Saleh Akram :
The banking sector of Bangladesh has of late been bogged down by a number of scandals involving pilferage of incredible sums of money in the name of industrial and commercial lending. Banks involved were either oblivious or willfully defied the basic principles of lending including credit risks involved and holed out huge chunks of loans against inadequate or fictitious assets. The inevitable result of such mindless and injudicious lending has been dearth of capital reserve or capital deficit with the banks concerned and confidence level of the potential investors was badly ruptured.
Risk is inherent in all aspects of a commercial operation. Banks and financial institutions are no exceptions in this regard and since they are engaged in money trading, for them, the issue of credit risk bears greater importance than all other operational risks. Credit risk has been defined as the risk of loss of principal or loss of a financial reward stemming out from a borrower’s failure to repay a loan or otherwise unlade to meet a contractual obligation. Obviously, credit risk management needs to be a robust process that will enable the banks to proactively manage loan portfolios in order to minimize losses and earn an acceptable level of return for shareholders. Given the fast changing scenario of the global economy, it is essential that Banks have Should robust credit risk management policies and procedures that are sensitive and responsive to these changes. Credit risk management being the process of mitigating losses by understanding the adequacy of both a bank’s capital and loan loss reserves at any given time, has long been a challenge for financial institutions.
The Banking sector of Bangladesh is in a state of compounding credit risk arising mainly out of indiscriminate and inept loan disbursement. Such mindless lending has thrown the country’s banking sector in doldrums precipitating an unforeseen capital deficit for most of the banks. In other words, banks are now way behind in terms of proportionate capital reserve in comparison to loans extended. According to latest Bangladesh Bank report, combined capital deficit of 9 commercial banks of the country now stands at almost Tk.120,000 millions. This was triggered by gross irregularities in the form of reckless and imprudent lending by these banks. According to the report, combined capital deficits of 9 commercial Banks stood at Tk.119,337 millions at the end of July this year. Capital deficits of state owned Sonali Bank and Rupali Bank are Tk.15,113 millions and Tk.2168 millions respectively, while those of Bangladesh Krishi Bank, Basic Bank and Rajshahi Krishi Bank are Tk.59985 millions, Tk.16755 millions and Tk.6499 millions respectively. Of the private sector Banks, Bangladesh Commerce Bank and ICB Islami Bank have capital deficits of Tk.400 millions and Tk.14158.5 millions respectively and that of National Bank of Pakistan, a foreign bank, amounts to Tk.3696 millions. The same report shows that there was a capital surplus of Tk.23777.4 millions at the end of March 2014, which reversed into a deficit of Tk.8481.8 millions in a space of only three months. In Sonali bank alone, capital deficit at the end of June 2014 was Tk.15113.1 millions, which was Tk.2784.3 millions at the end of March 2014, i.e., a stupendous increase of 443 percent in only three months. The foreign banks, however, present a different picture. Capital reserve of these banks at the time of the said BB report was Tk.86331.5 millions, against a regulatory capital reserve Tk.58359.7 millions, which means, they had capital reserve surplus of Tk.27971.8 millions.
The global financial crisis – and the credit crunch that followed – put credit risk management into the regulatory spotlight. As a result, regulators appeared on the centre stage and began to demand more transparency. They wanted to ensure that banks have thorough knowledge of their customers and associated credit risk. Same thing happened in Bangladesh and the Central Bank undertook a project last year to review the global best practices in the banking sector and examine the possibility of introducing those in the banking industry of Bangladesh. Four ‘Focus Groups’ were formed with participation from Nationalized Commercial Banks, Private Commercial Banks & Foreign Banks with representatives from the Bangladesh Bank as team coordinator to look into the practices of the best performing banks both at home and abroad. These focus groups aimed at identifying and selecting five core risk areas and producing a document that would be a basic risk management model for each of the five ‘core’ risk areas of Banking. The five core risk areas are: a) Credit Risks; b) Asset and Liability/Balance Sheet Risks; c) Foreign Exchange Risks; d) Internal Control and Compliance Risks; and e) Money Laundering Risks.
Credit risk management, being the practice of mitigating losses by understanding the adequacy of both a bank’s capital and loan loss reserves at any given time, has long been a challenge for financial institutions. To comply with the more stringent regulatory requirements and absorb the higher capital costs for credit risk, many Banks are overhauling their approaches to credit risk. But the banks who view this as strictly a compliance exercise, are being short-sighted. Better credit risk management also presents an opportunity to greatly improve overall performance and secure a competitive advantage.
Banks borrow money by accepting funds deposited on current accounts, by accepting term deposits, and by issuing debt securities such as banknotes and bonds. Banks lend money by making advances to customers on current accounts, by making installment loans, and by investing in marketable debt securities and other forms of money lending.
Banks can create new money when they make a loan. New loans throughout the banking system generate new deposits elsewhere in the system. The money supply is usually increased by the act of lending, and reduced when loans are repaid faster than new ones are generated. If all the banks increase their lending together, then they can expect new deposits to return to them and the amount of money in the economy will increase. Excessive or risky lending can cause borrowers to default which makes the banks more cautious, so there is less lending and therefore less money in the economy. Bangladesh has set a classic example in this direction.
The first step in effective credit risk management is to gain a complete understanding of a bank’s overall credit risk by viewing risk at the individual, customer and portfolio levels. While banks strive for an integrated understanding of their risk profiles, much information is often scattered among business units. Without a thorough risk assessment, banks have no way of knowing if capital reserves accurately reflect risks or if loan loss reserves adequately cover potential short-term credit losses. Vulnerable banks are targets for close scrutiny by regulators and investors. The key to reducing loan losses – and ensuring that capital reserves appropriately reflect the risk profile – is to implement an integrated and quantitative credit risk solution. This solution should get banks up and running quickly with simple portfolio measures. It should also accommodate a path to more sophisticated credit risk management measures as needs evolve.
(Saleh Akram is a well-known TV personality and writes on economic issues.)
