ASSESSMENT OF CREDIT RISK

MANAGEMNT PRACTICES;THE CASE OF

COMMERCIAL BANK OF ETHIOPIA

A RESEARCH PROPOSAL IN PARTIAL FULFILLMENTS OF THE

REQUIREMENTS FOR MASTER OF SCIENCE DEGREE IN
ACCOUNTING AND FINANCE

SUBMITTED TO
DEPARTMENT OF ACCOUNTING AND FINANCE
COLLEGE OF BUSINESS AND ECONOMICS
ADDIS ABABA UNIVERSITY

BY: FRAOL BELAY

ID: GSD/3592/11
 ADVISOR: ABEBAW KASSIE GUALU(PhD)

APRIL 2024 G. C.

Table of Contents

CHAPTER I: INTRODUCTION
1.1 Background Considerations
1.2 Statement of the Problem
1.3 Research Question
1.4 Objectives of the Study
1.4.1 The Study or General Objective
1.4.2 Specific Objectives
1.5 Significance of the Study
1.6 Scope of the Study
1.7 Limitation of the Study
1.8 Organization of the Study

CHAPTER 2: REVIEW OF RELATED LITERATURE

2.1 Introduction
2.2 Theoretical Literature
2.3 Empirical Literature
2.4 Research Gaps
2.5 Conceptual Framework

CHAPTER 3: RESEARCH METHODOLOGY

3.1 Introduction
3.2 Research Design
3.3 Research Approach
3.4 Sample Design
3.4.1 Population or Universe
3.4.2 Sampling Frame
3.4.3 Sampling Technique
3.4.4 Sample Size
3.5 Sources of Data
3.5.1 Primary Data Sources
3.6 Data Analysis and Interpretation
3.7 Model Specification and Operationalization (if applicable)
3.8 Validity and Reliability
3.9 Ethical Considerations

Acronyms
CBE: Commercial Bank of Ethiopia

Abstract

The purpose of this research is to evaluate the way Commercial Bank of Ethiopia (CBE) manages credit risk and
provide suggestions for improvement. self-administered Questionnaires and semi-structured interviews will be
conducted to collect primary data for this study.The research will use a mixed-method approach to analyze primary
data from CBE, focusing on credit appraisal and loan monitoring processes. Previous research has identified
shortcomings in CBE’s credit risk management, especially with regards to independent loan review mechanisms,
credit risk environment, and credit risk appraisal and monitoring challenges. The expected findings of this study
emphasize the need for effective risk identification, measurement, loan monitoring, and controlling credit risks to
ensure that the bank is profitable and stable. The study provides recommendations for improvement, including
introducing comprehensive loan review mechanisms, developing effective credit risk management policies and
procedures specific to banking activities, establishing an independent credit risk department, and emphasizing risk
identification, measurement, and treatment. The results of this research indicate that effective credit risk
management policies and procedures are vital for banks to remain stable, profitable and avoid significant losses due
to ineffective credit risk management practices. The findings of this study will be useful in guiding future research on
credit risk management practices in commercial banks, particularly in emerging markets.
Keywords: Credit risk management, Commercial Bank of Ethiopia, Loan monitoring, Credit appraisal.

CHAPTER I: INTRODUCTION

1.1 Background of the study

Managing credit risk is crucial for commercial banks to remain stable, profitable, and avoid significant losses that
can lead to the collapse of the banking system. Credit risk management involves identifying, measuring, monitoring,
and controlling credit risk. In emerging markets, credit risk is often high due to limited information on borrowers’
creditworthiness, limited diversification of the economy, and existing regulatory frameworks. Therefore, improving
credit risk management practices in banks is essential for the survival of the banks and the growth of the economy.
Despite the importance of credit risk management, several commercial banks globally have suffered substantial
losses due to ineffective credit risk management practices. The Commercial Bank of Ethiopia (CBE) has not been an
exception to this. The CBE’s credit risk management practices have been the subject of various studies, which have
identified gaps in the credit risk management of CBE, particularly in its independent loan review mechanisms, credit
risk environment, and credit risk appraisal and monitoring challenges. For example, a study by Gebrewahd Tesfay
Brhane (2016) identified a gap in the credit risk management practices of the CBE in terms of the independent loan
review mechanisms. To enhance credit quality, the study recommended that the bank needs a comprehensive loan
review mechanism. Similarly, a study in Ethiopia by Zergaw (2019) identified a gap in the credit risk management
practices of banks due to the lack of an appropriate credit risk environment, challenges in credit appraisal
measurement and monitoring, absence of market risk analysis, operational risk issues, and challenges in the credit
granting process. In addition, a study by Francis (2022) found that the CBE needs to improve its credit risk
management practices by focusing on risk identification, measurement, and treatment for effective credit risk
management.

Moreover, the credit risk management practices at the CBE continue to face challenges due to ineffective credit risk
appraisal and loan monitoring processes. However, the specific credit appraisal and loan monitoring processes that
need improvement within the bank are not well understood. Therefore, further research is necessary to identify the
specific factors affecting credit risk management practices in the CBE and provide recommendations to address
them.

The main objective of this study is to evaluate credit risk management practices in the Commercial Bank of Ethiopia
(CBE) and provide recommendations for improvement. The study aims to identify the gaps in credit appraisal and
loan monitoring processes in the Commercial Bank of Ethiopia and suggest possible improvements. The study will
contribute to the existing literature on credit risk management practices in commercial banks, provide insights for
improving credit risk management practices in the CBE, and guide the development of policies and procedures for
effective credit risk management in commercial banks in Ethiopia.

The significance of the study is for policymakers, regulators, commercial bank managers, and other stakeholders
interested in commercial banks’ credit risk management practices. The failure to manage credit risk effectively can
lead to significant losses, destabilize the financial system, and negatively affect the entire economy. Therefore, the
study’s findings will be critical in guiding future research on credit risk management practices in commercial banks,
particularly in emerging markets such as Ethiopia.

1.2. Statement of a problem

Managing credit risk is essential for the stability and profitability of commercial banks, particularly in emerging
markets where credit risk is high due to limited diversification of the economy, lack of information on borrowers’
creditworthiness, and existing regulatory frameworks (Asdecker et al., 2019). Effective credit risk management
enables banks to avoid over-exposure to risk, identify potential loan defaults, and take preventive measures.
Therefore, improving credit risk management practices in banks is crucial not only for their survival but also for the
growth of the economy.

Commercial banks worldwide have suffered significant losses due to ineffective credit risk management practices
(Saldanha, 2020). The Commercial Bank of Ethiopia (CBE) is one such bank that has faced this issue. Despite
several studies conducted to evaluate the effectiveness of credit risk management practices in the CBE, gaps still
exist in our understanding of the specific credit appraisal and loan monitoring processes that need improvement
within the bank.

For instance, Gebrewahd Tesfay Brhane’s (2016) study identified a gap in the CBE’s credit risk management
practices concerning independent loan review mechanisms. The study recommended the implementation of a
comprehensive loan review mechanism to enhance credit quality. Another study in Ethiopia by Zergaw (2019)
highlighted gaps in the credit risk management practices of banks, such as the absence of an appropriate credit risk
environment, challenges in credit appraisal measurement and monitoring, lack of market risk analysis, operational
risk issues, and difficulties in the credit granting process. Additionally, Francis’s (2022) study found that the CBE
needs to focus on risk identification, measurement, and treatment to enhance its credit risk management practices.
These studies collectively indicate gaps in credit risk management practices in the CBE, especially concerning credit
appraisal and loan monitoring processes. Further research is necessary to identify specific factors affecting credit risk
management practices in the CBE and provide recommendations to address them. The primary objective of this
research is to identify these gaps and provide recommendations to promote the stability and profitability of the CBE.

1.3 Research Question:

What are the gaps in credit appraisal and loan monitoring processes in the Commercial Bank of Ethiopia?
What factors contribute to the weaknesses in credit risk management practices at the CBE?
What recommendations can be made to improve the credit risk management practices at the CBE?

1.4 Objectives of the Study:

1.4.1 General Objective:

- To assess the credit risk management practices of the Commercial Bank of Ethiopia, focusing on credit appraisal
and loan monitoring processes.

1.4.2 Specific Objectives:

- To identify the factors contributing to weaknesses in credit risk management practices at the CBE.
- To identify the gaps in credit appraisal and loan monitoring processes at the CBE.
- To provide recommendations for improvement in credit risk management
Practices at the CBE.

1.5 Significance of the Study:

This study is significant for policymakers, regulators, commercial bank managers, and other stakeholders interested
in commercial banks’ credit risk management practices. It will contribute to the existing literature on credit risk
management practices in commercial banks, provide insights for improving credit risk management practices in the
CBE, and guide the development of policies and procedures for effective credit risk management in commercial
banks in Ethiopia. Significance of the Study:
This study is significant for policymakers, regulators, commercial bank managers, and other stakeholders interested
in commercial banks’ credit risk management practices. It will contribute to the existing literature on credit risk
management practices in commercial banks, provide insights for improving credit risk management practices in the
CBE, and guide the development of policies and procedures for effective credit risk management in commercial
banks in Ethiopia.

1.6 Scope of the study

The proposed study aims to investigate the credit risk management practices at the Commercial Bank of Ethiopia
(CBE) with a focus on credit appraisal and loan monitoring processes. The study will employ both survey
questionnaire and semi-structured interviews to collect data from employees of the Commercial Bank of Ethiopia
(CBE), specifically managers and loan officers who are involved in credit risk management practices in Addis Ababa
city.

However, the study is limited by the potential for response bias from the employees of the CBE, which may affect
the reliability of the study's findings. Additionally, the study's recommendations may not be applicable to other
commercial banks in Ethiopia or other countries with different economic, regulatory, and social contexts.

1.7 Organization of the study

The study will be divided into five chapters to provide a comprehensive analysis of credit risk management practices.
Chapter One will provide an introduction to the research by presenting the research questions, objectives,
significance, scope, and limitations. Chapter Two will review the literature on credit risk management practices in
commercial banks, with a particular focus on credit appraisal and loan monitoring processes.

Chapter Three will describe the research methodology and data collection procedures, including the sampling
technique, data collection instruments, and data analysis techniques. Chapter Four will present the data analysis and
findings from the survey questionnaire and semi-structured interviews. Finally, Chapter Five will provide a summary
of the study's findings, conclusions, and recommendations for improving credit risk management practices at the
CBE and other commercial banks in Ethiopia.

Chapter 2: Review of Related Literature

2.1 Introduction:

This chapter aims to review the existing literature on credit risk management practices in commercial banks. It
focuses on the theoretical and empirical literature related to credit appraisal and loan monitoring processes in
commercial banks. This chapter also identifies research gaps and presents a conceptual framework for the study.
2.2 Theoretical Literature

2.2.1 Introduction:
Credit risk management is a crucial aspect of maintaining the stability and profitability of commercial banks. This
theoretical literature review aims to explore relevant theories and concepts related to credit risk management
practices, specifically focusing on the case of the Commercial

2.2.2 Theoretical Framework:

Credit Risk
Credit risk refers to the potential loss arising from a borrower’s failure to meet their obligations under a loan or
credit agreement. It encompasses the uncertainty of repayment and the potential impact on a bank’s financial position
(Altman, 2018).

Credit Risk Management

Credit risk management involves identifying, measuring, monitoring, and controlling credit risk to minimize
potential losses. It encompasses the development and implementation of policies, procedures, and practices to assess
and mitigate credit risk (Crouhy et al., 2014).

Basel Accords
The Basel Accords are international regulatory frameworks developed by the Basel Committee on Banking
Supervision. Basel II and Basel III provide guidelines and standards for banks to manage credit risk, including
minimum capital requirements, risk measurement techniques, and risk management practices (Basel Committee on
Banking Supervision, 2006; 2010).

Loan Review Mechanisms

Loan review mechanisms refer to the processes and procedures employed by banks to evaluate the credit quality of
their loan portfolios. These mechanisms assess the adequacy of credit risk identification, measurement, and control
measures (Matić et al., 2020).

Credit Risk Identification and Measurement:

Credit Appraisal
Credit appraisal involves the evaluation of a borrower’s creditworthiness, including their financial position,
repayment capacity, and collateral. Effective credit appraisal techniques help banks assess the creditworthiness of
potential borrowers and make informed lending decisions (Chakraborty, 2018).
Credit Risk Models
Credit risk models are statistical tools used to estimate the probability of default and potential credit losses. These
models assist in quantifying credit risk, assigning risk ratings to borrowers, and determining appropriate risk
mitigation strategies (Altman & Saunders, 2008).

Credit Risk Rating

Credit risk rating is a systematic procedure used to assign a risk grade or score to borrowers based on their
creditworthiness. It aids in assessing the likelihood of default and helps banks in pricing loans and setting risk
provisions (Bessis, 2015).

Credit Risk Monitoring and Control:

Loan Monitoring
Loan monitoring involves ongoing surveillance of borrowers’ financial performance, loan repayment behavior, and
changes in credit risk. Effective loan monitoring helps banks identify early warning signs of potential default and
take appropriate remedial actions (Chakraborty, 2018).

Risk-Based Pricing
Risk-based pricing is a strategy where banks adjust interest rates and loan terms based on the credit risk associated
with each borrower. It ensures that the pricing of Loans aligns with the inherent credit risk, thereby incentivizing
prudent lending practices (Altman & Saunders, 2008).

Credit Risk Mitigation

Credit risk mitigation techniques aim to reduce the potential impact of credit risk. These techniques include
collateral requirements, credit enhancements, loan covenants, and risk transfer through securitization or insurance
(Crouhy et al., 2014).

2.3 Empirical Literature:

Existing studies on credit risk management practices in commercial banks suggest the need to improve credit
appraisal and loan monitoring processes in banks. For instance, a study by Francis (2022) found that the Commercial
Bank of Ethiopia needs to focus on effective risk identification, measurement, and treatment to improve credit risk
management. Similarly, Zergaw (2019) identified gaps in credit risk management practices in Ethiopian commercial
banks due to a lack of appropriate credit risk environment, challenges in credit appraisal measurement and
monitoring, and absence of market risk analysis. Cherinet Yohannes (2019) found that risk management practices at
the Commercial Bank of Ethiopia related to credit, market, liquidity, operational, strategic and reputational risks need
improvement.
2.4 Research Gaps:
The existing literature suggests that there is a need to assess credit risk management practices in commercial banks,
specifically the Commercial Bank of Ethiopia, focusing on credit appraisal and loan monitoring processes. The
literature highlights several gaps in credit risk management, including inadequate credit history systems, ineffective
independent loan review mechanisms, and the need for effective credit risk management policies and procedures
specific to banking activities.

2.5 Conceptual Framework:

Based on the theoretical and empirical literature, the conceptual framework for this study includes four key
components: risk identification, risk measurement, loan monitoring, and controlling credit risk. Risk identification
involves analyzing potential sources of risk, including customer and macroeconomic risks. Risk measurement
involves evaluating the probability of default and assessing the loss severity associated with the default. Loan
monitoring involves ongoing credit analysis to detect borrower creditworthiness changes that may affect loan
repayment capacity. Lastly, controlling credit risk involves providing credit loss reserves and capital to mitigate the
risk. The framework will guide the data collection and analysis process for assessing credit risk management
practices in commercial banks, specifically the Commercial Bank of Ethiopia, focusing on credit appraisal and loan
monitoring processes.

Chapter Three: Research Methodology

3.1 Introduction:
This chapter presents an overview of the research methodology, which is centered on the design, approach, sample
design, data sources, data analysis, and interpretation of the study. Additionally, the chapter discusses the model
specification, validity and reliability of the study, and ethical considerations.

3.2 Research Design:

The research design for this study will be descriptive in nature. It involves analyzing the current credit risk
management practices at the Commercial Bank of Ethiopia. The descriptive research design is the most appropriate
for this study since it allows the researcher to gather relevant data that will enable a comprehensive understanding of
the credit risk management practices at the Commercial Bank of Ethiopia.

3.3 Research Approach:

The study will use a mixed-method research approach that includes both qualitative and quantitative data collection
and analysis techniques. The mixed-method research approach is the most appropriate for this study since it enables
the researcher to integrate the strengths of both quantitative and qualitative research methods. The quantitative
research method will be used to analyze the numerical data obtained through self-administered questionnaires, while
the qualitative research method will be used to analyze the data obtained through semi-structured interviews.

3.4 Sample Design:

3.4.1 Population
The population of the study includes all employees of the Commercial Bank of Ethiopia who are responsible for
credit risk management activities. The target population is important in this study since it enables the researcher to
draw conclusions that are representative of the entire population.

3.4.2 Sampling Frame:

The sampling frame will include departments that are responsible for credit appraisal and loan monitoring activities.
These include the credit assessment and risk management departments. The sampling frame is important in this study
since it enables the researcher to select the appropriate sample that will represent the entire population.

3.4.3 Sampling Technique:

The study will use purposive sampling techniques to select respondents from employees of the Commercial
Bank of Ethiopia (CBE), specifically managers and loan officers who are involved in credit risk management
practices.
Purposive sampling is the most appropriate sampling technique for this study since it enables the researcher to select
respondents who involved in credit risk management practices that are relevant to the study.

3.4.4 Sample Size:

The sample size will be determined using the saturation method, which means that data collection will continue until
data saturation is achieved. The saturation method is the most appropriate sampling technique for this study since it
enables the researcher to collect data until a point where no new information or themes are emerging from the data.

3.5 Sources of data:

3.5.1 Primary Data Sources:

The primary data sources will be through self-administered questionnaires and semi-structured interviews with the
employees responsible for credit risk management activities.
3.6 Data Analysis and Interpretation:
The data collected will be analyzed using descriptive statistics, frequency distribution tables, and inferential statistics.
The findings will be presented quantitatively and qualitatively. The data analysis and interpretation techniques are
appropriate for this study since they enable the researcher to draw accurate and reliable conclusions from the data
collected.

3.7 Validity and Reliability:

The study will use content validity and test-retest reliability to ensure the validity and reliability of the study's
findings. Content validity is important in this study since it enables the researcher to ensure that the data collected is
relevant to the research questions. Test-retest reliability is important since it enables the researcher to ensure that the
data collected is reliable and consistent.

3.8 Ethical Considerations:

The study will follow ethical principles, including confidentiality, informed consent, and voluntary participation. The
study will obtain informed consent from the respondents before data collection and ensure that the participants'
identities and responses are kept confidential. The

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ADDIS ABABA UNIVERSITY

SCHOOL OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANCE

Questionnaires to be filled by employees

Research topic: assessment of credit risk management practices in a case of commercial bank of Ethiopia
 Dear respondents: I would like to express my earnest appreciation for your generous time, honest and prompt
responses.
This questionnaire is designed to collect data about credit risk management practices in a case of commercial bank of
Ethiopia. The information that you offer me with questionnaire will be used as a primary data in my case research
which I am conducting as a partial fulfillment of the requirements for the degree of Masters of Accounting and
Finance at Addis Ababa University. Therefore; this research is to be evaluated in terms of its contribution to our
understanding credit risk management practices in a case of commercial bank of Ethiopia and its contribution to
improve the area.
I need your help and would appreciate your golden time to complete the attached questionnaire on the assessment of
credit risk management practices in a case of commercial bank of Ethiopia. Results will be used to help and expand
our knowledge and understanding of any major shift in credit risk management practices in a case of commercial
bank of Ethiopia
All answers will be kept strictly confidential and only aggregate results will be reported.
Thank you in advance for your cooperation.

General Instructions
• There is no need of writing your name.
• In all cases where answer options are available please tick (√) mark on the space provided or circle it on the
five point scale accordingly.

1.1 Gender Male

Female

1.2 Age 18-25 yaers

26-40 years

41-50

Above 50 years

1.3 Educational Level Below Diploma

Diploma

First Degree

Master’s Degree & above

1.4 Work Experience 1-3 years

4-7 years

8-11 years

Above 11 years
 1
Question 2 3 4 5 (Strongly
(Strongly
Number (Disagree) (Neutral) (Agree) Agree)
Questions Disagree)
The credit risk
management practices
of the Commercial
1 Bank of Ethiopia are
effective in
minimizing potential
risks

The Commercial Bank

of Ethiopia has a well-
2 defined credit risk
management
framework in place

The Commercial Bank

of Ethiopia adequately
assesses the
3
creditworthiness of
borrowers before
granting loans

The loan monitoring

system of the
Commercial Bank of
4 Ethiopia effectively
identifies and
addresses potential
credit risks
5 The Commercial Bank
 of Ethiopia has
sufficient mechanisms
to mitigate credit risk

The Commercial Bank

of Ethiopia employs
6 advanced analytics
and models to assess
credit risk

The Commercial Bank

of Ethiopia provides
7 adequate training to
its staff on credit risk
management practices

The Commercial Bank

of Ethiopia has a
8 comprehensive credit
risk management
policy in place

9 The Commercial Bank

of Ethiopia effectively
communicates credit
 risk policies and
procedures to its
employees

The Commercial Bank

of Ethiopia regularly
10 reviews and updates
its credit risk
management practices

The Commercial Bank

of Ethiopia has a clear
understanding of the
11
credit risk
environment it
operates in
 The Commercial Bank
of Ethiopia
emphasizes proactive
12
risk identification in
its credit risk
management practices

The Commercial Bank

of Ethiopia effectively
13 measures and
quantifies credit risk
exposure

The Commercial Bank

of Ethiopia promptly
takes corrective
14
actions when credit
risks exceed
predefined thresholds
The Commercial Bank
of Ethiopia has robust
mechanisms to
15
monitor and control
credit risk on an
ongoing basis
The Commercial Bank
of Ethiopia conducts
regular stress testing
16
and scenario analysis
to assess potential
credit risk impacts
 The Commercial Bank
of Ethiopia actively
17 manages
concentration risks in
its loan portfolio

The Commercial Bank

of Ethiopia ensures
compliance with
18 regulatory
requirements related
to credit risk
management

The Commercial Bank

of Ethiopia
encourages a risk-
19 aware culture among
its employees
regarding credit risk
management
 The Commercial Bank
of Ethiopia
collaborates with
external stakeholders,
20
such as credit rating
agencies, to enhance
its credit risk
management practices

The Commercial Bank

of Ethiopia provides
sufficient resources
21 and technology to
support effective
credit risk
management
 The Commercial Bank
of Ethiopia conducts
regular training and
22 awareness programs
for customers
regarding credit risk
management

The Commercial Bank

of Ethiopia considers
23 market risk factors
while assessing and
managing credit risk
 The Commercial Bank
of Ethiopia has
established effective
24
mechanisms for credit
risk reporting and
communication

The Commercial Bank

of Ethiopia
continuously seeks
opportunities to
25
enhance its credit risk
management practices
based on industry best
practices

Interview questions

1. Can you describe the current credit risk management practices at the Commercial Bank of Ethiopia,
specifically focusing on the credit appraisal and loan monitoring processes?
2. What factors, in your opinion, contribute to the weaknesses or gaps in credit risk management practices
at the Commercial Bank of Ethiopia?

3. How would you assess the effectiveness of the independent loan review mechanisms in place at the
Commercial Bank of Ethiopia? Are there any areas that require improvement?

4. What challenges or difficulties have you encountered in the credit risk appraisal and loan monitoring
processes at the Commercial Bank of Ethiopia? Can you provide specific examples?

5. Based on your experience and observations, what recommendations would you suggest for improving
the credit risk management practices at the Commercial Bank of Ethiopia, particularly in terms of credit
appraisal and loan monitoring?