Chapter 1: Background of the Study

 INTRODUCTION

After completion of 8 semesters in the Evening MBA Program of the Faculty of Business Studies, Dhaka University, I prepared my project paper on Credit Risk Management of the Gulshan Branch of Eastern Bank prepared on the Credit Risk Management (CRM) department of the bank. In the report it has gone through the standard operating procedures carried out by the bank and understood them well. Project paper has try to understand the regulatory compliance issues proposed by Bangladesh Bank (BB) regarding credit management practices.

 OBJECTIVE OF THE REPORT

To provide a thorough understanding of the Credit Risk Management Practice followed by CRM, Gulshan Branch of Eastern Bank Limited for SME credits. The report attempts to show whether the whether the Credit Risk Management Practice followed by Eastern Bank is in compliance with Bangladesh Bank guidelines. Some core issues like Classification procedures and Non-performing Loan handling procedures will also be discussed thoroughly. Credit Risk grading procedure proposed by Bangladesh Bank has also been intended to be scrutinized in the report with the existing risk rating system followed by Eastern Bank Limited.

SCOPE OF THE STUDY

The scope of the study is limited to CRM, Gulshan branch only. There was no intention whatsoever, to focus on how the loan and advances were marketed to the customers, how the relationships were built and how each customers were followed up or handled by the Relationship Managers. Purpose of the report would be to focus on how the credit management practice is being carried out by the respective department like what is modus operandi, what is the evaluation techniques followed by the officers during evaluating a loan proposal and so on so forth. Also the report won’t cover various legal issues regarding disbursement and recovery procedures of a loan. And finally entire risk management issues in the report will revolve around SME loan proposals only.

 SOURCES OF DATA & METHODOLOGY

• Primary sources of data – Direct conversation with the employees of Eastern Bank Limited.
• Secondary Sources of data – Annual Reports of the bank, different reports, operational manual for the employees, Bangladesh Bank Circulars, Bank Database and various other publications and websites.
• For the analysis part, data have been collected from the loan proposals and other documentation packages of the bank.
• Interview method to the EBL Officials has been used for getting information.
• A case study has been used to present the Credit Risk Assessment process of Eastern Bank Limited.

 LIMITATIONS

The following limitations are apparent in the report—

• Time is the first limitation as the duration of the program was of 12 weeks only.
• Another limitation of this report is Bank’s policy of not disclosing some data and information for obvious reason, which could have been very much useful.

Chapter 2: Background of the Study

 FORMATION

In pursuance of the “Bank of Credit and Commerce International (Overseas) Limited in Bangladesh (Reconstruction) Scheme, 1992”, framed by the Bangladesh Bank and approved by the Government of Bangladesh, the Eastern Bank Limited was formed as a public limited company incorporated in Bangladesh with primary objective to carry on all kinds of banking business in and outside the country. Eastern Bank Limited had also taken over the business, assets and liabilities of erstwhile Bank of Credit and Commerce International (Overseas) Limited branches in Bangladesh with effect from 16th August, 1992.

VISION OF EBL

‘To become the bank of choice by transforming the way we do business and developing a truly unique financial institution that delivers superior growth and financial performance and be the most recognizable brand in the financial services in Bangladesh.’ EBL dreams to become the bank of choice of the general public including both the consumer and the corporate clients. It has adopted a new logo that looks very dynamic in its attractive colors that reflect all the changes that are taking place in EBL.

 MISSION OF EBL

• We will deliver service excellence to all our customers, both internal and external.
• We will constantly challenge our systems, procedures and training to maintain a cohesive and professional team in order to achieve service excellence.
• We will create an enabling environment and embrace a team-based culture where people will excel.

CURRENT BANKING SCENARIO IN BANGLADESH & EBL’S POSITION

From the beginning of the year 2004, the entire banking industry in Bangladesh started facing stiff competition to procure business, under the changed circumstances of the policy of Bangladesh bank to lower the rates of interest in lending and to go for syndication against large loan portfolios with the objective to ensure better operation and control of all functions of the bank.Despite such situation the year was a remarkable one for Eastern Bank Limited (EBL) when the bank finally completed the introduction of a state-of-the art IT technology platform of Flexcube, a world class banking software. All of bank’s 22 branches were connected to this IT platform giving an enviable opportunity to all the EBL customers to obtain the most coveted services that no other bank could offer them yet.Customers of new century are self-motivated, vigilant and informed about the market conditions, further more development of information technology and telecommunication systems created an environment whereby customers demand convenience, reasonably priced better quality financial products and personalized services. Customer demand together with technological advancement created new challenges and opportunities in the banking sector in Bangladesh. Adapting realistic and timely business policies, investments in IT are now prejudice to stay at the edge of this assertive and competitive banking business of the country. Invention of new financial products and services and introduction of new delivery methods are the key concern of staying close to customers.To cope with the status quo, Eastern Bank Limited welcomed these developments and restructured the bank to meet the challenges in future. The branches of the bank are now termed as the “Sales & Services Center” which are solely concentrated providing service to the corporate and consumer clients and maintain relationship with them. The strategic changes that it initiated back in 2002 to face this changing circumstance has been completed in 2004. As a result, this new business structure supported with the robust banking solution will allow the bank to focus on customers’ needs and provide the best services and products to customer’s doorstep at an attractive price.   Keeping in mind such changed circumstances the bank concentrated not only on wholesale banking but also on other alternatives. For example, introducing new products; diversifying Bank’s activities in consumer and retail banking; simultaneously securing low cost deposits to sustain profitability, increase shareholders’ wealth; rationalizing the expenses and optimizing fruitful use of the funds. The cost to operating income ratio of the bank in 2004 was at the lowest bracket compared with other banks.

PERFORMANCE OF EBL IN RECENT YEARS

Eastern bank limited began its stressful journey in 1992 and shaped itself to this position as a healthy financial institution and enjoy today commendable reputation in all circles in the country as well as abroad due to transparency in all layers of its transactions following the rules of business set by the Finance Ministry and Bangladesh Bank without any lapse. It has thus culminated a spirit of honest teamwork amongst the management and staff to produce strong balance sheets, quality portfolios, maintain high capital adequacy, paid up capital and reserves.Eastern Bank Limited today has a strongly motivated and dedicated management and staffs that are the pathfinders for introduction of sophisticated products. It has introduce the Automated Teller Machine (ATM), Point of Sales, Internet Banking, Phone Banking, Debit Card, etc. and also new products. Already it has introduced 3 ATM Machines in 3 of its branches. Debit Card has also been launched. Clients can also do their business transactions through Internet Banking. For example, they can pay their utility bills through Internet Banking.  These positive things shall broaden its customer base and enable the bank to have a competitive edge on other banks.

 REVIEW OF BANK’S OPERATION

As on 31st December 2004 total assets (including contingencies) went up to Taka 23,043 million from Taka 18,445 million of 2002. During the same period operating profit has increased to Taka 892.4 million from Taka 730.7 million of 2002.

 SHAREHOLDERS’ EQUITY

Eastern Bank Limited, as one of the largest capital based banks in Bangladesh with an Authorized Capital of Taka 1,000 million, maintained a strong capital position in the year 2004. At the end of the year under review, the total shareholders’ equity of the bank was Taka 2,630 million. Detail breakdown of changes in shareholders’ equity are given below: 

Bank’s Capital Adequacy Ratio (CAR) on the basis of Risk Weighted Assets (RWA as per Bangladesh Bank guidelines), both in terms of Tier-I & Tier-II was 14.82% as on December 31, 2004 as compared to 18.27% in the year 2003. Compared to the minimum requirement of CAR 9%, the Bank had sufficient surplus capital for growth and development.

DEPOSITS
The bank, a policy, discouraged high-cost term deposits and focused on reducing cost of funds by increasing low-cost deposits. Rates of interest were revised from time to time in response to internal as well as external market conditions. Even under these extreme situations deposit base has increased to TK 15,649 million (2004) from TK 11,952 (2003).

 ASSETS

Total assets of the bank stood at taka 23,048 million as on December 31, 2004 as against taka 18, 445 million as on December 31, 2002.

 LOANS & ADVANCES

Total loans and advances of the bank stood at TK 14,973 million indicating an increase of 32.64% as against TK 11,288 million of preceding year. The advance to deposit ratio as on December 31, 2004 was 95.68%.

Income, Expenses & ProfitEBL’s income, expense & profit statistics, Return on equity and cost to income ratios can be summarized as following:

 DIVIDEND

The Board of Directors recommended payment of Taka 43 as cash dividend for the year ended December 31, 2004 for each ordinary share of Taka 100 on total paid-up capital of 828 million as compared to 20% cash dividend per share of 2003, showing a growth of 115%.

CORPORATE GOVERNANCE & REGULATORY COMPLIANCE

Eastern Bank Limited practiced the principles of good corporate governance over the years that covered compliance of regulatory requirements, responsive to various stakeholders. Spirit of corporate governance also included practicing of the corporate culture within the organization and shared this by the employees.Eastern Bank Limited complied with all the regulatory guidelines prescribed by the Banking Companies Act, Bangladesh Bank, National Board of Revenue and Securities & Exchange Commission, International Accounting Standards, etc.

Chapter 3: Credit Sanction Procedure of EBL

 INTRODUCTION

Credit Risk Management is one of the most crucial components of the dynamics of bank management as credit lending is the principal activity for the commercial banks. In this segment of the report Credit Risk management practice of Eastern Bank Limited will be thoroughly discussed and then it will be compared and contrasted with Prudential Guidelines of Bangladesh Bank. Then two of the key credit management practices: Handling of Non-performing loans and procedures for loan classification will be discussed simultaneously.

CREDIT RISK

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 or counter party will fail to meet its obligations in accordance with agreed terms. Credit risk, therefore, arises from the bank’s dealings with or lending to corporate, individuals and other banks or financial institutions.Eastern Bank Limited has categorized its credit risks into four broad categories for its risk management purpose. Each class of risk has their unique management technique. Following are the four broad categories of risks defined internally by the bank:

Class- A

Class- B

Class- C

Class- D

 CLASS – A:

Credit facilities extended to clients which are secured by:

• 100% cash covered by having the funds available in EBL’s cash margin account
• 100% EBL Fixed Deposits fully liened & pledged in favour of the Bank
• 100% in the form of Govt. Sanchya Patra fully liened & pledged in favour of the Bank
• 110% cash covered if credit facilities are in different currency than that of collateral

CLASS – B:

Credit facilities extended to clients which are secured by:

• Hypothecation of business assets like Inventory, book debts & assets, Plant & Machinery
• Mortgage of fixed assets like Factory Land & Building and other real assets
• Partially cash covered or other collateral
• Guarantee from acceptable Financial Institution or Lien on fixed deposits issued by them
• Personal or Corporate Guarantees
• Government Guarantee through Ministry of Finance

CLASS – C:

Credit facilities extended to cover or to hedge foreign currency risk against Letters of Credit are called exchange fluctuation risk. The product, which EBL sells to its customers, is called Forward Contract (FWD FX) and can be further explained as follows:

• Exchange Fluctuation Risk
• Forward Contract against Letters of Credit
• Hedge FX risk of EBL/Other Bank Letters of Credit
• Risk for Max. 180/360 day

 CLASS – D:

This class of risk is concerned only with risks taken on a banking financial institution and can be further explained as follows:

• Risk on banking financial institutions (FI) including Bangladesh Bank
• Call/STD/Time placement with banking financial institutions
• Term Exposure on banking Financial Institutions
• Financing against banking Financial Institution’s acceptances
• Negotiation of Export documents against valid export lcees
• Purchase of Pay Order/Demand Draft drawn by a banking financial institutions
• Nostro Account with other banking Financial Institutions
• Purchase of Treasury Bills from Bangladesh Bank

CREDIT RISK MANAGEMENT PRACTICE

Credit lending is the principal activity for a commercial bank. In this competitive business market it has become very crucial for a bank to make prudential decisions while disbursing any loan; be it in corporate sector, in SME sector or be it consumer financing. While a bank cannot make a loan decision whimsically it also has to measure the cost and price against disbursement of a loan. Thus credit risk management needs to be a robust process that should enable banks to proactively manage loan portfolio in order to minimize losses and earn an acceptable level of return for shareholders. In this background it is very essential that a bank maintains a credit Risk Management department and that is the case for Eastern Bank Limited, which has a full fledged Credit Risk Management (CRM) unit exclusively to focus on the Corporate and SME loans of the overall portfolio.

CREDIT RISK MANAGEMENT DEPARTMENT

The credit risk management department is placed suitably in the organizational dynamics so that maximum output can be generated from it. All corporate and SME proposals of the bank are approved through this particular department of the bank. The activities of the department include:

• 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 aggregates 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.

The department is well equipped to handle all sorts of challenges of the business dynamics. Well equipped in the sense of having sufficient manpower, and brilliant technical facilities, the department has made its own distinctive place in the organization itself. The 7 member team is headed by its qualified team leader. The following sections will describe the standard operating procedures of the department for SME sectors.

The departmental structure of CRM is presented below:

 RESPONSIBILITY OF SME DEPARTMENT

The SME department is primarily responsible for bringing business to the bank. The Relationship Managers in different branches manage the clients; they prepare the proposals in the standard format (a specimen copy of the credit application package has been provided in the appendix) and send them directly to the SME department at the Head Office. The proposal is reviewed by the SME staffs for possible flaws and other documentation checking. Then the proposal is sent to the CRM department. Three out of the seven credit officers are assigned exclusively for the SME proposals. Each credit officers have been allocated with specific branches. So as per allocation of their respective branches the officers receive proposals from the SME department.

THE PROCEDURAL DATABASE

After receiving a particular loan proposal it is given entry into a database named ‘Log Sheet’. The principal function of this database is to keep track of each of the proposals that are assigned under each credit officer. Primary objective is to locate the status of each file at any time. A weekly report from the database is provided to the Head of CRM and also a monthly report on SME proposals is placed to the Head of SME from it. After giving entry into the database, proposals are placed to respective credit officers.

The credit officers then start to review the loan proposal. The basic intention is to measure the exact financial need of the customer and disburse the amount accordingly and to minimize the risk exposure of the bank in the process. In terms of regularity the proposals may be broadly classified as one time and regular. One time proposals include LBPD, FBPD, LC, Bank Guarantee and so on. The regular proposals refers to approval for fresh credit like Cash Credit, Demand Loan, Time loan Pay order, Time loan work order, restructuring of existing facilities etc. On an average following is the time needed by each of the officers to review these two broad types of proposals:

Note: The data have been colleted from the previous 3 months review performance as is recorded in the ‘Log Sheet’ Database.

Within these periods the officers review the files as per standard operating procedures.

 A SIMPLE WORKFLOW

The officer receives the loan proposal, he analyzes it. If there are any observations or queries that are not available in the proposal then he sends queries to the respective RM. After receiving the answers of queries he prepares his analysis and based on this prepares the recommendation for the proposal. The recommendation first needs to be approved by the immediate  supervisor of the officer, after the supervisor gives his approval then the officer places the recommendation with the loan proposal to the HOCRM. HOCRM after reviewing the proposals gives his decision. Then the credit officer prepares a sanction letter in the standard format of the bank and forwards the documents to the Credit Administration Department. The Credit Administration department then loads the limit into the system. This is a typical loan review activity of a credit officer which is presented in the figure below:

ANALYSIS OF A RENEWAL PROPOSAL (A CASE STUDY)

Renewal is a kind of proposal in which the existing relationship is renewed for a further period of time. The previous relationship was approved for a certain period of time for example, for one year. After the stipulated time period if the client wants to continue with the relation, he or she contacts the RM of the concerned branch. The RM then as per standard format prepares the renewal proposal. It is to be mentioned here that when the previous limit is to be increased for the current year then it is called ‘Renewal with enhancement’ when the previous limit is to be reduced then it is termed as ‘Renewal with reduction’ and when the previous proposal is to be restructured then it is called ‘Restructure and renewal’. Following is a case presentation of how renewal proposals are reviewed by a credit officer for Cash Credit (Hypo) facility.At first the credit officer matches the ‘facilities table’ in the Credit Memorandum (CM) and Application for Limit (AFL) of the current proposal with those of previous proposal to see whether there is any deviation. If there is any, he gets the flaw corrected by RM or by himself.

CM 2005

The figure shows the state of the facilities box. The facility under proposed column (2005) was approved for 31^st March 2006, should coincide with the existing column (2006), as it is now an existing facility. Any mismatch in this case should be corrected by the credit officer at the very outset of the evaluation procedure of the proposal.After checking the facilities box is complete the next task is to match the collateral box. This is done to find whether there is any mismatch between information regarding registered mortgage of the properties and so on. It is expected that the Collateral box and description of the scheduled property within will exactly be the same unless stated otherwise.

These are the major checklists for the credit officer. However, a detailed check list would be provided in the later section of the report.In case of evaluating renewal proposal the main focal point of the officer remains is the account performance of the customer. As this is a tested client the officer will not analyze the business dynamics as elaborately as before, when he sanctioned the proposed limit for the first time. Regarding the evaluation of account performance the officer tries to identify whether the account statements reflect the operational performance of the client. There are some ratios to consider in this case. These are:

 a. Deposit Ratio

Deposit ratio is defined as Credit Summation to Sales. The credit summation figure is readily available in the account profitability part of the CM package. This can also be verified from the account statement of the client. The purpose of this ratio is to measure how much amount was deposited in the account out of the entire sales proceeds during the stated period. It is expected that the client regularly deposit his money into the account.

 b. Average Utilization Ratio

Average utilization ratio captures whether the client is utilizing the sanctioned limit properly. If the utilization ratio is good then it is evident that he is doing so and vice versa. Average utilization is arrived by dividing the interest income for the year with respective interest rate. This amount is then divided by the total limit.Apart form these ratios account statement of the client is strictly scrutinized to find if there are any irregularities. The account statement should reflect the operations of the business for the client. The monthly credit summation should coincide with the average monthly sales figures. Also the officers check the source of the debit and credit transaction and their regularities. Also any window dressing in the account performance are tried to be figured outThe call report of the CM package states the current business position of the client and his business needs in detail. It is prepared by the RM disclosing his experience during his visit to the clients’ premises. The portfolio review basically provides a periodical statement of the financial health of the business. Also some queries regarding the operations of the business is reported in this part of the proposal.Stock inspection report is another important section of the proposal, which is to be strictly monitored in case of a renewal proposal. The report mentions the date of stock inspection, the break up of stocks and book debt as on that date, total value of security, amount of excess security and so on.

Calculation of excess security:

Funding Outstanding as on stock inspection date: XXX

Security Value on same date:                                          XXX

Drawing power: (Security value) X Drawing power (70%)

Excess Security = Funding outstanding – Drawing power.

Finally based on the data from the CM package the officers calculate the working capital requirement of the business and check whether it supports the proposed limit.On an average these are the things that are being analyzed for approving a renewal proposal of a client. These parts are addressed at its very basic if not anything more for the stated purpose. However, the analysis may not follow the same chronological order as is mentioned above. Following is the checklist that is pursued during the evaluation process (figure represents the excel model used to do the tasks):

The existing proposal has a stipulated time period for which it was sanctioned previously. After that date the limit will become past due if not settled fully. This would be detrimental for the client, as it will be reported in the CIB report of Bangladesh Bank. So it is very much necessary that the renewal proposal be submitted well within the existing expiry date. However, if there are any issues like
mortgage modification or so on, a time extension proposal may be approved for the client to avoid the embarrassment

The bank needs to have adequate insurance coverage on its security against fire, flood and other risks. The specific amount of insurance is 110% of the security value. It is to be checked during evaluation whether the insurance coverage has been renewed with the company.

The minimum interest rate is revised from time to time. For example current slab for interest rate in EBL is 15% for the regular SME clients. So the officer must make sure whether stated interest rate is as per regulation of the bank. Also the reduction of interest rate requires approval from higher authority so it is also to be checked whether interest rate is being reduced or not.

The address of the customer is usually mentioned but the officer needs to check whether there is any change in it or nonetheless it is mentioned or not.

Another important component of checklist is to look for any declaration from Credit Administration Department. The declaration regarding documentation and other procedures needs to be in place before sanction of the limit. So the officer checks whether all the declarations are in place or not. The declaration of the Credit Administration regarding the proposals are as following:

Another important component of checklist is to look for any declaration from Credit Administration Department. The declaration regarding documentation and other procedures needs to be in place before sanction of the limit. So the officer checks whether all the declarations are in place or not. The declaration of the Credit Administration regarding the proposals are as following:

If the client has other loan relationships then the account statements of other banks needs to be obtained.

 CONCLUSION

After all the analysis if the credit officer is satisfied with the justification of limit he prepares his recommendation. The recommendations are then submitted to his immediate supervisor for his approval.  Finally all the documents are submitted to HOCRM for his approval. After getting the approval from HOCRM the officer then prepares a sanction letter as per standard format of the bank. One copy of the sanction letter is sent to the Credit Administration department (this department is responsible for loading the limit into the system so that the clients gets his loan) and another copy (original documents) is then stored in the Credit File of the client. This is how the credit officer carries out a typical renewal analysis.

Chapter 4: Non-Performing loan Classification Criterion

INTRODUCTION

NPL (Non-performing Loans) include those loans, which are showing signs of weakness in the credit quality of the loans. When the quality of a loan deteriorates, the first signal comes as irregularity in client’s loan repayment. Often a loan account starts having past dues. International best practices require that a loan be classified as non-performing if its principal and/or interest are three months or more in arrears. Banks in Bangladesh are allowed to classify non-performing loans based on a time frame of three months. Early recognition of non-performing loans stimulates collection efforts and helps reduce the possibility of loss of such assets.

NON-PERFORMING LOAN: ELABORATION

Loans may be termed as Non-Performing both from the objective and subjective judgment. Objective criteria for loan classification are grossly set by Bangladesh Bank. Subjective judgment by the bank officials are guided by the Instruction Circulars from the top management.The following objective criteria were prescribed by Bangladesh Bank for loan classification vide BRPD Circular No. 16, dated 06 December, 1998 with subsequent amendments vide BRPD Circular No. 9 of 2001, BRPD Circular No.02 dated 15 February, 2005 and BRPD Circular No. 09 dated 20 August, 2005.

**SM = Special Mention, SS = Sub Standard, DF = Doubtful, BL = Bad & Loss

Besides the objective criteria, EBL uses the following subjective criteria to classify loans. It can be noted here that, loans are classified primarily by objective criteria. However, officials are encouraged to follow the subjective criteria side-by-side the objective criteria. Brief descriptions of the four classification categories are provided in the following table

A brief description of the activities of different departments other than CRM for better understanding of the NPL management function is presented below. Besides these departments, Relationship Managers of Corporate Banking Units and SME units (Small & Medium Enterprises) also play an active role in the NPL management.

CREDIT ADMINISTRATION DEPARTMENT (CAD)

Activities of Credit Administration Department include the following at its very basic:

1. Documentation of loans
2. Disbursement of loans
3. Credit Monitoring
4. Early Alert process
5. Reporting to Bangladesh Bank

 SPECIAL ASSET MANAGEMENT DEPARTMENT (SAMD)

Special Asset Management Department is responsible for all accounts classified in the bank’s loan portfolio. The three types of classification maintained by the department are given below:

i)     Sub‑standard,

ii)      Doubtful and

iii)     Bad & Loss,

SAMD’s responsibility sectors

1. Monitoring and controlling the classified accounts through monthly reporting and quarterly review/update.
2. Actively follow up with the borrowers for recovery,
3. Negotiating and restructuring/rescheduling debts wherever feasible, on its own and /or in association with the concerned Relationship Manager/ Unit Head/Area Head/Line of Business and Head Office Credit Risk Management.
4. Review for reschedule/restructure/waiver/write-off is presented by SAMD with, if deemed necessary, inputs from the related unit or branch/line of business. Proposal is placed as per the format with all relevant support/documents/ information to facilitate the process for approval from the appropriate authority duly recommended by Head of Credit Risk Management and Managing Director & CEO.
5. Advise client the reschedule / restructure / waiver letter after proper approval from the EBL Board.
6. Head Office Credit Risk Management releases the approved restructure /reschedule/waive/write-off proposal to Credit Administration Department who are responsible for communicating the decision jointly with Head of SAMD to client as well as initiating action on the books of account of the unit or the branch.
7. Follow‑up responsibility on such waiver/reschedule /write‑off loans is assigned to SAMD.

SAMD also prepares a Consolidated Report of all bad loans written‑off on a quarterly basis and submit the report to the Head of Credit Risk management and Managing Director & CEO.

 DETECTION PROCESS OF NPL

First and foremost requirement for any and all Relationship Managers / Sales & Service Managers and Credit Managers is to identify a problem credit in its earliest stages by recognizing the signs of deterioration. Such signs include, but not limited to, the following:

i)       Non‑payment of interest or principal or both on due dates or past‑dues beyond a reasonable period or recurring past dues.

ii)      In case of Overdrafts, (or Cash‑Credits or similar facility), no movement in the account beyond a reasonable period.

iii)     A deterioration in financial condition of the client, as gathered from client’s latest financial statements.

iv)      A shortfall in collateral coverage, particularly if the collateral was a key factor in the decision-making or the loan was predicated on the sole factor of collateral (i.e., fully secured transactions).

v)      Death or withdrawal of key owner(s) or management personnel.

vi)     Company filing for bankruptcy or voluntary dissolution.

•  vii)    Adverse market report about the company itself or its principal owners.
•  STEPS TO FOLLOW FOR CLASSIFICATION
• Steps to follow in such situations are:

i)    CAD rechecks the account, for all outstanding, including any outstanding in allied or sister company or in owner’s or partners’ or directors personal name(s).

ii)   CAD thoroughly reviews loan documentation to confirm that “the bank has what the bank needs”, documents are in proper form, properly executed and current (i.e. not time barred). A review of the documentation serves as a good reminder of the Bank’s legal rights against the debtor, principal owner/guarantors etc.

iii)   CAD obtains current figures to review these on strict liquidation basis, to take a close look at the assets and liabilities to determine who has the preferential right or prior lien to what assets. For Limited Liability companies, a title search at the RJSC office where all charges are filed is carried out.

iv)  If Guarantors are involved, CAD looks closely at the net worth statement and take steps to protect EBL’s interests’ vis-à-vis other creditors. In other words, if possible, perfect liens on Guarantor’s assets or give demand notice to guarantor.

v)   Concurrently with the assessment of situation, once the account is classified Sub‑standard, credit lines are frozen with notice to all concerned, on a “damage‑control” concept.

vi)   A report in the prescribed form as per standard format is submitted to classify the account. A concurrent initial Action Plan to up‑grade or recover the out‑standing is also submitted in the Portfolio Review Format for approval.

vii)   A full assessment of the problem situation surrounding the account leads the reviewer to decide options available to the bank: viz

[   Work‑out, with no rescheduling

[   Work‑out, with rescheduling, under proper rescheduling agreement and if needed with fresh documentation and renegotiated collateral security.

[   Legal action, which if situation so warrant, is taken immediately (with prior approval from appropriate approving authority) when the need is recognized to pre‑empt any dissipation or transfer of the assets of the borrower or the guarantor.

CLASSIFICATION PROCESS

For the purpose of determining the “Classified” status of an account, following guidelines are observed

i)    The process of Classification of an account starts with strict application of the risk rating assessment that is compulsory for each borrowing relationship. Account deemed to be classified are subject to Portfolio Review Form submission or a direct classification by Head Office Credit Risk Management:

[  Special Mention

[  Sub‑standard

[  Doubtful

[  Bad & Loss

ii)   However, unpaid Interest or Principal or Expired Limit for a period of 90 days or more or recurring past dues (of Principal) remain the most significant Rules of Thumb triggering the classification.

DOWN‑GRADING/UPGRADING CLASSIFIED ACCOUNTS

The followings are the procedures for upgrading or downgrading the classified accounts:

a)       Primary responsibility lies with the concerned Relationship Manager to initiate the classification by submitting the Portfolio Review Form in a timely manner.

b)       This responsibility first moves laterally to Relationship Managers and escalates upwards to Unit Head/Sales & Service Manager, if anyone having responsibility for the account in the layers fail to identify and report a classified name.

c)       If and when a Portfolio Review Form is submitted, the concerned Relationship Manager/Unit Head/Area Head, Head of Line of Business, reviews it promptly. The latter finally recommends the category or severity of classification along with Action Plan to upgrade/recover outstanding. Head of Credit Risk Management and Managing Director & CEO reviews and agrees to the classification and the related Action Plan for recovery/upgrade.Head Office Credit Risk Management is responsible to release and distribute copies of approved Portfolio Review Form to:

       1.  Area Head, Corporate Banking / Head of Line of Business

1. Concerned Unit Head / Sales & Service Manager
2. Head of Special Asset Management Department

d)       Head Office Credit Risk Management may also independently classify an account in the normal course of inspection of a branch or unit’s loan portfolio. In such event, the Portfolio Review Form will then be filled in by Head Office Credit Risk Management and will be referred to the respective Relationship Manager / Unit Head / Area Corporate Head / Head of Line of Business and/or Head of Special Asset Management Department for information. Action Plan for recovery/upgrade will then be presented by Head of Special Asset Management Department in consultation with RM / Unit Head / Area Head / Head of Line of Business to the Head of Credit Risk Management & Managing Director & CEO for approval.

e)        Such classification may be superseded by a more severe classification i.e. down grading, by the regulatory body (Bangladesh Bank).

f)          Wherever required an independent assessment of the classified credit may be conducted by Head Office Credit Risk Management or by internal auditor documenting as to why the credit deteriorated and what were the lapses.

g)          Only the Head of Credit Risk Management & Managing Director & CEO is empowered to up‑grade a classified account but the recommendation has to originate from the Head of Special Asset Management Department. Continuation of business strategy (if any) for the upgraded account will require the consent of Area Head – Corporate Banking / Head of Line of Business with proper justification.

h)        Upgrading of a classified account has to be well justified diligently and objectively by all recommending officers. Essentially, complete removal of the reason(s) for classification should be the basis of any upgrading.

i)          Classified Accounts are passed on to Special Asset Management Department in the following manner:

[  Any and all accounts, which have been downgraded to Sub Standard status.

[  Any and all accounts, which have been downgraded to Doubtful or Bad & Loss status.

[  Within 7 days of an account being downgraded to substandard (SS-5), a Request for Action and a Handover/Downgrade Checklist are completed by the RM and forwarded to SAMD for acknowledgment. The account is assigned to an account manager within the SAMD who will then in consultation with concerned Relationship Managers/Unit Head/Area Head/ Head of Line of Business prepare Action Plan for recovery or upgrade and get it approved by Head of Credit Risk Management and Managing Director & CEO.

[  Officer in Special Asset Management Department get the credit files transferred to their Department from Corporate Banking/Line of Business and under their custody for account being classified Substandard, Doubtful and Bad & Loss, and will monitor all upgrade/downgrade.

[  Officer in Special Asset Management Department must sign on the Loan Documentation Checklist to ensure review of loan documentation at his/her end.

[  Officer in Special Asset Management Department must review the Stock Report and Stock Inspection Report of classified accounts to arrive at an effective action plan for recovery/upgrade. Specimen of Stock Report and Stock Inspection Report attached.

[  Special Asset Management team in the standard waiver format processes proposal for restructure/reschedule/waiver for the classified accounts. The proposal should accompany copies of previous approvals, recent accepted Sanction Letter by client, Lawyer’s opinion and updated status on Loan Documentation.

j)         Head of Special Asset Management in H.O. interfaces with Head Office Credit Risk Management & Managing Director & CEO on all up‑grading/recovery efforts in the context of

[    Recovery,

[    Loan Loss Provision and

[    Restructure/Reschedule/Waivers/Write-offs.

REPORTING OF CLASSIFIED ACCOUNTS

The reporting procedure for classified accounts have been outlined below:

i)          Accounts, which are, once classified but not up-graded or recovered are to be separately reported on a monthly basis to Head Office Credit Risk Management and Managing Director & CEO. Complete accuracy is to be ensured while reporting these names. Such reports originate from Credit Administration Department

ii)         Head of Special Asset Management Department submits monthly results on recovery status on all existing and newly Classified Accounts to Head Office Credit Risk Management and Managing Director & CEO.

iii)        Head of Special Asset Management Department submits quarterly report on Classified Accounts to Head Office Credit Risk Management and Managing Director & CEO.

 NON- EARNING LOAN:

Following guidelines are strictly observed for treatment of unpaid/uncollected interest in classified accounts:

i)       If interest is over‑due by more than 90 days the outstanding must be classified Special Mention ‑ Non‑Earning or even lower (such as Sub-standard), if not already so classified.

ii)     If any loan is classified as Special Mention/Sub standard/Doubtful, interest is charged on this loan, but this cannot be treated as income. All such interest is credited to Interest Suspense (Credits) AC. or any other account specially designated for this purpose by Bangladesh Bank.

iii)     If a loan is classified as Bad & Loss, charging of interest thereafter is suspended from the date of Bad & Loss classification. A contingent/memo entry is taken up for the interest being suspended which is reversed/brought back as actual liability at the time of suit being filed for recovery or if restructure/waiver/settlement takes place. Head of Special Asset Management Department ensures that these contingent/memo items are monitored and reported on a quarterly basis to Head of Credit Risk Management and Managing Director & CEO.

iv)       A properly conducted overdraft facility can be considered earning as long, as outstanding with interest debited to the account remain within approved and valid limit. But, it is not permissible to increase overdraft limits to absorb interest charges unless specifically approved by Head of Line of Business/Area Head Corporate/Sales & Service Managers/ provided such interest is settled by cash deposit into the account within 60 days of such debits.

v)    Sometimes, Sub‑standard loans may be restructured or rescheduled, with the stipulation that as part of the rescheduling, accrued unpaid interest be capitalized. Only in these situations, exceptions to the foregoing rule may be allowed but strictly on the following conditions:

a)     The restructuring or rescheduling is approved by the appropriate approving authorities on the basis of a “Work-out” credit proposal.

b)     The interest to be capitalized with principal is reserved from interest suspense accounts only after full completion of documentation related to rescheduling and compliance of all conditions precedent related to rescheduling.

vi)     Classified accounts for which restructure/rescheduled approved may be upgraded/declassified to Marginal/Watchlist-3 i.e. placed under earning status provided the following two criteria are met

a)       Borrower displays sustained repayment performance in accordance with the repayment plan.

b)       All principal and interest amounts contractually due are assured of repayment within a reasonable period.

However, return of such accounts to earning status on this pretext must have Head Office Credit Risk Management’s pre‑fact concurrence.

vii)   Earlier, accounts which have been classified by Bangladesh Bank auditors during their course of inspection, would require pre-fact approval from Bangladesh Bank for declassification/upgrade as per their requirement. But in a recent amendment from BB states that the board of directors of the bank can de-classify an account. In this case, however, this phenomenon has to be reported to BB.

APPLICATION OF PAYMENTS INTO CLASSIFIED LOAN

If a classified loan or part of any classified loan is collected than accrued interest and suspended interest should be settled first any residual will be applied for settlement of Principal Loan.

REVIEW OF CLASSIFIED ACCOUNTS

Classified Accounts (like Sub‑standard, Doubtful and Bad & Loss) are reviewed on a quarterly basis in the manner and as stipulated in the Obligor Risk Rating (ORR) guidelines of the bank.If Relationship Manager feels that due to irregularities or over‑dues, etc., regular lines should not be renewed but existing outstanding should be placed on liquidation basis (i.e. adjustment purpose), a renewal work‑out CM covering

a)             The outstanding, with specific maturities,

b)             Anticipated date of liquidation (or expiry of the facilities) and

c)             Action plan to either up‑grade or complete recovery

must be submitted in the normal manner & account should be rated Special Mention – 4.If up-to-date financials are not available, Relationship Manager should submit renewals based on latest available ones. More than perfunctory trade/bank checking must accompany the CM.

CREATION OF LOAN LOSS PROVISION

As part of pragmatic and conservative approach to sustain the quality of the Bank’s loan portfolio and hence, the earning stream, Loan Loss Provision exercise is being made mandatory for all Line of Business and Head of Special Asset Management of the Bank.Such exercise is dictated by: a) generally accepted banking practice, b) conservative approach to assess the quality of Risk Assets whereby the most accurate health of the Loan Portfolio is reflected on the books of the Bank and c) to be guided by Bangladesh Bank instructions/guidelines on provisioning.

Following guidelines are observed:

i)     The prudential Provision Practice dictates that rather than wait until the close of the fiscal year; provision exercise would be an on‑going one, with the needed provision created, when an account is classified and continues to remain classified. The provision exercise is to be carried out by each quarter end, based on reports on Classified Accounts related to previous quarter.

ii)    Bangladesh Bank instructions/guidelines are followed for the purpose of Loan Loss Provision exercise.

iii)   Unless otherwise enhanced by Bangladesh Bank regulatory body, Loan Loss provision policy

as per the matrix given below is adopted and followed by the line of Business and Special Asset Management Department of the Bank.

For the purpose of provision against classified loans, “Eligible Securities” mean the following-        100% of deposit under deposit against the loan-        100% of the market value of gold or gold ornaments pledged with the Bank-        100% of the value of Govt. bond/Sanchayapatra under lien-        50% of the market value of easily marketable commodity kept under the control of the bank-        50% of the market value of land and building mortgaged with the bank-        50% of the average market value for last 06 months or 50% of the face value whichever is less, of the shares traded in stock exchangeThe amount of required provision may, in some circumstances, be reduced by an estimated realizable forced sale value of (i.e. Salvage Value) of any tangible collateral held (viz: mortgage of property, pledged goods / or hypothecated goods repossessed by the bank, pledged readily marketable securities etc). Hence, in these situations, it will be advisable to evaluate such collateral, estimate the most realistic sale value under duress and net‑off the value against the outstanding before determining the Net Loan value for provision purposes. Conservative approach is taken to arrive at provision requirement and Bangladesh Bank guideline to be properly followed.Provided:a)       The classification criteria are strictly and objectively applied andb)     Classified accounts are monitored in the manner as stipulated in this write-up, a concerted focused attention on the classified loans is expected. If an account is thus reviewed and rated say Sub-standard and 20% provision is made there against, in subsequent assessments if the account shows further signs of deterioration, downgrading to “Doubtful” is warranted. This should then prompt, as per the matrix, a 50% provision of the Net Loan Value.Therefore, the process of’ classification should trigger the Prudential Loan Loss Provision exercise.The action is not completely a “blind faith” one, since unique circumstances and recovery prospects may still lead the assessor to provide for less than the prudential level. Judgmental evaluation should accordingly play the desired role and final decision for the extent of loss provision will rest with the Head of Credit Risk Management and Managing Director & CEO.iv)    However, only the Managing Director & CEO can approve the Loan Loss Provision, whether specific (against each classified account) or general reserves on the strength of recommendation from Special Assets Management and Head of Credit Risk Management.

PROBABLE LOSS

Only for the purpose of Prudential Provision Exercise “Probable Loss” category of rating is to be determined. In general, accounts which are already classified “Doubtful” but have not been down‑graded to ‘Loss” should be evaluated from the “Probable Loss” perspective. To determine this, following factors should be reviewed and score be assigned against each (High score will mean higher probability of Loss and vice versa).

Note:    An account scoring more than 50% may qualify to be high as a “Probable Loss” and would despite being classified “Doubtful may deserve a higher provision on a Net Loan value basis.

 RECOVERY PROBABILITY CATEGORIES TO BE ASSIGNED TO ALL CLASSIFIED LOANS

A.         Loans determined to have high probability of recovery within 6 months; recovery efforts to continue on an on‑going basis.

B.       Loans determined to have moderate probability of recovery within 1 year; review recovery efforts on a 3 monthly basis.

C.           Loans determined to have low and remote probability of recovery; review case on a 6 monthly basis.

D.       Loans determined to have virtually no chance of recovery: charge‑off the books. However in this situation proper approval from the appropriate approving authorities should be obtained and also shall be guided by Bangladesh Bank circulars/instructions (if any) and subject to complete analysis of:

[   Banking practice,

[   Legal and tax implication and

[   Status of each individual credit.

Chapter 5: CRM Policies Recommended by Bangladesh Bank

 INTRODUCTION

This section details fundamental credit risk management policies that are recommended for adoption by all banks in Bangladesh by Bangladesh Bank and EBL’s compliance status with these guidelines. The guidelines outline general principles that are designed to govern the implementation of more detailed lending procedures within individual banks. EBL’s practice regarding general credit risk management has been explained in the following section with their congruence with the regulatory guidelines.

 LENDING GUIDELINES

The bank has its established Credit Policies (“Lending Guidelines”) that clearly outline the senior management’s 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 is updated at least annually to reflect changes in the economic outlook and the evolution of the bank’s loan portfolio, and is distributed to all lending/marketing officers. The Lending Guidelines is approved by the Managing Director/CEO & Board of Directors of the bank based on the endorsement of the bank’s Head of Credit Risk Management and the Head of Corporate/Commercial Banking.Any departure or deviation from the Lending Guidelines is explicitly identified in credit applications and a justification for approval is provided. The Lending Guidelines provides the key foundations for Relationship Managers (RM) to formulate their recommendations for approval, and includes the following:

INDUSTRY AND BUSINESS SEGMENT FOCUS

The Lending Guidelines clearly identify the business/industry sectors that should constitute the majority of the bank’s loan portfolio. This will provide necessary direction to the bank’s marketing staff.

TYPES OF LOAN FACILITIES

The type of loans that are permitted is clearly indicated and defined, such as Working Capital, Trade Finance, Term Loan, etc. A full list of EBL credit products for SME and consumer clients has been attached in the appendix.

 SINGLE BORROWER/GROUP LIMITS

In case of single borrower exposure limit the bank strictly follows Bangladesh Bank guidelines. The regulation regarding the stated purpose communicated vide BRPD circular no 5 dated April 09, 2005 is provided below:

“As a result of increase in capital of almost all the banks, now it has been decided to reduce the single borrower exposure limit from 50% to 35%, thus:

The total outstanding financing facilities by a bank to any single person or enterprise or organization of a group shall not at any point of time exceed 35% of the bank’s total capital subject to the condition that the maximum outstanding against fund based financing facilities (funded facilities) do not exceed 15% of the total capital.Non funded credit facilities e.g. letter of credit, guarantee etc. can be provided to a single large borrower. But under no circumstances, the total amount of the funded and non-funded credit facilities shall exceed 35% of a banks total capitalHowever, in case of export sector single borrower exposure limit shall remain unchanged at 50% of the bank’s total capital. But funded facilities in case of export credit shall also not exceed 15% of the total capital.”

DISCOURAGED BUSINESS TYPES

The BB guideline advices that banks should outline industries or lending activities that are discouraged. As a minimum, the following should be discouraged:

• Military Equipment/Weapons Finance
• Highly Leveraged Transactions
• Finance of Speculative Investments
• Logging, Mineral Extraction/Mining, or other activity that is ethically or environmentally sensitive
• Lending to companies listed on CIB black list or known defaulters
• Counterparties in countries subject to UN sanctions
• Share Lending
• Taking an Equity Stake in Borrowers
• Lending to Holding Companies
• Bridge Loans relying on equity/debt issuance as a source of repayment.

Eastern bank limited follows the guideline and also in addition they have a list of the discouraged business of their own which can not be printed for the sake of confidentiality.

 LOAN FACILITY PARAMETERS

Facility parameters (e.g., maximum size, maximum tenor, and covenant and security requirements) is clearly stated.   As a minimum, the following parameters (mentioned in the guideline) is adopted:

• Bank does not grant facilities where the bank’s security position is inferior to that of any other financial institution.

• Assets pledged as security is always properly insured. In fact, EBL ensures 110% insurance on the hypothecated security for a particular facility. The bank also has its own list of insurance companies from which the client can take insurance.
• Valuations of property taken as security is performed prior to loans being granted. Also recognized 3rd party professional valuation firm is appointed to conduct the valuations.

 CREDIT ASSESSMENT

A thorough credit and risk assessment is conducted prior to the granting of loans, and at least annually thereafter for all facilities.  The results of this assessment are presented in a Credit Application that originates from the relationship manager/account officer (“RM”), and is approved by Credit Risk Management (CRM). The RM is the owner of the customer relationship, and is held responsible to ensure the accuracy of the entire credit application submitted for approval.  RMs are familiar with the bank’s Lending Guidelines and should conduct due diligence on new borrowers, principals, and guarantors.It is essential that RMs know their customers and conduct due diligence on new borrowers, principals, and guarantors to ensure such parties are in fact who they represent themselves to be. The bank has its established Know Your Customer (KYC) and Money Laundering guidelines which is adhered to at all times.

Credit Applications summarize the results of the RMs risk assessment and include, as a minimum, the following details:

• Amount and type of loan(s) proposed.
• Purpose of loans.
• Loan Structure (Tenor, Covenants, Repayment Schedule, Interest)
• Security Arrangements

In addition, the following risk areas are also addressed:

 Borrower Analysis

The majority shareholders, management team and group or affiliate companies is assessed.  Any issues regarding lack of management depth, complicated ownership structures or inter-group transactions are addressed, and risks mitigated.

Industry Analysis

The key risk factors of the borrower’s industry are assessed by the RM. Any issues regarding the borrower’s position in the industry, overall industry concerns or competitive forces is addressed and the strengths and weaknesses of the borrower relative to its competition should be identified.

Supplier/Buyer Analysis

Any customer or supplier concentration is reported in the credit application, as these could have a significant impact on the future viability of the borrower.

Historical Financial Analysis

An analysis of a minimum of 3 years historical financial statements of the borrower is presented in bank’s specified format. The analysis should address the quality and sustainability of earnings, cash flow and the strength of the borrower’s balance sheet.  Specifically, cash flow, leverage and profitability must be analyzed.

Adherence to Lending Guidelines

Credit Applications should clearly state whether or not the proposed application is in compliance with the bank’s Lending Guidelines.

Mitigating Factors 

Mitigating factors for risks identified in the credit assessment is identified and reported in the application.

Loan StructureThe RM makes sure that the amounts and tenors of proposed financing are justified based on the projected repayment ability and loan purpose.  Excessive tenor or amount relative to business needs increases the risk of fund diversion and may adversely impact the borrower’s repayment ability.

Security

A current valuation of collateral is obtained and the quality and priority of security being proposed is assessed.  Loans are not granted based solely on security. Adequacy and the extent of the insurance coverage are also taken into consideration.

 Name Lending

In this case bank also follows the prudential guidelines which says “Credit proposals should not be unduly influenced by an over reliance on the sponsoring principal’s reputation, reported independent means, or their perceived willingness to inject funds into various business enterprises in case of need.  These situations should be discouraged and treated with great caution.  Rather, credit proposals and the granting of loans should be based on sound fundamentals, supported by a thorough financial and risk analysis”.

APPROVAL AUTHORITY

The prudential guidelines regarding approval authority by BB is stated below:“The authority to sanction/approve loans must be clearly delegated to senior credit executives by the Managing Director/CEO & Board based on the executive’s knowledge and experience.  Approval authority should be delegated to individual executives and not to committees to ensure accountability in the approval process. The following guidelines should apply in the approval/sanctioning of loans:

Credit approval authority must be delegated in writing from the MD/CEO & Board (as appropriate), acknowledged by recipients, and records of all delegation retained in CRM.
Delegated approval authorities must be reviewed annually by MD/CEO/Board.

The credit approval function should be separate from the marketing/relationship management (RM) function. The role of Credit Committee may be restricted to only review of proposals i.e. recommendations or review of bank’s 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 approval should be centralized within the CRM function.  Regional credit centers may be established, however, all large loans must be approved by the Head of Credit and Risk Management or Managing Director/CEO/Board or delegated Head Office credit executive.

The aggregate exposure to any borrower or borrowing group must be used to determine the approval authority required.

Any credit proposal that does not comply with Lending Guidelines, regardless of amount, should be referred to Head Office for Approval

MD/Head of Credit Risk Management must approve and monitor any cross-border exposure risk.
Any breaches of lending authority should be reported to MD/CEO, Head of Internal Control, and Head of CRM.

A monthly summary of all new facilities approved, renewed, enhanced, and a list of proposals declined stating reasons thereof should be reported by CRM to the CEO/MD”.

The bank tries to follow the above guidelines as perfectly as possible. The existing approval authority for approving credit proposals is summarized below:

 SEGREGATION OF DUTIES

EBL segregates the following lending functions

• Credit Approval/Risk Management
• Relationship Management/Marketing
• Credit Administration

The purpose of the segregation is to improve the knowledge levels and expertise in each department, to impose controls over the disbursement of authorized loan facilities and obtain an objective and independent judgment of credit proposals.

PREFERRED ORGANISATIONAL STRUCTURE & RESPONSIBILITIES

The guideline proposes that appropriate organizational structure must be in place to support the adoption of the policies of the guidelines.  The key feature is the segregation of the Marketing/Relationship Management function from Approval/Risk Management/Administration functions. It also proposes credit approval should be centralized within the CRM function.  Regional credit centers may be established, however, all applications must be approved by the Head of Credit and Risk Management or Managing Director/CEO/Board or delegated Head Office credit executive.The organizational structure of EBL (credit related) is compared below with that of the BB guideline. EBL ensures that all credit approvals are centralized within the CRM function. There are three regional corporate bases two in Dhaka and the other one in chittagong, however, all applications are submitted to CRM of Dhaka Head office and approved by the Board, MD/DMD or HOCRM as appropriate. For the SME sector, all proposals come to Dhaka SME center and then approved through CRM.

The following chart represents the preferred management structure in the BB guideline:

The credit related structure of EBL is as follows:

 Key Responsibilities:

 Key responsibilities of concerned parties as mentioned in the prudential guidelines are discussed below:

Credit Risk Management (CRM)

• 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.

Credit 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.

Relationship Management/Marketing (RM

• 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,
• 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.

APPROVAL PROCESS

The approval process segregates the work of Relationship Management/Marketing from the approving authority.  The responsibility for preparing the Credit Application rests with the RM within the corporate/SME banking department.  Credit Applications are recommended for approval by the RM team and forwarded to the approval team within CRM and approved by individual executives.The recommending or approving executives take responsibility for and are held accountable for their recommendations or approval.

 Approving SME proposals

The RM first sends the credit application to the SME center in Head office Dhaka. The SME center then checks the documents and make sure they are well within the lending guidelines of the bank. They also provide additional condition for sanction as appropriate. After reviewing they send the proposal to the CRM department. The respective credit officers review the proposal and get the approval from the approving authority.

The routing process of credit proposals and its approvals can be summarized as follows:

CREDIT MONITORING

To minimize credit losses, monitoring procedures and systems are in place that provides an early indication of the deteriorating financial health of a borrower.  At a minimum, systems are in place to report the following exceptions to relevant executives in CRM and RM team:

 Past due principal or interest payments, past due trade bills, account excesses, and breach of loan covenants;

• Loan terms and conditions are monitored, financial statements are received on a regular basis, and any covenant breaches or exceptions are referred to CRM and the RM team for timely follow-up.

• Timely corrective action is taken to address findings of any internal, external or regulator inspection/audit.

• All borrower relationships/loan facilities are reviewed and approved through the submission of a Credit Application at least annually.

EBL has an excellent IT backbone, which produces the above information for central/head office as well as local review.

 CONCLUSION

Compliance with the guidelines of BB circulars or directions is a must for all the scheduled banks in the country. EBL is no exception is this case. All the circulars related to credit are properly filed in the department. It is made sure from the top management that each and every credit officer understands all the circulars and directions and exercise due diligence during operation regarding the stated issue. The following section discusses a similar topic, which necessarily requires bank’s strong compliance regarding it.

Chapter 6: Analysis of Credit Risk Grading

 INTRODUCTION

Credit risk grading is an important tool for credit risk management as it helps the Banks & financial institutions to understand various dimensions of risk involved in different credit transactions. The aggregation of such grading across the borrowers, activities and the lines of business can provide better assessment of the quality of credit portfolio of a bank or a branch. The credit risk grading system is vital to take decisions both at the pre-sanction stage as well as post-sanction stage.At the pre-sanction stage, credit grading helps the sanctioning authority to decide whether to lend or not to lend, what should be the loan price, what should be the extent of exposure, what should be the appropriate credit facility, what are the various facilities, what are the various risk mitigation tools to put a cap on the risk level.At the post-sanction stage, the bank can decide about the depth of the review or renewal, frequency of review, periodicity of the grading, and other precautions to be taken.

DEVELOPMENT OF THE SCORE CARD

The Lending Risk Analysis (LRA) manual introduced in 1993 by the Bangladesh Bank has been in practice for mandatory use by the Banks & financial institutions for loan size of BDT 1.00 crore and above. However, the LRA manual suffers from a lot of subjectivity, sometimes creating confusion to the lending Bankers in terms of selection of credit proposals on the basis of risk exposure. Meanwhile, in 2003 end Bangladesh Bank provided guidelines for credit risk management of Banks wherein it recommended, interalia, the introduction of Risk Grade Score Card for risk assessment of credit proposals.Since the two credit risk models are presently in vogue, the Governing Board of Bangladesh Institute of Bank Management (BIBM) under the chairmanship of the Governor, Bangladesh Bank decided that an integrated Credit Risk Grading Model be developed incorporating the significant features of the above mentioned models with a view to render a need based simplified and user friendly model for application by the Banks and financial institutions in processing credit decisions and evaluating the magnitude of risk involved therein.

DEFINITION OF CREDIT RISK GRADING (CRG)

The Credit Risk Grading (CRG) is a collective definition based on the pre-specified scale and reflects the underlying credit-risk for a given exposure.A Credit Risk Grading deploys a number/ alphabet/ symbol as a primary summary indicator of risks associated with a credit exposure.Credit Risk Grading is the basic module for developing a Credit Risk Management system.

FUNCTIONS OF CREDIT RISK GRADING

Well-managed credit risk grading systems promote bank safety and soundness by facilitating informed decision-making. Grading systems measure credit risk and differentiate individual credits and groups of credits by the risk they pose. This allows bank management and examiners to monitor changes and trends in risk levels. The process also allows bank management to manage risk to optimize returns.

USE OF CREDIT RISK GRADING

The Credit Risk Grading matrix allows application of uniform standards to credits to ensure a common standardized approach to assess the quality of individual obligor, credit portfolio of a unit, line of business, the branch or the Bank as a whole. As evident, the CRG outputs would be relevant for individual credit selection, wherein either a borrower or a particular exposure/facility is rated. The other decisions would be related to pricing (credit-spread) and specific features of the credit facility. These would largely constitute obligor level analysis. Risk grading would also be relevant for surveillance and monitoring, internal MIS and assessing the aggregate risk profile of a Bank. It is also relevant for portfolio level analysis.

NUMBERS AND SHORT NAME OF GRADES USED IN THE CRG

The proposed CRG scale consists of 8 categories, of which categories 1 to 5 represent various grades of acceptable credit risk and categories 6 to 8 represent unacceptable levels of credit risk.

STEP II: ALLOCATING WEIGHT TO PRINCIPAL RISK COMPONENTS

According to the importance of risk profile, the following weights are proposed in guideline for corresponding principal risks.

Principal Risk Components:                                       Weight:

Financial Risk                                                                               50%

Business/Industry Risk                                                            15%

Management Risk                                                                       15%

Security Risk                                                                                10%

Relationship Risk                                                                       10%

 STEPIII: ESTABLISHING KEY PARAMETERS

STEP IV: ASSIGNING WEIGHT TO EACH OF THE KEY PARAMETERS

After the risk identification & weightage assignment process (as mentioned above), the next steps will be to input actual parameter in the score sheet to arrive at the scores corresponding to the actual parameters.This report provides a well programmed MS Excel based credit risk scoring sheet (developed by Bangladesh Bank) to arrive at a total score on each borrower. The excel program requires inputting data accurately in particular cells for input and will automatically calculate the risk grade for a particular borrower based on the total score obtained. The following steps are to be followed while using the MS Excel program.

Open the MS XL file named, CRG_SCORE_SHEET

The entire XL sheet named, CRG is protected except the particular cells to input data.

Input data accurately in the cells which are BORDERED & are colored YELLOW.

Some input cells contain DROP DOWN LIST for some criteria corresponding to the Key Parameters. Click to the input cell and select the appropriate parameters from the DROP DOWN LIST as shown below.

STEP VI: ARRIVING AT THE CREDIT RISK GRADING BASED ON TOTAL SCORE

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

CREDIT RISK GRADING PROCESS

The followings are the directives forwarded by Bangladesh Bank regarding the risk grading process:‘Credit Risk Grading should be completed by a Bank for all of its clients whose credit limit is BDT 1.00 crore and above. For Superior Risk Grading (SUP-1) the score sheet is not applicable. This will be guided by the criterion mentioned for superior grade account i.e. 100% cash covered, covered by government & bank guarantee.Credit risk grading matrix would be useful in analyzing credit proposal, new or renewal for regular limits or specific transactions, if basic information on a borrowing client to determine the degree of each factor is a) readily available, b) current, c) dependable, and d) parameters/risk factors are assessed judiciously and objectivelyRisk factors are to be evaluated and weighted very carefully, on the basis of most up-to-date and reliable data and complete objectivity must be ensured to assign the correct grading.Credit risk grading exercise should be originated by Relationship Manager and should be an on-going and continuous process. Relationship Manager shall complete the Credit Risk Grading Score Sheet and shall arrive at a risk grading in consultation with a Senior Relationship Manager and document it as per Credit Risk Grading Form, which shall then be concurred by the Credit Officer in consultation with a Senior Credit Officer.All credit proposals whether new, renewal or specific facility should consist of a) Data Collection Checklist, b) Limit Utilization Form c) Credit Risk Grading Score Sheet, and d) Credit Risk Grading Form.The credit officers then would pass the approved Credit Risk Grading Form to Credit Administration Department and Corporate Banking/Line of Business/Recovery Unit for updating their MIS/record.The appropriate approving authority through the same Credit Risk Grading Form shall approve any subsequent change/revision i.e. upgrade or downgrade in credit risk grade.’

EARLY WARNING SIGNALS (EWS)

Early Warning Signals (EWS) indicate risks or potential weaknesses of an exposure requiring monitoring, supervision, or close attention by management. If these weaknesses are left uncorrected, they may result in deterioration of the repayment prospects in the Bank’s assets at some future date with a likely prospect of being downgraded to classified assetsEarly identification, prompt reporting and proactive management of Early Warning Accounts are prime credit responsibilities of all Relationship Managers and must be undertaken on a continuous basis. Despite a prudent credit approval process, loans may still become troubled. Therefore, it is essential that early identification and prompt reporting of deteriorating credit signs be done to ensure swift action to protect the Bank’s interestIrrespective of credit score obtained by any obligor as per the proposed risk grade score sheet, the grading of the account highlighted as Early Warning Signals (EWS) accounts shall have the following risk symptoms.

Marginal/Watch list (MG/WL- 4):  if –

Any loan is past due/overdue for 90 days and above.

Frequent drop in security value or shortfall in drawing power exists.

 Special Mention (SM – 5): if –

Any loan is past due/overdue for 120 days and above

Major document deficiency prevails (such deficiencies include but not limited to; board resolution for borrowing not obtained, sanction letter not accepted by client, charges/hypothecation over assets favoring bank not filed with Registrar, Joint Stock Companies, mortgage not in place, guarantees not obtained, etc.)

A significant petition or claim is lodged against the borrower.The Credit Risk Grading Form of accounts having Early Warning Signals should be completed by the Relationship Manager and sent to the approving authority in Credit Risk Management Department. The Credit Risk Grade should be updated as soon as possible and no delay should be there in referring Early Warning Signal accounts or any problem accounts to the Credit Risk Management Department for their early involvement and assistance in recovery 

CREDIT RISK GRADING REVIEW

Credit Risk Grading for each borrower should be assigned at the inception of lending and should be periodically updated. Frequencies of the review of the credit risk grading are mentioned below;

RATING SYSTEM OF EASTERN BANK LIMITED

EBL has its own its risk rating methodology. Each corporate and SME client of the bank has their own ratings. It is termed as Obligor Risk Rating (ORR). Once a rating is given it is closely monitored in each quarter/ half yearly to justify its status or for upgrading or downgrading purpose of the same.

Obligor Risk Rating

The following table provides the rating and the features necessary for the assignment of rating to each of the obligor. It also states the preferred strategy to be followed for the rated clients. Once an obligor is awarded with a rating then it is reviewed on a quarterly basis. All the clients are closely monitored to see whether there are any violations of the conditions and covenants, deterioration of security, all the performance parameters are reviewed be the respective credit officer based on the quarterly report named ‘portfolio review’ and other excerpts as necessary. Then he recommends the rating to higher authority and if those are approved the new ratings are assigned to each client.

Recently Bangladesh Bank has provided a circular mentioning the classification category for the SME sector vide BRPD circular no 20, dated December 20, 2005 (to be implemented from April 2006) in which it has proposed the following category:

• Superior (SUP)
• Good (GD)
• Acceptable (Acceptable)
• Marginal/ watch list (MG/WL)
• Special Mention Account (SMA)
• Substandard (SS)
• Doubtful (DF)
• Loss (BL)

The original circular is provided in the appendix section of the report.

Chapter 7: Findings & Conclusion

 FINDINGS

Eastern Bank Limited follows a Credit Risk Management Practice that complies with the rules and regulation set by Bangladesh Bank. Eastern Bank has set extensive procedures both at the pre-sanction stage of credit proposal assessment and also at the post –sanction stage. The procedures are transparent, accountable and decentralized in such manner that they ensure maximum effectiveness in risk assessment of credit proposal. Thorough analysis of eastern Bank’s credit assessment procedure and extensive interpretation of Bangladesh Bank circulars regarding credit assessment and risk grading procedure helped in the comparison of the two systems. Eastern Bank’s process hardly deviates from that dictated by Bangladesh Bank.

• Bangladesh Bank credit risk management policies requires bank to set lending guidelines which EBL does and reviews on annual basis. As per BB requirement it is set by top management.
• EBL’s detailed product definition shows that each product falls under Bangladesh Bank broad classification of loan products.
• Eastern bank Limited follows the BB guideline regarding discouraged lending activities and also in addition they have a list of the discouraged business of their own.
• The Bank tries to adhere to the prudential guidelines regarding approval authority set by Bangladesh bank as perfectly as possible.
• Eastern Bank’s organization structure and delegation of responsibility is in line with the structure proposed by Bangladesh Bank.
• Bangladesh Bank requires all commercial banks to use risk grade score card for risk assessment of credit proposals. The Credit Risk Grading matrix allows application of uniform standards to credits to ensure a common standardized approach to assess the quality of individual obligor, credit portfolio of a unit, line of business, the branch or the Bank as a whole. The Credit Risk Grading scale consists of 8 categories which can be broadly classified into two categories that of acceptable and non-acceptable credit proposals. EBL’s obligor risk rating system has 7 categories, each of which is a reflection of the scales provided under CRG, except with that of Superior Credit. EBL’s rating starts from good. The criteria for rating matches more or less with that of CRG only in EBL’s case the outlook is more conservative.

RECOMMENDATION

EBL’s approach to credit is more conservative than that proposed by Bangladesh Bank. Although this approach might seem more prudent, however in face of increasing competition from new generation banks, EBL needs carry out the following:

• Develop more customized parameters for credit approval process under the general guidelines of Bangladesh Bank to increase its market.
• Data used for assessment of credit proposals should be checked for authenticity and accuracy.
• CRG score depends heavily on the financial data provided by potential borrower. Therefore steps should be taken to make those data more reliable.
• EBL’s RM should be more aware of manipulative qualitative data than business development. There should be procedures and parameters to identify and eliminate such manipulation.
• Continuous improvement of the lending procedure would reduce the default risk of the bank and increase its profitability.

  CONCLUSION

Bangladesh’s banking system is heavily affected by bad loans. This not only makes bank more conservative, contracts the lending system, it discourages investment. As a result growth of the economy is impeded. One major reason for default loan is banks’ ineffectiveness of assessing credit risk of a proposed investment. With time, Bangladesh Bank has set rules and general guidelines to help bank assess risk and mitigate their credit risk. In spite of that many banks fail to attract good credit and run profitably. Thus it is not only the guidelines provided by Bangladesh Bank that a commercial lending institution need to follow but it own lending policies should be in place to ensure maximum effectiveness of credit assessment. With this perspective in mind the report has attempted to analyze the lending procedures of Eastern Bank especially in the SME sector and check whether it complies with that of Bangladesh Bank. In doing so the standard operating procedures of the bank have been delineated in details along with a case study to present a picture of the operation carried out in the field. The report has also discussed banks procedures for managing its non-performing loans and loan classification procedures and cross checked those with the central bank guidelines. The newly proposed Credit Risk Grading Score sheet by Bangladesh Bank has also been discussed in the report with Eastern bank’s very own risk rating system. Above all, the report provides a detailed discussion of some the crucial issues of credit risk management and tries to focus on the practice of Eastern Bank Limited in this regard under the regulatory framework prevailing in the country. The report finds that EBL not maintains its guidelines and procedures in compliance with the Bangladesh bank directives but has a more conservative look to credit risk than that required by Bangladesh Bank. This conservative approach has its pros and cons. Therefore some suggestions has been made at the end to increase the profitability of the bank while still maintaining its appreciative position in credit risk assessment.