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Credit Risk Management


The purpose of writing this paper is to show the scenario of credit risk management for one of the fast growing private commercial banks in Bangladesh. It might be interesting to face the question of why to choose credit risk management instead of other operations of banking industry. Credit risk management for any bank should be a robust process that enables banks to proactively manage loan portfolios in order to minimize losses and earn an acceptable level of return for shareholders. Through this internship report the credit risk management of Mutual Trust Bank Limited has been examined which is the focal point of this report. In order to prepare this report both primary and secondary data has been used to better focus the scenario. The report exemplifies the facts and figure of credit risk issues of this bank which has been formulated through practical experience of working in this bank. Apart from the primary data, secondary data has also been used to portray the best background information of this bank. This report focuses on in depth analysis of Mutual Trust bank Limited of Bangladesh and presents some strong recommendations through which this bank not only can develop its credit risk policies, but can also develop the position of this bank significantly. It should also be noted that the report signifies those recommendations which could be applied to any private commercial bank, especially in the condition of Bangladesh.

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1.1 Significance of the Study
Risk is inherent in all aspects of a commercial operation. However, for banks and financial institutions, credit risk is an essential factor that needs to be managed. Credit risk is the possibility that a borrower of counter party will fail to meet its obligations in accordance with agreed terms. Credit risk, therefore arises from the banks dealings with or lending to corporate, individuals, and other banks or financial institutions. The goal of credit risk management is to minimize a banks risk adjusted rate of return by maintaining credit risk exposure within risk inherent in the entire portfolio as well as the risk in individual credits or transactions. Credit risk management needs to be a robust process that enables banks to proactively manage loan portfolios in order to minimize losses and earn an acceptable level of return for shareholders. Central to this is a comprehensive IT system, which should have the ability to capture all key customer data, risk management and transaction information including trade. Given the fast changing, dynamic global economy and the increasing pressure of globalization, liberalization, consolidation and dis-intermediation, it is essential that banks have robust credit risk management policies and procedures that are sensitive and responsive to these changes.

1.2 Objectives of the Study

The primary objective of the study is to qualitatively and quantitatively analyze the factors which influence the credit risk of MTB. Another objective is to measure the degree of risk related to credit level. Credit Risk Management is a critical factor for any organization. The importance of credit risk management is the main motive behind undertaking this report. Another objective is to achieve a wide knowledge of the various banking products and services offered by MTB which present characteristics and features of different consumer products and services offered by the bank. To point out their strengths, weakness, opportunity and threats. Finally, the other objective is to suggest ways of improving the services to accommodate the rapidly growing client base of MTB.

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2.0 Emergence of Mutual Trust Bank Ltd.
The Company was incorporated on September 29, 1999 under the Companies Act 1994 as a public company limited by shares for carrying out all kinds of banking activities with Authorized Capital of Tk. 38,00,000,000 divided into 38,000,000 ordinary shares of Tk.100 each. The Company (Bank) operates through its Head Office at Dhaka and 68 branches. The Company/ Bank carry out international business through a Global Network of Foreign Correspondent Banks. Over the years MTB has established itself as a leading private commercial bank in the country with undisputed leadership in Corporate Banking and a strong Consumer and SME growth engines. MTBs ambition is to be the number one financial services provider, creating lasting value for its clientele, shareholder, and employees and above all for the community it operates in.

2.1 Mission
To be one of the best admitted banks in the nation and is recognized as an innovative and client focused company; enabled by cutting edge technology and being a dynamic workforce and a wide array of financial products and services.

2.2 Vision
Mutual Trust Bank's vision is based on a philosophy known as MTB3V. We envision MTB to be: One of the Best Performing Banks in Bangladesh The Bank of Choice A Truly World-Class Bank

2.3 Values
2.3.1 Accountability We are accountable for providing the highest level of service along with meeting The strict requirements of regulatory standards and ethical business practices 2.3.2 Agility We can see things from different perspectives We are open to change We can respond rapidly and adjust our mode of operation to achieve our goals

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2.3.3 Trust We value mutual trust. We ensure transparent and candid communication among all parties. 2.3.4 Commitment Creation of sustainable economic value for shareholders. Committed to serve the society through employment creation, support community projects and events Render state of the art service to customers by offering diversified products and services. Be reliant on the inherent merit of the employees.

2.4 Board of Directors

The following are members of the MTB Board of Directors.

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Credit Risk Management 2.5 Organizational Hierarchy of MTB

2.6 Business Matrix

MTB follows centralized business line based matrix compared to branch based business matrix used by most of the local banks. The set up is identical to global banks practice proven to be efficient and effective for optimal return and control. The Business Matrix of MTB consists of Corporate, Retail, SME and Green Banking as core business units and Treasury being the manager of funds maintains CRR, SLR with Bangladesh Bank, makes investments, placements and borrowing in money and capital markets, deals with foreign exchange etc.

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2.6.1 Corporate Banking MTBL Corporate Banking provides financial products & services reaching the countrys growing corporate base. MTBL Corporate Banking, aim to provide the best possible services to its customers and with that in mind, it have proved themselves to be one of the leading bank in helping clients to achieve success in every business endeavor they have. MTB is looking after the countrys top business tiers to boost the growth of the bank. Segments of these business groups are Telecom Operators, Ready Made Garments (RMG), Textiles, Real Estate Developers, Fast Moving Consumer Goods and MNCs. 2.6.2 Retail Banking MTBL Retail Banking has sustained its growth in deposit base and has attracted low cost deposit fund. On the other hand, MTBL has also stepped up its Consumer Loan portfolio. Consumer Loan portfolio increased significantly during the year. Total Consumer Loan portfolio (including credit cards) increased by 32 percent from 2.26 to 2.99 billion.

Figure: 2: Consumer Loan portfolio 2.6.3 SME Division MTBL SME (Small and Medium Enterprises) division started its expedition from 2007. SME is a growing area of our country and MTBs commitment to this sector is demonstrated by the fact that it offers one of the lowest lending rates in the market for SME clients. As a leading Private Commercial Bank, MTB SME clients growth rate and development with providing rural based clients services has been remarkable. During the year 2010, MTB SME lending portfolio registered an impressive growth of 622.68%.

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Table 2: Growth of MTB SME in 2010

4000 3500 3000 2500 2000 1500 1000 500 0 2007 2008 2009 2010 188 720 69.4 320.3 856 641.9 2182 3667 Number Of Borrowings Loan Disbursed BDT (Million)

Figure 3: Growth of MTB SME in 2010 2.6.4 Green Banking MTB Green Banking practices of is connected with both internal operation and product ecology. Product ecology is concerned with the impacts of the banks products on the environment used by the clients. Green banks are engaged in creating socially responsible investment funds and sustainable project finance activities. Environmental concern is at the centre of green banking strategy. MTB Green Energy has been designed to finance renewable energy sector, i.e. solar energy, bio gas, SMEs, Agri SMEs and farmers are the main target customers of this loan facility.

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2.6.5 Other Divisions Treasury Division

The Treasury Division of MTB deals with fund management, viz. money market dealing and LC Payments. They are also responsible for maintaining the statutory requirements with Bangladesh Bank. Credit Risk Management Division

This division is responsible for evaluating the credit worthiness and debt repayment capability of present loan customers and loan applicants. The department also monitors the risk worthiness regularly. The branches send all proposals from the prospective borrowers to the corporate division, which in turn analyze the financial statements and prepare credit memorandum, application for limit, account profitability and other necessary papers and send them to the Credit Risk Management division for approval. The department keeps track of credit portfolio by obtaining regular information from the branches. It sets price for credits and ensures its implementation at the branches. This department also monitors the various loan accounts of the branches and prepares various statements for Bangladesh Bank. Finance Department

Finance division of the bank is responsible for: Budgeting and Cost Monitoring Planning and monitoring the banks liquidity Corporate Tax management Monthly accrued interest calculation of all interest bearing accounts Amortization of all fixed and other assets, Maintenance of accounts, Preparation of annual report of the bank, Human Resource Management Department

As MTB Human Resources directly involves with the People, Education and Innovation, it created a positive impression in the Banking Environment of Bangladesh. The communal task for the recruitment and selection team is not simply hiring the people to fill up the gap rather creating an enabling environment putting right people in right place on right time. The pre and

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post orientation programs, learning and development program enhance propensity of the employees to maximize their output through achieving target on time. Special Asset Management Department

Special Asset Management Division (SAMD) is responsible for management of all accounts, which are classified in the banks loan portfolio. Major responsibility of this department is to formulate strategies and action plans for minimization of risk, prevention of loss, maximization of recovery, and restoration profits through restructuring/rescheduling, direct recovery, and/or legal actions. Audit and Compliance

This division provides legal assistance to the branches and formulates strategy for classified loans and ensures observance of rules and policies by all stakeholders of the bank through routine and surprise inspection and audit. 2.7.1 Deposit Portfolio Mix

12%1% 19% 12% 56% Current Deposit Savings Deposit fixed Deposit Deposit Products bills Payable

Figure 4: Deposit Portfolio Mix

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2.7.2 Loans and Advances

Figure 5: Loans and Advances

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3.1 Over view
The word credit comes from the Latin word Credo meaning I believe. It is a lenders trust in a persons/ firms/ or companys ability or potential ability and intention to repay. In other words, credit is the ability to command goods or services of another in return for promise to pay such goods or services at some specified time in the future. For a bank, it is the main source of profit and on the other hand, the wrong use of credit would bring disaster not only for the bank but also for the economy as a whole. The objective of the credit management is to maximize the performing asset and the minimization of the non-performing asset as well as ensuring the optimal point of loan and advance and their efficient management. Credit management is a dynamic field where a certain standard of long-range planning is needed to allocate the fund in diverse field and to minimize the risk and maximizing the return on the invested fund. Continuous supervision, monitoring and follow-up are highly required for ensuring the timely repayment and minimizing the default. Actually the credit portfolio is not only constituted the banks asset structure but also a vital factor of the banks success. The overall success in credit management depends on the banks credit policy, portfolio of credit, monitoring, supervision and follow-up of the loan and advance. Therefore, while analyzing the credit management of MTBL, it is required to analyze its credit policy, credit procedure and quality of credit portfolio. Credit risk is the risk of loss arising from a borrowers or counterpartys inability to meet its obligations. The active management of credit risk has been receiving increasing regulator attention and strategic focus at many financial institutions. Regulators cite poor credit risk management at the portfolio level, weak credit standards for borrowers and counterparties, and insufficient attention to changes in economic and other circumstances affecting the capacity of borrowers and counterparties as the highest contributors to inadequate credit risk management. Regulators have changed capital charges to make financial institutions more responsive to actual credit exposure and have set new rules for how much capital banks must set aside to cover potential losses. It is important to formulate and implement a structured credit policy and related processes to manage credit risk. Strategies for credit risk management, including credit policy development and risk monitoring, is the responsibility of business unit and senior management, and the board of directors.

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Figure 6: classification of credit risk

3.2 Credit Objectives of MTB

For maintaining good asset quality and effective management of credit, MTB has set the following major objectives: Contributing to the balanced development of economy by pursuing a sound credit policy aiming at lending in desired sector. Providing directional guidelines to pursue the policy of sound lending Adoption of appropriate working method Strict compliance with the laws and norms related to lending operation Identifying proper lending area Maintaining balanced lending portfolio keeping strict watch on global economic situation Analyzing all aspects of credit and ascertaining viability of lending Maintaining adequate liquidity, making judicious investment planning and attaining sustainable growth and profitability Making credit documentation exhaustive Ensuring proper supervision, monitoring and follow up of asset portfolio Strengthening asset quality, ensuring safe return of money lent minimizing loss.

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3.2.1 Credit Principles of MTB To maximize stake holders value and protect the interest of the depositors as well as to improve asset quality, MTB abides by the following general rules: All credit extensions must comply with the requirement of Bank Company Act and the Central Bank Not to extend credit to the persons /entities not supported by CIB report To maintain judicious ratio between loan and deposit To allow credit in a manner which in no way compromises with banks standard of excellence Extension of credit normally from customers deposits and not out of short term funds or borrowing from other banks To optimize risk and reward To ensure ethical standard in all credit activities To extend credit in the areas, risk of which can be sufficiently understood and managed To extend credit facility upon adequate pre-investment analyses and repayment capacity of the clients To avoid excessive credit concentration through rational diversification of credit To avoid name lending To allow credit on business consideration after ascertaining viability, credit requirement quality of advance, security offered cash flows and level of risks. 3.2.3 Global Credit Portfolio limit of MTBL The features which deals with how much total deposits would be used as lending the proportion of long term lending, customer exposure, country exposure, proportion of unsecured facility etc. the most notable ones are: The aggregate of all cash facility will not be more than the 80% of the customers deposit Long term loan must not exceed 20% of the total loan portfolio. Facilities are not allowed for a period of more than 5 (Five) years. Credit facilities to any one customer group shall not normally exceed 15% of the capital fund or TK. 100 cores.


In identifying and pursuing a sound credit risk management process MTB has designed its overall strategy by starting with setting up its objective, mission and vision under its credit policy framework. Its main objective is to proactively manage loan portfolios in order to minimize

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losses and earn an acceptable level of return for shareholders. Side by side effective credit management tools have also been properly applied. The tools are: Framing general policy guidelines Following a proper credit assessment and risk grading system Practicing credit approval discretion Segregation of duties Conducting strong internal audits Pursuing strong credit monitoring and credit recovery Ensuring strict application of guidelines and instructions of central bank in overall credit operation.

3.3.1 Policy Guidelines Credit Policies clearly outline the senior managements view of business development priorities and the terms and conditions that should be adhered to in order for loans to be approved. The Lending Guidelines are updated at least annually to reflect changes in the economic outlook and the evolution of the banks loan portfolio. It is approved by the Managing Director & Board of Directors of the bank. These guidelines include the following: Financing legitimate and productive business, industrial and other activities, which are socially desirable, nationally important and financially viable. Abiding by KYC policy, anti money laundering regulations, BOI guidelines, industrial policy, export policy, import policy, transfer of property act. Lending to the clients having legitimate source of earning, clear purpose of loan utilization, specific sources of loan repayment and capacity to enter into loan agreement Assessing credit needs and setting loan tenors rationally matching cash conversion cycle/cash flows upholding central banks directives in this regard Extension of credit facilities to generally where industry/business data are available Lending to the clients who are reputed corporate, institutions, reliable individuals, firm, companies, retailers etc. Pursuing sector wise lending cap judiciously. 3.3.2 Various Type of Credit Risk Lending Risk Analysis (LRA): Modern Technique of Credit Appraisal The Financial Sector Reform Project (FSRP) has designed the LRA package, which provides a systematic procedure for analyzing and quantifying the potential credit risk. Bangladesh Bank has directed all commercial bank to use LRA technique for evaluating credit proposal amounting

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to Tk. 10 million and above. The objective of LRA is to assess the credit risk in quantifiable manner and then find out ways & means to cover the risk. However, some commercial banks employ LRA technique as a credit appraisal tool for evaluating credit proposals amounting to Tk. 5 million and above. Broadly LRA package divides the credit risk into two categories, namely: A. Business Risk B. Security Risk Both Business Risk and Security Risk are subdivided into the following categories that are illustrated through a hierarchy:

Figure7: Hierarchy of Credit Risk for LRA 3.3.3 Credit Assessment The objectives of credit risk assessment are to minimize bad loans by improving the risk/return profiles of the port folio, price credit risk adequately or risk based pricing, maximize benefits from potential credit opportunities, setting of concentration and exposure limits active portfolio management, adhere to credit policies and maintain and maintain a reliable database Credit Investigation: Credit investigation refers to the assessment of a loan proposal from different points of view to decide whether the bank should go for finance or not. Sources of Credit Information: Credit information are collected from: 1. Credit Agencies: CRAB, CIB (Bangladesh Bank); debtors/ borrower information, owners information, group/ affiliation information, credit exposure matrix, third party guarantors information. 2. Loan Application: client loan application and KYC

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3. Market report: bankers can collect information about the client from businessman doing the same business 4. Study of the account: accounts turnover of the client of last one year, 5. Other sources: Confidential report, Default borrower list, Financial statements, Press report, suppliers, tax papers etc. 6. Clients personal interview Preparation of Credit Report 3.3.4 Risk Grading System Risk grading is a key measurement of MTBs asset quality, and as such, it is essential that grading is a robust process. Where deterioration in Risk is noted, the Risk Grade assigned to a borrower and its facilities is immediately changed. Borrower Risk Grades are clearly stated on Credit Applications.

Table 3: Example of risk grading system

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3.3.5 Risk Rating Grade Definition

Table 4: Risk Rating According to Risk Type Superior Facilities are fully secured by cash deposits, government bonds or a counter guarantee from a top tier international bank. All security documentation should be in place. Good Satisfactory Risk (Grade2). The repayment capacity of the borrower is strong. The borrower should have excellent liquidity and low leverage. The company should demonstrate consistently strong earnings and cash flow and have an unblemished track record. All security documentation should be in place. Aggregate Score of 95 or greater based on the Risk Grade Scorecard. Acceptable Adequate financial condition though may not be able to sustain any major or continued setbacks. These borrowers are not as strong as Grade 2 borrowers, but should still demonstrate consistent earnings, cash flow and have a good track record. A borrower should not be graded better than 3 if realistic audited financial statements are not received. These assets would normally be secured by acceptable collateral (1st charge over stocks / debtors / equipment / property). Borrowers should have adequate liquidity, cash flow and earnings. An Aggregate Score of 75-94 based on the Risk Grade Scorecard.

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Marginal Assets warrant greater attention due to conditions affecting the borrower, the industry or the economic environment. These borrowers have an above average risk due to strained liquidity, higher than normal leverage, thin cash flow and/or inconsistent earnings. Facilities should be downgraded to 4 if the borrower incurs a loss, loan payments routinely fall past due, account conduct is poor, or other untoward factors are present. An Aggregate Score of 65-74 based on the Risk Grade Scorecard. Special Mention Assets have potential weaknesses that deserve managements close attention. If left uncorrected, these weaknesses may result in a deterioration of the repayment prospects of the borrower. Facilities should be downgraded to 5 if sustained deterioration in financial condition is noted (consecutive losses, negative net worth, excessive leverage), if loan payments remain past due for 30-60 days, or if a significant petition or claim is lodged against the borrower. Full repayment of facilities is still expected and interest can still be taken into profits. An Aggregate Score of 5564 based on the Risk Grade Scorecard. Substandard Financial condition is weak and capacity or inclination to repay is in doubt. These weaknesses jeopardize the full settlement of loans. Loans should be downgraded to 6 if loan payments remain past due for 60-90 days, if the customer intends to create a lender group for debt restructuring purposes, the operation has ceased trading or any indication suggesting the winding up or closure of the borrower is discovered. Not yet considered non-performing as the correction of the deficiencies may result in an improved condition, and interest can still be taken into profits. An Aggregate Score of 45-54 based on the Risk Grade Scorecard. Doubtful and Bad (non-performing) Full repayment of principal and interest is unlikely and the possibility of loss is extremely high. However, due to specifically identifiable pending factors, such as litigation, liquidation procedures or capital injection, the asset is not yet classified as Loss. Assets should be downgraded to 7 if loan payments remain past due in excess of 90 days, and interest income should be taken into suspense (non-accrual). Loan loss provisions must be raised against the estimated unrealizable amount of all facilities. The adequacy of provisions must be reviewed at least quarterly on all non-performing loans, and the bank should pursue legal options to enforce security to obtain repayment or negotiate an appropriate loan rescheduling. In all cases, the

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requirements of Bangladesh Bank in CIB reporting, loan rescheduling and provisioning must be followed. An Aggregate Score of 35-44 based on the Risk Grade Scorecard Loss (non-performing) Assets graded are long outstanding with no progress in obtaining repayment (in excess of 180 days past due) or in the late stages of wind up/liquidation. The prospect of recovery is poor and legal options have been pursued. The proceeds expected from the liquidation or realization of security may be awaited. The continuance of the loan as a bankable asset is not warranted, and the anticipated loss should have been provided for. This classification reflects that it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future. Bangladesh Bank guidelines for timely write off of bad loans must be adhered to. An Aggregate Score of 35 or less based on the Risk Grade Scorecard At least top twenty-five clients/obligors of the Bank may preferably be rated by an outside credit rating agency. The Early Alert Process should be completed in a timely manner by the RM and forwarded to CRM for approval to affect any downgrade. After approval, the report should be forwarded to Credit Administration, who is responsible to ensure the correct Facility/borrower Risk Grades are updated on the system. The downgrading of an account should be done immediately when adverse information is noted, and should not be postponed until the annual review process. The credit risk grading system is mandatory to analyze the borrowers credit risk as well as to prevent fresh NPLs. In this codified system, if a borrowers risk falls within the range of 45 -54 out of 100; he is not allowed to receive credit. Any borrower who has a score above the range of 45-54 is eligible to receive credits.

Table 5: Risk Grade Scorecard

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13% 16%

Financial Risk Technical Risk Business/Industry risk Marketing Risk Managerial and relationship Risk


11% 20%

Figure 8: Weights of Principal Risk Components 3.3.6 Credit Approval Discretion The following guidelines are applied in the approval/sanctioning of loans: Credit approval authority of MTB must be delegated in writing from the MD/CEO& Board, acknowledged by recipients, and records of all delegation retained in CRM. Delegated approval authorities are reviewed annually by MD/CEO/Board. The role of Credit Committee are restricted to only review of proposals i.e. recommendations or review of banks loan portfolios. Approvals must be evidenced in writing, or by electronic signature. Approval records must be kept on file with the Credit Applications. All Credit risks must be authorized by executives within the authority limit delegated to them by the MD/CEO. The pooling or combining of authority limits should not be permitted. Credit approvals are centralized within the CRM function. Regional Credit centers may be established, however, all large loans are approved by the Head of Credit and Risk Management or Managing Director/CEO/Board or delegated Head Office Credit executive. Any Credit proposal that does not comply with Lending Guidelines, regardless of amount, are referred to Head Office for Approval MD/Head of Credit Risk Management approves and monitors any cross-border exposure risk. Any breaches of lending authority are reported to MD/CEO, Head of Internal Control, and Head of CRM

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4.0.1 Approach Information used to prepare this report has been collected from both primary and secondary sources. The primary sources provide the report with reliable data and information relating to customer and the banks operations. On the other hand, the secondary sources have been an indispensable source of information regarding the historical background of the bank, its functions, and descriptions of its various departments. 4.0.2 Primary Sources I have collected primary data by interviewing employees and clients of Mutual Trust Bank Limited. Information was collected through the discussion with employees of MTB. I needed clarifications of different issues that I ensured from various concerned officials of this bank. 4.0.3 Secondary Sources: Information was obtained from various sources, such as: (1) Company annual report, (2) Company web site, (3) Various internal and external banking circulars, (4) Departmental guidelines and (5) Prudential Central Bank Guidelines and Circulars and (6) Internet resources and journals.

4.1 Limitations of the Study

I have been provide with all necessary information at Mutual Trust Bank Limited, but due to the exhaustive nature of this study, not all information requirements for an elaborate guideline could be acquired from the bank. And also due to time, resources, and data constraint, I could not perform, as I ought to. The study has been conducted to make an investigation of the banks credit risk management, on the study in this field; some problems may be termed as limitations of the study. They are as follows: Constraints arising from the use of Confidential Banking information which is required to be disguised so that official secrecy is consistently maintained. Non-disclosure of certain information.

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5.0 Collection of Data
In order to perform the analysis I collected 100 borrowers loan information from MTB. This information consists of loan volume, corresponding interest rate, type of loan, corresponding credit risk grading score, whether the loans are classified or not and whether there is any renewed loan or not. Then I categorized these loans in three types: Personal Loan Business Loan SME loan

5.1 Rating Data According to Their Type

After the collection of data, I rated the collected loans. The loans which fall into personal category I rated those as type 1, which fall into business category I rated those as type 2, which fall into SME category I rated those as type 3.

5.2 Credit Risk Grading Method at MTB

Like all other commercial banks, MTB used credit risk grading score for the measurement of risk associated with a single borrower. In order to provide score to business loans five types of risks are being considered and following weights are given to each type. These risks are as follows:

Table 6: Weights of Principal Risk Components Based on this format the business loans are categorized. In case of personal and SME loan the categorization procedure is quite different. Generally these loans are categorized on the basis of 35. Seven things are considered here. These are as follows:

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1. 2.

3. 4. 5. 6.

Family background Business profile Life style Behavior and willingness to repay Net worth or financial position of the applicant Guarantors status Other special remarks

5.3 Classified and Unclassified Loan Information

I also gathered information about whether the collected loans were classified or not. If the installment payment of the loan is regular then the loan is considered as unclassified loan. On the other hand if the installment payment by the borrower exhibits extreme irregularity then that will be considered as classified loan. Loans extended by a bank were classified into the following three categories: Substandard-if an advance or any portion of an advance or interest thereon remained overdue for more than three months but less than six months; Doubtful-if the advance or any portion of the advance or interest thereon remained overdue for more than six months but less than one year, Bad-if the advance or any portion of an advance or interest thereon remained overdue for more than one year.

5.4 Managing the Credit Risk

5.4.1 Segregation of Duties The purpose of the segregation is to improve the knowledge levels and expertise in each department, to impose controls over the disbursement of authorized loan facilities and obtain an objective and independent judgment of Credit proposals Banks should aim to segregate the following lending functions: Credit Approval/Risk management Relationship Management/Marketing Credit Administration Strong Internal Audit MTB has a segregated internal audit/control department charged with conducting audits of all departments. Audits are carried out annually and ensure compliance with regulatory guidelines, internal procedures, Lending Guidelines and Bangladesh Bank requirements.

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Credit Risk Management Credit Monitoring To minimize credit losses, monitoring procedures and systems are in place that provides an early indication of the deteriorating financial health of a borrower. There are systems to report the following exceptions to relevant executives in CRM and RM team: Past due principal or interest payments, past due trade bills, account excesses, and breach of loan covenants Loan terms and conditions are monitored, financial statements are received on a regular basis, and any covenant breaches or exceptions are referred to CRM and the RM team for timely follow-up Timely corrective action is taken to address findings of any internal, external or regulator inspection/audit. All borrower relationships/loan facilities are reviewed and approved through the submission of a Credit Application at least annually. Computer systems are able to produce the above information for head office as well as local review. Exceptions are followed up on and corrective action taken in a timely manner before the account deteriorates further. Early Alert Process An Early Alert Account is one that has risks or potential weaknesses of a material nature requiring monitoring, supervision, or close attention by management. If these weaknesses are left uncorrected, they may result in deterioration of the repayment prospects for the asset or in the Banks credit position at some future date with a likely prospect of being downgraded to CG 5 or worse (Impaired status), within the next twelve months. Early identification, prompt reporting and proactive management of Early Alert Accounts are prime credit responsibilities of all Relationship Managers and must be undertaken on a continuous basis. An Early Alert report should be completed by the RM and sent to the approving authority in CRM for any account that is showing signs of deterioration within seven days from the identification of weaknesses. The Risk Grade should be updated as soon as possible and no delay should be taken in referring problem accounts to the CRM department for assistance in recovery. Despite a prudent credit approval process, loans may still become troubled. Therefore, it is essential that early identification and prompt reporting of deteriorating credit signs be done to ensure swift action to protect the Banks interest.

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Credit Risk Management Credit Recovery The Recovery Unit (RU) of CRM directly manages accounts with sustained deterioration (a Risk Rating of Sub Standard (6) or worse). The RUs primary functions are: Determine Account Action Plan/Recovery Strategy Pursue all options to maximize recovery, including placing customers into receivership or liquidation as appropriate. Ensure adequate and timely loan loss provisions are made based on actual and expected losses. Regular review of grade 6 or worse accounts Management of Problem Loans MTB established a system that helps identify problem loan ahead of time when there may be more options available for remedial measures. Once the loan is identified as problem, it should be managed under a dedicated remedial process. The additional resources, expertise and more concentrated focus of a specialized workout section normally improve collection results. The management of problem loans (NPLs) is a dynamic process, and the associated strategy together with the adequacy of provisions is regularly reviewed. A process has been established to share the lessons learned from the experience of credit losses in order to update the lending guidelines:

a) NPL Account Management

At MTB, for effective NPL account management, Special Assets Management Department (SAM) is in place. All NPLs are assigned to an Account Manager within the RU, who is

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responsible for coordinating and administering the action plan/recovery of the account, and serve as the primary customer contact after the account is downgraded to substandard. The autonomy of RU is strictly maintained to ensure appropriate recovery strategies.

b) Account Transfer Procedures

Within 7 days of an account being downgraded to substandard (grade 6), a Request for Action and a handover/downgrade checklist are completed by the RM and forwarded to RU for acknowledgment. The account is assigned to an account manager within the RU, who reviews all documentation, meet the customer, and prepare a Classified Loan Review Report within 15 days of the transfer. The CLR must be approved by the Head of Credit, and copied to the Head of Corporate Banking and to the Branch/office where the loan was originally sanctioned. This initial CLR highlight any documentation issues, loan structuring weaknesses, proposed workout strategy and seeks approval for any loan loss provisions that are necessary. Recovery Units should ensure that the following is carried out when an account is classified as Sub Standard or worse: Facilities are withdrawn or repayment is demanded as appropriate. Any drawings or advances should be restricted, and only approved after careful scrutiny and approval from appropriate executives within CRM. CIB reporting is updated according to Bangladesh Bank guidelines and the borrowers Risk Grade is changed as appropriate. Prompt legal action is taken if the borrower is uncooperative.

C) Non-Performing Loan (NPL) Monitoring:

On a quarterly basis, a Classified Loan Review (CLR) is prepared by the RU Account Manager to update the status of the action/recovery plan, review and assess the adequacy of provisions, and modify the banks strategy as appropriate. The Head of Credit approves the CLR for NPLs up to 15% of the banks capital, with MD/CEO approval needed for NPLs in excess of 15%. The CLRs for NPLs above 25% of capital should be approved by the MD/CEO, with a copy received by the Board.

D) Provisioning and Write Off

The guidelines established by Bangladesh Bank for CIB reporting, provisioning and write off of bad and doubtful debts and suspension of interest are followed in all cases. The approval to take provisions, write offs, or release of provisions/upgrade of an account should be restricted to the Head of Credit or MD/CEO based on recommendation from the Recovery Unit. The RU Account Manager determines the Force Sale Value (FSV) for accounts grade 6 or worse. Force

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Sale Value is generally the amount that is expected to be realized through the liquidation of collateral held as security or through the available operating cash flows of the business, net of any realization costs. Any shortfall of the Force Sale Value compared to total loan outstanding should be fully provided for once an account is downgraded to grade 7. Where the customer in not cooperative, no value should be assigned to the operating cash flow in determining Force Sale Value. 5.4.2 CRM Systems & Procedure: In order to manage credit risk, MTB followed a four-step process:

A) Standards & Reports:

The process starts with standards and reports. To facilitate this, a substantial degree of standardization of process and documentation is required. This has lead to standardized ratings across borrowers and a credit portfolio report that presents meaningful information on the overall quality of the credit portfolio. A credit-rating form presents a single rating system where a single value is given to each loan, which relates to the borrower's underlying credit quality. Through this step the general credit worthiness of the borrower is measured. In the reported system all loans are rated using a single numerical scale ranging between 1 and 10. For each numerical category, a qualitative definition of the borrower and the loan's quality is offered and an analytic representation of the underlying financials of the borrower is presented. Such an approach allows the credit committee some comfort in its knowledge of loan asset quality at any moment of time. It requires only that new loan officers be introduced to the system of loan ratings, through training and apprenticeship to achieve a standardization of ratings throughout the bank. Given these standards, the bank can report the quality of its loan portfolio at any time, along the lines. The most important thing here is that there are sufficient gradations to permit accurate characterization of the underlying risk profile of a loan, or a portfolio of loans. Assuming the adherence to standards, the entirety of the firm's credit quality is reported to senior management monthly via this reporting mechanism. report from one period to another occur for two reasons, viz., loans have entered or exited the system, or the rating of individual loans has changed over the intervening time interval. The first reason is associated with standard loan turnover. Loans are repaid and new loans are made. The second cause for a change in the credit quality report is more substantive. Variations over time indicate changes in loan quality and expected loan losses from the credit portfolio. In fact, credit quality reports should signal changes in expected loan losses, if the rating system is meaningful.

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b) Position Limits and Rules:
A second technique is the use of position limits or minimum standards for participation. In terms of the latter, the domain of risk taking is restricted to only those assets or counterparties that pass some pre-specified quality standard. Then, even for those investments that are eligible, limits are imposed to cover exposures to counterparties, credits, and overall position concentrations relative to various types of risks. In general, each person who can commit capital will have a well-defined limit. This applies to traders, lenders, and portfolio managers. Summary reports show limits as well as current exposure by business unit on a periodic basis.

c) Investment Guidelines and Strategies:

Strategies are outlined in terms of concentrations and commitments to particular areas of the market, the extent of desired asset-liability mismatching or exposure, and the need to hedge against systematic risk of a particular type. The limits described above lead to passive risk avoidance and/or diversification, because managers generally operate within position limits and prescribed rules. Beyond this, guidelines offer firm level advice as to the appropriate level of active management, given the state of the market and the willingness of senior management to absorb the risks implied by the aggregate portfolio. Such guidelines lead to firm level hedging and asset-liability matching. In addition, securitization and even derivative activity are rapidly growing techniques of position management open to participants looking to reduce their exposure to be in line with management's guidelines.

d) Incentive Schemes: To the extent that management can enter incentive compatible contracts with line managers and
make compensation related to the risks borne by these individuals, then the need for elaborate and costly controls is lessened. However, such incentive contracts require accurate position valuation and proper internal control systems. Such tools which include position posting, risk analysis, the allocation of costs, and setting of required returns to various parts of the organization are not trivial. Notwithstanding the difficulty, well-designed systems align the goals of managers with other stakeholders in a most desirable way.

5.4.3 Asset Quality & Non-Performing Loans of MTB MTB upholds the principle of maintaining the asset quality and therefore focuses on strict supervision of its asset portfolio. As of the year 2010, MTBs total assets along with subsidiary had risen by 10.37% over 2009, reaching BDT 58,246 million. A major contributor to this growth was the increase in loans and advances. Accompanying this quantitative growth has been

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an improvement in asset quality, with the careful risk management measure of MTB contributing to high quality loans and advances.

Table 7: Summary of Assets MTBs credit portfolio is mostly comprised of corporate, consumer and SME clients. If we closely observe the loan portfolio of MTB in 2009 & 2010 then we shall see a clear indication of MTBs appetite for growth. MTB is paying more attention to Textile industry than it paid in previous year. Amount of loan disbursement in this sector increased almost 9.38 times in 2010 than that of 2009. Moreover, Food, Plastic and Rubber, Petroleum and Edible Oil, Chemical, Engineering industries enjoy more loan disbursement from MTB. On the other hand, shrinkage is observed in Jute, Cotton & Wearing Apparel, Paper & Printing and Service industries.

Table8: Most & Least preferential Credit Sectors of MTB

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The banks exposure to loans and advances increased from BDT 33,883 million to BDT 39,676 million in 2010 registering a 17.09% growth over last year, an increase of BDT 5,792 million. Despite this large growth, loans classified as substandard and below experienced a reduction by 5.11% which is a remarkable positive sign for the bank. This allowed the banks NPL ratio to fall from 2.81% to 2.28%, dropping below 3% mark. MTBs mission is to make NPL below 1% within three years following the year 2010. However, the bank has been able to keep the NPL ratio at a manageable level due to prudent risk management strategies, a committed recovery team and excellent monitoring and control system that was in place.

Table 9: Summary of Loans & NPL

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6.0 Key Findings
After analyzing the credit risk management process of Mutual Trust Bank Ltd I have found that the organization is working in according to their objective that is risk minimization. In the credit manual of MTB they articulated their challenge as an art of striking a balance between risk and revenue. Credit risk is the major category of risk of the bank. Its intervention has a positive impact so that its NPL ratio is diminishing over the periods. Findings of my report are given below: I have shown the major credit objectives and principles of MTB in order to maintain a sound credit environment. I have tried to present the credit policy framework based on which MTB conducts it lending process. I have presented the areas where MTB can provide and extend its loan facility, where its lending are encouraged and where it is discouraged, its risk grading system, its credit approval discretion I have shown its NPL (Non Performing Loan) management procedure and how they efficiently handle it. For this reason their non performing loan ratio is very low which is only 2.28%. I have also tried to examine the whole risk management system and procedure of MTB. I tried to find out the most preferential loan disbursement sector of MTB on which it would like to pay its more attention than other sectors. In RMG & textile sector its large volume of loan portfolio is seen to be involved.

6.1 Recommendation
A banker cannot sleep well with bad debts in his portfolio. The failure of commercial banks occurs mainly due to bad loans, which occurs due to inefficient management of the loans and advances portfolio. Therefore any banks must be extremely cautious about its lending portfolio and credit policy. So far Mutual Trust Bank Limited has been able to manage its credit portfolio skillfully and kept the classified loan at a very lower rate --- thanks goes to the standard and stringent credit appraisal policy and practices of the bank. But all things around us are changing at an accelerating rate. Today is not like yesterday and tomorrow will be different from today. Given the fast changing, dynamic global economy and the increasing pressure of globalization, liberalization, consolidation and disintermediation, it is essential that Mutual Trust bank limited has a robust credit risk management policies and procedures that are sensitive to these changes. To improve the risk management culture further, MTBL should adopt some of the industry best practices that are not practiced currently.

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Mutual Trust Bank should have a clear written lending guideline. The lending guideline should include Industry and Business Segment Focus, Types of loan facilities, Single Borrower and group limit, Lending caps, Discouraged Business Types, Loan Facility Parameters and Cross boarder Risk. It should adopt a credit grading system All facilities should be assigned a risk grade. And the borrowers risk grades should be clearly stated on credit application. Approval authority should be delegated to individual executives rather than Executive Committee/ Board to ensure accountability. This system will not only ensure accountability of individual executives but also expedite the approval process. All lending functions should be segregated in the following way Credit Approval / Risk Management * Relationship Management / Marketing * Credit Administration The segregation of duties will improve the knowledge levels and expertise in each department The organization structure should have to be changed to put in place the segregation of the Marketing/ Relationship Management function from Approval / Risk Management / Administration function. The responsibilities of the key persons of the above function must also be clearly specified. An Early Alert Account system should be introduced to have adequate monitoring, supervision or close attention by management.( An early Alert Account is one that has risk and potential weaknesses of a material nature) There should be a Recovery Unit to manage directly accounts with sustained deterioration. To encourage Recovery Unit incentive program may also introduced.

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The future of banking will undoubtedly rest on risk management dynamics. Only those banks that have efficient risk management system will survive in the market in the long run. The effective management of credit risk is a critical component of comprehensive risk management essential for long-term success of a banking institution. Techniques, practices, and tools for credit risk management are evolving rapidly, as are the challenges that banking organizations face in their business lending activities. For larger institutions, the number and geographic dispersion of their borrowers make it increasingly difficult for such institutions to manage their loan portfolios simply by remaining closely attuned to the performance of each borrower. In identifying and pursuing a sound credit risk management process MTB has designed its overall strategy by starting with setting up its objective, mission and vision under its credit policy framework. Its main objective is to proactively manage loan portfolios in order to minimize losses and earn an acceptable level of return for shareholders.

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List of Acronyms
SME: Small and Medium Enterprise CRR: Cash Reserve Ratio SLR: System Level Requirement LC: Letter Of Credit SAMD: Special Asset Management Division DFI: Development Financial Institutions CCS: Corporate Client Service KYC: know your customer BOI: Board of Investments FSRP: Financial Sector Reform Project LRA: Lending Risk Analysis CIB: Corporate, investment banking CRML Credit Risk Management CRM: Customer Relationship Management NPL: Non Performing Loan RU: Recovery Unit SAM: Special Assets Management CLR: Classified Loan Review FSV: Force Sale Value

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Annual Report (2010), Mutual Trust Bank Limited Gujarati, D.N. (2004), Basic Econometrics, McGraw-Hill/Irwin 4th Edition Internal documents, Mutual Trust Bank Limited Mutual Trust Bank Ltd, from,

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