A Study on Stress Testing of Agrani Bank Ltd.

1. Introduction

1.1Background

Stress testing has got the impressive attention in the last few decades as to measure the level of economic confrontation and to alert bankruptcy caution of the financial institutions, commercial banks.

Stress testing as defined by BIS, a simulation technique used on asset and liability portfolios to determine their reactions to different financial situations. Stress tests are also used to gauge how certain stressors will affect a company or industry. They are usually computer generated simulation models that test hypothetical scenarios. It is also an integral part of the BIS capital adequacy framework. The traditional focus of stress testing relates to exceptional but plausible events. Most of the studies related to this issue were done were done from the perspective of developed countries and they are done either by the domestic decision making authority such as Central Bank or by the International Monetary Fund (IMF). Only limited studies were done in developing countries, from academic research stand points particularly in Bangladesh. This study seek to perform stress testing of Agrani Bank Ltd (a state owned commercial bank) which is projected to flourish the theoretical, operational know how and the supervisory implications of stress test in institutional level to the academicians and practitioners. Since 2008, there is an economic recession around the globe and more or less every country has been struggling to cope up with the situation. Though developed country like USA, UK, and Greece were mostly affected, developing countries were not completely unaffected. We all live in a global village, where everything is connected to each other whether it is good or bad. Because of the globalization of finance, the wave of recession starts to spread around the globe with different intensity depending on the level of connectedness. Still USA is one of the major players in world economy and bangladesh’s foreign remittance mainly depends on readymade garments and textile. Meanwhile, United States is the biggest market for our garments and textile industry. So, if US economy affect negatively somehow it will create problem for Bangladesh. In addition, most of the Bangladeshi schedule bank gave huge credit in these two sectors. Recent world wide recession, originated in the United State of America (USA), prompted the development of new frameworks, tools and techniques to assess the stability of financial system (Paul and Mathew 2014). This shocking of the economy has increased the importance of better understanding of probable vulnerabilities in the financial system and measure these vulnerabilities for both the managers and the regulators. IMF and Basel committee on banking supervision has also recommended for performing stress test on the financial sector.

1.2 Purpose

The objective of this paper are to identify the financial situation of Agrani Bank limited if any vulnerability happens in the economy, to give a conceptual snapshot of stress testing and to measure the overall financial position after stock market collapse and mismanagement in credit.

1.3 Method of investigation

The essential data inputs to perform the study will be taken from the annual reports for the year 2012, 2013 and 2014. The accessible research papers, journals, working papers, guidelines of different central banks, relevant books, newspaper and websites on this particular study will be used. MS Excel computer program will be used for data analysis.

Firstly, I will assess the impact of increase in the level of non performing loans of the bank. This will include five individual shocking events. Each shocking event will contains minor, moderate and major level of shock. The shocking events will be-

-Increase in NPLs

-Increase in NPLs due to default of top ten borrowers

- Negative shift in NPL categories

-Increase of NPLs in two particular categories

Secondly, by using simple sensitivity analysis and duration GAP analysis, I will assess the vulnerability of the bank towards the adverse movements of the interest rate.

Thirdly, liquidity test to evaluate the resilience of the banks towards the fall in liquid liabilities.

Finally, combined shock will be assessed by aggregating the results of credit shock, equity shock and interest rate shock.