Issue-1

April, 2016

BIBM’s
Risk Enlightenment
Editorial
The banking sector in Bangladesh finds itself in a period of unprecedented change. Value
creation is increasingly under pressure from interest rate spread erosion, poor risk
origination processes and volatile capital markets to name a few. Value preservation is
also under pressure, with issues in relation to much publicised risk management failures,
Non Performing Loan exposures and sectoral concentrations. In this mix of rapidly
developing Credit Risk issues - we now have Operational Risk coming to the fore. The
recent ATM hacks are an example of how, as our banking infrastructure gets plumbed into
global networks, the risk exposures are going to get both broader but also deeper. This
rapid increase of the risk profile of Bangladeshi banks has not gone unnoticed by
Bangladesh Bank (BB). Their prudent response, by way of “Risk Management Guidelines
for Banks” and “Strengthening and updating the Risk Management Systems in Banks”,
represent a fundamental change in BB’s regulatory approach - and its expectations on
banks. Banks can expect an intrusive form of regulation that, at its very core, will place
high levels of accountability upon Boards and senior executives. Higher standards will ADVISOR
also be expected in terms wider risk governance, risk management sophistication/ - Dr. Toufic Ahmad Choudhury
disciplines and capital management supported by demonstrable enhancement of Board and
senior executive’s decision-making. To help our banks, BIBM has been working
extensively in building capacity in risk management. Given BIBM’s unique relationship
with both BB and the banking sector, we have been able to undertake a series of initiatives, EDITORIAL TEAM
informed by the demands of BB and the needs of the industry. In practical terms, this - Dr. Shah Md. Ahsan Habib
means that we aim to support the banks at all levels. For junior level bank executives, we
provide targeted training on risk issues. We also organise training workshops for mid-level - Sajib Azad
bank executives. Similarly, we have now initiated the ‘Certified Expart in Risk - Md. Nehal Ahmed
Management (CERM)’ programme with Frankfurt School of Finance and Management of - Atul Chandra Pandit
Germany to train bankers on ‘world class’ risk management techniques. Likewise, we
have extensive coverage of risk issues in our Masters Programs on Bank Management
(MBM and EMBM). Our latest initiative targets the “risk leads” - by way of the Chief Risk
Officer (CRO) Forum. The CRO Forum is designed to provide a forum where latest EXECUTIVE EDITOR
developments/ thought leadership on Risk Management (global and local) can be shared - Sajib Azad
with the senior executives in charge of risk. It should also facilitate informed and open risk
related discussions between industry leads in terms of risk. As the forum matures, it can
also be used to acquire feedback of proposed and developing regulations. Over time, the
CRO Forum should also create a sensibly collegiate atmosphere of knowledge sharing
among the CROs - especially when responding to common challenges faced across the
banking sector. We shall be holding the CRO Forum Introduction Workshop on 24 March
2016. The valuable feedback we are hoping to receive will be incorporated into the CRO
Forum design - that will be formally launched by the Governor of Bangladesh Bank in due
course. Finally, we would fail to make the most of all these risk capacity building
initiatives if they remained in their respective silos. As such, we are now launching ‘Risk
Enlightenment’ to provide a knowledge and/ or information dissemination point to all our
risk capacity building activities. We shall publish this 4 times a year focussing on specific
risk issues/ themes. The first Issue (that you are holding) targets ‘Credit Risk’. As the
saying goes, “although sometimes it is sufficient to do things better, at times, it is
imperative to do better things.” We believe we are now in a place where we have to do
“better things” in the risk space. We look forward to your active participation in these
timely and important initiatives.
Credit Risk: A Major Concern of the the spirit of the Basel regulation suggests banks not to
create inferior quality loans that in turn will increase
Banking Sector risk-weighted asset and require more capital. It is important
Md. Nehal Ahmed to note that bank must understand the main essence of
Associate Professor, BIBM Basel Accord which is nothing but the improved and
prudent credit risk management.
Credit is the most important source of revenue for the banks
but, at the same, time the single most potentially damaging Banks are exposed to a number of risk factors while
risk also arises from the loan portfolio of banks i.e. risk of offering different services to its clients. Since risk is
nonpayment by the borrowers. So, managing credit inherent in the banking business, nobody can ignore the
portfolio is crucial for a bank, that’s why banks need to importance of risk management. Maintaining adequate
strike a prudent balance between the risk-return trade-off amount of capital is an integral part of the risk management
from its credit portfolio for ensuring optimum outcome. process in banks. Credit risk remains the most important
Achieving this prudent risk-return mix demands an risk among a number of risk factors that banks have to
effective management of loan quality. In fact, it is manage. This is supported by the following table which
important to have a well-defined credit policy, sectoral shows the proportion of risk weighted assets of three major
preference, collateral requirement, appropriate credit risk components i.e. credit risk, market risk and operational
concentration, credit assessment, risk grading, pricing, etc. risk. Undoubtedly one can conclude that credit risk
for maintaining a good credit portfolio. Therefore, weighted asset (CRWA), with around 85 percent share, is
managing a quality loan portfolio is a multidimensional the leading component of aggregate risk weighted asset
task where all major stages in a credit cycle such as loan (table-1). The result suggests that bank should seriously
initiation, credit assessment and selection, credit concentrate on their credit risk management practices,
administration, credit monitoring, recovery procedures of which eventually ensures the quality of their asset portfolio.
loan are required to be dealt with professionally and
efficiently for having a strong and robust credit culture in a Table-1: Composition of Risk Weighted Assets
bank. 2010 2011 2012 2013 2014
Credit RWA 84.5 85.2 85.7 85.1 85.2
Asset quality management is considered extremely Market RWA 7.3 6.2 5.2 5.7 5.5
important by the banking sector. The Basle Committee on Operational RWA 8.2 8.6 9.1 9.2 9.3
Banking Supervision issued an important document in Total RWA 100 100 100 100 100
1997 titled “Core Principles for Effective Banking Source: Department of Off-Site Supervision, BB
Supervision,” to present a comprehensive set of twenty-five
core principles. Of these, one fourth are designed to address Non-performing loan (NPL) is a very important indicator to
the relevant issues of bank asset quality or credit risk measure the credit quality of a bank. Non-performing loan
management (Tsai and Huang 1999), suggesting that asset largely affects the efficiency of banks. This is because
quality is a general concern for the financial supervisory efficient banks are better at managing their credit risk.
authorities in every country throughout the world. Non-performing loans have risen, in recent years (table-2),
According to Basel regulation, banks need to allocate high due to a combination of factors, such as, a deterioration in
amount of capital for providing poor or risky credit. The intrinsic asset quality and stringent problem loan
quality of credit is considered by recognizing the rating of identification. The NPL of the banking sector actually rose
an exposure. If an exposure is rated as ‘AAA’, it is treated to 9.9 percent at end-September 2015 from 8.9 percent at
as high quality credit than an exposure rated as ‘C’ and it end-December 2013.The reasons for the increase in
requires less capital as per the regulation. Minor differences reported NPL were, mainly, due to the withdrawal of a
in how credit risk is estimated and measured can often one-time relaxation of the loan rescheduling procedure,
result in large swings in estimates of credit risk. Such which was given in 2013, and detection of substantial
movements can have significant impacts on risk nonperforming loans in a particular bank that has been
assessments and ultimately on business decisions including re-categorized as state-owned commercial bank (SOCB)
the using of collateral and credit risk mitigation. this year from its earlier status (Financial Stability
Report-2014, BB).
Credit risk is one of the significant risks of banks by the
nature of their activities. Through effective management of Table-2: Composition of Classified Loan
credit risk exposure, banks not only support the viability 2010 2011 2012 2013 2014 2015
and profitability of their own business but also contribute to (up to Sept)
Substandard 3043.15 3480.00 8378.60 4704.96 5755.79 6461.75
systemic stability and to an efficient allocation of capital in (13.4) (14.8) (19.1) (11.2) (11.0) (11.2)
the economy (Psillaki, Tsolas, and Margaritis, 2010). Credit Doubtful 1907.65 2704.05 6229.11 4242.86 5860.44 5077.09
risk is a risk of borrower default, which happens when the (8.4) (11.5) (14.2) (10.1) (11.2) (8.8)
counterpart fails to pay on time. Besides, if a borrower has Bad & Loss 17759.27 17329.45 29259.29 33060.72 40709.15 46155.38
(78.2) (73.7) (66.7) (78.7) (77.8) (80.0)
deteriorated credit portfolio, it can also cause credit risk Total
loss to the bank. However, the loss from the default of the 22710.06 23513.50 43867.00 42008.53 52325.39 57694.22
Classified Loan
bank does not have to be large. It depends on the percent of Total Loans
319860 379250 438670 472006 539437 582770
recovery from obligor and total exposure of banks. A good and Advances
Total Classified
risk management tries to avoid high exposure on credit risk Loan as % of 7.1 6.2 10.0 8.9 9.7 9.9
(Gestel & Baesems, 2008). To mitigate the credit risk, Total Loan
Basel regulations have placed explicitly the onus on banks Source: Financial Stability Report, BB
to adopt sound internal credit risk management practices to Note: Figure in the parenthesis shows the percentage of
assess their capital adequacy requirement. Implementation total classified loan
of Basel is expected to improve credit quality of banks as
Table-2 also represents the year-wise classified loan
composition. The ratio of bad loans to total classified loans
increased to 80 percent in September 2015 from 66.7
percent in 2012, meaning that a significant amount of worst
quality credit increased in 2015. Around four-fifths of total
classified loans (80.0 percent), amounting to BDT 46155
crore, is Bad/Loss. It is alarming because not only a bulk
amount of classified loans were bad loans but also the
proportion is increasing over the years. The sub-standard
and doubtful loans constituted 11.2 percent and 8.8 percent
respectively in September 2015.
Bank-wise information indicates that the non-performing
loans were widely distributed among the banks (Chart-1).
The distribution of banks based on their NPL to total loans
ratio indicates that the number of banks with double digit
NPL increased from 12 in 2013 to 15 in September 2015.
Moreover, 10 banks have NPL ratios over 20 percent which
should be the serious cause of concern for the regulator.
Chart-1: Distribution of Banks by Classified Loans to
Total Loan Ratio
20
18
16
14 13
12 12
12
10
No. of Banks
10
8 7 7 7
6 6
6 5
4
4 4
2
0
Upto 2% 2% to <3%
2011
Source: Financial Stability Report, BB and Quarterly Financial Stability
Assessment Report, BB
It is recognised that managing credit risk should be a
serious concern for the banks as it has significant impact on
profitability and has severe effect on financial stability. The
significance of financial stability can be better understood
in the backdrop of the global financial crisis of 2008 that
resulted in the collapse of financial markets and
institutions. To accomplish banking stability, the banks are
Credit risk is defined as the possibility that a
borrower or other contractual counterparty might
default, i.e. might fail to honor their contractual
obligations.
Migration Risk refers to the potential deterioration
of the credit quality of an un-defaulted exposure.
This form of potential loss is generally also
subsumed under a broader definition of credit risk.
Transaction Risk refers to individual loans and
essentially measures (1) the standalone probability
that the borrower will not be able to repay, as well
as (2) the ultimate loss in the case of a borrower
default after use of collateral and other mitigating
factors.
Portfolio Credit Risk is a risk that arises from
credit portfolio concentration or from systematic
reasons.
Expected Loss (EL) is the average or mean amount
of credit loss to be incurred over a particular time
period. The loss is measured as the present value or
required to maintain quality bank assets which can be
achieved through proper credit risk management. The
failure to ensure banking stability can cause financial
fragility and may lead to crisis scenarios. Credit risk not
only affects the financial and operating performance of the
bank, but also impacts the soundness of the national
financial system.
References
Bangladesh Bank, Financial Stability Report, Dhaka,
Various Issues.
Bangladesh Bank, Financial Stability Assessment Report,
Dhaka, Various Issues.
Ahmed, N., A. C. Pandit and M. Z. Hossain (2014), “Bank
Credit Quality in a Recent Changing Business
Environment: Issues and Challenges”, Banking Research
Series, BIBM, Dhaka.
Gestel, T.V. and Baesens, B. (2009), Credit risk
management [E-book] Available through: Oxford
Scholarship Online
18
16
Habib, S.M.A.H., M. N. Ahmed, A. C. Pandit and M. Z.
13 13 13
14 Hossain (2013), “Bank Credit Quality in a Recent
10
11
10
Changing Business Environment: Issues and Challenges”,
9
8 Banking Research Series, BIBM, Dhaka.
6
5
3 3
4 4 Psillaki, M., Tsolas, I.E. and Margaritis, D. (2010),
2 2 2
1 1 1 “Evaluation of Credit Risk Based on Firm Performance”
3% to <5%
2012 2013
5% to <10%
2014
10% to <15%
2015 (upto September)
15% to <20% 20% and above
European Journal of Operational Research, Vol. 201(3), pp.
873-888.
Siddique, M.M., D. R. Karmaker, M. Alamgir and M. M.
Hossain (2013), “Loan Quality Management in Banks:
Problems of Selecting Right Borrowers”, Banking
Research Series, BIBM, Dhaka, pp. 35-66
Tsai, D. H. and F. W. Huang (1999), “Management Quality
and Bank Efficiency: Empirical Evidence for Taiwanese
Banks.” Management Review, Vol. 18 (3), pp. 35-55
Glossary-Credit Risk
book value of receivables that will not be collected
or will have become unrecoverable and therefore
will be written off or otherwise expensed during a
particular period of time.
Probability of Default (PD) is the percentage
probability of a borrower entity to produce a default
event as perceived by the lender over a specified
period of time, typically one year. The PD is most
often stated for a future period beginning
immediately, but can also be expressed as a forward
default probability beginning in one year for one
year, for example.
Exposure at Default (EAD) is the total balance
owed by the borrower to the particular lender at
time of default expressed in currency units.
Loss-given-default (LGD) is the percentage of
EAD that is considered lost, once it has been
established that a default has occurred. The LGD is
equal to 100% minus the percentage of EAD that
will be recovered by way of liquidation of collateral
and other post-default collection actions.
Initiation of BIBM-Frankfurt School
Joint Certification Program on Risk
Management
Dr. Shah Md. Ahsan Habib
Professor, BIBM
BIBM launched its first joint certification program
‘Certified Expert in Risk Management’ with the Frankfurt
School of Finance and Management of Germany in 2015.
Actually, the initiative of this certification was rooted in
June 2014 when a MOU was signed between our
honourable Governor of Bangladesh Bank Dr. Atiur
Rahman and the President of the Frankfurt School.
Director General of BIBM Dr. Toufic Ahmad Choudhury
also attended the event. This opened the door for joint
initiatives and academic endeavors between these two
institutions.
In January 2015, I represented BIBM in a members’
meeting of European Banking and Financial Services
Training Association (EBTN) hosted by the Frankfurt
School and took the opportunity to negotiate with the
Frankfurt School management in regard to the initiation
of a joint certification program on Risk Management as
consented by the DG, BIBM. In the process of
negotiation, I conceptualized the structure of the program
that was agreed upon by Dr. Barbara Drexler, the
Associate Dean of Frankfurt School of Finance and
Management. I received immense cooperation of Mr.
Nicolas Parisel, Project Coordinator of International
Office, Frankfurt School in the process of negotiation.
Following an agreement with Frankfurt School, I along
with my two colleagues Mr. Md. Nehal Ahmed, Associate
Professor and Mr. Atul Chandra Pandit, Assistant
Professor of BIBM prepared a concrete proposal covering
detailed structure, syllabus, fees, and other relevant
issues, as instructed by the DG BIBM. The proposal was
then duly approved by the Executive Committee and
Governing Board of BIBM for implementation.
The Certification Course targets mainly to enhance
capacity of the bank executives on risk management
constituting all key banking risks-credit risk, operational
risk, interest rate risk, foreign exchange risks, and
liquidity risk. It is a program of nine months with two
modules: first module is offered online by the Frankfurt
school; and the second module will be delivered by BIBM
in its own campus. The initial response from the banking
community is really encouraging. The first two batches
(first intake) for the course were enrolled in September
2015 and already completed Module A with the Frankfurt
School. BIBM will start Module B for the first intake
batches in April 2016. Two batches for the March, 2016
session (second intake) are already enrolled for the
program.
To start the journey of this Joint academic venture, the
program was formally inaugurated by the honourable
Governor of Bangladesh Bank and Chairman of the
Governing Board of BIBM Dr. Atiur Rahman. We hope
and believe that with patronage and support of our
member banks the program would be able to deliver in
bringing positive changes in the risk management
practices of the bankig sector of Bangladesh.

Revised Core Risk Management Guidelines Published

Bangladesh Bank has undertaken initiatives to revise the core risk management guidelines. As part of the process, the
Bank has already published four revised guidelines in March 2016. These are ‘Internal Control & Compliance Risk
Management’ guidelines, ‘Credit Risk Management’ guidelines, ‘Asset-Liability Management (ALM)’ guidelines
and ‘Foreign Exchange Risk Management’ guidelines. This is an effort to update and improve the Risk Management
guidelines in line with the changed risk scenarios. These guidelines are available in the website of Bangladesh Bank and
the related link is https://www.bb.org.bd/. Other core risk management guidelines are also expected to be published soon.

Graphics & Design

Md. Nasir Uddin

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