Moody's Corporate Ratings

Credit granting is the ability and willingness of customers to repay debts that have been specifically quantified. And thanks to PD, LGD and EAD, hundreds, dozens of factors that affect customers as well as the credits granted to them have been summarized and reflected through just those three risk components.

More importantly, based on the results of PD, LGD, and EAD calculations, banks will develop applications in credit risk management in many aspects, the main applications of which include:

Calculating and measuring credit risk EL - expected loss and UL - unexpected loss

Z-score model

This model was developed by EIAltman to give credit scores to US companies. The Z-score is a composite measure to classify the creditworthiness of a borrower and depends on:

Values of the borrower's financial indicators (Xј)

The importance of these ratios in determining a borrower's past default probability

From there, Altman arrived at the following scoring model:

In there:

Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + X5

(1.23)

X1 = Net working capital to total assets ratio

X2 = Ratio of retained earnings to total assets

X3 = Profit before tax and interest on total assets X4 = Ratio of stock value to book value of long-term debt X5 = Ratio of revenue to total assets

The higher the Z-score, the lower the probability of default for the borrower and vice versa ( Z-score can be negative ). According to Altman's scoring model, any entity with a Z-score lower than 1.81 is classified as having high RRTD risk. Based on this conclusion, the bank will not grant credit to the customer until the Z-score is improved to greater than 1.81.

Moody's Rating Model

This model ranks the performance of a company based on its annual risk rating, which changes annually. Companies are ranked high when their risk rating is below 0.1%.

Ranking

Status	Annual Risk Rate
Aaa	Highest quality	0.02%
Aa	High quality	0.04%
A	Good quality	0.08%
Dad	Medium quality	0.2%
Three	Speculative noise	1.8%
B	Speculative	8.3%

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Table 1.2: Moody's corporate ratings

Source: According to Moody's Report

Measuring portfolio risk

Portfolio risk is assessed through Value at Risk (Var) models, Return at risk on capital (RAROC) models, and internal credit rating models according to Basel II (IRB).

Var Model

The var of an asset portfolio is defined as the maximum loss over a given period of time. The VAR model evaluates the risk level of a portfolio using two criteria: the value of the portfolio and the investor's risk tolerance.

Var determination is carried out in the following steps:

Assessing the value of a bank's risky assets is based on an analysis of which assets are exposed to credit risk:

Analysis of the volatility of the value of risky assets Selection of evaluation period

Select a given reliability

RAROC Model

The RAROC model is essentially a quantitative method of measuring profitability taking into account risk. RAROC calculates the variability of net income (profit) caused by variations in credit losses.

The central concept of risk according to RAROC is the level of loss, which includes two parts: expected loss (EL) and unexpected loss (UL). Since EL has been included in determining the price (interest rate), EL may not actually be considered a risk (because it is predictable). UL is actually a risk and the bank needs to prepare capital to compensate for this risk if it occurs.

The Raroc model is calculated based on some basic concepts as follows:

Net Income – Expected Risk Loss Raroc =

Economic capital

Source: According to Basel II

(1.24)

In there:

Income includes: Financial income (income from interest rate differential and prepaid fees and periodic fees), income from business activities

Losses include

The probability of risk occurrence is calculated through

Expected loss

rating * value

Outstanding balance when risk occurs * Loss value in

risk case (calculated through recovery rate)

Source: According to Basel II

(1.25)

Unexpected loss = standard deviation in loss distribution.

Credit Rating Models in Credit Risk Management

The XHTD system helps commercial banks manage credit risks using advanced methods, helping to control the level of customer creditworthiness, setting appropriate lending interest rates based on the forecast of the possibility of failure of each customer group. Commercial banks can evaluate the effectiveness of their loan portfolio by monitoring changes in outstanding debt and classifying debt in each ranked customer group, thereby adjusting resources to the safe customer group.

Credit rating model :

The simplest model used in XHTD is the one-variable model. Evaluation criteria must be unified in the model. Financial ratios used in the model include liquidity indicators, activity indicators, debt balance indicators, profit indicators, debt indicators and interest expenses. Non-financial indicators commonly used include the time of operation of the enterprise, the number of years of experience and qualifications of senior managers, and industry prospects. The disadvantage of the one-variable model is that the forecast results are difficult to be accurate if the analysis and scoring of evaluation criteria are performed separately, and each person can understand the evaluation criteria in a different way. To overcome this disadvantage, researchers have built models that combine many variables into one value to evaluate business failure such as regression analysis models, logical analysis, conditional probability analysis, and multivariate analysis.

Commercial banks apply different models depending on the subject of classification of individuals, businesses or credit institutions. These models can be adjusted after a few years of use when there are large errors between the ratings and reality.

Credit rating process:

Based on the credit policy and related procedures of each bank to establish the credit approval process. A credit approval process includes the following basic steps:

Collect information related to the criteria used in the assessment analysis, rating information of other credit institutions related to the rating object.

Model analysis to conclude on the rating level. The final rating level is decided by the opinion of the Rating Council. In credit rating, the credit rating results are not widely published.

Monitor the credit status of the rating object to adjust the rating level, the adjustment information is kept. Synthesize the rating results compared with the actual risk that occurs, and based on the frequency of rating adjustments made to customers to consider adjusting the rating model.

Credit rating method by score model

The purpose of credit risk analysis is to predict high-risk customers. Modern credit risk analysis methods include statistical research methods based on regression and classification trees or mathematical operations research methods to solve financial problems using linear programming, through which managers make rational decisions for current and future actions.

XHTD by scoring model is a scientific method that combines the use of data for statistical research and the application of algorithmic models to analyze and calculate scores for evaluation indicators in a single or multivariate model. The indicators used in XHTD are established in groups including industry analysis, business analysis, and financial analysis. Then put into the model to calculate scores according to weights and convert the received scores to the corresponding ranking table.

Measures the overall credit risk of a bank

Credit risk measurement is also assessed through calculating the scale of outstanding debt, outstanding debt structure, overdue debt ratio, bad debt, credit risk coefficient, and risk provisions.

The significance of measuring RRTD

One is to eliminate customers with too high a risk level and to be aware of potential risks in advance.

Second , help customers better understand their own strengths and weaknesses in order to advise them on appropriate loan security measures.

Third , conduct an objective analysis, according to banking regulations, to ensure that the customer can repay the debt and wishes to repay the debt.

Fourth , banks can offer more products to meet the development needs of society.

1.2.2.3 Risk response.

Once identified, analyzed, and measured, risks need to be monitored on a regular basis. The purpose of this step is to help the risk management department understand the bank’s risk profile over time.

Management and reporting are the steps that most clearly demonstrate the bank's strategy and thinking on credit risk. First of all, the bank needs to have a system of risk management tools (setting risk limits, levels of authorization for judgment, etc.). Along with credit risk management tools, credit risk management is organized at a centralized level throughout the bank.

Credit risk management tools

The authorization limit is the maximum credit limit that the head office gives to the branch with full authority to decide.

Risk limit is the maximum level of risk that a bank can tolerate to ensure achieving the corresponding level of profit .

Loan Portfolio Management

Banks must regularly analyze and monitor their credit portfolio, especially bad debts and problem debts, to take timely measures when risks arise. Based on the loan portfolio, banks classify debts into groups of debts within term, debts requiring special attention, substandard debts, doubtful debts and debts with the possibility of losing capital. In addition, banks also need to pay close attention to debts with special attention because when there are adverse changes in the bank's lending activities, these debts are easily transferred to the bad debt category. Banks take measures to manage these debts to ensure credit quality for the bank.

For effective credit risk management, banks need to establish a centralized credit information system that includes periodic and special reports. Periodic reports may include reports related to the following contents: Group of customers with the largest credit balance, largest outstanding balances; Credit portfolio analysis, exceptions (e.g. over-limit); bad and doubtful debts; early warning signs, provisions for each individual outstanding balance, profits for each customer and product, loan tracking log.

Review risk management policies periodically.

Credit risk management policy aims to expand credit while limiting credit risk to increase bank income. Credit risk management policy aims to limit risks such as: collateral policy, guarantee policy, co-financing policy... Credit risk management policy is the basis for forming a credit process with detailed operational instructions, specific steps in the credit granting process. A good credit risk management policy is a credit risk management policy presented in precise terms, clear instructions for different types of credit and must be a smart application of credit principles appropriate to changes in economic factors and environment. The policy must outline for credit officers the direction of operations and a clear frame of reference as a basis for considering loan needs. This creates general consistency in credit activities to limit risks and increase profitability.

Risk diversification

Risk dispersion in credit activities is the practice of granting credit to many industries, fields, and production and business areas to avoid major losses for commercial banks. The main forms of risk dispersion include:

+ Do not concentrate credit on one industry, one field or one region: To limit risks, do not concentrate too much capital on one type of business or one economic region. When a bank concentrates credit on one economic sector, it is like "putting eggs in one basket". That means: when the economic sector in which the bank concentrates its investment capital encounters adverse fluctuations, the bank's losses will be extremely large. Thus, dispersing risks or dividing investment sectors and investment regions is a measure for commercial banks in risk prevention.

+ Do not invest capital in one or several customers.

Along with the above purpose of risk diversification, this is an important recommendation for banks to make credit decisions. Regardless of whether a customer is doing business effectively or has a long-term relationship with the bank, the above requirement still needs to be followed because if the customer encounters unexpected difficulties or risks, the bank will suffer great losses, moreover, changes in the customer's business cycle are inevitable.

+ Diversify credit products.

Diversifying credit products helps to spread risks across asset portfolios, reducing losses that occur when there are risks to certain types of assets.

+ Co-financed loans.

It is a form of lending by a credit institution for an investment project and a credit institution acts as a liaison between the parties to implement the financing. Co-financing loans aim to improve the efficiency of lending activities, helping commercial banks to disperse risks without losing revenue from feasible business plans. Credit institutions participating in co-financing must sign a contract with each other that clearly states the responsibilities and powers of each member participating in co-financing. Therefore, when risks occur, the burden will be dispersed to each unit bearing a portion of the risk corresponding to the level of capital participation.

- Use derivative credit instruments to prevent and limit risks:

Using credit derivatives through credit swaps and credit options. Credit options are a tool to protect banks against losses in the value of credit assets, helping to offset higher borrowing costs when the bank's credit quality declines. Credit options can also be used to protect banks against the risk of increased borrowing costs due to a decline in the bank's credit quality.

Risk Management Organization

The simple risk management organizational model depends on the size of each bank. For small banks, the CEO can oversee

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