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Banking and Finance

Loan Grading & Risk Scoring under Basel III - Interview w/ Rob Newberry

Loan Grading Systems for Risk ScoringCan your financial institution survive the next economic downturn?  The recent financial crisis demonstrated how unexpected economic downturns and rapid deterioration in market conditions can significantly harm a bank’s financial condition and economic viability. Additionally, our ever-changing regulatory environment makes it more important than ever to understand the importance and benefits of loan portfolio management.  

To effectively manage a loan portfolio, senior leadership must understand what is driving current regulatory environment and implement a consistent risk-score model that is based on objective and subjective components. Data sources should be optimized so they can be used for environmental and qualitative factors and stress testing.  Proper forecasting of the institution’s ALLL reserve provision is vital for long term success. In addition, management must run a Loan Portfolio Stress test and understand the capital impacts to a financial institution, while assessing the effectiveness of loan policies.

To better understand the importance of loan portfolio management, we sat down with our expert Sheshunoff™ Webinar speaker, Rob Newberry, for an interview:

Q:  Help set the baseline for us: how is the regulatory landscape changing?

A:  As additional regulation continues to be introduced from Basel III and Frank-Dodd, the cost for financial institutions continues to rise.  The added complexity of all these rules, and the need for more data to monitor these rules, has highlighted an information system weakness that a majority of financial institutions face today. 

With the changes in regulatory oversight and formation of new oversight groups, the examiners that are reviewing national and regional banks are also now looking at smaller community banks and expecting the same types of technology and sophistication.  In order for these institutions to survive, they will need to embrace these changes and invest more into their technology infrastructure to help meet the growing need for information.

Q:  We’ve used the terms dual loan grade or risk scoring model - could you explain those for us?

A:  A dual loan grading/risk scoring model uses both objective and subjective components when evaluating the overall risk.  The objective components typically are industry specific financial ratios that can be compared to RMA Industry data or to internally set benchmarks.  Subjective components generally comprise factors that are not financially driven.  The combination of these components are how the final risk score/loan grade is calculated.

By consistently using a dual loan grading system, financial institutions can satisfy regulatory requirements of having a consistent and objective model, while still being able to incorporate the other C’s of credit when determining credit quality.

Q: Are small banks required to do a Stress Test? 

A: While Dodd Frank’s Stress Testing requirements were specifically for financial institutions greater than 10 Billion, both the FDIC and OCC have published guidance that states they do consider some form of stress testing or sensitivity analysis of loan portfolios on at least an annual basis to be a key part of sound risk management for community banks.

Register now for our two day Loan Portfolio Management event, in which Mr. Newberry will address Dual Loan Grading, ALLL Impairments, and more. You can see all LexisNexis® Sheshunoff™ resources and training and follow us on Twitter and Google+ for exclusive news and deals.

Rob NewberryRob Newberry, president of Legosys Corp., is a proven executive manager with 20 years of banking experience. Over the last 5 years, Rob has worked closely with multiple regulatory agencies and community banks to develop loan grading, stress testing and ALLL reserve capabilities for community banks in the FastGrade® suite of products.  Rob is also on the faculty team at the Graduate School of Banking in Wisconsin, teaching Credit Risk Management.