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Credit Risk Rating

The document discusses credit risk rating, including internal and external ratings, objectives of credit ratings, characteristics of good credit risk rating models, factors impacting borrower default, and examples of financial parameters and rating benchmarks.

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iyervsr
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43 views12 pages

Credit Risk Rating

The document discusses credit risk rating, including internal and external ratings, objectives of credit ratings, characteristics of good credit risk rating models, factors impacting borrower default, and examples of financial parameters and rating benchmarks.

Uploaded by

iyervsr
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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CREDIT RISK RATING

Practical aspects
Internal rating by the Bank and External
rating by Credit rating agencies
Methodology, uses and limitations of Credit
rating
Rating models for different segments of
credit portfolio

EXAMPLES OF RATING IN GENERAL LIFE


1. Hotels
2. Students
3. Films
4. Beauty Contest
5. Country for Tourism, Investment etc
6. ISO 9000
7. Customer rating by Telecom companies How remunerative is the
customer?
8. Bank customers for Money Laundering risk High risk, Medium risk
and Low risk.
9. Promotion to higher post
10.States for their Investor friendliness

WHAT IS CREDIT RISK RATING?


Tool of Credit Risk Measurement
Measurement of ability to pay and willingness to pay
Default / Credit Risk relative chances of failure of
borrower to honour obligation to service debt in timely
manner

OBJECTIVES OF CREDIT RATING


Ability to reasonably predict chances of future default
Use as additional tool for credit decision viz. lend,
enhance

limits,

monitor

intensely

and

frequently

depending on rating
Risk based pricing of loans
Attract high quality borrowers
When rating deteriorates, bank can decide on exiting


CREDIT INFORMATION BUREAU V/S CREDIT RATING AGENCIES

CREDIT INFORMATION BUREAU


CREDIT RATING AGENCIES
RBI approved CIB CIBIL, RBI approved Credit rating agencies
EQUIFAX, EXPERIAN, HIGHMARK CRISIL, ICRA, CARE, FITCH,
SMERA, ONICRA, BRICKWORK
Collects, Stores and provides Undertakes credit risk rating of
information on borrowers and Issuer, Issue, Papers, projects,
credit history including defaults builders etc
and credits availed from other
banks etc
Provides
scoring
on
retail Provides rating as and when asked
customers for consumer credit on for on payment basis.

LIMITATIONS OF CREDIT RISK RATING


It is a measure of Credit risk rating at a particular point of
time only
Risk being dynamic, the same should be reflected in Credit
risk rating which is reviewed only annually
Rating depends on information provided or made available
by the borrower which may or may not be true (e g Satyam)
Quality of rating arrived at depends on the skill level and
ability of a rater
Ratings have not been able to predict default e.g. Lehman
Crisis

INTERNAL CREDIT RISK RATING V/S EXTERNAL CREDIT RISK RATING

INTERNAL CREDIT RISK RATING


Undertaken internally by the staff of Bank
independently
by
Risk
Management
department
Basel guidelines require internal credit risk
rating to be done of borrowers for moving to
Advanced approach
Generally
undertaken
for
individual
borrowers
Captures information on borrower available
within the bank on the borrower such as
conduct of account, dishonour of cheques,
payments made etc
Reviewed frequently depending on the
strength of the rating and risk events that
come to the notice of the bank

EXTERNAL CREDIT RISK RATING


Undertaken by approved External credit risk
rating agencies such as CRISIL, ICRA, CARE,
FITCH, SMERA, ONICRA, BRICKWORK
Basel guidelines require external credit risk
rating to be done by RBI approved agencies
under Standardised approach
Generally undertaken for all viz. Individual
borrower, Portfolio, Issue / Paper
Captures better peer comparison, Industry &
Business risks, Economic scenario due to
specialised skills available with the rating
agencies
Reviewed yearly or as and when important risk
events impact the rating

CHARACTERISTICS OF A GOOD CREDIT RISK RATING MODEL


1. Should categorise borrowers into rating classes with similar characteristics
and calibrate the rating classes to their respective PDs
2. Identify all the critical factors which cause default and assign appropriate
weights
3. Capture all the quantitative and qualitative factors
4. Reasonably be able to predict future default and throw up danger signals /
alert in advance
5. Model should be able to adapt to changing risks and economic environment
6. Grade the borrowers with easily identifiable distinct grades not too large in
number nor too few
7. Outcome of the rating model should be uniform irrespective of the rater
across the country
8. Examples of rating classes Rating models for borrowers under : Real
Estate, NBFC, Large Corporate, Infrastructure, Projects ( New and existing),
Retail, SME, Small business & Services, Mid-Corporate

COMPONENTS OF FACILITY RATING


FACILITY
Nature / Type of Credit facility

COLLATERAL
Nature and composition of collateral
Liquidity and marketability

Purpose of facility

Quantity of collateral

Product type and loan structure

Quality of collateral Change in value due


to market risks

Priority rights of creditor in case of Quality of charge on collateral and whether


default / bankruptcy
shared for other facilities eg first exclusive
charge, first pari passu charge, second
charge
Degree of collaterisation of individual
facility

STANDARD & POOR'S CREDIT RATING GRADES

Credit Rating
AAA
AA
A
BBB
BB

Description
Best credit qualityExtremely reliable with regard to financial obligations
Very good credit qualityVery reliable.
More susceptible to economic conditionsstill good credit quality.
Lowest rating in investment grade
Caution is necessaryBest sub-investment credit quality
Vulnerable to changes in economic conditionsCurrently showing the ability to
B
meet its financial obligations
Currently vulnerable to nonpaymentDependent on favorable economic
CCC
conditions
CC
Highly vulnerable to a payment default
C
Close to or already bankruptpayment on the obligation currently continued.
D
Payment default on some financial obligation has actually occurred.
Note: Ratings are also modified with + or - signs, so an AA- is a higher rating than is an A+ rating. With such
modifications, BBB- is the lowest investment grade rating.
Source: Standard & Poor's

FACTORS IMPACTING CREDIT DEFAULT BY BORROWER

FINANCIALS

MANAGEMENT
& OWNERSHIP

Capital
or Ownership
owners stake structure
in business
of
Strength
Leverage
sponsors
Profitability
of
Level
Liquidity
Professionalism
Cash flows
of management
of
Quality
internal controls
in
the
organisation

QUALITATIVE
FACTORS

OTHERS

Industry Risk
Business Risk
Project Risk
Country Risk

o Collateral
o Exteranal
Rating
o Conduct
of
account
o Credit
information
report of other
banks

ILLUSTRATIVE FINANCIAL PARAMETERS AND RATING


BENCHMARKS
Parameter
AAA
AA
A
ABBB
Net Sales (Rs. crore )
>300
>200
>100
>50
<50
EBIDTA (Rs. crore)
>50
>30
>20
>10
<10
Net Profit Margin %
>10
10-Jul
7-Apr
4-Feb <1
ROCE %
>15
15-Oct 10-Jul 7-Apr <4
Total Debt/ Net Cash Accruals
0-0.25 0.25-0.5 0.5-1
1-1.5 >1.5
Total
Liabilities/Tangible
Net
0-0.5
0.5-1.0 1.0-1.5 1.5-2 >2
Worth
PBIDT/ Interest
>3
3-Feb
2-Jan 0.5-1 <0.5
Note: The above parameters and respective benchmarks are given as an
illustration. These may vary across financial institutions & industry sectors.

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