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.