Internship Report Proposal

On

Emerging Phenomenon of Asset Quality in the area of SME & Retail on

BRAC Bank Limited through Sustainable Financial Inclusion

Prepared By:

Md. Mazharul Islam

MBA, 3rd Batch, Id: M120203015
Session: 2012-2013
Department of Finance
Jagannath University

Prepared For:

Md. Sogir Hossain Khandoker

Associate Professor
Department of Finance
Jagannath University, Dhaka.

Date of Submission: 26 May, 2015

Emerging Phenomenon of Asset Quality in the area of SME & Retail on BRAC Bank Limited through Sustainable Financial Inclusion | 2015

1. Introduction to the Study

1.1 Introduction:

Recent economic turmoil and increasing market complexity has placed unprecedented pressure on
financial institutions. The main key lesson of the 2008 global financial crisis (GFC) was the importance
of containing systemic financial risk and maintaining financial stability. At the same time, developing
economies are seeking to promote financial inclusion, such as greater access to financial services for
low-income households and small firms, as part of their overall strategies for economic and financial
development. This raises the question of whether financial stability and financial inclusion are, broadly
speaking, substitutes or complements.

Banks as financial intermediary normally accept various short-term deposits and grant medium and long
term loans. These loans are given by the banks on condition that the borrower will repay the loan in
time and manner specified in the contract. In this way, banks also earn profit which is recycled into the
economy. But things do not always work as they are supposed to. Many borrowers fail to repay the
loans in time and in some cases they do not repay at all. These loans are known as non-performing-
loans (NPL's) which are classified by banks or financial intuitions as per instruction of Bangladesh
Bank.

Asset quality is one of the most critical areas in determining the overall condition of a bank. The primary
factor affecting overall asset quality is the quality of the loan portfolio and the credit administration
program. Loans typically comprise a majority of a bank's assets and carry the greatest amount of risk
to their capital. Securities may also comprise a large portion of the assets and also contain significant
risks. Other items which can impact asset quality are other real estate, other assets, off-balance sheet
items and, to a lesser extent, cash and due from accounts, and premises and fixed assets.

A high volume of non-performing loans cannot be a boon for the economy. If the invested funds in an
economy are not recovered, it limits the recycling of the funds is reduced by the amount of classified
loans which may lead to economic stagnation. NPL affects banks' profitability adversely because of
the provision of classified loans and consequent write-off as bad debts, reduces return on investment
(ROI), and disturbs the capital adequacy ratio (CAR). It also increases the cost of capital, widens assets
and liability imbalance and upsets the economic value additions (EVA) by banks. EVA is equal to the
net operating profit minus cost of capital.

The asset quality has always raised concerns among policy makers and the central bank took various
measures to reduce the increasing volume of classified loans. Recently, the central bank has asked the
commercial banks to take all-out measures to reduce the increasing volume of classified loans by the
end of 2014 through a rigorous recovery drive across the country. Bangladesh Bank also adopted
various policies, such as, loan re-scheduling facility, introduction of CIB report, waiver of interest etc.
to get rid of this excessive volume of NPL.

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Emerging Phenomenon of Asset Quality in the area of SME & Retail on BRAC Bank Limited through Sustainable Financial Inclusion | 2015

1.2 Review of Literature

Models linking credit risk to economic activity are not new in the literature. Theoretical papers,
developing business cycle models in which the financial sector is introduced typically find a link
between asset quality and economic activity. The magnitude of Nonperforming Loans (“NPLs”) in the
banking sector of Bangladesh since the adoption of prudential norms in the loan classification and
provisioning system in 1990.

The presence of an alarming amount of NPLs both in the Nationalized Commercial Banks (NCBs) and
in the Development Financial Institutions (DFIs), along with maintenance of inadequate loan loss
provisions, diminishes the overall credit quality of Bangladesh. Poor enforcement of laws relating to
settlement of NPLs, followed by insufficient debt recovery measures on the part of the banks, has also
aggravated the financial malaise, although a decrease in NPLs is noticed since the year 2000.

The problem of NPAs is related to several internal and external factors confronting the borrowers
(Muniappan, 2002). The internal factors are diversion of funds for expansion, diversification and
modernization, taking up new projects, helping/ promoting associate concerns, time/cost overruns
during the project implementation stage, business (product, marketing, etc.) failure, inefficient
management, strained labor relations, inappropriate technology/technical problems, product
obsolescence, etc., while external factors are recession, non-payment in other countries, inputs/power
shortage, price escalation, accidents and natural calamities.

Kent and D'Arcy (2000), while examining the relationship between cyclical lending behaviors of banks
in Australia argued that the potential for banks to experience substantial losses on their loan portfolios
increases towards the peak of the expansionary phase of the cycle. However, towards the top of the
cycle, banks appear to be relatively healthy; non-performing loans are low and profits are high,
reflecting the fact that even the riskiest of borrowers tend to benefit from buoyant economic conditions.
While the risk inherent in banks’ lending portfolios peaks at the top of the cycle, this risk tends to be
realized during the contractionary phase of the business cycle. At this time, banks non-performing loans
increase, profits decline and substantial losses to capital may become apparent. There are other reasons
why credit growth and loan quality are pro-cyclical aside from a financial accelerator. Herd behavior
of bank managers can lead to a deterioration of credit standards during economic booms, as credit
mistakes are judged more leniently (De Bock and Demyanets, 2012).

The links between financial crises and bank funding may be strongest during banking crises. Such crises
tend to arise primarily from deteriorating economic fundamentals, notably declines in asset quality
(Borio and Lowe, 2002). The issue is of particular importance after the recent global financial crisis and
the failure of some large institutions and bailouts that followed. In the Indian context also empirical
research suggests that asset quality is one of the main determining factors of credit, besides time deposits
and lending interest rate (RBI, RCF, 2006-08).
NPAs generate a vicious cycle of effects on the sustainability and growth of the banking system, and if
not managed properly could lead to bank failures. Empirical evidence indicates a relationship between
bank failures and higher NPAs worldwide (Chijoriga, 2000 and Dash, et al, 2010).

Reported asset quality of the banking system improved because of a somewhat lenient loan rescheduling
standard issued by BB, the performance of the new banks, and a cautious approach taken by the banks
in distributing new loans. At the end of December 2013 the classified loans' ratio of the banking sector
dropped by 1.1 percentage points from the ratio of 10.0 percent recorded in CY12. Provisions for

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Emerging Phenomenon of Asset Quality in the area of SME & Retail on BRAC Bank Limited through Sustainable Financial Inclusion | 2015

stressed assets are not adequate to deal with the possibility of a greater amount of their stressed loans
being defaulted by borrowers and turning into bad loans. Banks should give emphasis on sound risk
management activities and use these tools as an early warning signal for the probable downgrade of
their asset quality. (FSR, Bangladesh Bank, 2013)

1.3 Gap Analysis

Gap analysis is the comparison of actual performance with potential or desired performance. The key
to making sound strategic decisions lies in having the correct information on which to base those
decisions. After studying different paper on asset quality I have found some gap such as,
 Understanding the concept of asset quality and sustainable financial inclusion.
 Developing a relationship between asset quality and macroeconomic factors.
 Different aspects of better asset quality management.

1.4 Rationale of the Study:

The report titled “Emerging Phenomenon of Asset Quality in the area of SME & Retail on BRAC Bank
Limited through Sustainable Financial Inclusion” is prepared as an integral part of the internship
program of Master of Business Administration (MBA) degree in Department of Finance, Jagannath
University. To get acquainted with different financial model and theory theoretical knowledge is not
enough for a student of Department of Finance. There always exists massive gap between theoretical
knowledge and its practical implementation with present technology based world. This report is to
bridge up this gap.

Asset quality or portfolio quality remains a key aspect of financial performance for MFIs. While MFIs
continue to expand their provision of deposits, insurance and other financial products, the loan portfolio
is still typically the predominant component of its asset base. Accordingly, asset quality remains a key
indicator of an MFI's financial viability.

Non-performing loans refer to those financial assets from which banks no longer receive interest or
installment payments as scheduled. It is a very critical but frequent issue in bank fund management and
the present situation of asset quality in Bangladesh is a topic of great concern. It can bring down
investors’ confidence and if created by the borrowers willingly and left unresolved might act as a
contagious financial malaise by driving good borrowers out of the financial market.

In this report, I aim to explore current situation of asset quality in the area of SME & Retail on BRAC
Bank Limited through Sustainable Financial Inclusion. This report will be helpful to understand the
relationship among asset quality and sustainable financial inclusion. And also the BFIs industry
performance trend with the pace of non-performing loan. The research approach will be to investigate
and discover the range of answers to our research questions and then present findings, solutions, and
conclusions to readers.

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Emerging Phenomenon of Asset Quality in the area of SME & Retail on BRAC Bank Limited through Sustainable Financial Inclusion | 2015

1.5 Background of BRAC Bank Limited:

BRAC Bank Limited, one of the third generation commercial banks started its journey on July 04, 2001.
It is an affiliate of BRAC (Bangladesh Rural Advancement Committee), one of the world’s largest non-
governmental development organizations founded by Sir Fazle Hasan Abed in 1972. The Bank operates
under a "3P" agenda that is People, Planet and Profit where profit and social responsibility go hand in
hand as it strives towards a poverty-free, enlightened Bangladesh. BRAC Bank focuses on pursuing
unexplored market niches in the Small and Medium Enterprise Business, which has remained largely
untapped within the country. The management of the Bank believes that this sector of the economy can
contribute the most to the rapid generation of employment in Bangladesh. Since inception in July 2001,
the Bank's footprint has grown to 166 branches, over 350+ ATM Booths, 458 SME Unit Offices, 1,800
remittance delivery points and 8,000+ human resources. In addition to small business lending, BRAC
Bank has fast growing remittance, savings mobilization and consumer lending businesses.

BRAC Bank intends to set standards as the market leader in Bangladesh. BRAC Bank along with
world’s 24 leading banks develops Global Alliance for Banking on Values that work together to
promote ethical banking. The Bank wants to demonstrate that a locally owned institution can provide
efficient, friendly and Modern full- service banking on a profitable basis. The Bank produces earnings
and pay out dividends that can support the activities of BRAC, the Bank’s major shareholder.
Development and poverty alleviation on a countrywide basis needs mass production, mass consumption
and mass financing. The goal of BRAC Bank is to provide mass financing to enable mass production
and mass consumption, and thereby contribute to the development of Bangladesh.

2. Objectives of the Study

The objective of the study may be viewed as:

General Objectives:
The primary objective of my internship program is to gain practical work experience in the field of Banking
Business and get an overall idea of Special Asset Management of Banking sectors and its activity
specially the performance of Asset Quality of BRAC Bank Ltd.

Specific Objectives:
More specifically, this study entails the following aspects:

 To assess the present situation of asset quality in our banking sector.

 To show the relationship between asset quality and macro-economic factors in Bangladesh.
 To examine the asset quality status in SME and Retail sector of BRAC Bank Limited.
 To discuss legal aspect to recover loans from the defaulters.
 To raise some issues and observations which need to be looked upon quickly for ensuring a
financially sound banking sector.

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Emerging Phenomenon of Asset Quality in the area of SME & Retail on BRAC Bank Limited through Sustainable Financial Inclusion | 2015

3. Methodology
In order to explore the financial linkages of the asset quality phenomenon, the key variables used in this
report include credit growth of BRAC Bank Limited, GDP growth and interest rate cycles as also
inflation. The relationship between these variables and asset quality will have been tested in this report.
In Bangladeshi context, the Five year data of BRAC Bank Limited spanning from 2010 to 2014 are
used in this paper. Moreover, the asset quality data of BRAC Bank Limited are available from 2010.

This report is mainly prepared by the secondary sources of information and some few primary sources
of information. The research was an exploratory approach and data collection and analysis are
qualitative in nature. For this purpose, different recognized census, government rules, regulations,
policies, and laws, newspapers, national and international journals, periodicals have been consulted.
Data collection and analysis were made during the Internship period at BRAC Bank Limited.

3.1 Primary Sources of data:

The primary data of this report will be collected through:

 Personal Observation.
 Direct interview & Conversation with the Officers
 Practical experiences obtained from the Special Asset Management Department of BRAC Bank
Limited.
 Expert’s opinion.
 Official records.

3.2 Secondary Sources of data:

I have gathered the secondary data via following sources:

 Texts regarding Non Performing Loan.

 Annual report of BRAC Bank Limited.
 Printed outlines and documentation supplied by BRAC Bank Limited.
 Annual Financial Statement of last 4 years of different Banking Institutions.
 Website of BRAC Bank Limited (http://www.bracbank.com/)
 Internet sources.

4. Data Analysis & Presentation Technique

In order to analyze gathered data, I plan to use statistical software like SPSS & E-views that will run
different statistical test, Correlation, regression and such. Besides SPSS & E-views, I will use MS-Excel
to generate charts and graph of different ratio analysis. The data will be presented through graphs for
better visual understanding.

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