Report
On
An Analysis of Credit Risk Management of
Social Islami Bank Limited
Research methodology of the study
1.0 Sources of Information
Information collected to furnish this report is both from primary and secondary in nature. The secondary information was collected from the different publication, and books. For collecting books and periodicals we have used the following sources:
1.1 Methodology of the Report
The following methodology will be followed for the study. Both primary and secondary data sources are used to generate this report. It also includes some face to face interviews.
1.2 Primary sources of data:
Primary data sources are scheduled survey, informal discussion with professionals and observation while working in different desks.
1.3 Secondary sources of data:
The secondary data sources are annual reports, manuals, and brochures of Social Islami Bank limited and different publications of Bangladesh Bank. To identify the implementation, supervision, monitoring and repayment practice- interview with the employee and extensive study of the existing file was and practical case observations were done.
Company Profile
2.0 ABOUT THE ORANIZATION
2.1 AN OVERVIEW OF SOCIAL ISLAMI BANK LTD
Social Islami Bank Ltd started its operation on the 22nd November, 1995 as a second Generation Islami Bank in close co operation and assistance of some renowned personalities of the Islamic world. HE Dr.Hamid Al Gabid ,Former Sectary General of OIC and Prime Minister of Niger ,H E Dr Abdullah Omar Nseef , Deputy Speaker of Saudi Shura Council and Ex –Secretary General of Rabeta Al –Islami H E Ahmed M Salah Jamjoom, Former Commerce Minister of Saudi Government, H.E. Prof. Dr. Ahmad E1-Naggar (Egypt) participated to this noble endeavor as sponsor shareholders. Targeting poverty, Social Investment Bank Ltd. is indeed a concept of 21st century participatory three sector banking model in one: in the formal sector, it works as an Islamic participatory Commercial bank.
The formal corporate sector, this Bank would, among others, offer the most up-to date banking services through opening of various types of deposit and investment accounts, financing trade, providing letters of guarantee, opening letters of credit, collection of bills effecting domestic and international transfer, leasing of equipment and consumer durables, hire purchase and installment sale for capital goods, investment in low-cost housing and management of real estates, participatory investment in various industrial, agricultural , transport, educational and health projects and so on.
In the Non-formal non-corporate sector, it would, among others, involve in cash Waqf Certificate and development and management of WAQF and MOSQUE properties, and Trust funds.
2.2 BACKGROUND OF SOCIAL ISLAM BANK LTD.
The Bank was incorporated as a Public Limited Company in Bangladesh in the year 1995 under Companies Act, 1994. This Bank is one of the interest-free Shariah based Bank in the country and its modus- operandi are substantially different from those of other conventional Banks. The Bank by Banking Companies Act, 1991 and directives as received within the stipulations laid down Companies directives as received from time to time from Bangladesh Bank provides all types of commercial banking services. Besides as a matter of’ policy the Bank conducts its business on the principles of Mudaraba, Musharaka, Murabaha. Bai-Muazzal & Hire Purchase transaction approved by Bangladesh Bank. The Bank is listed with Dhaka Stock Exchange Limited and Chittagong Stock Exchange limited as a publicly traded company.The Bank carries its banking activities through twenty-eight branches operating as per Islamic Shariah in the country.
Social Investment Bank Limited was Problem bank in October 2005 on the Back drop of Bangladesh Bank and subsequent failure to make good the adjusted capital short shortfall, provisional shortfall and downsize the higher purchase of classified investment. To overcome this situation, the bank adopted strategic plan that include increase in efficiency, establishment of transparency, efficiency and accountability in all spheres of banking practices.
2.3 Mission
- High quality financial services the latest technology.
- Fast, Accurate and Satisfactory customer service.
- Balanced & sustainable growth strategy.
- Optimum return on shareholders’ equity.
- Introducing innovative Islamic Banking products.
- Attract and retain high quality human resources.
- Empowering real poor families and create local income opportunities.
- Providing support for social benefit organizations – by way of mobilizing funds and social services.
2.4 Vision
Social Islami Bank Ltd started its journey with the concept of 21st Century Islamic participatory three sector banking model: i) Formal Sector- Commercial Banking with latest technology; ii) Non-Formal Sector – Family Empowerment Micro-Credit & Micro-enterprise program and iii) Voluntary Sector – Social Capital mobilization through CASH WAQF and others. Finally, “Reduction of Poverty Level” is our Vision, which is a prime object as stated in Memorandum of Association of the Bank with the commitment Working Together for a Caring Society
2.5 Objectives :
- Be one of the best banks of Bangladesh.
- To introduce fully automated systems through integration of information technology.
- Achieve excellence is customer services and superior to all competitor.
- Cater to all differentiated segment of retail and wholesale customer.
- Be a high quality distributor of product and services.
- To ensure an adequate rate of return on investment.
- To maintain a healthy growth of burins with desired image.
- To ensure optimum Utilization of all available resources.
2.6 Organization Structure of SIBL
2.7 Capital:
The authorized capital of the bank is Taka 4000 million, whereas paid-up capital of the bank stood at Taka 1309.88 million as at 31st December 2008 compared to Taka 1119.55 million of 2007.
2.8 CAPITAL BASE :
Capital base consisting of tire I & II of the bank as on 31st December 2008 stood at Tk. 2168.30 million as against Tk. 1870.94 million as on 31st December 2007. The Comparative position of Capital Base of the year 2008 and 2007 is given below for kind information:
| (Fig. in million Taka) | ||
| Particulars | 2008 | 2007 |
| 1. Paid up capital | 1309.88 | 1119.55 |
| 2.Statutory Reserve | 415.52 | 344.55 |
| 3.Retained Earnings | 135.84 | 195.06 |
| 4.1 % provision on Unclassified Investment | 300.86 | 205.65 |
| 5.Exchange Equalization | 6.12 | 6.12 |
| Total | 2168.22 | 1870.94 |
| Capital Adequacy Ratio | 2008 | 2007 | |
| I. | Tier –I Capital Ratio (Requirement 5.00%) | 9.33% | 9.50% |
| ii. | Risk Weighted Capital Adequacy Ratio (RWCAR) (Requirement
10.00%) |
10.87% | 10.71% |
| iii. | Shareholders Fund to Investment (Loan & Advances) | 9.36% | 10.13% |
2.9 DEPOSIT:
Since deposit is the life blood of the bank, we drew -up series of action plan, both short term and long term to raise the deposit base of the bank in line with the directives of the Bangladesh Bank. The short -term action plan included launching of special drives like deposit mobilization months during April -.June. As a bduring result of continuous evaluation and monitoring we could significantly improve the liquidity position as well as deposit mix in 2008. The following graph shows the deposit mix of the bank:
INVESTMENT
The investment portfolio of the Bank was propelled efficiently in 2007 as per directives of Bangladesh Bank. The total investments of the Bank stood at Tk. 19951.30 million in various sectors as at 31st December, 2008 against Tk.16440.26 million of 2007 registering a growth by 21.36% that signifies the confidence of the clients on the Bank. The increase in investment by Tk. 351 1.04 million as compared to 2007 was due to expansion of business. We are now concentrating our efforts to increase quality investments to facilitate the investment earnings. It is mentionable here that the assets quality of some of our Branches have deteriorated since
2004 resulting in the increase of classification but we have successfully maintained required provision against classified investment as depicted in the Audit Report. To overcome the situation, we launched special drives to recover the sticky and, classified investments. The following graphs show the year wise position of investment:
2.10 CORRESPONDENT BANKING RELATIONSHIP
SIBL has a very strong Correspondent Banking network around the globe. The Bank has SWIFT Bi-lateral Key Exchange (BKE) arrangements with over 300 renowned Banks and 2200 branches around the world. We are capable to carryout International Trade & Foreign Exchange Business with most of the global trading regions. We have 22 Nos. Nostro Accounts with different correspondent Banks. We earn profits and rebates on overseas business through these accounts.
2.11 CORPORATE GOVERNANCE :
In recent times, corporate governance has been considered most essential aspect for efficient management of a business house. SIBL gives much emphasis on the corporate governance in promoting a sound management. The objective of the Bank is to comply with all regulatory requirements, ensure equitable treatment of all stakeholders.
2.12 FOREIGN EXCHANGE BUSINESS
Foreign Exchange Business stood at Tk. 33363.30 million in 2008 against Tk. 23903.80 million of 2007. The break-up of this foreign exchange business as under:
PROFIT PAID TO DEPOSITORS
The Bank has distributed Tk. 2071.31 million among the Mudaraba
3.12 PROFIT PID DEPOSITORS
Depositors as profit M 2008 as against Tk.1705.05 million in 2007. Profit to the depositors for the year 2008 has been paid at the following rates:
| Mode of Deposits | Profit rate for 2008 | Profit rate for 2007 | ||
| 1. Nludaraba Term Deposits: | ||||
| a) 36 Months | 12.50 | 11.75 | ||
| b) 24 Months | 12.50 | 11.75 | ||
| c) 12 Months | 12.50 | 11.75 | ||
| d) 06 Months | 12.25 | 11.50 | ||
| e) 03 Months | 12.00 | 11.25 | ||
| e) 01 Month | 8.00 | 7.00 | ||
| 2. Mudaraba Savings A/C: (MSD) | 6.1176 | 6.1175 | ||
| 3. Mudaraba Notice Deposit A/C: | 5.6176 | 5.6175 | ||
| 4. Mudaraba Scheme Deposit: | ||||
| a. Mudaraba Monthly Profit Deposit Scheme | 12.00 | 12.00 | ||
| b. Mudaraba Millionaire Savings Scheme | 12.00 | 12.00 | ||
| c. Mudaraba Education Deposit Scheme | 12.00 | 12.00 | ||
| d. Mudaraba Special Deposit Pension Scheme (10 Years) | 12.00 | 12.00 | ||
| e. Mudaraba Special Deposit Pension Scheme (5 Years) | 12.00 | 12.00 | ||
| f. Mudaraba Monthly Savings Scheme | 12.00 | 12.00 | ||
| g. Mudaraba Bashsthan Savings Scheme | 12.00 | 12.00 | ||
| h. Mudaraba Hajj Savings Deposit | 12.00 | 12.00 | ||
| i. Cash Waqf | 12.00 | 12.00 | ||
| j. Mudaraba Lakhopati Deposit Scheme | 12.00 | 12.00 | ||
| k. Mudaraba Double Benefit Deposit Scheme | 12.25 | 12.25 | ||
| 1. Mudaraba Marriage Savings Scheme | 12.00 | 12.00 | ||
| m. Mudaraba Moharana Saving Scheme (10 years) | 12.00 | 12.00 | ||
| n. Mudaraba Moharana Saving Scheme (5 years) | 12.00 | 12.00 | ||
2.13 FIXED ASSETS AND DEPRECIATION:
Assets have been shown at cost less depreciation as per BAS-16 “Property, Plant & Equipments”. Depreciation has been charged on reducing, balance method except motor vehicle; which has been charged on straight-line method. Depreciation on addition of assets has been charged from the date of purchase. Rate of depreciation are as under:
| Particulars | Rate (%) |
| Building | 2.5 |
| Furniture | 10 |
| Decoration | 10 |
| Mechanical Appliance | 20 |
| Motor Car | 20 |
| Books | 10 |
Analysis and Findings Credit Risk Management of SIBL
3.0 CREDIT MANAGEMENT IN SOCAL ISLAMI BANK LIMITED (SIBL)
3.1 Overview
The word credit comes from the Latin word “Credo” meaning we 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. For a bank, it 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 SIBL, it is required to analyze its credit policy, credit procedure and quality of credit portfolio.
3.2 Credit Policy of SIBL
One of the most important ways, a bank can make sure that its loan meet organizational and regulatory standards and they are profitable is to establish a loan policy. Such a policy gives loan management a specific guideline in making individual loans decisions and in shaping the bank’s overall loan portfolio. In Social Islami Bank Limited there is perhaps a credit policy but there is no credit written policy.
3.3 Credit Principles
In the feature, credit principles include the general guidelines of providing credit by branch manager or credit officer. In Social Bank Limited they follow the following guideline while giving loan and advance to the client.
Credit advancement shall focus on the development and enhancement of customer relationship.
All credit extension must comply with the requirements of Bank’s Memorandum and Article of Association, Banking Company’s Act, Bangladesh Bank’s instructions, other rules and regulation as amended from time to time.
Loans and advances shall normally be financed from customer’s deposit and not out of temporary funds or borrowing from other banks.
The bank shall provide suitable credit services for the markets in which it operates. It should be provided to those customers who can make best use of them.
The conduct and administration of the loan portfolio should contribute with in defined risk limitation for achievement of profitable growth and superior return on bank capital. Interest rate of various lending categories will depend on the level of risk and types of security offered.
3.4 Global Credit Portfolio limit of SIBL
The features which deals with how much total deposits would be used as lending the proportion of long term lending, customer exposure, country exposure, proportion of unsecured facility etc. the most notable ones are:
The aggregate of all cash facility will not be more than the 80% of the customers deposit Long term loan must not exceed 20% of the total loan portfolio.
Facilities are not allowed for a period of more than 5 (Five) years.
Credit facilities to any one customer group shall not normally exceed 15% of the capital fund or TK. 100 crores
3.5 Types of Credit
Credit may be classified with reference to elements of time, nature of financing and provision base.
3.6. Classification on the basis of time:
On the basis of elements of time, bank credit may be classified into three heads, viz.
Continuous loans:
These are the advances having no fixed repayment schedule but have a date at which it is renewable on satisfactory performance of the clients. Continuous loan mainly includes “Cash credit both hypothecation and pledge” and “Overdraft”.
Demand loan:
In opening letter of credit (L/C), the clients have to provide the full L/C amount in foreign exchange to the bank. To purchase this foreign exchange, bank extends demand loan to the clients at stipulated margin. No specific repayment date is fixed. However, as soon as the L/C documents arrive, the bank requests the clients to adjust their loan and to retire the L/C documents. Demand loans mainly include “Payment against Documents,” “Loan against imported merchandise (LIM)” and “Later of Trust Receipt”.
Term loans:
These are the advances made by the bank with a fixed repayment schedule. Terms loans mainly include “Consumer credit scheme”, “Lease finance”,” Hire purchase”, and “Staff loan”. The term loans are defined as follows:
• Short term loan: Upto 12 months.
• Medium term loan: More than 12 months & up to 36 months 3.5.2
Personal Loan (Consumer Credit Scheme)
Objectives :
The objectives of this loan are to provide essential household durable to the fixed income group (Service Holders) and other eligible borrowers. Car loan, loan for house renovation, vacation loan, marriage loan and loan for household equipment well as entertainment products are governed by personal loan program. The Total amount of loans along with the duration in which these loans taken, need to be repaid is given below:
| Type of Product | Loan Amount (Tk) Lac | Tenure |
| 1. Vehicle | Up to 7.00 | 4 to 5 years |
| 2. Household items
for Businessman |
1.00 | 2 years |
| 3.Household items
for Service holders |
Up to 3.00 | 2 to 3 years |
| 4. Others | Special Considerations | Special Considerations |
Personal loan is given under personal guarantee of the borrower and another third parson known to the borrower. As this loan is collateral free the rate of interest is little bit high such as 15% to 18%. There is also a processing fee of 1.5% taken at the time of disbursement of the loan.
3.7. Qualitative Judgment Basis of Classification
Beside the above-mentioned objective criteria,Social Bank Limited has other few qualitative judgment classified or not on the basis of the above mentioned objective criterion but if there is any doubt or for classifying the loan and advance. This judgement totally depends on the Branch Manger and or the Head office credit division. Whether any continuous credit, demand loan, fixed term loan are uncertainty as regarding their recovery then the loan can be classified on the basis of the Qualitative Judgment. The qualitative factors that are considered in Social Bank Limited are as follows: Borrower sustains a loss of capital significant decrease in the value of the security. Incorrect information supplied by the borrower or bankruptcy of the borrower.
Credit is rescheduled frequently or the rules of rescheduling are violated or a suit is filed for the recovery of the credit. Last year the classification of the loan and advance of SOCIAL ISLAMI BANK LIMITED were like this.
Table: Classification position last three years. Tk in million
| Year | Unclassified | Substandard | Doubtful | Bad |
| 2002 | 10940 | 12 | 5 | 250 |
| 2003 | 12470 | 200 | 20 | 200 |
Litigation: If after rescheduling the loan and or failed to negotiate withØ the delinquent client, SIBL go for taking legal action against the delinquent client to recover the loan.
3.8 Provisioning
Specific Provision: Head office credit division prepares a list of credit accounts, which are considered to be totally or partially be unrecoverable & keeps a provision against the outstanding loans. ate of Provisioning OCIAL ISLAMI BANK LIMITED in the time of loan provisioning to get the real picture of the income mainly follow the Bangladesh Bank guideline. The rate of provisioning used in SIBL is summarized in the following table.
Table 4: Rate of provisioning
| Class | Short Term Agriculture credit. | All other credit |
| Rate of Provisions | ||
| Unclassified (UC) | 5% | 1% |
| Substandard (SS) | 5% | 20% |
| Doubtful | 5% | 50% |
| Bad or Loss | 100% | 100% |
3.9 Credit Appraisal System
The functions of commercial banks to collect deposit from the common people and to invest deposited money in different sectors for overall development of the economy of the country. So the banks have to be very much careful in credit appraisal. The person who is primarily held responsible for appraising a loan proposal in Social Bank limited is called the credit officer.
The most important measure of appraising a loan proposal is safety of the project. Safety is measured by the borrower and repaying capacity of him. The attitude of the borrower is also an important consideration; liquidity means the inflow of cash into the project in course of its operation. The profit is the blood for any commercial institution.
3.10 Overall Portfolio Management:
The term means managing total exposure on different clients, in different industries of product or service, enjoying different types of facilities. The management may take into consideration the following
Market shares of different clients within Dhaka industry, sizes of different industries within country of operation. |
Relationship personnel should have fair idea of the market sizes in the country of operations at least. He/ she should follow the strategy of the senior management to maintain total exposure on each industry within limit defined by such strategy.
Exposure on individual client should also be planed. Quality of portfolio should also be determined by classification policy and should try to improve it. Cross financing clients within the portfolio may result in higher control. Change in strategy /policy of portfolio should be executed by increase or decrease of exposure in specified fields. |
Steps Involved in Credit Processing
3.11.1 Application for loan:
Applicant applies for the loan in the prescribed form of bank. The purpose of this forms is to eliminate the unwanted borrowers at the first sight and select those who have the potential to utilize the credit and pay it back in due time.
3.11.2 Getting Credit information:
Then the bank collects credit information about the borrower from the following ources:
1. Personal nvestigation
2. Confidential report from other bank/ Head office/Branch/Chamber of commerce
3. CIB report from central bank
3.11.3 Scrutinizing and Investigation:
Bank then starts examination that whether the loan applied for is complying with its lending policy. If comply, than it examines the documents submitted and the credit worthiness. Credit worthiness analysis, ie analyses of financial conditions of the loan applicant are very important. Then bank goes for Lending Risk Analysis (LRA) and spreadsheet analysis, which are recently introduced by Bangladesh Bank. According to Bangladesh Bank rule, LRA and SA is must for the loan exceeding Dhaka core.
If these two analyses reflect favorable condition and documents submitted for the loan appears to be satisfactory then, bank goes for further action.
3.11.4 Existing process of handling loans:
The process of sanctioning loans is as follows:
3.11.5.1 Character
The outcome of analyzing the character is to have overall idea about the integrity, experience, and business sense of the borrower. Two variables; Interaction/interview, and Market Research are used to analyze the character of the borrower.
1. Interaction/interview: the indicators are
a) Prompt and consistent information supply, information given has not been found false (Willingness to give information).
b) CIB also reveals business character.
c) Willingness to give owns stake/equity & collateral to cover.
d) Tax payer.
2. Market Research:
a) Information on business is verified.
b) Dealing with supplier and or customer as supplier is also a kind of lender; he payment character can also be verified.
3.11.5.2 Capital
For identifying the capital invested in the business can be disclosed using the following indicators.
a) Financial Statements
b) Receivable, Payable, statements to practically assess the business positions. Net worth through financial statements or from declaration of Assets & Liabilities.
3.11.5.3 Capacity (Competence)
Capability of the borrower in running the business is highly emphasized in the time of selecting a good borrower. As the management of the business is the sole authority to run the business that is use the fund efficiently, effectively and profitably. The indicators help to identify the capacity of the borrower.
3.11.5.4 Collateral
Make sure that there is a “second way out “of a credit, but do not allow that to drive the credit decision.
3.11.5.5 Cash Follow:
Cash flow is the vital factor that is used to identify whether the borrower will have enough cash to repay the loan or advance. Cash keeps the liquidity to ensure repayment. The relationship managers try to identify the annual cash flow from the submitted statements.
3.11.5.6. Communication:
Share credit objectives and credit decision making both vertically and laterally within the bank.
Lending Risk Analysis (LRA): Modern Technique Of Credit Appraisal
The Financial Sector Reform Project (FSRP) has designed the LRA package, which provides a systematic procedure for analyzing and quantifying the potential credit risk. Bangladesh Bank has directed all commercial bank to use LRA technique for evaluating credit proposal amounting to Tk. 10 million and above. The objective of LRA is to assess the credit risk in quantifiable manner and then find out ways & means to cover the risk. However, some commercial banks employ LRA technique as a credit appraisal tool for evaluating credit proposals amounting to Tk. 5 million and above. Broadly LRA package divides the credit risk into two categories, namely. Business risk Security risk.
A detail interpretation of these risks and the procedure for evaluating the credit as follows
3.12.1 Business risk:
It refers to the risk that the business falls to generate sufficient cash flow to repay the loan. Business risk is subdivided into two categories.
3.12.2 Industry risk.
The risk that the company fails to repay for the external reason. It is subdivide into supplies risk and sales risk.
3.12.3 Supplies risk:
It indicates that the business suffers from external disruption to the supply of imputes. Components of supplies risk are as raw material, Labor, power, machinery, equipment, factory premises etc. Supply risk is assessed by a cost breakdown of the inputs and then assessing the risk of disruption of supplies of each item.
3.12.4 Company risk:
This refers to the risk that the company fails for internal reasons. Company risk is subdivided into company position risk and Management risks.
3.12.5 Company position risk:
Within an industry each and every company holds a position. This position is very competitive. Due to the weakness in the company’s position in the industry, a company is the risk for failure. That means, company position risk is the risk of failure due to weakness in the companies position in the industry. It is subdivided into performance risk and resilience risk.
3.12.6 Performance risk:
This risk refers to the risk that the company’s position is so weak that it will be unable to repay the loan even under Favor able external condition. Performance risk assessed by SWOT(Strength, Weakness, Opportunity and Threat) analysis, Trend analysis, Cash flow forecast analysis and credit report analysis (i.e. CIB repot from Bangladesh Bank).
3.12.7 Management risk:
The management risk refers to the risk that the company fails due to management not exploiting effectively the company’s position. Management risk is subdivided into management competence risk and integrity risk.
.3.12.8 Management integrity risk:
This refers to the risk that the company fails to repay the loan amount due to lack of management integrity. Management integrity is a combination of honesty and dependability. Management integrity risk is determined by assessing management honesty, which requires evaluating the reliability of information supplied and then management dependability.
3.12.9 Security risk:
This sort of risk is associated with the realized value of the security, which may not cover the exposure of loan. Exposure means principal plus outstanding interest. The security risk is subdivided into two major heads i.e. security control risk and security cover risk.
3.12.11 Security control risk:
This risk refers to the risk that the bank falls to realize the security because of bank’s control over the security offered by the borrower i.e. incomplete documents. The risk of failure to realize the security depends on the difficulty in obtaining favorable judgment and taking possession of security. For analyzing the security control risk the credit office is required to verify documentation to ensure security protection, documentation completeness, documentation integrity and proper insurance policy. He/she also conducts site visit to verify security existence.
CREDIT RISK MANAGEMENT GUIDELINES
BY BANGLADESH BANK
4.0 INDUSTRY BEST PRACTICES AS SUGGESTD BY BBK
4.1 POLICY GUIDELINES
This section details fundamental credit risk management policies that are recommended for adoption by all banks in Bangladesh. The guidelines contained herein outline general principles that are designed to govern the implementation of more detailed lending procedures and risk grading systems within individual banks.
4.1.1 Lending Guidelines
All banks should have established Credit Policies (“Lending Guidelines”) that clearly outline the senior management’s view of business development priorities and the terms and conditions that should be adhered to in order for loans to be approved. The Lending Guidelines should be updated at least annually to reflect changes in the economic out look and the evolution of the bank’s loan portfolio, and be distributed to all lending/marketing officers. The Lending Guidelines should be approved by the Managing Director/CEO & Board of Directors of the bank based on the endorsement of the bank’s Head of Credit Risk Management and the Head of Corporate/Commercial Banking. (Section 2.1 of these guidelines refers) Any departure or deviation from the Lending Guidelines should be explicitly identified in credit applications and a justification for approval provided.. The Lending Guidelines should provide the key foundations for account officers/relationship managers (RM) to formulate their recommendations for approval, and should include the following:
Discouraged Business Types : Banks should outline industries or lending activities that are discouraged. As a minimum, the following should be discouraged:
– Military Equipment/Weapons Finance
– Highly Leveraged Transactions
– Finance of Speculative Investments
– Logging, Mineral Extraction/Mining, or other activity that is
– Ethically or Environmentally Sensitive
– Lending to companies listed on CIB black list or known defaulters
– Counter parties in countries subject to UN sanctions
– Share Lending
– Taking an Equity Stake in Borrowers
– Lending to Holding Companies
– Bridge Loans relying on equity/debt issuance as a source of repayment.
Loan Facility Parameters: Facility parameters (e.g., maximum size, maximum tenor, and covenant and security requirements) should be clearly stated. As a minimum, the following parameters should be adopted:
– Banks should not grant facilities where the bank’s security position is inferior to that of any other financial institution.
For example, export documents negotiated for countries like Nigeria.
4.1.2 Credit Assessment & Risk Grading
4.1.2.1 Credit Assessment
A thorough credit and risk assessment should be conducted prior to the granting of loans, and at least annually thereafter for all facilities. The results of this assessment should be presented in a Credit Application that originates from the relationship manager/account officer (“RM”), and is approved by Credit Risk Management (CRM). The RM should be the owner of the customer relationship, and must be held responsible to ensure the accuracy of the entire credit application submitted for approval. RMs must be familiar with the bank’s Lending Guidelines and should conduct due diligence on new borrowers, principals, and guarantors. It is essential that RMs know their customers and conduct due diligence on new borrowers, principals, and guarantors to ensure such parties are in fact who they represent themselves to be. All banks should have established Know Your Customer (KYC) and Money Laundering guidelines which should be adhered to at all times. Credit Applications should summaries the results of the RMs risk assessment and include, as a minimum, the following details:
– Amount and type of loan(s) proposed.
– Purpose of loans.
– Loan Structure (Tenor, Covenants, Repayment Schedule, Interest)
– Security Arrangements
In addition, the following risk areas should be addressed:
– Borrower Analysis. The majority shareholders, management team and group or affiliate companies should be assessed. Any issues regarding lack of management depth, complicated ownership structures or intergroup transactions should be addressed, and risks mitigated. Industry Analysis. The key risk factors of the borrower’s industry should be assessed. Any issues regarding the borrower’s position in the industry, overall industry concerns or competitive forces should be addressed and the strengths and weaknesses of the borrower relative to its competition should be identified.
– Supplier/Buyer Analysis. Any customer or supplier concentration should be addressed, as these could have a significant impact on the future viability of the borrower.
– Historical Financial Analysis. An analysis of a minimum of 3 years historical financial statements of the borrower should be presented. Where reliance is placed on a corporate guarantor, guarantor financial statements should also be analyzed. The analysis should address the quality and sustainability of earnings, cash flow and the strength of the borrower’s balance sheet. Specifically, cash flow, leverage and profitability must be analyzed..
– Mitigating Factors. Mitigating factors for risks identified in the credit assessment should be identified. Possible risks include, but are not limited to: margin sustainability and/or volatility, high debt load (leverage/gearing), overstocking or debtor issues; rapid growth, acquisition or expansion; new business line/product expansion; management changes or succession issues; customer or supplier concentrations; and lack of transparency or industry issues.
Security: A current valuation of collateral should be obtained and the quality and priority of security being proposed should be assessed. Loans should not be granted based solely on security. Adequacy and the extent of the insurance coverage should be assessed.
4.1.2.2 Risk Grading
All Banks should adopt a credit risk grading system. The system should define the risk profile of borrower’s to ensure that account management, structure and pricing are commensurate with the risk involved. Risk grading is a key measurement of a Bank’s asset quality, and as such, it is essential that grading is a robust process. All facilities should be assigned a risk grade. Where deterioration in risk is noted, the Risk Grade assigned to a borrower and its facilities should be immediately changed. Borrower Risk Grades should be clearly stated on Credit Applications. The following Risk Grade Matrix is provided as an example. The more conservative risk grade.
The Early Alert Process should be completed in a timely manner by the RM and forwarded to CRM for approval to affect any downgrade. After approval, the report should be forwarded to Credit Administration, who is responsible to ensure the correct facility/borrower Risk Grades are updated on the system. The downgrading of an account should be done immediately when adverse information is noted, and should not be postponed until the annual review process.
Approval Authority, Segregation of Duties & Internal Audit
4.1.3 Approval Authority
The authority to sanction/approve loans must be clearly delegated to senior credit executives by the Managing Director/CEO & Board based on the executive’s knowledge and experience. Approval authority should be delegated to individual executives and not to committees to ensure accountability in the approval process. The following guidelines should apply in the approval/sanctioning of loans:
Credit approval authority must be delegated in writing from the MD/CEO & Board (as appropriate), acknowledged by recipients, and records of all delegation retained in CRM .Delegated approval authorities must be reviewed annually by MD/CEO/Board. The credit approval function should be separate from the marketing/relationship management (RM) function. The role of Credit Committee may be restricted to only review of centralized within the CRM function. Regional credit centers may be established, training and experience to carry out their responsibilities effectively. As a minimum, approving executives should have:
– At least 5 years experience working in corporate commercial banking as a relationship manager or account executive.
– Training and experience in financial statement, cash flow and risk analysis.
– A thorough working knowledge of Accounting.
– A good understanding of the local industry market dynamics.
– Successfully completed an assessment test demonstrating adequate knowledge of the following areas:
o Introduction of accrual accounting.
o Industry / Business Risk Analysis
o Borrowing Causes
o Financial reporting and full disclosure
o Financial Statement Analysis
o The Asset Conversion/Trade Cycle
o Cash Flow Analysis
o Projections
o Loan Structure and Documentation
o Loan Management.
4.1.4 Segregation of Duties
Banks should aim to segregate the following lending functions:
– Credit Approval/Risk Management
– Relationship Management/Marketing
– Credit Administration
The purpose of the segregation is to improve the knowledge levels and expertise in each department, to impose controls over the disbursement of authorized loan facilities and obtain an objective and independent judgment of credit proposals.
4.1.5 Internal Audit
Banks should have a segregated internal audit/control department charged with conducting audits of all departments. Audits should be carried out annually, and should ensure compliance with regulatory guidelines, internal procedures, and Lending Guidelines and Bangladesh Bank requirements.
4.2.0 PREFERRED ORGANIZATIONAL
4.2.1. STRUCTURE & RESPONSIBILITIES
The appropriate organizational structure must be in place to support the adoption of the policies detailed in Section 1 of these guidelines. The key feature is the segregation of the Marketing Relationship Management function from Approval Risk Management Administration functions. Credit approval should be centralized within the CRM function. Regional credit centers may be established, however, all applications must be approved by the Head of Credit and Risk Management or Managing Director /CEO /Board or delegated Head Office credit executive.
4.2.2. Credit Risk Management (CRM)
Oversight of the bank’s credit policies, procedures and controls relating to all credit risks arising from corporate/commercial/institutional banking, personal banking, & treasury operations.
Oversight of the bank’s asset quality. Directly manage all Substandard, Doubtful & Bad and Loss accounts to maximize recovery and ensure that appropriate and timely loan loss provisions have been made. To provide advice/assistance regarding all credit matters to line management/ RMs.To ensure that lending executives have adequate experience and/or training in order to carry out job duties effectively.
4.2.3. Credit Administration:
To ensure that all security documentations comply with the terms of approval and is enforceable.
To monitor insurance coverage to ensure appropriate coverage is in place over assets pledged as collateral, and is properly assigned to the bank.
To control loan disbursements only after all terms and conditions of approval have been met, and all security documentation is in place.
To maintain control over all security documentation
To monitor borrower’s compliance with covenants and agreed terms and conditions, and general monitoring of account conduct/performance.
4.2.4..Internal Audit/Control
Conducts independent inspections annually to ensure compliance with Lending Guidelines, operating procedures, bank policies and Bangladesh Bank directives. Reports directly to MD/CEO or Audit committee of the Board PROCEDURAL GUIDELINES.
This section outlines of the main procedures that are needed to ensure compliance with the policies contained in Section 1.0 of these guidelines.
4.3.1 Approval Process
The approval process must reinforce the segregation of Relationship Management/ Marketing from the approving authority. The responsibility for preparing the Credit Application should rest with the RM within the corporate/commercial banking department. Credit Applications should be recommended for approval by the RM team and forwarded to the approval team within CRM and approved by individual executives. Banks may wish to establish various thresholds, above which, the recommendation of the Head of Corporate/Commercial Banking is required prior to onward recommendation to CRM for approval. In addition, banks may wish to establish regional credit centers within the approval team to handle routine approvals. Executives in head office CRM should approve all large loans.
The recommending or approving executives should take responsibility for and be held accountable for their recommendations or approval. Delegation of approval limits should be such that all proposals where the facilities are up to 15% of the bank’s capital should be approved at the CRM level, facilities up to 25% of capital should be approved by CEO/MD, with proposals in excess of 25% of capital to be approved by the EC/Board only after recommendation of CRM, Corporate Banking and MD/CEO.
Credit Application Recommended by RM/ Marketing
Zonal Credit Officer (ZCO)
Head of Credit & Head of Corporate Banking (HOBC)
4.3.2 Credit Administration
The Credit Administration function is critical in ensuring that proper documentation and approvals are in place prior to the disbursement of loan facilities. For this reason, it is essential that the functions of Credit Administration be strictly segregated from Relationship Management/Marketing in order to avoid the possibility of controls being compromised or issues not being highlighted at the appropriate level. Credit Administration procedures should be in place to ensure the following:
4.3.2.2 Custodial Duties:
Loan disbursements and the preparation and storage of security documents should be centralized in the regional credit centers.
Appropriate insurance coverage is maintained (and renewed on a timely basis) on assets pledged as collateral.
Security documentation is held under strict control, preferably in locked fireproof storage.
4.3.2.3 Compliance Requirements:
All required Bangladesh Bank returns are submitted in the correct format in a timely manner.
Bangladesh Bank circulars/regulations are maintained centrally, and advised to all relevant departments to ensure compliance.
All third party service providers (values, lawyers, insurers, CPAs etc.) are approved and performance reviewed on an annual basis. Banks are referred to Bangladesh Bank circular outlining approved external audit firms that are acceptable.
Credit Monitoring, Credit Recovery Process of SOCIAL ISLAMI BANK LIMITED
4.3.3 Credit Monitoring
To minimize credit losses, monitoring procedures and systems should be in place that provide an early indication of the deteriorating financial health of a borrower. At a minimum, systems should be in place to report the following exceptions to relevant executives in CRM and RM team:
4.3.4 Credit Recovery
The Recovery Unit (RU) of CRM should directly manage accounts with sustained deterioration (a Risk Rating of Sub Standard (6) or worse). Banks may wish to transfer EXIT accounts graded 4-5 to the RU for efficient exit based on recommendation of CRM and Corporate Banking. Whenever an account is handed over from Relationship Management to RU, a Handover /Downgrade Checklist should be completed.
The RU’s primary functions are
Determine Account Action Plan/Recovery Strategy
Pursue all options to maximize recovery, including placing customers into receivership or liquidation as appropriate. Ensure adequate and timely loan loss provisions are made based on actual and expected losses.
Regular review of grade 6 or worse accounts.
The management of problem loans (NPLs) must be a dynamic process, and the associated strategy together with the adequacy of provisions must be regularly reviewed. A process should be established to share the lessons learned from the experience of credit losses in order to update the lending guidelines.
4.3.4.2 Account Transfer Procedures
Within 7 days of an account being downgraded to substandard (grade 6), a Request for Action (RFA) and a handover /downgrade checklist should be completed by the RM and forwarded to RU for acknowledgment. The account should be assigned to an account manager within the RU, who should review all documentation, meet the customer, and prepare a Classified Loan Review Report (CLR) within 15 days of the transfer. The CLR should be approved by the Head of Credit, and copied to the Head of Corporate Banking and to the Branch/office where the loan was originally sanctioned. This initial CLR should highlight any documentation issues, loan structuring weaknesses, proposed workout strategy, and should seek approval for any loan loss provisions that are necessary.
Facilities are withdrawn or repayment is demanded as appropriate. Any drawings or advances should be restricted, and only approved after careful scrutiny and approval from appropriate executives within CRM.
CIB reporting is updated according to Bangladesh Bank guidelines and the borrower’s Risk Grade is changed as appropriate.
4.3.4.5 Incentive Program:
Banks may wish to introduce incentive programs to encourage Recovery Unit Account Managers to bring down the Non Performing Loans (NPLs). The table below shows an indicative incentive plan for RU account managers:
| Recovery as a % of Principal plus interest | Recommended Incentive as % of
net recovery amount |
|
| If CG 7-8 | if written off | |
| 76% to 100% | 1.00% | 2.00% |
| 51% t0 75% | 0.50% | 1.00% |
| 20% to 50% | 0.25% | 0.50% |
CONCLUSION AND RECOMMENDATIONS
05.1. CONCLUSIONS
A banker can not sleep well with bad debts in his portfolio. The failure of commercial banks occurs mainly due to bad loans, which occurs due to inefficient management of the loans and advances portfolio. Therefore any banks must be extremely cautious about its lending portfolio and credit policy. So far SIBL has been able to manage its credit portfolio skillfully and kept the classified loan at a very lower rate —thanks goes to the standard and stringent credit appraisal policy and practices of the bank.
But all things around us are changing at an accelerating rate. Today is not like yesterday and tomorrow will be different from today. Given the fast changing, dynamic global economy and the increasing pressure of globalization, liberalization, consolidation and disintermediation, it is essential that Social Islmi bank limited has a robust credit risk management policies and procedures that are sensitive to these changes.
5.2 RECOMMENDTIONS
To improve the risk management culture further, Social Islami bank limited should adopt some of the industry best practices that are not practiced currently. The<