Credit risk
What is risk rating?
Risk rating is an internal grade a lender assigns to a loan or borrower to express its assessed credit risk on a defined scale.
A risk rating, also called a loan grade or credit grade, places each commercial loan on an internal scale, often with eight to ten grades. The upper grades are pass categories of varying strength, and the lower grades usually align with the regulatory categories of special mention, substandard, doubtful and loss. Larger institutions may use a two-dimensional system with an obligor grade for default likelihood and a facility grade for loss severity.
Ratings drive many decisions: approval authority, pricing, monitoring frequency, watch list inclusion, reserve estimates and portfolio reporting to management and the board. They are assigned at origination and should be updated whenever new financial information or events change the risk. Independent loan review tests whether ratings are accurate, consistent and timely.
The most common problem is ratings that lag reality, with downgrades made only after a payment default. Grade definitions that are vague, inconsistent use of scorecards, and overrides without documentation also weaken a rating system. Examiners pay close attention to whether ratings match the underlying financial condition, because inaccurate ratings distort the allowance and management's view of risk.
See it in Risk OS
Loan risk rating software that keeps the reviewer's grade →
