Does your institution currently have an effective risk rating system?

During a banking industry webinar, Chuck Nwokocha, senior risk management consultant at Sageworks, discussed what is required to increase credit quality in a bank or credit union. And a requirement for those improvements is a working and effective risk rating system that is applied uniformly by different analysts at the institution.

Sageworks polled more than 160 financial institutions and found that 79 percent of responding bankers have an effective risk rating system, but 16 percent are unsatisfied with some components.

Of the 79 percent of institutions that have systems in place for rating loans, many use automated risk rating systems, which can

1. solve inconsistencies with analysts applying risk ratings differently,

2. alleviate concerns regarding accuracy with risk weighting and calculating and

3. account for different types of loans and their different risk categories.

Nwokocha noted that, when evaluating a risk rating system, it is important to consider whether there are differentiations between the types of loans or if there is broader system applied to multiple loan types.

If your institution’s risk rating system is not effective, it is likely that making small tweaks based on the type of loan would improve the process, according to Nwokocha.

For example, C&I and CRE loans will require different risk rating matrices, with CRE focusing more on vacancy and absorption rates, effective rental rates or sales prices and NOI of the property as shown below. And even with CRE, the bank or credit union might use even more granularly defined templates to distinguish between CRE-Retail and CRE-Owner Occupied.

The poll was conducted during a recent webinar, 5 Cs of Credit: Enhance Your Credit Quality. This webinar covered the 5 Cs of credit analysis and risk ratings, shift in the portfolio from CRE to C&I and best practices for successful examinations. You can watch it on-demand here.

Learn more about the importance of risk rating in the on-demand webinar “The Real Price of Risk“.