The Importance of Segregating a Bank’s Credit Function from its Lending Function

Posted by OnCourse Staff April 23, 2014 10:47am

Photo Credit: Ambro

By: Ian Strout, Senior Credit Risk Specialist

When I perform loan reviews for community banks, I’m surprised by the lending staff’s dominance of the loan approval process. The involvement of a credit department in the loan approval process is crucial to the maintenance of a quality loan portfolio.

A lending staff’s primary function is to generate revenue for the bank by both generating new borrowers and by cross-selling existing products to existing clients. A credit department’s primary focus is to ensure that all loans are approved in accordance with the Bank’s lending and credit policies and to assess the sufficiency of a borrower’s cash flow to repay the subject loan. There’s an inherent tension in this relationship, as a borrower that has the potential to be profitable may not be the most creditworthy. However, it is important for banks to maintain a credit department staffed with a credit manager for the following reasons:

1. The credit department will be able to work with the credit manager to make the best possible determinations of borrower credit worthiness and loan credit compliance.
2. The credit manager will work with the lending staff to determine the best possible loan product, loan structure and if there is sufficient rationale to approve the subject loan.

In order to maintain a degree of autonomy from the lending staff, banks may consider allowing the credit department to report to a credit officer as opposed to a senior lender.

The lending department can aid credit departments through the following measures:

1. Staying in contact with borrowers through property/business site visits and receipt of annual financial information
2. Establishing and adhering to a system of annual loan reviews to ensure the quality of the existing loan portfolio.
3. Requiring annual receipt of personal financial information from guarantors as well as requiring sufficiently complete personal financial statements and personal credit reports on an annual basis.

The credit and lending departments of a bank may not always agree regarding which loans should be approved. However, the presence of a well-managed credit department that works cooperatively with the lending staff can lead to a stronger overall loan portfolio.

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