CHAPTER ONE

1. INTRODUCTION

1.1 Back ground of the study

The environment of modern business, particularly the larger industrial unit is becoming
increasingly complied. The increased complexity creates greater needs for social attention to the
risks facing the enterprise. Most large corporations and many smaller one’s employ specialized
managers to grapple with the problems of increasing risk. Even if special risk managers are not
employed someone in the firm often the owner or chief accountant, perform risk management
functions: - such as insurance buying and loss control. The business of banking in owes the
measuring, managing and accepting of risk which means the heart of bank financial management
is risk management. Bank has been institutions that deals in money and its substitutes and provides
other financial services, banks accepted deposits, make loan and derive a profit from the
differences in the interest rates paid and charged respectively. Banks are critical to our economy.
The primary function of bank is to put use by lending it out to others who can then use it to buy
homes, business and the (Teklegiorgis Assefa 2004).

Banks are the largest and most obvious sources of credit risk. This mostly faced due to, tax credit
standards for borrowers and counter parties, poor portfolio risk management or a lack of attention
to change in economic or other circumstances. The heart of banking business is assessing credit
risk not necessarily taking risks but assessing them. The distinction is important because the ability
to assess a skill and whether credit risk is taken or not taken is management decisions.

Credit risk management in financial institution starts with the establishment of sound lending
principles and an efficient frame work for managing the risk, policies, industry specifies standards
and guidelines, together with risk concentration limits are design under the supervision of risk
management committee. These policies, standards and procedures also govern how credit risk is
measured, reported and controlled. Credit risk is the most obvious risk in the banking industry. In
unsure banks assumes credit risk when they act as itemed diaries of funds and credit risk is failure
of borrowers to pay bank their debt in accordance with requirement agree, along with interest rate
and at the agreed time. Currently it is the major treat of commercial banks whose main business is
loan and deposit as result of failure of borrowers to pay bank. Default of borrowers now a day is

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due to political and economic instability prevailing in the countries. It is customers to observe
demerit cement of sales of counters and mortgages size by banks due to failure of borrowers to
pay back their debt.

to this end, this study assesses the credit risk management practice of commercial bank of
Ethiopia’s branches in Dessie the area of establishing an appropriate credit risk environment,
operating under sound credit granting process, maintain an appropriate credit administration,
measurement and monitoring process and insuring adequate control over credit risk. The previous
researcher studies at different areas. For instance, Korgi (2011) evaluate the impacts of credit risk
management on the profitability of Nigerian bank and Achou and Tenguh (2008) show that there
is a significant relationship between bank performance and credit risk management. The researcher
studies in 2016 and these studies focus on the credit risk management in the commercial bank of
Ethiopia in Dessie town (Dawudo branch) so, there is a time and area gap between the previous
researchers and this paper and also the research focus on the collateral and ability of the applicant
to repay, managing credit risk, principle of credit risk management.

1.2 Statement of the problem

The main focus of this study is assessing the credit risk management in commercial bank of
Ethiopia. It is a well-known fact that managing credit risk is almost important to maximize
profitability. According to the various researchers is a problem of credit risk management in the
developing countries like Ethiopia. The problems are absence of clear structure allocation of
responsibilities and accountabilities, absence of information about borrower’s attitude after loan
much of information is collecting during loan documentation and commercial bank of Ethiopia.
Commercial bank of Ethiopia extends short, medium and long term loans. In giving this credit
services the bank faces default risk. Most major banking problems have been either explicitly or
indirectly the weakness in credit risk management. Previous researcher studies at different areas,
for instance korgi(2011) evaluate the impact of credit risk management on the profitability of
Nigerian bank and Achou and Tenquh(2008) show that there is a significant relationship between
bank performance and credit risk management. The research studies in 2018 and the purpose of
these study is focus on the credit risk management in Comerica bank of Ethiopia in Dessie town
Dawudo branch and also the research focus on the collateral and ability of applicant to repay or
borrowers repayment, managing credit risk, principles of credit risk management.

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1.3 Research question

The study will be try to address the following research question

1. Is there an appropriate credit risk involvement in commercial bank of Ethiopia?

2. Is the bank operating under sound credit granting process?
3. Does the bank maintain an appropriate credit administration, measurement and
monitoring process?
4. Does the bank insure an educate control over credit risk?

1.4 OBJECTIVE OF THE STUDY

1.4.1 General objective

The general objective of the study is to assess the credit risk management of commercial bank of
Ethiopia in Dessie town (Dawudo branch).

1.4.2 Specific objective

 To examine if there is an appropriate credit risk environment in commercial bank of
Ethiopia.
 To evaluate whether commercial bank of Ethiopia operate under credit grant process.
 To assess if commercial bank of Ethiopia has maintained an appropriate credit
administration, measurement and monitoring process
 To assess whether commercial bank of Ethiopia ensure educate control over credit risk

1.5 SIGNIFICANCE OF THE STUDY

This study will have its own contribution in the following important points.

 It will indicate the manager of commercial bank about the problem associated with credit
risk management.
 It will indicate appropriate solution for the problem.
 It will be used as a base for commercial bank of Ethiopia to design a better credit risk
management.
 Furthermore, the research paper will be used as a reference material for those who wants
to conduct their study on the same issue.

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1.6 SCOPE OF THE STUDY

In order to insure profitability and is financial health of the bank it should have manage risks. Like,
interest rate risk, foreign exchange risk and operational risk are types of risk. Even the above
mentioned risks face the bank the study concerns only credit risk in order managing the study.
Therefore, the scope of the study is limited only to credit risk management of commercial bank of
Ethiopia in Dessie town (Dawudo branch) for a period of 3 years i.e. from 2015 to 2017.

1.7 LIMITATION OF THE STUDY

The following are limitation, when conducting the study

 Lack of appropriate, accurate and reliable data

 Lack of the researcher past experience to conduct this research
 The respondents may not be give full information due to confidence of the information.

1.8 ORGANIZATION OF THE PAPER

This paper will be organized in to five chapters. The first chapter will conduct an introduction
part of the study i.e. (back ground of the study, statement of problems, objective of the study,
significance of the study, limitation of the study and scope of the study). The second chapter is
literature review Definition of credit risk, estimation of credit risk, types of credit risk, managing
credit risk, principles of credit risk and challenges of credit risk. The third chapter will be
conducted on the study of research methodology. The fourth chapter deals about consists of
respondent’s characteristic of data presentation and analysis and interpretation of findings .and the
final will be conclusion and recommendation of the study.

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 CHAPTER TWO

2. LITERATURE REVIEW

2.1. Definition of credit risk

Credit risk is the probability of a debtor not paying the principal or the interest due on an
outstanding debt. Interactive credit risks a measure of the credit worthiness of the issuer of
securities. Treasure securities are considered to have least credit risk because they are backed by
the federal government. In contrast corporate and municipal securities are viewed as big risky to
some degree. (Button and umbra, 2003)

The risk loss of principal or loss of financial reward statement from a borrower’s failure to repay
a loan otherwise meet contractual obligation. Credit risk refers to the risk that a borrower will
default on any type of debt by failing to make required payments. The risk is primarily that of
lender and includes lost principal interest, disruption to cash flows, and collection costs. Credit
risk is risk due to uncertainly in a counterparty’s (also called an obligor’s or credit’s) ability to
meet its financial obligations.

2.2 Estimation of credit risk

Having complied a basic file of information and investigated avenues supported by inconsistencies
derogatory comments and favorable opinions the analysis assesses the willingness and ability of
the applicant to repay.

1. Character: the customer’s willingness to meet credit obligations. An established

credit record (substantial borrowings and voluntary repayment) is one of the best
evidence of business or individuals willing to repay. Also character is implied by
applicant’s positions of trust accepted and fulfilled in business and social
organizations.
2. Capacity: it is the ability to repay debts as scheduled. The analyst considers the effect
of unusual events such as prolonged illness or unemployment on the economic capacity
of the household.
3. Capital: is asset minus liability. It provides a cushion to absorb operating and asset
lesser that night other cases impair debt repayment. Accounting values are often
adjusted for market values, encumbrance and contingency be for computing capital for
credit purpose.
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 4. Collateral: an asset pledged in case of default. The factor that should be considered
about collateral is standardization durability, Marketability and stability of value.

5. Conditions: borrowers may be subjected to unfavorable economic conditions beyond

their control. Repayment depends not only upon character, capacity, collateral and capital
but those factors our which the borrower exercises little or no control. The long run and
short run business cycle affects nearly all persons and individuals. ( R.O. Edmister, 1986).

2.3 Types of credit risk

1. Default risk

It is the risk that the issuer will go belly up and not be able to pay its obligation of interest and
principal, to help measure this risk an inventor can look at default rates. A default rate is the
percentage of a population of bonds that are expected to default. Another ration that an investor
can look at is the reoccupy rate. This rate indicates how much and investors can expect to go back
it a default occurs.

2 concentration risk

The risks associated with any single exposure or group of exposures with the potential to produce
large enable losses to certain a bank core operation. It may arise in the form of single name
concentration or industry concentration.

3. Credit spread risk

Credit spread risk is the yield spread or difference in yield securities dive to different quality the
spread reflects the additional net yield on investor that earn form securities with more credit risk
relative to one often quoted in relation to yield on credit risk.

4. down grade risk

It is a risk that abound price will decline dive to down grade in credit rating. Credit rating assigned
by agency is an indicator of default risk. The down grade risk arises from deterioration financial
condition do a company and also every bond fees this risk to a certain extent.

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5. Sovereign risk

A sovereign risk is the risk of government become unwilling or unable to meet its loan obligations
on reneging on loan it guarantees. The existence of sovereign risk means that creditors should take
a two stage decision process when deciding to lend to affirm based in foreign country. First one
should consider the sovereign quality of the county and revenue.

2.4 managing credit risk

A major part of the business of financial institution such as banks insurance company, pension
funds and finance companies is making loans. In order for this institution to earn profit they must
more successful loans that are paid bank in full. The concept of adverse selection and moral hazard
province affirm work for understanding the principle that financial institution manager must follow
to minimize credit risk make successful loans.

A adverse selection is problematic in loan markets because bad credit risk is the ones who usually
line up for loans. Borrowers with very risky investment projects in mined have matched to gain if
their projects are successful. And so they are the most eager to obtain loans. Moral hazard is a
problem in loan markets because borrowers may have in centimes to engage in activities that are
undesirable from the lenders point of view. In such institutions, it is more likely that the lender
will be exposed to the hazard of default. Once borrowers have obtained a loan, they are more likely
to inquest in high risk investment project that pay high returns to the borrower if they are
successful. The higher risk, however make it less likely that the loan will be pay back to profitable.
Financial institution must overcome the adverse selection and moral hazard problems that more
loans defaults more likely. (Mish kin and Eakins,2005). The credit risk management is a popular
among the bank and other financial resources. The main purpose of credit risk management is to
lesser or demission the effect of none performing loans comes from the customers. The procedures
and process of bank and their official crates a great impact in the flow of financial resources.
However, various economic uncertainties, international markets and financial constraints’ can
cause the financial status to be unstable.

Screening: adverse selection in loan markets requires that financial institutions screen out the
bad credit risk form the good ones, so that loans will be profitable. To accomplish effective
screening finances institutions, collect reliable information from prospective borrowers. Effective
screening and information collection together form an important principle of credit risk
management. (Mish kin and Eakins, 2005).
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Monitoring: To reduce moral hazard, financial instruction managers must adhere the principle
for managing credit risk of writing provisions in to loan contracts that prevents borrower from
engaging in overly risky activity. By monitoring borrower’s activity to see whether they are
complying with the restrictive covenants if they are not financial instruction managers can make
sure that borrowers and not taking on risk at the institutions expenses.

2.5 principle of credit risk management

The goal of credit risk management should always to maximize banks adjusted rate of return by
maintain credit risk exposure within the entire portfolio as well as the risk individuals credit or
transactions. Bank should also consider the relationships between credit risk and other risk. The
effective management of credit risk is a critical component of compressive approach to risk
management and essential to a long term success of any banking business.
(LTTP://www.bis.org/pub/bcbs 54.1tm). The basal committee established by the central bank
governors of the group often countries at the end 1970, meets regularly four times a year. The
committee promotes sound practice for managing credit risk. In line with this objective the
committee has outlined principles of credit risk management which are mainly applicable to
business of lending and it believes that banks should now have a keen awareness of the need to
identify, measure, monitor and control credit risk as well as to determine that they hold adequate
capital against these risks and that they are adequately compensated for risk incurred. Although
specific credit risk management practices may differ among banks depending up on the nature and
complexity of their credit activities, a compressive credit risk management program will address
the following four areas of credit risk management identified by the committee.

2.5.1 Establish an appropriate credit risk Environment

Principle 1: The board of director should have responsibility for approving and periodically (at
least annually) reviewing the credit risk strategy and significances credit risk policies of the bank.
The strategy should reflect the banks tolerances for risk and the level of profitability the bank
expects to achieve for incurring various credit risks.

Principle 2: Senior management should have responsibility for implementing the credit risk
strategy approved by board of directors and for developing policies and procedures for identifying,
measuring, monitoring and controlling credit risk. Such policies and procedures should address
credit risk in the all of banks activities and at both the individual credit and portfolio levels.

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2.5.2 Operating under a sound credit granting process

Principle3: Banks must operate within sound, well defined credit granting criteria. These criteria
should include a clear indication of the bank’s target market and through understanding of the
borrower or counter party, as well as the purpose and structure of the credit and its source of
repayment.

Principle 4: Banks should have a clearly established process in place for approving new credits as
well as new amendments renewal and refinancing of existing credits.

2.5.3 Containing an appropriate credit administration measurement and monitoring process

Principle 5: Banks should have in place the system for the ongoing administration of their various
credits bearing portfolio.

Principle 6: Banks must have in place system for monitoring the condition of individual’s credit
including determining the adequate of provision and resources.

Principle 7: Bank must have in place system for monitoring the overall compensation and quality
of the credit portfolio.

2.5.4 Insuring adequate controls over credit risk

Principle 8: Banks must establish a system of independent, ongoing assessment of the bank’s
credit risk management process and result of such reviews should be communicated directly to the
board of directors and senior management.

Principle9: Banks should establish and enforce internal controls and other practice to ensure that
exceptions to policies, procedures and limits are reported in a timely manner to the appropriate
level of management for action.

Principle 10: Banks must have a system in which place for early remedial action on deteriorating
credit, managing problem credit and similar work out procedures

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2.6. Challenges of risk management
 Risk management is relatively new fields: Many managers may not be familiar with its
principles and concepts. Lacking knowledge of the area, these managers are quite unlikely
to include risk management consideration in their decision making.
 Many important risk management concepts are not easily explained to managers in other
areas. Principles of probability or the relationship between information and uncertainty
may be challenging concept. Risk management also frequently requires a different
orientation towards time.
 Many important risk management issues requires scientific knowledge on the part of the
audience/and the communicator/ to fully appreciate the nature of exposure to risk.
Environmental impairment is a good example of this point. Most managers recognized the
environmental impairment can be a problem, with some possible scenarios that are
frightening.
 Attitudes towards risk are influenced by personal factors that may be unique to the
individual. Consequently, the risk manager faces the challenge of communicating
information that may be interpreted in different ways (Risk management and insurance 8
editions, William smith).

2.7. Review of empirical literature

Achou and Tenguh (2008) show that there is a significant relationship between Bank
Performance (in terms of return on asset) and credit risk management (in terms of loan
Performance). Better credit risk management results in better Bank performance. Thus, it is of
crucial importance that Banks practice prudent credit risk management and Safeguarding the assets
of the Banks and protect the Credit risk is a serious threat to the performance of Banks; therefore,
various researchers Have examined the impact of credit risk on Banks in varying dimensions.
Kargi (2011) evaluated the impact of credit risk on the profitability of Nigerian Banks.

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 CHAPTER THREE

3. METHODOLOGY OF THE STUDY

3.1. DESCRIPTION OF STUDY AREA

Commercial bank of Ethiopia (Dawudo branch) is located in Southern Wollo in Dessie town and
it fars from regions capital city of Bahr Dar 530km and from Addis Ababa 401km far.

3.2 RESEARCH DESIGN

The study will use the descriptive research method. It refers to a set of methods and procedure that describes
research variables in which the study will conduct under descriptive method in order to answer the questions
to attain general and specific objectives of the study. The descriptive research method can help the
researcher to take both qualitative and quantitative measurements. The qualitative method was helping the
researcher to use statistical measures in order to analyze what would be found by distributing
questionnaires. The qualitative measure was helping the researcher to interpret theoretically collected data.

3.3. DATA TYPE AND SOURCE

In this study the researcher will conducted primary source of data. The primary source of data is
closed ended questionnaires ‘and interviews. For collecting an effective research accurate and
reliable data are very important so, the necessary information was collected through different
methods of data collection. In this study primary source of data was used. Primary data was
collected using questioner and interview. Interview gives as detail information about specific
objectives of the study and questioner was bring as general information about general objectives
of the study. In this structured interview was used. In the questioner close ended questions is used.
It is used this source of data to gather the information and achieve the stated objectives of the
study.

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3.4 SAMPLE DESIGN AND SAMPLE SIZE

The sampling technique of the study is judgmental sampling technique. To meet the objective of
the study the data had been collected through a method of non-probability or judgmental.
Because the study will get accurate, fact, full, sufficient and reliable information from the credit
department or credit employees, so, judgmental sampling technique is essential in the credit
department. The total population number of commercial bank of Ethiopia (Dawudo branch)
officials of Dessie town is 38 employees, out of 38 employees, 19 are male and the rest are
female. From the total population the researcher selected _employees only. Thus are
managements and credit analysis, credit administers, district managers and credit appraisal
managers of the credit department

3.5. METHOD OF DATA ANALYSIS

After collecting row data through different instruments mentioned above the data was stored in
appropriate way, then after tallying them they will be analyzed and interpreted both qualitative
methods through interviews statements and quantitative methods the data collects through close
ended was explained quantitatively in percentage, tabular form, descriptive statistics involving to
determine varying degrees of response concentration regarding to principle of credit risk
management and to measure response disparity particularly for the liker scale question items.

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4. TIME AND BUDGET SCHEDULE
4.1 Time Schedule

Activities December January February march April May

No
1 Title selection √

2 Draft research proposal √ √

3 Final submission of proposal √

4 Compiling review literature √

5 Development of questionnaire and √

interview
6 Data collection √

7 Data analysis √

8 Report write the research paper √

9 Submitting the final research √

10 Presentation √

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4.2 Budget Schedule

No Items amount of items Total price of single item Total Birr

needed
1 Stationary

Binder 1 25 25

Pen 10 5 50

Paper 1 120 120

Binding 4 8 32

Writing and printing 50pages 5 250

Ruler 1 15 15

Flash 1 150 150

2 Other cost

Transport 75

Mobil card 50

Internet service 100

Total ETB. 867

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REFERANCE
 Teklegiorgis Assefa (2004) “Risk Management Insurance, 1st Edition”, Mega Printing
Enterprise.
 Credit Risk Management Objective: Http://www.Ehow.Com List 661085 Objectives
Credit Risk Management
 Fredric S. Meislkin And Stanly gherkins, (2005)”Financial Market And Institution,5th
Edition”, Addison Wesley.
 Maureen Button And Ray Lombard, (2003) “The Financial System And Economics,
3rd Edition”, Thomson South Western.
 Principle Of Credit Risk Management: Http:// Www.Bis,Org/Pub/Bcbsc 123.Pdf.
 Robert, Demister, (1986) “Financial Instruction And Market, 2nd Edition”, Mc Grew –Hall
Book Company, New York.
 Types of Credit Risk: Http:// Www. Bandg Ladesh- Bank Org/Media Room/Credit Risk.
PDF
 William Smith,” Risk Management And Insurance.8th Edition”.

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