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46
Problems of SMEs: Some observations on problems related to Marketing and Technology

SMEs face several problems like finance, management, information, marketing and technology etc.  Here, I am presenting a brief discussion on the Problems related to Marketing and Technology.

Marketing:
The marketing functions can be divided into sales promotion, price policy, advertizing, product design and finally selling methods. SMEs may face difficulties in marketing products due to poor quality, lack of knowledge of markets and marketing skills. Owing to the low level of technology, their products may be poor and of inconsistent quality. Often the products may not be attractively packaged or described. SMEs often lack the knowledge to explore niche markets for their products. The owner entrepreneur often have no special skills in these matters and does not know where he can get reliable information about the market developments, advertizing opportunities, or better marketing channels. They also lack the resources to advertize and promote their products. The business will not promote itself; advertising and promotions are the lifelines of a business. Yet, SMEs often do not have enough financial resources to spend on advertising.

In the context of the above, some possible suggestions for market development and market access are given below:

Market Development:
Product quality is the primary consideration in marketing. Various measurements may be taken to assist SMEs in developing their markets, both locally and internationally. The following steps may be taken:
•   Create institutions to enhance product quality.
•   Encourage SMEs to take up franchises and assist others to develop franchises
•   Provide incentives to SMEs to participate in trade fairs both at home and abroad
•    Make greater effort by government or private sector for developing marketing and management skills
•   Institute special marketing board to handle the marketing of SME products


Market Access at the national and international level
•   Enable SMEs to take advantage of the opportunities for market expansion through the adoption of electronic commerce.
•    Provide better information on markets
•   Encourage large companies to use SMEs in subcontracting
•   Assist SMEs to access the export market through joint trade and investment promotion missions
•   Facilitate the forging of intra-firm linkages
•   Make available electronic data bases on business matching and facilitation services.


Technology:
The problem of technology and access to and adoption of new technology is inextricably linked to Knowledge-based economy. To overcome the nature of the constraint faced by SMEs in applying and adopting technological improvements, government assistance is required in a package. The private sector may also assist in this regard. Many of the activities and initiatives with regard to removing impediments to technology access require at the outset, a comprehensive data base, which includes information on the technologies available, the cost of technology and the expertise available to impart the requisite skills that accompany the adoption of new technology. Such database also facilitates technology exchange and technology sharing.

Technology transfer may be facilitated through encouraging and bringing direct foreign investment. SMEs generally lack technological information and the technological capabilities. Even when SMEs are able to access the information on technology, their capacity to apply is constrained by the lack of financial resources and skills that go with new technology. This problem should be looked into by the government. Extensive technical training may be recommended for training extension workers who may be in a better position to explain new technology to SMEs

Whether technological change can be successfully applied in SMEs will depend also on managerial abilities. The difficulty of applying new technology in SMEs may require some qualitative change in the attitude of the managers. Education for a change in attitude and motivation may improve the situation.

Some strategic direction in addressing the access to technology will require:
•   The creation and increased awareness of technological developments
•   The encouragements of the adoption of appropriate technology
•   The encouragements and support of innovation and creativity in SMEs
•   The setting up of extension centers and providing trained personnel to help SMEs make effective decision about technology.

Professor Rafiqul Islam
Advisor, Faculty of Business & Economics
Daffodil International University


47
Problems of SMEs: Some observations on problems related to Marketing and Technology

SMEs face several problems like finance, management, information, marketing and technology etc.  Here, I am presenting a brief discussion on the Problems related to Marketing and Technology.

Marketing:
The marketing functions can be divided into sales promotion, price policy, advertizing, product design and finally selling methods. SMEs may face difficulties in marketing products due to poor quality, lack of knowledge of markets and marketing skills. Owing to the low level of technology, their products may be poor and of inconsistent quality. Often the products may not be attractively packaged or described. SMEs often lack the knowledge to explore niche markets for their products. The owner entrepreneur often have no special skills in these matters and does not know where he can get reliable information about the market developments, advertizing opportunities, or better marketing channels. They also lack the resources to advertize and promote their products. The business will not promote itself; advertising and promotions are the lifelines of a business. Yet, SMEs often do not have enough financial resources to spend on advertising.

In the context of the above, some possible suggestions for market development and market access are given below:

Market Development:
Product quality is the primary consideration in marketing. Various measurements may be taken to assist SMEs in developing their markets, both locally and internationally. The following steps may be taken:
•   Create institutions to enhance product quality.
•   Encourage SMEs to take up franchises and assist others to develop franchises
•   Provide incentives to SMEs to participate in trade fairs both at home and abroad
•    Make greater effort by government or private sector for developing marketing and management skills
•   Institute special marketing board to handle the marketing of SME products


Market Access at the national and international level
•   Enable SMEs to take advantage of the opportunities for market expansion through the adoption of electronic commerce.
•    Provide better information on markets
•   Encourage large companies to use SMEs in subcontracting
•   Assist SMEs to access the export market through joint trade and investment promotion missions
•   Facilitate the forging of intra-firm linkages
•   Make available electronic data bases on business matching and facilitation services.


Technology:
The problem of technology and access to and adoption of new technology is inextricably linked to Knowledge-based economy. To overcome the nature of the constraint faced by SMEs in applying and adopting technological improvements, government assistance is required in a package. The private sector may also assist in this regard. Many of the activities and initiatives with regard to removing impediments to technology access require at the outset, a comprehensive data base, which includes information on the technologies available, the cost of technology and the expertise available to impart the requisite skills that accompany the adoption of new technology. Such database also facilitates technology exchange and technology sharing.

Technology transfer may be facilitated through encouraging and bringing direct foreign investment. SMEs generally lack technological information and the technological capabilities. Even when SMEs are able to access the information on technology, their capacity to apply is constrained by the lack of financial resources and skills that go with new technology. This problem should be looked into by the government. Extensive technical training may be recommended for training extension workers who may be in a better position to explain new technology to SMEs

Whether technological change can be successfully applied in SMEs will depend also on managerial abilities. The difficulty of applying new technology in SMEs may require some qualitative change in the attitude of the managers. Education for a change in attitude and motivation may improve the situation.

Some strategic direction in addressing the access to technology will require:
•   The creation and increased awareness of technological developments
•   The encouragements of the adoption of appropriate technology
•   The encouragements and support of innovation and creativity in SMEs
•   The setting up of extension centers and providing trained personnel to help SMEs make effective decision about technology.

Professor Rafiqul Islam
Advisor, Faculty of Business & Economics
Daffodil International University


48
Faculty Forum / Concluding Section of Capital Adequacy
« on: July 07, 2013, 02:14:34 PM »
Concluding Section of Capital Adequacy

Although the capital of commercial banks have increased over the years, the more rapid increase in total assets and deposits continues to focus attention on the adequacy (or inadequacy) of bank capital. Regulatory authorities are especially concerned with this matter since they have been charged with responsibility of bank safety.

While it may be difficult to determine precisely the amount of capital that a bank or the banking system should have, the capital should be sufficient to fulfill the basic functions: financing the operation of a bank, providing protection to depositors and supervisory authorities.

Sometimes there are attempts to establish a set of standards that can be employed to test the adequacy of capital funds of a particulars bank or banking system. Although a ratio may be helpful as a starting point in analyzing the capital adequacy of an individual bank, it should not be considered as an end in itself. Is it beyond criticism just because a bank meets some ratio? The inquiry must go beyond the ratio to an examination of the bank’s operations and the risks it assumes in its loan and investment portfolio.
 
Capital funds have been measured in relation to various balance sheet items such as total deposits, total assets or risk assets. The ratio of a bank’s capital funds to these balance sheet items has been thought to indicate the extent to which a bank could suffer losses of one kind or another and still have enough capital to assure the safety of depositors’ fund. Various levels of these ratios have been used by supervisory authorities and others as standards of capital adequacy; the bank whose capital ratio were not at least equal to current standards at that time has often been considered undercapitalized for the volume of business it was doing or for the volume of assets or the volume of assets or deposits it held. The ratio of capital funds to total deposits has enjoyed the longest use of any ratio devised to measure and determine capital adequacy. The ratio of capital funds to total assets came into use by some supervisory authorities in the late 1940s. It was argued that the amount of capital the bank needs is not related to deposits, but to assets. Because a measure of capital adequacy purports to indicate the extent that a bank’s capital can absorb loss and still protect the depositors, a valid measure would have to be related to all items in the balance sheet that might be subject to loss. Losses are reflected in the bank’s balance sheet by reduced values of assets; therefore, a measure of capital adequacy should logically relate capital funds to those assets and not to deposits. Until very recently, the ratio of capital to total assets was in vogue.

But regulatory agencies did not seem to be completely satisfied with the above capital adequacy guidelines, and for that reason proposed revision that takes into account the risks of a bank’s assets. This would mean that banks with high proportion of risky assets would be required to maintain more capital than if assets possessed lower risk. This risk-adjusted capital requirement is given more attention at present. A variety of reasons prompted the introduction of the risk-adjusted ratio, including the growth of off-balance sheet item and the decline in the quality of loan portfolios of many banks, including loans to third world countries. Off-balance sheet items, such as letters of credit, loan commitments and promises to guarantee loans, are not considered to be assets; consequently, they do not presently require capital backing. The objective of the risk-adjusted ratio is to alter a bank’s assets mix and thus contribute to a safer banking system. For the purpose of this analysis, bank assets are divided into some rough groupings. These do not, of course, accurately reflect all the various shades or degrees of risk, but they appear to be the fundamental categories into which bank assets normally fall, and they provide a more selective basis than the simple distinction between risk and non-risk assets used in the risk-asset approach.

The ratios as stated above have been judged, at one time or another, to fall short of the requirements necessary for a valid standard of the adequacy of a bank’s capital funds. To the extent that adequate capital means enough to absorb losses and prevent failure, all have been poor predictors of bank failures and thus poor measures of capital adequacy.
 
It may be relevant to state U.S comptroller’s manual which provided official guidelines for the determination of capital adequacy that specifically denied reliance on capital ratios. Instead, its following eight factors are considered to be very important in assessing the adequacy of capital:
1.   The quality of management
2.   The liquidity of assets
3.   The history of earnings and of the retention thereof
4.   The quality and character of ownership
5.   The burden of meeting occupancy expenses
6.   The potential volatility of deposit structure
7.   The quality of operating procedures
8.   The bank’s capacity to meet present and future financial needs of its trade area, considering the competition it faces.

Each of these factors related in some way to the various kinds of risk that commercial bank faces. In addition to these qualitative factors, the regulatory agencies assess the growth rate in earnings and assets when attempting to judge the adequacy of bank capital. If a bank is not growing in earnings and assets, it obviously has more risk than does one that is enjoying a healthy growth. The existence of more risk indicates a need for more capital, other things being equal, than is necessary for a bank with less risk.
 
Bank management owes to itself, to the depositors, and to the economy as a whole. A careful appraisal of all the risks facing the bank is required when ascertaining the adequacy of bank capital. Bank management should not be lulled into a sense of false security by good times. It should not be forgotten that bank failures result in losses to depositors and stockholders, bring inability for banks to meet the legitimate demands of borrowers and reduces public’s confidence in the financial structure of the nation. Therefore, the banks must maintain adequate capital. But adequate capital is not, of course, a substitute for sound lending and investing policies; it cannot take the place of experienced and progressive management of a well-conceived programme of planning and control. However, adequate capital can provide assurance to the public, the stockholders, and the supervisor that the strength and the wherewithal to survive circumstances and conditions that even the best management can never foresee.


Professor Rafiqul Islam
Dean
Faculty of Business & Economics (FBE)

49
MBA Discussion Forum / Concluding Section of Capital Adequacy
« on: July 07, 2013, 02:14:03 PM »
Concluding Section of Capital Adequacy

Although the capital of commercial banks have increased over the years, the more rapid increase in total assets and deposits continues to focus attention on the adequacy (or inadequacy) of bank capital. Regulatory authorities are especially concerned with this matter since they have been charged with responsibility of bank safety.

While it may be difficult to determine precisely the amount of capital that a bank or the banking system should have, the capital should be sufficient to fulfill the basic functions: financing the operation of a bank, providing protection to depositors and supervisory authorities.

Sometimes there are attempts to establish a set of standards that can be employed to test the adequacy of capital funds of a particulars bank or banking system. Although a ratio may be helpful as a starting point in analyzing the capital adequacy of an individual bank, it should not be considered as an end in itself. Is it beyond criticism just because a bank meets some ratio? The inquiry must go beyond the ratio to an examination of the bank’s operations and the risks it assumes in its loan and investment portfolio.
 
Capital funds have been measured in relation to various balance sheet items such as total deposits, total assets or risk assets. The ratio of a bank’s capital funds to these balance sheet items has been thought to indicate the extent to which a bank could suffer losses of one kind or another and still have enough capital to assure the safety of depositors’ fund. Various levels of these ratios have been used by supervisory authorities and others as standards of capital adequacy; the bank whose capital ratio were not at least equal to current standards at that time has often been considered undercapitalized for the volume of business it was doing or for the volume of assets or the volume of assets or deposits it held. The ratio of capital funds to total deposits has enjoyed the longest use of any ratio devised to measure and determine capital adequacy. The ratio of capital funds to total assets came into use by some supervisory authorities in the late 1940s. It was argued that the amount of capital the bank needs is not related to deposits, but to assets. Because a measure of capital adequacy purports to indicate the extent that a bank’s capital can absorb loss and still protect the depositors, a valid measure would have to be related to all items in the balance sheet that might be subject to loss. Losses are reflected in the bank’s balance sheet by reduced values of assets; therefore, a measure of capital adequacy should logically relate capital funds to those assets and not to deposits. Until very recently, the ratio of capital to total assets was in vogue.

But regulatory agencies did not seem to be completely satisfied with the above capital adequacy guidelines, and for that reason proposed revision that takes into account the risks of a bank’s assets. This would mean that banks with high proportion of risky assets would be required to maintain more capital than if assets possessed lower risk. This risk-adjusted capital requirement is given more attention at present. A variety of reasons prompted the introduction of the risk-adjusted ratio, including the growth of off-balance sheet item and the decline in the quality of loan portfolios of many banks, including loans to third world countries. Off-balance sheet items, such as letters of credit, loan commitments and promises to guarantee loans, are not considered to be assets; consequently, they do not presently require capital backing. The objective of the risk-adjusted ratio is to alter a bank’s assets mix and thus contribute to a safer banking system. For the purpose of this analysis, bank assets are divided into some rough groupings. These do not, of course, accurately reflect all the various shades or degrees of risk, but they appear to be the fundamental categories into which bank assets normally fall, and they provide a more selective basis than the simple distinction between risk and non-risk assets used in the risk-asset approach.

The ratios as stated above have been judged, at one time or another, to fall short of the requirements necessary for a valid standard of the adequacy of a bank’s capital funds. To the extent that adequate capital means enough to absorb losses and prevent failure, all have been poor predictors of bank failures and thus poor measures of capital adequacy.
 
It may be relevant to state U.S comptroller’s manual which provided official guidelines for the determination of capital adequacy that specifically denied reliance on capital ratios. Instead, its following eight factors are considered to be very important in assessing the adequacy of capital:
1.   The quality of management
2.   The liquidity of assets
3.   The history of earnings and of the retention thereof
4.   The quality and character of ownership
5.   The burden of meeting occupancy expenses
6.   The potential volatility of deposit structure
7.   The quality of operating procedures
8.   The bank’s capacity to meet present and future financial needs of its trade area, considering the competition it faces.

Each of these factors related in some way to the various kinds of risk that commercial bank faces. In addition to these qualitative factors, the regulatory agencies assess the growth rate in earnings and assets when attempting to judge the adequacy of bank capital. If a bank is not growing in earnings and assets, it obviously has more risk than does one that is enjoying a healthy growth. The existence of more risk indicates a need for more capital, other things being equal, than is necessary for a bank with less risk.
 
Bank management owes to itself, to the depositors, and to the economy as a whole. A careful appraisal of all the risks facing the bank is required when ascertaining the adequacy of bank capital. Bank management should not be lulled into a sense of false security by good times. It should not be forgotten that bank failures result in losses to depositors and stockholders, bring inability for banks to meet the legitimate demands of borrowers and reduces public’s confidence in the financial structure of the nation. Therefore, the banks must maintain adequate capital. But adequate capital is not, of course, a substitute for sound lending and investing policies; it cannot take the place of experienced and progressive management of a well-conceived programme of planning and control. However, adequate capital can provide assurance to the public, the stockholders, and the supervisor that the strength and the wherewithal to survive circumstances and conditions that even the best management can never foresee.


Professor Rafiqul Islam
Dean
Faculty of Business & Economics (FBE)

50
BBA Discussion Forum / Concluding Section of Capital Adequacy
« on: July 07, 2013, 02:12:35 PM »
Concluding Section of Capital Adequacy

Although the capital of commercial banks have increased over the years, the more rapid increase in total assets and deposits continues to focus attention on the adequacy (or inadequacy) of bank capital. Regulatory authorities are especially concerned with this matter since they have been charged with responsibility of bank safety.

While it may be difficult to determine precisely the amount of capital that a bank or the banking system should have, the capital should be sufficient to fulfill the basic functions: financing the operation of a bank, providing protection to depositors and supervisory authorities.

Sometimes there are attempts to establish a set of standards that can be employed to test the adequacy of capital funds of a particulars bank or banking system. Although a ratio may be helpful as a starting point in analyzing the capital adequacy of an individual bank, it should not be considered as an end in itself. Is it beyond criticism just because a bank meets some ratio? The inquiry must go beyond the ratio to an examination of the bank’s operations and the risks it assumes in its loan and investment portfolio.
 
Capital funds have been measured in relation to various balance sheet items such as total deposits, total assets or risk assets. The ratio of a bank’s capital funds to these balance sheet items has been thought to indicate the extent to which a bank could suffer losses of one kind or another and still have enough capital to assure the safety of depositors’ fund. Various levels of these ratios have been used by supervisory authorities and others as standards of capital adequacy; the bank whose capital ratio were not at least equal to current standards at that time has often been considered undercapitalized for the volume of business it was doing or for the volume of assets or the volume of assets or deposits it held. The ratio of capital funds to total deposits has enjoyed the longest use of any ratio devised to measure and determine capital adequacy. The ratio of capital funds to total assets came into use by some supervisory authorities in the late 1940s. It was argued that the amount of capital the bank needs is not related to deposits, but to assets. Because a measure of capital adequacy purports to indicate the extent that a bank’s capital can absorb loss and still protect the depositors, a valid measure would have to be related to all items in the balance sheet that might be subject to loss. Losses are reflected in the bank’s balance sheet by reduced values of assets; therefore, a measure of capital adequacy should logically relate capital funds to those assets and not to deposits. Until very recently, the ratio of capital to total assets was in vogue.

But regulatory agencies did not seem to be completely satisfied with the above capital adequacy guidelines, and for that reason proposed revision that takes into account the risks of a bank’s assets. This would mean that banks with high proportion of risky assets would be required to maintain more capital than if assets possessed lower risk. This risk-adjusted capital requirement is given more attention at present. A variety of reasons prompted the introduction of the risk-adjusted ratio, including the growth of off-balance sheet item and the decline in the quality of loan portfolios of many banks, including loans to third world countries. Off-balance sheet items, such as letters of credit, loan commitments and promises to guarantee loans, are not considered to be assets; consequently, they do not presently require capital backing. The objective of the risk-adjusted ratio is to alter a bank’s assets mix and thus contribute to a safer banking system. For the purpose of this analysis, bank assets are divided into some rough groupings. These do not, of course, accurately reflect all the various shades or degrees of risk, but they appear to be the fundamental categories into which bank assets normally fall, and they provide a more selective basis than the simple distinction between risk and non-risk assets used in the risk-asset approach.

The ratios as stated above have been judged, at one time or another, to fall short of the requirements necessary for a valid standard of the adequacy of a bank’s capital funds. To the extent that adequate capital means enough to absorb losses and prevent failure, all have been poor predictors of bank failures and thus poor measures of capital adequacy.
 
It may be relevant to state U.S comptroller’s manual which provided official guidelines for the determination of capital adequacy that specifically denied reliance on capital ratios. Instead, its following eight factors are considered to be very important in assessing the adequacy of capital:
1.   The quality of management
2.   The liquidity of assets
3.   The history of earnings and of the retention thereof
4.   The quality and character of ownership
5.   The burden of meeting occupancy expenses
6.   The potential volatility of deposit structure
7.   The quality of operating procedures
8.   The bank’s capacity to meet present and future financial needs of its trade area, considering the competition it faces.

Each of these factors related in some way to the various kinds of risk that commercial bank faces. In addition to these qualitative factors, the regulatory agencies assess the growth rate in earnings and assets when attempting to judge the adequacy of bank capital. If a bank is not growing in earnings and assets, it obviously has more risk than does one that is enjoying a healthy growth. The existence of more risk indicates a need for more capital, other things being equal, than is necessary for a bank with less risk.
 
Bank management owes to itself, to the depositors, and to the economy as a whole. A careful appraisal of all the risks facing the bank is required when ascertaining the adequacy of bank capital. Bank management should not be lulled into a sense of false security by good times. It should not be forgotten that bank failures result in losses to depositors and stockholders, bring inability for banks to meet the legitimate demands of borrowers and reduces public’s confidence in the financial structure of the nation. Therefore, the banks must maintain adequate capital. But adequate capital is not, of course, a substitute for sound lending and investing policies; it cannot take the place of experienced and progressive management of a well-conceived programme of planning and control. However, adequate capital can provide assurance to the public, the stockholders, and the supervisor that the strength and the wherewithal to survive circumstances and conditions that even the best management can never foresee.


Professor Rafiqul Islam
Dean
Faculty of Business & Economics (FBE)

51
Faculty Forum / The Basel Accord on Risk-Based Capital Requirements
« on: June 20, 2013, 02:28:28 PM »
The Basel Accord on Risk-Based Capital Requirements

The increased integration of financial markets across countries and the need to make the playing field level for banks from different countries led to the June 1988 Basel accord by the industrialized nations under the auspices of the international banks for settlements in Basel, Switzerland. Under this agreement, proposal for a risk-based capital requirement was discussed. The risk weights currently given to different classes of assets were proposed by the Basel Committee. These were adopted as a basis for common system of prudential banking control in all industrial countries in 1993. The assets are divided into five categories on the basis of risk with lower weights given to less risky assets. Thus, cash has a weight of zero, loans to the discount market are weighted at 0.1, local authority bonds 0.2, mortgage loans 0.5, while commercial loans have a full weight of 1. The method of assessment, broadly speaking, is to multiply the market value of each asset by its risk factor and then to aggregate the risk-adjusted value. This is then compared with the bank’ capital base. This involves a two tier classification of capital.

Tier-1 or core capital consists essentially of shareholders’ equity, disclosed reserves and the current year’s retained profits, which are readily available to cushion the losses- these must be verified by the bank’s auditors.

Tier-2 or supplementary capital comprises funds available but not fully owned or controlled by the institution, such as general provisions that the bank has set aside against unidentified future losses and medium and long-term subordinated debt issued by the bank. Tier 2 elements were not permitted to make up more than 50 percent of an institution’s own fund.

The Basel Committee recommended a lower limit of 8 percent for the ratio of total capital to risk adjusted assets, though national bank supervisors had some discretion in applying this to different types of bank. The basic principle of such a ratio was that the risk of carrying on a banking business should be borne by the shareholders, rather than the bank’s clients, and that the bank’s capital should be sufficient to absorb any losses that could not be met out of current profits. Adjustments were later made to the Basel system, in particular to measure market risk- the risk that movements in the prices of financial instruments lead to loss. It is alleged that one of the crucial flaws in the existing framework-called Basel I is that it is too simple. Banks lending to a blue chip client have to set aside the same amount of capital to cover the possibility of risk as they would have to with a much lower quality borrower. One consequence is that the more sophisticated banks have “securitized some of their best loans—selling them on to other investors. That has left them with a riskier loan which, pay higher returns—to match the higher risk-- but, because the capital requirements are the same, produce a higher return on equity.

Therefore, the existing framework, brought in during the 1980s, is already regarded as inadequate. The top central bankers have been trying for sometime to finalize a new framework governing the amount of capital which commercial banks must set aside to meet individual or industry crisis. Now Basel II is aiming at providing a more flexible approach, matching the amount of capital that needs to be aside more closely to the risks attached to different types of loan and different borrowers. It will take, for example, a different approach towards commercial lending, credit cards lending, mortgage lending and between big and small companies. The Basel II proposals elicited great deal of comment: Each of the issues covered affected some banks one way or other banks another way, and many were expected to have unintended consequences. So, the Basel II comment- period was extended, and the definitive application of Basel II capital adequacy rules were differed. Complicating matters further was the fact that the Basel II proposals cover “operational risks”- risk associated with compliance failures, system failures, civil litigation and the like. Nobody knows how to measure these things, much less how to price them in order to provide adequate capital. So the initial Basel II proposals suggested a 20% capital charge—a simple heads-up, galvanizing banks into getting to work on the issue. But a final solution is sometime away, and its specifics remain far from obvious. The central bank officials involved are busy drawing up a new framework for Basel II the provisions of which are likely to be effective from 2010.


BB requirements for meeting banks' capital need under Basel-II (revised)

The Bangladesh Bank (BB) has revised guidelines allowing the capital market investments as supplementary capital of the banks to meet overall capital requirement under Basel-II framework. Under the revised guidelines, 10 per cent of revaluation reserves for equity instruments are eligible for tier-2 capital, generally known as supplementary capital.

Under the amended guidelines, the banks will have to comply with the minimum capital required (MCR) at 8.0 per cent from January 1, 2010 to June 30, 2010 while a rate of 9.0 per cent will be maintained from July 1, 2010 to June 30, 2011. The banks, however, must comply with the MCR at 10 per cent from July 1 next year (2011) and onwards.

The MCR had been set at 9.0 per cent with the risk-weighted assets of the banks or Tk 4.0 billion of total capital, whichever is higher, that would be treated as MCR of the banks under the Basel-II accord. The Basel-II accord came into force in Bangladesh from January 1 this year (2010) to consolidate capital base of the banks in line with the international standard.

The new Basel accord has been prepared on the basis of three pillars: minimum capital requirement, supervisory review process and market discipline. Three types of risks -- credit risk, market risk and operational risk -- have to be considered under the minimum capital requirement.

Professor Rafiqul Islam
Dean
Faculty of Business & Economics (FBE)

52
The Basel Accord on Risk-Based Capital Requirements

The increased integration of financial markets across countries and the need to make the playing field level for banks from different countries led to the June 1988 Basel accord by the industrialized nations under the auspices of the international banks for settlements in Basel, Switzerland. Under this agreement, proposal for a risk-based capital requirement was discussed. The risk weights currently given to different classes of assets were proposed by the Basel Committee. These were adopted as a basis for common system of prudential banking control in all industrial countries in 1993. The assets are divided into five categories on the basis of risk with lower weights given to less risky assets. Thus, cash has a weight of zero, loans to the discount market are weighted at 0.1, local authority bonds 0.2, mortgage loans 0.5, while commercial loans have a full weight of 1. The method of assessment, broadly speaking, is to multiply the market value of each asset by its risk factor and then to aggregate the risk-adjusted value. This is then compared with the bank’ capital base. This involves a two tier classification of capital.

Tier-1 or core capital consists essentially of shareholders’ equity, disclosed reserves and the current year’s retained profits, which are readily available to cushion the losses- these must be verified by the bank’s auditors.

Tier-2 or supplementary capital comprises funds available but not fully owned or controlled by the institution, such as general provisions that the bank has set aside against unidentified future losses and medium and long-term subordinated debt issued by the bank. Tier 2 elements were not permitted to make up more than 50 percent of an institution’s own fund.

The Basel Committee recommended a lower limit of 8 percent for the ratio of total capital to risk adjusted assets, though national bank supervisors had some discretion in applying this to different types of bank. The basic principle of such a ratio was that the risk of carrying on a banking business should be borne by the shareholders, rather than the bank’s clients, and that the bank’s capital should be sufficient to absorb any losses that could not be met out of current profits. Adjustments were later made to the Basel system, in particular to measure market risk- the risk that movements in the prices of financial instruments lead to loss. It is alleged that one of the crucial flaws in the existing framework-called Basel I is that it is too simple. Banks lending to a blue chip client have to set aside the same amount of capital to cover the possibility of risk as they would have to with a much lower quality borrower. One consequence is that the more sophisticated banks have “securitized some of their best loans—selling them on to other investors. That has left them with a riskier loan which, pay higher returns—to match the higher risk-- but, because the capital requirements are the same, produce a higher return on equity.

Therefore, the existing framework, brought in during the 1980s, is already regarded as inadequate. The top central bankers have been trying for sometime to finalize a new framework governing the amount of capital which commercial banks must set aside to meet individual or industry crisis. Now Basel II is aiming at providing a more flexible approach, matching the amount of capital that needs to be aside more closely to the risks attached to different types of loan and different borrowers. It will take, for example, a different approach towards commercial lending, credit cards lending, mortgage lending and between big and small companies. The Basel II proposals elicited great deal of comment: Each of the issues covered affected some banks one way or other banks another way, and many were expected to have unintended consequences. So, the Basel II comment- period was extended, and the definitive application of Basel II capital adequacy rules were differed. Complicating matters further was the fact that the Basel II proposals cover “operational risks”- risk associated with compliance failures, system failures, civil litigation and the like. Nobody knows how to measure these things, much less how to price them in order to provide adequate capital. So the initial Basel II proposals suggested a 20% capital charge—a simple heads-up, galvanizing banks into getting to work on the issue. But a final solution is sometime away, and its specifics remain far from obvious. The central bank officials involved are busy drawing up a new framework for Basel II the provisions of which are likely to be effective from 2010.


BB requirements for meeting banks' capital need under Basel-II (revised)

The Bangladesh Bank (BB) has revised guidelines allowing the capital market investments as supplementary capital of the banks to meet overall capital requirement under Basel-II framework. Under the revised guidelines, 10 per cent of revaluation reserves for equity instruments are eligible for tier-2 capital, generally known as supplementary capital.

Under the amended guidelines, the banks will have to comply with the minimum capital required (MCR) at 8.0 per cent from January 1, 2010 to June 30, 2010 while a rate of 9.0 per cent will be maintained from July 1, 2010 to June 30, 2011. The banks, however, must comply with the MCR at 10 per cent from July 1 next year (2011) and onwards.

The MCR had been set at 9.0 per cent with the risk-weighted assets of the banks or Tk 4.0 billion of total capital, whichever is higher, that would be treated as MCR of the banks under the Basel-II accord. The Basel-II accord came into force in Bangladesh from January 1 this year (2010) to consolidate capital base of the banks in line with the international standard.

The new Basel accord has been prepared on the basis of three pillars: minimum capital requirement, supervisory review process and market discipline. Three types of risks -- credit risk, market risk and operational risk -- have to be considered under the minimum capital requirement.

Professor Rafiqul Islam
Dean
Faculty of Business & Economics (FBE)


53
The Basel Accord on Risk-Based Capital Requirements

The increased integration of financial markets across countries and the need to make the playing field level for banks from different countries led to the June 1988 Basel accord by the industrialized nations under the auspices of the international banks for settlements in Basel, Switzerland. Under this agreement, proposal for a risk-based capital requirement was discussed. The risk weights currently given to different classes of assets were proposed by the Basel Committee. These were adopted as a basis for common system of prudential banking control in all industrial countries in 1993. The assets are divided into five categories on the basis of risk with lower weights given to less risky assets. Thus, cash has a weight of zero, loans to the discount market are weighted at 0.1, local authority bonds 0.2, mortgage loans 0.5, while commercial loans have a full weight of 1. The method of assessment, broadly speaking, is to multiply the market value of each asset by its risk factor and then to aggregate the risk-adjusted value. This is then compared with the bank’ capital base. This involves a two tier classification of capital.

Tier-1 or core capital consists essentially of shareholders’ equity, disclosed reserves and the current year’s retained profits, which are readily available to cushion the losses- these must be verified by the bank’s auditors.

Tier-2 or supplementary capital comprises funds available but not fully owned or controlled by the institution, such as general provisions that the bank has set aside against unidentified future losses and medium and long-term subordinated debt issued by the bank. Tier 2 elements were not permitted to make up more than 50 percent of an institution’s own fund.

The Basel Committee recommended a lower limit of 8 percent for the ratio of total capital to risk adjusted assets, though national bank supervisors had some discretion in applying this to different types of bank. The basic principle of such a ratio was that the risk of carrying on a banking business should be borne by the shareholders, rather than the bank’s clients, and that the bank’s capital should be sufficient to absorb any losses that could not be met out of current profits. Adjustments were later made to the Basel system, in particular to measure market risk- the risk that movements in the prices of financial instruments lead to loss. It is alleged that one of the crucial flaws in the existing framework-called Basel I is that it is too simple. Banks lending to a blue chip client have to set aside the same amount of capital to cover the possibility of risk as they would have to with a much lower quality borrower. One consequence is that the more sophisticated banks have “securitized some of their best loans—selling them on to other investors. That has left them with a riskier loan which, pay higher returns—to match the higher risk-- but, because the capital requirements are the same, produce a higher return on equity.

Therefore, the existing framework, brought in during the 1980s, is already regarded as inadequate. The top central bankers have been trying for sometime to finalize a new framework governing the amount of capital which commercial banks must set aside to meet individual or industry crisis. Now Basel II is aiming at providing a more flexible approach, matching the amount of capital that needs to be aside more closely to the risks attached to different types of loan and different borrowers. It will take, for example, a different approach towards commercial lending, credit cards lending, mortgage lending and between big and small companies. The Basel II proposals elicited great deal of comment: Each of the issues covered affected some banks one way or other banks another way, and many were expected to have unintended consequences. So, the Basel II comment- period was extended, and the definitive application of Basel II capital adequacy rules were differed. Complicating matters further was the fact that the Basel II proposals cover “operational risks”- risk associated with compliance failures, system failures, civil litigation and the like. Nobody knows how to measure these things, much less how to price them in order to provide adequate capital. So the initial Basel II proposals suggested a 20% capital charge—a simple heads-up, galvanizing banks into getting to work on the issue. But a final solution is sometime away, and its specifics remain far from obvious. The central bank officials involved are busy drawing up a new framework for Basel II the provisions of which are likely to be effective from 2010.


BB requirements for meeting banks' capital need under Basel-II (revised)

The Bangladesh Bank (BB) has revised guidelines allowing the capital market investments as supplementary capital of the banks to meet overall capital requirement under Basel-II framework. Under the revised guidelines, 10 per cent of revaluation reserves for equity instruments are eligible for tier-2 capital, generally known as supplementary capital.

Under the amended guidelines, the banks will have to comply with the minimum capital required (MCR) at 8.0 per cent from January 1, 2010 to June 30, 2010 while a rate of 9.0 per cent will be maintained from July 1, 2010 to June 30, 2011. The banks, however, must comply with the MCR at 10 per cent from July 1 next year (2011) and onwards.

The MCR had been set at 9.0 per cent with the risk-weighted assets of the banks or Tk 4.0 billion of total capital, whichever is higher, that would be treated as MCR of the banks under the Basel-II accord. The Basel-II accord came into force in Bangladesh from January 1 this year (2010) to consolidate capital base of the banks in line with the international standard.

The new Basel accord has been prepared on the basis of three pillars: minimum capital requirement, supervisory review process and market discipline. Three types of risks -- credit risk, market risk and operational risk -- have to be considered under the minimum capital requirement.

Professor Rafiqul Islam
Dean
Faculty of Business & Economics (FBE)

54
The Basel Accord on Risk-Based Capital Requirements

The increased integration of financial markets across countries and the need to make the playing field level for banks from different countries led to the June 1988 Basel accord by the industrialized nations under the auspices of the international banks for settlements in Basel, Switzerland. Under this agreement, proposal for a risk-based capital requirement was discussed. The risk weights currently given to different classes of assets were proposed by the Basel Committee. These were adopted as a basis for common system of prudential banking control in all industrial countries in 1993. The assets are divided into five categories on the basis of risk with lower weights given to less risky assets. Thus, cash has a weight of zero, loans to the discount market are weighted at 0.1, local authority bonds 0.2, mortgage loans 0.5, while commercial loans have a full weight of 1. The method of assessment, broadly speaking, is to multiply the market value of each asset by its risk factor and then to aggregate the risk-adjusted value. This is then compared with the bank’ capital base. This involves a two tier classification of capital.

Tier-1 or core capital consists essentially of shareholders’ equity, disclosed reserves and the current year’s retained profits, which are readily available to cushion the losses- these must be verified by the bank’s auditors.

Tier-2 or supplementary capital comprises funds available but not fully owned or controlled by the institution, such as general provisions that the bank has set aside against unidentified future losses and medium and long-term subordinated debt issued by the bank. Tier 2 elements were not permitted to make up more than 50 percent of an institution’s own fund.

The Basel Committee recommended a lower limit of 8 percent for the ratio of total capital to risk adjusted assets, though national bank supervisors had some discretion in applying this to different types of bank. The basic principle of such a ratio was that the risk of carrying on a banking business should be borne by the shareholders, rather than the bank’s clients, and that the bank’s capital should be sufficient to absorb any losses that could not be met out of current profits. Adjustments were later made to the Basel system, in particular to measure market risk- the risk that movements in the prices of financial instruments lead to loss. It is alleged that one of the crucial flaws in the existing framework-called Basel I is that it is too simple. Banks lending to a blue chip client have to set aside the same amount of capital to cover the possibility of risk as they would have to with a much lower quality borrower. One consequence is that the more sophisticated banks have “securitized some of their best loans—selling them on to other investors. That has left them with a riskier loan which, pay higher returns—to match the higher risk-- but, because the capital requirements are the same, produce a higher return on equity.

Therefore, the existing framework, brought in during the 1980s, is already regarded as inadequate. The top central bankers have been trying for sometime to finalize a new framework governing the amount of capital which commercial banks must set aside to meet individual or industry crisis. Now Basel II is aiming at providing a more flexible approach, matching the amount of capital that needs to be aside more closely to the risks attached to different types of loan and different borrowers. It will take, for example, a different approach towards commercial lending, credit cards lending, mortgage lending and between big and small companies. The Basel II proposals elicited great deal of comment: Each of the issues covered affected some banks one way or other banks another way, and many were expected to have unintended consequences. So, the Basel II comment- period was extended, and the definitive application of Basel II capital adequacy rules were differed. Complicating matters further was the fact that the Basel II proposals cover “operational risks”- risk associated with compliance failures, system failures, civil litigation and the like. Nobody knows how to measure these things, much less how to price them in order to provide adequate capital. So the initial Basel II proposals suggested a 20% capital charge—a simple heads-up, galvanizing banks into getting to work on the issue. But a final solution is sometime away, and its specifics remain far from obvious. The central bank officials involved are busy drawing up a new framework for Basel II the provisions of which are likely to be effective from 2010.


BB requirements for meeting banks' capital need under Basel-II (revised)

The Bangladesh Bank (BB) has revised guidelines allowing the capital market investments as supplementary capital of the banks to meet overall capital requirement under Basel-II framework. Under the revised guidelines, 10 per cent of revaluation reserves for equity instruments are eligible for tier-2 capital, generally known as supplementary capital.

Under the amended guidelines, the banks will have to comply with the minimum capital required (MCR) at 8.0 per cent from January 1, 2010 to June 30, 2010 while a rate of 9.0 per cent will be maintained from July 1, 2010 to June 30, 2011. The banks, however, must comply with the MCR at 10 per cent from July 1 next year (2011) and onwards.

The MCR had been set at 9.0 per cent with the risk-weighted assets of the banks or Tk 4.0 billion of total capital, whichever is higher, that would be treated as MCR of the banks under the Basel-II accord. The Basel-II accord came into force in Bangladesh from January 1 this year (2010) to consolidate capital base of the banks in line with the international standard.

The new Basel accord has been prepared on the basis of three pillars: minimum capital requirement, supervisory review process and market discipline. Three types of risks -- credit risk, market risk and operational risk -- have to be considered under the minimum capital requirement.

Professor Rafiqul Islam
Dean
Faculty of Business & Economics (FBE)


55
Faculty Sections / CAMELS Rating
« on: June 18, 2013, 01:38:56 PM »
CAMELS Rating

In the USA, however, federal and state regulators regularly assess the financial condition of each bank and specific risks faced via on-site examinations and periodic reports. A thorough review includes an evaluation of the bank’s asset quality- particularly the probability of default of interest and principal payments in the loan portfolio- loan review policies, interest rate risk profile, liquidity profile, cash management and internal audit procedures and management quality. Federal regulators rate banks according to the uniform financial institutions rating system, which now encompass six general categories of performance under the label CAMELS. Each refers to a specific category as follows:

C= Capital adequacy
A= Asset quality
M= management quality
E= Earnings
L= Liquidity
S= Sensitivity to market risk.

The sixth category, sensitivity to market risk, has only been used since January 1, 1997. The capital component (C) signals the institution’s ability to maintain capital commensurate to identify, measure, monitor and control these risks. Asset quality (A) reflects the amount of existing credit risk associated with the loan and investment portfolio as well as off balance sheet activities. The management category (M) reflects the adequacy of the broad of directors and senior management systems and procedures to identify, measure, monitor and control risks. Regulations emphasize the existence and use of polices and process to manage risks within targets. Earnings (E) reflect not only the quality and trend in earnings, but also the factors that may affect the sustainability or quality of earnings. Liquidity (L) reflects the adequacy of institution’s current and perspective sources of liquidity and funds management practices. Finally, the last category, sensitivity to market risk (S), reflects the degree to which changes in interest rate, exchange rate, commodity prices and quality prices can adversely affect earrings or economic capital.
Regulators numerically rate each bank in each category, ranging from the higher or best rating (1) to the worst or lowest (5) rating. It also assigns a composite rating for the bank’s overall operation. A composite rating 1 or 2 indicates a fundamentally sound bank. A rating of 3 indicates that the bank shows some underlying weakness that should be corrected. A rating of 4 or 5 indicates a problem bank with some near-term potential for failure.

The public opinion of how much capital is adequate is equally an important factor. If the depositors think the amount of capital is too small for a bank, they could withdraw deposits and force liquidation of assets. Thus a solvent bank should suffer loss and liquidation when capital is inadequate for the maintenance of confidence. Bank capital supports confidence in very real sense.

To monitor the capital adequacy requirement of banking institutions effectively, a strong financial regulator like a powerful central bank or an efficient financial services authority is essential. The financial regulator needs three things: a sound operating structure’ sensible procedures and competent staff’ and credibility so that wrong doers are properly punished and others deterred.   

Furthermore, the bank supervisor is concerned not only with what may be adequate at the moment but with what may be a needed in the future. Bank capital is a cushion not only against the facts of today, but also, or even more so, against the contingencies of tomorrow. Determining the size of bank capital is not easy, but it is important. And if a bank is to grow, with increased deposits and earrings assets, it must expand its capital base but at the same time keep the risk level constant.

Professor Rafiqul Islam
Dean
Faculty of Business & Economics (FBE)


Next topic will be on Basel Accords

56
Faculty Forum / CAMELS Rating
« on: June 18, 2013, 01:37:51 PM »
CAMELS Rating

In the USA, however, federal and state regulators regularly assess the financial condition of each bank and specific risks faced via on-site examinations and periodic reports. A thorough review includes an evaluation of the bank’s asset quality- particularly the probability of default of interest and principal payments in the loan portfolio- loan review policies, interest rate risk profile, liquidity profile, cash management and internal audit procedures and management quality. Federal regulators rate banks according to the uniform financial institutions rating system, which now encompass six general categories of performance under the label CAMELS. Each refers to a specific category as follows:

C= Capital adequacy
A= Asset quality
M= management quality
E= Earnings
L= Liquidity
S= Sensitivity to market risk.

The sixth category, sensitivity to market risk, has only been used since January 1, 1997. The capital component (C) signals the institution’s ability to maintain capital commensurate to identify, measure, monitor and control these risks. Asset quality (A) reflects the amount of existing credit risk associated with the loan and investment portfolio as well as off balance sheet activities. The management category (M) reflects the adequacy of the broad of directors and senior management systems and procedures to identify, measure, monitor and control risks. Regulations emphasize the existence and use of polices and process to manage risks within targets. Earnings (E) reflect not only the quality and trend in earnings, but also the factors that may affect the sustainability or quality of earnings. Liquidity (L) reflects the adequacy of institution’s current and perspective sources of liquidity and funds management practices. Finally, the last category, sensitivity to market risk (S), reflects the degree to which changes in interest rate, exchange rate, commodity prices and quality prices can adversely affect earrings or economic capital.
Regulators numerically rate each bank in each category, ranging from the higher or best rating (1) to the worst or lowest (5) rating. It also assigns a composite rating for the bank’s overall operation. A composite rating 1 or 2 indicates a fundamentally sound bank. A rating of 3 indicates that the bank shows some underlying weakness that should be corrected. A rating of 4 or 5 indicates a problem bank with some near-term potential for failure.

The public opinion of how much capital is adequate is equally an important factor. If the depositors think the amount of capital is too small for a bank, they could withdraw deposits and force liquidation of assets. Thus a solvent bank should suffer loss and liquidation when capital is inadequate for the maintenance of confidence. Bank capital supports confidence in very real sense.

To monitor the capital adequacy requirement of banking institutions effectively, a strong financial regulator like a powerful central bank or an efficient financial services authority is essential. The financial regulator needs three things: a sound operating structure’ sensible procedures and competent staff’ and credibility so that wrong doers are properly punished and others deterred.   

Furthermore, the bank supervisor is concerned not only with what may be adequate at the moment but with what may be a needed in the future. Bank capital is a cushion not only against the facts of today, but also, or even more so, against the contingencies of tomorrow. Determining the size of bank capital is not easy, but it is important. And if a bank is to grow, with increased deposits and earrings assets, it must expand its capital base but at the same time keep the risk level constant.

Professor Rafiqul Islam
Dean
Faculty of Business & Economics (FBE)


Next topic will be on Basel Accords

57
Real Estate / CAMELS Rating
« on: June 18, 2013, 01:37:15 PM »
CAMELS Rating

In the USA, however, federal and state regulators regularly assess the financial condition of each bank and specific risks faced via on-site examinations and periodic reports. A thorough review includes an evaluation of the bank’s asset quality- particularly the probability of default of interest and principal payments in the loan portfolio- loan review policies, interest rate risk profile, liquidity profile, cash management and internal audit procedures and management quality. Federal regulators rate banks according to the uniform financial institutions rating system, which now encompass six general categories of performance under the label CAMELS. Each refers to a specific category as follows:

C= Capital adequacy
A= Asset quality
M= management quality
E= Earnings
L= Liquidity
S= Sensitivity to market risk.

The sixth category, sensitivity to market risk, has only been used since January 1, 1997. The capital component (C) signals the institution’s ability to maintain capital commensurate to identify, measure, monitor and control these risks. Asset quality (A) reflects the amount of existing credit risk associated with the loan and investment portfolio as well as off balance sheet activities. The management category (M) reflects the adequacy of the broad of directors and senior management systems and procedures to identify, measure, monitor and control risks. Regulations emphasize the existence and use of polices and process to manage risks within targets. Earnings (E) reflect not only the quality and trend in earnings, but also the factors that may affect the sustainability or quality of earnings. Liquidity (L) reflects the adequacy of institution’s current and perspective sources of liquidity and funds management practices. Finally, the last category, sensitivity to market risk (S), reflects the degree to which changes in interest rate, exchange rate, commodity prices and quality prices can adversely affect earrings or economic capital.
Regulators numerically rate each bank in each category, ranging from the higher or best rating (1) to the worst or lowest (5) rating. It also assigns a composite rating for the bank’s overall operation. A composite rating 1 or 2 indicates a fundamentally sound bank. A rating of 3 indicates that the bank shows some underlying weakness that should be corrected. A rating of 4 or 5 indicates a problem bank with some near-term potential for failure.

The public opinion of how much capital is adequate is equally an important factor. If the depositors think the amount of capital is too small for a bank, they could withdraw deposits and force liquidation of assets. Thus a solvent bank should suffer loss and liquidation when capital is inadequate for the maintenance of confidence. Bank capital supports confidence in very real sense.

To monitor the capital adequacy requirement of banking institutions effectively, a strong financial regulator like a powerful central bank or an efficient financial services authority is essential. The financial regulator needs three things: a sound operating structure’ sensible procedures and competent staff’ and credibility so that wrong doers are properly punished and others deterred.   

Furthermore, the bank supervisor is concerned not only with what may be adequate at the moment but with what may be a needed in the future. Bank capital is a cushion not only against the facts of today, but also, or even more so, against the contingencies of tomorrow. Determining the size of bank capital is not easy, but it is important. And if a bank is to grow, with increased deposits and earrings assets, it must expand its capital base but at the same time keep the risk level constant.

Professor Rafiqul Islam
Dean
Faculty of Business & Economics (FBE)


Next topic will be on Basel Accords

58
BBA Discussion Forum / CAMELS Rating
« on: June 18, 2013, 01:36:42 PM »
CAMELS Rating

In the USA, however, federal and state regulators regularly assess the financial condition of each bank and specific risks faced via on-site examinations and periodic reports. A thorough review includes an evaluation of the bank’s asset quality- particularly the probability of default of interest and principal payments in the loan portfolio- loan review policies, interest rate risk profile, liquidity profile, cash management and internal audit procedures and management quality. Federal regulators rate banks according to the uniform financial institutions rating system, which now encompass six general categories of performance under the label CAMELS. Each refers to a specific category as follows:

C= Capital adequacy
A= Asset quality
M= management quality
E= Earnings
L= Liquidity
S= Sensitivity to market risk.

The sixth category, sensitivity to market risk, has only been used since January 1, 1997. The capital component (C) signals the institution’s ability to maintain capital commensurate to identify, measure, monitor and control these risks. Asset quality (A) reflects the amount of existing credit risk associated with the loan and investment portfolio as well as off balance sheet activities. The management category (M) reflects the adequacy of the broad of directors and senior management systems and procedures to identify, measure, monitor and control risks. Regulations emphasize the existence and use of polices and process to manage risks within targets. Earnings (E) reflect not only the quality and trend in earnings, but also the factors that may affect the sustainability or quality of earnings. Liquidity (L) reflects the adequacy of institution’s current and perspective sources of liquidity and funds management practices. Finally, the last category, sensitivity to market risk (S), reflects the degree to which changes in interest rate, exchange rate, commodity prices and quality prices can adversely affect earrings or economic capital.
Regulators numerically rate each bank in each category, ranging from the higher or best rating (1) to the worst or lowest (5) rating. It also assigns a composite rating for the bank’s overall operation. A composite rating 1 or 2 indicates a fundamentally sound bank. A rating of 3 indicates that the bank shows some underlying weakness that should be corrected. A rating of 4 or 5 indicates a problem bank with some near-term potential for failure.

The public opinion of how much capital is adequate is equally an important factor. If the depositors think the amount of capital is too small for a bank, they could withdraw deposits and force liquidation of assets. Thus a solvent bank should suffer loss and liquidation when capital is inadequate for the maintenance of confidence. Bank capital supports confidence in very real sense.

To monitor the capital adequacy requirement of banking institutions effectively, a strong financial regulator like a powerful central bank or an efficient financial services authority is essential. The financial regulator needs three things: a sound operating structure’ sensible procedures and competent staff’ and credibility so that wrong doers are properly punished and others deterred.   

Furthermore, the bank supervisor is concerned not only with what may be adequate at the moment but with what may be a needed in the future. Bank capital is a cushion not only against the facts of today, but also, or even more so, against the contingencies of tomorrow. Determining the size of bank capital is not easy, but it is important. And if a bank is to grow, with increased deposits and earrings assets, it must expand its capital base but at the same time keep the risk level constant.

Professor Rafiqul Islam
Dean
Faculty of Business & Economics (FBE)


Next topic will be on Basel Accords

59
MBA Discussion Forum / CAMELS Rating
« on: June 18, 2013, 01:33:40 PM »
CAMELS Rating

In the USA, however, federal and state regulators regularly assess the financial condition of each bank and specific risks faced via on-site examinations and periodic reports. A thorough review includes an evaluation of the bank’s asset quality- particularly the probability of default of interest and principal payments in the loan portfolio- loan review policies, interest rate risk profile, liquidity profile, cash management and internal audit procedures and management quality. Federal regulators rate banks according to the uniform financial institutions rating system, which now encompass six general categories of performance under the label CAMELS. Each refers to a specific category as follows:

C= Capital adequacy
A= Asset quality
M= management quality
E= Earnings
L= Liquidity
S= Sensitivity to market risk.

The sixth category, sensitivity to market risk, has only been used since January 1, 1997. The capital component (C) signals the institution’s ability to maintain capital commensurate to identify, measure, monitor and control these risks. Asset quality (A) reflects the amount of existing credit risk associated with the loan and investment portfolio as well as off balance sheet activities. The management category (M) reflects the adequacy of the broad of directors and senior management systems and procedures to identify, measure, monitor and control risks. Regulations emphasize the existence and use of polices and process to manage risks within targets. Earnings (E) reflect not only the quality and trend in earnings, but also the factors that may affect the sustainability or quality of earnings. Liquidity (L) reflects the adequacy of institution’s current and perspective sources of liquidity and funds management practices. Finally, the last category, sensitivity to market risk (S), reflects the degree to which changes in interest rate, exchange rate, commodity prices and quality prices can adversely affect earrings or economic capital.
Regulators numerically rate each bank in each category, ranging from the higher or best rating (1) to the worst or lowest (5) rating. It also assigns a composite rating for the bank’s overall operation. A composite rating 1 or 2 indicates a fundamentally sound bank. A rating of 3 indicates that the bank shows some underlying weakness that should be corrected. A rating of 4 or 5 indicates a problem bank with some near-term potential for failure.

The public opinion of how much capital is adequate is equally an important factor. If the depositors think the amount of capital is too small for a bank, they could withdraw deposits and force liquidation of assets. Thus a solvent bank should suffer loss and liquidation when capital is inadequate for the maintenance of confidence. Bank capital supports confidence in very real sense.

To monitor the capital adequacy requirement of banking institutions effectively, a strong financial regulator like a powerful central bank or an efficient financial services authority is essential. The financial regulator needs three things: a sound operating structure’ sensible procedures and competent staff’ and credibility so that wrong doers are properly punished and others deterred.   

Furthermore, the bank supervisor is concerned not only with what may be adequate at the moment but with what may be a needed in the future. Bank capital is a cushion not only against the facts of today, but also, or even more so, against the contingencies of tomorrow. Determining the size of bank capital is not easy, but it is important. And if a bank is to grow, with increased deposits and earrings assets, it must expand its capital base but at the same time keep the risk level constant.

Professor Rafiqul Islam
Dean
Faculty of Business & Economics (FBE)


Next topic will be on Basel Accords

60
Faculty Forum / Structuring a Credit Proposal
« on: June 06, 2013, 03:41:41 PM »
Structuring a Credit Proposal


The following are the key issues to be subject matter of discussion in a credit proposal:

1.   Purpose: The purpose of financing sets the main parameters for designing the credit structure, because it affects the safety of repayment and earnings from the business. The proposal should be bankable. The following proposals are relevant for the proposal:
•   Compliance of bank’s internal policy (for example financing for preferred sector and sun rise industries).
•   The commercial and economic logic of the purpose to be financed.
•   The ability and experience of management to handle the proposed venture.
•   Compliance with bank’s legal requirements.
•   Legal complications arising from the purpose of the financing which may impair the creditworthiness of the advance.
2.   Amount: Is it adequate for the purpose? The loan should be need-based, not more and not less. A bank which leads inadequately not caring how the balance requirement will be funded may create problem for itself as well as for the customer.

3.   Margin contribution: This is the stake of the proponent in the project. In project lending secured by fixed assets, a cash contribution from the company itself acts as evidence of commitment and cushion to the lenders against failure of the project or failure of the secured assets to generate repayment. In unsecured transactions, the focus shifts to the financing mix of debt and equity.

4.   Portfolio consideration: Bank’s proposed exposure to the relevant corporate group/ industry should be considered. It is not advisable to put all eggs in one basket.

5.   Credit risk and term: Banks will wish to limit their exposure to individual high risk and long term advances more tightly than to lower risk and short term advances.

6.   Yield: Increasingly banks are concerned with maximizing their yield from the use of their balance sheet and the amount lent can be a significant determinant of the overall return from the deal. The more the spread, the better for the bank.

7.   Legal Consideration: Whether the company has borrowing power to borrow the amount and the bank to lend it.

8.   Repayment: The key issue is how the bank is to be repaid and what is the margin of error if operations deteriorate. The following factors will be looked into in this regard.

•   The type of repayment source
•   The quality of repayment source
•   The currency of income from the repayment source
•   Cash flows protection (i.e. the margin of error)
•   Financial flexibility (i.e. the alternative sources of fund to cover shortages)
•   Asset protection to cover the bank if cash flow is inadequate
•   The need for good documentation

9.   Security and Quasi-security: Security whether main or collateral is the banker’s protection against non-payment from the primary repayment source. It is the insurance against failure and takes the form of a legally enforceable claim on tangible assets or a third party guarantee. However, unsecured transactions may be acceptable where cash flow protection is generous and reliable and adequate asset cover is available for general creditors of the company.


10.   Control and monitoring: The ability to take control of lending situation, before deterioration in borrower’s condition become terminal, is crucial. It is achieved by insertion in the documentation of provisions which is breached, will enable the bank to switch over from tern facility to one immediately repayable on demand.

11.   Designing Credit Facilities: Designing the details of credit facilities within the broad parameters of benefits to the borrower and protection and remuneration for the bank broadly involves:
•   Fixing up cash and working capital demand loan limits
•   Bills purchase and /or discounting facilities
•   Term loan / deferred payment facilities
•   Contingent liabilities limits for LCs and guarantees

12.   Pricing: This is a very important aspect of lending especially in a competitive environment for achieving satisfactory remuneration for the bank. Pricing is based on the directives issued by the central bank from time and the market rates. It will consider:
•   The risk-reward ratio
•   The cost of administration and overheads
•   Capital adequacy cost and cost of statutory reserves
•   The need to optimize yields on investments


Professor Rafiqul Islam
Dean
Faculty of Business & Economics (FBE)



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