Credit Management Policy of AB Bank Ltd

INTRODUCTION:

Risk is inherent in all aspects of a commercial operation, however for Banks and financial institutions, credit risk is an essential factor that needs to be managed. Credit risk is the possibility that a borrower or counter party will fail to meet its obligations in accordance with agreed terms. Credit risk, therefore, arises from the bank’s dealings with or lending to corporates, individuals, and other banks or financial institutions.

Credit risk management needs to be a robust process that enables banks to proactively manage loan 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, consolidation and dis- intermediation, it is essential that banks have robust credit risk management policies and procedures that are sensitive and responsive to these changes.

The purpose of this document is to provide directional guidelines to the banking sector that will improve the risk management culture, establish minimum standards for segregation of duties and responsibilities, and assist in the ongoing improvement of the banking sector in Bangladesh.

ORIGINS OF THE REPORT:   

The Report Titled “Credit Management Policy” A Case Study On AB Bank Is A Partial Requirement Of The BBA Program. The Internship Program Was Carried Out In Commercial Credit Division Main Branch Of AB Bank Under The Supervisor. During The Internship The Student Are Required To Prepare A Report On The Organization Where He Has Been Attached.

Assigned By The Guide Teacher This Report Is Prepared As Partial fulfilment Of BBA Requirement

OBJECTIVE OF THE REPORT

The Principal Intent Of This Report Is To Examine Credit Policy 0f Ab Bankltd. In Particular The Objectives Are Follws:

1 To Have A Glance At The Commercial Banking System In Bangladesh.

2 To Examine The Present Banking System In Bangladesh.

3 To Get Aquainted With The Loan Structure Size Profile Of Sector Wise Outstanding Position Of Loans And System Of Loan Classification Of AB Bank .

4 To Know The Deposit Behavior Of NCBs FCBs PCBs And AB Bank And To Cross Examine Any Structural Changes Regarding Deposit Behavior.

5 To R\Examine The Credit Operations By Our Commercial Banking System

6 To Explain The Procedures Systems Of Credit Management And Appraisal Of Ab Bank.

7 To Find Out The Nature And Size Of Problem Loans In Ab Bank

8 To Find Out The Causes Of Problem Loan

9 To Analyze The Effects Of Problems Loan On Income Of Ab Bank.

10 To Evaluate The Various Loans Programs Of Ab Bank Which Includes Industrial Trade And Commerce Transport Etc.

11 To Inspect The Recovery Of Loans Of AB Bank

12 To Examine Whether The Attributes Of Gook Performance Are Observed In AB Bank.

SCOPE OF THE STUDY

AB Bank Ltd. Is one of the leading and first commercial Bank in Bangladesh. The scope of the study is limited to the Board Bazar Branch-Gazipur only. The report covers the organizational structure,background,functions and the performance of the bank.

LIMITATIONS OF THE STUDY

The following limitations are apparent in the report:

• Deficiencies in data required for the study.
• Inaccurate or contradictory information.
• Field practice varies with the standard practice that also created problem.

 METHODOLOGY

To prepare the report following methodology is adopted: For the procedure of different banking operations I had observed the operations and worked with  the officers at the same time I had interviewed the
AB bank officials for getting more information. For the analysis part data have been collected from

• Different statement and the annual reports of the bank.
• Various files and documents of credit and industrial credit division of AB bank Ltd.

PART-TWO

BANKING IN BANGLADESH

Bangladesh’s New Banking System

After the liberation, the banking system in Bangladesh was put back to life through presedential Order No.26 titled Bangladesh Banks Nationalosation Order,1972. At the same time another order known as Bangladesh Bank Order,1972 was promulgated to create the country’s central Bank-Bangladesh Bank- to take over the assets,liabilities and responsibilities of the erstwhile State Bank of Pakistan.

In the early 1980s began the dream run of the private sector that had long been waiting in the wing to emulate their pre-liberation counterparts to get into the lucrative business of Banking. However,the first of the commercial banks set up in the private sector was Arab Bangladesh Bank Ltd on a jpint venture basis in 1981-82.

This was followed by three rounds of bank licensing creating the so called three generations of commercial banks each corresponding to the period of rule of three main political parties. As expected, political patronages weighted heavily in the grant of licenses.

Number and Types of Banks

The financial system of Bangladesh consists of Bangladesh Bank (BB) as the central bank, 4 State Owned Commercial Banks (SCB), 5 government owned specialized banks, 30 domestic private banks, 9 foreign banks and 29 non-bank financial institutions. Moreover, MRA has given license to 298 Micro-credit Organizations. The financial system also embraces insurance companies, stock exchanges and co-operative banks.

Central Bank

Bangladesh Bank
Pursuant to Bangladesh Bank Order, 1972 the Government of Bangladesh reorganized the Dhaka branch of the State Bank of Pakistan as the central bank of the country, and named it Bangladesh Bank with retrospective effect from 16 December 1971.

State-owned Commercial Banks

The banking system of Bangladesh is dominated by the 4 Nationalized Commercial Banks , which together controlled more than 54% of deposits and operated 3388 branches (54% of the total) as of December 31, 2004^[1]. The nationalized commercial banks are:

Specialised Bank of Bangladesh:

• Karmosangesthan Bank
• Bangladesh Krishi Bank

• Sonali Bank
• Janata Bank
• Agrani Bank
• Rupali Bank

Private Commercial Banks

Private banks are the highest growth sector due to the dismal performances of government banks (above). They tend to offer better service and products.

1. AB Bank Ltd
2. BRAC Bank Limited
3. Eastern Bank Limited
4. Dutch Bangla Bank Limited
5. Dhaka Bank Limited
6. Islami Bank Bangladesh Ltd
7. Pubali Bank Limited
8. Uttara Bank Limited
9. IFIC Bank Limited
10. National Bank Limited
11. The City Bank Limited
12. United Commercial Bank Limited
13. NCC Bank Limited
14. Prime Bank Limited
15. SouthEast Bank Limited
16. Al-Arafah Islami Bank Limited
17. Social Islami Bank Limited
18. Standard Bank Limited
19. One Bank Limited
20. Exim Bank Limited
21. Mercantile Bank Limited
22. Bangladesh Commerce Bank Limited
23. Mutual Trust Bank Limited
24. First Security Islami Bank Limited
25. The Premier Bank Limited
26. Bank Asia Limited
27. Trust Bank Limited
28. Shahjalal Islami Bank Limited
29. Jamuna Bank Limited
30. ICB Islami Bank
31. Moon Bank Limited
32. Bank Limited

Foreign Commercial Banks

1. Citibank na
2. HSBC
3. Standard Chartered Bank
4. Commercial Bank of Ceylon
5. State Bank of India
6. Habib Bank
7. National Bank of Pakistan
8. Wo Bank
9. Bank Alfalah

Specialized Development Banks

Out of the specialized banks, two (Bangladesh Krishi Bank and Rajshahi Krishi Unnayan Bank) were created to meet the credit needs of the agricultural sector while the other two ( Bangladesh Shilpa Bank (BSB) & Bangladesh Shilpa Rin Sangtha (BSRS) are for extending term loans to the industrial sector^[1]. The Specialized banks are:

• Grameen Bank
• The Dhaka Mercantile Co-operative Bank ltd
• Bangladesh Krishi Bank
• Bangladesh Development Bank Ltd
• Rajshahi Krishi Unnayan Bank
• Basic Bank Ltd (Bank of Small Industries and Commerce)
• Bangladesh Somobay Bank Limited(Cooperative Bank)
• Ansar VDP Unnyan Bank

PART- THREE

AN OVERVIEW OF AB BANK

BACKGROUND OF AB BANK LIMITED

AB Bank Limited, the first private sector bank was incorporated in Bangladesh on 31st December 1981 as Arab Bangladesh Bank Limited and started its operation with effect from April 12, 1982.

AB Bank is known as one of leading bank of the country since its commencement 28 years ago. It continues to remain updated with the latest products and services, considering consumer and client perspectives. AB Bank has thus been able to keep their consumer’s and client’s trust while upholding their reliability, across time.

During the last 28 years, AB Bank Limited has opened 77 Branches in different Business Centers of the country, one foreign Branch in Mumbai, India and also established a wholly owned Subsidiary Finance Company in Hong Kong in the name of AB International Finance Limited. To facilitate cross border trade and payment related services, the Bank has correspondent relationship with over 220 international banks of repute across 58 countries of the World.

In spite of adverse market conditions, AB Bank Limited which turned 28 this year, concluded the 2008 financial year with good results. The Bank’s consolidated profit after taxes amounted to Taka 230 cr which is 21% higher than that of 2007. The asset base of AB grew by 32% from 2007 to stand at over Tk 8,400 cr as at the end of 2008.

The Bank showed strong growth in loans and deposits. Deposit of the Bank rose by Tk. 1518 cr ie., 28.45% while the diversified Loan Portfolio grew by over 30% during the year and recorded a Tk 1579 cr increase. Foreign Trade Business handled was Tk 9,898 cr indicating a growth of over 40% in 2008.

The Bank maintained its sound credit rating in 2008 to that of the previous year. The Credit Rating Agency of Bangladesh Limited (CRAB) awarded the Bank an A1 rating in the long term and ST-2 rating in the short Term.

AB Bank believes in modernization. The bank took a conscious decision to rejuvenate its past identity – an identity that the bank carried as Arab Bangladesh Bank Limited for twenty five long years. As a result of this decision, the bank chose to rename itself as AB Bank Limited and the Bangladesh Bank put its affirmative stamp on November 14, 2007.

The Bank decided to change its traditional color and logo to bring about a fresh approach in the financial world; an approach, which like its new logo is based on bonding, and trust. The bank has developed its logo considering the contemporary time. The new logo represents our cultural “Sheetal pati” as it reflects the bonding with its clientele and fulfilling their every need. Thus the new spirit of AB is “Bonding”. The Logo of the bank is primarily “red”, as red represents velocity of speed and purity. Our new logo innovates, bonding of affiliates that generate changes considering its customer demand. AB Bank launched the new Logo on its 25th Anniversary year.

AB Bank commits to nation to take a lead in the Banking sector through not only its strong financial position, but also through innovation of products and services. It also ensures creating higher value for its respected customers and shareholders. The bank has focused to bring services at the doorstep of its customers, and to bring millions into banking channels those who are outside the mainstream banking arena. Innovative products and services were introduced in the field of Small and Medium Enterprise (SME) credit, Women’s Entrepreneur, Consumer Loans, Debit and Credit Cards (Local & International), ATMs, Internet and SMS Banking, Remittance Services, Treasury Products and Services, Structured Finance for Corporate, strengthening and expanding its Islamic Banking activities, Investment Banking, specialized products and services for NRBs, Priority Banking, and Customer Care. The Bank has successfully completed its automation project in mid 2008. It envisages enabling customers to get banking services within the comfort of their homes and offices.
AB Bank has continuously invests into its biggest asset, the human resource to drive forward with its mission “to be the best performing bank in the country.” The bank has introduced Dress Code for its employees. Male employees wear designed ties and females wear Sharee or Salwar Kamiz, all the dresses are consisted with the unique AB Bank logo.

AB is recognized as the people’s choice, catering to the satisfaction of its cliental. Their satisfaction is AB’s success.

CORPORATE INFORMATION OF AB BANK

Name of the Company
AB Bank Ltd
Legal Form: A public limited company incorporated on 31st December, 1981 under the Companies Act, 1913 and listed in the Dhaka Stock Exchange Ltd and Chittagong Stock Exchange Ltd.

Commencement of Business
27th February 1982

Registered Office
BCIC Bhaban, 30-31, Dilkusha C/A
Dhaka 1000, Bangladesh.
Tel:+88-02-9560312 +88-02-9560312
Fax: +88-02-9564122, 23
SWIFT: ABBLBDDH
E-mail: info@abbank.com.bd
Web: www.abbank.com.bd

Auditors
S.F. Ahmed & Co.
Chartered Accountants

Tax Consultant
K.M. Hassan & Co.
Chartered Accountants

Legal Retainer
A. Rouf & Associates

Chittagong Regional Office
Spensers Building, 26 Agrabad C/A, Chittagong
Tel: 713381-83,713385-86(031)
Fax: 713384 (031)
E-mail: agrmg@abbank.com.bd

Sylhet Regional Office
Biswa Road, Shahjalal Uposhohor Point, Sylhet 3100
Tel:   (0821)725042 (0821)725042, 815085
Fax: 725042
E-mail: gdntmg@abbank.com.bd

Khulna Regional Office
Mollick Shopping Complex Limited, 99 Khan A Sabur Road, Khulna
Tel: (041) 720311 (041)720311, 723062, 724090
Mobile: 01199-660075
Fax: (041) 720311
E-mail: khlnmg@abban

Rajshahi Regional Office
102-103 Shaheb Bazar, Rajshahi
Tel: 773261, 774283 (0721)Fax: 773261 (0721)

Merchant Banking Wing (MBW)
BCIC Bhaban (7th Floor)
30-31, Dilkusha C/A, Dhaka 1000
Tel: +88-02-9566688 +88-02-9566688
Fax: +88-02-956688
E-mail: mbw@abbank.com.bd

AB Bank  Foundation (ABBF)
BCIC Bhaban (7th Floor)
30-31, Dilkusha C/A, Dhaka 1000
Tel:               +88-02-9553939         +88-02-9553939
Fax: +88-02-9553773
E-mail: abbf@abbank.com.bd

AB Bank Limited, Islami Banking Branch
82, Kakrail, Ramna, Dhaka
Tel: +88-02-8332235 +88-02-8332235, 37, 38
Fax: +88-02-8332236
E-mail: ibb@abbank.com.bd

Overseas Branch
Mumbai Branch
Liberty Building
41-42, Sir Vithaldas, Thackerse Marg
New Marine Lines, Mumbai  400-020, India
Tel: 2005392-3 (0091)
SWIFT: ABBLINBB
E-mail: mumbai@abbank.com.bd

Subsidiary Company
AB International Finance Ltd
Hongkong
Unit 1201-B, 12/F, Admiralty Centre
Tower One, 18 Harcourt Road, Hongkong
Tel: 2866 8094 (00852)
SWIFT: ABFLNKHH
E-mail: aomrashed@abbank.com.bd

 Balance sheet

 Profit and loss account

 Cash flow statement

PART- FOUR

GUIDELINES FOR CREDIT RISK MANAGEMENT PROVIDED BY BANGLADESH BANK

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.

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. Approval of loans that do not comply with Lending Guidelines should be restricted to the bank’s Head of Credit or Managing Director/CEO & Board of Directors. 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:

Industry and Business Segment Focus

The Lending Guidelines should clearly identify the business/industry sectors that should constitute the majority of the bank’s loan portfolio. For each sector, a clear indication of the bank’s appetite for growth should be indicated (as an example, Textiles: Grow, Cement: Maintain, Construction: Shrink). This will provide necessary direction to the bank’s marketing staff.

Types of Loan Facilities

The type of loans that are permitted should be clearly indicated, such as Working Capital, Trade Finance, Term Loan, etc.

Single Borrower/Group Limits/Syndication

Details of the bank’s Single Borrower/Group limits should be included as per Bangladesh Bank guidelines. Banks may wish to establish more conservative criteria in this regard. Appendix-3.4.3 provides brief description of financing under syndicated arrangement.

Lending Caps

Banks should establish a specific industry sector exposure cap to avoid over concentration in any one industry sector.

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
• Counterparties 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.
• Assets pledged as security should be properly insured.
• Valuations of property taken as security should be performed prior to loans being granted. A recognized 3rd party professional valuation firm should be appointed to conduct valuations.

Cross Border Risk

Risk associated with cross border lending. Borrowers of a particular country may be unable or unwilling to fulfill principle and/or interest obligations. Distinguished from ordinary credit risk because the difficulty arises from a political event, such as suspension of external payments

• Synonymous with political & sovereign risk
• Third world debt crisis

For example, export documents negotiated for countries like Nigeria.

Credit Assessment & Risk Grading

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, mhistorical financial statements of the borrower should be presented. Where reliance is placed on a corporate guarantor, guarantor financial statements should also be analysed. 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.

– Projected Financial Performance. Where term facilities (tenor > 1 year) are being proposed, a projection of the borrower’s future financial performance should be provided, indicating an analysis of the sufficiency of cash flow to service debt repayments. Loans should not be granted if projected cash flow is insufficient to repay debts.

– Account Conduct. For existing borrowers, the historic performance in meeting repayment obligations (trade payments, cheques, interest and principal payments, etc) should be assessed.

– Adherence to Lending Guidelines. Credit Applications should clearly state whether or not the proposed application is in compliance with the bank’s Lending Guidelines. The Bank’s Head of Credit or Managing Director/CEO should approve Credit Applications that do not adhere to the bank’s Lending Guidelines.

– 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.

– Loan Structure. The amounts and tenors of financing proposed should be justified based on the projected repayment ability and loan purpose. Excessive tenor or amount relative to business needs increases the risk of fund diversion and may adversely impact the borrower’s repayment ability.

– 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.

– Name Lending. Credit proposals should not be unduly influenced by an over reliance on the sponsoring principal’s reputation, reported independent means, or their perceived willingness to inject funds into various business enterprises in case of need. These situations should be discouraged and treated with great caution. Rather, credit proposals and the granting of loans should be based on sound fundamentals, supported by a thorough financial and risk analysis.

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

(higher) should be applied if there is a difference between the personal judgment and the Risk Grade Scorecard results. It is recognized that the banks may have more or less Risk Grades; however, monitoring standards and account management must be appropriate given the assigned Risk Grade:

At least top twenty five clients/obligors of the Bank may preferably be rated by an outside

credit rating agency. The Early Alert Report 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

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 proposals i.e. recommendations or review of bank’s loan portfolios.
• Approvals must be evidenced in writing, or by electronic signature. Approval records must be kept on file with the Credit Applications.
• All credit risks must be authorized by executives within the authority limit delegated to them by the MD/CEO. The “pooling” or combining of authority limits should not be permitted.
• Credit approval should be centralized within the CRM function. Regional credit centers may be established, however, all large loans must be approved by the Head of Credit and Risk Management or Managing Director/CEO/Board or delegated Head Office credit executive.
• The aggregate exposure to any borrower or borrowing group must be used to determine the approval authority required.
• Any credit proposal that does not comply with Lending Guidelines, regardless of amount, should be referred to Head Office for Approval
• MD/Head of Credit Risk Management must approve and monitor any crossborder exposure risk.
• Any breaches of lending authority should be reported to MD/CEO, Head of Internal Control, and Head of CRM.

It is essential that executives charged with approving loans have relevant 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:

• Introduction of accrual accounting.
• Industry / Business Risk Analysis
• Borrowing Causes
• Financial reporting and full disclosure
• Financial Statement Analysis
• The Asset Conversion/Trade Cycle
• Cash Flow Analysis
• Projections
• Loan Structure and Documentation
• Loan Management.

·  A monthly summary of all new facilities approved, renewed, enhanced, and a list of proposals declined stating reasons thereof should be reported by CRM to the CEO/MD.

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.

 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, Lending Guidelines and Bangladesh Bank requirements.

 PREFERRED ORGANISATIONAL 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.

 Preferred Organisational Structure

The following chart represents the preferred management structure:

 Key Responsibilities

The key responsibilities of the above functions are as follows. Please also refer to

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 approve (or decline), within delegated authority, Credit Applications recommended by RM. Where aggregate borrower exposure is in excess of approval limits, to provide recommendation to MD/CEO for approval.
• 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.

 Credit Administration

• To ensure that all security documentation complies 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.

 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.

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 centres 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.

Application forwarded to Zonal Office for approved/decline

Advise the decision as per delegated authority (approved /decline) to recommending branches. A monthly summary of ZCO approvals should be sent to HOC and HOCB to report the previous months approvals sanctioned at the Zonal Offices. The HOC should review 10% of ZCO approvals to ensure adherence to Lending Guidelines and Bank policies.

ZCO supports & forwarded to Head of Corporate Banking (HOCB) or delegate for endorsement, and Head of Credit (HOC) for approval or onward recommendation.

• HOC advises the decision as per delegated authority to ZCO
• HOC & HOCB supports & forwarded to Managing Director
• Managing Director advises the decision as per delegated authority to HOC & HOCB.
• Managing Director presents the proposal to EC/Board
• EC/Board advises the decision to HOC & HOCB

** Regardless of the delegated authority HOC to advise the decision (approval/decline) to marketing department through ZCO

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:

Disbursement:

Security documents are prepared in accordance with approval terms and are legally enforceable. Standard loan facility documentation that has been reviewed by legal counsel should be used in all cases. Exceptions should be referred to legal counsel for advice based on authorisation from an appropriate executive in CRM.

Disbursements under loan facilities are only be made when all security documentation is in place. CIB report should reflect/include the name of all the lenders with facility, limit & outstanding. All formalities regarding large loans & loans to Directors should be guided by Bangladesh Bank circulars & related section of Banking Companies Act. All Credit Approval terms have been met.

Custodial Duties:

•  Loan disbursements and the preparation and storage of security documents should be centralised in the regional credit centres.
•  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.

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 (valuers, 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

To minimise 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:

• Past due principal or interest payments, past due trade bills, account excesses, and breach of loan covenants;
•  Loan terms and conditions are monitored, financial statements are received on a regular basis, and any covenant breaches or exceptions are referred to CRM and the RM team for timely follow-up.
•  Timely corrective action is taken to address findings of any internal, external or regulator inspection/audit.
•  All borrower relationships/loan facilities are reviewed and approved through the submission of a Credit Application at least annually.

Computer systems must be able to produce the above information for central/head office as well as local review. Where automated systems are not available, a manual process should have the capability to produce accurate exception reports. Exceptions should be followed up on and corrective action taken in a timely manner before the account deteriorates further.

 PART- FIVE

CREDIT POLICY, ANALYSIS AND MANAGEMENT OF AB BANK

PROCEDURE FOR GRANTING DIFFERENT TYPES OF ADVANCES

A.       LOAN AGAINST HYPOTHECATION OF CARS, BUSES,

        TRUCKS,    SCOOTERS    AND    WATER  –  CRAFTS :

1. While allowing loan against hypothecation of Cars, Buses, Trucks, Scooters or Water-Crafts, the following points should be taken into consideration subject to credit restriction imposed from time to time, by Bangladesh Bank.

1. The trustworthiness of the borrower.
2. The value of the vehicle.
3. Whether it is a brand new vehicle.
4. While importing vehicles, the total landed cost to be determined and import bill retirement arrangement to be made beforehand.
5. Whether the repayment capacity of the borrower is satisfactory.
6. The title of the borrower in respect of vehicle is absolute.

DOCUMENTATION AND CONTROL:

1. Sales receipt should be drawn in the joint name of ABBL and the client. Delivery of the vehicles to be taken under supervision of an officer of the Branch.
2. Vehicles are to be registered under the supervision of an officer of the Branch in the Joint name of ABBL and the client.
3. Comprehensive Insurance Policy to be obtained at client’s cost in the Joint name of ABBL and the client.

1. Agreement of Hypothecation to be executed on Non-Judicial Stamp paper duly filled in the blanks before execution as per format Annex – “A”. Execution of the document to be vetted by Legal Adviser/Retainer to suit in each case.
2. All taxes in respect of the vehicles are to be paid by the client.
3. A photocopy of the Blue Book duly attested by an officer of the Branch evidencing Joint Registration is to be obtained.

 CHARGE DOCUMENTS TO BE OBTAINED:

1. Demand Promissory Note (D. P. Note).
2. Letter of Agreement.
3. Letter of Continuity/Disbursement.
4. Letter of Revival.
5. In case of Partnership Firms:

i)         Photocopy of Registered Partnership Deed duly certified by Notary Public.

ii)        An undertaking in the prescribed form in case of firms not registered with Registrar of firms. (Annexure – “C”).

iii)       Photocopy of Registration Certificate duly certified by “NOTARY PUBLIC” in case of firms registered with Registrar of firms.

iv)       Individual Personal Guarantee of all the Partners.

1. Certified copy of Resolution of the Board of Directors in accordance with corporate Borrowing Power laid down in the Memorandum and Articles of Association of the Company, in case of Limited concern and resolution of the Board alongwith a copy of charter in case of corporation, to be vetted by Legal Adviser/Retainer.

1. Individual Personal Guarantee of all the Directors in case of a Limited Company.
2. Charge to be created with the Registrar of Joint Stock Companies for hypothecation in case of Limited concerns.
3. Agreement of hypothecation to be obtained as per format (Annexure – “A”) vetted by Legal Adviser/Retainer.

B.       LOAN AGAINST IMPORTED MERCHANDISE (L.I.M.):

1. Loan against the security of merchandise imported through the Bank may be allowed against pledge of goods, retaining margin prescribed on their Landed Cost, depending on their categories and credit restrictions imposed by the Bangladesh bank. Branches shall also obtain letter of undertaking and indemnity from the clients, before getting goods cleared through LIM account.

1. Clearance of the goods should be taken through Approved Clearing Agent of the Bank.

1. The following points must be taken into consideration while allowing advance against the security of imported goods:

1. That the landed cost of the merchandise is properly worked out before the goods are delivered to the customer against proportionate payments. The landed cost of the goods subject to the credit restrictions imposed by Bangladesh Bank is arrived at by taking into account:

i)         The invoice value of the merchandise including freight.

ii)        Customs Duty.

iii)       Sales Tax.

iv)       Wharfage.

v)        Clearing Agent’s charges.

vi)       Railway Freight etc.

vii)     Insurance premium.

viii)    Demurrage.

ix)       Other charge, if any.

1. The landed cost of each item should be separately worked out that goods are delivered to the customers against proportionate payment made for each item. While making part delivery, it must be ensured that slow moving items are also taken delivery simultaneously. Valuable and less valuable items should not be averaged together.

1. While creating forced LIM Branch manager should satisfy that forced sale value will cover the outstanding LIM, if not, arrangement should be made to recover the liabilities through sale of documents. Prior approval of Head Office to be obtained for creating forced LIM.

CHARGE DOCUMENTS:a)        Demand Promissory Note (D. P. Note).

b)        Letter of Agreement.

c)        Letter of Pledge.

d)        Merchandise to be duly insured with specific risk clauses alongwith Bank’s mortgage clause.

e)        Letter of disclaimer to be obtained from the owner of godown in case of rented godown.

A.     ADVANCE AGAINST SHARES (LOANS & OVERDRAFTS):

1. Advance may be allowed against share of various Companies approved by Head Office from time to time, quoted on the Stock Exchange against required margin subject to credit restriction imposed by Bangladesh Bank, & prior permission from Head Office.

1. Before allowing the advance, obtain the delivery of the shares and their Transfer Deed forms duly signed by the share holders and verified by the company’s authority and thoroughly scrutinise them with regard to the following:

a)        They are original share scripts and bear the seal of the Company.

b)        The shares are fully paid up. Do not allow advance against partly paid up shares, unless approved by the Head Office.

c)        The shares are accompanied with blank Transfer Deed duly signed by the person in whose name those shares stand and witnessed by somebody who is easily traceable.

d)        The transferor’s signature on the Transfer Deed is verified by the Company concerned under its stamp.

e)        The Transfer Deeds are undated.

f)         A fresh set of Transfer Deeds signed by the borrower, and witnessed by somebody who is easily traceable is obtained and retained with the branch, for all such shares which are to be sent to various companies for registration in his name, before the closure of their books, if so requested by him.

g)        These shares are lodged with the companies concerned for registration with their original Transfer Deeds, duly completed in all respects, under a covering letter from the branch, requesting them to return the shares to the branch, as the Bank has its lien on them. The Transfer Deeds attached with the shares are completed and signed by the borrower as transferee, before these are dispatched to the companies.

h)       A receipt is obtained from the companies and retained with branch, duly discharged by the share-holder, for exchange with the share certificates, when ready for delivery.

i)         The borrower’s signatures on the fresh set of Transfer Deeds are verified by the companies concerned and retained with branch along with their respective share certificate when received back from them after registration.

j)          The branch should obtain a letter of lien from the borrower in respect of all such shares which stand in his name, or which have been sent to the various companies for registration, in his name. Where advance has been allowed to the borrower at the specific request of a third party against shares owned by them the letter of lien shall be obtained from third party, in its own name.

k)        The branch shall not generally resort to transferring the shares registered in the name of the borrower or any third party, in its own name.

l)         In the event of transferring the shares in the name of the Bank with the approval of the Head Office, branches shall take specific notice of any declaration of Dividends, Bonus Shares or any offer of Right Shares made by the companies concerned. They shall also ensure that all such Dividends and Bonus Shares are duly received by them.

i)         The dividend is credited to the account of the borrowers and the bonus shares are kept along with other shares of the borrower.

ii)        In case of an offer of Right Shares, branches shall send an intimation to the borrowers concerned enquiring from them if they were interested to acquire them for the value mentioned on the letter of Right which should immediately be deposited by them with the Bank.

iii)       If the borrowers do not deposit the money from their own resources or make any alternate arrangement in that behalf, the letter of rights may be renounced with the permission of the Head Office and sold, and the sale proceeds should be credited to the borrower’s account under intimation to him.

CALCULATION OF DRAWING POWER:

If the branch manager is satisfied with the security offered, he will calculate the drawing power of the borrower as per guidelines given by Bangladesh Bank/Head Office from time to time.

RESTRICTION:

In terms of Section 27(1)a of the Banking Companies Act. 1991, no banking company shall make loans and advances against the security of its own shares.

 CHARGE DOCUMENTS:

Allow the advance on obtaining the following charge documents duly stamped:

a)        Demand Promissory Note.

b)        Letter of lien or in case of advance to a third party, Letter of Agreement.

c)        In case of Partnership Firms:

i)         Photocopy of Registered Partnership Deed duly certified by Notary Public.

ii)        An undertaking in the prescribed form in case of firms not registered with Registrar of firms. (Annexure – “C”).

iii)       Photocopy of Registration Certificate duly certified by “NOTARY PUBLIC” in case of firms registered with Registrar of firms.

iv)       Individual Personal Guarantee of all the Partners.

d)        Certified copy of Resolution of the Board of Directors in accordance with corporate Borrowing Power laid down in the Memorandum and Articles of Association of the Company, in case of Limited concern and resolution of the Board along with a copy of charter in case of corporation, to be vetted by Legal Adviser/Retainer.

e)        Letter of Ownership.

f)         Transfer Deeds duly signed and verified.

g)        Personal Guarantee of Directors (excepting nominated Directors by Govt./Corporations) in case of limited Companies.

h)       For Loans: Letter of Disbursement.

i)         For Overdrafts: Letter of Continuity.

j)          An undertaking from the Directors of the limited Company to obtain prior clearance from the Bank before declaring any interim/final dividend.

A.       ADVANCES AGAINST FIXED/SHORT TERM DEPOSIT

         RECEIPTS / BEARER   CERTIFICATE OF   DEPOSIT:

Scrutinize the Fixed/Short Term Deposit Receipts with regard to the following points subject to credit restriction imposed from time to time:

a)        The Fixed/Short Term Deposit Receipt is not in the name of a minor.

b)        It is duly discharged by the depositor on revenue stamp of adequate value and his signature is verified.

c)        If the receipt is issued in joint names and/or payable to either or survivor it shall be discharged by all the depositors named in the receipt on revenue stamp of adequate value and their signature, verified.

Both the depositors have the right, so long they are alive, to the proceeds of FDR or Short term deposit receipt and as such creation of liability on the deposit by any one of the depositors is irregular.

d)        If the Deposit Receipt is offered as a security for allowing advance to a third party, a letter of lien shall be obtained from the depositors, on the appropriate form.

e)        If the Deposit Receipt has been issued by the same branch, lien against that specific Deposit Receipt is marked in the Fixed Deposit and/or Short Term Deposit Register of the branch.

f)         As far as possible advances against FDR/STD receipts issued by other banks should be avoided. However, in case it is decided to make advance against such FDR/STD receipts, the branch concerned should request the Issuing Bank/Branch to register ‘LIEN’  of the Arab Bangladesh Bank Ltd. against the FDR/STD receipts and issue a letter confirming the registration of ‘LIEN’ in their books accounts under authorized signature. Further, the branch where the advance is allowed shall directly get the signature of the depositor on the letter of lien as well as his discharge on the back of the F.D. Receipts/S.T.D. Receipts duly verified from the Issuing Bank/Branch under authorized signature. The borrower shall not be allowed, under any circumstances, to have such verification done on his own.

g)        The discharged receipt, the letter of lien duly verified by the issuing branch and the letter confirming registration of the lien on the Deposit Receipt shall be kept along with other documents for the relative advance, duly entered in the documentation check list.

h)       Lien on the partial amounts on Fixed/Short Term Deposits shall not be accepted.

i)         The lien of the Bank has to be marked in red ink/rubber stamp on the face of the Deposit Receipt against which advance has been allowed. On adjustment of the advance, lien shall be released under signature of two Officers on the back of the Deposit Receipt.

j)          An undertaking from the borrower/third party (if the deposit is in the name of third party) for encashment of the FDR/Short Term Deposit and appropriation of the proceeds thereof without reference to them be obtained.

k)        An undertaking from the borrower/third party (if the deposit is in the name of third party) for renewal of the Fixed and Short Term Deposits without reference to them be obtained.

l)         In case of Bearer Certificate of Deposit, lien to be marked on the face of the certificate and margin to be calculated on the amount deposited.

CHARGE DOCUMENTS:

After full satisfaction on the above referred points, obtain the following charge documents duly stamped before allowing the advance:

a)        Demand Promissory Note.

b)        Fixed/Short Term Deposit Receipt duly discharged.

c)        Letter of Lien (1st party)

Or

Letter of Lien along with a guarantee (third party)

d)        Letter of Agreement.

e)        In case of Partnership Firms:

a)        Photocopy of Registered Partnership Deed duly certified by Notary Public.

ii)        An undertaking in the prescribed form in case of firms not registered with Registrar of firms. (Annexure – “C”).

iii)       Photocopy of Registration Certificate duly certified by “NOTARY PUBLIC” in case of firms registered with Registrar of firms.

iv)       Personal Guarantee of all the Partners.

f)         Certified copy of Resolution of the Board of Directors in accordance with corporate Borrowing Power laid down in the Memorandum and Articles of Association of the Company and in case of Corporations, resolution of the Board of Directors along with charter to be vetted by Legal Adviser/Retainer.

g)        Personal Guarantee of all the Directors in case of a limited Company.

h)       For Loans: Letter of Disbursement.

i)         For Overdrafts: Letter of Continuity duly stamped.

B.       ADVANCES AGAINST BALANCES IN SAVINGS

         BANK  AND  CURRENT  DEPOSIT ACCOUNTS:

Subject to the credit restrictions imposed, precautionary measures are to be observed in allowing advances against balances lying in the Savings Bank and/or Current Deposit Accounts of the parties:

a)        Ear-mark the balance in the account.

b)        Make a note of it at the top of the ledger folios/card of the account-holder in bold RED letters duly authenticated.

While allowing advance to the party against a credit balance ear-marked in another account kept by him in his own name and in the same rights, whether at the same branch or at some other branch of the Bank, take a letter of authority from the account-holder to combine the two accounts (one having a credit balance and the other a debit balance), at any time without notice, and to return cheques which, as a result of the Bank having taken such an action, would overdraw the combined account. He should also agree not to close the account and withdraw the balance, pending adjustment of the advance.

Where the advance is allowed against credit balance, ear-marked in the account of a third party, whether at the same branch or at some other branch of the Bank, take an irrevocable letter of authority from third party, authorizing the Bank to appropriate the credit balance lying in their account to the extent of the debit balance appearing in the account of the borrower, at any time, without any reference to them. This being an irrevocable letter of authority, they should agree neither to close the account pending adjustment of the advance allowed at their instance, nor to issue cheques which would reduce that balance.

The signature of the account-holder in whose account a credit balance is ear-marked is verified on the irrevocable letter of authority given by him.

 CHARGE DOCUMENTS:

Allow the advance on obtaining the following charge documents duly stamped:

a)        Demand Promissory Note.

b)        Letter of Lien (1st party)

Or

Letter of Lien (3rd party) along with guarantee.

c)        Letter of Agreement.

d)        In case of Partnership Firms:

i)         Photocopy of Registered Partnership Deed duly certified by Notary Public.

ii)        An undertaking in the prescribed form in case of firms not registered with Registrar of firms. (Annexure – “C”).

iii)       Photocopy of Registration Certificate duly certified by “NOTARY PUBLIC” in case of firms registered with Registrar of firms.

iv)       Personal Guarantee of all the Partners.

e)        Certified copy of Resolution of the Board of Directors in accordance with corporate Borrowing Power laid down in the Memorandum and Articles of Association of the Company and in case of Corporations, resolution of the Board of Directors along with charter to be vetted by Legal Adviser/Retainer.

f)         Personal Guarantee of all the Directors in case of a Limited Company.

g)        Letter of Authority to set off or appropriate the balance.

h)       For Loans: Letter of Disbursement.

i)         For Overdrafts: Letter of Continuity.

SET OF DOCUEMNTS TO BE OBTAINED AGAINST

DIFFERENT TYPES OF LOANS AND ADVANCES

The following three documents are common for each type of Loans and Advances:

a)        Documents common to all Advances:

i)       D. P. Note signed on Revenue Stamps.

ii)      Letter of Agreement.

iii)     Acceptance of the terms and conditions of sanction advice on duplicate.

b)        General Documents:

i)       D. P. Note.

ii)      Letter of Agreement.

iii)     Letter of Continuity.

iv)     Letter of Revival.

Other documents are to be obtained according to the types of advances, nature of securities offered and status of the borrower as classified below, in consultation with the Legal Adviser/Retainer.

a)        In case of Limited Company:

i)       Individual Personal guarantee of all Directors.

ii)      Board’s resolution covering corporate borrowing power, authorising the Director(s) to execute the security documents. Resolutions must be duly certified.

iii)     Memorandum and Articles of Association of the Company duly certified by the Registrar, Joint Stock Companies.

b)      In case of Partnership Firms:

i)         Photocopy of Registered Partnership Deed duly certified by Notary Public.

ii)        An undertaking in the prescribed form in case of firms not registered with Registrar of firms (Annexure – “C”).

iii)       Photocopy of Registration Certificate duly certified by “NOTARY PUBLIC” in case of firms registered with Registrar of firms(Reference: Credit Instruction No.04/87 dated 26.2.1987).

iv)       Individual Personal Guarantee of all the Partners.

v)        Resolution of the partners for taking loan(s) and authorising partner(s) to execute security documents.

Note:-

–          Loan to partnership-at-will should not be entertained.

–          Enquiry should be made about income tax liability. Preferably their TIN number should be obtained.

c)      In case of Proprietorship:

i)         Municipal Trade License to prove the ownership of the concern.

ii)        TIN number to ascertain whether he is an income tax assessee or not.

A.     PROCEDURES  FOR  SUBMISSION OF CREDIT PROPOSALS FOR APPROVAL:

Every credit facilities extendable to customers is subject to approval from competent authority. Due emphasis on the following points are required in sending Credit Proposals to the Sanctioning Authority.

 1.    Request for Credit Limit (RFCL)

 2.    Credit Information Bureau (CIB)

 3.    Lending Risk Analysis Form (LRAF)

 4.    Inspection Report (I-20)

 5.    Documentation Completion Certificate

 6.    Submission of Renewal Proposals

Lending Risk Analysis (LRA)

The Financial Sector Reform Project (FSRP) has been instituted in the early nineties in Bangladesh with a view to bringing about financial discipline through undertaking appropriate reform measures in the financial sector of our country. The project has been taken by the Government of Bangladesh (GOB) with combined support of the World Bank and USAID under the structural adjustment program. The banking sector constitutes the principal segment of the financial sector and hence the main thrust of the reform activities rests on this sector. The reform programs also gave freedom to the banks to select the borrowers on the basis of their own judgement.

Among the several reform measures that FSRP has so far recommended. Lending Risk Analysis (LRA) constitutes an important set of activities that has been prescribed for minimising and averting risk in funds business of local banks (public and private). It has been identified by the experts and bankers that risk (high) involved in providing loan to a particular borrower is the main reason for failing to recover the bank’s money and the issued of risk analysis remains as one of the main factors in determining the status of a loan/investment in terms of recovery.

Lending Risk Analysis (LRA): Terms & Definitions

Lending Risk Analysis (LRA) is simply a loan processing manual. By going through this manual the lending bankers can assess the creditworthiness of their prospective borrowers. Therefore, LRA is such an instrument which is definitely and directly related with lending information to analyze the borrower’s financial, marketing, managerial and organisational aspects subjectively and objectively. It also facilitates the analyst to know the security risk of the credit.

Lending Risk Analysis involves assessing the likelihood of repayment of loans to the bank as per agreement on the basis of analysis of certain risks. To analyze these risks bankers will need to fill-up a 16 page LRA Form. The form leads to scoring various risk factors involved in lending (Table A), first of all, has divided the various risks into two groups namely. Business Risk and Security Risk.

 Business Risk:

Business Risk is concerned with whether the borrowing company would fail to generate sufficient cash out of business to repay the loan. Business Risk, the main component of lending risk, consists of the Industry Risk and the Company Risk.

Industry Risk: Due to some external reasons a business may fail and the risk which arrives from external reasons of the business is called Industry Risk. It has two components:

(i)        Supplies Risk: When the business fails due to disruption in the supply of inputs, the consequent risk which would arise is known as Supply Risk.

(ii)      Sales Risk : t is another component of Industry Risk. When the business fails for disruption in sales, this type of risk would generate.

Company Risk: Company Risk is shown for some internal reasons of the business. It has also two main components and four sub-components.

(i)            Company Position Risk: Each and every company holds a position within an industry. This position is very much competitive. Due to weakness in the company’s position in its industry, a company may fail and the risk of failure is called Company Position Risk. It depends on –

(a)      Performance Risk: If a company fails to perform well enough to repay the loan because of its weakness under given expected external conditions, the company is said to suffer from performance risk.

(b)      Resilience Risk: When a company fails due to lack of its resilience to unexpected external conditions, the conditions, the resilience risk is generated.

(ii)          Management Risk: If the management of a company fails to exploit the company’s position effectively, the company can fails and this risk of failure is called management risk. It can be subdivided further.

(a)      Management Competence Risk: Management competence risk is the risk that the company fails to repay its loan due to lack of management integrity.

(b)      Management Integrity Risk: Management integrity risk is the risk that the company fails to repay its loan due to lack of management integrity.

Security Risk:

Security Risk is the risk that the realized value of the security does not cover the exposure of loan. Exposure means principal plus outstanding interest. Security risk can be divided into two parts:

(a)      Security Control Risk: Security Control Risk is the risk that the bank fails to realize the security because of lack of bank’s control over the security offered by the borrowers.

(b)      Security Cover Risk: Security cover risk is the risk that the realized security value may not cover the full exposure of loans.

Process of Lending Risk Analysis:

For the purpose of risk analysis for either trading or manufacturing companies, the credit officer or concerned persons who are involved to prepare the LRA report should first collect the information and data in respect of the loan proposal and the borrower.

The following steps are generally followed:

1. Collect all data available from published sources.
2. Visit company to collect company specific data that is not published.
3. Interview management to assess their ability and integrity.
4. Investigate the security.
5. Have an impression (by the credit officer) of the company’s operations.

After collecting the required information and data:

1. Prepare financial spreadsheet which includes Balance Sheet, Income Statement. Cash Flow Statement and Financial Ratios on the basis of at least 3 years financial statement of the borrowers.
2. Analysis of Spreadsheet Ratios.
3. Prepare supplementary questions for company management, if necessary.