DEPARTMENT OF Accounting AND FINANCE

A STUDY ON THE CREDIT RISK MANAGEMENT SYSTEM OF DASHEN

BANK IN CASE OF HAWASSA CITY.

A Senior Essay Submitted To The Department Of BANKING AND

FINANCE In The Partial Fulfillment Of The Requirement For The
Degree Of Bachelor Of Art (B.A) OF ACCOUNTING AND
FINANCE.

BY: SHIMELIS BOGALE

ADVISOR: Mr. P. ATHMA KARAN REDDY

JUNE, 2012
Hawassa
              

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  Acknowledgement

First   and for   most   our   thanks  goes  to God  and  without whom  we

could never have been what we are today.

Next   our   greatest   thanks   to   our   advisor   Mr.   Karan.   He   gave   us   a

constructive Advice and comments through out our work.

Finally, for myself only I would like to thank my friend Fekadu for

editing and Abinet business center who received the burden of typing

the essay.

                                     

                             Thanks All!

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                          TABLE OF CONTENTS 

CHAPTER ONE             PAGES

1. Introduction ………………………………………………………………………………….1

1.1 Background of the study ……………………………………………………………………1

1.2 Background of the organization …………………………………………………………….2

1. 3 Statement of the problem …………………………………………………………………..3

1.4 Objectives of the study …………………………………………………………………..…3

1.5 Objectives of the study ………………………………………………………………….….4

1.6 Scope of The study…………………………………………………………………………5

1.7 Limitation of the study……………………………………………………………………..5

1.8 Methodology of the study………………………………………………………………….5

1.9 Organization of the study ……………………………………………………………….…6

CHAPTER TWO REVIEW OF LTERATURE

2.1. Definition of credit risk……………………………………………………………………7

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2.2. The need of credit risk management ……………………………………………………...7

2.3 Principles of credit risk management ……………………………………………….……9

     2.3.1. Establishing an appropriate credit risk environment…………………………..……9

2.3.2. Operating under a sound credit granting process …………………………….…...10

2.3.3. Containing an appropriate credit

Administration, measurement and monitoring process …………………………………    10

2.3.4. Ensuring adequate controls over credit risk ………………………………………11

2.3.5. The role of supervisor…………………………………………………… ………11

2.4. Credit risk management approach ……………………………………………………..12

2.4.1. Minimal risk Approach ………………………………………………………….12

2.4.2. Price for risk approach ………………………………………………………….13

2.4.3. Diversity of Risk Approach…………………………………………………….15

2.5. Credit risk management cost……………………………………………………….….15

2.6. Credit risk management function ………………………………………………….….17

2.6.1. Credit analysis and appraisal …………………………………………………...17

2.6.2. Work out procedure …………………………………………………………..…19

2.6.3. Loan monitoring and review ……………………………………………………19

CHAPTERTHREE         DATA ANALYISIS AND INTERPRETATION

3.1. Lending activity of Dashen Bank ………………………………………………….…..20

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3.2. Organs involved in credit risk management……………………………………….…...22

3.3. Credit risk Management practice of Dashen Bank………………………………….…25

        3.3.1 Objectives of Credit Risk Management…………………………………….……26

       3.3.2. Causes of Credit Risk……………………………………………………………26

3.4. Preventive Techniques Method…………………………………………………….…...27

3.5. Mechanism to reduce credit risk ……………………………………………………….29

3.6    Problems in Dashen Banks Credit Risk Management………………………………....….33

CHAPTER FOUR      FINDINGS, CONCLUSIONS AND RECOMMENDATIONS

4.1   Findings and Conclusions………………………………………………………………..…35

4.2. Recommendation…………………………………………………………………………....37

       Reference

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 REFERENCE 

 Carol Alexander 1999, Risk management and analysis volume I

Paul S. may land  1993, bank operating credit risk

Pony von vestal 20014 credit risk management basic concept.

Tray G.Herrik 1990 Bank analysis 

Http/www. Bir.org.pdf: Battle committee, on bank supervision 
(Nov1999), principle for the management of credit risk.

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Http/www. Erisk.com v. vedson 2003: credit risk assessment in bank

Hawassa University 

School of Accounting and Finance 

Department of Accounting and Finance 
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 Interview Questions 

1. What are the major elements of credit policies and procedures in this area

bank?

2. What is the objective of credit risk management process in this local bank?

3. What is the cause for the existence of credit risk?

4. What are the preventive techniques or methods of credit risk? 

CHAPTER ONE

                                                  Introduction 

1.1   Background of the study 

In the banking there are various types of services provided by the institutions. Among these,

credit operations are one of the most important core businesses of the Bank. The word Credit

drives from the Latin word “Creder” which shows the existence of trusts between borrowers and

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lender.   Without   this,   the   development   of   modern   industrial   community   would   have   been

impossible. The major principle believed in credit is “Buy now­pay latter”. The principle shows

that in the absence of cash on hand business entities in the economy can delay payment until

fund is available, by making agreement with seller. Most of the time the counter made between

buyer and seller, borrower and lender may become inefficient because of many reasons.   The

existence of problems in the credit lends to the concepts of “credit risk management” on the

other hand the importance of credit for banks can be seen by its being one of the risks bank face.

Banks have managed four types of risk to earn profits for maximizing share holder wealth. The

risks are credit risks, interest rate risk, liquidity risk and operational risks. And all the risks

mentioned above are directly or indirectly related to credit. The credit risk management process

of bank is believed to be a good indicator of the quality of the banks portfolio. (Source: Robert J.

1994:4)

The importance of credit in the banking industry can be seen position in the financial statement

of banks.  Loans are the most important asset in any commercial bank. Loans account for half to

almost  three quarter of the total  value of all bank assets. In the income statement  of banks

interest and fees generated from loans account for most banks. Revenues, normally two­thirds or

more of the total income (http://www. erisk.com).

In the competitive environment, more and more lines of business which need a huge investment

are being opened. Some of these huge investments are financed through commercial banks loans.

With this respect, banks play a major role in the overall  economic  development  of country.

However,   in   this   process   of   extending   credit   to   customer,   a   bank   should   have   a   way   of

scrutinizing its borrowers so that it would minimize the risk of default .The effect of default is

not limited to that of affecting the profit   of one particular bank but it has a ripple effect that

extends itself in to the economy at large . Hence, prudent banks are concerned about the quality

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of their loan and the effectiveness of their risk management process in order to safeguarding their

business as well as the overall economy. (Herrick,1990:68)

       1.2    Background of the organization 

According   to   national   bank   of   Ethiopia   /NBE’s/   release   on   history   of   banking   in   Ethiopia;

monetary   and   banking   proclamation   number   83   /1994   and   the   licensing   and   supervision   of

banking business number 84/1994 laid down the legal basis for investment in the banking sector.

Consequently,   Dashen   Bank   succeeding   Awash   International   Bank   to   be   the   2 nd  private

commercial bank on September 1995. (The history of banking and other financial institutions in

Ethiopia, NBE: official website www.dashenbank .com/ index .htm)

The total number of Dashen area Banks had reached 52 excluding the previous four /4/. Foreign

exchange bureaus and the additional one at international while the number of cash points, A

automated Taler Machine (ATM) and point of sale (POS) terminal ,has reached 45 and 698

respectively (According to annual report of Dashen bank as per June 2010)

The bank use common banking solution called flex­Cube to support their banking operation as

the current business request. Dashen Bank starts to use FLEXCUBE some years back with latest

version 5.1. Thus, it gets much easy for the said bank to use the prospect and current fruits of

ICT world to give efficient and reliable service to customers.

Dashen Bank is the first bank in Ethiopia to be appointed a principal member of VISA. Payment

card usage the bank was prompted by a number of key requirements including the need for a

scalable solution to meet transaction growth objectives, support for multiple delivery channels

and devices, and the ability to offer world – class card payment services to over 300,000 existing

customer accounts in Ethiopia . “As per information comes from the Bank ,” there are 698 point

of sale /POS/machines at different merchant outlets and 45 ATMS installed at different place of

the country to serve more than   30,000 card holders. As  the result of Bank effort for fully

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networked branches, it has got more read to transfer money with seconds between area branches.

Broad Band  Local Money Transfer /BLMT/service count sometimes past with in banks, having

similar  effect of well known money transfer service, Telecom  Transfer /TT/,  but with more

efficient effective result.

Dashen Bank in Hawassa Area was established on January 15,1996. As of June 30,2010 the area

bank has 27,326 numbers of depositors, 259 numbers loanees and 4,396 payment card holder and

10 point of sale /POS/ merchants. Being a pioneer to introduce the payment card system and with

an excellently rated service delivery quality, the area bank has been also to maintain the leading

position for the last few years. 

Dashen Bank with in the country, are hopefully expected to show all achievements in electronic

banking and latest technology in use to handle more competitive market in the industry to come.

                    1. 3 Statement of the problem 
Credit risk is the main cause for most bank failure. It can be raised when the debtor can not

be able to pay interest or repayment of principal according to the terms specified in credit

agreement. High credit risk would reduce earnings   and capital, increase administration cost

of bank and induce liquidity problems affecting cash flow. That is why it is essential that

management focus much of its attention on managing the loan.
This study tries to investigate the following questions. 
 What are the credit policies of the bank?
 What are the preventive techniques and control procedure for a loan?
 What   are   the   problems   and   challenges   with   regard   to   the   bank’s   credit   risk

management endeavors?
 What is the sources of information to assess credit risk?
 What methods are used in order to assessing credit risk?
1.4      Objectives of the study 

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This study is to achieve both general and specific objectives related with   evaluation of credit

risk management practice of Dashen bank in Hawassa branch. 

1.4.1    General Objective
The general objective of this study is to assess credit risk management system of Dashen bank in

Hawassa branch and to find out the problem related with credit risk management practice.
               1.4.2   Specific objective

The specific objectives of the study are:

 To review  credit risk management practice of Dashen Bank (a review  of the

sufficiency of the information received which is used as a basis for extension of

credit ,loan supervision and work out procedure to collect bad debt.)
 To identify the major causes of credit risk management practices of Dashen bank
 To assess the methodology that the bank has used to reduce credit risk. 
 To identify problems and challenges that the bank is facing in managing credit

risk.

                            1.5 Significance of the study

An efficient credit risk management system is the determining factor for success in changing

business environment.  Banks need to predict scientifically the exact level of risk they are going

to assume by entering in to a contract in availing credit to the customer.(Paul,1991: 78)

The following are the significance of the study. 

This   study   is   useful   in   bringing   in   to   light   the   strong   and   weak   points   in   the   credit   risk

management.

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  This paper mentions several important ideas which is the best reference for the

future researcher.
 Other organizations use this method to avoid the risk of credit as the organization

perspective.
 This   study   attempt   to   find   out   problems   related   with   credit   risk   management

system. And as such better approach to deals with maintaining good credit risk

management system level in any organization. It provides information for future

research those who want to do.
 This study also provides relevant recommendation and conclusion by assessing a

theoretical and description for better method for credit risk management practice

in the organization.

               1.6    Scope of The study

Poor loan quality is not the only outcome of the poor credit management alone. There are other

factors that can contribute for the deterioration of quality of a loan, for example natural factors.

However, this study is limited to credit risk management of Dashen Bank in Hawassa branch. 

1.7    Limitation of the study

We face the following limitations when conducting the study: 

 Lack of appropriate , accurate and reliable and current data
 Financial constraint to collect enough and necessary data from different area
 Time constraints to conduct the study briefly
 Lack of our past experience to conduct this research.
1.8     Methodology of the study

1.8.1. Data type

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We use both quantitative and qualitative data to conduct our study. It consists of graph and tables

to conceptualize data analysis.

  1.8.2. Source of Data 

The paper is based on primary and secondary data source 

                               Primary data source: 

It   is   mainly   available   from   personal   interview   of   the   selected   division   head   of   the   Bank

/management   of   the   Bank   officer,   which   helps   the   study   to   be   furnished   with   first   hand

information. 

                             Secondary data source:

This data is mainly available from the policy manuals, annual reports and publications also used

as backup means of collecting second hand information.

              1.8.3 Methods of data analysis 

This paper is attempt to summarize more of what already known and inter related the existing

knowledge,   data,   reports,   study   etc.   In   this   paper   descriptive   and   analytical   techniques   are

employed  to  show  the  techniques  and methods  of credit  risk management  through manuals,

annual reports etc.

1.9     Organization of the study 

This paper organized in to four major parts. In the first part , the study have been tried to indicate

introduction with background of the study , background of the organization ,statement of the

problem ,objective of the study, significance of the study, scope of the study, limitation of the

study and research methodology . The second chapter deals with literature review. The third

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chapter   consists   of   data   analysis   and   interpretation   of   findings.   The   final   chapter   includes

conclusion and recommendation of the study.

CHAPTER TWO

Review of Literature

2.1. Definition of credit risk

Banks make money by providing services that their customer wants and by granting them credit.
There are some risks with these services and the most significance risk is credit risk.

According to Paul (1990) credit risk is the risk of loss due to the financial weakness of the bank’s
customers. Generally, that the customers will not be able to provide funds, to settle its
transaction, usually due to bankruptcy or some other liquidity crisis

It also defines credit risk by another author as follows:

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It is the risk that a borrower will be unable to meet its obligation. A bank reflects and aims to
profit from taking credit risk by charging higher interests margins on loans to those customer that
is consider present a higher risk.(Brigham,1991:400)

2.2. The need of credit risk management

According to (http/www.erisk.com) bank oil the wheels of the economy. They play a pivotal role
in mobilizing saving. In doing so, they face risks arising from credit, interest rate, liquidity,
exchange rate, transaction, compliance, strategic and reputation. Banks key challenge in
managing risk in understanding the interrelation of this risk factors they may be positively or
negatively correlated. To be consistent with the research them the focus here is on credit risk,
which is the risk repayment, that is the possibility that an obligor will fail to perform as agreed.
Banks led to individuals, corporations and government who in turn contribute to growth,
employment and better socioeconomic conditions.

The goal of credit risk management is to maximize a banks risk adjusted rate of return by
maintaining credit risk exposure with in acceptable parameters, Banks need to manage the credit
risk inherent in the entire portfolio as well as the risk in individual credit or transactions.

Banks should also consider the relationship between credit risk and other risk the effective
management of credit risk is a critical component of a comprehensive approach to risk
management and essential to the long term success of any banking organization. For most banks,
loans are the largest and most obvious source of credit risk. However, other sources of credit risk
exist throughout the activities of a bank, including the trading book and both on and off the
balance sheet. Banks ate increasingly facing credit risk(countered party risk) in various financial
instruments other than loans ,including acceptance, inter bank transaction, trade financing
foreign exchange transaction, financial future, swaps, bonds ,equities, options and in the
extension of commitment and guarantees, and the settlement of transaction.

The taking of credit risk is a principal function of banks. How a bank approaches credit risk
represents one of its important policies. The willingness of banks to take credit risk has provided
a major service to market economics throughout banking history. The help of banking business is
assessing credit risk not necessarily taking risks, but assessing them. The distinction is important

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because the ability to assess is asking and whether the credit risk are taken or not taken is a
management decision.

Since exposure to credit risk continuous to be leading sources of problems in banks and their
supervisors should able to draw useful lessons from past experience. Banks should now have a
keen awareness of a need to identify measure, monitor and control credit risk as well as to
determine that the hold adequate capital against these risks and that they are adequately
compensated for risks incurred.

A further particular instance of credit risk relates to the process of setting financial transactions.
If one side of transaction is settled but the other fails, a loss may be incurred that is equal to the
principal amount of the transaction. Even if one part simply lat in settling, the other party may
incurred relating to missed investment opportunities. Settlement risk (i.e. the risk that completion
of settlement of financial transaction will fail to take place as expected) thus includes elements of
liquidity, market, operational and reputation risks as well as credit risk. The level of risk is
determined by particular arrangement for settlement. Factors in such arrangement that have a
bearing on credit risk include. The timing of the exchange of value payment settlement finality.

2.3 Principles of credit risk management

The goal of credit risk management should always be to maximize banks risk adjusted rate of
return by maintain credit risk exposure with in the entire portfolio as well as the risk individuals
credit or transactions. Bank should also consider the relationships between credit risk and other
risk. The effective management of credit risk is a critical component of comprehensive approach
to risk management and essential to long term success of any banking business.

The Basel committee promotes sound practices for managing credit risk. In line with this
objectives, the committee has outlined principles of credit risk management which are mainly
applicable to the business of lending and it believes that banks should now have a keen
awareness of the need to identify, measure, monitor and control credit risk As well as to

17
determine that they hold adequate capital against these risks and that they are adequately
compensated for risk incurred.

Although specific credit risk management practices may differ among banks depending upon the
nature and complexity of their credit activities, a comprehensive credit risk management
program will address the following four areas of credit risk management identified by the
committee.

2.3.1. Establishing an appropriate credit risk environment

Principle 1: The board of director should have responsibility for approving and periodically (at
least annually) reviewing the credit risk strategy and significant credit risk policies of the bank.
The strategy should reflect the bank’s tolerance for risk and level of profitability the bank
expects to achieve for incurring various credit risks.

Principle 2: Senior management should have responsibility for implementing the credit risk
strategy approved by the board of directors and for developing policies and procedures for
identifying, measuring, monitoring and controlling credit risk. such policies and procedures
should address credit risk in all of the bank’s activities and at both the individual credit and
portfolio levels.

Principles 3: Banks should identify and manage credit risk inherent in all products and
activities. Bank should insure the risks of products and activities new to them are subject to
adequate risk management procedures and controls before being introduced or under taken and
approved the body of director or its appropriate committee.

2.3.2. Operating under a sound credit granting process

Principle 4: Banks must operate with in sound, well defined credit granting criteria. These
criteria should include a clear indication of the banks target market and a through understanding
of the borrower or counter party, as well as the purpose and structure of the credit and its source
of repayment.

Principle 5: Banks should established overall credit limits at the levels of individual borrowers
and counter parties and groups of connected counter parties that aggregate in comparable and

18
meaningful manner different types of exposure, the banking and trading book and on and off the
balance sheet.

Principle 6: Banks should have a clearly established process in place for approving new credits
as well as amendment, renewal and refinancing of existing credits.

Principle 7: All extensions of credit must be made on an arm’s length basis. In particular, credit
to related companies and individual must be authorized on the exception basis, monitored with
particularly care and other appropriate steps taken to control or mitigate the risks of non-arms
length lending.

2.3.3. Containing an appropriate credit Administration,

measurement and monitoring process

Principle 8: Banks should have in place a system for the ongoing administration of their various
credit bearing portfolios.

Principle 9:- Banks should have in place a system for monitoring the condition of individual
credit including determining the adequacy of provision and resources.

Principle 10:- Bank is encouraged to develop and utilize an internal risk rating system in
managing credit risk. The rating system should be consistent with the natures, size and
complexity of a bank’s activities.

Principle 11:- Banks must have information systems and analytical techniques that enable
management to measure the credit risk inherent in all on and off balance sheet activator. The
management information system should provide adequate information on the composition of the
credit portfolio, including identification of any concentration of risk.

Principle 12:- Bank must have in place a system for monitoring the over all composition and
quality of the credit portfolio.

Principle 13:- Banks should take in to consideration potential future changer in economic
conditions when assessing individual’s credits and their credit portfolio and should assess their
credit risk exposure under stressful conditions.

2.3.4. Ensuring adequate controls over credit risk

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Principle 14: Banks must establish a system of independent, ongoing assessment of the banks
credit risk management process and the result of such reviews should be communicated directly
to the board of director and senior management.

Principle 15: Banks must ensure that the credit granting function is being properly managed and
that the credit exposures are with in levels consistent with prudential standards and internal
limits. Banks should establish and enforce internal controls and other practices to ensure that
exceptions to the policies, procedures and limits are reported in a timely manner to the
appropriate level of management for action.

Principle 16: Banks must have a system in place for early remedial action on deteriorating
credits, managing problem credit and similar workout situations.

2.3.5. The role of supervisor

Principle 17: Supervisors should require that banks have an effective system in place to identify
measure, monitor and control credit risk as part of an overall approach to risk management
.Supervisors should conduct an independent evolution of a banks strategies, procedures and
practices related to the granting of credit and the ongoing management of the portfolio.
Supervisors should consider setting prudential limits to restrict bank exposure to single
borrowers or groups of connected counter parties.

2.4. Credit risk management approach

According to Herrick (1990) banks manage their credit risks there are three approaches. They are
minimizing risk, price risk and diversity of risk approach. All approach requires an ability to
assess credit risks. The difference between the three approaches is the way assessment of risk is
used by the banks.

2.4.1. Minimal risk Approach

The minimal risk approach to credit risk management attempts to separate loans, securities and
other assets in to two groups. The first group includes credit in which there is no reasonable
doubt that the asset will be redeemed at face value, or in the case of equity investment, no
reasonable doubt that the environment will provide a significant return over a period of years.
20
The other group include all assessments of credit risk where it appears that a credit might not be
redeemed or an equity investment might not provide a good return. Many young bankers of the
time told themselves that they would do that what ever was needed to prevent the experience
from happening again.

One preventive measure was to look carefully at qualify the loan application. Little could be
done about past loans. Many of them were either on the workout basis or on salvageable. But
new loans and some renewed loans were the type of business over which a banker had some
discretion .Banker did not feel confident about drawing fine lines of various degrees of risk and
credit worthier. Loans which were not likely to be repaid, beyond reasonable doubt simply were
made. The minimal risk approach relies on the classic three C’s of credit; character, capital and
capacity. The risk approach to credit risk requires that bankers act as a helpful friend, a
consultant and an advisor who user firm persuasion when necessary. This informal relationship
adds a subtle, but strong, pressure to the management of any organization to keep its affairs in
good shape. Moreover, if a banker approach credit risk from the minimal risk approach, his effort
is directed to prevent any losses risk from occurring. There is no place in his thinking for losses
and he makes extra ordinary efforts to full fill this outlook.

To a banker with this credit risk approach and with dedication to his customers, there is often a
feeling of person’s failure if loss occurs. This psychological incentive to prevent losses provides
an important part of attitudes of bankers with a strategy that strives to minimize risk. The effect
of the minimal risk approach is that it tends to keep activities restricted to areas that are already
well known to a bank new areas of banking involve greater uncertainties then areas that are part
of daily banking activity. A step outside this circle of knowledge and friends reduces the value of
years of banking acquaintance in other established areas of business or government .Although
the minimal risk approach has this important limitation built into its philosophy , many banks
have very successful for many years following this policy of credit risk.

2.4.2. Price for risk approach

Risks pricing recently has developed as an alternative approach to credit risk. The interest that
charged for a loan of greater risk. In recent years, this approach also has relied on the basic

21
method of credit analysis noted with the minimal risk approach, but carries the conclusion much
further.

The risk pricing approach looks at all degrees of risk as a normal part of the banking business. In
effect, it views the assets of the bank loans, securities, and investment in various shades of white
and grey and accepts all o\f them as legitimate ,worth while assets . Assets of greater credit risk
involves greater risk of loss but these of greater credit risk involve greater risk of loss , but these
assets are expected to be priced to earn enough more interest income to offset their credit risk , a
profit for the bank . Assets of little credit risk involve low risks of loss. These assets are expected
to earn lower interest rates and also earn profit for a bank. If risk pricing is done properly, assets
of all types of credit risk should show approximately the same profit to a bank. The risk pricing
approach reflects two trends in banking during the past decade. First, has been a growing
assurance among many banks that they possess the technical capabilities of assessing risk to
greater extent than did an earlier generation of bankers. New techniques have been applied to
banking that did not exist a generation ago. Computers have enabled banks to handle much
greater quantities of information. Operations research and system research have opened new
ways generation of analyzing information. Operations research and system research have opened
new ways of analyzing information.

A new generation of thinking has risen which believer that it can make more accurate
conclusions based on factual experience than on the rule –of – thumb guides and the personal
judgment of credit officers ,loans officers and securities traders .Many banker have been
emboldened by these greater technical resources in much the same way and at about the same
time that many economists developed their confidence in being able to “fine tune” the economy
and many psychologists developed their confidence about “motivating” people. All of these
approach to knowledge rest on supreme confidence that there are highly refined ways of
conducting operation that will bring superior results. The second trend underlies the growth of
risk pricing is the recent emphasis for the banks to show strong earnings gains.

Risk pricing opens the door to major expansion in banking. Business a large proportion of a
business that would be turned down on the basis of the minimal risk approach becomes choice
bankable business. To work successfully over a long period, the risk price approach requires
three conditions. The first requirement is a need for a large number of assets in the banks asset

22
portfolio. The basis of risk pricing is that a banker does not know which loan, security or
investment will require emergency efforts, reduced terms of fail, but he should have good idea of
likelihood that these difficulties could occur in large portfolio.

The second requirement is that the bank needs a staff with considerable analytical skills. The
process of assessing various degrees of risks is not a task that a one or two main credit
department can easily handle. The development of risk pricing format for a bank involves major
statistical operation. Moreover, the risk pricing format for one bank would not necessarily be
appropriate for another bank. A risk pricing format provides specific guidelines shown the way
particular bank will price a loans, security, or investment and reflects the franchise of a particular
bank,its personnel and its ongoing business relationship with customers.

The third requirement is that a bank needs to possess an outstanding forecasting capability. Risk
pricing is concerned about the future and must make much more complete and accurate
assumptions concerning the future conditions of credit markets, business activities and attitudes
of debtors.

2.4.3. Diversity of Risk Approach

Credit risk management often diversifies a portfolio of loans, securities and investments at a
simple yet.

Effective way of keeping problems of credit risk under control. However, the approach is
sometimes mistakenly used to justify taking greeter individual credit risk or slimmer risk price
premium than otherwise would be justified, which is mistaken.

In fact, diversity can only partially control risk and it is not an approach to credit risk that can
stand independently of other approaches. For example ,if credit department of bank is covered by
other departments , or is not well managed , and low quality assets are acquired with no
appreciable risk premium , a program to diversity these assets would not eliminate their risk . It
would mean that the bank would hold a wide variety of low quality assets. Diversity permits the

23
more fundamental approaches to credit risk minimal and risk pricing to be fulfilled in true colors.
If reduces the likely hood that random or accidental occurrence will have an appreciable effect
on one of these fundamental policies.

A major practical problem in diversifying credit risk is determining what constitutes diversity.
There are literally thousands of ways of classifying assets, and a case could be made that many
of the categories represent diversity on logical ground. Yet to be effective, risk diversity requires
relevant categories and the determination of the relevant categories is not an easy matter.(Herrick
,1990: 135)

2.5. Credit risk management cost

The starting point for efficient credit control is recognition of the cost of credit and its potential
effects on profit and liquidity. Techniques for managing operating credit risk build on the board
principles of risk management that are already deeply ingrained in banking practice. There are
three basic ways to manage carry costs to consider. They are:

1. Exposure reduction: - This credit exposure could be eliminated by requiring the

customer to provide collateral or guarantees. Banks have their own specialist lenders and
credit risk assessors who have the skill s and experience to assess risk reduction.
Although exposure reduction techniques are generally not expensive for banks to
implement, they often result in higher customer costs.
2. Risk control:-Programs to control risk on the other hand can involve a change on
operations and are often expensive to implement. This is designed to monitor the actual
level of risk or it changes and to refer to transaction to the proper credit authority for
approval before the exposure is carted.
3. Loss funding:-provision must also be made for any losses that do occur. Although banks
ensure loans losses by deducting a provision from earnings to create are sere, must do not
use this mechanism to ensure against losses from operating services. Ideally, reserves
should be built and capital allocated to operating services in proportion the risk they
incur.
The determine the level of credit risk to be funded , the following have to be considered :
how much risk remains after implementing exposure reduction and risk control

24
 procedures , the operation dependability of the efforts and an analysis of the likelihood of
loss from the remaining exposure.(Paul F.,1991:132)

Credit risk management is divided in to two faces according to Churchill and Dancoster (2001)

I. Prior to issuing a loan, a lender reducer credit risk through control, that reduce the potential for
delinquency or loss commonly known as preventive steps before issuing a loan and it includes :
loan terms , loan amount reflecting the clients repayment capacity ,legibility , criteria for a loan
request , repayment frequencies , collateral, ability and willingness of borrowers to repay a loan
and check credit history with suppliers and other credit organizations.

II. Once the loan is issued a lenders risk management expands control that reduce actual losses,
commonly know or controls after extending loans. It includes the following features

 Periodically analyzing the portfolio quality with intent to modify procedures and
policies before the loan quality deteriorates
 Field staff and clients must understand that late payments are not acceptable and
clients should be penalize for the late payments or rewards to early payments.
 There should be effective follow up procedures
 The consequence of loan default must be successfully unappealing to clients.
All credit departments should have credit management manual in order to standardize
procedures. The manual should be regularity updated to account for changes in procedure and
circumstances. The manual contains :- statements of credit policy , methods of payment for
various of account, specimen of management information forms and reports and the time table
for completion and procedures for account collection , credit sanction ,legal action, disputes ,bad
debits, credit limits etc.

2.6. Credit risk management function

According to Bass (1998) credit risk management is the core to achieve the desired objective
credit risk management contains three basic functions and these are: credit analysis and
appraisal, credit monitoring and review and workout procedures

2.6.1. Credit analysis and appraisal

25
Having compiled a basic file of information and investigated revenues suggested by
inconsistencies, derogatory comments, and favorable opinions, the analysis assess the
willingness and ability of the applicant to repay. Each of these describes an area of the persons or
firm’s credit worthiness.

1. Character: - The quality of desiring to repay debates when due is tanked above all other
considerations. Of course, honesty is a necessity, but character implies integrity and
empathy for the lender position as well. An established credit record (substantial
borrowing and voluntary repayment) is one of the best evidences of business or
individual willingness to repay. Also, character is implied by the applicants’ position of
trust accepted and full filled in business and social organizations follows that of top
management, its facilities for keeping records, the reutilization of office functions and
relations with employees.
2. Capacity: Capacity is the ability to repay debuts as scheduled for households, the
employment of the working member provides most of the income which is spent for
consumer expendables, and debt repayment .consumer capacity is a reflection of safety
margin between income and committed outflows and the stability of each. The analysts
must consider the effects of unusual events such as prolonged illness or unemployment
on the economic capacity of the household. Business capacity, like wise, depends upon
sales income expenditure patterns, and debt commitments. However, the complexities of
business operations are substantially greater than that of household, requiring analysis
highly trained in corporate finance and knowledge about the accounting, marketing and
financial peculiarities of the firm and its industry.
3. Capital: This faces of the applicant refers to his or her financial strength, that is, the
ability to raise funds from the liquidation of assets or other businesses. As last resort the
borrower’s capital may repay the debt, but such actions generally mean the termination of
the borrower’s business and, of course, the relation ship with the leading institution.
4. Conditions: - Borrowers may be subject to unfavorable economic conditions beyond
their control. Repayment depends not only upon character, capacity and collateral, but
those factors over which the borrowers exercise little or no control. The long-run and
short run business cycle affects nearly all persons and individuals, but certain industrials
are especially prone to oscillate between prospect and depression. Credit analysis monitor

26
 industrial patterns, looking for early signs of weakness which lead to unemployment, say
declines and/or operating losses. Under the extreme adverse pressures of falling sales and
loss of income, even strong, honest character may subvert the loan relationship in order to
pressure their economic position.
5. Collateral: - It is an asset, normally moveable property pledged against the performance
of an obligation. Bank can sell the collateral if the borrower defaults, while collateral
reduces banks risk; it enhances the cost in terms of documentation and monitoring the
collateral. The factor determines suitability of the collateral is standardization, durability,
identification, marketability and stability of value. Standardization helps in identifying
the nature of asset that is being used as collateral. Durable refers to useful life or ability to
with stand wear and tear. Durable asset make better collateral. Identification is possible if
the collateral has defined characteristics like a building or a serial number (motor
vehicle). Marketable collateral alone is of value to the bank if it has to sell it.
Marketability must be distinguished from liquidity. Liquidity refers to quick sale with
little of no loss from current of loan (Robabruce, 1997: 808).

2.6.2. Work out procedure

Works out procedure are important aspect of credit risk management. If timely action is not taken
to address the problem loans, opportunities to collect poor quality asset will soon vanish. Work
out procedure involves the following process. Identification of the problems loans, reviewing
loan history and documentation and meet the customer and openly discuss the problem.

The first element of workout procedures is to ensure collection. In the absence of ensuring
collection with in short period of time, arranging new agreements for the borrower if it helps to
get out of problem is an other alternative. The arrangement may be in terms of extending the loan
period for injecting additional capital if the problem is working capital shortage. The last step in
work out procedure is to collect the loan through litigation if possible.

2.6.3. Loan monitoring and review

27
Proper credit risk management involves due credit analysis, having proposition approved, cash
disbursed and ultimately follow up the loan in order to have the extended credit rapid back good
credit could become problem loans unless a continuous follow up is made which enables to
detect signs that reveal difficulties. The objective of credit monitoring and review among others
includes: ensuring the loan are directed to the intended purpose, ensuring that loan convenient
are compiled with following up borrowers business conditions , maintaining good quality of loan
and identifying emerging problems.

Attention should be given to the following while conducting monitoring and review of credit.

Check on all early working signals:- check the end use of the loan funds , assess all conditions of
the borrowers , assess financial need of the borrowers and state finding and interpret them
/improvements, deterioration and changes.

 CHAPTER THREE

                        DATA ANALYISIS AND INTERPRETATION

This chapter of the paper focuses on presentation and analysis of data and information collected

through interview, from annual report and manual .However it seems appropriate to start with

lending activity of Dashen Bank.

3.1. Lending activity of Dashen Bank 

In Dashen banking system, loans and advanced constitute the largest parts of the total asset of the

bank.   The   percentage   of   total   loans   of   advances   to   the   aggregate   asset   of   Dashen   bank   lie

between 61­74% over the last four years as shown in table 3.1.

28
Description  2007 2008 2009 2010
Total asset  108,232,098 142,857,857,143 208,482,868 256,826,392
Total   loans   and 66,021,378 94,285,714 145,527 189,925,113

advances 
Loans as percent 61% 66% 70% 74%

of total asset 
Provision   for 2,508,820 3,300,000 4,656,876 5,317,903

doubtful loans 
Provision   as 3.8 3.5 3.2% 2.8%

percent   of   total

loans   and

advances 
Capital   and 8,562,736 11,316,260 15,892,926 20,952,381

reserve 
            Sources: annual reports of Dashen Bank

As we can seen from the above table the total capital of Dashen Bank reached to 20,952,381 birr

at the end of June 30,2006.

Review of the trend of stock of outstanding loans and advances shows that there has been a

significant  increases  over  the four years. The  total  outstanding  loan  has  increased  from birr

315,402,493 in June 2007 to birr 563,021,789 in June 2010 as shown in table 3.2 below. 

Table 3.2 Outstanding loans and advancement

Categorization                                           Year 
2007 2008 2009 2010
loan 
Manufacturing  71,269,000 97,726,000 102,000,000 127,267,000

Domestic   trade 60,325,600 71,593,000 98,254,000 123,260,000

and services 
Building 56,112,700 63,000,000 87,900,000 115,789,000

29
construction 
Import  47,297,980 36,917,000 71,500,000 96,229,000
Transport  43,463,834 59,371,250 67,327,000 86,911,000
Export  23,481,379 36,000,000 41,289,000 72,539,000
Agricultural  13,452,000 18,229,000 25,886,370 56,700,000
Total  315,402,493 402,836,250 494,156,370 563,021,789
Source: annual reports from 2007­2010

The above table can simply explain the positions of outstanding loans and advance of Dashen

bank through four years. It can also see the position in chart I to show the trend of outstanding

loan were growing for the period from June 2007 to June 2010.

Chart I: outstanding loans and advances

30
From   the   total   loan   and   advances   granted   to   its   customers   the   transport   sector   is   more

emphasized. Because the transport sector is usually risky, purchased vehicles using the banks

assistance are held as collateral. The promoters defaults and disappears from the area hiding the

vehicle. 
               3.2. Organs involved in credit risk management 
The credit risk management department is principally in charge of overseeing the overall

credit risk management of the bank. This involves initiating new credit policies, enforcing

the existing ones and periodically revising the credit policies and procedures and ensuring

that   loans   are   processed   in   accordance   with   the   credit   policies   and   procedures   and   for

warding credit proposals for credit decisions.
The board of director and the president and bodies on the top of the organizational structure

that are involved in credit risk management issues. The BOD attends to the overall strategic

credit and risk management issue of the Bank. It approves credit policies and over sees the

overall credit and risk management of the Bank. The president is responsible for issuing

31
credit   policy   and   ensuring   their   proper   execution.   He   is   also   responsible   for   obtaining

appropriate feed back reports from the credit risk management department of loan status and

in the overall credit management performance and taking remedial actions on irregularities.
The organizational structure of Dashen Bank is presented to the next page.                    

32
Organizational structure                        Board of Director       

President (CEO)

Senior Risk Management Advisor

Controller

Corporate Planning And Development

Executive Secretary

Vice President System And Resource Management Vice

President Operations Management

Chief Of Security

Area Bank

Coordinator

Executive Secretary

Executive Secretary

Information Fund Mgt and Accounts Credit Risk Mgt

Technology

Promotion Customer
Related Service
Engineering And Building Human Resource And Logistics
International Banking

Legal

Area banks

33
                  3.3. Credit risk Management practice of Dashen Bank

As per the interview conducted, credit risk management, credit risk management department the

major element of credit policy are eligibility criteria for every sector being financed by the bank

and 5c’s. And it modifies the policy regularly Dashen bank gathered information by formal and

informal   in   order   to   assess   the   credit   the   credit   risk   of   potential   borrower.   Concerning   the

customers previous bank credit Exposure, the NBE credit information data center provides the

requited information. Besides through different approaches, including implementation of the 5c’s

approach and the customer is properly studied. 

Dashen bank to get the NBE credit information, the bank initiates, requesting letter to the NBE.

The rest information could be obtained through evaluating the organization financial statement

and assessing the background of the customers. Based on the previous credit performance of

borrowed engaged in similar line of business and the current status of the borrower by it self.

Besides external factors such as social, technology, economic and political factors also evaluated

to assess the credit riskiness of potential borrowers.

Credit risk, both on hand and off balance sheet, it managed and monitored in accordance with

credit policy and procedures. The credit worthiness of each counter party credit risk the bank

insures, whenever necessary, that all loans are secured by acceptable form of collateral .Although

the bank has not established credit limit across industries and product, it regularly reviews its

credit exposure.

 The primary roles of banks are to gather and deposits with safety and lend them on sound basis

for   attainment   of   the   ultimate   objective   which   is   generation   of   revenue   through   providing

loans   .As   a   Commercial   Bank   Dash   Bank   prime   task   concentrates   around   the   process   of

borrowing and lending money that involve collection of idle fund from different sources by way

34
of accepting deposit with the commitment to pay interest and deployment of fund mobilized in

the form of credit to areas where it is needed to support commercial activities that have economic

importance. 

As consequence of the financial intermediary it assumes, Dashen bank takes the responsibility to

safe guard the interest of depositors who provided the fund used for credit extension strength of

the bank to safeguard the interest of depositors emanate from effectiveness of the system applied

to manage its asset and liability to honor the claim of deposits as and when they occur without

supperssing   extension   of   legitimate   credit.   Hence,   the   primary   concern   of   management   in

availing loans, which is as a result of risk management, places.

                        3.3.1 Objectives of Credit Risk Management

Credit   risk   management   is   the   process   of   maximization   of   banks   return   on   it   assets   while

maintaining its credit risk exposure with in acceptable limits because effective risk management

is the foundation of any business. According to business development division head of the bank

with whom the interview is conducted, credit risk management is a necessity and not an option to

ensure sustainability of the bank, which is to a large extent governed by the quality of its assets.

There are, the credit administration standards of Dashen Bank deserves emphasis because the

level of competence exercised to effectively managed credit risk measures success or failure of

Bank. In general the objectives  of the credit risk management are assurance of healthy loan

portfolio, which is pivotal for the growth and expansion of the bank.

                        3.3.2. Causes of Credit Risk

As   per   the   interview   conducted   with   business   division   head   of   Dashen   Bank,   most   of   the

employees of the loan officer are assigned their position based on their job experience or loans

stay officers are assigned their position based on their job experience or loans stay on the job. A

35
bank is successful when risk it takes are reasonable, controlled with in its financial resources and

credit competence. 

Esperance has proved that the pivotal issue for preservation of the quality of loan is existence of

well developed policies and procedures, effective credit control and the most critical element of

all   a   well   trained   staff   that   is   qualified   to   implement   the   system.   Conversely   business

development division head of Dashen bank also stressed that absence of adequate guideline to

monitor administration of the leading function pave the way for occurrence of substantial amount

of problem loans.

Therefore,   the   basic   cause   for   the   occurrence   of   credit   risks   are   incomplete   information,

weakness   in   collateral   arrangements,   technical   incompetence   the   ability   to   analyze   financial

statements and to obtain and evaluation other credit information , lack of adequate supervision of

old familiar borrowers etc.

                            3.4. Preventive Techniques Method

As  per  the  interview   conducted  with  credit   risk management   department,   Dashen bank  face

problem due to the fact some of the loans and advances granted to various users turned to be bad

loans. 

Different factors can be considered for some loans and advances to turn out to be bad loans.  One

of the main reasons is that borrowers do not use the fund for the purpose they had taken it for .

Some   loans   become   sick   due   to   weak   follow   up   business   by   the   debtor.   To   overcome   this

problem before granting a loan, branch manager and the credit  investigator  go and visit the

working place of the applicant.

However,   the   loan   processing   is   not   considered   complete   simply   because   it   is   processed,

approved and disbursed. It should be supported by adequate loan follow up to ensure the beset

36
performance of the bank in collections repayments as scheduled. After loan is granted it must be

managed to ensure that it is repaid loan management is the most important responsibility of a

lending   officer.   Also   the   credit   risk   management   considers   the   following   signals   before   the

collateral is approved.

A.    Early management warning signals  
 Change in behavior / personal habit / lifestyle of the key people
    Change in attitude towards banks especially a seeming lack of cooperation 
 Failure to perform personal obligation
 Lack of experience in line of business 
 Illness or death of key personnel
 In ability to meet commitments on schedule 
 Poor financial reporting and control 
 Change in the business of industry 
 Unusual or unrealistic plans for the future 

A.  Early financial warning signals 
        Balance sheet
 Failure to get statements in timely fashion 
 Deterioration in customers cash position 
 Deterioration of working capital position 
 Rapidly changing concentration in fixed asset 
 Deterioration increase in current debt or decline in the current ratio
 Refusal to provide audited statements

       Income statements 

 Decline gross profit margin 
 Decline of revenue 
B.  Early operation warning signals 
 Changes in the  nature of the company’s business 
 Poor financial records and operation controls 
 Poor employee attitude and moral on banking 
C. Early banking warning signals 
 Inability to get timely  financial information 
 Sudden and excessive borrowing 

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  Declining bank balances 
 Transfer or operation account to another bank 
 Marked changes in borrowing or repayment patterns

Early detection of warning signal is crucial to maximize corrective action and minimize potential

losses. Supervision is particularly important when loans mature or become past due or terms of

agreements   are   violated.   Assessment   of   these   reviews   leads   to   the   expansion,   modification,

renewal or collection of existing facilities.

Finally   as   interview   conducted   the   credit   management   department   about   the   preventive

techniques used to reduce risk are occurrence of risk Sick loans could be minimized through

prudent analysis made prior to release of the of the loan. Moreover, if things are not as expected

and the loans is trouble, work   out loans loans procedure is implemented strong and regular

follow   up   practice   is   exercised.   Besides,   controlling   methods   and   approaches   are   revised

periodically to fit the dynamic business environment.

          3.5. Mechanism to reduce credit risk 

This study also tries to indicate some methodologies that are used in Dashen bank to reduce

credit. In Dashen Bank there are two stages to implement different mechanism to reduce credit

risk. One is before disbursement new loan and the other is after disbursement.

I. Before disbursement mechanisms

In Dashen Bank before disbursement mechanisms include proper credit analysis, proper design

and implementation of loan eligibility criteria and proper loan disbursement procedure.

Credit analysis in Dashen Bank

 Credit analysis should include a clear indication of the banks target. This analysis should set out

who eligible for credit and for how much ,what type of credit type are available and what term

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and condition the credit should be granted .According to Dashen bank loan manual the 5 C’s of

credit are practicable techniques in the bank. The 5 c’s of credit are already mentioned in chapter

two or credit analysis factors.

                      Loan eligibility criteria in Dashen Bank 

In evaluation of loans subjective judgment are to some extent unavoidable. But Dashen bank Set

loan eligibility criteria to minimize the effective of individual perceptions in loan evaluation.

One Dashen Bank manual these eligibility criteria are state broadly according to the purpose of

loan   and   type   of   the   loan.   But   in   general,   the   basic   loan   eligible   criteria   are:­   proof   of

engagement   in   licensed   business,   presentation   of   financial   statements.   or   filling   of   financial

credit report presentation of collateral to secure the loan, and the feasibility study in the case of

project finance.

              Credit Disbursement procedure in Dashen Bank

According to the loan manual, try to explain how the loans process starts, how a series of duties

are performed at the various stages of the proccess. That is initiation, evaluation and approval.

Initiation: ­ The basic document necessary to proceed loan processing is the loan application. It

is simply a letter lodged by customer to a bank that explains his desire to have a bank loan. The

loan application should be accompanied by valid and currently renewed trade licenses.   This

helps to prove the legal formation of the business organization and its existence. Once the loan

application is found in older and copy of relevant trade license are proved valid and genuine the

next step to be followed would be evaluation.
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Evaluation:  is   a   process   through   which   applicant’s   actual   need   for   bank   loan   is   assessed,

viability of the business he/she runs is studied, and repayment capacity is measured. However,

handling   this   task   is   not   as   such   simple.   It   requires   analysis   of   financial   statements   of   the

borrower to check financial soundness and gathering relevant information regarding character,

credit worthiness of the applicant. Assessment of financial soundness can be done by analyzing

financial   statements   of   the   applicant   (Balance   sheet   and   income   statement)   which   could   be

audited or provisional. But, it is not always possible to base the analysis on financial statements,

as most of the customers do not maintain accounting records. Therefore, banks result to fill in the

information required for analysis in a format prepared to serve the purpose. The next step is

collecting credit information.

Credit information: ­ Is information related to applicant performance and reputation. Personal

integrity, character and credit worthiness have to be collected from different sources carefully

and as much as possible genuinely .Useful sources could be other banks. In recent time National

Bank of Ethiopia has started new system of sharing credit information of any borrower’s with in

all banks.

Loan approval: All the steps taken in the evaluation process could only serve one purpose that

is to give decision on a loan request of a customer whether the analysis made on the financial

statements, and credit information collected gives positive or negative results, the request for a

loan has to have an answer. Thus, the next stage of the loan processing cycle will be decision

making that is approval or rejection. To arrive at a fair decision, analysis made on the financial

statements and information gathered is summarized in Bank format knowledge loan approval

form (LAF).

All the information given under the LAF is meant to serve the final stage of the loan process that

is approval. The individual or the committee authorized to pass decision on loan requests thus

have   summarized   information   about   the   loan   request,   hence   after   reviewing   the   information

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available in the LAF, and decisions are made with the committee members, decisions will be

made.   The   decision   is   written   on   the   decision   space   of   LAF   and   signed   by   the   committee

member .Approval date is also written. If there are deviations from recommendations reasons

will be given here. Deviations from recommendation reasons will be given here.

Once it has approved it ahs to be communicated to the customer. Then there should be a loan

contact.   Moreover   securities   should   be   registered   and   even   if   type   and   extent   of   insurance

coverage differ from property to property and the risk involved in any case the borrower is

required to ensure the property completion of the contract registration, recipients of documentary

evidence of properties held as collateral and insurance policy end or seed in the name of bank

proves formalities for disbursement of the loan.

Documentation: All documents beginning from the loan application up to the last paper have to

be properly filled in loan file. Loan file have to be properly  filled in loan file .Loan file have to

be properly kept under the control of responsibility person security documents  ,such as land

holding certificates , can ownership booklet ,and the like together with original contracts are

separately kept in safe under lock.

I.  After disbursement mechanisms 

According to the loan manual and different internal memos, in Dashen bank broadly used after

disbursement mechanisms to reduce credit risk is proper credit follow up.

            Credit follow up in Dashen Bank 

  In practicing proper follow up, once funds are disbursed the concerned bank officer can not

afford to rest and expect that a repayment will be collected as schedule. Therefore, the loan

officer prepare schedule which contain the repayment date and telephone address of the loans in

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order to make the follow up task easy. After this the officer is expect to call when payment is not

made on the payment date.

Even if the payment is regular follow up by visiting customers business or factory is necessary to

create   long   lasting   friendly   relationship.   This   may   elicit   future   payments   and   development

partnership relation. Sometimes borrowers seem to ignore repayment for one reason or another.

In such case, Dashen Bank undertakes the following follow up activities. 

 Giving verbal reminder after calling the customer and discussing the matter. If this fails

and no payment is made then the bank choose to the second step personal visit is more

reproductive than telephone calls. This should be performed with in one week after the

installment is due.

 Sending first written remainder using language of general persuasion and explaining that

the money the bank lent out belongs to the bank’s depositors and that is accountable. This

should be done if installment is our due by a month.

 If the first remainder fail second written reminder that shows the bank is legally and

morally bound to collect the debt would follow. The reminder will be order in such a way

as to show the bank’s determination to proceed with further measures if repayments are

not   forth   coming.   It   is   very   important   that   the   bank   use   every   means   to   make   the

borrower come up with alternative proposal if possible until the bank make fairly certain

that payments are unlikely to come. If the customer does not show any cooperation than

we would write and send the third reminder.

 On the third reminder the loan officer tell the borrower that if payments are not made

with in 15 days the bank would be compiled to pass the matter to the legal services.

In addition to the above mechanism to reduce credit risk the bank also use training for loan

officers and related staff especially the credit analysis.

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               3.6    Problems in Dashen Banks Credit Risk Management

For convenience of presentation, the problems are grouped in to two broad categories. They are

internal and external problems.

                                   Internal problems

 Poor   credit   assessment   in   determining   the   viability   of   a   business   due   to   lack   of

information and this forced the bank to follow collateral based lending process.

 A very long property (collateral) valuation and documents checking process irrespective

of the type of customer and requested product type.

 Absence of research work to provide the credit staff with appropriate information about

the national, international, geographical, sector information, which could increase their

performance.

 Unnecessary   delay   in   credit   information   processing   as   a   result   of   poor   internal   and

external communication media ,negligence of the credit staff to timely initiate a request

and responding to a request and absence accountability. 

 Absence   of   transparency   among   the   staffs   of   the   bank   at   different   and   the   banks

customers.

 Loan diversion is the main cause for reaching loan agreement.

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   Poor negotiation skill from the credit staff side and absence of any guidance to this effect

from the top management and absence of standard, which creates lack of confidence to

the staffs.

                                  External problems 

 Presence   of   unfavorable   economic   development   like   drought,   effect   of   the   world

economy. 

 Absence   of   record   keeping,   which   creates   difficulties   in   preparing   true   financial

statements and disclosing actual performance of the business.

 Lack of cooperation among banks on sharing customer’s credit information. And they

said that centralized credit information system is not up to date and it is operating in

efficiently.

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                                             Chapter Four

        Findings Conclusions and Recommendations

4.1   Findings and Conclusions

Since credit risk is a fact of life in banks, it is not possible to eliminate loan problems

all together. Even in the best run banking systems, the optimal rate of bank failure is

not   zero,   since   there   is   always   risk   inherent   in   banking.   Nevertheless,   by   taking

45
prompt, well throughout any consistent actions banks and regularly authorities can

minimize the chance of disruption. Early warning signals must be developed.

Dashen  bank has   both  strong and  weak  sides.  The  strong  sides   are  assessing  the

borrowers   past   financial   history   and   credit   worthiness.   Details   analysis   of   past

financial   history   of   the   borrowers   and   forecasting   of   the   future   prospective

development will enable the bank to identify the capacity of the borrowers and to

process loans in the safest condition this is of the bank’s strong points. The other

strong  point  of the   bank is   introduction   of the  wide  area  network  (WAN) which

makes the bank to have efficient communication system with its branches easily and

all current information will reach to the management of time, so that timely decision

will be made without savior damage or loss. Unfortunately however, the weak sides

out weight their antagonistic.

In   the   lending   front   through   the   balance   of   the   outstanding   loan   has   increasing

through the last four years. Dashen Bank provides various credit lines to different

sectors. This economic sector also defined as loan categories in banking industry .

However concentration levels to geographic areas, credit product and maturities are

not developed to data.

According to the study conducted the major4 cause of credit risk management  in

Dashen bank summariazed in to two basic levels. The first is at borrower’s level.

Under this level of diversion of borrowed fund to other purpose the second is at bank

level.     Under   this   level   mistake   on   estimation   of   collateral   and   evaluating   the

borrowers report take the highest under this level.

Dashen Bank implements  different  mechanisms  to reduce credit risk. Among this

mechanism   proper   credit   analysis,   loan   eligibility   criteria,   credit   disbursement

46
 procedure and follow up are the major applicable .From this proper analysis of the red

borrower air request and document indicated at the best mechanism to reduce credit

risk.

When   we   are   talking   about   problem   of   credit   risk   management   it   is   inevitable

technique to reduce the balance of the existing sick loans and entrance of the fresh

loan is important in Dashen Bank.

Most of them have been cited above in the analysis of the finding. Just to highlight of

some  of them, the  bank should make  the  employees  to aware  about the  policies,

procedures  and strategies  risk management  so that every employee  will be a risk

manager.

          

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                                    4.2. Recommendation

  Based   on   the   major   findings   of   the   study,   we   forward   the   following

recommendations.

 The staffing system of the Dashen bank is based on long stay on the job rather

than qualification. Therefore, the bank should assign qualified, professional

and experienced individual top their proper positions.

 Dashen bank needs to organize periodic training session which would enable

the credit personal of the bank to improve their skills in the identification,

measurement and control credit risk. More over, helping employees to update

their   knowledge   and   skill   in   risk   identification,   measurement   and   control

credit risk.

   Dashen Bank should implement effective credit risk evaluation system by

designing cost effective and efficient techniques in order to minimize risk of

management cost and increase the overall return of the Bank.

 The protection against risk of lending should consist maintaining high credit

standards, appropriate diversification and intimate knowledge of borrower’s

affairs. 

 Dashen bank should invest more in its; people, technology and system  so as

to register better performance in credit risk management.

 It   also   recommended   for   future   researcher   to   study   the   subject   matter   by

widening its scope.

48