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Presentation on

Credit Risk Grading Manual

1. Introduction

Credit/Loan constitutes the major revenue earning asset of a bank

Banks lend mostly depositors’ money

Credit/ Loanable Funds having cost implications and repayment obligations to the depositors have to be managed efficiently with minimum possible credit (default) risk.

Moreover, credit culture is undergoing rapid change due to

- Globalisation - Disintermediation- Liberatisation - Competition- Consolidation

Incidence of Credit Risk may be higher unless adequately cared and monitored.

Credit Risk

Credit Risk is the possibility that a borrower or counterparty will fail to meet obligations.

Credit risk arises from the bank’s dealings with or lending to the corporates, individual and

other banks or financial institutions.

To minimise losses, banks should have comprehensive credit risk management policies

and procedures

Credit Risk Management

To select Good Credit Risk

CRM – Steps

- Risk Identification

- Risk Assessment

- Risk Grading

- Risk Pricing

- Risk Monitoring

Credit Risk Grading (CRG)

Important tool of CRM to understand dimensions of risk in credit transactions

Aggregation of Grading across the borrowers, activities and lines of business reflecting the quality of credit.

Pre-sanction: Lending Decision/ Loan Pricing

Post-sanction: Review of Grading and Precautions

Backdrop of Integrated Credit Risk Grading Model: BB Initiatives

LRA introduced in 1993 suffers from subjectivity.

CRMG – Risk Grade Score Card introduced in 2003 is not comprehensive.

Hence, need for an Integrated Credit Risk Grading Model-simplified and user-friendly.

CRGM Introduced in 2005.

Risk Grading tool at Pre-sanction

Risk Grading Review tool at Post-sanction

2. Definition of CRG

Based on Pre-specified scale reflecting the credit risk for an exposure

Number/Alphabet/Symbol as summary indicator of risk

3. Use of CRG: A common standardized approach

Obligor-Level Analysis

Credit Selection and Pricing

Monitoring and Internal MIS

Also relevant for Portfolio Level Analysis

4. Short Name and Number Eightused in CRG Categories

GRADING SHORT NAME NUMBER

Superior SUP 1

Good GD 2

Acceptable ACCPT 3

Marginal/Watchlist MG/WL 4

Special Mention SM 5

Sub Standard SS 6

Doubtful DP 7

Bad & Loss BL 8

Sup-1: Fully Cash covered, Govt./ Int. Bank Guarantee

GD-2: Strong Repayment Capacity

Accpt-3: Not like GD-2, but Good Track Record

MG/WL-4: Greater attention required – Above Average Risk.

SM-5: Potential Weaknesses – Close attention required.

SS-6: Weak Fin. Condition

DF-7: Repayment Unlikely

BL-8: No progress in repayment/ on the verge of wind-up

Ref: Reg. Def. on Grading of CL. AccountsA. Objective CriteriaB. Qualitative Judgement

5. How to Compute CRG

Step-I: Identify all the Principal Risk Components

Financial Risk: Probability of failure to meet obligation due to fin. distress- High Leverage- Poor Liquidity- Low Profitability- Insufficient Cash Flow

Business/ Industry Risk: Adverse Ind. situation/ unfav. business condition to impact repayment

Management Risk: Probability of Default due to poor managerial ability

Security Risk: Probability of Default due to poor quality of security

Relationship Risk: Risk areas in terms of Borrower/ Dep. relationship

Step-II: Distribution of Weightage to Risk Components

Risk Components Weight* FR --- 50%* B/IR --- 18%* MR --- 12%* SR --- 10%* RR --- 10%

Step-III: Credit Risk Components and Key Parameters

CREDIT RISK

Financial Risk

Management Risk

Business/ Industry Risk

Relationship Risk

Security Risk

Leverage

Liquidity

Profitability

Coverage

Experience

Succession

Team Work

Business Outlook

Size of Business

Industry Growth

Market Competitio

n

Barriers to Business

Account Conduct

Utilization of Limit

Compliance of Covenants/ Condition

Personal Deposits

Security Coverage

Collateral Coverage

Support

Age of Business

Step-IV: Assigning Weight to Key Parameters

FR 50%*Lev. 15%*Liq. 15%*Prof. 15%*Cov. 5%

B/IR 18%*SB 5%*AB 3%*BO 3%*IG 3%*MC 2%*EB 2%

Step-V: Input Data to arrive at Score

Manually MS Excel based – steps followed

Step-VI: Arrive at CRG based on total Score

Number

RG/Short Name

Score

1 SUP 100% (cash covered Govt./ Int. Bank Guarantee

2 GD 85+

3 ACCPT 75-84

4 MG/WL 65-74

5 SM 55-64

6 SS 45-54

7 DF 35-44

8 BL <35

6. CRG Process

Applicable for all exposures (other than consumerand SE and short term Agri and Micro-Credit

Not Applicable for SUP. Grade Applicable for New or Renewal Cases

* RM to collect Inf. as per Data Collection Checklist (App-A)- Documents/Items required for CRG

• Required – Obtained- Pending Item Checklist

RM to fill up Limit Utilisation form (App-B) For assessing realistic earning status

Risk Factors to be evaluated and weighted on the basis of

- Up to date & reliable data- Complete objectivity

[CRG Score Sheet App-C]* Criteria* Weight* Parameter* Score* Actual Parameter* Score Obtained* RISK GRADE

CRG to be originated by RM & then an ongoing process- CRG Form (App-D) to follow for Risk Grading in

case of existing concerns.

All Credit proposals (New/Renewal) to accompany Data Collection Checklist (DCC) Limit Utilisation Form (LUF) CRG Score Sheet CRG Form

Credit officer to pass on the approved CRG Form to Credit Admn. Dept. and Corp. Banking Unit for MIS record.

Subsequent Revision of CRG by appropriate approving authority.

7. Early Warning Signals (EWS)

EWS indicate-- risks or potential weakness of an exposure- demanding close attention by management

In the absence of EWS,- likely of repayment prospects- probability of downgrading to classified assets

Hence, Early Identification, Prompt Reporting and Proactive Management of Early Alert Accounts (EAA)

Irrespective of Credit Score, Identified EAAs to have the following symptoms:

* MG/WL – 4: Loan overdue – 60 days & above Frequent security value or shortfall in DP

* SM – 5: Loan overdue – 90 days & above Major doc. deficiency exit Claim lodged against borrower

8. Exceptions to Credit Risk Grading

Downgrading/ Classifying an account by Head, CRM during inspection/ portfolio review

Upgrading to be justified by Recommending Officer - Upon complete removal of the reasons for Downgrade.

Marginal/ Special Mention/ Unacceptable, Cr. Risk may be accepted if addl. collateral exists.- Exceptionally approved

Indep. Assessment of CRG of an Account may be done by Head/ CRM or Internal Auditor

Bank may exercise option to continue with own CRG if equivalent or stricter.

9. Credit Risk Grading Review

CRG to be periodically updated after lending

Review Frequencies

RG RF (at least)SUP Annually

GD -Do-

ACCPT -Do-

MG/WL HY

SM Q

SS Q

DF Q

BL Q

10. MIS on Credit Risk Grading

Banks to have comprehensive MIS Reports on CRG to evaluate total credit portfolio

MIS Reports on CRG (Appendix – E) - CRG Report (Consolidated)- CRG Report (Branch wise)- CRG Report (Branch and Risk Grade wise)- CRG Report (Grade wise Borrower List)

Preparation of MIS Reports & Circulation on Quarterly basis.

11. Financial Spread Sheet (FSS)

Analyzing the Credit Risk elements from Financial Point of view

Input Sheets Output Sheets

FSS : Appendix F

12. Concluding Remarks:

Risk Grading does not imply Credit Decision

Credit Decision = RG + other Factors

Thank You All