1.

0 COMPANY BACKGROUND
Based on Islamic principles and Shariah (Islamic law), with an authorized capital of TK. 500 million
(US$ 12.5 million), Islami Bank Bangladesh Limited (IBBL) was incorporated on March 13, 1983 as
a Public Limited Company under the companies Act of 1913. This is one of the first interest free
banks in South Asia. It has 36.91% local and 63.09% foreign shareholders. With 285 branches and
11,465 staffs, IBBL is the largest private banking network in Bangladesh (as of 2013). The bank
is listed with both Dhaka Stock Exchange Ltd. and Chittagong Stock Exchange Ltd
1.1 FINANCIAL INFORMATION
As of 2013, the financials of IBBL stand as follows:
Authorized Capital
Paid-up Capital
Deposits
Investment (including
Investment in Shares)
Current Amount of Loan
Outstanding
Bad-debt

Tk. 20,000.00 Million ($ 250.47 Million)

Tk. 12,509.64 Million ($ 156.66 Million)
Tk. 417,844.14 Million ($ 5,232.87 Million)
Tk. 399,930.80 Million ($ 5,008.53 Million)
Around 500 crores
3-4%

1.2 CLIENT INFORMATION

As of 2013:
No. of clients
No. of debtors

Around 1 crore
Around 5 lakhs

2.0 FINANCIAL MODEL OF IBBL

The financial model of Islami Bank Ltd is slightly different from that of conventional banks, due to its
adherence to Islamic Banking Principles. This means, unlike conventional debtor creditor relationship
that exists with banks and depositors as well as borrowers, due to prohibition, banks run under the
Islamic banking system cannot act as intermediaries between depositors and borrowers.
2.1 KEY DIFFERENCES
Conventional Banks accept deposits, and give loans based on fixed interest rates. This is usually done
by transferring credit to the borrower once the application has been processed.
Islamic banking requires the bank to take some degree of ownership of risk, thus no direct
cash transaction to the account of the borrower is made. Instead the bank purchases goods or
machinery that the borrower requires, on behalf of the borrower, and re-sells these goods at a higher
rate to the borrower, with the provision of paying in installments or at a later date. Thus it is more
into product business than money business.

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This requirement of ownership then precludes Islami Bank from offering loans for personal uses like
medical cures, events, or service oriented companies since it is difficult or impossible to make direct
payments to sellers in these instances. Thus the arrangements are of 3 sorts:
a) Co-ownership
b) Hire-Purchase
c) Lease
(Details in the Appendix)
3.0 CURRENT SCENARIO OF NON-PERFORMING LOANS IN BANGLDESH
BANKING INDUSTRY
Default loans dropped 28.45% last quarter on the back of increased cash recovery, loan write-offs and
liberal rescheduling rules in the wake of political unrest
that hurt business. As of December 31 last year, the
banking sector's total classified loans stood at Tk.
40,583 crore, down from Tk. 56,720 crore on
September 30, 2013. Of the 56 banks, 40 managed to
cut down their default loans. This happened mainly due
to Bangladesh Banks relaxation of NPL Rescheduling
rules in June, 2012:
The bank must have a policy approved by its Board
Figure 1 NPL in different banks of
Bangladesh (Source: The Daily Star)

defining the circumstances/ conditions under which a

loan may be rescheduled but not in contravention of the contents of the Bangladesh Bank circular.
The policy must highlight the controlling mechanisms for avoidance of routine rescheduling/ repeat
rescheduling wherein lies the doubt of recovery of full amount of loan.
IBBL managed to cut down its default loan from Tk. 2786 crores to Tk. 1354 crores. However, it
is still higher than most of the private banks.
4.0 CREDIT DISBURSEMENT POLICY & PRACTICES OF IBBL
It is a known fact that a bank's financial well-being is essentially dependent upon the extent and size
of its performing assets. Credit losses are equivalent to capital losses. An increase in nonperforming loan (NPL) has far-reaching adverse impacts on bank's balance sheet having
consequential effects on profitability, liquidity and solvency. Thus, the bank management has to stay
focused on keeping credit portfolio performing to the maximum extent.
Adverse selection and moral hazard are related to asymmetric information between two contracting
parties. These concepts are very significant in the context of banking institutions. Adverse selection
arises due to defectiveness in selection of potential borrower, mistake in selection of business where

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to finance/not to finance, defective structuring of credit, under/over financing, faulty projections not
supported by adequate assumptions, etc. In case of moral hazard, one of the party hides information
that may appear to be vital during the contract and occurs mainly due to poor monitoring,
economic recession, political instability, etc. Discussed below are the policies and
practices of credit disbursement of IBBL with the aim of minimizing adverse selection and
moral hazard:
4.1 POLICIES & PRACTICES TO MINIMIZE ADVERSE SELECTION
The cure for information asymmetry is more information about potential fund receivers. After an
overall assessment, the individual/ organization are given a Credit Risk Grading (CRG). The
scores are arbitrary and dependent on the companys own credit policies. On a scale of 1-8, the cutoff point is usually 6. (Details in Appendix)
4.1.1 Assessment of credit worthiness for Fresher
In case of the potential borrower being a fresher, i.e. the proposal is for a new business, the bank takes
a number of steps to cross check credit worthiness. The broad approach is to break it down into two
aspects, the individuals credit worthiness as a borrower, and the business plans sustainability as a
successful enterprise.
Individual credit worthiness
A detailed Financial Analysis is done by the banks own analysts. In some instances, especially in case
of larger loans, external consultants are sometimes hired as well. The factors under inspection are:

Evaluation of bank statements: The individuals bank statements are evaluated. The current
balance, spending patterns, and net assets are also checked. In some cases, the potential
borrower is asked to present a guarantor of the loan, a person who is willing to bear the risk in

case of default.
Evaluation of tax statements: The borrower is required to produce their tax returns and

returns of several years are compared to account for inconsistencies.

Double-checking with Credit Information Bureau: Credit Information Bureau, a division
of the Bangladesh bank, is accessed. This division was created to monitor all credit within the
country, and banks are required to lodge information here as soon as a loan is granted. This is
the hub of information for all outstanding loans within Bangladesh at any given time. This

will reveal any loan the individual is yet to pay off.

Assessment of history of loans: In some cases the borrower is asked for a history of loans
that they may have taken and repaid. This information is then cross checked by calling the
borrowers prior banks. This is NOT a formal process, and is usually done over the phone as a
heads-up from one banker to another.
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Business Credit Worthiness

The analysts look at a number of things, including forecast for demand for that sort of a business,

financial climate, the business model etc.

They identify highly risk sensitive borrowers as well as assess geographical area-wise risk

sensitivity.
In instances where they feel that the plan requires substantial alterations, the bank makes these
alterations conditional for the loan to be granted. In most instances, the borrower is free to choose
between different suppliers or approaches, so long as none of the investments raise a red flag with
the analysts.

4.1.2 Assessment of credit worthiness of Existing firms

The process for appraisal for existing firms is quite similar. Since the business is already operational,
there is less emphasis on individual credit worthiness.
Auditing of firm by CRAB: On top of the usual analysis of the firms books, the business is
usually required to allow a third party, usually CRAB (Credit Rating Agency of
Bangladesh) to audit the company and give it a credit rating, on the basis of which the loan is

approved or disapproved. The expense for this audit is to be paid for the company itself.
Implementation Schedule: During the evaluation process, the business (be it a proposed or
current one) is also required to submit a Implementation schedule, which is basically a
timeline of the project. On the basis of this, the bank prepares a Fund Drawdown Schedule,
which outlines at the times at which the bank will sanction payment on behalf of the borrower
to a third party. While minor adjustments can be made to these schedules, usually the bank
tries to enforce adherence.

4.2 POLICIES & PRACTICES TO MINIMIZE MORAL HAZARD

In debt finance through the issuance of bonds, IBBL imposes restrictive covenants that prevent

the bond issuer from taking too many risks or to restrict the amount of debt that can be added.
Diversion of fund is one of the identified causes of loan default. Thus, they keep a close watch on
the borrowers business operations and the movement of their financial indicators after
disbursement. Since Islami Bank never actually transfers cash to borrowers account, it is much
easier to monitor the borrowers activity once loan is granted. This practice of continuous
monitoring is called supervised credit.

The monitoring process contains:

Random On-site inspections: Inspectors from the Bank turn up unannounced to the site of
the business to see if everything is proceeding as proposed. The objective is to assess how
close the company is to the proposal, and whether or not the requirement as per the schedules
is realistic for scale of operations

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Valuation of the business proposal: The business proposal given to the bank or fund
proposal whatever is given, is first has to go through the NPV evaluation.

Cash flow

statements are analyzed to check the businesss potential of repaying the loan. FV estimations

are done for checking the potential

Industry analysis: In order to re-assure that the proposed business is worth financing an

overall industry analysis is done. IFE & EFE matrix are also taken into consideration
Evaluation of Stock report: The borrower is to submit a routine stock report to the bank.
This is to account for the amount of stock/machinery that the bank paid for on behalf of the
customer is either in stock, or is accounted for in the sales ledger of the company. This is done
to make sure the borrowers cannot funnel money away from the project they initially

borrowed for.
Net Asset valuation- The worth of the mortgaged asset is acquainted its total worth which

gives the bank assurance of the mortgage. The loan amount is then discussed and adjusted
Contract binding: In whatever case the bank invests it follows the ancient shariah methods
of mudarabah,( shares the profit)

ijara ( shares ownership of equipment ) and shikket

( forms partnership with the business owner ) and as such the bank binds the debtors into legal

contract specifying the terms and conditions in case of loan default.

Legal Compliance- In cases where debtor is suspected to be a bad debtor, legal complaint is
filed under separate bank court. (Details in Appendix)

REFERENCE
In-Depth Interview

Md. Akther Hossain

Vice President & Branch Manager

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Islami Bank Bangladesh Ltd., Cantonment Branch

BIBLIOGRPAHY

Byron, R.K. (2015, Feb 18). Increased loan recovery, relaxed rules cut defaults. The Daily Star.
http://www.thedailystar.net/increased-loan-recovery-relaxed-rules-cut-defaults-12889
Masoon, M. (2013, Feb 16). Strategies for recovery of non-performing loans. The Financial Express.
http://www.thefinancialexpress-bd.com/old/index.php?
ref=MjBfMDJfMTZfMTNfMV85OV8xNjAzNDQ%3D
Islami Bank Bangladesh Ltd. Wikipedia, the free encyclopedia.
http://en.wikipedia.org/wiki/Islami_Bank_Bangladesh_Ltd
IBBL At a Glance. Islami Bank Bangladesh Limited Official Website.
http://www.islamibankbd.com/abtIBBL/abtIBBLAtaGlance.php
Managing Core Risks in Banking: Credit Risk Management-Industry Best Practices. Bangladesh
Bank.
http://www.bb.org.bd/openpdf.php

APPENDIX
MODES OF INVESTMENTS OF IBBL

a. Co-Ownership: The asset is purchased on a co-ownership basis between the bank and the
debtor. Gradually over time, debtor purchase the banks share in the car against monthly
payments and consequently the ownership is completely transferred under their name.
b. Hire-purchase: In Hire Purchase under Shirkatul Melk mode both the Bank and the Client
supply equity in equal or unequal proportion for purchase of an asset. They purchase the asset
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with that equity money, own the same jointly; share the benefit as per agreement and bear the
loss in proportion to their respective equity. The share, part or portion of the asset owned by
the Bank is hired out to the Client partner for a fixed rent per unit of time for a fixed period.
Lastly, the Bank sells and transfers the ownership of its share / part / portion to the Client
against payment of price fixed for that part either gradually part by part or in lump sum within
the hire period or after the expiry of the hire agreement.
c. Lease: Bank purchases all of the good on behalf of the borrower, and sets rates and time
duration for repayment, at the end of which the transfer of ownership of good is complete.
CREDIT RISK GRADING

According to Bangladesh Bank:

Risk Rating
Superior Low Risk

Grade
1

Definition
Facilities are fully secured by cash deposits, government
bonds or a counter guarantee from a top tier international

Superior Low Risk

bank. All security documentation should be in place.

The repayment capacity of the borrower is strong. The
borrower should have excellent liquidity and low leverage.
The company should demonstrate consistently strong
earnings and cash flow and have an unblemished track
record. All security documentation should be in place.
Aggregate Score of 95 or greater based on the Risk Grade

Acceptable Fair Risk

Scorecard.
Adequate financial condition though may not be able to
sustain any major or continued setbacks. These borrowers
are not as strong as Grade 2 borrowers, but should still
demonstrate consistent earnings, cash flow and have a good
track record. A borrower should not be graded better than 3
if realistic audited financial statements are not received.
These assets would normally be secured by acceptable
collateral (1st charge over stocks / debtors / equipment /
property). Borrowers should have adequate liquidity, cash
flow and earnings. An Aggregate Score of 75-94 based on

Marginal - Watch list

the Risk Grade Scorecard.

Grade 4 assets warrant greater attention due to conditions
affecting the borrower, the industry or the economic
environment. These borrowers have an above average risk
due to strained liquidity, higher than normal leverage, thin
cash flow and/or inconsistent earnings. Facilities should be
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downgraded to 4 if the borrower incurs a loss, loan

payments routinely fall past due, account conduct is poor, or
other untoward factors are present. An Aggregate Score of
Special Mention

65-74 based on the Risk Grade Scorecard.

Grade 5 assets have potential weaknesses that deserve
managements close attention. If left uncorrected, these
weaknesses may result in a deterioration of the repayment
prospects of the borrower. Facilities should be downgraded
to 5 if sustained deterioration in financial condition is noted
(consecutive

losses,

negative

net

worth,

excessive

leverage), if loan payments remain past due for 30-60 days,

or if a significant petition or claim is lodged against the
borrower. Full repayment of facilities is still expected and
interest can still be taken into profits. An Aggregate Score
Substandard

of 55-64 based on the Risk Grade Scorecard.

Financial condition is weak and capacity or inclination to
repay is in doubt. These weaknesses jeopardize the full
settlement of loans. Loans should be downgraded to 6 if
loan payments remain past due for 60-90 days, if the
customer intends to create a lender group for debt
restructuring purposes, the operation has ceased trading or
any indication suggesting the winding up or closure of the
borrower is discovered. Not yet considered non-performing
as the correction of the deficiencies may result in an
improved condition, and interest can still be taken into
profits. An Aggregate Score of 45-54 based on the Risk

Doubtful

and

performing)

Bad

(non-

Grade Scorecard.
Full repayment of principal and interest is unlikely and the
possibility of loss is extremely high. However, due to
specifically identifiable pending factors, such as litigation,
liquidation procedures or capital injection, the asset is not
yet classified as Loss. Assets should be downgraded to 7 if
loan payments remain past due in excess of 90 days, and
interest income should be taken into suspense (nonaccrual).
Loan loss provisions must be raised against the estimated
unrealisable amount of all facilities. The adequacy of
provisions must be reviewed at least quarterly on all nonperforming loans, and the bank should pursue legal options
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to enforce security to obtain repayment or negotiate an

appropriate loan rescheduling. In all cases, the requirements
of Bangladesh Bank in CIB reporting, loan rescheduling
and provisioning must be followed. An Aggregate Score of
Loss (non-pe

35-44 based on the Risk Grade Scorecard

Assets graded 8 are long outstanding with no progress in
obtaining repayment (in excess of 180 days past due) or in
the late stages of wind up/liquidation. The prospect of
recovery is poor and legal options have been pursued. The
proceeds expected from the liquidation or realization of
security may be awaited. The continuance of the loan as a
bankable asset is not warranted, and the anticipated loss
should have been provided for. This classification reflects
that it is not practical or desirable to defer writing off this
basically worthless asset even though partial recovery may
be effected in the future. Bangladesh Bank guidelines for
timely write off of bad loans must be adhered to. An
Aggregate Score of 35 or less based on the Risk Grade
Scorecard

LEGAL ACTION ON EVENT OF SUSPICIOUS ACTIVITY OF DEBTOR

1.
2.
3.
4.
5.

Give notice warning them to pay off the loan within 15 days.
If the person falters, then a final notice is given with another 15 day period.
On event of non-compliance, a legal notice is sent via their advocate.
If that doesnt work then they file a case under Non-negotiable Act of check dishonor.
If they can recover the loan by selling off mortgage then the case is not filed. However, if only a
partial amount is recovered then another case is filed to the court to ask for permission to seize
personal property equivalent to the unrecovered amount of the debtor.

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