Chapter Three
Credit Risk Management Techniques
OF
Al- Arafa Islami Bank Ltd
OF
Al- Arafa Islami Bank Ltd
Credit Risk Management
Credit risk is one of the major risks faced by the bank. This can be described as potential loss arising from the failure of a counter party to perform as per contractual agreement with the bank. The failure may result from unwillingness of the counter party or decline in his/her financial condition. Therefore, bank's credit risk management activities have been designed to address all these issues. The bank has an investment (Credit) risk management committee at head office. The committee reviews the investment risk issues on monthly basis. The bank has segregated the investment approval, investment administration, investment recovery and legal authority. The bank has
segregated duties of the officers/executives involved in credit related activities. A separate business development (marketing) department has been established at head office, which is entrusted with the duties of maintaining effective relationship with the customer, marketing of credit products, exploring new business opportunities etc. In the branches of the bank separate officials are engaged as relationship manager, documentation officer, verification officer, disbursement officer and recovery officer. Their jobs have been allocated and responsibilities have been defined.Credit risk is one of the major risks faced by the bank. This can be described as potential loss arising from the failure of a counter party to perform as per contractual agreement with the bank. The failure may result from unwillingness of the counter party or decline in his/her financial condition. Therefore, bank's credit risk management activities have been designed to address all these issues. The bank has an investment (Credit) risk management committee at head office. The committee reviews the investment risk issues on monthly basis. The bank has segregated the investment approval, investment administration, investment recovery and legal authority. The bank has
3.2.1 Investment (Credit) Risk Grading Manual
The bank has implemented the Investment (Credit) Risk Grading Manual (IRGM) since April 1, 2006 which is made mandatory by Bangladesh Bank vide BRPD Circular No. 18 of December 11, 2005. Investment Officials of the bank have been trained on IRGM. Investment Risk Grading is incorporated in the investment presentation form for all the cases.
3.2.2.Foreign Exchange Risk Management
Foreign exchange risk is defined as the potential change in earnings arising due to change in market prices. As per foreign exchange risk management guideline, bank has established a separate treasury department at head office. Under the treasury department, foreign exchange front office, foreign exchange back office and local money market have been physically demarketed. Duties and responsibilities of them have also been defined. All foreign exchange transactions are revalued at mark to market rate as determined by Bangladesh Bank at the month end. All Nostro accounts are reconciled on monthly basis and outstanding entry beyond 30 (thirty) days is reviewed by the management for its settlement. Regulatory reports are submitted on time to Bangladesh Bank.
3.2.3 Assets Liability Management
The Asset Liability Committee (ALCO) monitors balance sheet risk and liquidity risks of the bank. The balance sheet risk is defined as potential change in earnings due to change in rate of profit, foreign exchange rates which are not of trading nature. ALCO reviews liquidity requirement of the bank, the maturity of assets and liabilities, deposit and lending pricing strategy and the liquidity contingency plan. The primary objective of ALCO is to monitor and avert significant volatility in net profit income, investment value and exchange earnings.
Credit risk is one of the major risks faced by the bank. This can be described as potential loss arising from the failure of a counter party to perform as per contractual agreement with the bank. The failure may result from unwillingness of the counter party or decline in his/her financial condition. Therefore, bank's credit risk management activities have been designed to address all these issues. The bank has an investment (Credit) risk management committee at head office. The committee reviews the investment risk issues on monthly basis. The bank has segregated the investment approval, investment administration, investment recovery and legal authority. The bank has segregated duties of the officers/executives involved in credit related activities. A separate business development (marketing) department has been established at head office, which is entrusted with the duties of maintaining effective relationship with the customer, marketing of credit products, exploring new business opportunities etc. In the branches of the bank separate officials are engaged as relationship manager, documentation officer, verification officer, disbursement officer and recovery officer. Their jobs have been allocated and responsibilities have been defined.
3.1 Risk Management
Risk is inherent in any walk of life in general and particularly in banking sector. During their operations,
Banks are invariably faced with different types of risks that may have a potentially negative effect on their business. Risk Management in Bank operations includes risk identification, measurement and assessment, and its objective is to minimize negative effects on Bank's financial results by efficient management. Like other Banks, to minimize potential risks, Al-Arafah Islami Bank has also taken different steps as per direction of Bangladesh Bank. Besides, eight individual Risk Management Committee and a Risk Management Coordination Committee in Management level in addition to Board Risk Management Committee are working with utmost care to minimize the risk level. Regular meeting of all the committees are held on monthly/quarterly basis. On the other hand, an analytical paper titled "Risk Management Paper" incorporating all risk areas is prepared on monthly/ quarterly basis as per requirement of Bangladesh Bank. This paper is discussed in depth in the Risk Management Coordination Committee and Board Risk Management Committee and necessary instructions and guidance are given and implemented.
3.1 Risk Management
Risk is inherent in any walk of life in general and particularly in banking sector. During their operations,
Banks are invariably faced with different types of risks that may have a potentially negative effect on their business. Risk Management in Bank operations includes risk identification, measurement and assessment, and its objective is to minimize negative effects on Bank's financial results by efficient management. Like other Banks, to minimize potential risks, Al-Arafah Islami Bank has also taken different steps as per direction of Bangladesh Bank. Besides, eight individual Risk Management Committee and a Risk Management Coordination Committee in Management level in addition to Board Risk Management Committee are working with utmost care to minimize the risk level. Regular meeting of all the committees are held on monthly/quarterly basis. On the other hand, an analytical paper titled "Risk Management Paper" incorporating all risk areas is prepared on monthly/ quarterly basis as per requirement of Bangladesh Bank. This paper is discussed in depth in the Risk Management Coordination Committee and Board Risk Management Committee and necessary instructions and guidance are given and implemented.
3.2.4 Internal control and compliance
"Effective internal controls are the foundation of safe and sound banking. A properly designed and consistently enforced system of operational and financial internal control helps the bank management to safeguard the bank’s resources, produce reliable financial and managerial report, and comply with laws and regulations. AIBL has taken all-out efforts to mitigate all sorts of risk in line with the guidelines issued by Bangladesh Bank. To this effect, the bank has formed an Internal Control & Compliance (ICC) division headed by Senior vice president. The ICC division has been segregated to three departments which are audit & inspection department, audit monitoring department and regulatory compliance department. AIBL internal control contains self-monitoring mechanisms and to ensure effective control DCFCL, Investment documentation checklist and quarterly operation report have been developed and implemented. Internal audit and internal control teams carries out regular audit and surprise/special inspection of the branches to mitigate operational risk and restrain the possibility of circumvention or overriding the control procedure. ICC division submits parallel comprehensive internal audit report to the managing director and to the audit committee. Within 02 (two) months after receiving the audit report, audit monitoring department completes the compliance report and submits the report to the audit committee for their review. The committee reviews the system of internal control and the audit process for compliance with rules, regulation and code of conduct, financial reporting process, and also suggests actions to remedy the lapses/irregularities. By this time the ICC division has introduced concurrent audit, surprise inspection, auto information system, Quarterly Audited System, and mandatory leave policy to boost-up the functions of internal control and compliance."
3.2.5 Prevention of money laundering
Money laundering risk is defined as the loss of reputation and expenses incurred as penalty for being negligent in prevention of money laundering. For mitigating the risk the bank has a Central Compliance Unit (CCU) at head office. The unit reviews the anti-money laundering activities of the bank on regular basis. The bank has a designated Chief Anti Money Laundering Compliance Officers (CAMLCO) at head office and Branch Anti Money Laundering Compliance Officers (BAMLCO) at branches. The compliance officers review the Suspicious Transaction (STR) and record them properly. Manuals have been established for the prevention of money laundering and transaction profile has been introduced. Training has been continuously given to all categories of officers and executives for developing awareness and skill for identifying suspicious activities. The bank submits the STR, CTR and other periodical reports to Bangladesh Bank on time.
3.2.6 Guideline on information & Communication Technology:
Technology is the process by which humans modify nature to meet their needs and wants. The term Information Technology (IT) means computers, auxiliary equipment, software, hardware and similar procedures, services and related resources. Information Technology (IT) developed in a rapidly changing global environment, and challenges us to courageous initiatives to address a host of vital skilled human
"Effective internal controls are the foundation of safe and sound banking. A properly designed and consistently enforced system of operational and financial internal control helps the bank management to safeguard the bank’s resources, produce reliable financial and managerial report, and comply with laws and regulations. AIBL has taken all-out efforts to mitigate all sorts of risk in line with the guidelines issued by Bangladesh Bank. To this effect, the bank has formed an Internal Control & Compliance (ICC) division headed by Senior vice president. The ICC division has been segregated to three departments which are audit & inspection department, audit monitoring department and regulatory compliance department. AIBL internal control contains self-monitoring mechanisms and to ensure effective control DCFCL, Investment documentation checklist and quarterly operation report have been developed and implemented. Internal audit and internal control teams carries out regular audit and surprise/special inspection of the branches to mitigate operational risk and restrain the possibility of circumvention or overriding the control procedure. ICC division submits parallel comprehensive internal audit report to the managing director and to the audit committee. Within 02 (two) months after receiving the audit report, audit monitoring department completes the compliance report and submits the report to the audit committee for their review. The committee reviews the system of internal control and the audit process for compliance with rules, regulation and code of conduct, financial reporting process, and also suggests actions to remedy the lapses/irregularities. By this time the ICC division has introduced concurrent audit, surprise inspection, auto information system, Quarterly Audited System, and mandatory leave policy to boost-up the functions of internal control and compliance."
3.2.5 Prevention of money laundering
Money laundering risk is defined as the loss of reputation and expenses incurred as penalty for being negligent in prevention of money laundering. For mitigating the risk the bank has a Central Compliance Unit (CCU) at head office. The unit reviews the anti-money laundering activities of the bank on regular basis. The bank has a designated Chief Anti Money Laundering Compliance Officers (CAMLCO) at head office and Branch Anti Money Laundering Compliance Officers (BAMLCO) at branches. The compliance officers review the Suspicious Transaction (STR) and record them properly. Manuals have been established for the prevention of money laundering and transaction profile has been introduced. Training has been continuously given to all categories of officers and executives for developing awareness and skill for identifying suspicious activities. The bank submits the STR, CTR and other periodical reports to Bangladesh Bank on time.
3.2.6 Guideline on information & Communication Technology:
Technology is the process by which humans modify nature to meet their needs and wants. The term Information Technology (IT) means computers, auxiliary equipment, software, hardware and similar procedures, services and related resources. Information Technology (IT) developed in a rapidly changing global environment, and challenges us to courageous initiatives to address a host of vital skilled human
purchase policy, hardware policy, software development policy, banking application usage policy, security policy, disaster recovery policy etc. The bank is now implementing its on line banking project complying the IT policy.
3.2.7 Internal Audit
"As per Internal Control & Compliance (ICC) Risk Management Guideline of Bangladesh Bank, a ’Risk Based Audit Plan‘’ is to prepared for each calendar year for smooth conducting of Audit & Inspection of all the branches and departments & divisions of Head Office of the bank. Besides the Yearly Auditing, Internal Audit Department Conducts Special Audit, Quarterly Foreign Exchange & Investment Audit, Surprise Audit etc. To prevent incidence of errors and their recurrences, more emphasize are given on spot rectification of irregularities/lapses while auditing/inspecting of the branches. For Audit purpose, branches have been segregated into 05 risk categories (Extremely High, Very High, High, Medium & low risk). The regular Audit & Inspection Teams are also conducting Core Risks System Audit during their regular Audit & Inspections."
3.2.8 Fraud and Forgeries:
During the year 2013, Audit and Inspection department of ICCD, have detected some incidents/irregularities as fraud-forgery relating to cash misappropriation and investment disbursement in 03 branches of the Bank, which is little in terms of Bank’s overall financial transactions. In order to not jeopardize the bank’s interest, all such irregularities were regularized /mitigated by recovery of the defalcated money through strong monitoring and close supervision by the ICC Division. Furthermore, administrative actions were also taken against the delinquent officers/persons involved. Compliances of these issues were duly reported to the Board Audit Committee and Bangladesh Bank in time as per regulatory guidelines." During the period 1st January to 31st December, 2014 Audit and Inspection department of ICCD, have detected some incidents/irregularities as fraud-forgeries relating to cash misappropriation and investment disbursement in03 branches of the Bank, which is little in terms of Bank’s overall financial transactions. In order to not jeopardize the bank’s interest, all such irregularities were regularized /mitigated by recovery of the defalcated money through strong monitoring and close supervision by the ICC Division. Furthermore, administrative actions were also taken against the delinquent officers/persons involved. Compliances of these issues were duly reported to the Board Audit Committee and Bangladesh Bank in time as per regulatory guidelines.
3.2.9 Risk Based Capital (Basel II)
To comply with the international best practices and to make the bank's capital more risk sensitive as well as to build the banking industry more shock absorbent and stable, Bangladesh Bank is aimed to implement Basel-II reporting from 2010. As per the directive of Bangladesh Bank, all scheduled banks in Bangladesh are now required to report risk based capital adequacy for banks under Basel-II along with the existing capital adequacy rules and reporting under Basel-I during the parallel run i.e. 2009. All scheduled banks are also required to disclose capital adequacy in both quantitative and qualitative terms. The first disclosure as per guidelines shall be made as on the effective date viz. 31 March 2010.
3.2.7 Internal Audit
"As per Internal Control & Compliance (ICC) Risk Management Guideline of Bangladesh Bank, a ’Risk Based Audit Plan‘’ is to prepared for each calendar year for smooth conducting of Audit & Inspection of all the branches and departments & divisions of Head Office of the bank. Besides the Yearly Auditing, Internal Audit Department Conducts Special Audit, Quarterly Foreign Exchange & Investment Audit, Surprise Audit etc. To prevent incidence of errors and their recurrences, more emphasize are given on spot rectification of irregularities/lapses while auditing/inspecting of the branches. For Audit purpose, branches have been segregated into 05 risk categories (Extremely High, Very High, High, Medium & low risk). The regular Audit & Inspection Teams are also conducting Core Risks System Audit during their regular Audit & Inspections."
3.2.8 Fraud and Forgeries:
During the year 2013, Audit and Inspection department of ICCD, have detected some incidents/irregularities as fraud-forgery relating to cash misappropriation and investment disbursement in 03 branches of the Bank, which is little in terms of Bank’s overall financial transactions. In order to not jeopardize the bank’s interest, all such irregularities were regularized /mitigated by recovery of the defalcated money through strong monitoring and close supervision by the ICC Division. Furthermore, administrative actions were also taken against the delinquent officers/persons involved. Compliances of these issues were duly reported to the Board Audit Committee and Bangladesh Bank in time as per regulatory guidelines." During the period 1st January to 31st December, 2014 Audit and Inspection department of ICCD, have detected some incidents/irregularities as fraud-forgeries relating to cash misappropriation and investment disbursement in03 branches of the Bank, which is little in terms of Bank’s overall financial transactions. In order to not jeopardize the bank’s interest, all such irregularities were regularized /mitigated by recovery of the defalcated money through strong monitoring and close supervision by the ICC Division. Furthermore, administrative actions were also taken against the delinquent officers/persons involved. Compliances of these issues were duly reported to the Board Audit Committee and Bangladesh Bank in time as per regulatory guidelines.
3.2.9 Risk Based Capital (Basel II)
To comply with the international best practices and to make the bank's capital more risk sensitive as well as to build the banking industry more shock absorbent and stable, Bangladesh Bank is aimed to implement Basel-II reporting from 2010. As per the directive of Bangladesh Bank, all scheduled banks in Bangladesh are now required to report risk based capital adequacy for banks under Basel-II along with the existing capital adequacy rules and reporting under Basel-I during the parallel run i.e. 2009. All scheduled banks are also required to disclose capital adequacy in both quantitative and qualitative terms. The first disclosure as per guidelines shall be made as on the effective date viz. 31 March 2010.
3.3 Credit Rating
Credit Rating Agency of Bangladesh (CRAB) Limited has adjudged AA 3 (pronounced Double A Three) rating in the Long Term and ST-2 rating in the Short Term for Al-Arafah Islami Bank Limited.
Based on : Audited Financial Statement 2013
Date of Rating : 31st December, 2013
Validity : 30 June, 2015
Outlook : Positive
3.4 Information Technology
Al-Arafah Islami Bank Ltd.'s (AIBL) pledge to adhere with the principles of Islamic Norms and ethics and combine them with today's technology threw a great challenge to the ICT division. It has been a while now that AIBL is providing True Centralized online payment services to its customers in all its branches. Our Core Banking System (CBS) which is called "ABABIL "developed by Millennium Information Solution Ltd. CBS uses 3-tier application architecture with ORACLE Database (11g Enterprise Edition) along with other Oracle products like Active Data Guard (ADG) for ensuring data replication to the Disaster Recovery Site (DRS) maintaining consistency and accuracy adds to the efficiency and quality of service. AIBL with the vision of becoming the leading Bank in the country both in service and technical aspects have taken bold steps to full fill the requirements of the mass. Banking sector is going through massive change with the advent of new technologies, IT Division at Al-Arafah Islami Bank took the challenge of giving the best possible service to its users and customers alike.
3.5 Capital structure
3.5.1 Qualitative Disclosures:
a) The regulatory capital under Basel-II is composed of
(I) Core Capital (Tier-1)
(II) Supplementary Capital (Tier-2)
(III) Additional Supplementary Capital (Tier-3) [only for market risk]
Credit Rating Agency of Bangladesh (CRAB) Limited has adjudged AA 3 (pronounced Double A Three) rating in the Long Term and ST-2 rating in the Short Term for Al-Arafah Islami Bank Limited.
Based on : Audited Financial Statement 2013
Date of Rating : 31st December, 2013
Validity : 30 June, 2015
Outlook : Positive
3.4 Information Technology
Al-Arafah Islami Bank Ltd.'s (AIBL) pledge to adhere with the principles of Islamic Norms and ethics and combine them with today's technology threw a great challenge to the ICT division. It has been a while now that AIBL is providing True Centralized online payment services to its customers in all its branches. Our Core Banking System (CBS) which is called "ABABIL "developed by Millennium Information Solution Ltd. CBS uses 3-tier application architecture with ORACLE Database (11g Enterprise Edition) along with other Oracle products like Active Data Guard (ADG) for ensuring data replication to the Disaster Recovery Site (DRS) maintaining consistency and accuracy adds to the efficiency and quality of service. AIBL with the vision of becoming the leading Bank in the country both in service and technical aspects have taken bold steps to full fill the requirements of the mass. Banking sector is going through massive change with the advent of new technologies, IT Division at Al-Arafah Islami Bank took the challenge of giving the best possible service to its users and customers alike.
3.5 Capital structure
3.5.1 Qualitative Disclosures:
a) The regulatory capital under Basel-II is composed of
(I) Core Capital (Tier-1)
(II) Supplementary Capital (Tier-2)
(III) Additional Supplementary Capital (Tier-3) [only for market risk]
Tier-1 capital comprises highest quality capital items which are permanent in nature and allows a bank to absorb losses on an ongoing basis and includes paid-up capital, statutory reserve, general reserve and retained earnings.
Tier-2 capital lacks some of the characteristics of the core capital but bears loss absorbing capacity to a certain General provision, revaluation reserves etc are part of Tier 2 capital.
Tier-1 capital of the bank as of December 31, 2014 is Tk. 15,620.57 million which is 90.02 % of total eligible capital Tk. 17,352.63 million and out of Tier 1 capital 60.62 % is paid up capital & 29.73% is statutory reserve.
Tier-2 capital of the bank Tk. 1,732.06 million which constitutes 9.98% of total eligible capital and the major contributors are general provision 71.78% & asset revaluation reserves 28.22%.
.
Tier-2 capital lacks some of the characteristics of the core capital but bears loss absorbing capacity to a certain General provision, revaluation reserves etc are part of Tier 2 capital.
Tier-1 capital of the bank as of December 31, 2014 is Tk. 15,620.57 million which is 90.02 % of total eligible capital Tk. 17,352.63 million and out of Tier 1 capital 60.62 % is paid up capital & 29.73% is statutory reserve.
Tier-2 capital of the bank Tk. 1,732.06 million which constitutes 9.98% of total eligible capital and the major contributors are general provision 71.78% & asset revaluation reserves 28.22%.
.
3.5.2 Quantitative Disclosures: Figures in million taka
b) The total amount of Tier-I capital 13,073.14
b) The total amount of Tier-I capital 13,073.14
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