53307-002: Diagnostic Study and Strategy Development for ......Strategy Ten - Venture capital/Seed capital for sustainable CSIs who are experiencing shortages of equity capital: .....91

Technical Assistance Consultant’s Report

This consultant’s report does not necessarily reflect the views of ADB or the Government concerned, and ADB and the Government cannot be held liable for its contents. (For project preparatory technical assistance: All the views expressed herein may not be incorporated into the proposed project’s design.

Project Number: 53307-002 March 2020

Kingdom of Bhutan: Diagnostic Study and Strategy Development for Rural Finance Sector Development

Prepared by Akurange Somaratne

Thimphu, Bhutan

For Ministry of Finance

DIAGNOSTIC STUDY AND

STRATEGY DEVELOPMENT

FOR RURAL FINANCE SECTOR

DEVELOPMENT-

FINAL REPORT

TA-9805BHU

LIONEL SOMARATNE RURAL FINANCE SPECIALIST

March – 2020

BHUTAN DEVELOPMENT BANK LIMITED (BDBL)

AND RURAL ENTERPRISE DEVELOPMENT

CORPORATION (REDCL)

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Contents

ABBREVIATIONS ...................................................................................................................................... 1

1. EXECUTIVE SUMMARY ....................................................................................................................... 2

1.1. INTRODUCTION: ........................................................................................................................... 2

1.2. PROJECT: ...................................................................................................................................... 2

1.3. CONSTRAINTS FOR EXPANDING RURAL CREDIT: ......................................................................... 3

1.4. THE COUNTRY: ............................................................................................................................. 3

1.5. THE ECONOMY: ............................................................................................................................ 3

1.6. FINANCIAL SECTOR: ..................................................................................................................... 3

1.7. CURRENT STATUS OF RURAL FINANCE SECTOR: .......................................................................... 3

1.8. MICROFINANCE SECTOR: ............................................................................................................. 4

1.9. BHUTAN DEVELOPMENT BANK (BDBL): ....................................................................................... 4

1.10. RURAL ENTERPRISE DEVELOPMENT CORPORATION: ................................................................ 4

1.11. NEW STRATEGY FOR BDBL TO IMPROVE RURAL FINANCE: ....................................................... 5

1.12. NEW SYTRATEGY FOR REDCL TO IMPROVE ITS RURAL FINANCE:.............................................. 5

1.13. INTERVENTIONS SUGGESTED FOR IMPROVING RURAL FINANCE SECTOR: ............................... 5

2. PART ONE - PROJECT BACKGROUND .................................................................................................. 6

2.1. PROJECT: ...................................................................................................................................... 6

2.2. PROJECT RATIONALE: ................................................................................................................... 6

2.3. TERMS OF REFERENCE (TOR): ...................................................................................................... 7

2.4. THE COUNTRY: ............................................................................................................................. 8

2.5. ECONOMY: ................................................................................................................................... 9

2.6. FINANCIAL SECTOR: ................................................................................................................... 10

2.6.1. Access Points: .......................................................................................................................... 11

2.6.2. Performance of Banks: ............................................................................................................ 12

2.6.3. Interest Rates: ......................................................................................................................... 14

2.7. CURRENT STATUS OF RURAL FINANCE IN BHUTAN: .................................................................. 15

2.7.1. Constraints Faced by CSIs and Rural Poor in Accessing Banking Services: ............................. 17

2.7.2. Constraints Faced by Financial Institutions in Delivering Financial Services: ......................... 17

3. PART TWO - DIAGNOSTIC STUDY ON BHUTAN DEVELOPMENT BANK LIMITED ............................... 19

3.1. THE BANK: .................................................................................................................................. 19

3.2. PRODUCTS - CREDIT: .................................................................................................................. 20

3.3. PRODUCTS - DEPOSITS ............................................................................................................... 22

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3.4. BUSINESS PROCESS: ................................................................................................................... 24

3.5. OPERATING MODALITY .............................................................................................................. 25

3.6. LENDING PORTFOLIO: ................................................................................................................ 27

3.7. CREDIT OUTREACH: .................................................................................................................... 28

3.8. DEPOSITS OUTREACH: ................................................................................................................ 29

3.9. FINANCIAL PERFORMANCE: ....................................................................................................... 29

3.9.1. Profit and Loss Statements: ................................................................................................ 29

3.9.2. Balance Sheets: ................................................................................................................... 31

3.10. NON-PERFORMING LOANS: ..................................................................................................... 33

3.11. CAUSES FOR HIGH NPLs: .......................................................................................................... 35

3.11.1. Inadequate Skills in Credit Appraisal-Skills Gap Analysis: ................................................. 36

3.11.2. Lack of Proper Guidelines on Credit Appraisal: ................................................................ 37

3.11.3. Lack of Credit Risk Management Tools at Loan Origination: ............................................ 38

3.11.4. Lack of Loan Supervision: .................................................................................................. 38

3.11.5. Low Financial Literacy of Clients and need for client education: ..................................... 39

3.11.6. Lack of Professional Business Development Support Services (BDS) for CSIs and the need

for business facilitation: ................................................................................................................ 40

3.12. PRICING AND SECURITY (COLLATERAL):................................................................................... 40

3.13. TERMS AND CONDITIONS: ....................................................................................................... 42

3.14. COMMUNITY CENTERS: ........................................................................................................... 43

3.15. OPERATIONS OF REVOLVING FUND I (RFI): ............................................................................. 44

3.16. BRANCH AND CLIENT VISITS: ................................................................................................... 45

3.16.1. BDBL Branch - Phunaka ..................................................................................................... 46

3.16.2. BDBL Branch - Nobding: .................................................................................................... 46

3.16.3. BDBL Branch - Wongdue: .................................................................................................. 47

3.17. CONCLUSIONS: ......................................................................................................................... 48

4. PART THREE - DIAGNOSTIC STUDY OF REDCL ............................................................................... 50

4.1. INTRODUCTION TO REDCL: ........................................................................................................ 50

4.2. TYPES OF LOANS OFFERED: ........................................................................................................ 51

4.3. BUSINESS PROCESS: ................................................................................................................... 52

4.4. OPERATING MODALITY: ............................................................................................................. 53

4.5. LOAN APPLICATIONS RECEIVED: ................................................................................................ 54

4.6. LOAN APPROVALS: ..................................................................................................................... 54

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4.7. NON-PERFORMING LOANS: ....................................................................................................... 56

4.8. FINANCIAL PERFORMANCE: ....................................................................................................... 58

4.8.1. Financial Performance-Profit and Loss Statements: ........................................................... 58

4.8.2. Financial Performance-Balance Sheets: .............................................................................. 58

4.9. CAUSES FOR HIGH NPLs: ............................................................................................................ 59

4.9.1. Inadequate Skills in Credit Appraisal: ................................................................................. 59

4.9.2. Lack of Proper Guidelines on Credit Appraisal: .................................................................. 59

4.9.3. Lack of Credit Risk Management Tools at Loan Origination: .............................................. 60

4.9.4. Lack of Loan Supervision: .................................................................................................... 60

4.9.5 Low Financial Literacy of Clients: ......................................................................................... 61

4.9.6. Lack of Professional Business Development Support Services (BDS) for CSIs: ................... 62

4.10. BRANCH AND CLIENT VISITS: ................................................................................................... 62

4.10.1. REDCL Brach - Phunaka: .................................................................................................... 63

4.10.2. REDCL Branch .................................................................................................................... 63

4.10.3. Observation of the Consultant During Branch and Client Visits: ...................................... 64

4.11. CONCLUSION: ........................................................................................................................... 64

5. PART FOUR – STRATAGIES PROPOSED FOR BDBL ............................................................................. 65

5.1. INTRODUCTION: ......................................................................................................................... 65

5.2. STRATEGY ONE - IMPROVING CAPITAL ADEQUACY ................................................................... 65

5.3. STRATEGY TWO - MEASURES PROPOSED TO INCREASE THE RURAL FINANCE CREDIT

OUTREACH: ....................................................................................................................................... 65

5.3.1. Revitalization of Group Lending: ......................................................................................... 66

5.3.2. Making Use of Community Centers to Increase BDBLs Rural Outreach and Social

Mobilization: ................................................................................................................................. 66

5.3.3. Lending to Women Groups: ................................................................................................ 69

5.3.4 Lending to Unemployed Youth: ........................................................................................... 70

5.4. STRATEGY THREE - INTRODUCTION OF NEW PRODUCTS TO IMPROVE RURAL CREDIT ............ 70

5.4.1. Leasing-Equipment and vehicles: ........................................................................................ 70

5.4.2. Leasing for high - end consumer durables for rural households with regular or seasonal

incomes: ........................................................................................................................................ 71

5.4.3. Venture capital/Seed capital for sustainable CSIs who are experiencing shortages of

equity capital:................................................................................................................................ 71

5.4.4. Wholesale loans to sustainable MFIs through credit lines: ................................................ 72

5.4.5. Value chain financing programs for few industry sectors/commodities: ........................... 73

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5.4.6. Non Collateralized Loans: ................................................................................................... 74

5.5 STRATEGY FOUR - PROVISION OF BUSINESS DEVELOPMENT SERVICES TO CSIs TO PROMOTE

RURAL CREDIT: .................................................................................................................................. 75

5.6. STRATEGY FIVE - IMPROVING CREDIT APPRAISAL SKILLS .......................................................... 77

5.7. STRATEGY SIX - PROVIDING BETTER DOCUMENTARY GUIDELINES ON CREDIT APPRAISAL: ..... 77

5.8 STRATEGY SEVEN - INTRODUCING CREDIT RISK MANAGEMENT TOOLS AT LOAN ORIGINATION:

.......................................................................................................................................................... 78

5.9. STRATEGY EIGHT - IMPROVING LOAN SUPERVISION:................................................................ 80

5.10. STRATEGY NINE - DIVERSIFYING FUNDING BASE: .................................................................... 81

5.11. STRATEGY TEN - IMPROVING FINANCIAL LITERACY OF CLIENTS ............................................. 82

5.12. STRATEGY ELEVEN - CHAINGING TERMS AND CONDITIONS REALATING TO PRICING AND

SECURITY (COLLATERAL): .................................................................................................................. 83

5.13. STRATEGY TWELVE - RELAXING TERMS AND CONDITIONS OF LENDING ................................ 84

6. PART FIVE – STRATEGIES PROPOSED FOR REDCL ............................................................................. 86

6.1. INTRODUCTION: ......................................................................................................................... 86

6.2. STRATEGY ALREADY PROPOSED BY THE GOVERNMENT: .......................................................... 86

6.3. ADDITIONAL STRATEGIES SUGGESTED FOR IMPROVING THE PROPOSED STRATEGY: .............. 87

6.3.1. Strategy One - Improvements to the Lending Policy Manual: ............................................ 87

6.3.2. Strategy Two - improving skills of credit officers on cash flow based lending: .................. 88

6.3.3. Strategy Three - Introducing Credit Risk Management Tools at Loan Origination: ............ 88

6.3.4. Strategy Four - Introducing of New Products –Group Loans: ............................................. 89

6.3.5. Strategy Five- Lending to Women Groups: ......................................................................... 89

6.3.6. Strategy Six- Lending to Unemployed Youths: .................................................................... 89

6.3.7. Strategy Seven - Introducing New Products to Improve Rural Credit: ............................... 90

6.3.8. Strategy Eight - Leasing Equipment and Vehicles: .............................................................. 90

6.3.9. Strategy Nine - Leasing for high-end consumer durables for rural households with regular

or seasonal incomes: ..................................................................................................................... 91

6.3.10. Strategy Ten - Venture capital/Seed capital for sustainable CSIs who are experiencing

shortages of equity capital: ........................................................................................................... 91

6.3.11. Strategy Eleven - Wholesale loans to sustainable MFIs through credit lines: .................. 92

6.3.12. Strategy Twelve - Value chain financing programs for few industry sectors/commodities:

...................................................................................................................................................... 92

6.3.13 Strategy Thirteen - Provision of Business Development Services (BDS) to CSIs to Promote

rural credit: ................................................................................................................................... 94

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7. PART SEVEN - OTHER INTERVENTIONS SUGGESTED FOR IMPROVING RURAL FINANCE SECTOR AT

MACRO LEVEL. ...................................................................................................................................... 96

7.1. INTRODUCTION: ......................................................................................................................... 96

7.1.1. Intervention One - Development of Microfinance Sector: ................................................. 96

7.1.2. Intervention Two - Improving Professional Business Development Support Services for

CSIs: ............................................................................................................................................... 98

7.1.3. Intervention Three - Using Priority Sector Lending (PSL) Directives to Improve Rural

Finance: ......................................................................................................................................... 99

7.1.4. Intervention Four - Establishing a Credit Guarantee Scheme for CSIs: ............................ 100

7.1.5. Intervention Five - Development of Value Chain Financing ............................................. 100

ANNEXURE 01 .......................................................................................................................................... I

ANNEXURE 02 ........................................................................................................................................ III

ANNEXURE 03 ........................................................................................................................................ IV

ANNEXURE 04 ......................................................................................................................................... V

ANNEXURE 05 .................................................................................................................................... XVIII

ANNEXURE 06 ................................................................................................................................... LXVII

ANNEXURE 07 ................................................................................................................................. LXXVII

ANNEXURE 07 (A) ............................................................................................................................. LXXIX

ANNEXURE 08 .................................................................................................................................. LXXXI

ANNEXURE 09 ................................................................................................................................ LXXXIII

ANNEXURE 10 ................................................................................................................................ LXXXIV

ANNEXURE 11 ................................................................................................................................. LXXXV

ANNEXURE 12 ................................................................................................................................ LXXXVI

ANNEXURE 13 ............................................................................................................................... LXXXVII

ANNEXURE 14 ................................................................................................................................... XCIV

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ABBREVIATIONS

ADB Asian Development Bank

BDBL Bhutan Development Bank

BNB Bhutan National Bank

BOB Bank of Bhutan

BOIC Business Opportunity Information Center

CGAP Consultative Group to Assist Poor

CSI Cottage and Small Industries

DFI Development Finance Institution

FDI Foreign Direct Investment

GDP Gross Domestic Product

GNH Gross National Happiness

MFI Microfinance Institution

MLR Minimum Lending Rate

MoEA Ministry of Economic Affairs

MSME Micro, Small and Medium Enterprise

NPL Non-Performing Loans

NSFI National Strategy for Financial Inclusion

REDCL Rural Enterprise Development Corporation

RF Revolving Fund

RGoB Royal Government of Bhutan

RICB Royal Insurance Corporation of Bhutan

RMA Royal Monetary Authority

TA Technical Assistance

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BHU - RURAL FINANCE SECTOR DEVELOPMENT PROJECT

1. EXECUTIVE SUMMARY

1.1. INTRODUCTION: The Asian Development Bank (ADB) has launched a Technical

Assistance Project (TA 9805-BHU) in Bhutan with the objective of developing the Rural

Finance Sector in Bhutan. Under the project, diagnostic studies are to be conducted on two

leading rural finance institutions namely; Bhutan Development Bank Limited (BDBL) and

Rural Enterprise Development Corporation (REDCL). Based on the diagnostic reviews,

strategies are to be developed for improving the rural finance activities of BDBL and RECDL

in remote and inaccessible areas. In order to execute the Rural Finance Sector Development

Project, the ADB has recruited the following three international experts to cover the

different area’ of the project and one national consultant to assist the international

consultants.

- Banks and financial sector Specialist

- Rural finance Specialist

- Financial Management assessment and financial due diligence Specialist

This Final Report (prepared by Lionel Somaratne - Rural Finance Specialist) represents the

findings of the Diagnostic Studies of Bhutan Development Bank Limited (BDBL) and Rural

Enterprise Development Corporation Limited (REDCL) and the strategies proposed by him

(Rural Finance Specialist) for BDBL and REDCL based on the findings of the diagnostic

studies. The report also provides country and sector context.

1.2. PROJECT: The Bhutanese economy is cash based economy where households have a

vibrant informal savings and lending culture. Since cash is the predominant form of

exchange, people have no incentives to deal with banks or other financial institutions. The

access to finance situation in Bhutan is still at a very low level when compared with other

developing countries. Out of its total population of around 800,000 people, around 62.8%

(2017) live in rural areas with agriculture as the primary source of livelihood. BDBL and

REDCL are the two main financial institutions involved in the provision of rural finance and

both these institutions are fully owned by the Government. Although, the accounts

penetration of Bhutan is at a very high level of around 64%, the access to credit which is

essential to improve the living standard of poor people, is at extremely low level of around

16%. One of the main reasons for the low access to credit is the problems associated with

the rural financial institutions. The Royal Government of Bhutan (RGoB) has given priority to

improve access to finance and financial inclusion in the country. Royal Monetary Authority

(RMA) developed “National Strategy for Financial Inclusion 2018-2023 (NSFI 2018-2023)” focuses mainly on the Cottage and Small Industry (CSI) sector which is facing difficulties in

accessing finance from the financial institutions. The overall objective of the project is to

remedy the problems faced by the two main rural finance institutions.

3

1.3. CONSTRAINTS FOR EXPANDING RURAL CREDIT: Rural sector including the cottage

and Small Industries faces several constraints in accessing finance from the formal financial

sector (demand side issues) while financial institutions also face several constraints in

providing financial services (Supply side issues). Non-availability of acceptable collateral,

non-availability of viable projects, limited market opportunities and sparsely spread

population are some of the main problems faced by the potential borrowers and financial

institutions involved in rural finance.

1.4. THE COUNTRY: Bhutan is a land locked small and remote kingdom located in

Himalayas between its powerful neighbors; India and China. Its total land area is 38,364 sq.

km and around 70% of the land area is covered with forests. The land of Bhutan is rugged

and consists of steep mountains and deep valleys. The total population of the country is

around 0.8 Mn (2017). The population density of Bhutan is 18 people per sq. km and it is

one of the lowest population densities of the world. Bhutan has four season’s namely spring, summer, autumn and winter. Depending on the altitude of the location, the climate

varies.

1.5. THE ECONOMY: Bhutan’s small economy with a GDP of US$ 2,582 Mn (2018) is largely

based on hydropower, agriculture and forestry which provides livelihood for more than half

of the population. The GDP per capita in 2018 was US$ 3,423 and GDP has grown by 4.6%

over the previous year. The growth rate which was 8.0% in 2016 has dropped to 6.3% in

2017 mainly due to low investments in the hydropower projects. The estimated growth rate

for 2019 is 5.7% and 6% for 2020. The services sector contributes nearly 42% of GDP while

industrial sector including hydropower contributes around 41% of GDP. Although the

contribution from agriculture sector towards GDP is only around 17%, it provides livelihood

to around 62% of the population. The country is famous for its unique philosophy of Gross

National Happiness (GNH) which forms the basis of its development strategies.

1.6. FINANCIAL SECTOR: The financial sector of Bhutan consists of five (05) banks, three

(03) insurance companies, six (06) microfinance companies, one (01) credit information

bureau, one (01) National Pension & Provident fund, one (01) central registry and one (01)

stock exchange. Around 64% of the adult population have savings accounts and only 16%

had access to credit and 18% held life insurance. The banking sector is the dominant player

in the financial sector. Lending by banks to the rural sector is at a very low level and of the

five banks; involvement of four banks in rural finance is very limited. In order to compel

them to lend to the rural sector, RMA in 2018 introduced prudential guidelines on Priority

Sector Lending (PSL). Under these guidelines all banks are required to lend at least 1% their

lending portfolios to priority sectors. Rural sector and CSI sector are among the priority

sectors designated by RMA.

1.7. CURRENT STATUS OF RURAL FINANCE SECTOR: Since cash is the predominant form

of exchange, people have no much incentive to deal with banks or other financial

4

institutions. Rural areas are particularly unbanked where bank branches are distant and

banking culture poorly reflects people’s financial needs. The overall level of financial

inclusion in Bhutan is at a very low level. Rural areas are particularly unbanked where bank

branches are distant and banking culture poorly reflects people’s financial needs. Significant disparities persists in financial inclusion between rural and urban areas, youth and adults,

the poor and the rich and CSIs and large firms. According to the National Financial Inclusion

Strategy 2018-2023 (NFIS), as of December 2017, 64.47% of the adult population in Bhutan

had an account with a bank while only 16.08% had access to credit and 17.79% held a life

insurance policy. Out of the 64.47% of adults who held accounts with banks, 56% were male

and 44% were female. Similarly, out of the 16.08 % who had access to credit, 54% were

male and 46% were female.

1.8. MICROFINANCE SECTOR: A very important and effective role could be played by MFIs

in any developing country in improving the livelihood of poor households through the

provision of easily accessible, affordable and sustainable financial products. Six microfinance

institutions (MFIs) have been licensed by RMA and only two of them have licenses to accept

deposits from the general public. All the MFIs in Bhutan operating mainly in rural areas are

still at very early stage of development. These MFIs could be used to effectively deliver

financial products and services to the rural sector.

1.9. BHUTAN DEVELOPMENT BANK (BDBL): Bhutan Development Bank Limited (BDBL)

was originally known as Bhutan Development Finance Corporation. It was incorporated by

the Royal Charter in January 1988 with assistance from the Asian Development Bank (ADB)

to function as a Development Finance Institution (DFI). In 2010 it registered as a company

under the Companies Act 2000 and licensed by RMA under the Finance Institution Act. After

obtaining its banking license in March 2010, it started functioning as a domestic

development bank with current account facilities. The main objective of BDBL is to

“promote the industrial, agricultural and commercial development” of the economy of Bhutan mainly by providing financial services to Micro, Small and Medium Enterprises

(MSMEs) for the development and modernization of agricultural, industrial and commercial

enterprises of the country. BDBL is the leading rural finance service provider in the country.

The Bank has been faced with a very high NPL problem and a need has arisen for

restructuring of the Bank.

1.10. RURAL ENTERPRISE DEVELOPMENT CORPORATION: Under the Government

Economic Stimulus Plan (ESP) of 2003, with a budget of Nu 5.0 Bn, a Revolving Fund (RF) was

established with an allocation of Nu 1.9 Bn to improve the CSI sector and the informal

activities of the rural sector in 2014. An organization under the name of “Business Opportunities Information Center (BOIC)” established to carry out the activities of the Revolving Fund. The target group of the Revolving Fund was the CSIs and the non-formal

rural activities. Of the total fund of Nu 1.9 Bn, a sum of Nu 1.5 Bn was allocated under

Revolving Fund I (RF I) to finance new business start-ups primarily cottage and small

industries and a sum of 0.4 Bn was allocated under Revolving Fund II (RF II) to finance non-

formal rural activities. Due to some issues faced by BOIC, activities of it was terminated after

5

two years of operations. In order to continue the activities of RF II, the Government in May

2016 established Rural Enterprise Development Corporation (REDCL) as a wholly state

owned enterprise under the Companies Act and licensed by RMA as a Microfinance

Institution (MFI). All activities of RFII with a lending portfolio of Nu 127 Mn were transferred

from BOIC to REDCL which commenced operations in June 2016. The Management of RF I

was entrusted with BDBL. The main objective of REDCL is to “provide funds for the non-

formal rural activities on a low interest rate of 4% per annum and without any collateral

requirement in order to stimulate economic activities and add value to the domestic

resources and create employment”. The maximum loan amount is Nu 500,000 and the rate

of interest is 4% per annum and loans are non-collateralized.

1.11. NEW STRATEGY FOR BDBL TO IMPROVE RURAL FINANCE: Currently BDBL is

faced with several difficulties such as low capital adequacy, very high NPL, high cost of

funds, lending skills gaps and shortage of manpower for monitoring of lending portfolio. A

new strategy is to be implemented to remedy some of these problems based on the findings

of the diagnostic study.

1.12. NEW SYTRATEGY FOR REDCL TO IMPROVE ITS RURAL FINANCE: Although the

current Business model of REDCL is suitable for and capable of achieving its social

objectives, it is unable to achieve the sustainability objective. Financial institutions involved

in financing Micro, Small, Medium Enterprises are required to manage its “double bottom lines” and realizing the need to achieve long term sustainability, and the Government has

introduced legislation for up gradation of REDCL to a CSI Bank. A draft strategy document

has already been developed by REDCL/Government.

1.13. INTERVENTIONS SUGGESTED FOR IMPROVING RURAL FINANCE SECTOR:

Currently, the main players of the rural finance in Bhutan are BDBL and REDCL. Since there

are several constraints faced by these two institutions, they may not be able to deliver

entirely the financial services requirement of the rural sector. Micro level interventions

along is not sufficient to develop the rural finance sector. Some interventions by the

authorities at macro level are essential to create a conducive environment and some

mechanism outside these two institutions to supplement their services is required.

6

2. PART ONE - PROJECT BACKGROUND

2.1. PROJECT: Since 1982, ADB has supported Bhutan through various programs, mainly in

energy, transport, finance and urban development. The current ADB - TA project is to

undertake diagnostic studies on Bhutan Development Bank Limited (BDBL) and Rural

Enterprise Development Corporation (REDCL) and to develop strategies for the two

institutions based on the findings of the respective diagnostic studies (TA 9805-BHU -

Diagnostic Study and Strategy Development for Rural Finance Sector Development). The

diagnostic studies on the two rural finance institutions are to cover the current products and

services for rural MSMEs including but not limited to outreach, portfolio quality, business

process, pricing, costs and client services and identify issues and constraints to expand

BDBL’s and REDCL’s MSME client outreach. Based on the diagnostic review, develop strategies for BDBL’s and REDCL’s rural financing modality covering but not limited products, business process, pricing and security, terms and conditions, social mobilization and client

education value chain development and business facilitation in view of extending services to

remote and inaccessible areas.

2.2. PROJECT RATIONALE: Despite the recent private sector driven economic growth, the

Bhutanese economy is still largely rural and agriculture – based. Out of its total population,

around 62.8% live in rural areas with agriculture as the primary source of livelihood. Most

rural famers are subsistence small farmers with little land holdings and little incomes. In

rural areas opportunities to generate cash income outside agriculture or off-farm

employment opportunities are very limited making rural population dependent exclusively

on farming. The Government of Bhutan recognizes the Cottage and Small Industry (CSI)

Sector primarily based in rural areas as the driver of the economic development which can

positively impact the employment, income generation and poverty reduction. Currently,

CSIs accounts for more than 90% of the total business enterprises employing around

99,200 people representing about 20% of the adult population. Although the CSI sector is

extremely important from the economic development point of view, it faces several

constraints such as access to finance, poor infrastructure, limited market opportunities, very

limited Business Development Services (BDS) and strict labor regulations. The key objective

of the Rural Finance Sector Development project of ADB is to study the constraints faced by

CSI sector and rural farmers in accessing finance from the formal financial institutions and

also to study the constraints experienced by key rural finance financial institutions in

delivering finance to the CSI sector and rural farmers. Based on the studies, the Consultant

will develop strategies and appropriate recommendations to improve the access to finance

by CSIs and rural poor thereby improving the overall financial inclusion of Bhutan. In order

to execute the Rural Finance Sector Development Project, the ADB has recruited the

following three international experts to cover areas of the project and one national

consultant to assist the international consultants. The International Consultants recruited

are;

i. Banks and Financial Sector Specialist

7

ii. Rural Finance Specialist

iii. Financial Management Assessment and Financial Due Diligence Specialist

An international micro insurance specialist is to be recruited.

2.3. TERMS OF REFERENCE (TOR): Lionel Somaratne (The Consultant) has been recruited

as the Rural Finance Expert. A brief description of the Terms of Reference of the assignment

of the Rural Finance Expert is given below:

I. The Objective and Purpose of the Assignment: to develop rural financing strategies

financing strategies that will enable Bhutan development Bank Limited ( BDBL) and

Rural Enterprise Development Corporation Limited(REDCL) to reach the unbanked rural

micro, small and medium-sized enterprises(MSMEs)which will include a measure to

enhance access to finance for women and vulnerable groups.

II. Scope of Work: Conduct a diagnostic review of BDBL’s and REDCL’s current products and services for rural MSMEs and develop rural finance strategies for BDBL and REDCL

III. Tasks and/or Expected Output: Conduct a diagnostic review of BDBL’s and REDCL’s current products and services for rural MSMEs including but not limited to outreach,

portfolio quality, business process, pricing ,costs and client services and identify issues

and constraints to expand BDBL’s and REDCL’s MSME client out reach. Based on the

diagnostic review, develop strategies for BDBL’s and REDCL’s rural financing modality covering but not limited;

➢ products,

➢ business process,

➢ appropriate pricing and security ,

➢ terms and conditions ,

➢ social mobilization and client education,

➢ value chain development and

➢ Business facilitation.

iv. The rural finance strategies to cover the methodology and approach to extend rural

financial services to rural unbanked [population including poor, women and vulnerable

that are currently un-served by banks and other formal financial institutions.

v. Other tasks as reasonably requested by ADB

The Rural Finance Expert has also been requested to analyze the following aspects of BDBL

and make recommendations on how to improve these aspects.

➢ How BDBL can link its clients to Business Development Services

➢ How to improve client financial literacy

➢ How to expand non-collateral based group or individual based lending

8

➢ How to make better use of community centers on cost recovery basis

The assignment is to be completed during the period 1st November 2019 to 30th March

2020 in 44 man days.

2.4. THE COUNTRY: Bhutan also known as the “land of thunder dragon” is a landlocked

small and remote kingdom located in Himalayas between its powerful neighbors; India and

China and it also borders Bangladesh and Nepal. The country controls several key

Himalayan mountain passes. Bhutan occupies an area of approximately 38,364 sq. km. Out

of the total land area, 71% is under forest cover, and seven percent under year–round

snow and glaciers, about three percent cultivable agricultural, four percent meadows and

pastures and the balance is barren, rocky and scrub land. The land of Bhutan is rugged and

consists of steep mountains and deep valleys. Virtually, the entire country is mountainous

and ranges from 100 m to 7,554m at Kulha Gangri Peak on the Tibetan boarder. Bhutan has

four season’s namely spring, summer, autumn and winter. Depending on the altitude of the

location, the climate varies. The extremely varied climate of Bhutan can be attributed to

two factors: the vast difference in altitude present in the country and the influence of

north Indian monsoon. Southern Bhutan has a hot and humid subtropical climate that is

fairly unchanged throughout the year. The temperature can vary from 15-30 degree

Celsius. In the central part of the country which consists of temperate and deciduous

forests, the climate is more seasonal with warm, cool and dry summers.

The total population of the country was 727,145 (2017) of which 380,453 were male and

346,692 were female. The population of Bhutan had grown at an average annual rate of

1.3% during the period 2005-2017.The age profile of the population is shown below:

0-14 years 25.35%

15-24 years 18.40%

25-54 Years 43.73%

55 years and over 12.52%

The age structure of a population affects the nation’s key socio-economic issues. Countries

with young populations (high percentage under 15 years) need to spend and invest more in

education while countries with older population (65 years and over) also need to spend and

invest on social security programs and health. Healthcare and primary education in Bhutan

are provided by the government free of charge. The rapid growth in the young population

requires governments to create more job opportunities. In Bhutan young population

accounts for 18.4% of the population and the number of young people are increasing

continuously. In Bhutan, the unemployment among the young people has become an issue.

If young population is unable to find jobs it can lead to unrest. The overall unemployment

9

rate of Bhutan is 3.2% but the unemployment among youth is 10.7%. The population growth

rate of Bhutan was 1.02% in 2018.

The population density of Bhutan is 18 people per sq. km and it is one of the lowest

population densities of the world. There are three main ethnic groups in Bhutan namely;

Tshanglas, Ngalops and Lhotshampas. The official language of Bhutan is Dzongkha, a

language closely related to Tibetan and Nepali. For administrative purposes, Bhutan is

divided in to 20 Dzongkag or districts and 205 Gewogs or group of villages.

2.5. ECONOMY: Bhutan’s small economy with a GDP of US$ 2,582 (2018) is largely based

on hydropower, agriculture and forestry which provides livelihood for more than half of the

population. The GDP per capita in 2018 was US$ 3,423 and GDP has grown by 4.6% over the

previous year. The growth rate which was 8.0% in 2016 has dropped to 6.3% in 2017 mainly

due low investments in the hydropower projects. The estimated growth rate for 2019 is

5.7% and 6.0% for 2020. The services sector contributes nearly 42% of GDP while industrial

sector including hydropower contributes around 41%. One of the economic risks faced by

Bhutan is very high reliance on hydropower. Around 40% of the total exports of the country

are from hydropower while around 25% government revenue is from hydropower. Given

the size of the hydropower projects relative to the size of the economy, any setbacks in the

construction of hydropower projects will negatively impact the economy through lower

exports and reduced government revenue. Bhutan currently utilizes only 6.5% of its

hydropower potential of around 24,000 megawatts. Due to its capital incentive nature,

hydropower and construction sectors, the development of these two sectors does not

generate much employment opportunities. Although the contribution from agriculture

sector towards GDP is only around 17%, it provides livelihood to around 62% of the

population. Agriculture is mainly for subsistence and the average farm size is about 1.7

hectares. With much of Bhutan too steep, too high or too cold to farm, only around 3% of

the Bhutan is cultivable and most of this is fragmented and scattered in difficult terrain

making farming very difficult and labor intensive with mechanization being difficult.

Although the agriculture is livelihood of 62% of the population, it faces several constraints

including, small size of land holding, lack of adequate irrigation facilities, poor soil fertility in

some areas, limited access to technology and inputs, few off-farm employment

opportunities, poor access to markets and very high transport costs. Rice is the main crop

and is grown by nearly 60% of households. Livestock (cattle, pigs and poultry) is also an

important economic activity of farmers. The industrial sector is primarily of cottage and

small industry type except the hydropower projects. The economy is closely aligned with

Indian economy with trade and monetary links. Bhutanese currency is pegged to Indian

Rupee and impact of economic events in India is reflected in the economic events of

Bhutan. The country is heavily dependent on India for financial assistance and migrant

laborers for development projects such as roads, bridges and construction of buildings. The

entirety of electricity exports from Bhutan is to India and of the total exports of Bhutan,

India accounts for around 85% of exports. Of the total imports of the country, around 82% is

from India. The country is famous for its unique philosophy of Gross National Happiness

(GNH) which forms the basis of its development strategies. Economists all over the world

10

have argued and many of have agreed that the key to happiness is obtaining and enjoying

material wealth. This is why the world has been using the total material output of a country

measured in terms of Gross Domestic Product (GDP) as the indicator of the level of

development. Bhutan however, adheres to a different belief and advocates that amassing

material wealth does not necessarily lead to happiness. Bhutan now tries to measure the

country’s level of development not by the popular measure of GDP but through the Gross

National Happiness. The four main pillars of GNH are;

i. Equitable and sustainable socio-economic benefit

ii. Preservation and promotion of cultural and spiritual heritage

iii. Conservation of environment

iv. Good Governance

The concept of GNH implies that sustainable development should take a holistic approach

towards the notion of progress and give equal importance to non-economic aspects of well-

being. It includes an index which is used to measure the collective happiness and wellbeing

of the population. The index contains nine domains (psychological wellbeing, health,

education, time use, cultural diversity and resilience, community vitality, ecological diversity

and resilience, good governance and living standards). All economic plans of Bhutan are

based on this concept.

Since 1961, the economy of Bhutan has been guided through Five Year Development Plans.

The first Five-year development Plan was introduced in 1961 with financial assistance from

India and the five-year plan currently being implemented is the 12th Plan (2018 -2023). The

five-year plans of Bhutan are a series of national economic development plans created by

the government of Bhutan to implement its development plans. The objective of the 12th

Five Year Plan is to create a “Just Harmonious and Sustainable Society through enhanced

Decentralization”. A “just Society” is defined as a society where every citizen has equitable access to resources and opportunities to pursue and realize individual and national

aspirations. Some of the high priority areas that will be addressed under 12th Five-year plan

are economic growth and diversification, employment generation, access to reliable and

safe drinking water, rural income generation, efficiency and effectiveness of public service

and waste management.

2.6. FINANCIAL SECTOR: The financial sector of Bhutan consists of five (05) banks, three

(03) insurance companies, six (06) microfinance companies, one (01) credit information

bureau, one (01) National Pension & Provident fund, one (01) central registry and one (01)

stock exchange. The banking sector is the dominant player of the financial sector and the

five banks in Bhutan are Bank of Bhutan (BOB), Bhutan National Bank (BNB), Druk PNB Bank

(DPNBB), T Bank and Bhutan Development Bank. Bank of Bhutan (BOB) the largest bank in

Bhutan was established in 1968 as the country’s first commercial bank as a joint venture of the government with Standard Charted Bank. It served as country’s central bank, prior to

the establishment of Royal Monetary Authority (RMA) in 1983. In 1972, BOB was re-

organized with the State Bank of India (SBI) taking over 40% of the equity capital of the Bank

11

and taking over the management. In 2002, the management of the Bank was returned to

Bhutan and SBI’s share holdings were reduced to 20%. Currently, the remaining 80% is owned by the government through, Druk holding and Investment, a fully state owned

enterprise. Bhutan National Bank (BNB) commenced its operations in July 1980 as a Unit

Trust of Bhutan with a capital of Nu 2.5 mn contributed by Royal Insurance Corporation of

Bhutan (RICB). In 1992 it became an independent financial institution and the trust was

converted to a commercial bank in 1995. At present, BNB is a listed company. The Druk PNB

Bank (DPNBB) was setup in 2012 as the first Foreign Direct Investment (FDI) bank in Bhutan.

Out of the total capital of DPNBB, 51% is held by Punjab National Bank, 19% by the

Bhutanese promoters and the balance 30% is held by the general public. T Bank Ltd is the

fourth Commercial bank in Bhutan which commenced operations in 2012. It is a listed

company with three prominent individuals holding 60% of the share capital while the

balance 40 % is held by the general public.

Around 64% of the adult population in Bhutan have savings accounts and only 16% had

access to credit and 18% held life insurance. Lending by banks to the rural sector is at very

low level. Out of the 05 banks, involvement of 04 banks in rural finance is very limited. Only

BDBL is actively involved in rural sector lending. In order to compel banks to lend to the

rural sector, RMA in 2018 introduced prudential guidelines on priority sector lending (PSL).

Under these guidelines, all banks are required to lend at least 1% their portfolios to priority

sectors. Rural sector and CSI sector are among the priority sectors. The composition of the

credit market as at end Dec 2017 was as follows:

Source: National Strategy for Financial

Inclusion Strategy 2018-2023

Of the total lending by the banking sector, only around 55% has been granted for business

purposes and the balance 45% is for personal use.

2.6.1. Access Points: There is a wide array of access points for financial services including

bank branches and agents, MFIs, insurance companies and agents, ATMs and POS terminals.

Some data on access points are given below:

• For every 10,000 adults (15 and over) there 67 access points

Sector Amt (Nu Bn) %

Microfinance 2.97 2.87

Cottage 3.25 3.14

Small 11.72 11.34

Medium 22.94 22.02

Large 16.64 15.91

Total Enterprise 57.82 55.48

Non-Enterprise 46.00 44.52

Total 103.82 100.00

12

• For every 10,000 adults there are approximately three bank branches and one

insurance branch

• For every 10,000 adults there are eight bank agents and 35 insurance agents

• Approximately four ATMs for 10,000 adults

2.6.2. Performance of Banks: Lending in Bhutan is carried out by banks and non-bank

financial institutions such as insurance companies and MFIs. As per the Annual Report of

RMA for 2018, out of the total credit outstanding as at June 2018 amounting to Nu 10 8 Bn,

around 82% has been granted by banks and the balance 18% amounting to Nu 21.5 Bn by

non-bank financial institutions mainly by Royal Insurance Corporation Of Bhutan(RICB).

Some operational indicators of the five banks as at end of 2018 are shown in the following

table:

Source: Annual Reports of Respective Banks

* Overall financial sector

The total lending portfolios of five banks amounted to approximately Nu 95.1 Bn as at end

of 2018. In addition to lending by banks, lending by non-banks amounted to around 21.5 bn.

Out of the total lending portfolio of banks, only around 5% has been granted to the

agriculture sector while around 26% has been to the Services and Tourism Sector, 25% to

the Construction Sector (inclusive 23% for housing), and around 16% to Trade and

Commerce Sector. The national average of ratio of non-performing loans to loans and

advances portfolio was 11.5% which indicates a very high level of infected credit portfolio.

High NPL ratios are in Services and Tourism Sector (25%), Trade and Commerce Sector (22%)

and Housing Sector (18%). BOB and BNB together account for approximately 65% of the

total lending portfolio while BOB the largest among the five banks alone accounts for 38% of

the portfolio. In terms of the size of the lending portfolio, BDBL is in the 3rd place holding a

market share of 17%. The total customer deposits held by five banks amounted to Nu 115

Bn at the end of 2018 of which BOB holds 40% while 26% is held by BNP. The Market share

of BDBL in customer deposits is 18%. The joint market share of Druk Bank and TBank in

credit and deposit markets are less than 15%. Of the five banks only three banks have a

systemic influence on the financial sector in the country.

Indicator/Bank BNP BOB Druk B T Bank BDBL Total

Interest Income(Nu Mn) 2,670 3,464 885 556 2,042 8,920

Net Interest Income(Nu Mn) 1,604 1,993 403 265 680 4,945

Net fee & Commissions(Nu Mn) 122 251 108 31 65 577

Net operating Income(Nu Mn) 1,726 2,244 511 296 745 6,261

Operating expenses (Nu Mn) 784 999 354 133 422 2,693

Net Profit (Nu Mn) 606 1,040 233 119 300 2,298

Loans & Advances (Nu Bn) 29 36 9 5 16 95

Deposits (Nu Bn) 30 46 13 5 21 115

NPL/Loan portfolio (%) 5.62 2.87 1.66 6.44 20.73 11.5*

13

The total gross interest income earned by the five banks amounted to Nu 8,920 Mn in 2018

of which, 39% was earned by BOB while 30% was earned by BNB. The share of BDBL was

22%. The total profits earned by the banking sector in 2018 was Nu 2,298 Mn and BOB and

BNP account for 72% of the net profit earned while BOB alone accounts for 45% of total net

profits. Although, BOB accounts for 38% of the lending portfolio, 40% savings and 39% of

the gross interest income, it accounts for 45% the banking sector net profits indicating

higher profitability of its operations when compared with other four banks.

The interest cost as a percentage of gross interest income of the five banks has varied from

40% to 67% with an average ratio of 45% during the year 2018 as shown in the following

table:


The highest percentage of interest cost as a percentage of gross interest income has been

recorded by BDBL while lowest has been recorded by BNB. The ratio of BDBL was 67% while

the ratio of BNB was 40%. The level of interest cost as a percentage of gross interest income

makes a huge impact on the profitability of banks. In order to make an assessment of the

growth of banking activities of five banks during the last five years, a comparison was made

between indicators of 2018 with that of 2014. The performance indicators of 2014 are

shown in the following table:


During the five year period under review, the total lending portfolio of five banks has

increased by 76.5%. Two smaller banks (Druk Bank and T Bank) have recorded more than

100% growth in their lending portfolios. Of the five banks, the lowest growth has been

Indicator/Bank BNP BOB Druk T Bank BDBL Total

Gross Interest Income(Nu Mn) 2,670 3,464 885 556 2,042 8,920

Net Interest Income(Nu Mn) 1,604 1,993 403 265 680 4,945

Interest cost as a %Gross interest income 40% 46% 54% 52% 67% 45%

Indicator/Bank BNP BOB Druk T Bank BDBL Total

Gross Interest Income (Nu Mn) 2,161 2,142 472 335 1,345 6,462

Net Interest Income (Nu Mn) 1,356 1,279 195 165 685 3,681

Interest cost as a %Gross interest income 37% 40% 58% 50% 49% 43%

Net fee & Commission income (Nu Mn) 82 221 105 9 20 437

Total Operating Income (Nu Mn) 1,438 1,500 300 174 879 4,997

Operating Expensed (Nu Mn) 468 500 127 110 432 1,637

Net Profit (Nu Mn) 743 848 100 37 281 2,009

Loans & Advances (Nu Bn) 18.7 18.4 4 2.3 10.4 53.8

Deposits (Nu Bn) 15.1 33.4 5.7 2.3 12 68.9

14

achieved by BDBL which is 54%. The largest bank, BOB has achieved a growth of 96% during

the five years. Total deposits of the five banks have grown by 70%. The two smaller banks

have achieved growth rates of more than 100% while BNB, the second largest bank, has

achieved a growth of 98%. The growth in deposits of the largest bank, BOB was only 38%,

much below the growth of the overall deposit market. Deposit portfolio of BDBL has grown

by 75% during the five years. The rate of growth in deposits of the banking sector is less

than the growth in lending by the banks. The gross interest income of banks has grown only

by 28% during the five year period although the lending portfolio has grown by 76.5%

indicating a declining profitability trend of banks. The following table shows credit market

growth during the five years and changes of the relative market share of five banks:

Source: Annual reports of Respective Banks

The overall credit market has grown by 76.5% during the five year period while three banks

have achieved a growth in credit of more than the overall growth of 76.5%. Only DBBL and

BNB have achieved growth of less than the overall average. The BDBL has achieved the

lowest growth in credit among the five banks. During this five year period, BDBL has lost its

market share from 19.3% in 2014 to 16.8% in 2018 while all other banks have increased

their respective market shares. While all other four banks are catering mainly to the urban

corporate sector, BDBL caters mainly to the rural sector.

2.6.3. Interest Rates: Prior to 1999, interest rates were set by RMA. In 1999, RMA

deregulated interest rates and allowed banks to determine their lending rates and deposit

rates based on market forces. In order to strengthen the interest rate policy, RMA

introduced a base rate system. The base rate is the rate below which it is not viable for

financial institutions to lend. It also served as a reference benchmark for variable lending

rates. The base rate system was reviewed again in early 2016 and new forward looking

interest rate policy known as “Minimum Lending Rate (MLR)” was introduced to remedy the weaknesses of the base rate system. The main objective of MLR is to encourage competition

and to develop professionalism among financial institutions. The MLR is compiled by RMA

based on the data collected from individual banks. The MLR for an individual bank is

computed adding up the cost parameters of the respective banks. The cost parameters are;

Year/Bank 2014 2018 Market

Growth

(%)

Credit

Portfolio

(Nu Bn)

Market

Share

(%)

Position Credit

Portfolio

(Nu Bn

Market

Share

(%)

Market

Position

BOB 18.4 34.3 02 36.0 37.9 01 95.6

BNB 18.7 34.7 01 29.0 30.5 02 55.0

Druk 4.0 7.5 04 9.0 9.5 04 125.0

T Bank 2.3 4.2 05 5.0 5.3 05 117.0

BDBL 10.4 19.3 03 16.0 16.8 03 54.0

TOTAL 53.8 100.0 95.0 100.0 76.5

15

i. Marginal cost calculated based on interest rate times the weight. The weight is

derived as a percentage of total fund

ii. Negative carry charges on CRR.(i.e. the cost incurred by the banks while maintaining

10% cash reserve with RMA

iii. Operating cost (i.e. this is arrived at by dividing banks’ operating cost by total

deposits of the bank.

Each financial institution is free to add to the MLR computed by RMA, its spread, credit risk

premium and tenor premium. MLR published by RMA for June 2018 was 6.30% of which

marginal cost component was 4.89%. On an average, the lending rates of banks in 2018

were 11.5%. Deposit rates of banks ranged at 5% - 7.5% depending on the tenor and the

nature of the deposit.

NOTE:

As per the Financial Sector Performance Review Report issued by RMA on the

performance of the financial sector during the first quarter of 2019, the performance of

the sector has deteriorated further. The financial sector as a whole has incurred a loss of

Nu 1.19 Bn mainly due the deterioration of the NPL ratio further from 11.5% in 2018 to

16.08% as at March 2019. Further, RWCAR has declined to 14.07% as at March 2019 as at

March 2019 from 14.54% as at March 2018.The unfavorable performance of the financial

sector has come mainly due to poor performance of the non-bank financial institution

sector.

2.7. CURRENT STATUS OF RURAL FINANCE IN BHUTAN: Financial inclusion in Bhutan

particularly in rural areas is very low. According to Global Financial Inclusion (Global Findex)

Data Base launched by the World Bank in 2014, based on financial inclusion data of 2014,

Bhutan was rated lower than other developing countries in terms of access to finance.

Compared to other developing economies where adults had an account penetration of 54%,

Bhutan had account penetration ratio of only 34%. However, the female account

penetration rate was even lower with a penetration rate of 28% compared to average

penetration of 50% in developing economies. A comparison of data for the year 2014 of

SAARC Countries (Except Maldives) where Bhutan is a member shows that access to finance

in Bhutan was lower than India and Sri Lanka and higher than Afghanistan, Bangladesh and

Pakistan and in par with Nepal. The comparison is given below:

Country Account

Penetration %

Afghanistan 10

Pakistan 13

16

Source: Global Findex

According to a household survey carried out by a group of World Bank Consultants, the

Bhutanese economy is cash based economy where households have vibrant informal

savings and lending culture. Financial management strategies of most households in Bhutan

remains informal with formal financial services only weakly integrated with the daily

activities of rural families which constitute of around 60% of the country’s total population.

Since cash is the predominant form of exchange, people have no incentives to deal with

banks or other financial institutions. Rural areas are particularly unbanked where bank

branches are distant and banking culture poorly reflects people’s financial needs. Significant

disparities persists in financial inclusion between rural and urban areas, youth and adults,

the poor and the rich and CSIs and large firms. The access to finance situation of Bhutan has

improved considerably since 2014 due to measures introduced by the Royal Government of

Bhutan (RGoB) and Royal Monetary Authority (RMA) to improve the access to finance.

According to the National Financial Inclusion Strategy 2018-2023 (NFIS), as of December

2017, 64.47% of the adult population in Bhutan had an account with a bank while only

16.08% had access to credit and 17.79% held a life insurance policy. Out of the 64.47% of

adults who held accounts with banks, 56% were male and 44% were female. Similarly, out of

the 16.08 % who had access to credit, 54% were male and 46% were female. The current

status (as of December 2017) of financial inclusion in Bhutan is summarized in the following

table:

Source: National Financial Inclusion Strategy 2018-2023

From the above statistics it can be observed that although the account penetration of

Bhutan is at a satisfactory level, access to credit is at a very low level. The capital formation

in any economy is essential for economic growth and credit flow from the financial sector

plays an important role in capital formation required for economic growth. Steps towards

increasing the credit flow for economically productive activities are therefore essential for

GDP growth and thereby economic growth. Promoting the access to credit in the rural

Bangladesh 31

Nepal 34

Bhutan 34

India 53

Sri Lanka 83

Financial

Product

Adult

Population

Inclusion

Number

Inclusion

Percentage

Exclusion

Percentage

Savings Accounts 494,586 318,837 64 36

Credit 494,586 79,546 16 84

Life Insurance 494,586 88,008 18 82

17

sector is crucial in promoting inclusive growth in Bhutan. Cottage and Small Industry sector

is an important economic group in the rural sector. The Government of Bhutan believes that

a robust CSI sector could immensely contribute towards the economic growth of the

country and also towards the equitable distribution of national income. Bhutan’s CSI sector represents more than 95% of the business enterprises with 22,064 licensed enterprises with

99,200 employees. Although the sector is important from the economic point of view, the

credit flow to the sector is very low at 15% of the total lending by banks. In Bhutan CSIs are

classified by the number of employees and level of capital employment at start-Up.

Enterprises with start-up investment up to Nu 1.0 mn are classified as “cottage” while

enterprises with a start-up capital above Nu 1.0 Mn up to Nu 10.0 mn are classified as

“small”. Definition in terms of number of employees is enterprises with 1-4 employees are

defined as “cottage” while enterprises with 5-19 employees are defined as “small”.

2.7.1. Constraints Faced by CSIs and Rural Poor in Accessing Banking Services: Out of

the constraints faced by CSIs, the access to finance is by far the most serious and largest

constraint due to;

i. Weak financial and operational performance of key rural financial institutions

ii. Lack of adequate financial products and limited social mobilization to reach

rural CSIs.

iii. Strict collateral requirement mainly in the form of immovable assets.

iv. Limited sources of funds.

v. Lack of financial infrastructure such as branches, point-of-sales devices,

ATMs, and distance to service delivery points.

vi. Manually driven enterprises and limited usage of modern technology

vii. Low entrepreneurial skills.

viii. Lack of professional Business Development Services.

ix. Limited markets and limited scale of economies.

x. Lack of capacity to develop financially viable business proposals.

xi. Low financial literacy.

2.7.2. Constraints Faced by Financial Institutions in Delivering Financial Services:

i. Deteriorating credit quality due to reasons such as very high loan officer to

number of loans ratio, inadequate post disbursement credit supervision, and

very high distance between clients and the branch offices and in between clients.

ii. Inadequate skills in cash flow based lending.

iii. Lack of bankable viable projects.

iv. Low financial literacy of the potential borrowers.

v. Very high transaction cost of CSI lending when compared with relatively low

margins of lending.

18

vi. Regulated interest rates (Minimum Lending Rate Policy of RMA) and non-

existence of risks based pricing model. All types of lending are subjected to same

interest rate policy.

vii. Lack of entrepreneurial skills.

viii. Non-maintenance of financial records by existing CSIs to enable credit officers to

make a proper assessment of cash flows of potential borrowers.

19

3. PART TWO - DIAGNOSTIC STUDY ON BHUTAN DEVELOPMENT BANK

LIMITED

3.1. THE BANK: Bhutan Development Bank Limited (BDBL) originally commenced

operations as Bhutan Development Finance Corporation. It was incorporated by the Royal

Charter in January 1988 with assistance from the Asian Development Bank (ADB) to function

as a Development finance institution (DFI). In 2010, it registered as a company under the

Companies Act 2000 and was licensed under the Finance Institution Act. After obtaining its

banking license in March 2010, it started functioning as a domestic development bank with

current account facilities. The main objective of BDBL is to “promote the industrial, agricultural and commercial development” of the economy of Bhutan by:

• Providing financial services to Micro, Small and medium enterprises for the

development and moderation of agriculture, industrial and commercial enterprises of

the country;

• Enhancing income of the people to improve the living standard and alleviate poverty;

• Deepening financial inclusion by providing credit and inculcating saving habit among

the people;

• Providing financial and technical and advisory assistance to enterprises; and

• Mobilizing external and internal capital investment in enterprises.

The Bank is managed by a board of directors consisting of seven members including the

Chief Executive officer (CEO) of the Bank. All directors of the Bank, except the CEO, are

either former or serving top level government officials. The CEO had been with the Bank for

a long period of time before he was appointed as the CEO. All directors of the Bank including

the CEO are appointed directly by the Government. The Board of Directors is supported by

three sub committees on Risk Management, Audit and Credit, appointed in terms of the

Corporate Governance Regulations (CGR) of RMA. The top management of the Bank

consists of the CEO, seven General Managers in charge of Credit, ICT, Admin & HR,

Corporate Planning &Research, Finance & Treasury, Thimphu Main Branch and Internal

Audit together with the company secretary. For the purpose of administration, the Bank is

divided in to three regions namely; Western, Central and Eastern which are under the

supervision of three regional managers. The total staff strength in 2018 was 814 including

the 231 community center staff. The Bank regularly conducts a customer survey to measure

the level of customer satisfaction. The overall score of survey conducted in 2018 has

improved from 83.57 % in 2014 to 85.57% in 2018. The discussions with customers and

other related groups revealed that BDBL has a very favorable reputation among the general

public as the bank for rural poor. The core-values of the Bank are;

20

• Professionalism - give your best

• Excellence - aim for higher ideals

• Ownership - work together for growth

• Loyalty - Be true to one self and stake holders

• Efficiency - Deliver Prompt Services

The Bank provides a wide range of credit and savings products to its clients. The main credit

target customers are individuals, sole proprietorships, groups, associations, cooperatives,

partnerships, legally registered companies and corporations engaged in both income

generating and non-income generating activities. BDBL operates in almost all economic

sectors and it has tailor made credit products to suite the particular requirements of

particular sectors.

3.2. PRODUCTS - CREDIT: The main economic sectors in which BDBL operates and also

types of loan products in each sector are shown in the ANNEXURE 01. The main categories

of loans offered by BDBLK are shown below:

i. Agriculture

ii. Services

iii. Production and Manufacturing

iv. Trade and Commerce

v. Housing

vi. Transport Sector (All Automobiles)

vii. Loans to Purchase Shares

viii. Loans Against Shares

ix. Loans against Fixed Deposits

x. Education Loans

xi. Loans to Financial Institutions

xii. Personal Loans

xiii. Loans to Government

Based on the mode of operations, all loans granted by BDBL could be categorized under the

following broad categories:

i. Individual Loans

ii. Group Loans

Individual loans are loans granted to individuals, firms and corporate entities. Group loans

are loans granted to groups formed by a group of individuals for the purposes of borrowing

money for business purposes. This model of lending is also known as “Grameen Model”. All individual loans are granted against tangible collateral (except Employee Loans) and these

loans can be term loans or short term loans or revolving loans. Group loans are against cross

21

guarantees of solidarity group members. Financial institutions engaged in group lending

depend on “peer pressure” to recover loans. Guidelines for the valuation of assets to be

taken as collateral are revised and issued by BDBL from time to time. The Debt: Equity ratio

to be maintained when a business is financed is issued by RMA in its Prudential Rules and

Regulations. Although the current package of credit products offered by BDBL is

comprehensive, it is desirable that BDBL consider offering few more products which will

really help BDBL to reach rural unbanked population in inaccessible rural areas.

Most development banks in addition to providing fund based credit products it also

provides, savings products and trade related services such as guarantees and letters of

credit. At present BDBL mainly offers interest earning credit products or fund-based

products. Most banks offer a variety of fee based products and earn relatively a substantial

fee income. The offer of fee based products by BDBL is very limited and it offers only

Guarantees on (bid bonds, mobilization advances performance guarantees etc.) and letters

of credit for imports. It is recommended that BDBL consider offering a few new fund-based

product and a new fee based products. Fund based products recommended are described

below:

i. Leasing Equipment Leasing, Vehicle leasing and sale and lease back for CSIs who

cannot offer collateral in the form of immovable property. Sale and lease back of

equipment and vehicles for existing businesses to obtain working capital loans

ii. Leasing of high - end consumer durables for rural households with regular or

seasonal incomes

iii. Venture capital/Seed capital for sustainable CSIs who are experiencing shortages of

equity capital

iv. Wholesale loans to sustainable MFIs through credit lines or through the

securitization of lending portfolios of MFIs

v. Value chain financing programs for few industry sectors/commodities. The possible

sectors/commodities for introducing value chain financing programs are Fruits

Industry, Dairy Farming, Potato Cultivation and Textile Handicraft.

vi. Non-collateralized loan for low risk profile clients

In a country like Bhutan where lending is mainly done based on collateral and acceptable

collateral cannot be offered by most of the potential borrowers, the way forward is to

undertake group lending in a large scale. Although, BDBL commenced offering group loans

since 1998, the product has not been properly marketed and offered. It is the only credit

product offered by BDBL at present free of collateral and potential borrowers who do not

possess tangible collateral should have resorted in large numbers to borrow. However,

surprisingly this has not happened. Quality of the non-collateralized group lending portfolio

of BDBL is relatively better than the secured individual lending portfolio. BDBL currently

facing a severe problem of high NPL and therefore it is more prudent for them to lend more

in group loans which carry low NPLs. The details of currently outstanding on the group

22

lending portfolio together with the total outstanding lending portfolio are shown in the

following table:

Indicator Portfolio Value

Outstanding

As at Dec 2018

(Nu Mn)

Number of

borrowers

at Dec2018

Total portfolio 19,917 52,982

Group Lending portfolio 205 1,704

Total portfolio in NPL 4,841 8,462

Group lending portfolio in NPL 15 143

Group loans as percentage of total Loans 1.02% 3.22%

Total NPL as % of total lending portfolio 24.31% 15.97%

Group Loans in NPLs as %Total Group lending 7.31% 8.4%

Source: BDBL

The NPL ratio of the total Nu value of group loan portfolio was 7.31% while the overall NPL

ratio of the Nu value of the total portfolio was 24.3 %. Of the total borrowers 15.97% had

been infected while only 8.4% of the Group borrowers are infected. This clearly shows that

group lending is of high quality and BDBL should actively promote and pursue group lending.

Lack of promotion and reluctance on the part of the credit officers had resulted in very low

level of group lending portfolio. Some guidelines to revitalize the group lending are given in

ANNEXURE 13. BDBL may use these guidelines to supplement the guidelines given in the

Group Lending Manual of BDBL.

Development Banks also provides merchant banking services to its existing clients and also

to the general public for a fee which are known as fee based services. The main merchant

banking services, BDBL could consider offering are:

i. Preparation of feasibility reports

ii. Restructuring of sick enterprises

iii. Investment advisory

iv. Proving Business Development Support Services(BDS)

3.3. PRODUCTS - DEPOSITS: In addition to the credit products offered by BDBL it also

offers a package of liability (deposit) products to its customers. Main savings products

offered by BDBL are described below:

i. Fixed deposits- Fixed deposits offered by BDBL are of two types; namely corporate

and individual. The minimum tenor of both types of fixed deposits is three months

while there is no maximum tenor. The rates of interest paid on individual fixed

deposits are relatively higher than the rates paid on corporate fixed deposits. The

23

rate of interest paid in individual fixed deposits varies from 5.9% to 9.10% per

annum while the rate paid on corporate deposits vary from 2.0% to 9.1-% per annum

on annual basis.

ii. Recurring Deposit: Recurring deposit (RD) is a product for those people who have

regular income and who wish to regularly deposit small fixed amount at pre-

determined periods and for a fixed period. The rate of interest depends on the

period for which the depositor agrees to deposit money to the RD account. The

minimum deposit amount is Nu100 and there is no maximum deposit amount. The

minimum installment period is six months while the maximum is 120 months (time

period is yearly).The rate of interest depending on the tenor of the deposit varies

from 5.75% to 9.10% on an annual basis.

iii. Savings Account: The savings accounts are offered to encourage the culture of

savings among the private individuals, housewives and other members of the

community. In addition, BDBL offers two variations to the regular savings account

namely; Drinchen Savings accounts (focused on house makers/head of

households/mothers) and pensioners’ savings accounts. Pensioners’ savings accounts are maintained by BDBL as desired by National Pension and Provident Fund

(NPPF) for the convenience of pension holders. The current rate of interest paid on

all types of saving accounts is 5.6%.

iv. Steady Income Plan: Under Steady Income Plan (SIP) for individuals, interest is paid

at regular frequencies as desired by the depositor on monthly/quarterly/half yearly

and yearly basis and the principal is repaid on maturity. The minimum deposit is Nu

25,000 while there is no maximum. The minimum deposit period is one year and

there is no maximum deposit period. The rate of interest depends on the period of

the deposit and the frequency of the payment of interest. The rate applicable for

deposits for which the interest is paid on yearly basis at present varies from 6.79% to

7.46% while the rate paid on deposits for which the interest is paid monthly varies

from 6.57% to 7.17%.

v. Youth Ethics (YE) Banking Accounts: YE banking is a new banking concept floated by

RMA in 2018 with the aim of bringing young students to the banking system. Only

students below 18 years are eligible to hold YE banking accounts. The concept has

been designed to inculcate saving habit and to educate youngsters on practical

financial knowledge in banking, insurance and others.

vi. Current Accounts: Current accounts are non-interest bearing deposit accounts that

enable customers to handle their transactions, collect cheques/bills and making

payments. Current accounts can be operated using cheques and written instructions.

Product Outstanding as at

Dec 2018(Nu Mn)

24

Source: BDBL

The composition of the deposits measures in terms of CASA Ratio (balances in Current

Accounts and Saving Accounts as a percentage of total deposits) has a definite impact on

the cost of funds of banks/ financial institutions. Interest is not paid on current accounts

while the interest on savings accounts is relatively low. Term deposits will attract high rates

of interests. More the share of current accounts and savings accounts, lesser is the cost of

funds. CASA Ratio of BDBL based on the Annual Report of BDBL for 2018 was 24.7%. When

compared with other banks in Bhutan, the ratio of BDBL was the lowest. As per the annual

reports of respective banks, the CASA Ratio had been 77% for BOB, 57% for BNB 37% for

Druck BNP and 75% for T Bank. Lower CASA Ratio indicates high cost of funds and reducing

net interest margins. Improving the CASA ratio of BDBL should be part of its future strategy.

And The CASA ratio of BDBL is very low and almost all deposits are interest bearing deposits.

3.4. BUSINESS PROCESS: BDBL commenced operations as a development finance

institution in 1988 providing only credit products and its business model was limited to a

lending institution. It did not cover the entire gamut of banking activities. During the initial

period, BDBL was depending on the Government and/or multilateral development agencies

for free cost and low cost funding as it was not authorized to mobilized deposits from the

general public. The limited business model and the business process of BDBL changed

substantially in 2010 with the obtaining of the banking license from RMA. BDBL with started

as a DFI became a universal bank in 2010 providing development banking products( mainly

project loans) and all types of interest and fee based products. With this change the entire

business process of BDBL was also changed. The current business process of BDBL is almost

entirely focused on lending business as gross income from lending business accounts more

than 95% of the total gross income of BDBL. The gross income of o BDBL amounted to Nu

1995 Mn in 2018 of which the gross interest income from loans and advances amounted to

Nu 1962 Mn while the gross fee income in 2018 amounted to only Nu 33 mn. The gross

interest income from loans and advances represented 98% of the total gross income of the

bank. The Business process of any successful bank concentrating on lending should

encompass the following steps:

i. Pro-Active Marketing and sourcing of potential customers

ii. Initial screening of potential clients using an effective risk management tool

(Credit Scoring and/or client risk rating)

iii. Credit Appraisal of screened credit applications using 5Cs approach

iv. Credit decision making minimizing the credit risk

v. Proper disbursement of loan proceeds avoiding misuse of loan proceeds

Term Deposits 15,518

Saving Deposits 4,590

Current Deposits 594

Others 311

Total Deposits 21,013

25

vi. Collateral management to safeguard the asset and to prevent value deterioration

vii. Post Disbursement loan supervision/portfolio supervision

viii. Reporting

It was observed that the business process of BDBL covers only few of the steps described

above in its business process. The most important step in the business process of any

business organization is the” pro-active marketing” of its products and services. However, due to heavy load of work, the credit officers in branches are unable to undertake

marketing and mostly serve only “walk in” customers and this has resulted in low outreach

of BDBL. The approach used in initial screening of loan application is highly subjective and

whether to accept a loan application from a potential customer for further processing or not

depends entirely on a subjective judgment of the credit officer. No scientific method such as

Client Risk Rating or credit scouring is used for initial screening of loan applications. Post

disbursement loan monitoring is also lacking in the business process of BDBL. The weak

areas described above in the business process which has finally resulted in high NPLs need

improvements.

3.5. OPERATING MODALITY: The primary objective of BDBL is to promote rural finance in

Bhutan and it is the major and largest player in rural finance. In order strike a balance

between the profitability and social objective of providing financial services to unbanked

rural population which activity is not very profitable, BDBL follow a policy of lending 40% of

its portfolio to Urban Corporates where the risk is relatively low and the balance 60% to

Rural Households and CSIs where the risk is relatively higher. In order to achieve the

objectives of BDBL , it currently operates through Head Office in Thimphu, three Regional

Offices (Western-Paro, Central-Gelephu and Eastern-Trashigang), 35 nationwide branch

offices, 24 Gewogs (group of villages) Field Offices and 200 Community Centers across all 20

Dzongkag and 14 Dungkhags (sub districts. The operating modality followed by BDBL in its

main business activity of lending is described step by step in the following paragraphs. The

process involved in loan initiation and loan management is slightly different for branch

credit and credit from the Thimphu Main Branch (TMB). Most of the steps involved are

common. The Main branch accounts for 34 percent of the outstanding portfolio and 8%

percent of the number accounts. The Branch has nine credit officers. The steps involved in

the process of approving and managing individual loans (the number of group loans

accounts only for about 3% total number loans and the operating modality of group loans is

described elsewhere in this report.)

Step One: Loan applicants come to the branch and hand over applications to the Customer

Relationship Manager of the Branch. In other branches loan application is handed over to

the Loans officer or to the branch manager. Main branch handles only individual loans while

branches handle both individual and group loans.

Step Two: in the case of Main Branch, the Customer Relationship Manager distributes the

applications received among the 9 credit officers. In branches if the loan application is

handed over to the Branch Manager, it will be handed over to a credit officer for processing.

26

Step Three: Credit officers undertake the first screening of applications received. The

average time taken for initial screening is 2-3 days. Main reasons for rejections are; Bad past

debt servicing record, non-viability of proposal and inadequate collateral valuations.

Step Four: Client Visits: The credit officer who was allocated a credit application visits the

applicant to verify the data given in the application and to observe the operations of the

applicant. The average time taken for this step is 2-3 Days.

Step Five: Credit appraisal and preparation of Appraisal Report by the credit officer. Time

taken is 4-5 Days.

Step Six: Credit approval - Main Branch: the credit of the Main Branch is approved at four

different Levels: at General Manager Branch up to Nu 10 Mn, at Deputy CEO Level above

Nu 10 Mn and up to Nu 20 Mn, at CEO level Nu 20 to Nu 35.0 Mn and above Nu 35 Mn at

board level. Before a credit application is approved or rejected by the respective approving

authority it will be reviewed by credit committee and the credit officer is required to make a

power point presentation to the relevant credit committee on the credit proposals. This

process takes about 4-5 Days.

Step Six: Credit approval - Other Branches: The branch credit officer handles the credit

appraisal of branch up to Nu 1.0 Mn and the Branch managers have the authority to

approve loans up to Nu 1.0 Mn. Applications for loans above Nu 1.0 Mn and up to Nu 2.5

Mn are approved at Head office. The credit applications above Nu 2.5 Mn are appraised and

approved at the Head Office where a Credit Unit with 13 credit officers operates. The credit

function at Head Office (except TMB) is under a General Manager. This process takes about 4-

5 Days.

Step Seven: Documentation: Main documents include sanction letter and mortgage bonds.

Appraisal officers are responsible for coordination of documentation. On an average, it

takes 7-10 days to complete the documentation.

Step Eight: Approved loans, documentation of which has been completed are disbursed by

respective credit officers at branches. Depending on the type and purpose of the loan it is

disbursed either in one installment or in several disbursements though the clients’ savings accounts. Where necessary, loan or part of the loan is disbursed to suppliers of products or

services.

Step Nine: All disbursed loans are to be followed up by the credit officers. However, post

disbursement follow-up is very limited due to the high ratio of number of loans per credit

officer. It was observed that at TMB some credit officers handle as much as 800 loans in

addition to working towards their loan approval targets. One reason of very high NPL

(30.29%) at TMB as against other branches (15.75%) is this very high ratio of number of

loans per loans officer. For follow-up and recovery of loans which have been in arrears for

more than 90 days, there is a separate recovery unit with five officers in TMB. All loans in

arrears for more than 90 days are taken over by the recovery Unit. All branches handle their

27

own follow-up to the point of legal action. Recently a separate recovery unit was set up in

HO to provide logistic support to the branch staff with two officers.

The process involved in loan origination seems to be efficient although post disbursement

loan management is insufficient. It appears that credit officers have no adequate time for

pro-active marketing and promotions and effective supervision of loans due to very high

number of loans per credit officer

3.6. LENDING PORTFOLIO: The total credit portfolio of BDBL as at end of 2018 was

Nu 18.9 Bn representing 54,441 borrowers. The Bank started mobilizing deposits from the

general public in 2010 after obtaining its Banking license from RMA. Today, the Bank has a

total deposit portfolio of Nu 20.08 Bn representing 203,000 saving accounts. BDBL accounts

for nearly 18% of the total debt outstanding in the financial sector (banks and non-banks).

BDBL also manages the Revolving Fund I valued at Nu 1.5 Bn transferred from former BOIC.

BDBL grants micro finance loans under this scheme. The number of Credit approvals of BDBL

for the last five years and the first six months of 2019 under different product categories are

given in the following tables:

Year/Product 2014 2015 2016 2017 2018 Jan-Jun

2019

Agriculture Loans 339 8,083 4,017 7,915 6,955 3,547

Employee Loans 1,638 1,168 2,069 2,998 2,189 1,132

Transport loans 161 7 707 851 296 188

Housing Loans 1,566 6 999 2,624 2,411 1,621

Group Loans 523 340 154 637 582 398

Working Capital Loans 264 64 282 381 248 113

Micro Finance Loans 230 2 189 7 257 189

Small Industry Loans 85 73 44 94 63 42

Others 4,425 3,424 1,412 2,384 2,022 1,629

TOTAL 9,213 10,831 9,638 17,888 15,023 8,885

Source: BDBL

The Nu values of approvals of BDBL for the last five years and the first six months of 2019

under different product categories are given in the following tables:

Year/Product

Nu. Mn

2014 2015 2016 2017 2018 Jan-Jun

2019

Agri & livestock Loans 629 1,630 969 1,937 2,108 1,004

Employee Loans 408 324 632 991 739 386

Transport loans 70 4 352 386 172 147

Housing Loans 507 1 614 1,210 767 603

Group Loans 51 30 14 87 111 83

Working Capital Loans 611 145 555 573 596 244

28

Source: BDBL

It can be seen from the above two tables that number of loans and the value of such loans

granted to agriculture in 2018 account for nearly 40% and 35% respectively of the total

number loans and value of such loans. The Number of loans granted for employees and

loans granted for housing are also substantial. The number of new borrowers in 2018

accounts for around 3% of the adult population in the country. The total outreach of BDBL in

the credit market is around 9% while the overall credit outreach in the country is around

16%.

3.7. CREDIT OUTREACH: The credit portfolio of BDBL in comparison with that of other four

banks is shown below:


The number of credit customers of BDBL has increased from 46,326 in 2014 to 54,441 in

2018 reflecting growth rate in the number of customers of only 19% for the entire 5 year

period although during the same period, the credit portfolio has increased by 54%. The

increase in the average loan size from Nu 195,851 in 2014 to Nu 408,496 in 2018 is reflected

in the vast percentage difference (35%) between the growth rates in credit portfolio and the

number of customers. The slow growth in the number of credit customers clearly shows

that BDBL has not been successful in increasing its credit outreach. In a country where the

credit outreach is only 16% of the adult’s population, BDBL has an important role in increasing the credit outreach which is essential for country’s economic growth. The deposit portfolio of BDBL in comparison with that of other four banks is shown below.

Micro Finance Loans 33 - 28 1 75 54

Small Industry Loans 25 17 18 27 18 9

Others 1,254 408 1,078 1,459 1,482 801

TOTAL 3,588 2,559 4,260 6,671 6,068 3,331

Year/

Bank

2014 2018 Market

Growth

(%)

Credit

Portfolio

(Nu Bn)

Market

Share

(%)

Market

Position

Credit

Portfolio

(Nu Bn

Market

Share

(%)

Market

Position

BOB 18.4 34.3 02 36.0 37.9 01 95.6

BNB 18.7 34.7 01 29.0 30.5 02 55.0

Druk 4.0 7.5 04 9.0 9.5 04 125.0

T Bank 2.3 4.2 05 5.0 5.3 05 117.0

BDBL 10.4 19.3 03 16.0 16.8 03 54.0

TOTAL 53.8 100.0 95.0 100.0 76.5

29

3.8. DEPOSITS OUTREACH: The deposit portfolio of BDBL in comparison with that of other

four banks is shown below:


The growth in deposits of the largest bank, BOB was only 38%, much below the growth of

the overall deposit market. Deposit portfolio of BDBL has grown by 75% during the five

years. The rate of growth in deposits of the banking sector at 68% is less than the growth in

lending by the banks. The overall deposit market has grown at a lesser rate than that of the

credit market during the five year period. While the credit market has grown by 76.5% the

deposit market has grown only by 67.3%. BDBL has been able to increase its market share

from 17.5% in 2014 to 18.4% in 2018. The overall loans to deposit ratio has improved from

78% in 2014 to 83% in 2018.

BDBL is managing the Community Centers on behalf of the government to act as a “one stop shop” to efficiently deliver Government to Citizen (G2C) and other services to the

community. There are 200 community centers covering 200 Gewogs out of the total 205

Gewogs the entire country and BDBL is in a strong position to use these centers to increase

its deposits and credit outreach particularly in rural arrears where banking services are

needed most. A strategy is proposed herein on how to make use of community centers to

increase the credit and deposit outreach of the Bank.

3.9. FINANCIAL PERFORMANCE: Summarized profit and loss statements and Balance

Sheets of BDBL for the five-year period 2014 to 2018 are given in ANNEXURE 02 and

ANNEXURE 03 respectively.

3.9.1. Profit and Loss Statements: Key indicators extracted from the profit and loss statements

are given overleaf:

Year/

Bank

2014 2018 Market

Growth

(%)

Deposit

Portfolio

(Nu Bn)

Market

Share

(%)

Market

Position

Deposit

Portfolio

(Nu Bn

Market

Share

(%)

Market

Position

BOB 33.4 48.8 01 46.0 40.2 01 38.8

BNB 15.1 22.1 02 30.0 26.3 02 98.7

Druk 05.7 08.3 04 12.6 11.1 04 121.0

T Bank 02.3 03.3 05 4.4 03.9 05 91.0

BDBL 12.0 17.5 03 21.0 18.5 03 75.0

TOTAL 68.5 100.0 114.6 100.0 67.3

30

Nu Mn

Source: BDBL

During the five-year period, the gross interest income of five banks from Loans and

advances has grown by 56% while gross interest income of BDBL has grown by a lesser rate

of 36%. BDBL accounted for 21% and 23% of the total gross interest income of the banking

sector in 2014 and 2018 respectively. Although BDBL has been able to marginally grow its

gross interest income during this period, the net interest income has recorded a negative

growth of around 1% when the net interest income of the banking sector has grown by

around 36%. It can be seen that the profitability of BDBL has been declining when all banks

have experienced an improvement at the net interest income level. The trend in the interest

income and interest costs of BDBL during the period 2014 to 2018 is shown in the following

table:

Indicator/Year 2014 2015 2016 2017 2018

Gross Interest Income (Nu Mn) 1,345 1,789 2,157 1,973 2,092

Net Interest Income (Nu Mn) 685 852 1,027 625 680

Interest Cost (Nu Mn) 660 937 1,130 1,348 1,412

Int cost as % of Gross Int Income (%) 49 52 52 68 68

Int cost as % of Gross Int Income of the Banking Sector (%) 43 45

Source: BDBL and Annual Reports of other four Banks

It can be observed from the above table that the cost of interest as a percentage of gross

interest income is increasing resulting in declining profitability of BDBL. The ratio of BDBL is

substantially higher than that of the banking sector. When the cost of interest as a

percentage of gross interest of the banking sector is 45%, the BDBL incurs a cost of 68%. It

appears that BDBL has to offer relatively higher rates of interest to attract deposits. A

strategy to bring down the interest cost of BDBL has now become essential. The possibility

Year 2014 2015 2016 2017 2018

Int Income-Loans and Advances 1,345 1,789 2,157 1,973 2,092

Net Int income 685 852 1,027 625 680

Net Fee Income 20 29 35 37 34

Total operating Income 715 895 1,075 675 744

Less: Total operating Expenses 243 322 385 495 556

Profit before Impairment 450 573 689 180 188

Less: Impairments 169 180 393 971 (107)

Profit before tax 282 393 298 (791) 295

Net profit after tax 282 393 208 (921) 300

Loans & Advances 10,231 13,155 15,389 16,083 16,149

31

of diversifying the fund base into areas such as borrowings from multilateral development

agencies at concessionary rates should be pursued.

The interest cost as a percentage of gross interest income of BDBL has increased from 49%

in 2014 to 67% in 2018% substantially reducing its profitability. The market average of the

interest cost as a percentage of gross interest income in 2018 was 45%. The trend in in the

interest cost as a percentage of gross interest income of BDBL in comparison with other four

banks is shown in the following table:

Indicator/year 2014 2015 2016 2017 2018

Gross Interest Income(Nu MN) 1,345 1,789 2,157 1,973 2,092

Interest Cost (Nu MN) 660 937 1,130 1,348 1,412

Net Interest Income(Nu MN) 685 852 1027 625 680

Int Cost as % of Gross Int Income (%) 49 52 52 68 68

Ratio of Other banks (%) 43 45


When the interest cost as a percentage of gross interest income of the banking sector was

45%, the ratio of BDBL was 68% in 2018. The funds for lending has entirely come from

deposits (credit to deposit rate was 94.29% in 2018) and it appears that BDBL is

experiencing difficulties in mobilizing funds/deposits at low cost when compared with other

banks in the country. A new strategy for mobilizing funds is needed to arrest this situation.

The total operating cost (without impairment) as a percentage of total operating income of

BDBL shows an increasing trend further reducing the profitability of the Bank. The ratio of

operating expenses to total operating income (Net Interest Income + Net fee & Commission

income) has increased from 34% in to 75% reflecting the steep increase in interest cost as a

percentage of gross interest income reducing the net interest income. The operating income

as percentage of total operating income has increased from 33% in 2014 only to 43% in

2018. The high impairment costs of BDBL have further reduced its profitability. The bank

had to provide Nu 971 Mn in 2007 on account of bad debt resulting in a loss. Although the

Bank has been making profits continuously in the past, it had made substantial book loss of

Nu 921 Mn due to very high impairments on loans and advances. A detailed analysis of the

financial performance of BDBL during the last 5 years will be included in final report. The

Bank developed a five-year Business Plan for the period 2014 to 2019 with specific targets

such as number of borrowers, loan portfolio, PAR, deposits and number of savers. Most of

the actuals on these targets are less than the projected targets.

3.9.2. Balance Sheets: Summarized Balance sheets are given in ANNEXURE 03. Key financial

indicators extracted from the Balance Sheets of BDBL are given below:

Indicator 2014 2015 2016 2017 2018

Loans & advances to customers (Nu Mn) 10,231 13,155 15,390 16,083 16,149

32

Source: BDBL

Total assets of BDBL have grown by 52% during the five-year period as against the asset

growth of 44% of the banking sector during the period 2014 to 2018. In terms of assets

growth, BDBL has performed marginally above performance of the banking sector. Loans

and advances accounted for nearly 65% of the total assets of BDBL in 2018 which is almost

in par with banking sector ratio of 67%. The customer deposits of BDBL have grown by 68%

while the deposits of the banking sector had grown by 67%. The quality of the loans and

advances portfolio has deteriorated continuously affecting the profitability of the Bank

through very high impairment cost. The NPL issue has been dealt with elsewhere in this

report which is one of the serious issues faced by BDBL. The equity base of the bank has

grown only by 5% during the five-year period. The slow growth of the equity base is due to

the erosion of retained profits which part of equity, due to the loss incurred in 2017. The

marginal growth in equity has come mainly through the injection of new capital (Nu 93.0

mn) by the Government. The slow growth of equity base of BDBL has created constraints in

improving the lending activities of BDBL and also eroded its Capital adequacy Ratio. The

capital has not grown on par with the growth in the lending portfolio. The lending portfolio

has grown by 56% during 2014 - 2018 but equity has grown only by 5% during the same

period. The following table shows the trends in equity of the Bank and its CAR:

Source: BDBL and Annual Reports of RMA

In terms of the Prudential Regulations on Capital Adequacy of RMA, all financial institutions

should maintain Capital Adequacy Ratio of 10% and a Capital Conservation Buffer Ratio of

2.5% over and above of the CAR, bringing the total capital requirement to 12.5% of the Risk

Weighted Assets (RWA) of the financial institution. From the above table it can be observed

Financial Investments (Nu Mn) 443 462 469 465 490

Property & plants (Nu Mn) 152 197 293 286 254

Balances with the Central Bank (Nu Mn) 3,490 1,589 3,289 3,146 4,559

Other assets (Nu Mn) 2,247 3,670 3,289 3,146 4,559

TOTAL ASSETS (Nu Mn) 16,563 19,073 22,649 24,148 25,222

Customer Deposits (Nu Mn) 12,500 14,639 18,029 20,548 21,013

Due to Banks (Nu Mn) 1,519 1,276 1,136 997 1,322

Other outside liabilities (Nu Mn) 80 94 140 167 294

Total outside liabilities (Nu Mn) 14,099 16,009 19,305 21,712 22,629

Total Equity (Nu Mn) 2,464 3,063 3,344 3,435 2,592

Total Outside liabilities & Equity (Nu Mn) 16,563 19,072 22,649 24,148 25,221

Indicator/year 2014 2015 2016 2017 2018

Equity Capital of BDBL (Nu Mn) 2,464 3,063 3,344 3,435 2,592

Lending portfolio (Nu Mn) 10,231 13,155 15,390 16,083 16,149

CAR (%) 20.68 18.08 16.52 10.34 12.50

CAR of Banking Sector (%) 18.9 18.7 17.4 18.15 15.12

33

that as the equity of BDBL has declined due to the loss incurred in 2017, BDBL has not been

able to maintain the minimum capital adequacy in 2017. Even in 2018, CAR of the Bank is

just equal to the minimum requirement. Operating a financial institution with the minimum

requirement of capital is risky and it prevents expansion of lending which is the main source

of income of financial institutions. In order to continue the operations of BDBL it is

imperative that new capital is injected to strengthen the equity base.

3.10. NON-PERFORMING LOANS: Under the Prudential guidelines of RMA, all banks are

required to categorize its entire lending portfolio based on the repayment status of the

portfolio and make provisions depending on the category of the portfolio. The following

table gives the categorizations of the lending portfolios of banks and applicable rates for

provisioning for loan losses.

Category Age Provisioning

rate

Standard < 30days 1.0%

Watch 31 to 90 days 1.5%

Sub-Standard 91 to 180 days 20%(30% for the sector

with highest exposure

Doubtful 181 to 365 days 50%(60% for the sector

with highest exposure

Loss > 365 days 100%

Source: Prudential Guidelines of RMA

All loans falling under Sub-Standard, Doubtful and Loss categories are classified as Non-

Performing Loans (NPLs). NPLS as a percentage of total portfolios is known as NPL Ratio and

this ratio is used universally to measure the quality of portfolios of banks.

The Non-Performing loan situation in the banking system in Bhutan has been steadily

deteriorating during the last five years. The NPL ratio which was at 7.77% in 2014 has

deteriorated to 20.73% in 2018. The NPL situation of DBBL is worse than that of the overall

banking system as can be seen from the following table:

Category AS at Dec 2018 As at Oct 2019

Portfolio

Nu Mn

PAR

%

No. of

Clients

PAR

%

Portfolio PAR% No. of

Clients

PAR

%

>30 days 5,767 30.48 15,090 27.72 8,583 42.97 17,426 32.06

>90 days 3,753 19.80 8,276 15.20 6,308 31.58 11,687 21.05

TOTAL

PORTFOLIO

18,923 54,436 19,974 54,344

Source: BDBL

Of the total portfolio of Nu 18,923 Mn as at Dec 2018, around 30.48% was in arrears for

more than 30 days while 19.8% was in arrears for more than 90 days. Out of the total

number of borrowers of 54,436, 27.72% has been in arrears for more than 30 days while

15.2% has been in arrears for more than 90 days. The situation has been deteriorated

34

further as at Oct 2019. Of the total portfolio of Nu 19,974 Mn as at October 2019, around

42.97% was in arrears for more than 30 days while 31.58% was in arrears for more than 90

days. Out of the total number of borrowers of 54,344 as at October 2019, around 32.06 %

has been in arrears for more than 30 days while 21.05% has been in arrears for more than

90 days. Out of the 34 branches, 10 branches have recorded PAR of over 30% as at Oct 2019

as shown below:

Source: BDBL

Only one branch has been able to bring down the rate below 30% and all other nine

branches have increased their PAR ratios. Although the total portfolio has grown by around

6% during the period, the PAR Ratio has increased by 42.3% and >90 NPL ratio has increased

by 6.3%. It was observed from the 5th risk management report for the year 2018, out of the

new loans approved during the period 1st January 2018 to 31st July 2018, 198 loans

amounting to Nu 59.68 Mn have fallen in to NPL category which is 55 more loans compared

with the previous period. This clearly indicates that BDBL has not been able to recover the

NPL loans which had fallen in to arrears earlier but also had not been able to prevent new

loans falling in to arrears as well. As such there is a strong need to develop a new loan

initiation system and new portfolio management system throughout the loan life cycle. Risk

management framework of BDBL consists of management of credit risk, operational risk,

reputational risk, market risk and liquidity risk. The major risk that the bank is facing is credit

risk.

Although, the NPL ratio of BDBL is very high, the NPL ratios of other four banks are at

acceptable level ranging from 1.66% to 6.44%. Of the total lending portfolio of the banking

sector, these four banks accounts for 83% of the total lending portfolio indicating that

proper lending could prevent high NPL portfolio as the Bhutanese society seems to have a

good credit culture. One can argue and say that these four banks have very low NPLs as they

do not lend in rural areas. This argument does not hold good as MFIs of Bhutan operating

purely in rural areas are maintaining very low NPLs on their portfolios although MFIs

Branch PAR (%)

AS AT DEC 2018

PAR (%)

AS AT OCT 2019

Main Branch 34.9 61.3

Sjongher 32.7 37.9

Bumthak 48.82 50.4

Trongsa 42.2 49.5

Wamrong 30.78 26.1

Panban 39.75 46.6

Celephu 30.9 44.2

Yadhi 37.5 46.6

Samdrupcholing 39.6 56.0

Tashicholing 33.9 51.4

35

operations at present in Bhutan is very limited. The Largest MFI in Bhutan, RENEW, operates

in 10 rural districts and serve about 22,000 customers with around 3,000 borrowers. In

2018, RENEW had disbursed Nu 92.0 Mn (maximum repayment period of one year) and the

NPL ratio of these non-collateralized loan had been less than 3%. Bhutan Association of

Women Entrepreneurs (BAOWE) an MFI which commenced micro lending in 2017 has so far

granted 40 non-collateralized loans with a total value of Nu 13.6 Mn and currently maintains

zero percent NPL. Although the amounts involved are small, the example of MFIs clearly

shows that rural lending could be done with very low NPLs, if it is done properly. It appears

that that measures taken by BDBL in mitigating and controlling credit risk at all stages of the

life cycle of a loan are inadequate resulting in a very high NPLs. The conclusion that can be

made from the above analysis is that whether it’s rural lending or urban lending, portfolios

with low NPLs can be created if lending is carried out by experienced credit analysts using

proper credit granting and monitoring systems employing effective credit risk management

measures at every stage of the loan life cycle.

The breakdown of the portfolio of BDBL as per the guidelines of the RMA for the purpose of

estimating impairment cost as at Oct 2019 is shown in the following table:

Source: BDBL

The NPL Ratio (> 90 days) which was at 20.73% as at end of December 2018 has further

deteriorated to 31.58% as at end October 2019.

3.11. CAUSES FOR HIGH NPLs: The poor quality of the lending portfolio is the root cause

for most of the problems faced by BDBL including inadequate capital adequacy.

Impairments on bad loans had resulted in eroding the equity capital. There are several

reasons for the high level of NPL of BDBL. The main among the reasons for high NPL is the

inadequate credit analysis skills of the credit officers and the credit assistants. In Bhutan,

credit decisions are primarily based on collateral and not based on the cash flows of the

borrowers. More than 60% of lending by BDBL is in rural areas. In the event of a default

selling of the mortgaged properties in rural areas and realizing the full amount due from the

borrowers is extremely difficult. Banks in Bhutan also experience difficulties in seizing

collateral in a timely manner when borrowers default on loans due to delays in judicial

system. Many in Bhutan believe that judicial system in the country favors borrowers. A

recent World Bank Report states that in Bhutan “it requires 47 procedures spanning over

Category No. of

Accounts

As % of

Total

accounts

Value of

Portfolio

(Nu Mn)

As a percentage

Of total

portfolio

Impairment

Requirement

%

Standard 39,497 70.1 11,391 57.0 0.5

Watch 5,896 10.6 2,274 11.4 1.0

Sub-Standard 2,772 5.0 1,425 07.1 20.0

Doubtful 2,713 4.9 1,273 06.4 50.0

Loss 5,199 9.4 3,608 18.1 100.0

TOTAL 56,077 100.0 19,974 100.0

36

225 days and costing around 23% of the value of a claim to enforce a claim”. As such litigation on defaulted loans takes time and it is very expensive. Hence, lending decisions

taken mainly based on collateral is not really effective from the point view of loan recovery.

The main causes for high NPLs are described below:

3.11.1. Inadequate Skills in Credit Appraisal-Skills Gap Analysis: BDBL has total staff of as

at date and the total staff directly involved in the credit function is 225. The overall skill level

of the entire staff is essential for the efficient running of the Bank. However, the skill levels

of the credit staff are more relevant to the successful running of the Bank. A skill gap

analysis carried out by the consultant clearly indicates the inadequacy of credit skills. As

mentioned elsewhere in this report the credit analytical skills of the credit staff is

inadequate and this in turn has resulted in of the poor quality of the lending portfolio

resulting in High NPLs. The most critical problem faced by BDBL today is the unusually high

NPLS which is threatening the overall profitability of the Bank. A list of the credit staff,

broadly categorized to Credit/Project Officers and Credit Assistants together with the

training programs followed by them are given in the ANNEXURE 04. The following could be

observed from the data given in the ANNEXURE 04

Source: BDBL

In addition, the 41 credit officers who have undergone formal classroom training, 12 of

them have undertaken exposure visits to financial institutions in the countries such as India,

Sri Lanka, Thailand, Nepal and Vietnam. The number of Credit officers who have no formal

credit training is 46 as against 41 credit officers trained in formal training programs. Around

53% of the credit officers have no formal training in credit. The Credit Officers, who plays

the main role in credit activity of the Bank, require not only training in credit appraisal, they

also requires training in relevant areas such as credit marketing, credit portfolio

management and credit risk management, the training provided to credit officers in these

areas had been minimal. A reasonable percentage of around 77% of the credit assistants

whose responsibility is to assist credit officers in the credit granting and portfolio

management process, formal training on has undergone basic credit training and credit

recovery. Of the 39 Credit assistants who have not undergone any formal training, 12 have

participated in exposure visits to financial institutions in several countries in the region.

Type of Training Credit

Officers

Credit

Assistants

Total

Credit Appraisal 14 50 64

Credit Appr & Recovery/NPL MGT 12 28 40

Branch Supervision 05 - 05

Risk Management 03 - 03

Related other Training 07 21 28

Total Trained in formal training programs 41 99 140

Not trained in any formal Training Program 46 39 85

Total 87 128 225

37

It appears that in Bhutan and BDBL too, the primary consideration for lending decisions is

collateral and the cash flows which demonstrate the ability or capacity to repay is the

secondary consideration. In fact, in good lending it should be the other way around. The

“first way out” of a loan is the cash flow and the “second way out” is the collateral. Reliance on collateral as “first way out” in deciding on a loan is not prudent. The lending criteria for

any loan should be the future cash flows of the borrower which indicates his capacity for

debt servicing. Cash flow based lending requires specialized skills which may not be required

for collateral based lending and the skills among the BDBL officers on these aspects are

limited.

Most of the credit officers of BDBL have no experience and training in cash flow based

lending. It was observed that most of the borrowers have defaulted on their loans due to

cash flow difficulties. In some cases proper appraisal of cash flows would have prevented

granting of such loans. Most of the credit officers had joined the bank straight from

Universities/Colleges without any specialized training in credit. All new trainees undergo

initial “induction” training for around one week which is highly inadequate to be a

professional credit analyst. At present the credit staff consists of 76 credit officers and 112

credit assistants. Only very few of them have undergone profession training programs. Most

of the SME clients financed/to be financed by BDBL do not maintain proper books of

accounts and also do not make financial statements such as profit and loss statements and

balance sheets. Even the officers who have undergone training have followed only very

short programs of one to two weeks. When evaluating credit proposals for SME clients,

Credit Officer should be able to obtain necessary financial data from the potential

borrowers and construct financial statements. Most officers of BDBL do not have these

skills. A strategy should be launched to provide specialized skills in cash flow based lending

to all credit officers. The proper training to credit officers could prevent, to a great extent,

the “adverse selection” of borrowers and future NPLs. A program to provide specialized

credit training to all credit officers of the Bank should be a part of rural finance of BDBL. A

basic structure of a cash flow based lending covering 5Cs methodology is given in

ANNEXURE 05

3.11.2. Lack of Proper Guidelines on Credit Appraisal: Proper written guidelines/formats to

be used in collection of data/information and credit appraisal are required to ensure the

quality of credit appraisal. Although the Credit Manual of BDBL mentions about 5Cs

approach in credit analysis, no evidence were available to confirm that credit officers use

the 5Cs approach in practice. The examination of a representative sample of credit appraisal

reports reveals several information gaps such as analysis of past performance of applicants

of existing businesses, verifications of assumptions used in projections, proper calculation of

project cost, estimation of working capital and market assessment. In order to guide the

credit officers on what information they should collect before taking in hand the credit

appraisal and also to guide them on areas and aspects to be covered in the appraisal report,

it is essential to use a comprehensive appraisal format. Depending on the loan size and the

type, two to three different appraisal formats could be developed and used. An appraisal

format suggested is given in ANNEXURE 06

38

3.11.3. Lack of Credit Risk Management Tools at Loan Origination: The credit risk

management is to be done at all stages of the “life cycle “of a loan. The first stage of life cycle of a loan is loan origination. The credit risk management should start here. The Proper

and scientific selection of borrowers at the application stage is essential to prevent selecting

potential defaulters. Most banks adopt credit scoring systems or risk rating systems for the

preliminary screening to eliminate risky potential defaulters. Credit scoring is mostly used by

MFIs while banks/financial institutions lending to SMEs use system of risk rating clients. The

risk rating systems are scientific in selecting good borrowers as against judgmental

approaches used in client identification. At present the procedures followed by BDBL in

client identification seems to be highly judgmental and this could be one reason for high

NPLs. Introducing a comprehensive risk rating system to identify good borrowers would help

in reducing future NPLs. The format to be used in risk rating and guidelines on how to use

the format are given in ANNEXURES 07 and 07A respectively. This format is not suitable for

startup businesses. A separate format to be used for startups and the guidelines on how to

use this format are given in ANNEXURES 08 and 08 A respectively.

3.11.4. Lack of Loan Supervision: Lending portfolio of BDBL is highly infected. The PAR >30

days was 42.9% and the > 90 days was 31.58%. One reason for high infection ratios is the

very high ratio of number of loans per loans officer. Higher number of loans per loans officer

make it difficult for loans officers to monitor the post disbursement performance of

borrowers. Less supervision may result in misuse of funds and relaxing the need to service

loans by borrowers enhancing the possibility defaults. Frequent visits and meetings with

borrowers will reduce the probability of defaults According to guidelines of Consultative

Group to Assist poor (CGAP), the apex body for MFIs, the ratio should be around 300 to 400

per loans officer depending on the nature of the country. In South Asian Countries the ratio

was 400 in 2012. These norms are not applicable or relevant to Bhutan due to very high

distance in between clients and between branch offices and clients. The credit function of

BDBL is managed by 76 credit officers and 112 credit assistants. Credit officers are really

responsible for loan initiation, approval, disbursement, loan supervision, recoveries. Credit

assistants help the loan officers in performing the above duties. If only loan officers are

considered as responsible for above activities, the number of loans per loans officer works

out to be 725 which is very high in terms of any norm. If credit assistants are also

considered, the ratio works out to be 289.

A branch wise list of credit officers and credit assistants and the number of credit files of

each branch are given in ANNEXURE 09. It was observed that credit files are distributed

unevenly among the credit officers and branches. Some officers handle around 600 files

while some handles much less than that. Considering the distance in between clients and

the distance between the branch and the client, both above ratios seem highly excessive.

Taking the loans officers and Credit Assistants as one group, more realistic ratio of 200 loans

per officer is recommended as part of the strategy to improve the loan supervision and

reaching to new clients. The suggested number is based on the views expressed by the

officers involved in credit.

39

3.11.5. Low Financial Literacy of Clients and need for client education: Out of the 54,000

plus clients of BDBL, only around 70 clients are corporates and the majority of the balance is

rural based CSIs and rural households. Although, the corporate clients are capable of

managing its finances, the rural clients are not capable of doing so. Under the group lending

program of BDBL, financial literacy training is provided to potential borrowers under the

program. However, the percentage borrowers falling under this category is just around 3%

and percentage of corporate clients is even less than 1%. The BDBL at present does not

provide the large percentage of rural borrowers who do not fall either in to Group Loan

category or corporate loan category. Bhutanese entrepreneurs, particularly, among MSME

entrepreneurs is very low and most of them are financially illiterate. To remedy this issue

RMA has setup a separate secretariat to be responsible for promoting financial literacy

among entrepreneurs. Since MSMEs are playing an important role in the economic

development of any nation, the success of such enterprises is essential for the economic

growth. The success or otherwise of a MSME would depend largely on the financial literacy

level of the owner of the business. Low financial literacy among entrepreneurs result in high

number of business failures and also a large number of loans taken by them falling in to NPL

category. The financial literacy of an entrepreneur is measured in terms of the

entrepreneurs’ understanding of basic financial concepts such as interest rates, Compound

interest, Inflation, risk diversification, his knowledge in legal and regulatory matters, record

keeping, budgeting and his skills in raising funding from outside sources at minimum cost.

When lending to microenterprises by MFIs, they make it a prerequisite that potential

borrowers should undergo a two to three day financial literacy training program. MFIs in

Bhutan follow this practice in providing financial literacy programs for micro entrepreneurs.

Financial literacy programs provided are in two parts; first part is class room training

provided prior to lending and the second part during the operation of the business which is

known as: mentoring”. It is recommended that BDBL develop a financial literacy program

and mentoring program for its MSME Customers. Undergoing this training may be made

compulsory. The main topics, inter alia. That should be covered in a trading program would

be:

➢ Basic principles of money management

➢ Managing cash flows

➢ Building assets

➢ Interfacing with formal and informal financial institution

➢ Dealing with special challenges

➢ Earning money

➢ Record keeping and understanding of financial records

➢ Risk Diversification

➢ Online banking and usage of mobile phones for Banking

40

3.11.6. Lack of Professional Business Development Support Services (BDS) for CSIs and the

need for business facilitation: The credit to the CSI sector is an important component of the

rural credit offered by the financial sector. The Government believes that the CSI sector is

the engine of growth and hence the sector growth is essential for an inclusive economic

growth. Although the CSI sector accounts for nearly 95% of the country’s business units, it has received only 14% of the total credit of the Banking sector. The growth in the CSI sector

to a large extent depends on the availability of professional Business Development Support

(BDS) services. Almost all CSIs require professional BDS services to sustain and grow their

businesses as most CSI entrepreneurs are not conversant with all aspects of business

management. BDS required by CSIs includes a wide array of services such as preparation of

feasibility studies, assistance to start-up businesses, training on entrepreneurship, HR

management, technologies and marketing. Discussions with CSI entrepreneurs and bankers

revealed that the status of BDS services at present is not at a desired level and it needs

improvements. What the financial institutions could do to develop this is limited and it is the

responsibility of authorities to set up a “One Stop Shop” to Provide BDS services.

Multilateral development agencies could consider providing TA assistance the government

to set up such a facility. The consultant has personally involved in a few such facilities

financed by multilateral development agencies and operated by public entities in

collaboration with lending institutions. For increasing the rural outreach and also to improve

the quality of the rural lending portfolio it is essential to develop a professional system of

BDS Services. There are various options available to create a system of BDS Services. One

option available for BDBL and REDCL is to set up their own systems of DBS as a fee levying

financial service or both institutions to team up with Department of Cottage and Small

Industry (CSI) and set up a public sector entity to provide professional BDS Services at a

subsidized fee to CSIs. The government Departments may not be able to provide

professional DBS Services. Although, there are several public sector entities and NGOs

providing these services in Bhutan at present CSI sector is not happy with the quality of

services.

3.12. PRICING AND SECURITY (COLLATERAL): The Minimum Lending Rate (MLR) for the

banking sector is determined by the RMA and the banks are free to determine their lending

rate taking in to account other factors. Assets and Liability Committee (ALCO) of BDBL is

responsible for deciding the lending rate of the Bank. In deciding the lending rate, ALCO

takes in to account the following factors:

i. Cost of Funds

ii. Tenure/Duration

iii. Admin Cost

iv. Risk profile

v. Spread

The average cost of funds of BDBL is relatively higher when compared with other banks

resulting in higher lending rates. As almost all lending of BDBL is out of deposits, the lending

rate would ultimately depend on the rates the Banks pay on its deposits. It is observed that

41

the average rate paid by BDBL on its deposits is relatively higher than the rates paid by other

banks. Another issue related to pricing of loans faced by BDBL is the ignoring risk profile of

the borrower, size of the loan and relative loan administrative cost. Business borrowers of

the BDBL could be broadly categorized as micro enterprises, cottage industries, small

industries and Corporates. Risk profile of individual customers in each group and also the

risk profile of different customers in each group are different. Pricing of a loan should be

linked to the risk profile of the borrower. It is pertinent to mention here the principle of

“high risk high return and low risk low return” which is practiced by lenders and investors all

over the world. Further, the size of the loans to customers under each category is also

different. Loans granted to micros, cottage enterprises and small enterprises would be

relatively smaller than the size of loans granted to medium and large enterprises. Large

loans will generate a higher income to the lender than the income generated from smaller

loans. However, the administrative expenses incurred in originating and managing a loan

would almost be similar irrespective of the size of the loan. Therefore it is justifiable to

charge different rates from different categories of borrowers and different sizes of loan

categories and banks and financial institutions follow this principle in determining an

appropriate pricing structure for their lending products. All borrowers of BDBL are currently

charged the same rate (with marginal concessions of 1-2% to some priority sectors) of

interest decided by ALCO irrespective of the risk profile of the borrower and size of the

loan. The ALCO proposes the rate to the Board and the final decision is taken by the Board

also taking in to account political aspects of the decision. If the proposed risk rating system

is adopted by BBDL, a risk-based pricing system could be followed by BBDL. The Minimum

Lending rate of BDBL at present is around 8.8% while the average lending rate is 10.4%. The

rates of interests currently charged by BDBL are given in ANNEXURE 10. The lending rates of

banks where rates are not regulated by the regulator will largely depend on cost of funds of

respective banks. In Bhutan, the funds for lending by banks, including BDBL comes mainly

from deposits and hence cost of funds will mainly consist of rates of interest paid on

deposits.

For the purpose of security, the loans granted by BDBL are divided in to two categories

namely Individual Loans and Group Loans. The Credit Manual of BDBL clearly states that all

individual loans granted by the bank should be against the “mortgage of collateral”. Group loans are grated to members of a group against the cross guarantees of the other members

of that group. During the 5 ½ year period (January 2014 to June 2019), the number group

loans granted amounted only to 1.42% of the total loans granted. This indicates that around

98% of the loans approved during the last 5 ½ years are against tangible collateral. The main

types of security taken by BDBL on its individual loans are:

• Land-rural, semi urban and urban

• Resettlement/Kidu land

• Buildings-residential and commercial

• Apartments/flats having ownership certificates

• Plant and Machinery

42

• Cash Crops

• Private Plantations

• Vehicles

• Insured cattle

• Project assets

• Stocks and inventories

• Fixed deposits

• RGOB/Corporate Bonds/TB/Listed Commercial Papers

The following types of assets are not accepted as security:

• Religious articles and place of worship

• State owned lands

• Sokshing ( forest land used as leaf litter, fodder and manure ) and Tsamdro(grazing

land for livestock

• Land and buildings owned by monastic bodies will be accepted, if authorized by a CA

• Antiques

The lending manual provides guidelines on valuation of assets taken as security. Valuation

methodology prescribed is very restrictive. The dependence on tangible collateral for a

development bank in a country where security in the form of immovable property is not

abundantly available certainly restricts its outreach. The solution for this may be the

relaxation of security requirement and/or substantially increasing the group lending.

3.13. TERMS AND CONDITIONS: As practiced by all banks internationally, BDBL too grant

loans subject to certain terms and conditions. These terms and conditions are to ensure the

proper use of loan proceeds and regular repayments of loans. The Main categories of terms

and conditions relate to the following aspects:

i. Security-All individual loans are granted against tangible security. BDBL is to abide by

the RMA guidelines on Loan to Value (LTV) ratio. LTV varies according to the type of

the asset. Currently the ratio varies from 50% to 90%. While the LTV on fixed

deposits is at 90 %, the LTV on securities and corporate bonds is 50%. LTV on

immovable property value of which is always estimated conservatively is 75%.

ii. Insurance: All assets to be mortgaged should be insured.

iii. Debt: Equity: All borrowers are required to share the risk of the business by

contributing a certain percentage of the investment of the business in the form of

equity capital. The maximum debt equity ratio to be maintained on all lending is

75:25. However, this ratio will vary within the maximum limit depending on the risk

profile of the borrower and the risk profile of the business to be financed.

iv. Repayment Terms: Some loans such as overdrafts are revolving and some are (term

Loans) are with a fixed repayment period and a fixed repayment schedule. Term

43

loans will carry repayment periods ranging from 12 months to 20 years depending

on the purpose of the loan and the cash flow of the borrower.

v. Rate of Interest: For different types of loans the ALCO decides the rate based on the

Minimum Lending Rate determined by RMA. Different industry sectors and different

types of loans and different loan schemes will have different rates but the difference

would be very marginal and the difference will vary from 1% to 2%.Interest is

calculated on reducing balance basis.

vi. Types of Installments: Installments on term loans are in the form of Equated

Monthly Installments (EMIs) payable monthly, quarterly, half yearly or yearly.

Of the general terms and conditions applicable for loans, the Bank needs to consider making

some changes to the following term and conditions:

i. Non-Collateral based Loans: Lack of collateral is one of the main reasons for low

rural outreach as most rural CSIs and households cannot offer tangible collateral to

obtain loans from financial institutions. It is recommended to consider granting

Loans at least up to Nu 500,000 without “mortgage of Collateral: Loans up to a limit

say Nu 500,000 mn to be granted purely on the basis of cash flows and against the

guarantee of two acceptable individuals. Individual loans similar to group loans. This

can be limited to clients with high risk ratings.

ii. Lowering of Debt: equity for micros and Cottage Industries: One of the problems

faced by the potential borrowers in the rural areas is sourcing of equity/venture

capital required by lenders to maintain the minimum debt: equity requirements. It is

recommended that BDBL consider either reducing the ratio to around 80:20 or

90:10 for CSI s or introduce product to offer venture capital/seed capital to CSIs.

Venture capital is a product offered by development Banks internationally.

iii. Interest Rate: Introduce the risk based pricing depending on the risk rating of the

clients. It is recommended to introduce a system of client risk rating

iv. Higher rates of Interest on Smaller individual loans and group loans to be introduced

as the administration cost of such loans are relatively high. MFIs who handle group

loans and smaller amounts, charge around 2% per month and BDBL charges same

rate for big corporates and micros as well.

3.14. COMMUNITY CENTERS: The Government of Bhutan established a mechanism in

2012 to deliver Government-to-Citizen (G2C) services to the general public efficiently in one

venue. Community Centers (CC) were set up in Gewogs to implement this program.

Originally, the Government selected Bhutan Post to manage the community centers for five

years. All government services to the general public such as issuance of Citizen Identity

cards, registration of births, name changes, registration of deaths, and approval for

construction/reconstruction of houses, business registrations and several more online

services are delivered through the Service Centers. The service centers also provide off-line

services such as photocopying and printing to the community at nominal charge. For

44

administrative purposes, the country is divided in to 205 Gewogs (group of villages) and

each Gewog has an elected community leader. As at date, community centers have been set

up in 200 Gewogs. After few years of operations, the Government decided in 2015 to

transfer the management of Community centers to BDBL as it is in a better position to

deliver financial services which was most needed at that time. The Management of CCs was

transferred to BDBL in March 2015. The Bank has appointed one officer each to a

community center to run its operations. Centers provide 18 types of online Non-

Government to Citizen (Non-G2C) and 43 types of Government to Citizens (G2C) services

and 28 offline services to the citizens. The operations of Centers are not financial

sustainable as fees charged are not adequate to cover the operational costs incurred in

providing it services. The profitability of the overall performance of CCs is shown in the

following table:

The Bank uses these community Centers in a limited way to deliver its services to the

community. The Bank should make use of the community centers to their full potential to

enhance the Bank’s credit outreach. The community center operations are carried out as a

separate profit center and since the transfer of management of CCs; the Bank has made a

cumulative loss of approximately Nu 100 Mn including a loss of Nu 28.9 Mn in 2018. The

fees collected by offering services by CCs are less than 20% of the cost incurred by BDBL in

providing such services. The BDBL should make an attempt to achieve at least Break-Even

status of the center operations. It is recommended that BDBL undertakes center wise

profitability analysis comparing the fees charged by private service providers and come up

with recommendation to achieve the sustainability of the centers as a separate profit

center. At present BDBL does not prepare accounts on individual Community Centers.

Since, CCs have a presence in 200 Gewogs out of 205 Gewogs and BDBL is responsible for

managing the Centers, it could effectively use these centers to expand its outreach .A

strategy on how to make use of CCs to expand the outreach of BDBL is described under the

proposed strategy for BDBL.

3.15. OPERATIONS OF REVOLVING FUND I (RFI): Under the Government Economic

Stimulus Plan (ESP) of 2013 with a budget of Nu 5.0 Bn, a Revolving Fund (RF) was

established with an allocation of Nu 1.9 Bn to improve the CSI sector and the informal

Year Total Income from

All CCs (Nu 000)

Total Operational cost

Of all CCs (Nu 000)

Overall Profit/(loss)

(Nu 000)

2015 3,573 20,240 (16,666)

2016 4,681 32,314 (27,632)

2017 5,813 34,705 (28,891)

2018 4,506 31,899 (27,932)

45

activities of the rural sector. An organization under the name of “Business Opportunities Information Center (BOIC)” established to carry out the activities of the Revolving Fund. The target group of the Revolving Fund was the CSIs and the non-formal rural activities and BOIC

envisaged providing funding to this group at concessionary terms. Of the total fund of Nu

1.9 Bn, a sum of Nu 1.5 Bn was allocated under RF I to finance new business start-ups

primarily cottage and small industries and a sum of 0.4 Bn was allocated under Revolving

Fund II to non-formal rural activities. Due to some issues faced by BOIC, activities of it was

closed after two years of operations. In order to continue the activities of RF I and RF II, the

Government in May 2016 established Rural Enterprise Development Corporation (REDCL) as

wholly owned state enterprise under the Companies Act and licensed by RMA as a

Microfinance Institution (MFI). All activities of RF II with a lending portfolio of Nu 127 Mn

were transferred from BOIC to REDCL which commenced operations in June 2016. The

activities of RF I and a fund of Nu 1.5 Bn were transferred to BDBL for management. All

together 420 projects have been transferred from BOIC to BDBL for management. BDBL has

created a separate Unit to manage RF I and this unit has been in operation for nearly 3

years. The Unit headed by a senior officer of BDBL has five project officers and four recovery

officers. The transferred portfolio has not been taken into the books of BDBL mainly

because transferred portfolio has very high NPL at around 40%. Number of accounts in NPL

is 112 while 17 projects have been closed. It is proposed under the up gradation of REDCL to

a CSI bank, RF I portfolio also would be transferred to the new CSI bank. BBDL staff currently

deployed for managing RF I could be used for other lending activities of BDBL once the

portfolio under RFI is transferred. The aging analysis of the portfolio including outstanding

interest under RF I managed by BDBL is given in the following table.

Source: BDBL

The above statistics indicates that the quality of the portfolio managed by BDBL is not good

and nearly 35% of the value of the portfolio and 25% of the number of borrowers has been

in arrears as at end of Dec 2018.

3.16. BRANCH AND CLIENT VISITS: The Consultant visited three branches of BBDL on

26th, 27th and 28th of November and met several clients of these branches. Most of the

clients were met at their business premises and some clients of BDBL were met at the BDBL

Indicator Amount Outstanding

(Nu Mn)

No. of Accounts

Standard 274 3,111

Watch 82 568

Sub-Standard 26 184

Doubtful 23 139

Loss 15 126

Total 420 4,128

46

branch in Phunaka. Observation made during the branch visits and client meetings are

summarized below:

3.16.1. BDBL Branch - Phunaka – Meeting with the Branch Manager and Credit Staff: Branch

has 6 credit officers and the total number of clients handled is 2,600 and the total portfolio

was Nu 600 Mn. The branch undertakes individual lending as well as group lending. Majority

of loans are in the agriculture sector. All individual loans are against immovable collateral

and group loans against cross guarantees of group members. 20 groups with 40 members

have been formed and groups operate under three centers. Total portfolio of group loans is

around Nu 2.0 Mn and the maximum group loan is Nu 300,000. Around 400 clients out of

2,600 clients are in arrears and the portfolio in arrears is Nu 121 Mn representing 17% of

the portfolio (arrears above 90 days). Although a separate NPL ratio is not calculated on

group loans, the NPL of Group loans are much less than that of the individual loans. Branch

is also responsible for the management of 11 community centers. All group loans should

come with a recommendation of the Community leader, an elected official reporting to the

Local Government Authority. One bank officer is based in a community center. Branch credit

officers visit on pre-arranged two days of a month for banking business, mainly recoveries.

Each community center has a POS machine to support collection. The branch has a savings

portfolio of Nu 326 Mn and 7,300 saving accounts. Lending rate is around 10.25% on

individual loans and 10.0% on group loans. Interest on savings is 5.7%.

Two Clients of the branch was visited. One of these clients was involved in poultry farming

and the amount lent was Nu 500,000. He is in arrears for about 11 months even after a

rescheduling of the loan and the reason attributed for non-payment is inadequate funding

provided by the bank at the time of the commencement of the project. The other client is

engaged in agriculture, dairy farming and trading. The loan granted is Nu 152,000 and the

loan is regular. This is her second loan from BDBL and she has also borrowed from RENEW a

loan for educational purposes.

3.16.2. BDBL Branch - Nobding: Meeting at the branch with the Branch Manager and the two

credit officers. The total number of staff is 6 and two are credit officers. Portfolio is

Nu 258 Mn of which Nu 170 Mn is in the agriculture. Total number of borrowers is 1,050.

The number of loan accounts per credit officer is very high at around 700 clients per credit

officer. NPL ratio of the portfolio is 9.5% and the number of NPL clients is 113. The branch

lend to individuals as well as groups. Branch has lent to 23 groups with a total membership

of 90. Total portfolio lent under group lending is Nu 14.6 Mn. Branch has a saving portfolio

of Nu 170 Mn with around 3,700 saving accounts. Lending to potato cultivators is high and

lending to agriculture is at 10.25% and group loans are at 10.0%.

A group of potato cultivators consisting 5 borrowers including two women who had taken

individual loans for potato cultivation was visited and met them in a community center. All

potato farmers are performing well as they have ready market access to their product and

47

cash flow is regular. The maximum loan granted is Nu 300,000 and the average loan size is

Nu 200,000. All loans to potato farmers are revolving loans for a period of one year. They

are renewed after one year. The NPL on loans granted to potato farmers are very low NPL.

3.16.3. BDBL Branch - Wongdue: The Branch has a total staff of 12 and of which two are credit

officers and another two are credit assistants. Total loan portfolio is Nu 690 Mn and the

total borrowers are 2,630. Around 60% of the portfolio is in agriculture. The NPL ratio of the

branch is 10% and 219 borrowers are in NPL. Branch undertakes individual lending as well as

group lending. The branch has lent to 29 groups consisting of 78 group members and group

lending portfolio is Nu 29 Mn. NPL ratio of group lending is much lower than that of the

individual loans. The total savings portfolio is Nu 430 Mn and total savings accounts are

9,600. I also met a group of group borrowers and the branch of the Chamber of Commerce

and Industry (BCCI) has helped the borrowers and the Bank in organizing these groups.

Groups consist of both male and female from different business sectors. Details of the group

borrowers are given below:

Client Loan Amount

(Nu)

Activity

Purpose Status

Client 01

(male)

300,000 Grocery Working capital Regular

Client 02

(male)

200,000 Tailoring shop Working capital Regular

Client 03

(male)

300,000 Restaurant Working capital Regular

Client 04

(male)

300,000

Bar and Grocery working capital Regular

Client 05

(female)

300,000 Restaurant Working capital Regular

Source: BDBL

Consultant also visited two individual borrowers financed by the branch. One of the

individual borrowers is large scale poultry and dairy farmer and an animal feed

manufacturer. He had taken several loans from BDBL starting with a Nu 90,000 loan 30

years ago. Over the period has graduated to be large scale borrower. Loans are secured

against property mortgage and he is a very loyal customer of BDBL. The other individual

client visited is a women entrepreneur engaged in agriculture. Loan of Nu 20,000 granted to

this borrower is for a biomass project to generate gas for domestic consumption. She saves

about Nu 5,000 for three months.

3.15.4. Observations Made During Branch Visits and Client Meetings:

1. All individual lending are strictly on immovable collateral of lands and buildings.

48

2. Most borrowers are not happy with the valuations of lands by BDBL and borrowers

feel that the market value of the properties are much higher than the valuations by

BDBL/Panel valuers

3. Criteria for selection of borrowers appear to be the value of collateral offered and

the CIB Report which indicates the borrower’s credit history. Much less attention has

been paid to other areas such as experience in the industry,

managerial/entrepreneurial skills, and access to markets

4. Inadequate skills among credit officers in cash flow based lending. Most of the

officers involved in credit are strait from the Colleges/Universities with no

experience in credit

5. Very high number of loans per credit officer ratios. The ratio was as high as 700

clients per loan officer. Loan officers have no time for marketing of credit to increase

the outreach and no time for post disbursement supervising of portfolio there by

affecting the quality of the portfolio.

6. Most borrowers have poor financial literacy and credit officers have to spend more

times with borrowers in helping them to prepare project reports.

3.17. CONCLUSIONS: The Following conclusions were derived from the above diagnostic

analysis of BDBL. These conclusions are summarized below:

i. The Bank is faced with several problems. The root cause of all problems faced by

BDBL is the poor quality portfolio resulting in very high NPL and high provision for

loan impairment.

ii. The Bank is faced with a low capital adequacy and slower growth of equity base. The

high provisions for loan impairments have eroded the equity base of the Bank.

Recapitalization of the Bank has become essential to move forward.

iii. The overall outreach of the Bank is at low level when compared with magnitude of

unbanked population of the country particularly in the credit market. Although BDBL

has access to a wider network of access points through the Community Centers,

there is no proper plan to work jointly with them to increase the outreach of the

Bank.

iv. It is essential to introduce new financial products through which the outreach of the

Bank could be expanded.

v. Profitability of the Bank has been deteriorating during the past five year period

mainly due to increasing cost of interest as a percentage of gross interest income of

the Bank and also due to high impairment cost.

vi. The quality of the portfolio has deteriorated rapidly and PAR > 30 days and NPL > 90

days stand at 42.97% and 31.58% respectively as at October 2019. High NPLs are due

to the following reasons:

• Inadequate credit appraisal skills of credit officers

• Non-availability of proper appraisal guidelines, forms and formats

49

• Lack of appropriate credit risk management tools at the loan initiation stage

• No proper post disbursement loan supervision and very high number of loans

per loan officer

• Lack of Professional Business Support Services to professionally assist

borrowers in running their businesses efficiently.

50

4. PART THREE - DIAGNOSTIC STUDY OF RURAL ENTERPRISE

DEVELOPMENT CORPORATION (REDCL)

4.1. INTRODUCTION TO REDCL: Under the Government Economic Stimulus Plan (ESP) of

2003, with a budget of Nu 5.0 Bn, a Revolving Fund (RF) was established with an allocation

of Nu 1.9 Bn to improve the Cottage and Small Industry (CSI) sector and the informal

activities of the rural sector. An organization under the name of “Business Opportunities Information Center (BOIC)” was established to carry out the activities of the Revolving Fund.

The objective of the Revolving Fund was to;

i. Facilitate the access to credit

ii. Stimulate economic activities

iii. Promote import substitution and

iv. Generate employment

The target group of the Revolving Fund was the CSIs and the non-formal rural activities and

BOIC envisaged providing funding to this group at highly concessionary terms. Of the total

fund of Nu 1.9 Bn, a sum of Nu 1.5 Bn was allocated under RF I to finance new business

start-ups primarily cottage and small industries and a sum of Nu 0.4 Bn was allocated under

Revolving Fund II to finance non-formal rural activities. Due to some issues faced by BOIC,

activities of it was closed after two years of operations. In order to continue the activities of

RF II, the Government in May 2016 established Rural Enterprise Development Corporation

(REDCL) as wholly state enterprise under the Companies Act and licensed by RMA as a

Microfinance Institution (MFI). REDCL was launched on 21st May 2016, through the

Government Order 2/101/303 dated 18th May 2016. All activities of RF II with a lending

portfolio of Nu 127 Mn were transferred from BOIC to REDCL which commenced operations

in June 2016.

REDCL is managed by a Board of Directors consisting of five including the Chief Executive

Officer. All directors except the CEO are very high serving government officials representing

the ministries of Finance, Agriculture & Forestry, and Cottage of Small Industry and Ministry

of Economic affairs and all directors and the CEO of REDCL are appointed direct by the

Government. The Board is supported by the CEO and three other Deputy Directors in charge

of Corporate Services, Public Relations& Media and Revolving Fund Management. The total

staff of REDCL as at end of Dec 2018 was 37 including 20 branch project officers and 10

project officers in the Head Office. REDCL handles only the front office functions of the

credit process and all back office functions are handled by BDBL for a fee of 2% of the

amount of the loan.

The vision of REDCL is to stimulate growth of non-formal rural activities by providing

necessary support both administrative and funding while its mission is to generate

employment, substitute imports and/or promote exports by promoting non-formal rural

activities through the provision of timely integrated business support.

51

4.2. TYPES OF LOANS OFFERED: The main objective of REDCL is to “provide funds for the

non-formal rural activities on a low interest rate of 4% per annum and without any collateral

requirement in order to stimulate economic activities and add value to the domestic

resources and create employment”. REDCL offer five categories of loans as shown below:

i. Category 1 - Livestock

ii. Category 2 - Agriculture

iii. Category 3 - Weaving

iv. Category 4 - Horticulture or any the project

v. Category 5 - Others manufacturing

The maximum amount under any category of loans is Nu 500,000 and the rate of interest is

4% per annum. Maximum repayment period is 12 years with a maximum grace period of 12

months. No tangible collateral is required. However, a personal guarantee of an individual

having a good credit history with other financial institutions is required. The eligibility

criteria for loans from REDCL are described below:

• New start-up cottage and Small Industries (CSIs) engaged in manufacturing,

production and non-formal rural activities

• Projects meeting the industry classification and criteria of CSI under the production

and manufacturing category of the ministry of the Economic Affairs (MoEA), Royal

Government of Bhutan

• Projects that are technically feasible and financially viable

• Projects meeting the principles of priority sector as mentioned in Economic Stimulus

Plan Implementation Report (ESPIR), namely

➢ Import substitution

➢ Export enhancement or promotion, and

➢ Creation of Employment

Projects already financed by other financial institutions and civil servants, corporate

employees, selected candidates in local government elections and parliamentarians are not

eligible to receive loans from REDCL. REDCL mainly provide individual loans. On a selective

basis it also provides Group Loans in some geographical areas.

With the up gradation of REDCL to be a CSI bank, it will become a fully pledged development

finance institution (DFI). Once the REDCL is converted to a CSI bank, the package of

products currently offered by it is not adequate to play its role as a main rural finance

provider and to increase its rural outreach. The following new products are recommended

for the consideration REDCL for diversifying its product mix.

At present REDCL offers only interest earning fund based products or interest earning credit

products. Most banks offer a variety of fee based products and earn relatively a substantial

income. It is recommended that REDCL consider offering a few new fund-based product and

a new fee based products. Fund based products recommended are described below:

52

i. Leasing -Equipment and vehicle Leasing for CSIs and lease and “sale and lease back”

ii. Leasing of high - end consumer durables for rural households with regular or

seasonal incomes

iii. Venture capital/Seed capital for sustainable CSIs who are experiencing shortages of

equity capital

iv. Wholesale loans to sustainable MFIs through credit lines or through the

securitization of lending portfolios of MFIs

v. Value chain financing programs for few industry sectors/commodities. The possible

sectors/commodities for introducing value chain financing programs initially are

Fruits Industry, Dairy Farming and Potato Cultivation.

In a country like Bhutan where financial inclusion is at very low level and NPL ratios are at

very high level, one way to improve the financial inclusion while maintaining the quality of

the lending portfolio is to undertake group lending in a large scale. Although REDCL offers

group loans on a very selective basis only in some geographical areas, it is not properly

marketed and it is not promoted as a product. Inquiries made from rural finance institutions

revealed that quality of group loans is relatively better than the secured individual lending

portfolio. REDCL is currently facing a problem of high NPL and therefore it is more prudent

for them to lend more in group loans which carry low NPLs.

4.3. BUSINESS PROCESS: The current Business Process of REDCL is simple. It operates as a

Microfinance Institution (MFI) providing a single product to a particular segment of

enterprises. REDCL currently provides only term loans to start-up enterprises. The current

business process of REDCL is almost entirely focused on lending business as almost all of its

income is generated from the lending business. The Business process of any successful MFI

should encompass the following steps:

i. Pro-Active Marketing and sourcing of potential customers

ii. Initial screening of potential clients using an effective risk management tool (Credit

Scoring and/or client risk rating

iii. Credit Appraisal of screened credit applications using 5Cs approach

iv. Credit decision making minimizing the credit risk

v. Proper disbursement of loan proceeds avoiding misuse of loan proceeds

vi. Post Disbursement loan supervision/portfolio supervision

vii. Reporting

It was observed that the business process of REDCL covers only few of the steps described

above in its business process. The most important step in the business process of any

business organization is the” pro-active marketing” of its products and services. However, due to heavy load of work, the Project Officers in in branches are unable to undertake

marketing and mostly serve only “walk in” customers and this has resulted in low outreach of REDCL. The approach used in initial screening of loan application is highly subjective and

53

whether to accept a loan application from a potential customer for further processing or not

depends entirely on a subjective judgment of the credit officer. No scientific method such as

Client Risk Rating or Credit Scoring is used for initial screening of loan applications. Post

disbursement loan monitoring is also lacking in the business process of REDCL. The weak

areas described above in the business process have finally resulted in high NPLs and these

areas need improvements.

4.4. OPERATING MODALITY: The primary objective of REDCL is to promote the activities

of the non-formal rural sector Bhutan and it is the major and largest MFI catering to the

micro enterprises sector. All funding for REDCL had come from the government at free of

cost and the government has imposed a lending rate of 4% on its lending and it has a huge

competitive advantage over other MFIs in the country. Generally MFIs always try to strike a

balance between the profitability and social objective of providing financial services to

unbanked rural population. Since the funding is from the government at no cost and the

lending rate of f4% fixed by the government is inadequate to cover its operational expenses,

REDCL concentrate only on the social objectives of its operations and not on the long term

financial sustainability. In order to achieve the objectives of REDCL, it currently operates

through Head Office in Thimphu (Being shifted to Para) 20 nationwide branch offices

covering all 20 Dzongkag. The operating modality followed by REDCL its main business

activity of lending is described step by step in the following paragraphs. Each branch has one

project officer (except two branches) while head office has a total of 19 officers. Of the 19

officers in the Head Office, 08 are Field Officers/Project Officers. REDCL mainly provide

individual loans, although it in some areas provides group loans on a selective basis. The

steps involved in the process of approving and managing individual loans (the number of

group loans accounts only for about 3% total number loans and process operating modality

of group loans are described elsewhere in this report.)

Step One: Loan applicants come to the branch and hand over applications to the Customer

Project Officer of the Branch.

Step Two: Project officer collects the necessary documents from the potential borrowers

and compile a complete loan application.

Step Three: The branch Project Officer undertakes the first screening of applications

received. The branch project officer obtains the views and recommendations of the relevant

government officials responsible for the industry. (For example; if the loan application is for

a poultry farm the recommendations of the official of the livestock Department should be

obtained); some applications are rejected after the initial screening. The rejection rate

initially was high as much as 40% and the main reasons for rejections are; bad past debt

servicing record and non-viability of proposals.

Step Four: Client Visits: The project officer along with the government officials (industry

experts) visit the applicant for observations and verification of numbers and facts given in

the loan applications.

54

Step Five: Credit applications together with the necessary documents with the

recommendations/observations of industry experts are sent to Head Office. Appraisal and

preparation of Appraisal Report is done by the project officers at the head office by the

credit officer. Time taken is 4-5 Days.

Step Six: Approved credit proposals are sent to BDBL Head Office for documentation and

disbursement, REDCL pays a fee of 2% of the loan amount to BDBL for its back office

function.

Step Seven: Disbursed loans are to be followed up by the branch project officers and they

are also responsible recoveries. The supervision of loans granted is not very effective and

the NPL ratio is very high.

The process involved in loan origination seems to be efficient although post disbursement

loan management is insufficient. It appears that credit officers have no adequate time for

pro-active marketing and promotions and effective supervision of loans due to high number

of loans per credit officer in some branches.

4.5. LOAN APPLICATIONS RECEIVED: The REDCL commenced operations in June 2016

and applications received and the number of loans disbursed from the inception is shown in

the table below:

*The number of pending applications at the end of 2018 was 93.

From its inception in June 2016 up to December 2018, RDCL has received 7,716 applications

of which only 3,346 have been approved and disbursed (pending applications at the end of

the year was 93) indicating a very high rejection rate. Of the 7,716 applications received,

4,012 applications are from Agricultural sector, 3,066 are from Livestock Sector and the

balance 638 is from the Manufacturing Sector.

4.6. LOAN APPROVALS: Details of loans approved from its inception are given in the

tables below:

The sector wise breakdown of the cumulative number of loans approved and disbursed is

given below:

Indicator/Year 2016 2017 2018

No. of Applications received 4,025 2,419 1,272

No. of Loans Disbursed 1,241 860 1,245*

Amount Disbursed (Nu Mn) 112.67 105.52 267.59

55

Source: REDCL

The cumulative lending portfolio (Nu Mn) outstanding at the end of specified period is given

below:

Source: REDCL

The number of loans approved and disbursed during the specified periods is given below:

(Nu Mn)

Source: REDCL

The values of loans approved and disbursed during the specified periods are given below:

(Nu Mn)

Period/Sector 2016-

2017

2018

Jan-

Jun

2019

Agriculture 117 107 24

Livestock 95 134 51

Manufacturing 8 23 20

Others - 1 -

TOTAL 220 265 95

Source: REDCL

Period/Sector 2016 2017

2018 Jan-June

2019

Agriculture 731 1,140 1,703 1,813

Livestock 482 903 1,454 1,584

Manufacturing 23 72 216 336

Others - - - -

TOTAL 1,236 2,115 3,373 3,733

Period/Sector 2017

2018 Jan-

June

2019

Agriculture 128 143 142

Livestock 98 169 193


Others - - -

TOTAL 234 338 377

Period/Sector 2016-

2017

2018

Jan-

Jun

2019

Agriculture 1,542 443 91

Livestock 1,208 443 104


Others - 24 -

Total 2,890 1074 324

56

Although, REDCL has approved 2,890 loans for the first 18 months averaging to around 160

loans per month, the rate of approval has declined to about 90 per month in 2018 and to 54

per month in 2019. The high rate of rejection may be one of the reasons for low approvals

and outreach. During the year 2017, out of the 2,419 of applications received, 807

applications representing 33% of applications received have been rejected. The rate of

outreach has been declining. The average loan size indicates an upward trend. The average

loan size which was Nu 76,000 in 2016 has increased to Nu 247,000 in 2018 and to Nu

293,000 in 2019

4.7. NON-PERFORMING LOANS: Under the l guidelines of RMA, all MFIs REDCL is also a

MFI) are required to categorize all their lending portfolios based on the repayment status of

the portfolio and make provisions for loss of value depending on the category of the

portfolio. The following table gives the categorizations of the lending portfolios of banks and

applicable rates for provisioning for loan loss.

Category Age Provisioning Rate

Standard < 30days No provisioning

Watch 31 to 90 days No provisioning

Sub-Standard 91 to 180 days 30%

Doubtful 181 to 365 days 30%

Loss > 365 days 30%

Source: Prudential Guidelines of RMA

MFIs, world over use an indicator known as Portfolio at Risk (PAR) to measure the quality of

their portfolios. All loans falling under Watch, Sub-Standard, Doubtful and Loss are classified

as Portfolio at Risk. PAR ratio is calculated taking the portfolio at Risk as a percentage of the

total portfolio. As per the Microfinance norms of CGAP, the internationally accepted PAR

ratio for an efficiently managed MFI is around 6%. The quality of the portfolio of REDCL as at

end December 2019 is shown in the following table:

Category No. of

Borrowers

% Portfolio

Nu Mn

%

Standard 3111 75.0% 273 65.0%

Watch 568 13.8% 82 19.6%

Sub-Standard 184 04.5% 26 06.3%

Doubtful 139 03.5% 23 05.5%

Loss 126 03.2% 15 03.6%

Total 4128 100.0 420 100.0

Source: REDCL

57

The PAR ratio is very high at 65% and repayments of 25% borrowers had not been up to

date. If NPL ratio (ratio used by banks) is used to measure the quality of portfolio of REDCL

the situation is still not satisfactory. The NPL ratio of REDCL (> 91 days) was 27% in 2017 and

it has declined to 18.7% in 2018. Although the 18.7% NPL ratio is relatively high when

compared with the sector average of around 11.5%, REDCL’s NPL ratio is still within the

target of 30% fixed by the Government. It was observed that at the time of loan approval,

an adequate credit analysis is not carried out. At the field level, the branch officer work in

consultation with governmental officers such as Agricultural officers and livestock officers

mainly to check the eligibility of potential borrowers and send the eligibility checked

applications to Head Office where the approval is done. Here also there is no proper

appraisal of credit proposals. Project Officers require more credit appraisal skills. The

inadequate credit analysis skills among the credit officers are one of the main reasons for

high NPLs. The Lack of post disbursement supervision is also a reason for high NPL. It is

understood that since the loans are from Government at very low interest, most borrowers

are under the impression that there is no need to repay these loans and they are grants

from the Government.

The following table indicates the analysis of the quality of the portfolio in terms of number

of clients of REDCL as per the requirement of RMA or the purpose provisioning for

impairment.

Year Sector Standard Watch Sub-

Standard

Doubtful Loss Total

2016 Agriculture 349 172 95 98 17 731

Livestock 269 128 29 31 25 482

Manufacturing 143 5 2 2 0 152

Total 761 305 126 131 42 1,365

2017 Agriculture 640 230 91 79 100 1,140

Livestock 553 208 55 44 43 983


Total 1,237 463 149 123 143 2,115

2018 Agriculture 1,139 301 131 54 78 1,703

Livestock 968 284 111 56 35 1,454


Total 2,280 614 247 119 113 3,373

Jun 2019 Agriculture 1,505 77 86 73 72 1,813

Livestock 1,285 88 98 61 52 1,584


Total 3,096 180 192 140 125 3,733

Source: REDCL

It can be seen from the above table that as a percentage of number of borrowers in NPL

have been declining. The ratio which was 42% in 2016 has declined to around 17% in 2019.

58

4.8. FINANCIAL PERFORMANCE: Summarized profit and Loss Statements and Balance

Sheets are given in ANNEXURES11 and 12 respectively.

4.8.1. Financial Performance-Profit and Loss Statements: Key financial indicators extracted

from the profit and loss statement of REDCL from its inception up to 31st December 2018

are given in the following table:

With the growth in the lending portfolio and with the resultant other incomes, the total

income of REDCL has grown by three times during the period under review. However, the

operating expenses have increased by nearly 13 times which is disproportionate to the

increase in income. The increase in operational expenses has come mainly from the increase

in the cost of employee benefits. The lending rate of interest of REDCL is controlled by the

Government and the rate of 4% allowed by the Government is not adequate to meet its

operational expenses. With the reduction of the NPL ratio in 2018, the provision on

impairment also has declined. Still REDCL has not reached the “Operational Self Sufficiency”

and as such its income is insufficient to meets its operational expenses.

4.8.2. Financial Performance-Balance Sheets: Key financial indicators extracted from the

balance sheets of REDCL are given below:

Nu ‘000

Source: REDCL

Loans and advances have grown by around by nearly three times during the periods under

review. REDCL is a non-deposit taking MFI approved and licensed by RMA and hence it has no

Indicator (Nu ‘000) June 2016 2017 2018

Interest Income 2,230 3,634 9,422

Other Incomes 6 628 613

Total Income 2,236 4,264 10,036

Operating Expenses 2,236 4,263 31,234

Net Profits before Impairments (3,517) (23,669) (21,198)

Less: Impairment 0 8,230 5,620

Net Profit (3,517) (31,899) (26,819)

Indicator /Year June 2016 Dec 2017 Dec 2018

Loans and advances 84,048 141,430 323,059

Other assets 62,342 93,344 60,938

Total Assets 146,390 235,764 383,997

Share Capital 15,000 35,000 430,535

Revolving Fund II 127,296 225,296 -

Retained Profits 4,806 36,705 63,525

Other Reserves 6,820 6,820 6,820

Total Equity 144,309 230,410 373,830

Other Liabilities 2,081 5,354 9,599

Other Liabilities 146,390 235,764 383,429

59

deposits from the general public. All most all funds have been provided by the Government.

During the year 2018, the share capital has increased substantially mainly due to the

capitalization of revolving fund II.

REDCL follows a model which is different from the model followed by other MFIS due to its

involvement with the Government. It has not been able to achieve Operational Self

Sufficiency (OSS) or Financial Self Sufficiency (FSS). All steps have now been finalized for the

up gradation of REDCL to a Cottage and Small Industry Bank effective mid-2019. Considering

the relaxed terms and conditions of lending such as 4% rate of interest and no collateral and

having delivery points at each district, the level of outreach achieved by REDCL appears very

low.

4.9. CAUSES FOR HIGH NPLs: The poor quality of the lending portfolio is one of the

problems faced by REDCL. As the operations of RDCL are entirely control by the Government

it has to follow government policy rather than attempting to achieve sustainability and low

NPL/PAR. When compared with International Standard for PAR and the PAR of MFIs in

Bhutan PAR of REDCL appears excessively high. According to international norms adopted /

recommended by CGAP (Consultative Group to Assist Poor-an entity associated with World

Bank) an efficiently managed MFI should maintain it PAR at around 6%. PAR of the private

MFIs in Bhutan has been less than 3%, although the scale of their operations is very limited.

The Government of Bhutan is now intending to make REDCL a sustainable entity, the

introduction of measures to control future of NPL is essential. There are several reasons for

the high level of NPL of REDCL. The main reasons for high NPL of REDCL are described

below:

4.9.1. Inadequate Skills in Credit Appraisal: Lending activity of REDCL is carried out through

the 20 branch offices located in 20 districts. Origination of loans is by them and the credit

appraisal is by the 8 project officers attached to Head Office. Each Branch is managed by a

project officer. Discussions with branch project officers revealed that most of them are

straight from the College or the University without formal training in credit. REDCL is

required to finance only start -up businesses and also without taking any collateral. Lending

is based entirely on the perceived future viability of start-ups. The ascertaining of future

viability of start-ups requires very high credit appraisal skills and most REDCL project officers

lack such skills. It is recommended that all project officers are provided with proper training

in cash flow based lending. A brief structure of the type of training covering 5Cs of credit to

be provided is given in ANNEXURE 05

4.9.2. Lack of Proper Guidelines on Credit Appraisal: Proper written guidelines/formats to

be used in collection of data/information and credit appraisal are required to ensure the

quality of credit appraisal. REDCL has no credit manual giving guidelines on credit appraisal

and it has published some basic guidelines which are not adequate to ensure a proper

appraisal. The examination of a representative sample of credit appraisal reports of RDCL

reveals several information gaps such as verifications of assumptions used in projections,

proper calculation of project cost, estimation of working capital and market assessment. In

60

order to guide the credit officers on what information they should collect before taking in

hand the credit appraisal and also to guide them on areas and aspects to be covered in the

appraisal report, it is essential to use a comprehensive appraisal format. Depending on the

loan size and the type, two to three different appraisal formats could be developed and

used. An appraisal format suggested is given in ANNEXURE 06. Since the new CSI Bank is to

finance even expansion of existing businesses too, the suggested format covers existing

businesses too.

4.9.3. Lack of Credit Risk Management Tools at Loan Origination: The credit risk

management is to be done at all stages of the “life cycle “of a loan. The first stage of life cycle of a loan is loan origination. The credit risk management should start here. The Proper

and scientific selection of borrowers at the application stage is essential to prevent selecting

potential defaulters. Most banks adopt credit scoring systems or risk rating systems for the

preliminary screening to eliminate risky potential defaulters. Credit scoring is mostly used by

MFIs while banks/financial institutions lending to SMEs use system of risk rating of clients.

The risk rating systems are scientific in selecting good borrowers as against judgmental

approaches used in client identification. At present the procedures followed by REDCL in

client identification is highly judgmental and this could be one reason for high NPLs and for

high rate of rejections. Un-scientific or judgmental criteria used in screening of loan

applications could result in rejecting some good applications and selecting bad applications.

In the future, REDCL not only will undertake financing of micros, but also it will undertake

financing of SMEs too. REDCL also plans to achieve self-sufficiency from the sixth year of

becoming a CSI Bank. Introducing a comprehensive risk rating system to identify good

borrowers would help in reducing future NPLs. The format to be used in risk rating of

existing businesses and guidelines on how to use the format are given in ANNEXURES 07 and

07A respectively. This format is not suitable for startup businesses. A separate format to be

used for start-ups and the guidelines on how to use this format are given in ANNEXURES 08

and 08 A respectively.

4.9.4. Lack of Loan Supervision: Lending portfolio of REDCL is highly infected. The PAR > 30

days is 35% and the NPL > 90 days was around 18%. For a financial institution aiming at

sustainability, this ratio is too high. The national average of NPL in Bhutan for 2018 was

11.5%. One reason for high infection ratio is lack of supervision of disbursed loans. Although

the number of loans per loan officer is low at around 130 per loan officer, loan officers

have no time for loan supervision due to their heavy involvement of recoveries and also due

to distance to the client places from the branch and the distance in between client places. In

some branches the number of loans per loans officer is much higher than the average for

REDCL due to uneven distribution of loans among branches. Less supervision may result in

misuse of funds and relaxing the need to service loans by borrowers enhancing the

possibility defaults. Frequent visits and meetings with borrowers will reduce the probability

of defaults. According to guidelines of Consultative Group to Assist poor (CGAP), the apex

body for MFIs, the ratio should be around 300 to 400 per loans officer depending on the

nature of the country. These norms are not applicable or relevant to Bhutan due to very

high distance in between clients and between branch offices and clients. In the case REDCL

61

a realistic norm is to be developed taking in to account the fact that a branch is managed

only by one officer. He/she has to attend to several other activities in the branch in addition

to lending.

4.9.5 Low Financial Literacy of Clients: The entirety of the clientele of REDCL is from rural

informal sector. Most of them are without formal education and are illiterate. Although

large scale borrowers of other financial institutions are capable of managing their money

matters most micro entrepreneurs financed by MFIs are incapable of doing so and poor

financial management results in financial difficulties for the business. Although it is

mandatory that all MFIs provide to their customers financial literacy training as a

prerequisite for borrowing, REDCL at present does not provide such training to its customers

as pre-requisite for borrowing. Financial literacy of Bhutanese entrepreneurs, particularly,

among MSME entrepreneurs is very low and most of them are financially illiterate. To

remedy this issue RMA has setup a separate secretariat to be responsible for promoting

financial literacy among entrepreneurs. Since MSMEs are playing an important role in the

economic development of any nation, the success of such enterprises is essential for the

economic growth. The success or otherwise of a MSME would depend largely on the

financial literacy level of the owner of the business. Low financial literacy among

entrepreneurs result in high number of business failures and also a large number of loans

taken by them falling in to NPL category. The financial literacy of an entrepreneur is

measured in terms of the entrepreneurs’ understanding of basic financial concepts such as

interest rates, Compound interest ,Inflation, risk diversification, his knowledge in legal and

regulatory matters, record keeping ,budgeting and his skills in raising funding from outside

sources at minimum cost. When lending to microenterprises by MFIs, they make it a

prerequisite that potential borrowers should undergo a two to three day financial literacy

training program. MFIs in Bhutan follow this practice in providing financial literacy

programs for micro entrepreneurs. Financial literacy programs provided are in two parts;

first part is class room training provided prior to lending and the second part during the

operation of the business which is known as: mentoring”. It is recommended that BDBL develop a financial literacy program and mentoring program for its MSME Customers.

Undergoing this training may be made compulsory. The main topics, inter alia, that should

be covered in a training program would be:



➢ Building assets



➢ Earning money




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Even after becoming a CSI bank, RDCL will provide non-collateralized loans and where

possible it will take project assets as collateral. The risk of such non-collateralized loans and

loans granted only against the assets financed with loan proceeds, would be higher in the

future as the maximum loan amount would go up to Nu10.0 (present limit is only Nu

500,000).One way to minimize such risk is to resort to group lending where “peer pressure” could be used in recoveries. If CSI bank is to undertake group lending the first step would be

the development of a comprehensive operational manual together with necessary forms,

formats and guidelines. Some guidelines to introduce (currently REDCL offer group loans on

a very limited scale) group lending are given in ANNEXURE 13.

4.9.6. Lack of Professional Business Development Support Services (BDS) for CSIs: The

credit to the CSI sector including rural informal activity sector is an important component of

the rural credit offered by the financial sector. The Government believes that the CSI sector

is the engine of growth and hence the sector growth is essential for an inclusive economic

growth. Although the CSI sector accounts for nearly 95% of the country’s business units, it has received only 14% of the total credit of the Banking sector. The growth in the CSI sector

to a large extent depends on the availability of professional Business Development Support

(BDS) Services. Almost all CSIs require professional BDS services to sustain and grow their

businesses as most CSI entrepreneurs are not conversant with all aspects of business

management. BDS required by CSIs includes a wide array of services such as preparation of

feasibility studies, assistance to start-up businesses, training on entrepreneurship, HR

management, technologies and marketing. Discussions with CSI entrepreneurs and bankers

revealed that the status of BDS services at present is not at a desired level and it needs

improvements. What the financial institutions could do to develop BDS Services is limited

and it is the responsibility of authorities to set up a “One Stop Shop” to Provide BDS services. Multilateral development agencies could consider providing TA assistance the

government to set up such a facility. The consultant has personally involved in a few such

facilities financed by multilateral development agencies and operated by public entities in

collaboration with lending institutions. For increasing the rural outreach and also to improve

the quality of the rural lending portfolios of rural lenders it is essential to develop a

professional system of BDS Services. There are various options available to create a system

of BDS Services. One option available for REDCL and BDBL is to set up their own systems of

DBS as a fee levying financial service or both institutions to team up with Department of

Cottage and Small Industry (CSI) and set up a public sector entity to provide professional

BDS Services at a subsidized fee to CSIs. The government Departments may not be able to

provide professional DBS Services on their own direct to CSIs. Although, there are several

public sector entities and NGOs providing these services in Bhutan at present, there are

huge gaps in the demand and supply of such services and also quality of such services

provided by current suppliers.

4.10. BRANCH AND CLIENT VISITS: The Consultant visited two branches of REDCL on 26th

and 27th of November and met several clients of these branches. All the clients were met at

their business premises. Observation made during the branch visits and client meetings are

summarized below:

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4.10.1. REDCL Brach - Phunaka: Branch has only one officer and I met him in the field. The

total portfolio of the branch is Nu 30 Mn representing 164 borrowers. The percentage of NPL

portfolio is 14.5% representing 15 borrowers. Loans are mainly for agriculture. Branch

undertakes only individual lending. The maximum loan per borrower is Nu 500,000 and loans

are granted only against personal guarantees and other collateral is not required.

Meetings were held with three borrowers. One borrower (male) who has borrowed Nu

95,869 is engaged in dairy farming, horticulture and vegetable cultivation. The purpose of the

loan was to purchase two cows. His loan has been in arrears for about four months as he has

spent money in the business to meet family expenditure. The second borrower (female) who

is engaged in horticulture has been granted a loan of Nu 118,904 for land preparation and

fencing. This loan is regular. The third client (male) we met has been granted a loan of

Nu 87,576 engaged in vegetable cultivation. Loan given to the agriculture project is regular.

The loan granted to the borrower involved in vegetable cultivation was in arrears for 11

months as he has been experiencing difficulties in selling his products.

4.10.2. REDCL Branch - Wongdue: Only one officer in the branch and met her in the field.

The branch has a total portfolio of Nu 66 Mn representing 361 customers. Loans are mainly

for agriculture. NPL ratio of the branch is 12.79% and 35 borrowers are in arrears. I met four

borrowers. The details of the borrowers are given below:

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Client Loan (NU) Activity

Purpose Status

Client 01

(Female)

223,796 Agriculture Purchase of a hand tractor/tiller Regular

Client 02

(Male)

499,024 Poultry

Farming

Construction of sheds and purchase of

50,000 birds

Irregular

Misuse of

funds

Client 03

(Male)

446,283 Piggery Construction of sheds and buy 10 pig

lings

Regular

Client 04

(Female)

499,406

dairy Purchase five cows Regular

Client 05

(Female)

100,000 Dairy To purchase two cows Regular

Source: REDCL

4.10.3. Observation of the Consultant During Branch and Client Visits:

• Most of the loans are for agriculture

• Inadequate skills among loan officers for cash flow based lending and they are straight

from college/university without formal training

• Very high NPL mainly due to lack of post disbursement supervision

• Most borrowers consider loans as a grant from the government as loans are at very low

rate of 4% and REDCL is a fully government organization

• Inadequate staffing in branches results in low outreach and low quality portfolio

• Poor financial literacy of clients

• Inadequate Business Development Support Services (BDS) to support borrowers to

manage their businesses.

4.11. CONCLUSION: The following Conclusions were derived from the above diagnostic

study of REDCL:

i. The Business Model followed by REDCL at present is completely different from other

MFIs in Bhutan and in other countries

ii. The Business Model Followed by REDCL is not sustainable and viable.

iii. Project officers in the field and also in the head office lacks proper project appraisal

skills and this is one of the reasons for high NPL

iv. Lack of frequent supervision of disbursed loans is also a reason for high NPL

v. Outreach achieved from inception for nearly three years with 20 branches is low and

up to date the number of loans granted is 3,744.

vi. No credit risk rating measures used at the time of loan initiation

vii. Poor financial literacy of clients

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5. PART FOUR – STRATAGIES PROPOSED FOR BDBL

5.1. INTRODUCTION: BDBL is the key financial institution in Bhutan entrusted with the

task of providing financial services to the CSI sector and rural farming households. The

diagnostic study carried out on BDBL revealed that it could have performed much better if

not for the impediments and constraints faced by it. Some strategies are recommended

here to remedy the impediments and constraints faced by BDBL in improving its rural

finance activities. The following paragraphs described these strategies.

5.2. STRATEGY ONE - IMPROVING CAPITAL ADEQUACY: The capital adequacy of BDBL

has deteriorated over the period and in 2017 it was below the RMA stipulated ratio of 12.5%

(inclusive of capital conservation buffer of 2.5%) and CAR in 2018 was just meeting the

statutory requirement. In order to grow its lending business and to fulfill requirements of

RMA, the Bank needs additional capital without which moving forward is difficult. As 96% of

the capital is owned by RGoB and the balance 4% is also directly or indirectly owned by the

Government through public sector, wholly or partially owned, financial institutions namely,

RICB, BOB and BNB, it is incumbent upon the government to inject new capital using its own

funds or through funds to be raised from a multilateral development agency such as ADB. It

is understood that the government has budgetary constraints in injecting funds to BDBL. If

this option is not feasible, the government needs to consider the other option of inviting a

strategic investor to take up a minority equity stake in the Bank or list a minority

shareholding of the Bank in the Bhutanese Stock Exchange retaining the controlling interest

with RGoB. Injection of new capital will also resolve two problems of BDBL namely lack of

funds for lending and cost of funds. At present, all the directors of BDBL are ex-government

officials or serving government officials at very senior levels from different government

departments. There are no independent directors with exposure to private sector business

management or with exposure to private sector banking. Divesture of part of equity could

bring one or two directors with private sector exposure. This is strategic decision; the

Government of Bhutan has to take. The trend all over the world is that the governments to

fully privatize government owned development banks a divest at least minority interest in

such banks to attract private investments and private sector managerial inputs .Good

examples in the Region are originally government owned Industrial Development

Corporation of India (IDBI),Industrial Credit and Investment Corporation of India(ICICI) ,

National Development Bank of Sri Lanka,(NDB) and Development Finance Corporation of

Ceylon (DFCC). All these institutions started as government owned DFIs and subsequently

privatized or publically listed.

5.3. STRATEGY TWO - MEASURES PROPOSED TO INCREASE THE RURAL FINANCE

CREDIT OUTREACH: Although the accounts outreach of the BDBL is very high reaching

around 40% of the adult population, the outreach in the credit market is very low at around

10%. For a bank which has been in existence for a period of around 30 years, the credit

outreach is very low when compared with the unbanked credit market ‘of 84% of the total

credit market. The reasons for low credit outreach of BDBL are the inability of most

66

potential borrowers to offer tangible collateral and lack of proactive marketing of credit

products by credit officers due to heavy workload. There are various ways of increasing the

rural outreach by BDBL. The strategies recommended to be followed by BDBL in increasing

the rural outreach is described in the following paragraphs.

5.3.1. Revitalization of Group Lending: While the rationale behind the establishment of

BDBL was to provide financial services particularly in rural Bhutan, until 1988, not many

farmers, particularly poor farmers benefited from the credit schemes of the Bank as

potential borrowers in the farming community produce tangible collateral of significant

economic value commensurate with the value of the loans they wish to borrow. Hence the

rural farmers who were in need of credit were depending on rural money lenders at

exorbitant rates of interest. In order to increase the accessibility financial services of rural

poor farmers, BDBL in 1998 introduced non-collateralized group lending on Grameen model.

In a country like Bhutan where lending is mainly done based on collateral and acceptable

collateral cannot be offered by most of the potential borrowers, the way out is to undertake

group lending in large scale. Although BDBL commenced offering group loans since 1998,

the product has not been properly marketed and offered. It is the only credit product

offered by BDBL at present free of collateral and potential borrowers who do not possess

tangible collateral should have resorted for group loans in large numbers. Surprisingly this

has not happened. The lending under the group lending scheme had been very marginal. As

at present, out of the total number of loans of 52,982 only 1704 are group loans,

representing only 3.2% of the borrowers and the share of portfolio was only 1.02%. The

quality of the group lending portfolio is much better than that of the collateralized

individual loan portfolio. The NPL ratio of the total Nu value of group loan portfolio was

7.31% while the overall NPL ratio of the Nu value of the total portfolio was 24.3 %. Of the

total borrowers 15.97% had been infected while only 8.4% of the Group borrowers are

infected. This clearly shows that group lending is of high quality and BDBL should actively

promote and pursue group lending. Lack of promotion and reluctance on the part of the

credit officers had resulted in very low level of group lending portfolio. Some guidelines to

revitalize the group lending are given in ANNEXURE 10. BDBL may use these guidelines to

supplement the guidelines given in the Group Lending Manual. Although, there is an

Operational Manual on group lending activity, BDBL has not been able to push this product.

At present out of 35 branches, only 18 branches have undertaken group lending and with

the revitalization all branches should be required to handle group loans. It is recommended

that BDBL to consider appointing a group loan officer to each branch and targets be given to

them on the number of group loans to be granted from that branch. It is also necessary to

re-launch the product through a proper marketing campaign. All group loan officers to be

provided with a proper training on group lending. Some Guide Lines to re-launch group

lending are given in ANNEXURE 13)

5.3.2. Making Use of Community Centers to Increase BDBLs Rural Outreach and Social

Mobilization: The Government of Bhutan established a mechanism in 2012 to deliver

Government-to-Citizen (G2C) services to the general public efficiently in one venue.

Community Centers (CC) were set up in Gewogs to implement this program. Originally, the

67

Government selected Bhutan Post to manage the community centers for five years. All

government services to the general public such as issuance of Citizen Identity cards,

registration of births, name changes, registration of deaths, and approval for

construction/reconstruction of houses, business registrations and several more online

services are delivered through the Service Centers. The Community Centers also provide off-

line services such as photocopying and printing to the community at nominal charge. For

administrative purposes, the country is divided in to 205 Gewogs (group of villages) and

each Gewog has an elected community leader. As at date, community centers have been set

up in 200 Gewogs. After few years of operations, the Government decided in 2015 to

transfer the management of Community centers to BDBL as it is in a better position to

deliver financial services which was most needed at that time. The Management of CCs was

transferred to BDBL in March 2015. The Bank has appointed one officer each to a

community center to run its operations.

Centers provide 18 types of online Non-Government to Citizen (Non-G2C) and 43 types of

Government to Citizens (G2C) services and 28 offline services to the citizens. The operations

of Centers are not financially sustainable as fees charged are not adequate to cover the

operational costs incurred in providing it services. The profitability of the overall

performance branches is shown in the following table:

Source: BDBL

From the date of takeover of the management of CCs, BDBL has incurred a total cost

Nu 119,158 for managing these CCs and have earned only Nu 18,573 by providing services.

The fees charged is not adequate to meet the cost of services provided. The cost recovery is

only 16%. The BDBL should make an attempt to achieve at least Break-Even status of the

center operations. It is recommended that BDBL undertakes center wise profitability

analysis comparing the fees charged by private service providers for the type of services

provided by CCs and come up with recommendation to achieve the sustainability of the

centers as a separate profit center. The analysis of center wise profitability is not possible at

present as BDBL does not prepare accounts on individual Community Centers. The BDBL

may use a team of its officials preferably from the Finance Department and carry out this

center wise profitability and carry out a survey on market rates on types services provided.

There are some G2C services which are not provided by private sector service providers

where market rates are not available and in such cases BDBL team to undertake costing of

Year Total Income from

All CCs(Nu 000)

Total Operational cost

Of all CCs(Nu 000)

Overall Profit/(loss)

(Nu 000)

2015 3,573 20,240 (16,666)

2016 4,681 32,314 (27,632)

2017 5,813 34,705 (28,891)

2018 4,506 31,899 (27,393)

68

such services. Based on the finding of this analysis BDBL to revised fees to an extent at least

each CC is achieved Break Even Status.

BDBL could also use the CCs for social mobilization through which the rural communities

could be economically and socially developed. Social mobilization aims to facilitate change

in achieving goals for a community through an interdisciplinary approach. Through the

organization of the potential banking customers in to groups, the BDBL could assist the

members of the community to achieve more than access to credit.

The Bank at present uses these community Centers in a limited way to deliver its banking

services to the community. The Bank should make use of the community centers to their full

potential to enhance the Bank’s rural outreach. Since, CCs have a presence in 200 Gewogs

out of 205 Gewogs and BDBL is responsible for managing the Centers, it could effectively

use these centers to expand its outreach. As mentioned elsewhere in this report, a proposal

has been made to revitalize the group lending activity of the bank. In this exercise BDBL to

make use of all its branches and the community centers. The strategy recommended by the

Consultant how to make use of CCs in expanding the rural outreach is step by step

description is given below:

i. A new operational manual on group lending based on the current manual and the

Guidelines on Group Lending given in the report is to be developed

ii. BDBL to request managers of all branches that they should promote group lending

through their respective branches.

iii. Designate one of the credit officers of the branch as Group Lending Officer.

iv. A separate business unit within the Credit Department under General Manager

Credit to be responsible for Group Lending through branches.

v. The Branch Managers and the Group Lending officers of branches to work together

with Staff of the CCs coming under the purview of the branch. Each branch will have

around 5-7 CCs coming under its management. CCs are to be basis for lending the

revitalize Group Lending Program.

vi. All branch managers, credit officers and CC staff are to be well trained on group

lending methodology. An outside trainer with extensive experience is to use for this

training

vii. Group Lending Officer in the branch is to be given a target as one of his/her Key

Performance Indicators (KPIs). It is recommended that each Branch Group Lending

Officer is to be given a target of at least one group per two months (six groups per

annum per Gewog) to be formed in each Gewog coming under the respective

branches. Since BDBL operates in 200 Gewogs, it could form at least 100 groups per

month in 200 Gewogs. On this basis during the first round of launch of the new

group lending program, all branches should be able to form 1200 groups per annum

initially. If the average size of a group is assumed to be 4, the total number of group

borrowers would be 4800. The membership of these groups should be opened to

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every one irrespective of the gender or social background. This target could be

increased gradually during ensuing years.

viii. BDBL may launch group lending as a new product terming it as a “Collateral Free

Loan) through a country wide campaign.

ix. For the purpose of accounting Group Loans should be treated as a separate profit

Centre.

x. The loan size to be increased from current level of Nu 300,000 to Nu 500,000.

xi. Administrative cost of group loans is higher than that of individual large loans.

Therefore, it is justifiable to increase the lending rate of group loans from the

current level of 10% per annum to a rate around 24% per annum or 2% per month.

Micro entrepreneurs are more concern about the easy access to finance rather than

cost of finance. If there is no easy accessibility to credit from the formal banking

sector to them, the other option available to them is to borrow from village money

lenders in the informal financial sector, at exorbitant rates of interest, may be at

around 5- 10% per month. All other private sector MFIs charge 2% per month on

their micro credit. In the microfinance sector microfinance entrepreneurs.

xii. A micro savings product is also to be launch linking it to micro lending program. It

should be make mandatory that micro borrowers to deposit at least 10% of their

monthly installment in a “Savings Build- up Account”.

xiii. In implementing the new group lending program, BDBL may pay special attention to

the vulnerable groups in the community. In today’s context in Bhutan the most vulnerable groups in the community are Women and Youths. Offering preferential

treatment to women, the rural finance institutions could enhance their rural

outreach and the country could increase its financial inclusion. This will improve the

social impact of their operations. Providing financial services to these two groups

Strategies to follow in providing financial services to these two groups, BDBL may

follow the following methodology:

5.3.3. Lending to Women Groups: As a group, women in Bhutan are at a disadvantages

position when compared with men. According to the data of the National Statistical Bureau

of Bhutan, the total population of the country amounted to 763,094 (2017) of which women

accounted for 47.85%. The national Literacy rate (2017) was 71.4% and women literacy rate

was below the national average and in 2017 it was at 63.9%. According to the 16th Labor

Force Survey Report (2018), the national labor force participation (economically active

population 15 years and over) rate of the country was 62.6% while the labor force

participating rate of women was 55.5% while the rate for men was 70.1%. The total

economically in-active population (2017-National Statistics Bureau) was 185,694 and of

which 64.47% was women and 38.8% were men. 64.47% of adults in Bhutan have a savings

account with a bank, 56 % of which are male and 44% are female. Similarly, of the 16% of adults who

have access to credit, 54 percent are male and 46 percent are female. Of the 17% of adults who have

insurance, 59%t are male and 41% percent are female. Of the total borrowers of BDBL, 60% are men

70

while only 40% are women. The above statistics clearly indicates that as a group women are in

a disadvantage position and there is a need to initiate some measures to narrow the

economic gaps between men and women. In order play a role in promoting economic

activities of women, it is recommended that BDBL make use of its proposed group lending

scheme through Community Centers to provide access to credit to women micro

entrepreneurs .As mentioned above, Branch Group Lending officers are to be given a target

of 100 groups per month or 1200 per annum to be formed , BDBL should make it

mandatory that of the 1200 groups to be formed in 200 Gewogs during the initial year at

least 400 groups should be exclusively for women. If the average group size is four

members, this wills help1600 women entrepreneurs to access credit. A reduction of 2% to

3% on the rate of other group loans is to be considered for group loans to women to

encourage women entrepreneurship.

5.3.4 Lending to Unemployed Youth: Another vulnerable group in Bhutan is youth of the

age group of 14-24. This group accounts for18.40% of the population (2017) and the literacy

rate of the group is as high as 93.1% when the national literacy rate is 71.4%. While the

national unemployment rate of the country in 2017 was 3.4%, the unemployment rate

among youth has been 15.7%. Most of these unemployed youth are with high educational

qualifications. Of the total youth unemployment 37.1% has completed secondary higher

education followed by middle secondary 29.3% and bachelor degree 19%. Most educated

youth seek employment in the public sector where the job opportunities are limited. The

unemployment among youth is a serious social and political issue and youth unrest is a

threat to political stability. A remedy is urgently required. Creating opportunities for self-

employment is desirable as a solution to youth unemployment. BDBL could get involved in

this process through its proposed group lending scheme using the community Centers. It is

recommended that BDML make it compulsory that each community center form at least

one group exclusively for youth per annum for youth to commence businesses. On this

basis, 200 groups per annum could be formed through the 200 Community Centers.

Providing collateral free credit with easy access would motivate unemployed youth to

commence business ventures. The rate applicable to group loans to youths could be

reduced to about 18% per annum or to 1.5% per month to motivate youth.

5.4. STRATEGY THREE - INTRODUCTION OF NEW PRODUCTS TO IMPROVE RURAL

CREDIT: Another way of increasing the rural credit outreach is to introduce new fund based

and fee based financial products, in addition to the credit products the BDBL offers at

present. A brief description of these products is given below:

5.4.1. Leasing-Equipment and vehicles: Equipment Leasing for CSIs, vehicle leasing for

public transport, personal use and industrial use. This product is attractive particularly to

rural households who cannot offer immovable assets as collateral to borrow from banks.

Lease is an agreement between two parties whereby one party allows the other party to use

his/her asset for a certain period of time in exchange for a periodic fee. The assets covered

in leases are usually movable assets such as plant& Machinery, vehicles, Aircraft and ships.

The receiver of an asset under a lease agreement is called the “Lessee” and the owner of

71

the asset is called the “Lessor”. A lease is a legal contract and thus enforceable by all parties

under the contract law. There are basically 3 types of leases.

➢ Finance Leases: a long term lease where the ownership of the leased asset transfers

to the lessee at the end of the lease period at a nominal price. All risks and rewards

incidental to the ownership of the asset are with the lessee.

➢ Operating Leases: a short term lease where the lessor retains all risks and rewards

incidental to the ownership of the asset. Lessor retains the ownership at all times.

This method of leasing is mainly used for the acquisition fleets of vehicles.

➢ “Sale and Lease back” Leases: this is a variation of the finance leases with almost all features of a finance lease. Sale and lease back is a financial transaction where one

sells an asset and lease it back for a long term paying a periodic fee. Existing

businesses with unencumbered fixed assets can borrow from banks for their working

capital requirement through this method of leasing

5.4.2. Leasing for high - end consumer durables for rural households with regular or

seasonal incomes: It is a sign of economic development that more and more households

purchase consumer durables to improve the living standards of the households and to

change the life style of people. The consumer durables consist of durable goods and

appliances for domestic use such as refrigerators, air conditioners and washing machines. Products

that aren't consumed or quickly disposed and goods that could be used for several years

are durable goods and also called hard goods. Consumer durables are also grouped under three

categories namely white goods, Brown goods and consumer electronics. White goods are

Refrigerators, Washing machines, Air-conditioners, Speakers and Audio equipment. Brown

goods are Mixers, Grinders, Microwave ovens, Iron, Electric fans, Cooking range Chimneys,

Consumer electronics are Mobile phones, Televisions, MP3 players, DVD players and VCD

players. As most of the leases of consumer durables would be” small ticket leases”, BDBL

could consider simplifying the approval procedure and introduce a simple credit scoring

system to screen the applications for leases for consumer durables. Guidelines for the Credit

Scoring system for leasing of vehicles and consumer durable leases are given in ANNEXURE

14

5.4.3. Venture capital/Seed capital for sustainable CSIs who are experiencing shortages of

equity capital: One of the main impediments for the growth of the SME sector in developing

countries is the lack of risk capital or the seed capital. Venture capital by banks could be

provided only to limited liability companies and banks could encourage their potential

customers to carry out their businesses under limited liability framework. If the client of

BDBL who is in need of funding is a limited liability company, the BDBL has two options in

providing venture capital. One option is to invest in ordinary shares like the owners of the

business sharing risk and return equally with the owners. Most banks in their venture

investments prefer to reduce the risk with a guarantee of a minimum return. The

mechanism to reduce the risk and ensure a minimum return is to invest in Redeemable

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Cumulative Preference Shares with a fixed Coupon Rate. This is a hybrid venture capital

product with features of debt and equity. Risk to the investor is relatively less than that of

the ordinary share investments. The advantages of Preference Share Investments to SME

investee companies are threefold. First, Investee SME will start paying dividend only from

the time of it starting to generate profits and hence particularly start-up SMEs will have a

less financial burden during the initial years. Second, no need for collateral which is one of

the serious problems faced by SMEs world over. Third, in computing debt: equity of the

business, preference share investment is treated as part of equity.

Procedure to be followed in making venture investments for Investment:

➢ The investment is subject to a detail appraisal of the project

➢ The appraisal officers need to identify an equity gap based on the appraisal and

justify the need for institutional investment

➢ Restricted only for companies with very high growth potential and the promoters to

be with undisputed integrity.

➢ The Bank to get the Articles of Association of the investee company amended

specifying the rights and privileges of the Bank’s share investment.

➢ Reserve the right to appoint a nominee director.

5.4.4. Wholesale loans to sustainable MFIs through credit lines: BDBL is to expand its rural

outreach as the financially excluded percentage in rural areas is very high. The credit

outreach in the country is only 16%. Rural finance institutions and banks interested in

getting involved in rural finance adopt two strategies to enhance their credit outreach in

rural areas. One strategy is to lend direct to rural entrepreneurs and needy households and

the other strategy is to lend to rural entrepreneurs and rural households through MFIs.

BDBL at present follow the direct lending strategy. It is recommended that BDBL also

consider following the second strategy too providing “wholesale” loans to MFIs for on

lending to micro entrepreneurs. Microfinance sector in Bhutan is at its early stage of

development RMA has issued license to six MFIs. These institutions are RENEW, Bhutan

Association of Women Entrepreneurs (BAOWE), Taranaya Foundation, Bhutan Care Credit

(BCC), Microfinance Bhutan Private Limited and Rural Enterprise Development Corporation

(REDCL). For the purposes of regulating, MFIs are categorized in to two groups namely

deposit taking and non-deposit taking. Only RENEW and Microfinance Bhutan Private

Limited has the license to take deposits from the general public and others are involved only

in micro lending. The Consultant visited and had discussions with senior management of

three MFIs namely RENEW (Stands for Respect, Educate, Nurture, and Empower Women),

BAOWE (Bhutan Association of Women Entrepreneurs) and BHUTAN MICROFINANCE

PRIVATE LIMITED (BMPL). It was observed during the discussions with these three MFIs and

that they have sustainable operating models. Except RENEW, all other MFIs are constrained

by lack of funding to expand their operations. It is recommended that BDBL initiate actions

initially to work with these three institutions. All these MFIs are undertaking Group Lending.

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In undertaking whole sale lending to MFIs, the most important activity to be carried out by

BDBL is the Performance Evaluation of the MFI to be financed. It is to be done by a

knowledgeable experienced microfinance practitioner using the Guidelines issued by CGAP

on evaluation of MFIs covering five performance indicators namely; Outreach, Quality of

Portfolio, Sustainability (OSS and FSS) and Efficiency. Whole sale lending to a MFI is to be

undertaken only if the MFI’s performance is within the norms recommended by CGAP.

5.4.5. Value chain financing programs for few industry sectors/commodities: The possible

sectors/commodities for introducing value chain financing programs are Fruits Industry,

Dairy Farming and Potato Cultivation. Many countries use “Value Chain Financing” to enhance financial outreach and promote inclusive economic growth. Value Chain financing

could be used in developing countries to develop particularly CSIs engaged in agriculture.

The value chain finance is the provision of financial services to actors involved throughout

the series of transactions (chain) of a particular industry that results in producing a final

product and delivering it at the appropriate marketplace. During meetings with the Financial

Inclusion Secretariat of RMA, it was revealed that Bhutan could make use of value chain

financing mechanism to develop the agricultural sector. A study carried out by UNDP in

2016 has recommended that Agriculture Sector as suitable for developing value chain

programs and has identified several agricultural commodities (including Potato, Maize,

ginger ,cardamom and Dairy). Based on discussions the consultant had with several parties

and based on his observations, during visits to branches and borrowing CSIs , the above four

sectors are recommended for BDBL’s consideration to launch value chain financing

programs initially. BDBL could work closely with financial inclusion Secretariat of RMA in

developing value chain for the four products mentioned above. In a country like Bhutan the

factors to be taken in to account in developing a value chain program for a product are;

➢ Productive capacity

➢ Number of beneficiaries

➢ Sustainable livelihood options

➢ Product resilient to climate conditions

➢ Degree of vulnerability to climate change

➢ Scalability of the product

➢ Geographical distribution of the commodity.

The first step to be followed by BDBL in launching a value chain for a particular product is

the “Value Chain Mapping”. Value chain Mapping will show the flow of transactions from sourcing of raw materials and inputs, to production, processing, marketing and final sale.

The mapping can also illustrate costs, value addition at each stage, secondary services

important to each stage, critical constraints and relative clout of players along a value chan.

Some factors relating to the recommended for products for value chain programs are

described below;

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i. Fruit Industry Value Chain: Different groups involved in the Fruit Industry Value Chai

are i) input sellers (seeds, plants and fertilizer), ii) cultivators, iii) transporters iv)

processers (such as makers of fruit juice and fruit jams) and v) traders/Exporters.

The main fruits produced in commercial scale and also in home gardens are orange,

walnuts, apple, apricot, peach and cherry. Processers buy from growers or through

intermediaries, convert in to juice and export or sell in the local market. The

problem in Bhutan is the inadequate production of fruits to support the efficient

functioning of a value chain scheme. BDBL Financial institutions could step-in and

form groups among the different players in the chain and provide financing to such

groups of each stage of the chain including cultivators.

ii. Potato Cultivation Value Chain: Potato is Bhutan Most important cash crop and

almost 85% of the households in Bhutan grow potato either for export or for home

consumption. Hence the potato is a very good candidate for a value chain program.

The main categories of actors involved in the potato value chain would be i) seed

suppliers, ii) input suppliers such as fertilizer, iii) growers, iv) contractors/middlemen

v) Transporters and vi) exporters. BDBL to identify main players in each category and

form them in to groups. Group loans are to be provided to the members of groups.

iii. Dairy sector Value Chain: is also another sector where value chain financing could be

introduced. Dairy farming in Bhutan is traditionally based on small holder system

primarily subsistence-oriented mixed crop-livestock farming system. The sector is a

very significant importance to the country’s rural economy and over 78% of the rural

households own cattle. Dairy farming is an integral part of Bhutanese farming system

producing items such as milk, butter and cheese. In a dairy value chain, the main

group of actors are i) input suppliers, i) farmers (growers), iii) processers IV)

Transporters and v) traders (wholesale and retail). Players under each category could

be formed in to groups and group loans can be issued to group members.

BDBL needs the assistance of an expert in value chain financing initially to design and

develop the value chains for the three products mentioned above. BDBL could consider

obtaining TA assistance from multilateral development agencies such as World Bank, IFC,

ADB, UND and USAID. BDBL could launch the Value Chain Financing Program on its own or

jointly with REDCL, the other main player in rural finance. Depending on the success or

otherwise of the three value Chain Programs, few more value chain programs are to be

introduced.

5.4.6. Non Collateralized Loans: Guidelines on lending by BDBL clearly states that except

group loans, all other types of lending should be against tangible collateral. In a country

where needy borrowers could not offer tangible collateral, some exception should be

available to borrow without collateral. The consultant has recommended a client risk rating

system to be adopted by BDBL in assessing the risk profile of each borrower and to

implement a risk based pricing system. Under this system, loan applicants are rated using a

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scoring system in to six categories and the risk profile of loan applicants coming under each

risk category are shown below:

Risk Grade Range of points Description

AA 90-100 Highest quality

A 80—89 Very good quality

BB 70-79 Good quality

B 6 0-69 Average Quality

C 50-59 Less than average quality

D >40 lowest quality

Since the credit risk associated with loan applicants rated AA and A is minimal, BDBL may

consider lending at least up to Nu 500,000 to individual without any tangible collateral.

5.5 STRATEGY FOUR - PROVISION OF BUSINESS DEVELOPMENT SERVICES TO CSIs

TO PROMOTE RURAL CREDIT: The credit to the CSI sector is an important component of

the rural finance offered by the financial sector. The Government believes that the CSI

sector is the engine of growth and hence the sector growth is essential for an inclusive

economic growth. Although, the CSI sector accounts for nearly 95% of the country’s business units, it has received only 14% of the total credit of the Banking sector.

Entrepreneurial skills in Bhutan is still at very low level A recent report states that most of

the entrepreneurs in Bhutan are “necessity based” entrepreneurs and not “opportunity based’ based entrepreneurs. There is a great need to improve the entrepreneurship in

Bhutan, Several Government and NGO organizations have launched several programs aimed

at improving entrepreneurship in Bhutan. Ministry of Human Resources and Labor under its

Entrepreneurship and Self-Employment Division, Loaden Foundation, Druk Holdings and

Department of Cottage and Small Industry provide some BDS services to CSIs. The Cottage

and Small Industry Policy Paper 2019 of the Department of Cottage and Small Industry

(DCSI) emphasizes the need for provision of support services to CSIs. Although, these

institutions are engaged in providing different types of BDS Services, to improve the

entrepreneurship, Bhutan needs an entity to provide comprehensive package of Business

Development Services under one roof or there is a need for “one Stop Shop”. The growth in

the CSI to a large extent depends on the availability of professional Business Development

Support (BDS) services. Almost all CSIs require professional BDS services to sustain and grow

their businesses as most CSI entrepreneurs are not conversant with all aspects of business

management The types of BDS Services required by the CSI sector includes, inter alia, the

following:

➢ Entrepreneur skills training

76

➢ Access to markets

➢ Provision of infrastructure such as storage& warehousing, incubators

➢ Sourcing of raw materials

➢ Information on Markets and technology

➢ Assistance in identifying viable business opportunities

➢ Preparation of Business Plans

➢ How to face competition

➢ Assistance in selecting appropriate technology

➢ Training and mentoring

➢ Book keeping

➢ Assistance to understand legal issues and

➢ Assistance in Human Resource Management.

Lenders require BDS Services to their clients to ensure their smooth functioning which will in

turn help lenders in regular recoveries of loans. BDS interventions at the micro firm level can

lead to enhanced economic security and incomes thus permitting micro entrepreneurs to

invest in nutrition, housing, health and education of family members. Discussions with CSI

entrepreneurs and bankers revealed that the status of BDS services at present is not at a

desired level and it needs improvements. Considering the very high level of NPLs of BDBL

and REDCL and also considering the need to improve their rural outreach, BDBL and REDCL

consider commencing a BDS Services program particularly for its existing and future clients

and in general to the business community in Bhutan. BDBL and REDCL have three options to

commence BDS program. These three options are;

Option One: Set up a separate business unit within the organization and operate it as a fee

levying service

Option Two: REDCL and BDBL to get together and set up a joint entity and operate the joint

entity as a fee levying service

Option Three: BDBL, REDCL to team up with DCSI and set up joint public sector entity and

operate the joint entity as a fee levying sustainable entity.

The Consultant’s preferred option is Option Three. The government may negotiate a

Technical Assistance (TA) support facility from a multilateral development agency to setup a

“one stop shop” to provide BDS services to CSIs. In other countries, BDS services are either done by governments or by public private partnerships or entirely by the private sector on

sustainable basis. In establishing the BDS Service entity on a sustainable basis, the following

factors are to be kept in mind:

i. Necessity for targeting through a market assessment

ii. Necessity for a predominantly rural development approach

iii. The necessity to operate the program on sustainable basis

77

iv. The necessity use high quality human resources with private sector mentality for BDS

facilitation and delivery

v. Necessity to have system to monitoring and evaluation of the results of BDS that

have been delivered.

In order to motivate BDBL customers to seek the BDBs services, a subsidy on the rates to be

charged is to be offered to BDBL customers and the Bank to educate its customers on the

benefit of BDS Services. The BDS Services to deserving clients are to be provided free of

charge initially and then at a subsidized rate. Once the confidence of beneficiaries is build up

BDS services are to be provided at market rates,

5.6. STRATEGY FIVE - IMPROVING CREDIT APPRAISAL SKILLS: Inadequate skills among

the credit officers in credit appraisal appear to be one of the main reasons of high NPL. Skills

Gap Analysis carried out on credit staff of BDBL also reveals that there is a need to improve

the credit skills of BDBL staff. Most of the credit officers of BDBL have no experience and

training in cash flow based lending. It was observed that most of the borrowers have

defaulted on their loans due to cash flow difficulties. At present, the credit staff consists of

76 credit officers and 112 credit assistants. Only very few of them have undergone

professional credit training programs. Most of the SME clients financed/to be financed by

BDBL do not maintain proper books of accounts and also do not make financial statements

such as profit and loss statements and balance sheets. The proper training to credit officers

could prevent to a great extent the “adverse selection” of borrowers and future NPLs. A proper training program based on 5Cs approach is to be carried out by a professional trainer

with practical experience in banking. The classroom training is inadequate to properly train

lending officers and the trainer should also provide on the job training to credit officers

working with them through the entire loan initiation process working with them on actual

loan applications. The services of a professional banking trainer would be required for a

period of around one year. BDBL may consider obtaining TA assistance from a development

agency to finance cost of the training program. An outline of a suggested training program

based on 5Cs is given in ANNEXURE 05.

5.7. STRATEGY SIX - PROVIDING BETTER DOCUMENTARY GUIDELINES ON CREDIT

APPRAISAL: Proper written guidelines/formats to be used in and credit appraisal are

required to ensure the quality of credit appraisal. Although the Credit Manual of BDBL

mentions about 5 Cs approach in credit analysis, no evidence was available to confirm that

credit officers use the 5Cs approach in practice. The examination of a representative sample

of credit appraisal reports reveal several information gaps such as analysis of past

performance of applicants of existing businesses, computation of project cost, computation

of working capital cycle, verifications of assumptions used in projections and market

assessment. In order to guide the credit officers on what information they should collect

before taking in hand the credit appraisal and also to guide them on areas and aspects to be

covered in the appraisal report, it is essential to use a proper and comprehensive appraisal

78

formats. Depending on the loan size, two to three different forms and formats could be

used. Although the current appraisal formats for microfinance loans up to about Nu 500,000

are adequate, this format for loans above 500,000 where more depth of analysis is

required may not be adequate. A format suggested credit appraisal format mainly based on

5Cs approach is given in ANNEXURE 06. BDBL could simplify the format for smaller loans.

5.8 STRATEGY SEVEN - INTRODUCING CREDIT RISK MANAGEMENT TOOLS AT LOAN

ORIGINATION: The credit risk management is to be done at all stages of the “lifecycle” of

a loan. The first stage of the lifecycle of a loan is loan origination. The credit risk

management should start here. The Proper and scientific selection of borrowers at the

application stage is essential to prevent selecting potential defaulters. Most banks adopt

credit risk rating systems for the preliminary screening to eliminate risky potential

defaulters. Introducing a comprehensive risk rating system to identify good borrowers

would help in reducing future NPLs. The following risk rating system is recommended for

adoption by BDBL to be used as a credit risk rating tool at the time of loan origination. It is

proposed to adopt two risk rating systems, one for existing businesses and the other for

start-ups. The risk rating system proposed for BDBL consist of two broad risk categories and

five risk grading. Two broad risk categories are quantitative and qualitative. The weightages

given to these two categories are 60 points out of a total of 100 points for quantitative risk

category and 40 points for qualitative risk category. The number of points to be given for

qualitative factors will largely depend on the lending officer's judgments and this can be

highly subjective.

Most of the borrowers of BDBL will not have formally prepared financial statements.

However, they will have some records indicating the operational and financial performance

of their businesses. During the credit appraisal, credit officers are required to construct

profit and loss statements and balance sheets for potential borrowers who do not have

financial statements. The calculation is based on financial statements submitted by the

client or constructed by the BDBL credit officer for a period of at least two years.

Scoring/points recommended for each performance indicator is shown below.

Criterion Maximum Points

a) Type of financial accounts provided 5

b) Growth in turnover 5

c) Growth in GP/Sales Ratio 5

d) Growth in NP/Sales Ratio 5

e) Growth in Profit before tax 7

f) Current ratio 7

d) Debt: Equity ratio 5

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e) Debt service cover ratio 8

f) Repayment record (As per CRIB) 8

g) Account/facility conduct 5

Total 60

Qualitative: Assigning of points for qualitative aspect of the business is to be done jointly by

the Branch Manager and the Branch Credit Officer based on their judgment.

Criterion Maximum Points

a) Industry - Current position

- Future prospects

5

5

b) Market position of the firm 10

c) Management 10

d) Business history 10

Total 40

Based on the above risks rating system, it is proposed BDBL adopts the following risk grades.

Based on the above scores, the credit applications received from the potential borrowers

will be assigned one of the 6 risk grades described above, depending on the risk profile of

each potential borrower. Credit applications rated first four risk grades (AA, A, BB, and B)

will be accepted for further processing and credit applications with other two risk grades (D

and C) will be rejected. Category C and D will be used only to transfer loans after annual

review. The recommended format with the explanatory notes for risk rating of potential

borrowers is given in ANNEXURE 07 and ANNEXURE 07 (A) respectively.






C 50-59 Less than average quality

D >40 lowest quality

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Risk rating system for start-ups: The risk rating system can be used only for existing

businesses. BDBL also finance start-ups and therefore there is a need for a different risk

rating system to risk rate the credit applications from the start-ups.

The risk rating system recommended above is not suitable for start-ups and hence a

different format to be used for start-ups. The risk elements to be included in the proposed

risk rating for start-ups include the followings

1. Strengths of Promoters

2. Project Risk

3. Management/Directorate

4. Debt: Equity on Completion

5. Industry Status

6. Marketing Arrangements

The suggested Risk Rating Format with explanatory notes for the Start-ups is given in

ANNEXURES 08 and 08 (A) respectively.

The proposed risk rating systems will have six grades. The suggested six grades and range of

points for each risk grade are given below:

Only the prospective borrowers rated AA, A, BB and B will be considered for granted loans.

Category C and D will be used only to transfer loans after annual review.

5.9. STRATEGY EIGHT - IMPROVING LOAN SUPERVISION: Lending portfolio of BDBL is

highly infected. The PAR >30 days was 42.9% and the > 90 days was 31.58%. One reason for

high infection ratios is the very high ratio of number of loans per loans officer. Higher

number of loans per loans officer make it difficult for loans officers to monitor the post

disbursement performance of borrowers. Less supervision may result in misuse of funds and

relaxing the need to service loans by borrowers enhancing the possibility defaults. According






C 50-59 Less than average

quality

D <40 Lowest quality

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to guidelines of Consultative Group to Assist poor (CGAP), the apex body for MFIs, the ratio

should be around 350 to 400 per loans officer. In South Asian Countries the ratio was 400 in

2012. These norms are not applicable or relevant to Bhutan due to very high distance in

between clients and between branch offices and clients. The credit function of BDBL is

managed by 76 credit officers and 112 credit Assistants. Credit officers are responsible for

loan initiation, approval, disbursement, loan supervision and recoveries. Credit assistance

helps the loan officers in performing the above duties. If only loans officers are considered

as responsible for above activities, the number of loans per loans officer works out to be

725 which is very high in terms of any norm. If credit assistants are also considered, the ratio

works out to be 289. It was observed that credit files are distributed unevenly. Some officers

handle around 700-800 files while some handles much less than that. Considering the

distance in between clients and the distance between the branch and the client, both above

ratios seem highly excessive. Taking the loans officers and Credit Assistants as one group,

more realistic ratio of 200-250 loans per officer is recommended as part of the strategy to

improve the loan supervision and reaching to new clients. The suggested number is based

on the views expressed by the officers involved in credit. A mechanism is required to review

the number of loans per credit officer at regular intervals and make necessary adjustments

to maintain the ratio suggested. The current ratio of Loan files per Loan officer is given in

ANNEXURE 09.

5.10. STRATEGY NINE - DIVERSIFYING FUNDING BASE: The profitability of BDBL has

been declining over the period. One of the main reasons for the declining profitability is the

increasing cost of interest as a percentage of Gross Interest Income of BDBL. The cost of

interest as a percentage of gross interest income has continuously increased from 49% in

2014 to 68% in 2018. This ratio for the entire banking sector was 43% in 2014 and 45% in

2018. While the ratio of BDBL has increased by 19% during the five year period under

review, the ratio of the banking sector has increased only by 2%. The funding for the lending

of BDBL has come entirely from the customer deposits. The credit to deposit ratio of BDBL

had been 94.29% (as per old GAAP). When compared with other commercial banks, BDBL

appears to be experiencing difficulties in mobilizing deposits at comparable rates with other

commercial banks. At present BDBL have no outside borrowings like other development

banks in developing countries at concessionary rates of interest. Being a development bank

catering mainly to CSIs and rural farming households with an average loan size of around

US$ 58,000, BDBL would be in a strong position to mobilize funding from multilateral

development agencies such as the World Bank, Asian Development Bank, KfW (a German

development agency, FMO (a Dutch development agency), Japan Bank for International Co-

operation and from other socially oriented international investors. BDBL should make a

concerted effort together with the Government to generate funding from the sources

mentioned above at concessionary rates. Most of these lenders and investors extend

funding in foreign currency and the exchange risk could be managed by adopting a proper

hedging mechanism.

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5.11. STRATEGY TEN - IMPROVING FINANCIAL LITERACY OF CLIENTS: Out of about

54,000+ clients of BDBL only around 70 clients are corporates and the majority of the

balance is rural based CSIs and rural households. Although, the corporate clients are capable

of managing its finances, the rural clients are not capable of doing so. BDBL needs to

consider providing two types of financial literacy programs to its clients; one is the financial

literacy training for potential borrowers under its Group Lending Program which is

mandatory. Even at present, BDBL provide this training. One of the reasons for better

quality of the group lending portfolio is the provision of financial literacy training. However,

the percentage of borrowers falling under this category is just around 3% of the total

borrowers and percentage of corporate clients is even less than 1%. The BDBL at present

does not provide the larger percentage of rural borrowers who do not fall either in to Group

Loan category or corporate loan category. Financial literacy of Bhutanese entrepreneurs,

particularly, among MSME entrepreneurs is very low and most of them are financially

illiterate. To remedy this issue RMA has setup a separate secretariat to be responsible for

promoting financial literacy among entrepreneurs. Since MSMEs are playing an important

role in the economic development of any nation, the success of such enterprises is essential

for the economic growth. The success or otherwise of a MSME would depend largely on the

financial literacy level of the owner of the business. Low financial literacy among

entrepreneurs result in high number of business failures and also a large number of loans

taken by them falling in to NPL category. The financial literacy of an entrepreneur is

measured in terms of the entrepreneurs’ understanding of basic financial concepts such as interest rates, Compound interest ,Inflation, risk diversification, his knowledge in legal and

regulatory matters, record keeping ,budgeting and his skills in raising funding from outside

sources at minimum cost. When lending to microenterprises by MFIs, they make it a

prerequisite that potential borrowers should undergo a two to three day financial literacy

training program. MFIs in Bhutan follow this practice in providing financial literacy

programs for micro entrepreneurs. Financial literacy programs provided are in two parts;

first part is class room training provided prior to lending and the second part during the

operation of the business which is known as “mentoring”. It is recommended that BDBL

develop a financial literacy program and mentoring program for its MSME individual

borrowers. Undergoing this training program may be made a pre-requisite for borrowing

from BDBL. The main topics, inter alia. That should be covered in a trading program would

be:



➢ Building assets



➢ Earning money



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Experienced credit officers could conduct training programs to potential borrowers covering

the above topics.

5.12. STRATEGY ELEVEN - CHAINGING TERMS AND CONDITIONS REALATING TO

PRICING AND SECURITY (COLLATERAL): The Minimum Lending Rate (MLR) for the

banking sector is determined by the RMA and the banks are free to determine their lending

rate taking in to account other factors. Assets and Liability Committee (ALCO) of BDBL is

responsible for deciding the lending rate of the Bank. The lending rate of a bank generally

depends on its cost of funds. The average cost of funds of BDBL is relatively higher when

compared with other banks resulting in higher lending rates. As almost all lending of BDBL is

out of deposits, the lending rate would ultimately depend on the rates the Banks pay on its

deposits. It is observed that the average rate paid by BDBL on its deposits is relatively higher

than the rates paid by other banks. Another issue related to pricing of loans faced by BDBL is

the ignoring risk profile of the borrower, size of the loan and relative loan administrative

cost. Business borrowers of the BDBL could be broadly categorized as micro enterprises,

cottage industries, small industries and Corporates. Risk profile of individual customers in

each category and also the risk profile of different customers in each group are different.

Pricing of a loan should be linked to the risk profile of the borrower and administrative cost

of the loan. It is pertinent to mention here the principle of “high risk high return and low risk low return” which is practiced by lenders and investors all over the world. Further, the size of the loans to customers under each category is also different. Loans granted to

micros, cottage enterprises and small enterprises would be relatively smaller than the size

of loans granted to medium and large enterprises. Large loans will generate a higher income

to the lender than the income generated from smaller loans. However, the administrative

expenses incurred in originating and managing a loan would almost be similar irrespective

of the size of the loan. Therefore it is justifiable to charge different rates from different

categories of borrowers and on different sizes of loan categories. All borrowers of BDBL are

currently charged the same rate (with marginal concessions of 1-2% to some priority

sectors) of interest decided by ALCO irrespective of the risk profile of the borrower and size

of the loan. The ALCO proposes the rate to the Board and the final decision is taken by the

Board also taking in to account political aspects of the decision. If the proposed risk rating

system is adopted by BBDL, a risk-based pricing system could be followed by BBDL. The

Minimum Lending rate of BDBL at present is around 8.8% while the average lending rate is

10.4%. The lending rates of banks where rates are not regulated by the regulator will largely

depend on cost of funds of respective banks. In Bhutan, the funds for lending by banks,

including BDBL comes mainly from deposits and hence cost of funds will mainly consist of

rates of interest paid on deposits. The consultant recommends that BDBL adopts the risk

based pricing system and a realistic rate on smaller loans particularly on Group Loans

adequate to cover its admin cost. Group loans should be at around 24% per annum. This is

the rate charged by MFIs (other than REDCL) in Bhutan. The rates charged by BDBL at

present are given in ANNEXURE 10.

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For the purpose of obtaining security, the loans granted by BDBL are divided in to two

categories namely Individual Loans and Group Loans. The Credit Manual of BDBL clearly

states that all individual loans granted by the bank should be against the “mortgage of

collateral”. Group loans are grated to members of a group against the cross guarantees of

the other members of that group. During the 5 ½ year period (January 2014 to June 2019),

the number group loans granted amounted only to 3.79 1.42% of the loans granted

representing only 1.42% of the total loans granted. This indicates that 96% of the loans

approved during the last 5 ½ years are against tangible collateral. The lending manual

provides guidelines on valuation of assets taken as security. Valuation methodology

prescribed is very restrictive. The dependence on tangible collateral for a development bank

in a country where security in the form of immovable property is not abundantly available

certainly restricts its outreach. The solution for this may be the relaxation of security

requirement and/or substantially increasing the group lending.

5.13. STRATEGY TWELVE - RELAXING TERMS AND CONDITIONS OF LENDING: As

practiced by all banks internationally, BDBL too grant loans subject to certain terms and

conditions. These terms and conditions are to ensure the proper use of loan proceeds and

regular repayments of loans. The Main categories of terms and conditions relate to the

following aspects:

i. Security-All individual loans are granted against tangible security. BDBL is to

abide by the RMA guidelines on Loan to Value (LTV) ratio. LTV varies according

to the type of the asset. Currently the ratio varies from 50% to 90%. While the

LTV on fixed deposits is at 90 %, the LTV on securities and corporate bonds is

50%, the LTV on immovable property value of which is always estimated

conservatively is 75%

ii. Insurance: All assets to be mortgaged should be insured

iii. Debt: Equity: All borrowers are required to share the risk of the business by

contributing a percentage of the investment of the business in the form of equity

capital. The maximum debt equity ratio to be maintained on all lending is 75:25.

However, this ratio will vary within the maximum limit depending on the risk

profile of the borrower and the risk profile of the business to financed

iv. Repayment Terms: Some loans like overdrafts are revolving and some are (term

Loans) are with a fixed repayment period and a fixed repayment schedule. Term

loans will carry repayment periods ranging from 12 months to 20 years

depending on the purpose of the loan and the cash flow of the borrower.

v. Rate of Interest: For different types of loans the ALCO decides the rate based on

the Minimum Lending Rate determined by RMA. Different industry sectors and

different types of loans and different loan schemes will have different rates but

the difference would be very marginal and the difference will vary from 1% to

2%. Interest is calculated on reducing balance basis

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vi. Types of Installments: Installments on term loans are in the form of Equated

Monthly Installments payable monthly quarterly half yearly or yearly

Some of the above terms and conditions appear too strict and restrictive preventing the

enhancement of rural outreach of BDBL. Of the general terms and conditions applicable for

loans, the Bank needs to consider making some changes to the following term and

conditions:

i. Non-Collateral based Loans: Lack of collateral is one of the main reasons for low

rural outreach as most rural CSIs and households cannot offer tangible collateral

to obtain loans from financial institutions. It is recommended to consider

granting Loans at least up to Nu 500,000 without “mortgage of Collateral”. Loans

up to a limit say Nu 500,000 mn to be granted purely on the basis of cash flows

and risk rating and also against the guarantee of two acceptable individuals.

Individual loans similar to group loans.

ii. Lowering of Debt: equity for micros and Cottage Industries: One of the problems

faced by the potential borrowers in the rural areas in sourcing of equity/venture

capital required by lenders to maintain the minimum debt: equity requirements.

It is recommended that BDBL consider either reducing e the ratio to around

80:20 or 90:10 for CSI s or introduce a product to offer venture capital/seed

capital to CSIs. Venture capital is a product offered by development Banks

internationally

iii. Interest Rate: Introduce the risk based pricing depending on the risk rating of the

clients.

iv. Higher rates of Interest on Smaller individual loans and group loans to be

introduced as the administration cost of such loans are relatively high. MFIs who

are handling group loans and loans of smaller amounts charge around 2% per

month. BDBL charges same rate for big corporates and micros.

BDBL needs to hire an experienced consultant or a team of consultants for a period of

around one year to conduct classroom training and on the job training on cash flow

based lending and to develop forms and formats on its new lending programs including

leasing and group lending

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6. PART FIVE – STRATEGIES PROPOSED FOR REDCL

6.1. INTRODUCTION: Rural Enterprise Development Corporation currently operates as a

Non Deposit-Taking Microfinance Institution (MFI) licensed by RMA. Its current mandate is

to enhance the credit outreach of the rural informal activities. During its existence of 30

months from June 2016 to December 2018, rural credit outreach was achieved by REDCL

with 20 branch offices and eight credit officers at Head Office, which seems very low. It has

reached only 3,744 clients representing only around 10% of the total CSI Sector even though

it was authorized to lend free of collateral and at a relatively low rate of interest of 4% per

annum. The number of loans created per officer was only 4.5 and number of loans per credit

officer is only round 130. REDCL is in a better position to lend to CSIs as it is authorized to

lend without collateral at very low interest of 4% when compared with other financial

institutions who are lending based on collateral and at relatively high interest rates of

around 8-10%. The 4% interest margin allowed on lending by REDCL is not adequate to meet

its operational expenses and impairments on NPL portfolio which is at around 15%. REDCL is

therefore operating at loss from its inception. The business model followed by REDCL at

present is different from the business model followed by MFIs internationally whose

strategy is based on achieving “double bottom lines”. REDCL at present focuses more on “Social Bottom Line” ignoring the “Financial Bottom Line. The business model followed by

REDCL is not financially feasible and without the financial feasibility, the long term

sustainability is in doubt.

6.2. STRATEGY ALREADY PROPOSED BY THE GOVERNMENT: Realizing the need to

ensure long term sustainability of REDCL, the Government has instituted legislation for

upgrading of REDCL to a CSI bank under the name of “National Enterprise Development Bank”. With the upgrading of the REDCL to a CSI bank, it will change its business model and

function as a bank focusing on achieving financial sustainability while fulfilling its social

responsibility. Main features of the future strategy of the new CSI bank are highlighted

below:

• The core mandate of the Bank is to enhance access to financing and diversify the

economic growth through the promotion of cottage and rural enterprises. The Bank

will also have provisions to support and oversee employment financing.

• The Bank is expected to narrow the gap in availing financial support for start-up

enterprises which otherwise face difficulties in availing loans from other banks due

to their inability to offer collateral.

• At present, REDCL grants Microfinance loans only up to Nu 500,000. With the

upgrading, the CSI Bank will grant loans from Nu 500,000 to Nu 10.0 Mn.

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• There is a need to develop a credit and operational manual which will clearly lay

down the procedures on loan administration, disbursement, risk management

monitoring and recovery mechanism.

• The total fund requirement is estimated to be around Nu 816 Mn over the next six

years assuming an average principal recovery rate of 78.09%.

• The lending rate will be aligned with minimum lending rate determined by RMA as

required by the Rules and Regulations of CSI Banks (2018) and the initial rate would

be in the range of 5% to 8%.

• Initially, the Bank will use “Drukmicrofin” IT system developed by Maximus (India) and RMA and tailor made for MFIs and CSI banks.

• The new Bank will take into its books only clean and regular RF I and RF II portfolios.

NPL portfolios of both RFI and RFII will be managed by the Bank treating them as “off balance sheet” items. As and when these NPLs are recovered, those will be

transferred to the books of the Bank.

• Not like REDCL, the CSI Bank will finance both start-up businesses as well as existing

businesses which intend to expand and grow.

• CSI Bank will recruit initially 20 more staff to strengthen the existing staff of 36.

• The CSI Bank expect to achieve the following targets during the next five years

i. Self-sustaining and generating profits by the sixth year

ii. To finance about 75% of the CSI sector

iii. De-linked branch offices from Dzongkhag administration and set up

independent offices in all 20 Dzongkhags

• Parameters of loan products to be offered are as follows:

6.3. ADDITIONAL STRATEGIES SUGGESTED FOR IMPROVING THE PROPOSED

STRATEGY: The strategy that has been proposed by the Government seems adequate to

change the business model of REDCL. However, there is room for further improvement. The

following paragraphs suggest few strategies that would strengthen the strategy that has

been proposed by the government which has been described under Para 6.2 above.

6.3.1. Strategy One - Improvements to the Lending Policy Manual: The proposed Lending

Policy and operational manual should be done by a Professional Consultant or team of

Product % of Finance Maximum Tenor Collateral

Agriculture Development 100% 5 yrs. Guarantor

Cottage Industries 75% 10 Yrs. Project assets

Small Industries 75% 10 yrs. Project assets

Overseas Employment loans 75% 05 yrs. Guarantor

Non-Seasonal products 75% 10 yrs. Assets + Guarantor

Seasonal Products 75% 01 Yr. Guarantor

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consultants who should have senior level practical experience in SME/CSI Financing. The

document should cover steps to be followed at different stages of the loan life cycle and all

necessary forms and formats required for microfinance and SME lending. Two

comprehensive appraisal formats based on 5Cs methodology, one for microfinance and the

other for SMEs is a necessity to improve the quality of lending.

6.3.2. Strategy Two - improving skills of credit officers on cash flow based lending: The CSI

bank will not base its lending decisions on collateral but on cash flows. Hence, the credit

officers should have high skills in cash flow based lending. Inadequate skills among the

credit officers in credit appraisal appear to be one of the main reasons of high NPLs. It was

observed that most of the borrowers have defaulted on their loans due to cash flow

difficulties. At present the credit staff of REDCL consists of 20 field officers and 8 credit

officers at Head Office. Field officers collect applications and submit to Head Office and

Credit officers at Head office carry out the appraisal. Most of the SME clients financed/to be

financed by REDCL do not maintain proper books of accounts and also do not prepare

financial statements such as profit and loss statements and balance sheets. The proper

training to credit officers could prevent to a great extent the “adverse selection” of borrowers and future NPLs. A proper training program based on 5Cs methodology is to be

carried out by a professional trainer with practical experience in banking. The classroom

training is inadequate to properly trained bankers and the trainer should also provide on the

job training to credit officers working with them through the entire loan initiation process

working with them on actual loan applications. The services of a professional banking

trainer would be required for a period of around one year. An outline of a cash flow based

lending training program is given in ANNEXURE 05.

6.3.3. Strategy Three - Introducing Credit Risk Management Tools at Loan Origination:

REDCL experience very high NPLs. If the new bank is to archive self-sufficiency in six years, it

is imperative that the new bank should introduce measures to control its credit risk at all

stages of the lifecycle of the loan. The credit risk management is to be done at all stages of

the “lifecycle” of a loan. The first stage of lifecycle of a loan is loan origination. The credit

risk management should start here. The Proper and scientific selection of borrowers at the

application stage is essential to prevent selecting potential defaulters. Most banks adopt

credit risk rating systems for the preliminary screening to eliminate risky potential

defaulters. Introducing a comprehensive risk rating system to identify good borrowers

would help in reducing future NPLs. Introduction of a risk rating system by REDCL at least for

loans above Nu 500,000 is recommended. Comprehensive two risk rating systems, one for

existing businesses and the other for start-Ups, have been described under Para 5.4 of this

report. REDCL should consider adopting these systems as measures to control credit risk at

the stage of loan origination. A risk rating format for risk rating of existing businesses

together with the guidelines how to use the format are given in ANNEXURES 07 and 07 A

respectively. This risk rating format is not suitable for start -ups; a separate format has been

developed for start-Ups. The format to be used in risk rating of start-ups and the guidelines

on how to use the format are given in the ANNEXURES 08 and 08A respectively.

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6.3.4. Strategy Four - Introducing of New Products –Group Loans: Although REDCL has

been offering group loans on a selective basis; the product has not been properly marketed

and offered. The lending under the group lending scheme had been very marginal. It was

observed that the quality of the group lending portfolios including that of BDBL is much

better than that of the collateralized individual loan portfolios. This clearly shows that group

lending is of high quality and REDCL should actively promote and pursue group lending.

Some guidelines to launch the group lending in an organize manner are given in ANNEXURE

13. It is recommended that REDCL consider appointing a group loan Unit in the Head Office

officer to monitor the performance of group lending and each branch be given targets on

the number of group loans to be granted from that branch. It is also necessary to re-launch

the product through a proper marketing campaign. All project officers are to be provided

with a proper training on group lending. Each branch is given a target of forming at least

four groups per annum per branch. As the admin cost of group lending is high, REDCL may

consider charging a rate of around 18% on group loans. The membership of such branches

should be opened to any member of the community. REDCL should consider using its group

lending program to promote access to finance by the vulnerable groups of the community

such as women and unemployed youth.

6.3.5. Strategy Five- Lending to Women Groups: As a group, women in Bhutan are at a

disadvantages position when compared with men. According to the data of the National

Statistical Bureau of Bhutan, the total population of the country amounted to 763,094

(2017) of which women accounted for 47.85%. The national Literacy rate (2017) was 71.4%

and women literacy rate was below the national average and in 2017 it was at 63.9%.

According to the 16th Labor Force Survey Report (2018), the national labor force

participation (economically active population 15 years and over) rate of the country was

62.6% while the labor force participating rate of women was 55.5% while the rate for men

was 70.1%. The total economically in-active population (2017-National Statistics Bureau)

was 185,694 and of which 64.47% was women and 38.8% were men. 64.47% of adults

in Bhutan have a savings account with a bank, 56 % of which are male and 44% are female. Similarly,

of the 16% of adults who have access to credit, 54 percent are male and 46 percent are female. Of

the 17% of adults who have insurance, 59%t are male and 41% percent are female. The above

statistics clearly indicates that as a group women are in a disadvantage position and there is

a need to initiate some measures to narrow the economic gaps between men and women.

In order play a role in promoting economic activities of women, it is recommended that

REDCL make use of its proposed group lending scheme to provide access to credit to women

micro entrepreneurs. As mentioned above, branches are to be given a target of forming at

least four groups per branch per annum. REDCL should make it mandatory that of the 4

groups to be formed per branch per annum the initial year, at least one groups should be

exclusively for women. If the average group size is four members, this will help 80 women

entrepreneurs to access credit. A reduction of 2% to 3% on the rate of other group loans is

to be considered for group loans to women to encourage women entrepreneurship.

6.3.6. Strategy Six- Lending to Unemployed Youths: Another vulnerable group in Bhutan is

youth of the age group of 14-24. This group accounts for18.40% of the population (2017)

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and the literacy rate of the group is as high as 93.1% when the national literacy rate is

71.4%. While the national unemployment rate of the country in 2017 was 3.4%, the

unemployment rate among youth has been 15.7%. Most of these unemployed youth are

with high educational qualifications. Of the total youth unemployment 37.1% has completed

secondary higher education followed by middle secondary 29.3 % and bachelor degree 19%.

Most educated youth seek employment in the public sector where the job opportunities are

limited. The unemployment among youth is a serious social and political issue and youth

unrest is a threat to political stability. A remedy is urgently required. Creating opportunities

for self-employment is desirable as a solution to youth unemployment. REDCL could get

involved in this process through its proposed group lending scheme. It is recommended that

REDCL make it compulsory that each branch should form at least one group exclusively for

youth per annum for youth to commence businesses. On this basis, at least 20 groups per

annum could be formed through the 20 branches. Providing collateral free credit with easy

access would motivate unemployed youth to commence business ventures. The rate

applicable to group loans to youths could be reduced to from the rate charged on normal

group loans.

6.3.7. Strategy Seven - Introducing New Products to Improve Rural Credit: Another way of

increasing the rural credit outreach is to introduce new fund based and fee based financial

products, in addition to the credit products the REDCL offers at present. A brief description

of proposed is given below:

6.3.8. Strategy Eight - Leasing Equipment and Vehicles: Equipment Leasing for CSIs, vehicle

leasing for public transport, personal use and industrial use. This product is attractive

particularly to rural households who cannot offer immovable assets as collateral to borrow

from banks. Lease is an agreement between two parties whereby one party allows the other

party to use his/her asset for a certain period of time in exchange for a periodic fee. The

assets covered in leases are usually movable assets such as plant& Machinery, vehicles,

Aircraft and ships. The receiver of an asset under a lease agreement is called the “Lessee” and the owner of the asset is called the “Lessor”. A lease is a legal contract and thus

enforceable by all parties under the contract law. There are basically 3 types of leases.

➢ Finance Leases: a long term lease where the ownership of the leased asset transfers

to the lessee at the end of the lease period at a nominal price. All risks and rewards

incidental to the ownership of the asset are with the lessee.

➢ Operating Leases: a short term lease where the lessor retains all risks and rewards

incidental to the ownership of the asset. Lessor retains the ownership at all times.

This method of leasing is mainly used for the acquisition fleets of vehicles.

➢ “Sale and Lease back” Leases: this is a variation of the finance leases with almost all features of a finance lease. Sale and lease back is a financial transaction where one

sells an asset and lease it back for a long term paying a periodic fee. Existing

businesses with unencumbered fixed assets can borrow from banks for their working

capital requirement through this method of leasing

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6.3.9. Strategy Nine - Leasing for high-end consumer durables for rural households with

regular or seasonal incomes: It is a sign of economic development that more and more

households purchase consumer durables to improve the living standards of the households

and to change the life style of people. The consumer durables consist of durable goods and

appliances for domestic use such as refrigerators, air conditioners and washing machines. Products

that aren't consumed or quickly disposed and goods that could be used for several years

are durable goods and also called hard goods. Consumer durables are also grouped under three

categories namely white goods, Brown goods and consumer electronics. White goods are

Refrigerators, Washing machines, Air-conditioners, Speakers and Audio equipment. Brown

goods are Mixers, Grinders, Microwave ovens, Iron, Electric fans, Cooking range Chimneys,

Consumer electronics are Mobile phones, Televisions, MP3 players, DVD players and VCD

players. As most of the leases of consumer durables would be” small ticket leases”, REDCL

could consider simplifying the approval procedure and introduce a simple credit scoring

system to screen the applications for leases for consumer durables. Guidelines for the Credit

Scoring system for leasing of vehicles and consumer durable leases are given in ANNEXURE

14.

6.3.10. Strategy Ten - Venture capital/Seed capital for sustainable CSIs who are

experiencing shortages of equity capital: One of the main impediments for the growth of

the SME sector in developing countries is the lack of risk capital or the seed capital. Venture

capital by banks could be provided only to limited liability companies and banks could

encourage their potential customers to carry out their businesses under limited liability

framework. If the client of BDBL who is in need of funding is a limited liability company, the

BDBL has two options in providing venture capital. One option is to invest in ordinary shares

like the owners of the business sharing risk and return equally with the owners. Most banks

in their venture investments prefer to reduce the risk with a guarantee of a minimum

return. The mechanism to reduce the risk and ensure a minimum return is to invest in

Redeemable Cumulative Preference Shares with a fixed Coupon Rate. This is a hybrid

venture capital product with features of debt and equity. Risk to the investor is relatively

less than that of the ordinary share investments. The advantages of Preference share

Investments to SME investee companies are threefold. First, Investee SME will start paying

dividend only from the time of it starting to generate profits and hence particularly start-up

SMEs will have a less financial burden during the initial years. Second, no need for collateral

which is one of the serious problems faced by SMEs world over. Third, in computing debt:

equity of the business, preference share investment is treated as part of equity.

Procedure to be followed in making venture investments for Investment:

➢ The investment is subject to a detail appraisal of the project

➢ The appraisal officers need to identify an equity gap based on the appraisal and

justify the need for institutional investment

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➢ Restricted only for companies with very high growth potential and the promoters to

be with undisputed integrity.

➢ The Bank to get the Articles of Association of the investee company amended

specifying the rights and privileges of the Bank’s share investment. ➢ Reserve the right to appoint a nominee director.

6.3.11. Strategy Eleven - Wholesale loans to sustainable MFIs through credit lines: REDCL

is to expand its rural outreach as the financially excluded percentage in rural areas is very

high. The credit outreach in the country is only 16%. Rural finance institutions and banks

interested in getting involved in rural finance adopt two strategies to enhance their credit

outreach in rural areas. One strategy is to lend direct to rural entrepreneurs and needy

households and the other strategy is to lend to rural entrepreneurs and rural households

through MFIs. BDBL at present follow the direct lending strategy. It is recommended that

BDBL also consider following the second strategy too providing “wholesale” loans to MFIs for on lending to micro entrepreneurs. Microfinance sector in Bhutan is at its early stage of

development RMA has issued license to six MFIs. These institutions are RENEW, Bhutan

Association of Women Entrepreneurs (BAOWE), Taranaya Foundation, Bhutan Care Credit

(BCC), Microfinance Bhutan Private Limited and Rural Enterprise Development Corporation

(REDCL). For the purposes of regulating, MFIs are categorized in to two groups namely

deposit taking and non-deposit taking. Only RENEW and Microfinance Bhutan Private

Limited has the license to take deposits from the general public and others are involved only

in micro lending. The Consultant visited and had discussions with senior management of

three MFIs namely RENEW (Stands for Respect, Educate, Nurture, and Empower Women),

BAOWE (Bhutan Association of Women Entrepreneurs) and BHUTAN MICROFINANCE

PRIVATE LIMITED (BMPL). It was observed during the discussions with these three MFIs and

that they have sustainable operating models. Except RENEW, all other MFIs are constrained

by lack of funding to expand their operations. It is recommended that BDBL initiate actions

initially to work with these three institutions. All these MFIs are undertaking Group Lending.

In undertaking whole sale lending to MFIs, the most important activity to be carried out by

BDBL is the Performance Evaluation of the MFI to be financed. It is to be done by a

knowledgeable experienced microfinance practitioner using the Guidelines issued by CGAP

on evaluation of MFIs covering five performance indicators namely; Outreach, Quality of

Portfolio, Sustainability (OSS and FSS) and Efficiency. Whole sale lending to a MFI is to be

undertaken only if the MFI’s performance is within the norms recommended by CGAP.

6.3.12. Strategy Twelve - Value chain financing programs for few industry

sectors/commodities: The possible sectors/commodities for introducing value chain

financing programs are Fruits Industry, Dairy Farming and Potato Cultivation. Many

countries use “Value Chain Financing” to enhance financial outreach and promote inclusive economic growth. Value Chain financing could be used in developing countries to develop

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particularly CSIs engaged in agriculture. The value chain finance is the provision of financial

services to actors involved throughout the series of transactions (chain) of a particular

industry that results in producing a final product and delivering it at the appropriate

marketplace. During meetings with the Financial Inclusion Secretariat of RMA, it was

revealed that Bhutan could make use of value chain financing mechanism to develop the

agricultural sector. A study carried out by UNDP in 2016 has recommended that Agriculture

Sector as suitable for developing value chain programs and has identified several

agricultural commodities (including Potato, Maize, ginger, cardamom and Dairy). Based on

discussions the consultant had with several parties and based on his observations, during

visits to branches and borrowing CSIs, the above four sectors are recommended for BDBL’s consideration to launch value chain financing programs initially. BDBL could work closely

with financial inclusion Secretariat of RMA in developing value chain for the four products

mentioned above. In a country like Bhutan the factors to be taken in to account in

developing a value chain program for a product are;

➢ Productive capacity

➢ Number of beneficiaries

➢ Sustainable livelihood options

➢ Product resilient to climate conditions

➢ Degree of vulnerability to climate change

➢ Scalability of the product

➢ Geographical distribution of the commodity.

The first step to be followed by BDBL in launching a value chain for a particular product is

the “Value Chain Mapping”. Value chain Mapping will show the flow of transactions from

sourcing of raw materials and inputs, to production, processing, marketing and final sale.

The mapping can also illustrate costs, value addition at each stage, secondary services

important to each stage, critical constraints and relative clout of players along a value chan.

Some factors relating to the recommended for products for value chain programs are

described below;

i. Fruit Industry Value Chain: Different groups involved in the Fruit Industry Value Chai

are i) input sellers (seeds, plants and fertilizer), ii) cultivators, iii) transporters iv)

processers (such as makers of fruit juice and fruit jams) and v) traders/Exporters.

The main fruits produced in commercial scale and also in home gardens are orange,

walnuts, apple, apricot, peach and cherry. Processers buy from growers or through

intermediaries, convert in to juice and export or sell in the local market. The

problem in Bhutan is the inadequate production of fruits to support the efficient

functioning of a value chain scheme. BDBL Financial institutions could step-in and

form groups among the different players in the chain and provide financing to such

groups of each stage of the chain including cultivators.

ii. Potato Cultivation Value Chain: Potato is Bhutan Most important cash crop and

almost 85% of the households in Bhutan grow potato either for export or for home

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consumption. Hence the potato is a very good candidate for a value chain program.

The main categories of actors involved in the potato value chain would be i) seed

suppliers, ii) input suppliers such as fertilizer, iii) growers, iv) contractors/middlemen

v) Transporters and vi) exporters. BDBL to identify main players in each category and

form them in to groups. Group loans are to be provided to the members of groups.

iii. Dairy sector Value Chain: is also another sector where value chain financing could be

introduced. Dairy farming in Bhutan is traditionally based on small holder system

primarily subsistence-oriented mixed crop-livestock farming system. The sector is a

very significant importance to the country’s rural economy and over 78% of the rural households own cattle. Dairy farming is an integral part of Bhutanese farming system

producing items such as milk, butter and cheese. In a dairy value chain the main

group of actors are i) input suppliers, i) farmers (growers), iii) processers IV)

Transporters and v) traders (wholesale and retail). Players under each category could

be formed in to groups and group loans can be issued to group members.

REDCL needs the assistance of an expert in value chain financing initially to design and

develop the value chains for the three products mentioned above. BDBL could consider

obtaining TA assistance from multilateral development agencies such as World Bank, IFC,

ADB, UND and USAID. BDBL could launch the Value Chain Financing Program on its own or

jointly with REDCL, the other main player in rural finance. Depending on the success or

otherwise of the three value Chain Programs, few more value chain programs are to be

introduced.

6.3.13 Strategy Thirteen - Provision of Business Development Services (BDS) to CSIs to

promote rural credit: The credit to the CSI sector is an important component of the rural

finance offered by the financial sector. The Government believes that the CSI sector is the

engine of growth and hence the sector growth is essential for an inclusive economic growth.

Although, the CSI sector accounts for nearly 95% of the country’s business units, it has received only 14% of the total credit of the Banking sector. Entrepreneurial skills in Bhutan

is still at very low level A recent report states that most of the entrepreneurs in Bhutan are

“necessity based” entrepreneurs and not “opportunity based’ based entrepreneurs. There is

a great need to improve the entrepreneurship in Bhutan, Several Government and NGO

organizations have launched several programs aimed at improving entrepreneurship in

Bhutan. Ministry of Human Resources and Labor under its Entrepreneurship and Self-

Employment Division, Loaden Foundation, Druk Holdings and Department of Cottage and

Small Industry provide some BDS services to CSIs. The Cottage and Small Industry Policy

Paper 2019 of the Department of Cottage and Small Industry (DCSI) emphasizes the need for

provision of support services to CSIs. Although, these institutions are engaged in providing

different types of BDS Services, to improve the entrepreneurship, Bhutan needs an entity to

provide comprehensive package of Business Development Services under one roof or there

is a need for “one Stop Shop”. The growth in the CSI to a large extent depends on the availability of professional Business Development Support (BDS) services. Almost all CSIs

require professional BDS services to sustain and grow their businesses as most CSI

95

entrepreneurs are not conversant with all aspects of business management The types of

BDS Services required by the CSI sector includes, inter alia, the following:

➢ Entrepreneur skills training

➢ Access to markets

➢ Provision of infrastructure such as storage& warehousing, incubators

➢ Sourcing of raw materials

➢ Information on Markets and technology

➢ Assistance in identifying viable business opportunities

➢ Preparation of Business Plans

➢ How to face competition

➢ Assistance in selecting appropriate technology

➢ Training and mentoring

➢ Book keeping

➢ Assistance to understand legal issues and

➢ Assistance in Human Resource Management.

Lenders require BDS Services to their clients to ensure their smooth functioning which will in

turn help lenders in regular recoveries of loans. BDS interventions at the micro firm level can

lead to enhanced economic security and incomes thus permitting micro entrepreneurs to

invest in nutrition, housing, health and education of family members. Discussions with CSI


desired level and it needs improvements. Considering the very high level of NPLs of REDCL

and BDBL and also considering the need to improve their rural outreach, REDCL and BDBL

consider commencing a BDS Services program particularly for its existing and future clients

and in general to the business community in Bhutan. REDCL and BDBL have three options to

commence a BDS program. These three options are;

Option One: Set up a separate business unit within the organization and operate it as a fee

levying service

Option Two: REDCL and BDBL to get together and set up a joint entity and operate the joint

entity as a fee levying service

Option Three: REDCL and BDBL to team up with DCSI and set up a joint public sector entity

and operate the joint entity as a fee levying sustainable entity.

The Consultant’s preferred option is Option Three. The government may negotiate a Technical Assistance (TA) support facility from a multilateral development agency to setup a

“one stop shop” to provide BDS services to CSIs. In other countries, BDS services are either done by governments or by public private partnerships or entirely by the private sector on

sustainable basis. In establishing the BDS Service entity on a sustainable basis, the following

factors are to be kept in mind:

vi. Necessity for targeting through a market assessment

96

vii. Necessity for a predominantly rural development approach

viii. The necessity to operate the program on sustainable basis

ix. The necessity to use high quality human resources with private sector mentality for

BDS facilitation and delivery

x. Necessity to have system to monitoring and evaluation of the results of BDS that

have been delivered.

In order to motivate REDCL customers to seek the BDBs services, a subsidy on the rates to

be charged is to be offered to REDCL customers and it to educate its customers on the

benefit of BDS Services. The BDS Services to deserving clients are to be provided free of

charge initially and then at a subsidized rate .Once the confidence of beneficiaries are build

up BDS services are to be provided at market rates.

REDCL needs to hire an experienced consultant or a team of consultants for a period of

around one year to develop a lending manual with necessary forms and formats on its

new lending programs and also to provide classroom training together with “on the job” training on cash flow based lending to lending officers.

7. PART SEVEN - OTHER INTERVENTIONS SUGGESTED FOR IMPROVING RURAL

FINANCE SECTOR AT MACRO LEVEL.

7.1. INTRODUCTION: The strategies for the development of rural finance at institutional

level were discussed under Part Five and Part Six of this report. Those strategies to be

implemented at institutional level will not be adequate to improve the efficiency of the

overall rural finance sector of Bhutan. Some interventions at macro level are essential to

improve the overall efficiency of the rural finance sector development. These interventions

are described below:

7.1.1. Intervention One - Development of Microfinance Sector: Microfinance plays an

important role in any developing country in improving the livelihood of poor households

through the provision of easily accessible, affordable and sustainable financial credit.

Microfinance industry in Bhutan is still at early stage of development and only very few

players are in operation. Before the emergence of MFIs, unbanked poor and micro

enterprises depend on money lenders at exorbitant rates of interest although private

money lending was illegal in Bhutan. In December 2016 RMA approved “Private Money

Lending Rules and Regulations”. Under these rules and regulations, individuals undertaking

money lending as a business should register with RMA. The maximum amount that can be

lent is Nu 500,000 and the rate of interest is capped at 15% on a reducing balance basis.

Royal Monetary Authority (RMA) of Bhutan has issued licenses to six MFIs to operate. These

97

institutions are RENEW, Bhutan Association of Women Entrepreneurs (BAOWE), Taranaya

Foundation, Bhutan Care Credit (BCC), Microfinance Bhutan Private Limited and Rural

Enterprise Development Corporation (REDCL). For the purposes of regulating, MFIs are

categorized in to two groups namely deposit taking and non-deposit taking. Only RENEW

and Microfinance Bhutan Private Limited has the license to take deposits from the general

public and others are involved only in micro lending. The Consultant visited and had

discussions with senior management of three MFIs. Details are given below:

RENEW: Stands for Respect, Educate, Nurture, and Empower Women. The organization was

founded by Her Majesty the Queen Mother in 2004 dedicated towards the empowerment

of women and girls, especially the victims/survivors of domestic violence. The microfinance

program of RENEW was introduced in 2012 with the support from Savings Bank Foundation

for International Cooperation (SBFIC) of Germany with the primary objective to foster the

economic well-being of women. It operates in 10 districts out of the 20 districts of the

country. It offers three products namely; training on financial literacy, savings and micro

credit. All clients should follow the financial literacy program prior to becoming a client

either savings or credit. RENEW follows Grameen model in providing financial products. As

at end of 2018, it had 2,383 borrowers with a total lending portfolio of Nu 136 Mn. The total

number of savers was 15,094 with a total savings portfolio of Nu 134 Mn. All transaction

takes place through Centers and at presents it has 263 such centers. The loans account per

credit officer ratio is 77 and the total staff is 33. The NPL ratio is very low at 3%. RENEW was

the first MFI to receive deposit taking license.

BAOWE (Bhutan Association of Women Entrepreneurs): BAOWE is a legally resisted Non-

Government organization. The objective of the organization is to economically empower

women and girls contributing towards poverty reduction, promoting self-reliance and

business from a GNH perspective. The Micro finance program of BAOWE commenced in

2017 is very new. At present, it operates in 11 districts out of 20 districts of the country.

They undertake individual lending and group lending and it is not a deposit taking MFI. As at

date BAOWE has 42 loans including one group loan. No NPL loans. Lending rate is 10% per

annum and savings rate is 6% per annum. However, it can take deposits from its members

who amount to around 4,000. The number of saving members at present is 1,000. BAOWE

has applied for a license from RMA to be a deposit taking MFI.

BHUTAN MICROFINANCE PRIVATE LIMITED (BMPL): Received the Deposit taking MFI

license in early 2019 and has been in microfinance operations for 3 months. It is in

operation in three districts with three branches and 7 staff including 3 field staff. It has 50

borrowers with a total lending portfolio of Nu 8.2 Mn. All loans are regular. The total

number of savers is 134 with a savings portfolio of 12.8 Mn.

TARAYANA FOUNDATION (TF): TF was formally launched in 2014 and it is registered as a

public benefit organization. TF works in rural villages promoting community growth and

development by serving needy communities. TF commenced microfinance credit program in

2009 and up to date, it has granted micro credit to 258 clients and current outstanding

portfolio is around Nu 2.4 Mn.

98

BCC is yet to commence operations and details of REDCL have been given elsewhere.

SOME OBSERVATIONS ON THE MICROFINACE SECTOR:

➢ Microfinance sector in Bhutan is in its early stage of development. However, it is

growing fast

➢ MFIs are categorized in to two groups namely; deposit taking and Non-Deposit taking

for the purpose of regulation by RMA. Out of the six MFIs, two are authorized to take

deposits from the public and other four are not authorized.

➢ Some MFIs undertake both group lending and individual lending and some undertake

only group lending.

➢ Almost all MFIs are actively involved in providing financial literacy training to their

clients/members which is a pre-requisite to improve access to finance and financial

inclusion.

➢ Most MFIs lack adequate funding to expand their micro credit programs and financial

literacy programs. Banking sector has excess liquidity while microfinance sector suffers

from lack of funding. A mechanism to connect these two sectors for the mutual

benefit of both parties needs to be developed. “Whole sale lending’ by commercial banks to sustainable private sector MFIS could be used as one of the mechanism to

create a link between the banking sector and the MFI sector.

➢ A study to assess the funding and other needs of MFIs is a must for development of

the sector. An opportunity for a multilateral development agency for a Technical

Assistance (TA) project.

➢ Micro credit clients require coaching/mentoring in their day to day business

operations at least for few months from the commencement of their enterprises. Such

facilities are very limited. Multilateral development agencies could play an important

role here by providing TA for such programs. Government agencies such as “National

Commission for Women and Children” (NCWC) plays an important role in mobilizing

international grants and helping NGOs and MFIs in their financial literacy programs

and other social development activities.

➢ MFI sector has nearly 300 access points in rural areas and this is growing.

➢ MFI sector requires a “level playing field”. A government owned MFI enjoys an undue advantage over other MFIs in terms of funding and lending rate of interest.

➢ Banks and other rural finance institutions could consider the possibility of extending

“wholesale” loans to MFI who lacks adequate funding. This model is widely used in

many developing countries particularly in India. Large banks in India like ICICI Bank,

HSBC and Citi work very closely with MFIs. This would help banks in achieving their

priority sector lending targets. In India, the priority sector which includes MSME sector

lending target is high as 30%. In Bhutan it is only 1% of the total lending portfolio

7.1.2. Intervention Two - Improving Professional Business Development Support Services

for CSIs: The credit to the CSI sector is an important component of the rural finance offered

99

by the financial sector. The Government believes that the CSI sector is the engine of growth

and hence the sector growth is essential for an inclusive economic growth. Although, the CSI

sector accounts for nearly 95% of the country’s business units, it has received only 14% of the total credit of the Banking sector. The growth in the CSI to a large extent depends on the

availability of professional Business Development Support (BDS) services. Almost all CSIs

require professional BDS services to sustain and grow their businesses as most CSI

entrepreneurs are not conversant with all aspects of business management. BDS required

by CSIs includes a wide array of services such as assistance to start-ups, training on

entrepreneurship, HR management, technologies and marketing. Discussions with CSI


desired level and it needs improvements. What financial institutions could do to develop

this is limited and it is the responsibility of authorities to set up a “one stop Shop” to Provide BDS services. The government may negotiate a Technical Assistance (TA) support facility

from a multilateral development agency to setup a “one stop shop” to provide BDS services

to CSIs. In other countries, BDS services are either done by governments or by public private

partnerships or entirely by the private sector.

7.1.3. Intervention Three - Using Priority Sector Lending (PSL) Directives to Improve Rural

Finance: In Bhutan, lack of access to finance by the CSI sector rural farming households is

one of the biggest problems faced by the country. Data from RMA reveal that credit flow

from the banking sector to the agriculture sector was only Nu 5.7 Bn of the total credit

portfolio of Nu 107 Bn in 2017 representing only a 5% share to the agricultural sector which

is the livelihood of around 60% of the population. Priority sector lending is a mechanism

used by central banks all over the developing world to re-direct resources to neglected and

weaker sectors of the economy which are important from the economic development point

of view. Apart from BDBL, loans to the agriculture sector by rest of the banks were well

below 1% in 2017. Realizing the need to re-direct resources to the priority sectors, RMA

issued directives to banks in January 2018 compelling them to grant a minimum percentage

of their lending to priority sectors. PSL will bring the credit flow from the financial sector in

line with the country’s development priorities. Priority sectors have been defined for this purpose as agricultural activities, Non-Agricultural CSIs and Agricultural CSIs. PSL directive of

RMA came into operation in January with a six months preparatory period. A Priority Sector

Lending Council has been formed to monitor the implementation of the scheme. As per the

RMA guidelines, Cottage industries could borrow up to Nu 500,000 while Small industries

could borrow up to Nu 10.0 Mn under the PSL scheme.

The minimum limit for lending to priority sectors have been fixed at 1% of the lending

portfolios of respective banks. The minimum imposed by RMA appears low when compared

with the magnitude of the problem of access to finance prevailing in Bhutan. In other

counties of the region, the minimum lending percentages are very high when compared to

that of Bhutan. In India for an example, the ratio is as high as around 30%. On the basis of

current limit imposed by RMA, the total lending under the PSI program will be around Nu

1.0 Bn which is very low when compared with the prevailing credit gap in the CSI sector. The

100

multilateral development agencies such as the World Bank and Asian Development Bank

could play an important role in persuading RMA to increase the limit to a reasonable level.

7.1.4. Intervention Four - Establishing a Credit Guarantee Scheme for CSIs: Lending by

Banks in Bhutan is based on collateral and most of the individuals who want to borrow from

banks cannot offer collateral required by banks. Banks always ask for immovable property

as collateral and CSIs and rural households do not possess valuable collateral adequate to

borrow their requirement of capital. Due to the non-availability of collateral acceptable to

banks, the credit outreach of the country is very low at 16%. Micro, Small and Medium

enterprises (MSMEs) in most developing countries are faced with this problem and as a

remedy; governments have intervened by establishing Credit Guarantee Schemes to

support MSMEs. A credit guarantee is a form of insurance that helps to protect the interest

of a lender in the event of non-payment by a borrower. The credit guarantee covers the risk

of default by borrowers. The person or the entity who guarantees a loan granted by a lender

is obligated to honor the guarantee unconditionally, if and when the borrower defaults.

Credit guarantee is a substitute at least for part of the collateral required by banks from the

borrower. Since the guarantor is providing a risk cover, banks are motivated to lend to

MSMEs. The credit guarantee schemes will make it possible for a large number of MSMEs to

access credit from banks. This will enhance the credit outreach. The main benefit to the

economy arising from Credit Guarantee is the additional number of loans the banking sector

will approve. These additional borrowing enterprises are currently excluded from the formal

banking sector due to their inability to provide acceptable collateral to lenders. Multilateral

development agencies such as World Bank and Asian Development Bank support with TA

funding to countries wishing to set up credit guarantee schemes. It is recommended that

Government of Bhutan initiate action in this regard.

7.1.5. Intervention Five - Development of Value Chain Financing: Many countries use

“Value Chain Financing” to enhance financial outreach and promote inclusive economic growth. Value Chain financing could be used in developing countries to develop particularly

CSIs engaged in agriculture. A value chain is a series of steps and related actors that

transform raw materials/inputs in to finished products. Value chain finance includes any or

all of the financial services, products and support services that flow to improve the

efficiency of a group of activities that are needed to transform raw materials into end

product. The value chain finance is the provision of financial services to actors involved

throughout the series of transactions (chain) of a particular that results in producing final

product and delivering it at the appropriate marketplace. During meetings with the Financial

Inclusion Secretariat of RMA, it was revealed that Bhutan could make use of value chain

financing mechanism to develop the agricultural sector. Fruit cultivation and processing

industry is an ideal sector to introduce a value chain financing scheme. There are several

fruit cultivators who find it difficult to sell their produce. A value chain starting from input

sellers (seeds, plants and fertilizer), cultivators, processers (such as makers of fruit juice and

fruit jams) and sellers can be formed. The problem in Bhutan is the inadequate production

of fruits to support the efficient functioning of a value chain scheme. Financial institutions

101

could step-in and provide financing to actors of each stage of the chain including cultivators.

Dairy sector is also another sector where value chain financing could be introduced. The

financial institutions could play only a limited role in initiating value chains. Public Sector

Institutions such as Financial Inclusion Secretariat with the support of TA from multilateral

development agencies could play an effective role in initiating value chain financing

programs in Bhutan.

I

ANNEXURE 01

CREDIT PRODUCTS OFFERED BY BDBL

i. Agriculture

• Crop Cultivation

• Agro processing

• Farm Equipment

• Forestry

• Livestock farming

• Land Development

ii. Services

• Hotels and Restaurants

• Information and communication Technology

• Consultancy Services

• Hospitality, Entertainment and Recreational Services

• Automobile Workshops and Cleaning Services

• Saloons

• Repairs and Maintenance

• Tourism

• Institutional/Education Services

• Health Services and Traditional Medicines

• Contracts(non-Construction)

• Construction(Contract based)

iii. Production and Manufacturing

• Wood based Industry(Machines and Equipment)

• Hydropower

• Renewal Energy

• Petro Chemical/steel, Ferro Alloys, Cement

• Handicrafts and Textile production

• Mining and Quarrying

• Traditional and Herbal

• Manufacturing Enterprises

iv. Trade and Commerce

• Retail Trade

• Dealers for Machinery and Equipment

v. Housing

• Commercial(Rental

• Residential

II

vi. Transport Sector(All Automobiles)

• Construction Equipment

• Non-Commercial (personal cars)

vii. Loans to Purchase Shares

viii. Loans Against Shares

ix. Loans against Fixed Deposits

x. Education Loans

xi. Loans to Financial Institutions

• Banks

• Non-Banks

xii. Personal Loans

• Consumer/Employee

• Mortgage Loans (personal purposes

xiii. Loans to Government

• Loans to State owned Enterprises

• Loans to Enterprises owned by Druk Holdings and Investment

III

ANNEXURE 02

BDBL Financial Statements Profit and Loss Account

2014 2015 2016 2017 2018

Int income-Loans and Advances 1264.4 1668.8 2000.4 1844.3 1962.1

Due from banks 74.7 117.2 144.6 79.8 62.5

Income from short-term Investments 4.4 0.7 4.1 41.4 60.7

Other incomes 1.8 2 8 7.2 7.2

TOTALI NTEREST INCOME 1345.3 1788.7 2157.1 1972.7 2092.5

Less

Interest due to customers 584.4 862.8 1059.9 1295.6 1345.2

Interest due to banks 75.6 73.7 69.3 52.2 67.7

TOTAL INTEREST COST 660 936.5 1129.2 1347.8 1412.9

NET

INTEREST

INCOM

EST INCOME 685.3 852.2 1027.9 624.9 679.6

Net Fees and Commission income 20.1 28.8 34.5 36.5 33.5

Operating Lease Income 4.7 5 5.3 5.6 5.3

Other operating incomes 4.4 9.1 6.8 7.9 25.7

TOTAL OPERATING INCOME 714.5 895.1 1074.5 674.9 744.1

Less

Personnel Cost 138.6 159 171.6 198.5 235.6

Training Cost 19.8 30.5 31.1 28.4 31.7

Admin Expenses 56.8 58 63 100.2 127.6

Amortization 20.7 24.2 37.6 66.7 72.8

Advertising and Marketing 6.2 7.9 9.7 15.1 6.8

Other expenses 21.8 25.9 44 59.1 52.8

Community Center Exp 0 16.6 27.6 27.3 28.9

TOTAL OPERATING EXPENSES 243.2 322.1 384.6 495.3 556.2

PROFIT BEFORE IMPAIRMENT 450.6 573 689.9 179.6 187.9

Less Impairment 168.7 180.3 392.4 970.8 106.9

NET PROFIT BEFORE TAX 281.9 392.7 297.5 -791.2 294.8

Tax 0 0 0 130.1 -5.4

NET PROFIT AFTER TAX 281.9 392.7 297.5 -921.3 300.2

IV

ANNEXURE 03

BDBL Financial Statements- Balance Sheets Nu 000

As at 31st December 2014 2015 2016 2017 2018

Cash & cash equivalent 762.5 1262 1146.7 2057.7 1033.8

Balances with Central Bank 3489.8 1589.1 3289.1 3145.6 4558.5

Due from Banks 1332.3 2096.5 1610.2 1568.4 2226.5

Loans & Advances to Customers 10231.4 13155.5 15389.8 16083 16149.4

Financial Investments 443.6 462.8 468.8 465.7 489.8

Other assets 143.1 286.2 394 433.1 402.1

Property. Plant & Equipment 152.1 196.5 293.1 285.9 253.8

Intangible Assets 8.1 23.9 57.5 108.8 107.6

TOTAL ASSETS 16562.9 19072.5 22649.2 24148.2 25221.5

Liabilities

Due to banks 1519.1 1276.6 1136.2 996.5 1322

Due to Customers 12499.7 14639.2 18029.4 20548.7 21012.6

Retirement Benefit Plans 38.8 51.1 52.3 57.9 67.6

Other liabilities 41.5 41.9 86.6 109.8 227.3

Total Liabilities 14099.1 16008.8 19304.5 21712.9 22629.5

Equity

Stated Capital 300 507.3 507.3 507.3 600.3

Retained Earnings 1217.9 1473.9 1776.4 866.4 803.8

Other Reserves 924.8 1058.2 1055.7 1055.7 1172.5

Grants 21.5 25.2 0 0 0

AFS Reserve -0.4 -0.9 5.3 5.9 15.4

Total Equity 2463.8 3063.7 3344.7 2435.3 2592

TOTAL LIABILITIES AND EQUITY 16562.9 19072.5 22649.2 24148.2 25221.5

V

ANNEXURE 04

TRAINING PROGRAMS FOLLOWED BT CREDIT STAFF

Sl # Name Designation Date of

Appointment

# of times

travelled

outside

Training attended

Field of Training Year Country

1 Ms. Ngawang Zangmo Project

Officer

7/14/2010 2 2015 Malaysia Credit Appraisal

1 2014 Malaysia Credit Project

Management

2 Mr. Rinzin Rabgay Project

Officer

10/1/2010 2 2016 Thailand NPL Management

1 2011 India Risk management and

treasury

and Banking

management

3 Ms. Chencho Pem Project

Officer

12/12/2011 2 2016 Manila Study Visit to Card MRI

bank

1 2014 India Management of Rural

Financing

Institutions and Co-

operatives for

Rural Development

4 Mr. Wangda Asstt.PO 7/1/1996 3 2016 Thailand NPL Management

2 2010 Thailand Study Tour, Bangkok

(2010)

1 2006 Dhaka Study Tour, Study Tour

(2006) Dhaka

5 Ms. Sonam Choki Asstt. Branch

Manager

7/1/2009 4 2019 Bangkok,

Thailand

Credit Appraisal and

Loan recovery

3 2015 Malaysia Credit Appraisals

2 2014 Nepal Biogas

1 2012 India

6 Mr. Tandin Dorji ABM 7/19/1991 4 2017 Thailand Legal Procedure &

Banking

recovery

3 2016 Bangladesh Special Training for

Central

Bank Officials

2 2012 India

1 2010 Bangkok Study Tour

7 Mr. Ugyen Chenchen

Wangchuk

Project

Officer

7/1/2009 2 2016 Manila Study Visit to card MRI

bank


Financing


operatives

for Rural Development

8 Mr. Tshewang Phuntsho APO 6/23/1992 6 2019 Pune, India Agri value chain

financing

VI

5 2016 Manila Study Visit to Card MRI

bank

4 2014 Nepal Farmers Exposure Trip

3 2010 Thailand Study Tour

2 2002 Vietnam Study Tour

1 1997 Dhaka Study Tour

9 Ms. Thinley Dema Project

Officer

3/13/2014 2 2019 Bangkok,

Thailand


loan recovery

1 2016 India International Program

on Training

Techniques for Trainers

of Co-operatives

and Rural Financing

Institutions

10 Ms. Sonam Choden Project

Officer

5/1/2015 1 2017 Pune basic credit appraisal

training

11 Mr. Dhendup Namgyel Asstt. Branch

Manager

9/1/1999 6 2018 Bangkok Study Visit to new

generation

farmers enterprise

5 2016 Mumbai Finacle

4 2015 Malaysia Credit Appraisal

3 2012 India Exposure Trip

2 2011 Nepal Study Tour

1 2009 Philippines Sustainable quality

microfinance

program for

entrepreneurial poor

12 Mr. Sonam Namgyel Project

Officer

12/12/2011 2 2019 Bangkok Credit Appraisal and

Loan Recovery

1 2016 India Credit Appraisal

13 Ms. Goma Kafley ABM 5/1/2000 3 2019 Thailand Study Visit Program

2 2014 Malaysia Corporate Governance

1 2003 India Project Finance and

Development of

Co-operative agro

activities

14 Ms. Karma Choki Trainee

Officer

9/1/2017 3 2014 India Credit Appraisal

Training

2

15 Ms.Kezang Choden Project

Officer

3/21/2016 1 2018 Pune, India Credit Appraisal

Training

16 Ms.Tashi Yangzom PO 3/21/2016 1 2018 Pune, India Credit Appraisal

17 Ms. Kencho Wangmo PO 3/21/2016 1 2018 Pune, India Credit Appraisal

18 Ms.Sonam Wangmo Project

Officer

5/1/2008 2 2019 Bangkok,

Thailand


Loan Recovery

VII


Financing


operatives

19 Mr. Yejay Project

Officer

7/1/2012 5 2018 Bangalore,

India

Finalce Core Technical

training

4 2016 Mumbai Finacle Training

3 2015 Thailand Oracle

2 2014 Dhaka ABS Support System &

Business training

1 2013 Bangkok SQL Server Training

20 Ms. Tshering Choden Credit Officer 3/21/2016 1 2019 Pune, India Agri Value Chain

Financing

21 Ms.Tshering Choden Project

Officer

6/27/2016 2 2019 India Exposure & Study Visit

to

NABARD

1 2018 Sri Lanka IFRS

22 Ms. Tashi Yangtsho Trainee

Officer

5/1/2015 2 2018 Bangkok Managerial Skills

Training for

Supervisory Training

Executives

1 2017 India Basic Credit Appraisal

Training

23 Ms. Esther Karki Trainee

Officer

5/1/2015 2 2018 Bangkok Managerial Skills

Training for

Supervisory Training

Executives

1 2017 India Basic Credit Appraisal

Training

24 Ms. Chandra Kala Ghally Project

Officer

5/1/2008 2 2016 Thailand Financial Statement,

Fraud

Detection tools &

techniques

1 2010 India Risk based supervision

and

Risk Based internal

Audit in banks

25 Ms. Sonam Choden Assistant

Credit Officer

12/12/2011 2 2019 Bangkok,

Thailand

Branch Monitoring and

Supervision

1 2015 Malaysia Credit Appraisal

26 Ms. Rinzin Lhadon Bank

Guarantee

Assistant

9/1/1999 3 2019 Bangkok Customer Care

2 2015 Thailand Advance customer

relationship

Management

1 2002 Vietnam Hanoi, Vietnam (2002)

27 Mr. Gyem Tshering Credit Officer

(BG/FP)

7/14/2010 3 2018 Bangkok Banking Operation

VIII

2 2015 Malaysia Credit Appraisal/

Advance

Appraisal


Training

28 Mr. Sonam Tshering Credit Officer 8/1/2011 3 2019 Bangkok,

Thailand


S

supervision


Advance

Appraisal


Training

29 Mr. Tsheten Wangchuk Credit Officer 8/1/2011 3 2019 Bangkok,

Thailand


Supervision


Advance

Appraisal


Training

30 Mr. Pema Tshering Trainee

Officer

9/1/2017 Nil

31 Ms.Phuntsho Wangmo PO 1 2017 Bangkok Credit Appraisal &

Recovery

Techniques

32 Ms. Galey Wangmo PO 1 2017 Bangkok Credit Appraisal &

Recovery

Techniques

33 Mr. Samdrup Dorji Recovery &

M. Officer

7/12/2016 1 2018 Bangkok Credit Appraisal Cum

Loan Recovery

34 Mr. Kuenzang Geley Project

Officer


Loan Recovery

35 Mr. Kelzang Dawa Recovery &

M. Officer

7/12/2016 1 2018 Bangkok Credit Appraisal

Cum Loan Recovery

36 Ms. Kinzang Choden Disbursemen

t Officer


Loan Recovery

37 Ms. Bumpa Pelden Recovery &

M. Officer


Loan Recovery

38 Mr. Sonam Tobgay Disbursemen

t Officer


Loan Recovery

39 Ms. Sonam Choki Project

Officer


Loan Recovery

40 Ms. Phuntsho Choden Project

Officer


Loan Recovery

41 Mr. Sangay Tshewang Recovery & 7/12/2016 1 2018 Bangkok Credit Appraisal Cum

IX

M. Officer Loan Recovery

42 Sonam Zangmo Credit Officer 9/1/2017 Nil

43 Dorji Choden Credit Officer 1/1/2019 Nil

44 Dorji Gyeltshen Credit Officer 1/1/2019 Nil

45 Kinley Zam Credit Officer 9/1/2017 Nil

46 Sonam Jorden Credit Officer 1/1/2019 Nil

47 Tshering Choki Credit Officer 1/1/2019 Nil

48 Passang Lham Credit Officer 1/1/2019 Nil

49 Kezang Lhamo Credit Officer 1/1/2019 Nil

50 Kelzang Wangmo Credit Officer 9/1/2017 Nil

51 Damcho Wangchuk Credit Officer 9/1/2017 Nil

52 Tshering Eden Credit Officer 9/1/2017 Nil

53 Sangay Choden Credit Officer 8/15/2016 Nil

54 Thinley Wangmo Credit Officer 9/1/2017 Nil

55 Dawa Lham Credit Officer 1/1/2019 Nil

56 Kinley Penjor Credit Officer 1/1/2018 Nil

57 Thinley Norbu Credit Officer 1/1/2019 Nil

58 Kezang Dema Credit Officer 5/1/2017 Nil

59 Karma Choki Credit Officer 9/1/2017 Nil

60 Deki Pem Credit Officer 9/1/2017 Nil

61 Choney Wangmo Credit Officer 1/1/2019 Nil

62 Chencho Credit Officer 9/1/2017 Nil

63 Rinchen Zangmo Credit Officer 9/1/2017 Nil

64 Gyem Credit Officer 9/1/2017 Nil

65 Ngawang Tashi Credit Officer 1/1/2018 Nil

66 Ugyen Zangmo Credit Officer 9/1/2017 Nil

67 Tashi Dema Credit Officer 9/1/2017 Nil

68 Pema Samba Credit Officer 9/1/2017 Nil

69 Tashi Wangmo Credit Officer 1/1/2019 Nil

70 Sonam Duba Credit Officer 5/1/2017 Nil

71 Khandu Om Credit Officer 9/1/2017 Nil

72 Younten Tharchen Credit Officer 9/1/2017 Nil

73 Sonam Lhadon Credit Officer 9/1/2017 Nil

74 Sonam Dema Credit Officer 8/15/2016 Nil

75 Rinchen Zangmo Credit Officer 5/1/2017 Nil

76 Sonam Yangchen Credit Officer 9/1/2017 Nil

77 Chimi Dorji Credit Officer 1/1/2019 Nil

78 Ugyen Wangchuk Namgyel Credit Officer 9/1/2017 Nil

79 Tshering Dorjee Nesor Credit Officer 9/1/2017 Nil

80 Gyem Tshering Credit Officer 1/1/2019 Nil

81 Santi Ram Khandal Credit Officer 9/1/2017 Nil

82 Rinchen Choden Credit Officer 9/1/2017 Nil

83 Phurpa Zangmo Credit Officer 9/1/2017 Nil

84 Dorji Norbu Credit Officer 1/1/2019 Nil

85 Norbu Dendup Credit Officer 9/1/2017 Nil

86 Kezang Tshomo Credit Officer 1/1/2018 Nil

87 Bikash Lohar Credit Officer 9/1/2017 Nil

88 Mr. Sonam Phuntsho Credit

Assistant

3/8/2005 4 2019 India Exposure & Study

Visit to NABARD

3 2017 Bangkok banking operation

training

X

2 2015 Nepal Study Visit on ATM And

Network service

providers

1 2010 Thailand Study Tour (Bangkok)

89 Mr. Tshering Nima Credit

Assistant


Loan Recovery

1 2017 Pune Basic credit appraisal

Training

90 Ms. Tshering Tshomo Credit

Assistant

3/8/2005 3 2018 Bangkok NPL

2 2015 Thailand Customer relationship

Management


91 Mr. Sonam Tshering Credit

Assistant


2 2012 India Farmers Exposure trip


92 Ms. Lhakpa Dema Credit

Assistant

9/1/2008 2 2017 Bangkok delinquency

management

& loan recovery

1 2014 India (NIBM) NPA Management

93 Ms. Tshering Zangmo Sherpa Credit

Assistant

5/13/2013 2 2019 Bangkok,

Thailand


Loan Recovery

1 2017 Pune basic credit

appraisal training

94 Ms. Choki Credit

Assistant


95 Mr. Leki Dorji Gewog FA 9/11/2013 2 2019 Bangkok,

Thailand


Loan Recovery


training

96 Mr. Dorji Wangchuk Credit

Assistant

5/1/2008 2 2017 Bangkok Delinquency

management &

loan recovery


97 Mr. Dhendup Credit

Assistant

4/1/2000 3 2018 Bangkok NPL


Management


98 Mr. Cheten Tshering Credit

Assistant

3/8/2005 3 2018 Bangkok NPL


Management


99 Ms. Tashi Lhamo Credit

Assistant

7/14/2010 2 2018 Bangkok NPL


XI

100 Mr. Ugyen Tenzin Credit

Assistant

4/23/2012 2 2019 Bangkok,

Thailand


Loan Recovery

1 2014 Nepal Biogas financial Study

Visit

101 Ms. Tshering Deki Tamang Credit

Assistant


Loan Recovery

1 2017 Pune basic credit appraisal

training

102 Mr. Choki Zangpo Credit

Assistant


103 Mr. Phub Tshering Credit

Assistant

3/13/2014 1 2018 Pune , India Credit Appraisal

104 Mr. Barun Giri Credit

Assistant

3/13/2014 1 2018 Pune, India Credit appraisal

105 Mr. Prem Bdr. Biswa Credit

Assistant

7/1/2009 2 2017 Thailand Delinquency

management &

loan recovery


106 Ms. Deki Zangmo Credit

Assistant


107 Ms. Bir. Bdr. Rai Credit

Assistant


management

& loan recovery


108 Ms. Pema Tshoki Credit

Assistant

5/1/2006 1 2014 India (NIBM) NPA Management

109 Ms. Pem Dem Credit

Assistant

3/8/2005 3 2017 Bangkok delinquency

management

& loan recovery

2 2015 Nepal Study Visit on ATM And

Network service

providers


110 Ms. Dechen Dema Credit

Assistant


Loan recovery

2 2015 Thailand Customer Relationship

Management


111 Ms. Tshering Yangdon Credit

Assistant


management

& loan recovery



XII

112 Mr. Rinchen Zangpo Credit

Assistant


Loan Recovery

1 2017 India basic credit

appraisal training

113 Mr. Ugyen Phuntsho Credit

Assistant

4/1/2009 2 2016 Manila Study Visit to

Card MRI Bank

1 2012 India Exposure Trips

114 Mr. Dep Kumar Chhettri Credit

Assistant


115 Mr. Ngawang Tenzin Credit

Assistant


management

& loan recovery

3 2014 Nepal Biogas financial Study

Visit

2 2012 India Exposure trip


116 Mr. Pema Namgyel Credit

Assistant


management

& loan recovery


Management



2 2002 Vietnam Study Tour

1 1997 Dhaka Study Tour

117 Ms. Namgay Pem Credit

Assistant

7/14/2010 2 2018 Bangkok NPL

1 2016 India Credit appraisal

118 Mr. Jigme Tenzin Credit

Assistant


119 Ms. Tshering Dema GFA 3/1/2000 3 2018 Bangkok NPL


Management


120 Ms. Bir Maya Chhetri Credit

Assistant

7/14/2010 2 2019 Bangkok Credit Appraisal

and loan Recovery


121 Mr. Sangay Tenzin Credit

Assistant


122 Mr. Rudra Man Khapangi Credit

Assistant

7/1/2009 2 2015 Thailand Customer relationship

Management

1 2012 India Exposure Trips

123 Ms. Dorji Wangmo Credit

Assistant

12/11/2007 2 2016 Thailand Customer care


XIII

124 Ms. Galem Credit

Assistant


Loan Recovery


Training

125 Mr. Tshering Penjor Credit

Assistant

7/14/2010 2 2018 Bangkok NPL


126 Mr. Pema Tenzin Credit

Assistant


127 Ms. Dorji Dema GFA 3/13/2014 1 2018 Pune, India Credit Appraisal

128 Mr. Karma Dendup Credit

Assistant


129 Mr. Tenzin Wangchuk Credit

Assistant

7/14/2010 3 2018 Bangkok NPL

2 2014 Nepal Farmer Exposure Trip

1 2014 India NPA Management

130 Mr. Sonam Gyeltshen Credit

Assistant


131 Mr. Nidup Dorji Credit

Assistant

3/13/2014 N/A

132 Mr. Lungten Jamtsho Credit

Assistant


Loan Recovery


133 Mr. Dawa Tshering GFA 7/1/2014 1 2018 Pune, India Credit Appraisal

134 Mr. Sonam Lungchen GFA 7/14/2010 1 2014 India (NIBM) NPA Management

135 Mr. Jigme Thinley Credit

Assistant

5/13/2013 2 2019 Bangkok,

Thailand

Credit Appraisal

and Loan Recovery


training

136 Ms. Sangay Lhamo Credit

Assistant


137 Mr. Tshewang Tashi Credit

Assistant

5/13/2013 2 2019 Bangkok,

Thailand1


Loan Recovery


training

138 Ms. Rinzin Wangmo Credit

Assistant

7/14/2010 2 2018 Bangkok NPL

2014 India (NIBM) NPA Management

139 Mr. Jigme Tshering GFA 4/23/2012 2 2019 Bangkok Credit Appraisal and

XIV

Loan Recovery


140 Mr. Pema Dorji Credit

Assistant

7/14/2010 2 2018 Bangkok NPL

2014 India (NIBM) NPA Management

150 Mr. Pema Wangchuk Credit

Assistant

3/13/2014 N/A

151 Mr. Tshering Dorji Credit

Assistant


152 Mr. Sangay Dorji GFA 4/22/2014 1 2018 Pune, India Credit appraisal

153 Mr. Damber Kumar Biswa Credit

Assistant

9/11/2013 2 2019 Bangkok,

Thailand

credit Appraisal and

loan recovery

1 2017 India basic credit appraisal

training

154 Ms. Tshering Choden GFA 5/13/2013 1 2017 India Basic credit Appraisal

Training

155 Mr. Thinley Wangchuk Credit

Assistant


2012 Nepal Exposure trip (2012)

156 Mr. Thakur Prasad Rizal Credit

Assistant


management &

loan recovery

2012 Manila Strategic Marketing

Management

157 Ms. Dechen Wangmo Credit

Assistant

3/13/2014

158 Ms. Tashi Wangmo Credit

Assistant


159 Mr. Tashi Yangjay Credit

Assistant


160 Mr. Lobzang Tshering Credit

Assistant

3/8/2005 3 2016 Thailand Customer Care

2011 Nepal Study Tour

2010 India, Sikkim Study Tour

161 Mr. Dechen Wangdi Credit

Assistant


162 Mr. Tshering Tashi GFA 7/1/2014 1 2018 Pune, India Credit Apprisal

163 Mr. Kezang Dorji Credit

Assistant

3/13/2014 1 2018 Pune ,India Credit Appraisal

164 Mr. Tashi Dawa Credit

Assistant


Loan Recovery


XV


Financing


operatives

165 Mr. Cheki Wangchuk GFA 7/1/2014 1 2018 India Credit Appraisal

166 Mr. Sonam Jamtsho Credit

Assistant

2 2017 Bangkok Delinquency

Management

& Loan recovery

2013 Manila Study Tour

167 Mr. Kinzang Dendup GFA 12/6/2016 2 2019 Bangkok,

Thailand


Loan recovery


training

168 Mr. Sangay Dorji GFA 4/22/2014 1 2018 Pune, India Credit Appraisal

169 Ms. Sangay Lhamo Credit

Assistant


170 Ms. Yeshi Choden GFA 7/1/2010 1 2016 Thailand Office Management

171 Ms. Kinga Choden GFA 4/1/2011 1 2016 Thailand Office Management

172 Mr. Arjun Rai Credit

Assistant

5/13/2013 1 2017 Bangkok customer care

173 Mr. Kinley GFA 5/13/2013 1 2018 Thailand Customer care

174 Mr. Tshetrim Chophel GFA 5/13/2013 1 2017 Bangkok customer care

175 Mr. Rinchen Tshering Credit

Assistant


176 Sonam Choden Credit

Assistant


177 Sonam Dekar Geog Field

Assistant


178 Sonam Tenzin Geog Field

Assistant


179 Dorji Geog Field

Assistant


180 Kota Geog Field

Assistant


181 Dorji Wangchuk Credit

Assistant


182 RinchenTshering Credit

Assistant


XVI

183 Tshering Om Credit

Assistant


184 Cheku Wangchuk Credit

Assistant


185 Dorji Credit

Assistant


186 Karma Wangchuk Credit

Assistant


187 Ms. Tshering Dolkar Credit

Assistant

13-03-2014 1 2019 Bangkok,

Thailand


Loan Recovery

188 Phuntsho Norbu Credit

Assistant

6/27/2016 Nil

189 Jigme Dorji Credit

Assistant

12/6/2016 Nil

190 Yeshey Peldon Credit

Assistant

9/1/2017 Nil

191 Sonam Dema Credit

Assistant

9/16/2019 Nil

192 Lhamo Tshering Credit

Assistant

9/1/2017 Nil

193 Pema Wangmo Credit

Assistant

1/1/2019 Nil

194 Tshering Tobgay Credit

Assistant

6/27/2016 Nil

195 Rinchen Wangmo Credit

Assistant

9/16/2019 Nil

196 Yeshi Choden Credit

Assistant

9/1/2017 Nil

197 Yeshi Dorji Creit

Assistant

9/1/2017 Nil

198 Pema Zangmo Credit

Assistant

9/1/2017 Nil

199 Sonam Thukten Norbu Credit

Assistant

6/27/2016 Nil

200 Sonam Lhadon Credit

Assistant

5/1/2017 Nil

201 Ugyen Kelzang Credit

Assistant

9/1/2017 Nil

202 Samten Lhamo Credit

Assistant

5/1/2017 Nil

203 Karma Tenzin Credit

Assistant

9/1/2017 Nil

204 Karma Tshetrim Credit

Assistant

1/1/2019 Nil

205 Dawa Tshering Credit

Assistant

1/1/2019 Nil

206 Januka Biswa Credit

Assistant

9/1/2017 Nil

207 Tashi Dorji Credit

Assistant

9/16/2019 Nil

208 Sangay Choden Credit

Assistant

7/12/2016 Nil

XVII

209 Thinley Wangchuk Credit

Assistant

7/19/2007 Nil

210 Pema Dorji Credit

Assistant

5/1/2017 Nil

211 Chimi Wangmo Credit

Assistant

1/1/2019 Nil

212 Karma Jigme Credit

Assistant

7/12/2016 Nil

213 Phub Wangmo Credit

Assistant

12/6/2016 Nil

214 Sonam Lhamo Credit

Assistant

9/1/2017 Nil

215 Pema Laida Credit

Assistant

12/6/2016 Nil

216 Bishal Rai Credit

Assistant

9/16/2019 Nil

XVIII

ANNEXURE 05

TRAINING PROGRAM ON CASH FLOW BASED LENDING

LECTURE NOTE- 01

1) AN OVERVIEW TO ISSUES FACED BY SMEs/CSIs

1.1. What is a SME: Small and Medium Scale Enterprises, universally known as SMEs, are a

very heterogeneous group of enterprises engaged in business activities across a large

spectrum of sectors such as services, trade, agriculture and manufacturing. There is no

internationally accepted definition of SMEs. Definition of SMEs varies from country to

country due to the diverse nature of economies and also due to the difference in the level of

economic development of those economies. Many countries and multilateral development

agencies have their own definitions. The definition of SMEs is generally based on one of

three criteria namely; the annual turnover of the enterprise, number of workers employed

or value of assets (investment). The definition of SMEs used by all these multilateral

development agencies under these credit lines was based on the value of assets or value of

the investment in the enterprise. Why SMEs are so important?

According to a report by the OECD, SMEs represent the dominant form of business

organizations accounting for 95% and up to 99% of enterprises depending on the country.

SMEs have a definite economic importance to almost all economies in the world but

particularly to those in the developing countries who face challenges in employment

creation and income distribution. Most SMEs in developing countries use labor intensive

technologies and also uses local raw materials. As such, they substantially contribute to the

Gross Domestic Product (GDP) and creation of employment in developing countries. SMEs

are a nursery for large firms before they become corporate bodies and also it is the

graduation point for a large number of aspiring micro enterprises. SMEs not only directly

contribute to the economic growth and employment creation of developing countries, they

also play a prominent role in developing appropriate technology, entrepreneurship and

product innovations. SMEs can be established rapidly and produce quick results. Studies

have revealed that in developing countries, the formal SME sector contributes around 45%

to employment and 33% to GDP. However, in developed countries the contribution by the

SME sector to the GDP and employment is as high as 65% and 70% respectively.

1.2 Financing Gap: SMEs in many developing countries, including Sri Lanka, have still not

reached their full potential. The development of the SME sector in developing countries is

constrained by several financial and non-financial barriers. The main constraint is the

inability of the SMEs to raise required funds. A study carried out by the International

Finance Corporation (IFC) and McKinsey in 2010 revealed that only around 30-35% of SMEs

in developing countries have access to credit from the formal banking sector. Although

around 70% of SMEs in developing countries have a relationship with banks through savings

and/or current accounts, access to credit by them is very limited. Almost all SMEs require

external capital in the form of credit or equity to fund their activities but only very few could

access it from the formal banking sector. As such, there exists a huge financing gap between

XIX

the supply of funds from the formal banking sector and the demand for funds from the

SMEs in developing countries.

The flow of funds from the banking sector to the SME sector is slow in developing countries

such as Bhutan creating a huge financing gap principally due to two reasons as specified

below:

▪ Certain structural weaknesses in SMEs

▪ Wrong perception among bankers that SMEs carry high credit risk.

1.3. Structural weakness in SMEs: There are several inherent structural weaknesses in SMEs

which keep banks away from lending to them. Without correcting these weaknesses, it will

be difficult to motivate banks to lend to the sector. These inherent structural weaknesses

are discussed below.

- Non-availability of reliable financial records:

Banks when lending to any enterprise primarily look at the ability of the enterprise to repay

its debt. The ability to repay the debt will entirely depend on the cash flows of the

enterprise and the cash flows become the primary lending criteria. Future cash flows of an

existing enterprise can be estimated only based on its past cash flows. Therefore, it is

essential for all enterprises to maintain proper records of its past performance to enable

lenders to ascertain viability of the operations of the enterprise. When banks lend to

corporates they could reasonably depend on financial records maintained by borrowing

corporates to ascertain their ability to service debt. However, most SMEs in developing

counties do not maintain proper books of accounts or they do not maintain any record at

all. Even if they maintain some records, such records do not reflect the actual level of

performance of the enterprise. When a SME borrower approaches a bank for a loan, the

banker finds it very difficult to make and assessment of the profitability and the debt service

capacity of his enterprise due to non- availability of reliable financial records on the past

performance of the enterprise. This prevents SMEs accessing funds from the formal banking

sector. SME enterprises always understate their performance due to various reasons but

mainly to avoid or minimize payment of tax.

- Inability to provide acceptable collateral:

Another weakness of SMEs which prevent them from accessing funds from banks is their

inability to provide collateral acceptable to banks. The availability of collateral reduces the

risk of lending to some extent. The collateral is necessary to avoid willful defaults and in an

extreme situation to realize assets in a business failure. Collateral can be used by banks as a

means of “arms twisting” to collect debt from willful defaulters. The criticism against banks

is that they always insist on immovable property as collateral. However, most SMEs

experience difficulties in providing acceptable immovable properties as collateral. This is

due to two reasons. Some SMEs do not own immovable properties. Maybe they carry out

their businesses on rented or leased premises. These cannot be mortgaged.

XX

- Inadequate Risk capital:

When banks provide funds to any SME, they expect a reasonable equity stake or a risk

capital from the owner. This is common to lending by banks to any business. If the owner of

the business does not have an equity stake in the business, he is not taking any risk. Risk

taking is one of the primary characteristic of an entrepreneur. Today, banks expect

around30-40% as risk capital from the owners of enterprises in order to secure their full

commitment to the business; reduce the burden of debt servicing and also to share the risk

in a business failure. Most of the SME entrepreneurs find it difficult to raise this minimum

risk capital and the limitation in equity capital restricts the access to finance by SMEs from

the banking sector

- Use of outdated or substandard technology:

Most SMEs in Sri Lanka use locally developed technologies in producing and delivering

goods and services. One of the main factors that influences the success or failure of an

enterprise is the technology it uses. The quality of the products and services produced by

SMEs are of moderate quality or not up to international standards due to this substandard

technology. They find it difficult to compete with relatively high quality cheaper imported

products. With the globalization and phasing out of tariff and non-tariff barriers to widen

the international trade, the prospects for SMEs in developing countries be affected

adversely .This situation may adversely affect the SMEs in developing countries reducing

their viability. Due to the substandard quality of products produced by some SMEs, they

have only a very limited market regionally or nationally. Due to quality issues entering the

international market is difficult for them.

- Lack of Managerial Skills:

Due to the smallness of the business many SMEs find it difficult to employ skilled managers

to look after specific areas of their businesses. Like in larger firms there is no segregation of

owners from the managers. Owners and/or managers of SMEs often need to perform a

wider range of tasks than those do in larger firms since there is less room for specialization.

This requires the few managers or employees employed by SMEs to possess diverse skills

not limited to one or two specific skills. Managers in developing countries do not have this

multiple skills. Lack of specialization makes management capabilities of SMEs very weak.

Poor financial position of SMEs prevents those acquiring skills from outside. -

- Key Person Risk:

Key person risk occurs when a business or business unit becomes heavily reliant on a key individual

or a few individuals. Although this risk is found in almost all businesses, it is more common in SMEs.

Always this key person happens to be the promoter of the business or a member of the promoter's

immediate family. The key person’s loss through death, critical illness or long-term incapacity would seriously

impact their businesses

XXI

1.4. Why some Banks are reluctant to lend to SMEs and how to motivate them

In Sri Lanka, some banks are reluctant to lend to SMEs and as such banks are frequently

subjected to criticism by policymakers, politicians and SME Entrepreneurs. The criticism is

reasonable to some extent as the reluctance on the part of banks hampers the growth of

SMEs. There are three main reasons for some banks to be reluctant to lend to SMEs.

- Perception of banks that SMEs are with high risk:

Most banks have a perception that SMEs are high risk due to the following reasons;

▪ Insufficient assets and low capitalization, vulnerability to market fluctuations and high

mortality rates

▪ Information asymmetry arising from SMEs’ lack of accounting records ,inadequate financial records and reliable business plans

▪ High administrative and transaction cost and low returns

▪ High probability of default

▪ Inability of banks to properly assess whether the SME borrowers possess managerial

skills to generate adequate cash flows to service the debt

This perception is not correct and SMEs are an attractive line of business in developed

countries. The international researches have shown that Return on Assets (ROA) on

corporate lending is around 1.0-1.5% whereas the ROA on SME lending as high as 1.5-3.0%

provided SME lending is carried out properly. The managerial deficiencies in SMEs can be

minimized by promoting vibrant network Business Development Services (BDS) providers.

As in the past, banks should work closely with Authorities and international development

agencies for this purpose like in countries like Philippines and Indonesia.

- Lack of commitment of Top Management of banks:

Top management of many banks in Sri Lanka is not fully committed to promote lending to

SMEs. They are more comfortable with lending to few corporates, even if that segment of

the market is highly competitive. They perceive this sector to be risk free, hassle free and

with high profitability. This negative attitude of top management of some banks trickles

down to all level of management making SME lending in these banks negligible. SME activity

becomes less attractive career-wise to lending officers as corporate lending is more

recognized by the top management. The top management of these banks very often

considers SME lending as a corporate social responsibility for political reasons and not as a

profitable business line. This criticism is not common to all banks in Sri Lanka as there are

some banks truly committed to promotion of SME lending.

To change this negative attitude of some banks, it is necessary to use the “Carrot and Stick” approach to motivate the reluctant banks to lend to SMEs. The “Carrot” may be some fiscal incentives. The “stick “may be the directives from the Regulator making it mandatory to channel certain percentage of their loan portfolio to the SME sector. If this is not complied

with, banks will be penalized. This is known as priority sector lending. In India, all banks are

XXII

compelled to allocate 35% of their lending portfolio to priority sectors, one of which is the

SME sector.

- Lack of Skills for lending to SMEs

Bankers use two different approaches in lending; one based on collateral and the other

based on cash flows. Some banks wrongly perceive that if lending is secured by realizable

assets with adequate cover, such loans are risk free and that banks could realize the full

value of the assets to recover the total outstanding in default related situation. Realization

of mortgaged assets is a long drawn process and it might take on an average 3-5 years or

sometimes even more. By the time the asset is sold, its realizable value may be much less

than the original value if the asset is a movable one. Banks will have to spend huge amounts

on litigation and at the end of litigation, both parties might lose and only the lawyers;

auctioneers and security firms will be the winners. On the other hand, if the lending is done

only on the basis of cash flows, it makes room for willful defaults. In a situation where no

collateral is taken, the borrower will not lose anything in willful default situations or genuine

business failure. Collateral should only be a means of “hand twisting” and not a means of debt recovery. As such proper lending should be a combination of collateral based and cash

flow based lending approaches placing more emphasis on cash flows. The problem with

most banks is that they have no skills in cash flow based landing. Estimating cash flows

based on the appraisal of past performance and the future prospects of the enterprise is a

difficult task and it requires specific skills. If the lending is for a corporate, preparing cash

flows is not a difficult task as almost all corporates maintain proper financial records. As

most of SMEs do not maintain proper financial records, computing cash flows from

unreliable and incomplete financial records is a very difficult task. The situation becomes

more difficult for banks as most SMEs also do not have assets that are acceptable to banks

as collateral. Therefore, it is essential for banks involved in SME lending to vigorously train

their lending officers in cash flow based lending.

In conclusion it can be said that if the structural weaknesses of SMEs are corrected and the

reluctance of bankers to lend to SMEs are remedied, a smooth flow of funds from the

banking sector to the SME sector could become a reality.

2. INTRODUCTION TO CREDIT

2.1. What is Credit: Most dictionaries indicate that the term “credit” is derived from the Latin word “credito” which simply means faith. It is an agreement by which something of

value - goods, services or money is given in exchange for a promise to return at a later date.

Credit encompasses any form of deferred payment. The person who extends credit is known

as creditor or the lender and the person who accepts the credit is known as the debtor or

the borrower. Credit does not necessarily require money and it can be applied in barter

economies as well. Credit as a financial term refers to the granting of a loan and creating of

a debt. The debt is created when the commercial lender (the bank) “effectively delivers” a credit to a customer at the request and acceptance of the customer. Credit is denominated

by a unit of account.

XXIII

2.2. Types of credit: Banks offer wide range of loans to their customers. Different forms and

types of loans from banks to their customers are discussed below:

• Personal Loans and Business Loans. Personal loans are given to individuals to meet their

personal needs such as consumption, education, housing, and purchase of consumer

durables, purchase of vehicles and many other purposes. Here the primary consideration

among many others is the individual’s personal income. Business Loans are given to any type of business mainly for the purposes of financing the activities of the business such as

working capital, acquisition of fixes assets , for facilitating imports and exports(LCs,

Packing Credit etc.) and also for facilitating contractual obligations(bid bonds,

performance bonds etc.)

• Short term loans and long term loans. If the repayment period of a loan granted is less

than one year it is called a short term loan and if the repayment period is more than one

year it is called a term loan. Today, banks grant loans with very short repayment periods

as short as one month and with very long repayment period as long as 30-35 years.

• Installment loans and revolving loans/Overdrafts. An installment loan is a loan that is

repaid over a period of time with a set number of scheduled payments. Installments can

be equated throughout the period or can be varied for each interval of payment.

Installment can be adjusted to suite the borrowers’ cash flow. Revolving credit is a line of

credit made available by the bank to a customer where the customer pays a commitment

fee on the approved limit and allowed to use funds within the approved limit as and the

borrower needs funds. Revolving credit can be taken out by both individuals and

businesses. Interest is paid only on the utilized amount. When the borrower has excess

cash, he can use that money to reduce the balance outstanding in the revolving loan.

• Secured Loans and Unsecured Loans. Secured loan is a loan in which the borrower

pledges some assets (e.g. immovable or movable property, vehicles, and trading stocks) as

collateral. In a secured loan, the lender is relieved to some extent of the financial risk (but

not entirely) because it allows the lender to take over the collateralized asset in the event

(subject to a legal procedure) the debt is not repaid properly. On the other hand, the

borrower will receive more favorable terms if the debt is secured. The unsecured debt

which is also called “clean” and not collateralized by a lien on any specific assets of the borrower. In a situation of a bankruptcy or liquidation secured lenders have priority over

unsecured lenders.

2.3. Project Finance: Lending by banks can be basically grouped in to two; namely

commercial lending and project lending. In commercial lending (sometimes called corporate

lending and personal lending) the primary consideration for the lending decision is the

XXIV

borrower’s credibility and/or the collateral offered. In commercial lending, loans are always granted to people with wealth or with a regular monthly income and/or to people who can

offer valuable and readily saleable assets as collateral. If a loan granted under this category

is defaulted, the lender could resort to recover it from the borrower’s personal wealth or through the sale of collateral. In the other category of lending, namely project lending,

where the primary consideration for the lending decision is the cash flow of the project to

be funded and the collateral is considered as secondary criteria. This type of lending is also

known as cash flow based lending. Project finance is the financing of a particular project,

such as a tea factory, garment factory, hospital or a fleet of commercial vehicles which is

repaid from the cash-flow of that project. Project finance is different from traditional forms

of commercial finance because the financier principally looks to the revenues and assets of

the project in order to service and secure the loan. In contrast to an ordinary borrowing

situation, in project financing, the financier usually has little or no recourse to the non-

project assets of the borrower or the owners of the borrowing entity. SME lending is a type

of project lending. All principles applicable in project lending are applicable in SME lending.

3. CREDIT RISK MANAGEMENT AND CREDITAPPROVAL PROCESS:

3.1 What is Credit Risk: Basle Committee Banking Supervision defined credit risk as follows;"

Credit risk is most simply defined as the potential that a bank counter party will fall to meet its

obligations in accordance with agreed terms. The goal of credit risk management is to maximize

the bank's Risk- adjusted Rate of Return on capital (RAROC) by maintaining credit risk exposure

within acceptable limits".

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. Banks need to manage the credit risk inherent in the entire portfolio

as well as the risk in individual credits or transactions. Banks should also consider the relationships

between credit risk and other risks. The effective management of credit risk is a critical component

of a comprehensive approach to risk management and essential to the long-term success of any

banking organization.

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,

XXV

equities, options, and in the extension of commitments and guarantees, and the settlement of

transactions.

In order to maintain credit risk at acceptable levels, banks must operate within sound, well-defined

credit-granting criteria. These criteria should include a clear indication of the bank’s target market and a thorough understanding of the borrower or counterparty, as well as the purpose and structure

of the credit, and its source of repayment. 27. Establishing sound, well-defined credit-granting

criteria is essential to approving credit in a safe and sound manner. The criteria should set out who is

eligible for credit and for how much, what types of credit are available, and under what terms and

conditions the credits should be granted. Banks must receive sufficient information to enable a

comprehensive assessment of the true risk profile of the borrower or counterparty.

Once credit-granting criteria have been established, it is essential for the bank to ensure that the

information it receives is sufficient to make proper credit-granting decisions. This information will

also serve as the basis for rating the credit under the bank’s internal rating system. 29. Banks need

to understand to whom they are granting credit. Therefore, prior to entering into any new credit

relationship, a bank must become familiar with the borrower or counterparty and be confident that

they are dealing with an individual or organization of sound repute and creditworthiness. In

particular, strict policies must be in place to avoid association with individuals involved in fraudulent

activities and other crimes. This can be achieved through a number of ways, including asking for

references from known parties, accessing credit registries, and becoming familiar with individuals

responsible for managing a company and checking their personal references and financial condition.

However, a bank should not grant credit simply because the borrower or counterparty is familiar to

the bank or is perceived to be highly reputable. 30. Banks should have procedures to identify

situations where, in considering credits, it is appropriate to classify a group of obligors as connected

counterparties and, thus, as a single obligor. This would include aggregating exposures to groups of

accounts exhibiting financial interdependence, including corporate or non-corporate, where they are

under common ownership or control or with strong connecting links (for example, common

management, familial ties).5 Banks should also have procedures for aggregating exposures to

individual clients across business activities.

Many banks participate in loan syndications or other such loan consortia. Some institutions place

undue reliance on the credit risk analysis done by the lead underwriter or on external commercial

loan credit ratings. All syndicate participants should perform their own due diligence, including

independent credit risk analysis and review of syndicate terms prior to committing to the

syndication. Each bank should analyze the risk and return on syndicated loans in the same manner as

directly sourced loans. . Granting credit involves accepting risks as well as producing profits. Banks

should assess the risk/reward relationship in any credit as well as the overall profitability

3.2. Need to be selective: Although, lending by banks mutually benefit both the bank and

the borrower, every loan does not generate such benefits to both parties. Neither, the bank

nor the borrower benefits on a long term basis from a loan that cannot be repaid.

Therefore, banks should not grant loans to each and every customer who comes to the

bank. There should be a reliable process to separate prospective bad borrowers from the

prospective good borrowers. To identify the loans that should not be granted from the ones

that should granted banks rely on an analytical and process(also called an appraisal process)

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that begins either with an application (un-solicited)from a prospective borrower or with an

interview between the bank and the prospective borrower followed with an

application(Solicited) from him. During the first interview the banker (credit manager or the

lending officer) needs to be able to ask rights questions and accurately interpret customer’s responses to those questions. All the required personal skills-listening and observing,

expressing empathy, being positive and ethical is important during the interview and

negotiation process with the customer. In the loan interviews, the lender should focus on

efficient communication, effective questioning, note taking and professional behavior.

The credit approval process involved detailed analysis based on the information submitted

by the prospective borrower about himself, financial statements of the business, business

plans (if any), publically available information such as borrowers credit history, financial

needs of the business and the borrower’s ability to service what he is intended to borrow.

The lender should keep in mind that the story of a business may be completely different

from what is portrayed in its balance sheets and income statements. What the banker

gather during the interviews, credit investigations and negotiations would be more

important and useful than what we gather from documents. Successful lending requires

bankers who can correctly judge the human character, assess accurately financial records of

the borrower, understand business circumstances (past and future) and negotiate

effectively. Such skills cannot be programmed in to a computer and make the lending

process mechanical and hence lending today is profession. An efficient loan processing

which is also called “due diligence’ process has become so necessary for safe and sound

lending by banks. The banks internationally adopt the Five 'C' s approach or Five' C's

Analysis for credit due diligence to select good and reliable borrowers.

3.3 What is five Cs Analysis?: Every bank has a set of standards and guidelines specific to

that bank, to be followed by officers who are involved in lending when processing an

application from a prospective borrower. Although, different banks follow different

standards and guidelines in their credit processes, there are some common elements or

components in any credit approval process followed by any bank. The lending process of

any bank is facilitated by 5 financial analysis tools. These 5 analysis tools are Character,

Capacity, Capital, Collateral and Conditions. These tools are very helpful guides in credit

analysis for the banker to come to a decision. These 5 tools used in credit analysis are

commonly called the 5 Cs of credit. Of these 5 Cs, Capital, Capacity and Collateral form the

basis for quantitative financial analysis. Character and Conditions are subjective and the

analysis of these 2Cs will depend on the perception of the banker. The Five 'C' s used in

credit analysis is described in following chapters.

4. FIVE 'C's CREDIT ANALYSIS - CHARACTER (FIRST ‘C’)

4.1 Basic question for lenders: Every lending decision should answer a basic question. Is the

borrower of sound character and does he/she has management capability run the business

efficiently, make money and repay the loan?. When the lenders are required to find answers

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to this question, they need to look in to two aspects of the borrower which are discussed in

detail under a) and b) in the following paragraphs.

a) Personal character traits of the borrower

If the borrower is an individual, the Credit Analyst should analyze character of that

individual. If the borrower is a large company with several owners/shareholders, the analyst

should analyze the personal characters of the principal shareholders. For the purpose of

making lending decisions, character is defined as the customer’s willingness and determination to repay the loan regardless of the unforeseen adversity. Personal character

of a customer includes personal qualities such as honesty, openness, integrity and self-

discipline. In addition to these character traits, family and other personal issues which could

have an impact on the overall stability of the business and affect the customers loan

repayment performance. The customers’ ability to withstand many different sources of stress simultaneously and still make sound business decisions is an important character trait

of a borrower which will help in credit decision. When assessing the character in credit

decisions, the bankers should take in to account not only the character of the primary

customer but also that of the family members, employees and also principal customers if

the business is dependent on a very few of them. Customers, suppliers, creditors The

personal character of the borrower is the catalyst that transforms the expectations goals

and projection of a business in to realities. A key factor in the long term success of a

business is how well the owner/s of a business can look in to the future; understand

dynamics of the market place and chart the best direction for the business in a well thought

of business strategy. Since, even the best thought of business strategies can change, the

person’s true character is revealed in how well he or she can adapt to changed circumstances and make adjustment to the original business strategy to suite the changed

environment and various business partners provide valuable insights in to the character of a

prospective borrower. Over dependence on the personal character in credit decisions is

always not a sound and prudent practice in lending.

In some cases, the character of a borrower has less to do with subjective feeling of the

lender about the borrower’s trustworthiness, honesty and moral beliefs and more to do with his bills paying habits, the way they conduct their business affairs and the way they

respond to adversity

b) Financial performance of the business:

If the borrowing enterprise is an existing business and the requested loan is for an

expansion of the existing business, the assessment of the character of a prospective

borrower should also

Include the analysis of the financial performance of the business in the past. The analysis of

the past financials of a business will indicate the character of the business. This analysis will

also indicate whether the borrower has been capable of running his business efficiently and

XXVIII

make profits. The best intensions in the world cannot repay a loan if an income is not

generated from the business and such income is managed properly. Only a proper analysis

of financial statements would indicate whether the business is generating profits and such

profits are manage properly. If the lender is to make any real sense of the figures in the

financial statements those figures should be properly analyzed using a financial tool known

as “ratios”.

5. WHAT ARE FINANCIAL STATEMENTS

Financial statements show from where a company’s money came from, where it went, and where it is now. Financial statements are a collection of reports outlining the financial

activities of a business, an individual or any other organization. Basically, financial

statements will show transactions relating to incomes and expenses of a business for a

particular period and assets and liabilities of a business as at a particular date. Some of the

information requires little or no analysis to understand. If the income statement shows an

operating loss, the seriousness of that problem is fairly self-evident. However, to

understand the financial conditions of a business from the financial statements, some

analysis or interpretation of same is required.

5.1 Parties interested in financial statements: There are three groups of individuals that

have an interest in financial statement analysis. These groups are:

a) Investors/owners are interested in financial statements to evaluate whether the business

is generating a return on their investments.

b) Bankers usually require that borrowers who have existing businesses to submit financial

statements before granting loans to ascertain the firm’s financial condition and its prospects

for the future.

c) Managers are the group that has the most interest in financial statement analysis as they

need to discover quickly any area of mismanagement and deviations from the original plans

so that corrective action can be quickly taken.

5.2 Types of financial statements: The types of financial statement a business may prepare

will vary according to the size, type, industry and ownership of the businesses. However,

any business will prepare at least three types of financial statements. These three types of

financial statements are:

a) Income statement

Income statements are also known as Profit and Loss or P&L Account. The income

statement shows all items of income and expenses of a business. It reflects a specific time

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period such as week, month, quarter and one year. So, an Income Statement/Profit & Loss

Account for the 12 months period ended 31st December 2014 will show revenue and

expenses for January to December in 2012 period. An income statement is a report that

shows how much revenue a firm has earned over a specific time period (usually for a year or

some portion of a year). An income statement also shows the costs and expenses associated

with earning that revenue. The literal “bottom line” of the statement usually shows the

company’s net earnings or losses. This tells you how much the company earned or lost over the period.

b) Balance sheet

Accounting is based upon a double entry system - for every entry into the books there has

to be an opposite an equal entry. The net effect of the entries is zero, which results in books

being balanced. The proof of this balancing act is shown in the balance sheet when Assets =

outside Liabilities + Equity. The balance sheet shows the financial health of a business from

day one to the date on the balance sheet. Balance Sheets are always dated on the last day

of the reporting period. If the starting date of a business is say on 1st January 2008 and if

the balance sheet is dated 31st December 1014, the balance sheet will show the results of

operations of the business from 1st January 2008 to 31st December 1014.The balance sheet

provides detailed information about a company’s assets, liabilities and shareholders’ equity. Some of the balance sheet items are explained below: The balance sheet provides detailed

information about a company’s assets, liabilities and shareholders’ equity. Some of the balance sheet items are explained below:

i) Assets of a business are of two types; namely current assets and fixed assets. Fixed assets

are those assets used to operate the business but that are not available for sale, such as

land building, plant & machinery, trucks and office furniture. Current assets are assets that a

business expects to convert in to cash within period less than one year. Good examples are

stocks and debtors.

ii) Liabilities are amounts of money that a company owes to others, may be to lenders or

supplies of goods and services. Liabilities are said to be either current or long-term. Current

liabilities are obligations a company expects to pay off within a period of less than one year.

Long-term liabilities are obligations due for payment in more than one year.

iii) Owner’s equity is sometimes called owner’s capital or net worth. It’s the money that would be left if a company sold all of its assets and paid off all of its liabilities. This leftover

money belongs to the owner/s, of the business.

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c) Statement of Cash Flows

The statement of cash flow shows the ins and outs or receipts and payments of cash during

the reporting period. The difference between the profit and loss statement and a statement

of cash flows is that profit and loss statements take in to account all the incomes and

expenses relevant or applicable to that period irrespective of whether the business has

actually received incomes or paid for the expenses incurred. Items that don’t immediately affect cash such as depreciation, accounts receivable and accounts payable are treated as

non-cash items and will not appear in cash flows but will appear in profit and loss

statements. While an income statement can indicate whether the business has made a

profit or loss, a cash flow statement can only indicate whether operation during the

reporting period had generated a cash surplus or a deficit. The cash surplus does not mean a

profit and also a cash deficit does not mean a loss. It uses and re-arrange the information

from the balance sheet and income statement of the business.

6. WORKING CAPITAL: This is the amount of money required to finance the operations of a

project up to the point of generating a cash surplus from operations. This is also known as

working capital cycle or cash to cash cycle. Items included in the working capital cycle are:

i). Stocks of raw material (Including materials in transit, if any)

ii). Work-in Progress

iii). Stock of Finished goods

iv). Debtors

Minus

v). Creditors

vi). Short term borrowings/Overdrafts

The first four items (i-iv) shown above are known as current assets and the total of current

assets is known as Gross Working Capital. Items shown under v and iv are known as current

liabilities. The difference between the Gross Working Capital (ie total current assets) and the

total current liabilities is known as Net Working Capital .Thais is the amount that should be

taken in to the computation of Cost of Project.

7. BREAKEVEN POINT:

Investors and bankers also use Breakeven Analysis to ascertain the level of risk involved in a

business The breakeven point is the level of revenue of a business where total revenues

equals total expenses. In other words, the break-even point is the situation where a

business achieves the same amount of revenues which equals the total expenses of that

business during a manufacturing process or an accounting period. Since the revenue equals

expenses the profit for the period will be zero. At this level of operations the Business didn’t lose any money during the period, but it also didn’t make any profit either. It simply broke even. If the BEP is high the risk of that business will be high and vice versa.

XXXI

XXXII

- LECTURE NOTE 02

1.1 ANALYSIS OF FINANCIAL STATEMENTS (Continuation of analysis of first C)

Financial statements analysis is the process of examining relationships among elements of

the financial statements and making comparisons with relevant information. It is a valuable

tool used by investors, creditors, financial analysts, owners, managers and others in their

decision-making process. In order to explain the analysis of financial statements a case study

has been used. For this purpose, the Profits and Loss statements of ABC LTD for 3 years

ended 31st December 2012, 2013 and 2014 and the balance sheets as at end of these 3

years has been used. There are several methods to analyze financial statements. The widely

used three methods of analysis are horizontal analysis, vertical analysis and ratio analysis.

The first two methods of analysis are mainly used by managers as a management tool to

monitor the operations of the business. Lenders, investors and other outside interested

parties mainly use the third method of analysis, for their purposes. Bankers are more

interested in the ratio analysis and hence only a detailed description of ratio analysis is

carried out here. For the purpose of analysis, a typical Balance Sheet and a Profit and Loss

statement are given in attachment 01 and 02

1.2 RATIO ANALYSIS

In the ratio analysis of financial statements, the credit analyst examines the relationships

between items in the financial statements. Financial ratios illustrate relationships between

different aspects of the operations of a business and provide relative measures of its

conditions and performance. A ratio is a simple mathematical expression of the relationship

of a numerical number with another. Financial ratios may provide clues and symptoms of

the financial condition and indications of potential problem areas. Financial ratios generally

hold no meaning unless they are compared against something else, like past performance,

another company/competitor or industry average. Thus, the ratios of firms in different

industries, which face different conditions, are usually hard to compare. Financial ratios can

be calculated based the profit and loss statements or balance sheets or combining both

statements.

1.3. DIFFERENT TYPES OF FINANCIAL RATIOS

The financial ratios can be broadly categorized in to 5 as shown below:

a) Profitability ratios

b) Efficiency ratios

c) Liquidity ratios

d) Gearing ratios/Financing ratios

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a) Profitability ratios

One of the most important measures of the success of a business is its profitability. There

are 4 commonly used financial ratios. These 4 types of profitability ratios and how to

compute them are described below using the profit and loss statements given as

attachment 01 of this document

i) Gross profit to Sales Ratio:

This is also known as gross profit margin. This ratio tells us something about the business's

ability consistently to control its production costs or to manage the margins its makes on

products it manufactures or buys and sells. Whilst sales turnover value and volumes may

move up and down significantly, efficient businesses will endeavor to maintain the gross

profit margin constantly or increasing it. A small increase (or decrease) in the gross margin

can produce a substantial change in overall profit .Formulae for the Gross profit to turnover

ratio is as follows:

Gross Profit X 100 = Gross Profit Margin (%)

Turnover

Using the Profit and loss statements in the attachment 01, the gross profit ratio for ABC LTD

can be calculated as follows:

Year ended 31st December 2012 2013 2014

Gross Profit 950 x100 = 38.0% 497x 100 =17.8% 973x 100 =30.4%

Turnover 2500 2800 3200

The gross profit margin has dropped substantially from 38.0% in 2012 to 17.8% in 2013.The

analyst should find reason for this. By analyzing at the items between the turnover and the

gross profit, the analyst will be able to find the reason .In this case the main reason for the

drop in the gross margin is the increase in the cost of raw materials consumed. The cost of

raw materials consumed as a percentage of sales have increased from 38% in 2012 to 53.6%

in 2013.The analyst should find reasons for this and make sure this increasing trend will not

continue. This ratio has come down to 40.6% in 2014.The management have taken steps to

arrest the adverse trend.

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ii) Net profit to sales ratio:

This ratio is also known as net margin. This ratio shows the net margin the business is

earning on its sales. If the gross margin of a business is constant over the period, the

operating profit margin shows the analyst ability of the business to control its other

operating costs or overheads shown between the gross profit line and the net profit line.

Formulae for the net profit to sales ratio is as follows:

Net Profit X 100 = Net Profit Margin (%)

Turnover

Using the Profit and Loss statements in the attachment 01, the net profit ratio for ABC LTD

can be calculated as follows:

Year ended 31st December 2012 2013 2014

Net Profit 477 x 100 = 19.1% 87x 100 =3.1% 520 x 100 =16.3%

Turnover 2500 2800 3200

The net profit to sales ratio of ABC Ltd has dropped from 19.1% in 2012 to 3.1% in 2013. The

examination of expense items between gross profit and the net profit reveals that the

business has been able to manage efficiently these expense items and the reason for the

drop is the increased cost of raw materials consumed which resulted in the drop of the

gross margin.

iii) Return on capital employed (ROCE):

ROCE is sometimes referred to as the "primary ratio"; it tells the analyst what returns the

management has made on the resources use in the business made available to them before

making any distribution of those returns to providers of capital. The formulae for the ROCE

ratio are as follows:

NP+ Int LT x 100 = ROCE (%)

Equity +Term loans

Using the Profit and loss statements in the attachment 01 and balance sheets in attachment

02, the ROCE ratio for ABC LTD can be calculated as follows:

XXXV

2012 2013 2014

477+120 x 100 =36.7% 87+100 x100 = 11.6% 520+80 x 100 =26.3%

1227+400 1314+300 2084+200

Different analyst use different methods of calculating the above ratio. Some include even

the short term borrowings as part of the total capital employed. However, the above

calculation includes only the term funds as total capital employed. If we include short term

borrowings, then it is necessary to adjust return figure by including interest on such short

borrowings. Some analysts take the average of the capital employed (capital at the

beginning of the year +capital at the end of the year/ 2).Some analysts add back tax to net

profit and do not treat it as a cost to the business. Return on Capital Employed should

always be higher than the Weighted Average Cost of Capital (WACC)

iv). Return on equity (ROE):

The amount of net income expressed as a percentage of owner’s equity. Return on equity measures a firm’s profitability by revealing how much profit a firm generates with the

money owners have invested. Some industries have high return on equity because they

require less capital invested. Other industries require large investments. It is not a fair

conclusion that the industries with a higher Return on Equity ratio are better investment

than the lower ones. Here the analyst should inquire in to the environment within which the

industry operates. Generally, the industries which are capital-intensive and with a low

return on equity have a limited competition .Entry may be difficult. But, the industries with

high return on equity and small assets bases have a much higher competition because it is a

lot easier for new comers to enter. The formula for the ROE ratio is as follows:

Net profit x 100 = ROE (%)

Equity


2, the ROE ratio for ABC LTD can be calculated as follows:

2012 2013 2014

477 x 100 = 38.9% 87 x 100 = 6.6% 520 x 100 =24.9%

1227 1314 2084

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b). Efficiency Ratios:

These ratios are also known as Activity Ratios measure how rapidly and efficiently the

business converts current assets such stocks and debtors in to sales. Activity ratios can

provide a firm with information on historical trends, enabling it to implement changes if

necessary. These ratios also help investors and managers keep track of how well a firm is

performing in comparison to other firms in the industry. There are 5 widely used efficiency

ratios. These 5efficiency ratios are discussed below.

i) Stock turnover ratio:

This ratio is generally computed only for finished goods stocks meant for sale and not for

raw material stocks meant for internal use. The stock turnover is an activity ratio that

measures the number of times on an average the trading stock is sold and replaced. A low

stock turnover ratio is a signal of inefficiency. This may be due to various reasons such as

problems encountered in selling, over stocking or obsolete stocks. Higher ratio resulting

from strong sales is good indicator. Higher stock turnover ratio does not necessarily imply a

good situation. A higher ratio sometimes can be a result of ineffective buying of stocks. If

the firm buys too often in small quantities it will be expensive and the firm will lose bulk

discounts. Keeping high level of stocks is expensive while low level of stocks may result in

losing customers. Hence, the management should decide the best appropriate level of

stocks for the smooth running of the business. The formula for the stock turnover ratio is as

follows:

Cost of goods sold = Stock Turnover Ratio (....Times)

Average Stocks


2, the stock turnover ratio for ABC LTD can be calculated as follows: (Since we do not have

figures for 2001, average figures for 2012 cannot be calculated. Hence year end figure has

been used for 2012)

2012 2013 2014

1550=10.3 times 2303 =14.1 times 2227 = 12.5 times

150 162.5 177.5

The cost of sales is the cost incurred in acquiring goods or cost incurred in manufacturing

them. It is the difference between sales and gross profit. Ratio for 2013 is unusually high

due to the high cost of sales (due to high cost of raw materials consumed) and almost same

level of stocks. In reality if the cost of sales is high the value of stocks also should be high. If

XXXVII

we use the rule of thumb mentioned above (i.e. Gross margin x Stock turnover ratio =More

than 100) this ratio seems to be very satisfactory.

ii) Stock resident period:

The stock resident period indicates the average number of days that stock is held for by the

business after it is purchased or manufactured in house. A firm needs to carefully plan and

manage its stock levels. Ideally, it must avoid tying up too much money in stock, yet the

stock levels must always be sufficient to meet customer demand. A change in the stock

resident period can be a useful indicator of how well a company is doing. A lengthening in

the stock resident period may indicate a slowing down of trading or an unnecessary buildup

of stock. The formula for the ratio is as follows:

Number of days for the year (365 days)

Stock turnover ratio



figures for 2011, average figures for 2012 cannot be calculated. Hence year end figure has

been used for 2012)

2012 2013 2014

365= 36 days 365= 26 days 365 = 30days

10.3 14.1 12.5

The ratio appears reasonable. The Firm collects debt within a period of around one month.

iii) Debtors Turnover ratio:

Some firms make their sales entirely for cash and some firms entirely on credit. There are

some firms make a part of their sales for cash and a part on credit. Ratio is applicable only

for credit sales. If all sales are cash this ratio is not relevant .Most firms offer their

customers credit in order to increase their sales. However, giving credit to customers incurs

an opportunity cost as the cash is tied up in financing debtors, and there is also the risk of

the debts not being paid. Therefore, Firms will normally seek to collect their debts as soon

as possible. The formula for the stock turnover ratio is as follows:

Debtors turnover ratio = Credit sales

Average Debtors

XXXVIII


02 and assuming that all sales are on credit, the Debtors Turnover Ratio for ABC LTD can be

calculated as follows: (Since we do not have figures for 2011, average figures for 2020

cannot be calculated. Hence year end figure has been used for 2010)

2012 2013 2014

2500 =16.6 times 2800= 22.0 times 3200 = 18.3 times

150 127.5 175

Debtors’ turnover ratio indicates the number of times the debtors are turned over within a

year. The higher the value of debtors’ turnover ratio the more efficient is the management of debtors or more liquid the debtors are. Similarly, low debtors turnover ratio implies

inefficient management of debtors or less liquid debtors. It is the reliable measure of the

time of cash flow from credit sales. There is no rule of thumb which may be used as a norm

to interpret the ratio as it may be different from firm to firm.

iv). Debtors collection period:

The debtors’ collection period (in days or months) provides an indication of how successful

(or efficient) the debt collection process of the firm has been. It measures the number of

days or months that it takes a firm on average to collect their debts. Firms often allow a

period of credit to their customers, but it is important for their cash flow that they do not

take too long to collect their debts. The length of the collection period indicates the

effectiveness with which a firm's management grants credit and collects from customers. A

short period is desirable because the firm obtains cash more quickly for use in the business.

The formula for the ratio is as follows:

Number of days for the year = Debtors collection period

Debtors’ turnover ratio



figures for 2011 average figures for 2012 cannot be calculated. Hence year end figure has

been used for 2012).

2012 2013 2014

365 =22 days 365 = 17 days 365 =20days

16.6 22.0 18.3

The ratio appears reasonable. The Firm collects debt within a period of around 20 days.

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c) Liquidity ratios

Liquidity of a firm refers to the amount of cash it can generate quickly to settle its current

liabilities when there is a demand from the creditors or lenders of short term debts. Current

liabilities of a business ( items such as accrued expenses ,trade creditors and short term

borrowings ) are normally payable on demand .A reasonable level of liquidity is essential to

meet such demands .The firms either should have cash or other current assets (such as

stocks and debtors) which can be converted to cash without a much delay or a loss. If the

firm does not have sufficient cash or current assets it will be compelled to dispose of fixed

assets to

meet the demand from creditors disrupting the smooth operations of the business. The

poor liquidity management is one of the main reasons for business failures.

There are two commonly used liquidity ratios .These ratios are discussed below:

i) Current Ratio:

The current ratio compares a company’s liquid assets (ie cash and those assets held which will soon be turned into cash) with short-term liabilities (payables/creditors due within one

year). The higher the ratio more liquid is the firm. As liquidity is vital, a higher current ratio is

normally preferred to a lower one. However, a very high ratio may suggest that funds are

being tied up in cash or other liquid assets which assets are not earning any return. Caution

should always be exercised when trying to draw definite conclusions on the liquidity of a

firm the current ratio use figures from the balance sheet. The balance sheet is only a

‘snapshot’ of the financial position at the end of a specific period. It is possible that the

balance sheet figures are not representative of the liquidity position during the year. This

may be due to exceptional factors, or simply because the business is seasonal in nature and

the balance sheet figures represent the cash position at just one particular point in the

cycle. When analyzing the current ratio the analyst should pay the attention to the quality of

the current assets used in the calculation. The firm might have very high level of stocks and

debtors giving a very high current ratio but if the stocks are unsalable or if the debtors are

uncollectable such current ratios do not reflect the actual liquidity position of the business.

The formula for the ratio is as follows:

Current assets = current ratio

Current Liabilities


02, the Current ratio for ABC LTD can be calculated as follows:

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2012 2013 2014

912 = 4.9 : 1 1009 = 5.2 :1 1429 = 7.7 :1

195 245 185

Generally the bankers expect a business to maintain a current ratio of 2:1.The ABC LTD has

more favorable ratios throughout.

ii) Acid test ratio:

A stricter test of liquidity is the acid test ratio (also known as the quick ratio) which excludes

stock as a current asset. This approach can be justified because for many firms, the stocks

cannot be readily converted into cash. In a period of severe cash shortage, a firm may be

forced to sell it’s at a discount to ensure sales incurring massive losses. Like in the case of current ratio, Caution should always be exercised when trying to draw definite conclusions

on the liquidity of a company, as acid test ratio use figures from the balance sheet. The

balance sheet is only a ‘snapshot’ of the financial position at the end of a specific period. It is possible that the balance sheet figures are not representative of the liquidity position during

the year. This may be due to exceptional factors, or simply because the business is seasonal

in nature and the balance sheet figures represent the cash position at just one particular

point in the cycle. When analyzing the acid test ratio, the analyst should pay attention to the

quality of the assets used in the calculation. The firm might have very high level of debtors

and other current assets giving a very high current ratio but if the debtors are uncollectable,

such acid test ratios do not reflect the actual liquidity position of the business. The formula

for the ratio is as follows:

Current assets-stocks = current ratio

Current Liabilities


2, the Acid test ratio for ABC LTD can be calculated as follows:

2012 2013 2014

Current assets 912 -160=4.0:1 1009 -315= 3.6:1 1429-348=4.4:1

Current liabilities 185 195 245

The above ratio shows for one MVR worth of current liability how many MVR worth of

current assets are available. In the above example in 2012 , the company has had MVR 4.0

worth of current assets to meet MVR1.0 worth of current liabilities. Generally the bankers

expect a business to maintain an acid test ratio of 1:1.The ABC LTD has more favorable

ratios throughout.

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d) Gearing ratios

Gearing ratios concentrate on the effect of the capital structure on the business. The ratio

compares owner’s equity with borrowed funds. Gearing is a measure of financial leverage, demonstrating the degree to which a firm's activities are funded by owner's funds versus

creditor's funds. The more leverage a firm has, the riskier that firm may be. As with most

ratios, the acceptable level of leverage is determined by comparing ratios of like businesses

in the same industry. A firm with high gearing (high leverage) is more vulnerable to

downturns in the business cycle because it must continue to service its debt regardless of

how bad sales are. A larger proportion of equity provides a cushion and is seen as a measure

of financial strength. There are two commonly used gearing ratios. These two ratios are

discussed below:

i) Debt/Equity ratios:

The debt /equity ratio (also known as gearing ratio) measures the extent to which a firm is

financed by outside parties. The level of debt/equity in a firm is an important factor in

assessing risk profile of a business. A firm that has borrowed money obviously has a

commitment to pay future interest charges and make capital repayments. This sometimes

becomes a financial burden and possibly increases the risk of insolvency. Most firms will

always have debt financing to some extent. The debt/equity ratio measures the firm’s commitments to its long-term lenders against the owner’s equity.. The formula for the ratio is as follows:

Total term loans =Debt: equity ratio

Total term funds (Total term loans+ equity)


2, the Debt: equity ratio for ABC LTD can be calculated as follows:

2012 2013 2014

Total term loans 400 = 22:78 300 =19:81 200 =9:91

Total term loans+ equity 1812 1614 2284

In the above example in the year 2012 of the total capital employed (equity + term loans)

,22% is debt finance while 78% is equity financed. Generally, acceptable Debt: equity ratio

for a SME project is around 70:30 at the time of financing. From the above ratios it can be

said that the ABC LTD is a highly low geared firm. Financing of such a firm has very low risk.

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ii) Debt Service Cover Ratio (DSCR):

Debt service cover ratio essentially measures the repayment capacity of a borrower. This

ratio suggests the capability of the cash profits of a business to meet the repayment of the

loan with interest due. Just a year’s analysis of DSCR does not lead to any concrete

conclusion about the debt servicing capability of a firm.A DSCR of one indicates that a

company's net cash flow is just sufficient to cover its periodic debt service payments. DSCR

of greater than one is always preferable and correlate more strongly with a company's

ability to repay its outstanding debts. Conversely, values of less than one indicate that a

company is unable to generate income sufficient enough to cover its payments. The formula

for the ratio is as follows:

PBID- Tax = ...times

Interest on term loans+ Installment


02, the DSCR ratio for ABC LTD can be calculated as follows:

2012 2013 2014

750-53 = 5.8times 297-10 =1.4times 758-58= 3.9 times

120+100 100+100 80+100

The acceptable minimum DSCR for a SME project is around 1.2 times. From the above ratios

it can be said that the DSCR of ABC LTD is substantially high (except in 2011) as the firm is

low geared. More money is left to owners as they have provided more money to the firm

when compared with lenders. Financing of such a firm has very low risk. The interpretation

of the ratio should be done linking it the firm’s Debt: Equity ratio. If the firm is low geared it

will have a higher DSCR and I fit is high geared it will have a low DSCR.

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- LECTURE NOTE 03.

1. ASSESSMENT OF REPAYMENT CAPACITY (2nd C)

1.1. Cash flow approach: Assessment of a borrower to repay what he borrowed is done

based on future cash flows of the business. This is the approach adopted in SME lending.

The primary security in SME lending is the future cash flows of the business and hence

estimating the future cash flows of the business is the most important task in SME lending.

Generally in SME lending the lenders will note has the comfort of immovable collateral. The

estimated cash flows should be realistic and reliable as the entire decision is based on these

cash flows. In order to estimate the future cash flows, the lending officers need to go

through a process called project appraisal to gather the necessary information to estimate

the cash flows. Using the estimated cash flows the lending officer need to calculate some

ratios called viability ratios to ascertain whether the business/project is financially viable

and whether it has the capacity to service its debt commitments. The main ratio that

indicates whether the borrower is capable of servicing its debt commitments is known as

Debt Service Cover Ratio (DSCR).

1.2 Debt Service Cover Ratio: Capacity refers to the borrower's ability to generate sufficient

earnings from the business to promptly service his current and future financial obligations

to outside parties keeping an adequate margin for his personal needs and family obligations,

capital replacements and accumulation of reserves for adversity. Capacity can also be

defined as the management’s ability to generate adequate excess cash to meet all internal and external obligations. With the emphasis on cash, some commercial lenders refer to

capacity simply as cash flow. Bankers can resort to two sources of repayment; namely the

primary source and the secondary source. Primary source is the cash generated from the

earnings of the business and the secondary source is the cash generated from the sale of

collateral. However, for an efficient banker, the capacity means only the capacity of the

primary source of repayment .At the time of the credit decision, the banks never consider

collateral as a source of repayment. Cash flow has therefore become synonymous with

capacity and it is the quantitative determination of one’s ability to service a debt.

Once the lender is satisfied with the EBIDA estimation, it will be compared with the current

debt obligations (capital installments and interest payments fallen due for the period) of the

business. When revolving lines of credit are present, the lender may use the interest due on

the average outstanding balance. However it will be more prudent to calculate the interest

payment as if the line of credit is fully utilized. The resulting ratio is called the Debt Service

Coverage Ratio (DSCR). The DSCR is simply EBIDA/Interest + installments. In most cases, the

lender will want cash flow from operations to exceed debt service by at least 20 percent.

Therefore the DSCR should be greater than 1.20 times. What this mean? If the net cash flow

of a business is 120 ,the borrower needs 100 to service debt ( 120/100 =1.2 times) and he is

left only with 20 to meet other requirements such as building reserves for adversity,

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replacement of capital assets and also as a return on his investment. However, the

minimum DSCR required will vary from borrower to borrower depending on the other

aspects of the borrower. Gearing of the borrower is one such aspect, the banker should

consider in deciding the acceptability of the DSCR. If the borrower is very high geared (i.e.

more debt compared with debt) DSCR of 1.2 times may be acceptable. However, if the

borrower has more equity when compared with debt DSCR should be higher than 1.2 times

as 20 left for him may not be adequate to compensate his high equity.

2. FINANCIAL PROJECTIONS:

As mentioned above, the capacity of a borrowing enterprise is calculated based on the

future cash flows or projected cash flows of the enterprise. The lending officers should

therefore be very conversant with how to prepare future cash flows of a business. In

estimating the amount of cash available for debt serving the, lending officer should take in

to account all inflows and outflows (Capital and recurrent). The requests from an enterprise

for a loan is always either to finance an expansion of an existing business or to finance a

new venture. In both situations, the bank will treat the expansion or the new venture as a

"Project". In order to assess the future cash flows of a business, the banker need to go

through a long process examining and analyzing in detail several areas relating to the

project. The information collected during appraisal of these areas, the banker collect

information and data relevant to the project and in the financial appraisal convert these

information and data in to monetary values. The end result of estimating the monetary

values of a project is the future cash flow of that project.

2.1 Project Appraisal. The decision whether to approve or reject a loan to finance a project

is based on a detailed appraisal of the project. Appraisal of projects involves a careful

checking of the basic data, assumptions and methodology used in project formulation, an in-

depth review of the work plan, cost estimates and proposed financing, an assessment of the

project's organizational and management aspects, and finally the validity of the financial,

economic and financial benefits expected from the project. On the basis of such an

assessment, a judgment is reached as to whether the project is technically sound,

economically desirable and financially viable. The main areas to be appraised when a project

is considered for financing

a) Market Appraisal: The first step in project appraisal is to ascertain whether the product

or the service to be sold by the borrowing enterprise has a market and whether they are

capable of selling the product/service in that market. This is known as market appraisal and

the objective of market appraisal is to find out;

- The quantity that the borrowing firm can sell

- The price at which that quantity can be sold

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In order to find answers to the two basic questions raised above, the bankers need to

understand few other concepts in marketing. The products that are sold in the market place

can be categorized in to three types namely;

- Consumer products (end product consumed by consumers)

- Intermediate products (used as raw materials/inputs to produce a consumer product)

- Capital goods (such as plant and machinery used to produce consumer or intermediate

goods).

The market is the place where sellers and buyers meet and negotiate buying and selling

transaction. The market can be a physical place where buyer and seller meets faced to face

or it can be electronic or other media on which the transaction is negotiated and concluded.

Online buying and telemarketing are very common these days. There are 4 types of markets

where the goods and services are sold. Types of markets are:

- Single buyer markets (There is only one buyer for the products of the project)

- Regional market (product/service is sold only in the area where the project is located)

- National market (Product/service is sold throughout the country)

- International market (product/service is sold in the overseas market).

In order to undertake a proper market appraisal, the banker should know the type of the

product to be produced and also the type of the market in which the product is to be sold.

The market analysis consists of the analysis of 4 Ps relating to the product/service. The four

Ps, often referred to as the marketing mix, are all constrained by internal and external

factors in the overall environment. The market analysis is carried out under the following 4

Ps.

i) Product

ii) Price

iii) Place

iv) Promotion

i) Product:

When analyzing the product, the banker should first examine the followings relating to the

product

- What does the customer wants from the product/service?

- What needs does it satisfy?

- What features does it have to meet these needs?

- How and where will the customer use it?

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- What does it look like? How will customers experience it?

- What size(s), color(s), and so on, should it be?

- How is it branded?

- How is it differentiated versus competitors?

- What is the most it can cost to provide, and still be sold sufficiently profitably? (See also

- Price, below).

Once the product features are identified the analyst estimates the demand for and the

supply of the product in the market where the product is to be sold. As mentioned earlier

the market may be single buyer, regional, national or international. There are various

methods to estimate the demand for a product .Main methods used in estimating the

demand for a product are:

- Trend analysis-Extrapolation

- Moving average method

- Per capita consumption method

Once the demand for product is estimated, the analyst should look at the supply side to

determine the present level of supply .In determining the supply for product the analyst

should look at the following areas:

- Imports

- Local production

- Present capacity mutilation

- Plans for capacity expansion

- Increase expected in the consumer base.

Based on the above estimates, the analyst estimates the difference between the demand

and the supply. The difference can be a Gap meaning that the estimated demand is higher

than the estimated supply. Here a new project can be justified. Sometimes the difference

can be a surplus meaning estimated supply is more than the estimated demand. If this is the

situation, a new projector an expansion of an existing business cannot be justified. If the

estimated demand consist of imports and the surplus is mainly due to imports, still anew

project can be justified provided the new project is capable of substituting imports. At the

end of this analysis the analyst should estimate the share of the market gap the new project

is planning to capture. The borrowing enterprise should have a strategy to capture that

market share.

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ii) Price:

Once the market share for the project is estimated, a price for the product/service should

be determined. Pricing is one of the most important elements of the 4 Ps as it is the only

factor which generates a turnover for the organization. Pricing is difficult and must reflect

supply and demand relationship. Pricing a product/service too high or too low could mean a

loss of sales for the organization. When deciding a price for a product/service, two basic

factors should be taken in to considerations. These two factors are:

- Cost of Production

- Competition

A suitable price should be within these two boundaries. The pricing strategy of an enterprise

will depend on what objectives the firm has set to achieve. Different methods of pricing are

described below:

- Penetration Pricing: The firm sets a low price initially to penetrate the market and catch a

market share. Once a market share is captured the price will be gradually revised upward.

The cost production will be ignored initially.

- Skimming Pricing: The firm initially sets a very high price and skims the market making

very high profits before the competition sets in. Once the competition is set in price will

be gradually reduced and the product will be made available to a wider market

- Competition pricing: A price is set taking in to account the price of competitors. Bench

mark for the price is the price of the competitors. The price set can be higher, lower or

equal the price of competitors.

- Premium Pricing: The price set is higher than the market price to create an impression

that this product is superior to the other products available in the market. Premium

pricing will create exclusiveness.

- Cost plus pricing: The firm adds a percentage or a mark-up to the cost of production and

fixes the price.

- Return on Investment: The firm first decide the Return on investment (ROI)it wants (say

20%) and convert it to monetary value (say MVR 10.0Mn).If the sales volume of the

business is , say 250,000 units, each unit should have a mark –up of MVR 40.00.

iii) Place:

Although figures vary widely from product to product, roughly a fifth of the cost of a

product goes on getting it to the customer. 'Place' also known as distribution is concerned

with various methods of transporting and storing goods, and then making them available for

the customer. Getting the right product to the right place at the right time involves the

distribution system. The choice of distribution method will depend on a variety of

XLVIII

circumstances. Methods of distributing a product will vary from firm to firm and from

product to product. Main methods of product distributions are:

- Ex-factory –buyers will have to come to the factory to buy the product

- Whole sellers- producer will distribute the product to its appointed agents or whole

sellers.

- Retailers-producer will distribute the product to retailers

- Own out lets-Producer will sell the product through its own outlets.

Or

- Combination of two or more of all methods mentioned above.

iv) Promotion:

Promotion is the means of communicating with customers. The effective communication

will provide information that will assist them and influencing them in making a decision to

purchase a product or service. This is the strategy the firm will follow to reach and influence

its customers to by its products over other products available in the market. The strategy

may include advertising, promotional campaigns or personal selling. The cost associated

with promotion or advertising goods and services often represents a sizeable proportion of

the overall cost of producing an item. However, successful promotion increases sales so that

advertising and other costs are spread over a larger output.

In conclusion it can be said that to be a right marketing mix, it should have the following

features:

- The product has to have the right features - for example, it must look good and work

well.

- The price must be right. Consumer will need to buy in large numbers to produce a

healthy profit.

- The goods must be in the right place at the right time. Making sure that the goods arrive

when and where they are wanted is an important operation.

- The target group needs to be made aware of the existence and availability of the product

through promotion. Successful promotion helps a firm to spread costs over a larger

output

b) Technical Appraisal: By appraising the market, the credit analyst could find out the

demand for the product or the quantity that can be sold and the price at which that quantity

can be sold. Through the Technical appraisal we try to find out;

- How to produce the product

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- What will be the cost of production

The first step in technical appraisal is the selection, development or identifying the most

suitable and cost effective way of producing the product. The way of producing the product

is called the “production Process”. Production process is a planned series of actions or operations through which raw materials are transformed or converted into a final product.

Once the production process and the list of machinery are finalized, a layout for the

installation of machinery has to be designed in a manner to achieve the maximum

efficiency. A proper machinery layout will reduce the wastage, time taken and the

bottlenecks. The production process can be labor incentive or capital incentive. If more

labor is to be used in the production process it is said to be labor incentive and if more

machinery is to be used it is said to be capital incentive. In deciding the technology, firms

should take in to account the suitability of the location, availability of utilities, labor and raw

materials. The technology required for projects can be acquired in different ways. If the

project is a traditional one like fishing or rice milling or oil milling or garments , the

technology is freely available . If the product to be produced require specialized ,then it

should be acquired from outside. There are various ways of acquiring the technology. Some

of these are:

- Licensing-paying a royalty

- As part of the package of machinery to be purchased

- Outright purchase

- Through joint ventures

Once the technology and the production process are decided, the next step in the technical

appraisal is to decide the list plant and machinery required to perform the production

process and other ancillary equipment for the factory and other supporting facilities such as

transport and storage.

After the package of machinery required for the project is finalized, the next step in the

technical appraisal is to consider the location and the civil engineering aspects of the project

.In selecting and deciding the location, the following factors should be taken in to account.

- Infrastructure such as roads, telecommunication ,and power

- Facilities such as housing, schools and hospitals for the benefit of workers

- Proximity to the market ,if applicable

- Availability of labor

- Government regulations

- Availability of suitable land and cost of land

- Environmental aspects

L

The technical appraisal should also come out with the machinery lay-out or how to arrange

machinery to efficiently perform the production process. Based on the machinery layout,

the nature and the extent of the building requirement will be decided. In the civil

engineering area the followings should be considered,

- Cost of site development and preparation

- Engineering plans for factory and ancillary buildings such as stores, labs, office and

housing).

- BOQs and cost estimates

- Approval for buildings from authorities

- Methods of constructing buildings (turn-key, labor contract, full priced contract or market

price contracts.)

The technical appraisal should also decide the production program for the project based on

the capacity of the package of the machinery. The production program of a project should

be based on the achievable capacity of the plant. Achievable capacity will be always less

than the rated capacity and achievable capacity will depend on various factors specific to

the project such availability of skilled labor and quality of raw materials. The technical

report should also include an input/output analysis. The appraisal officer should be able to

get from the technical report the types and quantity of inputs (raw materials, labor power

etc.) to produce a unit or batch of the product.

c) Management appraisal: This is the most important input for a project. The success or

otherwise of a project will entirely depend on the management of the firm. If a good project

is badly managed it can become a problem project and if a bad project is properly managed

it can become a good project. The management of a business involves the management of 5

Ms. these 5 Ms. are:

- Management of Market – How efficiently and aggressively products are sold

- Management of Money-How efficiently money is used to maximize profits

- Management of Machinery -Ensure smooth production and cost of production is

managed properly.

- Management of Men- Productivity is maintain while staff welfare is looked after

- Management of Materials –Efficient stock management(FG&RM)

Management appraisal of a SME project consist of two components namely the appraisal of

the entrepreneur (this was done under Character) and the appraisal of the Key managers.

A good entrepreneur should have the following attributes:

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- Ability to take calculated risk

- Perception of market opportunities

- Creativity and innovation

- Desire to change and willingness to change

- Flexibility and adaptability

- Integrity

If the entity is small, the entrepreneur will be able to manage the entity by himself . If the

entrepreneur feels that he is weak in some areas of management he will recruit managers

to look after those areas. Most SME entrepreneurs recruit managers to manage finance

(money) and production machinery).if the entity is large he will have to recruit managers to

manage all 5 areas of management. The number of managers to be recruited will depend on

the capability of the entrepreneur and the size of the entity. Key attributes of a good

manager are listed below:

- Through knowledge of the specific area he is managing

- Clarity of goals and objectives

- Ability to plan, staff, implement and monitor

- Ability solve problems

- Ability take quick decisions

- Ability motivate and achieve targets

- Ability to lead

d) Financial Appraisal: Based on data collected under market, technical and management

appraisals, the credit officers are to carry out the financial appraisal of the project. This topic

is to be explained using a case study which is attached as an attachment. The financial

appraisal of a project covers four important areas. These four areas are:

a) Estimation of Project cost

b) Structuring a financing plan

c) Financial forecasting –Profit and Loss, Cash Flow and Pro-forma Balance sheet

d) Computation of Viability ratios.

3) ESTIMATION OF CAPITAL COST:

The total cost of a project consists of three major components. These components are:

i) Capital cost - Cost of all fixed assets such as land, buildings, Plant & Machinery, Furniture

& Fittings, motor vehicles and all other fixed assets.

ii) Preliminary& Pre-ops - All expenses which may incur during project Implementation and

start-up including initial losses (if any)

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ii) Net Working Capital - Money required financing raw materials and other Operational

expenses until cash is generated from sales (working capital cycle).

The proper estimation of cost of project (i.e. the total amount of money required to

implement the project until project generates sufficient cash (to be self-financed) is very

important due to the following reasons

- As a pre-requisite for a proper and realistic financial analysis

- To avoid under estimation and resultant cost overruns

- To avid over estimation and resultant excess financing

- As a guide for the project implementation

Main items that will include in a typical new manufacturing business would be as follows.

These will vary from project to project.

Land: The appraisal officer in consultation with other technical people should decide

whether the land and its location are suitable for the project. in selecting the location, the

bank should take in to account the followings:

- Availability of water, power, roads and other infrastructure facilities.

- Soil conditions

- Environment issues –approval from the relevant authority.

- Availability of labor and other services,

- Extent of the land –The extent of the land should be decided based on the actual needs

of the project. The need should cover the current needs and expansion needs in the near

future.

The appraisal officer should obtain certain documents from the borrower for to estimate

the cost of land to be included in the estimation of capital cost. These documents include:

- Title deeds

- Valuation reports

- Lease agreements if land is on lease

If the land to be used in the project is an inherited property placing a value on it will pose a

problem to the appraisal officer .What is the value the bank should place on such

properties. Different people have different views on this. My personal view is that the

market price of the land should be taken to compute the project cost.

Site development: most of the lands identified for projects require developments and

preparations before buildings are constructed .Activities relating to site development and

preparation will include the followings:

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- Site clearing

- Fencing or building parapet walls

- Excavations

- Filling

- Drainage

- Roads, walkways and paving

- Parking areas

Credit analysts should obtain estimates on above or quotations from contractors or

borrowers..

Buildings/civil works: The nature of the buildings and the extent of the buildings are based

on the machinery layout discussed under the technical appraisal. The types of buildings, a

typical industrial project would want to construct are as follows:

- Factory buildings where the plant & machinery will be installed.

- Administrative office buildings

- Stores and ware houses

- Facilities for employees such as canteens rest rooms

- Maintenance shop or workshop

The credit analyst should obtain the following documents /information from the borrower

on the buildings to be constructed.

- Approved building plans and designs

- Approval from the relevant authorities such as CEA

- Priced BOQs

- Method of construction

- Arrangement for supervision of construction.

The appraisal officer should make sure that the above documents are with then order and

agree with the borrower on the method of construction. There are several ways of

constructing buildings. Main methods are:

- Labor contract –borrower hire labor contractor and supplies all materials and payment

for labor is based on agreed rates.

- Fixed priced contract- Call for quotations from several contractors and select the best

person based on price and the reputation- Total contract value is fixed.

- Variable priced contracts-Prices of main building materials such as cement and steel are

linked to market prices at the time of purchase.

- Turnkey basis-Contractor will do everything hand over the keys to the building to the

owner for an agreed price.

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The banker, with the agreement of the borrower should appoint an Architect to value the

work done for the purpose of disbursements. Based on the method to be used for the

construction of the buildings and also based on the priced BOQs, the appraisal officer review

estimated cost of buildings. Buildings are not productive assets like plant & machinery.

Hence, only the minimum requirement of buildings should be considered in estimating the

cost of buildings. Most SME borrowers want to spend unnecessarily on buildings for prestige

purposes which are not really necessary forgo for operations of the project.

Plant & Machinery: Based on the production process, the technical people should prepare

the list of machinery required for the project. The list should include all items of machinery

required to perform all actions described in the production process. The types of machinery

required for a typical manufacturing project are as follows:

- Production equipment

- Ancillary equipment-(transport, Laboratory, storage, workshop, etc.)

- Service equipment (office, canteen etc.)

- Vehicles.

- Spare parts

The selection and the purchase of machinery and equipment can be done in three different

ways as described below:

- The total package from one suppler-He takes the full responsibility

- Item by item from different suppliers-No one to take the full responsibility

- Turn-key basis

Machinery can be imported (brand new, reconditioned or used), purchased locally or

fabricated locally. Most of the time these will be imported .Under the first method

mentioned above, one suppler will supply all machines. If he does not have all what the

project needs he will arrange with other suppliers, the main supply take the responsibility

and extend all guarantees. The project is responsible for importing, installing and trails runs.

Some projects buy the different items from different suppliers only with the guarantees on

individual items. The projects can acquire machinery on a turn-key basis also. Under turn-

key method, the project will obtain all machinery from one supplier and he will be

responsible for supplying the entire package. Installing it, training the technical people and

carrying out the trial runs. Whatever the method used, it is necessary to call for competitive

quotation from at least 3 different parties to ascertain the reasonableness of the prices

quoted. In estimating the cost of machinery and equipment the appraisal officers should

take in to account the followings:

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- CIF cost of all items to be imported

- Duty and taxes

- Clearing and transport charges

- Technical know-how fees, if applicable

- Installation and trail runs

When deciding on procurement of machinery and equipment, the appraisal officers should

consider the followings:

- Reasonableness of the price and the quality

- Reputation of the supplier

- Availability of spare parts

- If the machinery are to be imported, availability of local agents.

- If the machines are used or reconditioned, valuation and condition reports.

- Reasonable payment schedules

- Performers guarantees linked to payment schedule

Electrical installations: Before the procumbent of machinery and equipment the project

should get a letter from the Electricity Authority or any other relevant authority agreeing to

supply electricity to the project and a quotation indicating the cost of supply.

Vehicles: The requirement of vehicles should be decided based on the type of the business

or the industry of machinery.

Ancillary equipment: costs of these items should be based on competitive quotations.

These should include fixtures & fittings, furniture, computers and any other fixed assets the

project would require.

Preliminary and pre-ops: Preliminary and pre-operative expenses includes all expenses

incurred by the project promoters in promoting and establishing the project. Some of these

items are:

- Cost of feasibility studies

- Company formation and legal charges

- Consultancy fees

- Staff cost incurred prior to commencement of commercial operations

- Cost of trial runs

- Interest on loans and other financial charges prior to commencement of commercial

operations.

- Initial losses, if any.

LVI

Provision for contingencies: A provision for contingencies is necessary to cover likely price

escalations. The price escalations would take in to account the length of the implementation

schedule, firmness of the quotation for buildings and machinery, fluctuations in exchange

rates. Generally, a provision of 10%-15% the identified cost items may be adequate for a

project with an implementation period of 1-1/2 years.

Net Working capital: This is the amount of money required to finance the production of a

project up to the point of generating a cash surplus from operations. This is also known as

working capital cycle. Items included in the working capital cycle are:

i). Stocks of raw material

ii). Work-in Progress

iii) .Stock of finished goods

iv). Debtors

Minus

v) .Creditors

vi). Short term borrowings/Overdrafts

The first four items (i-iv) shown above are known as current assets and the total of current

assets is known as Gross Working Capital. Items shown under v and iv are known as current

liabilities. The difference between the Gross Working Capital (ie total current assets) and the

total current liabilities is known as Net Working Capital. This is the amount that should be

taken in to the computation of Cost of Project.

The case study given in this document (XYZ limited) has given the figures relevant to

estimating the working capital requirement. However, in reality credit analyst should

estimate the working capital requirement of the project he intends financing. A format to

estimate the working capital requirement of a project is given below. The format is for a

typical manufacturing enterprise which seeks loan funding to expand its existing operations.

if the project is a new venture, the first column of the format is to be ignored.

Format to estimate Working Capital:

Item

Existing level

Value in Nu

000

Proposed

Total No. of Days Value

Stocks- RM

-WIP

-FG

Debtors

Gross C/As

Less

Short term

LVII

loans

Creditors

Other

Net Margin

A format to be used in estimating the cost of project (expansion or new) is given below. The

format will vary from project to project. The credit analyst may change the format to suit

the project being appraised. What is important is to include all the cost items in estimating

the total cost of the project.

Item of Cost Existing

in the

Business*

Proposed Total

Land

Site Development

Buildings

Electricity and Water

Plant & Machinery

Fob Price

Insurance & Freight

Duty

VAT

Clearance

Installation Inspection

TOTAL COST OF PLANT & MACHINERY

Furniture & Fittings

Preliminary& Pre-ops

Pre-op Interest

Other pre-ops

TOTAL PRE-OPS

Any other costs(please specify)

Contingencies

Net Working capital

Total Project Cost

LVIII

* This column is applicable only for existing enterprises. Information can be extracted from

the latest balance sheet of the enterprises. In the case of XYZ Ltd , this column is not

applicable.

4. STRUCTURING A FINANCING PLAN/MEANS OF FINANCE

Once the total cost to implement the project is estimated, the Credit Analyst should

determine the most appropriate and cost effective financing plan for the project. Basically

there are three different options available for funding a project.

- Entirely with equity/Share capital

- Entirely with debt

- A combination of both.

The following format can be used to structure a financing plan

SORCES OF FUNDS EXISTING PROPOSED TOTAL

i) Borrower ’ own capital

ii) Borrowings from the applicant Bank

iii) Borrowings from other Banks and FIs

iv) Borrowing from other individuals

Total Funds in the Business

) Debt: Equity Ratio = ii + iii + iv

i + ii+ iii+ iv

LIX

- LECTURE NOTE 04:

PROFITABILITY PROJECTIONS:

The viability of a project is assessed based on the profitability projection which is computed

using a set of assumptions with regard to income and expenditure of the project .These

assumptions are developed using the findings under market, technical, management and

financial appraisal. Using these financial data, bankers prepare three financial statements;

- Projected Profit and Loss statement

- Projected Cash Flow Statement

- Projected Balance Sheet

How to prepare these statements will be discussed using the case study attached (LANKA

LIMITED). The standard formats for these statements are also given with the case study.

PROFITABILITY RATIOS/INDICATORS

Based on the financial projections we compute certain ratios to determine whether the

project is viable or whether it generates a sufficient return on the amount of money

invested on it. Basically there are three groups of people who would want to the viability of

projects. These groups are:

- Investors/entrepreneurs

- Lenders and

- Economic planners/Governments.

The indicators used by different groups to ascertain whether a project is viable or not will

differ from group to group. Different indicators are used by different groups are as follows:

Investors:

- Payback period method -PBP

- Return on Capital Employed -ROCE

-Return on Equity - ROE

- Net Present Value -NPV

- Internal Rate of Return- IRR

Lenders:

- Internal Rate of Return IRR

- Debt Service Cover Ratio DSCR

LX

LXI

Governments:

- Economic Internal Rate of Return EIRR

- Domestic resource cost Ratio DCR

Investors and lenders undertake financial appraisal of projects and compute viability

indicators to decide the financial viability while economic planners/governments use

economic appraisal and economic indicators to decide whether the project is desirable from

the economic point of view. In this lecture we will be discussing only the financial viability of

projects and hence the financial viability ratios are discussed below:

a) Payback Period Method (PBP): Here the investor looks at the minimum period within

which the total investment (Equity + Debt) can be recovered .If an investor wishes to

recover his investment as soon as possible he will use this method or the technique.

Investors who consider investing in projects with high technology which changes rapidly will

look at this ratio to decide whether to invest or not. The weakness of this method is it does

not take into account the profits generated after the recovery period and also the time

value of money. According to this method, the shorter the period for recovery the more

profitable is the project.

b) Return on Capital Employed: (ROCE): This is a measure of the return from the project

irrespective of the financing structure of the project. Generally this ratio is calculated for

period of one year and profits (Profit before interest on long term debt - tax) as a

percentage of total investment (Equity + Debt)

c) Return on Equity (ROE): These measures the annual return the project will generate on

the capital of the investors or owners of the project. The annual net profit is expressed as a

percentage of total equity.

The main weakness of ROCE and ROE is that the calculation does not take in to account the

time value of money. Hence, two other indicators are calculated taking in to account the

tome value of money. These two indicators are Net Present Value (NPV) and internal rate of

Rate of Return (IRR).

d) NPV and IRR: Before we discuss these two indicators we should understand the

concept of time value of money and discounting. (DCF). A fundamental principle in finance

is that money that a person has now is worth more than the same amount of money he

will receive in a future date. This is because if you have money today, that money can be

invested and earn a return and also due to the fact that purchasing power of money

reduces due to price increases or inflation. Hence, we bring down the future value of

money to the value of present day by a technique known as discounting. Discounting is

LXII

based on the concept of time value of money. Discounting is essentially a technique by

which one can "reduce" the future benefit and cost streams to their present worth. The

technique of discounting permits us to determine whether to accept or reject the projects

for implementation. The most common means of doing this is to subtract year by year the

costs from the benefits to arrive at the incremental surplus and then to discount that.

Once the future cash flows have been estimated the appraisal officer should decide the

rate at which the future cash flows should be discounted. How do we figure out the

discount rate to discount the projected cash flow of the project? . A wide variety of

methods can be used to determine the discount rate, but in most cases, appraisal officers

apply the concept of the Weighted Average Cost of Capital (WACC) which a blend of cost

of equity and cost of debt. If the WACC of a business is 20%, the investor will expect a

minimum return of 20& from the project.

NPV: Is simply the difference between the total of annual present values of the cash

surpluses of the project during its life span and the value of the total investment to be

made today. If the discount rate is assumed to be 20% (WACC) and if the difference

between the total of the discounted cash flows and the value of the total investment is

zero, then the Net Present Value of the Project is Zero.

IRR: Is the rate at which the NPV would be is zero. In this example it is 20%. If the net

present value is more than zero and has a positive value then the IRR will be more than

the discount rate of 20% and if the NPV is less than zero and has a negative value then the

IRR is less than the discount rate of 20%.

e) Debt Service Cover ratio (DSCR): When the bankers appraise projects they also use

financial indicators such as ROI, ROE, NPV and IRR. In addition, they also use another

indicator known as DSCR. The ratio will indicate whether the future free cash flows of the

enterprise is adequate to service the debt obligations (Interest and installment).

ECONOMIC CONSIDERATIONS

When Bankers consider large scale projects for financing it is appropriate to undertake an

economic appraisal of the project being considered for finance .The economic appraisal is

more applicable even though it can be done for SMEs too. For the purpose of

completeness, a brief introduction to Economic Appraisal is presented in this document.

Projects which are financially viable will not necessarily economically viable. This is mainly

due to transfer payments. Transfer payments are taxes and subsidies. If a project pays

taxes to the government, it is a cost to the project but not a cost to the economy. Because

the government receives it without adding any value to the project. Similarly, if the

project receives a subsidy from the government, it is an income to the project but not a

LXIII

value addition to the economy. Hence, when we compute economic viability ratios we

adjust the financial profitability removing transfer payments (taxes and subsidies) from

the costs and incomes from financial forecast. We calculate two ratios from the adjusted

cost of project and adjusted profitability forecast. These two ratios are Economic Internal

Rate of Return (EIRR) and Domestic Resource Cost Ratio (DCR).

ATTACHMENT

CASE STUDY- LANKA LTD - FINANCIAL PROJECTIONS

1) Lanka Ltd is a private limited liability company incorporated to start the manufacture of

rubber compounds with a view to supply the entire output to a rubber components

manufacturer. The total capital cost involved in the project is estimated at Rs 4.9 mn as

detailed below:

Rs 000

Land 500

Building, Electricity and water 1,200

Machinery 2,300

Preliminary & Pre ops* 500

Working capital 400

Total project Cost 4,900

*Preliminary and pre-ops includes pre-operative interest Rs 279,000 for 7 months, Company

formation Rs 50,000 ,feasibility reports Rs 50,000 and other preliminary expenses of

Rs121,000*

2).The above project cost is to be financed as shown below:

Rs 000

Share capital from Sponsors 2,150

Term Loan From Bank 2750

Total funding 4,900

LXIV

3). The Company is to commence implementation of the project on 1st January 2017 and

commercial operations to commence on 1st August 2017.

4). The installed capacity of the project is 1,000,000 kg of rubber compounds per annum.

The level of capacity utilization is expected to be 50% during year 01, 55% during year 02,

60% in year 03 , 65% in year 04 and 70% in year 05 and thereafter. The entire production

during a year would be sold during that year.

5). The rubber component manufacturer has agreed to buy the entire production of rubber

compound and to pay Rs 25.50 per kg of compound of acceptable quality. The Borrower

has agreed to provide one month credit to the buyer.

6).The company would be liable to pay VAT at 12.5% of turnover

7). Other taxes on turnover would be 7.5%

8).The raw materials required for the manufacture of rubber compound ( ie Ribbed Smoked

Sheets rubber- RSS)) is supplied by the rubber component manufacturer. However, the

other raw material required (chemicals) will be purchased by the company and the cost of

other raw material would be Rs 2.00 per kg of raw rubber used.

9). An extra provision of 5% of the total other raw materials will be required to meet losses

during the usage

10). Workers employed in the rubber compound manufacture are paid on a piece rate basis.

The rate applicable is Rs 9.00 per kg of rubber compound produced which covers EPF.ETF

etc as well.

11). Based on the proposed production program the consumption of electricity would be as

follows. The unit rate expected to be paid is 9.50 per unit

Year 1 (8

months0

2 3 4 5

No. of Units(KWH) 16,667 27,500 30,000 32500 35,000

LXV

12) Five officers work in the office. They are paid a monthly salary of Rs 25,000 inclusive of

EPF and ETF. As per the employment agreement, they are entitled for an annual salary

increase of 10% effective from 1st April 2018.

13) The factory will be managed by a production supervisor and two other technicians.

Supervisor is paid an all-inclusive monthly salary of Rs 50,000 and a technician is paid Rs

30,000 a month. The annual increment is 10% of the salary effective from 1st April 2018.

14). Depreciation is to be provided at 5% on buildings and 10% on machinery starting from

the financial year ending 31st March 2019

15).Pre-operative expenses to be written-off in equal amounts over a period of 5 years

starting from the financial year ending 31st March 2019.

16).The term loan of Rs 2.75 mn to bear interest at 17.4 % per annum on reducing balance

basis. The loan is to be repaid in equal monthly installments over a period of 5 years after a

grace period of 7 months (Starting from August 2017). The loan is to be released in January

2017.

17).The short term interest to be at 22% .The Company will borrow Rs 500,000 initially for

working capital purposes.

18) Corporate tax to be computed at 35%.

19) Dividend to be paid at 10% from the third year and at 15% thereafter.

20) Based on experience in relation to similar industries it is assumed that the company will

carry raw materials stock for one month, work-in-progress for two weeks, finished goods for

one week and debtors for one month at any given time. Credit is also available from the

suppliers of chemical for one month. Other current liabilities available to finance working

capital is Rs 162,000 .Of the initial Gross Working Capital requirement, around 40% (Rs

400,000) is to be taken to project cost as net working capital. The initial working capital level

will remain unchanged during the 5 year period.

21) The implementation of the project is to commence on 01st January 2017 and

commercial production is to commence on 01st August 2017. The loan is to be disbursed in

LXVI

January and repayments to commence with the commencement of commercial operations

in August 2018.

You are required to prepare the following financial statements for period of 5 years:

a) Profitability Forecast

b) Working Capital Computation

c) Cash Flow statement and

d) Pro-forma Balance Sheet and e) Viability Ratios

LXVII

ANNEXURE 06

APPRAISAL FORMAT

SME LOANS – Above Nu 500,000

SUMMARY SHEET

1. Borrower’s Name

2. Address

3. Business Registration No & Date

4. Type & Organization Proprietorship/Partnership/Ltd

5. Number of Years in Operation

6. Nature of Business

7. Risk Rating & Date of Rating

8. Repayment Record

9. CIB Reference

10. Exposure – Current Loans

Total Exposure

11. Purpose of the current Loan

12. Total Project Cost

13. Debt Equity - Project - Overall

14 Debt Service Cover Ratio

( DSCR)

15. LTV:

APPRAISAL REPORT ON LOAN OF GRANTED TO.............................................................

LXVIII

...................................................................................................................................................

.

1. Name and Address of the Borrower:

2. Introduction (Brief description covering what the business is and its history and

background of Promoters).

3. Borrowing history and Debt Servicing History (For each bank a separate table is to be

included indicating the name of the bank)

Facility Year

granted

Original

Amt

granted

Outstandin

g amount

Repayme

nt Period

Regular or

in arrears

Rate of Int

(%)

i)

ii)

iii)

iv)

4. Past Performance:

4.1 Profit and Loss Accounts: Summarized Profit and Loss statements are given as Attachment 01

of the Annex 03 .Key indicators extracted from the past P & L accounts are given below:

20... 20... 20...

Sales Volumes (no. of units)

Average Selling Prices (Rs/Unit)

Gross Sales

PBID

LXIX

Net Profit before tax

Net profit

Gross Margin

Net Margin

Comments on past Profit & Loss :

4.1.1 Gross Turnover

4.1.2 Gross Profit

4.1.3 Net Profit

4.1.4 Returns (ROCE and ROE):

4.2 Balance Sheets: Summarized past Balance Sheets are given as attachment 02 of Annex 03 Key

indicators extracted from the Summarized B/S are given below:

.

As at 31st.................. 20....... 20...... 20......

Total Assets

Equity

Term borrowings

Short term borrowings

LXX

DSCR

Debt; Equity ratio

Current ratio

Comments on past Balance Sheets

4.2.1 Total Assets (Composition and Trend):

4.2.2 DSCR:

4.2.3 Debt Equity:

4.2.4. Current Ratio:

5. Purpose of the proposed loan:

LXXI

6. Description Proposed Expansion /Project:

6.1 Rational for and description of the expansion /project

6.2. Cost of Expansion/ Project:

Assets to be acquired Existing

(A)

Proposed

Additional

(B)

Total after

Expansion

(A+B)

Land

Buildings

Machinery

Vehicles

Other assets

Pre - Ops

Contingency

Working Capital Margin

Total Investment

6.3. Working Capital Computation:

Item

Existing Level

(A)

From the latest

B/S

No of Days

(Working

capital

norms)

Total Requirement

after expansion

( B)Estimated for

future based on

W/C Norms)

Additional

Requirement

(B)- (A) =(C) .(Amount

to be taken to

estimate fund

requirement)

Stocks - RM

WIP

FG

Debtors

GROSS WORKING

CAPITAL

LXXII

(-) Short term

Loans

Creditors

Other Current

Liabilities

NET WORKING

CAPITAL

*

6.4. Financing of the Expansion/Project:

Sources of Funding Existing (A) Proposed/ Additional

(B)

Total (A)+(B)

= C

a) Borrowers’ Capital

b) Borrowings from PB

c) Borrowings from other sources

d) Total Funding

e) Debt to Equity Ratio

7. Existing and proposed arrangements for the marketing of the products and services

offered:

8. Existing and proposed arrangements for management of the Business

9. Employees: Existing …………… Additional/ Proposed……………… Total...........

10. Financial Projections: Projected profitability forecast, projected cash flow statement

and the pro-forma balance sheets for the next 3-year period are given in the Attachment

03 and 04 respectively of this Appraisal Format (Annex 03).

10.1 List below all the main assumptions used in financial projections:

LXXIII

10.2. Key financial indicators extracted from the projected financial statements for the

next 3 years are given are given below:

Year ended 31st March 20.. 20.. 20..

Gross sales

Profit Before Int, Dep and Tax

Net profit

Gross assets

Equity

Term loans

DSCR

Debt: Equity ratio

Current Ratio (CR)

Return on Investment (ROA)

Return on Equity (ROE)

10.3 Appraisal officers’ comments on the overall viability of the Business:

11. Security and Security Cover (Valuation Reports if any to be attached)

Description Item Value for

security

a).

b).

c).

d).

Total Value of Security

LXXIV

LTV

Note: Primary consideration for lending decision is the capacity of the borrower to repay

assessed based on the projected cash flow. However, BDBL will always obtain

mortgage/s over whatever the available movable and immovable assets of the business.

12. Risks and risk Mitigants:

13 Justification for recommending the loan (Comment on 5 Cs relevant to the borrowing

enterprise:

14. Terms and Conditions

a. Name of the Borrower

b. Loan Amount

c. Rate of Interest

d. Repayment Period (Excluding Grace Period)

e. Grace Period

f. Special Conditions

...................................................................................................

LXXV

...................................................................................................

....................................................................................................

...................................................................................................

Attachment 01 of Annexure 06

Projected Profit and loss statements

Year ending 31st December 20.. 20.. 20..

Gross sales

Net sales

Less: Variable Expenses

Raw Materials

Labor Wages

Production Expenses

Gross Profit

Less:

Selling and distribution

Admin and Estab. Expense

Profit before Int, Dep and Tax

Depreciation

Interest-LT

-ST

Profit before tax

Tax

Net Profit after tax

Profit C/F

LXXVI


Projected cash flow statement

For the year ended 20…… 20…… 20……. Sources

Profit Before Int, Dep and Tax

Equity

term Loans

Decrease in net working capital

Other Income (Pls Specify)

Total sources

Uses

Capital expenditure

Working capital

Interest payments

Installments

Increase in net working capital

Tax

Total Uses

Opening balance

Surplus/Deficit

Closing balance

LXXVII

ANNEXURE 07


Projected Balance Sheet

As at 31st December 20……… 20……. 20……... Fixed assets

land & Buildings

Plant and machinery

Vehicles

other fixed assets

Current assets

Stocks

raw materials

work-in-progress

finished goods

Debtors

Cash

Other current assets

Total Assets

Barrower’s Capital

Profit and loss balance

Net worth

Other term liabilities

Current liabilities

Creditors

Other Current Liabilities

Total Liabilities

FORMAT FOR RISK RATING (EXISTING BUSINESS)

LXXVIII

1. Quantitative Year

Audited/

Draft

Year

Audited/

Draft

Growth Max

Points

Points

Given

1.1 Growth in Turnover 5

1.2 Growth in GP/Sales Ratio 5

1.3 Growth In NP/Sales Ratio 5

1.4 Growth in Profit Before Tax 7

Current Assets

Current Liabilities

1.5 Current Ratio 7

Net Worth

Term Debt

1.6 Debt to Equity 5

1.7 Debt Service Cover 8

1.8 Payment Record (As per CRIB)

Prompt and Regular 8

Occasional Delay 5

Frequent Delay 0

1.10 Account/Facility Conduct

Very Well Conducted 5

Good Conduct 3

Poor Conduct 0

1.8 Types of accounts submitted

Constructed/draft 2

Management Reviewed 4

Audited 5

Total Quantitative 60

2. Qualitative

2.1 Industry – Current Position

Strong 5

Good 3

Weak 0

2.2 Future Prospects

Strong 5

Good 3

Weak 0

2.3 Market Position

Strong 10

Good 5

Weak 0

2.4 Management

Strong 10

Good 5

Weak 0

2.5 Business History

Well established (Over 25 years) 10

Short History (10 – 25 years) 7

Recently (>10 years) 3

Total Qualitative 40

LXXIX

ANNEXURE 07 (A)

EXPLANATORY NOTES TO ANNEX 07

1. Quantitative Description Max Points

1.1 Turnover Growth 1 – 10% 2

10 – 15% 3

>15% 5

1.2 Growth in GP/Sales Ratio 1-5% 2

5-10% 3

>10% 5

1.3 Growth In NP/Sales Ratio 1-5 2

5-10% 3

>10% 5

1.2 Growth in Profit Before Tax 1-5% 3

5- 10% 5

>10% 7

1.3 Current Ratio <1 0

1 – 1.25 3

1.25-1.50 5

<1.50 7

1.4 Debt Equity Ratio < 75:25 0

75:25 – 50:50 3

>50:50 5

1.5 Debt Service Cover (Times) <1.0 0

1.0 – 1.25 3

1.25-1.50 5

>1.50 8

1.6 Payment Record Prompt and

Regular

10

Occasional Delay 7

Frequent Delay 0

1.7 Account/Facility Conduct Very well

Conducted

5

Good Conduct 3

Poor Conduct 0

1.8 Types of financials provided Draft/Constructed 2

Management

Reviewed

3

Audited 5

Notes to 1.7

Very Well Conducted

No return Cheques

LXXX

All short term facilities s settled on time

All Sales Proceeds credited 5

Good Conduct

Very Few Returned Cheques

Major portion of Sales Proceeds credited

Occasional delays in TOD settlements

Poor Conduct

Frequent Cheque Returns

Sales Proceeds t deposited

Frequent delay in TOD settlement

LXXXI

ANNEXURE 08

RISK RATING FORMAT (START-UPS)

Criterion Max. Points Points Given 1 Sponsor’s Strength Strong 35

Good 20

Satisfactory 10

2 Project Risk Minimum 25

Moderate 15

High 5

3. Industry Rating Strong 15

Good 10

Satisfactory 5

4. Management Strong 15

Good 10

Satisfactory 5

5 Debt: Equity on Completion >50:50 10

75:25- 50:50 05

<75:25 02

TOTAL 100

LXXXII

ANNEX 08 A

EXPLANATORY NOTES TO ANNEX 08

1.Promoter’s Strength

i) Strong: Impressive record in Business

Highly connected to the industry

High financial strength

Well experienced in current business

Proven Management expertise

ii)Good: Good track record in business

Good connections to the industry

Sound financial standing

Some experience in management

iii)) Satisfactory: New to Business

New to the industry

Av financial strength

3.Industry Rating

i) Strong: Perform well at macro level

No threat of new entrant

No threat of substitutes

Conducive Govt {policy

Sector infection is less

ii) Good: Macro level performance

moderate

Possibility of new entrants and

Substitutes

iii) Weak: Poor performance at macro level

Heavy threats of new entrants

and substitutes

unfavorable Govt policy

2.Project Risk

i) Minimum: High probability of completion

No adverse technology changes

Excellent arrangements for

implementation

ii) Moderate: Good probability of completion.

Possibility of technology

Changes

Reasonable arrangements for

Implementation

iii) High Risk: Possibility of project not

implemented

Possibility of adverse tech

changes

4.Management

i) Strong: Reputed sponsors/ shareholders

High caliber management team

Clear succession plan

ii) Good: Little known sponsors

Quality management team

Good track record

No succession plans

iii)Weak: Unknown sponsors

Average management skills

Unknown track record

No succession plans

LXXXIII

LOAN FILES to LOANS OFFICER RATIO ANNEXURE 09

Branch Name Credit Officer Credit Assistants TOTAL Total loan

Customer

Ratio

THIMPHU MAIN 10 1 11 3654 332

THIMPHU 2 4 6 1357 226

PARO 2 4 6 2712 452

WANGDUE 2 3 5 2561 512

PUNAKHA 2 4 6 2581 430

GASA 1 1 298 298

HAA 1 7 8 1448 181

CHUKHA 2 1 3 1134 378

TRASHIGANG 2 11 13 3311 255

TYANGTSE 2 5 7 1590 227

MONGAR 1 6 7 2540 363

LHUNTSE 2 5 7 946 135

SJONGKHAR 1 9 10 1265 127

PGATSHEL 1 5 6 1408 235

BUMTHANG 2 5 7 1468 210

TRONGSA 2 5 7 1616 231

ZHEMGANG 4 4 1152 288

SARPANG 1 1 2 1222 611

DAGANA 2 2 843 422

SAMTSE 1 6 7 1906 272

TSIRANG 1 5 6 1596 266

WAMRONG 2 6 8 1161 145

PLING 2 4 6 1898 316

NGANGLAM 1 2 3 893 298

PANBANG 1 3 4 829 207

DOROKHA 1 2 3 999 333

JOMOTSHANGKHA 2 3 5 523 105

LHAMOIZINGKHA 1 2 3 459 153

GELEPHU 1 4 5 1631 326

YADHI 2 5 7 1347 192

DPELA 1 3 4 1368 342

SAMDRUPCHOLING 1 3 4 1255 314

TASHICHOLING 2 3 5 2097 419

GEDU 1 4 5 957 191

NUBDING 1 4 5 957 191

TOTAL 71 142 198 52982

LXXXIV

ANEXURE 10

CURENT INTEREST RATES

Cu

LXXXV

ANNEXURE 11

REDCL FINANCIALS- PROFIT AND LOSS STATYEMENTS Nu 000

Year Ended 2016 2017 2018

In come from Microfinance Activities 2230.1 3634.9 9422.6

Other incomes 6 628.6 612.9

TOTAL INCOME 2236.1 4263.5 10035.5

Less

Operational and Maintenance Expenses 2425.7 5536.3 9098.2

Employee Benefit Expenses 3123.8 18454.8 18188.5

Depreciation Expense 203.5 1239.1 1223.5

Other expenses 0 2702.1 2724.2

Total Operating Expenses 5753 27932.3 31234.4

NET PROFIT BEFORE IMPAIREMENT -3516.9 -23668.8 -21198.9

Imparement on Loan Portfolio 0 8230.4 5620.4

NET PROFIT -3516.9 -31899.2 -26819.3

LXXXVI

ANNEXURE 12

REDCL BALANCESHEETS As at 31st December 2016 2017 2018

Non-Current assets Property ,Plant and Equipment 1945.4 6965.4 6301.6

Non -current assets 118.1 59.5 322699.2

Total Non-Current assets 2063.5 7024.9 329000.8

Current Assets Short term loans and advances 84048.1 141420.8 323959.5

other current assets 595.9 866.2 908.3

Cash and Bank Balances

Bank

Balances 59682.6 86451.9 53727.2

Total current assets 144326.6 228738.9 54996

TOTAL ASSETS 146390.1 235763.8 383996.8

Equity and Capital Reserves Share Capital 15000 35000 430535

Revolving Fund II 127296 225296 0

Capital Reserves 6820.2 6820.3 6820.3

Retained Earnings -4806.6 -36705.8 -63525.1

TOTAL EQUITY 144309.6 230410.5 373830.2

Non-Current Liabilities Employee Benefits Liabilitie 155.5 506.7 567.7

Current Liabilities Trade and other payable 1708.9 3051.3 6773.3

Other current Liabilities 216.1 219.4 270.3

Employee Benefits Liabilities 0 1576.2 2555.3

Total current liabilities 1925 5353.6 9598.9

TOTAL EQUITY AND LIABILITIES 146390.1 235764.1 383429.1

LXXXVII

ANNEXURE 13

SUGGESTED GUIDELINES FOR GROUP LENDING

1. Step One-Identifying eligible Households /Micro Entrepreneurs: The first step in group

lending is to identify the eligible Households or micro entrepreneurs who are in need of

credit or facilities for savings. For administrative purposes Bhutan is divided in to 20

Dzongkhags (districts), some large districts have divided in to 10 Dungkhags (sub-districts)

205 Gewogs (Group of villages) and 4500 villages. Few villages together form a Gewog. Each

Gewog has an elected community leader working with the government officials in managing

the Gewog. Each district has a district development committee comprising of elected

representative. Each Gewog has a Community Centre and the community Centers are

managed by BDBL. With the assistance of the community leaders and district development

committees, BDBL to identify the villages and Gewogs where people want to borrow. Each

Gewog has a BDBL officer and this officer is to be given the responsibility of identifying

villages

2. Step Two- Selection of group members: The Credit Officer of the branch under which the

community center falls, together with staff at the Community Centre are responsible for

approaching the potential borrowers with the help of elected representative. In identifying

the prospective borrowers, priority will be given to women and unemployed youth. In some

countries the identification of eligible households is done using a poverty index or

acceptable selection criteria. Once a group of prospective borrowers is identified and

selected, the bank officers will interview the head of the household to obtain necessary

information on the households, its occupants and .its level and source of income. The Head

of the Household or any adult member of the household should have some idea of an

income generating activity he/she intends undertaking. If the identified person is a micro

entrepreneur, he will be able tell the actual income if the business is exiting or the projected

income if the business is a start-up. At this stage a separate file will be opened by the bank

LXXXVIII

for each prospective borrower (and also assign a number) to record the finding of the

interview.

3. Step Three-Group Formation: The next step in the process is the group formation. Based

on the findings of the households and micro entrepreneur interviews, the branch credit

officer and CC staff officer will try to motivate at least ten to fifteen households or micro

entrepreneurs in the first round of canvassing in a Gewog/Chiwog to become members of

the BDBL’s group lending program. The operating base of group lending is Member Groups

and Centers. The selected households /prospective borrowers who are willing to become

members of the BDBL’s group lending program, will be assisted to by BDBL staff to form

themselves into groups of three to five self-chosen prospective borrowers. Two or more

groups will form a center. Credit Officer and CC staff of BDBL who is in charge of a particular

Gewog will not insist which clients should form a group. Rather, he/she should assist the

prospective borrowers by explaining the criteria for forming groups. Once the formation of

few groups is completed Credit offer will help groups to form themselves in to Centers. At

its first meeting centers will appoint a Centre Leader, sometimes called the President and a

Centre Secretary. The Group and the Centre are the foundation of group lending. So it is

important for the credit officers of BDBL to create solid Groups and Canters in terms of their

solidarity. Before deciding to enroll a member, credit officers would make an assessment of

the character of the member to be enrolled. Checking with village leaders/elected

representatives or some other responsible entity such as temples is to be done to avoid

wilful defaulters in the future. Centers are to meet at least once a month. Lending Officer of

BDBL is responsible for conducting the fortnightly Centre Meeting along with Centre Leader

(CL). Centre meeting is the place where clients will do their all transactions and business

with LPB. Every client has an obligation to attend the center meeting. Lending Officer

should not have any transaction with the clients outside of the center meeting. So, the all

financial transaction is transparent to members of the center. Centre discipline of the new

groups will be observed closely from the beginning.

4. Step Four- Opening a savings account: Once a group formation and establishment of the

center is completed, group members who intend expanding existing micro enterprises or

commencing micro enterprises and wish to borrow from BDBL will be first asked to open a

LXXXIX

savings account with BDBL LPB as a pre-request for becoming a member of BDBL’s group

lending program. BDBL will decide the minimum amount the members should regularly save

in their accounts.

5. Step Five-Financial Literacy Training to Group Members: Most of the members recruited

May not aware of the working of the BLBL’s group lending program and benefits of same.

Hence, it is necessary to provide some training to the prospective borrowers. The purpose

of the financial education for clients is to educate each of them about the concept of money

and how to manage it wisely. The aim is to enable people to become more informed

financial decision makers, develop awareness of personal financial issues and some basic

financial skills. A comprehensive training program for would be borrowers is to be

developed by the Bank with assistance from a capable external party. The training program

will be of two parts .First part will be an introduction to BDBL and its services and part two

of the training program would be the financial training to the prospective borrowers. BDBL

may consider hiring an outside trainer first to train a team of trainers (Training of Trainers-

TOT) as a pilot project. These trainers will undertake the conducting of future financial

literacy training programs. Topics to be included, inter alia, in the financial literacy training

program would be as follows:

• Basic Principles of money management

➢ Assessing the financial situation of the client

➢ Setting financial goals

➢ Distinguishing between needs and wants

➢ Assessing the clients financial style or personality

• Managing cash flow and budgeting

➢ Making a financial plan

➢ Developing a budget

➢ How to adhere to the financial plan and the budget

➢ Spending wisely-stretching one's money

➢ Understanding of difference between cash flow and profitability

• Building assets

➢ Land and Buildings. Consumer durables and other physical assets

XC

➢ How to invest in an income generating activity

➢ Protecting assets

• Dealing with life cycle events

➢ Marriage

➢ Household formation

➢ Birth of Children

➢ Children's education

➢ Retirement old age

➢ Death

• Interfacing with formal and informal financial institutions.

➢ Savings-Opening a savings account and setting saving targets

➢ Participating in ROSCAS

➢ Borrowing when to borrow and when not to borrow. Risk associated with

borrowing.

➢ Understand how to calculate interest

➢ Understand terms and conditions of borrowing

➢ Compare terms and conditions of different financial institutions

➢ Need for insurance. Understanding what it is and how it works

• Dealing with Special challenges

➢ Illness of family members

➢ Death of family members

➢ Own illness

➢ Divorcee or family breakdown

➢ Job loss

➢ Natural disasters/calamities

• Earning Money.

➢ Developing money making ideas

➢ Looking or job and starting your own enterprise

➢ How to manage a micro enterprise

• Record keeping and understanding of financial statements

➢ What are the basic financial records

XCI

➢ Need for financial records

➢ Understanding of basic financial records

• Risk Diversification

➢ Risk in engaging only in one business

➢ Concept of “pouting all eggs in one Basket”

• Online Banking and usage of mobile phones in banking

➢ What is mobile banking

➢ New trends in banking

6. Step Six- Collecting Loan Applications: Once the training for clients is over, credit will

distribute the Loan applications to members to submit their loan proposals who are willing to

borrow. Credit Officer (CO) will also explain and assist the clients to fill the loan application.

BDBL may use the loan application they presently use for group loans application to submit

the loan proposals .Loan applications from the group members should be review by all group

members and recommend first it to the Centre Leader and the Centre Leader in turn will

submit same to CO. During the Centre meeting, members will submit their loan proposals and

these loan proposals first will be discussed among the fellow group members and get each

member’s recommendation before it is given to the Centre Leader. Every member of the

Centre should agree with the loan proposals submitted by other members .The CO is

responsible for appraising the loan proposals submitted by members. LO is also responsible

for getting the necessary information in the loan proposal form. It is essential to minimize the

credit risk by getting accurate information about the client’s business and his background.

The objective is to assess the client’s capacity to service what he is borrowing.

7. Step Seven- Loan Approval. The CO after collecting the loan proposals from the members

during the Centre meeting will discuss the loan application with the prospective borrowers

and collect the additional information he may require to process the application. He /She

then complete the evaluation and will also discuss it with the branch manager/branch

supervisor and decided whether to approve the loan. The decision to lend or reject an

application will be taken by the branch manager /Supervisor. Once the loan is approved, the

CO will get the loan documents completed and take those documents to the next Centre

Meeting and get the borrower to sign it. When a group member borrows, all other members

XCII

of the group will extend their guaranties for the loan taken by the fellow member. The Branch

manager/Supervisor will be the approving authority of the Group Micro Finance loans..

8. Step Eight - Loan Disbursements and Recoveries: All these are to be happened at the

Centre Meeting. Loans to be given under this program will have monthly Equated Monthly

Installments (EMIs). The Co when coming for the Centre meeting will bring two prepared

statements. One is the disbursement statement with details of loans to be disbursed during

the center meet. The other is the list of amounts to be collected on the loans already

disbursed. In some Financial Institutions both these are included in one statement which is

called “Collection and Disbursement Schedule (CDS)” The Computer system should be able to

produce this schedule. The CO should have clear understanding of how to conduct a Centre

Meeting and guidelines on conducting meetings. The CO should be present at the Centre

meeting at least 5 minutes before the schedule time. No excuse is acceptable for late arrival

by the lending officer to Centre meeting. All members must attend on time. Centre Leader

(CL) will sit close to the Lending Officer and check the client’s attendance and help the CO in

collection and disbursement. Centre Secretary records the attendance in Collection and

Disbursement Sheet (CDS). In case of usual sickness (own, child or husband) client should

come to Centre for a while to handing her payment to Group Leader(GL) and signing CDS and

can go back to home immediately. She does not need to sit in the meeting. For any

emergency, members can take leave from CL prior to the day of monthly Centre meeting

after handing his/her repayment to CL.

CL will lead the collection starting from group the first group. GL is responsible to collect

fortnightly payment and voluntary savings from his/her fellow clients and handover the

collected repayment to CO. After completing the collection, loan disbursement will take

place. Before the loan disbursement, CO will check the identification documents of the

borrower mentioned in the loan proposal. The borrower signs CDS that she/he has received

the loan. Loan proceeds are credit to the savings account of the borrower. During the Centre

meeting the CO will also encourage members to undertake voluntary savings. Once the first

cycle of loans is repaid satisfactorily; members are entitled for another cycle with a higher

quantum.

XCIII

XCIV

ANNEXURE 14

CREDIT SCORING FOR CONSUMER DURABLE LEASES FOR INDIVIDUALS

1) Introduction

A credit score is a number generated by pre-determined criteria to assess the extent of the risk

of a credit proposal, i.e. high, medium or low. Generally, low risk categories are accepted the

high-risk proposals are rejected at the outset. This is ideal for standard products like Credit

Cards and Personal Loans. Consumer durable product is product where credit scoring could be

used for decision making.

2) Reasons for proposing a Credit Scoring system for consumer durables for Individuals.

2.1) Since any credit proposal from an individual is not very complex, through a credit

score, approval process can be simplified to deliver the product faster.

2.2) Since the lending officers will be using standard pre-determined criteria and the result

will be thrown out by the computer, further appraisal and approval by higher

authorities would be redundant. This too will expedite the approval process further.

2.3) Since a standard set of questions will have to be answered by all the applicants, the

possibility of missing a certain vital area can be avoided, and the probability of a

human error in any appraisal will be minimized to a great extent. .

2.4) The product can be made available literally “over the counter” “which BDBL could

market as a niche product.

3) Methodology used.

Although, the credit scoring systems are is commonly developed by analyzing past statistics

and data and picking up characteristics of past borrowers that helps the banker to make an

assessment of the creditworthiness of future a borrowers. Since this is a new product to BDBL

and past data is not available, the Consultant has used his knowledge and experience and

literature available in the public domain to build up this credit scoring system. In this scoring

system the consultant assigns a score not only to the individual applying for leasing but also to

the consumer durable /assets to be purchased and the repayment capacity.

XCV

4). Range of Scores to be used:

The range scores used in the scoring system is shown below:

Attribute Minimum

Score

Maximum

Score

Applicant’s Age 05 20

Educational Qualifications 05 20

Current Occupation 05 40

Net monthly Salary/Household Income 05 25

Nature of income (Fixed/Variable) 05 10

Length of period of generating income from above

Source

00 30

Payment Guaranteed 00 10

No of Dependents 00 15

Own a Home 00 30

Declared Assets 00 25

Length of banking relationship with BDBL 00 10

Repayment Ability (DSCR) 00 35

Quantum Of Finance of the total cost of asset 05 25

No of upfront Rentals 00 15

Asset type to be leased 05 15

Value of the asset 05 20

Additional Security ,if any /Personal Guarantees 00 30

Debt Servicing History (CIB Report) 05 35

Total 55 420

XCVI

The risk rating system is to be incorporated to the current IT system and the calculation of the score

is to be done online and the approval is also to be done online.

ATTACHMENT 01 OF ANNEXURE 14

Credit Scoring Model – Assets Leasing for Individuals

Attribute Criteria Score

Applicant’s Age Below 23 Yrs 10

24 Yrs to 30 Yrs. 15



51 and above 05

Profession/Qualifications Civil Servants 20

Professionals 20

Public sector employees 15

Private sector employees 15

Farmers with Solid Income 10

Others 05

Net monthly Salary/Income Below - Nu 20,000 05

Nu . 20,001/= to 30,000 10

Nu 30,001/= to 40,000/= 15

Nu. 40,001/= to 50,000/= 20

Rs. 50,001/= & above 25

(These numbers can be changed)

Nature of Income Fixed 10

XCVII

Variable 05

Length of Time of the income

from above source

Less than 03 yrs 05

03 yrs. 10 Yrs 15

Over 10 yrs 30

Payment Guaranteed Yes 10

No 00

No of Dependents None 15

One 10

Two 05

More than two 00

Own a Home Yes –without borrowing 30

Yes with Finance 15

No 00

Declared Assets Not Declared 00

Less than Nu. 0.5 Mn 05

Nu. 0.5 Mn to Rs. 1.0 Mn 10

Nu. 1.0 Mn to 2.5 Mn 15

Over Nu 2.5 mn 25

(These numbers could be changed)

Past Debt servicing Regard(CIB) Prompt & Regular 15

Occasional Delays 10

XCVIII

Rescheduled 05

Length of banking relationship

with BDBL

Less than 12 months

00

12 months to 36 months 05

Over 36 months 10

Repayment Ability (DSCR) Below 1.3 times 00

Including the New exposure 1.31 to 1.5 times 15

1.51 to 2.0 times 25

> 2.0 times 30

Quantum Of Finance 100% 05

75% to 99% 15

51% to 74% 20

50% & below 25

No of upfront Rentals None 00

One 05

Two 10

More than two 15

Vehicle Type Vehicle 15

Consumer Durable-(White, Brown, Electronic) 10

Others 05

Value of Vehicle Below Rs. 1.0Mn 10

Rs. 1.0 to Rs. 2.0Mn. 20

XCIX

Rs. 2.01 to Rs. 3.0Mn. 10

Over Rs. 3.0 Mn. 05

Additional Security None 00

Personal Guarantors 05

Movable Mortgage without Guarantors 10

Immovable Mortgage without Guarantors 15

Cash Margin 20

Final Rating Maximum Points - 420

Range (%) Range (Points) Action/Decision

Over 75% Over 315 Proceed – Reduction of ALCO determined

rate by 1.0%

61% to 74% 253 to 314 Proceed - Reduction of ALCO rate by 0.5%

51% to 60% 211 to 252 Proceed - ALCO determined rate

41% to 50% 169 to 210 Proceed - Increase the ALCO determined

rate by 1.0% Approval by Next

Higher

Authority

Below 40% Below 168 DROP

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