CHAPTER 11
Credit Risk Rating Methodology
11.1 RATING METHODOLOGY DEVELOPMENT PROCESS
Credit risk rating (CRR) models capture the entire risk profile of the borrower and generate ratings based on the quantitative and qualitative assessment of risk factors. Banks also use discretion to modify model-generated ratings by applying judgmental factors. Several models exist for the derivation of risk ratings, but in this book I have recommended simplified methodologies for the computation of counterparty ratings. The model takes into account all credit facilities sanctioned to a borrower at different geographical locations relating to the borrower's entire operations and produces a rating that reveals the overall risk arising from the borrower's total obligations to the bank. The model recognizes facility characteristics in the derivation of the overall rating, but where appropriate, the facility structure risk can be separately rated and interpolated into the rating model to produce the final rating.
The sequential steps for credit risk rating are:
1. Determination of risk components.
2. Identification of risk factors.
3. Identification of risk elements.
4. Assignment of weights to risk components, risk factors, and risk elements.
5. Assignment of scores to risk elements.
6. Computation of risk component rating.
7. Assignment of overall risk rating or risk grade.
The risk rating process is explained in Figure 11.1.
FIGURE 11.1 Risk Rating Process
Risk Assessment and Weight Assignment ...
