Role of Credit Rating in The Banking Sector After Introduction of Basel Ii Regulation - A Review On Bangladesh Context

INTERNSHIP REPORT
ROLE OF CREDIT RATING IN THE BANKING SECTOR

AFTER INTRODUCTION OF BASEL II REGULATION- A
REVIEW ON BANGLADESH CONTEXT;
By
Md. Shahinuzzaman
Registration No: 01879, Session: 2008-2009
Department of Finance and Banking
Faculty of Business Administration and Management
PATUAKHALI SCIENCE AND TECHNOLOGY UNIVERSITY

DUMKI, PATUAKHALI- 8602.
April, 2013
Dedicated to
My Parents
ROLE OF CREDIT RATING IN THE BANKING SECTOR AFTER

INTRODUCTION OF BASEL II REGULATION- A REVIEW ON
BANGLADESH CONTEXT;
April, 2013
Patuakhali Science and Technology University

Dumki, Patuakhali-8602
ROLE OF CREDIT RATING IN THE BANKING SECTOR AFTER
INTRODUCTION OF BASEL II REGULATION- A REVIEW ON
BANGLADESH CONTEXT
By
Md. Shahinuzzaman
Registration Number: 01879
ID: 0803017
An Internship Report Prepared for the Partial Fulfillment

of the Requirements for the Degree
Bachelor of Business Administration

April, 2013
An Internship Report
On
Role of Credit Rating in the Banking Sector after Introduction of Basel II
Regulation- A Review on Bangladesh Context
By
Md. Shahinuzzaman
Examination Roll Number: 0803017
Session: 2008-2009
Bachelor of Business Administration (BBA)
Major in Finance and Banking
Submitted to the Department of Finance and Banking

In Partial Fulfillment of the Requirements for the Degree
Bachelor of Business Administration

DUMKI, PATUAKHALI-8602.
April, 2013
Role of Credit Rating in the Banking Sector after Introduction of Basel II

Regulation- A Review on Bangladesh Context;
An Internship Report
Has been approved on

April, 2013
.
Md. Nur Nabi
Assistant Professor
Internship Supervisor
..
M. Takibur Rahman
Internship Co-supervisor
Assistant Professor
Omar Faruque
External Examiner
Assistant Professor
Department of Finance
Jagannath University, Dhaka

1st April, 2013

To
Md. Nur Nabi
Assistant Professor and Internship Supervisor
Patuakhali Science and Technology University,
Dumki, Patuakhali-8602.
Subject: Letter of Transmittal
Dear Sir
It is a great pleasure for me to submit here with my dissertation, which has been prepared
under the sound and dynamic leadership of a personality like you.
This internship report is an integral part of my academic program in completion of the degree
named Bachelor of Business Administration, which has assigned me Role of Credit Rating
in the Banking Sector after Introduction of Basel II Regulation- A Review on
Bangladesh Context as a part of B.B.A. Program. I have tried my best to collect the relative
information as comprehensive as possible in preparing the report. During preparation of the
report I have experienced practically a lot that will help me a great in my career. It has
enlightened my practical knowledge regarding the present credit rating system. I will be able
to explain anything for more clarification if necessary.
I would like to thank you, for giving me the opportunity to do a report on the above
mentioned topic.
With best regards
Md. Shahinuzzaman
Session: 2008-2009
1st April, 2013

To
Md. Nur Nabi
Subject: Letter of Authorization
Dear Sir
This is our truthful declaration that the Report on Role of Credit Rating in the Banking
Sector after Introduction of Basel II Regulation- A Review on Bangladesh Context is
not an exact copy of any research report or book previously made by others. I also express
my honest confirmation in support of the fact that the report has neither been used before to
fulfill any other course related purposes and not it will be submitted to any other person or
authority in future.
With best regards
Md. Shahinuzzaman
Session: 2008-2009

Tel: 04427-56014, 01813899621Fax: 04427-56009, E-mail:
deanbam_pstu@yahoo.com
ENDORSEMENT OF THE SUPERVISOR
It is our pleasure to certify that, Md. Shahinuzzaman, student of Bachelor of Business

Administration (BBA), Patuakhali Science and Technology University, Dumki, Patuakhali8602; has been completed the Internship Program at Role of Credit Rating in the Banking
Sector after Introduction of Basel II Regulation- A Review on Bangladesh Context
under my supervision from 1st January , 2013 to 31st March, 2013.
I wish him success in his life.
.
Md. Nur Nabi
Foreword
In the name of Allah who can do everything without anything

It is with pleasure and affection that I acknowledge my indebtedness to my honorable Course
teacher Md. Nur Nabi, Assistant Professor, Department of Finance and Banking, Faculty of
Business Administration and Management, Patuakhali Science and Technology University,
Dumki, Patuakhali, who has assigned me to prepare this report and help me with his support,
encouragements and expertise. As an intern student of BBA, I am lucky incredibly to have
such a report which is a very rare initiative of working on Role of Credit Rating in the
Banking Sector after Introduction of Basel II Regulation- a Review on Bangladesh
Context; So I am very grateful to my honorable course teacher because of his trust on me for
preparing such a report in which I havent had enough strong familiarity on this ground.
My total efforts represent broad and throughout discussion of the role of credit rating in the
Banking Sector after introduction of Basel II Regulation in Bangladesh. The purpose of this
report is to fulfill the internship requirement for the Bachelor of Business Administration in
Patuakhali Science and Technology University, Dumki, Patuakhali-8602. While, I was
employed as an intern at WASO Credit Rating (BD) Ltd.: Haque Chamber (Level-5 & 6),
89/2, West Panthapath, Dhaka-1215, Bangladesh.
This report summarizes the role of credit rating in the banking sector in Bangladesh. Though
I face many problems I have tried my best to go into deep and present a report.
.
Md. Shahinuzzaman
Reg. No.: 01879
Session: 2008-2009
Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation A Review on Bangladesh Context;
Acronyms
(Alphabetic order)
ACRCL=ARGUS Credit Rating Company Limited

BAM=Business Administration and Management
BB=Bangladesh Bank
BCBS= Basel Committee on Banking Supervision
BDRAL=Bangladesh Rating Agency Limited
BoD=Board of Director
CAR=Capital Adequacy Ratio
CEO=Chief Executive Officer
CR=Credit Rating
CRA=Credit Rating Agency
CRISL= Credit Rating Information and Services Limited
CRAB=Credit Rating Agency of Bangladesh
CRD=Capital Requirements Directive
DSE=Dhaka Stock Exchange
EBIT=Earnings before Interest and Taxes
ECAIs=External Credit Assessment Institution
ECRL=Emerging Credit Rating Limited
EU= European Union
FASB=Financial Accounting Standard Board
FD=Fair Disclosure
GDP=Gross Domestic Product
IASB=International Accounting Standard Board
ICAAP=Internal capital Adequacy Assessment Process
ICCMS= International Conference on Computational Management Science
ICRA= Internet Content Rating Association
IFS=Issuer Financial Strength
IMF=International Monetary Fund
IOSCO= International Organization of Securities Commissions
IRB=Internal Rating-Based
IT=Information Technology
LC=Letter of Credit
LOSCO= Louisiana Oil Spill Coordinator's Office
MCR=Minimum Capital Requirements
NBFI=Non-Banking Financial Institutions
NCRL=National Credit Rating Limited
PSTU=Patuakhali Science and Technology University
RoA=Return on Asset
RoE=Return on Equity
SEC=Securities and Exchange Commission
SLR/CRR= Statutory liquidity ratio/Cash Reserve Ratio
SME=Small and Medium Enterprise
SRO= Statutory Regulatory Order
SRP=Supervisory Review Process
UK=United Kingdom
WB=World Bank
WCRCL=WASO Credit Rating Company Limited
WTO=World Trade Organization
II
Verse of Gratitude
I would like to acknowledge the following people for their support and assistance with this
internship, especially the person I most wish to thank is my academic internship supervisor
Md. Nur Nabi, Assistant Professor, Department of Finance and Banking, PSTU. My cordial
thanks also to my Co-Supervisor M. Takibur Rahman, Assistant Professor, Department of
Accounting and Information Systems, PSTU and Omar Faruque, Assistant Professor,
Department of Finance, Jagannath University, Dhaka.
I am very much grateful to the authority of WASO Credit Rating Limited to assign me as an
internee and have the opportunity to learn theoretical as well as practical knowledge related
to credit rating system and complete such an ambitious study for my internship program as
well as for preparation of this report.
Next I would like to show my heartiest gratitude towards Juthi Akter, Financial Analyst,
WCRCL. She hse truly been extremely supportive to me in spite of her busy schedule. It
wouldnt possible to thank all of those marvelous people of WASO Credit Rating Limited.
They have explained everything I asked for in details. Throughout time they were never
impatience. They did not allow me to feel uncomfortable for even a single moment. I am
really grateful to all for their supportive and friendly behavior.
All the people have been kind enough to take the time off their busy schedule and help me in
collecting the necessary information.
III
Table of Contents . . . . . .
SL
No.
Particulars
Page
No.
I
Foreword
Acronyms
Word of Gratitude
Table of Contents
List of Tables
List of Graphs
List of Appendixes
II
III
IV-V
VI
VI
VI
Chapter-01(Introduction)
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
1.10
Abstract
Keywords
Introduction
Definition of the Study
Origin of the Study
Purpose of the Study
Rationale of the Study
Objectives of the Study
Scope of the Study
Methodology
1.8.1
Sources of Data
1.8.2
No. of Companies
1.8.3
Data collection methods
1.8.4
Data processing
Limitations of the study
Literature Review
1
1
2
2
3
3
3
4
4
4
4
4
5
5
5
5-6
Chapter-02(Credit Rating and Basel II)

2.1
2.2
Overview of Credit Rating

2.1.1
Meaning and Definition of Credit Rating
2.1.2
Origin of Credit Rating (CR) and Credit Rating Agencies (CRAs)
2.1.3
Credit Rating and Bangladesh
2.1.4
Overview of Credit Rating Agencies in Bangladesh
2.1.5
Functions of a Credit Rating Agency
2.1.6
Advantages and Disadvantages of Credit Ratings
Overview of Basel II
2.2.1
Meaning and Definition of Basel II
2.2.2
Background of Basel II
2.2.3
The main objective of the Basel II Accord is to:
2.2.4
The Basel II Framework consists of three pillars:
2.2.5
The significant features of Basel II
2.2.6
Basel II Implementation Scenario in Bangladesh
7
7
7
8-9
9-11
11
12-14
14
14
14-15
15
15-17
18
18
IV
2.2.7
2.2.8
2.2.9
2.3
Positive and Negative Impact of Basel II

Role of Rating Agencies under Basel II
Problems in Developing Countries:
Matrix of Participants in the Basel Process
19-20
21
21
21-22
Chapter-03 (Credit Rating System and Mapping)

3.1
3.2
Credit Rating Systems or Modus Operandi of WCRCL

Mapping comparison
23
24
Chapter-04 (Credit Rating Methodology)

4.
4.1
4.2
4.3
4.4
4.5
4.6
Rating Methodology
List of Rating Methodologies in BD ECAIs
Corporate Rating Methodology
4.2.1 Diagram of Corporate Rating Methodology
4.2.2 Comparison among the Methodologies of Different ECAIs
Banks and Non-Banking Financial Institution Rating Methodology
4.3.1 Diagram of Banks and NBFIs Rating Methodology
Small Medium Enterprises (SMEs) Rating Methodology
General Insurance Rating Methodologies
4.5.1 Diagram of GIs Rating Methodology
WCRCL Rating Scales & Definitions
25
26-27
28-33
34
35-36
37-40
40
41
42-43
44
45-48
48
49-50
51-52
Chapter-05 (Growth and Impact of Rating after Basel II)
5.1
Total Credit Rating Scenario in Bangladesh from 2008-2012
53
5.2
5.3
5.4
5.5
The Growth Rate of credit rating in 2009-2012

Total number of Rating in 2012 by Credit Rating Agencies
Rating by CRISL & CRAB in 2008-2012
Total number of Rating in 2012 by Credit Rating Agencies (Grading Wise)
53
54
54
55
Chapter 06(Bank Performance (pre and post of Basel II)

6.1
6.2
6.3
Bank Performance (pre and post of Basel II)

Importance of Credit Rating in the Banking Sector
Impact of Basel II on banking industry
56-57
58
58-59
Chapter-07 (Conclusion)
7.1
7.2
7.3
7.4
7.5
7.6
Prospects
Findings of the Study
Recommendations
Conclusion
References
Appendices
60
60-61
61-62
62-63
63-64
65-68
List of Tables:
No:
Table-1
Table-2
Table-3
Table 4
Table-5
Table-6
Table-7
Name
The list of Credit Rating Agencies in Bangladesh
Evolution of the Regulatory Environment
Matrix of Participants in the Basel Process
Mapping Comparison
Sequential steps in the total rating assessment process
Comparison among the Corporate Rating Methodology of Different ECAIs
:
:
:
:
:
:
:
Table-8
Table-9
Table-10
:
:
:
Comparison among the SMEs Methodology of Different ECAIs

Comparison among the General Insurance Methodology of Different ECAIs
Table-11
Aggregate profitability ob banking Industry in Bangladesh
Comparison among the Banks and FIs Methodology of Different ECAIs
WCRCL Rating Scales & Definitions
Page
9
14
21
24
34
35-36
41
44
49-50
51-52
56
List of Figures:
No:
Figure-1
Figure-2
Figure-3
:
:
:
:
Name
Summary of Basel II
Credit Rating Systems
Rating Methodology
Figure-4
Figure-5
Figure-6
:
:
:

Banks and Financial Institution Rating Methodology
General Insurance Rating Methodology
Page
15
23
25
34
40
48
List of Charts or Graphs:

No:
Graph-1
Graph-2
Graph-3
Graph-4
Graph-5
Graph-6
Graph-7
Graph-8
:
:
:
:
:
:
:
:
Name
Total Credit Rating Scenario in Bangladesh from 2008-2012
Growth Rate of credit rating in 2009-2012
Rating in 2012 by Credit Rating Agencies
Rating by CRISL & CRAB in 2008-2012
Rating in 2012 by Credit Rating Agencies (Grading Wise)
Aggregate Return on Asset of Banking Industry in Bangladesh
Aggregate Return on Equity of Banking Industry in Bangladesh
Aggregate Return on NIM of Banking Industry in Bangladesh
Page
53
53
54
54
55
56
57
57
List of Appendixes:
No:
Appendix-1
Appendix-2
Appendix-3
Appendix-4
Appendix-5
:
:
:
:
Name
Rating Methodology Published BB
Rating Map Published BB
Rating in 2012 by Credit Rating Agencies
Rating Matrix in 2012
Aggregate profitability ob banking Industry in Bangladesh
Page
65
66
67
67
68
VI
Chapter # 01
INTRODUCTION
Abstract
1.1 Introduction
1.2 Definition of the Study
1.3 Origin of the Study
1.4 Purpose of the Study
1.5 Rational of the report
1.6 Objectives of the Study
1.7 Scope of the Study
1.8 Methodology
1.9 Limitations of the Study
1.10 Literature Review
Role of Credit Rating in the Banking Sector after Introduction of

Basel II Regulation- A Review on Bangladesh Context;
Md. Shahinuzzaman (April, 2013)
shahinpstu@gmail.com
Abstract: Credit Rating Agencies (CRAs) play a key role in financial

markets by helping to reduce the informative asymmetry between lenders
and investors, on one side, and issuers on the other side, about the
creditworthiness of companies or countries. CRAs' role has expanded with
financial globalization and has received an additional boost from Basel II
which incorporates the ratings of CRAs into the rules for setting weights
for credit risk. Ratings tend to be sticky, lagging markets, and overreact
when they do change. This overreaction may have aggravated financial
crises in the recent past, contributing to financial instability and crosscountry contagion.
The recent bankruptcies of Enron, WorldCom, and Parmalat have
prompted legislative scrutiny of the agencies. Criticism has been especially
directed towards the high degree of concentration of the industry.
Promotion of competition may require policy action at national and
international level to encourage the establishment of new agencies and to
channel business generated by new regulatory requirements in their
direction.
Financial regulators recognize certain credit rating agencies for regulatory
purposes. However, it is often argued that credit rating agencies have an
incentive to assign inflated ratings. This paper studies the Role of Credit
Rating in the Banking Sector after Introduction of Basel II Regulation- A
Review on Bangladesh. Credit rating agencies may collude to assign
inflated ratings. Yet it is showing that there exists vast role which induces
credit rating agencies to assign correct ratings.
Keywords: Credit Rating (CR), Credit Rating Agency (CRA), Basel II, WASO credit Rating
Co. (BD) Ltd., Credit Risk, Standard Approach.
1.1 Introduction:
Credit Rating Agencies (subsequently denoted CRAs) specialize in analyzing and evaluating
the creditworthiness of corporate and sovereign issuers of debt securities. In the new
financial architecture, CRAs are expected to become more important in the management of
both corporate and sovereign credit risk. Their role has recently received a boost from the
revision by the Basel Committee on Banking Supervision (BCBS) of capital standards for
banks culminating in Basel II. The logic underlying the existence of CRAs is to solve the
problem of the informative asymmetry between lenders and borrowers regarding the
creditworthiness of the latter. Issuers with lower credit ratings pay higher interest rates
embodying larger risk premiums than higher rated issuers. Moreover, ratings determine the
eligibility of debt and other financial instruments for the portfolios of certain institutional
investors due to national regulations that restrict investment in speculative-grade bonds.
The importance of credit rating is to
protect
the
investor who cannot
get inside
information about the instruments for investment due lack of time and lack of expertise.
credit rating has assumed an important place in the modern and developed financial markets.
It is a boon to the companies as well as investors. It facilities the company in raising funds in
the capital market and helps the investors to select their risk return trade off. As investors are
concerned with the timely payment of interest and principal, credit rating indicates the credit
worthiness of borrowers. Credit rating essentially indicates the risk involved in a debt
instruments as well as its quality. Higher the credit rating greater is the probability that the
borrower will make timely payment of principal and interest and vice versa.
Thus credit rating is not a general evaluation off the issuing organization. it essentially
reflex the probability of timely repayment of principal and interest buy a borrower a
company . The credit rating is not a onetime evaluation of credit risk of a security. The rating
agency may change the rating considering the changes periodically. Despite their ubiquity in
the financial markets, credit ratings are often misunderstood. Confusion about what credit
ratings are, and the role they play in the financial system, has sometimes led to their misuse
and prevented them from fulfilling their true role: that is, to help close the information gap
between lenders and borrowers by providing independent opinions of creditworthiness.
The credit rating has created an environment for a mushroom growth of such agencies in
Bangladesh as many industry or people have started considering it as a solid business
proposition without going into greater details. However, rating is a research on fundamentals.
The fate of the rating agencies is absolutely uncertain and the current scenario is bound to
destroy the rating market and ultimately most of the rating agencies are bound to face closure,
with the moving of the banks towards Internal Rating Based (IRB)-approach as per road map
of Bangladesh Bank.
In this paper, there have seven chapters. 1st chapters include introduction, objectives,
methodology and etc. 2nd chapter about credit rating and Basel II, 3rd chapter about credit
rating system and mapping, 4th chapter about credit rating methodology, 5th chapter include
growth and impact of rating after Basel II, 6th chapter include pre and post scenario of
banking industry after Basel II introduction and finally chapter 7th include prospect, findings,
recommendation, conclusion and references.
1.2 Definition of Study:
Study is a presentation of acts best on intensive review, observation, data analysis and
interpretation etc. It highlights the role of credit rating in the Banking Sector after
introduction of Basel II Regulation in Bangladesh.
1.3 Origin of the Study:

Practical acquaintance is fundamental part for applying academic intelligence. Bearing this
motto in mind the internship program was being included in Bachelor of Business
Administration program. After completing one hundred and twenty six credit hours at
Patuakhali Science and Technology University (P.S.T.U.) under the Bachelor of Business
Administration program, the student (I) was placed at WASO Credit Rating Co. (BD) Ltd.
as an intern for three months by the Faculty of Business Administration and Management
(BAM). This report is the result of internship program and requirement of the mentioned
company on the selected topic Role of Credit Rating in the Banking Sector after
Introduction of Basel II Regulation A Review on Bangladesh Context;
1.4 Purpose of the Study:
Knowledge and learning become perfect when it is associated with theory and practice.
Theoretical knowledge gets its perfection with practical application. The primary purpose of
this study is to provide the intern with the practical experience by orienting engaging with
an organization. As our educational system predominantly text based, inclusion practical
orientation program , as an academic component is as exception to the norm as the parties
educational institution and the organization substantially benefit from such a program, it
seems a win-win situation. It establishes contracts and networking contracts. Contracts may
help to get a job. That is, students can train and prepare themselves for the job market. In
such state of affairs the present aiming at analyzing the experience of practical orientation
related to an appraisal of WASO Credit Rating Co. Ltd.
1.5 Rationale of the report:
As a student of a faculty of business studies, it is helpful to gain the practical knowledge
about an organization and its overall activities. By doing this kind of activities, we can enrich
our practical knowledge .With the application of acquired knowledge we will be able to
develop ourselves and compete globally. So, I can say that the rationale of this is
comprehensive.
The concept of credit rating by the rating agencies to support capital adequacy of the banks
came up in view of the need for implementation of Base-II capital adequacy framework by
Bangladesh Bank. Under Basel-II framework, Bangladesh Bank adopted a standardized
approach for credit risk under which the services of rating agencies were required under
certain strict terms and conditions. Bank client rating is a very sensitive issue in view of the
fact that most of the private sector companies, enjoying banking facilities, are not
maintaining standard financials for appropriate evaluation. In addition, the businesses of the
clients are directly affected by the economy, government policy and many other
considerations, in addition to the factors dependent on the sponsors. Unless and until all the
above factors are properly evaluated through sectoral studies, the ratings are bound to give
wrong signals.
In this study I have tried my level best to show the role of credit rating regarding the banking
sector. This study will be helpful to evaluate the role of credit rating after introduction of
Basel II.
1.6 Objectives of the Study:

The first objective of preparing this report is to fulfill the partial requirements of the B.B.A
program. Generally every study is conducted to get one or more findings; if the findings are
predetermined they called the objectives of the study. The main objective of this study is to
evaluate the role of credit rating in the Banking Sector after introduction of Basel II
Regulation in Bangladesh. To invent something new perfect investigation and by through
above discussion of a known or unknown matter, and to make a right decision on that matter
by achieving real knowledge about that mater, is the main objective of internship.
Some motives of internship are given below:
1. To make theoretical knowledge clear and exact about credit rating and Basel II.
2. Assessment of Credit Rating services by a banking sector before and after
implementation of Basel II.
3. Assessment of awareness for Credit Ratings in the corporate sector.
4. Finding the contribution of Credit Rating Companies in the Banking Sector
1.7 Scope of the Study:
This report is a descriptive study which tries to focus on the theories and practices of Credit
Rating Agencies in the context of Bangladesh. In connection with this effort, a study has been
conducted on ECAIs approved by the central bank in Bangladesh.
1.8 Methodology:
1.8.1 Sources of Data:
The study is related with both primary and secondary data. Primary data has been collected
from practical work exposure and the direct interview of the senior employees of WASO
Credit Rating Co. Ltd., Credit Rating Information and Services Ltd (CRISL), Credit Rating
Agency of Bangladesh Ltd (CRAB), National Credit Ratings Ltd, Emerging Credit Rating
Ltd and ARGUS Credit Rating Services Ltd. It should be noted that CRISL, CRAB, NCRL,
ECRL and ARGUS are covering the momentous credit rating market in Bangladesh.
Secondary data has been collected form:
Related information is collected through internet.
Daily newspaper, journals.
Web site of the concerned companies (www.crislbd.com, www.crab.com.bd,
www.ncrbd.com, www.emergingrating.com, www.acrslbd.com,
www.wasocrditrating.com, www.apharating.com, www.bdral.com)
1.8.2 No. of Companies (CRAs): The data has been collected from the 8 credit rating
companies operating their business in Bangladesh. The sample size is 8. Their listing are
shown below-
01.
02.
03
04
05.
06.
07.
08.
Credit Rating Information and Services Ltd (CRISL)

Credit Rating Agency of Bangladesh Ltd (CRAB)
National Credit Ratings Ltd
Emerging Credit Rating Ltd
ARGUS Credit Rating Services Ltd.
WASO Credit Rating Company (BD) Limited
Alpha Credit Rating Limited
The Bangladesh Rating Agency Limited
1.8.3 Data collection methods: Considering the nature of the study The study requires the published rating report of the respective companies.
Data has been taken from the officials of the companies.
1.8.4 Data Analysis:
All the related data in this study are already produced by the ECAIs. Just I have made
analysis to arrive at a decision.
1.9 Limitations of the Study:
The study is entitled to the following limitations I have taken only three year period (2010- 2012) which is not enough to depict the
actual picture.
Reluctance of the companies to disclose the rating report.
All works have been done through computer so there is chance of printing mistake.
As a growing and newly launched sector its not well established.
It would be better if is it possible to highlights some additional banking scenario
(investment status, risk taking standard, etc.) pre and post of Basel II but for some
constraints (lack of information, time, confidentiality, complex and slow process, etc.)
it was not possible.
1.10 Literature Review:
The role of credit rating has increased considerably during recent years. However, there is an
unsettled debate about credit ratings impact and importance in the literature. On the positive
side, Graham and Harvey (2001) show that credit ratings are more important in affecting a
firms funding policy than factors suggested by capital structure theories. Along this front,
Faulkender and Petersen (2006) reveal that firms which issue rated bonds are more leveraged.
Kisgen (2006, 2009) finds that firms close to a rating upgrade or downgrade issue less debt
than equity, relativeto firms without a rating change. Tang (2009) also documents that credit
ratings significantly affect firms access to credit markets. Others, however, question the
importance of credit ratings as providers of information. For example, Brealey and Myers
(2003) argue that credit rating agencies reflect as much about market participants opinion
about a firms financial condition as providing new information. The consequences of rating
changes on the valuation of stock and bonds have been extensively examined. For example,
Hand et al. (1992) show that only rating downgrades have a negative impact on stock and
bond prices, while upgrades information is incorporated into prices prior to announcement.
Ederington and Goh (1998) reveal that downgrades cause negative equity returns and
analysts earnings forecast revisions. Brooks et al. (2004) confirm that rating changes have
the same impact on countries market returns as in the case of firms. Jorion et al. (2005)
explore the effect of the Fair Disclosure (FD) Regulation in the US, which prohibited the
selective, non-public disclosure of information by firms to favored investment analysts
excluding credit rating agencies, to find that the informational effect on stock prices of
downgrades and upgrades is much larger in the post-FD period.
In an effort to tie together the empirical findings, as well as to provide a comprehensive
explanation for the increased role of credit ratings, Boot et al. (2006) develop a theoretical
model to show that credit ratings coordinate investors beliefs. As they argue, credit ratings
have a real value and impact through their monitoring role, especially in the credit watch
procedure, and the significance of the ratings for institutional investors decisions. However,
Boot et al. (2006) point out that market participants increased reliance on credit rating
agencies might discourage other monitoring mechanisms and fuel an excessive dependence
on them.
More recently, Kuang and Qin (2009) document the role and significance of credit ratings on
firms managerial actions to find that credit ratings act as delegated monitors and deter
managers risk taking incentives. In accordance with this finding, Kang and Liu (2009)
provide evidence on the positive impact of rating changes on managers incentives. They
show that credit ratings play a disciplinary role on managers actions and help reduce agency
conflicts, in combination with other corporate governance mechanisms.
At present there are eight domestic credit rating agencies and no international or regional
credit rating agencies exist in Bangladesh. The first, Credit Rating Information and Services
Limited (CRISL), was set up in 1995 and got license from the Securities and Exchange
Commission to operate as a rating agency in 2002. It is a joint venture of Malaysia Berhad,
JCR-VIS Credit Rating Company of Pakistan, and a few financial institutions and
professionals of Bangladesh. The second, the Credit Rating Agency of Bangladesh (CRAB),
was established in 2003. CRAB received license in 2004 from SEC under Credit Rating
Companies Rules 1996. CRAB formally launched its operation in April 2004. The sponsors
are some leading personalities and professional in the private sector and institutions of the
country. CRAB has technical collaboration with ICRA Limited of India, which is a
subsidiary of Moodys Investors Service. ICRA is one of the largest rating agencies in Asia.
National Credit Ratings Ltd. and Emerging Credit Rating Ltd. were established in 22nd June
2010. Remaining four ARGUS Credit Rating Services Ltd., WASO Credit Rating Company
(BD) Limited, Alpha Credit Rating Limited and The Bangladesh Rating Agency Limited
were established in respectively 21st July 2011, 15th February 2012, 20th February 2012 and
7th March 2012.
Anytime that you apply for credit, whether it be for a credit card, auto loan or home loan, a
lender will review your credit report and determine your credit rating. The higher youre
rating, the more likely you are to qualify, as well as to nab higher loan amounts and lower
interest rates. A high credit rating can offer you a degree of financial freedom that those with
a low rating may never see.
Chapter # 02
OVERVIEW OF CREDIT
RATING AND BASE II
2.1 Overview of Credit Rating
2.1.1 Meaning and Definition of Credit Rating
2.1.2 Origin of Credit Rating (CR) and Credit Rating
Agencies (CRAs)
2.1.3 Credit Rating and Bangladesh
2.1.4 Overview of Credit Rating Agencies in
Bangladesh
2.1.5 Functions of a Credit Rating Agency
2.1.6 Advantages and Disadvantages of Credit
Ratings
2.2 Overview of Basel II
2.2.1 Meaning and Definition of Basel II
2.2.2 Background of Basel II
2.2.3 The main objective of the Basel II Accord is to:
2.2.4 The Basel II Framework consists of three
pillars:
2.2.5 The significant features of Basel II
2.2.6 Basel II Implementation Scenario in Bangladesh
2.2.7 Positive and Negative Impact of Basel II
2.2.8 Role of Rating Agencies under Basel II
2.2.9 Problems in Developing Countries:
2.3 Matrix of Participants in the Basel
Process
2.1 Overview of Credit Rating

2.1.1 Meaning and Definition of Credit Rating
Credit rating is the opinion of the rating agency on the relative ability and willingness of tile
issuer of a debt instrument to meet the debt service obligations as and when they arise. Rating
is usually expressed in alphabetical or alphanumeric symbols. Symbols are simple and easily
understood tool which help the investor to differentiate between debt instruments on the basis
of their underlying credit quality. Rating companies also publish explanations for their
symbols used as well as the rationale for the ratings assigned by them, to facilitate deeper
understanding.
In other words, the rating is an opinion on the future ability and legal obligation of the issuer
to make timely payments of principal and interest on a specific fixed income security. The
rating measures the probability that the issuer will default on the security over its life, which
depending on the instrument may be a matter of days to thirty years or more.
In fact, the credit rating is a symbolic indicator of the current opinion of the relative
capability of the issuer to service its debt obligation in a timely fashion, with specific
reference to the instrument being rated. It can also be defined as an expression, through use of
symbols, of the opinion about credit quality of the issuer of security/instrument.
2.1.2Origin of Credit Rating (CR) and Credit Rating Agencies (CRAs)

The credit rating system started in 1958 to keep track of which borrowers were not repaying
on their deals. Over time, more lenders adopted the practice created by the Fair Isaac
Corporation (FICO) to ensure better profits on their loans. As of 2009, the credit rating
system serves over 80 countries across the globe.
The concept of using rating agencies to assess the level of risk associated with a debt arose
around the beginning of the 20th century when three major credit rating agencies were
formed. Although additional rating agencies were formed in subsequent years, the original
rating agencies Fitch, Moodys, and Standard and Poors are the most prominent.
1. Fitch
The Fitch Publishing Company was founded in 1913 by John Knowles
Fitch, a 33-year-old entrepreneur who had just taken over his fathers
printing business. Fitch had a unique goal for his company: to publish
financial statistics on stocks and bonds.
In 1924, Fitch expanded the services of his business by creating a system for rating debt
instruments based on the companys ability to repay their obligations. Although Fitchs rating
system of grading debt instruments became the standard for other credit rating agencies, Fitch
is now the smallest of the big three firms.
2. S&P
Henry Varnum Poor was a financial analyst with a similar vision to John
Knowles Fitch. Like Fitch, Poor was interested in publishing financial
statistics, which inspired him to create H.V. and H.W. Poor Company.
Luther Lee Blake was another financial analyst interested in becoming a financial
publisher. In order to achieve this dream, Blake founded Standard Statistics in 1906, just a
year after Poors death. Standard Statistics and H.V. and H.W. Poor published very similar
information. Hence, it made sense for the two companies to consolidate their assets, and they
merged in 1941 to form the Standard and Poors Corporation. Today, Standard and Poors not
only provides ratings but also offers other financial services, such as investment research, to
investors. They are now the largest of the big three rating agencies.
3. Moodys
John Moody founded the financial holding company, Moodys Corporation,
in 1909. Although Moodys provides a number of services, one of their
largest divisions is Moodys Investor Services. While Moodys has
conducted credit ratings since 1914, they only conducted ratings of
government bonds until 1970.
Moodys has grown significantly over the years. Presently, Moodys is the second largest of
the big three firms.
2.1.3Credit Rating and Bangladesh

The rating industry in Bangladesh is now considered to be a parentless industry. The behavior
of the regulators towards nourishing this industry does not appear to be rational. As the
researcher and initiator of this highly prestigious global profession, this scribe feels frustrated
not because of the reason that there is a mushroom growth of licensing. The frustration is
rather about the management of the regulatory framework. The authorities concerned have
remained careless, while being responsible for creating such a bad environment. The rating
agencies are still defined by the SEC rules as an investment advisory company. This has not
changed over a long time. The paid-up capital still remains at Tk. 5.0 million (50 lakh), to
start a rating agency by any group of sponsors. The regulators will realize the adverse
consequences of such a situation at certain point of time when the total industry will lose its
credibility in the national and international market.
Credit Rating Information and Services Limited, now popularly known as CRISL, carries the
history of credit rating in Bangladesh. Although the Bangladesh capital market does not have
enough work for one credit rating agency to survive on commercial consideration as a fullfledged rating agency, the regulators have licensed in total eight rating agencies till 2012.
At present, there are a number of rules and regulations that are directed towards credit rating.
The Credit Rating Companies Rules 1996 (subsequently amended in 2009) of the Securities
and Exchange Commission (SEC) is the mother regulation which provides for the credit
rating of all debt instruments and right offers of equity securities at a premium. The direct
listing rules of Dhaka Stock Exchange (DSE) provides for having, at least, BBB rating to be
eligible for the purpose. The Bangladesh Bank (BB) made credit rating mandatory for all
banks with annual surveillance in 2006. The insurance regulator of the country also through a
SRO made the credit rating compulsory for all the general insurance companies and
biannually for all life insurance companies.
2.1.4Overview of Credit Rating Agencies in Bangladesh

SL
No.
Name of the Company
01.
Credit Rating Information

and Services Ltd (CRISL)
Credit Rating Agency of
Bangladesh Ltd (CRAB)
National Credit Ratings
Ltd
Emerging Credit Rating
Ltd
02.
03
04
05.
06.
07.
08.
Date of Issuance
of Registration
Certificate
21/08/02
24/02/04
22/06/2010
Address
Nakshi Homes (4th and 5th floor),
6/1A, Segunbagicha, Dhaka-1000
Chamber Building (6th Floor), 122124 Motijheel C/A, Dhaka-1000
3 BijoyNagor, 3rd floor, Dhaka-1000
22/06/2010
SHAMS Rangs, House #104, Park

Road, Flat# A1, A2, Baridhara,
Dhaka-1212
ARGUS Credit Rating
21/07/2011
13 level, BDBL Building, Motijheel,
Services Ltd.
Dhaka.
WASO Credit Rating
15/02/2012
Haque Chamber (Level-5), 89/2
Company (BD) Limited
West Panthopath, Dhaka-1205
Alpha Credit Rating
20/02/2012
Navana Rahim Ardent (1st floor), 39
Limited
Kakrail, Dhaka-1000
The Bangladesh Rating
07/03/2012
47 Karwan Bazar, Latif Tower (12th
Agency Limited
floor), Dhaka-1215
Table 1: The list of Credit Rating Agencies in Bangladesh
CRISL
Credit Rating Information and Services Limited is a company that started its journey to
implement a Concept in Bangladesh Credit Rating. Before CRISL, Credit Rating was
text paper words for the teachers and students of Bangladesh. The voyage of how CRISL
conceptualized this idea in 1995 and implemented it in Bangladesh and finally achieved its
operating license in 2002 after almost eight years of struggle has a long, interesting,
exciting and also painful history. CRISL is now the national flagship company representing
the profession at home and abroad.
CRAB
Credit Rating Agency of Bangladesh Ltd. (CRAB) was incorporated as a public limited
company under the Registrar of Joint Stock Companies in August 2003 and received its
certificate for commencement of business in November 2003. It has been granted licence by
the Securities & Exchange Commission (SEC) of Bangladesh for operating as a credit rating
company in February 2004. The formal launching of the company was held on 5 April 2004.
NCRL
National Credit Ratings Limited (NCR) is a full service rating company that offers a wide
range of services. Incorporated as a public company, NCR started its business with a paid up
capital of TK 10.00 million. The Securities and Exchange Commission granted the license to
NCR in June 2010 under the Credit Rating Companies Rules 1996.The Company is
recognized by the Bangladesh Bank as an External Credit Assessment Institution (ECAI).
ECRL
The ISLQ International Star for Leadership in Quality Award acknowledges the strong
commitment to quality and excellence. Mr. Ahsan Parvez (Managing Director& CEO) & Mr.
Noor-e-Khoda Abdul Mobin (Deputy Managing Director& COO) received the award in the
Concorde La Fayette Hotel in Paris on June 25, 2012, from the president of B.I.D., Mr. Jose
E. Prieto. Emerging Credit Rating Ltd. is made up of a team oriented towards the continuous
improvement of processes, striving for an important role in the leadership of the business
world.
ACRSL
ARGUS Credit Rating Services Ltd. (ACRSL) is the next-generation Credit Rating Agency
of Bangladesh. Founded as a joint-venture between global experts in credit & equity research
and local sponsors with strong capital markets track record, ACRSL received its license from
the SEC in 2011. ACRSL is partnered with DP Information Group (DP), the premier credit
rating agency of Singapore for over 30 years. Having pioneered credit rating in Singapore,
DP has played an influential role in the development of the credit rating sector in China,
Indonesia, and Philippines. Further, DPs parent company, the UK based Experian Group is
one of the worlds top credit reference agencies.
WCRCL
WASO Credit Rating Company (BD) Ltd. (WCRCL) was incorporated as a public limited
company under the Office of the Registrar of Joint Stock Companies and Firms in July of
2009. With the license from the Securities & Exchange Commission (SEC) of Bangladesh to
operate as a credit rating company, WCRCL has officially started its journey on 15th
February, 2012. It has also been recognized as an External Credit Assessment Institution
(ECAI) by Central Bank of Bangladesh in October of 2012.
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ALPHA
Alpha Rating was incorporated on the 24th of February 2011. a result of the initiative of a
few distinguished and renowned professionals of Bangladesh and the with support and
organizational assistance from SATCOM IT Ltd., Axis Resources Ltd., Equity Care
Bangladesh Ltd., and TAN Equity and Investment Ltd.Date of Issuance of Registration
Certificate is 20th February 2012.
BDRAL
The Bangladesh Rating Agency Ltd (BDRAL), a subsidiary of Dun & Bradstreet South Asia
Middle East Ltd., is the pioneer in rating the SME sectors in Bangladesh.BDRAL has
launched its SME ratings in Bangladesh following a successful pilot phase carried out in the
year 2009.Date of Issuance of Registration Certificate is 7th March 2012.
2.1.5 Functions of a Credit Rating Agency

A credit rating agency serves following functions:
1. Provides unbiased opinion:An independent credit rating agency is likely to provide an
unbiased opinion as to relative capability of the company to service debt obligations because
of the following reasons:
i. It has no vested interest in an issue unlike brokers, financial intermediaries.
ii. Its own reputation is at stake.
2. Provides quality and dependable information:.A credit rating agency is in a position to
provide quality information on credit risk which is more authenticated and reliable because:
i. It has highly trained and professional staff that has better ability to assess risk.
ii. It has access to a lot of information which may not be publicly available.
3. Provides information at low cost: Most of the investors rely on the ratings
assigned by the ratings agencies while taking investment decisions. These ratings are
published in the form of reports and are available easily on the payment of negligible price. It
is not possible for the investors to assess the creditworthiness of the companies on their own.
4. Provide easy to understand information: Rating agencies first of all gather information,
and thenanalyze the same. At last these interpret and summarize complex information in a
simple and readily understood formal manner. Thus in other words, information supplied by
rating agencies can be easily understood by the investors. They need not go into details of the
financial statements.
5. Provide basis for investment: An investment rated by a credit rating enjoys higher
confidence from investors. Investors can make an estimate of the risk and return associated
with a particular rated issue while investing money in them.
6. Healthy discipline on corporate borrowers: Higher credit rating to any credit investment
enhances corporate image and builds up goodwill and hence it induces a healthy/ discipline
on corporate.
11
7. Formation of public policy: Once the debt securities are rated professionally, it would be
easier to formulate public policy guidelines as to the eligibility of securities to be included in
different kinds of institutional port-folio.
2.1.6Advantages and Disadvantages of Credit Ratings

2.1.6.1 Advantages of Credit Rating
The advantages, importance or benefits of credit rating to the investors are:1. Helps in Investment Decision: Credit rating gives an idea to the investors about the
credibility of the issuer company, and the risk factor attached to a particular instrument. So
the investors can decide whether to invest in such companies or not. Higher the rating, the
more will be the willingness to invest in these instruments and vice-versa.
2. Benefits of Rating Reviews: The rating agency regularly reviews the rating given to
a particular instrument. So, the present investors can decide whether to keep the instrument or
to sell it. For e.g. if the instrument is downgraded, then the investor may decide to sell it and
if the rating is maintained or upgraded, he may decide to keep the instrument until the next
rating or maturity.
3. Assurance of Safety: High credit rating gives assurance to the investors about the
safety of the instrument and minimum risk of bankruptcy. The companies which get a high
rating for their instruments will try to maintain healthy financial discipline. This will protect
them from bankruptcy. So the investors will be safe.
4. Easy Understandability of Investment Proposal: The rating agencies give rating
symbols to the instrument, which can be easily understood by investors. This helps them to
understand the investment proposal of an issuer company. For e.g. AAA (Triple A), given by
CRISL for debentures ensures highest safety, whereas debentures rated D are in default or
expect to default on maturity.
5. Choice of Instruments: Credit rating enables an investor to select a particular
instrument from many alternatives available. This choice depends upon the safety or risk of
the instrument.
6. Saves Investor's Time and Effort: Credit ratings enable an investor to his save time
and effort in analyzing the financial strength of an issuer company. This is because the
investor can depend on the rating done by professional rating agency, in order to take an
investment decision. He need not waste his time and effort to collect and analyze the financial
information about the credit standing of the issuer company.
The merits, advantages, benefits of credit rating to the issuing company are:-
1. Improves Corporate Image: Credit rating helps to improve the corporate image of a
company. High credit rating creates confidence and trust in the minds of the investors about
the company. Therefore, the company enjoys a good corporate image in the market.
2. Lowers Cost of Borrowing: Companies that have high credit rating for their debt
instruments will get funds at lower costs from the market. High rating will enable the
company to offer low interest rates on fixed deposits, debentures and other debt securities.
The investors will accept low interest rates because they prefer low risk instruments. A
12
company with high rating for its instruments can reduce the cost of public issue to raise
funds, because it need not spend heavily on advertising for attracting investors.
3. Wider Audience for Borrowing: A company with high rating for its instruments can
get a wider audience for borrowing. It can approach financial institutions, banks, investing
companies. This is because the credit ratings are easily understood not only by the financial
institutions and banks, but also by the general public.
4. Good for Non-Popular Companies: Credit rating is beneficial to the non-popular
companies, such as closely-held companies. If the credit rating is good, the public will invest
in these companies, even if they do not know these companies.
5. Act as a Marketing Tool: Credit rating not only helps to develop a good image of the
company among the investors, but also among the customers, dealers, suppliers, etc. High
credit rating can act as a marketing tool to develop confidence in the minds of customers,
dealer, suppliers, etc.
6. Helps in Growth and Expansion: Credit rating enables a company to grow and
expand. This is because better credit rating will enable a company to get finance easily for
growth and expansion.
2.1.6.2 Disadvantages of Credit Rating
Disadvantages of Credit Rating are as follows:
1. Biased rating and misrepresentations: In the absence of quality rating, credit rating
is a curse for the capital market industry, carrying out detailed analysis of the company,
should have no links with the company or the persons interested in the company so that the
reports impartial and judicious recommendations for rating committee. The companies
having lower grade rating do not advertise or use the rating while raising funds from the
public. In such cases the investor cannot get information about the riskiness of instrument and
hence is at loss.
2. Static study: Rating is done on the present and the past historic data of the company
and this is only a static study. Prediction of the companys health through rating is
momentary and anything can happen after assignment of rating symbols to the company.
Dependence for future results on the rating, therefore defeats the very purpose of risk
inductiveness of rating. Many changes take place in economic environment, political
situation, government policy framework which directly affects the working of a company.
3. Concealment of material information: Rating Company might conceal material
information from the investigating team of the credit rating company. In such cases quality of
rating suffers and renders the rating unreliable.
4. Rating is no guarantee for soundness of company: Rating is done for a particular
instrument to assess the credit risk but it should not be construed as a certificate for the
matching quality of the company or its management. Independent views should be formed by
the user public in general of the rating symbol.
5. Human bias: Finding off the investigation team, at times, may suffer with human
bias for unavoidable personal weakness of the staff and might affect the rating.
6. Reflection of temporary adverse conditions: Time factor affects rating, sometimes,
misleading conclusions are derived. For example, company in a particular industry might be
13
temporarily in adverse condition but it is given a low rating. This adversely affects the
companys interest.
7. Down grade: Once a company has been rated and if it is not able to maintain its
working results and performance, credit rating agencies would review the grade and down
grade the rating resulting into impair ring the image of the company.
8. Difference in rating of two agencies: Rating done by the two different credit rating
agencies for the same instrument of the same issuer company in many cases would not be
identical. Such differences are likely to occur because of value judgment differences on
qualitative aspects of the analysis in tow different agencies.
2.2 Overview of Basel II

2.2.1 Meaning and Definition of Basel II
Basel II is an international business Standard that requires financial institution to maintain
enough cash reserves to cover risk incurred by operations.The Basel accords are a series of
recommendations on banking laws and regulations issued by the Basel Committee on
banking supervision (BCBS). The name for the accords is derived from Basel, Switzerland,
where the committee that maintains the accords meets.
2.2.2Background of Basel II
In June 2004, BCBS issued a revised framework of ICCMS, introduced the famous Three
Pillar Concept of Capital Adequacy for strengthening the risk management practices of the
banking industry. Later, in June 2006, a comprehensive revision of ICCMCS was in public
by incorporating Basel II Framework, June 2004, the elements of the 1988 Accord that were
not revised during the Basel II process, the 1996 Amendment to the Capital Accord to
Incorporate Market Risks, and the paper on the Application of Basel II to Trading Activities
and the Treatment of Double Default Effects, 2005. The paper has been invariably termed as
Basel-II framework. This was also supposed to be applied on a fully consolidated basis to
any holding company that is the parent entity within a banking group to ensure that it
captures the risk of the whole banking group. Basel-II incorporated the treatment for the
activities of banking entities, securities entities, financial entities, insurance entities and
commercial entities when they are subsidiaries or minority owner of any bank holding
company. Another groundbreaking addition in this version of this capital accord was the
incorporation of the treatment of securitization exposure for credit risk. Both traditional and
synthetic securitization exposures have been accounted for consideration.
Evolution of the Regulatory Environment
1988
Basel Capital Accord
1996
Market Risk Capital Amendment
1996 1998 Ad hoc rules for credit derivatives
Jun. 1999
Consultative Document from Basel Committee
Jan. 2001
Basel Committee proposes New Capital Accord
June 2004
The purpose of Basel II, which was initially published. BCBS issued a revised
framework of ICCMS, introduced the famous Three Pillar Concept of Capital
14
Nov. 2005
June 2006
Adequacy for strengthening the risk management practices of the banking industry.
Basel II: International Convergence of Capital Measurement and Capital Standards: A
Revised Framework
a comprehensive revision of ICCMCS was in public by incorporating Basel II
Framework
Table 2: Evolution of the Regulatory Environment
2.2.3The main objective of the Basel II Accord is to:
Strengthen the soundness and stability of international banking systems

Create and maintain a level playing field for internationally active banks
Promote the adoption of more stringent practices in the field of risk management
2.2.4The Basel II Framework consists of three pillars:

1. Calculation of minimum capital requirements
2. Supervisory review
3. Market discipline (public disclosure)
Basel II
Pillar-1
Pillar-2
Minimum Capital
Requirement (MCR)
Supervisory Review
Process (SRP)
o Credit Risk Standardized Approach

Foundation of IRB
Approach
Advanced IRB
Approach
o Market Risk Standardized Method,
Internal Model
Approach
o Operational risk Basic Indicator
Approach
Standardized Approach
o Bank End Internal Capital

Adequacy Assessment
Process (ICAAP)
Risk Management
o Supervisory End Evaluation of Banks
internal systems
(ICAAP)
Assessment of Risk
Profile
Review of compliance
with all regulations
Supervisory measures.
Pillar-3
Market Discipline
o Transparency For market participants
concerning bank risk
position (scope of
application, risk
management, detailed
information on own
funds etc.)
o Comparability
Between and among
the banks within the
jurisdiction.
Figure 1: Summary of Basel II

Pillar 1- Minimum Regulatory Capital Requirements
For the first pillar of the Basel II Capital Accord the Basel Committee proposed capital
requirements associated with three categories of risk:
15
1. Credit Risk
Credit risk is the possibility of a loss as a result of a situation that those who owe money to
the bank may not fulfill their obligation. The following methods can be used to determine
credit risk: The Standardized Approach, The Foundation Internal Rating Based Approach and
the Advanced Rating Based Approach. The Standardized Approach provides improved risk
sensitivity compared to Basel I. The two IRB approaches, which rely on banks own internal
risk ratings, are considerably more risk sensitive.
Standardized approach (credit risk)
The term standardized approach refers to a set of credit risk measurement techniques
proposed under Basel II capital adequacy rules for banking institutions.In this approach,
securitized claims will also be assigned their own risk weights depending on their external
ratings. Under this approach the banks are required to use ratings from External Credit Rating
Agencies to quantify required capital for credit risk. In many countries this is the only
approach the regulators are planning to approve in the initial phase of Basel II
Implementation.
The Basel Accord proposes to permit banks a choice between two broad methodologies for
calculating their capital requirements for credit risk. The other alternative is based on internal
ratings.
Internal Ratings-Based (IRB) Approach
Under the Basel II guidelines, banks are allowed to use their own estimated risk
parameters for the purpose of calculating regulatory capital. This is known as the Internal
Ratings-Based (IRB) Approach to capital requirements for credit risk. Only banks meeting
certain minimum conditions, disclosure requirements and approval from their national
supervisor are allowed to use this approach in estimating capital for various exposures.
Such an approach has two primary objectives
Risk sensitivity - Capital requirements based on internal estimates are more sensitive
to the credit risk in the bank's portfolio of assets
Incentive compatibility - Banks must adopt better risk management techniques to
control the credit risk in their portfolio to minimize regulatory capital
2. Market risk
Market risk is the risk that the value of a portfolio, either an investment portfolio or a
trading portfolio, will decrease due to the change in value of the market risk factors.
The associated market risks are.
Equity risk, the risk that stock prices and/or the implied volatility will change.
Interest rate risk, the risk that interest rates and/or the implied volatility will change.
Currency risk, the risk that foreign exchange rates and/or the implied volatility will
change.
16
Commodity risk, the risk that commodity prices (e.g. corn, copper, crude oil) and/or
implied volatility will change.
3. Operational Risk
An operational risk is a risk arising from execution of a company's business functions.
Operational risk is defined in the Basel II as the risk of loss resulting from inadequate or
failed internal processes, people and systems, or from external events. Three different
methods can be used to measure operational risk: The Basic Indicator Approach, the
Standardized Approach and the Advanced Measurement Approach.
Pillar 2- Supervisory review of capital adequacy
The second pillar of Basel II is a supervisory review of capital adequacy. The second pillar
notes that national supervisors must ensure that banks develop an internal capital assessment
process and set capital targets consistent with their risk profiles. Furthermore it encourages
the banks management to develop risk management techniques and their use within capital
management. The supervisors are responsible for evaluating how well banks are assessing
their capital adequacy needs relative to their risks. Internal processes of the bank are subject
to supervisory review and intervention. In the Bangladesh the role of supervisor is fulfilled by
the Bangladesh Bank (BB).
Pillar 3 Market discipline and disclosure
The third pillar of the Basel II Capital Accord is about market discipline and disclosure. The
main goal of this pillar is to promote the development of financial reporting about risks. In
this way market participants can get a better understanding of banks risks profiles and the
adequacy of their capital position by disclosure. Pillar 3 in the Basel II Capital Accord sets
out disclosure requirements and recommendations in several areas. These requirements apply
to all banks and when a bank cannot meet these requirements it can be constrained in the way
it manages capital. For example the bank may not use any of the advanced techniques under
Pillar 1.
17
2.2.5The significant features of Basel II
Significantly more risk sensitive capital requirements and takes into account
operational risk of banks apart from credit and market risks. It also provides for risk
treatment based on securitization.
Great use of assessment of risk provided by banks internal systems as inputs to
capital calculations.
Provides a range of options for determining the capital requirements for credit risk
and operational risk to allow banks and national regulators to select the approaches
that are most suitable for them.
Capital requirement under the new accord is the minimum. It has a provision for
supplementary capital that can be adopted by national regulators.
The Accord promotes strong risk management practices by providing capital
incentives for banks having better risk management practices.
One most note that the capital requirements under Basel II do not include liquidity risk,
interest rate risk of banking book, strategic risk, and business risk. These risks would fall
under Supervisory Review Process. If supervisors feel that the capital held by a bank is not
sufficient, they could require the bank to reduce its risk or increase its capital or both.
2.2.6 Basel II Implementation Scenario in Bangladesh
In2006, BB issued an action plan / roadmap.

Inconsequence 2 major tasks were done
Guidelines for recognition of eligible ECAIs- September 2008,
Guidelines on RBCA a Revised Regulatory Capital Framework in line with Basel IIDecember 2008.
Banks entered in Basel-II regime fully in January 2010.

Capital broadly categorized in 3 parts.
Tier-1:Core Capital
Tier-2:Supplementary Capital
Tier-3:Additional Supplementary Capital
MCR is now 10% of RWA with 5% core capital or Tk.400 million whichever is higher
(from July 2011).
BB structured its RBCA guidelines considering all propositions of Basel-II. Calculating
RWA following propositions of Basel-II. Calculating RWA following approaches used
Credit Risk-Standardized Approach,
Market Risk-Standardized (Rule Based)Method
Operational Risk- Basic Indicator Approach.
Foundation IRBA both at Bangladesh Bank and other banks level and Parallel run along
with Standardized Approach in 2012.
18
2.2.7 Positive and Negative Impact of Basel II

2.2.7.1Positive Impact of Basel II on banks:
The new Basel Accord i.e. Basel II will have an impact on the banking system in various
ways. The implementation of Basel II provides the Indian banks an opportunity to reduce
their credit risk weights as well as reduce their required regulatory capital. They can do so by
suitably adjusting their portfolios. The Internal Ratings Based approach would give freedom
to the individual banks by giving them the right to assess their own economic capital by
taking risk into consideration resulting in a degree of regulatory restraint1. The Standardized
or IRB approach will help the banks for most of its exposures, including its securitization
exposures. As incentives for adopting the more advanced approaches for credit and
operational risks, banks are anticipated to experience lower capital requirements and
therefore lower costs under these approaches (Francis, 2006). Basel II aligns economic risk
more closely with regulatory risk. This will make it easier for the banks to lend to corporate,
increase their retail lending and provide mortgage under loans with higher margins (crockett,
2005). It will change the treatment of credit risk ensuring that banks have sufficient capital to
cover operational risk. It will lead to an improvement in the risk measurement assessment
thereby giving banks an opportunity to gain competitive advantage by allocating capital to
those processes segments and markets that demonstrate a strong risk return ratio. Another
benefit that banks would get from Basel II is a better understanding of risk return trade off for
capital supporting specific business, customer products and processes. Some of the other
advantages that the banks would enjoy by implementing Basel II would be that the strong risk
management process will help them to serve the customers better and also the small and
medium sized business will get liquidity into the portfolio, helps in collateralizing and
hedging2. The Pillar 2 of Basel introduces the concept of economic capital which will help
the banks to determine capital adequacy based on the level of risk and required capital
thereby reducing arbitrage opportunity. It also provides incentives for banks to transfer credit
risks through instruments such as asset-backed securities or credit derivatives, while retaining
the customer relationship3. Basel II will also provide banks with businesses benefits by
improving corporate governance, improving allocation of capital, the risk based pricing will
help to improve the competitiveness, capital saving, better decision making will allow
counter parties to deal and enhancing the value of stakeholders (Oosthuizen, 2005). Basel II
will give the banks different options from which they can choose like large banks are
expected by the market and supervisors to apply advanced risk management methods. A bank
with non-complex operations may use a simple and less expensive system. Basel II is drafted
flexibly in order to incorporate future changes such as new financial instruments, new
activities and so on, can be incorporated without having to change the basic structure.
1.(www.ibase.br/userimages/FLGG%20-20Chalapurath%20Chandrasekhar.pdf)
2.(www.us.kpmg.com/microsite/FSLibraryDotCom/docs/Basel_AWorldwide%20Challenge_web%20(2))
3.(www.us.kpmg.com/microsite/FSLibraryDotCom/docs/Basel_AWorldwide%20Challenge_web%20 (2)).
19
Banks will get a higher degree of freedom in the way they operate or may operate in the
future, but has some built-in restraints to ensure at least a basic level of capital, such as
minimum floors on the capital requirements (Lind, 2005). Some of the other benefits of Basel
II would include a more active portfolio management and forward looking risk assessment in
which there would be more activeness in portfolio risk management by access to timelier and
higher quality risk information and by differential capital requirement. The pricing of risk
will be more proactive and there would also be an improvement in performance
management.4
2.2.7.2Negative of Impact Basel II on banks:
The banks in Bangladesh that would be applying Basel II will have to face certain drawbacks
as well. The Basic Indicator approach specifies that banks should hold capital charge for
operational risk equal to the average of the 15 per cent of annual positive gross income over
the past three years, excluding any year when the gross income was negative. Also the capital
required by the bank would depend on the level of bad debt it has or the non performing asset
lying with it. The preference of banks for government securities and the increased riskaversion of banks following the adoption of Basel II would adversely affect credit to
agriculture and small scale industries1. Banks which will not be adopting Basel II will not
face its compliance challenges but may nonetheless is pushed to use it as a competitive
benchmark. Regulators have to face a challenge as they have to provide a level playing field
in their jurisdiction and internationally as the Basel Committee's recommendations are
implemented by legislatures in various countries. In addition, they have to ensure that their
examiners are adequately trained to assess bank's compliance with the new capital rules.2
Medium-sized national banks which have limited international presence will have to think
hard about their credit ratings systems, given that credit risk remains the main part of their
total risk. Most will initially adopt the simpler Standardized approach to measuring credit
risk. Others will adopt the IRB Foundation approach indicating that banks with major retail
business might well expect significant capital reductions when applying the IRB Foundation
approach. Small banks might face the problem that the implementation of Basel II
requirements and the development of internal credit rating systems will turn out to be costly
for them. But without a credit ratings system of some kind it will be difficult for them to price
their loans competitively. Therefore, it may be out of reach for many smaller banks. It is very
unlikely that these banks will have the financial resources, intellectual capital, skills and large
scale commitment that larger competitors have to build sophisticated systems to allocate
regulatory capital optimally for both credit and operational risks.
4.(www.kpmg.com.mx/gobiernocorporativo//libreria_gc/rrr/Basilea%20II/basel_ii.pdf)
1.(www.ibase.br/userimages/FLGG%20-20Chalapurath%20Chandrasekhar.pdf)
2.(www.us.kpmg.com/microsite/FSLibraryDotCom/docs/Basel_AWorldwide%20Challenge_web%20
3.(http://www.globalriskregulator.com/archive/May2003-06.html)
20
2.2.8 Role of Rating Agencies under Basel II

As required by the Capital Requirements Directive (CRD), European authorities have
considered whether the methodologies of the three external credit assessment institutions
(ECAIs) meet the requirements of objectivity, independence, ongoing review and
transparency and that their ratings meet the requirements of credibility and transparency.
Furthermore they have considered which of the 'risk weights' should be attached to their
ratings (the 'mapping').
2.2.9 Problems in Developing Countries:

As Bangladesh is a developing country it can come across various problems in implementing
Basel II. The capital regulation that Basel II requires is a matter of concern that whether it
will ensure systematic banking stability or not. Even the currency mismatch which is a major
threat to banking is appropriately mentioned in Basel II or not. Then Basel II might reduce
the bank credit levels to developing economies both internationally and nationally. It could be
worse for poorer countries and those with low perceived creditworthiness. This could reduce
their investment, demand and future growth. Developing countries have a greater percentage
of lower rated borrowers. The IRB approach has a lesser incentives to lend to such borrowers.
This, along with withdrawal of uniform risk weight of 0% on sovereign claims may result in
overall reduction in lending by internationally active banks in developing countries and may
increase their cost of borrowing. Moreover, the concern is whether Basel II would increase
pro-cyclicality of bank lending, both domestically and from international banks. This would
increase volatility of growth and investment, as well as increase systemic risk in the banking
system. Moreover, the introduction of Basel II could discourage particularly lending to Small
Medium Enterprises (SMEs) and to other sectors or modalities crucial for growth,
employment and investment (Jones, 2007).
2.3 Matrix of Participants in the Basel Process

Supranational
National
Sub-national
Public
Private
Mixed
G10, G20, G77,
Core banks, the
Banks and
European Union,
financial markets,
investment firms;
BIS,
hedge funds,
risk management
BCBS, Basel Senior
financial
and credit rating
Supervisors Group,
engineers, financial agencies and
Financial Stability
risk analysts, credit
professional
Board, IMF, World
rating agencies, mass Economists. The
Bank, IOSCO, IASB, media
G30 and IIF
FASB
Executive branch,
Large national banks Federal Reserve
finance ministries,
and corporations,
Bank of New York,
central banks,
pension funds,
Governmentfinancial regulators,
insurance industry,
Sponsored
legislatures and
industry associations Enterprises
subcommittees,
and lobbyists
State banking
Community banks,
Supervisors
private citizens
Table 3: Matrix of Participants in the Basel Process
21
Basel is an example of multilevel governance. It involves supranational institutions (Bank for

International Settlements, the Basel Committee), central banks, finance ministries, multiple
overlapping financial regulators, industry lobbyists, legislative bodies with oversight powers,
transnational governance structures (regulators working across state boundaries to develop
new regulations), and transnational interest groups. The Bank of International Settlements
(BIS) was established by central banks in 1930 in Basel, Switzerland as the central bankers
central bank. It was initially intended to serve as a clearinghouse of information shared
between central banks overseeing the repayment of Germanys reparations from World War
I. Since then, the BIS has grown into the institutional setting in which central bankers can
address issues of concern to their individual economies and the global economy. The Basel
Committee on Banking Supervision (Basel Committee or BCBS), comprised of twentyseven countries, conducts its work under the review of its oversight body, the Group of
Central Bank Governors and Heads of Supervision of its member jurisdictions. The Financial
Stability Board also works closely with the Committee.
The dominant function of modern independent central banks is to control the national money
supply. Whether central banks should simultaneously act as regulators of their local banking
systems is not a universally agreed function. Felsenfeld surveyed thirty countries and
concluded that twenty do not give their central banks regulatory responsibilities. The central
bank of the United States does regulate a major share of the American financial system
including national banks and all bank holding companies.
England has gone the other way with the Central Bank of England performing regulatory
functions until they were taken away in 1997 and given to the newly formed Securities and
Investment Board (now Financial Services Authority). Debate over the independence of
central banks has not been settled, although independent central banks have spread around the
globe. When economic conditions become dire, the power of the central bank increases as the
need to rescue the economy increases and the central bank steps into the role envisioned as
the lender of last resort. Indeed the Global Financial Crisis has shown the extent to which
the Fed has the authority to act as lender of last resort not only to commercial banks but to
investment banks, insurance companies, and other businesses under a provision of a 1932
federal law concerning unusual and exigent circumstances. [Basel II implementation
guideline]
22
Chapter # 03
CREDIT RATING
SYSTEMS
3.1 Credit Rating Systems or Modus
Operandi of WCRCL
3.2 Mapping Comparison
3.1 Credit Rating Systems or Modus Operandi of WCRCL (Figure 2)

Client
Rating Request to
WCRCL
WCRCL Ratings
Acceptance of Mandate
MOU with Client Including
Confidentiality Agreement
Initiation of
Confidentiality Clause
Mandate of Authorized
Persons
Interaction with
Rating Team,
Responds to Queries,
Provide Information &
Support to Analysis
Ensuring the Facts &

Figures in the Draft
Report and also for
Rating Analysis
No
Accepts
Rating?
Yes
Operational
Independence
Business
Team
Analyst Team Formation

Interaction with Client, Collect &
Collate Information, Undertake Site
Visit and Others
Analysis of the Information,

Preparation of Draft and Submission to
Internal Review Committee (IRC)
Operations
Team
Review of IRC and Collection of

Additional Information, If Necessary
Issue of Draft Report without Rating to

Client & Finalization of the Draft
Report
Placing To Rating Committee the
Accepted Draft, Detail Analysis and
Also the Comments from Clients
Rating Committee Awards Rating And

Rating Release To Client with Rating
Rationale
Compliance
Team
Issue of Rating Report with Rating
Rationale
Press Release, Publish on the WCRCL

Website
23
3.2 Mapping Comparison

The mapping of rating scales of CRISL, CRAB, NCRL, ECRL and ARGUS with BB rating grades has already been specified in the Guidelines.
Now, the rating scales of CRISL, CRAB, NCRL, ECRL, ARGUS and WCRCL have been mapped with BB rating grades as given below:
Long Term Rating Category Mapping
BBs
Equivalent
Equivalent
Equivalent
Equivalent
Equivalent
Equivalent
Rating
Notch/Notation of
Notch/Notation of
Notch/Notation of Notch/Notation
Notch/Notation of
Notch/Notation of
Grade
CRISL
CRAB
NCRL
of ECRL
ARGUS
WCRCL
1
AAA
AAA
AAA
AAA
AAA
AAA
AA+, AA, AA
AA1, AA2, AA3
AA+, AA, AA
AA+, AA, AA
AA+, AA, AA
AA+, AA, AA
2
A+, A, A
A1, A2, A3
A+, A, A
A+, A, A
A+, A, A
A+, A, A
3
BBB+, BBB, BBB
BBB1, BBB2,
BBB+, BBB,
BBB+, BBB,
BBB+, BBB, BBB BBB+, BBB, BBB
BBB3
BBB
BBB
4
BB+,BB, BB
BB1, BB2, BB3,
BB+,BB, BB
BB+,BB, BB
BB+,BB, BB
BB+,BB, BB
5
B+, B, BCCC+, CCC, CCCCC+, CC, CC-
C+, C, C-, D
B1, B2, B3
CCC1, CCC2,
CCC3
CC
C, D
S1
S2
S3
S4
S5, S6
ST-1
ST-2
ST-3
ST-4
ST-5, ST-6
ST-1
ST-2
ST-3
ST-4
ST-5, ST-6
B+, B, B-
B+, B, B-
C+, C, C-, D
C, D
Short Term Rating Category Mapping
N1
ECRL-41
N2
ECRL-2
N3
ECRL-3
N4
ECRL-4
N5
D
Table 4: Mapping Comparison
B+, B, B-
B+, B, B-
C+, C, C-, D
C+, C, C-, D
ST-1
ST-2
ST-3
ST-4
ST-5, ST-6
P1
P2
P3
P4
P5&P6
Basel II Implementation Cell, Banking Regulation and Policy Department, Bangladesh Bank.www.bb.org.bd
24
Chapter # 04
Credit Rating
Methodology
4. Rating Methodology
4.1 List of Rating Methodologies in BD ECRAs
4.2 Corporate Rating Methodology
4.2.1 Diagram of Corporate Rating Methodology
4.2.2 Comparison among the Methodologies of
Different ECAIs
4.3 Banks and Non-Banking Financial Institution
Rating Methodology
4.3.1 Diagram of Banks and NBFIs Rating
Methodology
Different ECAIs
4.4 Small Medium Enterprises (SMEs) Rating
Methodology
4.4.1Diagram of SMEs Rating Methodology
Different ECAIs
4.5General Insurance Rating Methodologies
4.5.1Diagram of GIs Rating Methodology
Different ECAIs
4.6 WCRCL Rating Scales & Definitions
4. Rating Methodology
The specific insights of each sector (qualitative and quantitative factors, such as appraisal of
the historic and projected financials, level of profitability, capacity utilization, capital
expenditure need, and cash flow adequacy, debt servicing capacity, free cash flow, and time
series analysis) are converted to specific traits with appropriate weightage for highest
performance, lowest performance, industrial average etc. to arrive at a meaningful rating of
an organization.
LOCAL
CURRENCY
DEPOSIT
CEILING (AAA-C)
FINANCIAL
STRENGTH
RATING
(A-E)
BASELINE
RISK
ASSESSMEN
T
(Aaa-C)
LOCAL
CURRENCY
DEPOSIT/
DEBT
RATINGS
(Aaa-C)
Probability of
National
Government
Support
INTRINSIC FACTORS
LOCAL
CURRENCY
DEPOSIT
CEILING (AAA-C)
FOREIGN
CURRENCY
DEPOSIT/DEBT
RATINGS
(Aaa-C)
Other External
Support Factors
EXTERNAL FACTORS
Figure 3: Rating Methodology (Source: CRAB)
25
4.1 List of Rating Methodologies in Bangladesh Credit Rating Agencies

CRISL methodologies cover followings sectors:
Bank and Financial Institutions

Merchant Banks
Microfinance Institutions
Manufacturing Corporate
General Insurance
Securities Firm
Airlines
Life Insurance
Asset Backed Securities

Bank Loan / Facility Rating
Government Support Entities
Investment Company
Trading Concerns
Telecommunication
SME (Small Medium and
Enterprise)
CRAB rating methodologies are as follows:

1.
2.
3.
4.
5.
6.
7.
Bank Rating Methodology

Financial Institution Rating Methodology
General Insurance Rating Methodology
Life Insurance Rating Methodology
Government Owned Enterprise Rating Methodology
Securitization Rating Methodology
NCRL Rating Methodology

Financial Institutions Rating Methodology (Bank & NBFI)
Bank Loan Rating Methodology
Brokerage Rating Methodology
Insurance Company Rating Methodology (General)
Emerging Credit Rating Methodology

A. Corporate Debt Rating
1.
2.
3.
4.
5.
6.
Rating Process for Construction Companies

Rating Process for the Telecommunication Industry
Rating Process for the Oil & Gas Industry
Rating Process for Plantation Companies
Rating Process of Automotive Industry
Rating Process for Homebuilders
B. Financial Institution Rating

1. Rating Process for Financial Institutions
2. Rating Process for Financial Holding Companies
3. Rating Process for Islamic Financial Institutions
C. General Insurance
26
D.
E.
F.
G.
H.
Life Insurance
Project Finance
Issuer Debt Rating
Rating Process Govt. Agencies
Bond Rating
In this chapter I have tried to discuss the corporate rating methodology, Banking and NonBanking financial institution rating methodology, small and medium enterprise (SME) rating
methodology and general insurance rating methodology performed by different ECAIs in
Bangladesh with highlighting their diagram and comparison among theme.
27
4.2 Rating Methodology (Corporate/Manufacturing Corporate)

A. Industrial Risk
1. Regulatory framework: Regulatory framework has direct impact on the industry
and to the firms operating under the industry. The regulatory framework of the industry in
most cases are dictated by the government industrial policy, annual budgetary frame work
and measures including tax holidays, cash incentives, labour laws, environmental compliance
issues and even by the import policy of the government and sometimes also been influenced
by external factors such as buyers requirements from abroad, WTO Commitment of the
government etc.
2. Industrial Risks: Risk is inherent in all industrial firms. Risk assessment in manufacturing
units begins with an understanding of their operating environment. The operating
environment dictates the factors to be taken into account while evaluating its long term
performance and its possible impact on the cash flow, profitability and ultimately
repayment capacity. The operating performance of industrial units is affected by trend of
various economic variables including GDP, interest and exchange rates and nature of the
industry. In addition, pattern of demand growth, elasticity of demand, inherent risk in
manufacturing, unstable power supply, small and unstable market, entry of advance
technologies plays an important role in evaluation.
3. Growth potentials: Growth potential of a firm vis--vis its industrial growth plays an
important role in CRISL analytical rating framework. The industry life cycle such as
introductory stage, growth stage, maturity stage and sunset stage, all deserves a weightage in
analysis. However, the above potential is always reviewed in the context of future risks
potentials. Again the matured industries are not over risk weighted in view of maturity
rather the factors such as business stability gets due priority vis--vis its other peripheral
factors.
4. Vulnerability: The vulnerability of the industry through controllable and uncontrollable
factors are considered in the analytical framework of CRISL the degree of sensitivity of
demand to economic cycle, change in government policies such as import policy, industrial
policy, tariff policy etc are the key elements to be considered in rating an industrial unit. The
volatility of prices of raw material may also create a vulnerable situation for the
industries. The political influence on the trade unions effecting labour intensive industries
such as garments, are susceptible to vulnerability.
5. Industrial Cyclicality: Cyclical companies are those manufacturing units such as
sugar, cotton spinning, automobiles paper and pulp etc whose sales in volume moves with the
macroeconomic fundamentals and the operation of which needs different volume of resources
as it moves with cycle. CRISL analytical framework considers the high and low picks of the
cycle and gives due weights to the factors at each stage of cycle and tries rates through the
cycle. Under the above circumstances CRISL ratings are forward looking. Normally
the companies in cyclical industries accumulates cash and creates buffer during the
boom period in order to keeping the company in smooth operation during the down turn
28
6. Entry Barrier: Strong restriction on the new entrant in the industry protects the interest of
the existing companies and viewed as plus point while keeping the industry open for anybody
may at any point of time take away the share of the existing companies and ultimately poses a
threat for survival or profitable operation. However, CRISL considers that the strong
prohibition factors such as huge capital outlay, creation of franchise value and brand image of
the products needing time, Government restriction, distribution net work etc.
7. Size of the industry: Size of the industry on the economy and the size of the companies
operating under the industry play an important role in analyzing long term and long term
viability. Large companies have greater tenacity and staying power due to their extensive
resource base and stronger shields. Those companies also enjoys broader market access,
larger market share, strong marketing network, franchise value which ultimately assist the
companys long term viability.
8. Threats of product substitution: -Availability of substitute at cheaper price or
availability of substitute products at the door step may intensify the competition. CRISL
analysis inter alia considers existing and potential substitutes that may stand as threat to the
existing products of the company. In addition alternative uses of the products are also
explored to have an understanding under distress situation.
B. Business Risk Analysis
Under the business risk analysis CRISL evaluates the issuers business model, business
strategies and competitive strength in the industry. Again business risk can be classified in
two sub sector Market Risk and Operational Risk.
i)Market Risk
1. Competition: The nature of competition varies from industry to industry. However the
product lines and its market share determines the nature of competition an organization may
face. In order to survive in the competition, the cost efficiency in production and quality of
product at competitive price is essential. Presently competitive advantages are being created
through strong infrastructure build up and supply chain which are given due weight in the
analytical process.
2. Market position, size and Age of the Business: Market share, size and age of the
organization play an important role in deciding on the competitiveness of a company. Size of
an organization assist in achieving economy of scale, determining economic order size, cost
efficiency and thereby lowering the unit cost of production. The size of an organization also
justifies the research expenditure and capital intensive equipment, effective distribution
channel and branch network.
3. Product demand: Product demand in the market is a very important factor in the process
of ascertaining the market stability and future growth. In this connection CRISL reviews the
plant capacity utilization and quantity of production compared to the market demand,
seasonality of the product demand etc are critically reviewed.
29
4. Product and Service diversity: In a highly competitive environment more particularly in

the industries having frequent change in technology, product diversity and scope of
switchover to other alternative products with small or no cost is considered to be a favorable
point in the overall rating process. In the rating process, the diversity is considered to be
mitigating factor against concentration risk. Companies having more product lines are
always preferred to the companies dependent on single product or product line.
5. Customer Analysis: The number of customers occupying large portion of receivables,
customer concentration, company reliability on few customers, capacity of the company to
absorb the shock of switching over to new customer, impact of customer shifting to other
competitors are reviewed by CRISL in its analytical exercise. Dependence on the customers
in various market segments such as Domestic vs. export market, whole sale vs. retail
market, distribution channels, long term sales contract, impact on market due to change in
price all are given due weightage while carrying out customer analysis.
6. Customer satisfaction: CRISL reviews customer satisfaction of an organization in order
to ascertain the market continuation and market growth. Customer satisfaction can be
reviewed by average continuation of a customer with the company, repeat orders, product
rejection rate etc.
ii) Operational Risk
1. Plant location and production facilities: Plant facilities, technology and plant location
counts significantly in reviewing a manufacturing company. Location of an export oriented
company in the export processing zone or near to that or access to easy communication is
considered to be advantageous while the location of a company requiring heavy raw
material or selling heavy products in the port side or river side involving cost effective
transportation is considered to be a positive factor. Excess to low cost utilities facilities such
as gas and water and electricity is given due weightage.
2. Availability of Raw material: Availability of raw material either from local market or
export market plays an important role in the rating process. In case of local supply, the supply
chain, sufficiency in terms of quality, no of suppliers, seasonality, price fluctuation, lead time
and case of import, additional factors such as import policy, the government duty structure,
import restrictions, cash incentive considerations all plays important role in the CRISL
analytical process
3. Technology vs. Asset efficiency: Modern technology provides competitive edge over old
technology. Asset composition, balanced equipment for maximum production efficiency
all plays positive role while old and outdated technology reduces competitiveness having a
negative impact on rating
4. Cost Structure: Cost structure plays an important role in the industrial
production. CRISL classifies the cost into direct material, direct labour and overhead. Again
cost accumulation and it allocation to various products through job order costing system, or
process cost system is reviewed in order to arrive at a meaningful cost efficiency analysis.
30
Product wise contribution margin cost inefficiency arising out of unplanned expenditure, peer
comparison cost, labour availability, labour sensitivity, cost components, direct cost as
percentage of overall cost, all are reviewed in the rating process
5. Credit Controls: Credit control policies and its effectiveness play an important role in the
liquidity management of the manufacturing companies. It is more particularly important
when a company has been manufacturing for the local market. In order to maintain cash
operating cycle to order for raw materials, payment of labour and factory operation, the
companies require cash constantly from the business cycle. In case of export oriented
manufacturing companies, the Status of payment terms of the export LC vis--vis back to
back LCs needs review to assess the funding mismatch.
6. Inventory management: Inventory management plays a vital role in the working capital
management of manufacturing companies. Excess inventory increases the holding cost and
thus increase the working capital need while inadequate inventory leads to production stop or
excess production cost. CRISL reviews inventory planning, supply chain management,
lead time, economic order quantity etc in addition to the risk of getting the finished products
out of fashion , risk of expiry date etc.
C. Financial Risk:
Every business decision ultimately leads to a financial decision. While the financial risks are
the outcome of the business risk and activities, CRISL reviews the same from the perspective
of short-term and long term financial planning and projections vis--vis financial flexibility to
meet emergency financial need. CRISL generally reviews the audit reports in order to
ascertain as to its reliability from various perspectives. However, in many cases CRISL
reviews the financial statements from the view point of cash flow trend, management reports,
peer analysis based on quantitative
production/activity reports.
Accounting
systems/
practices,
measurement system, inventory valuation, depreciation methods,
quality of audit and auditors comfort level, audit qualification, management report of
the auditors, application of international accounting standards in accounting plays an
important role in CRISL financial analysis.
1. Profitability and coverage: Although the absolute profitability figures such as Earning
(profit) before Tax and interest,(EBIT), Return on equity, return in investment etc, CRISL
puts due weight to profitability indicators, profitability trend vis--vis industry norms,
position of a particular company in the peer.
2. Funding structure: Funding structure of an organization may have an impact on its
cash flow and mismatch is cash generation. CRISL places due importance to the
financing pattern of long term and short term assets vis--vis the short term and long term
debts. For example, if the long term investment in machinery is financed by working capital
loan or short term finance it may seriously affect the cash flow of the company. The
companies having excessive short term debts may face cash shortage in meeting its
obligations in the volatile economy. In addition, dependence of the company on
financial intermediaries such as leasing companies for short term fund may also face liquidity
31
problem in the economic volatile situation. CRISL also ties up the asset life with its financing
pattern. Any machinery purchased through lease must not have any repayments after
the machinery life is exhausted.
3. Capital Structure / leverage: Capital structure of an organization varies from industry to
industry. Capital intensive industries require high leverage while the labour intensive
industries work at low leverage. CRISL identifies industrial norms in respect of debt
equity ratio, coverage ratios, overall gearing ratio, interest coverage ratio, debt
servicing coverage ratio in order to measure the degree of leverage. CRISL also reviews
the off balance sheet assets and liability items such as guarantees, LCS together with BB
LCS in order to ascertain its leverage.
4. Cash flow stability and adequacy: Cash flow of a company plays a very important part in
CRISL assessment procedure. CRISL in many cases reads the Financial Statements with due
emphasis to cash flow. To CRISL Cash flow balance sheets rather provides more reliability
of financial statements than normal statements. Stable cash flow provides comfort of judging
the capability of the company to discharge its liabilities while free cash flow predicts
companys ability to go for expansion or loan repayment capacity or business growth.
5. Financial flexibility and liquidity: Liquidity is the key to judge the short term financial
flexibility of a company. In addition the franchise value of the company to borrow quick
fund from the market, relationship with the financial institutions, level of financial limits
allowed by the banks and its utilization level, perception of the financial institutions for
funding projects under the company, cash operating cycle etc provides wider coverage to the
CRISL analysis.
6. Financial Management: CRISL rating analysis places due weight to the quality of
financial management. Managing Finance through budgetary control system, working capital
management through budgetary control system, management of cost efficiency through
installation of appropriate cost accounting system, product costing , use of accounting
information by the management, IT base financial management system, quality of the
manpower and their qualification etc all are taken into consideration while ascertaining the
extent of financial management.
D. Governance Risk
1. Corporate goals and strategy: Although the Memorandum of Association of the
company contains a large number of objectives, the company normally pursues one or
two main objectives on the basis of which the MISSION and VISION Statements are
prepared in order to determine the corporate goals. Companies operating on the basis of
certain corporate goals as reflected in operating activities.
2. Corporate Governance: Corporate governance is a blend of law, regulations, enforcement
and appropriate voluntary practice by the organizations that permit a corporate to attract
capital, perform efficiently and generate long term economic value for its shareholders while
respecting the interest of its stakeholders and society as a whole. The specific areas covered
32
are composition of Board, formation of Committees, transparency in disclosure of relevant,

reliable financial and operational information, information on ownership and control and
information on internal processing of management. CRISL places due importance to the
governance factors in the rating process of an organization.
3. Succession planning/ Family owned outfit: The succession plan is the key indicator of
corporate philosophy that an organization is a going concern and it has unlimited life and its
viability will not be affected on the departure of any individual professional. In order
to reduce the dependency on single/few individuals a succession plan in a corporate
reflects the management idea of business management continuity and its succession.
CRISL while reviewing the management philosophy takes into consideration of the above
factor. In addition, through the succession plan, the visibility of family management vs.
professional management becomes more prominent.
4. Credibility and Banking Relationship: Credibility, to a great extent, may be reflected in
its franchise value and public perception in the market. However, in order to identify the
willingness of the company to discharge a liability in time, CRISL philosophy is to see the
corporate environment prevailing in the organization vis--vis the strategy being followed
to achieve the corporate goals through managing its diversified business. In
addition, corporate policy to management of conflict of interest, handling intercompany
transfer pricing and intercompany transactions also reflects the credibility of the
organization and its system. In addition to the above, banking relationship plays important
role to judge the credibility of an entity. CRISL carefully looks into all the exposures of the
entity enjoyed from the bank/FIs along with length of relationship. CRISL also reviews the
utilization limit of credit facility. Besides, the personal deposit of the key sponsors, if there is
any, are also taken into consideration. While reviewing the credit facilities, CRISL also
look into the present status of the same along with past performance.
5. IT Infrastructure: The extent of Information technology and communication
infrastructure
installation and the extent of its use in the production and product
management, cost management, inventory management play an important role in managing
an organization. CRISL review process places due importance to the above factors in order to
ascertain the competitiveness in both local and international market.
33
4.2.1 CRABs Corporate Rating Methodology

Input
Output
Industry Risk Analysis
Management Evaluation
Business Risk Analysis
Corporate Governance
Corporate
Rating
Operating Environment
Operating Performance
Strategy and Financial

Policies
Financial Strength
Security Risk Analysis
Generic Rating Factors
Relationship Risk Analysis
Figure 4: Corporate Rating Methodology
CRISL follows sequential steps in the total assessment process as below:

CRAs
Client (MFI)
Request for Ratings (Time
frame for each level)
Submits detailed information
Interacts with the team,
responds to queries, provides
any
Reviews the summary report

of IRC and suggest revision
if any and provides
additional information if they
consider necessary
> The CRISL team formally asks for primary information through a set
questionnaire with a given time frame of one week.
> The team collects, collates and analyzes information from the client and
identifies the gaps of further information from market and client.
> The team interacts with clients, visit site and analyzes data submitted
by the client.
Organizes interview with different levels officials of the
organization.
Team members interact, exchange views among them and prepare
report for Internal Review Committee (IRC) and IRC forwards a
summary report without rating rationale and symbol.
> IRC further reviews the report with the additional information from the
client and submits final report to Rating Committee with the indicative
rating.
Table 5: Sequential steps in the total rating assessment process
34
4.2.2 Comparison among the Corporate Rating Methodology of Different ECAIs

PARTICULARS
Industry Risk
Analysis
Business Risk
Analysis
CRISL
Regulatory framework;
Industrial Risks;
Growth potentials;
Vulnerability;
Industrial Cyclicality;
Entry Barrier ;Size of
the industry; Threats of
product substitution;
CRAB
Labor market
constraints or
incentives, Strength and
Political Direction of
labor unions; labor cost
and strike experience;
condition of general
infrastructure (water,
electricity, oil, gas,
roads, ports, airports,
etc.); Accounting and
reporting transparency;
regulatory risk;
taxation; corruption.
Market Risk
Size and scale; business
Competition; Market model, competition,
position, size and Age diversification.
of
the
Business;
Product
demand;
Product and Service
diversity;
Customer
Analysis;
Customer
satisfaction.
Operational Risk
Plant location and
production
facilities;
Availability of Raw
material; Technology
vs. Asset efficiency;
Cost Structure; Credit
Controls;
Inventory
management
NCRL
ECRL
WCRCL
ALPHA
Demand supply
factors, price
trends, changes
in technology,
international/do
mestic
competitive
factors in the
industry, entry
barriers, capital
intensity,
business cycles
etc
Market
share;
Diversification;
Size;
Seasonality and
Cyclicality;
Cost Structure;
Marketing and
Distribution
Arrangements
Industry/Operating
Environment;
Competitive
Position; Operations
Analysis
Industry
Risk; Market
Position;
Operating
Efficiency;
Size of
Business
Industry
Outlook
Competitive
Position
Operations
Analysis
35
Financial Risk
Analysis
Management/
Ownership/
Governance
Risk Analysis
Profitability
and
coverage;
Funding
structure;
Capital
Structure / leverage;
Cash flow stability and
adequacy;
Financial
flexibility and liquidity;
Financial Management
Strategies and plans;

acquisition strategies;
financial policies;
working capital
management
Cash Flow
Capital
Corporate goals and

strategy; Corporate
Governance;
Succession planning/
Family owned outfit;
Credibility and
Banking Relationship;
IT Infrastructure;
Environmental and
Legal Issues.
Ownership
Organization
Structure
Willingness and
ability of the
corporate;
Bankers confidential
report;
Corporate
Governance
Systems &
Control
Organizational
structure
Performance
of Group
Companies
Security Risk
&
Relationship
Risk
Structure
Financial
Flexibility
I. Profitability and
Earnings Ratios
II. Cash Flow and
Coverage Ratios
III.
Leverage
Measures
IV. Short Term Debt
Servicing
Ability/Liquidity
Accounting
quality;
Earnings
potential/prof
itability ;
Cash flows
analysis;
Financial
flexibility
Earnings; Cash
Flow Generating
Ability and Debt
Servicing
Capacity;
Capital
Adequacy;
Financial
Flexibility
Complexity of the
corporate structure;
Organization
structure,
management breadth
and experience;
Management
flexibility in
responding to
competition, track
record of
management;
Management
continuity; Strategy
and execution;
Financial risk
tolerance; Corporate
governance;
Ownership.
Management
Evaluation;
Geographical
Analysis;
Regulatory
and
Competitive
Environment;
Fundamental
Analysis
What businesses
to be in, what
strategies should
be pursued, and
how these
activities should
be financed;
Management
evaluation; Risk
management
principles and
practices.
Table 6: Comparison among the Corporate Rating Methodology of Different ECAIs
36
4.3 Financial Institutions Rating Methodology (Bank & NBFI)

NCRs rating opinion reflects the credit worthiness of an issuer to meet financial obligations
in timely manner over the life of the instrument. NCR has developed a comprehensive
methodology for rating Banks keeping in view of the conceptual framework of BASEL II.
The Analytical Process
NCR bases its analysis of banks on a number of quantitative and qualitative factors, the most
significant of which are covered below. No one factor has an overriding importance or is
considered in isolation and all the factors are reviewed in conjunction before assigning a
rating.
Quantitative Factors
A) Capital Adequacy: Capital Adequacy is a measure of the degree to which the
banks capital is available to absorb possible losses. It also indicates the ability of the
bank to undertake additional business. NCR examines the conformity of the bank to the
regulatory guidelines on capital adequacy ratio. The size and the composition of the
regulatory capital, internal capital generation, minimum capital adequacy requirement,
stability of capital adequacy ratios and the presence of the hidden reserve are reviewed. A
higher proportion of core capital (tier-1) in the total capital is viewed positively.
B) Asset Quality: Asset quality is the measure of Banks/FIs ability of managing credit risk.
In reviewing the asset quality, NCR places due importance to Banks /FIs credit Appraisal
mechanism portfolio management system rescheduling philosophy etc. in addition we also
examine the structure of the banks balance sheet, including the relative proportions of
different asset categories. In this context, we ask for a breakdown of lending by type of loan,
size, maturity, currency, economic sector & geographical distribution. We also look at
concentrations of credit risk, including large exposures (generally over 10% of equity) to
individual customers & credit risk concentrations in particular industries. Banks are taking on
increasing off-balance sheet commitments, & it is important to analyze the risks involved.
Such commitments include guarantees & letters of credit as well as derivatives.
C) Earnings Quality: A Banks solvency is reflected from its profitability and is therefore an
important area for analysis. NCR looks at the historical trend of a Banks earnings
performance, the stability and quality of its earnings and the capacity to generate profits.
NCR analyzes the composition of income of the bank by segregating it into those generates
from fee based and fund based activities. In the process NCR also reviews the net interest
income, non-interest income, interest rate policy, product mix management, risk vs. return
policy, risk appetite to increase earning etc. In the cost efficient side NCR focus cover a wide
range of measurements such as cost efficiency in terms of cost to income ratio, trends on Net
Interest Margin, Net Non Interest Margin and Net Operating Margin. The overall profitability
is reviewed in terms of Return on Equity, Return on Assets and Earning per Share. NCR
37
compares the Banks performance on each of the above parameters with its peers. Analysis is
carried out to identify the relative position of the Bank in its present operating environment.
D) Liquidity: NCR analyzes the structure and diversification of a banks funding base,
concentration of deposit or borrowing, significant trends in funding sources and in the banks
liquidity. NCR also evaluates the asset-liability maturity structure, deposit renewal ratios,
proportion of liquid asset to total asset and the extent to which core asset are fund by core
liabilities. We consider the core and non-core deposit mix and identify various indicators to
assess the mix of corporate and retail deposits. As far as liquidity is concerned, we analyze
both the banks internal sources of liquidity (marketable securities, maturing loans,
etc.) and external sources (such as access to capital markets, stand-by lines from other banks
and rediscount facilities at the central bank).
E) Competitive Position: The competitive strength of the bank in terms of its cost structure
is analyzed. The proportion of low cost deposits to total deposits and the deposit mix is
examined. Average as well as incremental cost of funds is examined in the context of
prevailing interest rate regime. The ability of the bank to mobilize additional deposits at
competitive rates is examined critically.
F) Size and Market Presence: The size of a bank in terms of its asset, liabilities and branch
network may have a bearing on the banks competitive position. NCR analyses the
diversification of activities undertaken by a bank, in terms of geographical location and
industrial sectors. It also examines the diversity of services and products it provides to
customers, and its ability to create new products.
NCR evaluates the quantitative factors in terms of absolute numbers, ratios and their
relativity and trends as well. NCR also compares the banks performance on each of the
above parameters with its peers. A detailed analysis is done to assess the relative
strengths and weaknesses of the bank in its present operating environment.
Qualitative Factors
Some of the qualitative factors that include our rating process include the following:
A) Risk Management: This includes an analysis of the banks appetite for risk and the
systems it has in place for managing risks related to the pliilar-1 of the conceptual framework
of BASEL II. Three kinds of risk such as credit risk, market risk and operational risk are
considered to determine the Minimum Capital Requirement. The Banks risk management
policy, procedure and processes in place and the degree to which these rules and procedure
are adhered to are also examined. In the recent past there has been perceptible improvement
in the risk management systems of our Banks under the supervision and guidance of the
Bangladesh Bank.
i. Credit risk: NCR evaluates all the credit risks arising from on balance sheet activities as
well as off balance sheet commitments. We examine the structure of the Banks Balance
Sheet, including the relative proportions of different asset categories. Generally, loans and
38
advances constitute the most significant portion of assets of a commercial bank and therefore
a comprehensive review of the credit portfolio is essential for the assessment of the credit
risk. NCR classify the loans and advances by type of loans, size, maturity, economic sector
and geographical location. With reference to the other assets, we analyze the general quality
of the securities, their maturity, any undue concentration and the valuation of these securities.
ii. Market risk: Our analysis of market risk covers all structural & trading risks across a
banks entire business. As far as structural risks are concerned, we examine the banks asset
& liability management strategy, & the role of position taking, hedging & accounting in this
strategy. We examine the sensitivity to market risks in terms of changes in interest rates,
foreign exchange rates and commodity prices. We calculate the ratio of rate sensitive assets
and liabilities for assessment of the impact of changing interest rates on a banks margin of
profit.
iii. Operational risk: Operational risk is defined as all other risks other than market, credit &
liquidity risk. In the context of Basel II, however, the Basel committee has adopted a
narrower definition of Operational risk: the risk of loss resulting from inadequate or failed
internal processes, people & systems or external events. Our analysis of operational risk
focuses on a number of issues, including (a) a Banks definition of such risk b) the quality of
its organizational structure c) operational risk culture d) the development of its approach to
the identification and assessment of key risks e) data collection efforts; and f) overall
approach to operational risk quantification and management.
B) Ownership and Support: The ownership of and potential support available to a bank is
crucial to our overall rating assessment. NCR analyze the stability of the shareholding
structure of the bank, as well as the ability and willingness of either its owners or the
government to bail out the bank in case of need.
C) Management Quality: A well defined management structure is an important ingredient
for the success of a bank. The composition of the board, frequency of change of CEO and the
organizational structure of the bank are considered. NCR looks at the dependence of
management team on one or more persons, coherence of the team, and the independence of
the management from major shareholders. The banks strategic objectives and initiatives in
the context of resources available, its ability to identify opportunities and track record in
managing stress situations are taken as indicators of managerial competence.
D) Corporate Governance: A banks corporate governance practices can have a material
impact on its credit quality. In assessing corporate governance, NCR analyses governance
data and information systematically and also performs more contextual, qualitative reviews of
an individual entitys governance practices. The important aspects, which are looked at by
NCR while evaluating the quality of corporate governance include, the independence and
effectiveness of the board of directors, oversight of related party transactions that may lead to
conflicts of interest, board oversight of the audit function, executive and director
remuneration, complex shareholding/ownership structures.
39
E) Compliance with Statutory Requirements: NCR examines the track record of a bank in
complying with SLR/CRR and other norms and practices as specified by the Bangladesh
Bank.
F) Accounting Quality: Rating depends profoundly on audited data. Policies for income
recognition, provisioning and valuation of investments are examined. Suitable adjustments
to reported figures are made for consistency of evaluation and meaningful interpretation.
G) Franchise Value: NCR take into account the strength and depth of a banks franchise as
well as its ability to safeguard existing business and gain new business. The joint
venture/strategic alliance with foreign/local partners, management contract/technical
collaboration with foreign/local partners and a banks alliance/arrangement with international
financial institutions or any certifications from such institutions are also taken into
account.[ncr]
4.3.1 Diagram of CRABs Bank Rating Methodology
Input
Output
Profitability
Earning Diversification
Earnings and Volatility
Bank Financial
Strength Rating
Asset Quality
Capital Adequacy
Liquidity and Funding
Control & Risk

Management
Asset Quality &
Provisioning
Sectoral Adjustment
Investment quality
Figure 5: CRABs Bank Rating Methodology
40
4.3.2Banking and Non-Banking Financial Institutions Rating Methodology

PARTICULARS
CRISL
CRAB
NCRL
A) Capital Adequacy
A) Capital Adequacy A) Capital Adequacy
Quantitative
B) Asset Quality
B) Capitalization
B) Asset Quality
Factors
C) Earning Prospects
C) Liquidity
D) Liquidity
and
Funding
Funding
E) Size of the Bank/ FI
& Market Position
F) Capacity
of
External
Fund
Mobilization
Qualitative
Factors
A) Management
B) Corporate
Governance
C) Application of
Information
Technology
D)Regulatory
Environment and
Compliances
E)Basel-II
Compliances
F)Risk Management &
Sensitivity To Market
Risk
G)Accounting Quality
Franchise Value
ECRL
A) Capital
Adequacy
and C) Earnings Quality
B) Asset Quality
D) Liquidity
C) Earnings
E)Competitive Position; D) Liquidity and
F) Size and Market
Funding
Presence
A) Franchising
strength and
Diversification
B) Management
Evaluation
C) Corporate
Governance
D) Controls and Risk
Management
E) Risk Positioning
F) Operating and
Regulatory
Environment
A) Risk Management
i. Credit risk:
ii. Market risk:
iii.Operational risk:
B) Ownership and
Support
C) Management Quality
D) Corporate
Governance
E) Compliance with
Statutory Requirements
F) Accounting Quality
G) Franchise Value
A) Management
B) Sensitivity to
Market Risk or
Risk
Management
WCRCL
A) Capital Adequacy
i) Size of Capital
ii) Quality of Capital Components
iii) Sustainability of Capital Ratios
iv) Capital Vs. Business Growth Plans
B) Asset Quality
i) Geographical Diversity and Sectoral
Diversity
ii) Profile of the Large Exposures
iii) Quality of Non Industrial/Specialized
Lending
iv) NPA/Weak asset Levels
v) Growth in Advances
C) Earnings Potential
D) Liquidity/
Asset
Liability
Management
E) Market Position
A) Management Evaluation
i) Goals and Strategies
ii) Systems and Monitoring
iii) Risk Appetite
iv) Competence and Integrity
B) Resource Raising Ability

i) Size of Deposit Base
ii) Deposit Mix
iii) Growth in Deposit Base
iv) Cost of Deposits
v) Diversity of Investor Base
C) Regulatory Compliance
D) Risk Management
E) Franchise Value
F) Government Support
Table 7: Banking and Non-Banking Financial Institutions Rating Methodology
41
4.4 Small Medium Enterprises (SMEs) Rating Methodology

The Bangladesh Rating Agency Limited (herein after referred to as BDRAL) rating
frameworks considers a number of financial and non financial parameters of the enterprise
and regulations and industry specific dynamics. BDRAL believes that the industry in which a
SME operates has a direct bearing on the overall performance of the SME and therefore rates
SMEs based on industry benchmarks. BDRAL Rating is a comprehensive assessment of the
enterprise taking into considerations the overall financial and non-financial performance of
the subject company vis--vis the other peers in the industry in the same line of business and
size criteria. Based on its assessment and understanding BDRAL has developed rating
methodology framework which mainly addresses the following areas
A) Industry Risk
The industry in which an enterprise operates plays a crucial role in the credit risk assessment.
It is a key determinant of the level and volatility in earnings of any business.
B) Business Risk
Business risk is the possibility of a credit customers failing to pay because of circumstances
connected with the customers business activities and management.
I) Market Risk: Market risk is the exposure of the unit to the forward and backward linkage
in the course of conducting its business, and the risk of facing sustained periods of
unfavorable trends in such factors as product prices, raw material prices, single product
dependence, pricing inflexibility, etc.
II) Operating Efficiency: In markets where competitiveness is largely determined by costs,
the market position is determined by the units operational efficiency. The result of these
factors is reflected in the ability of the unit to maintain /improve its market share and
command differential in pricing. In a competitive market, it is critical for any business unit to
control its costs at all levels. This assumes greater importance in commodity or me too
businesses, where low cost producers almost always have an edge. Cost of production to a
large extent is influenced by location of the production unit(s), access to raw materials, access
to human resources, scale of operations, technology, and level of integration, experience and
the ability of the unit to efficiently use its resources.
C) Management Risk
Management risk refers to the instance of risk of nonpayment arising out of a business failure
due to the perceived inefficacies of the management. The elements in management risk are
assessing the management quality judged on the basis of the basic educational qualification,
professional experience of the entrepreneur; and business attitude that is related to the
motivation of carrying out the business and pursuing business strategies. In assessing
management quality three factors are critical:
Character - relate to the willingness to pay. Apart from the characteristic disposition of
honesty and integrity, several aspects are judge in terms of
1. Track record of previous borrowing and payment is an indicator.
2. Whether the owners/ directors have a financial interest in the business.
3. Business premises given the impression of a well-run unit.
42
Ability - relates basically to the ability to pay. Credit worthiness of the buttoner/borrowing
company is assessed, including financial strength, and
Capacity - refers to the borrower having technical, managerial and financial abilities in order
to operate profitably and succeed in business.
D) Financial Risk
Financial risk analysis involves thorough evaluation of the financials of the SMEs. Careful
analysis of the audited financials, observations of auditors in the auditors report and notes to
accounts, consistent treatment of financials play an important role. Key ratio analysis, trend
ratios, and financial disclosures and off Balance sheet items and their impact on the
profitability is studied and analyzed in depth. Further the source of financial funding and their
impact on the capital employed structure needs to be analyzed. Availability of liquid
investments, unutilized lines of credit, financial strength of group companies, market
reputation, relationship with financial institutions and banks, enterprise perceptions and
experience of tapping funds from different sources also play an important role in financial
analysis. Past performance of the company, level of financial transparency i.e. quality of
documents and future plans plays an important role in the determination of rating.
Other parameters
Besides these 5 broad heads other parameters like applicability of pollution control
certificate, impact of subsidies and sales tax deferral loans, impact of changes in accounting
policies, unabsorbed depreciation and business loss, impact of non insurance or inadequate
insurance of assets, extraordinary or windfall gains and losses, analysis of bank statements,
violations of accounting standards if any, change in management, impact of the new
monetary or fiscal policies or significant development in the industry are thoroughly assessed
on case to case basis. Legal risks, foreign exchange fluctuation risk and hedging mechanism
followed by the enterprise if any, is studied in detail.
43
4.4.1Small Medium Enterprises (SMEs) Rating Methodology

CRISL
PARTICULA
RS
ARGUS
BDRAL
1. Industry
Risk
Impact of subsidies/ taxation by the

government, sudden business loss, impact of
non insurance or inadequate insurance of
assets, extraordinary gains and losses, legal
or environmental
embargo, impact of the new monetary or
fiscal
policies or significant development in the
industry
2.
3.
4.
5.
6.
Growth potential
Industry vulnerability
Barriers to entry / Exit
Threats of Substitute
Level of competition
In which an enterprise operates plays a

crucial role in the credit risk assessment.
It is a key determinant of the level and
volatility in earnings
2. Business
Risk
Market situation,
estimated project cost, cost overrun,
implementation plan, competence of the
sponsor in implementing new project,
estimated cash generation.
good control over the borrowers ;
willingness to repay loan; ability to pay its
obligations; handle the business efficiently;
Working condition and relationship between
the employer and employees
1.
2.
3.
4.
Market position
Business diversity
Operating efficiency
Cost structure
Possibility of credit customers failing to pay

because of customers business activities and
management.
I) Market Risk
II) Operating Efficiency
The instance of risk of nonpayment arising
out of a business failure due to the perceived
inefficacies of the management.
i)
Character
ii)
Ability
iii)
Capacity
3. Management
Risk
2. Track Record
3. Capacity to overcome
adversity
4. Risk appetite
5. Succession Plans
6. Goals, Philosophy and
strategies
4. Financial
Risk
Financial position, working capital utilization

and cash flow movement. net worth, asset
size, liability, turnover, cost pattern,
profitability, cash flow adequacy to debt
repayment
Earnings; Capital structure and

leverage; Interest coverage and
liquidity levels; Cash flow
analysis; Financial flexibility;
Financial policy.
Involves thorough evaluation of the

financials of the SMEs. Past performance of
the company, level of financial transparency
i.e. quality of documents and future plans
plays an important role in the determination
of rating.
Table 8: Small Medium Enterprises (SMEs) Rating Methodology
44
4.5 Rating Methodology (Insurance Company)

Insurer Financial Strength (IFS) rating of a General insurance company assesses the financial
strength of an insurance company and its capacity to meet obligations to policyholders on a
timely basis.
Methodology
NCRs analyses incorporate an evaluation of the rated companys current financial position
as well as an assessment of how the financial position may change (to meet all of its
obligations) in the future. NCRs rating methodology focuses on the following five areas of
analysis:
Industry Review
Management Review
Operational Review
Financial Review
Organizational Review
Industry Review
The starting point for NCRs ratings is a thorough understanding of the industry in which the
insurer operates. One of NCRs goals is to judge the extent industry dynamics can impact the
ratings levels that individual insurers operating in a given industry segment can achieve.
NCRs specific evaluation of the general insurance industry focuses on:
i.
Level of competition in specific sectors, and how variable competition has been
over time.
ii.
The basis for competitive advantage in the sector.
iii.
Barriers to entry and threats of new products
iv.
The potential tail of losses and ability to make accurate pricing decisions, as
well as exposure to large unexpected losses
v.
Regulatory, legal and accounting environment and framework.
Operational Review
NCRs operational review focuses on a given companys unique competitive strengths and
weaknesses, operating strategies, and business mix. NCRs analysis focuses on both the
historical and current business position and how it is expected to change over time. NCRs
operational review includes an evaluation of:
Underwriting expertise and market
Brand name recognition and
knowledge
franchise value
Distribution capabilities and mix
Expense efficiencies and
Classes of business and changes in
operational scale
mix
Product and geographical mix
Market share and growth
Administrative and technological
capabilities
45
Organizational Review
NCR places importance on the influence of the owners on the company and the extent of
financial support they would extend in case of any emergency. Moreover, NCR also assesses
the credibility, market reputation and experience of the owners in the relevant field.
Management Review
One of the most difficult, yet critical aspects of NCRs rating process is the level of
confidence we develop in the management team and its stated strategies. NCR specific
evaluation of management focuses on the following:
Strategic vision
Controls and risk management
Appetite for risk
capabilities
Credibility and track
Depth, breadth, and succession plans
record for meeting
Accomplishments of key executives
expectations
Financial Review
NCRs financial review includes the calculation of numerous financial ratios and other
quantitative measurements. These are evaluated based on industry norms, specific rating
benchmarks, prior time periods and expectations developed by NCR specific to the rated
entity. In addition to the published financial statements NCR examines the management
reports, evaluations and company projections. The financial review is broken into six main
segments:
Underwriting quality
Reinsurance utilization
Profitability
Reserves and Capital adequacy
Investments
Liquidity
Underwriting Quality:NCRs goal is to judge the overall health of the book of business, and
management understands of its risks and ability to control them. Key areas considered
include:
:
Underwriting expertise in each class of business

Pricing credibility
Pricing flexibility given competitive and regulatory environment
Exposure to large losses
Balance of premium growth and underwriting discipline
Controls over any third party underwriters, such as managing general agents
Claims management and expertise
Expense efficiencies, and impact of ceding commissions on expense ratios
NCR measures underwriting performance using two common ratios the loss ratio and the
expense ratio. To properly interpret these ratios, NCR considers the companys business mix,
pricing strategy, accounting practices, distribution approach and reserving approach. The
combination of the loss and expense ratios is referred to as the combined ratio. A combined
ratio below 100% translates into an underwriting profit, and above 100% represents an
underwriting loss.
46
Profitability: The focus of NCRs analysis of profitability is to understand the sources of

profits, the level of profits on both and absolute and relative basis, and potential variability in
profitability. Profits for general insurers are sourced from two primary functional areas
underwriting and investment income. Profits derived from investments can take the form of
interest, dividends and capital gains and can vary as to their taxable nature. To further
understand the quality of earnings, NCR evaluates the diversification of earnings, as earnings
that are well diversified tend to be less volatile. NCR also calculates the following standard
profitability ratios: return on assets (ROA) and return on equity (ROE).
Investments/Liquidity: NCRs analysis of the investment portfolio focuses on credit risk,
market risk, liquidity and historical performance. As part of NCRs analysis, the companys
investment guidelines and management controls are also evaluated to understand how the
investment portfolio may change over time. NCR examines credit risk by looking at the
companys exposure to higher risk investments relative to the total investment portfolio and
capital base. NCR examines the companys investment yield, total return, duration and
maturity structure, and historical default experience. Volatility of investment valuations is
considered in the context of both book value and underlying market (liquidation) values.
Reinsurance Utilization: In assessing an insurers use of reinsurance, NCRs goal is to
determine if capital is adequately protected from large loss exposures, and to judge if the
ceding companys overall operating risks have been reduced or heightened. In the traditional
sense, reinsurance is used as a defensive tool to lay off risks that the ceding company does
not want to expose to its earnings or capital. When reinsurance is used defensively, NCRs
goal is to gain comfort that:
Sufficient amounts and types of reinsurance are being purchased to limit net loss
exposures given the unique characteristics of the book
Reinsurance is available when needed
The cost of purchasing reinsurance does not excessively drive down the ceding
companys profitability to inadequate levels, and weaken its competitive pricing
posture
The financial strength of reinsurers is strong, limiting the risk of uncollectible
balances due to insolvency of the reinsurer.
Exposure to possible collection disputes with troubled or healthy reinsurers is not
excessive
Reserves and Capital Adequacy: Reserve adequacy is a critical part of the financial review,
and a demonstrated ability to maintain an adequate reserve position is a crucial characteristic
for a highly rated insurer. While the analysis of reserve adequacy includes a robust
quantitative element, much of NCRs reserve review is qualitative in nature. Accordingly, our
review focuses on the following:
Historical track record in establishing adequate reserves

Managements reserving targets
Key reserving assumptions
General market and competitive pricing environment, and propensity of management
to carry weaker reserves during down cycles
Use of discounting, financial reinsurance or accounting techniques that reduce carried
reserves
Comparison of company loss development trends relative to industry and peers
47
Liquidity: In short-tail insurance sectors, liquidity is particularly important. NCR justify

liquidity based on the marketability of investments. The manner in which the company values
its assets on the balance sheet is also closely examined.
NCR evaluates trends in operating and underwriting cash flows to judge liquidity at the
operating company level. NCR also considers cash flows in the context of future levels of
investment income generated by a shrinking or growing portfolio. Off balance sheet sources
of liquidity, including committed and uncommitted lines of credit, asset securitization and
other funding arrangements, are also considered.
4.5.1 Diagram of CRABs General Insurance Rating Methodology

Input
Output
Earnings Strength &

Stability
Management &
Corporate Strategy
Liquidity & ALM
Capital Adequacy
General
Insurance
Risk Underwritten
Business Profile
Asset Quality
Reserve Adequacy
Solvency Margin
Figure 6: CRABs General Insurance Rating Methodology
48
4.5.2General Insurance Rating Methodologies

PARTICULARS
CRISL
Regulatory Compliance; Level
of competition; competitive
advantage;
CRAB
Competitive position; Capital
Adequacy; Market Share;
Distribution; Product
Diversification; Asset Quality
NCRL
Level of competition;
competitive advantage;
Barriers to entry and threats of
new products; Regulatory,
legal and accounting
environment.
Operational
Review
Ownership Pattern; Parent

Support; The Board of
Directors; Financial Reporting
System; Marketing Strategy
Organizational
Review
Market Position; Re-insurance;

Quality of Investment Portfolio
Relationship between the BoD,

Management and Shareholders;
Degree of relationship to
balance effectively
shareholders and creditors
interest; Board Effectiveness;
Board Independence;
Management Compensation;
Key Personnel Risk; Insider
and Related Party Risk;
Integrity of Accounting and
Audit
Ownership and Organizational
Complexity
Underwriting expertise and

market knowledge;
Distribution capabilities and
mix; Classes of business and
changes in mix; Market share
and growth; Brand name
recognition and franchise
value; Expense efficiencies
and operational scale; Product
and geographical mix;
Administrative and
technological capabilities
Credibility, market reputation
and experience of the owners.
Management
Review
Market Risk; Operational

Risk; Event Risk; Management
Information System; Human
Resources Management
Underwriting Risks; Risk

Governance; Risk analysis and
Quantification; Risk
Infrastructures and Intelligence;
Credit Risk; Market Risk;
Sovereign Risk; Management
Evaluation(financial,
operational, strategic)
Strategic vision; Appetite for

risk; Credibility and track
record for meeting
expectations; Controls and risk
management capabilities;
Depth, breadth, and succession
plans; Accomplishments of
key executives
Industry Review
Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation A Review on Bangladesh Context;| 49
ECRL
Pricing environment and phase
in insurance cycle; trends in
gross and net premiums;
growth rates; distribution
profile; regulatory changes;
effect of the macroeconomic
environment; new entrants and
capital adequacy trends.
Business growth; Stability in
Operating Performance;
Underwriting and Investing.
Market position; competitive

advantage; Business mix;
Underwriting standards and
claims management.
Increasing efficiency
and productivity, enhancing
technical skills in areas such as
underwriting, information
Systems and asset
management, product
innovation, and improving
service quality.
Financial Review
Financial Performance
Profitability; Operating
Performance- Efficiency;
Capitalization; Liquidity and
Funding.
Earnings Strength and Stability

(Return on Assets, Sharp Ratio
of growth net income, Pretax
return in Revenue); Reserve
Adequacy; solvency Margin;
Liquidity Assets and Liability
Management
Underwriting
quality; Liquidity; Reserves;
Profitability;
Investments; Investments; Capitalization;
Reinsurance
utilization; Reinsurance Utilization;
Reserves
and
Capital
adequacy; Liquidity.
Table 9: General Insurance Rating Methodologies
4.6WCRCL Rating Scales & Definitions

LONG-TERM & SHORT-TERM RATINGS OF CORPORATE
Investment Grade
AAA
Issuer/Issue rated AAA is judged to be of the highest quality

with minimal credit risk.
AA1, AA2,
AA3
Issuer/Issue rated AA is judged to be of very high quality and

subject to very low credit risk.
A1, A2, A3
Issuer/Issue rated A is an upper medium grade and subject to

low credit risk.
Long Term Rating Categories
Issuer/Issue rated BBB is subject to medium credit risk. And

BBB1, BBB2,
considered medium grade and as such may possess certain
BBB3
speculative characteristics.
Speculative Grade
BB1, BB2,
BB3
Issuer/Issue rated BB is judged to have speculative elements

and subject to substantial credit risk.
B1, B2, B3
Issuer/Issue rated B is considered speculative and subject to

high credit risk.
Risky Grade
Issuer/Issue rated CCC is judged to be of poor standing and

CCC1,
CCC2, CCC3 subject to very high credit risk.
CC1, CC2,
CC3
Issuer/Issue rated CC is highly speculative and likely or very

near in default, with some prospect of recovery of principal
and interest.
Issuer/Issue rated C is the lowest rated class of bonds and

typically in default with little prospect of recovery of principal
and interest.
Default Grade
Indicates that the issuer/Issue is in default, is technically or

actually in bankruptcy.
Short Term Rating Categories
P1
Issuer/Issue rated Prime 1 has a superior ability to repay

short term debt obligations. It is most likely to have the
capacity to meet their obligations over the coming 12 months
through internal resources without relying on external sources
of committed financing.
P2
Issuer/Issue rated Prime 2 has a strong ability to repay

short term debt obligations. It is likely to meet their
obligations over the coming 12 months through internal
resources but may rely on external sources of committed
financing.
P3
Issuer/Issue rated Prime 3 has an acceptable ability to

repay short term debt obligations. It is expected to rely on
external sources of committed financing. Based on its
evaluation of near term covenant compliance, WCRCL
believes that the issuer may require covenant relief in order to
maintain orderly access to funding lines.
P4
A short-term obligation rated 'Prime- 4' is regarded as having

some speculative characteristics. The obligor currently has the
capacity to meet its financial commitment on the obligation;
however, it may face major ongoing uncertainties which could
lead to the obligor's inadequate capacity to meet its financial
commitment on the obligation.
P5
A short-term obligation rated 'Prime- 5 is currently vulnerable

to nonpayment and is dependent upon favorable business,
financial, and economic conditions for the obligor to meet its
financial commitment on the obligation.
P6
A short-term obligation rated 'Prime- 6 is in payment default

or jeopardized through bankruptcy petition of similar action.
Table 10: WCRCL Rating Scales & Definitions
Chapter # 05
Growth and Impact of

Rating after Basel II
5.1 Rating by CRISLImplementation
& CRAB in 2008-2012
5.2 The Growth Rate of credit rating in 2009-2012
5.3 Total number of Rating in 2012 by Credit Rating
Agencies
5.4 Total number of Rating in 2012 by Credit Rating
Agencies (Grading Wise)
Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation A Review on Bangladesh Context;| E
1. Impact of Rating after Basel II Implementation

5.1 Total Credit Rating Scenario in Bangladesh from 2008-2012
Total
2012
2860
2011
2008
1461
2010
2009
498
2010
2009
114
2008
88
0
2011
2012
500
1000
1500
2000
2500
3000
3500
Graph 1: Total Credit Rating Scenario from in Bangladesh 2009-2012

The above Graph-1, make clear the increasing scenario of credit rating in Bangladesh. After
introduction of Basel II it is increasing year to year at high rate. At 2008 it was only 88 where
2012 it is 2860. The total numbers of rating in 2011 to 2012 increase two times 1486.
5.2 The Growth Rate of credit rating in 2009-2012
400.00%
336.84%
300.00%
193.37%
200.00%
100.00%
29.55%
95.76%
0.00%
2009
2009
2010
2010
2011
2011
2012
2012
Graph 2: Growth Rate of credit rating from 2009-2012

From above Graph-2, it is indicates that the number of rating is growing at a significant rate
in every year. Its also point out that the growth rate is decreasing 2010-2012. In 2010; the
growth rate is high at 362.28%. Again growth rate decrease comparative to 2010. The growth
rate of credit rating in Bangladesh at 2011 and 2012 is 175.90% and 08.15% respectively.
5.3 Total number of Rating in 2012 by Credit Rating Agencies
Rating, 2012
1000
Number
800
600
400
200
0
Rating, 2012
CRISL
CRAB
NCRL
ECRL
923
832
556
404
ARGUS WCRCL
96
Alpha
BDRAL
17
15
17
Graph 3: Rating in 2012 by Credit Rating Agencies

The Graph-3 is viewing the market capturing area by ECAIs. Here, CRISL & CRAB are the
leading (923 & 832 respectively) and oldest credit rating agencies in Bangladesh. And
WCRCL, Alpha and BDRAL are newly launched, where BDRAL till not approved by
Bangladesh Bank as ECAIs.
5.4 Rating by CRISL & CRAB in 2008-2012
CRISL & CRAB in 2008-2012

CRISL
CRAB
923
600
832
660
300
198
40
48
2008
70
44
2009
2010
2011
2012
Graph 4: Rating by CRISL & CRAB in 2008-2012

The Graph-4 is denoting the number of rating 2008-2012 by CRISL & CRAB. These two are
capturing the momentous area of rating market in Bangladesh. Where, CRISL is the first and
largest credit rating companies in Bangladesh and CRAB is the second.
5.4 Total number of Rating in 2012 by Credit Rating Agencies (Grading Wise)
1200
BBB, 1113
1000
BB, 821
800
600
AA, 278
400
A, 339
B, 247
200
AAA, 10
0
AAA
AA
BBB
BB
Graph 5: Rating in 2012 by Credit Rating Agencies (Grading Wise)

Graph-5, highlighting the long term scale wise rating by eight credit rating agencies in 2012.
Where, Issuer/Issue rated AAA is judged to be of the highest quality with minimal credit risk
is lower (10). And Issuer/Issue rated BBB is subject to medium credit risk (considered
medium grade and as such may possess certain speculative characteristics) is at high 1113.
Chapter # 06
Banks Performance Pre &

Post of Basel II
6.1 Bank Performance
Implementation
(pre and post of Basel II)
6.2 Importance of Credit Rating in the Banking
Sector
6.3 Impact of Basel II on banking industry
Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation A Review on Bangladesh Context;| F
6.1 Bank Performance (pre and post of Basel II)

Profitability is one of the indicators to measure the improvement in the banking industry. We
analyze two profitability ratios, namely "Return on Assets (ROA)" and "Return on Equity
(ROE)", and the "Net Interest Margin (NIM) for the banking sector since 2005. All these
variables have increased considerably during the period.
2005
2006
2007
2008
2009
2010
2011
ROA
0.6
0.8
0.9
1.2
1.37
1.8
1.95
ROE
12.4
14.1
13.8
15.6
21.72
15.5
19.27
NIM
35.3
44.3
54.8
70.9
81.46
121.9
142.32
Table 11: Aggregate Profitability of the Banking Industry in Bd. (Source: Statistics Department,
Bangladesh Bank)
ROA: A basic measure of bank profitability that corrects for the size of the bank is the return
on assets (ROA), which divides the net income of the bank by the amount of its assets. ROA
is a useful measure of how well a bank manager is doing on the job because it indicates how
well a banks assets are being used to generate profits.
RoA=
Return on Assets
2.5
ROA
2
1.5
1
0.5
0
ROA
2005
2006
2007
2008
2009
2010
2011
0.6
0.8
0.9
1.2
1.37
1.8
1.95
Graph 6: Aggregate Return on Asset of Banking Industry in Bangladesh (Source: Statistics

Department, Bangladesh Bank)
The graph 6 is showing the increasing scenario of return on assets pre and post of Basel II in
2006 it was only 0.6 and in 2011 it was about 2(1.95).
ROE: Although ROA provides useful information about bank profitability, but it is not what
the banks owners (equity holders) care about most. They are more concerned about how
much the bank is earning on their equity investment, an amount that is measured by the return
on equity (ROE), the net income per dollar of equity capital. RoE=
Return on Equity
25
ROE
20
15
10
5
0
2005 2006 2007 2008 2009 2010 2011
ROE 12.4 14.1 13.8 15.6 21.72 15.5 19.27
Graph 7: Aggregate Return on Equity of Banking Industry in Bangladesh (Source: Statistics

The above graph 7 is indicating the pre and post (Basel II) scenario of return on equity of
banking industry. Where, immediate year (2009) after Basel II introduction ROE reach on the
peak (21.72).
NIM: Another commonly watched measure of bank performance is called the Net Interest
Margin (NIM), the difference between interest income and interest expenses as a percentage
of total assets: NIM=
Net Interest Margin
Axis Title
150
100
50
0
2005
NIM 35.3
2006
44.3
2007
54.8
2008
70.9
2009 2010 2011

81.46 121.9 142.3
Graph 8: Aggregate Return on Asset of Banking Industry in Bangladesh(Source: Statistics

The graph 8 is showing the increasing scenario of net interest margin of the banking industry
in Bangladesh. In 2005 it was only 35.3 but after Basel II implementation it increase at high
rate thats why, in 2011 it was 142.32.
6.2 Importance of Credit Rating in the Banking Sector

In this study I have found the following importance of credit rating in the Banking Sector:
To increase investor confidence and guide time to time.

Facilitate decision making at the time of taking loan or making investment.
Credit rating measures probability of default to meet obligations.
Credit rating states the strengths and weaknesses of the company by which company
take chance to use strengths and remove its weaknesses.
Rated instrument enjoys higher confidence to the clients of the company that they are
less risky.
Provide information and guidance to institutional and individual investors/creditors.
Enhance the ability of borrowers/issuers to access the money market and the capital
market for tapping a larger volume of resources from a wider range of the investing
public.
Assist the regulators in promoting transparency in the financial markets.
Provide intermediaries with a tool to improve efficiency in the funds raising process.
6.3 Impact of Basel II on banking industry

After all I found that Basel II affects the banking industry by the following ways:
Risk management:
The process of identification, analysis and either acceptance or mitigation of uncertainty in

investment decision-making. Essentially, risk management occurs anytime an investor or
fund manager analyzes and attempts to quantify the potential for losses in an investment and
then takes the appropriate action (or inaction) given their investment objectives and risk
tolerance. Inadequate risk management can result in severe consequences for companies as
well as individuals. For example, the recession that began in 2008 was largely caused by the
loose credit risk management of financial firms. Basel II gives emphasis on credit risk
assessment of banks.
Risk management is the continuing process to identify, analyze, evaluate, and treat loss
exposures and monitor risk control and financial resources to mitigate the adverse effects of
loss.
Loss may result from the following:
Financial risks: such as cost of claims and liability judgments
Operational risks: such as labor strikes
Perimeter risks: including weather or political change
Strategic risks: including management changes or loss of reputation
Expectations on the Board
Expectations on the board are vital point of modern business. Every stake holder has some
expectations on the board e.g. to treat each other with dignity and respect, to maintain the
confidentiality of information that is designated as confidential and discussed and/or
disclosed during the meetings etc. By making assessment basel ii express the degree of
expectations meeting by board.
Human capital
A measure of the economic value of an employee's skill set. This measure builds on the basic
production input of labor measure where all labor is thought to be equal. The concept of
human capital recognizes that not all labor is equal and that the quality of employees can be
improved by investing in them. The education, experience and abilities of an employee have
an economic value for employers and for the economy as a whole. By assessing human
capital basel ii express the quality of human capital and give chance to make improve.
Industry structure (mergers?) & competitiveness
Basel II also state the insight view of the industry and how much competitive to the market. If
anyone desire to merge or compete with the entity they should look first their rating or
weight, how much risky it.
Capital impact
The major impact of basel ii on capital. If the rating is good or high they can raise capital
easily and low cost, otherwise vice-versa. On another side, if rating is good then the banking
industry make investment in productive sector of their additional capital.
Chapter # 07
Conclusion
7.1 Prospects of Credit Rating in Bangladesh
7.2 Findings of the Study
7.3 Recommendation of the Study
7.4Conclusion
7.3 References
7.4 Appendixes
Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation A Review on Bangladesh Context;| G
7.1 Prospects of Credit Rating in Bangladesh

1. Bangladesh Bank is going to publish soon a rule that rating is mandatory for all clients
who will take loan one core or more than one core from bank.
2. Basis for proactive risk management alongside the development of the customer
creditworthiness;
3. Greater protection to depositors due to development of a better risk management culture
and systems for banks;
4. Improved risk management will enhance the banking sectors ability to offer to customers
more sophisticated products such as derivatives;
5. Greater sensitivity to customer risk due to changes in measuring risks, which will allow
for better risk-adjusted pricing, with lower rates for better customers;
6. While enhanced risk assessment might affect loan pricing, capital is just one of the factors
for credit margin (e.g. competition, cost and efficiency of individual bank and desired
minimum margin on assets);
7. Enhanced disclosure of information published CAR (Capital Adequacy Ratio) will
reflect more accurately change in risk profile; improvement of shareholder value and
public confidence.
7.2 Findings of the Study

The credit rating market in Bangladesh is going to vast competitive day by day after
introduction of Basel II (at present there are seven BB approved CRAs & One under
process in Bangladesh).
With the awareness of credit rating (Basel II) among the individual or corporation the
number of rating is increasing day by day (Chart-2).
Medium grade (BBB) achieved companies are the highest number in Bangladesh (841
in 2012, Chart-4).
CRISL and CRAB are the leading Credit Rating Agencies (CRAs) in Bangladesh
(Chart-3).
Bangladesh Bank is going to publish soon a rule that rating is mandatory for all
clients who will take loan one core or more than one core from bank.
The incorporation of credit ratings into the regulatory regime has occurred under the
first pillar of the Basel II Accord, which allows banks to use credit ratings to
determine risk weights in the standardized approach to capital adequacy.
Beside vast advantages it has some disadvantages (biasness, absence of quality rating,
concealment of material information).
Page | 60
For high competition among the credit rating agencies clients desire high rate, which
agency will provide high rate, they take rating from them.
CRAs greed, ignorance and incompetency undoubtedly had a key role in opening the
gates of the financial world to the poison chalice of structured instruments.
The central reason for CRAs failure is CRAs revenue maximum comes from the very
companies they rate, created conflicts of interest which inhibited the CRAs from
successful gate keeping.
If company owns poor grade or absence of quality rating, it would face a critical time,
where they do not take loan or make investment easily thats why company try to hide
the rating information.
If a company fall in down temporarily it will negatively reflects the company rating
and impact after rating.
Rating grade provided by the agencies vary from one to one. Because the
measurement techniques are not similar.
Certifying qualitative factors (management, ownership, accounting quality, franchise
value etc.) is not possible accurately.
Future is always uncertain it is only possible to guess. As credit rating based on the
past and present performances future can change at any time.
Information gap also can produce unqualified (reverse) grade thats why company can
downfall at any time (Enron).
With the growing awareness of credit rating after introduction of Basel II, all clients
are trying to increase the overall quality thats why the quality of rating is going up
year to year.
7.3 Recommendations
Bank and Fund technical assistance to countries should focus on strengthening
financial sector infrastructure, core supervisory functions in line with the BCP and
including risk-based supervision, as well as conditions allowing for the exercise of
market discipline. These are essential prerequisites for countries seeking to adopt the
Basel II framework. Bank and Fund staff should avoid conveying the perception that
countries will be criticized by the Bank or Fund for not moving to adopt the Basel II
framework.
Bank and Fund staff will provide assistance to host countries wishing to strengthen
their supervision but should, at the same time, take a neutral position with regard to
the question of whether host supervisors should permit foreign banks in their
countries to operate under Basel II (particularly the advanced approaches), while
Page | 61
domestic banks remain under Basel I. Host supervisors, however, should retain
responsibility for the supervision of all banks operating under their jurisdiction.
Internally, the Bank and the Fund would need to allocate resources to continue to
upgrade staff knowledge of all aspects of Basel II, including the more advanced
elements of Pillar I, through segment to supervisory agencies, through internal and
external training of existing staff and through hiring staff familiar with Basel II.
Although availability of resources in the area of Basel II will be scarce for the coming
years, the Fund and the Bank will need to position themselves, within the existing
resource envelope and using external funding where possible, to recruit outside shortterm and long-term experts to assist in building the IFIs' own expertise and to
participate in technical assistance activities.
Bangladesh Bank (BB) should ensure the quality of credit rating agencies.
Bangladesh Bank (BB) should directly control the Credit Rating Agencies (CRAs).
All Credit Rating Agencies (CRAs) should free from biasness, personal relation,
personal benefits etc.
Growing awareness among the clients about credit rating and Basel II. Make
mandatory rules ensure rating for every client who takes one core or more loans from
the banks.
Bangladesh bank should strictly control the propensity of getting higher grade than
actual have.
CRAs need to broadly adjust their methodologies and procedures. At the same time, a
critical review of CRA regulation is required.
7.4 Conclusion
Credit Rating is an assessment of ability to pay current obligation of an individual or
corporation on the basis of borrowing and repayment capacity by which anyone can take
decision where should make investment or from where should take loan devoid of any risk.
Without any doubt, the role of credit rating in the banking sector after introduction of Basel II
regulation is at remarkable position (growing in every year, Chart 2). It will promote adoption
of stronger risk management practices, which will help enhance the safety and stability of the
local banking sector. As a growing economics which prides itself on adopting the latest best
practices, it is going to natural for Bangladesh to implement Basel II at the same time as the
Basel Committee members. Introduction of Basel II will enhance the reputation and
international standing of Bangladesh and our banks. Clients timely feedback on the draft
Rules will help Bangladesh Bank to meet the target implementation timetable.
On the whole analyses I have able to take decision that the credit rating playing a great role in
minimizing credit risk by creating corporate image, market expansion, growth expediting,
cost minimizing, etc.. Though it has some negative impact on the related parties, the
significant reason for negative impact is undoubtedly the exponential growth of the structured
finance market (high volume of competition). To avoid that problem Bangladesh Bank
Page | 62
should directly/straightly control and make ensure the good practices of law and providing
CRAs incentives to the goal of high quality credit ratings.
In summary, Basel II aims not only to align regulatory capital more closely with risk but to
promote a more sophisticated approach to risk management and to create a 'risk culture'
inside lenders, whereby the organization, and senior management in particular, understand
risk and remain alert to risk as a core issue. Now that lenders have moved to Basel II, they
have discovered just how substantial a change it is, although for the time being they are also
still being required to conform to the Basel I capital floors as well, so are unlikely to have
seen a significant reduction in their regulatory capital requirement.
The recent global financial crisis has revealed weaknesses in the whole approach to risk
management that has been developed through the Basel II process. Management has been
expected to be vigilant about risk but risks have come from unexpected
places. Assumptions about the liquidity of financial instruments such as mortgage backed
securities (MBS) that were based on past performance have proven unfounded as has the
reliability of credit ratings on many of these MBS.
7.5 References
Akhtar, Shamshad, Governor of the SBP, 2006, Basel II Implementation: Issues, Challenges
and Implications, 56th Annual General Meeting Institute of Bankers Pakistan
Altman, EdwardI. and Herbert A. Rijken, 2004, "How Rating Agencies Achieve Rating
Stability," Journal of Banking and Finance 28(November), pp.2679-2714.
Berger, Allen, Sally Davies and Mark Fl annery, 2000," Comparing market and supervisory
assessments of bank performance- who knows what when", Journal of Money credit
and Banking 32(3)(August),641-667.
Bils, Mark, PeterJ.K lenow and Benjamin A. Malin, 2009, "Reset Price Ination and the
Impact of Monetary Shocks, "NBER Working Paper 14787,March.
BRPD circular available at: www.bb.org.bd
BRPD Circular no. 14/2007 dated December 30, 2007
BRPD Circular no. 7/2008 dated September 23, 2008
Cantor, Richard, 2004,"An Introduction to Recent Research on Credit Ratings,"Journal of
Banking and Finance 28(November), pp.2565-2573.
Carey, Mark and Mark Hrycay,2001."Para meterizing Credit Risk Models with Rating Data,"
Journal of Banking and Finance 25,197-201.
Page | 63
Chen,Qi and Wei Jiang, 2006,"Analysts Weighting of Publicand Private Infomration,"

Review of Financial Studies 19,319-355.
Fakhar, Fozia, 2005, Basel II: A Step Forward in Risk Management, Journal of IBP, AprilJune, pp 15-19.
Jacobson,Tor, Jesper Lind ,and Kasper Roszbach,2006,"InternalRatings Systems, Implied
Credit Risk and the Consistency of Banks Risk Classi cation Policies," Journal of
Banking and Finance 30,1899-1926
Rahman , Muhammad Mustafizur Banking Sector Reforms in Bangladesh and its Impact
(2012), thesis paper, Masters of Business Administration, The University of Dhaka,
Dhaka, Bangladesh
Roadmap for the implementation of Basel II in Bangladesh, BB.
Sheng, A. (1996). Bank Restructuring: Lesson from the 1980s. Washington: The World
Bank.
Supervisory guidance on cross-border cooperation is provided in "High-Level Principles for
the Cross-Border Implementation of the New Accord," Basel Committee on Banking
Supervision (August 2003).
Treacy, Williamand Mark Carey,2000,"Credit Risk Rating Systemsa Large U.S.Banks",
Journal of Banking and Finance 24,pp.167-201.
Page | 64
Appendixes
Appendix 1: Methodology requires minimum information on following
parameters
A. Corporate (other than Bank and Non-bank Financial Institution)
i) Financial Risk
Leverage
Liquidity
Profitability
Coverage ratio
ii) Business/Industry Risk
Size of Business
Age of Business
Business Outlook
Industry Growth
Competition
Entry/Exit Barriers to Business
iii) Management Risk
Experience
Succession
Team Work
B. Bank and Non-bank Financial Institution
iv) Security Risk

Experience
Succession
Team Work
iv) Security Risk
Security Coverage
Collateral coverage
Support/Guarantee
legal intervention (If any)
v) Relationship Risk
Account Conduct
Utilization of Limit If any loan from bank
Compliance of covenants/conditions with
banks & other counterparty
Deposit with bank or others
i) Quantitative Factors
Capital Adequacy
Asset Quality
Earning quality
Liquidity and Capacity of External Fund
Mobilization
Size of the Bank and Market Presence
ii) Qualitative Factors
Management
Regulatory Environment & Compliance
Risk Management
Sensitivity to Market Risk
Ownership (Share holding pattern) and
Accounting Quality
Franchise Value
C. Quantitative and Qualitative risk factors for other business segments i.e.
Securitization exposure, Insurance Company, Autonomous Bodies etc. have to be
enclosed.
Page | 65
Appendix 2: The mapping of rating scales of EACIs

BBs
Rating
Grade
1
Equivalent
Notch/Notation
of CRISL
AAA
AA+, AA, AA
B+, B, BCCC+, CCC,

CCCCC+, CC, CCC+, C, C-, D
Equivalent
Notch/Notation
of CRAB
AAA
AA1, AA2,
AA3
A1, A2, A3
BBB1, BBB2,
BBB3
BB1, BB2,
BB3,
B1, B2, B3
CCC1, CCC2,
CCC3
CC
C, D
2
3
A+, A, A
BBB+, BBB,
BBB
BB+,BB, BB
S1
S2
S3
S4
S5, S6
ST-1
ST-2
ST-3
ST-4
ST-5, ST-6
ST-1
ST-2
ST-3
ST-4
ST-5, ST-6
4
5
Long Term Rating Category Mapping

Equivalent
Equivalent
Equivalent
Notch/Notation Notch/Notation of Notch/Notation
of NCRL
ECRL
of ARGUS
AAA
AAA
AAA
AA+, AA, AA
AA+, AA, AA
AA+, AA, AA
A+, A, A
BBB+, BBB,
BBB
BB+,BB, BB
A+, A, A
BBB+, BBB,
BBB
BB+,BB, BB
A+, A, A
BBB+, BBB,
BBB
BB+,BB, BB
B+, B, B-
B+, B, B-
B+, B, B-
C+, C, C-, D
C, D
C+, C, C-, D
Short Term Rating Category Mapping
N1
ECRL-41
ST-1
N2
ECRL-2
ST-2
N3
ECRL-3
ST-3
N4
ECRL-4
ST-4
N5
D
ST-5, ST-6
Page | 66
Appendix 3: Rating Scenario in Bangladesh

Growth
Year
CRISL CRAB NCRL ECRL
ARGUS WCRCL ALPHA BDRAL Total
Rate*
40
48
0
0
0
0
0
0
88
2008
70
44
0
0
0
0
0
0
114 29.55%
2009
300
198
0
0
0
0
0
0
498 336.84%
2010
600
660
114
87
0
0
0
0
1461 193.37%
2011
923
832
556
404
96
17
17
15
2860 95.76%
2012
*Growth Rate=
Appendix 4: Rating Matrix

GRADE CRISL CRAB NCRL ECRL
ARGUS WCRCL ALPHA BDRAL Total
4
3
0
3
0
0
0
0
10
AAA
112
88
57
15
3
1
1
1
278
AA
109
49
77
41
59
2
1
1
339
A
241
302
248
273
33
3
5
8
1113
BBB
364
305
95
42
1
7
5
2
821
BB
79
68
65
23
0
4
5
3
247
B
0
0
0
0
0
0
0
0
0
CCC
0
0
0
0
0
0
0
0
0
CC
0
0
0
0
0
0
0
0
0
C
0
0
0
0
0
0
0
0
0
D
Page | 67
Appendix 5: Aggregate Profitability of the Banking Industry in Bangladesh

2005
2006
2007
2008
2009
2010
2011
ROA
0.6
0.8
0.9
1.2
1.37
1.8
1.95
ROE
12.4
14.1
13.8
15.6
21.72
15.5
19.27
NIM
35.3
44.3
54.8
70.9
81.46
121.9
142.32
Source: Statistics Department, Bangladesh Bank
Page | 68

Role of Credit Rating in The Banking Sector After Introduction of Basel Ii Regulation - A Review On Bangladesh Context

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INTERNSHIP REPORT

ROLE OF CREDIT RATING IN THE BANKING SECTOR

PATUAKHALI SCIENCE AND TECHNOLOGY UNIVERSITY

ROLE OF CREDIT RATING IN THE BANKING SECTOR AFTER

Patuakhali Science and Technology University

An Internship Report Prepared for the Partial Fulfillment

PATUAKHALI SCIENCE AND TECHNOLOGY UNIVERSITY

Submitted to the Department of Finance and Banking

PATUAKHALI SCIENCE AND TECHNOLOGY UNIVERSITY

Role of Credit Rating in the Banking Sector after Introduction of Basel II

Has been approved on

PATUAKHALI SCIENCE AND TECHNOLOGY UNIVERSITY

1st April, 2013

Subject: Letter of Transmittal

With best regards

1st April, 2013

Subject: Letter of Authorization

With best regards

Faculty of Business Administration and Management

ENDORSEMENT OF THE SUPERVISOR

It is our pleasure to certify that, Md. Shahinuzzaman, student of Bachelor of Business

I wish him success in his life.

In the name of Allah who can do everything without anything

ACRCL=ARGUS Credit Rating Company Limited

Chapter-02(Credit Rating and Basel II)

Overview of Credit Rating

Positive and Negative Impact of Basel II

Matrix of Participants in the Basel Process

Chapter-03 (Credit Rating System and Mapping)

Credit Rating Systems or Modus Operandi of WCRCL

Chapter-04 (Credit Rating Methodology)

Chapter-05 (Growth and Impact of Rating after Basel II)

Total Credit Rating Scenario in Bangladesh from 2008-2012

The Growth Rate of credit rating in 2009-2012

Chapter 06(Bank Performance (pre and post of Basel II)

Bank Performance (pre and post of Basel II)

Comparison among the SMEs Methodology of Different ECAIs

Aggregate profitability ob banking Industry in Bangladesh

Comparison among the Banks and FIs Methodology of Different ECAIs

WCRCL Rating Scales & Definitions

Corporate Rating Methodology

List of Charts or Graphs:

Aggregate profitability ob banking Industry in Bangladesh

Role of Credit Rating in the Banking Sector after Introduction of

Abstract: Credit Rating Agencies (CRAs) play a key role in financial

1.3 Origin of the Study:

1.6 Objectives of the Study:

Credit Rating Information and Services Ltd (CRISL)

2.1 Overview of Credit Rating

2.1.2Origin of Credit Rating (CR) and Credit Rating Agencies (CRAs)

2.1.3Credit Rating and Bangladesh

2.1.4Overview of Credit Rating Agencies in Bangladesh

Name of the Company

Credit Rating Information

SHAMS Rangs, House #104, Park

2.1.5 Functions of a Credit Rating Agency

2.1.6Advantages and Disadvantages of Credit Ratings

2.2 Overview of Basel II

2.2.3The main objective of the Basel II Accord is to:

Strengthen the soundness and stability of international banking systems

2.2.4The Basel II Framework consists of three pillars:

o Credit Risk Standardized Approach

o Bank End Internal Capital