INTRODUCTION

1.1 Background of the study

Banks are exposed to different types of risks, which affect the performance and activity of these
banks, since the primary goal of the banking management is to maximize the shareholders‟
wealth, so in achieving this goal banks‟ managers and loan related staffs should assess the cash
flows and assumed risks as a result of directing its financial resources in different areas of
utilization.
Credit risk is one of the most significant risks that banks face, considering that granting credit is
one of the main sources of income in commercial banks. Therefore, the management of the risk
related to that credit affects the profitability of the bank (Li and Zou, 2014).
Williams (1998) defines risk as a potential variation in outcomes and exposure to a potential loss.
Similarly risk is defined as uncertainty about economic losses due to the occurrence of as an
event; Economic losses are caused by perils such as crimes, fire and accidents. It is the
possibility of an adverse deviation from desired outcomes that is expected.
According to Trieschmary (1998) risk management is a managerial process that involves the
executive function of planning, organizing, leading and controlling those activities in a firm that
deal with specified types of risks in order to maximize the value of organization. The risk
manager is charged with minimizing the adverse impact of losses on the achievement of
company‟s goals. Risk management is the scientific approach to the problem faced by business
that deals with the techniques of forecasting future so as to plan, organize, direct and control
efforts to minimize the adverse effects of those potential losses. It is the reduction and prevention
of the unfavorable effects of risks at a minimum.
Credit is that it is originated from the Latin word “Credo” which means „I believe‟. Credit is a
matter of faith in the person and no less than in the security offered. Credit is purchasing power
not derived from income, but by financial institutions either as an offset to idle by depositors in
the banks, or as a net addition to the total amount of purchasing power. In fact, no economy can
function without credit; all economic transactions are settled by means of credit instruments
today. It is the very life blood of modern business and commercial system (Cole, 2000).
Credit risk management can be treated as the heart of any commercial banks. It plays the vital
role in the performance of financial institution as it analyzes credit-worth-ability of borrowers. If
there is any loophole in credit risk assessment, then recovery of the provided loans and advances
is challenged greatly, as a whole profitability falls in a great uncertainty.
A bad loan often arises from different factors or combination of factors, but the most important
reason is the absence of proper loan classification system. It can identify problem loans
immediately and take necessary steps to minimize potential defaults and consequent losses. Poor
credit risk management is the main consideration in case of bank‟s unsatisfactory performance
and often the reason of bankruptcy (Md. Moeid, 2014).
Amongst the many factors that can lead to bank problems, poor credit risk management has
always been pointed out by different writers as being the cause of bank problems and failures.
This is basically because since banks make their profits from interest gotten after lending money
to customer, a poor credit risk management during the lending process will also have negative
results on the bank at the end and vice versa. Directors should be aware that, as accountants
already know, non-payment is one of the most critical risks a company faces and all practical
steps should be taken to mitigate this risk (Roberts, 2010). The failure has chain effect to
influence payment systems and thus affect the whole economy in the long run. Despite the
consequences of credit risk, it cannot be avoided because it is associated with the core activities
of the bank. Banks like any other business entity makes their profit through loan granting so; a
collapse is assured with the least mistake in the course of the process. The root cause of this
problem has always been poor and unreliable information that lenders get from borrowers even
through other factors including poor risk management can be associated.
Effective management of credit risk is inextricable linked to the development of banking
technology, which will enable to increase the speed of decision making and simultaneously
reduce the cost of controlling credit risk. This requires a complete base of partners and
contractors (Lapteva, 2009).
Credit risk is one of significant risks of banks by the nature of their activities. Through effective
management of credit risk exposure banks not only support the viability and profitability of their
own business but also contribute to systemic stability and to an efficient allocation of capital in
the economy (Psillaki, Tsolas and Margaritis, 2010 P.873).
1.2. Statement of the Problem
The loan portfolio is typically the largest asset and the predominant source of revenue for the
bank. As such, it is also one of the major sources of risk for the bank‟s safety and soundness.
Loans are the most important resources held by banks. Lending activities require banks to make
judgment related to the credit worthiness of a borrower. However, the judgments do not always
prove to be accurate and the credit worthiness of a borrower may decline due to various factors.
Consequently, banks face credit risks. Credit risk is the risk that obligations will not be repaid on
time and fully as expected or contracted, resulting in a financial loss or non-Performing loans.
The borrower may fail to meet the terms of the underlining loan agreement (Seifu, 2013).
The magnitude and far reaching consequences of this exposures force business organizations to
put in place a structure that makes possible systematic approach to the management and hence
subsequent minimization the impact of such risks on their overall performance. Accordingly,
different organizations employ different risk management techniques, which they determine best
suites them to achieve their business objectives.
Credit assessment helps the banker to ensure selection of right type of loan proposals and right
type of borrower. For selecting the borrower, security should not the only thing to be relied up
on. So responsibilities the bankers to investigate the client from different view point. i.e. the
strength and weakness of the client so that the client will be able to repay the bank loan as
repayment with profit. To prevent future financial crises, it is necessary to improve the
borrowers‟ financial literacy, the lenders‟ process of transparency and to better assess loan
product affordability & suitability.
Most importantly, banks are exposed to credit risk since their principal profit making activity is
making loan, to their customers. Lending represents the heart of the industry. Loans are
dominant asset at banks; they generate the largest share of operating income and represent the
banks greater risk exposure (MacDonald and Koch, 2006).
Credit risk occurs when a debtor / borrowers fails to fulfill his obligations to pay back the loans
to the loans to the principal / lender. In banking business, it happens when “payment can either
be delayed or not made at all, which can cause cash flow problems and affect a bank‟s liquidity”
(Grevning and Bratanovic, 2009). Hence, credit risk management is a bank basically involves its
practices to „manage‟, or in other words to minimize the risk exposure and occurrence.
Researches were conducted in Ethiopia in the area such as that of Nigusu, (2009); Tekle, (2011);
Girma, (2011); Wondimagegnehu, (2012); Solomon, (2013) and Alebachew, (2015). Some of the
studies reviewed were focused on part of the credit risk management in banks like investigating
factors affecting loan recovery, evaluating credit analysis practice, determinants of NPLs and its
impact on performance and the credit risk management practice.
The researcher is interested to do on this due to diversified and intensified investments in the
country in the last five to ten years; there is an increase of loan demands among investors from
banks in the country. There was a policy revision in the bank, because of this revision the branch
discretion limit increased to one million. set by National Bank of Ethiopia (Source: Appendix I),
still forced the bank to maintain a huge amount of provisioning expenses which is 1.1 Billion birr
as considerable amount of loans are classified bad credits, in terms of sector wise Hotel &
Tourism term loan alone contribute about 23.74% of the total non-performing credits;
foreclosure activities of this year is highly increased from the previous years and the loan interest
rate changed three times from the previous studies (September 2015, 2016 & November 2017).
Because of the above mentioned points the researcher interested to do on this topic.
As indicated in the 2016/2017 annual report, it has been possible to mobilize a total of deposit of
4 billion birr that makes the banks‟ deposit position 16.42 billion birr. During 2016/2017 budget
year, the bank disbursed a total loan of 3.2 billion and also provision for doubtful debt increase
from 32.5 million to 41.9 million. Therefore, these researches assess credit risk management
practice of the bank and ways of controlling credit risk will be assessed in the research.
This research will investigate the credit approval procedure and credit portfolio management of
CBE. Specifically in Modjo branches.
The main research questions are:
 What are the credit risk management techniques and tools used by the bank?

 The action that CBE Bank takes in the past to control or minimize the bank‟s NPL?

 What kinds of mechanisms are used by the bank to handle credit risk?

 How the bank does identifies, measure, monitor, evaluate, and control credit risk?
1.3 Objective of the Study
It is important to conduct critical assessment of the viable factors, which determine approval of
credit mechanisms and evaluation of acceptability of loan request presented using appropriate
standards. The objectives of the study are described as follows
1.3.1 General Objectives of the Research
The general objective of the study is to assess the credit management practice in the case of NIB
International Bank S.C.
1.3.2 Specific Objective
 To assess the bank identification, measurement, monitor, evaluation and control
mechanism of credit risk

 To assess the credit risk management techniques and tools used by the bank

 To assess the procedure that the bank has used to reduce the amount of NPL in the past

 To identify the mechanisms used by the bank to handle its credit risk

1.4 Significance of the Study

This research would be significant to diagnose the existing credit risk management practice of
the bank. Thus, the bank might reconsider and improve the existing credit risk management
practice based on the recommendations given to the problems. It could also have practical
relevance to the Ethiopian banks by providing data to a policy environment for the credit risk
management operation of banks in the economy. Thus, it would also valuable lesson for the
banking sector of Ethiopia.
Finally, the study could also contribute to the existing body of knowledge regarding the credit
risk management and can serve as an insight or input for further research on the area.
1.5 Scope of the Study
The scope of the study cover the assessment of credit risk management practice of CBE at Modjo
branch and the researcher mainly focus on credit appraisal department, credit analysts, credit
information and portfolio management division, customer relation managers (CRM) department,
risk management department and five branches that have a significant loan disbursed amount
branch managers, loan officers and associate loan officers. Therefore, the study is limited to the
credit activity and risk management area of CBE on head office departments and Five branches
in Modjo.
1.6. Organization of the Study
The research report organized in five chapters. Chapter one provided the general introduction
about the whole report. Chapter two describes the review of related literatures. Chapter three
provide detail description of the methodology employed by the research. Chapter four contains
data presentation analysis and interpretation. Finally, the last chapter concludes the total work of
the research and gives relevant recommendations based on the findings.