Risk Rating 

A “notation” or one grade which gives a holistic view of the borrower and indicates the;

• Industry outlook impacting the business
• Business risk factors related to the activity
• Capability of the Management in running the Business
• Financial position of the borrower  

Content

• Understanding Credit Risk Rating Models:- 

1. Internal Rating Models
2. External Ratings

•  Using Credit Risk Rating for sound credit appraisal 

 Risk Rating - Objectives

• Establish  standards for assigning ratings to borrowers/ obligors and facilities and for pooling   of retail exposures 
• Understand the role of rating systems in risk management and decision making processes 
• Requirements of design, development and use of rating systems 
• Risk estimates namely Probability of Default (PD)  Facility rating grades  

 Risk Rating - Types

1. External Rating
2. Internal Rating

Point in Time (PIT): PIT assessment reflects the default risk over a one year horizon based on the current state of the credit cycle.  

Through the cycle (TTC): TTC assessment reflects the  default risk over the one year horizon based on the long term average of the credit cycle. 

Facility Rating : Based on transaction level characteristics such as collateral type, product type, with key elements of LGD included.

 Risk Rating – Business objective

• Identify the  customers and understand the propensity to default in the future 
• Decision making for onboarding customer and arrive at suitable limit
•  Supplement the underwriting process  
•  To meet the regulatory requirements under the IRB framework for credit risk capital computation
•  To predict probability of default (PD) and 

1. to assess risk of a borrower at the time of application and 
2. on-going through their internal / external transactional experience at frequent intervals.

 Risk Rating – Key principles 

• Rating assignments and periodic rating reviews shall not be in conflict with credit sanction
• Consistency in award of rating grades and descriptions for facilities posing similar risk 
•  Risk rating grades shall be refreshed at least on an annual basis , however for high risk limits and those with high exposures, the review to be at least on quarterly basis. 
• Effective process to obtain and update relevant and material information on the borrower’s financial condition, and on facility characteristics 
• Retail portfolio to be modeled separately with different characteristics bringing out the essence of risk

 Risk Rating – Macro requirement

• Predictive and intuitive 
• Sensitive to the risk characteristics and to industry and wider economic factors 
•  Classified within distinct attributes 
•  Consistent with the internal lending standards and loan policies
• Sufficient number of rating grades to allow a meaningful distribution of exposures 
• No excessive concentration in rating grades
•  Develop models distinctly based on sector / segment / Industry / scale of operation

 Risk rating – Retail SMEs

• Retail SME exposures will be assigned to homogenous risk pools based on assessment of a range of similar underlying risk characteristics:
• Borrower risk characteristics (e.g. Business type, sub sector, constitution type, demographics such as age/occupation)
• Transaction risk characteristics, including product and/or collateral types (e.g. loan to value ) measures, seniority (first vs. second charge) etc. - Delinquency status of the exposure 

 Rating – Use test

1. Ratings and risk estimates in all key credit decision making processes including: 

• Loan Sanctions and terms of sanction 
• Pricing of loans (risk based pricing) 
• Setting approval authority for loans/investments 
• Limit setting for counterparty/ obligor 
• Portfolio management, monitoring risk adjusted returns and internal capital purposes 
• Credit quality monitoring, loss forecasting and provisioning 
• Internal and external reporting 
• Strategic decision making 

 Rating – External Risk rating

Approved Rating Agencies approved by SEBI

• Domestic Credit Rating Agencies: 
• Credit Analysis and Research Ltd. (CARE) 
• CRISIL Ltd. (CRISIL) 
• India Ratings and Research Pvt Ltd. (FITCH) 
• ICRA Ltd. (ICRA) 
• Acuity rating and Research  P Ltd 
• Brickwork Ratings 
• International Credit Rating Agencies: 
•  Fitch Ratings Ltd. (FITCH) 
•  Moody’s Investor Services Ltd. (MOODY’S) 
•  Standard & Poor Rating Agencies Ltd. (S&P) 

Rating – External Rating

• 2 types : (Long term/Short Term)
• Loan rating  
• Issuer rating  
• Review rating at least once during the previous 15 months 
• Unsolicited ratings are not permitted for non-sovereign exposures 
• Rating must be published in an accessible form and included in the ECAI’s transition matrix 
• Cash credit exposures tend to be generally rolled over are considered as long term exposures

 Risk Rating – Usage for Analysis

• Risk profile by grade, activity. Demography, geographical representation, constitution, Industry/ service segment/subsector/ business model/Nature of limit
• Migrations across different grades
• Risk parameter estimates for each grade
• Comparison of the actual default rates against the expected as predicted by the rating system

 Rating – Role of Analyst

• Analysts play a very significant role in the rating process. 
• Subjective elements of the rating needs to be thoroughly analyzed
• Relevant parameters shall only be picked up
• Looking at things not  available in the papers 
• Beyond the financial statements 
• External factors affecting the borrowers business   

RATING – Information assimilation

• External media, Internet etc…  
• External Rating rationale  
• comparison to similar Industries in the portfolio,
• Impact of Unhedged Foreign currency exposure , if any
• Conduct of account – Extent of overdues
• Number of time requested for Ad Hoc
• Number of days in overdue
• Number of times in and out of SMA status, current SMA status 

Rating – Architecture

Credit Risk

• Industry Risk(External Factor)

Industry Characteristics

Industry Financials

• Business Risk(Efficiency)

Market Position

Operating

• Management Risk(Internal factors at borrowers level)

Track record

Credibility

Payment Record

Others

• Financial Risk

Existing Finance

Future Financial

Financial Flexibility

Accounting Quality