Stress Testing Report of Dhaka Bank Limited 2009

Executive Summary

The capital adequacy ratio (CAR) of Dhaka Bank Limited was satisfactory in 2009 and the bank was only in danger in cases of credit risk- increase in NPL, Increase in NPLs’ under B/L category in 1 or 2 sectors, Shift in NPLs categories:, Increase in NPLs’ due to Top 10 large loan borrowers, Fall in the FSV of Mortgaged Collateral. Since, it is very unlikely that all those adverse movement will take place at a time; I can say that the bank’s CAR is satisfactory. But the Dhaka Bank should have to pay more attention to the creditability of borrower & quality of collateral to reduce the credit risk. In that case the overall CAR will be immune to any adverse shock.

When cumulative shock of credit risk affects then for 3 scenarios’ Banks Revised CAR will be 7.61%, 4.67% and 1.59% respectively. Again cumulative shock of all factors will lead DBL’s Revised CAR into 6.75%, 2.82% and -1.41%.

The rise in interest rate would lower the CAR in 2009 because the duration gap of Dhaka Bank is positive (0.88). As a result the increase in interest rate would decrease the value of assets more than the value of liabilities.

Net exposure in foreign currency was always positive for Dhaka Bank. It means, the bank was in net long position in 2009. As a result, currency appreciation would harm the bank. The Bank would able to maintain required Capital Adequacy level in minor, moderate and major level shock in 2009 according to BASEL-I.

Due to adverse change in foreign exchange rate of 5%, 10% and 15%, the loss was BDT. 64,741,886 BDT. 129,483,772 and BDT. 194,225,658 respectively. As a result of those adverse change in rate the revised CAR will be 11.19%, 11.08% and 10.96% respectively.

Equity price risk management of Dhaka Bank Limited was very satisfactory. Dhaka Bank Limited was much robust in equity price risk because 10%, 20% and 40% fall in stock prices cause only 0.01%, 0.03%, 0.06% fall in CAR. Its Revised CAR became only 11.29%, 11.28% and 11.25% for the respective shock.

In the year 2009, Dhaka Bank’s liquidity risk would not suffer a lot. Any bank suffers the most in liquidity shock because banks are the borrower of short term and lender of long term. In 2009 DBL’s Revised Liquidity Ratio would be 84.39%, 82.44% and 79.93% respectively for 10%, 20% and 40% shock which is not so far from its actual liquidity ratio 86%.

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Stress Testing

Stress testing is a simulation technique, which are used to determine the reactions of

different financial institutions under a set of exceptional, but plausible assumptions through

a series of battery of tests. At institutional level, stress testing techniques provide a way to

quantify the impact of changes in a number of risk factors on the assets and liabilities

portfolio of the institution. For instance, a portfolio stress test makes a rough estimate of

the value of portfolio using a set of exceptional but plausible events in abnormal markets.

However, one of the limitations of this technique is that stress tests do not account for the

probability of occurrence of these exceptional events. For this purpose, other techniques,

for example VAR (value at risks) models etc, are used to supplement the stress tests. These

tests help in managing risk within a financial institution to ensure optimum allocation of

capital across its risk profile.

At the system level, stress tests are primarily designed to quantify the impact of possible

changes in economic environment on the financial system. The system level stress tests also

complement the institutional level stress testing by providing information about the

sensitivity of the overall financial system to a number of risk factors. These tests help the

regulators to identify structural vulnerabilities and the overall risk exposure that could cause

disruption of financial markets. Its prominence is on potential externalities and market

failures.

Techniques for Stress Testing

a) Simple Sensitivity Analysis (single factor tests) measures the change in the value of

portfolio for shocks of various degrees to different independent risk factors while the

underlying relationships among the risk factors are not considered.

b) Scenario Analysis encompasses the situation where a change in one risk factor affects a

number of other risk factors or there is a simultaneous move in a group of risk factors.

Scenarios can be designed to encompass both movements in a group of risk factors and the

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changes in the underlying relationships between these variables (for example correlations

and volatilities).

c) Extreme Value/ Maximum Shock Scenario measures the change in the risk factor in the

worst case scenario, i.e. the level of shock which entirely wipes out the capital.‐

Scope of Stress Testing

As a starting point the scope of the stress test is limited to simple sensitivity analysis. Five different risk factors namely; interest rate, forced sale value of collateral, non performing‐ loans (NPLs), stock prices and foreign exchange rate have been identified and used for the stress testing. Moreover, the liquidity position of the institutions has also been stressed separately. Though the decision of creating different scenarios for stress testing is a difficult one, however, to start with, certain levels of shocks to the individual risk components have been specified considering the historical as well as hypothetical movement in the risk factors.

Stress test shall be carried out assuming three different hypothetical scenarios:

Minor Level Shocks: These represent small shocks to the risk factors. The level for different risk factors can, however, vary.

Moderate Level Shocks: It envisages medium level of shocks and the level is defined in each risk factor separately.

Major Level Shocks: It involves big shocks to all the risk factors and is also defined separately for each risk factor.

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Dhaka Bank Limited

Bangladesh economy has been experiencing a rapid growth since the '90s. Industrial and agricultural

development, international trade, inflow of expatriate Bangladeshi workers' remittance, local and

foreign investments in construction, communication, power, food processing and service enterprises

ushered in an era of economic activities. Urbanization and lifestyle changes concurrent with the

economic development created a demand for banking products and services to support the new

initiatives as well as to channelize consumer investments in a profitable manner. A group of highly

acclaimed businessmen of the country grouped together to responded to this need and established

Dhaka Bank Limited in the year 1995.

The Bank was incorporated as a public limited company under the Companies Act. 1994. The Bank

started its commercial operation on July 05, 1995 with an authorized capital of Tk. 1,000 million and

paid up capital of Tk. 100 million. The paid up capital of the Bank stood at Tk 2,659,597,763 as on

March 31, 2010. The total equity (capital and reserves) of the Bank as on March 31, 2010 stood at Tk

6,036,368,754.

The Bank has 62 Branches, 3 SME Service Centers, 6 CMS Units, 2 offshore Banking Unit across the

country and a wide network of correspondents all over the world. The Bank has plans to open more

Branches in the current fiscal year to expand the network. The Bank offers the full range of banking

and investment services for personal and corporate customers, backed by the state–of–the-art

technology and a team of highly motivated Professionals. As an integral part of our commitment to

Excellence in Banking, Dhaka Bank now offers the full range of real-time online banking services

through its all Branches, ATMs and Internet Banking Channels.

Dhaka Bank Ltd. is the preferred choice in banking for friendly and personalized services, cutting

edge technology, tailored solutions for business needs, global reach in trade and commerce and high

yield on investments

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Capital Adequacy Ratio of Dhaka Bank Limited as per BASEL I

In Millions

Particulars 2009 (Basel-I)

Total eligible capital 5633.77

Risk weighted assets (RWA)

a. Credit risk 46976.80

i. On balance sheet 2839.03

ii. Off-balance sheet 49815.83

b. Market risk -

c. Operational risk -

Total RWA 49815.83

Required capital on RWA @ 10% as per Basel I 4981.58

Capital Surplus 652.19

Capital Adequacy Ratio (CAR) 11.31

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Stress Testing of Dhaka Bank Limited

Stress TestingDhaka Bank Ltd.

For the year ended on December 31, 2009

Balance Sheet Duration

Year : 2009 Book Value Coupon Re-pricing

Period in Years

Yield to Maturity

Market value Duration

Assets:Cash 5,035,699,739 - - - 5,035,699,739 -Cash with other Bank and Financial Institutions

8,224,866,995 - 8,224,866,995

-On Demand 2,885,740,693 - 2,885,740,693-Upto 1 month

180,776,302 0.08 180,776,302 0.08

-Over 1 month but not more than 3 months

300,000,000 0.25 300,000,000 0.25

-Over3 months but not more than 1 year

4,540,000,000 1.00 4,540,000,000 1.00

-Over 1 year but not more than 5 years

318,350,000 5.00 318,350,000 5.00

-Over 5 years - 5.00 - -Money at Call and Shot Notice

269,800,000 - - - 269,800,000

Investment 8,659,565,948 -28 days Treasury Bills

- - - - -

30 days Treasury Bills

- - - - -


499,795,327 - - - -


- - - - -


617,430,902 5.0% 1.00 0.06 29,124,099 1.00

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5 Years Bangladesh Government Treasury Bond

4,178,114,735 8.0% 5.00 0.07 4,349,425,688 4.33


2,629,241,495 11.0% 10.00 0.12 3,367,909,176 6.95


513,247,547 14.0% 15.00 0.13 546,415,548 7.21

Prize Bond 2,651,800 - - - - -Shares 149,423,110 - - - 149,423,110 -Debentures 6,000,000 7.0% 5.00 0.06 6,252,742 4.40Zero Coupon Bond

48,181,514 - 5.00 - 48,181,514 -

Other Investments

15,479,518 - - - 15,479,518 -

Loans and Advances

52,909,814,017

Repayable on Demand

9,809,871,510 - - - 9,809,871,510 -

Not more than 3 months

7,613,261,480 9.0% 0.25 0.09 7,613,261,480 0.25

More than 3 months but not more than 1 year

14,627,835,863 10.0% 1.00 0.10 14,627,835,863 1.00

More than 1 year but not more than 5 years

18,071,752,791 12.0% 5.00 0.12 18,071,752,791 2.77

More than 5 years

2,787,092,373 - - - 2,787,092,373 -

Premises and Fixed Assets

424,462,708 - - - 424,462,708 -

Other Assets 2,243,203,687 - - - 2,243,203,687 -Non Banking Assets

- - - - - -

Total Assets 77,767,413,094 0.07 77,767,413,094 -

Liabilities:Borrowings from Other Banks,

3,489,759,326

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Financial Institutions and AgentsRepayable on Demand

420,000,000 - - - 420000000 -

Repayable within 1 Month

- - 0.08 - - -

Over 1 month but within 6 months

2,592,500,000 0.50 7.00 2592500000 0.50

Over 6 months but within 1 year

73,940,000 1.00 9.00 73940000 1.00

Over 1 year but within 5 years

296,337,879 5.00 12.50 296337879 5.00

Over 5 years 106,981,447 5.00 15.00 106981447 5.00Deposit and other Accounts

60,918,374,023

Current Account and Other Accounts

5,552,769,281 - - - 5552769281 -

Bills payable 2,151,455,682 0.08 - 2151455682 0.08Savings Bank Deposits

5,881,201,270 0.50 - 2151455682 0.50

Term Deposits

47,332,947,790 1.00 - 47332947790 1.00

Non Convertible Subordinated Bond

- - -

Other Liabilities

8,393,597,775 - - - 8393597775 -

Total Liabilities

72,801,731,124 - - 72801731124 -

Total Capital 4,965,681,970 - - - 4965681970 -Total Liabilities and Capital

77,767,413,094 - - 77767413094

The Duration GAP has been calculated by using the following formula:DGAP = DA – (MVL/MVA) X DL

DA = Weighted average duration of assetsMVL = Market value of liabilitiesMVA = Market value of assetsDL = Weighted average duration of liabilities

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The change in market value of equity has been calculated using the following formula:

Δ MVE = ( DGAP) X Δ‐ i / (1+y) X Total Assets

Δi = Change in the interest ratey = Effective yield to maturity of all the assets

Duration of Assets (DA) 1.54 Duration of Liabilities (DL) 0.71 (MVL/MVA)*DL 0.67 Duration Gap 0.88

Stress TestingDhaka Bank Ltd.

For the year ended on December 31, 2009

Figure in BDTRegulatory Capital 5,633,768,159 5,633,768,159 5,633,768,159

RWA 49,815,831,250 49,815,831,250 49,815,831,250

CAR (%) 11.31% 11.31% 11.31%

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Interest Rate Risk

According to Bangladesh Bank, Interest rate risk is the potential that the value of the on‐

balance sheet and the off-balance sheet positions of the bank/DFI would be negatively

affected with the change in the interest rates. The vulnerability of an institution towards the

adverse movements of the interest rate can be gauged by using duration GAP analysis. The

banks and FIs shall follow the following steps in carrying out the interest rate stress tests:

Estimate the market value of all on balance sheet rate sensitive assets and liabilities‐

of the bank/DFI to arrive at market value of equity.

Calculate the durations of each class of asset and the liability of the on balance sheet‐

portfolio Arrive at the aggregate weighted average duration of assets and liabilities.

Calculate the duration GAP by subtracting aggregate duration of liabilities from that

of assets.

Estimate the changes in the economic value of equity due to change in interest rates

on on balance sheet positions along the three interest rate changes.‐

Calculate surplus/(deficit) on off balance sheet items under the assumption of three‐

different interest rate changes i.e. 1%, 2%, and 3%

Estimate the impact of the net change (both for on balance sheet and off balance‐ ‐

sheet) in the market value of equity on the capital adequacy ratio (CAR).

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The following assumptions are taken at the time of calculating the interest rate shocks on

Dhaka Bank Limited’s financial position because of some lack of disclosures about the term

to maturity, market value and interest rates of various rate sensitive assets and liabilities:

Deposit and lending rates are taken from the Bank’s current deposit and lending rate.

Market value and book value of deposits and borrowing are assumed to be same.

The impact of interest rate shocks on the CAR of Dhaka Bank are given below –

Interest Risk - Increase in interest rate Scenario 1 Scenario 2 Scenario 3

Magnitude of Shock 1% 2% 3%

Fall in MVE (on balance sheet)‐ ‐ 639,020,427 1,278,040,854 1,917,061,282

Net fall in MVE (on balance sheet & off‐ ‐ ‐balance sheet)

639,020,427 1,278,040,854 1,917,061,282

Tax Rate 42.50% 42.50% 42.50%

Tax adjusted loss 367,436,746 734,873,491 1,102,310,237

Total Regulatory capital 5,633,768,159 5,633,768,159 5,633,768,159

Revised Capital 5,266,331,413 4,898,894,668 4,531,457,922

Risk weighted assets 49,815,831,250 49,815,831,250 49,815,831,250

Revised risk weighted assets 49,448,394,504 49,080,957,759 48,713,521,013

CAR 11.31% 11.31% 11.31%

Revised CAR 10.65% 9.98% 9.30%

Fall in CAR (% age points) 0.66% 1.33% 2.01%

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Exchange Rate Shock

The stress test for exchange rate assesses the impact of change in exchange rate on the

value of equity.

Net exposure in foreign currency was always positive for Dhaka Bank. It means, the bank

was in net long position in 2009. As a result, currency appreciation would harm the bank.

The Bank would able to maintain required Capital Adequacy level in minor, moderate and

major level shock in 2009. Due to adverse change in foreign exchange rate of 5%, 10% and

15%, the loss was BDT. 64,741,886 BDT. 129,483,772 and BDT. 194,225,658 respectively. As

a result of those adverse change in rate the revised CAR will be 11.19%, 11.08% and

10.96%respectively.

Exchange Rate Shock


Net on balance sheet and off balance sheet ‐ ‐currency exposure

2,251,891,685 2251891685 2251891685

Exchange rate loss on % change 112594584.3 225189168.5 337783752.8

Tax Rate 42.50% 42.50% 42.50%

Tax adjusted loss 64,741,886 129,483,772 194,225,658

Total eligible capital 5,633,768,159 5,633,768,159 5,633,768,159

Revised Capital 5,569,026,273 5,504,284,387 5,439,542,501



CAR 11.31% 11.31% 11.31%

Revised CAR 11.19% 11.08% 10.96%


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Credit Shock

The bank is exposed to credit risk in its lending operation. Credit risk is the risk of loss that

may occur from the failure of any counterparty to make required payments in accordance

with agreed terms and conditions. Management of credit risk in the bank is governed by a

Credit Policy Manual which contains the principles for identifying, measuring, approving and

managing credit risk. These policies are established by the Board of Directors and are

designed to meet the organizational requirements that exist today, and to provide flexibility

for future. These policies represent the minimum standards for credit extension and are not

a substitute for experience and good management.

The stress test for credit risk assesses the impact of increase in the level of nonperforming

loans of the bank/FI. This involves six types of shocks:

1. Credit Shock - Increase in NPLs


Total Loan 52,909,810,000 52,909,810,000 52,909,810,000

Total Performing Loan 49,963,680,000 49,963,680,000 49,963,680,000

Total NPLs 2,946,130,000 2,946,130,000 2,946,130,000

NPLs to Loans (%) 5.57% 5.57% 5.57%

Increase in NPLs 499,636,800 999,273,600 1,498,910,400

Tax Rate 42.50% 42.50% 42.50%

Tax adjusted provision 499,636,800 999,273,600 1,498,910,400


Revised Capital 5,134,131,359 4,634,494,559 4,134,857,759



CAR 11.31% 11.31% 11.31%

Revised CAR 10.41% 9.49% 8.56%

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Revised NPLs 3,445,766,800 3,945,403,600 4,445,040,400

Revised NPLs to Loans (%) 6.51% 7.46% 8.40%

2. Credit Shock - Shift in NPLs categories


Weighted Amount of provision 1,488,012,764.50 1,488,012,764.50 1,488,012,764.50

Provision after shift in categories 1,751,633,617.40 2,069,870,604.44 2,282,028,595.80

Increase in provision 263,620,852.90 581,857,839.94 794,015,831.30

Tax adjusted provision 263620852.9 581857839.9 794015831.3

Revised Capital 5,370,147,306 5,051,910,319 4,839,752,328

Revised RWA 49,552,210,397 49,233,973,410 49,021,815,419

Revised CAR (%) 10.84% 10.26% 9.87%

Fall in CAR(% points) 0.47% 1.05% 1.44%

3. Credit Shock - Fall in the FSV of Mortgaged Collateral :


Total FSV 976,786,800.00 976,786,800.00 976,786,800.00

weighted FSV collateral 817,278,422.60 817,278,422.60 817,278,422.60

fall in the FSV 81,727,842.26 163,455,684.52 326,911,369.04

Tax adjusted provision 81,727,842.26 163,455,684.52 326,911,369.04

Revised Capital 5,552,040,316.74 5,470,312,474.48 5,306,856,789.96

Revised RWA 49,734,103,407.74 49,652,375,565.48 49,488,919,880.96

Revised CAR (%) 11.16% 11.02% 10.72%

Fall in CAR(% points) 0.15% 0.29% 0.59%

4. Credit Risk - Increase in NPLs in particular 1 or 2 sectors

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Magnitude of Shock 5.00% 7.50% 10.00%

Loan to Garments & Textile Sectors 9,728,960,598 9,728,960,598 9,728,960,598

Increase in NPLs 486,448,029 729,672,044 972,896,059

Increase in provision (after adjustment of value of eligible securities; if any)

486,448,029 729,672,044 972,896,059

Tax adjusted provision 486,448,029 729,672,044 972,896,059

Revised Capital 5,147,320,129 4,904,096,114 4,660,872,099

Revised RWA 49,329,383,220 49,086,159,205 48,842,935,190

Revised CAR (%) 10.43% 9.99% 9.54%

Fall in CAR 0.87% 1.32% 1.77%

5. Credit Risk - Increase in NPLs due to Top 10 large loan borrowers


Loan to Top 10 large loan borrowers 13,263,285,974 13,263,285,974 13,263,285,974

Increase in NPLs 663,164,298 994,746,448 1,326,328,597

Increase in provision (after adjustment of value of eligible securities; if any)

663,164,298 994,746,448 1,326,328,597

Tax adjusted provision 663,164,298 994,746,448 1,326,328,597

Revised Capital 4,970,603,860 4,639,021,710 4,307,439,561

Revised RWA 49,152,666,951 48,821,084,801 48,489,502,652

Revised CAR (%) 10.11% 9.50% 8.88%

Fall in CAR (% points) 1.20% 1.81% 2.43%

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Equity Price Shock

The stress test for equity price risk assesses the impact of the fall in the stock market index.

Here we have taken the market value of the portfolio of the bank. Appropriate shocks have

been absorbed to the respective securities if the current market value of all the on balance

sheet and off balance sheet securities listed on the stock exchanges including shares, NIT

units, mutual funds etc falls at the rate of 10%, 20% and 40% respectively. The impact of

resultant loss has been calibrated in the CAR.

Equity Price Risk - Fall in Stock Prices


Total exposure in stock market 145,423,110 145,423,110 145,423,110

Fall in the stock prices 14,542,311 29,084,622 58,169,244

Tax Rate 42.50% 42.50% 42.50%

Tax adjusted loss 8,361,829 16,723,658 33,447,315


Revised Capital 5,625,406,330 5,617,044,501 5,600,320,844



CAR 11.31% 11.31% 11.31%

Revised CAR 11.29% 11.28% 11.25%


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Liquidity Shock

The stress test for liquidity risk evaluates the resilience of the banks towards the fall in liquid

liabilities. The ratio “liquid assets to liquid liabilities” has been calculated before and after

the application of shocks by dividing the liquid assets with liquid liabilities.

Appropriate shocks have been absorbed to the liquid liabilities if the current liquidity

position falls at the rate of 10%, 20% and 30% respectively. The ratio of liquid assets to

liquid liabilities has been re‐calculated under each scenario.Liquidity Shock.

Liquidity Shock - Fall in liquid liabilities


Liquid assets (LA) 14,329,242,963 14329242963 14329242963

Liquid Liabilities (LL) 16,671,866,233 16671866233 16671866233

Liquidity Ratio (%) (LA/LL) 86% 86% 86%

Fall in liquid liabilities 1667186623 3334373247 5001559870

Revised Liquid Assets 12662056340 10994869716 9327683093

Revised Liquid Liabilities 15004679610 13337492986 11670306363

Revised Liquidity Ratio (%) 84.39% 82.44% 79.93%

Increase in liquidity ratio(% age points) -1.56% -3.51% -6.02%

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Cumulative Impact

Cumulative impact of Credit Shock 1st Scenario 2nd Scenario 3rd Scenario

Tax adjusted Provision 1,994,597,823 3,469,005,617 4,919,062,257.54

Revised Capital 3,639,170,335 2,164,762,541 714,705,901.46

Revised RWA 47,821,233,426 46,346,825,632 44,896,768,992

Revised CAR (%) 7.61% 4.67% 1.59%

Fall in CAR 3.70% 6.64% 9.72%

Cumulative impact of all shocks 1st Scenario 2nd Scenario 3rd Scenario

Tax adjusted Provision/ Loss 2,435,138,284.16 4,350,086,538.15 6,249,045,467.55

Revised Capital 3,198,629,874.84 1,283,681,620.85 (615,277,308.55)

Revised RWA 47,380,692,965.84 45,465,744,711.85

43,566,785,782.45

Revised CAR (%) 6.75% 2.82% -1.41%

Fall in CAR 4.56% 8.49% 12.72%

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Conclusion

Simple stress testing results of Dhaka Bank Ltd. reveals that the bank’s overall CAR would stay above the required level in minor and moderate shocks. But in major shocks the bank is exposed to risk to losing capital adequacy according to the required CAR.

Stress tests cover a range of methodologies. Complexity can vary, ranging from simple sensitivity tests to complex stress tests, which aim to assess the impact of a severe macroeconomic stress event on measures like earnings and economic capital. Most risk management models, including stress tests, use historical statistical relationships to assess risk. They assume that risk is driven by a known and constant statistical process and historical relationships constitute a good basis for forecasting the development of future risks. The recent financial turmoil has revealed serious flaws with relying solely on such an approach.

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References:

Bangladesh Bank, (April 2010), “Guidelines on Stress Testing”, Department of Offsite Supervision

Annual Report, (2009), Dhaka Bank Limited

http://www.dhakabankltd.com

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Stress Testing Report of Dhaka Bank Limited 2009

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Transcript of Stress Testing Report of Dhaka Bank Limited 2009