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Managing Risks in Commercial and Retail Banking by AMALENDU GHOSH

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CHAPTER 8

Credit Risk Rating Concept and Uses

8.1 CREDIT RISK RATING CONCEPT

Credit risk rating (CRR) communicates the relative degree of credit risk associated with a facility or a counterparty. The CRR framework captures the levels of credit risk in a granulated form, and the rating conveys the relative degrees of risk in terms of the probabilities of default for different types of exposures and counterparties, and the potential losses that are likely to arise in the event of default. CRR measures the risk inherent in an individual credit exposure and makes a meaningful differentiation between counterparties in terms of the risk levels they pose to the bank. The rating indicates whether an exposure carries high risk, moderate risk, or low risk and conveys the relative degree of safety inherent in an exposure, such as high safety, adequate safety, or low safety. In a granulated rating framework, the ratings are usually denoted through a combination of alphabets. Many banks have highly calibrated rating frameworks where marginal differences between the rating grades are denoted by adding positive or negative signs after the rating grade, such as AAA+, AAA–, AAA. The principle of rating implies that the higher the rating grade (signifying lower risk or greater safety), the lower is the probability of default. The principle is explained in the diagram in Figure 8.1.

This is an illustrative example. The diagram indicates risk grade default probability as shown below:

Risk Grade ...

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