What Is Asset Quality?

Asset quality refers to the degree of financial strength and risk in a bank’s assets, typically loans and investments. The quality of the bank’s assets impacts all components of a bank’s financial performance. High levels of low-quality assets can have a negative impact on earnings through:

  • lower interest income;
  • higher provisions to the loan loss reserve; and
  • increased administrative costs for managing and collecting these assets.

Asset quality problems can diminish the liquidity inherent in the loan portfolio and have a negative impact on the adequacy of bank capital. Poor asset quality also reflects upon management’s competence. Because of the importance of asset quality, examiners spend a considerable amount of time evaluating it, and so should you and bank management. Accordingly, a comprehensive evaluation of asset quality is one of the most important components in assessing the current condition and viability of a bank.

Your responsibilities regarding asset quality are to provide a basis for responsible lending and investing, oversee management’s maintenance of an adequate allowance for loan and lease losses (ALLL), and retain qualified lending and investment personnel. You will do this through your involvement in developing and approving your bank’s lending and investing policies, which will:

  • set the risk limits for the bank by specifying the types of investments to purchase and loans to make;
  • establish an internal loan review system; and
  • document the method used to determine the adequacy of the ALLL.

Directors may also participate in significant lending decisions or review, approve and monitor the loan decisions of others. This section of the course reviews methods by which to evaluate and monitor asset quality.

Lesson Objectives

After you complete this lesson, you should be able to:

  1. describe the importance of asset quality to a bank’s financial condition;
  2. recognize asset classification categories such as substandard, doubtful or loss; and
  3. measure and monitor your bank’s asset quality.