Lecture No_________________________________________
PRITISH KUMAR SARKER
Senior Executive Vice President
Head of Credit Risk Management Division
Southeast Bank Limited
Head Office, Dhaka
CREDIT RISK GRADING (CRG)
WHAT IS CREDIT RISK GRADING (CRG)?
The Credit Risk Grading (CRG) is a collective definition based on the pre-specified scale
and reflects the underlying credit-risk for a given exposure.
A Credit Risk Grading deploys a number/ alphabet/ symbol as a primary summary indicator
of risks associated with a credit exposure.
Credit Risk Grading is the basic module for developing a Credit Risk Management system.
FUNCTIONS OF CREDIT RISK GRADING
Well-managed credit risk grading systems promote bank safety and soundness by facilitating
informed decision-making. Grading systems measure credit risk and differentiate individual
credits and groups of credits by the risk they pose. This allows bank management and examiners
to monitor changes and trends in risk levels. The process also allows bank management to
manage risk to optimize returns.
USE OF CREDIT RISK GRADING
The Credit Risk Grading matrix allows application of uniform standards to credits to ensure
a common standardized approach to assess the quality of individual obligor, credit
portfolio of a unit, line of business, the branch or the Bank as a whole.
As evident, the CRG outputs would be relevant for individual credit selection, wherein
either a borrower or a particular exposure/facility is rated. The other decisions would be
related to pricing (credit-spread) and specific features of the credit facility. These would
largely constitute obligor level analysis.
Risk grading would also be relevant for surveillance and monitoring, internal MIS and
assessing the aggregate risk profile of a Bank. It is also relevant for portfolio level analysis.
NUMBER AND SHORT NAME OF GRADES USED IN THE CRG
The proposed CRG scale consists of 8 categories with Short names and Numbers are provided as follows:
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 DF 7
Bad & Loss BL 8
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MEANING OF THE GRADING
A clear definition of the different categories of Credit Risk Grading is given as follows:
Superior - (SUP) - 1
Credit facilities, which are fully secured i.e. fully cash covered.
Credit facilities fully covered by government guarantee.
Credit facilities fully covered by the guarantee of a top tier international Bank.
Good - (GD) - 2
Strong repayment capacity of the borrower
The borrower has excellent liquidity and low leverage.
The company demonstrates consistently strong earnings and cash flow.
Borrower has well established, strong market share.
Very good management skill & expertise.
All security documentation should be in place.
Credit facilities fully covered by the guarantee of a top tier local Bank.
Aggregate Score of 85 or greater based on the Risk Grade Score Sheet
Acceptable - (ACCPT) - 3
These borrowers are not as strong as GOOD Grade borrowers, but still demonstrate
consistent earnings, cash flow and have a good track record.
Borrowers have adequate liquidity, cash flow and earnings.
Credit in this grade would normally be secured by acceptable collateral (1st charge
over inventory / receivables / equipment / property).
Acceptable management
Acceptable parent/sister company guarantee
Aggregate Score of 75-84 based on the Risk Grade Score Sheet
Marginal/Watchlist - (MG/WL) - 4
This grade warrants greater attention due to conditions affecting the borrower, the
industry or the economic environment.
These borrowers have an above average risk due to strained liquidity, higher than
normal leverage, thin cash flow and/or inconsistent earnings.
Weaker business credit & early warning signals of emerging business credit
detected.
The borrower incurs a loss
Loan repayments routinely fall past due
Account conduct is poor, or other untoward factors are present.
Credit requires attention
Aggregate Score of 65-74 based on the Risk Grade Score Sheet
Special Mention - (SM) - 5
This grade has potential weaknesses that deserve management’s close attention.
If left uncorrected, these weaknesses may result in a deterioration of the
repayment prospects of the borrower.
Severe management problems exist.
Facilities should be downgraded to this grade if sustained deterioration in financial
condition is noted (consecutive losses, negative net worth, excessive leverage),
An Aggregate Score of 55-64 based on the Risk Grade Score Sheet.
Substandard - (SS) - 6
Financial condition is weak and capacity or inclination to repay is in doubt.
These weaknesses jeopardize the full settlement of loans.
Bangladesh Bank criteria for sub-standard credit shall apply.
An Aggregate Score of 45-54 based on the Risk Grade Score Sheet.
Doubtful - (DF) - 7
Full repayment of principal and interest is unlikely and the possibility of loss is
extremely high.
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However, due to specifically identifiable pending factors, such as litigation,
liquidation procedures or capital injection, the asset is not yet classified as Bad &
Loss.
Bangladesh Bank criteria for doubtful credit shall apply.
An Aggregate Score of 35-44 based on the Risk Grade Score Sheet.
Bad & Loss - (BL) - 8
Credit of this grade has long outstanding with no progress in obtaining repayment
or on the verge of wind up/liquidation.
Prospect of recovery is poor and legal options have been pursued.
Proceeds expected from the liquidation or realization of security may be awaited.
The continuance of the loan as a bankable asset is not warranted, and the
anticipated loss should have been provided for.
This classification reflects that it is not practical or desirable to defer writing off this
basically valueless asset even though partial recovery may be affected in the
future. Bangladesh Bank guidelines for timely write off of bad loans must be
adhered to. Legal procedures/suit initiated.
Bangladesh Bank criteria for bad & loss credit shall apply.
An Aggregate Score of less than 35 based on the Risk Grade Score Sheet.
HOW TO COMPUTE CREDIT RISK GRADING
The following step-wise activities outline the detail process for arriving at credit risk grading.
Step I : Identify all the Principal Risk Components
Credit risk for counterparty arises from an aggregation of the following:
Financial Risk
Business/Industry Risk
Management Risk
Security Risk
Relationship Risk
Each of the above mentioned key risk areas require to be evaluated and aggregated to arrive at
an overall risk grading measure.
a) Evaluation of Financial Risk:
Risk that counterparties will fail to meet obligation due to financial distress. This typically
entails analysis of financials i.e. analysis of leverage, liquidity, profitability & interest
coverage ratios. To conclude, this capitalizes on the risk of high leverage, poor liquidity, low
profitability & insufficient cash flow.
b) Evaluation of Business/Industry Risk:
Risk that adverse industry situation or unfavorable business condition will impact
borrowers’ capacity to meet obligation. The evaluation of this category of risk looks at
parameters such as business outlook, size of business, industry growth, market competition
& barriers to entry/exit. To conclude, this capitalizes on the risk of failure due to low market
share & poor industry growth.
c) Evaluation of Management Risk:
Risk that counterparties may default as a result of poor managerial ability including
experience of the management, its succession plan and team work.
d) Evaluation of Security Risk:
Risk that the bank might be exposed due to poor quality or strength of the security in case
of default. This may entail strength of security & collateral, location of collateral and
support.
e) Evaluation of Relationship Risk:
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These risk areas cover evaluation of limits utilization, account performance,
conditions/covenants compliance by the borrower and deposit relationship.
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CREDIT RISK
Business/Industry
Financial Risk Management Risk Security Risk Relationship Risk
Risk
Size of Business
Security
Leverage Experience Account Conduct
Coverage
Age of Business
Collateral
Liquidity Succession Utilization of Limit
Coverage
Business Outlook
Compliance of
Profitability Team Work Support Covenants/Conditi
on
Industry Growth
Coverage Personal Deposits
Market
Competition
Barriers to
Business
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Step II Allocate weightages to Principal Risk Components
According to the importance of risk profile, the following weightages are proposed for
corresponding principal risks.
Principal Risk Components: Weight:
Financial Risk 50%
Business/Industry Risk 18%
Management Risk 12%
Security Risk 10%
Relationship Risk 10%
Step III Establish the Key Parameters
Principal Risk Components: Key Parameters:
Financial Risk Leverage, Liquidity, Profitability & Coverage ratio.
Business/Industry Risk Size of Business, Age of Business, Business Outlook,
Industry Growth, Competition & Barriers to Business
Management Risk Experience, Succession & Team Work.
Security Risk Security Coverage, Collateral Coverage and Support.
Relationship Risk Account Conduct ,Utilization of Limit, Compliance of
covenants/conditions & Personal Deposit.
Step IV Assign weightages to each of the key parameters.
Principal Risk Components: Key Parameters: Weight:
Financial Risk 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%
Management Risk 12%
Experience 5%
Succession 4%
Team Work 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
/condition 2%
Personal deposit 1%
Step V Input data to arrive at the score on the key
parameters.
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After the risk identification & weightage assignment process (as mentioned above), the next steps
will be to input actual parameter in the score sheet to arrive at the scores corresponding to the
actual parameters.
This manual also provides a well programmed MS Excel based credit risk scoring sheet to arrive
at a total score on each borrower. The excel program requires inputting data accurately in
particular cells for input and will automatically calculate the risk grade for a particular borrower
based on the total score obtained. The following steps are to be followed while using the MS Excel
program.
a) Open the MS XL file named, CRG_SCORE_SHEET
b) The entire XL sheet named, CRG is protected except the particular cells to input data.
c) Input data accurately in the cells which are BORDERED & are colored YELLOW.
d) Some input cells contain DROP DOWN LIST for some criteria corresponding to the Key
Parameters. Click to the input cell and select the appropriate parameters from the DROP
DOWN LIST as shown below.
e) All the cells provided for input must be filled in order to arrive at accurate risk grade.
f) We have also enclosed the MS Excel file named, CRG_Score_Sheet in CD ROM for use.
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.
Number Risk Grading Short Name Score
1 Superior SUP 100% cash covered
Government guarantee
International Bank
guarantees
2 Good GD 85+
3 Acceptable ACCPT 75-84
4 Marginal/Watchlist MG/WL 65-74
5 Special Mention SM 55-64
6 Sub-standard SS 45-54
7 Doubtful DF 35-44
8 Bad & Loss BL <35
CREDIT RISK GRADING PROCESS
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Credit Risk Grading should be completed by a Bank for all exposures
(irrespective of amount) other than those covered under Consumer and Small
Enterprises Financing Prudential Guidelines and also under The Short-Term
Agricultural and Micro - Credit.
For Superior Risk Grading (SUP-1) the score sheet is not applicable. This will be guided by
the criterion mentioned for superior grade account i.e. 100% cash covered, covered by
government & bank guarantee.
Credit risk grading matrix would be useful in analyzing credit proposal, new or renewal
for regular limits or specific transactions, if basic information on a borrowing client to
determine the degree of each factor is a) readily available, b) current, c) dependable, and d)
parameters/risk factors are assessed judiciously and objectively. The Relationship Manager
as per Data Collection Checklist as shown in Appendix-A should collect required
information.
Relationship manager should ensure to correctly fill up the Limit Utilization Form as
shown in Appendix-B in order to arrive at a realistic earning status for the borrower.
Risk factors are to be evaluated and weighted very carefully, on the basis of most up-to-
date and reliable data and complete objectivity must be ensured to assign the correct
grading. Actual parameter should be inputted in the Credit Risk Grading Score Sheet as
shown in Appendix–C.
Credit risk grading exercise should be originated by Relationship Manager and should be
an on-going and continuous process. Relationship Manager shall complete the Credit Risk
Grading Score Sheet and shall arrive at a risk grading in consultation with a Senior
Relationship Manager and document it as per Credit Risk Grading Form as shown in
Appendix-D, which shall then be concurred by the Credit Officer in consultation with a
Senior Credit Officer.
All credit proposals whether new, renewal or specific facility should consist of a) Data
Collection Checklist, b) Limit Utilization Form c) Credit Risk Grading Score Sheet, and d)
Credit Risk Grading Form.
The credit officers then would pass the approved Credit Risk Grading Form to Credit
Administration Department and Corporate Banking/Line of Business/Recovery Unit for
updating their MIS/record.
The appropriate approving authority through the same Credit Risk Grading Form shall
approve any subsequent change/revision i.e. upgrade or downgrade in credit risk grade.
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EARLY WARNING SIGNALS (EWS)
Early Warning Signals (EWS) indicate risks or potential weaknesses of an exposure requiring
monitoring, supervision, or close attention by management.
a) Marginal/Watchlist (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.
b) 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.
The Credit Risk Grading Form of accounts having Early Warning Signals should be completed by
the Relationship Manager and sent to the approving authority in Credit Risk Management
Department. The Credit Risk Grade should be updated as soon as possible and no delay should be
there in referring Early Warning Signal accounts or any problem accounts to the Credit Risk
Management Department for their early involvement and assistance in recovery.
CREDIT RISK GRADING REVIEW
Credit Risk Grading for each borrower should be assigned at the inception of lending and should
be periodically updated. Frequencies of the review of the credit risk grading are mentioned below;
Number Risk Grading Short Review frequency (at least)
1 Superior SUP Annually
2 Good GD Annually
3 Acceptable ACCPT Annually
4 Marginal/Watchlist MG/WL Half yearly
5 Special Mention SM Quarterly
6 Sub-standard SS Quarterly
7 Doubtful DF Quarterly
8 Bad & Loss BL Quarterly
-Good Luck-
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