Page 155 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management

Notes Typically, an internal risk rating system categorises credits into various classes designed to take
into account the gradations in risk. The risk rating system should be drawn in a structured
manner, incorporating, inter-alia, financial analysis, projections and sensitivity, industrial and
management risks. Banks may use the following parametres for developing a risk rating system
suited for the bank:
Financial Aspects

1. Quantitative parametres
(a) Financial indicators - viz. net worth, sales turnover, profits, and ratios such as
liquidity, profitability, gearing, turnover, etc.

(b) Historical comparison of the indicators of the firm.
(c) Inter-firm comparisons.
2. Operational parametres – conduct of account, turnover in the account, etc.

Qualitative Aspects

Qualitative analysis of financial risks that could impact the borrowing company's bottom-line
such as:
1. Accounting policies
2. Auditor's qualifying remarks

Management Aspects

Evaluation of the management of the borrowing company, such as:
1. Structure & systems,

2. Its track record,
3. Honesty and integrity,
4. The promoters – their expertise, competence and commitment,
5. Market perception of the company and its promoters.

Industry Aspects

1. Industry and its trends

2. Trade cycle
3. Regulatory aspects such as Government policies and controls
4. Competition faced from peers and the market for the products
5. Technology levels of the unit vis-à-vis developments in the country and abroad

6. Input profile – raw materials and infrastructure and their pricing
7. Products/user characteristics, alternatives/substitutes available.
Once the risk rating systems are put in place, the ratings assigned to the borrowers can be used
as critical inputs for setting pricing and non-price terms of loans as also present meaningful

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