RATING OF BANKS

Business Risk of Banks Business risk –Operating risk –Regulatory risk –Environmental risk –Ownership structure –Government support –Governance structure –Management strength –Risk positions –Risk strategy –Risk systems

Financial Risk of Banks Asset quality Fund diversification Liquidity of banks Profitability of banks Capital adequacy

Ratios used in Bank Rating Profile –Total asset base – Scale of operations –Net worth –Net income –Age of the bank Capital adequacy –Net worth as a percentage of assets –Capital formation rate – net income as a percentage of net worth at the beginning of the year

Ratios used in Bank Rating Resources –Deposit growth rate- increase in deposits over the previous year –Composition of deposits – mix of tem to savings and current deposits –Demographic profile of deposits - mix of deposits in rural vs. other branches

Ratios used in Bank Rating Asset Quality –NPA as a percentage of credit –Gross NPA generation rate –Provisions for NPA as a percentage of NPA –Net NPA to tangible net worth –Increase in total doubtful and loss assets as a percentage of opening substandard assets –Loan growth

Ratios used in Bank Rating Profitability –Return on assets –Return on net worth –Yield on earning assets –Cost of interest bearing liabilities –Gross interest spread –Net interest margin –Non interest revenue percentage –Non interest expense percentage –Dividend payout

Ratios used in Bank Rating Liquidity –Liquid assets to deposits –Certificate of deposits to deposits –Credit as a percentage of deposits

Risk Based Rating Concept of larger bank resources to provide for larger risks Identify risk from banking functions Grade the risk on the basis of its occurrence and impact Provide for resources in accordance with the risk grades

Risk Rating in Banks Rating System – Single Dimension CAMELS (Capital adequacy, asset quality, management quality, earnings, liquidity, sensitivity to market risk) Rating System – Two Dimensional PF (Probability of failure) CGF (Consequences given failure)

CAMELS Capital component –Ability of capital to withstand risk from all components of bank risk Asset component –Amount of credit risk with the bank (loan, investment and off-balance sheet) Management component –Ability of Board of directors and senior management to identify, measure, monitor and control risks

CAMELS Earnings component –Quality and trend of earnings and ability of the bank to sustain earnings Liquidity component –Sources of liquidity and funds position of the bank Sensitivity to market risk component –Changes in economic capital due to sensitivity of interest rates, foreign exchange rates, commodity prices and equity prices.

Profitability and Impact Rating System Developed in US, UK, Canada Accounts for subjectivity Considers objectivity –Structured approach –Peer review –Quality control

Probability of Failure

Structured Approach Probability of Failure (PF) x Impact of Consequences Given Failure (CGF) = Index of supervisory attention Index of Supervisory Attention = Exponential from 1 to 56,000 Index groups Normal Oversight Mandated Improvement Restructure possibility

Supervisory Attetntion

Application of Risk Grading Risk based supervision Identification of banks with high risk levels Inspection of banks that is mandatory and at increased frequency Investigation of banks to contain risk Decisions on supervisory responses