ADMAS UNIVERSITY COLLEGE

DEPARTMENT OF ACCOUNTING

PRACTICES OF CREDIT RISK

MANAGEMENT IN BANK INSTITUTIONS:
CASE OF COMMERCIAL BANK OF
ETHIOPIA, SHIRE BRANCH.

PREPARED BY: MASHO TESFAY BISET

ADVISOR:

MARCH, 2025 G.C

SHIRE, TIGRAY
 ADMAS UNIVERSITY COLLEGE
DEPARTMENT OF ACCOUNTING

A RESEARCH FOR THE PARTIAL

FULLFILMENT OF A BACHELOR OF ARTS
DEGREE IN ACCOUNTING

PRACTICES OF CREDIT RISK MANAGEMENT IN

BANK INSTITUTIONS: CASE OF COMMERCIAL
BANK OF ETHIOPIA, SHIRE BRANCH.

PREPARED BY: MASHO TESFAY BISET

ID No:

APPROVED BY:
1. ADVISOR ________________________ SIGN ___________
2. EXAMINER ________________________ SIGN ___________

MARCH, 2025 G.C

SHIRE, TIGRAY

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Acknowledgment

Firstly, I am indebted to the Almighty God with whose grace; I could

satisfactorily complete my research paper.

Then, I am deeply grateful to my advisor for his professional suggestions,

guidance for the research paper, that without his assistance, successful
accomplishment of this research paper would have been very difficult.

Next, my specials thank goes to my relatives and real friends for their valuable
comments and significant suggestion during the research process, and for
giving me referring materials and in general for their friendly support.

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 TABLE OF CONTENTS

List Of Tables & Figures...................................................................................................6

List Of Acronyms...............................................................................................................7
Abstract..............................................................................................................................8
Chapter I.............................................................................................................................9
Introduction........................................................................................................................9
1.1-Background To The Study:..........................................................................................9
1.2. Statement Of The Problem........................................................................................10
1.3. Objectives Of The Study...........................................................................................12
1.3.1. General Objective...................................................................................................12
1.3.2. Specific Objectives.................................................................................................12
1.4. Significance Of The Study........................................................................................12
1.5. Scope Of The Study..................................................................................................13
1.6. Limitation Of The Study...........................................................................................14
1.7. Organization Of The Paper.......................................................................................14
Chapter Ii..........................................................................................................................15
Litreture Review...............................................................................................................15
2.1. The Origin And Evolution Of Bank And Credit Risk Management.........................15
2.2. The History Of Banking In Ethiopia.........................................................................16
2.3 Operational Definitions..............................................................................................18
3.1. Study..........................................................................................................................26
3.2. Methods Of Data Collection.....................................................................................26
3.3. Data Analysis............................................................................................................26
3.4. Sampling Techniques................................................................................................27
4.1 Data Gathering...........................................................................................................28
4.2.1. Assessing Credit Risk Environment.......................................................................30
4.2.2. Administration, Measurement And Monitoring Process........................................32
[Link]. Credit Risk Management Tools...........................................................................33
4.3. Trends Of Non–Performing Loans Of The Banks And Comparison With Nbe’s
Desired Maximum Level..................................................................................................35
Chapter V.........................................................................................................................38
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Conclusion And Recommendation...................................................................................38
5.1. Conclusion.................................................................................................................38
5.2. Reccomendation........................................................................................................40

List of Tables & Figures

Table 1: Responding Rate.............................................................................................................28

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Graph 1: respondents educational back ground............................................................................29
Graph 2: Respondents work experience........................................................................................29
Chart 1: Existing of Credit Risk Management Department..........................................................30
Chart 2: Credit policy and procedures approved by the BOD....................................................a31
Chart 3: Calculating of credit risk measurement inputs-probability of default............................32
Chart 4: Calculating of credit risk measurement inputs-loan recovery rate..................................33
Graph 3: credit risk management tools........................................................................................33
Graph 4: Credit exposure limit policy..........................................................................................34
Table 2: Trend of Non-performing loans of the banks.................................................................35
Chart 5: Existence of independent internal review.......................................................................36

List of Acronyms

BODs - Board of Directors

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 BIS - Bank for International Settlements

CBE - Commercial Bank of Ethiopia

FIs - Financial Institution

II – Interest Income

NBE- National Bank of Ethiopia

NPL- Nonperforming Loan

ROA- Return on Asset

ROE- Return on Equity

Abstract
Among the risk that face banks, credit risk is one of great concern to most
bank authorities and banking regulators. This is because credit risk is that risk
that can easily and most likely prompts bank failure. Therefore, sound credit risk

7
management structure is crucial for effective credit risk management process.
While banks may choose different structures, it is important to ensure that the
structure is commensurate with their size, complexity and diversification of their
activities.

The main objective of the study was to assess how banks manage their credit
risk, regarding the practices of commercial bank of Ethiopia, Shire branch.
The research qualitatively and quantitatively will examine policies,
strategies and associated practices regarding the banks credit risk
management systems and practices with the help of the following methods.

The research qualitatively and quantitatively examined policies,

strategies and associated practices regarding the banks credit risk
management systems and practices with the help of the following methods

The research design used was descriptive and didn’t use a high standard
statistical survey of the banks practice. Data collected from annual and quarterly
reports and primary data and information provided by banks were analyzed via
tables, graphs and pie charts to depict the reply of respondents and data
gathered through secondary data.

The study shows that there is a direct but inverse relationship between
profitability (ROE, ROA) and the ratio of non-performing loans to total loans.
These results are in line with the researcher’s expectation and actually tallies
with conventional wisdom.

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 CHAPTER I

INTRODUCTION

1.1-Background to the study:

Adequately managing credit risk in financial institutions (FIs) is critical for the
survival and growth of the FIs. In the case of banks, the issue of credit risk is of
even greater concern because of the higher levels of perceived risks resulting
from some of the characteristics of clients and business conditions that they
find themselves in. Banks are in the business of safeguarding money and
other valuables for their clients.

They also provide loans, credit and payment services such as checking accounts,
money orders and cashier’s checks. Banks also may offer investment and
insurance products and a wide whole range of other financial services.

The past decade has seen evolutionary revival of the banking industry in Ethiopia
following re-establishment of private banks. It is a normal phenomenon that
as the number of banks (and other institutions providing banking services)
increases, so does the competition, which in turn increases scope and
complexity of banks’ business to beat the competition and steer a
consistently profitable course. Generally, changes in the general business
environment alters the degree of risks banks, as any business, are subject to and
the concern they should give to manage these risks (Ethiopian Academy of
financial studies Training materials, Bank Risk Management).

Lessons from the traditional banking crises show that banks that had been
performing well suddenly announced large losses due to either credit
exposures that turned bad, liquidity problems, unmanaged interest rate and
exchange rate positions taken, derivative exposures that may or may not have been
assumed to hedge balances sheet risk or significant operational risks. In
response to such lessons, banks almost universally have embarked up on an
upgrading of their risk management system. Thus, in this increasingly dynamic area

9
of financial services, a distinctive position of any bank-be it private or public, large
or small- lies in the way it manages its risks (Ibid).

Risk is a fact of life in every business and if not managed properly, would adversely
affect the very existence of any businesses. However, the damage could be
more severe in the case of banks as banking business is not only a stake of the
owners but also that of depositors ( public), other banks and hence, the economy
as a whole. The main risks facing banks are credit risk, market risk, liquidity
risk and operational risk (Basle committee on banking supervision)
While banks engage in a large number of other financial activities and render a
wide range of services to customers, direct lending is one of the primary function
performed by them, the one in which they have a natural advantage over
a l m ost all financial institutions. This characteristic of banks can be
rationalized by the fact that loans and advances are the most significant
components of banks’ assets. Loan and advances usually represent about 50-70%
of their income. In 2006 for example, Commercial banks in Ethiopia generated
66% of their income from interest on loans and advances (National Bank of
Ethiopia).
Among the risk that face banks, credit risk is one of great concern to most
bank authorities and banking regulators. This is because credit risk is that risk
that can easily and most likely prompts bank failure (Basle committee on
banking supervision, 2004).

Therefore, sound credit risk management structure is crucial for effective credit risk
management process. While banks may choose different structures, it is
important to ensure that the structure is commensurate with their size, complexity
and diversification of their activities (Ibid).

1.2. Statement of the problem

The very nature of the banking business is so sensitive because more than 85%
of their liability is deposits from depositors (sounders, cornett, 2005). Banks use
these deposits to generate credit for their borrowers, which in fact is a revenue
generating activity for most banks. This credit creation process exposes the
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Banks to high default risk, which might lead to financial distress including
bankruptcy.

In today’s changing financial landscape-environment of intense

competitive pressure, volatile economic conditions, rising bankruptcies, a n d
increasing levels of consumer and commercial debt; an
organization’s ability to effectively monitor and manage its credit risk can mean the
difference between success and failure. Effective credit risk management
attracts today more attention than before.

Interest income and interest expense are the main determining factors for the
profitability of private banks in Ethiopia (Yigremachew, 2008).The negative
relationship of cre

Credit risk to corporate profitability may be evident that the more commercial
banks expos themselves to credit risk, the more accumulation of unpaid loans,
implying that these loan losses have produced lower returns to the banks. The
accumulation of non- performing loans caused by lack of proper credit risk
management would have substantial adverse impact on the performance of the
banks in particular and the overall economy in general. In turn this affects the
government by reducing its tax income and banks by imposing dawn ward
pressure on their respective profits and per share value of their stock price.

Apart from the above, significant amounts of non-performing loans

emanating from lack or poor credit risk management system could hinder
development and expansion of the Banks. It also leads clients to have lack of
confidence and the Banks to lose their loyal and prominent customers. Moreover,
investors may not be willing to invest their funds on the banks stock at the
desirable price or may avoid completely purchasing the stock. This in turn
affects the capital structure of the Banks. Therefore, unless the problems are
managed properly, it would definitely result in financial crises as in case of United
States of America, East Asia and Japan.

Following the free market economy of the country, loans are becoming large and
at the same time bad loans have increased substantially during the past few years.

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This appears as a problem and should be of interest to every commercial banker.
There should therefore be prior concern on the side of the commercial banks to
give due diligence in maintaining sound asset quality management, sound
portfolio and risk management, prudent loan processing and selection strategies.

Therefore, the principal concern of this paper is to a ascertain to what extent

banks can manage their credit risks, what tools or techniques are at their
disposal and to what extent their current performance is supported by proper
credit risk management policies and strategies.

1.3. Objectives of the Study

1.3.1. General Objective

The main objective of the study was to assess how banks manage their credit
risk, regariding the practices of commercial bank of Ethiopia, Shire brach.

1.3.2. Specific objectives

 Assessing whether the Banks are operating under appropriate credit risk
environment
 Identifying those methods that are used by the banks to mitigate their credit risk
exposure
 Assessing the Banks credit administration, measurement and monitoring
process
 Seeing interest income of the banks how significant it is as compared with the
other types of income.

1.4. Significance of the Study

This paper will examinew the application of credit risk management and
determines shortcomings. Thus, the subject matter of this research and the
resulting lessons drawn from the analysis are likely to benefit different
classes of people. This study is significant for its contribution to enhancing
knowledge, managerial decision making, reference material and serves as policy
frame work. Each is described below.
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Knowledge
The intended contribution of this paper is to increase the knowledge in the area.
The analysis is assumed to serve as a modest start and contributes to the
existing knowledge.
Managerial Decision Making
The study findings and recommendations are important to management of the
banks under study because it draws their attention to some of the points where
corrective actions are necessary and enable them to make such corrections.
Literature and Reference
The research can be used to establish a framework for subsequent studies
that can work with more comprehensive data set. Furthermore, it can stimulate
further research; thus keeping sustained interest in the area of credit risk
management and their use in minimizing the banks credit risk.

Policy framing
Credit granting is one of the main activities of banks and hence it is
beneficiary to make some reforms that lends to a better credit risk
management. The findings and recommendations of the study are highly important
to policy makers because it draws their attention to some of the points that need
corrective measures on their side.

1.5. Scope of the Study

The researcher believes that the findings of this study would have been more
productive if it has been conducted on all public and private Banks in Ethiopia.
However, due to time and financial constraints, it is out of the reach of the
researcher to incorporate all in this study. The study encompasses two selected
Ethiopian Commercial Banks (i.e. CBE, and WB) in which both of them have
branches in Shire town. Besides, due to the opaqueness of the sector and expected
shortage of longitudinal data and other elusive structural difficulties the
study is compelled to limit itself mainly on officially reported accounting data
for a period of the last six subsequent years up to 2009.

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1.6. Limitation of the Study
The study had likely face problem of accuracy for some data, which were
considered confidential by some banks, resulting from limited observation or
degree of freedom. It is known that loan losses can also occur as a result of the
borrowers’ character not to repay the debt in line with the agreement, apart from the
lenders lax credit risk management system. Therefore, the problem should
have been seen from both sides. Nevertheless, due to time and financial
constraint the researcher couldn’t incorporate views of borrowers.

1.7. Organization of the Paper

The paper was organized into five chapters; the first chapter describes the
introduction and cuts across, statement of the problem, objective of the study,
significance of the study, limitation and scope of the study, research design
and hypothesis. The second chapter concerned with the review of related
literature. The third chapter deals with analysis of the data collected and the fourth
chapter concludes the study with summery and recommendation.

CHAPTER II

LITRETURE REVIEW

2.1. The origin and Evolution of Bank and Credit Risk Management

It may be said that banking in its most simple form, is as old as authentic
history. As early as 2000B.C Babylonians had developed a system of banks. In
ancient Greece and Rome the practice of granting credit was widely prevalent.
“Trace of granting credit by compensation and by transfer orders” is found in

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Assyria, Phoenicia and Egypt before the system attained full development in
Greece and Rome (Shekhar,1993).

According to Machiraju (2003) it is believed to be the cradle of banking in northern

cities. As the center of commercial activity shifted from the Mediterranean to the
Atlantic and Northern Western Europe, banking growth fell behind in Italy.
However, banking reappeared in Italy during the catching up process of
industrialization in the 19th century. The banks then were functioning as main
lenders to the government and were lending money on collateral basis.

In today’s world banking is an important part of every body’s life, and they are one
of the most important financial institutions in the developed as well as developing
economies. Among the most crucial functions of a commercial banking is providing
credit to all participants of an economy. Commercial banks are the primary
sources of credit for many businesses, households and government bodies.
Banks are among the most important sources of short term working capital for
business and have become increasingly active in recent years in making long term
loans business organizations (Rose, 1993). In a nut shell, credit become “the business of
banking and primary basis, on which banks quality and performances are judged’
(McNaughton, 1992)

2.2. The History of Banking in Ethiopia

It is the agreement that was reached in 1905 between Emperor Menilik II and Mr.
McGillivray, representative of the British owned national Bank of Egypt marked the
introduction of the then modern banking in Ethiopia. Accordingly, the first
bank called Bank of Abyssinia was inaugurated in February 16, 1906 by the
Emperor. The society at that time being new for the banking service, Bank of
Abyssinia had faced difficulty of familiarizing the public with it. Despite its
monopolistic position, the bank earned no profit until 1941; profits were record in
1941, 1919, and 1920 and from 1924 onwards. The bank had faced many pressures as

15
a result of its inefficiency and purely profit oriented. Thus, an agreement was
reached to abandon its operation and be liquidated so as to disengage banking from
foreign control and to make the institution responsible to Ethiopian’s credit
needs. By shortly after Haile Sellassie came to power, the Bank of Ethiopia
was a purely Ethiopian institution and was the commercial activities of the Bank of
Abyssinia and was authorized to issue notes and coins. During the invasion (1935) the
Italians established branches of their main banks namely Banca d’ Italia, Banco
diRoma, Banko diNapoli, and Banca Nazionale del lavoro.

In 1941, another foreign bank, Barclays Bank came to service in Addis Ababa till it
withdraws in 1943, shortly before the commencement of the full operation of the state
Bank of Ethiopia. The state Bank of Ethiopia acted as the central Bank of Ethiopia and
as the principal commercial bank in the country and engaged in all commercial
banking activities until ceased to exist by bank proclamation issued on December 1963.

The Ethiopian Monetary and Banking proclamation that came in to force resulted in
splitting the function of commercial and central Banking creating National bank
of Ethiopia and Commercial bank of Ethiopia. National bank of Ethiopia performs
central banking functions while commercial bank of Ethiopia took over commercial
banking activities of the former State bank of Ethiopia. As first private bank Addis
Ababa Bank Share Company was also came to existence in 1964.

There were also other financial institutions in the country like the Imperial
Savings and Home ownership public Associations (ISHOPA) and Saving and Mortgage
Corporation of Ethiopia whose aim were to accept saving and trust, deposits
accounts and provide loans for the construction, repair and improvement of
residential houses. In 1945 Agricultural Bank that provide loans for agriculture and
other relevant project was establishing and replaced in 1951 by Investment Bank of
Ethiopia. In 1965 its name once again changed to Ethiopia Investment Corporation
Share Company. However proclamation No. 55 of 1970 established the Agriculture
and Industrial Development Bank Share Company by taking over the assets and
liability of the former Development Bank and Investment Corporation of Ethiopia.
16
Following the introduction of socialism economic system in 1974, the banking
sector was changed to a monopolistic banking system. The Housing and saving
Bank was established in 1975 by merging the former saving and Mortgage Corporation
of Ethiopia S.C and the Imperial Saving and Home ownership public Association
with the objective to provide loans for residential and commercial construction
industries. Then Addis Ababa Bank and commercial Bank of Ethiopia S.C was
merged by proclamation number 184/1980 to form the sole commercial Bank in the
country till 1994.
The pre 1994 Ethiopian banking industry was characterized by relatively less
competition, low deposit mobilization relatively high government intervention in
their management and more loan access to state owned sector.
Post 1994
Following the change in the economic policy, financial sector reform also took place.
Monetary and Banking proclamation of 1994 established the National bank of
Ethiopia as judicial entity, separated from the government.
In 1994, Construction and Business Bank was established under proclamation
number 203/1994 by taking over the rights and obligations of Housing and saving
Bank, which was previously established under proclamation number 60/1975.
Development Bank of Ethiopia has also established under Regulation of 1974.
Monetary and Banking proclamation No. 83/1994 laid down the legal basis for
investment in the banking sector; consequently shortly after the proclamation the first
private bank, Awash International Bank S.C was established in 1994. Dashen
Bank was established in 1995, and subsequently other private banks joined the
industry which brought number of banks in the industry to thirteen. Thus the
banking sectors are becoming more competitive today than pre 1994.

2.3 operational definitions

Banks make money by providing different services to their customers and granting
credits. However, there are some risks with these services and the most one are:
Financial risk3 in a banking organization is the possibility that outcome of an action or
event could bring up an adverse impact. Such outcomes could either result in direct

17
loss of earnings/capital or management result in imposition of constraints on bank’s
ability to meet its business objectives. Such constraints pose a risk as these could
hinder bank’s ability to conduct its ongoing business or to take benefit of opportunities
to enhance its business
Credit Risk4 is the potential that a bank’s borrower or counterparty will fail to meet its
obligations in accordance with agreed terms. Thus credit risk arises from non
performance by borrower or a counter party due to either inability or unwillingness to
perform as per the contracted. While the types & degree of risks an organization
may be exposed to depend upon a number of factors such as its size, complexity of
business activity, volume etc, it is believed that generally banks face credit,
market, liquidity, operational, compliance/legal/regulatory & reputation risks. Across
country experience evident that credit activities are the main determining factors
for the well being of the financial sector’s, especially in intermediation
activities such as banking services (Yigremachew, 2008) As discussed above,
loans are the largest and most obvious source of credit risk and hence, ensuring
prudent lending operation that reflects an acceptable risk reward ratio is, therefore,
an area in which banks have to devote considerable skills and research.
Risk management5; - is a discipline at the core of every financial institution
and encompasses all activities that affect its risk profile. It involves identification,
measurement, monitoring & controlling risks to ensure that the individuals who take or
manage risks clearly understand that 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 board of directors
2.4. Importance of credit risk Management
The future of banking will undoubtedly rest on risk management dynamics.
Only those banks that have efficient risk management system will survive in the market
in the long run. The effective management of credit risk is a critical component of
comprehensive risk management essential for long term success of a banking
institution. Credit risk is the oldest and biggest risk that bank, by virtue of its very nature
of business, inherits. This has however, acquired a greater significance in the recent
past for various reasons. Foremost among them is the wind of economic liberalization
that is blowing across the globe (Achou and Tenguh 2008).
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Moreover, it also classified credit risk management in to two distinct dimensions as
preventive measures and curatives measures. Preventive measures include risk
assessment, risk measurement and risk pricing, early warning system to pick early
signals of future defaults and better credit portfolio diversification. The curative
measures, on the other hand,
aim at minimizing post sanction loan losses through such steps as securitization,
risk sharing, legal enforcement etc. It is widely believed that an ounce of prevention is
worth a pound of cure.
A report issued by a committee on banking supervision of Bank for
international settlements (BIS, 2004) states that while financial institutions
have faced difficulties over the years for a multitude of reasons, the major cause
of serious banking problems continues to be directly related to lax credit standards for
borrowers and counterparties, poor portfolio risk management, or a lack of
attention to changes in economic or other circumstances that can lead to a
deterioration in the credit standing of a bank's counterparties. This experience is
common in both G-10 and non-G-10 countries.

According to (David Shimko, 2004), the goal of credit risk management to any bank is
to maximize a risk adjusted rate of return by maintaining credit risk exposure
within acceptable parameters. Banks need to manage the credit risk inherent in the
entire portfolio as well as the risk in individual credit or transactions. The effective
management of credit risk is a critical component of a comprehensive approach
to risk management and essential to the long term success of any banking
organization.
Peter S. Rose (1999) Pointed out that risk in banking tend to be
concentrated in the loan portfolio. Thus, a bank’s serious financial trouble usually
emanates from loans that have become uncollectible.
Studies reveal that the Japanese bank crises of 1993 and American financial
crises of 2007-2009, were the consequences of un-collectible (non – performing
loans). Bank for International settlements (2003), Fukao (2003), International
Monetary Fund (2003), Kashuap (2002), and organization for economic cooperation
and Development (2001) pointed out that credit misallocate on is one factor for banking
19
crises. World over, credit risk has proved to be the most critical of all risks faced by a
banking institution. A study of bank failures in New England found that, of the 62
banks in existence before 1984, which failed from 1989 to 1992, in 58 cases it was
observed that loans and advances were not
being repaid in time, (Achou and Tenguh 2008).
The effects of poor risk management can clearly be seen in the problems that have
arisen from the unregulated sub-prime mortgage lending market in the USA
where the loans had been securitized into ever more complex securities, which
when the housing prices stabilized and stopped increasing led to a huge increase
in defaults of the underlying sub-prime mortgages. This, in turn, led to massive
losses in the securities which had been sold. The reasons mentioned above indicate an
increased need to manage risk and in particular credit risk and default predictions
(Wikipedia, March 2009)

According to Ethiopian academy of financial study’s unpublished risk management

materials, credit risk arises any time bank funds are extended, committed,
invested, or otherwise exposed, whether reflected on or off the balance sheet as a result
of lax exposure management, poor economic conditions, or a variety of other factors.
However, generally the risk is assumed to be a rise from transaction (default) risk and
portfolio risk. These signify the role of credit risk management and therefore it
forms the basis of present research analysis.
Some of the strategies used for reducing and coping with portfolio credit r i s k
a c c o r d i n g t o A c h o u a n d T e n g u h , 2 0 0 8 , a r e g e o g r a p h i c diversification,
loan size limits (Rationing), over collateralization and credit insurance.
2.4.1. Credit Risk Management Models
It is hard to differentiate between the traditional approach and the new approaches
since many of the ideas of traditional models are used in the new models. The
traditional approach is comprised of four models6, as depicted herein under.
Expert systems
In this system, the credit decision is left in the hands of the branch lending
officer. His expertise, judgment, and weighting of certain factors are the most important
determinants in the decision to grant loans. The loan officer can examine as many
20
points as possible but must include the five “Cs” these are; character, credibility,
capital, collateral and cycle (economic conditions).
Artificial Neural Networks:
Due to the time consuming nature and error-prone nature of the computerized
expertise system, many systems use induction to infer the human expert’s decision
process. The artificial neural networks have been proposed as solutions to the
problems of the expert system. This system simulates the human learning process. It
learns the nature of the relationship between inputs and outputs by repeatedly
sampling input output information.
Internal rating at banks:
Over the years, banks have subdivided the pass/performing rating
category, for example at each time, there is always a probability that
some pass or performing loans will go into default, and that reserves
should be held against such loans.
Credit Scoring Systems:
A credit score is a number that is based on a statistical analysis of a borrower’s
credit report, and is used to represent the creditworthiness of the person. A credit score is
primarily based on credit report information. Lenders, such as banks use credit scores
to evaluate the potential risk posed by giving loans to consumers and to mitigate
losses due to bad debt. Using credit scores, financial institutions determine who are
the most qualified for a loan, at what rate of interest, and to what credit limits
(Wikipedia, 2008).
2.5. Credit Risk Measurement, Monitoring and control
Since exposure to credit risk continues to be the leading source of problems in
banks world-wide, banks and their supervisors should be able to draw useful lessons
from past experiences. Banks should have a keen awareness of the need to identify,
measure, monitor and control credit risk as well as to determine that they hold adequate
capital against these risks and that they are adequately compensated for risks incurred
as per the report issued by a committee on Banking supervision of Bank for international
settlements (BIS,2004).
Measurement or assessment of credit risk is of vital importance in credit risk
management to know how much credit risks a particular loan request or the
21
overall credit portfolios carry. To be effective in credit risk management, banks need
to devise mechanisms to measure the credit risk. Generally, credit risk measurement
involves both subjective and objective criteria (Ethiopian Academy of Financial
Studies unpublished, risk management materials).
Objective criteria may use benchmarks or pre-specified standards in terms of
financial ratios to quantify the risk level. Subjective criteria generally involve
judgments based on standards that the bank has generated as a result of its
experience and knowledge of the borrower and the type of credit requested. As with
the decision to grant credit, it is not possible to avoid human judgments in credit
risk measurement (Ibid).

Thus, both objective and subjective criteria are important and complement
each other. A number of qualitative and quantitative techniques of credit
risk measurement are evolving, including sophisticated quantitative models.
The four commonly used models according to Erisk7 are:
1. KMV's Portfolio Manager
2. JP Morgan's Credit Metrics
3. Credit Suisse Financial Products' Credit Risk+
4. McKinsey's Credit Portfolio View
The models use different methodologies to create a distribution of possible
credit portfolio values at some future point in time. Therefore, choice of model is an
important decision for any financial institution actively managing its portfolio credit
risk. For example, actuarial models (like Credit Risk+) may be more accurate for small
business portfolios or illiquid asset classes. Merton-based models (like Credit
Metrics and Portfolio Manager), on the other hand, may be better for publicly traded
companies (Ibid)
Prominent amongst the credit scoring models is the Altman’s Z-Score8.
The Z-score formula for predicting Bankruptcy of Dr. Edward Altman (1968) is a
multivariate formula for measurement of the financial health of a company and a
powerful diagnostic tool that forecast the probability of a company entering bankruptcy
within a two year period with a proven accuracy of 75-80%.
Z=1.2X1+1.4X2+3.3X3 + 0.6X4 + 1.0X5
22
Where, X1 = Working Capital/Total assets ratio
X2 = Retained earnings/ Total assets ratio
X3 = Earnings before interest and taxes/ Total Assets ratio
X4 = Market value of equity/ Book value of long-term debt ratio
X5 = Sales/Total assets ratio.
The higher the value of Z, the lower the borrower’ default risk
classification. According to Altman’s credit scoring model, any firm with a Z-Score less
than 1.81 should be considered a high default risk, between 1.81-2.99 an indeterminate
default risk, and greater than 2.99 a low default risk.
Critics: Use of this model is criticized for discriminating only among three borrower
behavior; high, indeterminate, and low default risk. Secondly, that there is no obvious
economic reason to expect that the weights in the Z-Score model – or, more generally,
the weights in any credit-scoring model-will be constant over any but very short
period. Thirdly the problem is that these models ignore important, hard to quantify
factors (such as macroeconomic factors) that may play a crucial role in the default
or no-default decision.
Potential benefits of credit risk models
The use of credit risk models offers banks a framework for examining
this risk in a timely manner, centralizing data on global exposures
and analyzing marginal and absolute contributions to risk. These
properties of models may contribute to an improvement in a bank’s
overall ability to identify measure and manage risk.
Credit risk models may provide estimates of credit risks, which reflect
individual portfolio composition; hence, they may provide a better
reflection of concentration risk compared to non-portfolio approaches.
By design, models may be both influenced by, and be responsive to,
shifts in business lines, credit quality, market variables and the
economic environment.
Consequently, modeling methodology holds out the possibility of providing a more
responsive and informative tool for risk management.
The other method used to measure credit risk is rating, which is summary
indicator of a bank's individual credit exposure. An internal rating system
23
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 lime. An internal rating framework would help banks in many ways such
as:

 Analysis of loan applications

 Determination of duration/tenure and price of loans,
 Frequency or intensity of loan monitoring
 More accurate computation of loan loss provision,
 Deciding the level of approving authority of loan and
 Determination of the overall portfolio risk.
 Determination of the overall portfolio risk

The extent to which authorities have been involved in developing criteria to distinguish
between “ good “ and “ bad “ loans defers substantially between countries. Some
countries use quantitative criteria for example number of days of overdue from the
scheduled payments, while other countries exclusively relay on qualitative norms
(such as a variability of information about the clients financial status, management
judgment about future payments).
In our country’s case the National Bank of Ethiopia has issued directive number
SBB/43/2008 pursuant to the authority vested in it by article 41 of the Monetary and
Banking proclamation number 83 / 1994 and by article 15 (1) and 36 of the
Licensing and Supervision of Banking Business proclamation number 54 / 1994.
According to this directive banks shall classify non – performing loans, weather such
loans have pre – established repayment schedule or not, in to five classifications (i.e.
Pass, Special mention, Substandard, Doubtful and Loss).

24
.

CHAPTER III
RESEARCH DESIGN AND METHODOLOGY
3.1. Study Design
The research qualitatively and quantitatively examined policies,
strategies and associated practices regarding the banks credit risk
management systems and practices with the help of the following methods.

3.2. Methods of Data collection

1. Questionnaires- a questionnaire with a standard set of questions addressed to
managers of credit and risk management, credit divisions, senior credit analyst
and controllers
2. Interview- both structured and unstructured interviews were conducted.
3. Annual report and documents of the banks and NBE’s were revised.
The investigation focused generally on management level of the selected banks
considering the fact that it is the manager that are responsible for developing and
implementing the policies and procedures, and at the same time who are

25
responsible for success or failure. Likewise, as the population is small, sampling
was not used.

3.3. Data Analysis

The research design used was descriptive and didn’t use a high standard
statistical survey of the banks practice. Data collected from annual and quarterly
reports and primary data and information provided by banks were analyzed via
tables, graphs and pie charts to depict the reply of respondents and data
gathered through secondary data. However, the hypotheses were tested using
regression model. In addition, NBE’s related policy and directives, practices
of some international peers and credit risk management guidelines of Bank for
international settlements have been in use as a bench mark for analysis.

3.4. Sampling Techniques

The researcher selected one commercial Bank from the government owned
banks that is CBE and one from private commercial banks, which have been
operational at least for the last ten years starting from 2016 GC up to 2025 G.C.

26
 CHAPTER IV
RESULTS AND DESCUSSION

4.1 Data Gathering

A survey has been carried out using the attached questionnaire (Annex I) with the
goal of assessing the credit risk management system and practices of
Ethiopian Commercial banks taking some public and private banks as a case
study. Structured questionnaires were sent to the selected banks, which are
listed in table 1. As shown below, 90% of them have responded.

Table 1: Responding Rate

S/N Male Female Total

1 12 12 24

2 4 4 8

Total 16 16 32

Soure: own survey (2009 E.C)

27
Banks should ensure that the staff involved in credit and related activities
are competent and fully understand its strategic direction, policies, tolerance of
risk and limits. Besides, their staff should also have appropriate professional
qualifications, technical and managerial skills, and experience to be able to
efficiently execute their duties.

In this regard, the respondents were risk managers, controller, credit managers,
and credit division heads, and senior credit analysts, risk officers and follow up
officers. Most of the respondents have an educational back ground of accounting,
business administration, business management, banking and finance and
economics with BA and above and have five to thirty eight years of work
experience as seen in the following Graph 1 & 2

25 22

20

15

10 7

5 3

0
Diploma BA/BSc MA/MSc

28
Graph 1: respondents educational back ground

15
16
14
12
10
7
8 6
6 4
4
2
0
1 upto 10 11 upto 20 21 upto 30 31 upto 40

Graph 2: Respondents work experience

Soure: own survey (2009 E.C)

.4.2 Empirical Results and Discussion

4.2.1. Assessing credit risk environment

There must be a risk management department in banks in order to achieve
their objectives properly. It is also the requirement of NBE to to establish this
department. Therefore, the first question in the survey a s k s b a n k s w h e t h e r
t h e y h a v e a c r e d i t r i s k m a n a g e m e n t department/unit. 66% of the
banks said that there was a credit risk management department/unit and 167%
of the banks said that there wasn’t and the rest 17% confirmed that

29
establishment was under process as seen in chart 1.

estballishmnet
in process
17%

NO
17%
YES
66%

Chart 1: Existing of Credit Risk Management Department

Soure: own survey (2009 E.C)

It is the overall responsibility of Board of Directors (BODs) 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.
Therefore, as seen in the following Chart 83% of the banks said that their bank’s
credit policy and procedures are approved by their board of director s. The
remaining 17% said no, simply as they didn’t have the respective policy.

NO
17%

YES
83%

Chart 2: Credit policy and procedures approved by the BOD

Soure: own survey (2009 E.C)

The establishment of a sound credit strategy and policy by the banks provide a
foundation for sound credit risk management. Besides, the BOD must ensure
that credit exposures in their bank’s portfolio were created following basic
objectives on a sound and collectible basis. These all indicates that having a
BOD with qualifications and experience coupled with well defined

30
responsibility is indispensable for the existence of banks. 83% of the banks,
which confirmed approval of their credit risk policy and procedures by BOD,
have stated that their bank’s BOD have the following responsibilities:

 defining the bank’s overall risk tolerance in relation to credit risk

 Ensuring that its overall credit risk exposure is maintained at prudent levels
and consistent with the available capital
 Ensuring that management as well as individuals responsible for credit risk
management possesses sound expertise and knowledge to accomplish the risk
management function
 Ensuring that the bank implements sound fundamental principles that facilitate
the identification, measurement, monitoring and control of credit risk
 Ensuring the existence of appropriate plans and procedures for credit risk
management

Therefore, the credit risk strategy and policy should be effectively

communicated throughout a bank and all relevant personnel should clearly
understand their bank's approach in taking credit risk and credit risk management.

4.2.2. Administration, measurement and monitoring process

Having proper internal risk rating system is an important tool to facilitate early
identification of risk profiles of borrowers. Nevertheless, among the banks under
study only 33% had said that they do have an internal rating system as a mechanism
of credit risk measurement being used while assessing a loan.

The most common method for measuring credit risk being usually utilized by
all the banks were the five C’s of credit, financial statements and human
judgment through experience. All banks also agree that even the sophisticated
quantitative models do not replicate experience and judgment rather these
techniques help and reinforce subjective judgment. Probability of default is one of
the most important inputs, which is used in credit risk measurement. According to

31
the survey, 67% of the banks don’t calculate probability of default and the
remaining 33% of the banks said that their studies, which is related to
calculating probability of default were still going on.

estballishmnet in
going on
33%

NO
67%

Chart 3: Calculating of credit risk measurement inputs-probability of default

Soure: own survey (2009 E.C)

The other input, which is used to calculate credit risk measurement, is recovery
rate. As per the response and as seen in the following Chart 4, 100% of the banks
calculate recovery rate of loans. All banks said that they do this on quarterly
basis while determining NPLs ratio of their bank’s to be sent for NBE.

Yes
100%
Chart 4: Calculating of credit risk measurement inputs-loan recovery rate
Soure: own survey (2009 E.C)

[Link]. Credit risk management tools

In credit risk management banks use various methods to mitigate credit risks such
as credit limits, taking collateral, diversification, loan selling, syndicated loans and
credit insurance. In Ethiopia, the methods which the banks use according to the
using intensity or priority given are shown in Graph 3. According to the first
using intensity, 49% of the banks said that they used credit limit method, 38%
32
of the banks said that they used taking collateral and13% of the banks said
that they used syndicated loan in credit risk management. In the second using
intensity, diversification (47%), credit limits (31%) and taking collateral (22%)
are the methods which are used by the banks in credit risk management.
60%

50%
49% 47%

40% 38%
31%
30%
22%
20%
13%
10%

0%
credit limt collateral syndicated loan diversification

First intensity Second intensity

Graph 3: credit risk management tools

Soure: own survey (2009 E.C)

A high level of concentration exposes the bank to adverse changes in the area in
which the credits are concentrated. However, they should also be careful not to
enter into transactions with borrowers or counterparties, which they do not know
or engage in credit activities and/or do not fully understand simply for the
sake of diversification. Hence, they need to have appropriate procedures and
policies in this regard. As depicted in Graph 4 all banks do have policy of maximum
credit exposure limit for single borrowers, in line with the NBE’s directive
[Link]/29/2002, which is 25% of each bank’s total capital. Besides, all banks
responded that they are complying and using the NBE’s directive as internal policy
in regard to the maximum exposure limit for groups of related parties, which is 35%.
On the other hand, 33% and 83% of the banks said that they do have credit exposure
limit policy at geographic category and for specific loan type, respectively.

33
 35%
29%
23%

13%

Borrowers Related parties Geographic category Specific loan type

Graph 4: Credit exposure limit policy

Source: Primary data, statistical report of the banks and own computation. (2009
E.C)
According to the respondents, 100% of the banks said that they have credit
management policies and objectives for categorizing loans that defines types of
loans, collection procedures, property appraisal policy, maximum tenures for
different loans and authority and responsibility of committees. However, 50% of
them don’t have credit policies and objectives with regard to geographical limits for
loan. 100% of the banks confirmed that they maintained credit files of all
borrowers with related information like purpose of the loan, planned repayment
schedule, loan contract and other legal documents. Moreover, they all said that
the appropriate financial statements drawn to ascertain repayment capacity of the
borrower(s) and the respective loan approval documents are also kept attached
with the file.

4.3. Trends of Non–performing loans of the banks and Comparison with

NBE’s desired maximum level

The following table shows trends of non – performing loans of the banks and
acceptable/desired maximum level set by the National Bank of Ethiopia. As
indicated in Table 2, NBE’s acceptable maximum NPL’s was 15% of the total
outstanding balance of each bank up to June 30, 2007. Though the current 5%
maximum desirable NPLs ratio, which came in to effect since July 2007, not

34
 officially distributed in the form of directive to concerned banks of the country,
the researcher learnt from NBE’s concerned body that banks are being
controlled via the 5%. To this effect also, all banks are aware of it, because NBE
was responding them while each bank sent its NPLs position for each quarter,
added by the respective official of NBE.

Table 2: Trend of Non-performing loans of the banks

Year % NPL % Acceptable/desired

Chan34ge level
2003 29 - 15
2004 19 34 15
2005 16 14 15
Sour
2006 11 30 15
c e:
2007 9 21 15
2008 8 7 5
Primary data, statistical report of the banks and own computation. (2009 E.c)
Though, the existing level of NPL of the banks’ was continuously falling and also
below the acceptable level of the NBE for the period from July 2006 up to June
2007, currently is still above NBE’s desired level as we can learn from the
above table 3. The existing high proportion of NPL still poses a red light for the
banks and desires a lot of effort to bring the level of NPLs to minimum level and
at the same time retaining their market share in the industry.

As can be seen from the table 3, proportion of non – performing loans of the banks
reached 29% of the total loan portfolio administrated by the banks in year 2003.
The total proportion has been registering good reduction and reached 8% by
the end of June 2008, which was 46.67% below the acceptable ceiling set by NBE.

Internal credit reviews, which are conducted by individuals’ independent from the
credit function, provide an important assessment of individual credits and the
overall quality of the credit portfolio. Besides, such credit review function can also
help evaluate the overall credit administration Process, determine the accuracy
of internal risk ratings and judge whether the account officer is properly

35
monitoring individual credits. In this regard as seen in chart 8, 83% of the banks
said that they do have independent internal review policy and procedures.
Nevertheless, while making discussion to conduct the interview, the researcher
learnt that only two banks (i.e. 33%) had independent internal review and
reporting systems and the remaining stated that the same job is done by their
internal auditors and credit follow up sections, which is part and parcel of the
credit department of the banks.

Chart 5: Existence of independent internal review

To BOD
23% Independent
38%

To Control dep't
18%
To senior man-
agement
21%

Source: Primary data, and own computation. (2009 E.c)

According to chart above 38 % said we do have an independent internal credit

review system, 23 % of them said that their review are addressed to the BODs,
21% of them report to their senior management and 18 % of them to control
department. Moreover, they also said that the same report is prepared the NBE on
demand.

As said at the beginning of the paper, the goal of credit risk management is to
maintain a bank’s credit risk exposure within parameters set by the board of
directors and senior management. The establishment and enforcement of
internal controls through independent internal review ensure that credit risk
exposures do not exceed levels acceptable to the individual bank. Such system
will enable bank management to monitor adherence to the established credit risk
objectives. Likewise, 100% of the banks said they do have an internal review
system whether independent or not that performs the following functions:
36
  Determines whether loan approvals were in line with the banks credit policy
and procedures Determines whether loan approvals were within the limits
of the bank’s lending authority
 Examines entries and checks interest posting to various loan accounts and
control ledgers and
 Confirms collaterals on a test basis
It should be noted that all the above functions are performed by internal auditors in

CHAPTER V

CONCLUSION AND RECOMMENDATION

5.1. Conclusion
Risk is the fundamental element that drives financial behavior without risk; the
financial system would be vastly simplified. However, risk is omnipresent in the
real world. In other words, risk is a fact of life in every business and if not managed
properly, it would adversely affect the very existence of any business. However,
the damage could be more sever in the case of banks as banking business is not
only a stake of the owners but also that of depositors(public), other banks and
hence, the economy as a whole. Banks, therefore, should manage the risk
effectively to survive in this uncertain world. The futures of banking will
undoubtly rest on risk management system. Only those banks that have efficient
risk management will survive in the market in the long run.

The analysis of secondary and primary data revealed some interesting aspects
about the credit risk management practices of the commercial banks under study.
The important among them are listed below:

 The tools which are used in credit risk management by the banks are taking
collateral, credit limits and diversification. The banks don’t use the other
methods like loan selling and credit insurance for mitigating and transferring
credit risk. Because loan selling market and credit insurance sector haven’t
developed yet.

37
 The most common and frequently occurring risk in the commercial banks is
credit risk.
 Lack of coordination among lending banks, failure of due diligence and
independent monitoring are the major reasons given by the banks for the
frequency of the credit risk occurrence in their banks.
 Only 17% of the banks had credit risk management department, which is
independent from the loan origination function.
 Still there are Banks who do not have written credit risk policy.
 Only 33% of the banks said that they effectively communicate their credit risk
strategy and policy throughout their organization.
 More popular credit evaluation techniques like KMV's Portfolio Manager,
Altman’s Z score model, J.P. Morgan credit matrix, etc do not find a place in the
credit evaluation tool kit of the commercial banks.
 Poor credit assessment in determining the viability of a project as a result of lack
of relevant and reliable information is the reason that forces the banks to follow
collateral based lending system
 Presence of unfavorable economic development like drought and war in the
country during the past and effect of the world economic crises are also the other
reasons for credit risk in the banks.
 Subjective decision-making by credit personnel’s of the banks also had
contributed for the accumulation of non-performing loans and in a Weaken the
credit risk management system.
 Many banks that experienced asset quality problems lacked an effective
credit review process (and indeed, almost all banks had no independent with well
equipped credit review function).
 As expected the larger share of the banks’ income has come from loans and
related activities. Hence, we can conclude that lending is the major source of
profit and credit risk for banks.
 The study shows that there is a significant relationship between bank
performance (in terms of profitability) and credit risk management (in
terms of loan performance). Better credit risk management results in
better bank performance. Thus, it is of crucial importance that banks
38
 practice prudent credit risk management and safeguarding the assets of the
banks and protect the investors’ interests.
 The study also reveals that banks with good or sound credit risk management
policies have lower loan default ratios (bad loans).

The study shows that there is a direct but inverse relationship between
profitability (ROE, ROA) and the ratio of non-performing loans to total loans.
These results are in line with the researcher’s expectation and actually tallies
with conventional wisdom. This has led to accept my hypothesis and conclusion
that banks with higher profitability have lower non-performing loans, hence
good credit risk management strategies. However, statistically the banks interest
income and non-performing loans shows positive relation despite the theoretical
assumption of negative relationship. The positive relationship was, however, at
insignificant level. This may be attributed to the insignificant annual percentage
growth shown in the Banks interest income as compared to the percentage
decline of average NPLs.

5.2. Reccomendation

In line with the findings obtained, the following recommendations are

forwarded:

 As credit information is crucial for the development of the credit system and
for addressing the problems of NPLs, banks should take the maximum
caution in dissemination of credit information of borrowers.
 In order to maintain credit discipline and to enunciate credit risk
management and control process, the banks are advised to establish a
separate department /unit independent of the loan origination function.
 In order to be effective, credit policies must be communicated
throughout the organization, Also, NBE made some regulations about risk
management. But, credit risk management is not to be in desired level and
there are some shortcomings and problems in credit risk management. Lack of
sufficient data about credit risk measurement inputs is also one of these

39
 problems. Hence, its centralized credit information data base should also be
reorganized to meet the requirements of banks.
 NBE should also regularly control and follow the banks financial
performance and their adherence of its liquidity, capital adequacy and asset
quality requirements.
 In order to reduce concentration risk the banks should incorporate geographic
loan limit in their credit procedures.
 The purpose of credit review is to provide appropriate checks and balances to
ensure that credits are made in accordance with bank policy and to provide an
independent judgment of asset quality, uninfluenced by relationships with
the borrower. Effective credit review not only helps to detect poorly
underwritten credits, it also helps prevent weak credits from being granted,
since credit officers are likely to be more diligent if they know their work was
subject to review. An effective credit review department and independent
collateral appraisals are important protective measures, especially to ensure
that credit officers and other insiders are not colluding with borrowers.
 Specifically, as expected interest income has proven to be the main determining
factors for the profitability of the banks. The negative relationship of credit
risk to banks profitability may evident that the more commercial banks
exposed themselves to credit risk, the more accumulation of unpaid loans,
implying that these loan losses have produced lower returns to the banks.
There should therefore prior concern to give due diligence in maintaining
sound asset quality management, sound portfolio and risk management,
prudent loan processing and selection strategies together with optimum
utilization of the available financial resources and findings ways to
maintain reasonably cheap source of loan able fund.
 A well-structured internal risk rating system is a good means of
differentiating the degree of credit risk in the different credit exposures
of a bank. This will allow more accurate determination of the overall
characteristics of the credit portfolio, concentrations, problem credits, and the
adequacy of loan loss reserves. Thus, all banks are encouraged to develop and
utilize an internal risk rating system to manage credit risk.
40
 Generally, the banks under study evaluates loan proposals through
the traditional tools of project financing, computing maximum
permissible limits, assessing management capabilities, and prescribing a
ceiling for an industry exposure. As banks move into a new high powered world
of financial operations and trading, with new risks, the need is felt for more
sophisticated and versatile instruments/models for risk assessment,
monitoring and controlling risk exposure. It is, therefore, time that
banks management should equip them fully to grapple with the demands
of creating tools and systems capable of assessing, monitoring and
controlling risk exposures in a more scientific manner.
 implemented through appropriate procedures, monitored and
periodically revised to take into account changing internal and external
circumstance. Banks should diversify their credit portfolios by avoider or
two sectors and /or on individuals

41
Bibliography
1. Australian prudential Regulation Authority, Credit Risk modeling: current
practices and Applications, for Basel committee April 1999.
2. Bank for international settlements, Sound Credit Risk Assessment and
Valuation for Basle committee Switzerland June, 2006.
3. Basle committee on Banking supervision, Principles for
Management of Credit Risk, 2004.
4. Bass,R.M.V.(1999), Credit Management,3rd Ed, Stanly Thorms
publishers Ltd
5. Benti Yigremachew.(2008), Determinants of private Bank’s
Profitability, Ethiopian.
6. Daniel C Hardy (May-June 1999), “ Are banking crises
predictable”, Biritu No 67, National Bank of Ethiopian publication.
7. David Shimko, Credit Risk Models and Management, 2nd Ed Canda
2004.
8. Gebdrel Jimenez, Credit cycles, credit Risk and prudential regulation,
international Journal of central banking , vole 2 No 2, Jun 2006
9. Koch, W.T. (1995) Bank Management, 3rd Ed, The Dryden press, sec Harbor
Drive, USA.
10. Laustein, H.C. (1978), “Management of Credit”, in encyclopedia of professional
management, New York; McGraw Hill.
11. Machiraju, H.R, (2003), Modern Commercial Banking, Vikas
Publishing House [Link], New Delhi.
12. McNaughton Diana. (1992), “ Managing of Credit Risk” in building strong
management and responding to change, Banking institution in Developing countries
Volume I, World Bank, Washington D.C. 14. Rose, S.p. (1993) Commercial Bank
Management, 2nd Ed, Irwin Home Wood, IL Boston.
13. Tenguh and Achou.(2008), “Credit risk management”.
42
Internet sources
[Link]
[Link]
[Link]
[Link]
[Link]
[Link]

43
Annex 1: Questionnaire
I am carrying out a research under the topic “ Credit Risk management,
therefore, your precise and clear answers to these questionnaire & interviews will
ended be critical for the success of this study. All information provided would
be kept entirely confidential and the interviewee can’t be identified and will remain
anonymous. This research is undertaken as part of fulfillment for the program
Thank you for taking some minutes of your precious time.
Part I. Personal information
1. Gender Male Female
2. Position in the bank ___________
3. Years of service:- _______________
4. Educational level (E.g. diploma in Accounting) _____________
5. Name of the Bank in which you are working____________________________
Part II. General issues in credit risk management
Put thick mark (√) to indicate your answer (put more than once if necessary)
1. How long since the bank is established and began operation__________________
2. Is there any risk, which the bank has faced during the last ten years period?
Yes ___________ No__________
3. What problem did the bank face in regard to credit risk management?
______________________________________________________________________
Part III. Credit risk environment
1. Do you have Credit Risk Management Department /unit?
Yes ______ No __________ Establishment is still going on _______
2. Does function of your credit risk management department independent of the loan
origination function?
Yes __________ No ______
3. Do you have a written credit risk policy, guidelines and procedures that explain objectives?
And principles of credit risk management process?
Yes __________ No __________ Establishment is still going on _______
If yes, has it been reviewed periodically and is helpful for processing credit request?
__________________________________________________________________
44
4. If your answer for question No.3 is yes, is the policy and procedures approved by the Board
of Directors?
Yes __________ No __________
5. If your answer for question No.4 is yes, what are the responsibilities of the Board
of
Directors?
____________________________________________________________________________
____________________________________________________________________________
______________
6. What are the responsibilities of senior management in the credit risk management?
__________________________________________________________________
__________________________________________________________________
7. Does the credit risk strategy and polices be effectively communicated through out
the organization.
Yes _____ No_____
8. Do credit management policies & objectives of your bank reviewed periodically to take in
to account internal and external circumstances?
Yes _____ No_____
If yes, what were those circumstances under which the policies and objectives were
reviewed?__________________________________________________________________
Part Iv. Administration, Measuring and monitoring process
1. Do you calculate probability of default of customers?
We calculate _____ We don’t calculate _____ our studies are going on_____
2. Do you calculate recovery rate of a loan?
Yes No
If yes, when do you calculate this (Hint: at the time loan is pass, special mention, or at all
time).__________________________________________________________________
3. In credit risk management banks use various methods to mitigate risks:
(Please rank the following based on your priorities)

criteria Priorities

1 2

Credit limits

45
 Taking collateral

Diversification

Syndicated loans

Credit insurance

Loan selling

5. Does your Bank has procedures/polices in regard to credit exposure limits, which is set for
Single Borrowers _____________
Groups of connected counter parties _____________
For particular industries or economic sectors ____________
Geographic regions ____________
Specific loan type ----------
6. Are there written credit management policies & objectives that establish

Yes No

Guidelines for categorizing loan

Geographical limits for loans

Authority & responsibility of committees & individual

lending officers

Definition of acceptable types of loans

Maximum maturities for various types of loans

Minimum financial information required at the inception of

credit

Collection procedures
Loan pricing & appraisal policy

7. Does your bank maintain credit files of all borrowers, which contain information on?

Yes No

Purpose of the loan

46
 Loan approval documents

planned repayment
schedule

Loan contracts& other

legal document

Insurance coverage
Financial statement

8. Does the bank maintain up-dated list of problem loans & list of loans reviewed indicating
the date of the review & the credit rating (hint pass, special mention etc)
Yes ________ No __________
9. What was your NPLs ratio as at June 30 of the following years?

Year NPLs Ratio % of total Sector Where is the major

loan NPLs came from

2003

2004

2005

2006

2007

2008

47
ANNEX 4: INTERVIEW QUESTIONS
1. Does your Bank use credit ratting like that of S&P, Moody’s, etc?
2. Do you have any model or technique through which you manage your credit risk?
3. If the trend of NPLS ratio was increasing, what might be the reason (s)?
4. Do you think the current credit procedures; reviewing and approval culture is
helping the
bank to achieve its objectives?
5. In your opinion what are the main reasons for violating covenants of loan by
customers.
6. How do you rate the level of cooperation among banks in sharing credit
information regarding customers?
7. Give your comment or suggestions regarding the credit risk management
system of the Bank.
8. Do you have any information about the current financial crises of the world?
9. Do you think that this have an impact on your Bank?
If Yes, how__________________________________________
If No, why ___________________________________________
In response to this what measures especially on credit does your bank have taken? If
in processes, please specify. __________________
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