Credit Rating: Internal and External
The agency's rating informs the bank. The bank's own grade decides the loan and its price. Here is how both work.
A credit rating is an opinion on how likely a borrower is to repay on time. Behind it sit two estimates: the probability that the borrower defaults, and how much the lender would lose if it did. The rating turns a long appraisal into one grade that the bank can act on.
Banks use two kinds. An external rating comes from a credit rating agency such as CRISIL, ICRA, CARE or India Ratings. An internal rating is the bank's own grade, produced by its rating model. The CCP syllabus covers both, how they compare, and the model formats banks use.
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Internal Versus External Rating
Who assigns it
Internal rating
The lending bank, through its own rating model
External rating
An RBI-accredited credit rating agency
Coverage
Internal rating
Every exposure above the bank's threshold, including small borrowers
External rating
Usually larger borrowers or rated debt instruments
Scale
Internal rating
Bank-specific grades, for example CB1 to CB8
External rating
Agency symbols, AAA down to D (long term), A1+ down to A4 (short term)
Main use
Internal rating
Sanction or rejection, pricing, exposure limits, tenure, portfolio monitoring
External rating
Market view of credit quality; an input into the internal rating and into capital calculations
Review
Internal rating
On the bank's schedule and after any major event
External rating
As the agency decides
| Point | Internal rating | External rating |
|---|---|---|
| Who assigns it | The lending bank, through its own rating model | An RBI-accredited credit rating agency |
| Coverage | Every exposure above the bank's threshold, including small borrowers | Usually larger borrowers or rated debt instruments |
| Scale | Bank-specific grades, for example CB1 to CB8 | Agency symbols, AAA down to D (long term), A1+ down to A4 (short term) |
| Main use | Sanction or rejection, pricing, exposure limits, tenure, portfolio monitoring | Market view of credit quality; an input into the internal rating and into capital calculations |
| Review | On the bank's schedule and after any major event | As the agency decides |
What a Rating Model Looks At
Rating agencies and bank models cover similar ground. CRISIL's framework for manufacturing and service companies, for example, combines four risk areas and then adjusts for support.
- check_circleBusiness risk: industry risk, market position and operating efficiency.
- check_circleFinancial risk: accounting quality, adequacy of cash flows against debt, and financial flexibility.
- check_circleManagement risk: competence, integrity, risk appetite and strategy.
- check_circleProject risk: time and cost overruns, funding and technology risk, when a large project is under way.
- check_circleParent, group or government support, factored into the final rating.
- check_circleBank models add their own items. One bank's policy, for instance, gives up to 10 marks in its internal rating for how well the borrower manages unhedged foreign exchange risk.
How a Rating Drives the Credit Decision: One Bank's Policy
Corporation Bank's 2019 group credit policy shows the mechanics clearly. Thresholds and grades differ from bank to bank; the logic is the same.
- 1
Who gets rated
All commercial proposals above ₹25 lakh are internally rated in the bank's Risk Assessment Module. Proposals with total exposure of ₹1 crore and above go to risk managers at head office for rating validation. Borrowal accounts above ₹5 crore also need an external rating, except loans fully secured by bank deposits or guaranteed by the Central or State Government.
- 2
Accept or reject
Grades CB1 to CB8 apply to performing loans. New borrowers are taken only in CB1 to CB5, and takeovers from other banks only in CB1 to CB4. A rating below the acceptance grade is a ground for rejection.
- 3
Price the loan
Interest is set as the MCLR of the relevant tenor plus a spread fixed for each grade, with a maximum spread per category. Any variance from the price prescribed for a grade must be documented and approved. The bank was also moving to RAROC, risk-adjusted return on capital, to price exposures against the economic capital they consume.
- 4
Set limits and tenure
Maximum exposure ceilings and the tenure of credit are tied to the rating grade, bank-wide.
- 5
Review and reprice
Ratings are reviewed half-yearly for limits of ₹10 crore and above and annually for limits between ₹1 crore and ₹10 crore. Pricing is confirmed or revised whenever the grade moves, and immediately after any event that changes the risk.
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Mapping External Ratings to Internal Grades
The same policy maps agency ratings to its internal grades.
A1+
Long-term external
AAA
Internal grade
CB1
A1
Long-term external
AA
Internal grade
CB2
A2
Long-term external
A
Internal grade
CB3
A3
Long-term external
BBB
Internal grade
CB4 / CB5
A4
Long-term external
BB
Internal grade
CB6
A4
Long-term external
B
Internal grade
CB6
A4
Long-term external
C
Internal grade
CB7
A4
Long-term external
D
Internal grade
CB8
| Short-term external | Long-term external | Internal grade |
|---|---|---|
| A1+ | AAA | CB1 |
| A1 | AA | CB2 |
| A2 | A | CB3 |
| A3 | BBB | CB4 / CB5 |
| A4 | BB | CB6 |
| A4 | B | CB6 |
| A4 | C | CB7 |
| A4 | D | CB8 |
Worked Case: When the Two Ratings Disagree
A borrower carries an external long-term rating of A, which maps to CB3. The officer's internal model returns CB5, two notches weaker. Under the policy above, a gap of two or more notches must be justified in the appraisal report, and head office risk management decides whether to allow the deviation. Since that bank sets the interest rate from the internal grade, accepting CB5 rather than CB3 puts this borrower in a weaker pricing grade. The external rating informs the decision; the internal rating drives the price.
Why External Ratings Still Matter to the Bank
- check_circleThey feed the internal rating. The policy says agency ratings should be given proper weightage when the bank assigns its own grade.
- check_circleThey can lower the borrower's cost. The same bank allowed an interest incentive of 0.50% for the highest-rated SME accounts and 0.25% for high and average-rated ones, where the rating came from an outside agency.
- check_circleThey allow comparison. The policy encouraged external rating because it gives broader comparability of ratings at all levels.
How the IIBF Exam Tests This
- check_circleWho assigns: an external rating comes from an RBI-accredited agency; the internal rating is the bank's own, built on its own model.
- check_circleUses of internal rating: sanction or rejection, pricing, exposure limits, tenure and portfolio monitoring. Expect "all of the above".
- check_circleScales: long-term agency ratings run from AAA down to D, short-term from A1+ down to A4.
- check_circleRisk-based pricing: a weaker grade means a higher spread over the benchmark rate. A downgrade on review leads to repricing.
FAQs
What is the difference between internal and external credit rating?expand_more
An internal rating is the bank's own grade from its rating model and drives sanction, pricing and limits. An external rating is assigned by an RBI-accredited agency such as CRISIL, ICRA or CARE, and is one input into the bank's view.
How does credit rating affect the interest rate on a loan?expand_more
Banks set the rate as a benchmark rate plus a spread, and the spread depends on the rating grade. A better grade means a lower spread. When the rating changes on review, the rate is revised.
Is an external rating compulsory for bank loans?expand_more
It depends on the bank's policy. The 2019 Corporation Bank policy, for example, required an external rating for borrowal accounts above ₹5 crore, with exemptions for loans fully backed by deposits or government guarantees.
What does a credit rating actually measure?expand_more
The likelihood of timely repayment. Analysts estimate the probability of default and the likely loss if default happens, after looking at business, financial, management and project risks.
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