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Risk is the element of uncertainty or possibility of loss that prevail in any business
transaction in any place, in any mode and at any time. In the Commercial Bank arena,
enterprise risks can be broadly categorized as Credit Risk, Operational Risk, Market Risk and
Other Risk. Credit risk is the possibility that a borrower or counter party will fail to meet
agreed obligations. Globally, more than 50% of total risk elements in banks are Credit Risk
alone. Thus managing credit risk for efficient management of a Commercial bank has
gradually become the most crucial task.
Credit risk management encompasses identification, measurement, matching mitigations,
monitoring and control of the credit risk exposures to ensure that:
I.
II.
III.
IV.
V.
VI.
Credit risk management needs to be a robust process that enables commercial banks to
proactively manage facility portfolios in order to minimize losses and earn an acceptable
level of return for shareholders. Central to this is a comprehensive IT system, which should
have the ability to capture all key customer data, risk management and transaction
information including trade & Forex. Given the fast changing, dynamic global economy and
the increasing pressure of globalization, liberalization, and consolidation it is essential that
commercial bank have robust credit risk management policies and procedures that are
sensitive and responsive to these changes.
Objectives
Broad Objective
To discuss the overall activities performed in Credit Risk Management in comparison to the
guidelines prescribed by Bangladesh Bank.
Specific Objectives
Credit Risk Management Practice in Nationalized Commercial Bank, Islamic Bank
& Foreign Bank: To have better orientation on credit management activities specially
credit policy and practices, credit appraisal, credit-processing steps, credit
management, risk grading, classification method and practices.
To compare the functions performed in CRMS of commercial bank with the CRM
policy formulated by Bangladesh Bank.
To identify and suggest scopes of improvement in credit management.
To reduce the lender's credit risk, the lender may perform a credit check on the prospective
borrower, may require the borrower to take out appropriate insurance, such as mortgage
insurance or seek security or guarantees of third parties, besides other possible strategies. In
general, the higher the risk, the higher will be the interest rate that the debtor will be asked to
pay on the debt.
3. Country risk - The risk of loss arising from sovereign state freezing foreign currency
payments (transfer/conversion risk) or when it defaults on its obligations (sovereign
risk).
The factors to be taken into account in drawing up the decision-making structure for
non-standardized credits such as corporate and SME lending are the following:
1. Level of Exposure: The level of exposure plays a decisive role in stipulating
the decision-making structure. This is reflected in the fact that in most cases,
the different levels of authority are defined by the level of exposure.
2. Value of Collateral: The value of the collateral restricts the unsecured portion
of the exposure and is therefore also of great significance. In most cases, the
translation of this criterion is effected by showing separately the maximum
unsecured volume within the scope of a level of authority.
3. Type of Borrower: There are credits to Banks, to sovereigns, which are
different from facilities to corporate and private customers because of the high
volumes involved. As a result, the volumes used to define the levels of
authority have to be determined separately depending on difference in risks
associated.
4. Probability of Default: The customer rating is usually taken as an indicator of
the probability of default in this case. As such, decision making structure may
commensurate with the risk hierarchical level of risk grading.
course of the credit approval process. Standardization can help reduce both sources of
errors considerably. On the one hand, the shorter and usually rigid process structure
allows less procedural errors to be made, and on the other, the credit rating processes
applicable to standardized credits make it possible to assess the credit standing based
on empirical statistical analyses and thus independently of the subjective evaluation of
a credit officer or account manager.
The standardized retail business in particular including home loan and car loan etc.
does mostly without individual interventions in the credit decision process, with the
result of the standardized credit rating process being the major basis for the credit
decision. Increasingly, mostly automated decision processes are also used in the small
business segment. The prerequisite is a clear definition of the data to be maintained
for this customer segment.
PREFERRED RISK MANAGEMENT STRUCTURE & RESPONSIBILITIES
To maintain FIs overall credit risk exposure within the parameters set by the Board of
directors, the importance of a sound risk management structure is second to none. The
appropriate organizational structure must be in place to support the adoption of the
policies. While the commercial bank may choose different structures, it is important
that such structure should be commensurate with institutions size, complexity and
diversification of its activities. The key feature is the segregation of the
Marketing/Relationship
Management
function
from
Approval/Risk
The Board of Directors should have the overall responsibility for management of
risks. The Board should decide the risk management policy of the commercial banks
and set limits for liquidity, interest rate, foreign exchange and equity price risks.
The Risk Management Committee will be a Board level Sub-committee including
CEO and heads of Credit, Market and Operational Risk Management Committees. It
will devise the policy and strategy for integrated risk management containing various
risk exposures of the FI including the credit risk. For this purpose, this Committee
should effectively coordinate between the Credit Risk Management Committee
(CRMC), the Asset Liability Management Committee and other risk committees of
the FI, if any. It is imperative that the independence of this Committee is preserved.
The Board should, therefore, ensure that this is not compromised at any cost. In the
event of the Board not accepting any recommendation of this Committee, systems
should be put in place to spell out the rationale for such an action and should be
properly documented. This document should be made available to the internal and
external auditors for their scrutiny and comments. The credit risk strategy and policies
adopted by the committee should be effectively communicated throughout the
organization.
Each bank may, depending on the size of the organization or facility/ investment
book, constitute a high level Credit Risk Management Committee (CRMC). The
Committee should be headed by the Chairman/CEO/ED, and should comprise of
heads of Credit Department, Treasury, and Credit Risk Management Department
(CRMD). The functions of the Credit Risk Management Committee should be as
under:
1. Be responsible for the implementation of the credit risk policy/ strategy
approved by the Board.
2. Monitor credit risk on a wide basis and ensure compliance with limits
approved by the Board
3. Recommend to the Board, for its approval, clear policies on standards for
presentation of credit proposals, commercial banks financial covenants, rating
standards and benchmarks .
4. Taking decisions in terms of capital allocation and design limits in line with
the risk strategy
5. Decide delegation of credit approving powers, prudential limits on large credit
exposures, standards for facility collateral, portfolio management, facility
review mechanism, risk concentrations, risk monitoring and evaluation,
pricing of facilities, provisioning, regulatory/legal compliance, etc.
Concurrently, each FI should also set up Credit Risk Management Department
(CRMD), independent of the Credit Administration Department. The CRMD should:
1. Measure, control and manage credit risk on an organization basis within the
limits set by the Board/ CRMC
2. Enforce compliance with the risk parameters and prudential limits set by the
Board/ CRMC
3. Lay down risk assessment systems, develop MIS, monitor quality of facility/
investment portfolio, identify problems, correct decencies and undertake
facility review/audit. Large Fi could consider separate set up for facility
review/audit.
4. Be accountable for protecting the quality of the entire facility/ investment
portfolio. The Department should undertake portfolio evaluations and conduct
comprehensive studies on the environment to test the resilience of the facility
portfolio.
Credit risk committees must be distinguished from those committees (often referred to
as credit committees) which have to make decisions on credit approval, extension etc.
The committee usually meets at least once a month and whenever necessary. The
advantages of the committee structure are the holistic perspective of the credit risk,
the possibility to make decision based on this holistic approach, as well as the fact that
several areas can be integrated resulting in better acceptance of the decisions.
Similarly, the integration of the chief risk and institution-wide risk management
control ensures that the credit risk is analyzed with regard to the FIs overall risk.
CREDIT ADMINISTRATION
The Credit Administration function is critical in ensuring that proper documentation
and approvals are in place prior to the disbursement of financial facilities. For this
reason, it is essential that the functions of Credit Administration be strictly segregated
3. Credit Monitoring: After the facility is approved and draw down allowed, the
facility should be continuously watched over. These include keeping track of
borrowers compliance with credit terms, identifying early signs of
irregularity, conducting periodic valuation of collateral and monitoring timely
repayments.
CREDIT MONITORING:
To minimize credit losses, monitoring procedures and systems should be in place that
provides 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:
1. Past due principal or interest payments, past due trade bills, account excesses,
and breach of facility covenants
2. Non-receipts of financial statements on a regular basis and any covenant
breaches or exceptions made
3. Action not taken on time for findings of any internal, external or regulator
inspection/audit
Credit Recovery
The Recovery Unit (RU) of CRM should directly manage accounts with
sustained deterioration (a Risk Rating of Sub Standard (6) or worse). bank may wish
to transfer EXIT accounts graded 4-5 to the RU for efficient exit based on
recommendation of CRM and Corporate FI.
The bank has a clearly-established process in place for approving new credits
as well as the extension of existing credits. A through credit risk assessment is
done before granting loan. The credit risk assessment includes Financial
performances, the conduct of the account and security against the proposed
loan. The assessment originates from relationship manager/account officer
and approved by credit committee at head office. The credit committee under
delegated authority approves the credit proposals.
5.
monitor risk viz. credit risk through credit review committee and risk
management units.
2. The bank has in place a system for monitoring the condition of individual
credits, including determining the adequacy of provision and reserves. For
NPL provisioning and write off the guidelines established be Bangladesh Bank
for CIB reporting, provisioning and write off of bad doubtful debts and
suspension of interest are followed in all cases.
3. The bank has in place a system for monitoring the overall composition and
quality of the credit portfolio. All credit extensions must comply with the
requirements of the banks memorandum and articles of the association, Bank
Company Act, 1991 as amended from time to time, Bangladesh Banks
instruction circulars, guidelines and other applicable laws, rules and
regulations, Banks credit risk management policy, credit operational manual
and all relevant circulars in force. Any deviation from the internal policy of the
bank must be justified and well documented. The portfolio shall always be
well diversified with respect to sector, industry, geographical region, maturity,
size, economic purpose etc. Concentration of credit shall be carefully avoided
to minimize risk.
To ensure adequate controls over credit risk Conventional Fi maintains
followings values:
1. Commercial Bank has a system in place for managing problem credits and
various other workout situations. All NPLs are assigned to account manager
within the recovery department, which is responsible for coordination and
administering the action plan, or recover of the account and serve as the
primary customer contact after the account is downgraded to substandard.
2. Commercial Bank ensures that the credit granting function is being properly
managed and that credit exposures are within levels consistent with prudential
standards and internal limits. The bank has established and enforced internal
controls and other practices to ensure that exceptions to policies, procedures
and limits are reported in a timely manner to the appropriate level of
management.
3. Commercial Bank has established a system of independent, ongoing credit risk
review and the results of such reviews are communicated directly to the board
of directors and senior management.
either by himself or by delegation from his partners or his establishment, and his
ability to generate income in future, because the repayment of the debt depends on
his cash receipts and payments.
2. Taking of collateral and personal and tangible securities along with an emphasis on
the ability of the bank to redeem its claims from these. Credit, however, is not
granted on the basis of the strength of collateral and guarantees, but on the ability of
the client to pay.
3. The economic circumstances in general and the special circumstances of the sector
that generates the income of the client. The inclination and the ability of the client to
abide by his obligations may be up to the desired level, but a change in the
environment in which the client operates, may force him to default or to
procrastinate due to reasons that are beyond his control.
1. The administration of PLS modes is more complex than conventional Financing. These
modes imply several activities that are not normally performed by conventional banks,
including the determination of profit / loss sharing ratios on investment projects in various
sectors of the economy, as well as the ongoing auditing of Financed projects to ensure proper
governance is doing. Also, there is a number of activities that Islamic banks can engage in, in
addition to a number of ways they can provide funds through the use of the PLS and non-PLS
modes.
2.
In this case the low profit or loss is shared between parties according to stipulated PLS ratios.
Islamic banks have no legal means to control the entrepreneur who manages the business
Financed through Mudarabah contracts. This individual has complete freedom to run the
enterprise according to his judgment. Banks are entitled only to share profit or loss from the
agent according to the contract ratio. In Musharakah and direct investment contracts, banks
have better opportunities to monitor the business because, in these contracts, partners may
influence on the enterprise and use the voting rights. In Islamic Finance PLS modes cannot
logically be made with collateral or other guarantees to reduce credit risk.
Islamic banks have historically been forced to hold a large proportion of their
assets in reserve accounts in central banks or in correspondent accounts than
conventional banks. This has significantly affected their profitability because
central banks give minimum or no return to these reserves. This in turn, has
affected their competitiveness and increases their potentiality to the external
shocks with its consequences.
3. Increasing the ability of banks to attract more demand deposits which are not
remunerated. On the part of bank, these deposits may share the same risks as
investment deposits.
4. To prevent a gradual destruction of investment deposits in the event of losses,
which may to lead a liquidity crisis which Islamic banks are perhaps less well
equipped than traditional banks.
5. To take into account the fact that Financing through PLS and non-PLS modes
comprise several unique forms of risks that need to be considered and also
monitored, depending on the specific nature of the contracts and the overall
environment.
Lending guidelines prior to facility approval in are:Project profile- Bank identifies whether the loan is for productive purpose or for nonproductive purpose.
Ratio Analysis- Evaluating the future performance of the borrower.
Financial Statement Analysis Evaluation of the borrowers present performance
Management- Citibank outsmarts the management to borrowers
Collateral- Security asset of the borrower should be closely monitored
External Issues- Tackling the unforeseen situation. Citibank Sensing the recent recession in
advance, it has cut its loans and advances by more than 30 percent.
Documentation- CRMS Unit ensures that the required documents are in place (or deferral
has been obtained) prior to releasing lines of the system. Facilities will be released only to the
extent completed and duly executed documentation is available.
Recommendations:
Policies and regulations are robust and much strict when it comes to the point of Credit Risk.
The ICG risk manual completely outlines the overall process of CRM from the starting point
to the end. It has described the roles of every single person associated to the process of CRM.
There is a separate group of employees who act as Risk Officers and assess the risk
vulnerability of the credits. So, one must say that the risk mitigation is in place from the very
beginning of the credit approval process.
But there are some irregularities in the case of loan monitoring. The creditworthiness and
changing financial abilities of the borrowers should be much more strictly monitored by RMs
as well as other officials to minimize the percentage of Non-Performing Loans (NPL) and
default. CIB reports should be more intensely checked on a regular basis so that there is no
compromise with the classified borrowers. In Bangladesh the Credit Information Bureau has
come up to gather and provide all borrowing customer related information. CIB is yet to
provide reliable data as its database is solely dependent on the reports provided by scheduled
banks. All these banks submit a regulatory report named Monthly CIB Online Report
which details the existing outstanding of the borrowers with those banks. But the banks are
not submitting the report prudently with accurate data. As a result the actual scenario is not
perfectly reflected in the CIB reports of the borrowers. So, there is a gap between actual
creditworthiness of the borrower and the findings from the report about the borrowers.
In case of classified customers the credit lines can be restricted to a lower amount as the
deterioration of the classification status may subsequently lead to non-performance and nonrepayment of the credit facilities.