Personal loan and credit risk management at NBP
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Transcript of Personal loan and credit risk management at NBP
Personal loan and Credit Risk
Management at NBP
A thesis
Presented to
The faculty of
Management Sciences
Government Collage University of Faisalabad sub campus Sahiwal
In Partial Fulfillment
Of the Requirement for the
Degree in Bachelor Business Administration
By
Azhar Hussain
DEDICATION
“I WOULD LIKE TO DEDICATE MY RESEARCH PROJECT
TO MY PARENTS AND WIFE FOR THEIR KIND SUPPORT AND
GENEORICITY IN EVERY SEMISTER. I WOULD LIKE TO
“EXTEND THIS OPPORTUNITY TO THANK
GOVERMENT COLLAGE UNIVERSTY OF
FAISLABAD FOR MAKING ME PROFESSIONAL”
ACKNOWLEDGEMENT
By the grace of Almighty Allah, The most beneficent and most mercifully, I
have finished my report and have been able to present.
My special thank is reserved for my advisor Mr Qusam and My Examiner Dr.Ahmad Nawaz
zaheer whose guidance and motivation during my research was a stepping stone to the successful
completion of the report, they guided me with a lot of encouragement and technical guidance in
the preparation of this repot
I would also like to thank various persons from NBP, for their help in providing me valuable
material relating to my thesis topic. Without the assistance of these people who were directly or
indirectly involved in the successful completion of this project, it would never have been
possible for me to materialize this report successfully.
ABSTRACT
Banks today is highly complex organization offering multiple services through various
departments, each staffed by specialists in making different kind of financial decisions.
Banks today realize that all these management decisions are intimately linked to each
other. In a well managed bank all of these management decisions must be coordinated
across the whole bank to ensure that they do not clash with each other.
For the project I have selected topic “Personal loan and credit risk management” because
of my personal interest in doing something in financial sector especially in the banking
sector because banks today focus heavily on the managing risk, attempting to control the
exposure to loss due to changes in the interest rate the inability or unwillingness of
borrowers to repay their loans, changing currency prices and other risk laden factors. But
effective management of risk requires careful coordination of decisions made on the asset
side of a bank with the decision made on liabilities side. Thus bankers use different
techniques of risk management that can be marshaled in a coordinative fashion to handle
many risks.
In the project NBP was taken to make the focused area of the project clear. During the
study the operations and activities to see how the guidelines are implemented and what its
impacts are on the performance of the respective bank. In the end of project I found out
some important findings for the readers and also have given some recommendation for
the bank to improvement and betterment in the business.
In the new deregulation and liberal financial initiative is quite obvious that bank will have
to be for more creative in responding to the challenges of a dynamic and competitive
market place .it will have to develop skills and expertise to strike a balance between the
prudent lending and a rapid portfolio which will be crucial in the new environment fund’s
management equity, foreign currency and interest rate hedging, venture capital
investment and mergers and acquisition technique.
It is highly encouraging to mention that due cognizance is being taken by the regulatory
authority that is state bank of Pakistan and the financial institutions to improve the
existing scenarios of the banking industry and individual bank, besides it is about time
that the National Bank should perform outstanding through taking efficient and effective
decisions about their business using different policies, techniques and methods for
mitigating the risk and providing the highly derived services to the customers through
this it will help the government for improving the performance of financial sector as well
as economy of the country.
It is real need of economy of our country that each sector understanding their
responsibilities and performs well through adopting attractive policies according to the
needs of time
TABLE OF CONTENTS
CHAPTER NO # 1
Introduction…………………………………………… 1
What is a bank………………………………………... 1
History of NBP……………………………………….. 1-4
What is risk…………………………………………… 4-5
Risk faced by financial institutions…………………… 5-7
What is risk Management……………………….......... 7-8
Risk Management.............…………………………….. 8-9
Board and Senior Management oversight……………... 10
Risk Management Frame work 10-11
Integration of Risk Management................................. 11
Business line accountability.......................................... 11
Risk Evaluation........................................................... 11-12
Independent Review....................................................... 12
Contingency Planning................................................. 12-13
Statement of Problem.................................................. 13
Significance of the study................................................ 13
Scope........................................................................... 14
Delimitations................................................................. 14
Definition......................................................................... 14-15
CHAPTER NO # 2
Research Design……………………………………….. 16
Methodology…………………………………………... 16
Investigation…………………………………………… 16
Study Setting…………………………………………... 16
Unit Analysis………………………………………….. 17
Time Horizon………………………………………….. 17
Respondents of the study……………………………… 17
Research instruments………………………………….. 17
Primary data collection……………………………….. 17
Secondary data collection……………………………... 18
Treatment of Data …………………………………….. 18
Presentation Analysis………………………………….. 18
CHAPTER NO # 3 Page No
Literature review...........................................................
5 C of credit worthiness.................................................
Managing credit Risk......................................................
Components of credit Risk management.......................
Board & senior management oversight..........................
Organizational Structure………………………………..
System and Procedures…………………………………
Measuring Credit Risk...................................................
Internal Risk Rating.......................................................
Credit Risk Monitoring and Control...............................
Risk Review…………………………………................
Delegation of authority…………………………………
Local literature................................................................
Foreign literature.............................................................
Gap to be a bridged by the study.....................................
Areas of further Study...................................................
CHAPTER NO # 4 Quantitative analysis of credit Risk Management at NBP
Qualitative Analysis of Credit Risk Management At NBP....
CHAPTER NO # 5 Findings.........................................................................
Conclusion.....................................................................
Recommendation............................................................
APPENDEIX
Questionnaire..................................................................
Bibliography.....................................................................
CHAPTER NO.1
Background of the Topic and Statement of the Problem
Introduction
Statement of problem
Significance of the study
Scope
Delimitation
Definitions
CHAPTER NO. 2
Research method and procedure
Research design
Respondent of the study
Research instruments
Treatment of the data
Presentation analysis
CHAPTER NO.3
Review The Literature & Studies
Local Literature
Foreign Literature
Gap To Be Abridge By This Study
Areas For Further Studies
CHAPTER NO.4
Presentation Analysis
Quantitative Analysis
Qualitative Analysis
CHAPTER NO.5
Conclusion & Recommendations
Findings
Conclusion
Recommendations
1.1 Introduction
1.1.1 What is a Bank?
A bank is an institution which deals in money broadly speaking, banks draw surplus money from
the people who are not using it at the time, and lend to those who are in a position to use it for
productive purposes. Modern banks have developed from very small beginnings. The earlier
bankers were gold-smiths.
Crothers observes that “the present day banker has three ancestors: merchant, money lender and
goldsmith. A modern bank is something of each of these. It is said money has two properties. It
is flat so that it can be piled up, and it is round so that it can circulate.
1.1.2 History of NBP
National Bank of Pakistan (the Bank) was established on November 9, 1949 under the National
Bank of Pakistan Ordinance, 1949 in order to cope with the crisis conditions Which were
developed after trade deadlock with India and devaluation of Indian Rupee in 1949. Initially the
Bank was established with the objective to extend credit to the Agriculture sector. The normal
procedure of establishing a banking company under the Companies Law was set aside and the
Bank was established through the promulgation of An Ordinance due to the crisis situation that
had developed with regard to financing of jute Trade. The Bank commenced its operations from
November 20, 1949 at six important jute Centers in the then East Pakistan and directed its
resources in financing of jute crop. The Bank’s Karachi and Lahore offices were subsequently
opened in December 1949. The nature of responsibilities of the Bank is different and unique
from other Banks/financial institutions. The Bank acts as the agent to the State Bank of Pakistan
for Handling Provincial/Federal Government Receipts and Payments on their behalf. The Bank
has also played an important role in financing the country’s growing trade, which has expanded
through the years as diversification took place. Today the Bank Finances import/export business
to the tune of Rs. 52.7 billion, whereas in 1960 financing under this head was only Rs.1.54
Bilion.
Objects and Activities
The Bank is providing all banking services of mercantile and commercial banking Permissible in the country, which include
• Handling of treasury transactions for the Government of Pakistan as agent to the
State Bank of Pakistan.
• Providing services under a Trust Deed as Trustee to the National Investment Trust
(NIT) including safe custody of securities on behalf of NIT.
• Accepting of deposits of money on current, fixed, saving, term deposit and profit and Loss Sharing accounts.
• Borrowing money and arranging finance from other banks.
• Advancing and lending money to its clients.
• Financing of projects, including technical assistance, project appraisal
through Long- term / Short-term loans, term finance and Musharika certificates, etc.
• Buying, selling, dealing, including entering into forward contracts of foreign
exchange.
• Financing of seasonal crops like cotton, wheat, rice, sugar cane, tobacco, etc.
• Receiving of bonds, scraps, valuables, etc. for safe custody.
• Carrying on agency business of any description other than managing agent, on behalf of clients including Government and local authorities.
• Generating, undertaking, promoting, etc. of issue of shares and, bonds, etc.
• Transacting guarantee and indemnity business.
• Undertaking and executing trusts.
• Joint venturing with foreign dealers, agents and companies for its representation
abroad.
• Participating in "World Bank" and "Asian Development Bank's" lines of credit
• .Providing personalized Hajj services to intending Hajjis.
Branch Network
Presently the Bank is divided into 10 Groups headed by SEVPs/EVPs. Its field operations are
controlled by 9 Regions reporting to as many Regional Chiefs, who control 40 Zones and 15
Single Branch Zones headed by Zonal Chiefs; 12 corporate branches and 1,395 domestic
branches headed by Branch Managers. With the geographical development of its branches, the
Bank has been able to extend its services to a much larger number of Pakistanis all over the
country. Today it has more than 8.5 million accounts. Bank maintains its presence in all the
major financial centers of the world through its 23 overseas branches and 5 representative
offices. Of these, three Representative offices have recently been set up at Tashkent
(Uzbekistan), Baku (Azerbaijan) and Almighty (Kazakhstan) to take advantage of the emerging
opportunities in CIS countries. Bank’s role globally is well assisted by its network of
correspondent banks Located strategically in Asia, America, Europe and Africa. Apart from
having a vast branch network, Bank is at the forefront in the acquisition and Application of new
technologies in every aspect of its banking facilities. It has acquired leased telephone lines for
on-line banking. The Bank has 12 Regional Computer Centers To cover various on-line and
batch system requirements of branches and controlling offices. Bank has also a presence on the
Internet. It has modernized its services by installing Automated Teller Machines (ATMs) called
"CASH LINK" at selected branches and presently 17 ATMs are operational in major cities.
NBP Vision
NBP vision and customer trust have made it one of the most profitable banks in the world. A
universals banking franchise offering a complete range of financial solutions. NBP are the largest
and strongest financial institution in Pakistan with a presence in 18 countries across the global.
To be the pre-eminent financial institution in Pakistan and achieve market recognition both in the
quality and delivery of service as well as the range of product offering.
NBP Mission
To be recognized in the market place by Institutionalizing a merit & performance culture,
Creating a powerful & distinctive brand identity, Achieving top-tier financial performance, and
Adopting & living out our core values.
1.2 What is risk?
Risk arises when there is a possibility of more than one outcome and the ultimate outcome is
unknown. Risk can be defined as the variability or volatility of unexpected outcomes. It is
usually measured by the standard deviation of historic outcomes. Though all businesses face
uncertainty, financial institutions face some special kinds of risks given their nature of activities.
The objective of financial institutions is to maximize profit and shareholder value-added by
providing different financial services mainly by managing risks. There are different ways in
which risks are classified. One way is to distinguish between business risk and financial risks.
Business risk
Business risk arises from the nature of a firm’s business. It relates to factors affecting the product
market.
Financial Risk
Financial risk arises from possible losses in financial markets due to movements in financial variables .It is usually associated with leverage with the risk that obligations and liabilities cannot be met with current assets. Another way of decomposing risk is between systematic and
unsystematic components.
Systematic risk
Systematic risk is associated with the overall market or the economy. The systematic risk is non
diversifiable. Parts of systematic risk, however, can be reduced through the risk mitigation and
transferring techniques.
Un systematic risk
Unsystematic risk is linked to a specific asset of firm. While the asset-specific unsystematic risk
can be mitigated in a large diversified portfolio.
1.2.1 RISKS FACED BY FINANCIAL INSTITUTIONS
The risks that banks face can be divided into financial and non-financial ones. Financial risk can
be further partitioned into market risk and credit risk. Non-financial risks, among others, include
operational risk, regulatory risk, and legal risk.
Market Risk
Market risk is the risk originating in instruments and assets traded in well-defined markets.
Market risks can result from macro and micro sources. Systematic market risk result from overall
movement of prices and policies in the economy. The unsystematic market risk arises when the
price of the specific asset or instrument changes due to events linked to the instrument or asset.
Volatility of prices in various markets gives different kinds of market risks. Thus market risk can
be classified as equity price risk, interest rate risk, currency risk, and commodity price risk. As a
result, market risk can occur in both banking and trading books of banks
Interest Rate Risk
Interest Rate Risk is the exposure of a bank’s financial condition to movements in interest rates.
Interest rate risk can arise from different sources. Reprising risk arises due to timing differences
in the maturity and reprising of Assets, liabilities and off-balance sheet items. Even With similar
reprising characteristics, basis risk may arise if the adjustment of rates on assets and liabilities
are not perfectly correlated. Yield curve risk is the uncertainty in income due to changes in the
yield curve. Finally instruments with call and put options can introduce additional Risks.
Credit Risk
Credit Risk is the risk that counterparty will fail to meet its obligations timely and fully in
accordance with the agreed terms. This risk can occur in the banking and trading books of the
bank. In the banking book, loan credit risk Arises when counterparty fails to meet its loan
obligations fully in the stipulated Time. This risk is associated with the quality of assets and the
Probability of default. Due to this risk, there is uncertainty of net-income and market value of
equity arising from non-payment and delayed payment of principal and interest. Similarly,
trading book credit risk arises due to a borrower’s inability or unwillingness to discharge
contractual obligations in trading contracts. This can result in settlement risk when one party to a
deal pays money or delivers assets before receiving its own assets or cash, thereby, exposing it to
potential loss. Settlement risk in financial institutions particularly arises in foreign-exchange
transactions. While a part of the credit risk is diversifiable, it cannot be eliminated completely.
Liquidity Risk
Liquidity Risk arises due to insufficient liquidity for normal operating requirements reducing the
ability of banks to meet its liabilities when it falls due. This risk may result from either
difficulties in obtaining cash at reasonable cost from borrowings (funding or financing liquidity
risk) or sale of assets (asset liquidity risk). One aspect of asset-liability management in the
banking business is to minimize the liquidity risk. While funding risk can be controlled by proper
planning of cash-flow needs and seeking newer sources of funds to finance cash shortfalls, the
asset. Liquidity risk can be mitigated by diversification of assets and setting limits of certain
illiquid products.
Operational Risk
Operational Risk is not a well-defined concept and may arise from human and technical Errors
or accidents. It is the risk of direct or indirect loss resulting from inadequate or failed internal
processes, people, and technology or from external events. While people risk may arise due to
incompetence and fraud, technology risk may result from telecommunications system and
program failure. Process risk may occur due to various reasons including errors in model
Specifications, inaccurate transaction execution, and violating operational control limits. Due to
problems arising from inaccurate processing, record keeping, system failures, compliance with
regulations, etc., there is a possibility that operating costs might be different from what is
expected affecting the net income adversely.
Legal Risk
Legal Risks relate to risks of unenforceability of financial contracts. This relates to statutes,
Legislation and regulations that affect the fulfillment of contracts and transactions. This risk can
be external in nature (like regulations affecting certain kind of business activities) or internal
related to bank’s management or employees (like fraud, violations of laws and regulations, etc.).
Legal risks can be considered as a part of operational risk, Regulatory risk arises from changes in
regulatory framework of the country.
1.3 What Is Risk Management
Introduction
The growth in the volume and complexity of financial markets, specially derivatives markets,
and banking sector over the past few years, risk in banking industry arising from ill-conceived
derivatives transaction, have increased concern over the risk measuring and managing by
derivatives and other complex instruments into the global marketplace. At individual firm’s
level. This poses an increasing threat to their ability to keep control over their exposure to risk in
a diverse environment. At an aggregate level, there have been some fears that default by one firm
could spread out to others in the same country or even cross-borders, and become a financial
crisis of huge proportions. This is a major concern not only for regulators, but also for markets
participants’ altogether.
In this context, risk management has become an essential part of firm and regulators activities. A
risk management system is a valuable instrument for assessing the exposure to risk that
participants in the financial sector in general are subject to. using such system, managers can
measure risk across markets in terms of their potential impact on profit and loss, quantify capital
allocation to market and dealers, establish meaningful risk limits and supervision performance.
Risk system also provides a measure of the amount of capital necessary to provide acushion
against potential future losses, a vital element for the both managers and regulators. The financial
marketplace strength, as a whole, ultimately depends upon individual firm’s ability to cover
unexpected losses with capital reserves. Even firms using the best risk management system are
statistically subject to losses, and then a proper capital cushion is essential. Not surprisingly,
setting capital adequacy standards is at the core of regulators responsibilities, together with
efficient surveillance and supervision of market participants.
1.3.1 Risk Management
Risk Management is a discipline at the core of every financial institution and encompasses all the
activities that affect its risk profile. It involves identification, Measurement, monitoring and
controlling risks ensuring that:
• The individuals who take or manage risks clearly understand it.
• The organization’s Risk exposure is within the limits established by Board of
Directors.
• Risk taking Decisions are in line with the business strategy and objectives
Set by BOD.
• The expected payoffs compensate for the risks taken
• Risk taking decisions are explicit and clear
• Sufficient capital as a buffer is available to take risk
In every financial institution, risk management activities broadly take place simultaneously at
following different hierarchy levels.
A) Strategic level
It encompasses risk management functions performed by senior [management and BOD.
For instance definition of risks, ascertaining institutions risk appetite, formulating
strategy and policies for managing risks and establish adequate systems and controls to
ensure that overall risk remain within acceptable level and the reward compensate for the
risk taken.
B) Macro Level
It encompasses risk management within a business area or across business lines.
Generally the risk management activities performed by middle management or units
devoted to risk reviews fall into this category.
C) Micro Level
It involves ‘On-the-line’ risk management where risks are actually created. This is the
risk management activities performed by individuals who take risk on organization’s
behalf such as front office and loan origination functions. The risk management in those
areas is confined to following operational procedures and guidelines set by management.
Expanding business arenas, deregulation and globalization of financial activities
emergence of new financial products and increased level of competition has necessitated
a need for an effective and structured risk management in financial institutions. A bank’s
ability to measure, monitor, and steer risks comprehensively is becoming a decisive
parameter for its strategic positioning. The risk management framework and
sophistication of the process, and internal controls, used to manage risks, depends on the
nature, size and complexity of institutions activities. Nevertheless, there are some basic
principles that apply to all financial institutions irrespective of their size and complexity
of business and are reflective of the strength of an individual bank's risk management
practices.
1.3.2 Board and senior Management oversight
To be effective, the concern and tone for risk management must start at the top. While the overall
responsibility of risk management rests with the BOD, it is the duty of senior management to
transform strategic direction set by board in the shape of policies and procedures and to institute
an effective hierarchy to execute and implement those policies. To ensure that the policies are
consistent with the risk tolerances of shareholders the same should be approved from board.
1.3.3 Risk Management Framework
A risk management framework encompasses the scope of risks to be managed, the
process/systems and procedures to manage risk and the roles and responsibilities of individuals
involved in risk management. The framework should be comprehensive enough to capture all
risks a bank is exposed to and have flexibility to accommodate any change in business activities.
An effective risk management framework includes
• Clearly defined risk management policies and procedures covering risk
identification, acceptance, measurement, monitoring, reporting and control.
• A well constituted organizational structure defining clearly roles and
responsibilities of individuals involved in risk taking as well as managing it.
Banks, in addition to risk management functions for various risk categories may
institute a setup that supervises overall risk management at the bank. Such a
setup could be in the form of a separate department or bank’s Risk Management
Committee (RMC) could perform such function. The structure should be such
that ensures effective monitoring and control over risks being taken. The
individuals responsible for review function (Risk review, internal audit,
compliance etc) should be independent from risk taking units and report directly
to board or senior management who are also not involved in risk taking.
• There should be an effective management information system that ensures flow
of information from operational level to top management and a system to address
any exceptions observed. There should be an explicit procedure regarding
measures to be taken to address such deviations.
• The framework should have a mechanism to ensure an ongoing review of
systems, policies and procedures for risk management and procedure to adopt
changes.
1.3.4 Integration of Risk Management
Risks must not be viewed and assessed in isolation, not only because a single transaction might
have a number of risks but also one type of risk can trigger other risks. Since interaction of
various risks could result in diminution or increase in risk, the risk management process should
recognize and reflect risk interactions in all business activities as appropriate. While assessing
and managing risk the management should have an overall view of risks the institution is
exposed to. This requires having a structure in place to look at risk interrelationships across the
organization.
1.3.5 Business Line Accountability
In every banking organization there are people who are dedicated to risk management activities,
such as risk review, internal audit etc. It must not be construed that risk management is
something to be performed by a few individuals or a department. Business lines are equally
responsible for the risks they are taking. Because line personnel, more than anyone else,
understand the risks of the business, such a lack of accountability can lead to problems.
1.3.6 Risk Evaluation/Measurement
Until and unless risks are not assessed and measured it will not be possible to control risks.
Further a true assessment of risk gives management a clear view of institution’s standing and
helps in deciding future action plan. To adequately capture institutions risk exposure, risk
measurement should represent aggregate exposure of institution both risk type and business line
and encompass short run as well as long run impact on institution. To the maximum possible
extent institutions should establish systems / models that quantify their risk profile, however, in
some risk categories such as operational risk, quantification is quite difficult and complex.
Wherever it is not possible to quantify risks, qualitative measures should be adopted to capture
those risks. Whilst quantitative measurement systems support effective decision-making, better
measurement does not obviate the need for well-informed, qualitative judgment. Consequently
the importance of staff having relevant knowledge and expertise cannot be undermined. Finally
any risk measurement framework, especially those which employ quantitative techniques/model,
is only as good as its underlying assumptions, the rigor and robustness of its analytical
methodologies, the controls surrounding data inputs and its appropriate application.
1.3.7 Independent Review
One of the most important aspects in risk management philosophy is to make sure that those who
take or accept risk on behalf of the institution are not the ones who measure, monitor and
evaluate the risks. Again the managerial structure and hierarchy of risk review function may vary
across banks depending upon their size and nature of the business, the key is independence. To
be effective the review functions should have sufficient authority, expertise and corporate stature
so that the identification and reporting of their findings could be accomplished without any
hindrance. The findings of their reviews should be reported to business units, Senior
Management and, where appropriate, the Board.
1.3.8 Contingency Planning
Institutions should have a mechanism to identify stress situations ahead of time and plans to deal
with such unusual situations in a timely and effective manner. Stress situations to which this
principle applies include all risks of all types. For instance contingency planning activities include
disaster recovery planning, public relations damage control, litigation strategy, responding to
regulatory criticism etc. Contingency plans should be reviewed regularly to ensure they encompass
reasonably probable events that could impact the organization. Plans should be tested as to the
appropriateness of responses, escalation and communication channels and the impact on other
parts of the institution.
1.4 Statement of Problem
This research is conducted in order to highlight the “Credit Risk Management at NBP”.
1.5 Significance of the Study
This research study would be significant to individual as well organization.
National bank of Pakistan
This thesis would help the individuals who are engaged in the national bank activities as
it include all the policy measures suggested by me for the NBP bank to manage its credit
risk and the way through which it can enhance the quality of thesis asset which in turn
would improve its financial activities well being.
Risk Management Professionals
This research is also significant to financial risk management professional they would
have an appreciation of the risk management policies of Pakistan or positive criticism for
the improvement.
Students
This research work will also help students to enhance their knowledge about the risk
management and corresponding policies of Pakistan
1.6 Scope
• Due to timing constraints only one local bank NBP from whole financial sector is
selected as a sample for analyzing the credit risk management.
• This study will be conducted in urban areas of Karachi only.
1.7 Delimitation
• Regulation and guide lines regarding credit risk management might change in
future.
• Changes in economic condition may prove to be a hurdle in application of these
policies.
• Political instability also my proved to be a hurdle in application of these policies.
•
1.8 Definitions
ATM: Automated Teller Machines
ADP: Asian Development Bank
Bank: Lending and borrowing of money called bank.
Creditor: One to whom money is owned.
Cross-sectional: It means data will be collected once over a period of time
Credit risk: The risk of loss through non-Payment or late payment of money
owed
Export: Things that are sale to other countries
Foreign exchange: Foreign exchange is the relative price of currencies, as
Determined by market supply and demand
Forward contract: future contract of buying /selling of currency for 90,180.etc
days
Import: Things that are buying from other countries
Indemnity: A Compensation for loss
Money lender: A person who give money to borrower.
NBP: National Bank of Pakistan
NIT: National Investment Trust
Non-contrived: Natural environment/reality
Ordinance: Here ordinance means law related to banks
Risk: The variability or volatility of unexpected outcomes
SBP: State Bank of Pakistan.
Safe custody: Security of assets
TFCs : Term finance certificates
IRAF: Institute of risk assessment framework
DFI: Direct foreign investment
SME: Small medium enterprise
SME means an entity, ideally not a public limited company, which does
not employ more than 250 persons (if is manufacturing concern and 50 person (if
it is traded service concern
2.1 Research design
2.1.1 Methodology
“Descriptive study will be under taken”
The reason being for the selection of this method is due to the nature of the data required
considerable amount of secondary data is available regarding policies and guidelines Issued for
credit risk management on websites, magazines, books, and news papers. Primary data will be
collected in order to make certain areas under consideration more clear.
2.1.2 Investigation
“Causal investigation will be conducted”
Type of investigation conducted is causal.
2.1.3 Study setting
“Field study is non-contrived setting”
The research will be conducted in natural environment with no interference from the research.
2.1.4 Unit analysis
National bank of Pakistan is related unit of analysis for the purpose of conducting the
thesis.
2.1.5 Time horizon
“Cross sectional”
Time horizon is cross-sectional as data will be collected once over a period of 4 months.
2.2 Respondents of the study
My immediate respondents will be personal of the NBP.
2.3 Research instruments
2.3.1 Primary date collection
Structured questionnaire, face to face interviews and telephonic interviews will be
conducted from the NBP personal
2.3.2 Secondary data collection
1. NBP website
2. Internet sources
3. Books
4. News papers
5. Magazines
2.4 Treatment of Data
The primary data collected during primary collection phase would only be Analyzed in
verbal context.
2.5 Presentation of analysis
Presentation of the facts will be partially in quantitative form and partially in qualitative
form. The quantitative form will consist of graph, charts tables whereas the qualitative part
of the presentation will have articles. Interviews, details and explanations pertaining to the
quantitative part of the presentation.
3.1 Literature Review
Credit Risk
Credit risk arises from the potential that an obligor is either unwilling to perform on an
obligation or its ability to perform such obligation is impaired resulting in economic loss to the
bank, Since the majority of bank’s earning assets are in the form of loan ,credit risk that is faced
by the banks. When borrowers do not pay the interest on their loans or they do not repay their
loans banks encounter financial difficulties.
With the majority of a bank’s assets in the form of loans, the lending function plays a critical role
in bank risk management the objective of the lending function is simple create value for the
bank. The primary danger in granting credit is the chance that the borrower will not repay the
loan on a timely basis.
Thereby destroying value. Proper and prudent manager of credit risk is the way to create value in
the lending function. Credit risk emanates from a banks dealing with individuals, corporate
financial institutions or a sovereign.
Credit risk arises from the poor loan quality and the problems with loan quality have been the
major cause of bank failure symptoms of poor loan quality include high levels of non performing
Loan’s, loan losses and examines. Classified loans (i.e.) standard, doubtful and loss. A high
proportion of loans relative to total assets and rapid growth of loan portfolio are potential early
warning signals of loan quality problems. This may indicate potential failures. In contrast high
performance banks. Tend to have high quality loan portfolio and characterized by low levels of
nonperforming loan and loan losses.
3.1.2 5C’s of Credit worthiness
1. Character
2. Capacity
3. Capital
4. Condition
5. Collateral
Character
The business character of a borrower rests on such traits as honor, trustworthiness and
commitment. The only good customers are the basically honors ones. The first of C’s is always
character. In the final analysis, it is ultimately the character that determines the credit worthiness
of borrower. How a borrower would respond to a real emergency when all the other C’s have
turned bad is the real test of the character of the borrower this is also the most difficult of credit
analysis, as it is predominantly judgmental. It is therefore, necessary to probe in to the most
important of C’s into greater depth. A good borrower is expected to maintain a code of conduct
relates to the use of funds by the borrower for the purpose for which they were lent.
Capacity
The capacity to honor commitments depends upon the ability of the business to generate cash
flows. Cash flows are often equated with profit after tax, plus depreciation and all other non-cash
expenditure but all the profit may not be available in cash, because a part of it is blocked in
current assests.it is not by profit that one can pay bills or repay loans, but only by cash. A
company may have a level of profit but at the same turn it may technically be insolvent, because
it may not have enough cash to meet its obligations.
Capital
Capital is the net worth of a business and provides that important cushion to with stand shocks
coming from adverse changes in external (economics, financial, legal etc) and internal (strikes,
lockout, breakdown etc) environment of the business, equity or net worth is therefore defined as
risk capital whose operational purpose is to absorb environmental shocks, and financial purpose
is to insulate the outside liability holders form the impact of their shocks.
Condition
As the banker is in the business of dealing with businesses, he should be aware and alert to the
changing economic and financial environment in which his borrowers operate. Almost every
industry suffers from cyclical fluctuations, price fluctuations, obsolescence, and competitive
structure.
Collaterals
The best security of a lender is the thriving business on which the appraisal should focus.
Whenever a bank is required to for close .the collaterals, it demonstrates that the lending decision
in the first place was unsound, the demand for collateral as a condition for a loan is a sufficient
indication that the borrower lacks the required level of credit worthiness. In fact collaterals. ether
as third party guarantees or a real estate mortgage or a pledge of other financial or non-financial
assets are meant to enhance the credit worthiness of the principal borrower .this is being
increasingly used in credit securitization.
The test of good collateral lies in its shift ability which, in other words means salability of assets.
The higher the shift ability is, the better the collaterals.
3.1.3 Managing credit risk
In a bank’s portfolio, losses stem from outright default due to inability or unwillingness of a
customer or counter party to meet commitments in relation to lending, trading, settlement and
other financial transactions. Alternatively losses may result from reduction in portfolio value due
to actual or perceived deterioration in credit quality. Credit risk emanates from a bank’s dealing
with individuals, corporate, financial institutions or a sovereign. For most banks, loans are the
largest and most obvious source of credit risk; however, credit risk could stem from activities
both on and off balance sheet.
In addition to direct accounting loss, credit risk should be viewed in the context of economic
exposures. This encompasses opportunity costs, transaction costs and expenses associated with a
non-performing asset over and above the accounting loss
Credit risk can be further sub-categorized on the basis of reasons of default. For instance the
default could be due to country in which there is exposure or problems in settlement of a
transaction.
Credit risk not necessarily occurs in isolation. The same source that endangers credit risk for the
institution may also expose it to other risk. For instance a bad portfolio may attract liquidity
problem.
3.1.3.1 Components of credit risk management
A typical Credit risk management framework in a financial institution may be broadly
categorized into following main components.
• Board and senior Management’s Oversight
• Organizational structure
Systems and procedures for identification, acceptance, measurement, Monitoring and control
risks.
3.1.3.2 Board and Senior Management’s Oversight
It is the overall responsibility of bank’s Board to approve bank’s credit risk strategy and
significant policies relating to credit risk and its management which should be based on the
bank’s overall business strategy. To keep it current, the overall strategy has to be reviewed by the
board, preferably annually. The responsibilities of the Board with regard to credit risk
management shall, interalia, include:
• Delineate bank’s overall risk tolerance in relation to credit risk
• Ensure that bank’s overall credit risk exposure is maintained at prudent
Levels and consistent with the available capital
• Ensure that top management as well as individuals responsible for credit risk
management possess sound expertise and knowledge to accomplish the risk management function
• Ensure that the bank implements sound fundamental principles that facilitate
the Identification, measurement, monitoring and control of credit risk.
• Ensure that appropriate plans and procedures for credit risk management
Are in place.
3.1.3.3 Organizational Structure
To maintain bank’s overall credit risk exposure within the parameters set by the board of
directors, the importance of a sound risk management structure is second to none. While the
banks may choose different structures, it is important that such structure should be
commensurate with institution’s size, complexity and diversification of its activities. It must
facilitate effective management oversight and proper execution of credit risk management and
control processes.
3.1.3.4 Systems and Procedures
Credit Origination
Banks must operate within a sound and well-defined criteria for new credits as well as the
expansion of existing credits. Credits should be extended within the target markets and lending
strategy of the institution. Before allowing a credit facility, the bank must make an assessment of
risk profile of the customer/transaction. This may include
Credit assessment of the borrower’s industry, and macro economic factors.
The purpose of credit and source of repayment
The track record / repayment history of borrower.
Assess/evaluate the repayment capacity of the borrower.
The Proposed terms and conditions and covenants.
Adequacy and enforceability of collaterals.
Approval from appropriate authority
Limit setting
An important element of credit risk management is to establish exposure limits for single
obligors and group of connected obligors. Institutions are expected to develop their own limit
structure while remaining within the exposure limits set by State Bank of Pakistan. The size of
the limits should be set on the credit strength of the obligor, genuine requirement of credit,
economic conditions and the institution’s risk tolerance. Appropriate limits should be set for
respective products and activities. Institutions may establish limits for a specific industry,
economic sector or geographic regions to avoid concentration risk.
Credit Administration
Ongoing administration of the credit portfolio is an essential part of the credit process. Credit
administration function is basically a back office activity that support and control extension and
maintenance of credit. A typical credit administration unit performs following functions:
a. Documentation
It is the responsibility of credit administration to ensure completeness of documentation (loan
agreements, guarantees, transfer of title of collaterals etc) in accordance with approved terms and
conditions. Outstanding documents should be tracked and followed up to ensure execution and
receipt
b. Credit Disbursement
The credit administration function should ensure that the loan application has proper Approval
before entering facility limits into computer systems. Disbursement should Be affected only
after completion of covenants, and receipt of collateral holdings. In case of exceptions necessary
approval should be obtained from competent authorities.
c. Credit monitoring
After the loan is approved and draw down allowed, the loan should be continuously Watched
over. These include keeping track of borrowers’ compliance with credit terms, identifying
early signs of irregularity, conducting periodic valuation of Collateral and monitoring timely
repayments.
d. Loan Repayment
The obligors should be communicated ahead of time as and when the principal/markup
installment becomes due. Any exceptions such as non-payment or late payment should be tagged
and communicated to the management. Proper records and updates should also be made after
receipt.
e. Maintenance of Credit Files
Institutions should devise procedural guidelines and standards for maintenance of credit files.
The credit files not only include all correspondence with the borrower but should also contain
sufficient information necessary to assess financial health of the borrower and its repayment
performance. It need not mention that information should be filed in organized way so that
external / internal auditors or SBP inspector could review it easily.
f. Collateral and Security Documents
Institutions should ensure that all security documents are kept in a fireproof safe under dual
control. Registers for documents should be maintained to keep track of their movement.
Procedures should also be established to track and review relevant insurance coverage for certain
facilities/collateral. Physical checks on security documents should be conducted on a regular
basis.
3.1.3.5 Measuring credit risk.
The measurement of credit risk is of vital importance in credit risk management. A number of
qualitative and quantitative techniques to measure risk inherent in credit portfolio are evolving.
To start with, banks should establish a credit risk rating framework across all type of credit
activities.
3.1.3.6 Internal Risk Rating
Credit risk rating is summary indicator of a bank’s individual credit exposure. An internal rating
system categorizes all credits into various classes on the basis of underlying credit quality. A
well-structured credit rating framework is an important tool for monitoring and controlling risk
inherent in individual credits as well as in credit portfolios of a bank or a business line. The
importance of internal credit rating framework becomes more eminent due to the fact that
historically major losses to banks stemmed from default in loan portfolios. While a number of
banks already have a system for rating individual credits in addition to the risk categories
prescribed by SBP, all banks are encouraged to devise an internal rating framework. An internal
rating framework would facilitate banks in a number of ways such as
Credit selection
Amount of exposure
Tenure and price of facility
Frequency or intensity of monitoring
Analysis of migration of deteriorating credits and more accurate
Computation of future loan loss provision
Deciding the level of Approving authority of loan.
3.1.3.7 Credit Risk Monitoring & Control
Credit risk monitoring refers to incessant monitoring of individual credits inclusive of Off-
Balance sheet exposures to obligors as well as overall credit portfolio of the bank. Banks need to
enunciate a system that enables them to monitor quality of the credit portfolio on day-to-day
basis and take remedial measures as and when any deterioration occurs. Such a system would
enable a bank to ascertain whether loans are being serviced as per facility terms, the adequacy of
provisions, the overall risk profile is within limits established by management and compliance of
regulatory limits. Establishing an efficient and effective credit monitoring system would help
senior management to monitor the overall quality of the total credit portfolio and its trends.
Consequently the management could fine tune or reassess its credit strategy /policy accordingly
before encountering any major setback. The banks credit policy should explicitly provide
procedural guideline relating to credit risk monitoring. At the minimum it should lay down
procedure relating to
The roles and responsibilities of individuals responsible for credit risk monitoring
The assessment procedures and analysis techniques (for individual loans &
overall portfolio)
The frequency of monitoring
The periodic examination of collaterals and loan covenants
The frequency of site visits
The identification of any deterioration in any loan
3.1.3.8 Risk review
The institutions must establish a mechanism of independent, ongoing assessment of credit risk
management process. All facilities except those managed on a portfolio basis should be subjected
to individual risk review at least once in a year. The results of such review should be properly
documented and reported directly to board, or its subcommittee or senior management without
lending authority. The purpose of such reviews is to assess the credit administration process, the
accuracy of credit rating and overall quality of loan portfolio independent of relationship with the
obligor.
3.1.3.9 Delegation of Authority
Banks are required to establish responsibility for credit sanctions and delegate authority to
approve credits or changes in credit terms. It is the responsibility of banks board to approve the
overall lending authority structure, and explicitly delegate credit sanctioning authority to senior
management and the credit committee. Lending authority assigned to officers should be
commensurate with the experience, ability and personal character. It would be better if
institutions develop risk-based authority structure where lending power is tied to the risk ratings
of the obligor.
3.2 Benefits of managing risk
The new risk measurement and management techniques are associated with, and in some cases
are driving, a number of important changes in financial systems, including
A better appreciation of the types of risk to be considered and of the relationships
among them
Better understanding of the drivers and dynamics of each type of risk and of how
to model and manage risk.
New instruments and markets that support risk transformation and risk shifting
such as securitization and derivative products.
Changes in the industrial organization of financial system:
1. Larger financial institutions can be more efficiently managed, adding
impetus to trends toward greater concentration.
2. New kinds of institutions, such as hedge funds and boutique securitization
sponsors.
3. A blurring of traditional classifications of types of institutions by type of
risk borne, aided by new instruments and by entry into each others
markets.
Greater attention to legal, accounting, regulatory and other “financial
infrastructure”.
The new techniques flourish in environments that support good data and
enforceable contracts.
Changes in the nature and incidence of systematic risk.
Changes in the appropriate structure of regulatory and central bank policy.
3.3 Local Literature
Evolution of banking supervision
The first prudential regulation regarding the corporate/commercial banks was issued in
1992.Since then there have been amendments in these regulations. In 1997 the amendment in
banking law has given autonomy to SBP in the area of banking supervision. In 2003 SBP has
also issued risk management guidelines covering the guidelines for all the risk that a banking
industry can encounter. After 1997 SBP has been playing a major role in managers, supervising
and controlling the activities of banks.
After the privatization of the major bank in Pakistan and with the introduction of corporate
governance in the banking sector the banks themselves have also formulated their own credit
policies to ensure the better management of credit, keeping in view the risk management
guidelines, prudential regulations credit risk management guidelines 2003 and other circulars
issued by SBP from time to time regarding the lending function.
Prudential Regulations
The prudential regulations for corporate and commercial banks include a separate section for the
risk management which includes the regulations regarding the management of credit risk. These
regulations include
1. Limit on exposure (fund based/non Fund based)to a single person
2. Limit on exposure (fund based/Non-fund based) to any group.
3. Limit on exposure against contingent liabilities.
4. Minimum condition for taking any exposure
5. Limit on exposure against unsecured financing facilities.
6. Linkage between financial indicators of the borrower and the total exposure from
financial institutions.
Exposure against shares/TfCs
Classification and provisioning of assets
Monitoring
Margin payment
State Bank Guidelines on Internal Control
This article mainly talks about the internal control of credit risk. It has discussed various
prudential policies and guidelines for the improvement in effectiveness and efficiency of banking
operations. I have taken few paragraphs that were related to the guidelines. They are as follows:
There has been always there in the form policies, plans and processes an affected by the board of
directors and performed on continuous basis by the senior management and all levels of
employees within the banks/DFI.s. In the general internal controls are simply good business
practices, adequate checks and balances and include anything, which serves to safeguard bank’s
assets and improve the effectiveness and efficiency of the operations. the issue of new guide
lines aims at bringing our local practices to the level of the best practices in the developed world
.it is more re-focusing attention to the key areas having strong bearing on the existence,
organizational structure ,growth and profitability of our banks and DFI.s.
A few decades ago almost all banks and DFI.s used to have statement of policies adopted by the
respective boards of directors these policies were periodically amended to met the new
challenges. The purpose was served well for quite sometimes these days the prudential
regulations. Various Risk management guides and the proposed guidelines aim to achieve the
same objectives admittedly the ICs are important for the good governance and improved
performance of the corporate sector as well as the banks and DFI.s and therefore must be
properly complied with.
The supervisory authorities must require the banks and the DFI.s to institute procedures and
practices for recruitment on merit, extensive training, and fair compensation including promotion
to employees at the different tiers of the hierarchy. This should be followed in practices as well.
No amount of the policies and guidelines are going to help much if the employees are not fully
motivated and trained.
In term of the principles regarding management oversight and the control culture. the board of
the directors have responsibility for approving and periodically reviewing the overall business
strategies and significant policies of the banks, setting acceptable levels for these risks approving
the organizational structure, and ensuring that senior management takes the steps necessary to
identify, measure, monitor and control these risks, and ensuring that senior management is
monitoring effectiveness of the internal control system. the board of the directors in ultimately
responsible for ensuring that an adequate and effective system of internal controls is established
and maintained further, the board of the directors and the senior management are responsible for
the promoting high ethical and integrity standards, and for the establishing a culture with in the
organization that emphasizes and demonstrates to all levels of personnel the importance of
internal controls.
The SBP has been doing very well by issuing new guidelines and by amending the existing ones
as per needs of the current situation.
The New Shape of Banking
The following paragraph has been extracted from the article written by Shabbir kazmi It states
that shift to guidelines driven framework will require internal effort by the banks, In addition the
SBP supervision should be Stricter for successful implementation.
There new areas require Expertise, system and procedures, controls, techniques, the banks, have
to strike a balance between prudent lending and the rapid buildup of risky portfolio the Gradual
transition from prudential regulation to a guidelines driven framework would require in house
risk management capacity within the banks and further elimination of weaker banks from the
system.
The banking regulation and supervision are risk based and are fully compliant with prescribed by
the based committee. The risk management practices are being modified to conform to Basel II
rules. The financial soundness indicators show a healthy and sound banking system with high
degree financial stability.
Under the new system the control banks has to follow a cohesive supervisory approach whereby
the findings from on-site inspection periodic reports from the off-site surveillance and market
information will be integrated to produce a comprehensive assessment and composite internal
risk rating of each banking institution. The banks which have low ratings or show high
probability of deterioration is financial soundness will then be taken up for prompt corrective
actions.
Commercial banks: New Challenges Ahead
All the measure taken is for the smooth implementation of Basel II this article also states the
same.
For achieving consolidated supervision, cooperation with other regulatory bodies, both foreign
and local, will be intensified leading to enhanced off-site monitoring and targeted on site
inspections of the cross boarder branches. In the medium to long term a smooth transaction form
Basel I to Basel II and institutionalization of stress testing will strengthen the existing risk
management regime.
Guidelines on risk management BSD circular
The following extract has been taken from the circular of SBP to all banks and DFI.s It
summarizes the fact that all of these measures are taken in order to facilitate the Basel II
implementation in future.
Banks are encouraged to put in place an effective risk management strategy based on the
attached guidelines. These guidelines are flexible in the sense that banks can adopt them in line
with the size and complexity of these businesses. As against the prudential regulations which
need to be fully complied with at all times for every transaction both in letter and sprit the
adoption of these guidelines will also facilitate the banks in their preparation for the
implementation of new Basel capital accord is introduced in Pakistan these guidelines will
converge with the requirement of the accord and will become enforceable regulation. The banks
are, therefore encouraged to take necessary steps for their implementation the banks are also
expected to provide necessary training to their concerned staff in risk management through
institute of bankers or other training institutions/experts having expertise in this area.
IMF World Bank Assessment
Total non-performing loans (NPLs) of commercial banks have maintained their downward trend
this has partly reflected an increase in the amount of gross loans but also has been recently
facilitated by the SBP, write-off guidelines, issued in October 2002, which enabled the banks to
clear stock of old NPLs more aggressively this process is likely to continue in near future, since
banks have any long maintained a practices to keep NPLs on their books indefinitely even after
100% provisioning. Banks have generally been reluctant to write bad loans out of concern that
this would compromise their legal position in pursuing loan recovery.
3.4 Foreign Literature
Federal Reserve Banks of Philadelphia supervision, Regulations and Credit
Informally defined credit culture is the way things get done around in any bank precise definition
of credit .culture is the sum of all the characteristics of an organization unique behavior in its
extension of credit .It not only encompass the tangible written policies and procedures, but also
intangible, such as ideas, traditions, skills, attitudes, philosophies and standards credit culture is
developed overtime, and then communicated and passed on. It is the true sprit behind the rules.
Credit culture is the entical micro piece of the credit risk management process, since an
appropriate credit culture determines not only banks profitability but also its very survival a
sound effective credit risk management in any bank. A bank without a sound credit culture is like
a ship in the dark during a raging storm. When the rocks appears. It is too late to change course,
and certain disaster waits.
3.5 Gap to be a bridged by the study
The first prudential regulations regarding the corporate /commercial bank were issued in
1992.since then there have been amendments in those regulations. In 1997 the amendment in
banking law has given autonomy to SBP in the area of banking supervision. In 2003 SBP has
also issued risk management guidelines covering the guidelines for all the risks that a banking
industry can encounter after 1997 SBP has been playing a major role in managing, supervising
and controlling the activities of banks.
After the deregulation banks have ventured in to consumer finance, house finance, and SMEs which
is undoubtedly a spur for the restoration of economic activity in the country ,but and increased the
credit risk because there are concerns that the banking system does not enjoy the same level of skills,
expertise and loan appraisal systems in there sectors as compared to acceleration in lending to control
and manage the risk SBP has issued risk management guidelines and prudential regulations for
corporate/commercial banks, consumer financing and SMEs and has promulgated new recovery
laws, after all these major steps taken by SBP .the banking system is expected to be strong enough to
respond to unanticipated incidents more effectively now. The success of these measures is visible
from the fact that the heavenly pace of accumulation of Non-Performing loans (NPLs) has been
contained.NPLs of the banking system have come down significantly from what they used to be a
few year back. Moreover, the low interest rate regime has also reduced significantly the burden on
debt repayment capacity of borrowers, this coupled with the substantial increase in liquidity and
profitability of the corporate sector as well as rising income levels have reduced the chances of large
scale loan defaults, as witnessed in the past. this report main emphasis would be on the guidelines as
the new guiding and supervisory tool for the new era of economy in our country As nothing has been
done in this aspect of banking, there is no gap to be abridged by this study As a matter of fact, these
guidelines were issued for the first time in Pakistan before policies and prudential regulations were
issued that banks were bound to follow. It is first of its kind .It is a transitions from prudential
regulations to a guideline driven framework. not only this, the adoption of these guidelines will also
facilitate the banks in the preparation for the implementation of Basel II is introduced in Pakistan
.These guidelines will converge with the requirement of the Accord and will become enforceable
regulation. The study will try to conclude that the new guidelines are feasible and flexible
enough for our banking sector and that there is no such hesitation or difficulties in adopting it. In
addition, the efforts made by the banks in successful implementation of these guidelines. If there
were any hesitation in the adoption, what were the reasons? To make these aspects NBP will be
analyzed as the sample.
3.6 Areas for further studies
During the research process, as banks have undertaken the diversification of assets, embarked on
to new areas of banking (i-e) consumer financing,SMEs and etc .Limited guidelines are present
in ways of conducting the business thus SBP can take initiatives in facilitating these areas of
banks .Moreover, the guideline describes general way of mitigating risks Its is deficient in the
specifications in how to cater for individual type of banking activity .After my research I have
come to know that vast Study (development of detailed guidelines) could be undertaken on these
topic individually so as to enhance the banking sector of ours and bring it to the international
standards.
4.1 Quantitative Analysis of Credit Risk Management at
NBP
What are the board and senior management oversight/strategy and
significant policies Related to credit risk and its management?
Boards of Directors are responsible for approving and reviewing NBP Risk
Management Strategy and policy whereas senior management responsible for
Implementing approved policies considering risk factor at minimum level
How are the policies embedded in the culture of the organization?
It is the responsibility of each & every individual to follow and implement
Policies Starting from BOD, senior Management, Middle management and
Bottom line Managers.
What are your credit strategy and your preferred level of diversification
Concentration in each lending segments?
NBP level of diversification concentration in each lending segments totally
Depend on the movement of industries.
How often is it reviewed?
NBP reviewed its credit strategies at least once throughout the year
What is your banks overall risk tolerance in relation to credit risk?
NBP risk tolerance in relation to credit risk depend on various sectors ie
Industrial Breakup, per party/per Group exposure, top borrowers including
PSE& others and top group etc.
How do you monitor the compliance of credit limit set by the board and how
often it is reviewed?
NBP Credit monitoring function is monitoring the credit limit set by the board
and it is reviewed on every quarter.
Does your organization structure help in credit risk management?
Choices Responses
Yes 95%
No 5%
Organization structure help in credit risk management 5%
Yes
No
Yes NBP structure help in credit Risk management
How do you delegate the credit approving power?
NBP use Bank Discretionary process for delegation of credit approvals
Is your credit organization functions separate from other activities e.g.
Monitoring and Controlling?
Choices Responses
Yes 90%
No 10%
Credit organization function
Separate from other activities
Yes
No
Yes bank credit organization function separate from other activities
At the time of credit origination what factors NBP taken in considered and
evaluated With respect to old and new clients?
There are different factors which include credit history of the client,
Industry analysis, security analysis, PR compliance, Risk rating (external as
well as internal).
Is your credit administration function effective?
Choices Responses
Yes 80%
No 20%
Credit Administration function
effectiveness
20%
Yes
No
80%
Yes NBP credit administration function is effective .
How do you measure creditworthiness of your customer?
CIB Report from SBP and Credit Worthiness report from other banks reflecting
past histories are helpful which considering credit worthiness. Furthermore
cash flow Analysis & ratio analysis must be considered.
Reputation of clients often influences the credit worthiness? Does it lead to
Name Lending?
Choices Responses
Yes 5%
No 95%
Reputaion of Cllients often
influence the Credit Worthiness
5%
Yes
No
NO In NBP lending on Names are restricted.
How often do you monitor and report loan portfolio?
Loan portfolio is monitor & repotted at the end of every Quarter.
What is your strategy/action plans to deal with problems of loan?
Every loan must have its contingency planning for e.g. continuously follow up on
The client, sending of legal notices, restricting of limit, security perfection
Analysis etc
What techniques do you is employing measuring credit risk?
NBP measure risk Through Industry analysis, security analysis, financial analysis,
Policies (Internal), SBP PR-complience, credit worthiness etc.
What is your organization internal credit risk rating and how often
is reviewed?
NBP has its own internal credit risk rating for corporate /commercial clients and
on every quarter it is reviewed.
How is credit risk monitored and controlled?
Credit monitoring unit with the Help of Business Unit Perform this task at NBP
Do you have credit risk management department, what are to functions?
Choices Responses
Yes 100
No 0%
Seperate Crdit Risk Managmenet
Department
Yes
No
100%
Yes NBP have credit risk management department at individual as well as at enterprise
level. At enterprise level credit Policies are formulated along with credit rating tool
(internal). Furthermore credit review is also done randomly on the credit portfolio for
making recommendations of credit quality etc.
Does your organization have risk management committee? What do they
do?
Choices Responses
Yes 98%
No 2%
Risk Management Committee
2%
Ye s
NO
98%
Yes NBP has risk management committee that is responsible for reviewing and
approving risk management frame work including prudential policies and
methodologies, credit, market, operational risk & control.
Is you reviewing of Risk management independent?
Choices Responses
Yes 90%
No 10%
Review of Risk Management
Independent
10%
Yes
NO
Yes NBP review Risk management department independent looking after credit, market, and operational risk along with Basel II compliance.
Are you following SBP risk management guidelines for commercial banks
And DFI 2003 or institution Risk Assessment form work?
Choices Responses
Yes 80%
No 20%
Follow SBP Risk Management
guidelines
20%
Yes
No
80%
Yes NBP follow SBP Guidelines for Risk Assessment.
Are SBP guidelines computable and flexible with you organization
and economic and Political environment of Pakistan?
Choices Responses
Yes 60%
No 40%
SBP guideline flexible and computable
40%
Yes
No 60%
Yes SBP Guidelines flexible and computable with NBP.
Expanding business arenas, deregulation and globalization of financial
activities Emergencies of new financial products and increased level of
competition has necessities a need for an effective and structured risk
management in financial Institution is your system capable of handling
in credit risk how?
Choices Responses
Yes 95%
No 5%
NBP system is capable for Risk
handling
5%
Yes
NO
As far as NBP is Concerned it has its own and intact internal policies which are formulated & implemented on every level on Continuous basis therefore it has strong capability to face any competition.
Has the guidelines help in bridging the gap between the acceleration in
banking activity and skill and expertise required by banks for Appraisal?
Choices Responses
Yes 85%
No 15%
Guidelines help in bridging the Gap between the acceleration in banking activity
and skill and expertise required by bank for Appraisal
15%
Yes
No
85%
Yes SBP guidelines helping bridging the gap between the acceleration in banking activity and skill and expertise required by banks for Appraisal.
Are these guidelines help in the implementation of Basel ll?
Choices Responses
Yes 90%
No 10%
SBP Guidelines Help in implemetation
of basel II
10%
Ye s
No
90%
Yes SBP Guidelines help in implementation of Basel II
4.2 Qualitative analysis of credit risk management at NBP
In a short span of time NBP has transformed in to leading market player. The strength lies in
offering customer –oriented solutions that are backed by a liquid balance sheet. This can be
attributed to the successful strategic and operational repositioning of the bank by management
confronted with the dual challenges of appreciably lower spreads and intense competition the
past result depict the success of the bank’s restoring initiatives that were aimed at streamling of
domestic operations and empowerment of the field to facilitate decision-making, teamwork and
communication NBP is better Positioned to pursue their drive for diversification of revenue base
to preserve their margins and ensure optimum returns for stake holders. These results have been
possible due to the commitment and dedication of their staff. The other main contributing factor
behind the success of NBP is the implementation and continuous monitoring of these guidelines
issued by SBP and risk management framework.
NBP management continually strive to adopt the best corporate governance practices to
safeguard the interest of depositors, customers and shareholders. Thus implementation of SBP
credit risk management guidelines for commercial banks and DFI.s is not a surprise like any
other financial institutions. NBP risk management activity broadly takes place simultaneously at
following different hierarch levels.
1. Strategic level
2. Macro level
3. Micro level:
At NBP the board is fully aware of its responsibilities established by the code of corporate
Governance issued by the securities and exchange commission of Pakistan (SECP).The board
has approved the vision,mission,core values, objectives and NBP strategic Plan 2003-2007
The senior management has transformed strategic direction set by board in the shape of policies
and procedures and established an effective hierarchy to execute and implement these policies.
To ensure that the policies are consistent with the risk tolerance of shareholders. The same
should be approved from board. The bank has a comprehensive framework of written policies
and procedures on all major areas of operations such as credit, treasury operations, finance,
Internal audit and compliance approved by the board and is constantly reviewed.
They also ensure that the credit risk remains within the limit set by the senior management .To
make sure that the risk tolerance is efficient the bank has effective budgeting system in place
annual budget of the bank is approved by the board and monthly comparison of actual results
with the budget are prepared and reviewed by the senior management and corrective actions are
taken when necessary. This not only acts as providing direction to the employees but serve to
monitor and control the performance of the bank. This way no outside regulatory authorities is
required instead everything is managed internally and independently. Moreover the preferred
segment of lending and level varies with requirement of the client and bank policies but like all
other financial institutions NBP prefers to lend for short term. This is so because short term loans
are less prone to credit risk. The essence of its efficiency lies with clear communication of these
policies down the line it is the responsibility of senior management to ensure effective
implementation of these policies.
The human resource development at NBP has also played a vital role in its outstanding
performance .the ongoing transformation of the bank would not have Yield the desired result
unless it was complemented by a comprehensive training program aimed at inculcating a
customer focus approach which developing core competencies now each individual in the bank
is competent to handle any situation at his sphere of influence in addition to the regular training
program at the regional staff colleges ,several initiated were undertaken to better orient the bank
staff with the recently promulgated state bank prudential regulation and guidelines the retail
banking products launched by the bank as well new trends in risk management and derivative
instruments.
The importance of organizational structure is not ignored at NBP .The bank has clearly defined
organizational structure which support clear line of communication and reporting relationship
there exist a properly defined financial and administrative power of various committees and key
management personnel, which supports delegations of authority and accountability. In addition
the limit of the authority of various management levels. All the powers were exercised by the
relevant authorities with in the materiality thresholds.
One more attribute of NBP success lies with the implementation of comprehensive information
technology system .NBP has under gone a paradigm shift by synchronizing the adaptation of
technology with product development as it is a tool for optimizing customer satisfaction round
the clock payment of utility bills in important cities is now in place and branches covering 80%
of the bank’s business will soon be fully automated on a real time basis while the ‘one-link”
ATM switch sharing arrangement will serve to enhances the 24 hour banking facility available to
customers, NBP is expanding its owned ATM base as well.
The growing portfolio of products and services has reinforced the need for a proactive and
effective risk management operation. NBP has made great strides in strengthening. This area as a
comprehensive risk management manual was developed in line with the regulatory guidelines.
The manual ensures timely and accurate identification of bank’s exposure and serve to control
and mitigate the various risks. The system of internal control is sound design and has been
effectively implemented and monitored throughout the year the board is responsible for
establishing and maintaining the system of internal control in the bank and for its ongoing
monitoring. However such as a system is designed to manage rather than eliminate the risk of
failure to achieve objectives and provide reasonable but not absolute assurance against material
misstatements or loss. The process used by the board to review the efficiency and effectiveness
of the system of internal control includes the following.
The board has formed an audit committee comprising of three non-executive directors the audit
committee has written the audit committee has written terms of reference in the firm, of a charter
(deed), which has been approved by the board of Directors. The committee is responsible for the
oversight of the internal audit function and reviews its approach and methodology from time to
time. It also receives and reviews the internal and external audit reports to the internal control
account and related matters. The committee on a continuous basis reviews the material control
weaknesses and areas of concern and actions are taken by executive management to address
these issues.
The board has setup an effective internal audit function. All the branches, regins and groups are
subject to audit .All the internal audit reports are accessible to the audit committee and important
pints rising out of audit are reviewed by the audit committee and important points requiring
board’s attention are brought into their notice. Internal audit department of the bank conducts the
audit of all branches, region and groups at head office level on ongoing basis to evaluate the
efficiency and effectiveness of internal control system and proper follow up of irregularities and
control weaknesses is carried out. The board received confirmations/representatives from all
group and regional heads on annual basis confirming effectiveness of the internal control system
established and maintained by them within their function.
Moving further observing the performance of NBP one can conclude that its system and
procedures for conducting the business is full intact for effective credit risk management system
plays a vital role. It helps in identification, acceptance, measurement, monitoring and controlling
risk. At NBP the system and personnel organize themselves in a manner that the risk is identified
at the earliest stage possible. this is done through various ways such as credit assessment of the
borrowers industry, and macroeconomic factor, the purpose of credit and source of settlement,
repayment, history of borrowers and proper valuation of collateral in addition the measurement
and acceptance is guided by the authority given by the given management then the credit limit is
reviewed to keep it current with the dynamic environment of today’s banking. Lastly the
monitoring and controlling of risk is independent of all the other departments, It is performed by
the credit risk department moving further the internal control system of audit committee also
plays a vital role in the monitoring of the elements that might negatively affect the bank’s credit
risk exposure.
5.1 Findings
At the start of the project it seemed that the study I have undertaken will not reap fruits as
I expected because any official paper that is brought about in Pakistan are fanaticized in
the paper but never get implemented. Similar was the case was with the guidelines
unintentionally at the back of my mind I had conducted that hypotheses will never be
proven correct.
As time went by and I got more engrossed in the study the information uncovered to me
was unanticipated .the interviews, questionnaire and the analysis of the financial
performance of the bank revealed the changes that have taken place not only in the paper
but is sprit as well. The main finding:
The guidelines are the transition form prudential regulation to guideline driven
framework for risk management.
It is flexible enough be customized according to the need and size of the
respective bank.
Looking at the performance and interviewing the personnel of regulatory
authority and bank representatives it can be concluded that guidelines are flexible
and efficient for the local efficient for the local banking industry
During the literature review the SBP’s guidelines were also compared with
guidelines of other developing countries. As a result the guidelines are fully
applicable in Pakistan because other countries are also practicing it and are termed
as the combination of the best practice in industry.
Local commercial banks are fully complying with the guidelines with necessary
modification as per requirement of their banks and are happy with the result
.they have achieved so far as a result of its implementation.
The banks are taken to implement any further guidelines issued by SBP that will
result in the betterment of the bank and as a whole of banking industry. The main
Upcoming guideline seems to be in the form of Basel II which will be enforced in
due course.
5.2 Conclusion
The topic of my project is “Credit Risk management at NBP” following SBP credit risk
management guidelines in their credit risk management department”. In the starting I mentioned
the reason Why I Chose this topic and it is the real need of time that NBP understand their
operations and activities in well manners and adopt outstanding policies for handling different
problems and contribute in the economy of the country, at the same time SBP playing its role by
coming up with efficient and practical guiding principal for the banking sector.
For the project the research was designed in a manner that fulfills the requirement of the study
and does justice to the cause. In other words while designing the research I considered that it
should serve the cause properly and shall be in line with the purpose of the study. The purpose of
the study is “descriptive” in nature, as it aimed to collect more appropriate information about
implementation of SBP’s credit risk management guidelines at NBP bank. In addition the
performance of NBP was analyzed with respect to guidelines.
The method of conducting this research was based on primary as well as secondary data.
Structured Questionnaire, face to face interviews were held with different representatives of
bank. I have also adopted the secondary data approach for that I went through the news papers,
internets, book, magazines, annual reports of NBP Then SBP library was also considered.
For the project I selected NBP the reason being that I wanted to see whether the guidelines are
practical and implemented in both private and public sector .In the preceding chapter, I have
discussed what credit risk is? What exactly the guidelines is about and how does it helping
mitigating the credit risks that banks are exposed to During the literature review I also found out
that the guidelines are similar in nature with other developing countries guidelines with affcourse
due modification according to their environment. In addition the experts are completely satisfied
with the guidelines. They believe that it is a step towards institutionalization of the internal
control which in turn will render them to excel and achieve the international standards.
Moving into the practical aspect of the project looking at the annual report and concluding the
performance of the bank clearly reveals that the guidelines are efficient and viable for our
country according to the political and economic environment .one must not be mistaken that all
of the practices and improvement in banking sector was brought about after the guidelines were
issued but the tremendous turnaround is addressing the issue pertaining to credit risk is only
credited to the new guidelines. Although the practices in the bank previously were in place and
different regulations were passed but never made am impact as comparable to this besides no
such guidelines were in past.
After analyzing the whole project I evaluated that as the country moved towards a more open,
liberal and sophisticated financial structure, The authorities in the light of experience of other
countries realized the importance of a strong regulatory guideline framework to sustain the
confidence of savers and ensures the healthy development of banks moreover the bank is even
cooperative in adopting these principles. The banker believe that if the guidelines are in footsteps
of Basel II then there should not be problem in practicing it once it is enforced as the regulation.
In the end of project I found out important finding from the whole study and I also given the
recommendation for the betterment and improving the performance of the bank. I hope that all
the findings and recommendations are of great help for the readers of this project and enhance
their knowledge in the sphere.
The new financial environment where in there is intense competition between a large number of
institutions in the content of greater integration with global economy has to be accompanied by
the new volatility in the risk and nature of funds base. It is the low cost producer and mitigating
risk expense that will be able to meet the challenge and capitalize on the opportunities managing
risk in it will be key determinants of how successful a bank can respond to market needs.
5.3 Recommendations
SBP should make aggressive policies for NBP so as to match the International standards
around the world.
SBP should continue to focus on the Economic condition of the country.
SBP should make separate supervisory department for Commercial Banks.
SBP should protect bank from unnecessary regulatory risk.
As NBP have expanded its business arena SBP should provide related and
appropriate guidelines.
NBP should eliminating unnecessary management and other layers; it helps
the bank in reducing cost and effective communication.
NBP should have excellent employees with necessary skill for the smooth and
control of operations.
Job rotation of employees should take place in different departments so that
they have knowledge of the whole organization.
Proper training should be provided so that the employees are better equipped
to handle the credit management and sharpen their analytical skill.
Bank should employ excellent accounts software for the accuracy.
The banks should employ cutting edge technology because this is the only
source of meeting the ever rising demand of the customers and survive in the
competition market.
APPENDIX
BIBLIOGRAPHY
BOOKS
Deservinging & Renault
Measuring and Managing credit Risk
Hrishikes Bhattacharia Credit Risk Analysis
ANNUAL STATEMENT
NBP
JOURNALS
Journal of the institute of Banks Pakistan
MAGIZIES
Pakistan and gulf Economist
State Bank Guidelines On Internal Control (By Muhammad Bashir Chaudry)
The New Shape of Banking
Commercial banks: New Challenges Ahead (By: Shabbir H.Kazmi)
IMF World Bank Assessment (Recorder report Islamabad)
INTERNET
www.google.com www.askjeeves.com
www.paksearch.com www.sbp.org.pk
www.nbp.com.pk
Government college university Faisalabad(Sub-campus Sahiwal) Pakpattan Road, Sahiwal, Phone:(040) 4400088
June 31, 2017
National Bank of Pakistan (NBP)
City Branch sahiwal
Dear Ma’am/Sir:
I am the student Government collage university Faisalabad (Sub-campus
Sahiwal)requesting permission to conduct an interview. This is a good Opportunity to have an interview with you to know more about how
People Behave and credit risk management
In line with this, we are asking for your permission to conduct a short
interview on at your most convenient time.
Thank you so much for considering this request
Sincerely,
Azhar Hussain 15351
Received By:________________
Date:_______________
Government college university Faisalabad(sub-campus Sahiwal) Pakpattan Road, Sahiwal, Phone:(040) 4400088
June 29, 2017
National Bank of Pakistan (NBP)
Freed Town Branch Sahiwal
Dear Ma’am/Sir:
I am the student Government collage university Faisalabad (Sub-campus Sahiwal)requesting permission to conduct an interview. This is a good
Opportunity to have an interview with you to know more about how People Behave and credit risk management
In line with this, we are asking for your permission to conduct a short
interview on at your most convenient time.
Thank you so much for considering this request
Sincerely,
Azhar Hussain 15351
Received By:________________
Date:_______________
QUESTIONNAIRE
This study is being conducted as part of the requirements for the award of a Commonwealth
Blucher in Business Administration Degree by the GCUF Sub campus Sahiwal
The research topic is “Credit risk management A Case Study of national Bank Pakistan,
Punjab Zone”
The information you provide will therefore be used for academic purposes only and will be
Treated with confidentiality. Please answer the questions which are stated below
• Name ……………………………………………….. • Age ………………………………………………. • Name of Branch ………………………………………………………….
• What is your designation at NBP? ………………………………….
3. How many years have you been working at NBP ?.....................................
• Please state your core duties at NBP ………………………………………
No Question Yes No
1 Does your organization structure help in credit risk management?
2 Is your credit organization functions separate from other
activities e.g. Monitoring and Controlling?
3 Is your credit administration function effective?
4 Reputation of clients often influences the credit worthiness? Does it
lead to Name Lending?
5 Do you have credit risk management department, what are to
functions?
6 Does your organization have risk management committee? What
do they do?
7 Is you reviewing of Risk management independent?
8 Are you following SBP risk management guidelines for commercial
banks And DFI 2003 or institution Risk Assessment form work?
9 Are SBP guidelines computable and flexible with you organization and economic and Political environment of Pakistan?
10 Expanding business arenas, deregulation and globalization of
financial activities Emergencies of new financial products and
increased level of competition has necessities a need for an effective
and structured risk management in financial Institution is your
system capable of handling in credit risk how?
11 Has the guidelines help in bridging the gap between the acceleration in
banking activity and skill and expertise required by banks for
Appraisal?
12 Are these guidelines help in the implementation of Basel ll?
13
14
Question for interview What are the board and senior management oversight/strategy and
significant policies Related to credit risk and its management?
How are the policies embedded in the culture of the organization?
What are your credit strategy and your preferred level of diversification
Concentration in each lending segments?
How often is it reviewed?
What is your banks overall risk tolerance in relation to credit risk?
How do you monitor the compliance of credit limit set by the board and how
often it is reviewed?
How do you delegate the credit approving power? At the time of credit origination what factors NBP taken in considered and
evaluated With respect to old and new clients?
How do you measure creditworthiness of your customer?
How often do you monitor and report loan portfolio?
What is your strategy/action plans to deal with problems of loan?
What techniques do you is employing measuring credit risk?
What is your organization internal credit risk rating and how often
is reviewed?
How is credit risk monitored and controlled?