Credit Risk Management in National Bank Limited

The main objective of this report is to analysis to get a sound understanding of credit risk management system and procedure followed in the National Bank Limited. This report is covered by the structural, functional and overall performance. Other objectives are analysis about the credit related operations and maintenance in this bank. Also focus on the credit risk grading system for analyzing the credit assessment procedure of National Bank Limited. Finally draw SWOT analysis and suggest recommendation based on credit risk management performance of this bank.

Objective of the study

The objectives of this study are as follows:

1. To have a sound understanding of credit risk management system and procedure followed in the National Bank Limited.
2. To gain knowledge about the credit related operations and maintenance in this bank.
3. To analyze in detail the credit risk management process of the bank and to make recommendations if needed.
4. To focus on the credit risk grading system for analyzing the credit assessment procedure of National Bank Limited.
5. To have a general idea about the credit risk management performance of this bank.

METHODOLOGY OF THE STUDY

The information incorporated in this report has been gathered from primary and secondary sources. While conducting the study, sources were explored for primary information and data. But hardly any updated data could be found. In the absence of updated information or data dependence on secondary data has been inevitable. However, whenever possible primary data has been used. Data were also collected by some documents & statement printed by the bank and website of NBL.

Primary Data:

Data has been collected primarily through correspondence with the personnel working in different departments of National Bank Limited, personnel of the North Brook Hall Road Branch, in following ways-

Practical working exposures from the different desks of the different departments of the branch, and relevant file and documents.

Secondary Data:

Sources of secondary data are showing below by the following table for easy and quick understanding

TABLE: SOURCES OF SECONDARY INFORMATION

HISTORY AND HERITAGE OF NATIONAL BANK LIMITED

National Bank Limited has its prosperous past, glorious present, prospective future and under processing projects and activities. Established as the first private sector bank fully owned by Bangladeshi entrepreneurs, NBL has been flourishing as the largest private sector Bank with the passage of time after facing many stress and strain. The members of the board of directors are creative businessmen and leading industrialists of the country. To keep pace with time and in harmony with national and international economic activities and for rendering all modern services, NBL, as a financial institution, automated all its branches with computer networks in accordance with the competitive commercial demand of time. Moreover, considering its forth-coming future, the infrastructure of the Bank has been rearranging. The expectation of all class businessmen, entrepreneurs and general public is much more to NBL. At present we have 145 branches under our branch network. In addition, our effective and diversified approach to seize the market opportunities is going on as continuous process to accommodate new customers by developing and expanding rural, SME financing and offshore banking facilities. We have opened 10 branches and 5 SME/Agri branches during 2010.

The emergence of NBL in the private sector is an important event in the Banking arena of Bangladesh. When the nation was in the grip of severe recession, Govt. took the farsighted decision to allow in the private sector to revive the economy of the country. Several dynamic entrepreneurs came forward for establishing a bank with a motto to revitalize the economy of the country. NBL was born as the first hundred percent Bangladeshi owned Bank in the private sector. From the very inception it is the firm determination of NBL to play a vital role in the national economy. We are determined to bring back the long forgotten taste of banking services and flavors. We want to serve each one promptly and with a sense of dedication and dignity.

The then President of the People’s Republic of Bangladesh Justice AhsanuddinChowdhury inaugurated the bank formally on March 28, 1983 but the first branch at 48, Dilkusha Commercial Area, Dhaka started commercial operation on March 23, 1983. The 2nd Branch was opened on 11th May 1983 at Khatungonj, Chittagong. At present, NBL has been carrying on business through its 130 branches and 15 SME / Agri Branches (total 145 service locations) spread all over the country. Since the very beginning, the bank has exerted much emphasis on overseas operations and handled a sizable quantum of home bound foreign remittance. It has drawing arrangements with 415 correspondents in 75 countries of the world, as well as with 37 overseas Exchange Companies located in 13 countries. NBL was the first domestic bank to establish agency arrangements with the world famous Western Union in order to facilitate quick and safe remittance of the valuable foreign exchanges earned by the expatriate Bangladeshi nationals. This has meant that the expatriates can remit their hard-earned money to the country with much ease, confidence, safety and speed.

NBL was also the first among domestic banks to introduce international Master Card in Bangladesh. In the meantime, NBL has also introduced the Visa Card and Power Card. The Bank has in its use the latest information technology services of SWIFT and REUTERS. NBL has been continuing its small credit programmes for disbursement of collateral free agricultural loans among the poor farmers of Barindra area in Rajshahi district for improving their livelihood.

NBL focused on all key areas covering capital adequacy, maintaining good asset quality, sound management, satisfactory earning and liquidity. As a consequence, it was possible to a record growth of 175.51 percent with Tk. 8,809.40 million pre tax profit in the year under review over the preceding year. The net profit after tax and provision stood at Tk. 6,860.34 million which was Tk. 2,070.47 million in the previous year registering a 231.34 percent rise. The total deposits increased to Tk. 102,471.83 million being 33.37 percent increase over the preceding year. Loans and advances stood at Tk.92,003.56 million in the year under report which was Tk. 65,129.289 million representing 41.26 percent rise over the preceding year. Foreign trade stood at Tk. 144,255.00 million in 2010 compared to Tk. 115,939.00 million, increased by 24.42 percent compared to that of the previous year. During 2010, the bank handled inward remittance of Tk. 49,145.30 million, 10.73 percent higher than that of the previous year. Return on Equity (ROE) registered a 77.84 percent rise over the preceding year.

NBL stepped into a new arena of business and opened its Off Shore Banking Unit at Mohakhali to serve the wage earners and the foreign investors better than before.

National Bank, since its inception, was aware of complying with Corporate Social Responsibility. In this direction, we remain associated with the development of education, healthcare and sponsored sports, and culture and during the times of natural disasters like floods, cyclones, landslides we have extended our hand to mitigate the sufferings of victims. The bank established the National Bank Foundation in 1989 to remain involved with social welfare activities. The foundation is running the NBL Public School & College at Moghbazar where present enrolment is 1140. Besides awarding scholarship to the meritorious children of the employees, the bank has also extended financial support for their education. It provided financial support to Asiatic Society of Bangladesh at the time of their publication of Banglapedia and observance of 400 years of Dhaka City.

Transparency and accountability of a financial institution is reflected in its Annual Report containing its Balance Sheet and Profit & Loss Account. In recognition of this, NBL was awarded Crest in 1999 and 2000, and Certificate of Appreciation in 2001 by the Institute of Chartered Accountants of Bangladesh.

A team of highly qualified and experienced professionals headed by the Managing Director of the Bank who has vast banking experience operates bank and at the top there is an efficient Board of Directors for making policies.

STRATEGIC DIRECTION AND THE CHALLENGES OF THE NBL

The strategic direction of the bank is critically reviewed by the management as well as by the Board at the time of preparing and approving the corporate plan and the budget. In keeping with the vision and mission statement of the bank, the strategic direction has been clearly identified and laid down in the corporate plan. It detailed out SWOT analysis of the corporate banking, personal banking, treasury, information technology, human resources management and Bangladesh operations of the bank. Besides, it spells out goals and objectives of these main segments along with detailed action plans with specific time frames to achieve them.

The corporate plan and the budget incorporate highly ambitious targets for the planned period. Undoubtedly, the corporate plan and the budget have immensely contributed in guiding the organization to its present level. Further, it has contributed to building up the target driven culture across the organization and leading to record superlative performance and to maintain the preeminent position in the banking industry.

CORE VALUES OF THE NATIONAL BANK LIMITED

NBL creates new value by forming teams of specialists in various fields and providing optimal services to customers. The NBL’s core values consist of six key elements. These values bind NBL’s people together with an emphasis that people are essential to everything being done in the bank.

Integrity:

NBL protects and safeguards all customer information, treats everyone in an equitable and consistent manner, and creates an environment which earns and maintains customer trust.

Open communication:

NBL builds customer relationships based on integrity and respect, offers a full line of products and excellent service, and is committed to the prosperity of the customers and shareholders.

Performance driven:

In National Bank Limited, customers and employees are judged in terms of their performance.

Continuous self improvement:

Continuous learning, self-challenge and strive make ways for self improvement of workforce at National Bank Limited.

Quality:

National Bank Limited offers hassle free better service timely, and builds-up quality assets in the portfolio.

Teamwork:

Interaction, open communication, and maintaining appositive attitude reflect NBL’s commitment to a supportive environment based on teamwork.

PRINCIPAL ACTIVITIES OF THE NATIONAL BANK LIMITED

The principal activities of NBL are to provide a comprehensive range of financial services, personal and commercial banking, trade service, cash management, treasury and security, and custody services. Other activities are:

• National Bank Limited provide a comprehensive range of financial services; personal and commercialbanking, trade service, cash management, treasury, security and custody services.
• Offshore Bank is a Bank located outside the country of residence of depositors, typically in the low tax jurisdiction (or tax haven) thatprovides financial and legal advantage. Offshore Banking Unit (the Unit) a separate business unit of National Bank Limited, governedunder the Rules and guideline of Bangladesh Bank. The Bank obtained the Offshore Banking permission vide letter No. BRPD/(P-3)744(97)/2008-2005 dated 01 June 2008 from Bangladesh Bank. The unit commenced its operation from September, 2008 and itsoffice is located at 9, Mohakhali, Dhaka.

HIGHLIGHTS ON THE OVERALL ACTIVITIES OF NBL AND ITS OFFSHORE UNIT

Offshore Bank is a Bank located outside the country of residence of depositors, typically in the low tax jurisdiction that provides financial and legal advantage. The offshore banking unit a separate business unit of National Bank Limited, governed under the rules and guidelines of Bangladesh Bank. The unit commenced its operation from September 2008 and its office is located at 9, Mohakhali, Dhaka.

CAPITAL STRUCTURE OF THE NATIONAL BANK LIMITED

In 2010, 55.00 percent stock dividend was declared which increased the amount of paid-up capital to Tk. 4,412.13 million in 2010. Reserve and surplus was enhanced by 142.06 percent consisting of statutory reserve, general reserve, retained earnings and other reserve. Total shareholders’ equity as on December 31, 2010 stood Tk. 19,105.60 million.

CAPITAL ADEQUACY RATIO OF THE NATIONAL BANK LIMITED

Capital Management of the Bank is to maintain an adequate capital base to support the projected business and regulatory requirement. NBL always maintain a prudent balance between Tier- 1 and Tier-2 capital. Total capital as on Decemder 31, 2010 was Tk. 19,190.79 million and capital adequacy ratio was 12.29%.Maintenance of adequate capital enhanced the Bank’s single borrower’s exposure limit up to a high level to cope with the corporate customers demand.

TECHNOLOGY USED IN NATIONAL BANK LIMITED

Innovation has been called the most precious capability that any organization in today’s economy must have and nurture. Without a constant flow of new ideas- not only for new products and services, but also for new ways of doing things- an organization is doomed to obsolescence or even worse, failure. Automation is a technological change that replaces certain tasks done by people with machines. Probably the most visible technological changes in recent years are computerization.

Most organizations of developed countries now have sophisticated information systems. E-business is a comprehensive term describing the way an organization does its work by using electronic linkages with its key constituencies (employees, managers, customers, and partners) in order to efficiently and effectively achieve its goals. Managing in an e-world, organization requires new insights and perspectives.

National Bank is the private sector bank to realize the importance of technology for Bangladesh market and introduced on-line banking. Due to various obstacles the IT development process slowed down in the past few years. However, to meet the customers demand in this competitive market, NBL management, once again, turned their focuses on the IT sector. Under the guidance of the management, the IT Division of the bank designed a plan and engaged the resources in the implementation of the IT projects at various segments of the banking business. Following is the list that details the work of ongoing IT projects:

At first, the management has decided to build communication infrastructure for the institution and advised the IT division to bring all its branches under one communication network. Without communication network, centralization of information is virtually impossible. Today, we are proud to disclose that 61 of our 106 branches are connected under one network. Twenty-four hours banking service is increasingly getting popular among the customers of all ages. Witnessing such facts, National Bank has launched Q-Cash ATM service at various locations within Dhaka and Chittagong for its customers. Detail information of the service is discussed below.

Customers, nowadays, demand to access their account information and transact from any branch regardless of its location. To implement the concept, proper communication network, centralized customer accounts, and modern banking software is a must. In order to meet customer’s requirements, Management, together with the IT division of the bank is searching for reputed banking software to support all the services provided by modern banks. In addition to any branch banking, the new software will allow many other services including phone or Internet banking. The concept “One profile per National Bank Limited customer all over Bangladesh” is now the reality.

All the above ongoing projects will have an instant and positive impact on the ways our customers currently do banking with us. In addition to that there are many other computer-based services that are being implemented in all the departments of the organization to increase the work efficiency. Thus, IT division of the bank is effortlessly working toward improving the customer service quality and training of the NBL staffs and executives.

Credit and Loan of NBL

INTRODUCTION

Banks act as intermediaries between surplus and deficit economic unit by mobilizing fund from surplus economic unit and deploying it to deficit economic unit. The interest earned on the deployed fund is bank’s main source of income. Out of this income they pay interest depositors and meet other expenditures. The difference between the income earned from the borrowers & the interest generates to the depositors is the main source of income of the bank. A banker has to be very cautious while lending money because he lends depositors money which does not belong to the bank and which must be returned on demand.  The banker has to keep in mind that lending is for the best interest of the community and lending should be directed to productive sectors only.

The principal of lending is a collection of certain accepted time tested standards, which ensure the proper use of loan fund in a profitable way and its timely recovery. Different authors describe different principals for sound lending. NBL follows the following principles in its lending activity:

Safety

Safety should get the prior importance in the time of sanctioning the loan. At the time of maturity the borrower may not or may unable to pay the loan amount. So in the time of sanctioning the loan adequate securities should be taken from the borrowers to recover the loan. Banker should not sacrifice safety for profitability.

Liquidity

Banker should consider the liquidity of the loan in time of sanctioning it. Liquidity is necessary to meet the consumer need.

Security

Banker should be careful in the selection of security to maintain the safety of the loan. Banker should properly evaluate the proper value of the security. If the estimated value is less than or equal to loan amount, the loan should be given against such securities. The more the cash near item the good the security. In the time of valuing the security the Banker should be more conservative.

Adequate Yield

As a commercial origination Banker should consider the profitability. So banker should consider the interest rate when go for lending. Always Banker should fix such an interest rate for its lending which should be higher than its savings deposits interest rate. To ensure this profitability banker should consider the prospect of the project.

 Diversity

Banker should minimize the fort-polio risk by putting its fund in the different fields. If Bank put its entire loan able fund in one sector it will increase the risk. Banker should distribute its loan able fund in different sectors. So if it faces any problem in any sector it can be covered by the profit of another sector.

The credit & Loan department of National Bank Ltd divided into two sections as Credit service department and Loan Administration department.

Credit service department  

Credit is the institutional arrangement of lending funds mainly to the traders and industrial entrepreneurs by the banking company. The major portion of bank’s funds is employed by various ways of loans and advances, which is the most profitable employment of its funds. The major part of bank income is earned from interest and discount on the funds so lent. The job in this department starts from the application made by the client; approve the same, which is disbursed to customers. There are five employees one chief officer, one senior officer, two officers and one asst. officer currently working over desks in this department.

Functions:

The following are the main functions performed by the credit department:

• Preparation of sanction letter as per Head Office approval.
• Monitoring & follow-up of credit facilities extended from the Branch.
• Compliance of review of Client-wise Position.
• Reporting of daily task force to Head Office.
• Export L/C checking & preparation of credits Memos relating to back-to-back L/ Cs, monitoring Project loans of Garments Project
• Preparation of Statement and maintaining all records of the credit extended under ADB Project.
• Preparation of maintaining record of the Foreign Investments.
• Preparation for proposal of Project loan for board’s Approval.
• Monitoring of Foreign investments in capital market through the branch.
• Preparation of Credit Memos for approval/renewal of the Credit facilities.
• Preparation of Credit Memos for the Credit facilities under Cash L/C.
• Processing of Consumer Credit Loans & preparation of all statements of the Consumer Credit Loans.

CREDIT ADMINISTRATION DEPARTMENT

The job of loan Administration Department starts from the disbursement of credit facilities to the customers, as they desired. There are four employees one chief officers, one senior officer and two officers   in this department performs various jobs to disburse the credit, to keeping the recovery records of credit extended to different types of borrowers.

Functions:

The following are the main functions performed by the Loan Administration department:

• Bank Guarantee related all works.
• Preparation of Offering Sheet & Memo against Cash Collateral Loans and advances.
• Balancing of non-judicial & adhesive stamps.
• Loan documentation Scrutinizing and preparation of related papers.
• Maintaining records and safety of all Loan Documents/related papers along with the records of the Loan portfolio.
• Preparation of Tickets related to Loans and Advances.
• Execution of Registered Mortgage formalities with the Sub-Registrar.
• Preparation of CIB, and other monthly, quarterly & yearly statements relating to Loans & Advances.
• Preparation of checklist and Offering Sheet.
• Maintaining records, Calculation and Treatment of Interest Suspense for the past due accounts.

Credit Risk Management

Banks earn the maximum return when all of their loans pay off interest and principle in full. In reality, some loans default on interest payments, principle payments, or both. Thus the average return on the assets portfolio would be less than the maximum possible return from a no-default case. Basically banks consent this trade-off between maximum to average return on its assets as costs inherited with credit risk, which associated with loans. But today’s Credit/Relationship Managers give their utmost effort to settle down the term ‘Credit Risk’ to make optimum return on their assets.

Credit Risk

Credit risk arises from the potential that an obligor is either unwilling to perform on an obligation or its inability to perform such obligation resulting in economic loss to the bank. So inability and unwillingness are two basic sources of credit risk. It may have an adverse impact on the bank’s earnings or capital.

Loans are the largest and most obvious source of credit risk; however, credit risk could stem from various financial instruments along with loans, including inter-bank transactions, trade financing, foreign exchange transactions, and in the extension of commitments and guarantees, and the settlement of transactions. Credit risk originates from a bank’s dealing with individuals, corporate, financial institutions or a sovereign.

Risks Associated with Lending

For lending, basically banks have to tackle almost nine categories of risk factors, those are: credit, interest rate, liquidity, foreign exchange, transaction, price, compliance, counter party and reputation. Therefore, a credit/relationship manager must be understood all the risks embedded in the loan portfolio and their potential impact on the institution. However, this report only focuses on the credit risk, which is the most vital and crucial risk between all the risks associated with lending.

Credit risk basically has two main wings: Default Risk and Portfolio Risk. Default risk is the risk that the borrower is unable or unwilling to fulfill the terms promised under the loan contract, whereas portfolio risk includes all the deficiencies in the policies and actions taken by the bank when pursuing lending process. Portfolio risk also comprises with two more forms of risks: – intrinsic risk and concentration risk.

Intrinsic risks emerge from the inception of each portfolio and risk diversification can truncate or limit the probabilities of the bad outcomes in the portfolio. On the other hand, Concentration Risk or Systematic Risk by its nature very difficult to mitigate as this form of risk inherited beyond banks control. The bestowed table shows some sources of intrinsic and concentration risk.

However some of these risks are being mitigated through a sound credit policy.

Credit Policy Topics

The elements of a credit policy are determined by the specific lending activities and standards of each bank contained by central bank’s legislations. Credit policy also affected by the rules and regulations, banks portfolio objectives, geographic location, economic condition etc. However, most loan policies discuss the topics below.

Loan Authority: The lending policy should delegate power and describe who is authorized to approve credit and should establish specific approval limits for credit approvers. Lending limits may also be set for a group, allowing a combination of officers or a committee to approve loans larger than the members would be permitted to approve individually. The policy should describe reporting procedures and the frequency of committee meetings.

Responsibilities should be segregated between authorities, because segregation improves the knowledge levels and expertise in each department, imposes controls over the disbursement of authorized loan facilities and obtain an objective and independent judgment of credit proposals.

Limiton Aggregate Loans and Commitments: Size or limit of credit portfolio should be established relative to other balance sheet accounts following Bangladesh Bank’s guidelines. Limits should be developed for the aggregate volume of outstanding loans as well as for total commitments.

Traditionally, limits have been set relative to deposits, capital, or total assets. For example BRAC Bank’s policy is to take exposure to single borrower up to 30% (including funded and non-funded) of it’s paid up capital. Usually this limit is being fixed by Bangladesh Bank. A benefit of this approach is that limits are more closely tied to risk. The credit demands of the community, the volatility of the bank’s funding, and the relative level of risk in the loan portfolio should also be considered when limiting the size of the loan portfolio.

Distribution by Loan Category and Product: Banks should establish a specific industry sector exposure cap or a particular loan category or concentration to avoid over concentration in any one-industry sector or loan category. The type of loans that are permitted should be clearly indicated, such as Working Capital, Trade Finance, Term Loan, and Lease Finance etc. Limits may also be placed on individual loan products within a loan category. Loan category and product limits enable a bank to direct the composition of its loan portfolio to achieve strategic objectives.

Types of Loans: The lending policy may identify specific types of loans that the bank views as desirable or undesirable. For example, many banks do not finance business start-ups, and others avoid loans to gambling concerns. These guidelines should be based on the expertise of the lending staff, anticipated credit demands of the community, and the deposit structure of the bank.

Financial performance standards: Financial performance standards usually are based on the purpose and type of loan. At a minimum, the policy should establish repayment requirements that stipulate acceptable primary and secondary sources of repayment, their relative adequacy, and circumstances in which guarantors are required. The policy may also require a certain minimum working capital, customer size, external agency credit rating, access to financial markets, leverage, and debt service coverage ratio.

Financial information: The credit policy should define the financial statement requirements for businesses at various borrowing levels and set guidelines for audited, un-audited, fiscal, interim, operating, cash flow, projections, and other types of statements. At BBL clients have to submit their audited financial statement within 120 days from the ending of fiscal year.

Collateral and structure requirements: Policies usually describe acceptable credit structures and establish permissible collateral types. They also establish limits for the amount financed, which may vary by loan type. For instance, the policy might limit loans to finance the purchase of equipment to 80 percent of purchase price and might limit the amortization schedule of such loans to the lesser of five years or the useful life of the equipment.

Maturity scheduling should be based on a realistic assessment of the anticipated source of repayment, the purpose of the loan, and the useful life of the collateral. For term loans, the lending policy should define the maximum amortization period. Guidelines should be established for lines of credit, including renewal requirements.

Pricing Guidelines: Policies generally describe loan-pricing principles. Interest rates and fees should be set at a level that covers the bank’s cost of funds and overhead, and provides the bank with an acceptable return. In setting profit goals, management should consider the risk/reward relationship.

Banks may also use pricing to implement their strategic credit goals or to modify their risk profiles. Rates and fees may be set at levels that either encourage or discourage specific lines of business, certain industries, or certain types of customers. Pricing is one of the most effective ways that a bank can control or change its risk profile.

Documentation Standards: Policies should establish guidelines for the internal and legal documents on various types loans. Internal documents include such items as borrowing resolutions, credit memoranda, financial analysis, appraisals, insurance, and processing documents; common legal documents are mortgages, security agreements etc.

Collections and Charge-Offs: The lending policy should require a systematic collection process that grows more aggressive as the risk of loss increases. Guidelines should specify charge-off requirements.

Reporting: The lending policy may describe the types, contents, and frequency of reports provided to senior management and the board of directors. Common management reports include summaries of the level and trends of loans that are delinquent, non-accrual, non-performing, or charged off. Reports on larger problem credits should include information on the level of risk, loss potential, and alternative courses of action.

Other Matters: The policy may also address affiliate transactions, the code of ethics, community support, appraisal requirements, environmental assessment requirements, relevant accounting issues (such as non-performing loans, and debt restructuring), and the allowance for loan and clients credit policy. Any administrative requirements for granting loans should be

covered in the policy. Policies and procedures should also ensure compliance with laws and regulations.

Credit Policy Enforcement

Policies do not have any value unless those are being worked-out. Consistent Credit Policy Enforcement ensures application of credit policies to loan generation, administration, and maintenance. The results include reduced credit risk and increased productivity.

Banks should have an internal control and compliance department who will conduct audits of all departments. This audit should be done frequently or at least once in a year. One of the main job of this department should be to ensures that the credit administration comply with regulatory guidelines, internal procedures, lending guidelines and Bangladesh Bank Requirements.

Importance of Credit Risk Management

Since lending or offering credit is a Banks core business transaction, credit risk carries the potential of wiping out enough of a bank’s capital fund or even to force bank into bankruptcy. This horizon draw significant concentration on credit risk management throughout the world, in fact this is very true for country like us, where credit market is not yet structured, rules and regulation are not practiced properly or corruption plays a crucial role in credit administration. So managing this kind of risk has always been one of the predominant challenges in running a bank. An effective credit risk management system can ensure:

• Efficient Use of Economic and Regulatory Capital
• Sound Credit Approval and Limit Monitoring
• Business Opportunity Analysis
• Prudence Reserve Management
• Portfolio Management
• Earnings Potentiality
• Confidence in the market place

TRADEOFF BETWEEN Credit Risk and Expected Return

Risk management as commonly perceived does not mean minimizing risk; rather the goal of risk management is to optimize risk-reward trade -off. Notwithstanding the fact that banks are in the business of taking risk, it should be recognized that an institution need not engage in business in a manner that unnecessarily imposes risk upon it: nor it should absorb risk that can be transferred to other participants. Rather it should accept those risks that are uniquely part of the array of bank’s services.

Ideally, a bank will manage its assets so as to simultaneously maximize return on assets and minimize credit risk. But, obviously, both objectives cannot be achieved simultaneously. The return on any bank assets depends on the risk involved. Because riskier assets offer higher returns, a bank’s strategy to increase its return on assets will typically entail an increase in the overall credit risk of its assets portfolio. This way a bank attempts to earn a reasonable return on its overall assets portfolio and maintain credit risk at a tolerable level.

Credit Culture and Risk Profile

Credit culture refers to an implicit understanding among bank personnel that certain standards of underwriting and loan management must be maintained, even in the face of constant pressures to increase revenues and bring in new business. The credit culture exerts a strong influence on a bank’s lending and credit risk management.

Risk profile describes the various levels and types of risk in the portfolio. The profile evolves from the credit culture, strategic planning, and the day-to-day activities of making and collecting loans.

Quality of risk profile directly depends upon credit culture and bank’s objectives for asset quality, growth, and earnings shape credit culture. For example some banks approach credit very conservatively, lending only to financially strong, well-established borrowers. This type of bank will have conservative credit culture, consequently less risky profile. On the other hand growth-oriented banks may approach lending more aggressively and hence require more detailed credit policies and more controlling administrative and monitoring systems to manage credit risk properly.

CREDIT PRINCIPLES

To achieve the bank’s goal for maximizing the stockholders’ value and protect the interest of the depositors as well as to improve the quality of banks assets as fundamentally sound financial institution, the bank will be abided by but will not be limited to the following credit principles, which should guide the bank’s behavior in lending decision:

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 will be presented in a Credit Application duly signed/approved by the official of the branch.

The official of the branch 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. The officials must be followed with the National Bank’s Lending Guidelines and will conduct due diligence on new borrowers, principals, and guarantors to ensure such parties are in fact who they represent themselves to be. They will also adhere to the NBL’s established Know Your Customer (KYC), Money Laundering guidelines and Bangladesh Bank regulations.

Credit Applications will summaries the results of the credit official’s 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), and
• Security Arrangements.

Risk Assessment Areas:

• Borrower Analysis: The majority shareholders, management team and group or affiliate companies will be assessed. Any issues regarding lack of management depth, complicated ownership structures or inter-group transactions will be addressed, and risks mitigated.
• Industry Analysis: The key risk factors of the borrower’s industry will be assessed. Any issues regarding the borrower’s position in the industry, overall industry concerns or competitive forces must 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 must 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 historical financial statements of the borrower will be presented. Where reliance is placed on a corporate guarantor, guarantor financial statements will also be analyzed. The analysis must 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 will be provided, indicating an analysis of the sufficiency of cash flow to service debt repayments. Loans must 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) will 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 will approve Credit Applications that do not adhere to the bank’s Lending Guidelines.
• Mitigating Factors: Mitigating factors for risks identified in the credit assessment will 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 must 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 must be obtained and the quality and priority of security being proposed should be assessed. Loans must not be granted based solely on security. Adequacy and the extent of the insurance coverage will be assessed.
• Name Lending: Credit proposals will 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 will be discouraged and treated with great caution. Rather, credit proposals and the granting of loans will be based on sound fundamentals, supported by a thorough financial and risk analysis.

Credit Risk Grading Review:

Credit Risk Grading for each borrower should be assigned at the inception of lending and should be periodically updated. Consistency and accuracy of the Risk grade should be examined periodically by the branch and Internal Control and Compliance Division while conducting inspection it must also be ensured that CRG has been properly done and periodically updated. Frequencies of the review of the credit risk grading are mentioned below:

CREDIT 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 is delegated to individual executives and not to committees to ensure accountability in the approval process. The following guidelines must 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 is restricted to only review of proposals i.e. recommendations or review of the 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 cross border exposure risk, and any breaches of lending authority should be reported to MD/CEO, Head of Internal Control, and Head of CRM.

CREDIT APPROVAL PROCESS

National Bank conducts its banking operation under branch banking system. For administrative control and smoothing its day-to-day operation and extension of appropriate and quick services, quick credit delivery, some branches have been placed under some regional offices. Responding to the requirement of customers in the state of full computerization facilities of the branches and on line banking facilities some credit sanctioning powers have been delegated to the Branch Managers and the Regional Managers.

Credit proposal are generally originated at branch. However proposals may also be received at Head Office for syndication and also from big clients, Financial Institutions. At the branch level, the officers/executives of credit department will have full knowledge of the policy and procedures of credit operations. The credit officers/executives after obtaining credit applications through Branch Manager along with all required papers/documents ensure sufficiency and consistency of the papers/documents. They will originate credit proposals, prepare detailed credit memorandum after undertaking a through credit cheek and conducting credit risk assessment of the client in light of credit policy Guidelines of the Bank. The fully documented Credit Memorandum will placed to the branch credit committee by the in charge credit. Credit committee after thoroughly and critically examining the proposal will recommend it to the Branch Manager who will approve credit under his delegated authority. When the proposal falls beyond the power of the Branch Manager, it will be sent by the Branch Manager to the Regional Manager with his recommendation. Regional Manager will get the proposal critically examined by the credit officers and recommended by the credit committee at regional office and will approve under his delegation of business power, if the proposal is found approval worthy.

When the proposal falls beyond Regional Manager’s power he will send it to Head Office, Credit Division. Divisional Head, Credit will get credit and risk assessed by credit officials. The proposal being found acceptable will be placed to Head office credit committee if the proposal falls under the delegated authority of the Management. When the proposal will be under the approval authority of the executive committee, the proposal, having been assessed by the credit officers/executives will be placed to the Executive Committee, through Divisional Head, Credit, DMD (Credit) and the Managing Director, where the approval will be accorded. If a proposal does not meet the basic lending criteria as per CRM guidelines and banking norms, it will be declined and Credit Operation Division will inform the decision to the branch accordingly. Head Office Credit Operations Division will keep credit files under proper control number and its use will be restricted to the authorized officials only.

Credit Administration Function:

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.

 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 will be referred to legal counsel for advice based on authorization from an appropriate executive in CRM. Disbursements under loan facilities are only be made when all security documentation is in place. CIB report will reflect/include the name of all the lenders with facility, limit & outstanding. All formalities regarding large loans & loans to Directors must 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 will be centralized in the regional credit centers. 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.

Credit Monitoring 

To minimize credit losses, monitoring procedures and systems should be in place that provides an early indication of the deteriorating financial health of a borrower. At a minimum, systems will 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 are able to produce the above information for central/head office as well as local review. Where automated systems are not available, a manual process has the capability to produce accurate exception reports. Exceptions must be followed up on and corrective action taken in a timely manner before the account deteriorates further.

Credit Recovery

The Recovery Unit (RU) of CRM directly manages accounts with sustained deterioration (a Risk Rating of Sub Standard (6) or worse). The Bank wishes to transfer EXIT accounts graded 4-5 to the RU for efficient exit based on recommendation of CRM and Corporate Banking. Whenever an account is handed over from Relationship Management to RU, a Handover/Downgrade Checklist will be completed.

The RU’s primary functions are:

• Determine Account Action Plan/Recovery Strategy
• Pursue all options to maximize recovery, including placing customers into receivership or liquidation as appropriate.
• Ensure adequate and timely loan loss provisions are made based on actual and expected losses.
• Regular review of grade 6 or worse accounts.

The management of problem loans are a dynamic process and the associated strategy together with the adequacy of provisions are regularly reviewed.

NPL Account Management:

All NPLs are/will be assigned to an Account Manager within the RU, who is responsible for coordinating and administering the action plan/recovery of the account, and  serves as the primary customer contact after the account is downgraded to substandard. Whilst some assistance from Corporate Banking/Relationship Management may be sought, it is essential that the autonomy of the RU be maintained to ensure appropriate recovery strategies are implemented.

Non-Performing Loan (NPL) Monitoring:

On a quarterly basis, a Classified Loan Review (CLR) will be/is prepared by the RU Account Manager to update the status of the action/recovery plan, review and assess the adequacy of provisions, and modify the bank’s strategy as appropriate. The Head of Credit will approve the CLR for NPLs up to 15% of the bank’s capital, with MD/CEO approval needed for NPLs in excess of 15%. The CLR’s for NPLs above 25% of capital are or will be approved by the MD/CEO, with a copy received by the Board.

NPL Provisioning and Write Off:

The guidelines established by Bangladesh Bank for CIB reporting, provisioning and write off of bad and doubtful debts, and suspension of interest is followed in all cases. These requirements are the minimum, and the Bank is encouraged to adopt more stringent provisioning/write off policies. Regardless of the length of time a loan is past due, provisions should be raised against the actual and expected losses at the time they are estimated. The approval to take provisions, write offs, or release of provisions/upgrade of an account are restricted to the Head of Credit or MD/CEO based on recommendation from the Recovery Unit. The Request for Action (RFA) or CLR reporting format is used to recommend provisions, write-offs or release/ upgrades.

The RU Account Manager determines the Force Sale Value (FSV) for accounts grade 6 or worse. Force Sale Value is generally the amount that is expected to be realized through the liquidation of collateral held as security or through the available operating cash flows of the business, net of any realization costs. Any shortfall of the Force Sale Value compared to total loan outstanding is fully provided for once an account is downgraded to grade 7. Where the customer in not cooperative, no value will be assigned to the operating cash flow in determining Force Sale Value. Force Sale Value and provisioning levels should be updated as and when new information is obtained, but as a minimum, on a quarterly basis in the CLR.

Credit Pricing

Pricing is one of the important elements in credit management process, once the decision to make a loan has been made. This includes adjustments for the perceived credit risk or default risk of the borrower as well as any fees and collateral backing the loan.

Banks pay significant attention on pricing for credit. Several factors influence on this issue. The factors include the following:

• The interest rate on the loan
• Any fees relating to the loan
• The credit risk premium on the loan
• The collateral backing of the loan.
• Other non-price terms (especially compensating balances or reserve requirements).

Risk Mitigation

There are many ways that credit risk can be managed or mitigated.

• The first line of defense is the use of credit scoring or credit analysis to avoid extending credit to parties that cause excessive credit risk.
• Credit risk limits are widely used. These generally specify the maximum exposure a firm is willing to take to a counter party. Industry limits or country limits may also be established to limit the sum credit exposure a firm is willing to take to counter parties in a particular industry or country.
• Effective loan structuring such as setting tenor in favor to bank or made repayment schedule complying with borrowers future cash flow etc help banks mitigate risks.
• Credit risks can be hedged with credit derivatives.
• Finally, banks can hold sufficient economic capital against outstanding credit exposures.

Analysis & Findings

Statistical Analysis:

TOTAL Loans and advances

Total loans and advances performed by NBL Bank ltd. are quite satisfactory and are maintaining an increasing trend over the years. The below graph shows, in 2010, the amount increased significantly than the previous years.

Taka in million

Figure: Total Loans & Advances (Source: Annual Report of NBL)

INDUSTRY-Wise Loans And Advances. Amount in Taka

(Source: Annual Report of NBL)

The graph shows the most loan providing industry by the bank is Trade finance sector. It was about 42 % of the total industry loan in 2010. The bank is maintaining an increasing trend almost every sector it provides loan previous years. The second best loan providing sector is Consumer credit.

Financial Analysis of National Bank (Ratio Analysis)

Measure Profitability:

Table : Measure Profitability of National Bank Ltd

 (Source: NBL Annual Report)

Comments:

As per the Income Expenditure Ratio, Total income is more than three times greater than its Expenditure Again Profit is also one & half times higher than expenditure that show a sound Profitable position of National Bank Ltd. The Bank’s profit is also four time than its Total Liabilities. Their net income is also satisfactory in response to total Asset.

Measure Liquidity:

Table: Measure Liquidity of National Bank Ltd

 (Source: NBL Annual Report)

Comments:

A higher Liquidity ratio indicates a less Risk & Less Profitability of a Bank. The Bank has the Loan: Deposit ratio in 2009 is .63:1, But in 2010 the proportion of loan amount gradually increase in respect to Deposit collection. In year 2010, National Bank grand taka 1.17 of loan in respect of deposit taka 1, which show a grater utilization of Deposit money. Furthermore Bank’s Loan to Liabilities ratio is also increases from 2009 to 2010, which show higher utilization of Bank fund, it also indicate higher default risk. Finally National Bank’s Asset level also increase in respect with total Asset in last year.

Measure Financial Leverage:

Table : Financial Leverage of NBL

Comments:

The debt equity ratio of NBL is lower then the 2010. The financial position of NBL is not satisfactory. The equity multiplier of NBL in 2010 is 6.94 times which is smaller then the previous year. Time interest earned ratio increases then the previous year which is 1.96 times.

Du Pont Analysis:

Du Pont identity is the popular expression that breaks ROE into three parts:

1. Operating efficiency measured by profit margin
2. Asset use efficiency measured by total asset turnover
3. Financial leverage measured by equity multiplier

ROE= [Profit margin]*[Asset turnover]*[Equity multiplier]

= ROA* [Equity multiplier]

Comment:

Du Pont system analyzes ways of improving Banks performance. This analysis shows the ROE of 2010 is 36% which is greater than the ROE of previous year. So NBL is using the shareholders money more profitably than last year.

SWOT Analysis:

SWOT Analysis is a strategic planning method used to evaluate the Strengths, Weaknesses, Opportunities, and Threats involved in a project or in a business venture. It involves specifying the objective of the business venture or project and identifying the internal and external factors that are favorable and unfavorable to achieving that objective.

Examination of the internal strengths and weaknesses, external opportunities and threats affecting an organization called SWOT Analysis, a situational analysis is a basic element of the corporate plan and is used to make projections for the proposed the corporation activities. Typically the analysis seeks to answer two general questions:

• Where is the organization now And,
• In what direction is the organization headed?

Factors studied in order to answer these questions are the social and political developments impacting on the corporate strategy, competitors, technological advances, and other industry developments that may affect the corporate plan.

SWOT ANALYSIS OF national bank limited

Here I am trying to show the Strength, Weakness, Opportunity, and Threats of National Bank Limited by focusing the both internal as well as the external factors in following-

Strength:

• Brand image
• Strong deposit base
• Expertise in credit operation
• Long term customer relationship
• Strong advertising & promotion
• Smart credit recovery scheme
• Updating on-line network service
• Strong presence in capital market
• Customer satisfaction is positive
• Honest, reliable, knowledgeable and helpful workforce
• Customer retention is increasing day by day, and
• Wide branch network among the third generation banks

Weakness:

• The bank should try to arrange more training programs for their officials; quality training will provide the officials to enrich them with more recent knowledge of international trade financing
• Not providing one stop banking
• The bank lacks a division for customer service, because there are customers who have no banking knowledge. So they need to be properly guided. Sometimes the officers are so busy they don’t have enough time to spare
• The bank lacks a division for customer service, because there are customers who have no banking knowledge. So they need to be properly guided. Sometimes the officers are so busy they don’t have enough time to spare
• High price product deposit, loan, L/C
• Limitation of offering diversified credit facilities
• Lengthy loan Approval process
• Low liquidity
• More inactive and closed accounts
• Bank reduces service support of the unprofitable customer

Opportunity:

• Bank has installed returns screen for smooth operation of foreign currency dealing.
• Remittance and fund transfer purpose customer could take the advantage to online facility
• Deposit down turn in international trade, it has produced steady steam of revenues
• Banker expresses deep apperception to the clients for their support and patronages

Threats:

• The earth quake disaster by Tsunami and Seedor is expected to cost is adverse impact in the coming year
• Economic recession in the world
• Government policy change, some government banks are turn into public bank
• Islamic Shariah based banking system
• Lack of planning, organizing and supervising to establishes culture

FINDINGS

After analyzing all the parts of the study finally, I review the following points as on summary and findings:

• As a private bank, NBL always wants to earn satisfactory profit with little emphasis on all the variables of the economic welfare of the people.
• NBL used to focus its attention on commercial sector for large and medium scale industrialization but the recent concentration on Small and Medium Enterprise (SME) got the new momentum as lending spheres. Though the SME is the focusing attention, National Bank’s contribution on agricultural sector is insignificant.
• The NBL loans & advances are dominated by financing on short-term credit programs mainly to the trade commerce & processing units rather in any manufacturing unit.
• NBL has also increased its lending in export finance and working capital support.
• Classified loan and advances has down ward trend, which represents excellent performance of credit administration and monitoring review.
• The human resources (HR) of NBL are better set for the achievement of the organizational goal. The position of per employee loans and advances is very satisfactory and the ratio increased gradually from previous years.
• Branch management performance as well as the contribution of the branches in funds utilization and overall profitability contributions there on.
• NBL properly follow the credit guideline provided by Bangladesh Bank.
• For smooth functioning of credit management NBL always adopt modern automation system. Especially for controlling the branch activities NBL delegates disbursement to the credit administration division.

Recommendations

On the basis of my practical working at National Bank Limited (NBL) the following recommendations may be put forwarded:

• Loan should be given to borrower depending on his credit worthiness, past performance etc.
• The management should impart more imphasis on the advertisement of the bank in differentelectronic and printing media about their credit facilities.
• Since decision making is the fundamental of all business operations, the management should be bold and quick in making decision considering the internal efficiency and external market competitiveness.
• More credit facilities of varied interests should be introduced for the diversified client group.
• It seemed to me that the bank having a large amount of deposit is not encouraging the large scale producers that much of long term industrial loans to accelerate the economy as well as to help the economy to solve unemployment problem.
• All the lending and savings packages should offered to the Premium customers are same as offered to the general customers, excepting the waiver of service charges for Premium Ones.
• The interest rates on several loan and credit schemes should be differentiated for the Premium customers.
• Top management must ensure the proper implication of IT in all branches.
• Finally NBL should introduce Islamic Banking System in different locations in the country.

Conclusion

Now-a-days banking sector is more competitive. To achieve a proper reward about performance, it is essential to satisfy its customer by providing them different valuable and dynamic services. Because a satisfied customer will talk to others about the services those he/she is very justifiable enjoying and a satisfied customers statement is more effective than a thousand of commercial advertisement. People depend on the people – is the mode of human civilization. Therefore, the importance to satisfy customer is increasing day by day in the private commercial sector especially in the private banks.

As all the activities those are required to provide valuable services to its customers to make them satisfy, are related with the fund management system, NBL is so much careful about its fund management system. NBL always gives its highest attention in monitoring and managing the bank fund, which is consists of fund, capital, reserve, deposit, loan and advance. At present NBL is successful in effectively and efficiently managing these vital issues. In spite of that, in order to keep its success continue and reach at the pinnacle of success it, its managers, board of directors and employee must have the comprehensive and clear idea about the reserve, fund, loan, capital, deposit and liquidity regarding the smooth control of bank and continue its vital operation toward country’s economic development.