ADDIS ABABA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICES

DEPARTMENT OF ACCOUNTING AND FINANCE

ASSESSMENT OF CREDIT RISK MANAGEMENT SYSTEMS AND PRACTICES OF ETHIOPIAN

COMMERCIAL BANKS. (CASE OF SOME PRIVATE BANKS)

A Research Paper Submitted to Department of Accounting in partial fulfillment of the

requirement for the award of a Bachelor Degree in Accounting

Name: Utban Ashab

ID: UGR/6006/12

Advisor: Takele Fufa (PHD)

Submission date: 3//2023

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ACOCR Adequate Control over Credit Risk

ACRE Appropriate Credit Risk Environment

CRMP Credit Risk Management Practice

EPRDF Ethiopian People’s Revolutionary Democratic Party

SPSS Statistical Package for Social Sciences

NBE National Bank of Ethiopia

ACOCR Adequate Control over

CRM credit risk management

LAF loan Approval form

Abstract

The primary aim of this research will be to investigate the credit risk management systems and
practices of private commercial banks in Ethiopia between 2019 and 2023. From 8 private
commercial banks, the two will be chosen based on two criteria: that they are operational during
the study period, and that they are included in the top 2 banks according to their size. The
researcher will be selected banks such as Berhan International Bank S.C and Bunna International
Bank S.C. In this study, given the large number of branches nationwide it could potentially be
difficult to manage the research within the available timeframe and resources. As such,
purposive sampling will be used in order to select participants. The primary data for the study
will be collected using questionnaires. The questionnaires will be distributed to Bank Managers
and Senior Officers involved in loan processing. The data will be analyzed by using SPSS
software version 21 and descriptive statistics.

List of figures

Figure 2.1. model of credit Risk Management practice (Basel, 2000) -----------------page 9.

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Chapter one.................................................................................................................................................1
1.0. Introduction..........................................................................................................................................1
1.1. Background of the study...................................................................................................................1

1.1.1. Table of Contents

Background of the banking industry in Ethiopia..................................................................................2
1.2. Statement of the problem................................................................................................................3
1.3. Research questions...........................................................................................................................5
1.4. Objectives of the study.....................................................................................................................5
1.4.1. General objective of the study...................................................................................................5
1.4.2. Specific objectives of the study..................................................................................................5
1.5. Significance of the study...................................................................................................................5
1.6. Scope of the study............................................................................................................................6
1.7. Limitations of the study....................................................................................................................6
1.8. Organization of the study.................................................................................................................6
Chapter two.................................................................................................................................................7
2.0. Literature review..................................................................................................................................7
2.1. Theoretical review............................................................................................................................7
2.1.1. Definitions and concepts of credit risk management................................................................7
2.2. Empirical review...............................................................................................................................8
2.3. Conceptual framework.....................................................................................................................8
Chapter three............................................................................................................................................10
3.0. Research methodology.......................................................................................................................10
3.1. Research design..............................................................................................................................10
3.2. Population size and sampling techniques.......................................................................................10
3.3. Sample size.....................................................................................................................................11
3.4. Data collection instruments............................................................................................................11
3.5. Variables and method of data analysis...........................................................................................11
3.6. Reliability measure.........................................................................................................................11
References.................................................................................................................................................13

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 Chapter one
1.0. Introduction
1.1. Background of the study
Credit risk is an important component of financial systems and the banking sector in particular.
There is a need for well-established credit risk management frameworks in order to ensure the
safety and soundness of financial institutions, particularly in developing countries like Ethiopia.
This paper will investigate the current credit risk management practices in Ethiopian private
commercial banks by conducting purposive sampling of bank managers and senior officers.
Primary data will be collected from these participants through questionnaires and analyzes with
descriptive statistics and SPSS software version 21. The results from this study will be used to
provide recommendations to improve the current risk management environment in Ethiopia, as
well as useful directions for future research initiatives.

It is essential for banks to have a sound and comprehensive credit risk management system in
order to ensure the stability of the financial system. Ethiopian banks, especially private
commercial banks, need to enhance their credit risk management framework in light of the
changing environment. New technologies, competition, regulations and liberalization have
resulted in an increase in the number and type of risks faced by financial institutions. As banking
services become more accessible, it is important for banks to be able to effectively manage the
risks they face. This research aims to examine the current credit risk management practices in
Ethiopian private commercial banks with the help of a purposive sample of Bank Managers and
Senior Officers. The results of this study will be used to provide recommendations to improve
the existing risk management frameworks and also to guide future research initiatives

Credit risk management is a critical component of the banking industry, and is of utmost
importance in developing countries like Ethiopia. Before 2010, there was inadequate attention
given to the development of modern risk management systems that comply with changing
environment and global financial standards. The Risk Management Guidelines published in that
year paved the way for the continued development of credit risk management practices. Banks
must have a sound and effective risk management system, as their funds are highly leveraged and
at risk of public losses.

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Practicing effective credit risk management is key to protecting consumers, investors and the
banking industry from financial losses and instability.

It can also help improve efficiency through enhancing competitive advantage, mobilizing and
deploying funds, and optimizing risk-return trade-offs.

According to Poudel (2012), inadequate risk management leads to the accumulation of non-
performing loans, where generated profits are not only eroded through loan provisions, but also
the soundness, safety and stability of the bank is affected. However, effective credit risk
management can improve credit performance by establishing an appropriate credit risk setting,
maintaining acceptable credit limits, and having a careful credit granting process with
appropriate monitoring and control of the credit risk. Thus, it is important to examine the level of
credit risk management systems and practices of Ethiopian commercial banks in order to develop
policy measures to mitigate adverse consequences generated from the credit function

The aim of this research is to explore the level of credit risk management system and practices
among Ethiopian commercial banks, assess the perception and awareness of risk management
personnel, and determine the types of risks and methods of risk identification through a
descriptive survey research approach.

1.1.1. Background of the banking industry in Ethiopia

As a result of the agreement reached between Emperor Menelik II and Mr. Ma Gillivray,
representative of the British owned National Bank of Egypt; modern banking in Ethiopia began
in 1905 with the Bank of Abyssinia, a private company controlled by the Bank of Egypt In 1931.

It was liquidated and replaced by the Bank of Ethiopia which was the bank of issue until the
Italian invasion of 1936. During the Italian occupation, Bank of Italy banknotes formed the legal
tender. Under the subsequent British occupation, Ethiopia was briefly a part of the East Africa
Currency Board. In 1943; the State Bank of Ethiopia was established, with two and practices 3
departments performing the separate functions of an issuing bank and a commercial bank. In
1963, these functions were formally separated and the National Bank of Ethiopia (the central and
issuing bank) and the Commercial Bank of Ethiopia were formed. In the period to 1974, several
other financial institutions emerged including the state owned: The Agricultural and Industrial
Development Bank (established largely to finance state owned enterprises); The Savings and

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Mortgage Corporation of Ethiopia; The Imperial Savings and Home Ownership Public
Association (which provided savings and loan services)

Major private commercial institutions, many of which were foreign owned, included the Addis
Ababa Bank, the Banco di Napoli, the Banco di Roma. However, the banking business could not
move further because of the nationalization of private investments by the Socialist regime (the
Drogue regime) that came into power leaving only three government banks; the National Bank of
Ethiopia, the Commercial Bank of Ethiopia and agricultural and Industrial Development Bank.

This was reversed when the Socialist regime was overthrown in 1991. Following the overthrown
of the Dergue regime in 1991, the EPRDF declared a liberal economic system. In line with this,
Monetary and Banking proclamation of 1994 established the National Bank of Ethiopia (NBE)
as a judicial entity, separated from the government and outlined its main function.

Monetary and Banking proclamation No.83/1994 and the Licensing and Supervision of Banking
Business No.84/1994 laid down the legal basis for investment in the banking sector
(www.nbe.gov.com).After the proclamation of 1994, the first private bank, Awash International
Bank was established in 1994 by 486 shareholders paving a way to the establishment of related
private banks such as Dashen Bank (1995), Abyssinia Bank (1996), Wegagen Bank
(1997),United Bank (1998), Nib International Bank (1999), Cooperative Bank of Oromia
(2004),Lion International Bank (2006), Oromia International bank (2008), Semen Bank
(2006),Bunna International Bank (2009), Berhan International Bank (2009), Enat Bank (2011) ,
Debub Global Bank (2012) and others which are under establishment.

1.2. Statement of the problem

The ultimate success of credit management depends on the bank's credit policy, portfolio of
credit, surveillance, management and tracking of loans and advances. Continuous surveillance,
monitoring and tracking are essential to guarantee timely repayment and reduce defaults. In
reality, the credit portfolio not only makes up the bank's asset structure but is also a vital factor in
the bank's success.

In reality, the credit portfolio not only constitutes the bank's asset structure, but is also a crucial
factor of the bank's success. Only proper credit assessment can bring to attention the likelihood

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of credit loss due to genuine business components and suggests potential ways to mitigate such a
precarious situation in order to keep it in check (Rana Al Musharraf, 2013).

Properly managing credit risk in financial organizations is of the utmost importance for their
survival and development. When it comes to banks, this issue of credit risk management takes on
even greater significance due to the higher degree of risks associated with certain client
characteristics, market conditions, and economic setting.

Credit assessment is an integral process in financial institutions that helps to minimize the risks
associated with lending large sums of money. Proper credit assessment helps bankers understand
the creditworthiness of their potential clients, as well as their ability to repay a loan on time.
Having this knowledge helps ensure that the loan is safe and profitable for the bank. To make
sure that a loan proposal is creditworthy, the lender must consider different aspects of the
borrower's financial profile such as income, assets and liabilities. Furthermore, the lender should
also consider other relevant information such as the company's industry, its past performance,
current competition and a detailed analysis of the loan's repayment terms

By carefully studying all these factors, lenders can ensure that their loans are desirable and
profitable for both their clients and for themselves.

This research will analyze the current credit risk management systems and practices in Ethiopian
commercial banks, and investigate their effectiveness in managing credit risk. The results of this
study will provide insights into the level of credit risk management used by financial institutions
in Ethiopia, as well as ways to enhance their current approaches. Additionally, the analysis will
also include an assessment of the importance of credit assessment techniques used to identify the
probability of credit loss due to genuine business elements.

1.3. Research questions

1. Have the two private commercial banks established appropriate credit risk environment?
2. Have the two private commercial banks undertaken sound credit granting process?
3. Have the two private commercial banks maintained appropriate credit administration,
measurement and monitoring system?
4. Have the two private commercial banks ensured the adequate control over credit risk?

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 5. Do the two private commercial banks have effective credit risk management system and
practice?

1.4. Objectives of the study

1.4.1. General objective of the study
The general objective of the study is to assess the credit risk management systems and practices
in Ethiopian banking, specifically in two private banks: Berhan International Bank S.C. and
Buna Bank S.C.

1.4.2. Specific objectives of the study

Evaluate the appropriate credit risk environment established by the two private commercial
banks.
Review the sound credit granting process undertaken by the two private commercial banks.
Assess the credit administration, measurement, and monitoring process of the two private
commercial banks.

Review the adequate control over credit risk of the two private commercial banks.

Assess the effectiveness of the credit risk management system and practice of the two private
commercial banks.

1.5. Significance of the study

This study will be vital because it addresses challenges that banks will face in the future. Due to
the fact that interest earned from loans and advances is such a crucial source of income for
banks.

It is essential to properly assess loan applications before approval, as well as closely monitor
granted loans to ensure they do not become bad debts.

This study is important in order to help banks combat the present challenges concerning credit
risk management.

By providing banks with clear strategies on risk assessment and control, this study will be
enables to reduce the potential of loan losses and ensure a good credit management process.

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This study will help to reduce bad debts to a minimum by assessing the capacity of bank risk
assessment and credit control processes to provide careful analysis and monitoring of banks'
credit administration.

It will be also making credit managers aware of the importance of effective risk assessment and
control in credit administration, as well as make important contributions to efficient and effective
credit risk management.

1.6. Scope of the study

This study will assess the commercial banks' credit risk management systems and practices over
the period 2019-2023 for which there are consecutive four years of financial statements
available.

Based on this criterion, up to June, 2023 there will eight banks in Ethiopia, out of them two
banks will be selected for this study at head office level.

1.7. Limitations of the study

The research will have constraints which serve as limitations to the study. Firstly, access to data
posed a great challenge to the research.

On numerous occasions, an interview appointment with the Head of Credit of the bank will be
unsuccessful because of the tight schedules of the respondent.

Feedback will have to staff respondents was also another constraint due to lack of time, resulting
in the case of unanswered and semi-answered questionnaires. Obtaining accurate or exact answer
from respondent may be another challenge to the researcher.

1.8. Organization of the study

The proposed study will have a structure of three chapters. The first chapter will introduce the
background of the study, the research problem, research questions, research objectives,
significance of the research, scope of the study, limitations of the study and the organization of
the study.

The second chapter will include a theoretical and empirical review of the relevant literature.

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Finally, the third chapter will cover the methodology of the study.

Chapter two

2.0. Literature review

The purpose of this chapter is to provide a brief review of the existing literature regarding credit
risk management the focus will be on the theories and empirical studies of credit risk
management in Ethiopia, and other countries with similar practices.

2.1. Theoretical review

This study is anchored in information asymmetry theory, as this theory is highly relevant to this
particular topic of exploration. According to this theory, both lenders and business owners
should be aware of the potential risks and returns associated with any potential investment
projects for which the funds are earmarked.

2.1.1. Definitions and concepts of credit risk management

This literature review is intended to assess the credit risk management systems and practices of
Ethiopian commercial banks, with a focus on some of the private banks.
It will examine the various theories and empirical studies related to this topic and assess the
important factors such as qualified staff, technological advancements, regulatory frameworks,
and changes in customer practices that can help inform the assessment of credit risk management
systems and practices of Ethiopian banks.
The review will also explore current challenges faced by the financial sector in the country with
respect to credit risk management and identify potential areas for further research and
development

The primary objective of credit risk management is to minimize the effects of risks associated
with the investments made by the public (Brigham et al., 2016). Generally, loans are considered
the primary and most visible source of credit risk to banks. However, other sources of credit risk
can be present throughout various banking operations as well, including those on and off the
balance sheet. In recent years, commercial banks have been increasingly exposed to relatively
high levels of credit risk (Olson and Zoubi, 2017).
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 2.1.1.1. Credit initiation
Edward (2004) defines the credit initiation process as one that begins with a market analysis and
ends with application approval.

This process typically includes the following steps: Surveys and industry studies by loan officers,
customer relationship officers, and branch managers to identify key players and potential
business opportunities for the Bank.

Presentation: The accuracy of the information gathered from the market and industry analysis
will be verified by consulting other sources.

Credit committee approval: A copy of the annex and Loan Approval Form (LAF) will be
submitted to each member of the credit committee for review and approval or rejection of the
request.

2.1.1.2. Documentation and disbursement

The documentation and disbursement must comply with the applicable laws and the
requirements of the bank's legal department.
Documentation provided must satisfy the bank's legal department and afford maximum
protection to the bank. The documentation will be periodically reviewed to keep them up to date
with ever-changing legal systems and practices (Edward, 2004).

The legal department will be consulted before making any compromises with the customer. Any
amendments will be done in consultation with the legal department.

2.2. Empirical review

There will be a large number of empirical studies in the area of safety and soundness,
particularly in the area of credit risk management, as the environment in Ethiopian banking
systems continues to change. Few academic and professional researches will be conducted
related to the history and performance of Ethiopian bank systems.
The following attempt will be made to summarize the main findings of some selected studies in
the area of risk management in commercial banks. Al-Tamimi and Al-Mazrooei (2007) will
carry out a comparative study of bank's risk management between national and foreign banks in
the United Arab Emirates through a survey.

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 Summary and knowledge gap

From the above theoretical as well as empirical reviews, risk identification, risk assessment and
analysis, and risk monitoring will be the most influential variables for risk management in the
banking industry, and will identify and rank three important types of risks. But the literature will
not consider effective loan repayment critically. An appropriate credit risk environment will be
established, a sound credit granting process will be maintained, appropriate credit administration
will be maintained, and adequate control over overall credit risk will be enforced

In order to address the above gaps, The Basel Committee on Banking Supervision (BCBS) will
publish a document entitled “credit risk management principles.”

2.3. Conceptual framework

One of the main purposes of this study will be to examine/confirm the relationship between
credit risk management practice and four aspects of NBE (2010) and Basel's credit risk
management standards (1999) (see figure 1).

Credit risk management practices

Figure 2.1. Model of credit risk management practice (Basel, 2000)

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 The principles of the Model of Credit Risk Management Practice (Basel, 2000) are as follows:

1. Establish, implement and maintain clear and effective policies and procedures for credit risk
management (CRM), setting out the credit risk appetite, setting an appropriate level of
measurement, methods for assessing the likelihood of default, etc.

2. Identify, monitor and manage changes in the credit risk of underlying exposures, identify and
keep up-to-date statistics on the various types of loans and other credit exposures of the
institution.

3. Monitor and assess the performance of credit portfolios and monitor their impact on the
institution's overall financial performance.

4. Establish regular processes to review appropriate corrective actions when the portfolio
deviates from managed credit risk limits or other risk parameters adopted by the institution.

5. Establish, implement and maintain credit risk measurement systems and methods to closely
monitor, model and understand changing portfolio characteristics, including determining
appropriate levels of provisioning for each category of exposure.

6. Take into account the risks related to guarantees, collaterals as well as concentrations in terms
of geography (e.g., countrywide portfolios) or sector (e.g., retail banking).

7. Take into account any risk arising from business relationships with related entities.

8. Ensure regular training programs for all staff involved in credit risk management activities in
order to maintain their knowledge up-to-date with regard to international best practices in credit
risk management (CRM).

Basel (1999) and other literature in the area of credit risk management suggested that banks
should have sound and updated credit strategy, policy and procedures, sound credit granting
process,. Therefore, four explanatory variables (appropriate credit risk environment (ACRE),
sound credit granting process (SCGP), credit administration, measurement and monitoring
process (CAMMP)

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 Chapter three

3.0. Research methodology

In this chapter the researcher clearly and neatly describes the research design, population size
and sampling techniques, data collection instruments, variables and method data analysis, and
Reliability Measures.

3.1. Research design

In order to achieve the objectives of the study, the research will employ descriptive approach by
using both qualitative and quantitative data. Researcher will be tried to develop structured
questionnaire based on the Basel’s credit risk management principles/activities of 1999 and
NBE’s credit risk management guideline of 2009. 41 closed ended questions with five Likert
scale level of agreement will be developed on five aspects of credit risk management activities.

3.2. Population size and sampling techniques

In order to obtain reliable information and to fill the structured questionnaires the researcher will
select respondents. These respondents that will be involved professional working in the banks
such as department managers and senior officers working on loan processing (risk management
staffs of head office practical oriented response such as credit manager, credit director, credit
analyst, recovery officers, credit follow up, risk and compliance managers and risk experts will
be the major respondents).

There are eighteen banks in Ethiopia. Out of them only two banks’ data will be taken. As noted
by Kothari (2004) good sample design must be viable in the context of time and funds available
for the research study. Besides, purposive sampling offers the researcher to deliberately select
items for the sample concerning the choice of items as supreme based on the selection criteria set
by the researcher. Accordingly, this study will employ purposive sampling technique to select
the required sample of banks from the above listed banks. The selection criteria set by the

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researcher will be first, the required banks should be only commercial banks in Ethiopia. Second,
those two commercial banks, which were selected

For study should operate during 2019-2023 having financial statements for consecutive four
years. In this study, the researcher will be utilized purposive sampling technique in order to
select participants of the study. The idea behind purposive sampling is to concentrate on people
who are directly involved in credit processing and administering because they should better be
able to assist with the relevant research data.

3.3. Sample size

The researcher will work in the two commercial banks out of 8 in Ethiopian banks, related to
credit and credit related operations as a whole will be taken as participants of the study. These
are Berhan International Bank S.C. and Buna Bank S.C.

3.4. Data collection instruments

For the purpose of the study, both primary and secondary data will be employed. Primary data
will be collected through questionnaires. The questionnaires will be distributed to respondents
that involve professional working in the banks such as department managers and senior officers
working on loan processing (risk management staffs of head office practical oriented response
such as credit manager, credit director, credit analyst, recovery officers, credit follow up, risk
and compliance managers and risk experts will be the major respondents). The secondary data
will be collected from financial statements, annual reports, National Bank of Ethiopia (NBE)
directives.

3.5. Variables and method of data analysis

We will analyze the data by using descriptive summaries, an econometrics model, and Cronbach’
Alpha to evaluate re liability of data. We will use statistical package for social science (SPSS
version 21) for this analysis.

3.6. Reliability measure

Cronbach’s alpha will employ to test the consistency of the questionnaire. CRMP, ACRE,
SCGP, CAMMP and ACOCR had high reliabilities, all Cronbach’s α =0.963. Yfield, (2009, P.
676) suggested that Cronbach’s α value of 0 .7 to 0. 8 will acceptable and ensure the reliability of
items.
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 References

 Rana Al Musharraf (2013). Credit Risk Management Practices in Private Banks of

Bangladesh. International Journal of Management and Development Studies, Volume 2,
Issue 1.
 Pallant, J. (2007). SPSS Survival Manual: A Step-by-Step Guide to Data Analysis using
SPSS for Windows third edition (3rd).
 Yfield, A. (2009). Discovering Statistics using SPSS (3rd). New Delhi: SAGE
Publications India Pvt Ltd. www.sas.com. (2006). Effective Credit Risk Management.
 National Bank of Ethiopia Supervision of Banking business directive SBB/43/2008: In
determining the extent of provisions for impairments.
 Alam, M. Z., & Masukujjaman, M. (2011). Risk Management Practices: A Critical
Diagnosis of Some Selected Commercial in Bangladesh. Journal 16 of Business and
Technology, 06(01), 16-35.
 Yfield (2009) and Pallant (2007).
 Kothari, C.R. (2004). Research Methodology: Methods and Techniques. New Age
International Publishers.
 Basel Committee on Banking Supervision. (1999). “International Convergence of Capital
Measurement and Capital Standards: A Revised Framework". Basel: Bank for
International Settlements.
 Sahlemichael M. (2009) Credit Risk Management System of Ethiopian Commercial
Banks (Case of some public and private banks).

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