“A Conceptual Framework for Selection of Entrepreneurs by Commercial Banks in Bangladesh”

Presentation :

Presented By:MD. ARMAN HOSSAIN A.B. (30006)MUHAMMAD NURUL AMIN (30078)HAFIZUR RAHMAN (30041)MD. ABU HANIF (30040)ABDUR RAZZAK (26012)

Importance of

Entrepreneurs Selection

Selection Criteria for Financing

Entrepreneurs

Assessment of Credit’s Attractivene

ss

Economic Theory of

Entrepreneur’s Selection

& Performanc

e

Factors Influencing

the Behavior of

an Entrepreneu

r

A Brief Summary of Our TopicAssessment of Risk of Commercia

l Bank Credit

Importance of Entrepreneurs Selection:

Surplus Units

Deficit Units

Banks

Credit Manageme

nt

Entrepreneurs are the Real Risk

Takers of the Economy

Selection of right

EntrepreneursTo reduce

The Default Rate of Credit

Personal Guarantees and pledges made by the owners of a business

firm or by cosigners to a credit

Personal Guarantees

Resources on the Customer’s Balance Sheet 

Balance Sheet

Customer’s Expected Profits, Income or Cash Flows

Expected Cash flow

Safety Zones Surrounding the Funds Credited by a Bank….:

Personal

Guarantees

Balance Sheet

Cash flow

Combinatio

n

More

However, The most outer or remote safety zone of a credit is the guarantee from the borrowers or cosigners where they pledged their personal assets to back the credit taken from the bank. On the other hand, income and cash flow from business are to be the primary safety zones of a credit and these are actually preferred sources of ensuring repayment of credit.

Which option among these three should be more logical?

Innovative Idea

Determination

Capacity Building

Financial Aspects

Legal Aspects

Environmental Issues

Ethical Issues

R&D

Assessment of Credit’s Attractiveness…………..:

Gathering ideas both

internally and

externally

Coordination of

Knowledge and

Experience

Extra ordinary quality,

confidence and skills

Feasibility Analysis of Expected

Cash flows

Trade License and Other

Documents

Waste management,

Ecological Balance etc

Maintaining ethical

standards

Future development of business

Pote

ntia

l Suc

cess

of

Cred

it

Case study: Bank lending decisions using projections

Loan Application….:Suppose, PAPERBASIS’s working capital line of credit is approaching its renewal date. Mr. Tison - the manager and business owner of the firm, wants to renew the line at a higher (by 10%) amount and at better terms. He thinks sales will slightly increase, but in his opinion, the present $500 working capital line should not be necessary for receivables and inventory financing. Further, Mr. Tison indicated that he will not need to spend external funds on new equipment.

Process of Bank Assessment…:Mr. Tison’s request is very typical. Every business owner is interested in making money. The starting point for making money is focusing on revenue, as Tison has done. It is the starting point for virtually every planning or budgeting process, whether highly informal and carried around in the owner’s head or very structured and contained in countless papers and reports. Though acknowledged, balance sheet accounts are often an afterthought. In making his request, Mr. Tison did not necessarily comment on his precise expectations about accounts receivable or inventory. He intuitively ignores that even if sales increase his accounts receivables or inventories are likely to decrease and as a consequence (held other parameters constant) borrowing needs to be lower, at least in the short term.

Bank’s Decision….:

Bank decided to reject the credit application because of the abnormality in projections.

Verification of Documents The existence of the company/ business, its

directors/business owner’s legality of borrowing. The business operations risks and management

depth, experience and expertise of the owners. The financial strength and repayment capability

(including the cash flow) of the borrower. The operating risks of the business The strategy plans of the borrower to mitigate such

risks and maximize profitability The borrowing needs proposed facilities are in line

with the. The overall risk associated with the proposed

borrowing.

The Determinants of Probability of Default

The probability of default refers to the ability or capacity of a borrower to service/repay debt obligations. The higher this ability, the less likely the borrower will default. For a corporate borrower, its repayment ability is determined by various factors including business and financial performance, industry trends, management experience and strategies, funding lines, parental support etc.

Academic theory/research – which highlight various indicators from corporate financial statements that are predictive of creditworthiness

Past experience – although not necessarily perfect, the past is a useful predictor of the future. Thus, a bank can use its past experience to identify key default drivers and develop a rating model.

Economic Theory of Entrepreneurship Selection and Performance

Education as a Determinant of Entrepreneurship Selection and Performance

The level of education might influence the propensity to become self-employed through several channel. Education enhances managerial ability, which increases the probability of entrepreneur. Working in the opposite direction, higher levels of education might generate better option and thus decrease the likelihood of entrepreneurship.

Education may also influence entrepreneurship performance in several ways.

The main factors affecting earnings are schooling and experience. This specification and the implied positive returns to schooling have found empirical support in the wage sector. This reasoning would seem to apply in other occupational sectors as well, such as entrepreneurship, but little systematic work has been done on the subject. Schooling is acknowledged both for its productive effect on the quality or quantity of labor supplied, as assumed by Mincer, and for its value as a signal of productive ability in labor markets without complete information.

Lending Technologies and the Supply of Entrepreneurs’ Credit

• Researchers looked more closely at each of the lending technologies: the five transactions technologies. In addition to a brief description of each technology, they highlighted the nature of the information used in underwriting by each technology (e.g., soft vs. hard), and how each technology solves the opacity problem. They also discussed how the financial institution structure and the lending infrastructure affect the feasibility and efficacy of each technology.

Financial Statement Lending Small Business Credit Scoring: Asset-Based Lending Factoring Trade Credit Relationship Lending

13

Analysis of Entrepreneur’s Selection.

Analysis of Entrepreneur’s Skills.

Risk Factors of Commercial Bank Loan.

Hierarchy Model of Commercial Bank Loan Risk.

Agenda…….:

Monday, May 1, 2023 14

Management Aspect Marketing Aspect

Technical Aspect: Financial Aspect

Analysis of Entrepreneur’s Selection

Monday, May 1, 2023 15

Entrepreneurship Skills: Technical Skills

Management Skills:

Analysis of Entrepreneur’s Skills

Monday, May 1, 2023 16

Object Risks Loan Terms Risks

Management Risks System Environment Risks

Assessment of Risk of Commercial Bank Credit

Hierarchy Model of Commercial Bank Loan Risk

Define the set of loan risks as A, loan object risks A1, loan terms risks A2, management risks A3, system environment risks A4, define weight as W=(W1 ， W2 ， W3 ， W4) then subdivide the four factors, A1=(S1、 S2、 S3、 S4、 S5)， A2=(S6、 S7、 S8、 S9)， A3=(S10、 S11,S12、 S13) A4=(S14、 S15、 S16).

Inde

xSu

b-In

dex

W

Goal

Case study: Sally’s loan is rejected because of the probability of repayment uncertainty

Sally applied for a business loan at her bank. She wanted to borrow $10,000 to buy machinery. She thought the bank would accept her loan application as her sales projection is enough to cover her loan repayments. Sally was disappointed when the bank rejected her application. They felt she would not be able to make the loan repayments as she also has a $5000 debt to pay off and no savings in her bank account. Sally decided to focus on paying off her debt and build up some savings before she applied for another loan.

The Financial Sector Reform Program (FSRP) was introduced in the early nineties in Bangladesh with a view to bringing about financial discipline by undertaking appropriate reform measures in the financial sector. The program was undertaken by the Government of Bangladesh with combined support of the World Bank and USAID under the ‘Structural Adjustment Program’.

Observation of Previous Practices of Lending Risk Analysis

Observations on Recent Risk Management Practices in Banks in Bangladesh

Bangladesh Bank issued its BRPD Circular No. 17 dated

October 07, 2003 advised all the scheduled banks to put in

place an effective risk management system by December,

2003 based on the certain guidelines furnished to them. It

appears from the circular that the banking industry is

completely different from other industries in terms of the

diversity and complexities of the risks they are exposed to.

Definition of Credit Risk

It is defined as the possibility that a borrower will fail to repay his/her debt (s) to the bank/lender on the due date.

When the bank/lender is unable to collect the debt (s) from the borrower (s), the bank/lender will be short by the amount of cash that the borrower has failed to repay.

Another terminology that can be used to describe such arisk factor - “Risk of Default”.

As a bank or any financial services provider’s credit riskincreases over time, this institution is compelled to makeprovision to write off the debt (s) in its books of account.

Loans written-off translates into an operating expenses.

Specific factors for credit approval for business customers

Internal factors Financial risk

Assessment of the existing financial positionAssessment of the expected financial positionAccounting quality

Business riskMarket positionOperating Efficiency

Management riskManagement business expertisePayment record

External factors Conditions in the respective economic sector of activity Economic trends in the industry of activity

A Typical Example of Credit Risk

Suppose, I took a loan of US$1,000 from Citibank at the interest rate of 5% per annum for a period of 5 years.

I repaid for the first 6 months regularly and then stopped repaying the loan on month 7 because I have made other commitment elsewhere.

Is Credit Risk Important for a Bank?

For most banks, loans are the largest asset on the bank’sBalance Sheet, and obviously the major source of credit risk.

Besides loans, there are other pockets of credit risk, both on and off-balance sheet such as:

(a) Investment portfolio,(b) Overdrafts,(c) Letters of credits (L/Cs), and(d) Guarantees.

If a bank or financial institution does not ensure that thereis a systematic credit appraisal system in place, then thisbank is likely to become heavily exposed to credit risk.

Introduction of Credit Risk Grading (CRG) System in Credit Operations

The risks associated with the borrower or counter-party need to be carefully and critically analyzed before funding to the client’s business. To quantify the risk exposure, it should be graded as per credit risk score sheet by the individual banks in line with the guidelines of CRG Manual.

A Typical Risk Grading (Credit Rating) System under CRG Manual