CREDIT RISK MANAGEMENT OF LAXMI BANK LIMITED

A Project Work Report

Submitted By
…………
TU Reg. No:……………………….
TU Symbol No:…………..
Herald International College

Submitted to;
The Faculty of Management
Tribhuvan University
Kathmandu

In Partial Fulfillment of the Requirements for the Degree of

BACHELOR OF BUSINESS STUDIES (BBS)

Basundhara, Kathmandu
February, 2022
 Declaration

I hereby declare that the project work entitled Credit risk management of Laxmi bank
limited submitted to the faculty of Management, Tribhuvan University, Kathmandu is an
original piece of work carried out under the supervision of Mr……………………….,
faculty member, of Herald International College and is submitted in partial fulfillment of
the requirements for the degree of Bachelor of Business Studies (BBS). The Project Work
Report hasn’t been submitted to any other university or institution for the award of any
degree.

……………………
Name of student
Date:…….

ii
 Supervisor's recommendation

The Project of report entitled CREDIT RISK MANAGEMENT OF LAXMI

BANK LIMITED submitted by ………….of HERALD INTERNATIONAL COLLEGE
BASUNDHARA, is prepared under my supervision as per the procedure and format
requirements laid by the Faculty of Management, Tribhuvan University, as partial
project. The work has been prepared for the completion of BBS course of TU. The study
is original and carries useful information in the concerned area.

I, therefore, recommend the project work report for evaluation.

………………………….
Supervisor
Herald International College
Date:……….

iii
 Endorsement

We hereby endorse the project work report entitled CREDIT RISK MANAGEMENT
FOR LAXMI BANK LIMITED submitted by ……….. of HERALD INTERNATION
COLLEGE, BASUNDHARA , in partial fulfillment of the requirements for award of the
Bachelor of Business Studies (BBS) for external evaluation.
Approved by

………………………….. ……………………………..
(Prem Kumar Bisowkarma) (Narayan Prasad Upadhyay)
Chair of Management Research Committee) Campus Chief
Herald International College Herald International College
Data: Data:

iv
 Acknowledgement

This report entitled “Credit risk management of Laxmi bank limited” has been
prepared in partial fulfillment for the degree of Bachelors of Business Studies (BBS)
under the course designed by the Faculty of Management, T.U. This study is based on the
prescribed research format involving the deposit collection made in fixed account and
current account.

At the time of preparing this study, I have consulted with various personalities. So I
would like to extend my sincere thanks to all whose works and ideas helped me in
conducting the study. Sincerely, I would like to pay my sincere gratitude to my report
advisor ………(Teacher Name) of …………. Campus who guided through research
work with providing valuable suggestions, supports and supervision.

Finally, I would like to offer my profound gratitude to my family members, my friend,

colleagues, and well-wishers for their encouragement and support during the entire period
of my study.

__________________
Name of student
Herald International College

v
 TABLE OF CONTENTS
Title page…………………………………………………………………………………….………i
Declaration ......................................................................................................................... ii
Supervisor's recommendation ............................................................................................ iii
Endorsement ...................................................................................................................... iv
Acknowledgement ................................................................................................................v
Abbreviation ..................................................................................................................... viii
List of Tables ...................................................................................................................... ix
List of Figures ......................................................................................................................x
CHAPTER I ........................................................................................................................ 1
INTRODUCTION .............................................................................................................. 1
1.1 Background of the study ........................................................................................... 1
1.2 Profile of the Company ............................................................................................. 6
1.3 Objective of the Study .............................................................................................. 8
1.4 Rational of the Study ................................................................................................ 8
1.5 Literature Review ..................................................................................................... 9
1.5.1 Conceptual review ............................................................................................. 9

1.5.2 Review of Previous Study................................................................................ 10

1.6 Research Gap .......................................................................................................... 14

1.7 Research Methodology ........................................................................................... 14
1.7.1 Research design ............................................................................................... 14

1.7.2 Population and sample ..................................................................................... 14

1.7.3 Nature and sources of data ............................................................................... 14

1.7.4 Data analysis tools ........................................................................................... 15

1.8 Limitations of the Study ......................................................................................... 16

1.9 Report Structure ...................................................................................................... 17
CHAPTER II ..................................................................................................................... 18
RESULT AND ANALYSIS ............................................................................................. 18
2.1 Data presentation & Analysis ................................................................................. 18
2.1.1 Trend of Capital Adequacy Ratio .................................................................... 19

vi
 2.1.2 Trend of Cash Reserve ratio ............................................................................ 20

2.1.3 Trend of Non-Performing loan ........................................................................ 21

2.1.4 Bar Graph of Credit risk indicators .................................................................. 22

2.1.5 Pie Chart of credit risk management ................................................................ 23

2.2 Analysis of Results ................................................................................................. 25

2.3 Findings .................................................................................................................. 25
CHAPTER III ................................................................................................................... 26
SUMMARY AND CONCLUSION ................................................................................. 26
3.1 Summary ................................................................................................................. 26
3.2 Conclusion .............................................................................................................. 27
3.2 Recommendations ................................................................................................... 27
References ......................................................................................................................... 27

vii
 Abbreviation

CAR: Capital adequacy Ratio

CB: Commercial Bank
CRR: Cash Reserve Ratio
NI: Net Income
NPL: Non-performing loan
ROA: Return on Assets
ROE: Return on Equity

viii
 List of Tables

Table 1 Calculation of Mean and Standard deviations .................................................... 18

ix
 List of Figures

Figure 1: Trend analysis of capital adequacy ratio ........................................................... 19

Figure 2: Trend of cash reserve ratio ................................................................................ 20
Figure 3 Trend analysis of NPL ........................................................................................ 21
Figure 4: Bar graph of Credit risk indicators .................................................................... 22
Figure 5: Pie chart of Capital Adequacy Ratio ................................................................ 23
Figure 6: Pie chart of CRR................................................................................................ 23
Figure 7: Pie chart of NPL ................................................................................................ 24
Figure 8: Mean of Credit Risk Indicators ........................................................................ 24

x
 1

CHAPTER I

INTRODUCTION

1.1 Background of the study

Management of bank risks is the most important factor for financial stability and
economic growth in the developed economies (Roger, 2003). Management of tradeoff
between risks and return is important for sustainable profitability of banks and other
financial institutions. Among risks in banking operation credit risk which is related to
substantial amount of income generating assets is found to be important determinants of
bank performance. So, credit risk management capability of a bank remained a live
managerial discourse in financial management and overall health of financial institutions
depend upon the proper management of credit risk. The risk focused examination process
has been adopted to direct the inspection process to the more risk areas of both operation
and business.

Credit risk is considered as greater risk from all other risk affecting in the
financial performance of bank. Policies, industry specific standards and guidelines,
together with risk concentration limits are designed under the supervision of risk
management committee. The profitability ratios used to measure how well a business is
functioning in terms of profit. As market conditions change rapidly, adequacy and
effectiveness of internal controls should be reviewed regularly to manage the credit risk
effectively. Risk management is defined as the process that bank puts in place to control
its financial exposures (Chatterjee, 2005).

Risk management is essential for the survival of a bank and this enables the
management to allocate resources of the risk units based on a compromise between risk
and potential return. The diversity of the business and economic conditions has led to the
development of highly sophisticated tools and models to measure the exposure of a
financial institution to credit risk. Incase of an individual loan portfolio, the probability of
default, loss given default or credit rationing are the most commonly used ones to
measure the exposure to credit risk. The invention of various credit scoring models that
 2

use observed loan applicants’ characteristics either to calculate a score representing the
applicant ‘s probability of default or to sort borrowers into different risk classes bring the
ability to address credit risk on a new level (Mekasha, 2011). Good risk management is
not only a defensive mechanism but also an offensive weapon for commercial banks and
this is heavily dependent on the quality of leadership and governance. Financial
institutions are exposed to a variety of risks among them; interest rate risk, foreign
exchange risk, political risk, market risk, liquidity risk, operational risk and credit risk
(Yusuf, 2003). Banks that are primarily exposed to credit risk, result in the reduction of
their profitability.

Some financial institutions have collapsed or experienced financial problems due

to inefficient credit risk management systems typified by high levels of insider loans,
speculative lending, and high concentration of credit in certain sectors among other
issues. The definition given by Basel (1999) who defines it as the potential that debtor of
counter party default in satisfying contractually predetermined obligation according to the
agreed up on terms. Because failure of trading partner to repay its debt in full can
seriously damage the affair of the other partner, credit risk always has been the vicinity of
concern throughout the world (Achou and Tengah, 2008). Credit risk management
practices and poor credit quality continue to be a dominant cause of bank failures and
banking crises worldwide. Again, financial institutions have faced difficulties over the
years for a multitude of reasons, the major cause of serious banking problems continues
to be directly related to lax credit standards for borrowers and counterparties, poor
portfolio risk management, or lack of attention to changes in economic or other
circumstances that can lead to a deterioration in the credit standing of a bank’s
counterparties (Diaz, 1994).

Credit is the amount of money lent by the creditors (banks) to the borrower either
on the basis of security or without security. Credit and advances is an important item on
the asset side of the balance sheet of commercial bank. Bank earns interest on credit and
advances which is one of the major sources of income for banks. Bank prepares credit
portfolio; otherwise, it will not only effect debts but also affect profitability adversely
(Varshney and Swaroop, 1994). Credit is regard as the most income generating assets
 3

especially in commercial bank. It also regarded as the heart of commercial bank in the
sense that, it occupies large volume of transactions. It covers the main part of investment.
It is the main factor for creating profit and determining the profitability. It should affect
the overall economy. While the commercial banks have faced difficulties over the years
for a multitude of reasons, the major cause of serious financial problems continues to be
directly related to credit standards for borrowers, poor portfolio risk management or lack
of attention to change in the economic circumstances and competitive climate (NRB,
2014). The credit decision should be based on thorough evaluation of the risk conditions
of the lending and the characteristics of the borrower. The profitability of the banking
sector has received attention always greatly in recent years. Nowadays there is a vast
empirical literature which examined the relationship between credit risk management and
bank profitability.

Credit in finance is a term used to denote transaction involving the transfer of

money on other property on promise of repayment, usually at a fixed future date. “In
economics, the term credit refers to a promise by one party to pay another for money
borrowed or goods or services received. It is a medium of exchange to receive money or
goods on demand at some future date” (Francis, 2002). Credit is financial asset resulting
from the delivery of cash or other assets by a lender to a borrower in return of obligation
repay or specified date on demand.

Banks as financial intermediation institutions are defined as business that receive

and manage various risks. Banking risk management is the most important factor for
financial stability and economic growth in developed economies. The increase in the
credit risk will increase the marginal cost of debt and equity which translates rising costs
of funds for the bank. Profitability is the main concern of banks. Profitability ratios serve
to measure the success of the bank. The importance of strong credit risk management for
building quality loan portfolio is of paramount importance to robust performance of
commercial banks as well overall economy of Nepalese commercial banks (Santimero,
1997).

Credit risk management is an important predictor of bank financial performance

(Poudel, 2012). Thus success of bank performance depends on effectiveness of credit risk
 4

management. Default risk is one kind of investment risk of non-payment of loan at the
fixed future date. In Nepalese context, when interest rate is increased it causes the
decreases in economic activities as well as capacity of borrower. Sometimes debtor
knowingly does not pay back the loan, and invest the loan in unproductive sector. Such
kind of activities occurs continuously, if there is lack of sound credit policy improper
credit analysis, lack of information about loan holders and lack of regular supervision. So
banks should formulate and implement sound credit policy. Loan approval and
disbursement process should be conducted in better way proper credit analysis and
regular supervision can control the credit risk (Chatterjee, 2005).

Credit risk involves inability or willingness of a customer or counterparty to meet

commitments in relation to lending, trading, hedging, settlement and other financial
transaction. “Credit risk is generally made up of transaction risk or default risk and
portfolio risk” (Santimero, 1997). The portfolio risk in turn comprises intrinsic and
concentration risk. The portfolio risk depends on both external and internal factors. The
external factors are the state of economic, wide swings in commodity, equity prices,
foreign exchange rate and interest rates, trade restrictions, economic sanctions,
government policies etc.

Another variant of credit risk is counter party risk which comes from none
performing of a trading partner. The nonperformance may arise from counter party’s
refusal to perform due to an adverse price movement caused by systematic factors or
from some other, political or legal constraints that was not anticipated by the principals.

The credit risk is the potential financial loss resulting from the failure of
customers to honors fully the terms of loan or contract. On the other hand, the market risk
includes balance sheet risk and trading risk such as potential risk to earn and capatal
resulting from changes in interest rate liquidity conditions, impact of foreign exchange
rate fluctuations etc. Meanwhile operating risk arises from the natural disasters, errors in
processing and settlement of transactions safeguarding assets, system failure, fraud and
forgery. Therefore, portfolio management helps to minimize or manage the credit risk by
spreading over the risk to various portfolios. These methods of managing credit risk are
guided by the saying “Do not put all the eggs in a single basket” (Bhandari, 2004).
 5

Credit risk is defined as the possibility that a borrower will fail to meet its
obligations accordance with the agreed forms and conditions. Credit risk is not restricted
to lenders doing activities only, but includes off balance sheet and inters bank exposures.
The goal of credit risk management is to maximize the bank risk adjusted rate of return
by maintaining the CRE within acceptable parameters. For most banks, loan is the largest
and most oblivious resources of credit. However other sources of credit risk exist
throughout the activities of bank including in the banking book and in the trading book
and also in both on and off-balance sheet. Banks are increasingly facing credit risk or
counterpart risk in various financing, foreign exchange transaction and guarantee and the
settlement of transactions (Santimero, 1997).

In today's context, it also effects on national economy in some extent because if

the bank provides credit to retailer, it will make the customer status. Similarly, it provides
cash to trade and industry too. The government will get tax from them and help to
increase national economy. It is also the security against depositors. It is supposed from
the very beginning that, credit is the wealth maximization derivative. However, other
factors can also affect profitability and wealth maximization but the most effective factor
is regarded as credit risk. It is the most challenging task because it is the backbone in
commercial banking. Thus, effective management of credit should seriously be
considered. Credit extended to borrowers may be at the risk of default such that whereas
banks extend credit on the understanding that borrowers well repay their loans, some
borrowers usually default and as a result, banks income decrease due to the need to
provision for the loans. Where commercial banks do not have an indication of what
proportion on their borrowers will default, earnings well vary thus exposing the banks to
an additional risk of variability of their profits. So, the study focuses on the following
problem.

What is the trend of credit risk on Laxmi Bank Limited?

Is bank properly managing the credit risk indicators?

 6

1.2 Profile of the Company

Laxmi Bank Ltd. was incorporated in April 2002 as the 16th commercial bank in
Nepal. In 2004 Laxmi Bank merged with HISEF Finance Limited, a first generation
financial company which was the first merger in Nepali corporate history. Further, the
bank acquired Professional Diyalo Bikas Bank in January 2017, a class “B” development
bank.

Today, through its branches and a host of IT enabled channels, the Bank serves a
wide range of customers. Despite a relatively short history, Laxmi Bank has emerged as a
major player across all business lines – retail, midmarket, corporate, infrastructure and
treasury. The Bank is widely recognized as one of the best-managed banks in Nepal with
high standards of corporate governance culture, risk-management systems and a strong
technology.

Laxmi Bank’s microfinance subsidiary – Laxmi Laghubitta Bittiya Sanstha Ltd, a

category D financial institution licensed by Nepal Rastra Bank is in operation since
2012.Similarly, Laxmi Bank’s investment banking subsidiary – Laxmi Capital Market
Ltd, licensed by the Securities Board of Nepali’s offering various merchant and
investment banking services since February 2009. Laxmi Capital also manages Laxmi
Value Fund – 1 and Laxmi Equity Fund, the two Mutual Funds sponsored by Laxmi
Bank, both of which are listed and traded at the Nepal Stock Exchange.

The Bank closed the previous financial year 2020/21 with a balance sheet size of
NPR 152 billion that includes deposits and risk assets of NPR 117 billion and NPR 108
billion respectively. All key financial indicators of the Bank are well within prudential
and regulatory norms.

Our Vision

We will be the Bank of choice for a growing, vibrant Nepal – reaching and
enriching households, businesses and communities.
 7

Our Mission

 We believe relationships are more important than transactions and will strive to
offer the best customer experience keeping our clients at the front and center in
order to realize their economic potential.
 We will expand physically and digitally to allow customers to access us through
the channel of their choice and leverage technology to help make banking smart,
simple and secure.
 We believe in responsible banking and adopt high standards of governance,
transparency, ethics and integrity across the company.
 We understand our responsibilities extend beyond financial services and will
actively invest in the communities where we operate and work towards being a
green company reducing our carbon footprint for a sustainable future.
 We will use the power of people and ideas to create sustainable value to all our
stakeholders through one engaged and empowered team.
 8

Major Shareholders

Major Shareholders Percentage

Laxmi Corp Nepal Pvt. Ltd. 14.60%

Sneha Khetan 11.30%

Citizen Investment Trust 8.68%

Sarika Khetan 7.82%

1.3 Objective of the Study

The main objective of the study is to fulfill the partial requirement of T.U to complete
BBS project. The objective of this fieldwork is to analyses of saving deposits of Laxmi
Bank Limited. The study intends to present a brief and clear picture of credit risk
management and its utilization. The objective of the study includes.

 To examine the credit risk trend of Laxmi Bank Limited

 To analyses the credit risk management
 To analyses whether the credit risk management are being properly managed or
not.

1.4 Rational of the Study

The study tries to clear the importance for regulators, industry participants and
investors. So, Credit risk management has jumped to the forefront of risk management
activities carried out by commercial banks. It is designed to shed light on the current loan
 9

practices and its effect on banks. It is served as a reference material for research along
similar topics.

1.5 Literature Review

1.5.1 Conceptual review

Simply, Bank is a financial institution that accepts deposits and invests the
amount in the lending activities and also provides commercial services. In ancient times,
the word 'Bank' was emerged from Latin word 'Bancus', French word 'Banque' and Italian
word 'Banca', which means a 'Bench' where sitting over there to invest, exchange and
keep record of money and cash. These all functional activities are formed as current
banking activities.

Different Authors and Economists have given some structural and functional
definition on Bank from different angles:

"Bank is and institution which collects idle money temporarily from the public and lends
to other people as per need"…R.P. Kent

"Bank is such a financial institution which collects money in current savings or fixed
deposit account, collects cheque as deposits and pays money from the depositors' account
through cheque"…Sir John Pagette.

The word 'Bank' refer as Central bank, Commercial bank, Development bank,
Exchange bank, Saving bank, Co-operative bank, Merchant bank, Housing bank,
Equipment bank, Infrastructure bank and Mutual fund etc. They provide financial as well
as non-financial services. It is the financial intermediary between depositors or lenders
and withdrawal or loaner. Bank plays a great role that helps investors to invest in
different sectors by giving a loan and providing other consultancy and agency services.
Thus the word 'Bank' itself provides huge sense of banking activity.

Credit risk management is one of the main issues of modern financial institutions
with recent dramatic growth in retail credit and increase in volatility of real economy.
This is the risk of financial loss due to the applicants’ failure to pay the credit back.
 10

Financial institutions and banks are trying to deal with the credit risk by determining
capital requirements according to the risk of applicants and by minimizing the default
risk with using the statistical techniques to classify the applicants to ‖good‖ and ‖bad‖ risk
classes.

Common credit risk types that are described in literatures as follows:

Default risk: this is commonly understood as the unwillingness or inability of an

obligor to payback his debt in timely manner and quantified by probability of default
(PD) that takes value between 0 and 1. The default definition can seriously impact on the
PD and other components of credit risk quantifications while minor difference among
default estimation stem from methods used.

Migration risk: as discussed above, it is risk that is connected with deterioration of

counterparty’s creditworthiness. It is known as downgrading risk when borrowers has
been rated by public credit rating and the institution that issued the grade might
downgrade the counterparty.

Spread risk: this is the risk associated with arise in the spreads required of
borrowers by the market; in the event of increased risk aversion by investors, the spread
associated with a given probability of default may increase; in such a case the market
value of the securities declines ,without any reduction in the issuer’s credit rating.

Recovery risk: indicates the risk that actual estimated recovery rate that is for a
insolvent counterparty will be less than the rate that is estimated originally. This is could
be because of the liquidation process takes longer time than estimated or value the
counterparty is liquidated is lower than anticipated and so on.

1.5.2 Review of Previous Study

Bhattarai (2016) examined the effect of credit risk on performance of Nepalese

commercial banks. The descriptive and causal comparative research designs have been
adopted for the study. The pooled data of 14 commercial banks for the period 2010 to
2015 have been analyzed using regression model. The regression results revealed that
'non-performing loan ratio' has negative effect on bank performance whereas 'cost per
 11

loan assets' has positive effect on bank performance. In addition to credit risk indicators,
bank size has positive effect on bank performance. Capital adequacy ratio and cash
reserve are not considered as the influencing variables on bank performance. This study
concludes that there is significant relationship between bank performance and credit risk
indicators.

Subedi (2018) studied on the title “Risk Management Practices: Evidence from
Commercial Banks of Nepal” on the objectives of analyzing the risk management
practices of commercial banks of Nepal. Father, the study has explored the level of
understanding on risk and its management along the components of risk management
system. The study is based on questionnaire survey of 120 banking officials from 20
different banks. The empirical evidence has suggested that Nepalese banks regard credit
risk as the major source of risk followed by operational risk and interest rate risk,
respectively. Inspection by risk manager, financial statement analysis, audit or physical
survey and risk survey respectively are four major risk identification methods. In
addition, the study has revealed that the six explanatory variables in understanding of risk
and its management i.e., board and senior management’s oversight, credit risk
management practices, risk identification, risk assessment and measurement, risk
monitoring and ownership structure do have the significant relationship with the risk
management practices.

Shah (2019) examined on the title “Credit Risk Management of Commercial

Banks in Nepal”. The study is primarily focused on credit risk assessment practices in
commercial banks on the basis of their internal efficiency, assessment of assets and
borrower. The model of the study is based on the analysis of relationship between credit
risk management practices, credit risk mitigation measures and obstacles and loan
repayment. Based on a descriptive research approach the study has used survey-based
primary data and performed a correlation analysis on them. It discovered that credit risk
management practices and credit risk mitigation measures have a positive relationship
with loan repayment, while obstacles faced by borrowers have no significant relationship
with loan repayment. The study findings can provide good insights to commercial bank
managers in analyzing their model of credit risk management system, policies and
 12

practices, and in establishing a profitable and sustainable model for credit risk
assessment, by setting a risk tolerance level and managing credit risks vis-a-vis the
prevailing market competition.

Pradhan and Shah (2020) studied on the title “Credit Risk Management of
Commercial Banks in Nepal” with the objectives of credit risk assessment practices in
commercial banks on the basis of their internal efficiency, assessment of assets and
borrower. The model of the study is based on the analysis of relationship between credit
risk management practices, credit risk mitigation measures and obstacles and loan
repayment. Based on a descriptive research approach the study has used survey-based
primary data and performed a correlation analysis on them. It discovered that credit risk
management practices and credit risk mitigation measures have a positive relationship
with loan repayment, while obstacles faced by borrowers have no significant relationship
with loan repayment. The study findings can provide good insights to commercial bank
managers in analyzing their model of credit risk management system, policies, and
practices, and in establishing a profitable and sustainable model for credit risk
assessment, by setting a risk tolerance level and managing credit risks vis-a-vis the
prevailing market competition.

Alshatti (2020) analyzed on the title “The effect of credit risk management on
financial performance of the Jordanian commercial banks”. This research aims at
examining the effect of credit risk management on financial performance of the Jordanian
commercial banks. During the period (2005-2013), thirteen commercial banks have been
chosen to express on the whole Jordanian commercial banks. Two mathematical models
have been designed to measure this relationship, the research revealed that the credit risk
management effects on financial performance of the Jordanian commercial banks as
measured by ROA and ROE. the researcher recommends banks to improve their credit
risk management to achieve more profits, in that banks should take into consideration, the
indicators of non-performing loans/Gross loans, Provision for facilities loss/Net facilities
and the leverage ratio that were found significant in determining credit risk management.
Also, banks should establish adequate credit risk management policies by imposing strict
credit estimation before granting loans to customers, and banks in designing an effective
 13

credit risk management system, need to establish a suitable credit risk environment;
operating under a sound credit granting process, maintaining an appropriate credit
administration that involves monitoring, processing as well as enough controls over credit
risk, and banks.

Buchadadi et al. (2020) examined the influence of credit risk and capital adequacy
of a rural bank on financial distress, proxied by interest coverage ratio (ICR). Samples
used in this research are 123 rural banks located in the Jakarta metropolitan area from
2013 to 2018. In this area, almost 70% of cash flow circulation in Indonesia was
happening. The logistic regression model was employed to analyze the collected data.
The findings show that both credit risk and capital adequacy had significant influences on
financial distress, with positive and negative effects, respectively. Realizing the important
role of credit risk and capital adequacy, this study makes some suggestions that rural
banks should utilize both variables as a measure to monitor their financial performance.

Aduda and Obondy (2021) studied on the title “Credit Risk Management and
Efficiency of Savings and Credit Cooperative Societies: A Review of Literature” for the
objectives to conduct literature review on how credit risk management impacts efficiency
and to identify the knowledge gaps in the relationship between the two variables. From
the empirical studies reviewed, credit risk management was found to influence financial
performance but there is no concrete evidence on the relation that credit risk management
has with efficiency of SACCOs. The previous studies have mostly focused on financial
performance instead of efficiency and they also differ on the direction of the relationship
between the two variables. The difference in findings among the scholars might arise
from methodological differences and operationalization of the study variables. Contextual
differences might also explain the inconsistent findings as most of the studies have
focused on commercial banks and in different economies.
 14

1.6 Research Gap

Generally in the previous report focuses on the relating to comparative financial

analysis of Profitability, Importance of Credit Risk and capital adequacy. But this report
is mainly focused on the study of credit risk management of Commercial Bank in Nepal.
So, this study focuses on the Credit risk management of Laxmi bank limited. Where the
capital adequacy ratio, Non-performing loan and Cash reserve ratio has been taken as
main indicators of credit risk.

1.7 Research Methodology

Any systematic research requires a proper and scientific methodology to achieve

the set objectives. This chapter provides the methodology followed to achieve the
objective stated in this research work

1.7.1 Research design

. A research design is an overall framework or plan for the collection and analysis
of data. The research design serves as framework for the study, guiding the collection and
analysis of the data. Design sets up the framework for adequate tests of the reactions
among variables. It tells us about, what observations to make, how to make them and how
to analyze the quantitative representation of the observation. So, this research is followed
descriptive research design.

1.7.2 Population and sample

The population and sample of the study is taken among the 27 commercial bank
only one bank is taken a sample of the study.

1.7.3 Nature and sources of data

All the data are secondary sources of data. This was taken from websites of
concern banks. Many more information are collected from the different journals,
bulletins, internet etc.
 15

1.7.4 Data analysis tools

In order to collect the data, annual reports published by banks NRB, economic
report and other published statistical data have been used, and to obtain the additional
information, informal talks and procedures has been used. Similarly, information may be
collected from bulletin, booklets and journals published from relevant banks and other
external sources also have been used.

The secondary data are those which have been already collected by someone and
already been passed through the statistical process. Thus, the sources of secondary data
are journals, newspaper, government material related to the study; master degree thesis
related to this research, book related to financial management and different related web
sides. Hence, data collection procedures consist both the way of data collection
procedures.

Arithmetic Mean (A.M.)

The mean is the figure we get the total of all the values in a distribution is divided
by the number of values in a distribution is divided by the number of values in the
distribution. The arithmetic mean is also known as average. It should, however, be
remembered that the mean can only be calculated for numerical data. The mean is an
appropriate term than saying average. The mean of data is biased toward extreme values.
The mean is suitable when the sores are distributed symmetrically about the center of the
distribution.

Sum of total numbers (Ʃx)

𝐴𝑀 (𝑋̅) =
Number of samples (n)

Standard Deviation (S.D.)

The measurement of the scatterings of the mass of figure in a series about an

average is known as dispersion. The standard deviation measures the absolute dispersion.
The greater amount of dispersion, greater the standard deviation. A small standard
deviation means a high degree of uniformity of the observation as well as homogeneity of
a series and vice-versa.
 16

√Ʃ(x − x̅)2
𝑆𝐷 =
n

Coefficient of variation (CV)

The coefficient of variance is the relative measure of dispersion, comparable

across distribution, which is defined as the ratio of the standard deviation to the mean
expressed in percentage.

σ
𝐶𝑉 =
̅
X

Karl Pearson’s Correlation Coefficient (r)

If two quantities vary in such a way that movements in the one are accompanied
by movement in other, these quantities are correlated. The degree of relationship between
the variables under consideration is measure through the correlation analysis. Correlation
analysis only helps in determining the extent to which the two variables are correlated but
it does not tell us about cause and effect relationship.

Ʃ(X − x̅) (𝑌 − 𝑌̅)

𝑟=
√Ʃ(X − x̅)2 √(𝑌 − 𝑌̅)2

1.8 Limitations of the Study

The study has been subjected to the following limitations:

a) There are many factors that affect profitability and valuation of the financial
institutions. However, this study will concentrate only on Credit risk indicator of the
study.
b) Mostly, secondary data analyzed are only of a period of 5 years trend is considered
i.e. from 2016/17 to 2020/21. Hence the conclusion drawn confines only to the above
period.
c) The study is based on secondary data obtained from various sources. The reliability of
analysis depends on the reliability of the data.
d) Only three credit risk indicators is taken on a study ( CAR, NPL and CRR)
 17

1.9 Report Structure

A project work report has the following three chapters.

Chapter - I

It includes background of the study, objective of the study, rational, method, review of
literature, limitation of the study.
Chapter - II

It includes presentation and results and findings of project work.

Chapter - III

It includes a brief summary of the report and conclusion based on the figure of the report.
Lastly reference added at the end of this report writing.
 18

CHAPTER II

RESULT AND ANALYSIS

This chapter is focused with the analysis, presentation, interpretation and major
findings of relevant data of Sanima Bank Ltd. in order to fulfill the objectives of research
study. To obtain better result, the data's have been analyzed according to the research
methodology as mentioned in first chapter. The main purpose of this chapter is to
introduce the mechanics of data analysis and interpretation.

2.1 Data presentation & Analysis

In this chapter, raw data form of data which are collected from various sources are
processed and changed into an understandable presentation using the using the financial
as well as statistical tools as, mentioned in the previous mention.

Table 1 Calculation of Mean and Standard deviations

Year CAR `CRR NPL

2073/74 13.58 7.32 0.93
2074/75 12.43 6.57 1.29
2075/76 11.83 5.59 1.11
2076/77 13.02 8.29 1.04
2077/78 12.15 8.29 0.25
Mean 12.602 7.212 0.924
Standard 0.626 1.037 0.357

(Source: Annual report of Laxmi Bank limited)

In the given table 1 it shows that Capital adequacy ratio has been highest in year
2073/74 and lowest in 2075/76. Where Cash reserve ratio has been maximum value is
8.29 in year 2076/77 and 2077/78 respectively and minimum value at 2075/76 is 5.59.
Non-performing loan has maximum in 2074/75 is 1.29 and minimum in 2077/78 is 0.25
respective.
 19

2.1.1 Trend of Capital Adequacy Ratio

Capital adequacy ratio (CAR) is a measurement of a bank's available capital

expressed as a percentage of a bank's risk-weighted credit exposures. The capital
adequacy ratio, also known as capital-to-risk weighted assets ratio (CRAR), is used to
protect depositors and promote the stability and efficiency of financial systems around
the world. Two types of capital are measured: tier-1 capital also known as Core Capital,
The key element of capital on which the main emphasis should be placed is Tier 1 (core)
capital, which is comprised of equity capital and disclosed reserves, which can absorb
losses without a bank being required to cease trading, and tier-2 capital Supplementary
Capital, . The Supplementary (Tier 2).

Capital adequacy ratio (CAR) = Tier 1 capital + Tier 2 capital)

Risk weighted Assets

CAR
14

13.5 13.58

13 13.02

12.5 12.43
12.15
12
11.83
11.5

11

10.5
2073/74 2074/75 2075/76 2076/77 2077/78

Figure 1: Trend analysis of capital adequacy ratio

(Source: Annual report of Laxmi Bank limited)

In the given figure 1 seems that there was increase and decreasing conditions on
credit risk indicators. From 2073/74 to 2077/78 where the banks are increasing managing
their capital adequacy ratio. Where banks has minimum at CAR in 2075/76 and
maximum in 2073/74.
 20

2.1.2 Trend of Cash Reserve ratio

The Cash Reserve Ratio refers to a certain percentage of total deposits the
commercial banks are required to maintain in the form of cash reserve with the central
bank. Cash reserve ratio is one of the control variables used in analyzing effect of credit
risk on the performance of banks.

Cash reserve ratio (CRR) = Reserve Requirement

Bank Deposits

CRR
9
8.29 8.29
8
7.32
7
6.57
6
5.59
5

0
2073/74 2074/75 2075/76 2076/77 2077/78

Figure 2: Trend of cash reserve ratio

(Source: Annual report of Laxmi Bank limited)

In the given figure 2 shows the trend of CRR which is fluctuating in trend.
Whereas bank CRR is maximum in 2076/77 and 2077/78 respectively. Which mean that
the bank was able to maintain the liquidity and minimum at 2074/75 is 5.59.
 21

2.1.3 Trend of Non-Performing loan

Non-performing loan ratio reflects the bank's credit quality and is considered as
an indicator of credit risk management. NPLR, in particular, indicates how bank manage
their credit risk because it defines the proportion of loan losses amount in relation to total
loan amount. NPLR has been used as the default rate on total loan and advances. It is the
major indicator of commercial banks credit risk. It is expected that negative relationship
could be expected between non-performing loan ratio and profitability of commercial.

Non-performing loan= Non-performing loan

Total loan

NPL
1.4 1.29

1.2 1.11
1.04
1 0.93

0.8

0.6

0.4
0.25
0.2

0
2074 2075 2076 2077 2078

Figure 3: Trend analysis of NPL

(Source: Annual report of Laxmi Bank limited)

It seem that banks was decreasing and increasing trend shown in the given figure
3. Whereas bank has maximum NPL in 2074/75 and minimum in 2077/78. It means that
the banks are not properly maintain the NPL.
 22

2.1.4 Bar Graph of Credit risk indicators

Credit Risk Indicators

14

12

10

0
2073/74 2074/75 2075/76 2076/77 2077/78

CAR `CRR NPL

Figure 4: Bar graph of Credit risk indicators

(Source: Annual report of Laxmi Bank limited)

In the given figure 2 shows the bar graph of the credit risk management indicators
according to base on year. So, among the study CAR is highest in 2073/74 and lowest in
2075/76. Non-performing loan seem lower in every year which means that the banks is
running on the good condition and it can manage the required CRR ratio from the banks.
 23

2.1.5 Pie Chart of credit risk management

CAR

19% 21%

21% 20%

19%

2074 2075 2076 2077 2078

Figure 5: Pie chart of Capital Adequacy Ratio

(Source: Annual report of Laxmi Bank limited)

Above figure 5 show the CAR Ratio on the Pie chart. Where all the ratio has been
changed into the percentage based on the 360 degree. Where the maximum value in 2077
and 2078 ie 21% and lowest in 2074 and 2076 is19%.

CRR

23% 20%

18%
23%

16%

2074 2075 2076 2077 2078

Figure 6: Pie chart of CRR

(Source: Annual report of Laxmi Bank limited)
 24

In the given figures 6 shows the relationship CRR in every year. Which shows the
maximum value in 2078 and 2077 ie 23% and minimum at 2076.ie 16%.

NPL
5%
20%
23%

28%
24%

2074 2075 2076 2077 2078

Figure 7: Pie chart of NPL

(Source: Annual report of Laxmi Bank limited)

In the given figure 7 indicates the percentage of NPL of the banks. Which is
calculated and found that the maximum value in 2075 i.e. 28% and lowest value in 2078
i.e. 5%.

Mean
4%

35%

61%

CAR CRR NPL

Figure 8: Mean of Credit Risk Indicators

(Source: Annual report of Laxmi Bank limited)
 25

It seems that the figure 8 indicate the percentage of mean of credit risk
management indicators. Where capital adequacy ratio show the highest percentage
coverage, CRR show 35% ratio and reaming from Non-performing loan shows 4% on Pie
chart.

2.2 Analysis of Results

The result shows among the 27 commercial banks. Among them about Laxmi
bank limited has been taken as a sample of the study.

The result shows that the credit risk indicators are in increasing as well as
decreasing trend. Among them capital adequacy ratio has increasing in trend which
associated with the good performance. And CRR and Non-performing loan has
increasing so, it means that the banks are maintain the NRB directive of CRR.

2.3 Findings

The major finding of the study are listed as below:

 The Credit risk management indicators are increasing trend as well as decreasing
trend.
 The study found that the CAR ratio maximum at 2073/74 and 2077/78 and
minimum at 2075/76.
 The study found that CRR ratio was maximum in 2076/77 and 2077/78
respectively and minimum at 2074/75.
 The study found that there the maximum at 2074/75 and minimum at 2077/78.
 The study found that there was maintaining the risk indicators so the bank won't
be failure for the profit.
 The study found that the banks are maintaining the proper CRR which was
implement by NRB.
 The study found that the bank Non-performing loan has been maintain so, banks
are able to maintain the funding with the internal sources.
 26

CHAPTER III

SUMMARY AND CONCLUSION

3.1 Summary

The purpose of the study is explain the credit risk of Laxmi bank limited of Nepal.
Which determine the impact of credit risk indicator (capital adequacy ratio, cash reserve
ratio and non-performing loan). Whereas it shows the trend of the indicators among the
study period with mean, standard deviation with table and figure.

Capital adequacy ratio of the bank was statistically strong and which shows the
increasing trend of bank. So, the banks is considered safe and likely to meet its financial
obligation.

Cash reserve ratio of the bank was increasing and decreasing trend it means that
the banks able to maintain the requirement which is generally directed by the bank.
Generally, CRR is 3% which bank managing the properly which means they are able to
deposit into the bank.

Non-performing loan is increasing and decreasing trend. Which means the

increase in NPL is bank stock price will be decrease so, that the banks want to manage its
NPL. Decrease in NPL increase the stock price of the bank so, bank always want to
manage the NPL.

From the above study it shows that the commercial bank has changes with the
flow of different time frame. Where the investor has to make a decision to invest in the
banks. So that .The current study investigates the credit risk management the capital
adequacy ratio, cash reserve ratio and non-performing loan. However, from the above
evidence provided in this study based in the empirical finding, shows that sound credit
risk management strategies and enhanced capital requirement can promote banks
profitability.
 27

3.2 Conclusion

The study is conducted on analysis of credit risk management of Laxmi bank, which is
one of the lending banks in Nepal. Laxmi bank has been maintaining the capital adequacy
ratio, non-performing loan ratio and cash reserve ratio properly.

However the banks has increasing and decreasing trend in credit risk indicators. It can be
conclude that the banks are maintaining all the indicators, so that the bank can
maximizing the profit. Where bank is properly maintain the rate of CRR and CAR
smoothly which means that the bank can able to provide the information all the investor
can secure the invest in bank.

3.2 Recommendations

Based on the findings, following recommendations are made:

The result in this study suggests that banks should maintain adequate capital. This will
increase their profitability. Therefore, Laxmi bank should have to maintain capital
adequacy ratio at least 10% which was set by directives of Nepal Rasta Bank. It suggests
the need for strong credit risk and loan service process management must be adopted to
keep the level of default ratio as low as possible which will enable to maintain the high
performance (profitability) of bank.
Further, this study is also hoped to be useful to academicians as a source of knowledge
for further research. The study is concentrated only on few factors and thus, further study
should be carried out on the topic to point out the other factors that enhance mitigation of
credit risk to improve performance of different banks.

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 28

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Pandey, I. M. (2008). Venture Capital for financing technology in Taiwan. Tec novation,
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Pradhan, S. & Shah, A. K. (2020). Credit risk management of commercial banks in

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 29

Subedi, P. S. (2018). Risk Management Practices: Evidences from Commercial Banks of

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www.nrb.org.np

www.laxmibanklimited.org.np

Appendix I

Year CAR `CRR NPL

2073/74 13.58 7.32 0.93

 30

2074/75 12.43 6.57 1.29

2075/76 11.83 5.59 1.11

2076/77 13.02 8.29 1.04

2077/78 12.15 8.29 0.25

 31

APPENDIX II