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Managing Risks in Commercial and Retail Banking by AMALENDU GHOSH

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CHAPTER 9

Credit Risk Rating Issues

9.1 RATING PRACTICES IN BANKS

A rating is a summary indicator of the risk inherent in credit exposure and conveys the potential loss the bank may suffer if the borrower commits default in repaying its dues. The quantum of loss is never static because the default probability and the loss intensity vary from time to time on account of changes in the political and economic environment and the market conditions. It is difficult to design a credit risk rating framework (CRRF)1 that will apply equally to all types of borrowers and all types of banks. Practices vary among banking institutions in framing the design of credit risk rating models. The Models Task Force of the Basel Committee on Banking Supervision carried out a survey of around 30 institutions in G-10 countries in 1999 to gather information about the “best practice” and the “sound practice” in the internal rating systems design. The committee found that “there is no single standard for the design and operation of an internal rating system.” There were “both similarities and differences in the structure, methodology and application of internal rating systems at banking institutions.” Broadly, the commonality among the banking institutions in the credit risk rating system related to (1) the types of risk factors taken into account for risk compilation, (2) the assignment of ratings based on the assessment of the counterparty, and (3) the use of ratings for different facets of risk management. ...

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