CRG Theorty and Practical

8/18/2019 CRG Theorty and Practical

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Credit Risk GradingCredit Risk Grading

Sheikh Mozaffar HossainSheikh Mozaffar Hossain

GM, BBGM, BB

[email protected] [email protected]


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IntroductionIntroduction

The major source of Income of the banks is income

from loans and advances

And the major source of loans and advances is money

taken as deposits from the customers, which has

- Cost implication and

- Repayment obligation to the depositors

Credit culture is changing continuously

oans and advance have to be managed in such a way

as the default risks are minimi!ed If ade"uate steps are not taken, if not monitored

properly, risks incidence will increase#


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Credit RiskCredit Risk

Credit risk is the possibility that a borrower or counter

party will fail to meet its obligations in accordance with

agreed terms#

Credit risk arises from the back$s dealing with % lending

to the corporate, individual and other financial

institutionsTo minimi!e losses, banks should have comprehensive

credit risk management policies & procedure in place

'ajor percentage of assets is subject to Credit risk (or )anks , credit risk is an essential factor that needs to

be managed


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The selection of the best available credit risk grade

from the available option CR'-*teps

- Risk Identification

- Risk Assessment

- Risk +rading

- Risk ricing

- Risk 'onitoring

Credit Risk Management


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The Credit Risk +rading CR+. is a collective definition

based on the pre-specified scale and reflects theunderlying credit-risk for a given e/posure#

It is an aggregation of +rading across the borrowers,

activities and lines of business, which reflects the "uality

of a loan It is an important tool of CR' to understand dimension

of risk in the disbursement of a loan

Credit Risk +rading is the basic module for developing aCredit Risk 'anagement system#

Credit Risk Grading


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It is a risk grading tool that influences

- ending decision at the pre section stage

- recautionary measures by review ofgrading at post section stage

It is based on pre-specified scale reflecting the credit

risk e/posure

0umber %Alphabet is used as summery indicator of risk


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1ell-managed credit risk grading systems promote bank

safety and soundness by facilitating informed decision-making#

+rading systems measure credit risk and differentiate

individual credits and groups of credits by the risk they

pose#This allows bank management and e/aminers to monitor

changes and trends in risk levels#

The process also allows bank management to managerisk to optimi!e returns#

Function of CRG


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CR+ matri/ allows application of uniform standards to

credits to ensure a common standardi!ed approach toassess the "uality of individual obligor, credit portfolio

of a unit, line of business, the branch or the )ank as a

whole#

CR+ output is relevant for individual credit selection,wherein either a borrower or a particular e/posure%

facility is rated#

CR+ largely constitutes obligor level analysis#CR+ is also relevant for surveillance and monitoring,

internal 'I* and assessing the aggregate risk profile of a

)ank# It is also relevant for portfolio level analysis#

Use of CRG


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1here

Grading Short name and Number of CRG

Grading Short Name Number

*uperior *2 3+ood +4 5

Acceptable ACCT 6

'arginal% 1atch list '+%1 7*pecial 'ention *' 8

*ub *tandard ** 9

4oubtful 4( :

)ad & oss ) ;


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*2 3 (ully covered by cash % +overnment %international bank guarantee

+4 5 *trong repayment capacity, e/cellent li"uidity andlow leverage, strong earnings and cash flow,good management skill, covered by the guaranteeof a top tier local )ank Aggregate *core of ;8.#

ACCT 6 )orrowers have ade"uate li"uidity, cashflow and earnings & good track record,normally be secured by acceptablecollateral Aggregate *core of :8-;7.

'+%1 7 1arrants greater attention, thin cashflow and%or inconsistent earnings, borrower incurs a loss oanrepayments routinely fall past due

Aggregate *core of 98-:7 .


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*' 8 otential weakness % Close monitoring re"uired,*evere management problems e/ist, consecutivelosses, negative net worth, e/cessive leverage,

An Aggregate *core of 88-97 based** 9 1eak financial condition, capacity or inclination

to repay is in doubt, weaknesses jeopardi!e thefull settlement of loans# An Aggregate *core of

78-87 based4( : Repayment unlikely and the possibility of loss

is e/tremely high# An Aggregate *core of 68-77 based on the Risk +rade *core *heet

) ; 0o progress in obtaining repayment % legaloptions have been pursued# roceeds e/pectedfrom the li"uidation or reali!ation of security may

be awaited# An Aggregate *core of less than 68


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(or the purposing of preparation of C and maintaining provisions all loans and advances will however, beclassified on the basis of

A. objective criteria and).


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Step-1> Identify all principal risk component

(inancial Risk> robability of failure to meet obligationdue to financial distress

- ?igh leverage relationship with iability and 0et

1orth.

- oor li"uidity relationship with Current Assets &

Current iability.

- ow profitability relationship with *ales & rofit.

- Insufficient cash flow relationship with @arningand Interest on 4ebt .

Ho! to calculate CRG


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)usiness % Industry risk> Adverse industrial situation%

unfavorable business condition to affect repayment

amount of sales, age of the business, prospects, growth,

competition level, e/it entry barrier are considered.

'anagement risk> robability of default due to poor

management capacity e/perience of senior management,

succession and team work are considered.*ecurity Risk> robability of default due to poor "uality

of security primary security, collateral & guarantee are

considered.

Relationship risk> Risk in terms of borrower relationship

account condition, utili!ation of limit, compliance of

covenants & personal accounts are considered.


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Credit Risk com"onents # $arameter

CREDIT RISK

Financial Risk Management RiskBusiness/Industry

RiskRelationship RiskSecurity Risk

Leverage

Liquidity

Proftaility

!overage

"#perience

Succession

$eam %ork

Business&utlook

Si'e o( Business

Industry )ro*th

Market!ompetition

Barriers toBusiness

+ccount!onduct

,tili'ation o(Limit

!ompliance o(!ovenants/!ond

ition

Personal-eposits

Security!overage

!ollateral!overage

Support

+ge o(Business


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*tep-5 > 4istribution of weights to risk component

rincipal risk component 1eight

3# (inancial Risk 8 B

5# )usiness%Industry Risk 3; B

6# 'anagement Risk 35 B

7# *ecurity Risk 3 B

8# Relationship Risk 3 B

Investment risk for counterparty arises from an

aggregation of the above risks#


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Ste" %& 'stablish the (e $arameters

Principal Risk

Components:

Ke Parameters:

(inancial Risk everage, i"uidity, rofitability & Coverageratio#

)usiness%Industry Risk *i!e of )usiness, Age of )usiness, )usiness

utlook, Industry +rowth, Competition &)arriers to )usiness

'anagement Risk @/perience, *uccession & Team 1ork#

*ecurity Risk *ecurity Coverage, Collateral Coverage and*upport#

Relationship Risk Account Conduct ,2tili!ation of imit,Compliance of covenants%conditions & ersonal4eposit#


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Step !: "ssigning weights to Ke Parameters

(R

D8B

total

everage 38 I4

D3;B

total

*i!e of)usiness

8 'R

D35B

total

@/peri-ence

8

i"uidity 38 Age of)usiness

6 *uccess-

ion

7

rofitabil-

ity

38 )usiness

utlook

6 Team

1ork

6

Coverage 8 Industrial+rowth

6

'arketCompetition

5

)usiness)arriers

5


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*R

Dtotal

3B

rimary 7 RR

D3oB

total

Account Conduct 8

Collateral 7 2tili!ation imit 5

+uarantee 5 Compliance

Covenant

5

ersonal 4eposit 3


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Step #: Input data to arrive at *core on the key parameters

After the risk identification & weightage assignment process as mentioned above., the ne/t steps will be toinput actual parameter in the score sheet to arrive at thescores corresponding to the actual parameters#

'* @/cel based credit risk scoring sheet to arrive at atotal score on each borrower

The entire E sheet named, CRG is protected e/cept the particular cells to input data#


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*tep 8> contd#.

Input data accurately in the cells which are $%R&'R'&

& are colored ('))%**ome input cells contain &R%P &%*N )+S, for some

criteria corresponding to the Fey arameters# Click to theinput cell and select the appropriate parameters from the

&R%P &%*N )+S,All the cells provided for input must be filled in order to

arrive at accurate risk grade#


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CR+ score sheet has following columns for all the five principal risk components

- Criteria

- 1eight

- arameter

- *core

- Actual arameter - *core obtained

- Risk +rade


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3# everage> Total iabilities % 0et worth - *ource (*balance sheet.

5# li"uidity> Current Asset % Current liability - *ource (*balance sheet.

6# rofitability> perating profit % *ales - *ource (*

income statement.7# Coverage> @arning before intt# & ta/ % intt# paid -

*ource (* income statement.

8# *i!e of business> *ales amount of business - *ource (*

income statement.9# Age of business> (or how many years the borrower is

engaged in same line of business - *ource 4ate ofestablishment

)he Criteria # their calculation


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:# )usiness outlook 44> It is a "ualitative factor, for

favorable if the growth is consistent. highest point is

allocated

;# Industry growth 44> It is the overall condition of all

other business of the same industry - *ource industry

website, )) "uarterly review, economic trendG# 'arket competition 44> osition of the borrower with

regard to profitability and stability in comparison with

its competitors - *ource annual report, web site,

assumption

3# @ntry & @/it )arriers 44> 1hether it is easy or difficult

to enter into the business go out of the business - *ource


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33# @/perience 44> @/perience of '4 & other senior

management - Annual report

35# *econd line of succession 44> 1hether the owner %

director of the borrower % company has successor who

cam run the business in his % their absence H *ource

collected personally36# Team work 44> The e/tent of team work prevailing in

the organi!ation# *ecurity coverage

status# If 3st charge created with R=*C. highest point H

*ource loan application, bank

)he Criteria # their calculation *contd+

)h C it i # th i l l ti * td


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38# Collateral coverage 44> (or registered mortgage

borrower gets highest point H *ource loan application,

bank

39# *upport guarantee. 44> (or personal guarantee with net

worth borrowers get highest point H *ource loan

application, bank 3:# Account conduct 44> 1hether the borrower has been

maintaining satisfactorily conducted account or not

H *ource historical and !ero for new client

3;# 2tili!ation of limit> (or e/isting client, to what e/tent

the borrower utili!ed the approved limit# H *ource

historical# (or new client forecasted


)h C it i # th i l l ti * td


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3G# Compliance of covenants 44> 1hether borrower

provided all re"uired documents

5# ersonal deposits 44> 1hether the owner % borrower

has any deposit in personal name H *ource account of

the director % owner

et us fill up the CR+ score sheet practically


http://crg_score%20sheet%20golden%281%29.xls/http://crg_score%20sheet%20golden%281%29.xls/


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*tep 9> Arrive at the Credit Risk +rading )ased on the

total score obtained

Number R+ % *hort name Score

1 *uperior *2 3B cash covered +overnment guarantee International )ank guarantees

+ood +4 ;8J

. Acceptable ACCT :8-;7

! 'arginal%1atchlist '+%1 98-:7

# *pecial 'ention *' 88-97

/ *ub-standard ** 78-87

0 4oubtful 4( 68-77

)ad & oss ) K68


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Applicable for all e/posure e/cept for C(, *@ & *A'C

0ot applicable for *2 grade

Applicable for both 0ew & Renewal cases

@ffectiveness of CR+ depends on the


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CR+ to be originated by R' & then it is an ongoing

process

Relationship 'anager shall complete the Credit Risk

+rading *core *heet and shall arrive at a risk grading inconsultation with a *enior Relationship 'anager and

document it as per Credit Risk +rading (orm

H All credit proposals new or renewal. should accompany

- 4ata collection check listL imit 2tili!ation formL CR+

*core *heet & CR+ form

- Credit officer to pass on the approved CR+ (orm to

Credit Administration 4epartment and Corporate)anking 2nit for 'I* record

H Any subse"uent revision of CR+ should be done by

appropriate approving authority of CR+ form


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'.ce"tion of CRG'.ce"tion of CRG

?ead of Credit Risk 'anagement may also

downgrade%classify an account- in the normal course of inspection of a )ranch or

- during the periodic portfolio review#

Recommendation for upgrading of an account has to bewell justified by the recommending officers#

In case an account is rated marginal, special mention or

unacceptable credit risk as per the risk grading score

sheet, this may be substantiated and credit risk may be

accepted if

- the e/posure is additionally collaterali!ed through cash

collateral, good tangible collaterals and stron guarantees#


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These are e/ceptions and should be e/ceptionally

approved by the appropriate approving authority#

1henever re"uired an independent assessment of thecredit risk grading of an individual account may be

conducted by the ?ead of Credit Risk 'anagement or

- by the Internal Auditor documenting

- as to why the credit deteriorated andalso pointing out the lapses#

65

R i f CRG


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CR+ should be updated periodically after investment#

Review fre"uency depends on the Risk +rade as under

Re/ie! of CRG

Risk +rade 'inimum (re"uency

*2 Annually

+4 Annually

ACCT Annually

'+ % 1 ?alf yearly

*'


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CRG Theorty and Practical

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