Credit Risk Management

1. Presentation on
Credit Risk Management: An Experiential
Learning Approach
Md. Abdul Jabbar
Executive Vice President
Islami Bank Bangladesh Limited
Risk Management Wing

2. The Risk Concept

3. The Risk Concept
ISO 31000 (2009)/ISO Guide 73 defines Risk as
 “Effect of uncertainty on objectives”
Other Popular Definition of Risk:
 “Existence of uncertainty about future outcomes”
 “Difference between expected and actual result”

4. The Risk Concept (Cont’d…)
 Risk is an integral part of our
life;
 Human brain is programmed
to learn to manage risk.
 Financial risk in a banking
organization is the
possibility that the outcome
of an action or event could
bring up adverse impacts.
Are those people (jumping from
5000 ft height without any life
protection measures) in the
picture at Risk?
No. Because expected outcome
(death) is certain.

5. The Credit Risk Concept
The risk of loss of principal or loss of a financial reward
stemming from a borrower's failure to repay a loan or otherwise
meet a contractual obligation.
Basel Defines Credit Risk as under:
Credit risk is the potential that a bank borrower or counterparty
fails to meet its obligation in accordance with agreed term.

6. Credit Risk Concept in Islam
“O you who have believed, when you contract a debt for a specified term,
write it down.” (mitigant of legal, residual, settlement risks etc.)
(Surah Al-Baqara 282)
"And if you are upon a journey and you do not find a scribe, then a security
may be taken into possession." (mitigant of credit default risks)
(Surah Al Baqara 283)
And he said, "O my sons, do not enter from one gate but enter from different
gates; and I cannot avail you against [the decree of] Allah at all. The decision
is only for Allah ; upon Him I have relied, and upon Him let those who would
rely [indeed] rely.“ (mitigant of concentration risk)
(Surah Al Yusuf 67)

7. Credit Risk Concept in Islam
“Then will come after that seven difficult [years] which will consume what you saved
for them, except a little from which you will store.”
(counter cyclical buffer, Capital Conservation Buffer for absorbing future loss)
(Sura Yusuf 48)
"Narrated Aisha, Ummul Mu'minin:
The Apostle of Allah (peace_be_upon_him) said: Profit follows responsibility of
bearing loss. “ (Importance of undertaking risks in business)
(Sunan e Ibn Majah Book 23, Number 3501)
Prophet (PBUH) once asked a Bedouin who had left his camel untied, “Why do you not
tie your camel?” The Bedouin answered, “I put my trust in God”.
Prophet (PBUH) then said, “tie up your camel first then put your trust in God”.
Knowing Sharia’h Ruling of the tasks that you do is a must being a Muslim.
So dependence on Allah only or Risk Management too?

8. Modern Concept of CRM

9. Why Credit Risk Management?
• Bank deals with the Depositors’ money;
• Bank’s fund have cost implication & repayment
obligation; and
• Investment constitutes the major revenue
earning asset of a bank.
• “Credit Losses have, historically, been the single
largest cause of bank failures” – Economist
• RoE for banks worldwide has been below 10%
and declining after 1960 if one excludes non-
interest income.
• 9 out of 10 banking failures attributable to poor
credit risk management
Hence Bank’s fund is required to be invested with
minimum possible default risk. Risk may be higher
unless it is adequately cared & monitored.

10. Central Bank Initiatives in Investment Risk Mgt.
• 1993: Lending (Investment) Risk Analysis
Limitations: lot of Subjectivity, lack of objectivity, only decisive for lending or not,
indifference about limit utilization etc.
• 2003: Credit Risk Management Guideline [as
one of the 6 (six) Core Risks]
• 2005: Credit Risk Grading Manual
• 2011: Inclusion of Environmental Risk
Management in CRM.

11. Contents of CRM Guideline
The CRM Guideline is segmented into the
following sections:
1. Policy Guideline;
2. Preferred Organizational Structure &
Responsibilities;
3. Procedural Guideline

12. Recommended Feature of the Policy Guidelines
 business development priorities
 terms and conditions for loans to be
approved.
 should be updated at least annually
 should be approved by the Managing
Director/CEO & Board of Directors of the
bank
 should provide the key foundations for
account officers/relationship managers (RM)

13. Regulatory Guidelines: Industry Best Practices

14. Points of Consideration for RM to Recommend
 Industry & Business segment focus (Bank’s appetite of
exposure in the major industry)
 Types of Investment Facilities (Term, WC, Trade Finance etc.
& other products/schemes)
 Single borrower/Group Limit/Syndication (35% of total
equity but not more than 15% of funded liability, for Export
50% of total equity but not more that 15% of funded, 10%
of total equity is said to be large investment)
 Lending Caps (Industry sector exposure cap)
 Discouraged Business Types (military equipment, weapons,
speculative investment etc.)
 Cross Border Risk (world debt crisis, political risk, sovereign
risk etc.)

15. Investment Assessment & Risk Grading
 Investment & Risk assessment prior to grant
investment;
 At least annually thereafter for all facilities;
 Result should be presented in Investment
Application;
 RM will maintain relationship with the customer &
ensure the accuracy of the entire Investment
application;

16. Risk Areas to be Covered by RM for Assessment & Grading
 Borrower analysis (shareholders, management etc.)
 Industry analysis (position in the industry, overall industry concern)
 Supplier/buyer analysis (supplier concentration)
 Historical financial analysis (cash flow, 3 yrs a/c, profitability etc.)
 Projected financial performance (cash flow to service debt repayments)
 Account conduct (payments, cheques, interest & principal payments
etc.)
 Adherence to lending Guideline (whether inline with the lending
guidance)
 Mitigating factors (sustainability, high debt load, rapid growth, etc. )
 Loan Structure (tenor & amount on the basis of repayment ability,
purpose etc.)
 Security (valuation, insurance etc.)
 Name Lending (should not be influenced by only name & fame of the
client)

17. What does IRG imply?
• Based on Pre-specified scale reflecting the
Investment risk for an exposure;
• Number/ Alphabet/ Symbol are used as summary
indicator of risk.
• Important tool of IRM to understand dimensions of
risk in Investment transactions.
• Aggregation of Grading of evaluated key risk areas
reflects the quality of investment.

18. Risk Grading System
• system should define the risk profile of borrower’s to
ensure that account management, structure and pricing
are commensurate with the risk involved.
• Risk grading is a key measurement of a Bank’s asset
quality
• All facilities should be assigned a risk grade
• Where deterioration in risk is noted, the Risk Grade
assigned to a borrower and its facilities should be
immediately changed.
• Borrower Risk Grades should be clearly stated on Credit
Applications.

19. Usage of Investment Risk Grading?
Stage of Use of IRG
Pre-investment: Investment Decision/Investment Pricing;
Post-investment: Review of Grading and Precautions.
IRG - Common Uses
 Obligor-Level Analysis
 Investment Selection and Pricing
 Monitoring and Internal MIS
 Also relevant for Portfolio Level Analysis of the Bank.

20. Grading Codes-Eight Categories
GRADING SHORT
NAME
NUMBER
Superior SUP 1
For Pre- Sanction
Stage
Good GD 2
Acceptable ACCPT 3
Marginal/Watch
list
MG/WL 4
Special Mention SM 5
For Post Sanction
Stage
Sub Standard SS 6
Doubtful DB 7
Bad & Loss BL 8

21. Description of Risk Grading Scale
Sup-1: Fully Cash covered, Govt./ Int. Bank Guarantee
GD-2: Strong Repayment Capacity
Accpt-3: Not like GD-2, but Good Track Record
MG/WL-4: Greater attention required – Above Average
Risk.
SM-5: Potential Weaknesses – Close attention required.
SS-6: Weak Financial Condition
DF-7: Repayment Unlikely
BL-8: No progress in repayment/ on the verge of wind-up

22. Investment Risk Grading Parameters
• 1. Leverage
• 2. Liquidity
• 3. Profitability
• 4. Coverage
• 5. Business Size
• 6. Business Age
• 7. Business Outlook
• 8. Industry Growth
• 9. Competition
• 10. Entry/Exit
• 11. Experience
• 12. Succession
• 13. Team Work
• 14. Security
• 15. Collateral
• 16. Support
• 17. Account Conduct
• 18. Limit Utilization
• 19. Compliance
• 20. Personal Deposit

23. Investment Risk Grading Parameters
CREDIT RISK
Financial Risk Management Risk
Business/Industry Risk Relationship Risk
Security Risk
Leverage
Liquidity
Profitability
Coverage
Experience
Succession
Team Work
Business Outlook
Size of Business
Industry Growth
Market Competition
Barriers to Business
Account Conduct
Utilization of Limit
Compliance of
Covenants/Conditi
on
Personal Deposits
Security Coverage
Collateral
Coverage
Support
Age of Business

24. Weightage of Risk Grading Parameters
Sl. Parameters Description Weight
Financial Risk (Risk Weight:50%):
1. Leverage TL/NW 15%
2. Liquidity CA/CL 15%
3. Profitability OPx100/Sales 15%
4. Coverage EBIT/Interest 5%
Business/Industry Risk (Risk Weight:18%):
5. Size of Business Sales Volume 5%
6. Age of Business Years in Business 3%
7. Business Outlook Mid Term Prospect 3%
8. Industry Growth Sector Growth 3%
9. Market Competition Borrower Position 2%
10.Entry/Exit Barrier Difficult/Easy 2%
Management Risk (Risk Weight:12%):
11. Experience Sr. Mgt Team 5%
12. Succession Ready/ Not Ready 4%
13.Team Work Good/ Poor 3%
Security Risk (Risk Weight:10%):
14. Security Coverage Fully Covered/Not 4%
15.Collateral Coverage Fully Seconded/Not 4%
16. Support Guarantors 2%
Relationship Risk (Risk Weight:10%):
17. Account Conduct Regular/Irregular 5%
18. Limit Utilization Satisfactory/ Not 2%
19. Compliance Full/Not 2%
20. Personal Deposit Yes/No 1%
Total: 100%
Sl. Parameters Description Weight

25. Early Alert Signal
The Early Alert Report should be completed in a timely
manner by the RM and forwarded to CRM for approval
to affect any downgrade. After approval, the report
should be forwarded to Credit Administration, who is
responsible to ensure the correct facility/borrower
Risk Grades are updated on the system. The
downgrading of an account should be done
immediately when adverse information is noted, and
should not be postponed until the annual review
process

26. Segregation of Duties
 Investment Approval/Investment Risk Management;
 Relationship Management/Marketing
 Credit Administration
 Internal Audit

27. Preferred Organizational Structure

28. Preferred Organizational Structure

29. Key Responsibilities of Investment Risk Management
• Oversight of the bank’s credit policies, procedures and controls relating to
all credit risks arising from corporate/commercial/institutional banking,
personal banking, & treasury operations.
• Oversight of the bank’s asset quality.
• Directly manage all Substandard, Doubtful & Bad and Loss accounts to
maximize recovery and ensure that appropriate and timely loan loss
provisions have been made.
• To approve (or decline), within delegated authority, Credit Applications
recommended by RM. Where aggregate borrower exposure is in excess of
approval limits, to provide recommendation to MD/CEO for approval.
• To provide advice/assistance regarding all credit matters to line
management/RMs.
• To ensure that lending executives have adequate experience and/or
training in order to carry out job duties effectively.

30. Key Responsibilities of Investment Administration
• To ensure that all security documentation complies with the
terms of approval and is enforceable.
• To monitor insurance coverage to ensure appropriate
coverage is in place over assets pledged as collateral, and is
properly assigned to the bank.
• To control loan disbursements only after all terms and
conditions of approval have been met, and all security
documentation is in place.
• To maintain control over all security documentation.
• To monitor borrower’s compliance with covenants and
agreed terms and conditions, and general monitoring of
account conduct/performance.

31. Key Responsibilities of Relationship Management/Marketing
• To act as the primary bank contact with borrowers.
• To maintain thorough knowledge of borrower’s business and
industry through regular contact, factory/warehouse inspections,
etc. RMs should proactively monitor the financial performance and
account conduct of borrowers.
• To be responsible for the timely and accurate submission of Credit
Applications for new proposals and annual reviews, taking into
account the credit assessment requirements.
• To highlight any deterioration in borrower’s financial standing and
amend the borrower’s Risk Grade in a timely manner. Changes in
Risk Grades should be advised to and approved by CRM.
• To seek assistance/advice at the earliest from CRM regarding the
structuring of facilities, potential deterioration in accounts or for
any credit related issues.

32. Credit Administration (procedural guideline)
 ensuring that proper documentation and approvals are in
place prior to the disbursement of loan facilities.
 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.

33. Disbursement (procedural guideline)
• Security documents are prepared in accordance with approval
terms and are legally enforceable.
• Standard loan facility documentation has been reviewed by legal
counsel should be used in all cases.
• Exceptions should be referred to legal counsel for advice based on
authorisation from an appropriate executive in CRM.
• Disbursements under loan facilities are only be made when all
security documentation is in place.
• CIB report should reflect/include the name of all the lenders with
facility, limit & outstanding.
• All formalities regarding large loans & loans to Directors should be
guided by Bangladesh Bank circulars & related section of Banking
Companies Act.
• All Credit Approval terms have been met.

34. Custodial Duties (procedural guideline)
• Loan disbursements and the preparation and storage of
security documents should 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.

35. Procedural Guideline Cont’d….
Procedural Guidelines also include the following:
– Investment Administration
– Disbursement
– Custodial Duties
– Compliance Requirements
– Investment Monitoring
– Early Alert Process
– Investment Recovery
– NPI Account Management
– Account Transfer Procedure
– NPI Monitoring
– NPI Provisioning & Write off

36. Experience Sharing

37. Example of Investment Risk
• ABC Bank issued a performance guarantee of Tk. 100 crore
favouring a corporate borrower XYZ Shipyard Ltd. without
having the required collateral/security coverage. The
corporate failed to perform the guaranteed task and the
guaranteed amount was forced to be repaid by the Bank due
to default of its corporate and lead to incur a loss of Tk. 100
crore by the Bank.

38. Credit Risk Sources and Consequences
Risk Areas Sources of Risks Consequences
Investment  Faulty Induction
 Faulty Appraisal
 Biased Recommendation
 Non segregation of duties
 Wrong/biased decision
 Incomplete documentation
 Non compliance of policies
 Faulty disbursement
 Faulty valuation
 Inadequate security coverage
 Lack of monitoring
 Lack of supervision
 Lack of follow up and recovery
 Improper IRG
 Failure in Risk Rating
 Inadequate margin & security
against LC, BG
 Portfolio structuring
 Inadequate professionalism in
handling export, import
business
 Increase of NPI
 Decay of profit
 Enhanced provision requirement
 Enhanced capital requirement
 Less return on assets, equity
 Decrease of RR for depositors
 Decay of capital
 Liquidity crunch
 Increased expenditure like legal,
admin etc.
 Limiting scope for new
investment
 Losing confidence of
stakeholders.
 Additional capital charge against
documentation and valuation
error.
 Additional capital charge against
investment concentration
 Increased provision

39. Impact of Inadequate Risk Management
Provision:
 Are maintained for expected loss like investment classification
 Are kept from profit.
Capital:
 Capital is the last resort to cover losses
 Capital comes from shareholder’s equity and reserves which are kept
from profit
 Capital is the high cost bearing source of fund
 Capital determines organizational growth
Cushion
Provision
Capital
Expected Loss
Unexpected Loss

40. FAQ