The banking sector in Bangladesh finds itself in a period of unprecedented change. Value creation is increasingly under pressure from interest rate spread erosion, poor risk origination processes and volatile capital markets to name a few. Value preservation is also under pressure, with issues in relation to much publicised risk management failures, Non Performing Loan exposures and sectoral concentrations. In this mix of rapidly developing Credit Risk issues - we now have Operational Risk coming to the fore. The recent ATM hacks are an example of how, as our banking infrastructure gets plumbed into global networks, the risk exposures are going to get both broader but also deeper. This rapid increase of the risk profile of Bangladeshi banks has not gone unnoticed by Bangladesh Bank (BB). Their prudent response, by way of “Risk Management Guidelines for Banks” and “Strengthening and updating the Risk Management Systems in Banks”, represent a fundamental change in BB’s regulatory approach - and its expectations on banks. Banks can expect an intrusive form of regulation that, at its very core, will place high levels of accountability upon Boards and senior executives. Higher standards will also be expected in terms wider risk governance, risk management sophistication/ disciplines and capital management supported by demonstrable enhancement of Board and senior executive’s decision-making. To help our banks, BIBM has been working extensively in building capacity in risk management. Given BIBM’s unique relationship with both BB and the banking sector, we have been able to undertake a series of initiatives, informed by the demands of BB and the needs of the industry. In practical terms, this means that we aim to support the banks at all levels. For junior level bank executives, we provide targeted training on risk issues. We also organise training workshops for mid-level bank executives. Similarly, we have now initiated the ‘Certified Expart in Risk Management (CERM)’ programme with Frankfurt School of Finance and Management of Germany to train bankers on ‘world class’ risk management techniques. Likewise, we have extensive coverage of risk issues in our Masters Programs on Bank Management (MBM and EMBM). Our latest initiative targets the “risk leads” - by way of the Chief Risk Officer (CRO) Forum. The CRO Forum is designed to provide a forum where latest developments/ thought leadership on Risk Management (global and local) can be shared with the senior executives in charge of risk. It should also facilitate informed and open risk related discussions between industry leads in terms of risk. As the forum matures, it can also be used to acquire feedback of proposed and developing regulations. Over time, the CRO Forum should also create a sensibly collegiate atmosphere of knowledge sharing among the CROs - especially when responding to common challenges faced across the banking sector. We shall be holding the CRO Forum Introduction Workshop on 24 March 2016. The valuable feedback we are hoping to receive will be incorporated into the CRO Forum design - that will be formally launched by the Governor of Bangladesh Bank in due course. Finally, we would fail to make the most of all these risk capacity building initiatives if they remained in their respective silos. As such, we are now launching ‘Risk Enlightenment’ to provide a knowledge and/ or information dissemination point to all our risk capacity building activities. We shall publish this 4 times a year focussing on specific risk issues/ themes. The first Issue (that you are holding) targets ‘Credit Risk’. As the saying goes, “although sometimes it is sufficient to do things better, at times, it is imperative to do better things.” We believe we are now in a place where we have to do “better things” in the risk space. We look forward to your active participation in these timely and important initiatives. Issue
Md. Nehal Ahmed
Associate Professor, BIBM
Credit is the most important source of revenue for the banks but, at the same, time the single most potentially damaging risk also arises from the loan portfolio of banks i.e. risk of nonpayment by the borrowers. So, managing credit portfolio is crucial for a bank, that’s why banks need to strike a prudent balance between the risk-return trade-off from its credit portfolio for ensuring optimum outcome. Achieving this prudent risk-return mix demands an effective management of loan quality. In fact, it is important to have a well-defined credit policy, sectoral preference, collateral requirement, appropriate credit concentration, credit assessment, risk grading, pricing, etc. for maintaining a good credit portfolio. Therefore, managing a quality loan portfolio is a multidimensional task where all major stages in a credit cycle such as loan initiation, credit assessment and selection, credit administration, credit monitoring, recovery procedures of loan are required to be dealt with professionally and efficiently for having a strong and robust credit culture in a bank.
Asset quality management is considered extremely important by the banking sector. The Basle Committee on Banking Supervision issued an important document in 1997 titled “Core Principles for Effective Banking Supervision,” to present a comprehensive set of twenty-five core principles. Of these, one fourth are designed to address the relevant issues of bank asset quality or credit risk management (Tsai and Huang 1999), suggesting that asset quality is a general concern for the financial supervisory authorities in every country throughout the world. According to Basel regulation, banks need to allocate high amount of capital for providing poor or risky credit. The quality of credit is considered by recognizing the rating of an exposure. If an exposure is rated as ‘AAA’, it is treated as high quality credit than an exposure rated as ‘C’ and it requires less capital as per the regulation. Minor differences in how credit risk is estimated and measured can often result in large swings in estimates of credit risk. Such movements can have significant impacts on risk assessments and ultimately on business decisions including the using of collateral and credit risk mitigation.
Credit risk is one of the significant risks of banks by the nature of their activities. Through effective management of credit risk exposure, banks not only support the viability and profitability of their own business but also contribute to systemic stability and to an efficient allocation of capital in the economy (Psillaki, Tsolas, and Margaritis, 2010). Credit risk is a risk of borrower default, which happens when the counterpart fails to pay on time. Besides, if a borrower has deteriorated credit portfolio, it can also cause credit risk loss to the bank. However, the loss from the default of the bank does not have to be large. It depends on the percent of recovery from obligor and total exposure of banks. A good risk management tries to avoid high exposure on credit risk (Gestel & Baesems, 2008). To mitigate the credit risk, Basel regulations have placed explicitly the onus on banks to adopt sound internal credit risk management practices to assess their capital adequacy requirement. Implementation of Basel is expected to improve credit quality of banks as the spirit of the Basel regulation suggests banks not to create inferior quality loans that in turn will increase risk-weighted asset and require more capital. It is important to note that bank must understand the main essence of Basel Accord which is nothing but the improved and prudent credit risk management.
Banks are exposed to a number of risk factors while offering different services to its clients. Since risk is inherent in the banking business, nobody can ignore the importance of risk management. Maintaining adequate amount of capital is an integral part of the risk management process in banks. Credit risk remains the most important risk among a number of risk factors that banks have to manage. This is supported by the following table which shows the proportion of risk weighted assets of three major risk components i.e. credit risk, market risk and operational risk. Undoubtedly one can conclude that credit risk weighted asset (CRWA), with around 85 percent share, is the leading component of aggregate risk weighted asset (table-1). The result suggests that bank should seriously concentrate on their credit risk management practices, which eventually ensures the quality of their asset portfolio.
Source: Department of Off-Site Supervision, BB
Non-performing loan (NPL) is a very important indicator to measure the credit quality of a bank. Non-performing loan largely affects the efficiency of banks. This is because efficient banks are better at managing their credit risk. Non-performing loans have risen, in recent years (table-2), due to a combination of factors, such as, a deterioration in intrinsic asset quality and stringent problem loan identification. The NPL of the banking sector actually rose to 9.9 percent at end-September 2015 from 8.9 percent at end-December 2013.The reasons for the increase in reported NPL were, mainly, due to the withdrawal of a one-time relaxation of the loan rescheduling procedure, which was given in 2013, and detection of substantial nonperforming loans in a particular bank that has been re-categorized as state-owned commercial bank (SOCB) this year from its earlier status (Financial Stability Report-2014, BB).
(up to Sept)
|Substandard||3043.15 (13.4)||3480.00 (14.8)||8378.60 (19.1)||4704.96 (11.2)||5755.79 (11.0)||6461.75 (11.2)|
|Doubtful||1907.65 (8.4)||2704.05 (11.5)||6229.11 (14.2)||4242.86 (10.1)||5860.44 (11.2)||5077.09 (8.8)|
|Bad & Loss||17759.27 (78.2||17329.45 (73.7)||29259.29 (66.7)||33060.72 (78.7)||40709.15 (77.8)||46155.38 (80.0)|
|Total Classified Loa||22710.06||23513.50||43867.0||42008.53||52325.39||57694.2|
|Total Loans and Advances||319860||379250||438670||472006||539437||582770|
|Total Classified Loan as % of Total Loan||7.1||6.2||10.0||8.9||9.7||9.9|
Source: Financial Stability Report, BB
Note: Figure in the parenthesis shows the percentage of total classified loan
Table-2 also represents the year-wise classified loan composition. The ratio of bad loans to total classified loans increased to 80 percent in September 2015 from 66.7 percent in 2012, meaning that a significant amount of worst quality credit increased in 2015. Around four-fifths of total classified loans (80.0 percent), amounting to BDT 46155 crore, is Bad/Loss. It is alarming because not only a bulk amount of classified loans were bad loans but also the proportion is increasing over the years. The sub-standard and doubtful loans constituted 11.2 percent and 8.8 percent respectively in September 2015
Bank-wise information indicates that the non-performing loans were widely distributed among the banks (Chart-1). The distribution of banks based on their NPL to total loans ratio indicates that the number of banks with double digit NPL increased from 12 in 2013 to 15 in September 2015. Moreover, 10 banks have NPL ratios over 20 percent which should be the serious cause of concern for the regulator
Source: Financial Stability Report, BB and Quarterly Financial Stability Assessment Report, BB
It is recognised that managing credit risk should be a serious concern for the banks as it has significant impact on profitability and has severe effect on financial stability. The significance of financial stability can be better understood in the backdrop of the global financial crisis of 2008 that resulted in the collapse of financial markets and institutions. To accomplish banking stability, the banks are
required to maintain quality bank assets which can be achieved through proper credit risk management. The failure to ensure banking stability can cause financial fragility and may lead to crisis scenarios. Credit risk not only affects the financial and operating performance of the bank, but also impacts the soundness of the national financial system.
Bangladesh Bank, Financial Stability Report, Dhaka, Various Issues.
Bangladesh Bank, Financial Stability Assessment Report, Dhaka, Various Issues.
Ahmed, N., A. C. Pandit and M. Z. Hossain (2014), “Bank Credit Quality in a Recent Changing Business Environment: Issues and Challenges”, Banking Research Series, BIBM, Dhaka
Gestel, T.V. and Baesens, B. (2009), Credit risk management [E-book] Available through: Oxford Scholarship Online
Habib, S.M.A.H., M. N. Ahmed, A. C. Pandit and M. Z. Hossain (2013), “Bank Credit Quality in a Recent Changing Business Environment: Issues and Challenges”, Banking Research Series, BIBM, Dhaka.
Psillaki, M., Tsolas, I.E. and Margaritis, D. (2010), “Evaluation of Credit Risk Based on Firm Performance” European Journal of Operational Research, Vol. 201(3), pp. 873-888.
Siddique, M.M., D. R. Karmaker, M. Alamgir and M. M. Hossain (2013), “Loan Quality Management in Banks: Problems of Selecting Right Borrowers”, Banking Research Series, BIBM, Dhaka, pp. 35-66
Tsai, D. H. and F. W. Huang (1999), “Management Quality and Bank Efficiency: Empirical Evidence for Taiwanese Banks.” Management Review, Vol. 18 (3), pp. 35-55
Credit risk is defined as the possibility that a borrower or other contractual counterparty might default, i.e. might fail to honor their contractual obligations.
Migration Risk refers to the potential deterioration of the credit quality of an un-defaulted exposure. This form of potential loss is generally also subsumed under a broader definition of credit risk.
Transaction Risk refers to individual loans and essentially measures (1) the standalone probability that the borrower will not be able to repay, as well as (2) the ultimate loss in the case of a borrower default after use of collateral and other mitigating factors.
Portfolio Credit Risk is a risk that arises from credit portfolio concentration or from systematic reasons.
Expected Loss (EL) is the average or mean amount of credit loss to be incurred over a particular time period. The loss is measured as the present value or book value of receivables that will not be collected or will have become unrecoverable and therefore will be written off or otherwise expensed during a particular period of time.
Probability of Default (PD) is the percentage probability of a borrower entity to produce a default event as perceived by the lender over a specified period of time, typically one year. The PD is most often stated for a future period beginning immediately, but can also be expressed as a forward default probability beginning in one year for one year, for example.
Exposure at Default (EAD) is the total balance owed by the borrower to the particular lender at time of default expressed in currency units.
Loss-given-default (LGD) is the percentage of EAD that is considered lost, once it has been established that a default has occurred. The LGD is equal to 100% minus the percentage of EAD that will be recovered by way of liquidation of collateral and other post-default collection actions.
Dr. Shah Md. Ahsan Habib
BIBM launched its first joint certification program ‘Certified Expert in Risk Management’ with the Frankfurt School of Finance and Management of Germany in 2015. Actually, the initiative of this certification was rooted in June 2014 when a MOU was signed between our honourable Governor of Bangladesh Bank Dr. Atiur Rahman and the President of the Frankfurt School. Director General of BIBM Dr. Toufic Ahmad Choudhury also attended the event. This opened the door for joint initiatives and academic endeavors between these two institutions.
In January 2015, I represented BIBM in a members’ meeting of European Banking and Financial Services Training Association (EBTN) hosted by the Frankfurt School and took the opportunity to negotiate with the Frankfurt School management in regard to the initiation of a joint certification program on Risk Management as consented by the DG, BIBM. In the process of negotiation, I conceptualized the structure of the program that was agreed upon by Dr. Barbara Drexler, the Associate Dean of Frankfurt School of Finance and Management. I received immense cooperation of Mr. Nicolas Parisel, Project Coordinator of International Office, Frankfurt School in the process of negotiation. Following an agreement with Frankfurt School, I along with my two colleagues Mr. Md. Nehal Ahmed, Associate Professor and Mr. Atul Chandra Pandit, Assistant Professor of BIBM prepared a concrete proposal covering detailed structure, syllabus, fees, and other relevant issues, as instructed by the DG BIBM. The proposal was then duly approved by the Executive Committee and Governing Board of BIBM for implementation.
The Certification Course targets mainly to enhance capacity of the bank executives on risk management constituting all key banking risks-credit risk, operational risk, interest rate risk, foreign exchange risks, and liquidity risk. It is a program of nine months with two modules: first module is offered online by the Frankfurt school; and the second module will be delivered by BIBM in its own campus. The initial response from the banking community is really encouraging. The first two batches (first intake) for the course were enrolled in September 2015 and already completed Module A with the Frankfurt School. BIBM will start Module B for the first intake batches in April 2016. Two batches for the March, 2016 session (second intake) are already enrolled for the program.
To start the journey of this Joint academic venture, the program was formally inaugurated by the honourable Governor of Bangladesh Bank and Chairman of the Governing Board of BIBM Dr. Atiur Rahman. We hope and believe that with patronage and support of our member banks the program would be able to deliver in bringing positive changes in the risk management practices of the bankig sector of Bangladesh.
Bangladesh Bank has undertaken initiatives to revise the core risk management guidelines. As part of the process, the Bank has already published four revised guidelines in March 2016. These are ‘Internal Control & Compliance Risk Management’ guidelines, ‘Credit Risk Management’ guidelines, ‘Asset-Liability Management (ALM)’ guidelines and ‘Foreign Exchange Risk Management’ guidelines. This is an effort to update and improve the Risk Management guidelines in line with the changed risk scenarios. These guidelines are available in the website of Bangladesh Bank and the related link is https://www.bb.org.bd/. Other core risk management guidelines are also expected to be published soon.