RMPG Learning Series CRM Workshop Day 5

IMaCS 2010Printed 11-May-11

Page 1For Classroom discussion only

Agenda for Day 5

Presentation of Cases by Participants

Lunch Break

IMaCS’ Recommendations to Banks

Session on current regulations in Bangladesh

Discussions on Issues Raised



Regulatory framework: Banks

• Tk. 200 croreMinimum Capital

• 10%• 5% Core Capital

Capital adequacy ratio

• Not more than % of capital in a bank may be acquiredwithout the approval of the Bangladesh Bank.Ownership

• Up to xx%Foreign ownership

• 365 days (in case of asset financing) , 180 days (incase of loans and other exposures)Provisioning

• YesAvailability of deposit insurance facility for

depositors



Categories of Loans

Categories of Loans

Continuous Loan

Demand Loan

Fixed Term Loan

Short-term

Agricultural and Micro

Credit

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 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



Loan Classification

• If not repaid/renewed within the fixed expiry date for repayment will be treated as past due/overdue from the following day of the expiry date

Past due/overdue

• A Continuous Loan/Demand loan/Term Loan which will remainoverdue for a period of 90 days or more, will be put into the "SpecialMention Account(SMA)"

Special Mention Account

• Sub-standard if it remains past due/overdue for 6 months or beyond but less than 9 months.Sub-standard

• `Doubtful' if for 9 months or beyond but less than 12 monthsDoubtful

• Bad-Debt' if for 12months or beyondBad-Debt



Provisioning Norms …1

Classified Continuous, Demand and Fixed Term Loans

Sub-standard 20%

Doubtful 50%

Bad/Loss 100%

Provision in respect of Short-term Agricultural and Micro-Credits is to be maintained at the following rates

All credits except 'Bad/Loss'(i.e. 'Doubtful', 'Sub-standard', irregular and regular credit accounts)

5%

'Bad/Loss' 100%



Provisioning Norms…2

Banks will be required to maintain General Provision

All unclassified loans (other than loans under ConsumerFinancing and Special Mention Account

1%

Unclassified amount for Consumer Financing whereas it has tobe maintained @ 2% on the unclassified amount for (i) Housing Finance and (ii) Loans for Professionals to set up business under Consumer Financing Scheme.

5%

Outstanding amount of loans kept in the 'Special MentionAccount' (SMA) after netting off the amount of Interest Suspense.

5%



Agenda for Day 5

Presentation of Cases by Participants

Lunch Break

IMaCS’ Recommendations to Banks

Session on current regulations in Bangladesh

Discussions on Issues Raised



Governance framework for Risk Management

Organization structure with well defined roles

and responsibilities

Formulation of policies, processes and formation of different committees

Monitor execution through periodic reviews done by these committees

Robust reporting and analysis infrastructure for

early warnings or monitoring trends

Review of existing policies, processes and

systems and modifications if required



Risk Management Process and Tools

Pre Sanction

Appraisal

Assessment through rating models

Prudential exposure limits

Post Sanction Pre disbursement

Execution of all documents

Meeting pre disbursement conditions

Post disbursement

DP report and stock audits

Monitoring report

Branch Compliance Certificate

Loan Review Mechanism

Re-rating of large accounts annually

Default

Special Mention Accounts report

NPA reporting

Evaluate decoupling of origination and assessment /

credit rating

Evaluate possibility of setting up a centralized legal

cell

Sector wise, product wise rating migrations

Sector wise, product wise NPA and SMA rating



Policy for Internal Capital Adequacy Assessment Process : Objectives

periodical internal audit

� Enunciate Bank’s overall risk philosophy

� Define acceptable risk measurement methodologies including risk mitigation

mechanisms

� Ability to assess capital adequacy to ensure

� Compliance with Bangladesh Bank guidelines

� Adequate capital as buffer to ensure business stability simultaneously with rapid growth

� Provide better internal governance environment and facilitate proactive Capital

Budgeting

� Define organization structure and responsibilities for effective internal assessment

process including reporting mechanisms

� Ensure continued validity and relevance of risk assessment methodologies through

periodical internal audit



ICAAP framework

Identification of all material risks

Measurement and reporting of all

the material risks

Capital cushion based on

understanding of implicit risks

Linking capital requirements to

the level of Risks

Strategy for ensuring capital

adequacy

Oversight process and

structure

� RMD, CRMC, ORMC & ALM Cell

� Based on materiality

� Measurement methodology aligned with RBI guidelines

� Scenarios sensitized to bank’s profile

� Required to manage unexpected scenarios

� Stress testing framework to provide a measure of capital cushion

�Additional Capital for normal growth

�Additional capital for increased risks

�Additional Capital for normal growth

�Additional capital for increased risks

�Reporting of risks assessed

� Reporting of CRAR

�Actions



Capital Planning

Additional Capital

Requirement

Strategy to acquire riskier assets for

higher target profitability or entry

into new areas

Expected asset growth with the

same portfolio mix

Stress test results indicate a breach in

tolerance levels

Planned investments

Notional capital cushion for risks not mentioned in

Pillar I and could be based on the stress

test results



Importance of Risk Based Pricing

� Aligns the incentive for a bank to balance risk with return

� Pricing is a tool to maintain proactive provisioning

� Necessary for value creation and preservation

� Building block for credit risk management



Pre-requisites for “Risk Pricing” credit - A Bank must have the capability to generate...

� Loss given default

� History of risk score of borrowers

� Variance in loss given default

Information on defaults associated with the risk score � Information on defaults associated with the risk score of borrowers



Computing Risk Premia - Expected Loss

ExpectedLoss (EL)

ExposureatDefault(EAD)

Probability of Default (PD)

Borrower Risk Score

1

2

3

4

5

6

7

8

9

10

PD

.05%

-

-

-

10%

-

-

-

-

100%

Loss Given Default (LGD)

Collateral Type

1

2

3

4

5

6

7

8

9

10

LGD

5%

-

-

-

20%

-

-

-

-

75%

x x=



Present status in many banks - How mis-pricing of risk is harmful.

• Good credit risks subsidising the poor credit risk accounts

• Threat of disintermediation leaves banks with poor credit risk accounts

• Already beginning to happen in most markets

The cross-subsidy

Bank pricing

Good credits overpriced

Risk-basedpricing

“Bad risks” under-priced

Subsidy

AAA BBB

%

Risk

Interest rate



Risk Based Pricing - An example

Cost of Funds 5.50%Cost of Funds 5.50%

Cost of Operation 1.00%Cost of Operation 1.00%

1

2

3

4

Risk Adjusted Pricing (1+2+3+4)

=

8.78 %

Return on Capital (I*V*VI) (Loan Size %) 1.28%Return on Capital (I*V*VI) (Loan Size %) 1.28%

Expected Loss (III*IV) 1.00%Expected Loss (III*IV) 1.00%

Risk Grading B+I Loan Size (Tk. Crore) 100II Tenor (Years) 5III Probability of Default 2%IV Loss Given Default 50%V Hurdle Rate on Equity (Share holder Expectation) 16%VI Capital as % of funded assets 8%VII Cost of Funds for 5 Yr Tenor (From FTP) 5.50%

Client: XYZ



� Banks’ activities are increasingly arranged along business unit lines to improve

focus

� Shareholders demand optimum risk-adjusted return on their risk capital

� Bank Management is able to allocate scarce capital among business units based on their potential risk-adjusted performance

Performance Measurement

Performance Budgeting

Capital Allocation

Lending decision

RAROC is gaining popularity as it links investor aspirations to Management goals



5 steps to RAROC of a loan/ business line/ portfolio

STEP 1: Calculate Net Interest EarnedSTEP 1: Calculate Net Interest Earned

STEP 2: Calculate Expected Loss

STEP 3: Calculate the Risk-Adjusted Spread

STEP 4: Calculate the Risk Capital to be allocated for that activity

STEP 5: Calculate RAROC from inputs of Step 3 and 4



RAROC: Step 1 of 5

Net Interest earned = (Interest Rate –Interest Expenses) x Amount of Loan

1.Interest rate is market determined on which the banker has limited control

2.Interest expense depends on bank’s cost of funds and is given by ALM

STEP 1 Calculate Net Interest Earned

STEP 2 Calculate Expected Loss

STEP 3 Calculate the Risk-Adjusted Spread

STEP 4 Calculate the Risk Capital to be allocated for that activity

STEP 5 Calculate RAROC from inputs of Step 3 and 4



RAROC: Step 2 of 5

Expected Loss = Probability of Default x Loss Given Default x Amount of loan

1.Probability of Default can be derived from transition matrix

2. Loss given default is the proportion of

money lost after recoveries on a defaulted

account

-














RAROC: Step 3 of 5

Risk Adjusted Spread *=

Net Interest Earned (Step 1)

Less: Expected Loss (Step 2)

Less: Administrative Expenses

Add: Non-interest income

This is similar to risk-based pricing , but RAROC goes a step further

* The spread is in absolute amount













RAROC: Step 4 of 5











Capital Allocated *= Standard Risk Weight (of an asset) x Minimum Regulatory capital x Loan amount

*Capital allocated may be Regulatory Capital



RAROC: Step 5 of 5











Risk-Adjusted Spread (Step 3)

Risk Capital (Step 4)

If the RAROC is higher than the “Hurdle

rate” a loan is acceptable in terms of

risk/return

RAROC =



Credit Risk framework under Basel II

Credit RiskAlign regulatory capital more closely with economic capital

Measurement

Standardised Method

IRB Method

Foundation

Advanced

Regulatory

Economic Capital

Supervisory Risk weights and Credit Risk Mitigation



Ownership and policy review

� The policy would be reviewed regularly to incorporate

� Additional material risks as and when they arise and are measurable

� Changes in risk measurement methodology based on regulatory

directives or implementation of various tools

� Reporting by different functions and levels

� Risk Management Department would review and maintain the policy



Recommendations for Systems supporting credit process

� Risk Management Solution to be used for capturing origination data

� Sanction process workflow to be automated based on defined rules

� Credit rating to be automated and centralized

� User profiles to avoid conflicts of interest and decouple rating from

origination

� Capture data for rejected loan application and make it available in a

centralized manner

� Collateral management can be done using Risk Management Solution



DISCUSSIONS



All the contents of the presentation are confidential and

should not be published, reproduced or circulated without the

written consent of IFC, Bangladesh Bank and IMaCS.

Economy & Finance

RMPG Learning Series CRM Workshop Day 5