FDIC Examines Bank Credit Risk Grading Systems

In its latest issue of Supervisory Insights, the FDIC Division of Risk Management Supervision (“DRMS”) reported that strong credit grading systems typically have “identifiable processes” and a “sound governance framework.”

The article, “Credit Risk Grading Systems: Observations from a Horizontal Assessment,” was drawn from examiner observations about the loan risk grading systems at certain state nonmember banks. The FDIC DRMS discovered that:

  • smaller institutions used “expert judgment”-based systems, in which a loan officer or relationship manager gives a grade based on his or her knowledge of the credit;
  • as banks grew bigger, management would switch from an expert judgment-based system to a quantitative scorecard or modeled approach consisting of qualitative adjustments;
  • certain institutions buy credit grading scorecard and statistical models from external vendors;
  • various institutions that depended on internal data were not retaining their “historical borrower information in a database or other centralized repository”;
  • certain banks were able to “assess grade accuracy well by comparing key borrower financial metrics and the internal grades across loans of a similar type”;
  • credit risk grading systems differ across the banking system;
  • risk grading can help in the implementation of the Current Expected Credit Loss accounting standard; and
  • efficient credit risk grading systems depend on timely and accurate data, among other things.

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