2014

Shah Amir Akbar S.

1/6/2014
The Impact of Credit Risk on
Bank Alfalahs Profitability
1 | P a g e

Table of Contents
PREFACE ........................................................................................................................................................ 2
EXECUTIVE SUMMARY .................................................................................................................................. 3
ABOUT BANK AL FALAH ................................................................................................................................ 4
CREDIT RISK ................................................................................................................................................... 5
LITERATURE REVIEW ..................................................................................................................................... 6
ARTICLE #1 ................................................................................................................................................ 6
ARTICLE #2 ................................................................................................................................................ 7
ARTICLE #3 ................................................................................................................................................ 8
ARTICLE #4 ................................................................................................................................................ 9
ARTICLE #5 .............................................................................................................................................. 10
ARTICLE #6 .............................................................................................................................................. 11
ARTICLE #7 ............................................................................................................................................. 12
RESEARCH OBJECTIVE ................................................................................................................................. 13
METHODOLOGY .......................................................................................................................................... 13
DATA COLLECTION .................................................................................................................................. 13
DATA ANALYSIS ....................................................................................................................................... 13
DEPENDENT VARIABLE ............................................................................................................................ 13
INDEPENDENT VARIABLE ........................................................................................................................ 13
STATISTICAL TOOL ................................................................................................................................... 14
EMPIRICAL RESULTS & ANALYSIS OF FINDINGS .......................................................................................... 14
CONCLUSION AND RECOMMENDATIONS ................................................................................................... 18
BIBLOGRAPHY ............................................................................................................................................. 19
APPENDIX .................................................................................................................................................... 20



2 | P a g e

PREFACE

This report analyzes the impact of credit risk on bank Alfalahs profitability over 14 years
from 2000-2013.
With the esteem depth of my heart, I am thankful to my Treasury and Fund
Management Instructor, Maqbool-ur-Rehman, for the valuable guidance and advice. He
inspired me greatly to work on this report. His willingness to motivate me contributed
tremendously to my report.
It has been a privilege to work on this report and I have put in my utmost effort to
prepare a comprehensive report on this topic. If you will be having any queries
regarding this report I will be happy to discuss it with you.















3 | P a g e

EXECUTIVE SUMMARY

The study investigated the impact of credit risk on the profitability of Bank
Alfalah. The data collected are for the periods of 2000 2013 from the Annual Reports.
From the findings it is concluded that banks profitability is inversely influenced by
the levels of loans and advances, non-performing loans and deposits thereby
exposing them to great risk of illiquidity and distress.

4 | P a g e

ABOUT BANK AL FALAH

Bank Alfalah Limited was launched on June 21, 1997 as a public limited company under
the Companies Ordinance 1984. The bank commenced its operations on November 1,
1997. The bank introduced commercial banking and related services as defined in the
Banking companies ordinance, 1962. Bank Alfalah is the 6th largest bank of Pakistan
with 576 branches.
After a few years, the bank introduced its new identity of H.C.E.B after the privatization
in 1997. The management of the bank had implemented strategies and policies so the
bank would become a major player in the market. With a partnership with the Abu Dhabi
Group the position of the bank became stronger which allowed the bank to invest more
in technology to increase its range of products and services.
Vision
To be a premier financial services organization, operating both locally and globally,
offering a complete range of financial products and services to diverse segments under
one umbrella.

Mission
To develop & deliver the most innovative products and deliver exceptional service
quality which contribute to strengthening brand equity strength and maximize value for
the stakeholders of the Bank


5 | P a g e

CREDIT RISK

Credit risk is the current and prospective risk to earnings or capital arising from an
obligors failure to meet the terms of any contract with the Bank or otherwise to perform
as agreed. Credit risk is found in all activities in which success depends on
counterparty, issuer, or borrower performance. It arises any time bank funds are
extended, committed, invested, or otherwise exposed through actual or implied
contractual agreements, whether reflected on or off the balance sheet.
The potential for loss due to failure of a borrower to meet its contractual obligation to
repay a debt in accordance with the agreed terms
Commonly also referred to as default risk
Credit events include bankruptcy, failure to pay, loan restructuring, loan moratorium,
accelerated loan payments
For banks, credit risk typically resides in the assets in its banking book (loans and
bonds held to maturity)
Credit risk can arise in the trading book as counterparty credit risk




6 | P a g e

LITERATURE REVIEW

ARTICLE #1
JOURNAL

ARTICLE
INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN
BUSINESS.
CREDIT RISK AND THE PERFORMANCE OF NIGERIAN BANKS.
(NOVEMBER 2012)
AUTHOR Muhammad Nawaz, Shahid Munir, Shahid Ali Siddiqui, Tahseen-Ul-
Ahad, Faisal Afzal, Muhammad Asif, Muhammad Ateeq.
IMPACT FACTOR No impact
RESEARCH OBJECTIVE CREDIT RISK AND THE PERFORMANCE OF NIGERIAN BANKS
RESEARCH DESIGN DEPENDENT VARIABLES:
ROA= Return on Assets

INDEPENDENT VARIABLES:
NPL/LA = Ratio of Non-performing loan to loan & Advances)
LA/TD = Ratio of Loan & Advances to Total deposit)
METHODOLOGY Multiple regression models which adopt Ordinary Least Square (OLS)
model in estimating the parameter of the model and is expressed as:
ROA = 0 + NPL/LA + LA/TD
DATA COLLECTION Data collected are for the periods of 2004 2008 from the Annual
Reports and Accounts of the chosen banks.
CONCLUSION The regression result of the study model suggests that all the
independent variables have negative impact on profitability. This study
shows that there is a significant relationship between bank performance
(in terms of profitability) and credit risk management (in terms of loan
performance). Loans and advances and non-performing loans are major
variables in determining asset quality of a bank. These risk items are
important in determining the profitability of banks in Nigeria.

ROA = 1.634046 - 0.515976 NPL/LA 2.519801 LA/TD








7 | P a g e

ARTICLE #2

JOURNAL

ARTICLE
University of Gothenburg. School of business, economics and law

Credit Risk Management and Profitability in Commercial Banks in
Sweden. (24th of May 2009)
AUTHOR Ara Hosna, Bakaeva Manzura and Sun Juanjuan
IMPACT FACTOR No Impact
RESEARCH OBJECTIVE The purpose of the research is to describe the impact level of credit risk
management on profitability in four commercial banks in Sweden.
RESEARCH DESIGN DEPENDENT VARIABLE:
ROE = Return on equity

INDEPENDENT VARIABLE:
NPLR is defined as NPLs divided by TLs
CAR is regulatory capital requirement (Tier 1 + Tier 2) as the percentage
of RWAs.

METHODOLOGY The method of our study is quantitative. We use regression model to
analyze data collected from the annual reports of the sample banks.
Based on the regression outputs we conduct the analyses and answer
our research question. The analyses are presented by using descriptive
approach. Since we only describe the regression results without
providing further explanation on the issues.

We have employed the multivariate regression model which is
presented below:

ROE= +1NPLR+ 2CAR+

DATA COLLECTION We have selected four major commercial banks in Sweden: Nordea,
SEB, Svenska Handelsbanken and Swedbank. We have used annual
reports from 2000 to 2008 of each bank to collect the data. Therefore,
there are total 36 observations in the regression analysis.

CONCLUSION The big four banks together have a strong position in the Swedish
financial market. The regression outputs of all four banks show that
NPLR has negative and significant effect on ROE compared to CAR. It
indicates that profitability is fairly affected by credit risk management
in this banking group. The results obtained from the regression model
show that there is an effect of credit risk management on profitability on
reasonable level with 25,1% possibility of NPLR and CAR in predicting the
variance in ROE.


8 | P a g e

ARTICLE #3

JOURNAL

ARTICLE
International Journal of Business and Public Management (April 2012)


The impact of credit risk management on the financial performance of
Banks in Kenya for the period 2000 2006
AUTHOR Danson Musyoki, Adano Salad Kadubo
IMPACT FACTOR No Impact
RESEARCH OBJECTIVE The objective of study was to assess various parameters pertinent to
credit risk management as it affects banks financial performance. Such
parameters covered in the study were; default rate, bad debts costs
and cost per loan asset.
RESEARCH DESIGN DEPENDENT VARIABLE:
Return on Assets (ROA)

INDEPENDENT VARIABLE:
Default rate ratio (DR )= Non Performing Loans/ Total loan
Bad debt costs ratio (BDC )= Bad debt cost/ Total cost.
Cost per loan asset (CLA) = Total Operating Cost/ Total amount of loans.
METHODOLOGY The research design used for the study was a descriptive
research design. We have employed the multivariate regression model
which is presented below:

Y= +1X1+ 2X2+ 3X3+


DATA COLLECTION The study covered the period between 2000 and 2006 of the banks
operating in Nairobi; ten banks were involved in the study.

CONCLUSION The result of the showed that credit risk
management is an important predictor of bank financial
performance thus success of bank performance depends on risk
management to the extent of around 36%. Default Rate management is
the single most important predictor of the bank performance
since it influences 54% of the total credit risk influence on bank
performance. Risk management indicators such as Bad Debt Cost and
Cost per Loan Asset are not significant predictors of bank
performance.




9 | P a g e

ARTICLE #4
JOURNAL

ARTICLE
Asian Transactions on Basic and Applied Sciences

Effectiveness of Credit Risk Management of Saudi Banks in the Light of Global Financial Crisis: A Qualitative
Study
AUTHOR Dr. Khalil Elian Abdelrahim
IMPACT FACTOR No Impact
RESEARCH OBJECTIVE (1) To identify the characteristics of credit risk management of Saudi Banks.
(2) To investigate the determinants of effectiveness of credit risk
management of Saudi Banks.
(3) To find out the most serious challenges facing the effectiveness of credit risk management of Saudi Banks.
(4) To explore the development methods of effectiveness of credit risk
management of Saudi Banks.
RESEARCH DESIGN DEPENDENT VARIABLE: Effectiveness Of Credit Risk Management
INDEPENDENT VARIABLES:
1.Capital Adequacy Ratio (C) 2.Assets Quality (A) 3.Management Soundness (M) 4. Earnings of Credit Facility
(E) 5. Liquidity (L) 6.Bank Size(S)
METHODOLOGY H0 1: There is no statistically significant relation between capital adequacy and effectiveness of credit risk
management in Saudi Banks.
H0 2: There is no statistically significant relation between asset quality and the effectiveness of credit risk
management in Saudi Banks.
H0 3:There is no statistically significant relation between management soundness and effectiveness of credit
risk management in Saudi Banks.
H0 4:There is no statistically significant relation between bank's earning and effectiveness of credit risk
management in Saudi Banks.
H0 5: There is no statistically significant relation between liquidity and the effectiveness of credit risk
management in Saudi Banks.
H0 6:There is no statistically significant relation between bank Size and the effectiveness of credit risk
management in Saudi Banks.

The tools of analysis are: frequency distribution, mean, standard deviation for descriptive analysis, besides the
use of regression analysis to test research hypotheses and the use of t-statistics to detect differences in the
answers of respondents.
CONCLUSION The study recommends an overall strategy for effective credit risk management of Saudi Banks
based on enhancing capital adequacy, upgrading asset quality, strenghthening management
soundness, increasing earnings, having adequate liquidity and reducing sensitivity to market risk
besides hedging credit risk; having adequate provisions for doubtful credit; renegotiating loan terms,
transferring credit risk to a third party, extending credit maturity and lowering interest rate on
insolvent loan.


10 | P a g e

ARTICLE #5

JOURNAL

ARTICLE
Annals of the University of Petroani, Economics,
THE IMPACT OF EFFECTIVE CREDIT RISK MANAGEMENT ON BANK
SURVIVAL
AUTHOR KOSMAS NJANIKE
IMPACT FACTOR No Impact
RESEARCH OBJECTIVE The study seeks to evaluate the extent to which failure to effectively
manage credit risk led to Zimbabwes banks demise in 2003/2004 bank
crisis. It also seeks to establish other factors that led to the banking crisis
and to outline the components of an effective credit risk management
system.

METHODOLOGY The researcher chose the survey as the appropriate research design for
the study, and as such, questionnaires and interviews were used as
research instruments. Some unclear or hanging issues in the
questionnaires were clarified in interviews.
DATA COLLECTION The research data was collected over six months
to June 2009. A sample of 10 commercial banks randomly chosen was
used in this analysis. Twenty questionnaires were used to gather data
with two for each commercial bank chosen. A total of 10 interviews were
held with the heads of credit or senior managers from those banks.
CONCLUSION The results obtained from the research clearly support the assertion that
poor credit risk management contributed to a greater extent to the bank
failures in Zimbabwe. Therefore effective credit risk management is
important in banks and allows them to improve their performance and
prevent bank distress. The success of the systems depends critically
upon a positive risk culture. Banks should have in place a comprehensive
credit risk management process to identify, measure, monitor and
control credit risk and all material risks and where appropriate, hold
capital against these risks.
11 | P a g e

ARTICLE #6


ARTICLE
Department of accounting Faculty of Administration Ahmadu Bello
University, Zaria Nigeria
JULY, 2011

CREDIT RISK AND THE PERFORMANCE OF NIGERIAN BANKS
AUTHOR Hamisu Suleiman Kargi
IMPACT FACTOR No Impact
RESEARCH
OBJECTIVE
The study considers the extent of relationship that exists between the core variables
constituting Nigerian Bank default risk and the profitability. It therefore seek to examine the
impact of credit risk on the profitability of Nigerian banking system and identifies the
relationships between the non-performing loans and banks profitability and evaluate the
effect of loan and advance on banks profitability on Nigerian banks.
RESEARCH DESIGN DEPENDENT VARIABLE:Ratio of profit after tax to total assets.
INDEPENDENT VARIABLE:
NPL/LA = Ratio of Non-performing loan to loan & Advances).
LA/TD = Ratio of Loan & Advances to Total deposit).
METHODOLOGY The pooled data was analysed using correlation and multiple regression models which adopt
Ordinary Least Square (OLS) method in estimating the parameter of the model and is
expressed as;
ROA = 0 + 1NPL/LA + 2LA/TD
DATA COLLECTION The study is both historical and descriptive as it seeks to describe the pattern of credit risk of
Nigerian banks in the past.
The sample size is based on the following criteria;
a)The availability of consistent data-set over the period.
b) The banks were not involved in any merger during the study period and were not involved
in any merger during the study period with at least a branch in all states of the federation.
c) The banks are listed and quoted on the Nigeria Stock Exchange.
Considering the above criteria, six out of twenty four banks in Nigeria were selected (Appendix
I) and data collected are for the periods of 2004 2008 from the Annual Reports and Accounts
of the chosen banks.
CONCLUSION This study shows that there is a significant relationship between bank performance (in terms
of profitability) and credit risk management (in terms of loan performance). Loans and
advances and non performing loans are major variables in determining asset quality of a bank.
These risk items are important in determining the profitability of banks in Nigeria. Where a
bank does not effectively manage its risk, its profit will be unstable.
12 | P a g e

ARTICLE #7


ARTICLE

BCBS (1999)
IMPACT FACTOR No Impact
CONCLUSION
BCBS (1999) observed that banks are increasingly facing credit risk (or
counterparty risk) in various financial instruments other than loans, including
acceptances, interbank transactions, trade financing foreign exchange
transactions, financial futures, swaps, bonds, equities, options, and in the
extension of commitments and guarantees, and the settlement of transaction.
Anthony (1997) asserts that credit risk arises from non-performance by a
borrower. It may arise from either an inability or an unwillingness to perform in
the pre-committed contracted manner. Brownbridge (1998) claimed that the
single biggest contributor to the bad loans of many of the failed local banks was
insider lending. He further observed that the second major factor contributing
to bank failure were the high interest rates charged to borrowers operating in
the high-risk. The most profound impact of high non-performing loans in banks
portfolio is reduction in the bank profitability especially when it comes to
disposals.








13 | P a g e

RESEARCH OBJECTIVE
The objective of the research is to describe the impact of credit risk on the profitability of
bank Alfalah in Pakistan.
METHODOLOGY
DATA COLLECTION
The data collected are for the periods of 2000 2013 from the Annual Reports.
Therefore, there are total 14 observations in the regression analysis. Theoretically, the
number of observations should be 14:1 (14 observations per one independent variable)
in the regression analysis. The data includes Loans and Advances, Non-performing
Loan, total deposits, Profit after Tax and total assets of the sampled banks. In this study
the ratio of Non-performing loan to loan & Advances and ratio of Total loan & Advances
to Total deposit were used as indicators of credit risk while the ratio of Profit after Tax to
total asset known as return on asset (ROA) indicates performance.

DATA ANALYSIS
I have used multiple regression analysis in this study: the relation of one dependent
variable to multiple independent variables. The regression outputs are obtained by
using SPSS.

DEPENDENT VARIABLE
Return on Assets
An indicator of how profitable a company is relative to its total assets. ROA gives an
idea as to how efficient management is at using its assets to generate earnings.

INDEPENDENT VARIABLE
I have chosen two independent variables namely NPL/LA = Ratio of Non-performing
loan to loan & Advances) and LA/TD = Ratio of Loan & Advances to Total deposit)
because these two are the indicators of credit risk which affect the profitability of banks.
NPL/LA = Ratio of Non-performing loan to loan & Advances)
LA/TD = Ratio of Loan & Advances to Total deposit)
14 | P a g e

STATISTICAL TOOL
The pooled data was analyzed using multiple regression models which adopt Ordinary
Least Square (OLS) model in estimating the parameter of the model and is expressed
as:
ROA = 0 + NPL/LA + LA/TD
EMPIRICAL RESULTS & ANALYSIS OF FINDINGS











Model Summary
b

Mod
el R
R
Square
Adjusted R
Square
Std. Error
of the
Estimate
Change Statistics
Durbin-
Watson
R Square
Change
F
Change df1 df2
Sig. F
Change
1 .519
a
.269 .137 .51998 .269 2.029 2 11 .178 2.596
a. Predictors: (Constant), LATD, NPLLA
b. Dependent Variable: ROA
ANOVA
b

Model Sum of Squares df Mean Square F Sig.
1 Regression 1.097 2 .549 2.029 .178
a

Residual 2.974 11 .270
Total 4.071 13
a. Predictors: (Constant), LATD, NPLLA
b. Dependent Variable: ROA
15 | P a g e


Coefficients
a

Model
Unstandardized Coefficients
Standardized
Coefficients
t Sig. B Std. Error Beta
1 (Constant) .526 1.293

.406 .692
NPLLA -51.425 27.146 -.489 -1.894 .085
LATD .012 .021 .143 .555 .590
a. Dependent Variable: ROA








REGRESSION EQUATION:
ROA = 0 + NPL/LA + LA/TD
ROA = Ratio of profit after tax to total assets.
0 - 2 = Coefficients
NPL/LA = Ratio of Non-performing loan to loan & Advances).
LA/TD = Ratio of Loan & Advances to Total deposit).



Descriptive Statistics

Mean Std. Deviation N
ROA .8593 .55962 14
NPLLA .007093 .0053249 14
LATD 59.6407 6.85067 14
16 | P a g e

APPLYING THE REGRESSION MODEL (LEAST SQUARE MODEL)
ROA = 0.526 -0.489NPL/LA -0.143LA/TD
S.E = 1.293 27.146 0.021
T= 0.406 -1.894 0.555
P= 0.692 0.085 0.590
R
2
= 0.269 , R
2
adjusted
= 0.137

The least square method shows that a negative relationship exist between ROA and the
independent variables NPL/LA and LA/TD.
The result show that the ratio Non-performing loan to loan & Advances negatively relate
to profitability though not significant The parameters shows that increase in the level of
loan & advances to total deposit significantly decrease profitability of the banks by
14.3%, however, increase in non-performing loans decreases profitability (ROA) by
48.9%, this expose them to higher risk level. The study shows that there is a direct but
inverse relationship between profitability (ROA) and the ratio of non-performing loan to
loan & Advances and the ratio of loan & advances to total deposit.
The model further explains that 13.7% variation in the ROA is explained by NPL/ LA and
LA/TD while the remaining 86.3% is unexplained. The mean of the data are ROA
(0.8693), NPL/LA (0.007093) and LA/TD (59.647) while the standard deviations of the
data are ROA (0.55962), NPL/LA (0.0053249) and LA/TD (6.85067).
The test of overall significance of regression implies testing the null hypotheses. The
overall significance of the regression is tested using Fishers statistics. In this study the
calculated F* value of 2.029 is significant at 5%. It is therefore, concluded that linear
relationship exist between the dependent and the independent variables of the model.
The evidence established that the independent explanatory variables (credit risk
indicators) have individual and combine impact on the return of asset of banks.
This study shows that there is a significant relationship between bank performance (in
terms of profitability) and credit risk management (in terms of loan performance). Loans
and advances and non performing loans are major variables in determining asset
quality of a bank. These risk items are important in determining the profitability of banks.
Where a bank does not effectively manage its risk, its profit will be unstable. This means
that the profit after tax has been responsive to the credit policy of bank Alfalah. The
17 | P a g e

deposit structure also affects profit performance. Many highly profitability banks hold a
large volume of core deposits. The growth of loan has been relatively fast for the past
few years and which is not fully covered by the deposit base. Banks become more
concerned because loans are usually among the riskiest of all assets and therefore may
threatened their liquidity position and lead to distress. Better credit risk management
results in better bank performance. Thus, it is of crucial importance for bank Alfalah to
practice prudent credit risk management to safeguard their assets and protect the
investors interests.















18 | P a g e

CONCLUSION AND RECOMMENDATIONS
The study investigated the impact of credit risk on the profitability of Bank Alfalah. From
the findings it is concluded that banks profitability is inversely influenced by the levels of
loans and advances, non-performing loans and deposits thereby exposing them to great
risk of illiquidity and distress.
Therefore, management need to be cautious in setting up a credit policy that will not
negatively affects profitability and also they need to know how credit policy affects the
operation of the bank to ensure judicious utilization of deposits and maximization of
profit. Improper credit risk management reduce the bank profitability, affects the quality
of its assets and increase loan losses and non-performing loan which may eventually
lead to financial distress.
One direct way is to assess the degree of credit crunch by isolating the impact of supply
side of loan from the demand side taking into account the opinion of the firms about
banks lending attitude.
Finally, strengthening the securities market will have a positive impact on the overall
development of the banking sector by increasing competitiveness in the financial sector.
When the range of portfolio selection is wide people can compare the return and
security of their investment among the banks and the securities market operators. As a
result banks remain under some pressure to improve their financial soundness.


19 | P a g e

BIBLOGRAPHY

BANK ALFALAH OFFICIAL WEBSITE
http://www.bankalfalah.com/about-us/financials-results/

THE IMPACT OF CREDIT RISK MANAGEMENT ON THE FINANCIAL PERFORMANCE OF BANKS IN
KENYA FOR THE PERIOD 2000=2006
http://mku.ac.ke/journals/images/Vol2/The%20impact%20of%20credit%20risk%20managem
ent%20on%20the%20financial%20performance%20of%20Banks%20in%20Kenya%20for%20th
e%20period%202000%20%E2%80%93%202006.pdf

EFFECTIVENESS OF CREDIT RISK MANAGEMENT OF SAUDI BANKS IN THE LIGHT OF GLOBAL
FINANCIAL CRISIS: A QUALITATIVE STUDY
http://www.asian-transactions.org/Journals/Vol03Issue02/ATBAS/ATBAS-10305028.pdf

THE IMPACT OF EFFECTIVE CREDIT RISK MANAGEMENT ON BANK SURVIVAL
http://rmr.lixin.edu.cn/files/100134/1110/109_1392b787e1b.pdf








20 | P a g e

APPENDIX

14 YEARS DATA
ROA NPL LA NPL/LA LA/TD
2000 0.89 103950 15242317 0.0068 72.42
2001 0.9 13705 19131494 0.0007 63.33
2002 0.85 53619 28319401 0.0019 54.79
2003 2.59 87091 49216120 0.0018 64.17
2004 0.86 370208 88931400 0.0042 68.56
2005 0.84 402298 118864010 0.0034 53.46
2006 0.67 697690 149999325 0.0047 62.63
2007 1.04 2370867 171198992 0.0138 62.67
2008 0.38 2035997 191790988 0.0106 63.77
2009 0.24 3694546 188042438 0.0196 57.9
2010 0.24 2243687 207152546 0.0108 58.52
2011 0.8 1864510 198468512 0.0094 49.46
2012 0.91 1848535 233933358 0.0079 51.18
2013 0.82 954563 260779850 0.0037 52.11


KEY

ROA RETURN ON ASSETS
NPL NON-PERFORMING LOANS
LA LOANS AND ADVANCES
TD TOTAL DEPOSITS