Internship Report on

Impact of Credit
Rating Reports on
Loan Financing of
Banks: A Study in
Bangladesh’s
Perspective
Impact of Credit Rating Reports on Loan Financing of
Banks: A Study in Bangladesh’s Perspective

Submitted to:

Dr. Shaikh Shamsuddin Ahmed

Professor, Department of Finance
Faculty of Business Studies

Submitted By:

Sadia Afroj
ID: 22-012, Department of Finance
Faculty of Business Studies

Date of Submission: September 10, 2020

i
 Letter of Transmittal

Date: September 10, 2020

Dr. Shaikh Shamsuddin Ahmed

Professor
Department of Finance
University of Dhaka

Subject: Submission of Internship Report.

Dear Sir/Madam,
I am pleased to present the final internship report on " Impact of Credit Rating Reports
on Loan Financing of Banks: A Study in Bangladesh’s Perspective" prepared in
accordance with the BBA program requirements. For me, the report is extremely valuable
as it has helped me gain practical experience with two crucial financial sectors: the Credit
Rating Sector and the Banking Sector. My internship with Credit Rating Agency of
Bangladesh (CRAB) was a worthwhile experience and I definitely value the exposure to
such an organization.

In completing the report, I have tried my best to provide every available details regarding
the topic I focused on, avoiding unnecessary amplification of the report. I hope that this
internship report will meet the standards of your judgments.

Sincerely
________________

Sadia Afroj
BBA 22nd Batch, Section: B
Department of Finance
University of Dhaka

ii
 Supervisor’s Certificate

This is to certify that this report on " Impact of Credit Rating Reports on Loan
Financing of Banks: A Study in Bangladesh’s Perspective " is a bona fide record. The
report is done by Sadia Afroj as a partial fulfillment of the requirement of BBA degree
from the Department of Finance, University of Dhaka.

The report has been prepared under my guidance and is a record of a bona fide work
carrying out successfully.

------------------------------------

Dr. Shaikh Shamsuddin Ahmed

Professor
Department of Finance
Faculty of Business Studies
University of Dhaka

iii
 Student’s Declaration

I hereby declare that the internship report entitled " Impact of Credit Rating Reports on
Loan Financing of Banks: A Study in Bangladesh’s Perspective " has been prepared by
me under the supervision of Dr. Shaikh Shamsuddin Ahmed, Department of Finance,
University of Dhaka.

I also declare that all the information embodied in this report is original and neither this report
nor any part of this report has been submitted elsewhere for the award of any other degree or
any other purpose.

________________

Sadia Afroj
BBA 22nd Batch, Section: B
Department of Finance
University of Dhaka

iv
 Acknowledgement

At the beginning I would like to thank Almighty Allah most sincerely for giving me the
strength and composure to complete the internship report. Words will never be enough to
express how grateful I am to some people, but nevertheless I will try my best to express my
gratitude to some people. Without the necessary practical knowledge, help from books,
articles, websites and primary data, this internship report could never be completed.

Indeed I am grateful to my faculty member of BBA program, Dr. Shaikh Shamsuddin

Ahmed, University of Dhaka, who constantly kept supporting and guiding me in various
ways during the internship work period and at the time of study.

I would like to express my sincere gratitude to all employees, from Credit Rating Agency
of Bangladesh (CRAB) who helped me immensely while in internship period gave me
their support on my way to complete this report.

v
 Executive Summary
The whole report focuses on approaching the single topic- impact of credit rating reports
on loan financing of banks. The analysis is done considering the environment of
Bangladesh.

The report starts by providing an overview of the banking industry and indicating its
importance in Bangladesh’s economy. Then I focus on the main service provided by the
banks- loan financing. We get a basic overview on the existing services and regulations
regarding them, and step into the next chapter.

This chapter focuses on Credit Rating Reports (CRRs) provided by Credit Rating Agencies
(CRAs)that are mandatory for any kind of loan approval. Here we get an overview of the
comparatively new industry, along with the rules, regulations, challenges and limitations it
faces. One of the main indicators that is often used by public to assess the impact and
performance of CRRs and CRAs is the rate of Non-performing Loans (NPL) in the
economy. The next chapter shows the current situation and actual factors that work most
behind changes in NPL.

Then we go through data collected from primary survey, and statistical analysis to measure
the impact of credit rating reports and the scores they provide, on loan financing and NPL.

Finally, a few other issues that are often ignored are mentioned, along with some
recommendations for improving the current situation.

vi
 Table of Contents

S.L. Chapter Page

Letter of Transmittal ii

Supervisor’s Certificate iii

Student Declaration iv

Acknowledgement v

Executive Summary vi

Internship Experience viii

1
Introduction 1
2
Literature Review 3
3
Banking Industry of Bangladesh: Loan Financing 5
4
Credit Rating in Bangladesh 11
5
Non-Performing Loans or NPL- An Indicator of Performance? 17
6
Impact of Credit Rating Report 20
7
Conclusion 25

Appendix 26

References 36

vii
PART I
Internship
Experience

viii
About Credit Rating Agency of Bangladesh (CRAB)

The Credit Rating Agency of Bangladesh Ltd. (CRAB) is the leading credit rating agency
in Bangladesh offering ranking, ranking, advisory and information services. The
Corporation was incorporated as a public limited company under the Registrar of Joint
Stock Companies in August 2003 and issued the certificate of commencement of business
in November 2003. CRAB was issued a license by the Securities & Exchange Commission
(SEC) of Bangladesh to operate as a credit rating company in February 2004. The official
launch of the Organization took place on 5 April 2004. In 2009, CRAB was certified as the
ECAI by Bangladesh Bank, allowing it to score bank credit exposures for the measurement
of risk-weighted capital appropriateness.

CRAB is an autonomous and competent organization set up in technical partnership with

ICRA Ltd (Hyperlink) of India. CRAB is Bangladesh's leading supplier of credit
assessment and investment information services. The shareholders of CRAB include the
Bangladesh (ICB) Investment Company and IDLC.

Internship Experience at Credit Rating Agency of Bangladesh (CRAB)

Since the very end of our undergraduate course classes have finished, I was excited to start
my internship opportunity. With no prior experience or idea about the business world, I
was looking for forward to this internship because it was an opportunity for me to a new
environment. I was looking for an internship opportunity which would be related to
financial analysis since I have an interest on this. Luckily got selected from several others
from an interview. CRAB works on assessing different industries as well as analyzing
individual clients based on quantitative and qualitative research and I was looking forward
to getting a hand-to-hand experience.

I started my internship on February 2, 2020 with a tenure of 3 months as an intern in one

of the research teams consisting of credit analysts and research associates. Because my
team had to analyze individual, corporate and SME, I had the chance to work on the credit
analysis of all these types of clients. I started with getting to know the frameworks used for
credit rating, different criteria and data inputs on these criteria. I also took part in
overviewing and editing credit reports and had a chance to take part in an internal research

ix
regarding a specific industry. I also got the chance to visit banks for data collection and
observe the overall process of credit rating.

However, due to the recent pandemic, my internship period was cut short and ended on
March 25, 2020. But the knowledge and experience I gained from this short period is from
every point of view, invaluable.

My biggest takeaways from the whole internship experience were:

a) Getting a first-hand experience of corporate environment

b) Updating datasheets for different clients
c) Understanding the framework of credit rating and getting first-hand experience on credit
analysis
d) Working on qualitative and quantitative facts regarding credit rating
e) Getting to observe credit rating approval processes
f) Observing and taking part in evaluating different entity’s credit worthiness

x
 PART II:
Impact of Credit Rating
Reports on Loan Financing of
Banks: A Study in
Bangladesh’s Perspective

xi
Chapter 01: Introduction
1.1 Introduction
Some of the essential roles of a bank or financial institution in the modern banking
framework are "Credit Risk Management." Risk is present in all facets of company
operations. Credit risk, however, is an important element for banks that needs to handle.
While the banking industry's competition is increasing rapidly, the risk of non-performing
loans or NPLs seems to have become an extra burden.
Credit rating agencies (subsequently denoted as CRAs) specialize in analyzing and
evaluating corporate and sovereign debt securities issuers' creditworthiness. It is expected
from CRAs to become more important and essential parts in the management of credit risks
in the new financial structure. As for banks, credit ratings are part of the mandatory
documents needed for investments and loan decisions.
This report focuses on the impact the credit rating reports have over banks' financing
decisions, from Bangladesh's perspective. Through this report, we will have an overview
of credit rating, related methods, banking systems, rules, and regulations that tie them. We
will see how much importance the reports hold in assessing a borrower, whether an
individual or a corporation.
1.1.1 Objective

General Objective:
Understanding the impact of credit ratings on banks’ loan investment decisions.

Specific Objective:
● Analyzing the current banking sector and its loan investment services
● Understanding credit rating and how it helps evaluate a company or an individual
● Understanding how to use financial information to evaluate the financial position
● Analyzing the non-performing loans, reasons behind them and the relationship
between loan conditions and credit rating reports
● Overviewing the overall situation, possibilities, and challenges regarding credit
rating and bank-loans in Bangladesh

1.2 Methodology
The report is a combination of theoretical analysis and quantitative tools and methods. I
have collected situational information, past data, and findings from experts' previous works
and research, relative to the report.

1
I have used questionnaires and direct interactions with persons involved (such as bank
personnel, analysts from the credit rating agency) to collect information to understand the
current situation and probable reasons behind them regarding my topics.

I have also used mathematical and statistical tools such as regression models to identify the
current relationship between banks' loan investment decisions and credit rating reports and
the effectiveness of the credit ratings regarding the losses banks face from such
investments.

1.3 Data Source

The methodology of this report is collective. The data used here include both primary and
secondary data. The primary data were collected using a questionnaire (see appendix).
Simultaneously, the secondary sources were past articles, news reports, and research
works on similar topics that were publicly available.

1.4 Scope
This report attempts to analyze the actual situation regarding the credit rating system, loan
financing systems of banks. It also focuses on the impacts of a credit rating report on the
later, using qualitative, quantitative data and mathematical tools.

1.5 Limitations

Everything has its limitations, so does a report. While conducting research and preparing
the report, we faced several limitations. The main limitation faced by us were:
● Lack of Experience:
Analysis of theoretical learning and implementing them in a situation is very
much comprehensive. It is an accumulation of both information and analytical
ability. It requires a great deal of experience. As students, we lack that kind of
experience.

● Lack of Appropriate and Latest information:

Developing a report on such a sensitive issue makes it difficult to find accurate

data and collect confidential information from banks regarding their loan
investments. Also, many of the information available is not up to date.

Despite all these limitations, the best effort was given to prepare a standard report with the
data available and submit the report within the timeframe.

2
Chapter 02: Literature Review
The whole credit rating system appeared as a necessity when loan financing of financial
institutions entered a broader range in the early years of the 19th century. In the aftermath
of the financial crisis of 1837, the merchant credit agencies, the precursors to current rating
agencies were set up. Since then, it has been a matter of debate whether these credit ratings
and reports provided with them are effective or impactful on banks' loan financing
decisions.

In Bangladesh, the credit sector includes banks and non-bank financial institutions or
NBFIs. While the NBFIs are still on the growing stage, they are still insignificant compared
to banks' loan and deposit services (Habib, 2019). That leaves us with no doubt how
competitive and, at the same time, cautious the banks have to be with their loan financing
decisions. Thus, credit ratings provide a balance between human judgments and the
structure, business line, authority over decisions, cost constructions, and the expansion of
credit rates perceived by banks individually (Carey, William F. Treacy and Mark S., 1998).
The banks themselves even do the same task at a lower cost if they do the scrutinizing
themselves.

Today, in many countries, credit rating is part of the regulations, along with the costs
incurred from the process. So, it is easier to assume that CRs are taken as impactful over
loan financing because they are required or considered something that must be acquired.
However, Achim and Martin (1998) showed in their studies that credit ratings affected
banks' behaviour even when they were not a mandatory requirement. Also, the study took
place on the banking of Germany, where banks do the ratings themselves.

According to this study, when the banks hold more information on borrowers than any
other outsiders. So, they tend to provide more accurate and frequently changing rates and
are ready to take measures needed for distressed borrowers based on their past, present,
and forecast performance. On the contrary, when the banks have less information, they
have to rely on past ratings. Nevertheless, ratings are still needed to understand the
borrowers and thus make the final decision.
Here comes the question of why the banks in Bangladesh rely more on credit rating
agencies rather than doing the research fully by themselves. The banking industry in
Bangladesh holds various services to provide and manage; loan financing is one of them.
Robert J. Rhee describes in his paper (Rhee & R.J., 2015) that rating agencies correct
information asymmetry and that they "de facto regulate" investments. He also adds along
with these reasons saying, "While rating agencies produce little new information, they sort

3
information available in the credit market. This sorting function is needed due to the large
volume of information in the credit market. Sorting facilitates better credit analysis and
investment selection, but bond investors or a cooperative of them cannot easily replicate
this function." According to this research, rating agencies serve a useful market purpose
outside of their roles regarding information intermediation and regulations despite credit
ratings inherently providing little new information, which shows the necessity of the credit
rating agency policies to be implicated and regulated in the industry.
However, in a more recent publication made by the US Security and Exchange
Commission (Investor Alerts and Bulletins, 2017), it has been advised that credit ratings
should not limit an investor's research. Using credit rating as an independent measure does
not provide a complete picture of an investment, since creditworthiness is just one factor
from many that banks should consider when making an investment decision.
Credit rating agencies were highly criticized during the global financial crisis in 2007-2008
due to their lack of efficiency in forecasting and thus rating the companies' potentials. In
2011, some renowned CRAs got accused of unprecedented downgrading that negatively
affected the Eurozone Crisis, and provided preferential treatment to the United States.
(Alessi & Wolverson, 2013). These events show that despite the advice described in the
publication mentioned above, credit ratings affect loan financing from local banks up to a
global extent.
Ratings and changes in ratings help banks to determine their loan financing policies to
implement on different borrowers (Claessens, Wang, & Teng, 2018). While upward
changes do not affect the decisions much, downward changes may make the banks take
drastic steps to fight off the risk of defaults, which shows similarity to bankers' behavior in
Bangladesh.
Despite all these protective measures, Bangladesh is still facing high default risks (Banking
sector poised to derail growth momentum for Bangladesh economy , 2020) compared to
the deposits they hold. If credit ratings are so effective on loan decisions, why do these
defaults or non-performing loans occur? This question takes us to our topic of the report
that works on various challenges and potentials existing in the banking sector and credit
rating industries. We also focus on the underlying determinants of non-performing loans,
such as poor restriction from regulatory authorities, lack of quality management, and moral
hazards (Waqas, Fatima, Khan, & Arif, 2017) and the actual impact credit rating reports
on loan financing of banks in Bangladesh.

4
Chapter 03: Banking Industry of
Bangladesh: Loan Financing
3.1 The Banking Sector
3.1.1 History
The banking sector in Bangladesh seems more like a mine-field rather than just a sector
that helps with the growth of the country's economy while facing frequent ups and downs
themselves.

Bangladesh's banking sector endured difficult times, particularly in the immediate

aftermath of the country's independence. In the early 1970s, authorities nationalized
commercial banks to channel the predominant low savings into the formal sector, except
for a few international commercial banks, to finance economic activities. It was fair, as
economic operations were propelled largely by players from the public sector. Bangladesh
Bank, the central bank, initially controlled both lending and deposit rates directly, and
much of the lending went to state-owned enterprises. The government introduced changes
to the financial system in the early 1980s, including encouraging private-sector financing
to participate. Two major state-owned commercial banks (SCBs) were privatized in June
1983. The government further recapitalized banks, launched new credit rating schemes,
and made interest rates more stable to boost the money and capital markets. Subsequently,
more international commercial banks (FCBs) were allowed, and many private commercial
banks (PCBs) were set up. By this date, there are 60 scheduled and five non-scheduled
banks listed. The scheduled banking sector comprises of the following categories-

● 6 State-Owned Commercial Banks (SOCBs)

● 3 Specialized Banks (SDBs) which were established for specific objectives like
agricultural or industrial development. These banks are also fully or majorly owned
by the Government of Bangladesh.
● 42 Private Commercial Banks (PCBs): Individuals/Private entities own 42
private commercial banks in Bangladesh. We can categorize PCBs into two
groups: Conventional PCBs and Islami Shariah based PCBs that hold 34 banks and
eight banks, respectively.

● 9 Foreign Commercial Banks (FCBs) are operating in Bangladesh as the branches

of banks incorporated abroad.

5
3.1.2 Current Situation
The banking sector plays an important role in the economy, mobilizes savings, and calls
for efficient investment savings. Better, more sustainable economic activity and less
financial instability would boost the economy in the long term. In Bangladesh, banks need
to fulfill these roles, but the environment they are working in, questions whether or how
much of it can be done efficiently.

In one of its working papers (2018), CPD showed that banks' current performance and
overall financial situations are unsatisfactory. Banks consistently went through capital
shortfalls, and decreasing return on assets (ROA) and return on equity (ROE). (Figure 3.1
in Appendix)

The most recent annual reports of Bangladesh Bank support this downgrading financial
position as they show that State-owned commercial bank, two private commercial banks
and even a foreign commercial bank as well as the Development Financing sector broadly,
reportedly failing to maintain the minimum rate of Capital to Risk-Weighted Assets Ratio
(CRAR). (Figure 3.2 in Appendix)

The regulators and the government's plans on this important financial sector is a mixture
of both good and bad initiatives. The banking system's speed of trying to adopt BASEL III
is just one example of how backdated and inadequately efficient the sector still is, weak in
its core while trying to fit in new regulations and the ever-increasing competition. On
February 09, the Board of Directors of the Bank of Bangladesh approved the floatation of
a bank named Bengal Commercial Bank Ltd. This approval brings the total number of
banks to 60. The number can increase as soon as the central bank is almost ready to
authorize another bank. Of course, there is no doubt that these banks and other financial
institutions and intermediaries are needed in an economy that is rising at a remarkable pace.
However, the need cannot be infinite or unlimited. Also, these steps are criticized from the
belief that a large part of the current problems in the banking sector is related to the political
ties used to secure permits for floating new banks, obtaining loans, and rescheduling default
loans. The vague process used by the government to protect depositors' interest in the case
of one or two banks, The Oriental Bank (former Al-Baraka Bank and incumbent ICB
Islamic Bank) and the latest example, the Farmers' Bank (now renamed as Padma Bank),
seems to have put more fuel in the fire.

Despite all these challenges and troubles, the banking sector still holds onto hopes. The
current situation still indicates the potentials of improvement. The recovery of industrial
term loans rose by 23.79%, and over the same time frame of the previous fiscal year,
22148.24 crores were recovered in October-December 2019 compared to Taka 17891.76.
The unpaid sum of industrial term loans at the end of December 2019 amounted to Taka

6
259314.87 crores. Around the same time, the unpaid amount of industrial term loans
amounted to 35903.91 crores, which was 13.85 per cent of the unpaid sum.The recovery
of industrial term loans rose by 23.79%, and over the same time frame of the previous fiscal
year, 22148.24 crores were recovered in October-December 2019 compared to Taka
17891.76. The unpaid sum of industrial term loans at the end of December 2019 amounted
to Taka 259314.87 crores. Around the same time, the unpaid amount of industrial term
loans amounted to 35903.91 crores, which was 13.85 per cent of the unpaid sum
(Bangladesh Bank Major Econimic Indicators, Monthly Update, 2020). The most
significant indicator of asset quality is the ratio, albeit very slowly increasing, of gross non-
performing loans (NPLs) to total loans and net NPLs to total Net loans (Figure 3.3 in
Appendix).

3.2 Loan Financing: Service Structure in Bangladesh

There are various types of loans with different terms and conditions and validity. In
general, the banks of Bangladesh provide with the following types of loans-
i. Business Loan
ii. Consumer Loan
iii. Home Loan
iv. Personal Loan
v. Car Loan
vi. Education Loan
vii. Overseas Job Loan
viii. SME Loan

These loans are classified based on their fields of service. For instance, in a broader sense,
all these loans are put under four common categories for loan classification later on
(Prudential Regulations for Banks, 2014). This classification helps banks manage their
risks rising from loan financing, which I will describe later on. The four categories include:
a) Continuous Loan: Loan accounts in which transactions may be made within a certain
period and have an expiry date for full adjustment shall be treated as Continuous Loans,
such as- Cash Credit, Overdraft.

b) Demand Loan: Loans that become repayable on demand by the bank shall be treated
as a demand loan. If any contingent or any other liabilities are turned to a forced loan (i.e.,
without any prior approval as a regular loan), those too will be treated as Demand Loan.
Such as Forced Loan against Imported Merchandise, Payment against Document.

c) Fixed Term Loan: The portion of loans which are repayable under a certain repayment
schedule within a specific time frame are treated as fixed-term loans.

7
d) Short-term Agricultural & Micro-Credit: Short-term Agricultural Credit will include
the short-term credits as listed under the Annual Credit Program issued by the Agricultural
Credit and Financial Inclusion Department (ACFID) of Bangladesh Bank. Credits in the
agricultural sector repayable within 12 (twelve) months will also be included herein. Short-
term Microcredit will include any micro-credits not exceeding an amount [ Tk. 50,000 (Tk.
Fifty Thousand)] 23 determined by the ACFID of Bangladesh Bank from time to time and
repayable within 12 (twelve) months, be those termed in any names such as Non-
agricultural credit, Self-reliant Credit, Weaver's Credit or Bank's project credit.
For all these types of loans, banks tend to check individuals’ and firms’ documents that
prove their capability to take loans and repay them with required interests. Such loans and
interests being a crucial income source for banks make these documents more important
and impactful.

3.4 Loan Classification

The Central Bank of Bangladesh has defined stages of loan classification based on different
criteria. The latest available declaration from the authority states the following instructions
regarding this issue:

Source: (BRPD Circular 14 & 19)

3.5 Regulations Regarding Loan Financing

The loan financing process itself shows the numerous complexities both the borrower and
the lending bank go through. The central bank has set up various norms, rather than
regulations regarding loan financing and risk management for banks, as a part of steps
taken to support the banking industry to flourish. This step would help banks from the view
that a key point could be what kind of policies and frameworks a bank is providing with its
respective loan financing offer in an industry with such high competition. However, as

8
mentioned, there are still some prudential norms (Prudential Regulations for Banks, 2014)
that banks are to follow. Such as-

a) Banks shall collect credit information from their borrowers at the Credit Information
Bureau (CIB) of Bangladesh Bank prior to sanctioning, renewing or rescheduling loans to
ensure that credit facilities are not offered to defaulters.
b) Banks must determine credit risk by implementing credit risk scoring (CRG) prior to
sanctioning or renewing broad loans. If the ranking of the CRG turned out to be "Marginal,"
the banks will not be responsible for a big loan. However, it may suggest the extension of
the current broad loan, taking into account other desirable conditions and considerations.
However, if the "Special Mention Account (SMA)" is the product of the CRG, no interest
or redemption of large loans can be considered.
c) When approving or reinstating large loans, banks should determine the total debt
repayment ability of their creditors by assessing the borrower’s obligations to other banks
and financial institutions.
d) Banks shall review their borrower's Cash Flow Statement, Audited Balance Sheet,
Income Tax, and other financial documents to ensure that the borrower can repay the loan.

e) For local banks, the Board of Directors shall accept large loans for approval,
reconstruction or re-arrangement. Such decisions shall be made by the Chief Executive in
the case of international banks. However, compliance with this circular must be ensured
when authorizing applications for large loans, among other items.
f) If a credit is jointly issued to an authorized borrower by two or more banks under a joint
loan facility (such as syndicated loan), paragraph 2(a) only covers the pro-rata share of the
overall loan of the bank and refers to funds provided by the individual banks.
g) A group of counterparties faces a "single risk" close to that of a single counterparty.
Such a group shall be referred to as a group of related counterparties. Banks shall evaluate
the relationship between clients, with reference to Paragraph (1.e.i) and Paragraph (1.e.ii),
in order to assess the existence and extent of a single risk. However, banks must exercise
a reasonable degree of due diligence, including the 'Know Your Customer (KYC)'
principle, in order to obtain sufficient information on their customers to determine their
interconnectedness.
h) Suppose an exposure becomes 'non-conforming' for any reason, as mentioned in
Paragraph-1(c). In that case, the Chief Executives of banks are required to act promptly to
bring the exposure into compliance unless doing so would be inconsistent with prudent
banking practices and adversely affect the ultimate recovery of the disclosure. Such non-
conforming disclosures may be renewed, have their maturity extended or be restructured
without violating this circular provided –

9
 i) there is no increase in the amount of the exposure, either direct or indirect;
ii) security collateral, if any, shall not be released;

iii) there is no change in the borrower with the exception of modifications arising from
the merger of the creditor with another person;
iv) the renewal, extension or re-schedule shall not otherwise avoid the conditions laid
down by Bangladesh Bank regarding the current policies , rules and regulations;
v) if necessary, banks shall alert the Off-site Monitoring Department of Bangladesh Bank
about such exposure.

Besides these, different kinds of benefits, services, and charges will be added with loan
financing differing from bank to bank.

From these regulations, it is evident that banks require several documents and criteria to
measure a potential borrower's creditworthiness and take necessary steps to manage risks
as best as possible. These include the client's audit reports, financial statements, credit
history, and credit rating information, and credit risk ratings.

In Bangladesh, banks check these either though self-assessments or internal risk rating, or
through a third-party opinion (which here is a credit rating agency), or through both for
more thorough analysis. Since credit rating reports are mandatory, banks' self-assessments
are often operated alongside credit analysts or on a small scale to focus on the most
important aspects of the client, such as the existence of working places or collaterals and
other credit relationships.

10
Chapter 04: Credit Rating in
Bangladesh
4.1 Credit Rating Industry in Bangladesh
4.1.1 What is Credit Rating?
A credit rating indicates a process of evaluating the credit risk of a prospective debtor. In
other words, credit rating is used to determine the eligibility of a debtor regarding paying
back the loan and the likelihood of default in the future. Banks use credit scores or credit
reporting to check the eligibility of loan applications, a subset of credit rating. As for
Bangladesh, credit rating is required by banks and financial institutions for loan financing
decisions and researchers for an in-depth overview of industries. In general, credit rating
is considered an external activity for the agencies involved.
The process of credit rating includes evaluating a potential borrower’s -

● The past and most recent financial position, including cost management and
performance in respective fields
● Operational structures, cost structures
● Risk management methods
● Records of credit
● Compliance with regulations
● Level of availability and credibility of financial documents and other useful
information.

4.1.2 Credit Rating Process

Credit rating analysts collect required data, and may even visit the borrower in person to
get the actual information needed. After that, they assess the data they are provided and the
data collected to prepare and provide the aspects of the loan applicant through a credit score
or report.
The data requirements, methods of processing the information, and providing credit scores
will differ according to the type of parties assessed and different credit rating agencies.
This report includes both quantitative and qualitative assessment of the related party. (See
Table 4.1, Table 4.2 and Figure 4.1 in Appendix)

11
4.1.3 Internal Credit Risk Rating (ICRR) for Financial Institutions
Banks and financial institutions use internal credit risk ratings for their welfare and
increasing efficiency. Overall, such credit rating is beneficial for
a) Providing an objective, transparent and consistent framework for measuring and
evaluating the credit risk of borrowers

b) Facilitating the practices of risk management

c) Determining the performance of the individual lenders to assist banks in determining the
profitability of the loan portfolio, business entity, division or bank as a whole.

d) Helping clients negotiate on the distribution of loans, the price of loans, and the setting
of credit caps and terms and conditions

4.2 Regulations of the Credit Rating Industry

Globally, CRAs are mostly self-regulating. As in Bangladesh, a domestic CRA must be
recognized as an external credit assessment institution to have its rating scores accepted
for a higher evaluation. The United States Congress passed the 2006 Credit Rating Agency
Reform Act to allow the US Securities and Exchange Commission (SEC) to regulate
internal processes, record-keeping as well as certain commercial practices of CRAs. For
domestic CRAs in Bangladesh, there are several regulatory authorities with their respective
guidelines on credit rating. For instance,
● Bangladesh Securities and Exchange Commission (BSEC) has been one of the
primary regulators for CRA, along with the licensing and quarterly monitoring
authority for CRA Nominations, and also oversees the compliance requirements
and rules laid down in the Credit Rating Companies Rules of 1996.
● Bangladesh Bank regulates credit Rating Companies ('Company') through various
circulars, policies, and guidelines. To be able to carry out a credit assessment, credit
rating companies must be recognized as an external credit assessment institution
(ECAI) under the risk-based capital adequacy framework (Basel II) issued by the
Bank of Bangladesh. Companies must comply with certain requirements utilizing
this recognition. These requirements are that the creditworthiness rating assessed
should be independent, consistent, and free from conflict of interest.
Apart from recognition, credit rating companies are also governed by circulars and
guidance issued from time to time by Bangladesh Bank. The Banking Regulation
and Policy Department (BRPD) issued Circular No.05 of May 29, 2004, making it
mandatory for banks to be credited to collecting money from the stock market via
the IPO. Insurance Development and the Regulatory Authority of Bangladesh
(IDRA) is the respective regulatory authority for the credit rating assessment of

12
 insurance companies. Credit rating firms may be accredited as a credit rating
agency by IDRA to conduct a credit rating assessment.
Often it might be confusing what the credit rating should focus on. For example, Bhatia
[2002] argues that the S&P methodology of rating sovereigns aims to capture only the
probability of default occurrence, rather than the severity of default and does not provide a
more general estimate of predicted fault time, default resolution mode or recovery values.
While another international rating agency, Moody's rating concentrates on anticipated loss,
which is based on the likelihood of default and the expected recovery rate after default.
The regulatory authority sometimes sets out guidelines for designing the methodology to
avoid this specific problem. For instance, according to Bangladesh Bank Circular, "The
evaluation of operations of the SME should take account of both quantitative and
qualitative factors. This approach covers five broad categories of risk: financial risk,
market risk, and industry risk, management risks, banking relationship risk, financial
security risks, etc. The assessment framework is detailed. Although the concentration areas
referred to above are consistent with the corporate rating methodology, the relative
weighting for different parameters may vary between the two sectors. The financial
position (i.e. balance sheet and income statement) and the cash flow statement may be
collected per the accounting standard provided by the regulators concerned, which may
be audited or signed by the competent authority."

4.3 Challenges and Limitations

Being a relatively new concept in Bangladesh, credit raters get to enjoy a unique scope of
work. At the same time, they have to face several challenges and limitations as well.

4.3.1 Challenges

 One of the most mentioned and discussed challenges for credit rating agencies is
the conflict of interest. Different past researches also call it the most impactful on
the rating decisions. Credit analysts have to face the dilemma of choosing between
providing the best picture of an entity to the lenders and investors and providing
the best service to an entity through a satisfactory credit rate. There is always a
chance that a client may change from one credit rater to another just to get a more
favorable rating or rating at a lower cost. (Shil, 2015)
 Lack of specific guidelines is another hurdle for CRAs to pass in Bangladesh.
Bangladesh Bank provides certain measurements for credit rating. However, most
of them are based on audit reports and numeric data, with little to no mentioning
qualitative analysis and opinion freedom.
 Credit rating being the only source of income for CRAs impact their service
provided. Many banks tend to undermine credit raters' service since they can do

13
 most of it, or so they think. Despite there being only eight CRAs, which have
specific service areas, credit raters feel the subtle yet pressuring competition of
getting clients and holding onto existing once.
 Unavailability of the necessary information is more like an "everyday problem" for
credit raters. They are often only provided with audited financial information and
documents, which have high chances of being fabricated or manipulated.
Sometimes they are not allowed to visit the clients' business, leaving relative
assessments to the analyst's imagination. Also, another frequent issue faced by
analysts is that not all businesses keep their records properly. Some SMEs, for
example, may only be able to provide the number of sales and fixed costs and loans
of a quarter of the whole financial period, nothing else.

4.3.2 Limitations

 It is very difficult to access actual information regarding the financial position and
other qualitative and quantitative conditions. Credit analysts have to persuade
clients with assurances like not providing the data to regulatory authorities or
potential investors
 Credit raters are often bound to analyze according to banks’ instructions. It might
just be "providing a credit rate based on the audit report."
 There is no well-defined benchmark to decide the financial worthiness other than
past credit history and changes in profits, assets, and liabilities. This limitation often
ignores other hidden aspects like how well the business is running or the inherent
risk regarding the income source or industry related to the client.
 Credit raters are often exposed to economic and political influences. Regulators fail
to notice or ignore this. When banks assess loan applications, they, too, are affected
by economic conditions and political influences. For example, after an economic
crisis, banks may be more flexible about the financial conditions of a client, so may
the credit raters.

4.4 Credit Rating Agencies of Bangladesh

Credit rating is an opinion of a particular credit agency on the ability and willingness of an
entity (governmental, corporate, or individual) to fulfill its financial obligations in full and
within the dates set. Also, a credit rating means the likelihood that a debtor will default.
Also, a credit rating means the likelihood that a debtor will default. It is also representative
of a debt instrument's credit risk – whether a loan or a bond issue.
Currently, there are eight established credit rating agencies in our country as follows
according to Bangladesh Business Directory-

14
 1. Credit Rating Agency of Bangladesh (CRAB)
CRAB provides rating services for Banks, NBFIs, MFI, and corporate sectors.
2. Credit Rating Information and Services Limited (CRISL)
CRISL is dedicated to Credit Rating and related services and is being recognized
by Bangladesh Bank as the External Credit Assessment Institution (ECAI) to offer
its services to the banking community for banking client ratings. CRISL provides
its services with high business and ethical code as approved by the International
Organization of Securities Commission (IOSCO), Securities and Exchange
Commission of Bangladesh, and Bangladesh Bank ECAI recognition Criteria.
3. Bangladesh Rating Agency Limited (BDRAL)
A subsidiary of Dun & Bradstreet South Asia Middle East Ltd. is the pioneer in
rating the SME sectors in Bangladesh.
4. ARGUS Credit Rating Services Ltd. (ACRSL)
Founded in 2011, ACRSL provides Credit Rating, Credit Advisory, Project
Feasibility, Credit Research, etc.
5. Emerging Credit Rating Limited (ECRL)
Services include – Corporate Debt Rating, Bond Rating, Financial Institutions
Rating, Structured Finance Rating, General Insurance Rating, Life Insurance
Rating, Issuer Rating, and Shariah Banking Rating.
6. National Credit Ratings Limited (NCR)
Range of products and services includes Entity Rating, Bank Loan Rating,
Financial Institution Rating, Insurance Company Rating, Asset Manager Rating,
Instrument Rating, and Sectorial Grading & Rating.
7. Alpha Credit Rating Limited
Services include advisory services (financial feasibility, financial structuring,
modeling, and client-specific need-based studies in the different sectors), Training
(designing, developing and delivering customized training in credit, risk and
corporate finance), Analysis, and Research.
8. WASO Credit Rating Company (BD) Ltd. (WCRCL)
Services include Corporate Ratings, Bank & FIs Ratings, Stature Finance Ratings,
Insurance Ratings, SMEs, and Research (Economy, Industry, and Specific).
These agencies are recognized as external credit assessment institutions by Bangladesh
Bank. In addition to these credit rating agencies, the Bangladeshi Regulatory Authorities
also recognize the following international credit rating agencies primarily for sovereign
rating purposes. (Domestic Credit Rating – Operation and Effectiveness in Bangladesh)

I. Standard and Poor’s (S&P)

II. The FitchRatings
III. Moody’s Investor Service (Moody’s)

15
4.5 Credit Raters Rated
Credit raters of our country are often criticized for various reasons. Such as-

a) High fees imposed by credit raters often make them subject to criticism. Most often
clients and banks tend to think they are charged more than actual for the value they
get
b) Some researchers believe that economic circumstances highly influence credit
ratings. It is a dilemma for credit analysts when they have to rate clients from
specific, sensitive industries, such as clients from the garments sector.
c) Conflict of interest is mentioned almost everywhere when credit raters are
discussed. In the global business climate, credit raters frequently evaluate the
corporate clients to determine their ratings based on requests obtained from their
managers (Care et al. 2013), which also indicates credit rating system being
exposed to authoritative, personal, and sometimes political influence.
(Seetharaman, Patwa, & Nagarajan, 2019)

16
Chapter 05: Non-Performing Loans or
NPL- An Indicator of Performance?
5.1 Non-Performing Loan: What It Means for a Bank
The core of the bank is divided into two segments, i.e., deposits and loans. The bank's main
objective is to collect the deposit from the surplus portion and supply the surplus to the
deficit portion of the fund collected. Non-performing loan indicates the portion of loan
financing provided by the bank that has either become a default or is close to being a default
one.
The International Monetary Fund (IMF) has indicated that a loan is not effective when
paying interest and principal are due for 90 days or more; or interest payments equal to or
more than 90 days have been capitalized, refinanced or delayed by agreement; or payments
are due for less than 90 days, but there are other good reasons such as a bankrupt debtor to
doubt that payments will be made in full. (Bloem & Freeman, 2005). In Bangladesh, as
mentioned before, Bangladesh Bank has eight different bank loan classifications to indicate
quality. Among these, Sub Standard (SS), Doubtful (DF) and Bad & Loss (BL) are
considered as a non-performing loan (NPL)
A bank having a troubling amount of NPL is a sign of irregularities in a bank's credit
management, as well as in the overall financial condition of the country/countries where
the bank operates. In a general sense, the presence of an alarming amount of NPL indicates
insufferable effects such as limiting a bank's lending capacity, making banks increase their
provision for NPL rather than spending on management efficiency and developments, and
finally, weaken the banks' strength to put up against risks. This hinders banks' overall credit
quality, one of the most important components in a country's economy.

5.2 Reasons behind NPLs

The actual factors working behind non-performing loans being created can be different
from one country to another. On a general sense, these NPLs may occur mostly because of
two factors (923 articles)

I. External factors or economy (both or either of macro and micro economy)

II. Internal factors or variables relative to banks themselves
However, which of these factors has a more significant impact, is a debatable topic itself.
Andriani and Wiryono (2015) and Bohachova (2007), hint us on the impact of economic
variables being more prominent on banks' loan financing decisions. According to Andriani

17
and Wiryono, for example, the relationship between banks and microeconomic factors
influence systematic risks. We can take this as a factor affecting banks' decisions on earning
sources because we know banks are organizations needing profit as well. With the
systematic risks fluctuating, it is normal for a bank to change its loan policies to get hold
of potential borrowers or vice versa. A high systematic risk makes banks depend on their
"expectations'', either loosening loan-decision policies taking the high risk as a chance of
high profit, or tightening the policies fearing possible loss due to loans turning out to be
unpaid for real.
On the other hand, Chaibi et al. (2015) suggest that bank-specific variables such as overall
management of loan providing services, benchmarks used to select potential borrowers,
etc. are more impactful and that it is the government and authority's responsibility to focus
more on such problems.
As for Bangladesh, both economic and bank-specific factors play roles behind the growing
rate of NPLs, while constantly being affected and overlapped by each other. In brief, the
following facts can be considered some of the main attributes behind non-performing loans
occurring in Bangladesh, some being frequently mentioned by the bankers I interviewed –

1. Most of the time, non-performing loans occur due to banks' inability to choose the
right customer for the right kind of loan financing. In a highly competitive industry,
emerging and goal-oriented banks can be more focused on quantity over customers'
quality.
2. Banks have to go through several steps while taking loan financing decisions. 6 out
of 8 bankers say they check the credit rating reports more because it is mandatory
due to regulations, rather than necessary to avoid risks. This behavior shows a
possible reluctance to check a customer's potential thoroughly.
3. Another reason mentioned by bankers is fund diversion. According to Anis A khan,
a prominent career banker with an experience of about four decades in the banking
sector, this indeed is one of the major reasons behind the rise in non-performing
loans (Rahman S. , 2019). Often, borrowers spend up the money they obtain in
places other than the original intention. Such cases bearing failures, leave the
borrowers unable to pay for the loans, and thus create non-performing loans.
4. Lack of proper supervision from both banks and related authorities can also be
considered impactful behind non-performing loans. Lack of supervision leads to
wrong decisions and problematic loans left as they are, encouraging both customers
and bankers to be lenient about loan payments.
5. The dominance of loans and deposits in a bank's overall assets and financial
position makes the bankers desperate and reckless about loan decisions, often
leading to ignorance towards the rising amount of loan unpaid and focus on creating
new deposits, borrowers, and areas of investments.

18
 6. Other than the ones stated above, the direct and indirect reasons behind the
occurrence of NPLs include fluctuating domestic and global economy, global
financial crisis, rising inflation, weak bank fundamental structure of banks, and
their policies regarding loan financing, etc. (Kumar, Hossain, & Islam, 2020)

5.3 The Core Problem

If we take a good look at the reasons behind the occurrence of NPLs, one thing that catches
the eyes is that banks often tend to choose the wrong customers, either due to high
competition or economic position. However, since these things are out of banks' control,
the only way left is to improve the loan decisions banks make. This fact makes the selection
of borrowers far more important for the banks, leading us to check the credibility of loan
applicants, through documents and other proofs previewed.

In our country, the banks check an applicant's list of assets, other loans, past credit history,
present financial condition, mortgages, possible risks, etc. One document that provides the
best and most reliable source of all this information is the applicant's credit rating report.

5.4 NPL: The Performance Indicator

The alarming growth of non-performing loans in the economy has led to various
assumptions regarding its causes. From a general perspective, credit raters are often blamed
because they provide some of the key elements when banks decide on providing loans.
This fact is supported by our participants who claim the main mistake to be the wrong
choice of clients.
However, as we learned earlier, CRAs face several challenges and limitations that hinder
their ability to provide more accurate ratings from time to time. Banks can also be put at
fault for depending on credit raters for the majority of the assessments regarding a loan
applicant. As N K A Mobin FCA, FCS, CFC describes regarding the operation and
effectiveness of credit ratings, it is difficult to predict future events and trends, the
distribution of ratings is not an exact science (Domestic Credit Rating – Operation and
Effectiveness in Bangladesh, 2015). For this purpose, credit rating opinions are not
intended as credit quality assurances or as accurate measurements of the likelihood that a
particular issuer or debt issue may default.

19
Chapter 06: Impact of Credit Rating
Report

6.1 Impact on Loan decisions

6.1.1 Where do Credit Rating Reports Stand for Bankers?
According to existing rules and regulations provided for the banks, credit rating reports
(CRRs) are mandatory to check for every borrower. According to most of our participants,
CRRs hold a great impact on providing loans rather than making detailed decisions. In
other words, good ratings compel banks to sanction loans quicker, rather than checking
further on the customer and following cautionary processes. (Figure 6.1 in Appendix)
While CRRs are just evaluations of borrowers from one perspective, banks tend to take
these rates as a sort of ultimate indicator of a borrower's ability. Our participants also
showed high confidence that customers with good rates rarely default, close to 0-10 cases

out of every 100.

Rate of Defaults from Borrowers with Good Credit Rates (from Primary Survey)

However, CRAs often say that the banks or clients seeking credit ratings often ask them to
provide specific rates despite not being eligible. This can happen when the borrower holds
an influential image, or the banks simply do not want to record a bad rating for customers.

6.1.2 Where Does the Focus Go?

Since the CRRs hold such an impact, it is normal to assume that the bankers check every
credit analyst element. However, the report being more of a "part of the regulations” and
the rates being considered the main benchmarks, banks sometimes tend to be reluctant

20
about the clients' inherent risks. However, most of our participants mentioned checking
financial analysis provided even if they do not check the actual business or client
descriptions. One reason can be that the banks make their inspection (mostly) on the
businesses or clients and thus feel they already know about the existing risks.

Also, focus on credit rating reports gets affected by the type of clients as well. Corporate
borrowers get the most focus on their reports, indicating this particular type of clients seems
to be riskier. (Figure 6.2 in Appendix)

The second place goes to new projects which get their reports checked with utmost
importance. However, projects of existing clients are checked less frequently, indicating
banks being reluctant over the potential risks of changes in credit risks of clients who have
been provided loans before or have a previous credit history with the particular banks.

6.1.3 Loan Policy Adjustments

Various research on the banks' behavior based on credit ratings shows that banks tend to
change their interest rates, mortgage qualities, and financial verifications based on upward
and downward changes of clients' credit rates or to-be clients.

Based on bank-data analysis from 2011 to 2016 on how credit rates influence bank lending
decisions, the findings consistently show that, following a shift in credit ratings, the spread
of interest appears to increase while the expected exposure decreases.

The results are rather statistically significant and have a strong economic importance. For
example, in the specification of all fixed effects, the adjustment of ratings leads to a change
of some 33 basis points in the spread of interest paid and an 18 per cent improvement in
the exposure committed. Rating changes therefore have a clear treatment effect on the price
and size of the loan. We also note substantial changes in the maturity of the loan following
any modification of the value, after testing the unobservable characteristics of the issuer,
borrower, period and amount of the loan. (Figure 6.3 in Appendix)

21
As for upward and downward changes, regression findings provide clear evidence of
asymmetrical reactions to upward vs. downward adjustment of credit ratings by banks. We
use regressions with all of the fixed effects included.

Source: (How Do Credit Ratings Affect Bank Lending Under Capital Constraints, 2018)

We notice that banks are responding to a downward adjustment of ratings by increasing

spreads paid by some 41 basis points and by-committed exposures by 29 per cent. The
maturity of the loans also falls by some 25%. The effect of upward changes on the terms
of the loan is less than the previous one. Only the distribution and scale of the undertaking
have statistically meaningful results; even then, the extent of the effects is lower for spreads
and much lower for exposures than their downward-adjustment counterparts. Differential
results indicate that the influence of rating changes occurs during downward adjustment as
banks respond to the implications of capital constraints.

6.2 Impact performing Loans on Non-Performing Loans

From the banks' side, it appears that banks rely heavily on the credit rating reports, and
they make adjustments based on changes in credit rates. This takes us to another question,
do CRRs hold any impact on non-performing loans at all? We have used Difference-in-
Differences analysis using “Treatment Effect” to check whether the use of these reports
changed the rate of non-performing loans, and if yes, how.
Through this analysis, I found out that over the years (1993 to 2019), credit rating service
itself affected the non-performing loan rate by decreasing it by 23%. Making credit scoring
mandatory from 2007 took part in decreasing the rate by 11%, compared to the years before
when credit rating was not of strong existence and was not mandatory, respectively.

22
Also, it was indicated that had the credit rating system not been made mandatory, the NPL
rate would have a high potential to increase by up to 20.22%. This shows that credit rating
reports have performed satisfactory enough to decrease the rate of classified loans within
the total loan financing of banks in Bangladesh. (Figure 6.4 and 6.5 in the Appendix)

6.3 Impact on Loan Financing

According to the central bank's guidelines, risk management regarding overall bank
activities is the responsibility of the risk management department. At the same time, higher
authorities are solely responsible for creating the benchmarks and policies regarding a
bank's view on the level of risk tolerance and ensuring the most effective decision-making
structure that complies with the bank's risk-tolerance and benchmarks.

In the case of loan-financing, risk of frauds such as loan frauds and misinformation by
clients are included as type B or "External Frauds" in the operational risks. However, the
guidelines do not provide any specific indicators of the minimum credit rates acceptable
by banks and leave it for banks' judgments and risk analysis. It indicates that credit rating
reports are simply a source of information supporting banks' decisions taken on certain
loan financing.

The participants from the primary survey also mention credit rating reports to be effective
on loan financing decisions. 33.33% of bankers agree that credit rating reports are useful
to determine loan performance and loan policies, but only 8.3% think the reports are
directly impactful enough to decide on loan approvals. (Figure 6.6 in Appendix)

6.3 Some Facts to Consider

As for now, the impact of credit rating reports, more precisely the credit rates of borrowers
seem to have a significant impact on the loan decisions of banks. However, some facts
must be considered before we blame the downfalls in loan financing on credit rating reports
and credit analysts. The participants from the primary survey themselves drew attention to
some facts that should and must be considered-

I. Banks do not always check reports for renowned or old clients,

II. CRAs can be affected by the fact that they are serving clients and thus manipulate
the reports
III. There exists a high chance of banks manipulating financial documents for clients
that affect the credit rating (Figure 6.7 in Appendix)
IV. Neither banks nor CRAs always gets full access to original documents or the clients
directly
V. The regulations imposed on credit rating are vague and need quick up gradation

23
6.4 Findings
From all the qualitative and quantitative analysis, we can summarize the findings into the
following points-

A. Credit Rating Reports have some impact on loan financing decisions, mostly
because they are part of the mandatory regulations to meet for both banks and
borrowers
B. Banks are more dependent on credit rating reports for gathering information and
getting financial insights on potential borrowers, and decide on the potential risk a
client holds, rather than using the report to decide whether to provide loan to the
certain client or not
C. However, both banks and Credit Rating Agencies face the lack of proper and
authentic information regarding clients and often have to rely on public information
and own judgments
D. Credit rating reports are subject to a higher level of influence of conflict of interest,
economic conditions, politics, and data manipulation.
E. Banks are subject to the above influences as well, but there is a chance of
manipulation from their side as well.
F. There is a guideline on how to rate a client, but no clear instruction on which rates
should be accepted when giving loans, banks are on their own regarding this.

6.5 Recommendation
After considering the analysis and suggestions from the participants, the following steps
can be useful suggestions to improve the current distress in loan financing-

 Credit Rating System and Credit Risk Management systems should be more
specific and transparent
 More focus should be put on industrial analysis
 Information such as account liquidity behavior, more detailed analysis of the
creditworthiness of clients should be accessible and added along with existing
analysis
 Credit analysts should be provided with authentic data, at least regarding the overall
performance of the client

24
Chapter 07: Conclusion

Sensitivity to market risk accounting quality and corporate governance issues are
insignificant compared to other qualitative factors in the existing classification manual risk
management. The value of qualitative factors is that day by day, and Bangladesh bank
released corporate governance guidelines in 2012. Only market risk management is
focused on risk management, but other risks such as operational risk, liquidity risk, and
reputation risk must be taken into account. As far as accounting quality is concerned,
whether the income recognition policies are documented and accounted for in the financial
statements and the provision and valuation of investments are considered, but there is a
possibility of framing the accounting figures.
Accountants are only playing with the numbers. They may manipulate financial
information if management wants to do so. For this reason, the existing risk grading system
needs to be modified. Both qualitative and quantitative factors must be balanced to evaluate
the performance of any client. Only numerical facts and figures do not guarantee that
quantitative factors are presented in a true and fair light. Therefore, Bangladesh Bank must
increase its weight towards qualitative factors, specifically accounting quality, corporate
governance, and risk management.

25
Appendix

26
 A. Questionnaire

(The Questionnaire is added at the end of the report)

27
 B. Figures

Figure 3.1 Return on Assets and Equities of Commercial Bank Groups

Figure 3.2 Capital to Risk-Weighted Assets Ratio (CRAR) by Types of Banks

28
Figure 3.3 Ratio of Gross NPL to Total Loans by bank type (in percent)

Table 4.1 Quantitative Indicators and Associated weights regarding ICRR

(Bangladesh_Bank, 2018)
Quantitative Indicators Weig Def
ht init
ion
a) Debt to Total Interest-bearing liabilities or
Tangible Net 7 Financial Debt/ Total
1.Leverage Worth (DTN) Tangible Net Worth1
(10%)
b) Debt to Total Total Interest-Bearing Liabilities
3
Assets (DTA) or Financial Debt/ Average Total
Assets
a) Current Ratio (CR)
7 Current Assets/ Current
2.Liquidity Liabilities
(10%)
Cash and easily marketable
b) Cash Ratio (Cash) 3
securities/ Current Liabilities
a) Net Profit Margin
5 Net profit after tax/ Net Sales
(NPM)
Net profit after tax/
3.Profitabi b) Return on Assets 3
Average Total Assets
lity (10%) (ROA)
c) Operating Profit to Operating Profit/ Average
2
Operating Assets Operating Assets
(OPOA)

29
 Earnings Before
a) Interest Coverage 3
Interest and
(IC)
Tax/Interest Expense
b) Debt Service Earnings Before Interest Tax
4.Coverage Coverage Ratio 5 Depreciation Amortization/
(15%) (DSCR) Debts to be
Serviced
c) Financial
Debt to 4 Financial Debt / Operating Cash
Operating Cash Flow
Flow
(FDOCF)
d) Cash flow Cash flow from operation /
3
Coverage Ratio Debts to be Serviced
(CCR)
a) Stock Turnover Days (Total Inventory/Cost of Goods
5.Operational 4
(STD) Sold)*360
efficiency
b) Trade Debtor
(10%) 3 (Total Accounts Receivable/
Collection
Days (TDCD)

Sales)*360
c) Asset Turnover (AT) 3 Sales /Average Total Assets
a) Operating Cash
3 Operating Cashflow / Sales
6.Earning Flow to Sales
quality (5%) (OCFS)
b) Cash flow-based
=NI-(CFO+CFI)
accrual ratio (CAR) 2
/Average Net Operating
Assets
1
Total Tangible Net Worth= Total Equity-Intangible Assets.

30
Table 4.2 Qualitative Indicators and Associated weights regarding ICRR
(2018)

31
Figure 4.3 Credit Risk Grading Process in Commercial Banks
(Mohammad & Onni, 2015)

Figure 6.1 Necessity of Credit Rating Reports for Banks

(Source: Primary Survey)

32
Figure 6.2 Focus on different borrowers’ Credit Rating Reports

Source: Primary Survey

Figure 6.3 Effect of Changes in Loan Ratings on Interest Spread

Source: (How Do Credit Ratings Affect Bank Lending Under Capital Constraints, 2018)

33
Figure 6.4 Effect of Credit Rating Report on Non-Performing Loan Rate

Figure 6.5 Effect of Credit Rating Reports Being “Mandatory” on Rate

of Non-Performing Loans

Note: Here, nplrate = gross non-performing loan rate from 1992-2019;

scored = indicates treatment group exposed to credit rating report;
mandate = shows treatment group exposed to credit rating reports being
ruled as mandatory

34
Figure 6.6 Position of Credit Rating Reports in Loan Financing

Decisions
Source: Primary Survey

Figure 6.7 Probability of Financial Document Manipulation by Any

Related Party

Source: Primary Survey

35
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Journal of Accounting, Business and Management vol. 26 no. 2, 59-78.
Shil, S. (2015). An Exploratory Study on Bangladesh’s Emerging Credit Rating.
Independent Business Review, Volume 8 Number. 1 & 2.
Waqas, M., Fatima, N., Khan, A., & Arif, M. (2017). Determinanats of Non-
performing Loans: A Comparative Study of Pakistan, India, and Bangladesh.
International Journal of Finance & Banking Studies, Volume 6 No 1, 51-68.
Wikipedia. (n.d.). Credit Rating Agency. Retrieved from Wikipedia:
https://en.wikipedia.org/wiki/Credit_rating_agency

37
7/16/2020 Impact of Credit Rating Reports for Loan Financing of Banks:Bangladesh Perspective

Impact of Credit Rating Repo s for Loan

Financing of Banks:Bangladesh
Perspective
All the information collected will be used for my internship report on the topic of the same title
as above
* Required

1. name *

2. Bank *

3. Designation *

4. For which type of client/industry do you check the reports most carefully? *

Check all that apply.

Individual Borrower
Corporate Borrower
SME
New project/ Business
Project of Existing Clients
Other:

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7/16/2020 Impact of Credit Rating Reports for Loan Financing of Banks:Bangladesh Perspective

5. Why do you check reports of these particular clients/industries? *

Check all that apply.

Mandatory due to regulations

Holds more risk

6. Do you check the full credit rating report for each client?

Check all that apply.

Yes
No

7. Rate the topics based on how frequently they are checked *

Mark only one oval per row.

Always Most of the Time Sometimes Rarely

Ratings

Business Description

Client Description

Risks described by analysts

Financial analysis

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7/16/2020 Impact of Credit Rating Reports for Loan Financing of Banks:Bangladesh Perspective

8. How many times a good credit rate holder may default out of every 100
(approximately)? *

Mark only one oval.

0-10%

11-20%

21-30%

31-40%

41-50%

More than 50%

9. Why do you think non-performing loans (NPLs) occur (brief points) *

10. Are Credit Rating Reports frequently checked for renowned companies? *

Mark only one oval.

Yes

No

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7/16/2020 Impact of Credit Rating Reports for Loan Financing of Banks:Bangladesh Perspective

11. Credit Rating Reports for banks are *

Mark only one oval.

Only a part of regulations

Effective for and impactful on the loans bank provides

Should be improved to be more transparent, effective and impactful

For Regulating the types of loans, default or performing

12. What do you suggest be added/ deduced from existing structures of credit rating
reports? (3/4 points)

13. Apparently, banks do loan financing based on the credit rating report or they have
alternative rating measurements from their end. Is there any chance to manipulate
the financial statement of the client for acquiring the loan?

Mark only one oval per row.

Very High High Average Low Very Low

Yes

No

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