The Financial Sector Reform Project (FSRP) has designed the LRA package, which provides a systematic procedure for analyzing and quantifying the potential credit risk. Bangladesh Bank has directed all commercial bank to use LRA technique for evaluating credit proposal amounting to Tk. 10 million and above. The objective of LRA is to assess the credit risk in quantifiable manner and then find out ways & means to cover the risk. However, some commercial banks employ LRA technique as a credit appraisal tool for evaluating credit proposals amounting to Tk. 5 million and above. Broadly LRA package divides the credit risk into two categories, namely      

Business risk
Security risk.

A detail interpretation of these risk and the procedure for evaluating the credit as follows

3.21.1 Business risk:

It refers to the risk that the business falls to generate sufficient cash flow to repay the loan. Business risk is subdivided into two categories.

3.21.2 Industry risk.

The risk that the company fails to repay for the external reason. It is subdivide into supplies risk and sales risk.

3.21.3 Supplies risk:

It indicates that the business suffers from external disruption to the supply of imputes. Components of supplies risk are as raw material, Labor, power, machinery, equipment, factory premises etc. Supply risk is assessed by a cost breakdown of the inputs and then assessing the risk of disruption of supplies of each item.

3.21.4 Sales risk:

This refers to the risk that the business suffers from external disruption of sales. Sales may be disrupted by changes to market size, increasing in competition, change in the regulation or due to the loss of single large customer. Sales risk is determined by analyzing production or marketing system, industry situation, Government policy, and competitor profile and companies strategies.

3.21.5 Company risk:

This refers to the risk that the company fails for internal reasons. Company risk is subdivided into company position risk and Management risks.

3.21.6 Company position risk:

Within an industry each and every company holds a position. This position is very competitive. Due to the weakness in the company's position in the industry, a company is the risk for failure. That means, company position risk is the risk of failure due to weakness in the companies position in the industry. It is subdivided into performance risk and resilience risk.

3.21.7 Performance risk:

This risk refers to the risk that the company’s position is so weak that it will be unable to repay the loan even under Favor able external condition. Performance risk assessed by SWOT(Strength, Weakness, Opportunity and Threat) analysis, Trend analysis, Cash flow forecast analysis and credit report analysis (i.e. CIB repot from Bangladesh Bank).

3.21.8 Resilience risk:

Resilience means to recover early injury, This refers to risk that the company falls due to resilience to unexpected external conditions. The resilience of a company depends on its leverage, liquidity and strength of connection of its owner or directors. The resilience risk is determined by analyzing different financial ratio, flexibility of production process, shareholders willingness to support the company if need arise and political and private affiliation of owners and key personnel.

3.21.9 Management risk:

The management risk refers to the risk that the company fails due to management not exploiting effectively the company’s position. Management risk is subdivided into management competence risk and integrity risk.

3.21.10 Management competence risk:

 This refers to the risk that falls because the management is incompetent. The competence of management depends upon their ability to manage the company's business efficiently and effectively. The assessment of management competence depends on management ability and management team work. Management ability is determined by analyzing the ability of owner or board of the members first and then key personnel for finance and operation. Management team work is determined by analyzing management structure and its strength and weakness.

3.21.11 Management integrity risk:

This refers to the risk that the company fails to repay the loan amount due to lack of management integrity. Management integrity is a combination of honesty and dependability. Management integrity risk is determined by assessing management honesty, which requires evaluating the reliability of information supplied and then management dependability.

3.21.12 Security risk:

 This sort of risk is associated with the realized value of the security, which may not cover the exposure of loan. Exposure means principal plus outstanding interest. The security risk is subdivided into two major heads i.e. security control risk and security cover risk.

3.21.13 Security control risk:

This risk refers to the risk that the bank falls to realize the security because of bank's control over the security offered by the borrower i.e. incomplete documents. The risk of failure to realize the security depends on the difficulty in obtaining favorable judgement and taking possession of security. For analyzing the security control risk the credit office is required to verify documentation to ensure security protection, documentation completeness, documentation integrity and proper insurance policy. He/she also conducts site visit to verify security existence. Assessment of security control risk requires analyzing the possibility of obtaining favorable judgement and analyzing the case with which the bank could take the possession and liquidate the securities.

3.21.14 Security cover risk:

This refers to the risk that the realized value of security is less than exposure. Security cover risk depends on speed of realization and liquidation value. For analyzing security cover risk, the official requires assessing the power of the customer to prolong the legal process and to analyze the market demand for the security For assessment of security control risk, the officials times the time that would require to liquidate the security and assess the risk and estimates the security value at liquidation and assess the risk.

Before completing the LRA form, the relationship manager collects data specially industry specific from published sources and company specific data that not usually published., by personally visiting the company. After collecting the necessary data he/ she prepares financial spreadsheet. This spreadsheet provides a quick method of assessing business trend & efficiency and helps to assess the borrower ability to pay the loan Obligation. Financial spreadsheet includes balance sheet, income statement, cash flow statement and ratios for the purpose of financial statement analysis. Through analyzing data and collected information, the concerned official completes the LRA form and all scores are transferred to the scoring matrix to find the overall risk of lending. The overall matrix provides four kinds of lending risk for decision making viz.  (I) Good (ii) Acceptable (iii) Marginal and (iv) Poor. The bank does not provide any credit request having an over all risk as “ marginal" and " Poor" without justification. All credit application rated "Poor" shall require the approval of the Board of Directors regardless of purpose tenor or amount. Therefore bank can minimize the dangers regarding the bad loan and advances through using the LRA.