Session 4 – Credit Rating- Internal & External(Part-3)

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Importance of Rating in Financial Institution & Banks…

• Banks/FI on many occasion use public money for lending. So, there is necessity
to assess their performance so the public money is safe
• Banks/FI play an
important role in developing the economy with lending and acting as a catalyst
for development of the business.
• Banks/FI gets themselves rated for easy
access of finance at good ROI
• For a good rated Bank, RBI will not hesitate to
lend money

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Steps in Rating a Bank…
Rating of a Bank has two step process:
• The first step involves analysis of the macroeconomic environment
• The second part involves analysis of the bank specific factor

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Macroeconomic factors
To understand Macroeconomic factors we need to understand PESTLE Analysis..
• Political
• Economic
• Socio cultural
• Technological
• Legal
• Environmental

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Political factor..
Government laws affect the state of the banking sector. The government can
intervene in the matters of banking whenever, leaving the industry susceptible to
political influence. This includes corruption amongst political parties, or specific
legislative laws such as labor laws, trade restrictions, tariffs, and political stability.

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Economic factor

The banking industry and the economy are tied. How income flows, whether the
economy is prospering or barely surviving during times of recession, affects how
much capital banks can access. Spending habits, and the reasons behind them,
affect when customers borrow or spend funds at banks. Additionally, when
inflation skyrockets, the bank experiences the backlash. Inflation affects currency
and its value and causes instability. Foreign investors think twice before
providing their funds when a particular country’s currency value is high.

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Socio cultural factor
Cultural influences, such as buying behaviors and necessities, affect how people
see and use banking options. People turn to banks for advice and assistance for
loans related to business, home, and academics. Consumers seek knowledge
from bank tellers regarding saving accounts, bank related credit cards,
investments, and more.

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Technological Factor…
Technology is changing how consumers handle their funds. Many banks offer a
mobile app to witness accounts, transfer funds, and pay bills on smartphones.
Smart phones can scan cheque, and the bank can process it from their end, at their
location. This change helps to save paper and the need to drive directly to the branch
to handle these affairs. Debit cards are also changing. Chips have been implemented,
requiring users to insert their card into debit machines rather than swiping them.
Other countries, such as Canada, have implemented a “tap” option — tapping the
debit card onto the device, requiring no pin, for a transaction to complete. These
changes make it easier on the user to make purchases without required intrusion
from banks. Banks themselves are utilizing technology within the workplace.
Telecommunicating through virtual meetings is being embraced. It replaces the need
for in-person meetings
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Legal Factor..
The banking industry follows strict laws regarding privacy, consumer laws, and
trade structures to confirm frameworks within the industry. Such structures are
required for customers in the allocated country and for international users.

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Environmental Factor.
With the use of technology — particularly with mobile banking apps — the use for
paper is being reduced. Additionally, the need to drive directly to a branch to
handle affairs is minimized as well Many issues are taken care of through mobile
apps and online banking services. Consumers can apply for credit cards online,
buy cheque online, and have many of their banking questions answered online
or by phone. Thus, reducing individual environmental footprints.

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Intrinsic Factors affecting Rating of a Bank…

• Size & Market Share

• Capital Adequacy
• Basel III
• Resource Profile
• Asset Quality
• Quality of Management
• Corporate Governance
• Liquidity Risk
• Earning Profile

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Size & Market Share
Size of the bank is determined in terms of its Asset Under Management,
Customer Base & other factors. Market share is determined by the percentage of
business or customer the Bank can retain out of the total customer base in a
Segment.

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Capital Adequacy…
Capital Adequacy Ratio is also known as Capital to Risk Assets Ratio, is the ratio
of a bank's capital to its risk. National regulators track a bank's CAR to ensure
that it can absorb a reasonable amount of loss and complies with statutory
Capital requirements. It is a measure of a bank's capital.

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Basel III norms

Basel III is a global, voluntary regulatory framework on bank capital adequacy,

stress testing, and market liquidity risk. This third installment of the Basel
Accords was developed in response to the deficiencies in financial regulation
revealed by the financial crisis of 2007–08

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Resource Profile of a Bank…
• Deposits
• Composition of borrowing
• Geographic Distribution
• Size & growth of deposits
• Cost of funds
• Concentration

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Asset Quality

Key parameters of asset quality are:

• Gross NPA
• Slippage Ratio
• Extent of Loan Provisioning
• Restructured Loans as percentage of Advances
• Stressed assets as percentage of Net Worth

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Quality of Management…

• Composition of the Board

• CEO
• Key persons
• Management Policy
• Internal Risk Control
• Attrition Rate
• Management Philosophy

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Corporate Governance…

Corporate governance is the combination of rules, processes or laws by which

businesses are operated, regulated or controlled. The term encompasses the
internal and external factors that affect the interests of a company's stakeholders,
including shareholders, customers, suppliers, government regulators and
Management.

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Liquidity Risk…

Liquidity risk is a financial risk that for a certain period of time a given financial
asset, security or commodity cannot be traded quickly enough in the market
without impacting the market price.

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Earning Profile/Income…
• Earning Potential & Stability
• Diversity of Earnings
• Efficiency of Operations
• Net Interest Income
• Proportion of Fee Based Income
• ROTA (Return On Total Assets) • RONW (Return On Net Worth)

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CAMELS Rating System

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Thank You