Quality of Internal Risk Rating Frameworks at Commercial Banks in Pakistan

Ali, Syed Babar (2012): Quality of Internal Risk Rating Frameworks at Commercial Banks in Pakistan.

Abstract

The importance of internal risk rating system for an effective credit risk management system can not be overemphasized. The system demands contunuous support and involement of top management of the commercial banks, and the regulators. The attempt to develop robust internal risk rating systems is ongoing among commercial banks. This study was made to measure the quality of internal credit risk rating systems of commercial banks in Pakistan in terms of the various aspects of an internal rating system.

To achieve this objective interviews of head of risk management of 10 commercial banks operating in Pakistan were conducted. The unstructured questions used in the interviews were transcribed and the technique of content analysis was used. The findings revealed that internal risk rating systems of commercial banks in Pakistan are generally strong but need improvement in a few aspects. The following areas of internal risk rating systems of commercial banks in Pakistan were found weak: 1. Environment specific to internal risk rating methodologies employed by the banks. 2. Environment specific to the documentation in the internal risk rating system. Other areas such as credit grades, use of qualitative and quantitative factors, methodology, internal risk rating policy, external credit rating, rating definitions, rating criteria, boards involvement were found in lines with the internal risk rating guidelines issued by the SBP.

Key Words: Credit Risk, Credit Risk Management, Internal Risk Rating

• Item Type: MPRA Paper
• Language: English
• Keywords: Credit Risk, Credit Risk Management, Internal Risk Rating
• Subjects: G - Financial Economics > G1 - General Financial Markets; G - Financial Economics > G2 - Financial Institutions and Services > G29 - Other

References

Apostolik et al., 2009. Foundations of banking Risk. Hoboken: Global Associations of Risk Professionals in association with John Wiley & Sons, Inc.

Bank of Japan, 2005. Advancing Credit Risk Management through Internal Rating Systems. Tokyo:Risk assessment Section

Basurto, M. S. and Lowe, P.W., 2002. Internal Ratings, the Business Cycle and Capital Requirements: Some evidence from an Emerging Market Economy. BIS Working Paper No. 117.

Bessis, J., 2006. Risk Management in Banking. 2nd ed. West Sussex: John Wiley & Sons Ltd.

Caouette et al., 2008. Managing Credit Risk: The Great Challenges for Global Financial Markets. 2nd ed. Hoboken: John Wiley and Sons, Inc.

Damel, P., 2006. How to calculate an internal rating? Synthesis and Proposition for a Contingent Approach using a Monte Carlo simulation and a rate stochastic model following poisson’s law. International journal of business, vol. 11,no.2.

English, W.B. and Nelson, W.R. 1998. Bank Risk Rating of Business Loans, working paper , Federal Reserve Board.

Frerichs, H. and Wahrenburg, M., 2003. Evaluating internal credit rating systems depending on bank size. Paper presented at the 6th conference of the Swiss society for financial markets research, EFMA, Frankfurt.

Hertig, G., 2005. Using Basel II to Facilitate Access to Finance: The Disclosure of Internal Credit Ratings. ECGI - Law Working Paper No. 31/2005.

Jacobson, T., Linde, J. and Roszback, K. F., 2006. Internal ratings, implied credit risk and the consistency of banks’ risk classification policies. Journal of Banking & Finance, vol. 30(7), pp.1899-1926.

Kauko, K., 2012. Can credit risk be rated through-the-cycle? Frontier in Finance and Economics, vol. 9, p.1-32.

Kirstein, R., 2001. The New Basle Accord, Internal Ratings, and the Incentives of Banks. International Review of Law and Economics, Vol. 21, No.4.

Krahnen, J.P. and Weber, M., 2000. Generally Accepted Rating Principles: A Primer. Journal of Banking and Finance

Lehmann, B., 2003. Is it worth the while? The relevance of qualitative information in credit rating. EFMA 2003. Helinski meetings. Mingo, J. and Falkenstein, E., 2000. Internal Credit Risk Rating Systems Must Evolve to Stay Relevant. Journal of lending and Credit Risk Management. Monica, D. and Monica, B.M., INTERNAL RATINGS SYSTEMS: AN EMPIRICAL APPROACH

Sarac, M., 2010. Measuring the effectiveness of internal credit rating: an application on a participation bank. International Research Journal of Finance and Economics. EuroJournal Publishing, inc.

Saunders, A. and Cornett, M. M., 2008. Financial Institutions Management: A Risk Management Approach. 6th ed. USA: The McGraw-Hill/Irvin.

SBP., 2010. Guidelines on Internal Credit Risk Rating Systems. Karachi:

Saunders, A. Allen, L., 2010. Credit Risk: Measurement In and Out of the Financial Crisis. 3rd ed. Hoboken: John Wiley and Sons, Inc.

Servigny, A. d. and Renault, A. O., 2004. Measuring and Managing Credit Risk. New York: McGraw Hill Companies, Inc.

Shimko, D.C. and Went, P., Credit Risk Management, The GARP Risk Series. Jersey City: Global Association of Risk Professionals.

Stephanou, C. and Carlos M. J., 2005. Credit Risk Measurement under Basel II: An Overview and Implementation Issues for Developing Countries. World Bank Policy Research Working Paper Series.

Topp, R. and Perl, R., 2010. Through-the-Cycle Ratings versus Point-in-Time Ratings and Implications of the Mapping between Both rating Types. Financial Markets, Institutions and Instruments, Vol. 19, Issue 1, pp.47-61.,

Treacy, W. F. and Carey, M.,2000. Credit risk rating systems at large US banks. Journal of Banking and Finance, vol.24(1-2), pp.167-201.

US Department of the Treasury 2001. Comptroller Handbook, rating credit risk. New York: office of the comptroller of currency.

Varotto, S., 2008. An Assessment of the Internal Rating Based Approach in Basel II. Journal of Risk Model validation, Forthcoming.