Guidelines on Internal Credit Risk Rating (ICRR) system for banks
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Guidelines on Internal Credit Risk Rating (ICRR) system for banks
Background of Internal Credit Risk Rating System
- Lending Risk Analysis (LRA)- 1993
- Credit Risk Grading (CRG) 2005
- Internal Credit Risk Rating System 2018
Background of Internal Credit Risk Rating System
- Prepared for 20 Different Sectors .
- Ideal Assessment Parameters Fixed on the Analysis of three-year Data of 220 Audited Financial Statements Collected From 22 Scheduled Banks .
- Data also collected from 54 Companies Listed on Dhaka Stock Exchange
- ICRRS refers to the system to analyze a borrower’s repayment ability based on information about a customer’s financial condition including their liquidity, cash flow, profitability, debt profile, market indicators, industry and operational background, management capabilities, and other indicators.
- The summary indicator derived from the system will be called Internal Credit Risk Rating (ICRR).
Use of Internal Credit Risk Rating (ICRR) – (Four Uses)
- To provide a granular, objective , transparent, and consistent framework for the measurement and assessment of customers’ credit risk.
- To facilitate the portfolio management activities.
- To assess the quality of individual borrower to help the banks to determine the quality of the credit portfolio, line of business, the branch or the Bank as a whole.
- To be used for individual credit selection, credit pricing, and setting credit limit and terms and conditions.
Function of ICRR System –(Three Functions)
- ICRR System a Fully Automated System that calibrates the characteristics of different sector and industries in one single model;
- If the borrower is in multiple lines of business, the sector should be used for assessing the line of business generating the highest portion of the revenue &/or profit.
- If there is no particular line of businesses can be singled out- the ICRRS should be conducted using “other industry- if manufacturing” or “other service-if service”.
General Instructions –(Ten Instructions )
- Using ICRR by Bangladeshi Bank without making any changes, extensions, modification or deletion.
- ICRR for all exposures except consumer loans, small enterprises having total loans exposure less than BDT 50 lac, short term agree , micro-credit and loan to bank, NBFI and Insurance.
- The quantitative part of the ICRR completed by an analyst other than Relationship Manager.
- Verified by an independent verifier on an on-going basis.
- Relationship Manager shall complete the qualitative assessment part .
- ICCR shall be an integral part of the credit approval process.
- Independent credit risk function responsible for the accuracy and integrity of the rating.
- The executive summary report of the ICRR of the borrower shall be approved and signed by the Chief Risk Officer (CRO) and
- Those loans that are approved below the CRO level e.g zonal office or branch office, the executive summary report of the ICRR shall be approved and signed by the final approval authority
- Banks shall use the latest audited financial statements of the borrower.
- All credit proposals whether new, renewal or enhancement shall be gone through the ICRR process .
- A set of the ICRR report shall be retained in the credit file.
- The Relationship Manager shall pass the approved ICRR report to the related department for updating their MIS/record.
- Banks shall conduct the routine internal audit to check whether the ICRRS is functioning as per the instructions laid down in the guidelines.
Frequency of Credit Risk Scoring
- ICRR shall be conducted for all credit proposals including renewal or enhancement of the existing proposal;
- For existing credit relationship, the ICRR shall be reviewed at least annually at the time of annual/regular credit review.
Selected Sectors :
Industry (14 Sectors)
Ready Made Garments (RMG), Textile (including spinning, knitting, weaving), Food and Allied Industries, Pharmaceutical, Chemical, Fertilizer, Cement, Ceramic, Ship building, Ship breaking, Jute Mills, Steel Engineering, Power and Gas, Other industry (only to be selected if the borrower falls under industry but does not fit with other 13 specific sub-categories)
- Trade and Commerce
- Agro Base and Agro Processing
- Service (Four Sectors )
Credit Risk Rating Scores:
The ICRR consists of 4-notched rating system covering the Quantitative and Qualitative parameters.
Definitions of Credit Risk Rating:
- Aggregate score of 80 or greater in ICRR.
- Strong repayment capacity of the borrower evident by the high liquidity, low leverage, strong earnings, and cash flow
- Borrower has well established strong market share.
- Very good management skill & expertise.
- Aggregate score of 70 or greater but less than 80 and the quantitative score of at least 30.
- These borrowers are not as strong as “Excellent “borrowers, but still demonstrate consistent earnings, cash flow and have a good track record.
- Borrower is well established and has strong market share.
- Very good management skill & expertise.
- Aggregate score of 60 or greater but less than 70 and the quantitative score of at least 30.
- 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.
- Aggregate score of less than 60
- Financial condition is weak and no capacity or inclination to repay.
- 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).
Management Action Triggers (Seven Triggers):
- Banks are allowed lending to a borrower if the borrower’s ICRR is “Excellent” or “Good”
- For the “Marginal “cases, the bank shall take cautionary measures in renewing the facilities or lending new money to the customers.
- No loan can be sanctioned to borrowers whose ICRR is “Unacceptable” unless the loan is 100% cash covered or guaranteed by the government, sovereign entity or banks or the loan is for any state-owned organization or state-owned project.
- If the ICRR falls under “Marginal” or “Unacceptable” for any risk criteria (among 16 quantitative and 18 qualitative); whatever the aggregate score is, the relationship manager should evaluate what would be the impacts of such on loan repayment and justify how those risk(s) is(are) mitigated;
- In deriving ICRR, whatever score a borrower gets in the qualitative analysis if the score in the quantitative part is less than 50%, the borrower’s ICRR shall be “Unacceptable”.
- Bank can make renewal and enhancement of existing loans for maximum 2 (two) times if the borrower’s ICRR is “Unacceptable”.
- In conducting qualitative analysis, justifications for all criteria are required to be documented.
- Bank must maintain portfolio level data base for the asset base with “Excellent”, “Good” “Marginal” and “Unacceptable” category and maintains risk appetite/tolerance level for portfolio.
Exceptions to Credit Risk Scoring (Seven Exceptions ):
- For a newly established company with no meaningful financial statement, the bank can apply a manual rating based on the projected financial statements .
- For the Above , rating of the borrower shall not better than Marginal. However, the bank must run the rating module once the full year audited financial statements are available.
- For large business conglomerate, rating substitution is allowed based on the rating of Corporate Guarantor (legally enforceable, irrevocable and unconditional) of the performing concern of the same group or holding company.
- ICRR shall be conducted on the guarantor to determine whether the guarantor has the ability to support the borrower at the time of need.
- Rating generation is discouraged using outdated financial statements (i.e available audited financial statements are more than 18 months old).
- In exceptional cases where there is valid reason for delay in audited financial publication, out dated financial statements can be accepted only if up to date unaudited financial statement is submitted, but the rating shall not be better than “Marginal”. In this case, the conditioned mentioned in para 1.10(a) is to be followed.
- Rating shall be downgraded if there is any internal/external factors or information that have not been captured in the rating/financial statements .
- For the proprietorship & partnership, un audited financial statement can be used but due diligence should be conducted on financial statements through checking bank statements recording the sales collection, stock/receivable position, peer analysis, bank liabilities etc.
- If the customer is in multiple lines of business, the most appropriate sector/industry shall be the line of business generating revenue more than 50% of total revenue. If there is no particular line of businesses can be singled out- the rating for “other industry” or “other services” should be used.
- This guideline and enclosed model will be the minimum standard of risk rating; and banks may adopt more sophisticated risk rating model in line with the size and complexity of their business.
Quantitative Indicators and Associated Weights ( Six Broad Categories):
|1.Leverage (10%)||a) Debt to Tangible Net Worth (DTN)||7||Total Interest-bearing liabilities or Financial Debt/ Total Tangible Net Worth|
|b) Debt to Total Assets (DTA)||3||Total Interest-Bearing Liabilities or Financial Debt/ Average Total Assets|
|2.Liquidity (10%)||a) Current Ratio (CR)||7||Current Assets/ Current Liabilities|
|b) Cash Ratio (Cash)||3||Cash and easily marketable securities/ Current Liabilities|
|3.Profitability (10%)||a) Net Profit Margin (NPM)||5||Net profit after tax/ Net Sales|
|b) Return on Assets (ROA)||3||Net profit after tax/ Average Total Assets|
|c) Operating Profit to Operating Assets (OPOA)||2||Operating Profit/ Average Operating Assets|
Quantitative Indicators and Associated Weights:
|4.Coverage 15%||a)Interest Coverage (IC)||3||Earnings Before Interest and Tax/Interest Expense|
|b)Debt Service Coverage Ratio (DSCR)||5||Earnings Before Interest Tax Depreciation Amortization/ Debts to be Serviced|
|c) Financial Debt to Operating Cash Flow (FDCF)||4||Financial Debt / Operating Cash Flow|
|d) Cash flow Coverage Ratio (CCR)||3||Cash flow from operation / Debts to be Serviced|
|5.Operational Efficiency (10%)||a) Stock Turnover Days (STD)||4||(Total Inventory/COGS)*360|
|b) Trade Debtor Collection Days (TDCD)||3||(Total Accounts Receivable/ Sales)*360|
|c) Asset Turnover (AT)||3||Sales /Average Total Assets|
|6.Earning Quality (5%)||a) Operating Cash Flow to Sales (CFS)||3||Operating Cash flow / Sales|
|b) Cash flow based accrual ratio (CAR)||2||=NI-(CFO+CFI) /Average Net Operating Assets|
Qualitative Indicators and Associated Weights:
|1. Performance Behavior||10|
|Performance Behavior With Banks Borrowings||9|
|Performance Behavior With Suppliers/ Creditors||1|
|2. Business and Industry Risk||7|
|Age Of Business||2|
|Long-Term External Credit Rating Of The Borrower||2|
|3. Management Risk||7|
|Experience Of The Management||2|
|Existence Of Succession Plan||2|
|Change In Auditors In Last 4 Years||1|
Qualitative Indicators and Associated Weights
|4. Security Risk||11|
|Collateral/ Security Coverage||5|
|Type Of Guarantee||2|
|5. Relationship Risk||3|
|6. Compliance Risk||2|
|Compliance With Environmental Rules, Regulations And Covenants||1|
Input Primary Information of Borrower and Select Sector/ Industry of the Borrower:
|Bank’s Name||:||ABC Bank Limited|
|File/ Reference No||:||10000/100/10/1|
|Borrower Name||:||XYZ Limited|
|Group Name, if any||:||PQR|
|Type of Industry/ Sector||:||1. RMG|
|Ownership Type||:||Sole Proprietorship|
|Registration No/Trade License No||:||123|
|Financials Audit Status:||:||Audited|
|Name of Audit Farm||MNO|
|Analyst Name, Designation||:||PQR|
|Verifier Name, Designation||:||UBW|
|Date of Financials||:||43191|
|Date of Analysis (DD-MM-YYYY)||:||43191|
|Date of Verification (DD-MM-YYYY)||:||43191|
Input data of balance sheet, profit and loss statement and cash flow statement:
- In the input sheet of the balance sheet, profit, and loss statement and cash flow statement, Input must be given to all cells that are marked with yellow colors.
- Moreover, while providing input to the balance sheet, profit and loss statement and cash flow statement following issues should be taken care of:
a) Current Portion of Long-Term Borrowing/Loan
- Input must be given to this cell. If “Current Portion of Long-Term Borrowing/Loan” is not found in the balance sheet, the analyst shall communicate this to the borrower.
- If the amount is already added with the total loans in the balances sheet then “Current Portion of Long-Term Borrowing/Loan” must be deducted from the total loans and must insert the split figures in related cells.
- If the figure is still zero, it means the borrower has no existing long-term borrowings; which is unusual. If found so, the analyst should interview the borrower.
- If the analyst becomes certain that the borrower has no existing borrowings, then 0.01 shall be inserted in the corresponding cell.
b) Other Current Liabilities:
- To make the balance sheet balance i.e assets = liabilities + equity, deduct amount 0.01 in this cell, if the same is inserted in row 56: Current Portion of Long-Term borrowing/ Loan.
c) Financial/Interest Expenses
- Input must be given to this cell. If not found in the P&L, the analyst shall look into the notes of financial statement and communicate with the borrower to determine the amount.
- If the figure is zero, it means the borrower has no existing borrowings; which is unusual.
- If the analyst becomes certain that the borrower has no existing borrowings, then figure 1 must be inserted in the corresponding cell.
|G.1||Performance behavior with banks borrowings|
|G.1.1||How many times the borrower got adversely classified in last 3 years|
|[ Aversely classified means the borrower’s loans classified as per BB loan classifications policy i.e SS, DF, BL]||0 time||5|
|G1.2||How many times the borrower’s loans got rescheduled/ restructured in last 3 years|
|G.2||Performance behavior with suppliers/ Creditors|
|Did the borrower pay its Suppliers/ Creditors regularly in last 1 year||Yes||1|
|H||Business and Industry Risk||7|
|* Sales growth means the growth of sales from previous year sales||>10%||2|
|The formula for calculating sales growth is [(current year sales – previous year sales)/ previous year sales]*100||5%-10%||1|
|Less than 5%||0|
|H.2||Age of Business|
|The number of years the borrower||>10 years||2|
|engaged in the primary line of business||7 to 10 years||1.5|
|5 to 7 years||1|
|4 to 5 years||0.5|
|Critical assessment of 5 (five) years prospect of industry and borrower’s sales volatility||Growing and Low volatility||1|
|* Volatility denotes sales volatility||Stable||0.75|
|Growing but High Volatility||0.5|
|H.4||Long-Term External Credit Rating of the Borrower|
|Rating Grade should be assigned in line with BB Rating Mapping as per BRPD circular 14/2018 on Risk-Based Capital Adequacy in line with Basel III.||2&3||1.5|
|I.1||Experience of the Management|
|Quality of the management based on total number of years of experience of the senior management in the Industry.||More than 10 years in the related line of business||2|
|* Senior Management means MD and next two tiers||5–10 years in the related line of business||1|
|Less than 5 years||0|
|I.2||Existence of Succession Plan|
|Yes, with good capability of successor||2|
|Yes, but questionable capacity of successor||1|
|BSEC listed auditors are considered as recognized||Recognized Auditors||2|
|I.4||Change in Auditors in last 4 years|
|Fully Pledged Facilities||2|
|Registered Hypothecation (1st Charge/1st Pari passu Charge)||1.5|
|2nd charge/Inferior charge||1|
|Registered Mortgage on Municipal corporation/Prime Area property||2|
|Registered Mortgage on Pourashava/Semi-Urban/ Union parishad area property||1.5|
|Equitable Mortgage or No property but Plant and Machinery as collateral||1|
|The formula of collateral coverage is [forced sale value of collateral/ total loans]||>100%||5|
|80% to 100%||4|
|* Forced sale value should be determined as per policies of BB. If there is no policy bank should determine their own policy.||70% to 80%||3|
|50% to 70%||2|
|J.4||Type of guarantee|
|Strong Corporate Guarantee means the credit rating of the guarantor should be at least 1 or 2 as per BB rating mapping mentioned in BRPD circular 18/2014 on Risk Based Capital Adequacy in line with Basel III.||Strong Corporate Guarantee||1.5|
|Personal Guarantees or Corporate Guarantee without Strong Financial Strength||1|
|K.1||Account Conduct||More than 3 years Accounts with Faultless Record||3|
|Less than 3 years Accounts with faultless record||2|
|Accounts having satisfactory dealings with some late payments.||1|
|Frequent Past dues & Irregular dealings in account||0|
|L.1||Compliance with environmental rules, regulations and covenants|
|Independence of Management||Good Corporate Governance||1|
|Questionable Corporate Governance||0|
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