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BIBM's
Risk Enlightenment
Editorial
The banking sector in Bangladesh nds itself in a period of unprecedented change.
Value creation is increasingly under pressure from interest rate spread erosion, poor
risk origination processes and volatile capital markets to name a few. Value
preservation is also under pressure, with issues in relation to much publicised risk
management failures, Non Performing Loan exposures and sectoral concentrations. In
this mix of rapidly developing Credit Risk issues - we now have Operational Risk coming
to the fore. The recent ATM hacks are an example of how, as our banking infrastructure
gets plumbed into global networks, the risk exposures are going to get both broader but
also deeper. This rapid increase of the risk pro le of Bangladeshi banks has not gone
unnoticed by Bangladesh Bank (BB). Their prudent response, by way of Risk
Management Guidelines for Banks and Strengthening and updating the Risk
Management Systems in Banks, represent a fundamental change in BBs regulatory
approach - and its expectations on banks. Banks can expect an intrusive form of
regulation that, at its very core, will place high levels of accountability upon Boards and
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senior executives. Higher standards will also be expected in terms wider risk
governance, risk management sophistication/ disciplines and capital management
supported by demonstrable enhancement of Board and senior executives decision-
making. To help our banks, BIBM has been working extensively in building capacity in
risk management. Given BIBMs unique relationship with both BB and the banking
sector, we have been able to undertake a series of initiatives, informed by the demands
of BB and the needs of the industry. In practical terms, this means that we aim to
support the banks at all levels. For junior level bank executives, we provide targeted
training on risk issues. We also organise training workshops for mid-level bank
executives. Similarly, we have now initiated the Certi ed Expart in Risk Management
(CERM) programme with Frankfurt School of Finance and Management of Germany to
train bankers on world class risk management techniques. Likewise, we have extensive
coverage of risk issues in our Masters Programs on Bank Management (MBM and
EMBM). Our latest initiative targets the risk leads - by way of the Chief Risk Of cer
(CRO) Forum. The CRO Forum is designed to provide a forum where latest
developments/ thought leadership on Risk Management (global and local) can be shared
with the senior executives in charge of risk. It should also facilitate informed and open
risk related discussions between industry leads in terms of risk. As the forum matures, it
can also be used to acquire feedback of proposed and developing regulations. Over
time, the CRO Forum should also create a sensibly collegiate atmosphere of knowledge
sharing among the CROs - especially when responding to common challenges faced
across the banking sector. We shall be holding the CRO Forum Introduction Workshop
on 24 March 2016. The valuable feedback we are hoping to receive will be incorporated
into the CRO Forum design - that will be formally launched by the Governor of
Bangladesh Bank in due course. Finally, we would fail to make the most of all these risk
capacity building initiatives if they remained in their respective silos. As such, we are
now launching Risk Enlightenment to provide a knowledge and/ or information
dissemination point to all our risk capacity building activities. We shall publish this 4
times a year focussing on speci c risk issues/ themes. The rst Issue (that you are
holding) targets Credit Risk. As the saying goes, although sometimes it is suf cient to
do things better, at times, it is imperative to do better things. We believe we are now in
a place where we have to do better things in the risk space. We look forward to your
active participation in these timely and important initiatives. Issue

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Credit Risk: A Major Concern of the Banking Sector

Md. Nehal Ahmed
Associate Professor, BIBM

Credit is the most important source of revenue for the banks but, at the same, time the
single most potentially damaging risk also arises from the loan portfolio of banks i.e. risk
of nonpayment by the borrowers. So, managing credit portfolio is crucial for a bank,
thats why banks need to strike a prudent balance between the risk-return trade-off
from its credit portfolio for ensuring optimum outcome. Achieving this prudent risk-
return mix demands an effective management of loan quality. In fact, it is important to
have a well-de ned credit policy, sectoral preference, collateral requirement,
appropriate credit concentration, credit assessment, risk grading, pricing, etc. for
maintaining a good credit portfolio. Therefore, managing a quality loan portfolio is a
multidimensional task where all major stages in a credit cycle such as loan initiation,
credit assessment and selection, credit administration, credit monitoring, recovery
procedures of loan are required to be dealt with professionally and ef ciently for
having a strong and robust credit culture in a bank.

Asset quality management is considered extremely important by the banking sector. The
Basle Committee on Banking Supervision issued an important document in 1997 titled
Core Principles for Effective Banking Supervision, to present a comprehensive set of
twenty- ve core principles. Of these, one fourth are designed to address the relevant
issues of bank asset quality or credit risk management (Tsai and Huang 1999), suggesting
that asset quality is a general concern for the nancial supervisory authorities in every
country throughout the world. According to Basel regulation, banks need to allocate
high amount of capital for providing poor or risky credit. The quality of credit is
considered by recognizing the rating of an exposure. If an exposure is rated as AAA, it is
treated as high quality credit than an exposure rated as C and it requires less capital as
per the regulation. Minor differences in how credit risk is estimated and measured can
often result in large swings in estimates of credit risk. Such movements can have
signi cant impacts on risk assessments and ultimately on business decisions including
the using of collateral and credit risk mitigation.

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Credit risk is one of the signi cant risks of banks by the nature of their activities.
Through effective management of credit risk exposure, banks not only support the
viability and pro tability of their own business but also contribute to systemic stability
and to an ef cient allocation of capital in the economy (Psillaki, Tsolas, and Margaritis,
2010). Credit risk is a risk of borrower default, which happens when the counterpart
fails to pay on time. Besides, if a borrower has deteriorated credit portfolio, it can also
cause credit risk loss to the bank. However, the loss from the default of the bank does
not have to be large. It depends on the percent of recovery from obligor and total
exposure of banks. A good risk management tries to avoid high exposure on credit risk
(Gestel & Baesems, 2008). To mitigate the credit risk, Basel regulations have placed
explicitly the onus on banks to adopt sound internal credit risk management practices
to assess their capital adequacy requirement. Implementation of Basel is expected to
improve credit quality of banks as the spirit of the Basel regulation suggests banks not
to create inferior quality loans that in turn will increase risk-weighted asset and require
more capital. It is important to note that bank must understand the main essence of
Basel Accord which is nothing but the improved and prudent credit risk management.

Banks are exposed to a number of risk factors while offering different services to its
clients. Since risk is inherent in the banking business, nobody can ignore the importance
of risk management. Maintaining adequate amount of capital is an integral part of the
risk management process in banks. Credit risk remains the most important risk among a
number of risk factors that banks have to manage. This is supported by the following
table which shows the proportion of risk weighted assets of three major risk
components i.e. credit risk, market risk and operational risk. Undoubtedly one can
conclude that credit risk weighted asset (CRWA), with around 85 percent share, is the
leading component of aggregate risk weighted asset (table-1). The result suggests that
bank should seriously concentrate on their credit risk management practices, which
eventually ensures the quality of their asset portfolio.

Table-1: Composition of Risk Weighted Assets

2010 2011 2012 2013 2014

Credit RWA 84.5 85.2 85.7 85.1 85.2

Market RWA 7.3 6.2 5.2 5.7 5.5

Operational RW 8.2 8.6 9.1 9.2 9.3

Total RWA 100 100 100 100 100

Source: Department of Off-Site Supervision, BB

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Non-performing loan (NPL) is a very important indicator to measure the credit quality
of a bank. Non-performing loan largely affects the ef ciency of banks. This is because
ef cient banks are better at managing their credit risk. Non-performing loans have
risen, in recent years (table-2), due to a combination of factors, such as, a deterioration
in intrinsic asset quality and stringent problem loan identi cation. The NPL of the
banking sector actually rose to 9.9 percent at end-September 2015 from 8.9 percent at
end-December 2013.The reasons for the increase in reported NPL were, mainly, due to
the withdrawal of a one-time relaxation of the loan rescheduling procedure, which was
given in 2013, and detection of substantial nonperforming loans in a particular bank
that has been re-categorized as state-owned commercial bank (SOCB) this year from its
earlier status (Financial Stability Report-2014, BB).

Table-2: Composition of Classi ed Loan

2015
(up to
2010 2011 2012 2013 2014 Sept)

Substandard 3043.15 3480.00 8378.60 4704.96 5755.79 6461.75

(13.4) (14.8) (19.1) (11.2) (11.0) (11.2)

Doubtful 1907.65 2704.05 6229.11 4242.86 5860.44 5077.09

(8.4) (11.5) (14.2) (10.1) (11.2) (8.8)

Bad & Loss 17759.27 17329.45 29259.29 33060.72 40709.15 46155.38

(78.2 (73.7) (66.7) (78.7) (77.8) (80.0)

Total 22710.06 23513.50 43867.0 42008.53 52325.39 57694.2

Classi ed
Loa

Total Loans 319860 379250 438670 472006 539437 582770

and
Advances

Total 7.1 6.2 10.0 8.9 9.7 9.9

Classi ed
Loan as % of
Total Loan

Source: Financial Stability Report, BB

Note: Figure in the parenthesis shows the percentage of total classi ed loan

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Table-2 also represents the year-wise classi ed loan composition. The ratio of bad loans
to total classi ed loans increased to 80 percent in September 2015 from 66.7 percent in
2012, meaning that a signi cant amount of worst quality credit increased in 2015.
Around four- fths of total classi ed loans (80.0 percent), amounting to BDT 46155
crore, is Bad/Loss. It is alarming because not only a bulk amount of classi ed loans were
bad loans but also the proportion is increasing over the years. The sub-standard and
doubtful loans constituted 11.2 percent and 8.8 percent respectively in September 2015

Bank-wise information indicates that the non-performing loans were widely distributed
among the banks (Chart-1). The distribution of banks based on their NPL to total loans
ratio indicates that the number of banks with double digit NPL increased from 12 in
2013 to 15 in September 2015. Moreover, 10 banks have NPL ratios over 20 percent
which should be the serious cause of concern for the regulator
Chart-1: Distribution of Banks by Classi ed Loans to Total Loan Rati

Source: Financial Stability Report, BB and Quarterly Financial Stability Assessment

Report, BB

It is recognised that managing credit risk should be a serious concern for the banks as it
has signi cant impact on pro tability and has severe effect on nancial stability. The
signi cance of nancial stability can be better understood in the backdrop of the global
nancial crisis of 2008 that resulted in the collapse of nancial markets and institutions.
To accomplish banking stability, the banks are

required to maintain quality bank assets which can be achieved through proper credit
risk management. The failure to ensure banking stability can cause nancial fragility and
may lead to crisis scenarios. Credit risk not only affects the nancial and operating
performance of the bank, but also impacts the soundness of the national nancial
system.

References
Bangladesh Bank, Financial Stability Report, Dhaka, Various Issues.

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Bangladesh Bank, Financial Stability Assessment Report, Dhaka, Various Issues.

Ahmed, N., A. C. Pandit and M. Z. Hossain (2014), Bank Credit Quality in a Recent
Changing Business Environment: Issues and Challenges, Banking Research Series,
BIBM, Dhaka

Gestel, T.V. and Baesens, B. (2009), Credit risk management [E-book] Available through:
Oxford Scholarship Online

Habib, S.M.A.H., M. N. Ahmed, A. C. Pandit and M. Z. Hossain (2013), Bank Credit

Quality in a Recent Changing Business Environment: Issues and Challenges, Banking
Research Series, BIBM, Dhaka.

Psillaki, M., Tsolas, I.E. and Margaritis, D. (2010), Evaluation of Credit Risk Based on
Firm Performance European Journal of Operational Research, Vol. 201(3), pp. 873-
888.

Siddique, M.M., D. R. Karmaker, M. Alamgir and M. M. Hossain (2013), Loan Quality

Management in Banks: Problems of Selecting Right Borrowers, Banking Research
Series, BIBM, Dhaka, pp. 35-66

Tsai, D. H. and F. W. Huang (1999), Management Quality and Bank Ef ciency: Empirical
Evidence for Taiwanese Banks. Management Review, Vol. 18 (3), pp. 35-55

Glossary-Credit Risk
Credit risk is de ned as the possibility that a borrower or other contractual
counterparty might default, i.e. might fail to honor their contractual obligations.

Migration Risk refers to the potential deterioration of the credit quality of an un-
defaulted exposure. This form of potential loss is generally also subsumed under a
broader de nition of credit risk.

Transaction Risk refers to individual loans and essentially measures (1) the standalone
probability that the borrower will not be able to repay, as well as (2) the ultimate loss in
the case of a borrower default after use of collateral and other mitigating factors.

Portfolio Credit Risk is a risk that arises from credit portfolio concentration or from
systematic reasons.

Expected Loss (EL) is the average or mean amount of credit loss to be incurred over a
particular time period. The loss is measured as the present value or book value of
receivables that will not be collected or will have become unrecoverable and therefore
will be written off or otherwise expensed during a particular period of time.

Probability of Default (PD) is the percentage probability of a borrower entity to

produce a default event as perceived by the lender over a speci ed period of time,
typically one year. The PD is most often stated for a future period beginning
immediately, but can also be expressed as a forward default probability beginning in one
year for one year, for example.
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Exposure at Default (EAD) is the total balance owed by the borrower to the particular
lender at time of default expressed in currency units.

Loss-given-default (LGD) is the percentage of EAD that is considered lost, once it has
been established that a default has occurred. The LGD is equal to 100% minus the
percentage of EAD that will be recovered by way of liquidation of collateral and other
post-default collection actions.

Initiation of BIBM-Frankfurt School Joint

Certi cation Program on Risk Management
Dr. Shah Md. Ahsan Habib
Professor, BIBM

BIBM launched its rst joint certi cation program Certi ed Expert in Risk
Management with the Frankfurt School of Finance and Management of Germany in
2015. Actually, the initiative of this certi cation was rooted in June 2014 when a MOU
was signed between our honourable Governor of Bangladesh Bank Dr. Atiur Rahman
and the President of the Frankfurt School. Director General of BIBM Dr. Tou c Ahmad
Choudhury also attended the event. This opened the door for joint initiatives and
academic endeavors between these two institutions.

In January 2015, I represented BIBM in a members meeting of European Banking and

Financial Services Training Association (EBTN) hosted by the Frankfurt School and took
the opportunity to negotiate with the Frankfurt School management in regard to the
initiation of a joint certi cation program on Risk Management as consented by the DG,
BIBM. In the process of negotiation, I conceptualized the structure of the program that
was agreed upon by Dr. Barbara Drexler, the Associate Dean of Frankfurt School of
Finance and Management. I received immense cooperation of Mr. Nicolas Parisel,
Project Coordinator of International Of ce, Frankfurt School in the process of
negotiation. Following an agreement with Frankfurt School, I along with my two
colleagues Mr. Md. Nehal Ahmed, Associate Professor and Mr. Atul Chandra Pandit,
Assistant Professor of BIBM prepared a concrete proposal covering detailed structure,
syllabus, fees, and other relevant issues, as instructed by the DG BIBM. The proposal
was then duly approved by the Executive Committee and Governing Board of BIBM for
implementation.

The Certi cation Course targets mainly to enhance capacity of the bank executives on
risk management constituting all key banking risks-credit risk, operational risk, interest
rate risk, foreign exchange risks, and liquidity risk. It is a program of nine months with
two modules: rst module is offered online by the Frankfurt school; and the second
module will be delivered by BIBM in its own campus. The initial response from the
banking community is really encouraging. The rst two batches ( rst intake) for the
course were enrolled in September 2015 and already completed Module A with the

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Frankfurt School. BIBM will start Module B for the rst intake batches in April 2016.
Two batches for the March, 2016 session (second intake) are already enrolled for the
program.

To start the journey of this Joint academic venture, the program was formally
inaugurated by the honourable Governor of Bangladesh Bank and Chairman of the
Governing Board of BIBM Dr. Atiur Rahman. We hope and believe that with patronage
and support of our member banks the program would be able to deliver in bringing
positive changes in the risk management practices of the bankig sector of Bangladesh.

Revised Core Risk Management Guidelines

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

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