The main objective of this report is to Analysis of Credit Risk Management of National Bank. Other objectives are provide directional guidelines to all concerned to analysis of risk management and keep legal aspects relating to loans and advances. Here also identify proper lending area and analyze all aspects related to credit and ascertain viability of lending. Finally make credit documentation exhaustive.
Risk is inherent in all commercial operations. For Banks and Financial institutions, Credit risk is an essential factor, which needs to be managed properly. Credit risk virtually is the possibility that a borrower will fail to repay debt in accordance with the terms of sanction. Credit risk therefore arises from the bank’s lending operations. In the present day’s state of deregulation and globalization, banks range of activities have increased, so also are the risks. Expansion of bank’s lending operations covering new products have forced the banks to confront newer risk areas and therefore to work out proper risk addressing devices. Credit risks are so exhaustive that a single device cannot encompass all the risks. Moreover lending risks today have assumed such diverse nature, that newer techniques are to be applied to effectively contain the risks. In order to effectively contain risks, credit risk management has to be done in order to enable the bank to proactively manage loan portfolios in order to minimize losses and earn acceptable level of return for the shareholders. In the present scenario of fast changing, dynamic global economy and the increasing pressure of globalization, liberalization, consolidation and disintermediation, it is essential to undertake robust credit risk management policies and procedures, sensitive and responsive to these changes.
National Bank Limited is committed to extend high quality services to its clients through different financial products and profitable utilization of fund by undertaking various lending operations including financing trade, commerce & Industry etc. In conducting lending operations NBL always bears in mind the essence of proper risk identification and their effective management. It is also recognized that failure in proper identification and management of risks may result in a large quantum of bank advances turning into non-performing.
In the above back drop, National Bank Limited underscoring the need of an effective credit risk management process has prepared the policy guidelines for Credit Risk Management. The policy will be reviewed annually by the Board of Directors of our bank.
The policy shall be distributed to the concerned officials, all divisional Heads, Branches, Regional Offices and top management officially. The policy shall be strictly followed by all concerned. Any deviation from the guidelines to be clearly identified and justification for approval to be provides.
The main objectives of the guidelines are as under:
- To provide directional guidelines to all concerned to analysis of risk management.
- To adopt an appropriate working method.
- To keep legal aspects relating to loans and advances.
- To introduce and adopt uniform practice in working..
- To make working procedure rational.
- To make lending correct information based.
- To identify proper lending area.
- To analyze all aspects related to credit and ascertain viability of lending.
- To make credit documentation exhaustive.
- To ensure proper supervision, monitoring & follow up.
Objectives of the study
The objectives of this study are as follows:
- To study the activities and overall performance of National Bank Limited.
- To have a sound understanding of credit risk management system and procedure followed in the National Bank Limited.
- To know overall banking activities of National Bank Limited.
- To analyze the CRM process of the bank and to make recommendations if needed.
- To focus on the credit risk grading system for analyzing the credit assessment procedure of National Bank Limited.
- To identify the strength and weakness and secondary data available have been used in preparing in report.
Methodology of the study
The methodology includes the sample selection, sources of data and method of data analysis.
The organization to be discussed is National Bank Limited. All the departments and functional areas will be covered with more emphasis on credit division.
Sources of data
The study is conducted on the basis of both primary and secondary data.
The primary data are collected from all the departments of National Bank Limited by interviewing personnel of the respective departments. The heads of the departments or senior executives have been interviewed. However, the analysis and the explanation are the authors’ own.
The secondary data of the study are based on a review of existing brochures, documents and database of National Bank Limited. The industry best practices are largely based on Bangladesh Bank manual, guidelines and databases. Books and published articles on this topic have also been consulted.
The credit risk management data of National Bank Limited will be analyzed in a descriptive manner.
Company Profile of National Bank Limited:
National Bank Limited is one of the pioneers of first generation private commercial bank incorporated in 1983. Since inception, NBL to provide modern banking facilities to the mass people is opening branches in rural areas alongside urban areas giving due importance. Presently, the bank created a strong market base through 121 branches and 10 SME centers throughout the country. Customer’s satisfaction and involvements gets priority in our daily activities.
The bank got priority as pioneer in different sectors for taking innovate steps in development of counter’s economy and upgrading the socio-economic status of rural people. Moreover, to encourage expatriates and to generate trust in sending money through legal channel, the bank took some challenging steps and became the pathfinder.
Meeting the need of the customers through modern technology with efficiency and searching new sectors of business, the bank strives to increase its trends of growth. The not only dedicated to profit maximization, it also remains active in fulfilling its social responsibilities.
Besides participating in building national economy, NBL is always a caring bank in adding value to the assets of the shareholders. In short, these are the focus of our banking ethics.
Historical Background :
National Bank Limited has its prosperous past, glorious present, prospective future and under processing projects and activities. Established as the first private sector bank fully owned by Bangladeshi entrepreneurs, NBL has been flourishing as the largest private sector Bank with the passage of time after facing many stress and strain.
At present we have 149 branches under our branch network. In addition, our effective and diversified approach to seize the market opportunities is going on as continuous process to accommodate new customers by developing and expanding rural, SME financing and offshore banking facilities. We have opened 10 branches and 5 SME/Agri branches during 2011.
The then President of the People’s Republic of Bangladesh Justice Ahsanuddin Chowdhury inaugurated the bank formally on March 28, 1983 but the first branch at 48, Dilkusha Commercial Area, Dhaka started commercial operation on March 23, 1983. The 2nd Branch was opened on 11th May 1983 at Khatungonj, Chittagong.
Vision: Ensuring highest standard of clientele services through best application of latest information technology, making due contribution to the national economy and establishing ourselves firmly at home and abroad as a front ranking bank of the country are our cherished vision.
Mission: Efforts for expansion of our activities at home and abroad by adding new dimensions to our banking services are being continued unabated. Alongside, we are also putting highest priority in ensuring transparency, account ability, improved clientele service as well as to our commitment to serve the society through which we want to get closer and closer to the people of all strata. Winning an everlasting seat in the hearts of the people as a caring companion in uplifting the national economic standard through continuous up gradation and diversification of our clientele services in line with national and international requirements is the desired goal we want to reach.
Role of Banks in the modern Economy
The prosperity of a country depends upon its economic activities. Like any other sphere of modern socio-economic activities, banking is a powerful medium of bringing about socio-economic changes of a developing country. Agriculture, Commerce and Industry provide the bulk of a country’s wealth. Without adequate banking facility these three cannot flourish. For a rapid economic growth a fully developed banking system can provide the necessary boost. The whole economy of a country is linked up with its banking system.
Functions of the bank
The functions of the bank are now wide and diverse. Of all the functions of modern bank, lending is by far the most important. They provide both short-term and long-term credits. The customers come from all walks of life, from a small business to a multi-national corporation having its business activities all around the world. The banks have to satisfy requirements of different customers belonging to different social groups. They function as a catalytic agent for bringing about economic, industrial and agricultural growth and prosperity of the country.
Product and Service
Service of the Professional Personal
The officers of National Bank limited have to their credit, decades of banking experience with national / international banks at home and abroad.
A State-Of-The-Art Technology Banking
The Bank will provide a state-of-the-art technology banking such as Any Branch Banking, ATM Services, Home-Banking, Tele-Banking, etc.
Bank offers individuals the best services, including to provide complete customer satisfaction:
- Deposit services.
- Current Account in both Taka and major foreign currencies.
- Convertible Taka Accounts.
- Local and foreign currency remittances.
- SME Banking.
- Any Purpose loan
National Bank Limited caters to the needs of the corporate clients and provides a comprehensive range of financial services, which include:
- Corporate Deposit Accounts.
- Project & Infrastructure Development Finance, Syndicated Finance, Linkage Finance, Investment Business Counseling, Working Capital and other finances.
- Bonds and Guarantees.
Being a commercial bank, National Bank Limited provides comprehensive banking services to all types of commercial concerns. Some of the services are:
- Trade Finance.
- Commodity Finance.
- Issuance of Import L/Cs.
- Advising and confirming Export L/Cs. – Bonds and Guarantees.
- Investment advice.
National Bank limited offers ‘Any branch’ banking service (to limited scale) that facilitates its customers to deposit, withdraw and transfer funds through the counters of any of its branches within the country.
Merchant Banking Advisory Services
The Bank will provide Merchant Bank advisory services, offer complete packages in areas of promotion of new companies, evaluation of projects, mergers, take-over and acquisitions, liaise with the Government with regard to rules and regulations, management of new issues including underwriting support etc.
Capital Market Operation
The Bank will also introduce capital market operation which will include Portfolio Management, Investors Account, Underwriting, Mutual Fund Management, Trust Fund Management etc.
Farm and Off-Farm Credits (Rural)
Out of Bank’s social commitment towards the population at the grass-root level, it will participate in farm and off-farm credit programmers in rural Bangladesh to bring in economic buoyancy in the periphery.
Credit To Women Entrepreneurs
The Bank believes in ‘Equal Opportunity Policy’ and as such has been contemplating to introduce credit programmers for willing and talented women entrepreneurs.
Counter for Payment of Bills
Dedicated counters are available at National Bank Limited’s branches to receive the payment of various utility bills.
- Remit funds from one place to another through DD, TT and MT etc.
- Conduct all kinds of foreign exchange business including issuance of L/C, Traveler’s Cheque etc.
- Collect Cheque, Bills, Dividends, Interest on Securities and issue Pay Orders, etc.
- Act as referee for customers.
- Locker facility for safe keeping of valuables and documents.
Deposits and advances
Deposit of the Bank showed a continuous increase during the year and in 2010 stood at TK.102471.8 million. The growth over previous year was 33.37 percent. The growing customers’ confidence in National Bank helped the necessary broadening of customer range that spanned private individuals, corporate bodies, multinational concerns and financial institutions. The Bank introduced various products/ schemes to attract the depositors.
Cash and Balances with Banks and Financial Institutions
Cash and Balances with Bangladesh Bank was TK. 8695.31 million as against Tk. 6843.69 million in 2010. The funds are maintained to meet Cash Reserve Requirement (CRR) and Statutory Liquidity Requirement (SLR) of the Bank. TK. 1101.57 million as at 31 December 2010. The Bank maintained sufficient balances with correspondents outside Bangladesh to facilitate prompt settlement of payments under Letter of Credits commitments.
Investments of the Bank were TK. 24993.33 million showing an increase of 11.53 percent during the year under review. Investment activities centered around meeting the Bank’s SLR and were mostly in the form of Government Treasury Bills having varying dates of maturity. The average yield on the bills was 7.00% per annum.
Loans and Advances
The Bank’s total Loans and Advances stood at TK. 92003.56 million in 2010 showing a growth of 28.55 percent compared to Tk. 65129.29 million of 2009. Bank’s clientele comprised of corporate bodies engaged in such vital economic sectors as Trade Finance, Steel-Re-Rolling, Ready Made Garments, Textiles, Ship Scrapping, Edible Oil, Cement, Transport, Construction etc.
The Bank continued to offer loans under Consumer Credit Scheme to the fixed income group to enable borrowers to acquire consumer products such as household appliances, office equipment, motor vehicles, mobile phone etc.
Foreign Exchange and Foreign Trade
The bank opened a total number of 24,385 LCs amounting USD 1,117.61 million in import trade in 2010. The main commodities were scrap vessels, rice, wheat, edible oil, capital machinery, petroleum products, fabrics & accessories and other consumer items.
The bank has been nursing the export finance with special emphasis since its inception. In 2010 it handled 18,761 export documents valuing USD 559.78 million with a growth of 5.41 percent over the last year
Merchant Banking activity has lately gained popularity in our country. At the initial stage the activities would center on issue Management, Portfolio Management, pre-placement and underwriting.
The Bank has established a wide network of branches in urban and rural areas totaling 356. National Bank Limited is the largest Commercial Bank in Private Sector in Bangladesh.
Divisional Operations in National Bank Limited
The operations in National Bank limited are carried out through 5 separate departments:
- General Banking (GB)
- Trade Finance
1) General Banking
The General Banking division, in National Bank Limited, generally performs the following functions:
- Account opening
- Cheque book issue
- FDR issue and encashment.
- Product issue and encashment
- Account transfer from one branch to another branch
- Pay order issue and encashment
- Fund transfer from one account to other account
- Inward Remittance and Outward Remittance
- Demand Draft (DD) issue
- Stop payment order
- Issue of solvency certificate
- Inward and outward clearing
Cash division is the center point of any bank. In National Bank Limited, the cash division performs an integral part of its banking operations.
The tellers in the cash division receive cash from the clients and gives necessary postings in the PIBS (National Bank Integrated Banking Software). At the time of receipt, ‘cash received’
and ‘posted’ seal is attached to the deposit slip. At the time of payment, the tellers first verify the signatures and then make payment. If the check is for a big amount, then it has to be authorized by the cash in charge and branch in charge. The seals used here are ‘cash paid’, posted’ and ‘signature verified’.
In National Bank Limited, the accounts related information is fully computer generated. The central IT department generates several important statements such as the General Ledger, profit and Loss Account, Transaction journal, Overdraft and Advances Position, Full Balance position etc. These statements are disseminated in the network so that every branch can have access to its accounting information at the beginning of each working day.
4) Trade Finance
Trade Finance division operates independently in the branches and it generally deals with the followings:
- Import L/C
- Export L/C
- Local & foreign Bills Purchased
a) Import L/C
When a client comes to open an L/C, basic queries about the IRC, VAT registration number, TIN etc, are made. If the bank is satisfied with all the documents, an L/C is opened and an operational entry for L/C opening is passed in Micro Bank.
b) Export L/C
National Bank Limited provides money to the borrowers in terms of Packing Credit and Back to Back L/C.Packing credit is essentially a short term advance with a fixed repayment date granted by the bank to an eligible exporter for the purpose of buying, processing, manufacturing, packing and shipping of the goods meant to be exported.
The credit division is also an independent division in National Bank limited. This division basically deals with the extension of credit to the worthy clients and thus to make a profit from the interest charges. The bank invests the money of the depositors and thus the credit division has to be very cautious in terms of credit extension.
The credit division arranges for different types of loans and high emphasis is given on Small and Medium Enterprises (SMEs). It also issues bank guarantee in favor of the clients. Necessary postings are made through Micro Bank software.
FINALCIAL STATUS OF NBL
NBL always maintains a prudent balance between Tier-I and Tier-2 capital. Total capital as on December 31, 2010 was Tk. 19,190.79 million and capital adequacy ratio was 12.29 %. National Bank Limited formulated befitting credit risk management criteria and strategies for creation of balanced lending mix in its portfolio both for short and long term with the bottom line objective to ensure risk adjusted rate of return in its credit transactions. Loan and advances in the year 2010 registered an increase by 41.26% to BDT 92,003.56 million from BDT 65,129.29 million in 2009. During the year 2010, the credit expansion mainly was in bilateral project finance, syndicate finance, export, import and trade finance as well as SME and Agri finance.
Summary of the Income Statement Item: Figure in Million
|Net Interest Income||1224.56||1405.35||2191.87||2516.29||4039.05|
|Non Interest Income||2054.48||2893.83||3106.36||3999.51||8995.97|
|Non Interest Expenses||2132.26||2134.08||2174.4||3118.11||4093.71|
|Net Non Interest Income||-77.78||759.75||931.96||881.4||4902.26|
|Profit before Tax & Provision||1146.78||2215.1||3123.83||3397.5||8940.6|
|Profit after Tax||507.49||1238.11||1517.43||2070.47||6860.34|
Net Profit: Efficient Board and management, strong capital base, wide branch network, support from other stakeholders helped NBL in revenue earnings and profit maximization. During the period NBL earned profit after tax BDT 6860.34 million with growth of 231.34% which has BDT 2070.47 in 2009.
Summary of the Balance Sheet Item:
Figure in Million
|Paid up Capital||805.47||1208.2||1872.72||2846.54||4412.13|
|Reserve Funds & Surplus||2468.78||3360.19||4253.55||6070.22||14693.47|
|Shareholders’ Equity(capital& reserve)||3274.25||4568.39||6126.27||8916.76||19105.6|
|Cash (including balance with Bangladesh bank)||2140||4473.08||5421.06||6843.69||8695.31|
|Loans & Advances||32709.68||36475.74||50665.07||65129.29||92003.56|
|Fixed Assets(including non banking assets)||1627.29||1842.28||1981.6||2200.85||2609.46|
Loan and advances: In the year 2010 registered an increased by 41.26% to BDT 92,003.56 million from BDT 65,129.29 million in 2009. During the year 2010, the credit expansion mainly was in bilateral project finance, syndicate finance, export, import and trade finance as well as SME and Agri finance.
Total Assets: With the expansion of business, asset profile of the bank also increased. Total assets of the bank grew up by 46.56% to Tk. 134,732.31 million as at December 31, 2010 as against Tk. 91,931.63 million reported as on December 31, 2009. The significant increase in assets was achieved due to raise in loans and advances, investments, cash and balance with Bangladesh Bank and other financial institutions.
Cash: Cash in hand increased by Tk.184.14 million while the balances maintained with the Bangladesh Bank and its agents increased by 30.03% at the end of the December 31, 2010. The deposit growth increased the balances with Bangladesh bank and its agents for maintaining the Cash Reserve Requirement (CRR).
Investments: Investment portfolio of NBL consisting of government and private securities as on December 31, 2010 was Tk. 24,993.33 million registering a growth of 102.95% over previous year, out of which investment in Government securities was 60.08% and rest 39.92% in private securities. The growth is due to mainly purchase of Government Treasury Bills, Debentures and stocks.
Deposits: The deposit base of the bank registered a growth of 33.37% in the reporting year over the last year and stood at Tk. 102,471.83 million. Expansion of branch network, competitive interest rate and innovative deposit products contributed to the growth.
Shareholder Equity: In 2009, 55% stock dividend was declared which increased the amount of paid up capital to Tk. 4,412.13 million in 2010. Reserve and surplus was enhanced by 142.06% consisting of statutory reserve, general reserve, retained earnings and other reserve. Total shareholder’s equity as on December 31, 2010 stood Tk. 19,105.60 million. NBL has increased the authorized capital of the bank to Tk. 17,500 million.
Current Ratio: In 2009 was the highest current ratio and 2006 was the lowest current ratio indicator of National Bank Ltd. The Bank has been decreased their current ratio 1.88 % from 2009.
Liquid Securities Indicator: This ratio compares the most government securities an institution can hold with the overall size of its asset portfolio.
Government Securities / Total Assets*100
|Liquid Securities (%)||10.89%||11.32%||9.19%||9.34%||11.15 %|
Liquidity Assets Ratio: Liquidity assets ratios are a set of ratios or figures that measure a company’s ability to pay off its short-term debt obligations.
Cash+Reserve+Govt. Securities/ Total Assets*10
|Liquid Assets (%)||19.86%||23.96%||21.23%|
Capital Adequacy Ratio: Capital adequacy ratio (CAR) is a measure of how much capital is used to support the banks’ risk assets. It is calculated as follows:
Total Capital / Total Risk Weighted Assets *100
|Capital Adequacy Ratio (%)||10.10%||13.11%||13.42%||8.61%||12.29%|
Leverage Ratio: Leverage ratio indicate the capacity to meet up short and long term debt obligation.
Debt Equity Ratio: The Debt Equity Ratio (D/E) is a financial ratio indicating the relative proportion of shareholders’ equity and debt used to finance a company’s assets. It is calculated as follows:
|Debt Equity Ratio (Times)||8.13||6.77||6.99||9.31||6.05|
Debt Ratio: Debt Ratio is a financial ratio that indicates the percentage of a company’s assets that are provided via debt. It is calculated as follows:
Total Debt/Total Assets*100
|Debt Ratio (%)||93.00%||91.93%||91.51%||90.28%||84.16%|
Activity Ratio: Activity ratio indicates how effectively firm is utilizing its asset. Here effectively means operating efficiency of the firm.
Total Assets Turnover: Total Asset Turnover is a financial ratio that measures the efficiency of a bank’s use of its assets in generating interest income. It is calculated as follows:
Interest Income / Assets*100
|Total Assets Turnover (%)||7.85%||7.59%||8.01%||7.62%||7.14%|
Return on Equity (ROE): Return on equity measures a bank’s profitability by revealing how much profit a bank generates with the shareholders investment. It is calculated as follows:
Net Income/ Total Shareholder Equity*100
Net Interest Margin: Net Interest Margin (NIM) is a measure of the difference between the interest income generated by banks or other financial institutions and the amount of interest paid out to their lenders. It is calculated as follows:
(Interest Income – Interest Expense) / Total Asset
SWOT Analysis is an important tool for evaluating the companies Strengths, Weaknesses, Opportunities and Threats. It helps the organization to identify how to evaluate its performance and can scan the macro environment, which is turn would help the organization to navigate in the Turbulence Ocean of competition. Following is given the SWOT analysis of National Bank Ltd:
1. Top Management
The top management of the bank, the key strength for NBL has contributed heavily towards the growth and development of the bank.
2. Company Reputation
The reputation of the bank is increasing day by day. People are relying on this bank gradually.
The sponsors of the bank are some of the top companies and top business personnel of our country.
4. Modern Facilities and Computer
For speedy service to the customer, NBL had installed money-counting machine in the teller counter. The bank has computerized banking operation under software called PC banking. More over computer printed statements are available to internal use and occasionally for the customers. NBL is equipped with telex and fax facilities
5. Interactive Corporate Culture:
The corporate culture of NBL is very much interactive compare to other local organization. This interactive environment encourages the employee to work attentively.
1. Limitation of Information System (PC Bank):
PC bank is not comprehensive banking software. It is desirable that a more comprehensive banking system should replace PC bank system.
2. Hierarchy Problem:
The hierarchy problem treated as a weakness for NBL, because the employee will not stay for a long. So there will be a chance of brain drain from this bank to other bank.
3. Advertisement Problem:
There is another weakness for NBL is advertisement. Their media coverage is so much low that people do not know the bank thoroughly.
National Bank can pursue diversification strategy in expanding its current line of business.
2. Business Banking
The investment potential of Bangladesh is foreign investors. So NBL has opportunity to expand in business banking.
3. Credit Card
There is an opportunity to launch Credit Card in Bangladesh by NBL. Beside this, NBL can acquire services for cards like VISA, MASTER CARD etc. So that they can enhance the market based card service.
1. Contemporary Banks
The contemporary banks of National Bank like: Dhaka Bank, Dutch Bangla Bank, The Trust Bank, Mercantile Bank is its major rivals. NBL should remain vigilant about the steps taken by these banks, as these will in turn affect NBL strategies.
2. Multinational Bank
The Rapid expansion of multinational bank poses a potential threat to new PCB’s. Due to the booming energy sector, more foreign banks are expected to operate in Bangladesh. Moreover, the existing foreign banks such as HSBC, AMEX, CITI N.A, and Standard Chattered are now pursing an aggressive branch expansion strategy
3. Default Culture
Default culture is very much familiar in our country. For a bank, it is very harmful. As National Bank is new, it has not faced it seriously yet. However as the bank grows older it might become big problems.
Credit Risk Management: A Theoretical Framework
Contemporary banking organizations are exposed to a diverse set of market and non-market risks, and the management of risk has accordingly become a core function within banks. Banks have invested in risk management for the good economic reason that their shareholders and creditors demand it. But bank supervisors, such as the Bangladesh Bank, also have an obvious interest in promoting strong risk management at banking organizations because a safe and sound banking system is critical to economic growth and to the stability of financial markets. Indeed, identifying, assessing, and promoting sound risk management practices have become central elements of good supervisory practice.
What is credit?
In banking terminology, credit refers to the loans and advances made by the bank to its customers or borrowers. Bank credit is a credit by which a person who has given the required security to a bank has liberty to draw to a certain extent agreed upon. It is an arrangement for deferred payment of a loan or purchase. (Wikipedia dictionary)
Credit means a provision of, or commitment to provide, funds or substitutes for funds, to a borrower, including off-balance sheet transactions, customers’ lines of credit, overdrafts, bills purchased and discounted, and finance leases. (Guideline on credit risk management, Bank of Mauritius)
What is credit risk?
Risk means the exposure to a chance of loss or damage. Risk is the element of uncertainty or possibility of loss that exist in any business transaction. Credit risk is the likelihood that a borrower or counter party will be unsuccessful to meet its obligation in accordance with agreed terms and conditions. (Wikipedia dictionary)
Credit risk is most simply defined as the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms (Basel Committee on Banking Supervision,2000).
PRISM Model of credit risk management
PRISM model is a contemporary model used in the credit risk management in modern world. It is called PRISM, an acronym for –
P = Perspective
R = Repayment
I = Intention
S = Safeguards
M = Management
Management, a PRISM component, centers on what the borrower is all about, including history and prospects. Intention or loan purpose serves as the basis for repayment. Repayment focuses on internal and external sources of cash. Internal operations and asset sales produce internal cash, whereas new debt or equity injections provide external cash sources. Internal safeguards originate from the quality and soundness of financial statements, while collateral guarantees and covenants provide external safeguards.
Prerequisites for Efficient Risk Management
In order to implement efficient risk management, sound and consistent
- Processes and organizational structures and
- IT systems and an IT infrastructure are required for all five components of the control cycle.
The methods used show how risks are captured, measured, and aggregated into a risk position for the bank as a whole.
Processes and organizational structures
Processes and organizational structures have to make sure that risks are measured in a timely manner that risk positions are always matched with the defined limits, and that risk mitigation measures are taken in time if these limits are exceeded.
IT systems and an IT infrastructure
IT systems and an IT infrastructure are the basis for effective risk management. Among other things, the IT system should allow:
— The timely provision and administration of data;
— The aggregation of information to obtain values relevant to risk controlling;
— As well as an automated warning mechanism prior to reaching critical risk limits.
Why manage credit risk?
The reasons behind managing credit risks are as follows:
a) Increase shareholder value
- Value creation
- Value preservation
- Capital optimization
b) Instill confidence in the market place
c) Alleviate regulatory constraints and distortions thereof.
A successful, bank-wide risk management requires the definition of a risk strategy which is derived from the bank’s business policy and its risk-bearing capacity. Risk strategy is defined as
— the definition of a general framework such as principles to be followed in dealing with risks and the design of processes as well as technical-organizational structures; and
— the definition of operational indicators such as core business, risk targets, and limits.
The definition of limits is necessary to curb the risks associated with bank’s activities. It is intended to ensure that the risks can always be absorbed by the predefined coverage capital.
Methods of Defining Limits
The risk limits in the bank’s individual business units are based on the bank’s business orientation, its strategy, and the capital allocation method selected. Such a system has to meet the following requirements:
— The parameters used to determine the risks and define the limits should be taken from existing systems. The parameters should be combined using automated interfaces. This ensures that errors due to manual entry cannot occur during the data collection process.
— The defined indicators should be used consistently throughout the bank. The data should be consistent with the indicators used in sales and risk controlling.
— Employees should be able to understand how and why the indicators are determined and interpreted. This is intended to ensure acceptance of the data and the required measures, e.g. when limits are exceeded.
The maximum risk limit is determined by the capital allocated to cover credit risks in the planning process. The bank’s organizational structure has a significant impact on the way in which the limits are designed. Besides the types of limits mentioned above, there are further limit categories:
- Product, business area, country, and industry limits
- Risk class limits
- Limits on unsecured portions
- Individual customer limits
Product, business area, country, and industry limits
Product limits can be defined, among other things, for loans to retail and corporate customers, for real estate loans, as well as for project finance. Banks with an international focus can also define country limits in order to manage their risks arising from transactions in other regions.
Risk class limits
Monitoring and limiting the concentration of exposures in certain risk classes is necessary to be able to detect a deterioration of the portfolio in time, and thus to be able to avoid losses as far as possible by withdrawing from certain exposures. (Bernanke, 2006)
Limits on unsecured portions
The definition of limits for unsecured portions restricts loans that are granted without the provision of collateral or which are collateralized only partly. These limits allow banks to manage their maximum risks efficiently, as it is easy to determine and monitor unsecured portions.
Individual customer limits
Limits for individual borrowers represent the most detailed level of risk controlling. The main purpose for their application is the prevention of cluster risks in the credit portfolio.
Rigidity of Limits
In practice, the rigidity of limits varies in terms of their impact on a bank’s business activities.
— Certain limits are defined rigidly and must never be exceeded, as otherwise the viability of the bank as a whole would be endangered.
— In addition, there are early warning indicators that indicate the risk of exceeding limits ahead of time.
Limit Monitoring and Procedures Used When Limits Are Exceeded
The credit decision is taken based on the borrower’s credit standing and any collateral, but independently of the portfolio risk. Such ex-post observation can result in a relatively high number of cases in which limits are exceeded, thus reducing the effectiveness of the limit stipulations.Some banks check the compliance with the limits immediately during the credit approval process. Prior to the credit decision, compliance with the relevant limits is checked in case the credit is approved. Bringing limit monitoring into play at this early stage is also referred to as ex-ante monitoring. This helps prevent the defined limits from being exceeded in the course of approving new loans. Ex-ante monitoring is quite complex.
Credit Risk Management Process
Credit risk management process should cover the entire credit cycle starting from the origination of the credit in a financial institution’s books to the point the credit is extinguished from the books (Morton Glantz, 2002). It should provide for sound practices in:
- Credit processing/appraisal
- Credit approval/sanction
- Credit documentation
- Credit administration
- Monitoring and control of individual credits
- Monitoring the overall credit portfolio (stress testing)
- Credit classification and
- Managing problem credits/recovery
Credit processing is the stage where all required information on credit is gathered and applications are screened. Credit application forms should be sufficiently detailed to permit gathering of all information needed for credit assessment at the outset. Financial institutions should set out pre-qualification screening criteria, which would act as a guide for their officers to determine the types of credit that are acceptable. For instance, the criteria may include rejecting applications from blacklisted customers. These criteria would help institutions avoid processing and screening applications that would be later rejected.
In the case of loan syndication, a participating financial institution should have a policy to ensure that it does not place undue reliance on the credit risk analysis carried out by the lead underwriter
As a general rule, the appraisal criteria will focus on:
a) amount and purpose of facilities and sources of repayment;
b) integrity and reputation of the applicant as well as his legal capacity to assume the credit obligation;
c)performance of the borrower in any credit previously granted by the financial institution,
d)the borrower’s capacity to repay based on his business plan, if relevant, and projected cash flows using different scenarios;
e)cumulative exposure of the borrower to different institutions;
f)physical inspection of the borrower’s business premises as well as the facility that is the subject of the proposed financing;
g)current and forecast operating environment of the borrower;
h)background information on shareholders, directors and beneficial owners for corporate customers; and
i)Management capacity of corporate customers .
Approval authorities should be sanctioned by the board of directors. Approval authorities will cover new credit approvals, renewals of existing credits, and changes in terms and conditions of previously approved credits, particularly credit restructuring, all of which should be fully documented and recorded.The approval process should be based on a system of checks and balances. Some approval authorities will be reserved for the credit committee in view of the size and complexity of the credit transaction.
Documentation is an essential part of the credit process and is required for each phase of the credit cycle, including credit application, credit analysis, credit approval, credit monitoring, collateral valuation, and impairment recognition, foreclosure of impaired loan and realization of security. Credit applications must be documented regardless of their approval or rejection. All documentation should be available for examination by the Bangladesh Bank. Financial institutions must establish policies on information to be documented at each stage of the credit cycle. For security reasons, financial institutions should consider keeping only the copies of critical documents (i.e., those of legal value, facility letters, signed loan agreements) in credit files while retaining the originals in more secure custody. Credit files should also be stored in fire-proof cabinets and should not be removed from the institution’s premises.
Financial institutions should maintain a checklist that can show that all their policies and procedures ranging from receiving the credit application to the disbursement of funds have been complied with. The checklist should also include the identity of individual(s) and/or committee(s) involved in the decision-making process.
Financial institutions must ensure that their credit portfolio is properly administered, that is, loan agreements are duly prepared, renewal notices are sent systematically and credit files are regularly updated. A financial institution’s credit administration function should, as a minimum, ensure that:
- credit files are neatly organized, cross-indexed, and their removal from the premises is not permitted;
- the borrower has registered the required insurance policy in favor of the bank and is regularly paying the premiums;
- the borrower is making timely repayments of lease rents in respect of charged leasehold properties;
- credit facilities are disbursed only after all the contractual terms and conditions have been met and all the required documents have been received;
- collateral value is regularly monitored;
- the borrower is making timely repayments on interest, principal and any agreed to fees and commissions;
- information provided to management is both accurate and timely;
- responsibilities within the financial institution are adequately segregated;
- funds disbursed under the credit agreement are, in fact, used for the purpose for which they were granted;
- “back office” operations are properly controlled;
- the established policies and procedures as well as relevant laws and regulations are complied with; and
- on-site inspection visits of the borrower’s business are regularly conducted and assessments documented (L.R.Chowdhury,2004).
Monitoring and Control of Individual Credits
To safeguard financial institutions against potential losses, problem facilities need to be identified early. A proper credit monitoring system will provide the basis for taking prompt corrective actions when warning signs point to deterioration in the financial health of the borrower.
In broad terms, the monitoring activity of the institution will ensure that:
- funds advanced are used only for the purpose stated in the customer’s credit application;
- financial condition of a borrower is regularly tracked and management advised in a timely fashion;
- borrowers are complying with contractual covenants;
- collateral coverage is regularly assessed and related to the borrower’s financial health;
- the institution’s internal risk ratings reflect the current condition of the customer;
- contractual payment delinquencies are identified and emerging problem credits are classified on a timely basis; and
- Problem credits are promptly directed to management for remedial actions.
Monitoring the Overall Credit Portfolio (Stress Testing)
An important element of sound credit risk management is analyzing what could potentially go wrong with individual credits and the overall credit portfolio if conditions/environment in which borrowers operate change significantly. The results of this analysis should then be factored into the assessment of the adequacy of provisioning and capital of the institution. Such stress analysis can reveal previously undetected areas of potential credit risk exposure that could arise in times of crisis.
Possible scenarios that financial institutions should consider in carrying out stress testing include:
- Significant economic or industry sector downturns;
- Adverse market-risk events; and
- Unfavorable liquidity conditions.
Classification of credit
It is required for the board of directors of a financial institution to “establish credit risk management policy, and credit impairment recognition and measurement policy, the associated internal controls, documentation processes and information systems;”
Credit classification process grades individual credits in terms of the expected degree of recoverability. Financial institutions must have in place the processes and controls to implement the board approved policies, which will, in turn, be in accord with the proposed guideline.
Managing Problem Credits/Recovery
A financial institution’s credit risk policy should clearly set out how problem credits are to be managed. The positioning of this responsibility in the credit department of an institution may depend on the size and complexity of credit operations. The collection process for personal loans starts when the account holder has failed to meet one or more contractual payment (Installment). It therefore becomes the duty of the Collection Department to minimize the outstanding delinquent receivable and credit losses.
The collector’s responsibility will commence from the time an account becomes delinquent until it is regularized by means of payment or closed with full payment amount collected. The goal of the collection process is to obtain payments promptly while minimizing collection expense and write-off costs as well as maintaining the customer’s goodwill by a high standard of service. The customers who do not respond to collection efforts – represent a financial risk to the institution. The Collector’s role is to collect so that the institution can keep the loan on its books and does not have to write-off / charge off.
Identification and allocation of accounts
When a customer fails to pay the minimum amount due or installment by the payment due date, the account is considered in arrears or delinquent. When accounts are delinquent, collection procedures are instituted to regularize the accounts without losing the customer’s goodwill whilst ensuring that the bank’s interests are protected.
Risk Assessment Areas:
Full particulars of the proprietor, partners, directors, etc to be examined, their management capability to be ascertained. Overall performance and credit status of the allied concerns of the client i.e. group will be assessed.
Before extending credit in an area, over all business conditions of that area/ sector will be critically examined, prospects and problems to be ascertained.
Supplier/ Buyer Analysis:
Lending decision will be preceded by an intensive analysis on whether the borrower depends on a single or a very few customer or gets the supply of the raw materials/ dealing items from a single supplier.
Historical Financial Analysis:
An analysis of a minimum of 3 years historical financial statements of the borrower shall be presented. The analysis shall address the quality and sustainability of earnings, cash flow and the strength of the borrower’s balance sheet.
Projected Financial Performance:
Where term facilities (tenor more than 1 year) are proposed, borrower’s future / projected financial performance should be provided, indicating an analysis of the sufficiency of cash flow to service debt repayments.
Adherence to lending guidelines:
Credit proposals to be prepared in line with Bank’s lending Guidelines. A credit application/proposal will clearly mention whether or not the proposal complies with the bank’s lending guidelines.
In credit assessment, possible risks, such as margin sustainability and / or volatility , high debt load ( leverage/ gearing ), over stocking or debtor issues, rapid growth, acquisition or expansion, new business line/ product expansion, management changes or succession issues, customer or supplier concentrations and lack of transparency or industry issues and their mitigating factors to be identified.
Amount and tenor of loan will be fixed justifiably depending on income generation prospect, Projected repayment capacity and the purpose of the loan.
Our banks’ lending will generally be adequately securitized. Securities to be obtained, will be acceptable, valuable, easily marketable & defect less.
Credit Risk Grading (CRG)
Credit risk grading is an important tool for credit risk management as it helps the Banks & financial institutions to understand various dimensions of risk involved in different credit transactions. The aggregation of such grading across the borrowers, activities and the lines of business can provide better assessment of the quality of credit portfolio of a bank or a branch. In line with the above expectation our bank will undertake gradation of credit risks taking into consideration the varied complexities involved in lending operation. CRG with the above expectation will be a mandatory replacement of LRA. (Our bank has already adopted a Credit Risk Grading System as per Bangladesh bank CRG Manual. The details of CRG are as under:-)
DEFINITION OF CREDIT RISK GRADING (CRG)
- The Credit Risk Grading (CRG) is a collective definition based on the pre-specified scale and reflects the underlying credit-risk for a given exposure.
- A Credit Risk Grading deploys a number/ alphabet/ symbol as a primary summary indicator of risks associated with a credit exposure.
- Credit Risk Grading is the basic module for developing a Credit Risk Management system.
USE OF CREDIT RISK GRADING
- The Credit Risk Grading matrix will allow application of uniform standards to credits to ensure a common standardized approach to assess the quality of individual obligor, credit portfolio of a unit, line of business, the branch or the Bank as a whole.
- As evident, the CRG outputs would be relevant for individual credit selection, wherein either a borrower or a particular exposure/facility is rated
- Risk grading would also be relevant for surveillance and monitoring, internal MIS and assessing the aggregate risk profile of a Bank. It is also relevant for portfolio level analysis.
To minimize credit losses, monitoring procedures and system should be reinforced and more effective system should be developed in view of varied complexities involved in various types of credit. The procedures and system must provide early indication of deteriorating financial health of a borrower.
At a minimum, report on the following to be generated and submitted to management and instruct the branch to regularize the same.
- Overdue principal & interest (Monthly)
- Overdue trade bills (Monthly)
- Excess over limit/ Excess over facility approved (Monthly). Status reports on Excess Over Limit and expired credit limit on a regular basis.
- Status reports on drawing power and Collateral shortfall on a regular basis.
- Breach of loan covenants/ terms and conditions/Documentations deficiencies (Fortnightly)
- No payment and late payment
- Branch monitors OD/CC facilities on a regular basis to ensure accounts turn over.
- Non-Receipt of Financial Statements in time (Annually)
- Objections of internal/external or regulator Inspection/ Audit and advise corrective measures timely.
- Details of Early Alert Accounts and preparation of list of delinquent account & Special Mention Account (SMA). (Monthly)
- Identification of early alert accounts, delinquent account & Special mention account (Monthly)
- Identification of the accounts, which have assumed SMA status due to non-renewal. (Monthly)
- Listing of the accounts, which shall be SMA if not renewed within 2 months and taking necessary measures. (Monthly)
- Status of timely renewal of limits and informing Branch, regional Office & Credit Division, Head Office 2 months ahead of expiry limit dates.
Early Alert Process:
An account that has risks or potential weakness of material nature, requiring monitoring, supervision or close attention by the Management will be brought under Early Alert Process, otherwise these weaknesses will result in deterioration of repayment prospects for the assets or in the bank’s credit position at future date.
When an account will show breach of loan covenants or adverse market rumors an Early Alert report should be raised. An Early Alert Account, when shows that the symptoms causing Early Alert classification have been regularized, the account will be reclassified as a Regular account under the approval of Credit Administration.
As part of Early Alert Process the following takes will be performed:
- Control mechanism to be made more effective and where required to be devised, to ensure that calls/inspections are made regularly on the clients and documented.
- Regular inspections will be conducted to confirm that bank’s security / collateral is secured.
- Call /Early Alert Reports to be analyzed by branch & Head office credit administration to ensure that affairs of the borrower are being run on expected lines and there are no material changes in the status of borrower.
- Relationship Manager/ credit officer shall regularly monitor the performance of the clients business as well as repayment and shall prepare status report.
- Relationship Manager/ credit officer shall prepare Early Alert Report within 7 days after identification of weakness and signs or deterioration
Recovery Unit (RU) will directly manage accounts with the status of Sub-standard /DF/BL. Exit accounts graded 4 – 5 may also be transferred to RU for efficient exit, based on recommendation of In-charge credit.
Recovery Unit (RU) shall:
- Determine Account Action plan/ Recovery strategy.
- Make all out efforts to maximize recovery including placing customers into receivership or liquidation as appropriate.
- Provide for adequate and timely loan loss provision, based on actual and expected losses.
- Reschedule accounts as per norms.
- Review classified accounts.
- Initiate legal action as per norms.
- Follow up Court cases regularly and ensure that necessary steps are taken for early resolution.
Non-performing Loan (NPL) Accounts Management:
NPLs shall be assigned to a responsible official within Recovery unit (at Branch/ Regional Office/Head Office level) who will be responsible for coordinating and administering the action plan/recovery of the advance. Recovery Unit (Branch/ Regional Office/Head Office), if required, will seek assistance from HO Credit Division but the responsibility to recover NPL shall be with Recovery Unit (Branch/ Regional Office/Head Office).
Non-performing Loan (NPL) monitoring:
Classified Loan Review (CLR) for NPLs up to 15% of the bank’s capital will be approved by Head of law and Recovery Division. While NPLs above 15% but below 25% shall be approved by Head of Law and Recovery Division with the approval of MD/CEO. NPLs for more than 25% of bank’s capital will be approved by the MD/CEO and Board will be informed.
Our bank will primarily pursue the policy of recovery of NPLS of the bank through its dedicated personnel by making them realize the essence of maintaining quality of bank’s assets. Providing incentives to the officers/staff will be considered as an effective instrument for recovery of Non-performing loans. Such incentives may be awarded in the form of cash reward, Letter of citation, expedited promotion etc to be decided by the MD/CEO/EC from time to time.
Problem identified and Findings
- Format of Credit Risk Grading (CRG) provided by the central bank is Limited to the Credit Officer. There is no choice of credit officers to modify it or make a grading depending on the case.
- The information provided by the borrower to the Banks for taking loans are mostly overstate leading to the acceptable score for taking positive score but this may lead to the bad financing for the Banks.
- Credit Risk Grading (CRG) system gives Fifty Percent weight ages to the Financial Risk and there is scope of manipulating of financial data in Bangladesh.
- Credit Risk Grading (CRG) gives emphasis only on four financial ratios that may not work properly for all types of Business.
- Credit Risk Grading (CRG) emphasis only on current data that may not reflect the actual position of the business.
- Credit Risk Grading (CRG) emphasis only on Operating Profit Margin that may not work properly for all types of Business.
- Market/Industry risk gives Eighteen percent weight ages but in our country there is no authenticate date about the market position. As such the credit officer has to depend on the available data that are real sense do not reflect the actual Industry risk.
The findings of this study are summarized below:
- Some extent it is good because high liquidity decrease profitability on the other hand lower liquidity unable to meet up short term obligation. My comment on this ratio is not bad.
- The bank as a matter of policy prioritizes to make leading in the thrust sectors of the economy so as to make distinctive value addition in overall economic uplift of the country.
- The significant increase in assets was achieved due to raise in loans and advances, investments, cash and balance with Bangladesh Bank and other financial institutions.
- The credit risk management process of National Bank Limited is quite commendable. Systematic and timely monitoring and appropriate documentation are tried to be maintained.
- Customer satisfaction level is quite good. Informal conversation with some customers reveals that they approve the credit evaluation and management process of National Bank Ltd.
- Filing procedure is not maintained in a definite and clear manner. It is difficult to locate the documents in a chronological and sequential manner.
- A definite practice, though mentioned in the credit policy is not always maintained by the credit officials.
- The credit sanction and disbursement procedure is quite lengthy.
- Networking system in National Bank Limited has to be improved.Network gets disconnected several times a day which causes delays in the overall process and other operations of the bank.
In the light of the above findings, following recommendations are proposed:
- An uninterrupted network system has to be ensured. It will save the officials from much hassle and will save time.
- The credit sanction procedure should be made quicker since competition is very hard in today’s business world. People do not want to wait for three to four weeks on an average to get a loan which is even protected by security.
- Decision making process can be made more decentralized. Participative approach should be adopted to gain prompt and effective result.
- Filing is a very important component of proper documentation. It has to be dealt with importance.
- The Credit Officer should be given some flexible while grading in the Format provided by Bangladesh Bank or the Bank can use their own Risk Grading system based on the format provided by Bangladesh Bank.
- The Credit Officers should be trained up so that they can perform quite well in calculating the Risk Grading
- Credit Risk Grading (CRG) system should give weight age at least Seventy Percent to the Financial Risk.
- While Calculating liquidity Ratio, the Credit Officers should use Quick Ratio because it gives a better measure of overall liquidity of a firm.
- While Calculating leverage Ratio, the Credit Officers should use debt Service Coverage Ratio because it indicates the ability of a firm to generate cash to pay interest and principal payments.
- While Calculating Profitability Ratio, the Credit Officers should not give emphasis on Operating Profit Margin because the sales of a company depends on the size of the business.
- The Credit Offices should justify the credibility of the information provided by the Borrower and then they should calculate the Credit Risk Grading.
- There should have a authenticate data that will reflect the actual market position.
- Through proper monitoring the Loans and Advance with an either by the auditors or by the head office management can ensure better Credit Risk Management.
Credit risk management is becoming more and more important in today’s competitive business world. It is all the more important in the context of Bangladesh. The tools for improving management of consumer credit risk have advanced considerably in recent years. Therefore, as a responsible and reputed commercial bank, National Bank has instituted a contemporary credit risk management system. From the study, it is evident that the bank is quite sincere in their approach to managing the consumer credit risk though there are rooms for improvement. They have to be more cautious in the recovery sector and preferential treatments to some big clients should also be stopped. However, they follow an in-depth procedure in assessing the credit risk by using the credit risk grading techniques which provides them a solid ground in the time of any settlement.
From the discussion in this research report, it has become clear that credit risk management is a complex and ongoing process and therefore financial institutions must take a serious approach in addressing these issues. They have to be up to date in complying with all the required procedures and must employ competent people who have the ability to deal with these complex matters. Utmost importance should be given to the improvement of the networking system which is essential for modern banking environment and obviously for efficient and effective credit risk management process.