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Credit Risk Grading is an important tool for credit risk management as it helps a Bank to understand
various dimensions of risk involved in different credit transactions. The credit risk grading system is vital
to take decisions both at the pre-sanction stage as well as post-sanction stage.
At the pre-sanction stage, credit grading helps the sanctioning authority to decide whether to lend or not
to lend, what should be the pricing for a particular exposure, what the extent should be of Exposure, what
should be the appropriate credit facility and the various risk mitigation tools. At the post-sanction stage,
the bank can decide about the depth of the review or renewal, frequency of review, periodicity of the
grading, and other precautions to be taken. Having considered the significance and necessity of credit risk
grading for a Bank, it becomes imperative to develop a credit risk grading model which meets the
objective outlined above.
Risk grading would also be relevant for surveillance and monitoring, internal MIS and assessing
the aggregate risk profile. It is also relevant for portfolio level analysis.
Short Name
Number
Superior
SUP
Good
GD
Acceptable
ACCPT
Marginal/watch list
MG/WL
Special Mention
SM
Substandard
SS
Doubtful
DF
Bad Loss
BL
Special Mention
Substandard
Doubtful
(non-performing)
QUANTITATIVE FACTOR:
Capital Adequacy
Asset Quality
Earnings Quality
Liquidity and Capacity of External Fund Mobilization
Size of the Bank & Market Presence
QUALITATIVE FACTOR:
Management status
Regulatory Environment & Compliance
Risk Management
Sensitivity to Market Risk
Ownership (Share holding pattern) & Corporate Governance
Accounting Quality
Franchise Value
Step II: Allocate weightages to Principal Risk Components
According to the importance of risk profile, the following weights are proposed for corresponding
principal risks components (Quantitative and Qualitative factors).
Principal Risk Components:
Weights
QUANTITATIVE FACTOR:
60%
Capital Adequacy
15%
Asset Quality
15%
Earnings Quality
15%
Liquidity and Capacity of External Fund Mobilization
10%
Size of the Bank & Market Presence
5%
QUALITATIVE FACTOR:
40%
Management
10%
Regulatory Environment & Compliance
10%
Risk Management
5%
Staff turnover
Emphasis to Information Technology and staff knowledge in this area
Key Parameters for Regulatory Environment & Compliance:
Policy on loan classification and provisioning
Policy on large loans
Disclosure requirement for banks
Delegation of power at operating level
Internal Control and Compliance mechanism
Status on Basel II compliance
Key Parameters for Risk Management:
Implementation of risk management in the areas of Credit Risk,
Implementation of risk management in the areas of Operational Risk
Implementation of risk management in the areas of and Market Risk
Key Parameters for Sensitivity to Market Risk
Degree to which changes in interest rates can adversely affect companys earnings
Degree to which changes in foreign exchange rates can adversely affect companys earnings
Degree to which changes in commodity prices can adversely affect companys business
Key Parameters for Ownership (Share holding Pattern) & Corporate Governance:
Ownership pattern & composition of Board (current shareholding with names of promoters)
Conflict of interest issues in the operational management
Personal policy and employee satisfaction
Application of information technology in the system
Key Parameters for Accounting Quality:
Policies for income recognition
Provisioning and valuation of investment are examined
Quality of Auditors
Key Parameters for Franchise Value:
Joint venture partner or Strategic Alliance
Management contract or Technical collaboration
Alliance/arrangement with World Bank/ADB/IFC/SEDF or awards/certification/recognition
Step IV: Assign weightages to each of the key parameters
Once the above mentioned key risk parameters are evaluated, analyzed and reviewed properly the next
step will be to further assign weightages against each key parameter depending on its strength and
merits.
Step V: Input data to arrive at the score on the key parameters
After the risk identification & weightages assignment process (as mentioned above), the next steps
will be to input actual score obtained by the Bank (under review process) against the key parameters in
the score sheet to arrive at the total scores obtained.
Step VI: Arrive at the Credit Risk Grading based on total score obtained
The following is the proposed Credit Risk Grade matrix based on the total score obtained by an
obligor (i.e. a Bank).
Risk Grading
Short Name
Superior
SUP
Score
i.
ii.
iii.
iv.
Good
Acceptable
Marginal/watch list
Special Mention
Substandard
Doubtful
Bad & Loss
GD
ACCPT
MG/WL
SM
SS
DF
BL
Grade
85 100
Credit facilities fully cash
covered (100%) or near cash.
Government guarantee
International Bank guarantee
75 84
65 74
55 64
45 54
35 44
25 34
< 25
2
3
4
5
6
7
8
KEY PARAMETERS
Points
1.Capital Adequacy
Banks plan to raise equity to
support its growth is acceptable
(Internal Capital Generation)
15.00
4.00
2.00
15.00
2.00
2.00
Parameter
Excellent
Strong
Good
Moderate
3% or more above RR
1% to 2% above RR
Required minimum ratio
1% to 2% below RR
More than 2% below RR
9 % or More
7 % to less than 9%
5% to less than 7%
2% to less than 5%
Less than 2%
Satisfactory
Acceptable
Unsatisfactory
Always
Sometimes
Never
Satisfactory
Moderate
Actual
4
3
2
1
5
4
3
2
1
4
3
2
1
2
1.5
1
2
1
0
2
1
Score
Obtained
11.50
3
Strong
1.85 %
Fair
Acceptable
1.5
Always
10.00
2
Satisfactory
3.00
Is level of non -performing loans
acceptable
Sector wise gross NPL
1.00
1.00
1.00
1.00
2.00
2.00
2.00
1.00
1.00
Unsatisfactory
Less than 3%
3% to5%
5% to 10%
10% to 15%
More than 15%
Satisfactory
Moderate
Unsatisfactory
Regularly
Sometimes
Hardly
Yes
No
0
3
2.5
2
1.5
1
1
.5
0
1
.5
0
2
0
Always
Sometimes
Hardly
Regularly
Irregularly
Not at all
Justified
Poor
Unjustified
1
.5
0
1
.5
0
1
.5
0
Satisfactory
Unsatisfactory
1
.5
5% to 10%
Moderate
.5
Regularly
Regularly
Sometimes
.50
Irregularly
.5
1
Poor
Unsatisfact
ory
15.00
2.00
1.00
2.00
1.00
1.00
.5
12.00
Yes
No
Yes
No
Satisfactory
Moderate
Lower
Satisfactory
Moderate
Lower
Highly
Moderate
Low
Yes
No
2
1
1
.5
2
1.5
1
2
1.5
1
2
1.5
1
1
.5
Yes
N0
.5
Satisfactory
Satisfactory
1.5
Moderate
1.5
Yes
Regularly
Sometimes
1
.5
Regularly
Hardly
.25
1.00
Regularly
Sometimes
Hardly
1
.5
.25
Regularly
1.00
Yes
No
Strong
Weak
1
.5
1
.5
Yes
Weak
.5
1.00
10.00
2.00
Satisfactory
Moderate
Hardly
2
1.5
1
Satisfactory
2.00
Yes
No
2
1
Yes
2.00
Yes
No
Yes
No
2.00
1.00
1.00
.50
Satisfactory
No
.50
1.00
Regularly
Irregularly
1.00
.50
Irregularly
.50
1.00
Capable
Failure
Yes
No
1.00
.50
Yes
Capable
1.00
1.00
Level of automation
2.00
9.00
1.00
5.00
2.00
1.00
4.50
Large
Medium
Small
High
Medium
Low
Regularly
Irregularly
2.00
1.50
1.00
2.00
1.50
1.00
1.00
0.50
Large
2.00
1.50
Medium
Regularly
1.00
60.00
46.50
QUALITATIVE FACTOR
6. MANAGEMENT : 10 POINTS
10.00
1.00
1.00
1.00
1.00
1.00
1.00
1.00
1.00
1.00
1.00
7.00
Yes
No
Satisfactory
Moderate
Unsatisfactory
Sufficient
Moderate
Good
Yes
No
1
.5
1
.5
.25
1
.5
.25
1
.5
No
.5
Satisfactory
1.00
Moderate
.5
No
.5
Always
Regular
Sometimes
Satisfactory
Unsatisfactory
Yes
No
1
.5
.25
1
.5
1
.5
Regular
.5
Unsatisfactory
.5
Yes
1.00
Yes
No
Yes
No
Very Good
Fair
Poor
1
.5
1
.5
1
.5
.25
No
.5
Yes
Fair
.5
10.00
2.00
7.50
Highly
Moderate
Low
Yes
No
2.00
1.50
1.00
1.00
00
Moderate
1.5
Yes
.50
0.50
Yes
No
.50
00
Yes
.50
1.00
Yes
No
Sufficient
Negligible
Satisfactory
Moderate
Unsatisfactory
1.00
.50
1.00
.50
2
1.5
1
Yes
1.00
Sufficient
.50
Moderate
1.5
1.00
1.00
2.00
1.00
2.00
1.00
5.00
1.00
1.00
3.00
1.00
1.00
0.50
5.00
2.00
2.00
2.00
1.00
Excellent
Moderate
Low
Fully
Partially
Poorly
Satisfactory
Negligible
1.00
.50
00
1.00
.50
00
.50
00
Moderate
.50
Fully
1.00
Satisfactory
.50
Highly
Moderately
Partially
Completely
Moderately
Partially
Completely
Moderately
Partially
2
1.5
1
2
1.5
1
1
.5
.25
High
3.50
1.5
Moderately
1.5
Moderately
.5
3.50
Highly
Moderate
Highly
Moderate
Heavily
Lower
2.00
1.00
2.00
1.00
1.00
.50
High
Moderate
Lower
.5
5.00
2.00
1.00
1.00
1.00
2.00
1.00
3.50
Joint
Single
Always
Sometimes
Satisfied
Unsatisfied
Strong
Weak
2
1
1
.5
1
.5
1
.5
Joint
Sometimes
.5
unsatisfied
.5
Weak
.5
2.50
Yes
No
Yes
No
Yes
No
Joined
Single
1.00
0.50
1.00
.50
1.00
.50
1.00
.50
Yes
No
.5
Yes
Joined
2.00
1.00
Management Contract/Technical
collaboration (foreign or local partners
adding to the synergy)
Alliance/arrangement with World
Bank/ADB/IFC/SEDF or any
awards/certification or any other recognition
granted to the Bank
TOTAL QULIITATIVE FACTOR
0.50
Joined
Single
Join
ed
.50
.25
.50
0.50
Joined
Single
Join
ed
.50
.25
.50
GRAND TOTAL
40.00
100.00
29.50
76.00
GOOD (GD)-2
If a Bank has its own well established risk grading system equivalent to the proposed credit
risk grading or stricter, then they will have the option to continue with their own risk grading
system.
Limitations of CRG
Credit Risk Grading is a good cushion for the banks. Hence it has some limitation. The most common
limitations are given below:
The weightage given are not proportionate equally.
The weights are fixed always rather than flexible.
Various categories of bank exist in the industry but the weightage are not of various
categories.
It is very complicated to identify the principle risk components.
Problems are found in case of setting key parameters.
It is very easier said than done to find consistency in the theory and practice.
No formal revision of the manual is made since its inaugural.
Its a very lengthy process to calculate the aggregate score
Complexity is observed in interpreting score obtained through the process.
Conclusion
An appropriate, precise and flexible Credit Risk Grading system is mandatory for creating and
adopting a risk management culture in the organization for developing a sustainable credit risk
management environment in the banking sector of Bangladesh. Credit risk generates not only from
counter party but also from improper policies, procedures and systems within the organization. This
paper focuses on the weakness of the existing risk evaluation system that entails assessing risk through
counter party or single obligor wise risk analysis. The new proposed Credit Risk Grading and
Evaluation system describes a new lending system that specifically addresses the flaws, thus helping
all parties to the process. Based on the proposed evaluation system, it is expected that the credit risk
analysis policies should: always follow the detailed and formalized credit evaluation or appraisal
process, provide risk identification, measurement, monitoring and control, define target markets, risk
acceptance criteria, credit approval authority, credit maintenance procedures and guidelines for
portfolio management, be communicated to branches or controlling offices and clearly spell out roles
and responsibilities of units involved in origination and evaluation system of credit risk for any
industrial project.
References
I. Lehaj-Ul-Hasan, Principles, Policies and Guidelines for Sustainable Credit Risk
Management in Bangladesh, A thesis work submitted to the Department of Industrial and Production
Engineering, Bangladesh University of Science and Technology (BUET), December, 2007.
II. Commercial Bank Financial Management, In the Financial Services Industry, Sixth EditionJOSEPH F. Sinkey, JR.
III.CRG Guidelines of Bangladesh Bank (www.bangladesh-bank.org)
IV.www.fe-bd.com
V.www.investopedia.com
VI.www.wikipedia.com