Financial Institutions Rating

Financial institution rating is to assess the long-term relative credit quality and credit risks. It focuses largely on the institution’s capacity to honour its general obligations - deposits, borrowings and other liabilities in a timely manner. The criterion is based on clear understanding of fundamentals of the banking industry generally and of specific financial institution. The criteria include:

Operating environment

• Regulatory environment relates to how financial institutions are regulated and supervised. The assessment includes risk absorption, prevention of related party transactions, non-performing asset recognition, provisioning, capital adequacy, liquidity ratio, benchmark lending rate, expansion and directed lending.
• Macroeconomic environment affects the business of banking as such the size of economy, structural and sectoral compositions, fiscal and monetary policies, growth prospects, trends in savings and investment in the economy are assessed.
• Banking industry is assessed in terms of competition and performance to establish a benchmark to which comparison can be made within the given time frame.

Information system and strategy

• Quality of disclosures: Adequacy, timeliness and transparency of information provision for decision making and disclosures are assessed.
• Financial reporting systems: Financial reporting on a consistent basis and limits instances of regulatory non-compliances.
• Credit monitoring: Information system should support efficient monitoring of asset quality while generating early warning signals.
• Strategy: Well laid-out strategic plan, business plan, budget with regular disclosures on progress and goal achievements attributes.

Risk management

Bank’s risk management – risk identification, measurement, mitigation, monitoring and control – for asset quality, liquidity, profitability and capitalisation. The bank’s risk management policy is evaluated for the following:

• Credit risk: Quality of exposures, performance of vulnerable accounts with corrective action plan and concentration of exposures.
• Market risk: Sensitivity of investment portfolio to interest rate risks and cushion available in the investment book to absorb losses.
• Operational risk: Instances of frauds and amount involved in such frauds and corrective actions to strengthen the system.

Asset quality reflects the quantum of existing and potential risks associated with loans, advances, investment portfolios, other income earning assets, and off-balance sheet transactions. The processes, procedures and capability of management to identify, measure, mitigate, monitor and control credit risk associated with these assets are determined. Furthermore, the adequacy of impairment provision, exposure to counterparty, issuer, or borrower default under actual or implied contractual agreements are assessed. All other risks that may affect value or marketability of a bank’s assets, including operations, market, reputation, strategic, or compliance risks are assessed. Key aspects of asset quality assessment include:

• Non-performing loans growth rate
• Non-performing loans/ total assets
• Non-performing loans/ net-worth
• Non-performing loans/ gross loans
• Non-performing loans provision rate
• Securitised assets/ total assets
• Total securities/ total assets
• Government securities/ total asset

An assessment of funding profile of in terms of sources of funds, mix of funds and cost of funds along the following lines:

• Deposit mix: Deposits, current and savings accounts, certificate of deposits and bulk deposits from corporate and institutional depositors. A higher portion of retail deposits also lends stability to earnings as the cost of these tends to be less volatile than bulk deposits.
• Quality of deposit: Quality of deposit base is measured by the following parameters and is benchmarked with peers:

(i) Current and savings accounts growth

(ii) Share of current and savings accounts/total deposits

(iii) Share of retail deposits/ total deposits

• Share of bulk deposits/total deposits

• Money market funding and foreign currency deposits from banks with overseas operations.
• Money transfer services: Value-added money transfer services like international money transfers, bill payments, and online transfer facilities.

A strong deposit base, stable and low-cost liquidity is a function of branch network, customer service level, level of trust with depositors, competitive pricing and brand image. The following factors are assessed:

• Total liquid assets as a percentage of total assets
• Total liquid assets as a percentage of total deposits
• Total liquid assets as a percentage of total short-term liabilities

The capability to generate adequate returns is utmost important to shareholders and debt holders. Various sources of revenue and profit - interest income - and others incomes. Capacity to grow profit over time and retain profits in reserves. The profitability assessment factors include:

• Gross profit margin
• Operating profit
• Net profit margin
• Return on equity
• Return on assets
• Operating expenses to income

Financial institutions are expected to maintain capital commensurate with the nature and extent of risks to its business operations. Capital adequacy assessment factors include:

• Equity to total assets
• Equity to loan and advances
• Risk weighted assets to Tier 1 capital
• Growth internal capital generation
• Profit retention ratio
• Tier 1 capital to risk-weighted assets
• Tier 1 capital to risk-weighted assets

The governance structure in terms of competence and track record in relation to banking business governance are assessed. Key factors assessed include:

(i) Board independence

(ii) Board composition

(iii) Board committees

(iv) Strategy execution track records

• Board oversight responsibilities
• Board support for management

The quality of management in terms of competence and track records of banking business are assessed. The following factors are assessed:

1. Management stability
2. Management pro-activeness
3. Management’s track record
4. Depth and breadth of management
5. Management succession plans
6. Line management’s track record
7. Management’s appetite for risk
8. Management’s risk management track record

Rating outlook assesses the potential direction of financial institution’s rating over the intermediate term- typically over a one- to two-year period. Ratings from AA to B may be modified by a positive (+) or negative (-) suffix to show its relative standing within the major rating categories.