Outlining the Board’s Responsibility in Lending

January 25th, 2013

How actively involved should directors be in the lending process? Most bank failures occur because of deficiencies or weaknesses in the institution’s credit culture, and the board is ultimately responsible for those shortcomings. And board members’ personal liability is at stake when they get involved, or don’t get involved, in the lending process. Sean Kehoe with Kilpatrick Townsend discusses how to address lending issues at the board level.

How should boards get involved with lending?

The first thing to know is that there is no one-size-fits-all set of rules for board involvement in the loan approval process due to the size, complexity and other unique factors of the bank. That said, I think a board should approach the loan approval question as it would any other significant decision it faces. First, educate yourself. It is incumbent on directors to become educated in bank operations, in particular lending, in order to effectively govern. Know the rules and restrictions. While most regulators generally don’t dictate any particular system of loan approval (except for loans to insiders), your bank may be subject to a regulatory order or agreement that places limitations on the bank’s lending authority. Also, know your policies. Directors should review and be familiar with their loan policies. Even if you are not approving many loans, you should be active in the formulation of a loan policy. Board policy, drafted to best fit your bank’s risk tolerance, can be an effective tool that directors can use to fulfill their governance role and oversight responsibilities. And remember, it is by the policies and the board’s implementation of these policies that a board’s actions or inactions are often judged. Finally, directors should educate themselves as to the material risks facing the bank and how the board’s decisions with respect to lending can impact such risks.

What mistakes do you see boards making in this regard?

We’ve seen boards not fully complying with a regulatory order or the board’s own lending policy. It seems simple enough–follow the rules and your own policies and procedures. However, proper compliance and documentation can be complex so it’s not always an easy thing to do in practice. That’s why it’s important, whether or not the board approves loans, that it stay active in the process and work to ensure that the policies, procedures and limitations are being followed.

Will a director be personally liable for loans that go bad?

The FDIC (Federal Deposit Insurance Corp.) has filed lawsuits against hundreds of directors and officers of failed banks in recent years. One consistent theme in these cases is that the FDIC is focusing on loan committee members and board members who approve loans that ultimately don’t perform. And while these cases focus primarily on loan approval processes at the far end—or wrong end—of the compliance spectrum, all bank directors can learn from the FDIC’s actions and step up their governance efforts in the loan approval process. Even so, it would be wise to review and update your Directors & Officers insurance policy to ensure you have adequate coverage, just in case.

Should directors even be approving loans?

If you are going to approve loans, generally you should ensure that you have sufficient information about the credit to make an informed decision. Importantly, ask questions if you have concerns. If you do not approve loans, know that not being involved in specific loan approvals does not mean removal from the entire process. You still must diligently and actively perform your governance role. Polices should be comprehensive and up-to-date and the board should ensure that the lending team conforms to the policy.

What are some other good governance practices regarding lending?

Hiring a qualified lending team seems obvious but it cannot be overlooked as a good governance practice. The quality of the lending team, from top to bottom, is critical to the success of the bank and the quality of its loan portfolio. And make sure your lending team has the expertise and experience to handle the lending that the bank conducts. If you have a traditional mortgage lender involved in commercial lending, you will run into problems. Also, consult with management and outside parties when formulating policies and educating yourself on the issues. Outside parties can bring a new perspective on your process and can demonstrate to regulators additional diligence and care on the part of the board. Finally, regularly review your loan policies and update them as needed to improve their effectiveness.


Sean Kehoe is a partner at Kilpatrick Townsend in Washington, D.C., where he focuses his practice on corporate finance, mergers and acquisitions, securtities and regulatory matters.