Presentation

A Conceptual Framework for

Selection of Entrepreneurs
by Commercial Banks in Bangladesh
Presented By:

MD. ARMAN HOSSAIN A.B. (30006)

MUHAMMAD NURUL AMIN (30078)
HAFIZUR RAHMAN (30041)
MD. ABU HANIF (30040)
ABDUR RAZZAK (26012)

A Brief Summary of Our

Topic

Selection
Criteria for
Financing

Importance
Entrepreneu
of
rs
Entrepreneu
rs Selection

Factors
Influencing
the
Behavior of
an
Economic
Entrepreneu
Theory of
r
Entrepreneur
Assessmen s Selection
t of Credits
&
Attractivene Performanc
ss
e

Assessmen
t of Risk of
Commercia
l Bank
Credit

Importance of Entrepreneurs Selection:

Surplus

Deficit

Units

Units

Entrepreneur
s are the
Real Risk
Takers of the
Economy

Banks
Credit
Manageme
nt

Selection of
right
Entrepreneurs

The Default Rate

of Credit

Safety Zones Surrounding the Funds Credited by

a Bank.:
Personal
Guarantees

Personal Guarantees and pledges

made by the owners of a business
firm or by cosigners to a credit

Balance
Sheet

Resources on the Customers

Balance Sheet

Expected
Cash flow

Customers Expected Profits,

Income or Cash Flows

Which option among these three should be more logical?

Balance
Sheet

C as
h
flow

io
at
bin
m n
Co

nal
o
s
Per antee
r
Gua s

More
However, The most outer or remote safety zone of a credit is the
guarantee from the borrowers or cosigners where they pledged their
personal assets to back the credit taken from the bank. On the other
hand, income and cash flow from business are to be the primary safety
zones of a credit and these are actually preferred sources of ensuring

Assessment of Credits
Attractiveness..:

Potential Success of
Credit

Innovative
Idea
Gathering
ideas
both
internally
and
externally

Capacity
Building
Legal
Aspects
Extra
ordinary
quality,
confidenc
e and
skills

Trade
License
and Other
Document
s

Feasibility
Analysis of
Expected
Cash flows

Waste
managem
ent,
Ecological
Balance
etc

Coordinatio
n of

Knowledge
and
Experience

Environment
al Issues

Determinati
on
Financial
Aspects

Ethical
Issues
Maintaini
ng ethical
standards
Future
developm
ent of
business

R&D

Case study:

Bank lending decisions using projections

Loan Application.:
Suppose, PAPERBASISs working capital line of credit is approaching its renewal date.
Mr. Tison - the manager and business owner of the firm, wants to renew the line at a
higher (by 10%) amount and at better terms. He thinks sales will slightly increase,
but in his opinion, the present $500 working capital line should not be necessary for
receivables and inventory financing. Further, Mr. Tison indicated that he will not
need to spend external funds on new equipment.

Process of Bank Assessment:

Mr. Tisons request is very typical. Every business owner is interested in
making money. The starting point for making money is focusing on
revenue, as Tison has done. It is the starting point for virtually every
planning or budgeting process, whether highly informal and carried around
in the owners head or very structured and contained in countless papers
and reports. Though acknowledged, balance sheet accounts are often an
afterthought. In making his request, Mr. Tison did not necessarily comment
on his precise expectations about accounts receivable or inventory. He
intuitively ignores that even if sales increase his accounts receivables or
inventories are likely to decrease and as a consequence (held other
parameters constant) borrowing
needs
to be lower, at least in the short
Banks
Decision.:
term.

Bank decided to reject the credit application because of the

abnormality in projections.

Verification of Documents
The existence of the company/ business, its
directors/business owners legality of borrowing.
The business operations risks and management
depth, experience and expertise of the owners.
The financial strength and repayment capability
(including the cash flow) of the borrower.
The operating risks of the business
The strategy plans of the borrower to mitigate such
risks and maximize profitability
The borrowing needs proposed facilities are in line
with the.
The overall risk associated with the proposed
borrowing.

The Determinants of Probability of

Default
The probability of default refers to the ability or capacity of a
borrower to service/repay debt obligations. The higher this ability,
the less likely the borrower will default. For a corporate borrower,
its repayment ability is determined by various factors including
business and financial performance, industry trends, management
experience and strategies, funding lines, parental support etc.
Academic theory/research which highlight various indicators
from corporate financial statements that are predictive of
creditworthiness
Past experience although not necessarily perfect, the past is a
useful predictor of the future. Thus, a bank can use its past
experience to identify key default drivers and develop a rating
model.

Economic Theory of Entrepreneurship

Selection and Performance
Education as a Determinant of Entrepreneurship Selection and
Performance
The level of education might influence the propensity to become
self-employed through several channel. Education enhances
managerial ability, which increases the probability of entrepreneur.
Working in the opposite direction, higher levels of education might
generate better option and thus decrease the likelihood of
entrepreneurship.
Education may also influence entrepreneurship performance in
several ways.

The main factors affecting earnings are schooling and experience.

This specification and the implied positive returns to schooling
have found empirical support in the wage sector. This reasoning
would seem to apply in other occupational sectors as well, such as
entrepreneurship, but little systematic work has been done on the
subject. Schooling is acknowledged both for its productive effect
on the quality or quantity of labor supplied, as assumed by Mincer,
and for its value as a signal of productive ability in labor markets

Lending Technologies and the Supply of

Entrepreneurs Credit
Researchers looked more closely at each of the lending
technologies: the five transactions technologies. In addition to
a brief description of each technology, they highlighted the
nature of the information used in underwriting by each
technology (e.g., soft vs. hard), and how each technology
solves the opacity problem. They also discussed how the
financial institution structure and the lending infrastructure
affect the feasibility and efficacy of each technology.
Financial Statement Lending
Small Business Credit Scoring:
Asset-Based Lending
Factoring
Trade Credit
Relationship Lending

Agenda.:
Analysis of Entrepreneurs Selection.
Analysis of Entrepreneurs Skills.
Risk Factors of Commercial Bank Loan.
Hierarchy Model of Commercial Bank Loan Risk.

13

Analysis of Entrepreneurs Selection

Management Aspect
Marketing Aspect

Technical Aspect:
Financial Aspect

10/15/16

14

Analysis of Entrepreneurs Skills

Entrepreneurship Skills:

Technical Skills

Management Skills:

10/15/16

15

Assessment of Risk of Commercial Bank

Credit
Object Risks
Terms Risks

Management Risks
Environment Risks

10/15/16

Loan

System

16

Hierarchy Model of Commercial Bank Loan Risk

Sub-Index

Index

Goal

Define the set of loan risks as A, loan object risks A1, loan terms risks A2,
management risks A3, system environment risks A4, define weight as
W=(W1 W2 W3 W4) then subdivide the four factors,
A1=(S1 S2 S3 S4 S5) A2=(S6 S7 S8 S9) A3=(S10 S11,S
12 S13) A4=(S14 S15 S16).

Case study: Sallys loan is rejected because of the

probability of repayment uncertainty
Sally applied for a business loan at her bank. She wanted to borrow
$10,000 to buy machinery. She thought the bank would accept her loan
application as her sales projection is enough to cover her loan repayments.
Sally was disappointed when the bank rejected her application. They felt
she would not be able to make the loan repayments as she also has a
$5000 debt to pay off and no savings in her bank account. Sally decided to
focus on paying off her debt andbuild upsome savings before she applied
for another loan.

Observation of Previous Practices of Lending Risk

Analysis

The Financial Sector Reform Program (FSRP) was

introduced in the early nineties in Bangladesh with
a view to bringing about financial discipline by
undertaking appropriate reform measures in the
financial sector. The program was undertaken by
the Government of Bangladesh with combined
support of the World Bank and USAID under the
Structural Adjustment Program.

Observations on Recent Risk Management Practices in

Banks in Bangladesh

Bangladesh Bank issued its BRPD Circular No. 17

dated October 07, 2003 advised all the scheduled
banks to put in place an effective risk management
system by December, 2003 based on the certain
guidelines furnished to them. It appears from the
circular that the banking industry is completely
different from other industries in terms of the diversity
and complexities of the risks they are exposed to.

Definition of Credit Risk

It is defined as the possibility that a borrower will fail to
repay his/her debt (s) to the bank/lender on the due
date.
When the bank/lender is unable to collect the debt (s)
from the borrower (s), the bank/lender will be short by
the amount of cash that the borrower has failed to
repay.
Another terminology that can be used to describe such a
risk factor - Risk of Default.
As a bank or any financial services providers credit risk
increases over time, this institution is compelled to make
provision to write off the debt (s) in its books of account.
Loans written-off translates into an operating expenses.

Specific factors for credit approval for

business customers

Internal factors

Financial risk
Assessment of the existing financial position
Assessment of the expected financial position
Accounting quality
Business risk
Market position
Operating Efficiency
Management risk
Management business expertise
Payment record
External factors
Conditions in the respective economic sector of activity
Economic trends in the industry of activity

A Typical Example of Credit

Risk
Suppose, I took a loan of US$1,000 from Citibank at the
interest rate of 5% per annum for a period of 5 years.

I repaid for the first 6 months regularly and then

stopped
repaying the loan on month 7 because I have made
other commitment elsewhere.

Is Credit Risk Important for a

Bank?
For most banks, loans are the largest asset on the banks
Balance Sheet, and obviously the major source of credit risk.
Besides loans, there are other pockets of credit risk, both on
and off-balance sheet such as:
(a)Investment portfolio,
(b)Overdrafts,
(c)Letters of credits (L/Cs), and
(d)Guarantees.
If a bank or financial institution does not ensure that there
is a systematic credit appraisal system in place, then this
bank is likely to become heavily exposed to credit risk.

Introduction of Credit Risk Grading (CRG)

System in Credit Operations
The

risks

associated

with

the

borrower

or

counter-party need to be carefully and critically

analyzed before funding to the clients business.
To quantify the risk exposure, it should be graded
as per credit risk score sheet by the individual
banks in line with the guidelines of CRG Manual.

A Typical Risk Grading (Credit Rating) System

under CRG Manual