The Impact of Credit Risk on Bank Alfalah Upload

The Impact of Credit Risk on Bank Alfalahs Profitability

Table of ContentsPREFACE2EXECUTIVE SUMMARY3ABOUT BANK AL FALAH4CREDIT RISK5LITERATURE REVIEW6ARTICLE #16ARTICLE #27ARTICLE #38ARTICLE #49ARTICLE #510ARTICLE #611ARTICLE #712RESEARCH OBJECTIVE13METHODOLOGY13DATA COLLECTION13DATA ANALYSIS13DEPENDENT VARIABLE13INDEPENDENT VARIABLE13STATISTICAL TOOL14EMPIRICAL RESULTS & ANALYSIS OF FINDINGS14CONCLUSION AND RECOMMENDATIONS18BIBLOGRAPHY19APPENDIX20

PREFACE

This report analyzes the impact of credit risk on bank Alfalahs profitability over 14 years from 2000-2013.With the esteem depth of my heart, I am thankful to my Treasury and Fund Management Instructor, Maqbool-ur-Rehman, for the valuable guidance and advice. He inspired me greatly to work on this report. His willingness to motivate me contributed tremendously to my report. It has been a privilege to work on this report and I have put in my utmost effort to prepare a comprehensive report on this topic. If you will be having any queries regarding this report I will be happy to discuss it with you.

EXECUTIVE SUMMARY

The study investigated the impact of credit risk on the profitability of Bank Alfalah. The data collected are for the periods of 2000 2013 from the Annual Reports. From the findings it is concluded that banks profitability is inversely influenced by the levels of loans and advances, non-performing loans and deposits thereby exposing them to great risk of illiquidity and distress.

ABOUT BANK AL FALAH

Bank Alfalah Limited was launched on June 21, 1997 as a public limited company under the Companies Ordinance 1984. The bank commenced its operations on November 1, 1997. The bank introduced commercial banking and related services as defined in the Banking companies ordinance, 1962. Bank Alfalah is the 6th largest bank of Pakistan with 576 branches.After a few years, the bank introduced its new identity of H.C.E.B after the privatization in 1997. The management of the bank had implemented strategies and policies so the bank would become a major player in the market. With a partnership with the Abu Dhabi Group the position of the bank became stronger which allowed the bank to invest more in technology to increase its range of products and services.VisionTo be a premier financial services organization, operating both locally and globally, offering a complete range of financial products and services to diverse segments under one umbrella.MissionTo develop & deliver the most innovative products and deliver exceptional service quality which contribute to strengthening brand equity strength and maximize value for the stakeholders of the Bank

CREDIT RISK

Credit risk is the current and prospective risk to earnings or capital arising from an obligors failure to meet the terms of any contract with the Bank or otherwise to perform as agreed. Credit risk is found in all activities in which success depends on counterparty, issuer, or borrower performance. It arises any time bank funds are extended, committed, invested, or otherwise exposed through actual or implied contractual agreements, whether reflected on or off the balance sheet. The potential for loss due to failure of a borrower to meet its contractual obligation to repay a debt in accordance with the agreed terms Commonly also referred to as default risk Credit events include bankruptcy, failure to pay, loan restructuring, loan moratorium, accelerated loan payments For banks, credit risk typically resides in the assets in its banking book (loans and bonds held to maturity) Credit risk can arise in the trading book as counterparty credit risk

LITERATURE REVIEW

ARTICLE #1JOURNAL

ARTICLEINTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS.CREDIT RISK AND THE PERFORMANCE OF NIGERIAN BANKS. (NOVEMBER 2012)

AUTHORMuhammad Nawaz, Shahid Munir, Shahid Ali Siddiqui, Tahseen-Ul- Ahad, Faisal Afzal, Muhammad Asif, Muhammad Ateeq.

IMPACT FACTORNo impact

RESEARCH OBJECTIVECREDIT RISK AND THE PERFORMANCE OF NIGERIAN BANKS

RESEARCH DESIGNDEPENDENT VARIABLES:ROA= Return on Assets

INDEPENDENT VARIABLES:NPL/LA = Ratio of Non-performing loan to loan & Advances)LA/TD = Ratio of Loan & Advances to Total deposit)

METHODOLOGYMultiple regression models which adopt Ordinary Least Square (OLS) model in estimating the parameter of the model and is expressed as: ROA = 0 + NPL/LA + LA/TD

DATA COLLECTIONData collected are for the periods of 2004 2008 from the Annual Reports and Accounts of the chosen banks.

CONCLUSIONThe regression result of the study model suggests that all the independent variables have negative impact on profitability. This study shows that there is a significant relationship between bank performance (in terms of profitability) and credit risk management (in terms of loan performance). Loans and advances and non-performing loans are major variables in determining asset quality of a bank. These risk items are important in determining the profitability of banks in Nigeria.

ROA = 1.634046 - 0.515976 NPL/LA 2.519801 LA/TD

ARTICLE #2

JOURNAL

ARTICLEUniversity of Gothenburg. School of business, economics and law

Credit Risk Management and Profitability in Commercial Banks in Sweden. (24th of May 2009)

AUTHORAra Hosna, Bakaeva Manzura and Sun Juanjuan

IMPACT FACTORNo Impact

RESEARCH OBJECTIVEThe purpose of the research is to describe the impact level of credit risk management on profitability in four commercial banks in Sweden.

RESEARCH DESIGNDEPENDENT VARIABLE:ROE = Return on equity

INDEPENDENT VARIABLE:NPLR is defined as NPLs divided by TLsCAR is regulatory capital requirement (Tier 1 + Tier 2) as the percentage of RWAs.

METHODOLOGYThe method of our study is quantitative. We use regression model to analyze data collected from the annual reports of the sample banks. Based on the regression outputs we conduct the analyses and answer our research question. The analyses are presented by using descriptive approach. Since we only describe the regression results without providing further explanation on the issues.

We have employed the multivariate regression model which is presented below:

ROE= +1NPLR+ 2CAR+

DATA COLLECTIONWe have selected four major commercial banks in Sweden: Nordea, SEB, Svenska Handelsbanken and Swedbank. We have used annual reports from 2000 to 2008 of each bank to collect the data. Therefore, there are total 36 observations in the regression analysis.

CONCLUSIONThe big four banks together have a strong position in the Swedish financial market. The regression outputs of all four banks show that NPLR has negative and significant effect on ROE compared to CAR. It indicates that profitability is fairly affected by credit risk managementin this banking group. The results obtained from the regression model show that there is an effect of credit risk management on profitability on reasonable level with 25,1% possibility of NPLR and CAR in predicting the variance in ROE.

ARTICLE #3

JOURNAL

ARTICLEInternational Journal of Business and Public Management (April 2012)

The impact of credit risk management on the financial performance of Banks in Kenya for the period 2000 2006

AUTHORDanson Musyoki, Adano Salad Kadubo

IMPACT FACTORNo Impact

RESEARCH OBJECTIVEThe objective of study was to assess various parameters pertinent to credit risk management as it affects banks financial performance. Such parameters covered in the study were; default rate, bad debts costs and cost per loan asset.

RESEARCH DESIGNDEPENDENT VARIABLE: Return on Assets (ROA)INDEPENDENT VARIABLE:Default rate ratio (DR )= Non Performing Loans/ Total loanBad debt costs ratio (BDC )= Bad debt cost/ Total cost.Cost per loan asset (CLA) = Total Operating Cost/ Total amount of loans.

METHODOLOGY The research design used for the study was a descriptive research design. We have employed the multivariate regression model which is presented below:

Y= +1X1+ 2X2+ 3X3+

DATA COLLECTIONThe study covered the period between 2000 and 2006 of the banks operating in Nairobi; ten banks were involved in the study.

CONCLUSIONThe result of the showed that credit risk management is an important predictor of bank financial performance thus success of bank performance depends on risk management to the extent of around 36%. Default Rate management is the single most important predictor of the bank performance since it influences 54% of the total credit risk influence on bank performance. Risk management indicators such as Bad Debt Cost and Cost per Loan Asset are not significant predictors of bank performance.

ARTICLE #4JOURNAL

ARTICLEAsian Transactions on Basic and Applied Sciences

Effectiveness of Credit Risk Management of Saudi Banks in the Light of Global Financial Crisis: A Qualitative Study

AUTHORDr. Khalil Elian Abdelrahim

IMPACT FACTORNo Impact

RESEARCH OBJECTIVE(1) To identify the characteristics of credit risk management of Saudi Banks.(2) To investigate the determinants of effectiveness of credit risk management of Saudi Banks. (3) To find out the most serious challenges facing the effectiveness of credit risk management of Saudi Banks. (4) To explore the development methods of effectiveness of credit risk management of Saudi Banks.

RESEARCH DESIGNDEPENDENT VARIABLE: Effectiveness Of Credit Risk ManagementINDEPENDENT VARIABLES:1.Capital Adequacy Ratio (C) 2.Assets Quality (A) 3.Management Soundness (M) 4. Earnings of Credit Facility (E) 5. Liquidity (L) 6.Bank Size(S)

METHODOLOGYH0 1: There is no statistically significant relation between capital adequacy and effectiveness of credit risk management in Saudi Banks. H0 2: There is no statistically significant relation between asset quality and the effectiveness of credit risk management in Saudi Banks. H0 3:There is no statistically significant relation between management soundness and effectiveness of credit risk management in Saudi Banks.H0 4:There is no statistically significant relation between bank's earning and effectiveness of credit risk management in Saudi Banks.H0 5: There is no statistically significant relation between liquidity and the effectiveness of credit risk management in Saudi Banks.H0 6:There is no statistically significant relation between bank Size and the effectiveness of credit risk management in Saudi Banks.

The tools of analysis are: frequency distribution, mean, standard deviation for descriptive analysis, besides the use of regression analysis to test research hypotheses and the use of t-statistics to detect differences in the answers of respondents.

CONCLUSIONThe study recommends an overall strategy for effective credit risk management of Saudi Banks based on enhancing capital adequacy, upgrading asset quality, strenghthening management soundness, increasing earnings, having adequate liquidity and reducing sensitivity to market risk besides hedging credit risk; having adequate provisions for doubtful credit; renegotiating loan terms, transferring credit risk to a third party, extending credit maturity and lowering interest rate on insolvent loan.

ARTICLE #5JOURNAL

ARTICLEAnnals of the University of Petroani, Economics,THE IMPACT OF EFFECTIVE CREDIT RISK MANAGEMENT ON BANK SURVIVAL

AUTHORKOSMAS NJANIKE

IMPACT FACTORNo Impact

RESEARCH OBJECTIVEThe study seeks to evaluate the extent to which failure to effectively manage credit risk led to Zimbabwes banks demise in 2003/2004 bank crisis. It also seeks to establish other factors that led to the banking crisis and to outline the components of an effective credit risk management system.

METHODOLOGYThe researcher chose the survey as the appropriate research design for the study, and as such, questionnaires and interviews were used as research instruments. Some unclear or hanging issues in the questionnaires were clarified in interviews.

DATA COLLECTIONThe research data was collected over six months to June 2009. A sample of 10 commercial banks randomly chosen was used in this analysis. Twenty questionnaires were used to gather data with two for each commercial bank chosen. A total of 10 interviews were held with the heads of credit or senior managers from those banks.

CONCLUSIONThe results obtained from the research clearly support the assertion that poor credit risk management contributed to a greater extent to the bank failures in Zimbabwe. Therefore effective credit risk management is important in banks and allows them to improve their performance and prevent bank distress. The success of the systems depends critically upon a positive risk culture. Banks should have in place a comprehensive credit risk management process to identify, measure, monitor and control credit risk and all material risks and where appropriate, hold capital against these risks.

ARTICLE #6

ARTICLEDepartment of accounting Faculty of Administration Ahmadu Bello University, Zaria NigeriaJULY, 2011

CREDIT RISK AND THE PERFORMANCE OF NIGERIAN BANKS

AUTHORHamisu Suleiman Kargi

IMPACT FACTORNo Impact

RESEARCH OBJECTIVEThe study considers the extent of relationship that exists between the core variables constituting Nigerian Bank default risk and the profitability. It therefore seek to examine the impact of credit risk on the profitability of Nigerian banking system and identifies the relationships between the non-performing loans and banks profitability and evaluate the effect of loan and advance on banks profitability on Nigerian banks.

RESEARCH DESIGNDEPENDENT VARIABLE:Ratio of profit after tax to total assets.INDEPENDENT VARIABLE:NPL/LA = Ratio of Non-performing loan to loan & Advances).LA/TD = Ratio of Loan & Advances to Total deposit).

METHODOLOGYThe pooled data was analysed using correlation and multiple regression models which adopt Ordinary Least Square (OLS) method in estimating the parameter of the model and is expressed as;ROA = 0 + 1NPL/LA + 2LA/TD

DATA COLLECTIONThe study is both historical and descriptive as it seeks to describe the pattern of credit risk of Nigerian banks in the past. The sample size is based on the following criteria;a)The availability of consistent data-set over the period.b) The banks were not involved in any merger during the study period and were not involved in any merger during the study period with at least a branch in all states of the federation.c) The banks are listed and quoted on the Nigeria Stock Exchange. Considering the above criteria, six out of twenty four banks in Nigeria were selected (Appendix I) and data collected are for the periods of 2004 2008 from the Annual Reports and Accounts of the chosen banks.

CONCLUSIONThis study shows that there is a significant relationship between bank performance (in terms of profitability) and credit risk management (in terms of loan performance). Loans and advances and non performing loans are major variables in determining asset quality of a bank. These risk items are important in determining the profitability of banks in Nigeria. Where a bank does not effectively manage its risk, its profit will be unstable.

ARTICLE #7

ARTICLE BCBS (1999)

IMPACT FACTORNo Impact

CONCLUSIONBCBS (1999) observed that banks are increasingly facing credit risk (or counterparty risk) in various financial instruments other than loans, including acceptances, interbank transactions, trade financing foreign exchange transactions, financial futures, swaps, bonds, equities, options, and in the extension of commitments and guarantees, and the settlement of transaction. Anthony (1997) asserts that credit risk arises from non-performance by a borrower. It may arise from either an inability or an unwillingness to perform in the pre-committed contracted manner. Brownbridge (1998) claimed that the single biggest contributor to the bad loans of many of the failed local banks was insider lending. He further observed that the second major factor contributing to bank failure were the high interest rates charged to borrowers operating in the high-risk. The most profound impact of high non-performing loans in banks portfolio is reduction in the bank profitability especially when it comes to disposals.

RESEARCH OBJECTIVEThe objective of the research is to describe the impact of credit risk on the profitability of bank Alfalah in Pakistan.METHODOLOGYDATA COLLECTIONThe data collected are for the periods of 2000 2013 from the Annual Reports. Therefore, there are total 14 observations in the regression analysis. Theoretically, the number of observations should be 14:1 (14 observations per one independent variable) in the regression analysis. The data includes Loans and Advances, Non-performing Loan, total deposits, Profit after Tax and total assets of the sampled banks. In this study the ratio of Non-performing loan to loan & Advances and ratio of Total loan & Advances to Total deposit were used as indicators of credit risk while the ratio of Profit after Tax to total asset known as return on asset (ROA) indicates performance.

DATA ANALYSISI have used multiple regression analysis in this study: the relation of one dependent variable to multiple independent variables. The regression outputs are obtained by using SPSS.

DEPENDENT VARIABLEReturn on AssetsAn indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings.

INDEPENDENT VARIABLEI have chosen two independent variables namely NPL/LA = Ratio of Non-performing loan to loan & Advances) and LA/TD = Ratio of Loan & Advances to Total deposit) because these two are the indicators of credit risk which affect the profitability of banks.NPL/LA = Ratio of Non-performing loan to loan & Advances)LA/TD = Ratio of Loan & Advances to Total deposit)STATISTICAL TOOLThe pooled data was analyzed using multiple regression models which adopt Ordinary Least Square (OLS) model in estimating the parameter of the model and is expressed as: ROA = 0 + NPL/LA + LA/TDEMPIRICAL RESULTS & ANALYSIS OF FINDINGS

Model Summaryb

ModelRR SquareAdjusted R SquareStd. Error of the EstimateChange StatisticsDurbin-Watson

R Square ChangeF Changedf1df2Sig. F Change

1.519a.269.137.51998.2692.029211.1782.596

a. Predictors: (Constant), LATD, NPLLA

b. Dependent Variable: ROA

ANOVAb

ModelSum of SquaresdfMean SquareFSig.

1Regression1.0972.5492.029.178a

Residual2.97411.270

Total4.07113

a. Predictors: (Constant), LATD, NPLLA

b. Dependent Variable: ROA

Coefficientsa

ModelUnstandardized CoefficientsStandardized CoefficientstSig.

BStd. ErrorBeta

1(Constant).5261.293.406.692

NPLLA-51.42527.146-.489-1.894.085

LATD.012.021.143.555.590

a. Dependent Variable: ROA

Descriptive Statistics

MeanStd. DeviationN

ROA.8593.5596214

NPLLA.007093.005324914

LATD59.64076.8506714

REGRESSION EQUATION:ROA = 0 + NPL/LA + LA/TDROA = Ratio of profit after tax to total assets. 0 - 2 = Coefficients NPL/LA = Ratio of Non-performing loan to loan & Advances). LA/TD = Ratio of Loan & Advances to Total deposit).

APPLYING THE REGRESSION MODEL (LEAST SQUARE MODEL)ROA = 0.526 -0.489NPL/LA -0.143LA/TDS.E = 1.293 27.146 0.021T= 0.406 -1.894 0.555P= 0.692 0.085 0.590R2 = 0.269 , R2 adjusted = 0.137

The least square method shows that a negative relationship exist between ROA and the independent variables NPL/LA and LA/TD. The result show that the ratio Non-performing loan to loan & Advances negatively relate to profitability though not significant The parameters shows that increase in the level of loan & advances to total deposit significantly decrease profitability of the banks by 14.3%, however, increase in non-performing loans decreases profitability (ROA) by 48.9%, this expose them to higher risk level. The study shows that there is a direct but inverse relationship between profitability (ROA) and the ratio of non-performing loan to loan & Advances and the ratio of loan & advances to total deposit.The model further explains that 13.7% variation in the ROA is explained by NPL/ LA and LA/TD while the remaining 86.3% is unexplained. The mean of the data are ROA (0.8693), NPL/LA (0.007093) and LA/TD (59.647) while the standard deviations of the data are ROA (0.55962), NPL/LA (0.0053249) and LA/TD (6.85067).The test of overall significance of regression implies testing the null hypotheses. The overall significance of the regression is tested using Fishers statistics. In this study the calculated F* value of 2.029 is significant at 5%. It is therefore, concluded that linear relationship exist between the dependent and the independent variables of the model. The evidence established that the independent explanatory variables (credit risk indicators) have individual and combine impact on the return of asset of banks.This study shows that there is a significant relationship between bank performance (in terms of profitability) and credit risk management (in terms of loan performance). Loans and advances and non performing loans are major variables in determining asset quality of a bank. These risk items are important in determining the profitability of banks. Where a bank does not effectively manage its risk, its profit will be unstable. This means that the profit after tax has been responsive to the credit policy of bank Alfalah. The deposit structure also affects profit performance. Many highly profitability banks hold a large volume of core deposits. The growth of loan has been relatively fast for the past few years and which is not fully covered by the deposit base. Banks become more concerned because loans are usually among the riskiest of all assets and therefore may threatened their liquidity position and lead to distress. Better credit risk management results in better bank performance. Thus, it is of crucial importance for bank Alfalah to practice prudent credit risk management to safeguard their assets and protect the investors interests.

CONCLUSION AND RECOMMENDATIONSThe study investigated the impact of credit risk on the profitability of Bank Alfalah. From the findings it is concluded that banks profitability is inversely influenced by the levels of loans and advances, non-performing loans and deposits thereby exposing them to great risk of illiquidity and distress. Therefore, management need to be cautious in setting up a credit policy that will not negatively affects profitability and also they need to know how credit policy affects the operation of the bank to ensure judicious utilization of deposits and maximization of profit. Improper credit risk management reduce the bank profitability, affects the quality of its assets and increase loan losses and non-performing loan which may eventually lead to financial distress. One direct way is to assess the degree of credit crunch by isolating the impact of supply side of loan from the demand side taking into account the opinion of the firms about banks lending attitude. Finally, strengthening the securities market will have a positive impact on the overall development of the banking sector by increasing competitiveness in the financial sector. When the range of portfolio selection is wide people can compare the return and security of their investment among the banks and the securities market operators. As a result banks remain under some pressure to improve their financial soundness.

BIBLOGRAPHY

BANK ALFALAH OFFICIAL WEBSITEhttp://www.bankalfalah.com/about-us/financials-results/

THE IMPACT OF CREDIT RISK MANAGEMENT ON THE FINANCIAL PERFORMANCE OF BANKS IN KENYA FOR THE PERIOD 2000=2006 http://mku.ac.ke/journals/images/Vol2/The%20impact%20of%20credit%20risk%20management%20on%20the%20financial%20performance%20of%20Banks%20in%20Kenya%20for%20the%20period%202000%20%E2%80%93%202006.pdf

EFFECTIVENESS OF CREDIT RISK MANAGEMENT OF SAUDI BANKS IN THE LIGHT OF GLOBAL FINANCIAL CRISIS: A QUALITATIVE STUDYhttp://www.asian-transactions.org/Journals/Vol03Issue02/ATBAS/ATBAS-10305028.pdf

THE IMPACT OF EFFECTIVE CREDIT RISK MANAGEMENT ON BANK SURVIVALhttp://rmr.lixin.edu.cn/files/100134/1110/109_1392b787e1b.pdf

APPENDIX

14 YEARS DATAROANPLLANPL/LALA/TD

20000.89103950152423170.006872.42

20010.913705191314940.000763.33

20020.8553619283194010.001954.79

20032.5987091492161200.001864.17

20040.86370208889314000.004268.56

20050.844022981188640100.003453.46

20060.676976901499993250.004762.63

20071.0423708671711989920.013862.67

20080.3820359971917909880.010663.77

20090.2436945461880424380.019657.9

20100.2422436872071525460.010858.52

20110.818645101984685120.009449.46

20120.9118485352339333580.007951.18

20130.829545632607798500.003752.11

KEY

ROARETURN ON ASSETS

NPLNON-PERFORMING LOANS

LALOANS AND ADVANCES

TDTOTAL DEPOSITS

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