ASSESSMENT OF CREDIT RISK MANAGEMENT (lN CASE OF UNITED BANK IN

BARENTU BRANCH).

A RESEARCH PROPOSAL SUBMITTED FOR PARTIAL FULFILLMENT OF

RESEARCH PROJECT REQUIREMENT FOR BACHELOR OF ARTS (BA) DEGREE
IN BUSINESS MANAGEMENT

PREPARED BY:

ABDULMALIK JEMAL 0483/19

DERARTU AMIN 0502/19
FEVEN AREGA 0514/19
HAILU DABA 0519/19
MEGERTU LULE 0549/19
SOSENA SOLOMON 0561/19

ADVISOR: Ms. ADANECH.(Msc)

RIFT VALLEY UNIVERSITY ADAMA MAIN CAMPUS

FACULTY OF BUSINESS AND SOCIAL SCIENCE

DEPARTMENT BUSINESS MANAGEMENT

JUNE, 2022

ADAMA, ETHIOPIA

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Table of Contents
ACKNOWLEDGEMENT.................................................................................................................................II
ABSTRACT...................................................................................................................................................III
CHAPTER ONE..........................................................................................................................................1
1 INTRODUCTION...............................................................................................................................1
1.1 Background of the Study.............................................................................................................1
1.2 Statement of the problem...........................................................................................................2
1.3 Research Question.......................................................................................................................2
1.4 Objectives of the Study................................................................................................................2
1.4.1 General objective.................................................................................................................2
1.4.2 The Specific Objective..........................................................................................................3
1.5 Significance of the Study..............................................................................................................3
1.6 Scope and delimitation of the Study............................................................................................4
1.7 Organization of the Paper............................................................................................................4
Chapter 2.....................................................................................................................................................5
2 Literature Review................................................................................................................................5
2.1 Theoretical literature...................................................................................................................5
Chapter 3...................................................................................................................................................12
3 Research methodology.......................................................................................................................12
3.1 Research Design.........................................................................................................................12
3.2 Study area and population.........................................................................................................12
3.3 Type and source of data............................................................................................................12
3.4 Sampling technique and sample size.........................................................................................12
3.4.1 Sampling technique...........................................................................................................12
3.4.2 Sample size........................................................................................................................12
3.5 Instrument of data collection....................................................................................................12
3.6 Method of analysis and presentation........................................................................................13
TIME AND COST BUDGET...........................................................................................................................14
Reference..................................................................................................................................................15

I
ACKNOWLEDGEMENT
First of all I would like to all almighty GOD, who give me health and strength. Secondly, I
would like to forward and express my heartfelt gratitude to my advisor, Ms.Adanech (MBA) for
his technical guidelines and constructive comments throughout the preparation to a completion
of this paper as planned a needed. Thirdly I have greatest love, belongings and gratitude my
families and to all my friends whose hand and encouragement is not separate from my all
careers. Finally I would like thank to all those who support me in the course of study completion

II
ABSTRACT
Credit risk management is very important issue for profitability of banks. This study is
investigated to analyze the credit risk practice of united bank Adama Boset branch. For the sake
of achieving the objective of the study, the researcher will use both primary and secondary data.
Primary data will be collected through questionnaire and interview. And secondary data will be
collected from annual report of the bank. The researcher will use non- probability sampling
techniques. Descriptive method of data analysis will be employed to analyze the collected data.
The data collected will be presented in tabular form with percentage computed values. Then
based on the finding of the study, recommendation and conclusion will be forwarded to the
concerned body

III
CHAPTER ONE

1 INTRODUCTION
1.1 Background of the Study
Credit risk management in a financial institution starts with the establishment of sound lending
principles and an efficient framework for managing the risk. For most banks, loans are the
largest and most obvious source of credit risk study and find out that there is a significant
relationship between bank performance and credit risk management. Loans and advances and
non-performing loans are major variables in determining asset quality of a bank. These risk items
are important in determining the profitability of banks. Where a bank does not effectively
manage its risk, its profit will be unstable.

Credit risk is defined as the potential that a bank borrower or counterparty will fail to
meet its obligations in accordance with agreed terms. Thus credit risk arises from
nonperformance by borrower or a counter party due to either inability or unwillingness to
perform as per the contracted. While the types & degree of risks an organization may be exposed
to depend upon a number of factors such as its size, complexity of business Risk activity, volume
etc., it is believed that generally banks face credit, market, liquidity, operational,
compliance/legal/regulatory & reputation risks. Across country experience evident that credit
activities are the main determining factors for the wellbeing of the financial sector’s, especially
in intermediation activities such as banking services (Yigremachew, 2008).

Credit risk is still the major single cause of bank failures, for the reason that more than 80% of a
bank’s balance sheet generally related to this aspect of risk management. The consultative paper
issued by Basel (1999) also pointed out that the major cause of serious banking problem
continuous to be directly due to the loose of credit standards for borrowers and counter
parties, poor portfolio risk management and so on (Hinnies, 2003).

Loan is typically the largest asset and the predominant source of revenue. As such it is one of the
greatest sources of risk to a bank safety and soundness. The very nature of the banking business
is so sensitive because more than 85% of their liability is deposits from depositors Banks use
these deposits to generate credit for their borrowers, which in fact is a revenue generating
activity for most banks. This credit creation process exposes the banks to high default risk
which might lead to financial distress including bankruptcy (Saunders & Cornett, 2005).

The key principles in credit risk management are establishment of a clear structure,
allocation of responsibility and accountability, processes have to be prioritized and
disciplined, responsibilities should be clearly communicated and accountability assigned thereto.
Organizing and managing the lending function in a highly professional manner and doing so pro-

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actively can minimize whatever the degree of risk assumed losses. Banks can tap increasingly
sophisticated measuring techniques in approaching risk management issues with the
advancements of technology (Yang, 2013).

This work takes one of private bank which is called united Bank as a case study and examines
the Bank’s state with regards to credit risk management.

1.2 Statement of the problem

Banking industry is a major source of finance for any type of business it may be in the form of
loan. Loan is one of the mechanisms used by financial institutions as a major source of
income. Also the process of repayment default is also fraud for the institutions. There are a
number of studies on credit risk management in Ethiopia, which examine the impact level of
credit risk management towards the profitability of selected united Bank.

The major issue of this paper is to assess and find out what tools and techniques are used in the
bank and to what extent their current performance are supported by proper credit risk
management policy, procedure and strategy and to what extent united Bank can manage its
credit risk.

Credit risk in banking is commonly the probability of a lender defaulting on his or her loan
commitments. Customers unwilling or unable to repay the credit they lend on timely base, the
officer’s failure in analysis of customer’s financial statement periodically and significant
numbers of none Performing Loans contribute to increased credit risks.

Taking the above concerns into account, it has been found appropriate to initiate this study to
make further investigation on the credit risk management practices of united Banks. To make the
study manageable within available time and resources, one of the private banks in Ethiopia,
united bank has been selected as a case study. Thus, the purpose of this study is to assess the
practice of credit risk management Practice as applied in united Bank S.C.

1.3 Research Question

 What are the challenges of credit risk in united Bank?

 What are the credit risk management practices in united Bank?

 What measure has been taken to minimize the credit risk of united Bank?

1.4 Objectives of the Study

1.4.1 General objective
The general objective of the study is to assess the practice of credit risk management system as
applied in united Bank S.C.

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 1.4.2 The Specific Objective
 To identify the challenges of credit risk management in united Bank

 To assess the credit risk management practices in united Bank

 To examine the measures that has been taken to minimize the credit risk of united Bank

1.5 Significance of the Study

This paper examines the application of credit risk management and determines shortcomings.
Thus, the subject matter of this research and the resulting lessons drawn from the analysis are
likely to benefit different classes of people. This study is significant for its contribution to
enhancing knowledge, managerial decision making, reference material and serves as policy
frame work. This study contributes to for the policy maker, for the bank itself and for coming
researcher.

For the policy makers

Credit granting is one of the main activities of banks and hence it is beneficiary to make some
reforms that lends to a better credit risk management. The findings and recommendations of the
study are highly important to policy makers because it draws their attention to some of the points
that need corrective measures on their side.

This study enhances knowledge and creates deep awareness for policy makers to execute rule
and regulation for controlling check and balance system, in the current situation the technology
up great itself human activity especially in business activity flourishes day to day and everything
become easy in this case the policy makers should have to care to make policy

For the bank itself

As we know, in the current situation the credit risk without examination or managing it become
the way of failure or bankruptcy for the creditor because the debaters’ does not fulfill their
obligation, therefore the creditors should have focus or read the situation of movement up on
credit risk management, as a result the significance of the study for the united Bank there is the
gap or hole what we are looking and review the practical and theoretical part of the united Bank.

The findings and recommendations are important to management of the banks under study
because it draws their attention to some of the points where corrective actions are necessary and
enable them to make such corrections.

For the coming researchers

The research can be used to establish a framework for subsequent studies that can work with
more comprehensive data set. Furthermore, it can stimulate further research; thus keeping
sustained interest in the area of credit risk management and their use in minimizing the banks
credit risk
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1.6 Scope and delimitation of the Study
The focus of the research is assessment of credit risk management practice of united Bank and
the research mainly focus on credit risk and loan recovery areas of this bank is engaged in
currently .in conducting this study the researcher face certain constraints. The first one is due to
data collection; respondent does not give full information desires for study. The reason is due to
work load. The second and the main obstacles are time and financial constraints, so this are limit
the study.

1.7 Organization of the Paper

The study will be organized into five chapters. Chapter one contains the introduction part of the
research, that include background of the study, statement of the problem ,objective of the study,
significance of the study, and scoop and delimitation of the study. Chapter two present important
related literature review. Chapter three is about research methodology that includes research
design, type and source of data, data collection method, target population and sampling
technique and sample size.

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 Chapter 2

2 Literature Review
2.1 Theoretical literature
Definition of credit

The amount of money available to be borrowed by an individual or a company is referred to as a

credit because it must be paid back to the lender at some point in the future, Basel (1999).

Definition of Risk

Risk can be defined as it is the potential for uncontrolled loss of something or it is a condition in
which there is a possibility of an adverse deviation from a desired outcome that is expected or
hoped for.

Definition of Credit Risk

Credit risk is the risk of default on debt that may arise from a borrower failing to make required
payment.

Credit risk is most simply defined as the potential that a bank borrower or counterparty will fail
to meet its obligation in accordance with agreed terms Basel (1999).

Definition of Credit Risk Management

Credit risk management is the practice of mitigating losses by understanding the adequacy of a
bank’s capital and loan loss reserve at any given time and it is a process which begins with
identifying the target markets and proceeds through a series of stages to loan repayment with the
objective of maximizing a bank’s risk adjusted rate of return by maintaining credit risk exposure
within acceptable parameter (Basel, 1999: 3).

The Need of Credit Risk Management

The goal of credit risk management should always be to maximize bank’s adjusted rate of return
by maintaining credit risk exposure within the entire portfolio as well as the risk in individual’s
credit or transactions. According to (http/www.erisk.com) bank oil the wheels of the economy.
They play a pivotal role in mobilizing saving. In doing so, they face risks arising from credit,
interest rate, liquidity, exchange rate, transaction, compliance, strategic and reputation. Banks
key challenge in managing risk in understanding the interrelation of this risk factors they may be
positively or negatively correlated. To be consistent with the research them the focus here is on
credit risk, which is the risk repayment that is the possibility that an obligor will fail to perform
as agreed. Banks led to individuals, corporations and government who in turn contribute to
growth, employment and better socioeconomic conditions.

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Banks should also consider the relationship between credit risk and other risk the effective
management of credit risk is a critical component of a comprehensive approach to risk
management and essential to the long term success of any banking organization. For most banks,
loans are the largest and most obvious source of credit risk. However, other sources of credit risk
exist throughout the activities of a bank, including the trading book and both on and off the
balance sheet. Banks are increasingly facing credit risk(countered party risk) in various financial
instruments other than loans ,including acceptance, interbank transaction, trade financing foreign
exchange transaction, financial future, swaps, bonds ,equities, options and in the extension of
commitment and guarantees, and the settlement of transaction.

Basel (2000) in his study on credit risk management held the financial institutions needed to
meet forthcoming regulatory requirements for risk measurement and capital. Managers need
reliable risk measures to direct capital to activities with the best risk or reward ratios. They need
the estimate of the size of potential losses to stay within limits imposed by readily available
liquidity.

Principles of Credit Risk Management

The goal of credit risk management should always be to maximize bank’s risk adjusted rate of
return. The credit risk management is the most critical issue in banking business success. It is
known that specific credit risk management practices may differ among banks depending on the
complexity of their credit activities; however this study is on the following important areas of
credit risk management.

 Establishing appropriate credit risk environment

 Operating under sound credit granting process
 Maintaining an appropriate credit administration,
 Measurement and monitoring process
 Ensuring the right internal control over credit risk
 The role of supervisors in credit risk management

Basel (1999:7-9) outlines basic principles while addressing the above areas of credit risk
management and presented in the following paragraphs.

Establishing an Appropriate Credit Risk Environment

Principle 1: The board of directors should have responsibility for approving and periodically
reviewing the credit risk strategy and significant credit risk policies of the bank. The strategy
should reflect the bank’s tolerance 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

6
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
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

Principle 4: Banks must operate under sound, well-defined credit-granting criteria. These criteria
should include a thorough understanding of the borrower or counter party, as well as the purpose
and structure of the credit, and its source of repayment.

Principle 5: Banks should establish overall credit limits.

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.

Maintaining an appropriate credit administration, measurement and monitoring process

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 should develop and utilize internal risk rating systems in managing credit
risk. The rating system should be consistent with the nature, size and complexity of a bank’s
activities.

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.

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Ensuring Adequate Controls over Credit Risk

Principle 14: Banks should establish a system of independent, ongoing credit review 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.

Principle 16: Banks must have a system in place for early remedial action on deteriorating
credits, managing problem credits and similar workout situations.

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.

Credit Risk Management Approach

According to Herrick (1990) banks manage their credit risk through three approaches. They are;

 Minimizing risk
 Price risk and
 The diversity of risk approaches

Credit Risk Management Functions

According to Basel (1998) credit risk management is the core to achieve the desired objectives.

It has three basic functions. These are:

 Credit analysis and appraisal,

 Credit monitoring and review and
 Work out procedures

Credit Analysis and Appraisal;

The purpose of credit analysis is to assess the likelihood that the customer will repay the loan in
accordance with stipulated terms. Each of these describes an area of person’s credit worthiness.

Character; assesses the customer willingness and assessing capacity involves determining ability
to repay.

8
The character of the debtor evaluated by seeing past credit experience, there credit reference and
accuracy of application.

Capacity: It is the ability to repay debts as scheduled. For salaried individual the analysis is
concerned with job stability.

Consumer capacity is reflection of safety margin between income and committed outflows and
the stability of each business capacity is depend upon sales income, monthly out flow and
inflow, stability of income source, stability of customer ,liquidity.

Capital: involves analysis of the customer’s net worth, is important in establishing the customer
ability to repay the loan by falling bank on other assets that could be used to generate cash to
repay the loan.

Collateral: is used to secure the loan .if the loan is secured by collateral and customer fails to
repay the loan as promised, the bank has the right to the assets to secure the loan. To provide an
alternative source of repayment the collateral must be marketable and the value of the collateral
must exceed the balance of the loan at the time of default.

The collateral should serve only as an alternative source of repayment and in most cases should
not be major consideration in granting credit. It serves to limit loss of the bank is finally forced
to resolve the loan through repossession.

Condition: whether the current economic condition indicates any potential problems in customer
ability to repay the loan.

Work out procedure

Once problems loans are identified, it requires special attention and thus transferred to Workout
Loan Division for further analysis. Workout Loans Division is an organ, which is established
under Credit Analysis and Appraisal Department to find out the prospect of recovery of the
problem loan. On receipt of the problem loan, the workout officer analyzes the reason for
default, business and security strength of the borrower’s business, determine the extent of risk
exposure and recommend the appropriate workout strategy (extension of repayment period,
injection of additional loan, changing the form of the loan, requesting additional collateral,
foreclosure of collateral etc.). Based on the analysis of the workout officer, the Credit
Committees shall pass appropriate decision on workout loan.

Loan monitoring and review

Credit monitoring refers to the day-to-day and/or periodic checking, analysis and reporting of the
proper implementation of credit decisions as well as the Credit Policy and procedure to ensure
that the credit function of the Bank is executed as planned and structured. Credit monitoring is a

9
critical element in maintaining the asset quality of the bank. It includes proper documentation,
disbursement and identification of warning signals.

Credit Policy and Procedure

Policy Mean program of action adopted by a person, a group, or government or set of principles
on which they are based In simple term, policies are way of doing things, Policies are core stone
of sound credit man and polices is agreement.

Objective of credit policy

 Provide guidance and standardize credit decision

 Avoid exposing excessive credit risk
 Proper evaluation of business opportunities
 Ensure operational consistency

Procedure

Procedure is Established Method-Correct method of doing things. In credit, it indicates correct

way of processing, disbursing, collecting, reviewing loan. That is Interviewing, Document, visit,
credit information, Credit analysis, Negotiation, recommendation, approval, [appeal]
disbursement-Contract-registration- stamp duty, file maintenance –file prune, follow up, report
Loan categorization, provisioning Legal action, foreclosure, rescheduling, write off etc

Empirical literature of the Study

Empirical literature in Ethiopia

Solomon (2013) in his paper entitled “Credit risk management techniques and practice of NIB
International Bank” has conclude that credit risk management system of commercial Banks
should incorporate a check and balance for the extension of credit that integrate separation of
credit risk management from credit sanction, credit processing/approval from credit
administration and finally establishment of an independent credit audit and risk review function.

Tibebu (2011) “Credit risk management and profitability of commercial banks in Ethiopia”
emphasized that Banks board of directors are responsible for each and every activities of the
bank, so they need to conduct continues training for their employees particularly for credit risk
management department managers and employees as well. Policy maker of banks (NBE) need to
set policy , and guidelines which force banks to think over their credit policy ,risk management
policy , and other related things.

Abdus (2004) has examined empirically the performance of Bahrain’s commercial banks with
respect to credit (loan), liquidity and profitability during the period 1994-2001. Nine financial
ratios (Return on Asset, Return on Equity, Cost to Revenue, Net Loans to Total Asset, Net Loans
to Deposit, Liquid Asset to Deposit, Equity to Asset, Equity to Loan and Non-performing loans

10
to Gross Loan) were selected for measuring credit, liquidity and profitability performances. By
applying these financial measures, this paper found that commercial banks’ liquidity
performance was not at par with the Bahrain banking industry. Commercial banks are relatively
less profitable and less liquid and, are exposed to risk as compared to banking industry. With
regard to asset quality or credit performance, this paper found no conclusive result.

The existing literatures indicate that several studies were carried out about credit risk
management on commercial banks abroad and in Ethiopia. However, due to diversified and
intensified investments in the country during last 10 and or above years there is an increase of
loan demands among investors from commercial banks in the country. In addition to this, high
demands for loan commercial banks are highly busy in launching branches across the country.
These situations have created an environment in which commercial banks to encounter risks in
credit management. Loans are becoming large and at the same time, bad loans have increased
substantially during the past few years, Sahlemichael(2009). Therefore, this study investigated
these newly emerging challenges in credit risk management process in commercial banks
encounter in Ethiopia.

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 Chapter 3

3 Research methodology
3.1 Research Design
Research design will provide a plan or a framework for data collection and its analysis, which
contain the research method and properties of the research while conducting the research. In
order to achieve the objective of the researcher, the researcher will use descriptive type of
research design. This study involves the description of the extent of the association between two
or more variables.

3.2 Study area and population

The study target population will be addresses such as top level manager, middle level manager
and workers related with credit risk management of the Banks.

3.3 Type and source of data

In order to realize the objectives of the study, the researcher will use qualitative data type. And
the researchers will use both primary and secondary sources of data. The researcher use primary
data to get information that cannot find on secondary source of data and to get fresh data and use
secondary data to collect data already found about credit risk management of united bank.

3.4 Sampling technique and sample size

3.4.1 Sampling technique

The researcher will be uses non-probability sampling, specifically purposive sampling method
from internal auditors depending on their responsibility.

3.4.2 Sample size

A sampling of 80% target population will be taken from the internal audit officer based on their
position for Questioners

3.5 Instrument of data collection

Data is collected by using many methods, as mentioned before researcher will use both primary
and secondary data, under primary data researcher uses interview and questionnaire method. In
an interview researcher will discuss with manager and workers related with credit and loan. The
questionnaire will filled by respondents like workers participate on credit and loan of this Bank.
Secondary data is from Internal files /related documents/ and annual reports of the Bank will be
collected.

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3.6 Method of analysis and presentation
Data analysis and presentation procedures will undertake manually and analysis by manual
computations. In data processing categorizing variables will done manually. The Describing data
is presented in tabular with appropriate percentage values.

13
TIME AND COST BUDGET

14
Reference
Abdus.F. (2004). Bahrain’s Commercial Banks Performance; Credit and financial performance.
New Delhi: Vikas Publishing House

Basel Committee (2000). Best Practice for Credit Risk Disclosure. Committee on Banking
Supervision.

Basel Committee (1999). Principles for the Management of Credit risk. Basel Committee on
Banking Supervision.

Hagos, M. (2010). Credit management (A Case Study of Wegagen Bank Share Company in
Tigray Region.

Sahlemichael, M. (2009) Credit Risk Management System of Ethiopian Commercial Banks

(Case of some public and private banks)

Solomon, G.(2013). Credit Risk Management Practice on NIB International Bank, Unpublished
Master’s Thesis, St. Mary University.

Tesfaye, B. (2014). Factors Influencing the Level of Credit Risk in the Ethiopian

Tibebu, T. (2011) Credit Risk Management and Profitability of Commercial Banks. A

Commercial Banks: The Credit Risk Matrix Conceptual Framework, University of South Africa

15