ADMAS

UNIVERSITY COLLEGE

DEPARTMENT OF
ACCOUNTING
Practices of credit risk
management in bank
institutions: Case of commercial
bank of Ethiopia, Shire branch.

PREPARED BY:
ADVISOR:

JUNE, 2025 G.C

Shire, TIGRAY
 ADMAS UNIVERSITY COLLEGE
DEPARTMENT OF ACCOUNTING

A RESEARCH FOR THE PARTIAL

FULLFILMENT OF A BACHELOR OF ARTS
DEGREE IN ACCOUNTING

CREDIT RISK MANAGEMENT SYSTEM OF

ETHIOPIAN COMMERCIAL BANKS
(CASE OF SOME COMMERIAL BANKS IN
Shire TOWN)

PEPARED BY:

APPROVED BY:

1. ADVISOR ________________________ SIGN ___________

2. EXAMINER ________________________ SIGN ___________

JUNE, 2025 G.C

Shire, TIGRAY

2
ACKNOWLEDGMENT

Firstly, I am indebted to the Almighty God with whose grace; I could

satisfactorily complete my research paper.

Then, I am deeply grateful to my advisor for his professional suggestions,

guidance for the research paper, that without his assistance, successful
accomplishment of this research paper would have been very difficult.

Next, my specials thank goes to my relatives and real friends for their
valuable comments and significant suggestion during the research process,
and for giving me referring materials and in general for their friendly support.

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Acronyms:

BODs - Board of Directors

BIS - Bank for International Settlements

CBE - Commercial Bank of Ethiopia

FIs - Financial Institution

II – Interest Income

NBE- National Bank of Ethiopia

NPL- Nonperforming Loan

ROA- Return on Asset

ROE- Return on Equity

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TABLE OF CONTENTS
Page
Chapter one: Introduction
1.1. Background of the study------------------------------------------------------- 8
1.2. Statement of the Problem ---------------------------------------------------- 10
1.3. Objective of the Study -------------------------------------------------------- 11
1.4. Significance of the study ---------------------------------------------------- 12
1.5. Research Design --------------------------------------------------------------- 13
1.6. Scope and limitation of the study -------------------------------------------- 14
1.7 Organization of the Paper ------------------------------------------------------ 15
Chapter two: Literature Review
2.1. The origin and Evolution of Bank and Credit Risk Management-------- 16

2.2. The History of Banking in Ethiopia ----------------------------------------- 17

2.3 Operational definitions -------------------------------------------------------- 19

2.4. Importance of credit risk Management ------------------------------------- 20

2.4.1. Credit Risk Management Models ----------------------------------------- 22

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2.5. Credit Risk Measurement, Monitoring and control ----------------------- 23

Chapter III: Discussion and Analysis

3.1. Data Gathering ----------------------------------------------------------------- 27

3.2 Empirical Results and Discussion -------------------------------------------- 29

3.2.1. Assessing credit risk environment ---------------------------------------- 30

3.2.2. Administration, measurement and monitoring process----------------- 32

3.2.2.1. Credit risk management tools ------------------------------------------- 33

3-2.2.2. Trends of Non –performing loans of the banks

And Comparison NBE’s desired maximum level ---------------------------- 35

Chapter IV Conclusion and Recommandation

4.1. Conclusion ------------------------------------------------------------------- 39

4.2. Recommandation ----------------------------------------------------------- 41

Bibliography
Appendix one: Questionnaire

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LIST OF CHARTS, TABLES AND GRAPHS
Charts

Chart 1: Existing of Credit Risk Management Department-------------------------- 29

Chart 2: Establishment of a written credit risk policy ------------------------------- 30

Chart 3: Calculating of credit risk measurement inputs-Probability of default---- 31

Chart 4: Calculating of credit risk measurement inputs-loan recovery rate-------- 32

Chart 5: Existence of independent internal review ----------------------------------- 35

Tables
Table 1: Responding rate ---------------------------------------------------------------- 27

Table 2: Trend of Non-performing loans of the banks ------------------------------ 34

Graphs
Graph 1: Respondents educational back ground ------------------------------------- 28

Graph 2: Respondents work experience ----------------------------------------------- 28

Graph 3: Credit Risk Management Tools --------------------------------------------- 32

Graph 4: Credit exposure limit policy ------------------------------------------------ 33

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 CHAPTER I

INTRODUCTION

1.1-Background to the study:

Adequately managing credit risk in financial institutions (FIs) is critical for the
survival and growth of the FIs. In the case of banks, the issue of credit risk is of
even greater concern because of the higher levels of perceived risks resulting
from some of the characteristics of clients and business conditions that they
find themselves in. Banks are in the business of safeguarding money and
other valuables for their clients.

They also provide loans, credit and payment services such as checking accounts,
money orders and cashier’s checks. Banks also may offer investment and
insurance products and a wide whole range of other financial services.

The past decade has seen evolutionary revival of the banking industry in Ethiopia
following re-establishment of private banks. It is a normal phenomenon
that as the number of banks (and other institutions providing banking
services) increases, so does the competition, which in turn increases scope and
complexity of banks’ business to beat the competition and steer a
consistently profitable course. Generally, changes in the general business
8
environment alters the degree of risks banks, as any business, are subject to and
the concern they should give to manage these risks (Ethiopian Academy of
financial studies Training materials, Bank Risk Management).

Lessons from the traditional banking crises show that banks that had been
performing well suddenly announced large losses due to either credit
exposures that turned bad, liquidity problems, unmanaged interest rate and
exchange rate positions taken, derivative exposures that may or may not have
been assumed to hedge balances sheet risk or significant operational risks. In
response to such lessons, banks almost universally have embarked up on an
upgrading of their risk management system. Thus, in this increasingly dynamic
area of financial services, a distinctive position of any bank-be it private or public,
large or small- lies in the way it manages its risks (Ibid).

Risk is a fact of life in every business and if not managed properly, would
adversely affect the very existence of any businesses. However, the
damage could be more severe in the case of banks as banking business is not
only a stake of the owners but also that of depositors ( public), other banks and
hence, the economy as a whole. The main risks facing banks are credit risk,
market risk, liquidity risk and operational risk (Basle committee on banking
supervision)

While banks engage in a large number of other financial activities and render a
wide range of services to customers, direct lending is one of the primary
function performed by them, the one in which they have a natural
a dvantage over almost all financial institutions. This characteristic of
banks can be rationalized by the fact that loans and advances are the most
significant components of banks’ assets. Loan and advances usually represent
about 50-70% of their income. In 2006 for example, Commercial banks in
Ethiopia generated 66% of their income from interest on loans and advances
(National Bank of Ethiopia).

9
Among the risk that face banks, credit risk is one of great concern to most
bank authorities and banking regulators. This is because credit risk is that risk
that can easily and most likely prompts bank failure (Basle committee on
banking supervision, 2004).

Therefore, sound credit risk management structure is crucial for effective credit
risk management process. While banks may choose different structures, it is
important to ensure that the structure is commensurate with their size, complexity
and diversification of their activities (Ibid).

1.2. Statement of the problem

The very nature of the banking business is so sensitive because more than 85%
of their liability is deposits from depositors (sounders, cornett, 2005). Banks use
these deposits to generate credit for their borrowers, which in fact is a revenue
generating activity for most banks. This credit creation process exposes the
Banks to high default risk, which might lead to financial distress including
bankruptcy.

In today’s changing financial landscape-environment of intense

competitive pressure, volatile economic conditions, rising bankruptcies, a n d
increasing levels of consumer and commercial debt; an
organization’s ability to effectively monitor and manage its credit risk can mean the
difference between success and failure. Effective credit risk management
attracts today more attention than before.

Interest income and interest expense are the main determining factors for the
profitability of private banks in Ethiopia (Yigremachew, 2008).The negative
relationship of cre

Credit risk to corporate profitability may be evident that the more commercial
banks expos themselves to credit risk, the more accumulation of unpaid loans,
implying that these loan losses have produced lower returns to the banks. The

10
accumulation of non- performing loans caused by lack of proper credit risk
management would have substantial adverse impact on the performance of the
banks in particular and the overall economy in general. In turn this affects the
government by reducing its tax income and banks by imposing dawn ward
pressure on their respective profits and per share value of their stock price.

Apart from the above, significant amounts of non-performing loans

emanating from lack or poor credit risk management system could hinder
development and expansion of the Banks. It also leads clients to have lack of
confidence and the Banks to lose their loyal and prominent customers. Moreover,
investors may not be willing to invest their funds on the banks stock at the
desirable price or may avoid completely purchasing the stock. This in turn
affects the capital structure of the Banks. Therefore, unless the problems are
managed properly, it would definitely result in financial crises as in case of United
States of America, East Asia and Japan.

Following the free market economy of the country, loans are becoming large
and at the same time bad loans have increased substantially during the past few
years. This appears as a problem and should be of interest to every commercial
banker. There should therefore be prior concern on the side of the commercial
banks to give due diligence in maintaining sound asset quality management,
sound portfolio and risk management, prudent loan processing and selection
strategies.

Therefore, the principal concern of this paper is to a ascertain to what extent

banks can manage their credit risks, what tools or techniques are at their
disposal and to what extent their current performance is supported by proper
credit risk management policies and strategies.

1.3. Objective of Study

The main objective of the study is to assess how banks manage their credit
risk. To this effect the writer tried to cover the following specific objects

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 Assessing whether the Banks are operating under appropriate credit risk
environment
 Identifying those methods that are used by the banks to mitigate their credit risk
exposure
 Assessing the Banks credit administration, measurement and
monitoring process
 Seeing interest income of the banks how significant it is as compared with the
other types of income.
 Examining the existence of adequate control over credit risk.
 Creating awareness and give high lights (if necessary) to the banks mangers if
there are any deficiencies in this regard.
 To make the study as stepping stone for further study.

1.4. Significance of the Study

This paper examines the application of credit risk management and

determines shortcomings. Thus, the subject matter of this research and the
resulting lessons drawn from the analysis are likely to benefit different
classes of people. This study is significant for its contribution to enhancing
knowledge, managerial decision making, reference material and serves as policy
frame work. Each is described below.

Knowledge

The intended contribution of this paper is to increase the knowledge in the area.
The analysis is assumed to serve as a modest start and contributes to the
existing knowledge.

Managerial Decision Making

The study findings and recommendations are important to management of the

banks under study because it draws their attention to some of the points where
corrective actions are necessary and enable them to make such corrections.

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Literature and Reference

The research can be used to establish a framework for subsequent studies

that can work with more comprehensive data set. Furthermore, it can stimulate
further research; thus keeping sustained interest in the area of credit risk
management and their use in minimizing the banks credit risk.

Policy framing

Credit granting is one of the main activities of banks and hence it is

beneficiary to make some reforms that lends to a better credit risk
management. The findings and recommendations of the study are highly important
to policy makers because it draws their attention to some of the points that need
corrective measures on their side.

1.5. Research Design

Methodology

1.5.1. Source and method of Data collection

The research qualitatively and quantitatively examined policies,

strategies and associated practices regarding the banks credit risk
management systems and practices with the help of the following
methods.

1. Questionnaires- a questionnaire with a standard set of questions addressed to

managers of credit and risk management, credit divisions, senior credit analyst
and controllers

2. Interview- both structured and unstructured interviews were conducted.

3. Annual report and documents of the banks and NBE’s were revised.
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The investigation focused generally on management level of the selected banks
considering the fact that it is the manager that are responsible for developing and
implementing the policies and procedures, and at the same time who are
responsible for success or failure. Likewise, as the population is small, sampling
was not used.

1.5.2. Data Analysis

The research design used was a descriptive and didn’t use a high
standard statistical survey of the banks practice. Data collected from annual
and quarterly reports and primary data and information provided by banks were
analyzed via tables, graphs and pie charts to depict the reply of respondents
and data gathered through secondary data. However, the hypotheses were
tested using regression model. In addition, NBE’s related policy and
directives, practices of some international peers and credit risk management
guidelines of Bank for international settlements have been in use as a bench mark
for analysis

1.5.3. Sample construction

The researcher selected one commercial Bank from the government owned
banks that is CBE and one from private commercial banks, which have been
operational at least for the last ten years starting from 1999GC up to 2009GC,
(i.e. Wegagen Bank) Both the banks have branches in Shire.

1.6. Scope and Limitation of the Study

The researcher believes that the findings of this study would have been more
productive if it has been conducted on all public and private Banks in Ethiopia.
However, due to time and financial constraints, it is out of the reach of the
researcher to incorporate all in this study. The study encompasses two selected

14
Ethiopian Commercial Banks (i.e. CBE, and WB) in which both of them have
branches in Shire town. Besides, due to the opaqueness of the sector and expected
shortage of longitudinal data and other elusive structural difficulties the
study is compelled to limit itself mainly on officially reported accounting
data for a period of the last six subsequent years up to 2009.

The study also likely to face problem of accuracy for some data, which were
considered confidential by some banks, resulting from limited observation or
degree of freedom. It is known that loan losses can also occur as a result of the
borrowers’ character not to repay the debt in line with the agreement, apart from
the lenders lax credit risk management system. Therefore, the problem
should have been seen from both sides. Nevertheless, due to time and
financial constraint the researcher couldn’t incorporate views of
borrowers.

1.8. Organization of the Paper

The paper is organized into four chapters; the first chapter describes the
introduction and cuts across, statement of the problem, objective of the study,
significance of the study, limitation and scope of the study, research design
and hypothesis. The second chapter concerned with the review of related
literature. The third chapter deals with analysis of the data collected and the
fourth chapter concludes the study with summery and recommendation.

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 CHAPTER II

LITRETURE REVIEW
2.1. The origin and Evolution of Bank and Credit Risk Management

It may be said that banking in its most simple form, is as old as authentic
history. As early as 2000B.C Babylonians had developed a system of banks. In
ancient Greece and Rome the practice of granting credit was widely prevalent.
“Trace of granting credit by compensation and by transfer orders” is found in
Assyria, Phoenicia and Egypt before the system attained full development in
Greece and Rome (Shekhar,1993).

According to Machiraju (2003) it is believed to be the cradle of banking in northern

cities. As the center of commercial activity shifted from the Mediterranean to the
Atlantic and Northern Western Europe, banking growth fell behind in Italy.
However, banking reappeared in Italy during the catching up process of
industrialization in the 19th century. The banks then were functioning as main
lenders to the government and were lending money on collateral basis.

In today’s world banking is an important part of every body’s life, and they are one
of the most important financial institutions in the developed as well as developing
economies. Among the most crucial functions of a commercial banking is providing
credit to all participants of an economy. Commercial banks are the primary
sources of credit for many businesses, households and government bodies.
16
Banks are among the most important sources of short term working capital for
business and have become increasingly active in recent years in making long term
loans business organizations (Rose, 1993). In a nut shell, credit become “the business
of banking and primary basis, on which banks quality and performances are judged’
(McNaughton, 1992)

2.2. The History of Banking in Ethiopia

It is the agreement that was reached in 1905 between Emperor Menilik II and Mr.
McGillivray, representative of the British owned national Bank of Egypt marked
the introduction of the then modern banking in Ethiopia. Accordingly, the
first bank called Bank of Abyssinia was inaugurated in February 16, 1906 by the
Emperor. The society at that time being new for the banking service, Bank of
Abyssinia had faced difficulty of familiarizing the public with it. Despite its
monopolistic position, the bank earned no profit until 1941; profits were record in
1941, 1919, and 1920 and from 1924 onwards. The bank had faced many pressures as
a result of its inefficiency and purely profit oriented. Thus, an agreement was
reached to abandon its operation and be liquidated so as to disengage banking
from foreign control and to make the institution responsible to Ethiopian’s credit
needs. By shortly after Haile Sellassie came to power, the Bank of Ethiopia
was a purely Ethiopian institution and was the commercial activities of the Bank of
Abyssinia and was authorized to issue notes and coins. During the invasion (1935)
the Italians established branches of their main banks namely Banca d’ Italia,
Banco diRoma, Banko diNapoli, and Banca Nazionale del lavoro.

In 1941, another foreign bank, Barclays Bank came to service in Addis Ababa till it
withdraws in 1943, shortly before the commencement of the full operation of the state
Bank of Ethiopia. The state Bank of Ethiopia acted as the central Bank of Ethiopia and
as the principal commercial bank in the country and engaged in all

17
commercial banking activities until ceased to exist by bank proclamation issued on
December 1963.

The Ethiopian Monetary and Banking proclamation that came in to force resulted in
splitting the function of commercial and central Banking creating National bank
of Ethiopia and Commercial bank of Ethiopia. National bank of Ethiopia
performs central banking functions while commercial bank of Ethiopia took over
commercial banking activities of the former State bank of Ethiopia. As first private
bank Addis Ababa Bank Share Company was also came to existence in 1964.

There were also other financial institutions in the country like the Imperial
Savings and Home ownership public Associations (ISHOPA) and Saving and Mortgage
Corporation of Ethiopia whose aim were to accept saving and trust, deposits
accounts and provide loans for the construction, repair and improvement of
residential houses. In 1945 Agricultural Bank that provide loans for agriculture and
other relevant project was establishing and replaced in 1951 by Investment Bank
of Ethiopia. In 1965 its name once again changed to Ethiopia Investment
Corporation Share Company. However proclamation No. 55 of 1970 established the
Agriculture and Industrial Development Bank Share Company by taking over
the assets and liability of the former Development Bank and Investment Corporation
of Ethiopia.
Following the introduction of socialism economic system in 1974, the banking
sector was changed to a monopolistic banking system. The Housing and saving
Bank was established in 1975 by merging the former saving and Mortgage Corporation
of Ethiopia S.C and the Imperial Saving and Home ownership public Association
with the objective to provide loans for residential and commercial construction
industries. Then Addis Ababa Bank and commercial Bank of Ethiopia S.C was
merged by proclamation number 184/1980 to form the sole commercial Bank in the
country till 1994.

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The pre 1994 Ethiopian banking industry was characterized by relatively less
competition, low deposit mobilization relatively high government intervention in
their management and more loan access to state owned sector.
Post 1994
Following the change in the economic policy, financial sector reform also took place.
Monetary and Banking proclamation of 1994 established the National bank of
Ethiopia as judicial entity, separated from the government.
In 1994, Construction and Business Bank was established under proclamation
number 203/1994 by taking over the rights and obligations of Housing and saving
Bank, which was previously established under proclamation number 60/1975.
Development Bank of Ethiopia has also established under Regulation of 1974.
Monetary and Banking proclamation No. 83/1994 laid down the legal basis for
investment in the banking sector; consequently shortly after the proclamation the first
private bank, Awash International Bank S.C was established in 1994. Dashen
Bank was established in 1995, and subsequently other private banks joined the
industry which brought number of banks in the industry to thirteen. Thus the
banking sectors are becoming more competitive today than pre 1994.
2.3 operational definitions
Banks make money by providing different services to their customers and granting
credits. However, there are some risks with these services and the most one are:
Financial risk3 in a banking organization is the possibility that outcome of an action
or event could bring up an adverse impact. Such outcomes could either result in
direct loss of earnings/capital or management result in imposition of constraints on
bank’s ability to meet its business objectives. Such constraints pose a risk as these
could hinder bank’s ability to conduct its ongoing business or to take benefit of
opportunities to enhance its business
Credit Risk4 is the potential that a bank’s borrower or counterparty will fail to meet
its obligations in accordance with agreed terms. Thus credit risk arises from non
performance by borrower or a counter party due to either inability or unwillingness to
perform as per the contracted. While the types & degree of risks an organization
may be exposed to depend upon a number of factors such as its size, complexity of

19
business activity, volume etc, it is believed that generally banks face credit,
market, liquidity, operational, compliance/legal/regulatory & reputation risks. Across
country experience evident that credit activities are the main determining factors
for the well being of the financial sector’s, especially in intermediation
activities such as banking services (Yigremachew, 2008) As discussed above,
loans are the largest and most obvious source of credit risk and hence, ensuring
prudent lending operation that reflects an acceptable risk reward ratio is, therefore,
an area in which banks have to devote considerable skills and research.
Risk management5; - is a discipline at the core of every financial institution
and encompasses all activities that affect its risk profile. It involves identification,
measurement, monitoring & controlling risks to ensure that the individuals who take
or manage risks clearly understand that the organization’s risk exposure is within the
limits established by board of directors. Risk taking decisions are in line with the
business strategy and objectives set by board of directors
2.4. Importance of credit risk Management
The future of banking will undoubtedly rest on risk management dynamics.
Only those banks that have efficient risk management system will survive in the market
in the long run. The effective management of credit risk is a critical component of
comprehensive risk management essential for long term success of a banking
institution. Credit risk is the oldest and biggest risk that bank, by virtue of its very nature
of business, inherits. This has however, acquired a greater significance in the recent
past for various reasons. Foremost among them is the wind of economic liberalization
that is blowing across the globe (Achou and Tenguh 2008).
Moreover, it also classified credit risk management in to two distinct dimensions
as preventive measures and curatives measures. Preventive measures include risk
assessment, risk measurement and risk pricing, early warning system to pick early
signals of future defaults and better credit portfolio diversification. The curative
measures, on the other hand,
aim at minimizing post sanction loan losses through such steps as
securitization, risk sharing, legal enforcement etc. It is widely believed that an ounce
of prevention is worth a pound of cure.

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A report issued by a committee on banking supervision of Bank for
international settlements (BIS, 2004) states that while financial institutions
have faced difficulties over the years for a multitude of reasons, the major cause
of serious banking problems continues to be directly related to lax credit standards for
borrowers and counterparties, poor portfolio risk management, or a lack of
attention to changes in economic or other circumstances that can lead to a
deterioration in the credit standing of a bank's counterparties. This experience is
common in both G-10 and non-G-10 countries.

According to (David Shimko, 2004), the goal of credit risk management to any bank is
to maximize a risk adjusted rate of return by maintaining credit risk exposure
within acceptable parameters. Banks need to manage the credit risk inherent in
the entire portfolio as well as the risk in individual credit or transactions. The
effective management of credit risk is a critical component of a comprehensive
approach to risk management and essential to the long term success of any
banking organization.
Peter S. Rose (1999) Pointed out that risk in banking tend to be
concentrated in the loan portfolio. Thus, a bank’s serious financial trouble
usually emanates from loans that have become uncollectible.
Studies reveal that the Japanese bank crises of 1993 and American financial
crises of 2007-2009, were the consequences of un-collectible (non – performing
loans). Bank for International settlements (2003), Fukao (2003), International
Monetary Fund (2003), Kashuap (2002), and organization for economic cooperation
and Development (2001) pointed out that credit misallocate on is one factor for
banking crises. World over, credit risk has proved to be the most critical of all risks
faced by a banking institution. A study of bank failures in New England found that, of
the 62 banks in existence before 1984, which failed from 1989 to 1992, in 58 cases it
was observed that loans and advances were not
being repaid in time, (Achou and Tenguh 2008).
The effects of poor risk management can clearly be seen in the problems that have
arisen from the unregulated sub-prime mortgage lending market in the USA

21
where the loans had been securitized into ever more complex securities, which
when the housing prices stabilized and stopped increasing led to a huge increase
in defaults of the underlying sub-prime mortgages. This, in turn, led to
massive losses in the securities which had been sold. The reasons mentioned above
indicate an increased need to manage risk and in particular credit risk and default
predictions (Wikipedia, March 2009)

According to Ethiopian academy of financial study’s unpublished risk management

materials, credit risk arises any time bank funds are extended, committed,
invested, or otherwise exposed, whether reflected on or off the balance sheet as a
result of lax exposure management, poor economic conditions, or a variety of other
factors. However, generally the risk is assumed to be a rise from transaction (default)
risk and portfolio risk. These signify the role of credit risk management and
therefore it forms the basis of present research analysis.
Some of the strategies used for reducing and coping with portfolio credit r i s k
a c c o r d i n g t o A c h o u a n d T e n g u h , 2 0 0 8 , a r e g e o g r a p h i c diversification,
loan size limits (Rationing), over collateralization and credit insurance.
2.4.1. Credit Risk Management Models
It is hard to differentiate between the traditional approach and the new approaches
since many of the ideas of traditional models are used in the new models. The
traditional approach is comprised of four models6, as depicted herein under.
Expert systems
In this system, the credit decision is left in the hands of the branch lending
officer. His expertise, judgment, and weighting of certain factors are the most
important determinants in the decision to grant loans. The loan officer can examine as
many points as possible but must include the five “Cs” these are; character,
credibility, capital, collateral and cycle (economic conditions).
Artificial Neural Networks:
Due to the time consuming nature and error-prone nature of the computerized
expertise system, many systems use induction to infer the human expert’s decision
process. The artificial neural networks have been proposed as solutions to the

22
problems of the expert system. This system simulates the human learning process. It
learns the nature of the relationship between inputs and outputs by repeatedly
sampling input output information.
Internal rating at banks:
Over the years, banks have subdivided the pass/performing rating
category, for example at each time, there is always a probability that
some pass or performing loans will go into default, and that reserves
should be held against such loans.
Credit Scoring Systems:
A credit score is a number that is based on a statistical analysis of a borrower’s
credit report, and is used to represent the creditworthiness of the person. A credit score
is primarily based on credit report information. Lenders, such as banks use credit
scores to evaluate the potential risk posed by giving loans to consumers and to
mitigate losses due to bad debt. Using credit scores, financial institutions
determine who are the most qualified for a loan, at what rate of interest, and to
what credit limits (Wikipedia, 2008).
2.5. Credit Risk Measurement, Monitoring and control
Since exposure to credit risk continues to be the leading source of problems in
banks world-wide, banks and their supervisors should be able to draw useful lessons
from past experiences. Banks should have a keen awareness of the need to identify,
measure, monitor and control credit risk as well as to determine that they hold
adequate capital against these risks and that they are adequately compensated for risks
incurred as per the report issued by a committee on Banking supervision of Bank for
international settlements (BIS,2004).
Measurement or assessment of credit risk is of vital importance in credit risk
management to know how much credit risks a particular loan request or the
overall credit portfolios carry. To be effective in credit risk management, banks need
to devise mechanisms to measure the credit risk. Generally, credit risk
measurement involves both subjective and objective criteria (Ethiopian Academy of
Financial Studies unpublished, risk management materials).

23
Objective criteria may use benchmarks or pre-specified standards in terms of
financial ratios to quantify the risk level. Subjective criteria generally involve
judgments based on standards that the bank has generated as a result of its
experience and knowledge of the borrower and the type of credit requested. As with
the decision to grant credit, it is not possible to avoid human judgments in credit
risk measurement (Ibid).

Thus, both objective and subjective criteria are important and

complement each other. A number of qualitative and quantitative techniques
of credit risk measurement are evolving, including sophisticated quantitative
models.
The four commonly used models according to Erisk7 are:
1. KMV's Portfolio Manager
2. JP Morgan's Credit Metrics
3. Credit Suisse Financial Products' Credit Risk+
4. McKinsey's Credit Portfolio View
The models use different methodologies to create a distribution of possible
credit portfolio values at some future point in time. Therefore, choice of model is an
important decision for any financial institution actively managing its portfolio
credit risk. For example, actuarial models (like Credit Risk+) may be more accurate
for small business portfolios or illiquid asset classes. Merton-based models (like
Credit Metrics and Portfolio Manager), on the other hand, may be better for publicly
traded companies (Ibid)
Prominent amongst the credit scoring models is the Altman’s Z-Score8.
The Z-score formula for predicting Bankruptcy of Dr. Edward Altman (1968) is a
multivariate formula for measurement of the financial health of a company and a
powerful diagnostic tool that forecast the probability of a company entering bankruptcy
within a two year period with a proven accuracy of 75-80%.
Z=1.2X1+1.4X2+3.3X3 + 0.6X4 + 1.0X5
Where, X1 = Working Capital/Total assets ratio
X2 = Retained earnings/ Total assets ratio

24
 X3 = Earnings before interest and taxes/ Total Assets ratio
X4 = Market value of equity/ Book value of long-term debt ratio
X5 = Sales/Total assets ratio.
The higher the value of Z, the lower the borrower’ default risk
classification. According to Altman’s credit scoring model, any firm with a Z-Score less
than 1.81 should be considered a high default risk, between 1.81-2.99 an
indeterminate default risk, and greater than 2.99 a low default risk.
Critics: Use of this model is criticized for discriminating only among three borrower
behavior; high, indeterminate, and low default risk. Secondly, that there is no
obvious economic reason to expect that the weights in the Z-Score model – or, more
generally, the weights in any credit-scoring model-will be constant over any but
very short period. Thirdly the problem is that these models ignore important, hard
to quantify factors (such as macroeconomic factors) that may play a crucial role
in the default or no-default decision.
Potential benefits of credit risk models
The use of credit risk models offers banks a framework for examining
this risk in a timely manner, centralizing data on global exposures
and analyzing marginal and absolute contributions to risk. These
properties of models may contribute to an improvement in a bank’s
overall ability to identify measure and manage risk.
Credit risk models may provide estimates of credit risks, which reflect
individual portfolio composition; hence, they may provide a better
reflection of concentration risk compared to non-portfolio approaches.
By design, models may be both influenced by, and be responsive to,
shifts in business lines, credit quality, market variables and the
economic environment.
Consequently, modeling methodology holds out the possibility of providing a more
responsive and informative tool for risk management.
The other method used to measure credit risk is rating, which is summary
indicator of a bank's individual credit exposure. An internal rating system
categorizes all credits into various classes on the basis of underlying credit quality. A

25
well-structured credit rating framework is an important tool for monitoring and
controlling risk inherent in individual credits as well as in credit portfolios of a bank
or a business lime. An internal rating framework would help banks in many ways such
as:

 Analysis of loan applications

 Determination of duration/tenure and price of loans,
 Frequency or intensity of loan monitoring
 More accurate computation of loan loss provision,
 Deciding the level of approving authority of loan and
 Determination of the overall portfolio risk.
 Determination of the overall portfolio risk

The extent to which authorities have been involved in developing criteria to

distinguish between “ good “ and “ bad “ loans defers substantially between
countries. Some countries use quantitative criteria for example number of days of
overdue from the scheduled payments, while other countries exclusively relay on
qualitative norms (such as a variability of information about the clients financial
status, management judgment about future payments).
In our country’s case the National Bank of Ethiopia has issued directive number
SBB/43/2008 pursuant to the authority vested in it by article 41 of the Monetary and
Banking proclamation number 83 / 1994 and by article 15 (1) and 36 of the
Licensing and Supervision of Banking Business proclamation number 54 / 1994.
According to this directive banks shall classify non – performing loans, weather such
loans have pre – established repayment schedule or not, in to five classifications (i.e.
Pass, Special mention, Substandard, Doubtful and Loss).

Provisioning Requirement for Loans or Advances

According to National Bank of Ethiopia’s Directive No.SBB/43/2008, all banks shall
maintain provisions for Lon Losses Account which shall be created by charges to
provision expanse in the income statement and shall be maintained at level
adequate to absorb potential losses in the loans or advances portfolio. In

26
determining the adequacy of the Provisions for Lon Losses Account,
provisions may be attributed to individual loans or advances or groups of loans or
advances.

27
 CHAPTER THREE

RESULTS AND DESCUSSION

3.1 Data Gathering

A survey has been carried out using the attached questionnaire (Annex I) with the goal
of assessing the credit risk management system and practices of Ethiopian
Commercial banks taking some public and private banks as a case study. Structured
questionnaires were sent to the selected banks, which are listed in table 1. As shown
below, 90% of them have responded.

Table 1: responding rate

S/N Selected banks Male Female Total

1 Commercial Bank of Ethiopia 12 12 24

2 Wegagen bank S.C 4 4 8

Total 16 16 32

Soure: own survey (2025 G.C)

Banks should ensure that the staff involved in credit and related activities are
competent and fully understand its strategic direction, policies, tolerance of risk
and limits. Besides, their staff should also have appropriate professional qualifications,
technical and managerial skills, and experience to be able to efficiently execute their
duties.

In this regard, the respondents were risk managers, controller, credit managers, and
credit division heads, and senior credit analysts, risk officers and follow up officers.
Most of the respondents have an educational back ground of accounting, business
administration, business management, banking and finance and economics with BA
and above and have five to thirty eight years of work experience as seen in the
following Graph 1 & 2

28
 25 22

20

15

10 7

5 3

0
Diploma BA/BSc MA/MSc

Graph 1: respondents educational back ground

15
16
14
12
10
7
8 6
6 4
4
2
0
1 upto 10 11 upto 20 21 upto 30 31 upto 40

Graph 2: Respondents work experience

Soure: own survey (2025 G.C)

29
.3.2 Empirical Results and Discussion

3.2.1. Assessing credit risk environment

There must be a risk management department in banks in order to achieve their

objectives properly. It is also the requirement of NBE to to establish this department.
Therefore, the first question in the survey a s k s b a n k s w h e t h e r t h e y h a v e a
c r e d i t r i s k m a n a g e m e n t department/unit. 66% of the banks said that there
was a credit risk management department/unit and 167% of the banks said that
there wasn’t and the rest 17% confirmed that establishment was under process as
seen in chart 1.

estballishmnet
in process
17%

NO
17%
YES
66%

Chart 1: Existing of Credit Risk Management Department

Soure: own survey (2025 G.C)

It is the overall responsibility of Board of Directors (BODs) to approve bank’s

credit risk strategy and significant policies relating to credit risk and its
management, which should be based on the bank’s overall business strategy.
Therefore, as seen in the following Chart 83% of the banks said that their bank’s credit
policy and procedures are approved by their board of director s. The remaining 17%
said no, simply as they didn’t have the respective policy.

30
 NO
17%

YES
83%

Chart 2: Credit policy and procedures approved by the BOD

Soure: own survey (2025 G.C)

The establishment of a sound credit strategy and policy by the banks provide a
foundation for sound credit risk management. Besides, the BOD must ensure that
credit exposures in their bank’s portfolio were created following basic objectives on
a sound and collectible basis. These all indicates that having a BOD with
qualifications and experience coupled with well defined responsibility is
indispensable for the existence of banks. 83% of the banks, which confirmed
approval of their credit risk policy and procedures by BOD, have stated that their
bank’s BOD have the following responsibilities:

 defining the bank’s overall risk tolerance in relation to credit risk

 Ensuring that its overall credit risk exposure is maintained at prudent levels and
consistent with the available capital
 Ensuring that management as well as individuals responsible for credit risk
management possesses sound expertise and knowledge to accomplish the risk
management function
 Ensuring that the bank implements sound fundamental principles that facilitate the
identification, measurement, monitoring and control of credit risk
 Ensuring the existence of appropriate plans and procedures for credit risk
management

Therefore, the credit risk strategy and policy should be effectively

communicated throughout a bank and all relevant personnel should clearly
understand their bank's approach in taking credit risk and credit risk management.
31
3.2.2. Administration, measurement and monitoring process

Having proper internal risk rating system is an important tool to facilitate early
identification of risk profiles of borrowers. Nevertheless, among the banks under study
only 33% had said that they do have an internal rating system as a mechanism of credit
risk measurement being used while assessing a loan.

The most common method for measuring credit risk being usually utilized by all
the banks were the five C’s of credit, financial statements and human judgment
through experience. All banks also agree that even the sophisticated quantitative
models do not replicate experience and judgment rather these techniques help
and reinforce subjective judgment. Probability of default is one of the most important
inputs, which is used in credit risk measurement. According to the survey, 67% of the
banks don’t calculate probability of default and the remaining 33% of the banks said
that their studies, which is related to calculating probability of default were still
going on.

estballishmnet in
going on
33%

NO
67%

Chart 3: Calculating of credit risk measurement inputs-probability of default

Soure: own survey (2025 G.C)

The other input, which is used to calculate credit risk measurement, is recovery rate.
As per the response and as seen in the following Chart 4, 100% of the banks
calculate recovery rate of loans. All banks said that they do this on quarterly basis
while determining NPLs ratio of their bank’s to be sent for NBE.

32
 Yes
100%
Chart 4: Calculating of credit risk measurement inputs-loan recovery rate

Soure: own survey (2025 G.C)

3.2.2.1. Credit risk management tools

In credit risk management banks use various methods to mitigate credit risks such as
credit limits, taking collateral, diversification, loan selling, syndicated loans and credit
insurance. In Ethiopia, the methods which the banks use according to the using
intensity or priority given are shown in Graph 3. According to the first using
intensity, 49% of the banks said that they used credit limit method, 38% of the
banks said that they used taking collateral and13% of the banks said that they
used syndicated loan in credit risk management. In the second using intensity,
diversification (47%), credit limits (31%) and taking collateral (22%) are the
methods which are used by the banks in credit risk management.
60%

50%
49% 47%

40% 38%
31%
30%
22%
20%
13%
10%

0%
credit limt collateral syndicated loan diversification

First intensity Second intensity

Graph 3: credit risk management tools

33
Soure: own survey (2025 G.C)

A high level of concentration exposes the bank to adverse changes in the area in
which the credits are concentrated. However, they should also be careful not to
enter into transactions with borrowers or counterparties, which they do not know or
engage in credit activities and/or do not fully understand simply for the sake
of diversification. Hence, they need to have appropriate procedures and policies in
this regard. As depicted in Graph 4 all banks do have policy of maximum credit
exposure limit for single borrowers, in line with the NBE’s directive
No.SBB/29/2002, which is 25% of each bank’s total capital. Besides, all banks
responded that they are complying and using the NBE’s directive as internal policy in
regard to the maximum exposure limit for groups of related parties, which is 35%. On
the other hand, 33% and 83% of the banks said that they do have credit exposure limit
policy at geographic category and for specific loan type, respectively.

35%
29%
23%

13%

Borrowers Related parties Geographic category Specific loan type

Graph 4: Credit exposure limit policy

Source: Primary data, statistical report of the banks and own computation. (2025 G.C)

According to the respondents, 100% of the banks said that they have credit
management policies and objectives for categorizing loans that defines types of
loans, collection procedures, property appraisal policy, maximum tenures for
different loans and authority and responsibility of committees. However, 50% of
them don’t have credit policies and objectives with regard to geographical limits for
34
 loan. 100% of the banks confirmed that they maintained credit files of all borrowers
with related information like purpose of the loan, planned repayment schedule, loan
contract and other legal documents. Moreover, they all said that the appropriate
financial statements drawn to ascertain repayment capacity of the borrower(s) and the
respective loan approval documents are also kept attached with the file.

3 . 3 . T r e n d s o f N o n – p e r f o r m i n g l o a n s o f t h e b a n k s a n d Comparison
with NBE’s desired maximum level

The following table shows trends of non – performing loans of the banks and
acceptable/desired maximum level set by the National Bank of Ethiopia. As
indicated in Table 2, NBE’s acceptable maximum NPL’s was 15% of the total
outstanding balance of each bank up to June 30, 2007. Though the current 5%
maximum desirable NPLs ratio, which came in to effect since July 2007, not
officially distributed in the form of directive to concerned banks of the country, the
researcher learnt from NBE’s concerned body that banks are being controlled via
the 5%. To this effect also, all banks are aware of it, because NBE was responding
them while each bank sent its NPLs position for each quarter, added by the respective
official of NBE.

Table 2: Trend of Non-performing loans of the banks

Year % NPL % Acceptable/desired

Chan34ge level
2003 29 - 15
2004 19 34 15
2005 16 14 15
2006 11 30 15
2007 9 21 15
2008 8 7 5
Source
: Primary data, statistical report of the banks and own computation. (2025 G.C)

35
Though, the existing level of NPL of the banks’ was continuously falling and also
below the acceptable level of the NBE for the period from July 2006 up to June 2007,
currently is still above NBE’s desired level as we can learn from the above table 3.
The existing high proportion of NPL still poses a red light for the banks and desires a
lot of effort to bring the level of NPLs to minimum level and at the same time
retaining their market share in the industry.

As can be seen from the table 3, proportion of non – performing loans of the banks
reached 29% of the total loan portfolio administrated by the banks in year 2003.
The total proportion has been registering good reduction and reached 8% by the
end of June 2008, which was 46.67% below the acceptable ceiling set by NBE.

Internal credit reviews, which are conducted by individuals’ independent from the credit
function, provide an important assessment of individual credits and the overall quality
of the credit portfolio. Besides, such credit review function can also help evaluate the
overall credit administration Process, determine the accuracy of internal risk
ratings and judge whether the account officer is properly monitoring individual
credits. In this regard as seen in chart 8, 83% of the banks said that they do have
independent internal review policy and procedures. Nevertheless, while making
discussion to conduct the interview, the researcher learnt that only two banks (i.e.
33%) had independent internal review and reporting systems and the remaining
stated that the same job is done by their internal auditors and credit follow up
sections, which is part and parcel of the credit department of the banks. Moreover,
they were doing these activities rather on a need basis at some interval periods instead
of as a regular activity.

To BOD
23%
Independent
38%

To Control
dep't
18%

To senior management
21%

Chart 5: Existence of independent internal review

36
Source: Primary data, and own computation. (2025 G.C)

According to chart above 38 % said we do have an independent internal credit review

system, 23 % of them said that their review are addressed to the BODs, 21% of
them report to their senior management and 18 % of them to control department.
Moreover, they also said that the same report is prepared the NBE on demand.

As said at the beginning of the paper, the goal of credit risk management is to maintain a
bank’s credit risk exposure within parameters set by the board of directors and senior
management. The establishment and enforcement of internal controls through
independent internal review ensure that credit risk exposures do not exceed levels
acceptable to the individual bank. Such system will enable bank management to
monitor adherence to the established credit risk objectives. Likewise, 100% of the banks
said they do have an internal review system whether independent or not that
performs the following functions:

 Determines whether loan approvals were in line with the banks credit policy and
procedures Determines whether loan approvals were within the limits of the
bank’s lending authority
 Determines documentations were satisfactory prior to the loan approved
 Determines new loans have been posted accurately.
 Examines entries and checks interest posting to various loan accounts and
control ledgers and
 Confirms collaterals on a test basis

It should be noted that all the above functions are performed by internal auditors in

37
 CHAPTER IV

CONCLUSION AND RECOMMENDATION

4.1 CONCLUSION

Risk is the fundamental element that drives financial behavior without risk; the
financial system would be vastly simplified. However, risk is omnipresent in the
real world. In other words, risk is a fact of life in every business and if not managed
properly, it would adversely affect the very existence of any business. However, the
damage could be more sever in the case of banks as banking business is not only a
stake of the owners but also that of depositors(public), other banks and hence, the
economy as a whole. Banks, therefore, should manage the risk effectively to
survive in this uncertain world. The futures of banking will undoubtly rest on risk
management system. Only those banks that have efficient risk management will
survive in the market in the long run.

The analysis of secondary and primary data revealed some interesting aspects about
the credit risk management practices of the commercial banks under study. The
important among them are listed below:

 The tools which are used in credit risk management by the banks are taking
collateral, credit limits and diversification. The banks don’t use the other
methods like loan selling and credit insurance for mitigating and transferring
credit risk. Because loan selling market and credit insurance sector haven’t
developed yet.
 The most common and frequently occurring risk in the commercial banks is credit
risk.

38
 Lack of coordination among lending banks, failure of due diligence and
independent monitoring are the major reasons given by the banks for the
frequency of the credit risk occurrence in their banks.
 Only 17% of the banks had credit risk management department, which is
independent from the loan origination function.
 Still there are Banks who do not have written credit risk policy.
 Only 33% of the banks said that they effectively communicate their credit risk
strategy and policy throughout their organization.
 More popular credit evaluation techniques like KMV's Portfolio Manager,
Altman’s Z score model, J.P. Morgan credit matrix, etc do not find a place in the
credit evaluation tool kit of the commercial banks.
 Poor credit assessment in determining the viability of a project as a result of lack of
relevant and reliable information is the reason that forces the banks to follow
collateral based lending system
 Presence of unfavorable economic development like drought and war in the
country during the past and effect of the world economic crises are also the other
reasons for credit risk in the banks.
 Subjective decision-making by credit personnel’s of the banks also had contributed
for the accumulation of non-performing loans and in a Weaken the credit risk
management system.
 Many banks that experienced asset quality problems lacked an effective credit
review process (and indeed, almost all banks had no independent with well equipped
credit review function).
 As expected the larger share of the banks’ income has come from loans and
related activities. Hence, we can conclude that lending is the major source of profit
and credit risk for banks.
 The study shows that there is a significant relationship between bank
performance (in terms of profitability) and credit risk management (in
terms of loan performance). Better credit risk management results in better
bank performance. Thus, it is of crucial importance that banks practice

39
 prudent credit risk management and safeguarding the assets of the banks and
protect the investors’ interests.
 The study also reveals that banks with good or sound credit risk management
policies have lower loan default ratios (bad loans).

The study shows that there is a direct but inverse relationship between
profitability (ROE, ROA) and the ratio of non-performing loans to total loans. These
results are in line with the researcher’s expectation and actually tallies with
conventional wisdom. This has led to accept my hypothesis and conclusion that
banks with higher profitability have lower non-performing loans, hence good credit
risk management strategies. However, statistically the banks interest income and non-
performing loans shows positive relation despite the theoretical assumption of
negative relationship. The positive relationship was, however, at insignificant level.
This may be attributed to the insignificant annual percentage growth shown in the
Banks interest income as compared to the percentage decline of average NPLs.

4.1. RECCOMENDATION

In line with the findings obtained, the following recommendations are forwarded:

 As credit information is crucial for the development of the credit system and for
addressing the problems of NPLs, banks should take the maximum caution in
dissemination of credit information of borrowers.
 In order to maintain credit discipline and to enunciate credit risk management
and control process, the banks are advised to establish a separate
department /unit independent of the loan origination function.
 In order to be effective, credit policies must be communicated throughout
the organization, Also, NBE made some regulations about risk management.
But, credit risk management is not to be in desired level and there are some
shortcomings and problems in credit risk management. Lack of sufficient data about
credit risk measurement inputs is also one of these problems. Hence, its centralized
credit information data base should also be reorganized to meet the
requirements of banks.
40
 NBE should also regularly control and follow the banks financial performance
and their adherence of its liquidity, capital adequacy and asset quality requirements.
 In order to reduce concentration risk the banks should incorporate geographic loan
limit in their credit procedures.
 The purpose of credit review is to provide appropriate checks and balances to
ensure that credits are made in accordance with bank policy and to provide an
independent judgment of asset quality, uninfluenced by relationships with the
borrower. Effective credit review not only helps to detect poorly underwritten
credits, it also helps prevent weak credits from being granted, since credit officers
are likely to be more diligent if they know their work will be subject to review. An
effective credit review department and independent collateral appraisals are
important protective measures, especially to ensure that credit officers and other
insiders are not colluding with borrowers.
 Specifically, as expected interest income has proven to be the main determining
factors for the profitability of the banks. The negative relationship of credit risk to
banks profitability may evident that the more commercial banks exposed
themselves to credit risk, the more accumulation of unpaid loans, implying that
these loan losses have produced lower returns to the banks. There should
therefore prior concern to give due diligence in maintaining sound asset quality
management, sound portfolio and risk management, prudent loan processing and
selection strategies together with optimum utilization of the available
financial resources and findings ways to maintain reasonably cheap source
of loan able fund.
 A well-structured internal risk rating system is a good means of differentiating
the degree of credit risk in the different credit exposures of a bank. This will
allow more accurate determination of the overall characteristics of the credit
portfolio, concentrations, problem credits, and the adequacy of loan loss reserves.
Thus, all banks are encouraged to develop and utilize an internal risk rating system
to manage credit risk.
 Generally, the banks under study evaluates loan proposals through the
traditional tools of project financing, computing maximum permissible

41
 limits, assessing management capabilities, and prescribing a ceiling for an industry
exposure. As banks move into a new high powered world of financial operations
and trading, with new risks, the need is felt for more sophisticated and versatile
instruments/models for risk assessment, monitoring and controlling
risk exposure. It is, therefore, time that banks management should equip
them fully to grapple with the demands of creating tools and systems
capable of assessing, monitoring and controlling risk exposures in a more
scientific manner.
 implemented through appropriate procedures, monitored and periodically
revised to take into account changing internal and external circumstance. Banks
should diversify their credit portfolios by avoider or two sectors and /or on
individuals

42
Annex I Questionnaire
I am carrying out a research under the topic “ Credit Risk management, therefore,
your precise and clear answers to these questionnaire & interviews will ended be critical
for the success of this study. All information provided would be kept entirely
confidential and the interviewee can’t be identified and will remain anonymous. This
research is undertaken as part of fulfillment for the program

Thank you for taking some minutes of your precious time.

Part I. Personal information

1. Gender Male Female

2. Position in the bank ___________

3. Years of service:- _______________

4. Educational level (E.g. diploma in Accounting) _____________

5. Name of the Bank in which you are working____________________________

Part II. General issues in credit risk management

Put thick mark (√) to indicate your answer (put more than once if necessary)

1. How long since the bank is established and began operation__________________

2. Is there any risk, which the bank has faced during the last ten years period?

Yes ___________ No__________

3. What problem did the bank face in regard to credit risk management?

______________________________________________________________________

Part III. Credit risk environment

1. Do you have Credit Risk Management Department /unit?

Yes ______ No __________ Establishment is still going on _______

2. Does function of your credit risk management department independent of the loan

origination function?

Yes __________ No ______

3. Do you have a written credit risk policy, guidelines and procedures that explain objectives?

And principles of credit risk management process?

Yes __________ No __________ Establishment is still going on _______

If yes, has it been reviewed periodically and is helpful for processing credit request?

__________________________________________________________________
4. If your answer for question No.3 is yes, is the policy and procedures approved by the
Board

of Directors?

Yes __________ No __________

5. If your answer for question No.4 is yes, what are the responsibilities of the Board
of

Directors?

___________________________________________________________________________
___________________________________________________________________________
________________

6. What are the responsibilities of senior management in the credit risk management?

__________________________________________________________________

__________________________________________________________________

7. Does the credit risk strategy and polices be effectively communicated through out
the organization.

Yes _____ No_____

8. Do credit management policies & objectives of your bank reviewed periodically to take in
to account internal and external circumstances?

Yes _____ No_____

If yes, what were those circumstances under which the policies and objectives
were

reviewed?__________________________________________________________________

Part Iv. Administration, Measuring and monitoring process

1. Do you calculate probability of default of customers?

We calculate _____ We don’t calculate _____ our studies are going on_____

2. Do you calculate recovery rate of a loan?

Yes No

If yes, when do you calculate this (Hint: at the time loan is pass, special mention, or at all

time).__________________________________________________________________

3. In credit risk management banks use various methods to mitigate risks:

(Please rank the following based on your priorities)

44
 criteria Priorities
1 2
Credit limits
Taking collateral

Diversification
Syndicated loans

Credit insurance

Loan selling

5. Does your Bank has procedures/polices in regard to credit exposure limits, which is set for

Single Borrowers _____________

Groups of connected counter parties _____________

For particular industries or economic sectors ____________

Geographic regions ____________

Specific loan type ----------

6. Are there written credit management policies & objectives that establish

Yes No
Guidelines for categorizing loan
Geographical limits for loans
Authority & responsibility of committees & individual
lending officers

Definition of acceptable types of loans

Maximum maturities for various types of loans
Minimum financial information required at the inception of
credit
Collection procedures
Loan pricing & appraisal policy

7. Does your bank maintain credit files of all borrowers, which contain information on?

Yes No
Purpose of the loan
45
 Loan approval documents
planned repayment
schedule
Loan contracts& other
legal document
Insurance coverage
Financial statement

8. Does the bank maintain up-dated list of problem loans & list of loans reviewed indicating

the date of the review & the credit rating (hint pass, special mention etc)

Yes ________ No __________

9. What was your NPLs ratio as at June 30 of the following years?

Year NPLs Ratio % of total Sector Where is the major

loan NPLs came from
2003
2004
2005
2006
2007
2008

46
INTERVIEW QUESTIONS

1. Does your Bank use credit ratting like that of S&P, Moody’s, etc?

2. Do you have any model or technique through which you manage your credit
risk?

3. If the trend of NPLS ratio was increasing, what might be the reason (s)?

4. Do you think the current credit procedures; reviewing and approval culture is
helping the

bank to achieve its objectives?

5. In your opinion what are the main reasons for violating covenants of loan by
customers.

6. How do you rate the level of cooperation among banks in sharing credit
information regarding customers?

7. Give your comment or suggestions regarding the credit risk management

system of the Bank.

8. Do you have any information about the current financial crises of the world?

9. Do you think that this have an impact on your Bank?

If Yes, how__________________________________________

If No, why ___________________________________________

In response to this what measures especially on credit does your bank have taken?
If in processes, please specify. __________________

47
Bibliography

1. Australian prudential Regulation Authority, Credit Risk modeling: current

practices and Applications, for Basel committee April 1999.

2. Bank for international settlements, Sound Credit Risk Assessment and

Valuation for Basle committee Switzerland June, 2006.

3. Basle committee on Banking supervision, Principles for

Management of Credit Risk, 2004.

4. Bass,R.M.V.(1999), Credit Management,3rd Ed, Stanly Thorms

publishers Ltd

5. Benti Yigremachew.(2008), Determinants of private Bank’s

Profitability, Ethiopian.

6. D a n i e l C H a r d y ( M a y - J u n e 1 9 9 9 ) , “ Are banking crises

predictable”, Biritu No 67, National Bank of Ethiopian publication.

7. David Shimko, Credit Risk Models and Management, 2nd Ed Canda

2004.

8. Gebdrel Jimenez, Credit cycles, credit Risk and prudential regulation,

international Journal of central banking , vole 2 No 2, Jun 2006

9. Koch, W.T. (1995) Bank Management, 3rd Ed, The Dryden press, sec Harbor
Drive, USA.

10. Laustein, H.C. (1978), “Management of Credit”, in encyclopedia of

professional management, New York; McGraw Hill.

11. Machiraju, H.R, (2003), Modern Commercial Banking, Vikas

Publishing House PVt.Ltd, New Delhi.

48
12. McNaughton Diana. (1992), “ Managing of Credit Risk” in building strong
management and responding to change, Banking institution in Developing countries
Volume I, World Bank, Washington D.C. 14. Rose, S.p. (1993) Commercial
Bank Management, 2nd Ed, Irwin Home Wood, IL Boston.

13. Tenguh and Achou.(2008), “Credit risk management”.

Internet sources

http://www.commerialbankofethiopia.com

http://www.bis.org/publ/bcbs54.html

http://www.wegagenbank.com

http://www.erisk.com

http://www.hibretbank.com

http://www.Nbe.gov.et

49