Internship report final body by lawjuris

Capital Adequacy problems in UCBL IBA

1.0 INTRODUCTION 1.1Background Consequent upon globalization, Banks and other financial institutions all over the world are exposed to different types of risks. The emergence of Basel-II accord and its increasing applicability throughout the world are for sound practices in risk management. To cope with the challenges, the Bank of Bangladesh has put in place various risk management practices and processes in line with the guidelines of the Bangladesh Bank issued from time to time. The Bankâ&#x20AC;&#x2122;s risk management objectives broadly covers proper identification, measurement, monitoring / control and mitigation of the risks towards enhancing and maximizing the shareholdersâ&#x20AC;&#x2122; value by addressing appropriate trade off between an expected reward and potential risk. 1.2 Origin of the report This internship report has been prepared for submission to Institute of Business Administration, University of Dhaka as a partial requirement for the fulfillment of Masters of Business Administration (MBA) Program.

1.3 Objective Broad objective of the study is to find out reasons behind capital adequacy problems in UCBL and recommend solving the problem from the perspective of Basel II. Specific Objectives •

To focus on the first pillar of Basel II.

•

To find out if United Commercial Bank Ltd. has adopt improved risk management according to Bangladesh Bank guideline in line with Basel II framework.

•

To discuss on whether there is adequate capital in relation to risk, and other criteria comply with Bangladesh Bank guideline.

•

To locate out merits and demerits of the course of action that United Commercial Bank Ltd. can implement to resolve capital adequacy problems.

1.4 Scope The Capital Requirement is a Bank regulation, which sets a framework on how banks and depository institutions must handle their capital. This Capital Adequacy framework is commonly known as Basel II. The Categorization of assets and capital are highly standardized so that it can be risk weighted .Each national regulator normally has a very slightly different way of calculating bank capital, deigned to meet the common requirements within their individual national legal framework. In Bangladesh Banks are subject to risk-based capital guidelines in the line with Basel II issued by Bangladesh Bank. These guidelines are used to evaluate capital adequacy based on primarily on the perceived credit risk. Now a day these are really important issues whether banks are able to comply with Bangladesh bank’s guidelines, to meet the criteria problems they are facing and also the necessary steps they are taking to overcome the critical situation. This study shows a fruitful outcome in the context of showing recent position of United Commercial Bank Ltd. from the perspective of Basel II.

1.5 Methodology Before going depth into the study a clear concept about Basel II is acquired through Basel II full document from BIS website. Then required data was collected from various relevant sources. Data sources are of two types: •

Primary Sources

•

Secondary Sources

Primary Sources Finance and Accounts Division of United Commercial Bank Ltd. was an important source of primary data. Face to Face interview were conducted several times to get a clear view of the information. The interviews were not only limited to the executives but also with Top management. Secondary Sources The necessary secondary data regarding capital adequacy was collected from related journals, articles and website articles. Website of Bangladesh Bank was also a major source of secondary data. Data Collection Mechanism •

A review on Bank’s present financial performance will be accomplished.

•

Some open ended question will be prepared and an in-depth interview will be conducted to survey directly to the people those who are stakeholders of the corresponding bank.

•

High ranked professionals of the bank will be asked about their business strategies.

•

Top management gave a view on Capital Adequacy problems and further action plan can be taken.

•

A survey can also be conducted to figure out the ongoing condition of capital market after issuing Bonus share of the Bank.

1.6 Limitation â&#x20AC;˘

Undoubtedly Basel II is a complex phenomenon and there is lack of experienced people in Bangladesh in this particular field. So there was difficulty in understanding the process to me.

â&#x20AC;˘

My job responsibility is monitoring all branches performance, preparing MIS report and follow up Branches to comply with the target which is quiet different from my research study.

2.0 COMPANY OVERVIEW 2.1 About UCBL Sponsored by some dynamic and reputed entrepreneurs and eminent industrialists of the country and also participated by the Government, UCB started its operation in mid 1983 and has since been able to establish one of the largest networks of 100 branches among the first generation banks in the private sector. With its firm commitment to the economic development of the country, the Bank has already made a distinct mark in the realm of Private Sector Banking through personalized service, innovative practices, dynamic approach and efficient Management. The Bank, aiming to play a leading role in the economic activities of the country, is firmly engaged in the development of trade, commerce and industry thorough a creative credit policy. 2.2 Management The Bank has in its Management a combination of highly skilled and eminent bankers of the country of varied experience and expertise successfully led by Mr. M. Shahjahan Bhuiyan, a dynamic banker, as its Managing Director and well educated young, energetic and dedicated officers working with missionary zeal for the growth and progress of the institution.

2.3 Code of conduct of United Commercial Bank Ltd. It is the policy of united Commercial Bank Ltd. to conduct the business of the bank being compliant with the laws, rules and regulations of the community in which it operates and to

adhere to the highest ethical standards. To these ends employees are expected and directed to manage the business of the bank with: •

The highest ethical standard of integrity and sincerity in conformity with the code of ethics & business conduct.

•

Due diligence and proficiency in all business activities.

•

Compliance of legal and regulatory requirements.

•

A manner that no disfavor will reflect on the bank, both on and off the job.

2.4 CSR Activities As part of organization’s corporate social responsibility, UCB took initiative of launching a public awareness campaign in September 2009 just before Eid-ul-Fitr holiday when the Swine flow disease out broke in Bangladesh and fast becoming an epidemic in the country. The campaign was launched to make the public aware of what they can do to reduce the risk of catching swine flu. The core message of this campaign is: “Swine Flu-Don’t be scared, be prepared”.

2.5 Recent News •

UCB signs Corporate Agreement with Apollo Hospital

•

Agreement signing with United Hospital

•

Agreement signing with KAFCO

•

Agreement signing with Fit Elegance Ltd.

•

UCB signs Corporate Agreement with Siemens Bangladesh Limited

•

Agreement signing with Hotel Sea Crown, Cox’s Bazar

•

Last AGM held on: JUNE 07,2010 Ten

2.6 Financial and Market Status Financial and Market Status of UCBL is given below in tabular format. Table 2.1: Market information and Basic information Market Information: Last Trade Change

209.25 8.43%

Open Price Yesterday Close Day's Range Volume Total Trade Market Cap in BDT* (mn) Bonus Issue Right Issue Year End Reserve & Surplus in BDT* (mn) Basic Information: Authorized Capital in BDT* (mn) Paid-up Capital in BDT* (mn) Face Value Total no. of Securities

Fig. 2.1: Close price graph for last one month

40%B '06, 50%B '05, 90%B '02 '03 & ' n/a 200612 1128.28 2000.0 1193.83 100.0 11938275

Fig 2.2: Total Trade Graph for last one month

Gainer Considering Close Price & YCP on Jun 27, 2010 at 15:32:38 2.6.1 Top ten gainer After holding AGM after long time UCBL share become doing well in Market. Table 2.2: UCBL become Top Gainer # 1 2 3 4 5 6 7 8 9 10

TRADING CODE UCBL EXIMBANK RUPALIBANK SHAHJABANK EBL NCCBANK MIRACLEIND ARAMIT ARAMITCEM ISLAMIBANK

CLOSEP* 2673.0 57.1 1799.0 528.25 670.75 477.0 32.6 648.7 1090.25 663.25

HIGH 2696.0 57.5 1820.0 530.0 673.0 478.5 34.0 654.9 1100.0 665.0

LOW 2485.0 54.0 1700.0 501.0 638.25 451.0 32.4 616.0 1036.0 631.25

YCP

2480.75 53.4 1693.25 499.0 634.0 452.75 31.0 618.6 1040.25 633.5

CHANGE 7.7497 6.9288 6.2454 5.8617 5.7965 5.3562 5.1613 4.8658 4.8065 4.6961

2.6.2 Profit Status: Current Price Earning Ratio (P/E) (Based on Continuing operation)

Basic

Diluted

4.91

19.61

Current Price Earning Ratio (P/E) (Including Extra-ordinary Income)

* Note - Based on Annualized EPS of 2010 (Q1) 8.Table 2.3: Interim Financial Performance: 2010 Particulars

Unaudited / Audited Q2(6 Q3(9 Q4 (12 Months)

Q1(3 Months) 201003 876.68

Months)

n/a

Net Profit After Tax in BDT *(mn)

406.82

n/a

(Continuing Operations) Net Profit After Tax in BDT *(mn)

n/a

(Including Extra-ordinary Income) Basic EPS in BDT*

135.97

n/a

(Based on continuing operations) Diluted EPS in BDT* (Based on

34.08

n/a

continuing operations) Basic EPS in BDT*

0.00

n/a

(Including Extra-ordinary Income) Diluted EPS in BDT* (Including

0.00

n/a

Turn Over in BDT* (mn)

Extra-ordinary Income) Table 2.4: Financial Performance Year

Basic EPS

Basic EPS (restated)

Net

Restated Net Profit After Tax

Asset Net Asset Based on

Based on

(mn)

Value Value Per Per

Share Continuing Including Continuing Including

Continuing Including

operations

Extra-

operations

Extra-

Ordinary

Income

2000

6.08

n/a

251.60

n/a

13.99

n/a

2001

49.43

n/a

301.04

n/a

113.77

n/a

2002

40.39

n/a

341.14

n/a

92.95

n/a

2003

99.59

n/a

466.96

n/a

229.22

n/a

2004

73.15

n/a

168.35

n/a

2005 139.40 2006 194.43 2007 n/a 2008 n/a 2009 n/a

n/a n/a n/a n/a n/a

n/a 48.73 n/a n/a n/a

n/a n/a n/a n/a n/a

417.10 581.76 n/a n/a n/a

n/a n/a n/a n/a n/a

540.01

579.83 n/a 776.09 194.51 n/a n/a n/a n/a n/a n/a

Table 2.5: Financial Performance (Continue) Year

2000 2001 2002 2003 2004

Year End P/E Based on Continuing Including Extra-Ordinary operations 14.19 4.54 5.06 2.61 19.48

Income n/a n/a n/a n/a n/a

% Dividend

% Dividend Yield

30%B 90%B

(combining year 2005 2006 2007 2008 2009

8.18 30.41 n/a n/a n/a

n/a n/a n/a n/a n/a

of '02,'03&'04) 50%B 40%B n/a n/a n/a

n/a n/a n/a n/a n/a

Table 2.6: Other Information of the Company: Listing Year Market

1986 Z

Category Electronic Share Y Share Percentage:

Sponsor/Direc Govt.

Institute

Foreign

Remark

tor 43.35% 6.23% 0% Available data is provided As per their fresh Balance Sheet(As per Court Order Dated 11.06.2008) For the year ended December 31, 2006

3.0 EVOLUTION OF BASEL II 3.1 About the Basel Committee The Basel Committee on Banking Supervision provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. It seeks to do so by exchanging information on national supervisory issues, approaches and techniques, with a view to promoting common understanding. At times, the Committee uses this common understanding to develop guidelines and supervisory standards in areas where they are considered desirable. In this regard, the Committee is best known for its international standards on capital adequacy; the Core Principles for Effective Banking Supervision; and the Concordat on cross-border banking supervision. The Committee's members come from Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. The present Chairman of the Committee is Mr Nout Wellink, President of the Netherlands Bank. The Committee encourages contacts and cooperation among its members and other banking supervisory authorities. It circulates to supervisors throughout the world both published and unpublished papers providing guidance on banking supervisory matters. Contacts have been further strengthened by an International Conference of Banking Supervisors (ICBS) which takes place every two years. The Committee's Secretariat is located at the Bank for International Settlements in Basel, Switzerland, and is staffed mainly by professional supervisors on temporary secondment from member institutions. In addition to undertaking the secretarial work for the Committee and its many expert sub-committees, it stands ready to give advice to

supervisory authorities in all countries. Mr Stefan Walter is the Secretary General of the Basel Committee. 3.1.1 Main Expert Sub-Committees The Committee's work is organized under four main sub-committee: The Standards Implementation Group •

The Policy Development Group

•

The Accounting Task Force

•

The Basel Consultative Group

More information on each sub-committee is provided below. The Standards Implementation Group (SIG) was originally established to share information and promote consistency in implementation of the Basel II Framework. In January 2009, its mandate was broadened to concentrate on implementation of Basel Committee guidance and standards more generally. It is chaired by Mr José María Roldán, Director General of Banking Regulation at the Bank of Spain. Currently the SIG has two subgroups that share information and discuss specific issues related to Basel II implementation. The Validation Subgroup explores issues related to the validation of systems used to generate the ratings and parameters that serve as inputs into the internal ratings-based approaches to credit risk. The group is chaired by Mr Alvir Alberto Hoffman, Deputy Governor at the Central Bank of Brazil. The Operational Risk Subgroup addresses issues related primarily to banks' implementation of advanced measurement approaches for operational risk. Mr Kevin Bailey, Deputy Comptroller, Office of the Comptroller of the Currency, United States, chairs the group. The primary objective of the Policy Development Group (PDG) is to support the Committee by identifying and reviewing emerging supervisory issues and, where appropriate, proposing and developing policies that promote a sound banking system and high supervisory standards. The group is chaired by Mr Stefan Walter, Secretary General of the Basel Committee.

Seven working groups report to the PDG: the Risk Management and Modelling Group (RMMG), the Research Task Force (RTF), the Working Group on Liquidity, the Definition of Capital Subgroup, a Basel II Capital Monitoring Group, the Trading Book Group (TBG) and the Cross-border Bank Resolution Group. The Risk Management and Modeling Group serves as the Committee's point of contact with the industry on the latest advances in risk measurement and management, and is chaired by Mr Mark White, Assistant Superintendent at the Office of the Superintendent of Financial Institutions. It focuses on assessing the range of industry risk management practices and the development of supervisory guidance to promote enhanced risk management practices. The Research Task Force serves as a forum for research economists from member institutions to exchange information and engage in research projects on supervisory and financial stability issues. It also acts as a mechanism for facilitating communication between economists at member institutions and in the academic sector. It is chaired by Mr Peter Praet, Executive Director at the National Bank of Belgium and member of the Management Committee of the Banking, Finance and Insurance Commission, Belgium. The Trading Book Group addresses issues relating to the application of Basel II to certain exposures arising from trading activities. A current focus of this group is the appropriate capital treatment of event risk in the trading book. It is co-chaired by Ms Norah Barger, Associate Director, Board of Governors of the Federal Reserve System, United States, and Mr Alan Adkins, Manager, Financial Services Authority, United Kingdom. The Working Group on Liquidity serves as a forum for information exchange on national approaches to liquidity risk regulation and supervision. In September 2008, the Working Group issued Principles for Sound Liquidity Risk Management and Supervision, the global standards for liquidity risk management and supervision. The Working Group is also examining the scope for additional steps to promote more robust and internationally consistent liquidity approaches for cross-border banks. The group is co-chaired by Mr Thomas Wiedmer, Deputy Head at the Swiss national Bank, and Mr Marc Saidenberg, Senior Vice President in the Banking Supervision Group of the Federal Reserve Bank of New York, United States.

3.2History of Basel II 3.2.1Basel I The special role of banks in today’s economies has already been discussed, as have the competing economic demands of risk provisioning and maintaining a strong position in international competition among banks. In the mid-1980s, when the capital ratios of the world’s largest banks fell to dangerously low levels due to competitive pressure, the Basel Committee on Banking Supervision felt compelled to take action: From the mid-1970s onward, the committee had mainly been making efforts to close gaps in international supervision and to develop suitable supervisory standards, and at that point they decided to publish capital adequacy recommendations. The result was the Basel Capital Accord, which was applied to international banks in G-10 countries. This system of capital measurement (called "Basel I" in retrospect), which is still in force today, was a milestone in the international harmonization of regulatory capital requirements. The accord first concentrated on credit risk and required a minimum capital ratio of 8% of a bank’s riskweighted assets. This level of capital adequacy was implicitly meant to cover other risks as well. Although the new capital adequacy framework at first only applied to banks which operated internationally, in the 1990s it gained recognition as the worldwide standard for capital adequacy in banking and is now applied in over 100 countries around the world. The corresponding EU directives – and consequently also the corresponding national legal regulations such as the Austrian Banking Act (BWG) – have likewise been influenced heavily by the Basel Capital Accord. 3.2.2 Basel I in Practice Naturally, banking has changed dramatically since the original accord was introduced in 1988, as in recent years banks have increasingly become providers of broad-based (financial) services. Risk management practices in the banking business – especially on the financial markets themselves – have also seen significant changes. The new capital adequacy framework was expanded several times, mainly to cover banks’ off-balance-sheet activities and risks. Due to the growing significance of trading activities at banks, the accord was amended in 1996 to include market risk. The risks arising from trading positions in

bonds, equities, foreign exchange, and commodities were separated from credit risk calculations and combined in a new risk category with explicit capital requirements based on positions outstanding in each instrument. For the first time, this allowed many banks to use their own systems for measuring market risk (market risk models) and for determining the capital required to cover this risk.

However, the contrast between capital requirements (such as the uniform 8% capital charge for the private sector), which were still clearly defined but increasingly considered to be too general and imprecise, and the increasingly complex internal methods used by banks to determine their economic capital requirements was becoming more and more evident. New financial instruments and credit risk management methods as well as risk mitigation techniques were practically not covered by Basel I. 3.2.3 The Transition to Basel II In June 1999, the Basel Committee on Banking Supervision began the process of replacing the 11-year-old accord with a more up-to-date framework and published the first consultation paper, which was (intentionally) rather vague in its details as it was intended to encourage early international discussions on this topic. In this context, three measures were introduced to help achieve the goal of increased risk sensitivity: â&#x20AC;˘

expanding the quantitative standards used to date (minimum capital requirements) and adding two additional "pillars" (supervisory review process and market discipline),

â&#x20AC;˘

allowing banks to use ratings from approved external rating agencies to classify exposures to sovereigns, corporate offices and banks in risk classes, and

â&#x20AC;˘

Allowing banks with more sophisticated risk management mechanisms to use internal ratings, that is, in-house systems for assessing credit risks.

The consultation paper published in June 1999 also introduced a capital requirement for "other risks." Based on the comments received from banks and supervisory authorities as well as the

dialog with banking practitioners, it was possible to specify the new framework further; as a result, the second consultation paper appeared in January 2001. This paper was also changed in the course of ongoing discussions in the ensuing consultation stage; an overview of the ideas and approaches used in the current version of the new capital accord can be found under Basel II Basics. 3.3 Basel II basics The objective of Basel II is to modernize the existing capital requirements framework to make it more comprehensive and risk sensitive. The Basel II framework is therefore designed to be more sensitive to the real risks that firms face than Basel I. As well as looking at financial figures, such as how much money the firm controls, it also considers operational risks, such as the risk of systems breaking down or people doing the wrong things, and also market risk. The Basel II framework consists of three "pillars":

Figure 3.1: Structure of Basel II

3.4 Basel II and the Capital Requirements Directive Basel II applies to internationally active banks. As noted above, in the European Union, the framework has been implemented through the Capital Requirements Directive (CRD). The CRD affects certain types of investment firms and all deposit takers (including banks and building societies), except credit unions. The framework under the CRD reflects the flexible structure and the major components of Basel II. It has been based on the three "pillars", but has been tailored to the specific features of the EU market. In the UK, the new capital adequacy framework has been implemented by the Financial Services Authority (FSA) and detailed rules are contained in its Handbook. 3.5 Minimum capital requirements Basel II requires that an institution's total regulatory capital must be at least 8% of its risk weighted assets, based on measures of its credit risk, market risk and operational risk. This ratio is unchanged from Basel I. 3.6 Measuring credit risk In relation to credit risk, Basel II permits banks to use one of two methodologies. They can assess risk using the "Standardized" Approach, which involves external credit assessments, or they can use their own internal systems for rating credit risk. The standardized approach is similar to Basel I but risk weights are based on credit ratings provided by external credit assessment institutions such as rating agencies. In contrast, the foundation and advanced internal ratings based approaches reflect the fact that many internationally active banks already have in place extremely sophisticated internal methods for modeling, assessing and managing risk. These latter methods can be used only with the explicit approval of the institution's supervisor. 3.7 Measuring operational risk One of the key changes in Basel II is the addition of an operational risk measurement to the calculation of minimum capital requirements. This has also been included in the CRD. Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, such as exposure to fines, penalties and private settlements. It does not, however, include strategic or reputation risk.

In calculating operational risk capital charges, Basel II sets out three different methods which may be adopted. The Basic Indicator Approach is the simplest of the three approaches, and will be the default option for most firms. It applies a calculation based on the firm's income to determine its capital requirements. The Standardized Approach (not to be confused with the approach for credit risk of the same name) again relies on calculations based on income, but with different percentages applying across different business lines. To be able to take advantage of the Standardized Approach, firms will have to meet certain qualifying criteria. The Advanced Measurement Approach is the most advanced of the three options. Under this approach, each firm calculates it own capital requirements, by developing and applying its own internal risk measurement system. As with the Standardized Approach, the firm must meet certain qualifying criteria, and the risk measurement system must be validated by the FSA before it will be allowed to take advantage of the AMA. 3.8 Calculating market risk As with credit and operational risk, Basel II is designed to reflect the increasingly sophisticated risk management practices that exist in many financial institutions by offering them the opportunity to use advanced internal models for calculating market risk. The aim is to encourage institutions to monitor and control risk effectively, by obliging them to make a series of disclosures about their risk profiles and regulatory capital procedures which are available to market participants. The intention is that they strike a balance between meaningful disclosures and the need to protect confidential and proprietary information. Undoubtedly, Basel II introduces a vastly more sophisticated and risk sensitive framework. There is even a school of thought that, had Basel II been fully implemented a few years ago, at the height of the credit "boom", the current "crunch" may have been less severe. Nevertheless, we can expect to see increased regulation (possibly in the form of refinements to Basel II) as governments and regulators respond to current market turmoil.

4.0 CAPITAL ADEQUACY FRAMEWORK 4.1 Why do financial institutions need to hold capital? Lenders are financial intermediaries, taking funds from savers and lending them on to borrowers. Given the risk that some borrowers will be unable to repay their loans or that losses will occur for other reasons, lenders need capital of their own to protect their depositors (the savers) from the risk of losing money. Capital thus acts as a cushion to absorb unexpected losses. 4.2 Managing Credit Risk While financial institutions have faced difficulties over the years for a multitude of reasons, the major cause of serious banking problems continues to be directly related to lax credit standards for borrowers and counterparties, poor portfolio risk management, or a lack of attention to changes in economic or other circumstances that can lead to a deterioration in the credit standing of a bank's counterparties. This experience is common in both G-10 and non-G-10 countries. Credit risk is most simply defined as the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms. The goal of credit risk management is to maximize a bank's risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Banks need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions. Banks should also consider the relationships between credit risk and other risks. The effective management of credit risk is a critical component of a comprehensive approach to risk management and essential to the long-term success of any banking organization. For most banks, loans are the largest and most obvious source of credit risk; however, other sources of credit risk exist throughout the activities of a bank, including in the banking book and in the trading book, and both on and off the balance sheet. Banks are increasingly facing credit risk (or counterparty risk) in various financial instruments other than loans, including

acceptances, inter bank transactions, trade financing, foreign exchange transactions, financial futures, swaps, bonds, equities, options, and in the extension of commitments and guarantees, and the settlement of transactions. Since exposure to credit risk continues to be the leading source of problems in banks worldwide, banks and their supervisors should be able to draw useful lessons from past experiences. Banks should now have a keen awareness of the need to identify, measure, monitor and control credit risk as well as to determine that they hold adequate capital against these risks and that they are adequately compensated for risks incurred. The Basel Committee is issuing this document in order to encourage banking supervisors globally to promote sound practices for managing credit risk. Although the principles contained in this paper are most clearly applicable to the business of lending, they should be applied to all activities where credit risk is present. 4.3 The objectives of Basel II In order to better appreciate the impact of Basel II on the banking industry, it is worth recalling the objectives of the Basel Committee regarding the overall level of capital requirements. According to the revised framework, issued in June 2004: â&#x20AC;&#x153;The objectives are to broadly maintain the aggregate level of minimum capital requirements, while also providing incentives to adopt more advanced risk-sensitive approaches of the revised frameworkâ&#x20AC;?. Governor Susan Schmidt Bies of the Federal Reserve System of the USA has described the objectives of Basel II a little more elaborately in the following words: â&#x20AC;&#x153;The major objectives of Basel II include creating a better linkage between the minimum regulatory capital and risk, enhancing market discipline, supporting a level playing field in an increasingly integrated global financial system, establishing and maintaining a minimum capital cushion sufficient to foster financial stability in periods of adversity and uncertainty, and grounding risk measurement and management in actual data and formal quantitative techniques. Let me emphasize that last objective, since it is often overlooked. Critical to

Basel II is the effort to improve risk measurement and management, especially at our largest, most complex organizations.” Thus, it would be reasonable to infer that the main focus of the new framework is on providing the right incentives to the banks to adopt data-based, quantitative risk management systems to be able to adopt the advanced risk-sensitive approaches of the revised framework, which, in turn, would contribute to systemic and financial stability. Hence, inducing the adoption of advanced risk management systems by the banking institutions would seem to lie at the heart of the new framework. 4.4 Guidelines of Bangladesh Bank 4.4.1 Guidelines on ‘Risk Based Capital Adequacy for Banks’ (Revised regulatory capital framework in line with Basel II) To comply with international best practices and to make the bank's capital more risksensitive as well as to build the banking industry more shock absorbent and stable, all the scheduled banks will start implementing revised regulatory capital framework "Risk Based Capital Adequacy for Banks" from January 2009. With a view to above, a National Steering Committee and a Coordination Committee on Basel II Implementation have been working since July 2005. To assess the supervisory effectiveness and operational independence of BB, a self-audit on compliance with Basel Core Principles (BCP) for effective banking supervision was made in October 2006. This shows favorable position for Basel II implementation in Bangladesh. A study carried out on banks which suggested initial implementation of Basel II with the following specific approaches: •

Standardized Approach for calculating Risk Weighted Assets (RWA) against Credit Risk;

•

Standardized (Rule Based) Approach for calculating RWA against Market Risk; and

•

Basic Indicator Approach for calculating RWA against Operational Risk.

Under the Standardized Approach of the Risk Based Capital Adequacy Framework (Basel II), credit rating is to be determined on the basis of risk profile assessed by the External Credit Assessment Institutions (ECAIs) duly recognized

by BB.

All scheduled banks will be required to nominate recognized ECAIs for their own as well as their counterparty credit rating. Along with the existing capital adequacy rules & reporting to BB (Ref. BRPD Circular no. 10, dated 25-11-2002) banks will start quarterly reporting as per the set of reporting formats enclosed in the Guideline. For the purpose of statutory compliance during the period of parallel run i.e. 2009, the computation of capital adequacy requirement under existing rules will prevail. Regular reporting in line with the Guideline should reach the Department of Offsite Supervision (DOS) by the end of the month following the end of each quarter. 4.4.2Risk Weights Risk Weights Applicable for On Balance-Sheet Items (Other Financial Institutions under Advances Head) have been reviewed and it has been decided to add an on-balance sheet item named Claims on AAA rated Multilateral Development Banks (MDBs) with risk weights of 20%. As such items under Advances now stand as under: Advances Government •

Ministry of Food 0%

•

President's Office, Prime Minister's Office, Parliament, 0%

Judiciary & Non-Food Ministries •

Autonomous & Semi-Autonomous bodies 20%

Other Financial Institutions: •

Other Financial Institutions-Public 20%

•

Other Financial Institutions-Private 50%

•

Claims on AAA rated Multilateral Development Banks (MDBs) 20%

Major Non-financial Public Enterprises 50% Other Non-financial Public Enterprises 50%

Local Authorities 20% Private Sector 100% Deposit Money Banks 20% Risk Weights Applicable for Off-Balance Sheet Items (Contingent Assets as per contra) have also been reviewed and it has been decided to add an Off-balance sheet item named Claims guaranteed by, or collateralized by securities issued by AAA rated Multilateral Development Banks (MDBs) with risk weights of 20%. As such items under Other Assets now stand as under: Other Assets Contingent Assets as per contra (Off-balance sheet items) Letter of Credit and Letter of Guarantee 0% issued on account of Government •

Deposit Money Banks 20%

•

Others 50%

•

Claims guaranteed by, or collateralized by securities issued 20% by AAA rated Multilateral Development Banks (MDBs)

Fixed Assets 50% Valuation adjustments 50% Expenditure Account 0% Other 100% Note: Multilateral Development Banks (MDBs) are: the World Bank Group comprised of the International Bank for Reconstruction and Development (IBRD) and the International Finance Corporation (IFC), the Asian Development Bank(ADB), the African Development Bank (AfDB), the European Bank for Reconstruction and Development (EBRD), the InterAmerican Development Bank (IADB), the European Investment Bank (EIB), the European Investment Fund (EIF), the Nordic Investment Bank (NIB), the Caribbean Development Bank(CDB), the Islamic Development Bank (IDB) and the Council of Europe Development Bank (CEDB).

4.4.3 Current Capital Regulation Existing regulation requires all scheduled banks to maintain minimum paid up capital and reserve fund of BDT 4 billion or 9 percent risk-weighted asset whichever is higher. Banks can maintain their capital in the following constituents:

4.4.4 Constituents of Capital Capital Base Bank capital and risk are intimately related to each other. Capital is the bank’s last line of defense against failure. Thus, the greater the risk of failure, the more capital a bank should hold. For the purpose of calculating regulatory capital requirement, capital is categorized into three tiers: Core Capital (Tier I) •

Paid-up Capital

•

Non-repayable Share premium account

•

Statutory Reserve

•

General Reserve

•

Retained Earnings

•

Minority interest in Subsidiaries

•

Non-Cumulative Irredeemable Preference Shares

•

Dividend Equalization Account

Supplementary Capital (Tier II) General provision (1-5 percent of Unclassified Loans)1 •

Assets Revaluation Reserves

•

All other Preference Shares

•

Perpetual Subordinated Debt

•

Exchange Equalization Account

Constituents of Supplementary Capital (Tier-2) have been reviewed and it has been decided to replace "General provision (1% of unclassified loans)" by "General provision maintained against unclassified loans". As such the component of Supplementary Capital now stands as under: •

General provision maintained against unclassified loans

•

Assets Revaluation Reserves

•

All other Preference Shares

•

Perpetual Subordinated debt

•

Exchange Equalization Account

All other instructions as stipulated in BRPD Circular No. 10 dated November 25, 2002 will remain unchanged. 4.4.5 Scope for expansion of capital base Tier I Capital: Banks can maintain their capital in 8 (eight) constituents of Tier I capital as specified. Four of them, namely, Statutory Reserve, General Reserve, Retained Earnings and Dividend Equalization Account are greatly dependent on annual income of a bank. A certain percentage of income that is retained as per requirement of the Banking Companies Act (BCA) 1991 is named as Statutory Reserve. General Reserve is made to meet contingencies which are indeterminate at the time of making such reserve. Retained earnings are defined as shareholders’ equities in a banking company resulting from earnings in excess of losses and declared dividends. The purpose of Dividend Equalization Account is to create a fund in those years in which profits are large, so as to enable the bank to pay dividend at normal rate when profits are small. Thus a bank cannot enhance capital immediately in these items

to meet any regulatory obligation. A bank can raise capital and no repayable premium account by issuing right share, bonus share and IPOs. But a bank whose shares have already been floated in the stock market can further expand capital base by issuing either bonus shares or right shares or both. Issue of bonus share again depends on genuine annual profit of a bank. This process does not enhance financial resources of a bank; rather it converts earnings into shares. Whether a bank can issue share at premium depends on each shareâ&#x20AC;&#x2122;s existing net worth value which, among other, also depends on its accumulated earnings. The above analysis indicates that if regulation requires banks to raise Tier I capital substantially, the immediate option available for listed banks is to issue right shares. For the state-owned banks government will require to inject capital while branches of foreign banks will require collecting funds from their parent office. In addition, banks can respond to regulator's instruction by issuing non-cumulative irredeemable preference shares. But there is a lack of regulatory guideline regarding issue of such instruments.

Tier II Capital: As mentioned earlier, Tier II capital comprises of General Provision, Asset Revaluation Reserve, Preference Shares, Perpetual Subordinated Debt and Exchange Equalization Account. Banks maintain general provision out of their business earnings. So they cannot raise general provision immediately in response to enhancement of regulatory capital. Similar argument can be applied for asset revaluation reserve and exchange equalization account. Since Bangladesh is following free floating exchange rate policy since May 2003, exchange equalization account has become ineffective in reality. In these circumstances, the options available for banks to raise capital are either to issue perpetual subordinated debt or to issue preference share or to issue both. However, there are no regulatory guidelines for the issuance of such instruments. 4.4.6 Minimum Capital Requirement (MCR) against Credit Risk According to the standardized approach of Basel- II framework, the risk weights will be based on the risk assessment (hereinafter called credit rating) made by External Credit Assessment Institutions (ECAIs) duly recognized by Bangladesh Bank.

Credit Rating Information and Services Ltd. (CRISL) and Credit Rating Agency of Bangladesh (CRAB) have been recognized as eligible ECAIs. All the scheduled banks operating in Bangladesh may nominate any or both the rating agency (ies) for their own and counterparty credit rating for the purpose of calculating RWA against credit risk under Standardized approach of Risk Based Capital Adequacy for Banks. The mapping of CRISL and CRAB rating with BB Rating Grade will be as follows Sl. 1

Exposure Type

BB's Rating Grade

Claims on Public Sector Entities (other than 1 2, 3 Government) in Bangladesh 4, 5 6 Unrated Claims on Banks: i) Maturity over 3 months 1 2, 3 4, 5 6 Unrated ii) Maturity less than 3 months Claims on Corporate (excluding equity 1 exposures)

20 50 100 150 100 20 20 50

3, 4

100

5, 6 Unrated

150 125

finance) Consumer Finance Claims fully secured by residential property Claims fully secured by commercial real estate Past Due Claims (to be calculated at Head Office) Investments in venture capital Investments in premise, plant, and equipment, and all other fixed

10 assets 11 Claims on all fixed assets under operating lease 12 All other assets Table 4.2: Risk Weights against BB Rating Category

Weights 20 50 100 150 50

Fixed Risk Weight Groups: 4 Claims on retail portfolio & small enterprise (excluding consumer 5 6 7 8 9

Risk

75 100 50 100 150 100 100 100

Table 4.1: Mapping of CRISL and CRAB rating with BB Rating Grade BB Rating Grade 1 2 3 4 5

Equivalent Rating of CRISL AAA AA+, AA AA-, A+, A, ABBB+, BBB, BBBBB+, BB, BB-, B+, B, B-, CCC+,

CCC, CCC6 CC+, CC, CC-, C+, C, CShort Term Rating Category Mapping S1 ST-1 S2 ST-2 S3 ST-3 S4 ST-4 S5 ST-5 S6 ST-6

Equivalent Rating of CRAB AAA AA1, AA2 AA3, A1, A2, A3 BBB1, BBB2, BBB3 BB1, BB2, BB3, B1, B2, B3, CCC1, CCC2 CCC3, CC, C, D ST-1 ST-2 ST-3 ST-4 ST-5 ST-6

4.4.7 Basel II and Capital Raising Options The argument that implementation of Basel II may require higher capital for banks has been supported by several empirical studies. For example, the Fifth Quantitative Impact Study, conducted by the Basel Committee on Banking Supervision (BCBS) in India, found that combined capital adequacy ratio of surveyed banks is expected to come down by about 100 basis points when these banks apply Basel II norms for standardized approach for credit risk and basic indicator approach for operational risk. However, Basel II also requires capital charge against market risk. It is highly likely that banks in Bangladesh may require higher capital than those of Indian banks and implementation of Basel II may substantially undermine capital position of banks in Bangladesh. Guidelines on â&#x20AC;&#x2DC;Risk Based Capital Adequacy (RBCA) for Banksâ&#x20AC;&#x2122; (Revised regulatory capital framework in line with Basel II) was introduced from January 01, 2009 parallel to existing BRPD Circular No. 10 , dated November 25, 2002. From January 01, 2010 Basel II regime will be started and the guidelines on RBCA will fully come into force with its subsequent supplements/revisions. Accordingly, instructions regarding Minimum Capital Requirement (MCR), Adequate Capital and Disclosure requirement as stated in the guidelines have to be followed by all scheduled banks for the purpose of statutory compliance. This circular will replace BRPD Circular No. 10, dated November 25, 2002 and its amendment thereof. Regular quarterly reports in line

with the guidelines should reach the Department of Off-site Supervision (DOS) by the end of the month following the end of each quarter. 4.4.8 Guidelines of CAR According to the circular, Basel II regime has been started from January 01, 2010 and the 'Guidelines on RBCA for banks' has fully come into force from the aforesaid date. The overall situation has since been reviewed and it has been decided that all scheduled banks will maintain regulatory Capital Adequacy Ratio (CAR) and Minimum Capital Requirement (MCR) as per following timetable:

Table 4.5: Capital Adequacy Guideline Capital

From

Adequacy January 01, 2010 - July 01, 2010 - June 30, July

01,

Ratio

June 30,

2011

onwards

(CAR)

2010 CAR ≥ 8%

CAR ≥ 9%

CAR ≥ 10%

2011

CAR = (Eligible Regulatory Capital/ Risk Weighted Assets (RWA)) ×100 MCR 8% of RWA** 9% of RWA** 10% of RWA** **MCR will be the above stipulated percentage of RWA or the amount of MCR fixed by Bangladesh Bank from time to time which one is higher. **In every case, at least 50% of the CAR and MCR must be constituted by Tier-I capital components.

4.4.9 Guidelines for issuing Subordinate Debt Recently BB has released the guidelines for issuing subordinated debt instruments for raising capital under tier-2 or 3. BB has set the eligibility criterion for issuing subordinated debt is obtaining minimum CAMELS rating 2 and BB rating 2. Most of the banks in

Bangladesh scored 3 or more in their CAMELS rating and it is not possible for the banks to upgrade their scores instantly. So, this eligibility criterion slows down the speed to meet capital adequacy. 4.5 Matters should take into consideration before preparing report under Basel II 4.5.1 Category of Credit Portfolio under Basel-II •

Claims having Zero Risk Weights

Cash and Cash Equivalent, Claims on Bangladesh Government (other than PSEs) and Bangladesh Bank, Claims on other Sovereigns and Central Banks, Claims on BIS, IMF, ECB, Claims on IBRD, IFC, ADB, IDB etc have zero risk weights. •

Claims on Public Sector Entities (Other than Government)

Public Sector Entities are categorized as

Public Non Financial Corporations (BTMC, BRTC, Petrobangla, DESA, WASA etc.)



Local Authorities (City Corporations, Zila, Thana, Union, Gram Parishad, Municipalities)



Non Bank Depository Corporations-Public (Ansar-VDP, Karmasangsthan Bank etc)



Other Financial Intermediaries-Public (HBFC, ICB etc)



Insurance Companies and Pension Funds- Public (Jiban Bima and Sadharan Bima Corporation etc)

•

Claims on Banks and NBFIs

All exposures including loans and advances, placements, deposits, debentures (which are not treated as capital of the issuing bank or NBFI) and investments in all scheduled and nonscheduled banks including NBFIs incorporated in Bangladesh and foreign bank Branches operating in Bangladesh and abroad. •

Claims on Corporate

Corporate refers to any proprietorship, partnership or limited company that is neither a Public Sector Entity (PSE) and Bank or Non Bank Financial Institutions nor borrower within the definition of retail portfolio and Small Enterprises.

•

Claims on Medium Enterprise

Medium Enterprise means that enterprise which is ideally not any public limited company and fulfills the following criteria: Table 4.6: Criteria of Medium Enterprise Total fixed assets excluding land and Manpower building (i.e. machineries, equipments, Trading Concern Service Sector Manufacturing

furniture and fixture etc.) 50 lac to 10 crore

Not

exceed

Do 1.50 crore to 20 crore

persons Do Not exceed

150

Concern •

persons

Claims on Small Enterprise

Small Enterprise means that enterprise which is ideally not any public limited company and fulfills the following criteria:

Table 4.6: Criteria of Small Enterprise Total fixed assets excluding land and Manpower building (i.e. machineries, equipments, Trading Concern

furniture and fixture etc.) 50 thousand to 50 lac

Not

Service Sector Manufacturing

Do 50 thousand to 1.50 crore

persons Do Do

exceed

Concern •

Claims on Retail Portfolio

Qualifying Criteria for Retail Portfolio are as follows: 

Orientation criterion: The exposure should be to an individual person or persons.



Product criterion: The exposure should be of one of the following product types:

− Revolving credit and lines of credit including overdrafts and credit cards − Personal term loans and leases (e.g. installment loans, vehicle loans and leases, student and educations loans, personal finance) Note: Consumer loan is also retail loan but it is to be reported separately. As such particular Retail Product of UCBL (for the purpose of Basel-II reporting) would be: SOD (FO) (to Person1) •

Consumer Financing (As per Prudential Regulations for Consumer Financing - 2004, Bangladesh Bank)

Consumer financing means any financing allowed to individuals for meeting their personal, family or household needs. The facilities categorized as consumer financing are given as under. •

Auto Loan •

Secured by way of hypothecation or charge on vehicle.

•

On a case to case basis, banks may also wish to secure the loan partially by the commonly acceptable form of cash or quasi cash securities available in the market.

•

Consumer Durable Loans •

Consumer durables for personal or family use

•

Items like: Television, Refrigerator, Air Conditioner, Hi-Fi, Washing

Machine, Computers, Other household furniture etc. •

Loans for Professionals •

For professionals only (doctors, engineers, IT professionals, lawyers, management consultants etc) to support their small scale purchase of different equipments, tools and small machineries for installation at their business sites or offices (e.g. purchase of X-ray machine, medical beds, ultra-

1 SOD (FO) to any enterprise be reported to Small/Medium Enterprise or Corporate

sonogram machine, engineering or mechanical tools, or set up of an office or chamber on small scale etc) •

Partially secured product, security being the commonly acceptable form of cash or quasi cash securities available in the market

•

Unsecured Personal Loan •

To individual salaried or self-employed people living in the cities/towns where the bank has its operations. •

It is a clean or unsecured loan in the sense that only security in this

type of loan product is: a) Letter of introduction from employer; b) Transfer of monthly salary and assignment of terminal benefits; or c) Personal guarantee taken from specific section of people •

This is as ‘any purpose’ loan which means the applicant does not have

to declare the purpose for which he or she is taking the loan, hence there will be no hypothecation over the asset to be purchased •

Purposes may be: house renovation, marriage in the family, advance

rental payments, hospitalization or other emergency medical needs, trips abroad, purchase of miscellaneous household appliances, purchase of personal computers, purchase of refrigerators, purchase of audio-video equipment, purchase of furniture, others. •

Credit Cards •

Credit cards forms of clean lending with a maximum

limit of Tk. 5 lac to a single borrower. Supplementary credit cards shall be considered the part of the principal borrower for this purpose. The limits exceeding Tk. 5 lac shall be secured appropriately by the banks • •

Corporate cards will not fall under this category

Particular Consumer Loans of UCBL are •

Car Loan (Staff)

•

Furniture Loan (Staff)

•

Loan under Personal Credit Scheme- Staff

•

Auto Loan

•

Marriage Loan

•

Any Purpose Loan (to Person2)

•

Education Loan

•

Hospitalization Loan

•

Advance against Salary

•

Travel Loan `

•

Claims secured by residential property

Lending fully secured by mortgages on residential property that is or will be occupied by the borrower or that is rented. As such the particular products of UCBL under this head are- HBL (Gen)

•

HBL (Staff)

•

Home Loan

•

Home Mortgage Loan

Claims secured by commercial real estate

Lending fully secured by mortgages on commercial real estate mortgages will be used for office and/ or multi-purpose commercial premises and/ or multi-tenanted commercial premises etc. except residential property. As such the particular product of UCBL is- HBL (Com) 4.5.2 Eligible financial collateral •

Cash (as well as certificate of deposit or Fixed Deposit or comparable instruments of same bank) on deposit with the bank, which is incurring the counterparty exposure.

•

Debt securities3

•

Gold

2 Any Purpose Loan to any enterprise be reported to Small/Medium Enterprise or Corporate 3 subject to fulfillment of certain conditions

•

Equities (including convertible bonds) which are included in a DSE 20 or CSE 30.

•

mutual funds

4.5.3 Risk Weighted Asset for Off Balance Sheet (OBS) Exposures Banks are required to calculate their risk-weighted assets for all off-balance sheet exposures. The total risk weighted assets with respect to credit risk of OBS exposure will be the sum of risk-weighted assets for market related and non-market related OBS transactions. We will focus only on non-market related OBS transactions, as we do not incur market-related OBS transactions. The risk weighted amount of OBS transaction is generally calculated by means of two step process: •

First, the notional amount of the transaction is converted into a balance sheet equivalent (i.e., credit equivalent amount) by multiplying the amount by a specific Credit Conversion Factor (CCF). The table below gives the CCF associated with various types of non-market related OBS transactions.

Table 4.7: Credit Conversion Factor for non-market related OBS transactions Sl. a)

Exposure Type Gl. Code Direct Credit Substitutes: i. Customer Liabilities Accept. Against BB Usage 9011003080 ii. Customer Liabilities Accept. Against Usage LC 9011003070 iii. Customer Liabilities Accept. Against Usage 9011003081 Normal iv. Letter of Guarantee (Bid Bond) 9011002011 iv. Letter of Guarantee (Advance Payment) 9011002013 iv. Letter of Guarantee (Counter guarantee) 9011002014 Performance Related Contingencies: Letter of Guarantee Local (Performance 9011002012 Bond) Customer

Liability 9011002021

CCF

100%

50%

LG foreign Trade

contingencies: i. Customer Liability sight LC -Local ii. Customer Liability sight LC -Foreign iii. Customer Liability

sight

-EDF iv.

Customer

Liability

sight

9011003020

LC 9011003030 20%

LC 9011003040

-Aid/Grant/Barter v. Customer Usance

9011003010

LC -BB vi.

Customer

Liability

sight

9011003050

LC 9011003100

(OLD) Other Commitments: i. Local Bill Lodged 9011001010 ii. Foreign Bill 9011001020 Lodged iii.Customer liability 9011003110 forward contract

Table 4.7: Credit Conversion Factor for non-market related OBS transactions(Continued) 4.5.4 Assigning Customer IDs This is the high time to assign unique ID to each credit clients. IDs will consist of eight digits (the first 3 digits will be for Branch code and the rest five digits for individual customer no.). Say, in ID 09500001, 095 is Branch code for Gulshan Avenue Branch, Dhaka and 00001 is for individual customer number. Branches will assign customer number numerically from 00001 to 99999. If a customer has loan in more than one Branch, the 1 st Branch will assign

Customer ID and other Branches will use the same number. In the format of ‘Claims on Banks and NBFIs, Customer ID need not be incorporated at this stage. Specific ID of Banks and NBFIs will be communicated to Branch later on. 4.5.5Preparation/Creation of Data at Branches •

Create excel sheet as per given format

•

Generate loan listing as on specific date from Bank Software

•

Separate customers by exposure types. Say, starting from Retail, Consumer, Residential Property, Commercial Real State, Banks, NBFIs and Past Due Claims.

•

For grouping of Corporate, Medium and Small customers, take declaration from the customers regarding their Fixed Assets except land and building as well as number of Manpower.

•

According to declaration and definition, Branches will sort out Small and Medium grouping customers. The rest will be reported under Corporate.

Each Branch will prepare a summary sheet, which will reflect the position of the Branch at a glance. 4.5.6 When an enterprise customer has multiple mode liabilities Personal loans be reported under Retail, Consumer, Residential Property as the case may be. •

Commercial HBL loan, if any, be reported under that category

•

NPLs (SMA to BL products) be reported under ‘Past Due Claims’ format

•

LBPD loans o enterprise customers be reported under claims on Banks and NBFIs. Here

the

name

customer

would

written

‘___________Bank

Account___________________________________’ •

FBPD liabilities of customers be shown as customer’s liability as usual.

•

The rest product claims be reported under Small, Medium or Corporate as the case may be.

•

SOD (FO) in the name of an enterprise be reported under small/Medium Enterprise or Corporate as the case may be.

•

Any purpose loan in the name of an enterprise be reported under small/Medium Enterprise or Corporate as the case may be.

•

Other information, as required in the format be collected from customer’s file/ customer.

 Formats to be used at Branches  For Non-Collateralized Transaction  For Collateralized Transaction  Formats to be used at Head Office  For Non-Collateralized Transaction  For Collateralized Transaction 4.5.7 Case Study Branch Name

: Principal Branch

Customer Name

: ABC Spinning Mills Pvt. Ltd.

Table 4.8: Rating of Customer, AA by CRISL Facility

Outstan- Expiry

Security

ding

Security

Matu

Value

rity

Issuer

Rat

NPL

ing

(in lac) Term Loan CC (H) HBL (Com) SOD (FO)

Share 1000

30.12.12

(DSE

100

30.09.09

20 listed) -

200

30.12.12

200

31.12.10

FDR

210

Desh

STD

SMA

STD

31.12.10

Desh

STD

Bank

Bank Car Loan in

the

31.12.10

30.06.10

100

30.06.10

name of Directors LBPD SLC

Cash Margin

Desh Bank -

STD

Company’s Fixed Asset Sl. Particulars

Value (Tk in lac)

Land

100

Building

200

Machinery

500

Vehicle

Others

Total Manpower base:

200 Persons

Requirements •

Grouping of Claims

•

Selection of Formats

•

Computation of Capital Requirement against the claim on the Company

•

Computation of Capital Requirement against the claim on the personal liabilities of the Directors of the Company

Reporting Branches must report all required data to Head Office within scheduled time positively.

4.6 Quarterly Report to Bangladesh Bank A quarterly report in the line with Basel II following Bangladesh bank Guideline is given below: 4.6.1Operational Risk 4.6.1.1Qualitative Disclosure Operational Risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. Operational risk includes legal risk but excludes strategic and reputation risks. The bank has framed Operational Risk Management Policy duly approved by the Board. Supporting policies adopted by the Board which deal with management of various areas of operational risk are Compliance Risk Management Policy, Forex Risk Management Policy, Policy Document on Know Your Customers (KYC), Anti Money Laundering (AML) Procedures, Business Continuity and Disaster Recovery Policy etc. The Operational Risk Management Policy adopted by the Bank outlines organization structure and detailed processes for management of operational risk. The basic objective of the policy is to closely integrate operational risk management system into the day-to-day risk management processes of the bank by clearly assigning roles for effectively identifying, assessing, monitoring and controlling / mitigating operational risks and by timely reporting of operational risk exposures, including material operational losses. Operational risks in the Bank are managed through comprehensive and well articulated internal control frameworks. In line with the final guidelines issued by Bangladesh Bank, the Bank has adopted the Basic Indicator Approach for computing capital for Operational Risk. As per the guidelines, the capital for operational risk is equal to 15% of average positive annual Gross Income of previous three years as defined by RBI. 4.6.1.2 Quantitative Disclosure Table 4.9: Gross Income

Particulars

April

(BDT in million) 2007- April 2008- April 2009-

March 2008

March 2009

March 2010

Interest Income

4,704.82

6,101.94

8,761.83

Less Interest Expense

2,927.88

4,097.21

5,784.47

Net Interest Income

1,776.94

2,004.73

2,977.36

Plus Non Interest Income

1,943.79

2,004.49

2,801.25

Total Operating Income

3,720.74

4,009.22

5,778.61

3,720.74

4,009.22

5,778.61

372.07

400.92

577.86

Less Interest Received on HTM Gross income Amount in BDT Crore

Table 4.10: Capital Charge for Operational Risk, Basic Indicator Approach (Tk in Crore) Gross Income 15% of Average Year Average GI (GI) GI April 2009-March 577.86 2010 April 2008-March 400.92 2009 450.29 67.54 April 2007-March 372.07 2008 Total GI

1,350.86

4.6.2Market Risk 4.6.2.1Qualitative Disclosure Market Risk is defined as the possibility of loss caused by changes/movements in the market variables such as interest rates, foreign currency exchange rates, equity prices and commodity prices. Bankâ&#x20AC;&#x2122;s exposure to Market risk arises from investments (interest related instruments and equities) in trading book (both AFS and HFT categories) and the Foreign

Exchange positions. The objective of the market risk management is to minimize the impact of losses on earnings and equity. 4.6.2.2 Quantitative Risk Table 4.11: Capital Charge on Foreign Exchange Position (General Market Risk) Net Long (+) / Currency

Exchange

Short (-) position

Rate

in USD equivalent

US dollar

USD

1.0000

(million) 3.18

Japanese yen

JPY

0.0103

0.03

Swiss Franc

CHF

Taka Equivalent (in Crore Tk). 21.86 0.19

Pound Sterling

GBP

1.5058

0.34

2.36

Euro

EUR

1.3385

(0.56)

(3.88)

Canadian Dollar Australian

CAD

Dollar Singapore

AUD

Dollar Other

SGD

Currencies Sum of the net

LONG

Position Sum of the net SHORT Position Overall net position Risk weight Capital charge for

Foreign

Exchange Exposure

0.004

24.42

(3.88) 24.42 8%

1.95

Net Long (+) / Short Currency

Exchange Rate

(-)

position in USD Taka Equivalent (in Crore Tk). equivalent (million)

Table 4.11: Capital Charge on Foreign Exchange Position (General Market Risk)(Continued)

Table 4.12: Capital Charge on Equities (Tk in Crore) Required Capital Charge for 1

Market Value 2

Weight

Capital

Charge 4=(2x3)

a) Specific Risk:

159.95

12.80

b) General Market Risk:

159.95

12.80

Table 4.13: General Risk on Interest Rate Related Instruments As on December 31, 2009 (BDT in Crore) Amount Counter Party Maturity Weight Capital Charge (Market Value) Government

2.5

102.09

1.75%

1.79

Government

2.6

53.76

1.75%

0.94

Government

2.7

16.14

1.75%

0.28

Government

2.3

80.41

1.75%

1.41

Government

2.8

32.34

1.75%

0.57

Government

2.9

32.41

1.75%

0.57

Government

3.0

10.82

2.25%

0.24

Government

3.6

54.63

2.25%

1.23

Government

4.0

27.47

2.75%

0.76

Government

4.1

53.10

2.75%

1.46

Government

4.2

32.56

2.75%

0.90

Government

4.9

19.99

2.75%

0.55

Government

9.5

20.11

3.75%

0.75

Government

10.0

82.99

4.50%

3.73

Government

15.0

22.01

5.25%

1.16

Government

10.1

30.02

4.50%

1.35

Total

670.85

17.68

Table 4.14: Specific Risk on Interest Rate Related Instruments, As on March 31, 2010 (BDT in Crore) Amount Counter Party

Maturity

(Market

Weight

Capital Charge

Value) Government

2.5

102.09

Government

2.6

53.76

Government

2.7

16.14

Government

2.3

80.41

Government

2.8

32.34

Government

2.9

32.41

Government

3.0

10.82

Government

3.6

54.63

Government

4.0

27.47

Government

4.1

53.10

Government

4.2

32.56

Government

4.9

19.99

Government

9.5

20.11

Government

10.0

82.99

Government

15.0

22.01

Government

10.1

30.02

Table 4.15: Capital Charge for Market Risk (Balance Sheet Exposures) As on March 31, 2010 (Tk in Crore) Capital Charge for Total Capital Capital Charge Details General Market Charge for Market for Specific Risk Risk Risk 1 2 3 4=(2+3) A. Interest Rate 17.68 17.68 Related instruments B. Equities C. Foreign Exchange Position Total (A+B+C):

12.80

25.60

1.95

12.80

32.43

45.23

4.6.3 Credit Risk 4.6.3.1 Qualitative Disclosure Lending involves a number of risks. Credit Risk is broadly the probability of losses associated with diminution in the credit quality of borrowers or counterparties. Credit Risk or default risk involves inability or unwillingness of a customer or counterparty to meet commitments in relation to lending, trading, hedging, settlement and other financial transactions. The Credit Risk is generally made up of transaction risk or default risk and portfolio risk. Credit approving authority, prudential exposure limits, industry exposure limits, credit risk rating system, risk based pricing, loan review mechanism and Credit Risk Mitigates are the instruments used by the bank for credit risk management. Credit risk is controlled through segmental exposure limits to various industries and sectors, prudential exposure and substantial exposure ceilings and risk mitigation by obtaining collateral and guarantees. In accordance with the Bangladesh Bank guidelines, the Bank has adopted Standardized Approach of the New Capital Adequacy Framework (NCAF) for computation of capital for credit risk with effect from 31.03.2010. In computation of capital, the bank has assigned risk weights to different asset classes as prescribed by the Bangladesh Bank. 4.6.3.2Quantitative Disclosure

Table 4.16: Risk Weighted Asset for Credit Risk, Off - Balance Sheet Exposures, March 31, 2010 (Tk in Crore) BB's Exposure Types: 1 a) Direct Credit Substitutes b) Lending of Securities or posting of securities as collateral c) Other commitments with certain

CCF

Rating

2 100%

grade 3 Unrated

Risk

Notional

Credit

Weight

Amount

Exposure

6=(5 x CCF) 704.55

704.55

drawdown d)

Performance

contingencies e) Commitments

with

related original

50%

Unrated

1.25

243.24

121.62

20%

Unrated

1.25

964.76

192.95

Unrated

1.25

45.53

maturity of over one year f) Trade related contingencies g)

Commitments

with

original

maturity of less than one year h) Other commitments that can be unconditionally cancelled by any time

Table 4.17: Risk Weighted Asset for Credit Risk Balance Sheet Exposures, March 31, 2010 (Tk in Crore) Risk Risk Weighted Sl. Exposure Type Exposure Weight Asset i) Claim under Credit Risk Mitigation [ From Work 61.17 Sheet - 1(a)] Fixed Risk Weighted Group j) Claims catagorized as retail portfolio & Small 0.75 2,009.70 1,507.28 Enterprise (excluding consumer loan) k) Consumer Loan 1.00 241.81 241.81 l) Claims fully secured by residential properly 0.50 296.73 148.37 m) n)

Claims fully secured by commercial real estate Past Due Claims (Risk weights are to be assigned

1.00

295.11

1.50

159.65

239.47

net of specific provision) 1. The claim (other than claims secured by eligible residential properly) that is past due for more than 90 days and/or impaired will attract risk weight as follows: - Where specific provisions are less than 20 percent of the outstanding amount of the past due claim.

- Where specific provisions are no less than 20 percent of the outstanding amount of the past due

1.00

26.61

0.50

10.29

5.14

1.00

claim. - Where specific provisions are more than 50 percent of the outstanding amount of the past due claim. 2. Claim fully secured against residential properly that are past due for more than 90 days and/or impaired and specific provision held there-against is less than 20% of outstanding amount

Table 4.17: Risk Weighted Asset for Credit Risk Balance Sheet Exposures, March 31, 2010(Continued) Sl.

Exposure Type

Risk Weight

Exposure

Risk Weighted Asset

3. Loans and claims fully secured against residential properly that are past due by 90 days and/or impaired and specific provision held there-

0.75

1.50

1.00

150.64

against is more than 20% of outstanding amount o) p)

Investments in venture capital Investments in premises, plant and equipment and all other fixed assets

Claims on all fixed assets under operating lease

1.00

All other assets

1.00

309.52

Total

6,647.36

Table 4.18: Risk Weighted Asset for Credit Risk Balance Sheet Exposures, March 31, 2010

BB's Sl.

Exposure Type

Rating Grade

a) b)

Cash & Cash Equivalents Claims on Bangladesh

Bangladesh Bank Claim on other Sovereigns & Central Bank

d) e)

Government

Claims on BIS, IMF & ECB Claims on Multilateral Development Banks

Risk

Risk Exposure

Weighted

111.88

Asset -

960.85

Weight

(MDBs) i) IBRD, IFC, ADB, AFBD, EBRD, IADB, EIB, EIF,

NIB, CDB, IDB, CEDB Table 4.17: Risk Weighted Asset for Credit Risk Balance Sheet Exposures, March 31, 2010(Continued) BB's Sl.

Exposure Type

ii) Claims on other MDBs

f) Claims on Public Sector Entities (PSE) (other than Government) in Bangladesh g)

Rating Grade 1 2&3 4&5 6 Unrated 1 2&3 4&5 6 Unrated

Risk Weight

Risk Exposure

0.20 0.50 1.00 1.50 0.50 0.20 0.50 1.00 1.50 0.50

2.50

1 2&3 4&5 6 Unrated

0.20 0.50 1.00 1.50 1.00 0.20

113.33 134.85

1 2 3&4 5&6 Unrated

0.20 0.50 1.00 1.50 1.25

19.02 9.27 122.30 2,757.29

3.80 4.63 122.30 3,446.62

i) Maturity less than 3 months h) Claim on Corporate

Weighted Asset 1.25 56.66 26.97

Claim on Banks & FIs (Banks wise)

ii) Maturity over 3 months

Table 4.18: Risk Weighted Assets (RWA), March 31, 2010 (Tk in Crore) Risk Weighted Assets (RWA) for A. Credit Risk On-Balance Sheet (From WS-1)

6,647.36

Off-Balance Sheet (From WS-2)

1,157.47

7,804.83

B. Market Risk (From WS -3)

45.23

12.50

565.43

C. Operational Risk (From WS -4)

67.54

12.50

844.29

Total RWA (A+B+C)

9,214.54

Table 4.19: Eligible Capital, As on March 31, 2010 1 1.1 1.2 1.3 1.4

Tier-1 (Core Capital) Fully Paid-up Capital / Capital Deposited with BB Statutory Reserve Non-repayable Share Premium account General Reserve

1.5

Retained Earning

1.6 1.7

Minority Interest in Subsidiaries Non-Cumulative Irredeemable Preferences Shares

1.8

Dividend Equalization Account

1.9

Sub-Total (1.1 to 1.8)

(Tk. In Crore) 29.92 184.12 36.36 273.76

524.16

Deductions from Tier-1 (Core Capital) 1.1 0 1.1

Book Value of Goodwill Shortfall in provisions required against classified assets

1 1.1

irrespective of any relaxation allowed Deficit on account of revaluation of investment in AFS

Category

1.13 1.14

Any increase in equity capital resulting from a securitization transaction Any investment in TFCs of other banks exceeding the prescribed limit

1.15 Other if any

1.16 Sub-Total (1.10 - 1.15)

1.1 7 2 2.1

Total Eligible Tier-1 Capital (1.9 - 1.16) Tier-2 (Supplementary Capital) General Provision (Unclassified loan + off Balance Sheet exposure) Limited to 1.25% of RWA

2.2

Assets Revaluation Reserves up to 50%

2.3

All other preference shares

2.4

Perpetual Subordinated debt up to max. 50% of row

524.16 (Tk. In Crore) 103.44 43.53 -

2.5

1.17 Balance of Exchange Equalization A/C

2.6

Sub-Total (2.1 to 2.5)

2.7

Deductions if any

2.8

Total Eligible Tier-2 Capital (2.6 - 2.7)

Tier-3 (eligible for market risk only)

3.1

Short-term subordinated debt

4 5

Total Supplementary Capital (2.8+3.1) (Maximum up to 100% of Total eligible tier-1 Capital) Total Eligible Capital (1.17+4)

1 Tier-1 (Core Capital) Table 4.19: Eligible Capital, As on March 31, 2010(Continued)

0.80 147.77

147.77

147.77 671.93 (Tk. In Crore)

4.7 Risk Combination Risk weighted Asset Consisted of capital for Credit Risk, Market Risk and Operational risk. Proportional contribution of credit risk, operational risk and market risk is shown below as pie chart. Figure 4.1: Risk weighted Asset Combined with Risk exposures

Table 4.20: Minimum Capital Requirement (MCR) Under Risk Based Capital (Basel II) As on March 31, 2010 Particulars

(Tk. In Crore)

A. Eligible Capital: 1. Tier-1 (Core Capital)

524.16

2. Tier-2 (Supplementary Capital)

147.77

3. Teir-3 (eligible for market risk only) 4. Total Eligible Capital (1+2+3)

671.93

B. Total Risk Weighted Assets (RWA) C. Capital Adequacy Ratio (CAR) (A4/B)*100

9,214.54 7.29

D. Core Capital to RWA (A1/B)*100 E. Supplementary Capital to RWA (A2/B)*100

5.69 1.60

F. Minimum Capital Requirement (MCR) (8% of

737.16

RWA) G. Capital Shortfall

65.23

5.0 FINDINGS 5.1 Very low paid up Capital According to Circular of Bangladesh Bank Minimum Paid up capital and Reserve Fund is required to be raised to 400 crore within August 11, 2010.In addition to this, Paid up capital must be maintained 200 crore whereas UCB bankâ&#x20AC;&#x2122;s paid up capital is only 29.92 crore, As on March 31,2010. Reserve Fund of UCB is 220.48 crore taka which is adequate to comply with Bangladesh Bankâ&#x20AC;&#x2122;s Circular.

5.2 Reasons behind Capital Adequacy Problems 5.2.1 AGMs were withheld for last few years On September 28, 2005, the AGMs were postponed by the issuer in pursuance to the stay order dated September 28, 2005 passed by the Hon’ble Vacation Judge of the Appellate Division of the Supreme Court of Bangladesh; Whereas, the Dhaka Stock Exchange Limited through letter dated September 29, 2005 informed the Commission that the issuer’s said annual general meetings which were scheduled for October3, 2005, have been postponed due to stay order from the Appellate Division of the Hon’ble Supreme Court and, as such, the Dhaka Stock Exchange management temporarily suspended trading of shares of United Commercial Bank Limited due to uncertainty about the status of general investors regarding entitlement of declared corporate benefits; on October 3, 2005, the issuer requested the Exchange to withdraw the trade suspension stating that further action in respect of holding of AGMs and “Record Date” could be taken only after the decision of the Hon’ble Supreme Court; Whereas, the issuer also requested the Commission through letter dated October 19, 2005 to instruct Dhaka Stock Exchange Limited for resuming normal share trading in the interest of shareholders; the Commission through letter dated November 22, 2005 requested the Dhaka Stock Exchange Limited to explain justification for continuing trade suspension of shares of United Commercial Bank Limited within one week stating that the President and the Chief Executive Officer of the Exchange met the SEC Chairman on October 24, 2005 and agreed to withdraw the trade suspension of shares of the issuer with effect from the last trading day before the ensuing vacation of Eid. Dhaka Stock Exchange Limited, acknowledging the said assurance, has informed the Commission through reply letter that neither the listing committee nor the Board of the Exchange agreed to withdraw trade suspension of United Commercial Bank Limited and that the Board also resolved that if the Securities and Exchange Commission or the company could ascertain what should be the price basis i.e. ‘cum dividend’ and ‘ex-dividend’ then it would be possible to resume trade of United Commercial Bank Limited. The Commission considers that indefinite suspension of trading of shares of United Commercial Bank Ltd. by the Dhaka Stock Exchange Limited is unjustified and contrary to public interest because the whole matter is pending before the Hon’ble Court and that until and unless a decision is

given by the Hon’ble Court, no one can decide on ‘cum dividend’ and ‘ex-dividend’ issue as stated by the issuer. Capital shortfall has been created basically because of not holding AGMs since 1997, for which additional capital from external sources could not be raised keeping pace with growing assets of the bank. Asset quality also did not support generation of internal capital from operational profit. Bank held its AGM recently after holding of its AGM and issuing Bonus Share Bank’s Paid up Capital increased from 29.92 crore to 119.9 crore. 5.2.2 Credit Risk Rating by ECIAs is under process Risk rating of risk weighted assets was done by UCBL Finance and accounts division internally on the basis of Basel II requirements, but according to Bangladesh bank guideline Risk Rating must be done by ECAIS. In Bangladesh there are two ECAIS, CRISLE and CRAB among these two Bangladesh Bank has recommended CRAB. Recently UCBL has given responsibility to CRAB and CRISLE to assess credit rating of their corporate clients this external Credit assessment in on process. After processing external credit risk assessment risk weighted assets will be reduced and hence capital requirement will be reduced on the result capital shortfall will be decreased. In this connection, we must remember that the utilization of the services of rating agencies for bank loan under Basel-II is a temporary phenomenon. The banks will ultimately be required to develop their internal rating over a period of five to six years. Basel-II document requires a bank to have at least five years customer data to go for Internal Rating Based Approach (IRB). Up to that period, perhaps, the services of rating agencies will be required by the banking community. 5.3 Risk weighted asset (RWA) has increased by Tk. 2664.23 crore than that of last quarter (Dec-2009) RWA increased due to migration from Basel-I to Basel-II. In Basel-I Risk weighted Assets were calculated with consideration of Credit risk only, whereas in Basel II Risk weighted

Assets are calculated with consideration of Credit Risk, market Risk, Operational Risk and some other criterions.

5.4 Quarterly Report in line with Basel II A quarterly report on Capital requirement should be submitted to Bangladesh Bank. Reporting format and all necessary calculation required to be done in the light of Bangladesh bank Guideline. A quarterly report on March 31, 2010 has prepared following Bangladesh Bank Guidelines in line with Basel II and submitted as per instruction circular. . 5.5 Requirement criteria MCR is taken as 8% of RWA as this is prescribed in the time frame of Jan 01, 2010-June 30, 2011.Capital Adequacy ratio (CAR) is required to be greater or equal to 8%.Capital Adequacy ratio (CAR) of UCBL is 7.42% which fails to meet the requirement According to Bangladesh bankâ&#x20AC;&#x2122;s Guidelines, In every case at least 50% of the CAR and MCR must be constituted by Tier-I capital components. This requirement is fulfilled as 50% of MCR is 368.58 crore which is less than Tier-I capital of 524.16 crore. In addition to this 50% of Capital Adequacy ratio (CAR) is 3.65 crore is less than the ratio Core Capital to RWA which is 5.69.

5.6 Restriction on lending rate BB has imposed restrictions on lending rate for the corporate sector at a maximum 13 per cent year for both short and long term lending. The restriction has substantially reduced the net interest margin income of the banks, eventually reducing the retained earning, which is a component of core capital Thus, while banks are striving to attain the maximum capital requirement the new regulations are slowing down the pace.

5.7 Increased competition for better rated clients The new framework could also intensify the competition for the best clients with high credit ratings, which attract lower capital charge. This could put pressure on the margins of the banks. The banks would, therefore, need to streamline and reorient their client acquisition and retention strategy. 5.8 Higher cost of banking services The possible increased capital requirement and the significant cost of implementation may ultimately result in higher cost of banking services for the society. This may be especially true for corporate clients with weaker risk profile. Since the capital requirement on such clients will be several times higher than a larger, less risky client, banks will be inclined to charge them a significantly higher price for loan-type products. 5.9 Delay of implementation of Basel II I believe that the regulators will be able to maintain the time-table and will continuously improve when the implementation will start. None can expect that we first develop ourselves and start, rather start and development always goes together. Therefore, I believe that Basel-II implementation time-frame is right for the country and any delay will go against the economy. If Basel-II implementation is delayed the foreign banks operating in Bangladesh will be benefited immensely. Its dominance with huge capital base and franchise value will continue to have the good clients at low interest rate keeping the bad borrowers with the local banks who do not bargain on interest rate and they want loan at whatever interest rate. While it is important that we move ahead with the world by implementing Basel II, it may not be a very bad idea to go slow in this regard to allow the industry more time to prepare itself for the new accord. Especially the development of local ECAIs should be a top priority before abruptly adopting the Standardized approach of Credit Risk - which is fully dependent on external rating. At the time of the implementation, the impact on the banks, the industry and the society should be carefully evaluated. 5.10 Banking vs. non-banking financial institutions (NBFIs)

Since only banking institutions are subject to Basel II requirements, banks may find themselves in competitive disadvantage against specialized financial institutions, especially, leasing companies, microfinance institutions, foreign exchange remittance facilitating institutions and mutual funds. More specifically where banks provide services similar to these organizations, they may find it difficult to compete due to additional capital requirement which NBFIs would not have. This may create an asymmetry in the industry. 5.11Comparison with other Banks Dhaka Bank Ltd., Eastern Bank Ltd,Prime Bank Ltd.,South East Bank Ltd.,Do not have any capital shortfall.Mutual Trust Bank Ltd. has capital shortfall and for this they have issued Bonus and Right share before and now is planning to issue Bond.other Banks those have capital shortfall have issued Bonus or Right share or planning to issue to increase capital.

6.0 STEPS TAKEN INTO CONSIDERATION AND RECOMMENDATION 6.1 Reflection Before taking any step to gain capital the bank must consider the merits and demerits of the process and then should go ahead. In connection to this, issuing Bonus share and right share are most common practices to raise capital.

6.1.1 The bank has already issued Bonus share to increase Capital. A bonus share is a free share of stock given to current shareholders in a company, based upon the number of shares that the shareholder already owns. While the issue of bonus shares increases the total number of shares issued and owned, it does not increase the value of the company. Although the total number of issued shares increases, the ratio of number of shares held by each shareholder remains constant. An issue of bonus shares is referred to as a bonus issue. Depending upon the constitutional documents of the company, only certain classes of shares may be entitled to bonus issues, or may be entitled to bonus issues in preference to other classes. The Bank issued 40%B '06, 50%B '05, 90%B '02 '03 & '04.

A bonus issue (or scrip issue) is a stock split in which a company issues new shares without charge in order to bring its issued capital in line with its employed capital (the increased capital available to the company after profits). This happens after UCBL has made profits, thus increasing its employed capital. Therefore, a bonus issue can be seen as an alternative to dividends. No new funds are raised with a bonus issue. Unlike a rights issue, a bonus issue does not risk diluting your investment. Although the earnings per share of the stock will drop in proportion to the new issue, this is compensated by the fact that you will own more shares. Therefore the value of investment remains the same although the price will adjust accordingly. The whole idea behind the issue of Bonus shares is to bring the Nominal Share Capital into line with the true excess of assets over liabilities.

6.1.1.1 Implications

Issue of bonus shares has two implications in the mind of the people •

Number of shares available for trading gets increased.

•

Management's positive contribution towards growth of profit.

6.1.1.2 Advantages of issuing bonus shares

•

Shareholders can get their undistributed profits in the form of shares.

•

Without disclosing the financial position and liquidity of the company, company can keep its shareholders happy.

•

Security of the creditors gets increased due to increase in share capital.

•

It increases marketability of the shares as the number of shares increases in the hands of the existing shareholders.

6.1.1.3 Disadvantages of issuing bonus shares

•

Issue of bonus shares declines the rate of dividend in future.

•

It encourages speculative dealings in shares of the companies.

•

Approval of SEC is necessary before issue of bonus shares. Hence, it is a lengthy process. It may delay in the issue of shares.

6.1.2 The bank has recently planned to issue Right share to increase Capital An analysis of issuing right shares and its merits and demerits is our matter of concern. Before issuing right share we have to focus on how it will affect share price , company value, financial performance and capital.

6.1.2.1 How Right issue can help company to raise capital •

A rights issue is an exercise in which a company issues the rights to existing shareholders to purchase new stocks which are being issued by the company. These stocks will be sold to those who hold the rights at a discount to the current stock price of the company.

•

Rights issue is a way for company to raise capital. Capital can be raised when the market pays for the new stocks that are being issued. There are other ways in which a company can raise capital such as by issuing bonds or by borrowings from banks. However, this depends on the economic climate and situation on which is the most favorable method to raise capital. There can be times where the interest rate on the borrowings charged by the banks or the issue of bonds is high or if the company is not doing well, banks may be reluctant to borrow. Thus, rights issue is a way in which company can raise capital.

•

Basically during a rights issue, the company will issue the rights to the existing shareholders. The shareholders will then decide if they wish to subscribe to the rights i.e. pay the amount of money to exercise the rights and receive the stock. It

may also be possible for the existing shareholders to sell the rights to other buyers in the market.

6.1.2.2 Fixing of the price of the right shares In fixing of price of the right shares following considerations should be borne in mind: •

The first consideration is as to what the market can bear. If the amount collected by issue of right shares is not invested in securities yielding a good return or normal return, the market price of shares in the long run will go down. In that case, rights will not be used and investors will invest their funds in alternative investments.

•

The other consideration in the state of capital market. The company should keep vigil on the market price and see how its shares have been moving in the market in the past and how these are likely to move, if the rights are fixed at a particular price.

•

The company should also take the general price trend in the capital market into consideration i.e., whether the general prices are stable or fluctuating. If trend is not stable, the investors will not like to invest funds in securities hence rights cannot be favored.

•

The profit-earning capacity of shares also affects the price of right shares. If they have no capacity or low capacity or low capacity to earn profits, they will not be offered by the shareholders howsoever low their price may be. On the other hand, if profit earning capacity of the shares is somewhat, higher, regular an dependable, the rights will attract the existing shareholders as well as their nominees whether rights are priced a bit higher.

•

The prospects of proposed plans of expansion also affect the pricing issue. If plans seem profitable, the right may be priced a bit high. On the other hand, if the plans are not attractive or slow, the price will be fixed differently.

â&#x20AC;˘

Dividend policy of the enterprise is also an important factor. If conservative policy of dividend is adopted by to be company, the shareholders shall not be interested in purchasing the rights. The price may be fixed much lower. If they are getting good dividend, the price may be fixed much lower. If they are getting good dividend, the price may be fixed somewhat higher.

â&#x20AC;˘

The resource position of the company also affects the pricing of right issue. If financial position of the company is sound, the shareholders will be attracted to invest and the price may be fixed at somewhat higher level otherwise the position will be reserved.

If the bank issue Total market price of three existing shares The

issue

price

right

3 x 2550

share(40%

Rs 7650 =

1530

Discount) Total for 4 shares

9180

Average Price Per Share

9180/4

Value of right

= Rs. 2550 (-) Rs. 2295

2295

255

But, whatsoever the pricing policy of rights, the enterprise will have to take into consideration to basic facts-Firstly, it should fix the premium, not so low, nor so high an secondly, it should yield the shareholders a fair return. The enterprise should strike a judicious balance between the two.

6.1.2.3 The issue of right shares affects the financial policy of an enterprise in the following manner â&#x20AC;˘

As we know, that right shares are issued at a price much lower than the market price of the existing shares. The market price is expected to fall by the issue of right shares, to a considerable extent. The problem should be considered by the company well in advance taking in view the fall in market price of shares of the company.

•

If the existing shareholders decline the offer, the shares are offered to other persons at the same price. The customers are tempted to purchase such shares at lower price even though, a decline in market price in obvious if the company has a good record of payment of dividend, because they expect an increase in the market price of shares after a short spell and if it is so, the goodwill of the company also goes up.

•

Right issue has another adverse effect on the market due to lower payment of dividend. It is but natural that due to increase in the number of shares the dividend per share will be lower. It is, of course, on the presumption that additional amount realized through the issue of rights will not be put to profit immediately and it will take time in increasing the profits. Accordingly, a situation might arise that even good shareholders might fill disinclined to continue with the enterprise and began to sell their holding. Such a trend will affect the market adversely and the prices of shares will go down. The company should take proper care and ensure that a healthy balance is struck between the use of amount invited and the income from the investment failing which market will be adversely affected.

•

Another factor that needs consideration is the capacity to purchase shares of the existing shareholders. In case, they are fully subscribed by the shareholders, the market will not be very adversely affected. But on the other hand, if they do not have capacity to purchase shares, they will either surrender their rights or renounce it in favor of their nominee. In that case even, the nominee will also surrender such shares thereby making these shares available in the market and the market well be affected adversely. It is better, in such circumstances, to offer rights in lower proportions.

•

The factor is the fluctuation in the market price of the shares of the company. If the shares are favorably traded in the market, without having any fluctuation in the price of a considerable degree, the rights will attract the shareholders and the price may be fixes somewhat higher. But if on the other hand, the shares invariably fluctuate,

the issue will adversely affect the market and the company will have to fix the price of the right share much lower. •

Usually share market in respect of that particular share comes under heavy pressure in pre-offering period just after it is known to the public that company is about to offer rights shares. This pre-offering pressure is usually considerably great and the financial management should take every effort to check that pressure otherwise, its financial policy will be adversely affected.

•

There are usually downward trends during the period of right issue and even the existing shares will come under heavy strains. In case financial management does not move swiftly on the terms, its whole financial policy might come under unbearably heavy strains.

6.1.2.4 Advantages •

Right issue gives the existing shareholders an opportunity to maintain their pro-rata share in the earning and surplus of the company and the voting power as before.

•

The goodwill of the company increases in the eyes of existing shareholders.

•

The cost of issue of such shares will also be lower.

•

The financial management is relived from the bothered of selling the shares.

•

If right shares are offered by the shareholders enthusiastically, it proves that financial position of the company is sufficiently good, and the company can obtain more loans at lower rate of interest.

•

This type of issue gives existing shareholders securities called "rights", which give the shareholders the right to purchase new shares at a discount to the market price on a stated future date. The company is giving shareholders a chance to increase their exposure to the stock at a discount price.

•

Until the date at which the new shares can be purchased, shareholders may trade the rights on the market the same way they would trade ordinary shares. The rights issued to a shareholder have a value.

•

Troubled companies typically use rights issues to pay down debt, especially when they are unable to borrow more money.

•

Not all companies that pursue rights offerings are shaky. Some with clean balance sheets use them to fund acquisitions and growth strategies. For reassurance that it will raise the finances, a company will usually, but not always, have its rights issue underwritten by an investment bank.

6.1.2.5 Disadvantages •

The value of each share will be diluted as a result of the increased number of shares issued.

•

It is awfully easy for investors to get tempted by the prospect of buying discounted shares with a rights issue. But it is not always a certainty that you are getting a bargain. But besides knowing the ex-rights share price, you need to know the purpose of the additional funding before accepting or rejecting a rights issue.

•

A rights issue can offer a quick fix for a troubled balance sheet, but that doesn't necessarily mean management will address the underlying problems that weakened the balance sheet in the first place.

6.2 To reduce RWA following steps need to be actively initiated •

Rating of credit customers

•

Raising credit portfolio on SME, Retail, Consumer Banking and HBL (Res).

•

Emphasizing on financial securities.

•

Reducing of Past Due Claims, i.e., classified loans.

•

Guard against carrying over expired contingent liabilities.

•

Proper segregation of credit portfolio in line with Basel II.

•

Minimization of Equity Position (Investment in Share) by rationalizing in terms of capital requirement and holding requirement.

•

Rationalization of HFT (Held for Trading) requirement and holding requirement.

•

Rationalization of net foreign exchange position on quarter end.

•

Supplementing operational risk by minimizing operational risk by minimizing operational expenses and maintaining high quality of credit portfolio.

•

Minimizing reconciliation gap at Branches and Head office transaction.

•

Rationalizing purchase/creation of Fixed Assets.

6.3 To minimize Capital Shortfall To cope up with the capital shortfall a long term capital plan has been approved through Board of directors (BoDs) on 30.05.2010. and the plan will be conveyed to BB by 24.06.2010. Besides this under noted steps have also taken to minimize shortfall •

Proper segregation and grouping of customers in 10 categories in line with Basel II guidelines.

•

Attaching importance of capital requirement while taking funding decisions.

•

Rating of medium and corporate customers (122) by ECAIs. Summery status of rating is as under

Table 6.1: Credit Rating Process Particulars Rating Completed Rating on going Agreement on progress

Number of Customers 10 41 71

Remarks Done Be completed by June,201 Be completed by September,2010

Total

122

6.4 A Good number of Trainings and Conferences Most countries implementing Basel II have experienced a shortage of skilled people in the industry who can understand and implement the sophisticated Basel II requirements. So, there is an almost certain likelihood that the banks in Bangladesh may also face a similar constraint. A good number of trainings and conferences can help ease this pressure.

7.0 CONCLUSION

Primary data is the basis of accuracy of any type of computation. For the time being, Branches are advised to send data in the prescribed formats. After collecting data from Branches, Head Office will do all the calculations and associated activities to find out the Risk Weighted Assets and Capital Requirement thereon. In future, Branches will have to calculate their own capital requirement against credit portfolio. As such, Head of Branch and respective credit officers are to improve their individual knowledge and efficiency on the subject issue. While the implementation of Basel II may be a powerful tool to strengthen banks in Emerging Markets, it could also exacerbate weaknesses and increase the fragility of banking systems. Appropriately adapting the Accord to the risk features of emerging markets as well as designing complementary policies is essential to derive benefits from the international capital standards. The effectiveness of the Basel Capital Accord in emerging markets depends on countriesâ&#x20AC;&#x2122; degree of financial development, which varies significantly across this category of countries. Effective banking supervision in emerging markets needs to take into account particular features of these economies that are different from those in industrial countries. This implies the implementation of additional policies to complement Basel and, sometimes, even transitional policies before fully implementing Base

REFERENCES http://www.dsebd.org/ http://www.bis.org/ http://www.bangladesh-bank.org/ http://www.ucbl.com/

APPENDIX MCR against Credit Risk (for non-collateralized exposure) = Credit Exposure x Risk Weight x Capital Adequacy Ratio

Where transactions are secured by eligible collateral, banks need to first calculate the net exposure amount by taking into account the effect of collateral. The net exposure amount (if positive) is then weighted according to risk-weight of the counterparty to obtain the riskweighted asset amount for the collateralized transaction. In calculating the adjusted exposure amount after risk mitigation, adjustments (hereinafter called â&#x20AC;&#x153;haircutsâ&#x20AC;?) are applied to both the collateral and the exposure to take into account possible future price fluctuations. Where the exposure and collateral are held in different currencies an additional downward haircut must be made to the volatility-adjusted collateral amount to take account of possible future fluctuations in exchange rates. Where the volatility-adjusted exposure amount is greater than the volatility-adjusted collateral amount (including any further adjustment for foreign exchange risk), banks shall calculate their risk-weighted assets as the difference between the two multiplied by the risk weight of the counterparty. The framework for performing these calculations is as follows: E* = max [0, E x (1+He) - C x (1-He)] Where: E* = the exposure value after risk mitigation E = current value of the exposure for which the collateral qualifies as a risk mitigant. He = haircut weight appropriate to the exposure C = the current value of the collateral received Hc = haircut weight appropriate to the collateral Hfx = haircut weight appropriate for currency mismatch between the collateral and exposure The exposure amount after risk mitigation (i.e. E*) will be multiplied by the risk weight of the counterparty to obtain the risk-weighted assets amount for the collateralized transaction.

MCR against Credit Risk (for collateralized exposure) = Credit Exposure after Risk Mitigation x Risk Weight x Capital Adequacy Ratio

Table : Haircut weights for exposures Counterparty

Maturity

Sovereigns (%)

Others (%)

≤ 1 year 1 year < Maturity ≤ 5 years > 5 years ≤ 1 year 1 year < Maturity ≤ 5 years > 5 years ≤ 5 years > 5 years all

0.5 2 4 1 3 6 9 12 15

1 4 8 2 6 12 12 15 25

Sovereigns (%)

Others (%)

≤ 1 year

0.5

1 year < Maturity ≤ 5 years > 5 years ≤ 1 year

2 4 1

4 8 2

2, 3, S2 & S3

1 year < Maturity ≤ 5 years > 5 years

3 6

6 12

Rating (BB Rating Grade) 1

2, 3 4 5, 6 & Unrated

Table : Haircut weights for collaterals Issue rating for debt Maturity securities (BB Rating Grade)

Unrated all Equities included in DSE 20 Other than DSE 20 and Gold Undertakings

collective

Investment

and

Transferable Securities (UCITS)/Mutual funds

15 12 15 Highest haircut applicable to any security in which the fund can

invest Cash in same currency (as well as certificates of 0 deposit or comparable instruments issued by the

lending bank The standard supervisory haircut for currency risk where exposure and collateral are denominated in 10% different currencies

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