Loan Risk Grading and Loan Appraisal

Loan Risk Grading

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. Well-managed credit risk grading systems will promote bank safety and soundness by facilitating informed decision-making. Grading systems will measure credit risk and differentiate individual credits and groups of credits by the risk they pose. This will allow bank management and examiners to monitor changes and trends in risk levels. The process also allows bank management to manage risk to optimize returns.
The Credit Risk Grading matrix will allow application of uniform standards of 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. All Banks should adopt a credit risk grading system. The system should define the risk profile of borrowers to ensure that account management, structure and pricing are commensurate with the risk involved. Risk grading is a key measurement of a bank’s asset  quality, and as such, it is essential that grading is a robust process. All facilities should be assigned a risk grade. Where deterioration in risk is noted, the risk grade assigned to a borrower and its facilities should be immediately changed. Borrower risk grades should be clearly stated on credit applications.

Implementation of Credit Risk Grading 

Credit Risk Grading Manual (CRGM) has been developed and forwarded to the banks and banks were advised to implement Credit Risk Grading for all exposures (irrespective of amount) other than Consumer Financing. Small Enterprises Financing and Short-Term Agricultural and Micro-Credit Financing Risk Grading Matrix provided in the Manual is the minimum standard of risk rating and banks may adopt more sophisticated risk grades in line with the size and complexity of their business. Banks have also been advised to adopt the credit risk grading system outlined in the other two separate manuals(Credit Risk Grading Manual-Bank, Credit Risk Grading Manual-NBFI) for assessing credit risk in case of taking exposure on another Bank/Non-Bank Financial Institute.

Loan Appraisal

For selecting the right type of borrower and business, credit appraisal is a must. For this purpose, Relationship Management is to conduct appraisal of managerial, organizational, marketing, technical, socio-economic and environmental aspects. Besides, the bank assesses the credit worthiness and risk profile of the borrower. By and large, this assessment covers loan proposition and purpose, borrower analysis, industry analysis, supplier/buyer analysis, historical financial analysis, projected financial performance analysis, etc.
Moreover, bank should grade the borrower By completing Credit Risk Grading Sheet (CRGS). In case of large loan, banks refer to External Credit Assessment Institution (ECAI) for credit rating according to the direction of Basel-II. The assessments are mostly one based on the information collected from the borrower. Besides, market reports, study of accounts, financial statements on line CIB and personal interview are also worked source of inputs for decision making. In case of corporate credits where the borrower is a group of companies, banks conduct credit assessment on a consolidated or group basis known as Obligor. In case of Loan syndication, besides the lead bank all participatory banks also perform their own independent assessment, analysis and review.