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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 banks 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 used in CRG GRADING Superior Good Acceptable Marginal/Watchlist Special Mention Sub Standard Doubtful Bad & Loss

Eight Categories NUMBER 1 2 3 4 5 6 7 8

SHORT NAME SUP GD ACCPT MG/WL SM SS DP BL

 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. Accounts A. Objective Criteria B. 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 * FR * B/IR * MR * SR * RR Weight ----------50% 18% 12% 10% 10%

Step-III: Credit Risk Components and Key Parameters

CREDIT RISK
Financial Risk Business/ Industry Risk Size of Business Age of Business Business Outlook Industry Growth Market Competition Barriers to Business Management Risk Security Risk Relationship Risk

Leverage Liquidity Profitability Coverage

Experience Succession Team Work

Security Coverage Collateral Coverage Support

Account Conduct Utilization of Limit

Compliance of Covenants/ Condition

Personal Deposits

Step-IV: Assigning Weight to Key Parameters FR *Lev. *Liq. *Prof. *Cov. B/IR *SB *AB *BO *IG *MC *EB 50% 15% 15% 15% 5% 18% 5% 3% 3% 3% 2% 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 1 2 3 4 5 6 7 8 RG/Short Name SUP GD ACCPT MG/WL SM SS DF BL Score 100% (cash covered Govt./ Int. Bank Guarantee 85+ 75-84 65-74 55-64 45-54 35-44 <35

6. CRG Process Applicable for all exposures (other than consumer and 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
SUP GD ACCPT MG/WL SM SS DF BL

RF (at least)
Annually -Do-DoHY Q Q Q 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