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EXECUTIVE SUMMARY
The purpose of writing this paper is to show the scenario of credit risk management for one of the fast growing private commercial banks in Bangladesh. It might be interesting to face the question of why to choose credit risk management instead of other operations of banking industry. Credit risk management for any bank should be a robust process that enables banks to proactively manage loan portfolios in order to minimize losses and earn an acceptable level of return for shareholders. Through this internship report the credit risk management of Mutual Trust Bank Limited has been examined which is the focal point of this report. In order to prepare this report both primary and secondary data has been used to better focus the scenario. The report exemplifies the facts and figure of credit risk issues of this bank which has been formulated through practical experience of working in this bank. Apart from the primary data, secondary data has also been used to portray the best background information of this bank. This report focuses on in depth analysis of Mutual Trust bank Limited of Bangladesh and presents some strong recommendations through which this bank not only can develop its credit risk policies, but can also develop the position of this bank significantly. It should also be noted that the report signifies those recommendations which could be applied to any private commercial bank, especially in the condition of Bangladesh.
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INTRODUCTION
1.1 Significance of the Study
Risk is inherent in all aspects of a commercial operation. However, for banks and financial institutions, credit risk is an essential factor that needs to be managed. Credit risk is the possibility that a borrower of counter party will fail to meet its obligations in accordance with agreed terms. Credit risk, therefore arises from the banks dealings with or lending to corporate, individuals, and other banks or financial institutions. The goal of credit risk management is to minimize a banks risk adjusted rate of return by maintaining credit risk exposure within risk inherent in the entire portfolio as well as the risk in individual credits or transactions. Credit risk management needs to be a robust process that enables banks to proactively manage loan portfolios in order to minimize losses and earn an acceptable level of return for shareholders. Central to this is a comprehensive IT system, which should have the ability to capture all key customer data, risk management and transaction information including trade. Given the fast changing, dynamic global economy and the increasing pressure of globalization, liberalization, consolidation and dis-intermediation, it is essential that banks have robust credit risk management policies and procedures that are sensitive and responsive to these changes.
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2.1 Mission
To be one of the best admitted banks in the nation and is recognized as an innovative and client focused company; enabled by cutting edge technology and being a dynamic workforce and a wide array of financial products and services.
2.2 Vision
Mutual Trust Bank's vision is based on a philosophy known as MTB3V. We envision MTB to be: One of the Best Performing Banks in Bangladesh The Bank of Choice A Truly World-Class Bank
2.3 Values
2.3.1 Accountability We are accountable for providing the highest level of service along with meeting The strict requirements of regulatory standards and ethical business practices 2.3.2 Agility We can see things from different perspectives We are open to change We can respond rapidly and adjust our mode of operation to achieve our goals
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2.3.3 Trust We value mutual trust. We ensure transparent and candid communication among all parties. 2.3.4 Commitment Creation of sustainable economic value for shareholders. Committed to serve the society through employment creation, support community projects and events Render state of the art service to customers by offering diversified products and services. Be reliant on the inherent merit of the employees.
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Figure: 2: Consumer Loan portfolio 2.6.3 SME Division MTBL SME (Small and Medium Enterprises) division started its expedition from 2007. SME is a growing area of our country and MTBs commitment to this sector is demonstrated by the fact that it offers one of the lowest lending rates in the market for SME clients. As a leading Private Commercial Bank, MTB SME clients growth rate and development with providing rural based clients services has been remarkable. During the year 2010, MTB SME lending portfolio registered an impressive growth of 622.68%.
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Figure 3: Growth of MTB SME in 2010 2.6.4 Green Banking MTB Green Banking practices of is connected with both internal operation and product ecology. Product ecology is concerned with the impacts of the banks products on the environment used by the clients. Green banks are engaged in creating socially responsible investment funds and sustainable project finance activities. Environmental concern is at the centre of green banking strategy. MTB Green Energy has been designed to finance renewable energy sector, i.e. solar energy, bio gas, SMEs, Agri SMEs and farmers are the main target customers of this loan facility.
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Percentage
12%1% 19% 12% 56% Current Deposit Savings Deposit fixed Deposit Deposit Products bills Payable
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LITERATURE REVIEW
3.1 Over view
The word credit comes from the Latin word Credo meaning I believe. It is a lenders trust in a persons/ firms/ or companys ability or potential ability and intention to repay. In other words, credit is the ability to command goods or services of another in return for promise to pay such goods or services at some specified time in the future. For a bank, it is the main source of profit and on the other hand, the wrong use of credit would bring disaster not only for the bank but also for the economy as a whole. The objective of the credit management is to maximize the performing asset and the minimization of the non-performing asset as well as ensuring the optimal point of loan and advance and their efficient management. Credit management is a dynamic field where a certain standard of long-range planning is needed to allocate the fund in diverse field and to minimize the risk and maximizing the return on the invested fund. Continuous supervision, monitoring and follow-up are highly required for ensuring the timely repayment and minimizing the default. Actually the credit portfolio is not only constituted the banks asset structure but also a vital factor of the banks success. The overall success in credit management depends on the banks credit policy, portfolio of credit, monitoring, supervision and follow-up of the loan and advance. Therefore, while analyzing the credit management of MTBL, it is required to analyze its credit policy, credit procedure and quality of credit portfolio. Credit risk is the risk of loss arising from a borrowers or counterpartys inability to meet its obligations. The active management of credit risk has been receiving increasing regulator attention and strategic focus at many financial institutions. Regulators cite poor credit risk management at the portfolio level, weak credit standards for borrowers and counterparties, and insufficient attention to changes in economic and other circumstances affecting the capacity of borrowers and counterparties as the highest contributors to inadequate credit risk management. Regulators have changed capital charges to make financial institutions more responsive to actual credit exposure and have set new rules for how much capital banks must set aside to cover potential losses. It is important to formulate and implement a structured credit policy and related processes to manage credit risk. Strategies for credit risk management, including credit policy development and risk monitoring, is the responsibility of business unit and senior management, and the board of directors.
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3.3.1 Policy Guidelines Credit Policies clearly outline the senior managements view of business development priorities and the terms and conditions that should be adhered to in order for loans to be approved. The Lending Guidelines are updated at least annually to reflect changes in the economic outlook and the evolution of the banks loan portfolio. It is approved by the Managing Director & Board of Directors of the bank. These guidelines include the following: Financing legitimate and productive business, industrial and other activities, which are socially desirable, nationally important and financially viable. Abiding by KYC policy, anti money laundering regulations, BOI guidelines, industrial policy, export policy, import policy, transfer of property act. Lending to the clients having legitimate source of earning, clear purpose of loan utilization, specific sources of loan repayment and capacity to enter into loan agreement Assessing credit needs and setting loan tenors rationally matching cash conversion cycle/cash flows upholding central banks directives in this regard Extension of credit facilities to generally where industry/business data are available Lending to the clients who are reputed corporate, institutions, reliable individuals, firm, companies, retailers etc. Pursuing sector wise lending cap judiciously. 3.3.2 Various Type of Credit Risk 3.3.2.1 Lending Risk Analysis (LRA): Modern Technique of Credit Appraisal The Financial Sector Reform Project (FSRP) has designed the LRA package, which provides a systematic procedure for analyzing and quantifying the potential credit risk. Bangladesh Bank has directed all commercial bank to use LRA technique for evaluating credit proposal amounting
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Figure7: Hierarchy of Credit Risk for LRA 3.3.3 Credit Assessment The objectives of credit risk assessment are to minimize bad loans by improving the risk/return profiles of the port folio, price credit risk adequately or risk based pricing, maximize benefits from potential credit opportunities, setting of concentration and exposure limits active portfolio management, adhere to credit policies and maintain and maintain a reliable database Credit Investigation: Credit investigation refers to the assessment of a loan proposal from different points of view to decide whether the bank should go for finance or not. Sources of Credit Information: Credit information are collected from: 1. Credit Agencies: CRAB, CIB (Bangladesh Bank); debtors/ borrower information, owners information, group/ affiliation information, credit exposure matrix, third party guarantors information. 2. Loan Application: client loan application and KYC
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Table 4: Risk Rating According to Risk Type Superior Facilities are fully secured by cash deposits, government bonds or a counter guarantee from a top tier international bank. All security documentation should be in place. Good Satisfactory Risk (Grade2). The repayment capacity of the borrower is strong. The borrower should have excellent liquidity and low leverage. The company should demonstrate consistently strong earnings and cash flow and have an unblemished track record. All security documentation should be in place. Aggregate Score of 95 or greater based on the Risk Grade Scorecard. Acceptable Adequate financial condition though may not be able to sustain any major or continued setbacks. These borrowers are not as strong as Grade 2 borrowers, but should still demonstrate consistent earnings, cash flow and have a good track record. A borrower should not be graded better than 3 if realistic audited financial statements are not received. These assets would normally be secured by acceptable collateral (1st charge over stocks / debtors / equipment / property). Borrowers should have adequate liquidity, cash flow and earnings. An Aggregate Score of 75-94 based on the Risk Grade Scorecard.
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Weight
13% 16%
Financial Risk Technical Risk Business/Industry risk Marketing Risk Managerial and relationship Risk
30%
11% 20%
Figure 8: Weights of Principal Risk Components 3.3.6 Credit Approval Discretion The following guidelines are applied in the approval/sanctioning of loans: Credit approval authority of MTB must be delegated in writing from the MD/CEO& Board, acknowledged by recipients, and records of all delegation retained in CRM. Delegated approval authorities are reviewed annually by MD/CEO/Board. The role of Credit Committee are restricted to only review of proposals i.e. recommendations or review of banks 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 approvals are centralized within the CRM function. Regional Credit centers may be established, however, all large loans are approved by the Head of Credit and Risk Management or Managing Director/CEO/Board or delegated Head Office Credit executive. Any Credit proposal that does not comply with Lending Guidelines, regardless of amount, are referred to Head Office for Approval MD/Head of Credit Risk Management approves and monitors any cross-border exposure risk. Any breaches of lending authority are reported to MD/CEO, Head of Internal Control, and Head of CRM
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Methodology
4.0.1 Approach Information used to prepare this report has been collected from both primary and secondary sources. The primary sources provide the report with reliable data and information relating to customer and the banks 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. 4.0.2 Primary Sources I have collected primary data by interviewing employees and clients of Mutual Trust Bank Limited. Information was collected through the discussion with employees of MTB. I needed clarifications of different issues that I ensured from various concerned officials of this bank. 4.0.3 Secondary Sources: Information was obtained from various sources, such as: (1) Company annual report, (2) Company web site, (3) Various internal and external banking circulars, (4) Departmental guidelines and (5) Prudential Central Bank Guidelines and Circulars and (6) Internet resources and journals.
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Table 6: Weights of Principal Risk Components Based on this format the business loans are categorized. In case of personal and SME loan the categorization procedure is quite different. Generally these loans are categorized on the basis of 35. Seven things are considered here. These are as follows:
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3. 4. 5. 6.
7.
Family background Business profile Life style Behavior and willingness to repay Net worth or financial position of the applicant Guarantors status Other special remarks
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d) Incentive Schemes: To the extent that management can enter incentive compatible contracts with line managers and
make compensation related to the risks borne by these individuals, then the need for elaborate and costly controls is lessened. However, such incentive contracts require accurate position valuation and proper internal control systems. Such tools which include position posting, risk analysis, the allocation of costs, and setting of required returns to various parts of the organization are not trivial. Notwithstanding the difficulty, well-designed systems align the goals of managers with other stakeholders in a most desirable way.
5.4.3 Asset Quality & Non-Performing Loans of MTB MTB upholds the principle of maintaining the asset quality and therefore focuses on strict supervision of its asset portfolio. As of the year 2010, MTBs total assets along with subsidiary had risen by 10.37% over 2009, reaching BDT 58,246 million. A major contributor to this growth was the increase in loans and advances. Accompanying this quantitative growth has been
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Table 7: Summary of Assets MTBs credit portfolio is mostly comprised of corporate, consumer and SME clients. If we closely observe the loan portfolio of MTB in 2009 & 2010 then we shall see a clear indication of MTBs appetite for growth. MTB is paying more attention to Textile industry than it paid in previous year. Amount of loan disbursement in this sector increased almost 9.38 times in 2010 than that of 2009. Moreover, Food, Plastic and Rubber, Petroleum and Edible Oil, Chemical, Engineering industries enjoy more loan disbursement from MTB. On the other hand, shrinkage is observed in Jute, Cotton & Wearing Apparel, Paper & Printing and Service industries.
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6.1 Recommendation
A banker cannot sleep well with bad debts in his portfolio. The failure of commercial banks occurs mainly due to bad loans, which occurs due to inefficient management of the loans and advances portfolio. Therefore any banks must be extremely cautious about its lending portfolio and credit policy. So far Mutual Trust Bank Limited has been able to manage its credit portfolio skillfully and kept the classified loan at a very lower rate --- thanks goes to the standard and stringent credit appraisal policy and practices of the bank. But all things around us are changing at an accelerating rate. Today is not like yesterday and tomorrow will be different from today. Given the fast changing, dynamic global economy and the increasing pressure of globalization, liberalization, consolidation and disintermediation, it is essential that Mutual Trust bank limited has a robust credit risk management policies and procedures that are sensitive to these changes. To improve the risk management culture further, MTBL should adopt some of the industry best practices that are not practiced currently.
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CONCLUSION
The future of banking will undoubtedly rest on risk management dynamics. Only those banks that have efficient risk management system will survive in the market in the long run. The effective management of credit risk is a critical component of comprehensive risk management essential for long-term success of a banking institution. Techniques, practices, and tools for credit risk management are evolving rapidly, as are the challenges that banking organizations face in their business lending activities. For larger institutions, the number and geographic dispersion of their borrowers make it increasingly difficult for such institutions to manage their loan portfolios simply by remaining closely attuned to the performance of each borrower. In identifying and pursuing a sound credit risk management process MTB has designed its overall strategy by starting with setting up its objective, mission and vision under its credit policy framework. Its main objective is to proactively manage loan portfolios in order to minimize losses and earn an acceptable level of return for shareholders.
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List of Acronyms
SME: Small and Medium Enterprise CRR: Cash Reserve Ratio SLR: System Level Requirement LC: Letter Of Credit SAMD: Special Asset Management Division DFI: Development Financial Institutions CCS: Corporate Client Service KYC: know your customer BOI: Board of Investments FSRP: Financial Sector Reform Project LRA: Lending Risk Analysis CIB: Corporate, investment banking CRML Credit Risk Management CRM: Customer Relationship Management NPL: Non Performing Loan RU: Recovery Unit SAM: Special Assets Management CLR: Classified Loan Review FSV: Force Sale Value
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BIBLIOGRAPHY
Annual Report (2010), Mutual Trust Bank Limited Gujarati, D.N. (2004), Basic Econometrics, McGraw-Hill/Irwin 4th Edition Internal documents, Mutual Trust Bank Limited Mutual Trust Bank Ltd, from, http://www.MTB.com.bd
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