Section IV. Independent Credit Review System
4.1. Introduction
All Saudi banks are expected to establish a system of independent, ongoing credit review and results of such reviews should be communicated directly to senior management, the Board of Directors and the Audit Committee. While the determination of the impairment of an asset is made by banks based on their own internal credit review procedures, which can vary from one bank to another, this regulation is aimed at ensuring that banks’ own systems as a minimum meet the following requirements.
4.2. Objectives
The principal objectives of an effective independent credit review system are as follows:
• To ensure the credits are appropriately classified;
• To ensure that credits with potential or well-defined weaknesses are identified promptly and that timely action is taken to minimize credit losses;
• To project relevant trends that affect the collectibility of the portfolio and to isolate potential problem areas;
• To review the adequacy of the allowance for credit losses;
• To assess the adequacy of and adherence to internal credit policies and administrative procedures and to monitor compliance with relevant laws and regulations;
• To evaluate the activities of credit personnel;
• To provide senior management, the Board of Directors and the Audit Committee with an objective and timely assessment of the overall quality of the credit portfolio; and,
• To ensure that management is provided with accurate and timely information related to credit quality that can be used for financial and regulatory reporting purposes.
For an effective achievement of the above objectives, financial institutions should operate an independent credit review system having regard to the size of the institution and the complexity of its operations.
4.3. Elements of an Independent Credit Review System
An institution’s written policy on its independent credit review system should address the following elements:
• Qualifications of credit review personnel
• Independence of credit review personnel
• Frequency of reviews
• Scope of reviews
• Depth of reviews
• Review of findings and follow-up
• Workpaper and report distribution
4.4. Qualifications of Credit Review Personnel
Persons involved in the credit review function should be qualified based on level of education, experience, and extent of formal credit training and should be knowledgeable in both sound lending practices and the institution’s lending guidelines for the types of credits offered by the bank. In addition, these persons should be knowledgeable of all relevant laws and regulations affecting the bank’s lending activities.
4.5. Independence of Credit Review Personnel
An effective credit review system utilizes both the initial identification of emerging problem credits by credit officers, and the review of credit by individuals independent of the credit approval decisions. An important element of an effective system is to place responsibility on credit officers for continuous portfolio analysis and prompt identification and reporting of problem credits. Because of their frequent contact with borrowers, credit officers can usually identify potential problems before they become apparent to others. However, financial institutions should be careful to avoid over-reliance upon credit officers for identification of problem credits. Financial institutions should ensure that credits are also reviewed by individuals who do not have control over the credits they review and are not part of, or influenced by anyone associated with, the credit approval process.
While larger financial institutions would typically establish a separate department (unit) staffed with credit review specialists, cost and volume considerations may not justify such a department in smaller financial institutions. In smaller financial institutions, an independent credit review officer or internal audit may fill this role.
4.6 Frequency of Reviews
Optimally, the credit review function can be used to provide useful continual feedback on the effectiveness of the credit process in order to identify any emerging problems. For example, the frequency of independent review of significant credits could be at least annually, upon renewal, or more frequently for ‘Special Mention’ loans, or when internal or external factors indicate a potential for deteriorating credit quality in a particular type of credit or pool of credits. A system of on-going or periodic portfolio reviews is particularly important for the provisioning process, which is dependent on the accurate and timely identification of problem credits.
4.7. Scope of Reviews
The review should cover all credits that are significant. Also, the review typically includes, in addition to all credits over a pre-determined size, a sample of small credits, past due, non-accrual, renewed credits, restructured credits, credits previously considered non-performing or designated as ‘Special Mention’, related party credits, and concentrations and other credits affected by common repayment factors. The sample for each type of facility/portfolio selected for review should provide reasonable assurance that the results of the reviews have identified the major problems in the portfolio and reflect its quality as a whole, Financial institutions’ management is required to document the scope and the process of its reviews. The scope of credit reviews should be approved by the financial institutions’ Board of Directors and its Audit Committee on an annual basis or when any significant changes to the scope of reviews are made.
4.8. Depth of the Reviews
These reviews should analyze a number of important aspects of selected credits, including:
• Credit quality
• Sufficiency of credit and collateral documentation
• Proper lien perfection
• Proper approvals
• Adherence to any credit agreement covenants
• Compliance with internal policies and procedures and laws and regulations
• Appropriateness of the classification assigned to the credits
• Adequacy of the provisions made against such credits
Furthermore, these reviews should consider the appropriateness and timeliness of the identification of problem credits by credit officers and the adequacy of the overall level of provisions for the whole credit portfolio and for the nonperforming credits.
4.9. Review of Finding and Follow-Up
Findings should be reviewed with appropriate credit officers, department managers, and members of senior management and any existing or planned corrective action should be clarified for all noted deficiencies and identified weaknesses, including the timeframes for correction. All noted deficiencies and identified weaknesses that remain unresolved beyond the assigned timeframes for correction should be promptly reported to senior management, the Board of Directors and the Audit Committee.
4.10. Workpaper and Report Distribution
A list of credits reviewed, the date of the review and documentation (including summary analysis) to substantiate assigned classifications of credits should be prepared on all credits reviewed. A report that summarizes the results of the credit review should be submitted to the Board of Directors on at least a quarterly basis. In addition to reporting current credit quality findings, comparative trends can be presented to the Board of Directors that identify significant changes in the overall quality of the portfolio. Findings should also address the adequacy of and adherence to internal policies, practices and procedures, and compliance with laws and regulations so that any noted deficiencies can be remedied in a timely manner.