Loan Portfolio Management

23089 Words Nov 6th, 2008 93 Pages
Loan Portfolio Management

Introduction

Background:

L ending is the principal business activity for most commercial banks. The loan portfolio is typically the largest asset and the predominate source of revenue. As such, it is one of the greatest sources of risk to a bank’s safety and soundness. Whether due to lax credit standards, poor portfolio risk management, or weakness in the economy, loan portfolio problems have historically been the major cause of bank losses and failures.

Effective management of the loan portfolio and the credit function is fundamental to a bank’s safety and soundness. Loan portfolio management (LPM) is the process by which risks that are inherent in the credit process are managed and controlled.
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An unregulated banking financial institution might be fraud with unmanageable risks for the purpose of maximizing its potential return. In such a situation, the banking financial institutions might find itself in a serious financial distress instead of improving its financial health. Consequently, not only the depositors but also the shareholders will be deprived of getting back their money from the bank. The deterioration of loan quality also affects the intermediative efficiency of the financial institutions and thus the economic growth process of the country. This the reason for which the banking financial institutions are being regulated in all countries. The banking financial institutions are also the most regulated among all types of financial institutions in all countries, because of their substantial role in payment mechanism (in addition to protect the loan portfolio from decaying).
Portfolio management is crucial for commercial banks, be it in developed or developing countries. Mere accumulation of deposits gives rise to entries both in liabilities and assets sides of the balance sheets. So, portfolio management involves in both liability and assets of commercial banks. If deposits of a bank grow at a steady rate and if loan demands can be met from deposit growth, the bank will have no problem of liquidity. In real life, deposits do not grow steadily all the time, nor does loan demand grow in keeping with growth in deposits.
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