Best Practice in Credit Rating
Credit rating tells business people about the credit worthiness of financial institutions that issue debt. Businesses issuing credit loans must ensure best practices to ensure risk management. When the borrower defaults, there can be consequences which have massive impact on both the debtor and the creditor. In order to ensure risk management in financial institutions there are international best practices in credit rating which as beneficial.
The Association of Southeast Asian Nations and the People’s Republic of China, Japan and the Republic of Korea have collaborated with the Asian Bond Market Initiative and the Asian Development Bank (ADB). This team has provided assistance to build the capacity of domestic rating agencies (DCRA) to encourage comparability of ratings as a best practice.
Understanding the DCRA ratings is important because it has been assigned by global rating agencies (GCRS) to ensure standards in best practices of credit agencies.
Essential Best Practices for Credit Rating
- Fulfill Pre-rating requirements: There must a written and signed contract requisition of the DCRA credit rating services. The DCRA must ensure the best practice which requires that the rating decision must not be influenced by the rating fees it receives.
- Recognition of Defaults: When there is a missed payment, there must be best practices to detect them either on or after the grace period.
- Defined Policies and Processes: A DCRA must have a well defined and updated credit rating system. The criteria for credit rating must be assigned by the rating committee and announced promptly. This criterion must be publically available for best practices.
- Compliance with Confidentiality Requirements: Information about the credit issued must be kept confidential as an essential best practice. Members of the Board of Directors cannot access such information unless approved by the rating committee.
- Maintain a Neutral Approach: A DCRA must ensure compliance with regulations about avoidance of conflict of interests, maintaining neutrality and preventing abuse of confidentiality by employees.
- Availability of Private Rating: Issuers can be allowed to seek private credit assessments. A DCRA must be able to provide private rating best practices with complete confidentiality of the rating.
- Ensure Audit of Processes: There must be audit check pointes which ensure compliance with best practices, procedures and policies. These audit check points must also comprise of best practices in executing, communication and surveillance of the rating criterion.
- Use of Technology: The DCRA must be well equipped with computational systems for statistical evaluations. There must be a dedicated functional group focused on ensuring best practices in quality assurance and data management.
- Market Feedback: A DCRA should ensure compliance with the best practice in which a market survey is conducted whenever there are changes in the credit rating criteria.
These standard best practices are essential for success in risk management for all financial institutions that issue debts all over the world. The ADB has ensured that the DCRA is well trained on rating best practices by producing the Handbook on International Best Practices in Credit Rating.