Financial Planning & Control of Garments Industries A Study on Li & Fung (Trading) Ltd.

Financial Planning & Control of Garments Industries: A Study on Li & Fung (Trading) Ltd. ORGANIZATIONAL PROFILE Introduction IDLC Finance Limited commenced its journey in 1985, as the first ever leasing company of the country. In 1995, IDLC was licensed as a Financial Institution by the country's central bank, Bangladesh Bank, following the enactment of the Financial Institution Act 1993. Over the last two decades, IDLC has grown in tandem with the country's transition into a developing country and has emerged as Bangladesh's leading multiproduct financial institution. To encapsulate the evolving nature of the company, IDLC has changed its name to IDLC Finance Limited from earlier Industrial Development Leasing Company of Bangladesh Limited in August 2007. Since 1985, when IDLC was formed as the pioneering leasing company in Bangladesh, the company continues to evolve as an innovative financial solutions provider. It is now able to offer its customers, integrated and customized financial solutions - all under one roof. Its wide array of products and services range from retail products, such as home and car loans, corporate and SME products including lease and term loans, structured finance services ranging from syndications to capital restructuring and a complete suite of merchant banking and capital market services.

IDLC Finance Limited is a multi-product financial institution, established in 1985 with the collaboration of reputed international development agencies such as: Korean Development Leasing Corporation (KDLC), South Korea Kookmin Bank, South Korea International Finance Corporation (IFC) of the World Bank Group Aga Khan Fund for Economic Development (AKFED) German Investment and Development Company (DEG) The primary goal of IDLC was to help modernize the financial services industry, by introducing modern modes of financing hitherto unknown to Bangladesh. This, we set about to do, by pioneering the launch of a multitude of financial products and services.

History-Key Milestone Table 1: Key Milestone of IDLC Finance Limited May 23, 1985 Incorporation of the Company February 22, 1986 Commencement of leasing business October 01, 1990 Establishment of branch in Chittagong, the main port city March 20, 1993 Listed with the Dhaka Stock Exchange Limited Licensed as Non-Banking Financial Institution under the February 07, 1995 Financial Institutions Act, 1993 November 25, Listed with the Chittagong Stock Exchange Limited 1996 Commencement of Home Finance and Short Term Finance May 27, 1997 operations Licensed as a Merchant Banker by the Securities and Exchange January 22, 1998 Commission January 15, 1999 Commencement of Corporate Finance and Merchant Banking

operations January 29, 2004 Opening of the first retail focused branch at Dhanmondi June 29, 2004 Opening of Gulshan Branch November 22, Launching of Investment Management Services "Cap Invest" 2004 Issuance of Securitized Zero Coupon Bonds by IDLC February 07, 2005 Securitization Trust 2005 January 02, 2006 Opening of SME focused branch at Bogra April 06, 2006 Opening of Branch at Uttara Opening Merchant Banking Branch in the port city of May 18, 2006 Chittagong Relocation of Company's Registered and Corporate Head July 01, 2006 Office at own premises at 57, Gulshan Avenue, Dhaka September 18, Commencement of operation of IDLC Securities Limited, a 2006 wholly owned subsidiary of IDLC Launching of Discretionary Portfolio Management Services March 14, 2007 "Managed Cap Invest", renamed as “Max Cap Invest�

Company name changed to IDLC Finance Limited from August 05, 2007 Industrial Development Leasing Company of Bangladesh Limited December 03, IDLC Securities Limited Chittagong Branch commenced 2007 operation December 18, IDLC Securities Limited DOHS Dhaka Branch opened 2007 IDLC Finance Limited and IDLC Securities Limited opened January 06, 2009 Sylhet branches August 09, 2009 IDLC Securities Limited inaugurated its Gulshan Branch August 26, 2009 Inauguration of Gazipur SME Booth September 09, Opening of Imamganj SME Booth 2009 February 03, 2010 IDLC started its operation at Narayanganj February 24, 2010 Inauguration of Savar Branch August 08, 2010 IDLC opened its 2nd branch in Chittagong at Nandankanon October 27, 2010 IDLC stepped in Comilla December 2010 IDLC inaugurated its Narsingdi and Keranigonj Branches Mission, Vision and Objective of IDLC Finance Limited Vision Become the best performing and most innovative financial solutions provider in the country.

Mission Create maximum possible value for all the stakeholders by adhering to the highest ethical standards.

For Customers: Relentless pursuit of customer satisfaction through delivery of top quality services.

For Shareholders: Maximize shareholders' wealth through a sustained return on their investments.

For Employees: Provide job satisfaction by making IDLC a centre of excellence with opportunity for career development.

For the Society: Contribute to the well being of the society, in general, by acting as a responsible corporate citizen.

Goal Long term maximization of stakeholders' value in a socially responsible manner.

Corporate Philosophy Discharge our functions with proper accountability for actions and results and bind ourselves to the highest ethical standards.

Pattern of Shareholding of IDLC Finance Limited The shareholding structure at the year-end of 2010 is given below: Table 2: Shareholding Structure (2010) Shares held Name of Shareholders as a % of total holdings Sponsors/Directors: The City Bank Limited 28.37 Sadharan Bima Corporation 7.62 Sub-Total 35.99 GENERAL Institutions : Eskayef Bangladesh Limited 8.00 Mercantile Bank Limited 7.50 Reliance Insurance Company Limited 7.00 Transcraft Limited 4.01 Eastern Bank Limited 3.33 Bangladesh Lamps Limited 1.32 ICB 1.16 Marina Apparels Limited 1.00 Other Institutions 17.38 Sub total 50.70 Individuals : General Public (Individual) 13.31 Sub total 13.31 Total Holdings 100.00 Source: IDLC Annual Report 2010 CAPITAL Authorized Paid-up

: BDT 1,000,000,000 (10,000,000 ordinary shares of BDT 100 each) : BDT 600,000,000 (6,000,000 ordinary shares of BDT 100 each)

Figure 1: Pattern of Share Holding of IDLC Finance Limited Organizational Structure The organizational structure of IDLC Finance Limited is as follows-

Figure 2: Organization Structure of IDLC Finance Limited Diversity of Services To ensure steady and long term growth as well as to sharpen its competitive edge in a changing and challenging business environment, IDLC always endeavors to diversify into other financial services which have long term prospects. In 1997, it expanded its range of services by introducing Housing Finance and Short Term Finance. In early 1999, after getting license of Merchant Banking from Securities and Exchange Commission, IDLC started its operation of underwriting, issue management, corporate financing and other investment banking related services.

Leasing: Full payout lease finance for any type of machinery and equipment required in the manufacturing and service sectors.

Term Loans: Term loan is offered for corporate and project financing to establish project or to expand business or re-financing existing financing. IDLC’s Term Loan offers: Funding for specific purposes Competitive interest rates, fixed or variable Flexible terms

Variety of collateral options Short Term Finance (STF): STF provides Factoring of Accounts Receivables and Work Order Finance services to assist in the finance and management of accounts receivables and maximize business growth.

Home Loan & Real Estate: Individual House Loan Scheme for: Purchase of apartments, Construction of house, Renovation & extension of house and Purchase/construction of house for the employees under corporate house finance scheme.

Developers’ Finance Scheme for: Construction of Apartments projects Corporate Finance Scheme for: Purchase of office space/chamber/display center, Construction/purchase of commercial building, Constructions of commercially viable projects and Constructions of industrial buildings like factory, godown, warehouse etc.

Corporate Finance Syndication services for large-scale investments Advisory services such as corporate counseling, project counseling, capital restructuring, financial engineering, etc.

Merger and acquisition services Securitization of assets Merchant Banking Issue Management Underwriting Private placement of stocks Trusteeship management SME Division SME Retail Products Research Activities of IDLC Except for the regular functions, the credit risk management department is also responsible for conduction research activities on the industrial sectors of the country.

CRM department has identifies more than fifty industrial sectors of Bangladesh and planned to develop a database on those.

This research-based program started mid-way in 2003 and has so far covered sixteen industries. Usually industrial data is collected from secondary sources by the internal staffs of the interns doing their internship at IDLC, are assigned on some industries.

This research activity can be regarded as a proactive approach. The results are used in preparing internal reports, developing credit risk assessment criteria and briefing the relationship management team in business development activities.

Consolidated Key Operating and Financial Highlights Table 3: Financial & Operating Highlights for the year 2010

Source: IDLC Annual Report 2010

(BDT in millions)

Financial Performance of IDLC Finance Limited Liquidity Ratio

Figure3: Current of IDLC Finance Limited IDLC Finance Limited observes current ratio to check the liquidity position of the firm.

Over the years,the firm has been able to maintain standard level of current ratio. Except for 2006, the ratio has always been above 1.

Solvency Ratio

Figure4: Debt Equity Ratio of IDLC Finance Limited To check the solvency position of the firm, debt equity ratio and financial expense coverage ratio are observed. Being a financial organization, IDLC operates its business with borrowed fund. So, historically we can observe, that debt equity ratio is high.In 2010, we have observed a complete opposite scenario, due to comparetively high mobilization of deposit and low borrowing due to high call money rate at the end of this fiscal year.

Profitability Ratio

Figure5: Return on Asset Figure6: Return on Shareholder’s Equity Profitability ratio is checked with return on asset and return on shaheholder’s equity. The profit of the firm has increased over the years. As a result the ROA and ROE both have increased over the years. It shows gradually increasing financial condition.

Valuation Ratio

Figure7: Valuation Ratio of IDLC Finance Limited Valuation ratios are observed with three ratios: earning per share (EPS), Dividen per share (DPS), and price earnings ratio (PE). EPS has increased significantly over the years due to increased profitability. It has also been seen through return on equity. DPS has also increased over the years. But in 2008, it decreased to 35 from 40 in 2007. PE ratio has remained quite stable over the years as increased earnings has been accompanied by increased price.

Non-performing Loan Ratio

Figure8: Non-performing Loan Ratio of IDLC Finance Limited Non -performing loan ratio is very important ratio, to judge the financing expertise of the firm. The non performing loan ratio has significantly decreased over the years. It shows that, the CRM division has been able to provide financing facility to good clients and thus bad loans have decreased significantly over the years. In fact, IDLC is competing to maintain lowest level of NPL rate in the market.

SWOT Analysis Strength 1) Reputation and Brand Image: IDLC is well-reputed company and has developed a brand image that is recognized by the customers. IDLC is an international joint-venture company and its shareholders have long records of sustainability and reliability in their respective fields. IDLC is one of the esteemed names in financial market of Bangladesh.

Since 1985, IDLC has marked its journey through introduction of various innovative products and thus meeting the needs of large corporate clients.

2) Product Portfolio: IDLC has diverse product portfolio for customers which made them second to none in Non-Banking Financial Industry.

3) Quality Customer Portfolio: IDLC has a Credit Risk Management department of Multinational standard which enables the company to maintain a quality customer portfolio.

4) Reputation: It is the mostly reputed non banking financial institution in the country.

5) Existence: IDLC is operating in the Bangladesh financial market for the last 24 years.

Today, it has expanded its operations in Chittagong, Bogra and Sylhet city.

6) Credit Rating: Awarded A+ rating by CRISL. 7) Institutional Shareholding: Mostly institutional shareholders. The institutions are reputed business houses their respective fields in Bangladesh.

8) Human Resources: The Company has competent management team. The overall work force of the company is considered as key resources for the organization. IDLC personnel are motivated, competent, energetic and creative. The company provides utmost support in terms of both technical and moral.

9) Operational Efficiency: IDLC provides customized solution to their customers to adjust their need. The company processes the loan applications quickly and smoothly.

The sanction and disbursement of the loans are hassle-free.

10) Employee Empowerment: At IDLC decision-making is free flowing and transparent.

Every appraiser is given ample opportunity to exercise his/her creativity in accommodating a customer. Approvers are open for any discussion and sanction is largely based upon recommendation of the appraisers. The open and free flow of communication ensures clarification of any queries in no time--from any level of hierarchy. Reasonable suggestions are not only welcome but are highly appreciated.

Effective suggestions by the employees are immediately set for action. This flexibility has helped IDLC a lot in shaping up its operations into a level of efficiency and to be an excellent performer in case of loan recovery.

11) Knowledge Base: Being the oldest and largest non banking financial organization, IDLC has always tried for innovation. Those innovations were in the form of creation of a new financing avenue in a new industry, creation of new financial products, advisory services to the industry players to acquire modern technology and others. During the last 24 years, the organization has learned some invaluable knowledge, regarding several industries, market dynamics, and local as well as global economy.

12) Large Customer Base: Today, IDLC has more than 3,000 satisfied customers served by its personal finance division and other business units. It has also around 2,000 valued customers operating is the stock market. It has very good relationship with the NRBs Weakness 1) High Cost of Fund: IDLC as any other NBFIs have high cost of fund in comparison to banks. As NBFIs can take deposit for less than one year from any individuals as banks can do, the deposit base of IDLC is not strong enough to reduce the average cost of fund.

2) More Focus on Volume: Although IDLC has department called Credit Risk Management to monitor the asset quality of the company, still the company sometimes

for the sake of profit and past relationship provide loans to customers who at the end hamper the portfolio quality of IDLC. 3) Too Much Diversification: Too much diversification of product and services offering hamper the focus on the core services of the organization.

4) Less People in Liability Marketing: IDLC still employs lesser number of workforces for the aggressive liability marketing in comparison to banks and NBFI like DBH. 5) No Subsidiary in Any Other Field: IDLC does not have any other subsidiary operating other than the financial industry.

6) Focus Problem: IDLC gives less focus on bottom line companies compared to any other institutions. As a large NBFI, it has the ability to focus the bottom line sectors.

7) Weak Inter-departmental Coordination: Still the co-ordination between the inter department is not that much well-organized.

Opportunities Continuity of Liberalization: Government has continued to liberalize the economy towards more market orientation. This encouraged both local and foreign investors to invest in potential sectors. The privatization plan of government is likely to have positive impact on industrialization.

Foreign Investment in Prospective Sectors: In recent days foreign investment in the various prospective sectors has increased phenomenally. This creates a good opportunity for all financial institutions to enter in the booming new sector.

Local Banks Inefficiency: One of the major reasons for thriving of leasing company in Bangladesh is local banks inefficiency of providing project loan. This phenomenon still persists.

Islamic Wing: IDLC can easily form its own Islamic wing to attract new customers segment. As a result, its revenue will go up.

Threats High Competition from both Banks and Leasing Companies: Today more than seventy eight banks and leasing companies are almost at the same platform. The products and the target clients are almost same. The existing FIs are continuous threat to the business of corporate division as well as the organization.

Regularity Control of Government: The legal framework of Bangladesh is relatively weak. Lack of effective foreclosure laws and manual land recording system creates possibility of forgery and disputes. This may hinder the loan recovery from the defaulters.

POLICY AND STRATEGY GUIDELINES BY BANGLADESH BANK This section details fundamental credit risk management policies and strategies that are recommended for adoption by all FIs in Bangladesh. The guidelines contained herein outline general principles that are designed to govern the implementation of more detailed lending procedures and risk grading systems within individual FIs. It is the overall

responsibility of FI’s Board to approve FI’s credit risk strategy and significant policies relating to credit risk and its management which should be based on the FI’s overall business strategy. To keep it current, the overall policy and strategy has to be reviewed by the Board, preferably annually.

Credit Risk Policy Every FI should have a credit risk policy document that should include risk identification, risk measurement, risk grading/ aggregation techniques, reporting and risk control/ mitigation techniques, documentation, legal issues and management of problem facilities.

Such policies and procedures shall provide guidance to the staff on various types of lending including Corporate, SME, Consumer, Housing etc. Credit risk policies should: Provide detailed and formalized credit evaluation/ appraisal process Provide risk identification, measurement, monitoring and control Define target markets, risk acceptance criteria, credit approval authority, credit origination/ maintenance procedures and guidelines for portfolio management Be communicated to branches/controlling offices. All dealing officials should clearly understand the FI’s approach for credit sanction and should be held accountable for complying with established policies and procedures Clearly spell out roles and responsibilities of units/staff involved in origination and management of credit In order to be effective, these policies must be clear and communicated down the line.

Further any significant deviation/exception to these policies must be communicated to the top management/Board and corrective measures should be taken. It is the responsibility of senior management to ensure effective implementation of these policies duly approved by the Board.

Credit Risk Strategy The very first purpose of FI’s credit strategy is to determine the risk appetite of the FI. Once it is determined the FI could develop a plan to optimize return while keeping credit risk within predetermined limits. It is essential that FIs give due consideration to their target market while devising credit risk strategy. The credit procedures should aim to obtain an in-depth understanding of the FI’s clients, their credentials & their businesses in order to fully know their customers.

Each FI should develop, with the approval of its Board, its own credit risk strategy or plan that establishes the objectives guiding the FI’s credit-granting activities and adopt necessary policies/ procedures for conducting such activities. This strategy should spell out clearly the organization’s credit appetite and the acceptable level of risk-reward tradeoff for its activities The strategy would, therefore, include a statement of the FI’s willingness to grant facilities based on the type of economic activity, geographical location, currency, market, maturity and anticipated profitability. This would necessarily translate into the identification of target markets and business sectors, preferred levels of diversification and concentration, the cost of capital in granting credit and the cost of bad debts The strategy should delineate FI’s overall risk tolerance in relation to credit risk, the institution’s plan to grant credit based on various client segments and products, economic sectors, geographical location, currency and maturity

The strategy should provide pricing strategy and ensure that FI’s overall credit risk exposure is maintained at prudent levels and consistent with the available capital Senior management of a FI shall be responsible for implementing the credit risk strategy approved by the Board.

Lending Guidelines All FIs should have established “Lending Guidelines” that clearly outline the senior management’s view of business development priorities and the terms and conditions that should be adhered to in order for facilities to be approved. The Lending Guidelines should be updated at least annually to reflect changes in the economic outlook and the evolution of the FI’s facility portfolio, and be distributed to all lending/marketing officers.

Any departure or deviation from the Lending Guidelines should be explicitly identified in credit applications and a justification for approval provided. The Lending Guidelines should include the following: Industry and Business Segment Focus: The Lending Guidelines should clearly identify the business/industry sectors that should constitute the majority of the FI’s facility portfolio. For each sector, a clear indication of the FI’s appetite for growth should be indicated.

Types of Facilities: The type of facilities that are permitted should be clearly indicated, such as Lease, Term Loan, Home Loan, and Working Capital etc.

Single Borrower/Group Limits/Syndication: Details of the FI’s Single Borrower/Group limits should be included as per Bangladesh Bank guidelines.

Sector Lending Caps: An important element of credit risk management is to establish exposure limits for single obligors and group of connected obligors. FIs are expected to develop their own limit structure while remaining within the exposure limits set by Bangladesh Bank. FIs may establish limits for a specific industry, economic sector or geographic regions to avoid concentration risk.

Product Lending Caps: FIs should establish a specific product exposure cap to avoid over concentration in any one product.

Discouraged Business Types: FIs should outline industries or lending activities that are discouraged. The FI may have segregated sectors to be discouraged.

Facility Parameters: Facility parameters (e.g., maximum size, maximum tenor, and covenant and security requirements) should be clearly stated.

Credit Assessment and Risk Grading Credit Assessment A thorough credit and risk assessment should be conducted prior to the granting of a facility, and at least annually thereafter for all facilities. The results of this assessment should be presented in a Credit Application and is reviewed by Credit Risk Management (CRM) for identification and probable mitigation of risks.

All FIs should have established Know Your Customer (KYC) and Money Laundering guidelines which should be adhered to at all times.

Credit Applications should summarize the results of the RMs risk assessment and include, as a minimum, the following details: Amount and type of facility(s) proposed Purpose of facilities

Facility Structure (Tenor, Covenants, Repayment Schedule, Interest) Security Arrangements Government and Regulatory Policies Economic Risks In addition, the following risk areas should be addressed: Borrower Analysis- The majority shareholders, management team and group or affiliate companies should be assessed. Any issues regarding lack of management depth, complicated ownership structures or inter-group transactions should be addressed, and risks mitigated.

Industry Analysis- The key risk factors of the borrower’s industry should be assessed.

Any issues regarding the borrower’s position in the industry, overall industry concerns or competitive forces should be addressed.

Supplier/Buyer Analysis- Any customer or supplier concentration should be addressed, as these could have a significant impact on the future viability of the borrower.

Historical Financial Analysis- Preferably an analysis of a minimum of 3 years historical financial statements of the borrower should be presented. The analysis should address the quality and sustainability of earnings, cash flow and the strength of the borrower’s balance sheet.

Projected Financial Performance- Where term facilities (tenor > 1 year) are being proposed, a projection of the borrower’s future financial performance should be provided, indicating an analysis of the sufficiency of cash flow to service debt repayments.

Credit Background- Credit application should clearly state the status of the borrower in the CIB (Credit Information Bureau) report. The application should also contain liability status with other Banks and FI’s and also should obtain their opinion of past credit behavior.

Account Conduct- For existing borrowers, the historic performance in meeting repayment obligations (trade payments, cheques, interest and principal payments, etc) should be assessed.

Adherence to Lending Guidelines- Credit Applications should clearly state whether or not the proposed application is in compliance with the FI’s Lending Guidelines.

Mitigating Factors- Mitigating factors for risks identified in the credit assessment should be identified. Possible risks include, but are not limited to: margin sustainability and/or volatility, high debt load (leverage/gearing), overstocking or debtor issues; rapid growth, acquisition or expansion; new business line/product expansion; management changes or succession issues; and customer or supplier concentrations.

Facility Structure- The amounts and tenors of financing proposed should be justified based on the projected repayment ability and facility purpose.

Purpose of Credit- FIs have to make sure that the credit is used for the purpose it was borrowed. Where the obligor has utilized funds for purposes not shown in the original proposal, FIs should take steps to determine the implications on creditworthiness.

Project Implementation- In case of a large expansion, which constitutes investment of more than 30% of total capital of a company or for a green field project, project implementation risk should be thoroughly assessed.

Foreign Currency Fluctuation- Credit application should clearly state the assessment of foreign currency risk of the applicant and identify the mitigating factors for its exposure to foreign currency.

Security- A current valuation of collateral should be obtained and the quality and priority of security being proposed should be assessed internally and preferably by a third party valuer.

Type of Control on Cash Flow- The credit application should contain and assess if there is any control on the borrowers cash flow for securing the repayment. This may include payment assignment from export proceed, payment assignment from customers of the borrower etc.

Exit Option- Credit application should state the exit option from the borrower in early identification of deterioration of grading of the borrower.

Name Lending- Credit proposals should not be unduly influenced by an over reliance on the sponsoring principal’s reputation, reported independent means, or their perceived willingness to inject funds into various business enterprises in case of need.

Appendix contains a template for credit application.

Risk Grading The Credit Risk Grading (CRG) is a collective definition based on the pre-specified scale and reflects the underlying credit-risk for a given exposure. Credit Risk Grading is the basic module for developing a Credit Risk Management system. Credit risk grading is an important tool for credit risk management as it helps the Financial Institutions to understand various dimensions of risk involved in different credit transactions. The aggregation of such grading across the borrowers, activities and the lines of business can provide better assessment of the quality of credit portfolio of a FI. The credit risk grading system is vital to take decisions both at the pre-sanction stage as well as post-sanction stage. At the pre-sanction stage, credit grading helps the sanctioning authority to decide whether to lend or not to lend, what should be the lending price, what should be the extent of exposure, what should be the appropriate credit facility, what are the various facilities, what are the various risk mitigation tools to put a cap on the risk level. At the post-sanction stage, the FI can decide about the depth of the review or renewal, frequency of review, periodicity of the grading, and other precautions to be taken. Risk grading should be assigned at the inception of lending, and updated at least annually. FIs should, however, review grading as and when adverse events occur. A separate function independent of facility origination should review risk grading.

1 Use of Credit Risk Grading The Credit Risk Grading matrix allows application of uniform standards to credits to ensure a common standardized approach to assess the quality of individual obligor, credit portfolio of a unit, line of business, the FI as a whole.

CRG would provide a quantitative measurement of risk which portrays the risk level of a borrower and enables quick decision making.

As evident, the CRG outputs would be relevant for individual credit selection, wherein either a borrower or a particular exposure/facility is rated. The other decisions would be related to pricing (credit-spread) and specific features of the credit facility.

Risk grading would also be relevant for surveillance and monitoring, internal MIS and assessing the aggregate risk profile of an FI. It is also relevant for portfolio level analysis.

CRG would provide a quantitative framework for assessing the provisioning requirement of a FI’s credit portfolio.

Risk Grading for Corporate and SME The proposed CRG scale is applicable for both new and existing borrowers.

It consists of 8 categories, of which categories 1 to 5 represent various grades of acceptable credit risk and 6 to 8 represent unacceptable credit risk. However, individual FI depending on their risk appetite may implement more stringent policy.

Table 4: Risk Grade Matrix

Risk Rating

Short Name

Grade

Definition

Superior SUP – Low Risk

1

Good – GD Satisfacto ry Risk

2

Acceptab ACC le – Fair PT Risk

3

Marginal MG/ - Watch WL list

4

Special Mention

5

Credit facilities, which are fully secured i.e. fully cash covered.

Credit facilities fully covered by government guarantee.

Credit facilities fully covered by the guarantee of a top tier international Bank.

Strong repayment capacity of the borrower The borrower has excellent liquidity and low leverage.

The company demonstrates consistently strong earnings and cash flow certainty.

Borrower has well established, strong market share.

Very good management skill & expertise.

Credit facilities fully covered by the guarantee of a top tier local Bank.

Aggregate Score of 85 or greater based on the Risk Grade Score Sheet These borrowers are not as strong as GOOD Grade borrowers, but still demonstrate consistent earnings, cash flow certainty and have a good track record.

Borrowers have adequate liquidity, cash flow and earnings.

Credit in this grade would normally be secured by acceptable collateral (1st charge over inventory / receivables / equipment / property).

Acceptable management Acceptable parent/sister company guarantee Aggregate Score of 75-84 based on the Risk Grade Score Sheet This grade warrants 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, thin cash flow and/or inconsistent earnings.

Weaker business credit & early warning signals of emerging business credit detected.

The borrower incurs a loss Facility repayments routinely fall past due Account conduct is poor, or other untoward factors are present.

Credit requires attention Aggregate Score of 65-74 based on the Risk Grade Score Sheet This grade has 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.

Severe management problems exist.

Facilities should be downgraded to this grade if sustained deterioration in financial condition is noted (consecutive losses, negative net worth, excessive leverage), An Aggregate Score of 55-64 based on the Risk Grade Score

SM

Risk Rating

Short Name

Grade

Substand ard

SS

6

Doubtful and Bad (nonperformi ng)

DF

7

Definition Sheet.

Financial condition is weak and capacity or inclination to repay is in doubt.

These weaknesses jeopardize the full settlement of facilities.

Bangladesh Bank criteria for sub-standard credit shall apply.

An Aggregate Score of 45-54 based on the Risk Grade Score Sheet.

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 Bad & Loss.

Bangladesh Bank criteria for doubtful credit shall apply.

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

Loss BL 8 Credit of this grade has long outstanding with no progress in (nonobtaining repayment or on the verge of wind up/liquidation. performi Prospect of recovery is poor and legal options have been ng) pursued.

Proceeds expected from the liquidation or realization of security may be awaited. The continuance of the facility 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 valueless asset even though partial recovery may be affected in the future. Bangladesh Bank guidelines for timely write off of bad facilities must be adhered to. Legal procedures/suit initiated.

Bangladesh Bank criteria for bad & loss credit shall apply.

An Aggregate Score of less than 35 based on the Risk Grade Score Sheet.

Source: Credit Risk Management-Industry Best Practices by Bangladesh Bank Risk Rating for Consumer Lending For consumer lending, FIs may adopt credit-scoring models for processing facility applications and monitoring credit quality. FIs should apply the above principles in the management of scoring models. Where the model is relatively new, FIs should continue to subject credit applications to rigorous review until the model has stabilized.

Ratings Review The rating review can be two-fold: Continuous monitoring by those who assigned the grading. The Relationship Managers (RMs) generally have a close contact with the borrower and are expected to keep an eye on the financial stability of the borrower. In the event of any deterioration the grading are immediately revised /reviewed.

Normally CRG should be reviewed at least once in a year. For risk grades starting from 5 to 8, CRG should be reviewed in every six months.

Secondly the risk review functions of the FI or business lines also conduct periodical review of grading at the time of risk review of credit portfolio.

Approval Authority All commercial activities, which commit the FI to deliver risk sensitive products, require prior approval by authorized committees/individuals. A FI may have the Board, Management/Executive Committee, and Credit Committees for reviewing and approving financing proposals. The concerned CRM officials should be the owner of their independent review and identification of risks based on the credit application. The authority to sanction/approve facilities must be clearly delegated by the Managing Director/CEO & Board to the Corporate Center and further down to the Business Units.

Business Units are independent and responsible for managing all business activities within the approved limits.

Segregation of Duties Adequate segregation of duties is a prerequisite for an effective system of internal control.

To be adequate, segregation must ensure that the following functions are performed by persons independent of each other, although, within limits, certain may be combined so long there is adequate supervision: Credit Approval/Risk Management/Recovery Relationship Management/Marketing Credit Administration The credit approval team will be independent from the sales and branch team who will evaluate and approve the facility. The Credit Administration department will check and ensure the documentation and disburse the facilities. This will ensure better control of the FI asset and mitigate the risk of compromise of the duties. The purpose of the segregation is to improve the knowledge levels and expertise in each department, to impose controls over the disbursement of authorized facilities and obtain an objective and independent judgment of credit proposals.

Internal Audit FIs should have a segregated internal audit/control department charged with conducting audits of all departments Internal audit should verify the continuing adequacy and applicability of credit risk management policies and procedures, provide an independent assessment of the credit portfolios' existence, quality and value, the integrity of the credit process, and promotes detection of problems.

Every year, internal audit should prepare an auditing plan to be approved by the Board according to which the audits are carried out. This auditing plan should be carried out in a risk-oriented manner, taking into account size and nature of the credit institution, as well as type, volume, complexity, and risk level of the FI’s activities A written audit report has to be prepared following each audit.

Internal auditing should monitor the swift correction of any problems detected in the audit as well as the implementation of its recommendations in a suitable form, and if necessary to schedule a follow-up audit.

The following audit areas are particularly relevant: All operational and business procedures within the credit institution Risk management and risk management control

The internal review system The FI’s internal rules and directives All mandatory audit areas (especially large-exposure investments, money laundering and compliance, diligence, reporting requirements, securities trading book) Credit audit is conducted on-site, i.e. at the branch which has appraised the advance and where the main operative credit limits are made available Reports on conduct of accounts of allocated limits are to be called from the corresponding branches Credit auditors may visit borrowers’ factory/ office premise Preferred Risk Management Structure To maintain FI’s overall credit risk exposure within the parameters set by the Board of directors, the importance of a sound risk management structure is second to none. The appropriate organizational structure must be in place to support the adoption of the policies detailed in Section 1 of these guidelines. While the FIs may choose different structures, it is important that such structure should be commensurate with institution’s size, complexity and diversification of its activities. The key feature is the segregation of the Marketing/Relationship Management function from Approval/ Risk Management/ Administration functions. It must facilitate effective management oversight and proper execution of credit risk management and control processes. The following chart represents the preferred risk management structure Board of Directors

Risk Management Committee (CEO and Heads of Credit, Market, and Operational Risk Management Committees) Credit Risk Management Committee

Head of Credit Risk Management

Head of Business Units

Credit Administration

Other Direct Report (Internal Audit/Etc.)

Relationship Management

Credit Approval Business Development Monitoring /Recovery

Figure 9: Preferred Risk Management Structure Key Responsibilities of Credit Risk Management Risk Management Functions Oversight of FI’s credit policies, procedures and controls relating to all credit risks arising from corporate/commercial/institutional/personal/ treasury operations Oversight of the FI’s asset quality

To ensure that lending executives have adequate experience and/or training in order to carry out job duties effectively.

Credit Functions To review Credit Applications recommended by RM and to provide independent risk assessment and recommendation to MD/CEO/Board for approval To provide advice/assistance regarding all credit matters to line management/RMs Monitoring Functions Directly manage all Substandard, Doubtful & Bad and Loss accounts to maximize recovery and ensure that appropriate and timely facility loss provisions have been made Procedural Guidelines This section outlines of the main procedures that are needed to ensure compliance with the policies.

Approval Process The approval process must reinforce the segregation of Relationship Management/Marketing from the approving authority. The responsibility for preparing the Credit Application should rest with the RM within the business unit. Credit Applications should be recommended for approval by the RM team and forwarded to CRM for their review and assessment. The credit should subsequently be approved by proper approval committee. The approval process may vary among FI’s depending on the types of products and exposure. For example, lending to Corporate and SME’s is mostly unstructured due to diverse nature of risk exposure. On the other hand, consumer lending is mostly structured by standardizing the product and risk aspects of individuals.

Credit Administration The Credit Administration function is critical in ensuring that proper documentation and approvals are in place prior to the disbursement of financial facilities. For this reason, it is essential that the functions of Credit Administration be strictly segregated from Relationship Management/Marketing in order to avoid the possibility of controls being compromised or issues not being highlighted at the appropriate level. Ongoing administration of the credit portfolio is an essential part of the credit process. Credit administration function is basically a back office activity that support and control extension and maintenance of credit. A typical credit administration unit performs following functions: Documentation It is the responsibility of credit administration to ensure completeness of documentation (facility agreements, guarantees, transfer of title of collaterals etc) in accordance with approved terms and conditions.

Disbursement Disbursements under facilities should only be made when all security documentation is in place. CIB report should reflect/include the name of all the lenders with facility, limit & outstanding.

Credit Monitoring After the facility is approved and draw down allowed, the facility should be continuously watched over. These include keeping track of borrowers’ compliance with credit terms, identifying early signs of irregularity, conducting periodic valuation of collateral and monitoring timely repayments.

Facility Repayment The obligors should be communicated ahead of time as and when the principal/markup installment becomes due.

Custodial Duties Facility disbursements and the preparation and storage of security documents should be centralized in the regional credit centers. Appropriate insurance coverage should be maintained on assets pledged as collateral.

Compliance Requirements All required Bangladesh Bank returns should be submitted in the correct format in a timely manner. Bangladesh Bank circulars/regulations are maintained centrally, and advised to all relevant departments to ensure compliance Credit Monitoring To minimize credit losses, monitoring procedures and systems should be in place that provide an early indication of the deteriorating financial health of a borrower. At a minimum, systems should be in place to report the following exceptions to relevant executives in CRM and RM team: Past due principal or interest payments, past due trade bills, account excesses, and breach of facility covenants Non-receipts of financial statements on a regular basis and any covenant breaches or exceptions made Action not taken on time for findings of any internal, external or regulator inspection/audit All borrower relationships/facilities are reviewed and approved through the submission of a Credit Report at least annually.

Refer to the Credit Report format attached as Appendix.

Credit Recovery The Recovery Unit (RU) of CRM should directly manage accounts with sustained deterioration (a Risk Rating of Sub Standard (6) or worse). FIs may wish to transfer EXIT accounts graded 4-5 to the RU for efficient exit based on recommendation of CRM and Corporate FI. The RU’s primary functions are: Determine Account Action Plan/Recovery Strategy Pursue all options to maximize recovery, including placing customers into receivership or liquidation as appropriate Ensure adequate and timely loan loss provisions are made based on actual and expected losses Regular review of grade 6 or worse accounts The management of problem facilities (NPLs) must be a dynamic process, and the associated strategy together with the adequacy of provisions must be regularly reviewed.

NPL Account Management All NPLs should be assigned to an Account Manager within the RU, who is responsible for coordinating and administering the action plan/recovery of the account, and should serve as the primary customer contact after the account is downgraded to substandard.

Whilst some assistance from Corporate FI/Relationship Management may be sought, it is essential that the autonomy of the RU be maintained to ensure appropriate recovery strategies are implemented.

Account Transfer Procedures Within 7 days of an account being downgraded to substandard (grade 6), a Request for Action should be completed by the RM and forwarded to RU for acknowledgment. The account should be assigned to an account manager within the RU, who should review all documentation, meet the customer, and prepare a Classified Loan Review Report within 15 days of the transfer. Recovery Units should ensure that the following is carried out when an account is classified as Sub Standard or worse: Facilities are withdrawn or repayment is demanded as appropriate. Any drawings or advances should be restricted, and only approved after careful scrutiny and approval from appropriate authorities.

CIB reporting is updated according to Bangladesh Bank guidelines and the borrower’s Risk Grade is changed as appropriate Loan loss provisions are taken based on Force Sale Value (FSV) Prompt legal action is taken if the borrower is uncooperative Rescheduling FI’s should follow clear guideline for rescheduling of their problem accounts and monitor accordingly. Rescheduling of problem accounts should be aimed at a timely resolution of actual or expected problem accounts with a view to effecting maximum recovery within a reasonable period of time.

Purpose of Rescheduling: To provide for borrower’s changed business condition For better overdue management For amicable settlement of problem accounts Modes of Rescheduling: Rescheduling can be done through adopting one or more of the following means.

Extension of financing term keeping lending rate unchanged Reduction of lending rate keeping financing term unchanged Both reduction of lending rate and extension of financing term Bodily shifting of payment schedule Deferment of payment for a short-term period with or without extending the maturity date.

However, under any circumstances reschedule period must not exceed economic life of the asset.

Non Performing Loan (NPL) Monitoring On a quarterly basis, a Classified Loan Review (CLR) should be prepared by the RU Account Manager to update the status of the action/recovery plan, review and assess the adequacy of provisions, and modify the FI’s strategy as appropriate.

NPL Provisioning and Write Off The guidelines established by Bangladesh Bank for CIB reporting, provisioning and write off of bad and doubtful debts, and suspension of interest should be followed in all cases.

Regardless of the length of time a facility is past due, provisions should be raised against the actual and expected losses at the time they are estimated. The Force Sale Value (FSV) for accounts grade 6 or worse. Any shortfall of the Force Sale Value compared to total facility outstanding should be fully provided for once an account is downgraded to grade 7.

SME SCENARIO IN CONTEXT OF BANGLADESH Bangladesh is a densely populated country. Job opportunity here is very scanty; Unemployment rate is approximately 40%. Population below poverty line is 36%.

Therefore, it is the prime concern for the nation to generate income through creation of job opportunity & employment. Creation of job opportunity at large scale by us is not possible. What can be done better is to help self-employment through financial support.

There are many small and medium entrepreneurs in the country that have innovative idea, spirit and potentiality to do something productive for local consumers as well as export abroad. They can generate income and contribute to the GDP. They may also provide employment to other people also. Development and growth of Small and Medium Enterprise is vital for national development. In the context of Bangladesh, the development of Small and Medium Enterprises (SMEs) can be considered as a vital instrument for poverty alleviation and ensure the rapid industrialization. The performance of SMEs of Bangladesh especially in terms of employee turnover rate, quality assurance, allocation of funds, marketing activities have been found significantly below the international standard.

The sector gets negligible support from government. The rate of development of SME is not up to the expectation. Such type of beneficial enterprising borrower cannot go a long way for want of financial support because they have no access to institutional credit facilities, as they cannot provide collateral security as demanded for such credit facility.

The research findings of “National Private Sector Survey Of Enterprises In Bangladesh” (a study conducted by USAID, DFID and CIDA) indicates that SMEs contribute to the extent of 25% of the GDP in Bangladesh, about 40% of the Gross Manufacturing Output, 80% of Industrial Jobs and around 25% of the total Labor Force and the total number of SME Entrepreneur is about 06 Million. Among other findings, the study concludes that SME sector is significantly a rapid growth oriented sector to flourish in Bangladesh.

Categories of SMEs According to the World Bank (2006) medium enterprises are defined as enterprises which have at most 300 employees and an annual turnover not exceeding 15 million US dollars.

Further there is the distinction of small enterprises — they have fewer than 50 staff members and up to 3 million US dollars turnover — and micro-enterprises have up to 10 persons and $100,000 turnover.

Different countries and organizations define SME differently. The Government of Bangladesh has categorized SME into two broad classes: Manufacturing enterprise Non Manufacturing activities Manufacturing Enterprise Manufacturing enterprises can be divided into two categories; Small enterprise : an enterprise would be treated as small if, in current market prices, the replacement cost of plant, machinery and other parts/components, fixtures, support utility, and associated technical services by way of capitalized costs (of turn-key consultancy services, for example), etc, excluding land and building, were to up to Tk. 15 million;

Medium enterprise : an enterprise would be treated as medium if, in current market prices, the replacement cost of plant, machinery and other parts/components, fixtures, support utility, and associated technical services by way of capitalized costs (of turn-key consultancy services, for example), etc, excluding land and building, were to up to Tk. 100 million; Non-manufacturing activities (such as trading or other services) Non-manufacturing activities can be divided into two categories; Small enterprise: an enterprise should be treated as small if it has less than 25 workers, in full-time equivalents; Medium enterprise: an enterprise should be treated as small if it has between 25 and 100 employees.

According to Bangladesh Bureau of Statistics different enterprises are defined as; Table 5: Categories of Enterprises Category No. of employees Micro 0-9 Small 10-49 Medium 50-99 Large Above 99 The Ministry of Industries, Government of Bangladesh has been identified following 11 booster sectors; Table 6: Booster Sectors in Bangladesh 1) Electronics and electrical 7) Plastics and other synthetics 2) Software-development 8) Healthcare & diagnostics 3) Light engineering and metal-working 9) Educational services 4) Agro-processing/agro-business/ 10) Pharmaceuticals/cosmetics/toiletries plantation agriculture/ specialist farming/tissue-culture 5) Leather-making and leather goods 11) Fashion-rich personal effects, wear and consumption goods.

6) Knitwear and ready-made garments Present Scenario of SME in Bangladesh In 2003 the International Consultancy Group (ICG) of the UK, in collaboration with the Micro Industries Development Assistance and Services (MIDAS), conducted the National Private Sector Survey of Enterprises in Bangladesh. The survey results drew the conclusion that there were approximately 6 million Small and Medium Enterprises (SMEs), which included enterprises with up to 100 workers employing a total of 31 million people, equivalent to 40 per cent of the population of the country of age 15 years and above. The survey also found that the industrial structure of SMEs consisted of primarily wholesale and retail trade and repairs (40 per cent), production and sale of agricultural goods (22 percent), services (15 percent), and manufacturing only (14 per cent). Thus the survey brought out the fact that the large untapped potential for expansion in manufacture and production could be exploited (or contributing more significantly to the national economy. Another vital findings of the survey under discussion was that

SMEs contributed BDT 741 ($ 12.5) billion i.e. nearly 25 per cent of the GDP (BDT 2,996 billion) in 2003. It is reflected from this survey that enterprises employing 2-5 workers contribute 51 percent share of the total SME contribution to the economy, followed by 26 percent by those having only one worker and 10 per cent by those having 6-10 workers. For LDCs like Bangladesh, SMEs are a highly cost-effective route for industrial development.

It is observed from Table-1 (appendix) that micro enterprises run by up to 10 workers contribute the most which is 87% of the total contribution from SMEs to GDP of Bangladesh. It is also observed that micro enterprises run by more than 21 workers contribute about 7% of total contribution from SME to GDP of Bangladesh.

Table-2 (appendix) provides the information regarding sector wise contribution of SMEs to GDP. It is reflected from the table that manufacturing sector contributes the highest contribution in GDP i.e., 38%. It is also observed from the table that agriculture and wholesale and retail sector contribute more than 22 percent in the GDP of Bangladesh.

Table-3 (appendix) shows the growth pattern of SME. It is observed that during 20012002 to 2004-2005 in every financial year the growth rate of SME is about 7%. In 20052006 the growth rate was 9.21%. The highest growth was in 2006-2007 i.e., 10.28%.

Table-4 (appendix) shows the growth pattern of manufacturing sector. It is observed that the average growth during 1972 to 2005 was 6.4%. During 2001-2002 to 2006-2007 the highest growth was in year 2006-07 i.e., 11.19%. It is also observed that during 20022003 to 2005-2006 in every financial year the growth of manufacturing sector was more than 6%.

Problems in SME Sector of Bangladesh At present SME sector is facing a lot of problems in Bangladesh. Some major problems are as follows; Resource scarcity In Bangladesh scarcity of raw materials hinder the ability of SME to be export oriented and limits its ability to reach more advanced stages of international business.

High employee turnover Due to limited growth of SME most of the skilled employees leave SMEs. Levy (2003) observed that SMEs are knowledge creators but poor at knowledge retention.

Absence of modern technology One of the main barriers for the development of SME in Bangladesh is inadequate technologies. Many SMEs have failed to adopt modern technology.

Poor physical infrastructure Inadequate supply of necessary utilities like electricity, water, roads and highways hinder the growth of SME sector. Moreover unfavorable geographical conditions increase the transportation cost.

Financial constraints Availability of finance hinders the growth of SMEs in Bangladesh. Bangladeshi bank considers SMEs as high risk borrowers because of their inability to comply with the bank’s collateral requirements. Only about 15-20% of the owners of SMEs own any immovable property. Bankers issue loan on the basis of ownership of immovable property as collateral risk. As a result it automatically excludes rest 80% SME’s from the list of privileged clients of the banks. Whatever collateral SME’s can manage gets used up in

talking the term loan leaving them with no means to seek working capital loans from banks. Because of low access to institutional financing SME’s rely on inefficient financing services from informal sources.

Lack of uniform definition In Bangladesh the definition of SME has changed overtime in different industrial policy announced by the government in different year. Absence of uniform definition makes the formulation and implementation of SME policy difficult.

Lack of information In Bangladesh, SMEs have very limited use of information technology (IT). Accounting package is used by 1-2% of the SMEs. The use of computers is revealed by say 15% of the SMEs, while the use of the Internet for business purposes applies to say 8-10% of SMEs. Lack of entrepreneurship skills Conservative attitude towards risk, lack of vision, ability to make plan and implementing those hinder the growth of SME in Bangladesh.

Participation of women entrepreneurs Equality of opportunity is a major problem for SME. Female entrepreneurs are treated discriminately. They are not well represented in business organization. Government does not provide adequate institutional assistance for women entrepreneurs.

Access to Market and lack of awareness regarding marketing tool For SME, owing a retail space is very expensive in the major cities in Bangladesh. As a result many customers are not interested to buy products and services from SMEs. Because they can’t judge the quality until they physically examined the product. Most of the cases SMEs in Bangladesh are not able to use the Integrated Marketing Communication (IMC) tools. But these tools play the role of important stimulus to motivate the customers and retain them. The country does not have enough marketing capability and resources to invest in marketing.

Bureaucracy Wang (1995) observed that the inadequate government supports are top ranking constraints for SMEs. Unnecessary layers of Bureaucracy and red-taps reduce the competitiveness of SME and raising the cost of transactions and operations.

Absence of transparent legal system The absence of an effective and transparent legal system discourages SMEs in exploring into risky ventures of business. There are a number of unnecessary formal requirements to start and run business that create high compliance costs and become barriers to SME development, growth and market entry.

Lack of commitment to innovation and customer satisfaction Ernesto (2005) stated that to keep in pace with international competition, firms of all size are challenged to improve and innovate their products processes constantly. But in Bangladesh SMEs are still not relating the importance of satisfying and retaining customers by offering novel and desired benefits.

Lack of quality assurance Govt. has failed to frame a national quality policy, provide adequate support systems and establish a national quality certification authority. As a consequence SME of Bangladesh has failed to ensure the quality of their products and services both in local and international market.

Lack of research and development facilities It is observed that investment in R&D is still negligible.

Fierce competition with the cheaper foreign goods

Fierce competition with the cheaper goods of China, Taiwan, Korea, India, and Thailand also pose threat to SME in Bangladesh.

Steps Required for Development of SME Sector in Bangladesh In order to overcome the above mentioned problems the following steps are required; Government must have to take adequate measures to ensure the uninterrupted supply of raw materials for SME. Government needs to take appropriate measures to fix the minimum salary/wages of the employees of SME. That will help to minimize the employee turnover.

Government and financial institution may provide adequate finance for modernization and technological advancement.

Development of infrastructure is essential for the optimum growth of SME. So government of Bangladesh needs to take appropriate policy strategy for the infrastructure development of Bangladesh.

Government, financial institutions and Non Government Organizations (NGOs) may take necessary steps to ensure uninterrupted financial support to the prospective SMEs in Bangladesh.

Due to the absence of uniform definition the policy formulation and implementations are not possible. Government should take initiative to develop a uniform definition of each category of SMEs. Govt. of Bangladesh should take the initiative to develop web pages exclusively for SME and an integrated SME database. It will reduce the barriers to SME access to global market.

In order to ensure the retention of skilled workforce the government should make the entrepreneurial career attractive by minimizing the uncertainty.

In order to encourage women entrepreneurship govt. may involve women entrepreneurs in policy formulation and implementation, arrange funds for women entrepreneurs, and provide necessary training to women entrepreneurs in rural and urban area of Bangladesh.

SME foundation may take appropriate marketing tools to popularize their products.

For minimizing red tapes and accelerating the growth of SME government may provide one roof service under the SME foundation.

Appropriate legal framework is necessary to ensure the development of SME of Bangladesh.

In this era of intense competition continuous planning and quality improvement act as a prerequisite for the survival of SMEs. In order to improve the quality SMEs can follow the Just in Time (JIT) philosophy and use Total Quality Management (TQM) and can ensure the improvement of quality and productivity at a time.

Government should establish a credible certification authority especially for SMEs. So that this sector can obtain a technical evaluation of the quality of their products within a shortest possible time. The certification of the authority should be worldwide accepted.

Govt. may also provide assistance to SMEs during the certification process and promote the importance of product certification for international acceptance among the SMEs. Research and Development (R&D) is must for the development and growth of SME. So government must have to invest in R&D for ensuring the intensification of SME of Bangladesh.

Restriction may be imposed on import of SMEs’ products which are available in Bangladesh.

Small and medium enterprises (SMEs) act as a vital player for the economic growth, poverty alleviation and rapid industrialization of the developing countries like Bangladesh. SMEs are significant in underlying country’s economic growth, employment

generation and accelerated industrialization. SME also foster the development of entrepreneurial skills and innovation. Along with poverty alleviation SME can reduce the urban migration and increased cash flow in rural areas. Bangladesh government should continue to give more focuses on some areas, such as arrangement of finance, provide infrastructure facilities, frame appropriate legal framework, establish national quality policy etc. It seems that for the economic development of Bangladesh SME can play a vital role. We are quite optimistic that if the above mentioned steps are implemented then the growth of SME sector in Bangladesh will be accelerated.

SME FINANCING OF IDLC FINANCE LIMITED SME Division of IDLC Finance Limited Small & Medium Enterprise (SME) plays a pivotal role in the economic growth and development of a country. IDLC Finance Limited is committed to play positive role in the overall socioeconomic development of the country. The organization has developed it SME Division in early 2002-2003 and since then, it has been participating in SME financing with success. SME division of IDLC provides lease and loan facility to medium and small enterprises.

SME Division has two units-SME Small and SME Medium.SME Medium is known as SME-MID and SME Small is known as Small Business Financing (SBF) unit. The organizational structure for SME Division is depicted in the following figure-

Figure 10: Organization Structure of SME Rationale for SME Financing The scope of investment of NBFI is gradually going to be limited due to stiff competition and small economy compared to large numbers of Financial Institution. But the SME segment is still almost virgin, untapped and uncovered by institutional finance and as such there is ample scope and good opportunity for investment so as to take the advantage to increase the portfolio providing a viable and vast lending outlet for IDLC.

Effective rate of return on SME Financing is comparatively higher over the large loan because of lower bargaining strength of the customers. The large customers are generally price sensitive and hard bargainers. As such the earning rate from SME Financing is higher.

Large customers do not usually offer tangible securities and if given, very insignificant compared to the credit volume to cover the risk. Thus the credit risk is very high in case of Large Loan because of the big exposure without any tangible security. Hence, IDLC is put into serious trouble in case of default making recovery of the loan. But in case of SME, the risk is comparatively low as the loan amount is small / moderate and in most cases is covered by security. Above all, lending risk of IDLC is minimized, as the portfolio is diversified with small credit size.

Under SME it is easier to recover IDLC’s money by selling / foreclosing the security as the customers have not that much strength to face court case unlike big customers.

Customer Segment Initially, small entrepreneurs located within the accessible area of our branches will be the targeted areas under this program. The entrepreneurs should have an existing profitable business or a viable business plan.

Selection of Borrowers Small Enterprise financing, like other credit facilities must be subject to the Bank's risk management process setup for this particular business. The process may include, identifying source of repayment and assessing customer' ability to repay, expected future cash flows, his/her past dealings with the bank, the net worth and information obtained from a Credit Information Bureau of Bangladesh Bank. The bank must be able to identify the key drivers of their borrowers businesses, the key risks to their businesses and their risk mitigates.

At the time of granting facility under various modes of Small Enterprise financing, a written declaration shall be obtained from the borrower divulging details of various facilities already obtained from other institutions to ensure that the total exposure in relation to the repayment capacity of the customer does not exceed the reasonable limits as laid down in the approved policies of the bank as well as to help avoid exposure having multiple facilities.

Nationality The borrowing company/firm must be registered in Bangladesh and shares owned by Bangladeshis. The applicant must be 100% privately owned, controlled and operated. The applicant’s principal place of business must be in Bangladesh.

Age Limit The age of the proprietor / partners / directors must range between 20 years to 60 years.

The business has to be in regular operation for at least 2 years.

Purpose SMEs have vast jurisdiction covering food, leather, electronic, light engineering, agrobased industries, garment industries, trading, service industries etc. The SEs also do a good deal of subcontracting jobs for large and medium scale industries, especially in the garments sector. It simultaneously covers the areas of manufacturing, trading and services. Loans are disbursed in the SEs to meet the following requirements:

i) Working capital, ii) Purchasing of capital machinery; iii) Delivery Van / Transport for business purpose, iv) Refurbishing office/Business premises, v) Other eligible portfolio of the bank, vi) Purchase of commercial land, possession for new venture.

Legal Form of Business The applying concern can be Sole Proprietorship/ Partnership/ Private Limited Company.

Tenure of the Facility Table 7: Tenure of the Facility For Loan and Lease: BDT 3 Lac to BDT 10 Lac 13 months to 24 months Above BDT 10 Lac to BDT 35 Lac 13 months to 36 months Above BDT 35 Lac 13 months to 48 months For vehicle Lease: BDT 3 Lac to BDT 20 Lac 13 months to 48 months Above BDT 20 Lac 13 months to 60 months Per Party Exposure Limit The minimum and maximum exposure of the bank on single SE shall remain within the range of TK 3 lac and TK 75 lac respectively subject to the following: In case of working capital finance – Maximum up to 70% of the net required working capital or 75% of the sum total of inventory and receivables whichever is lower. b) In case of fixed assets purchase – Maximum up to 80% of the purchase price.

Security Requirement On case-to-case basis depending on whether the facility is unsecured or secured (with cash security or mortgage) following security are generally required: Hypothecation on the inventory, receivables, advance payments, plants & machineries; Registered mortgage over immovable properties with registered power of Attorney and Disclaimer from the mortgagor(s); Personal Guarantee of Spouse / parents / other family members; One third party guarantee from a person acceptable to the Bank; Post dated cheques for each installment and one post dated cheque for full loan value including full interest.

Loan Documentation For all facilities, banks must obtain (as applicable) and not limiting to following common documents before disbursement of loan can be made: Loan Application Form duly signed by the customer. Loan Application From should be accompanied by a ‘Borrower’s Basic Fact Sheet’ under the seal and signature of the borrower.

A written declaration shall be obtained from the borrower divulging details of various facilities already obtained from other institutions.

Acceptance of the terms and conditions of Sanction Advice Trade License Photographs of the proprietor /partners /directors duly attested.

Personal net worth statement of the proprietor /partners / directors.

Copy of TIN Certificate.

Short description of the products of the enterprise.

Project Profile (if new project).

Quotation/Intent / Pro-forma Invoice etc (as applicable).

Marketing distribution system of the company.

Short profile of the proprietor / partners / directors mentioning their business experience/education etc.

Brief description of the management of the company mentioning their educational & professional experiences.

Name and address of the sister/allied concerns.

Group Brochure Name and address of present bankers A latest liability statement of all the business concerns of the Group with other Banks/Financial Institutions (Mentioning – name of business concern, name of bank and branch, nature of facility, limit amount, outstanding. overdue if any etc.)

Credit Information Bureau (CIB) report from Bangladesh Bank Wherever practical, insurance policy for 110% of the stock value covering potential risks with bank’s mortgage clause. .In case of Proprietorship firm Copy of financial statements for last 03 years for analysis and record. However, financial statements singed by the borrower will suffice where the exposure is fully secured by liquid assets.

In case of Partnership Firm Copy of Registered Partnership Deed duly certified as true copy or a Partnership Deed on non-judicial stamp of TK. 150 denomination duly notarized.

Copy of financial statements for last 03 years, for analysis and record. However, financial statements singed by the borrower will suffice where the exposure is fully secured by liquid assets.

In case of Limited Company Copy of Memorandum & Articles of Association of the company including Certificate of Incorporation duly certified by Registrar Joint Stock Companies (RJSC) and attested by the Managing Director accompanied by an up-to-date list of Directors.

Copy of Board Resolution of the company for availing credit facilities and authorizing Managing Director / Chairman / Director for execution of documents and operation of the accounts.

An Undertaking not to change the management of the company and the memorandum and articles of the company without prior permission.

Copy of financial statements for last 03 years for analysis and record. However, financial statements singed by the borrower will suffice where the exposure is fully secured by liquid assets.

Personal Guarantee of all the Directors including the Chairman and Managing Director.

Certificate of Registration of charges over the fixed and floating assets of the company duly issued by RJSC. Certificate of registration of amendment of charges over the fixed and floating assets of the company duly issued by RJSC in case of repeat loan or change in terms and condition of sanction advice regarding loan amount, securities etc.

Common Charge Documents applicable for Proprietorship/ Partnership/Limited Company Demand Promissory Note.

Letter of Hypothecation on stock-in-trade, raw materials, work in process and finished goods.

Letter of Hypothecation on plant, machineries, equipments, vehicles etc.

Assignment of receivables, lease rentals, contract receivables etc.

Assignment of security money, advance rent, if any Personal Letter of Guarantee from the Proprietor / Partners / Directors Personal Guarantee from any other persons.

Post dated cheques for each installment and one undated cheque for full loan value including full interest.

Lien on deposits/financial instruments (FDR, shares of companies listed in stock exchange, ICB Unit certificates etc with perfected lien) observing necessary formalities.

Any other documents as expedient/ deemed necessary by the branch/bank depending on the nature of security such as, -Insurance Guarantee, Cross Corporate Guarantee, Assignment of Contract, Security Money etc.

All security documents pertinent to the mortgage of properties to be examined by the Panel Lawyer of the bank along with legal opinion.

Margin Requirement IDLC takes minimum margin requirement as prescribed by Bangladesh Bank.

Credit Information Bureau (CIB) Clearance While considering a proposal, banks should give weightage to the Credit Information Bureau (CIB) Report of Bangladesh Bank relating to the borrower & his group.

Period of Loan i) For Continuous Loan : 01 (One) year. ii) For Term Loan : Maximum up to 05 (Five) years. But, only for Commercial Space Loan maximum up to 10 (Ten) years.

Mode of Repayment For continuous loan credit turnover must be equal to the limit amount in a quarter and full and final adjustment within the validity period; For term loan, repayment to be made by monthly installments and full and final adjustment within the validity period.

Minimum Conditions for Taking Exposure It is recognized that a large number of enterprises other than limited companies (i.e., sole proprietorship/partnership firms etc) may not have proper books of accounts including balance sheet, profit & loss account and they may not be able to prepare current and future cash flows due to lack of sophistication and expertise.

In such cases, borrowers are required to develop such books of accounts as per forms/formats prescribed.

IDLC does not approve and/or provide any exposure (including renewal, enhancement and rescheduling) until and unless the prescribed Loan Application From is accompanied by a ‘Borrower’s Basic Fact Sheet under the seal and signature of the borrower.

5.3.19. Sales Team The sales team / branch staff responsible for loan sales and should be the owner of the customer relationship, and must be held responsible to ensure the accuracy of the loan application submitted for approval.

5.3.20. Approving of Credits – by Credit Unit

Applications are received at Credit Approval unit as per delegation of power. The credit approval team will be independent from the sales team who will evaluate and approve the loan. On receipt of the Applications it will be evaluated / assessed by Credit Analysts / Managers on the basis of a fully documented Loan Presentation Forms (LPF).

5.3.21 Disbursement – by Credit Administration After approval, Credit Team will send / forward the Sanction Advice to the operation unit for completion of documentation and disbursement of the loans having disbursement authority from Credit Administration Unit. This will ensure the better control of the bank asset and mitigate the risk of compromise of the duties.

5.3.22. Custody of Security Documents Loan disbursements and the preparation and storage of security documents should be maintained in the branches. Security documentation is held under strict dual control, in locked fireproof storage.

5.3.23. Classification and Provisioning Provision is made on the basis of credit worthiness of the borrower, its cash flow, operation of the account, adequacy of the security, inclusive of its realizable value and documentation covering the advances for different categories of Loans provision to be made as under: Special Mention Account (SMA-overdue 90 days), no provision is required ii) Unsatisfactory (overdue 120 days), provision 10%, iii) Substandard (overdue 180 days), provision 20%, iv) Doubtful (overdue 270 days), provision 50%, iv) Loss (overdue by 12 months or above), provision 100%.

5.3.24 Timing of Creating Provisions Branches shall review, at least on a quarterly basis, the collectability of their loans /advances portfolio and shall properly document the evaluations so made. Shortfall in provisioning, if any, determined, as a result of quarterly assessment shall be provided for immediately in their books of accounts by the branch on quarterly basis.

5.4 Appraisal Procedure of SME Client After the marketing stage, appraisal procedure starts. In appraising, a comprehensive report is prepared on the business performance of the client. The whole procedure is carried out through the following step by step procedure: Collecting preliminary information regarding the client: to collect the preliminary information, IDLC maintain a standard formatted checklist. This checklist is designed to collect the information regarding the necessary legal documents of the company, owners liability position, financials of the business and its sister organization and other necessary information. A sample checklist format is attached at the Appendix for better understanding Collecting CIB report of Bangladesh Bank to know the liability status of the client: before any loan disbursement, Availing report from Credit Information Bureau (CIB) of Bangladesh Bank regarding the liability status of the client is mandatory.

Writing the main report: ECD follows a standard format to write the appraisal report on its client. This report format contains the following part to investigate the credit worthiness of the client:

Client’s name, address, business type and other preliminary information In case of an existing client, the exposure status of the client with IDLC Description of the financing proposal in details and client’s previous track record (in case of an existing client) Financing rationales on client from different aspects like: Background of the business and the main sponsors of the business Analyzing the market potentials of the product client deals with Analyzing the shareholding structure of the company to reveal whether any problem lies with it.

Keenly analyzing the previous 3 to 4 years financials of the client and make different comments on the changes he faced over the years Analyzing the business and financial condition of the sister concerns, if any and its impact on the said concern.

Detail liability position of the client Projection regarding the income statement and cash flow of the client at post financing period and calculating the Debt Service Coverage Ratio.

In case of lease, brief description of the leased equipment and its price verification 5.4.1 Credit Control Procedure After the completion of appraisal procedure, the report is sent to the Credit Risk Management Committee to assess the riskiness of the investment. The risk of the investment is measured from different point of view. The major headline along with major risk parameters under which the riskiness of an investment is measured is described below: Industry risk: Demand and supply condition, availability of the raw material, availability of the technology, extent of the competition, the growth pattern of the market, etc.

Company Risk: company’s position in the market, strength of the company in the market, market coverage of the company’s product, etc.

Management risk: Years of operation, Management structure, Experience of the key persons, status of any legal proceedings against the company, etc.

5.4.2 Loan Approval Procedure After the appraisal is done, the appraisal report is submitted to the Credit Evaluation Committee (CEC). The member of this committee is the management people of Credit Risk Management and General Manager. After their approval, it goes to Deputy Managing Director (DMD) and to Managing Director (MD).

IDLC’s SME Loan Disbursement Trend Over the last five years IDLC experienced a spectacular growth in the disbursement of SME Loan. The following figure shows SME loan disbursement from 2006 (Tk. 750.82 mln) to 2010 (Tk. 2,884.39 mln).

Figure 11: SME Loan Disbursement Trend From the figure, we can observe. It was only Tk. 750. 82 mln in 2006. In the following years it was 983.34 mln, 1270.19 mln, 1,803.41 mln and 2,884.39mln respectively.

Almost increment of Tk. 2,133.57 mln in five years. In terms of growth, it ranges from 29%- 60% over the years with the highest growth in last year 2010 (60%). From the future plan and activities of SME Division, it looks in the coming years it will strike higher growth.

Portfolio Structure of SME Financing of IDLC Sector wise distribution of the SME portfolio of IDLC is given below. This distribution shows the distribution pattern of some of the important sector.

Figure 12: Sector wise distribution of SME portfolio Product wise distribution of the SME portfolio of IDLC is described in the diagram:

Figure 13: Product wise distribution of SME portfolio 5.6.1 Facts Regarding the SME Financing of IDLC Around 78% of total client belongs to SME based on fixed capital investment size.

SME clients share 56% of our total loan portfolio.

SME financing is run through 10 branches out of 12.

Future Strategy for SME Financing In this year in 2010, 5 branches opened at Narayangonj; Savar; Nandankanon, Chittagong; Narshingdi, Keraniganj. In 2011, other two branches opened at Mirpur and Tongi. Among all the branches Nandankanon, Narshingdi and Keranigong are SME focused.

In 2012, one branch shall be opened at Jessore and IDLC has planned to expand the branch network to various regional areas and increase geographical coverage.

CREDIT APPRAISAL PROCESS OF SME AT IDLC FINANCE LIMITED Credit Appraisal is a process to ascertain the risks associated with the extension of the credit facility. It is generally carried by the financial institutions which are involved in providing financial funding to its customers.

IDLC Finance Limited is one of the leading multi-product NBFIs of Bangladesh providing a wide range of credit facility to large corporate, emerging corporate and small and medium enterprises. IDLC always concentrates on delivering high value to its stakeholders through appropriate tradeoff between risk and return. A well structured and proactive risk management system is in place within the company to address risks.

In addition to the industry best practices for assessing, identifying and measuring risks, IDLC also considers guidelines for managing core risks of financial institutions issued by the Country's Central Bank, Bangladesh Bank; vide FID Circular No. 10 dated September 18, 2005 for management of risks.

At IDLC, credit risk may arise in the forms like default risk, exposure risk, recovery risk, counter party risk, related party risk, legal risk and political risk.

To encounter and mitigate credit risk the following control measures are in place at IDLC: Multilayer approval process Policy for maximum sector , group exposure limit and Policy for customers maximum asset exposure limit Mandatory search for credit report from Credit Information Bureau Looking into payment performance of customer before financing Annual review of clients Adequate insurance coverage for funded assets Vigorous monitoring and follow up by Special Assets Management Team Strong follow up of compliance of credit policies by Operational Risk Management Department Taking collateral Seeking external legal opinion Maintaining neutrality in politics and following arm's length approach in related party transactions Regular review of market situation and industry exposure The Credit Evaluation Committee (CEC) regularly meets to review the market and credit risk related to lending and recommend and implement appropriate measures to counter associated risks. The CEC critically reviews projects considering the current global financial crisis and its probable impact on the project.

An independent Credit Risk Management Department is in place, at IDLC, to scrutinize projects from a risk-weighted point of view and assist the management in creating a high quality credit portfolio and maximize returns from risk assets.

The SME Division of IDLC Finance Limited provides various credit facilities to a wide range of client. So credit appraisal process is an integrated part of these divisions. This chapter discusses the credit appraisal process practiced in the SME –Small Business Finance (SBF) Unit and SME-Medium Business Unit.

6.1 Main Function The main task of the business units of IDLC is to make new credit client as well as to maintain the relationship with the existing client. So, these divisions are very important for the IDLC Finance Limited because, the company’s sustainability and prosperity are very much dependent on these divisions. Generally, SME Division deals with the various forms of loan and lease with the client.

The main functions of this division are: To maintain relationship with the existing clients To search for new client and make deal with the new client To offer new products to the client To prepare the proposal report and appraisal report To create various documents for the client to execute the contract To collect the required documents from the client To visit the client’s premises if required To follow up the monthly installment provided by the client In performing these activities, SME division interacts with other internal departments like Credit Risk Management (CRM) for evaluation and approval of proposal Credit Administration (CAD) for preparing documents Legal Department for legal issues Accounts, Special Asset Management (SAM) for overdue follow-up Internal Compliance and Control (ICC) for compliance 6.2 Working Process The SME Division extends a wide range of credit facilities to different types of business entity. There work starts form the marketing stage and proceeds with credit appraisal, loan disbursement and finally regular follow-up. The working process of these business divisions are described below.

6.2.1 SME –Mid SME-Mid starts with client call where the Relationship Managers (RMs) approach prospective clients to offer financial services like loan, lease, project finance etc. The RMs assess the client’s requirements on discussion with the clients. If the clients require factoring facilities, the RMs introduces them to the Factoring Department respectively.

If the client is new, the RMs does the initial screening from client’s basic company papers, asset liability position and third party verification. If found reasonable offer letter is sent. When the clients accept the offer, the RMs initiate the CIB collection process and the appraisal process by collecting further detailed information. Basic security papers for

vetting and valuation is also collected. The ARMs write the appraisal report under direct supervision of the RMs .Then the report is posted online seeking an approval from authority. If CRM has any observations, then the queries are fulfilled by collecting further information. If required the RMs further negotiates with the client and change the terms and conditions/ security proposition of the report.

On approval, the RMs handover the Credit Control Report (CCR) for documentation to CAD. The CAD prepares the list of required documents on the basis of CCR. The final documents are printed and handed over to the RMs to get them signed by the clients. The RMs collect the signed documents and insurance undertaking from the clients and send the collected documents to CAD along with the correspondence file for document management and client service.CAD checks the collected documents and confirms the documentation status, which acts as an integral part of approval for disbursement, purchase order. On collecting the documents and charges (service charge and documentation charge) from the clients, the RMs initiates the disbursement memo and the fund is disbursed on approval with the help of Department of Accounts and CAD.

Internal reference Reference from existing clients Recurring needs of existing clients Database Marketing

Getting Business Reference

Further information collection on business performa nce a nd a ssetlia bility position

Go for Disbursement and Execution

Collecting necessa ry information

Fa ctory/Office visit

If accepted

Sending Offer Letter

If found favora ble

Lease/loan am ount

Insta llment size Property va luation

If approved

Submitted to Approval Authority

Initial Screening

Ba sic company pa pers Business performance a nd Asset/Lia bility position Third pa rty Verifica tion

Lea se/loa n tenure

Legal vetting

fy caseo In isf eq rth u

Security creation and establishing assets ownership (if lease)

If ma tches with ba sic criteria

Collection of Security documents

Walk in clients Charge documents preparation and Agreement signing

Initial Meeting with client a nd understa nding the business need

Number/amount of Lea se/Loan deposit

Preparing Appraisal Report Main Report Credit Control

Security proposition Registration/insura n ce requirement, if Lea se

Ba nk opinion Customers’/supplier s opinion

Sending CIB inquiry Any other investiga tion, if needed

Other terms and condition, if required

Exposure Sheet Further informa tion collection/cha nges in terms a nd condition

Risk Gra ding Model

Figure 14: Work-flow process - SME-Mid 6.2.2 SME -SBF The working process for SBF starts with the sales team. The Customer relationship Executive (CRE) initiates the appraisal process by meeting the client. The sales team does the following things

Generation of Loan Proposal by the CRE Review and Verification of Loan Proposal by the Sales Team Manager (STM) and Business Development Manager (BDM) depending on the amount of facility, and if feasible, forward to the credit officer of CRM-SBF. The sales team/branch staffs are responsible for loan sales and are responsible to ensure the accuracy of the loan application submitted for approval. The loan application form is the complete information book of a client. If they finds the client worthy for lending then the file is forwarded to the Credit Officer.

The Credit Officer appraises the proposal, visits the client along with RMs and prepares the appraisal report. This report is then approved by the appropriate authority.

The department of Credit Administration is responsible for preparation and finalization of all required documents. SME Division transfers the signed credit control and appraisal report to CAD and they start preparing, collecting and signing of related documents. After all documents have been prepared SME division gets those documents signed and returns to CAD. For any pending items CAD declare pending items which needs to be cleared by the CREs of SME division before disbursement.CAD also maintains control over all the documents. Once the required documents are completely signed and ready, a disbursement memo is prepared and approved by head of CAD and is forwarded to Accounts department for cheque preparation. The cheque is handed over to the client by CAD. The workflow process for SME-Small is shown in the following exhibit.

A. Generation of proposal 1. Generation of proposal by CREs. Tasks include: Filling up of Appraisal Form Collection of CIB undertaking and other supporting documents.

Undertaking sent for collection of CIB report.

Filling up of TBR form for cases involving TBR 2.Marketing Manager reviews proposal and sends to Senior Manager, SME, along with terms & conditions of financing for review and approval. Senior manager forwards proposal to Credit Risk Manager.

Sends Loan Application Form on new prospects with initial terms and conditions

SME DIVISIONRM Initial Screening

Inform concerned Branch Manager of non-compliance No

execution

Complies with IDLC’s lending policies?

Forwards Loan Application Form to Credit Risk Yes Management

CREDIT RISK MANAGEMENT Assigns the Credit Officer (CO) the Risk Assessment, Client Visit,Credit Investigation.

Appraisal Report to be prepared by CO satisfactory Investigation

HO OPERATIONS DIVISION Documentation Support

Figure 15: Work-flow Process – SME-SBF Yes Financing Proposal Approved?

No

CREDIT EVALUATION COMMITTEE Business Segment Head, Approver of Credit facilities within delegated limit.

Forwards Appraisal Report to CEC upon satisfactory business standing of the prospect

6.3 Credit Appraisal Process The credit appraisal and ends with the approval or sanction of 29 January 2011 follows the marketing stageLease the proposal. The credit appraisal process can be divided in the following two phases Investigation

Report Writing In CD and SME-Mid the RMs are responsible for investigation and report writing. Thus the RMs appraises the credit proposal which is evaluated by Credit Evaluation Committee (CEC) and then approved by the approval authority. So the RM is responsible for the accuracy of the credit appraisal process.

In SME-SBF unit the credit appraisal is done by the credit officer. Both RM and credit officer took part in the investigation process, but the appraisal report is prepared by credit officer of CRM-SBF. 6.3.1 Investigation The most important part of credit appraisal process is the investigation. After the marketing stage, appraisal procedure starts. In appraising, a comprehensive report has to be prepared. For that thorough investigation is done .The whole procedure is carried out through the following step by step procedure: 6.3.1.1 Collecting preliminary information regarding the client: To collect the preliminary information, IDLC maintain a standard formatted checklist.

This checklist is designed to collect the information regarding the necessary legal documents of the company, owners liability position, financials of the business and its sister organization and other necessary information. Collection of security document is also done and is sent for vetting and valuation. For Corporate and SME Medium the RMs collects the documents. For SME-SBF at first the CREs collects the information and document, the STM, CM or BDM observe the proposal and hand it over to the Credit Officer (CO) if applicable. A query/pending list is prepared after getting the loan proposal from the marketing end. Then the respective CO visits the client’s premises to cross check the information that has already been provided through the loan application form.

The information checklists for corporate division, SME-Mid and SME-SBF are provided in the Appendix.

As the size and category of the clients business varies in these three divisions, there are some specific requirements for the divisions. The large corporate concerns keep formal accounts where the SBF client in most cases lack formal accounts and thus the CO needs to construct income Statement/Balance Sheet from the information obtained from sales data, inventory report, list of receivable /payable etc. although SME-Mid clients provide financial account, they are cross checked and verified by the RMs from other documents like export proceeds/sales register/sales ledger, purchase copy/import LC’s copy/purchase register, salary sheet, electricity/gas/water Bills copy ,Current Stock position of raw materials etc.

6.3.1.2 Collecting CIB report of Bangladesh Bank: As per Bangladesh Bank regulation IDLC are to check the CIB report of the clients before sanctioning any financial facility to avoid extending facilities to any defaulter. As per Bank Company Act 1991, Section 27 (AA) (3), no financial institution shall provide any loan facilities to any defaulter. To comply with this Act, FID of Bangladesh Bank vide in its Circular No.07 dated June 29,2002, where it made it mandatory to collect the CIB report of the client to ensure that facilities are not extended to defaulters.

Accordingly, the internal policy had been developed to obtain CIB report for every proposal. To collect the CIB report, RMs/CREs obtain the following from the client during their initial interaction: RJSC certified copy of MEMART RJSC certified copy of Form XII

CIB undertaking of all directors TIN number Trade license Fund requirement On collection of documents, the RM/CRE hands over the following documents to the CIB team to prepare the request documents for BB: CIB undertaking of the directors Application amount Trade license Form XII TIN number When the CIB report is received from Bangladesh bank, it is posted on the Electronic Database Management System (EDMS) and the RM/CO checks the liability status of the client.

6.3.1.3 Analysis of the Information The information obtained is analyzed to assess the eligibility of financing the project before preparing the appraisal report.

The SME-SBF unit has a Product Program Guide (PPG) which includes specific guideline for all aspect. It contains specific guideline for Target group Product type Purpose Legal form of business business location Age of proprietor/ partners/key person(s) of limited company and business age Experience Credit ceiling Determination of loan/lease amount Determination of repayment capacity Disbursement amount and mode Repayment mode, Tenure, interest rate Interest rate for repeat financing Processing Fee, other fees and charge Validity of limit and sanction Debt-equity ratio Disbursement, security for unsecured , partially secured or full secured financing Qualification of guarantors CIB reports.

For Corporate and SME MID Unit there is no specific Product Program Guide. There is a general credit policy of IDLC .The RMs analyses the obtained information in the light of Bangladesh Bank Guideline and IDLC’S Credit policy. The obtained information is analyzed in following manner.

Table 8: Procedure of Analyzing the Information

Credit Standing

Weak

With other FIs tenure or relationship transaction/payment Poor remarks from the banks behavior or little experience for the Bank’s dealing officers bank remarks on the credit behavior CIB report with classified CIB Report overdue for the company or its sister concerns Overdue against existing With IDLC-for existing contracts or poor payment client behavior on previous contracts

Strong

Commendable remarks from the concerned people in the banks

Clean CIB report, no overdue Excellent performance

payment

Ownership & Management Industry Experience: How long are they in this business Managerial Depth: In terms of decentralized decision making, Whether management driven or sponsor

Weak

Strong

New or less than one year Long experience and one of industry experience the trend setters Highly centralized decision Structured ,management with making with no delegation good number of professionals or poor professional involved in decision making management structure

Substantial cross investment Investment in other group in other group concerns concerns especially when other concerns are weak

Less cross investment in group concerns. Clearly separated financial dependency

Ownership & Management

Strong

Weak

Labor Management: Past Not good trends

Good

Managerial know how/business Poor or in adequate know Good vision, in depth know Exposure/Vision: how haws, planned growth etc.

Technical& financial, local or international level Sponsors reputation business community

in

Not satisfactory

Multiple ownership (not within one family) with Ownership structure and probable ownership conflict integrity among owners or no inheritance of present ownership Market-Macro

Weak

Industry growth rate- Poor growth or high supply Demand supply situation or or substantial external threat industry prospect to the industry Low entry barrier and high Entry barriers or competition competition Dependency on other High dependency on industries or any backward or forward international phenomenon industries Industry sensitiveness to Highly sensitive external changes Sales growth and causes of Poor or no growth and growth decline in sales

Highly regarded businessman.

as

Ownership confined with few owners and particularly within the family and has second generation involved in the business.

Strong Steady growth with high demand and inadequate supply High entry barrier and low competition Moderate or low dependency Not that sensitive at present Steady growth

and

good

sales

Market-Macro

Weak

Strong

Product diversification or No or little diversification of diversified and product strength products product base Market share

Negligible Market Share

Significant market share

Relationship with clientsNo long term relationship whether niche market player with client or not No particular pricing Pricing and marketing strategy or distribution channel

Technical verification

Weak

strong

Long and steady relationship with client Structured pricing strategy and distribution channel

Strong

Very good capacity and Low capacity utilization and utilization with no bottleneck in process bottlenecks Balancing of infrastructural Balanced infrastructure Imbalance in infrastructure facilities facilities Threat of technological No immediate threat of Technological obsolescence obsolescence visible technological obsolescence New technology with Known technology with technological dependency or inadequate technical people adequate technical hands required manpower available available Time frame for project Stringent time frame for Flexibility in time frame for implementation project implementation project implementation Capacity utilization bottlenecks

Financial analysis Revenue trend

volume

Profit margin Asset base Debt equity Receivable situation

Weak

Strong

and Declining or non growth Steady growth in revenue revenue Good profit margin compared Very low to industry Low fixed asset base

Considerable fixed asset base

More than three times debt Equal to or less than 1 debt of equity equity ratio High receivable turnover very low receivable turnover more than 3 months

Debt service coverage in Less than 1.2 in debt service More than 1.5 debt service financial projection Inventory and liquidity High inventory and poor Reasonable inventory; healthy position current ratio situation current ration

6.3.2 Report Writing When the project has been investigated, for corporate and SME-Mid, the Assistant Relationship Managers (ARMs) prepare the appraisal report of the proposed project under the supervision of RMs using the information collected. For SME-SBF unit the appraisal report is prepared by Credit Officer .The appraisal report includes all details of the enterprise, owners 窶話ackground and details of the financing.

6.3.2.1 Risk Grading Model Risk grading model is an essential element for an organization to assess the risk associated with the potential new project or existing project. It is an important part of appraisal report. Without it, no appraisal can be conclusive. The groups of researchers have developed a risk grading model to assess the risk of the project where IDLC is going to invest. So, necessary information should be collected by the individual who is doing the appraisal.

Application of Models Risk Grading Model is applicable for business entities with minimum one year of operation Risk Grading Model is not applicable for Bank and Financial Institutions.

Types of Model Different risk grading model is used for the following different types of situation those areLarge Corporate Large Corporate with Project Manufacturing Manufacturing with Project Service Service with Project Trader Steps towards using Risk Grading Model For Existing Business Step 1 Choose model Step 2 Identify/Choose Risk Factors Step 3 Assign weight in Risk Factors Step 4 Scoring Risk Factors Four types of risks are considered in the risk grading model. Those are: Industry Risk Business Risk Management Risk Financial Risk Interpretation of Grades Table 9: Interpretation of Grades

Grade IDLC 1

IDLC 2

IDLC 3 IDLC 4 IDLC 5 IDLC 6

Degree of safety with regard to Interpretation servicing Debt obligations The fundamentally strong debt servicing capacity of such companies is most Very High unlikely to be adversely affected by changes in circumstances.

Adverse business conditions are unlikely to affect debt-servicing capacity. Such High companies differ in safety from those in Grade I only marginally.

Debt servicing capacity is less likely to be Satisfactory adversely affected by changes in circumstances than for lower grades.

Changes in circumstances are more likely Average (with relatively to lead to weakened debt servicing capacity higher standing) than for higher grades.

Average (with relatively lower While such companies are less susceptible standing) to default than those in lower grades, uncertainties faced by them could adversely Below Average affect debt-servicing capacity.

IDLC 7

Low

IDLC 8

Very low

Adverse business or economic conditions are likely to lead to lack of ability or willingness to service debt obligations.

Debt servicing capacity is highly vulnerable to adverse changes in circumstances.

6.3.3 Writing the main report The Corporate Division, SME-Medium Unit and SME-SBF Unit follow specific formats to prepare the appraisal reports. They follow standard format to write the appraisal report on their client. This report format contains the following part to investigate the credit worthiness of the client: Client’s name, address, business type and other preliminary information In case of an existing client, the exposure status of the client with IDLC Description of the financing proposal in details and client’s previous track record (in case of an existing client) Financing rationales on client from different aspects like: Background of the business and the main sponsors of the business Analyzing the market potentials of the product client deals with Analyzing the shareholding structure of the company to reveal whether any problem lies with it Keenly analyzing the previous 3 to 2 years financials of the client and make different comments on the changes he faced over the years Analyzing the business and financial condition of the sister concerns, if any and its impact on the said concern.

Detail liability position of the client

Projection regarding the income statement and cash flow of the client at post financing period and calculating the Debt Service Coverage Ratio.

In case of lease, brief description of the leased equipment and its price verification, security related information The appraisal report for corporate division contains appraisal report and report annexure.

The appraisal report contains the following partsOverview of the company Directors’ and Shareholders’ Particulars Major Financials Current Proposal IDLC Financing & Exposure CIB Report The report annexure contains Background of company Information of market, product, plant Group concerns Analysis of industry performance (macro) and company performance (micro) For SME-Mid the appraisal report contains the following parts Snapshot of the report including basic information, financing amount, tenure, rate, exposure with IDLC, RGM, security Financing proposal Financing rationale Risk Grading Business performance Shareholding structure Sister concerns Strength of the proposal Credit investigation part containing liability position of the company Facility and security details including details of facility, security and DSCR Financials of the organization The appraisal report of SME-Small unit has total ten parts: General Information Branch name of IDLC, Business name, address, registered address, phone number, TIN number, years of relevant business experience of the owner/key personnel of the business, Commencement of business operations, trade license no. and date Total fixed assets and investments in the business, Name of the main sponsor and his/her personal net worth, Nature of the business, sector and sub sector, Legal status of the applying concern, Relationship with IDLC since how many years, Total manpower, Date of factory/premise visit by the RM and officers, Premise ownership status, Name of the employees who made visit, Name of the person with whom IDLC officers talked and met.

Rationale of Financing Client’s total experience, relevant business experience, Local advantage IDLC net exposure for current proposal and effective rate with or without cash security, Risk factors/weaknesses of the client, Strength of the proposal Cumulative DSCR ( Debt Service Coverage Ration) Business Details Name of the concern and nature of the business, Name of the proprietor/director/shareholders, Life of the business, Details background of the main sponsor.

Owner’s information Name of sponsor, Age, designation and relationship with the business, Share and personal net worth, Experience and educational qualification, Succession plan Particulars of sister allied concern CIB Compliance CIB report includes nature of fund undertaking, borrower’s name, nature of credit facility, sanction limit/amount, total outstanding loan, overdue amount, loan classification Previous Experience with other Institutions Name of the financial institutions Accounts name, Facility type, Term, Interest rate, Security provided Financial Performance Sales/revenue, Net profit after tax, Fixed assets, Current assets, Other assets, Total assets Current liabilities, Long term liabilities, Total liabilities, Tangible net worth Important ratios such as net profit margin, current ratio, quick ratio, inventory turnover ratio, receivable turnover ratio, debt to equity ratio, debt to total assets, debt to service coverage ratio Key Management Personnel Name and position in the firm Age, educational background and experience Current exposure with the Client: (Not applicable for a new client) Contract Number, Term and loan amount, Disbursement date and Installment Remaining term and Outstanding amount Liability Performance (can be verified from the loan repayment slip of financial institution and Bank statements) Concern name and Financial institution’s name Total amount taken as loan (both short and long term) and current outstanding Installment amount and Installment outstanding and installment recovered Facility Details (Applicable for lease finance) Security Assessment (if cash) Description of the security type Name of the Depositor Amount deposited Tenure and Rate of interest IDLC Net exposure and Security coverage The appraisal report along with Credit Control Report (CCR), Risk Grading Model and Exposure with IDLC is posted in the IISAF for evaluation and approval.

6.4 Approval Process As per IDLC’s policy, divisions must take approval from the appropriate approving authority before sanctioning any financial facilities to its clients. The appraisal is placed before the evaluation committee for evaluation and approval.

The Board of Directors is the highest approval authority. An executive can exercise only the powers delegated by the Board of Directors in ways and manners specified by them.

Board of directors delegated power to ensure prompt and efficient service to sanctioning authorities in following manner: Approval authorities, in sequence of their capacity, are: Board of Directors Management Committee

CEO & Managing Director Approval authority Table 10: Categories of Approval Authority Approving Authority (Based on group Amount exposure) New client - For exposure more than 15% up to 25% of equity Board of Directors Existing client – For exposure more than 20% up to 25% of equity New client - For exposure exceeding 5% up to 15% of equity Management Committee Existing client – For exposure exceeding 10% up to 20% equity CEO & Managing New client - For exposure up to 5% of equity Director Existing client – For exposure up to 10% equity Approval Authorities Cumulative net exposure as % of group total asset (Based on group total asset) Managing Director Up to 50% Board of Directors

More than 50%

Approval Authorities Net exposure in a single sector as % of IDLC’s portfolio (Based on single sector exposure) Managing Director Up to 15% Management Committee

Up to 20%

Board of Directors

Up to 25%

Credit Evaluation Committee (CEC) MD & CEO shall determine the constituents, Roles & Responsibilities and Process of works of the Credit Evaluation Committee (CEC). Credit Evaluation Committee members are, Chief Executive Officer & Managing Director Deputy Managing Director General Manager Chief Financial Officer Head of Corporate Division Head of CRM or any other CRM member nominated by Head of CRM Credit Evaluation Committee (CEC) holds rights to approve an appraisal report as per proposed terms and conditions for consideration of sanctioning authority; request for additional information; request evidence regarding any information provided; suggest changes in or inclusion of terms and conditions regarding client’s liability with IDLC Finance Limited or any other financial institution or bank; suggest changes in terms and conditions concerned with repayment; including repayment schedule, transfer price, late

payment interest rate, true rate and effective rate; suggest to change or increase security; suggest increasing equity participation of client; suggest providing additional guarantor or decline a financial proposal based on overall risk assessment. Credit Policy acts as a guideline in every step of approval process for all concerned personnel.

The CEC members evaluate appraisal reports for all possible credit risk possibilities. To accomplish this objective, CEC members address following issues: Compliance with Credit Policy of IDLC Analysis of CIB report and bank opinions Analysis of financial statements Verification of financial projections and evaluating assumptions taken to construct the financial projections Factory/site visit of project type investments; if considered important, for other investments as well Verification of market information Verification of security and evaluation of security coverage Awarding of appropriate risk grades to clients After CEC clearance, the appraisal report along with credit control report is placed before the appropriate authority for signing. As the approval process takes place, the RMs initiates the documentation process and collection of security documents.

The specific approving authority for proposal sanction, appraisal report, sanction letter and disbursement has been delegated by the higher management and there are various tier of approving authority depending on the amount to be sanctioned.

CREDIT ANALYSIS OF ‘SAJIB PRODUCTS’ Credit analysis and loan appraisal preparation in IDLC Finance Limited is performed on the basis of a thorough analysis with excel sheet. The firm has developed an “Appraisal Format” for the purpose. This section is based on such loan appraisal preparation and credit analysis of a client “Sajib Products” for SME Financing.

The appraisal format contains the following sheets: Table 11: Appraisal Format Appraisal Credit Control Income Statement & Balance Sheet (IS BS) Debt Service Coverage Ratio (DSCR) Rate Effective Rate (ER) Depreciation (DEP) Personal Net Worth (PNW) Sales & Inventory URPA Sheet The analysis for the loan appraisal of client “Sajib Products” will be discussed here on the sequence of preparation of the sheets.

7.1 Appraisal The appraisal contains the information about the client and the basic findings of the analysis. The appraisal of the applying concern “Sajib Products” was prepared on March 14, 2011. The appraisal contains the following information: Table 12: An Overview of Sajib Products Business Name: Sajib Products Business Address: Showroom 1: 48/A-B, Ground Floor, Purana Paltan, Dhaka Showroom 2: 11, Chawk Circular Road, Shop no. 5, Dhaka

Registered Address: Customer Code (CIB): TIN Number: Years of Relevant Business Experience: Commencement of Operation (Applying Concern) Trade License No. and Date: Name of Main Sponsor: Nature of Business: Sector: Sub Sector: Legal Status of Applying Concern: Relationship with IDLC Since: Total Manpower:

26, Purana Platan, G.P.O, Paltan, Dhaka.

CIB/2010/0656-0657 155-101-7305/Circle-48, Tax Zone 5, Dhaka.

20 Years 1990 0427966

Date:

November 24, 2008

Mohammad Shajahan Printing and Packaging Paper & Paper Products Printing Proprietorship New client of IDLC 35 Persons

Some explanations are required here. For example: Credit Information Bureau (CIB) tracking number is sent to Bangladesh Bank to collect CIB report containing credit history of the client.

Tax Identification Number (TIN) is used to check client’s taxpaying practice which includes TIN number, tax circle and tax zone.

Updated Trade License of the applying concern is collected from the client through Customer Relationship Officer (CRO).

The sector and subsector are formed and maintained to identify and maintain the product portfolio of IDLC Finance Limited.

We can see that appraisal shows information of the client at a glance.

7.1.1 Purpose of Financing of “Sajib Products” Reportedly, Mr. Mohammad Shajahan jointly with another preson purchased 10 katha of land at Chamelibagh at the cost of BDT 70,000,000/- approximately where he owns 5 katha of land. The equity for purchasing the land came from the business savings and also liquidating a portion of the business investment. The client has approached us for the credit facility to replenish the working capital.

7.1.2 Background of the Sponsor Mr. Mohammad Shajahan completed his post graduation in Accounting from University of Dhaka in 1987. He started trading business of printing materials at Paltan area while he was a student and continued it under the banner of Sajib Enterprise till 1989. In 1990 he renamed the business as Sajib Products and initiated printing facilities of its own and moved to the current location in 1997. The information has been collected through client visit.

7.1.3 Business Dynamics/Client and Product Portfolio Sajib Products is a manufacturer and trader of calendars, diaries, promotional items, posters, stickers, literatures and a host of other related products. Papers and rexin for the manufacturing of products are imported directly from abroad using the IRC of others and

related accessories are procured from Nawabpur area. It has seperate printing, designing, cutting & binding section for providing quality services.

The factory is housed on a rented premise sized around 1,779 sft at 21/A, Purana Paltan which is equipped with 2 Bi-Color Offset Printing Machines ( 1 Roland Parva & one Favorite) of German origin, 1 unit of lamination Machine, 1 unit of Cutting machine, 1unit of Perforation Machine and several other equipments. Almost all sorts of Printing and Binding services for the manufacturing of calendars, diaries, other promotional items etc. are completed in house while in peak season it has to outsource some of the manufacturing facilities.

Products manufactured in the factory are sold through two of its outlets at Purana Paltan and Chawk Bazar. Besides, the client also serves corporate customers.

The business is marked by high degree of seasonality. November to April is considered to be its peak season and to meet up the high demand in the peak seasons it has to run its factory all round the year.

The client has been able to create a large portfolio of customers consisting of Pharmaceutical companies, Advertising Firms, Service Industries, Garments Industires and Food and Cosmetic Companies due to its long term presence in the industry. Usually the renowned corporate houses place direct orders to the client. Based on the orders, the client manufactures the products and delivers to its customers. Besides, the client also sells ready to order diaries, calendars, posters and stickers to meet the instant demand of others.

7.1.4 Record of Bank Transaction Table 13: Bank Transaction Records of Sajib Products a) From: 1-Jan- to 19-JanACC Name Sajib Products 09 10 Name Prime Branch: Bijoy Credit 22,466,08 % of 67.58% of Bank Nagar Summation: 5 Revenue Bank: Ltd. reflected : b) From: 8to 2-Mar-10 ACC Name M Shahjahan (Savings A/C) Sep09 Name HSBC Branch: Motijheel Credit 341,081 % of 1.03% of Summation: Revenue Bank: reflected : Bank transaction reflects many important issues like installment payments (if any), condition of fund flow etc. Percentage of revenue reflected is calculated by dividing credit summation by yearly sales. It has to be at least 5% for eligibility for financing. The bank statements are usually collected for at least 1year.

7.2 Credit Control Credit control sheet is prepared for checking the security position against the proposed facility. Along with that, the facility amount and associated rates are mentioned here.

7.2.1 Facility amount and Associated Rates

Table 14: Facility amount and Associated Rates Facility amount BDT 3,000,000.00 (BDT Three Million Only) Facility type Business loan.

Purpose To expand the business Availability period 3 (Three) months from the date of Loan Agreement.

Moratorium N/A period Mode of Disbursement to be made in one shot.

Disbursement Loan Term 24 (Month) Rate of Interest Interest 18.50% rate: Effective Rate (without Cash 18.50% Security): Effective Rate (with Cash Security): 19.13% The client has been offered BDT 3,000,000/- after calculating and analyzing the financial condition of the client through financial statements and subjective judgments. The first time borrowers are given loan for tenure of 24 months and the rate is 18.50% if cash security is taken. However, including cash security, the effective rate becomes 19.13%.

This calculation is shown in ER (effective rate) sheet.

7.2.2 Proposed Security Table 15: Proposed Security Proposed a. Hypothecatio Security: n of

b. c. d. e. f.

I II II I I V

Stock & Machinery Raw Work Finished Receivable & materials in goods s Equipment process √ √ √ √ √ Office & Showroom: 48/A-B, Ground Floor, Purana Paltan, Dhaka Factory: Ground Floor of Nawab Ali Tower (South Vajhi Cooperative Society), 21/A, Purana Paltan, Motijheel, Dhaka.

Outlet: Shop-5, 11 No. Chawk Circular Road,Ground Floor, Lalbagh, Dhaka.

Fire Insurance on the hypothecated items covering 110% of the sanction limit Non Interest Bearing Security Deposit of 0 to be adjusted with (BDT) last ins.

Rental Deed/Possession Deed: N/A Cash 600,000 Rate 9.50% Tenure 24 Security(BDT ) Personal Guarantee: Name Relationship PNW(BD T) Mohammad Shajahan Proprietor 90,400,00 0 Salma Begum Spouse of the 2,220,000 proprietor Mohammad Kamrul Hasan Businessman 6,250,000 Friend Mir Abu Akhter Fazle Rob Businessman 15,130,00 Friend 0

The proposed securities are required to ensure the safety of the lending firm. In case of “Sajib Products”, Stock & Receivables, Machinery & Equipment, Raw materials, Work in process and finished goods placed at the factory and two showrooms have been hypothecated against the loan. Fire insurance on the hypothecated items covering 110% of the sanction limit has also been arranged for safety of the hypothecated products.

Another form of security taken is FDR of 20% of the loan amount. It is usually taken for large amount of financing. Finally, personal guarantee has also been taken which includes the proprietor, Spouse of the proprietor and at least two third party guarantors. In this case, two mentioned third party guarantors are business friends. Personal Net Worth (PNW) statements of the client, the spouse and the 2 third party guarantors are very vital.

Because, if the client fails to pay back the facility amount timely and if it becomes overdue, then the guarantors become responsible for paying back the loan amount. The PNW are calculated and determined through PNW statement sheets. The PNW statements contain detail information about all the net worth which are identified by contacting with the guarantors and collecting required documents from them with marketing team’s help.

Need to mention that, if credit officers require often simple deposition of rental deeds of outlets or godowns are taken as security. In case of net exposure above BDT 3,500,000/registered mortgage is taken. In that case, vetting and valuation documents are required which are outsourced to Prime Asset Management Company. However, in this case, no such documents were taken. The credit control sheet carries detail information of the guarantors including father’s name, mother’s name, present address, permanent address, national ID number, business address, phone number etc. A very important point in credit control in Sectoral Exposure is shows the exposure of IDLC to a particular sector. For the sector “Paper and Products” the exposure is 2.00%.

Sectoral Exposure as % of Portfolio 2.00% 7.3 Sales and Inventory Sales and Inventory sheet shows the total sales of the applying concern for at least one year executed through all the outlets. For “Sajib Products”, the sales have been collected for 1 year from January ’09 to December ’09 for both the outlets at Paltan and Chawk bazar. The total sales have been BDT 41,556,006/-. Monthly Debt Service Coverage Ratio (DSCR) is also checked because if historically monthly DSCR tend to be less than 1, it can hamper the monthly installment payments. However, for the client, it is always above 1. There is seasonality in sales problem with the client. Seasonality is 33% which is winter. It has been found that, at year end, paper business sales is usually higher compare to other months for examinations and book publications. Monthly DSCR is also higher in these two months.

7.4 Depreciation Depreciation is calculated for furniture and fixture, interior decoration, and machinery and equipment. For the client, it has been calculated on furniture and fixture, and machinery and equipment. The rate is always considered 10%.

Table 16: Depreciation Details Value as of Particulars Year of Procurement Purchase 2009 2010 Depreciation Value Furniture & 2000 100,000 38,742 34,868 3,874 Fixture Machinery & 2006 7,000,000 5,103,00 4,592,70 510,300

Equipment Total

7,100,000

0 5,141,74 2

0 4,627,56 8

514,174

7.5 Rate and Effective Rate Rate sheet and effective rate sheet are prepared for checking the installment amount to be paid be the borrower for the facility. Along with that, the charges and interest rates are also determined here. For “Sajib Products� such sheets show that: Table 17: Rate and Effective Rate Sheet Acquisition cost Tk 3,000,000 Interest rate 18.50% Loan Term 24 months Service/Documentation Tk Charge 1,250 Processing Fee 30,000 Cash Security Tk. 600,000 Loan Tk. Installment/month 150,500 IRR 1.5418% IRR (with cash 1.5942% security) Effective rate 19.13% The effective rate and IRR (with cash security) are higher than the interest rate because 20% of facility amount is taken as cash security. The installment amount (EMI) is BDT 150,500/- monthly to be taken at end of each month. Processing fee and documentation charge are actually the expenses required for the internal expenses for making the facility amount available for the client.

7.6 Income Statement and Balance Sheet Income statement and balance sheet are prepared to analyze the financial condition of the applying concern. All the expenses are annualized. After preparing the statements, some basic check points are observed to determine whether to give loan r not. The check points are: Debt Service Coverage Ratio (DSCR): Minimum 1.75 when net exposure is up to BDT 3,500,000/- and beyond that 1.50 (applicable only for registered mortgage).

Ratios: Ratios are vital for observing the financial condition of any organization. IDLC also checks ratios based on the income statement and balance sheet. Following ratios are observed for analysis: Table 18: Different Ratios Profitability Ratios Gross Profit to Sales Net Profit to Sales Return on Asset Return on Equity EBIT to Total Asset

Debt Management Ratios Total Liability to Equity Ratio Long Term Debt to Equity Debt to Total Asset Debt Service Coverage Ratio Asset/Liability Utilization Ratios

Liquidity Ratios Current Ratio Quick Ratio

Asset Turnover Inventory Turnover (days) Accounts Receivable Turnover (days) Accounts Payable turnover

An important notation is that, in case of small business financing, clients often intend to overestimate the values while reporting. As small businesses do not preserve financial data in a structured manner, so CRM division often applies personal judgment while analyzing the data. For this purpose, values are regularly discounted to avoid the impact of overestimation.

In case of “Sajib Products” following observations have been found while analyzing the Income Statement and Balance Sheet: Information was collected after consulting with the client and verifying the information provided with the sales ledger and sales vouchers that he maintains. Accounts show the consolidated performance of Sajib Products & Sajib Printing & Packaging for the period January 2010 to December 2010.

Current assets include Cash of BDT 200,000/-, Accounts Receivable of BDT 4,000,000/against the credit sales and inventory of BDT 5,000,000/-.

Fixed assets include furniture & fixture of BDT 34,868/-, Plant and Machinery of BDT 4,592,700/-, and have been amortized @ 10% using declining balance method. It also include FSV of the outlet at Paltan of BDT 6,000,000/Other asset comprises of security deposit of BDT 575,000/- against showroom of Chawkbazar and the space rented for printing press, Preliminary Expenses of BDT 20,000/- and power & telephone of BDT 50,000/-.

Current liabilities include accounts payable of BDT 500,000/- against credit purchase and Other Payables (Salary & Utility Bill) of BDT 200,000/-.

The proprietor has been enjoying a personal loan facility of BDT 500,000/- with HSBC for a tenure of 48 months, where principal outstanding is BDT 209,859/-. The proprietor stands regular against the facility so far.

Gross profit margin is 18.80% and net profit margin in 10.24%. The client maintains comfortable level of Return on Equity at 17.41%.

The liquidity position is significantly high due to high level of current assets (a/c receivable and inventory) with Current Ratio at 13.14:1 and Quick Ratio at 6:1.

The turnover ratios show good level efficiency of the firm with Inventory Turnover (days) at 67.62 days Accounts Receivable Turnover (days) at 43.92 days.

DSCR, at 2.00, was calculated based on the performance of January 2009 to December 2009 and considering the existing financial obligations with HSBC of BDT 14,951/- per month & the proposed financial obligation of BDT 150,500/- per month to IDLC Finance Limited.

A CC (cash credit) Hypo facility of BDT 8,000,000/- has been sanctioned from Prime Bank Ltd. in favor of the concern which the client hasn't availed yet. However, the client will have to cancel the sanction of that facility before availing the proposed facility with IDLC. 7.7 Debt Service Coverage Ratio Debt service coverage ratio is calculated to judge the client’s ability to repay the availed facility from IDLC. For this purpose Unrealized Principal Amount (URPA) sheet is prepared for every term loan the client has so far availed and also one for the proposed facility of IDLC. In calculation of existing financial obligation, “monthly installments x

12” is used for each term loan and also for the calculated with the following formula: Table 19: Formula of DSCR Sales Less: COGS Gross Profit Less: General & Admin Expenses Net Operating Profit Add: Depreciation Funds available for debt service Existing Financial Obligation(If any) Proposed Financial Obligation (IDLC) Total Financial Obligation DSCR

proposed facility of IDLC. DSCR is *** *** *** *** *** *** *** *** *** *** Funds available service/ Total Obligation

for debt Financial

In case of “Sajib Products”, two URPA sheets have been prepared for existing facility with HSBC and proposed facility with IDLC. 7.7.1 URPA (HSBC) Table 20: URPA (HSBC) Branch: Facility Type: Facility Amount: Monthly installment: Interest (Yearly):

Motijheel Personal Loan 500,000 14,951

Interest (Yearly): 7.7.3

June 12, 2007 48 months

Installment Date: Installment Period

15

Execution Date: Loan Term:

March 14, 2010 24 months

Installment Date: Installment Period

25

July 15, 2007 to June 15, 2011

Rate 19.00%

7.7.2 URPA (IDLC Finance Limited) Table 21: URPA (IDLC Finance Limited) Branch: Dilkusha Facility Type: Business Loan Facility Amount: 3,000,000 Monthly installment:

Execution Date: Loan Term:

150,500 Rate 18.50%

Cash Amount

April 25, 2010 to March 25, 2012 Security 600,000

Debt Service Coverage Ratio of “Sajib Products”

Considering the financial obligations with HSBC and IDLC and observing the funds available with the concern for repaying the debt service, following DSCR has been calculated which is above the floor rate (1.75) of IDLC. So the client can be financed considering DSCR. Table 22: Debt Service Coverage Ratio of “Sajib Products” Funds available for debt service 3,973,201 Existing Financial Obligation(HSBC) 179,412 Proposed Financial Obligation (IDLC) 1,806,000 Total Financial Obligation 1,985,412 DSCR 2.00 7.8 Risks and Strengths of the Proposal 7.8.1 Risks factors / weaknesses The business is marked by moderate degree of seasonality. Majority of the sales occurs within the months of November to April.

The client is a first time borrower and has no experience of serving long term debts.

There are lots of accounts receivable in the market, some of which might become baddebt.

Market of paper is volatile. Profitability of the concern might be affected due to unstable market.

7.8.2 Strengths of the Proposal The client has been involved with the similar trade for more than two decades and has very good understanding regarding the dynamics of the business.

There is very good equity investment in the business and no long term obligation in the name of the concern.

The client provides complete printing solution. It has entire facility of printing and binding. Moreover, papers are also imported by the client using the IRC of others.

The proprietor owns significant real estate property. The outlet at Paltan is housed at the ground floor of the proprietor's own building. He owns 2.16 katha of land with floor space of 17,720 sft spread across the 12 storied building having forced sales value of BDT 10,340,000/- approximately. Reportedly the proprietor has rental earning of BDT 400,000/- per month from there.

Mohammad Shajahan is one of the directors of Abed Holdings Ltd. He has 5% shareholding in the company. It is worth mentioning that the Abed Holdings availed a Lease facility of BDT 2,000,000/- in 2004 from IDLC Finance Limited. and has successfully settled it off as well.

In this way, Credit Risk Management division performs an extensive analysis on the applying concern and takes decision whether to provide financing facility to clients in SME Financing. Further execution of the loan and disbursement is performed by the credit administration division.

STUDY RESULTS AND FINDINGS Throughout the report, I have shown credit risk policy and SME in Bangladesh focusing credit risk appraisal process of SME division at IDLC. In the analytical part through a case study of “Sajib Product” I have shown the practical implication of credit assessment practiced in this organization.

In this chapter I will present major findings in two segments. These arePresent SME scenario a) From Bangladesh Aspect In Bangladesh, SME consists of almost 90% of the total industrial setup. SME contributes almost 80% to 85% industrial employment, which is the 25% of the total employment of Bangladesh. SME accounts for 25% to 30% of total GDP. In terms of value addition, SME contributes 45% to 50% of the total value addition of a year’s total production.

(Source: IDLC database).

From Financial Institution’s point of view, all the risk factor involved in the SME sector are as followsInadequate asset base of the owner Inadequate business knowledge of the owner Absence of formal accounting system in case of maintaining financials High seasonality in the business High competition in the business Inadequate security coverage from the borrower Possibility of misrepresentation and misleading information regarding business provided by the borrower. b) From IDLC AspectIn IDLC, last five years SME Division is experiencing extravagant growth. Almost 60% increase in SME growth in last FY 2010. From present scenario of IDLC, it seems that, IDLC’s will continue having similar or higher growth trend in coming years.

As a NBFI, in a single year (2010), they have opened 5 branches and in 2011 2 other branches. Among all the branches 3 are SME focused. They also have future plan to expand branch various regional areas to stronger the geographical coverage. This indicates, their heavy concentration on SME business In line with expansion, heavy recruitment at market and credit end is also occurring which ensures unaffected enhancement of SME portfolio with nil NPL. Credit Appraisal Process of IDLC To encounter and mitigate credit risk IDLC practice a multilayer approval process, make CIB report mandatory, review clients annually, strong follow up of compliance of credit policies by Operational Risk Management Department, review market situation and industry exposure regularly. Credit Appraisal process of SME client is segmented into three categories like- Investigation, Report Writing and Approval.

Firstly, Investigation is made to collect information about clients. In SBF segmented it is conducted by the dedicated credit personnel and in mid segment it is done by ARMs. Mostly, they collect information via visiting there setup, from other Bank\FI’s with whom it already has relationship or from its supplier and customers, in short from market. In this relation, CIB report is send mandatorily collected from Bangladesh Bank to understand the client’s payment behavior. It is to be mentioned, in SBF segment, they strictly follow Product Pricing Guidelines in case of eligible someone for availing loan.

Secondly, in Report Writing segment, a credit appraisal report incorporating client background, business dynamics, financials, liability status, strength, risk analysis through a risk grading model and purpose of the loan is prepared. This report is further presented to approving authority for the approval of the loan.

Finally, in Credit Approval segment, the control measures are in place at IDLC: in case of SBF unit as dedicated credit team prepare the report so the approval lie within the Assistant Manager, Manager, AGM and Finally the Head of Credit depending on the loan range.. Whereas in case SME- Mid segment within Tk. 10.0 mln Head of Credit Risk Management approves it and on above that CEC Meeting is held regularly in presence of MD, CFO ,Head of Corporate, Head of CRM and Head of SME where loan is finally approved.

Over all, a very structured format is used in credit assessment in IDLC. RECOMMENDATIONS AND CONCLUSION 9.1 Recommendations In terms of huge business opportunity and high recovery rate, SME sector is quite a promising sector for financial institutions to make the investment. In my opinion, to eliminate the risk factors substantially and thus make a new ground for profitable investment, government, central banks, and financial institutions should consider the following propositions9.1.1 From the perspective of Government and Policy-makers Central Bank Policy – Central Database Bangladesh Bank facilitates the financial institutions in effective credit risk management by offering the services of CIB (Credit Information Bureau). CIB maintains a central database for all the individuals and organizations, who have ever undertaken credit facility from financial institutions. Borrowers’ repayment pattern and history of credit availability can be found from CIB report. This CIB report is absolutely essential in decision making process of every credit facility.

Currently, the CIB facility offered by the Bangladesh Bank has some vital flaws. The CIB report does not contain the borrowing information and repayment behavior of the borrowers for the current quarter. As a result, financial institutions have to rely on the information of past quarter to make lending decisions. This increases the credit risk substantially as a borrower can become irregular in repaying loans or may have borrowed very recently from other financial institutions, which would be overlooked during disbursing new credit facility. Small and medium enterprises are mostly unfamiliar in the financial arena, thus, comprehensive information is a must for financing these institutions.

Moreover, it usually takes more than a week to obtain CIB report from Bangladesh Bank, which reduces the efficiency of financial institutions in processing credit facility.

Bangladesh Bank should take immediate steps to eradicate these flaws in order to enable the financial institutions to manage credit risk effectively. CIB report should be made online for any officer of financial institutions to access any borrower’s information instantly. Furthermore, skilled and sufficient human resources have to be facilitating in this regard to ensure smooth flow of the overall operation.

Industry and Sector Analysis Government and the central bank have to come up with the idea to constructing a central knowledge base for the financial institutions to prudent financing decisions. Broadly, overall industry and sector analysis should be conducted by the intellectuals and researchers. This analysis should be aimed at obtaining insights into the nature, profit

margin, and business dynamics of different industries and sectors, as well as assessing the strengths, weaknesses, opportunities, and challenges of these segments.

Uniformity of Record Records of every transaction in every government offices have to be uniform. Different ways of recordkeeping surely leads to discrepancy, and allows room for manipulation.

For example, an importer can declare deflated quotation of the imported products to dodge additional duties. But enduring a consistent HS code may ascertain such practice can be avoidable. Moreover, the regulatory bodies should encourage the organizations and individuals to follow uniform accounting principles.

Training & Development Besides policies and regulations, the government also has to ensure the human resources of the financial institutions be trained and nurtured in such a way that credit risk can be minimized. Seminars and symposium have to be organized on a regular basis to ensure the financial institutions understand the new challenges and exposures of credit risk of different sectors. Intensive training should be on the offering to build up manpower for effective risk management.

Credit Rating One of the effective means to increase the effectiveness and efficiency of credit risk management is to establish a credit rating procedure for prospective borrowers.

Independent and renowned rating agencies should be hired for credible credit rating. This will certainly allow the financial institutions to increase the efficiency in its operation significantly, and also the cost of borrowing will decrease substantially. Recently, BRAC Bank has come to an agreement with Dun & Bradstreet, a renowned British rating agency, for credit rating of small & medium enterprises. Such steps have to be taken in broader perspective by the Government.

9.1.2

From the Perspective of Financial Institutions

The Board of Directors should have responsibility for approving and periodically reviewing the credit risk strategy and significant credit risk policies of the bank. The strategy should reflect the bank’s tolerance of risk and the level of profitability the bank expects to achieve for incurring various credit risks.

Senior management should have responsibility for implementing the credit risk strategy approved by the board of directors and for developing the policies and procedures for identifying, measuring, monitoring and controlling credit risk. Such policies and procedures should address credit risk in all of the bank’s activities and at both the individual credit and portfolio levels.

Financial Institutions should identify and manage credit risk inherent in all products and activities. Financial Institutions should ensure that the risks of products and activities new to them are subject to adequate procedures and controls before being introduced or undertaken, and approved in advance by the board of directors or its appropriate committee.

Financial Institutions must operate under sound, well-defined credit granting criteria.

These criteria should include a thorough understanding of the borrower or counter party, as well as the purpose and structure of the credit, and its source of repayment.

Financial Institutions should establish overall credit limits at the level of individual borrowers and counter parties, and groups of connected counter parties that aggregate in comparable and meaningful manner different types of exposures, both in the banking and trading book and on and off the balance sheet.

Financial Institutions should have a clearly-established process in place for approving new credits as well as the extension of existing credits.

All extensions of credit must be made on an arm’s-length basis. In particular, credits to related companies and individuals must be monitored with particular care and other appropriate steps taken to control or mitigate the risks of connected lending.

Financial Institutions should conduct sector wise research to know more about the business nature of different SMEs, construct specialize credit risk parameters to evaluate the credit friskiness of SME clients more properly and construct customize credit appraisal procedure for the SME client which will make the evaluation process faster and thus enable the Financial Institutions to deal with more SME Client.

Financial Institutions should have in place a system for the ongoing administration of their various credit risk bearing portfolios.

Financial Institutions must have in place a system for monitoring the condition of individual credits, including determining the adequacy of provisions and reserves.

9.2 Conclusion Credit risk in its simplest definition refers to the task of loss through default on financial assets. If this risk is not managed and mitigated effectively and efficiently, the fundamental business of lending can brought trouble to entire financial industry.

Establishing an effective credit risk management framework should be a top priority for every organization in this regard. But if the established framework is not feasible enough for generating sufficient return for the stakeholders, we cannot hope that it will be sustainable in the long run. So, the managements of the financial institutions have to find out an effective, at the same time, profitable and sustainable credit risk management policy for the smooth running of its operations in the lending business.

Small and Medium Enterprises (SMEs) play a vital role in the economic growth and development of the country, especially in one like ours. Bangladesh has approximately six (6) million micro, small, and medium enterprises with less than 100 workers, out of which around 27,000 are SMEs. Micro, small, and medium enterprises provide more than 75% of the income of the households in Bangladesh. The sector contributes nearly 25% of the GDP, 40% of gross manufacturing output, 80-85% of industrial jobs and constitutes around 25% of the total labor force making this sector an attractive one for lending by financial institutions.

Despite such high potential, this sector has been largely neglected by the financial sector in this country until recently. Inadequate asset base of the owners, inadequate technical know-how of the entrepreneurs, absence of formal accounting system in maintaining

financials, high seasonality in the business, inadequate security coverage for credit facility, high competition in the business have constrained the financial institutions in exploring this vital segment of the economy.

Very recently, banks and NBFIs have started to take notice of the potential of this sector.

In terms of huge business opportunity, high margin, and encouraging recovery rate, SME sector is proving to be a very promising sector of prudent investment for financial institutions. When squeeze in the profit margin of the traditional banking business is making telling effect on the balance sheet of financial institutions, the unexplored potential of SME financing could breathe fresh air in the financial sector.