Assignment on Loan Approval Techniqes and Process
Subject: Finance | Topics:

Banking Industry

The number of banks in all now stands at 49 in Bangladesh. Out of the 49 banks, four are Nationalized Commercial Banks (NCBs), 28 local private commercial banks, 12 foreign banks and the rest five are Development Financial Institutions (DFIs).

Sonali Bank is the largest among the NCBs while Pubali is leading in the private ones. Among the 12 foreign banks, Standard Chartered has become the largest in the country. Besides the scheduled banks, Samabai (Cooperative) Bank, Ansar-VDP Bank, Karmasansthan (Employment) Bank and Grameen bank are functioning in the financial sector. The number of total branches of all scheduled banks is 6,038 as of June 2000. Of the branches, 39.95 per cent (2,412) are located in the urban areas and 60.05 per cent (3,626) in the rural areas. Of the branches NCBs hold 3,616, private commercial banks 1,214, foreign banks 31 and specialized banks 1,177.

Bangladesh Bank (BB) regulates and supervises the activities of all banks. The BB is now carrying out a reform programmed to ensure quality services by the banks.

  •   Bangladesh Bank (BB)
  •   Nationalized Commercial Banks (NCBs)
  •   Private Commercial Banks (PCBs)
  •   Specialized Banks

Bangladesh Bank

Bangladesh Bank (BB) has been working as the central bank since the country’s independence. Its prime jobs include issuing of currency, maintaining foreign exchange reserve and providing transaction facilities of all public monetary matters. BB is also responsible for planning the government’s monetary policy and implementing it thereby.

The BB has a governing body comprising of nine members with the Governor as its chief. Apart from the head office in Dhaka, it has nine more branches, of which two in Dhaka and one each in Chittagong, Rajshahi, Khulna, Bogra, Sylhet, Rangpur and Barisal.

History & role of Bangladesh Bank

The central bank and monetary authority of the country. It came into existence under the Bangladesh Bank Order 1972 (Presidential Order No. 127 of 1972) which took effect on 16 December 1971. Through this order, the entire operation of the former State Bank of Pakistan in the eastern wing was transferred to Bangladesh Bank.

Bangladesh Bank has been entrusted with all the traditional central banking functions including the sole responsibilities of issuing currency, keeping the reserves, formulating and managing the monetary policy and regulating the credit system of Bangladesh with a view to stabilizing domestic and external monetary value and promoting and maintaining a high level of production, employment and real income in the country. The bank acts as the banker to the government and accepts government deposits, cheques and drafts, and undertakes collection of cheques and drafts drawn on other banks. The government deposits all its cash balances with the Bangladesh Bank free of interest. The bank transfers government funds from one place to another as requested by the government and its agencies. It makes ways and means for advances to the government, which is repayable not later than three months. It acts as the public debt manager and runs a public debt office (PDO) within itself. The bank also sells government treasury bills on tender, prize bonds and different types of saving certificates (sanchayapatra). The bank acts as the clearing house of the scheduled banks

The purchase, sale and rediscount of bill of exchange and promissory notes drawn on and payable in Bangladesh are also included in the activity of the bank. The bank acts as the lender of last resort for the government as well as for the country’s scheduled banks. All scheduled banks are required to maintain a minimum reserve with the Bangladesh Bank. The present statutory liquidity reserve (SLR) requirement is 20% of total demand and time liabilities, 4% of which is to be maintained as cash reserve ratio (CRR), and the rest 16% as approved securities. The SLR requirement for Islamic banks is 10% and they are to keep 4% of this reserve as CRR and the rest 6% in approved securities.

Bangladesh Bank exercises its wide range of power in credit control through different types of traditional and non-traditional methods. In addition to bank rate and open market operations, it uses a number of other weapons. It can vary the minimum reserve requirements of scheduled banks whenever circumstance so warrant. Being responsible for maintaining external value of Bangladesh currency, the bank also handles the exchange control. It ensures that all foreign exchange inflows are accounted for, and surrendered to the authorized dealers. It allocates and rations foreign exchange in line with the set priorities. Bangladesh Bank is empowered to manage the country’s international reserves, which represent aggregate of its holding of gold, foreign exchange, SDR and reserve position in the IMF. The bank also acts as the representative of the government in different international agencies and other forums such as World Bank, IMF, Asian Clearing Union, ADB, etc.

Bangladesh Bank is empowered to act as the watchdog of the country’s banking system, and all scheduled banks are accountable to Bangladesh Bank, which has extensive powers to ensure soundness of the banking system. No bank can commence banking business in Bangladesh and no existing bank can open a new branch in or outside the country or shift any branch from one place to another without obtaining a licence/permission from the Bangladesh Bank.

Bangladesh Bank runs a Deposit Insurance Scheme established under the Deposit Insurance Ordinance 1984. The objective of the scheme is to safeguard the deposits of the customers with both local and foreign deposit money banks doing business in Bangladesh. The deposits amounting up to Tk 100,000 of all customers in a scheduled bank are insured under the scheme. All scheduled banks in Bangladesh are required to be members of the scheme and pay premium on their deposits at a rate determined by the Bangladesh Bank from time to time. Bangladesh Bank accumulates the premiums in the Deposit Insurance Fund.

The paid up capital of Bangladesh Bank is Tk 30 million divided into 300,000 shares of Tk 100 each that are fully paid up by the government. A nine-member board of directors comprising the governor as chairman, one deputy governor and seven members oversees the affairs of the bank. The governor and the deputy governors of the Bank are appointed by the government for a period not exceeding five years and are eligible for reappointment.

Bangladesh Bank has 9 branch offices, two in Dhaka city (sadarghat and Motijheel), and one each in chittagong, khulna, rajshahi, sylhet, bogra, rangpur and barisal. The head office discharges its duties with 28 departments. The departments are International, Law, Financial Institutions, Computer (2), Agricultural Credit, Agricultural Credit Inspection, Agricultural Credit Project, Credit Information Bureau, Research (3), Public Relations and Publications, Audit and Inspection, Statistics (2), Engineering, Problem Bank Monitoring, Administration, Training Academy, Foreign Exchange Policy, Foreign Exchange Inspection, Foreign Exchange Investment, Administration and Expenditure, Banking Inspection, Banking Regulation and Policy, Banking Operation and Development, Monetary Management and Technical Unit, Currency Management and Accounts, Industrial Credit, and Security Management.

Bangladesh Bank has correspondent relationships with one international and 8 foreign central banks viz., the Federal Reserve Bank of New York, Bank of Canada, Bank of England, Bank De France, Deutsche Bundes Bank, Bank of Japan, Svereges Riks Bank of Stockholm, Reserve Bank of India and the Bank for International Settlements, Basle. Besides, Bangladesh Bank has now invested its foreign exchange reserves with 14 banks at different international financial centers.

To reduce the huge costs of printing currency notes from foreign countries Bangladesh Bank had initiated a Security Printing Project, which was converted into a limited company of the name The Security Printing Corporation (Bangladesh) Ltd. on 18th October 1992. The corporation is now working as a commercial concern and prints all currency and bank notes in Bangladesh. Other security papers, such as judicial and non-judicial stamps, prize bonds, revenue stamps, postal envelope and stamps, band rolls for customs and excise department, and cheque books of different private banks in Bangladesh are also printed by this company. The company however, does not have a minting plant and the country still remains dependent on foreign mint companies for minting the coinage.

The powers and functions of Bangladesh Bank are governed by various laws and acts including the Banker’s Books Evidence Act 1891, Insolvency Act 1920, Banking Companies Ordinance 1962, Bangladesh Bank Order 1972, Foreign Exchange (Regulation) Act 1986, Money Loan Court Act 1990, Banking Companies Act 1991, Financial Institutions Act 1993 and Rules 1994, Companies Act 1994 and Bankruptcy Act 1997. [S M Mahfuzur Rahman]

LOAN APPROVAL:

Appraisal and approval process of a bank loan application involve a series of activities. These activities reveal a true element of banking intermediation ranging from establishing relationship with a stranger (walk-in customer) to structuring a credit line for the existing clients. In order to manage the risk inherent in lending, banks across the world developed many tools. One of such tools is a robust process guideline. The aim of these processes is to give precise input in order to get a desired output. These processes are generally benchmarked for application across the bank. Yet they are dynamic in the sense that their modification becomes imminent with the change in risk profile, regulatory guidelines, market conditions etc.

LOAN APPROVAL TECHNIQUE:

Lending Risk Analysis (LRA)

The Financial Sector Reform Project (FSRP) has designed the LRA package, which provides a systematic procedure for analyzing and quantifying the potential credit risk. Bangladesh Bank has directed all commercial bank to use LRA technique for evaluating credit proposal amounting to Tk. 10 million and above. The objective of LRA is to assess the credit risk in quantifiable manner and then find out ways & means to cover the risk. However, some commercial banks employ LRA technique as a credit appraisal tool for evaluating credit proposals amounting to Tk. 5 million and above. Broadly LRA package divides the credit risk into two categories, namely

1) Business risk
2) Security risk.

A detail interpretation of these risks and the procedure for evaluating the credit as follows

Business risk:

It refers to the risk that the business falls to generate sufficient cash flow to repay the loan. Business risk is subdivided into two categories.

Industry risk.

The risk that the company fails to repay for the external reason. It is subdivide into supplies risk and sales risk.

Supplies risk:

It indicates that the business suffers from external disruption to the supply of imputes. Components of supplies risk are as raw material, Labor, power, machinery, equipment, factory premises etc. Supply risk is assessed by a cost breakdown of the inputs and then assessing the risk of disruption of supplies of each item.

Sales risk:

This refers to the risk that the business suffers from external disruption of sales. Sales may be disrupted by changes to market size, increasing in competition, change in the regulation or due to the loss of single large customer. Sales risk is determined by analyzing production or marketing system, industry situation, Government policy, and competitor profile and companies strategies.

Company risk:

This refers to the risk that the company fails for internal reasons. Company risk is subdivided into company position risk and Management risks.

Company position risk:

Within an industry each and every company holds a position. This position is very competitive. Due to the weakness in the company’s position in the industry, a company is the risk for failure. That means, company position risk is the risk of failure due to weakness in the companies position in the industry. It is subdivided into performance risk and resilience risk.

Performance risk:

This risk refers to the risk that the company’s position is so weak that it will be unable to repay the loan even under Favor able external condition. Performance risk assessed by SWOT (Strength, Weakness, Opportunity and Threat) analysis, Trend analysis, Cash flow forecast analysis and credit report analysis (i.e. CIB repot from Bangladesh Bank).

Resilience risk:

Resilience means to recover early injury, This refers to risk that the company falls due to resilience to unexpected external conditions. The resilience of a company depends on its leverage, liquidity and strength of connection of its owner or directors. The resilience risk is determined by analyzing different financial ratio, flexibility of production process, shareholders willingness to support the company if need arise and political and private affiliation of owners and key personnel.

Management risk:

The management risk refers to the risk that the company fails due to management not exploiting effectively the company’s position. Management risk is subdivided into management competence risk and integrity risk.

Management competence risk:

 This refers to the risk that falls because the management is incompetent. The competence of management depends upon their ability to manage the company’s business efficiently and effectively. The assessment of management competence depends on management ability and management team work. Management ability is determined by analyzing the ability of owner or board of the members first and then key personnel for finance and operation. Management team work is determined by analyzing management structure and its strength and weakness.

Management integrity risk:

This refers to the risk that the company fails to repay the loan amount due to lack of management integrity. Management integrity is a combination of honesty and dependability. Management integrity risk is determined by assessing management honesty, which requires evaluating the reliability of information supplied and then management dependability.

Security risk:

 This sort of risk is associated with the realized value of the security, which may not cover the exposure of loan. Exposure means principal plus outstanding interest. The security risk is subdivided into two major heads i.e. security control risk and security cover risk.

Security control risk:

This risk refers to the risk that the bank falls to realize the security because of bank’s control over the security offered by the borrower i.e. incomplete documents. The risk of failure to realize the security depends on the difficulty in obtaining favorable judgement and taking possession of security. For analyzing the security control risk the credit office is required to verify documentation to ensure security protection, documentation completeness, documentation integrity and proper insurance policy. He/she also conducts site visit to verify security existence. Assessment of security control risk requires analyzing the possibility of obtaining favorable judgement and analyzing the case with which the bank could take the possession and liquidate the securities.

Security covers risk:

This refers to the risk that the realized value of security is less than exposure. Security cover risk depends on speed of realization and liquidation value. For analyzing security cover risk, the official requires assessing the power of the customer to prolong the legal process and to analyze the market demand for the security For assessment of security control risk, the officials times the time that would require to liquidate the security and assess the risk and estimates the security value at liquidation and assess the risk.

Before completing the LRA form, the relationship manager collects data specially industry specific from published sources and company specific data that not usually published, by personally visiting the company. After collecting the necessary data he/ she prepare financial spreadsheet. This spreadsheet provides a quick method of assessing business trend & efficiency and helps to assess the borrower ability to pay the loan Obligation. Financial spreadsheet includes balance sheet, income statement, cash flow statement and ratios for the purpose of financial statement analysis. Through analyzing data and collected information, the concerned official completes the LRA form and all scores are transferred to the scoring matrix to find the overall risk of lending. The overall matrix provides four kinds of lending risk for decision making viz.  (I) Good (ii) Acceptable (iii) Marginal and (iv) Poor. The bank does not provide any credit request having an over all risk as “marginal” and “Poor” without justification. All credit application rated “Poor” shall require the approval of the Board of Directors regardless of purpose tenor or amount. Therefore bank can minimize the dangers regarding the bad loan and advances through using the LRA.

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.

Function of Credit Risk Grading

Well-managed credit risk grading systems promote bank safety and soundness by facilitating informed decision-making. Grading system measure credit risk and differentiate individual credits and groups of credits by the risk they pose. This allows bank management and examiners to monitor changes and trends in risk levels. The process also allows bank management to manage risk to optimize returns.

Use of Credit Risk Grading

The credit risk-grading matrix allows application of uniform standards to credits 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 evidence, the CRG outputs would be relevant for individual credit selection, wherein either a borrower or a particular exposure/facility is related. The other decisions would be related to pricing (credit-spread) and specific features of the credit facility. These would largely constitute obligor level analysis.

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.

CRG Scale

The proposed CRG scale consists of 8 categories with short names and Numbers are provided as follows:

GRADINGSHORT NAMENUMBER
SuperiorSUP1
GoodGD2
AcceptableACCPT3
Marginal/Watch listMG/WL4
Special MentionSM5
Sub StandardSS6
DoubtfulDF7
Bad & LossBL8

A clear definition of the different categories of credit risk grading is given as follow:

Superior- (SUP)-1

  •    Credit facilities, which are fully secured i.e. fully cash covered.
  •    Credit facilities fully covered by government guarantee.
  •    Credit facilities fully covered by the guarantee of a top tier international Bank.

Good- (GD)-2

  •    Strong repayment capacity of the borrower
  •    The borrower has excellent liquidity and low leverage.
  •    The company demonstrates consistently strong earnings and cash flow.
  •    Borrower has well established, strong market share.
  •   Very good management skill & expertise.
  •    All security documentation should be in place.
  •    Credit facilities fully covered by the guarantee of a top tier local Bank.
  •    Aggregate score of 85 or greater based on the risk grade score sheet.

Acceptable- (ACCPT)-3

  •    These borrowers are not as strong as GOOD Grade borrowers, but still demonstrate consistent earnings, cash flow and have a good track record.
  •    Borrowers have adequate liquidity, cash flow and earnings.
  •    Credit in this grade would normally be secured by acceptable collateral (1st charge over inventory/ receivables/ equipment/ property).
  •    Acceptable management.
  •    Acceptable parent/ sister company guarantee.
  •   Aggregate score of 75-84 based on the Risk Grade Score.

Marginal/ Watch list- (MG/WL)-4

  •    This grade warrants greater attention due to conditions affecting the borrower, the industry or the economic environment.
  •    These borrowers have an above average risk due to strained liquidity, higher than normal leverage, thin cash flow and/ or inconsistent earnings.
  •   Weaker business credit & early warning signals of emerging business credit detected.
  •    The borrower incurs a loss.
  •    Loan repayments routinely fall past due.
  •    Account conduct is poor, or other untoward factors are present.
  •    Credit requires attention.
  •    Aggregate Score of 65-74 based on the Risk Grade Score Sheet.

Special Mention-(SM)-5

  •    This grade has potential weaknesses that deserve management’s close attention. If left uncorrected, these weaknesses may result in a deterioration of the repayment prospects of the borrower.
  •    Serve management problems exist.
  •    Facilities should be downgraded to this grate if sustained deterioration in financial condition is noted (consecutive losses, negative net worth, excessive leverage).
  •   An aggregate score of 55-64 based on the Risk Grade Score Sheet.

Substandard-(SS)-6

  •    Financial condition is weak and capacity or inclination to repay is in doubt.
  •    These weaknesses jeopardize the full settlement of loans.
  •    Bangladesh Bank criteria for sub-standard credit shall apply.
  •    An Aggregate Score of 45-54 based on the Risk Grade Score Sheet.

Doubtful-(DF)-7

  •    Full repayment of principal and interest is unlikely and the possibility of loss is extremely high.
  •    However, due to specifically identifiable pending factors, such as litigation, liquidation procedures or capital injection, the asset is not yet classified as bad & loss.
  •    Bangladesh Bank criteria for doubtful credit shall apply.
  •    An Aggregate score of 35-44 based on the Risk Grade Score Sheet.

Bad & Loss-(BL)-8

  1.    Credit of this grade has long outstanding with no progress in obtaining repayment or on the verge of wind up/liquidation.
  2.    Prospect of recovery is poor and legal options have been pursued.
  3.    Proceeds expected from the liquidation or realization of security may be awaited. The continuance of the loan as a bankable asset is not warranted, and the anticipated loss should have been provided for.
  4.    This classification reflects that it is not practical or desirable to defer writing off this basically valueless asset even though partial recovery may be affected in the future. Bangladesh Bank guidelines for timely write off of bad loans must be adhered to. Legal procedures/ suit initiated.
  5.    Bangladesh Bank criteria for bad & loss credit shall apply.
  6.    An Aggregate score of less than 35 based on the Risk Score Sheet.

Credit Risk Grading Calculation

The following step-wise activities outline the detail process for arriving at credit risk

Grading.

Credit risk for counterparty arises from an aggregation of the following:

  •   Financial Risk
  •   Business/ Industry Risk
  •   Management Risk
  •   Security Risk
  •   Relationship Risk

Each of the above-mentioned key risk areas require be evaluating and aggregating to arrive at an overall risk grading measure.

      Evaluation of Financial Risk:

Risk that counterparties will fail to meet obligation due to financial distress. This typically entails analysis of financials i.e. Analysis of leverage, liquidity, profitability & interest coverage ratios. To conclude, this capitalizes on the risk of high leverage, poor liquidity, low profitability & insufficient cash flow.

      Evaluation of Business/ Industry Risk:

Risk that adverse industry situation or unfavorable business condition will impact borrowers’ capacity to meet obligation. The evaluation of this category of risk looks at parameters such as business outlook, size of business, industry growth, market competition & barriers to entry/exit. To conclude, this capitalizes on the risk of failure due to low market share & poor industry growth.

      Evaluation of Management Risk:

Risk that counterparties may default as a result of poor managerial ability including experience of the management, its succession plans and teamwork.

      Evaluation Of Security Risk:

The bank might be exposed due to poor quality or strength of the security in case of default. This may entail strength of security & collateral, location of collateral and support.

After the risk identification & weight age assignment process (as mentioned above) next steps will be to input actual parameter in the score sheet to arrive at the scores corresponding to the actual parameters.

This manual also provides a well-programmed process MS Excel based credit risk scoring sheet to arrive at a total score on each borrower. The excel program requires inputting data accurately in particular cells for input and will automatically calculate the risk grade for a particular borrower based on the total score obtained. The following steps are to be followed while using the MS Excel program.

a)      Open the MS XL file named, CRG_SCORE_SHEET.

b)      The entire XL sheet named, CRG is protected except the particular cells to input data.

c)      Input data accurately in the cells, which are BORDERED & are colored YELLOW.

d)      Some input cells contain DROP DOWN LIST for some criteria corresponding to the Key parameters. Click to the input cell and select the appropriate parameters from the DROP DOWN LIST as shown below.

e)      All the cells provided for input must be filled in order to arrive at accurate risk grade.

f)       We have also enclosed the MS Excel file named, CRG_SCORE_SHEET in CD ROM for use.

The following is the proposed Credit Risk Grade matrix based on the total score obtained by an obligor.

Number

Risk Grading

Short Name

Score

1

Superior SUP* 100% cash covered.

* Government guarantee.

* International bank guarantee

2

GoodGD

85+

3

AcceptableACCPT

75-84

4

Marginal/Watch listMG/WL

65-74

5

Special MentionSM

55-64

6

Sub-standardSS

45-54

7

DoubtfulDF

35-44

8

Bad & LossBL

<35

Credit risk grading process

Credit risk grading should be completed by a Bank for all exposures (irrespective of amount) other than those covered under consumer and shall enterprises financing prudential guidelines and also under the short-term agricultural and Micro-Credit.

 For superior risk grading (SUP-1) the score sheet is not applicable. This will be guided by the criterion mentioned for superior grade account i.e. 100% cash covered, covered by government & bank guarantee.

Credit risk grading matrix would be useful in analyzing credit proposal, new or renewal for regular limits or specific transactions, if basic information on a borrowing client to determine the degree of each factor is

a) Readily available,

b) Current,

c) Dependable, and

d) Parameters/risk

These factors are assessed judiciously and objectively. The Relationship Manager as per Data Collection Checklist as shown in  should collect required information.

 Relationship manager should ensure to correctly fill up the Limit Utilization Form as shown in  in order to arrive at a realistic earning status for the borrower.

Risk factors are to be evaluated and weighted very carefully, on the basis of most up-to-date and reliable data and complete objectivity must be ensured to assign the correct grading. Actual parameter should be inputted in the Credit Risk Grading Score Sheet as shown in 

 Credit risk grading exercise should be originated by Relationship Manager and should be an on going and continuous process. Relationship Manager shall complete the Credit Risk Grading Score Sheet and shall arrive at a risk grading in consultation with a Senior Relationship Manager and document it as per Credit Risk Grading From as shown in Appendix- D, which shall then be concurred by the Credit Officer in Consultation with a Senior Credit Officer.

ALL credit proposals whether new, renewal or specific facility should consist of a) Data collection checklist,

b) Limit Utilization form,

c) Credit Risk Grading Score Sheet, and

d) Credit Risk Grading Form.

 The credit officers then would pass the approved credit risk grading form to Credit Administration Department and Corporate Banking/ Line of Business/Recovery Unit for updating their MIS/record.

 The appropriate approving authority though the same Credit Risk Grading form shall approve any subsequent change/revision i.e. upgrade or downgrade in credit risk grade.

                       Jamuna Bank Limited Sonargoan Road Branch                Table-7

DATA COLLECTION CHECKLIST

ABC Company Limited

Banglamotor, Dhaka

SLDocuments/items required for Credit Risk Grading Required? YESObtained

YES   NO

 Company accounts for at least 3 years

Yes

Yes

 Bank Statement for period 12 months from previous bank (for new customer)

Yes

No

 Set of accounts for at least two competitors (if published)

Yes

No

 Set of accounts for at least two competitors (if published)

Yes

No

 Industry average figures (If applicable)

Yes

No

 Financial projection required for:

Team loans; forecasts should be for the duration of the loan

New overdraft facilities-forecast should be for 12 months

Working capital estimation for new/renewal/enhancement of facility

Yes

No

 Financial Spread Sheet (FSS)

Yes

Yes

 Customer Limit Utilization Form

Yes

Yes

 Current CIB Report of the Obligor

Yes

Yes

 Organization Chart

Yes

Yes

 Bio-data for-

All Direction- Other key executives

Head of operations/ Marketing

Yes

Yes

 Copies of all reports on site visits made during the last 12 months

Yes

Yes

 Valuations of securities/ collateral offered

Yes

Yes

 Memorandum/article of association/certificate of incorporation

Yes

Yes

 Business plan/Project Feasibility Report (required for start up company)

Yes

Yes

 Receivables Aging

Yes

Yes

 Client’s declaration of stock/ inventory and Book Debts for the last 12 months

Yes

Yes

 Trade License

Yes

Yes

 TIN Certificate

Yes

Yes

LIMIT UTILIZATION FORM  

Borrower: ABC Company Limited – Principle Branch                                Date

Period:   For the period from 1-1-2005 to 1-1-2006 (12 months actual/Projected)

Account Performance:

(Amount in ‘000’ Taka)

Nature of the Account

Debit Summation

Credit Summation

Balance/ Outstanding

Maximum

Minimum

Current deposit Account

6000

4000

10000

2000

Overdraft (OD)

4000

3000

8000

1000

Cash Credit (CC)

5000

5000

5000

1000

Term Loan

N/A

N/A

N/A

N/A

Import Loan

N/A

N/A

N/A

N/A

Local/ Export Bills outstanding

N/A

N/A

N/A

N/A

Guarantee

N/A

N/A

N/A

N/A

Account Volume:

FacilitiesTotal No of transactionAmount in ‘000’ Taka
Letter of Credit

20

50000

Guarantees

N/A

N/A

Local/Export Bills Handled

15

4000

 

Account Profitability

Nature of Account/Facility

Average Utilization

Rates of Interest

Interest Income

Commission

Other Revenue

Total

Current Accounts0000

00

24

00

24

Overdraft/Cash Credit350015%

525

175

00

700

SLC2000

00

40

00

40

Term Loan  

Import Loan Hypo  

Demand Loan Hypo  

Guarantees  

LBDP/Export Bills Handled15 

00

30

00

30

Gross Earnings  

525

269

000

794

Less: Cost of Fund  

25

198

Net Earnings   

500

269

000

596

Comment on Relationship/ Earnings:

  •  Our earnings from borrower for last year was BDT—and from Group BD—-
  •  Our projected earnings from borrower for the next year will be BDT—and group BDT—-
  •  Account Turnover and utilization of limit during the year was satisfactory.

Relationship Officer (RO)                                                      Relationship Manager /

Branch Manager

CriteriaWeightParameterScoreActual ParameterScore Obtained
A. Financial Risk50%
1. Leverage: (15%)

Debt Equity Ratio (x)-Times Total Liabilities to Tangible Net Worth

 

All calculations should be based on annual financial statements of the borrower (audited preferred

  • Less than 0.25x
  • 0.26x to 0.35x
  • 0.36x to 0.50x
  • 0.51x to 0.75x
  • 0.76x to 1.25x
  • 1.26x to 2.00x
  • 2.01x to 2.50x
  • 2.51x to 2.75x
  • More than 2.75x
15

14

13

12

11

10

8

7

0

1313
2. Liquidity: (15%)

Current Ratio (x)-Times Current Assets to Liabilities

  • Grater than 2.74x
  • 2.50x to 2.74x
  • 2.00x to 2.49x
  • 1.50x to 1.99x
  • 1.10x to1.49x
  • 0.90x to 1.09x
  • 0.80x to 0.89x
  • 0.70x to 0.79
  • Less than 0.70x
15

14

13

12

11

10

8

7

0

1414
3. Profitability: (15%)

Operating profit Margin (%)

 

Operating Profit Margin

Sales

  • Greater than 25%
  • 20% to 24%
  • 15% to 19%
  • 10% to 14%
  • 7% to 9%
  • 4% to 6%
  • 1% to 3%
  • Less than 1%
15

14

13

12

10

9

7

0

1313
4. Coverage (5%)

Interest Coverage Ratio (x)-Times

Earning Before Interest & Tax (EBIT)

Interest on debt

  • More than 2.00x
  • More than 1.51x Less than 2.00x
  • More than 1.25x Less than 1.50x
  • More than 1.00x Less than 1.24x
  • Less than 1.00
5

4

 

3

 

2

 

0

 

33
Total Score- Financial Risk  50 43

CriteriaWeightParameterScoreActual ParameterScore Obtained
B. Business Risk18%
1.Size of Business (Sales in BDT (crore)

 

The size of the borrower’s business measured by the most recent year’s total sales. Preferably based on audited financial statements.

 

  • > 60.00
  • 30.00-59.99
  • 10.00-29.99
  • 5.00-9.99
  • 2.50-4.99
  • < 2.50
5

4

3

2

1

0

33
2. Age of Business

The number of years the borrower has been engaged in the primary line of business.

 

  • > 10 years
  • > 5 to 10 years
  • > 2 to 5 years
  • < 2 years
3

2

1

0

33
3.Business Outlook

 

A. Critical assessment of the medium term prospects of the borrower, taking into account the industry, market share and economic factors.

  • Favorable
  • Stable
  • Slightly Uncertain
  • Cause of concern

 

3

2

1

0

22
4. Industry Growth
  • Strong
  • Good (>5%-10%)
  • Moderate (1%-5%)
  • No Growth (< 1%)

 

3

2

1

0

11
5. Market Competition
  • Dominate Player
  • Moderately Competitive
  • Highly Competitive
2

 

1

 

0

11
6. Entry/Exit Barriers
  • Difficult
  • Average
  • easy
2

1

0

11
Total Score-Business/Industry Risk 18 11
CriteriaWeightParameterScoreActual ParameterScore Obtained
Management Risk12%  
1.Experience

(Management & Management Team)

 

The quality of management based on the aggregate number of years that the Senior Management Team has been in the industry.

  • § More than 10 years in the related line of business
  • § 5-10 years in the related line of business.
  • § 1-5 years in the related line of business.
  • § No experience
5

 

 

3

 

2

 

0

33
2. Second Line/ Succession
  • Ready Succession
  • Succession within 1-2 years
  • Succession within 2-3 years
  • Succession in question
4

 

3

 

2

0

23
3. Team Work
  • Very Good
  • Moderate
  • Poor
  • Regular Conflict
3

2

1

0

22
Total Score-Management Risk 12 8

 

CriteriaWeight

Parameter

ScoreActual ParameterScore Obtained
D. Security Risk10%
1. Security Coverage (Primary)
  • § Fully pleased facilities
  • § Registered Hypothecation (1st charge)
  • § 2nd Charge/ Inferior charge
  • § Simple hypothecation/ Negative lien on assets.
  • § No security
4

3

 

2

1

 

0

33
2. Collateral Coverage (Property Location)
  • § Registered Mortgage on Municipal Corporation/ Prime area property.
  • § Registered Mortgage on Pourashava/ semi-urban area property.
  • § Equitable Mortgage or to property but plant & machinery & collateral.
  • § Negative lien on collateral.
  • § No collateral
4

 

 

3

 

2

 

 

1

 

0

33
3.Support (Guarantee)
  • § Personal guarantee with high net worth or Strong Corporate Guarantee.
  • § Personal Guarantees or Corporate Guarantee with average financial strength.
  • § No Support/Guarantee.
2

 

 

1

 

 

0

00
Total Score-Security Risk 10 6

 

CriteriaWeightParameterScoreActual ParameterScore Obtained
E. Relationship Risk10%
1. Account Conduct
  • § More than 3 (three) years accounts with faultless record.
  • § Less than 3 (three) years accounts with faultless record.
  • § Accounts having satisfactory dealings with some late payments.
  • § Frequent past dues& irregular dealings in account.
5

 

 

4

 

 

2

 

 

 

0

55
2.Utilization of limit(Actual/Projection)
  • § More than 60%
  • § 40%-60%
  • § Less than 40%
2

1

0

11
3. compliance of Covenants/ Conditions
  • § Full Compliance
  • § Some Non- Compliance
  • § No Compliance
2

1

0

11
4. Personal Deposits

 

The extent to which the bank maintains a personal banking relationship with the key business sponsors/ principals.

  • Personal accounts of the key business Sponsors/ principals are maintained in the bank, with significant deposits
  • No depository relationship
1

 

 

 

 

 

0

11
Total Score-Relationship Risk 10 8
Grand Total-All risk 100 76

Query: 

Are we receiving financials regulatory?
Monthly sales deposit receipt and adjustment by the Bank:

(For last 6 months)

Is client in business?
What the happening to sister company cash flow?
Do we have corporate guarantee? What is the valuation?
Are stock of client verified/When/what is the value?
When RM and comment by RM made last client/ factory visit?
In Registered Mortgage in place/What is the value?
We all the approval conditions/covenants complied by borrower?

Reason for change (if any) in credit5 risk grading:

General comment by RM Recommended action steps for upgrade if required:

Relationship Manager (RM)                             Senior Relationship Manager (SRM)

Grading Approval

Credit Officer, CRM                                            Senior Credit Officer, CRM

CREDIT RISK GRADING SCORE SHEET     

Borrower:ABC Company Limited  
Group Name (If any):ABC Company LimitedAggregate Score: 76

 

Date Grading: ACCPT

Branch:Principle Branch
Industry/Sector:N/A
Date of Financials:2-2-2007
Completed by:JBL S. R. Br.
Approved by:JBL S. R. Br.
NumberGradingShortScore
1GoodSUPFully cash secured, secured by Governmental bank GUARANTEE
2AcceptanceGD85+
3Marginal/Watch listACCPT75-84
4Special MentionMG/WL65-74
5SubstandardSM55-64
6DoubtfulSS45-54
7Bad & LossDF35-44
8 BL<35

ABC Company obtained 76 score which is Acceptable. These borrowers are not as strong as GOOD Grade borrowers, but still demonstrate consistent earnings, cash flow and have a good track record. So the ABC Company has capability to get loan from Bank. Bank always considers the all requirement of CRG and after that Bank take decision about their Customer. If the Customer can obtain minimum score then they will be accepted. On the other hand, if they cannot obtain minimum score, they will be failed to get a loan.

Why Credit Risk Grading (CRG)) is introduced in terms of LRA:

At the pre sanction stage, credit grating helps the sanctioning authority to decide whether to lend or not to lend, what should be the loan price, what should be the extent of exposure, what should be the appropriate credit facility, what are the various facilities, what are the various risk mitigation tools to put a cap on the risk level.

The lending risk analysis (LRA) manual introduced in 1993 by the Bangladesh Bank has been practice for mandatory use by the Banks & financial institutions for loan size of BDT 1.00 crore and above. The objective of LRA is to assess the credit risk in quantifiable manner and then find out ways & means to cover the risk. Broadly LRA package divides the credit risk into two categories, namely 1) Business risk 2) Security risk. This also includes company risk, company position risk, sales risk, supplies risk etc. The main task of BANKS in this method is to find out and evaluate necessary and relevant information regarding these risks of the firms or individuals who are applied for loan.

Before completing the LRA form, the relationship manager collects data specially industry specific from published sources and company specific data that not usually published, by personally visiting the company. After collecting the necessary data he/ she prepare financial spreadsheet. This spreadsheet provides a quick method of assessing business trend & efficiency and helps to assess the borrower ability to pay the loan Obligation. Financial spreadsheet includes balance sheet, income statement, cash flow statement and ratios for the purpose of financial statement analysis. Through analyzing data and collected information, the concerned official completes the LRA form and all scores are transferred to the scoring matrix to find the overall risk of lending. The overall matrix provides four kinds of lending risk for decision making viz.  (I) Good (ii) Acceptable (iii) Marginal and (iv) Poor. The bank does not provide any credit request having an over all risk as “marginal” and “Poor” without justification. All credit application rated “Poor” shall require the approval of the Board of Directors regardless of purpose tenor or amount. Therefore bank can minimize the dangers regarding the bad loan and advances through using the LRA.

However, the LRA manual suffers from a lot of subjectively, sometimes creating confusion to the lending Bankers in terms of selection of credit proposals on the basis of risk exposure. Meanwhile, in 2003 end Bangladesh Bank provided guidelines for credit risk management of Banks wherein it recommended, interlaid, the introduction of risk grade score card for risk assessment of credit proposals.

Since the two credit risk models are presently in vogue, the Governor Board of Bangladesh Institute of Bank Management (BIBM) under the chairmanship of the Governor, Bangladesh Bank decided that an integrated credit risk grading model be developed incorporating the significant features of the above mentioned models with a view to render a need based simplified and user friendly model for application by the Banks and financial institutions in processing credit decisions and evaluating the magnitude of risk involved therein.

Having considered the significance of credit risk grading, it becomes imperative for the banking system to carefully develop a credit risk grading model which meets the objective.

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. The credit risk grading system is vital to take decisions both at the pre-sanction stage as well as post-sanction stage.

The proposed CRG scale consists of 8 categories with short names and Numbers are provided as follows:

GRADINGSHORT NAMENUMBER
SuperiorSUP1
GoodGD2
AcceptableACCPT3
Marginal/Watch listMG/WL4
Special MentionSM5
Sub StandardSS6
DoubtfulDF7
Bad & LossBL8

In CRG models there are a series of activities which must be obtain by the banks. The first step is to identify all the principal risk components. Credit risk for counterparty arises from an aggregation of the following:

  •   Financial Risk
  •   Business/ Industry Risk
  •   Management Risk
  •   Security Risk
  •   Relationship Risk

Each of the above-mentioned key risk areas require be evaluating and aggregating to arrive at an overall risk grading measure. Then allocating weight ages to principal Risk Components. The weights of these risks are difference according to their importance. Then Establish the key parameters for all of these principal risk  for example: the parameters of Financial Risk  are Leverage, Liquidity, Profitability & Coverage ratio. After the risk identification & weight age assignment process (as mentioned above) next steps will be to input actual parameter in the score sheet to arrive at the scores corresponding to the actual parameters.

This manual also provides a well-programmed process MS Excel based credit risk scoring sheet to arrive at a total score on each borrower. The excel program requires inputting data accurately in particular cells for input and will automatically calculate the risk grade for a particular borrower based on the total score obtained. At last arrive at the Credit Risk Grading based on total score obtained. If the bank find good grade then it approve loan and if they get any unsatisfactory score then they reject the proposal.

The credit risk-grading matrix allows application of uniform standards to credits 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 evidence, the CRG outputs would be relevant for individual credit selection, wherein either a borrower or a particular exposure/facility is related. The other decisions would be related to pricing (credit-spread) and specific features of the credit facility. These would largely constitute obligor level analysis. 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.

Bangladesh Bank expects all commercial banks to have a well-defined credit risk management system, which delivers accurate and timely risk grading. This manual describes the elements of an effective internal process for grading credit risk. It also provides a comprehensive, but generic discussion of the objectives and general characteristics of effective credit risk grading system. In practice, a bank’s credit risk grading system should reflect the complexity of its lending activities and the overall level of risk involved.

LOAN APPROVAL  PRACTICE IN BANGLADESH

APPROVAL PROCESS:

This section outlines of the main procedures that are needed to ensure compliance with the policies contained guidelines OF BANGLADESH BANK.

Approval Process

The approval process must reinforce the segregation of Relationship Management/ Marketing from the approving authority. The responsibility for preparing the Credit Application should rest with the RM within the corporate/commercial banking department. Credit Applications should be recommended for approval by the RM team and forwarded to the approval team within CRM and approved by individual executives. Banks may wish to establish various thresholds, above which, the recommendation of the Head of Corporate/Commercial Banking is required prior to onward recommendation to CRM for approval. In addition, banks may wish to establish regional credit centres within the approval team to handle routine approvals. Executives in head office CRM should approve all large loans.

The recommending or approving executives should take responsibility for and be held accountable for their recommendations or approval. Delegation of approval limits should be such that all proposals where the facilities are up to 15% of the Bank’s capital should be approved at the CRM level, facilities up to 25% of capital should be approved by CEO/MD, with proposals in excess of 25% of capital to be approved by the EC/Board only after recommendation of CRM, Corporate Banking and MD/CEO.

The following diagram illustrates the preferred approval process:

Credit Application

Recommended by RM/ Marketing

Zonal Credit Officer (ZCO)

Head of Credit &

Head of Corporate Banking (HOBC)

Managing Director

Executive Committee/ Board

1. Application forwarded to Zonal Office for approved/decline

2. Advise the decision as per delegated authority (approved /decline) to recommending branches. A monthly summary of ZCO approvals should be sent to HOC and HOCB to report the previous month’s approvals sanctioned at the Zonal Offices. The HOC should review 10% of ZCO approvals to ensure adherence to Lending Guidelines and Bank policies.

3. ZCO supports & forwarded to Head of Corporate Banking (HOCB) or delegate for endorsement, and Head of Credit (HOC) for approval or onward recommendation.

4. HOC advises the decision as per delegated authority to ZCO

5. HOC & HOCB supports & forwarded to Managing Director

6. Managing Director advises the decision as per delegated authority to HOC & HOCB.

7. Managing Director presents the proposal to EC/Board

8. EC/Board advises the decision to HOC & HOCB

 Regardless of the delegated authority HOC to advise the decision (approval/decline) to marketing department through ZCO

Recommended Delegated Approval Authority Levels

HOC/CRM Executives      Up to 15% of Capital
Managing Director/CEO    Up to 25% of Capital
EC/Board all exceed          25% of Capital

Appeal Process
Any declined credit may be re-presented to the next higher authority for reassessment/approval. However, there should be no appeal process beyond the Managing Director.

Credit Administration:

The Credit Administration function is critical in ensuring that proper documentation and approvals are in place prior to the disbursement of loan facilities. For this reason, it is essential that the functions of Credit Administration be strictly segregated from Relationship Management/Marketing in order to avoid the possibility of controls being compromised or issues not being highlighted at the appropriate level. Credit Administration procedures should be in place to ensure the following:

Disbursement:

Security documents are prepared in accordance with approval § terms and are legally enforceable. Standard loan facility documentation that has been reviewed by legal counsel should be used in all cases. Exceptions should be referred to legal counsel for advice based on authorization from an appropriate executive in CRM.

Disbursements under loan facilities are only be made when all § security documentation is in place. CIB report should reflect/include the name of all the lenders with facility, limit & outstanding. All formalities regarding large loans & loans to Directors should be guided by Bangladesh Bank circulars & related section of Banking Companies Act. All Credit Approval terms have been met.

Custodial Duties:

Loan disbursements and the preparation and storage of security  documents should be centralized in the regional credit centers.

Appropriate insurance coverage is maintained (and renewed on a timely  basis) on assets pledged as collateral.

Security documentation is held  under strict control, preferably in locked fireproof storage.

Compliance Requirements:

All required Bangladesh Bank returns are submitted in the  correct format in a timely manner.

Bangladesh Bank  circulars/regulations are maintained centrally, and advised to all relevant departments to ensure compliance.

All third party service providers  (valuers, lawyers, insurers, CPAs etc.) are approved and performance reviewed on an annual basis. Banks are referred to Bangladesh Bank circular outlining approved external audit firms that are acceptable.

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