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Risk Appetite and Exceptions/Exception Tracking and Management

Loan exception tracking and management is an emerging area of focus for prudent bank risk managers. Many times bankers may wish to make a reasonable exception to policy in order to accommodate a client need. How do we know that we are making good exceptions? Do we know that they performed as well as the non-exception loans in the same category? This is an important area for originating lines of business, and for credit and enterprise risk managers to understand and manage appropriately.

Bankers should be able to validate that the exceptions granted during underwriting or portfolio management conform to the bank’s articulated risk appetite statement. This is not only a good practice, but also a regulatory expectation. The OCC’s Comptroller’s Handbook Corporate and Risk Governance section has several things to say on the topic, including:

  • “The [board] credit committee should monitor loan policy exceptions.”
  • “Performance and risk reports should…monitor the types, volumes, and impacts of exceptions to policies and operating procedures.”
  • And, in the examination procedures section, “Determine how management ensures that adopted policies are followed and that exceptions are documented.”

What are the leading practices in this area? A group of risk and credit leaders shared some of their recommendations:

  • Differentiate between levels of severity among exceptions. For example, some exceptions may be deemed to be critical exceptions and require approval of senior bank management, e.g., supervisory LTV limit exceptions; while others may be deemed guideline exceptions and be approved by the field approver. A dated guarantor tax return could be an example of such an exception. These two examples pose different levels of risk, and should be categorized differently within the exception tracking hierarchy.
  • Report the appropriate level of detail about exceptions to the appropriate audience.  Exception reporting for underwriting managers or business leaders may differ in the amount of detail from reporting for senior management or the board.
  • Do not change your policy just to reduce the exceptions, but do challenge your policies if you see a high number of exceptions. Is your policy truly a reflection of your risk appetite?
  • Transactions with exceptions should frequently have one-up, or in some cases two-up approval. All exceptions should have mitigants and the rationale for the exception should be clearly documented.
  • Finally, compare potential portfolio acquisitions to the acquiring bank’s policies to get an idea of cultural fit during due diligence.