The document discusses risk ratings, which are assessments of financial risk provided by rating agencies. The top three global agencies are Standard & Poor's, Moody's, and Fitch, which provide risk ratings for companies, financial instruments, and countries. Internal risk ratings are also used by banks and other financial institutions to assess risk at the customer level. These internal ratings consider both quantitative financial data and qualitative factors to determine an overall risk level.

1. Risk Rating
Hammad J. Vohra

2. Risk Rating
 Risk Rating plays an important role in assessing customers in
the financial world.
 There are professional agencies which provide global risk
rating.
 The world largest and most respected rating agencies are:
 Standard & Poor’s (S&P)
 Moody’s
 Fitch Rating
 S&P and Moody’s together control 80% of the global rating
clientele, while Fitch holds 15% further market share.
 Note that Ratings are a combination of Quantitative &
Qualitative factors.

3. Risk Rating
 These rating agencies provide ratings on:
 Companies (Entity Rating)
 Instrument (Instrument Rating)
 Country (Country Risk Rating)
 Companies risk rating covers the broad aspect of
the company including its business profile,
sponsors & management, Corporate governance
framework, the Management Information System
they have, Financial standing including capital
structure.

4. Risk Rating
 Instrument rating usually covers individual instruments
issued by companies which normally includes Bonds.
These rating covers the type of bond being issued, any
options attached to it, whether the company has any
sinking fund in place, the company’s strength, the
project strength for which the bond is intended.
 Country Risk Rating covers the profile of the country
including its financials (Balance of Payment, Forex
Reserve, Fiscal & Monetary Policy), Management (i.e
Government & Its Policies), Political scenario and
stability. Such ratings help countries to borrow in the
international market and also provide backing in
International Trade.

5. Risk Rating
 One must understand that ratings provided by these
agencies form an opinion and must not be considered as
a concrete criteria.
 The 2008 global crisis occurred owing to some
instruments (MBS) which were rated highly by these
rating agencies (which as per information were bribed to
rate such instruments high).
 Upon inquiry the rating agencies claimed that all such
ratings form an opinion based on the analyst knowledge
and research and must not be considered as a final
verdict. Investor must exercise judgement.

6. Risk Rating in Pakistan
 In Pakistan there two Credit Rating agencies, which are
 PACRA (Pakistan Credit Rating Agency)
 JCR-VIS (Japan Credit Rating – Vital Information
Services)
 The rating mechanism followed by Pakistan is similar to
international standards and again takes into account
Quantitative & Qualitative factors including future
outlook.
 Similarly, ratings even in Pakistan provides an opinion to
investors / lenders, while also provide additional support
to lenders (Banks/DFIs) for their Capital Adequacy Ratio
(CAR) as per criteria laid down by SBP under BASEL.

7. Risk Rating in Pakistan
 The rating agencies in Pakistan provides/issue rating
on:
 Entity (Company) Rating
 Instrument Rating (non-equity instruments)
 Any company issuing debt (TFC, SUKKUK) are required
to get the instrument rated by either of the rating
agencies.
 It is also mandatory for Banks (and DFIs, Financial
Companies including Insurance) to get themselves rated
(entity rating).
 Similarly, Asset Management Companies and their
respective Funds are required to be rated in Pakistan.

8. Risk Rating in Pakistan
 The rating agencies in Pakistan provides/issue rating on:
 Entity (Company) Rating
 Instrument Rating (non-equity instruments)
 Any company issuing debt (TFC, SUKKUK) are required to get
the instrument rated by either of the rating agencies.
 It is also mandatory for Banks (and DFIs, Financial
Companies including Insurance) to get themselves rated
(entity rating).
 Similarly, Asset Management Companies and their respective
Funds are required to be rated in Pakistan.
 (PLEASE REFER TO PACRA RATING SCALE)

9. Risk Rating in Pakistan
 Entity & Debt Rating scale are similar. (these are divided into
two parts Long-term & Short-term). The focus is usually on
long-term.
 For asset management industry a separate scale is used
known as Asset Manager Rating.
 For Asset Management’s individual funds, there are other
rating scales “Fund Performance Rankings” and “Fund
Stability Ratings).
 For Insurance industry there is another rating scale known as
“Insurers Financial Strength”
 (For the purpose of understanding & studies we will only
focus on Entity & Debt Instrument rating scale - PLEASE
REFER TO PACRA RATING SCALE)

10. The Concept of Internal Risk Rating
 Obviously, getting your business from an external agencies
requires time, money, disclosures & also good organization to get
a good rating.
 Hence, not many companies voluntarily get themselves rated
(here in Pakistan and even globally).
 So for Banks & DFIs, the SBP requires that irrespective whether
External Rating is available or not, the Bank or DFI shall conduct
its own Internal Risk Rating (IRR).
 These IRRs are required for each type of borrower, be it:
 Corporate
 Commercial
 Retail
 SME
 Consumer / Individual

11. The Concept of Internal Risk Rating
 Internal Risk Rating covers two types of rating:
 Obligors Risk Rating (ORR)
 Facility Risk Rating)
 Hence Banks/DFI IRR comprises of an ORR & FRR
together.
 Obligors Risk Rating (ORR) is simply the entity’s risk
rating. It focuses on the borrower (either company or
individual) and covers both quantitative & qualitative
aspects of the borrower.
 It tends to quantify the qualitative aspects and note that
not all criteria can be covered.

12. The Concept of Internal Risk Rating
 ORR are based on an IT module either produced in-
house (even on excel) or purchased /designed from an
expert agency.
 Quantitative aspect include key financials figures &
ratios example, sales, sales growth, profit, profit
margins, current ratio, debt-to-equity, debt coverage,
equity etc. (Depending on the module)
 Qualitative include various aspect including
management quality, experience with the Bank, type of
industry, reliance on supplier etc. ( in order to quantify
the same, the rating modules include drop-down scales
for such criteria e.g. management quality (high,
medium, low)

13. The Concept of Internal Risk Rating
 Hence, these ratings do-not reflect the real picture.
 Usually Banks have a rating scale of “1 to 12” or “1 to
10” with one being the best (if mapped with external
rating then 1 is equivalent to AAA rating by PACRA).
 Due to module limitations, there maybe cases that the
rating turns out to be 5 or 4 or perhaps 1. But if the
Analyst believe the rating to be different, for example as
per module rating is 1, but analyst believe that it should
be 3 (since he has info that there is a feud between
management or an experienced CEO has resigned), then
the Analyst over-rides the rating and puts his/her
comments for the over-ride which should justify the
over-ride (either downgrade or upgrade).

14. The Concept of Internal Risk Rating
 Facility Risk Rating: This rating covers the individual risk attached with
the transaction/product and what is the second way out (i.e. security).
 These are usually placed at a scale of “A to F” or “1 to 5” (depending on
Bank). (with A being the most secured – liquid security and F being very
weak security)
 For instance, a company having ORR of 2 can have a FRR of F. How and
why?
 ORR covers the company itself, while FRR covers the product/facility
allowed and the security there against.
 So if the company is given for example RF facility against ranking charge
over current assets. This shows that our facility coverage is very weak.
 In such case, the IRR will be “2 F”

15. The Concept of Internal Risk Rating
 Usually banks provide customers with multiple facilities, hence the FRR
is an averaged out rating based on each facility’s proportion in total.
 For example ABC company was allowed total limits of Rs. 400 Mn in the
following form:
 RF Rs. 200 Mn against 1st Pari Passu over current assets.
 LC (S) Rs. 100 Mn against Title over LC goods/documents
 TF 100 Mn against exclusive charge over Plant & Machinery.
 Most likely, the rating will be as follows:
 RF - F
 LC – C
 TF – E
 Since the proportion of RF is highest, there is a possibility that our
average FRR would turn-out to be D or E (depends on the module)

16. The Concept of Internal Risk Rating
 Also note that, in cases where there are sub-limits too, for
example (using previous case)
 For example ABC company was allowed total limits of Rs. 400 Mn
in the following form:
 RF Rs. 200 Mn against 1st Pari Passu over current assets.
 FIM Rs. 200 Mn as sub-limit of RF against pledge over stocks
 LC (S) Rs. 100 Mn against Title over LC goods/documents
 TF 100 Mn against exclusive charge over Plant & Machinery.
 Note that in such a case, the main limit will be given preference
by the module, hence RF will again dominate and FIM will be
ignored because it’s a sub-limit (however this may vary
depending on the IT system/module in place).
 IRR is hence:
 2 A, 3 B, 1 C etc etc