SME Portfolio Credit Stress Testing Program Bangladesh Bank

Sukamal Sinha Choudhury General Manager Bangladesh Bank

SME at a glance in Bangladesh

SMEs in Bangladesh comprises of cottage, micro, small and medium enterprises SMEs comprise about 99% of private industrial establishments Of the total share of manufacturing value added to GDP, SMEs contribution is estimated at 28-30% SMEs employment are about 80% of total industrial labor force SMEs are taking finances both formally and informally SME is accelerating financial inclusion which in turn helping to achieve the targeted growth of the economy Half of the population is women who are not involved in economic activities

SME Priority and Strategy

Government Priority :
Formulating a separate policy for SME Promulgation of new industrial policy in 2010. Defining SMEs Giving emphasis to booster sectors Including cottage and micro enterprises to SME definition Formulating a strategic committee to achieve objective of the SME policy

Bangladesh Banks Priority :

Bringing SME Banking under proper monitoring and supervision of the Central Bank Ensuring end use of SME credit through monitoring and evaluation Financial inclusion of marginal, small and women entrepreneurs Capacity development of the bankers

Central Banks Policy Initiatives

Formation of a Separate Department Objective of the Department
Reduction of poverty and hunger Women empowerment Employment generation Gender equality Economic development of the country

Formulating SME credit policy and programs Bringing Discipline in SME Financing Performing Environment Friendly SME Activities Emphasis has been shifted from large credit to small credit Emphasis on manufacturing and service sector.

Central Banks Policy Initiatives

Bangladesh Bank has issued SME credit policy and programs where following a number of new measures have been taken:
Target Based Lending (TBL) Cluster Financing (CF) Women Entrepreneurship Development(WED) Promotion of SME issues Training [for bankers and entrepreneurs] Incentives for bankers

Stakeholders in SME financing

47 Commercial Banks and 30 Non Bank Financial Institutes Bangladesh Bank International Donor Agencies (Refinance Programs)
ADB WB (IDA Credit)/EGBMP JICA

Ministries- Ministry of Finance, Ministry of Industries Chambers/Business Organizations

The federation of Bangladesh Chambers of Commerce and Industry (FBCCI) Dhaka Chambers of Commerce and Industry (DCCI) Metropolitan Chambers of Commerce and Industry (MCCI) National Association of Small and Cottage Industries in Bangladesh (NASCIB)

Role of Bangladesh Bank

Formulation and circulation of SME related policy, rules, regulations and guidelines Review and evaluation of SME Financing activities of Banks and NBFIs Supervision and monitoring of SME Financing Monitoring Cell Mobile monitoring Onsite & Offsite supervision Help create a SME credit market Maintenance of Low cost refinance fund- JICA, ADB, WB & BB Own Fund Cluster Financing Promotion and Development Arranging Fair, Seminar, Workshops, Exchange of Views, Awareness building Capacity Development of Bankers and Entrepreneurs

Defining SME in line with Industrial Policy

The basis of Bangladeshi definition is assets [excluding land & building] and/or number of employee employed. The latest definition was adopted in the industrial policy 2010 and by SMESPD of BB circular No 01 of 2011.
Criteria Size Cottage Fixed Asset excluding land and Building (million BDT) Manufacturing < 0.5 Service Trade No. of Manpower employed Manufacturing Service Trade

10 [including family members]

Micro

> 0.5 - 5.0

< 0.50

< 0.50

10-24

< 10

< 10

Small

> 5.0- 100.00

> 0.50 - 10.0

> 0.50 - 10.00

25- 99

10-25

10-25

Medium

>100.00-300.00 >10.00- 150.00 >10.00-150.00

100-250

50-100

50-100

SME Financing Performance & Evaluation

(Amt in bn USD)
10 9 8 7 6 5 4 3 2 1

8.72 7.12 7.38 6.71

6.69 4.86

0
2010 2011 2012

SME Credit has a persistent increase over the last three years. Financial Institutes set their targets by themselves and achieve targets.

Target

Achievement

Small Enterprise Financing Performance and Evaluation

Disbursement to small enterprises and share increasing
(Amt in bn USD) Credit to Small Total SME Enterpri Credit ses
100% Rate of Increase 80%
56.98%

Year

Share

51.87%

45.77%

60%

2010
2011 2012

2.88
3.23 4.73

6.69
6. 71 8.72

43.02 48.13 54.23 +11.82% +12.67%

40% 20% 0%
2010 2011 2012 43.02% 48.13% 54.23%

Small

Medium

SME Financing Performance and Evaluation

Disbursement to manufacturing and service sectors has increased in the last three years. Disbursement to women entrepreneurs has also increased both in number of enterprises and in amount Disbursement to new enterprises has increased considerably
0.3 3 2.5 2 1.5 32.0%

31.4% 31.0%
30.0%

29.4% 28.3%

29.0% 28.0% 27.0% 26.0%

1 0.5 0

2010

2011 Disbursement

2012 Share

Disbursement to Mfg. (bn USD)

4.0% 0.25 0.2 0.15 0.1

SME Credit Performance Rating of Banks/NBFIs on the basis of target achievement, sectoral segregation, women Entrepreneur financing, cluster financing & promotional activities.

3.8%

3.8% 3.6%

3.4%

3.4%

0.05
0 2010 2011 Disbursement

3.2% 3.2%
3.0% 2012 share

Disbursement to Women Ent. (bn USD)

SME Credit portfolio (As on Dec/2012)

Credit Exposure to SME Sector
23.5 23 22.5 22 21.5 21 20.5 20 2010 2011 2012 0 2010 2011 2012 NPL% SNPL% 10 7.27% 3.49%

Comparative NPL position

15 10.03%

22.9%

21.5%

6.12% 3.36%

6.71%

21.2%

SME credit has overall increase over the last three years.

Non performing loan in SME sector is always much lower than NPL in overall credit. An increase in the NPL in the SME sector (also in overall credit) may be explained by introduction of newer loan classification system under BASEL II .

Stress Testing: A Modern Supervisory Technique

Importance
Stress testing is Central to the Basel II Supervisory Framework; Large Banks & Supervisory or Financial stability authorities worldwide are employing stress tests for their risk analysis. Recent global financial markets turmoil also highlighted the importance of stress tests.
Objective

Safeguarding and maintaining financial stability for achieving and maintaining price stability.

Defining stress testing

Stress testing is a risk management technique used to evaluate the potential effects on an institution's financial condition of a specific event and/or movement in a set of financial variables. It is an integral part of the BIS Capital Adequacy framework. -BIS Stress testing is a simulation technique, used to determine the reactions of different financial institutions under a set of exceptional, but plausible assumptions through a series of tests. Bangladesh Bank (the Central Bank of Bangladesh) first adopt Stress Testing in 2010 Established a New Department in Bangladesh Bank Financial Stability Department

Banking System of Bangladesh

As on June, 2012 USD in Million
Banks/ NBFIs No. of Banks/ NBFIs No. of Branche s Total Assets Total Deposit Total Loans & Advances Total SME Credit

Amount

% of the Industry

Amount

% of the Indust ry 97.5%

Amount

% of the Industry

Amount

% of the Industry

Banks SCBs DFIs PCBs FCBs

47 4 4 30 9

8059 3449 1417 3130 63

83679.5 22735.1 4733.0 50890.9 5320.5

95.5%

63354.4 16746.1 3123.2 39687.7 3797.4

51878.6 11157.3 3334.2 34423.6 2963.5

92.6%

11581.5 3135.4 667.8 7496.5 281.8

96.9%

NBFIs

31

164

3960.0

4.5%

1593.7

2.5%

4137.0

7.4%

371.2

3.1%

Total

78

8223

87639.5

100%

64948.1

100%

56015.6

100%

11952.7

100%

1 USD = BDT 77.93; 1 USD= AED 3.6729

Bangladesh Banks Stress testing Guidelines

Banks & NBFIS
Guidelines on Stress Testing Issued on April 21, 2010

Objective:
To ensure soundness and stability of the banking system.

First time in Bangladesh

Banks
Revised Guidelines on Stress Testing
Issued on February 23, 2011 Incorporate some new issues Sensitivity Analysis for Interest Rate based Stress Test International standard practice for liquidity Stress Test Inclusion of VaR Analysis Changing Frequency LevelQuarterly

NBFIs
Revised Guidelines on Stress Testing for NBFIs Issued on 12 July, 2012 Incorporating New dimensions
Introducing Insolvency Ratio (IR) Introducing Stress Testing Rating Scale (WAR-WIR)
16

Bangladesh Banks Stress testing Guidelines At the system levelStress Tests are primarily designed to quantify the impact of possible changes in economic environment on the financial system.

At Institutional Level Stress Test technique provide a way to quantify the impact of changes in a number of risk factors on the assets and liabilities portfolio of the institution.

17

The objective of stress testing

It helps banks in assessing their potential vulnerability to adverse changes in market conditions, e.g.

the extent to which their asset quality might be affected by an economic downturn.
how the value of their securities holdings might be affected by changes in interest rates/credit spreads. provide banks with more forward-looking information to manage their risks and enable them to be better prepared for stressed situations.

Supervisors can make use of stress tests to monitor the risk profile of individual banks and assess the strength and soundness of the banking system.
18

Stress Testing Process

Identification of Specific Vulnerabilities

Construction of a Scenario

Performing Numerical Analysis

Considering the Numerical Analysis

Summarizing and Interpreting results

19

Scope of Stress Testing

Simple Sensitivity Analysis

(First Guideline, 2010)

Intt. Rate

F.Ex Rate

5 Risk Factors
Stock Prices

Forced Sale value of Collaterals

NPLs

Liquidity : Stressed Separately

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Scope of Stress Testing (Revised Guidelines)

Maturity Gap Analysis for Intt. Rate Risk

Duration Gap Analysis for Change in Market value of equity

Value at Risk (VaR) for Estimating actual amount of potential loss

Scope of Stress Testing

Stress test is carried out assuming three different hypothetical scenarios:
Minor Level Shocks:
Small shocks to the risk factors; The level for different risk factors can, however, vary.

Moderate Level Shocks:

Medium level of shocks; The level is defined in each risk factor separately.

Major Level Shocks:

Big shocks to all the risk factors; The Level also defined separately for each risk factor.

Assumptions behind each Scenario:

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.
22

Techniques
Simple Sensitivity Analysis
Measures the change in the value of portfolio for shocks of various degrees to different independent risk factors . Ex.: Adverse movement of intt. Rate by 100 basis and 200 basis. The Impact will be measured only on dependent variable (e.g. Capital)

Scenario Analysis
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. Stress testing can be based on The historical scenarios- a backward looking approach, or The hypothetical scenario-a forward-looking approach. Maximum Shock Scenario measures the change in the risk factor in worst-case scenario (level that wipe out Capital)
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Stress test results: Banking System Aggregate

The Banking system in Bangladesh is largely risk sensitive to the credit risk. Intt. Rate Risk, Ex. Rate Risk, Equity Price Risk do no bring down the CAR below the required level.

Source: Financial Stability Report, 2011-BB

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Stress test results

Negative Impact on CAR due to Stress on Different Factors (Bank Group-Wise) (as of December 2012)
Factors Default of sector concentration-1 Default of top large loan borrowers Negative shift in NPL categories Decrease in FSV of the collateral Change in interest rate SCB 3 4 4 4 1 PCB (Conv.) 0 18 0 1 1 PCB (Is.) 1 4 1 1 1 FCB 0 2 0 0 0 SDB 2 2 2 2 0 Total 6 30 7 8 3 No possibility of concentration in SMEs

No possibilities for SMEs

Most SME loans are collateral backed
(value more than double
of loan size)

SME Loans are out of Spread

SMEs in BD have insignificant international exposure

Change in exchange rate

Change in equity price Increase in NPL

3
3 3

0
2 7

1
1 2

0
0 0

1
1 2

5
7 14

25

Linkage Between Stress Testing and SME Financing For SME provisioning is set at 0.25% against 1.0% provisioning for other credits Credit Shock leads to Capital Adequacy Shock
UC
Rate of Provision

SMA

SS

DF

BL
0.25%

Minor

Moderate

Major

Therefore, the shock is lower for SME financing

Banks SME Exposure & CAR

Top 10 SME Exposure Banks
2011 Name of Banks BASIC Uttara Janata SME Exposure (%) 72.5 53.2 50.4 CAR (% of RWA) 10.13 12.79 9.19 Required Minimum CAR of RWA= 10% as per Basel II All the Top 10 SME exposure Banks except Janata (a SCB) Bank maintained the minimum requirement. It is expected that the banks (except a few) is resilient to minor shocks due to credit, interest rate risk could be arisen for SME exposures.

BRAC
Exim UCBL AB Bank IBBL IFIC

48.7
38.8 35.9 32.3 31.5 26.5

11.6
10.89 10.44 11.37 13.09 10.01

DBBL

25.1%

11.23

Limitations and Challenges

Stress testing:
SME financing has gained focus in Bangladesh only since 2010, therefore the market is still nascent. Stress testing for sectoral lending is also newer idea in Bangladesh. Bangladesh Bank is still doing the stress testing on trial and error basis State-of-the art online reporting system by Banks/NBFIs not yet established. SCBs with large branch network are lagging behind; and they are unable to accommodate with modern technology, approaches and initiatives. Lack of trained officials both in Banks and NBFIs.

A new department established in Bangladesh Bank. However, the bank is working under a lot of limitations.

Limitations and Challenges

SME Sector:
SME lending is usually highly supervised therefore interest rate is high. Often the enterprises can not meet collateral requirements; even not easily available. As the banks are owned by industrialists who also own large corporate, sometimes focus of the banks are concentrated on large corporate credit. Financial literacy is low in case of women and small, micro and cottage enterprises. Reduce regulatory burden for small, micro and cottage enterprises. Absence of Credit Guarantee Scheme, venture capital financing. Lack of awareness and training towards modern technology.

Future Planning
Start up financing Credit Guarantee/Insurance Scheme Venture Capital Financing Extending refinancing and prefinancing SME deposit mobilization Cluster mapping SME product marketing, specially web based marketing Non Financial Services, Governance Rating of Fis on the basis of SME financing Stress testing Other modern techniques and tools to make SME financing profitable, secured & entrepreneur friendly. Communication with international world to large extent to get benefit of modern technologies.

Q/A Thank you

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