Magazine article American Banker

Lending Officers Cannot Afford a Short Memory

Magazine article American Banker

Lending Officers Cannot Afford a Short Memory

Article excerpt

What we remember of the recent past has always played an important role in financial services.

And a study released at the recent 39th Annual Conference on Bank Structure and Competition, hosted by the Federal Reserve Bank of Chicago, provides new evidence that memory has a big influence over the behavior of lending officers.

Because the proportion of nonperforming loans is low during expansions in the business cycle, banks become confident and increase their lending by taking on riskier credits. Then the problems these new credits breed are revealed during the next downturn. As a result, the banks become conservative again and reduce their risk taking.

This retightening of credit standards takes place because the lessons of a bust are fresh in the memory of loan officers who are witnessing the results of their previous decisions.

But Allen Berger of the Federal Reserve Board and Gregory Udell of Indiana University report that, as time passes, two things happen: First, because of turnover, the percentage of experienced loan officers decreases, so that the bank ends up with many officers who have not experienced a loan bust. Also, some experienced officers' skills may atrophy, and they forget the lessons of the past.

What makes the problem of memory -- or a lack of it -- even more difficult to fix, the authors assert, is that fewer loan problems come up as the economy recovers, and time passes since the last bust. Yet analysis of problem loans is an essential tool for information managers when evaluating individual officers. …

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