Академический Документы
Профессиональный Документы
Культура Документы
Literature Review
1.1 Adverse selection in corporate lending context
Adverse selection, anti-selection, or negative selection is a term used in economics, insurance, risk
management, and statistics. It refers to a market process in which undesired results occur when buyers
and sellers have asymmetric information (access to different information); the "bad" products or services
are more likely to be selected.
Adverse selection occurs when a product or service is selected by only a certain group of people who
offer the worst return for the company. Adverse selection occurs because of information asymmetries and
difficulties in selecting customers.
1.2 Consequence of adverse selection
Information imperfections, such as asymmetric information, are important frictions in financial markets.
Even in normal times, borrowers in credit markets often know more than lenders about the quality of the
collateral and the riskiness of their investments. If high- and low-risk borrowers are indistinguishable,
then high-risk borrowers benefit at the expense of low-risk borrowers. The resulting problem of adverse
selection (when high-quality borrowers choose not to participate in the market) leads to higher interest
rates and a decrease in lending.
In the presence of asymmetric information, a small increase in the interest rate can lead to a large
reduction in lending. A higher interest rate increases the likelihood that high-quality borrowers will
withdraw from the market, aggravating the problem of adverse selection. As a result, the average quality
of the borrowers falls, which in turn raises the interest rate even further. If adverse selection is severe
enough, the credit market may collapse. Adverse selection may cause banks to impose credit rationing
putting quantitative limits on lending to some borrowers.
1.3 Measures to tackle adverse selection
In some situations, the problem of adverse selection is mitigated by signaling: letting participants in the
marketplace who possesses inside information take actions that will reveal the nature of that unique
information of those potential participants.
In case of corporate customers, one signal could be the actions taken by an insider. An insider who knows
her company is experiencing financial turmoil may give off this signal by selling the companys stock. If
the public happens to see insiders selling out, they too may begin to sell, ultimately driving the value of
the companys stock lower in the financial marketplace. An astute banker may notice this falling stock
price and may choose a stringent evaluation of credit worthiness of that company.
By limiting the supply of loans, banks can reduce the average default risk and therefore alleviate adverseselection problems. Another way to reduce adverse selection is to require collateral for the loan. With
collateral, even if the borrower defaults, the lender can recover losses by selling the collateral. Therefore,
the asymmetric information about the borrowers default probability becomes less important.
duties, and internal control & compliance guidelines have been specifically set to establish a benchmark
in order to prevent the intentional or accidental adverse selection problem. On the other hand, the
procedural guidelines of the policy is outlined with approval process, credit administration, credit
monitoring, and credit recovery to help the employees correct any inadvertently performed adverse
selection mishaps to be rectified in an efficient manner.
2.1 Lending Guidelines
a. Industry & Business Segment Focus:
The Bank focused on Industry and Business Segmentation to diversify the concentration or pool of
exposures effect, whose collective performance has the potential to affect the bank negatively even if
each individual client of an industry is financially sound. To reduce this effect, the bank directed
industry specific expansion, reduction or maintenance of status quo, and exposure cap in terms of
lending; it also specified exceptions where lending can be opted beyond these guidelines which must
cite clear & financially viable supportive logic favoring the exceptions and be duly approved by the
Board of Directors.
b. Types of Loan Facilities & Parameters:
Depending upon the nature of financing in respect of purpose, security as well as repayment terms,
loan facilities in DBL have been put under following broad categories:
Overdrafts
Cash Credit
Demand Loan
Term Loan
Short Term Loan
House Building Loan
Transport Loan
Lease Finance
Syndicated Loan
Foreign Bills Purchased
Letter of Credit as well as Back-to-Back
Payment against Documents [PAD]
Loan against Imported Merchandise [LIM]
Loan against Trust Receipt [LTR]
Time Loan
Packing Credit
Export Cash Credit
Foreign Documentary Bill Purchased [FDBP]
Inland Documentary Bill Purchased [IDBP]
Inland Bills Discounting
Bank Guarantee
Similar Islamic Banking Products
Consumer Loans: Credit Card, Education Loan, Home Loan, Car Loan
SME Loans
Offshore Banking Facilities
Agricultural Finance
These loan facilities categorize different customer needs and satisfy the exact ones that in the
very first place diminish the probability of adverse selection by a great lot. The set parameters against
each loan facility help credit managers identify customer needs quickly and cater them accordingly.
f. Others:
The policy also includes guidelines on clients credit rating (both foreign & domestic) to reduce
default risk along with cross border risk, specified credit principles, loan pricing strategy etc.
Though the bank understands that the future of a credit can anytime go off course due to
unforeseeable events, it also emphasizes on the complete and proper appraisal of credit proposals to
minimize the probable loss arising from future loan classifications. It compels that any and every credit
facilities should be reassessed on an annual basis beyond its regular periodic assessment.
The banks CRM policy includes in its latter part the monitoring process & recovery of loans
classified. The policy states that there will be the following types of monitoring processes with
simultaneous client correspondence in effect:
Ongoing monitoring of accounts: specific directional guidelines & techniques
Weekly Monitoring: Expired, Excess of Limit, Overdue accounts
Onsite visit: Frequency of Clients business/mortgaged property visit & immediate call report with
specified contents
Central Early Alert Report: Branch through Monitoring Unit to Management Credit Committee
Continuous client correspondence as well as arrangement of inter-alia meetings between banks &
clients senior as well as top management
To emphasize the recovery activities more, the bank segregated legal affairs & recovery division
from monitoring, processing and marketing function. Hence, the recovery division will solely
oversee the following relevant activities process flows of which are described as detailed guidelines
in the policy:
To undertake necessary recovery responsibilities of classified accounts from SMA to BL
To complete the transfer of account as per outlined Account Transfer Procedure
To comply with related Bangladesh Bank Guidelines and prevalent laws of land
To prepare periodic action plan
Quarterly Classified Loan Review
Ensure, implement & follow up of proper & timely legal action as well as court proceedings
Proper negotiation process with the classified borrowers outside court proceedings for mutually
favorable repayment
Annual Review of third party recovery agents performance
Approval for inclusion/deduction of recovery agents along with enlistment of panel lawyers
Conducting monthly recovery meeting and periodic portfolio review meeting
Non-Performing Loan (NPL) monitoring through quarterly updates & action plans
NPL Provisioning & Write off procedure
Periodic Incentive Program to boost up recovered amount