Policies are “the cornerstones for sound lending and loan administration,” and risk rating policies are a key component. Regulatory agencies lay out elements that loan policies should cover, such as what types of loans an institution will make and what information will be required from borrowers, but they rarely dictate the details.
An institution must develop appropriate policies and procedures based on its size and the complexity of its portfolio. These governing documents should require credit analysts to maintain timely and accurate risk ratings with appropriate oversight.
Here are three best practices when developing risk rating policies.
Determine Number of Risk Ratings Based on Portfolio Complexity
Regulators expect a lending institution to have a risk rating system that can distinguish criticized and classified assets. Additionally, even the smallest and least complex institution is expected to have some gradation within its non-criticized (i.e., Pass) assets. Larger, more complex institutions would have more stratification. An institution should align these distinctions to its processes. As a simple example, the institution can tie the frequency of review to risk ratings. A bank with 5 grades of Pass along with Special Mention, Substandard, Doubtful and Loss might set account review frequency for its C&I portfolio as follows:
|Risk Rating||Review Frequency|
|Special Mention (6)||Quarterly|
|Doubtful & Loss (8-9)||Weekly|