- General Information About Rating
- Corporate Credit Rating Methodology
- Bank and Financial Institutions Credit Rating Methodology
- Corporate Governance Rating Methodology
- Structured Finance
- The Methodology of Country Rating
- Project Finance Rating Methodology
- Rating Methodology of Local Authorities and Their Issuances
- Multilateral Development Banks, Financial Institutions, Other Supranational Institutions Rating Methodology
- Sovereign Rating Methodology
- Public Enterprises Rating Methodology
- General Principles for Issue Rating
- JCR-ER Rating Update Policies
- Case of Default and Probability of Default Definitions
1. OVERALL APPROACH
Bank concept in terms of JCR ER; includes banks and their holdings, investment banks, private/public banks and participation banks that are within the scope of BASEL regulations and Banking Legislation.
The bank rating systems used by JCR ER are quite versatile, as long as they don't weaken or render rating results and procedures ineffective. The important aspect of rating methodologies is to try to understand the fields of activity of banks, the risks associated with these fields, the expectations and objectives of bank management and partners, possible changes and all developments in the general socio-economic environment, and to arrive at an internationally valid point of view at the macro level and the current position of the bank and to objectively assess unique, sectoral, regional, and national situations, without prejudices. During the examinations, detailed data requests that are not useful for analysis or are unlikely to be applicable will be avoided. However, in order for the data provided by banks to be consistent and to reach a sufficient level of explanatory power, standardization is applied in our data requests, apart from a few minor changes depending on the situation.
The review is based on consolidated records, tables, and reports in the rating process. However, depending on the purpose and type of the rating, it may be necessary to examine the individual records of the holding companies of the bank group or other organizations that have a commitment in terms of collateral/guarantee even if they do not have a hierarchical partnership/management link with the holding. Our strategy is based on the rating and business model, as well as the structure and support of the organization, as well as the predicted benefits/deficiencies from the model. Among the elements to be examined are industry trends, operating performance and revenue structure, quality of management, risk management, capital requirements and control, and capital changeability.
Banks are comparable to other economic institutions in many ways, but there are some significant differences. Banks' responsibilities and functions in money supply and demand, as well as determining the value of money, have important implications for other businesses. Banks' economic distress or bankruptcy has a very rapid spread and serious consequences, including the real sector. An issue in national and international payment systems that develops into a systemic danger will bring the economy into a state of crisis. For this reason, national banking authorities want to maintain public trust in their financial institutions. As a result, the availability of lenders of last resort is a critical feature to examine when rating banks. A critical part of analytical reviews is who will support a bank and under which conditions. Monitoring changes in national governments' and independent boards' attitudes on bailouts is necessary and valuable.
JCR ER - Support Rating
Our opinions about the possibility and basis of supporting the banks are shared to the public in the form of Support Notes. JCR ER's assessments will cover the capacity and propensity of local authorities to support the industry as a whole. Therefore, support rating includes “country” ratings as well.
On the other hand, Support Ratings are not related to the good or bad distinction of the rated bank. It is about the issue of whether that bank can receive support in a time of difficulty.
JCR ER - Stand-Alone Rating
Stand-Alone ratings are used to examine banks' risk exposure, risk taking inclinations, and risk management, as well as to form a judgment on their ability to continue their operations, according to JCR ER. The analysts' evaluations and projections of these evaluations for the future, as described in the analytical techniques section, are considered when deciding on the Stand-Alone Ratings. Generally, a group comparison is made on a local basis. Even though the issues considered in terms of comparison are the same worldwide, it is quite natural that it varies according to the type of banks. Although the theoretical foundations of the ratios we utilize are well-established in the literature, their applications may vary between banks and countries. Our comparisons get complicated by international practice, different banking and reporting practices, and conventions. However, it is considered in the rating processes that the standards established by developed country banks and particularly the BIS, are used as a universal reference and that the activities are tested against these reference values.
JCR ER Long and Short-Term Credit Ratings: On local currency and foreign currency
Apart from the Support and Stand-Alone ratings, we also rate the debt securities issued by the banks we evaluate. The purpose of these ratings is not to indicate how good or bad a bank is, but to measure whether the bank will fulfill its intermediary function in a timely manner, and the probability that the bank will be able to repay the money it will receive in return for the debt securities it can issue in a timely manner. Accordingly, one of the “investment grade", "speculative" or "speculative grade" ratings is given.
While a bank's Short-term and Long-term credit ratings prioritize the overall creditworthiness of that bank, ratings for special issues include the relative priority of the security owner, the terms of that issue, and the collateral.
Short-term and long-term international ratings are available in both foreign and local currencies. Although it is assumed in the rating literature that foreign currency ratings are generally restricted to the “country ceiling”, in some cases, the long-term ratings of some banks may be higher than the long-term country ratings in terms of JCR ER. This approach has also been adopted by many of the well-known international rating institutions. The rule of placing local currency ratings on the "country ceiling" by definition also remains valid for JCR ER. Because a country's local currency rating will usually be the highest credit rating in that country. However, banks with some special strengths may exceed that rating.
Both foreign currency and local currency ratings of JCR ER have international comparability. Our local currency ratings are a measure of the likelihood of receiving payment in that country's currency within the rated country's boundaries, and unlike foreign currency ratings, they do not account for exchange rate regulations that may affect convertibility. 'National' ratings are awarded to banks in emerging markets to meet the need for such ratings. National ratings are issued in relation to the best credit risk inside a country's borders; while the best credit risk in a country does not always belong to that country, a long-term AAA notch indicates that it does. This rating list excludes that country's rating, which serves as the country ceiling to international ratings.
Positive, Stable, Negative, and Developing outlooks are also added to these ratings to give a notion of how they might change in a year. A "Positive" or "Negative" outlook does not always imply that a grade will be changed. By the same logic, a "Stable" outlook rating can also change without changing its appearance to "Positive" or "Negative" if circumstances warrant. They can be included in the scope of Rating Monitoring in order to alert investors to changes in all ratings other than support ratings and their potential direction. The expectation's direction; It can be stated as “Positive” if it is a possible rating increase, “Negative” if it indicates a possible decrease in ratings, or as “Developing” if there is a possibility of increasing, decreasing or stable constant. Rating Watching is resolved in a short time.
2. ANALYTICAL PROCESSES
JCR ER evaluates banks based on a variety of qualitative and quantitative criteria.
The most important of these are:
- Macroeconomic Risk, Industry Risk and operating environment
- Corporate Structure, Management and Strategy
- Accounting and Financial Reports
- Credit Risk and Credit Management
- Market Risk and Market Management
- Operating, Operational Risks and losses
- Legal Risks
- Funding and Liquidity
- Securitization and Credit Derivatives
- Capital Requirements and Partnership Structure
2.1. Macroeconomic Risk, Industry Risk and Operating Environment
Understanding the operating environment is key in the rating processes. Factors that significantly affect the creditworthiness of banks: The size and health of the economy in which banks operate, growth expectations; structural problems that the economy may face; political environment of the country; structure of banking sector, relative size of banks, market concentration, merger tendencies; the bank's position in the industry, its market shares in key business areas, its ability to influence prices; competition from other banks or non-bank financial institutions; regulatory environment, role of regulators, quality of bank oversight, reporting requirements, regulations for specific types of financial institutions and financial products, history of bank failures in the country, policymakers' attitudes towards supporting banks and other financial institutions in need, existing savings deposits insurance-guarantee regulations, the quality of accounting and reporting standards within the country, and the degree of ease of entry and exit into the sector.
The primary macroeconomic indicators of the countries in which the banks operate, general structural changes, crises, if any, which are experienced or likely to occur, economic and political stability, national banking sector, competitiveness, local banking regulations, and entry conditions into the sector are all evaluated. At the same time, consultations are held with local banking regulatory-supervision agencies to obtain information about their roles and duties, and the state's control or freedom over the banking system. The public accessibility of bank records, as well as the inspection of accounting standards, are both under doubt. The evaluations encompass the concepts of compliance and conformity with international standards, as well as capital requirements, as defined by the Basel Committee and subsequent changes.
In terms of economic risk, JCR ER assesses the economy's risk level in connection to the country's credit quality, as well as how that risk impact financial institutions. This includes the economy's strength, diversity, and variability, as well as the corporate and personal sectors' financial health, and the government's ability to control the economy throughout boom and bust periods.
Industry risk category includes several elements. JCR ER measures the dynamics of the financial services industry and the degree to which these dynamics pose more or less risk from the lender's or counterparty's perspective. The regulatory system and all types of bank assistance mechanisms are significant factors to consider while making this assessment.
It analyzes the distribution of business areas and the distribution of a bank's activities in terms of geographical, local, international and industrial sectors in terms of systems. At the same time, it considers the variety of services and goods available to customers, as well as the company's potential to develop new items. It also analyzes the bank's overall strength and depth in the system, as well as its capacity to develop new business lines while maintaining existing ones.
2.2. Corporate Structure - Management and Strategy
The structure of corporate values and strategic goals within the bank, the degree of determination of powers, responsibilities, and procedures, the morale of the board of directors and management levels, the functionality of internal audit measures, and transparency are all reviewed. Forasmuch as banks are becoming members of complex groups that play increasingly important roles in the markets. If a bank is part of a larger company, JCR ER will examine the parent's actions to see if they increase or decrease the subsidiary bank's financial health. In many circumstances, being a part of a larger organization has enormous benefits, both locally and internationally. JCR ER examines if the Group has the ability and inclination to support the bank in times of need, as well as whether it has the legal authority to do so. If group members are weaker than the bank, it should be determined to what extent bank profits can be diverted to group members or to what extent loans can be made to group members or related parties without an economic basis, and to what extent this will adversely affect the bank's financial condition.
In the evaluation of the bank management, the organizational structure of the bank, the interdependence and cohesion of the management team, independence from the major shareholders and the continuation of the operational efficiency and increasing the market share of the bank are evaluated by ensuring the distribution of work. It analyzes the growth plans of internal and external elements to assess the quality and reliability of the management strategy. Whether the plans meet past expectations or adherence to strategies is highlighted. Financial performance outcomes over time will provide a more objective baseline for JCR ER, despite the fact that managerial decisions are subjective.
In determining any rating, historical data only gives estimates of expected profitability and capital levels as an indicator of the future, but face-to-face meetings with senior management are much more valuable in reaching these estimates. These discussions include economic conditions, the current and expected regulatory and competitive environment, and future changes and acquisitions. The assessment also discusses how the requisite levels of capital and liquidity will be financed, as well as the extent to which profitability levels may be maintained. The approaches of the management in these two areas are also taken into consideration.
2.3. Accounting and Financial Reports
The rating activities of JCR ER are focused on determining whether the information and indicators in a bank's financial statements accurately reflect the bank's financial performance and balance sheet integrity. After an assessment of the banks' accounting systems and practices has been made, their financial data will be compared to that of other banks. The compliance of the effectiveness of the applied accounting methods with the International Accounting Standards (IAS) is searched.
JCR ER closely examines the accounting rules applied and the underlying assumptions used by the bank. The purpose of this analysis is not to rate banks’ accounting. Rather, it aims to identify the impact of ratings on quantitative factors like asset quality, profitability, liquidity, and capital, as well as qualitative variables like fiscal policy, internal information systems, and management.
JCR ER's accounting analysis includes investigating the impact of national accounting postulates and practices, which vary widely from country to country and even from bank to bank. Despite recent moves toward convergence of accounting standards, JCR ER intends to continue to examine individual banks' accounting and make necessary adjustments to their financial statements and ratios for analytical purposes.
2.4. Credit Risk and Credit Management
A bank's risk approach and risk management systems encompass the definition, measurement, implementation, monitoring, and evaluation of the notion of risk, which is molded by varied combinations of the triad of uncertainty, hazard, and opportunity. Credit risk refers to the chance of the bank losing money if customers who owe the bank money do not pay on time and in full. JCR ER examines the independence and effectiveness of risk management, whether all risks are reviewed under one roof, the procedures and limits imposed, who defines these limits, and how strictly these procedures and restrictions are followed. The risk management understanding and participation of the senior level and the status of subordinate-superior reporting are evaluated. The underlying causes are evaluated if it has securitized or is considering securitizing some of its assets as part of its risk management. The most common reasons for securitization may be better management of risk concentration, divestment of non-performing loans or more capital-intensive assets, reducing assets with low interest margins, improving liquidity, and maintaining minimum capital requirements.
Banks have recently focused on the Basel Capital Agreements' criteria, and have built or are in the midst of building internal rating systems to quantify credit risk and lower the regulatory capital requirement. As a result, many risk reduction techniques available to banks will have a significant effect on the credit risk profile. Banks are also encouraged to set up more sophisticated systems for measuring operational risks due to the revised Basel required capital coverage ratio. While no modifications to the agreement for measuring market risks are expected, banks are continuing to develop and fine-tune their market risk measurement instruments in order to better monitor market risks.
The concept of credit risk encompasses the entirety of an institution's activities, including loans, bill for debt, equity investments, and in and on the balance sheet counterparty risks. The areas which need to be addressed first are alteration and risk. JCR ER breaks down a bank's overall credit risk by area, collateral, maturity, industry sector, and borrower type (consumer, commercial, institutional, bank, or government). Rather than following a strict framework, JCR ER prefers to work with the bank's own internal information and reports to understand how the bank manages its credit risk and loan portfolio. Subjective aspects such as the bank's experience and records of various debt raised and investment activities, as well as its competitive strengths and market share, all play a role in the analysis. To compare institutions in different countries, JCR ER makes extensive use of risk-adjusted asset quality indicators.
The loan approval process, including lending criteria and approval limitations, is thoroughly examined. Portfolio monitoring procedures and audit function are also discussed.
The general structure of the bank's statement is analyzed, as well as any credit risks arising from statement and off the balance sheet assets, as well as the relative ratios of various asset types on the statement. Generally, it is necessary to examine the loans in more detail because the credit records are the most important items among the assets of a bank or the most risk concentrated items. The examinations are carried out in this context based on the type, size, maturity, currency, economic sector, and geographical distribution of the loans. We look at risk concentrations, credit exposures of specific retail customers and big loans, as well as non-performing loans, restructured loans, or credit follow-up in great detail. It is important to define “non-performing” loans well, as definitions can vary from country to country and even from bank to bank. The assigned loan provisions are taken into consideration when analyzing the risks associated with non-performing loans. We also look at the bank's overall approach for provisions, as well as past lost loans and loans that it has written off or recovered. When assessing asset quality, absolute or relative criteria and, if possible, ratio comparisons with domestic and international equivalents in similar categories are used. When it comes to the quality of other assets, we look at both fixed income and share portfolios, as well as the overall quality of the securities, their maturity, any over-concentration or exceptionally big investments, and their prices. Similarly, in a bank's interbank deposit and loan records, we also consider account size, maturity, concentration and creditworthiness of counterparties.
Banks are increasingly undertaking off balance sheet obligations, necessitating a rigorous assessment of the risks that may be linked with them. Non-cash loans (letters of credit, letters of guarantee), commitments, guarantees, derivative financial instruments, credit letters and credit default swaps, liabilities to buy-sell, and securitized assets are all examples of these. The use of derivative instruments by banks is quite common today. As part of the rating process, it also looks at the gross implied and real value of the derivatives portfolio; as well as the types of derivative instruments used by the bank and their intended use. The procedures used by banks to evaluate credit deficit, valuation practices, and the quality of the parties are all examined when it comes to credit risk. Aside from credit risk, derivative products may also pose market, legal, and operational risks. Credit derivatives are also employed as a risk management tool, particularly by commercial banks to distribute and decrease credit risk, and their market has grown significantly in recent years. Although credit derivatives improve banks' efficiency and risk distribution by distributing credit risk throughout the market, their lack of transparency and short-term nature necessitates examining banks' openness to credit derivatives and determining whether credit risk is excessively concentrated. At the same time, it looks at why credit derivatives are used and how credit derivative records are handled.
When looking at a loan portfolio, it's vital to consider the risk distribution. JCR ER determines whether the bank provides general loans or specializes in any type of loan. Additional information regarding the sector, as well as the rationale for the bank's concentration in that sector, is asked in cases where a considerable share of the assets is utilized in that segment. JCR ER will assess the bank's main credit exposures to determine the importance of debtors. Country risks are analyzed in the context of foreign assets based on their amounts, categories, and maturities.
History data of doubtful assets, loan losses and provisions are extremely important and the last five years of data on each of them are examined. JCR ER assesses the genuine degree of non-performing loans by looking beyond regulatory categories to estimate the amount of balance sheet and off-balance sheet assets to which the bank is exposed to elevated credit risk.
JCR ER, in the process of analyzing a bank's provisions for loan losses; It focuses on the time period in which an outstanding loan is deemed to be in default, how long a provision is made for the defaulted loans, and how long the loan and its provisions must continue to exist, the extent to which collateral and provisions cover an upcoming loss, disposals, focused on whether it is done conservatively to ensure that most of it is recovered in a short time, or whether they are recorded only if the eventual loss is certain to occur. These decisions will be influenced by tax and regulatory assessments and the answers to these questions will show which data are the most essential indicators of real credit losses.
Credit Risk Reduction
Credit risk reduction is the process of lowering a loan's risk exposure by obtaining assurances from the counterparty or third parties acting on the counterparty's behalf through various financial assets, guarantees, sureties, or credit derivatives. In short, credit risk mitigation is the collateralization of an exposed credit transaction.
In order for the assurances issued to be subject to credit risk reduction, that is, to become legal, within the scope of the legal capital requirement, all legal documents of the assurance transactions and this transaction must be as follows, according to the Basel II accord:
- It must be binding on all parties,
- It must have the power of sanction according to the provisions of the legislation,
- It is essential that sufficient legal examination has been made by the banks that it is binding on all parties and has the power of sanction,
- It is essential for banks to have a solid legal infrastructure that can reach this legal conclusion,
- It is essential that additional examinations have been made to ensure the continuity of the existing sanctioning power of the banks,
- In the legal system, in the event that the other party or the collateral custodian defaults, becomes insolvent, or goes bankrupt, the bank must have the right to turn the collateral into cash on time or to transfer it to its possession,
- In order to protect and maintain the bank's interests arising from the collateral, it is necessary to register the collateral in a registry or to take all legal actions to exercise the right of netting or set-off regarding the transfer of the collateral,
- There must be a positive correlation between the credit quality of the counterparty and the collateral value,
- It is essential that the other party has legal procedures including how to declare that it is in default, how to quickly turn the collateral into cash or how to put it into possession,
- In cases where the collateral is kept in the custodians, it is essential that measures are taken to keep the collateral separate from its own assets belonging to the custodians.
Otherwise, the assurances provided cannot be legalized for risk reduction under Basel II.
Financial Collaterals, on balance sheet netting, Guarantees and Bails, and Credit Derivatives are the four kinds of collaterals that can be employed among the risk mitigation factors in Basel II. In this context, the collaterals received by banks for risk reduction will be examined by JCR ER. For credit risk and collateral;
- Continuous volatility adjustment will be made,
- If there is a currency mismatch between the credit risk and the collateral, the money mismatch will be removed by accounting for any exchange rate variations,
- The maturity mismatch between the loan and the collateral will be eliminated.
If the adjusted loan amount is more than the adjusted collateral amount in the comparison of the adjusted amounts based on volatility and currency mismatch, the difference will be increased by the counter party's risk weight and the necessary computation will be made. The important thing while making the calculations is the calculation of the discount (deduction) rates. Here, two methods have been proposed by Basel. The first is the official standard discounts proposed by the Committee. The second is the discounts based on the internal estimates of the banks. All these processes will also be reviewed by JCR ER.
- Indirected Loans - Requirements of Companies Partners and Businesses
- Sme (according to Turnover/Amount of Loan criteria) Credits
- Directed Loans - Requirements of Companies Partners and Businesses
- Project Finance
- Finance for Fixed Assets
- Commodity Finance
- Income Generating Real Estate Financing
- High Volatility Commercial Real Estate Financing
- Acquired Corporate Receivable
Treasury and Central Bank Credits
- Revolving Credits
- Mortgage Credits
- Qualifying Revolving Retail Credits
- Acquired Retail Receivable
For banks classified in these five groups, there are three basic components for each asset, namely, risk components, risk weight functions and minimum requirements. Risk components are; The probability of default, percentage of loss in case of default, risk amount in case of default, and effective maturity are determined as four in total. In addition to the fact that banks estimate these risk components through internal systems, there may be instances where supervisors may foresee some of these components and banks can use them.
Risk-weighted functions are functions that enable the risk components to be converted first into risk-weighted assets and then into capital requirements. The Minimum Requirements are the requirements that banks must meet in order to use the internal rating approach on all or some of the asset types listed above. Internal rating approaches for most of the assets categorized above are divided into two subheadings as follows;
- Baseline internal rating approaches,
- Advanced internal rating approaches
In the baseline approach, banks estimate the Probability of Default, while supervisors provide the other risk components. It is allowed to estimate the effective maturities by the banks in some cases. Banks, on the other hand, can evaluate all risk components using advanced internal rating approaches if certain circumstances are met. However, the risk weight functions that will be utilized in both techniques must be calculated using the Basel formulas. All these processes will be reviewed by JCR ER.
3. MARKET RISK AND MANAGEMENT
The concept of market risk and management, as defined by Basel practices and local authorities, expresses the probability of loss that banks may be exposed to as a result of general market risk, currency risk, specific risk, commodity risk, and settlement risk, as well as the management capabilities of the bank's management within these probabilities.
Specific risk is the probability of loss arising from institutions that issue or guarantee financial instruments that constitute positions including financial instruments in bank trading accounts and that are obliged to pay, during the phase of unusual market movements, exchange risk, on the other hand, expresses the possibility of loss that the bank will be exposed to due to price changes of the securities, foreign currency or commodity subject to the transaction, since the settlement transaction does not take place on the maturity date.
The credit risk amount is made up of the sum of the balance sheet assets and credit risk amounts connected to non-cash loans, commitments, and derivative financial instruments.
Our market risk analysis, including balance sheet and off-balance sheet records, covers all structural and commerce risks in a bank's business. The bank's asset/liability management strategy, the importance of positioning, and the hedging and accounting parts of this strategy are all considered when it comes to structural risks. Their situation is assessed in light of the risk limits set for hazards related to and depending on the statement’s hidden interest rates, currency rates, and stock risks. On the trading side, we examine the bank's overall trading strategy and break it down by product and market, concentrating on revenue volatility and the bottom line of profitability, utilizing VAR, stress scenarios, and other tools. We also consider market risk against shareholders’ equity in the bank records, considering over-concentration and how these shareholders are valued.
JCR ER assesses the level of market risk across the entire financial institution's activities, including asset and debt structure, trading activity, and collateral taking activities, whether balance sheet or off-balance sheet. In these areas, management's strategy and the overall risk scenario are critical.
The asset and liability mix of a bank is determined by a combination of external and internal factors that affect interest, maturity, and currency matching. At this stage, the bank's overall asset and debt management philosophy, as well as risk monitoring methods, are discussed. JCR ER keeps track of how management reacts to changing conditions. When there is a negative movement in the markets, a bank that takes an interest rate or currency position and retains its risk regardless of following events is seen more unfavorably than a bank that quickly liquidates or ends open positions.
In terms of commerce risk management, JCR ER's process includes assessing its policies, practices, and organizational structure in all areas of risk management, as well as the consequences, in collaboration with management. During the evaluation of management policies and procedures, JCR ER will observe how well and consistently the majority of governments are aware of what appropriate policies should be and are prepared to adopt those policies.
4. OPERATIONAL RISK AND MANAGEMENT
It is considered as the sum of all risks other than long-term credit risk and market risk and is the risk of loss arising from inadequate or unsuccessful internal processes, employees, customers, third parties and systems. Our operational risk review includes the systems/tools used to measure these risks, controls to limit operational risk, and the amount of capital management considers necessary to meet those risks. We also consider the information technology system's security (including whether a backup mechanism is in place) and the impact of the internal audit function (Internal control systems, Audit Systems, Risk Management Systems). We also investigate how investment and private banking banks compensate customers for errors in trading and transmission. It's critical to look into whether there's a guarantee in place, such as an insurance-compensation fund, to protect against errors, negligence, abuse, fraud, and natural disasters caused by employees, customers, internal procedures, systems, external events, and legislative incompatibility of the banks. In this context, it is important to consider internal control and business processes within the scope of Basel II. Information belonging to all persons, groups and committees within the risk management organization is evaluated. All sub-details categorized under the Basel Committee's activity lines (Corporate Banking, Commerce, Retail Banking, Commercial Banking, Clearing and Payments, Agency Services, Asset/Fund Management) are inspected and evaluated for operational risks and losses. The capital calculations to be allocated for possible risks that may arise in this area are analyzed.
In fact, this subject is also examined within the scope of Operational risk, but is also handled separately here because of the importance JCR ER gives to the subject. Employment practices, non-compliance with labor legislation and workplace safety, and documentation all contribute to legal risks; documents must be legally enforceable and in good order. Such a risk can only be minimized by a detailed examination of clients and by continuous cooperation with legal counseling. In these evaluations, the due diligence methodologies and documentation principles of the banks are evaluated.
5. FUNDING AND LIQUIDITY
Liquidity analysis focuses on both the content and sources of bank funds, as well as the characteristics of their assets. Despite the importance of a single aggregated general liquidity ratio for JCR ER, distinct liquidity ratios derived from each currency type and maturity bracket are underlined. As a measure of the bank's management dominance in this area, standard deviation ratios are calculated by comparing expected and unexpected liquidity needs.
Banks that are financed by deposits and can offer a variety of products through their branch/correspondent networks differ from wholesale banks that access money capital markets within a broad and diverse customer group. Both types of banks are assessed based on the stability of their funding sources and the maturity structure of their debts, as well as their capacity to meet their liabilities on time. Another crucial part of the bank's ability to satisfy its liabilities is its ability to convert assets into cash, either by arriving at maturity or by selling them on liquid markets.
The structure and distribution of a bank's financing base, as well as consideration of major changes in funding sources and a bank's liquidity, including significant concentrations of deposits or loans, are all important areas to look into.
The principal risk associated with funding for a bank is its inability to ever renew or replace overdue debts at reasonable cost, due to unexpected delays in collections and exposure to unexpected draws. This risk can be mitigated by a well-distributed and stable financial base, as well as a proper distribution of debt/resource suppliers within each source. As a result, it's critical to look at a bank's savings deposit base and other borrowing sources in terms of securitization possibilities, size, maturity, currency, and geographic origin. When it comes to liquidity, we look at the bank's secondary market, such as securities and maturing loans, as well as central money markets, capital markets, other banks, the central bank, and rediscount facilities, in order to evaluate its internal/external liquidity capabilities. Stocks, bonds, and other similar assets are kept in the portfolio in case of a possible cash shortage, in order to convert them to cash if necessary. Banks can also use part of their assets as collateral and borrow for a short period of time. However, it's crucial to know how liquid these assets are and how liquid they can be in a crisis. Banks should have clear backup plans, which should be defined by region, and should indicate who would be accountable for liquidity in the case of a crisis, how to respond, and what transactions to make with the central bank, lender of last resort or liquidity sources at what moment. It should be highlighted, however, that the Central Banks' liquidity will not be unconditional, free, unrestricted, or unsecured.
Government-provided liquidity support mechanisms, such as access to central bank financing or deposit insurance programs, that help to stabilize a bank's financing would be seen favorably.
6. SECURITIZATION AND CREDIT DERIVATIVES
The rapid growth in both volume and product of securitization markets in recent years, which was carried out with the goal of facilitating cash flows and reducing the default risk, pointed to important issues in leverage, funding, credit risk, and performance analysis in the rating of banks. If the sole purpose of transferring the risk of default is intended, besides securitization, credit derivatives (Total Return Swaps, Credit Options, Credit Default Swaps, Credit Linked Notes, Collateralized Dept Obligations) are also within our scope of review. Securitization has helped banks with additional liquidity and cost-effective funding, assisting in credit risk management, regulatory capital release, and profitability performance metrics. However, while securitization generally benefits banks, the risks it carries must also be considered. When calculating capital ratios, securitized assets should be included in the balance sheet and calculated accordingly. While securitizations offer various benefits to banks, the most important benefit is that they increase banks’ liquidity while lowering funding costs. While securitization allows a bank to better manage credit risk, it is not a complete and total risk transfer. Thus, the analysis of a bank's securitized assets is essentially a credit risk analysis. The Basel Accord treats securitization in capital adequacy calculations essentially as a loan transaction.
7. CAPITAL REQUIREMENTS AND PARTNERSHIP STRUCTURE
As JCR ER, the relevance of a capital level that will allow the bank to continue operating in sufficient capacity and liquidity after unanticipated losses are covered is considered. The partners' financial strength, the fact that the paid-in capital corresponds to cash and the partners' true ownership, and the presence of subordinated resources are all critical.
After the necessary deductions are made from the Capital account, which consists of core capital, supplementary capital, and tier 3 capital, we look at the capital base calculations to be taken as a basis for all kinds of risks (market, credit, operational). In the weighting of assets, JCR ER's country ratings will be emphasized rather than local regulations in the coefficients of debt securities belonging to the country's treasury. Because countries interpret the Bank for International Settlements’ (BIS) capital standards differently and impose different capital requirements, any analysis of a bank's capital requirements must start with government legislation. Minimum capital requirements are an important rating factor that is frequently examined, as these regulations might limit the system's flexibility and development. For this reason, the starting point for JCR ER will be to meet with the relevant regulators. Generally, regulators purpose to protect bank depositors, while JCR ER is concerned with timely repayments of principal and interest for lenders and counterparties.
While it is necessary for a bank's local regulators to meet capital requirements, JCR ER takes a broader view of the bank's capital structure and does not include certain instruments that may absorb losses in any restructuring or liquidation scenario in its capital adequacy accounting.
After compiling the essential data, JCR ER evaluates the bank's capital structure in both local and international contexts. More traditional balance sheet measures are used alongside risk-adjusted capital adequacy analyses. With regard to international comparisons, adjustments are made in light of different accounting and financial practices so that the ratios of institutions are as comparable as possible. But, the capital adequacy decision will be heavily influenced by relative profitability, risk profile, and asset quality.
Partnership Structure and Support
A bank's shareholding structure and the existence of potential support to the bank play an important role in determining support ratings and short-term and long-term ratings. When examining a bank's shareholding structure, we also consider the ability and willingness of shareholders or the government to support the bank in case of need. In banks owned by individuals or families, we also examine the impact or potential impact of partners on banks' decisions. We also try to consider the existence of other interests that may affect the bank's management. For example, industrial interests of bank owners that may need bank support.
8. EARNINGS AND PERFORMANCE
It's a crucial subject to analyze because banks' earnings will ultimately affect their ability to pay their debts, as required by the well-known cash flow rule. JCR ER considers and examines bank revenue patterns, stability, quality, and future profitability. When assessing the operational environment, it is also important to analyze a bank's key performance metrics in comparison to its competitors. It also looks at a bank's revenue from several lines of business when possible. In this regard, the following tendencies are noted:
- Income and expenses generated by the balance sheet and income and expenses arising from off balance sheet transactions are analyzed separately. In the balance sheet profit/loss calculation, special importance is attached to the net free ratios being in favor of the resources.
- The trends in lending and funding costs are observed, considering the net interest income generated by interest-sensitive assets and resources, including the evolution of business segments in interest spreads.
- Gross non-interest gross incomes are looked at to include the more fixed incomes that the balance sheet generates in the form of commissions, as well as the more variable trading income.
- The distribution of non-interest expenses, staff, and other expenses, as well as the number of branches (in individual-corporate-treasury-corresponding banking) and workers, are compared to total income and, if possible, to the assets that create profits.
- Provisions and their levels are evaluated together with the capacity of bank revenues to handle the provision.
- Extraordinary income and expenses items are handled together with the developments in tax bills.
Although cross-border comparisons are not always meaningful when considering the differences in accounting standards between countries, when necessary, a bank's financial indicators can be compared from bank to bank or country to country by making the necessary adjustments to the recorded income statement figures of a bank. Revenue projections based on the bank's budgets and forecasts, as well as medium-term goals, are thoroughly evaluated. External factors that may have an impact on future incomes as well as management's ability to deliver a solid budget and projections are also considered. The main factors considered in measuring profitability are income and profit levels, their trend and stability. In other words, it can be called main long-term earnings power. JCR ER calculates the rate of earnings according to various definitions. These are business, pre-tax, ratio of net income to average total assets, earnings assets and risk-adjusted assets, etc. In addition, net interest and net income margins are also examined along with efficiency measures. The reasons for past performance are examined and debated, and it is assessed whether past outcomes are a reliable predictor of future performance. After making the necessary modifications, these rates are compared to those banks of similar size and type in other countries.
Loan provisions and losses are handled differently in different countries. As a result, the loan loss provision is sometimes viewed as a discretionary item rather than an actual operating expense. Some provisions are frequently handled differently than others. Special taxation can also sometimes have a significant impact on “final” net income. Determining the trends in margins is more important for JCR ER, rather than the results being in favor of profit or loss.