1 CREDIT ANALYSIS& RESEARCH LIMITED
www.careratings.comCAREsratingsareanopinionontherelativeabilityandwillingnessofanissuertomaketimelypaymentsonthespecificdebtobligationsoverthelifeoftheinstrument.CAREhasdevelopedacomprehensivemethodologyforcreditratingofdebtinstrumentsissuedbybanks.SomeofthefactorsconsideredinCAREsratinganalysisaredescribedbelow:QUANTITATIVEFACTORSThestartingpointinreachingaratingdecisionisadetailedreviewofkeymeasuresoffinancialperformanceandstability:CapitalAdequacyCapitalAdequacyisameasureofthedegreetowhichthebankscapitalisavailabletoabsorbpossiblelosses.CAREexamines
the conformity of the bank to the RBI guidelines on capital
adequacy ratio. The extent of possible
Governmentsupporttosubscribetothecapitalofweakbankstoimprovethecapitaladequacyratioisexamined.AssetQualityAssetQualityreviewassessesthequalityofthebanksoverallloanportfolioandincludesasectorbysectoranalysisoftheloanandguaranteeportfolio,aswellasinter-bankexposures.
Thehistoricalrecoveryrateofannualdemandsofprincipalandinterestandthebanksexperienceofloanlossesandwrite-off/provisionsarestudied.
Thepercentageofassetsclassifiedintostandard,substandard,doubtfulorlossisexaminedclosely.Theportfoliodiversificationandexposuretotroubledindustries/areasisevaluatedtodeterminetheextentofpotentiallosses.Inaddition,thebanksowncreditrisknormsareexamined.Funding
and
leverageThefundingmixdeterminestheleverageandthecostofcapital.OneofCAREsprincipalaimsinbankanalysisistoassesstheinstitutionsabilitytofinanceitselfintimesofstress.CAREexaminesthecompositionofdepositsintermsofshorttermorlongterm,domesticorforeigncurrencyandalsothecompositionofcurrencies.Thevolatility,growthandshiftinthecompositionofthefundingpatternisalsostudied.Overallgearing,interestcoverageandtheirtrendsaretakenasmeasuresoffinancialriskarisingasaresultoffundingdecision.LiquidityLiquidityisoftentheproximatecauseofbankfailure,while,strongliquiditycanhelpevenanotherwiseweakinstitutiontoremainadequatelyfundedduringdifficulttimes.CAREdeterminesthemaximumstresswhichthebankislikelytofaceandevaluatestheinternalandexternalsourcesavailabletomeetthis.Factorsexaminedarethecreditdepositratio,thematuritymatchingofassetsandliabilities,proportionofliquidassetstototalassetsandthedegreetowhichcoreassetsthatareilliquidarefundedbycoreliabilities.TheshorttermexternalfundingsourcesintheformofrefinancefacilitiesfromRBIandtheinter-bankborrowinglimitsavailableareconsidered.ThebanksCRRandSLRinvestmentsareimportantsourcesofreserveliquidity.Earnings
qualityEarningsqualityreviewscovertheperformanceandriskassessmentofeachbusinessarea;theloanportfolio,guaranteesandforex&treasuryoperations,andnonfundbasedactivitiessuchasmerchantbankingandadvisoryservices.CAREfocusesonthestrengthofeachmajorbusinessanditsearningprospects.
Themainindicatorsusedtomeasureprofitabilityarereturnonassets,spreads,theexpenseratiosandtheearningsgrowthrate.METHODOLOGY
FOR RATING BANKS2 CREDIT ANALYSIS& RESEARCH LIMITED
www.careratings.comEvaluationofquantitativefactorsisdone,notonlyoftheabsolutenumbersandratios,buttheirvolatilityandtrendsaswell.Theattemptistodeterminecore,recurringmeasuresofperformance.CAREalsoexamineshowthebanksperformanceoneachoftheabovediscussedparametersis,comparedtoitspeers.Detailedinter-firmanalysisisdonetodeterminetherelativestrengthsandweaknessesofthebankinitspresentoperatingenvironmentandanyimpactonit,infuture.QUALITATIVEFACTORSSomeofthequalitativefactorsthataredeemedcriticalintheratingprocessare:OwnershipAnassessmentofownershippatternandshareholdersupportinacrisisissignificant.Incaseofpublicsectorbanks,thewillingnessofthegovernmenttosupportthebankisanimportantconsideration.ManagementqualityThe
composition of the board, frequency of change of CEO and the
organisational structure of the bank are
considered.Thebanksstrategicobjectivesandinitiativesinthecontextofresourcesavailable,itsabilitytoidentifyopportunitiesandtrackrecordinmanagingstresssituationsaretakenasindicatorsofmanagerialcompetence.Themanagementsresponsetothederegulationinthefinancialsectorintermsofsettingupspecialisedsubsidiariesandbranchestocatertodifferentbusinesssegmentsisstudied.CAREanalysesthebanksbudgetingprocessandcostcontrolintermsoftheireffectiveness.Theadequacyoftheinformationsystemsusedbythemanagementisevaluatedintermsofqualityandtimelinessoftheinformationmadeavailabletobankmanagers.Theextentoffraudscommittedinthebankistakenasanindicationoftheimperfectionsofthecontrolsystems.CAREfocusesonthemodernbankingpracticesandsystems,degreeofcomputerisation,capabilitiesofseniormanagement,personnelpoliciesandextentofdelegationofpowers.Thetrackrecordoflabourrelationsisalsoexamined.RiskManagementCredit
risk management is evaluated through the appraisal, monitoring and
recovery systems and the internal
prudentiallendingnormsofthebank.Thebanksbalancesheetisexaminedfromtheperspectiveofinterestratesensitivityandforeignexchangeraterisk.Interestrateriskarisesduetodifferingmaturityofassetsandliabilitiesandmismatchbetweenthefloatingandfixedrateassetsandliabilities.CAREalsoassessestheextenttowhichthebankhasassetsdenominated
in one currency with liabilities denominated in another currency.
The derivatives and other risk
managementproductsusedinthepastandimplicationofthesedealsisalsoanalysed.CompliancewithstatutoryrequirementsCARE
examines the track record of the bank in complying with SLR/CRR and
priority sector lending norms as specifiedbytheRBI.Accounting
QualityRatingreliesheavilyonauditeddata.Policiesforincomerecognition,provisioningandvaluationofinvestmentsareexamined.
Suitable adjustments to reported figures are made for consistency
of evaluation and meaningful
interpretation.SizeandMarketPresenceThe fund base and branch
network of the bank are taken as important indicators of strength.
In a fast changing
environment,abiggerbankcanmeetthecompetitivechallengesfromotherfinancialintermediariesduetoitseconomiesofscaleandwiderreach.Alsoifthebankrepresentsasubstantialpercentageofthebankingsector,itsfailurewouldcauseseveredisruptionsforthecountryasawholeanditisthuslikelytoobtaingovernmentsupportintimesofdistress.Allrelevantquantitativeandqualitativefactorsareconsideredtogether,asrelativeweaknessinoneareaofthebanksperformancemaybemorethanadequatelycompensatedforbystrengthselsewhere.However,theweightsassignedtothefactorsaredifferentforshorttermratingsandlongtermratings.
Theintentionoflongtermratingsistolookoverabusinesscycleandnotadjustratingsfrequentlyforwhatappeartobeshorttermperformanceaberrations.Thequality
of the management and the competitiveness of the bank are ofgreater
importance in long term rating decisions.3 CREDIT ANALYSIS&
RESEARCH LIMITED www.careratings.comThe rating process is
ultimately a search for the fundamentals and the probabilities for
change in the fundamentals.
Theassessmentofmanagementquality,thebanksoperatingenvironmentanditsroleinthenationsfinancialsystemareusedtointerpretcurrentdataandtoforecasthowwellthebankispositionedinthefuture.ThefinalratingdecisionismadebytheRatingCommitteeafterathoroughanalysisofthebankspositionoverthetermoftheinstrumentwithregardtobusinessfundamentals.DisclaimerCAREsratingsareopinionsoncreditqualityandarenotrecommendationstobuy,sellorholdanysecurity.CAREhasbaseditsratingsoninformationobtainedfromsourcesbelievedbyittobeaccurateandreliable.CAREdoesnot,however,guaranteetheaccuracy,adequacyorcompletenessofanyinformationandisnotresponsible
for any errors or omissions or for the results obtained from the
use of such information. Most
issuersofsecuritiesratedbyCAREhavepaidacreditratingfee,basedontheamountandtypeofsecuritiesissued.For
Further details please contact at :CREDIT ANALYSIS& RESEARCH
LIMITEDKalpataru Point, 2nd Floor, Kamani Marg, Sion (East), Mumbai
- 400 022 INDIA.Tel. : 56602871-75 / 2402 4541/3 Fax : 56602876
E-mail : [email protected]
