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Credit Risk GradingCredit Risk Grading
Sheikh Mozaffar HossainSheikh Mozaffar Hossain
GM, BBGM, BB
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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
)he Criteria # their calculation *contd+
)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
)he Criteria # their calculation *contd+
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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