DEVELOPMENT BANK OF ETHIOPIA

RISK MANAGEMENT PROCESS

REVISED GUIDELINES AND FORMATS FOR PRE

AND POST CREDIT RISK MEASUREMENT

JANUARY, 2010
TABLE OF CONTENTS
Page
I INTRODUCTION.......................
II CREDIT RISK MEASUREMENT........
2.1. PRE-CREDIT RISK MEASUREMENT..
A. Business/Applicant Strength......................
1. Character of the Applicant..
2. Project Management Risk..
3. Capital Adequacy Risk
4. Market Risk.
5. Business Risk..
6 Summary.........
B. Collateral Strength.........
C. Credit Risk Measurement Matrix...
2.2. POST CREDIT RISK MEASUREMENT
A Performance Indicators..
1. Financial Information..
2. Production Capacity and Production Cost of the Project
3. Market Risk.
4. Potential of the Project for Growth
5. Project Management and Personnel
6. Environmental Impacts and Employee Safety
7. Borrowers/Business Strength
8 Summary.
B. Collateral Strength.
C. Credit Risk Measurement Matrix.......
ANNEXES
Format I- Format for Pre-Credit Risk Measurement
Format II- Format for Post Credit Risk Measurement
Format III-Format for List and Risk Classification of Borrowers

I. INTRODUCTION
Credit risk is defined as the risk of loan repayment default by borrowers. Credit risk
arises from poor lending discipline, quite often-inadequate attention to credit analysis,
poor follow up and management of loans and too much reliance on collateral. As a result,
asset prices decline and credit risk emerges. Loan default is a common feature of credit
risk. It is the likelihood that a debtor to a bank will not meet obligation in accordance
with agreed terms. Good loans are the most profitable assets for banks and are the base
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for their existence. Conversely, bad loans pose threats to the financial and institutional
sustainability of banks. Credit risk is, therefore, understood as the critical problem in the
banking industry that needs to receive managements priority attention and proper
administration.

Like any development financial institutions, credit risk is a major problem to the
Development Bank of Ethiopia. Looking at the portfolio, the size of non-performing
loans has continued to rise from one fiscal year to the subsequent due to loan repayment
default by debtors, and this has contributed to the deterioration of the portfolio quality.
To cope up with the current looming threats, it is imperative to manage credit risk at bank
level and ensure sustainability, which is critical to financial institutions. Credit risk
management essentially means the process that assesses the qualitative and quantitative
factors that support credit worthiness; mainly it focuses on evaluation of borrowers
creditworthiness, loan security and periodic valuation.
This manual is prepared to replace the existing pre and post credit risk measurement or
rating criteria of DBE which has been in use since March, 2006. The former manual was
prepared so as to assess the credit risks that emanate from projects owned primarily by
sole proprietors and it does not exhaustively incorporate criteria for assessments of risks
associated with the major share holders, board of directors and general managers of
private limited companies, share companies, corporations, etc. when these entities come
to the Bank with loan requests to fulfill the financial requirements of their projects.
Hence, based on the feedback obtained from operators involved in the loan approval and
credit processes of the Bank, this manual is revised in such a way that it can be
used so as to measure or rate the risks that originate from the nature of these
business organizations. Furthermore, best practices of some financial institutions
have been used as bench marks to come up with relevant approaches to assess
the sources of risks and their mitigation mechanisms.
To this end, in DBE credit risks should be measured at pre and post credits and methods
of pre and post credit measurements are discussed separately as follows.
3

II.

CREDIT RISK MESUREMENT

2.1.

PRE CREDIT RISK MEASUREMENT

Pre credit risk analysis covers the period from the appearance of the borrower till the
preparation of the loan contract. Pre-credit risk consists of potential risks that are likely to
occur due to failure to examine rigorously the credit worthiness of the borrowers and
bankability of the project. Before credits are sanctioned, the Development Bank of
Ethiopia undertakes a series of screening measures to ascertain the feasibility and
4

bankability of the project. The loan applications are checked for their completeness and
meeting the standard criterion set by the Bank.
The following yardsticks are used to measure the risk associated at the pre-appraisal
stage. These can be divided into two broad categories: applicant/business and collateral
strengths. For a development bank, however, collateral risk is the last option compared to
the applicant risk. Hence, in our situations too, a measurement value has been allotted to
those risks which arise from the strengths of businesses or applicants only. For the
purpose of credit risk measurement matrix, however, business or applicant and collateral
strengths are considered together. Regarding securities accepted by the Bank, it is
recommended that the Credit Process and Branch Offices should adhere to the existing
collateral policy adopted by the Bank.
Assigned
Points

Expected Risk

A. Business and/ or Applicant Strength (Critical issue)

1.
2.
3.
4.
5.

400

Character of the Applicant

Project Management Risk
Capital Adequacy Risk
Market Risk
Business Risk
Total

300
300
250
250
1500

A. Business and/or Applicant Strength

It is the most important and desirable issue seriously considered and given due attention.
High quality and performing loan portfolio begins with the selection of prospective
applicant or business at the outset. Hence, the screening criteria shall be set to achieve
this goal. This includes the borrower characteristics, competence, capital, market and
business conditions. The weight associated with each of them is determined as follows:-

1. Character of the Applicant (400 points)

5

Feasible and bankable project basically depends on adequate selection of appropriate

applicant at the beginning. It helps for increasing the Bank performance as well as the
economic growth of the country. Hence, before accepting the project for appraisal,
screening of the incoming borrowers past credit history with banks, tax payment history,
account

misuse

and/or

delinquency

history

and

social

interactions

of

the

applicant/business should be critically evaluated. The following table shows measuring

the risk factors associated with the character of the applicant with corresponding points
assigned.

Description

Assigned Points

The applicant's credit history with banks

The applicants tax payment history
Delinquency record of the applicant
The applicants social interaction
Total

1.1.

150
100
100
50
400

Settlement of Loans Borrowed (150 points)

Settlement of Loan
Borrowed more than 3 times & no record of default
Borrowed more than 2 times but settled 30 days after the

Rating
Excellent

due date
Borrowed more than 2 times but settled the loan 30-89

Very good

days after the due date

Has no credit history with Banks
Borrowed more than 2 times but the loan settled 3-6

Good
Satisfactory

months after the due date

Borrowed 2 and more times but the loan settled after 6
month and above or by foreclosure/litigation

Unsatisfactory

Unacceptable

Assigned

Points

Point
150

Scored

120
90
75
50
0

*In case of PLC, share company, partnership & corporation, please rate the major
shareholders which have 5% or more of the prescribed capital of the business organization
separately and take the average figure.

1.2.

The applicants Tax Settlement History to Tax

Authorities (100 Points)

Description

Rating

The applicant has good track record of meeting

Excellent

tax obligations on time

The applicant has settled the required tax a little
behind schedule
The applicant has settled the required tax after
reminder is served.
The applicant has settled the required tax after
transferred to court
The applicant did not pay tax (tax evader)

Assigned

Points

point
100

scored

75

Very Good
Satisfactory

50

Unsatisfactory

25

Unacceptable

*In case of PLC, share company, partnership & corporation, please rate the major
shareholders which have 5% or more of the prescribed capital of the business organization
separately and take the average figure.

1.3.

Number of Times the Applicant being Delinquent

(100 points)

Delinquency Record
Not delinquent for last 5 years
Delinquent 1 time for last 5 years
New account holder/new entrepreneur
Delinquent 2 or more times in 5yrs

Rating
Excellent

Satisfactory
Unsatisfactory
Unacceptable

Assigned Point

Points
Scored

100
50
25
0

*In case of PLC, share company, partnership & corporation, please rate the major
shareholders which have 5% or more of the prescribed capital of the business organization
separately and take the average figure.

Note: Delinquency indicates that a situation whereby a person or a company has effected
payments to their customers by a post dated cheque without having sufficient fund in
their respective accounts. In addition, it also includes persons or business organizations
which have been involved in illegal activities like money laundering, event of tax evading
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and bypassing restrictions set by concerned government organs not to do businesses

which have been prohibited in one way or other.

1.4.

The Applicants Social Interaction (50 points)

Rating

Description

Assigned

Points

point

scored

The applicant is socially well recognised in

his/her surrounding

Excellent

The applicant is not properly known in

Satisfactory

his/her surrounding socially

The applicant has bad image in his/her

Unsatisfactory

surrounding socially

50
25
0

*In case of PLC, share company, partnership & corporation, please rate the major
shareholders which have 5% or more of the prescribed capital of the business organization
separately and take the average figure.

2. Project Management Risk (300 Points)

This subheading specifically deals with managerial ability, competency, experience and
technical knowledge of the concerned management organ of the business organization. It
is also important to view educational background, special trainings and experience of the
key and professional personnel being planed to be assigned to run the project. So, the key
management personnel of the project will be rated under the following criteria.
Description

Assigned Point

Experience of key management staffs of the project

Educational background of key management staffs of the project
Technical knowledge of key management staffs of the project
Total

2.1.

Experience of the key management staffs of the

project (80 points)

Level of experience (X)

X 5 Years
X = 4 Years

80
100
120
300

Rating
Excellent
Very good
8

Assigned
Point
80
65

Points
Scored

X = 3 Years
X = 1-2 Years
X = 0 Year

Good
Satisfactory
Unsatisfactory

2.2.

Educational Background of the Key Management

Staffs of Project (100 points)

Educational Level
BA degree and above
Diploma
Certificate
Grade 8-12
Below grade 8

2.3.

50
40
0

Rating
Excellent
Very good
Good
Satisfactory
Unsatisfactory

Assigned
Point
100
80
60
50
25

Points
Scored

Technical Knowledge of the Key Management Staffs

of the Project (120 points)

Description
The key management staffs of the
Project have technical knowledge on
the same business for more than 3
years
The key management staffs of the
Project have technical knowledge
for more than 1 year and less than 3
years
The key management staffs have
only technical knowledge but not
engaged on same business
The key management staffs have no
technical knowledge but engaged on
same business for more than 3 years
The key management staffs have no
technical knowledge

Rating

Assigned
Point

Excellent

120

Very good

100

Good

80

Satisfactory

60

Unsatisfactory

Points
scored

*Here depending on the size and organizational structure of the project, please rate
the CEO, the general manager, department manager, production manager, etc. of the
project separately and take the average figure.

3. Capital Adequacy Risk (300 points)

9

In rating capital adequacy risk the proportion of equity to loan or operating leverage,
proportion of fixed versus variable costs, sources of capital and capacity to increase
equity contribution when required are considered.

Description

Assigned Point

Gearing/Leverage
Level of Fixed Asset vs. Variable Cost
Sources of capital
Capacity to Increase Capital

3.1.
Equity (x)
X75%
60%x<75%
50%x<60%
30%x<50
X<30%

120
80
50
50

Gearing/Leverage (120 points)

Rating
Excellent
Very Good
Good
Satisfactory
Unsatisfactory

Assigned point
120
100
80
60
0

Points Scored

X-referred to Equity Contribution of the client

3.2.

Level of Fixed Vs Variable Costs (80 points)

The proportion of variable versus fixed cost has substantial influence on the operation
and profitability of the project. Projects which have low fixed and high variable costs are
expected to have better financial performance specifically expressed by very high margin
of profit.

Proportion

Rating

Low fixed and high variable costs

Balanced fixed and variable costs
Moderately higher fixed and moderately low variable
costs
High fixed and low variable costs
10

Assigned

Points

point

Scored

Excellent

80

Very Good

70

Good

60

Satisfactory

40

Very high fixed and very low variable costs

3.3.

Unsatisfactory

Sources of capital (50 points)

Sources of capital

Rating

Return from business activities

Sales of shares
Saving
Family support, Donation, Lottery & Prize
Unidentified sources

3.4.

Assigned

Points

point
50
40
30
25
0

Scored

Excellent
Very Good
Good
Satisfactory
Unsatisfactory

Capacity to Raise Capital (50 points)

This factor is included so as to show how much the promoter has a capacity to finance the
project in cases whereby the project faces shortage of cash as a result of cost overrun and
unforeseen costs faced by the project during its implementation.

Capacity to Raise Capital from owner sources of fund

The promoter has high capacity to raise equity to implement
the project without getting additional loan.
The promoter has capacity to raise equity to maintain the
required debt equity ratio but needs additional loan for the

Rating

Assigned

Points

Point

Scored

Excellent

50

Very good

40

Unsatisfactory

completion of the project.

The promoter has no capacity to raise equity to maintain the
required debt equity ratio but needs additional loan for the
completion of the project.

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4 Market Risk (250 points)

Description

Assigned Point

Demand and Supply gap

Susceptibility to shortage of foreign currency
Susceptibility to change in price of raw material
Diversification of customers (consumers or wholesalers)
Diversification of suppliers or raw material providers
Vulnerability to Product Substitutes
T O TAL

4.1.

Demand and Supply Gap for the Products and/or

Services of the Project (50 Points)

Demand and Supply gap

Rating

10 times the project capacity & good future demand

forecast
7 times the project capacity & good future forecast
4 times the project capacity & good future forecast
2 times and below the project capacity

4.2.

50
40
40
40
40
40
250

Assigned

Points

Point

Scored

Excellent

50

Very Good
Satisfactory
Unsatisfactory

40
25
0

Foreign Currency Shortage and Exchange Rate

Fluctuation (40 Points)

Under this subtopic assessment has to be made to evaluate whether the project is
sensitive or susceptible to foreign currency shortage and exchange rate fluctuation.
Susceptibility to Foreign Currency

Rating

Shortage and Exchange Rate Fluctuation

Very Low
Low
High
Very High

4.3.

Excellent
Very Good
Satisfactory
Unsatisfactory

Assigned
Point
40
30
20
0

Points Scored

Susceptibility to Change in Price of Raw Materials

(40 Points)
12

Susceptibility to Change in Price

of Raw Materials
Very Low
Low
High
Very High

4.4.

Rating
Excellent
Very Good
Satisfactory
Unsatisfactory

Points Scored

Diversification of Customers (Consumers or Retailers or

Wholesalers ) (40 Points)

Diversification of Customers for the

products of the project
There are large number of customers for
the product or the product is totally for
export market
There are medium number customers for
the product or the product is partially for
export market
There are low number of customers for
the product and the product is totally for
local market
So far there are no customers for the
product and the product is totally for local
market

4.5.

Assigned
Point
40
30
20
0

Rating

Assigned
Point

Excellent

40

Very Good

30

Satisfactory

20

Unsatisfactory

Points
Scored

Diversification of Suppliers/Raw Material Providers

(40 Points)
Rating

Assigned
Point

Excellent
Very Good
Satisfactory
Unsatisfactory

40
30
20
0

Diversification of suppliers
More than 5
4-5
3
Below 3

Points Scored

Here, please enumerate the list and indicate the locations of the potential suppliers of the
raw materials for the project.

4.6.

Vulnerability to Product Substitutes (40 Points)

Product substitution

Rating
13

Assigned

Points Scored

Point
No product substitutes
Few product substitutes
Large number of product substitutes
Very large number of product
substitutes

Excellent
Very Good
Satisfactory

40
30
20

Unsatisfactory

5. Business Risk (250 points)

Under the business risk, conditions and/or environments in which businesses or projects
are operating should be assessed and the associated risks be identified as well based on
the following table.

Assigned

Description

Point
100
50
100

Vulnerability to Technology Changes

Socio-economic benefits
Competitor capacity
Barriers to entry in the industry (10 Points)
Competitive rivalry in the industry (10 Points)
Product innovation in the industry (10 Points)
Profit Margin in the industry (30 Points)
Competitive Advantage (20 Points)
Meeting quality control standards (20 Points)
T O TAL

5.1.

250

Vulnerability to Changes in Technology (100 points)

Vulnerability to Tech.
change
Recent and flexible to
change
1-4 years old and could be
updated for minimum cost
5-8 years old and could be
updated for minimum cost
Above 8 years old

Rating

Assigned

Points

Point

Scored

Excellent

100

Very good

80

Satisfactory

50

Unsatisfactory

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5.2.

Socio-Economic Benefits (50 points)

Socio-economic benefits shall include tax earnings to the government, employment

opportunities created in favor of the general public, foreign currency earnings or savings
etc.

Socio-economic benefits

Rating

Assigned Point

Very high socio-economic benefits

High socio-economic benefits
Medium socio-economic benefits
Low socio-economic benefits
Very low socio-economic benefits

Excellent
Very Good
Satisfactory
Unsatisfactory
Unacceptable

50
40
25
10
0

Points
Scored

Note: If possible, please give your rating by comparing to the industry average.

5.3.

Competitor Capacity (100 Points)

Before making decisions to start a new business, the promoter has to assess the
conditions of competitors environments into which the new business is planned to enter
for the successes of his/her business operations. The major factors to be considered while
assessing the environments in view of competition are as follows.

5.3.1. Barriers to Entry into the Industry (10 Points)

Barriers to entry

Rating

No barriers to enter the market for similar firms in

the industry
15

Excellent

Assigned
Point
10

Points
Scored

Some barriers by means of quotas or tariffs or

policy restrictions to enter the market for similar

Very Good

Unsatisfactory

firms in the industry

Many barriers by means of quotas, tariffs or
policy restrictions to enter the market for similar
firms in the industry

5.3.2. Competitive Rivalry in the Industry (10 Points)

Competitive rivalry

Rating

Assigned
Point

No rivalry

Excellent

10

Few rivalry firms in the industry

Large number of rivalry firms in

Very Good

Satisfactory

Unsatisfactory

the industry
Very large number of rivalry firms
in the industry

Points Scored

5.3.3. Product Diversity or Innovation Prospects of the Project

(10 Points)

Product Diversity and Innovation

Rating

Prospects of the Project

So many innovations and product
diversifications
Many innovations and product
diversifications
Some innovations and product
diversifications
No innovations and product
diversifications

Assigned
Point

Excellent

10

Very Good

Satisfactory

Unsatisfactory

5.3.4. Profit Margin in the Industry (30 Points)

16

Points
Scored

Profit Margin

Rating

More than 30%

26%-30%
21%-25%
15%-20%
Below 15%
Note: Profit margin

Assigned
Point
30
25
20
15
0

Excellent
Very Good
Good
Satisfactory
Unsatisfactory
Net income
Sales

Points Scored

100

5.3.5. Competitive and Comparative Advantages of the Project

(20 Points)
Competitive and Comparative Rating

Assigned

Advantages of the Project

So many Advantages

Point

(5 or more sound advantages)

Many Advantages
(3-4 sound advantages)
Some Advantages
(2 sound advantages)
No or 1 Advantage only

Excellent

20

Very Good

15

Satisfactory

10

Unsatisfactory

Points Scored

Note: Write down the list of competitive and comparative advantages of the planned
project over the existing firms in the industry.

5.3.6. Meeting Quality Control Standards (20 Points)

Rating

Assigned
Point

Excellent

20

Meeting Quality standards

The products meet both world
accepted standards (ISO Standards)
17

Points Scored

and local standards

The products meet only the local
standards
The products meet no standards

Very Good

15

Bad

Note: This parameter can only be used to evaluate loan applications came to the Bank for
credit facilities meant for expansion of the projects or loan buyout purposes.

6. Summary
Based on the above parameters and points scored, show your results of rating the
standard measurement scales for the particular business/applicant strength that you have
evaluated by the following table.

X>1275
1125x1275
975x<1125
750x<975
X< 750

Grade Interval

Rating List

(85%-100%)
(75%-85%)
(65%-75%)
(50%-65%)
(Below 50%)

Prime
Acceptable
Watch list
Doubtful
Loss

Your Rating
(Show the result by

X=Cumulative total of all mentioned risks under business/applicant strength.

B. Collateral Strength
The term collateral refers to fixed and/or movable assets of the project or out of the
project or other securities which have been pledged to the Bank to provide guarantees for
loan repayments. It helps the bank, to some extent, to decrease credit losses during events
of defaults of the client. A particular collateral or security may be held in order to cover a
particular loan or multiple loans.

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Sell of collateral is, therefore, the last option to the Bank when the project fails to service
the loan as per the contract agreement entered between the Bank and the borrower. To
evaluate the strength of the collateral, whether loan security offered is able to provide
adequate guarantee to the loan or not, shall be rated as follows:

Strongly secured

Fully secured

Partially secured with moderate risk

Partially secured with high risk

Poorly secured

First and foremost in taking collateral on loans three conditions shall be properly
examined. These conditions are seniority, protection and control. Seniority refers to the
non-existence of a preferential claim to the collateral by third organ. Protection mean a
determination of proper margin for lending against collateral and control signifies
knowing at all time how the condition of collateral is and its value at a specific time. By
assuming that seniority and control are in place the analysis in this heading is concerned
with protection.
The evaluation of collateral depends on its nature. Therefore, it is better to classify the
collateral into collateral of fixed assets such as building and vehicles and Government
guarantees and other securities separately. Although evaluation of collaterals offered to
the bank must be done when loans are granted, in measuring risks of the Bank, evaluation
of the collateral has not given a prime importance. To show how much the loans of the
Bank are backed by collateral coverage, however, the following assessments should be
done at pre-credit stage.

1. Collateral of Fixed Assets (Building and Vehicles)

In order to classify the loan on various security standards, the following steps shall be
first determined:

Calculate the loan amount (it may be one or more) secured by the collateral.
Second degree collateral may not be included in this calculation.
19

Estimate the value of the collateral or security accurately based on sufficient

grounds.

After determination of collateral value and loan amount, divide the value of
the collateral to the loan amount in order to arrive at a particular percentage.

2.

Other Guarantees and Securities

In case of cash, Government and bank guaranties the agreed amount with the institutions
is considered and divided by the loan amount.
Based on the above mentioned procedures rating points shall be as follows:
Your Rating
Grade Interval

Security Strength

(Show the result by

x150%

Strongly secured

125%x<150%

Fully secured

100%x<125%

Partially secured with a moderate risk

75%x<100%

Partially secured with a high risk

x<75%

Poorly secured with a very high risk

X= Collateral value divided by loan amount

C. Credit Risk Measurement Matrix

The combination of borrower and collateral strengths are used to establish appropriate
risk grade. By applying these variables the following credit risk-rating model is
established by adapting the Standard and Poors (S&P`s) issuer rating.

Security Strength
Strongly Secured

Borrower/Business Strength
Prime
AAA
20

Acceptable

Watch list

AA

Doubtful
B

Loss
B

Fully Secured

AA

BBB

CCC

Partially Secured with moderate risk

BBB

BB

CCC

CC

Partially secured with high risk

BBB

BB

CCC

CC

Poorly secured with high risk

BB

CCC

CC

Note: The shaded area of the above table shows the possibility whereby the projects
appeared to the Bank are found to be feasible and bankable for financing.

Based on the above risk rating matrix, risk level is listed below:
Risk Grade
AAA
AA
A
BBB
BB
B, CCC, CC, C, and D

Risk Class

Your Rating
(Show the result by

Extremely lower risk

Very low risk
Lower risk
Acceptable risk
Medium risk
High risk

Hereby it is to be noted that this risk rating criteria shall be used to screen at the outset to
reject or accept the application for the loan.

Note: Explanations on symbols used for rating

AAA-stands for extremely strong capacity to meet financial Commitment
AA-stands for strong financial capacity to meet commitment
A- stands for strong commitment, but vulnerable to adverse changes in risk factors.
BBB- stands for adequate capacity to meet its commitment but highly vulnerable

to adverse changes in risk factors.

BB- stands for an obligor in this category is highly vulnerable to adverse changes

in risk factors and faces major uncertainties and exposures to adverse business,
financial or economic conditions which could lead to inadequate capacity to meet
financial commitments.
B- stands for an obligor currently has the capacity to meet its commitments, but

adverse conditions impair the capacity to meet commitments,

21

 CCC-stands for an obligor is extremely vulnerable to adverse changes in risk

factors and dependent upon favorable business, financial and economic conditions
to meet financial commitments.
CC-stands for extremely high vulnerability to uncertainties and major exposure of

adverse conditions.
C-stands for close to or already bankrupt
D-stands for payment default which has actually occurred on some financial

obligations.

2.2. POST CREDIT RISK MEASUREMENT

A. Performance Indicators
Post credit risk begins after the first disbursement onwards. The following benchmarks
are used to measure risk at post credit stage. These can be divided into seven broad
categories. These are Financial Information, Production capacity and cost structures,
Competitiveness; Marketing, Growth Potential of the Project; Project Management,
Environmental Impact, and promoters character and collateral strength.
The table below shows the seven categories of rating criteria and corresponding assigned
values.

Rating Factors
Financial Information
Production capacity and production cost
Market
Growth Potential of the Project
Project Management
Environmental Impact
Promoters character (Promoters/Business strength)
Total values assigned

1. Financial Information (300 Points)

22

Assigned Points
300
100
200
100
300
100
400
1500

Financial information can be obtained from organized documents which includes

financial statements, transactions, financial ratios, etc. which are used by internal
management, external stakeholders and government to pass sound decisions. It is also
compared with the organization plan, budget as well as the common industry average of
the same firms.

The following factors are considered under this subtitle:

Assigned

Description

Points
80
70
50
50
50
300

Management of Financial Reports

Liquidity
Return on Asset
Capital Structure
Proportion of Variable and Fixed Costs
T O TAL

1.1 Management of Financial Reports (80 Points)

Management of Financial Reports

Rating

Assigned

Points

Points

Scored

Recording, organizing, Analyzing, controlling and

reporting financial transactions meet the required

Excellent

80

Very Good

60

Satisfactory

40

standards
Recording, organizing, Analyzing, controlling and
reporting financial transactions moderately meet the
required standards
Recording, organizing, Analyzing, controlling and
reporting financial transactions fairly meet the required
standards
Poor Recording, organizing, Analyzing, controlling and
reporting financial transactions poorly meet the required
standards

23

Unsatisfactory

1.2 Liquidity (70 Points)

Liquidity

Rating

Current asset to current liability 4:1-3:1

Current asset to current liability 3:1-2:1
Current asset to current liability 2:1-1:1
Current asset to current liability 1:1 & below

Very Good
Good
Satisfactory
Unsatisfactory

Assigned

Points

Points
70
50
35
0

Scored

Assigned

Points

Points
50
40
25
0

Scored

1.3. Return on Asset (50 Points)

Profitability

Rating

Return on Asset is above 15% per annum

Return on Asset is 10%-15% of per annum
Return on Asset is 5%-9% per annum
Return on Asset is below 5% per annum

Excellent
V. Good
Satisfactory
Unsatisfactory

Note:

, where ROA is Return on Assets

1.4. Capital Structure (Debt-Equity Ratio) (50 points)

Capital Structure (Debt-Equity Ratio)

Debt to equity ratio = 1:1
Debt to equity ratio = 2:1
Debt to equity ratio = 3:1
Debt to equity ratio = 4:1
Debt to equity ratio >4:1

Rating

Assigned

Points

Points
50
40
30
10
0

Scored

Excellent
V. Good
Satisfactory
Unsatisfactory
Unacceptable

1.5. Proportion of Variable and Fixed Costs (50 points)

24

Proportions
Low fixed and high variable costs
Balance of fixed versus variable cost
Moderately higher fixed and variable cost
High fixed and low variable costs
Very high fixed and very low variable costs

Rating
Excellent
Very Good
Good
Satisfactory
Unsatisfactory

Assigned
Points
50
40
30
25
10

Points
Scored

2. Production Capacity and Production Cost of the Project (100 Points)

2.1 Annual Growth Rate (50 Points)
Annual Growth Rate

Rating

Above 20% increment in annual production growth

15%-20% increment in annual production growth
10%-14% increment in annual production growth
5%-9% increment in annual production growth
<5% increment in annual production growth

Excellent
V. Good
Good
Satisfactory
Unsatisfactory

2.2.

Assigned
Points
50
40
30
25
0

Points
Scored

Cost Structure (50 Points)

Cost Structure

Very low production, storage, marketing and admin

costs per unit.
Low production, storage, marketing and admin
costs per unit.
Moderate production, storage, marketing and
admin costs per unit.
High production, storage, marketing and admin
costs per unit.
Very high production, storage, marketing and

Rating

Assigned
Point

Excellent

50

V. Good

40

Good

30

Satisfactory

25

Points
Scored

Unsatisfactory
0
admin costs per unit.
Note: If it is possible, please compare the cost structure of the project to the industry
average.

3. Market Risk (200 Points)

Identifying markets for input and output is critically important for the success of any
project. Not only identifying but also acting accordingly is also important too. Under this
heading Competitiveness, degree of dependency and vulnerability to inputs and outputs
market should be assessed to identify the associated risks.
25

3.1.

Competitiveness (100 Points)

3.1.1. Competition by Quality of Products or Services
(50 Points)

Quality

Rating

Products or services meet world and local

standards
Products or services meet local standards only
Standard of the product/service is not rated yet
but has many customers
Products or services do not meet at least the
local standard

Assigned

Points

Points

Scored

Excellent

50

V. Good

40

Satisfactory

25

Unsatisfactory

3.1.2. Competition by Price of the Products or Services

(50 Points)
Price of the Products or Services

Rating

Very low price in the market

Moderately low price in the market
Equivalent price to the market price.
High price compared to the market price.
Very high price compared to the market price.

Excellent
Very Good
Good
Unsatisfactory
Unacceptable

Assigned

Points

Points
50
40
30
15
0

Scored

3.2. Dependency (50 points)

It refers to the accessibility of the project both to outputs and inputs markets. Analysing
market share, segmentation, diversification and timing are important to take precaution
measures.
Description

Assigned

Points
Scored

Excellent

Points
50

V. Good

40

Rating

Highly diversified customers and suppliers base

Limited customers and/or suppliers of sales or
purchases
26

Customers and/or suppliers limited to few Industries,

sales or purchases
Highly dependent on one or two other industries or
customers group

Satisfactory

25

Unsatisfactory

10

Unacceptable

Completely dependent in one industry or customer

3.3. Vulnerability to output substitutes (50 points)

Description

Rating

Assigned

Points
Scored

No substitute available or likely

Excellent

Points
50

Few substitutes available or high switching costs

V. Good

40

Satisfactory

25

Unsatisfactory

10

Moderate no of substitutes available or moderate switching

costs
Many substitutes easily available or no switching costs

4. Potential of the Project for Growth (100 Points)

At this point, assessment must be made so as to evaluate the DBE financed projects in
terms of their potential for growths i.e., horizontal and vertical growths which they can
fetch during their periods of operation. When it is said the potential of the projects for
horizontal growth, it means that the future capacity of projects for expansion of their
activities into other geographical regions and/or increment of the range of products and
services they offer to the current markets. In a similar manner, the potential for vertical
growth of projects means future capacity of the business enterprises to take over
functions previously performed by a supplier or a distributor.

27

Potential of the Project

for Growth
High potential for both
horizontal and vertical growths
High potential for either
horizontal or vertical growths
Medium potential for both
horizontal and vertical growths
No
potential
for
both
horizontal and vertical growths

Rating

Assigned
Points

Excellent

100

Very Good

80

Satisfactory

50

Unsatisfactory

Points Scored

Note: Please give justifications for your ratings.

5. Project Management and Personnel (300 Points)

Project management plays a vital roll for the success of a given business enterprise. A
weak management can cause project failures as opposed to expectations of the loan
appraisal reports. In order to take remedial action, evaluation of project management is
necessary and the assessment is based on the following points.

Description
Experience of the key management staff of the project
Qualification & skill of key management staff of the project
Task Performance of the key management staff of the project
Salaries and benefits of employees of the project
T O TAL
28

Assigned
Point
90
90
80
40
300

5.1. Experience of the key management staff of the project (90 Points)
Rating

Level of experience (X)

X 5 Years
X = 4 Years
X = 3 Years
X = 1-2 Years
X <1 year

5.2.

Assigned

Points

Point
90
60
45
30
0

Earned

Excellent
V. Good
Satisfactory
Unsatisfactory
Unacceptable

Qualification or Educational Background of Key

Management Staffs of the Project (90 Points)

Qualification of Key Managers

Rating

First Degree or above

Diploma
Certificate
Grade 8-12
Below grade 8

Excellent
Good
Satisfactory

Unsatisfactory
Unacceptable

Assigned

Points

Point
90
60
45
20
0

Scored

5.3. Task Performance (80 points)

Not only the education and experience of the management staff that greatly matters, but
understanding the business character, performing what is required accurately on time and
handling of such necessary statistical facts are also crucial in assessing management
capability.
Tasks
Understanding the business character, accurate planning,
adhering to plan implementation, and information handling
Understanding the business character, accurate planning and
implementation but information handling is not proper
Business character is understood and the plan is accurate but
plan implementation and statistical information is lacking
Business character is well understood but the remaining
duties are not proper
All tasks of the business are performed without plan and no
relevant documentation of facts

Rating

Assigned
Point

Excellent

80

V. Good

60

Satisfactory

40

Unsatisfactory

20

Unacceptable

5.4. Salaries and benefits of employees of the project (40 Points)

29

Points
Scored

Salary and Benefits

Rating

Very good salary and benefit package compared to

Point

Scored

40

V. Good

30

Satisfactory

25

Unsatisfactory

competitors firms.
Equivalent salary and benefit package compared to

competitors firms.

Points

Excellent

competitors firms.
Good salary and benefit package compared to

competitors firms.
Low salary and benefit package compared to

Assigned

6. Environmental Impacts and Employee Safety (30 Points)

Environmental Impacts and Employee safety
No environmental impact, high employee safety
No environmental impact, moderate employee safety
Low environmental impact, moderate employee safety
High environmental impact, Low employee safety

Rating
Excellent
V. Good
Satisfactory
Unsatisfactory

Assigned

Points

Point
30
25
15
0

Scored

7. Borrowers/Business Strength (400 Points)

It is clear that when loans granted to borrowers, banks expect the loans will be recovered
from the incomes generated from the normal operation of the businesses on regular bases.
To this end, the adequacy of the under listed variables are crucial. The description, rating
and associated point of each variables are shown separately as follows.

Description
Loan Repayment Status and Default Risk
Condition for Settlement of Loan (100 points)
Intentional Failure (100 points)
Diversion of Fund (100 points)
Tax settlement Conditions of the Borrower
T O TAL

30

Assigned Point
300

100
400

7.1. Loan Repayment Status and Default Risk (300 points)

7.1.1. Loan Settlement (100 points)
Condition of loan settlement

Rating

Settled the loan regularly meeting the agreed repayment

Assigned

Points

Point

Scored

Excellent

100

Very Good

75

loan is past due 90 days or more but less than 180 days.
Settled the loan after it was classified as doubtful, i.e. the

Satisfactory

50

loan is past due 180 days or more but less than 360 days.
Settled the loan after it was classified as loss, i.e. the loan is

Risky

30

Unsatisfactory

15

Unacceptable

schedule.
Settled the loan after it was classified as special mention, i.e.
the loan is past due 30 days or more, but less than 90 days.
Settled the loan after it was classified as substandard, i.e. the

past due 360 days or more.

Settled the loan by a means of legal measures

7.1.2. Intentional Failure (100 points)

Description

Rating

Generates sufficient income and not lags behind the

repayment period
Generates sufficient income but lags behind the loan
repayment period by 30-90 days

Excellent

Assigned
Point
100

V. Good

75

Satisfactory

50

Risky

30

Generates sufficient income but lags behind loan

repayment period by 91-180 days
Generates sufficient income but lags behind loan
repayment period by 181-360 days
31

Points
Scored

Generates sufficient income but lags behind loan

Unsatisfactory
repayment period by more than 360 days

15

Generates sufficient income but settled the loan by a

Unacceptable
means of legal measures

7.1.3. Diversion of Fund (100 points)

Under this category diversion of loan and diversion of income are treated separately.

7.1.3.1. Diversion of loan (50 points)

Assigned

Points
Scored

Excellent

Point
50

V. Good

40

Satisfactory

25

Unsatisfactory

10

Unacceptable

Description

Rating

Did not divert the whole loan amount

Diverted part of the loan for expansion
program of same business
Purchased inferior quality of machinery and
siphoning off part of the loan for other
purpose
Diverted part of the loan to unrelated business
activities
Diverting the whole loan amount to unrelated
business

7.1.3.2. Diversion of project Income (50 points)

Assigned

Points
Scored

Description
Did not divert the project income
Diverted the whole project income for

Rating
Excellent

Point
50

expansion of the same project

Diverted part of project

V. Good

40

expansion of the same project but the loan

Satisfactory

25

account shows some unsettled balances

Diverted part of project income to other
activities and paid the remaining balance.
Diverted the whole project income to other

Unsatisfactory

15

Unacceptable

income

for

32

activities.

7.2. Tax settlement Conditions of the Borrower (100 points)

Condition of

project income tax

Rating

Assigned Point

settlement
Settled project income tax on time.
Settled project income tax a little

Excellent
Very Good

100
75

behind schedule
Settled project income tax after a

Satisfactory

50

Unsatisfactory

25

Unacceptable

reminder has been served

Settled project income

tax

by

implementing legal measures

The borrower did not pay project
income tax

Points Scored

8. Summary
Based on the above parameters and points allotted, standard measurement scale for the
particular business/applicants strength can be grouped as follows:

Grade Interval
X>1275
1125x1275
975x<1125
750x<975
X< 750

(85%-100%)
(75%-85%)
(65%-75%)
(50%-65%)
(Below 50%)

Rating List

Your Rating
(Show the result by

Prime
Acceptable
Watch list
Doubtful
Loss

X=Cumulative total of all mentioned risks under business/applicant strength.

33

B. Collateral Strength (Last Option)

Sell of collateral (loan security) is the last option of the Bank when the project fails to
service the loan as agreed between the Bank and the borrower. A particular collateral or
security may be held in order to cover a particular loan or multiple loans. At the level of
post credit measurement phase, in a similar manner with that of the pre credit risk rating
stage, it is important to rate the strength of the collateral held by the Bank, whether it
provides adequate coverage or not, and the rates shall be as follows:

Strongly secured

Fully secured

Partially secured with moderate risk

Partially secured with high risk

Poorly secured with a very high risk

The evaluation of collateral depends on its nature. Therefore, it is better to classify the
collateral into collateral of fixed assets such as building and vehicles and Government
guarantees and other securities separately.

1. Fixed Assets (Building and/or Vehicles) Held as Collateral

In order to classify the loan on various security standards, the following steps shall be
first determined:

Calculate the loan amount (it may be one or more) secured by the
collateral. Second degree collateral may not be included in this
calculation.

Estimate the value of the collateral or security accurately based on

sufficient grounds.

After determination of collateral value and loan amount, divide the

value of the collateral to the total loan outstanding balance in order to
arrive at a particular percentage.

34

2. Other Guarantees and Securities

In case of Cash, Government and Bank guaranties, the agreed amount of the offered
guarantees will be considered and divided by the total loan outstanding balance.
Based on the above-mentioned procedures, rating points shall be as follows:

Grade Interval

Your Rating

Security Strength

(Show the result by

x150%
125%x<150%
100%x<125%
75%x<100%
x<75

Strongly secured
Fully secured
Partially secured with a moderate risk
Partially secured with a high risk
Poorly secured with a very high risk

X= Collateral value divided by the total loan outstanding balance.

C. Credit Risk Measurement Matrix

At the post credit risk level, the combination of borrower and collateral strength is also
used to establish appropriate risk grade. By applying these variables the following credit
risk-rating model is established by adapting the Standard and Poors (S&P`s) issuer
rating.

Borrower/Business strength
35

Security strength

Prime

Watch

Acceptable

list

Doubtful

Loss

Strongly Secured
Fully Secured

AAA
AA

AA
A

A
BBB

B
B

B
CCC

Partially Secured with moderate risk

A
BBB
BB

BBB
BB
CCC

BB
CCC
CC

CCC
CC
C

CC
C
D

Partially secured with high risk

Poorly secured with high risk

Note: The shaded area of the above table shows whereby the projects financed by the
Bank fall in an acceptable range with different level of strengths of the borrower or the
business and the security pledged to the Bank.
Based on the above risk rating matrix, risk level is listed below:

Risk Grade
AAA
AA
A
BBB
BB
B, CCC, CC, C and D)

Risk Class

Your Rating
(Show the result by

Extremely lower risk

Very low risk
Lower risk
Acceptable risk
Medium risk
High risk

Note: As the above ratings are applicable for projects at the phase of production, here it is
also recommended that it is important to rate projects at the phase of implementation and
when they are under progress so as to take the necessary action on time to achieve the
required results.

Note: Explanations on symbols used for rating

AAA-stands for extremely strong capacity to meet financial Commitment
AA-stands for strong financial capacity to meet commitment
A- stands for strong commitment, but vulnerable to adverse changes in risk factors.
BBB- stands for adequate capacity to meet its commitment but highly vulnerable

to adverse changes in risk factors.

BB- stands for an obligor in this category is highly vulnerable to adverse changes

in risk factors and faces major uncertainties and exposures to adverse business,
36

financial or economic conditions which could lead to inadequate capacity to meet

financial commitments.
B- stands for an obligor currently has the capacity to meet its commitments, but

adverse conditions impair the capacity to meet commitments,

CCC-stands for an obligor is extremely vulnerable to adverse changes in risk

factors and dependent upon favorable business, financial and economic conditions
to meet financial commitments.
CC-stands for extremely high vulnerability to uncertainties and major exposure of

adverse conditions.
C-stands for close to or already bankrupt
D-stands for payment default which has actually occurred on some financial

obligations.

37