Internship Report on Policies and Practices of Credit Management in Premier Bank - Assignment Point
Internship Report on Policies and Practices of Credit Management in Premier Bank
Subject: Finance | Topics:

 Introduction:

The word credit comes from the Latin word “Credo” meaning “I believe”. It is a lender’s trust in a person’s/ firm’s/ or company’s ability or potential ability and intention to repay. In other words, credit is the ability to command goods or services of another in return for promise to pay such goods or services at some specified time in the future. Credit Management is a branch of accountancy, and is a function that falls under the label of “Credit and Collection’ or ‘Accounts Receivable’ as a department in many companies and institutions. They will usually deal with the credit vetting of customers, the resolution of any invoice queries or disputes, allocations of payments or cash application, internal fund movements, reconciliations and also maintaining positive working relationships with customer during the debt collection or credit review and approval process.

For a Bank, Credit is the main source of profit and on the other hand, the wrong use of credit would bring disaster not only for the bank but also for the economy as a whole. The objective of the credit management is to maximize the performing asset and the minimization of the non-performing asset as well as ensuring the optimal point of loan and advance and their efficient management. Credit management is a dynamic field where a certain standard of long-range planning is needed to allocate the fund in diverse field and to minimize the risk and maximizing the return on the invested fund. Continuous supervision, monitoring and follow-up are highly required for ensuring the timely repayment and minimizing the default. Actually the credit portfolio is not only constitute the banks asset structure but also a vital factor of the bank’s success. The overall success in credit management depends on the banks credit policy, portfolio of credit, monitoring, supervision and follow-up of the loan and advance. Therefore, while analyzing the credit management of PBL, it is required to analyze its credit policy, credit procedure and quality of credit portfolio.

A key requirement for effective revenue and receivables management is the ability to intelligently and efficiently manage customer credit lines or credit limits. In order to minimize exposure to bad debt, over-reserving, and bankruptcies, companies must have greater insight into customer financial strength, credit score history and changing payment patterns. Likewise, the ability to penetrate new markets and customers hinges on the ability of a company to quickly make well informed credit decisions and set appropriate lines of credit. This paper is entitled Policies and Practices of Credit Management in Premier Bank: Strength and Weakness and what should be done to Improve”.

Objectives of the study:

The main objectives of this study is to familiarize with the concepts of credit  management, internal and external risk factors, guidelines and techniques used by the Premier Bank for identification, measurement and management of credit risks in handling various loan accounts  as well as loan portfolio. The study has been undertaken with the following objectives:

       To have better orientation on credit management activities specially credit policy and practices, credit appraisal, credit-processing steps, credit management, financing in various sector and recovery, loan classification method and practices of Premier Bank  Limited (PBL)

      To identify the strength and weakness of premier bank in credit management

       To compare the existing credit policy of Premier bank limited with that of best practices guideline given by Bangladesh Bank, the central bank of Bangladesh.

      To identify and suggest scopes of improvement in credit management of PBL.

      To get an overall idea about the performance of Premier Bank Ltd.

 Methodology of the study:

 For preparing the report the following methodology is adopted. This report is an exploratory and analytical one in nature.  Most of the data has been collected from the secondary sources.

  1. Collection of data:

This report is an exploratory and descriptive one in nature. Among primary and secondary source most of the data has been collected from the both primary and secondary sources.

Primary sources of information:

  • Face to face conversation with the bank officials.
  • Face to face conversation with the clients.

    Secondary sources of information:

  • Annual report of Premier Bank Ltd.
  • Different books and newspaper articles written on credit management system of the banks.
  • Various publication of Bangladesh Bank
  • Internet
  1. Segregation of data

Collected data were segregated from the source material for the purpose of preparing report.

 c. Processing of data

Collected data were compiled and processed for the purpose of preparing the report. SPSS software is used to calculate the regression equation. Many type financial ratios are calculated using Spread sheet and a Case Study on Credit risk grading is done using Excel templates.

d. Presentation of data

Collected data were compiled in charts and tables and presented in the body of the report for this purpose we use Bar Diagram, Pie chart and Trends graph.

Scope of the study:   

My decision and analyses are done based on the practices applied at Premier Bank Limited. The study was wide spread and has greater scope to focus on different aspect of credit management on banking sector but my study probably will not reflect the practices in the overall banking sector. Moreover, it does not include the credit management practices done by the non-banking financial organizations.

The study would focus on the following areas of Premier Bank Limited.

  •  Credit appraisal system of Premier Bank Limited
  •  Procedure for different credit facilities
  • Portfolio (of Loan or advances) management of Premier Bank Limited.
  • Organization structures and responsibilities of management
  • Each of the above areas would be critically analyzed in order to determine the efficiency of PBL’s Credit appraisal and Management system.

 Limitations of the study:

If there are some advantages of any work at the same time there will be some difficulties of that work also. But with these limitations people become successful, they achieve their desire goals. There are so many examples of that. So, no excuse should be given to hide the weaknesses of any given job. But if there is hard work and full efforts behind it then people appreciate the whole work no body search the flaws. There are some limitations of this paper. But these limitations represent only the facts that really hampered the quality of report. Like this report focuses on loan and advance part of Premier Bank Ltd., which is the most sensitive element of the bank so in some cases the bank authority hesitated to disclose important information to maintain the business secrecy.

Publications of Premier Bank Ltd. were not sufficient to collect the needed information. But they provided the required annual reports of the bank. But the main difficulty was to collect the information of other commercial bank to make the peer group average. Because of the limitation of time it was not possible to collect data directly from the particular bank .As a full time service holder time constraint for collect massive data  has led to a difficulty as well.

 An over View of the Premier Bank Limited:

The Premier Bank Limited is incorporated in Bangladesh as banking company on June 10, 1999 under Companies Act.1994. Bangladesh Bank, the central bank of Bangladesh, issued banking license on June 17, 1999 under Banking Companies Act.1991. The Head Office of the Premier Bank Limited is located at Banani, one of the fast growing commercial and business areas of Dhaka city.

The Head Office of Premier Bank Limited at 42 Banani Commercial Area

Corporate Information:
Authorised Capital: BDT 2000.00 Million
Paid up Capital: BDT 1681.45 Million   

Total Capital Fund: BDT 2792.33 Million

The Premier Bank  started its journey from October 26, 1999 with a clear vision of ‘CORPORATE EXCELLENCE’ together with a popular motto of ‘SERVICE FIRST’ under the auspices of 11 successful enterpreneurs, well known at their respective fields of business and industy. From the very beginning the bank set forth a dream to creat a financial institution that would stand out in crowd and meet the demand of 21st century. Now after 10 successful years of operation, the bank is justified in its vision and mission and well-set to complete its 10th year on progress.

The Head Office of the Premier Bank Limited is located at Banani, one of the fast growing commercial and business areas of Dhaka city. Still now it has opened 30 branches in different areas of the country.

The bank got listed with both the stock exchange of the country viz. Dhaka Stock Exchange and Chittagong Stock Exchange in may, 2007 whereby the trading of shares of the bank began. It was first bank in the country to introduced daily balance based interest on deposit account.

Premier bank Corporate Culture:

“Believe in promotion of trust, team work and professionalism which benefits Their customers, employees, shareholders and whole society”.

 Board of Directors:

The Board consist of 11 (eleven) Directors. The members of the Board of Directors of the Bank hold very respectable positions in the society. They are from highly successful group of Business and Industries in Bangladesh. Out of 11 members one is from Taiwan. Each member of the Board of Directors plays a significant role in the socio-economic domain of the country. A list of the Directors and their shareholding along with associated business is given below:

Vision

 The Premier Bank aim to provide financial services to meet customer expectations so that customers feel that they are always there when they need Banking service, and can refer them to their friends with confidence. They want to be a preferred bank of choice with a distinctive identity.  Stand steady in the teeth of advertises and ensure sound profitability in a bid to safeguard the optimum benefit of the shareholders.

  • To build a sustainable and respectable financial institution.
  • To be a leading Commercial Bank, with a social focus, assisting in the economic development of the country.
  • The Profit of the bank used for the Socio-economic development of  Bangladesh

 Mission:

The mission of the Premier Bank is to make banking easy for their customers by implementing one-stop service concept and provide innovative and attractive products & services through their technology and qualified human resources. They always look out to benefit the local community through supporting entrepreneurship, social responsibility and economic development of the country. The mission of the Premier Bank is as follows.

  • Achieving sound and profitable growth in Assets & Liabilities, with focus to maintain non-performing assets at acceptable levels.
  • To build long-lasting, credible and mutually dependable relationships with customers.
  • Efficiently managing interest and operating costs.
  • To excel in rendering superior customer service.
  • To be the preferred employer among Banks in Bangladesh.

 Positioning statement:

Premier Bank is a contemporary, upbeat brand of distinctive quality of service and solution that offers a rewarding banking experience as preferred choice of banking partner every time, every where.

Premier bank’s Value

To be the most caring provider of financial services, creating a befitting atmosphere for clients to thrive and for employees to develop

  • Dependable
  • Reliable
  • Professional
  • Dynamic
  • Fair

 Branch Network:

The Branch network of the Premier Bank Limited is quite strong. With an age of only ten years the bank is now having a network of 30 branches across Bangladesh as on 31 December, 2008. These branches are situated at various strategically important commercial and industrial locations in the country. Among these branches, 20 branches are in Dhaka division, 5 branches in Chittagong division, 2 branches in Sylhet division, 1 branch in Rajshahi and I branch in Barisal, 1 branch at Khulna The above branch network is expected to be sufficient to maintain required growth rate of the bank.

Financial performance on the over all activities of the Premier Bank limited

 (TK. In Million)

Particulars

2002

2003

2004

2005

2006

2007

Authorized Capital

1000.00

1000.00

2000.0

2000.00

2000.00

2000.00

Paid-Up Capital

239.76

408.91

557.55

557.55

845.00

1689.99

Reserve Fund

98.24

130.00

301.08

403.85

543.76

649.79

Total Capital Funds

380.60

768.10

1312.63

1318.99

1855.58

2792.33

Deposits

5373.75

  10030.52

18005.20

20290.47

24199.01

27114.47

Advances

4280.73

8095.57

15383.93

20677.68

18032.50

23637.61

Investment in Govt. Securities

680.09

1330.20

2750.00

2392.01

2240.78

3461.45

Foreign Trade Business

11782.80

20934.30

34108.50

33850.23

38797.18

43222.20

Foreign Remittance

54.80

364.50

1408.00

940.10

1427.40

1620.60

Income

576.78

1251.76

2395.45

2863.86

3622.05

4186.33

Expenditure

380.54

851.03

1464.52

1964.83

2679.98

3188.22

Operating Profit

196.24

400.73

930.93

899.03

942.07

998.11

Fixed Assets

73.29

107.90

149.57

165.48

163.93

219.79

Total Assets

6036.92

11096.30

20100.25

22767.84

27170.45

32573.19

Book Value per Share (Taka)

140.97

168.12

207.69

203.31

192.44

145.88

Earning per Share (Taka)

28.30

67.02

84.40

32.45

43.63

4.66

Dividend

13.70%

36.35%

36.84%

24.00%

10.00%

7% bonus share
Loan as a % of total Deposits

79.66%

80.71%

85.44%

88.87%

85.45%

87.18%

Non-Performing Loan as % of total Loan

1.16%

0.36%

0.43%

3.86%

4.91%

5.96%

Capital Adequacy Ratio

9.27%

11.76%

10.69

8.24%

10.66%

12.66%

Number of Branches

12

17

21

21

26

27

No. of Foreign Correspondents

156

238

297

345

350

397

Number of Employees

281

435

554

605

677

731

Source: Annual Report 2007.

 Deposits Composition of Premier Bank:

As December 31, 2007 total deposit of the bank stood Tk.27, 114.47 million which was Tk.24119.01 milllion in the previous year, registering 12.05% growth. The upward trend of Deposits growth reflecting continous trust of the coustomer on Premier bank emanated from their untiring marketing and promotional efforts during the whole year.

Table: 1  Deposits Composition of Premier Bank

Sl. No.               ItemTk.In Million% of Total deposit
1Current Deposit1125.254.15%
2Savings bank Deposite1744.096.43%
3Fixed Deposite18184.2867.07%
4Bills Payable235.331.95%
5Short time deposit915.383.37%
6Deposit Scheme2944.6310.86%
7Others1672.966.17%
Total27114.47100%

Source: Annual Report 2007.

From the above graph we can see that the main source of deposit of the premier bank is fixed deposit, which account for almost 68% of the total deposit of the premier bank.

The overall Deposit and Profit also increased from the preceding year. Premier Bank has launched Islamic Banking which was highly cheered by the customers. Among the third generation bank the Premier bank first issued Visa Debit card. It also ensures online banking for its client. The customer can now deposit and withdraw money from any branch according to their needs. The bank also update it technology for the better service of its customer. The bank set ATM booth for providing the 24 hours banking facility to its customer.

SOWC analysis of Premier Bank Limited:

 Strength                                                             

  • Satisfactory asset quality
    • Good internal capital generation
    • Satisfactory operating efficiency
    • Diversified product lines
    • Low human resource turnover
    • Experienced Management team

 

 Weaknesses

  • § Limited market share
  • Dependency on Term Deposit
  • Moderate MIS
  • High cost of fund
  • Moderate corporate
  • § Governance

 

 Opportunities

  • § Investment in SME
  • Basel-II compliance for capital
  • § Adequacy
  • § Creation of brand image
  • Dual currency credit card
  • § On line products & services
 Challenges

  • § Increasing cost of fund
  • § Market pressure
  • Increasing the SLR
  • Implementation of Basel-II
  • Increased Market competition
  • Product Risk.

 

Types of credit made by the Premier bank ltd:

Modern banking operation touches almost every sphere of economic activity. The extension of bank credit is necessary for expansion of business operations. Bank credit is a catalyst bringing about economic about economic development. Without adequate finance there can be no growth or maintenance of a stable output. Bank lending is important to the economy, for it makes possible the financing of commercial and industrial activities of a nation. The credit facilities are generally allowed by the bank may be in two broad categories. They are as follows:

Funded Facilities:

Funded facilities can also be divided into the following categories

Term Loans:

The term of loan is determined on the basis of gestation period of a project generation of income by the use of the loan. Such loans are provided for Farm Machinery, Dairy, Poultry, etc. It is categorized in three segments:

Types of Term LoanTime (Period)
Short Term1 to 3 years
Medium Term3 to 5 tears
Long TermAbove 5 years

Over Draft (OD):

OD is some kind of advance. In this case, the customer can over draw from his/her current account. There is a limit of overdraw, which is set by the bank. A customer can with draw that much amount of money from their account. For this there is a interest charge on the over draw amount. This facility does not provide for every one, the bank will provide only those who will fulfill the requirement. It means that only real customer can get this kind of facility.

Cash Credit (Hypo):

It allows to individuals or firm for trading as well as whole-sale purpose or to industries to meet up the working capital requirements against hypothecation of goods as primary security fall under this type of lending. It is a continuous credit. It allowed under two categories:

  1. Commercial Lending
  2. Working Capital

Cash Credit (Pledge):

Financial accommodation to individual/firm for trading as well as whole sale purpose or to industries as working capital against pledge of goods primary security falls under this head of advance. It also a continuous credit and like the above allowed under the categories:

  1. Commercial Lending
  2. Working Capital

SOD (General):

Advance allowed to individual/firm against financial obligation (i.e. lien of FDR/PS/BSP etc.) and against assignment of work order for execution of contract works fall under this head. This advance is generally allowed for allowed for definite period and specific purpose. It is not a continuous credit.

SOD (Imports):

Advances allowed for purchasing foreign currency for opening L/C for imports of goods fall under this type of leading. This is also an advance for a temporary period, which is known as preemptor finance and falls under the category ‘Commercial Lending’.

PAD:

Payment made by the bank against lodgment of shipping documents of goods imported through L/C falls under this type head. It is an interim type of advance connected with import and is generally liquidated shortly against payments usually made by the party for retirements of documents for release of import goods from the customer authority. It falls under the category ‘Commercial Lending’.

LTR:

Advances allowed for retirement of shipping documents and release of goods imported through L/C without effective control over the goods delivered to the customer fall under this head. The goods are handed over the importer under trust with arrangement that sales proceed should be deposited to liquidate the advances within a given period. This is also temporary advance connected with import that is known post-import finance under category ‘Commercial lending’.

IBP:

Payment made through purchase of inlands bill to meet urgent requirements of customer fall under this type of credit facility. This temporary advance is adjusted from the proceeds of bills purchased for collection. It falls under the category ‘Commercial Lending’.

FDBP:

Payment made to a party through purchase of foreign documentary bills fall under this head. This temporary advance is adjustable from the proceeds of negotiable shipping/export documents. It falls under category ‘Export Credit’.

LDBP:

Payment made to a party through purchase of local documentary bills fall under this head. This temporary liability is adjustable from proceeds of the bill.

Bank Guarantee:

The exporters pay of the imported goods on behalf of the importer through bank guarantee. If the exporter fails to make the fulfill payment at the moment the bank will take the liability and pay to the exporter. This type of guarantee is also needed to attend in any tender.

Micro Credit:

Loan has given only to the Person for the purpose of Repairing and Reconstruction of dwelling Houses

HBL: House building Loan: A credit facility is available for the person having land property.

Non Funded Facilities:

Non funded facilities are divided into the following categories:

Guarantee:

A credit facility in contingent liabilities from extended by the banks to their clients for participation in development work, like supplies goods and services.

Letter of Credit:

A credit facility in contingent liabilities from provided to the clients by the banks for import/procurement of goods and services.

CREDIT RATING REPORTON PREMIER BANK LIMITED:

CRISL assigns A- (A minus) to Premier Bank Limited in long term and St-3 rating for short term. It has been done on the basis of Bank’s good fundamentals such as good asset quality, good profitability, moderate growth rate, reasonable capital adequacy and diversified product lines. However the above factors are moderated, to some extent, by limited market share, high dependence on term loans and average risk management. Bank rated in this category are adjudged to offer adequate degree of safety for timely payment of financial obligations. This level of rating indicates a corporate entity with an adequate credit profile. Risk factors are more variable and greater in periods of economic stress than those rated in higher categories. The short term rating indicates good certainty of timely payment. Liquidity factors and company fundamentals are sound. Although on going funding needs may enlarge total financing requirements, access to capital markets is good. Risk factors are small.

Definition of Credit Management:

Credit Management is a branch of accountancy, and is a function that falls under the label of “Credit and Collection’ or ‘Accounts Receivable’ as a department in many companies and institutions. They will usually deal with the credit vetting of customers, the resolution of any invoice queries or disputes, allocations of payments or cash application, internal fund movements, reconciliations and also maintaining positive working relationships with customer during the debt collection or credit review and approval process.

A key requirement for effective revenue and receivables management is the ability to intelligently and efficiently manage customer credit lines or credit limits. In order to minimize exposure to bad debt, over-reserving, and bankruptcies, companies must have greater insight into customer financial strength, credit score history and changing payment patterns. Likewise, the ability to penetrate new markets and customers hinges on the ability of a company to quickly make well informed credit decisions and set appropriate lines of credit.

Credit Management has evolved now from being a pure accounting function into a front-end customer facing function. It involves screening of customers and only those who are credit worthy are allowed to do business. A sound review of the financial position of the customer, and understanding of their business model is the first step in ensuring that the company does not end up selling to a customer who ends up seriously delinquent or in default.

Hence, before the sales function commences its business with the particular customer, the credit management role begins. Later as the customer starts dealing with the company, the accounts receivable function is used to ensure recovery as per agreed terms of credit is followed.

Definition of credit risk:

Credit risk is risk due to uncertainty in a counterparty’s (also called an obligor’s or credit’s) ability to meet its obligations. Because there are many types of counterparties—from individuals to sovereign governments—and many different types of obligations—from auto loans to derivatives transactions credit risk takes many forms. Institutions manage it in different ways. (Source internet)

In assessing credit risk from a single counterparty, an institution must consider three issues:

Default probability: What is the likelihood that the counterparty will default on its obligation either over the life of the obligation or over some specified horizon, such as a year? Calculated for a one-year horizon, this may be called the expected default frequency.

Credit exposure: In the event of a default, how large will the outstanding obligation be when the default occurs?

Recovery rate: In the event of a default, what fraction of the exposure may be recovered through bankruptcy proceedings or some other form of settlement?

When we speak of the credit quality of an obligation, this refers generally to the counterparty’s ability to perform on that obligation. This encompasses both the obligation’s default probability and anticipated recovery rate.

To place credit exposure and credit quality in perspective, recall that every risk comprise two elements: exposure and uncertainty. For credit risk, credit exposure represents the former, and credit quality represents the latter.The goal of credit risk management is to maximize a bank’s risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Banks need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions. Banks should also consider the relationships between credit risk and other risks. The effective management of credit risk is a critical component of a comprehensive approach to risk management and essential to the long-term success of any banking organization.1 (Coen Mr William).Most of a bank’s funds are used either to make loan or to purchase debt securities. For either use of funds, the bank is acting as a creditor and is subject to credit (default) risk, or the possibility that credit provided by the bank will not repaid. The type of loans provided and the securities purchased will determine the over all credit risk of the asset portfolio. [A bank also is exposed to credit risk if it serves as guarantor]. (Madura, jeff)

An important part of credit risk management is to measure it. This requires a credit assessment of loan applicants. The bank employ credit analyst who review the financial information of a corporation applying for loans and evaluate their creditworthiness. The evaluation should indicate the possibility of that a firm meet its loan payment so that the bank can decide whether to grant the loan. 3(Madura, jeff)

 Tools used in credit risk management:

There are many ways that credit risk can be managed or mitigated. The first line of defense is the use of credit scoring or credit analysis to avoid extending credit to parties that entail excessive credit risk. Credit risk limits are widely used. These generally specify the maximum exposure a firm is willing to take to counterparty. Industry limits or country limits may also be established to limit the sum credit exposure a firm is willing to take to counterparties in a particular industry or country. Calculation of exposure under such limits requires some form of credit risk modeling. Transactions may be structured to include collateralization or various credit enhancements. Credit risks can be hedged with credit derivatives. Finally, firms can hold capital against outstanding credit exposures.

Credit analysis:

The term credit analysis is used to describe any process for assessing the credit quality of counterparty. While the term can encompass credit scoring, it is more commonly used to refer to processes that entail human judgment. One or more people, called credit analysts, will review information about the counterparty. This might include its balance sheet, income statement, recent trends in its industry, the current economic environment, etc. They may also assess the exact nature of an obligation. For example, secured debt generally has higher credit quality than does subordinated debt of the same issuer. Based upon this analysis, the credit analysts assign the counterparty (or the specific obligation) a credit rating, which can be used for making credit decisions.

Credit ratings:

Many banks, investment managers and insurance companies hire their own credit analysts who prepare credit ratings for internal use. Other firms—including CIB (credit information bureau, Moody’s and Fitch—are in the business of developing credit ratings for use by investors or other third parties. Institutions that have publicly traded debt hire one or more of them to prepare credit ratings for their debt. Those credit ratings are then distributed for little or no charge to investors. Some regulators also develop credit ratings. In the United States, the National Association of Insurance Commissioners publishes credit ratings that are used for calculating capital charges for bond portfolios held by insurance companies.Credit Rating of Borrowers in Bangladesh : BB has made it mandatory for all banks and NBFIs to obtain professional credit rating, However not enough attention has been given to the subject of credit rating of large borrowers, an issue the regulatory authorities may want to pursue.

Credit scoring:

For loans to individuals or small businesses, credit quality is typically assessed through a process of credit scoring. Prior to extending credit, a bank or other lender will obtain information about the party requesting a loan. In the case of a bank issuing credit cards, this might include the party’s annual income, existing debts, whether they rent or own a home, etc. A standard formula is applied to the information to produce a number, which is called a credit score. Based upon the credit score, the lending institution will decide whether or not to extend credit. The process is formulaic and highly standardized

Credit exposure:

The manner in which credit exposure is assessed is highly dependent on the nature of the obligation. If a bank has loaned money to a firm, the bank might calculate its credit exposure as the outstanding balance on the loan. Suppose instead that the bank has extended a line of credit to a firm, but none of the line has yet been drawn down. The immediate credit exposure is zero, but this doesn’t reflect the fact that the firm has the right to draw on the line of credit. Indeed, if the firm gets into financial distress, it can be expected to draw down on the credit line prior to any bankruptcy. A simple solution is for the bank to consider its credit exposure to be equal to the total line of credit. However, this may overstate the credit exposure. Another approach would be to calculate the credit exposure as being some fraction of the total line of credit, with the fraction determined based upon an analysis of prior experience with similar credits.

Importance of Credit Risk Management for banking institutions.

[Accurately assess and report the risk of potential credit losses and calculate the capital reserves required to adequately cover that risk. Banks and other lending institutions must constantly balance risks and rewards. Too high a price on loan products, and the bank will lose its customer; too low, and the bank will starve the profit margin or take a loss. Too much capital on reserve, and the bank will miss investment revenue; too little, and the bank will run risk of regulatory noncompliance and financial instability]. 6(SAS CRM for Banking)

Credit risk management practices in Bangladesh:

Credit risk is the primary financial risk in the banking system. Identifying and assessing credit risk is essentially a first step in managing it effectively. In 1993, Bangladesh Bank as suggested by Financial Sector Reform Project (FSRP) first introduced and directed to use Credit Risk Grading system in the Banking Sector of Bangladesh under the caption “Lending Risk Analysis (LRA)”. The Banking sector since then has changed a lot as credit culture has been shifting towards a more professional and standardized Credit Risk Management approach.

[The Lending Risk Analysis (LRA) manual introduced in 1993 by the Bangladesh Bank has been in practice for mandatory use by the Banks & financial institutions for loan size of BDT 1.00 crore and above. However, the LRA manual suffers from a lot of subjectivity, 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, interalia, the introduction of Risk Grade Score Card for risk assessment of credit proposals.10(BB (2005) “Credit Risk Grading Manual (CRGM)

Since the two credit risk models are presently in vogue, the Governing 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 [Furthermore, during the last cuple of years, the management of credit has experienced some crucial changes with the enactment of some important rules, regulation and laws like Artho Rin Adalat, money laundering prevention act, registration act, etc. further the most important guidelines on “Managing Core Risk in Banking” developed by the focus group under the auspices of Bangladesh bank already implemented within the given deadline, have made new dimension in the whole banking arena. Following implementation of guidelines on credit risk management, entire credit operation has been streamlined with maintaining separate demarcation among the department under credit risk management.11 (Premier Bank credit policy manual)

 [In order to improve the performance of the banking sector the Bangladesh Bank announced its first ever policy towards loan classification, suspension of interest due and the making of provisions against potential losses vide BCD (Banking Control Department) circular no. 34 in 1989. According to the circular all loans should be termed as classified or unclassified, classified loans would further to be divided as sub-standard, doubtful and bad/losses. In 1998, BRPD circular no. 16 is issued with major amendments in BCD circular no.34/1989 and 20/1994 with the objective of bring the loan classification and provisioning regulation in line with the international standards. The loan provisioning and classification system was modified further through BRPD circular no. 02/2005, 08/2005, and 09/2005 and finally to find all the instructions in one place and with new instructions a master circular BRPD 05/2006 is issued. As part of the process ‘Special Mention Account’ was introduced for the accounts that shows sign of weaknesses as early as possible and formats for loan classification and provisioning system (CL-1,2,3,4 and 5) was introduced].12BB (2006).

Issue of non-performing loans (NPL) in Bangladesh is a major concern of the monetary authority due mainly to its adverse affect on bank balance sheet, particularly asset side of the balance sheet. Causes of non-performing loans both in general and in the Bangladesh context has been analyzed in depth in a previous issue of FSR (BB, 2006). As of December, 2006 the classified loans of four nationalized banks have been accrued to nearly BDT 115.03 billion, of which Sonali tops the list of classified loan burdened nationalized banks with BDT 58.82 billion followed by Agrani with BDT 27.81, Rupali BDT 11.35 billion and Janata BDT 17.03 billion.

The very high NPL ratio for public sector banks (NCBs and SBs) especially for term lending and agricultural and micro lending suggests that these activities should be re-examined and the authorities must establish a viable rationale for their continuation. The development of the credit rating agencies and improved accounting standards required by BB should help in better shifting of risks in the economy. Since SOE loans (term) is a major contributor to the poor NPL record of

NCBs and SBs, in term lending, the arguments in favor of divestment of these entities gain additional strength. The energy pricing policy is a relevant factor here. Besides, the area of agricultural lending, the thrust of the above arguments suggests that the credit delivery mode is perhaps better be done by the private banks or Non-Government organization.

Role of Credit Information Bureau (CIB) in Credit Risk Management:

Credit Information Bureau (CIB) was introduced in 1992 at the Bangladesh Bank and started operation in 1993. Its database has been expanded to include outstanding loans of BDT 50,000 and above, and for credit cards the amount is BDT 10,000 and above. The CIB report is a first useful check on the credit standing of potential borrowers. BB is in the process of modernizing CIB to provide online information. CIB is the most successful and very useful data base on the country’s borrower’s information. From CIB the borrower’s information on loans and advances i.e. types of loan, amount of loan, the present value of loan can be learned. Therefore it is advisable that the credit officer will inevitably collect borrower information from the CIB, Bangladesh bank and if found anything adverse in the CIB report, no loan application will be processed. Before processing loan application, always latest CIB report i.e. not older than 3 months will be considered, similarly after disbursing loan the borrower information will be submitted to the CIB, Bangladesh bank so as to update their data base.

Power of Bangladesh Bank to control advance:

Under the provisions of the Bank Companies Act 1991 and its subsequent amendment, the Bangladesh bank is empowered to determine the lending policy of the banks and give direction among others, as to the purpose for which loans and advance may or may not be made, margins to be maintained, rates of interest to be charged etc. and the banks are bound to comply with any such directions, failing which the banks will be liable to penalty. It is, therefore, advised that while considering a credit proposal, current credit restrictions imposed by Bangladesh bank are kept in view by the lending officers.

 Default risk: provisioning and write down:

Provision is used as a tool for managing risk, reducing earnings volatility and signaling future changes in earnings. The danger of under provisioning is that it may cause inflated income for banks. Stockholders may ask for higher dividend; employees may ask for incentive bonuses and tax authority may ask for higher taxes. In the long run sustainability of the institution and stability of the financial system may be threatened. Bangladesh Bank, therefore, introduced a strong regulation on provision requirement vide BRPD Circular Letter No. 18, dated 20 October 2002. Central bank advised banks, prior to declaration of dividend, to maintain adequate provision as per instruction. New policy also requires banks to obtain authentication from the external auditor to this effect that provision have been properly maintained having followed/complied with the rules, regulations and norms issued by the central bank and there is no shortfall in respect of maintenance of capital adequacy and provision requirement.

Recent Changes in Provisioning Policy:

Banks were required to maintain only 1 percent general provision against unclassified loans including Special Mention Accounts (SMA) under BRPD circular no. 16, dated 06 December 1998. Bangladesh Bank enhanced this requirement for two categories of loans such as consumer financing and small enterprise financing vide BRPD circular no. 20, dated 20 December, 2005. In the latter circular unclassified loans and advances are ranked into five categories such as Superior, Good, Acceptable, Marginal/Watch list and SMA. Banks were instructed to maintain 5 percent general provision against SMA. For other categories of unclassified loans, they were advised to maintain two different rates of provision: 2 percent provision for small enterprise financing and 5 percent for consumer financing. Under consumer financing, an exception has been made for housing finance and loans for professional to set up businesses: two percent provision is required on unclassified amount of these two categories of loans. Bangladesh Bank further tightened this requirement by BRPD circular no.5, dated 05 June, 2006. The new circular has incorporated earlier requirements and has expanded the coverage of provision requirement against SMA. According to the new directive, banks are required to maintain 5 percent general provision against SMA (after netting off the amount of interest suspense) for all types of loans and advances. The changed provisioning policies for the banking sector are shown in Table 3.6.1

 Performance of Banking Sector in Terms of Required Provision:

Banks are required to include this provision as risk premium during loan pricing. If the required provision as a percentage of total lending declines over the years, it can be argued that their performance has improved. This study shows that from 1998 to 2005 banking sector as a whole experienced robust performance. However, this performance did not continue in 2006. Required provision as a percentage of total lending increased consecutively in the first three quarters of2006. At the end of first quarter, the rate was 7.05 which increased to 7.47 at the end of third quarter. Looking at different categories of banks, the rate was substantially higher for state-owned banks than PCBs and FCBs. However, required provision as a share of total lending consecutively increased for NCBs and PCBs in the first three quarters which indicates deterioration of their performance in risk management. Though performance of FCBs and SBs deteriorated in the first quarter, they recovered in the third quarter. Since market share of PCBs and FCBs are rising over the years, they may further contribute to reducing credit risk premium.

Credit Management is a branch of accountancy, and is a function that falls under the label of “Credit and Collection’ or ‘Accounts Receivable’ as a department in many companies and institutions. They will usually deal with the credit vetting of customers, the resolution of any invoice queries or disputes, allocations of payments or cash application, internal fund movements, reconciliations and also maintaining positive working relationships with customer during the debt collection or credit review and approval process.

A key requirement for effective revenue and receivables management is the ability to intelligently and efficiently manage customer credit lines or credit limits. In order to minimize exposure to bad debt, over-reserving, and bankruptcies, companies must have greater insight into customer financial strength, credit score history and changing payment patterns. Likewise, the ability to penetrate new markets and customers hinges on the ability of a company to quickly make well informed credit decisions and set appropriate lines of credit.

Credit Management has evolved now from being a pure accounting function into a front-end customer facing function. It involves screening of customers and only those who are credit worthy are allowed to do business. A sound review of the financial position of the customer, and understanding of their business model is the first step in ensuring that the company does not end up selling to a customer who ends up seriously delinquent or in default.

Hence, before the sales function commences its business with the particular customer, the credit management role begins. Later as the customer starts dealing with the company, the accounts receivable function is used to ensure recovery as per agreed terms of credit is followed.(Source internet)

Existing Credit Policy of Premier Bank Limited

Components of the Lending operations maintained by the Bank

Written Loan Policy:

One of the most important ways a bank can make sure its loans meet regulatory standards and are profitable is to establish a written loan policy. Such a policy gives loan officers and the bank’s management specific guidelines in making individual loan decisions and in shaping the bank’s overall loan portfolio. The actual make up of a bank’s Loan portfolio should reflect what its loan policy says. Otherwise, the loan policy is not functioning effectively and should be either revised or more strongly enforced by senior management.

  1. A goal statement for the bank’s loan portfolio (i.e., statement of the characteristics of a good loan portfolio for the bank in terms of types, maturities, sizes, and quality of loans)
  2. Specification of the lending authority given to each loan officer and loan committee (measuring the maximum amount and types of loan that each person and committee can approve and what signatures are required).
  3. Lines of responsibility in making assignments and reporting information within the loan department.
  4. Operating procedures for soliciting, reviewing, evaluating, and making decisions on customer loan applications.
  5. The required documentation that is to accompany each loan application and what must be kept in the banks credit files (required financial statements, security agreements etc.).
  6. Lines of authority within the bank, detailing who is responsible for maintaining and reviewing the banks credit files.

  7.    Guidelines for taking, evaluating, and perfecting loan collateral.

       8.    A presentation of policies and procedures for setting loan interest rates and fees and the terms     for repayment of loans.

  1.   A statement of quality standards applicable to all loans.
  2. A statement of the preferred upper limit for total loans outstanding (i.e. the maximum ratio of total loans to total assets allowed).
  3. A description of the bank’s principal trade area, from which most loans should come.
  4. A discussion of the preferred procedures for detecting, analyzing, and working out problem loan situation.
 Appraisal of credit proposal:

Any types of lending procedure starts with building up relationship with customer through account opening. Control of credit operations is done at branch and Corporate Office Level.

Step-One: Loan Application:

Most bank loans to individuals arise from a direct request from a customer who approaches a member of the bank’s staff and asks to fill out a loan application. Business can requests, on the other hand, often arise from contacts the bank’s loan officers and sales representatives make as they solicit new accounts from firms operating in the banks market area. Sometimes loan officers will call on the same company for months before the customer finally agrees to give the bank a try by filling out a loan application.

A loan procedure starts with a loan application from a client who must have an account with the Bank. At first it starts form the branch. Branch receives application from client for a loan facility. In the application client mention what type of credit facility he/she wants form the Bank including his personal information and business information. Branch Manager or regarding Officer- in charge of credit department conducts the initial interview with the customer.

Once a customer decides to request a loan, an interview with a loan officer usually follows right away, giving the customer the opportunity to explain his or her credit needs. That interview is particularly important because it provides an opportunity for the bank’s loan officer to assess the customer’s character and sincerity of purpose.

Step-Two: Credit investigation:

After receiving the loan application form, sends a letter to Bangladesh Bank for obtaining a credit report of the customer from there. This report is called CIB (Credit information Bureau) report. This report is usually collected if the loan amount exceeds Tk. 50 thousands. The purpose of this report is to be informed that whether the borrower has taken loan from any other Bank or not; if ‘yes’ then whether these loans are classified or not.

Step-Three: Document Collection:

If Bangladesh Bank sends positive CIB report on that particular borrower and if the Bank thinks that the prospective borrower will be a good one, then the Bank will scrutinize the documents. Required documents are;

  • Incase of Corporate Client Financial documents of the company of last three to five years. If the company is new then projected financial data are required.
  • Personal net worth of the borrower/Borrowers.
  • In this stage, the Bank will look whether the documents are properly filled up and signed. Credit in charge of the relevant branch is responsible to know about the ins and outs of the client’s business through discussing with him.

Step-Four: Inspection:

If a business or mortgage loan is applied for, a site visit is usually made by an officer of the bank to assess the customer’s location and the condition of the property and to ask clarifying questions. The loan officer may contact other creditors who have previously loaned money to this customer to see what their experience has been.Project for which the loan is applied is inspected by Bank officials. Project’s existence, distance from Bank office, viability, monitoring cost and other possibilities are also examined.

Step-Five: Evaluation of Credit:

If all is favorable to this point, the customer is asked to submit several crucial documents the bank needs in order to fully evaluate the loan request, including complete financial statements and, in the case of a corporation, board of directors’ resolutions authorizing the negotiation of a loan with the bank. Once all documents are on file, the credit analysis division of the bank conducts a thorough financial analysis of them aimed at determining whether the customer has sufficient cash flows and backup assets to repay the loan. The credit analysis division then prepares a brief summary and recommendation, which goes to the loan committee for approval.

Any loan proposal needs to be evaluated on the Basis of financial information provided by the applicant. Credit Risk Grading (CRG) is a technique by which the risk of the loan is calculated. Banker must analyze CRG when loan application is above 1 crore. Experienced people of Credit department in the branch  do this analysis. It is a ranking whose total score is 140. Among this score, 120 is for Total Business Risk and 20 for Total Security Risk.

In CRG, following aspects are analyzed:

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

Step-Six: Collateral Collection:

If the loan committee approves the customer’s request, the loan officer or the credit committee will usually check on the property or other assets to be pledged as collateral in order to ensure that the bank has immediate access to the collateral or can acquire title to the property involved if the loan agreement is defaulted. This is often referred to as perfecting the bank’s claim to collateral. Once the loan officer and the bank’s loan committee are satisfied that both the loan and the proposed collateral are sound, the note and other documents that make up a loan agreement are prepared and are signed by all parties to the agreement, whether those are properly submitted – regular and up to date or else those documents will be asked to regularize by the client.

Step-Seven: Issuance of Sanction letter to client:

If the proposal meets PBL’s lending criteria and is within the manager’s discretionary powers, the credit line disapproved. The manager and the sponsoring officer sign the credit line proposal and issue a sanction letter to client.

If the value of the credit line is above the branch managers’ limit then it is send to head office for final sanction with detailed information regarding clients, business or purpose of the loan, security papers.

Step-Eight: Review of Credit Proposal by Credit Committee:

Head office processes the credit proposal and afterwards puts up a memorandum to credit committee. The credit committee reviews the credit proposal and accepts or rejects the proposal.

Step- Nine: Loan Approval:

After approval by the Credit Committee head office gives an approval letter to the branch and branch gives a sanction letter. The client should accept sanction advice with seal which will prove his agreement with the terms and condition offered by the Bank.

Step-Ten: Collection of charge document:

After the sanction advice, bank will collect necessary charge document. Charge documents vary on the basis of types of facility, types of collateral. Generally the following charge documents are required as per the nature of the loan.

  1. D.P. Note (Demand Promissory Note)
  2. GLCA (General Loan & Collateral Agreement)
  3. Letter of Continuity
  4. Letter of Lien – [In case of loan against any instruments or documents]
  5. Continuing Guarantee
  6. Letter of Hypothecation
  7. Hypothecation of Debts & Assets
  8. Counter Indemnity
  9. Trust Receipt
  10. Authority for Borrowing Limited Liability Company.

Step-Eleven: Loan Disbursement:

Finally loan is disbursed and monitoring of loan starts as well.

 Selection of borrowers, credit investigation including CIB:

The division of the bank responsible for analyzing and recommendations on the fate of most loan applications is the credit department. Experience has shown that this department must satisfactorily answer three major questions regarding each loan application:

  1. Is the borrower creditworthy? How do you know?
  2. Can the loan agreement are adequately protected and the customer has a high probability of being able to service the loan without excessive strain?
  3. Can the bank perfect its claim against the assets or earnings of the customer so that, in the event of default, bank funds can be recovered rapidly at low cost and with low risk?

Let’s look in turn at each of these three key issues in the “yes” or “no” decision a bank must make on every loan request.

Eligibility of getting loan: Whom the bank Grant Credit, Is the Borrower Creditworthy?

The question that must be dealt with before any other is whether or not the customer can service the loan-that is, pay out the credit when due, with a comfortable margin for error. This usually involves a detailed study of six aspects of the loan application- character, capacity, cash, collateral, conditions, and control. All must be satisfactory for the loan to be a good one from the lender’s point of view.

Character:

The loan officer must be convinced that the customer has a well-defined purpose for requesting bank credit and a serious intention to repay. If the officer is not sure exactly why the customer is requesting a loan, this purpose must be clarified to the bank’s satisfaction.

Responsibility, truthfulness, serious purpose, and serious intention to repay all monies owed make up what a loan officer calls character.

Capacity:

The loan officer must be sure that the customer requesting credit has the authority to request a loan and the legal standing to sign a binding loan agreement. This customer characteristic is known as the capacity to borrow money. For example, in most states a minor (e.g., under age 18 or 21) cannot legally be held responsible for a credit agreement; thus, the bank would have great difficulty collectors on such a loan.

Cash:

 This key feature of any loan application centers on the question: Does the borrower have the ability to generate enough cash, in the form of cash flow, to repay the loan? In general, borrowing customers have only three sources to draw upon to repay their loans: or (a) cash flows generated from sales or income, (b) the sale or liquidation of assets, or (c) funds raised by issuing debt or equity securities. Any of these sources may provide sufficient cash to repay a bank loan.

Collateral :

In assessing the collateral aspect of a loan request, the loan officer must ask, does the borrower possess adequate net worth or own enough quality assets to provide adequate support for the loan? The loan officer is particularly sensitive to such features as the age, condition, and degree of specialization of the borrower’s assets.

Conditions :

The loan officer and credit analyst must be aware of recent trends in the borrower’s line of work or industry and how changing economic conditions might affect the loan.

Control :

The last factor in assessing a borrower’s creditworthy status is control which centers on such questions as whether changes in law and regulation could adversely affect the borrower and whether the loan request meets the bank’s and the regulatory authorities’ standards for loan quality.

Can the Loan Agreement Be Properly Structured and Documented?

The six Cs of credit aid the loan officer and bank credit analyst in answering the broad question: Is the borrower creditworthy? Once that question is answered, however, a second issue must be faced: Can the proposed loan agreement be structured and documented to satisfy the needs of both borrower and bank?

A properly structured loan agreement must also protect the bank and those it represents- principally its depositors and stockholders- by imposing certain restrictions (covenants) on the borrower’s activities then these activities could threaten the recovery of bank funds. The process of recovering the bank’s funds- when and where the bank can take action to get its funds returned-also must be carefully spelled out in a loan agreement.

Needs for Collateral:

Most Borrowers at one time or another will be asked to pledge some of their assets or to personally guarantee the repayment of their loans. Getting a pledge of certain borrower assets as collateral behind a loan really serves two purposes for a lender. If the borrower cannot pay, the pledge of collateral gives the lender the right to seize and sell those assets designated as loan collateral, using the proceeds of the sale to cover what the borrower did not pay back. Secondly, collateralization of a loan gives the lender a psychological advantage over the borrower. The goal of a bank taking collateral is to precisely define which borrower assets are subject to seizure and sale and to document for all other creditors to see that the bank has a legal claim to those assets in the event of nonperformance on a loan.

 Sources of Information about Loan Customers:

The bank relies principally on outside information to assess the character, financial position, and collateral of a loan customer. Such an analysis begins with a review of information supplied by the borrower in the loan application. The bank may contact other lenders to determine their experiences with this customer. Were all scheduled payments in previous loan agreements made on time? Were deposit balances kept at high enough levels? How much was borrowed previously and how well were those earlier loans handled? Is there any evidence of slow or delinquent payments? Has the customer ever declared bankruptcy?

Sources of Information about the Loan customers:

  • Physical Investigations
  • Customer financial statements
  • Experience of other lenders with this customer
  • Customer Annual Report
  • Local or regional credit bureaus
  • Local Newspapers
  • Local chamber of commerce

Credit policy is the guideline for the bank’s credit division. It generally aims at firstly creating healthy loan assts to ensure good interest earnings for the bank, secondly ensuring ultimate safety through good selection of assets based on its saleability and thirdly improving discipline on use of resources. It providing limit to total loan of a bank in relation to its deposit funds, limits of its exposure to different sectors, limits of risk assets on types of security, limits of loans to single borrower entity and limits of loan approval authority at different tiers is the single most important document of guidance to managers and executives of a bank.

Loan Structuring:

 Premier Bank is a new bank, it successfully run their business through a standard credit policy. From the very beginning, the initiator of the Bank decided not to encourage the defaulters to obtain credit from this esteem bank. On the other hand, they want to deal with limited customer who has established their business with integrity.  With this view, the board of directors and the higher executives of the Bank structured their credit policy, which covers the following important aspects:

  1. Loan limits
  2. Sectoral allocation of loan
  3. Loan pricing
  4. loan approval Authority
  5. Restrictions of loans.
  6. Loan Renewal and Follow-up.
  7. Loan Classification & Provisioning

Loan Limits:

As Bangladesh Bank requires the banks to keep 5% deposit in cash reserve ratio and 15% in investment against eligible securities towards statutory liquidity reserve, in the absence further guidelines Premier Bank can extend credit up to 80% of deposits.But in practice it invest 87.18% of deposit.

Sectoral allocation of Loans:

After determining the total extendable limit of loan in the policy, it becomes essential for PREMIER Bank to fix limits of loans for disbursing the loans in the different sector to diversify the risk. Premier Bank. Premier Bank emphasis in the following sector to disbursement of their loan.

 Loan Pricing:

Another important aspect of credit policy is pricing of loans. PREMIER bank’s management determine rate of interest through considering the cost of their allocated fund. Bank’s management proves their skill by determining their loan pricing which reflects on their high rate of profitability. Comparing to the newly established Bank’s, PREMIER bank’s loan pricing is competitive.

Loan Approval Authority:

At the initial stage, Concerned Branch manager has the Authority to consider whether the bank is going to give loan to the particular borrower. After submitting the proposal to the Head office, it is their responsibility to take the final decision to disburse the loan.

Restrictions of Loans:

Premier bank follows some restriction to disburse the loan according to the Bangladesh Bank’s rules and regulation. For example:

  • Bank does not provide loan against security of its own share.
  • Bank does not provide loan to a minor or a company where a minor is holding majority share.
  • Bank does not make loans against accommodation bills.
  • Bank does not approve loan in favor of customers who have unpaid loans with another bank with out no objection certificate from the later.
  • Bank does not make loan to borrowers whose integrity is questionable.
  • It is prohibited by Bangladesh Bank in 2005 not to provide loan to the members of Board of Directors of the respective Bank.
  • Bank does not provide loan in the case when the business is located cross-boarder area.
  • Bank does not allow any loan against illegal purpose.

Monitoring and follow up of loans and advance:

The objective of monitoring and follow up is to control end use of funds, to prevent diversion of fund to ensure that the borrower observes financial discipline. This is achieved through post sanction care, control and monitoring till the advance is fully repaid.

Follow up is exercised with the regard to the following aspects:

  1. Terms of sanctions
  2. Documentation
  3. Disbursal
  4. Operations in the account
  5. Financial statements, up dating credit information
  6. Inspection of security
  7. Renewal of limit

Terms of sanctions:

The borrower should be informed about the sanction of the proposal in writing, along with the terms of sanction, and acknowledgement from the borrower should be obtain. The sanction terms include

(i)                 Amount of sanction with sub limits

(ii)               Margin

(iii)             Rate of interest

(iv)             Name of guarantors

(v)               Repayment schedule

(vi)             Insurance

(vii)           Security

(viii)         Date of renewal

(ix)             Any other special terms and conditions

Documentation:

The borrowing power of the company is verified and necessary resolution regarding the borrowing is obtained from the company. No advance is made unless documentation is complete both with regard to the borrower as well as with regard to guarantor/s

Disbursal:

Disbursal of advance made in such a way that the end use of the funds as per the terms of sanction of the advance is ensures. For instance in case of term loans against machinery payment is made directly to the suppliers by means of pay order. No disburse is made in cash or otherwise.

Operation in the account:

Once the advance has been disbursed, a watch is kept over operation in the account. A close scrutiny of the entries in the account will give information regarding the nature of the transactions, sales and purchase.

Here are some indicator which is closely enquire by the bank,

  • Decline in the number of operation
  • Frequent return of cheques issued by the borrower or failure in retiring bills drown on him
  • Frequent return of cheque / bills deposited by the borrower
  • Withdrawal of large amounts in cash.

Recovery and follow up:

If a borrower fails to make repayment of the dues, Premier bank considers the following steps to recover the stuck up advances.

  1. Exerting Moral Pressure

 The Bankers visit the borrower’s place of business and find out the causes of non-payment of the bank’s dues. The banker may also request some influential of the area to exert pressure on the borrower to clear bank’s dues.

  1. Notice:

In case the borrower does not adjust the account as desired, the only course left open to the bank would be to sent a notice by registered post to the last known address of the borrower and the guarantor, if any, preferably through a lawyer.

Loan Classifications and Provisioning:

Loan classification is required to have a real picture of the loan and advances provided by the Bank. It helps to monitor and take appropriate decision regarding each loan account like other Banks, all types of loans of BA fall into following four scales:

  1. Unclassified : Repayment is regular
  2. Substandard: Repayment is stopped or irregular but has reasonable prospect of improvement.
  3. Doubtful debt: Unlikely to be repaid but special collection efforts may result in partial recover.
  4. Bad/Loss: very little chance of recovery.
Loan TypeUnclassified

(MonthSubstandard (Month)Doubtful (Month)Bad

(Month)Continuous Loan

Demand LoanExpiry up to 5 month6 to 8 month9 to 11 month12 month+Term loan up to 5 year0 to 5 month6 to 11 month12 to 17 month18 month+Term Loan more then 5 years0 to 11 month12 to 17 month18 to 23 month24 month+Micro Credit0 to 11 month12 to 13 month36 to 59 month60 month+

Loan Provisioning:

A Certain amount of money is kept for the purpose of provisioning. This percentage is set following Bangladesh Bank rules.

Type of ClassificationRate of Provision
Unclassified1%
Substandard20%
Doubtful50%
BAd debt100%

Loan follow-up means the technique of supervision (of loan). The branch manager keep a close and constant watch on all their loans and advances to ensure that timely action is initiated in each case for adjustment of account or its renewal, if it is decided to continue the facility. For this purpose each branch maintain a diary or card in prescribed format in which the due date of expiry of loan facilities are noted down. At least thirty days before the date of expiry of any loan facility, a notice send to the borrower reminding him of the due date of repayment and making formal demand of repayment are renewal as the case may be. Vigorous follow up actions there after taken by issuing repeated reminders and putting pressures on the borrower by calling on him personall

 Early alert process:

An early alert account is one that has risks or potential weakness of material nature requiring monitoring, supervision, or close attention by management, if these weakness are left uncorrected, they may result in deterioration of the repayment prospect for the asset or in the bank’s credit position at some future date. Early identification, prompt reporting and proactive management of early alert accounts are prime credit responsibilities of all relationship manager and be undertaken on a continuously basis.

Despite of a prudent credit approval process, loans may still become troubled. Therefore, it is essential that early identification and prompt reporting of deteriorating credit signs be done to ensure swift action to protect the bank interest. Moreover, regular contact with the customer will enhance the like hood of developing strategies mutually acceptable to both the customer and the bank. An account may be reclassified as regular account from early alert account status when the symptom, symptoms causing the early alert classification have been regularized or no longer exist.

Early Warning System Department (EWSD):

PBL has a special department called EWSD who are responsible for all accounts classified in the bank’s portfolio. Actually they have work like CID officers. However EWSD’s responsibility will cover the areas of

  1. Monitoring and controlling the classified accounts through monthly reporting and quarterly review.
  2. Actively follow the borrowers for recovery.
  3. Negotiate and reschedule the debts.
  4. If the client don’t utilize the new offer than it is the EWSD’s responsibility to file suit against the client.

EWSD will also prepare a Consolidated Report of all bad loans written-off on a quarterly.

Early alert account: As a part of ongoing monitoring process, an account may be found to have some weakness which clearly indicates the symptom of nonpayment of loan. This type of account reported as early alert account.The purpose of introducing early alert account is as follows:

(I)Detect the weakness of the client earlier

(II)Ensure proper monitoring

(III) Take appropriate measure at appropriate time

(IV) Maintain the health of the credit in all time good condition

             (V) Ensure timely repayment of loan

(VI) Finally prevent the loan from being stuck up and quality asset.

 When and how the account will be treated as early alert is briefly stated below:

Table: 2

S L NoRisk ConcernSymptomsEarly alert rating

1.

Industry concern(i)                   if the industry or sector itself is deteriorating

(ii)                 if the industry is already saturated and there is no scope of further growth

(iii)                if there is possibility of cyclical down turn

EA- 1

2.

Ownership/ management concern(i)                   if problem arises for existing management to efficiently run the business

(ii)                 if there is lack of commitment among the management

(iii)                if the key person changes in the management structureEA-2

3.

Balance sheet weakness(i)                   delay in preparing and submission of financial statement

(ii)                 operating result i.e. sales and profit is decreasing

(iii)                quality of asset is deterioratingEA-3

4.

Cash flow concern(i)                   if there is liquidity crisis

(ii)                 if bank loan limit is limited or totally absent

(iii)                if there is evidence of misusing of fundEA-45.

Account performance(i)                   if account turn over decline drastically

(ii)                 if the interest is not served within 15 days of being charged

(iii)                if there is adverse report in CIBEA-56.

Expired limit \pending documentation(i)                   if the credit facility remains expired more than one month and the client does not approached for renewal

(ii)                 if the three installment remains overdue

(iii)                if the documentation formalities remain incomplete for more than 3 monthEA-6

Credit recovery and NPL account management legal and non legal measure:

The Premier bank loan recovery policy aim to give details of the strategies to adopted for recovery of dues, period –wise targeted level of reduction in NPLs, norms for entering into compromised proposals involving sacrifice\ waiver, factors to be taken into account before considering the waiver

1. Repayment of loans:

Repayment of loan depends on income generating capacity of the borrowing concern. A unit not earning profit will not be able to repay the term loan. Therefore, it is necessary to fix the repayment schedule for term loan according to the income generating capacity of the unit.

2. Rehabilitation of potentially viable unit:

If a sick unit is potentially viable, necessary efforts are made to finalize the rehabilitation package without loss of time.

3. Acqusition of sick unit by healthy units:

If a sick unit is acquired by a healthy unit, the outstanding loan amount of sick unit may be transferred to a healthy unit and entire loan amount may even be wiped off. Therefore, the bank encourage merger\ acquisition of sick units whenever they feel it may reduce the NPL s. bank’s may even help the sick unit to get suitable buyer.

4. Negotiation with the borrower:

A negotiation may be called as a compromise formula or amicable settlement in which the borrower agrees to pay a certain amount to the bank after getting certain concessions. Compromise proposal now a days being considered to be a very effective measure which in most of the cases work well instead of resorting to expensive recovery proceedings spread over a long period.

5. Follow -up for recovery of NPLs, stuck –up and classified loans and advance:

To keep a close follow up and monitoring, the recovery of the overdue and classified loans and advance, the head of the branches take serious initiative and make efforts involving the officer and staff of all level for recovery of the over due\ stuck-up and classified loans and advances. The head of branch create team and assign the follow up responsibility for specific client. The team members will call on the defaulting clients\ borrower and guarantors for following –up the recovery of the over due, classified loan and will submit call report on the progress of follow-up actions the developments as reported in the call report will reflected in the remarks column of past due statement submitted to the head office. The call report will be placed in the files of the respective client for review. The call report must be reviewed by the manager and sub manager jointly and should assess objectively the progress of recovery.

6. Calling up the advance & filing of civil suits:

If it is not possible to revive a unit or enter into a reasonable settlement with the borrower, it is better to recall the advance at an early stage instead of waiting for a long time which may result in deterioration of the security available. Further if it is not possible to sell the security under artho rin adalat or without obtaining any court’s order, civil suit may be filed against such borrower who is not likely to come to a reasonable settlement.

7. Settlement of claim with ECGS:

If ECGS covers are available, bank should submit the proposal for same with necessary details. Proper follow-up with sadharan bima corporation is necessary for settlement of claims and reducing the NPLs to certain extent.

8. Special mention account:

Before classification of loan, a period review and follow-up will have to be carried out and the loan account which is not being properly performed \serviced or have remained overdue \ expired for certain period will have to be treated special mentioned account. Interest earned on this account cannot be taken into income rather to be retained in the interest suspense account. Even provision @ 5.00% will have to be created against this account. The procedure laid down in the circular issued by the Bangladesh bank will have to be followed in transferring the loan account to special mentioned account.

9. Write -off the out standings:

If all the efforts for recovery fail, bank may have to write off the advance. Such write-off should be done after exhausting all other remedies. In this regard specific guidelines already issued and to be issued by the Bangladesh bank will have to be followed.

Strength of Premier Bank in Credit Management:

Every Bank’s has it’s own credit appraisal procedure. Premier Bank possesses a standard credit procedure. The strength of Premier bank credit management practices are as follows:

  • Premier Bank possesses a standard credit procedure
  • From the existing credit condition we have seen that the Credit of Premier Bank is increase in 2007 than the 2006.
  •  The upward tendency of the credit show increase in profit. That means the bank is able to investment money in the suitable sector.
  • The bank gives priority of trade finance in loan approval. The bank also encourages Ready made Garments.
  • The bank’s recovery of credit is satisfactory. Premier Bank Ltd. has a quite good credit approval process which brings 84% recovery of credit.
  • The bank also follows Bangladesh Bank order in case of credit approval.
  • For minimizing risk Bangladesh Bank introduced credit risk grading, the bank also follows this approach accurately.
  • The bank does not provide loan to the person or business who is below acceptable. Premier bank maintains a standardized framework for the approval of credit.

Weakness of Premier bank in credit management:

It has observed that Premier bank is not much different from other commercial bank of Bangladesh. It follows the same practice and procedure which is followed by its elders. But one thing should be mentioned new loan reformation have slightly changed the approval procedure. This Credit Risk Grading makes the procedure better than previous

  •  But there exists a Some difference between Bank’s policy and practice in case of credit management
  •  Small loans are neglected, which is another shortcomings of Premier bank credit management approaches,
  • Credit policy is not properly cared in practice.
  • Credit deposit ratio is 87.18%, which shows PBL utilize large amount of its deposit in lending.
  • Small loans are given without following CRG strictly.
  • Directors’ reference in credit approval hampers the credit appraisal procedure.
  • In crediting Premier Bank doesn’t have any proper sector wise planning.
  • New and small entrepreneurs don’t get priority in having loan from the bank for the lack of strong guaranty.

 What should be done to improve the credit management practices of Premier Bank?

  • More training should be conducted for the bankers to improve their analytical ability and professional standard regarding the use of CRG and other tools and techniques in selecting the borrowers and analyzing the loan proposals.
  • Authority should be delegated to the lower level with adequate measures for the necessary control and follow-up for making the lending decision and recovery
  • One proper standard procedure should be developed for all types of clients and no interpersonal relationship should be involved in approve a loan
  • Bank should fixed-up specific types of client strategy according to the different character of client.
  • Interest income occupies the major part of the total earnings of a bank and bank’s profitability mainly depends on interest earning capacity, so bank should establish a research and development cell for the purpose of lending analysis and recovery of loans.

INTRODUCTION OF CREDIT RISK GRADING:

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.

At the pre-sanction stage, credit grading 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.

At the post-sanction stage, the bank can decide about the depth of the review or renewal, frequency of review, periodicity of the grading, and other precautions to be taken.

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 outlined above.

The Lending Risk Analysis (LRA) system introduced in 1993 by the Bangladesh Bank has been in practice for mandatory use by the Banks & financial institutions for loan size of BDT 1.00 crore and above. However, the LRA system suffers from a lot of subjectivity, 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, interalia, the introduction of Risk Grade Score Card for risk assessment of credit proposals.

Since the two credit risk models are presently in vogue, the Governing 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.

Bangladesh Bank expects all commercial banks to have a well-defined credit risk management system, which delivers accurate and timely risk grading. This system 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.

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

FUNCTIONS OF CREDIT RISK GRADING:

Well-managed credit risk grading systems promote bank safety and soundness by facilitating informed decision-making. Grading systems 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 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. 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.

 NUMBER AND SHORT NAME OF GRADES USED IN THE CRG

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

GRADING

SHORT NAME

NUMBER

SuperiorSUP

1

GoodGD

2

AcceptableACCPT

3

Marginal/Watchlist MG/WL

4

Special MentionSM

5

Sub standardSS

6

DoubtfulDF

7

Bad & LossBL

8

 CREDIT RISK GRADING DEFINITIONS:

A clear definition of the different categories of Credit Risk Grading is given as follows:

  • 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 Sheet

  • 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.

      Severe management problems exist.

      Facilities should be downgraded to this grade 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

      Credit of this grade has long outstanding with no progress in obtaining repayment or on the verge of wind up/liquidation.

      Prospect of recovery is poor and legal options have been pursued.

      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.

      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.

      Bangladesh Bank criteria for bad & loss credit shall apply.

      An Aggregate Score of less than 35 based on the Risk Grade Score Sheet.

 REGULATORY DEFINITION ON GRADING OF CLASSIFIED ACCOUNTS 

Irrespective of credit score obtained by a particular obligor, grading of the classified names should be in line with Bangladesh Bank guidelines on classified accounts, which is extracted from “PRUDENTIAL REGULATIONS FOR BANKS: SELECTED ISSUES” (updated till August 07, 2005) by Bangladesh Bank are presently as follows:

Basis for Loan Classification:

(A)       Objective Criteria:  

□   Any Continuous Loan if not repaid/renewed within the fixed expiry date for repayment will be treated as irregular just from the following day of the expiry date. This loan will be classified as Sub-standard if it is kept irregular for 6 months or beyond but less than 9 months, as `Doubtful’ if for 9 months or beyond but less than 12 months and as `Bad & Loss’ if for 12 months or beyond.

□   Any Demand Loan will be considered as Sub-standard if it remains unpaid for 6 months or beyond but not less then 9 months from the date of claim by the bank or from the date of forced creation of the loan; likewise the loan will be considered as ‘Doubtful’ and ‘Bad & Loss’ if remains unpaid for 9 months or beyond but less then 12 months and for 12 months and beyond respectively.

□   In case any installment(s) or part of installment(s) of a Fixed Term Loan is not repaid within the due date, the amount of unpaid installment(s) will be termed as `defaulted installment’.

In case of Fixed Term Loans, which are repayable within maximum 5 (five) years of time: –

If the amount of `defaulted installment’ is equal to or more than the amount of installment(s) due within 6 months, the entire loan will be classified as ‘Sub-standard’.

If the amount of ‘defaulted installment’ is equal to or more than the amount of installment(s) due within 12 months, the entire loan will be classified as ‘Doubtful’.

If the amount of ‘defaulted installment’ is equal to or more than the amount of installment(s) due within 18 months, the entire loan will be classified as ‘Bad & Loss’.

In case of Fixed Term Loans, which are repayable in more than 5 (five) years of time: –

□   If the amount of ‘defaulted installment’ is equal to or more than the amount of installment(s) due within 12 months, the entire loan will be classified as ‘Sub-standard.’

□   If the amount of ‘defaulted installment’ is equal to or more than the amount of installment(s) due within 18 months, the entire loan will be classified as ‘Doubtful’.

□   If the amount of ‘defaulted installment ‘is equal to or more than the amount of installment(s) due within 24 months, the entire loan will be classified as ‘Bad & Loss’.

Explanation:  If any Fixed Term Loan is repayable at monthly installment, the amount of installment(s) due within 6 months will be equal to the amount of summation of 6 monthly instalments. Similarly, if repayable at quarterly installment, the amount of installment(s) due within 6 months will be equal to the amount of summation of 2 quarterly instalments.

(B) Qualitative Judgment:

If any uncertainty or doubt arises in respect of recovery of any Continuous Loan, Demand Loan or Fixed Term Loan, the same will have to be classified on the basis of qualitative judgment be it classifiable or not on the basis of objective criteria.

If any situational changes occur in the stipulations in terms of which the loan was extended or if the capital of the borrower is impaired due to adverse conditions or if the value of the securities decreases or if the recovery of the loan becomes uncertain due to any other unfavorable situation, the loan will have to be classified on the basis of qualitative judgment.

Besides, if any loan is illogically or repeatedly re-scheduled or the norms of re-scheduling are violated or instances of (propensity to) frequently exceeding the loan-limit are noticed or legal action is lodged for recovery of the loan or the loan is extended without the approval of the proper authority, it will have to be classified on the basis of qualitative judgment.

Despite the probability of any loan’s being affected due to the reasons stated above or for any other reasons, if there exists any hope for change of the existing condition by resorting to proper steps, the loan, on the basis of qualitative judgment, will be classified as ‘Sub-standard’. But even if after resorting to proper steps, there exists no certainty of total recovery of the loan, it will be classified as ‘Doubtful’ and even after exerting the all-out effort, there exists no chance of recovery, it will be classified as ‘ Bad & Loss’ on the basis of qualitative judgment.

The concerned bank will classify on the basis of qualitative judgment and can declassify the loans if qualitative improvement does occur.

But if any loan is classified by the Inspection Team of Bangladesh Bank, the same can be declassified with the approval of the Board of Directors of the bank. However, before placing such case to the Board, the CEO and concerned branch manager shall have to certify that the conditions for declassification have been fulfilled.

Note:

a)      Any change in classification criteria provided by the Bangladesh Bank shall supersede this grading system for classified accounts.

b)      An account may also be classified based on qualitative judgment in line with Bangladesh Bank guidelines.

c)      A particular bank may have classification criteria stricter than Bangladesh Bank guidelines.

HOW TO COMPUTE CREDIT RISK GRADING:

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 to be evaluated and aggregated 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 plan and team work.

         Evaluation of Security Risk:

Risk that 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.

         Evaluation of Relationship Risk:

These risk areas cover evaluation of limits utilization, account performance, conditions/covenants compliance by the borrower and deposit relationship.

According to the importance of risk profile, the following weightages are proposed for corresponding principal risks.

Principal Risk Components:                         Weight:

  • Financial Risk                                                      50%
  • Business/Industry Risk                                        18%
  • Management Risk                                                            12%
  • Security Risk                                                       10%
  • Relationship Risk                                                 10%

Principal Risk Components:                           Key Parameters:

  • Financial Risk                              Leverage, Liquidity, Profitability & Coverage ratio.
  • Business/Industry Risk                 Size of Business, Age of Business, Business Outlook,                                                                              Industry Growth, Competition & Barriers to Business
  • Management Risk                                    Experience, Succession & Team Work.
  • Security Risk                               Security Coverage, Collateral Coverage and Support.
  • Relationship Risk                         Account Conduct ,Utilization of Limit, Compliance of

covenants/conditions & Personal Deposit.

Principal Risk Components:                           Key Parameters:                  Weight:

  • Financial Risk                                                                                                     50%

      Leverage                                        15%

      Liquidity                                        15%

      Profitability                                                15%

      Coverage                                       5%

  • Business/Industry Risk                                                                                       18%

      Size of Business                             5%

      Age of Business                               3%

      Business Outlook                           3%

      Industry growth                              3%

      Market Competition                                     2%

      Entry/Exit Barriers                           2%

  • Management Risk                                                                                               12%

      Experience                                                   5%

      Succession                                     4%

      Team Work                                                  3%

  • Security Risk                                                                                                      10%

      Security coverage                           4%

      Collateral coverage                                     4%

      Support                                          2%

  • Relationship Risk                                                                                                            10%

      Account conduct                           5%

      Utilization of limit                         2%

      Compliance of covenants

/condition                                        2%

      Personal deposit                               1%

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 guarantees

2

Good

GD

85+

3

Acceptable

ACCPT

75-84

4

Marginal/Watch list

MG/WL

65-74

5

Special Mention

SM

55-64

6

Sub-standard

SS

45-54

7

Doubtful

DF

35-44

8

Bad & Loss

BL

<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 Small 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 factors are assessed judiciously and objectively.
  • 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.
  • Credit risk grading exercise should be originated by Relationship Manager and should be an on-going and continuous process.
  • 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 through the same Credit Risk Grading Form shall approve any subsequent change/revision i.e. upgrade or downgrade in credit risk grade.

 EXCEPTIONS TO CREDIT RISK GRADING:

      Head of Credit Risk Management may also downgrade/classify an account in the normal course of inspection of a Branch or during the periodic portfolio review. In such event, the Credit Risk Grading Form will then be filled up by Credit Risk Management Department and will be referred to Corporate Banking/Line of Business/Credit Administration Department/Recovery Unit for updating their MIS/records.

      Recommendation for upgrading of an account has to be well justified by the recommending officers. Essentially complete removal of the reasons for downgrade should be the basis of any upgrading.

      In case an account is rated marginal, special mention or unacceptable credit risk as per the risk grading score sheet, this may be substantiated and credit risk may be accepted if the exposure is additionally collateralized through cash collateral, good tangible collaterals and strong guarantees. These are exceptions and should be exceptionally approved by the appropriate approving authority.

      Whenever required an independent assessment of the credit risk grading of an individual account may be conducted by the Head of Credit Risk Management or by the Internal Auditor documenting as to why the credit deteriorated and also pointing out the lapses.

      If a Bank has its own well established risk grading system equivalent to the proposed credit risk grading or stricter, then they will have the option to continue with their own risk grading system.

CONCLUTION:

CRG has now become an important and imperative tool for credit Risk management by helping the BFI & NBFI to understand various aspects of risk involved in different credit transactions. The system is vital to take decisions both at the pre-sanction and post sanction stage.

The success of CRG is largely depended on a symmetric information system. In a symmetrical information system available is more on less authentic. As such CRG derived from that information tends to be reliable. But in the context of Bangladesh where information furnished to Banks/NBFI’s are fabricated in most cases, the success of CRG is still some times in question. For example even large corporations trying to evade taxes prepare dummy financial statements and furnish it to CRG users.

The basic bareback in CRG is its overemphasis only on four rates which carry 50% risk weight age and selection of ratios. For instance debt equity ratio formula dose not fit to our company’s liability management. In practice most company have small figure as paid up capital and retained earning in the early years of incorporation. Finance is largely managed from director’s loan or sister Concern Company’s loan which is considered as debt portion in external claim. Thus 15 marks from 100, there remain only 85 marks and out of which it becomes difficult to get a acceptable credit decision.

However, CRG may not effective enough for loan recovery but despite some limitations CRG has given a platform from which Banks/NBFI’s are trying to analyze various risk types that helps to take good credit decision and maintains acceptable discipline in credit portfolio. That is the main essence of CRG.

Figure 5. 1 organ gram of Credit management of Premier bank limited

5.8 Case Study on Credit Management of Premier Bank:

To see the practices of credit management of premier bank, I collect the information of perspective borrower and the grade the client according to the financial information.

Profile of the Potential Client:

 Dr. Md. X is a Physician. He is a Medical Officer of Upazilla Health Complex, Karimgonj, Kishoregonj. He was also an Ex-Medical Officer, Cardiology Department, DhakaMedicalCollegeHospital, Dhaka. He has obtained an M.B.B.S. degree from Mymensingh Medical Collage. He has obtained a Medical Practitioner Certificate from Bangladesh Medical and Dental Council on 03.12.1986. He is doing private practice at Jamin Pharmacy, 10/10, Aziz Mahallah, Joint Quarter, Mohammadpur, Dhaka. He is well known as a General Physician for fifteen years in the Locality. The chamber has been established in the Ground floor measuring 300 sq. feet of Jamin Pharmacy, 10/10, Aziz Mohallah, Joint Quarter, Mohammadpur, Dhaka.Every day at least 30/40 patients met him for their physical problem and as such he earned about Tk.67,000.00 per day on the average as consultation fee. Dr. X   earns on average of Tk. 67,000/- per month from his professional practice chamber. He is the owner of 8 katha land at Zoharshahara, Khilkhet, Dhaka & 5 katha land at Domni, Khilkhet, Dhaka. The value of those properties is above Tk. 80.00 lac. So, his total net–worth is Tk. 80.77 lac. His wife, Ms. X, Proprietor of M/S. xyz Pharmacy at 10/10, Aziz Mohallah, Joint Quarter, Mohammadpur, Dhaka. She is also the Partner of M/S. xyz Ladies Fashion, at Shop No. 52 & 53, Block#D, Level#4, BashundharaCity, Panthopath, Dhaka. Her monthly income is about Tk. 30,000/- only from her business. She is a co-applicant of the proposed loan. She is also the owner of 5 katha land at Mouza Domni, PS: Khilkhate, Dhaka. Her total net-worth is Tk. 40.20 lac. Moreover, they have total monthly income is about Tk. 133,600/- and monthly expense is Tk. 43,575/- only and become monthly disposable income is Tk. 90,025/- only (as per declaration by the applicant). So we think that they are fully capable of repaying the monthly installments.

Step-One: Loan Application:

Our hypothetical Loan applicant is the  Dr. Md. X The client has requested us to sanction HBL-Residential Facility of Tk. 11.00 lac for purchase of the flat measuring 1282 sft. with one car parking at “Lake City Concord –BornaliBuilding” Flat#14-E/B-1, Khilkhet, Dhaka from Concord Real Estate & Development Ltd. The total market value of land & building is Tk. 32.05 lac and forced sale value is Tk. 24.03 lac as surveyed by Surveyor

 

Step-Two: Credit investigation:

The banks credit officer have sent CIB inquiry to Bangladesh Bank about Dr. Mr. X through Head Office

Step-Three: Document Collection

In this stage, the Bank will look whether the documents are properly filled up and signed. Credit in charge of the relevant branch is responsible to know about the ins and outs of the client’s business through discussing with him and collects all the document requried.

Step-Four: Inspection

In this phase the respective credit officer inspect the site. , a site visit is usually made by an officer of the bank to assess the customer’s location and the condition of the property and to ask clarifying questions. The loan officer may contact other creditors who have previously loaned money to this customer to see what their experience has been.Project for which the loan is applied is inspected by Bank officials. Project’s existence, distance from Bank office, viability, monitoring cost and other possibilities are also examined.The total market value of land & building is Tk. 32.05 lac and forced sale value is Tk. 24.03 lac as surveyed by Surveyor

Step-Five: Evaluation of Credit

Any loan proposal needs to be evaluated on the Basis of financial information provided by the applicant. Credit Risk Grading (CRG) is a technique by which the risk of the loan is calculated. Banker must analyze CRG when loan application is above 1 crore. Experienced people of Credit department in the branch  do this analysis. Considering the clients net-worth, reputation, financial condition, repayment capacity & relationship with the bank I analyze the financial and other data using Credit Risk grading Score sheet and result of detailed calculation is shown in the appendix, here we summaries the result of Credit Risk Grading of MR. X. Mr.  The potential borrower has got 82 out of 100 and his credit rating belongs to acceptable class and we safely can make loan to him

Step-Six: Collateral Collection

The applicant is offering the following securities against the proposed facility:

  • · Down payment of Tk. 8.45 lac which has been already deposited to developer(photocopy of money receipts are enclosed).
  • · Personal guarantee of Dr. X and Mrs. X
    • · Registered Mortgage of 1282 sft. flat with one car parking space at “Lake City Concord –BornaliBuilding” Flat#14-E/B-1, Khilkhet, Dhaka from Concord Real Estate & Development Ltd.

Step-Seven: Review of Credit Proposal by Credit Committee:

Head office processes the credit proposal and afterwards puts up a memorandum to credit committee. The credit committee reviews the credit proposal and accepts or rejects the proposal.

Step- Nine: Loan Approval

After approval by the Credit Committee head office gives an approval letter to the branch and branch gives a sanction letter. The client should accept sanction advice with seal which will prove his agreement with the terms and condition offered by the Bank

The ProposedBuilding is located in demandable Residential area ,Existing tested customer of the Bank as he adjusted a CCS Car Loan for Tk. 7.00 lac to our Dilkusha branch in time. he ha timely Payment habit. He Never overdue his bill with the bank Security Coverage & Control is of the loan is good.

Above all, the client is Financially Sound and solvent to repay the loan liability.

Considering the clients net-worth, reputation, financial condition, repayment capacity & relationship with the bank I analyze the financial and other data using Credit Risk grading Score sheet and result of detailed calculation is shown in the appendix, here we summaries the result of Credit Risk Grading of MR. X. Mr.  The potential borrower has got 82 out of 100 and his credit rating belongs to acceptable class and we safely can make loan to him                                                                                  Table: 1 CRGM Summary

Reference No.:

 

 

Date:

12-Mar-09

Borrower MR. X
Group Name (if any)  Aggregate Score:

82

Branch:Savar Bazar Stand Branch
Industry/SectorTextile Risk Grading:     

Acceptable

Date of Financials

31-Dec-08

Completed by
Approved by

 

 

 

 

 

Criteria                        Weight

Parameter

Score

Actual Parameter

Score Obtained

A. Financial Risk                  50%
1. Leverage: (15%)0.51× to 0.75 x

15

0.53

12

2. Liquidity: (15%)Greater  than 2.74×

15

54.00

15

3. Profitability: (15%)Greater  than 25%

15

78.00%

15

4.  Coverage: (5%) More than 2.00×

 5

 10

Total Score- Financial Risk

50

47

 

B. Business/ Industry Risk  18% 

 

 

 

1. Size of Business (in BDT crore)

5

<2.50

0

2. Age of Business

3

15

3

3. Business Outlook

3

Stable

2

4. Industry Growth

3

Good (>5% – 10%)

2

5. Market Competition

2

Highly  Competitive

0

6. Entry/Exit Barriers

2

Easy

0

Total Score- Business/Industry Risk

18

7

C. Management Risk            12% 

 

 

 

1. Experience

5

5–10 years in the related line of business

3

2. Second Line/ Succession

4

Succession within 2-3 years

2

3. Team Work

3

Moderate

2

Total Score- Management Risk

12

7

 

D. Security Risk                   10% 

 

 

 

1. Security Coverage (Primary)

4

Fully Pledged facilities/substantially cash covered / Reg. Mortg. for HBL

4

2. Collateral Coverage (Property Location)

4

Registered Mortgage on Municipal corporation/Prime Area property

4

3. Support (Guarantee)

2

Personal Guarantees or Corporate Guarantee with average financial strength

1

Total Score- Security Risk

10

9

E. Relationship Risk              10% 

 

 

 

1. Account Conduct

5

More than 3 years Accounts with faultless record

5

2. Utilization of Limit

2

65.00%

2

3. Compliance of Covenants /

2

Full Compliance

2

4. Personal Deposits

1

Personal accounts of the key business Sponsors/ Principals are maintained in the bank, with significant deposits

1

Total Score- Relationship Risk

10

10

 

Grand Total – All Risk 

100

 

82

 

ASSET MANAGEMENT OF PREMIER BANK LIMITD:

The asset quality of PBL was good and its size was in line with its peer. At Year 2007, the Bank’s total asset size was TK. 32,573.19 million which was Tk. 27170.45 million at Year 2006. The growth rate of total asset base was 19.88% which was almost 50% more than Year 2005.

Figure 6.1 Total asset of premier bank limited

Figure 6.2 Sources of fund of premier bank limited

As on 31 December 2007 the total assets of PBL was mostly created through deposit collection (83.57%) and the rest of the volume was financed by borrowings (5.43%), other liabilities (2.70%) and stockholders equity (8.73%).

Total loans and Advances of Premier Bank Limited:

Figure-6.3 Total loans and Advances of Premier Bank Limited

Total loan of the premier bank has increase over the year, in Year 2007 it is 2367.61 million TK and 18032.5 million tk in 2006 the rate of growth of loan and advance from the Year 2006 to Year 2007is 31%.

Return on Asset of Premier Bank Limited:

 Net Profit after Tax

                                     X 100

Total Asset

 

Return on Asset =

Return on Asset of Premier Bank Limited is as follows

                                                                                                              Taka in Million

Years200520062007
Net Income After Tax79369181
Total Asset22767.8427170.4532573.19
Calculated Ratio0.34%1.35%0.55%

The above graph shows that the ROA of the premier bank is fluctuating, it was 0.34% in the year 2005 and increase in the year 2006 to 1.34% and again it falls to 0.55% in the yea2007. The reason behind the fall of ROA of premier Bank is decline of the profit in the year 2007. the reason for profit decline is the slowness of the economic activities in the country in the year 2007 in which caretaker government is power, there is fear among the investor / business man and they are reluculant to take new business activities and investment project.

Return on Equity of Premier Bank Limited:

 Net Profit after Tax

                                                   X 100

Total Share holder Equity

 

Return on Equity =  

Return on Equity of Premier Bank Limited is as follows

                                                                                                              Taka in Million

Years200520062007
Net Income After Tax79369181
Total Equity1318.991855.582792.33
Calculated Ratio5.97%19.86%6.47%

The above graph shows that the ROE of the premier bank is fluctuating, it was 5.97% in the year 2005 and increase in the year 2006 to 19.86% and again it falls to 6.47% in the yea2007. The reason behind the fall of ROE of premier Bank is decline of the profit in the year 2007. the reason for profit decline is the slowness of the economic activities in the country in the year 2007.

Net Profit margin of Premier Bank Limited:

 Net Profit after Tax

                                                   X 100

Total loan and Advances

 

Net Profit margin =  

 Net profit margin of Premier Bank Limited is as follows

                                                                                                              Taka in Million

Years200520062007
Net Income After Tax79369181
Total loan and Advances20677.6818032.523637.61
Calculated Ratio0.38%2.04%0.76%

The net profit margin is a profitability measure, the higher the ratio, better the performance of the bank in terms of profitability.

The above graph indicates that the net profit margin of the premier bank is fluctuating, it was 0.38% in the year 2005 and increase in the year 2006 to 2.04% and again it falls to 0.76% in the yea2007. The main reason behind the reduction of net profit margin is reduction of interest income in the year 2007.   

 Non Performing Loan (NPL):

PBL’s NPL (Non-performing Loan) has increased to TK 1405.37 million as on December 31, 2007 from TK 885.97 million at Year 2006. The gross NPL ratio (5. 96%) of the bank was more in the Year 2007 than the year 2006 (4.91%). Which is increased by 1.04% from the Year 2006, but it was higher than the peer average of 2.90% during YE2007.

The net NPL ratio of the bank increased slightly at 1.04 % during Year 2006 from 3.86 % than Year 2005 which was also fairly above the peer average of 1.19% at Year 2006. During Year 2007 the bank’s total NPL composed of 51.14% substandard loans, 1.96% doubtful loans and 46.90% bad/loss loans.

 Sectoral Concentration of loan of Premier bank limited:

The loan portfolio of the bank is well diversified. The management of the bank identifies privileged sectors each year after assessing the economic and industrial outlook and profitability factors. The loan composition of the bank reveals that trade finance consists of 29. 20%, House building loans 6.14%, loan against textile 6.09% while other loans & advances consists of 30. 00% during Year 2007.

The bank’s loan portfolio of TK. 23,637 million during Year 2007 constituted mainly trade Finance (30. 11%), which is followed by RMG (11.19%) and agriculture (3.34%) and other manufacturing and service sectors. The sect oral loan portfolio reveals that PBL has high concentration on garments sector.

Large and Director Loan:

As on December 31, 2007 large loan were held in 49 accounts amounting to Tk 10,276.50 million (both funded and Non funded). The net of which stood at Tk 7533.20 million amounting to 45.75% of total outstanding loans & advances YE 2007. The exposure was well below the ceiling applicable to PBL i.e 56.00% .Besides, as on December 31, 2007 there were 5 accounts exceeding TK 100 million aggregating to TK 648.01 million or 4.91% of total outstanding loans and advances. The advances provided to company directors and other officials amounted TK 94.40 million and TK 53.19 million during YE2007 and YE2006 respectively reflecting an increase of 77.47% in FY 2007.

 Rescheduled Loan:

The amount of rescheduled loans and advances of Premier Bank Limited was TK 79.06 million (against 33 accounts) and TK 63.90 million (against 19 accounts) during YE2007 and YE2006 respectively. There are only 2 accounts which have been rescheduled for 2nd time and was declassified (TK 8.45 million). This amount of rescheduled loan was 0.60% and 0.66% of total loans and advances during YE2007 and YE2006 respectively. The bank’s recovery position was satisfactory which was TK 6.4 million and TK 5.27 million at YE2007 and YE2006 correspondingly.

 Off Balance Sheet Exposure:

PBL’s Off Balance Sheet exposure is at acceptable level and within the parameter set by prudential guidelines of Bangladesh Bank. The Bank’s contingent liabilities to total assets with contra stood at 21.11% and 24.02% during YE2007 and YE2006 respectively whereas the same figures of peer average were 25.84% and 25.09% respectively. The Bank’s contingent liability is made up of 15.43% acceptances and endorsements, 56.58% irrevocable letter of credits and 11.98% letter of guarantee during the YE 2007. (Sources: Annual report of PBL)

CAPITAL ADEQUACY:

The capital adequacy ratio of PBL is above the peer average. The Bank’s risk weighted capital adequacy ratio stood at 12.66% and 10.66% at the end of year 2007, 2006 respectively against the minimum requirement of 9.00% fixed by Bangladesh Bank. The increase in capital adequacy ratio was mainly due to bank profit generation ability. During YE2007 total risk weighted assets of the bank stood at TK32573.19 million against TK.27170.45 million at YE2006 recording 8% growth. The internal capital generation ratio stood at 26.79% and 18.74% at YE2007 and YE2006 respectively compared to peer average of 24.92% and 22.45% during YE2006 and YE2005 respectively.

Classified Loan conditions of the PBL (In million):

Table 3 Classified Loan conditions of the PBL

Particulars200520062007
Unclassified Loans & Advances17.33619.36122.211
Sub-Standard Loans & Advances0.1080.1250.217
Doubtful Loans Advances0.1060.2420.345
Bad/Loss Loans & Advances0.4800.6470.856

From the table and graph we find that the classified loans of the Premier Bank is increasing in year 2007. The percentage of classified Loan to Total loan in the year 2007 was 0.06%, it in the year 2006 0.05%, According to international rules, a bank may have a maximum limit of classified Loans as 5% of the total Lending. As PBL did not pass this limit and has a good portfolio of loan

From the graph we can see that Premier Bank unclassified loan and advance has increasing, it is good sign for them, as the bank is able to maintained the classified loan  to total loan ratio at acceptable level

From the graph we can see that Premier Bank Substandard loan and advance has increasing, it is not a good sign for them the substandard loan of the premier bank in the year 2007 was tk.0.21 million against the total  loan of 23.637 million which is significant rise from the previous year 2006 Tk.0.16 million

Doubtful loan and advance of the premier bank in the year 2005 was 0.11million tk. And this amount has increase in the year 2006 to .0242 million and reached 0.345 million in the year 2007, this mean that the bank provide more loan to the weaker party and unproductive sector.

 Bad loan  have no possibility of recovery in the any proceedings, the Bad loan of the premier bank is increase in year by year, in the year 2005 it was TK.0.48 million and in the year it stood at Tk. 0.85 million , for better performance in the future it should reduced the bad loan.

Loan Loss Provision Procedure:

As pert of pragmatic and conservative approach to sustain the quality of the Bank’s loan portfolio, Loan Loss Provision exercise made mandatory for all Line of Business. Such exercise is decided by: a) generally accepted banking practice, b) conservative approach to assess the quality of Risk Assets whereby the most accurate health of the Loan Portfolio is reflected on the books of the Bank and c) to be guided by Bangladesh Bank instructions on provisioning.

Following guidelines are to be observed:

  1. The prudential Provision Practice dictates that rather that wait until the close of the fiscal year; provision exercise would be an on-going one, with the needed provision created, when an account is classified and continues to remain classified. The provision exercise is to be carried out by each quarter end, based on reports on Classified Accounts related to previous quarter.
  2. Bangladesh Bank instructions are to be followed for the purpose of Loan Loss Provision exercise.
  1. Unless otherwise enhanced by Bangladesh Bank regulatory body, Loan Loss Provision Policy as per the matrix given below is to be adopted and followed by the Bank:
Past Due O/S

Expired Credit

(CRITERIA)Classification

StatusMaximum Provision to be held against Net Loan Value

  • 180 days
  • 270 days
  • 360 days

Substandard

 

Doubtful

Bad / Loss20%

50%

100%

  1. Following formula is to be applied in determining the required amount of provision:

1. Gross Outstanding                                                                     XXX

2.   Less: (I)           Cash margin held or fixed

                              Deposit                                                            (XXX)

             (II)            Interest in Suspense Account                                  (XXX)

  1. Loan Value

(For which provision is to be created before

considering estimated realizable value of other

 security/collateral held)                                                           (XXX)

4.   Less: Estimated salvage value of security / collateral held       (XXX)

Net Loan Value                                                                                   (XXX)

 Provisions for Loans & Advances maintained by the PBL

PARTICULARS200520062007
Provision held at the beginning of the year250.7150.00258.00
Fully provided debts written off
Recovery during the year
Provision during the year134.388.00140.96
Provision at the end of the year385.0238.00398.96

 Premier Bank limited is made provision for loans and advance on the basis of period-ended reviewed by the management on the basis of instruction contained in Bangladesh Bank BCD circular No.34 of 1989, BCD circular No.20 of 1994,BCD circular No. 12 of 1995, BRPD circular No.16 of 1998 and BRPD circular No.9 of 2004.

Although provisioning is associated with classified loans but it has a positive effect on the banks. The Income Statement shows net profit after deduction of provisioning fund. As a result tax goes down. But the most important thing is, it doesn’t affect the dividend. Although naturally banks pay dividends from net profit but some times they pay dividends from previous retained earnings. Moreover banks don’t keep money as idle fund for provisioning. Money circulates among the operations. They just show this fund to cover actual loss. So the bottom line is nothing is wrong to provision though it is associated with classified loans.

 Loan ratio:

The loan ratio indicates the extent to which assets are devoted to loans as opposed to other assets such as cash, securities, and plant and equipment. It measures what is the percentage of loan and advance portion out of the total assets of the Bank. Although loan and advance usually is the biggest part of the assets of the balance sheet of any commercial banks. But if the loan and advance is large then the credit risk is also high because a chance of not getting the money back is higher in loan investment then the investment in securities. Because securities, plant, equipment can provide a certain return with very minimum risk. But default risk in loan investment is very high. So a bank, which has high amount of provision for loan losses, should not expand its loan portfolio without proper consideration of all the factor of loan sanctioning.

Loan ratio can be calculated as follows:

Loan ratio=(Net loans & Advances¸Total assets)´100

The table of loan ratio of Premier Bank Ltd. is in the following:

                                                                                                                        Taka in Million

Years20032004200520062007
Net loan and advance

8095.57

15383.93

20677.68

18032.5

23637.61

Total asset

11096.3

20100.25

22767.84

27170.45

32573.19

Calculated Ratio

72. 96%

76.54%

90. 82%

66.36%

72.56%

The above graph indicates that the PBL has able to keep the amount of loan ratio at acceptable levelwhich is 72.56% in the year2007 that mean 72.56% of the total assets of the PBLis consist of loan and advance.

 Bad loan to total loan ratio:

Bad loan to total loan ratio can be calculated as follows:

Bad loans to total loans ratio= (Total Bad loans¸Total loans & Advances)´100

Bad loans to total loans ratio of Premier Bank Ltd is as follows

                                                                                                              Taka in Million

Years200520062007
Total bad loans58.6375.1081.77
Total loans and advance20677.6818032.523637.61
Calculated Ratio1.25%0.97%1.61%

This indicates the bad loan as a percentage of total loans and advances. It measures that how much bad loan a commercial bank is carrying. Bad loan is the loan, which has almost no chance of recovery. So bad loan should not be very high for any bank. If the amount of bad loan is very high the ratio of bad loan to total loan will be high. If it is higher than the peer group it means that the competitors have better quality of loan portfolio. From the above trend graph we can see that the bad loans to total of the premier bank has increase slightly in the year 2007 to 1.61% from 0.97% in the year2006, which indicate the poor performance of the bank in terms collection and recovery of credit department.

Provision for loan loss ratio:

Provision for loan loss ratio =(Provision for loan losses¸Total loan & advances)´100

This ratio measures the bank’s chances of loan losses as a percentage of total loans and advances. It means if the percentage of loan provision is large then chances of loan losses is higher. So if the ratio is large the qualities of the loans are questionable and the future of the bank is not also good. It will also indicate the performance of the managers because it is the duty of them to make this ratio lower as much as possible.

Provision for loan losses ratio of Premier Bank is as follows:

                                                                                                                        Taka in Million

Years200520062007
Total provision for loans385.20238.00398.96
Total loans and advance20677.6818032.523637.61
Calculated Ratio1.86%1.32%1.69%

Premier Bank is able to reduce its provision for loan loss ratio slightly in the year 2006, but it is not able to further reduce the provision of loan loss in the year 2007 which is visible from the graph. It indicates the quality of the loan is weakening.

 Regression Analysis:

Regression analysis is very important statistical tools, for calculating regression analysis I collects information of few borrower of term loan from premier bank, Savar Bazaar Stand branch, the distribution of the data are as follows

BorrowerRecovery Amount in lac tk Loan Amount in lac TKMaturity of the loan (Year)Rate of interest(%)Age of the Business (Year)Profit of the business in  lac TKCedit Grade obtained

A

10

10

5

16

10

1.5

89

            B

8

8

5

17

8

2

85

C

11

11.5

4

18

12

2.3

82

D

5

5

3

16

10

1

90

E

4,

5

3

18

4

0.5

80

F

7

7.50

8

14.5

15

1.53

95

G

3.50

3.50

5

16

5

1.6

85

H

5

5

5

16.5

8

0.8

88

I

6

6

7

14.5

12

1.5

92

J

9

10

8

18

5

0.75

85

For calculating the regression analysis I use SPSS software and input data in to the soft ware and the out put is shown in the appendix, From the regression analysis we find the required equation,

                              Y= b0+b1X1+b2X2+b3X3+b4X4+b5X5+b6X6

               Y= – 62.160 -.026X1+.352 X2 +2.17 X3+.345 X4+1.649 X5 +0.314 X6

Y = Recovery (Dependent Variable)

Independent Variables are as follows

X1 = Loan amount

X2 = Maturity of the loan

X3 = Rate of Interest

X4 = Age of the Business

X5 = Profit of the Business

X6 = Credit Grade Obtained

From the regression analysis we find the required equation, here in the equation constant is

– 62.106 that is the intercept, b1= 0.026, the beta of loan amount indicates that if we reduce sanctioning loan of TK. 0.026 thousand then the recovery increase by 1 thousand  Tk, holding all other variable constant , b2  = .352 X2 indicates that if the maturity  of the loan increase the by one year then the recovery amount increase

B3= Rate of interest. the positive beta indicates that  if we increase the loan amount 2.71thousad then the recovery Amount increase. Holding all other variable constant

 B4 = 2.17 indicates that Age of the business increase by 1 year than the recovery amount increase. B5 = 1.69 indicates if   the  profit of  the business increase by tk 1 lac for a business then the recovery amount increase by TK1.69 and finally if the borrower credit grading increase by.314 points then the recovery amount of the bank increase by1Tk  holding all other variable constant                        

r= 0.921 – indicates a very high degree of positive relationship between recovery and loan amount, Maturity of the loan, interest rate, Age of the business profit, credit rating grade obtained

The explanatory power of the independent variable can be assessed by the coefficient of determination (r2), r2 =     0.841 –            indicates that 84.1% of the variation in the recovery of loan can be explained by the variation in the loan amount, Maturity of the loan, interest rate, Age of the business profit, credit rating grade obtained, an examination of the correlation matrix in the appendix shows that that maturity of the loan, interest of the loan, age of the business, profit of the business and credit grade obtained by the firm are positively related to recovery and has good predicting ability.

ANOVA test ( F test) , the result of Anova table indicates that the relationship among the recovery and independent variables are statistically significant as the test  calculated F value is 2.78. The calculated value is less than the table value of 8.74 at  6 d.f and  at 95% confidence level. So  the relationship among the recovery and independent variables are statistically significant

T test, the result of t table indicates that the relationship among the recovery and loan are statistically significant as the test calculated t value is -1.069The calculated value is less than the table value of 1.833 at 9 d.f and at 95% confidence level. So the relationship among the recovery and loan is statistically significant.

the relationship among the recovery and Maturity of loan are statistically significant as the test calculated t value is .86 The calculated value is less than the table value of 1.833 at 9 d.f and at 95% confidence level. So the relationship among the recovery and maturity of loan is statistically significant

Findings:

After analyzing the credit management practice of Premier bank we find the followings:

  • The asset quality of PBL was good and its size was in line with its peer. At YE2007, the Bank’s total asset size was TK. 32,573.19 million which was Tk. 27170.45 million at YE2006. The growth rate of total asset base was 19.88% which was almost 50% more than YE 2005. As on 31 December 2007 the total assets of PBL was mostly created through deposit collection (83.57%) and the rest of the volume was financed by borrowings (5.43%), other liabilities (2.70%) and stockholders equity (8.73%).
  • Premier Bank possesses a standard credit procedure; from the existing credit condition we have seen that the Credit of Premier Bank is increase in 2007 than the 2006. Total loan of the premier bank has increase over the year, in Year 2007 it is 2367.61million TK and 18032.5 million tk in 2006 the rate of growth of loan and advance from the Year 2006 to Year 2007is 31%.
  •  The upward tendency of the credit show increase in profit. In the year 2007 the operating profit stood 998.11 million which is 942.07 million in the year 2006. That means the bank is able to investment money in the suitable sector. The bank gives priority of trade finance in loan approval. The bank also encourages Ready made Garments.
  • PBL’s NPL (Non-performing Loan) has increased to TK 1405.37 million as on December 31, 2007 from TK 885.97 million at YE2006. The high gross NPL ratio (5. 96%) of the bank sign of weakness in credit portfolio, which must be reduced to 1%.
  • The bank’s recovery of credit is satisfactory. Premier Bank Ltd. has a quite good credit approval process which brings 84% recovery of credit.
  • The bank also follows Bangladesh Bank order in case of credit approval.
  • For minimizing risk Bangladesh Bank introduced credit risk grading, the bank also follows this approach accurately.
  • The bank does not provide loan to the person or business who is below acceptable. Premier bank maintains a standardized framework for the approval of credit.

There exists  some difference between Bank’s policy and practice in case of credit management at premier bank

  •  Small loans are neglected, which is another shortcomings of Premier bank credit management approaches,
  • Credit policy is not properly cared in practice.
  • Credit deposit ratio is 87.18%, which shows PBL utilize large amount of its deposit in lending.
  • Small loans are given without following CRG strictly.
  • Directors’ reference in credit approval hampers the credit appraisal procedure.
  • In crediting Premier Bank doesn’t have any proper sector wise planning.
  • New and small entrepreneurs don’t get priority in having loan from the bank for the lack of strong guaranty.

Policy implications:

What should be done to improve the credit management practices of Premier Bank?

  • More training should be conducted for the bankers to improve their analytical ability and professional standard regarding the use of CRG and other tools and techniques in selecting the borrowers and analyzing the loan proposals.
  • Authority should be delegated to the lower level with adequate measures for the necessary control and follow-up for making the lending decision and recovery
  • One proper standard procedure should be developed for all types of clients and no interpersonal relationship should be involved in approve a loan
  • Bank should fixed-up specific types of client strategy according to the different character of client.
  • Interest income occupies the major part of the total earnings of a bank and bank’s profitability mainly depends on interest earning capacity, so bank should establish a research and development cell for the purpose of lending analysis and recovery of loans.
  • At first the Premier Bank should find out the way to Reduce its bad loan amount further, to improve is loan quality.
  • If PBL assign score on specific loan criteria it will become easier for the approval officers to assess the loans. Scoring system will help to reduce bad applications automatically and the burden on approval officer will be reduced. On the other hand strength of a loan will be stemmed out from scoring system. However, the assessment procedure should remain same.
  • Premier Bank should increase their loan investment because increase the loan investment will maximize the interest income of the Bank. So the investment, which will give the expected return, should be increased. And for that they should strictly follow the factors considering before sanction of any loan.
  • If the loan and advance is large then the credit risk is also high because a chance of not getting the money back is higher in loan investment then the investment in securities. Because securities, plant, equipment can provide a certain return with very minimum risk. But default risk in loan investment is very high. So a bank, which has high amount of provision for loan losses, should not expand its loan portfolio without proper consideration of all the factor of loan sanctioning.
  • They can diversify the loan portfolio in to the securities. And should give more emphasize in the foreign exchange and remittance services to maximize income.

In order to increase the profitability and reduce the credit risk, PBL should maintain a well-balanced portfolio. For example, instead of focusing on just corporate banking and high profile business loan and leasing, it should also give equal importance to retail banking. The more diversified the portfolio is the lesser the risk of losses.

Conclusion:

There is basic framework of regulations and policies regarding Credit management, that are exist in Bangladesh. Regulators and market participants need to evaluate comprehensive set of factors to determine which ones constrain their market’s growth and how to deal with them. Every Bank’s has it’s own credit appraisal procedure. Premier Bank possesses a standard credit procedure. It has observed that Premier bank is not much different from other commercial bank of Bangladesh. It follows the same practice and procedure which is followed by its elders.  The bank does not provide loan to the person or business who is below acceptable. The bank’s recovery of credit is satisfactory. Premier Bank Ltd. has a quite good credit approval process which brings 84% recovery of credit.  Premier bank maintains a standardized framework for the approval of credit. But one thing should be mentioned new loan reformation have slightly changed the approval procedure in order to remain successful and profitable in the future.

Premier Bank

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