Board of Governors of the Federal Reserve System

Federal Deposit Insurance Corporation

National Credit Union Administration

Office of the Comptroller of the Currency

Interagency Guidance on Credit Risk Review Systems

May 2020

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Introduction

The Interagency Guidelines Establishing Standards for Safety and Soundness

(Guidelines) [Footnote 1

- 12 CFR part 30, Appendix A (OCC); 12 CFR part 208, Appendix D-1 (Board); and 12 CFR part 364, Appendix A

(FDIC). Part 723 of NCUA Rules and Regulations. End of Footnote 1.]

underscore the critical importance of credit risk review and set safety and

soundnessstandards for insured depository institutions to establish a system for independent,

ongoing credit risk review, and for appropriate communication to their management and boards

of directors. [Footnote 2

- For foreign banking organization branches, agencies, or subsidiaries not operating under single governance in the

United States, the U.S. risk committee would serve in the role of the board of directors for purposes of this guidance. End of Footnote 2.]

This guidance, which aligns with the Guidelines, is appropriate for all institutions [Footnote 3

- For purposes of this guidance, regulated institutions are those supervised by the following agencies: The Board of

Governors of the Federal Reserve System (Board), the Federal Deposit Insurance Corporation (FDIC), the National

Credit Union Administration (NCUA), and the Office of the Comptroller of the Currency (OCC), hereafter referred

to as the “agencies.” End of Footnote 3.]

and describes a broad set of practices that can be used either within a dedicated unit or across

multiple units throughout an institution to form a credit risk review system that is consistent with

safe and sound lending practices. This guidance outlines principlesthat an institution should

consider in developing and maintaining an effective credit risk review system.

Overview of Credit Risk Review Systems

The nature of credit risk review systems [Footnote 4

- The credit risk review function is not intended to be performed by an institution's internal audit function.

However, as discussed in the agencies' March 2003 Interagency Policy Statement on the Internal Audit Function

and its Outsourcing (2003 policy statement),some institutions coordinate the internal audit function with several

risk monitoring functions, such as the credit risk review function. The 2003 policy statement states that coordination

of credit risk review with the internal audit function can facilitate the reporting of material risk and control issues to

the audit committee, increase the overall effectiveness of these monitoring functions, better utilize available

resources, and enhance the institution's ability to comprehensively manage risk. However, an effective internal audit 

function maintains the ability to independently audit the credit risk review function. (The NCUA was not an issuing

agency of the 2003 policy statement.) End of Footnote 4.]

varies based on an institution'ssize,

complexity, loan types, risk profile, and risk management practices. For example, in smaller or

less complex institutions, a credit risk review system may include qualified members of the staff,

including loan officers, other officers, or directors, who are independent of the credits being 

assessed. In larger or more complex institutions, a credit risk review system may include

components of a dedicated credit risk review function that are independent of the institution's
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lending function. [Footnote 5

- Credit risk review may be referred to as loan review, credit review, asset quality review, or another name as

chosen by an institution. The role of, expectations for, and scope of credit risk review as discussed in this document

are distinct from the roles, expectations, and scope of work performed by other groups within an institution that are

also responsible for monitoring, managing and reporting credit risk. Examples may be those involved with lending

functions, independent risk management, loan work outs, and accounting. Each institution indicatesin its own

policies and proceduresthe specific roles and responsibilities of these different groups, including separation of

duties. A credit risk review unit, or individuals serving in that role, can rely on information provided by other units

in developing its own independent assessment of credit risk in loan portfolios, but the credit risk review unit

critically evaluates such information to maintain its own view, as opposed to relying exclusively on such 

information. End of Footnote 5.]

A credit risk review system may also include various responsibilities assigned

to credit underwriting, loan administration, a problem loan workout group, or other

organizational units of an institution. Among other responsibilities, these groups may administer

the internal problem loan reporting process, maintain the integrity of the credit risk rating

process, confirm that timely and appropriate changes are made to risk ratings, and support the

quality of information used to estimate the Allowance for Credit Losses (ACL) or the Allowance

for Loan and Lease Losses (ALLL), as applicable. Additionally, some or all of the credit risk

review function may be performed by a qualified third party.

Regardless of the structure, an effective credit risk review system accomplishes the

following objectives:

• Promptly identifies loans with actual and potential credit weaknesses so that timely

action can be taken to strengthen credit quality and minimize losses.

• Appropriately validates and, if necessary, adjusts risk ratings, especially for those

loans with potential or well-defined credit weaknesses that may jeopardize

repayment.

• Identifies relevant trends that affect the quality of the loan portfolio and highlights

segments of those portfolios that are potential problem areas.

• Assesses the adequacy of and adherence to internal credit policies and loan

administration procedures and monitors compliance with applicable laws and 

regulations.

• Evaluates the activities of lending personnel and management, including compliance

with lending policies and the quality of their loan approval, monitoring, and risk

assessment.

• Provides management and the board of directors with an objective, independent, and

timely assessment of the overall quality of the loan portfolio.

• Provides management with accurate and timely credit quality information for 

financial and regulatory reporting purposes, including the determination of an 

appropriate ACL or ALLL, as applicable.

Credit Risk Rating (or Grading) Framework

The foundation for any effective credit risk review system is accurate and timely risk

ratings to assess credit quality and identify or confirm problem loans. An effective credit risk
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rating framework includes the monitoring of individual loans and retail credit portfolios, or

segments thereof, with similar risk characteristics. An effective framework also provides

important information on the collectibility of each portfolio for use in the determination of an 

appropriate ACL or ALLL, as applicable. Further, an effective framework generally places

primary reliance on the lending staff to assign accurate and timely risk ratings and identify

emerging loan problems. However, given the importance of the credit risk rating framework, the

lending personnel's assignment of risk ratings is typically subject to review by qualified and 

independent: (i) peers, managers, or loan committee(s); (ii) part-time or full-time employee(s);

(iii) internal departments staffed with credit review specialists; or (iv) external credit review

consultants. A risk rating review that is independent of the lending function and approval

process can provide a more objective assessment of credit quality. [Footnote 6

- Small or rural institutions that have few resources or employees may adopt modified credit risk review procedures

and methods to achieve a proper degree of independence. For example, in the review process, such an institution

may use qualified members of the staff, including loan officers, other officers, or directors, who are not involved

with originating or approving the specific credits being assessed and whose compensation is not influenced by the

assigned risk ratings. It is appropriate to employ such modified procedures when more robust procedures and

methods are impractical. Institution management and the board, or a board committee,should have reasonable

confidence that the personnel chosen will be able to conduct reviews with the needed independence despite their

position within the loan function. End of Footnote 6.]

An effective credit risk rating framework includes the following attributes:

• A formal credit risk rating system in which the ratings reflect the risk of default and 

credit losses, and for which a written description of the credit risk framework is

maintained, including a discussion of the factors used to assign appropriate risk

ratings to individual loans and retail credit portfolios, or segments thereof, with

similar risk characteristics. [Footnote 7

- A bank or savings association may have a credit risk rating framework that differs from the framework for loan 

classifications used by the federal banking agencies. Such banks and savings associations should maintain

documentation that translates their risk ratings into the regulatory classification framework used by the federal

banking agencies. This documentation will enable examiners to reconcile the totals for the variousloan

classifications or risk ratings under the institution's system to the federal banking agencies' categories contained in

the Uniform Agreement on the Classification and Appraisal of Securities Held by Depository Institutions

Attachment 1 - Classification Definitions (OCC: OCC Bulletin 2013-28; Board: SR Letter 13-18; and FDIC: FIL51-2013). The NCUA does not require credit unions to adopt a uniform regulatory classification system. Risk

rating guidance for credit unions is set forth in NCUA letters to credit unions 10-CU-02, “Current Risks in Business

Lending and Sound Risk Management Practices,” issued January 2010 and 10-CU-03, “Concentration Risk,” issued

March 2010. See also the Commercial and Member Business Loans section ofthe NCUA Examiner's Guide

(Commercial and Member Business Loans > Credit Risk Rating Systems) and the preamble to 1 CFR Parts 701, 723

and 741 Member Business Loans; Commercial Lending: Proposed Rule July 2015. End of Footnote 7.]

• Identification or grouping of loans that warrant the special attention of management

or other designated “watch lists” of loans that management is more closely

monitoring. [Footnote 8

- In addition to loans designated as “watch list,” this identification typically includes loans rated special mention,

substandard, doubtful, or loss. End of Footnote 8.]

• Clear explanation of why particular loans warrant the special attention of
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management or have received an adverse risk rating.

• Evaluation of the effectiveness of approved workout plans.

• A method for communicating direct, periodic, and timely information to the

institution's senior management and the board of directors or appropriate board

committee on the status of loans identified as warranting special attention or adverse 

classification, and the actions taken by management to strengthen the credit quality of

those loans.

• Evaluation of the institution's historical loss experience for each of the groups of

loans with similar risk characteristics into which it has segmented its loan portfolio. [Footnote 9

- In particular, institutions with large and complex loan portfoliostypically maintain records of their historical loss

experience for credits in each of the categories in their risk rating framework. For banks and savings associations,

these categories are either those used by, or those that can be translated into those used by, the federal banking 

agencies. End of Footnote 9.]

Elements of an Effective Credit Risk Review System

An effective credit risk review system starts with a written credit risk review policy [Footnote 10

- See 12 CFR part 30, Appendix A (OCC); 12 CFR part 208, Appendix D-1 (Board); and 12 CFR part 364

Appendix A (FDIC). See also 12 CFR part 723 (NCUA). End of Footnote 10.]

that

is reviewed and typically approved at least annually by the institution's board of directors or

appropriate board committee to evidence its support of, and commitment to, maintaining an

effective system. Effective policies include a description of the overall risk rating framework

and establish responsibilitiesfor loan review based on the portfolio being assessed. An effective

credit risk review policy addresses the following elements, described in more detail below: the

qualifications and independence of credit risk review personnel; the frequency, scope, and depth

of reviews; the review of findings and follow-up; and communication and distribution of results.

Qualifications of Credit Risk Review Personnel

An effective credit risk review function is staffed with personnel who are qualified based

on their level of education, experience, and extent offormal credit training. Qualified personnel

are knowledgeable in both sound lending practices and the institution's lending guidelines for the

types ofloans offered by the institution. The level of experience and expertise for all personnel

involved in the credit risk review process is expected to be commensurate with the nature ofthe

risk and complexity ofthe portfolios. In addition, qualified credit risk review personnel possess

knowledge ofrelevant laws, regulations, and supervisory guidance.

Independence of Credit Risk Review Personnel

An effective credit risk review system incorporates both the initial identification of

emerging problem loans by loan officers and other line staff, and an assessment ofloans by 

personnel independent ofthe credit approval process. Placing primary responsibility on loan

officers, risk officers, and line staffis important for continuous portfolio analysis and prompt

identification and reporting of problem loans. Because offrequent contact with borrowers, loan

officers and line staff can usually identify potential problems before they become apparent to

others. However, institutions should be careful to avoid over-reliance on loan officers and line
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staff for identification of problem loans. An independent assessment of risk is achieved when

personnel who perform the loan review do not have control over the loan and are not part of or

influenced by individuals associated with the loan approval process.

While a larger institution may establish a separate departmentstaffed with credit review

specialists, cost and volume considerations may not justify such a system in a smaller institution.

For example, in the review process, smaller institutions may use an independent committee of

outside directors or qualified members of the staff, including loan officers, other officers, or

directors, who are not involved with originating or approving the specific credits being assessed

and whose compensation is not influenced by the assigned risk ratings. Whether or not the

institution has a dedicated credit risk review department, it is prudent for the credit risk review

function to report directly to the institution's board of directors or a committee thereof,

consistent with safety and soundnessstandards. Senior management may be responsible for

appropriate administrative functions provided such an arrangement does not compromise the

independence of the credit risk review function.

The institution's board of directors, or a committee thereof, may outsource the credit risk

review function to an independent third party. [Footnote 11

- For supervisory guidance related to outside service providers, refer to SR letter 13-19/CA letter 13-21, “Guidance

on Managing Outsourcing Risk,” issued by the Board on December 5, 2013; FIL-44-2008, “Guidance for Managing

Third-Party Risk,” issued by the FDIC on June 6, 2008; and OCC Bulletin 2013-29, “Third-Party Relationships:

Risk Management Guidance,” issued by the OCC on October 30, 2013. For credit unions, refer to NCUA letters to

credit unions 01-CU-20 “Due Diligence over Third Party Service Providers,” issued November 2001 and 07-CU-13

“Evaluating Third Party Relationships,” issued December 2007. End of Footnote 11.]

However, the responsibility for maintaining a

sound credit risk review system remains with the institution's board of directors. In any case,

institution personnel who are independent from the lending function typically assess risks,

develop the credit risk review plan, and verify appropriate follow-up of findings. Outsourcing of

the credit risk review function to the institution's external auditor may raise additional

independence considerations. [Footnote 12

- See footnote 4. End of Footnote 12.]

Frequency ofReviews

An effective credit risk review system provides for review and evaluation of an

institution's significant loans, loan products, or groups ofloans typically annually, on renewal, or

more frequently when internal or external factors indicate a potential for deteriorating credit

quality or the existence of one or more other risk factors. The credit risk review function can

also provide useful continual feedback on the effectiveness ofthe lending process in order to

identify any emerging problems. Ongoing or periodic review of an institution's loan portfolio is

particularly important to the estimation ofACLs or the ALLL because loss expectations may

change as the credit quality of a loan changes. Use of key risk indicators or performance metrics

by credit risk review management can support adjustments to the frequency and scope of

reviews.

Scope ofReviews
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Comprehensive and effective reviews cover all segments of the loan portfolio that pose

significant credit risk or concentrations, and other loans that meet certain institution-specific

criteria. A properly designed scope considers the current market conditions or other external

factors that may affect a borrower's current or future ability to repay the loan. Establishment of

an appropriate review scope also helps ensure that the sample of loans selected for review, or

portfolio segments selected for review, is representative of the portfolio as a whole and provides

reasonable assurance that any credit quality deterioration or unfavorable trends are identified.

An effective credit risk review function also considers industry standards for credit risk review

coverage consistent with the institution's size, complexity, loan types, risk profile, and risk

management practices and helps to verify whether the review scope is appropriate. The

institution's board of directors or appropriate board committee typically approves the scope of

the credit risk review on an annual basis or whenever significant interim changes are made in

order to adequately assess the quality of the current portfolio. An effective scope of credit risk

review is risk-based and typically includes:

• Loans over a predetermined size;

• A sufficient sample of smaller loans, new loans, and new loan products;

• Loans with higher risk indicators, such as low credit scores, high credit lines, or those

credits approved as exceptions to policy;

• Segments of loan portfolios, including retail, with similar risk characteristics such as

those related to borrower risk (e.g. credit history), transaction risk (e.g. product and/or

collateral type), or other risk factors as appropriate;

• Segments of the loan portfolio experiencing rapid growth;

• Exposures from non-lending activities that also pose credit risk;

• Past due, nonaccrual, renewed, and restructured loans;

• Loans previously adversely classified and loans designated as warranting the special

attention of the institution's management; [Footnote 13

- See footnote 8. End of Footnote 13.]

• Loans to insiders or related parties;

• Loans to affiliates;

• Loans constituting concentrations of credit risk and other loans affected by common

repayment factors.

Depth of Transaction or Portfolio Reviews

Loans and portfolio segments selected for review are typically evaluated for:

• Credit quality, soundness of underwriting and risk identification, borrower

performance, and adequacy ofthe sources ofrepayment;

o When applicable, this evaluation includes the appropriateness of automated

underwriting and credit scoring, including prudent use of overrides, as well as the
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effectiveness of account management strategies, collections, and portfolio

management activities in managing credit risk;

• Reasonableness of assumptions;

• Creditworthiness of guarantors or sponsors;

• Sufficiency of credit and collateral documentation;

• Proper lien perfection;

• Proper approvals consistent with internal policies;

• Adherence to loan agreement covenants;

• Adequacy of, and compliance with, internal policies and procedures (such as those

related to nonaccrual and classification or risk rating policies), laws, and regulations;

• The appropriateness of credit loss estimation for those credits with significant

weaknesses including the reasonableness of assumptions used, and the timeliness of

charge-offs;

• The accuracy ofrisk ratings and the appropriateness and timeliness ofthe

identification of problem loans by loan officers.

Review ofFindings and Follow-Up

An important activity of an effective credit risk review system is the discussion ofthe

review findings, including all noted deficiencies, identified weaknesses, and any existing or

planned corrective actions (including time frames for correction) with appropriate loan officers,

department managers, and senior management. An effective system includes processes for all

noted deficiencies and weaknesses that remain unresolved beyond the scheduled time frames for

correction to be promptly reported to senior management and the board of directors or

appropriate board committee.

It is important to resolve risk rating differences between loan officers and loan review

personnel according to a pre-arranged process. That process may include formal appeals

procedures and arbitration by an independent party or may require default to the assigned

classification or risk rating that indicates lower credit quality. If credit risk review personnel

conclude that a loan or loan portfolio is of a lower credit quality than is perceived by the

portfolio management staff, the lower classification or risk rating typically prevails unless

internal parties identify additional information sufficient to obtain the concurrence ofthe

independent reviewer or arbiter on the higher credit quality classification or risk rating.

Communication and Distribution ofResults

Personnel involved in the credit risk review process typically prepare a list of all loans

(and portfolio segments) reviewed, the date ofreview, and a summary analysis that substantiates

the risk ratings assigned to the loans reviewed. Effective communication also typically involves 

providing results ofthe credit risk reviews to the board of directors or appropriate board
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committee quarterly. [Footnote 14

- An effective credit risk review system provides for informing the board of directors or appropriate board

committee more frequently than quarterly when material adverse trends are noted. When an institution conducts loan

file reviewsless frequently than quarterly, the board or appropriate board committee will typically receive results on

other credit risk review activities quarterly. End of Footnote 14.]

Comprehensive reporting includes comparative trends that identify

significant changes in the overall quality of the loan portfolio, the adequacy of, and adherence to,

internal policies and procedures, the quality of underwriting and risk identification, compliance

with laws and regulations, and management's response to substantive criticisms or

recommendations. Such comprehensive reporting provides the board of directors or appropriate

board committee with insight into the portfolio and the responsiveness of management and 

facilitates timely corrective action of deficiencies.