Supercharging Loan Analysis
Arscott, Richard B., American Banker
During the last 10 years, the reduction and control of loan losses and chargeoffs has become a major managerial challenge for financial institutions.
The root of the problem has been failure to adapt the credit review process to a wide variety of analytical challenges.
How many times at loan committee meetings have you or someone you know been asked a question you couldn't answer fully, because information access was inadequate?
Maybe the problem was with physical access, such as someone else having portions of the credit file. Maybe some legwork analysts usually do to fill information gaps was lacking.
And maybe the right kind of strategic information is not being gathered.
Research by my associate Hassell H. McClellan of Boston College's Wallace E. Carroll School of Management has shown that application of strategic analysis techniques to credit analysis would improve the decisions made.
In his book, "Managing One-Bank Holding Companies," Prof. McClellan combined a review of bank managementt and lending practices with an examination of the loan-loss patterns of a sample of banking institutions.
A key conclusion was that loan analysis based primarily on traditional financial and historical credit information gives short shrift to strategic factors that identify borrowers whose operations will remain credit-worthy over the life of a loan.
Prof. McClellan suggests that major institutions can lend more efficiently by integrating strategic analysis better into the credit approval process and expanding the information basis upon which loans are extended.
For several reasons, it is hard to implement strategic analysis techniques in the loan review analysis process.
* Traditional lending practices tend to be plagued by "analysis myopia," relying primarily on historical financial information instead of forward-looking data.
Historical information does not identify the projective factors of change that contribute to flaws in initial loan decisions and undetected erosion in outstanding loans.
* Many banks have tried to capitalize on learning curves in analysis by creating lending groups that specialize in particular industries.
A better idea would to specialize the analysis function, creating a strategic analysis unit on which individual lending groups could rely.
* If the lending process becomes overly routine, economies of scale in credit analysis can have diminishing marginal returns.
New loans tend to receive the most scrutiny; ongoing review is exemplified by monitoring the loan covenants, not by evaluating threats to the success of the loan by unforeseen factors.
Many Data Sources
Computer systems are available today that can provide timely, reliable information and that let the user perform a series of structured analyses in minutes.
A wealth of business information is available via data bases residing within the institution as well as from external data sources. …