Credit Risk Grading

Speaker
Atul Chandra Pandit
Assistant Professor, BIBM

Bangladesh Institute of Bank Management

Credit Risk
It is the probability that a borrower will not be able to
pay interest or repay Principal according to terms
specified in the credit agreement.
It is probability of default on the part of the borrower
to act as per the agreement.
It also refers to the risk of negative effects on the
financial result and bank capital due to borrowers
default on its obligation to the bank.

Credit Risk
Credit risk comes from a banks dealing with
individual, Corporate, bank, NBFI or a sovereign.
It may arise due to inability or unwillingness to
perform
It may stem from on-balance sheet and off-balance
sheet activities

Types of Default
Technical default
Strategic default
Payment default
Economic default

Why CR is so Important?
Credit is the main source of earning and a source of
regular cash flow for a bank
Delay or default in payment cause cash flow
problems and affect bank liquidity
Erodes confidence of the depositors
It invites bank failure

Types of Credit Risk

Credit Risk
Standalone Risk
Concentration Risk

Portfolio Risk
Systematic Risk

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Transaction/ Standalone Risk

It refers to the losses in the event of default or in the
event of decline in the borrowers credit quality.
It includes default risk & downgrade risk
It is involved with banking book, trading book and
off-Balance sheet activities
Standard credit risk and counterparty risk

What are the causes of

Transaction/ Standalone risk?

Causes of Standalone Risk

Improper or weak need assessment
Wrong structuring
Insufficient cash flow generation
Failure to understand forex risk
Name lending ignoring fundamentals

Causes of Standalone Risk

Lack of monitoring of approval condition
Lack of proper succession
Insufficient security and guarantee
Incomplete documentation
Undermining the importance of interbank deposits
and OBSA
Poor Governance (corruption, failure to stand in pressure,
related party transaction)

Measuring Standalone Risk

Risk Grading
CRG

Credit Risk Management Process

Identification
Assessment
Pricing
Monitoring
Mitigation and Control

Risk Identification with Borrower

Internal Risk Factors

Risk in Planning
Risk in Execution/Implementation
Marketing Risks
Financial Risks
Managerial Risks

External Risk Factors

Input/Utility Availability
Govt. Policies
Natural Calamities
Technological Obsolescence
Political Situations

Bangladesh Institute of Bank Management

Credit Risk Grading (CRG)

Important tool of CRM to understand dimensions of
risk in credit transactions
Based on Pre-specified scale reflecting the credit risk
for an exposure
Number/Alphabet/Symbol is used as summary
indicator of risk

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Use of CRG
Obligor-Level Analysis
Credit Selection and Pricing
Monitoring and Internal MIS
Also relevant for Portfolio Level
Analysis
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Risk Grades under CRG

GRADING

SHORT
NAME

NUMBER

Superior
Good
Acceptable
Marginal/Watch list
Special Mention
Sub Standard
Doubtful
Bad & Loss

SUP
GD
ACCPT
MG/WL
SM
SS
DF
BL

1
2
3
4
5
6
7
8

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Risk Grades under CRG

Sup-1: Fully Cash covered, Govt./ Int. Bank Guarantee
GD-2: Strong Repayment Capacity
Accpt-3: Consistent Earnings, Cash Flow and Good Track Record
MG/WL-4: Greater attention required Above Average Risk.
SM-5: Potential Weaknesses Close attention required.
SS-6: Weak Financial Condition
DF-7: Repayment Unlikely
BL-8: No progress in repayment/ on the verge of wind-up
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How to Compute CRG?

Step-I: Identify all the Principal Risk Components
Step-II: Allocation of Weightages to Risk Components
Step-III: Establish Key Parameters
Step-IV: Assigning Weight to each of the Key Parameters
Step-V: Input Data to arrive at the total Score
Step-VI: Arrive at CRG based on total Score
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Step-I: Identify all the Principal Risk Components

Financial Risk
Business/ Industry Risk
Management Risk
Security Risk
Relationship Risk
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Principal Risk Components

Financial Risk: Probability of failure to meet obligation due

to financial distress. It arises due to high leverage, poor

liquidity, low profitability and insufficient cash flow.
Business/Industry Risk: Adverse industry situation/
unfavorable business condition will impact borrowers capacity
to meet obligation.
Management Risk: Probability of default due to poor
managerial ability.
Security Risk: Probability of default due to poor quality of
security.
Relationship Risk: limit utilization, account performance,
compliance of covenants and deposit relationship.

Bangladesh Institute of Bank Management

Step-II:
Allocation
of Weightages to Risk
Components
Principle
Risk Components
Weights
Financial Risk

50%

Business/ Industry Risk

18%

Management Risk

12%

Security Risk

10%

Relationship Risk

10%

Bangladesh Institute of Bank Management

Step-III: Establish Key Parameters

CREDIT RISK

Financial Risk

Leverage

Liquidity

Business/
Industry Risk

Size of
Business
Age of
Business

Management
Risk

Relationship
Risk

Experience

Security
Coverage

Account
Conduct

Succession

Collateral
Coverage

Utilization of
Limit

Team Work

Support

Compliance of
Covenants/
Condition

Business
Outlook
Profitability

Security Risk

Industry
Growth
Coverage
Market
Competition
Barriers to
Business
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Personal
Deposits

Step-IV: Assigning Weight to each of the Key Parameters

Principle Risks and Parameters
Financial Risk:

Weights
50%

Leverage

15%

Liquidity

15%

Profitability

15%

Coverage

5%

Business/ Industry Risk:

18%

Size of Business

5%

Age of Business

3%

Business Outlook

3%

Industry Growth

3%

Market Competition

2%

Entry / Exit Barriers

2%

Bangladesh Institute of Bank Management

Principle Risks and Parameters

Management Risk:

Weights
12%

Security

5%

Succession

4%

Teamwork

3%

Security Risk:

10%

Security Coverage

4%

Collateral Coverage

4%

Support

2%

Relationship Risk:

10%

Account Conduct

5%

Utilization of Limit

2%

Compliance of Covenants

2%

Personal Deposits

1%

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Step-V: Input Data to arrive at the total

Score

Manually give input to CRG Score

Sheet
Excel based-steps to be followed
(Appendix-C of CRG guidelines)

Bangladesh Institute of Bank Management

Step-VI: Arrive at CRG based on total Score

Number

RG/Short Name

Score

SUP

100% (cash covered Govt./ Int. Bank

Guarantee

GD

85+

ACCPT

75-84

MG/WL

65-74

SM

55-64

SS

45-54

DF

35-44

BL

<35

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Early Warning Signal (EWS)

Early Warning Signals (EWS) indicate risks
or potential weaknesses of an exposure
requiring monitoring, supervision, or close
attention by management.

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Symptoms Early Warning Signal (EWS)

Marginal/Watch list (MG/WL- 4): if

Any loan is past due/overdue for 60 days and above.

Frequent drop in security value or shortfall in drawing power
exists.

Special Mention (SM - 5): if

Any loan is past due/overdue for 90 days and above

Major document deficiency prevails (such deficiencies include
but not limited to; board resolution for borrowing not obtained,
sanction letter not accepted by client, charges/hypothecation
over assets favoring bank not filed with Registrar, Joint Stock
Companies, mortgage not in place, guarantees not obtained,
etc.)

A significant petition or claim is lodged against the borrower.

Bangladesh Institute of Bank Management

Exceptions to CRG
Head of Credit Risk Management may also
downgrade/classify an account in the normal
course of inspection of a Branch or during the
periodic portfolio review. In such event, the Credit
Risk Grading Form will then be filled up by Credit
Risk Management Department and will be referred
to Corporate Banking/Line of Business/Credit
Administration Department/Recovery Unit for
updating their MIS/records.
Recommendation for upgrading of an account has
to be well justified by the recommending officers.
Essentially complete removal of the reasons for
downgrade should be the basis of any upgrading.
Bangladesh Institute of Bank Management

Exceptions to CRG
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 exposure is additionally collateralized through cash
collateral, good tangible collaterals and strong guarantees.
These are exceptions and should be exceptionally
approved by the appropriate approving authority.
Whenever required an independent assessment of the credit
risk grading of an individual account may be conducted by
the Head of Credit Risk Management or by the Internal
Auditor documenting as to why the credit deteriorated and
also pointing out the lapses.
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.
Bangladesh Institute of Bank Management

CREDIT RISK GRADING

REVIEW
Superior
Good
Acceptable
Marginal/Watchlist
Special Mention
Sub-standard
Doubtful
Bad & Loss

Annually
Annually
Annually
Half yearly
Quarterly
Quarterly
Quarterly
Quarterly

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Other Areas

MIS ON CREDIT RISK GRADING

FINANCIAL SPREAD SHEET (FSS)
Appendix-A:DATA COLLECTION CHECK LIST
Appendix-B:LIMIT UTILIZATION FORM

Appendix-C:CREDIT RISK GRADING SCORE SHEET

Appendix-D:CREDIT RISK GRADING FORM
Appendix-E:MIS REPORTS ON CREDIT RISK GRADING
Appendix-E:FINANCIAL SPREAD SHEET (FSS)

Bangladesh Institute of Bank Management

Thank You

Bangladesh Institute of Bank Management