ASSESSMENT OF CREDIT RISK MANAGEMENT PRACTICE IN

NIB INTERNATIONAL BANK S.C

A PROPOSAL SUBMITTED TO DEPARTMENT OF BUSINESS ADMINISTRATION FOR

PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE AWARD OF MSC
DEGREE IN BUSINESS ADMINISTRATION

BY: Natnael Abera

Advisor: Dr. Alazar A.

NOVEMBER, 2024

ADDIS ABABA, ETHIOPIA

 ACKNOWLEDGEMENT

First of all, I would like to thank the Almighty of God for giving the aptitude, determination, and
endurance throughout my daily live. Without his support nothing can be accomplished. And I
would like to express my gratitude and appreciation to my advisor Alazar A. (PhD). My
appreciation also goes to the employees of the Bank for their valuable comments and their support
in filling the questionnaires. All Branch managers, directors, division managers and loan officers of
the Bank for providing the relevant data. I would also like to show my gratitude to Ato Alemu
Semaye (Director of Credit Appraisal Department) of Nib International Bank.

II
 Abstract

Credit risk management has become an important topic for financial institutions, especially since
the business sector of financial service is related to conditions of uncertainty. The turmoil of the
financial industry emphasizes the importance of effective risk management procedures. The purpose
of the research is to assess the credit risk management practices of NIB International Bank S.C.
through examining the policy and procedures, the tools of credit risk management the credit
granting process, performed activities of credit risk management reporting system and credit risk
management process. This research Paper will b e conducted with a qualitative and quantitative
research approach by employing descriptive research design and these research target group is
employees who directly involved in credit risk management and administration. The researcher will
use primary and secondary data source. The main primary source of data is through the use of
questionnaires for credit and risk management related staffs and borrowers of the bank and
interview for management staffs. In the case of the secondary data, annual and quarterly reports are
used. The researcher will use purposive sampling technique under non-probability sampling to
collect data from employee of the bank and use the descriptive data analysis method.
Key words: Risk management, credit risk management

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Contents
ACKNOWLEDGEMENT.........................................................................................................II

Abstract.......................................................................................................................................III

CHAPTER ONE...............................................................................................................................4

INTRODUCTION............................................................................................................................4

1.1. Background History of Nib International Bank.................................................................4

1.2. Background of the study....................................................................................................5

1.3. Statement of the Problem...................................................................................................7

1.4. Research Question.............................................................................................................9

1.5. Objective of the Study.......................................................................................................9

1.5.1. General Objectives of the Research................................................................................9

1.5.2. Specific Objective...........................................................................................................9

1.6. Significance of the Study...................................................................................................9

1.7. Scope of the study............................................................................................................10

1.8. Definition of Terms.........................................................................................................10

1.9. Limitation of the Study....................................................................................................11

1.10. Organization of the paper..............................................................................................11

CHAPTER TWO............................................................................................................................12

REVIEW OF RELATED LITERATURE......................................................................................12

2. Introduction....................................................................................................................12

2.1. Theoretical Perspective..................................................................................................12

2.2. Empirical Evidence..........................................................................................................12

2.2.1. Definition and Concept of Risk Management..............................................................11

2.2.2. Sources of credit risk....................................................................................................12

2.3. General Principles of Sound Credit Risk Management in Banking..............................12

 2.3.1. Establishing an Appropriate Credit Risk Environment.................................................12

2.3.2. Process Operating under a Sound Credit Granting.......................................................13

2.3.3. Maintaining an Appropriate Credit Administration, Measurement and Monitoring

Process...........................................................................................................................15

2.3.4. Ensuring Adequate Controls over Credit Risk.............................................................16

2.4. Analysis of the creditworthiness of bank loan applicants..............................................16

2.4.1. Pre-requisites of creditworthiness.................................................................................17

2.4.2.Accounting information and creditworthiness analysis.................................................17

2.5. Credit Risk Management in Banks................................................................................17

2.5.1.Obstacles to credit Risk Management............................................................................18

2.5.2.Deficiency in Credit Risk Management........................................................................18

2.6. Credit Risk Management Policy....................................................................................18

2.7. Credit Risk Management Practices................................................................................19

2.8. Credit Risk Management Strategies..............................................................................19

2.9. Credit Risk Management process..................................................................................20

2.10. Credit risk management for Ethiopian banks................................................................20

2.11. Credit Risk Models........................................................................................................20

2.12. Tools of Risk Management............................................................................................21

2.12.1. Risk control tools.................................................................................................21

2.12.2 Risk financing tools.....................................................................................................22

2.13. Policy guidelines............................................................................................................23

2.14. Banks Performance and Its Determinants......................................................................25

2.14.1. Internal determinants...........................................................................................25

2.14.2. External determinants..........................................................................................26

CHAPTER THREE........................................................................................................................27

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RESEARCH DESIGN AND METHODOLOGY..........................................................................27

Introduction.....................................................................................................................................27

3.1 Research Methodology.....................................................................................................27

3.1.1. Research Design..................................................................................................27

3.1.2. Research approach...............................................................................................27

3.1.3. Population (target groups)...................................................................................28

3.1.4. Sampling techniques and sample size..................................................................28

3.1.5. Source of data......................................................................................................28

3.1.6. Method of data collection....................................................................................28

3.1.7. Method of Data analysis......................................................................................29

CHAPTER FOUR...........................................................................................................................30

COST AND TIME PLAN..............................................................................................................30

4.1. Time schedule................................................................................................................30

4.2. Financial Budget............................................................................................................31

REFERENCES...............................................................................................................................32

Appendix I......................................................................................................................................36

Appendix II.....................................................................................................................................42

Appendix III....................................................................................................................................43

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 CHAPTER ONE
INTRODUCTION
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
1.1. Background History of Nib International Bank
Nib International Bank S.C. was established on 26th May 1999 under license No. LBB/007/99 in
accordance with the Commercial Code of Ethiopia and the proclamation for Licensing and
Supervision of Banking Business No. 84/1994 with a paid up capital of Birr 27.6 million and
authorized capital of Birr 150 million by 717 shareholders and commenced its operation on 28th
October 1999. At the end of June 2013, the authorized and Paid-up capital of the Bank reached Birr
2 billion and Birr 999.9 million respectively. Shareholders’ and employees number also increased
and reached to 3,877 and 2,278 respectively.
As a financial institution NIB provides all banking services which are provided in Ethiopia under
consent of NBE by opening different branch and developing different departments at Head Office
level. From those departments, Risk and Compliance Management Department is one of them. And
Risk management performs its operation within this department through Identifying, Measuring
and Monitoring risk and reports directly to the Board of Directors Risk Management Committee.
This department recognizes that it has a responsibility to manage risks effectively in order to
control its assets and liabilities, protect its shareholders and other stakeholders against potential
losses, minimize uncertainty in achieving its goals and objectives and maximize the opportunities

4
to achieve its mission and vision. It is imperative that NIB has to identify the most significant risks
and possible strategies to offset the risks by developing applicable risk management system within
the context of NBE guidelines. Accordingly, the following risks in line with NBE directives are
considered in this program: credit risk, liquidity risk, interest rate risk, foreign exchange risk and
operational risk. And it also aware that some risks can never be eliminated fully and it has in place
a strategy that provides a structured, systematic and focused approach to managing risk. However,
risk management is not about being ‘risk averse’, it is about being ‘risk aware’. Some amount of
risk taking is inevitable in achieving the Bank’s objectives. The Bank seeks to make utmost
opportunities and achieve its objectives.
1.2. Background of the study
Banks are financial institutions that play intermediary role in the economy through channeling
financial resources from surplus economic units to deficit economic units. In turn, they facilitate
the saving and capital formation in the economy. In the course of their operations, banks are
invariably faced with different types of risks that may have a potentially adverse effect on their
business. So Banks are obliged to establish a comprehensive and reliable risk management system
because once a risk has been happened, it is too difficult not to switch even to minimize. Risk is the
chance or possibility of loss, damage, injury or failure to achieve objectives caused by an unwanted
or uncertain action or event. Risk management implies adopting a planned and systematic approach
to the identification, evaluation and economical control of those risks, which can threaten the assets
or financial and organizational well-being of the organization. Banking, like most business
ventures, is inherently risky. These risks are of a wide variety and have an impact on the Bank's
profitability. Banks can only be successful if the risks it takes are reasonable, controlled and within
its financial resources.
In their operations banks are particularly exposed to or may potentially be exposed to the following
risks: liquidity risk, credit risk (including residual risk, dilution risk, settlement/ delivery risk, and
counterparty risk); market risks; interest rate risk; foreign exchange risk; operational risk
particularly including legal risk; risk of compliance of the bank’s operations; risk of money
laundering and terrorist financing; and strategic risk.
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).

5
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. Credit risk management in a financial
institution starts with the establishment of sound
lending principles and an efficient framework for managing the risk. Policies, industry specific
standards and guidelines, together with risk concentration limits are designed under the supervision
of risk management committee. These policies, standards and procedures also govern how credit
risk is measured, monitored, reported and controlled. As market conditions change rapidly,
adequacy and effectiveness of internal controls should be reviewed at least quarterly. The diversity
of the business and economic conditions has led to the development of highly sophisticated tools
and models to measure the exposure of a financial institution to credit risk. In case of an individual
loan portfolio, the probability of default, loss given default or credit rationing are the most
commonly used ones to measure the exposure to credit risk. The invention of various credit scoring
models that use observed loan applicant’s characteristics either to calculate a score representing the
applicant’s probability of default or to sort borrowers into different risk classes bring the ability to
address credit risk on a new level. Credit risk is an investors risk of loss arising from a borrower
who does not make payments as promised. Such an event is called a default. Another term for
credit risk is default risk. Investor losses include lost principal and interest, decreased cash flow,
and increased collection costs, which arise in a number of circumstances: consumer does not make
a payment due on a mortgage loan, credit card, line of credit, or other loan, a business does not
make a payment due on a mortgage, credit card, line of credit, or other loan, a business or
consumer does not pay a trade invoice when due, a business does not pay an employee ‘s earned
wages when due, a business or government bond issuer does not make a payment on a coupon or
principal payment when due, an insolvent insurance company does not pay a policy obligation; an
insolvent bank will not return funds to a depositor, and a government grant bankruptcy protection
to an insolvent consumer or business. 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 is of
even of 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. They also provide
loans, credit and payment services such as checking accounts, money orders and cashier ‘s checks.
6
Banks also may offer investment and insurance products and a wide whole range of other financial
services which they were once prohibited from selling.
Credit creation is the main income generating activity for the banks. But this activity involves huge
risks to both the lender and the borrower. The risk of a trading partner not fulfilling his or her
obligation as per the contract on due date or anytime thereafter can greatly jeopardize the smooth
functioning of a bank’s business. On the other hand, a bank with high credit risk has high
bankruptcy risk that puts the depositors in jeopardy. 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.
Credit risk management is a structured approach to managing uncertainties through risk
assessment, developing strategies to manage it and mitigation of risk using managerial resources.
The strategies include transferring to another party, avoiding the risk, reducing the negative effects
of the risk, and accepting some or all of the consequences of a particular risk. Some traditional risk
managements focused on risk stemming from physical or legal causes (such as natural disasters or
fires, accidents, deaths and lawsuits). Financial risk management on the other hand focuses on risks
that can be managed using traded financial instruments. The objective of risk management is to
reduce the effects of different kinds of risks related to a pre-selected domain to the level accepted
by society. It may refer to numerous types of threats caused by environment, technology, humans,
organizations and politics. On the other hand, it involves all means available for humans, or in
particular, for a risk management entity.
1.3. 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

7
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.
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. NBE declared a regulation on credit ceiling or credit cap
of banks. At the end of second quarter November 30, 2017 the level of non-performing credit in
NIB International Bank S.C. report shows 9.46% NPL position above the required threshold 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

8
2015, 2016 & November 2017). Because of the above mentioned points the researcher interested to
do on this topic Assessment of Credit Risk Management Practice in Nib International Bank S.C.
Therefore, this research will investigate the credit approval procedure and credit portfolio
management of NIB Bank S.C.

1.4. Research Question

 What are the credit risk management techniques and tools used by Nib International banks?
 How well credit analysis and approval process is carrying out in NIB International Bank S.C.?
 How the bank does identify, measure, monitor, evaluate, and control credit risk?
 What kinds of mechanisms are used by the bank to handle credit risk?
 What is the major challenge that affects credit risk management practice in NIB International
Bank?
 What are the efficiency and effectiveness of credit risk management decision?
1.5. 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 because of this objective of the study was categorized into general and specific objective.
1.5.1. General Objectives of the Research
The general objective of the study is to assess the credit risk management practice in the case of NIB
International Bank S.C.
1.5.2. Specific Objective

 To assess the credit risk management techniques and tools used by the bank.
 To evaluate how well Credit analysis and approval Process is caring out in NIB International
Bank.
 To assess the bank identification, measurement, monitor, evaluation and control mechanism of
credit risk.
 To identify the mechanisms used by the bank to handle its credit risk.
9
 To identify the challenges that affect credit risk management practice for NIB International
Bank.
 To evaluate the effectiveness and efficiency of credit risk management decision.
1.6. Significance of the Study
This research will 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. Since credit is the back bone of the banking
industry in generating income, the outcome of the study is expected to be relevant to those parties
who have similar objectives and seek information on issues related to credit risk management.
Specifically, the investigation is expected to help policy maker, loan processing and credit
appraisal department, credit administration department and credit risk management department of
Nib International Bank by forwarding relevant information that will help improve their credit risk
management practice. Moreover, the study may also have relevance for other banks policy makers
by providing empirical data that help in improving or formulating the policy environment for credit
risk management practice of their banks. Furthermore, the research may serve as an input for future
study in the area of credit risk management policy and practice.
1.7. Scope of the study
Since the issue of credit risk is a broad area of study, the present study focuses on only assessing
credit risk management policies and practices in Nib International Bank excluding other area of
Bank risks such as operational, interest rate, liquidity risks etc. The focus of the research is
assessment of credit risk management practice of Nib International Bank and the researcher mainly
focuses on credit administration, credit appraisal and related area at head office and risk
management department in order to gather relevant information about the area of study. Therefore,
the study is limited to the credit activity and risk management practice of Nib International Bank
on the above mentioned departments. Other operations of the bank were not the subject matter of
this research. the paper is limited to cover only Nib International Bank S.C.s credit risk
management practice. On top of this, due to time and cost constraints, the study focused only on
respondents residing at Head Office and Addis Ababa Branches staffs of NIB International Bank
S.C.
1.8. Definition of Terms
Collection policy: It is the steps followed by a company to ensure that borrowers make their

10
 timely payment
Credit risk management: It is loss mitigation process through an understanding of adequacy of
capital in the banks’ and reserves for loan that is lost at any particular time
Credit risk: It is uncertainty that a borrower may not comply with the obligations that were
agreed on in the terms.
Profitability: this is company’s ability to make use of its resources with the aim of generating
revenue more than what their expenses are.
Terms of credit: It is an agreement between a borrower and lender that outlines the timing and
amount of payment that the borrower should make within a stated period of time
1.9. Limitation of the Study
The data used for the study was collected from 77 participants. This sample may not be adequate for a
descriptive survey study. However, it is believed that the fact that participants being employees who
have relevant information about the issue studied are assumed to give comprehensive data about the
risk management policies and practices of the bank. The study’s scope being limited to Addis Ababa
branches can also limit the generalization of the study for other branches out of Addis Ababa City
government. Nevertheless, since the practice and policy of the Bank are expected to majorly similar for
the Bank much of the findings can be applied for other branches.
1.10. Organization of the paper
This Study will be organized into five chapters. The first chapter focuses on background of the
bank, background of the study, statement of the problem, objective of the study, research
question, significance of the study, scope of the study, limitation of the study, organization of
the paper, chapter two focuses on different literatures written on issues related to credit risk
management practices. The third chapter shows the design and methodology of the research,
Chapter four is analysis of the research data with interpretation. Chapter five concludes the
study with major findings, conclusions and recommendations.

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 CHAPTER TWO
REVIEW OF RELATED LITERATURE
2. Introduction
Literature review means locating in a variety of sources Reading it carefully and thoroughly
organizing it into themes along with the line of investigation. This chapter include the theoretical
and empirical evidences concerning about credit risk management practice of Nib International
Bank. The theoretical part includes definition and concept of risk management, general principle
of sound credit risk management in banking, ensuring adequate controls over credit risk, credit
risk management in bank, and credit risk management policy and strategy. Empirical
evidence determines specific definition about credit risk management.
2.1. Theoretical Perspective
The theory that researchers used is bank credit risk management theory. It was developed by David
H. Pyle University of California and it will be used to study why risk management is needed and
our lines some of the theoretical under pinning of contemporary bank risk management, with an
emphasis on credit risk.
2.2. Empirical Evidence

Kwaku D. (2015) studied assessing credit risk management practices in the banking industry of
Ghana: process and challenge and obtained the following findings. Some of the key findings from
the study revealed that the bank has documented policy guidelines on credit risk management
with a senior manager having oversight responsibility for implementation. However, the study
shows that there are some implementation challenges of the credit risk policies which have
12
 resulted low quality of loan portfolio of the bank. It is being submitted that bank's risk policy
shall be review frequently.
Chen J. and Shuping H(2012) conducted research on the credit management of commercial banks
of Lianyungang city for the small scale and medium enterprise (SMEs).Investigators have found
out that the risk management plan and operation method that really suit for credit demand for the
SMEs is still not mature and it caused that the bad debts and dead loan were overstocked in
lianyungang commercial bank, thus it seriously impact on the capital operation of commercial
banks, and it has caused some adverse impact to the development of local economy . There for it is
necessary for commercial banks in Lianyungang city to supervise and manage the whole process
of credit of the small and medium-sized enterprise.
Abdu’s (2004) has examined empirically the performance of Bahrain a commercial bank with
respect to credit (loan), liquidity and profitability during the period 1994-2001. Nine financial
ratios (return on Asset return on Equity, cost to Revenue ,Net Loans to Total Asset, Net Loan to
Deposit ,Liquid Asset to Deposit, Equity to Asset, Equity to Loan and Non-performing loan to
Gross loan )are selected for measuring credit ,liquidity and profitability performance. By applying
these financial measures, this paper found that commercial banks' liquidity will not at par with the
Bahrain banking industry. Commercial banks are relatively less profitable and less liquid and, are
exposed to risk as compared to banking industry. With regard to asset quality or credit
performance, this paper found no conclusive result.
Hagos M. (2010) has investigated credit management on Wegagen banks. The main objective of
the study is to evaluate the performance of credit management of Wegagen bank in Tigray Region
as compared to National bank's requirements in comparison with its credit policy and procedures.
The following findings are the result of the investigation: the issues impeding loan growth and
rising loan client’s complaint on the bank regarding the valuing of properties offered for collateral,
lengthy of loan processing, amount of loan processed and approved, loan period, and discretionary
limit affecting the performance of credit management.

The existing literature indicates that several studies are carried out about credit risk management
on commercial banks abroad and Ethiopia. However due to diversified and intensified investments
in the country during last 10 and or above years there is an increase of loan demands among
investors from commercial banks in the country. In addition to this, high demands for loan

13
commercial banks are highly busy in launching branches across the country. These situations have
created an environment in which commercial banks to encounter risk in credit management. Loans
are becoming large and at the same time, bad loans have increased substantially during the past
few years.

Risk is the element of uncertainty or possibility of loss that prevail in any business transaction in
any place, in any mode and at any time. To sustain its operation, a business has to earn
revenue/profit and thus has to be involved in activities whose outcome may be predictable or
unpredictable. Hence, risks don’t disappear, they gave users a choice; which to retain and which
to shed (Bagch 2006),
In the financial arena, such risks can be broadly categorized as Credit Risk, Market risks and
organization risk (Bagch 2006). Managing such risk is not a new phenomenon, has been there
over the ages in some form or other, to make decision on which to retain and on which to shed,
through its various forms and were not called market risk, credit risk or operational risk as they
are today. Specially, the concern over risk management arose from the development of the
downfall of the oldest merchant bank in February-1995, the Asian financial crisis in July 1997, the
Japanese bank crisis of 1993 and Bank for International settlements (2003), Fukao (2003),
International Monetary Fund (2003), Kashuap (2002), American financial crises of 2007-2009,
were the consequences of uncollectible (non – performing loans). The above incidents make to
come to certain conclusion about risk and risk taking decisions, among that
● risk do increase over time in a business, especially in globalized environment Increasing
competition, the removal of barriers to entry to new business units by many countries, higher
order expectations by stakeholders lead to assumption of risk without adequate support and
safeguards.
● a mere quantitative approach to risk perceptions –arising out of trading volume, earning
level. doesn’t reveal the inherent drawback in an organization/ system
● The introduction of new technologies, while introducing countless benefits, has also created
many new risks for an organization
● The external operating environment in the 21 century is noticeably different. it is not
possible to manage tomorrows event with yesterday’s system and procedures and today’s

14
human skill

15
Such incident and the existing globalized stiff competitive market highly magnify the importance
of risk management in recent times. The international regulatory authority, the Bank for
International Settlement at Basel, Switzerland, has been working on a well- structured risk
management system. Risk management is thus a functional necessity and adds to the strength and
efficiency of an organization on an ongoing basis. Effective risk management is critical to any
bank for achieving financial soundness. In view of this, aligning risk management to bank’s
organizational structure and business strategy has become integral in banking business. The
efficacy of any risk management system depends on its architecture, this comprise the following
essential elements (Bagch, 2006)
● A clearly defined and structured organizational set- up to manage enterprise- wide risks
● Commitment of the highest level of those who see the policy framework and oversee
implementation within the organization- that is the Board Directors and Senior Management
● Codification of risk management policies/principles, articulated is such a way that it serves the
organizational risks appetite within the continuous of risk perceptions,
● Implementing strategy of the direction through specific risk management process so as to
effectively identify measure and control risk.
● Manpower development initiatives to improve the skill- sets of people in the organization
● Periodic evaluation
● Risk audit
Prerequisites for Efficient Risk Management in order to implement efficient risk management,
sound and consistent methods, processes and organizational structures as well as IT systems and
an IT infrastructure are required for all five components of the control cycle. The methods used
show how risks are captured, measured, and aggregated into a risk position for the Bank as a
whole. In order to choose suitable management processes, the methods should be used to
determine the risk limits, measure the effect of management instruments on the Banks risk
position, and monitor the risk positions in terms of observing the defined limits and other
requirements. Processes and organizational structures have to make sure that risks are measured
in a timely manner that risk positions are always matched with the defined limits, and that risk
mitigation measures are taken in time if these limits are exceeded. Concerning the processes, it is
necessary to determine how risk measurement can be combined with determining the limits,
risk controlling, as well as monitoring. Furthermore, reporting processes have to be introduced.

10
The organizational structure should ensure that those areas which cause risks are strictly separated
from those areas which measure, plan, manage, and control these risks. IT systems and IT
infrastructure are the basis for effective risk management. The IT infrastructure is a central
prerequisite for implementing modern risk management. Hence, implementing risk management
will also insist to have supported with defined organizational – set up and defined role of the
officials, principles and policy. It will also have a clear risk management process. Risk
management process is a vehicle to implement an organization’ risk principles and policies, aided
by organizational structure, with the sole objective of creating and maintain a healthy risk culture
across the organization.
Internationally, the risk management process has four components; -identification, measurements,
monitoring and control. It is apparent, therefore that the risk management process through all its
four wings – identification, measurement, monitoring and control- facilitates the organization's,
sustainability and growth.
2.2.1. Definition and Concept of Risk Management
Management is the simplest understand definition can be defined as the act of planning, directing,
controlling, monitoring and testing for designed results to be obtained. Risk on the other hand
defined as uncertainty concerning the occurrence of loss (Radjda, 2011). When companies
indulge in business, it is obvious that they would be exposed to one type of risk or another which
in most cases in uncertainty although at times it can be certain that it would occur. Banks are one
of such business whose risk is very sure because they do not function in isolation given the
dynamic environment in which they operate.

Risk management is a systematic process for the identification and evaluation of pare loss
exposures faced by an organization or individual and for the selection and implementation of the
most appropriate technique, for treating such exposures ( Radja, 2011). Credit risk can be defined
as the potential that a contractual party would fail to meet its obligations in accordance with
agreed terms. Credit risk is the largest element of risk in the books of most banks and, if not
managed in a proper way, can weaken individual banks or even cause many episodes (divisions)
of financial instability by impacting the whole banking system. Thus to the banking sector,
credit risk is

11
 definitely an inherent and crucial part as by (Jackson and Perraudin, 1999). Credit risk
management defined as the process of controlling the potential consequence of credit risk.
2.2.2. Sources of credit risk

The main source of credit risk includes, limited institutional capacity, economic and market
fluctuation, inappropriate credit policies, volatile interest rates, poor management, inappropriate
laws, ineffective control process, poor loan underwriting, poor lending practice, government
interference, absence of real financial statement from the customer, customer awareness problem,
and inadequate supervision by the central bank (Kithinji,2010). He identified poor project
supervision, evaluation and management, untimely loan disbursement, division of funds, and
dishonesty of loan beneficiaries as a case of loan default which ultimately leads to credit risk. To
reduce the probability of credit risk, financial institutions should take-part in different situations
that may enables them to overcome the occurrence of un-expected default. So as to attain these
objectives institutions should create a trustworthy information to both the staffs and borrowers,
develop the habit of good understanding (relationship) between the high level executives’ and
those who are operates through the organization, follow-up regularly the performance of the
debtors, recover loans which are due.
2.3. General Principles of Sound Credit Risk Management in Banking
Reviewing the general principles of credit risk management can provide a clearer picture on how
banks carry out their credit risk management, despite of the specific approaches that may differ
among banks.
Some of the principles of sound practices of bank credit risk management as outlined in the Basel
committee publications (http://www.ibm.com/us, 2008) cover the following four areas:
2.3.1. Establishing an Appropriate Credit Risk Environment
To establish an appropriate credit risk environment mainly depends on a clear identification of
credit risk and the development of a comprehensive credit risk strategy as well as policies. To
banks, the identification of existing and potential credit risk inherent in the products they offer and
the activities they engage in is a basis for an effective credit risk management, which requires a
careful understanding of both the credit risk characteristics and their credit-granting activities.

12
Besides, the design of objective credit risk strategies and policies that guide all credit-granting
activities is also the cornerstone in bank credit risk management process.

It is stated that a credit risk strategy should clarify the types of credit the bank is willing to grant
and its target markets as well as the required characteristics of its credit portfolio. According to
Saunders (2006), these strategies should reflect the banks tolerance for risk and the level of
profitability the bank expects to achieve for incurring various credit risks. Again, Boatengs (2004)
study shows that the credit risk strategy of a bank should give recognition to the goals of credit
quality, earnings and growth. Every bank, regardless of size, is in business to be profitable and,
consequently, must determine the acceptable risk-return trade-off for its activities, factoring in the
cost of capital (Richard, 2010).

While credit policies express the banks credit risk management philosophy as well as the
parameters within which credit risk is to be controlled, covering topics such as portfolio mix, price
terms, rules on asset classification, etc. According to Boating (2004), a cornerstone of safe and
sound banking is the design and implementation of written policies and procedures related to
identifying, measuring, monitoring and controlling credit risk. Moreover, establishing an
appropriate credit environment also indicates the establishment of a good credit culture inside the
bank, which is the implicit understanding among personnel about the lending environment and
behavior that are acceptable to the bank.
2.3.2. Process Operating under a Sound Credit Granting
The Basel Committee (2000) asserts that in order to maintain a sound credit portfolio, a bank must
have an established formal transaction evaluation and approval process for granting of credits.
Approvals should be made in accordance with the banks written guidelines and granted by the appropriate
level of management. There should be a clear audit trail documenting that the approval process was
complied with and identifying the individual(s) and/or committee(s) providing input as well as making the
credit decision (Boating, 2004).
A sound credit granting process requires the establishment of well-defined credit granting criteria as well
as credit exposure limits in order to assess the creditworthiness of the obligors and to screen out the
preferred ones. In this regard Thomas (2002) asserts that banks have traditionally focused on the principles
of five Cs to estimate borrowers’ creditworthiness. This five C’s are:

13
i. Character. This refers to the borrower’s personal characteristics such as honesty, willingness
and commitment to pay debt. Borrowers who demonstrate high level of integrity and
commitment to repay their debts are considered favorable for credit.
ii. Capacity. This also refers to borrowers’ ability to contain and service debt judging from the
success or otherwise of the venture into which the credit facility is employed. Borrowers who
exhibit successful business performance over a reasonable past period are also considered
favorable for credit facility.
iii. Capital. This refers to the financial condition of the borrower. Where the borrower has a
reasonable amount of financial assets in excess of his financial liabilities, such a borrower is
considered favorable for credit facility.
iv. Collateral. These are assets, normally movable or unmovable property, pledged against the
performance of an obligation. Examples of collateral are buildings, inventory and account receivables.
Borrowers with a lot more assets to pledge as collateral are considered favorable for credit facility.

v. Condition. This refers to the economic situation or condition prevailing at the time of the
loan application. In periods of recession borrowers find it quite difficult to obtain credit facility.
Banks must develop a corps of credit risk officers who have the experience, knowledge and
background to exercise prudent judgment in assessing, approving and managing credit risks.

A banks credit-granting and approval process should establish accountability for decisions taken
and designate who has the absolute authority to approve credits or changes in credit terms.
2.3.3. Maintaining an Appropriate Credit Administration, Measurement and
Monitoring Process
Credit administration is a critical element in maintaining the safety and soundness of a bank. Once
a credit is granted, it is the responsibility of the bank to ensure that credit is properly maintained.
This includes keeping the credit file up to date, obtaining current financial information, sending
out notices and preparing various documents such as loan agreements, and follow-up and
inspection reports.
Credit administration, as emphasized by Wesley (1993) can play a vital role in the success of a
bank, since it is influential in building and maintaining a safe credit environment and usually
saves the institution from lending problems. Therefore, banks should never neglect the
effectiveness of their credit administration operations. Then talking about credit risk
measurement in banks, it is required that banks should adopt effective methodologies for

15
 assessing the credit risk inherent both
in the exposures to individual borrowers and credit portfolios The last focus in this area of
principles is related to credit risk monitoring, which is definitely a must in banks’ risk
management procedure. A proper credit monitoring system will provide the basis for taking
prompt corrective actions when warning signs point to deterioration in the financial health of the
borrower.
2.3.4. Ensuring Adequate Controls over Credit Risk
In order to ensure adequate controls over credit, there must be credit limits set for each officer
whose duties have something to do with credit granting. Material transactions with related parties
should be subject to the approval of the board of directors (excluding board members with conflicts
of interest), and in certain circumstances (e.g. a large loan to a major shareholder) reported to the
banking supervisory authorities. The means for guaranteeing adequate controls over credit risk in
banks lay in the establishment of different kinds of credit reviews. Regular credit reviews can
verify the accordance between granted credits and the credit policies, and an independent
judgment can be provided on the asset qualities.

As types of credit, facilities of one bank can be broadly classified in to two groups’ funded and
non-funded credit. Any type of credit facility which involved direct flow of banks fund on
account of borrowers is treated as funded credit facility.

Funded credit facility may be classified in to four major types: - loans, cash credit, overdraft and
bill discounted and purchase. A type of credit facility where there is no involvement of direct out
of banks find on account of borrower termed as non-funded credit facility. Non funded credit
facilities may turn in to funded facilities at times. As such, liabilities against those types of credit
facilities are termed as contingent liabilities.

The major no funded credit facilities are letter of credit bid bond, performance bond, advance
payment guarantee and foreign counter guarantee.

2.4. Analysis of the creditworthiness of bank loan applicants

The notion ‘creditworthiness’ can be defined as a presumed ability to meet agreed deadlines
related to repaying the credit and interest accrued without affecting the vitality of the borrower,
that means the repayment process should be based on the income received in the process of the

16
borrowers

17
usual activity, without affecting adversely his financial situation, his financial results as well as
other business entities (stoyanov, 2008).
2.4.1. Pre-requisites of creditworthiness
According to stoyanov, the prerequisites of credit worthiness are divided in to personal and
financial prerequisites.

Personal prerequisites: the will to work and demonstrate enterprise along with courage in decision
making and ability to respond quickly and adequately to the changing environment. To the
personal creditworthiness, prerequisites belong: the ability to make an estimate when comparing
incomes and expenditure for the corresponding business activity for higher achievements and to
implement effective management.

Financial pre-requisites: it is the data about the financial and economic situation of the loan
applicant. These includes forecast about expected development of the industry and the role that the
enterprise plays in it, a study whether the loan can be repaid in accordance with the terms and
using revenue from the activity of the business entity.
2.4.2. Accounting information and creditworthiness analysis
From the presented data of creditworthiness analysis of bank loan applicants, the accounting
information has highest relative share in the total value of this information. The minimal required
number of accounting reports presented by the loan applicants such as accounting balance sheet,
profit and loss account, statement of changes in equity and statement of cash flows.

2.5. Credit Risk Management in Banks

Although the effects of all risks type cause negative consequences to the bank, credit risk has been
identified as the key risk associated with negative consequences, in terms of its influences on the
bank performance (Sinkey, 1996). This means if credit risk is not well managed it can lead to
failure. Thus for any bank to succeed its credit risk management, it must be handled with a lot of
effective follow up activities.

A clear reason why a correct management of credit risks is very important that before a banking
gives out a loan, it should try are as much as possible to have a reliable view of the borrower.

18
The bank has to assess the credit risk worthiness of the borrower even after the loan is granted in
terms. Monitoring is required until when the borrowers has finished repaying the loan. This
monitoring is very important because with the uncertainty in the future any potential event that can
cause a borrower to default payment can be fast identified or a mechanism can be part in place on
time to reduce the frequency of loss should it occur. Early identification of borrowers at risk is
good because it enables services adequately staff collections departments, determine the most
effective type of customer we reached and initiate repayment plans before borrower’s situation
worsens to the point which for closure is on a voidable (Cocardi, 2009).
2.5.1. Obstacles to credit Risk Management
According Machiraju (2002), the task of management of credit risk is rendered difficulty in
developing markets by government controls, political pressures, delays in production schedule
and frequent instability in production schedule and frequent instability in a business environment
undermine the financial information is unreliable and the legal frame work does not support debt
recovery. The difficult external context is reinforced by internal weakness of banks further
undermine the asset quality.
2.5.2. Deficiency in Credit Risk Management
The common deficiencies observed in credit risk management according to Machiraju (2008) in
Banks are absence of written policies, absence of portfolio concentration, inadequate financial
analysis of borrowers, Excessive reliance on collateral, inadequate check and balance in the credit
process, absence of loan supervision and failure to control and Audit the credit process effectively.
2.6. Credit Risk Management Policy
Banks like any other firm have formal laid down policies and principles that have been put in
places by the board of directors on how to manage credits and this have to be supervisors or
managers on how to take action. Manass and Zietflow (2005) specify that credit policy has three
major components. The primary component is credit sanders which is the profile of minimally
acceptable credit period stipulating how long from the invoice the customer has to pay and the
cash discount to (if any). the second, is credit limit that the dollar amount that cumulative credit
is extended and the last is collection procedures and these are detailed statement regarding when

19
and how the company would carry out collection of past due accounts, Despite the rules it does
not mean that credit policies are stereotyped. “A good lending policy is not very restrictive, but
allows for the presentation of loans to the board that officers believe are worthy of consideration
but which do not fall within the parameters of written guide lines”. Since the future is uncertain
flexibility must be allowed for easy adaption to changing condition (may be internal or
environmental). For the risk management policies and philosophies have to be used in order to
control the credit risk (Geruring and Bratanvic, 2003).
2.7. Credit Risk Management Practices
Banks have different credit risk management policies or philosophies same do the risk
management practices differ from the financial institution to another despite the fact that they can
open to the same risk. The policies and philosophies each and every bank has their individual level
of risk that they can decide to let go based on how it is out lined in their risk management policy.
To exit from firms in the same industry but the implementation in practices differs practices is
not consistent with theory in most cases because of data limitation for most industries, it difficult
to describe which firms manage more risk than others or whether firms language in dynamic risk
management strategies and more importantly it cannot be reliably tested whether firms language
in dynamic risk management strategies and more importantly it cannot be reliability tested
whether a firms management practices conform with existing of theories (Tufano, 1996).
2.8. Credit Risk Management Strategies
E. Michael (1996) defines a strategy as a plan (Method) for achieving something. A strategy thus,
simply means a way to go about activity. This thus goes that as a bank has different credit risk
policies (philosophies and different practices, their strategy to attain their deferred goals in the
same way differ. A strategy position means performing different activities from rivals or
performing different activities from rivals or perform its rivals only if it can establish a difference
that it can preserve by effective strategy (porter, 1996). When banks carry out its operational
activities which are the same activities carried out by other banks, they should try to make
differences from their rivals by not only typing to be more efficient but also try to make a
difference. For example, maintaining an appropriate credit administration, monitoring process,
ensuring adequate control over credit, but these practices in conjunction with sound practice

20
related to the assessment of asset quality adequacy of provision and reserves and the disclosure of
credit risk.
2.9. Credit Risk Management process
The same way that bank has different credit culture (the policies, practices, and philosophy and
management style). They also have different credit risk management process. It is a set of out lined
activities aimed at managing credit risk.

These phases are not distinct like the other three phases. In the control phase, measure which can
be used to avoid, reduce, prevent, or eliminate the risk are put in phase. The monitoring phase is
used to make a constant check so that all process or activity which have been put in place for the
risk management process are well implemented for desired result to be gotten and in case of any
distortion, corrections are then made. All this is done because credit risk is a very important and
delicate risk that banks face and needs to be managed with great care (precaution) because its
consequences are always every detrimental to the bank. Despite the changes in the financial
services sector, credit risk remains the major single cause of banks failure (Greuning of Bratanovic,
2003).

2.10. Credit risk management for Ethiopian banks

This was disclosed at a one-day seminar on Credit and Risk Management, held on Thursday,
February 14 at the Sheraton Addis and organized by Zemen Bank incollaboration with eVentive
and Harland Financial Solutions. The Bank is also taking the lead in the country in implementing
the Basel II Framework. The Basel II Framework describes a more comprehensive measure and
minimum standard for capital adequacy that national supervisory authorities are now working to
implement through domestic rule-making and adoption procedures. It seeks to improve on the
existing rules by aligning regulatory capital requirements more closely to the underlying risks
that banks face. Basel II requires banks to collect more data about customers and consistently
use best practices for credit risk management. Participants at the seminar were credit officials
from both private and government banks and from the Ministry of Capacity Building.The
purpose of organizing the seminar was to create awareness among other banks so that they too
would benefit by using the software. At the seminar, Harland Financial Solutions
Worldwide and Kenya Commercial Bank presented a Credit Risk Symposium for Ethiopian
banks. Harland Financial

21
Solutions Worldwide is a global software company with over 7,000 financial institution customers
and delivers Credit Quest solutions for credit risk management for banks worldwide. The full day
symposium also covered the Evolution of Credit Risk and Lending Systems, Regulatory
Requirements for Lending and Credit Risk Systems (Basel II), a demonstration of the Credit Quest
product and a Case Study of KCB ‘s implementation of Credit Quest.
2.11. Credit Risk Models
Over the last decade, a number of the world ‘s largest banks have developed sophisticated systems
in an attempt to model the credit risk arising from important aspects of their business lines. Such
models are intended to aid banks in quantifying, aggregating and managing risk across
geographical and product lines. The outputs of these models also play increasingly important roles
in banks ‘r i s k management and performance measurement processes, including performance-
based compensation, customer profitability analysis, risk-based pricing and, to a lesser (but
growing) degree, active portfolio management and capital structure decisions. The task force
recognizes that credit risk modeling may indeed prove to result in better internal risk management,
and may have the potential to be used in the supervisory oversight of banking organizations.
However, before a portfolio modeling approach could be used in the formal process of setting
regulatory capital requirements for credit risk, regulators would have to be confident not only that
models are being used to actively manage risk, but also that they are conceptually sound,
empirically validated, and produce capital requirements that are comparable across institutions. At
this time, significant hurdles, principally concerning data availability and model validation, still
need to be cleared before these objectives can be met, and the committee sees difficulties in
overcoming these hurdles in the timescale envisaged for amending the capital accord. Credit
scoring models use data on observed borrower characteristics either to calculate the probability of
default or to borrowers into different default risk classes (Saunders and Cornett, 2007).
Prominent amongst the credit scoring models is the Altman ‘s Z-Score. The Z-score formula for
predicting bankruptcy of Dr. Edward Altman 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%.
The Altman ‘s credit scoring model takes the following form;
Z=1.2x1+1.4x2+3.3x3+0.6x4+1.0x5
Where, X1 = Working capital/ Total assets ratio

20
 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 ‘s default risk classification. According nto
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.
2.12. Tools of Risk Management
Risk is handled in several ways most authors give the following risk handling tools. These are
avoidance, loss prevention and reduction, separation, diversification /combination, non-insurance
transfer, retention and insurance. Those tools are classification to two (1) Risk Control and, (2)
Risk finance tools.
2.12.1. Risk control tools

Avoidance: Avoidance of risk exists when the individual or the organization free itself from the
exposure through abandonment of refusal to accept the risk, an individual can avoid third person
disability by not owing a care product, liability can be avoided by dropping the product. Leasing
avoids the risk organizing from property ownership.

Avoidance is a useful common approach to handle the risk. By avoiding a losses or uncertainties
that exposure may generate.

Loss prevention and reduction measurement: This measure refers to the safety taken by the firm
to prevent the occurrence of the loss or reduce its severity. Loss reduction measurements try to
minimize the severity of the loss once the partial happened. Example automobile accidents can be
prevented or reduced by having good road, better light and sound affect regulations and control
fast first aid service and control. The libel loss prevention and loss reduction measures must be
considered the risk manager considers the application of any risk financing instrument.

Separation: Separation of the firm exposure to loss instead of concentrating them at one location
where they might be involved in some loss. For example, instead of placing its entire inventory in

21
one wear have, the firm may prefer to separate this exposure by placing equal parts of the
inventory in ten widely separated warehouses.

Combination or Diversification: Combination is a basic principle of insurance that follows the low
of large numbers. It can reduce risk by making loses more predictable with a higher degree of
accuracy. The difference is that unlike separation, which spreads a specified number of exposure
units under the control of the firm.

Diversification most speculative risk in the business can deal with diversification. A business firm
diversifies their product, i.e. a decline in profit of one business could be compensated by profits
from others.

Non-insurance transfer- this may be accomplished on two ways: -

Transfer of the activity or property: The property or activity responsible for the risk may be
transferred to some another person or group of person. This type of transfer is closely related to
avoidance through risk control measure because it eliminates a potential loss that may strike the
firm must pass in to someone else.

Transfer of the probable loss: The risk but not the property or activity, may be transferred leasing
rather than buying. If the goods remain unsold or expired, they would be returned to the consignor.
2.12.2 Risk financing tools
Retention: this is the earliest method of handling risk. The firm consciously or unconsciously,
decides to assume the risk. The loss is to be burned by the person or firm, and specific
measurements should be taken to retain the loss it the loss is less is severity. The firm decides to
retain the risk for a number of reasons. It is probably impossible to transfer the risk as in the case
of gambling besides the attitude of the individual of the firm towards risk. The value of goods to
be insured compared to insurance cost is another factor that may force businesses to assume risk,
cost benefit analysis. Retention can be effectively used in a risk management program when
contain conditions exist.

22
 2.13. Policy guidelines

The fundamental credit risk management policies that are recommended for adoption by all banks
in Bangladesh. The guidelines contained herein outline general principles that are designed to
govern the implementation of more detailed lending procedures and risk grading systems within
individual banks.

Lending Guidelines

All banks should have established Credit Policies (Lending Guidelines) that clearly outline the
senior management‘s view of business development priorities and the terms and conditions that
should be adhered to in order for loans to be approved. The Lending Guidelines should be updated
at least annually to reflect changes in the economic outlook and the evolution of the bank‘s loan
portfolio, and be distributed to all lending/marketing officers. The Lending Guidelines should be
approved by the Managing Director/CEO & Board of Directors of the bank based on the
endorsement of the bank‘s Head of Credit Risk Management and the Head of
Corporate/Commercial Banking. Any departure or deviation from the Lending Guidelines should
be explicitly in credit applications and a justification for approval provided. Approval of loans that
do not comply with Lending Guidelines should be restricted to the bank‘s Head of Credit or
Managing Director/CEO & Board of Directors.

The Lending Guidelines should provide the key foundations for account officers/relationship
managers (RM) to formulate their recommendations for approval, and should include the
following:

 Industry and Business Segment Focus

The Lending Guidelines should clearly identify the business/industry sectors that should
constitute the majority of the bank‘s loan portfolio. For each sector, a clear indication of the
bank‘s appetite for growth should be indicated (as an example, Textiles: Grow, Cement:
Maintain, Construction: Shrink). This will provide necessary direction to the bank‘s marketing
staff.

 Types of Loan Facilities

The type of loans that are permitted should be clearly indicated, such as Working Capital, Trade

23
Finance, Term Loan, etc.

24
  Single Borrower/Group Limits/Syndication

Details of the bank‘s Single Borrower/Group limits should be included as per Bangladesh Bank

guidelines. Banks may wish to establish more conservative criteria in this regard.

 Lending Caps

Banks should establish a specific industry sector exposure cap to avoid over concentration in
any one industry sector.

 Discouraged Business Types

Banks should outline industries or lending activities that are discouraged. As a minimum, the
following should be discouraged:

 Military Equipment/Weapons Finance

 Highly Leveraged Transactions
 Finance of Speculative Investments
 Logging, Mineral Extraction/Mining, or other activity that is Ethically or
Environmentally Sensitive
 Lending to companies listed on CIB black list or known defaulters
 Counterparties in countries subject to UN sanctions
 Share Lending
 Taking an Equity Stake in Borrowers
 Lending to Holding Companies
 Bridge Loans relying on equity/debt issuance as a source of repayment.
 Loan Facility Parameters

Facility parameters (e.g., maximum size, maximum tenor, and covenant and
security requirements) should be clearly stated. As a minimum, the following parameters should
be adopted:

Banks should not grant facilities where the bank ‘s security position is inferior to that of any
other financial institution.

Assets pledged as security should be properly insured.

25
Valuations of property taken as security should be performed prior to loans being granted. A
recognized 3rd party professional valuation firm should be appointed to conduct valuations.

 Cross Border Risk

Risk associated with cross border lending. Borrowers of a particular country may be unable or
unwilling to fulfill principle and/or interest obligations. Distinguished from ordinary credit risk
because the difficulty arises from a political event, such as suspension of external payments

 Synonymous with political & sovereign risk

 Third world debt crisis

2.14. Banks Performance and Its Determinants

The role of bank remains central in financing economic activity and its effectiveness could exert
positive impact on overall economy as a sound and profitable banking sectoris better able to
withstand negative shocks and contribute to the stability of the financial system (Athanasoglou et
al, 2005). Therefore, the determinants of bank performance have attracted the interest of academic
research as well as of bank management, financial markets and bank supervisors since the
knowledge of the internal and external determinants of banks profits and margins is essential for
various parties. During the last two decades the banking sector has experienced worldwide major
transformations in its operating environment. Both external and domestic factors have affected its
structure and performance. Correspondingly, in the literature, bank profitability is usually
expressed as a function of internal and external determinants.

The internal determinants refer to the factors originate from bank accounts (balance sheets and/or
profit and loss accounts) and therefore could be termed micro or bank specific determinants of
profitability. The external determinants are variables that are not related to bank management but
reflect the economic and legal environment that affects the operation and performance of financial
institutions. A number of explanatory variables have been proposed for both categories, according
to the nature and purpose of each study (Yuqi Li).

2.14.1. Internal determinants

Studies dealing with internal determinants employ variables such as size, capital, risk management
and expenses management. Size is introduced to account for existing economies or diseconomies
of scale in the market. Akhavein et al. (1997) and Smirlock (1985) find a positive and significant

26
relationship between size and bank profitability. Demirguc-Kunt and Maksimovic (1998) suggest
that the extent to which various financial, legal and other factors (e.g. corruption) affect bank
profitability is closely linked to firm size. In addition, as Short (1979) argues, size is closely
related to the capital adequacy of a bank since relatively large banks tend to raise less expensive
capital and, hence, appear more profitable. Taking the similar approach, Haslem (1968), Short
(1979), Bourke (1989), Molyneux and Thornton (1992) Bikker and Hu (2002) and Goddard et al.
(2004), all link bank size to capital ratios, which they claim to be positively related to size,
results indicated that as size increases. Especially in the case of small to medium-sized banks.
Profitability rises. However, many other researchers suggest that little cost saving can be
achieved by increasing the size of a banking firm (Berger et al., 1987), which suggests that
eventually very large banks could face scale inefficiencies. Other internal factors, such as credit
or liquidity are considered as bank specific factors, which closely related to bank management,
especially the risk management. The need for risk management in the banking sector is inherent
in the nature of the banking business. Poor asset quality and low levels of liquidity are the
two major causes of bank failures and represented as the key risk sources in terms of credit and
liquidity risk and attracted great attention from researchers to examine their impact on bank
profitability.
2.14.2. External determinants
Turning to the external determinants, several factors have been suggested as impacting on
profitability and these factors can further distinguish between control variables that describe the
macroeconomic environment, such as inflation, interest rates and cyclical output, and variables
that represent market characteristics. The latter refer to market concentration, industry size and
ownership status (Athanasoglou et al, 2005).

27
 CHAPTER THREE
RESEARCH DESIGN AND METHODOLOGY
Introduction
This chapter discussing the methodology that used during the collection, analyzing and
interpretation of data, it also the research design, population size and sampling techniques, data
collection instrument and methods of data analysis discussed on this chapter.
3.1 Research Methodology

The objective of the study is to assess the existing credit risk management practice of NIB
international Bank S.C. The research design looked at the overall methodology used in the study.
It adopts the following structure: First the research design is described, and then research
approach, data collection methods, research procedures and data analysis methods to be followed
in the research process.
3.1.1. Research Design
This study will b e conducted by employing descriptive research design because it involves a systematic
collection and presentation of data and describe (justify) the current nature of credit risk management
practice in Nib International Bank.

3.1.2. Research approach

This study will be using both quantitative and qualitative (mixed) approach. Quantitative approach is based
on the measurement of quantity or amount of the data. On the other hand, the purpose of qualitative
approach is to search the data that occurs in the credit risk management.

28
3.1.3. Population (target groups)
The target groups of this study are employees who are directly involved in credit risk management
and administration. This means for this study only credit appraisal department, credit analysts,
credit information and portfolio management division, customer relation managers (CRM)
department, risk management department and selected branches that have a significant loan
disbursed amount from the total loan disbursed by the bank.
3.1.4. Sampling techniques and sample size

Purposive sampling will be use under the non-probability sampling to collect data from the
employee of the bank in line of the research question. The rationale behind employing this
purposive sample type is to identify the employee that have specialized knowledge of credit risk
management and to share their understandings about the study. The study populations
drowning from Nib International Bank professionals and clerical employees those are working
at Addis Ababa Branches. There are 568 credit related employees working on the bank and
2,235 borrowers throughout 215 branches. For this study only credit appraisal department,
credit analysts, credit information and portfolio management division, customer relation
managers (CRM) department, risk management department and selected eighteen branches
that have a significant loan disbursed amount from the total loan disbursed by the bank.
There are a total of 58 employees in the departments and 44 employees and 30 borrowers
from those selected eighteen branches a total of 102 employees and 30 borrowers included
in the research as a sample size.
3.1.5. Source of data
In order to get efficient and relevant information about the study, researcher use primary and
secondary data source.
3.1.6. Method of data collection
For the purpose of this study, will use primary and secondary data source. Primary data collected
through questionnaires distributed to respondents that involve professional working in the
banks such as branch managers, credit analysts, customer relation managers, loan recovery
officers & loan officers as well as loan customers of the bank. In addition, interview employed for
management members as primary data sources to supplement the questionnaire. The secondary
data collected from financial statements and annual reports of the bank.

3.1.7. Method of Data analysis 29

The relevant information that will be collected from primary and secondary source of data shall
depend on the basis of descriptive analysis method. Because of, descriptive analysis uses
transformation of raw data in to a form and will be easy to understand to the reader and
enterprise. Descriptive is largely the study of the distribution of one variable form. In line with
descriptive data analysis the study will be use frequency, percentage and interpretation analysis.

30
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Eisenhardt, K.M. (1989) “Agency Theory: An Assessment and Review”. Academy of

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Jensen, M.C. and Meckling, W. (1976) “Theory of the Firm: Managerial Behavior, Agency costs

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35
Appendix I
GRADUATE STUDIES MBA PROGRAM

Dear Sir / Madam, the purpose of this questionnaire is to gather data regarding the credit risk
management practice in NIB International Bank S.C.
I would appreciate your point of view regarding the credit risk management practice at your bank.
Your specific response to the questions here will facilitate me in completing my thesis. I assure you that
STRICTLY CONFIDENTIAL and used for academic research purpose only.
I thank you in advance for your valuable time and participation in this research. For further
queries, please do not hesitate to contact me in the following address
Natnael Abera Tel. 0925913179
E-Mail Addresses- [email protected]

I. Personal Details
1. Age:
18 – 25 26 – 35 36 – 45 Above 45
2. Your Education qualification
Diploma Holder Degree Holder Masters and Above
3. In which department /section/ of the bank are you working?

4. Year of experience in the Bank?

1 – 4 5 – 8 9 – 12 Above 13

36
 II. Details on manuals:
S.No Statement Yes No
5 The bank‟s credit policy and procedure is it
flexible based on conditions
6 The bank uses internal credit rating system for
all credit facilities
7 The bank‟s credit risk management guideline
or policy easily understandable
8 The guidelines support the goals and
objectives of credit risk management

III. Credit creation and Procedure

S.No Statement Strongly Agree Neutral Disagree Stron
Agree gly
Disag
ree
9 The bank‟s have excellent credit analysis and
procedures followed by the bank in extending
credit
10 The branch lending limit has sufficient as your
branch grade level to serve the borrowers

IV. Follow – up collection

S.No Statement Strongly Agree Neutral Disagree Stron
Agree gly
Disag
ree
11 The credit collection technique used by your
bank is effective

37
 12. What do you think is / are the major reason /s/ for default in your bank? (Please indicate
your choice)
S.No Major reasons to default

Agree

Agree

Neutral

Disagree

Disagree
Strongly

Strongly
a Lack of follow – up
b Lack of training
c Inadequate information about customer credit
worthiness
d Loan diversion
e Lack of market for clients‟ product
f Unfavorable environment conditions
Other, (Please specify)

13. What preventive measures do you think effective to be used before failing loans to
default?
14. What measure /s/ is/are taken on the side of the bank to improve the repayment situation?
(Hint: Check all answers that apply)
a. Loan rescheduling 
b. Additional loan 
c. Frequently insisting the client 
d. Others, (Specify)
15. Which one of forcing measurements do you think most effective and convenience?
a. Foreclosure 
b. Court proceedings 
c. Both 
16. How does your organization effectively communicate to reduce credit risk? (please
indicate your choice)

38
S.No. Statement Strongly Agree Neutral Disagree Strongly
Agree Disagree
A Creating clear and trustworthy information
B Developing understanding between
management team and employee
C Fast and sharp communication between
management team and stakeholders
D Regularly communicating among
management and staff
E Creating and maintain a clear
communication
Other, (Please specify)

17. How often does your organization provide credit risk management training courses?

Never 1 time per year 2 times per year More than 2 times per year
18. What challenges you face in credit risk management?

39
Part II
Kindly read the questions carefully and tick (√) the selected choice.

S.No. Statement

Disagree

Disagree
Strongly

Strongly
Neutral
Agree

Agree
Risk understanding:
19 There is a common understanding of credit risk management in
the bank
20 There is a proper system for understanding credit risks
implemented in the bank
21 Responsibility for risk management is understood throughout
the bank
22 Accountability for risk management is understood throughout
the bank
Risk Identification
23 The bank carries out a compressive and systematic
identification of credit risks relating to each of its declared aims
and objectives
24 Changes in credit risks are recognized and identified with the
bank‟s roles and responsibilities
25 The bank is aware of the strengths and weaknesses of the credit
risk management systems of other banks
26 The bank has developed and applied procedures for the
systematic identification of opportunities
Risk Assessment and Analysis
27 This bank assesses the likelihood of occurring credit risks.
28 This bank‟s credit risks are assessed by using quantitative
analysis methods
29 This bank‟s credit risks are assessed by using qualitative
analysis methods (e.g. High, Moderate, Low)
30 The bank analyses and evaluates opportunities it has to achieve
objectives
31 The bank undertake a credit worthiness analysis before
granting credit or executing transactions
32 Before granting credit by the bank undertakes specific analysis
including the applicant‟s character, capacity, collateral, and
conditions
33 The bank has a computer based support system to
estimate the earnings and risk management variability
34 The bank relies on the output of quantitative data with
human judgment
Risk Monitoring and Controlling
35 Monitoring the effectiveness of credit risk management is an
integral part of routine management reporting

40
36 The level of control by the bank is appropriate for the credit
risks that it faces
37 The bank has adopted a standard reporting system about the
credit risk management from bottom to top management
38 Reporting and communication processes within the bank
support the effective management of credit risks
39 The bank effectively monitors the credit limit of everyone
counterparty
40 The borrower‟s business performance is regularly observed by
the bank following the extension of financing
Managing Credit Risk:
41 The credit risk strategy set by the Board of directors are
effectively communicated within the bank in the shape of
policies by the top management
42 The bank has an effective risk management framework
(infrastructure, process and policies) in place for managing
credit risk
43 The bank has a credit risk rating framework across all type of
credit activities
44 The bank monitors quality of the credit portfolio on day to day
basis and takes remedial measures as and when any
deterioration occurs
45 The bank regularly prepares periodic report of credit risk
Risk Management Practices:
46 The bank‟s executive management regularly reviews the
organization‟s performance in managing its credit risks
47 The bank has highly effective continuous review /
feedback on credit risk management strategies and
performance
48 The bank‟s credit risk management procedures provide
guidance to staff about managing credit risks
49 The bank‟s policy encourages training programs in the
area credit risk management
50 Efficient credit risk management is one of the
bank‟s objectives
Thank you once again for your participation.

41
Appendix II

Interview questions
This interview’s content is confidential and serves the purpose of collecting data for the final
thesis. The researcher guarantees not to disclose the bank’s and the respondents’ identities in
the work.
1. What are the credits services that NIB International Bank S.C. if offering?
2. In your opinion, what type of risk exists in those services?
3. How if the credit risk situation that your bank is dealing with? How many types of credit
risk? In your opinion, which one is the most serious?
4. Could you please kindly tell in detail about the bank’s internal credit rating system? In
your opinion, is it helpful to NIB International Bank S.C. credit management?
5. How does the level of training contribute to credit management?
6. What do you think of the role of internal control in credit risk management in your bank?
Is internal control conducted on a timely basis?
7. Are the policies and procedures constantly reviewed to adjust to new conditions? Usually
on what basis? Please give an example of the most recent change?
8. What do you think of the lending policy of the bank with regard to credit risk
management? Do you think it is effective or not?
9. What extra elements do you think could be incorporated into your credit management
process to make it more robust?

42
Appendix III
GRADUATE STUDIES MBA PROGRAM

Dear Sir / Madam, the purpose of this questionnaire is to gather data regarding the credit risk
management practice in NIB International Bank S.C.
Your specific response to the questions here will facilitate me in completing my thesis. I assure
you that STRICTLY CONFIDENTIAL and used for academic research purpose only.
I thank you in advance for your valuable time and participation in this research.
For further queries, please do not hesitate to contact me in the following addresses
Natnael Abera Tel. 0925913179
E-Mail Addresses- [email protected]

Questionnaire for Loan customers

1. Who initiates you to approach the bank for your first loan request?
a. Self b. Loan clients of the bank c. Staff
2. For how long are you loan client of the bank?
a. 1 – 2 years b. 3 – 4 years c. 5 – 7 years d. >7 years
S.No Statement

Disagree

Disagree
Strongly

Strongly
Neutral
Agree
Agree

3 The bank loan processing time short for you

4 The bank loan processing method convenient for you
5 The bank visit your business sites frequently after loan
granting
6 The amount of loan approved was enough for the
intended purpose per your request
7 The loan repayment duration convenient for your
business
8 The bank needs improvement on accepting loan
application
9 The bank needs improvement on collateral estimation

43
10 The bank needs improvement on follow and collection
of loans
11 The bank needs improvement on processing and
approving loans
12 You’re so far relationship with the bank as a loan client
is good

12. Do you think the following items are the most important ones motivating you to
repay your loan on time?
S.No Statement

Important

Important

Important

Important
Neutral
Most

Less

Not
a Not to lose collateral
b To keep social status
c Expectation of getting another loan
d Knowing that paying bank loan per the agreement is
ethical and an obligation
Other, (Please specify)

Thank you once again for your participation.