Getting the Lending Policy Right
Wednesday 10 January 2024
Every credit union’s Policy Manual should include a Loan Policy and a Credit Control Policy. Within the limits established by law and regulation, the credit union should set out its decisions concerning its loan business, bearing in mind the size and scale of its lending operation, its members’ needs and local competition. It is the responsibility of the Board of Directors to set policy and to ensure that it is regularly reviewed and updated to reflect the developing business of the credit union and the needs of the membership. It is the responsibility of the staff and volunteers to implement the agreed policy.
Loan Policy
- The lending policy sets out how the credit union will implement its strategy
- The Board is responsible for setting the policy
- Policy needs to set out the rules, roles and responsibilities connected with lending
- The policy needs to be clear, easily understood, and comprehensive
Elements of a loan policy
- Principles
- Levels of authority
- Loan products and rates
- Criteria for acceptance
- Documentation
- Emergency Loans
- Guarantors
- Repayment terms
- Credit control/arrears management
- Record keeping
- Controls and checks
- Levels of authority
It is usual for the Board to delegate authority for taking lending decisions. This leads to quicker decisions (better service) and more consistency. Authority may be delegated to a Credit Committee, and/or to Loan Officers (paid or volunteers). .
Loan products & rates/criteria for acceptance
Connected to criteria for acceptance. A small sum loan at higher rate may have less stringent criteria for acceptance than larger loan at lower rate; smaller loan has less exposure and some element of higher risk priced into the interest rate.
The criteria for acceptance should include what is/isn’t acceptable when approving applications. This enables the credit committee/loan officers to be consistent. This part of the policy should include some flexibility around declining cases allowing people to not feel obliged to lend just because the application ticks all the boxes.
Documentation
This section should list what is acceptable documentation from the borrower – to confirm housing tenure, income, financial circumstances, and any other information Also the required forms from the credit union side – application form, loan agreement form, and related letters.
Credit control/arrears management
The credit union needs to have a strong process for managing arrears. This should be set out in detail – and followed! Remember some people can’t pay, as well as those who won’t. Credit control starts with making good loans in the first place – application assessment is crucial to good long term portfolio performance
Reviews
The Board should review Lending Policy at least every six months and react quickly where a problem is discovered. For example, if a high percentage of loans suddenly go bad then a change in policy to prevent similar loans being made would be prudent. The management/Credit Committee should play a key role in ongoing policy development.
Controls
The Board should receive regular lending reports – showing how much is being lent and at what rates. Arrears management reports should show both point-in-time data, and trends too. Supervisory committee should check that policy is being followed, particularly regarding staff & officer loans. The Management/Credit Committee should also be checking samples of applications to ensure that policy is being followed
Legislation put in place on January 8 2012 clarifies the position in relation to the attachment of shares and all credit unions, regardless of whether they are choosing to take up options under the LRO, should be aware of this.
Attachment of Shares
What do we mean by attached shares?
Attached shares are shares which cannot be withdrawn because the credit union member has an outstanding loan in excess of his/her shareholding.
Are attached shares the same as secured loans?
No. The fact that shares are attached does not convert an unsecured loan into a secured loan. A loan may only be secured on shares if the member makes an application and has shares equal to or greater than the loan, and is not allowed to withdraw those shares in any circumstances.
Before the LRO
Before the LRO, attached shares could only be withdrawn at the discretion of the credit union by following an internal policy. For example, a member with a loan of £1,000 and £1,500 in shares could freely withdraw £500, but the rest of the share amount could only be withdrawn at the discretion of the relevant committee, or in line with internal procedures.
What does the LRO require of all credit unions regarding attachment of shares?
From January 8 2012 all credit unions attaching shares should clearly set out, in each new loan agreement, the extent to which shares will be attached. Credit unions are able to set out how this will be done in several ways, including specifying the monetary value or the proportion of shares to be attached, or by treating different shares accounts held by the member in different ways. The term in a loan agreement identifying which shares are unattached (withdrawable) and which are attached (non-withdrawable) for the duration of the loan may be varied in line with contract law.
As there can be so many versions of the term of agreement it would be difficult to give a specific form of wording but to satisfy the guidance you should clarify the terms by including the words ‘any amount equivalent to the loan or amount outstanding on the loan; whichever is the greater; and any such interest or expenses which may become due…’.
It would also be good to seek legal advice on the wording of any agreement terms.
You should also introduce to your application process a clear, prominent and distinct message (written or verbal) about which shares will be attached.
What should the loan agreement include?
• All loan agreements must include a term identifying which of the member’s shares can be withdrawn and the amount that is attached;
• The loan agreement may break down the attached shares in different ways, including stating which accounts the funds are held in, or stating whether they are below a specific amount or proportion of the member’s shareholding or outstanding balance; and
• The agreement should make clear the shares already held by the credit union and state the date of the agreement and the treatment of shares received after that date.
What should credit unions do to make sure a robust policy is in place for dealing with attached shares?
• Credit unions will need to devise policies covering the terms appearing in loan agreements for unsecured loans, and the procedures that should be followed when considering whether to vary an agreement; and
• They will need systems capable of identifying at all times whether individual shares are either withdrawable or non-withdrawable, as this will feed into a number of other areas including the calculation of arrears provision requirements and the assessment of large exposures
Legal Considerations
The Credit Unions Act 1979 establishes the maximum legal repayment periods for loans.
A small number of credit unions, operating under Version 2 regulatory restrictions, in return for meeting higher regulatory requirements are able to grant loans over longer repayment periods.
The rate of interest charged on loans is determined by the Board of Directors, but must not exceed a rate of 3% per month on the declining balance of the loan.
A 3% per month loan rate is quoted as 42.6% APR. Less than 3% per month can be charged if the credit union needs to price its loan products more competitively and can afford to do so.
A loan can only be granted to a member of the credit union and in order to borrow, a member should be at least 18 years of age. Although the law used to absolutely forbid lending to minors under the age of 18, under the Age of Legal Capacity (Scotland) Act 1991 and the Minors Contracts Act 1987, they may now enter into credit agreements. However, these laws give them the rights to withdraw from such agreements if they can be proven to be prejudicial to the minor or entered into ill-advisedly. In such cases a claim for an outstanding loan could not be enforced against a minor. Nor is the parent legally obliged to repay their child’s debts.
Regulatory Considerations
The Credit Union Specialist Sourcebook (CREDS) contains the regulatory restrictions and controls that the regulators have established to limit and control the extent of risk employed by a credit union in granting credit.
CREDS outlines the key limits on a credit union’s lending as well as minimum provisioning that must be made for bad debt. The rules around lending are set out in CREDS 7.
CREDS 7.2.1A: “A credit union must establish, maintain, and implement an up-to-date lending policy statement approved by the committee of management that is prudent and appropriate to the scale and nature of its business, having regard to the limits outlined in CREDS 7.3.”
CREDS 7.2.9: “A credit union should have a documented arrears management policy, setting out the procedures and process for dealing with borrowers who fall into arrears. This should be reviewed regularly and promptly in the light of experience.”