Govt. Azizul Haque College, Bogra

Term Paper on Evaluation of Credit Assessment & Risk Grading

Management Of

Dutch Bangla Bank Ltd

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Term Paper On

Evaluation of Credit Assessment & Risk Grading Management

Of

Dutch Bangla Bank Ltd

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Submitted to : Submitted by :

Letter Of Transmittal Student’s Declaration

Preface

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Table Content

Title Page NoChapter 1 :1.2.3.4.Chapter 2 :1.2.3.4.Chapter 3 :1.2.3.4.Chapter 4 :1.2.3.4.5.6.Chapter 5:1.2.

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1 .Introduction

The increased number of bankruptcy cases worldwide, both corporate and personal, is the main reason for the renewed interest in credit risk management. A bad loan situation often arises from a combination of factors, amongst which the major one is the absence of an adequate system to classify loans properly and to identify problem loans promptly so as to minimize the potential defaults and consequent losses. More defaults mean more missed loan payments and a reduction in profitability for banks. Poor management of credit risk is considered to be the major cause of banks’ bad performance and often the reason for their bankruptcy.

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2. Statement of the Problem

Credit risk rating s ystems are becoming an increasingly important element of commercial banks’ measurement and management of credit risk. Such an importance has in fact been highlighted in the proposed Credit Risk Grading Manual of Bangladesh Bank was circulated by Bangladesh Bank vide BRPD Circular No. 18 dated December 11, 2005,that includes the internal rating approach to credit risk as one of its cornerstones. This paper attempts to investigate the extent to which the credit rating systems are used in DBBL based on a recent survey.

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3 Purpose of the StudyThe report is based on my critical observation while working in the loans and advancement division of DBBL. The report reveals the various types of loan scheme and the criterion to get the loan and the risk grading system.This report will not only help the management of the bank, but also the stakeholders on a whole. Different financial institutions can be motivated to consider the study conducted in this report, in order to improve the various offerings of the transaction banking services for clients.

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4.OBJECTIVES OF THE STUDY

I. Broad/General Objective of the report are: To achieve a wide knowledge of the various types of loan scheme, credit assessmentprocedure and risk grading system of DBBL bank.II. Specific Objectives of the report are: To examine the knowledge level of clients regarding the services of credit division. Toinvestigate employees views regarding the quality and standard of the services offered bycredit division. To identify the gaps between the services and solutions that clients want from thissegment and those which are actually being provided by credit division. To suggest ways of improving the services and solutions offered by credit division toaccommodate the rapidly growing client base of Dutch Bangla Bank.

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1. Literature Review

Banks manage a wide range of assets, liabilities, and equity capital that support their operations and activities. Proper risk management is therefore a vital and integral part of effective bank operation. Widely cited risks include credit risk, interest risk, liquidity risk and operational risk.All these risks are derived from banks’ most fundamental and traditional roles of lending and borrowing. Among those risks, credit risk, which is associated with the potential variability of the stream of cash flows from an asset, is one of the most crucial ones, as it is often appointed as the cause of a bank failure. To perfect its credit risk assessment, monitoring and management, banks use a variety of methods and tools. In the past few years, banks have been adopting andimproving credit scoring system so as to evaluate certain types of loans more objectively, accurately and efficiently. Recently, the industry has started implementing credit rating as a mechanism to better manage its credit risk and to improve its overall portfolio performance. Credit risk rating is a summary indicator of risk for banks’ individual credit exposures and is generally assigned at the time of each underwriting or credit approval and reassessed during the credit review process. It functions as the barometer for the banks to measure their credit riskexposure to each individual customer, either in isolation or as part of their loan portfolio. The rating allows banks to measure the relevant default probabilities at different rating levels more accurately. It helps banks to reduce their risk exposure and to improve their profitability by 32 reducing the number of potential default loans as well as minimizing the cost associated with bad debt recovery.Although the major objective of credit rating is to determine the ability and willingness of a borrower to pay at the agreed terms, the rating does a bit more than just classifying the borrowers into “pass” and “fail” categories. The most important benefits for banks in using the rating system to assess their loans include:Credit Risk Rating System in the Banking Sector Identify and decline potential risky applicants Reduce losses due to defaults Price the loan properly Increase liquidity Maximize the profit Improve monitoring process Reduce monitoring cost Minimize administrative costs with debt collection Help banks to achieve their objectives Allow allocation of resources where they are more productive Avoid loan concentration

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Tracy and Carey (2000) suggest that in designing a credit rating system, a bank should consider numerous factors, including cost, efficiency of information gathering, consistency of rating produced, staff incentives, nature of a bank’s business, and uses to be made of the internal ratings. They notice that the proportion of grades used to distinguish among relatively low-riskcredits versus the proportion used to distinguish among riskier pass credits tend to differ with the business mix of a bank. A rating system with more rating categories is better than a system with just a few categories. Finer distinctions of risk, especially among riskier assets, can enhance a bank’s ability to analyzeits portfolio risk exposure. However, an internal rating system with larger number of grades is costly to operate because of the extra work required to distinguish finer degrees of risk. When assigning a loan applicant to a particular grade, Croupy et al. (2001) suggest that banks should analyze three different categories of variables – quantitative, qualitative and legal. The quantitative analysis concentrates mainly on financial analysis and is often based on a firm’s financial reports. The four main quantitative factors used in the assessment model include net income, total operating income, total equity capital and total asset values. These factors allow the banks to calculate a variety of ratios including return on assets (ROA), return on equity (ROE) and assets utilization (AU), etc. Once computed, these ratios would be compared with the Credit Risk Rating System in the Banking Sector industry standard. In addition to the information disclosed in the financial statements, the rating also includes information about the quality of 33collateral and the third party support. For certain type of loans like overseas loans or loans for customer in import/export business, country risk is also another important factor to take into account.

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2.CONCEPTUAL FRAMEWORK

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3. Research Questions

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4.Hypothesis:

There is a major influence of reliability and responsiveness of a client on credit sanction , because the loan officer must be convinced that the customer has a well defined purpose for requesting credit and a serious intention to pay . As well as accessibility , assurance factor of the client and credit monitoring policy of the bank have major impact on credit risk.

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1.Methodology of the report My objective was to find out specific correlations between the independent and dependent variables associated in this research subject matter. Therefore, my objective was to look at the relationship between various services provided by Credit department as well as proper and prior analysis of credit proposals of the same sector. For the purpose of my research, I initially designed a descriptive- correlational study to assess whether there is any correlation among the variables. This method would be most effective as I am trying to find out the extent of the associations between the variables, whether any exists, as well as their statistical significance on my overall research. However, due to time constraints and imitational length of the project, only qualitative study has been made over the findings from this research. The research has been carried out over a one period of time through questionnaires answered by the employees using the conventional method of personal interview.Further information used to prepare this report has been collected from both primary and secondary sources. The primary sources have provided the report with reliable data and information relating to Local clients and the bank’s operations. On the other hand, the secondary sources have been an indispensable source of information regarding the historical background of the bank, its functions, and descriptions of its various departments and products.

i. PRIMARY SOURCES

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Data collected from the employees by personal interview conducted through questionnaires. Informal discussion with the bank’s staff, especially the credit division managers of the corporate segment. Relevant data from the bank’s reports, presentations and other documents.

ii. SECONDARY SOURCES Annual reports of the Dutch Bangla Bank. Various product and service brochures. Intranet Site of the Dutch Bangla Bank. Official local website of the Dutch Bangla Bank. Various web researches.

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2. SAMPLING

i. POPULATION

The population targeted for this research was mainly the employees of the bank.

ii. SAMPLE UNITS

The sampling unit in case of this research consisted of the employees taken from the population of the bank.

iii. SAMPLING FRAME

The sampling frame usually contains a list of elements from which the sample is drawn. Thesurvey has been conducted among different levels of employees representing industries likemanager, senior officer, officer etc. Also, all levels of managers have been considered startingfrom associate to associate directors of this segment.

iv. SAMPLING DESIGN

The sampling frame usually contains a list of elements from which the sample is drawn. Thesurvey had been conducted among different levels of employees representing industries likemanager, senior officer, officer etc.

v. SAMPLE SIZE

The sample size consisted of 20 respondents who are the employees of the bank. Employees may not reveal information through online survey due to confidentiality concerns. Also, because of time constraint it will not be possible to go to every employee and take the survey. For thisresearch, those employees will be chosen who has maximum possibilities of answering thesurvey questions. So, keeping limitations in mind, a sample size of 20 has been chosen from thebanana branch of Dutch bangla bank.

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3. DATA COLLECTION METHODS

Employees are usually less in number at the same time corporate clients may not reveal information through online survey due to confidentiality concerns. The questions were prepared in such a way keeping their confidentiality concerns in mind. Also, because of time constraint it was not possible to go to every employee and take the survey. Therefore, data for this report was collected through structured questionnaires from employees, who were asked by personal interview with the help of the respective relationship managers of the credit division. Also, informal discussions with the relationship managers of the segment provided invaluable data for the report. Published statistics relating to the bank and Local clients was also used in this report.

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3.7.4 DATA ANALYSISAnalysis can be done for both qualitative and quantitative data. Due to time constraints and manyother limitations, only qualitative research has been done to limit the research to a reduced lengthas required by the internship program in the university. To analyze the data collected in thesurvey through questionnaires, analysis was conducted mainly through the use of MicrosoftExcel.

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3.8 LIMITATIONS OF THE STUDYThe survey was limited to the local clients of the wholesale banking division only. Lack of comprehension and responsiveness of the clients was a major problem in thecollection of data. Large-scale research was not possible due to constraints and restrictions posed by thebank as well as the university. Confidentiality of data acted as a barrier during the study, as banks have confidential datarelated to its operations and clients which they did not want to reveal. Time constraint was also one of the factors that curtailed the scope of the study. Rush banking hours and hectic schedules of the banking staff was another obstacle to thescope of the study. The Mangers of the concerned department were busy meeting theirtargets and it was very difficult for me to get some practical ideas regarding their ideas,expectations and opportunities regarding my topic.

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3.9 QUALITATIVE ANALYSISQualitative questions were relatively less in the questionnaire that has been prepared for thecredit officers. Through questionnaire respondents had a chance to express their views openlyabout credit assessment and credit rating policies. Unfortunately, not many respondents had clearviews about the qualitative questions and only few responses were fit to be recorded. Also, someresponses were found to be repetitive and therefore only some responses were suitable to bepresented as part of the analysis.

Which credit reporting agency does your bank use?

Credit Rating Information and Services Ltd (CRISL) Credit Rating Agency of Bangladesh Ltd (CRAB) National Credit Ratings Ltd Emerging Credit Rating Ltd

Most of the officers’ responded with CRAB as credit rating agency for the bank. Few were skipped this question as they were not sure about the agency.

Credit Rating Agency of Bangladesh (CRAB) Limited has assigned ‘A1’(PronouncedSingle A One) rating in the Long Term and ‘ST-2’ in the Short Term to Dutch-BanglaBank Limited in view of the performance of the Bank for the last business Year.(Source: Rating Report -Dutch Bangla Bank Limited)

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Did the Bank update its credit rating for the last financial year within six months from the date of close of the financial year?

Yes No Not Always.

Credit Rating report of a bank is an important tool for the borrower. To do a sound practice, bank should update their important data on time. According to the response bank is concern about updating their credit rating but sometime, due to pressure of other work, they fail to do that.

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Did the Bank fully secure itself against all guarantees issued for the conditionsmentioned in the Regulation of Bangladesh Bank? Yes No Not Always.

The borrower must possess adequate net worth or enough quality assets to provide adequatesupport for the loan. The value of the collateral security must cover the loan exposure. The recenttrend of borrower’s line of work or industry must be taken into considerations by the Bank.

If bank uses a credit rating score that results in an adverse effect onqualification or rating of the applicant, do you advise the applicant? Yes, in all cases Yes, in some cases No, not at all Not applicable

The Credit Risk Grading Manual released by Bangladesh Bank earlier was applicable only in

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case of lending to commercial clients. Now it’s mandatory for all borrowers. So having a soundcredit rating is important in business culture. Bank always updates their data, so if they find anydownward indication about their clients they notify them.

Does factory visits are made before approved the loan? Yes No Not Always

Factory visit is part of the process in evaluating client’s operational activities and granting creditapproval. According to their response bank does a factory visit most of the time, especially incase of a new business project. But some time, if the client has a good past record and a soundrelationship with bank, they skipped this segment.

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Does the officers well aware of different business type? Yes No Not Always.

The loan officer must be convinced that the customer has a well defined purpose for requestingcredit and a serious intention to pay. To clarify client’s project, loan officer should have a soundknowledge about that project. But according to their response, officers are not well aware of alltype of projects.

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3.10 Findings:Bases on observation and interpretation I found some positive and negative side in DBBL. Thoseare given below: Bank Follow the overall credit assessment and risk grading process according toBangladesh Bank at maximum case. Loan and the advances are vital to finance the projects. An appropriate creditdistribution system and monitoring will ultimately lead to the profit maximizing ofbanks. It is evident from that the size of DBBL loans and advances are increasing overthe years. It indicates mire earning for the bank. It shows a positive growth rate. DBBL has a positive growth rate in Net profit.

PROBLEM IDENTIFICATIONS: The Bank does not go through back ground investigation all parties. Some time the loan documentation is not fairly done. Some time the document verification is done after loan sanction. The SME loan section is very poor because they focused on corporate loan.

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3. Analytical Prove :

PRINCIPAL RISKCOMPONENTS:

KEY PARAMETERS: WEIGHT:

Financial Risk LeverageLiquidityProfitabilityCoverage

15%15%15%5%50%

Business/IndustryRisk

Size of BusinessAge of BusinessBusiness OutlookIndustry growthMarket CompetitionEntry/Exit Barriers

5%3%3%3%2%2%18%

Management Risk ExperienceSuccessionTeam work

5%4%3%12%

Security Risk Security coverageCollateral coverageSupport

4%4%2%10%

Relationship Risk Account conductUtilization of limitCompliance of covenantsPersonal deposit

5%2%2%1%10%

(Source: CREDIT RISK GRADING MANUAL of Bangladesh Bank)

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The following is the proposed Credit Risk Grade matrix based on the total score obtained by anapplicant.

(Source: CREDIT RISK GRADING MANUAL of Bangladesh Bank)

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3.11 RECOMMENDATIONS The Bank can organize more training program and workshop to make the employeesmore efficient in their sector. The Bank has to establish a strong “Credit Manual”. The Bank has to go through back ground investigation of all party’s. All the loan documentations have to done honestly. All the document verifications have to done before loan sanction. The Bank has to construct a long term strong investment policy. The Loan and Advance section has to make strong and the employees have to be devotedto the Bank. The Bank has to give emphasis the SME loan section.

The Bank should introduce more loan section.

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3.12 ConclusionDutch-Bangla Bank Limited is one of the most potential Banks in the banking sector. It has alarge portfolio with huge assets to meet up its liabilities and management of this bank isequipped with the export bankers and managers in all level of management. So it is not an easyjob to find out the drawbacks of this branch.It has been observed that DBBL started its banking services with a view to minimize thecustomer’s needs by offering different products and services which are easy and affordable forall level of customers. To that extent, DBBL always emphasizes its customer services, productdevelopment, resource management, branch networking and the contribution to the economicdevelopment of the country. The bank also provides social services through DBBF as their socialresponsibility.The success of a bank depends on the quality of the services it offers. All the commercial banks,therefore, try to provide quality services with competitive interest rates. DBBL is not anexception. Life line package has been developed with the same purpose. Although, thecomparative analysis shows that DBBL is in better position, but there are some obstacles it facesto sustain the position. However, the continuous improvement of the services will certainly place

the bank in the best position in one decade.

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4: ReferencesBooks Cooper, Donald R. Schindler, Palmer. S. (2009) Business Research Methods (9th Ed).McGraw Hill.Journals and Reports Internal Credit Risk Rating Systems in the Macao Banking Sector.http://www.amcm.gov.mo/publication/quarterly/Jan2007/!%20InternalCredit_en.pdf%20(20070214) A Loan Assessment System for Centenary Rural Development Bank.http://dspace.mak.ac.ug/bitstream/123456789/617/3/nassali-josephine-cit-mastersreport.pdf Focus group, 2007. Credit Risk Management Industry Best Practices. Available at:http://www.bangladesh-bank.org/mediaroom/corerisks/creditrisk.pdf Crouhy, M., D. Galai, and R. Mark (2001), “Prototype Risk Rating System,” Journalof Banking and Finance, No. 25, 47-95. Treacy, W. F. and S. M. Carey (2000), “Credit Risk Rating System at Large U.S.Banks,” Journal of Banking and Finance, No. 24, 167-201. Rating Report of Dutch Bangla Bank Limited Report on automation of DBBL. Guidelines for Credit Management of Bangladesh Bank – 1996. Credit Management Policy Order: 2008 – 2009Websites: http://www.dutchbanglabank.com http://www.bangladesh-bank.org http://www.e-mortgages.com.au/credit-assessment/default.aspx www.thefinancialexpress-bd.com

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