Credit Operations System of Social Islami Bank Limited

The main objective of this report is to analysis Credit Operations System of Social Islami Bank Limited. Other objectives of this reports are to know about the credit operations system of Social Islami Bank Limited and to have a clear-cut knowledge of credit appraisal and management practice by the bank and to know the effectiveness of credit appraisal system in the process of credit approval system and the portfolio of loan and advances and how they manage it. Finally this report make swot analysis Credit Operations System of Social Islami Bank Limited.

Introduction of the Study:

Social Islami Bank Limited (SIBL) was incorporated on 5^th JULY, 1995 as a result of dedicated efforts of a group of established Bangladeshi entrepreneurs and internationally important personalities under the company Act 1994 and Banking Company Act, 1991. The bank started commercial operation on 22^nd November, 1995 with a clear manifesto to demonstrate the operational meanings of particularly economy, banking and financial activities as an integrated part of Islami code of life. It is an alternative concept of Islamic banking with a unique human face approach to credit and banking based on interest free economic and financial transactions and income generating program for the millions of the urban and rural poor and a profitable investment option for the rich to invest, earn and live in a better society with greater security and peace at the operational level, SIBL is operating three sector banking such as formal, non-formal and voluntary sector. As I was working in Dhanmondi branch of SIBL, the focus of the study is on that branch. The branch is headed by manager and there are four departments which are as follows:

Departments of Dhanmondi Branch

General Banking:

• Deposit mobilization A/C opening.
• Papers/ documents required for opening different account.
• Opening of different types of Mudaraba saving deposit.
• Check issue
• Remittance of funds.

• Demand draft (DD).
• Cancellation of D.D
• Duplicate D.D
• Telegraphic transfer (IT).
• Pay order
• Clearing

Investment department:

• Bai- Mudaraba
• Bai- Muajjal
• Hire purchase under sirkatul meelk
• Mudaraba
• Musharaka
• Bai- salam

Foreign exchange department:

• Import
• Import financing

• L/C opening
• Documentary requirements for opening L/C.
• Charge for opening an L/C.
• Cancellation of L/C.
• Export
• Export procedure
• Foreign remittance.

Cash section:

• Cash receipt
• Cash payment

Credit Department:

Credit department is very important for a bank. The money mobilized from ultimate surplus units (depositors) are allocated through this department to the ultimate deficit unit (borrower). The success of this department keeps a great influence over the profit of a bank. Failure of this department may lead the bank to huge losses or even to bankruptcy. So special care should be given to this department.

Credit department receive application form in a prescribed application form supplied by the SIBL. This application form contains detail about the borrowers such as names address of the borrowers/directors/partners/proprietors, type and nature of the business, security offered market of the borrower product, annual sales and production etc. The applicant must duly sign the application form. The branch officer after receiving the application form scrutinize the information provided in the form, collect additional financial information of the proposed firm, detail financial and other relevant information of sister concern, if any. After appraising the credit request and its securities the branch makes a credit proposal with detail information to the head office for approval. The officer in-charge and manager must sign this credit proposal as well. If head office approves the credit proposal, the branch prepares all documentation and make arrangement for credit disbursement Social Islami Bank Limited offer various types of credit.

Statement of Research Problem:

Lending is the principal function or the ‘bread and butter’ of a banking company. Bank gives money as loan to the society for the development of economy as a whole. Credit or loan management of banking company is a very important activity & special emphasis is given on Credit administration & management in every type of bank. Commercial banks collect funds to provide both individual and corporate credit to the economy. For doing so a policy and guideline must be followed. Every bank has its own guideline regarding credit facilities given to the customers. And the officials and administrators are the follower of this guideline. This report on Credit Operation System of Social Islami Bank Limited (SIBL). Where I have tried to find the procedures and the guideline of Credit operations of Social Islami Bank Limited.  The report is consisting of the rules and procedures of Credit facilities given to the customers by SIBL, to whom the credit is given and how. Finally I have tried to find some recommendations to improve the credit operations of SIBL.

Objectives of the study

• To know about the credit operations system of Social Islami Bank Limited.
• To have a clear-cut knowledge of credit appraisal and management practice by the bank and to know the effectiveness of credit appraisal system in the process of credit approval system and the portfolio of loan and advances and how they manage it.
• To comment in the existing credit operations system of the SIBL and also suggest some measures for possible improvement in future.

Types of Credit (SIBL)

• Bai-Murabaha
• Musharaka (partnership)
• Mudaraba
• Bai-salam
• Qard hasan (benevolent loans)
• Bai-Muajjal (deferred sale)
• Ijarah
• Hire purchase

Credit Policy of SIBL:

Policy Guidelines

• Lending guidelines
• Credit assessment & risk grading
• Approval authority
• Segregation of duties
• Internal audit

Preferred organizational structure & responsibilities

Procedural guidelines

• Approval process
• credit administration
• Credit monitoring
• Credit recovery.

Portfolio Management of Credit:

Portfolio management can be done by careful consideration of the factors mentioned in the following:

• Bank’s capital position
• Deposit mix (tenure of deposit)
• Credit environment
• Influence for monetary and fiscal policies
• Credit needs of the respective commanding area
• Ability & experience of the bank personnel to handle the loan portfolio

I n designing a loan portfolio, three things should be decided- first, the type of customers the bank wants. Second, involvement of risks with various kinds of loans. And finally, the relative profitability kinds of loans.

Loan Pricing

In pricing business loan, bank management must consider the cost of raising loanable funds and the operating costs of running the bank. This means that banks know what their costs are in order to consistently make profitable, correctly priced loans of any type.

The simplest loan- pricing model assumes that the rate of interest charged on any loan includes four components

Cost of fund (COF): The cost to the bank for raising adequate funds to lend.

Cost of administration (COA): The bank’s non-fund operating costs (including wages and salaries of loan personnel and the cost of materials and physical facilities used in granting and administering).

Cost of capital (COC): Return on capital or the rate of return investors would expect to receive from their investment in a bank or cost of capital is the desired profit margin on each loan that provider the bank’s stockholders with an adequate return on their capital.

Risk premium (PR): Necessary compensation paid to the bank for the degree of default risk inherent in a loan request. The price a borrower must pay t o the bank for assessing and accepting the risk is called the risk premium.

Thus, COF +COA +COC = Base Rate or Prime Rate

Loan Interest Rate = Base Rate + Risk Premium.

Credit Operation System of SIBL

There is no hard and fast procedure of managing credit, yet is should follow the instructions of the Bangladesh Bank, Central Bank of Bangladesh and the circular of head office from time to time. The first step of credit proceedings is the request for credit from the clients. Then scrutinizing and collection of information from primary and secondary sources take place. Credit appraisal and evaluation is the most important part of credit management. On the basis of evaluation approval is given by the higher-authority with certain conditions to be fulfilled. Sanction of credit is done by the sanctioning officer, who has the authority to sanction the credits. After fulfilling the conditions the credit is disbursed. Credit monitoring and reviewing start at the time of disbursement. Necessary steps should be taken to minimize the risk and increase the return of the bank. Delegation of business power is important in credit sanctioning. Four-tire level is maintained in case of large amount of credit sanctioning. Lending risk analysis is also done in case of credit above TK. 10 Lac.

Credit Management

Credit management refers to the assessment of a loan proposal from different points of view to decide whether the bank should go for finance or not, i.e. the study of the borrower specially justifying credit status of the borrower. Credit investigation helps then banker to ensure selection of right type of loan proposal/ project/ventures/enterprise and right type of borrower. For selecting the borrower security should not the only thing to be relied upon. So responsibility of the bankers to investigate the client from different view points i.e. the strength and weakness of the client so that the client will be able to repay the bank loan as repayment schedule with profit.

Credit investigation refers to the assessment of a loan proposal/intending entrepreneurs/borrowers from different points of view for justifying the credibility of the project-visit= a-VIS credit worthiness of the borrowers/sponsors. The overall success in credit management depends on the banks credit policy, portfolio of credit, monitoring, supervision and follow-up of the loan and advance.

Steps of Credit Management & Appraisal System

Step1: Request for Credit from the Client

Bank provides credit facilities to the people who are credit worthy to the bank. Credit worthiness depends on the credibility and feasibility of the project and management ability of the credits to earn profits. When bank is satisfied with all these then the client is provided with the request credit. At this point it should be mentioned that the client has to go through an interview where his potentiality is justified through critical observation. When credit officer is satisfied with the customer he is asked to submit an application and to fill up a form with specific details.

In general the client having an account approached the bank official for financial help in the form of credit. The client may directly   department or talk with the manager of the branch while talking with the client the officer try to find out the following cues:

• Borrower’s identity, family background, character, capacity and integrity.
• Reputation in business circles, friends, and competition and employees.
• Educational qualification, business experiences.
• Physical fitness and eagerness.
• Purpose of he loan, popularity and marketability of the product.
• Availability of the raw materials, transport and communication.
• Owen stake in business and security offered.
• Expected terms of repayment.
• Other sources of income.
• Lifestyle of the borrower.
• Declaration of the assets and liabilities.
• Whether reason for credit facility seeking is justifiable.
• Tendency to disclose the information.

Here this discussion is like preliminary screening of the client. So the credit officers need to be cautious about the facility the client is seeking and the available fund in the bank. Moreover most of the businesses in our country don’t have any standard form of accounting department and don’t any audited statements. So the main task of the credit is to make a relationship with the client to find out the hidden income sources.

Credit Application

Completeness of information can best be obtained by requesting the applicant to fill out a comprehensive application. Psychological attitudes toward the seriousness of credit obligations are improved when the application is rather formal and complete.

When the customer fills in the application, it is well for the interviewer to look over the form to provide supplemental information, which will assure completion of the blanks not filled in, or which probes more deeply into the questionable areas. It is well to provide space on the form for the recording of more information after the customer has left. Points in favor of having the applicant fill out the form that fewer skilled credit personnel are necessary and that more customers can be accommodated in the same space.

The client has to provide the following information in the credit application form

• Mode of financing and amount of credit sought.
• Primary information of the business.
• Directors name along with their shareholding percentage and net-worth and the filled up net-worth statement.
• Sister concern’s information and working capital related basic information.

Signature and Contract

It is regarded as good credit practice to have the applicant   sign the application. Some credit department adds words above the signature, which make the application a rather formal written contract. The clause may be a testimony that the information is given for the purpose of obtaining credit and the facts are complete and correct. The clause may also be recite the terms and be drawn as contract creditor and debtor.

Step 2: Scrutinizing and Collection of information

Selection of Borrower

Selection of borrower is a very significant part of a credit decision. There are some parameters for selection of a borrower. Some C’s commonly expresses the parameters. And thus the criteria for selection of a borrower are popularly known as 5 C’s such as:

1. Character: Family background, market reputation, morality, and promptness in repayment.
2. Capacity: Ability to manage the business, ability to employ the fund in the right way, ability to overcome unforeseen problems.
3. Capital: Equity strength, assets & properties.
4. Collateral: The easy marketability of the properly given as security.
5. 5. Condition: Over all business condition.

If the borrower’s found satisfactory in terms of all C’s only hen it is suggested to entertain he borrower.

Preliminary Screening of a Credit Proposal Submitted by the Borrower

Screening means critical diagnosis of a credit proposal at the very initial stage. It should be made carefully the proposal comes to the bank. At the time of screening of a credit proposal the preliminary screening should be done on the following premises:

• Quality of management and the entrepreneurial background of the sponsors.
• Equity strength i. e., the own capital positions.
• Position of assets & properties.
• Line of business, it’s future prospects and the existing position of the respective industry.
• Required technology, machinery, equipment and their availability.
• Location, whether the infrastructural facilities are available.
• Potential contribution to the overall economic development of the country.
• Security proposed to be given and the genuinely of the title of documents.

Analyzing the above matters, it is to be convinced that the credit proposal satisfies all the key elements of a sound lending policy such as:

• Safety of fund
• Security (easy marketability of the property given as security )
• Liquidity (the tenure of the loan )
• Profitability
• Diversity
• National interest

In case of clients who have previous record of taking credit facilities, their in- file records are examined to see whether the client has a good record of payments in time.

Information gathered through direct inquiry

Direct inquiry one of the common methods of obtaining information to verify facts presented on the application of during the interview of an applicant for an initial credit transaction. A careful distinction is made between obtaining credit information directly form sources having such facts and between buying somewhat similar credit data in the form of prepared reports from the credit reporting bureaus and agencies.

Call report is a form of direct inquiry where the credit officers directly go to the project sits to prove the physical existence of the project. This report is submitted to the broad when the credit grating decision is taken.

Information gathered through in-file ledger fact

In file ledger facts are one of the most important sources of information available to credit committee whether to accept or reject a larger of credit from an established credit customer. From the in file records, credit analysts have at their disposal the experience of the concern with the customer. They know the customer’s payment habits, the complaints registered, and the collection efforts, if needed to keep the customer in line with the established terms.

Step 3: Credit Appraising & Presentation of Credit Proposal for Approval

When credit is satisfied with his credit worthiness, financial capability, management ability and feasibility of the project through credit appraisal of clients in a prescribed form, he can hope for credit from the bank. Credit appraisal is done through credit appraisal form. Ratio analysis is given importance in case of project finance. But most of the medium quality loans are given on the basis of financial capability of repaying and credit worthiness of the client. Lending risk analysis is done in a prescribed form in case of large amount of loan, above 10 Lac.  There is a specific prescribed form for the credit proposal of SIBL given by the head office used as the credit proposal for particular client. Where following factors must be mentioned step by step.

Information about the Client or Credibility Appraisal

The credit officer has to check the integrity and the honesty of the client that is the management and the other allied company as well. The integrity is checked through different ways. They are as follows:

Personal Interview: When the client approached for credit, the credit officer talked with him to identify whether the client has any need of seeking credit facility. The credit officer has to have deep analyzing power to find out the clue. Report from SIBL: If the customer hold an account or is enjoying credit facility from the SIBL, the statements of the accounts are collected for analyzing the performance of the existing facility, transaction summery of the accounts along with the integrity of the client.

Report from Other Bank: The client has to mention whether he has other liability in other bank in the name of the project and /or in the name of the sister concern in the time applying for credit. From the given information the credit officer contact, communicate with the respective authority of those banks with which the credit seeker has the transaction to collect the information about few things:

• Whether the client has taken any loan in the name of the proposal project or any other sister concern.
• The amount outstanding and whether classified or not.
• The payment habit of the client.

All the collected information is kept confidential.

Report from Society: Some times the credit officer collects information from other businessman having relationship with SIBL. Informally the credit officers discuss about project and the initiator and the potentiality with the businessman. Moreover the information about the sponsor is also collected from the socially important person like community representative, chamber representative.

CIB (Credit Information Bureau of Bangladesh) Report: There is possibility of hiding information about the current liability and transaction with other bank. So to get the appropriate information about the credibility of the customer. The branch office collects CIB report through the head office. It is known that all the banks have to send liability position of the client. The CIB authority provides the related information for which he is asked for.

Financial Strength Analysis

Analyzing the financial position is one of the main factors to be identified before financing any business. In the application form the client has to the total investment made by him in the said project he is seeking loan facility. The net-worth of the client must be found out by the credit officer.

• Look for the net-worth of all the directors
• Paid-up capital
• Investment in business
• Leverage (Equity Multiplier)
• Cash flow
• Allied deposit in SIBL
• Tangible net-worth of the business for the lasts three years and projected two years.
• Total Asset-Total Debt
• Overall group strength (if applicable)
• The strength also appraised by the business performance.

Liability Position Analysis

Facility from SIBL & other banks taken by the client must be provided while applying for credit facility. The credit officer looks for

• Existing facility enjoying by the company client from the SIBL and other banks.
• Existing facilities for the sister concerns if applicable.
• Debt to asset ratio.
• The credit officers need to look for the nature, limit, outstanding, overdue, CL status, security value of the credit facilities.
• Whether the amount outstanding are classified or not.
• Monthly installment payment or fixed charge coverage performance of the client.

Details of The Proposed facilities: In this phase of the credit proposal followings are mentioned:

• Nature of credit facility
• Amount of credit
• Margin
• Rate of interest/profit
• Validity/Expiry
• Mode of repayment
• Purpose
• Security/Collateral

Risk Assessment:

This part is very much important for the bank, as the risk involved with the project will determine the return of that particular project. For assessing the risk the bank follows some factors those are the key risk factors associated with that business. Here the economical, social, political, technical and other aspects of the client business are considered at the time of risk assessment.

There is some other special steps to be taken incase of risk assessment and those are,

Credit Scoring System:

Credit scoring system is a modern approach for assessing the credit worthiness of a potential borrower. Credit scoring system helps to produce a rating which provides an indication of a company’s management and financial strength. LRA & FSS are used as the tool for scoring a credit By preparing LRA, the degree of risk associated with  the credit proposal is determined. By preparing FSS, two scores termed as ‘Y’ score and ‘Z’ score derived using financial ratio to make an inference about the firm.

Lending risk analysis (LRA) & Financial Spread Sheet (FSS) are the two of those products which are being used as a tool for assessing the nature and extent of risk lying with a credit proposal which is in turn, most significant matter for a credit decision. FSS helps to see the financial strength of the borrowers firm. The asset, liability & equity position is being analyzed by using FSS. At the same time, the critical synchronization of flow of fund is verified to gather information about the sources & utilization of fund.

SWOT Analysis: Here the,

• Strength
• Weakness
• Opportunities
• Threats of the business of customer must be considered and SWOT analysis should be done. There are some specific risks of any projects and to mitigate those there are some suggestions by following which those risks can be diminish. Those are,

Table: Project Risk and Mitigation

Source: Credit risk unit (CRM) of SIBL.

Financial Information

Financial statements and its analysis :

Financial statement is the end use of financial accounting. Financial statements are prepared by collecting formulating & compiling the accounting data in a consistent & logical accounting procedure. Very popularly we used to understanding the financial statements simply by the balance sheet & income statement. But financial statement is in fact purpose oriented financial picture. There can be various types if financial statements such as:

• Retained earning statement
• Fund flow statement
• Cash flow statement
• Profit & loss account

Analysis of financial statement is the process of evaluating significant relationship between the components of the financial statement. The purpose of analysis is obtaining a better understanding of the firm’s position & performance.

Assessment of Working Capital:

The capital, which is needed to meet current obligation and to finance day to day operational expenditure of a firm, is working capital. Assessment of working capital bears great importance because, excess working capital incurs cost for the firm and in reverse, shortage of working capital may totally upset the smooth operation of the firm.

Practically working capital becomes obvious for the following reasons :

• For purchase of raw materials, stores & spares.
• For making advance payment to the raw material suppliers
• Blocking of fund in work- in –process and finished goods
• Blocking of fund with sundry debtors
• For meeting day to day cash expenditures

Assessment:

Required components of working capital are to be computed prudently, for example : for a manufacturing concern, need for working capital can be assessed by calculating the major components :

• Projected annual sales
• Yearly consumption of raw materials
• Annual labor charges
• Overhead costs
• Stock of raw materials
• Stock in process
• Stock of finished goods
• Credit allowed to customer in days
• Credit received from suppliers in day
• Annual selling & administrative expenses
• Annual depreciation
• Closing inventory

The days or tied up period for stock of raw material (local/imported), stock in process, stock of finished goods, credit allowed to customers, credit received from suppliers should be considered very prudently.

Assessing the financial viability of the project:

It is another significant part of appraisal. Financial viability of a project is examined in this part. Various financial tools & techniques are used in testing the financial viability such as:

• Capital Budgeting
• Break Even Analysis
• Sensitivity Analysis
• Ratio Analysis

a) Capital Budgeting Technique :

A process of analyzing or evaluating an investment decision. The capital budgeting tools used for evaluating an investment opportunity are:

Non- Discounted Method (time value of money not adjusted) :

• Accounting rate of return (ARR) :

Arithmetic expression of expected return from the investment. The higher the rate, the more is the financial viability of the project.

• Payback period :

The period within which the volume of investment is expect to be return from the project. The “period” should be< the maximum acceptable pay back period.

Discounted Method (time value of money adjusted) :

• Net Present Value (NPV) :

It is the difference between present value (time adjusted value) of expected inflow or benefit and that of outflow or investment.

Under this method expected future benefits are being converted into present value using reasonable rate of discount. In case of a single project, the project can be accepted present value of inflow is higher than the present value of outflow. But incase of a mutually exclusive decision, the project having higher NPV should be accepted.

• Internal Rate of Return (IRR) :

It is a rate at which the present value of inflow equates the present value of outflow. IRR tells the minimum required rate of return from an investment. Acceptable IRR is being determined by considering the opportunity cost, cost of capital, the prevailing maximum return in the economy etc. IRR is a trial and error method. Under trial & error process two discounting rate-one, at which NPV is negative and another one, at which NPV is positive are used in calculating IRR.

• Profitability Index :

PI is calculated by dividing present value of inflow with the present value of outflow. A project can be accepted if PI > 1.

Break Even Analysis :

Break even analysis is commonly known as the cost-volume-profit (CVP) analysis. Break –even analysis shows the relationship between cost and revenue with respect to profit. By showing the break-even point, this analysis says the minimum level of output or sales that is required to equate the cost. More-over, break- even analysis provides a clear idea about the required volume of sales to earn a target profit. Thus break-even analysis helps the decision criteria.

Fixed cost

BEP    =   ———————————————–

Sale per unit – variable cost per unit

Sensitivity Analysis :

Sensitivity analysis provides the picture of relative changes in overall profitability due to change in any variable. Usually changes (increase) in material and other variable cost or changes (decrease) in selling price are being taken into consideration for making sensitivity analysis.

Ratio Analysis :

Ratio analysis is the analysis and interpretation of data given in the financial statement such as: Balance sheet, income statement etc. Ratio is the quantitative expression of relationship between two accounting figures. Ratio analysis gives a clear picture about the strength and weakness of a firm, its historical performance and current financial condition. The common ratios that are being used in the analysis are:

Liquidity Ratio:

• Current Ratio
• Acid test etc.

Solvency Ratio:

• Debt-equity ratio
• Debt to total asset ratio
• Debt service coverage ratio etc.

Activity Ratio:

• Inventory turnover ratio
• Debtors/received turnover ratio
• Total asset turnover ratio etc.

Profitability Ratio:

• Profit margin
• Return on investment
• Return on

Appraising the Business/Details of the Business of the Customer

The main task of the credit officer is to analyze the vehicle’s (for which the credit is sought) market potentiality, competitors, distinctive competitiveness and the strategy taken.

In appraising the business, the main concern is whether there is any prospect of the business. SIBL look for,

Industry outlook

1. Number of competitors
2. Prospect of the business
3. Influence technology changes

Client’s business appraisal

Initialization of the business,

1. Customer base (increasing trend)
2. Relationship with the customer
3. Work done so far and the value
4. Annual income at least stable
5. Overall growth of the business
6. Basis of competition (guessed)
7. Quality of services (guessed)

Management Competence’s or Capability Appraisal

The ability of the management to run the business smoothly and business background of the promoter and the sponsor director and the management are important. As most of the established businessman are traditional and has not business education it is very difficult to find out. to identify and judge SIBL collect the following information from the client :

• Brief description of the directors educational background & business background.
• Brief profile of the management
• Business performance for the last three years as performance of the business implies the capability of the management’s running the business.
• Equity mobilization of the directors as it implies their risk-taking attitude.

If it is revealed that the directors are in the business for a long time and have operated the business well is said to have the capability to run the business.

The management personnel should have-

• Technical skill to use knowledge, method and techniques (acquired from experience education and training) to performing the job.
• Human skill to maintain interpersonal relationship within or outside the organization.
• Conceptual skill to understanding the complexities in overall organization.

Marketing Aspect

Marketing aspect is the most significant aspect. Whether a project will be able to generate profit depends largely upon the market position. The market demand for the product of the project is analyzed in this part of appraisal. The following assessments are made under marketing feasibility test:

• Past & present demand for the product.
• Past & present supply of the product.
• Expected future demand for the product.
• Demand and supply gap.

Existence and impact of complementary goods and the distribution channel or marketing mechanism is critically analyzed in this part of project appraisal.

Technical Aspect

In this part, the factors those are more or less technical in nature are examined. Examination of the technical factors us to know whether the project is technically feasible. The points of observation in this area are :

• Location or site of the project
• Availability of infrastructural facilities such as : roads & transport, school college.
• Availability of raw materials
• Availability of utilities such as : electricity, gas water etc.
• Availability of required machinery
• Climatic position in the project area.
• Availability of required labor.
• Nearness of market for the product.
• Political factors such as Govt. patronage, industrial policy of the Govt.

Socio- economic Aspect

The observation of this aspect is to whether the project is socially desirable. How much contribution will be made by the project to the G.D.P. and how many numbers of employment will be generated by the project should be ascertained.

Product Appraisal

The client has to furnish brief description of the product or services; he or she is producing or going to produce or rendered. After getting the product description, the credit officer in SIBL has the job is to find the,

Table: criteria of products of borrowers

Source : credit risk unit of SIBL

Security Appraisal & Valuation

Asset that will be offered as security must be analyzed thoroughly on the basis of few criteria as different assets as different influencing factors. The factor that has to be considered in the time of asset valuation are briefly discussed below,

Liquidity :

In a word it means, “how quickly an assets can be converted into cash”. The more liquid the asset the greater its value as collateral. Stocks, bonds, and other marketable securities are easily sold and for this reason, represent attractive value as collateral and highest liquidity.

Depriciability :

Some types of assets lose their values rapidly than others. Computers and other electronic assets are continuously upgraded so that last years model are technical obsolete. Dresses suits and apparels also quickly lose their values as public’s fashion taste change frequently. But however real estate and certain other fixed assets may increase in value day by day. These assets are attractive sources as collateral.

Marketability: The market available for purchasing liquid assets is a vital part of having a good collateral value. Secondary market is necessary for buying and selling the liquid assets. If secondary market is not available the bank has to lose the value of the asset and has to sell it at discount. So if there exists secondary market for the collateral assets, it can yield an attractive value.

Controllability: This refers to the bank’s ability to locate and hold the assets. Bonds and stocks posted as collateral can be held in the bank’s volt easily and highly controllable by the bank. Therefore, prior lien offsets. Warranties & other legal claims should be investigated by the credit officer before taking any thing as collateral as the higher the complexity in realizing the collateral the lower the value. Once the collateral loan value is established the commercial loan officer should deduct the costs that can be expected to be incurred if the collateral is liquidated. The bank may absorb forecasting cost (legal & appraisal) and holding cost (including tax and maintenance costs) before proceeds are realized from the sale of the collateral assets. The amount remaining after deducting all this cost, the bank can expect to apply to the principal, interest and cost of the loan.

In providing loan SIBL take mortgage of land and buildings along with PSP.EDR.MBDS. In the time of taking documents the borrower has to disclose all the information related to the land and buildings, which will be offered as collateral against the loan.

• The credit officer must collect all the documents to verify the land’s actual owner and the updated government fees paid receipt.
• For justification the documents should be communicated with the bank’s lawyer.
• Whether the sites plan of the land is permitted by the RAJUK (if applicable)
• The client must have to submit valuation certificate from an engineering firm.
• Valuation by the two credit officers must be submitted after visiting the land and discussing with the neighborhood about the value, and the market value and the forced value of the land and/ or building must be submitted in prescribed form and duly signed by them as well.
• Three photographs from three different angles of the mortgage land should be submitted photographs must be duly attested by the credit officer.

The client may seek for credit in terms of working capital, work-order finance, and project loan. The credit officer has to analyze the required amount though the client revealed their credit demand in the credit application .The calculated or assessed amount by the credit officer may be lower than client’s demand. SIBL analyze the financial statements and the amount required as working capital. the credit officers analyze earning forecast, expense estimation.

Credit officer prepares a credit proposal along with the prescribed ‘credit proposal form’. Credit officer measures the risk associated with the credit facility. No credit proposal can be put for approval unless there has been a complete written analysis. It is absolute responsibility of the proposing officer to ensure that all necessary proposal documentation have been collected before the facility request is sent to the sanctioning officer.

In spite of some limitations, LRA is really appreciable tool in assessing the risk lying with the credit proposal. But it should be modified for the sake of simplicity and consistency in the context of our country to get rid of the drawbacks illustrated.

Step 4: Approval of Credit by Higher Authority

Branch Credit Committee: Branch credit committee to be headed by the branch manager, other members to be by the manager in consultation with had office.

Head Office Credit Committee: Head office credit in accordance with authority established and delegated by the board of directors.

• Reviewing, analyzing and approving extension of credit in accordance with authority established and delegated by the board of directors.
• Evaluate the quality of tending staff in the bank & take appropriate steps to improve upon.
• Recommending credit proposal to the executive committee/board of directors which are beyond the delegated authority.
• Ensuring that all elements of credit application i.e. forms, analysis of statements and other papers have been obtained and are in order.
• Confirming that the transaction is consistent with existing loan policy and Bangladesh Bank guidelines & if not the committee may prepare a recommendation form an exception to or change in policy for consideration by the executive committee/ board of directors.

Executive Committee : Approving credit facilities as delegated by the board of directors. Supervising the implementation of the directives of the board of directors. Reviewing of each extension of credit approval by the Head Office credit committee/ Managing Director. Keeping board of directors informed covering all these aspect.

Board of Directors: Establishing overall policies and procedures for approving and reviewing credits. Delegating authority to approve and review credits. Approving credit for which authority is not delegated. Approving all extensions of credit which are contrary to bank’s written credit policies.

Step 5: Sanction and disbursement of Credit

Most important step of proving credit facility is the sanctioning of credit. Because sanctioning authority will be held responsible for any discrepancy.  In this step all the documentation is completed and the customer is sent an advising letter for the credit facility along with all the terms and conditions. Norms maintained in sanctioning of credits are described below:

• Credit will be sanctioned and disbursed strictly in terms of the approved credit operational manual of the bank and Head office circulars issued from time to time.

• All norms informed through the circulars of credit division in particular and all other relevant circulars in general, which are to be followed meticulously while exercising power.

• Credit will be subject of Bangladesh Bank restriction.
• The party to whom credit will be allowed should be as far as possible within the command area i.e. Area of operation of the branch. Deviations, if any to be explicitly explained in the proposal.

• No sanctioning officer can sanction any credit to any of his near relation and to any firm / company where his relations have financial interest. Such cases should be sent to the Head Office.
• All sanctioning officers maintain a sanctioned register for recording serially all the credits sanctioned by him. Sanctioning officer will accountable for non-recovery due to his injudicious decision.
• All approval of credit facilities must be conveyed under dual signature. Ideally both the signatories must have the required lending authority. If however, two lending officers of the required lending are not available, one of the signatories must have the required authority.

Limit Enhancement / Renewal:

If the client approach for limit enhancement or time extension, his previous performance of the loan account is highly emphasized and analyzed. In the case for analyzing the account, the performance is measured din the in the following way:

Recycle Time         = Credit Turnover/ / Limit

Debit Turnover       = Summation of Credit Transaction

Credit Turnover      = Summation of debit Transaction

Adjustment Time   = How many times the party has adjusted the accounts, which implies that the party has made reasonable transactions. The standard is that party will adjust the account every quarter.

Disbursement of Credit:

Disbursement of credits presupposes observance of all norms and procedures, which are conveyed through different circulars of Head Office, issued from time to time.

Steps 6: Credit Administrations and File Maintenance

Credit File Maintenance: The credit file for each facility shall contain all information necessary to facilitate ready monitoring of that facility. It should contain a through history of the customer relationship to help credit officer; track any problems, assist newly assigned credit officer in understanding the customer and make the lending process transparent. Primary items in credit file include:

• Credit application and credit approval notes / analysis. Evidence of credit approval and data upon which approval was granted together with any comments, if appropriate.
• Copy of sanction and loan agreement. A checklist along with copies of all legal & banking documents obtained / to be obtained. Details and 6 monthly updated information of all related facilities to the name customer group.
• All supporting data such as financial statement and analysis , references, credit investigation results , CIB & other bank reports and notes of all discussions with the borrower and other relevant parties with paper clipping.
• Correspondences call reports, site visit reports, stock report etc. each credit file shall be maintained in a secured location and where access restricted to authorized personnel’s only. Copies of the information may be kept where regular access required.

Facility Evidence Maintenance: All charge documents should be maintained in a place of utmost security. All charge documents as prescribed by the bank & local laws, for the relevant credit facility, signed credit agreement , signed guarantees or other evidence of credit security or collateral agreement shall be kept in fire proof safe under the custody of branch manager or his designate alternative and another officer . A register of and security documents should be maintained under the supervision of the branch manager. Type of documents to be signed by the client varies depending upon the nature of loan and advances given. Some common documents are listed below:

• Demand promissory (DP) note
• Letter arrangement
• Letter of agreement
• Letter of continuity (in case of continuous loan)
• Letter of pledge (in case of pledge)
• Letter of hypothecation (in case of hypothecation)
• Letter of undertaking
• Letter of debit authority
• Letter of installment (in case of term to be paid in installment)
• Letter of guarantee (Personal Guarantee)

Creation of charges over securities : As a safety, bank has to create charges over the securities against the risk of non-repayment of loan. Here in this chapter, the most common modes of charge creation are defined below in a very brief from:

Pledge

According to the section 172 of the contract act when a borrower surrenders his business goods to the banker’s custody as the security of loan given by the bank then it is called pledge. The pledge goods remain with the possession and control of the bank and the client draw the goods in case of need with the permission of the bank by repaying adequate amount of loan. Bank usually permits drawing power (DP) to the borrower to draw the goods from its custody after checking the stock report. In case of default, bank deserves the right to realize the loan by selling the pledge goods. Bank create this charge based upon the letter of pledge which has been taken form the borrower before disbursement.

Hypothecation

When loan is given to the borrower against hypothecation possession of goods then it is called hypothecation, the physical possession & control remain with the borrower’s custody. Bank creates charge over the hypothecated goods in case of default. For creation of this charge bank takes the letter of hypothecation from the borrower.

Lien

 Lien is the right of the creditor to retain the goods or properties given by the borrower to the creditor as the security against the loan. The creditor deserves the right of lien until the debt is paid. Lien can be of two types:

Particular lien: In particular lien, the creditor can retain goods only introspect of a particular debt.

General lien: As per the declaration under section 171 of the contract act 1872 the creditor, in absence of any contract on any contract to the contrary exercise lien and retain the security of any goods bailed to them for a general balance of account.

In the event of default by a customer the banker can sell the goods / securities retained after giving a reasonable notice.

Assignment

Assignment is the transfer of a right, property or debt, existing or future by one person to another person. In the banking the usual subject of assignment is “auction able claims”. Common types of assignment are:

• Book debts
• Contract money due from Govt. bodies
• Supply bills
• Life insurance policies

Set-off

Right of set- off is the right of a banker to combine all the account of a customer to realize the debt. Set off accrues to the banker as a result of banker-customer relationship. If a customer maintains more than one account with the bank, usually bank obtains a prior letter of set-off so that bank can combine them at its discretion without giving any notice to the customer. The judgments in different cases reveal that bank can combine more than one account of a customer maintains with different branches of the same bank.

Mortgage

As per the declaration of the transfer of property act 1882 under section 58 (a) mortgage is the transfer of an interest in specific immovable property for the purpose of securing the repayment of money advance or to be advanced by way of loan, existing or future debt, the performance of an engagement which may give rise to a pecuniary liability. The transferor is called the mortgage and the transferee is called the mortgagee. The mortgagor gets back all his rights to the mortgaged property on repayment of loan due three on. Mortgage may be of different types, such as:

• Register or simple mortgage
• Equitable mortgage
• English mortgage
• Anomalous mortgage etc.

Among these, first two are used more frequently.

1. Register or simple mortgage: where without delivering possession of the mortgaged property, the mortgagor binds himself personally o the debt. The mortgage (bank) can sell the property obtaining decree from the court.
2. Equitable mortgage: Where mortgagor delivers the documents of title of immovable property with intention to create a security thereon, the transaction is called mortgage by deposit of the deeds or equitable mortgage.

Step 7: Credit Monitoring and Reviewing

It is the responsibility of the mortgage to monitor the over all profile and risk aspect of the credit profile in accordance with the criteria set down in the bank credit policy. Such monitoring shall be evidenced from the comments of the manager in monthly call/ visit report and be kept in the credit file with a copy to the Head Office.

This review shall be formally performed at intervals prescribed by Head Office but it is the responsibility of the manager to ensure at all times that the credit portfolio meets the standard set forth by the bank.

Periodic review and follow-up should aim at ensuring:

• Terms of approval have been maintained.
• Conduct (turnover, regularity of repayment etc.) of the borrowing accounts during the period under the review has been satisfactory or as expected.
• Continuing value of the collateral is adequate.
• There are no adverse trends in market, economic and political conditions which may endanger the reliability of the facility.
• Business reciprocity offered and received is commensurate with the facilities allowed.
• Earning from the account is cost effective (i.e. adequate to meet business cost of finds and leaves sufficient margin for adequate risk reward, overheads and profits).
• Borrowers business is being satisfactorily conducted as reflected through a review and analysis of the financial and operating statements.

Assessment of Group Exposure:

If facilities of any one-customer group are booked in a number of locations, an officer designated by Head Office shall be responsible for the management of the bank’s global exposure to that customer group. Any development in the customer’s which may effect the management of the facility and in particular the credit rating assigned to the customer, shall be documented and advised by the designated officer to the concerned branch & to the Head Office, credit division.

General Norms for Monitoring Credit Facilities:

The Branches will submit a monthly statement of the credits allowed under the discretionary powers of the manager to the Head Office irrespective whether the same are outstanding or not on the date of return.

Recovery of loan ensures the recycling of fund. Non-recycling of fund leads a bank or financial institution to become stagnant. So, recovery of loans and advances is a must. But the scenario of loan recovery is undoubtedly poor and inefficient in our system. Willful non- repayment of loan has become a culture our country. This is mainly because of inadequate, inefficient and even absence of supervision & monitoring system.

Recovery can be ensure or at least making close supervision and monitoring can increase rate of recovery. Supervision should be started the starting point of a credit proposal. Supervision can be done in two stages:

Finance Stage Supervision:

In this stage, supervision should be made:

• To select the right borrower i.e. credit worthiness of the borrower
• To be sure about the business prospect
• To see whether any misstatement made by the borrower etc.

Post Finance Stage Supervision

Post finance stage supervision is sometimes synonymous to the monitoring. Monitoring is a continuous process of overseeing the borrower, his business, his trend in repaying the loan. In this stage, supervision and monitoring should be made:

• To see whether the borrower draws the sanctioned credit regularly
• To see whether the loans are being properly & fully utilized
• To see whether the borrower repays the loan regularly
• To see whether the any significant change happens in the management of the borrower
• To see whether the borrower maintains close contact with bank regularly
• To see whether the any significant change happens in the borrower’s business plan
• To make the borrower aware about the timely repayment of loan
• To take necessary step in case of need

Supervision & monitoring help to develop a cooperative attitude between the borrower and the bank. Moreover, close supervision & monitoring make the borrower loyal to the bank and thus, supervision & monitoring ensure the recovery of loan.

Step 8: Taking Precaution / Legal Action Against Delinquent Clients

The responsibility for review and classification of credit facilities starts at branch level. The frequency of the supervision and monitoring depends on the classification of credits.

Sub-standard Advances: This classification contains accounts where irregularities have occurred but where such irregularities are considered to be either “technical” or “temporary” in temporary irregularities no loss is expected to arise.

These accounts will require close supervision by the management to ensure that the situation does not deteriorate further.

Provision@15% of the base is required for debt in this classification where the base is the outstanding balance less interest kept in interest suspense account less the value of eligible securities.

Doubtful Debt: This classification contains debts where doubt exists the full recoverability of the principal and / or interest. Although a loss is anticipated it is not possible at this state to quantity the exact extent of that loss. Management is required to handle such debts with the utmost caution to either avoid or minimize the bank’s losses. Provision @50% of the base is required for debts in this classification.

Bad Debts: These facilities are considered to be uncorrectable shall be made a provision @ 100% of the base.

Special Mention: In addition to the above classification rating, there should be another category which is not classified but where special attention is necessary to keep the out of classification. This category will be known as special mention. Facilities required special monitoring are to be flagged or put on a watch list.

No provision is necessary for this category.

Management of Delinquent Client:

When a problem loan is detected the responsible loan officer takes the corrective action and tries to minimize the loan losses allowing different facilities to the client. The steps practice in SOCIAL ISLAMI BANK LIMITED to the delinquent loan is:

Persuasion:

This is the first step practiced in the SIBL to manage the problem loan. This steps involves-

• Open discussion with the borrower about the problem he is facing.
• Discussion with third party to find out the underlying reasons.
• Issuing “1^st Reminder” letter to inform the due date and ever due installments.
• If the doesn’t response issuing “2^nd Reminder” and then “3^rd Reminder” letter.

Litigation:

If after rescheduling the loan and or failed to negotiate with the delinquent client, SIBL go for taking legal action against the delinquent client to recover the loan. The branch managers send a letter to the head office credit department informing the borrower’s reluctance to repay and negotiate the loan.

• Filing case against the client
• Assigning the loan officer for assisting the lawyer.

As soon as an account is classified delinquent a detailed report will be sent to the Head Office credit division by the branch manager. After that, a monthly report on all delinquent facilities is to be sent to the head office credit division jointly signed by the branch manager with the second officer / credit officer. Beside this branch manager should include the action plan taken against the delinquent account and status report.

Performance of SIBL at a glance

Taka in million

Capital

The authorized capital of the bank is Taka 4000 million. The paid-up capital and equity of the bank stood at Taka 1309.88 million and Taka 1867.36 million respectively as at 31^st December 2008

Deposit

Treasury operation of SIBL was featured by increment of client deposit and reduction on dependency of bank deposits compared to the year 2007 to bring stability in fund management. Besides the borrowing from Bangladesh government mudaraba Islamic bond fund has added some value in liquidity of SIBL. Therefore, despite of liquidity crisis in the whole year 2008 in the market, we could efficiently saved the bank from any liquidity mishap. We could significantly improve the deposit mix in 2008.

Investment

Our investments stood at Taka 19951.30 million in various sectors as at 31^ST December 2008 against Taka 16440.26 million of 2007 registering a growth that signifies the confidence of the clients having on their bank. The increment of investment by TK. 3511.04 million compared to the year 2007 was due to expansion of business with some renowned business house and qualified borrower of our country.

Foreign exchange business

Foreign exchange business stood at TK. 33363.2 million in 2008 against TK. 23903.8 million of 2007.

Deposit Mix

The customer base of the SIBL is large in its kind in any other Islamic bank. It has targeted both the lower income group and higher income groups as well.

Table: Deposit Mix of SIBL

Source: Annual report of SIBL, 2008.

Sources of fund

Sources of fund of the Social islami Bank Limited, like other bank the sources of fund comes from deposit, paid up capital, Reserve fund and other liabilities. Deposit is the main sources of fund followed by paid up capital. The equity capital was Taka 4000 million at the end of 2008.

Fixed Assets

SIBL has used its fixed assets at TK. 132.03 million in 2007 & at TK. 443.28 million in 2008.

FINDINGS & RECOMMENDATION

Findings: Some Findings of the study on Credit operations of Social Islami Bank Limited are given bellow:

1. Credit Policy: Social Islami Bank Limited has introduced a credit policy and credit instruction manual which encompasses all credit risk components as well as mitigate factor of the probable risks. Risk manager has strictly follows the credit policy accordingly to lending. But the management and the board of the bank have the authority for exceptional credit approval.
2. Insufficient time for risk assessment: The risk managers have often insufficient time for credit risk management. So, it is very troublesome to manage the risk in a prudent manner for the risk managers.
3. Few numbers of tools and techniques for risk management: Banks has a few numbers of tools and techniques for credit risk assessment i.e CRG, FSS, CIB which are not sufficient for all kinds of risk management.
4. Illegal pressure from political persons, directors and management of the bank: The banks in Bangladesh has faces a lot of illegal pressure from political persons, directors and management of the bank for approval of loan. In the cases risk managers are bound to approve the loan without any assessment and rationality.
5. Lack of information in the credit proposal: Risk managers often could not found all necessary documents and information for credit risk assessment. That’s why risk managers use their assumption on risk management. Data collection checklists are not filled by the relationship managers.
6. Limited security coverage: Customer has offered a limited collateral security against credit facility. So there is a significant risk for loan defalcation. Bank will may loose in case of defalcation.
7. Lack of customer banker relationship: Due to centralization of banking systems SIBL has maintain a very week relationship with the valued customer. The customers are very much dissatisfied with this worst situation.
8. Lack of follow-up and monitoring: Credit quality depends on close follow-up and monitoring of loans. The follow-up and monitoring of loans is not strong here. As a result special mention accounts and deteriorating credit are increasing day by day.

Recommendation:

There is no straight easy way for getting success. Most of the organization has to face some problems. But for getting success it should overcome those problems. In the period of my internship, I tried to find out that. For achieving the target level of success SIBL should take care of those problems and should not allow the customer to find any weakness in their service. So they should always be competitive technologically advanced and be creative in the business to maintain position and to do even better then in this regard some recommendation are proposed below:

1. Introduction of an easy understandable credit policy: The credit policy of the bank is very complicated. It should be easy understandable and user friendly. So that all the credit concerns can understand the instruction and follow it meticulously at the time of credit risks management.
2. Improvement of credit risk grading systems: An industry wise integrated credit risk grading systems should be developed. So that risk can measure for different industry of business.
3. Sufficient workforce and allocate a standard risk assessment time: Sufficient risk managers should recruit in credit risk management division and standard time should allocate for a credit proposal analysis. So that, risk managers could go through the credit proposal for risk managers and have sufficient time for better analysis and assessment.
4. Credit report: Credit report obtained for all sort of credit proposal. Single credit proposal should not approve without having clean CIB report from Bangladesh bank.
5. Development of tools and techniques for credit risk management: Banks has a few numbers of tools and techniques for credit risk assessment i.e CRG, FSS, CIB which are not sufficient for all kinds of risk management. So new and effective credit risk management tolls and techniques should be introduced by the help of IT division.
6. Reduce of political pressure and influence of the directors and management: It is unavoidable of political pressure & influence of the directors and management. So some technique should introduce so that those pressure and influence should reduce.
7. Strong security coverage: Adequate collateral security should obtain by the borrower as security. So that in case of bank may save from financial losses.
8. Adequate information & documents: Adequate information and documents should prove in the credit proposal so that risk managers can make their decision with a very minimum time.
9. Follow-up and monitoring: Credit quality depends on close follow-up and monitoring of loans. The follow-up and monitoring of loans is not strong here. As a result special mention accounts and deteriorating credit are increasing day by day.
10. Develop customer bankers’ relationship: Today is the time for relationship banking. For better performance customer satisfaction is very much important. So, Bank should develop the relationship with the customer.

CONCLUSION

SIBL is one of the third generation banking service providers, but their employees are needed to prompt service provider. We strongly believe that banking services marketing are different from goods marketing in a significant way. It involves totally different strategy and tactics.

Performance of SIBL during the last six years has proved that with strong desire and will power one achieve whatever target he/she may have. Almost all the leading banks in our country have various extra facilities in offer for the customers in comparison with SIBL but SIBL has succeeded in achieving more customers than many other competitors. This has been possible only because of strong customer relation and excellent customer service.

Though there are some drawbacks in implementing credit facilities in SIBL limited as per manual, it can be overcome through involvement of more financial expert in the decision making process and utilizing the tolls to judge integrity of the customers, finally it can be argued that though the results achieve so far are not satisfactory, credit financing is a modern scientific technique for enhancing SIBL’ strength and there lies the opportunities to make it more effective in the future for their own benefit.