Stress Testing of DBBL
Stress Testing of DBBL
Stress Testing of DBBL
Submitted to,
Submitted by,
2/14/2015
1
LETTER OF TRANSMITTAL
September 16, 2017.
Dr. Mahmood Osman Imam
Professor,
Department of Finance
University of Dhaka
Dear Sir,
I am very glad to submit you the term paper on Stress Testing: Dutch-Bangla Bank
Limited. I would like to say that this report is helpful for me to know about the banking
practices followed by a bank to be safe with its capital adequacy. I am very thankful to you for
giving me such a fantastic opportunity to make a report on this topic.
This term paper also contains some brief idea about our economy, financial system, risk in
banking business etc.
Yours sincerely,
2
DECLARATION
I am thankful and grateful to almighty Allah who has given me the strength and ability to
complete the report on the Stress Testing Practices followed by Dutch-Bangla Bank Ltd. I am
also grateful to my Course Instructor Dr. Mahmood Osman Imam as he has helped me to
prepare this very important report. He has given all sorts of guidelines required to complete
this term paper. I am also grateful to those who have given me suggestion and interaction.
I also do sincerely declare that this term paper has been submitted, in partial fulfillment of the
requirement for the Financial Derivatives (F-503) course. The report is written in my own
language. Though I have taken the guidelines for stress testing directly from Bangladesh Bank
Publication, no part of this term paper consists of materials, copied or plagiarized from
published or unpublished work of other writers and all materials borrowed and reproduced
from other published or unpublished sources have either been put under quotation or duly
acknowledged with full reference in appropriate places. I understand that the term paper may
be cancelled if subsequently it is discovered that this term paper is not my primeval work and
that it consists of materials copied or plagiarized or borrowed without proper
acknowledgement.
I, at last, express special thanks from the bottom of my heart to all who helped me directly &
indirectly to complete this term paper.
3
TABLE OF CONTENTS
Section Topics Page No.
Executive Summary 05-06
1 Introduction 07-09
1.1 Objective of the Study 08
1.2 Procedure of the Study 08
1.3 Methodology of the Study 09
1.4 Limitations of the Study 09
2 Bangladesh Economy, Financial System & 10-15
Banking Risk
2.1 Economy & Financial System in Bangladesh 11-13
2.2 Risk in Bangladesh Banking Sector 14-15
3 Stress Testing Concept & Methodology 16-24
3.1 About Stress Testing 17-19
3.2 Methodology of Stress Testing 20-24
4 Dutch-Bangla Bank Limited Profile 25-29
4.1 About the Bank 26-27
4.2 Risk Management of DBBL 28-29
5 Stress Testing for Dutch-Bangla Bank Limited 30-71
5.1 Interest Rate Risk Calculation 31-39
5.2 Exchange Rate Risk Calculation 40-43
5.3 Equity Price Risk Calculation 44-47
5.4 Liquidity Risk Calculation 48-49
5.5 Credit Risk Calculation: (6 Types & Cumulative) 50-63
5.6 Cumulative Shock Calculation 64
6 Findings & Conclusion 65-71
6.1 Impact of All Shocks Separately 66-68
6.2 Impact of All Shocks Cumulative 69
6.3 Reporting to Bangladesh Bank 70-71
7 Appended Part 72-75
7.1 Glossary 73-74
7.2 References 75
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EXECUTIVE SUMMARY
Bangladesh banking sector is demonstrating a moderate level of resilience as reflected in the
improvement in key financial indicators of the banking industry, favored by a congenial
domestic macroeconomic environment. Despite that, there is some liquidity stress faced by
the interbank money market. Again, high credit growth is related to credit risk, as reflected by
nonperforming bank loans.
The Basel-II capital adequacy framework came into force on 1 January 2010 on a regulatory
basis. Under this framework, a majority of the banks were found to have maintained the
minimum required capital adequacy ratio (CAR).Risk weighted assets of banking sector
comprised credit risk, market risk and operational risk. Direct impact comes from three
major components of market risk which includes interest rate risk, exchange rate risk and
equity price risk. Most of the banks try to maintain the required minimum CAR and Tier-1
ratio. Under the Basel II requirement, Bangladesh Bank also monitors the gravity of threats
stemming from lapses in banks' internal control environments. Banks are, for this purpose,
advised by the central bank to follow the core risk guidelines on 'Internal Control and
Compliance'.
It is of vital importance to understand and appreciate the risks the banking industry is exposed
to so that soundness and sustainability of the industry can be ensured. Earlier, Bangladesh Bank
has issued core risk management guidelines so that banks can develop a sound risk management
practice while carrying out their daytoday activities which is not enough now. So, the
regulators and managers of the financial system around the globe have developed a number of
quantitative techniques to assess the potential risks to the individual institutions as well as
financial system. The widely known Stress testing is a range of quantitative techniques that
could serve the purpose. IMF and Basel Committee on banking supervision have also suggested
for conducting stress tests on the financial sector. According to Bangladesh Bank, All banks
and FIs are expected to carry out stress testing on half-yearly basis i.e. on June 30 and
December 31 each year.
In this report, I have done stress testing on Dutch-Bangla Bank Limited for the year 2011,
2012 and 2013. As per the guideline from Bangladesh Bank, I have calculated Interest rate
risk, Exchange rate risk, Liquidity risk, Credit risk of different types, cumulative credit
risk and cumulative all shocks under 3 scenarios (Minor., Moderate and Major level of
shocks).
DBBL has a strong capital base and capital adequacy stands at 13.70% in the year 2013 of the
risk weighted assets against the regulatory requirement of 10 percent. The core risks- credit,
market, interest rate risk, foreign exchange and operational risks are monitored continuously
to ensure quality of the Banks assets. In order to manage these risks properly Bangladesh Bank
has issued risk management guidelines, which are being followed by Dutch-Bangla Bank with
utmost dedication. To strengthen the fulfillment of Basel-II accord, the Banks Risk
5
Management Unit undertaken Stress Tests as per Bangladesh Banks guidelines. The objective
of Stress Test is to assess the capacity of the Bank to manage unanticipated crises and
management response to manage the crises.
I have done stress testing on this bank for the year 2011, 2012 and 2013 using information from
annual reports of the bank and some assumptions. My findings are summarized in the following
table:
In my analysis I have found that the fall in CAR (%) increases with the level of cumulative
shock and one type of credit risk namely increase in NPLs due to top borrowers shows the
greatest impact on that fall. Most of the shocks decreased in the year 2012 from the year 2011
and again increased in 2012 and the ultimate impact of cumulative of all shock was highest in
2013 and lowest in 2011.
I have provided details of my calculation and findings in the report using both tabular and
graphical form
In this chapter I
will discuss
about the
Introduction objective,
procedures,
Methodology and
Limitation of this
report.
7
Stress Testing:
DutchBangla Bank Limited
Objective of the Study:
As a student of Finance, we should know about the Stress Testing practices followed by a
banking company. We have come to know about the practices theoretically. But this is not
enough for us. So, it is necessary to know about the practical use of these Theoretical
discussions by a real banking company or business. There are many banks in Bangladesh. So,
it is very essential to know about the process of stress testing guided by the central bank for the
safety of those banks. Gaining knowledge from practical field is much more important than
gaining from text book. So, I decided to give my proper effort to apply my knowledge
practically on Dutch-Bangla Bank Ltd. In a word, my objective of making this report is
widening my practical knowledge of Finance by knowing about the risk in banking sector and
the practices followed by a bank to measure and avoid those risks.
8
Methodologies of the Study:
Briefly, the methodologies of preparing this report are as follows:
Despite these limitations, I have tried to give my best effort to prepare the report as properly as
possible.
9
Most of the banks try
to maintain the
required minimum
CAR and Tier-1 ratio.
An increasing trend
Bangladesh
in these two ratios
indicates that banks
Economy,
are gradually
becoming sounder Financial System
financially.
& Banking Risk
10
ECONOMY & FINANCIAL SYSTEM IN
BANGLADESH
Economy of Bangladesh:
Bangladesh is in the process of a transition from a predominantly agrarian economy to an
industrial and service economy. The private sector is playing an increasingly active role in the
economic life of the country, while the public sector concentrates more on the physical and
social infrastructure. There have been significant structural shifts in the economy over the past
two decades.
CAPITAL MARKET:
The Capital market, an important ingredient of the financial system, plays a significant role in
the economy of the country. The Securities and Exchange Commission exercises powers under
the Securities and Exchange Commission Act 1993. It regulates institutions engaged in capital
market activities. The SEC has issued licenses to 27 institutions to act in the capital market
including 19 Merchant Banker & Portfolio Manager, 7 Issue Managers and 1 Issue Manager
and Underwriter. There are two stock exchanges (the Dhaka Stock Exchange (DSE) and the
Chittagong Stock Exchange (CSE)) which deal in the secondary capital market.
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Banking System:
CENTRAL BANK
Bangladesh Bank (BB), as the central bank, has legal authority to supervise and regulate all
banks and non-bank financial institutions. It performs the traditional central banking roles of
note issuance and of being the banker to the government and banks. Given some broad policy
goals and objectives, it formulates and implements monetary policy, manages foreign exchange
reserves and lays down prudential regulations and conduct monitoring thereof as they apply to
the entire banking system.
COMMERCIAL BANKS
The commercial banking system dominates the financial sector with limited role of Non-Bank
Financial Institutions and the capital market. The Banking sector alone accounts for a
substantial share of assets of the financial system. The banking system is dominated by the 4
State Owned Commercial Banks, which together control more than 30% of deposits and
operates 3383 branches (50% of the total) as of June 30, 2008. There are also 39 domestic
private banks and 9 foreign banks in Bangladesh.
SPECIALIZED BANKS
Out of the 4 specialized banks, two (Bangladesh Krishi Bank and Rajshahi Krishi Unnayan
Bank) were created to meet the credit need of the agricultural sector and another one
(Bangladesh Development Bank Ltd.) is for extending term loans to the industrial sector of
Bangladesh.
Insurances:
The insurance Sector is regulated by the Insurance Act, 1938 with regulatory oversight
provided by the controller of Insurance on authority under the ministry of commerce. General
insurance is provided by 21 companies and life insurance is provided by 6 companies.
NBFIs:
In Bangladesh, Non-Bank Financial Institutions (NBFIs) are licensed and regulated under the
Financial Institution Act, 1993. NBFIs play an important role in financing various sectors like
industry, trade, housing, transport, information technology as well as the capital market. There
12
are 30 NBFIs in the country. At present there are 115 branches of which 59 in Dhaka, 22 in
Chittagong and the rest 34 in other districts.
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RISK IN BANGLADESH BANKING SECTOR
Bangladesh banking sector is demonstrating a moderate level of resilience as reflected in the
improvement in key financial indicators of the banking industry, favored by a congenial
domestic macroeconomic environment. The banking sector's balance sheet shows sizable
growth, which is broad-based as most of the income-earning assets registered positive growth;
banking assets are not too much concentrated among a small number of banks; and loans also
are not heavily concentrated.
There is some liquidity stress faced by the interbank money market. However, the intervention
of BB and prudent policies of the financial institutions help banking business quickly return to
the pre-stress level. The stressed condition of the interbank market suggests that banks need to
monitor their asset-liability mismatch closely while making financing decisions.
Risk weighted assets of banking sector comprised credit risk, market risk and operational
risk. Most of the banks try to maintain the required minimum CAR and Tier-1 ratio. An
increasing trend in these two ratios indicates that banks are gradually becoming sounder
financially. However, a cross-country scenario of capital adequacy suggests that the
Bangladesh banking sector still has a long way to go, as the industry CAR of some South Asian
countries namely India, Sri Lanka and Pakistan, is much higher than that of Bangladesh.
High credit growth is inseparable from mounting credit risk, as reflected by nonperforming
bank loans. Banks tended to become more selective when extending credit as the probability
of non-performing loans increased.
The second important source of market risk is exchange rate risk, which is primarily driven by
banks' investments in foreign exchange dealings and adverse movement in exchange rates, in
addition to the direct exposure arising from foreign exchange placements in different exchange
markets.
The third important source of market risk is equity price risk, which is primarily driven by
banks' investments in equities and adverse movement in equity prices, in addition to the indirect
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exposure from the quantum of bank loans collateralized by shares. Insofar as banks' investment
in shares is concerned, the overall exposure of such investments is capped by section 26(2) of
Bank Company Act, 1991. Specifically, the total holdings of banks in shares cannot exceed
10.0 percent of their total liabilities.
Operational risk has always been important for the banking system due to the strong role of
customers' confidence in the banking business. Its importance has been increased manifold
over the last two decades. In practice, it is quite difficult to predict disruptions to the continuity
of business and associated losses.
Although banks are maintaining capital for operational risk according to the basic indicator
approach under Basel II, the difficulty of going from a series of isolated, infrequent operational
incidents to a comprehensive capital charge is a source of concern for both the banking sector
and the central bank. Lack of sophisticated techniques and insufficient data on actual loss
events aggravate the challenges faced by the regulator and banks for managing operational
risks. In addition to imposing this capital charge for operational risk under the Basel II
requirement, Bangladesh Bank also monitors the gravity of threats stemming from lapses in
banks' internal control environments. Banks are, for this purpose, advised by the central bank
to follow the core risk guidelines on 'Internal Control and Compliance'.
15
The widely
known Stress
testing is a range
of quantitative
techniques
assess
to
the
Stress Testing
potential risks to
the individual Concept &
institutions as
well as financial
system.
Methodology
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ABOUT STRESS TESTING
Financial institutions around the world are increasingly employing stress testing to determine
the impact on the financial institution under a set of exceptional, but plausible assumptions
through a series of battery of tests. Bangladesh Bank has designed a stress testing framework
for banks and FIs to proactively manage risks in line with international best practices.
Concept:
Stress testing is one of the effective and popular ways to alert bank management with regard
to adverse unexpected outcomes related to variety of risks and provides an indication how
much Capital Adequacy Ratio (CAR) might be needed to absorb losses should any large shocks
occur. Stress testing is a simulation technique, which are used to determine the reactions of
different financial institutions under a set of exceptional, but plausible assumptions through a
series of battery of tests.
At institutional level, stress testing techniques provide a way to quantify the impact of changes
in a number of risk factors on the assets and liabilities portfolio of the institution. For instance,
a portfolio stress test makes a rough estimate of the value of portfolio using a set of exceptional
but plausible events in abnormal markets.
At the system level, stress tests are primarily designed to quantify the impact of possible
changes in economic environment on the financial system. The system level stress tests also
complement the institutional level stress testing by providing information about the sensitivity
of the overall financial system to a number of risk factors. These tests help the regulators to
identify structural vulnerabilities and the overall risk exposure that could cause disruption of
financial markets. Its prominence is on potential externalities and market failures.
Importance:
It is of vital importance to understand and appreciate the risks the banking industry is exposed
to so that soundness and sustainability of the industry can be ensured. Earlier, Bangladesh Bank
has issued core risk management guidelines so that banks can develop a sound risk management
practice while carrying out their daytoday activities. The recent financial turmoil in the US
financial system has augmented the importance of establishing more developed risk
management regime in the financial industry. Present risk management culture based on normal
business conditions and historical trends is not enough to cope with the disorders that have
happened in the financial systems globally. This required an appropriate response in the
regulatory and supervisory activities of the Central Bank.
Extreme market movements or crises in the past reveal the inadequacy of managing risks based
only on normal business conditions and historical trends. In particular, crises in the 1990s (e.g.
Asian Crisis) and current financial turmoil have augmented the importance of better
understanding of potential vulnerabilities in the financial system and the measures to assess
17
these vulnerabilities for both the regulators and the bankers. The regulators and managers of
the financial system around the globe have developed a number of quantitative techniques to
assess the potential risks to the individual institutions as well as financial system. The widely
known Stress testing is a range of quantitative techniques that could serve the purpose. IMF
and Basel Committee on banking supervision have also suggested for conducting stress tests
on the financial sector.
b) Scenario Analysis:
It encompasses the situation where a change in one risk factor affects a number of other risk
factors or there is a simultaneous move in a group of risk factors. Scenarios can be designed to
encompass both movements in a group of risk factors and the changes in the underlying
relationships between these variables (for example correlations and volatilities). Stress testing
can be based on the historical scenarios, a backward looking approach, or the hypothetical
scenario, a forwardlooking approach.
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Calibrating the scenarios or shocks applied to the data and interpreting the results.
An effective management information system that ensures flow of information to the
senior management to take proper measures to avoid certain extreme conditions.
Setting the specific trigger points to meet the benchmarks/standards set by Bangladesh
Bank.
Ensuring a mechanism for an ongoing review of the results of the stress test exercise
and reflecting in the policies and limits set by management and board of directors.
Taking this stress test as a starting point and developing inhouse stress test model to
assess the bank/FIs specific risks.
Minor Level Shocks: These represent small shocks to the risk factors. The level
for different risk factors can, however, vary.
Moderate Level Shocks: It envisages medium level of shocks and the level is
defined in each risk factor separately.
Major Level Shocks: It involves big shocks to all the risk factors and is also
defined separately for each risk factor.
Assumptions behind each Scenario: The stress test at this stage is only a single
factor sensitivity analysis. Each of the five risk factors has been given shocks of three different
levels. The magnitude of shock has been defined separately for each risk factor for all the three
levels of shocks.
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METHODOLOGY OF STRESS TESTING
Credit Risk:
The stress test for credit risk assesses the impact of increase in the level of nonperforming loans
of the bank/FI. This involves six types of shocks:
The first deals with the increase in the NPLs and the respective provisioning. The three
scenarios shall explain the impact of 1%, 2% and 3% of the total performing loans
directly downgraded to bad/loss category having 100% provisioning requirement.
The second deals with the negative shift in the NPLs categories and hence the increase
in respective provisioning. The three scenarios shall explain the impact of 50%, 80%
and 100% downward shift in the NPLs categories. For example, for the first level of
shock 50% of the SMA shall be categorized under substandard, 50% of the substandard
shall be categorized under doubtful and 50% of the doubtful shall be added to the
bad/loss category.
The third deals with the fall in the forced sale value (FSV) of mortgaged collateral.
The forced sale values of the collateral shall be given shocks of 10%, 20% and 40%
decline in the forced sale value of mortgaged collateral for all the three scenarios
respectively.
The fourth deals with the increase of the NPLs in particular 1 or 2 sector i.e. garments
&Textiles and the respective provisioning. The three scenarios shall explain the impact
of 5%, 7.5% and 10% performing loans of particular 1 or 2 sectors directly downgraded
to bad/loss category having 100% provisioning requirement.
The fifth deals with the increase of the NPLs due to default of Top 10 large borrowers
and the respective provisioning. The three scenarios shall explain the impact of 5%,
7.5% and 10% performing loans of Top 10 large borrowers directly downgraded to
bad/loss category having 100% provisioning requirement.
The sixth deals with extreme events in which due to increase in the certain percentage
of NPLs, the whole capital position of a bank will be wiped out to offset the increased
amount of provision due to cover respective loan losses. The forced sale value of the
collaterals and taxadjusted impact of the additional required provision (if any) will be
calibrated in the CAR for the each scenario under all categories.
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Interest Rate Risk:
Interest rate risk is the potential that the value of the onbalance sheet and the off-balance
sheet positions of the bank/DFI would be negatively affected with the change in the interest rates. The
vulnerability of an institution towards the adverse movements of the interest rate can be gauged
by using duration GAP analysis.
The banks and FIs shall follow the following steps in carrying out the interest rate stress tests:
Estimate the market value of all onbalance sheet rate sensitive assets and liabilities of
the bank/DFI to arrive at market value of equity
Calculate the durations of each class of asset and the liability of the onbalance sheet
portfolio Arrive at the aggregate weighted average duration of assets and liabilities
Calculate the duration GAP by subtracting aggregate duration of liabilities from that of
assets.
Estimate the changes in the economic value of equity due to change in interest rates on
onbalance sheet positions along the three interest rate changes.
Estimate the impact of the net change (both for onbalance sheet and offbalance sheet)
in the market value of equity on the capital adequacy ratio (CAR).
Market value of the asset or liability shall be assessed by calculating its present value
discounted at the prevailing interest rate. The outstanding balances of the assets and Liabilities
should be taken along with their respective maturity or repricing period, whichever is earlier.
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The duration GAP is measured by comparing the weighted average duration of assets with the
weighted average duration of liabilities (leverageadjusted). The weighted average duration of
assets and liabilities is calculated as follows:
The duration GAP indicates how the market value of equity (MVE) of a bank/FI will change
with a certain change in interest rates. If the weighted average duration of assets exceeds the
weighted average duration of liabilities (leverageadjusted), the duration GAP is said to be
positive. A positive duration gap signifies that the assets are relatively more interest rate
sensitive than liabilities. Hence if the interest rates rise, the value of assets will fall
proportionately more than the value of liabilities and the market value of equity will fall
accordingly and vice versa. Duration Gap will be calculated as under:
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The change in market value of equity shall be calculated as:
The impact of interest rate change on interest bearing offbalance sheet contracts shall be
separately calculated. As a first step, the actual market price of each contract shall be
determined which should represent the actual price of the contract if sold immediately. The
second step involves calculating the market price again by marking to market each contract
separately assuming a change in interest rate. The difference between the two market prices
would determine the amount of revaluation surplus or deficit. The revaluation surplus would
arise if the actual market price of the contract is less than the price calculated after assuming a
change in the interest rate and revaluation deficit would result in, if otherwise. The revaluation
surplus/deficit arising due to the change in the interest rates of the offbalance sheet contracts
should be subtracted/ added to the fall in market value of equity derived by the DGAP approach
to arrive at the net change in the market value of equity.
The impact of this net change in the market value of equity will then be calibrated in the CAR.
The taxadjusted impact of this net fall (if any) in the MVE shall be adjusted from the regulatory
capital and the riskweighted assets and the revised CAR shall be calculated under each of the
above scenarios.
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Equity Price Risk:
The stress test for equity price risk assesses the impact of the fall in the stock market index.
Appropriate shocks will have to be absorbed to the respective securities if the current market
value of all the on balance sheet and off balance sheet securities listed on the stock exchanges
including shares, NIT units, mutual funds etc. falls at the rate of 10%, 20% and 40%
respectively. The impact of resultant loss will be calibrated in the CAR.
Liquidity Risk:
The stress test for liquidity risk evaluates the resilience of the banks towards the fall in liquid
liabilities. The ratio liquid assets to liquid liabilities shall be calculated before and after the
application of shocks by dividing the liquid assets with liquid liabilities. Liquid assets are the
assets that are easily turned into cash without the threat of loss. They include cash, balances
with Bangladesh Bank and balances with banks, call money lending, lending under repo and
investment in government securities. Liquid liabilities include the deposits and the borrowings.
Appropriate shocks will have to be absorbed to the liquid liabilities if the current liquidity
position falls at the rate of 10%, 20% and 30% respectively. The ratio of liquid assets to liquid
liabilities shall be recalculated under each scenario.
According to Bangladesh Bank, All banks and FIs are expected to carry out stress testing on
half-yearly basis i.e. on June 30 and December 31 each year.
24
DBBL has a strong
capital base and
capital adequacy
Dutch-
stands at 12.49% of
the risk weighted
assets against the
Bangla Bank
regulatory
requirement of 10%.
The bank is also well
Profile
positioned to
maintain capital
under Basel-II.
25
ABOUT THE BANK
Dutch-Bangla Bank Limited (the Bank, DBBL) is a scheduled joint venture commercial bank
between local Bangladeshi parties spearheaded by M Sahabuddin Ahmed (Founder &
Chairman) and the Dutch company FMO. DBBL was established under the Bank Companies
Act 1991 and incorporated as a public limited company under the Companies Act 1994 in
Bangladesh with the primary objective to carry on all kinds of banking business in Bangladesh.
Committed for excellence, Dutch-Bangla Bank is a top-tier bank in Bangladesh and reputed
among regulators as distinctly compliant and among customers as agile and responsive to
change. The Bank is aligned to its vision, mission, values and strategic priorities.
Core Business:
Dutch-Bangla Bank focuses on a wide range of financial products and services which include
commercial banking through conventional, Merchant and Investment Banking, SME & Retail
Banking, Credit Card and Off-shore Banking. It plays role in Syndicated & Structured
Financing. It has expertise in Corporate Credit and Trade Finance and made extensive market
penetration with continuous growth in Corporate, Commercial and Trade Finance sectors. It is
pioneer in ATM network.
DBBL At a Glance
26
Incorporation of the Company 1995
Formal launching of the Bank 1996
Initial Public Offerings (IPO) 2001
Listed with Chittagong Stock Exchange Limited 2001
Listed with Dhaka Stock Exchange Limited 2001
27
RISK MANAGEMENT OF DBBL
Bank continues to manage its capital efficiently in order to support its annual business plan and
also to ensure adequate return on capital to shareholders. Dutch- Bangla Bank recognizes the
impact on shareholders return of the level of equity and seeks to maintain a prudent balance
between Tier-I and Tier-II capital. Bangladesh Bank has started implementing risk based
capital accord Basel-III from the year 2013 and Dutch- Bangla Bank has already imparted
training to the officers and also streamlined the risk management process in order to be
prepared for implementation of Basel-III on time.
28
The Bank has put in place its Standard Operating Procedure (SOP) as per international best
practices prepared by Dilotte. This SOP has strengthened internal control system and facilitated
the risk management process of the Bank. Internal Control System is being made effective by
increasing the internal audit, both comprehensive and others, of the branches and Head Office.
These cautious and stringent practices are to keep the risk at a very low level.
29
For this part, I have
collected data from
annual reports of
DBBL and made some
Stress Testing
assumptions
unavailable data. I
for
for Dutch-
Bangla Bank
have shown detail
process of my
Calculation for Stress
testing of DBBL.
Limited
30
INTEREST RATE RISK CALCULATION
For Dutch-Bangla Banks Interest Rate Risk calculation for the year 2011, 2012 and 2013 I
have taken data from Balance Sheet and Notes given for the items in the Balance Sheet. I have
calculated market value and duration for all the items classifying into different segments. I have
assumed the repricing periods, interest rate for treasury bills Bonds and the interest rate
on borrowings from other banks and FIs.
After that I have calculated duration for investments of the bank. There are investments in
Bangladesh Government Treasury Bills & Bonds, Prize Bonds, debentures, Zero coupon
bonds, subordinated bonds and other bonds, investment in shares etc.
For T-bills and bonds I have calculated market interest rate from annual report by using
arithmetic mean. These market interest rate for bills and bonds are considered as yield to
maturity of those. For calculating market value I have used the formula PV (rate, nper, pmt,
[fv], [type]) and for duration I have used the formula DURATION (settlement, maturity,
coupon, yield, frequency, [basis]) in Microsoft Excel Program. I have calculated maturity date
using the present date (1st January, 2012) and repricing period and used annual & semi-annual
frequency for bill & bond respectively. Duration of investment in shares is 0.
31
Then I have calculated duration for Loans, advances and lease divided into different maturity
classes. The average yield on this investment was given in the annual report (13.06%). Here
Market value is equal to book value and the duration is equal to the assumed repricing period.
By combining the items of Assets segment of the balance sheet, I have found the total asset of
the bank. Then I have calculated the Market Value weighted Yield to maturity and Duration
for the total assets.
32
Then I have calculated Market Value weighted Yield to maturity and Duration for the total
Liabilities also. Here interest rate for borrowings is assumed and the average interest rate for
deposit is given in the annual report. Market value is equal to book value and the duration is
equal to the assumed repricing period.
We have seen that market value of Total assets or Total liabilities & shareholders equity is
lower than the book value for discounting with the yield to maturity. So, if the interest rate
increases by 1%, 2% or 3% then the market value will fall more which will reduce the capital
and the Capital Adequacy Ratio (Regulatory Capital/ Risk Weighted Asset).
According to the guideline of Bangladesh Bank the risk of fall in CAR for the increase in
interest rate are calculated for Dutch-Bangla Bank in the following way:
33
Calculation for Year-2012:
Like year 2013, I have also calculated fall in CAR of Dutch-Bangla Bank for the increase in
interest rate for year 2012, the process of which are given below step by step:
34
35
36
Calculation for Year-2011:
Like year 2013 and 2012, I have also calculated fall in CAR of Dutch-Bangla Bank for the
increase in interest rate for year 2011, the process of which are given below step by step:
37
38
Comment on Interest risk: Thus, I have calculated interest rate risk for the year 2013, 2012
and 2011 for Dutch-Bangla Bank Ltd. I have found that, the interest rate risk increased in the
year 2012 from that in the year 2011 and again it decreased in the year 2011 from year 2012.
But the risk was highest in the year of 2012 and lowest in the year of 2011 among the 3 years.
39
EXCHANGE RATE RISK CALCULATION
For exchange rate risk calculation, I have calculated data about the exposure of Dutch-Bangla
Bank Ltd. in foreign currency from annual reports. (Assets in Foreign Currency Liabilities in
Foreign Currency)= Net position in foreign currency is not given in the annual report directly.
for different currency separately and in the total figure. I have calculated these information
from the annual reports for the year 2011, 2012 and 2013 and calculated foreign exchange rate
risk for those years.
FC Liabilities
Borrowing from outside Bangladesh 1,017,960,910
Irrevocable LC 10,645,830,109
Total 11,663,791,019
Net Exposure (5,818,000,124)
5,818,000,124
After that I have used the data to calculate the foreign exchange rate risk, that is, the decrease
in CAR for the increase in different exchange rate. Here, 5%, 10% and 15% increase of
exchange rate is used to show the decrease of CAR. The exchange rate loss on % change has
been calculated by multiplying the increase of exchange rate with the total net foreign currency
position. The overall Calculation process is shown in the following page:
40
Calculation for Year-2012:
Like the year 2013, I have calculated net exposure in foreign exchange for the year of 2012
from annual report of 2012 and calculated Foreign exchange rate risk for that year. The
calculation is given below:
FC Liabilities
Borrowing from outside Bangladesh 1,044,314,135
Irrevocable LC 8,409,046,102
Total 9,453,360,237
Net Exposure (3,402,442,271)
3,402,442,271
41
Calculation for Year-2011:
Like the year 2013 and 2012, I have calculated net exposure in foreign exchange for the year
of 2011 from annual report of 2011 and calculated Foreign exchange rate risk for that year. The
calculation is given below:
FC Liabilities
Borrowing from outside Bangladesh 621,760,048
Irrevocable LC 7,646,121,408
Total 8,267,881,456
Net Exposure (7,662,039,026)
7,662,039,026
42
Comment on Exchange rate risk: Thus, I have calculated fall in CAR (%) for the year 2011,
2012 and 2013 for different level of shocks such as major (15%), moderate (10%) and minor
(5%). I have found that, the exchange rate risk decreased in the year 2012 from that in the year
2011 and again it increased in the year 2012. But the risk was highest in the year of 2011 among
the 3 years.
43
EQUITY PRICE RISK CALCULATION
The information that is required to determine the equity price risk has been collected from
annual report of Dutch-Bangla Bank. Total Investment in share is given here for both quoted
and unquoted shares. From the notes I have collected this information and used the information
to calculate Equity Price Risk for the year of 2011, 2012 and 2013.
After that I have used the data to calculate the equity price risk, that is, the decrease in CAR
(%) for the increase in different stock prices. Here, 10%, 20% and 40% fall in the market price
of stocks is used to show the decrease of CAR. The amount of fall in the stock prices has
been calculated by multiplying the % fall in the market price with the total exposure in the
stock market. The overall Calculation process is shown in the following page:
44
Calculation for Year-2012:
Like the year 2013, I have collected information from annual report of 2012 and calculated
Equity price risk for that year. The information and calculation is given below:
45
Calculation for Year-2011:
Like the year 2013 and 2012, I have collected information from annual report of 2011 also and
calculated Equity price risk for that year. The information and calculation is given below:
46
Comment on Equity price risk: Thus, I have calculated fall in CAR (%) for the year 2011,
2012 and 2013 for different level of shocks such as major (10%), moderate (20%) and minor
(40%). I have found that, there is almost no equity price risk in every year. The risk is same for
every year.
47
LIQUIDITY RISK CALCULATION
Liquidity ratio is (Liquid asset/Liquid liability) which is calculated. I have taken this calculated
ratio. Then, I have calculated the Liquid asset by multiplying Liquid liability and Liquidity
ratio.
After that I have calculated fall in Liquidity Ratio for the increase of % fall in Liquid Liabilities
under 3 scenarios. The amount of fall in Liquid Liabilities is calculated by multiplying % fall
in liquidity ratio with the Liquid Liabilities. Then I have calculated Revised Liquid assets and
Liabilities by subtracting fall in Liquid Liabilities from the previous Liquid assets and
Liabilities respectively. Finally I have calculated revised Liquidity ratio and found the % fall
in Liquidity Ratio under different level of shock.
I have used this procedure to calculate Liquidity Risk for the year of 2011, 2012 and 2013 and
the overall calculation process for those years is given below:
48
Calculation for Year-2012:
Comment on Liquidity risk: Thus, I have calculated fall in Liquidity Ratio (%) for the year
2011, 2012 and 2013 for different level of shocks such as major (10%), moderate (20%) and
minor (30%). I have found that, the Liquidity Risk slightly decreased in the year 2012 from
that in the year 2011 and again it more decreased in the year 2013. The risk was highest in the
year of 2011 among the 3 years.
49
CREDIT RISK CALCULATION: (6 TYPES)
1. Increase in NPLs:
The information that is required to determine the Credit Risk for the % increase in Non-
Performing Loans (NPLs) or % of loans directly downgraded to bad/loss category has been
collected from annual report of Dutch-Bangla Bank. Total investment of Loans, Advances and
Lease portfolio is given here. From the notes I have collected this information and used the
information to calculate Credit Risk for increase in NPLs for the year of 2011, 2012 and 2013.
NPL Ratio and Total NPLs are given in the annual report. I have calculated the amount of
increase in NPLs by multiplying Total NPLs and % increase in NPLs. Then I have calculated
Revised Regulatory capital and Risk Adjusted Asset by subtracting Tax adjusted provision for
NPLs from previous Regulatory capital and Risk Adjusted Asset respectively. Using those I
have calculated Revised CAR (%) and Revised NPLs to Loans Ratio.
I have used this procedure to calculate Credit Risk for increase in NPLs for the year of 2011,
2012 and 2013 and the overall calculation process for those years is given below:
50
Comment on Credit risk-1: Thus, I have calculated fall in CAR (%) and Revised NPL Ratio
(%) for the year 2011, 2012 and 2013 for different level of shocks such as major (1%), moderate
(2%) and minor (3%). I have found that, the Credit Risk slightly increased in the year 2012
from that in the year 2011 and again it increased in the year 2013. The risk was highest in the
year of 2013 among the 3 years.
51
2. Shift in NPLs Categories:
For calculating Credit risk for this category, the total NPLs are divided into 4 classes which are
Special Mention Account or SMA (10% of NPLs), Substandard (10% of NPLs), Doubtful (20%
of NPLs) and loss (60% of NPLs) and 5%, 20%, 50% and 100% of provisioning are created
for these classes respectively. These percentages are considered under the assumptions and
techniques found from Bangladesh Bank guidelines on stress testing. The impact of shift in
50%, 80% or 100% NPLs to next categories with no change in total NPLs can create minor,
moderate or major level of credit shock for a bank.
The weighted amount of provision has been calculated by the MS Excel formula
SUMPRODUCT (Classes of NPLs, Provisions for those classes). Provision after shift in
categories is the revised weighted amount of provision for the revised amount of NPLs in each
class. The increase in provision is subtracted from capital and RWA to revised capital and
RWA. Then revised CAR and fall in CAR is determined for each level of shock.
I have used this procedure to calculate Credit Risk for shift in NPL category for the year of
2011, 2012 and 2013 and the overall calculation process for those years is given below:
52
Thus, I have calculated fall in CAR (%) for the year 2011, 2012 and 2013 for different level of
shocks such as major (50%), moderate (80%) and minor (100%). I have found that, the Credit
Risk increased in the year 2012 from that in the year 2011 and again it increased in the year
2013 from that of the year of 2012. The risk was highest in the year of 2013 among the 3 years.
53
For this calculation, the amount of mortgaged collateral of the bank is required. I have not
found any information about the mortgaged collateral of the bank for the year 2011, 2012 and
2013.
I couldnt calculate Forced Sale Value because of absence of mortgage collateral value. This
Forced Sale Value (FSV) is classified into 4 classes which are Special Mention Account or
SMA (10% of NPLs), Substandard (10% of NPLs), Doubtful (20% of NPLs) and loss (60% of
NPLs) and 5%, 20%, 50% and 100% of provisioning are created for these classes respectively.
These percentages are considered under the assumptions and techniques found from
Bangladesh Bank guidelines on stress testing. The impact of fall in FSV of collateral by 10%,
20% or 40% can cause minor, moderate or major level of credit shock for a bank.
The weighted amount of provision has been calculated by the MS Excel formula
SUMPRODUCT (Classes of FSVs, Provisions for those classes). Increase in the Provision is
calculated by multiplying Weighted FSV of Collateral and % Fall in FSV of Mortgaged
Collateral. The increase in provision is subtracted from capital and RWA to revised capital and
RWA. Then revised CAR and fall in CAR is determined for each level of shock.
I have used this procedure to calculate Credit Risk for fall in FSV of Mortgaged Collateral for
the year of 2011, 2012 and 2013 and the overall calculation process for those years is given
below:
54
55
Comment on Credit shock-3: Thus, I have calculated fall in CAR (%) for the year 2011, 2012
and 2013 for different level of shocks such as major (10%), moderate (20%) and minor (40%).
I have found that, the Credit Risk slightly increased in the year 2012 from that in the year 20011
and again it increased in the year 2013 from that in the year 2012. The risk was highest in the
year of 2013 among the 3 years.
The information collected from the notes of annual report of the year 2011, 2012 and 2013 is
shown below:
I have calculated the amount of increase in NPLs under bad/ loss category by multiplying Total
loan in textile sector and % increase in NPLs. Then I have calculated Revised Regulatory
capital and Risk Weighted Asset by subtracting Tax adjusted provision for NPLs from previous
Regulatory capital and Risk Weighted Asset respectively. Using those I have calculated
Revised CAR (%) and Fall in CAR (%).
56
I have used this procedure to calculate Credit Risk for increase in NPLs in textile sector for the
year of 2012, 2013 and Ready-made garments industries for 2011 and the overall calculation
process for those years is given below:
57
Comment on Credit risk-4: Thus, I have calculated fall in CAR (%) for the year 2011, 2012
and 2013 for different level of shocks such as minor (5%), moderate (7.5%) and major (10%).
I have found that, the Credit Risk increased in the year 2012 from that in the year 2011 and
again it increased in the year 2013. The risk was highest in the year of 2013 among the 3 years.
58
5. Increase in NPLs due to default of top large loan
borrowers:
From the annual report information we can find out the large borrowers to whom the bank
provides large amount of loan (10% of total capital). So, if % of NPL increases for default of
those borrowers then it will create great adverse impact on the bank. So, this is necessary to
calculate credit risk of this type for the bank by making some scenario analysis with different
level of shock in this sector. Here, I will use 5%, 7.5% and 10% increase in NPL due to default
of large borrowers to determine credit risk for the bank under different scenarios.
I have calculated the amount of increase in NPLs under bad/ loss category by multiplying Total
loan to large borrowers (collected from annual report) and % increase in NPLs. Then I have
calculated Revised Regulatory capital and Risk Adjusted Asset by subtracting Tax adjusted
provision for NPLs from previous Regulatory capital and Risk Adjusted Asset respectively.
Using those I have calculated Revised CAR (%) and fall in CAR (%).
The overall calculation procedure followed to determine this type of credit risk of the year
2011, 2012 and 2013 is shown below:
59
Comment on Credit risk-5: Thus, I have calculated fall in CAR (%) for the year 2011, 2012
and 2013 for different level of shocks such as major (5%), moderate (7.5%) and minor (10%).
I have found that, the Credit Risk slightly decreased in the year 2012 from that in the year 2011
but it increased in the year 2012. The risk was highest in the year of 2013 among the 3 years.
60
6. Increase in NPLs up to that position in which whole
capital will be wiped out:
To calculate the level of NPLs that will wipe out whole capital of the bank I have set the
increase in the amount of NPL equal to the Total regulatory capital. Then I have calculated
Revised Regulatory capital and Risk Adjusted Asset by subtracting Increase in provision for
NPLs from previous Regulatory capital and Risk Adjusted Asset. Using those I have calculated
Revised CAR (%) and fall in CAR (%). Revised NPLs is calculated by adding the increase in
NPL with the previous NPL. Finally I have calculated the Revised NPLs to loans ratio (%) and
this is the ratio which will wipe out total capital. That is, if this type of shock comes then the
Regulatory capital will be 0.
The overall calculation procedure followed to determine this type of credit risk of the year
2011, 2012 and 2013 is shown below:
Comment on Credit risk-6: We can see here that the year 2013 was the riskiest as it was
required that NPL to loans ratio to be 18.48% to make the regulatory capital 0 where 16.43%
and 15.96% was required in year 2012 and 2011 respectively. The risk level is the lowest for
the year 2011 according to calculation.
61
Cumulative Credit Risk:
Now I will show the cumulative credit risk by adding up all the provisions under 5 types of
credit risk for each scenario for the year 2011, 2012 and 2013. Firstly I have calculated
Cumulative impact of credit shock and then cumulative tax adjusted provision for this shock.
Then I have calculated Revised Regulatory capital and Risk Adjusted Asset by subtracting
Increase in cumulative tax adjusted provision from previous Regulatory capital and Risk
Adjusted Asset. Using those I have calculated Revised CAR (%) and fall in CAR (%). The
overall calculation procedure followed to determine cumulative credit risk for the year 2011,
2012 and 2013 is shown below:
62
Comment on Cumulative credit risk: Thus, I have calculated fall in CAR (%) for the year
2011, 2012 and 2013 for different level of cumulative credit shocks such as major, moderate
and minor. I have found that, the Credit Risk slightly increased in the year 2012 from that in
the year 2011 and again it highly increased in the year 2013 from that in 2012. So, we can say
that the risk was highest in the year of 2013 among the 3 years.
63
CUMULATIVE SHOCK CALCULATION
Now I will calculate the cumulative of all types of shocks by adding up all the provisions under
each types of risk (Credit, Interest rate, Exchange rate and equity price risk). Firstly I have
calculated Cumulative impact of all types of shock and then cumulative tax adjusted provision
for this shock.
Then I have calculated Revised Regulatory capital and Risk Weighted Asset by subtracting
Increase in cumulative tax adjusted provision from previous Regulatory capital and Risk
Weighted Asset. Using those I have calculated Revised CAR (%) and fall in CAR (%). The
overall calculation procedure followed to determine cumulative risk for the year 2011, 2012
and 2013 is shown below:
Comment on cumulative shock: We can say cumulative shock for 2013 is the highest that than
that for the year 2012 and 2011.
64
In this part I have
shown my Findings
after comparing
Findings &
different risk level
of the year 2011,
2012 & 2013 with
each other with
Tabular
Graphical
Presentations.
and
Conclusion
65
IMPACT OF ALL SHOCKS SEPARATELY
I have summarized my findings from the stress testing on Dutch-Bangla Bank Limited about
the impact of different shocks separately on the fall in CAR (%) for the year of 2011, 2012 and
2013 in the following tables and graphs:
66
4.500%
Impact of different Shocks (Year 2013)
4.000%
3.500%
3.000%
Fall in CAR (%)
2.500%
2.000%
1.500%
1.000%
0.500%
0.000%
Minor Moderate Major
(Level of Shock)
2.500%
2.000%
Fall in CAR (%)
1.500%
1.000%
0.500%
0.000%
Minor Moderate Major
(Level of Shock)
67
3.000%
Impact of different Shocks (Year 2011)
2.500%
2.000%
Fall in CAR (%)
1.500%
1.000%
0.500%
0.000%
Minor Moderate Major
(Level of Shock)
From the tables and Graphs we can see that, every year the highest shock (fall in CAR %)
comes from the increase in NPLs due to large borrowers (one type of credit risk) and the lowest
shock comes from equity price risk.
I think Dutch-Bangla Bank Ltd. should be more concerned about the impact of the fall in CAR
(%) for the increase in NPLS Due to Top Borrowers for the safety of its capital.
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IMPACT OF ALL SHOCKS CUMULATIVE
My findings about the cumulative shock under each scenario for the year 2011, 2012 and 2013
are summarized in the following table and graph:
7.00% 6.37%
Fall in CAR (%)
6.07%
6.00% 2013
6.25%
5.00%
3.95% 4.26% 2012
4.00% 4.37%
3.00% 2011
2.71%
2.00% 2.64%
1.00%
0.00%
Minor Moderate Major
Level of Shock
Here we can see that the fall in CAR (%) is increasing with the level of cumulative shock.
Again, we can see that the impact of cumulative of all shock was the highest in 2013 and the
lowest in 2011. Cumulative shock increased in the year 2012 from the year 2011 and again
increased in 2013.
So, the bank should be cautious about the risks again and take proper steps to decrease the level
of shock in the following years.
69
REPORTING TO BANGLADESH BANK
70
71
Appended parts
provide
additional
Appended
information
regarding the
report. Here I
Parts
have provided the
glossary &
references.
72
GLOSSARY
Basel Accords:
The Basel Accords refer to the banking supervision Accords (recommendations on banking
regulations)Basel I, Basel II and Basel IIIissued by the Basel Committee on Banking
Supervision (BCBS). They are called the Basel Accords as the BCBS maintains its secretariat
at the Bank for International Settlements in Basel, Switzerland and the committee normally
meets there.
Basel I is now widely viewed as outmoded. The reason behind it is the world has changed as
financial conglomerates, financial innovation and risk management have developed. Therefore,
a more comprehensive set of guidelines, known as Basel II are in the process of implementation
by several countries and new updates in response to the financial crisis commonly described as
Basel III.
Basel II uses a "three pillars" concept (1) minimum capital requirements (addressing risk),
(2) supervisory review and (3) market discipline. Under Basel II, banks are required to maintain
a total capital ratio (Tier 1 + 2 + 3) of minimum 8%.
BASEL III is a global regulatory standard on bank capital adequacy, stress testing and market
liquidity risk agreed upon by the members of the Basel Committee on Banking Supervision in
2010-11. Under the Basel III rules, banks must have top quality capital equivalent to at least
7% of their risk-weighted assets or they could face restrictions on their ability to pay bonuses
and dividends.
Regulatory Capital:
73
Capital adequacy ratio is defined as:
Tier 1 Capital:
It is (paid up capital + statutory reserves + disclosed free reserves) - (equity investments in
subsidiary + intangible assets + current & b/f losses). It can absorb losses without a bank being
required to cease trading
Tier 2 Capital:
It consists of A) Undisclosed Reserves, B) General Loss reserves, C) hybrid debt capital
instruments and subordinated debts. It can absorb losses in the event of a winding-up and so
provides a lesser degree of protection to depositors.
Tier 3 Capital:
It consists of short-term subordinated debt. A bank may only use this capital for covering
market risk.
74
REFERENCES
Persons
Professor Dr. Mahmood Osman Imam
Course Instructor, F-503(Financial Derivatives)
Department of Finance, University of Dhaka
Periodicals
Guidelines on Stress Testing
(Published by Department of Offsite Supervision,
Bangladesh Bank)
Websites
www.dutchbanglabank.com
www.bangladesh-bank.org
en.wikipedia.org
www.dsebd.org
www.investopedia.com
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