credit policy manualkasb

CREDIT POLICY MANUAL

Table of Contents

1 INTRODUCTION ............................................................. 2

1.1 Introduction .......................................................................... 2

1.2 Business Planning & Organization ....................................... 2

1.2.1 Risk Management Committee (RMC) of BOD ............................. 3

1.2.2 Credit Risk Management Committee (CRMC) ............................. 3

1.2.3 Line Management ......................................................................... 3

1.2.4 Business Segments ...................................................................... 3

1.3 Roles and Responsibilities ................................................... 7

1.3.1 Risk Management Committee ...................................................... 7

1.3.2 Credit Risk Management Committee ........................................... 7

1.4 Credit Management Models ................................................. 8

1.4.1 Credit Program ............................................................................. 8

1.4.2 Credit Transactions ...................................................................... 8

CREDIT POLICIES AND PROCEDURES .............................. 10

2 Sources ......................................................................... 11

2.1 Credit Approval Authority ................................................... 12

2.1.1 Level of Credit Authority Required ............................................. 12

2.1.2 Obligor Risk Rating (ORR) ......................................................... 13

2.2 Types of Credit Officers ...................................................... 14

2.2.1 Eligibility Credit Officers ............................................................. 14

2.2.2 Who Appoints Credit Officers ..................................................... 15

2.2.3 Senior Credit Officers (SCO’s) ................................................... 15

2.2.4 Who Appoints Senior Credit Officers .......................................... 17

2.2.5 Credit Authority ........................................................................... 17

2.2.6 Declined Credit Applications ...................................................... 17

2.2.7 Approvals Under Credit Program ............................................... 17

2.3 Group Facilities .................................................................. 18

2.3.1 Background ................................................................................ 18

2.3.2 Definition ..................................................................................... 18

2.3.3 Responsibility ............................................................................. 20

2.4 Excess Approval procedures .............................................. 21

2.4.1 Introduction ................................................................................. 21

2.4.2 Excess Approval Authority ......................................................... 21

2.4.3 Monitoring ................................................................................... 22

2.5 Earmarking ......................................................................... 23

2.5.1 Rules .......................................................................................... 24

2.5.2 Earmarking Limits ....................................................................... 24

2.6 Inferior Position .................................................................. 26

2.6.1 Approval Authority ...................................................................... 26

2.6.2 Corporate/Middle Market ............................................................ 26

2.6.3 Small and Medium Enterprises .................................................. 26

3 Types Of Facilities ........................................................ 27

3.1 Short Term Credit Facilities ................................................ 28

3.1.1 Maximum Expirations ................................................................. 28

3.1.2 Interim Reviews .......................................................................... 28

3.1.3 Demand/Short Term Financing .................................................. 28

3.1.4 Lines of Credit ............................................................................ 28

3.1.5 Short – Term Committed Facilities ............................................. 29

3.1.6 Commitments (Other than for Short Term Credit) ...................... 29

3.2 Term Credit Facilities ......................................................... 29

3.2.1 Approval Authority ...................................................................... 30

3.2.2 Additional Approval Authority ..................................................... 30

3.2.3 Contingent Commitments (Guarantees Commercial Letters

Credit, Etc.) ............................................................................................. 31

3.3 Counterparty Exposure ...................................................... 33

3.3.1 Definitions ................................................................................... 33

3.3.2 Credit Approval and Reporting Requirements ........................... 34

3.3.3 Description of Facilities .............................................................. 35

3.4 Issuer Risk ......................................................................... 36

3.4.1 Definition ..................................................................................... 36

3.4.2 Credit Approval and Reporting Requirements ........................... 36

3.5 Standard Credit Lines Description ...................................... 37

4 Initiation of Credit Facilities ........................................... 41

4.1 Customer Solicitation ......................................................... 42

4.2 Negotiation ......................................................................... 42

4.3 Presentation ....................................................................... 43

4.4 Commitment ....................................................................... 43

4.5 Documentation ................................................................... 44

4.5.1 Essential Steps in Documenting Credit Transactions ................ 44

4.5.2 Basic Elements of Documentation ............................................. 44

4.5.3 Agreements for Public Sector Borrowers ................................... 45

4.6 Disbursement ..................................................................... 46

4.6.1 Documentation ........................................................................... 46

4.6.2 Collateral/Support ....................................................................... 46

4.6.3 Approval ..................................................................................... 46

4.6.4 Deferral of Credit/Legal Documents ........................................... 46

4.6.5 Offering Tickets .......................................................................... 47

5 Preparation Of Credit Packages .................................... 48

5.1 Credit Package ................................................................... 49

5.1.1 Credit Approval (CA) .................................................................. 49

5.2 Obligor Risk Rating Form (ORR) ........................................ 50

5.3 Basic Information Report (BIR)........................................... 55

5.3.1 Ownership Structure: .................................................................. 55

5.3.2 Directors and Management ........................................................ 56

5.3.3 History: ....................................................................................... 56

5.3.4 Banking & Other Financing Arrangements ................................. 56

5.3.5 Facilities ...................................................................................... 57

5.3.6 Products And Products Mix ....................................................... 57

5.3.7 Selling And Distribution Terms ................................................... 58

5.3.8 Affiliated Companies And Related Business ............................. 58

5.4 Management Assessment Form ......................................... 59

5.5 Financial Spreads ............................................................... 59

5.5.1 Financial Projections .................................................................. 60

5.6 Credit Memorandum ........................................................... 60

5.6.1 Purpose ...................................................................................... 61

5.6.2 Relationship Background ........................................................... 61

5.6.3 Relationship Profitability ............................................................. 61

5.6.4 Relationship Strategy ................................................................. 61

5.6.5 Management Assessment .......................................................... 62

5.6.6 Financial Analysis ....................................................................... 62

5.6.7 Industry Outlook ......................................................................... 63

5.6.8 Security/Support Analysis .......................................................... 63

5.6.9 Risk Analysis .............................................................................. 64

5.6.10 Conclusion/Recommendations ................................................. 64

5.7 Site Visits ........................................................................... 65

5.8 Target Market/RAC’s Compliance ...................................... 65

5.9 Prudential Regulation Compliance ..................................... 65

5.10 CIB Checkings .................................................................... 65

5.11 Bank/Market Checkings ..................................................... 66

5.12 Registrar Checkings ........................................................... 66

5.13 Covenants Check-offs ........................................................ 66

5.14 Account Profitability ............................................................ 66

5.15 Conclusion ......................................................................... 67

5.16 Legal Lending Limit ............................................................ 68

5.17 Temporary Extensions ....................................................... 69

5.18 Personal Guarantees ......................................................... 70

6 Credit Process Normal .................................................. 72

6.1 Administration of Approved Credit Facilities ....................... 73

6.1.1 Customer Meetings/Call Reports ............................................... 73

6.1.2 Credit / CIB Checkings ............................................................... 73

6.1.3 Financial Information .................................................................. 73

6.2 Properties taken as Security .............................................. 74

6.2.1 Collateral Inspections ................................................................. 74

6.2.2 Collateral Evaluations ................................................................. 74

6.2.3 Documentation Lodging, Reviews and Follow-Up ..................... 75

6.2.4 Safeguarding Our Security Interests .......................................... 75

6.2.5 Annual Review of Term Credits .................................................. 76

6.2.6 Release of Collateral /Security / Support ................................... 76

6.3 Maintenance of Credit Information ..................................... 76

6.3.1 Credit Files: ................................................................................ 76

6.3.2 Background Information ............................................................. 77

6.3.3 Credit Department ...................................................................... 78

6.4 Temporary Overdrafts ........................................................ 79

7 Credit Maintenance ....................................................... 81

7.1 Scope and Objectives ........................................................ 82

7.2 Functional Responsibilities ................................................. 83

7.2.1 Facility Implementation and maintenance .................................. 83

7.2.2 Documentation ........................................................................... 83

7.2.3 Collateral .................................................................................... 84

7.2.4 Compliance ................................................................................. 84

7.2.5 Management Information ........................................................... 85

7.3 Facility Implementation Procedures ................................... 86

7.3.1 Utilization of Facilities ................................................................. 86

7.4 Credit Monitoring ................................................................ 87

7.4.1 Monthly Credit Admin Updates ................................................... 87

7.4.2 Delinquency Report .................................................................... 87

7.4.3 Monitoring Past Due Obligations ................................................ 88

7.5 Documentation ................................................................... 89

7.5.1 Basic Documentation.................................................................. 89

7.5.2 Scrutiny ....................................................................................... 91

7.5.3 Lodgement .................................................................................. 91

7.5.4 Review ........................................................................................ 92

7.5.5 Documentation Controls and Follow-ups ................................... 93

7.5.6 Deferrals ..................................................................................... 93

7.6 Availment Procedures ........................................................ 94

7.7 Collateral Guidelines .......................................................... 95

7.7.1 Valuation ..................................................................................... 96

7.7.2 Registrar checkings .................................................................... 97

7.7.3 Monitoring ................................................................................... 97

7.7.4 Pledge (Mucaddam/Warehousing) ............................................. 99

4.7.4.1 Monitoring ................................................................................ 99

7.7.5 Inventory Inspection ................................................................. 100

7.7.5.1 Frequency .............................................................................. 101

7.7.6 Insurance .................................................................................. 101

7.7.7 Release of Collateral ................................................................ 102

7.8 Credit Files: Composition and Maintenance ..................... 103

8 Problem Recognition and Classification Process ........ 105

8.1 Credit Classification .......................................................... 106

8.1.1 Obligor Risk Rating................................................................... 107

8.1.2 Classification Categories .......................................................... 107

8.1.3 1/ Current .................................................................................. 108

8.1.4 IA /Watch List Account: ............................................................ 108

8.1.5 II /Sub-Standard ....................................................................... 108

8.1.6 III/ Doubtful ............................................................................... 108

8.1.7 IV / Loss .................................................................................... 108

8.1.8 Guidelines for Applying Classification ...................................... 109

8.2 IA/Watch List Account ...................................................... 110

8.2.1 II/Substandard .......................................................................... 111

8.2.2 III/Doubtful ................................................................................ 111

8.2.3 IV/Loss ...................................................................................... 111

8.3 Split Classifications .......................................................... 112

8.3.1 Splits within a Relationship. ...................................................... 112

8.3.2 Splits between Facilities. .......................................................... 112

8.3.3 Splits within a Single Facility. ................................................... 112

8.4 Special Assets Management Process Standards ............. 113

8.4.1 Responsibility for Action ........................................................... 113

8.5 Initiating or Changing Adverse Classifications ................. 113

8.6 Credit Approvals Requirements ........................................ 113

8.6.1 Availments:- .............................................................................. 114

8.6.2 Remedial Action ....................................................................... 114

8.6.3 Formal Action Plan ................................................................... 115

8.6.4 Documentation Review ............................................................ 115

8.6.5 Reviews .................................................................................... 115

8.6.6 Frequency of Reviews .............................................................. 116

8.6.7 Circulation of Reviews .............................................................. 116

8.6.8 Abandonment ........................................................................... 116

8.6.9 Accounting Policies for Problem Credits .................................. 116

8.7 Past Due Obligations ........................................................ 117

8.7.1 Non Accrual Status ................................................................... 117

8.7.2 Payments Against Documents (PADs)..................................... 117

8.7.3 Reversals .................................................................................. 118

8.7.4 Approval Requirements ............................................................ 118

8.7.5 Responsibility ........................................................................... 118

8.7.6 Confidentiality ........................................................................... 118

8.7.7 Initiating Non – Accrual or Cash Status.................................... 119

8.7.8 Returning to Accrual Status ...................................................... 119

8.7.9 Applying Cash Basis mark-up Payments ................................. 119

8.7.10 Reserves/ Provisions .............................................................. 119

8.8 Acquisition of Real Estate (property) in Retirement Debt . 120

8.9 SBP’s Guidelines For Classification of All Financing

Facilities: - ................................................................................... 122

8.9 a SBP’s Guidelines For Classification of All Financing

Facilities: - ................................................................................... 123

8.10 CREDIT CARDS: -(Consumer R8) ................................... 124

8.11 AUTO LOANS CONSUMER R-I4 - .............................. 125

8.12 HOUSING FINANCE CONSUMER R-23 .................... 126

8.13 PERSONAL LOANS CONSUMER R - 28 .................... 127

8.14 Reserves/Remissions/Write-offs ...................................... 128

8.14.1 Liquid Assets: ......................................................................... 129

8.14.2 Land and Building ................................................................... 130

8.14.3 Plant and Machinery ............................................................... 130

8.14.4 Pledged Stocks:...................................................................... 130

8.14.5 Investments And Other Assets ............................................... 131

8.15 Submission Of Returns: ................................................... 132

8.16 Timing Of Creative Provisions: ......................................... 132

8.17 Verification By The Auditors: ............................................ 132

8.18 Reserves/Remissions/Write-offs ...................................... 133

9 CREDIT REVIEWS ..................................................... 135

9.1 Risk Asset Review – (RAR) .............................................. 136

9.1.1 Line Management – Portfolio Reviews ..................................... 136

9.2 Non-Reporting Limits (NRL) Review ................................ 137

9.3 Independent Auditors ....................................................... 138

9.4 Special Credit Reviews .................................................... 139

9.5 Response to Reviews ....................................................... 139

9.6 State Bank of Pakistan Inspections .................................. 139

ANNEXURE I ....................................................................... 140

Annexure 1 – CA Approval ................................................... 155

Annexure 2 – ORR ............................................................... 164

Annexure 3 – BIR ................................................................. 168

Annexure 4 – Management Assessment Form ..................... 172

Annexure 5 – Financial Spreads .......................................... 174

Annexure 6 – Credit Memorandum ...................................... 180

Annexure 7 – PR Checklist .................................................. 184

Annexure 8 – BBFS ............................................................. 186

Annexure A – Classification Memorandum ........................... 191

C R E D I T P O L I C Y M A N U A L

1

Introduction

Section

1


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1 INTRODUCTION

1.1 Introduction

Credit policies are formulated to support the Bank‟s business strategies. The objective is to achieve the earnings target with minimum volatility, based on a sound credit portfolio. In order achieve this objective, the Bank must have:

A clearly defined Business Strategy.

A focused Target Market approach which allows build up of strong customer relationships, through offering of a diverse product range to meet the customer needs.

A proactive Portfolio Risk Management system

Checks and balances in the form of portfolio and process, evaluation and reporting systems which ensure compliance with the Policies and Procedures and corrective actions required thereof.

Credit quality must take precedence over business development. Process and Management should be geared towards avoiding losses, but at the same time it should ensure efficiency both in terms of response time and market needs, and most importantly ensure an adequate return on assets employed.

The credit policies have been formulated keeping in view the above perspective, and provide a framework to help manage the risks in any business. Certain standards have been established and a set of policies and procedures defined to ensure that these standards are met.

All policies and procedures will be subject to observation of Prudential Regulations in force.

1.2 Business Planning & Organization

Strategic business planning requires an assessment of the external and internal environment, taking into consideration:

General economic outlook (global, national, local)

Political, social, regulatory and legislative environment

Market size, potential, and competition

Adequacy of resources and infrastructure to implement the strategy


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1.2.1 Risk Management Committee (RMC) of BOD

The Risk Monitoring Committee of the Board of Directors, based on the assessment of the above stated factor, establishes the Bank‟s overall risk taking capacity. This involves effective portfolio management strategy keeping in view the growth target and capital constraints.

The committee reviews/approves:

1. The aggregate risk profile of the total exposure of the Bank.

2. Concentration limits (by industry, geography, size tenor) so that no one category of assets or dimension of risk can materially harm the bank.

1.2.2 Credit Risk Management Committee (CRMC)

The Credit Risk Management Committee (see section 1.3) has the responsibility to translate these decisions about strategy into policies and standards for the extension of credit, and also participates setting up the Bank‟s target portfolio profile and limits.

1.2.3 Line Management

The line management (Business Group), within the guidelines set by the RMC and CRMC, develops and executes its own business plans, initiates and approves credit, and is responsible for credit quality through effective Risk Management systems.

In short, in addition to setting and achieving business goals, Line Management is responsible for creating and managing risk in line with the concept of decentralization and responsibility. This may require setting up of additional policies and procedures to supplement those provided by Credit Risk Management Committee.

Line management is expected to develop Target Market and Risk Acceptance Criteria and get CRMC approval for compliance, within the RMC guidelines on portfolio parameters;

Monitor portfolio and process quality through an effective Credit Administration Unit which should ensure compliance with credit policies.

1.2.4 Business Segments


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Business Groups

It shall be the responsibility of each Business Group (Corporate Banking, Middle Market, Small and Medium Enterprise and Retail Banking) to identify its own target market and establish Risk Acceptance Criteria. While doing so, the geographical location of the individual units, close proximity of specific industries/business activities, desirable names, healthy financial state of affairs of business, performance of a particular sector etc, shall necessarily have to be taken into consideration. It will thus follow that the target market of location B from that of location of C and so on. It also follows that target markets will be open to periodic reviews and revisions. It shall be upto each Business Group to fix the frequency with which it wants to review these targets markets. The advantages of periodic reviews are numerous. To mention two of them firstly marketing efforts will be focused, and more energy will be spent on marketing more desirable names rather than vice versa, and secondly, less time will be wasted on adventures where internal approvals shall seldom be forthcoming. It shall be essential to obtain approval of these target markets from the Head of Risk Management before implementing them. Corporate Banking Group (CBG)

Any borrowers with aggregate borrowings in excess of Rs.100 million or with an annual turnover of Rs.750 million plus, qualifies to be booked under Corporate Banking Group‟s umbrella. If any constituent of a group of borrowers falls into this category, regardless of whether the others do or do not, shall also qualify to be booked under the Corporate umbrella. However, where the exposure is 100% cash collateralized (deposits and Government instruments only) regardless of the bottom limit, and has been marketed by the CBG, such exposures shall be retained by them. Cases falling in the borderline area but otherwise in the Middle Market Segments domain (described in detail later), should the relationship niceties & demand particular handling, shall be domiciled under the CBG.


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Middle Market Group

Any borrower with aggregate borrowing in excess of Rs.50 million and with an annual turnover of Rs.300 million and above would qualify to be booked under Middle Market Segment. If any constituent of a Group of borrowers, falls into this category, regardless of whether the other do or do not, shall also qualify to be booked under Middle Market Segment. However, where the exposure is 100% cash collateralized (deposits & Government instruments) regardless of the bottom limits, the exposure would be retained by the Segment which has marketed it i.e. Middle Market. Cases falling in borderline area, but otherwise in SME domain shall be domiciled in Middle Market Segment of the relationship demands particular handling. Small and Medium Enterprise Group (S & MEG)

Borrowing relationships with aggregate borrowings of less than Rs.50 million or with an annual turnover of less than Rs.300 million shall be domiciled at the S & MEG. Should any constituent of a group of borrowers breach these limits, that entire group should be transferred to the Middle Market for specialized handling of the relationship commensurate with their size and requirements. However, cases falling in the borderline area but otherwise in the Middle Market domain, should the relationship niceties demand particular handling, shall be domiciled under SME. Where the exposure is 100% cash collateralized (deposits and Government instruments only) regardless of the upper limit and has been marketed by the S & MEG, such exposures shall be retained by them. Consumer Banking Group

This business group is involved with underwriting more of a consumer oriented risk. This may include credit cards, loan products to individual, consumer finance, vehicle finance, mortgage finance, housing finance etc. The Consumer Banking Group would formulate its own Risk Acceptance Criteria, and design specific Product Programs for risk assets acquisition. The competent authority of the bank shall approve such programs. Financial Institutions

Within the KASB Bank structure, Financial Institutions (FIs) is a separate Business Group set up to deal with matters relating purely to FIs‟ such as Banks, Development Financial Institutions, Leasing Companies etc. These matters include setting up lines/exposures that may comfortably be underwritten on FIs‟


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establishing relations with foreign as well as local correspondents and taking credit exposure on them. Audit Division

Their sphere of activity and responsibility is to monitor the Bank‟s activities at Branch level, (credit included) to gauge the level of adherence to pre-set rules and policies of the bank, and the rules and regulations that have been imposed and/or maybe imposed by the State Bank of Pakistan from time to time.

Risk Asset Review (RAR)

RAR is entrusted with the responsibility to review each and every risk asset acquired by either of the business groups, units, to judge the level of risk assets quality and the underlined credit process through which such acquisitions were made, adherence to rules and regulations imposed by the State Bank of Pakistan or by the bank internally, to see to what extent the Credit/Risk management Bulletins have been followed and implemented. Also to check whether all risk assets have been appropriately classified/risk rated, and if not so, then what to do and recommend reserves (provisions) that have to be taken. In order to have a bird‟s eye view of the unit, RAR also is supposed to check and assess the credit talent available locally and to judge whether it is sufficient or needs beefing up. Credit Administration Department (CAD) CAD is the back office for the Corporate, Middle Market, SME Group. They are Middle office, primarily the custodians of securities and collaterals alongwith security documentation. CAD is an integral part of Risk Management Group. Special Assets Management (SAM) Group Assets that deteriorate to such an extent where it is deemed fit and appropriate to pay focused attention to them, so as to retrieve them with the least possible loss to the bank, are transferred to the Special Assets Management (SAM) Group. At SAM, attention is focused and situation specific, and in cases, legal resort is also adopted. Detailed criteria to qualify for transfer and functions etc. are given in Bulletin #016 and any subsequent amendment made thereto.


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1.3 Roles and Responsibilities

1.3.1 Risk Management Committee

The RMC functions to oversee risk and to direct and shape lending activities by:

Establishing credit policies and corporate standards that conform to local regulations

Maintaining a sound, and an effective Risk Management architecture.

Participating in portfolio planning and credit loss forecasting.

Keeping aggregate credit risk well within the Bank‟s risk taking capacity

Appointing Senior Credit Officers and grant credit approval authority to skilled and adequately qualified officers.

Supervise Risk Asset Review (RAR) process and provide guidance, direction to the Line Management to rectify portfolio and process anomalies.

The Chairman, Risk Management Committee is responsible for periodic reports to the Board. Such reports may include but are not limited to:

A summary of policy exceptions that represents significant policy exceptions.

Portfolio reviews emphasizing quality assessment, risk profiles, tenors, concentrations and any such excesses over limits.

Significant portfolio indicators and problem credits consistent with Board‟s guidelines and regulatory requirements.

In the execution of its various responsibilities, the RMC exercises its writ through the Risk Management Group, which for these functions directly reports, to the President and CEO.

1.3.2 Credit Risk Management Committee

This committee is responsible for the following tasks:

Assessing and evaluating credit risk strategies.

Overseeing the formal development of credit policy procedures and manuals.

Monitoring and assessing credit risk portfolio composition.

Evaluating risks under stress scenarios and tolerance level.

Evaluate the risk-return tradeoff.


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Reviewing and evaluating various credit products.

Reviewing reports of credit review processes and asset quality.

Ensure compliance with regulatory requirements on credit risk management.

1.4 Credit Management Models

Basically, two credit approval models are to be adopted. Credit is to be approved on an individual transaction basis or, as a set of defined customers, on a program basis, as characterized below.

1.4.1 Credit Program

This represents a credit approval system for a group of customers with similar characteristics, product needs, or risk profile. It is a cost effective, standardized approach to cater to high volume credit activities. Risk is managed on a statistical basis according to objective, predetermined, and clearly defined standard terms and conditions. A credit program must specify

Target customer or customer segments;

Standard Risk Acceptance Criteria for evaluation;

System for approval of individual transactions under the program.

Refer to section 2.2.7 for approval requirements under credit programs.

Credit Programs are primarily used for:

Consumer installments loans

Residential mortgages

Auto loans

Consumer and small business loans

1.4.2 Credit Transactions

This approach focuses on the decision to extend credit to an individual customer or relationship.

Generally, this is applicable when:

customers cannot be considered homogenous

credit requirements are specific, large or multiple, or involve complex corporate finance transactions

risks require in-depth evaluation of each customer.


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approval is based on detailed financial analysis and individual judgment of Credit Officers.

there are multiple facility structures and forms of collateral

risk is managed on an individual customer basis.

Under this system, credit is approved using the credit proposal process (section 4).

It may however be noted that credit transactions must follow the Target Market and RAC process.


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CREDIT POLICIES AND PROCEDURES

Section

2


11

2 Sources

The Rules Governing the Extension of Credit (the Rules) are the basic statements of credit policy. All Credit Officers should make themselves thoroughly familiar with the requirements contained therein. It is particularly important that everyone follows the spirit as well as the letter of the Rules. (Annexure I)

Deviations to the Rules require written approval of the President/CEO and the Risk Monitoring Sub-Committee of the Board through the Risk Manager.

Credit/Risk Management bulletins and other communications are issued from time to time whenever a situation arises that requires either a policy or a supplementary guideline to implement a policy.

Business segment manuals provide specific credit policies and procedures related to particular businesses, products and services.


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2.1 Credit Approval Authority

At KASB Bank credit is not extended on the judgment of one credit officer alone. Extensions of credit whether by way of establishing regular credit lines, or special/one – off transactions or Product Programs, are approved by three credit officers whose current position involve responsibility for extending credit. One of the three credit officers so designated must have a credit limit equal to or greater than the amount of the credit, being approved.

The three-initial system clearly establishes Line Management‟s accountability for credit decisions with three Credit Officers, each of whom independently approves the entire credit. While each officer is equally accountable, officers may personally oversee different aspects of the underlying credit process and may add different values to the ultimate credit decisions. Attention to details, communication, teamwork between units, and follow through are critical particularly as credit activities become larger and more complex. Therefore, one of the three approving credit officers is named the “Responsible Senior”. The “Responsible Senior” officer ensures that all aspects of the credit process for a particular Credit Transaction or a Product Program are properly coordinated and executed.

Credit Officers accord their approvals by initialing the CA, Product Program or a Credit Transaction approval document; their approval must be distinguished clearly from any additional signatures that may be required by the Line Management. The “Responsible Senior” must be clearly identified by his/her initials and name stamp.

2.1.1 Level of Credit Authority Required

The level of credit authority required for approval of any credit transaction would be determined by the following yardsticks. (refer to Credit Risk Bulletin #_____., alongwith Credit Approval Grid Chart)

The amount of the credit exposure being proposed, and

The Obligor Risk Rating (ORR) assigned to the borrower (for details, please see section 5 of this manual)

The credit exposure amount being recommended for approval is to be aggregated with the amount(s) of all other existing facilities (direct and contingent obligations and commitments)


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It is appropriate to aggregate credit facilities extended to related customers (parent companies, branches of the same borrower, subsidiaries, common/family ownership etc) to arrive at the facilities amount indicated in point (i) above.

Since KASB Bank is a Rupee based bank, all credit facilities being recommended for approval are expressed in Rupee. Letters of Credit facilities may however, be denominated in U.S. Dollars but expressed in Rupee equivalent at the mid exchange rate as of that day.

2.1.2 Obligor Risk Rating (ORR)

Each risk asset acquired carries a certain level or degree of risk which to some extent of accuracy, should be gauged. The primary objective is to assess, at any given point of time, realistically recoverable value of underlined risk assets. ORR has its parallels with the State Bank of Pakistan‟s classification codes as well as with the Bank‟s Internal Classification System, normally used by the Risk Asset Review Department. For further details please refer to section 5.1.2. for an additional note on Obligor Risk Rating.


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2.2 Types of Credit Officers

As stated earlier, the authority for credit extensions at KASB Bank have the joint approval of at least three credit officers. It is not intended that credit be extended on the judgment of one officer alone. A specific title of an officer by itself will not be sufficient to allow an officer to approve any form of credit extension. Only those officers who have duties and responsibilities that involve the approval of loans and other extensions of credit are Credit Officers.

2.2.1 Eligibility Credit Officers

Credit Officers focus on day-to-day credit decisions and credit maintenance. Credit Officers are appointed on the basis of their experience, abilities and personal characteristics. They must have appropriate experience and training.

appropriate experience in credit/marketing Corporate, Middle Market or SME.

satisfactory completion of entry-level training. They must have sound capabilities:

adequate knowledge of credit analysis, negotiation skills, structuring credit abilities, credit maintenance expertise.

sound knowledge of the Bank‟s credit policies and procedures and the ability to apply this knowledge to specific situations

ability to communicate clearly in speech and writing. They must display these personal characteristics:

integrity, honesty, sound judgment, common sense

attention to detail

the character to think and act independently

the sense to know when to ask for guidance from experienced officers.


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2.2.2 Who Appoints Credit Officers

Appointment of Credit Officers requires the approval of the Risk Management Committee of the Board. Officers nominated by the Line Management to become Credit Officers should meet the following criteria:

Should be an Grade III Officer or higher

Should have minimum 2 years experience at KASB as Relationship Manager/Lending Officer, if he/she is a fresh hire. In case of mid-career hires, minimum previous experience required is 2 years as Relationship Manager or in an equivalent position. Additionally, minimum 6 months experience as Relationship Manager at KASB environment will be required before his/her nomination can be made for a Credit Officer position.

Credit Authority

A Credit Officer, on appointment, may or may not be awarded an individual credit (approval) limit. It is at the sole discretion of the RMC to accord such a limit to a particular Credit Officer depending on his/her credit skills and judgment. Individual credit limit accorded to a Credit Officer on appointment may not exceed Rs.250,000/- reviewable annually at the sole discretion of the senior management.

A Credit Officer on appointment shall deem to be member of the Regional/Area Credit Committee of the Business Group he/she is assigned to.

2.2.3 Senior Credit Officers (SCO’s)

Senior Credit Officers bring seasoned judgment to bear on material credit risk and process decisions. Senior Credit Officers are appointed on the basis of their experience, abilities and personal characteristics.

They must have wide and diverse experience:

ten years experience in Corporate or SME lending environment. Of this, at least 1 year in KASB Bank‟s environment.

two years in grade SVP or equivalent.

exposure to more than one geographic or business area.


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remedial management or workout experience either through direct account responsibility or through participation in Risk Asset Reviews.

an acceptable track record with respect to the performance of portfolio under his/her responsibility.

They must have a wide range of capabilities:

advanced knowledge of the Bank‟s credit culture, policies, and procedures and the ability to interpret and apply this knowledge to specific situations.

sensitivity to portfolio management strategies.

understanding of the business cycle and its effect on the portfolio and individual credits.

ability to identify current risks and to anticipate potential risks.

negotiating ability, especially in difficult or troubled credits.

ability to work with customers, other banks, lawyers, etc.

ability to maintain a personal “check and balance‟ in divorcing intrinsic credit decisions from short-term profit pressures.

ability to consult and work with seniors, peers, and subordinates in a team approach to any situation.

ability to work under pressure and maintain a detached, independent perspective.

ability to apply knowledge and experience to actual credit situations and to communicate assessments and opinions clearly and directly in speech and writing.

ability to give rigorous, and to show a commitment to, credit training.

They must display the following personal characteristics;

integrity, honesty, sound judgment and common sense are the paramount factors in the selection of the SCO‟s.

balance and independent judgment, with the character to assess each credit proposal on its merit, and to approve only when satisfied with all aspects of the credit.


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decisiveness, including the ability to make unpopular decisions - a reasoned sense of when to say “Yes” and “No”

leadership

Senior Credit Officers lead by example and should demonstrate a commitment to KASB Bank‟s basic values and strengthen our credit culture through personal behavior. They are our credit role models.

2.2.4 Who Appoints Senior Credit Officers

Risk Management Committee of the Board, unanimously. Any exception to the foregoing conditions has necessarily to be authorized by the Chairman, RMC.

2.2.5 Credit Authority

Credit approval authority of Senior Credit Officer is described in the grid attached to the addendum to the Rules Governing the Extension of Credit – Commercial Banking Rules.

2.2.6 Declined Credit Applications

If a credit is declined by any SCO, the same will not be approved by any other SCO. The respective business unit may not reinitiate and seek approval of the credit at an exposure level which may not require an SCO‟s approval.

2.2.7 Approvals Under Credit Program

Credit programs initiated by a Business Group must specify:

target customers or customer segment

contain standard Risk Acceptance Criteria

procedure for approval of individual transactions

targets for yield, delinquencies and write-offs

have an effective reporting and tracking system

an aggregate exposure on the program and individual transaction limit.


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2.3 Group Facilities

2.3.1 Background

In order to get a consolidated view of credit risk, in a particular relationship, it would be prudent for the Bank to aggregate credit facilities to a related GROUP of borrowers. These may be independent legal entities, and/or with different legal ownership, but from the Bank‟s point of view are sufficiently interdependent, financially or business-wise, insofar that the performance of one may have a direct or an indirect impact on the other. Therefore, to control risk in such situations, and determine appropriate approval levels, all credit facilities to a related group of borrowers need to be aggregated.

2.3.2 Definition

A group can be defined to include company(ies) which is/are directly or indirectly owned by, controlled by, or affiliated with an individual or an association of individuals. Where ownership is evident by, say, a 51% or larger holding by a person 1 , test of “control” is not required for aggregation. In many cases, however, it is not easy to determine the ownership through ascertainment of the exact holding, by the person, as it may be in the form of investments through off-shore companies, proxy shareholders, or cross holdings in other companies, etc. Therefore, the major criterion for basis of aggregation is “EFFECTIVE CONTROL”, which can either be demonstrated by 1. Majority ownership or when persons acting in concert own 25% of voting

shares

Or 2. Control of election of a majority of directors

Or 3. Exercise of a “controlling influence” over management or policies

1 Person is defined as an individual and/or family and or group of individuals and or a group of companies


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To illustrate the point, aggregation would be required under the following conditions:

A company owns less than 50% shares of another company (an affiliate) but exercise management control.

For e.g., company ABC holds 30% shares of company XYZ, but the rest of the shares are widely held by individuals and institutions which may or may not have a proportionate representation on the board, i.e. effective management control is with ABC.

A company ABC, owns 20% of shares directly in company XYZ, but has majority or controlling interests in other companies DEF and GHI, who in turn (let us say) own 20% and 15% shares, respectively, in XYZ, and as such ABC has effective control over of 55% of voting stock of company XYZ.

Where company A provides (significant) support to company B, i.e. it acts as a guarantor for credit facilities extended to company B.

Companies and/or affiliates AND associated individuals are engaged in a common enterprise as evidenced by:

i. Interdependent business – as evidenced by substantial business

transactions. Textile mill XYZ sells 40% of its yarn to another company ABC, and both companies also have some common sponsors.

OR

ii. Substantial financial interdependence (inter-company loans, etc).

Also, the financial health of one depends on the health of the other.

OR

iii. Have a common set of key decision makers or managers, or the

same marketing or sales force. Textile units A and B use the same marketing team (provided they have some common decision makers)


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2.3.3 Responsibility

It will be the responsibility of the originating unit when extending a credit to check whether there are any other affiliated companies, or companies under “effective control” of key decision makers. Any questions should be referred to the control unit if one exists for the particular name.

A list of globally managed names, along with the designated RMs, will be circulated from time to time. Credit Departments, of respective Business Groups, will be additionally responsible for checking if grouping is required.

Grouping function will further be centralized at the Head Office with Credit Policy to co-ordinate with the Business Groups to ensure compliance.

In case of any ambiguity arising with regard to an aggregation issue, Credit Policy is to be consulted.

Note The Bank‟s criteria for aggregation of facilities may differ from those of the State Bank of Pakistan, in which case the reporting should continue as is. Wherever possible, efforts will be made to achieve congruity, to avoid duplication, but for credit approval purposes, the aforementioned policy will apply.

2.3.4 Group’s Legal Lending Limit

It is 50% of Bank‟s Equity and unimpaired reserves of the Bank (as discussed in the latest audited financial statements). Subject to the condition that the maximum outstanding against fund based exposure does not exceed 35% of bank‟s equity.


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2.4 Excess Approval procedures

2.4.1 Introduction

Incidental drawings resulting in i. a debit balance for which a facility has not been arranged; ii. drawings in excess of existing limits and, iii. drawings in excess of availability security; should be discouraged and treated as exceptions. The request for excesses can be due to:

client‟s needs have not been properly assessed.

client‟s lack of understanding of their business requirements or lack of familiarity with the Bank‟s policies and procedural requirements.

diversion of funds or changing cash cycle. Should the excesses be recurring in nature, the account should be reviewed for classification or proper structuring of facilities.

2.4.2 Excess Approval Authority

A Credit Officer, with an individual credit limit, can approve a temporary overdraft or an excess over an approved facility (alongwith two other credit officers-three initials) for an amount, which is lower of

10% of approving officer‟s individual credit limit.

Or

10% of specific credit line (in which the excess is being created);

And

the period, in case of funded facilities, is less than 15 days; and


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for unfunded facilities, less than 30 days.

This temporary excess rule does not apply to accounts classified OAEM or worse. It is the primary responsibility of the Relationship Manager to have the excess cleared by the stipulated date. For excesses beyond these limits, or where it is expected that the maximum time limit (for excesses) will be exceeded, normal credit approval procedure should be followed. Should the excess not be settled within the stipulated period, then a credit proposal has to be submitted and the excess has to be approved at the appropriate level, i.e. total credit facilities to the Group/Borrower plus the amount of excess.

2.4.3 Monitoring

Each excess has to be recorded in the “Referral Card” duly signed by the authorized persons.

Every week, Credit Administration Department will submit an excess report, which should list the date the excess was initiated and the date by which it has to be settled.

Amounts not settled by due dates will be shown in the “overdue” category.

Appropriate approvals should be sought promptly for these overdue excesses.


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2.5 Earmarking

At times, it may be convenient to accommodate an unanticipated/one off request from a customer for enhancement in a specific facility by sub-allocating or earmarking from another facility, without an increase in overall exposure to the company/group. Earmarking of facilities should, however, be treated as an exception, as excessive use of this flexibility reflects poor facility structuring. Earmarking can be done from a high-risk facility to a low-risk facility but not the other way around. Facilities, in order of risk (starting with higher risk at the top), both funded and non-funded, are as follows:

Fund Based Risk Category R-1 High Risk

Running Finance (RF)

FAFB – Non rated banks‟ L/Cs, contracts, etc.

Cash Finance (CF)

ERF-II

FATR

IBP R-II

Cash Finance – Pledge (CF – Pledge)

FIM

FAPC

ERF – 1

ERF - Post Shipment

FAFB – Rated banks‟ L/Cs. Low Risk


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Non Fund Based

G‟tees – long tenors

G‟tees – short tenors

Letters of Credit – Usance

Letters of Credit – Sight Earmarking is allowed between facilities in each risk category, or from RI to RII, provided other conditions as outlined below are met.

2.5.1 Rules

Earmarking can only be from high risk to facilities of equal or lower risk.

The tenor of the transaction being done through earmarking should not exceed the tenor of facility being earmarked from.

Earmarking from a specifically approved (special transaction) is not permissible.

Non-fund based facilities cannot be earmarked for fund based facilities.

The facility being earmarked from is effective i.e. all security or documentation is in place, or adequate documentation is taken for the proposed transaction. Also, all regulatory or other requirements for the transaction being executed should be in place.

There can be no earmarking from funded term facilities.

Earmarking from lower risk facility to a higher risk facility (i.e., proposed transaction) can only be allowed if the proposed transaction is secured by cash or near cash collateral.

In case of a group credit, earmarking from facilities of one company to another company is not allowed, unless specifically allowed in the previously approved CP.

No earmarking is allowed in classified accounts.

2.5.2 Earmarking Limits

Aggregate (cumulative) amount earmarked from a facility should not exceed 20% of the approved facility.


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And

A Credit Officer with the rank of VP may approve earmarking of upto 20% of his credit authority or PKR 10 million, whichever is higher.

Earmarking from one facility to the other should be for a specific period of time, but in any case it should not exceed 180 days, or the expiry of the facility, whichever is earlier.


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2.6 Inferior Position

It is not the Bank‟s policy to lend in a position that is inferior to other lenders who extend similar credit. The Bank should maintain, at minimum, a pari-passu status to other banks. Second charge or lower or second mortgage or lower, are not to be accepted as primary collateral. In cases where for some reason credit cannot be extended on the basis of first charge (non-availability of NOC from other lenders), such credits should be referred to a higher level, for approvals, as follows.

2.6.1 Approval Authority

For facility/facilities which are not secured by first charge.

2.6.2 Corporate/Middle Market

Amounts under PKR 10 million or equivalent, Regional Head‟s approval required.

Amounts between PKR 10 million and 50 million, Group Executive‟s approval is required.

For amounts over PKR 50 million, Credit Policy approvals are required from Risk Manager.

2.6.3 Small and Medium Enterprises

For amounts under PKR 5 million approval of Regional Head is required.

For amounts between PKR 5 million and 10 million, approval of SME Head is required.

For amounts between PKR 10 million and 20 million Group Executive‟s approval is required.

For amounts over PKR 20 million, Credit Policy approval is required, from Risk Manager.


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3 Types Of Facilities

Section

3


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3.1 Short Term Credit Facilities

3.1.1 Maximum Expirations

Approvals for all short-term credit facilities will expire no later than one year after approval.

3.1.2 Interim Reviews

Notwithstanding the revision/expiry date, whenever there is a significant adverse change in the financial or business situation of the borrower, all credit facilities for that borrower should be reviewed promptly at the appropriate level of credit authority for such modification or action as may be required.

3.1.3 Demand/Short Term Financing

Short term financing facilities not covered under approved lines will carry an internal revision date of not more than six months. Any renewal or extension must be approved at the level of credit authority required by the “Rules”. (Note: The provision does not apply to credit facilities that are approved with specific revision dates longer than six months but which are documented by demand notes for legal or other reasons)

3.1.4 Lines of Credit

Lines for short-term credit may be approved for either internal purposes only (internal guidance lines) or advised to customers.

If a letter is to be sent advising the customer of the extension of a line of credit the letter must be signed at least by an officer of VP grade who is a credit officer and subject to legal/regulatory requirements, should include language to emphasize the following:

The line is established for no more than one year and may be altered or cancelled at the bank‟s option without prior notice to the customer. This language is to highlight that the line is not a commitment and that it continues as long as the relationship is satisfactory, rather than as a matter of legal obligation.


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The letter should specify the form(s) of borrowing permitted including tenors.

Markup rate. The letter must clearly establish the rate to be charged on all borrowings.

Flexible balance understanding. The letter should include language that avoids iron-clad balance arrangements but instead establishes a flexible balance arrangement that can be adjusted as conditions change.

Line Management should establish and use standard wording for advising lines of credit. Standard wording should be approved by bank attorneys in each legal jurisdiction to ensure legal sufficiency and to preclude their being construed as commitments.

3.1.5 Short – Term Committed Facilities

When a short-term credit facility is committed, the CA must describe the facility clearly and the nature of the commitment. The commitment letter must be signed by the Vice President who is a credit officer of the lending unit or another officer who is empowered specifically for this purpose.

Covenants must be included in the letter to permit cancellation.

1. In case of adverse developments; and 2. Either: a) on or after a certain date; or b) upon specific notice.

3.1.6 Commitments (Other than for Short Term Credit)

Commitments, other than for short-term credit facilities, may also be advised/confirmed to customers via letter. There are many different types of commitments, not all of which can be described herein. The commitment letter form should be tailored to reflect the particular commitment and terms of the applicable credit agreement.

3.2 Term Credit Facilities

Lending units are authorized to approve credit facilities exceeding one year, within authorized credit approval limits, under the following conditions:


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3.2.1 Approval Authority

Term transactions must be referred to the next higher level for approval.

3.2.2 Additional Approval Authority

Term transactions regardless of amount not fulfilling all of the following conditions must also be referred to the Credit Risk Manager for consent.

Forecasts of annual balance sheets, income statements, and cash generation statements, preferably covering the term of the loan. Such projection may be waived in special cases by the Credit Risk Manager if considered unnecessary due to underlying strengths of the credit.

Covenants, in the loan agreement requiring the borrower to submit annual balance sheets and income statements (preferably independently audited) and, whenever, possible, interim financial statements during the term of the loan.

Material adverse change

KASB Bank‟s policy requires a Material Adverse Change (MAC) clause be included in either the conditions precedent, or in the representations and warranties section of loan agreements. Through MAC language, the borrower confirms that there has been no MAC upon the occasion of any borrowings or reborrowing.

It is also preferable to include MAC as an event of default, giving the lender the ability to take action if deterioration occurs after funds have been advanced. Lending officers may add MAC as an event of default, but there is no policy requirement to do so if, other “triggers” are included giving the bank the right to accelerate the loan prior to maturity.

Loan Agreement

Formal loan agreements are necessary for term loans and revolving credits. Loan agreements must have covenants, which include either (a) “triggers” to accelerate the loan prior to maturity if the borrower‟s financial condition begins to deteriorate; or (b) a material adverse change clause as an event of default.

It is not intended or desired that lending officers assume independent responsibility for preparation or review of these documents. Loan


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agreements must be referred to legal counsel to ensure that the agreements are in acceptable legal form and that the bank‟s interest are fully protected.

Legal Counsel Review And Approval of Loan Documents

Review and approval by legal counsel of loan and other credit agreements and related documentation is required.

3.2.3 Contingent Commitments (Guarantees Commercial

Letters Credit, Etc.)

For all contingent commitments, besides the applicable requirements outlined in 3.2.2, the following additional conditions are required. Exceptions require approval.

The commitment must contain a specific maximum monetary liability of the bank.

The commitment must contain a specific legally defensible expiry date. If an expiry date is not obtainable, the underlying agreement with the account party will require the account party unconditionally to furnish the bank with cash collateral after a specific date or upon demand by the bank.

The commitment must represent a bank obligation which is separate and independent from any contract between the account party and the beneficiary.

The commitment must require the bank to make payment either only upon simple demand or against clearly specified documents or certificates, without any subjective or value judgment on the part of the bank.

The underlying agreement with the account party must require the account party to provide the bank with the following:

Cash collateral under at least one of the following conditions:

i. Upon demand by the bank; or

ii. Upon the account party‟s default of specified financial covenants; or

iii. In the event of a material adverse change in the account party‟s conditions


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Annual financial statements including audited balance sheets and income statements and, whenever possible, interim statements.


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3.3 Counterparty Exposure

Since trading can involve a number of different items (foreign exchange, securities, commodities), the term “item” is used below to mean anything traded. Moreover, “cash” means cash or other good or collected funds.

3.3.1 Definitions

Unlike funded facilities, foreign exchange transactions do not create risk assets. These transactions do not provide financing, but instead change the nature of the obligation or assets that is already in existence. Such transactions are subject to two types of counterparty risk: Clean Risk at Settlement (Liquidation) and Market (Rate/price Fluctuation) Risk:

Clean Risk at Settlement (Liquidation)

It is frequently impractical to verify the receipt of items or cash from the counterparty prior to paying out or delivering the item exchanged. Any such payment/delivery create a Clean Risk at Settlement (Liquidation).

The maximum loss is the total value of the cash or items to be received from the counterparty on any one-day or series of days depending on when receipt can be verified.

Market (Rate/Price Fluctuation Risk)

When the Bank enters into a contract with a counterparty, the Bank relies on the counterparty to deliver a certain amount of a specified currency or item on a given date. If the counterparty fails to fulfill it‟s side of the contract at maturity (defaults), and the value of the currency or item it has agreed to deliver has increased in the interim, the Bank will suffer a loss equivalent to the increase in value.

A predetermined percentage (Trading Risk Percentage) of the nominal amount of a transaction is used to determine the amount to be used for credit approval purposes. Minimum percentages for foreign exchange and certain other items are established by Credit Risk Manager and are advised from time to time.

When no minimum percentage is established, or the minimum is considered to be inadequate, an appropriate percentage should be recommended by the line management and approved in accordance with


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the “Rules”. If the “Rules” do not prescribe an approval procedure for the item, the recommendation should be submitted to the Credit Risk Manager for approval

3.3.2 Credit Approval and Reporting Requirements

Credit Approval

The responsibility for assessment and initiation of counterparty risk rests with the Relationship Manager, who should be a credit officer. The approval authority should not rest with Treasury, Securities, or other trading department personnel, regardless of amount.

This restriction, however, does not apply to approvals of availments under approved counterparty lines.

Total counterparty risk must be added to the total of all other credit risks to be approved to determine the level of credit authority required. These totals should be included in the Counterparty Risk box on the CA.

Policy/Legal Limit Considerations

Foreign exchange transactions and the various rate products are not included in the calculation for policy limit purposes for non-bank customers. These transactions are also not included in the legal lending limit.

Determination of Amount of Counterparty Risk

The total Counterparty Risk for credit approval purposes is arrived as follows:

a) The aggregate contract amount is multiplied by the appropriate Trading Risk percentage. The result is added to the Clean Risk at liquidation. This sum equals the total counterparty risk to be approved. However, the maximum approvable amount is never to exceed 100% of the aggregate amount

b) FX Transactions (Spot and Forward) For Banks

For the purpose of calculating outstandings under approved FX lines for all banks rated A or better exchange buy contracts may be offset (or netted) against exchange sell contracts with the same counterparty, if in the same currency, with the same maturity date, if booked at the same location and if, in the opinion of local counsel, in form


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satisfactory to country senior management, local law recognizes the validity of such netting on a blanket basis. However, the tracking of the associated clean risk at liquidation will continue to apply.

c) Spot FX Transactions for AAA Banks

For the purpose of calculating outstanding under approved FX lines with any bank rated A or better, all aggregate FX contracts maturing within seven calendar days, including the clean risk at liquidation, may be eliminated from the total of contracts outstanding.

1. Use of Approved FX Lines

Forward contracts executed under approved lines may be closed for maturities up to one year for both banks and corporate clients and be considered “short term”.

3.3.3 Description of Facilities

Separate lines should be established for each type of counterparty risk (foreign exchange, securities, etc.).

If a Clean Risk at Liquidation is to be permitted, lines for counterparty risks should be expressed in the following manner: “$ ------------- (or equivalent) for aggregate (foreign exchange, etc) contracts outstanding at any one time, with a sub-limit of $---------(or equivalent) for related clean risk”

In the line description above, the sub-limit will be used to express the maximum clean risk outstanding at any one time.

In the event it is unnecessary or undesirable to permit a Clean Risk at Liquidation, the line should be worded as follows:

“$------------- (or equivalent) for aggregate ( foreign exchange, gold, securities, etc.) contracts outstanding at any one time, with no clean risk permitted,

The risk amount which is calculated for approval and reporting purposes will also be indicated for all such lines.


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3.4 Issuer Risk

3.4.1 Definition

The value of certain items, such as bonds, TFC‟s and other instruments representing debt obligations of a third party, is dependant on the credit standing of the third party (the issuer). Should the issuer suffer business or financial reverses, the value of the item can diminish to as little as nil. Whenever the Bank purchases such an item for its own account, it occurs a risk in the name of the issuer.

Trading units may have occasion to carry positions in such items in connection with active participation in markets and for investment, hedging and other purposes.

Issuer Risk exists any time a long (overbought) positions in such items in connection with active participation in markets and for investments, hedging and other purposes.

When an item selected for trading or investment, an approved credit line covering Issuer Risk must be established before any purchases are made for the account of the Bank.

Note: Pakistan Government local currency securities are assumed to have no Issuer Risk

3.4.2 Credit Approval and Reporting Requirements

Issuer Risk must be added to the total of all other credit risks approved for the issuer to determine the level of credit authority required. In addition, Issuer Risk Lines are to be included for Policy Limit purposes.

In as much as it is advisable to segregate, to the degree feasible, the activities of trading departments form the credit function, the credit officer providing the highest approval authority for Issuer Risk must not be directly associated with the Treasury, Securities, or other trading department, regardless of the amount.

This restriction does not apply to approvals of availments under approved counterparty and issuer lines


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3.5 Standard Credit Lines Description

In order to maintain consistency in our credit presentations/approval process, description of credit lines are being standardized. All lending units are to use these descriptions as appropriate. These descriptions will be used in their entirety without carrying out any modifications unless it becomes absolutely necessary.

1. For Current Financing

Mark-up @ Base Rate (3 months KIBOR) + premium Quarterly/semiannual clean ups required

2. For Term Financing

Mark-up @ Base Rate (6 month KIBOR) + premium

Purpose :

Tenor : xx years door to door including grace period or none

Grace Period : xx months / years

Repayment : In xx equal months / quarterly / semi-annual / annual installments of Rs. xx M each. First installment repayment to commence (day/month/year)

Final Maturity: Month/Day/Year e.g. June 30, 2010

3. For Term Financing: (Syndicated)

On xx% shares in a syndicate for Rs.xxx M led by us/xx Bank. Other participating banks in the syndicate are:

ABC Bank Ltd. : xx% XYX Bank Ltd. : xx% CED Bank Ltd. : xx% Total : 100%

Mark-up @ Base Rate (6 months KIBOR) + premium Purpose : Tenor : xx years door to door including grace period or none Grace Period : xx months/years


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Repayment : In xx equal months/quarterly/semi-annual/annual installments of Rs.xx M each. First installment repayment to commence (day/month/year)

Final Maturity : Monthly/Day/Year e.g. June 30, 2010

4. For Term Financing

Remaining outstandings under a term loan approved in (month/year) Mark-up @ Base Rate (6 months KIBOR) + premium Purpose : Tenor : xx years door to door including grace period

or none Grace Period : xx months / years

Repayment: : In xx equal months / quarterly / semi-annual / annual installments of Rs. xx M each. Next installment due on (Day / Moth / Year-e.g. July 31, 2000)

Final Maturity : Month/Day/Year e.g. September 30, 2010

5. For Short Term

Mark-up @ Base Rate (3/6 months KIBOR) + premium Maximum Tenor : (Not to exceed 12 months) Grace Period : xx months/years Repayment : In xx equal months/quarterly/semi-

annual/annual installments of Rs.xx M each. Next installment repayment to commence (day/month/year)

6. For Pre-Shipment Finance-Part I (Funded through own sources) Mark-up @ Base Rate (3 months KIBOR) + premium Maximum Tenor: : xxx days

7. For Pre-Shipment Finance-Part I (Funded through SBP Refinance Scheme) Mark-up @ x % p.a. over SBP rate of Refinance


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(All-in @xx % p.a.) Maximum Tenor: : xxx days

8. For Pre-Shipment Finance-Part II (Funded through SBP Refinance Scheme) Mark-up @ x % p.a. over SBP rate of Refinance

(All-in @xx % p.a.) Maximum Tenor: : xxx days

9. For Discounting / Purchase of Export Bills ( Funded through sources)

Mark-up @ Base Rate (3 months KIBOR) + premium

Maximum Tenor: xxx days 10. For Discounting / Purchase of Export Bills

(Funded through SBP refinance Scheme) Mark-up @ x %p.a. over SBP rate of Refinance (All-in @xx % p.a) Maximum Tenor : xx days from B/L Roll-overs Not Allowed

11. For Opening Sight Document Letters of Credit Purpose : For import of…

Cash Margin : xx % or as per SBP requirements which ever is higher

Commission : APSC 12. For Opening Usance

Documentary Letter of Credit Purpose : For import of… Usance Tenor : xxx days Cash Margin : xx % or nil Commission : APSC


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13. For Financing Under Trust Receipts

Mark-up @ Base Rate (3/6 months KIBOR) + premium Purpose : Finance imports undertaking through us

under the SLC line. Tenor : xxx days

14. For Financing Against Pledge of Imported Merchandize

Mark-up @ Base Rate (3/6 months KIBOR) + premium Tenor :

15. For Issuance of Financial Guarantees

Cash Margin : xx % Commission : APSC Maximum Tenor : x year(s)

16. For Issuance of Bid / Performance / Advance Money / Retention Money Guarantees

Cash Margin : x% for Bid Bonds xx% for Performance Bonds xx% for Advance/Retention Money

Guarantees

Maximum Tenor : xx years for Performance Bonds xx years for Advance/Retention Money

Guarantee Commission :

These standard descriptions should be used on page 2 of the Credit Approval Form.


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4 Initiation of Credit Facilities

.

Section

4


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4.1 Customer Solicitation

The definition of a target market is an important part of the business strategy plan. This strategy process should result in the identification of an acceptable and desirable profile of customers and the development of Risk Acceptance Criteria (RAC) which form the basis for solicitation or acceptance of individual lending risk. Business plans and lending criteria should be reviewed at least annually in light of the state of the economy, industry or market conditions and trends, the bank‟s lending capacity and the extent of current exposure. Lending officers are expected to follow departmental guidelines in establishing plans for individual lending relationships and for soliciting or accepting new relationships.

No set of criteria or business plan is intended to be all-inclusive or to relieve lending officers and Senior Credit Officers from the responsibility and opportunity of exercising independent judgment of individual lending decisions. Credit policy recognizes that circumstances frequently justify the acceptance of risks that deviate from identified norms and established lending criteria. However, any significant deviation from established target markets and /or RAC must be approved by the Group Head with written advice to the Risk Manager and must be fully justified in the supporting memoranda.

4.2 Negotiation

Term extensions of credit frequently involve extensive negotiations with the borrower, including offers and counter offers, complex legal documentation, other lenders as members of syndicates, and third parties to act as custodians, agents, etc. Relationship Managers should be careful to consult attorneys, senior credit officers, and other specialists at an early stage as appropriate, to ensure smooth and productive negotiations.


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4.3 Presentation

The evaluation of all credit proposals will be based on a written presentation/analysis. Section 5 covers the scope of such a presentation.

4.4 Commitment

No commitment, implied or actual, may be made until the transaction has been fully approved in accordance with the “Rules”.

The Bank‟s credit policy requires that an officer of the rank of Vice President or more senior officers sign letters of commitment.

To ensure that “Letters of Intent,” “Proposal Letters,” etc., do not constitute unintended commitments on the part of the Bank, such letters must also be approved by an officer of the rank of Vice President or more senior officer, prior to dispatch. Careful wording is required to avoid legally or morally binding commitments.


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4.5 Documentation

The prime responsibility for obtaining complete documentation related to the extension of credit lies with the Relationship Manager.

4.5.1 Essential Steps in Documenting Credit Transactions

Selections of appropriate standard forms or preparation by legal counsel of specialized documents

Review of documentation for

a. Appropriateness to the transaction.

b. Adequacy of coverage of the risk

c. Completeness and enforceability

Proper execution and registration

Safekeeping

Periodic review

4.5.2 Basic Elements of Documentation

Some basic requirements that credit officers should have in mind are:

Valid debt instrument under appropriate governing law.

Evidence of the authority of signers to execute documentation.

Guarantees, if required, executed on standard forms. If other language is used, approval by counsel must be obtained. Any required registration must also be effected.

Securities must be hypothecated in negotiable form, approved by counsel.

Merchandise collateral requires.

a. A security agreement enforceable where the collateral is located; and


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b. Adequate current insurance coverage.

Collateral may, under law, require a security agreement advice to debtors and/or legal registration.

Real estate, plant, and equipment collateral require properly executed liens or mortgages that have been duly registered and are enforceable where the asset is located.

Pledge, hypothecation mortgage and other such documents should be drawn in accordance with the laws of the province in which the collateral is located.

Insurance companies must be notified when insurance policies are assigned to the benefit of the Bank.

The foregoing only highlights some important considerations in obtaining credit documentation. The list is not exhaustive; credit officers must assure themselves that complete and legally enforceable documentation for each credit transaction is obtained and properly held in safekeeping.

4.5.3 Agreements for Public Sector Borrowers

When a credit to a government entity is under consideration, legal counsel must be consulted to determine the status and legal position of the borrower.

Loans and guarantees, etc. to governments and government entities subject to government privileges must be documented with policies established with the advice of counsel. Guarantees of governments and privileged government entities also require special documentation.

The modification or elimination of any clauses, covenants, etc. in the standard documentation approved by the counsel must be approved by a Senior Credit Officer.


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4.6 Disbursement

4.6.1 Documentation

No advance or takedown is permitted until all documentation is completed and received, registered if necessary and all conditions precedent in the loan agreement have been met. Any temporary exceptions (upto 60 days) except collateral/support documentation (see section 4.6.2 below) must be approved at least by Business Level Head who is credit officer. Any exception over 60 days requires approval at the next higher level.

Controls must be in place to follow up and report periodically to management concerning any approved but unresolved documentation exceptions.

4.6.2 Collateral/Support

No advance or takedown is permitted until all necessary collateral/support is held in the quantities and manner stated in the credit transaction approval (usually, all collateral/support will be held under the Bank‟s control or for the Bank‟s benefit by approved independent third parties).

Any exception requires full credit approval in accordance with the “Rules”.

4.6.3 Approval

Each disbursement /availment under an approved credit facility (other than drawings under approved lines for current Financing requires approval of the availment in accordance with the “Rules.”

Implicit in these approvals is the approving officer‟s confirmation/verification that documentation is in order and that collateral/support is held in accordance with the credit approval, or that any exceptions are properly approved.

4.6.4 Deferral of Credit/Legal Documents

Regional business Heads (Corporate, Middle Market & SME) are authorized to approve deferrals of the receipt of credit documentation. Such deferrals may be approved for a maximum period of thirty (30) days, and the reasons for such deferrals should be recorded. In cases such deferrals are required beyond thirty (30 days), it must be authorized by the relevant business segment Head, justifying reasons for such extended deferrals. Please note that credit documents without


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which the Bank may not be able to establish its claim in a court of law, cannot be deferred or waived

CAD is responsible for monitoring all documentation deferrals. A detailed exception report must be produced by CAD on a monthly basis and sent to the Credit Risk Manager.

Needless to mention that requests for deferrals should only be initiated in cases of extreme needs, i.e. all reasonable attempts having been made to complete the documentation prior to disbursements and foiled because of unusual circumstances.

4.6.5 Offering Tickets

Transactions resulting in credit extension for which existing credit lines either do not exist, or have expired or if fully consummated, may result in exceeding the approved credit lines. Such transactions require special approval treatment and hence should be managed on “one – Off” or “Special Transaction” basis.

Operating Departments which encountered with “One-offs” or “Special Transactions”, as referred to above, are required to prepare an “Offering Ticket” (or in the case of Cash Finance-Referral item card) as per specimen attached, and promptly forward it to the Credit Administration Department.

Credit Administration Department on receipt of such an “Offering Ticket” is to coordinate with the relevant Relationship Manager to procure the required level of approvals, ensure to obtain necessary documentation/security/collateral to protect bank‟s interests, and return the same to the originating Operating Department with the remarks “O.K. to consummate this transaction” with full signatures and name of the designated Officer of the Credit Department.

The originating Operating Department is required to consummate the transaction after verifying/authenticating Credit Department‟s authority.

“Special Transactions” originated at the relationship Manager‟s level will receive the same treatment and the relevant Operating Department will consummate the transaction after verifying Credit Department‟s authority.


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5 Preparation Of Credit Packages

Section

5


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5.1 Credit Package

All regular facilities whether long or short term in nature must be reviewed annually to evaluate as to how a borrower has performed during its most recent fiscal period. Such annual or initials reviews (in case of new customer coming on board) will be conducted based on written presentations/analysis. The presentation thus conducted serves not only to communicate to approving officers the information needed for arriving at a credit decision, but also records the approval process. While no essential analytical elements should be omitted in such presentations, brevity is desirable. A typical credit presentation package will consist of the following pieces of information, on prescribed forms

1. Credit Approval (CA) See Annexure1 2. Obligor Risk Rating Form See Annexure 2 3. Basic Information Report (BIR) See Annexure 3 4. Management Assessment Form See Annexure 4 5. Financial Spreads See Annexure 5 6. Financial Projections (for term financing) Use same format as in

Annexure 5 7. Credit Memorandum See Annexure 6 8. Target Market /RAC Compliance

Checklist 9. Prudential Regulation Compliance checklist See Annexure 7 10. CIB Checkings 11. Bank/Market Checkings 12. Registrar Checkings / Search Reports 13. Covenants Check List (for term financing) 14. Account Profitability /Account Plan 15. Borrowers Basic Fact Sheet please see annexure 8 Following substance is expected from Relationship Managers as their input on these credit presentation format:

5.1.1 Credit Approval (CA)

The two-letter “CA” is an abbreviation of the word Credit Approval. The CA form is a three-page document with a reverse side, confined only to its first page. This form once completed with diligence and accuracy summarizes the aggregate credit risk being approved, description of individual credit lines, and details of security/support obtained/to be obtained against each line. Reverse side of page 1


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(face of CA form) is meant to be completed when approval of the credit is required at the Credit Committee level. Guidelines (key) to prepare this important approval document with its specimen is provided in Annexure 1.

5.2 Obligor Risk Rating Form (ORR)

“Risk Rating” is a unique system designed to measure the quality of individual credits. Risk ratings enable us to weigh and compare all KASB Bank‟s credits regardless of type, nature, or location of the borrower. Risk ratings in our model are assigned on an obligor level on a scale of 1 to 10, 1 being the highest quality risk and 10 being the lowest, usually adversely classified as doubtful of recovery. Risk ratings are determinant to:

Price each obligor: Higher the risk rating of an obligor will be, steeper the risk we will be underwriting. Therefore, logic will dictate to price our credit facilities higher than an obligor whose rating is relatively lower or better.

Calculate potential loss a credit carries based on its Corporate Benchmark Loss Norm. (CBLM) Assigning a risk rating to a credit is not a prediction that there will be an actual loss on a particular obligor, it is rather a statement that a particular obligor displays characteristics similar to other obligors which over an average period of time, produced a present value loss equal to certain Loss Norm or within a range of Loss Norm

Obligor risk ratings may be assigned either systematically through the use of a debt Rating Module (DRM) or judgmentally. As DRMs‟ are complex analyses of both qualitative and quantitative factors (e.g. reliability of financial information, relevant industry, competitive conditions, economic environment and quality of obligor‟s management), development of DRMs‟ for obligors of our young institution may take a while. We would therefore, follow a rather simple DRM based on an arithmetically driven formula. This simple DRM also provides cushion for a rating on judgmental basis and also takes into account the Relationship Manager‟s gut feel about a credit. Judgmental ratings are allowed to deviate from the arithmetic rating, only one notch better or worse.

The Relationship Manager, Relationship Senior and the Credit Risk Management, where applicable, must approve assignment of all risk ratings.

Risk ratings must be assigned and approved when credit is initially extended and must be updated at least annually if otherwise warranted earlier due to any significant development. Risk ratings should also be reviewed immediately and accordingly adjusted, if necessary, whenever there is a material adverse event such


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as adverse classification of the credit facilities. Comprehensive methodology to compute the ORR and definition of various levels are as follows.

Following general guidelines should be used to arrive at a realistic ORR level.

i. Target Market: This for the Branch/Area to formulate for itself, in direct consultation with the Group/Business Head, and then consider scores accordingly.

ii. Position in Industry: In order to assess borrower‟s position, in the relevant industry it operates in, it is important to have turnover data on a Pakistan-wide basis of that particular industry/trade; then compare the borrower‟s turnover figures with that, establish a percentage share, and see where the borrower stands.

iii. Management Quality: The inherent strengths and weaknesses of the management/owner(s) are important. Systems, production processes, manufacturing/operational facilities etc. are important. Systems, production processes, manufacturing/operational facilities etc. are aspects that merit close scrutiny. One may also want to consider whether any second line management/second generation management is in place/is being groomed to take over the business in case of a contingency. The “strong” label must not be used indiscriminately. There are only a few local companies that have strong managements, such as Packages, Lakson Group, Engro, Rafhan Maize, etc. Not all multi nationals have strong managements either. Those that do have strong managements include (to name a few) IBM, Unilever, Abbott Laboratories, Wyeth etc.

As it is, the essence of this section is purely subjective, and hence requires an impartial, honest and clear analysis of the borrower‟s Management.

iv. Ownership Structure: Needs no elaboration.

v. Seasoning: Is reflective of the number of years the borrower has been maintaining an account with us.

vi. Financial RACs Compliance as per audited statements: As the title suggests, audited financials are a pre requisite. In their absence, one can safely assume that a zero score would be awarded here in normal circumstances. But keeping in mind the peculiar market characteristic that exist in most areas, this can be treated as one deviation. Other general deviations could possibly be a current ratio of less than 1:1, high leverage (should not be <3.0:1), a low net profit/sales percentage (should be>3%),


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declining sales, losses, eroding net worth, constant deterioration in turnover ratios, etc. Scores will have to be awarded accordingly. But as a general rule, unaudited financials will never be graded “Fully Complies”.

vii. Security/Support: Is self-explanatory. It may be noted that hypothecation of stocks for a partnership concern will attract a zero score, because hypothecation agreement of a partnership cannot be registered. “LCs from Foreign/Overseas Banks” denotes Letters of Guarantees received from such institutions, conventionally also known as Standby Letters of Credit.

viii. Tenor: Self explanatory. One must consider whether the line(s) or any portions thereof are of term nature or not.

ix. Cross Border: LC lines (imports) are to be considered as Fcy based lines. Hence, to the percentage extent of the total exposure, LC lines will be considered as cross border facilities, and hence deducted from 100% and the remainder, mentioned here.

The concept of “Responsible Senior” is also re-emphasized. In the line management, the last person who signs off on a CA (invariably the Chairman of the first level credit committee), is the “Responsible Senior”, and it is his/her responsibility to verify the soundness of the ORR being assigned and ensure that generosity has not been used in it‟s tabulation; and then to sign off on the risk rating sheet. It may therefore, be ensured that all ORRs are countersigned by the Responsible Senior without exception.

Definitions:

ORR 1 Substantially Risk Free

This category defines the largest and strongest corporations. These companies are leaders in their respective industries, and participate in growing market. Have a strong capital position. Have experience continuous sales and earning growth. Have a broad and talented management team equipped with technical and market know-how. Borrowers in this category are well diversified and have substantial unused debt capacity. Their cash flows are significantly greater than any potential debt servicing requirements.

ORR 2 Minimal Risk

Borrowers rated 2 demonstrate financial and operating characteristics that are high by all standards. The elements of risk for these borrowers are slightly more than those associated with ORR 1.


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ORR 3 Limited Risk

These borrowers are sound credits having limited vulnerability to changing economic or industry conditions. They are significant and successful competitors in their markets, have well seasoned management, maintain sound balance sheets, have not experienced deteriorating sales or earnings and have adequate margins of excess cash to service their debt.

ORR 4 Reasonable Risk

Borrowers with sound operating and financial histories in which some elements of uncertainty may exist should be rated 4. Such factors as liquidity, breath of markets and products, depth of management, capital adequacy, concentration of assets, profit margins, stability of cash flow and cyclical trend should be slightly above satisfactory level.

ORR 5 Acceptable Risk

Rating 5 describes borrowers whose financial condition is acceptable without undue reliance on borrowed funds. Cash flow appears to be adequate to cover the debt service. Sales and earning trends may have been occasionally negative. Depth continuity or financial expertise of management is an acceptable level. The enterprise of key components of it may be relatively young with limited historical operating performance upon which to base projections with any confidence.

ORR 6 Moderate risk

This category is described as “pink zone” and covers situations in which there have been indications of negative trend in the business, industry or collateral position. There may have been a failure to meet previous projections or expectations, failure to obtain capital or financing, or failure to satisfy covenants or other expectations, although actual default has not occurred, and is not expected. Circumstances warrant more than normal monitoring of these situations but these do not reflect the risk described in the criticized ratings defined below.

ORR 7 Moderate Risk

Exposure to borrowers in this category are protected but are potentially weak. Borrowers demonstrate decline in business trends which may include declining profitability, tightening cash flows, increasing leverage, industry “specific” problems eventually affecting obligor‟s performance. The credit risk may be relatively lower, yet constitute an unwarranted risk in the light of the circumstances surrounding a specific commitment or loan. Borrowers in this category are labeled as watch list borrowers and warrant constant watch.


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ORR 8 Substandard

A substandard facility is inadequately protected by the current net worth and paying capacity of the obligor is impaired. Repayment of debt may be protracted. Facilities so classified must have a well defined weakness or weaknesses that may jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected. Mark up or principal is overdue by 90 days or more from the due date.

ORR 9 Doubtful

Facilities in this category have all the weaknesses inherent in a classified substandard situation with the added characteristics that the weaknesses make collections or liquidations in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is high, although certain important and reasonably specific pending factors (merger, acquisition) which may work to the advantage and strengthening of the facility. It‟s classification as an estimated loss is deferred until its more exact status may be determined. One of the significant features of this category is that, the mark up or principal is overdue by 180 days or more from the due date.

ORR 10 Loss

Facilities in this category are uncollectible. The probability of default is the highest. Mark up or principal is overdue by one year or more from the due date. Build up of claims and litigation will limit recovery amount. The facility would normally be transferred to Special Assets Management, for recovery of principal and/or mark up.

Annexure 2 provides specimen and working methodology of the Risk Rating module


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5.3 Basic Information Report (BIR)

Our ability to effectively manage a credit relationship entirely depends upon our knowledge of the customer and the business(es) it runs. Customer knowledge cannot be acquired overnight. Knowledge acquisition is a long drawn process and is a derivative of free flow of information.

In the credit world, there are three types of customers:

Those who voluntarily offer all information about themselves

Those who offer information on request

Those who donot divulge information We do not encourage dealing with the third type of customers.

It remains, however, the responsibility of the Relationship Manager to collect as much information about our customers as it is possible, at the time of initiation of a relationship, and keep it current at all times thereafter.

The enclosed BIR format (Annexure 3) designed to fetch the basic information about a customer is to be completed by the relevant Relationship Manager and shall form an integral part of the credit package. The source of information to be provided on this format will be of course, our customer but the transcription will be by the relevant Relationship Manager with his/her evaluating comments.

Following guidelines must be followed while preparing this form:

5.3.1 Ownership Structure:

State in this section the financial character of the company i.e. whether it is a sole proprietorship (and of whom), a general partnership, a limited partnership, a private limited company or a public limited company (unquoted or quoted). Give amount of paid-in capital and retained earnings. A typical description of this section will be as follows:

“A public limited company. Paid in capital Rs.100,000,000 retained earnings Rs.15,000,000. The stock is held as follows:

Sponsors : 30% Financial Institutions : 15% General public : 55%”


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5.3.2 Directors and Management

List names of Directors on the Board, Vice Chairman, Chairman and (if applicable), Company‟s secretary. Under the Management column, list names of top tier management team. This may include Chief Executive/Managing Director, Director Finance, Treasurer, Marketing Manager, Production Manager, Procurement Manager etc. Show ages of each member of the board of directors and management personnel in parenthesis. This is considered imperative to gauge how young, dynamic and seasoned the management of the company is.

Underneath the information provided under the Board of Directors and Management sections, the Relationship Manager is expected to sum up his/her assessment of management‟s caliber, reputation, technical know-how and market knowledge. This assessment should stay in coherence with the “summary of Rating” calculated in the Management Assessment Form, (to be discussed later) and the Obligor Risk Rating form.

Asteric mark the names of the directors and management personnel known the Bank‟s Relationship Manager.

5.3.3 History:

Trace in this section company‟s brief operating history from the date of its inception, in most coincised form. Relationship Manager may tell the reader transformation of company‟s financial character from the date of its inception to date. Additions to or deletions from its core product line(s), capacity expansion, modernization and balancing of the manufacturing facilities, and its position versus its competitors are the other topics which may be discussed here.

5.3.4 Banking & Other Financing Arrangements

This section is meant to portray a clear picture of customer‟s existing arrangements to finance its both operating and non-operating funds from sources other than its capital and income from operations (banks, other financial institutions). Relationship Managers are expected to provide in this section a list of financiers/banks that extend both short and long term funded and non-funded credit facilities to the company. This list should essentially provide bank wise security/support offered by the company to the financiers/banks. This information enables us to assess our financing and security position vis-a-vis other financiers.


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5.3.5 Facilities

Describe in concise form in this section the company‟s manufacturing/trading facilities. If the company is a manufacturing concern, it is expected of the Relationship Manager to provide information in this regard to it‟s:

Location

Area size on which the manufacturing plant & equipment is installed. If the land is owned by the company or leased. If leased, what is the annual lease rental in Rupee terms, useful tenor of the lease.

Origin of plant and machinery, its make and model.

Installed capacity and current operating efficiency of the plant

Condition of the plant & machinery

If the company is a trading house, whether it is stockist / wholesaler or a retailer. Information along following lines should be developed.

Location of main showroom, retail outlets or warehouse(s)

Whether showroom, retail outlets and warehouses are owned or leased. If leased what is the annual lease rental?

Additionally information needed is:

Number of permanent/temporary employees

Labour unions exist or not. If they do, are these unions professional in playing collective bargaining agents role or are trouble makers?

Is management / union relationship cordial or sour. Any strike, lockouts occurred in the past or foreseen in the future.

5.3.6 Products And Products Mix

This section is expected to provide information on company‟s product line i.e. what does the company manufacture, import/export or trade in.

If the company produces more than one product, list the products with the percentage share of each product in the total production.


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If the company both sells domestically as well as overseas, give percentage of local sales as well as exports. This piece of information helps to assess company‟s trade flows and hence provide us ammunition to claim ancillary business from the company to enhance our revenues.

List names of company‟s suppliers of raw material or finished products, country of their origin and the selling terms offered to the company (collection basis, sight LC, Usance LC). This information helps understanding magnitude of company‟s foreign trade and payables concentration/mix.

If the company has a sole supplier in a war torn or a politically unstable country, regular supplies can be delayed or interrupted making company vulnerable to closure.

5.3.7 Selling And Distribution Terms

What are company‟s selling terms; strictly against cash or against sight/usance local/export LCs. Give percentages against each term vis-à-vis sales.

What credit terms are offered by the company to its customers (30 days, 60 days, 90 days, 120 days). Check this number against Days Receivables in the financial summary form.

What criteria does the company follow to extend credit to its customers?

What is company‟s collection experience? Are sales made on credit and receivables collected within the framework of credit terms?

5.3.8 Affiliated Companies And Related Business

If our customer is a complexed group or a conglomerate, it must have subsidiaries (more than 50% owned) or affiliated (less than 50% owned) companies. List each subsidiary or affiliated company and mark if it has an account relationship with one of our branches or it does not have any relationship. Asterisk marks each situation in the pertinent column. It may help us solicit business in the future from those companies of the group/ conglomerate, which do not have any relationship with us currently.

For the sake of precision, information provided in BIR should not be repeated elsewhere in the credit package. For repetition does not add value to the credit presentation.


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5.4 Management Assessment Form

Quality of management is paramount to the success or failure of a business. Study of global corporate history suggests that 60% business failures were caused by poor quality management practices. Assessment of management quality therefore, becomes more relevant in evaluating a credit. We, at KASB Bank as financiers, investors or underwriters to a debtor company should exercise extreme diligence in analyzing its management profile with intense focus at each tier of responsibility. A self explanatory, and simple management assessment form is designed (refer to Annexure 4) to take account of all important aspects of a debtor company‟s management team. This form forms an integral part of our credit package.

5.5 Financial Spreads

Financial spread forms are designed internally to meet the Bank‟s specific financial analysis requirements. These forms, four pages in total, are fully automated on “excel” system (see Annexure 5). Relationship managers / financial analysts are required to punch in Balance Sheet numbers on page 2, and Income Statements numbers on page 3. Computerized system does the remaining job for us. It automatically generates summary of the financial statements on page 1 and provides key financial indicators, growth historic patterns and ratio analysis. Operating and Non-operating Cash Generation statements is likewise system generated on page 4.

Intervention to the computerized spread form by Relationship Manager/financial analyst may be needed, on times to round off the financial numbers on page 2 to balance the Balance Sheet numbers, and on page 3 to reconcile the Income Statement and the Networth Reconciliation Statement. A system “check” pointer is placed at the end of page 3,4 and 5. System generated “0” section will indicate that financial numbers inserted by the Relationship Manager / analyst are accurate and balanced and therefore, no further doctoring is required. However, if a number appears against “check” section on either of pages 3 or 4 or on both, the Relationship Manager/Financial analyst will be required to go back to the balance sheet once more, locate the difference and rerun to the system.

KASB‟s institutional requirement is to obtain and analyze at least three years historic audited financial statements of a borrower. Attempt should however, made to obtain the most recent financial statements. Since we always lend into the


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future of a business, our Relationship Managers should make concerted efforts to obtain financial projections, for at least the current or the next fiscal year.

5.5.1 Financial Projections

Financial Projections are a useful tool used by the businesses while planning and forecasting their performance in years to come. Such financial projections are also imperative for lenders like us, particularly in financing situations of term nature. Reviewing and analyzing financial projections provided by our customers have a different usage for us. It helps us to understand a term borrower‟s expected assets and liabilities position and cash generating ability to repay/service its debt owed to us. Financial projections prepared by our customers are based on a set of assumptions. For us, critical review of such assumptions (based on our knowledge of the economic environment and the expected behaviour of a specific industry) is more important and relevant. It is not necessary for us to agree with the assumptions used by our customer in preparing its financial projections. We must challenge these assumptions if found unrealistic and ask the customer to revise the projections. For we have yet to see a set of financial projections which do not portray optimistic future financial picture of a borrower.

5.6 Credit Memorandum

Credit memorandum is the most important constituent of a credit package. Officers responsible for approving a credit read this document thoroughly and base their credit decision on the contents presented in this document. Credit memorandum should be therefore, prepared with precision and accuracy of information. Due weightage should be given to the facts encompassing the credit. Adjectival or verbalist nature of a credit memorandum does not add any value to the strength of a credit and hence, use of adjectives, in the text of the memorandum should be avoided. Use of simple English with structured flow of information formatted in small sentences brings clarity of thought and substance.

Credit memorandum should avoid repeating the information provided elsewhere in the credit package (BIR, industry study etc). A concisely written credit memorandum has much more effect on the reader than a memorandum having cocktail taste.

There are no hard and fast rules which govern as to how lengthy a credit memorandum should be in terms of pages. Institutional standards, mostly practiced in the international financial institutional do not encourage the length of such a write-up of more than 5 pages. We will adopt this standard. Additional information, if felt necessary to be provided can be supplemented through addendums. Addendums give reading choice to the reader. If a reader is interested


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in knowing more than what is given in the credit memorandum, he/she can refer to such addendum for additional information.

As mentioned earlier, the flow of information in a credit memorandum should be structured in such a manner that it answers all questions raised in the mind of a reader while reading it. Again there are no thumb rules, which dictate as to how the information flow in a credit memorandum should be structured. Prudence however, dictates that all salient feature of a credit be presented.

A well structured credit memorandum usually evolves around the following topics.

5.6.1 Purpose

Purpose of presenting the credit memorandum is described in this section. The purpose should be focused and coincised e.g. “Initial Review” to recommend aggregate credit exposure of Rs. xxx, Annual Review to analyze ABC company‟s‟ financial performance for the fiscal year ended September 30, 2xxx; “Interim Review” to recommend enhancement in funded/non- funded exposure to a new level of Rs. xxx, and alike.

5.6.2 Relationship Background

Trace the history of KASB Bank‟s relationship with the borrower i.e. when was it first initiated (no need to give exact date, just mention month and year e.g. March 2004, October 2005) or it is a new relationship being solicited. Describe how our credit exposure to this relationship has grown over the years. Summarize our past experience with the borrower, particularly with regard to furnishing us financial and other information as and when we required.

5.6.3 Relationship Profitability

State % age share of borrower‟s ancillary business routed through us during the past 12 months. Measure our gross earnings from total funded exposure, commission and FX earnings separately. Spell out our profitability goals for the next 12 months. Measure these goals against our profitability threshold for corporate names and if our profitability objective does not conform to it, give a plan as to how shall we meet this objectives and when?

5.6.4 Relationship Strategy

State clearly what is our overall marketing strategy towards this relationship. What is our %age share of borrower‟s short/long term financing needs as of now? Do we want to bail ourselves out (mention approximate time horizon) or stay with our present share or increase our share? What approximate additional financing share we plan to take within next 12 months? If we are sole bankers to the


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company, state how do we plan to end this sole reliance on us, by introducing another bank to the company or ask company to look for another bank (former route is more desirable as we, as lead bank, can control the flow of business to the other bank).

5.6.5 Management Assessment

An objective but critical and honest assessment by Relationship Manager of debtor company‟s management team, its competence level, technical/ market know and general reputation is detrimental to company‟s success. Input by Relationship manager on these areas should be valuable. Emphasis must be given as to how company‟s financial needs are managed (through repeated requests for limit increases form banks or mature approach is adopted in dealing with banks). Does the company have adequate MIS systems in place? Are these systems automated? How does company management deal with its labour force? Any labour unions in place. If there is one, how is the relationship between the management and KASB‟s? Any strikes/lock outs in the past?

5.6.6 Financial Analysis

Typically this section of the credit memorandum attempts to analyze debtor company‟s historical financial achievements covering past two to three years period. It has been observed that most such analyses are vanillic in nature and confine to take account of year to year changes in assets, liabilities and key numbers of company‟s income statements without any attempt to find out how and why such changes took place. Vanillic type financial analyses are of limited use or of no use at all. An approving officer does not necessarily need financial analyst‟s help to figure out that sale of a company increased by 10% during a particular year but net margin declined by a specific percentage. Such an information can be found without much struggle by looking at the financial spread summary sheet. All what an approving officer requires to know is the reasons for which sales registered 10% increase over precious year‟s sales. This increase could have been due to price hike of products, or volume increase or perhaps combination of both. Similarly, there could be variety of reasons which could be responsible for decline in profit margins e.g. increase in cost of goods sold which could not be passed on to the end consumers due to competitive reasons, increase in administrative expenses, increase in financing cost, one-time expense of extra ordinary nature or sale of assets at loss. Likewise, on the balance sheet attempt should be made to get behind the numbers to fully understand changes. Nothing should be assumed in analyzing borrowers‟ financial statements. Financial analyst should work closely with debtor company‟s CFO, and if needed obtain necessary breakdown of all key numbers to fully understand the business cycle.


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Analysis of historic statements of a borrower is helpful in understanding its historic business pattern but its usefulness is limited to intelligently forecast its behaviour in the near term. Since we, as financers lend into the future of a borrower‟s business, it is therefore, imperative, for us to know, as to how its business is expected to perform, at least a year from now. Our knowledge of the industry in which a particular borrower operates economic environment we live in and borrower‟s own business expectations/assumptions can be instrumental in drawing sketchy business and financial outlook for a minimum one to two years. Such futuristic analysis will henceforth form an integral part of our credit memorandum.

In term lending situations, it is expected that the financial analyst will obtain comprehensive financial projections and underlined assumptions for number of year‟s equivalent to the tenor of the transaction, and analyze them with our own assumptions and sensitivity addition. We do not necessarily have to agree with borrower provided financial projections and assumptions used in preparing these projections.

5.6.7 Industry Outlook

Futuristic approach adopted in analyzing a borrower‟s business would necessitate that we take a critical look of the expected behaviour of the industry in which our borrower operates. If an industry is thriving and expected to excel in the coming years, our borrower‟s expectations to double its sales volume in three of four years would probably make sense. However, in case of a gradually shrinking or dying industry, borrower‟s expectations may not be realistic. Key players in an industry and our borrower‟s position in rank would be helpful in forecasting its future position

5.6.8 Security/Support Analysis

An objective assessment of security/collateral held in this section with ways out clearly identified. Our level of comfort with the security package must be expressed. If we have our charge registered over borrower‟s inventory of stocks and trade receivables, status of our charge must be clearly spelt out. Use of expression “ranking charge” must be avoided strictly. In case we hold real property as our security, its most recent market or forced sale value evaluated by a professional appraiser must be stated. Third party property ownership if any, should be highlighted. In lending situations where our exposure is guaranteed by a personal or a corporate guarantee, an intelligent estimate of guarantors‟ networth should be provided. It is also important to disclose if we solely rely on such a guarantee or the guarantee held has no but nuisance value


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5.6.9 Risk Analysis

Every credit is a unique lending situation surrounded by various risks. Risks associated with credit situation “A” may not be synonymous to risks confronted by credit “B”. As lending officers, we are expected to identify such risks, understand them correctly, box them together and then see if all or some of these risks are mitigatable or not. In certain credit situations, there are risks which can not be instantly mitigated such as “single product” risk (borrower manufactures only one product), “single buyer risk or combination of both risks. If one or two risks in a credit are not mitigatable in the near term, it does not necessarily mean that we shall not underwrite the credit. It is more important to be abreast of relevant risks in a credit. Unawareness of such risks is unforgivable and has been usually seen translating into financial loss for the lender. Typical credit risks in our type of loan portfolio are:

(i) one –man show/sole proprietorships with no clear succession plan in place

(ii) Single product/single buyer

(iii) Mismatch of cash flows; long term cash needs satisfied with short term sources

(iv) Higher leverage / under capitalization

(v) Technology risk

(vi) labour intensive industry

Such risks must be vouched for and mitigants, if any identified

5.6.10 Conclusion/Recommendations

This is the most important part of the credit memorandum. Relationship Managers are expected to summarize various aspects of the credit discussed earlier, draw logical conclusions from it and conclusively formulate their recommendations with due emphasis as to why the credit being recommended represents a bankable risk.

Credits presented with fabricated or weak conclusions usually carry high risks and often cause financial losses.


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5.7 Site Visits

Periodic visits by Relationship Managers to our borrower‟s facilities are a good monitoring tool. Such visits not only help the bank in understanding our borrowers‟ business but also enhance our knowledge of the industry we lend to.

While our Relationship Managers do conduct such site visits, it is not apparent to the supervisory levels. It is therefore required that our credit packages should contain site visit memorandum also. It will be preferred if such site visits are conducted as close to the annual review cycle as possible.

It is to re-emphasize that site visits do not mean calls on borrowers‟ senior management personnel in their posh air conditioned offices but are supposed to be performed at the place(s) where our borrowers‟ core business activities actually take place; be it a warehouse or a showroom (trading activity) or a factory

5.8 Target Market/RAC’s Compliance

Annexure 6, is a self explanatory check-list designed to see if a particular credit conforms to our definition of a target market (TM) name and complies with our Risk Acceptance Criteria. Deviation to TM or any of the established RACs must be highlighted for approval at the appropriate level of authority. Credits with TM or RACs deviation(s) carry more than usual degrees of risk.

5.9 Prudential Regulation Compliance

Compliance to local regulations is an important part of the credit process. Prudential Regulations laid out by State Bank of Pakistan provide basic guidelines for lending activities by commercial banks. Relationship managers are expected to be fully familiarized with these regulations and ensure strict compliance. A check-list (see Annexure 7) has been designed to remind ourselves that compliance to these regulations is a must in every lending situation. This checklist is to be submitted with every credit proposal.

5.10 CIB Checkings

One of the fundamental requirements of lending is to have independent checkings on a borrower. The best available platform to furnish such information is State Bank sponsored Credit Investigation Bureau (CIB). Relationship Managers must


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ensure that each credit proposal submitted does have a most recently obtained CIB report.

5.11 Bank/Market Checkings

It is extremely useful to obtain checkings on a borrower from its customers, suppliers and competitors. These sources usually provide unpredejuced information on a borrower when requested by a bank. Such checkings may be obtained by the Relationship Manager on telephone and must be candidly minuted by him/her. No credit proposal should be submitted without such checkings. Credit Checkings on a borrower from its bank(s) must be also obtained and should form an integral part of the credit package.

5.12 Registrar Checkings

Checkings /search reports must be obtained when a borrower is a private limited company, or an unquoted public limited company quoted public company. Registrar Joint Stock companies (RJSC) in all major cities of the country maintains public records of all charges created by lenders on debtor companies assets. As part of our due diligence exercise Relationship Managers through the Credit Administration Department are expected to check such records at least once a year (on the eve of annual review of borrowers) to ascertain our charge / security position vis-à-vis other charge holders. Such checkings are integral part of any credit proposal submitted.

5.13 Covenants Check-offs

Term lendings are usually governed by multiple covenants (financial as well as qualitative covenants) imposed by lenders. It is important to check at least annually if such covenants are adhered to by a borrower, at the time of annual review of term facilities. This check must be submitted with annual review package.

5.14 Account Profitability

It is prudent to know whether a borrowing relationship in our portfolio is profitable or not, and if it is profitable, we should know what is the level of profitability in Rupee terms. It therefore, becomes meaningful to provide revenue generation history of a borrowing relationship for the past 12 months. Based on track record of a relationship and credit lines being recommended we can intelligently forecast our profitability level for the past 12 months. Until such time


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an automated and workable Account Profitability system is devised, Relationship Managers are expected to provide the above stated information on one pager.

5.15 Conclusion

We have tried to design the credit package with precision and structured approach. The information required in a credit package is the minimum needed for arriving at quick and meaningful credit decision. The quantum of documents needed in the package may look voluminous at first sight, but in fact it is sufficiently compressed provided Relationship Manager apply precision techniques while processing the information. Repetition of information can make credit package voluminous and burdensome to read. We expect our Relationship Managers to keep their focus on precision and produce a succinct credit package.


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5.16 Legal Lending Limit

Legal lending Limit (LLL) is the maximum amount of exposure (fund based and non funded based) that a financial institution can take on a single borrower. The formula by which this amount is worked is given in the Prudential Regulations # 1 of the State Bank of Pakistan. It is 30% of Bank‟s equity and unimpaired reserves of the bank (as discussed in the latest audited financial statements). Subject to the condition that the maximum outstanding against fund based exposure does not exceed 20% of bank‟s equity.

Office of the Risk Manager will advise line Management from time to time, exact amount of KASB‟s legal lending limit


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5.17 Temporary Extensions

As already mentioned in section 5.1 credit lines (whether short or long term in nature) approved for our customers must be reviewed annually. Annual review cycles should usually correspond with the availability of latest annual audited financial statements of the borrowers. All review dates should be kept at the (12th) month end.

Situations may arise however, where it may not be possible to preserve review cycles. Such situations may be beyond our control, and could include unavailability of borrowing customer‟s audited financial statements in time, or absence of a borrowing company‟s senior manager(s) whose input is vital to chalk out the company‟s financing needs for the next 12 months. In such situations, Relationship Managers may request a temporary extension in the review date of a customer on a simple memorandum addressed to the next approving level in the chain of command giving reasons for the extension sought. Such requests may be approved maximum twice for an aggregate period not exceeding 60 days beyond previously approved annual review date. Extension requests should be pushed up the approved channel at least 15 days before the actual review date to avoid rush at the month end.

The temporary extensions requiring approval of the President shall be approved by the Credit Risk Manager and in his absence by at least two SCOs.

Failure to submit the credit package well before the temporarily extended date shall result in cancellation of the credit lines.


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5.18 Personal Guarantees

In terms of Prudential Regulation No.R-10 (new), KASB‟s policy guidelines with regard to obtaining personal guarantee of directors of private limited companies are as under:

Corporate/Middle Market Customers

a. KASB‟s may not require to obtain personal guarantees of director/sponsors of private limited companies, which are risk rated 4 or better. Personal guarantees of directors/sponsors should be however, required for private limited companies risk rated 5 or worse.

b. KASB Bank also may not require to obtain personal guarantees of director/sponsors of those private limited companies which:

Have been the bank‟s customers for 5 years or more.

Have run their operations profitability during the last 3 fiscal years.

Have not been reported as defaulters in CIB during the last 3 years

Meet criterion as above.

c. KASB Bank shall require personal guarantees of sponsor/owners of borrowers who are registered or unregistered partnerships, regardless of their respective risk ratings or meeting some and/or all criteria listed in b above

SME Customers

All facilities extended to SMEs shall be backed by personal guarantees of the owners of the SMEs. In case of limited liability companies, guarantees of all directors other than nominee directors shall be obtained. Such personal guarantees should be supported by guarantor‟s net worth.

In the recent past, the Honourable Lahore High Court has, in few cases decided against the unconditional continuity of these PGs. They have held that a guarantee issued in respect of a particular loan stands discharged and becomes invalid if.

1. The loan is rescheduled, or 2. There has been change of directors with the permission of the bank.


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It therefore, becomes imperative of our business units to ensure that fresh PGs are taken from all such persons whose liability/obligations they desire to bind and continue with (in the changed scenario),

a) when rescheduling/restructuring any loan/financing b) when the bank has approved any change in the borrower‟s board of

directors/partnership structure etc.

This is in addition to obtaining fresh charge documents (inclusive of fresh PGs) at the time of each enhancement/annual renewal of lines, and must not be compromised at any cost.


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6 Credit Process Normal

Section

6


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6.1 Administration of Approved Credit Facilities

6.1.1 Customer Meetings/Call Reports

To evaluate properly the ongoing quality of management and overall business condition of the borrower it is critical that Relationship Managers maintain direct contact with their clients through periodic visits at their place(s) of business as well as ours. All pertinent information derived from such visits should be recorded in the credit file.

6.1.2 Credit / CIB Checkings

The gathering of bank, credit checkings from market sources and from the Credit Information Bureau (SBP) is an important part of the continuing assessment of borrowers and their management teams. Credit Administration Department is responsible for supplying credit information in accordance with local laws and business practices.

6.1.3 Financial Information

In the ongoing administration of credit facilities, periodic analysis of financial statements plays a fundamental role. While the availability of reliable information varies, our objective should be to obtain the most reliable possible but never less than is felt necessary to make a proper evaluation. To facilitate and standardize the analysis of financial statements, financial spread forms have been developed and should be used when appropriate.


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6.2 Properties taken as Security

It is observed that in most lending situations, our ultimate reliance for final bail out of a relationship is borrower‟s properties; equitably mortgaged to us. While such a security may not be as preferable as we would like it to be, the ground reality is that acceptance of such a security is market practice and we cannot swim against the stream. We shall therefore, continue to accept such securities but more discretely and with extreme diligence. Steps to be taken to exercise such diligence in this regard, include, but not limited to obtaining clearance certificate of accuracy and genuineness of property title deeds and related documents from our approved legal counsel. This may involve carrying out a proper search in Land Revenue records to ascertain that the properties offered are genuinely owned and are unencumbered. If mortgaged properties belong to a third party, counsel‟s opinion should be also sought.

6.2.1 Collateral Inspections

Periodic (at least quarterly) inspections must be made to ensure the existence and adequacy of all collateral securing outstandings. These inspections must include the examination of security agreements to determine enforceability of liens, verification of adequate insurance protection, proper legal registration, and the adequacy of overall safeguards.

6.2.2 Collateral Evaluations

Depending on the nature of the collateral, systems must be in place for periodic valuation of collateral held and adequacy of margins. The more volatile the price movements, the more frequent the valuations should be. Outside professional appraisers approved by KASB should be used where necessary, especially in the case of real estate collateral.

Evaluations of properties from a bank approved appraiser should clearly indicate its estimated “forced sale” value. If in the opinion of the Relationship Manager, value of the property given by the appraiser is not true reflection of the property market conditions, evaluation may be obtained from a second appraiser.

Every property equitably mortgaged to us must be appraised after every two years preferably at the time of annual review of that relationship.

Security/support section of the CA must address the above steps. Date of evaluation of the property with “forced sale value” must be provided in this section.


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6.2.3 Documentation Lodging, Reviews and Follow-Up

All legal documentation must be held in a KASB vault and its existence evidenced in the credit file by an initialed receipt from the loan department. Documentation and collateral must agree with that specified in the approval document, except for a short-term waiver of receipt of documentation which has been approved in accordance with the “Rules” RM must verify the execution signatures on documentation by initialing next to them, unless this task is performed by the loan department. There must be at least an annual physical check of the documentation to ensure that it is intact and in order.

6.2.4 Safeguarding Our Security Interests

In financing situations where our credit exposure is either fully or partially secured by hypothecation (charge-whether registered with the SEC or not) over the borrower(s) stocks and trade receivables, it becomes imperative for us to keep serious account of such assets to safeguard our security interests.

We can achieve our security safeguard objectives by ensuring that:-

i. Borrowers keep us informed about movements in their stocks and trade receivables on a monthly basis, preferably at the end of each month.

ii. We conduct periodic surprise inspections of stocks and verify reported movements (by the customer) in these stocks, and separately verify reported movements (by the customer) in these stocks, and separately verify the movement in trade receivables and also maturity check on each trade receivable to ensure that a hard core is not forming in these trade receivables.

iii. Borrower(s) keep their stocks (raw materials, in transit, finished goods etc.) insured with insurance companies of repute, and that we are nominated in the policy document as “Loss Payees”, at least to the extent of our security interests.

iv. We obtain outstandings and stocks/receivables hypothecated to other banks in situation where we have pari passu security interests.

All Relationship Managers are required to inscribe a “Procedural Information Section (PIS)” on the Security/Support page of the CA to provide the above information. A typical reading under this newly inscribed section, would be:

1. Borrower to submit stocks and/or trade receivables report at the end of each calendar month, latest by the 5th of the following month. Surprise


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inspections of stocks to be performed on a monthly/quarterly/semi-annually basis (this frequency is to be specified by the RM).

2. Borrower‟s stocks are insured with XXX insurance company for at least an aggregate value of Rs. Zzzz (equal to our hypothecation interest in those goods) naming us the Loss Payer.

In cases where our credit exposure is covered by charge over borrower‟s fixed assets exclusive/inclusive of plant and machinery, the insurance coverage requirements will also have to be stated along the lines described in point 2 above.

Credit Administration Department is entrusted with the responsibility to keep track of receipt of stocks/receivables reports, surprise inspections and adequacy of insurance coverages.

6.2.5 Annual Review of Term Credits

All outstanding term credits and commitments must be reviewed by the approving unit at least annually. The review will be in the form of a CA, with a convenant check-off list. The review will be initialed by three credit officers with direct responsibility for administration of the credit under review and must be approved in accordance with the “Rules”.

6.2.6 Release of Collateral /Security / Support

The release of any collateral/Security/Support requires the following approvals 1.Before cancellation of the corresponding commitment and / or repayment of the collateralized/secured/supported outstandings: Full credit approval in accordance with the “Rules.” After cancellation of the corresponding commitment and / or repayment of outstanding: The minimum approval level is a Vice President who must be a Credit Officer.

6.3 Maintenance of Credit Information

6.3.1 Credit Files:

Maintenance of credit files is an important part of the credit process, Credit files contain credit approvals, financial analysis and business strategy information submitted to the Bank by our clients in trust, and on the premise that such information shall be kept confidential. Adequate systems need to be in place to


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restrict access to such information to only those personnel who are authorized to use and maintain it.

Maintenance of a complete and orderly credit file is also necessary to determine whether or not credit extensions are based on complete information.

The following guidelines ensures a consistent procedure:

Each borrowing client must have a credit file

Credit Department in each lending centre will be responsible for the custody of the files, when not in use.

Credit files are never to be removed from Bank premises under any circumstances.

All Credit files released from CAD custody, must be signed out in the credit file check-out card. Under no circumstances should a credit file be released without proper check-out procedures being followed. If a credit proposal is being prepared, and the credit file is to be circulated for approval, the Relationship Manager will sign out the file and be responsible for it until its return to CAD. Under no circumstance should the file be kept overnight by the Relationship Managers in their desks/cabinets.

Proper filing of credit related material is essential to ensure that required information is easily locatable.

Relationship Managers, when sending material for filing must indicate the name of the particular file and the section in which the material is to be filed. The “FILE” stamp should be used on all materials sent for filing.

It will be the responsibility of each Relationship Manager to cull credit files, at the time of annual review of the relationship. The culled material will be retained in a separate file and subsequently be sent to the warehouse for storage.

6.3.2 Background Information

The maintenance and annual updating of certain basic background information on customers and prospective customers is essential. This information should be recorded in a readily retrievable format, such as a Basic Information Report (BIR)


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6.3.3 Credit Department

Establishment of a formal Credit Department to assist in credit administration / analysis and to maintain credit records is to be decided locally. The scope of its duties / responsibilities must be clearly defined.


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6.4 Temporary Overdrafts

The most commonly used funded line of credit by our customers, is the Current Financing line (CF). For business reasons, it becomes necessary, at times to accommodate financing needs either of an existing borrower beyond its approved CF line or of a significant depository client of the bank. If such an accommodation is considered by the time management, it may give rise to an Excess over the approved line (EOL) or create a Temporary Current Financing situation (TCF).

To ensure expediency of the approval of such situations, a Referral Item Card system (RIC) is maintained by the Credit Administration Department (CAD) assuming the primary responsibility of securing the necessary approvals of such exceptions and promptly advising the concerned Cash or Clearing departments. It is pertinent to mention here that Referral Item Card is only used for unanticipated excesses over approved credit lines (EOL/TCF). A customer‟s request for a short term increase in CF limit should be handled under the temporary increase or normal credit approval rules.

The approval process which must be strictly followed is produced below: 1. Initiating department (Cash counter, clearing, or any other operations

department), after ensuring that there is no inflow of funds in the desired account, must forward its request with the relevant debit instrument (debit ticket, cheque etc) to the Credit Administration Department. For evidence purpose, an “INTERNAL FUNDING SLIP” (IFS) is to be used by the initiating Department.

2. The Credit Administration Department upon receipt of debit request will fill in the Referral Card with necessary details (Referral Card Specimen is attached. Separate Referral Card for each borrower will be maintained by the Credit Administration Department) and circulate among the relevant Credit Committee members for their approval. It will be the responsibility of the Credit Administration Department to ensure that appropriate level of approvals for that transaction is obtained, as promptly as possible.

3. Once required approvals are in hand, the designated person in the Credit Administration Department (usually the Head or his deputy) will initial the debit instrument with remarks “OK to debit” or “Ok to pay” as appropriate, and promptly forward the debit instrument to the initiating department.


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4. Initiating department on receipt of the debit instrument will ensure presence of Credit Administration Department‟s authorization and consummate the transaction.

5. It will however, remain the responsibility of the Initiating (Operating) Departments to exercise extreme diligence in ensuring genuineness of the debit instrument including signature verification of the borrower, date and amount and appropriate crossing or otherwise in case of cheques.

6. Credit Administration Department will keep the Referral Cards in alphabetical order at all times for easy access and reference.

Temporary overdrafts may be extended for a maximum period of 7 calendar days. In the event such an overdraft is not regularized within the stipulated time, a full credit package will require to be put at an appropriate level of approval.

Approval requirements for such overdrafts will be provided in Credit Risk Bulletin covering Credit approvals and delegation of Authority.


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7 Credit Maintenance

Section

7


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7.1 Scope and Objectives

The responsibility of providing administrative support for the lending activities of the Bank, and day-to-day monitoring of credit exposure is vested in the Credit Administration Department (CAD)

The primary objectives of establishing CAD is to monitor the Bank‟s lending activity and to ensure that:

Proper checks and balances are maintained with regard to correct utilization (viz. amount, tenor, collateral, pricing etc.) of credit facilities according to the terms and conditions of the credit approval.

All loan documentation relating to transactions is scrutinized, verified to be legally enforceable, and lodged in the vault.

Collateral securities are effectively controlled and monitored.

All customer outstandings are accurately recorded in the Bank‟s ledgers for monitoring and control purposes.

An effective follow-up system for routine actions (i.e. documentation, collateral, etc.) is in place, and all irregularities are recorded and reported as required.


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7.2 Functional Responsibilities

7.2.1 Facility Implementation and maintenance

Implement credit facilities in accordance with the terms of the credit approval, and ensure prompt input of this on the system (for utilization), of the same (for utilization), on the computer-based, on completion of all requirements.

Scrutinize internal transaction approval documents (“availment” and “offering” tickets) for correct disbursements under approved (and released) credit facilities.

On the instructions of the RM, allocate facility limits to other extending units and monitor such allocated limits

Follow up with RM for regularization of any excesses/TODs

Follow up with RM for repayment of maturing advances, loans or regular movement in OD accounts, or liquidation of temporary overdrafts by the due dates

Monitor all past due obligations, tracking the same for prompt settlement

Ensure that approval gaps do not arise.

7.2.2 Documentation

Ensure that standard loan documentation is in place for each credit facility, prior to disbursal (if documentation requirements are different from the Bank‟s standard approved format, arrange for vetting of the same by legal counsel)

Ensure that the documentation is correct, complete, and corresponds with the approved facilities (i.e, the blank spaces are filled, documents are dated, signed and stamped, the signer is authorized to execute such documents, signatures are verified etc.)

Act as custodian for legal borrowing documentation, lodging the documents in the vault, and maintaining proper records as per the Bank‟s operating procedure.


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Keep track of expiry of borrowing documentation, insurance policies, etc.

Follow up for regularization of any approved documentation deferrals (rectification of discrepancies)

Maintain documentation checklist, updating it properly each time new documentation received.

Keep custody of credit files, ensuring that all credit files are kept under department‟s custody and are at no time given to RM without obtaining proper approval.

7.2.3 Collateral

Maintain in safe custody, all collateral (for e.g. shares, government securities, property title deeds, mortgage documents, etc.) as per the bank‟s standard operating procedures.

Ensure receipt of periodical statement of stocks and receivables from customers, as per frequency specified in the credit approval

Undertake periodic evaluation of hypothecation/pledged inventories (as per the terms of approval i.e. using applicable margins, such that the drawing power adequately covers outstanding at all times), on a regular basis, through analysis of stock report submitted by the customer/mucaddam.

Undertake periodic inspection of goods and merchandise, hypothecated or pledged to the Bank, in accordance with the terms of the credit approval

Ensure that the goods hypothecated or pledged are covered through a valid insurance policy (written by an approved insurer), with appropriate risk coverage, adequately covering the Bank‟s facility amount.

7.2.4 Compliance

Ensure compliance with the institutional credit policies and procedures as laid down in the Credit Policy Manual, and advised from time to time through Credit Bulletins.

Ensure compliance with local regulatory (i.e. central bank) requirements

Ensure timely submission of correct information in the prescribed format, as may be required by the central bank.


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7.2.5 Management Information

Prepare various portfolio composition reports

Prepare various exception reports, etc., for submission to RMs/TLs and senior management.


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7.3 Facility Implementation Procedures

Upon approval of credit proposal, the CA is handed over to CAD. CAD determines the nature of documentation required, and on receipt of the same ensures that all legal documents (i.e., loan documents, security documents, board resolutions, etc.) along with the specified collateral requirements (as per the terms of credit approval), are obtained and are legally enforceable. After this it can release the facility for utilization.

If certain documents (other than the promissory note, the mark-up agreement, and security/support documents) can not be obtained prior to implementation of the facility or certain discrepancies exist, and it is necessary to disburse funds under the facility, the RM may request for approval to defer obtaining/rectifying the same (refer to Credit Bulletin No.005)

7.3.1 Utilization of Facilities

In addition to the credit approval process, each transaction within the validity of the approval, requires further authority to implement such approval. Such authority is obtained on a standard transaction form called an “Availment Ticket” or AT.

The respective operating department (advances, trade finance) initiates the AT, while booking a transaction. The AT contains information like the nature of the facility, amount of approved limit, amount currently outstanding, total amount outstanding after inclusion of the proposed transaction amount, tenor of the proposed transaction, facility expiry date, etc. After getting approval from the relevant approving authority, the operating department gives the AT to CAD. CAD checks the ticket, and if it is in order, gives its concurrence for booking the transaction.


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7.4 Credit Monitoring

7.4.1 Monthly Credit Admin Updates

To keep line management informed, CAD prepares and circulates a comprehensive report on a monthly basis. The report contains the following information:

Credit Approval (CA) expiry status i.e. list of CAs due for annual review in the subsequent two months

List of expired CAs

Documentation and insurance expiry status, i.e. a list of documents

Documentation and insurance expiry status, i.e. a list of documents expiring in the subsequent two months

List of expired documents and insurance policies

List of overdue stock reports

List of outstanding insurance premium payment receipt.

Client wise clean-up monitoring target dates (where applicable)

Document deficiency/discrepancy report and deferral expiry status.

This is not an exhaustive list, and any material issue requiring, monitoring over an extended period of time; and having the need to keep various units/departments informed, may be included.

7.4.2 Delinquency Report

The purpose of this report is to track/monitor Temporary Overdrafts (TODs) in current account, and temporary excesses in any previously approved facilities.

The delinquency report also shows the status of approvals required for regularization of excesses / TODs, extending beyond a period of 15 days. Such extensions require approval of the aggregate exposure amount. This report also helps in keeping track of the excesses/TODs that need to be designated as Past Due Obligations (PDO), if not adjusted/regularized within the specified period of


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time. The delinquency report is circulated to RMs/TLs/RLH and Group Heads, on a daily basis, and to CAD HO-Karachi, on weekly basis.

7.4.3 Monitoring Past Due Obligations

Loans and advances are treated as Past Due if they meet any of the following criteria:

Any principal repayment or interest payment is unpaid 30 days after becoming due; even if only an interest payment or a principal instalments is past due, the entire unpaid principal must be transferred to past due account.

Temporary overdrafts (where the overdraft is extended in the current temporary a/c, and an approved facility does not exist) that remain unpaid for a period of 15 days; TODs on approved facilities are considered past due when not covered within the terms of the underlying agreement, or in any event, on expiry of the facility.

When a principal installment, or interest is past due for more than 90 days, all facilities to the Borrower/Group are blocked. The accrued (but unpaid) interest is reversed from the relevant income a/c by debiting the profit and loss account, and the entire fund based outstandings are transferred to non-accrual status.

CAD monitors non-accrual and PDO accounts, and prepares a customer wise delinquency report on a fortnightly basis, for circulation to senior management. It also states RM‟s remarks, and lists corrective action to be taken along with the target dates for implementation.


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7.5 Documentation

It is the Bank‟s policy to obtain complete, legally executed documentation from customers, prior to extension of credit.

The responsibility for obtaining complete documentation from customers lies with the respective RM, whereas, it is CAD‟s responsibility to provide them with the requisite documents/formats for execution by the customer.

When accepting documentation from customers, the RM must ensure that documents are prepared as per the Bank‟s (approved) standard forms, and check for completeness and enforceability. Where documentation is incomplete, or any discrepancies exist, the RM is responsible to seek rectification prior to disbursal. In extreme circumstances, and then only as an exception, deferral/waiver may be requested from the appropriate approving authority (refer to Credit Bulletin 005)

7.5.1 Basic Documentation

The following documents are referred to, collectively, as basic loan documents 2:

Accepting “Facility Offer Letter”

Promissory Note

Mark up Agreement

Given below, is a list of documents typically required for the following types of transactions:

Bill discounting/purchase Letter of agreement for bills discounting Letter of arrangement for bills purchase limit Letter of hypothecation (bills)

Financing against Trust Receipt Letter of trust receipt

Letter of Guarantee Counter guarantee

2 With the exception of public limited companies, personal guarantees form the proprietor, or all partners, or all directors of the company if required under policy also form part of the basic documents.


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Listed below, are the security documentation requirements for different types of security:

Security Documentation

Pledge/Hypothecation Letter of Pledge

Letter of Hypothecation Charge to be registered with the Registrar JSC (NOCs to be obtained for attainment of pari passu status, if prior charges exist) or a Joint Pari Passu Agreement should be signed by all lenders.

Mortgage (Equitable) Memorandum of Deposit of Title Deed(s)

Agreement for sale

General Power of Attorney registered with sub-registrar of properties

Affidavit

Personal guarantee of mortgagor(s)

Mortgage (Registered) In addition to charge documents required for equitable mortgage (listed above), a registered mortgage deed (to be drawn up by legal counsel), if required, as per approval.

Marketable Securities Letter of lien on marketable securities

All listed shares to be pledged through CDC.

General Power of Attorney.

Deposits Letter of set-off.

Deposits receipts to be discharged

Charge on the Assets Necessary documents to be drawn up by legal counsel.

CAD is responsible for preparation of borrowing documentation. For creation of Equitable and/or Legal Mortgage ,and related documentation or any non-standard document, CAD must seek internal or external legal counsel‟s services.

On receipt of approved sanctioned advice, CAD prepares documents as per approval requirements, and hands over the same to the RM. The RM is responsible for getting the document signed by the customer.


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7.5.2 Scrutiny

Documents are on Bank‟s standard forms (RM must obtain necessary approvals where deviations from the approved standard text are required; legal counsel‟s written opinion is required in support of such requests)

Documents show the correct amount of approved facility or special transaction (amounts stated in figures and words are consistent with each other).

Each document must be dated, and blank spaces, if any, in the document must be properly completed.

Documents are executed by authorized signatories of the borrower (if signed by the borrower‟s representative, heir(s) other partners, then a specific Power of Attorney evidencing such delegation, and authority, should be requested for and a copy attached with the documentation )

Multi-page documents should be preferably initialed on each page by the customer (and the Bank where necessary), unless the document is firmly bound (as opposed to being stapled together). Although a missing initial does not invalidate the document, it is a precaution against substitution of any pages there from

Corrections, errors, overwriting, alternations, etc., in a document, must always be initialed/signed by the authorization signatory of the customer.

7.5.3 Lodgement

CAD is responsible for lodgement and controlling of borrowing documents. After the RM has reviewed the documentation, and found it to be in order, he/she initials it with a lead pencil, evidencing his/her independent document verification.

The person, in CAD, designated for documentation control, also reviews each document, independently.

It is then recorded in the documentation tickler and sent for lodgement in the vault.


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A checklist specifying details of documentation held, is prepared by CAD, and signed by the RM to confirm its content and validity.

Items, such as property title documents, government securities, etc., which are required to be held in dual custody, are lodged in the main vault, jointly, by two officers of the Bank. Record is maintained by CAD in the “safe in” “safe out” Register. CAD is also responsible for ensuring that all new documentation, as required by the RM, or any documents replacing the existing documentation (as required by the credit approval) is lodged in the vault, and details thereof concurrently recorded in the checklist and a copy kept in the documentation folder.

7.5.4 Review

At each annual review, the RM must review all documentation held for the customer to ensure documents are adequate, complete, and legally valid.

The review should not only be confined by a count of the documents held, but should also include an examination of working/clauses/signature etc to ensure that the document is legally correct and affords the protection (to the Bank) expected of it. Where documents have become obsolete, RM must provide instructions to CAD for removal (if they are not required any longer) or to be held, as necessary.

Once a year, all documentation of corporate clients should be reviewed by an officer independent of that Corporate Center.

Once every three years, all documentation of corporate clients should be reviewed by legal counsel and/or external auditors. This exercise is also required to be undertaken when a RM is relinquishing responsibility for an account.

When a facility is adversely classified, the loan documentation and collateral must be reviewed by legal counsel, within 15 days of such action. Legal counsel must certify in writing that they are satisfied with the effectiveness and validity of the documentation, and suggest any further steps that should be taken to improve the Bank‟s position.

When a facility/borrower classification is further downgraded, special action program must be developed, including review of documents by legal counsel (in case the last such review, done at the time of initial adverse classification was completed more than a year ago). If the last review was done less than himself/herself of its adequacy and appropriateness. Such review must be documented in the credit line.


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7.5.5 Documentation Controls and Follow-ups

No credit facility is to be released for utilization, if requisite documentation is not available or proper deferral approvals have not been obtained.

In order to keep track of deferrals, CAD must prepare a fortnightly report on deferred documents, showing list of pending items by respective RM. The date of the relevant deferral approval, and corresponding expiry date are shown in separate columns. This report serves as a follow-up tickler for the expiring deferrals.

RMs should take steps to rectify the situation, and only in extreme cases, may seek a further extension of appropriate deferrals approvals, before the expiry of the existing deferral.

Documentation for allocated credit facilities (i.e. approved by another unit) is governed by the same procedures and controls, unless the respective Control Units confirms (in writing, by tested telex) that the required documentation has already been obtained. For any subsequent increases in facilities or renewals, the CAD at the Extending Unit must obtain written confirmation from the Control Unit, that adequate documentation coverage is being maintained.

7.5.6 Deferrals

No credit facility is allowed to be released nor any disbursements permitted until:

All documentation is completed, executed, delivered, and registered (if necessary)

All necessary collateral, guarantees and/or support are held.

All conditions precedent, as defined in the agreement have been met (in accordance with the terms outlined in the approval document and/or in the agreement with customer)

Request for deferral should only be processed in cases of extreme need, i.e. all reasonable attempts have been made to complete the documentation prior to disbursements and have failed only because of unsual circumstances.

Deferral relating to the perfecting of Promissory Notes, collateral, guarantees and support may be approved for 30 days by Business Group Head/CRM provided that the facility(ies) relating to the collateral or security is within his approved limit.


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Exception after 30 days, if unresolved, requires approval from the original (highest) approving authority, based on the total facilities to the group.

Deferral relating to minor discrepancies on the documents such as cutting authentication, company stamp missing on some pages, etc. may be approved for 30 days by the respective Regional Heads. An exception, if unresolved after 30 days, has to be approved based on the related facility amount.

Respective CADs are responsible for monitoring deferrals. A detailed exception report is circulated to the respective RCBHs and Group Heads on a fortnightly basis, and to the Credit Risk Management Committee on a monthly basis.

7.6 Availment Procedures

For booking of all transactions, with the exception of disbursements under Running Finance/Cash facilities, the operating department is to use transaction forms. Availments are allowed, provided the proposed transaction is within approved lines and parameters, documentation is in order and/or an adequate deferral is in place. Unless otherwise stipulated in the Credit Approval, an availment under an existing and current credit facility may be approved as follows:

(i) Up to Rs. 5,000,000 by the RM

(ii) In excess of Rs. 5,000,000 but not exceeding Rs. 50,000,000, the RM and Team Leader.

(iii) In excess of Rs. 50,000,000.At least a Senior Vice President/Regional Head in addition to the relevant Relationship Manager and Team Leader


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7.7 Collateral Guidelines

As a general policy, the Bank essentially lends against cash flow, i.e. the cash flow is the primary means of repayment. Collateral is taken as a secondary way-out, in case cash flow be insufficient or become unavailable. Collateral may also be taken for one or more of the following reasons:

To improve bank‟s rights with respect to other lenders

To gain financial and psychological leverage in negotiations with the customer.

Collateral may be taken in any of a number of forms, for instance:

First exclusive charge, senior to all other lenders

First pari-passu charge (where the prior charge holders, by issuance of No Objection Certificate (NOCs), agree to share pro-rata the collateral under charge

Inferior charge

Pledge and exclusive charge (which confers physical possession of assets carved out of the assets charged to other lenders)

Equitable or legal mortgage, i.e. any of a number of types of claims against real property or fixed assets.

Standby letter of credit/bank guarantee.

Corporate or personal guarantees (supported by the personal net worth statement of the guarantor)

Collateral should match the purpose, nature and structure of the transaction, it should reflect the form and capacity of the obligor, its operations, and the business and economic environment. Collateral may include the assets acquired through the funding provided, i.e. stock, receivables, or export bills, a well as cash, govt. securities, other marketable securities (such as shares) current assets, fixed assets, specific equipment, and commercial and personal real estate.


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7.7.1 Valuation

Valuation of assets charged to the Bank is an important function, as it has a direct bearing on the amount of loss that the Bank might have to suffer in the event that the Borrower defaults. The method of valuation employed, has to be appropriate to the nature of the assets.

Some standard definitions are:

Market value based on the unadjusted price quoted in the market-place

Forced Sale Value the adjusted value against which the bank extends facilities

Equitable Mortgage Value the value defined in the agreement with the customer, against which we monitor our customer‟s compliance with the terms of the agreement(s)

All valuations must be supported with factual data, in order to qualify the collateral for FSV; valuators estimates without supporting information are not acceptable. Valuation should be conducted by a Valuator of the Bank‟s choice (with expenses to be reimbursed by the customer). Valuations of real property and fixed assets should be updated at least every two years.

Valuation of commercial real estate should be conducted, keeping the following considerations in mind.

Prices in recently concluded sales of comparable properties

Replacement cost with appropriate depreciation

Discounted cash flow from existing or potential leases.

Stocks, work-in process and finished goods should be valued using generally accepted accounting principles. Receivables should be valued at a discount to face value determined by considering the credit worthiness of the issuers and of the borrower. Credit value, should in no case exceed 90% of receivables‟ face value. Value of current assets should exclude assets subject to specific charges, and inter-company receivables.


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7.7.2 Registrar checkings

In order to establish the fact that the collateral offered, is free of all liens or encumbrances, the Bank conducts a search in the relevant registrar‟s records. CAD is to ensure that the Bank‟s lien is correctly recorded in the SECP records. Registrar checking for each borrowing name is conducted by a review of the SECP records by CAD, either directly or through an outside investigation agency.

7.7.3 Monitoring

In case of hypothecated stocks, customer should be made to submit stock statement on agreed intervals as per the terms of the credit approval. CAD maintains an inventory tickler, specifying stock report submission frequencies.

Frequency of stock reports and maintenance of lending margins, as per credit approval, are to be strictly followed.

Where the customer fails to furnish stock statements. CAD is required to followup either verbally or through reminder memo to RM‟s and Regional Heads. RM‟s should send a written notice to the customers if stock report is not received by the 20th of each month.

Stock reports that are overdue should be highlighted in the monthly exception report.

Collateral valuation reports should be documented in the credit lines. The value of stocks and receivables and the most recent valuation date should be indicated in the security/support box of the credit proposal.

Stock shortfalls should be reported to the concerned RM, as well as being highlighted in monthly exception report.

For processing of stock reports, where the aggregate Bank borrowing figure is required, the Bank relies on information provided by the customer. However, on a best effort basis, the Bank will attempt to cross check (on, atleast, a quarterly basis) with other consortium/lending banks.

Where the Bank holds shares as security:

CAD regularly values listed securities at published (closing) prices


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Top-up and close-out ratios must be mentioned in the procedural information of the Credit Approval.

In case the top-up threshold is reached, the concerned RM and the Regional Head must be notified immediately and a target date set, for rectification of shortfall.

The monthly exception report should reflect the above.


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7.7.4 Pledge (Mucaddam/Warehousing)

Under a pledge, transfer of possession (of a moveable property) to the Bank takes place, as a security for the payment of a debt of an obligation. Ownership or the title of goods remains with the customer (as does responsibility for insurance, and storage costs, etc.) In KASB Bank, we take pledge in the following scenarios:

Finance against imported merchandise through opening of sight L/C. At the time of delivery of documents, the customer agrees to pledge the “Delivery Order” against payment by the customer

Cash Finance against pledge of commodities such as Cotton, Rice, Sugar, etc.

Upon pledge of goods to the Bank, the goods are secured (under lock and key) at either Bank owned godowns, with the Bank‟s staff placed as watchmen, or in the Customer‟s premises or godowns under lock and key custodianship and supervision of the Bank‟s Mucaddam. Goods are released only against Delivery Orders issued by the Bank.

7.7.4.1 Monitoring

CAD has to ensure the following:

The Mucaddam is enlisted with the Bank, under a properly executed legal contract, which protects the Bank‟s rights

In the case of pledged goods stored in the Bank‟s godowns, that guards are posted, accordingly.

That signboards of the Bank are permanently fixed, and displayed at the warehouse at the place(s) where pledged goods are stored.

That customer does not take delivery of pledged goods, without issuance, against payment, of a properly signed Delivery Order (DO) from the Bank

That pledged goods are comprehensively insured against fire risk, theft, burglary, for the full value.

Periodical reports of value, quantity, quality, weight, and measurement of pledged goods are obtained from the customer, and are duly verified by the Bank‟s warehouse staff or Mucaddam.


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Random, unannounced checks, and detailed inspection of the pledged stocks are conducted by the RM or other designated personnel of the Bank. This is the Bank‟s greatest protection in maintaining the possession and quality of its security. Inspections should be scheduled fortnightly to quarterly depending upon the integrity, financial condition and the apparent distress of the company.

7.7.5 Inventory Inspection

At least, as frequently as specified in the respective Credit Proposal, stock inspections must be carried out by personnel, independent of those who have control over stocks (i.e. the customer or the Mucaddam). The merchandise is to be checked against the Bank records, and a written report filed in the credit file.

Surveyors should endeavour to conduct surprise inspections, on dates as close as possible to the dates of stock statement provided by customer. Stock inspection can be conducted by the RM, CAD, or contracted out to an external agency. Such inspections can also be carried out by the Bank‟s auditors (as part of the external audit), if the Bank‟s exposure to a client is large and/or collateral is a pivotal factor in credit.

Stock inspection form must contain the following information, at the minimum:

Stock break-up/details

Quality of collateral

Evidence of ownship

Adequacy of insurance

Quality of warehouse

Adequacy of fire protection devices

Adequate protection from theft/burglary

CAD maintains a stock inspection tickler, in which all the inspection frequencies are recorded. Based on frequency, CAD may assign inspection to the respective Bank employee or to outside surveyors. On receipt of the inspection report, the inspection tickler is updated. The report is circulated to the respective RM and Regional Heads. CAD maintains an active follow-up with the surveyors to ensure that inspections are carried out on schedule. Any irregularity in the inspection, i.e.


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stock shortfall or non-compliance is immediately reported to Regional Frequency Bank Head.

7.7.5.1 Frequency

Given the general guidelines, the frequency of the stock inspection is determined by the concerned RM, and should be clearly mentioned in the procedural information section of the Credit Approval. Pledged stocks, under lock and key control of the Mucaaddum, are inspected as per the following schedule (unless otherwise specified):

Textiles Monthly

Ginning & Oil extraction Monthly

Rice Mills Monthly

Sugar Mills Monthly

Others Quarterly

This does not apply where collateral has been obtained for regulatory purposes only.

7.7.6 Insurance

All assets under the Bank‟s lien should be insured through an approved insurance company, and the interest of the Bank noted, irrespective of whether the assets are under the Bank‟s pledge, hypothecation, or mortgage. All insurance policies are to carry “owners‟ pilferage” clauses, and to cover war, R & D, RSD and malicious damage etc.

All credit proposal should mention the specific insurance coverage held. Insurance policies are to be kept in separate folders in the vault, under single custody. This is CAD‟s responsibility.

Upon receipt of a fresh insurance policy, the CAD must enter notice of receipt on an insurance tickler.

One month before the expiry of the policy, CAD is required to issue a tickler to RM/TL requesting them to obtain renewal of insurance policy from the company. If this is not received one week before expiry, a reminder letter is sent to the RM, who is ultimately responsible for obtaining the insurance policy(ies).


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CAD follows up on all expired insurance policies in their monthly exception report. A maximum period of 30 days is allowed, after expiry of a policy, if the Bank receives a cover note in lieu of the insurance policy. A liability tickler per each insurance company to be maintained to monitor per party/aggregate limits.

7.7.7 Release of Collateral

If collateral is to be released prior to liquidation of outstandings, then approval is required from the original approving authority. In cases where outstandings against a specific item of collateral are liquidated, CAD checks all outstandings and adequacy of coverage, prior to release. Extreme caution is to be exercised in such cases, to ensure that the Bank, at no time remains without proper collateral.


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7.8 Credit Files: Composition and Maintenance

Maintenance of credit files is an important part of the credit process, to determine whether or not credit extensions are bases on adequate and complete information. Credit files contain records, analysis, and business strategy information submitted to the Bank by our clients, based on our ability to maintain confidentiality. Adequate systems need to be in place to restrict access to this confidential information to only those personnel who are authorized to use and maintain it.

The following guidelines ensures a consistent procedure.

Each borrowing client must have a credit file

Credit files are confidential in nature and must be kept locked in the CAD custody, when not in use. Credit files are never to be removed from Bank premises

All Credit files released from CAD custody, must be signed out in the credit file check-out card. Under no circumstances should a credit file be released without proper check-out procedures being followed. If a credit proposal is being prepared, and the credit file is to be circulated for approval, the RM will sign out the file and be responsible for it until its return to CAD. Under no circumstances should the files be kept overnight by the RM, in their desks/cabinets.

Proper filing of credit related material is essential to ensure that required information is easily locatable and maintained in good order

RMs, when sending material for filing must indicate the name of the particular file and the section in which the material is to be filed. The file stamp should be used on all materials sent for filing.

It will be the responsibility of each GRM/RM to cull credit files, at the time of annual review of the relationship. The culled material will be retained in a separate file and subsequently be sent to the warehouse for storage.

Given below, is the list of sections and retention period of each document there-against in the credit file. It is the responsibility of the RM to keep the file updated at all times.


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SECTION RETENTION REMARKS PERIOD Credit Application/ Approver‟s Comments 5 years Basic Information Report/Risk Rating 3 years To be updated at the

time of annual review Credit Memorandum 3 years Current

Memorandum plus those for the prior 2 years

Classification Memos/ 5 years Remedial Plan Call memos/Site visits 3 years TM/RAAC/Prudential 3 years Regulations Account Plans/APR 2 years One latest APR

(current and previous years)

Checkings/Legal Reviews 2 years To be obtained at the

time of annual review from other bank and CIB.

Client Correspondence 2 years All correspondence

with customers and third parties.

Miscellaneous /Others 1 year


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8 Problem Recognition and Classification Process

Section

8


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8.1 Credit Classification

Every credit has unique characteristics, and degree of risks associated with it. Effective techniques employed for portfolio management dictate that the Bank has a credible system which can measure credits according to the degree of risks they carry for the bank.

Classification process being described hereunder takes full account of the above stated objective. This process should be used to highlight exposures with greater than normal risks, to evaluate overall portfolio quality and to ensure that problem credit situations are recognized in a timely manner. Once problem credit situations are labeled appropriately, it becomes easier for the management to take prompt, structured and rigorous actions to protect bank‟s interests. This process has four components:

Credit Classification

Special Assets Management Process Standards

Accounting Policies for Problem Credits

Approval Requirements

This process is independent of a similar process required in terms of Prudential Regulations but should not be confused with it. This Classification System initiated by the bank is a continuous process aiming at to monitor the portfolio quality on an on-going basis where as the objective of SBP regulated system quarterly review with an objective to create and set-aside required (by SBP) level of reserves for individual credits.


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Credit Classification:

Credit Classifications are standard categories that indicate the degree of risk in individual credit exposures. Credit classifications also trigger specific internal remedial management process.

8.1.1 Obligor Risk Rating

In addition to credit classifications, our Portfolio Management Process uses a system of “risk ratings” to manage portfolio quality and composition. In terms of this process, each obligor is assigned a risk rating based on its loss norm. These risk ratings do not replace credit classifications; they rather compliment them and are used for different purposes. Risk ratings, ideally are intended to reflect objectively determined loss probabilities as a basis for pricing, loss forecasting and portfolio diversification. Credit classifications, which take broader judgment factors into account, are the basis for our traditional remedial management process. Consequently, adverse classifications do not necessarily correspond to specific risk ratings, but parallels can be drawn between them as explained in section 8.1.2 below.

8.1.2 Classification Categories

In the KASB Bank initiated classification process, there are five classification categories; one category for sound credit exposures, and the remaining four for adverse classification situations indicating increasing degree of potential risks of loss. The same five-level system is used for all types of borrowers and exposures. The five categories and abbreviated definitions are:

ORR KASB Initiated SBP Classification Classification system 1. 1 - 2 1 - 3 1 - 4 1 - 5 1 - 6 1 1 7 1A Watch List Account 8 II Substandard 9 III Doubtful 10 IV Loss


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8.1.3 1/ Current

No evident weakness: Obligations or portion of obligations for which profit and principal payments are fully upto date and orderly repayment and/or timely settlement in the future is without doubt.

8.1.4 IA /Watch List Account:

Evidence of weakness. The obligor demonstrates deteriorating business trends jeopardizing repayment of obligations as they become due. Such trends may include; declining profitability, tightening liquidity or cash flow, increasing leverage and/or weakening net worth, weakened marketability and/or value of collateral, industry specific, economic and/or political problems effecting the obligor‟s performance, concerns about the obligors management competence or depth, material documentation problems, or our inability to obtain current financial information

8.1.5 II /Sub-Standard

Timely repayment and/or settlement at risk: An obligation or part of an obligation that is inadequately protected by the current financial condition of the obligor or the collateral offered. The normal repayment of principal and mark-up or settlement at maturity may be or has been jeopardized, or collateral coverage is clearly deficient. Well-defined weakness is present. There is a possibility of loss if the deficiencies are not corrected in a timely fashion.

8.1.6 III/ Doubtful

Full repayment and/or settlement improbable. An obligation or part of an obligation where there is a high probability of some loss, the extent of which cannot be quantified at this time. There may be certain important and reasonably specific pending factors such as a proposed merger, acquisition, equity injection, perfection of collateral, etc., which could work to strengthen the credit. Classification as measurable loss is deferred until the status may be determined more exactly. Estimated reserves may however, be provisioned.

8.1.7 IV / Loss

Unrecoverable. An obligation regarded as unrecoverable for which the required write-off has not yet been taken. Any amount so classified should be fully provided and subsequently, written off and previously accrued and unpaid mark-


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up must be reversed. Once written off, amounts are no longer shown as IV/Loss although recovery is still a potential outcome.

8.1.8 Guidelines for Applying Classification

To apply the proper classification, credit officers must:

differentiate between symptoms (e.g., margin erosion) and their causes (e.g., over supply product obsolescence, rising cost)

assess the borrower‟s ability to rectify the problem within a reasonable time frame

consider the options available to the business to improve its position as a creditor

The general characteristics below, while not limited in scope, suggest the varying degrees of credit weakness indicated by each classification category.


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8.2 IA/Watch List Account

Environmental /Operational

clear evidence of adverse changes

absence of control (sloppy plant, frequent accidents, messy inventory)

labour problems

lack of management depth and/or key management departures

cash-draining subsidiaries

over-reliance on a single product or supplier or customer

products subject to intense competition or technical obsolescence

over-reliance on imports or exports or certain types of currencies which bear strong devaluation risks

Adverse regulatory, political or environment

Financial Performance

adverse trend in sales and earnings

profit margin erosion

interim losses

fixed-price contracts in highly inflationary environments

Balance Sheet Deterioration

leverage related to past, plan or industrial norms

receivables or inventory excesses

trade payables slowness

Transactional

no seasonal line clean up, lingering excess

term loan covenant violations ( waivers, amendments)

unrealistic repayment schedule

diversion of loan proceeds

absence of adequate collateral, if required

mark-up or principal repayments are past due 60 days or more


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Others

failed syndication or sell-down, reflecting market assessment

weak operational or financial controls and internal MIS

inadequate or outdated financial data

qualified opinion by auditors

material adverse change vis-à-vis the rationale employed for the original risk decision

8.2.1 II/Substandard

same characteristics as in above classifications but of more aggravated nature

credit lines frozen due to political pressures, legal actions etc.

bank locked in due to lack of alternative funding source

ineffective creditor coordination

pledging of assets

debt restructuring required

bankruptcy, foreclosure, forced liquidation

profit or principal repayments are past due 90 days or more

8.2.2 III/Doubtful

same characteristics as II/Substandard but more adverse

auditors disclaimer of opinion or qualification as to continued viability

uncertain collateral coverage

negative net worth and working capital

trade credit frozen

full recovery depending upon improbable events

ineffectiveness of borrower‟s or creditor‟s remedial efforts

consistent failure to meet commitments

mark-up or principal repayments are past due 180 days or more

8.2.3 IV/Loss

Quantified collateral shortfall

Build-up of claims and litigation that will limit recovery amount

Profit or principal repayments are past due one year or more.

Trade bills are past due 180 days or more.


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8.3 Split Classifications

Split classifications refer to the practice of assigning different classifications to different entities within the same relationship, or to different facilities extended to the same obligor, or to different portions of a single facility.

8.3.1 Splits within a Relationship.

Facilities extended to subsidiaries of a parent company on the basis of direct or implied support from the parent are generally classified at the same level as the parent. Conversely, facilities extended to subsidiaries without parent support may be classified at a different level than the parent. However, the basis for such split classifications must be evaluated carefully as subsidiaries are often under some form of parent control (e.g dividends, licensing fees, sales contracts, management know-how, and product expertise) is also not necessarily financially independent.

8.3.2 Splits between Facilities.

All credit facilities to a borrower are generally classified at the same level. However, certain credit facilities to an obligor may be classified at a different level than other facilities if they are secured by collateral of guarantees of unquestionable value. For example, a facility secured by cash collateral would be less severely classified than other less well-secured facilities to the same borrower.

8.3.3 Splits within a Single Facility.

A single facility may be assigned more than one classification when there are distinct differences in the probability of collecting different portions of the facility. Distinct differences are more likely to be evident in the advanced stages of classifications, i.e. the II/Substandard and III/Doubtful categories.


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8.4 Special Assets Management Process Standards

Special Assets Management Process Standards ensure that senior management and experienced credit officers are informed and involved; that a disciplined remedial action strategy is implemented, and that potential losses on individual credit exposures are determined, and whenever possible, avoided

8.4.1 Responsibility for Action

The Business Groups (Corporate Banking, Middle Market, Small & Medium Enterprises) which initially proposed the credit, are responsible for promptly identifying problems, adversely classifying credits that require special attention and taking appropriate reserves. The relevant Business Group must specifically assign responsibility for assigning the credit to the Special Assets Management, once it has decided to exit from the relationship.

8.5 Initiating or Changing Adverse Classifications

It is the responsibility of the relevant Relationship Manager to initiate a change of classification by preparing a Classification Memorandum as per the format marked as Annexure A. The Head of Risk Management or the Risk Assets Review Officer may also initiate a new or a changed classification during the approval and / or risk assets review process. Business Units are encouraged to classify the accounts in a timely manner. Initiation of classification by any source other than the Relationship Manager would indicate a weak management by a Business Group. The Head of Risk Management has final authority in the event of a difference of opinion with the Business Groups.

8.6 Credit Approvals Requirements

Adversely classified credit facilities inherently involve greater risk than facilities, which are categorized 1/ Current. Therefore, the levels of approval required to initiate, renew or increase classified facilities must be more restrictive. Approved requirements are specified in Credit Approval grid. Initiation of fresh credits to classified accounts, must however, be discouraged, and if otherwise justified as a viable business proposition.


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8.6.1 Availments:-

Availments under approved credit facilities classified 1A shall be authorized at the following levels:

Upto Rs. 2.5M An Officer of AVP Grade, who should also be a Credit Officer/ member of the relevant Credit Committee

Rs.2.5 to Rs.5.0M Team Leader (also a Credit officer) of the VP Grade.

Rs5.0 to Rs.7.5M An officer of Grade G who should also be a member of the Regional Credit Committee

Rs.7.5 to Rs.10.0M Business Group Head

In excess of Rs.10.0M Credit Risk Management and Business Group Head

Classified II or Worse: All availment, regardless of the amount involved, must have authorization of the Business Group Head and the Credit Risk Manager.

8.6.2 Remedial Action

Immediately after any credit facility has been adversely classified, regardless of the scheduled annual review date, the responsible Relationship Manager must develop and seek approval for a remedial strategy to be put into action at the earliest. The typical focus of the remedial strategy in each classification category is:

IA/WATCH LIST: Greater management attention is warranted including substantive discussions with the obligor. The development of a specific action plan is required to address deficiencies.

II/SUBSTANDARD: Prompt corrective action is required to strengthen the bank‟s security position, to reduce exposure wherever possible, and assure that adequate remedial measures are taken by the borrower. The relevant Business Group at this stage has to decide whether it wishes to continue with the relationship or phase it out. In the latter case responsibility to do so should be transferred to the Special Assets Management Group.


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III/DOUBTFUL: Vigorous remedial action is required. Efforts should be effective within twelve to eighteen months. No mark-up should be accrued on Doubtful obligations unless otherwise approved by the Head of Risk Management.

IV/Loss: Vigorous collection efforts should continue until no further repayment is possible and efforts are formally abandoned.

8.6.3 Formal Action Plan

The remedial strategy must be documented in a formal action plan with target dates. Special expertise, internal or external, should be solicited, if appropriate. An explicit decision should be made to either stay in or exit from the relationship. Concrete benchmarks should be set to trigger changes in the level of classification and /or the remedial strategy.

8.6.4 Documentation Review

When a credit is classified substandard or is risk rated 8 or worse on an obligor basis a legal review of all documentation and collateral supporting the credit should be triggered and any deficiencies pointed out should be promptly corrected.

8.6.5 Reviews

The responsible Relationship Manager must follow developments closely, compare them with the established benchmarks, and take alternative measures if the credit continues to deteriorate. This remedial management review must be formally documented, as per format marked as “Classified Credit Review Memorandum” (CCM). Classified Credit Reviews must record at least the following:

amount of classified facilities and outstanding markup

reason for classification\summary of the remedial strategy vis-a-vis the client

stay/leave decision

action plan to achieve this strategy

current performance against the plan

indication of whether the credit has strengthened, weakened, or remained the same since the last report


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8.6.6 Frequency of Reviews

The minimum frequency of formal reviews is:

IA/WATCH LIST : Quarterly

SUB-STANDARD : Monthly

III/DOUBTFUL : Periodic as decided by SAM

Exception to these minimum frequencies may be approved for stabilized accounts as specified in the Credit Classification Review (CCM) form. In addition, a new CCM must be circulated if there is a significant change in strategy. If abandonment of recovery has been approved, no further review is required.

8.6.7 Circulation of Reviews

CCM‟s need to be circulated to each member of the credit committee initially approving the credit. A final review shall be conducted by the Head of Risk Management.

8.6.8 Abandonment

When losses have been recognized on a credit, every effort should be made to recover the full gross amount of loans, and / or mark-up owned to the Bank. When all recovery possibilities have been exhausted, a decision may be made to abandon further collection and recovery efforts. The approval to do so must be documented in the credit file.

8.6.9 Accounting Policies for Problem Credits

Ensures that action affecting assets, income, losses and recoveries related to problem credits, receive the proper level of management scrutiny and are suitably reflected in the bank‟s financial statements.


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8.7 Past Due Obligations

When principal or mark-up on an outstanding liability of a customer remains unpaid for 30 days after its due date, the outstanding liability will be treated as Past Due Obligation (PDO). However, we will keep accruing mark-up on this over-due risk asset.

8.7.1 Non Accrual Status

In order to streamline our non-accrual policy in line with the regulatory requirements, the following guidelines will apply to all risks assets managed by the Corporate Banking, Middle Market, Small & Medium Enterprises, Consumer and Branch Banking Groups: When principal or mark-up remains unpaid for 90 days, i.e. it remains unpaid for 60 days after being labeled P.D.O., all outstanding liabilities in the name of that one Borrower and its group accounts being handled as one relationship, and approved through one CA for the entire group, will be placed on a “non accrual status.” Any mark-up amount(s) accrued earlier, and debited to the customer‟s account remaining unpaid, will be reversed to the debit of Profit & Loss account, and transferred to “Suspended Mark-up”. However, this policy will not be applicable to those customers who have Current Financing limits only, so long as their aggregate outstanding (principal + mark-up) remains within the approved limit In addition to the above, the Business Group Head, or the Head of Risk Management or RAR may decide to put any finance on a “non-accrual status” if in their opinion the conduct of the account has deteriorated and warrants this treatment. A detailed memo-stating reason for the same should support such an action. All movements out of non-accrual status will need to be signed off by the full Credit Committee of the relevant Business Group.

8.7.2 Payments Against Documents (PADs)

PADs will be considered overdue after 45 days from the date of lodgment. However, such outstandings will be transferred to “Non Accrual Status” after a further period of 45 days i.e. a total of 90 days from the date of lodgment if these remain unpaid.


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8.7.3 Reversals

“Non-Accrual Status” of any account will not be changed unless the entire over-due amounts of principal and mark-up have been rescheduled (and appropriate approvals obtained thereto) and/ or repaid. Any partial payments received in cash relating to a specific liability will be applied to reduce suspended mark-up, and then, the overdue principal outstandings. Such reversals and /or repayments shall be authorized by the full Credit Committee of the relevant Business Group.

8.7.4 Approval Requirements

Accounts qualifying for transfer from “Non-Accrual /Special Asset Status” back to accrual status, will be identified by the Relationship Manager, Business Group Head, through a memo addressed to the Head of Risk Management each month. The Head of Risk Management will have the authority to approve such a request after examining all aspects of the relationship.

8.7.5 Responsibility

Credit Administration Department will be responsible to identify and monitor the PDOs and non-accrual status of all accounts on a monthly basic. A complete list of such names will be advised to the Business Group Head with a copy to the Head of Risk Management and the CFO. Accounting Treatment: Upon receipt of the list from the Credit Administration Department, CFD will process the necessary accounting entries before the end of the month. Credit Administration Department is to ensure that the necessary accounting entries have been processed.

8.7.6 Confidentiality

The status of non-accrual should never be communicated to the borrower. The adverse classification of any account is the internal policy matter of the bank. Any reference / correspondence regarding classified accounts should be handled with utmost care and confidentiality.


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8.7.7 Initiating Non – Accrual or Cash Status

The full amount of any outstanding obligation must be placed on non-accrual or cash basis status, and any previously accrued and unpaid mark-up must be reversed and/or held in a Suspense Account whenever

The borrowers ability to repay mark-up or principal is questionable, OR

Mark-up or principal repayments are past due 90 days, OR

The loan is classified III/Doubtful or worse

Any exceptions to this policy should be rare and must be approved by the Head of Risk Management

8.7.8 Returning to Accrual Status

Obligations may be returned to an accrual status if the following conditions are met

Payments of both principal and profit are current, and all overdue have been settled

Future payments of principal and profit are expected to be made on schedule.

8.7.9 Applying Cash Basis mark-up Payments

If mark-up payment is received in cash on a facility wholly or partly classified, after it has been placed on non-accrual, the mark-up payment(s) should be applied to reduce mark-up reserves. Any exception to this policy needs the approval of the Head of Risk Management

8.7.10 Reserves/ Provisions

Minimum benchmarks prescribe by SBP Prudential Regulations (Regulation # VIII) from time to time, will apply on any portion of credits where a loss is anticipated and a reserve/provision needs to be created. On all such obligations, previously accrued and unpaid mark-up must be promptly reserved and /or held in a Suspense Account.


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8.8 Acquisition of Real Estate (property) in Retirement

Debt

In delinquent situations where our credit exposure is solely secured by equitable mortgage over real property, the only way out sometimes, for us, is to acquire the underlined property, at the prevalent market price, sell it and retire the debt. Such a way out, though highly undesirable, is at times, the only practical solution to the impasse that we are confronted with, but poses additional risks which need to be properly assessed, analyzed, and weighed against the expected gains from the property acquisition.

It is therefore, necessary to lay down guidelines in this regard that must be followed prior to the Bank committing itself to purchase a real estate in settlement of a sour debt:

a. Ensure that all other possible avenues of recovery have exhausted.

b. At this stage, when a property acquisition is being considered, the account would have become a SAM asset, and hence, the recommendation will have to come from the SAM Unit.

Such a recommendation shall contain details of the account and a brief run of efforts made by SAM to recover the debt. The recommendation shall additionally contain the following details/documents:-

a. A site visit report, jointly conducted by the SAM officer and the SAM Head, should mention first hand details as to the exact location of the property in question, distance from the city‟s commercial centre, nature of the property (residential/commercial/open plot/factory etc.) area, prospect of sale ability of the property, its expected sale price should we sell it (i) immediately (ii) one year down the road (iii) two years or (iv) three years.

b. Confirmation as to the exact legal ownership of the property. A current certificate from our legal counsel to this effect is required. The certificate should additionally confirm that our documentation in respect of that property is absolutely airtight.

c. Expected costs of acquisition e.g. stamp duty, legal fees, etc.

d. Latest valuation report of the property. This valuation should have been conducted by an approved surveyor on our list, and should


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not be the same surveyor who might have conducted a prior valuation. Copies of the prior valuation reports may also be attached.

“Under no circumstances whatsoever, any property acquisition is to be committed/finalized/effected without the prior approval of the Risk Management Committee of the Board.


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8.9 SBP’s Guidelines For Classification of All Financing Facilities: -

(including short, medium & long term) Corporate/Commercial Banking (R 8)

Classification Determinant Treatment of Income Provisions to be made

1 2 3 4

1. Substandard Where mark-up/interest or principal is overdue by 90 days or more from the due date.

Unrealized mark-up/interest to be kept in Memorandum Account and not to be credited to Income Account except when realized in cash. Unrealized markup/ interest already taken to income account to be reversed and kept in Memorandum Account.

Provision of 25% of the difference resulting from the outstanding balance of principal less the amount of liquid assets realizable without recourse to a Court of Law and adjusted forced sale value of mortgaged/pledged assets (subject to Note 1 below) as valued by valuers fulfilling prescribed eligibility criteria, in accordance with the guidelines provided in this regulation.

2. Doubtful Where mark-up/ interest or principal is over-due by 180 days or more from the due date

As above Provision of 50% of the difference resulting from the outstanding balance of principal less the amount of liquid assets realizable without recourse to a Court of Law and adjusted forced sale value of mortgaged/pledged assets (subject to Note 1 below) as valued by valuers fulfilling prescribed eligibility criteria in accordance with the guidelines provided in this regulation.

3 Loss (a)Where mark-up/ interest or principal is over-due by one year or more from the due date

As Above Provision of 100% of the difference resulting from the outstanding balance of principal less the amount of liquid assets realizable without recourse to a Court of Law and adjusted forced sale value of mortgaged/pledged assets, subject to note 1 below, as valued by valuers fulfilling prescribed eligibility criteria.

(b) Where Trade Bills (Import/export or inland bills) are not paid/adjusted within 180 days of the due date

As Above As Above

Note 1 : The Benefit of FSV is allowed against NPLS of over Rs.10m only.

Note 2 : Classified loans/advances that have been guaranteed by the Government would not require provisioning, however, markup/ interest on such accounts to be taken Memorandum Account instead of Income Account


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8.9 a SBP’s Guidelines For Classification of All Financing Facilities: -

(including short, medium & long term) SME : Prudential Regulation #11 Classification Standard Treatment of Income Provisions to be made

1 2 3 4

1.Substandard Where mark-up/ interest or principal is over due by 90 days or more from the due date.

Unrealized markup/ interest to be kept in Memorandum Account and not to be credited to Income Account except when realized in cash. Unrealized mark-up/interest already taken to income account to be reversed and kept in Memorandum Account.

Provision of 25% of the difference resulting from the outstanding balance of principal less the amount of liquid assets realizable without recourse to a Court of Law and adjusted forced sale value of mortgaged/pledged assets (subject to Note 1 below) as valued by valuers fulfilling prescribed eligibility criteria in accordance with the guidelines provided in this regulation.

111. Doubtful Where mark-up/interest or principal is over-due by 180 days or more from the due date.

As above Provision of 50% of the difference resulting from the outstanding balance of principal less the amount of liquid assets realizable without recourse to a Court of Law and adjusted forced sale value of mortgaged/pledged assets (subject to Note 1 below) as valued by valuers fulfilling prescribed eligibility criteria in accordance with the guidelines provided in this regulation.

3. Loss

(a) Where mark-up/ interest or principal is over-due by one year or more from the due date.

b) Where Trade Bills (Import/export or inland bills) are not paid/adjusted within 180 days of the due date.

As above

As above

Provision of 100% of the difference resulting from the outstanding balance of principal less the amount of liquid assets realizable without recourse to a Court of Law and adjusted forced sale value of mortgaged/pledged assets as valued by valuers fulfilling prescribed eligibility criteria, in accordance with the guidelines provided in this regulation.

As above

Note 1.: The Benefit of FSV is allowed against NPLS of over Rs.10m only .

Note 2: Classified loans/advances that have been guaranteed by the Government would not require provisioning, however, markup/interest on such accounts to be taken to Memorandum Account instead of Income Account.


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8.10 CREDIT CARDS: -(Consumer R8)

CLASSIFICATION DETERMINANT TREATMENT OF INCOME

PROVISIONS TO BE MADE*

1 2 3 4

1.Loss Where mark-up/ interest or principal is overdue (past due) by 180 days from the due date.

Unrealized markup/interest to be put in Suspense. Account and not to be credited to Income Account except when realized in cash.

Provision of 100% of the difference resulting from the outstanding balance of principal less the amount of liquid securities with the bank/DFI.

* Note: This specific provision will be in addition to general reserve maintained under Regulations R4 of Consumer PR.


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8.11 AUTO LOANS CONSUMER R-I4 -



I 2 3 4

1. Substandard Where mark-up/interest or principal is over due by 90 days or more from the due date.

Unrealized markup/ interest to be kept in Memorandum Account and not to be credited to Income Account except when realized in cash. Unrealized markup/ interest already taken to income account to be reversed and kept in Memorandum Account.

Provision of 25% of the difference resulting from the outstanding balance of principal less the amount of liquid assets.

2. Doubtful Where mark-up/ interest or principal is overdue by 180 days from the due date.

As above Provision of 50% of the difference resulting from the outstanding balance of principal less the amount of liquid assets.

3. Loss Where mark-up/interest or principal is over-due by one year or more from the due date.

Provisions of 100% of the difference resulting from the outstanding balance of principal less the amount of liquid assets.

* Note: This specific provision will be in addition to general reserve maintained under Regulations R4 of Consumer PR.


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8.12 HOUSING FINANCE CONSUMER R-23

CLASSIFICATION

DETERMINANT TREATMENT OF INCOME

PROVISIONS TO BE MADE

1 2 3 4



Provision of 25% of the difference resulting from the outstanding balance of principal less the amount of liquid assets realizable without recourse to a Court of Law and adjusted forced sale value of mortgaged/pledged assets (subject to Note 1 below) as valued by valuers on the approved panel of PBA.


As above Provision of 50% of the difference resulting from the outstanding balance of principal less the amount of liquid assets realizable without recourse to a Court of Law and forced sale value of mortgaged/pledged assets (subject to Note 1 below) as valued by valuers on the approved panel of PBA.


As Above Provision of 100% of the difference resulting form the outstanding balance of principal less the amount of liquid assets realizable without recourse to a Court of Law and forced sale value of mortgaged/ pledged assets as valued by valuers on the approved panel of PBA.

Note; The Benefit of FSV is allowed against housing loans under all categories irrespective of loan amount. However, this position was to be reviewed after Dec. 31, 2006.


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8.13 PERSONAL LOANS CONSUMER R - 28



(I) (2) (3) (4)



Provision of 25% of the difference resulting from the outstanding balance of principal less the amount of liquid assets.


As above Provision of 50% of the difference resulting from the outstanding balance of principal less the amount of liquid assets.


As Above Provision of 100% of the difference resulting from the outstanding balance of principal less the amount of liquid assets.

* Note; These specific provision will in addition to General Reserve maintained under Regulation R-4 of

Consumer PR.


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8.14 Reserves/Remissions/Write-offs

In addition to the above time based criteria, subjective evaluation of performing and non- performing credit portfolio shall be made for risk assessment and where considered necessary the category of classification determined on the basis of time based criteria shall be further downgraded. Such evaluation shall be carried out on the basis of adequacy of security inclusive of its realizable value, cash flow of borrower, his operation in the account, documentation covering advances and credit worthiness of the borrower etc The rescheduling / restructuring of non-performing loans shall not change the status of classification of a loan/advance etc. The condition of one year retention period, prescribed, for restructured/rescheduled loan account to remain in the classified category, will not apply in case the borrower has repaid or adjusted in cash at least 50% of the total restructured loan amount (principal + markup), either at the time of restructuring agreement or later on during the grace period if any. However, while reporting to the Credit Information Bureau (CIB), such loans/advances may be shown as „rescheduled/restructured‟ instead of „default‟ Bank shall classify their loans/advances portfolio and make provisions there-against in accordance with the time based criteria prescribed above. However, where a bank wishes to avail the benefit of collaterals held against loans/advances they can consider the realizable value of assets mortgaged/pledged for deduction from the outstanding principal amount of loan/advances against which such assets are mortgaged/pledged, before making any provision. The realizable value shall be the value that could currently be obtained by selling the mortgaged/pledged asset in a forced /distressed sale conditions. Accordingly, banks shall take into account only forced sale value into consideration while determining the required provisions. Loans/advances against which securities are not available, or which have not been valued according to these guidelines and verified by the external auditors shall continue to be classified and provided for according to the time-based criteria. Banks shall follow the following uniform criteria for determining the realizable value of assets mortgaged/pledged a. Only assets having registered mortgage, equitable mortgage (where NOC

for creating further charge has not been issued by bank/NBFI) and pledged assets shall be considered. Assets having pari-passu charge shall be considered on proportionate basis

b. Hypothecated assets and assets with second charge and floating charge

shall not be considered


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c. Valuations shall be carried out by an independent professional valuer who

should be listed on the panel of valuers maintained by the Pakistan Bank‟s Association (PBA) for this purpose. PBA shall lay down the minimum eligibility criteria with the prior approval of the State Bank of Pakistan for placement of valuers on the panel to be maintained by it. The valuer while assigning any valuers to the mortgaged /pledged assets shall take into account all relevant factors affecting the sale ability of such assets including any difficulty in obtaining their possession, their location land condition and the prevailing economic conditions in the relevant sector, business or industry. The realizable values of mortgaged/pledged assets so determined by the valuers must have to be a reasonably good estimate of the amount that could currently be obtained by selling such assets in a forced /distressed sale condition. The valuers should also be mention in their report the assumptions made, the calculations/formulae /basis used and the method adopted in determination of the realizable values

d. Valuation shall be done at least once in three years. For example any

valuation done on November 01, 2004 would be valid for consideration for accounting periods ending on December 31, 2004, December 31,2005 and December 31,2006 and for subsequent accounting periods a fresh valuation would be required. If valuation is older than three years as explained above, a revaluation should be done, otherwise the valuation shall be taken as NIL.

e. The categories of mortgaged/pledged assets to be considered for valuation

alongwith discounting factors to be applied would be as under (no other assets shall be taken into consideration):

8.14.1 Liquid Assets:

Valuation of Liquid Assets, excluding pledged stocks, which are dealt with at (d) below, shall be determined by the bank itself and verified by the external auditors. However, in the case of pledged shares of listed companies values should be taken at market value as per active list of Stock Exchange(s) on the balance sheet. Moreover, valuation of shares pledged against loans/advances shall be considered only if these have been routed through Central Depository Company of Pakistan (CDC), otherwise these will not be admissible for deduction as liquid assets while determining required provisions


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8.14.2 Land and Building

Valuation of land and buildings would be accepted as determined by the valuers in accordance with criteria given at point 4(iii) above and no further discounting factor would be applied on forced sale value determined by then.

8.14.3 Plant and Machinery

Entities of classified borrowers shall be divided into following categories at the balance sheet date and discounting factors shall be applied to forced sale value as under

Category Discounting factors to be applied to forced sale value

A) In operation No discounting factor to be applied

B) In operation at the time of valuation but now closed/in liquidation

C) Closed/in liquidation at the

time of valuation and no change in situation

15% of forced sale value on date of closure

1st year after closure – 25% FSV

2nd year 50% of FSV

After valuation – 1st year 25% of FSV

2nd year – 50% of FSV

8.14.4 Pledged Stocks:

In case of pledged stocks of perishable and non-perishable goods, forced sale value should be provided by valuers, which should not be more than six months old, at each balance sheet date. The goods should be perfectly pledged, the operation of the godowns should be in the control of the bank and regular valid insurance and other documents should be available. In case of perishable goods the valuer should give the approximate date when these are expected to be of no value.

For valuations of mortgaged assets carried out within a period of twelve months prior to March 31, 2007, these may be considered provided they were carried out


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by an independent professional valuer and revised certificate is obtained from the valuer regarding the forced sale value of the assets as on the date the valuation was carried out. These valuations should then be subject to the discounting percentages and other criteria as laid down in this regulation. The values of the mortgaged /pledged assets determined by the valuers shall be subject to verification by the external auditors, who may reject cases of valuation, which in their opinion, do not appear to have been professionally carried out and values determined are unreasonable, or in the case of which valid documentation of mortgage/pledge, supported by legal opinion wherever required, is not available on record.

8.14.5 Investments And Other Assets

Subjective evaluation of investment portfolio and other assets shall be carried out by the Bank. Classification of such assets and provision required there - against shall be determined keeping in view the risk involved and the requirements of the International Accounting Standards.


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8.15 Submission Of Returns:

Besides submitting the party-wise annual statements regarding classified loans/advances to our Banking Inspection Department, as is being done currently, banks shall submit a yearly statements giving consolidated position of their classified assets and provisions required there-against to the Banking Supervision Department as per Annexure-I, within three months of close of the close of their accounting year.

8.16 Timing Of Creative Provisions:

Banks shall review, at least on a quarterly basis, the collectibility of their loans/advances portfolio and shall properly document the evaluations so made. Shortfall in provisioning, if any, determined, as a result of quarterly assessment shall be provided for immediately in their books of accounts by the banks.

8.17 Verification By The Auditors:

The external auditors as a part of their annual audits of banks shall verify that all requirements of Prudential Regulations-VIII for classification of assets and determination of provisions required there-against have been complied with. The State Bank of Pakistan shall also check the adequacy of provisioning during on-site inspection


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8.18 Reserves/Remissions/Write-offs

Any portion of a classified credit on which a reserve is warranted in terms of SBP guidelines, it must be promptly provided and any previously accrued and unpaid mark-up reversed.

All allocated reserves must be reviewed by Line Management at least quarterly to determine whether any portion should be written-off.

For reporting purposes, when financing has been reserved the relevant CA should report the gross amount of the credit exposure, and comment the amount of the reserve taken. Financing that has been written off should show only the net amount.

Recoveries and Reversals of Allocated Reserves

As a general rule, recoveries of amounts previously written-off or reserved should be booked only when cash is received. In the case of contingent exposures, recoveries of amounts previously reserved should be recognized only when such contingent liabilities are extinguished

Records

To ensure that Bank‟s interests are properly protected, records of reserves/write-offs and any other claims against our customer shall be maintained either on a centralized basis or at any appropriate business level

Abandonment

When all recovery possibilities have been exhausted a decision may be made to abandon further collection and recovery efforts. This will require approval from Head of Risk Management. The approval to abandon collection and recovery efforts must be documented in the credit file.

Approval Requirements

Would ensure that progressively higher levels of management are involved in approving key remedial decisions affecting adversely classified credit facilities, and any significant exceptions to classified credit policies


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Transfer of Credits to Special Assets Management (SAM

The primary business objective of Special Asset Management Group (SAM) is to provide support to the Marketing Units and help the latter recover assets which maybe in process of becoming sour, or have emerging symptoms to become such. The practice of handing over credits to SAM for recovery when they are vitally “dead” is not meaningful. This practice does not leave many options for SAM but to institute legal proceedings against the debtor straightaway, which in turn means spending more money (legal another expenses) and executive time to pursue litigation process. It is therefore, imperative that we establish some thresholds for our borrowers in this respect. If any of our borrowers crosses the following thresholds, the credits should be handed over to SAM.

a. Inability of a borrower to service Mark-up on any funded facilities for two consecutive Quarters (Mark-up service does not mean debiting Current Financing line but means actual cash payments).

b. Failure of a borrower to settle in cash, overdue outstanding under any

funded or non-funded facility within 180 days after it has become overdue. c. Relevant Marketing Unit‟s three written monthly reminders to the

borrower to settle their dues, having remained unresponded unacted upon d. Relevant Marketing Unit‟s firm internal decision to disassociate from the

relationship

All eligible transfers to SAM should be proposed in writing by the Relationship

Manager and endorsed by the relevant Business Head, explaining justification

for the transfer. Acceptance of such transfers by SAM will require the approval

of the Retail Banking Head.

Once a credit has been transferred to SAM, it may require some assistance/orientation from the previous Relationship Manager enabling SAM to fully understand the complexities associated with the credit. Otherwise, the previous Relationship Manager or the Branch that has managed the relationship earlier will stay away from the ensuring actions by SAM


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9 CREDIT REVIEWS

Section

9


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9.1 Risk Asset Review – (RAR)

The Risk Asset Review Unit continuously monitors portfolios and process quality. It reports regularly to the Audit Committee of the Board and Senior Management on all portfolios, maintains and analyzes the Institution‟s records in adversely classified credits, and conducts periodic inspections. RAR reviews on-site and reports on every portfolio and credit process at least every 12 months (with interim reviews conducted in 6 months or less).

9.1.1 Line Management – Portfolio Reviews

Risk Asset Reviews may be supplemented by line management in two ways:

a. By augmenting RAR teams with line reviewers/experts to assist in large portfolios reviews

b. With interim independent portfolio reviews conducted by credit officers

not associated day-to-day with the portfolios under review. Line Management Business Group Head, S&ME Head) should initiate credit-reviews:

a. Whenever RAR reviews occur at longer intervals than those desired by line management for business / credit planning purposes.

b. To cover those smaller credits (usually Rs.1000,000 or less) not subject to

full RAR review (this is often done in conjunction with RAR reviews).

c. Whenever there is an indication of significant deterioration in portfolio quality/classifications

d. Whenever the portfolio is subject to abnormal growth, or when new

business represents a significant departure from established patterns or target market criteria.

Management portfolio reviews should be performed in accordance with standards recommended by the Head of Risk Management and approved by the President/CEO. Credits that management should consider for review are:


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1. All adversely classified credits 2. All non-target market names 3. A percentage of all credit between Rs.1,000,000 and Rs.5,000,000 4. A high percentage of all credits over Rs.5,000,000

The reviews should be performed by a carefully selected credit officer(s) designated by the Business Head. Such officer(s) should not have been regularly assigned during the preceding year to the unit being reviewed. Outstandings with more than a normal credit risk must be adversely classified in keeping with RAR definitions

9.2 Non-Reporting Limits (NRL) Review

The credit approved process at KASB is essentially centrally monitored with some degree of decentralization imparted at the regional levels. That is to say, regional credit committees have been delegated independent credit approval limits and are therefore, authorized to approve credit within their respective limits. Supervisory approvals of Senior Credit Officer (s), CRM or the President/Group CEO becomes necessary only for credits which are either in excess of the assigned regional committee limits or possess ORR 6 rating or worse. However, in view of the control oriented regulatory environment, the need to exercise greater vigilance and tighter controls cannot be overemphasized. To address this, Risk Management has evolved a process to ensure that smaller credits are given the same degree of vigilance, due time and attention as the big ticket credits. Risk Management has therefore entrusted on itself, the responsibility to undertake sporadic credit reviews for relationships, which are approved at regional levels. Such an exercise will henceforth be referred to as “Non Reporting Limits Review” (NRL).

Before NRL reviews are initiated, it is imperative to lay the ground rules for the interest of both the businesses as well as Risk Management. Some of the rules are listed below

Time Frame: To start with, NRL review of every business unit shall be conducted once a year; the frequency may be subsequently lengthened as the process matures or reduced if sufficient vigilance does not appear to have been :exercised by a particular lending region.


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Degree of formality: To avoid overlap with RAR functions, the nature of the review would be restricted to an informal one with findings shared with the line management during the review. There will be no “pass” or “fail”. Units under review will not require to prepare/submit any data.

Authorized Reviewers: The review could be performed by the CRM, any SCO or a Review Officer from Risk Management.

Criteria for Sampling: All credits up to Rs.20m for SME and Rs.75m for CBG shall qualify for NRL reviews. However, Risk Management can also review credits beyond these limits, if need arises.

Notice Period: Since the idea is to check the credit quality impromptu, no formal notice period shall, as such, be given. Business units to be subjected to NRL reviews shall however, be informally advised a week before the review commences

Financial Cost: The travel cost of the Review officer(s) shall be split between the Unit under review and Risk Management. The former shall be charged for hotel/lodging while the latter will bear the airfare of reviewers.

9.3 Independent Auditors

Independent auditing firms, have the responsibility for examining the bank, and certifying the accuracy of the statements of financial condition. The audit is continuous and is performed in close coordination with the Central Finance Division. The independent auditors review, participate in, and check the internal audit process and also performs audits in selected areas. They may conduct surprise audits from time to time


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9.4 Special Credit Reviews

From time to time, Senior Management may wish to review various aspects of credit exposure. Accordingly, requests for information will be made by the Head of Risk Management, RMC or other authority with instructions regarding preparation

9.5 Response to Reviews

During the course of any internal or external examination, it is important that credit officers maintain an open line of communication with the examiner

a. Before external examiners leave a unit, any differences pertaining to classifications should be resolved

If a mutual agreement on classifications cannot be reached with an examiner, full details should be forwarded immediately to the Head of Risk Management and copy to the Business Head.

b. For internal examinations, management response to Risk Asset Review reports is due in ten working days. Management will include specific references to major items requiring remedial follow-up. The response to the review should be written and signed by the Head of the unit being reviewed or by a more senior officer

9.6 State Bank of Pakistan Inspections

State Bank of Pakistan, at its discretion, conducts periodic reviews of bank‟s credit portfolio, Operations and Treasury functions. Such inspections are carried out comprehensively with prior notice. State Bank chooses branches to be inspected. Inspections are coordinated by Head of Internal Audit or Compliance Unit at each branch During the course of such inspections Branch Managers, Regional Business Heads should maintain an open line of communication with the inspectors. If a mutual agreement cannot be reached with an inspector, full details should be forwarded to the Head of Internal Audit and the Head of Risk Management


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ANNEXURE I

RULES GOVERNING THE EXTENSION OF CREDIT

The Rules Governing the Extension of Credit (“Rules”) define the fundamental lending principles which all lending groups of KASB and its subsidiaries must follow when extending credit. The “Rules” codify the collective lending experience of KASB, and shall be revised from time to time to respond to changes in the risk characteristics of the market, to accommodate new products, and to reflect the on-going restructuring of KASB.

At present we shall work under one set of “Rules”, specifically designed for our lending activities encompassing Corporate and Small and Medium Enterprises (S&ME) groups. Separate sets of “Rules” will be established for our other business groups (Consumer, Branch Banking / Retail, Equities Trading / Investments) as we gain more experience in these areas.

Following is the broad spectrum of the “Rules”.

I. GENERAL RISK MANAGEMENT POLICIES

These policies provide for the development of a systematic and consistent approach to identify and manage risks contained in all products. The approach provides flexibility to each business to determine risk management processes and approval requirements that are appropriate for all transactions. These policies should guide the management of all Business Groups.

II. KNOWING YOUR CUSTOMER

Customers must be of good character. We want to deal only with those customers who will always meet their obligations in the marketplace in a timely and professional manner, and who maintain business and ethical standards that are compatible with those of KASB. Fundamental to risk management is our ability to know the customer well. A reasonable knowledge of our customers gives us a good idea of their strengths and weaknesses and permits us to define better the risks that arise in a transaction-oriented environment. Each Business Group is responsible for establishing criteria and setting standards for establishing account relationships with all customers.

One of the guiding principles in KASB‟s credit management process is the requirement to monitor, track and control in the appropriate unit (usually called the Control Unit) all the credit risks that we take with a customer or related group of customers. Unless a separate process or exception has been approved, it is the


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responsibility of any unit considering a transaction with a particular client to determine if there is any other credit relationship in the Bank with that client or any of its related entities and then to communicate appropriately, i.e. advise and/or seek approval.

III ACCOUNTABILITY

The Business Manager is responsible for the management of risk. The Risk Management Committee establishes the overall policies, approves procedures, and monitors on-going performance. Credit Officers, Relationship Managers, and other staff support are responsible to assist in the recognition and management of risk and ensure that a reasonable degree of consistency and control is developed in the risk management processes for similar products and risks among the various Business Groups. These supporting and controlling elements in our process do not remove the ultimate responsibility for risk management from the Business Managers, who are at the core of our decentralized risk management system.

IV. GENERAL REQUIREMENTS

A. Product Program

Traditionally, our products in the bank have involved generally similar risk characteristics, and are therefore, approved under uniform sets of rules on a transaction by transaction basis. As our business grows more complex and with the introduction of consumer finance, approval of Product Programs becomes more important so that policies and procedures can be tailor made to reflect the specific risk characteristics of the product. Such Product Programs will be reviewed annually. To the extent that transactions are not under an approved Product Program, they must be approved by the level of authority required for the amount involved under the “Rules”.

It is intended that the Product Program review process will be used to streamline and make more efficient our credit and risk management procedures. The process should cover as appropriate the following risks:

Product description;

Customer profile and/or target market identification and segmentation;

Policies and procedures to manage the risks;

Transaction approval process;


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Quantification of the amount to be approved;

Documentation guidelines;

Overall exposure limits and hedging procedures;

Legal, tax, regulatory, and accounting approvals;

Operating and control procedures;

Systems requirements; and

Risk versus return.

B. Product Program Approval

Product Programs shall be prepared by relevant Business Group responsible prior to offering the product to customers. In the absence of specific approval levels the approval requirements based on the amount of the expected maximum credit commitments, is:

Aggregate Amount Approval Level

Upto Rs.100 M One Credit Officer from the relevant Business Group and the Business Group Head plus one Senior Credit Officer (SCO).

Rs.100 M to Rs.300 M Approval level above and the Head of Risk Management.

In excess of Rs.300 M Approval level above and the President/CEO.

C. Risk Management

1. CREDIT RISK

Each Business Group which undertakes credit risk on its own authority must develop an appropriate process and support organization to judge and properly control such risks. The “Rules” will govern traditional lending risks including placement limits and foreign exchange.


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Where appropriate, Business Group should adopt their own rules which may be tighter but cannot be more liberal than the “Rules”.

2. PRICE RISK

The management and control of price risk is the responsibility of each Business Group in accordance with policies and procedures approved by the Group. Management and control of all foreign exchange interest rate and liquidity risks should follow the guidelines set by the Country Treasurer in the annual Funding and Limits Package.

Price risk can be managed by interest Rate Limits (IRL), volume limits to control net open position, risk points, sensitivity limits, stop loss limits or a combination of these.

Interest rate risk may result from the mismatch of the repricing date for assets and liabilities as well as unliquidated foreign exchange contracts. The Interest Rate Limit (IRL) serves to contain interest rate exposure from both positive and negative gaps.

Risk point limits are required for all financial futures activities, both trading and hedging, as well as for the trading of underlying cash securities, e.g. Government of Pakistan Securities.

3. FUNDING AND LIQUIDITY MANAGEMENT

Liquidity risk and interest rate risk are related, but because of different characteristics are managed separately. Liquidity is the ability to continuously meet all financial commitments when contractually due or needed. To avoid undue concentration of maturity or market share, it is critical to control the amount of funds that must be raised on any given day.

KASB is required to prepare a country funding and liquidity plan annually for final approval by the President/CEO and ALCO.

4. INDEPENDENCE/SEPARATION OF DUTIES

The concept of checks and balances has served the bank well. Business Managers, especially those with active trading and positioning responsibilities, should be sensitive to the clear requirement of separation of duties among trading, operations, accounting, and transaction approval.


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e. FIDUCIARY, LEGAL, TAX REGULATORY & COMPLIANCE RISK

Once any of these risks is identified in a particular product or business group, the Business Head after consultation with counsel and others, is responsible for designing and implementing a process with the appropriate controls to ensure that all applicable regulations are complied with and all such risks to the bank minimized. The Business Heads will review these aspects of the business at least annually.

6. SYSTEM RISKS

The Business Manager, after consultation with systems and operations experts, is responsible for installing systems and data processing equipment with the appropriate controls needed to ensure systems and operating risks are minimized.

V. RISKS AND DEFINITIONS

A. Credit Risk

1. LENDING RISK

Lending risk (direct and contingent) includes the risk associated with extensions of credit and/or credit-sensitive products, such as loans current/running placements, letters of credit, guaranties, etc. where the bank bears the full risk for the entire life of the transaction. The ultimate risk is that the debtor fails to repay principal and/or mark up when due or otherwise meets its obligations to the bank.

2. ISSUER RISK

Issuer risk occurs when the market value of a security or other debt instrument plus accrued interest changes when the issuer of the security does not pay at maturity or defaults in any other way prior to the maturity of the obligation.

3. COUNTER PARTY RISK

a. Trading (or Pre-settlement) Risk

Trading (or pre-settlement) risk occurs when a counter party defaults on a contractual obligation before the settlement date and the bank must then balance the position in the market with another


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counterparty at the then prevailing rate. The bank is exposed to possible adverse price fluctuations between the contract price and the market price on the date of default or ultimate cover.

b. Clean Risk at Liquidation or Settlement Risk

Clean risk at liquidation or settlement risk occurs when items of agreed upon original equal value are not simultaneously exchanged between counterparties and/or when items are released without knowledge that counter value items have been received by the bank. Typically the duration is intra-day, overnight/over weekend, or in some situations even longer. The risk is that we deliver but do not receive delivery. In this situation 100% of the principal amount is at risk. The risk may be larger than 100% if in addition there was an adverse price fluctuation between the contract price and the market price.

4. PERFORMANCE RISK

The ability/willingness of our customers to perform is a facet of all of the above credit risks. We incur specific performance risk in multiparty transactions, where the ability of a customer to meet its contractual obligations to another party is linked through KASB, especially in situations where there may not be any readily available trading market for the product. Depending on our role, that is, principal or agent, the bank may be exposed to the possibility of loss if one party fails to perform. In addition, there are systemic risks of the market itself, be it a clearinghouse, an exchange, etc.

B. Price Risk

1. INTEREST RATE/PRICE RISK

This is the impact of a movement in market interest rates on the price of the assets held in a portfolio, or a position undertaken without offsetting assets or other form of hedge.

a. Interest Rate Risk

One element of the risk is a change in the level of interest rates or prices. This includes underwriting risk related to being unable to meet sell-down targets for underwritten equity or debt issues, syndicated loans, private placements, etc., because of misjudgement in determining market conditions such as pricing, structuring,


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market demand for the issuer/borrower, or market events between the date of commitment and date of sell-down. A perceived change in the condition of the issuer/borrower might also impact the price.

b. Interest Rate Differential Risk

The second element of the risk relates to a change in interest rate differentials between different instruments and/or maturities. This includes all deliberate spread positions as well as the basis risk resulting from customer hedges which are covered with similar but not identical instruments.

2. NET FOREIGN EXCHANGE POSITION RISK

Wherever, within a given currency, all assets and unliquidated purchases on one side, and all liabilities and unliquidated sales on the other side, do not balance, we have either a net overbought or a net oversold foreign exchange position.

Borrowing in one currency, swapping the principal amount with forward cover into another currency, and investing this other currency involves accounts of interest payable and interest receivable in two different currencies. This also represents a net foreign exchange position, even though it is not initially reflected in the position book.

Any net foreign exchange position is exposed to the fluctuation of currency values against each other which can be caused by a multitude of economic and/or political events anywhere in the world.

C. Liquidity Risk

Liquidity risk arises when liabilities mature before assets. Such a portfolio is referred to as being in a “negatively gapped” position. The extent of the gapped position can be measured by the net outflow (liabilities and forward sales contracts less assets and forward purchase contracts) for each time period and the cumulative net outflow over time.

D. Country/Transfer Risks

Country risk refers to economic problems, political and geopolitical disturbances and sovereign actions in a given country which may


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make it impossible for KASB to recover, on schedule, exposure to residents of that country. This includes wholesale cross border expropriation, destruction by civil or external war of the relevant business activity, and the potential for those residents of a country not being able to acquire legally and/or transfer out appropriate currencies to service their external obligations.

E. Venture Capital/Equity Risk

These are the risks associated with KASB acting as long-term principal investor in equity, equity-like securities or other junior obligations.

F. Fiduciary Risk

Those risks in a fiduciary relationship which could result in losses include:

1. failure to establish clear agreement/guidelines in documentation, opening the KASB to charges of imprudent conduct;

2. failure to disclose all relevant information in documentation, opening the possibility for clients to argue that KASB breached a fiduciary duty;

3. a conflict of interest arising when there is an actual or potential conflict between KASB‟s own interests and its fiduciary responsibilities, or

4. acting in a manner subsequently determined by a judicial body to be inconsistent with governing documents or applicable laws.

G. Legal/Regulatory/Compliance Risk

1. DOCUMENTATION

These are risks that arise when documentation does not adequately protect the bank because it is either incomplete or unenforceable.

2. REGULATORY / STATUTORY

This is a risk that a transaction does not comply with all applicable laws and SBP imposed Prudential Regulations and therefore, KASB


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is exposed to possible civil, criminal and/or administrative sanctions as well as unfavourable publicity.

3. DISCLOSURE

These are risks arising from acting as agent, underwriter or advisor:

a. failure to disclose material information, including actual or potential conflict of interest;

b. disclosure of incorrect information.

c. disclosure of information without client authorization, or

d. an inadequate due diligence process.

4. LITIGATION

This is the risk of liability arising from being sued for failure to act or for taking improper action.

H. Systems Risk

These are some of the risks arising from operational aspects of the product (such as data processing, premises and facilities services, and telecommunications):

1. sufficient capacity;

2. threats to normal business operations;

3. disruption of services;

4. emergency conditions;

5. data integrity;

6. data security;

This is not intended to be an all-inclusive list. Other normal business risks, such as tax, competitive environment, personnel, etc., are to be found in every Business Unit and also must be addressed and managed by the Business Manager.


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VI. KASB SUBSIDIARIES

KASB subsidiaries must establish their own Corporate Credit Standards substantially in conformance with the present KASB credit standards. Such Corporate Credit Standards, any subsequent changes thereto, as well as appointment of Senior Credit Officers, must be approved by their respective Boards of Directors.

VII. INTERPRETATION/CHANGES

These Corporate Credit Standards should be interpreted and implemented in a conservative manner consistent with their underlying purpose. Should interpretation be required, the Head of Risk Management or a Member of the Risk Management Committee should be consulted. All credit officers will be held responsible for being thoroughly familiar with these Credit Standards, as well as the credit policy and procedure of their units. In addition, all credit officers should have a familiarity with all Pakistani banking regulations (Prudential Regulations).

Any change in these Corporate Credit Standards shall be approved by the Chairman Risk Management Sub-Committee.

The maintenance of a strong credit and risk management culture embodying sound fundamental credit practices has been our best protection over time against the risks created in our loan portfolio. But as KASB‟s activities have expanded into the multi-business financial services, the range of risks has broadened. Our continued ability to manage these risks effectively is critical to the success and long-term profitability of KASB.

VIII. EXCEPTIONS AND OTHER CONDITIONS

1. Credit with inferior security/charges shall be approved at the next higher level.

2. SME credits risk rated 6 or worse (obligor basis), regardless of the amount of exposure involved, shall require approval of the Business Segment Head, SME and one SCO.

3. Corporate Bank/Middle Market credits risk rated 6 or worse (obligor basis), SCO level approval shall be required as stipulated from time to time through bulletins or Delegation of Credit approval authority.


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4. Excesses over approved credit lines of borrowers may be permitted in exceptional cases but up to the maximum extent of 10% of that particular approved line or 10% of the respective Credit Committee‟s approval limit whichever is LOWER provided.

Borrower is not adversely classified.

Such excesses are regularized within 30 calendar days.

Such excesses are adequately secured.

5. Credit Committees shall have the authority to approve funded and/or non-funded credit facilities up to any extent provided such credit facilities are fully cash collateralized and meet the margin and other Prudential requirements as stipulated by State Bank of Pakistan from time to time.

6. All credit extensions must be documented through standard Credit Approval (CA) package.

IX. INDUSTRY CONCENTRATION LIMITS

Concentrations are probably the single most important cause of major credit problems. Credit concentrations are viewed as any exposure where the potential losses are large relative to bank‟s capital, its total assets or Bank‟s overall risk level. Credit concentration can be grouped roughly into two categories:

a) Single borrowers or counter parties, a group of connected counterparties

b) Sectors or industries, such as textiles, cement, oil & gas etc.

Management of concentration risk in category (a) above is governed by the Prudential Regulations which provides guidelines for Legal Lending Limits to single borrower and group exposures.

As far as the concentration risk in category (b) above is concerned, the following limit structure would provide the initial guidelines:

Textile Sector: Maximum 30% of the total loan portfolio

All other sectors: Exposure in any other industry sector should not exceed 15% of the Bank‟s total loan portfolio.


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COMMERCIAL BANKING RULES

A. GENERAL REQUIREMENTS

1. Approval:

Approval for all types of credit extension shall be evidenced on the credit approval summary or authorized approval document by the signatures or initials of the credit officers approving the credit. Any written commitment to extend credit must be executed by a credit officer with the Grade ____ or higher, unless special powers of attorney have been issued to other credit officers for this purpose.

2. Documentation:

Any deferral of the receipt of documentation required under credit agreements, or otherwise essential to the granting of credit, requires the approval of a Credit Officer of Grade ___; if such deferral is more than 90 days it must be approved at the same level as originally approved in accordance with Rule 3. Waiver of documentation or any material change in terms, conditions, or covenants of a credit as originally approved must be approved according to the level required by Rule 4 as determined by the amount of aggregate facilities.

It should be kept in mind that credit in the broadest sense encompasses any transaction which creates an actual or potential obligation to pay KASB. This includes risk perhaps not readily recognized, such as placements of treasury funds with other institutions, the purchase of checks or drafts and the delivery of negotiable instruments on consignment or in trust. Business managers in areas originating credit products defined in this broader sense will be responsible for preparing and obtaining proper approval of appropriate Rules for governing such products.

3. Three Initial System

Authority for credit extensions must have the joint approval of at least three credit officers. It is not intended that credit be extended on the judgment of one officer alone. A specific title by itself will not be sufficient to allow an officer to approve the extension of credit. Only those officers who have duties and responsibilities that involve the approval of loans and other


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extensions of credit are credit officers. The maximum lending limits of credit officers are described in Rule 4. These may be supplemented by specific delegations of lending authority, all of which should be based on rank, experience and proven ability.

4. Approval Levels.

KASB‟s credit approval process is decentralized but centrally monitored through established supervision credit approval limits.

Each Business Group has its own Credit Committees established along regional lines. Minimum quorum required for each of these Credit Committees is three credit Officers whose current positions involve responsibility for extending credit (Rule 3), and one of whom has a defined individual approving limit. Credit extensions exceeding the limit of any of a Credit Committee are referred to a Senior Credit Officer, the Head of Risk Management and /or the President/CEO.

Except as modified in these Rules, the minimum requirements for Credit approved are mentioned in the attached addendum.

5. Designation of Senior Credit Officers

A Senior Credit Officer may be designated by two Senior Credit Officers, with the concurrence of a Member of the Risk Monitoring Sub-Committee, the President/CEO and the Chairman, Risk Monitoring Sub-Committee. Those appointed shall have been in grade ___ or equivalent for at least two years, and have a minimum of ten years relevant experience. Recommendation should stress the qualifications of a nominee in terms of his/her education, experience, skills and personal characteristics.

Senior Credit Officers are appointed on a year-to-year basis.

6. Tenor and Review of Credit Facilities

Short-term credit extensions, including lines of credit, shall expire one year from date of approval unless an earlier expiration is specially provided. Term extensions of credit must be reviewed at least annually by three officers with direct responsibility for administration of the credit under review, one of whom must have an authorized or delegated credit limit sufficient to cover the aggregate outstandings of the client involved.

7. Credit to Newly Established Enterprises or to Borrowers in New Industries


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Facilities of Rs, 25,000,000 or more to newly established enterprises or to companies in relatively new industries require supervisory approval of one Senior Credit Officer.

7(a) Sole Bankers Issue

As a matter of policy, we do not want to be sole bankers to any borrowing customer. One of the criterion of accepting any new borrowing customer into our portfolio is that we do not assume the role of sole bankers. This leaves us with borrowing customers with whom we have “long” and established sole banker relationship. We do not want us to radically change this arrangement. A careful review of such situations must be undertaken by every Regional Corporate team, and appropriate strategies should be forged for sole banker relationships. Time frame be chalked out a gradually exit from such situations, overtime. This may involve Relationship Managers to identify/introduce another bank to the customer or politely suggest to the customer to look for another bank themselves. Exceptions to this policy may however, be accommodated at next higher approval level with extreme discretion.

8. Inferior Position

All extensions of credit to borrowers in situations where we are in an inferior position to that of other lenders extending similar credit facilities must be appropriately highlighted in the approval documented and approved at the required level.

9. Approval and Review of Adversely Classified Credit Facilities

Adversely classified credit facilities inherently involve greater risks than facilities, which are current. Therefore, approval procedures must be more restrictive. The minimum approved requirements for all adversely classified credit facilities risk rated 7 (WATCHLIST) or worse.

Aggregate Account of exposure

Approval Level

Upto Rs, 25,000,000 (i) Next higher level than would normally require. If the next higher level in approval chain is an SCO, then one SCO must sign.


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Rs. 25,000,000 – Rs, 50,000,000 (ii) Approval level above plus one SCO

Rs, 50,000,000 – Rs, 100,000,000

(iii) Approval level (i) plus two SCOs and the Head of Risk Management*

In excess of Rs, 100,000,000

(iv) Approval level (iii) and the President/CEO**

* as the Head of Risk Management is also an SCO he may sign once but will represent his dual capacity

** in the absence of the President/CEO the Head of Risk Management will also exercise the credit approval authority of the President/CEO.

Regardless of the scheduled review date, any credit facility adversely classified including loans, commitments, lines of credit and contingent liabilities should be referred to the next higher level of approval authority for review and development of future strategy immediately. Credits classified II (Sub-Standard) or worse other than those assigned to Special Assets Management Group must be reviewed monthly and credits classified IA (WATCHLIST) at least quarterly by the appropriate level of approval authority as described in this Rule.


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Annexure 1 – CA Approval


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Annexure 2 – ORR


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Annexure 3 – BIR


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Annexure 4 – Management Assessment Form


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Annexure 5 – Financial Spreads


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Annexure 6 – Credit Memorandum


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Annexure 7 – PR Checklist


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Annexure 8 – BBFS


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Annexure A – Classification Memorandum

credit policy manualkasb

Documents

credit program

credit policies

credit transactions

credit management models

credit approval authority

types of credit officers

eligibility credit officers

level of credit authority