Internship Report on Compliance of Basel II in Credit Risk Management of Dhaka Bank Limited

At DEPARTMENT OF BANKING, students are required to complete an Internship Program to fulfill all the requirement of the MBA degree. The writer joined Dhaka Bank Limited as a Management Trainee Officer in Karwan Bazar Branch. Dhaka Bank mainly deals with large corporate customers seeking large loan facilities. But for banks, loans are the largest and most obvious source of risk. Experience in recent years has shown that absence of proper management of such risk has resulted in significant losses or even crippling losses for a number of banking institutions. Effective credit risk management is therefore vital to ensure that a banking institution’s credit activities are conducted in a prudent manner and the risk of potential bank failures reduced. So, appropriate policies, procedures and systems should be implemented at each financial institution for identifying, measuring, monitoring and controlling credit risk effectively.
DBL follows a centralized approach in extending its credit. Relationship Managers (RM) brings in new customers and prepares credit proposals for them. The proposal package is then sent to the Credit Risk Management (CRM) department analyzes the risk mitigating factors and sends the proposal with recommendation to the credit approving authority. Credit approving authority approves the proposal or denies it and sends the same to CRM again. DBL has a written credit policy manual. It fully complies with Bangladesh Bank Guidelines. DBL does not extend credit to a business, if it does not understand the business. The process of credit assessment is also guided by the central bank directives. A thorough credit and risk assessment is conducted prior to the granting of loans, and at least annually thereafter for all facilities. The loan structure is matched with the cash conversion cycle of the business and appropriate security is taken as collateral. In short, credits are not extended relying on just the borrower’s or sponsoring units’ reputation in Dhaka Bank Limited.

Though all these steps are taken for managing credit risk, it is not enough. Due to the system, failure can occur. As Bank deals with the depositors’ money, it must have some safety precaution when giving loan. To prevent such failure international accords like Basel I, Basel II are formulated. Bangladesh Bank instructed all the Banks of Bangladesh to adopt Basel II from 2007. Now it has been made fully activated and meticulously maintained in DBL, still it’s a big challenge for the Banking industry. Regulatory authorities are therefore making efforts to design appropriate strategies that would enable the banking sector for smooth transition to Basel II.

'The New Accord' comprises of three pillars. Pillar I sets out the minimum capital requirements. Pillar II defines the process of supervisory review of a financial institution's risk management framework. Pillar III determines market discipline through improved disclosure. It is argued here that implementation of Pillar I is a more critical than the other two. It requires minimum bank capital against three kinds of risk: credit risk, operational risk and market risk. Since existing regulation requires banks to maintain capital against credit risk only, it is plausible to expect that additional capital requirement for two other risks will cause all banks to raise capital appreciably. RBI (2006) also argues that banks would need to raise additional capital to support expansion of their balance sheets. As a regulator, Bangladesh Bank is required to design policies that will facilitate smooth transition to Basel II.

Calculations of capital requirement suggest that Dhaka Bank Limited has adequate Capital Adequacy Ratio as it is over 8% in the last quarter. But, as per Bangladesh Bank Guideline, from July 2010 the ratio must be maintained over 9%, so DBL has to raise capital quickly to be compliant with the regulation. As, per the standardized approach of credit risk, every unrated client will be risk weighted by 150% of their loan amount, so it will be tougher for DBL as most of the clients are unrated. So, this is a very big challenge the Bank are trying to take in the next quarter of the year. Basel II has manifold implications, like it will prevent the small and unrated borrowers to take loan as Bank don’t want to be charged, higher lending cost etc. In summary, it can be said that, upto now DBL is compliant with the capital requirements, but in the next quarter the capital requirements will not be enough. It has to increase capital by raising fund from public, issuing subordinated bonds or issuing right share. Already, DBL has decided to issue subordinated bond to fill the capital requirements for market risk. More of such efforts are needed.