A robust risk rating system is a crucial component of any financial institution’s credit risk management process. Risk ratings are multi-purpose, useful in pricing loans, stress testing the portfolio or individual customers and determining appropriate reserve for the allowance. As an important component in your risk management strategy, it’s smart to take some time to perform a “check up” for your process for calculating risk ratings to ensure the risk rating process continues to be robust and useful to the institution. Some risk rating topics to review on a regular basis include:
1. The big picture. Start by taking a big step back and looking at the whole risk rating system and how it interacts with other areas of the institution from pricing, to loan administration to the ALLL. Resource: Risk Rating: The common language of credit
2. Best practices. While every bank and credit union will need its own unique risk rating system, there are some core best practices recognized by the industry and regulators. Check in to make sure the institution is keeping pace with industry best practices. Resource: 3 Risk rating best practices
3. Case study. Once familiar with the basic components and best practice for a risk rating system, check out an applied case study to see these principles in action. Resource: Commercial risk rating: Case study
4. Qualitative factors. Undoubtedly, risk rating factors will include some qualitative factors along with quantitative ones. These might include things like whether the borrower is already a customer of the institution, or the economic outlook for the next year. Resource: Understanding and defining qualitative risk rating factors
5. Different types of loans. Its important that risk ratings mean the same thing across the portfolio. For example, a 3 rating on a mortgage should convey the same amount of risk as a 3 on a CRE loan, even if the calculations to determine each rating are very different. Resource: How to calculate risk ratings for different loan types
For additional resources on risk ratings, check out Sageworks Risk Rating platform, or watch the webinar The Real Price of Risk.