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“On Site and Off Site Supervision of Schedule Banks by Bangladesh Bank’.

Executive Summary In order to prepare our term paper on “On Site and Off Site Supervision of Schedule Banks by Bangladesh Bank”, we have included the functions, responsibilities, and practices of department of banking inspection and off site supervision of Bangladesh Bank. We have shown the vital elements of banking operation which are included in banking inspection report prepared by an inspector appointed by the governor, Bangladesh bank for use in the supervision of the bank. In addition, we have included the process and guidelines followed by the inspector in preparing the inspection report. We have explained the points included in the head office inspection report with the help of inspection manual followed by department of banking inspection of Bangladesh Bank. The information contained in the inspection report is based upon the books and records of the bank, upon statements made to the inspectors by officers and employees, upon information obtained from the sources believed to reliable and presumed by the inspector to be correct. The supervision of schedule banks is one of the significant functions performed by Bangladesh bank, so in our term paper, we have tried our best to include all the relevant data regarding this topic. CHAPTER 1 Introduction 1. Origin of the Report We are student of Bachelor of Business Administration of United International University. Our respectable course instructor Nazir Ahmed khan, school of business, United International University, assigned this term paper, as the partial requirement of the course “Banking & Insurance” to gather knowledge to our work associated fields


2. Purpose of the Report Our purpose is to know the functions, guidelines, and processes followed by department of on site and off site supervision of Bangladesh Bank to inspect the scheduled banks. Our main purpose was to identify their methods, policies and practices they use in inspecting the schedule banks. 3. Limitation We, the members of the group, faced some problems when we tried to prepare our term paper properly. We faced some problems such as time management, organizing and developing group, and technical problem. Since we needed the information of the activities performed by the department of banking inspection and department of off site supervision, we searched information by going to the real life scenario. We went to respective address given by our teacher to collect information but they did not give us any data since banking inspection is very confidential matter. However, we have succeeded to complete our term paper with the sufficient data provided by our respectable course instructor. We have tried our best and we are feeling glad because we believe that we have overcome from all the difficulties and completed our term paper. Chapter 2 Methodology 1. Information Need Since our topic is related with the on site and Off site supervision of schedule banks by Bangladesh bank, we were seeking the related information. To obtain sufficient information we have specified our area of information. We have collected some information based on the functions and responsibilities of department of banking inspection and off site supervision and the methods and guidelines these departments follow for inspection. 2. Sources of Data For our research, we collect and use the data from two sources: 

Primary Data

Primary data: We have used relevant primary data from sources like: Inspection manual which is used by the bank supervision departments. 

Secondary Data

Secondary data: We have used internet as secondary data to get the company profile of Bangladesh bank.


3. Conceptual Framework We have not used any kind of complicated word in our report. Anybody can simply understand the whole things, just only need careful reading. Moreover, we have not tried to oversimplify to keep a standard and we have maintained judicial attitudes. Chapter 3 Bangladesh Bank in Brief Bangladesh Bank, the central bank of the country, was established as a body corporate vide the Bangladesh Bank Order, 1972 (P.O. No. 127 of 1972) with effect from 16th December, 1971. The general superintendence and direction of affairs and business of the Bank are entrusted to a nine member Board of Directors which consists of the Governor as chairman, a Deputy Governor, three senior government officials and four persons having experience and proven capacity in the fields of banking, trade, commerce, industry or agriculture - all nominated by the government. The board, which is the highest policy making body, meets at least six times a year and at least once every quarter under the chairmanship of the Governor. The Governor, appointed by the government as the chief executive officer, directs and controls all the affairs of the Bank on behalf of the Board. The broad objectives of Bangladesh Bank are: •

To regulate the issue of the currency and the keeping of reserves

To manage the monetary and credit system of Bangladesh with a view to stabilizing domestic monetary value

To preserve the par value of the Bangladesh Taka

To promote and maintain a high level of production, employment and real income in Bangladesh; and to foster growth and development of the country's productive resources for the national interest

Chapter 4 Machineries of Bangladesh Bank for Inspection 1. Department of Banking Inspection (DBI) 2. Financial Institution Department (FID) 3. Money Laundering Prevention department (MLPD) 4. Department of off site supervision (DSO)


Now descriptions; 1. Department of Banking inspection (DBI)-1 Department of Banking Inspection-1 (DBI) conducts comprehensive inspection of the private commercial banks including Islami Banks and Foreign Commercial Banks according to a predefined annual inspection program. Branches of the a foreside banks which are authorized to carry on foreign exchange business, designated as Authorized Dealers also come under the purview on site inspection of DBI-1. On site inspection of banks including authorized dealers are carried out according to the annual inspection program chalked out by the department well ahead of the beginning of each calendar year. DBI-1 has also the responsibility to follow up inspection reports of the banks including authorized dealers and to enforce implementation of the recommendations contained therein and rectification of irregularities. DBI-1 through on site inspection of the financial statements and books of accounts of private and foreign commercial banks undertakes to evaluate the financial position, operating soundness and quality of management of banks. In evaluating the overall performance of the banks DBI-1 also makes CAMEL rating of the head office of banks on the basis of the crucial dimensions capital adequacy, asset quality, management competence, earning capacity, and liquidity position. CAMEL rating of banks acts as an early warning system for the central bank to determine the level of supervisory concern and plan of action needed for banks not considered to be sound. On site supervision of the authorized dealers of private and commercial banks is undertaken to ensure that foreign exchange business such as export and import, trade, in ward- out ward remittance and all other dealings in foreign exchange are done strictly in accordance with the foreign exchange regulation act and the guidance’s for foreign exchange transactions issued by Bangladesh Bank. Department of Banking Inspection (DBI)-2 Department of Banking Inspection conducts comprehensive inspection of all the NCBs, Specialized Banks, and financial institutions like BSRS, BSB, Basic bank Ltd, Ansar VDP Unnayan bank, Grameen bank and ICB in accordance with the scheduled outlined in the Annual Inspection Program. Branches of a foreside banks authorized to deal in foreign exchange transactions come under the purview of DBI-2. Moreover, money changes are also under the purview of inspection of DBI-2. An inspection team is required to evaluate the financial position, operational soundness, and management quality of bank branches including review of foreign exchange transactions. During head office inspection, CAMEL rating of the banks is also done highlighting the core indicators. Some of the key areas of inspection are: •

Evaluating of assets with emphasis on classification & provisioning

Assessing capital position to work out required capital

Verification of artificial manipulation of figures relating to profit

Review of liquidity position so that required amount of CRR & SLR is maintained

Evaluation of loan operation, project financing, and other off balance sheet activities


Analysis of large loans and concentration of credit

Incidence of fraud, forgery, and action there of

Evaluation of management quality as well as customer services at the branch level

Compliance of various circulars issued by BB as well as respective banks.

2. Financial institution department (FID) Financial institution department was created under financial institution act, 1993. Major functions are: • Issuance of license for non banking financial institution •

Formulation of policies relating to functions of NBFIs

Monitoring relevant compliance issues through on site and off site supervision

Presently FID supervises 28 NBFIs of which 1 is fully government owned, 2 are public sector join ventures, 10 are private sector joint ventures and the rest 15 are locally owned private sector financial institutions.

3. Money Laundering Prevention department (MLPD) As per money laundering act (act 7 of 2002) the responsibility and power of Bangladesh Bank for prevention of money laundering activities are as follows: In order to abate and prevent money laundering activities or crimes related there to Bangladesh Bank (Anti money laundering department) will; •

Investigate offence relating to money laundering

Supervise and observe the activities of banks, financial institutions, and other organizations involved in financial activities.

Call banks, financial institutions and other organizations involved in financial activities for submission of reports on any subject related to money laundering

Review the report received under (3) above and take proper steps on the basis of those

Arrange training for the offices and employees of banks, financial institutions and other organizations in financial activities.

4. Department of off site supervision (DOS) This department supervises and monitors the functions of the schedule banks in Bangladesh through off site surveillance. Through off site supervision the bank continuously analyses the overall position particularly financial condition of the scheduled banks on the basis of five crucial indicators of banking operation, capital adequacy, asset quality, management efficiency, earning power and liquidity position. Ratings are done on a scale of 1 to 5 in ascending order of performance deficiency. A bank is identified as problem bank if it has a CAMEL composite score of 4 or 5. Such problem


banks are then brought under the fold of problem bank monitoring department for closer and more intensive supervision. This department also performs the following functions: •

Asses the overall credit and liquidity position of the banking system

Approves large loans extended by the scheduled banks.

Monitors maintenance of reserve requirement by scheduled banks.

Review approval procedures and techniques followed by the scheduled banks in approving loans amounting to taka. 10 million and above to ensure proper compliance of standard practices.

Monitors capital adequacy of the scheduled banks, position of non performing assets and performance of top 20 defaulters.

Maintains accounts of the liquidated banks and deals with the movable and immovable properties of the liquated banks as liquidator.

Prepare and submits quarterly memorandum detailing financial conditions of the nationalized commercial banks to the board of directors of Bangladesh bank.

Chapter 5

1.

Organ gram of Bank Supervision Departments:

Organ gram of Bank Supervision Departments ↓ ↓ ↓ Dept. of Banking Inspection- Dept. of Banking Inspection- Foreign Exchange Inspection 1 (DBI-1) 2 (DBI-2) & Vigilance Dept. ↓ ↓ ↓ a. Private Bank Division a. Division-1 (Sonali Bank) Vigilance ↓ ↓ ↓ b. Foreign & Islami Banks & b. Division-2 (Agrani Bank) Foreign Exchange Inspection Policy Division ↓ ↓ ↓ c. Problem Bank Division c. Division-3 (Janata Bank) ↓ ↓ d. Inspection Division d. Division-4 (Rupali Bank Ltd.) ↓ e. Division-5 (BKB & RAJKUB) ↓ f. Division-6 (ICB, Grameen BSRS & BSB) ↓ g. Implementation Division

2.

Provisions for inspection lay down in certain statutes:


• • • • • •

Bangladesh Bank Order, 1972 Bank Company Act, 1991 Foreign Exchange Regulations Act, 1947 Financial Institutions Act, 1993 Financial Institutions Regulations, 1994 Co-operative Society Ordinance, 1984

3.

Provisions under which Bangladesh Bank conducts inspections:

Provisions

Institutions subject to inspections • Scheduled Banks and all branches

(a)Under section 44(i) of the Bank

• Investment Corporation of Bangladesh

Company Act-1991

• Grameen Bank

(b) Under Article 55 of the Bangladesh Bank Order, 1972

• Ansar VDP Bank Ltd. Scheduled Banks, all branches of Scheduled Banks & other financial institutions • International Department (ID) • Authorized dealer branches

(c) Under section 19A of the Foreign Exchange RegulationsAct-1947

• International hotels • Indenting firms • Money Changers • Air lines

(d) Under 82(i) (B) of the Co-operative societies Ordinance-1984

(e) Under Article 3 of the Bank Company Act-1991

(f) Under section 5 and 20 of the Financial Institutions Act-1993 and the Financial Institution Regulations-1994

4.

• General sales agent etc. • Thana Central Co-operative Association (TCCA) • Sugarcane Growers Co-operative Societies (SGCS) • Bangladesh Samabaya Bank Ltd, (BSBL) • Central Co-operative Bank Ltd. (CCBL) • Central Co-operative Land Mortgage Bank Ltd. (CCLMBL) • Others viz. Aziz Co-operative Bank Ltd. etc. • Financial Institutions • Industrial Dev. Leasing Company (IDLC) • United Leasing Company (UIC) UAE • Bangladesh Investment Co. Ltd. (BICL)

Objectives of Inspection/Supervision :


SL. No. a.

Points Asses the financial soundness bank and financial institutions Dig out procedural defects/lapses/deficiencies and functional irregularities and to

b.

incorporate the same in the inspection reports Bring out the various irregularities incorporated and recommendations made in

c.

the report to the notice of the top management of the organization concerned in

d.

order to put it on sound footing& Develop sound banking practice in Bangladesh.

5.

6.

Type of inspection: •

Comprehensive

Special

Summary

Policies / Procedures followed for Inspection:

Comprehensive: Branches covering normally 70%-75% of outstanding loans once in every year. Rest of the branches once in every three years. Special: As and when any allegations received or published in national/local dailies. Summary: To know/gather particular data/ information Chapter 6 1. Points subject to inclusion in branch inspection report: •

Introduction

Other assets

Compliance of last inspection report

Frauds and forgeries

Cash

Miscellaneous irregularities

arrangements

Inter branch transactions

Statement of assets & liabilities

Customer services

Deposits

Internal audit & inspection

Profit & loss accounts

Branch management

Liquid assets

Discussions

Loans and advances

Conclusions & recommendations

Examination of F.E issues

verification

&

security

2. Schedules / pages to be prepared & points to be included in the Head Office inspection report: Inspectors Statement of assets and liabilities:


Banks which have branches in foreign countries must have a balance sheet and profit and loss statement on a fully consolidated on the date of inspection as prescribed by the banks of inspection. This date of the inspection will be used for the completion of all official returns. The primary purpose is to provide an accurate description on a uniform basis of each asset, liabilities & capital account segregation. Among the adjustments which will be necessary are the followings: Cash and due from banks: Balances due from closed banks should be shown as “other Assets” rather than as “cash and due from banks” This adjustment maintains the “quick assets” liquidity which should necessarily characterize “cash and due from banks” Loans and discounts: It includes cash credits, loans, over drafts and money at call on short notice. Bills discounts and purchase shown as a separate figure here. Fixed deposits receipts held by a bank which represent borrowings on the part of the issuing banks should be set under loans and discounts. Deposits and other liabilities: Deposits of banks and government deposits should be shown separately on either as time or demand, depending on circumstances. Capital account: A balance sheet is viewed as consisting of three parts: assets, liabilities and loss in the capital accounts. Generally reserve accounts excluding reserves for bad and doubtful assets are shown here. Depreciation of fixed assets which reflect the depreciated value from cost of an existing fixed assets and it should be subtracted from the asset gross book value and the asset shown net. Not included in the statement of assets and liabilities: These are off balance sheet items. All the contra accounts should be shown below the line and not included in the statement of assets and liabilities. 1. It’s an instrument in which a issuing bank undertakes to pay a party named in the instrument a sum of money on behalf of the banks customer. Issuing bank specifies documents as required by the terms of the letter of credit. 2. Undisbursed portions of irrevocable and unexpired loan commitments. 3. Commitments to purchase securities not yet delivered. 4. Foreign exchange contracts 5. Standby letter of credit and guarantees Banks own Statement of Assets and Liabilities: Adjustment and reconciliation worksheet by the inspector: Assets and liabilities will be shown on the reconciliation worksheet by the inspector


Inspection conclusions and recommendations: This provides an overview of the bank’s financial conditions which will indicate a bank’s principal points of weakness and their relative significance. All important orders should be primarily on an exception basis, describing areas of the bank’s operations and aspects of its financial condition that display weakness, deficiencies and recognizing positive actions taken by the management. Inspectors should avoid personal references or reference to other banks. Inspectors should indicate action taken or promised by management. As a result of discussion during the inspection. The first part of the report addresses the components of the camel which should be explained and the appropriate key ratios in the description of each component. Then overall assessment of the bank’s condition should be made. Content Check: •

Include a description of each component of the CAMEL?

Include an assessment of the overall condition?

List significant issues from the body of the report?

Contain all significant recommendation?

List all violations of law, in summary or by reference to report violations of the Law and Regulations?

Include any open items from the previous inspection?

Violations of Law and Regulations: There are variety of banking laws and regulations. When violations are found, they should be presented in details. Significant violations should also be briefly described. “Inspection conclusions and recommendations” Summary of assets subject to adverse classification: Substandard Assets: Its inadequately protected by the current sound worth and paying capacity of the obligor if any. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are corrected. Doubtful assets: it has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses collection or liquidation in full, on the basis of currently existing facts, conditions and values. Loss assets: It considered uncollectible and of such little value that continuance as bankable assets are not warranted but rather it’s not practical or desirable to defer writing of this basically worthless asset even though practical recovery may be affected in the future. According to the BCD Circular no.34 of 1989 will be applied to all classified assets and BCD Circular no.20 of December, 1994. Other appropriate deductions are made from the asset to establish the base for the amount of the provision to be established. The individual inspection report of branch offices


will include on report page 3 only a summary of the classification of assets of the branch. It’s the responsibility of the inspector to discuss his classifications with the branch management.

Detailed Statement of Assets Subject To Adverse Classification Any loan that represents 1% of the total capital and reserves of the bank should be listed separately. Small loan can be shown in group totals. And the inspector in charge to decide what loans will be shown and what will be listed individually. Large branch loans representing 1% of the total capital and reserves of the bank should be shown separately. Large Lines and Concentrations of Credit: This schedule is for the purpose of displaying all unduly large direct and indirect of credit to the same of the related interests, regardless of whether adversely classified in whole or in the part or of whether shown elsewhere in the inspection report. Loans of all types, overdrafts and all other forms of credit extensions are to be considered in determining a concentration. Large Lines: Large line are objectionable if they violate a basic principle of sound banking, adequate risk diversification. The schedules sound includes only lines which are large in relation to the capital structure of the bank. The schedule is not intended to include small lines which are large in the sense that they are disproportionate to the borrower’s resources. All lines that represent 15% or more of the Capital and Reserve of the bank should be listed. Other large lines that represent a significant portion of the Capital and Reserves of the bank may be listed. This will be at the discretion of the inspector. Concentrations of Credit: A line to an individual firm or obligor which is large in relation to the banker’s total capital structure is obviously a concentration, are extensions to two or more obligors, the repayment of which is based upon the same kind of collateral or the same type of production or business. In scheduling a concentration of credit which is composed of extensions to several different individuals or firms, the relationship between the advances should be made clear. The same is true of extensions to closely allied interests, the repayment of whose obligations is inter-dependent by reason of affiliated ownership or control. It is nearly impossible to list all types of concentrations which might exist. And an Inspector should use their informed judgment in deciding the extent of investigation necessary to disclose report of examination. The handling of concentrations in the report of examination is flexible and requires some degree of inspector judgment. A guideline for listing concentrations in the inspection report should be 25% or more of the bank’s capital structure. Check - Up: • Has a policy been adopted which specifically addresses concentrations of credits? Have controls been instituted to monitor the following types of concentrations: • Loans and other obligations of one borrower? • Loans predicated on the collateral support afforded by a debt or equity issue of a corporation? • Loans dependent upon one crop or herd? • Loans dependent upon one industry group? Extension of Credit to Directors, Shareholder and Their Interests and Executive Officers:


Indebtedness as used in this schedule includes all direct and indirect extensions of credit regardless of form. In general, a person may be said to be substantially interested in a concern, or if he is an active officer, or director of that concern, or if he has a substantial ownership interest. A substantial ownership interest need not be voting control, but it should not be interpreted as the ownership of only few shares. Comments in this schedule with respect of management loans should be extremely brief. If a line is adversely classified or otherwise subject to comment, it will have been toughly discussed in other schedules of the report, to which reference may be made for supporting information. The total line and its classification are all that are necessary at this point. If a loan is not subject to adverse classification only the total line need be shown, since other details would be superfluous. Duplications Within and Between Groups: All duplications within and between groups should be eliminated in the recapitulation at the head of the schedule. If a line is direct in one instance and indirect in another the indirect should be eliminated. Notations should be made in the schedule of all lines duplicated in whole or in part so that a check can be made at any later date as to the accuracy of the eliminations. Analysis of Aggregate Management Indebtedness: Whenever there is evidence of self serving upon the part of a bank’s management credits is large and their quality questionable certain computations, in addition to the recapitulation at the head of the schedule, will be useful in illustrating the situation. Accordingly, a summarization of the classification of all management items at the conclusion of the schedule will at times prove valuable. This memoranda data will serve as a basis for calculations, showing the percentages of total credit extensions to managements and their interests which are adversely classified. It is difficult to set any maximum percentage ratio beyond which management loans should not expand. There is no basis for saying that management loans should not exceed 10%, 50%, 100% or some other particular percentage of book capital. Nor is there any basis of assuming that management loans should never exceed a certain percentage of total assets or total loans. It can be said, however, that all management loans should be of high quality. Ratios designed to point out the general quality of such loans are therefore more practical than ratios comparing their aggregate with some other balance sheet segregation. Nevertheless, comparisons of total management indebtedness with book capital, total loans, or other balance sheet aggregates will from time to time be useful and persuasive in lending emphasis to the inspector’s remarks in a discussion of management loans. If the comparison is with capital, the most advisable denominator is total book capital. The inclusion of both direct and indirect indebtedness in the numerator is usually, although not invariably, justified. A comparison of management loans with book capital will reflect the extent to which capital funds have been lent to the management and their interests. In this particular ratios based upon total assets or total loans and investments. Loans Not Supported By Adequate Credit Information: In here the documentation expectations should be listed under comments. Only large loans should be reported here. A guideline is 1 corer and above. Examples of technical expectations that should be listed include:


Missing or State Financial Statement

Missing or State Guarantees Or State Financial Statements For Guarantors

Missing or Stale Cash Flow And Income Information

Stale or Missing Borrowing Resolutions/Partnership Agreements

Missing Security Agreements

Unrecorded Lines on Collateral

Inadequate or Missing Appraisals

Missing or Expired Hazard Insurance

Missing Rent Rolls/Tenant Listing

Lending Policies and Asset Quality: With respect to specific policies, inspectors should review loan, investment and significant operating policies relating to asset quality. These policies should be in written from, approved and reviewed periodically by the board of directors, and communicated to all appropriate bank personnel. When assessing loan policies consideration should be given to the following: •

Internal loan approval, review and monitoring and control procedures;

Loan reports used by management to monitor lending practices;

Loan processing procedures and controls;

Adequacy of staffing, including number, competence, reporting lines, and compensation schemes;

Individual lending authorities;

The organization and completeness of the credit files;

Collateral administration and evaluation procedures;

Procedures for evaluating credits;

Collection and workout procedures;

Procedures for renewing or extending loans;

The accrual and capitalization of past due interest and prepaid interest;

Any other unfavorable practice that may result in poor asset quality.

Asset Quality: An accurate assessment of asset quality is critical to evaluating the overall condition of the bank. Analysis should be straight – forward and, if all conditions are satisfactory, a brief statement to this effect addressing each factor listed below.


In assessing the quality of assets, the LEVEL of classified credits refers to their total volume and amount in relation to off-balance sheet items. SEVERITY refers to the relative distribution of credits subjects to classification among the substandard, doubtful, or loss classifications and the effect on the bank’s financial condition. TREND refers to whether or not the overall asset quality has been improving or deteriorating over time or since the previous examination. Capital Account Analysis: Totals book capital as defined by Bangladesh Bank is shown here plus provisions made for adversely classified loans and provisions made for other classified assets. Deducted from the above sub-total amount are the following: •

Shortfall in provision requirement against classified assets.

Shortfall in the 1% General Provision against unclassified loans.

Liabilities not shown on the bank’s books.

Other deductions that may be classified by the inspector.

Following the above deductions, the inspector arrives at the bank’s adjusted capital position. There is not any question that a bank’s adjusted capital position is one of the most important indicators of the health of a financial institution. A bank’s losses accumulated over a number of years and sometimes carried in Other Assets should be classified loss and deducted from the bank’s capital. In reviewing the bank’s statement of Assets and Liabilities, the inspectors should review carefully all accounts to determine if any losses exist and classify them accordingly. Comparative Statement of Income and Expenses and Changes in Equity capital Page 5 The comparative report of income and expenses should reflect the trend of a bank’s operations over the past four fiscal years of operation. The recurring, current operating earnings less recurring, current operating expenses should be shown separately to reflect the current operating earnings of the bank as distinguished from non-recurring profits, recoveries, and charge-offs, as well as dividends and income-taxes. Income furnishes a year to year and bank to bank comparison which is a more accurate measure of the bank’s earning capacity than its net increase to capital account. It is essential that a bank’s earning capacity be known, for out of such earnings the bank must provide for losses and furnish a fair return to its stock holders. Earnings are necessary for any growing bank which seeks to attract new investment capital. The scheduled is to be prepared on book basis. Any income which the inspector believes has been improperly taken into profit and loss should be classified loss elsewhere in the report. Any loss


classification of cash credits and overdrafts will normally include the portion which represents accrued interest. In other instances in which the bank might substantially over-accrue income, or fail to accrue substantial expenses, i.e., interest due on Fixed Deposits, the inspector will note that fact by showing the amount “Liabilities not shown on books”. While the several items of income and expense required for this form should be self-explanatory, the inspector will find the bank’s book frequently inadequate in score and detail necessary to complete the form on page 5. Accordingly, recommendations should be made to the management, and in the report, that the bank’s books should record income and expense items sufficient detail to furnish the required information. A reconciliation of the changes show in the aggregate capital accounts should be included in a schedule 5(A) for the years covered on page 5. The non-recurring items of Profits, Recoveries, Losses and Charge-offs are shown in respective totals for the year on page 5. Loan write-offs should be treated the same whether charged to Profit and Loss or Reserve for Bad and Doubtful Assets. In either instance, it amounts to a write-off against the aggregate capital account. Comments on Capital and Earnings Page 5(B): Capital adequacy is evaluated against the factors listed in the heading of page 5(B). Inspectors should explicitly evaluate capital in relation to the volume and trend of classified assets. Weak and/or deteriorating asset quality increases the bank’s need for capital. An assessment of growth in capital should include consideration of growth form the various sources of capital such as retained earnings, new capital stock issue and capital injections by the shareholders, and should be compared to growth in total assets, other balance sheet categories and off balance sheet items. Balance sheet composition refers to changes in the make-up of the bank’s assets and liabilities. A bank’s capital growth may keep pace with growth in total assets; however, a change in asset composition, by decreasing relatively low-risk assets and increasing relatively high risk assets, can increase the risk exposure of the bank and thereby necessitate higher capital ratios. Likewise, a substantial shift in the composition of a bank’s liabilities from stable core deposits to volatile short term funding vehicles increases a bank’s risk and necessitates higher capital ratios. Banks with aggressive growth plans will need to ensure that adequate capital is available to support planned growth. •

Overall financial condition?

Growth experience and future growth prospects?

The retention of earnings for capital needs?

Plans for maintaining adequate capital and correcting any deficiencies?

Compliance with regulatory capital directives?

Investment Policies Page 6: The investment securities records and subsidiary records of the bank should be reviewed carefully. If the bank has an investment committee, the minutes of the investment committee should be read carefully.


Investment Securities and Shares Page 6(A): The securities section on this page is a supporting schedule of the inspection report’s page 1 which is the Inspector’s statement of Assets and Liabilities. The breakdown should show book value, market value and appreciation of depreciation. The total book value should agree with page 1 for total investments. Fixed Assets Page 7: •

Insurance Coverage on banking house; furniture and Fixtures;

Any appreciable increase in book value of banking house or furniture ankh fixtures since the previous inspection;

If the bank has written up the value of its building at any time over cost, or if it is not regularly depreciating the book value, comments should made by he inspector.

Other Real Estate: Immovable property owned by the bank is real asset which is obtained against security for bad and doubtful loans. Since it has less liquidity banks should not hold this for long time and the amount of this asset should not cross the amount of loan. The real estate can be hold maximum 5 years and if the book value of real estate is not nominal figure then inspector should comment on page 2. Brief description of property must be shown in the schedule of other real estate and excess of book value over appraised value of real estate is classified as loss. Other Assets: Other assets are listed or classified in the schedule on page 1 and the grouping of theses assets should be scheduled according to the order listed on page 1.Inspector should review the classifications of totally supervision assets and the losses incurred due to other assets should be maintained as loss. Inspector should classify “goodwill” shown in other asset and the classification of other assets should be shown on page 3A. Liquidity/ asset liability management: Liquidity for a bank means the ability to meet its financial obligations as they come due. Bank lending finances investments in relatively illiquid assets, but it fund its loans with mostly short term liabilities. Thus one of the main challenges to a bank is ensuring its own liquidity under all reasonable conditions Interest Sensitivity page 9 (A): It refers to the effect in total earnings due to changes in market interest rate. Interest rate risk exposure is the consequence of mismatching maturities of rate sensitive assets and rate sensitive liabilities. Here rate sensitive means interest rate can be changed within less than one year. There are several methods to measure the risk of interest rate, but gap analysis is mainly used in examination report which is to evaluating the net interest rate exposure of asset and liability in several time periods to


determine the absolute size of gap. The positive gap raises a bank’s earnings if interest rate rise and vice versa. On the other hand, negative gap causes decline in earnings if rates rise and vice versa. Examiners must carefully analyze the changes in bank’s earnings due to interest rate, and page 9 (A) will assist examiner to measure the risk. High gap positions which may exceed +10% or -10% must be commented on page 2 inspection conclusion and recommendation.

Trend of Deposits and Sector wise distribution of deposits: Inspector should know the stability and source of various deposits. Change in the deposit or liability mix should be mentioned in the report. Inspector should compare the rate of deposits with the rate offered by competitors and he should determine the reasons why premium rates are paid since it indicates disability of bank raising funds. In page 9B the schedule of the growth trend of deposits over the past 4 years must be included. Large Deposits Page 9C: While assessing the stability of deposits, the concentration of large deposits should be discussed in the report. Contingent Liabilities 9D: The off balance sheet items are contingent liabilities which are discussed in this page to determine whether the bank has sufficient liquid assets or not to cover these items and the classification of these liabilities is also included in this page. Borrowings page 10: Borrowings must be included in schedule and these are verified by form of borrowing, amount, date of loan, interest rate, due date of loan and security pledged. Liabilities not shown on bank’s book page 11: Liabilities which are not shown in bank’s book are included in this schedule. Inspector should verify these liabilities and give comments. Large amount of past due bills are the common non book liabilities which are encountered from time to time. The inspector should not adjust in this schedule due to inaccurate accruals. If bank’s record overstate due to inaccurate accruals then the use of this schedule is necessary. Audit and Internal controls page 12: An inspector will evaluate a bank’s internal controls by including effectiveness of internal auditing and implementation internal control questionnaire. Inspector should not eliminate the internal or external audit functions satisfactorily performed. The inspector should review and evaluate independence and competency of the internal auditors and verify whether the audit program is effective or not.


Supervision by Directors page 13: The inspector should include in this section the answers to questions shown on page 13 of the report, based on findings during the course of his inspection. Fidelity and other insurance page 14: Describe surely protection provided by bank against officer and employee defalcation. Foreign Exchange position page 15 A: This page shows the foreign exchange position of various currencies held by the bank. Key ratio analysis page 16: Inspector analyzes the key ratios of bank to decide whether the banks are performing well or not. By analyzing inspector can project the future and predict possible problems. Chapter 7 1. Guidelines and Procedures for the Uniform Evaluation and Rating of Banks (CAMEL) The rating system is based on an evaluation of five vital dimensions of a bank’s operations that reflect in a broad manner, an institutions financial condition, compliance with banking regulations and acts and overall operating soundness. The specific dimensions that are to be evaluated are the following; 1. Capital Adequacy 2. Asset quality

=A

3. Management

=M

=C

4. Earnings

=E

5. Liquidity

=L

Each of the dimensions is to be rated on a scale of one through five in ascending order of performance deficiency. Thus 1 represents the highest and 5 the lowest level of operating performance. Each bank is agreed a composite rating that is predicated upon the evaluations of the specific performance dimensions. The composite rating is also based upon a scale of 1 through 5 in ascending order of supervisory concern. Furthermore, at a composite rating each financial dimension must be considered and due consideration given to the interrelationships among the various aspects of a bank’s operations.

2.

Composite Rating

The five composite ratings are defined and distinguished as follows:


Composite 1: Banks in this group are sound institutions in almost every aspect; any critical findings are basically of a minor nature and can be handled in routine manner. Such banks are resistant to external economic and financial disturbances and capable of withstanding the vagaries of business conditions more ably than banks with lower composite ratings. •

Basically sound in every respect

Findings are of a Minor Nature and can be handled routinely

Resistant to external economic and financial disturbance

No cause for supervisory concern

Composite 2: Banks in this group are also fundamentally sound institutions but may reflect modest weaknesses correctable in the normal course of business. Such banks are stable and also able to withstand business fluctuations quite well. Areas of weakness could develop into conditions of greater concern. To the extent that the minor adjustments are handled in the normal course of business, the supervisory response is limited. •

Fundamentally sound

Findings are of a minor nature and can be handled routinely

Stable and can survive business fluctuations well

Supervisory concerns are limited to the level that are corrected

Composite 3: Banks in this group exhibit a combination of weaknesses ranging fro moderately severe to unsatisfactory. Such banks are only nominally resistant to the onset of adverse business conditions and could easily decline if concerted action is not effective in correcting the areas of weakness. Consequently, such banks are vulnerable and require special supervisory attention. Overall strength and financial capacity are still such as to make failure only a remote possibility. Generally, formal or informal administrative action is presumed necessary for banks in these groups. •

Financial, operational, or compliance weakness ranging from moderately severe to unsatisfactory

Weak to the onset of unfavorable business conditions

Easily decline if actions are not effective in correcting weaknesses

Supervisory concern and more than normal supervision to address deficiencies


Composite 4: Banks in this group have an immoderate volume of asset weaknesses, or a combination of other conditions that are unsatisfactory. Unless prompt action is taken to correct these conditions, they could reasonably develop in to a situation that could impair future viability. A potential for failure is present but is not pronounced. Banks in this category require close supervisory attention and financial surveillance. The assumption is that formal administrative action is necessary for banks in this group. •

Immoderate volume of serious financial weaknesses

Unsafe and unsound conditions may exist which are not being satisfactorily addressed

Without corrections, these conditions could develop further and damage future viability

High potential for failure

Close supervision observation and a exact plan for correcting deficiencies

Composite 5: This category is reserved for banks whose conditions are worse than defined under no. 4 above. The volume and character of weaknesses are such as to require urgent aid from the shareholders or other sources. Such banks require immediate corrective actions and constant supervisory attention. The probability of failure is high for these banks and formal admin action is presumed necessary. •

High immediate or near team probability of failure

Severity of weaknesses is so critical that urgent aid from stockholders or other financial sources is necessary

Without immediate corrective actions, will likely require liquidation, merger, or acquisition

3.

Performance Evaluation:

As already noted that the five key performance dimensions Capital adequacy, asset quality, management, earnings and liquidity are to be evaluated on a scale of one to five.

Rating no. 1: Indicates strong performance. It is the highest rating and is indicative of performance that is significantly higher than average. Rating no. 2: Reflects satisfactory performance. It reflects performance that is average or above. It includes performance that adequately provides for the safe and sound operation of the bank. Rating no. 3:


Represents performance that is flawed to some degree. As such is considered fair. It is neither satisfactory nor unsatisfactory but is characterized by performance of below average quality.

Rating no. 4: Refers to marginal performance and is significantly below average. If it left unchecked, such as performance might evolve into weaknesses or conditions that could threaten the viability of the institution. Rating no. 5: Reflects unsatisfactory performance. It is the lowest rating and is indicative that performance is critically deficient and in need of immediate remedial attention. Such performance by itself, or in combination with other weaknesses, threatens the viability of the institutions.

4.

Bank Analysis Checklist (CAEL)

Capital Adequacy: •

Is level of capital high enough?

Is capital growing comfortably?

Can additional debt be raised if needed?

Does there appear to be pressure to maintain an abnormally high dividend rate?

Asset Quality: •

Are high charge offs predicted for next year?

Is the bank house cleaning and is reserve level adequate?

Is management slow to charge off bad loans?

Earnings: •

Adequate level and trend?

Valid reporting?

If poor, ascribable to one or more of the following: •

Low asset yields

High cost of funds & High overhead


Loan losses & mismanaging taxes

Poor other income level

If strong, ascribed to: •

Strong asset yields

Low cost of funds & low overhead

Low loan losses & adequate tax planning

Significant other income

Liquidity: •

Is bank dependent on borrowed money?

Is asset growth: • Founded by core deposit growth? •

Supported by capital growth?

Funded by borrowed money?

5.

(C A M E L)

Capital Adequacy: Capital is rated 1 through 5 in relation to the volume of risky assets, the volume of marginal and inferior quality assets, bank growth experience, plans, and prospects and, the strength of management. In addition, consideration should be given to banks capital ratios relative to its peer group, its earnings retention and its access to capital markets or other appropriate sources of financial assistance. The bank’s policy statement must also be taken into account. Asset Quality: Asset quality is rated 1 through 5 in relation to the level, distribution and severity of classified assets, the level and distribution of non accrual and reduced rated assets, the adequacy of valuation reserves, and demonstrated ability to administer and collect problem credits. Obviously, adequate valuation reserves and a proven capacity to police and collect problem credits mitigate to some degree the weaknesses inherent in a given level of classified assets. In evaluating asset quality, consideration should also be given to any undue degree of concentration of credits or investments, the nature and volume of special mention classification, lending policies, and the adequacy of credit administration procedures. Management: Management’s performance must be evaluated against virtually all factors considered necessary to operate the bank within accepted banking practices and in a safe and sound manner. Thus, management is rated 1 through 5 with respect to technical competence, leadership and administrative ability, compliance with regulations and statutes, ability to plan and respond to


changing circumstances, adequacy of and compliance with internal policies, and depth and succession. The assessment of management also takes into account the quality of internal controls, operating policies, and the involvement of the directors and shareholders. Earnings: Earnings will be rated 1 through 5 with respect to the ability to cover losses and provide for adequate capital, earnings trends, peer group comparisons and quality and composition of net income. Consideration should also be given to the interrelationships that exist between the dividend payout ratio, the rate of growth and retained earnings and the adequacy of bank’s capital. A dividend payout rate that is sufficiently high as to cause an adverse relationship to exist suggests conditions warranting a lower rating despite a level of earnings that might otherwise warrant a more favorable appraisal. Quality is also an important factor in evaluating this dimension of a bank’s performance. Consideration should be given to the adequacy of transfer to the valuation reserve and the extent to which extraordinary items, securities transactions, and tax effects contribute to net income. Liquidity: Liquidity is rated 1 through 5 with respect to the volatility of deposits, degree of reliance on interest sensitive funds and frequency and level of borrowings, technical competence relative to structure of liabilities, availability of assets readily convertible into cash, and access to money markets or other ready sources of cash. Ultimately the banks liquidity must be evaluated on the basis of its capacity to promptly meet the demand for payment of its obligations and to readily fill the reasonable credit needs emanating from the communities which it serves. In appraising liquidity, attention should be directed to the banks average liquidity over a specific time period as well as its liquidity position on any particular date. Consideration should be given, where appropriate to the overall effectiveness of asset-liquidity policies. The nature, volume and anticipated usage of a bank’s credit commitments are also factors to be weighed in arriving at an overall rating for liquidity.

6.

Ratings

1 = Strong 2 = Satisfactory 3 = Fair 4 = Marginal 5 = Unsatisfactory


In composite 1, performance evaluation is followed from 1 to 1.4.

In composite 2, performance evaluation is followed from 1.5 to 2.4.

In composite 3, performance evaluation is followed from 2.5 to 3.4.

In composite 4, performance evaluation is followed from 3.5 to 4.4.

In composite 5, performance evaluation is followed from 4.5 to 5.

7.

Examples of Composite Ratings

Here, as example: CAMEL 5 Suppose, CAMEL is 1, 2, 2, 3, 2 or in addition 10 So, composite is 2. (10/5)

Chapter 8 Asset Classification

1.

Assets classification: Usually 3(three) categories of banking assets are classified. These are as under: •

Loans and advances including bills purchased & discounted.

Securities ( Bank’s Investments)

Other assets

2.

Importance & Objects of Assets Classification:

Help to find out Net worth (N.W)/ Adjusted capital

Help to assess financial sound footing in order to develop sound banking practice in Bangladesh

Help to strength Credit discipline

Help to improve loan recovery position

Help to calculate the required provision & the amount of interest suspense

Help to make planning for future course of action


3.

4.

Type of loans to be classified:

Continuous Loans

Demand Loans (DL)

Fixed Term Loans (Repayable within 5 years)

Fixed Term Loans (Repayable within more than 5 years)

Agriculture Short Term (AST) Loans & Micro-Credits.

Basis for Loan Classification

i.

Objective Criteria (OB)

ii.

Qualitative Judgment (QJ)

5.

Status of Loan Classification

UC  Standard  SPECIAL Mention Account

SS – Sub-Standard

DF – Doubtful

B/L – Bad & Loss

Chapter 9 Conclusion

The departments of banking inspection and off site supervision are accountable for the inspection of schedule banks and other financial institutions. This inspection is very vital because it measures the financial soundness of bank’s assets. Through this inspection any sort of irregularities in following banking rules and norms, violations of laws and regulations can be found out. These significant noted issues are noticed to the top management so that they can take necessary measures in right time. As banks and financial institutions are liable and accountable for the safety of public money, so this inspection is important to find out whether the banks are properly doing their responsibilities. If the banks’ performance does not seem well, the supervision of on site and off site supervision department of Bangladesh bank make the banks on sound footing and it assist the banks to develop good banking practice.


Chapter 10 References We have used these sources as our references…. •

Bangladesh Bank Website

Bangladesh Bank Inspection Report

Internet Articles

CAMEL Ratings and so on


On site and off site supervision of schedule banks by bangladesh bank’