1.0 COMPANY BACKGROUND

Based on Islamic principles and Shariah (Islamic law), with an authorized capital of TK. 500 million

(US$ 12.5 million), Islami Bank Bangladesh Limited (IBBL) was incorporated on March 13, 1983 as

a Public Limited Company under the companies Act of 1913. This is one of the first interest free

banks in South Asia. It has 36.91% local and 63.09% foreign shareholders. With 285 branches and

11,465 staffs, IBBL is the largest private banking network in Bangladesh (as of 2013). The bank

is listed with both Dhaka Stock Exchange Ltd. and Chittagong Stock Exchange Ltd

1.1 FINANCIAL INFORMATION

As of 2013, the financials of IBBL stand as follows:

Authorized Capital Tk. 20,000.00 Million ($ 250.47 Million)Paid-up Capital Tk. 12,509.64 Million ($ 156.66 Million)Deposits Tk. 417,844.14 Million ($ 5,232.87 Million)Investment (including Investment in Shares)

Tk. 399,930.80 Million ($ 5,008.53 Million)

Current Amount of Loan Outstanding

Around 500 crores

Bad-debt 3-4%

1.2 CLIENT INFORMATION

As of 2013:

No. of clients Around 1 croreNo. of debtors Around 5 lakhs

2.0 FINANCIAL MODEL OF IBBL

The financial model of Islami Bank Ltd is slightly different from that of conventional banks, due to its

adherence to Islamic Banking Principles. This means, unlike conventional debtor creditor relationship

that exists with banks and depositors as well as borrowers, due to prohibition, banks run under the

Islamic banking system cannot act as intermediaries between depositors and borrowers.

2.1 KEY DIFFERENCES

Conventional Banks accept deposits, and give loans based on fixed interest rates. This is usually done

by transferring credit to the borrower once the application has been processed.

Islamic banking requires the bank to take some degree of “ownership of risk” , thus no direct

cash transaction to the account of the borrower is made. Instead the bank “purchases” goods or

machinery that the borrower requires, on behalf of the borrower, and “re-sells” these goods at a higher

rate to the borrower, with the provision of paying in installments or at a later date. Thus it is more

into “product business” than “money business”.

Page | 1

This requirement of ownership then precludes Islami Bank from offering loans for personal uses like

medical cures, events, or service oriented companies since it is difficult or impossible to make direct

payments to sellers in these instances. Thus the arrangements are of 3 sorts:

a) Co-ownership

b) Hire-Purchase

c) Lease

(Details in the Appendix)

3.0 CURRENT SCENARIO OF NON-PERFORMING LOANS IN BANGLDESH

BANKING INDUSTRY

Default loans dropped 28.45% last quarter on the back of

increased cash recovery, loan write-offs and liberal

rescheduling rules in the wake of political unrest that hurt

business. As of December 31 last year, the banking

sector's total classified loans stood at Tk. 40,583 crore,

down from Tk. 56,720 crore on September 30, 2013.

Of the 56 banks, 40 managed to cut down their default

loans. This happened mainly due to Bangladesh Bank’s

relaxation of NPL Rescheduling rules in June, 2012:

“The bank must have a policy approved by its Board

defining the circumstances/ conditions under which a

loan may be rescheduled but not in contravention of the contents of the Bangladesh Bank circular.

The policy must highlight the controlling mechanisms for avoidance of routine rescheduling/ repeat

rescheduling wherein lies the doubt of recovery of full amount of loan.”

IBBL managed to cut down its default loan from Tk. 2786 crores to Tk. 1354 crores. However,

it is still higher than most of the private banks.

4.0 CREDIT DISBURSEMENT POLICY & PRACTICES OF IBBL

It is a known fact that a bank's financial well-being is essentially dependent upon the extent and size

of its performing assets. Credit losses are equivalent to capital losses. An increase in non-

performing loan (NPL) has far-reaching adverse impacts on bank's balance sheet having

consequential effects on profitability, liquidity and solvency. Thus, the bank management has to stay

focused on keeping credit portfolio performing to the maximum extent.

Adverse selection and moral hazard are related to asymmetric information between two contracting

parties. These concepts are very significant in the context of banking institutions. Adverse selection

arises due to defectiveness in selection of potential borrower, mistake in selection of business where

Page | 2

Figure 1 NPL in different banks of Bangladesh (Source: The Daily Star)

to finance/not to finance, defective structuring of credit, under/over financing, faulty projections not

supported by adequate assumptions, etc. In case of moral hazard, one of the party hides information

that may appear to be vital during the contract and occurs mainly due to poor monitoring, economic

recession, political instability, etc. Discussed below are the policies and practices of credit

disbursement of IBBL with the aim of minimizing adverse selection and moral hazard:

4.1 POLICIES & PRACTICES TO MINIMIZE ADVERSE SELECTION

The cure for information asymmetry is more information about potential fund receivers. After an

overall assessment, the individual/ organization are given a Credit Risk Grading (CRG). The

scores are arbitrary and dependent on the company’s own credit policies. On a scale of 1-8, the cut-

off point is usually 6. (Details in Appendix)

4.1.1 Assessment of credit worthiness for Fresher

In case of the potential borrower being a fresher, i.e. the proposal is for a new business, the bank takes

a number of steps to cross check credit worthiness. The broad approach is to break it down into two

aspects, the individual’s credit worthiness as a borrower, and the business plan’s sustainability as a

successful enterprise.

Individual credit worthiness

A detailed Financial Analysis is done by the banks own analysts. In some instances, especially in case

of larger loans, external consultants are sometimes hired as well. The factors under inspection are:

Evaluation of bank statements: The individual’s bank statements are evaluated. The current

balance, spending patterns, and net assets are also checked. In some cases, the potential

borrower is asked to present a guarantor of the loan, a person who is willing to bear the risk in

case of default.

Evaluation of tax statements: The borrower is required to produce their tax returns and

returns of several years are compared to account for inconsistencies.

Double-checking with Credit Information Bureau: Credit Information Bureau, a division

of the Bangladesh bank, is accessed. This division was created to monitor all credit within the

country, and banks are required to lodge information here as soon as a loan is granted. This is

the hub of information for all outstanding loans within Bangladesh at any given time. This

will reveal any loan the individual is yet to pay off.

Assessment of history of loans: In some cases the borrower is asked for a history of loans

that they may have taken and repaid. This information is then cross checked by calling the

borrowers prior banks. This is NOT a formal process, and is usually done over the phone as a

“heads-up” from one banker to another.

Page | 3

Business Credit Worthiness

The analysts look at a number of things, including forecast for demand for that sort of a business,

financial climate, the business model etc.

They identify highly risk sensitive borrowers as well as assess geographical area-wise risk

sensitivity.

In instances where they feel that the plan requires substantial alterations, the bank makes these

alterations conditional for the loan to be granted. In most instances, the borrower is free to choose

between different suppliers or approaches, so long as none of the investments raise a red flag with

the analysts.

4.1.2 Assessment of credit worthiness of Existing firms

The process for appraisal for existing firms is quite similar. Since the business is already operational,

there is less emphasis on individual credit worthiness.

Auditing of firm by CRAB: On top of the usual analysis of the firms books, the business is

usually required to allow a third party, usually CRAB (Credit Rating Agency of

Bangladesh) to audit the company and give it a credit rating, on the basis of which the loan is

approved or disapproved. The expense for this audit is to be paid for the company itself.

Implementation Schedule: During the evaluation process, the business (be it a proposed or

current one) is also required to submit a Implementation schedule, which is basically a

timeline of the project. On the basis of this, the bank prepares a Fund Drawdown Schedule,

which outlines at the times at which the bank will sanction payment on behalf of the borrower

to a third party. While minor adjustments can be made to these schedules, usually the bank

tries to enforce adherence.

4.2 POLICIES & PRACTICES TO MINIMIZE MORAL HAZARD

In debt finance through the issuance of bonds, IBBL imposes restrictive covenants that prevent

the bond issuer from taking too many risks or to restrict the amount of debt that can be added.

Diversion of fund is one of the identified causes of loan default. Thus, they keep a close watch on

the borrower’s business operations and the movement of their financial indicators after

disbursement. Since Islami Bank never actually transfers cash to borrower’s account, it is much

easier to monitor the borrower’s activity once loan is granted. This practice of continuous

monitoring is called “supervised credit”.

The monitoring process contains:

Random On-site inspections: Inspectors from the Bank turn up unannounced to the site of

the business to see if everything is proceeding as proposed. The objective is to assess how

close the company is to the proposal, and whether or not the requirement as per the schedules

is realistic for scale of operations

Page | 4

Valuation of the business proposal: The business proposal given to the bank or fund

proposal whatever is given, is first has to go through the NPV evaluation. Cash flow

statements are analyzed to check the business’s potential of repaying the loan. FV estimations

are done for checking the potential

Industry analysis: In order to re-assure that the proposed business is worth financing an

overall industry analysis is done. IFE & EFE matrix are also taken into consideration

Evaluation of Stock report: The borrower is to submit a routine stock report to the bank.

This is to account for the amount of stock/machinery that the bank paid for on behalf of the

customer is either in stock, or is accounted for in the sales ledger of the company. This is

done to make sure the borrowers cannot funnel money away from the project they initially

borrowed for.

Net Asset valuation- The worth of the mortgaged asset is acquainted its total worth which

gives the bank assurance of the mortgage. The loan amount is then discussed and adjusted

Contract binding: In whatever case the bank invests it follows the ancient shariah methods

of mudarabah,( shares the profit) ijara ( shares ownership of equipment ) and shikket

( forms partnership with the business owner ) and as such the bank binds the debtors into legal

contract specifying the terms and conditions in case of loan default.

Legal Compliance- In cases where debtor is suspected to be a bad debtor, legal complaint is

filed under separate bank court. (Details in Appendix)

REFERENCE

In-Depth Interview

Md. Akther Hossain

Vice President & Branch Manager

Page | 5

Islami Bank Bangladesh Ltd., Cantonment Branch

BIBLIOGRPAHY

Byron, R.K. (2015, Feb 18). Increased loan recovery, relaxed rules cut defaults. The Daily Star.

http://www.thedailystar.net/increased-loan-recovery-relaxed-rules-cut-defaults-12889

Masoon, M. (2013, Feb 16). Strategies for recovery of non-performing loans. The Financial Express.

http://www.thefinancialexpress-bd.com/old/index.php?

ref=MjBfMDJfMTZfMTNfMV85OV8xNjAzNDQ%3D

Islami Bank Bangladesh Ltd. Wikipedia, the free encyclopedia.

http://en.wikipedia.org/wiki/Islami_Bank_Bangladesh_Ltd

IBBL At a Glance. Islami Bank Bangladesh Limited Official Website.

http://www.islamibankbd.com/abtIBBL/abtIBBLAtaGlance.php

Managing Core Risks in Banking: Credit Risk Management-Industry Best Practices. Bangladesh

Bank.

http://www.bb.org.bd/openpdf.php

APPENDIX

MODES OF INVESTMENTS OF IBBL

a. Co-Ownership: The asset is purchased on a co-ownership basis between the bank and the

debtor. Gradually over time, debtor purchase the bank’s share in the car against monthly

payments and consequently the ownership is completely transferred under their name.

b. Hire-purchase: In Hire Purchase under Shirkatul Melk mode both the Bank and the Client

supply equity in equal or unequal proportion for purchase of an asset. They purchase the asset

Page | 6

with that equity money, own the same jointly; share the benefit as per agreement and bear the

loss in proportion to their respective equity. The share, part or portion of the asset owned by

the Bank is hired out to the Client partner for a fixed rent per unit of time for a fixed period.

Lastly, the Bank sells and transfers the ownership of its share / part / portion to the Client

against payment of price fixed for that part either gradually part by part or in lump sum within

the hire period or after the expiry of the hire agreement.

c. Lease: Bank purchases all of the good on behalf of the borrower, and sets rates and time

duration for repayment, at the end of which the transfer of ownership of good is complete.

CREDIT RISK GRADING

According to Bangladesh Bank:

Risk Rating Grade Definition

Superior – Low Risk 1 Facilities are fully secured by cash deposits, government

bonds or a counter guarantee from a top tier international

bank. All security documentation should be in place.

Superior – Low Risk 2 The repayment capacity of the borrower is strong. The

borrower should have excellent liquidity and low

leverage. The company should demonstrate consistently

strong earnings and cash flow and have an unblemished

track record. All security documentation should be in

place. Aggregate Score of 95 or greater based on the Risk

Grade Scorecard.

Acceptable – Fair Risk 3 Adequate financial condition though may not be able to

sustain any major or continued setbacks. These borrowers

are not as strong as Grade 2 borrowers, but should still

demonstrate consistent earnings, cash flow and have a

good track record. A borrower should not be graded

better than 3 if realistic audited financial statements are

not received. These assets would normally be secured by

acceptable collateral (1st charge over stocks / debtors /

equipment / property). Borrowers should have adequate

liquidity, cash flow and earnings. An Aggregate Score of

75-94 based on the Risk Grade Scorecard.

Marginal - Watch list 4 Grade 4 assets warrant greater attention due to conditions

affecting the borrower, the industry or the economic

environment. These borrowers have an above average

risk due to strained liquidity, higher than normal leverage,

Page | 7

thin cash flow and/or inconsistent earnings. Facilities

should be downgraded to 4 if the borrower incurs a loss,

loan payments routinely fall past due, account conduct is

poor, or other untoward factors are present. An Aggregate

Score of 65-74 based on the Risk Grade Scorecard.

Special Mention 5 Grade 5 assets have potential weaknesses that deserve

management’s close attention. If left uncorrected, these

weaknesses may result in a deterioration of the repayment

prospects of the borrower. Facilities should be

downgraded to 5 if sustained deterioration in financial

condition is noted (consecutive losses, negative net worth,

excessive leverage), if loan payments remain past due for

30-60 days, or if a significant petition or claim is lodged

against the borrower. Full repayment of facilities is still

expected and interest can still be taken into profits. An

Aggregate Score of 55-64 based on the Risk Grade

Scorecard.

Substandard 6 Financial condition is weak and capacity or inclination to

repay is in doubt. These weaknesses jeopardize the full

settlement of loans. Loans should be downgraded to 6 if

loan payments remain past due for 60-90 days, if the

customer intends to create a lender group for debt

restructuring purposes, the operation has ceased trading

or any indication suggesting the winding up or closure of

the borrower is discovered. Not yet considered non-

performing as the correction of the deficiencies may

result in an improved condition, and interest can still be

taken into profits. An Aggregate Score of 45-54 based on

the Risk Grade Scorecard.

Doubtful and Bad (non-

performing)

7 Full repayment of principal and interest is unlikely and

the possibility of loss is extremely high. However, due to

specifically identifiable pending factors, such as

litigation, liquidation procedures or capital injection, the

asset is not yet classified as Loss. Assets should be

downgraded to 7 if loan payments remain past due in

excess of 90 days, and interest income should be taken

into suspense (nonaccrual). Loan loss provisions must be

Page | 8

raised against the estimated unrealisable amount of all

facilities. The adequacy of provisions must be reviewed at

least quarterly on all non-performing loans, and the bank

should pursue legal options to enforce security to obtain

repayment or negotiate an appropriate loan rescheduling.

In all cases, the requirements of Bangladesh Bank in CIB

reporting, loan rescheduling and provisioning must be

followed. An Aggregate Score of 35-44 based on the Risk

Grade Scorecard

Loss (non-pe 8 Assets graded 8 are long outstanding with no progress in

obtaining repayment (in excess of 180 days past due) or

in the late stages of wind up/liquidation. The prospect of

recovery is poor and legal options have been pursued.

The proceeds expected from the liquidation or realization

of security may be awaited. The continuance of the loan

as a bankable asset is not warranted, and the anticipated

loss should have been provided for. This classification

reflects that it is not practical or desirable to defer writing

off this basically worthless asset even though partial

recovery may be effected in the future. Bangladesh Bank

guidelines for timely write off of bad loans must be

adhered to. An Aggregate Score of 35 or less based on the

Risk Grade Scorecard

LEGAL ACTION ON EVENT OF SUSPICIOUS ACTIVITY OF DEBTOR

1. Give notice warning them to pay off the loan within 15 days.

2. If the person falters, then a final notice is given with another 15 day period.

3. On event of non-compliance, a legal notice is sent via their advocate.

4. If that doesn’t work then they file a case under Non-negotiable Act of check dishonor.

5. If they can recover the loan by selling off mortgage then the case is not filed. However, if only a

partial amount is recovered then another case is filed to the court to ask for permission to seize

personal property equivalent to the unrecovered amount of the debtor.

Page | 9