Mitigating Information Asymmetry in Bank Lending

Abstract

The report is based on the three month long internship carried

out in Shahjalal Islami Bank Limited - one of the leading Islamic

banks of the country with a good reputation and rich investment

portfolio comprising different sectors of the economy as well as

some highly reputed businesses. The internship was hosted by the

investment department, where great opportunities to learn about

its functions, importance and impact were possible. It enabled

grasping a sound concept on the entire process of bank lending,

the role of information asymmetry and its practical mitigation as

well as identifying the loopholes in the progress towards an even

stronger methodical stance for ensuring successful investments.

1

Introduction

Bank lending in Bangladesh has become a crucial element for

sustaining the economy, as most business enterprises are heavily

dependent on the banking sector to obtain the capital for

maintaining its production activities. Whether it is the pair of

shoe we are wearing, or the taxi cab we hired last time, or the

gas pump we stopped by to refuel our vehicle, chances are that

the company manufacturing/importing the footwear and the ones

procuring and supplying the cab or gas, all have accounts in one

or more of the country’s local/foreign banks from which they have

borrowed money to establish their business or are currently

borrowing funds to run the trade. One important reason for this

reliance on banks has been given by Diamond in 1984 and aptly

phrased by Iyer et al. in their 2009 paper on Screening in New

Credit Markets:

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“Traditionally, banks have played the dominant role in allocating credit partly because

they are attributed to have the financial expertise to evaluate borrowers and effectively

intermediate capital”

Lending involves taking risks. The risk arises due to information

asymmetry. For the purpose of this report, information asymmetry

can be defined as “a situation where the owner-manager possesses more

knowledge about the prospects and risks facing the business than lenders” (K.H.

Abdesamad and K. Abd Wahab, 2014). Thus the borrower has an

incentive to exploit that information gap in any number of ways

including squandering the money, underwriting realized returns to

avoid a repayment of the loan, etc. To mitigate the information

asymmetry and arrive at a reasonably correct decision regarding

selection of the right kind of borrower, the bank needs to

conduct comprehensive investigations by collecting a long chain

of information about the borrower pertaining to his character,

business integrity, potential of generating returns from the

business, etc. This is done by verifying and correlating the

particulars in the loan application forms filled in and documents

submitted by the borrowers, as well as other means of assessments

which will be discussed through the sections 4 to 6 of this

report, basing on the facts gathered primarily from the author’s

internship program at one of the country’s well-established

banking institution, Shahjalal Islami Bank Limited, and supported

by reference to relevant literature where necessary.

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The objective of this text is to reflect upon the experiences

collected during the 3 months’ internship from the perspective of

a BSS student in Mitigating Information Asymmetry in Bank

Lending. The first part of the report offers an overview of the

organization, followed by a description of the internship hosting

department. Then it proceeds to describe in some detail the most

relevant knowledge acquired and their respective analysis.

Finally, the report wraps up with a few closing remarks and

conclusions from the experience.

4

An Overview of Shahjalal Islami Bank Limited(SJIBL)

Shahjalal Islami Bank Limited (SJIBL) is the 7th Shariah-based

Islamic bank established in Bangladesh [Source: Bangladesh Bank (2011)]. It

was incorporated as a public limited company on 1st April 2001

under companies’ act 1994 and commenced its commercial operation

in accordance with principles of Islamic Shariah on 10th May 2001

under the Bank Companies Act, 1991. Its corporate head quarter is

situated at 10, Dilkusha, C/A, Jiban Bima Bhaban, Dhaka- 1000.

Its corporate head quarter is situated at Uday Sanz, Plot

No.SE(A)2/B Gulshan South Avenue, Gulshan – 1, Dhaka-1212. 

Shahjalal Islami Bank Limited offers the full range of banking

services for personal and corporate customers, covering all

segments of society within the framework of Banking Company Act

and rules and regulations laid down by the central bank.

Diversification of products and services include Corporate

Banking, Retail Banking and Consumer Banking.  During the

past thirteen years, SJIBL has diversified its service coverage

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by opening new branches at different strategically important

locations across the country offering various service products

both investment & deposit. The sponsors of SJIBL are leading

business personalities and renowned industrialists of the

country. At present, the bank has a network of 92 branches with

around 2156 employees stationed in both rural and urban areas of

the country. Features of the bank include 39 ATM booths and

acceptability at all Q-cash ATMs around the country, anywhere

anytime mobile banking and online banking, and the broad range of

products for deposit schemes, investment, etc.

The vision of the bank is to be the unique modern Islami Bank in

Bangladesh and to make significant contribution to the national

economy and enhance customers' trust & wealth, quality

investment, employees' value and rapid growth in shareholders'

equity. The stated objectives are:

To provide quality services to customers.

To set high standards of integrity.

To make quality investment.

To ensure sustainable growth in business.

To ensure maximization of Shareholders' wealth.

To extend its customers innovative services acquiring state-

of-the-art technology blended with Islamic principles.

To ensure human resource development to meet the challenges

of the time.

6

All the activities of the bank are continuously monitored by

the Shariah Council of the bank for implementation and

compliance of Islamic Shariah principles. The council is

constituted of prominent ulemas, experienced bankers, reputed

lawyers and eminent economists of the country. The Shariah

Council of the Bank plays a vital role in guiding and

supervising the implementation and compliance of Islamic

Shariah principles in all activities of the bank since its

inception. Members of the Shariah Council meet frequently and

deliberate on different issues confronting the bank on

Shariah matters. They also conduct Shariah inspection of

branches regularly in order to ensure that the Shariah

principles are implemented and complied with meticulously by

the branches of the Bank.

The operations of Shahjalal Islami Bank Ltd. can be divided

into three major categories:

1. General Banking:

 It is the department which provides day to day services

to customers. Deposits from the customers are received

and their demand for cash is met through this

department. General banking services include

opening/closing accounts, providing bank statements and

other services, issue and payment of demand draft and

pay orders, handling transfer transactions, etc.

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SJIBL provides services of Savings account and Current

account as a commercial bank. In addition, it provides

Term deposit and Short notice deposit accounts for its

clients. Mudaraba Term deposit account is for duration

of 3 months and its multiple periods. Mudaraba short

notice deposit account requires a notice of minimum 7

days for withdrawal of money. The profit for these

accounts is decided in compliance with Shariah. The term

for Millionaire scheme of SJIBL is 12, 15, 20 and 25

years and the installment is decided depending on term

length; the installment amount must be deposited every

month; after completing the term, total sum of the

principal and profit add up to about a million taka.

Those who are financially weak to perform Hajj are

offered with the Hajj scheme to save money gradually and

build up a fund sufficient to perform this obligatory

duty of Islam; a term from 1 year to 25 years can be

chosen by the account holder. Mudaraba Housing Scheme

of SJIBL is designed for a term of one year through 25

years; after the term, aggregated amount of the

principal and profit is received as per Shariah.

Some of the most popular deposit schemes offered by

SJIBL are:

- Al-Wadiah Current Account

- Mudaraba Savings Account

- Mudaraba Term Deposit Account

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- Mudaraba Special Notice Account

- Mudaraba Monthly Deposit Scheme

- Mudaraba Millionaire Scheme

- Mudaraba Hajj Deposit Scheme

- Mudaraba Education Scheme

2. Foreign Exchange Service:

The Foreign Exchange Department plays a vital role in

providing substantial revenue in the bank income pool.

It consists all banking activities related to export,

import and remittance including issuance of letter of

credit and international debit cards.

3. Investment Operations:

Investment is one of the most important activities in

banking. Shahjalal Islami Bank offers loan to deserving

candidates in different professions. Small

and medium entrepreneurs, small businessmen, doctors,

executives are in the priority list. Car and CNG

conversion, Housing and car purchase are also in the

list to invest. Overseas employment seekers and people

going to be married may ask for a loan to meet up the

ensuing expenses. Some of the most important schemes

besides its extensive corporate investments are:

- Small & Medium Enterprise Investment

- Small Business Investment

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- Housing Investment

- Car Investment

- CNG Conversion Investment

- Overseas Employment Investment

- Investment Scheme for Education

Despite changing macro-economic conditions with volatile money

and foreign exchange markets, Shahjalal Islami Bank Limited had

successfully achieved much higher than the national growth rate

in deposit, investment, export, import and remittance business.

This can be attributed to the fact that SJIBL provides services

tailored to the specific needs of the customers in the areas of

trade, commerce and industry. While services like Debit Cards,

ATMs and SWIFT payment systems are already in place, the bank

plans to introduce Real Time Online Integrated Banking System

with all modern delivery channels in the future.

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Investment Department at SJIBL

As opposed to conventional banking, Islamic banks, including

Shahjalal Islami bank Ltd., are characterized by their investment

policies being based on a profit-loss sharing system in

accordance with the tenets and principles of Islamic Shari'ah.

Hence, the lending activities are termed as “Investment” rather

than “loan” as referred by the conventional banks. Besides

earning a profit, the most important objective of the investment

department of the bank is attaining social goal of creating and

facilitating employment opportunities. Broadly speaking,

investment is the process through which pooled money of the

depositors of the bank is channeled to productive activities

which generates a return divided among the bank and the

depositors in a proportion depending on several factors including

the type of deposit schemes of individual depositors, economic

stability of the country, portion of non-performing investments,

etc.

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The composition of the investment portfolio of the bank can be

broken down into Money/Capital market portfolio and General

Investment portfolio.

The bank is required to maintain a portion of its deposit

liability as statutory cash reserve and liability requirement in

account with the central bank and in approved securities. The

bank may also, at its own discretion, invest in securities with

the view to ensure regular return, avoid investable surplus and

diversify the overall portfolio to minimize risk of deterioration

in its financial status.

General investment not only constitutes the major share of the

bank’s portfolio, it also has the greatest contribution in the

total revenue generated from all the assets of the bank. Besides,

it is the general investment function where the bank usually

accepts the greatest risk. Thus general investment is critical to

the success of the bank as most of the bank’s resources are

committed to it, the bulk of their revenue is generated by it and

the maximum risk is centered in it.

The most prominent activity of the investment department is

corporate investment, which is a facility extended to the

corporate clients for purchasing goods or services for their

business use on the assumption that the company has a stable

source of income over the next few years. It enables the

consumers have access to their desired goods and services based

on future purchasing power.

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The investments are made as either Term Investment or Continuous

Investment, depending on the time frame of providing the funding.

Term Investment implies that the payments to the client are made

on an annual basis; Continuous Investment entails payment within

one year, which is the case when equipment, goods or services are

required by the client. The bank purchases the item from the

manufacturer/retailer and sells it to the client on credit with a

marked up price consisting the administration and other costs of

the bank.

INVESTMENT MODES

The modes of investment offered to the clients of Shahjalal

Islami Bank Ltd. are ‘Bai’ and ‘Hire Purchase under Shirkatul

Meelk (HPSM)’.

BAI MODE

The word ‘Bai’ means purchase or sale of goods in cash or on

credit or in advance at an agreed upon profit, which may or may

not be disclosed to the client. Majority of investments of

Islamic banks are extended through this mechanism. A good number

of investment products have been designed to facilitate mainly

working capital financing which goes as follows:

a. Bai-Muajjal:

It is a contract between a buyer and a seller under which

the seller sells specific goods (permissible under Islamic

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Shari‘ah and Law of the land) to the buyer at an agreed

fixed price payable at a fixed future date in lump sum  or 

within a fixed period by installments. The seller may also

sell the goods purchased by him as per order and

specification of the buyer. The goods are purchased as per

order and specification of the client. Thus it is a credit

sale of goods by which ownership of the goods is transferred

by the bank to the client but the payment of sale price by

the client is deferred for a fixed period. The bank acts as

financier to the client not in the sense that the bank

finances the purchase of goods by the client; rather it is a

financier by deferring the receipt of the sale price of

goods which it sells to the client. The purchase of goods

and the payment of goods by the bank are made for and on

behalf of the bank, and then sold to the client at a marked

up price.

b. Bai-Murabaha:

it is a contract between a buyer and a seller under which

the seller sells specific goods (permissible under Islamic

Shariah and the Law of the land) to the buyer at a cost plus

agreed profit payable in cash or on any fixed future date in

lump sum or by installments. The profit marked up may be

fixed in lump sum or in percentage of the cost price of the

goods. The client offers an order for purchase of particular

goods by the bank deciding its specification and committing

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to buy the same from the Bank on Murabaha, i.e. cost plus

agreed upon profit.

c. Bai-Salam:

This is export finance. Bai-Salam is a term used to define a

sale in which the buyer makes advance payment, but the

delivery is delayed until some time in the future. Usually

the seller is an individual or business and the buyer is the

bank. The Bai-Salam sales serve the interest of both

parties:

The seller- receives advance payment in exchange for the

obligation to deliver the commodity at some later date. He

benefits from the Salam sale by locking in a price for his

commodity, thereby allowing him to cover his financial needs

whether they are personal expenses, family expenses or

business expenses. 

The purchaser benefits because he receives delivery of the

commodity when it is needed to fulfill some other agreement,

without incurring storage costs. Second, a Bai-Salam sale is

usually less expensive than a cash sale. Finally a Bai-Salam

agreement allows the purchase to lock in a price, thus

protecting him price fluctuation.

Hire Purchase under Shirkatul Melk (HPSM)

15

Under this mode, the bank may supply implements, equipment or

goods on a rental basis. The supplied items have joint ownership

of the bank and the client, and the portion of the client remains

with the Bank as mortgage until the closure of the investment

account. But the client will be authorized to possess the

equipment for a fixed period. After completion of the

installments, the client becomes the owner of the asset.

Hire Purchase under Shirkatul Melk facilities may be for medium-

term or long-term period. HPSM facilities are utilized for the

expansion of production and services, as well as housing

activities. The duration of Hire Purchase under Shirkatul Melk

contract cannot exceed the useful life of the subject / asset of

the transaction. 

Hire Purchase under Shirkatul Melk transaction facilitates the

Client to get benefit from the hired asset in exchange of rental

and also to become full owner of the asset by purchasing it part

by part. Hence the target groups for this mode of investment

facility are Small Businessmen such as Wholesalers, Retailers,

Small-scale Manufacturer/Producer and Trader etc., Small &

Cottage Industries, Self-Employed individuals like

Doctors/Engineers/Professionals etc. and other existing & new

small business, micro & small industries and commerce.

The investment department suggests the appropriate mode of

investment for individual clients depending on their specific

needs and preferred schemes. Then the pricing of investment

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products is decided taking in view several factors such as the

bank’s administration cost, agreed upon profit for the particular

investment product/facility, purchase price of the

capital/asset/equipment/implement, ruling investment prices of

the banking sector, demand/supply interaction of the investment

product, socioeconomic impact of the investment product, etc. The

pricing is evaluated from time to time and revised is the

necessity arises.

Rebate is allowed to the investment account by lowering the

calculated rate of profit, if the client requests for such

rebate. This facility is only availed to the client if all the

installment payments have been adjusted regularly within due date

of the concerned amounts. Overdue investment accounts cannot ask

for rebate until proper adjustments. Hence the officers of the

investment department have to maintain regular correspondence

with the customer and the Head Office for fulfilling all

screenings and formalities required to allow for rebates

requested by the client.

LOAN CLASSIFICATION

An accurate valuation of a bank’s capital is necessary for both

the bank’s own managerial and Bangladesh Bank’s supervisory

purposes. An accurate capital valuation relies on proper

valuation of assets, for which a standardized method is loan-loss

provisioning – the recognition that some or all of the required

17

payments on a loan may never be made. It is the single most

important aspect of asset valuation to bankers and bank

supervisors, as loans typically make up almost 60% of the total

assets of the bank. Expected losses can be assigned to loans

based on a loan classification system, which has been utilized in

Bangladesh for many years and has been updated with the

Bangladesh Bank circular, where all loans and advances are

grouped into four categories for the purpose of classification,

namely- (a) Continuous Loan (b) Demand Loan (c) Fixed Term Loan

and (d) Short-term Agricultural & Micro- Credit.

In SJIBL, the first three categories are more common and hence

brief descriptions for only those categories, adopted from BRPD

Circular No.05 dated June 06, 2006, are provided. The loan accounts, in

which transactions may be made within certain limit and have an

expiry date for full adjustment are treated as Continuous Loan.

Examples are Cash Credit, Overdraft etc. The loans that become

repayable on demand by the bank are treated as Demand Loan. If

any contingent or any other liabilities are turned to forced loan

(i.e. without any prior approval as regular loan), those too are

treated as Demand Loan, such as Forced Loan against Imported

Merchandise, Payment against Document, Foreign Bill Purchased,

and Inland Bill Purchased etc. The loans which are repayable

within a specific time period under a specific repayment schedule

are treated as Fixed Term Loan.

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An investment account becomes classified if the payments become

overdue for stipulated periods for each type of classification.

The definition of overdue or past due also varies with the type

of loan, and is articulated in the BRPD Circular as follows:

(i) Any Continuous Loan if not repaid/renewed within the

fixed expiry date for repayment will be treated as past

due/overdue from the following day of the expiry date.

(ii) (ii) Any Demand Loan if not repaid/rescheduled within the

fixed expiry date for repayment will be treated as past

due/overdue from the following day of the expiry date.

(iii) In case of any installment(s) or part of installment(s)

of a Fixed Term Loan (not over five years) is not repaid

within the fixed expiry date, the amount of unpaid

installment(s) will be treated as past due/overdue from

the following day of the expiry date.

(iv) In case of any installment(s) or part of installment(s)

of a Fixed Term Loan (over five years) is not repaid

within the fixed expiry date, the amount of unpaid

installment(s) will be treated as past due/overdue after

six months of the expiry date.

The different stages that lead up to the classification of a loan

account is Special Mention Account (SMA), Sub-Standard (SS),

Doubtful (DF) and Bad/Loss (BL) respectively.

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All unclassified loans other than Special Mention Account (SMA)

are treated as Standard. A Continuous loan, Demand loan or a Term

Loan which remains overdue for a period of 02 (two) months or

more, is put into the “Special Mention Account(SMA)” and the

profit accrued on such loan is credited to Suspense Account

instead of Income Account. This helps the bank to look at

accounts with potential problems in a focused manner and also

captures early warning signals for accounts showing first sign of

weakness.  Loans in the “Special Mention Account (SMA)” are

reported to the Credit Information Bureau (CIB) of Bangladesh

Bank. Special Mention Accounts and Sub-Standard Accounts are not

considered to be defaulted loans according to the Banking

Companies Act 1991.

A central focus of the activities in the investment department of

SJIBL is keeping track of each of the investment accounts so that

the list classified accounts is always up to date, which is

crucial to the maintenance of the financial health of the bank.

The investment client starts repayment as per schedule in regular

manner for the disbursed amount. In parallel, the Branch

Investment Officer starts monitoring. If any deviation is found

in compliance of terms and conditions or financial health of the

investment, the officer prepares a letter of intimation and sends

it to Investment Administration Division at the Head Office.

If the customer repays the Investment regularly the account is

adjusted at maturity. Restructuring of the repayment schedule may

20

be done at any time during the validity period. If repayment is

irregular, it becomes overdue and/or classified. At the end of

month, the profit accrued to the all the accounts (except those

marked BL) applies to the Investment account and the profit for

the regular investment is credited to the income account. In case

of classified account other than Bad/Loss, the profit is credited

to the Suspense Account.

The classified Investment information is reported to the central

bank at the month end and quarter end by submitting the CL, CIB

and SBS3 reports.

Whenever an investment account is marked Bad/Loss, the profit

calculation continues but the profit application to the account

stops. If the Classified Investment account seems recoverable,

then as per Head office approval, the Investment account

proceeds to rescheduling, and this gives it a new life. The

rescheduled Investment information is kept in the system for

Central bank reporting. During the rescheduling, the suspense

account balance for that Investment account is recovered first.

Some balance may remain after the rescheduling and

declassification of the investment account if the recovered

amount is less than the suspense balance for that investment.

If the Classified Investment account seems unrecoverable, then

the Head Office recovery unit proceeds to file a Lawsuit. After

lawsuit filing, the system stops profit calculation and all

unapplied profit to the investment account. The system simply

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holds the account status open until a resolution is given by

the Court. As per court order, the recovery unit of Head office

liquidates the collaterals of the customer and adjusts the

Investment.

If the Investment is not rescheduled, the Recovery Unit writes

off the Investment and transfers the Investment to a separate

Written-off Investment Register. Though it is washed out from

the balance sheet of the Bank, the recovery process continues.

The processing of all investment products is same. The

following two sections give a short overview about the process

of sanctioning of an investment in the light of the author’s

internship experience at Shahjalal Islami Bank Limited.

Summary of the Internship Experience

The three months internship was a very insightful experience in

terms of learning about the workflow of banking in general, and

in particular, the process of investment operations which is

one of the most important aspects of banking. Investments are

made to entrepreneurs and the business community, thereby

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channeling funds from the depositors who keep their money with

the bank as a form of safe-keeping to various sectors which are

expected to yield a profit but are full of risks and

uncertainties. The borrowers or clients have an incentive to

downplay those risks and uncertainties to convince the bank to

lend them money regardless of their chance of repayment

failure. The bank must therefore judge which particular clients

are least likely to cause unproductive channeling of the money

to ensure a good return for the bank as well as its depositors.

This internship allowed learning by observation how the

investment portfolio is prudently managed by assessing the

shortcomings in the proposal for an investment and identifying

the risks involved.

Dealing with the clients on a typical day in the investment

department at the Gulshan Branch of Shahjalal Islami Bank Ltd.

involves handing out the application form to prospective

clients and various charge documents to the clients whose loans

have been sanctioned, preparing sanction advice, responding to

clients’ requests and queries, balancing portfolio statements,

updating the classification status of investment accounts,

correspondence with the Head Office, updating the record files

of individual clients, etc.

A basic outline of how an investment account is operated is

given below.

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The prospective customer collects an investment application

form from the branch and submits it to the relationship

officer/Branch Investment Officer. The relationship

officer/Branch Investment Officer scrutinizes the application

form, collects further necessary information and assesses the

investment worthiness of the client. If the proposal is

unacceptable, he returns a refusal letter to the customer

immediately. If it is acceptable he forwards it to the Branch

investment committee. If the Branch Investment committee finds

it viable to approve the Investment, they forward the

application to the Investment Division at the Head office;

otherwise they will reject the proposal. The Head office

Investment Official evaluates the application, analyzes and

prepares a memo with due diligence along with their

observations/results of analysis and places it to the Head

Office Investment Committee. He also submits “One Obligor

Report” for the customer if the customer has other liabilities

with the Bank. After full satisfaction regarding the credit

worthiness of the client and prospects of the investment, the

proposal is approved by the delegated authority of head office.

The hierarchy of the delegated authority is as follows:

Head of investment Committee

Managing Director

Executive Committee

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Board

If it is not approved in any of these stages, the proposal is

declined. If the Proposal is approved, the sanction letter of

the investment is sent to branch along with required terms and

conditions and documentation list called charge documents. And

investment administration division sets up an approval limit

for the customer of sanctioned/approved investments. After

getting the approval, the branch offers the Investment to the

customer and collects the customer’s acceptance along with

required security documents. The branch then informs the head

office with the list of documents that have been received from

the customer and puts the documents in safe custody and records

the entry in Safe in/ Safe out register.

The branch then initiates the investment commitment and

requests for disbursement authority from Head office Investment

Administration division. Head Office Investment Administration

Division sets up the Disbursement Limit and renders authority

to the branch to facilitate withdrawal of the fund by the

client, which is termed as limit loading. Getting the

disbursement authority, the branch creates the Investment

Account against the investment limit and disburses the amount

to customer by crediting the Pay Order or Service Account and

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debiting the Investment Account that generates a repayment

schedule as per Head Office sanction.

The client is frequently communicated by the bank regarding the

repayment status, where the bank provides sanction advice to the

client depending on individual business needs, repayment

difficulties faced by the client, overdue issues, readjustment of

profit rate, intimation of any changes in the security status of

the account, etc.

As an intern, it was possible to learn these processes by

observing the activities of the Investment Officers and asking

about specifics regarding the different documentations and

everyday conversations that took place in the office.

Activities during the internship also included helping the

officers in the Portfolio statement balancing, preparing the

list of charge documents for different clients according to the

Head Office instructions. The charge documents included various

forms depending on the type of investment mode. Some of them

were Purchase Schedule, Trust Receipt, Letters of Guarantee,

Letter of Undertaking, Letter of Disbursement, Letter of

Authority, etc.

It was also an opportunity to study the Sharish guidelines that

regulate the operations of the bank, help in preparing sanction

advice letters and successfully learn to operate photocopy

machines, networked printers and scanners.

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Analysis of Information Asymmetry Mitigation inLending Operations at SJIBL

The bank’s comprehensive IT system plays a central role in

screening and monitoring to mitigate the information asymmetry

between the bank and its clients with its ability to capture

all key customers data, risk management and transaction

information including trade & foreign exchange transaction.

Shahjalal Islami Bank Ltd has formulated a robust investment

risk management policy and procedures that sets out the basic

procedures to be followed throughout SJIBL for sanctioning and

controlling investment facilities. These procedures are

intended to provide bank management with an accurate and

detailed information base for investment decision. These are

27

supplemented from time to time by Bangladesh Bank circulars and

guidelines, which remain valid until further revision or new

developments in banking practices.

Shahjalal Islami Bank Ltd has an internal audit/control

department charged with conducting audit of all departments. An

audit is usually carried out annually, and ensures compliance

with regulatory guidelines, internal procedures, investment

risk grading guidelines and Bangladesh bank requirements.

Bangladesh Bank’s core risk guidelines are followed in this

regard. Shariah compliance Inspection and random audits are

also conducted without prior notice to ensure there is no

negligence on part of the bank or branch officials in

maintaining the investment quality of the bank.

The lending guidelines of the bank form the base which its

mitigation of information asymmetry stands upon. Shahjalal

Islami Bank’s investment guidelines clearly identify the

business/industry sector that should constitute the majority of

the bank’s investment portfolio. indication of the type of

investment that are permitted such as working capital, trade

finance, etc., details the bank’s single customer/group limits

as per Bangladesh banks guidelines that specify industry sector

exposure cap to avoid over concentration in anyone industry

sector, outline industries or investment activities that are

discouraged, states the facility parameters (e.g. maximum size,

28

maximum tenor, and covenant and security requirements) & policy

regarding management of Cross Boarder Risk. Any nonconformity

to the investment guidelines have to be explicitly identified

in the Investment Application/Investment Memo and justification

for Approval (if required) is to be given. Hence it ensures

diversity in the portfolio which is the first step towards

covering losses due to information asymmetry in a particular

firm/industry/sector by profit from other profitable

investments so that overall financial status of the bank is not

troubled.

When a client approaches any of the branches of Shahjalal

Islami Bank Limited for an investment, he can directly speak to

the manager or any of the investment officers from whom he can

collect the Investment Application Form. The filled in

application form is submitted along with necessary papers and

documents. The following Papers/Documents are required to

process the investment proposal:1. Request for investment limit of customer.

2. Account opening form along with copies of clients

photograph.

3. CIB reports.

4. Project profile/profile of business.

5. Copy of trade license duly attested (up to date)

6. Copy of TIN certificate.

7. Certified copy of Memorandum & Articles of Association.

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8. Certificates of incorporation.

9. Partnership deed (where applicable)

10. Resolution of Board of Directors for taking

investment facilities from Shahjalal Bank Ltd.

11. Personal net worth statement of the

Owner/Proprietor/Partner/Director in banks format

12. Three years’ Balance Sheet, Income statements and

Cash Flow statement/Projected.

13. Bio-Data of Directors/Partner/proprietor

14. Photograph of the Directors/Partners/Proprietor duly

attested.

15. Photograph of the site.

16. Indent/Pro-forma Invoice/Quotation.

17. Statement of Account (C/D, S/B, CC) for the last 12

months.

18. In case of renewed/enhanced of the investment

facilities total income earned, detail position of the

existing liabilities of the customer i.e. Date of expense,

Date of expiry, present outstanding, remarks, if any.

19. Declaration of the customers of the name of

sister/allied concern and liability with other banks, if

any, and an undertaking to the effect that they have no

liability beyond those declared.

20. CIB inquiry form.

21. Valuation certificate in the Bank’s format along with

photograph of collateral.

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22. Inspection/visit report of the

factory/establishment/business/landed property of the

customers.

23. Lending risk analysis (for investment facilities of

Tk. 1.00 crore and above).

24. Credit report from the bank.

25. Price verification report.

26. Background of the customers.

27. Total financing plan & source of finance of the

project.

28. History of relationship with SJIBL.

29. Status of factory land & building (including title

holder & areas).

30. Trade checking (from major buyers & sellers).

31. Major competitors and competitive position for the

customer.

32. Working capital assessment.

33. All allied/sister concerns’ information.

34. List of equipment/machineries.

35. Total employment strength with back up.

36. Security with detail particulars.

37. TIN certificate of the director.

38. LC performance for the last three years.

39. Sanction advice for existing investment facilities of

different banks.

40. Details of business of sister/allied concern.

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The required documentations accompanied with each investment

application form are kept in the investment files of each

client. The officials concerned with appraising and evaluation

of the investment proposal by the branch comply with the KYC

(know your customer) procedures positively in case of all

customers. One of the officials is the authorized signatory the

head of investment.

The first hand discussion with the bank official and the

filled-in application form along with the attached documents

helps the bank to decide on whether to proceed with the

investment by analyzing the 5 Cs of the client:

Character (includes track record in the business)

Capacity (includes debt-to-income ratio)

Capital (individual net worth)

Collateral (includes assets/guarantees available as

security)

Conditions (status of the particular industry, local

market, competition, etc.)

Besides reviewing the information supplied by the borrower, the

bank may contact other lenders to determine their experiences

with this customer. This provides knowledge about whether all

scheduled payments in previous investment agreements were made

on time, deposit balances were kept at sufficient levels,

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previously borrowed amounts and handling of those investments,

existence of any evidence of slow or delinquent payments or any

history of bankruptcy. For these the bank relies on physical

investigations, customer financial statements, experience of

other lenders with this customer, Annual Report of the

customer’s business, local or regional credit bureaus, local

chamber of commerce, etc.

A ratio analysis is carried out to estimate the profitability

of the investment, the associated risks and the provisions for

losses. The analysis is then scored out of 100. If the overall

outcome of the ratio analysis is below 75%, the investment

proposal is rejected.

If all the inquiries and analysis indicates the investment is

good, it is approved by the Head Office. Once approval is

granted according to the procedures mentioned is the previous

section, funds or goods are disbursed according to the

specifications of the client. At the final stage of the

investment processing at the Shahjalal Islami Bank Ltd., the

bank contacts the client continually for obtaining and

verifying information such as monthly stock reports and other

updated data. If required, the bank officials physically verify

the client’s operations and alert the branch and Head Office if

any suspicion regarding misuse of funds or failure of the

business arises.

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The collaterals against investments are documented and cross-

checked with all other accounts to ensure that in case of default

or a non-performing investment, no difficulty is faced in

liquidation of the asset to finance the debts of the client.

Cheques containing the amounts of each installment for repayment

and a cheque containing the entire amount of the investment

facilitated to the client are kept with the bank as an important

form of security which acts as evidence against the client if a

lawsuit is filed due to defaulting. The cheques are stamped with

the seal of SJIBL Gulshan Branch so that it cannot be

fraudulently cashed by any bearer.

Letters of guarantee act as a most important instrument to ensure

loans are recovered. All the board of directors of the borrowing

company, relatives of the borrowers including parents, spouse and

even in-laws are subjectively required to sign the letter of

guarantee along with details of the financial capability of the

guarantor to ensure their ability to pay the liabilities of the

client with the bank in case of default. Many cases of loan

recovery were successfully executed after the persistent pressure

created on the guarantors which put the client’s reputation on

stake and forced them to surrender to the court and allow

recovery through collaterals or come to mutual agreement with the

bank to pay back the lent amount within the shortest feasible

time.

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Recommendation

CIB report constitutes a most important aspect of gathering

information on the creditworthiness of the client. However, it

has been noted that sometimes the entries made by certain banks

are not visible in the CIB report obtained through the

Bangladesh Bank website. Hence measures should be taken on an

urgent basis to ensure timely and accurate entries to the CIB

database by all the banks so that it does not produce deceiving

reflection of the client’s financial status.

Most of the banks efforts apparently focus on loan recovery in

case of overdue/repayment failure. A lot of resources are spent

on recovery which could have been saved if the delinquent

borrowers were identified before making the investment or

measures were put in place to make them reluctant towards

overdue in the first place. Therefore, besides the existing

35

measures to mitigate information symmetry, more procedures need

to be developed by the experts on the field to weed out the

investments that are likely to default or provide strong

incentives for the borrowers to avoid defaulting at all costs.

Conclusions

The current practices of mitigating information asymmetry in

Shahjalal Islami bank, which in turn is a reflection of the

general practices of private commercial banks, can be considered

as adequate to keep the banks in business for the foreseeable

future. However, to cope with tougher challenges and maximize the

36

profits from the investment operations, more stringent methods to

analyze potential bad loans should be discovered and implemented.

Working for this internship provided interesting insight of how

investment operations are conducted and the associated

information asymmetry is mitigated in context of fully

functioning commercial banks. Simultaneously, it was a good

opportunity to put in practice and develop organizational skills

and refresh some concepts in economics of financial institutions

and the business cycle.

37

Bibliography

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Screening in New Credit Markets: Can Individual Lenders

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USA: Harvard Kennedy School.

3. Mishkin, F. S. (2009), The Economics of Money, Banking and

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the-five-cs-of-credit

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