2.

Literature Review

Risk is the element of uncertainty or possibility of loss that prevail in any business transaction in any place,
in any mode and at any time. In the financial arena, enterprise risks can be broadly categorized as Credit
Risk, Operational Risk, Market Risk and Other Risk. Credit risk is the possibility that a borrower or counter
party will fail to meet agreed obligations. Globally, more than 50% of total risk elements in Banks and
Financial Institution (FI) s are credit risk alone. Thus managing credit risk for efficient management of a FI
has gradually become the most crucial task. Credit risk management encompasses identification,
measurement, matching mitigations, monitoring and control of the credit risk exposures. As a leading bank
of Bangladesh, Basic Bank Limited has a fully functioning department to perform the crucial task of Credit
Risk Management (CRM).

Credit Risk Management and Risk based Supervision in Banks has been the subject of study of many
Agencies and Researchers and Academicians. There is a treasure of literature available on the subject. A
careful selection of relevant material was a formidable task before starting the research. Efforts have been
made to scan the literature highly relevant to the Context.

Rajagopal (1996) made an attempt to overview the bank’s risk management and suggests a model for pricing
the products based on credit risk assessment of the borrowers. He concluded that good risk management is
good banking, which ultimately leads to profitable survival of the institution. A proper approach to risk
identification, measurement and control will safeguard the interests of banking institution in long run.

Froot and Stein (1998) found that credit risk management through active loan purchase and sales activity
affects banks’ investments in risky loans. Banks that purchase and sell loans hold more risky loans (Credit
Risk and Loss loans and commercial real estate loans) as percentage of the balance sheet than other banks.
Again, these results are especially striking because banks that manage their credit risk (by buying and selling
loans) hold more risky loans than banks that merely sell loans (but don’t buy them) or banks that merely buy
loans(but don’t sell them).

Treacy and Carey (1998) examined the credit risk rating mechanism at US Banks. The paper highlighted the
architecture of Bank Internal Rating System and Operating Design of rating system and made a comparison
of bank system relative to the rating agency system. They concluded that banks internal rating system helps
in managing credit risk, profitability analysis and product pricing.

Bagchi (2003) examined the credit risk management in banks. He examined risk identification, risk
measurement, risk monitoring, and risk control and risk audit as basic considerations for credit risk
management. The author concluded that proper credit risk architecture, policies and framework of credit risk
management, credit rating system, and monitoring and control contributes in success of credit risk
management system.
Muninarayanappa and Nirmala (2004) outlined the concept of credit risk management in banks. They
highlighted the objectives and factors that determine the direction of bank’s policies on credit risk
management. The challenges related to internal and external factors in credit risk management are also
highlighted. They concluded that success of credit risk management require maintenance of proper credit
risk environment, credit strategy and policies. Thus the ultimate aim should be to protect and improve the
loan quality.

Khan, A.R. (2008) illustrates that Credit risk is one of the most vital risks for any commercial bank. Credit
risk arises from non performance by a borrower. It may arise from either an inability or an unwillingness to
perform in the precommitment contracted manner. The real risk from credit is the deviation of portfolio
performance from its expected value. The credit risk of a bank is also effect the book value of a bank. The
more credit of a particular is in risk, the more probability of a bank to be insolvent.

Banerjee, Prashanta K., &Farooqui Q.G.M. (2009) said that the objective of the credit management is to
maximize the performing asset and the minimization of the nonperforming asset as well as ensuring the
optimal point of loan and advance and their efficient management. The lending guideline should include
Industry and Business Segment Focus, Types of loan facilities, Single Borrower and group limit, Lending
caps. It should adopt a credit grading system .All facilities should be assigned a risk grade.

Rose, Peter S. (2001) examined that for most banks, loans are the largest and most obvious source of credit
risk; however, other sources of credit risk exist throughout the activities of a bank, including in the banking
book and in the trading book, and both on and off the balance sheet. Banks are increasingly facing credit risk
(or counterparty risk) in various financial instruments other than loans, including acceptances, interbank
transactions, trade financing, foreign exchange transactions, financial futures, swaps, bonds, equities,
options, and in the extension of commitments and guarantees, and the settlement of transactions.

2.1 Definition of Credit

According to Investopedia, the credit is a promised contract where a borrower receives some of the value for
consideration and later the lender promises to repay, usually with some amount of interest. The provision
also decreases or increases the company's financial statements, indicating liabilities and equity accounting a
game of property. In addition, the net income in the income statement of the company loan, while the credit
increases have reduced net income.
The provision also shows the credibility or credit history of an individual or company. For instance,
someone could say, "There are many advantages to this, so the bank has rejected its mortgage application is
not important." In other cases, the credit balance is deducted. For instance, suppose a company has a $ 1000
credit card but owes $ 300 in the store. You receive credit in your account and you only need $ 700.

(Source: Investopedia, Available at: https://www.investopedia.com/terms/c/credit.asp)

2.2 Types of credit

There are many forms of credit. When banks lend to auto loans, mortgages, loans and transactions to their
customers, they take all kinds of loans. Basically, the bank has made payments to the borrower and to be
paid later on the borrower. For example, when someone purchases your local mail through your VISA card,
your payment is considered as a credit size because you know that you will have to pay for them later.
However, loans are not just a form of credit. Providers offer goods or services to a person but the next
payment is not required, it is a form of credit. For example, if a seller receives a food loaded truck from a
seller, then the seller does not require a month's payment, the seller provides a credit form to the credit.

(Source: Investopedia, Available at: https://www.investopedia.com/terms/c/credit.asp)

2.3 Definition of credit risk

According to Horcher (2011), credit risk is a potential risk of loss due to the bankruptcy of the borrower to
pay a loan or fulfil its contractual obligations. Traditionally, it refers to the riskthat a creditor may not
receive outstanding capital and interest, which results in a cash stoppage and an increase in the cost of
collection. Although it is impossible to know who will adapt to the obligations, correctly evaluate the credit
risk and reduce the severity of the loss of the administration. There is a lender or reward from the investor
for managing credit risk, issuing interest or borrowing from the borrower.

(Source: KA Horcher, 2011, Book Name: Essentials of financial risk management, Availavle
at:https://books.google.com.bd/books?hl=en&lr=&id=X__zoNzVh-QC&oi=fnd&pg= PT9&=
Essentials+of+financial+risk+management)

2.4 The importance of credit risk management

According to Wagner (2011), Banks will not be there without credit risk management! Builders / service
providers need money to do their job. They are banks / SE or shareholders of the bank. Bank credit is used
for real (short-term) needs or for the creation of productive assets of the equity (long-term) of capital.

It is provided in many companies (see suppliers-customers) and in many ways is paid by the banks. But
more importantly, lenders also have to give time. Credit risk management essentially guarantees that the
borrower is an integral part of the stability of the loan, repayment capacity, well managed and managed
personnel, the elements of implementation, regulatory and legal requirements and not necessarily the
violation or other offense obligations. If a borrower's account is offensive, it will have a significant effect on
banks, as well as reducing the impact on bank profits, without the cost of operating a particular account.
Much of the hidden costs of the wrong account and reduce the bureaucracy, as well as the recovery efforts
deployed for the transaction and costs. When a large number of borrowers is disconnected accounts, this
requires banks.

The advantages of credit risk management beyond the banking sector, because each company covers the
price of the supply chain and also damages the individual production chain (not paid to suppliers, which are
predominantly small and medium-sized companies) due to losses, that are not a bad deal beyond the general
consideration) and so on. Credit risk management is extremely important.
(Source: W. Wagner, 2011, Name of the journal: Journal of Banking &Finance, Title: Credit risk transfer
activities and systemic risk: How banks became less risky individually but posed greater risks to the
financial system at the same time)