Day 3: Pricing:

Cost of Funds: Cost of Deposit + Admin Cost + Cost of

Capital;
Cost of funds has 2 segments 1-Direct Cost – profit paid to
depositors; 2-Intermediation cost – cost bank incures to
play its role as intermediation b/w funds providers
(depositors) and fund users (borrowers);
Intermediation cost is further divided into 2: Admin Cost
and Bad Debts Cost.
KIBOR: Karachi Interbank Offer Rate: it is daily; weekly;
monthly; 1 yr. 2 yr. & 3 yrs. Given by Specialized
Institutions (Banks/FIs); This rate is inflation adjusted
rate and Banks add 1, 2 or 3 percent; SBP directive to
apply KIBOR rate to corporate customers.

Slide 1
 Cont’d… pricing….

Discount Rate: The rate SBP gives loans to commercial banks

is know as bank rate or discount rate; Also rate of
discounting Treasury Bills; SBP raise or lower discount rate
to discourage or encourage borrowing by commercial
banks. Presently 13.5% dropped from 14%.
PIBs – Pakistan Investment Bonds: PIBs are issued by SBP on
behalf of Govt. of Pak. The only long term debt security.
Expert advice required for good profit making.
Structuring floating mark up rate (pricing): KIBOR, Discount
Rate and PIB rates and credit facility tenor are basis for
structuring floating mark up rate.

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 How to Price:
 step 1: Look up at KIBOR av rate, it is min
rate required for funds by banks;
 step 2: Measure Risk – risk metrics are debt to
equity for public ltd co’s or debt to assets for
individuals.
 Step 3: Assign points to different levels.
Example: 3 levels of risk – 1st level (good
credit) is assigned 100 points; and 3rd level
(poor credit) is assigned 300 points. So max
rate would be KIBOR+300bps

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 Prudential Regulations:
 PRs divided into 4 categories:
 Risk Management (R); Corporate Governance;
(G); Know your Customer & Anti Money
Laundering (M); and Operations (O).
 PRs (R) for Corporate / Commercial Banking,
SMEs Financing, Consumer Financing are
almost same.
 Bank/DFI Equity: Paid up Capital+gen
reserves+bal in share premium
account+reserve for issue of bonus shares and
retaining earnings / losses. Reserves include
revaluation reserves on account of fixed assets.

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 Borrower’s equity:
 Paid up capital+gen reserves+bal in share
premium account+reserve for issue of bonus
shares and retained earnings/losses.
Revaluation benefit part of equity for first 3
yrs. Sub ordinated loans also part of equity.
 Group: besides others: Significant influence
over decision making; policies; material inter
company transactions.

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 PRs…………… cont’d…
 R-1: Limit on outstanding exposure to a single
person: FB+NFB not exceeding 30%; FB not
exceeding 20%. To group: not exceeding 50%;
max FB 35% of DFI’s/Bank’s equity.
 R-2: Limit on exposure against contingent Liab.:
not exceed 10 times of equity; cash margin,
Govt. LCs and LGs not included.
 R-3: Min conditions for taking exposure:
 R-4: Limit… clean financing:
 R-5: FB+NFB not to exceed 10 times of equity
 R-6: Exposure against shares: 30% margin

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 PRs….. Cont’d…..
 R-7: Guarantee: Fully secured except….
 R-8: Classification: Overdue 90 days Sub-standard;
o/due 180 Doubtful and 365 days o/due Loss.
 R-9: Assuming obligations on behalf of NBFCs:

 R-10: Fac to pvt ltd company.

 R-11: Full provisioning by banks/DFIs.
 R-12: Monitoring: Stock reports; inspection
 R-13: No margin except against shares

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 Day 4: Lending Risk Assessment:
 Risk? Happening of unforeseen, any
misfortune, loss; Risk can not be eliminated
but minimized.
 Visualize what could happen, likely hood of
occurance, intensity/impact of these events.
 Risk Management is taking appropriate steps
that reduce either risk of happening event or
reduce losses due to that happening.
 Credit risk is the financial loss incurred due to
the inability of a customer to repay their
loan/financial obligation.

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 In house defense lines:
 Bank’s own people both in front-line staff and
specialized areas as Treasury.
 Bank staff – e.g. auditors; business risk
review; legal / litigation deptt.
 Bank’s Board, external auditors; regulatory
bodies. There are number of committees that
consider the risk areas. The most relevant
area is credit risk.

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 Identification of inherent risks:
proactive approach:
 Exchange rate risk
 Default risk

 Liquidity risk
 Business risk
 Inflation risk
 Regulatory risk
Bottom Line “Risk Return Trade Off”

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 Risk & Economic environment:
 Inflation:
 Slow growth or no growth – slow market /
business activities.
 Tariff and taxes
 Political stability – country risk

Slide 11
 Corporate governance and
organizational structure:
 Operations management analysis with external
factors and financial analysis; customer
position as industry leader, average player or
lagging performer; understanding why
business exists, its position in market, its
product and its operating characteristics,
including OWNERSHIP: Proprietorship;
partnership: short business life; Private limited
and public limited: longer business life; analyse
“going concern” concept; legal structure and
type of organization; major shareholders and
concentrations. Background and brief history –
length of time in business, changes or
problems faced; Succession Plan.
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 External Reporting:

 To SBP, PR compliance, SBP Audit.

 To provincial and federal government
agencies.

 External Auditors
 International obligations – money laundry etc.
UCP etc.

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 Source of lending risk

 Default risk – will full default norm in local

culture.
 Business/Industry risk: stage of life cycle; price
trends of raw material and competition
products.
 Transaction failure risk: LC, LG, Performance
Bonds; Project failure.
 Others: political, economic, market, liquidity,
foreign exchange, interest rate risks.
 Labor /Management relationship.

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 Risk Assessment:
 Financial Analysis: Ratios; Cash Flows;
Profitability
 Market check: from banks, market players in
the field, suppliers/buyers, SECP search.
 Compliance with regulation requirement:
 Customer integrity, capability and
commitment:
 Track record.
 Dependence on Key suppliers / buyers.
 Alternatives in market.

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 Risk Management:
Life Cycle: Identification – Assessment –
Mitigation – and Monitoring.
 Credit Policy: CP is a high level internal doc describing
credit framework and objectives.
 Delinquency portfolio – trends and control measures.
 Collection and Recovery: Strategies and methods; SBP
guidelines; Remedial management.
 Mitigation: High probability/high impact – must be
avoided. High impact/low probability – can be managed
by risk transference (insurance; joint ventures or other
contract but high cost). Low impact/low probability –
generally these are acceptable.

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 Risk Monitoring:

 Elements of ops risk (customer’s business):

Process risk, People risk, System risk, External
risk.
 Internal checking: ops risk controllers; internal
auditors.

 Bank’s monitoring: thru analysis of financials;

periodical stock reporting and inspections;
regulatory compliances; muccadams;
collateral monitoring; call / visit reports;
periodical review of fin doc / legal doc if these
are enforceable, and other actions.

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 Documentation and Collateral:
 Different types of financing agreements:
Project fin; Account Receivable fin; Lease fin.
 Types of collateral doc: Hypo agreement
(LoHypo); Letter of Lien; Letter of Pledge;
Stand by Letter of Credit.
 Safe keeping of doc: In house arrangement –
vault; Ex house arrangements – private
vaults; Storage of doc & system for recording;
Safe-in-Safe out.

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 CHECKING:

CENTRAL INVESTIGATING BUREAU (CIB): preferably should be

clean.

BORROWING FROM OTHER BANKS – may be obtained from the

borrower itself.

CREDIT REPORT – may be obtained from creditor banks.

MARKET REPORT – may be obtained from suppliers, buyers etc.

REGISTRAR CHECKING – Search Report to know charges of

other creditors

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