Executive Summary The capital adequacy ratio (CAR) of Dhaka Bank Limited was satisfactory in 2009 and the

bank was only in danger in cases of credit risk- increase in NPL, Increase in NPLs under B/L category in 1 or 2 sectors, Shift in NPLs categories:, Increase in NPLs due to Top 10 large loan borrowers, Fall in the FSV of Mortgaged Collateral. Since, it is very unlikely that all those adverse movement will take place at a time; I can say that the banks CAR is satisfactory. But the Dhaka Bank should have to pay more attention to the creditability of borrower & quality of collateral to reduce the credit risk. In that case the overall CAR will be immune to any adverse shock. When cumulative shock of credit risk affects then for 3 scenarios Banks Revised CAR will be 7.61%, 4.67% and 1.59% respectively. Again cumulative shock of all factors will lead DBLs Revised CAR into 6.75%, 2.82% and -1.41%. The rise in interest rate would lower the CAR in 2009 because the duration gap of Dhaka Bank is positive (0.88). As a result the increase in interest rate would decrease the value of assets more than the value of liabilities. Net exposure in foreign currency was always positive for Dhaka Bank. It means, the bank was in net long position in 2009. As a result, currency appreciation would harm the bank. The Bank would able to maintain required Capital Adequacy level in minor, moderate and major level shock in 2009 according to BASEL-I. Due to adverse change in foreign exchange rate of 5%, 10% and 15%, the loss was BDT. 64,741,886 BDT. 129,483,772 and BDT. 194,225,658 respectively. As a result of those adverse change in rate the revised CAR will be 11.19%, 11.08% and 10.96% respectively. Equity price risk management of Dhaka Bank Limited was very satisfactory. Dhaka Bank Limited was much robust in equity price risk because 10%, 20% and 40% fall in stock prices cause only 0.01%, 0.03%, 0.06% fall in CAR. Its Revised CAR became only 11.29%, 11.28% and 11.25% for the respective shock. In the year 2009, Dhaka Banks liquidity risk would not suffer a lot. Any bank suffers the most in liquidity shock because banks are the borrower of short term and lender of long term. In 2009 DBLs Revised Liquidity Ratio would be 84.39%, 82.44% and 79.93% respectively for 10%, 20% and 40% shock which is not so far from its actual liquidity ratio 86%.

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Stress Testing Stress testing is a simulation technique, which are used to determine the reactions of different financial institutions under a set of exceptional, but plausible assumptions through a series of battery of tests. At institutional level, stress testing techniques provide a way to quantify the impact of changes in a number of risk factors on the assets and liabilities portfolio of the institution. For instance, a portfolio stress test makes a rough estimate of the value of portfolio using a set of exceptional but plausible events in abnormal markets. However, one of the limitations of this technique is that stress tests do not account for the probability of occurrence of these exceptional events. For this purpose, other techniques, for example VAR (value at risks) models etc, are used to supplement the stress tests. These tests help in managing risk within a financial institution to ensure optimum allocation of capital across its risk profile.

At the system level, stress tests are primarily designed to quantify the impact of possible changes in economic environment on the financial system. The system level stress tests also complement the institutional level stress testing by providing information about the sensitivity of the overall financial system to a number of risk factors. These tests help the regulators to identify structural vulnerabilities and the overall risk exposure that could cause disruption of financial markets. Its prominence is on potential externalities and market failures.

Techniques for Stress Testing

a) Simple Sensitivity Analysis (single factor tests) measures the change in the value of portfolio for shocks of various degrees to different independent risk factors while the underlying relationships among the risk factors are not considered.

b) Scenario Analysis encompasses the situation where a change in one risk factor affects a number of other risk factors or there is a simultaneous move in a group of risk factors. Scenarios can be designed to encompass both movements in a group of risk factors and the
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changes in the underlying relationships between these variables (for example correlations and volatilities).

c) Extreme Value/ Maximum Shock Scenario measures the change in the risk factor in the worstcase scenario, i.e. the level of shock which entirely wipes out the capital.

Scope of Stress Testing

As a starting point the scope of the stress test is limited to simple sensitivity analysis. Five different risk factors namely; interest rate, forced sale value of collateral, nonperforming loans (NPLs), stock prices and foreign exchange rate have been identified and used for the stress testing. Moreover, the liquidity position of the institutions has also been stressed separately. Though the decision of creating different scenarios for stress testing is a difficult one, however, to start with, certain levels of shocks to the individual risk components have been specified considering the historical as well as hypothetical movement in the risk factors.

Stress test shall be carried out assuming three different hypothetical scenarios:

Minor Level Shocks: These represent small shocks to the risk factors. The level for different risk factors can, however, vary.

Moderate Level Shocks: It envisages medium level of shocks and the level is defined in each risk factor separately.

Major Level Shocks: It involves big shocks to all the risk factors and is also defined separately for each risk factor.

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Dhaka Bank Limited Bangladesh economy has been experiencing a rapid growth since the '90s. Industrial and agricultural
development, international trade, inflow of expatriate Bangladeshi workers' remittance, local and foreign investments in construction, communication, power, food processing and service enterprises ushered in an era of economic activities. Urbanization and lifestyle changes concurrent with the economic development created a demand for banking products and services to support the new initiatives as well as to channelize consumer investments in a profitable manner. A group of highly acclaimed businessmen of the country grouped together to responded to this need and established Dhaka Bank Limited in the year 1995. The Bank was incorporated as a public limited company under the Companies Act. 1994. The Bank started its commercial operation on July 05, 1995 with an authorized capital of Tk. 1,000 million and paid up capital of Tk. 100 million. The paid up capital of the Bank stood at Tk 2,659,597,763 as on March 31, 2010. The total equity (capital and reserves) of the Bank as on March 31, 2010 stood at Tk 6,036,368,754.

The Bank has 62 Branches, 3 SME Service Centers, 6 CMS Units, 2 offshore Banking Unit across the country and a wide network of correspondents all over the world. The Bank has plans to open more Branches in the current fiscal year to expand the network. The Bank offers the full range of banking and investment services for personal and corporate customers, backed by the stateofthe-art technology and a team of highly motivated Professionals. As an integral part of our commitment to Excellence in Banking, Dhaka Bank now offers the full range of real-time online banking services through its all Branches, ATMs and Internet Banking Channels. Dhaka Bank Ltd. is the preferred choice in banking for friendly and personalized services, cutting edge technology, tailored solutions for business needs, global reach in trade and commerce and high yield on investments

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Capital Adequacy Ratio of Dhaka Bank Limited as per BASEL I

In Millions Particulars Total eligible capital Risk weighted assets (RWA) a. Credit risk i. ii. On balance sheet Off-balance sheet 46976.80 2839.03 49815.83 2009 (Basel-I) 5633.77

b. Market risk c. Operational risk Total RWA Required capital on RWA @ 10% as per Basel I Capital Surplus Capital Adequacy Ratio (CAR)

49815.83 4981.58 652.19 11.31

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Stress Testing of Dhaka Bank Limited

Stress Testing Dhaka Bank Ltd. For the year ended on December 31, 2009 Balance Sheet Duration

Year : 2009

Book Value

Coupon

Repricing Period in Years -

Yield to Maturity

Market value

Duration

Assets: Cash Cash with other Bank and Financial Institutions -On Demand -Upto 1 month -Over 1 month but not more than 3 months -Over3 months but not more than 1 year -Over 1 year but not more than 5 years -Over 5 years Money at Call and Shot Notice Investment 28 days Treasury Bills 30 days Treasury Bills 91 days Treasury Bills 181 days Treasury Bills 364 days Treasury Bills

5,035,699,739 8,224,866,995

5,035,699,739 8,224,866,995

2,885,740,693 180,776,302 300,000,000

0.08 0.25

2,885,740,693 180,776,302 300,000,000

0.08 0.25

4,540,000,000

1.00

4,540,000,000

1.00

318,350,000

5.00

318,350,000

5.00

269,800,000

5.00 -

269,800,000

8,659,565,948 499,795,327 617,430,902 5.0%

1.00

0.06

29,124,099

1.00

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5 Years Bangladesh Government Treasury Bond 10 Years Bangladesh Government Treasury Bond 15 Years Bangladesh Government Treasury Bond Prize Bond Shares Debentures Zero Coupon Bond Other Investments Loans and Advances Repayable on Demand Not more than 3 months More than 3 months but not more than 1 year More than 1 year but not more than 5 years More than 5 years Premises and Fixed Assets Other Assets Non Banking Assets Total Assets Liabilities: Borrowings from Other Banks,

4,178,114,735

8.0%

5.00

0.07

4,349,425,688

4.33

2,629,241,495

11.0%

10.00

0.12

3,367,909,176

6.95

513,247,547

14.0%

15.00

0.13

546,415,548

7.21

2,651,800 149,423,110 6,000,000 48,181,514 15,479,518 52,909,814,017 9,809,871,510 7,613,261,480

7.0% -

5.00 5.00 -

0.06 -

149,423,110 6,252,742 48,181,514 15,479,518

4.40 -

9.0%

0.25

0.09

9,809,871,510 7,613,261,480

0.25

14,627,835,863

10.0%

1.00

0.10 14,627,835,863

1.00

18,071,752,791

12.0%

5.00

0.12 18,071,752,791

2.77

2,787,092,373 424,462,708 2,243,203,687 77,767,413,094

2,787,092,373 424,462,708 2,243,203,687 -

0.07 77,767,413,094

3,489,759,326

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Financial Institutions and Agents Repayable on Demand Repayable within 1 Month Over 1 month but within 6 months Over 6 months but within 1 year Over 1 year but within 5 years Over 5 years Deposit and other Accounts Current Account and Other Accounts Bills payable Savings Bank Deposits Term Deposits Non Convertible Subordinated Bond Other Liabilities Total Liabilities Total Capital Total Liabilities and Capital

420,000,000 -

0.08

420000000 -

2,592,500,000

0.50

7.00

2592500000

0.50

73,940,000

1.00

9.00

73940000

1.00

296,337,879

5.00

12.50

296337879

5.00

106,981,447 60,918,374,023

5.00

15.00

106981447

5.00

5,552,769,281

5552769281

2,151,455,682 5,881,201,270 47,332,947,790 -

0.08 0.50 1.00

2151455682 2151455682 47332947790 -

0.08 0.50 1.00 -

8,393,597,775 72,801,731,124 4,965,681,970 77,767,413,094

8393597775 72801731124

4965681970 77767413094

The Duration GAP has been calculated by using the following formula: DGAP = DA (MVL/MVA) X DL DA MVL MVA DL = Weighted average duration of assets = Market value of liabilities = Market value of assets = Weighted average duration of liabilities 8|Page

The change in market value of equity has been calculated using the following formula: MVE = (DGAP) X i / (1+y) X Total Assets i y = Change in the interest rate = Effective yield to maturity of all the assets

Duration of Assets (DA) Duration of Liabilities (DL) (MVL/MVA)*DL Duration Gap

1.54 0.71 0.67 0.88

Stress Testing Dhaka Bank Ltd.

For the year ended on December 31, 2009 Figure in BDT 5,633,768,159 49,815,831,250 11.31%

Regulatory Capital RWA CAR (%)

5,633,768,159 49,815,831,250 11.31%

5,633,768,159 49,815,831,250 11.31%

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Interest Rate Risk

According to Bangladesh Bank, Interest rate risk is the potential that the value of the onbalance sheet and the off-balance sheet positions of the bank/DFI would be negatively affected with the change in the interest rates. The vulnerability of an institution towards the adverse movements of the interest rate can be gauged by using duration GAP analysis. The banks and FIs shall follow the following steps in carrying out the interest rate stress tests:

Estimate the market value of all onbalance sheet rate sensitive assets and liabilities of the bank/DFI to arrive at market value of equity. Calculate the durations of each class of asset and the liability of the onbalance sheet portfolio Arrive at the aggregate weighted average duration of assets and liabilities. Calculate the duration GAP by subtracting aggregate duration of liabilities from that of assets. Estimate the changes in the economic value of equity due to change in interest rates on onbalance sheet positions along the three interest rate changes. Calculate surplus/(deficit) on offbalance sheet items under the assumption of three different interest rate changes i.e. 1%, 2%, and 3% Estimate the impact of the net change (both for onbalance sheet and offbalance sheet) in the market value of equity on the capital adequacy ratio (CAR).

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The following assumptions are taken at the time of calculating the interest rate shocks on Dhaka Bank Limiteds financial position because of some lack of disclosures about the term to maturity, market value and interest rates of various rate sensitive assets and liabilities:

Deposit and lending rates are taken from the Banks current deposit and lending rate. Market value and book value of deposits and borrowing are assumed to be same.

The impact of interest rate shocks on the CAR of Dhaka Bank are given below

Interest Risk - Increase in interest rate Magnitude of Shock Fall in MVE(onbalance sheet) Net fall in MVE(onbalance sheet & offbalance sheet) Tax Rate Tax adjusted loss Total Regulatory capital Revised Capital Risk weighted assets Revised risk weighted assets CAR Revised CAR Fall in CAR (% age points) 1% 639,020,427 639,020,427

Scenario 1 2%

Scenario 2

Scenario 3 3% 1,917,061,282 1,917,061,282

1,278,040,854 1,278,040,854

42.50% 367,436,746 5,633,768,159 5,266,331,413 49,815,831,250 49,448,394,504 11.31% 10.65% 0.66%

42.50% 734,873,491 5,633,768,159 4,898,894,668 49,815,831,250 49,080,957,759 11.31% 9.98% 1.33%

42.50% 1,102,310,237 5,633,768,159 4,531,457,922 49,815,831,250 48,713,521,013 11.31% 9.30% 2.01%

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Exchange Rate Shock The stress test for exchange rate assesses the impact of change in exchange rate on the value of equity. Net exposure in foreign currency was always positive for Dhaka Bank. It means, the bank was in net long position in 2009. As a result, currency appreciation would harm the bank. The Bank would able to maintain required Capital Adequacy level in minor, moderate and major level shock in 2009. Due to adverse change in foreign exchange rate of 5%, 10% and 15%, the loss was BDT. 64,741,886 BDT. 129,483,772 and BDT. 194,225,658 respectively. As a result of those adverse change in rate the revised CAR will be 11.19%, 11.08% and 10.96%respectively.

Exchange Rate Shock Magnitude of Shock Net onbalance sheet and offbalance sheet currency exposure Exchange rate loss on % change Tax Rate Tax adjusted loss Total eligible capital Revised Capital Risk weighted assets Revised risk weighted assets CAR Revised CAR Fall in CAR (% age points) 5% 2,251,891,685 10% 2251891685 15% 2251891685

112594584.3 42.50% 64,741,886 5,633,768,159 5,569,026,273

225189168.5 42.50% 129,483,772 5,633,768,159 5,504,284,387

337783752.8 42.50% 194,225,658 5,633,768,159 5,439,542,501 49,815,831,250 49,621,605,592 11.31% 10.96% 0.35%

49,815,831,250 49,815,831,250 49,751,089,364 49,686,347,478 11.31% 11.19% 0.12% 11.31% 11.08% 0.23%

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Credit Shock The bank is exposed to credit risk in its lending operation. Credit risk is the risk of loss that may occur from the failure of any counterparty to make required payments in accordance with agreed terms and conditions. Management of credit risk in the bank is governed by a Credit Policy Manual which contains the principles for identifying, measuring, approving and managing credit risk. These policies are established by the Board of Directors and are designed to meet the organizational requirements that exist today, and to provide flexibility for future. These policies represent the minimum standards for credit extension and are not a substitute for experience and good management.

The stress test for credit risk assesses the impact of increase in the level of nonperforming loans of the bank/FI. This involves six types of shocks:
1. Credit Shock - Increase in NPLs Magnitude of Shock Total Loan Total Performing Loan Total NPLs NPLs to Loans (%) Increase in NPLs Tax Rate Tax adjusted provision Total eligible capital Revised Capital Risk weighted assets Revised risk weighted assets CAR 1% 52,909,810,000 49,963,680,000 2,946,130,000 5.57% 499,636,800 42.50% 499,636,800 5,633,768,159 5,134,131,359 49,815,831,250 49,316,194,450 11.31% 2% 52,909,810,000 49,963,680,000 2,946,130,000 5.57% 999,273,600 42.50% 999,273,600 5,633,768,159 4,634,494,559 49,815,831,250 48,816,557,650 11.31% 3% 52,909,810,000 49,963,680,000 2,946,130,000 5.57% 1,498,910,400 42.50% 1,498,910,400 5,633,768,159 4,134,857,759 49,815,831,250 48,316,920,850 11.31%

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Revised CAR Fall in CAR (% age points) Revised NPLs Revised NPLs to Loans (%)

10.41% 0.90% 3,445,766,800 6.51%

9.49% 1.82% 3,945,403,600 7.46%

8.56% 2.75% 4,445,040,400 8.40%

2. Credit Shock - Shift in NPLs categories Magnitude of Shock Weighted Amount of provision Provision after shift in categories Increase in provision Tax adjusted provision Revised Capital Revised RWA Revised CAR (%) Fall in CAR(% points) 50% 1,488,012,764.50 1,751,633,617.40 263,620,852.90 263620852.9 5,370,147,306 49,552,210,397 10.84% 0.47% 80% 1,488,012,764.50 2,069,870,604.44 581,857,839.94 581857839.9 5,051,910,319 49,233,973,410 10.26% 1.05% 100% 1,488,012,764.50 2,282,028,595.80 794,015,831.30 794015831.3 4,839,752,328 49,021,815,419 9.87% 1.44%

3. Credit Shock - Fall in the FSV of Mortgaged Collateral : Magnitude of Shock Total FSV weighted FSV collateral fall in the FSV Tax adjusted provision Revised Capital Revised RWA Revised CAR (%) Fall in CAR(% points) 10% 976,786,800.00 817,278,422.60 81,727,842.26 81,727,842.26 5,552,040,316.74 20% 976,786,800.00 817,278,422.60 163,455,684.52 163,455,684.52 5,470,312,474.48 40% 976,786,800.00 817,278,422.60 326,911,369.04 326,911,369.04 5,306,856,789.96 49,488,919,880.96 10.72% 0.59%

49,734,103,407.74 49,652,375,565.48 11.16% 0.15% 11.02% 0.29%

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4.

Credit Risk - Increase in NPLs in particular 1 or 2 sectors 5.00% 9,728,960,598 486,448,029 486,448,029 7.50% 9,728,960,598 729,672,044 729,672,044 10.00% 9,728,960,598 972,896,059 972,896,059

Magnitude of Shock Loan to Garments & Textile Sectors Increase in NPLs Increase in provision (after adjustment of value of eligible securities; if any) Tax adjusted provision Revised Capital Revised RWA Revised CAR (%) Fall in CAR

486,448,029 5,147,320,129 49,329,383,220 10.43% 0.87%

729,672,044 4,904,096,114 49,086,159,205 9.99% 1.32%

972,896,059 4,660,872,099 48,842,935,190 9.54% 1.77%

5.

Credit Risk - Increase in NPLs due to Top 10 large loan borrowers Magnitude of Shock 5.00% 13,263,285,974 663,164,298 663,164,298 7.50% 13,263,285,974 994,746,448 994,746,448 10.00% 13,263,285,974 1,326,328,597 1,326,328,597

Loan to Top 10 large loan borrowers Increase in NPLs Increase in provision (after adjustment of value of eligible securities; if any) Tax adjusted provision Revised Capital Revised RWA Revised CAR (%) Fall in CAR (% points)

663,164,298 4,970,603,860 49,152,666,951 10.11% 1.20%

994,746,448 4,639,021,710 48,821,084,801 9.50% 1.81%

1,326,328,597 4,307,439,561 48,489,502,652 8.88% 2.43%

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Equity Price Shock The stress test for equity price risk assesses the impact of the fall in the stock market index. Here we have taken the market value of the portfolio of the bank. Appropriate shocks have been absorbed to the respective securities if the current market value of all the on balance sheet and off balance sheet securities listed on the stock exchanges including shares, NIT units, mutual funds etc falls at the rate of 10%, 20% and 40% respectively. The impact of resultant loss has been calibrated in the CAR.

Equity Price Risk - Fall in Stock Prices Magnitude of Shock Total exposure in stock market Fall in the stock prices Tax Rate Tax adjusted loss Total eligible capital Revised Capital Risk weighted assets Revised risk weighted assets CAR Revised CAR Fall in CAR (% age points) 10% 145,423,110 14,542,311 42.50% 8,361,829 5,633,768,159 5,625,406,330 49,815,831,250 49,807,469,421 11.31% 11.29% 0.01% 20% 145,423,110 29,084,622 42.50% 16,723,658 5,633,768,159 5,617,044,501 49,815,831,250 49,799,107,592 11.31% 11.28% 0.03% 40% 145,423,110 58,169,244 42.50% 33,447,315 5,633,768,159 5,600,320,844 49,815,831,250 49,782,383,935 11.31% 11.25% 0.06%

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Liquidity Shock The stress test for liquidity risk evaluates the resilience of the banks towards the fall in liquid liabilities. The ratio liquid assets to liquid liabilities has been calculated before and after the application of shocks by dividing the liquid assets with liquid liabilities.

Appropriate shocks have been absorbed to the liquid liabilities if the current liquidity position falls at the rate of 10%, 20% and 30% respectively. The ratio of liquid assets to liquid liabilities has been recalculated under each scenario.Liquidity Shock.

Liquidity Shock - Fall in liquid liabilities Magnitude of Shock Liquid assets (LA) Liquid Liabilities (LL) Liquidity Ratio (%) (LA/LL) Fall in liquid liabilities Revised Liquid Assets Revised Liquid Liabilities Revised Liquidity Ratio (%) Increase in liquidity ratio(% age points) 10.00% 14,329,242,963 16,671,866,233 86% 1667186623 12662056340 15004679610 84.39% -1.56% 20.00% 14329242963 16671866233 86% 3334373247 10994869716 13337492986 82.44% -3.51% 30.00% 14329242963 16671866233 86% 5001559870 9327683093 11670306363 79.93% -6.02%

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Cumulative Impact

Cumulative impact of Credit Shock

1st Scenario

2nd Scenario

3rd Scenario

Tax adjusted Provision Revised Capital Revised RWA Revised CAR (%) Fall in CAR

1,994,597,823 3,639,170,335 47,821,233,426 7.61% 3.70%

3,469,005,617 2,164,762,541 46,346,825,632 4.67% 6.64%

4,919,062,257.54 714,705,901.46 44,896,768,992 1.59% 9.72%

Cumulative impact of all shocks

Tax adjusted Provision/ Loss Revised Capital Revised RWA

1st Scenario
2,435,138,284.16 3,198,629,874.84 47,380,692,965.84

2nd Scenario
4,350,086,538.15 1,283,681,620.85 45,465,744,711.8 5 2.82% 8.49%

3rd Scenario
6,249,045,467.55 (615,277,308.55) 43,566,785,782.4 5 -1.41% 12.72%

Revised CAR (%) Fall in CAR

6.75% 4.56%

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Conclusion Simple stress testing results of Dhaka Bank Ltd. reveals that the banks overall CAR would stay above the required level in minor and moderate shocks. But in major shocks the bank is exposed to risk to losing capital adequacy according to the required CAR. Stress tests cover a range of methodologies. Complexity can vary, ranging from simple sensitivity tests to complex stress tests, which aim to assess the impact of a severe macroeconomic stress event on measures like earnings and economic capital. Most risk management models, including stress tests, use historical statistical relationships to assess risk. They assume that risk is driven by a known and constant statistical process and historical relationships constitute a good basis for forecasting the development of future risks. The recent financial turmoil has revealed serious flaws with relying solely on such an approach.

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References:

Bangladesh Bank, (April 2010), Supervision

Guidelines on Stress Testing, Department of Offsite

Annual Report, (2009), Dhaka Bank Limited

http://www.dhakabankltd.com

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