiness.

The loan policy needs to be documented in a written and detailed form. The transfer, absence, or death of the designated staff(s) cannot cause the newly assigned person any difficulty while dealing with the new loan cases.

Moreover, for favorable settlement from a legal point of view, loan contracts, when prepared after sanction, require necessary documentation throughout the whole process. It should be kept in mind that loan recovery depends on how well the bank can handle and monitor the loan processes.

Definition of Bank Loan Policy

A loan policy is necessary for a bank to attain its objectives and also serve the public its lending must be conducted in an orderly manner.

To conduct loan operations efficiently and successfully, it is important to formulate a clear-cut and comprehensive loan policy.

Without an adequate loan policy, even efficient loan officers often fail to run the loan activities properly.

The loan activities will be prone to error and mistake if the directions regarding the availability of loanable funds, the guidelines about the sectors for which loans are to be made available, the duration and maturity of the loan, and the nature of collaterals are spelled out and prefixed.

On the other hand, loan officers may be absent, ill, transferred, dismissed, or retired.

In that case, written policy guidelines will facilitate the new officers being replaced in such positions. Under these circumstances, if there is no specific loan policy, management will suffer greatly in making many loan-related decisions.

Otherwise, the newly employed officer may suffer from indecision, make delayed decisions, or even remain confused. The written loan policy is beneficial in handling the loan activities of a bank in the situations stated.

The absence, transfer, retirement, or plight for better prospects of any employee may not create any complexity if the policy is properly spelled out and documented.

The bank loan policy compiles wise decisions that help the loan officer execute their duty efficiently and properly in every loan process step.

According to Edward W. Reed, a bank scholar, “(A loan) policy establishes the direction and use of the funds of a bank that have derived from stockholders and depositors and influences the decision on whether or not to lend.”

Structure of Bank Loan Policy

Responsibility of Preparing Loan Policy

A loan policy is a special aspect of the important policies taken by a bank. The Board of directors has ultimate power and responsibility in this regard.

Before that, loan officers prepare a draft loan policy, make necessary modifications through several workshops, and then submit it to the loan committee formed by the board of directors.

The loan committee restructures the loan policy in several meetings and submits it to the board of directors. After necessary modifications and improvements, the loan policy gets final approval from the board of directors.

Written or Unwritten Loan Policy

Both written and unwritten loan policies are in practice in different banks.

However, a written loan policy is preferable to the unwritten one because the written loan policy can overcome the situation in the absence of experienced bank officers or misunderstanding among the newly assigned loan officers.

Written loan policy can be updated based on experiences and the need of the hour.

Whether loan Policy should be Rigid or Flexible

Loan policy can be rigid or flexible. A flexible loan policy has some benefits as well as some problems.

But as expert bankers and banking specialists believe, a flexible loan policy has more benefits than problems. Flexible loan policy becomes popular because its liberal stands for adjustment in a changed situation and other unavoidable future contingencies.

Elements of Successful Loan Policy

Loan policy provides proper directions and guidelines to the officers in charge of loan management. It helps bankers to handle loan operations smoothly and effectively. The bankers find it easier to decide when the policy covers all loan case management areas.

Elements of Bank Loan Policy

There are two types of elements to be considered in framing an effective loan policy-

  1. General elements
  2. Policy-procedure related elements

These elements can be gleaned from multiple factors in the following chart:

General elements of Bank Loan Policy

  1. Goals & objectives of loan management
  2. Duties and responsibilities of the loan personnel
  3. Loan-mix strategy
  4. Liquidity strategy
  5. Determining loanable fund
  6. Determining the higher and lower levels of loans
  7. The geographic area of loan operations
  8. Scope of loan operations
  9. Loan-maturity mix
  10. Collateral strategy
  11. The procedure for loan approval
  12. Strategy to face the competitors
  13. Business ethics
  14. Loan collection strategy
  15. Training and development of loan personnel
  16. Loan review procedure
  17. Loan classification
  18. Norms of loan operations
  1. Loan Insurance
  2. Loan documentation
  3. Maintenance of accounts of loan transactions
  4. Regulatory scope of loan operation
  5. Delegation of authority to the executives
  6. Job description of the loan executives
  7. Loan pricing
  8. Loan sanctioning authority
  9. Strategy for collecting credit information
  10. Processes and steps of credit analysis
  11. Repayment schedule
  12. Average quantum of loan ease
  13. Review and supervision of loans
  14. Identification of problem loans
  15. Steps taken in handling problem loans
  16. Arrangement of selling collaterals of default loans
  17. Minimum deposit balance of loanee

To sum up, a loan policy consists of all the instructions and guidelines regarding the process of credit analysis, types of insurance policy to be taken, nature and condition of the collateral, loan review and supervision, process of identifying a problem loan, and steps to lie taken to those defaulters, etc.

In addition, decisions about the maximum amount of credit by the branches, regional or head offices, and participation in the societal philanthropic activities in the locality where the banks are situated must be minutely mentioned in the loan policy.

This will help to reduce the extent of misunderstanding in the loan process.

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