banks credit rating
TRANSCRIPT
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Presented by : Dr. Peter Larose
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Banks Credit Rating
Sit Back,
Relax,
Enjoy,
The Presentation
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1. What is credit rating?2. Why the need for a credit rating?
3. Who are the credit rating agencies?
4. Factors influencing change in banks rating,
5. Rating definitions used by Standard & Poors (S&P),
6. S&P criteria for rating,
7. Where do the Taiwanese banks fit?
8. The role of rating agencies,
9. Use of external rating scales,
10.Internal ratings,11.Banks rating methodology,
12.Financial ratios used by S&P,
13.Taiwan banking outlook, and
14.What have we learnt?
Focus of this Presentation
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Banks Credit Rating
A credit rating is an evaluation report of how well or bad
a company is performing in absolute terms in a particular
market or industry.
Such a report makes it possible for the stakeholders to
compare a companys credit worthiness against other
companies operating in similar market or industryinternationally.
The rating exercise is considered as one of the most
essential reports, besides the External auditors report,which provides the stakeholders an overview of the
financial standing of the commercial entity.
The report is made up of both; (a) quantitative, and (b)
qualitative information.
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Banks Credit Rating
Why the Need for a Credit Rating?
(a) The financial sector especially the banking industry in
most emerging economies is going through a process
of change,
(b) Financial transactions have become a major economic
activity in most service-based economies, thus any
disruption or imbalance in its infrastructure will have asignificant impact on the whole economy,
(c) A safe and sound banking industry can bring about
stability within the financial markets,
(d) During the last decade, banks around the world had to
respond to the emerging challenges of competition,
risks and uncertainties,
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Banks Credit Rating
Why the Need for a Credit Rating?
(e) It is considered part of the Corporate Governance
principlesfor a commercial entity to practice good
governance, especially banks,
(f) The stakeholders normally expects such a report as
part of their overall assessment of the companys or
banks financial soundness and stability,
(g) Analysts and investors can compare a company or banks
performance with another company or bank operating in
the same market or industry internationally, and
(h) Depending on the jurisdiction, the companies or banks
listed on the Stock Exchange must fulfilled such a
requirement as part of the regulatory and commercial
laws.
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Who Are the Credit Rating Agencies?
There are at least 74 Credit Rating Agencies around the
world. Just to name a few:
Country Name
Australia Australian Rating
International Standard & Poors
International Moody's Investors ServiceEurope Central European Rating Agency
Europe Fitch/IBCA
Japan Nippon Investors Service
Japan Japan Credit Rating Agency LtdTaiwan Taiwan Ratings Corporation
India Credit Rating Information Services of India
China Shanghai Far East Credit Rating Co Ltd.
Russia RUS Ratings
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Factors Influencing Change in Banks Rating
Higher Rating
* Ability to generate sound, stable earnings and capital overtime (inc lusive of bo th the regulatory and economic capi tal)
The prevailing political stability in the country, where the
banks are operating (upgrade of the BFSR by S&P focus onpreferent ial capita l , and sub ordin ated debts).
Application of conservative risk metrics (e.g. credit , interest
rate, foreign exch ange rate), and
Consistent earnings a fundamental underpinning factor
for any rating exercise.
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Factors Influencing Change in Banks Rating
Lower Rating
Major legislative changes that affect the banks in theoperating jurisdiction(e.g. new taxes on banks profits),
Significant decline in the banks profits (say 35%),
Material alteration to the Governance structure could
presage a downgrade,
Breach of securities covenants, and
Failure to comply with any regulatory capital requirement
based on the jurisdiction regulatory rules.
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Ratings Definitions Used by Standard & Poors
The rating services use a 9-point rating scale based on the
following symbols:
1. A has a Very Strong fundamental strength compared
with that of its global peers.
NB: It is the highest BFSR assigned by Standard Poors
2. B+ - show the higher relative standing with its rating category.
3. B - has a Strong fundamental strength.
It is more susceptible to the adverse effects of changes in circumstance
economic conditions than those entities rated as A
4. C+- show the higher relative standing with its rating category.
BSFR means Bank Fundamental Strength Ratings by S&P
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Ratings Definitions Used by Standard & Poors
5. C has adequate fundamental strength.
It is more sensitive to uncertainties and adverse circumstances
to a greater degree than higher rated entities.
6.D+ - show the higher relative standing with its rating category.
7. D - is vulnerable to a greater degree than those banks
rated higher, to adverse circumstances in its
operating environment.
8.E+ - show the higher relative standing with its rating category.
9.E - is likely to be facing significant weaknesses in its
fundamental credit profile and may be in default
on some or all of its financial obligations.
It is the lowest BFSR assigned by Standard Poors.
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BSFR represent an S&P opinion of a banks
fundamental strength, or more specifically, whathas been formally referred to as status quo rating
on the bank.
Different rating agencies use different methodology.
BSFR assessment of what a single legal entity
within a group would be rated, which incorporate
the benefits or burden of being part of the group.
A BSFR would not include any potential capital
assistance from the group, regulator or Government
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S&P does consider the following factors when
assessing a banks fundamental strength rating(BSFR):State of the economy,
Industry structure,
Regulatory environment,
Degree of competition,
Status of business,
Scope of geographic diversification & distribution,
Quality assets & investments,
Credit and market risk appetite,Funding & liquidity position,
Capitalization, profitability & risk management structure,
These factors are embodied in a business & financial riskmodel.
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These risk factors include actions or inaction by the
Govt, conducted in its normal course of activity,that may directly or indirectly affect banks.
Direct EffectsChange by the Government
Regulator changes:
tax regime,
lending requirements, &
other regulations.
Indirect EffectsDecline in value of bonds,
Adverse change in external
balance of payment (BOP),
Increase credit leverage,
Increase money-marketvolatility.
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A BSFR is a form of long-term issuer credit rating.
It must be noted that it is neither a counterparty credit rating
nor a substitute for one.
Normally, it complements a traditional counterparty credit
rating and it is intended to provide additional information
to all the stakeholders of banks.
A bank, which does not have a credit rating may be faced
with uncertainties for its future operations.
This is due that the business of banking is about information
which customers, investors, stock markets, lenders are
demanding all the time.
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While, we discuss the credit rating for banks around the
World, irrespective of the jurisdiction, where they operate,It is vital, that we ask
where do the Taiwanese banks fit with the Asia- Pacific
banking market?
The next slide addresses this question based a research
findings carried out by Standard & Poors.
The research takes into consideration the level of economic
risk vs the business risk.
& f S
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Economic & Industry Risk in Asia-Pacific Banking Systems
ECONOMIC RISK
Very
High High
Moderately
High Moderate
Moderately
Low
L
o
w
Low Australia
Moderately
Low
New Zealand
Singapore
Moderate HongKong
Malaysia
Moderately
High
Thailand
South
Korea
Taiwan
Japan
High ChinaPhilippines India
Very High IndonesiaVietnam
INDUSTRY
RISK
Source: Standard & Poors : Asia-Pacif ic Bankin g Outloo k 2005
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The role of the rating agencies within the reformed Capital
Accord is predetermined by their being the only globally
accepted benchmarks for the banking industry.
For this reason, the credit risk management functions of
many financial institutions & banks have been built on the
basis of methodologies comparable to the major externalagencies.
A key objective/function of the reform process is to build
on approaches already inherent and actively used by banks
As such the external rating methodologies must play an
Important role in any reform process.
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The role of rating agencies is also important given the
standing of public ratings within financial markets.
Reliance on the rating agencies for providing background
analysis & ratings for external rated names also
compounds the level of penetration of rating agency
methodologies into banks rating processes.
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The factors that allow banks to continue to promote the use
Of the rating agencies scales are as follows:
(1) Publicly Available Data Set
Moodys & Standard and Poors have made their internal
default and recovery information publicly available to any
interested party.
These data products are now widely used by the industry
to feed models used within the credit risk management
processes.
(2) Market Forces
The credit derivatives and asset securitization markets
have requirements for public ratings.
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(3) Quantitative Ratings
Rating agencies have begun to develop more quantitative
ratings, which provide useful benchmarks for internal
rating models.
Regulatory Grades
An approach using more rating grades should be preferred.
If a counterparty lies at the boundary of two rating grades,
the capital impact of a rating difference is reduced
significantly with more rating grades.
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Since many financial institutions define their internal rating
processes differently, it is useful that minimum standards
are established for the model approval of internal ratings.
In this respect, it is very important for Basel Accord to focus
on the development of a minimum standards on banks
overall internal rating processes, not just the rating models
used within these processes.
It is generally accepted by banking specialists that the
processes required to set globally consistent ratings will
depend on:
(a) Credit policy applied, (e) Risk Review,
(b) Credit culture, (f) Credit Forum, and
(c) Rating models, (g) Delegated Authorities.d Peo le,
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Credit Policy AppliedThis should outline how the internal rating process be
applied to various transactions and facilities.
Credit CultureA definition of acceptable credit risk that is known & applied
throughout the organization, such that the risks taken
reflect stated risk appetite.
Rating ModelsThe models should provide the basis of the internal rating
procedure to ensure consistency of approach to the setting
of ratings.
PeopleHowever, good the model sounds, it is very crucial that the
banks employ high-quality personnel to handle the models.
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Banks Credit Rating
Credit ReviewAnalysis & audit of previous decisions on the credit
portfolio must be carried out.
Credit ForumThe setting of internal rating methodology for particular
portfolio segments is also vital, if the rating is to be effective.
Delegated AuthoritiesManagement must ensure that the most appropriate level
of credit sign-off approves transactions, or facilities,
culminating in the credit committee.
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Banks Credit Rating
The factors considered in the rating of banks or financial
Institutions are as follows:
Industry Risk Financial Risk
Structure Funding & LiquidityOwnership profile Capitalization
Customer base Earnings
RegulationMarket position
Degree of diversification
Management style & strategies
Standards of accounting used
Perceived Economic Risk Risk Management
Credit Risk Strategy Market Risk
Market/Structural Risk Credit Risk
Trading Risk Financial Flexibility
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Banks Credit Rating
Industry RiskStructure
Depth of publicly traded capital markets and the trends inthis area,
Basic structure of the banking system,
(e.g. number & sizes of inst i tut ion s)
Proportion of finance in the economy that is intermediated
through banks, non-bank competitors in the market & the
extent of that they pose a serious challenge to the banks,
Dynamics of inter and intra-industry competition,
(e.g. expec tation of change, degree of dis- intermediation, & barr iersto entry).
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Industry RiskStructure
Strategic investments in industrial companies & types ofbenefits/risks posed by holding these investments,
Is there any consolidation trend in the banking system?,
Degree of transparency, standards of accounting, reporting
systems, auditing standards applied, and
Reliability/strength of the countrys legal system & judiciary
procedures.
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Industry RiskOwnership Profile
Are the banks owned by corporate groups or individuals?
The advantages/disadvantages emerging from the
relationship.
Level of government-owned banks within the banking system
The extent to which state-owned banks perform any special
public sector role or compete on equal footing with the
private sector banks (i .e. any s pecial pr ivi leges? )
Extent which government involvement in the banking system
affects the sectors competitiveness.
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Industry RiskCustomer Base
Existing commercial relationship prevailing between thebanks & corporate customers,
Financial strength of the personal sector & the level of social
benefits offered in the operating jurisdiction, and
Price sensitivity and the level of sophistication of the
customer base.
A very usefu l p iece of in format ion to assess the scope of bankingbus iness f lour is hing , stagnat ing, or decl in ing .
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Banks Credit Rating
Industry RiskRegulation
Is there any deposit insurance facilities for banks?,
Process of de-regulation, areas within the financial system
that have already been de-regulated,Any addit ion al measu res expected, t ime frame for de-regulat ion process
& expected impact on various econom ic sectors?
What sort of legislations are observed by the banks?(e.g. state, nation al, international s tandards)
Governments regulatory philosophy in relation to the needof continuous intervention within the banking system & the
corporate sector,
Regulatory structure in place (e.g. level/quali ty of supervis ion etc)
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Banks Credit Rating
Industry RiskMarket Position
Degree of vulnerability of the market position,
Banks market shares in key business sectors & size of
those markets,
Tangible advantages from the market position,
(e.g. fund ing so urces, qual i ty of bus iness, pr icing sty le)
What are the trends emerging from the existing market?
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Industry RiskDegree of Diversification
To what extent is the banks business represented bydiversification strategy?
What are the geographic spread of the banks customers
base?
Consideration of the banks segmental diversity,
(e.g. business uni ts, custom er segments, & produ cts/serv ices).
Are the banks internationally represented throughdiversification?(e.g. percentage of revenue local, internat ional & bo th).
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Industry Risk (Management Style & Strategies)Risk level of strategic direction,
Growth prospects,(e.g. internal vs external grow th, merger & acquis i t ions, f inanc ing pol icy
and pract ices).
Quality of forward planning (e.g. financial & st rategic issues),
Credibility of management style (e.g. track reco rd, pastPerformance),
Corporate independence of the banks management(e.g. political interferences, shareholders pressure on strategic decisions
Organizat ional stru ctu re (e.g centr al ized or decent ral ized)
Quality & depth of management (e.g. dependence on key personne
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Industry Risk (Accounting Standards Used)Accounting for past due loans, restructured loans, other
problem loans, foreclosures, commitments, contingencies.
Valuation of other balance-sheet items, (e.g. real es tates,Foreclosed assets, der ivat ives, & o ther intangib les).
Revenue recognition policies, including interest accrual onproblem loans & scurrilities, fee income, income from the
securitization proceeds.
Expense recognition, impairment charges, pension expensedeferred taxes.
Use of expense reserves (inc lud ing restructur ing cos ts), their
materiality & movements.
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Industry Risk (Accounting Standards Used)Accounting principles used (e.g. IFRS or US GAAP)
Use of special purpose vehicles, joint ventures, non-financial
subsidiaries, other subsidiaries.
Securities valuation policies (e.g. book values vs market values).
Overall quality of accounting for earnings, considering the
Impact of special and non-recurring items, accounting
changes, & other smoothing techniques.
Adequacy of problem asset coverage, including provisioning
policy & valuations.
Off-balance sheet items (e.g. pensio n, retirement benefits ,
con t ingent l iabi l i t ies, guarantees, performance bonds)
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Perceived Economic RiskThe countrys political stability (e.g. has the country a s table gov t?)
Structural problems facing the country (a number of und er-Developed countr ies face such problems namely in Afr ica and South
Amer ica).
Structural problems can be categorized as:* current account deficits,* high inflation,
* high unemployment rate,
* lack of competitiveness, and
* fiscal deficits
From rating viewpoint these problems must be corrected
with measures so as to improve the countrys image in the
international community.
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Perceived Economic RiskThe size of the economy is equally vitalsmall island states
economies has great difficulties with the management ofthe economy (i .e. strength s vs vu lnerabi l i ty).
This due to their size-effect, where it is difficult to achieve
economies of scale in mass production.
The small island states are very vulnerable to external
shocks due to its integration with the rest of the industrial
world.
The business cycle (e.g. vo lati l i ty in GDP, volati l i ty in asset p rices,bankruptc ies, and other changes in the econ omy).
Constraints on the authorities to take appropriate economic
measures in good time.
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Perceived Economic RiskThe growth prospects for the economy and the rate of credit
and monetary growth relative to the economic growth rate.
The openness of the economy with the rest of the world.
(e.g. regional, intra-regio nal, and international agreements).
Dynamics of savings and investment in the economy.(e.g. pol icy on savings culture, and prom otion o f foreign directinvestmentsFDI).
Structure and overall financial strength of the corporate &personal sectors.
Does the Government allow the private sector to play a key
role in the economyas engine of growth?
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Banks Credit Rating
Credit RiskStructure of the balance sheet of the banks including the
relative proportion in different low-credit risk assets(e.g. govt. bills. Inter-bank deposits) compared with higher-
risk assets (e.g. loans, equities).
Credit portfolio split into : loan type, maturity, collateral,
customer base, economic sector, size, currency & country.
Level of fixed income securities (e.g. type, largest positions,
market value, & maturity structure).
Loan loss reserves, (e.g. type, general & specif ic, reserves againston and off-balance sheet exposures, l iquidat ion p rovis ions , charge-off
for th e past 5 years, and recover ies reco rd).
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Banks Credit Rating
Credit RiskConcentration of credit risk (e.g. large exposures to specif icIndu str ies, markets, indiv idual borrowers, or sp ecif ic loan types).
Equity securities (e.g. econom ic sector, largest exposures,Propor t ion of inv estment por t fo l io relat ing to p revious underwr i t ing
Posit ion s, investment strategy, boo k value vs market value).
Reserves policy & adequacy.
Problem loans (e.g. Large credit exposu res, levels in & changes inNon-performing assets, past due loans, restruc tured loans, and
Expected future trends w ith other problem assets).
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Trading RiskClear description of the organization structure.
Breakdown of products/services by currency, credit quality,
volume, and maturity profile.
Future product & market expansion plans.
Identification of the market strengths & weaknesses, and
level of interest in position taking.
Trading strategy on group basis & by individual products.
Review of historic trading records (e.g. prod uc ts, market, sizeof posi t ion s, vo lat i l i ty of net revenues, & prof i tabi l i ty).
Liquidity of the market , which banks operate.
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Financial Risk (Earnings)Operating expenses : level & trend of overhead relative to the
banks business mix and distribution network.
Quality of the accounting practices in place.
Net operating income analysis (level & trend).
Loan loss provision (e.g. curr ent level, past v olati l i ty, & abil i ty toabsorb fu ture requ irements).
Net interest income: margin trends & ability to maintain
volume.
Non-interest income: diversity & sustainability of other
income sources & growth potential.
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Financial Risk (Earnings)Impact of extra-ordinary gains, and/or, charges.
Tax position (e.g. histor ic al and future use of net operat ing lo ss ,other tax planning scenar ios).
Impact of inflation on earnings, return on equity vs the
reporting periods of inflation rate.
Earnings outlook or projections (e.g. budget vs actual , project ionfor the medium to long -term).
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Risk Management (Credit Risk)Problem assets (e.g. respon sibi l i ty to fo l low u p, col lect ion s,foreclosures, col laterals, style of credit management & monito r ing).
Monitoring of credit exposures (e.g. control of d isbu rsements ,review func t ion, internal rat ing s ystem , role of audit department, problem
of exposu res).
Underwriting policiesthat is, the approval process for
Different types of products/ services, customer groups.(e.g. f ixed in com e secur i t ies, investm ent or trading equit ies, mo rtgage
loans, consumer loans , corp orate loans, delegated lend ing powers,
co l lateral valuat ion, and monito r ing).
Essentially, it is very important for management to have a
clear cut guideline or policy on the handling of credit risk
because it can have serious financial consequences for the
banks.
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Risk Management (Market Risk)A general understanding of market risk by the senior
mangers or executives and the importance of sound riskmanagement architecture.
Strategy regarding intentional position taking, limits,
authorities required for the breaching limits.
How traders and desk executives monitor positions & how
the system interacts with the overall risk management
structure in place.
Dynamics of the Asset & Liability Management Committee
(ALM) towards the different types of risk.
Hedging strategies (if any), and management view on
hedging transactions.
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Risk Management (Market Risk)Audit function (e.g. both internal & external auditors)
Accounting policies (i .e. consis tency vs change)
Back office operations (e.g. valuat ion pos it ions , organizat ion,disaster recov ery procedures & pol ic ies).
Stress testing of the loan portfolio & other earning assets.
Impact of the information technology system on the entire
operations.(e.g. adequacy of h ardware & so ftware, virus protect ion software,
safeguards against in trusio n, theft , and d amage, disaster recovery
plan, insu rance protect ion).
These criteria are applied by Standard & Poors.
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The ratios are categorized into FOUR types:
(a) Profitability,
(b) Liquidity,
(c) Capital,
(d) Asset Quality.
Whereas, banks are assessed using CAMEL system
for inter-bank comparison.
CAMEL represents Capital, Asset, Management,
Earnings, & Liquidity.It is also the current practice to include sensitivity analysis
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Profitability Revenue/Average Assets
Net Interest Income/Average Assets
Non-interest Income/Average Assets Non-interest expenses/Average Assets
Net operating Income before Loan Loss Provision/ Average Assets
Net operating income after Loan Loss Provision/Average Assets
Loan Loss Provision/Average Assets
Net Income/Average Assets (ROA) Revenue/Average risk-adjusted Assets
Net Income/Average risk-adjusted Assets
Net Interest Income/Total Revenue
Non-interest Income/Total Revenue
Non-interest Expense/Total Revenue
Net Operating Income before Loan Loss Provision/Total Revenue
Net Operating Income after Loan Loss Provision/Total Revenue
Pre-tax Profit/Total Revenue
Net Income/Total Revenue
Net Interest Income/Average Earning Assets
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Liquidity
Total Deposits/Total Liabilities
Loans/Customer (core) Deposits
Loans/Total Assets
Net inter-bank Deposits/Total Liabilities
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Capital
Adjusted Equity Capital/Total Assets
Adjusted Equity Capital/Total Risk Assets
Adjusted Equity Capital/Total Loans
Double Leverage Equity Capital + Loan Loss Reserves/Total Loans
Tier 1 Capital/Regulatory Risk Assets
Adjusted Total Equity Capital/Total Assets
Adjusted Total Equity Capital/Regulatory Risk Assets
Dividend Pay Out Ratio
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Asset Quality
Loan Loss Provision/Average Loans
Net Charge-offs/Average Loans
Loan Loss Reserve/Gross Loans
Loan Loss Reserve/Risk Assets
Non-performing Assets (NPA)/Total Loans
Net NPA/Net Loans
Loan Loss Reserve/Non-performing Assets
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Conclusion made by S P suggests that the banking sector needs to
further improve its risk management structure to cope with an
increasingly dynamic operating environment.
Quote: Asia-Pacif ic Bank ing Outlo ok 2005S&P Report
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Positive Factors Identified
1. Enhanced Transparency
Regulator is committed to enhance the systems transparency &bring disclosure standards closer to international norms.
It is tightening up definitions of non-performing loans and plan
a much stricter loan provision requirementseffective from July 05
2. Improvement in Asset QualityNon-performing loans have been reduced from 15% in 2001 to 8%
as at June 2004.
It is expected that the banking sectors impaired asset ratio is likely
to drop within a range of 5% to 7% .
3. Regulatory-driven Takeovers & Consolidations
The first regulatory-driven takeover of a distressed bank through
Government auction system took place in 2004.
The regulator wants to use this strategy for other insolvent banks
in future.
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Negative Factors Identified
1. Severe CompetitionTaiwans banking system is high fragmented, while its product menu
are homogeneous.
There is intense competition for several key business products.
2. Overdependence on Interest IncomeThe banks rely too much on interest income, and non-interest revenue
is a small proportion of total revenue.
3. Government Privatization Initiative
More privatization of some govt-linked banks will not benefit fromthe Government supportwhich previously improved the ratings.
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Negative Factors Identified
4. Inadequate Loan Loss Provisions
Average provision coverage ration increased to 23% (end o f 2003) ascompared to 14% in 2001. (est imated loss accoun t for 50%)
In spite of the banks developing their own provisioning practices, the
overall provisioning exercise is still considered inadequate.
5. Underdeveloped Risk Management Structure
Only a few banks have developed rather sophisticated risk
management structure.
The sectors overall risk management capacity is still in its infancystage.
Some banks remain over-reliant on the regulatory guidelines to
manage their risks profile.
Source: S&P Outlook 2005
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I wish you all,
good luckin your studies.
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8/11/2019 Banks Credit Rating
62/63
Banks Credit Rating
-
8/11/2019 Banks Credit Rating
63/63