Financial Institutions Rating Introduction Financial institution rating is to assess the long-term relative credit quality and credit risks. It focuses largely on the institution’s capacity to honour its general obligations - deposits, borrowings and other liabilities in a timely
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Beacon Ratings Financial Sector
Financial Institutions Rating Introduction Financial institution rating is to assess the long-term relative credit quality and credit risks. It focuses largely on the institution’s capacity to honour its general obligations - deposits, borrowings and other liabilities in a timely manner. The criterion is based on clear understanding of fundamentals of the banking industry generally and of specific financial institution. The criteria include:Operating environmentRegulatory environment relates to
Financial Institutions Rating
Introduction
Financial institution rating is to assess the long-term relative credit quality and credit risks. It focuses largely on the institution’s capacity to honour its general obligations - deposits, borrowings and other liabilities in a timely manner.The criterion is based on clear understanding of fundamentals of the banking industry generally and of specific financial institution. The criteria include:
Operating environment
Regulatory environment relates to how financial institutions are regulated and supervised. The assessment includes risk absorption, prevention of related party transactions, non-performing asset recognition, provisioning, capital adequacy, liquidity ratio, benchmark lending rate, expansion and directed lending.
Macroeconomic environment affects the business of banking as such the size of economy, structural and sectoral compositions, fiscal and monetary policies, growth prospects, trends in savings and investment in the economy are assessed.
Banking industry is assessed in terms of competition and performance to establish a benchmark to which comparison can be made within the given time frame.
Information system and strategy
Quality of disclosures: Adequacy, timeliness and transparency of information provision for decision making and disclosures are assessed.
Financial reporting systems:Financial reporting on a consistent basis and limits instances of regulatory non-compliances.
Credit monitoring:Information system should support efficient monitoring of asset quality while generating early warning signals.
Strategy:Well laid-out strategic plan, business plan, budget with regular disclosures on progress and goal achievements attributes.
Risk management
Bank’s risk management – risk identification, measurement, mitigation, monitoring and control – for asset quality, liquidity, profitability and capitalisation. The bank’s risk management policy is evaluated for the following:
Credit risk:Quality of exposures, performance of vulnerable accounts with corrective action plan and concentration of exposures.
Market risk:Sensitivity of investment portfolio to interest rate risks and cushion available in the investment book to absorb losses.
Operational risk:Instances of frauds and amount involved in such frauds and corrective actions to strengthen the system.
Asset quality
Asset quality reflects the quantum of existing and potential risks associated with loans, advances, investment portfolios, other income earning assets, and off-balance sheet transactions. The processes, procedures and capability of management to identify, measure, mitigate, monitor and control credit risk associated with these assets are determined. Furthermore, the adequacy of impairment provision, exposure to counterparty, issuer, or borrower default under actual or implied contractual agreements are assessed. All other risks that may affect value or marketability of a bank’s assets, including operations, market, reputation, strategic, or compliance risks are assessed. Key aspects of asset quality assessment include:
Non-performing loans growth rate
Non-performing loans/ total assets
Non-performing loans/ net-worth
Non-performing loans/ gross loans
Non-performing loans provision rate
Securitised assets/ total assets
Total securities/ total assets
Government securities/ total asset
Diversity of funding
An assessment of funding profile of in terms of sources of funds, mix of funds and cost of funds along the following lines:
Deposit mix:Deposits, current and savings accounts, certificate of deposits and bulk deposits from corporate and institutional depositors. A higher portion of retail deposits also lends stability to earnings as the cost of these tends to be less volatile than bulk deposits.
Quality of deposit: Quality of deposit base is measured by the following parameters and is benchmarked with peers:
(i) Current and savings accounts growth
(ii) Share of current and savings accounts/total deposits
(iii) Share of retail deposits/ total deposits
Share of bulk deposits/total deposits
Money market funding and foreign currency deposits from banks with overseas operations.
Money transfer services:Value-added money transfer services like international money transfers, bill payments, and online transfer facilities.
Liquidity position
A strong deposit base, stable and low-cost liquidity is a function of branch network, customer service level, level of trust with depositors, competitive pricing and brand image. The following factors are assessed:
Total liquid assets as a percentage of total assets
Total liquid assets as a percentage of total deposits
Total liquid assets as a percentage of total short-term liabilities
Profitability
The capability to generate adequate returns is utmost important to shareholders and debt holders. Various sources of revenue and profit - interest income - and others incomes. Capacity to grow profit over time and retain profits in reserves. The profitability assessment factors include:
Gross profit margin
Operating profit
Net profit margin
Return on equity
Return on assets
Operating expenses to income
Capital adequacy
Financial institutions are expected to maintain capital commensurate with the nature and extent of risks to its business operations. Capital adequacy assessment factors include:
Equity to total assets
Equity to loan and advances
Risk weighted assets to Tier 1 capital
Growth internal capital generation
Profit retention ratio
Tier 1 capital to risk-weighted assets
Tier 1 capital to risk-weighted assets
Corporate governance
The governance structure in terms of competence and track record in relation to banking business governance are assessed. Key factors assessed include:
(i) Board independence
(ii) Board composition
(iii) Board committees
(iv)Strategy execution track records
Board oversight responsibilities
Board support for management
Management quality
The quality of management in terms of competence and track records of banking business are assessed. The following factors are assessed:
Management stability
Management pro-activeness
Management’s track record
Depth and breadth of management
Management succession plans
Line management’s track record
Management’s appetite for risk
Management’s risk management track record
Rating scale
Imported table
Rating grade
Interpretation of rating grade
AAA
The financial institution has an exceptionally strong capacity to meet its financial commitments and exhibits a high degree of resilience to adverse developments in the economy, and in business and other external conditions.
AA
The financial institution has a very strong capacity to meet its financial commitments, and is generally in a position to withstand adverse developments in the economy, and in business and other external conditions.
A
The financial institution has a strong capacity to meet its financial commitments but is somewhat more susceptible to adverse developments in the economy, and to business and other external conditions than institutions in higher-rated categories.
BBB
The financial institution has adequate capacity to meet its financial commitments. While some shortcomings are apparent, the institution is generally in a position to resolve these within an acceptable timeframe.
BB
The financial institution exhibits some obvious weaknesses in its operating practices and key financial indicators. The financial performance has typically fallen below peer group standards.
B
The financial institution exhibits fundamental weaknesses in its operating practices and key financial indicators.
CCC
The financial institution has several immediate problems of serious nature.
CC
The financial institution has a high risk of going into default.
C
The financial institution has very high risk of going into default.
D
The financial institution requires sustained external support without which its continued viability is in doubt. Defaults on its financial commitments have already occurred.
Rating outlook
Rating outlook assesses the potential direction of financial institution’s rating over the intermediate term- typically over a one- to two-year period. Ratings from AA to B may be modified by a positive (+) or negative (-) suffix to show its relative standing within the major rating categories.
Imported table
Positive
Indicates a rating may be raised
Negative
Indicates a rating may be lowered
Stable
Indicates a rating is likely to remain unchanged
Developing
Indicates a rating may be raised, lowered or remain unchanged