BANGLADESH RESEARCH PUBLICATIONS JOURNAL

ISSN: 1998-2003, Volume: 9, Issue: 2, Page: 103-110, November - December, 2013

Review Paper

STRESS TESTING ON BANKS IN BANGLADESH

*Mohammad Nazrul Islam Bhuiyan1

Mohammad Nazrul Islam Bhuiyan (2013). Stress Testing on Banks in Bangladesh.

Bangladesh
Res.
Pub.
J.
9(2):
103-110.
Retrieve
from
http://www.bdresearchpublications.com/admin/journal/upload/1309116/1309116.pdf
Abstract
Stress testing is one of the effective and popular ways to alert bank management
with regard to adverse unexpected outcomes related to variety of risks and
provides an indication how much capital adequacy ratio (CAR) might be needed
to absorb looses if any large shocks occur. In this paper, 29 banks are considered,
those operates in Bangladesh those operates their activities based on different
categories, like foreign Islamic banks, Government Commercial Banks, Private
Islamic Banks, Private conventional Banks, Private Commercial and Conventional
Banks. Besides that, several indicators for conducted stress testing of nonperforming
loan (NPL), nonperforming loan in two major sectors, equity price risk, liquidity
shocks and Interest rate shocks. This study has been used the data for the years of
2010, 2011 and 2012 taken from the annual reports of the selected twenty nine
banks. Finally, this study has some interesting implications that might help the senior
management, policy makers, depositors, owners as well as stakeholders of the
banks.

Key words: Stress Test, Credit Risk, Non-performing loan, NPL in two major sectors, Equity
Price Risk, Liquidity Risk, Interest Rate Risk, Financial soundness
Introduction
Stress test has got the impressive attentions in the last few decades as to measure the
level of economic confrontation and to alert bankruptcy hazard caution of the financial
institutions, commercial banks. Stress test can be classified, into three main types such as i)
sensitivity analysis, which looks at impacts of changes in relevant economic variables such
as interest rate and exchange rate ii) scenario analysis, which assesses the impacts of
exceptional but possible scenarios iii) contagion analysis which seeks to take account of
the transmission of shocks from individual exposure to the system as a whole (Martin
CIHAK, 2004, 2005). To measure financial system soundness, good quantitative inputs are
required. Financial soundness indicators (FSI) are the indicators of current financial position
and reliability of the financial institutions of a country (Jones et al, 2004). Most of studies
related to the issue were done from the perspective of developed countries and they are
done either by the domestic decision-making authority such as Central Bank or by the
International Monetary Fund (IMF). Only limited studies were done in developing countries,
from academic research stands points, particularly in Bangladesh. This study seeks to
perform stress testing of some preferred conventional commercial banks (CCB), Islamic
banks (IB), Foreign Islamic Banks (FIB), Government commercial banks (GCB), Islamic and
Conventional banks (ICB) which is projected to flourish the theoretical, operational know
how and the supervisory implications of stress test in institutional level to the academicians
and practitioners. Since 2008 there is an economical recession in the world and more or
less every country is facing problem due to this. Though developed country like USA, UK,
Germany faced more problems than developing countries but developing countries is
also affected. Still USA is one of the major players in world economy and Bangladeshs
foreign remittance mainly depends on readymade garments and textile. Meanwhile,
*Corresponding Author: E-mail: Nazrul.acc.fin@gmail.com, nazrul_aiub@yahoo.com
Bachelor of Business Administration (BBA), Dept of Accounting and Finance, American International
University-Bangladesh (AIUB), Bangladesh.

Bhuiyan

104

United State is the big market for our garments and textile industry. So, if US economy
affect negatively somehow it will create some problem in some selective country like
Bangladesh. In addition, most of the Bangladeshi schedule bank gave huge amount of
money as loan in these two sectors (garments and textile industry). Recent world wide
economic recession, originated in the United State of America (USA), prompted the
development of new frameworks, tools and techniques to assess the stability of financial
system (Paul and Mathew 2004). This shocking of the economy has increased the
importance of better understanding of probable vulnerabilities in the financial system and
measures these vulnerabilities for both the regulators and the managers. IMF and Basel
committee on banking supervision have also recommended for performing stress test on
the financial sector. Stress test is primarily designed to measure the impact of probable
changes in economic environment on the financial system (Paul and Mathew, 2004).
These test focus on detecting credit risk, exchange rate and interest rate structure of
portfolios and capturing the potential impacts of interbank contagion. Credit risk uses to
measure future portfolio quality (Cihak and Harmanek, 2005). Stress testing for the
insurance sector took solvency position, focusing on the available capital before and
after stress test, analysed what if situations, value of corporate bond, stock, movement of
asset and liability and consider five account risks such as interest rate, equity risk, property,
credit spread and fall risk (Martin Cihak, 2007), (European Central Bank, 2007),
(Komarkova and Gronychova, 2012), (End et al 2006). Financial Sector Assessment
Program (FSAPs) have addressed different risk in stress test such as credit risk, market risk
like interest rate, exchange rate, equity, volatility, real estate and other asset price risks,
liquidity risk and contagion risks (Moretti. et al. 2008), (Blaschke, et al. 2001). Financial
soundness indicators are capital adequacy, asset quality, earnings and profitability,
liquidity, sensitivity to market risk (Sorge, 2004, BIS working paper 165). There are several
indicators for stress testing like credit risk due to NPL (Sorge, 2004 BIS working paper 165),
(Moretti, et al. 2008), credit risk due to NPL in two sector, equity price risk, and liquidity risk
(Kamal and Mohsin, 2011). Bangladesh bank gives a guideline for stress test and
suggested indicators are; NPL, increase NPL in 2 sectors, fall in the value of eligible
securities, and top ten borrowers of the bank, interest rate output, and liquidity output
(Bangladesh Bank 2012). After the calculation, those banks need additional capital to
meet regulatory requirements they should raise the capital (Ellahie, 2013). Stress testing for
the banking system, uses some indicators like i) macroeconomic (output and inflation) ii)
capital-to-loan ratio iii) default rate iv) NPL to loan ratio. v) Interest margin to the total
intermediated funds ratio (Filosa. 2007). However, beginning of 2010 our stock market
(Dhaka and Chittagong stock exchange) faced crisis and this crisis took place till 2012,
during this time most of the share prices decrease at least 150%, (www.dsebd.org.bd
13/05/2013) index of DSE fall 8900 to 3300 (approximately) and daily turnover falls 30000
million to 1100 million, these information actually represents stock market crisis
(www.eprothomalo.com). Most of the bank had huge investment in the stock market.
Now, World Bank and International Monetary Fund (IMF) are trying to motivate each
central bank so that local bank of particular country can do stress test. In addition, this
paper will help senior management of the banks, policy makers, depositors, owners and
all other stakeholders of the banks.
Consider the above mention problem, the objectives of this paper are to identify the
financial situation of each particular bank if any vulnerability happens in the economy, to
give a conceptual snapshot of stress testing and to measure the overall banking scenario
in Bangladesh after stock market collapse and mismanagement in loan provide.
Methodology
The essential data inputs to perform the study have been together from the annual reports
for the year 2010, 2011 and 2012 of the twenty nine sample banks. The accessible
research papers, journals, working papers, guidelines of different central banks, relevant
books, newspaper and websites on this particular study have been used. MS Excel
computer program software has been used to analysis the primary data.
Results
Main finding of the study based on the data of 2010 varies according to justification
criteria. All 29 banks required additional capital according to criteria NPL. All 28 banks,
except Prime Bank Limited, were required for additional capital when NPL to Two Major
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Sectors was taken into justification. According to indicator Liquidity, all 28 banks, except
United Commercial Banks, were required for additional capital. On the other hand, 19
banks were required for additional capital when Equity Price Risk was considered as a
determinant of capital. In addition to that, 15 banks were required for additional capital
according to indicator Increase in Interest Rate. It can be concluded that banks, in 2010,
were doing well in two indicators, i.e., i. Equity Price Risk & ii. Increase in Interest Rate.
Capital requirement of banks does vary according to the analysis based on various
indicators and data of 2011. According to NPL in 2011, All 28 banks, except NBL, were
required for additional capital. According to indicator Investment to Top Two Sectors, 26
banks were required for additional capital. According to indicator Liquidity, 24 banks were
required for additional capital. According to indicator Investment to the Stock Market, 7
banks were required for additional capital. According to indicator Increase in Interest
Rate, only 2 banks were required for additional capital. Banks, in 2011, were found doing
well in two indicators, i.e., i) Investment to the Stock Market & ii) Increase in Interest Rate.
Capital requirement for the banks according to data of 2012 were found exactly similar to
2011 only for indicators Investment to Top Two Sectors. Finding for indicator NPL was
almost similar to that of 2011. i.e. 29 banks are required for additional capital according to
this criterion. 20 banks were required for additional capital according to criterion Liquidity.
According to criterion Investment to the Stock, three banks were required for additional
capital and according to criterion Increase in Interest Rate, only two banks were required
for additional capital. This result is also similar to that of 2011.
According to analysis of data of 2012, it can be concluded that banks were sufficient in
capital according to two criteria. i.e. i. Increase in Interest Rate & ii. Investment to the
Stock. As the banks were found to have sufficient capital according to criteria Increase in
Interest Rate for the three consecutive years of 2010, 2011 and 2012, it can be said that
banks are doing well in this criterion.
Discussions
Among these entire 29 banks ICB Islamic banks situation is really very worse (table 6). ICB
Islamic banks belongs to Foreign Islamic Banks category. This banks will be bankrupt if
minimum shock happens in any indicator. So ICB Islamic bank should raise their capital.
Besides that, they can take financial help from the parent company so that they can
operate their business in a moderate way. All foreign Islamic banks have low investment in
stock market (table 7) but now they can invest more money in the stock market in order
to earn more money. Because, now in our capital market most of the shares price
earnings ratio (PE ratio) is less than 10 which indicates that stock is already undervalued
(www.dsebd.org.bd 07/04/2013). As we know that standard PE ratio is 10 as well as
investor can invest in a particular stock if PE ratio is up to equivalent to 40. However, these
three banks should focus on nonperforming loan and loan to two major sectors so that
they can face any undue situations. Those banks are belongs to Private Conventional
and Islamic banks groups (table 9) should monitor very carefully in terms of giving loan
because all banks need additional capital if shock level is only 5% (table 8).Ten banks
have been considered in Private Conventional Commercial Banks category (table 9)
except interest rate risk indicators others four indicators result are not good enough.
However they can introduce Islamic banking window because result shows, it is better to
open Islamic banking window to minimize lose. In addition, these banks should raise liquid
asset to overcome short term liquidity crisis.
Conclusions
Stress testing is a key management tool that helps supervisors to settle on whether
financial institutions are financially stretchy sufficient to absorb losses that could occur in
different adverse scenarios. By doing stress test top management of financial organization
will be able to know how to take the edge off risk, what should be the combination of
banks portfolio, in which area bank can be more flexible and in which area bank should
reduce investment. One of the alarming areas is stock market collapse in December 2010.
Because all bank had investment in stock market except IBBL. And one more
apprehension area is, due to world economy recession Bangladeshi garments and textile
industry directly affected so NPL in two large sectors affect by this way because data
shows greater part of these 29 banks has major investment in these two areas.
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References
Martin CIHAK, (2004). CNB Internal research and policy note/2/. CNB CZECH NATIONAL
BANK.
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from
http://www.cnb.cz/miranda2/export/sites/www.cnb.cz/en/research/research_pu
blications/irpn/download/irpn_2_2004.pdf
Martin CIHAK, (2005). Stress Testing of Banking Systems. Czech Journal of economics and
finance,
vol.55,
no.9-10.
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Jones, Hilbers and Slack (2004), Stress Testing Financial Systems: What To Do When The
Governor
Calls',
IMF
Working
Paper,
WP/04/127.
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Komarkova & Gronychova. (2012). Models for Stress testing in the Insurance Sector,
CNBresearch and policy notes 2. CNB CZECH NATIONAL BANK. Retrieved from
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blications/irpn/download/rpn_2_2012.pdf
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Blaschke, Jones, Majnoni & Peria, (2001). Stress Testing of Financial Systems: An Overview
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Methodologies, and FSAP Experiences.IMF working paper.
WP/01/88.
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from
http://www.imf.org/external/pubs/cat/longres.aspx?sk=15166
Marco

Sorge, (2004), Stress-testing financial systems: an overview of current

methodologies. Bank for International Settlements (BIS) working paper, no 165.
Retrieved from http://www.bis.org/publ/work165.pdf

Kamal & Mohsin, (2011), Managing Stress Test for Banks: A case study on Ten Commercial
Bank in Bangladesh. IOSR Journal of Business and Management, vol.2, no.5,
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(2012). Guidelines on Stress Testing for Non-Banking Financial Institution. Bangladesh
Bank. Retrieved from
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Renato Filosa (2007), Stress testing of the stability of the Italian banking system: a VAR
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Martin Cihak, (2007), Introduction to Applied stress testing IMF working paper, WP/07/59.
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(2007), Risk measurement and systemic risk, European central bank. Retrieved from
http://www.ecb.europa.eu/pub/pdf/other/riskmeasurementandsystemicrisk20070
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End, Hoeberichts and Tabbae, (2006), Modelling Scenario Analysis and Macro StressTesting. De Nederlandsche Bank (DNB) Working Paper no.119. Retrieved from
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Cihak, Hermanek (2005), Stress testing the Czech Banking System: Where Are We? Where
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www.eprothomalo.com.
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Appendix1: Calculation format of five indicators.

Table 1: Credit risk due to increase in NPLs
SL
No.
A
B
C
D
E
F
G
H
I

Magnitude of the shock

Total Loan
Nonperforming loan(A-B)
Total Performing Loan
Increase in NPL (% of shocks)
Increase in provision(D-0)
Tax adjusted provision D-(1-0)
Revised regulatory capital (CapitalD)
Revised Risk Weighted Assets (RWA-D)
Revised CAR (G/H)

Scenario
(2%)

1,

Scenario
(5%)

2,

Scenario
(10%)

3,

Table 2: Credit risk due to Increase in NPLs in major investment in two sectors.
SL
No.
A
B
C
D
E
F
G

Magnitude of the shock

Loan to top 2 sector
Increase in NPL (% of shock)
Increase in provision (B-0)
Tax adjusted provision B-(1-0)
Revised regulatory capital (Capital-B)
Revised RWA (RWA-B)
Revised CAR (E/F)

Scenario
1, (5%)

Scenario
2, (10%)

Scenario
3, (15%)

Table 3: Equity price risk Equity price risk.

SL
No.
A
B
C

Magnitude of the stock

Total exposure in stock market
Fall in stock price(% of shock)
Tax adjusted loss (B+(1-42.5% of B)
Revised regulatory capital(CapitalC)
Revised RWA (RWA-C)
Revised CAR (D/E)

D
E
F

Scenario
(10%)

1,

Scenario
(25%)

2,

Scenario
(50%)

3,

Table 4: Liquidity risk

SL
No
A
B
C
D
E
F
G

Magnitude of the stock

Liquid Asset (LA)
Liquid Liabilities (LL)
Liquid ratio (%) (A/B)
Fall in liquid Liabilities (% of shock)
Revised liquid Asset(A-D)
Revised liquid Liabilities(B-D)
Revised liquid Ratio (%) (E/F)

Scenario
(10%)

1,

Scenario
2, (20%)

Scenario 3,
(30%)

Table 5: Appropriate shocks due to increase in interest rate in the economy.

SL No.
A
B
C
D
E
F
G
H

Particulars
Market value of Assets
Market value of Liabilities
Gap of Amount
Magnitude of interest rate change
Fall in the market value of equity
Revised regulatory capital
Revised RWA
Capital adequacy ratio (CAR)

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1%

2%

3%

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108

Table6: ICB Islamic banks situation in 2010, 2011 and 2012.

201
1

-45.23

201
2

-44.70

201
0
201
1

-36.6

201
2

-44.61

201
0
201
1
201
2
201
0
201
1
201
2

-44.19

NPL in 2 major
sectors
(Scenario
1,2,3, 5%,10%
and 15%
respectively)

Equity price
Risk Scenario
1,2,3, 10%,25%
and 50%
respectively)

Liquidity
Scenario
1,2,3, 10%,20%
and 30%
respectively)
Interest rate
Scenario
1,2,3, 1%,2%
and 3%
respectively)

-45.23
-44.38
-36.6

-45.23

37.20
46.23
39.71
38.9
6
48.0
2
42.6
4
-36.6

x
x
x
x

38.12
47.78
39.55
41.41

Need Additional
Capital

-36.6

Scenario
3,

201
0
201
1
201
2
201
0

Scenario
2,

NPL (Scenario
1,2,3 2%,5%
and 10%
respectively)

With Stress: Revised Capital Adequacy Ratio in % (CAR)

Fall in
Fall in
Fall in
potenti
potenti
potential
al
al
threat if
threat if
threat if
revised
revised
revised
CAR<10
CAR<1
CAR<1
%
0%
0%
%
%
%

Scenario
1,

Indicator

Year

Without
Stress CAR
(Minimum
CAR as
per
Basel2=
10%)

x
x
x
x

39.69
50.41
39.38
43.96

Yes

Yes

Yes

Yes

50.93

53.96

Yes

45.51

48.51

Yes

36.61
45.24

36.62
45.24

Yes

Yes

38.90

38.91

Yes

19.99
25.26
22.62
36.02
46.40

Yes

Yes

Yes

Yes

Yes

39.38

Yes

-36.6

45.2
4
39.8
9
6.68

-4.98

-45.23

2.57

-9.61

-44.32

4.63

-7.29

-36.6

-36.4

-45.23

41.1
4
39.7
1

36.21
43.06
39.55

Table7: Average investment in the stock market for each category in three different years.
Category
Private Conventional & Islamic
Commercial Banks
Government Commercial Bank
Private Islamic Bank
Foreign Islamic Bank
Private Conventional Commercial
Banks

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Invest in 2010
per bank
878

Invest in
2011per bank
1487

Invest in 2012
per bank
1563

4835
647
89.5
1525

3090
1772
317.5
2010.6

2397
1631
502
2159

Stress Testing on Banks

109

2012

Private Conventional &

Islamic Commercial Banks

2011

Private Conventional &

Islamic Commercial Banks

2010

Private Conventional &

Islamic Commercial Banks

AB
BA
CBL

8.84
6.82
10.21

x
x

DBL
JBL (2)
MTB
PREMIE
R
PRIME
SOUTH
TRUST
AB
BA
CBL
DBL
JBL (2)
MTB
PREMIE
R
PRIME
SOUTH
TRUST
AB
BA
CBL
DBL
JBL (2)
MTB
PREMIE
R
PRIME
SOUTH
TRUST

8.84
8.15
10.2
8.83

Fall in
potential
threat if
revised
CAR<10%

Need Additional
Capital

Fall in
potenti
al
threat if
revised
CAR<1
0%

Scenario 3,
10%

Fall in
potential
threat if
revised
CAR<10
%

Scenario 2,
5%

Scenario 1,
2%

Bank name

Year

Category

Table 8: Private Conventional and Islamic banks situation in three different years to show
NPL indictor performance

7.19
4.83
8.77

x
x
x

4.31
1.31
6.28

x
x
x

Yes
Yes
Yes

x
x

6.91
6.06
8.2
7.0

x
x
x
x

3.49
2.36
4.66
3.8

x
x
x
x

Yes
Yes
Yes
Yes

10.57
10.27
7.93
10.19
13.2
11.67
9.51
9.78
10.54
9.3

x
x
x

8.84
8.65
6.21
8.37
10.57
9.95
7.68
7.48
8.33
7.36

x
x
x
x

x
x
x
x
x

5.81
5.83
3.18
5.15
5.80
6.92
4.47
3.33
4.40
3.93

x
x
x
x
x
x
x
x
x
x

Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes

11.23
10.7
10.04
10.36
11.61
13.56
9.43
10.97
9.18
9.76

x
x

9.27
8.64
8.08
8.39
9.35
10.92
7.40
9.01
6.82
7.75

x
x
x
x
x
x
x
x
x

5.83
5.6
4.62
4.9
5.33
7.32
3.82
5.58
2.57
4.23

x
x
x
x
x
x
x
x
x
x

Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes

11.30
9.64
11.75

9.22
7.75
9.70

x
x
x

5.50
4.42
6.07

x
x
x

Yes
Yes
Yes

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110

Table 9: List of the Banks selected for conducting stress testing

3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29

Government
Commercial
Bank

Private
Islamic
Bank

Category

Foreign
Private Conventional & Islamic Private Conventional Commercial
Islamic
Commercial Banks
Banks
Banpk

SL No.

Name of the Bank

Acronyms

Agrani Bank limited

Agrani

Basic Bank Limited

BB

Janata Bank limited

JBL (1)

First Security Islami Bank limited

Islami Bank limited
EXIM Bank limited
Shajalal Islami Bank limited
Al-arafa Islami Bank limited
ICB Islamic Bank limited

FSIBL
IBL
EXIM
SHAJAlAL
Al-ARAFA
ICBIBL

Eastern Bank limited

IFIC Bank limited
Mercantile Bank limited
National Bank limited
National Credit and Commerce Bank
limited
One Bank limited
United Commercial Bank limited
Uttara Bank limited
Dutch-Bangla Bank limited
Standard Bank limited
Arab Bangladesh Bank limited
Bank Asia
City Bank limited
Dhaka Bank limited
Jamuna Bank limited
Mutual Trust Bank limited
Premier Bank limited
Prime Bank limited
Southeast Bank limited
Trust Bank limited

EBL
IFIC
MBL
NBL
NCC

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OBL
UCBL
UBL
DBBL
STANDARD
AB
BA
CBL
DBL
JBL (2)
MTB
PREMIER
PRIME
SOUTH
TRUST