Why Credit Risk Rating Systems Matter


By Mary Ellen Biery, Sageworks L


ow market rates and intense compe  on have been hallmarks of the lending environment in recent years, and regulators have taken no ce that this can lead to weaker discipline around pricing and


structuring of loans.


Indeed, the Of ce of the Comptroller of the Currency in its latest Semiannual Risk Perspective noted, “Competitive pressures from banks and non- banks contribute to easing in underwriting and to the risk that sound pricing structures and practices may be compromised.”


Loan pricing and the importance of pricing as it relates to managing risk in the portfolio are subjects that Robert Ashbaugh, senior risk management consul- tant at Sageworks, knows well. He recommends institu- tions familiarize themselves with the key components of effective pricing models, as well as current pricing trends and how changes such as CECL may impact pricing decisions going forward.


Surveys by Sageworks in recent years have found that banks worry about issues of subjectiv- ity with risk ratings, and many believe they can improve upon current risk rating systems. Ashbaugh explained that one of the challenges with the risk rating process is that it forms the basis of so much of what financial institutions know about risk management, and yet the risk rating process itself can be imperfect.


WHY CREDIT RISK RATING SYSTEMS ARE IMPORTANT Here are four reasons why credit risk rating systems deserve the attention of your bank:


14 OCTOBER 2018 WWW.CBAK.COM


1. Credit risk rating systems often determine the approval process for credits, as well as the price for the loan. Without a reliable and consistent way of providing a risk rating, it is dif cult to have an accurate read on the borrower’s ability to repay, which can lead to undue risk in the portfolio.


2. Credit risk rating systems equip lenders to deter- mine how to review and analyze the borrower business relationship and how often to do so. Risk rating systems de ne the loan review and watch list process, as well as the workout process. A risk rating can also help the lender plan ahead to determine if repricing or restructuring the loan will be preferable when it comes times for renewal.


3. Credit risk rating systems form the basis for banks’ broader risk management efforts, includ- ing stress testing, setting the reserve and capital and strategic planning. If risk information for individual loans is incorrect, risk information for the overall portfolio might also be inaccurate, so it is crucial to have accurate risk ratings for every single loan.


4. Credit risk rating systems give  nancial institu- tions’ management teams, boards and auditors a more accurate measure of portfolio risk and the trends in risk levels. Management teams armed with better information can make decisions that minimize risk and grow pro tably.


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