Activities of Credit Operations in Banks!

Activities of Credit Operations in Banks!

Activities of Credit Operations in Banks!

 

Introduction:

A bank usually has procedural guidelines indicating list and sequence of several activities associated with its credit operations. The procedural guideline is prepared in the light of Credit Risk Manual introduced by Bangladesh Bank. However, bank’s own credit policy, vision, mission as well as guidelines and policies given by Bangladesh Bank from time to time are also reflected in procedural guidelines. The activities of credit operations start with discussion between bank and client and end with adjustment and/or recovery of loan. Credit operations in banks may be centralized or decentralized. However, the overall activities of the credit operations of a bank are outlined in the figure-4.1

bluehostBorrower Selection:

Each year Head Office prepares a credit budget indicating the amount of credit to be sanctioned and disbursed in different areas, categories, products and sectors. Credit committee/CRM is entrusted to sanction and disburse the budgeted amount prudently. Generally, there is a credit committee /CRM head office of each bank which reviews every aspect of a loan proposal to be considered in approving and sanctioning loan. Relationship Management (RM) acts as a primary bank contact with a borrower. At first, the banker and the customer discuss with each other about the credit facilities offered by the bank and required by the customer. Through discussion, RM is to ensure that proposed credit is from expected business segment/sector and for permissible and expected credit facility. He also ensures that there is a scope of lending to the client. After a successful discussion, customer is to apply for credit in a prescribed format provided by the bank. After receiving loan application from the prospective borrower, RM scrutinizes the submitted information and collects all other required information from different parties including Credit Information Bureau (CIB) report. Only sanctioning a credit will not serve the purpose of the bank. It is only good credit that will serve the purpose of the bank. It is even better not to sanction any credit rather than sanctioning a bad credit. Selection of good borrower is the starting point of the process of creation of good credit. Before sanctioning credit, a banker wants to be sure about the repayment. For ensuring loan repayment a bank can go for preventing measure or curative measure or both. But curative measures are always costlier than preventive measures in terms of both time and money. So credit investigation as a preventive measure is required for selection of good borrower. Credit investigation and selection of good borrower may substantially help a bank in the recovery of extended credit.

Preparation of Credit Proposal :

The quality of a loan proposal is a key factor in achieving the results for a business. It can make the difference between a ‘yes’ and a ‘no’ to a loan application. An effective loan proposal should be prepared such that it is a proxy for a credit submission within the financial institution. It should deliver a good understanding of the business or group, and satisfactorily address all credit risks. The structure should contain purpose of the credit, background of the business, details of the existing and proposed facilities and securities, ownership structure, management, overview of the business/project, financial analysis, debt service/repayment/security and summary & recommendations can be applied to most loan proposals. However, depending on the situation, it may be appropriate to change the order in which things flow or add sections to address issues specific to the business. The objective when writing content under each heading is to progressively build a brief well[1]argued financing case through critical assessment of the business and/or the transaction. “What?”, “Why?” and “How?” are the questions one should be constantly asking himself during this process. Apart from giving business the best chance of getting a ‘yes’, a good loan proposal can significantly shorten turnaround time and limit the number of extended piecemeal requests for information. The effort in putting together a well-thought out proposal is minimal compared to the benefits to all parties involved.

 

Credit Appraisal :

For selecting the right type of borrower and business, credit appraisal is a must. For this purpose, RM is to conduct appraisal of managerial, organizational, marketing, technical, socio-economic and environmental aspects. Besides, the bank assesses the credit worthiness and risk profile of the borrower. By and large, this assessment covers loan proposition and purpose, borrower analysis, industry analysis, supplier/buyer analysis, historical financial analysis, projected financial performance analysis, etc. Security offered by the customer against the proposed loan should also be considered for credit decision. Moreover, bank should grade the borrower by completing Credit Risk Grading Score Sheet (CRGS). In case of large loan, banks refer to External Credit Assessment Institution (ECAI) for credit rating according to the direction of Basel-II. The assessments are mostly done based on the information collected from the borrower. Besides, market reports, study of accounts, financial statements, on line CIB and personal interview are also worked as source of inputs for decision making. In case of corporate credits where the borrower is a group of companies, banks conduct credit assessment on a consolidated or group basis known as ‘Obligor’. In case of loan syndication, besides the lead bank, all participatory banks also perform their own independent assessment, analysis and review of terms of the syndicate loan. On the basis of appraisal, RM recommends the application for approval to the appropriate authority mentioning amount and type of loan proposed, purpose of loan, loan structure, security arrangement, etc.

Internal Credit Risk Rating System (ICRRS) :

Internal Credit Risk Rating System refers to the system to analyze a borrower’s repayment ability based on information about a customer’s financial condition including their liquidity, cash flow, profitability, debt profile, market indicators, industry and operational background, management capabilities, and other indicators. The summary indicator derived from the system will be called Internal Credit Risk Rating (ICRR) – a key reference for credit risk assessment and decision making. Internal Credit Risk Rating System will be an integral part of credit risk management for the banks. The key uses of these guidelines are as follows:

  1. a) To provide a granular, objective, transparent, consistent framework for the measurement and assessment of borrowers’ credit risk.
  2. b) To facilitate the portfolio management activities
  3. c) To assess the quality of individual borrower to help the banks to determine the quality of the credit portfolio, line of business, the branch or the Bank as a whole.
  4. d) To be used for individual credit selection, credit pricing, and setting credit limit and terms and conditions.

The core functions of Internal Credit Risk Rating System are:

  1. a) Internal Credit Risk Rating System is a fully automated credit risk scoring system that calibrates the characteristics of different sectors and industries in one single model;
  2. b) To get the appropriate rating and score, the analyst shall select the appropriate sector or industry from the dropdown list given in the top page of the template; If the right sector or industry is not selected; the rating will not reflect the unique characteristics of the particular sector or industry.
  3. c) If the borrower is in multiple lines of business, the sector should be used assessing the line of business generating the highest portion of the revenue &/or profit. If there is no particular line of businesses can be singled out- the ICRRS should be conducted using “other industry- if manufacturing” or “other service-if service”.

 

Credit Approval:

The authority to sanction/approve loans is clearly delegated to senior credit executives by the Managing Director (MD)/Chief Executive Officer (CEO) and Board of Directors (BOD). Approval authority is required to be delegated to individual executives based on the executives’ knowledge and experiences. The recommending/ approving executives should take responsibility for and be held accountable for their recommendation/ approval. Delegated authority including capacity of approval must be reviewed annually and the pooling or combining of authority limits of different executives should not be permitted. Considering the size and strategy of the bank, approval function is centralized in some banks. However, approval functions are generally decentralized in zonal, divisional, and branch level. In case of centralized system, irrespective of amount, there is an approval authority in the head office level. In case of decentralized system, for example, delegation of approval limits may be such that all proposals where the facilities are up to 15% of the bank’s capital should be approved at the CRM level, facilities up to 25% of capital may be approved by CEO/MD, facilities in excess of 25% of capital to be approved by the Executive Committee (EC)/Board only after recommendation of CRM and MD/CEO according to the CRM guideline. Before approval, the Head of CRM forward the loan proposal to Risk management unit (RMU) for their observation regarding risk. After getting observations from RMU, the Head of CRM processes the proposal for approval. After following all the due process, approval authority may approve or decline the recommended proposal.

 

Credit Administration:

Getting the approval for the loan proposal, Relationship Manager (RM) makes two copies of the proposal and sends one copy to RMU and the other to Credit Administration & Management (CAM) for documentation. Then, CAM issues sanction /offer letter to the customer through RM. Customer should agree with the terms and conditions incorporated in the offer letter. Subsequently, RM completes the Loan Documentation Check List (LDCL) and forwards the acceptance to CAM. A typical CAM performs the activities relating to disbursement, custodian, monitoring and compliance. Main responsibilities of CAM are: ensuring that all security documentations comply with the terms of approval and are enforceable, examining insurance coverage to ensure appropriate coverage in place over assets pledged as collateral, and is properly assigned to the bank, disbursing loan only after all terms and conditions of approval have been met, and all security documentations are in place; maintaining control over all security documentations and monitoring borrower’s compliance with covenants and agreed terms and conditions. After ensuring full compliance, CAM takes necessary steps for disbursement of the loan amount. After disbursement, RM regularly follows-up the credit. Monitoring unit under CAM alongside of zonal office monitors credit based on due-date-diary. Identification of early alert account and reporting the same to CRM are responsibility of RM. Through close monitoring, the quality of early alert account may improve but conversion of this account to regular account status is under the discretion of CRM. As per credit policy, RM is to classify the accounts and maintain required provisions.

Credit Recovery:

There is a separate Recovery Unit (RU) in each bank as per CRM manual. This unit should directly manage accounts with continuous deterioration. Its primary responsibilities are to determine recovery strategy, pursue all options to maximize recovery, ensure adequate and timely loan loss provisioning, etc. The management of Non-Performing Loan (NPL) must be a dynamic process, and the associated strategy together with the adequacy of provisions should be reviewed regularly. All NPLs should be assigned to an account manager within the RU, who is responsible for coordinating and administering the action plan and should serve as the primary customer contact after the account is downgraded to substandard or worse. Account manager should review all documents, meet the customer and prepare a Classified Loan Review Report (CLR). The head of credit should approve the CLR for NPLs up to certain percentage (say 15%) of the bank’s capital, and excess of that should be approved by MD/CEO according to CRM guideline. As per CRM guideline, the CLR’s for NPLs above certain percentage (say 25%) of capital should be approved by the MD/CEO, with a copy received by the Board. Bank may wish to introduce incentive program to encourage RU to bring down the NPLs. RU should take legal action against the defaulted borrower as a last resort to recovery the credit.

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