Get your rating right to fix bad loans, PSBs told--FE
The finance ministry wants public sector banks to beef up their internal mechanism for rating of borrowers. The ministry's directive is in the wake of lenders, who saw a jump in bad loans, resorting to taking the cover of good rating given by external credit rating agencies to some of their defaulting borrowers.
"Every PSB will have to do their own due diligence and internal rating before extending credit to each and every borrower. It is important that they strengthen their internal rating mechanism as it will help in bringing down bad loans," a senior finance ministry official told FE. The RBI is also in favour of banks strengthening their own internal rating mechanism to "capture the reality independently."
The issue was discussed during recent meetings that the finance ministry had with PSBs. "We (finance ministry) have told the banks that they should not suspend their due diligence and internal rating process in favour of external rating and external due diligence."
Banking sources said some leading PSBs such as SBI, Punjab National Bank, Bank of India and Bank of Baroda have sought RBI's permission to shift to an advanced Internal Rating Based approach (IRB) wherein the Integrated Risk Management Department of these lenders develop modules on their own to assess risks and rate borrowers using better data gathering techniques. Currently, these banks are conducting a pilot run of their advanced IRB with the RBI nod.
Meanwhile, the sources said, the other PSBs are also developing advanced IRB modules albeit with the help of models purchased from external rating agencies and consultants. All PSBs are likely to migrate to an independent advanced IRB system within three to four years, they added.
An advanced IRB helps in giving a clear record of the performance of the borrowers and their past history. However, repayment defaults have many other aspects and may not be a reflection of the rating of the borrowers," a public sector bank chief said.
Incidentally, in compliance with the Basel III norms, banks have a Credit Risk Management Policy, under which for their fund-based and non-fund based exposure they use the services of RBI-approved external credit assessment agencies such as ICRA, CARE, CRISIL, Brickworks, India Rating and SMERA for domestic firms and Fitch, Standard & Poor’s and Moody’s for foreign counter parties. They carry out their own internal rating as well.
Basel II norms give banks two options: The standardised approach, which most Indian banks have adopted in computing capital requirement for credit risks where banks depend on rating given by external rating agencies, and the second option, which is the IRB model under which their own rating is used.
However, most banks are now using a foundation IRB, where bank assesses the Probability of Default (PoD) linked to each borrower with the help of outside inputs. When they migrate to advanced IRB, they have to estimate with a PoD data for at least five years in addition to data on other factors such as exposure at default for a minimum of seven years. In addition to this, they have to design dynamic modules on corporate governance, ratings, controls and operations. However, even under Basel II, once the bank decide to shift to an advanced IRB model, they have to get an RBI nod.
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