The Asset Quality of a lending institution reflects the quantity of existing and potential credit risk associated with the loan and investment portfolios, other real estate owned, other assets, and off-balance-sheet transactions, but also the ability of management to identify, measure, monitor, and control credit risk.
The evaluation of asset quality considers the adequacy of the allowance for loan and lease losses and weigh the institution’s exposure to counterparty, issuer, or borrower default under actual or implied contractual agreements. All other risks that may affect the value or marketability of an institution’s assets, including but not limited to operating, market, reputation, strategic, or compliance risks, should be considered.
The asset quality of a financial institution is based on, but not limited to, an assessment of the following evaluation factors:
- the adequacy of underwriting standards, soundness of credit-administration practices, and appropriateness of risk-identification practices
- the level, distribution, severity, and trend of problem, classified, non-accrual, restructured, delinquent, and non-performing assets for both on- and off-balance-sheet transactions
- the adequacy of the allowance for loan and lease losses and other asset valuation reserves
- the credit risk arising from or reduced by off-balance-sheet transactions, such as unfunded commitments, credit derivatives, commercial and standby letters of credit, and lines of credit
- the diversification and quality of the loan and investment portfolios
- the extent of securities underwriting activities and exposure to counterparties in trading activities
- the existence of asset concentrations
- the adequacy of loan and investment policies, procedures, and practices
- the ability of management to properly administer its assets, including the timely identification and collection of problem assets
- the adequacy of internal controls and management information systems
- the volume and nature of credit-documentation exceptions
Asset Quality Review
A well documented exercise of review asset quality for a large cross section of European Banks is provided in the Asset Quality Review manual.
- CAMELS Rating Model