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Credit Risk Management in NBL

Introduction of Risk Management: Risk is inherent in all commercial operations. For Banks and Financial Institutions, Credit risk is an essential factor, which needs to be managed properly. Credit risk virtually is the possibility that a borrower will fail to repay debt in accordance with the terms of sanction. Credit risk therefore arises from the banks lending operations. In the present days state of deregulation and globalizations, banks range of activities have increased, so also are the risks. Expansion of banks lending operations covering new products have forced the banks to confront newer risk areas and therefore to work out proper risk addressing devices. Credit risks are sop exhaustive that a single device can not encompass all the risks. Moreover lending risks today have assumed such diverse nature, that newer techniques are to be applied to effectively contains the risks. In order to effectively contain risks, credit risk management has to be done in order to enable the bank to proactively manage loan portfolios in order to minimize losses and earn acceptable level of return for the shareholders. IN the present scenario of fast changing, dynamic global economy and the increasing pressure of globalization, liberalization, consolidation and dis-intermediation, it is essential to undertake robust credit risk management policies and procedures, sensitive and responsive to these changes. National bank limited is committed to extend high quality services to its clients through different financial products and profitable utilization of fund by undertaking various lending operations including financing trade, commerce & Industry etc .In conducting lending operations NBL always bears in mind the essence of proper risk identification and their effective management. It is also recognized that failure in proper identification and management of risks may result in a large quantum f bank advances turning into nonperforming. In the above back drop, National Bank Limited, underscoring the need of an effective credit risk management process has prepared the policy guidelines for credit risk Management. The policy will be renewed annually by the Board of Directors. The policy shall be distributed to the concerned officials, all divisional Heads, Branches, Regional Offices and top management officially. The policy shall be strictly followed by all concerned. Any deviation from the guideline to be clearly identified and justification for approval to be provides. The main objectives of the guidelines are as under: 01. To provide directional guidelines to all concerned to improve risk management culture & establish minimum standard for managing risks in credit operations. 02. To adopt an appropriate working method. 03. To keep legal aspects relating to loans and advances vivid. 04. To introduce and adopt uniform practice in working.

05. 06. 07. 08. 09. 10. 11.

To make working procedure rational. To make lending correct information based. To identify proper lending area. To analyze all aspects related to credit and ascertain viability of lending. To make credit documentation exhaustive. To ensure proper supervision, monitoring and follow-up. To ensure safe return of money lent, avoidance of credit loss and strengthen asset quality and to protect banks interest.

Mission and Vision of Lending Policy of NBL Mission of NBL is to ensure quality services, establish and maintain modern and electronic banking services covering all financial activities with highly motivated and skilled personnel, maintaining transparency, accountability & integrity and thereby ensure stable and sound financial operational system National Bank Limited will: 01. Extend credit facilities at competitive price with prudence & efficiency 02. Offer wide range of products 03. Encourage loans & advances to income generating activities and will thereby create employment opportunity and improve standard of living of the common people. Loans and advances for productive purpose which will alleviate poverty will be stressed upon. 04. Prioritize welfare oriented banking service. 05. Diversify lending activities, avoiding sectoral concentration, ensuring geographical dispersal. 6. Design its loan operations keeping social and economic factors in consideration. 7. Attach importance to consumer credit, Loans to small businessmen, Festival loan, Small Loans for finishing and expansion of house, Personal loan for Salaried persons and any purpose loan. 8. Prefer lending which will be adequately secured with acceptable security. Borrowers stake in any activity will be ensured. 09. Encourage syndicated financing in prospective/ profitable ventures. 10. Not incur any uncovered foreign exchange risk in lending fund. 11. Invest at reasonable lending rates. 12. Monitor End use of loans/advances. 13. Generally prefer short term lending promoting through lending small and medium enterprises. 14. Constantly explore prospective and profitable investment areas in order to achieve institutional and country objectives. 15. Extend of credit which should contribute within defined risk limitation to the Banks achievement of profitable growth and superior return on the Bank's capital.

Credit Principles To achieve the goal for maximizing the stockholders' value and protect the interest of the depositors as well as to improve the quality of banks assets as fundamentally sound financial institution, every one will abide by but will not be limited to the following Credit Principles, which should guide the behavior in lending decisions: I 2 3 4 Assessment of the customer's character, integrity and willingness to repay will form basis of lending. Customers having capacity and ability to repay shall only be lent. Possibility of default will be worked out before lending. Credit will be extended in the areas risks of which can be sufficiently understood and managed. 5 6 7 8 Independent Credit participation in the credit process shall be ensured. Ethical behavior in aU credit activities shall be ensured. Be Proactive in identifying, managing and communicating credit risk. Be diligent in ensuring that credit exposures and activities including processing function complying with NBL requirements as well requirement of regulatory authority. 9 10 11 Risk and reward to be optimized. Diversified Credit Portfolio to be built and maintained. Credit will normally be financed from customers' deposits and not out of short-term temporary funds or borrowing from other banks. The bank shall provide suitable credit services and products for the market in which it operates. 13 14 Credit will be allowed in a manner which will in no way compromise with the Bank's standard of excellence and to customers who will not compromise such standards. All credit extension must comply with the requirement of banking companies Act. 1991 and amendments thereof from time to time.

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Credit Evaluation

National Bank follows the following Credit evaluation process: Prevailing credit practices in the market. Credit worthiness, background and track records of the borrower. Financial standing of the borrower supported by financial statement and other Documentary evidences. Legal jurisdiction and implications of applicable laws. Effect of any applicable regulations and laws. Purpose of the loan/facility. Tenure of the loan /facility. Viability of the business concern. Cash flow analysis and also projections thereof. Quality, value and adequacy of security, if available. Risk taking capacity of the borrower. Entrepreneurship and managerial capabilities of the borrower. Reliability of the sources of repayment. Volume of risk in relation to the risk taking capacity of the bank or company concern. Profitability of the proposal to the bank or company concerned. Credit Risk Grading Yield from the facility Market aspect Total global exposure of the borrower CIB status

Credit Policy Guidelines:


Lending Guidelines:
Industry and Business Segment Focus: The main focus of NBL on various lending/areas will be as under: SL no 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Industry and Business Segment** Trading Business Ready Made Garments Textile(Yarn/Fabrics Manufacturing) Chemicals/ Toiletries Entertainment Telecommunication/IT Power Generation and Distribution Energy (Power/Fuel/Gas) Electric Goods Services viz GSA, Freight Forwarder, Airlines, etc Steel and Re-rolling Mills Engineering and construction Small Traders/SME Agro based industries /Dairy Products/Fishery/Tea/Crop Export Oriented Industry Pharmaceuticals Consumer Loans(Personal, auto, Credit Card) Food and allied (Edible oil, Flour, etc) Ship Breaking Real Estate Paper Transport Cold Storage Finance Financing Cement Industries Focus Grow Grow Grow Grow Grow Grow Grow Grow Grow Grow Grow Grow Encourage Encourage Encourage Encourage Encourage Maintain Maintain Maintain Maintain Discouraged Discouraged Discouraged

** The Industry and Business Segment Focus will be revised from time to time depending on national requirements,market conditions, Cyclic aspect of the economy, appetite for growth for each sector, shift in Government Policy and Naional Banks Credit Planning.

Types of Loan Facilities:


National Bank Limited has been offering wide range of credit facilities as under: SL 01 02 03 04 Name Cash Credit (hypo and Pledge) SOD ( General) SOD (Export) Purpose Business capital/Working Capital Against F.O./Work Order/Supply Order Payment of accepted bills at maturity before receipt of export prceceed. Loan (Gen) Acquiring capital assets/purchasing , construction, finishing , expansion, repair, renovation of House/Flats/Real Estate business etc. LCA ( Loans against cash Financing for the period of non-receipt of Assistance) re-imbursement from Bangladesh Bank. LC (Local & Foreign ) sight & For Import/Local procurements of on deferred payments basis goods/services. PAD For making payments of the L/C obligations against receipt of documents. LTR Retirement of shipping documents. LIM Retirement of shipping documents. PC Meeting financial requirements of the exporter at pre shipment stage against Export L/C. LDBP/FDBP As post shipment finance against Local/Foreign Export Bills. BTB L/C Importation of raw/Packing materials against Export L/C. Bank Guarantee Local/ For submission of tender/to obtain and offer Foreign as security against work order, supply order/For Gas, Electricity connection, against delivery of goods/against release of goods, without or against partial payments by customer.

05 06 07 08 09 10 11 12 13

National will also finance any other activity under any credit nature, which will meet the institutions basic principles of safety, liquidity and spread, upholding, credit norms and complying with the guidelines / directives of the central Bank/ regulatory body.

Single Borrower /Group Limits/Syndication


National Bank Ltd pursues /will continue to pursue the policy of avoiding too much loan concentration to a single borrower /group in order to by pass possible threat in the event of such advance turning sticky. In a bid to keep credit risk at the minimum level in respect of large but prospective advance. National Bank will prefer syndicated financing (Appendix R) after proper feasibility study. National Bank Limited has been following strictly and will continue its lending operation, in complete obedience to the guidelines circulated by Bangladesh Bank on single party exposure limit to a borrower/group. National Bank Limited will not extend credit (Funded + non funded) for more than the percentage on capital of the bank, permitted by Bangladesh Bank and will follow all modifications, amendments, additions alterations that may be made by Bangladesh Bank from time to time. However, National Bank will flow the following Guidelines of Bangladesh Bank on lending to single borrower / group under one obligor: Lending cap to single borrower Total exposure (Funded and non funded) Maximum funded exposure Maximum non-funded exposure where there will be no funded exposure Maximum exposure for export sector Amount 35 % of Bank's total capital 15 % of Bank's total capital 35 % of Bank's total capital 50 % of Bank's total capital (But funded facility will not exceed 15% of the total capital)

The above Single Borrower / Group Exposure is currently mandatory as per Bangladesh Bank instruction. However, this is subject to change depending on Bangladesh Bank's policy. The Total Capital is to be determined in accordance with Section 13 of the Bank Company Act 1991

Lending Caps:
National Bank Limited is very much aware of over concentration of credit in a particular area, which may under some situation, create disaster for the bank. Keeping this in consideration and also the over all business, trend, prospects/ potentials, problems, risks & mitigates, pricing, owner's stake in business, business competitors involvement, safety, liquidity, security etc. Our bank will be guided by the following Lending caps generally: Sector Caps* Trade & Commerce SME Industry-working Capital Project Finance-Long Term Retail/Consumer (CCS) Agro Credit Work/Supply Order (Contractual Finance) Others Total % 45% 10% 10% 10% 10% 5% 5% 5% 100%

*The caps will be revised from time to time depending on the market conditions, shift in Government Policy and National Banks Credit focus.

Discouraged Business Types:


While National Bank will follow the policy of financing prospective, feasible & rewarding areas, it will have (as presently has) some areas, identified as discouraged. Generally the following areas will be discouraged for financing: Military Equipments/ Weapon Finance Highly Leveraged Transactions. Finance of speculative business. Logging, Mineral Extraction/Mining or other activity that is ethically or environmentally sensitive. Lending to companies listed on CIB black list or know defaulters. Counter parties in countries subjects to UN sanctions. Share lending. Taking an equity stake in borrowers. Lending to holding companies. Bridge Loans relying on equity/debt issuance as a source of repayment. New cold storage finance. Financing Cement Industries.

Loan Facility Parameters


National Bank Limited extends and will extend credit for various genuine purposes. One type of advance requires to be treated differently from other types. Depending on the type financed, ownership pattern, business mode, cash flow, security and other related matters facility parameters are to be set. However the general parameters in facility will be as under: 0 Nature of Advance 0 Purposes WHAT CAN 0 Limit/Amount of Facility/Maximum Size 0 Margin/ Equity 0 Rate of Interest 0 Rate of commission/charges 0 Mode of disbursement 0 Mode of repayment 0 Security 0 Validity/Maximum tenor 0 General/Special conditions/ Covenants Nature of Advances: Each advance to be made will be categorized under one of the arranged types and will be governed under the terms & conditions related thereto. Purpose: Our lending will be guided by legitimate purpose. Financing for hoarding, speculative purpose and which will be utilized for degrading the character of the people will be avoided. Credit which will contribute to production, trade, commerce, import, export, development of Industries, development activities/Economic growth, infrastructural development, employment generation, poverty alleviation etc will be stressed. Limit /Amount of facility/Maximum Size: Facility will be considered based on assessment of requirement & justification subject to the overall lending cap as per Bangladesh Bank single party exposure limit. Margin/Equity: It will be the general policy of the bank to judiciously ensure stake of the borrower in any financing plan. Margin will ,however, be subject to institutional policy in this regard. and central bank policy where applicable. Rate of Interest/ Commission and other charges: Rate of interest will be charged as per declared rate of the bank. Pricing will be basically risk based. Higher price will be considered for riskier borrowers because of their higher risk) involved (i.e. lower score obtained by an obligor as per CRG score sheet is called a risky client). Similarly lower price will be considered for prime clients on the basis of their low risk (Low risk grade clients means where an obligor obtained higher aggregate

score as per CRG score sheet or 100% cash covered or Govt./International Top bank Guarantee). In fixing interest rate cost of fund & the prevailing rate in the competing market shall also be considered. Concessional interest rates to the deserving customers will be allowed within the declared interest rates band of the bank. Commission/ charges on credit facilities will be realized taking the competing scenario in the banking market into account, involved risks in financing & overall policy of the bank. Mode of disbursement: In disbursing credit the bank ensures drawing for the purpose the loan has been sanctioned. Where required visit of the business/site etc are suggested and all subsequent disbursements are made conditional to full utilization of disbursed money in the preceding phase. In case of disbursement of loan. money for acquisition of assets, payment is suggested after receipt of the assets by the borrower. For commercial lending, storage of merchandise against which facilities have been sanctioned are ensured either in shop/ show room or in godown. Against LlM /pledge, godownizing required stock is ensured. Mode of Adjustment/ Repayment: For the borrower to exhibit capability to periodically adjust the drawings taken and as such to have idea regarding the rationale for continuation of the facility, adjustment mode is given. In term of lending, where revolving transaction is not allowed, adherence to adjustment stipulation ( monthly, quarterly, half yearly, yearly or other wise) is suggested to ensure recovery of the loan disbursed. By perusing adherence / non-adherence to the stipulated adjustment mode, status of the advances, capability of the borrower, how the account to be treated and course of action to be taken, etc are decided. Security: Our bank mostly relies/will continue to rely on security based lending, taking into consideration, the character of the borrower, nature of business cash flow, environmental, economic, business and other influencing factors. In obtaining security primary and collateral security are suggested. Primary securities are valued on the basis of landed cost in case on imported goods/ ex-mill or factory price/ whole sale market price for the local goods.Collateral security of acceptable type having adequate market /sale value is accepted. Collateral property is Judiciously valued before accepting the same. The property is valued by the branch officials by applying prudence and considering prevailing rate in the locational area of the property. Our bank has some potential values engaged to assess the valuation of the mortgage able property. These appraisers assess the value of the property independently & submit the same to the bank directly. Assets in the form of goods pledged as security are duly insured protecting the Bank's interest. Goods and machinery (for industry) taken as primary security are also insured.

Validity/Expiry/Maximum tenor: Validity/Expiry date for continuous credit is set at a period not exceeding 1 year. Short term loan mostly is allowed for trade/ Commerce. This expiry date is virtually the date for adjustment/review of the facility, subject to periodical and satisfactory turn over of the limit. Conduct of the business during the whole of validity period determines the fate of continuation of the facility for the next period. Loans for short/medium/long term are also sanctioned depending upon the requirement thereof and also on cash flow generation, repayment capability and over all lending feasibility. Such loans are allowed for adjustment in installments. Short term Medium Term Long Term : Up to 12 months. :More than 12 months and up to 60 months. :More than 60 months.

Security and Support: The following types of securities are generally accepted: 01. Machineries of factory/industry on hypothecation basis. Value of machineries are checked 02. Raw materials, work in process, finished goods, stock in trade on hypothecation and pledge basis. Inventory is held in a warehouse godown for financing against pledge under Bank's control. Value of Inventory is checked 03. Land and building of acceptable type and value, under registered mortgage. 04.Financial obligation (to be kept under lien) after ascertaining its genuineness of issuance, ensuring marking of lien of the lender bank on the instrument and obtaining confirmation from the issuing bank that encashment including even before maturity date will be allowed to the lender bank on request without referring to the instrument holder. 05. Bills receivable against work order/supply order duly assigned /supported by registered P.A. executed by the client favouring the bank, confirmed by the work entrusting authority that the cheques/bills against the work shall be issued in the name of the bank A/C of the client. 06. Cars/buses/Water crafts/vessels under hypothecation and joint registration. 07. Shipping documents as lien against LC. 08. Trust Receipt for LTR. 09. Export documents under lien (For LDBP/FDBP)

10.Export documents-under lien (for BTB L/C) 11. Packing Credit Letter (For PC) 12. Personal guarantee /corporate guarantee /cross corporate guarantee. 13. Post dated Cheques. 14.1st /2nd charge /1st ranking pari passue charge on fixed and floating assets of the limited companies financed. 15. Bank obtain authorization to debit clients account in order to keep policy in force. Quality of Security: Primary security having adequate market value is accepted. Perishable goods and seasonal goods are generally discouraged as primary security. Acceptable financial obligations are preferred. Receivables bills against work order/supply order funded by Foreign Agency which bear adequate funding arrangements are preferred. Documents which are drawn in conformity with the export L/C terms (i.e. documents which do not have discrepancies ) are accepted for negotiation. Personal guarantee of those persons having high net worth /assets, satisfactory commitment fulfillment track record and no connection with any irregular/ classified advances are obtained. Subordinated rank (in respect of financing) on fixed and floating assets of the companies proposed for financing are generally discouraged. Land, Building having defectives title, chain of proper documents, adequate valuation and acceptable forced sale value, located under municipality/ Municipal corporation/RAJUK/KDA/CDA important Commercial centers are best choice for creating mortgage thereon. 3rd party mortgage is backed by personal guarantee of the owner of the property .Property located outsides the above areas are also accepted as collateral, with out compromising with proper valuation proper title, non-encumbrance sale possibility in requirements etc. RAJUK/KDA/CDA/other Govt. authority owned properly is mortgaged after getting NOC of the owning authority favouring the allottee-mortgagor to mortgage the property against advance are also obtained. In syndicated financing mortgage is executed on first ranking pari passu basis. Legal Interest Protection: Title searches are conducted periodically for collateral both with RJSC and land Registrar for mortgages. Collateral arrangements are detailed in credit proposal.

Banks legal adviser establishes the required legal documents for a borrowers legal standing and enforcement of the banks interest. Mortgage documents are properly vetted by Banks legal Adviser. Registered mortgage of property are supported by registered irrevocable general power of attorney to sell the property. Bank has proper inventory of standard security documentations vetted by legal counsel. Non-standard documentations are vetted by appropriate authority.

Valuation of collateral: Credit administration department independently will control and match the value of cash collateral which will be liened to the bank and against which borrowings are/will be allowed as per approval. Value of inventory and machineries supplied by client will be cross checked. Credit administration department will ensure receivable that actually exist and that past due. Disputed and other items with impaired collateral value to be identified and removed from collateral pool. Value is sourced from Independent appraisals addressed to the bank.

Insurance: Our bank having insurable interest on a property /an asset obtain insurance policy as per norms against credit facilities extended in order t protect our banks interest Insurance policy shall be taken covering all possible risks. Branches shall ensure that insurance policy is current and renewed on a timely basis. Insurance shall be obtained form a reputed company.

General/Special conditions/covenants: General/special conditions /covenants will be according to the nature of advance , security arrangements, ownership pattern, mode of acquisitions , institutional norms/instructions, guides lines of the central bank/regulatory authority.

Cross Border Risk:


The bank takes /will take care of /analyze the risks involved with cross border lending . Risks associated with import of a commodity is kept in mind which may basically take the form of failure of the foreign supplier to : Supply goods of specified standard and quality. Supply the contracted goods timely.

These risks are tried to be handled by obtaining satisfactory credit report on the supplier before opening L/C. Track record of the exporter, past performance, capability of the seller to comply with the terms of sale-purchased , timely shipment etc are examined before opening L/C. Advance payment against import is avoided in order to avert credit associated risk. Risks involved in export deal is also taken care of . Capability of the consignee is, when required , ascertained by obtaining credit report on them. Here also past record , past payment behaviour, instances of payment refusal, instances of taking discount, frequency of raising of objections on minor grounds and making delay in payments etc are carefully persued and the results from the basis of proceeding properly avoiding risks associated with export deal. Besides, the country risks both of the importing and exporting countries are kept in view in respect of handling the importexport .

Credit Assesment
A thorough credit and risk assessment is to be conducted before granting of loans, and once approved; all facilities are to be reviewed at least annually. Credit assessment will be presented, in a credit application duly signed/approved by the official of the branch In case an account deviates from the guidelines the same should be identified in credit applications and justification for approval should be provided by the originating officials of the branch. Bank will conduct financial analysis on a regular basis & monitor changes in the client's financial condition. The proposals are prepared in proposal format that originates in the credit department of the branch and is processed and approved by the head of branch/Regional Head/Head office Management/Executive committee as per delegated authority. At the time of originating a proposal accuracy of all information to be ensured. Originating officers shall follows credit principles, credit policy and guidelines and conduct due diligence on new borrowers, principals and guarantors. They will also adhere to the NBL's established Know Your Customer (KYC), Money Laundering guidelines, and Bangladesh Bank's regulations. For initiating credit relationship credit officer/Relationship Manager will call on the client, visit factory / business centers to see production facility / stock/storage pattern / business transactions/reputation etc and through these, to assess possibilities of establishing a remunerative relationship. He / she will also conduct due diligence to get market information on the borrower from industry sources, competitors, local area.

Branch Manager may also be part of this process. In this regard. if required, the BM/ Credit officer//Relationship Manager will also take help of Head Office Engineer/HO personnel for initial assessing credit needs of large borrowers. Based on findings of such calls / visits/inspection, Relationship Manager (RM)/Credit Officer, (along with the Branch Manager) will initiate proposal, containing information on client's background, business, market share, integrity, credit exposure / existing banking relationships, and credit needs along with pricing, loan structure (tenor, covenants, repayment schedule) purpose of credit, type of credit, security arrangement, etc. Before sending proposal to the approving authority, the originating officials of the branch shall ensure that the following steps/formalities have been taken/completed properly and incorporated in the credit proposal appropriately: Current CIB Report obtained Repayment sources of the borrower has been justifiably established by financial analysis Purpose and amount with types of loan proposed by the borrower stated in the proposal. Earnings from the relationship properly assessed in the credit proposal. Pre-sanction Inspection report/call report/site visit report is in place.

Managements profile & capital structure, constitution, date of establishment are stated in the proposal. Experience of the borrowers, business skills, management & successions are properly mentioned in the proposal. Borrowers rating in the industry is assessed along with overall industry concerns and borrowers strength & weakness relative to its competitors are identified. Industry's position along with supplier and buyer risk is analyzed. Borrower credit worthiness is established by review of 3 years historical financial statements and past track record. Cash Flow analysis justifying client's ability to repay is reflected in the credit proposal. Industry and Business analysis is done in the proposal. Credit facilities availed from other banks are clearly stated in the proposal and opinions are obtained regarding the credit standing of the borrowers. Credit facilities are based on an evaluation of the borrower's business needs. Credit proposals clearly mention current outstanding against all limits. Audited financials, Large Loan position etc. are reflected in the credit proposals. Branches ensure that collateral has been properly valued, verified and are managed

.Account conduct of the borrower & his allied concerns has been done. Amount and Tenors are justified based on the projected repayment ability & loan purpose. Adequacy and the extent of Insurance Coverage are assessed. Policy compliance are clearly stated in the Credit Proposal. Changes in pricing of facilities are highlighted in credit proposal. Usages of borrowed fund is confirmed through financial statement analysis. Borrowers Risk Grade has been done as per Bangladesh Bank Guidelines, examined & approved by the authorized official and stated in the credit proposal.

Credit Memorandum(CM)/Credit Proposal: The Credit Memorandum (CM/Credit Proposal should contain : 1. Correct name of the borrower. 2. Borrowers office, business, show room and factory address with phone number. 3. Account number and date of Account opening. 4. Nature of business. 5. Constitutions. 6. Capital Structure. 7. Date of establishment of business./Date of incorporation. 8. Date of commencement of business. 9. Business net worth. 10. Banking relation ship history. 11. Name of individual borrower/proprietor/partners/Directors, status in the co. % of share holding of the directors in the co/firm. Age , present (Residential) and permanent address with phone number. 12. Management profile. 13. Personal net worth of the individual/proprietor/partners/directors. 14. Name, present ( Residential), permanent address, personal Net Worth, A/C number, Business Particulars, status of liability/allied liability etc. of the guarantor. 15. Liability of the client/allied concerns with NBL/or other banks. 16. Recycling /periodical adjustment of the existing credit facility during last 03 ( Three) years. 17. CIB status. 18. Assigned Risk Grading. 19. Amount of Facility ( Existing + Proposed)-on one obligor basis. 20. Credit allowing capacity of our bank ( as per Bangladesh Bank single Exposure Limit) 21. facility structure: a. Nature of advance.

b. Amount of limit. c. Purpose. d. Margin/ Equity. e. Interest , commission, other charges. f. Mode of repayment. g. Validity/ expiry. 22.Security: a. Primary b. Collateral. c. Others. 23.Cost of project ( where applicable) a. Land b. Building. c. Other structures. d. Machineries. e. Others. 24. Working capital assessment/Assessment of the requirements. 25. Financial Highlight. 26. Business performance of the client. 27. Earnings from the client (Last 03 years) and projected earnings from the relationship. 28. Sales profitability (Last 03 years) , projected sales. 29. Important ratio (where applicable) 30. Cash Flow. 31. Experience of the borrowers, business skills, management & successions. 32. SWOT 33. Major 05 competitors. 34. Possible risks & risk mitigating factors. 35. Other Terms, conditions and covenants.

Risk Assessment Areas:


Borrower analysis:
Full

particulars of the proprietor, partners, Directors, etc to be examined, their management capability to be ascertained. Overall performance and credit status of the allied concerns of the client i.e. group will be assessed. Lack of management capability of the co. concentration of the whole affairs of business is one hand and lack of initiative to create subsequent management line, complicated ownership structures of inter group transactions shall be addressed and related risks to be mitigated. Industry Analysis:

Before extending credit in an area over all business conditions of that real sector will be critically examined, Prospects and problems to be ascertained. Demand and supply of the concerned goods / services, Demand and supply gap, contribution of the borrower in meeting the gap, strength and weakness of the borrower & their competitors to be accurately assessed. Sales concentration of the borrower, borrowers rating with competitors in terms of market share, prevalence of substitutes of the produced items in the market and barriers to entry into the product line of the borrower to be properly identified Lending decision will be preceded by an intensive analysis on whether the borrower depends on a single or a very few customer or gets the supply of the raw materials/ dealing items from a single supplier. Such sales and supply concentration will be given a very careful consideration, because it will have significant impact on the future viability of the borrower. Supplier/Buyer Analysis: Lending decision will be preceded by an intensive analysis on whether the borrower depends on a single or a very few customer or gets the supply of the raw materials /dealing items from a single supplier. Such sales and supply concentration will be given a very careful consideration , because it will have significant impact on the future viability of the borrower. Historical Financial Analysis: An analysis of a minimum of 3 years historical financial statements of the borrower shall be presented. Where reliance is placed on a corporate guarantor, guarantor's financial statements shall also be analyzed. The analysis shall address the quality and sustainability of earnings, cash flow and the strength of the borrower's balance sheet Projected Financial Performance : Where term facilities (tenor more than I year) are proposed, borrower's future / projected financial performance should be provided, indicating an analysis of the sufficiency of cash flow to service debt repayments. Loans should not be granted if projected cash flow is insufficient to repay debts Account conduct: For existing borrowers, historic performance in meeting repayment obligations (trade payments, cheque, interest and principal payments etc) shall be addressed. Credit- debit summation, maximum -minimum balance, recycling and adjustment of the liability will be looked into which generally will back our renewal decision. Adherence to lending guidelines: Credit proposals to be prepared in line with Banks lending Guidelines. A Credit applications /proposal will clearly mention whether or not the proposal complies with the banks lending guidelines. A proposal that will not adhere to the banks lending guidelines will not be approved.

Mitigating Factors: In credit assessment , possible risks, such as margin sustainability and /or volatility , high debt loan ( leverage/gearing0, over stocking or debtor issues, rapid growth, acquisitions, new business line/ product expansion, management changes or succession issues, customer or supplier concentration and lack of transparency or industry and their mitigating factors to be identified. Loan Structure: Amount and tenor of loan will be fixed justifiably depending on income generation prospect, projected repayment capacity and the purpose of the loan. Failure in properly persuing these factors especially allowing loan for excessively long period of more than what is really justified/required in the business, will expose the bank to risk and also to non-repayment by the borrower. Security: Natioinal Banks Lending will generally be adequately securitized. Securities to be obtained will be acceptable , valuable , easily marketable & defect less ( in title). Valuation of security will be properly assessed. Security will comprise primary and collateral and will be adequately ( where applicable)

Loan Pricing
Various components of loan pricing & their calculation 1. Banks are the major financial institutions, which intermediate between actual lenders and actual borrowers. 2. For this intermediation banks are to pay actual lenders and charge actual borrowers. 3. The price of loan is the interest rate the borrowers must pay to the bank, in addition to the amount borrowed (principal) 4. The price/interest rate of a loan is determined by the true cost of the loan to the bank ( base rate) plus profit/risk premium for the banks services and acceptance risk. 5. The components of true cost of a loan are: i. Interest expense Deposit interest + Central bank borrowing ii. Administrative cost- Deposit as well as loan administration cost iii. Cost of Capital Return on capital or the rate of return investors would expect to receive and investment in a bank. 6. Risk is the measurable possibility of losing or not gaining value. 7. The primary risk which making a loan repayment risk, which is the measurable possibility that a borrower will not repay their obligation as agreed. 8. A good lending decision is none that minimizes repayment risk. 9. The price a borrower must pay to the bank for assessing and accepting the risk is called the risk premium.

10. Since past performance of a sector, industry or company is a strong indicator of future performance, risk premiums are generally based on the historical quantifiable amount of losses in that category. 11. Interest rate charge = Base Rate + Risk Premium 12. Loan pricing is not an exact science. There are several methods of calculating loan prices : ONE ALTERNATIVE WAY TO CALCULATE BASE RATE INTEREST EXPENSE ( 2 COMPONENTS) + ADMINISTRATION COSTS ( 2 COMPONENTS) + = BASE RATE CALCULATION OF INTEREST EXPENSE FOR A SIMPLE BANK % TOTAL 85% AVERAGE RATE 8% 6% = 6.8% = 0.6% %

LIABILITIES CONTRIBUTION DEPOSITS

CENTRAL BANK BORROWERS 10%

TOTAL WEIGHTED AVERAGE INTEREST EXPENSE = 7.4% CALCULATION OF 2ND COMPONENT OF BASE RATE ADMINISTRATIOIN COST TOTAL ADMINISTRATION COST/ EXPENSES DIVIDED BY TOTAL LOANS = % ADMINISTRATION COST/LOAN ANALYSIS OF CENTRAL BANK DATE ESTIMATES THIS TO BE APPROXIMATELY 2.5% CALCULATION OF 3RD COMPONENT OF BASE RATE COST OF CAPITAL COST OF CAPITAL = INVESTORS EXPECTED RATE OF RETURN INVESTMENT IN A BANK IS EXPECXTED TO RETURN 20% TO INVESTORS INVESTORS EXPECTED R/R X % BANK CAPITAL DIVIDED BY % BALANCE SHEET IN LOANS = COST OF CAPITAL PER UINT OF LOAN 20% X 5% DIVIDED BY 80& =1.25%

RISK PREMIUM= HISTORICAL LOSS RATE FOR A PARTICULAR CATEGORY OR TYPE OF LOAN EXAMPLE LARHE & MEDIUM SCALE INDUSTRIES CENTRAL BANK DATE INDICATES THAT HISTORICAL AVERAGE LOSS RATE FOR THIS SECTOR =4% LOSS RATE = LOSSES DIVIDED BY TOTAL CATEGORY LOANS 11.15% +4% = 15.15%

EXERCISE ON LOAN PRICING Suppose a bank has the following Balance Sheet ASSETS RESERVES LOANS TK 80 600 ( Figures in million Taka) LIABILITIES TK DEPOSIT 500 BORROWING 100 CAPITAL 80

If the Bank suffers a bad loan amounting 100, what would be its effect on the banks balance sheet as well a on lending price, assuming reserve in 10% of deposit capital is also 10% of earning assets cost of fund ( including administrative cost) is 5% and cost of capital is 8% Various methods of Loan pricing : There are 06(six) methods of loan pricing (LP). They are as follows: Cost plus loan pricing The price leadership Below prime market pricing Loan bearing maximum Interest rate (CAPs) Cost-Benefit loan pricing Customer profitability Analysis Cost plus loan pricing The bank must consider the cost of raising fund for giving loan and the non-fund operating cost for pricing the loan. That means that banks must know what their cost in order to consistently make profitable and correctly priced loan.The dimpliest loan pricing model assume that for pricing the loan there are four component consider in the interest rate : The cost of raising loanable fund to give the lend to borrower Banks non0fund operating cost Compensation for the banks degree of default risk

The Banks desired profit margin Compensation of

Loan interest rate = The cost of raising loanable fund + bank non-fund operating cost + default risk + profit margin

The price leadership model: The main drawback of cost plus loan pricing model is that the bank accurately knows the cost of various components and on that basois it find out the appropriate rate of interest on loan. This draw back lead to the new loan pricing model named the price leadership model.. In this model the major banking institution to establish a uniform base lending fee known as prime rate. The bank give loan at prime rate to its most credit worthiness customer. The interest rate on the loan is determined by the following way: Interest rate on loan = Prime rate ( its includes bank desire + profit + Administrative & operating cost) Mark up Compensation for default risk for non-prime rate bank borrower Term risk premium for the long term borrower

Below prime market pricing: These are again modification is needed on the calculated of the bank interest rate. This occurs because of the increasing/growing commercial paper market. In this model the bank provide loan to its customer below prime rate. It gives its most creditworthiness customer at a cost of money market interest rate plus a minimum mark up for risk & profit. So the interest rate on this model will be: Loan interest rate = Money market interest rate + mark up for risk profit Loan bearing Maximum Interest rate (CAPs): Another recent variation of old leadership model is the CAP rates. It is the agreed upon maximum rate of interest on the loan contract. It can not be exceed in the future regardless of the future market interest rate. For example : the prime rate is 10% Floating rate is 2%

CAP rate is 5% So the initial loan rate is 12%. So it in future interest rate increase than it would never be higher than 17%. Cost- Benefit loan Pricing: Most of the loans are priced under the prime rate or LIBOR rate. In recent years there are another model, which considers both cost & benefit of the loan. In this model thee are 3 steps involved: Step-1 : Estimate the total revenue of the loan which is generated from a variety of interest rates & other fees. Estimate total revenue= Portion of the loan used * interest rate + Un-used portion of the loan * commitment fees. Step-2: Estimate the net loanable funds that must be urn over to the borrowers Estimate the net loanable fund withdrawn by customer= Used portion of loan Compensating balance require + deposit resume requirement. Estimated revenue _______________________________ Loanable fund withdrawal by customers

Before Tax Yield =

Step-3: Estimate the before tax yield of the loan by dividing the estimated total revenue of the loan by net loanable funds the borrowers will actually use. Customer profitability Analysis (CPA): The cost benefit loan pricing is the narrow concept than most wider CPA. In this model, the whole customer relationship is consider when pricing each of the loan. Before Tax rate of return from the whole bank customer relationship= Revenue from loan and other service provided by the bank- Expenses for providing loan and other services to this customer. ____________________________________________________________ Net amount of loan withdrawn by the customer In the revenue includes loan interest, commitment fees cash management services, data processing changes. Expenses includes wages & salaries of the employee, credit investigation fees, deposit

interest accrued on deposit, Bank recommendation & processing cost

CREDIT RISK GRADING (CRG)


INTRODUCTION: Credit risk grading is an important tool for credit risk management as it helps the Banks & financial institutions to understand various dimensions of risk involved in different credit transactions. The aggregation of such grading across the borrowers, activities and the lines of business can provide better assessment of the quality of credit portfolio of a bank or a branch. The credit risk grading system is vital to take decisions both at the presanction stage as well as post-sanction stage. At the pre-sanction stage, credit grading helps the sanctioning authority to decide whether to lend or not to lend, what should be the loan price, what should be the extent of exposure, what should be the appropriate credit facility, what are the various facilities, what are the various risk mitigation tools to put a cap on the risk level. At the post-sanction stage, the bank can decide about the depth of the review or renewal, frequency of review, periodicity of the grading, and other precautions to be taken. Having considered the significance of credit risk grading, it becomes imperative for the banking system to carefully develop a credit risk grading model which meets the objective outlined above. The Lending Risk Analysis (LRA) manual introduced in 1993 by the Bangladesh Bank has been in practice for mandatory use by the Banks & financial institutions for loan size of BDT 1.00 crore and above. However, the LRA manual suffers from a lot of subjectivity, sometimes creating confusion to the lending Bankers in terms of selection of credit proposals on the basis of risk exposure. Meanwhile, in 2003 end Bangladesh Bank provided guidelines for credit risk management of Banks wherein it recommended, interalia, the introduction of Risk Grade Score Card for risk assessment of credit proposals. Since the two credit risk models are presently in vogue, the Governing Board of Bangladesh Institute of Bank Management (BIBM) under the chairmanship of the Governor, Bangladesh Bank decided that an integrated Credit Risk Grading Model be developed incorporating the significant features of the above mentioned models with a view to render a need based simplified and user friendly model for application by the Banks and financial institutions in processing credit decisions and evaluating the magnitude of risk involved therein.

Bangladesh Bank expects all commercial banks to have a well defined credit risk management system which delivers accurate and timely risk grading. This manual describes the elements of an effective internal process for grading credit risk. It also provides a comprehensive, but generic discussion of the objectives and general characteristics of effective credit risk grading system. In practice, a banks credit risk grading system should reflect the complexity of its lending activities and the overall level of risk involved. DEFINITION OF CREDIT RISK GRADING (CRG) The Credit Risk Grading (CRG) is a collective definition based on the prespecified scale and reflects the underlying credit-risk for a given exposure. A Credit Risk Grading deploys a number/ alphabet/ symbol as a primary summary indicator of risks associated with a credit exposure. Credit Risk Grading is the basic module for developing a Credit Risk Management system. FUNCTIONS OF CREDIT RISK GRADING Well-managed credit risk grading systems promote bank safety and soundness by facilitating informed decision-making. Grading systems measure credit risk and differentiate individual credits and groups of credits by the risk they pose. This allows bank management and examiners to monitor changes and trends in risk levels. The process also allows bank management to manage risk to optimize returns. USE OF CREDIT RISK GRADING The Credit Risk Grading matrix allows application of uniform standards to credits to ensure a common standardized approach to assess the quality of individual obligor, credit portfolio of a unit, line of business, the branch or the Bank as a whole. As evident, the CRG outputs would be relevant for individual credit selection, wherein either a borrower or a particular exposure/facility is rated. The other decisions would be related to pricing (credit-spread) and specific features of the credit facility. These would largely constitute obligor level analysis. Risk grading would also be relevant for surveillance and monitoring, internal MIS and assessing the aggregate risk profile of a Bank. It is also relevant for portfolio level analysis. NUMBER AND SHORT NAME OF GRADES USED IN THE CRG The proposed CRG scale consists of 8 categories with Short names and Numbers are provided as follows: GRADING SHORT NAME NUMBER Superior SUP 1 Good GD 2 Acceptable ACCPT 3 Marginal/Watch list MG/WL 4 Special Mention SM 5

Sub standard Doubtful Bad & Loss

SS DF BL

6 7 8

CREDIT RISK GRADING DEFINITIONS OF THE DIFFERENT CATEGORIES A clear definition of the different categories of Credit Risk Grading is given as follows: Superior - (SUP) - 1 Credit facilities, which are fully secured i.e. fully cash covered. Credit facilities fully covered by government guarantee. Credit facilities fully covered by the guarantee of a top tier international Bank. Good - (GD) - 2 Strong repayment capacity of the borrower The borrower has excellent liquidity and low leverage. The company demonstrates consistently strong earnings and cash flow. Borrower has well established, strong market share. Very good management skill & expertise. All security documentation should be in place. Credit facilities fully covered by the guarantee of a top tier local Bank. Aggregate Score of 85 or greater based on the Risk Grade Score Sheet

Acceptable - (ACCPT) - 3 These borrowers are not as strong as GOOD Grade borrowers, but still demonstrate consistent earnings, cash flow and have a good track record. Borrowers have adequate liquidity, cash flow and earnings. Credit in this grade would normally be secured by acceptable collateral (1st charge over inventory / receivables / equipment / property). Acceptable management Acceptable parent/sister company guarantee Aggregate Score of 75-84 based on the Risk Grade Score Sheet Marginal/Watch list - (MG/WL) - 4 This grade warrants greater attention due to conditions affecting the borrower, the industry or the economic environment. These borrowers have an above average risk due to strained liquidity, higher than normal leverage, thin cash flow and/or inconsistent earnings. Weaker business credit & early warning signals of emerging business credit detected.

The borrower incurs a loss Loan repayments routinely fall past due Account conduct is poor, or other untoward factors are present. Credit requires attention Aggregate Score of 65-74 based on the Risk Grade Score Sheet

Special Mention - (SM) - 5 This grade has potential weaknesses that deserve managements close attention. If left uncorrected, these weaknesses may result in a deterioration of the repayment prospects of the borrower. Severe management problems exist. Facilities should be downgraded to this grade if sustained deterioration in financial condition is noted (consecutive losses, negative net worth, excessive leverage), An Aggregate Score of 55-64 based on the Risk Grade Score Sheet. Substandard - (SS) 6 Financial condition is weak and capacity or inclination to repay is in doubt. These weaknesses jeopardize the full settlement of loans. Bangladesh Bank criteria for sub-standard credit shall apply. An Aggregate Score of 45-54 based on the Risk Grade Score Sheet. Doubtful - (DF) - 7 Full repayment of principal and interest is unlikely and the possibility of loss is extremely high. However, due to specifically identifiable pending factors, such as litigation, liquidation procedures or capital injection, the asset is not yet classified as Bad & Loss. Bangladesh Bank criteria for doubtful credit shall apply. An Aggregate Score of 35-44 based on the Risk Grade Score Sheet. Bad & Loss - (BL) - 8 Credit of this grade has long outstanding with no progress in obtaining repayment or on the verge of wind up/liquidation. Prospect of recovery is poor and legal options have been pursued. Proceeds expected from the liquidation or realization of security may be awaited. The continuance of the loan as a bankable asset is not warranted, and the anticipated loss should have been provided for. This classification reflects that it is not practical or desirable to defer writing off this basically valueless asset even though partial recovery may be affected in the future. Bangladesh Bank guidelines for timely write off of bad loans must be adhered to. Legal procedures/suit initiated.

Bangladesh Bank criteria for bad & loss credit shall apply. An Aggregate Score of less than 35 based on the Risk Grade Score Sheet. REGULATORY ACCOUNTS DEFINITION ON GRADING OF CLASSIFIED

Irrespective of credit score obtained by a particular obligor, grading of the classified names should be in line with Bangladesh Bank guidelines on classified accounts, which is extracted from PRUDENTIAL REGULATIONS FOR BANKS: SELECTED ISSUES (updated till August 07, 2005) by Bangladesh Bank are presently as follows: Basis for Loan Classification: 7.7.1 Objective Criteria: Any Continuous Loan if not repaid/renewed within the fixed expiry date for repayment will be treated as irregular just from the following day of the expiry date. This loan will be classified as Sub-standard if it is kept irregular for 6 months or beyond but less than 9 months, as `Doubtful' if for 9 months or beyond but less than 12 months and as `Bad & Loss' if for 12 months or beyond. Any Demand Loan will be considered as Sub-standard if it remains unpaid for 6 months or beyond but not less then 9 months from the date of claim by the bank or from the date of forced creation of the loan; likewise the loan will be considered as Doubtful' and Bad & Loss if remains unpaid for 9 months or beyond but less then 12 months and for 12 months and beyond respectively. In case any installment(s) or part of installment(s) of a Fixed Term Loan is not repaid within the due date, the amount of unpaid installment(s) will be termed as `defaulted installment'. In case of Fixed Term Loans, which are repayable within maximum 5 (five) years of time: If the amount of `defaulted installment' is equal to or more than the amount of installment(s) due within 6 months, the entire loan will be classified as Substandard. If the amount of 'defaulted installment' is equal to or more than the amount of installment(s) due within 12 months, the entire loan will be classified as Doubtful. If the amount of 'defaulted installment' is equal to or more than the amount of installment(s) due within 18 months, the entire loan will be classified as Bad & Loss. In case of Fixed Term Loans, which are repayable in more than

5 (five) years of time: If the amount of defaulted installment' is equal to or more than the amount of installment(s) due within 12 months, the entire loan will be classified as 'Substandard.' If the amount of defaulted installment' is equal to or more than the amount of installment(s) due within 18 months, the entire loan will be classified as 'Doubtful'. If the amount of 'defaulted installment 'is equal to or more than the amount of installment(s) due within 24 months, the entire loan will be classified as 'Bad & Loss'. Explanation: If any Fixed Term Loan is repayable at monthly installment, the amount of installment(s) due within 6 months will be equal to the amount of summation of 6 monthly installments. Similarly, if repayable at quarterly installment, the amount of installment(s) due within 6 months will be equal to the amount of summation of 2 quarterly installments. 7.7.2 Qualitative Judgment:

If any uncertainty or doubt arises in respect of recovery of any Continuous Loan, Demand Loan or Fixed Term Loan, the same will have to be classified on the basis of qualitative judgment be it classifiable or not on the basis of objective criteria. If any situational changes occur in the stipulations in terms of which the loan was extended or if the capital of the borrower is impaired due to adverse conditions or if the value of the securities decreases or if the recovery of the loan becomes uncertain due to any other unfavorable situation, the loan will have to be classified on the basis of qualitative judgment Besides, if any loan is illogically or repeatedly re-scheduled or the norms of rescheduling are violated or instances of (propensity to) frequently exceeding the loan-limit are noticed or legal action is lodged for recovery of the loan or the loan is extended without the approval of the proper authority, it will have to be classified on the basis of qualitative judgment . Despite the probability of any loan's being affected due to the reasons stated above or for any other reasons, if there exists any hope for change of the existing condition by resorting to proper steps, the loan, on the basis of qualitative judgment, will be classified as 'Sub-standard'. But even if after resorting to proper steps, there exists no certainty of total recovery of the loan, it will be classified as Doubtful' and even after exerting the all-out effort, there exists no chance of recovery, it will be classified as ' Bad & Loss' on the basis of qualitative judgment.

The concerned bank will classify on the basis of qualitative judgment and can declassify the loans if qualitative improvement does occur. But if any loan is classified by the Inspection Team of Bangladesh Bank, the same can be declassified with the approval of the Board of Directors of the bank. However, before placing such case to the Board, the CEO and concerned branch manager shall have to certify that the conditions for declassification have been fulfilled. Note: a) Any change in classification criteria provided by the Bangladesh Bank shall supersede this grading system for classified accounts. b) An account may also be classified based on qualitative judgment in line with Bangladesh Bank guidelines. c) A particular bank may have classification criteria stricter than Bangladesh Bank guidelines. 7.8 HOW TO COMPUTE CREDIT RISK GRADING The following step-wise activities outline the detail process for arriving at credit risk grading. Step I : Identify all the Principal Risk Components

Credit risk for counterparty arises from an aggregation of the following: Financial Risk Business/Industry Risk Management Risk Security Risk Relationship Risk

Each of the above mentioned key risk areas require to be evaluated and aggregated to arrive at an overall risk grading measure. Evaluation of Financial Risk: Risk that counterparties will fail to meet obligation due to financial distress. This typically entails analysis of financials i.e. analysis of leverage, liquidity, profitability & interest coverage ratios. To conclude, this capitalizes on the risk of high leverage, poor liquidity, low profitability & insufficient cash flow. Evaluation of Business/Industry Risk:

a)

b)

Risk that adverse industry situation or unfavorable business condition will impact borrowers capacity to meet obligation. The evaluation of this category of risk looks at parameters such as business outlook, size of business, industry growth, market competition & barriers to entry/exit. To conclude, this capitalizes on the risk of failure due to low market share & poor industry growth. Evaluation of Management Risk: Risk that counterparties may default as a result of poor managerial ability including experience of the management, its succession plan and team work. Evaluation of Security Risk: Risk that the bank might be exposed due to poor quality or strength of the security in case of default. This may entail strength of security & collateral, location of collateral and support. Evaluation of Relationship Risk: These risk areas cover evaluation of limits utilization, account performance, conditions/covenants compliance by the borrower and deposit relationship.

c)

d)

e)

Step II

Allocate weightages to Principal Risk Components

According to the importance of risk profile, the following weightages are proposed for corresponding principal risks. Principal Risk Components: Financial Risk Business/Industry Risk Management Risk Security Risk Relationship Risk Weight: 50% 18% 12% 10% 10%

Step III

Establish the Key Parameters Key Parameters: Leverage, Liquidity, Profitability & Coverage ratio. Size of Business, Age of Business, Business Industry Growth, Competition &

Principal Risk Components: Financial Risk Business/Industry Risk Outlook, Barriers to Business

Management Risk Security Risk Relationship Risk Step IV

Experience, Succession & Team Work. Security Coverage, Collateral Coverage and Support. Account Conduct ,Utilization of Limit, Compliance of covenants/conditions & Personal Deposit.

Assign weight ages to each of the key parameters.

Principal Risk Components: Financial Risk 50%

Key Parameters:

Weight:

Business/Industry Risk 18% Management Risk 12%

Leverage Liquidity Profitability Coverage

15% 15% 15% 5%

Size of Business Age of Business Business Outlook Industry growth Market Competition Entry/Exit Barriers

5% 3% 3% 3% 2% 2%

Experience Succession Team Work Security Risk 10% Security coverage Collateral coverage Support Relationship Risk 10%

5% 4% 3%

4% 4% 2%

Account conduct 5% Utilization of limit 2% Compliance of covenants /condition 2% Personal deposit 1%

Step V

Input data to arrive at the score on the key

After the risk identification & weight age assignment process (as mentioned above), the next steps will be to input actual parameter in the score sheet to arrive at the scores corresponding to the actual parameters. This manual also provides a well programmed MS Excel based credit risk scoring sheet to arrive at a total score on each borrower. The excel program requires inputting data accurately in particular cells for input and will automatically calculate the risk grade for a particular borrower based on the total score obtained. The following steps are to be followed while using the MS Excel program.
a) b)

Open the MS XL file named, CRG_SCORE_SHEET The entire XL sheet named, CRG is protected except the particular cells to input Input data accurately in the cells which are BORDERED & are colored YELLOW.

data.
c)

Some input cells contain DROP DOWN LIST for some criteria corresponding to the Key Parameters. Click to the input cell and select the appropriate parameters from the DROP DOWN LIST as shown below.
d)

e) f)

All the cells provided for input must be filled in order to arrive at accurate risk grade. We have also enclosed the MS Excel file named, CRG_Score_Sheet in CD ROM for Step VI Arrive at the Credit Risk Grading based on total score obtained.

use.

The following is the proposed Credit Risk Grade matrix based on the total score obtained by an obligor. Number 1 Risk Grading Superior Short Name SUP Score 100% cash covered Government guarantee International Bank

2 3

Good Acceptable

GD ACCPT

guarantees 85+ 75-84 65-74 55-64 45-54 35-44 <35

4 Marginal/Watchlist MG/WL 5 Special Mention SM 6 Sub-standard SS 7 Doubtful DF 8 Bad & Loss BL 7.9 CREDIT RISK GRADING PROCESS

Credit Risk Grading should be completed by a Bank for all exposures (irrespective of amount) other than those covered under Consumer and Small Enterprises Financing Prudential Guidelines and also under The Short-Term Agricultural and Micro - Credit. For Superior Risk Grading (SUP-1) the score sheet is not applicable. This will be guided by the criterion mentioned for superior grade account i.e. 100% cash covered, covered by government & bank guarantee. Credit risk grading matrix would be useful in analyzing credit proposal, new or renewal for regular limits or specific transactions, if basic information on a borrowing client to determine the degree of each factor is a) readily available, b) current, c) dependable, and d) parameters/risk factors are assessed judiciously and objectively. The Relationship Manager as per Data Collection Checklist as shown in Appendix-A should collect required information. Relationship manager should ensure to correctly fill up the Limit Utilization Form as shown in Appendix-B in order to arrive at a realistic earning status for the borrower. Risk factors are to be evaluated and weighted very carefully, on the basis of most up-to-date and reliable data and complete objectivity must be ensured to assign the correct grading. Actual parameter should be inputted in the Credit Risk Grading Score Sheet as shown in AppendixC. Credit risk grading exercise should be originated by Relationship Manager and should be an on-going and continuous process. Relationship Manager shall complete the Credit Risk Grading Score Sheet and shall arrive at a risk grading in consultation with a Senior Relationship Manager and document it as per Credit Risk Grading

Form as shown in Appendix-D, which shall then be concurred by the Credit Officer in consultation with a Senior Credit Officer. All credit proposals whether new, renewal or specific facility should consist of a) Data Collection Checklist, b) Limit Utilization Form c) Credit Risk Grading Score Sheet, and d) Credit Risk Grading Form. The credit officers then would pass the approved Credit Risk Grading Form to Credit Administration Department and Corporate Banking/Line of Business/Recovery Unit for updating their MIS/record. The appropriate approving authority through the same Credit Risk Grading Form shall approve any subsequent change/revision i.e. upgrade or downgrade in credit risk grade.

7.10 EARLY WARNING SIGNALS (EWS) Early Warning Signals (EWS) indicate risks or potential weaknesses of an exposure requiring monitoring, supervision, or close attention by management. If these weaknesses are left uncorrected, they may result in deterioration of the repayment prospects in the Banks assets at some future date with a likely prospect of being downgraded to classified assets. Early identification, prompt reporting and proactive management of Early Warning Accounts are prime credit responsibilities of all Relationship Managers and must be undertaken on a continuous basis. Despite a prudent credit approval process, loans may still become troubled. Therefore, it is essential that early identification and prompt reporting of deteriorating credit signs be done to ensure swift action to protect the Banks interest. The symptoms of early warning signals as mentioned below are by no means exhaustive and hence, if there are other concerns, such as a breach of loan covenants or adverse market rumors that warrant additional caution, a Credit Risk Grading Form (Appendix-D) should be presented.

Irrespective of credit score obtained by any obligor as per the proposed risk grade score sheet, the grading of the account highlighted as Early Warning Signals (EWS) accounts shall have the following risk symptoms.
a)

Marginal/Watchlist (MG/WL - 4): if

Any loan is past due/overdue for 60 days and above. Frequent drop in security value or shortfall in drawing power exists. Any loan is past due/overdue for 90 days and above Major document deficiency prevails (such deficiencies include but not limited to; board resolution for borrowing not obtained, sanction letter not accepted by client, charges/hypothecation over assets favoring bank not filed with Registrar, Joint Stock Companies, mortgage not in place, guarantees not obtained, etc.) A significant petition or claim is lodged against the borrower.

b)

Special Mention (SM - 5): if

The Credit Risk Grading Form of accounts having Early Warning Signals should be completed by the Relationship Manager and sent to the approving authority in Credit Risk Management Department. The Credit Risk Grade should be updated as soon as possible and no delay should be there in referring Early Warning Signal accounts or any problem accounts to the Credit Risk Management Department for their early involvement and assistance in recovery. 7.11 EXCEPTIONS TO CREDIT RISK GRADING Head of Credit Risk Management may also downgrade/classify an account in the

normal course of inspection of a Branch or during the periodic portfolio review. In such event, the Credit Risk Grading Form will then be filled up by Credit Risk Management Department and will be referred to Corporate Banking/Line of Business/Credit Administration Department/Recovery Unit for updating their MIS/records. Recommendation for upgrading of an account has to be well justified by the recommending officers. Essentially complete removal of the reasons for downgrade should be the basis of any upgrading. In case an account is rated marginal, special mention or unacceptable credit risk as per the risk grading score sheet, this may be substantiated and credit risk may be

accepted if the exposure is additionally collateralized through cash collateral, good tangible collaterals and strong guarantees. These are exceptions and should be exceptionally approved by the appropriate approving authority. Whenever required an independent assessment of the credit risk grading of an individual account may be conducted by the Head of Credit Risk Management or by the Internal Auditor documenting as to why the credit deteriorated and also pointing out the lapses. If a Bank has its own well established risk grading system equivalent to the proposed credit risk grading or stricter, then they will have the option to continue with their own risk grading system. 7.12 CREDIT RISK GRADING REVIEW Credit Risk Grading for each borrower should be assigned at the inception of lending and should be periodically updated. Frequencies of the review of the credit risk grading are mentioned below;

Number 1 2 3 4 5 6 7 8

Risk Grading Superior Good Acceptable Marginal/Watchlist Special Mention Sub-standard Doubtful Bad & Loss

Short SUP GD ACCPT MG/WL SM SS DF BL

Review frequency (at least) Annually Annually Annually Half yearly Quarterly Quarterly Quarterly Quarterly

7.13 MIS ON CREDIT RISK GRADING Bank should have comprehensive MIS reports on credit risk grading to evaluate entire credit portfolio of the Bank. Format of such MIS reports on credit risk grading has been presented in Appendix - E. Credit Risk Grading Report (Consolidated) Credit Risk Grading Report (Branch Wise) Credit Risk Grading Report (Branch & Risk Grade Wise) Credit Risk Grading Report (Grade Wise Borrower List)

MIS reports as mentioned above should be prepared and circulated at least on a quarterly basis. FINANCIAL SPREAD SHEET (FSS) A Financial Spread Sheet (FSS) has been developed which may be used by the Banks while analyzing the credit risk elements of a credit proposal from financial point of view.The FSS is well designed and programmed software having two parts. Input and Output Sheets. The financial numbers of borrowers need to be inputted in the Input Sheets which will then automatically generate the Output Sheets. The Financial Spread Sheet (FSS) is attached as Appendix - F. Case studies on Credit Risk Grading Ifad Flour Ltd.Have about 14 years experience in the same line of business. The teamwork of the company is very good. The industry turnover of food processing ( Flour mill) agro-based sector has increased rapidly from year to year. The supply of raw materials comes from local market and import as well and the demand of Flour is increased rapidly. Initially a CC(H) limit of Tk. 30.00 lac was sanctioned by National bank Limited, Agrabad branch. in favour of the party in the year 2003 and availing LC facility on case to case basis. Subsequently, the CC(H) limit was renewed. Recently,. their business activities have been increased. As such the party has approached the National bank Limited, Agrabad branch for sanction of L/C limit for Tk. 50.0 lac (including PAD) ,LTR limit for Tk. 10.00 lac and renewal with enhancement of CC(H) limit from Tk. 30.00 lac to Tk. 50.00 lac. The company has been enjoying a Term Loan of Tk. 155.00 lac from IDLC as project loan. Present outstanding of the Term Loan is Tk. 135.00 lac The company offered 10 decimal lands with 03 stored building as colleteral security situated at Nasirabad ,Chittagoing having forced value of Tk. 150.00 lac . The valuation of the security has been assessed by surveyor company M/s Shahriar & Co & Branch on 07/03/2007 Moreover machinery & Inventory of the company will be hypothecated in favour of National bank Limited, Agrabad Branch and the same will be registered with the RJSC. The managing Director & the Directors also provide personal guarantee against the proposed facility. Last factory visit was made by the branch manager & credit Officer jointly on 15.02.2008 and found satisfactory operating activity of the Mill. They also verified the clients stock on 15.02.2008 and found total worth of stock of Tk. 60.00 lac

CIB report : CIB report dated 24.02.2008 with the position as on 31.12.2007 shows STD liability of Tk. 150.00 lac in the account of the party out of which Tk. 15.00 lac is with National Bank Limited and the rest is with other bank and another liability of Tk. 15.00 lac in the account of its sister concern which shows as STD. Existing liability position with NBL
Facility Limit O/S as on 28-02- Expiry 2008 Days past due Interest Suspense Provision

CC(H) Tk. 30 lac Tk. 2 lac Particulars of 02 (Two) competitors: Sl no. 01 02 Name of competitors the

30.07.08 Total assets as on 28.02.08 350.00 lac 250.00 lac

NIL sales as on 28.02.08 150.00 lac 88.00 lac

N/A

N/A Net profit as on 28.02.08 18.00 lac 10.00 lac

Mostafa Flour Mills Ltd Muscan Flour Mills Ltd

Account performance: Nature of the account Debit summation Cash Credit (CC) 6000 Account volume ( actual) Facilities Letter of Credits

Credit summation 5800

Balance/Outstanding Maximum Minimum 3000 200

Total No. of Transaction 20

Amount in 000 Taka 8000

Account Profitability: Period: for the period from 28.02.07 to 28.02.08 ( 12 months actual)
Nature of Account Overdraft/Cash Credit SLC Gross Earnings Less: Cost of fund (9% approx) Net earnings Average Utilization Tk. 1806 60.20 % Rate Interest 16.00% of Interest Income 280 XXX XX XXX XXX XXX Commission Other revenue Total 280 40 XXX XXX 40 320 162 158

Account Performance: (Projected) Period: For the period from 28.02.08 to 28.02.2009 Account performance Nature account of the Debit summation 15000 Credit summation 14500 ( Amount in 000 Taka) Balance/Outstanding Maximum Minimu m 5000 200 200 50 Amount in OOO Taka 10000 2000

Cash Credit (CC) LTR

Account Volume ( Projected) Facilities Letter of Credits LTR

Total No. of Transaction 25 25

Account Profitability: Period: for the period from 28.02.07 to 28.02.08 ( 12 months actual)
Nature of Account Overdraft/Ca sh Credit SLC LTR Average Utilization Tk. 3000 60.00% Rate of Interest Interest Income 16.00% 280 232.50 ( Amount in 000 Taka) Commission Other revenue Total 465 50 XXX XXX 50 253

1500 16.00% (average used for 09 months out of 12 month)

Gross Earnings Less: Cost of fund (9% approx) Net earnings

XXX XX

XXX

XXX

748 405

XXX

XXX

XXX

343

Enclosure:

Three years audited Financial Statement Other related information is to be collected by Credit Officer/RM of the branch if require. Requirements Please prepare the Financial Spreadsheet (FSS) and also compute the Credit Risk Grade as per CRG manual

Ifad Flour Mills Ltd Balance Sheet as on 31st December 2007 2007 Particulars Assets A. Current assets Stock & Stores L/C Margin Prepaid Expenses Accounts Receivable Marketable Securities Cash in Hand Cash at Bank Total Current Assets (A) B. Non-Current assets Advances Due from sister Concern Tangible Fixed Assets ( As per annexure 5) Preliminary Expenses Total Non-current assets (B) Total Assets (A+B) Liabilities C. Current Liabilities Directors loan Cash Credit Expenses Accruals Accounts payable Proposed Dividend Tax Provision Total Current Liabilities (C) D. Non-Current liabilities 13500000 Long Term Loans 0 1610000 70000 210000 360000 200000 2450000 200000 3000000 400000 290000 170000 110000 4170000 3250000 0 1000000 500000 25660000 0 27160000 32800000 0 400000 2928000 0 50000 2973000 0 0 400000 32380000 100000 32880000 34230000 900,000 350000 160000 2000000 760000 540000 930000 5640000 880000 320000 140000 700000 400000 40000 290000 2770000 880000 50000 100000 250000 0 30000 40000 1350000 2006 2005

100000 1420000 380000 90000 260000 150000 2400000

15500000

15950000 E. Total liabilities (C+D) Capital F. Shareholders Equity Paid up capital General Reserve Retained Earnings Total Liabilities & Shareholders equity(E+F) 12500000 1610000 2740000 16850000 32800000 1250000 0 1250000 1850000 1560000 0 3250000 0 Ifad flour Mills Ltd Income Statement as on 31st December 2007 2007 Particulars 1. Sales 2.Cost of goods sold (Annex-1) 1. Gross Profit (1-2) 2. Operating Expenses: Admn. & General ( Annex -02) Selling & Distribution ( Annex03) Total operating Expense 3. Operating Profit (3-4) 4. Non-Operating Expenses ( Annex-04) 5. Profit before Tax (5-6) 6. Provision for Taxation 7. Net profit after Tax (7-8) 8. Add, Balance of profit b/f from previous year 9. Surplus available for appropriations 13250000 10620000 2630000 420000 160000 580000 2050000 240000 1810000 200000 1610000 1850000 3460000 1245000 0 1022000 0 2230000 390000 160000 550000 1680000 230000 1450000 150000 1300000 1100000 2006 1450000 0 1690000 0

19670000

12500000 960000 1100000 14560000 34230000

2005 11320000 9560000 1760000 250000 150000 400000 1360000 220000 1140000 110000 1030000 470000 1500000

(9+10) 10. Appropriations: Transferred to general Reserve Proposed Dividend 11. Balance of profit/Retained Earnings tr. to Balance Sheet (11-12)

2400000 360000 360000 720000 2740000 290000 260000 550000 1850000 230000 170000 400000 1100000

Cost of Goods Sold Particulars 1. Opening Stock of Finished Goods 2. Cost of Goods Manufactured ( annex1.1) 3. Cost of Goods Available for Sales (!+2) 4. Less Closing Stock of finished goods 5. Cost of Goods Sold (3-4)

Annexure- 01 2007 400000 10620000 11020000 400000 10620000 2006 400000 1022000 0 1062000 0 400000 1022000 0 Annexure- 1.1 2007 2006 120000 6120000 4090000 110000 1022000 0 2005 220000 5980000 3370000 120000 9450000 2005 510000 9450000 9960000 400000 9560000

Cost of Goods Manufactured Particulars 1. Opening Stock of Work-in-process 2. Raw materials Used ( annex-1.2) 3. manufacturing Cost (Annex-1.3) 4. Less Closing Stock of Work-in-process 5. Cost of production/Manufacturing Cost

110000 5750000 4860000 100000 10620000

Cost of Material Used Particulars 1. Opening Stock of Raw materials 2. Add-Net purchase of Raw materials 3. Raw materials available

Annexure- 1.2 2007 370000 5780000 6150000 2006 360000 6130000 6490000 2005 360000 5980000 6340000

4. Less Closing Stock of Raw materials 5. Cost of Raw materials Used

400000 5750000

370000 6120000

360000 5980000

Manufacturing Cost Particulars 1. Wages, Bonus & Allownaces 2. Power, Fuel & Gas 3. Godown Rent 4. Repairs & maintenance 5. Excise duty 6.Depriciation 7. Total Administration & General Expenses Particulars 1. Salaries & Allownaces 2. Office Rent 3. Telephone,Telex & Fax 4. Stationary 5. Traveling & Conveyance 6.Donation 7. Audit & Legal fees 8. Bad debts 9. Misc Expenses 10. Depreciation 11.Preliminary Expenses Write-Off Selling & Distribution Expenses Particulars 1. Sales Commission 2. Sales Promotion Expenses 3. Advertisement 4. Traveling 5. Carriage Outwards 6.Total

Annexure- 1.3 2007 150000 150000 20000 30000 210000 4300000 4860000 2006 130000 150000 20000 30000 200000 3560000 4090000 Annexure- 2 2007 130000 40000 20000 20000 30000 10000 10000 20000 30000 60000 50000 420000 2006 120000 30000 20000 20000 20000 10000 20000 20000 20000 60000 50000 390000 Annexure- 3 2007 50000 30000 30000 20000 30000 160000 2006 50000 30000 30000 20000 30000 160000 2005 50000 20000 30000 20000 30000 150000 2005 100000 30000 10000 20000 10000 10000 20000 20000 0 30000 0 250000 2005 130000 150000 20000 30000 200000 2840000 3370000

Non-Operating Expenses Particulars 1. Bank Interest 2. Bank Charge & Commission

Annexure- 4 2007 2006 200000 200000 40000 30000 240000 230000 Annexure-5 31st December 2006 WD Ad Acc. V diti Dep on
1250 4200 21980 0 0 230 0 1200 6320

2005 190000 30000 220000

Schedule of Fixed Assets Items 31st December 2007 WD Addi Acc. V tion Dep
1250 3780 18380 0 0 0 0 1620 9920

( Tk 000) 31st Dec 2005 WD Acc. V DEp


1250 4600 23830 0 800 4240

Land Factory Building Plant & Machiner y Equipmen ts Furniture & Fix. Total

1610 640 25660

720 20 740

1540 180 1326o

1170 680 29280

0 290 520

1260 120 8900

2250 450 32380

180 60 5280

Note: Cost of the Fixed assets = WDV + accumulated Dep. Written down value (WDV)= Cost Accumulated Depreciation Name of Party:Ifad Flour Mills Ltd. Name of the Branch: National BanK Limited, Agrabad Branch,Chittagong. Auditor Analyst FYE Period Amount DETAILED FINANCIAL REPORT CURRENT ASSETS Cash/Bank Balances L/C Margin Fixed Deposits/marketable Securities Acc. Receivable- Trade 70 50 0 250 330 320 400 700 1470 350 760 2000 Audited Name of RM 31.12.05 12 Mts in (000) Taka Audited Name of RM 31.12.06 12 Mts in (000) Taka Audited Name of RM 31.12.07 12 Mts In (000) Taka

Accounts Receivable Others Goods in Transit Inventory Due from Affiliates- Current

0 0 880 0

0 0 880 0

0 0 900 0

FIXED ASSETS Gross Fixed Assets Less: Depreciation ( Acc) NON-CURRENT ASSETS Due from Principal, Emp & Affiliate Advance Income Tax Deferred Charges, Pre-pymts & Adv CURRENT LIABILITIES Short Term Bank Borrowings Current Funded Portion of Term Debit (CMLTD) Account Payable- Trade Accrued Items Provision for Income Tax/Def. I/T Liabilities Advance Payment Dividends Payable LONG TERM LIABILITIES Term Loan NET WORTH Paid up Capital Directors Loan ( Subordinated) Retained Earnings Reserves

37660 5280 400 0 200

38180 8900 400 0 190

38920 13260 500 0 1160

3000 0 290 400 110 0 170 15500 12500 200 1100 960

1420 0 90 380 150 0 260 14500 12500 100 1850 1250

1610 0 210 70 200 0 360 13500 12500 0 2740 1610

BALANCE Difference (if any)

TRUE 0

TRUE 0

TRUE 0

Name of Party:Ifad Flour Mills Ltd. Name of the Branch: National BanK Limited, Agrabad Branch, Chittagong. Auditor Analyst FYE Period Amount INCOME STATEMENT Audited Name of RM 31.12.05 12 Mts in (000) Taka Audited Name of RM 31.12.06 12 Mts in (000) Taka Audited Name of RM 31.12.07 12 Mts in (000) Taka

Gross Sales Less: VAT Add. Other Operating Income Less: Cost of Goods Sold

11320 0

12450 0

13250 0

6720

6660

6320

Less: Selling, Expenses Less: Depriciation

Gen.

&

Admn.

370 2870 220

490 3620 230

520 4360 240

Less. Interest Expense Add: Other Income Income Taxes Cash withdrawals/Dividend BALANCE Difference (if any)

110 170

150 260 TRUE 0 0

200 360 TRUE 0

Name of Party:Ifad Flour Mills Ltd. Name of the Branch: National BanK Limited, Agrabad Branch,Chittagong.
Auditor Analyst FYE Period Amount DETAILED FINANCIAL REPORT CURRENT ASSETS Cash/Bank Balances L/C Margin FixedDeposits/marketable Securities Acc. Receivable- Trade Accounts Receivable -Others Goods in Transit Inventory Total Inventory Due from Affiliates- Current TOTAL CURRENT ASSETS FIXED ASSETS Gross Fixed Assets Less: Depreciation ( Acc) NET FIXED ASSETS NON-CURRENT ASSETS Due from Principal, Emp & Affiliate Advance Income Tax Deferred Charges, Pre-pymts & Adv TOTAL NON-CURRENT ASSETS TOTAL ASSETS CURRENT LIABILITIES Short Term Bank Borrowings Current Funded Portion of Term Debit (CMLTD) Account Payable- Trade Accrued Items Provision for Income Tax/Def. I/T Liabilities Advance Payment Dividends Payable TOTAL CURRENT LIABILITIES LONG TERM LIABILITIES Term Loan TOTAL LIABILITIES NET WORTH Paid up Capital Directors Loan (Subordinated) Retained Earnings Reserves NET WORTH Audited Name of RM 31.12.05 12 Mts In (000) Taka % TBS Audited Name of RM 31.12.06 12 Mts in (000) Taka % TBS Audited Name of RM 31.12.07 12 Mts in (000) Taka % TBS

70 50 0 250 0 0 880 880 0 1250 37660 5280 32380 400 0 200 32980 34230 3000 0 290 400 110 0 170 3970 15500 19470 12500 200 1100 960 14760

0 0 0 1 0 0 3 3 0 4 0 0 15 95 1 0 1 96 100 9 0 1 1 0 0 12 45 57 37 1 3 3 43

330 320 400 700 0 0 880 880 0 2630 38180 8900 29280 400 0 190 29870 32500 1420 0 90 380 150 0 260 2300 14500 16800 12500 100 1850 1250 15700

1 1 1 2 0 0 3 3 0 8 117 27 90 1 0 1 92 100 4 0 0 1 0 0 1 7 45 52 38 0 6 4 48

1470 350 760 2000 0 0 900 900 0 5480 38920 13260 25660 500 0 1160 27320 32800 1610 0 210 70 200 0 360 2450 13500 15950 12500 0 2740 1610 16850

4 1 2 6 0 0 3 3 0 17 119 40 78 2 0 4 83 100 5 0 1 1 0 1 7 41 49 38 0 8 5 51

TOTAL LIABILITIES & NET WORTH

34230

100

32500

100

32800

100

Name of Party:Ifad Flour Mills Ltd. Name of the Branch: National BanK Limited, Agrabad Branch,Chittagong.
Auditor Analyst FYE Period Amount INCOME STATEMENT Gross Sales Less: VAT NET SALES Add. Other Operating Income TOTAL SALES REVENUE Less: Cost of Goods Sold GROSS PROFIT/REVENUE 11320 0 11320 0 11320 6720 4600 100 0 100 0 100 59 41 12450 0 12450 0 12450 6660 5790 100 0 100 0 100 53 47 13250 0 13250 0 13250 6320 69630 100 0 100 0 100 48 52 Audited Name of RM 31.12.05 12 Mts In (000) Taka % TBS Audited % Name of RM TBS 31.12.06 12 Mts in (000) Taka Audited % Name of TBS RM 31.12.07 12 Mts in (000) Taka

Less: Selling, Gen. & Admn. Expenses TOTAL OPERATING PROFIT (EBITDA) Less: Depreciation Less. Interest Expense PROFIT BEFORE TAXES & EXTR ITEM

370 4230 2870 220 1140

3 37 25 2 10

490 5300 3620 230 1450

4 43 29 2 12

520 3410 4360 240 1810

4 48 33 2 14

Add: Other Income

Income Taxes NET PROFIT

110 1030

1 9

150 1300

1 10

200 1610

2 12

Cash withdrawals/Dividend

170

260

360

TOTAL CHANGES IN RETAINED EARNINGS

860

1040

1250

Name of Party:Ifad Flour Mills Ltd. Name of the Branch: National BanK Limited, Agrabad Branch,Chittagong.
FINANCIAL RATIOS GROWTH RATIOS Sales Growth, Sales % Net Sales Growth, Composite % Net Income Growth,% Total Assets Growth,% Total liabilities Growth,% Net Worth Growth,% PROFITABILITY RATIOS Gross Margin, Composite % SG & A,% Cushion (Gross Margin-SG & A),% Depreciation, Amortization,% Operating Profit Margin,% Interest Expense,% Operating Margin,% Net Margin,% Return on Assets,% Return on Equity,% Cash Withdrawal/Dividend Payout Rate ,% COVERAGE RATIOS Interest Coverage ( EBIT/Total Interest) Debt Ser. Coverage (EBITDA/Total Interest +CMLTD) ACTIVITY RATIOS Receivable in Days Payable in Days Inventory in Days Sales/Total Assets (X) LIQUIDITY RATIOS Working Capital Quick Ratio (X) Current Ratio (X) Sales/Net Working Capital (X) LEVERAGE RATIOS Total liabilities/Net Worth (X) 1.32 1.07 0.95 -2720 0.09 0.31 -4.16 330 0.76 1.14 37.73 3030 1.87 2.24 4.37 8 16 48 0.3 21 5 48 0.4 55 12 52 0.4 6.18 19.23 7.30 23.04 8.54 26.71 40.64 3.27 37.37 25.35 37.37 1.94 10.07 9.10 3.01 6.98 16.50 46.51 3.94 42.57 29.08 42.57 1.85 11.65 10.44 4.00 8.28 20.00 52.30 3.94 48.38 32.91 48.38 1.81 13.66 12.15 4.91 9.55 22.36 N/A N/A N/A N/A N/A N/A 9.98 9.98 26.21 -5.05 -13.71 6.37 6.43 6.43 23.85 0.92 -5.06 7.32 31.12.05 % 31.12.06 % 31.12.07 %

Affiliate Exposure/Net Worth (%) Total liabilities/( Net Worth Affiliates)(X)

2.7 1.36

2.5 1.10

3.0 0.98

Name of Party:Ifad Flour Mills Ltd. Name of the Branch: National BanK Limited, Agrabad Branch,Chittagong. Auditor Analyst FYE Period Amount CASH FLOW STATEMENT Profit Before Tax after Extra Items Add: Interest Expense Add: Depreciation Add/Minus : Change in Deferred Taxes EBITDA CASH FLOW Less: Interest Expense Less: Taxes Less: Dividends CF BEFORE INVESTING ACTIVITIES Less/Add : Capital Expenditures/Gain CF BEFORE WORKING CAPITAL CHANGES Plus/Minus : Change in Accts Receivable Plus/Minus : Change in Inventory Plus/Minus : Change in prepaid expense Plus/Minus : Change in Accts Payable Plus/Minus : Change in Accrued Expenses Plus/Minus : Change in Dividend payable TOTAL WORKING CAPITAL CHANGES CF BEFORE TRANSACTION INTERCOMPANY 1450 230 3620 40 5340 -230 -150 -260 4700 -520 4180 -450 0 10 -200 -20 90 -570 3610 0 3610 0 3610 -1580 -1000 -2580 1810 240 4360 50 6460 -240 -200 -360 5660 -740 4920 -1300 -20 -970 120 -310 100 -2380 2540 -100 2440 0 2440 190 -1000 -810 Audited Name of RM 31.12.07 12 Mts in (000) Taka Audited Name of RM 31.12.07 12 Mts in (000) Taka

Plus/Minus : Inter Trade Rec from/ to Affiliate CF BEFORE OTHERS B/S MOVEMENTS Plus/Minus : Others BS Movements FINANCING NEEDS/SURPLUS Plus/Minus : ST Bank Debt Plus/Minus: LT Bank Debt TOTAL FINANCING

CF AFTER FINANCING Plus/Minus: Change In Cash

1030 1030

1630 1630

CREDIT RISK GRADING SCORE SHEEET Reference No:RZT-2/ADV /AGB/CC/08 Borrower: Group Name (if any): Branch: Industry/Sector: Date of Financials: Completed by: Approved by: Number 1 2 3 4 5 6 7 8 Ifad Flour Mills Ltd

Date: 06-04-2008

Aggregate Score: 84 Agrabd Branch Flour Mill 31.12.2007 Mohammad Zakir Hossain Senior Officer Mr. X (Branch Incharge) Grading Superior Good Acceptable Marginal/Watchlist Special Mention Substandard Doubtful Bad & Loss

Risk Grading:

Acceptable

Short SUP GD ACCPT MG/WL SM SS DF BL

Score Fully cash secured, Government/International Guarantee 85+ 75-84 65-74 55-64 45-54 35-44 <35

secured

by Bank

Criteria A. Financial Risk 1. Leverage: (15%)

Weight 50%

Score Parameter Less than 0.25 0.26 to 0.35 x 0.36 to 0.50 x 0.51 to 0.75 x 0.76 to 1.25 x 1.26 to 2.00 x 2.01 to 2.50 x 2.51 to 2.75 x More than 2.75 15 14 13 12 11 10 8 7 0

Actual Parameter 0.95

Score Obtained 11

Debt Equity Ratio () - Times Total Liabilities to Tangible Net worth All calculations should be based on annual financial statements of the borrower (audited preferred).

2. Liquidity: (15%) Current Ratio () - Times Current Assets to Current Liabilities

3. Profitability: (15%) Operating Profit Margin (%) Operating Profit 100 Sales

4. Coverage: (5%) Interest Coverage Ratio ()-Times Earning Before Interest & Tax (EBIT) Interest on debt Total ScoreFinancial Risk

Greater than 2.74 2.50 to 2.74 x 2.00 to 2.49 x 1.50 to 1.99 x 1.10 to 1.49 x 0.90 to 1.09 x 0.80 to 0.89 x 0.70 to 0.79 x Less than 0.70 Greater than 25% 20% to 24% 15% to 19% 10% to 14% 7% to 9% 4% to 6% 1% to 3% Less than 1% More than 2.00 More than 1.51 Less than 2.00 More than 1.25 Less than 1.50 More than 1.00 Less than 1.24 Less than 1.00

15 14 13 12 11 10 8 7 0 15 14 13 12 10 9 7 0 5 4 3 2 0 50

2.24

13

48.38%

15

8.54

44

Criteria B. Business/Industry Risk

Weight

Parameter > 60.00 30.00 59.99 10.00 29.99 5.00 - 9.99 2.50 - 4.99 < 2.50 > 10 years > 5 - 10 years 2 - 5 years < 2 years Favorable Stable Slightly Uncertain Cause for Concern Strong (10%+) Good (>5% - 10%) Moderate (1% - 5%) No Growth (<1%)

Score 5 4 3 2 1 0 3 2 1 0 3 2 1 0 3 2 1 0

18% 1. Size of Business (Sales in BDT crore) The size of the borrowers business measured by the most recent years total sales. Preferably based on audited financial statements 2. Age of Business The number of years the borrower has been engaged in the primary line of business. 3. Business Outlook

Actual Parameter 1.33

Score Obtained 0

11

Stable

A critical assessment of the medium term prospects of the borrower, taking into account the industry, market share and economic factors. 4. Industry Growth

Good (>5% 10%)

Criteria 5. Market Competition

Weight Dominant Player Parameter Moderately Competitive Highly Competitive Difficult Average Easy 2 Score 1 0 Moder 1 Actual Score ately Parameter Competitiv Obtained e lt 10 Difficu 2

6. Entry/Exit Barriers

2 1 0 18

Total Score-Business/Industry Risk

Criteria C. Management Risk

Weight 12%

Parameter

Score 5 3 2 0 4 3 2 0 3 2 1 0 12

Actual Parameter More than 10 years in the related line of business Ready Succession

Score Obtained 5

1. Experience (Management & Management Team)

More than 10 years in the related line of business 510 years in the related line of The quality of management based on the business aggregate number of years that the Senior 15 years in the related line of Management Team has been in the business industry. No experience 2. Second Line/ Succession Ready Succession Succession within 1-2 years Succession within 2-3 years Succession in question 3. Team Work Very Good Moderate Poor Regular Conflict Total Score-Management Risk

Very Good

12

Criteria D. Security Risk

Weight 10%

Score Parameter

Actual Parameter

Score Obtained

Criteria Weight 1. Security Coverage (Primary)

2. Collateral Coverage (Property Location)

Fully pledged facilities/substantially cash Parameter covered/Reg. Mortg, for HBL Registered Hypothecation (1st charge/1st Pari passu charge) 2nd Charge/Inferior charge Simple hypothecation/negative lien on assets. No security Registered Mortgage on Municipal Corporation/Prime area property. Registered Mortgage on Pourashava/semi-urban area property Equitable Mortgage or No property but plant & machinery as collateral Negative lien on collateral No collateral Personal guarantee with high net worth or Strong Corporate Guarantee Personal Guarantees or Corporate Guarantee with average financial strength No Support/Guarantee

4 Score 3 2 1 0 4 3 2 1 0 2

Regist 3 ered Actual Score Hypothecat Obtained Parameter ion (1st st charge/1 Pari passu charge)

Regist ered Mortgage on Municipal Corporatio n/Prime area property. Person al Guarantees or Corporate Guarantee with average financial strength

3. Support (Guarantee)

1 0

Total Score- Security Risk

10

Criteria E. Relationship Risk 1. Account Conduct

Weight 10%

Parameter More than 3 (three) years accounts with faultless record Less than 3 (three) years accounts with faultless record Accounts having satisfactory dealings with some late payments Frequent Past dues & Irregular dealings in account More than 60% 40% - 60% Less than 40% Full Compliance Some Non-Compliance No Compliance

Score 5 4 2 0

Actual Parameter More than 3 (three) years accounts with faultless record More than 60% Full Complianc e

Score Obtained 5

2. Utilization of Limit (actual/projection) 3. Compliance of Covenants / Conditions

2 1 0 2 1 0

Criteria 4. Personal Deposits

Weight 1 Score 0 Person 1 Actual al accounts Score Parameter of the key Obtained business Sponsors/ Principals are maintained in the bank, with significant deposits 10 84

Personal accounts of the key business Parameter Sponsors/ Principals are The extent to which the bank maintains a maintained in the bank, with significant personal banking relationship with the deposits key business sponsors/principals. No depository relationship

Total Score-Relationship Risk Grand Total- All Risk

10 100

------------Ratio Analysis and Interpretation of Financial statements for Credit appraisal and Risk Grading in Banks Financial Statements Financial analysis involves the use of various financial statements. The financial statements are the end products of financial accounting. A financial statement is a collection of data organized according to logical and consistence accounting procedure. The Financial statements carry lot of data. As such, it is not possible to draw any conclusion by a mere glance over the figures contained in the financial statements for taking lending decisions. For arriving at this decisions the bankers are to analyze and interpreter the data given in the financial statements of their clients. The term Financial Statements includes two basic accounting statements. Balance sheet and Income statement, statement of accounting retained earning, Statement of the source and application of funds etc. In the case of trading concern, trading account and profit and Loss account are prepared. Other names for financial statements are annual reports of directors and auditors addressed to the Shareholders, Financial reports, published accounts or annual accounts. Since these statements provide a summary of financial position of a concern, they are collectively called, Financial Statement.

Financial Statement Analysis The focus of financial analysis is on key figures in the financial statements and the significant relationships that exist between them. The analysis of financial statements is a process of evaluating relationships between component parts of financial statements to obtain a better understanding of the firms position and performance. The first task of the financial analysist is to select the information relevant to the decision under consideration from the total information contained in the financial statement. The second step involved in financial analysis is to arrange the information in a way to highlight significant relationships. The final step in interpretation and drawing of inference and conclusion. In brief financial analysis is the process of selection, relation and evaluation. Three type of analysis is done with the help of the following tools of financial analysis: (a) Comparative Balance Sheet and Income Statement analysis. (b) Common size statements (c) Ratio analysis Financial analysis usually starts with the examination of a companys four basic fiscal documents. The first and most basic document revealing the financial statement of a firm is its balance sheet, so named because it presents the balance between the firms assets and its liabilities, including the stock holders equity, at a particular point in time, generally at the end of the fiscal year. It is also frequently called a financial position statement. The second basic financial document is the companys income statement which presents the gain or loss achieved during the firms most recent period of operation. Hence, its is also known as the profit and Loss Account. The third basic document associated with both balance sheet and income statements, is the statement of accumulated retained earnings. This shows how much money the firm has retained itself from its earnings over the years, after it has paid out dividend to the preferred and common stock holders. To all the prior accumulated earnings will now be added those funds retained by the company from its current earnings, less dividends. The final major financial document of a company is its statements of the source and application of funds, also called the sources and uses of funds and the statement of changes in financial position. Accompanying it is an analysis of change in working capital. This document reveals the financial changes that have resulted from the operation of a company and reports the flow of all funds between two stated periods of time generally the two most recent years. The statement of the source and application of funds will thus show the flow of the firm cash as well as its near cash (that is the running liquid assets), which together constitute its flow of working capital. Our preferred term in this case, funds flow includes the flow of all forms of capital that may have occurred in any of the firm transactions, such on the purchase and sale of property, equipment, investments and so on. Framework for analysis

A number of different approaches might be used in analyzing a firm. Many Analysts have a favorite procedure for coming to some generalizations about the firm being analyzed. At the risk of treading on some rather sacred ground. We present a conceptual framework that lends itself to situations in which external financing is contemplated. the factors to be considered are shown in Figure-1: Figure 1 Framework for Financial Analysis
Analysis of the

funds need of the firm


Analysis of the

financial condition and profitability of the firm


Analysis of the

Determining the

financial needs of the

Negotiations with suppliers of capital

of the firm

business risk of the firm taking tem in order, our concern in the first case is with the trend and seasonal component of a firms funds requirements. How much funding will be required in the future and what is the nature of these needs? Is there a seasonal component to the needs? Analytical tools used to answer these questions include sources and uses of funds statements, statements of cash flow and cash budgets. The tools used to assess the financial condition and performances of the firm are financial ratios. The skilled analyst uses these ratios much like a skilled physician uses lab-test results. In combination, and over time, this data offers valuable insight into the health of a firm its financial condition and profitability. Completing our first set of three factors is an analysis of the business risks of the firm. Business risk relates to the risk inherent in the operations of the firm. Some companies are in highly volatile lines of business and / or may be operating close to their breakeven point. Other companies are in very stable lines of business and/or find themselves operating far from their break-even point. A machine tool company might fall in the first category, while a profitable electric utility would probably fall in the latter. The analysts needs to estimate the degree of business risk of the firm being analyzed.

All three of these factors should be used in determining the financial needs of the firm. Moreover, they should be considered jointly. The greater the funds requirements, of course, the greater the total financing that will be necessary. The nature of the need for funds influences the type of financing that should be used.. If there is a seasonal component to the business, this component lends itself to short-term financing bank loans in particular. The firms level of business risk also strongly affects the type of financing that should be used. The greater the business risk, the less desirable debt financing usually becomes relative to common stock financing./ In other words, equity financing is safer in that there is no contractual obligation to pay interest and principal, as there is with debt. A firm with a high degree of business risk is generally ill advised to take on considerable financial risk as well. The financial condition and performance of the firm also influence the type of financing that should be used. Then greater the firms liquidity, the stronger the overall financial condition, and the greater the profitability of the firm, the more risky the type of financing that can be incurred. That is, debt financing becomes more attractive with improvements in liquidity, financial condition, and profitability. The items is Figure 1 indicates that it is not sufficient to determine the best financing plan from the viewpoint of the firm and simply assume that it can be achieved. The plan needs to be sold to outside suppliers of capital. The firm may determine that it needs $ 1 million in short-term financing. But lenders may not go along with either the amount or the type of financing requested by management. In the end, the firm may have to compromise its plan to meet the realities of the market place. As we have just seen, there are a number of facts to financial analysis. Presumably, analysis will be in relation to some structural framework similar to that presented here. Otherwise, the analysis is likely to be loose and not lend itself to answering the questions for which it was intended. As we shall see, an integral part of financial analysis is the analysis of financial ratios- a topic that fills most of the remainder of this section.

Financial Ratios defined : Meaning and rationale Ratio analysis is a widely used tool of financial analysis. It is defined as the systematic use of ratio to interpret the financial statements so that the strengths and weaknesses of a firm as well as its historical performance and current financial condition can be determined. A ratio is a statistical yard stick that provides a measure of relationship between two accounting figures. Ratio analysis is the process of determining and interpreting numerical relationships based on financial statements. A tool frequently used during these cheek up is a financial ratio or index, which relates two financial data by dividing one quantity by other.

The term ratio refers to the numerical or quantitative relationship between two items/variables. This relationship can be expressed as Percentages , say, net profits are 25% of sales ( assuming net profits of Tk. 25,000.00 and sales of Tk. 1,00,000/ Fraction ( net profit is one-fourth of sales) Proportion of numbers ( the relationship between net profits and sales is 1:4) These alternative methods of expressing items that are related to each other are, for purposes of financial analysis, referred to as ratio analysis. It should be noted that computing the ratios does not add any information not already inherent in the above figures of profits and sales. What the ratios do is that they reveal the relationship in a more meaningful way so as to enable us to draw conclusions from them. The rationale of ratio analysis lies in the fact that it makes related information comparable. A single figure by itself has no meaning but when expressed in terms of a related figure, it yields significant inferences. For instance, the fact that the net profits of a firm amount, to say, Tk. 10 laks throws no light on its adequacy or otherwise. The figure of net profit has to be considered in relation to other variables. How does it stand in relation to sales? What does it represent by way of return on total assets used or total capital employed? If, therefore, net profits are shown in terms of their relationship with items such as sales, assets, capital employed, equity capital and so on., a meaningful conclusion can be drawn regarding their adequacy. The presentation of an elaborate system of ratio analysis was made in 1919 by Alexander Wall. Users of Financial Ratios The Partiers interested in the financial analysis can be grouped under two heads Internal and External Internal Users : Owner Management Share holders Trade Union etc, External Users: Potential Investors Lending company Tax Department Debenture holder Stock Exchange Financial Institution

Govt. etc. Users of ratio Analysis The first few lines of the present chapter have pointed out the usefulness of the financial ratio for those who manage the firm as well as for those who are somehow or other related with it, such as Creditors, investors, financial analysts and so on. Here it is discussed how the different ratios should be used in order to arrive at any conclusion. In fact any ratio percent cannot be perfect indicator of a firms performance or financial position unless it is viewed against, or compared with, any norm. In the generality of cases, the norm is the average of the industry as a whole. For example, if the current ratio in a particular industry is, on an average, 2:1, a firm having current ratio of 2:1 would be said conforming to the norm. Any deviation in either side would mean either illiquidity or more than desired level of liquidity. The reason behind this type of intra-industry comparison is that different firms in the same industry have more or less in common most of the financial variables. However, if majority of the firms in the industry are facing, for example, Illiquidity , any comparison of the current ratio of the firm with the industry average would be a misleading one. Sometimes a particular ratio of a firm is compared with a similar ratio of another firm in some other industry or industries. This is known as inter-industry comparison, which indicates variations among different industries. But it is very difficult to say whether a particular firm is doing well or it is lagging behind, as the firm in different industries operate under varying settings. Sometimes when the trend is to be found out whether it is moving upward or downward in respect of profitability or liquidity or in some other financial aspects during a period of time, the ratios are compared on an inter-period or time-series basis. For example, if the profit margin of a firm is 20% in 2006 as against 18% in 2005 and 15% in 2004, the trend of profitability is said to be an upward one. Here it would be relevant to mention that the different financial ratios of a firm are interrelated meaning thereby that one ratio influencers the other. It is because of this interrelationship that the ratios must be evaluated together, and not individually. For example, a low current ratio does not matter much for a longer period of the debt ratio is low. It is because the firm can safely raise long-term debt to finance the current assets and repay thereby the short-term, liabilities. Similarly, a lower profit margin does not matter much if the firm has reduced prices with a view to raising the sales volume. It is because in such cases the yield on investment would be quite high even with a lower profit margin. These types of interrelationship are many which must be taken into account In short, whenever, a financial analysts or a Creditor or an investor looks into the financial ratios of a firm, he must make himself of the reliability of the norm against which he views the ratio, as also be must view it in the totality.

IMPORTANCE OF RATIO ANALYSIS The importance of ratio analysis lies in the fact that it presents facts on a comparative basis and enables the drawing of interference regarding the performance of a firm. Ratio analysis is relevant in assessing the performance of a firm in respect of the following aspects: Liquidity position With the help of ratio analysis conclusions can be drawn regarding the liquidity positions of a firm. The liquidity position of a firm would be satisfactory if it is able to meet its current obligations when they become due. A firm can be said to have the ability to meet its short-term liabilities if it has sufficient liquid funds to pay the interest on its shortmaturing debt usually within a year as well as the principal. This ability is reflected in the liquidity ratios of a firm. The liquidity ratios are particularly useful in credit analysis by banks and other suppliers of short-term loans. Long Term Solvency Ratio analysis is equally useful for assessing the long-term financial viability of a firm . This aspect of the financial position of a borrower is of concern to the long-term creditors, security analysis and the present and potential owners of a business. The long term solvency is measured by the levearage/capital structure and profitability ratios which focus on earning power and operating efficiency. Ratio analysis reveals the stength and weaknesses of a firm in this respect. The leverage ratios, for instance, will include whether a firm has a reasonable proportion of various sources of finance or whether heavily loaded with debt in which case its solvency is exposed to serious strain. Similarly, the various profitability ratios would reveal whether or not the firm is able to offer adequate return to its owners consistent with the risk involved. Operating Efficiency Yet another dimension of the usefulness of the ratio analysis, relevant from the viewpoint of the management, is that it throws light on the degree of effieiency in the management and utilisation of its assets . It would be recalled that the various activity ratios measure this kind of operational efficiency. In fact, the solvency of a firm is, in the ultimate analysis, dependent upon the sales revenues generated by use of its assets total as well as its components. Overall Profitability Unlike the outside parties which are interested in one aspect of the financial position of a firm, the management is constantly concerned about the over-all profitability of the enterprises. That is, they are concerned about the ability of the firm to meet its short-term as well as long-term obligations to its creditors, to ensure a reasonable return to its

owners and secure optimum utilization of the assets of the firm. This is possible if an integrated view is taken and all the ratios are considered together. Inter-firm Comparison Ratio analysis not only throws light on the financial position of a firm but also serves as a stepping stone to remedial measures. This is made possible due to inter-firm comparison/ comparison with other industry avenges. ZA single figure of particular ratio is meaningless unless it is related to some standard or norm. One of the popular techniques is to compare the ratios of a firm with the industry average. It should be reasonably expected that the performance of a firm should be in broad conformity with that of the industry to which it belongs. An inter-firm comparison would demonstrate the relative position vis-a-vis its competitors. If the results are at variance either with the industry average or with those of the competitors, the firm can seek to identify the probable reasons and, in that light, take remedial measures. Trend Analysis Finally, ratio analysis enables a firm to take the time dimension into account. In other words, whether the financial position of a firm is improving or deteriorating over the years. This is made possible by the use of trend analysis.This significance of a trend analysis of ratios lies in the fact that the analysts can know the direction of movement,i.e. whether the movement is favourable or inmfavourable. For example, the ratio may be low as compared to the norm/standard but the trend may be upward. On the other hand, though the present level may be satisfactory but the trend may be declining one. Thus, trend analysis is of great significance. Over the course of the business cycle, sales and profiutability may expand and contract, and ratio analysis for any one year may not present an accurate picture of the firm. Therefore, we look at trend analysis of performance over a number of years. However, without industry comparisons, even trend analysis may not present a complete picture. Objectives of analysis of financial statement The objectives of analysis of financial statements are to obtain some indications regarding the financial health of the business. If we consider it from the view point of a lending banker, then the objective would be to improve decision in the case of sanctioning of loans, supervision and follow up of advances and nursing of sick units. The main objectives of analysis of financial statements can be summarized as follows: Determine liquidity position of the organization Determine solvency position of the organization Determine profitability position of the organization Determine management efficiency of the organization

Market efficiency of the organization CLASSIFICATION SYSTEM Classification of Ratios Accounting Ratio Traditional classification Balance Sheet ratio Revenue Statement ratio Composite ratio classification according to Functional classification importance Primary ratio Liquidity ratio Secondary ratio Solvency Ratio Activity ratio Profitability ratio Market ratio

Following is the classification of ratios giving in a tabular form. Profitability ratios The word profitability is composed of two words profit and ability. Therefore profitability means the profit making ability of the enterprise. In a word, it means, as the ability of a given investment to earn a return from its use. The profitability can be measured in terms of different components of income statement and balance sheet. Most important ratios, which are used for measuring profitability is as below Name of ratios Profitability ratio Formula Net Profit ------------ x 100 Sales Meaning Analysis Measures profitability with respect to sales generated net income or profit per dollar of sales Measures overall effectiveness in generating profits with available assets, earning power of invested capital Meaning Measures earning power on shareholders book value investment Measures Analysis Equity= Share capital + Reserve + Retained earnings Capital employed=

Profit margin Return on Net Profit investment or ------------ x 100 Asset (ROI or Total Assets ROA)

Name of ratios Formula Return on Equity Net Profit (ROE) -----------Equity or share holders fund Return on capital Net Profit after tax

employed (ROCE) ---------------------capital employed Asset Utilization Ratios ( Activity or turn over ratios)

effectively of Fixed Assets capital employed (CA-CL)

It indicates overall performance of a firm. it has been widely accepted that profitability of a business enterprise depends to a large extent on the manner in which its activity is performed. The inefficient activity not only reduces profitability but ultimately may lead a concern to a financial crisis. Overall performance i.e. activity of a concern could very well be measured with the help of the following ratios Name of ratios Formula Meaning Analysis Asset utilization Sales Measures how many Ratio( activity -----------time the inventory Ratios or Asset Inventory has been turned over Management (sold) during the efficiency) year. Provide inside into liquidity of Inventory inventory and turnover tendency to work

Inventory turnover in days

Receivable Over Ratio

Average inventory x 365 ---------------------Cost of goods sold Measures how many times the receivable have been turned Sales over during the year -----------------provide inside into Turn Receivable quality of the receivable Average number of days receivable are outstanding before being collected

Cost of goods sold = opening inventory + cost of production closing inventory

Receivable x 365 Receivable = Receivable Turn --------------------credit Debtors + B R Over Ratio in -Annual sale Measures the relative days efficiency of total assets to generate

sales Sales asset --------------------Total Assets

Total Turnover

Creditors Turnover ratio

Payable x 365 ------------------Annual Credit Purchase

payable = Sundry Creditors +BP

Selling, general and Selling, general administrative and administrative expense x 100 expense ------------------Sales Cost of goods sold+ operating expense x 100 --------------------Sales

Operating ratio

Liquidity ratios (Short Term Solvency) Short-Term creditors of the enterprise are primarily interested in knowing the enterprisers ability to pay its short-term creditors as and when they become due. So short-term solvency is an important factor for measuring efficiency of an enterprise. The liquidity & solvency of any organization could very well be measured with the help of current ratio and acid test ratio: Name of ratios Liquidity Ratio Formula Current asset Standard Norm, Meaning Measures Analysis CA= cash at bank

-------------------Current Ratio

-------------------Current liabilities

2:1

Quick ratio ( Acid test ratio)

Liquid Asset ---------------------Current liabilities

1:1

ability to balance, Debtors meet B/R, Inventory current Advance Payment debts to current CL= Creditors, B/P, assets Bank O/D Accrue, Advance received Measures Liquid Asset= CA- ( ability to Inventories+ Prepaid meet expense) current debts with most liquid current asset

Debt utilization ratios/Long-term solvency/Capital Structure Ratio (Leverage Ratio) The long tern financial strength and future solvency of a company are of interest and importance to employees, suppliers and potential suppliers of materials and equipment and in particular lenders and potential lenders of money. It depends on the structure that has been imposed on the business in financing more permanent asset requirements. Lets define some of the more common ratios dealing with long-term financial strength or solvency here. Name of ratios Formula Debit utilization ratio ---------------Total long Term Debt Equity ratio debt ---------------Share holder equity Debt to total asset Total debt ---------------Total asset Equity share capital ---------------Preference share+ Meaning Analysis

Indicates the Long Term debt = extent to which Long Term Loan + debt financing is Debenture used relative to equity financing

Shows the relative extent to which the firm is using borrowed money

Capital gearing ratio

Debenture capital Income before interest and take interest ---------------Interest

Time earned

Income before fixed charge and Fixed charge coverage coverage ( Total ---------------coverage ratio) Fixed charge Net profit after Tax + Interest on long-term debt Debt service ---------------coverage ratio Debt repayment installment + Interest on long term debt Market ratios

Total charge 12. Interest charge + preferred share 13. Interest of long-term loan + Dividend of preferred share

Market ratios identify the financial market evaluation of earnings and ownership funds employed by the concern . Name of ratios Earning ratios ---------------Earning per share ( EPS) Price-earning ratio Formula Earning to equity holders -----------------------Number of outstanding share market price of share ------------------------Earnings per share Meaning Analysis

Equity Book value per share ------------------------Number of common share

Price to book value

Dividend ratio -----------------Dividend payout ratio Dividend per share ------------------------Earning per share Dividend Yield

Price Per share ------------------------Book value per share

Dividend per share ------------------------Market price of share

Retained ratio

EPS Dividend per share earnings -----------------------EPS

Basis of Comparison Ratios, are relative figures reflecting the relationship between variables . They enable analysis to draw conclusions regarding financial operations. The use of ratios, as a tool of financial analysis, involves their comparison, for a single ratio, like absolute figures, fails to reveal the true position. For example, if in the case of a firm, the return on capital employed is 15% in a particular year, what does it indicate? Only if the figure is related to the fact that in the preceding year the relevant return was 12% or 18%, can it be inferred whether the profitability of the firm has declined or improved. Alternatively, if we know that the return for the industry as a whole is 10% or 20%, the profitability of the firm in question can be evaluated. Comparison with related fact is, therefore, the basis of ratio analysis. Four types of comparisons are involved: Trend Ratios Inter-Firm Comparison Comparison of items within a single years financial statement of a firm Comparison with standards or plans

Trend ratios involved a comparison of ratios of a firm over time, i.e. present ratios are compared with past ratios for the same firm. The comparison of the profitability of a firm, say, year 1 through year 5 is an illustration of a trend ratio. Trend ratios indicate the direction of change in the performance- improvement, deterioration or constancy over the years.

The Inter-firm comparison involving comparison of the ratios of a firm with those of others in the same line of business or for the industry as a whole reflects its performance in relation to its competitors. Other types of comparison may relate to comparison of items within a single years financial statement of a firm and comparison with standards or plans. Limitation of Ratio Analysis Ratio analysis is, as already mentioned, a widely used tools of financial analysis. Yet it suffers from various limitations. The operational implication of this is that while using ratios, the conclusions should not be taken on their face value. Some of the limitations that characterize ratio analysis are:

5.6 Financial statement Spread Sheet & Credit Scoring system: Financial Spread Sheet (FSS) is a process hat provides a quick method of assessing business and efficiency and efficiency of an organization. It helps to assess borrowers ability to repay. Realistically shows business trends and allow comparisons to be made within industry. It is an important tool in a disciplined organized approach to credit analysis. The historic financial reports of a company are primary indicator of its financial position. Spread sheets allow proper analysis of financial statements. It is a means of presenting the main balance sheet and profit and loss categories in form hereby a comparison can be made between similar figures on different dates. It also includes cash flow statement and ratio analysis. 5.6.1 How the General Information of the FSS to be entered Name Type Date have been columns Assets physical receivable. % column total Assets are segregated into two categories : Current Assets and Non Current Assets : Express the individual assets or liability as a percentage of either first. : Assets are the possessions of the business. They may be of a nature i.e. building or inventory, or represent legal claims i.e. : Enter customers name here. : Mention whether accounts are audited or un-audited. : Enter the ending date of the financial year for which accounts prepared. The most current year to be noted in the extreme left

assets or total liabilities & net worth. Profit & loss items as percentage of net sales. 5.6.2 How figures are to be entered into the FSS 1. Cash in Hand cash, cash float ( in 2. Cash at Bank Accounts, the bank are pledged as security ( margin) and are not immediately available to the company they should be entered as other Non3. Securities (Marketable) treasury the customers account should indicated that marketable securities are 4. Receivable Trade provided against 5. Less : Bad Debt Allowance uncollectible 6. Net receivable 7. Inventories the process 8. Blank kept for desired to 9. All other Current Asset security any ,finished goods and supplies. :Enter the amount of any other current asset that it is show separately. :Amount of those current assets not shown separately i.e. deposits of repayment can be obtained in under 12 months, carried at the lower of cost or market : Amount due from customers for sales or services payment to be received at later date : The amount of any allowance made for bad or accounts : Gross receivable less bad debt allowance : The amount of goods on hand. Depending on the nature of business this can include: raw materials, work incurrent Assets : Shares or debt instruments of the Government or other companies that an be readily converted into cash i.e. bonds, shares of companies quoted on the Stock Exchange ( : All cash and cheques not yet banked i.e. petty transit) : All cash held in bank i.e. Current Accounts, Savings Fixed Accounts. Where it is indicated that balances with

non trade receivable, excluding prepaid items which should be entered in All other Non Current Assets 10. Total Current Assets: Total line 1 to 3 and 6 to 9. Current assets are possessions such as cash, items held for resale, and receivable which will generate cash within 12 months. 11.Land and Building : Enter the amount of land and building owned. Land and building are valued at acquisition cost plus cost of permanent improvements to buildings. Leasehold improvements should also be included. While land and buildings are normally entered t historical cost, the fair market value may be different. 12. Less Depreciation : The amount of accumulated depreciation, normally only applies to building and machinery and not to land. Depreciation is a method of spreading the cost of the asset over its useful life. 13. Net Land & Building : Value of line 11 less value of line no. 12 14. Machinery & equipment: Enter the amount of machinery & equipment ( Machinery & equipment is valued at cost together with delivery and installation costs, plus cost of any substantial improvement that extents its life or increases its capacity) 15. Less Depreciation : The amount of accumulated depreciation. Normally only applies to building and machinery and not to land. 16. Net Machinery & Equipment : Value of line no. 14 less value of line no. 15 net machinery and equipment is not a good indicator of either the market value or the replacement value of these assets. Depreciation does not measure actual decline in asset value. There are a number of different methods of calculating depreciation. The value of the asset will vary depending on the method chosen. (N.B. some

procedures are to be followed for other fixed assets viz. Furniture, vehicles etc. N.B. In case of CAPITAL LEASE both land and buildings and equipment & machinery should include as items owned under capital lease arrangements. A capital lease is normally no cancelable and has one or more of the following characteristics : a) Leasee retains the assets at the end of the lease. b) Lease is for the useful life of the assets. c) The risks of ownership are with the lease. 17. Blank Kept for desired : Enter the amount of any other non-current asset that it is

to show separately. 18. Investment Subsidiaries : Enter the amount of stocks and bonds at cost owned of another company for the purpose of maintaining a business relationship or existing control. Enter as investment in subsidiary if more than 50% of the voting shares are held. 19. Investment Associated Co.: Enter as investment ( at cost) in associated company if 50% or less voting shares are held. 20. All other Non-Current Assets: Enter the amount of all other non current assets,i.e. prepayments, restricted cash, non trade receivables with an original maturity of over 12 months. Intangible assets such as patents, copyrights, trade marks and goodwill generally only have if the company is an onward going concern. For analytical purposes they are not included as assets. Their total value is subtracted from networth on the liabilities side of the Balance Sheet. 21. Total Non-Current Assets: Total line no. 13,16 to 20 non current assets are generally possessions which are not for resale, but will be retained and used by the business,i.e. land, building, machinery etc. Additionally assets that

cannot be considered as current assets because of their longterm nature are included here,i.e. restricted cash or cash margin, investment for the purpose of control and any other long-term investment. 22. Total Assets : Total line no. 10 to 21 Liabilities : Liabilities represent claims against the assets of the company by outsiders. Liabilities are segregated into two categories : Current liabilities and noncurrent liabilities. 23. Overdraft/cash 24. Loan from bank ( Under 1 year) year( including : Enter the amount of any current/operating account which has a debit or negative ( overdrawn) balance. Cash credit facilities should also be entered on this line. : Enter the amount of loan/ advances due to banks or other financial institutions that are payable within one

demand loans) 25.Loan from others : Enter the amount of loans due to parties other than financial ( Short Term) institutions that are payable upon demand or within one year. 26. Account Payable Trade: Amount owed to suppliers of goods and services. Items purchased include inventory, supplies and capital items which have been obtained on open account with payment required in less than one year. 27.Long Term Debt : The amount of principal due on long term debt/obligation (i.e. installments due on capital leases) which is due for repayment within twelve months. 28. Provision for Tax : Enter the amount of any taxes due including VAT 29.Blank Kept for : Enter the any amount of current liabilities that it is desired to show separately. 30. All other current liabilities: Enter the amount of all other current liabilities i.e. accruals, dividend payable etc. 31. Total current liabilities: Total of line no. 23 to 30. Current liabilities are claims that have to be satisfied within one year. 32.Long Term Debt: Enter the amount of loans and notes payable to banks, individuals and other parties with maturities of more than 12 months. Amounts owed under a capital lease arrangement should be included under this categories.

33. Debenture/Bonds: Enter the value of debt instruments which have been issued for the purpose of financing. 34. Optional Line Kept : Subordinated debt should be shown separately here. N.B. At the event of winding up of a company subordinated debt is paid after all other creditors have been paid, but before shareholders are paid. Moreover, enter the amount of any other non-current liabilities that it is desired to show separately. 35. All other non-current liabilities : Amount of all other non-current liabilities i.e. deferred tax payments, minority interests ( in the case of consolidated balance sheets this represents portion of subsidiary owned by third parties. 36. Total non-current liabilities : Total of line no. 32 to 34 . Non current liabilities are those claims due after more than 12 months. 37. Total liabilities : Total of line no. 31 to 36 Owners equity : Owners claims against the resources of the business. 38. Capital ( Paid up) can be 39. Paid in surplus from the 40. Reserves reserves or 41. Retained earnings 42.Less: Intangibles 43. Net worth no. 43. after liabilities have been subtracted. 44. Total liabilities & Net worth : Total of line no. 37 & 43. Total asset must be Equal to total liabilities and Net Worth. If not the figure are wrong. : The par or stated value of the shares issued. The shares either common or preference shares. : Enter the amount received in excess of the par amount sale of shares. : Enter the amount of profit not allocated to specific retained earnings : The amount of cumulative undistributed profit or loss. : Deduct the amount of intangible assets excluded from total assets. : Add line no. 38 to 41 and minus line no. 42 to get line Net worth represents the owners interest in the assets

Profit & Loss A/C expenditure of a period

: The profit & loss a/c is a summary of the income and company together with the resulting net income ( loss) for a given of time.

45. Sales (Net) should be

: The revenue received from the sale of goods or services. Sales

net of any discount or returns. 46. WIP opening Balance: Enter opening balance of WIP. 47.Materials used/Goods purchased: The amount of material used or goods purchased. For trading companies only cost of goods purchased figure should be available. If the figures is not reported separately the following calculation can be used. All opening stock of raw materials/goods plus purchases minus all closing stock equals materials used/goods purchased. N.B. Different methods of accounting for inventory can have a direct effect on profit. It is necessary to ensure that the bank is advised if there is a change in accounting policy. 48. Labour: The amount of factory wages directly related to the cost of manufacturing goods. 49. Manufacturing expenses : The amount of any other expenses directly related to manufacturing the goods. i.e. Factory rent, factory insurance etc. 50. Depreciation on plant & machinery: Enter the total amount of depreciation, that relates to manufacturing, expensed during the period, i.e. factory building, machinery. 51. Less : ending WIOP: Subs tract the amount of WIP of current year. 52. Cost of production : Add line no. 46 and 47 to 50 and minus 51 53. Add: Finished goods : Opening balance 54. Cost of goods : Add line no. 52 & 53 Available for sale 55. Less : Finished goods closing balance : Substract the amount of unsold stock of finished goods of current year. 56. Cost of goods sold : total line of 52 & 53 and minus 55. It is the amount paid for the goods that was sold.

57. Gross profit : Subs tract line no. 57 from 45. Gross profit is net sales revenue less the cost of goods sold ( it does not include operating expenses). This gross profit margin must cover all other expenses of the company if the company is to make a net profit 58.General & admn. expenses : Expenses which are associated with the general running of the company i.e. salaries, rent, supplies, insurance etc. 59. Selling & Dist. Expenses : The expenses associated with the companys efforts to develop sales; i.e. advertising, salesmans commission, sales supplies etc. Service companies will not differentiate between selling and administrative expenses. Some trading /manufacturing companies may also choose to report these figures on a combined basis. 60. Interest : Enter the all interest paid amounts on any debt instrument whether bank or other third party. While not theoretically correct for the purpose of FSS interest is being shown as an operating expense. 61. Depreciation & Write-Off: The total amount of depreciation, related to selling and administration, expensed during the period i.e. office building, office equipment. Amortization of goodwill or other intangibles should also be entered as write-off on this line. 62. Total operating expenses : Total of line. no. 58 to 61. Operating expenses are not directly attributable to production costs and consist of two types : Selling and General & administration. Depreciation is normally included in general and administration expenses. 63. Operating profit: Operating profit is the Gross Profit (L-57) less operating Expenses (L-67) 64. Other income : Amount of income that relates to secondary activities of the company i.e. rental income of manufacturing companies, dividend income, profit on sale of fixed assets etc. 65. Other expenses the : Amount of expense that relates to secondary activities of

company: i.e. an uninsured casualty loss,loss caused by newly enacted law,loss on sale of fixed assets, capital issues expenses etc. 66. Profit before Tax operating : All L-63 and L-64 than substract L-65 to get L-66. It is

profit plus or minus income or expenses not related to the companys primary activists. 67.Pro. for Taxes/Income Tax : Enter all the provision or income tax based on the reported profit. 68. Net profit after tax : Substract L-67 from line 66. Net profit is profit less all income and capital gains taxes payable. 69.Add: balance of profit b/f from previous year : Enter from previous year balance sheet figures. 70. Less: Dividends : Enter only cash dividends of current year 71.Less: other appropriated items: Enter any other appropriated items which is not covered earlier 72.Retained earnings/ Inappropriate profit : Ensure this agrees with customers figure. 73. Contingent liabilities: Contingent liabilities are those liabilities that may result in a payment in the future dependent on a particular occurance. Example : Guarantees, litigation settlements etc. Contingent liabilities should be stated in the footnotes to the balance sheet. 74. working capital : L-10 minus L-31. Working capital is the excess of total current assets over current liabilities. It represents the amount that would remain if all current obligations were paid. The working capital figure is one of the primary indications of shortterm solvency. 75. Dividend paid : The amount paid out in cash during the current financial year. Normally it will be divided declared for the prior financial year and should be obtainable from the profit and loss appropriation account. 5.7 CASH FLOW STATEMENT 5.7.1 Operating activities :

Starts with net profit after tax of current year. Here all current assets and current liabilities are covered to calculate the net result. Rules for data entry are : Increase in C A (Other than Cash and bank balance) Decrease in C A (Other than Cash and bank balance) will increase the cash. Increase in C L ( other than O/D, C/C and short term loans which are parts of financing activities) will increase in cash Decrease in C L will decrease in cash :

5.7.2 Investment activities

All information related to sale out or procurement of non-current assets are covered here. The rules are : Increase in non-current assets will decrease in cash Decrease in non-current assets will increase in cash 5.7. 3. Financing activities :

All information related to non-current liabilities & short term financing and equity are covered here. The rules are : Increase in non-current liabilities & items related to short-term financing and owners equity will lead to increase in cash Decrease in above items will lead to decrease to cash

N.B. Term of financing should match term of investment. Of internal funds generated 60% should go to fixed assets and 40 % to working capital. 5.8 FUND FLOW STATEMENT: Balance sheets tell us the position of the company at a point in time, fund flow statement describes the changes that have taken place between the current balance sheet and the previous one. It has two parts: Increase ( decrease ) in working capital Sources and (Uses) of Funds

5.8.1 Current ratio Computation Interpretation : Total current assets divided by total current liabilities : Rough indications of a companys ability to service its current obligations. Generally the higher the ratio,the greater the Cushion between current obligations and a firms ability to pay them. However,the composition and quality of current assets is a critical factor in analysis of an individual firms liquidity. Rules of Thumb : 2:1 is considered good.

5.8.2 Quick ratio Computation : Cash and securities plus net receivables divided by total current liabilities Interpretation : It is a refinement of the current ratio and is a more conservative measure of liquidity. The ratio shows the degree to which a companys current liabilities are covered by most liquid current assets. Rules of Thumb : 1:1 is acceptable. Less than 1:1 implies a dependency on inventory or other current assets to liquidate short-term debt. 5.8.3 Receivables Turnover in Days: Computation : 365 (no. of days in a year) divided by (sales divided by not receivable) Interpretation : The figure expresses the average time in days that receivables are outstanding for. The lower no. of days the shorter the time between the sale and cash collection. The greater the no. of days outstanding the greater the probability of delinquencies. The terms offered by a company to its customers must be known when considering this ratio. Care must also be taken with this ratio in that it compares receivables as shown at statement date with annual sales and does not take into consideration seasonal fluctuations. Rules of Thumb : Should not be more than 1/3rd greater than companys terms of sale 5.8.4 Inventory Turnover in Days: Computation : 365 (no. of days in a year) divided by (the cost of goods sold divided by inventory) Interpretation : Indicates the no. of days units are in inventory. Low no. of days generally indicates better liquidity or superior merchandising. However, a long no. of days can indicate a shortage of inventory for sales, high inventory days can indicate poor liquidity, possible over stocking or obsolence there is the problem that the ratio capers inventory one days ( statement date) to annual cost of goods sold and does not take into account seasonal fluctuations. Rules of Thumb : Compare with previous year

5.8.5 Accounts payable Turnover in Days: Computation : 365 (no. of days in a year) divided by (the cost of goods sold

Interpretation

divided by accounts payable) : Indicates the average length of time trade debt is outstanding. If no. of days is high their company may be experiencing cash shortages, disputing invoices, taking extended terms, or simply expanding trade credit. The normal terms the company buys on must be known. There is the problem that the ratio compares accounts payable on one day ( statement date) to annual cost of goods sold and does not take into account seasonal fluctuations.

5.8.6 Sales to working capital: Computation Interpretation : Net sales divided by working capital : Working capital reflects the ability of a company to finance current operations and is a measure of the margin of protection for current creditors. Relating working capital to sales indicate how efficiently working capital is employed. A low ratio can indicate inefficient use of working capital while a very high ratio usually indicates over trading. If working capital is negative ratio will be shown as N. A. : Increase of ratio indicates overtrading. Check for other signs i.e. decline in current and quick ratios.

Rules of Thumb

5.8.7 Debt Equity ratio: Computation Interpretation : Total liabilities divided by tangible equity ( good will etc. is deducted from equity) : Ratios shows the relationship between capital contributed by the creditors and that contributed by the owners. The higher the ratio the less protection there is for creditors and the more difficult it will be for the company to increase debt. A low ratio indicates greater ling term financial safety and the ability to borrower in the future. : Not normally more than 1:1

Rules of Thumb

5.8.8 Sales to Fixed Assets: Computation Interpretation : Net sales divided by net fixed assets ( fixed assets net of accumulated depreciation) : Ratio is a measure of the productive use of a companys operating fixed assets. Distortions may occur if fixed assets are largely depreciated or operations are labor intensive.

5.8.9 Debt Service Coverage:

Computation Interpretation

Rules of Thumb

: After tax profit plus interest paid plus depreciation divided interest paid and plus principal. : Ratios indicates abilities of company to generate cash to pay interest and principal repayments. It is also an indicator of a companys ability to assume additional debt. While it can be misleading to assume all cash flow is a valuable foe debt service this ratio is a good measure of a companys ability to service long term loans this ratio will be misleading. : Must be greater than one.

5.9 CREDIT SCORING SYSTEM 5.9.1 Z- Score : Should be applied to the manufacturing companies. The formula to calculate the Zscore is as follow : Z = .012X1 + .014X2+ .033X3 + .006X4+ .999X5 Where, X1= working Capital/Total Assets X2= Retained Earnings/Total assets X3= Earnings Before Interest Taxes/Total Assets X4= Equity/Total liabilities X5= Sales/Total Assets Formula notes: Variables X1 to X4 must be calculated as absolute percantages,i.e. where the result of the calculation of X1 is 0.052 it should be taken as 5.2 . Thus X1=5.2 multiplied by the weighting factor of 0.012 Variables X5 uses the whole number ,i.e. an X5 calculation of 1.5 gives an X5 of 1.5 multiplied by the weighting factor of 0.999

Interpretation: A score higher than 3 rates a good risk A score of under 3 indicates further investigation is necessary A score of under 1.81 evidences an inherent weakness and a profitability of the company failing within two years A constant downward trend requires investigation even when this score is satisfactory.

5.9.2

Y- Score :

Should be applied to all trading companies. The formula calculates 5 ratios and awards point to each according to the table below. Current Ratio (CR) = Current assets/Current liabilities Quick Ratio (QR) = Cash + equivalents + Accounts Receivable/Current liabilities Liquidity ratio (LR) = cash+ Equivalents/current liabilities Asset ratio(AR) = Total Assets/Total Liabilities Return on Equity (ROE)= Net profit for the year/ Ending net worth Y - credit score table Points 4 3 2 1 0 CR 2.00 1.67 1.33 1.00 Less QR 1.00 0.75 0.50 0.25 Less LR 0.40 0.30 0.20 0.10 Less AR 2.75 2.00 1.67 1.33 Less ROE 0.10 0.075 0.05 0.025 less

Formula notes: Cash include cash in hand, cash at bank and securities (marketable). It does not include restricted cash,i.e. margins Accounts receivable is after allowance for bad and doubtful debt and excludes receivable from directors, employees and special transactions Net profit is after tax, but before payment of dividend. Profit for periods of less than a year must be annualized before ROE is calculated. Interpretation: A total score of less than 12 evidences an unusual degree of risk and a strong reliance on security Low score indicate a close review of the components of working capital is required Again the trend is just as important as the actual score. Comparing Y and Z scores If the two scores appear contradictory review each of the component ratios of the lower score. Identify the weak ratios and obtain explanation. If the Z score is satisfactory and the Y score is not ,review sales to total assets ratio. If sales to total asses ratio and sales to working capital ratio are high the company is probably overtrading

Approval Authority of Loan in NBL


The authority to sanction/approve loans must be clearly delegated to senior credit executives by the Managing Director/CEO & Board based on the executives knowledge and experience. Approval authority should be delegated to individual executives and not to committees to ensure accountability in the approval process. The following guidelines should apply in the approval/sanctioning of loans: Credit approval authority must be delegated in writing from the MD/CEO & Board (as appropriate), acknowledged by recipients, and records of all delegation retained in CRM. Delegated approval authorities must be reviewed annually by MD/CEO/Board. The credit approval function should be separate from the marketing/relationship management (RM) function. The role of Credit Committee may be restricted to only review of proposals i.e. recommendations or review of banks loan portfolios. Approvals must be evidenced in writing, or by electronic signature. Approval records must be kept on file with the Credit Applications. All credit risks must be authorized by executives within the authority limit delegated to them by the MD/CEO. The pooling or combining of authority limits should not be permitted. Credit approval should be centralised within the CRM function. Regional credit centres may be established, however, all large loans must be approved by the Head of Credit and Risk Management or Managing Director/CEO/Board or delegated Head Office credit executive. The aggregate exposure to any borrower or borrowing group must be used to determine the approval authority required. Any credit proposal that does not comply with Lending Guidelines, regardless of amount, should be referred to Head Office for Approval MD/Head of Credit Risk Management must approve and monitor any cross border exposure risk. Any breaches of lending authority should be reported to MD/CEO, Head of Internal Control, and Head of CRM. It is essential that executives charged with approving loans have relevant training and experience to carry out their responsibilities effectively. As a minimum, approving executives should have: - At least 5 years experience working in corporate/commercial banking as a relationship manager or account executive. - Training and experience in financial statement, cash flow and risk analysis. - A thorough working knowledge of Accounting. - A good understanding of the local industry/market dynamics. - Successfully completed an assessment test demonstrating adequate knowledge of the following areas: o Introduction of accrual accounting. o Industry / Business Risk Analysis o Borrowing Causes

o Financial reporting and full disclosure o Financial Statement Analysis o The Asset Conversion/Trade Cycle o Cash Flow Analysis o Projections o Loan Structure and Documentation o Loan Management. A monthly summary of all new facilities approved, renewed, enhanced, and a list of proposals declined stating reasons thereof should be reported by CRM to the CEO/MD. 1.4 Segregation of Duties Banks should aim to segregate the following lending functions: - Credit Approval/Risk Management - Relationship Management/Marketing - Credit Administration The purpose of the segregation is to improve the knowledge levels and expertise in each department, to impose controls over the disbursement of authorised loan facilities and obtain an objective and independent judgment of credit proposals. Internal Audit Banks should have a segregated internal audit/control department charged with conducting audits of all departments. Audits should be carried out annually, and should ensure compliance with regulatory guidelines, internal procedures, Lending Guidelines and Bangladesh Bank requirements. 2. PREFERRED ORGANISATIONAL STRUCTURE The appropriate organisational structure must be in place to support the adoption of the policies detailed in Section 1 of these guidelines. The key feature is the segregation of the Marketing/Relationship Management function from Approval/Risk Management/Administration functions. Credit approval should be centralised within the CRM function. Regional credit centers may be established, however, all applications must be approved by the Head of Credit and Risk Management or Managing Director/CEO/Board or delegated Head Office credit executive. Preferred Organisational Structure: Preferred Organisational Structure (Branch): Branch Manager

Credit Department

Credit Administration

Recovery Unit

Preferred Organisational Structure (Regional Office): Regional Head

Credit Department

Credit Administration

Recovery Unit

Preferred Organisational Structure (Head Office): CEO/Managing Director

Deputy Managing Director (Credit Operations & Credit

Deputy Managing Director (Credit Operations & Credit

Administration)

Administration) Classified Loan Recovery Unit

Credit Operation

Credit Operation

Credit Administration

Division -1

Division -I1

Division

Law Unit

Internal Control & Compliance Division:


It shall conduct inspection annually to ensure extension of credit facilities in compliance with the terms Other Direct Reports Written off of sanction, lending guidelines, procedures, bank policies and Bangladesh Bank directives. While conducting inspection it must also ensure that before sending proposal CRG has been properly done (Internal Control & Loan Recovery and periodically Compliance, etc updated, all documentations have been completed as per sanction terms, Security Unit documents are in place and under custody of Credit Administration and it must be ensured that disbursement has been allowed after getting clearance from credit administration of branch. National Bank Limited has operationally independent Control & Compliance Division and they report directly to MD/Audit Committee of the Board. Internal audit is conducted by qualified officials with necessary experience and technical capabilities. Procedural Guidelines: Credit Approval Process National Bank conducts its banking operations under branch banking system.For administrative control and rendering better and quick service some branches have been placed under some Regional Offices. Credit proposals are generally originated at branch. However proposals may also be received at Head Office for syndication and from big client, Financial Institutions. Flow Chart for approval process of Loans and Advances

Credit Applications processed by credit officers and recommended by credit In Charge of the branch Branch Credit Committee.

Branch Manager Regional Office Head Regional Credit Head (Credit) OfficeRegionalDirector Division Executive Operation Managing Committee Credit Committee Deputy Office Credit Committee. Head Managing Director

Credit Administration (For HO, Regional Office & Branch)

Credit Administration function will be critical in ensuring that proper documentation and approvals are in place in respect of disbursement of loan facilities. Credit Administration functions will comprise the following:
Functions of Credit Administration Department

Disbursement
Getting Approval

Custodian

Monitoring
Overdue Principal & Interest

Compliance

Ensuring completion of security

Obtaining security Documentation as per approval

Overdue Trade Bills

Ensuring adherence to the approved terms and other requirements before disbursement by the Branch

Safely storing Loan/Security Documents (Fire Proof)

Excess Over Limit/Excess over facility approved

Credit Administration functions shall maintain Bangladesh Bank circulars/regulations centrally, ensure issuance of corresponding circulars and advice all relevant departments to ensure compliance of the contents of the circular.

Breach of loan covenants/terms and conditions Periodic Review of Documentations

Ensuring Limit Creation & complying Disbursement Check List by Branch

Non-receipt of Financial Statements in time

Credit Administration shall submit all required Bangladesh Bank returns in the specific format in a timely manner.

Branch Credit administration will keep the documents under their strict control preferably in locked fire proofs storage and will ensure that all the terms of approval has been

Ensuring Insurance of the Insurable Objects.

Objections of internal /external or regulator inspection/Audit and Advise corrective measures timely

All 3rd party services providers like valuers, lawyer, CPAS, etc shall be approved and performances reviewed on annual basis.

Details of Early Alert Accounts and preparation of List of delinquent account & Special Mention Account (SMA) Identification of Early Alert Account, delinquent account & Special Mention Account.

Periodically Means

Risk Grade >6 4-5 1-3

Review frequency Quarterly Semi Annual Annually

Identification of the Accounts, which has assumed SMA status due to non renewal.

Listing of the Accounts, which shall be SMA if not renewed with in 2 months and taking necessary measures.

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