CHAPTER 1

BACKGROUND OF THE STUDY

Introduction

According to Bank for International Settlements (2003),

while 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 a 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.

For most banks, loans are the largest and most obvious

source of credit risk; however, other sources of credit risk

exist throughout the activities of a bank, including in the

banking book and in the trading book, and both on and off

the balance sheet. Banks are increasingly facing credit risk

(or counterparty risk) in various financial instruments

other than loans, including acceptances, interbank

transactions, trade financing, foreign exchange

transactions, financial futures, swaps, bonds, equities,

options, and in the extension of commitments and guarantees,

and the settlement of transactions.

 For the researchers, since exposure to credit risk

continues to be the leading source of problems in banks

world-wide, banks and their supervisors should be able to

draw useful lessons from past experiences. Banks should now

have a keen awareness of the need to identify, measure,

monitor and control credit risk as well as to determine that

they hold adequate capital against these risks and that they

are adequately compensated for risks incurred.

This research paper was conducted in order to encourage

banking supervisors locally to promote sound practices for

managing credit risk. Although the principles contained in

this paper are most clearly applicable to the business of

lending, they should be applied to all activities where

credit risk is present.

This research paper focused on the credit risk

management of Chinabank in Cabanatuan City. The researchers

focused on the management techniques and strategies being

utilized in the management of credit risks of China bank in

Cabanatuan City.

Review of Related Literature

According to SAS Institute, Inc. (2016), Credit risk

refers to the probability of loss due to a borrower’s

failure to make payments on any type of debt. Credit risk

management, meanwhile, is the practice of mitigating those

losses by understanding the adequacy of both a bank’s

capital and loan loss reserves at any given time – a process

that has long been a challenge for financial institutions.

The global financial crisis – and the credit crunch that

followed – put credit risk management into the regulatory

spotlight. As a result, regulators began to demand more

transparency. They wanted to know that a bank has thorough

knowledge of customers and their associated credit risk. And

new Basel III regulations will create an even bigger

regulatory burden for banks.

SAS Institute, Inc. (2016) also added that to comply with

the more stringent regulatory requirements and absorb the

higher capital costs for credit risk, many banks are

overhauling their approaches to credit risk. But banks who

view this as strictly a compliance exercise are being short-

sighted. Better credit risk management also presents an

opportunity to greatly improve overall performance and

secure a competitive advantage.

A commercial bank is a type of financial intermediary

and a type of bank. After the Great Depression, the U.S.

Congress required banks only engage in banking activities,

whereas investment banks were limited to capital market

activities. Since the two no longer have to be under

separate ownership, some use the term "commercial bank" to

refer to a bank or a division of a bank primarily dealing

with deposits and loans from corporations or large

businesses. Commercial bank is the term used for a normal

bank to distinguish it from an investment bank.

This is what people normally call a "bank". The term

"commercial" was used to distinguish it from an investment

bank. Since the two types of banks no longer have to be

separate companies, some have used the term "commercial

bank" to refer to banks which focus mainly on companies. In

some English-speaking countries outside North America, the

term "trading bank" was and is used to denote a commercial

bank. During the great depression and after the stock market

crash of 1929, the U.S. Congress passed the GlassSteagall

Act 1930 (Khambata,1996) requiring that commercial banks

only engage in banking activities (accepting deposits and

making loans, as well as other fee based services), whereas

investment banks were limited to capital markets activities.

This separation is no longer mandatory. It raises funds by

collecting deposits from businesses and consumers via

checkable deposits, savings deposits, and time (or term)

deposits. It makes loans to businesses and consumers. It

also buys corporate bonds and government bonds. Its primary

liabilities are deposits and primary assets are loans and

bonds.

Commercial banking can also refer to a bank or a division of

a bank that mostly deals with deposits and loans from

corporations or large businesses, as opposed to normal

individual members of the public (retail banking).

Origin: The name bank derives from the Italian word

banco "desk/bench", used during the Renaissance by

Florentine bankers, who used to make their transactions

above a desk covered by a green tablecloth (de Albuquerque,

Martim, 1855). However, there are traces of banking activity

even in ancient times.

In fact, the word traces its origins back to the

Ancient Roman Empire, where moneylenders would set up their

stalls in the middle of enclosed courtyards called macella

on a long bench called a bancu, from which the words banco

and bank are derived. As a moneychanger, the merchant at the

bancu did not so much invest money as merely convert the

foreign currency into the only legal tender in Rome- that of

the Imperial Mint (Matyszak and Philip, 2007).

In the most basic terms, commercial banks take deposits

from individual and institutional customers, which they then

use to extend credit to other customers. They make money by

earning more in interest from borrowers than they pay in

interest to those whose deposits they accept. They're

different from investment banks and brokerages in that those

kinds of institutions focus on underwriting, selling, and

trading corporate and municipal

securities.

The Balance Sheet: A bank's balance sheet is different

from that of a typical company. You won't find inventory,

accounts receivable, or accounts payable. Instead, under

assets, you'll see mostly loans and investments, and on the

liabilities side, you'll see deposits and borrowings.

Loans represent the majority of a bank's assets

(Saunders and Cornett, 2005). A bank can typically earn a

higher interest rate on loans than on securities, roughly

6%-8%. Loans, however, come with risk. If the bank makes bad

loans to consumers or businesses, the bank will take a hit

when those loans aren't repaid. Because loans are a bank's

bread and butter, it's critical to understand a bank's book

of loans. Other assets, including property and equipment,

represent only a small fraction of assets. A bank can

generate large revenues with very few hard assets. Compare

this to some other companies, where plant, property, and

equipment (PP&E) is a major asset. Surprisingly, cash

represents only about 2% of assets. That's because the bank

wants to put its money to work earning interest. If the bank

simply sticks its cash in a vault and forgets about it, it

will have a hard time making a profit. Thus, a bank keeps

most of its money tied up in loans and investments, which

are called "earning assets" in bank-speak because they earn

interest. Banks don't like putting their assets into fixed-

income securities, because the yield isn't that great.

However, investment-grade securities are liquid, and they

have higher yields than cash, so it's always prudent for a

bank to keep securities on hand in case they need to free up

some liquidity.

Assessing Assets: A bank's assets are its meal ticket,

so it's critical for investors to understand how its assets

are invested, how much risk they are taking, and how much

liquidity the bank has in securities as a shield against

unforeseen problems. In general, investors should pay

attention to asset growth, the composition of assets between

cash, securities, and loans, and the composition of the loan

book. Also, investors should note a bank's asset/equity

(equity multiplier) ratio, which measures how many times a

dollar of equity is leveraged.

The liability side of a bank’s balance sheet is made up

of various types of deposit accounts and other forms of

borrowings used to fund their investments. A major

difference between banks and other is their high leverage or

debt-to-asset ratio.

Assets and liability management (ALM) is the management

of the structure of a bank’s balance sheet in such a way

that interest related earnings are maximized within the

overall risk tolerance of the bank’s management (J.S.G

Wilson, 1988).

In a study conducted by Achoiu et. al (2008), banking

is topic, practice, business or profession almost as old as

the very existence of man, but literarily it can be rooted

deep back the days of the Renaissance (by the Florentine

Bankers). It has sprouted from the very primitive Stone-age

banking, through the Victorian-age to the technology-driven

Google-age banking, encompassing automatic teller machines

(ATMs), credit and debit cards, correspondent and internet

banking.

Credit risk has always been a vicinity of concern not only

to bankers but to all in the business world because the

risks of a trading partner not fulfilling his obligations in

full on due date can seriously jeopardize the affaires of

the other partner. The axle of the study was to have a

clearer picture of how banks manage their credit risk. In

this light, the study in its first section gives a

background to the study and the second part is a detailed

literature review on banking and credit risk management

tools and assessment models. The third part of this study is

on hypothesis testing and use is made of a simple regression

model. The researchers concluded in the last section that

banks with good credit risk management policies have a lower

loan default rate and relatively higher interest income.

The thesis took a fast look on Banking and Credit risk

management and further probes into bank risk exposure,

assessment, management and control. An attempt will be made

to unfold the use of some risk management, evaluation and

assessment tools, models, and techniques.

The Bank for International Settlement (BIS)

The Bank for International Settlements (or BIS) is an

international organization of central banks which exists to

"foster cooperation among central banks and other agencies

in pursuit of monetary and financial stability" (Wikipedia

online, 2008). It carries out its work through

subcommittees, the secretariats it hosts, and through its

annual General Meeting of all members. The BIS also provides

banking services, but only to central banks, or to

international organizations like itself. Based in Basel,

Switzerland, the BIS was established by the Hague agreements

of 1930. As an organization of central banks, the BIS seeks

to make monetary policy more predictable and transparent

among its 55 member central banks. While monetary policy is

determined by each sovereign nation, it is subject to

central and private banking scrutiny and potentially to

speculation that affects foreign exchange rates and

especially the fate of export economies. Two aspects of

monetary policy have proven to be particularly sensitive,

and the BIS therefore has two specific goals: to regulate

capital adequacy and make reserve requirements transparent.

Capital adequacy policy applies to equity and capital

assets. These can be overvalued in many circumstances.

Accordingly, the BIS requires bank capital/asset ratio to be

above a prescribed minimum international standard, for the

protection of all central banks involved. The BIS' main role

is in setting capital adequacy requirements. From an

international point of view, ensuring capital adequacy is

the most important problem between central banks, as

speculative lending based on inadequate underlying capital

and widely varying liability rules causes economic crises as

"bad money drives out good" (Gresham's Law).

The BIS sets "requirements on two categories of

capital, Tier 1 capital and Total capital. Tier 1 capital is

the book value of its stock plus retained earnings. Tier 2

capital is loanloss reserves plus subordinated debt. Total

capital is the sum of Tier 1 and Tier 2 capital. Tier 1

capital must be at least 4% of total risk-weighted assets.

Total capital must be at least 8% of total risk-weighted

assets. When a bank creates a deposit to fund a loan, its

assets and liabilities increase equally, with no increase in

equity. That causes its capital ratio to drop. Thus the

capital requirement limits the total amount of credit that a

bank may issue. It is important to note that the capital

requirement applies to assets while the bank reserve

requirement applies to liabilities."

Statement of the Problem

This research study was conducted to establish

information in the credit risk management of Chinabank in

Cabanatuan City.

The principal concern of this research paper is to

ascertain to what extent China bank can manage their credit

risks, what tools or techniques are at their disposal and to

what extent their performance can be augmented by proper

credit risk management policies and strategies.

Research questions were raised by the researchers and

specifically, it sought to answer the following questions

and objectives:
1. How may the demographic profile of the respondents be

described in terms of:

a. sex;

b. age;

c. educational attainment; and

d. number of years in banking?

2. How may the perception of the supervisors and managers be

described in terms of utilization of strategies in credit

risk management?

3. What are the implications of the study to the banking

industry?

Theoretical Framework

This research study is based on the theory of Bank Risk

Management by Pyle (1997). Pyle (1997) described that recent

financial disasters in financial and non-financial firms and

in governmental agencies point up the need for various forms

of risk management. Financial misadventures are hardly a new

phenomenon, but the rapidity with which economic entities

can get into trouble is. In Pyle’s Risk Management Theory,

banks and similar financial institutions need to meet the

forthcoming regulatory requirements for risk measurement and

capital.
 Pyle’s Theory on Risk Management focused on the process

by which mangers satisfy the needs by identifying the risks,

obtaining consistent, understandable, operational risk

measures, choosing which risks to reduce and which to

increase and by what means, and establishing procedures to

monitor the resulting risk position.

Scope and Delimitation

The research study focused on the credit risk

management of Chinabank in Cabanatuan City and the sources

of information were the immediate supervisors and managers.

The study was conducted in 1st Semester of Academic

Year 2016-2017 in Ecija University of Science and Technology

under the Department of College of Management and Business

Technology.

Significance of the study

The result of this study entitled “Credit Risk

Management of Chinabank in Cabanatuan City” will serve as

basis of the banking institutions in creating more effective

strategies as well as creating programs/methods to decrease

the loss in the profit so that the institution can produce

more income in credit services.

 This will also help immediate supervisors and managers

in acquiring the knowledge, skills, and behavior needed in

their teaching profession more effectively.

This study may also serve as an important bridge

between the field of banking profession and higher education

to address the high quality and knowledgeable banking

officers.

This study will serve as a basis for further studies

regarding the credit risk management of banking

institutions.

CHAPTER II

RESEARCH METHODOLOGY

This chapter presents the research method, respondents

of the study, research sites, instruments used, statistical

treatment of the data and data gathering process.

Research Method

The researchers utilized the descriptive method of

research in determining the credit risk management of

Chinabank in Cabanatuan City.

As pointed out by Balaria et. al (2015) descriptive

research describes and interprets what exists; and it seeks

to contribute knowledge through the development of a theory

or knowledge.
 Descriptive method of research approach to the problem

solving seeks to answer the questions as the real facts

relating to existing conditions and phenomena (Palispis,

1993).

The Research Locale

The study was conducted in the City of Cabanatuan in

the province of Nueva Ecija. It is considered as one of the

business hub of the province.

The study was limited to the immediate supervisors and

managers o China bank who are directly engaged in the credit

risk management.

The Respondents

The study involved supervisor and managers in China

bank in Cabanatuan City. This number of respondents was set

by purposive sampling under the Non-Probability Sampling in

selecting group.

Table 1. The Respondents and their position

No. of Respondents Position

8 Bank Supervisor
2 Bank Manager

The Instrument
 The researchers used questionnaire as instrument in

gathering data. This type of questionnaire calls for a short

answer only requiring checking of items. The concerns and

items that will be explored in the questionnaire will be

made by the researchers and based on the objectives of the

study.

The questionnaires were checked and approved by the

research adviser before the distribution of the instrument.

In addition to that, the researchers also conducted and

interviewed to get additional information.

Validation of the Instrument

The survey-questionnaire underwent careful checking for

correctness of the statements. Researchers’ adviser also

assisted them in the formulation of the questionnaire with

the statement of the problem as guide.

Administration of the Instrument

The collection and gathering of data is the primary

source of information of the researchers in coming up for

conclusion. The researchers were aided by a questionnaire

that served as the source of information.

In order for the researchers to identify the

respondents of the study, they meet personally the immediate

supervisors and managers of China bank as the respondents of

the research study.

Statistical Treatment of Data

The demographic profile of the respondents and their

perception on the utilization of credit risk management were

analyzed based on the responses derived from the self-made

questionnaire administered by the researchers.

The total weighted frequency and total weighted mean

were computed to evaluate and analyze the responses. The

formulae are:

For Percentage:

F
P= x 100
N

Where:

P = Percentage

F = Frequency

N = Total number of respondents

100 = Constant multiplier

For weighted mean:

TWF
WM =
N

Where:

WM = Weighted mean
 TWF = Total Weighted Frequency

N = Total number of respondents

For weighted frequency:

WF = W x f

Where:

WF = Weighted Frequency

W = Degree of response

f = Frequency

The computed weighted mean for all of the responses of

the respondents were given class interval and equivalent

verbal interpretation. The Likert Scale served as the

options offered to respondents for a response which

corresponds as follows:

Table 2. Verbal Interpretation for Weighted Mean

Weight Class interval Verbal Interpretation

5 4.50 – 5.00 Strongly Agree

4 3.50 – 4.49 Moderately Agree

3 2.50 – 3.49 Agree

2 1.50 – 2.49 Moderately Disagree

1 1.00 – 1.49 Strongly Disagree

 CHAPTER III

PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

This chapter presents, analyzes and interprets from the

data gathered. The data collected were shown in the form of

graphs, charts and tables for easy comprehension with

corresponding analyses and adequate interpretations of data.

Profile of the Respondents

 27-30
43 and above

Below 18
19-22
23-26
31-34 27-30
31-34
35-38
39-42
39-42 43 and above

35-38

Fig 1. Age of the Respondents

Out of the ten (10) – respondents in the survey, 30% or

3 respondents belong to the age bracket of 31 – 34, 20% or 2

respondents belong to the 35 – 38 age bracket, 20% or 2

respondents belong to the 39 – 42, 20% or 2 respondents

belong to 43 and above age brackets and 10% or 1 respondent

belong to the 27 – 30 age bracket respectively.

This result implies that most of the supervisory and

managerial positions in the banking industry is dominated my

middle age individuals with sufficient skills, knowledge,

and experiences need in handling difficult situations

especially in decision-making scenarios.

 Male

Male
Female

Female

Fig 2. Sex of the Respondents

Majority of the respondents were female with 90% or 9

respondents. This implies that the banking industry is still

considered by many people as a female – dominated

profession.
 1-4 years

Below 1 year
10 years 1-4 years
and above 5-10 years
10 years and above

5-10 years

Figure 3. Number of years in banking

Majority of the respondents were in the field of

banking industry with experience of more than ten (10) years

and above with a numerical data of five (5) respondents.

Respondents with five (5) to ten (1) years got the second

ranking consisting of three (3) respondents, on the other

hand, respondents with one (1) to four (4) years of

experience got the third ranking with a numerical data of

two (2) respondents.

The data gathered implies that banking industry

requires individuals with enough experience in banking

operations, that, not at all, supervisory and managerial

positions are filled with experienced and well-trained

professionals.
 Doctor's
Degree
Holder
College
Graduate

Elementary Graduate
High School Graduate
College Graduate
Master's Degree Holder
Doctor's Degree Holder

Master's Degree Holder

Figure 4. Highest Educational Attainment

In figure 4, the pie graph shows that majority of the

respondents finished their master’s degree consisting of

five (5) respondents which is equivalent to 50%. Three (3)

or 30% of the total respondents have earned their college

degree, and two (2) or 20% of the respondents earned their

doctor’s degree of education.

The data shows that banking industry is being filled

and handled by highly educated individuals who are qualified

to banking job.
Table 2. Perception on Strategies on Credit Risk Management

Credit Risk Management Strategies WM VI

1. Ensuring that the bank has appropriate
credit risk assessment processes and
effective internal controls to 4.8 SA
consistently determine provisions for
loan losses.
2. Providing a system in place to
reliably classify loans on the basis 3.5 MA
of credit risk.
3. Appropriate validation of any internal
credit risk assessment models. 3.6 MA
4. Periodic evaluation of the
effectiveness of a bank’s credit risk
policies and practices for assessing 4.2 MA
loan quality.
5. Consideration of credit risk
assessment and evaluation practices 4.1 MA
when assessing a bank’s capital
adequacy.
6. Participation in portfolio planning 5 SA
and management.
7. Granting approval authority to
qualified and experienced individuals. 4.1 MA
8. Establishment of credit policies and
standards that conform to regulatory
requirements and the bank’s overall 4.7 SA
objectives.
9. Loans to individuals are typically
secured by autos for car loans and
private or income producing real 5 SA
estate is secured by a mortgage over
the relevant property.
10. Ensuring that all employees are
attending continuous professional 3.2 A
education such as training and
seminars.
Average Weighted Mean 4.2 MA
 Respondents are found to be Moderately Agree on items

two (2), three (3), four (4), five (5), and seven (7).

However, on items number one (1), six (6), eight (8), nine

(9) and ten (10), the respondents’ perception showed a

verbal interpretation of Strongly agree.

Lastly, in item number ten (1) with the statement

“Ensuring that all employees are attending continuous

professional education such as training and seminars.”, the

result revealed a verbal interpretation of “Agree” with a

weighted mean of 4.2.

Overall, results showed that the respondents are

Moderately Agree on the utilization of the strategies on

credit risk management with an average weighted mean of 4.2

which is equivalent to “Moderately Agree”.

The results also implied that most of the respondents

agreed to the use of the strategies in managing the credit

risks. It also implied that the respondents believed that

strategies in handling credit risks contributes to the

bank’s operation in order to have a profitable business.

 CHAPTER IV

SUMMARY, CONCLUSION AND RECOMMENDATIONS

Summary

The study summarizes that China bank used different

credit risk management tools, techniques and assessment

models to manage their credit risk, and that they all have

one main objective, to reduce the amount of loan default

which is a principal cause of bank failure.

The study also reveals that the bank has credit risk

management policies that lower loan default ratios (bad

loans) and higher interest income (profitability).

Conclusion

The study concluded that a bank with higher profit

potentials can better absorb credit losses whenever they

crop up and therefore record better performances.

These results are in line with our expectations and

actually tallies with conventional wisdom.

This has led us to accept that banks with higher

interest income have lower non-performing loans, hence good

credit risk management strategies.

Recommendations

We would suggest that the banks could establish a credit

risk management team that should be responsible for the

following actions that will help in minimizing credit risk;

• Participation in portfolio planning and management.

• Working with Business Groups in keeping aggregate

credit risk well within the bank’s risk taking capacity

(risk tolerance).

• Developing and maintaining Credit Approval Authority

structure.

• Approving major credits.

• Granting approval authority to qualified and

experienced individuals.

• Reviewing the adequacy of credit training across the

bank

• Setting systems to identify significant portfolio

indicators, problem credits and level of provisioning

required.

• Presents information about the bank’s exposure to and

its management and

control of credit risks, in time

• Establishment of credit policies and standards that

conform to regulatory requirements and the bank’s

overall objectives.

• Counterparty ratings, are obtained through the local

authorized and External Credit Rating Agencies

• Assessment and the continuous monitoring of

counterparty and portfolio credit exposures is carried

out by the

• To ensure that the wholesale portfolio, which includes

corporate, commercial and agricultural loans are

ideally collateralized by cash equivalents, fixed and

current assets including property plant and equipment,

and land.

• Loans to individuals are typically secured by autos for

car loans and private or income producing real estate

is secured by a mortgage over the relevant property.