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ADDIS ABABA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICES
DEPARTMENT OF ACCOUNTING AND FINANCE
ASSESSMENT OF CREDIT RISK MANAGEMENT SYSTEMS AND
PRACTICES OF ETHIOPIAN COMMERCIAL BANKS. (CASE OF SOME
PRIVATE BANKS

The research proposal prepared by:

Utban Ashab

ID No UGR/6006/12

Submitted to advisor: Takele Fufa (PHD)

Submission date……………

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DECLARATION
I, Utban Ashab hereby declare that the project work entitled “Assessment of Credit Risk
Management systems and Practices- case of selected private banks.
In Addis Ababa Submitted by me for the award of degree Bachelor of Accounting and Finance.
Place: Addis Ababa Signature ______________________
Date: February 2023 Name: Utban Ashab
The these is prepared by Utban Ashab entitled “Assessment of Credit Risk Management Systems and
Practices in Private Commercial Banks of Ethiopia: The Case of Selected Private Banks” has been
submitted for examination with my approval as an Advisor.
Takele Fufa (PH.D)__________________ __________________ ____________
Advisor Name Signature Date

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Acknowledgment
First of all, I owe my deepest gratitude to the Almighty God for giving me the path, power, wisdom and
determination to finish this task successfully. I am also deeply appreciative of the guidance and support of
my advisor Dr Takele Fufa throughout this project.
I am especially grateful for the generous advice of my advisor throughout the thesis process.
I owe my parents immense thanks for their unconditional support and tireless efforts during my thesis
work and entire program.
I want to express my sincerest gratitude to all of the respondents who kindly filled out the questionnaire,
without whom this project would not have been possible. Finally, I would
like to acknowledge the many people who provided encouragement and support on my journey, even
though I may not have mentioned their names directly. Without them, achieving this dream would not
have been possible.

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Abstract
The primary aim of this research will be to investigate the credit risk management systems and practices
of private commercial banks in Ethiopia between 2013 and 2018. From 18 private commercial banks, the
four will be chosen based on two criteria: that they are operational during the study period, and that they
are included in the top 15 banks according to their size. The researcher will be selected banks such as
Berhan International Bank S.C, Bunna International Bank S.C, Debub Global Bank S.C and Enat Bank
S.C. . In this study, given the large number of branches nationwide it could potentially be difficult to
manage the research within the available timeframe and resources. As such, purposive sampling will be
used in order to select participants. The primary data for the study will be collected using questionnaires.
The questionnaires will be distributed to Bank Managers and Senior Officers involved in loan processing.
The data will be analyzed by using SPSS software version 21 and descriptive statistics. .

Keywords: Commercial banks, Credit risk, Managers, Credit risk Management, Assessing

CHAPTER I
INTRODUCTION

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1.1 Background of The study

Credit risk is an important component of financial systems and the banking sector in particular. There is a
need for well-established credit risk management frameworks in order to ensure the safety and soundness
of financial institutions, particularly in developing countries like Ethiopia. This paper will investigate the
current credit risk management practices in Ethiopian private commercial banks by conducting purposive
sampling of bank managers and senior officers. Primary data will be collected from these participants
through questionnaires and analyzed with descriptive statistics and SPSS software version 21. The results
from this study will be used to provide recommendations to improve the current risk management
environment in Ethiopia, as well as useful directions for future research initiatives

It is essential for banks to have a sound and comprehensive credit risk management system in order to
ensure the stability of the financial system. Ethiopian banks, especially private commercial banks, need to
enhance their credit risk management framework in light of the changing environment. New technologies,
competition, regulations and liberalization have resulted in an increase in the number and type of risks
faced by financial institutions. As banking services become more accessible, it is important for banks to
be able to effectively manage the risks they face. This research aims to examine the current credit risk
management practices in Ethiopian private commercial banks with the help of a purposive sample of
Bank Managers and Senior Officers. The results of this study will be used to provide recommendations to
improve the existing risk management frameworks and also to guide future research initiatives

Credit risk management is a critical component of the banking industry, and is of utmost importance in
developing countries like Ethiopia. Before 2010, there was inadequate attention given to the development
of modern risk management systems that comply with changing environment and global financial
standards. The Risk Management Guidelines published in that year paved the way for the continued
development of credit risk management practices. Banks must have a sound and effective risk
management system, as their funds are highly leveraged and at risk of public losses.
Practicing effective credit risk management is key to protecting consumers, investors and the banking
industry from financial losses and instability.
It can also help improve efficiency through enhancing competitive advantage, mobilizing and deploying
funds, an d optimizing risk-return trade-offs.

According to Poudel (2012), inadequate risk management leads to the accumulation of non-performing
loans, where generated profits are not only eroded through loan provisions, but also the soundness, safety
and stability of the bank is affected. However, effective credit risk management can improve credit
performance by establishing an appropriate credit risk setting, maintaining acceptable credit limits, and

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having a careful credit granting process with appropriate monitoring and control of the credit risk. Thus, it
is important to examine the level of credit risk management systems and practices of Ethiopian
commercial banks in order to develop policy measures to mitigate adverse consequences generated from
the credit function

The aim of this research is to explore the level of credit risk management system and practices among
Ethiopian commercial banks, assess the perception and awareness of risk management personnel, and
determine the types of risks and methods of risk identification through a descriptive survey research
approach.

1.2 Background of the Banking Industry in Ethiopia

As a result of the agreement reached between Emperor Mimilik II and Mr. Ma Gillivray, representative of
the British owned National Bank of Egypt; modern banking in Ethiopia began in 1905 with the Bank of
Abyssinia, a private company controlled by the Bank of Egypt In 1931. It was liquidated and replaced by
the Bank of Ethiopia which was the bank of issue until the Italian invasion of 1936. During the Italian
occupation, Bank of Italy banknotes formed the legal tender. Under the subsequent British occupation,
Ethiopia was briefly a part of the East Africa Currency Board. In 1943; the State Bank of Ethiopia was
established, with two and practices 3 departments performing the separate functions of an issuing bank
and a commercial bank. In 1963, these functions were formally separated and the National Bank of
Ethiopia (the central and issuing bank) and the Commercial Bank of Ethiopia were formed. In the period
to 1974, several other financial institutions emerged including the state owned: The Agricultural and
Industrial Development Bank (established largely to finance state owned enterprises); The Savings and
Mortgage Corporation of Ethiopia; The Imperial Savings and Home Ownership Public Association
(which provided savings and loan services)

Major private commercial institutions, many of which were foreign owned, included the Addis Ababa
Bank, the Banco di Napoli, the Banco di Roma. However, the banking business could not move further
because of the nationalization of private investments by the Socialist regime (the Dergue regime) that
came into power leaving only three government banks; the National Bank of Ethiopia, the Commercial
Bank of Ethiopia and agricultural and Industrial Development Bank.

This was reversed when the Socialist regime was overthrown in 1991. Following the overthrown of the
Dergue regime in 1991, the EPRDF declared a liberal economic system. In line with this, Monetary and
Banking proclamation of 1994 established the National Bank of Ethiopia (NBE) as a judicial entity,
separated from the government and outlined its main function.

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Monetary and Banking proclamation No.83/1994 and the Licensing and Supervision of Banking Business
No.84/1994 laid down the legal basis for investment in the banking sector (www.nbe.gov.com).After the
proclamation of 1994, the first private bank, Awash International Bank was established in 1994 by 486
shareholders paving a way to the establishment of related private banks such as Dashen Bank (1995),
Abyssinia Bank (1996), Wegagen Bank (1997),United Bank (1998), Nib International Bank (1999),
Cooperative Bank of Oromia (2004),Lion International Bank (2006), Oromia International bank (2008),
Semen Bank (2006),Bunna International Bank (2009), Berhan International Bank (2009), Enat Bank
(2011) , Debub Global Bank (2012) and others which are under establishment.

1.3 Statement of the Problem

The ultimate success of credit management depends on the bank's credit policy, portfolio of credit,
surveillance, management and tracking of loans and advances. Continuous surveillance, monitoring and
tracking are essential to guarantee timely repayment and reduce defaults. In reality, the credit portfolio
not only makes up the bank's asset structure but is also a vital factor in the bank's success.

In reality, the credit portfolio not only constitutes the bank's asset structure, but is also a crucial factor of
the bank's success. Only proper credit assessment can bring to attention the likelihood of credit loss due to
genuine business components and suggests potential ways to mitigate such a precarious situation in order
to keep it in check (Rana Al Musharraf, 2013). Properly managing credit risk in financial organizations is
of the utmost importance for their survival and development. When it comes to banks, this issue of credit
risk management takes on even greater significance due to the higher degree of risks associated with
certain client characteristics, market conditions, and economic setting.

Credit assessment is an integral process in financial institutions that helps to minimize the risks associated
with lending large sums of money. Proper credit assessment helps bankers understand the
creditworthiness of their potential clients, as well as their ability to repay a loan on time. Having this
knowledge helps ensure that the loan is safe and profitable for the bank. To make sure that a loan
proposal is creditworthy, the lender must consider different aspects of the borrower's financial profile
such as income, assets and liabilities. Furthermore, the lender should also consider other relevant
information such as the company's industry, its past performance, current competition and a detailed
analysis of the loan's repayment terms. By carefully studying all these factors, lenders can ensure that
their loans are desirable and profitable for both their clients and for themselves.

This research will analyses the current credit risk management systems and practices in Ethiopian
commercial banks, and investigate their effectiveness in managing credit risk. The results of this study

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will provide insights into the level of credit risk management used by financial institutions in Ethiopia, as
well as ways to enhance their current approaches. Additionally, the analysis will also include an
assessment of the importance of credit assessment techniques used to identify the probability of credit
loss due to genuine business elements.

1.4 Research Questions

1. Have the four private commercial banks established appropriate credit risk environment?
2. Have the four private commercial banks undertaken sound credit granting process?
3. Have the four private commercial banks maintained appropriate credit administration, measurement
and monitoring system?
4. Have the four private commercial banks ensured the adequate control over credit risk?
5. Do the four private commercial banks have effective credit risk management system and practice?

1.5 Objectives of the Study

1.5.1 General Objectives of the Study

The general objective of the study is to assess the credit risk management systems and practices in
Ethiopian banking, specifically in four private banks: Berhan International Bank S.C, Bunna International
Bank S.C, Debub Global Bank S.C, and Enat Bank S.C

1.5.2 Specific Objectives of the Study

Evaluate the appropriate credit risk environment established by the four private commercial banks.
Review the sound credit granting process undertaken by the four private commercial banks.
Assess the credit administration, measurement, and monitoring process of the four private commercial
banks.
Review the adequate control over credit risk of the four private commercial banks.
Assess the effectiveness of the credit risk management system and practice of the four private commercial
banks.

1.6 Significance of the Study

This study will be vital because it addresses challenges that banks will face in the future. Due to the fact
that interest earned from loans and advances is such a crucial source of income for banks, it is essential to

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properly assess loan applications before approval, as well as closely monitor granted loans to ensure they
do not become bad debts.

This study is important in order to help banks combat the present challenges concerning credit risk
management.
By providing banks with clear strategies on risk assessment and control, this study will be enables to
reduce the potential of loan losses and ensure a good credit management process.

This study will helps to reduce bad debts to a minimum by assessing the capacity of bank risk assessment
and credit control processes to provide careful analysis and monitoring of banks' credit administration. It
will be also make credit managers aware of the importance of effective risk assessment and control in
credit administration, as well as make important contributions to efficient and effective credit risk
management.

1.7 Scope of the Study

This study will assess the commercial banks' credit risk management systems and practices over the
period 2013-2018 for which there are consecutive five years of financial statements available.

Based on this criterion, up to June, 2018, there were eighteen banks in Ethiopia, out of them four banks
will be selected for this study at head office level.

1.8 Limitations of the Study

The research will have constraints which serve as limitations to the study. Firstly, access to data posed a
great challenge to the research. On numerous occasions, an interview appointment with the Head of
Credit of the bank was unsuccessful because of the tight schedules of the respondent. Feedback will have
to staff respondents was also another constraint due to lack of time, resulting in the case of unanswered
and semi-answered questionnaires. Obtaining accurate or exact answer from respondent may be another
challenge to the researcher.

1.9 Organization of the Study

The proposed study will have a structure of three chapters. The first chapter will introduce the
background of the study, the research problem, research questions, research objectives, significance of the
research, scope of the study, limitations of the study and the organization of the study. The second chapter
will include a theoretical and empirical review of the relevant literature. Finally, the third chapter will
cover the methodology of the study.

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CHAPTERII
2.1 REVIEW OF LITERATURE

The purpose of this chapter is to provide a brief review of the existing literature regarding credit risk
management the focus will be on the theories and empirical studies of credit risk management in
Ethiopia, and other countries with similar practices

2.1 Theoretical Review

This study is anchored in information asymmetry theory, as this theory is highly relevant to this
particular topic of exploration. According to this theory, both lenders and business owners should be
aware of the potential risks and returns associated with any potential investment projects for which the
funds are earmarked.

2.1.1 Definitions and Concepts of Credit Risk Management

This literature review is intended to assess the credit risk management systems and practices of
Ethiopian commercial banks, with a focus on some of the private banks.
It will examine the various theories and empirical studies related to this topic and assess the important
factors such as qualified staff, technological advancements, regulatory frameworks, and changes in
customer practices that can help inform the assessment of credit risk management systems and
practices of Ethiopian banks.
The review will also explore current challenges faced by the financial sector in the country with respect
to credit risk management and identify potential areas for further research and development

The primary objective of credit risk management is to minimize the effects of risks associated with the
investments made by the public (Brigham et al., 2016). Generally, loans are considered the primary and
most visible source of credit risk to banks. However, other sources of credit risk can be present
throughout various banking operations as well, including those on and off the balance sheet. In recent
years, commercial banks have been increasingly exposed to relatively high levels of credit risk (Olson
and Zoubi, 2017).

2.1.2.1 Credit Initiation

Edward (2004) defines the credit initiation process as one that begins with a market analysis and ends
with application approval. This process typically includes the following steps: Surveys and industry
studies by loan officers, customer relationship officers, and branch managers to identify key players and
potential business opportunities for the Bank. In addition, potential high-growth industries that could
represent good business for the Bank will be listed alongside any associated risks.

Presentation: The accuracy of the information gathered from the market and industry analysis will be
verified by consulting other sources. Credit committee approval: A copy of the annex and Loan Approval
Form (LAF) will be submitted to each member of the credit committee for review and approval or
rejection of the request.

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2.1.2.2 Documentation and Disbursement

The documentation and disbursement must comply with the applicable laws and the requirements of
the bank's legal department.
Documentation provided must satisfy the bank's legal department and afford maximum protection to
the bank. The documentation will be periodically reviewed to keep them up to date with ever-changing
legal systems and practices (Edward, 2004).

The legal department will be consulted before making any compromises with the customer. Any
amendments will be done in consultation with the legal department.

2.2 Empirical Review

There will be a large number of empirical studies in the area of safety and soundness, particularly in the
area of credit risk management, as the environment in Ethiopian banking systems continues to change.
Few academic and professional researches will be conducted related to the history and performance of
Ethiopian bank systems.
The following attempt will be made to summarize the main findings of some selected studies in the area
of risk management in commercial banks. Al-Tamimi and Al-Mazrooei (2007) will carry out a
comparative study of bank's risk management between national and foreign banks in the United Arab
Emirates through a survey.

Summary and Knowledge Gap

From the above theoretical as well as empirical reviews, risk identification, risk assessment and analysis,
and risk monitoring will be the most influential variables for risk management in the banking industry,
and will identify and rank three important types of risks. But the literature will not consider effective
loan repayment critically. An appropriate credit risk environment will be established, a sound credit
granting process will be maintained, appropriate credit administration will be maintained, and adequate
control over overall credit risk will be enforced

In order to address the above gaps, The Basel Committee on Banking Supervision (BCBS) will publish a
document entitled “credit risk management principles.”

2.3 Conceptual Framework

One of the main purposes of this study will be to examine/confirm the relationship between credit risk
management practice and four aspects of NBE (2010) and Basel's credit risk management standards
(1999) (see figure 1).

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Credit risk management practices

Figure 1: Model of credit risk management practice (Basel, 2000)

The principles of the Model of Credit Risk Management Practice (Basel, 2000) are as follows:

1. Establish, implement and maintain clear and effective policies and procedures for credit risk
management (CRM), setting out the credit risk appetite, setting an appropriate level of measurement,
methods for assessing the likelihood of default, etc.

2. Identify, monitor and manage changes in the credit risk of underlying exposures, identify and keep up-
to-date statistics on the various types of loans and other credit exposures of the institution.

3. Monitor and assess the performance of credit portfolios and monitor their impact on the institution's
overall financial performance.

4. Establish regular processes to review appropriate corrective actions when the portfolio deviates from
managed credit risk limits or other risk parameters adopted by the institution.

5. Establish, implement and maintain credit risk measurement systems and methods to closely monitor,
model and understand changing portfolio characteristics, including determining appropriate levels of
provisioning for each category of exposure.

6. Take into account the risks related to guarantees, collaterals as well as concentrations in terms of
geography (e.g., countrywide portfolios) or sector (e.g., retail banking).

7. Take into account any risk arising from business relationships with related entities, including complex
corporate structures where the relationship with a parent or other affiliates affects the credit exposure.

8. Ensure regular training programs for all staff involved in credit risk management activities in order to
maintain their knowledge up-to-date with regard to international best practices in CRM.

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Chapter three
3.1 Research methodology
In this chapter the researcher clearly and neatly describes the research design, population size
and sampling techniques, data collection instruments, variables and method data analysis, and
Reliability Measures.

3.1.1 Research Design

In order to achieve the objectives of the study, the research will employ descriptive approach by using
both qualitative and quantitative data. Researcher will be tried to develop structured questionnaire based
on the Basel’s credit risk management principles/activities of 1999 and NBE’s credit risk management
guideline of 2009. 41 closed ended questions with five Likert scale level of agreement will be developed
on five aspects of credit risk management activities.
3.1.2 Population Size and Sampling Techniques
In order to obtain reliable information and to fill the structured questionnaires the researcher will select
respondents. These respondents that will be involved professional working in the banks such as
department managers and senior officers working on loan processing (risk management staffs of head
office practical oriented response such as credit manager, credit director, credit analyst, recovery officers,
credit follow up, risk and compliance managers and risk experts will be the major respondents).
There were eighteen banks in Ethiopia. Out of them only four banks data will be taken. As noted by
Kothari (2004) good sample design must be viable in the context of time and funds available for the
research study. Besides, purposive sampling offers the researcher to deliberately select items for the
sample concerning the choice of items as supreme based on the selection criteria set by the researcher.
Accordingly, this study will employ purposive sampling technique to select the required sample of banks
from the above listed banks. The selection criteria set by the researcher will be first, the required banks
would be only commercial banks in Ethiopia. Second, those four commercial banks, which were selected
for study should operate during 2013-2018 having financial statements for consecutive five years. In this
study, the researcher will be utilized purposive sampling technique in order to select participants of the
study. The idea behind purposive sampling is to concentrate on people who are directly involved in credit
processing and administering because they would better be able to assist with the relevant research data.

3.1.3 Sample Size

The researcher will work in the four commercial banks out of 18 in Ethiopian banks, related to credit and
credit related operations as a whole will be taken as participants of the study. These are Berhan
International Bank S.C, Bunna International Bank S.C, Debub Global Bank S.C and Enat Bank S.C.

3.1.4 Data Collection Instruments

For the purpose of the study, both primary and secondary data will be employed. Primary data will be
collected through questionnaires. The questionnaires will be distributed to respondents that involve
professional working in the banks such as department managers and senior officers working on loan

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processing (risk management staffs of head office practical oriented response such as credit manager,
credit director, credit analyst, recovery officers, credit follow up, risk and compliance managers and risk
experts will be the major respondents). In addition, interview will employ on banks professionals as
primary data sources to supplement the questionnaire. The secondary data will be collected from financial
statements, annual reports, NBE directives, and bulletins of the banks.

3.1.5 Variables and Method of Data Analysis

The data will be analyzed by using descriptive summaries, econometrics model and Cronbach’s alpha
with the help of Statistical Packag

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e for Social Sciences (SPSS version 21).

3.1.6 Reliability Measure

Cronbach’s alpha will employ to test the consistency of the questionnaire. CRMP, ACRE, SCGP,
CAMMP and ACOCR had high reliabilities, all Cronbach’s α =0.963. Yfield, (2009, P. 676) suggested
that Cronbach’s α value of 0 .7 to 0. 8 was acceptable and ensure the reliability of items while Pallant,
(2007,P. 292) suggested that Cronbach’s α value of above 0.8, was preferably to be considered reliable.

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