Evaluating Asset Quality

An important quality control you will need in order to evaluate asset quality is an internal loan review system, since the loan portfolio is typically a bank’s largest asset. A loan review is a risk management process in which loans are periodically and regularly analyzed in order to promptly identify loans with potential credit weaknesses. This allows for an assessment of the inherent risk in a loan portfolio. In this review, loans are graded, often using the regulatory classification system described in this section. Other grading systems may be used, but bank management should be able to equate or translate their grades into the regulatory classifications. Having a grading system that is consistent with the regulator’s serves two purposes; it provides a consistency that allows:

  • comparison of internal and external loan review data in assessing bank asset quality; and
  • calculation of the asset quality ratios used by the banking agencies during the interim period between bank examinations.

The scope and frequency of a loan review should be commensurate with the size and complexity of a bank. This review may be done by bank personnel or by a third-party vendor hired by the bank. In any event, the reviewer should be independent of the loan transactions being reviewed.

As with capital, ratio analysis is also a useful tool for evaluating your bank’s asset quality. There are several financial ratios that can give you a broad view of asset quality. Refer to the "Ratio Analysis - Asset Quality" under the Learn More column for more information.