Bangladesh Institute of Bank Management Credit Risk Grading Speaker Atul Chandra Pandit Assistant Professor, BIBM

Bangladesh Institute of Bank Management

Credit RiskIt 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.

Bangladesh Institute of Bank Management

Credit RiskCredit 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

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Types of DefaultTechnical default

Strategic default

Payment default

Economic default

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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

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Bangladesh Institute of Bank Management Types of Credit Risk

Bangladesh Institute of Bank Management

Transaction/ Standalone RiskIt 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

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What are the causes of Transaction/ Standalone risk?

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Causes of Standalone RiskImproper or weak need assessment

Wrong structuring

Insufficient cash flow generation

Failure to understand forex risk

Name lending ignoring fundamentals

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Causes of Standalone RiskLack 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)

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Measuring Standalone RiskRisk Grading

CRG

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Credit Risk Management ProcessIdentification

Assessment

Pricing

Monitoring

Mitigation and Control

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Bangladesh Institute of Bank Management Internal Risk Factors Risk in PlanningRisk in Execution/ImplementationMarketing RisksFinancial RisksManagerial Risks

External Risk Factors Input/Utility AvailabilityGovt. Policies Natural Calamities Technological Obsolescence Political Situations

Risk Identification with Borrower

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Bangladesh Institute of Bank Management 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 riskCredit Risk Grading (CRG)

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Bangladesh Institute of Bank Management Use of CRG Obligor-Level Analysis

Credit Selection and Pricing

Monitoring and Internal MIS

Also relevant for Portfolio Level Analysis

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Bangladesh Institute of Bank Management Risk Grades under CRG

GRADINGSHORT NAMENUMBERSuperiorSUP1GoodGD2AcceptableACCPT3Marginal/Watch listMG/WL4Special MentionSM5Sub StandardSS6DoubtfulDF7Bad & LossBL8

Bangladesh Institute of Bank Management

Bangladesh Institute of Bank Management Risk Grades under CRGSup-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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Bangladesh Institute of Bank Management 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

Bangladesh Institute of Bank Management

Bangladesh Institute of Bank Management

Step-I: Identify all the Principal Risk Components

Financial Risk

Business/ Industry Risk

Management Risk

Security Risk

Relationship Risk

Bangladesh Institute of Bank Management

Bangladesh Institute of Bank Management 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

Bangladesh Institute of Bank Management

Step-II: Allocation of Weightages to Risk Components

Principle Risk Components WeightsFinancial Risk50%Business/ Industry Risk18%Management Risk12%Security Risk10%Relationship Risk10%

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Bangladesh Institute of Bank Management Step-III: Establish Key Parameters

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Bangladesh Institute of Bank Management Step-IV: Assigning Weight to each of the Key Parameters

Principle Risks and ParametersWeightsFinancial Risk:50% Leverage15% Liquidity15% Profitability15% Coverage5%Business/ Industry Risk:18% Size of Business5% Age of Business3% Business Outlook3% Industry Growth3% Market Competition2% Entry / Exit Barriers2%

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Bangladesh Institute of Bank Management

Principle Risks and ParametersWeightsManagement Risk:12% Security5% Succession4% Teamwork3%Security Risk:10% Security Coverage4% Collateral Coverage4% Support2%Relationship Risk:10% Account Conduct5% Utilization of Limit2% Compliance of Covenants2% Personal Deposits1%

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Bangladesh Institute of Bank Management 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)

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Bangladesh Institute of Bank Management

Step-VI: Arrive at CRG based on total Score

NumberRG/Short NameScore1SUP100% (cash covered Govt./ Int. Bank Guarantee2GD85+3ACCPT75-844MG/WL65-745SM55-646SS45-547DF35-448BL

Bangladesh Institute of Bank Management 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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Bangladesh Institute of Bank Management 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 aboveMajor 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

Bangladesh Institute of Bank Management Exceptions to CRGHead 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

Bangladesh Institute of Bank Management Exceptions to CRGIn 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.

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Bangladesh Institute of Bank Management CREDIT RISK GRADING REVIEW

SuperiorAnnually GoodAnnually AcceptableAnnually Marginal/WatchlistHalf yearly Special MentionQuarterly Sub-standardQuarterly DoubtfulQuarterly Bad & LossQuarterly

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Bangladesh Institute of Bank Management Other AreasMIS ON CREDIT RISK GRADING FINANCIAL SPREAD SHEET (FSS)Appendix-A:DATA COLLECTION CHECK LISTAppendix-B:LIMIT UTILIZATION FORMAppendix-C:CREDIT RISK GRADING SCORE SHEET Appendix-D:CREDIT RISK GRADING FORMAppendix-E:MIS REPORTS ON CREDIT RISK GRADINGAppendix-E:FINANCIAL SPREAD SHEET (FSS)

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Bangladesh Institute of Bank Management Thank You

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