Functions Of A Credit Rating System

Credit risk is the biggest risk for any financial institution or a bank. A bank’s performance, reputation and long term existence depends on how it manages this risk. Most financial institutions have failed owing to poor management of risks and hence losing out on capital through loan losses. Loan portfolio management plays a key role in determining the reserve required to counter loan losses.

Good credit risk rating systems focus on the bank’s safety by making practical decisions on loan reserve. Rating systems give an estimate of risks not only on a group level but also on individual level and this makes it easier for banks to determine trends in risk levels.

Commercial loan risk rating systems are important for other important functions as mentioned below:

• Loan pricing credit risk ratings guide price setting. A sufficient price for taking credit risk should be planned in order to compensate for capital risk. Incorrect planning can lead to imbalances.

• Portfolio management information systems aggregate risk and give knowledge about the risk’s trends within the portfolio. These are hence very critical to loan risk management and decision making.

• Portfolio management credit risk ratings influence a lot of a bank’s decisions to sell, buy or hold credit facilities.

Every bank has a different credit risk rating system and hence a different loan policy modification as well. Some attributes are common to all banks but the way they combine differs from bank to bank. The whole idea is to have a credit rating system that looks into the bank’s overall portfolio risk and risk ratings must be accurate. When risks change, the ratings should also change. A credit risk rating system should be close to flawless in performance on which the banks and financial institutions can rely without worries because as mentioned before, this is a vital aspect of any bank and it is a strong determinant of its reputation and strength of capital. A good review company should be associated with banks in order for the banks to successfully survive and thrive in any kind of economic conditions.