BIBM-Frankfurt School Joint Certification Program

on
CERM (8th Intake)

Assignment topic: 
“Probable Impact of COVID-19 Outbreak on the level of Credit Risk of
Banks in Bangladesh and how should a Bank Respond”

Prepared By:
Mohammad Iqbal Hossain
Principal Officer
Janata Bank Limited
Risk Management Department

Submitted To:
BIBM Certification (CERM) Program Office
Bangladesh Institute of Bank Management (BIBM)

Last Date of Submission: April 11, 2020

Executive Summary
Today we are facing economic turmoil potentially more cruel than we witnessed during the
global economic crisis. The coronavirus (COVID-19) epidemic is a different kind of upset.
Never before, have modern economies shut down at the drop of a hat. From one week to the
next, many workers lost their jobs and paychecks. Many business firms, SMEs, Industries
and small businesses lost their production & business, which lead to failure of revenue
generation. Restaurants, hotels, and airplanes all emptied. In addition, consumers and
businesses now face steep losses in income—and potentially widespread bankruptcies.

Pressure on the banking system is growing and higher defaults on debt (Credit Risk) are
imminent. And many now expect a shock to the financial sector similar in magnitude to the
2008 crisis. The less the credit quality, the more the MCR requirement. Bank will face the
huge capital shortfall and difficulties to maintain the minimum capital requirement (MCR)
according to Basel III accord. Capital is called a shock absorber. It absorbs the unexpected
loss or unforeseen losses. So, the banks which have enough capital (MCR+Conservation
Buffer), loan loss provisioning and liquidity that banks can survive in this distressed scenario.
The question on the minds of policymakers is how they should prepare for this.

Coronavirus outbreak is "just beginning" in Bangladesh. Asian Development Bank (ADB)

forecasts Bangladesh may lose up to $3.021 billion if the ongoing coronavirus outbreak
across the globe turns to the worst. The loss will be $8.0 million in the best scenario and $16
million, or 0.01 per cent of the GDP if it ends moderately. The economic losses of
Bangladesh will be mostly in the industrial and service sectors due to disruption in the supply
and decline in the number of tourists, ADB says.

In the current crisis, national authorities are taking a host of measures to provide fiscal
support, and central banks are opening new liquidity lines. How should bank supervisors
respond to ensure continued trust and confidence in the banking system?
 1. Introduction
1.1 About the COVID-19 Outbreak

The 2019–20 coronavirus outbreak is an ongoing pandemic of coronavirus disease

2019 (COVID-19), caused by severe acute respiratory syndrome coronavirus 2 (SARS-CoV-
2). The outbreak was identified in Wuhan, China, in December 2019, declared to be a Public
Health Emergency of International Concern on 30 January 2020, and recognized as a
pandemic on 11 March 2020. As of 10 April 2020, approximately 1.65 million cases of
COVID-19 have been reported in 210 countries and territories, resulting in approximately
100,000 deaths. About 368,000 people have recovered.

The first COVID-19 infected person in Bangladesh has been identified on March 8, 2020.
From this date to till April 10, 2020 it has been raised to 424 cases, resulting
in approximately 27 deaths and about 30 people have recovered. Bangladesh has entered in
4th phase of this pandemic. To ensure the more effectual social or physical distancing among
the people, the ongoing closure or lockdown has been extended to April 25, 2020.

The virus is mainly spread between people during close contact, often via small

droplets produced during coughing, sneezing, or talking.

Common symptoms include fever, cough and shortness of breath. Complications may

include pneumonia and acute respiratory distress syndrome.

Recommended measures to prevent infection include frequent hand washing, maintaining

physical distance from others (especially from those with symptoms) through Self/home
quarantine, self isolation, lockdown, covering coughs and sneezes with a tissue or inner
elbow and keeping unwashed hands away from the face as well as using the face mask.

1.2 What is the Credit Risk of Banks

Credit risk is defined as the possibility that a borrower or other contractual counterparty
might default, i.e might fail to honor their contractual obligation.

Counterparty credit risk aside, we should still amend the above definition by a further
dimension called Migration Risk. Of course, credit risk is essentially about the loss that
occurs, if a borrower does not pay. Yet, credit losses may arise well before a borrower
actually misses a payment. Losses can be triggered simply by the fact that the perceived
likelihood of a future default has increased while an exposure is outstanding.

Hence, the potential deterioration of the credit quality of an un-defaulted exposure is called
migration risk. This form of potential loss is generally also subsumed under a broader
definition of credit risk.

Therefore, Credit Risk is –

.Default Risk or fail to honor their contractual obligation 

;Declining quality of assets (Loans & Advances) 
;Assets not to perform well 
.Gradually deteriorating of credit quality/ credit rating 
 2. Problem Analysis
2.1 Probable Impact of COVID-19 Outbreak on the level of Credit Risk of Banks in
Bangladesh
The COVID-19 Outbreak is ominous/looming to Physical health as well as Financial Health.
The ongoing outbreak of COVID-19 has put in backlash on the socio-economic condition of
any country. It has thrown challenges to the socio-economic capacity and has enhanced
socio-economic vulnerability. The probable impact of COVID-19 outbreak has given below-

.Disruption of business & trade 

.Economic & Financial loss 
.Accounting Loss 
.Deadlock in Export & Import 
.Backlash on Supply chain 
.Lose/sack of Job 
.Increasing unemployment 
.Increasing Laid off 
.Cutting of wages & salaries 
.Loss of production & Output 
.Negative impact on foreign remittance 
.Decline in sales revenue 
.Declining in revenue income 
.Declining in earnings or income 
.Increasing of loss given default 
.Credit default Risk in the Banking & financial Sector 
.Deteriorating of Credit quality 
.Fail to repayment of loan Installment & credit obligation 
.Increasing Counterparty Risk 
.Chance of increasing Non-Performing Loans (NPL) in Banking sector 
.Increasing Bad loans in Banking Sector 
.Increasing of Liquidity problem in the banking sector 
.Threatening to maintaining Capital Adequacy according to Basel III 
.Increasing the more stressed scenario in the banking sector 
.menacing to Food security 
Increased Vulnerability of informal worker of informal sector (the people who lives 
from hand to mouth)
.Threatening the nutrition 
.Dearth or scarcity of food 
.Stressed people will be more stressed etc 

First, though banks are not being hit by the novel coronavirus as directly as other retail
institutions, they are at the forefront of public attention. Banks sit at the heart of the economy
and provide funding to corporates and individuals. Their stability is crucial to keep the
system up and running. Innumerable consumers are now being placed under quarantine or
lockdown. COVID-19 shuts down large segments of the economy – not just because of
factors such as supply chain disruption but simply because of the effects of social-distancing
restrictions – the risk of mass loan defaults (Credit Risk) continues to mount. Also, business
loans, especially to small and medium enterprises (SME), manufacturing and retail
companies, are at risk due to the forced shutdown. They will have no way to make up for the
lost revenues in the future. So, Companies experiencing severe drops in revenue may struggle
to repay loans. Households may struggle to pay off credit cards and make mortgage
payments. The question is whether banks will be able to withstand the Pressure from this in
months to come.
Second, the particular case of suspended payments (debt moratorium measures) is a further
credit risk. It would be inappropriate to consider that the suspension of contractual payments
as part of moratorium measures automatically results in all the loans concerned being in
default. Equally, it would be just as inappropriate to consider that none of the companies
.benefiting from the moratorium measures will default in the coming months
Analysis, therefore, should be conducted on a case-by-case basis, taking into account several
factors. These factors include the bank’s policy for granting moratorium-related measures,
modalities of the moratorium implemented (e.g. does interest continue to accrue?), as well as
the risk profile of the counterparty which benefits from the moratorium (e.g. pre-crisis rating,
sector of activity). Such analysis may have to be performed at a portfolio level before being
.able to collect individual information

Third, pressure on the banking system is growing and higher defaults on debt (Credit Risk)
are imminent. The less the credit quality, the more the MCR requirement. Bank will face the
huge capital shortfall and difficulties to maintain the minimum capital requirement (MCR)
according to Basel III accord. Capital is called a shock absorber. It absorbs the unexpected
loss or unforeseen losses. So, the banks which have enough capital (MCR+Conservation
.Buffer), loan loss provisioning and liquidity that banks can survive in this distressed scenario

2.2 How Should a Bank Respond

-In this crisis, a bank can respond the following way to mitigate the credit risk

banks can start waiving late payment fees, penalty, increasing credit card limits, and 
granting mortgage payment holidays and access to fixed saving accounts to those
.impacted by the virus
banks can extend interest payment and other debt-service holidays to mortgage 
 .borrowers and corporations, and keep credit lines open

At this difficult time, it’s important to make the impacted clients feel that a bank has their
back and to offer payment holidays or short-term cash-flow support. This is clearly also in
.their own interest, but this is only a temporary fix

Generally, banks should not have a problem with liquidity and offering clients a mortgage
payment holiday due to record low interest rates. But they should be reassessing the risk
profiles of their customers and particularly reclassifying borrowers impacted by the
.coronavirus as high risk

If the COVID-19 crisis lasts longer than one or two months, this option will increasingly
become untenable. Of course, unless the state steps in and forces a moratorium on debt or
.lends directly to the customer, banks themselves will begin to struggle

For example, interest rate payments are essential income for banks. Without it, banks will see
liquidity shortages themselves, at a time where the cost of loans is going up due to the lack of
.liquidity in the interbank market
Banks needs to be responded the following Government Aid Packages

Prime Minister Sheikh Hasina announced a second stimulus package for the affected sectors
on April 5, 2020. The second package covers four areas and amounts to Tk 67,750 crore to
overcome the economic losses caused by the coronavirus situation. . Earlier, on March 25,
2020, the government declared the first stimulus package amounting to Tk 5,000 crore for the
export-oriented sectors. Thus, the total size of the stimulus packages stands at Tk 72,750
crore, which is about 2.5 percent of Bangladesh's gross domestic product (GDP). This
support is deemed to help both local and export-oriented sectors which are facing the heat of
 .Covid-19

In the new package, Tk 30,000 crore is set aside for big industries and the service sector
which will be distributed by commercial banks as working capital loan at 9 percent interest
rate. Here, the government will provide 4.5 percent as interest subsidy. Small and medium
enterprises (SMEs), including the cottage industries, will receive Tk 20,000 crore as working
capital loan at 9 percent interest rate, and the government will give 5 percent interest subsidy.
An amount of Tk 12,750 crore has been allocated under the Export Development Fund (EDF)
of Bangladesh Bank to facilitate raw materials imports under back-to-back Letter of Credit.
The interest rate here has been reduced to 2 percent from 2.73 percent. The fourth component
is the allocation of Tk 5,000 crore to facilitate the "Pre-shipment Credit Refinance Scheme"
.at 7 percent interest rate

Apparently, it seems that the major responsibility will be on the commercial banks. The
banks have to generate the funds to provide working capital loan for business, trade and
.services. In this respect, a number of issues can be raised

First, one of the important features of Bangladesh's stimulus package is that the lion's share
of the package—Tk 67,750 crore—is repayable loan. In other words, this is a liquidity
support. Except for the support under EDF of the central bank, the commercial banks will be
responsible for the selection of their customers, and thus for absorbing all types of risks
attached to the loan, such as management risk, sectoral risk and market risk. The banks will
.also have to ensure that the loan is paid back to them in due course

Given the current health of the banking sector, whether it is in a position to perform this huge
responsibility is a natural question. The banking sector is now overburdened with huge non-
performing loans (NPLs), liquidity shortage, low net profitability, lack of skilled human
.resources, poor risk management preparation and inadequate technological skills

Several banks have lost their reputation due to bad loans and poor management. People have
turned away from them and do not want to keep their hard-earned money in these banks.
Particularly, the new banks and several non-banking financial institutions are suffering from
.a serious management crisis that led to loss of confidence of the depositors
In the current fiscal year, the government has imposed restrictions on further sales of the
savings certificate as it was creating a fiscal burden for the government. As a result, bank
deposit has increased by about 10 percent in the current fiscal year. However, those deposits
are kept in the good private banks and in the state-owned banks. Therefore, not all banks are
.equally capable of providing loans to support the Covid-19 affected businesses

Second, if the Covid-19 loans become bad loans, the banking sector will run into further
trouble. It has been mentioned that borrowers will be selected by the banks based on bank-
client relationship. Unfortunately, this understanding did not bring any good for the banking
sector so far. Much of the NPLs in the banking sector is due to the habitual defaulters who
have been given leeway through various supports by the policymakers. Given the historical
experience of loan default, one cannot but be apprehensive of the misuse of the new
opportunities announced for the corona-affected businesses. The wilful defaulters are mostly
powerful and politically connected people. Banks have had always difficulties both in case of
refusing loans to them and in recovering the loans from them. Thus, banks should be hundred
percent compliant in disbursing these loans during such a critical time. The central bank has a
.critical overseeing role to play here

This is more so because the full responsibility of fund distribution and management will be
on the commercial banks. No other organizations will be there for them. Even any irregularity
with regard to the distribution of EDF fund will not be the responsibility of the central bank.
The Ministry of Finance will provide export support. In case of bank loans, the ministry will
.pay the interest subsidy on loans, which are projected to be Tk 3,000 crore

Third, how the money will be generated is another issue. As the coronavirus continues to
affect the economy, the liquidity crunch will deteriorate further since economic activities will
shrink. Bangladesh Bank has undertaken quantitative easing by reducing policy rates.
Towards this, the Cash Reserve Ratio (CRR) has been reduced by 0.5 percentage point. This
will generate an additional Tk 6,200 crore. If needed, Bangladesh Bank may have to reduce
the CRR further and reduce other rates such as the Statutory Liquidity Ratio (SLR) given the
.demand for liquidity during the Covid-19 crisis

Fourth, the transparency and accountability of this stimulus package will be of paramount
importance. Who will get the support, on what basis the demand of the applicants will be
assessed, and whether there will be non-interference from the powerful groups are issues that
are attached to the distribution of the incentive package. Of course, the prime minister herself
warned against misappropriation and mismanagement of the stimulus package. One only
hopes this message reaches the people at the ground level—and for once at least, the
 .opportunists keep themselves away from grabbing a share from this humanitarian support

Banks needs to be responded the following Monetary and Macro-Financial supports

declared by Bangladesh Bank to implement the Government Aid package to boost up the
-economy, business industries, SME & Counterparty

The focus of Bangladesh Bank is to ensure that there is adequate liquidity in the financial
system to support the operations of financial institutions, and it has announced that it will buy
treasury bonds and bills from banks. Bangladesh Bank has also issued circulars to delay non-
performing loan classification, extend tenures of trade instruments, and ensure access to
financial services. Effective March 24th, the repo rate has been lowered from 6 percent to
5.75 percent, while the CRR has been reduced to 4.5 percent from 5 percent on a daily-basis
.requirement and from 5.5 percent to 5 percent for the bi-weekly requirement
 Banking system prescription during this outbreak according to IMF

Like the health experts, bank supervisors are responding to a fast-moving and extraordinary
situation. Supervisors must combine the tools from their playbooks for dealing with natural
disasters, operational risk events, and bank stress episodes. With its global vantage point, and
drawing from past experience, the IMF can offer some additional guidance on the way
:forward

Don’t change the rules. Doing this in the midst of a crisis will likely cause more confusion.
Likewise, be prepared to give banks time to meet rules if they fall short, and hold off on
implementing new initiatives—banks should remain focused on maintaining ongoing
.operations, given the increased difficulties of conducting such operations remotely

Use the buffers. Regulators have to communicate clearly that capital and liquidity buffers
should support continued bank lending, without adverse consequences for bank management.
Banks built these buffers well above Basel minimum standards to manage strains on liquidity
.and revenue loss from missed loan repayments

Encourage loan modification. Supervisors should clearly communicate to banks to be

proactive in rescheduling their loan portfolio for those borrowers and sectors that have been
hard hit by the severe, but temporary, shock. They should also remind banks about flexible
credit risk management and the accounting standards for impairment in these situations.
Accounting bodies have helpfully stepped in to clarify to auditors how such modifications
.should be viewed once the economy begins to recover

Don’t hide the losses. Banks, investors, shareholders and even taxpayers have to bear them.
Transparency helps prepare all stakeholders; surprises only worsen their response, as was
.proven during the 2008 crisis

Clarify regulatory treatment of support measures. Clarifying upfront how banks and

regulators should treat fiscal measures, including measures directly targeted at borrowers,
credit guarantees, payment holidays, direct transfers and subsidies—beyond any current
.guidance in the Basel capital framework—would help with overall transparency

Strengthen communication. Encourage continuous dialogue between supervisors and banks,

especially in this unprecedented situation of working remotely with colleagues, customers,
and supervisors. Typically, reporting requirements in key areas, such as liquidity and creditor
positions, are enhanced in a crisis, but given operational disruptions, deferring other reporting
.requirements less material to assessments of financial health may make sense

Coordinate across borders. Banking is a global business. Broad coordination among

national regulators at the international level is imperative. This crisis will pass eventually,
and the effects may take time to dissipate, but preserving the integrity of the international
framework will be crucial for the credibility and integrity of the global financial system.
International bodies like the Financial Stability Board and the Basel Committee on Banking
.Supervision are working night and day to do just this