Bank Rating

COMMERCIAL BANKS RATING CRITERIA

CRAB uses a comprehensive methodology for credit rating of commercial banks developed in collaboration with its technical collaboration partner ICRA Ltd of India. The methodology addresses the international standards for credit rating of Commercial banks and incorporates the regulatory framework in Bangladesh. The major factors considered in CRABs rating analysis are described below: QUANTITATIVE FACTORS The starting point in reaching a rating decision is a detailed review of key measures of financial performance and stability: Capital Adequacy Capital Adequacy is a measure of the degree to which the banks capital is available to mitigate the stress of possible losses. CRAB examines the conformity of the bank to the Bangladesh Bank guidelines on Capital Adequacy ratio. Asset Quality Asset Quality review assesses the quality of the banks overall investment portfolio and includes a sector by sector analysis of the investment and guarantee portfolio, as well as inter-bank exposures. The historical recovery rate of annual demands of principal and profit and the banks experience of investment losses and writeoff/provisions are studied. The percentage of assets classified into standard, substandard, doubtful or loss is examined closely. The portfolio diversification and exposure to troubled industries/areas is evaluated to determine the extent of potential losses. In addition, the banks own credit risk norms are examined. Funding and leverage The funding mix determines the leverage and the cost of capital. One of CRABs principal aims in bank analysis is to assess the institutions ability to finance itself in times of stress. CRAB examines the composition of deposits in terms of short term or long term, domestic or foreign currency and also the composition of currencies. The volatility, growth and shift in the composition of the funding pattern are also studied. Overall gearing, profit coverage and their trends are taken as measures of financial risk arising as a result of funding decision.

Credit Rating Agency of Bangladesh Ltd Sena Kalyan Bhaban, Suite No: 403, Flr: 4th 195 Motijheel C/A. Dhaka 1000 Phone: 9571238, 9571497, 9553254, Fax: (8802)9563837 Email info@crab.com.bd Web www.crab.com.bd

Contact H S Sohrawardhi Sr. Vice President 01713032807 info@crab.com.bd

Liquidity Liquidity is often the proximate cause of bank failure, while, strong liquidity can help even an otherwise weak institution to remain adequately funded during difficult times. CRAB determines the maximum stress which the bank is likely to face and evaluates the internal and external sources available to meet this. Factors examined are the credit deposit ratio, the maturity matching of assets and liabilities, proportion of liquid assets to total assets and the degree to which core assets that are illiquid are funded by core liabilities. The short term external funding sources in the form of refinance facilities from Bangladesh Bank and the inter-bank borrowing limits available are considered. The banks CRR and SLR investments are important sources of reserve liquidity.

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Earnings quality Earnings quality reviews cover the performance and risk assessment of each business area- the investment portfolio, guarantees and forex & treasury operations and non fund based activities. CRAB focuses on the strength of each major business and its earning prospects. The main indicators used to measure profitability are return on assets, spreads, the expense ratios and the earnings growth rate. Evaluation of quantitative factors is done, not only of the absolute numbers and ratios, but their volatility and trends as well. The attempt is to determine core, recurring measures of performance. CRAB also examines how the banks performance on each of the above discussed parameters is, compared to its peers. Detailed inter-firm analysis is done to determine the relative strengths and weaknesses of the bank in its present operating environment and any impact on it, in future. Sensitivity to Market Risk The sensitivity test of a bank addresses the degree to which changes in profit rates, foreign exchange rates, commodity prices or equity prices can adversely affect a financial institution's earnings or capital. For most institutions, market risk primarily reflects exposures to changes in profit rates. (An institution's ability to monitor and manage its market risk is also assessed in the qualitative risk management area) QUALITATIVE FACTORS Some of the qualitative factors that are deemed critical in the rating process are: Ownership An assessment of ownership pattern and shareholder support in a crisis is significant. In case of public sector banks, the willingness of the government to support the bank is an important consideration. Management quality The composition of the board, top management and the organizational structure of the bank are considered. The banks strategic objectives and initiatives in the context of resources available, its ability to identify opportunities and track record in managing stress situations are taken as indicators of managerial competence. CRAB analyses the banks budgeting process and cost control in terms of their effectiveness. The adequacy of the information systems used by the management is evaluated in terms of quality and timeliness of the information made available to bank managers. CRAB focuses on the modern banking practices and systems, degree of computerization, capabilities of senior management, personnel policies and extent of delegation of powers. Risk Management Credit risk management is evaluated through the appraisal, monitoring and recovery systems and the internal prudential lending norms of the bank. The banks balance sheet is examined from the perspective of profit rate sensitivity and foreign exchange rate risk. Liquidity risk arises due to differing maturity of assets and liabilities and profit rate risk appears because of mismatch between the floating and fixed rate assets and liabilities. CRAB also assesses the extent to which the bank has assets denominated in one currency with liabilities denominated in another currency. Compliance with statutory requirements CRAB examines the track record of the bank in complying with SLR/CRR and priority sector lending norms as specified by Bangladesh Bank.

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Accounting Quality Rating relies heavily on audited data. Policies for income recognition, provisioning and valuation of investments are examined. Suitable adjustments to reported figures are made for consistency of evaluation and meaningful interpretation. Size and Market Presence The fund base and branch network of the bank are taken as important indicators of strength. In a fast changing environment, a large bank can meet the competitive challenges from other financial intermediaries due to its economies of scale and wider reach. Also if the bank represents a substantial percentage of the banking sector, its failure would cause severe disruptions for the country as a whole and it is thus likely to obtain government support in times of distress.

Long Term and Short Term Rating All relevant quantitative and qualitative factors are considered together, as relative weakness in one area of the banks performance may be more than adequately compensated for by strengths elsewhere. However, the weights assigned to the factors are different for Short Term Ratings and Long Term Ratings. The intention of long term ratings is to look over a business cycle and not adjust ratings frequently for what appear to be short term performance aberration. The quality of the management and the competitiveness of the bank are of greater importance in long term rating decisions. The rating process is ultimately a search for the fundamentals and the probabilities for change in the fundamentals. The assessment of management quality, the banks operating environment and its role in the nations financial system is used to interpret current data and to forecast how well the bank is positioned in the future. The final rating decision is made by the Rating Committee after a thorough analysis of the banks position over the time with regard to business fundamentals.

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CRAB RATING SCALES AND DEFINITIONS LONGTERM COMMERCIAL BANKS ENTITY RATING
AAA (Triple A): Have extremely strong capacity to meet commitments, maintains highest quality, with minimal credit risk. financial

AA1, AA2, AA3* (Double A): Have very strong capacity to meet financial commitments, maintains very high quality, with very low credit risk. A1, A2, A3 (Single A): Have strong capacity to meet financial commitments, maintains high quality, with low credit risk, but susceptible to adverse changes in circumstances and economic conditions. BBB1, BBB2, BBB3 (Triple B): Have adequate capacity to meet financial commitments but are susceptible to moderate credit risk. Adverse changes in circumstances and economic conditions are more likely to impact capacity to meet financial commitments. BB1, BB2, BB3 (Double B): Have inadequate capacity to meet financial commitments and possess substantial credit risk, with major ongoing uncertainties and exposure to adverse business, financial, or economic conditions. B1, B2, B3 (Single B): Have weak capacity to meet financial commitments and are subject to high credit risk. Currently meeting the financial commitments, but adverse business, financial, or economic conditions are likely to impair capacity to meet obligations. CCC1, CCC2, CCC3 (Triple C): Currently vulnerable, and are dependent upon favourable business, financial, and economic conditions to meet financial commitments. Have very weak standing and are subject to very high credit risk. CC (Double C): Currently highly vulnerable, highly speculative and are very near to default, with some prospect of recovery. C (Single C): Currently very highly vulnerable to non-payment, may be subject of bankruptcy petition or similar action, though have not experienced payment default. C is typically in default, with little prospect for recovery. D Default. 'D' rating also will be used upon the filing of bankruptcy petition or similar action if payments on an obligation are jeopardized.
*Note: CRAB appends numerical modifiers 1, 2, and 3 to each generic rating classification from AA through CCC. The modifier 1 indicates that the obligation ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of that generic rating category.

RATING DEFINITION : Commercial Banks

ST-1 : Highest Grade. Highest capacity for timely repayment of obligations. ST-2 : High Grade. Strong capacity for timely repayment of obligations. ST-3 : Average Grade. Average capacity for timely repayment of obligations. ST-4: Below Average Grade. Below average capacity for timely repayment of obligations. ST-5 : Inadequate Grade. Inadequate capacity for timely repayment of obligations. ST-6: Lowest Grade. High risk of default or are currently in default.

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