ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Internal Credit Rating Practices of Indian Banks

The overarching goal of the second Basel accord is aligning the capital requirements of banks with risk sensitivity. The accord emphasises the quantification of capital requirements on the basis of internal rating models. The internal credit rating models of banks are expected to produce the probability of default and loss given default to estimate the capital requirements of credit risk. This paper presents an analysis of the current status of internal credit rating practices of Indian banks. The survey reveals that the components of internal rating systems, their architecture, and operation differ substantially across banks. The range of grades and risks associated with each grade vary across banks analysed. This implies that lending decisions may vary across banks. There are differences among the rating systems of various banks. This paper presents a set of actions to improve the quality of internal rating models of Indian banks.

T he initiatives for global best practices and banking standards began with the constitution of the Basel Committee in 1975. The first Basel Accord of 1988 (Basel I) emphasised the importance of minimum capital adequacy to address credit risk by devising the standardised approach. Capital adequacy is defined as the ratio of capital funds and risk weighted assets. Here the Basel Committee adopted a portfolio approach for deciding risk weighted assets. Each asset in the balance sheet carries a risk weight and sum total of these products are called as risk weighted assets. In India, the Reserve Bank of India (RBI) has suggested risk weights of 0, 20, 50, 75, 100 and 125 percentages for various types of assets. The rule is that a banks capital should not be less than 8 per cent (in India it is 9 per cent) of its risk weighted assets. However, Basel I has a number of limitations, particularly its insensitiveness to the risk of specific assets. It assumes a one size fits all approach by prescribing a standard risk capital requirement globally.

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