Risk
Reading Material on Credit Operations and Management
Authors
Mr. Md. Ali Hossain Prodhania: Supernumerary Professor, BIBM, Former Managing Director Bangladesh Krishi Bank
Mr. Md. Nehal Ahmed: Professor and Director, Dhaka School of Bank Management, Bangladesh Institute of Bank Management (BIBM)
Date: April 15, 2023
Foreword
Institute of Bankers, Bangladesh (IBB) established in 1973 aims to develop professional skills of employees in banks and financial institutions in Bangladesh.
IBB conducts the Banking Professional examination, JAIBB and AIBB, usually held twice a year.
A committee led by Dr. Toufic Ahmad Choudhury was formed to update and upgrade the syllabus for the banking examinations.
The committee worked on formulating standard reading materials to aid examinees.
The reading material on Credit Operations and Management (COM) has been compiled by the authors.
All reading materials will be uploaded to the IBB e-library portal, and examinees are encouraged to give feedback for continuous improvement.
Table of Contents
Module-A: Introduction of Loans and Advances (Pages 5-21)
1.1 Introduction
1.2 Types of Borrowers and Loans & Advances
1.3 Banker-Customer Relationship
1.4 Credit Planning
1.5 Credit Policy
1.6 Centralized and Decentralized Credit Operations
1.7 Qualities of a Good Borrower
1.8 Features of Different Credit Products
1.9 Indicative Questions
Module-B: Principles of Sound Lending and Credit Process & Investigation (Pages 22-53)
2.1 Principles of Sound Lending
2.2 Borrower Selection Process in Banks
2.3 Credit Investigation
2.4 Preparation of Credit Proposal
2.5 Analysis of Financial Statements and Financial Ratios
2.6 Internal Credit Risk Rating Systems (ICRRS)
2.7 Indicative Questions
Module-C: Term Loan and Working Capital Financing (Pages 55-101)
3.1 Appraisal of Term Lending
3.2 Importance of Credit Appraisal
3.3 Different Aspects of Credit Appraisal
3.4 Cost of the Project and Means of Financing
3.5 Capital Budgeting Techniques
3.6 Sensitivity Analysis
3.7 Cost-Volume-Profit Analysis
3.8 Assessment of Working Capital Requirement
3.9 Indicative Questions
Module-D: Credit Risk Management (Pages 102-113)
4.1 Concepts and Types
4.2 Principles of Bank‘s Credit Risk Management
4.3 Indicators of High Credit Risk in a Bank
4.4 Indicators of Poor Credit Risk Management
4.5 General Steps in Credit Risk Management
4.6 Modern Approach for Measurement of Credit Risk
4.7 Portfolio Credit Risk Management
4.8 Credit Derivatives and Credit Risk Mitigation
4.9 Indicative Questions
Module-E: Credit Documentation and Administration (Pages 114-133)
5.1 Concept of Security
5.2 Characteristics of Good Security
5.3 Acceptable Security and Valuation
5.4 Valuation
5.5 Legal Vetting
5.6 Insurance Coverage
5.7 Margin and Drawing Power
5.8 Creating Charges on Security
5.9 Modes of Creating Charge on Securities
5.10 Documents and Documentation
5.11 Indicative Questions
Module-F: Supervision and Follow-up of Loans and NPL Management (Pages 135-165)
6.1 Introduction
6.2 Supervision, Monitoring and Follow-up
6.3 Credit Monitoring
6.4 Credit Review
6.5 Problem Loan
6.6 Loan Classification and Provisioning
6.7 Rescheduling of Loans
6.8 Loan Write Off
6.9 Credit Recovery
6.10 Indicative Questions
Module-G: Leasing and Hire Purchase (Pages 166-181)
7.1 Lease Financing
7.2 Hire Purchase
7.3 Indicative Questions
Module-A: Introduction of Loans and Advances
1.1 Introduction
Banks act as financial intermediaries, focusing on collecting deposits and providing credit, which is vital for promoting the economic development of a country.
Bank credit is crucial for economic activities in Bangladesh, generating growth and employment.
A significant aspect of traditional banking revolves around issuing credit; however, it is emphasized that only prudent credit extended to economically viable projects benefits the economy and the banking institution. Excessive credit for unproductive activities can be detrimental both to the economy and financial institutions.
1.2 Types of Borrowers and Loans & Advances
Definition of credit: the ability to make purchases with a promise to pay later.
Types of borrowers include:
Individuals (e.g., retail traders, farmers, consumers)
Sole proprietorships
Partnerships
Private limited companies
Public limited companies
Corporations and government entities
1.2.2 Types of Credit Facility
Funded credit: involves direct cash outflow from the bank. Key types:
Loans: Fixed sum repayable in installments or lump sum (short-term, medium-term, long-term)
Cash Credit: Used primarily by traders, meets working capital needs (pledge or hypothecation)
Overdraft: Advance on current accounts
Bill Purchase and Discount: Loans against bills of exchange
Non-funded credit facilities: do not require immediate cash outflow, e.g.
Letters of Credit
Bank Guarantees (Bid Bond, Performance Bond)
Deferred Payment Guarantees
Customs and Excise Guarantee
1.3 Banker-Customer Relationship
The banker-customer relationship is multifaceted, characterized by:
Debt and creditor relationships
Agent and principal relationships
Fiduciary relationships, imposing obligations on banks to:
Honor customers' cheques under specified conditions
Maintain confidentiality of customer accounts
1.4 Credit Planning
Credit planning involves defining how credit will be allocated to achieve banking goals while adhering to government objectives. Key considerations:
Mandate and goals of the bank
Economic conditions and market performance
1.5 Credit Policy
A set of rules that guide lending practices, key features of a good credit policy include:
Volume of credit, asset quality
Compliance regulations, pricing methods
Documentation and monitoring guidelines
Management of non-performing loans
1.6 Centralized and Decentralized Credit Operations
Centralized operations can improve efficiency and controls; however, decentralized systems allow personalized customer relationships.
1.7 Qualities of a Good Borrower
Creditworthiness includes credit history, income stability, ability to pay back, and integrity. Key characteristics:
Money management skills
Purposeful spending and prudent debts
1.8 Features of Different Credit Products
Overview of funded and non-funded credit features and respective categories.
1.9 Indicative Questions
Types of borrowers in banking.
Categories of credit reporting.
Features of funded credit.
Credit relationships between bankers and customers.
Informed credit decision process.
Centralized vs. decentralized credit management.
Qualities of a good borrower.
Module-B: Principles of Sound Lending and Credit Process & Investigation
2.1 Principles of Sound Lending
Safety, liquidity, and profitability as primary considerations in lending:
Safety involves security and borrower's reliability.
Liquidity refers to conversion ease of assets into cash.
Profitability ensures adequate return on investment.
2.2 Borrower Selection Process in Banks
Proper selection necessitates comprehensive checks to ensure borrower viability through:
CIB checks, credit worthiness assessment, and risk grading.
2.3 Credit Investigation
Comprehensive due diligence on borrower capacity and character based on 6 Cs:
Character, Capacity, Capital, Condition, Collateral, and Cash flow.
2.4 Preparation of Credit Proposal
Efficient documentation of essential facts aiding decision-making including purpose and exposure of borrowers.
2.5 Analysis of Financial Statements and Financial Ratios
Financial reports provide essential insights into borrower financial health, utilizing various analytical tools.
2.6 Internal Credit Risk Rating Systems (ICRRS)
A structured framework for assessing creditworthiness, ensuring calculated risk assessment and management.
2.7 Indicative Questions
Activities associated with credit operations.
Functions of RM.
Credit review process details.
Significant criteria in borrower appraisal.
Module-C: Term Loan and Working Capital Financing
3.1 Appraisal of Term Lending
Credit appraisal ensures selection of appropriate investment proposals through detailed evaluation of technical and financial viability.
3.2 Importance of Credit Appraisal
Assists in identifying legitimate borrowing needs, compliance, and ensuring project viability.
3.3 Different Aspects of Credit Appraisal
Evaluation techniques include:
Managerial, organizational, technical, marketing, financial, socio-economic, and environmental assessments.
3.4 Cost of the Project and Means of Financing
Detailed understanding of project costs, necessary funds, and sources of financing (e.g., equity and debt).
3.5 Capital Budgeting Techniques
Overview of assessing capital projects and their future returns, ensuring effective use of financial resources.
3.6 Sensitivity Analysis
Evaluates how changing variables affect project viability.
3.7 Cost-Volume-Profit Analysis
Analyses revenue, costs, and operating income to maximize profitability.
3.8 Assessment of Working Capital Requirement
Focus on estimating the amount needed to support day-to-day operations effectively.
3.9 Indicative Questions
Different aspects of credit appraisal.
Techniques for analyzing financial viability.
Importance of environmental considerations in project assessments.
Module-D: Credit Risk Management
4.1 Concepts and Types
Credit risk relates to a borrower's inability to repay loans as per agreements. This includes types such as standalone risk and portfolio risk which arise from deviations from expected standards.
4.2 Principles of Bank’s Credit Risk Management
Importance of a structured approach to credit risk management including board approval and ongoing assessment protocols.
4.3 Indicators of High Credit Risk in a Bank
Monitoring metrics such as loan growth versus standards and the incidence of properties under loan distress help detect risk.
4.4 Indicators of Poor Credit Risk Management
Poor practices lead to deteriorated financial health for banks.
4.5 General Steps in Credit Risk Management
Key steps include risk identification, assessment, monitoring, and mitigation actions to limit exposure.
4.6 Modern Approach for Measurement of Credit Risk
Measurement revolves around the expected loan loss, articulating the components: Probability of Default (PD), Exposure at Default (EAD), and Loss Given Default (LGD).
4.7 Portfolio Credit Risk Management
Techniques for assessing and managing concentration risks that arise from over-exposure to particular sectors or clients.
4.8 Credit Derivatives and Credit Risk Mitigation
Mechanisms to offset risks, including credit default swaps and securitization.
4.9 Indicative Questions
Types of credit default.
Main causes of standalone credit risk.
Techniques for managing portfolio credit risk.
Module-E: Credit Documentation and Administration
5.1 Concept of Security
Security involves collateral that ensures debts are repaid. It also refers to forms of tangible assets pledged for loans.
5.2 Characteristics of Good Security
Ideal securities must provide stability, ease of valuation, marketability, and low supervision costs among other attributes.
5.3 Acceptable Security and Valuation
Security must be legally enforceable and adequately valued according to market conditions.
5.4 Valuation
Accurate asset valuation is critical for assessing potential losses if loans go into default.
5.5 Legal Vetting
Legal security ensures documentation and ownership concerns are adequately addressed.
5.6 Insurance Coverage
Policies should safeguard goods pledged, aiding protection against collateral loss.
5.7 Margin and Drawing Power
Properly defining margins gives assurance against declines in security value and defines lending limits.
5.8 Creating Charges on Security
Different modalities to create charges including pledges and hypothecation ensure legal rights over secured assets.
5.9 Modes of Creating Charge on Securities
Pledge and hypothecation are key methods for securing debt and covering against defaults.
5.10 Documents and Documentation
Accurate documentation is crucial for establishing banks' rights and ensuring compliance on loans.
5.11 Indicative Questions
Essential characteristics of good security.
Determining the value of different securities.
Importance of comprehensive documentation in loan agreements.
Module-F: Supervision and Follow-up of Loans and NPL Management
6.1 Introduction
Effective credit management includes oversight of borrower selection, constant monitoring, and robust recovery efforts.
6.2 Supervision, Monitoring and Follow-up
Describes methodologies for ensuring compliance and operational oversight to maintain loan health and timely recovery.
6.3 Credit Monitoring
Outlines measures for preventing delinquency and tightening credit assessments through regular evaluations.
6.4 Credit Review
The necessity of sequential examination of borrowed funds ensuring continuous tracking and risk assessment.
6.5 Problem Loan
Defines folds in performance and illustrates methodologies for recovery from non-performing loans.
6.6 Loan Classification and Provisioning
Regulations concerning classification level and necessary provisions need to maintain financial stability.
6.7 Rescheduling of Loans
Detailing processes for managing and reevaluating loan terms under default scenarios.
6.8 Loan Write Off
Guidelines for accounting for loans deemed uncollectible while still pursuing recoveries through other measures.
6.9 Credit Recovery
Describes legal remedies and the significance of strategic non-legal measures for efficient recovery.
6.10 Indicative Questions
Significance of timely loan recoveries.
Discuss non-legal measures for loan recovery.
Explain legal frameworks under which banks operate for loan collateralization and recovery.
Module-G: Leasing and Hire Purchase
7.1 Lease Financing
Definition: Lease contracts allow utilization of capital goods without outright purchase, providing flexibility and lower initial costs.
7.2 Hire Purchase
Definition: A hire-purchase arrangement allows ownership to pass upon the completion of installments as opposed to as goods are used, unlike leasing.
7.3 Indicative Questions
Benefits and limitations of leasing and hire purchase systems.
Differences between leasing and hire purchase agreements.
References
Various academic contributions and publications regarding banking, credit operations, and financial management standards relevant across sectors.