INVESTMENT RISK GRADING

INVESTMENT RISK GRADING

                            

Investment Risk Grading

The Investment Risk Grading is a collective definition based on the pre- specified scale & reflects the under lying investment risk for a given exposure. It is a basic module for developing an Investment Risk Management System

Function of Investment Risk Grading

Well - managed investment risk grading systems promote bank safety and soundness by facilitating informed decision-making. Grading system measure investment risk and differentiate individual investment and group of investments by the risk they pose. This allows the bank management and examiners to monitor changes and trends in risk levels. This process also allows bank management to manage to optimize returns.

Uses of Investment Risk Grading

·         The investment Risk Grading Matrix allows application of uniform standards to investment to ensure a common standardized approach to assess the quality of individual obligator, investment portfolio of a unit, line of business the branch or bank as a whole.

·         As evident, the Investment Risk Grading outputs would be relevant for individual investment selection, wherein either or a particular exposure facility is rated. The other decisions would be related to pricing and specific feature of the investment facility. These would largely constitute obligator level analysis.

·         Risk grading would also be relevant for surveillance and monitoring, internal MIS and assessing the aggregate risk profile of a bank. It is also relevant for portfolio level analysis.

NUMBER OF GRADES

The Investment Risk Grading scale consists of 8 (eight) Categories and are provided as follows:

Superior- (SUP)-1

·         Investment facilities fully secured i.e. fully covered.

·         Investment facilities fully covered by government guarantee.

·         Investment facilities fully covered by the guarantee of a top tier international bank.

·         Review frequency of risk Grading -Annually

Good-(GD)-2

·         Strong repayment capacity of the client

·         The client has strong liquidity and low leverage.

·         The company demonstrates consistently strong earnings and cash flow.

·         Client has well established, strong market share

·         Very good management skill and expertise

·         All security documents should be in place

·         Investment facilities fully covered by the guarantee of a top tier local bank.

·         Aggregate score of 85 or greater based on Risk Grade score sheet.

·          Review frequency of risk Grading –Annually.

Acceptable- (ACCPT)- 3

·           These clients are not as strong as Grade-2, but still demonstrate consistent earnings, cash flow and have a good track record

·         Clients have adequate liquidity, cash flow and earnings

·         Investment in this grade would normally be secured by acceptable collateral – 1st charge over inventory/ receivables/equipment/ property

·         Acceptable Management

·         Acceptable Parent/sister company Guarantee

·          Aggregate score of 75-84 based on Risk Grade score sheet.

·         Review frequency of risk Grading –Annually.

Marginal/ Watch List- (MG/WL)- 4

·         This grade warrants greater attention due to conditions affecting the client, the industry or the economic environment

·         These clients have an above average risk due to strained liquidity, higher than normal leverage, thin cash flow, and or inconsistent earnings

·         Weaker business investment or early warning signals of emerging business investment detected.

·         The client incurs loss

·         Investment repayments routinely fall past due

·         Account conduct is poor or other untoward factors are present

·          Investment requires attention

·         Aggregate score of 65-74 based on Risk Grade score sheet.

·         The account highlighted as Early Warning Signals (EWS) if

(a)          Investment is past due/ overdue for 60 days or above

(b)          Frequent drop in security value or shortfall in drawing power exits.

·         Review frequency of risk Grading –Half yearly

Special Mention- (SM)-5

·         This grade has potential weakness that deserve management’s close attention. If left incorrect, these weaknesses may result in a deterioration of the repayment prospects of the client

·         Severe management problems exist

·         Facilities should be downgraded to this grade if sustained deterioration in financial is noted – consecutive losses, negative net worth, excessive leverage

·         Aggregate score of 55-64 based on Risk Grade score sheet.

·         The investment is classified as SMA:

(a)          a continuous or demand investment if remains over due for a period of 90 day or more but not more that 6- months

(b)          a term investment which is repayable within 5-years of time the entire investment will be classified if the amount of defaulted installment (s) due with in  90 day or more but not more that 6- months

(c)          a term investment which is repayable in more than 5-years of time the entire investment will be classified if the amount of defaulted installment (s) due with in  90 day or more but not more that 12- months

·         The account highlighted as Early Warning Signals (EWS) if

(a)          Investment is past due/ overdue for 90 days or above

(b)          Major document deficiency prevails

(c)          A Significant petition or claim is lodged against the client.

·          Review frequency of risk Grading –Quarterly

Substandard- (SS) –6

·         Financial condition is weak and capacity or inclination to repay is in doubt

·         These weakness jeopardize the full settlement of investment

·         Bangladesh bank criteria for sub- standard investment shall apply

·         Aggregate score of 45-54 based on Risk Grade score sheet.

·         The investment is classified as SS :

(a)        a  continuous or demand investment if remains over due for a period of 6- months or beyond but less than 9- months

(b)        a term investment which is repayable within 5-years of time the entire investment will be classified if the amount of defaulted installment (s) due within  6-months.

(c)        a term investment which is repayable in more than 5-years of time the entire investment will be classified if the amount of defaulted installment (s) due with in  12- months

·          Review frequency of risk Grading –Quarterly.

Doubtful- (DF)-7

·         Full repayment of principal and profit is unlikely and the possibility of loss is extremely high

·         However, due to specifically identifiable pending factors, such as litigation, liquidation, procedures or capital injection, the asset is not yet classified as Bad & loss

·         Bangladesh bank criteria for doubtful investment shall apply

·         Aggregate score of 35-44 based on Risk Grade score sheet.

·         The investment is classified as DF:

(a)        a  continuous or demand investment if remains over due for a period of 9- months or beyond but less than 12- months

(b)        a term investment which is repayable within 5-years of time the entire investment will be classified if the amount of defaulted installment (s) due within  12-months

(c)        a term investment which is repayable in more than 5-years of time the entire investment will be classified if the amount of defaulted installment (s) due with in  18- months.

·         Review frequency of risk Grading –Quarterly

Bad & Loss –(BL)-8

·         Investment of this grade is long outstanding with no progress in obtaining repayment or on the verse of wind up / liquidation.

·         Prospect of recovery is poor and legal option have been perused

·         Proceeds expected from the liquidation or realization of security may be awaited. The continuance of the investment as a bankable asset is not warranted and anticipated loss should have been provided for

·         This classification reflects that it is not practical or desirable to defer writing –off that basically valueless asset even though partial recovery may be affected in the future Bangladesh bank guidelines for timely write-off of bad investment must be adhere to legal procedures/suit initiated

·         Bangladesh bank criteria for Bad & Loss investment shall apply

·         Aggregate score of less than 35 based on Risk Grade score sheet.

·         The investment is classified as BL:

(a)        a  continuous or demand investment if remains over due for a period of 12- months or beyond

(b)        a term investment which is repayable within 5-years of time the entire investment will be classified if the amount of defaulted installment (s) due within  18-months

(c)        a term investment which is repayable in more than 5-years of time the entire investment will be classified if the amount of defaulted installment (s) due with in  24- months.

*    Review frequency of risk Grading –Quarterly.

QUALITATIVE JUDGMENT

·         If any uncertainty or doubtful arises in respect of any investment, the same will be classified on the basis of qualitative judgment not on the basis of objective criteria

·         If any situational changes occurs   in the stipulated in the terms of which the investment was extended or if the capital of the client is impaired due to adverse conditions or if the value of security decreases or if the recovery of the investment becomes uncertain due to any other unfavourable situation the investment will be classified on the basis of qualitative judgment not on the basis of objective criteria.

·         If any investment is illogically or reputedly re-scheduled or the norms of re=scheduling is violated or instances of frequency exceeding the limit are needed or legal action is lodged for recovery of the investment or the investment is extended without the approval of the proper authority the investment will be classified on the basis of qualitative judgment not on the basis of objective criteria.

COMPUTE OF INVESTMENT RISK GRADING

Sl. No	Principal Risk component	Key parameter	Weight
01.	Financial Risk Risk that Counter parties will fail to meet obligation due to financial distress. This capitalizes on the risk of high leverage, poor liquidity, low profitability, insufficient cash flow		50%
		Leverage Debt Equity Ratio-   Total liabilities to tangible net worth	15%
		Liquidity Current Ratio-          Current assets to current liabilities	15%
		Profitability Operative profit margin-     (Operating profit /sale) X 100	15%
		Coverage Interest coverage ratio-   Earning before interest  & tax(EBIT) - Interest on debt	05%
02	Business/ Industry Risk Adverse industry situation or unfavorable business condition. This capitalizes on the risk of failure due to low market share & poor industry growth.		18%
		Size of Business (BTk) The size of business measured by most recent year’s total sales (60,30,10,5 2.5).	5%
		Age of Business The number of years the client engaged in primary line in business (10,5,2)	3%
		Business outlook Critical assessment of medium term prospects of industry, market share and economic factors- Favorable/ stable / slightly uncertain/ cause for concern	3%
		Industry growth Strong / good/ moderate/ no growth (10,5,1)	3%
		Market competition Dominant player/ modernly competitive / highly competitive	2%
		Entry/ Exit Barrier Difficult/ average easy	2%
03	Management Risk Risk that counter parties may default as a result of poor managerial ability, its succession plan and team work		12%
		Experience Quality of management based on years of experience (10,5,2,0)	5%
		Second line/Succession Ready succession/ succession with in a period/ Succession in question	4%
		Team work Very good / moderate poor / regular conflict	3%
04	Security Risk Risk that the bank might be exposed due to poor quality / strength of security. This may entail strength of security & collateral, locator of collateral & support.		10%
		Security coverage (Primary) Fully pledged / substantially cash covered/ Reg. Mort for HBL/ Regd. Hyp. (Ist charge, Ist pari passu) /2nd charge/ inferior charge/ Simple hypo/ negative lien on asset/ no security	4%
		Collateral Coverage (Collateral) Property location- RM in Prime area / semi urban area/ Plant & Machinery as collateral / Negative lien on collateral/ No collateral	4%
		Support Personal guarantee- High/ average Financial strength/No guarantee	2%
05.	Relationship Risk Risk area covers for limit utilization, account performance, conditions/covenants compliance of the client & deposit relationship		10%
		Account Conduct A/C with faultless record with period, / A/c with satisfactory dealing with some late payment/ Frequent past due & irregular dealings in A/C	5%
		Utilization of limit (actual or projection)	2%
		Compliance of Convents/ Condition Full compliance / some non- compliance / no compliance	2%
		Personal Deposit Personal deposit of the client with significant deposit	1%