Credit Rating Methodology

Definition

Credit Rating Methodology is an analytic framework (set of considerations, analyses, tools, models and algorithms) that underpin the generation (assignement) of a Credit Rating.

Methodology Components

Credit rating methodologies vary significantly by the market segment (type of issuer) that is being rated. This reflects:

• the available Credit Information
• the nature of borrowers / instruments
• the investor due diligence practices / demands
• legal /regulatory frameworks in different jurisdictions

Indicative components:

• Quantitative Analysis of Corporate Balance Sheet (Financial Ratios, Liquidity) usually from audited reports
• Qualitative Analysis of Corporate Balance Sheet
• Analysis of Operating Performance and Assessment of Operating Plan
• Analysis of Business Profile (Business Model Risk, product mix, quality of management, Internal Governance, SWOT Analysis)
• Analysis of Enterprise Risk Management
• Analysis of Sectoral Profile (business model trends, technological developments) and Comparison with Peers
• Comparison with Industry Benchmarks
• Analysis of Political Risk and FX Lending Risk
• Assessment of Credit Support
• Assessment of legal environment
• Scenario Analysis, Simulation or other tools

The above elements are usually brought together an overall operational [[Credit Rating Process] including any models or tools, intermediate results or assessments, iterative fact finding etc. culminating into a final placement in one or more credit rating scales within a concrete Credit Rating System and an eventual Credit Rating Report.

Issues and Challenges

• Methodologies for different market segments and asset classes can be very inconsistent with each other

See Also

• Credit Rating Model, the concrete algorithm / quantitative procedure
• Credit Rating Philosophy, the conceptual and economic / financial context