CREDIT RISK

MANAGEMEN
T
FINANCIAL RISK
MANAGEMENT
SUBMITTED TO
AJAB KHAN BURKI

BILAL NASEER (GL)

KHAWAR AZIZ
USMAN AZIZ
MISBAH JAMIL
WAQAS KHALID
MAJJID IMTIAZ
CLASS:

MBA-6(A)

DATE: 15-012015

TABLE OF CONTENTS

INTRODUCTION..................................................................................................... 4
GLOBAL SCENARIO................................................................................................ 4
DOMESTIC SCENARIO............................................................................................ 6
COMPANY PROFILE OF MEEZAN BANK..................................................................6
PROBLEM STATEMENT.......................................................................................... 7
OBJECTIVES.......................................................................................................... 7
COLLECTION OF DATA........................................................................................... 7
BASEL I.................................................................................................................. 8
CREDIT RISK.......................................................................................................... 9
CREDIT RISK MANAGEMENT PRACTICES IN MEEZAN BANK..................................9
POLICIES, STRATEGIES AND PROCESSES.............................................................10
STRATEGIES ADOPTED BY MEEZAN BANK FOR MANAGING THE RISK.................13
CREDIT RISK MITIGATION................................................................................... 13
PROCESSES AND PRACTICES OF CREDIT RISK MANAGEMENT IN MEEZAN BANK 15
CREDIT RISK MITIGATION................................................................................... 16
FINDINGS............................................................................................................. 16
RECOMMENDATIONS........................................................................................... 17
CONCLUSION....................................................................................................... 17
LEARNING OUTCOMES........................................................................................ 18
BIBLIOGRAPHY.................................................................................................... 18

EXECUTIVE SUMMARY
The dissertation project done is on the credit risk management practices followed by
Meezan Bank. In the fast growing world, banks are facing many types of risks among which
credit risk stands at the top of the list. Hence, the topic is credit risk management. One bank
was chosen to understand the practices followed by them in depth which would apply to other
banks in general.
Meezan bank is one of the public sector banks and is supposed to be in line with SBP
guidelines. This helped in understanding the credit risk management practices followed by
the bank in a better way.
The process of credit risk management is identification, measurement, monitoring and
control. The bank follows these steps very clearly and has a sound credit risk management
system installed. It has also installed software for risk rating which was provided by CRISIL
which is in turn in lines with SBP guidelines. The banks net profit has seen a growth of 35%
and the total business is up by 16%. The banks deposits are up by 13% and gross advances
are up by 19%. The credit risk exposure is increased to 80064.90 as of Sep, 30 2011.
The credit risk of the bank has decreased over the past five years. They have installed
an integrated risk management system in line with BASEL II norms and SBP guidelines.
They follow strict hedging policies to reduce credit risk of the bank. They take financial
collaterals and guarantees to hedge their credit risk.
Hence all the policies and strategies have led to a sound credit risk management
system. The recommendations include up gradation to internal ratings based approach which
is the next step of risk measurement. They have to improve their systems so as to adhere to
BASEL III norms which might be implemented in near future. They need to include credit
risk during yearly policy making.

INTRODUCTION
Pakistani economy today is trying their level best for becoming a one of the world
class economy. The Pakistani banking industry is making great advancement in terms of
quality, quantity, expansion and diversification and is keeping up with the updated
technology, ability; stability and thrust of a financial system, where the commercial banks
play a very important role emphasize the need of a strong effective control system with extra
concern for the risk involved in the business.
The risk arises due to uncertainties, which in turn arise due to changes taking place in
the economic, social and political environment and lack of non-availability of information
concerning such changes. Risk means uncertainty/possibility of loss. In the financial arena,
enterprise risks can be broadly categorized as credit risk, market risk, operational risk,
strategic risk, funding risk, political and legal risk. Credit risk is the possibility that a
borrower or counter party will fail to meet agreed obligations. Globally more than 50% of
total risk elements in banks and financial institutions are credit risk alone. In banks, losses
shoot from outright default due to inability or unwillingness of customer or counter party to
meet commitments in relation to lending, trading, settlement and other financial transactions.
Thus managing credit risk for efficient management of a financial institution or bank
has gradually become the most crucial task and this is the motivation for this research.

GLOBAL SCENARIO
The period 2007-2012 underwent financial crisis, also known as the Global Financial
Crisis (GFC), or the Great Recession, is considered by many economists to be the worst
financial crisis since the great depression of the 1930s. This resulted in the collapse of large
financial institutions, the bailout of banks by national Governments, and downturns in stock
markets around the world. Even the housing market suffered, resulting in evictions,
foreclosures and prolonged unemployment contributing to the failure of key businesses,
declines in consumer wealth estimated in trillions of US dollars, and a significant decline in
the economic activity, leading to a severe 2008-2012 global recessions.
The bursting of the U.S. housing bubble, which peaked in 2007, caused the values of
securities tied to U.S. real estate pricing to plummet, damaging financial institutions globally.
The financial crisis was triggered by a complex interplay of valuation and liquidity problems
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in the United States banking system in 2008. Securities in stock markets suffered large losses
during the 2008 and early 2009. Economies worldwide slowed down during this period, as
credit tightened and international trade declined. This financial crisis ended by around late
2008 and mid-2009.
The current European sovereign debt crisis is an ongoing financial crisis that has
made it difficult or impossible for some countries in the euro area to re-finance their
Government debt without the assistance of third parties. From late 2009, fears of a sovereign
debt crisis developed among investors as a result of the rising Government debt levels around
the world together with a wave of downgrading of Government debt in some European states.
Concerns intensified in early 2010 and thereafter, leading Europes finance ministers on 9
May 2010 approved a rescue package worth 750 billion to ensure financial stability across
Europe creating the European financial stability facility (EFSF). In October 2011 and
February 2012, the Euro zone leaders agreed on more measures designed to prevent the
collapse of member economies.

M & AS (MERGER AND ACQUISITION) ON THE RISE

The banking and capital market is readily transforming itself with increased
competition and globalization. Investment banking has bounced back because merger and
acquisition (M&A) has gathered momentum. Hedge fund activity and increase of M&A
activity are the main characteristics of globalized banking. M&As are usually horizontal in
banking sector as it is the same business. Ex: The Bank of Tokyo-Mitsubishi UFJ, which
became the worlds largest bank, by merging with Mitsubishi Tokyo Financial Group Inc.
and UFJ holdings Inc.
It created the bank of Tokyo-Mitsubishi, worlds largest financial group by assets at
around $1.6 trillion, leaving behind; the U.S. based Citigroup Inc.s $1.55 trillion.

FUNDS CONTINUE TO FLOW TO EMERGING COUNTRIES

Emerging market continues to bring in more funds in the banking sector. Lending to
emerging markets rose. More and more funds continue to flow in the emerging markets like
Latin American countries. Hedge fund activity has also increased over time.

DOMESTIC SCENARIO
Pakistani banking industry has evolved over a long period of time. Despite the recent
growth of private banks, the sector is dominated by Government-controlled banks that hold
nearly three-fourths of total banks assets. The global financial crises have not much affected
the Pakistani banks significantly one, two banks affected due to the crisis. Internet, wireless
technology and global straight-through processing have created a paradigm shift in the
banking industry.
The growing market is attracting more and more banks into the Pakistani territories.
In Pakistan, the most significant achievement of the financial sector reforms is the
improvement in the financial health of commercial banks in terms of capital adequacy,
profitability and asset quality as well as greater attention to risk management. Later on, after
adopting the policy of deregulation, it opened the new opportunities for the banks to increase
revenues by diversifying into investment banking, insurance, credit cards, depository
services, mortgage financing, securitization, etc. As now banks benchmark themselves
against global standards, they have increased the disclosures and transparency in bank
balance sheets, the banks also started focusing more on corporate governance.

COMPANY PROFILE OF MEEZAN BANK

INTRODUCTION
Meezan Bank Ltd has grown to become the largest Islamic bank in the country. The
bank claims to be the Pakistan premier Islamic bank determined to set higher standards of
achievements. The bank comes in to existence by the order promulgated by governor general
and standard functioning from Nov 20, 1997.
Meezan Bank is the major business partner our government of Pakistan with special
emphasis on fostering Pakistan economic growth through aggressive and balanced lending
policies, technologically oriented products and services offered through its large network of
203 branches. Meezan Bank is a commercial bank which receives deposits from the people
who have it spare and invests it with those who are in need of them. It has got the license of
commercial banking from the State Bank of Pakistan and is registered under the legislation of
Banking Companies Ordinance 1962. It has dedicated itself to do business of banking
according to Islamic rules and regulations and is supervised by a Shariah Board who keeps an
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eye on the operations of the bank and ensures that the same must be in accordance with the
teachings of Islam and there must be no element of Riba in it.

PROBLEM STATEMENT
To analyze the credit risk management practices of Meezan Bank and suggest ways to
Improve them.

OBJECTIVES
To study the credit risk faced by Meezan Bank.
To analyze the process of credit risk management and the practices followed in
Meezan Bank.
To analyze methods used by Meezan Bank to mitigate their risks.
To suggest ways to improve the credit risk management system in Meezan Bank.

COLLECTION OF DATA
The data is collected from both secondary and primary data. The secondary
data is derived from SBP website and various other related websites and books. The
secondary data comprises of understanding credit risk management as a subject and
its parameters. These parameters comprise of the various guidelines framed by SBP
for all banks for better credit risk management. Primary data is collected through
conducting the interview from Khurrum Rashid from Meezan Bank as a Regional
Credit Manager.

Before going to proceed futher about how the bank handle the credit risk first we will
discuss the BASEL 1 and 2 what it says regarding handling of risk.

BASEL I
Basel I primarily focused on credit risk. Assets of banks were classified and grouped
in five categories according to credit risk, carrying risk weights of zero, ten, twenty, and fifty
and up to one hundred percent. Banks with international presence are required to hold capital
equal to 8% of the risk weighted assets. The creation of the credit default swap helped large
banks hedge lending risk and allowed banks to lower their own risk.
.BASEL II
Basel II is the second of the Basel Accords, which are recommendations on banking
laws and regulations issued by the Basel Committee on Banking Supervision. The purpose of
Basel II, is to create an international standard that banking regulators can use when creating
regulations about how much capital banks need to put aside to guard against the types of
financial and operational risks banks face.
In theory, Basel II attempted to accomplish this by setting up risk and capital management
requirements designed to ensure that a bank holds capital reserves appropriate to the risk the
bank exposes itself to through its lending and investment practices.

OBJECTIVE of Basel II
Ensuring that capital allocation is more risk sensitive;
Separating operational risk from credit risk, and quantifying both;
Attempting to align economic and regulatory capital more closely to reduce the
scope for regulatory arbitrage.
While the final accord has largely addressed the regulatory arbitrage issue, there are
still areas where regulatory capital requirements will diverge from the economic.
Basel II has largely left unchanged the question of how to actually define bank
capital, which diverges from accounting equity in important respects. The
Basel II uses a "three pillars" concept (1) minimum capital requirements (addressing
risk), (2) supervisory review and (3) market discipline.

CREDIT RISK
Credit risk is the possibility of loss from a credit transaction. In a banks portfolio,
losses stem from outright default due to inability or unwillingness of a customer or

counterparty to meet commitments in relation to lending, trading, settlement and other

financial transactions. Credit risk emanates from banks dealings with individuals, corporate,
bank, financial institution or a sovereign.
Credit risk includes the following:
Credit growth in the organization and composition of the credit folio in terms of
sectors, centers, and size of borrowing activities so as to assess the extent of credit
concentration.
Credit quality in terms of standard, sub-standard, doubtful and loss-making assets.
Extent of the provisions made towards poor quality credits.

CREDIT RISK MANAGEMENT PRACTICES IN MEEZAN BANK

CREDIT RISK:
The bank has put in place a robust risk management architecture with due focus not
only on capital optimization, but also on profit maximization, i.e. to do maximum business
out of the available capital which in turn maximize profit or return on equity.
Bank is benchmarking on globally accepted sound risk management system,
conforming to BASEL II framework, enabling a more efficient equitable and prudent
allocation of resources.
In capital planning process, the bank reviews:
Current capital requirement of the bank
The targeted and sustainable capital in terms of business strategy and risk appetite.
Capital need and capital optimization are monitored periodically by the Capital
Planning Committee comprising Top Executives. Sensitivity analysis is conducted quarterly
on the movement of Capital Adequacy Ratio, considering the projected growth in advances,
investments in Subsidiaries/ Joint Ventures and the impact of Basel II framework etc. The
Committee takes into consideration various options available for capital augmentation in tune
with business growth and realignment of Capital structure duly undertaking the scenario
analysis for capital optimization.
The Banks policies maintain moderation in risk appetite and a healthy balance
between risk and return in a prudent manner. The primary risk management goals are to
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maximize value for shareholders within acceptable parameters and to the requirements of
regulatory authorities, depositors and other stakeholders. The guiding principles in risk
management of the Bank comprise of Compliance with regulatory and legal requirements,
achieving a balance between risk and return, ensuring independence of risk functions, and
aligning risk management and business objectives. The Credit Risk Management process of
the Bank is driven by a strong organizational culture and sound operating procedures,
involving corporate values, attitudes, competencies, employment of business intelligence
tools, internal control culture, effective internal reporting and contingency planning.
The overall objectives of the Banks Credit Risk Management are to:
Ensure credit growth, both qualitatively and quantitatively that would be sector ally
balanced, diversified with optimum dispersal of risk.
Ensure adherence to the regulatory prudential norms on exposures and portfolios.
Adequately enable to price various risks in the credit exposure.
Form part of an integrated system of risk management encompassing identification,
Measurement, monitoring and control.

POLICIES, STRATEGIES AND PROCESSES

The Board of directors and Risk management Committee of the Board gives
directions, the Credit Risk management committee headed by Chairman and Managing
Director ensures its implementation.
The bank has defined policy guidelines for Credit Risk Management, Collateral
Management and Credit Risk Mitigation (CRM), Ratings, etc. where the whole process and
procedure to be adopted has been detailed.
The bank has taken up implementation of Integrated Risk Management system
through six solutions for Credit Risk Rating, Credit Risk, Market Risk, Operational Risk, and
ALM & FTP to move towards advanced BASEL II norms.
The Income recognition and Asset classification norms of Banks policy are in tune
with SBP guidelines. Ninety days delinquency norm is followed to classify assets as
performing & non-performing. The data is audited and adequate provisions for both
performing and non-performing assets are made. For restructured assets additional provision

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is made and the bank also has a general floating provision. Definition of impaired assets (for
accounting purposes):
An asset becomes non-performing when it ceases to generate income for the bank
when
Interest and instalment of the loan remains overdue for a period of more than 90 days,
in respect of term loan
The account remains out of order for a period of more than 90 days, in respect of
operative limits such as cash credit
The bill remain overdue for a period of more than 90 days in cases of bills
purchased/discounted
The interest charged during any quarter, not fully serviced within 90 days from the
end of the quarter
The instalment of principal or interest thereon remains overdue for 2 crop seasons in
the case of short duration crop loans and if instalment of principal or interest thereon
remains overdue for one crop season in the case of long duration crop loans, as far as
agricultural loans are concerned
90 days from the date of crystallization of non-fund based commitments expire
The Bank has formulated a comprehensive Credit Risk management policy and
constituted various committees.

The structure of credit risk management in the bank is as under:

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The bank has fine-tuned the Risk

management policies and lending policy,
to include Credit appraisal standard like
benchmark/hurdle ratios on key financial
indicators, internal ceilings, prudential
norms, standards for loan collateral,
portfolio
concentration,

management,
loan

credit
review

mechanism/credit audit, special review of

high

value

borrowed

concentration/monitoring

accounts,
and

risk

pricing

based on risk ratings, and review based on

risk ratings etc, besides covering exposure
ceiling for sensitive sectors

such as

capital market, real estate, and commodity

sector. A comprehensive recovery policy
is also put in place and revised from time
to time.

For exposure amounts after risk mitigation subject to the standardized approach,
amount of a banks outstanding (rated and unrated) in the three major risk buckets as well as
those that are deducted are shown below:

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STRATEGIES ADOPTED BY MEEZAN BANK FOR MANAGING THE

RISK
The bank has introduced some strategies for credit risk management such as:
Lending policy is revised from time to time to include new aspects of risk
management order to enhance the effectiveness of the loan review mechanism, the
bank introduced onsite credit audit for exposures of Rs. 5 Crore and above and also
modified its loan review mechanism for exposures below Rs. 5 Crore.
30-40% of the credit exposures are covered under the loan review mechanism/credit
audit.
Stress test on credit risk is carried out on an annual basis.
A comprehensive risk scoring system is put in place for better credit decisions
Separate risk scoring models for housing and other retail sectors has been evolved
and put in place so as to ensure higher coverage of risk rating exercise which is
presently around 90%.
Migration analysis is carried out on half yearly basis in respect of exposures of Rs. 1

crore and above.

Bank has introduced credit risk rating software from CRISIL which is BASEL II
compliant for conducting risk rating of all retail and non-retail loans.

CREDIT RISK MITIGATION

The general principles, like having a specific lien, requisite minimum margin
stipulation, valuation, legal certainty, documentation, periodical inspection, easy
liquidity etc. as enumerated in BASEL II final guidelines of SBP has been used for
credit risk mitigation techniques.
All the prescribed haircuts with adjustments for currency mismatch and maturity
mismatch are done.
The financial collaterals are netted out of the credit exposure before assigning the risk
weights. The effect of credit risk mitigation system is not double counted.
The financial collaterals taken include:
o Banks own term deposits
o Cash margin
o Life policies
o Gold benchmarked at 99.99 purity

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CREDIT RATING FRAMEWORK AT MEEZAN BANK

INTRODUCTION
Credit Rating Framework (CRF) is one of the risk measurement techniques the banks
use to a great extent under risk management system. In line with the guidelines of SBP, the
Bank has proposed to bring in all the borrowed accounts (Standard accounts) with limits of
Rs.2 lakh and above under the purview of credit risk rating. However, the rating model that
will be applied varies according to the type / extent of exposure to suit the borrowers
activities. The Bank is utilizing their own internal Credit Rating Model for grading the
borrowed accounts so far.
The grades used in the internal credit risk grading system should represent without
any ambiguity, the default risks associated with an exposure. Hence, SBP suggests that the
Bank can initiate the risk grading activity on a relatively smaller scale initially and introduce
new categories as the risk gradation improves

NEED FOR CREDIT RISK RATING

The need for Credit Risk Rating has arisen due to the following:
Banking face new risks and challenges. Competition results in the survival of the
fittest. It is therefore necessary to identify these risks, measure them, monitor and
control them.
It provides a basis for Credit Risk Pricing i.e. fixation of rate of interest on lending to
different borrowers based on their credit risk rating thereby balancing Risk & Reward
for the Bank.
The Basel Accord and consequent State Bank of Pakistan guidelines requires that the
level of capital required to be maintained by the Bank will be in proportion to the risk
of the loan in Bank's Books for measurement of which proper Credit Risk Rating
system is necessary.
The credit risk rating can be a Risk Management tool for prospecting fresh borrowers
in addition to monitoring the weaker parameters and taking remedial action.

CREDIT RISK MANAGEMENT FRAMEWORK AT MEEZAN BANK

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As per SBP guidelines on Integrated Risk Management of Banks, all exposures across
the Bank have to be risk rated. In this regard,Bank appointed Consultants recommended the
following in respect of Credit Risk Management Framework for the Bank.

AUTHORITY FOR RATING

The recommending Authority for the Credit Risk rating shall be the Manager (Credit),
in respect of VLB/ELBs and the Manager in-charge, RO in respect of RO power accounts.
Sanctioning authority will be assigned with the power for confirming the rating of an
account. In respect of ELB/VLBs, the rating will be done at the branch level itself and the
rating will be confirmed by the respective AGM/CM of the branch. In respect of RO power
accounts, branches shall ensure to furnish all the required particulars to the concerned RO
while submitting the credit report at the time of renewal (as per the Annexure).

PROCESSES AND PRACTICES OF CREDIT RISK MANAGEMENT IN

MEEZAN BANK
The bank has understood the need for credit risk management as described by SBP.
They have identified the types of risks and are disclosed in the BASEL II disclosures
every quarter appropriately in the banks website.
Credit risk faced by the bank is properly identified which includes the following:
1) The gross credit risk exposure has grown to Rs. 80064.90 crore as of 30.9.2011 which
is a 29% increase from the previous year that is 30.9.2010. Credit quality has is
standard due to their sound credit risk management system.
2) They have made sufficient provisions for NPAs, NPIs and depreciation.
3) Volume of off-balance sheet exposures for both financial collateral and guarantee
covered credit portfolio together is Rs. 136281.33 crore as of 30.9.2011 as against Rs.
101320.2 crore as of 30.9.2010.
The bank decides on how much risk to take based on their risk appetite.
The banks risk management policy is fine tuned to include credit appraisal
standard like benchmark/hurdle ratios on key financial indicators, internal
ceilings, prudential norms, etc. besides covering exposure ceiling for sensitive
sectors such as capital market, real estate and commodity sector.

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CREDIT RISK MITIGATION

Based on the policies strategies are developed by the bank to mitigate credit risk.
Credit risk is mitigated by appropriate credit appraisal systems before lending and

proper collateral or guarantees are taken to hedge the risk.

Integrated risk management system is put in place for better management of credit
risk and a risk rating software is installed which is developed by CRISIL in

compliance with SBP guidelines.

The risk management function is reviewed periodically usually every quarter.
The rating system for term loans is annual.
The risk weights of the banks products are shown in the figure below:

FINDINGS
The bank has a documented credit risk management policy.
The bank uses credit rating system to assess credit risk as a part of loan lending
mechanism.
They use standardized approach for credit risk measurement currently and are fine
tuning to upgrade to advanced approaches as per SBP guidelines.
They have implemented an integrated risk management system as per SBP guidelines
(MIS).
They mitigate credit risk exposure through diversification, collaterals and guarantees.

17

 The credit risk exposure of the bank has decreased considerably in the last five years
indicating a sound risk management policy.
The risk weights associated with the banks products are in line with SBP guidelines.
They have regular trainings for their credit risk management teams on the policies and
guidelines.
They rely on ratings provided by CRISIL/CARE/ICRA as per SBP guidelines.

RECOMMENDATIONS
They can invest in securitization as securitization exposures are nil.
They have to start preparing for BASEL III norms which might come into effect in

the near future.

They can further decrease their credit risk exposures with better credit risk

management policies and advanced approaches as per SBP guidelines.

Bank should include credit risk component in yearly forecast based on multiple
market scenarios.

CONCLUSION
The bank follows a sound credit risk management and credit risk mitigation policy
which is proven by the decreasing credit risk exposure of the bank for the past five years. The
bank has adhered to SBP guidelines and implemented BASEL II norms and an integrated risk
management system and risk rating software.
The credit risk policies and strategies of the bank have improved over years and the
bank is in a better position. The study shows that compliance with BASEL II norms helps the
banks to improve their profitability through better credit risk management systems.

LEARNING OUTCOMES
Understanding of the risk management in banks.
Understanding of the credit risk management practices of MEEZAN Bank.
Understanding of the SBP guidelines in respect of risk management practices to be
followed by the banks.
Understanding of risk rating framework of banks and lending policies of the bank.
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 Understanding of BASEL II norms and implications.

**************************

BIBLIOGRAPHY
http://ercim-news.ercim.eu/en78/special/improving-banks-credit-risk-management
http://www.sas.com/news/preleases/risk-management-for-banking.html
http://www.financialexpress.com/news/banks-need-to-review-credit-risk-mgmtsystems/464894/
http://www.amazon.com/Credit-Risk-Assessment-Borrowerswww.Meezan bank.pk
Notes of FRM Given by Sir Ajab Khan Burki

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