ST.MARY’S UNIVERSITY 
SCHOOL OF GRADUATE STUDIES 
 
 
CREDIT RISK MANAGEMENT PRACTICE IN PRIVATE 
BANKS 
CASE STUDY BANK OF ABYSSINIA 
  
BY 

YOHANNES ARGAW 

MAY, 2016 

1 

 
 ADDIS ABAB, ETHIOPIA 

CREDIT RISK MANAGEMENT PRACTICE IN PRIVATE 
BANKS 
CASE STUDY BANK OF ABYSSINIA 
  
BY 

YOHANNES ARGAW 

 
 
A THESIS SUBMITTED TO ST MARY'S UNIVERSITY,  
SCHOOL OF GRADUATE STUDIES IN PARTIAL FULFILLMENT OF 
THE REQUIREMENTS FOR THE DEGREE OF MASTER OF 
BUSINESS ADMINISTRATION (MBA) 
 
 
 
May, 2016 

2 

 
 ADDIS ABAB ETHIOPIA 

 
 
 

ST MARY’S UNIVERSITY 

SCHOOL OF GRADUATE STUDIES 

FACULTY OF BUSINESS 

 
 
CREDIT RISK MANAGEMENT PRACTICE IN PRIVATE 
BANKS 
CASE STUDY BANK OF ABYSSINIA 
BY 

YOHANNES ARGAW DESTA 

APPROVED BY BOARD OF EXAMINERS 
____________________________  _________________ 
Dean , Graduate Studies  Signature & Date 
 
 
____________________________  ____________________ 
Advisor  Signature & Date 
 
3 

 
_______________________________  _____________________ 
External  Examiner  Signature & Date 
 
 
_____________________________  _______________________ 
Internal Examiner  Signature & Date 
 
 
 
 
 

DECLARATION 

 
I hereby declare that this research is prepared with my own effort
under the guidance of my advisor T/Giorgis Aseefa (Asst.Prof.).

____________                      __________         _____ 

Student name                      Signature              Date 

 
 
 
 

4 

 
  
 
 
 
 

ACKNOWLEDGMENTS 

 
I would like to express my especially gratitude to my Advisor
​
T/Gorgis Assefa (Asst.Prof) for his guidance, encouragements,
humble and exemplary supportive mentality and meticulous
looking.

A very special gratitude to my loving and supportive family,

especially to my wife’s best caring personality ( yeshiembet Assefa )

And finally to my colleagues who forward their support in

collecting data, also to all my course mates and to all those who
contributed to the success of this work, I say a big thank you

5 

 
  

Introduction
Chapter 1

1.1​
. Background of the Study
…………………………………… .. ……………...…………...2
1.2 Statement of the Problem……………………….……….……..…………….……………5
1.3 Research questions……………………………………..……..…………………..………..6
1.4 Objective of the paper………………………………………………………..…………… 7
1.4.1 General objective……………….…………………………………………..…………..7
1.4.2 Special objective…………..……………………………………………………..…….7
1.5 Significance of the study………………………………​
​ ………………………..……….....7
1.6 Scope of the study………………………………………………………………………..….8
1.7 Organization of the study……………………………………………………….….……..8
Chapter 2

Literature Review

2.1 Risk and risk management process………………………………………………..………..9

2.2 Credit risk………………………………………………………………………………...………12

2.2.1 Common cases for credit risk………………………………………………..……….13

6 

 
 2.2.2 Forms of credit risk exposures in Banks…………………………………… ....…14
2.3 Credit risk management………………………………………………………………….. …15
2.3.1​
General principles of CRM…………………………………………………….…....16
2.3.2 Credit risk management process………………………………………… …….….19
2.3.3 Credit risk management measurement…………………………………… ….…..20
2.3.3.1 Credit risk rating …..........................................................................21

2.3.3.2 Credit scoring system………………………….…………………………..……21

2.4 Tools for Credit risk Management………………………….……………………………....23

Chapter 3

Research Methodology

3.1.Research design………………………………………………………………..…………….....25
3.2 Type of data collected and used……………………………………………………………...25

3.3​
.Source of Data​
………………………………………………………………….… …………...25
3.4 Method of data collection…………………………………….……………….………………...26
3.5.​
Sampling techniques…​
………………………………………………………………………..26
3.6. Sample size……………………………………………….………………………………………26
3.7 Data analysis………………………… .……………….…….………………………………….27

Chapter 4

Data Analysis and Discussion

4.1 Demography………………………………………………..….……………………………..…28

4.2 Credit Risk Assessment……………………………………………………………………....30

4.2.1 Leave of credit risk…………………………………………………………….…….…30

4.2.2 Challenge for the effectiveness of Credit Risk Management……….……….…31

7 

 
 4.2.3 The technique /instrument used for credit management………….………….31

4.2.4 Off-balance sheet commitment…………………………………………………….. 32

4.2.5 Pricing credit risk……………………………………………………………………….33

4.2.6 Credit risk model used………………………………………………………….……..34

4.2.7 Measuring credit risk…………………………………………………………….…….34

4.2.8 Calculation of probability of default of customers………………………….…..35

4.2.9 Calculation of recovery rate of a loan………………………………….…………..35

4.2.10 Activity performed for credit risk management……………. ……….…………35

4.3 Credit risk management review functions………………………………………………..37

4.3.1 Risk reporting and training………………………………………………….….……37

4.3.2 How often the Bank provides credit risk management training….….…..….37

4.3.3 Does the Bank provide any advisory services to its loan customers…..…. 37

4.3.4 The problems encountered during debit recovery from customers…….…..38

4.4. Credit Risk Management process…...................................................................39

4.4.1 Credit processing and appraisal…………………………………………………...…40

4.4.2 Credit Administration……………………………………………………………….....41

4.4.3 Monitoring and control of credit……………………………………………………..42

4.4.4 Managing credit problem/recovery………………………………………………….43

4.5. Secondary Data Analysis………………………………………………………….………. ..44

4.5.1 Disbursement performance and quality of loan………………………………...46

4.5.2 Credit Concentration Risk Indicators.................................................…....48

4.5.3 Credit quality -Non Performing Loans………………………………….……….....49

Chapter 5

Conclusions and Recommendation

8 

 
 5.1 Conclusions………………,…………………………………………….………….……………50

5.2 Recommendation………………………………………………………………….……….…..53

List of Tables
     
Table 1 Respondents with respect qualification 29
level
Table 2 Respondent with respect work experience 29

9 

 
Table 3 Respondent with respect current position 30
Table 4 Level of credit risk on various transactions 30
Table 5 Major challenges on implementation of 31
credit risk management
Table 6 The technique/instrument, used for credit 32
risk management
Table 7 Factors considered for pricing credit risk 33
Table 8 Credit risk models 34
Table 9 The tools used to measure credit risk 34
Table 10 Probability of default 35
Table 11 Calculation of recovery rate of loan 35
Table 12 Activities for credit risk management 36
Table 13 Risk reporting status 37
Table 14 Credit risk management training 37
Table 15 Providing advisory service 38
Table 16 Credit risk management process 39
Table 17 Cumulative position to loans and advances 48
ratio

List of Figures
     
Chart 1 Loan to deposit ratio 47
 

List of Abbreviations and Acronyms

10 

 
BOA Bank of Abyssinia
NPL Non performing loans
BASEL A city in NW Switzerland, on the Rhine
River, Where the Name of a set of
international banking regulations put
forth by the ​Basel Committee on Bank
Supervision​,

IT Information technology
VAR Value-at-risk
 

ABSTRACT

11 

 
The financial sector plays vital role in any economy by transferring funds from
surplus to deficit area by giving credit. In today’s changing financial
landscape-environment of intense competitive pressure, volatile economic
conditions, rising bankruptcies, and increasing levels of consumer and commercial
debt; an organization’s ability to effectively monitor and manage risk associated to
credit become critical. Therefore, managing its credit risk, using the credit risk
management tools, can make the difference between success and failure.

Hence it is essential to overview of the credit risk management practice of the banks
and identifies the gap to take proactive measures and to protect the banks from any
damage. Therefore the research to identify the gap on credit risk management
practices of private banks case study in one of the private banks, Bank of Abyssinia
was conducted.

Qualitative research method was used and data has been collected from primary and
secondary sources. In obtaining information from the primary data, a survey
questionnaire was developed, pre-tested and used for collecting data. Simple random
sampling technique was used to select respondents of the Bank and the data were
collected from credit professionals.

The study found that lack of information system that support the risk management
process , absence of risk identification focused tools on customers’ business and the
associated environment , unsound lending practices associated to credit processing
and appraisal activities and lack of accountability, lack of measures associated to non
performing loans, high concentration of loan on sector ,product ,geography and also
on by large borrowers as a key drawbacks on credit risk management practices of the
Bank.. Thus, it is suggested that Bank should build well organized management
information system, should put in- place a system capable of assessing, monitoring
and controlling risk exposures in more scientific manner, should give a key concern
to minimize concentration risk and should develop code of conduct to proactively
monitoring ethical standards, and prudent application of policies.

12 

 
 CHAPTER 1

INTRODUCTION

13 

 
1.1 Background of the Study
Risk is the element of uncertainty or possibility of loss that prevail in any
business transaction in any place, in any mode and at any time. To sustain its
operation, a business has to earn revenue/profit and thus has to be involved in
activities whose outcome may be predictable or unpredictable. Hence, risks
don’t disappear, they gave users a choice; which to retain and which to shed
(Bagch, 2006 ) .

The integral element of uncertainty or possibility of loss, risk, is faced by the

Banks also associated to lending or credit activity, that prevail in any business
transaction in any place, in any mode and at any time (Macdonal and Koch,2006)
.The damage could be more severe in the case of banks as banking business is
not only a stake of the owners but also that of depositors (public), other banks
and hence, the economy as a whole (Ataklti, 2015). According to Macdonal and
Koch, (2006) as cited in Solomon (2013) lending represents the heart of the
Banking industry. Hence, managing the associated risk which is the Bank’s
largest asset, credit, is a key task for success, survival and to thrive on the
existing competitive environment. The higher the exposures of a bank to credit
risk the higher the tendency of the Bank to experience financial crisis. The issue
of credit risk is of even greater concern because of the higher levels of perceived
risks resulting from some of the characteristics of clients and business
conditions that they find themselves.

Credit is evil for economy if it is not properly used and managed. Its
improper management causes default and bad reputation and credit losses
/bankruptcy (Joseph, 2013). ( Hennie ,2003 as cited by Solomon G.2013 ) states
that despite innovations in the financial services over the years, credit risk is still
the major single, cause of bank failure. For the reason that more that 80% of a

14 

 
bank balance sheet generally relates to this aspect of risk management. (Basel
,1999 ) stated that the major cause of serious banking problem is associated to
the loss of credit standards for borrower and counterparties, poor portfolio risk
management and so on. Therefore, all the above facts prove that the extremely
vital role of credit risk management in bank’s risk management activities as well
as the sustainable success of the organization.

Credit risk management system and practice is an ingredient part of safety,

soundness, liquidity and profitability of banks.  ​
Credit risk management
encompasses identification, measurement, matching mitigations, monitoring
and control of the credit risk exposures. That is why many authors considered
that Failure of Credit risk management system and practice as one of the main
cause of financial crises in general and banking failure particularly (Bagchi,
2006), ( Bessie, 2008). Thus banking industry will only serve the backbone of
economic development if only comprehensive credits risk management system
is properly in practice.

In a Country like Ethiopia, where capital markets are not yet created and
developed banking industry is the only formal key sector which plays the
intermediary role through provisioning of financial service to the society. Like
bridge in which fund of savers are transferred to borrowers through financial
intermediary. Hence, this sector plays a critical role on responding such demand
by mobilizing surplus funds from the economy (Sahlemichale, 2009).

The past decade has seen evolutionary revival of the Banking industry in
Ethiopia following the liberalization and the re-establishment of private banks. It
is a normal phenomenon that as the number of banks (and other institutions
providing banking services) increases, so does the competition, which in turn
increases scope and complexity of banks’ business to beat the competition and

15 

 
steer a consistently profitable course. Lessons from the traditional banking
crises show that banks that had been performing well suddenly announced large
losses due to either credit exposures that turned bad, liquidity problems,
unmanaged interest rate and exchange rate positions taken, derivative
exposures that may or may not have been assumed to hedge balance sheet risk
or significant operational risks. (Atakilti, 2015). In response to such lessons,
banks almost, universally have embarked upon an upgrading of their risk
management systems. Thus, in this increasingly dynamic area of financial
services, a distinctive position of any bank-be it private or public, large or small-
lies in the way it manages its risks. (Bagchi ,2006).

Ethiopian banking system had been not given enough attention before 2010
specially regarding to the development of modern system of assessing,
controlling and managing risk in banking operation in line with the changing
environment and global financial standard (Ataklit ,2015). Risk management
guidelines of the NBE 2010 paved the way for the latest development of Risk
management practice in Ethiopian banking industry. Commercial banking earn
profit out of managing risk as a result banking business is all about
managing risk. As no gain no loss principles of nature, (Verma , 2005) cited by
Solomon (2013 ) noted that ‘Profiting without exposing to risk is like trying to live
without being born’. Risk and return are therefore the core reason for the
existence of commercial banks. (Atakelit ,2015) Therefore it is important to
examine the level of credit risk management system and practice of Ethiopian
Commercial banks to initiate top level management and regulatory bodies to take
policy measure toward maintaining adverse effect of the credit function.

This is where the concern about this research topic began and stimulated the
researcher to assess the credit risk management practice in one of the private
banks, BOA, the Bank which had faced high credit default and bounded to

16 

 
minimize its profit up to 80%. Hence, this paper endeavors to assess the actual
credit risk management practicing of Bank of Abyssinia by comparing with the
most important and best practices behind credit risk management, identify and
recommend the new initiation which will improve the credit risk management
system of the Bank

1.2. Statement of the Problem

Channeling fund from surplus area, to needed area, financial intermediations,

using product and service associated to lending is the key activity and the major
source of income for commercial banks. According to Maclonal and Koch (2006)
cited by Solmon (2013), lending represent the heart of the Banking industry. The
loan balance is typically the largest asset and predominant source of revenue.
The very nature of the Banking business is so sensitive because more than 85%
of their liability is deposits from depositors (Sounders, Cornett, 2005) cited
Solomon (2013). Banks use these deposits to generate credit for their borrowers,
which in fact is a revenue generating activity for banks. This credit creation
process exposes the Banks to high default risk, which might lead to financial
distress including bankruptcy.

In today’s changing financial landscape-environment of intense competitive

pressure, volatile economic conditions, rising bankruptcies, and increasing
levels of consumer and commercial debt; an organization’s ability to effectively
monitor and manage it risk is critical.

In addition more than 80% of a bank balance sheet is generally related to this
aspect of risk management, and also a large portion of their income is derived
from interest income associated to credit management process. This high
dependence on credit creation process and the availability of huge demand on

17 

 
credit exposes the Banks to different risks associated with such facility. Hence,
credit risk management is crucial to the success of any bank.

The organization’s ability to effectively monitor and manage its credit risk can
mean the difference between success and failure. Effective credit risk
management attracts today more attention than before. Interest income and
interest expense are the main determining factors for the profitability of private
banks in Ethiopia (Yigremachew, 2008).

In this regarded, Bank of Abyssinia is the one and the only private bank which
had faced big credit default and minimize its profit by 80% and also still the
amount of provision for loss loan, though it was a declining trend is the highest
from its peers banks average ( Dashen, Wegagen, Hibert, Awash,NIB)(NBE data
from year 1997-2013)

Few researches were conducted in Ethiopia in the area of credit risk

managements such as Sahlemichel (2009), Atakleit (2015) , Wondimagegnehu
(2012). Most of the studies reviewed focuses were on factors affecting the credit
risk management and their impact of tackling credit default, assessment of
determinants of NPLs and its performance on banks instead of evaluating the
full implementation of credit risk management pillars. Consequently, this
research will focus on an entire review of the credit risk management
techniques and practices of the Bank.

Therefore, the above problems in addition with the knowledge gaps associated to
evaluation of the full implementation of credit risk management pillars is the
principal concern of this paper. Considering implementation of proper credit
risk management is key tool that helps to mitigate risk failure depending on its
application.

18 

 
1.3. Research Questions

The organization’s ability to effectively monitor and manage its credit risk, using
the credit risk management tools, can make the difference between success and
failure in today's highly competitive environment. In this regard the study will
describe the present state of affair of the Bank since it doesn’t have any control
over the variables, which is the extent of application of credit risk management
tools and measurement techniques of the Bank. Therefore, the study attempts to
answer the following questions.
● What are the activities performed in the credit management process at the
Bank?
● What tools/techniques of credit risk management are used by the Bank?
● How does the Bank, identify, measure, monitor and control credit risk?
● What gaps exist between the credit risk management system of the Bank
and the benchmark theories and principles?

1.4. Objective of the Paper

1.4.1. General Objective

The main objective of this study is to assess the credit risk management
practice of the Bank.

19 

 
 1.4.2. Specific Objectives

The following were specific research objectives

● to identify the techniques that the Bank is used to measure its

credit risk
● to identify the gap in relation to best practice

1.5. Significance of the Study

This paper examines the proper application of credit risk management in the
private banking industry with special focus on Bank of Abyssinia to clearly
diagnose the existing credit risk management practice. The Bank may consider
the recommendation to improve its existing credit risk management processes
which in turn will help to protect the Bank from future damages.

The outcome of this study could also have practical relevance to pinpoint key
point for policy makers towards credit risk management implementation in the
Banking industry. Finally, It also fill some knowledge gap associated the
implementation of credit risk management pillars by producing the status of
credit risk management application and could also serve as input for further
research on the area more specifically on the implementation of key variables or
component of standardized credit risk management tools.

1.6. Scope of the study

The scope of the study is to overview the application of credit risk management
practice of the Bank, hence, the key area on credit risk management process as
compare to acceptable standard focusing only on city branches, which consists
up to 80% of credit portfolio of the Bank.

20 

 
1.7. Organization of the study

The paper presented on five chapters; the first chapter covers the introduction,
background of the study, research question, and objective statement of the
problem, significance and scope of the study. The second chapter indicates
review of related literature which includes information from books, journals,
articles and reports, chapter three describes the research design, type and
source of data the sampling techniques and size and data analysis methods while
the fourth chapter presents the data analysis and interpretation part, the last,
which consists of summary ,conclusion and recommendation is chapter five

CHAPTER 2

Literature Review 

21 

 
In this chapter the researcher tries to discuss overview of the theoretical
consideration to explain factors related to credit risk management from books,
articles, research papers, internet publications and unpublished sources

2.1. Risk and Risk Management Process

Risk is the element of uncertainty or possibility of loss that prevail in any

business transaction in any place, in any mode and at any time. To sustain its
operation, a business has to earn revenue/profit and thus has to be involved in
activities whose outcome may be predictable or unpredictable. Hence, risks
don’t disappear, they gave users a choice; which to retain and which to shed
(Bagch 2006 ),

In the financial arena, such risks can be broadly categorized as Credit Risk,
Market risks and organization risk (Bagch 2006 ). Managing such risk is not a
new phenomenon, has been there over the ages in some form or other, to make
decision on which to retain and on which to shed, through its various forms and
were not called market risk, credit risk or operational risk as they are today.
Specially, the concern over risk management arose from the development of
–the downfall of the oldest merchant bank in February-1995, the Asian financial
crisis in July 1997, the Japanese bank crisis of 1993 and Bank for International
settlements (2003), Fukao (2003), International Monetary Fund (2003), Kashuap
(2002), American financial crises of 2007-2009, were the consequences of
uncollectible (non – performing loans). The above incidents make to come to
certain conclusion about risk and risk taking decisions, among that

● risk do increase over time in a business, especially in globalized

environment

22 

 
 ● Increasing competition, the removal of barriers to entry to new business
units by many countries, higher order expectations by stakeholders lead to
assumption of risk without adequate support and safeguards.
● a mere quantitative approach to risk perceptions –arising out of trading
volume, earning level. doesn’t reveal the inherent drawback in an
organization/ system
● The introduction of new technologies , while introducing countless
benefits, has also created many new risks for an organization
● The external operating environment in the 21 century is noticeably
different. it is not possible to manage tomorrows event with yesterday’s
system and procedures and today’s human skill

Such incident and the existing globalized stiff competitive market highly
magnify the importance of risk management in recent times. The international
regulatory authority, the Bank for International Settlement at Basel, Switzerland,
has been working on a well- structured risk management system. Risk
management is thus a functional necessity and adds to the strength and
efficiency of an organization on an ongoing basis. Effective risk management is
critical to any bank for achieving financial soundness. In view of this, aligning
risk management to bank’s organizational structure and business strategy has
become integral in banking business. The efficacy of any risk management
system depends on its architecture, this comprise the following essential
elements (Bagch, 2006)

● A clearly defined and structured organizational set- up to mange

enterprise- wide risks
● Commitment of the highest level of those who see the policy framework
and oversee implementation within the organization- that is the Board
Directors and Senior Management

23 

 
 ● Codification of risk management policies/principles, articulated is such a
way that it serves the organizational risks appetite within the continuous
of risk perceptions,
● Implementing strategy of the direction through specific risk management
process so as to effectively identify measure and control risk.
● Manpower development initiatives to improve the skill- sets of people in
the organization
● Periodic evaluation
● Risk audit

Prerequisites for Efficient Risk Management In order to implement efficient risk

management, sound and consistent methods, processes and organizational
structures as well as IT systems and an IT infrastructure are required for all five
components of the control cycle. The methods used show how risks are
captured, measured, and aggregated into a risk position for the Bank as a whole.
In order to choose suitable management processes, the methods should be used
to determine the risk limits, measure the effect of management instruments on
the Banks risk position, and monitor the risk positions in terms of observing the
defined limits and other requirements. Processes and organizational structures
have to make sure that risks are measured in a timely manner that risk positions
are always matched with the defined limits, and that risk mitigation measures
are taken in time if these limits are exceeded. Concerning the processes, it is
necessary to determine how risk measurement can be combined with
determining the limits, risk controlling, as well as monitoring. Furthermore,
reporting processes have to be introduced.

The organizational structure should ensure that those areas which cause risks
are strictly separated from those areas which measure, plan, manage, and
control these risks. IT systems and IT infrastructure are the basis for effective

24 

 
risk management. The IT infrastructure is a central prerequisite for
implementing modern risk management. Hence, implementing risk
management will also insist to have supported with defined organizational – set
up and defined role of the officials, principles and policy. It will also have a clear
risk management process. Risk management process is a vehicle to implement
an organization’ risk principles and policies, aided by organizational structure,
with the sole objective of creating and maintain a healthy risk culture across the
organization.

Internationally, the risk management process has four components;

-identification, measurements, monitoring and control. It is apparent, therefore
that the risk management process through all its four wings – identification,
measurement, monitoring and control- facilitates the organization's,
sustainability and growth.

2.2. Credit Risk.

The concept of credit has existed from the early day of civilization. Nowadays
credit implies monetary and monetary- equivalent transactions. It also includes
non- monetary and/or barter transactions. Roughly we can define. “a transaction
between two parities in which one ( the creditor or lender ) supplies money or
monetary equivalent good, service, etc. in return for promise of future payment
by other ( the debtor or borrower ) .such transaction normally include the
payment of interest to the lender (Joseph, 2006 ). The term ‘credit’ in the
terminology of finance has an omnibus connotation. it not only includes all
types of loans and advances ( known as funded facilities ) but also contingent
items like letter of credit, guarantees and derivative ( non funded/ non credit
facilities ). investment in security is also treated as credit exposure (Bagchi,2006

25 

 
).Credit risk is the bank’s risk of loss arising from a borrower who does
not make payments as promised. . Accordingly to Basel Committee “ Credit
risk is most simply defined as the potential that a borrower or counterparty will
fail to meet its obligation in accordance with agreed terms.

Banks need to manage credit risk inherent in the entire portfolio as well as the
risk in individual credits or transactions. Credit risk is calculated on the basis of
possible losses from the credit portfolio. Potential losses in the credit business
can be divided into — expected losses and — unexpected losses Expected losses
are derived from the borrower's expected probability of default and the
predicted exposure at default less the recovery rate, i.e. all expected cash flows,
especially from the realization of collateral. The expected losses should be
accounted for in income planning and included as standard risk costs in the
credit conditions. Unexpected losses result from deviations in losses from the
expected loss.  ​
Unexpected losses are taken into account only indirectly via
equity cost in the course of income planning and setting of credit conditions.
They have to be secured by the risk coverage capital (Oesterreichische National
bank ).

Additionally, banks should be aware that credit risk does not exist in isolation
from other risks, but is closely intertwined with other risks. Credit risk is by far
the most significant risks faced by banks and the success of their business
depends on accurate measurement and efficient management of these risks to a
greater extent than any other risk (Gieseche, 2004 cited by Solomon2013).

2.2.1. Common Causes for Credit Risk

Credit risk decision is a complex process which implies a careful analysis of
information regarding the borrower in order to estimate the probability of

26 

 
regular repayment. Any consequence on such decision will result to severe
damage to banks. It. is, therefore, necessary to look into the cases of credit risk
vulnerability. The main cause of credit risk include, limited institutional
capacity, inappropriate credit policies, volatile interest rates, poor management,
inappropriate laws, ineffective control processes, poor loan underwriting, laxity
in credit assessment, poor lending practices, government interference and
inadequate supervision by the central bank( Kithinji,2010). cited on Solomon(
2013 ). According to (.Bagchi,2006 ) broadly, there are three sets of causes
● Credit concentration​
- The extent of concentration any group can pose a
threat to the lender’s well being. Such measure should be evaluated in
relation to institution’ capital base (paid- up –capital+ reserves), total
tangible assets and prevailing risk level. The alarming consequence is the
like hood of large losses at one time or in succession without an
opportunity to absorb the shock.
● Credit granting and/or monitoring process​
​ - ineffective appraisal system
and pre sanction care with lack of supplemented by an appropriate and
prompt post- disbursement supervision and follow-up system
● Credit exposure in the market and liquidity-sensitive sectors- ​
associated to
absence of compact analytical system to check for the customers’
vulnerability of liquidity problem.

2.2.2. Forms of Credit Risk Exposures in Banks

Credit involves not only funds outgo by way of loans and advances and
investment, but also contingent liabilities. Therefore, credit risk should cover the
entire gamut of an organization’s operations. Whose ultimate “loss factor is
quantifiable in terms of money. According to( Bagchi, 2006). The following can
be considered as the form credit risk

27 

 
 ● Non repayment of the principal of the loan and/ or the interest on it
● Contingent liabilities like letter of credit/ guarantee issued by the Bank
of the client and upon crystallizations amount not deposited by the
customer.
● In the case of treasury operation, default by the counterparties in
meeting the obligations
● In the case of securities trading. settlement not taking place when it due
● In the case of cross- border obligations, any default arising from the
flow of foreign exchange and/or due to restrictions imposed on
remittance out of the country

2.3. Credit Risk Management  

Credit risk Management is the process of controlling the potential con-sequence
of credit risk. ( Solomon, 2013).The credit risk management provides the broad
canvas and infrastructure to effectively identify, measure, manage and control
credit risk both at the portfolio and individual levels- in accordance with an
organization’s risk principles, risk policies.(Ibid). Credit risk management
processes enforce the Banks to establish a clear process in for approving new
credit as well as for the extension to existing credit. These processes also follow
monitoring with particular care, and other appropriate steps are taken to control
or mitigate the risk of connected lending (Basel, 1999).Credit granting
procedure and control systems are necessary for the assessment of loan
application, which then guarantees a bank’s total loan portfolio as per the
bank’s overall integrity (Boyd, 1993). It is necessary to establish a proper
credit risk environment, sound credit granting processes, appropriate credit
administration, measurement, monitoring and control over credit risk, policy
and strategies that clearly summarize the scope and allocation of bank credit

28 

 
facilities as well as the approach in which a credit portfolio is managed i.e. how
loans are originated, appraised, supervised and collected, a basic element for
effective credit risk management (Basel, ,1999). The Basel committee has
pointed out the main problems associated to bank failure- which looks, lax credit
standard for borrowers and counterparties, poor portfolio risk management and
lack of attention to change in the economic situation or other circumstance. Thus
international regulatory authorities felt that a clear and well laid management
system is the first prerequisite in ensuring the safety and stability of the system.
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
(Basel, 1999). Since exposure to credit risk continues to be the leading source of
problems in banks world-wide, 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.( Basel ,1999 )
Accordingly to Basel requirement the following are the key principle or
standards that should be apply

2.3.1. General Principles of CRM

29 

 
Principles for the Assessment of Banks’ Management of Credit Risk
A. Establishing an appropriate credit risk environment
Principle 1: The board of directors should have responsibility for
approving and periodically (at least annually), reviewing the credit
risk strategy and significant credit risk policies of the Bank. The
strategy should reflect the Bank’s tolerance for risk and the level of
profitability the Bank expects to achieve for incurring various credit
risks.
Principle 2: Senior management should have responsibility for
implementing the credit risk strategy approved by the board of
directors and for developing policies and procedures for identifying,
measuring, monitoring and controlling credit risk. Such policies and
procedures should address credit risk in all of the Bank’s activities
and at both the individual credit and portfolio levels.
Principle 3: Banks should identify and manage credit risk inherent
in all products and activities. Banks should ensure that the risks of
products and activities new to them are subject to adequate risk
management procedures and controls before being introduced or
undertaken, and approved in advance by the board of directors or
its appropriate committee.

Operating under a sound credit granting process

B. ​
Principle 4: Banks must operate within sound, well-defined
credit-granting criteria. These criteria should include a clear indication of
the Bank’s target market and a thorough understanding of the borrower or
counterparty, as well as the purpose and structure of the credit, and its
source of repayment.

30 

 
 Principle 5: Banks should establish overall credit limits at the level of
individual borrowers and counterparties, and groups of connected
counterparties that aggregate in a comparable and meaningful manner
different types of exposures, both in the Banking and trading book and on
and off the balance sheet.

Principle 6: Banks should have a clearly-established process in place for

approving new credits as well as the amendment, renewal and
re-financing of existing credits.

Principle 7: All extensions of credit must be made on an arm’s-length

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

C. Maintaining an appropriate credit administration, measurement and

monitoring process
Principle 8: Banks should have in place a system for the ongoing
administration of their various credit risk-bearing portfolios.

Principle 9: Banks must have in place a system for monitoring the

condition of individual credits, including determining the adequacy of
provisions and reserves.

Principle 10: Banks are encouraged to develop and utilize an internal risk
rating system in managing credit risk. The rating system should be
consistent with the nature, size and complexity of a bank’s activities.

31 

 
 Principle 11: Banks must have information systems and analytical
techniques that enable management to measure the credit risk inherent in
all on- and off-balance sheet activities. The management information
system should provide adequate information on the composition of the
credit portfolio, including identification of any concentrations of risk.

Principle 12: Banks must have in place a system for monitoring the overall
composition and quality of the credit portfolio.

Principle 13: Banks should take into consideration potential future changes
in economic conditions when assessing individual credits and their credit
portfolios, and should assess their credit risk exposures under stressful
conditions.
D. Ensuring adequate controls over credit risk
Principle 14: Banks must establish a system of independent, ongoing
assessment of the Bank’s credit risk management processes and the
results of such reviews should be communicated directly to the board of
directors and senior management.
Principle 15: Banks must ensure that the credit-granting function is being
properly managed and that credit exposures are within levels consistent
with prudential standards and internal limits. Banks should establish and
enforce internal controls and other practices to ensure that exceptions to
policies, procedures and limits are reported in a timely manner to the
appropriate level of management for action.

32 

 
 Principle 16: Banks must have a system in place for early remedial action
on deteriorating credits, managing problem credits and similar workout
situations.
E. The role of supervisors
Principle 17: Supervisors should require that banks have an effective
system in place to identify measure, monitor and control credit risk as part
of an overall approach to risk management. Supervisors should conduct
an independent evaluation of a bank’s strategies, policies, procedures and
practices related to the granting of credit and the ongoing management of
the portfolio. Supervisors should consider setting prudential limits to
restrict bank exposures to single borrowers or groups of connected.

2.3.2. Credit Risk Management Process

Credit risk management process is a set of outlined activities aimed at managing
credit risk. These activities will cover the range from credit granting to credit
collection. They are risk identification, measurement, assessment, control and
monitor (Ngwa cited by Solomon 2013). As any risk management process, credit
risk management process started by identifying the risk involved in the credit
process. It is necessary to spell out the danger signals. This in turn helps
decision makers to get the best from various activity points of the organization,
allowing them to take calculated risks and not be risk averse. While identifying
risk, all types of risk must be identified and their likely effect in short- run be
understood. The magnitude of each risk segment should be identified and
dominate risk activities must be separated from the other. In addition a clear
way of identifying risk in an organization is to scan both balance sheet items and
off- balance sheet items and finds the risk elements.

33 

 
The other activity in credit risk management process is measurement.
Measurement means weighing the contents and /or value intensity magnitude of
any object against a yardstick. In risk measurements it is necessary to establish
clear ways of evaluating various risks categories in an organization. In lending
activity, for higher credit limit detailed qualitative and quantitative analysis with
sophisticated credit rating models may be required because the size of the credit
rating models would indicate the size of default and risk and its ultimate effect
on the institution. Among the factor the availability sufficient and compatible and
reliable MIS and conducting the validation activities is the critical one.
Then the monitoring phase then comes in. in this phase, keeping close track of
risk identification measurement activities in the light of the risk, principles and
policies is a core function. it is essential that the operating wings perform their
activities within the broad contour of the organization, risk perception. Such
activity ensures that each credit decisions activities to have clear lines of
authority and responsibility.

The final issue is controlling phase, this is the activity that helps to regulate or
guide the credit risk management process in the credit as well as on the entire
organizations thorough set of control devices. Such activities can be achieved by
assessing risk profile techniques regularly, analyzing internal and external audit
feedback from the risk angle and by putting in place a well drawn- out risk
focused audit system.

2.3.3 Credit Risk Management Measurement

Measuring risk is always a critical part in risk management process, and
suggested by (Fabozzi ,2006) there are three categories of methods for bank
credit risk measurement-

34 

 
 2.3.3.1. Credit Risk Rating
​
A credit rating is for assessing the credit worthiness of an individual or
corporations to predict the probability of default, which is based on the financial
history and current assets and liabilities of the subject (Solomon ,2013). Such
rating framework deploys a number / alphabets/ symbol as a primary summary
of risk associated with a credit exposure, and involved both internal and external
credit rating. A well structured risk rating system provides a good means of
differentiating the degree of credit risk in the credit portfolio of a banking
institution (Ibid). This will allow more accurate determination of the overall
characteristics of the credit portfolio, quality distributions, problems credits, and
the adequacy of loan loss reserves. (Comptroller’s handbook ,2011 )

2.3.3.2. Credit Scoring System -Credit scoring uses quantitative measures

of the performance and characteristics of past loans to predict the future
performance of loan with similar characteristics (Dean and kossmann ,2003 )

2.3.3.3. Credit Risk Modeling​

-
Accordingly to (Basel ,1999b) credit risk models attempt to aid banks in
quantifying, aggregating and managing credit risk across geographical and
product lines, and the outputs can be very important to banks’ risk management
as well as economic capital assignment. regarding the potential benefits from the
application of credit risk models in banking sector, (Basel ,1999b) has conclude
that they are responsive and informative tools offering banks a framework for
examining credit risk in a timely, manner, centralizing data on global exposures
and analyzing marginal and absolute contribution to risk. In most cases, credit
models concentrate on one single important issue – default risk. Investigating its
characteristic (mostly finding statistical distribution) analytics can transform it

35 

 
into related dilemmas: how to measure it and how to price credit risk. The first
one gives a chance of proper distinguishing more risky investments from the
saver ones, the second one allows to calculate the value of the debt considering
yield margin reflecting risk undertaken. (Tomas ,2011)

According to four types of credit risk models that are better known or commonly
used by banks are – Altman’s Z score model, Credit metrics model, value at risk
model and KMV model (Jackson and perraudin ,1999).

● Altman’s Z score model​

- predicts whether or not a company is likely to
enter into bankruptcy within one or two years. The Z-score is a linear
combination of four or five common business ratios, weighted by
coefficients. The coefficients were estimated by identifying a set of firms
which had declared bankruptcy and then collecting a ​
matched sample of
firms which had survived, with matching by industry and approximate
size (assets)Altman applied the statistical method of ​
discriminates
analysis to a dataset of publicly held manufacturers. The Variables
influencing the financial strength of a firm are; current asset, total assets,
net sales, interest, total liability, current liability, market value of equity,
earning before taxes and retained earnings.

Credit metrics model​

-  is a tool for assessing portfolio risk due to changes
in debt value caused by changes in obligor credit quality. We include
changes in value caused not only by possible default events, but also by
upgrades and downgrades in credit quality. Also, we assess the
value-at-risk (VaR) – the volatility of value – not just the expected losses.
Importantly, we assess risk within the full context of a portfolio. We
address the correlation of credit quality moves across obligors. This allows

36 

 
 us to directly calculate the diversification benefits or potential
over-concentrations across the portfolio .(George and finger ,2007 ). The
model advocates that the amount of portfolio value should be viewed not
just in terms of likelihood of default, but also in terms of credit quality over
time of which default is just a specific case.

Value at risk (VaR) - is a statistical technique used to measure and

quantify the level of ​
financial risk within a firm or investment ​
portfolio
over a specific time frame. Value at risk is used by risk managers in order
to measure and control the level of risk which the firm undertakes. The
risk manager's job is to ensure that risks are not taken beyond the level at
. ​
which the firm can absorb the losses of a probable worst outcome​ Value at
Risk is measured in three variables: the amount of potential loss, the
probability of that amount of loss, and the time frame​
.  

­​
Merton​based models​
- are a model, named after the financial scholar
Robert C. Merton​
, that was developed in the 1970s and is used today to
evaluate the ​
credit risk of a corporation's debt in order to determine a
company's ability to service its debt, meet its financial obligations and to
gauge the overall possibility of credit default.. The current value and the
volatility of the firm’s assets, the outstanding debt and its maturity are
required as inputs from which the borrower’s default probability can be
determined ( Hull, and white, 2004 )

37 

 
 
2.4. Tools for Credit Risk Management
​

● The instruments and tools, through which credit risk management is

carried out are detailed below:(Thirupathi and Manojkumar,2013)
o Exposure ceilings- prudential limits is linked to capital funds say X
percent for individual borrowers
o Review/renewal –multi-tires credit approval authority, constitution
wise delegations of powers
o Risk rating model- set-up of comprehensive risk scoring system on
a six to nine point scale.
o Risk based scientific pricing-lining loan pricing to expected loss.
o Portfolio management-stipulating quantitative ceiling on aggregate
exposure on specific rating categories, distribution of borrowers in
various industry, business group
o loan review mechanisms- independent review credit functions

38 

 
 CHAPTER 3

Research Methodology

3.1. Research Design

To search design used is a descriptive research method. The main aim of the
study is to describe the present state of affair of the Bank in relation to the
implementation of credit risk management principles and to evaluate to which
extent the credit risk management tools are implemented.

The pertinent data needed to answer the research questions is the main focus of
the design through structured questionnaires, and review of relevant
documents, annual reports, central bank directives and other related
publications. Respondents were professionals and senior managers from risk
management, credit department and branch managers.

3 .2 Source of Data
In this study, both primary and secondary data were collected. Primary data
from using structured questionnaire. As a base for defining the questionnaire
some adoption was considered from the study of Sahlemeichal mekonnee,2009.
The secondary data from reviewing the working policy documents, periodic and
central bank directives and other relevant documents were collected.

3.3. Method of Data Collection

39 

 
 The method of data collection was survey method. To collect the required data
from respondents structured questionnaire ( Adopted from Hailm,,) was
employed. The primary data were collected from selected key personnel from
the credit and risk management and branches using hand delivered
questionnaire and the secondary data were collected from the Bank’s working
policies, procedures and other materials.

3.5. Sampling Techniques

The bank lending process has been operated by the new concept of liability
processing center where by the whole credit processing and decision making
practice is done at head office. The branch is role is minimized to collection
information about customers and some analysis work. Hence, the key
participants on the population size of the this study are by few employees- on
Head office organs and selected branch. Hence, Stratified sampling method was
employed to select relevant respondents with each group. Thus, the population
of the study was divided into sub- population or strata based on Sample
respondents were randomly selected from each stratum accordingly .Such
measure will enable the researcher to have sufficient information or different
opinion of various personnel working at different areas.

3.6. Sample Size

The credit processing activity of the Bank is organized with the new concept,
liability processing center, under the credit division. The analysis, the
relationship management activities to corporate customers and sanction
activities above certain limit has been done by the head office organ under the
processing center. In addition the workout activities are separately organized
under legal division to handle and manage the problematic loans. The role of the

40 

 
branches towards credit processing somehow limited; their main activity is to
dwell on small credit, facilitating credit relationship management and on
managing non- performing loans. In addition the risk management department
is also established , as per the NBE guidelines, Hence, the head office organ, ,the
credit analysis , relationship management and portfolio management wings, the
workout divisions , the risk management and 45 big branches with average loan
size of Birr 20 Million are considered as the population size. The minimum staff
involved on credit on the above selected branches, is two. Thus the total
population size of the above selected branches 118.

The total number of sample that represent the 100 population with 99%
confidence level size is 87 (Krejcie and Morgan, 1970). Hence, the total sample
size is for the above population looks as follows.

Selected group Representative sample

Credit analysis and relationship management 15
Risk management Department 6
Workout Division 7
Branch staff 60
Total 88

3.7. Data Analysis

All the data gathered through this research were analyzed using descriptive
statistics. Thus, frequency count and percentage were used to analyze the data.
Tables were employed to substantiate the research undertaken.
3.8. Validity and Reliability

41 

 
Validity is about the honest nature of the research conclusion and applicability (
Ghauri & Gronhaug 2010). Accordingly, to ensure the contents validity, 10
selected officers, those who know better about the issue being investigated as a
pilot test. As a result the researcher proven that and reached at the confidence
level same answer would be availed to another independent researcher.

42 

 
 CHAPTER FOUR

DATA ANALYSIS AND DISCUSSION

The chapter discusses the result of the empirical data collected. It will also define
the conclusions and also the recommendations, proffered for improvement of
the credit risk management activity of the BOA.

The analysis part is done with two main parts in relation to source, primary and
secondary, used for the study. The primary data are analyzed using frequency
distribution tables and the secondary data are also descriptively analyzed using
different ratios.

The questionnaires were distributed to represents the key credit risk managing
organs. As per the Bank’s organizational structure, the credit processing activity
of the Bank is organized with the new concept, liability processing center, under
the credit division. The head office organs, the credit analysis and portfolio
management wings, the workout divisions, the risk management and the big
branches with average loan size of Birr 20 Million are considered as the
population size.

All officers in risk management department, credit analysis and portfolio staff
and 8 staff of workout and 50 branches are considered to the population size.
Thus the total population size of the above selected branches is 118. Considering
60 staff from randomly selected branches an, all, 15, staff from credit analysis, 7
staff from risk management and 6 staff from workout were considered as
sample size and to be taken as respondents. Thus the total sample size is 88,
which was about 63% of the total population. Among such sample size 72
questionnaires or 81% were collected and used for analyzing the Data.

43 

 
4.1. Demography

Table 1-Respondent with respect qualification level

Qualification Frequency Percentage

Master and above 12 17
Degree 60 83
Diploma -
Total 72 100
​
Source: own survey 2016

As we can see from the above table, among the respondent who responded to the
questioner 83% of them have degree and 17% of them with master degree. This
result was attested that the majority of the respondents were graduates who
have the required knowledge to understand the concept of risk management
which they applied to their day to day activities​
.

Table 2-Respondent with respect work experience

Qualification Frequency Percentag

e
1-5 years 18 25
5-10 years 18 25
Above 10 years 36 50
Total 72 100
​
Source: own survey 2016

The above table shows that the frequency and percentage of years of experience
of the respondents whom they have worked in areas defined on the
determination of the population size. The researcher asked this question to
verify the knowhow and experience of the respondents on the subject matter.
The result shows that 75% of the respondents have working experience above
five years, and the remaining 25% working with the range of 1-5 years. Such
result implies that most of the respondents have sufficient experience pertaining

44 

 
to credit risk management. From such result it is possible to conclude that the
better possibility to amass sufficient information about the subject matter, risk
management, and which in turn would help to reach to the correct conclusion.

Table 3-Respondent with respect current position

Qualification Frequency Percentage

Managerial 47 65
Professional 25 35
Clerical
Total 72 100
​
Source: own survey 2016

As shown in the above frequency distribution, 65% of the respondents are

working at managerial position and the remaining 35% are professionals. This
indicates that this study paper addresses the supervisory line employees which
functionally related and part of the critical decisions making practices associated
to credit sanctioning and credit risk operational activities of the Bank​
.

4.2. Credit Risk Assessment

​

4.2.1. Level of Credit Risk

Table 4-Level of credit risk on various transactions

No risk Very low High Very

risk risk high
risk
Direct lending 10% 90%
Guarantees or letter of 87% 13%
credit
​
Source: own survey 2016

The researcher asked the above question in order to know the understanding of
the respondents about the type of credit product and the associated degree of

45 

 
risk that the Bank will highly exposed to. Such question will also help to evaluate
the understanding and the associated measures of the respondent in relation to
the risk level. Accordingly, the respondents indicates that direct lending is a high
risk category product with which 90% of them attested on, while the risk
associated to guarantees or letter of credit risk is categorized as very low risk
category. Hence, direct lending product is highly vulnerable to credit risk to the
Bank.

.2. 2. The technique / instrument used for credit risk management

Table 6- The technique/instrument, used for credit risk management

Credit approval authority 2

Prudential limit 3
Risk rating 5
Portfolio management 6
Loan review policy 4
Collateral 1
Diversification 7
Other please specify____________
​
Source-own survey 2016

On an effort to know more about a question associated on identifying the most

important instrument/techniques which were used by the Bank for credit risk
management, is forwarded to the respondents. As per the summarized result
presented on the above table, number one instrument which is used as a key
instrument or technique for managing the risk associated to credit is collateral,
which is followed by credit approval, prudential limit. On summarizing the
above table the respondent is choosing more than one instrument/ techniques
for managing credit risk, which they utilized on their day to day activities.

46 

 
 Diversification, prudential limit and portfolio management are ranked low by
majority of the respondents. Considering this fact, the Bank rely on collateral as
a key instrument to manage the risk associated to borrower default​
.

4.2.3. Off- Balance Sheet Commitment

One of the questions associated to credit risk management is the question
associated to off- balance commitment, which some time neglected by due to
understanding of the nature of standard accounting practice. Which mainly
focused on the items associated and categorized as , asset , liability and capital
and not critically examining the impact of such exposures associated to other
balance sheet items. This exposure is one of the major sources of credit risk, it is
important to access whether the Bank has defined any exposure to manage off
balance-sheet exposure in its book. Hence, the question, does the Bank have
defined exposures for managing off- balance sheet exposures? is forwarded to
the respondent. Accordingly, 75% of them attested that the existence of exposure
limit, while the remaining 25% of them didn’t responded to the questions, this
may occur due to the unfamiliarity and lack of due concern about the office-
balance sheet commitment. As per the respondent, the Bank has defined
off-balance sheet commitment exposure limit associated to its capital.

4.2.5 Pricing Credit Risk

Table 7. Factors considered for pricing credit risk
Highly considered Somehow Not
considered considered considered
Portfolio quality 80% 14% 4% 2%
Value of collateral 86% 14% 1
Future business potential 27% 17% 40% 16%
Portfolio industry exposure 20 12 31% 37%
Tenure period of credit 25% 20% 32% 23
Any other please specify

​
Source-own survey 2016

47 

 
The responses obtained in this regard are presented in the above table.
According to the amassed data presented on the above table, value of collateral
and portfolio quality are the most important and the second most important
factors that are considered for pricing credit risk by the majority of the
respondent. Tenure period of credit and future business potential have claimed
third and fourth position, respectively. The last rated parameter is the portfolio
industry exposure.

The pricing of credit risk should depend on how much the riskier of the loan
product and viability of the customers business than concentrating on value of
collateral, which is the second way out in the event of default. While the practice
of the Bank associated to pricing credit risk is mainly rely on collateral value.

4.2.6 Credit Risk Model Used

Table8.Credit risk models

Models Frequency percentage

Altman’s Z score model -
Merton based model/KMV model

Credit metrics model 5 7%

Value at risk model 9 13%
Other please specify
Not used 11 15%
25
No response 47 65%
Total 72 100%
​
Source-own survey 2016

In this uncertain and volatile economic environment, it is necessary to utilize

any tools that help proactively assess the default risk and to handle any risk
associated to their customers regarding payment of their obligations. Hence,
making use of different credit risk model for evaluating the existing credit

48 

 
portfolio of the Banks is merely applied on banks. Accordingly, the researcher is
asking the respondent about the use of models on the Bank.

As per the result shown on the above table, the respondent didn’t have any
knowledge or awareness regarding the models that are mentioned on the
questioner. Considering the target group, which is directly engaged on credit
risk management activity, lack of awareness on such tool, risk model, should
question about understanding of using of models on credit risk management
activities.

4.2.7. Measuring Credit Risk

Table 9. The tools used by the Bank to measure credit risk?

Activities Frequenc Total Percentage

y Frequenc
y
Internal rating 54 72 75%
Through the Five C’s if credit 40 72 55%
Through financial statesman 45 72 62%
Human Judgment through 33 72 46%
experience
Other specify
​
Source-own survey 2016

As it was found on the above table, the Bank has utilized different tools to
measure credit risk, as per the respondent , the internal rating is more utilized
tool to evaluate following on relying on financial statement judgment. As per the
Bank’ credit manual also the combination of different measurement tools used
to evaluate the credit risk. Such measures help the Bank to analysis the risk in
relation to the different risk exposures.

49 

 
4.2.8., Calculation of Probability of Default of Customers
​
Table10- probability of default

Frequency Percentage
We calculate 5 7%
We don’t calculate 38 52%
Our studies are going on 29 41%
Total 72 100%
​
Source-own survey 2016

As we can see from the above table, 93% of the respondent attested for not doing
calculation of probability of default at customer level. Such measure has shown
the gap on the activity of the Bank in relation to the risk identifications,
measurement and controls activity.

4.2.9.. Calculation of Recovery Rate of a loan

​
Table 11- calculation of recovery rate of loan

Frequency Percentag
e
yes 59 82%
No 13 18%
Total 72 100%
​
Source-own survey 2016

The 82% of the respondents have ascertained that the existence of the activity
associated to the calculation of recovery rate of the loan. Associated to the
corresponding question of when, some of the respondents indicate that time
when the loan status is categorized as NPL.

50 

 
4.2.10 Activity Performed for Credit Risk Management
Table 12- Activities for credit risk management
Rank
Industries studies/ profiles 5
Periodic credit calls 3
Periodic visits of plants 2
Developed MIS 6
Credit risk rating/ risk scoring 1
Annual review of accounts 4
​
Source-own survey 2016

The response from the respondents associated to ranking the activities

performed for credit risk management at the Bank is shown on the above table.
The main aim of the question is to evaluate the tendency of the Bank on various
activities that should be performed for managing credit risk. As per the amassed
information from the respondent, “credit risk rating” and periodic visits of plants
are the most popular activities. While among activities, credit risk rating is also
properly handle with certain standards. “Periodic credit calls and annual review
of accounts are performed in their order of importance for managing credit risk.
Industries studies/profiles and developed MIS are given the minimum
importance as credit risk management activities.

The required importance is not given to the “development of MIS “which should
deserve to be the key area of attention. In addition the “industries studies”
should also be considered the best attention area. MIS is one of the important
tools that enable the management to properly asses, identify, measure and
monitor and control the risk associated on credit risk management. Even the
other credit risk management activities should also not be an effective tool
without the availability of the proper MIS. Even further the industries
studies/profiles should also be given the necessary attention in relation to

51 

 
properly analyzing the overall industry profile, in the face of huge competition in
the market. Injecting additional disbursement without properly analyzing the
industry position may enlarge the occurrence of the probability of default.

Thus, the Bank should focus on developing MIS as the prerequisite to developed
effective credit risk management activity. Organized information are the key
tools to forecast and or also to develop the better probability of identifying the
risk and or also to develop the mitigating and controlling mechanisms

4.3. Credit Risk Management Review Functions

4.3.1 Risk Reporting and Training
Table 13 risk reporting status

Activities Frequency Percentage

On a regular, formal basis 69 96%
(separate )
As part of other 3 4%
management reporting
On and adhoc basis
Not reported at all
Total 72 100%
​
Source-own survey 2016

The above table shows 96% of the respondent acknowledge that the risk
management report is prepared on regular or formal basis.

4.3. 2 Credit Risk Management Training

Table 14- Credit risk management training

Activity Frequency Percentage

Never 12 17%
Half yearly 8 11%
quarterly 6 8%
Annually 46 64%
Total 72 100%

52 

 
 ​
Source-own survey 2016

Risk management training is a key instrument in order to build the required

knowledge and to create the necessary awareness on new risk management
techniques and updates on newly and identified risk types. As per the
respondent 64% of them have taken training program annually, while the
remaining 8% have taken quarterly. Considering the above efforts as a good
endeavor, the reaming 17% had never taken any training program. In relation to
the sample groups, which have the role to make decisions on credit management
activities, such figures may have some impact on the efficiency of the
performers.

4.3.3.. Advisory Services to its Loan Customers

Table 15-providing advisory service

Frequency Percentage
Yes 29 39%
No 43 61%
Total 72 100%
​
Source-own survey 2016

The respondents for question associated to the advisory service to its loan
​
customers 61% of them have witnessed for not giving the necessary advisory
service to the client while the remaining 39% of them had supported the
availability of the service. The researcher understand that, such gap is observed
due to the Bank marketing segmentation strategy and the corresponding service
to its clients, corporate customers who owns the highest amount of credit
exposure are separately handled with assigned relationship manager. Each
corporate customer has one relationship manger who facilitate and follow-up
the overall relationship and gives the necessary advisory service.

53 

 
As per the respondents, the following points are the forms used by the Bank

● Recommending the best way to handle the situation whenever the

customers face difficulty in any condition associated to their business
through consultation ;
● Visiting their business and the corresponding marketing activities and
recommending the best way to handle and
● Communicating whenever there is big macro and micro economic
environment changes.

4.3.4.. The problems Encountered During Debt Recovery from

Customers

On this open ended question some of the respondents have given their response
as follows;

● Mostly customers have taken long time to get involved in the recovery
process;
● Unplanned and spontaneous movements to mitigate the problem and
● Diversion of fund and not clearly stated their doing and associated the
failure to the existing business.

Regarding the measures that have been taken in connection to processing

and sanctioning activities associated to credit which later turn out bad, the
respondent stated that the availability of different work out strategies to
mitigate the problem such as extending of time, injection of funds and so on.

54 

 
4.4.. Credit Risk Management process
Table 16-level of agreement for credit risk management process

4.4.1.. Credit processing /appraisal Strongl Agre Neutra Disagree Strongly

y agree e l disagree
The Bank checks the borrowers history before 59% 41%
granting loans
The Bank properly assess the customer ability 23% 28% 49%
to meet obligation
Credit- granting approval process established 30% 50% 20%
accountability for decision taken
There are times credit granting and monitoring 31% 53% 16%
process is overridden by Executives
The Bank carried out credit processing 69% 18% 13%
activities independent of the appraisal function
4.4.2.Credit administration
The process of credit administration is 29% 18% 25%
performed independently of individuals
involved in the business organizations
The Bank has well structured documentation 19% 39% 19% 23%
tracking system for credit and collateral files
4.4.3.monitoring and control of credits
Collateral coverage is regularly assessed and 17% 34% 11% 18%
related to the borrower’s financial health
The Bank regularly undertakes stress testing on 29% 14% 57%
the overall credit portfolio
The Bank periodically prepared credit quality 11% 45% 44%
reports for signaling loan loss in any portfolio
The Bank monitors the business of clients after 14% 40% 33% 13%
granting credits on regular interval basis
Customers are often given sufficient training on 10% 25% 11% 52%
loans usage
4.4.4. Managing problem credit/recovery
The Bank segregates the workout activity from 47% 53%
the area that originated the credit
The Bank has credit risk policy that clearly set 21% 72% 7%
out how problem credits are to be managed
The Bank has appropriate criteria for credit 26% 74%
classification, provisioning and write off
Adequate measures are put in place to recover 5% 55% 40%
non-performing loans
Source-own survey 2016

55 

 
The researcher define these questions in order to clearly understand the overall
credit risk management process of the Bank .The key categories which the
researcher wants to find responses from the respondents, who are the critical
points on this activity, are the credit processing / appraisal process, the credit
administration, monitoring and control of credits and managing problem credit/
recovery. Accordingly, key questions were forwarded to the respondents to get
the confirmation of their agreements or disagreements on established scales, the
result looks as follows.

4.4.1. Credit Processing and Appraisal

Under this category, the first question forwarded to the respondents is regarding
to their agreement whether the Bank checks the borrower's history before
granting loans. Accordingly, 59% of them strongly agree and the remaining 41%
also confirm their agreements on checking of borrowers history before granting
loans. From this we can conclude that the Bank has made an effort to check the
borrower's’ history before granting the loan. The next question under this
category is associated to the proper assessment of customers’ ability to pay or to
meet their obligations, which mainly support the quality of the assessment on
the side of the Bank. Accordingly, 23% of them strongly agree and 28% of agree
on popper assessment of the customers’ request and the overall agreement rate
of the respondents were 51%. While the remaining 49% of them remain neutral,
such agreement somehow questioned the assessment quality of the Banks
associated to customers’ capacity to meet their obligations.

The third question on this category is associated to availability of the

accountability process of the Bank associated to the credit decisions practices.
To the questions associated to find the confirmation of their agreements for the
time that credit granting process is established accountability, among the

56 

 
respondents 50% of them remain neutral and the remaining the 30% agree, while
20% of them disagree. Such result clearly indicate the absence of accountability
to credit decision and critically questioned of the Bank’s commitment on setting
accountability associated to each empowerment on credit process.

The question associated to the interference of the Bank’s executives on credit

granting process, were to confirm their degree of agreement on there are times
credit granting and monitoring processes is overridden by , 31% of the
respondent strongly agree and 53% of them confirms their agreement, while only
the remaining 16% of them are disagree. Such result, the interference of the Bank
executives, is critically hamper the process of proper appraisal of the customers
based on facts and data associated to the customer and also the prevailing
economic condition, macro and micro environment. Instead subjective
evaluation on the capacity and knowledge of the executive is become the key
decision parameters.

The final question on this category is to confirm the availability of independent

appraisal function. Accordingly to the question requested the respondent
agreement of the Bank carried out credit processing activities independent of the
appraisal function. 18% of the respondent disagree and the 13% remaining neutral
and the remaining 6% agree on credit processing activities are carried out
independent of the appraisal function.

Based on the above facts associated to credit processing and appraisal activities
of the Bank, the quality of the assessment on customers’ ability is in question
and also absence of accountability on credit decision and the unnecessary
intervention of the executive on credit granting process are the key drawbacks.

57 

 
4.4.2. Credit Administration
The researcher wants to confirm that how the credit administration activity of
the Bank is done associated to its independence and or on its organization.
Accordingly, regarding the question on independent organizations of the credit
administration 60% of them disagree on while 22% of them agreed and the
remaining 18% of them holds neutral status. On the availability of well structured
documentation and tracking system the 24% respondent disagree while the
remaining 42% agree and the remaining 14% remain neutral. This result shows
that the credit administration activity of the Bank is neither organized
independently not well structured.

4.4.3. Monitoring and Control of Credit

Under this category, the researcher wanted to evaluate the monitoring and
control activity of the Bank associated to credit risk management. Accordingly,
the implementation and the availability of key tools such as collateral coverage
and regular assessment, stress testing, business visit were examined based on
respondent responses.

The first question under this category is associated to regular assessment of

collateral in relation to borrowers’ financial health. Accordingly, 47% of the
respondents agreed on the assessment of collateral while 18% of them disagree
and 11% of them remain at neutral status. In relation to the activity associated to
stress testing, the 57% of them disagree on implementation of such activity and
14% are neutral on status.

To the level of agreement question associated to the preparation of credit quality

reports, 56% of them agreed on the implementations of such activity, while the
remaining 44 remained neutral. The next level of agreement question associated
to the activity in relation to monitoring the business activity of the ients after

58 

 
granting credits on regular interval basis, on agreement level, 14% strongly agree
and 40% agree on while 13% remain neutral and the remaining 13% disagree on
the implementations of the activity. The final level of agreement question is the
activity on regular and sufficient training to the customers on loan usage.
Accordingly, 52% of the respondent disagrees on the availability of the activity
and 8% of them remain neutral.

On the monitoring and control activity of the Bank associated to conducting

stress testing activity, which enables to see the capacity and the associated
measures in relation to different scenarios, worst and good, and on evaluating
the capacity to stand with on such scenarios are not as per the standard of credit
risk management activity. In addition, the Bank has conducted regular visit of its
customers, while the effort towards developing a mechanisms on creating the
necessary awareness is only focused to its corporate customers.

4.4.4. Managing Credit Problem/recovery

On this category, the researcher wants to know more about the activity in
relation to the management of problems on credit. The first key question
associated to the activity is the organizational position of the workout activity.
Accordingly, on the level of agreement question associated to the segregation of
workout activity from the area that the credit is originated, 100% of the
respondents agree on the segregation of the workout activity. Regarding the
availability of the credit policy regarding the management of problem credits 72%
of them agreed and 18% strongly agreed only the 10% remained neutral. In
connection to the availability of sufficient criteria for classification, provisioning
and write off, 74% of the respondent agree and the remaining 26% with strong
agreement endorse the availability of the documents.

59 

 
The final question, after the attesting, the availability of all documents on
managing the problem loans, the researcher wants to ask is the availability of
the corresponding measures associated to recover non-performing loans.
Accordingly, to the level of agreement questions associated to the availability of
adequate measures to recover non-performing loans, 60% of them agree, while
40% of them remain neutral

As per the respondents, the Bank has the necessary organizational frame works,
which separate the workout from the loan credit process, and also sufficient
document and criteria to bad loan classification, while the availability of
sufficient measure associated to non-performing loans is not as proven by the
respondent.

4.5. Secondary Data Analysis

One of the tools used by the researcher used in order to meet the object of the
study is secondary data collections. The Bank’s policy, procedures annual and
quarterly reports, central bank directives and financial report status( unofficial )
were critically examined to in order to further examined to show the actual
Credit Risk Management . The analysis made on evaluating the existing position
of the Bank rather than predicting the trend.

Bank of Abyssinia was established on February 15, 1996 and started operation
with an authorized and paid up capital of Birr 50 Million and Birr 17.8. Million
respectively, and with only 131 shareholders and 32 staff,. In about seventeen
years since its establishment of Bank of Abyssinia has registered a significant
growth in paid up capital and total assets. Currently, the Bank has an authorized
capital of Birr 1.5 Billion and a total deposit balance of Birr 9.Billion and a total
loan and advance of Birr 7.Billion. Presently, Bank of Abyssinia has almost 3,000

60 

 
employees and more than 400,000 customers. The number of share holders
reached to 1,637.

The main activities of the Bank are mainly focused on playing the intermediary
role or mobilizing deposit from surplus section and delivering in the form of
credit to the needy sector, to perform such activities the Bank has deliver
different product and services to its customers. Among the activities the
account management activities like saving account, demand deposit, are the key
to mobilize deposit from surplus section and to support the cash movement
transactions to its customers. On the other part, transactional service activities,
such us money transfer foreign and local, foreign letter of credit and facilitating
export transactions are the main ones. In addition the Bank also gives different
service to its customers such as, Card banking, mobile banking, the conventional
banking service of Domestic banking and international banking service.

As one of the key activity of the Bank, credit risk management activity, presently
has organized on three distinct activities under two Departments and one
section. The activities are the credit analysis and appraisal department, the
relationship management and work-out section. The two credit departments,
credit analysis and appraisal and the corporate relationship management are
accountable to the V/President Operations, while the work-out division is
organized under the legal department. The Bank has adequate policies and
procedure, limits and graining criteria as well as documented credit risk
management guidelines.

In addition the Bank establish risk management Department, which is

independently organized and accountable to the Bank’ Board. Based on this
principle BOA has developed a risk and compliance management Guidelines
enacted since 2011. Accordingly, as part of the risk management framework of

61 

 
the Bank, the Risk Management and Compliance Department has been entrusted
with the following tasks

1. Overview the overall credit quality of the Bank’s total loans and
advances at portfolio and transaction level, provisioning
requirements and customers’ exposures;
2. Ensure that the lending process is being done in accordance with
the provisions of the credit-risk-management policy;
3. Conduct periodic reviews of internal credit ratings;
4. Produce quarterly reports regarding the loan portfolio and the
overall credit risk, using the designed reporting system; and
5. Prepare a matrix that shows the overall direction of the
credit-risk-management level of the Bank on quarterly basis.

4.5.1. Disbursement Performance and Quality of loan

One of the key components which may help us to evaluate the Bank
performance on credit is loan to deposit ratio, which mainly shows the capacity
of the Bank’s management towards utilizing the resource mobilized. The overall
trend of the Bank in utilizing the overall deposit mobilization looks as follows.

62 

 
 Graph 1. Loan to deposit ratio

Source NBE report

As we can seen from the above table, the capacity to utilize the resource
mobilized in the form deposit is very fluctuating. On the year 2011, the ratio was
reached to lowest stage, which shows the availability of the amount of deposited
mobilized not properly disbursed, in the face of high credit demand in market.
As the acceptable ratio, 80-85% considering NBE bill and 53-58% excluding NBE
bill is a key performance indicator which are somehow constant at any time,
the trend of loan to deposit ratio of the Bank shouldn’t fluctuate as above.

The second trend that the researcher wants to examine is the credit risk
management endeavor of the Bank, associated to the cumulative provision on
doubtful loans as a ratio of outstanding loans and advances. Such figure mainly

63 

 
associated to the amount of Non Performing loan of the Bank which helps to
understand the effect of credit risk management activity of the Bank.

The research wants to analyze such trend of the Bank as compare to peer
groups instead of the overall bank's’ position as well from all private banks. Peer
banks are somehow similar on their capital strength, age of establishment,
number of customer, human resource, and technology usage. Comparing the
Bank’s position with the peer banks may help to critically evaluate the overall
trend of the Bank’s credit risk management capacity as compare to the key
participant on the market with the same capacity

Table17 : Cumulative provision to loans and advances ratio

Average Total
Name of (6 Average Averag
Bank Years) 2009 2010 2011 2012 2013 (5 Years) e

Dashen 2.55 2.23 2.17 2.03 2.11 - 2.14 2.71

AIB 2.90 5.82 4.95 3.77 2.78 2.36 3.94 4.05

BOA 6.11 10.90 8.00 3.45 2.64 2.03 5.40 6.26

Wegagen 4.57 6.48 4.14 4.76 2.49 2.29 4.03 4.82

United 2.61 3.19 3.79 2.85 2.39 1.89 2.82 3.07

NIB 3.28 4.83 4.06 4.30 2.79 2.57 3.71 3.87

Source: Annual Reports of Peer Banks

64 

 
As obviously known the poor asset quality of BoA’s loans and advances is the
main reason for high ratio of provision to loans. The Bank’s first six years
average was more than 6%, it reaches its pick level in 2009 (i.e. 10.9%) and
shows a declining trend and reach to 2.03% in 2013. The annual provision held
on doubtful loans and advances as a ratio of total loan portfolio which mainly
associates to the amount of nonperforming loan of the Bank is higher on average
from its peer banks​ Which one way or another shows that relatively poor
. ​
capacity on credit risk management activity of the Bank specially on properly
addressing and managing the credit risk starting from origination up to
settlement of the loan.

4.5.2. Credit Concentration Risk Indicators

Under this category the researcher wants to evaluate the Bank’s portfolio
 ​
associated to one of the key risk measurement tools, concentration risk.

A. Sector Review

Economic sector concentration showed that Domestic Trade & Services took
the highest share (43.05%) of total loan balance trailed by Export (20.05%) and
Housing and construction sector loans (14.85%), while Import loans represent
(14.12%). The sector wise loan concentration of the Bank was not evenly
distributed. While in general the Bank’s outstanding loan portfolio is
dominated by domestic and international trade finance with the three
(domestic trade, Export and Import) sector categories representing nearly
(78%) of the Bank’s outstanding loan portfolio stand out as the more
concentrated sector at.

65 

 
 Overall assessment of sector wise loan concentration shows that (92.75%) the
Bank’s outstanding loans are lent in two broader sectors of the economy: the
trade sector and the construction sector. Outstanding loans due to the other
three important sectors of the economy: Industry, Transport &
Communication and Agriculture along with personal loans represent only
7.25% of the Bank’s total outstanding loan portfolio as at March 31, 2016.

While the Bank’s focus on lending for trading businesses is associated with
the overall structure of the economy and the very nature of commercial banks
reliance on short term funding.

B. Product Review

Concentration of loan portfolio by product type indicated that Term Loans

constituted the majority by taking up 65% followed by Overdraft facilities
taking a share of 23% of the total portfolio, while Advances on Import & Export
Bills and Merchandise Loans represent 9% as at March 2016

C. Geographical Concentration
​

Concentration of loans by Branches showed that outstanding loans are

distributed between city branches and outlying branches in an uneven
manner favoring city branches. That is, 73% of the total outstanding balance of
loans and advances was held by city branches while the rest 27% was held by
outlying branches. This indicates the Bank’s outstanding loans are
geographically highly concentrated at the Addis Ababa City. Given the
economic activity concentration in the Capital City, this could be considered a
structural reality with inherent risk element as at March 2016.

66 

 
 However, geographical loan concentration within the capital city if seen
together with the sector wise concentration of the outstanding loans in the
Domestic & International Trade Sectors can become a cause for enhanced
concentration risk.
D.​
​
Concentration of Loans at Large Borrowers

The total amount of outstanding loan and advance possessed by top twenty
borrowers has reached Birr 25.09% of the total outstanding loans at the end
of March 2016. This indicates that one-fourth of the loan is concentrated in
twenty borrowers and this shows there is high concentration loans by few
borrowers as at March 2016.

4.5.3. Credit Quality- Non-Performing Loans

NPLs balance at the end march 2016 has reached to 5.41% of the total loan
portfolio. This is above the statutory requirement set by the NBE or
regulatory authority.

67 

 
 CHAPTER FIVE

CONCLUSIONS AND RECOMMENDATIONS

5.1. Conclusions

Lending is the heart of banking industry. While doing so, the integral
element of uncertainty or possibility of loss, risk, is faced by the Banks
associated to lending or credit activity. Managing this risk is a vital with the
help of standardized credit risk management tools in order to survive and
thrive in such volatile and competitive environment.

Accordingly, this study aim to evaluate the credit risk management practice
of one of the private bank, Bank of Abyssinia, with the established objective.
The analysis of primary and secondary data revealed some very interesting
aspect about the credit risk management practices of the Bank. Regarding
the respondents who responded to the questionnaires, 83% of them have a
degree and the remaining 17& with master degree, which sufficiently
support the availability of the required knowledge associated to the risk
management practice of the Bank. The majority of respondents believe that
direct lending is the key source of risk the Bank will exposed. The result as
per the predefined objective of the study looks as follows.

i. The overall assessment of the credit risk management practice of the

Bank look as follows. The Bank has adequate policies and procedure,
limits and graining criteria as well as documented credit risk
management guidelines. In addition the Bank has also established

68 

 
 risk management Department, which is independently organized and
accountable to the Bank’ Board. Based on this principle BOA has
developed a risk and compliance management Guidelines enacted
since 2011. While doing so the under mentioned results have been
obtained as a research findings.
● The key challenges on implementing credit risk management
activities of the Bank are lack of management information
system and also the timeliness and quality of information, which
are the key variable to make proper credit assessment and able to
forecast the probability of any occurrence.

o The tools which are used in credit risk management by the Bank
are mainly depending on collateral value and credit approval
authority. the Bank didn’t utilize other methods like portfolio
management, diversification

o As part of credit risk management activities different tasks were

conducted by the Bank, as a good juncture, while the key activity
such as industries studies , which help to critically examine the
industry potential to accept the new demand is not properly
handled or get due consideration

69 

 
 o The activity associated to risk report is a good endeavor , which
helps to review the risk management activity of the Bank, though
the researcher couldn’t find any responses associated to any
finding emanated from the such regular reports
o Pricing of credit risk mainly associated to the collateral value in
the Bank. the Bank didn’t consider the viability of customer
business, which should be the key point to consider the pricing
risk
o Under credit processing and appraisal activities of the Bank, the
quality of assessment on customer ability is not fully attested by
the respondent, and also lack of sufficient information, were
identified as a drawback. In addition lack of accountability and
executives overridden activities were also noted on the Bank’s
credit processing and appraisal activity. Such activities will have
negative impact on the quality of credit process and appraisal
activities
o The credit administration activity of the Bank is not getting the
necessary attention and there is no structured document tracing
system
o Under monitoring and control activities of the Bank, stress
testing on the overall credit portfolio is not conducted,
o The necessary advisory service had not given to all Banks’ loan
customer.

o The Bank has adequate policies and procedure, limits and

granting criteria as well as documented credit risk management
guidelines on managing problem loans. while on managing

70 

 
 problem loans the adequate measures are not taken as required
to recover non-performing loans
o Concentration risk associated to sector, product and geography
are also existed on the Bank. In addition high concentration of
loan by large borrowers is also witnessed on the credit portfolio
of the Bank.
ii. The techniques used by the Bank to measure its risk,
▪ The study finding shows that collateral is used as a number
one technique used by the Bank to manage credit risk.
Regarding the use of model to forecast the portfolio risk,
presently, the Bank didn’t utilize any model. Even the
awareness of the staff in relation to the matter is not as per the
expectation. In addition The Bank didn’t calculate the
probability of default of each customer. In general proper
credit risk measurements are not used by the Bank such as
credit risk rating, credit scoring system and credit risk
modeling.

iii. The following key points are observed as compared to best practices.
According to Basel requirements, the key four categories are defined
as best practice to manage credit risk. The under mentioned gaps are
observed by the Bank based on the result found

71 

 
 o Establishing an appropriate credit risk environment is one
of the best practices established to manage credit risk.
Such practices mainly depend on key requirements, on the
availability of credit procedure and about the role of the
Bank’s Executives associated to the implementation of
such procedure. Accordingly as per the input found on
secondary data, the Bank has sufficient credit risk strategy
and credit policy approved by the concerned organs.

o Operating under sound credit granting process under this

practice, the key issues under this best practice are mainly
depends on the availability of credit granting criteria,
limits, process on approving new credits as well as the
amendments. Regarding such best practices, the Bank has
defined credit granting criteria, which is almost deepened
on the value of collateral, which is the critical gap on this
best practice.

o Maintaining an appropriate credit administration,

measurement and motioning process. Under this best
practices frame works, the critically tasks are the
availability of administering capacity of various credit risk
portfolios, system of monitoring the condition of individual
credit, the availability of information system and analytical

72 

 
 techniques , assessing individual credit portfolios. As per
the research finding, the wide gap on implementation of
best practices is observed on this category. The bank has
no well defined management information system, the
monitoring effort also jeopardize due the absence of the
required information. The analytical techniques used to
define credit risk are almost not compatible to the existing
environment.

o Ensuring adequate control over credit risk, under this

category the key issues are the independent assessment of
the credit risk, and the availability of internal control and
remedial actions. Accordingly, the Bank has established
risk management department and the independent review
has been conducted regular.

In summary there are both good points that are appreciated and areas need
improvement. To this the following points are recommended based on the study
findings

5.2. Recommendation
​

73 

 
 In line with the findings obtained, the following recommendations are
forwarded

● Information is a crucial input for conducting, proper assessment on

customers’ ability and on understanding the overall track record of the
customer. It also help to measure and monitor the credit risk inherent in
all on-and off- balance sheet items. Hence the Bank should build well
organized management information system , which support the overall
credit assessment activity of the Bank

● The Bank management should prepare itself to move into the new
environment of financial operation and trading and equip itself to cope-up
with new tools and systems capable of assessing, monitoring and
controlling risk exposures in a more scientific manner. Different portfolio
management tools, risk monitoring and control tools and model should be
used, instead of relying on traditional project financing and computing
mechanism and dependence on collateral.

● The Bank should give a key concern on minimizing its concentration risk,
by developing different methodologies to diversify the credit
concentration on one or two sectors, location and geographical areas.
Associated to individual credit concentration one fourth of the credit
portfolio of the bank is in the hand of very few large borrowers, which the
Bank should consider serious concentration.

74 

 
 ● The Bank should strengthen its advisory role associated to create the
necessary awareness on timely payments and other and should also
incorporate the whole credit customers of the Bank. In addition to present
practice of availing the service to corporate customers.

● National Bank of Ethiopia should also strengthen its on-site examination

and also regularly review the credit risk management activity of the Bank

● NBE should also enforce the Bank to develop code of conduct, to prohibit
the interference of executives from overriding the Bank’s policy and
procedures.
✓ Recommendation for further study.

The improper credit risk management practices of any Bank will have a great
impact on the overall financial sector and also on the economy. Hence, the result
what is obtained on this paper may also be the fact of other private banks. Hence,
future research should be required on how to develop a standardized credit risk
management practices in the sector.

75 

 
 

Saint Marry University

Questionnaire

Dear respondent
This questionnaire is designed to gather information for the research to be conducted
on “Credit risk Management practice at Bank of Abyssinia”. The purpose of the study
is to fulfill a thesis requirement for the Masters of Business Administration (MBA ).
Your response for this questionnaire is extremely important for successful
completion of my thesis and also to serve as a great input the Bank.

The information that you will provide will only be used for the purpose of the study
and kept strictly confidential.

I would like to thank you for your cooperation and sparing your valuable time for my
request.

Please put tick mark one of the give choice

Part I. Personal information

1. Gender Male Female

2. Years of service:- _______________

3. Educational level _____________

76 

 
4. Your working place__________________

Part II. Research related questions

1. Please tick the level of credit risk being faced by the Bank on the following questions

No risk Very low High Very

risk risk high
risk
Direct lending
Guarantees or letter of
credit

2. Tools of credit risk management

2.1. Which technique/instrument, do you use for credit risk management in your
bank? (​
Please tick and you can choose more than one answer)​

Credit approval authority

Prudential limit
Risk rating
Portfolio management
Loan review policy
Collateral
Diversification
Other please specify____________

2.2​
. Does the Bank have defined exposures for managing off- balance sheet
exposures?

Yes no

2.3. Please rate, which of the following factors you consider for pricing credit risk?

77 

 
 Highly considered Somehow Not
considered considered considered
Portfolio quality
Value of collateral
Future business potential
Portfolio industry exposure
Tenure period of credit
Any other please specify

Altman’s Z score model

Merton based models/KMV model
Credit metrics model
Value at risk model
Other please specify____________
Not utilized
2.4. Please indicate which of the following credit risk module your use for evaluation
of ​
please tick you can choose more than one answer

2.5. What are the tools used by the Bank to measure credit risk?

1. Internal rating

2. Through the five C’s of credit

3. Through financial statement ratios

4 .Human judgments through experience

5. Others, please specify._____________________________________________

_______________________________________________________________

2.6, Do you calculate probability of default of customers?

We calculate we don’t calculate our studies are going on

78 

 
2.7. Do you calculate recovery rate of a loan?

Yes No

2.8. If yes, when do you calculate this (Hint: at the time loan is pass, special mention,
or at all

Time).____________________________________________________________
______

3. Activity performed for credit risk management

3.1. Does the Bank perform the following activities for credit risk management

Most Important Least Not

important Important used
Industries studies/ profiles
Periodic credit calls
Periodic visits of plants
Developed MIS
Credit risk rating/ risk scoring
Annual review of accounts

3.2. Which of the following best describes the way risk management is reported
within the Bank?

1. on regular. Formal basis

2. as part of other management reporting

3. on an adhoc basis

4. Not reported at all

3.3. How often the Bank provides credit risk management training

79 

 
 1. Never

2. Half yearly

3. Quarterly

3. Annually

3.4. Does the Bank provide any advisory services to its loan customers?

Yes no.

3.5. If yes. What form does it take?

----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------

3.6. What are the problems encountered during debt recovery from customers?

----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
-----

3.7. What measures have been taken in connection to processing and sanctioning
activities associated to credit which later turn out bas?

----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
-----------

5. Credit Risk Management process

Please provide your level of agreement using the following rates

5.1.. Credit processing /appraisal Strongl Agre Neutra Disagree Strongly

y agree e l disagree
The Bank checks the borrowers history before
granting loans

80 

 
The Bank properly assess the customer ability
to meet obligation
Credit- granting approval process established
accountability for decision taken
There are times credit granting and monitoring
process is overridden by Executives
The Bank carried out credit processing
activities independent of the appraisal function
5.2.Credit administration
The process of credit administration is
performed independently of individuals
involved in the business organizations
The Bank has well structured documentation
tracking system for credit and collateral files
5.3.monitoring and control of credits
Collateral coverage is regularly assessed and
related to the borrower’s financial health
The Bank regularly undertakes stress testing on
the overall credit portfolio
The Bank periodically prepared credit quality
reports for signaling loan loss in any portfolio
The Bank monitors the business of clients after
granting credits on regular interval basis
Customers are often given sufficient training on
loans usage
5.4. Managing problem credit/recovery
The Bank segregates the workout activity from
the area that originated the credit
The Bank has credit risk policy that clearly set
out how problem credits are to be managed
The Bank has appropriate criteria for credit
classification, provisioning and write off
Adequate measures are put in place to recover
non-performing loans

6. Please give any comment or opinion about the Bank’ credit risk management practices

---------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------

81 

 
 REFERENCES

Credit Risk Management Practice of Ethiopian Commercial

Ataklet Hailu (2015) ​
Banks

Abdullahi Sani Rufai (2013) E

​fficiency of Credit Risk Management on the
Performance of Banks in Nigeria A​
Study of Union Bank PLC (2006-2010).

82 

 
AbedalfattahZuhair Al-Abedallat and 2faris Nasif Al- Shubiri (2013), A
​nalysis the
Determinants of Credit Risk In Jordanian Banking​
: An Empirical Study.

Determinants of Bank Profitability: Company-Level Evidence from

Aburime, U. (2005) ​
Nigeria. Nigeria: ​
University of Nigeria, Enugu Campus.

Ainembabazi Brenda (2013), R

​isk Management and Profitability of Financial
Institutions:​
A case of Stanbic Bank, Katwe Branch.

Akhavein, J.; Berger, A. N.; Humphrey, D. B. 1997. The effects of megamergers on

efficiency and prices: Evidence from a bank profit function, Review of Industrial
Organization 12(1

Sound practice for the

Basel committee on banking and supervision (2001) ​
​asel committee publication No.86.Basel
management of Operational risks, B

Principles for the management of credit risk

Basel committee (July, 1999a) ​

Credit risk modeling​

Basel committee,(April 1999b). ​ ; current practice and
applications Basel committee on supervision

Determinant of Private banks profitability​

Benti Yigremachew (2008 ) ​ .

Practice and challenge of CRM in selected Ethiopian banks​

Berhan Tefera (2014) ​ ,
unpublished

rd​
Credit Management​
Bass,R.M.V.(1999), ​ ,3​ Ed, Stanly Thorms Publishers Ltd
Credit Risk Management​
Boyd.A 1993 ​ , Journal of Banking regulation 9(1) 24-45

Comptroller‘s Handbook (2001 ). R

​ating credit risk​
, comptroller of the currency
Administration of National banks

83 

 
 Credit Risk Analysis​
Ciby Joseph (2006) ​ Tat McGraw hill

nd​
Credit Risk Models and Management​
David Shimko, ​ ,2​ Ed Canda 2004.
Risk Management in Ethiopian private Banks​
Desaleng Ayalew (2014) ​ ,
unpublished

Dean,Cair and Rober Kosman (2003) C

​redit Risk Scoring​
, www.modelrs.ac.sir

The risk metrics growth​

George M.Gupton.Christpher.C, finger (2007) ​ .J.P.
Morgan 2007

George S. Oldfied (1997 ) the Place of Risk Management in Financial institutions

University of Pennsylvanian

Ghauri, Prevez & Gronhagu, Kjell (2010 ). R

​esearch Methods in Business
t​
h​
Studies,4​ Edition Pearson Education Limited Essex, England.

Credit Risk Modeling​

Jackson, Nickel and Perradin (1999) ​ , Bank of England.

John hull ,Izzay Nekien (2004) M

​erton Model​
. www.rotamn.utranto.

Risk Management in Banking​

Joel Besis (2008) ​ John wiley & sons

Credit Risk Management and Profitability of Commercial

Kithnijc.A.M.(2010 ).​
Banks in Kenya​
School of business, University of Nairobi, Nairobi

Determining Sample Size for Research Activities​

Krejjice & morgan, ​ , Educational
and Psychological Measurements ,http//research advisor.com/

Machiraju, H.R, (2003), M

​odern Commercial Banking​
,Vikas 18.Publishing House
PVt.Ltd, New Delhi

Bank Management. ​
S.Cott Macdonald and Timothy W.Kock ​ South-western
carger learning

84 

 
 Credit Derivatives: New Financial Instruments for controlling
Neal,R.S. (1996) ​
nd​
Credit Risk​
.Economic Review 2​ quarter.

The Impact of Credit Risk Management on the

Nahom Shiferaw (2015) ​
Performance of Selected Commercial Banks in Ethiopia​
, unpublished

Proshenfi Ghosho (2014 Vol 5, No.1 ) Credit Risk Management .An empirical
study on BRAC bank Ltd

Credit Risk Management Practices in Commercial

Radd Mozib lalon (2015) ​
Banks of Bangladesh​
, International Journal of Economics, Finance and
management Sciences.

Bank Management​
Scott Macdonal and W.Koch(2006) ​ ,University of South
Carolina

Sahlemichale mekonnen (2009) C

​redit Risk Management System of Ethiopian
Commercial banks

Credit Risk Management​

S.k.Bagchi S.K. (2006 )” ​ -Jaico publishing house

Assessment of Credit Risk Management Practices at

Solomon goshime (2013) ​
Nib International bank, un​
published

Thirpuathi K. and M.Manojkumar (2013). Risk Management in Banking sector-

an Empirical Study, International Journal of Marketing Financial Service and
Management Research,Vol.2.No.2.

Thomas Zielinski(2014) Merton and KMV Models in Credit Risk Management,

University of Katowice,

85