Model Documentation

Internal Credit Rating Model

for NBFCs

Proposed by:

Care Analytics and Advisory Private Limited

(Formerly known as Care Risk Solutions Private Limited)
(Wholly owned subsidiary of CARE Ratings Limited)
Office No. 602, 6th Floor, Rustomjee Aspiree, Off Eastern Express Highway,
Sion East, Mumbai – 400 022, India
Tel.: +91 (22) 6174 8900

The document is prepared for the sole use of “DCB Bank” and confidential in nature. No part of the document should be shared
with anyone outside the organisation without the explicit consent of CAAPL.
Table of Contents

1. EXECUTIVE SUMMARY.................................................................................................................. 3
2. DOCUMENT STRUCTURE .............................................................................................................. 4
3. MODEL OVERVIEW ........................................................................................................................ 5
3.1 OVERVIEW ...................................................................................................................................... 5
3.2 STRUCTURE OF THE MODEL ....................................................................................................... 5
4. COMPANY SCORE ......................................................................................................................... 8
4.1 FINANCIAL RISK ............................................................................................................................ 9
4.2 BUSINESS RISK ........................................................................................................................... 18
4.3 MANAGEMENT RISK .................................................................................................................... 22
4.4 INDUSTRY RISK ........................................................................................................................... 27
4.5 TRANSACTIONAL PARAMETERS............................................................................................... 27
5. PARENTAGE ................................................................................................................................. 31
6. RATING.......................................................................................................................................... 34

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1. Executive Summary
DCB Bank has selected CARE Analytics & Advisory Pvt Ltd. (CAAPL) for the development of Credit Rating Model
tailored to the unique characteristics of the Non-Banking Financial Corporations (NBFC) borrowers of the Bank.

This document describes the model construction philosophy, the approach and methodology adopted in the
construction of the model, the model structure, and the rating definitions. The document will assist the Bank in
understanding the framework of the credit scoring model. The model is intended to be used for rating proposals
where the prospective borrower is an NBFC.

CAAPL adopted a phased and iterative approach in the design and construction of the model. The design and
construction of the NBFC model involved identification of essential parameters, short-listing of the scoring
parameters, and defining benchmarks for the same.

The Final Borrower Risk Rating is based on an 10-Point Scale AAA to D which was calibrated with a view to ensure
that the model ratings were broadly in convergence with external ratings.

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2. Document Structure
This Document comprises of 6 chapters. Besides the first chapter which is an Executive Summary and the current
one that gives an overview of the document structure, there are 4 more chapters structured along the following
lines:

Chapter 3 provides an introduction and an overview, covering the Model Structure, and a high-level step-by-step
method to arrive at the final rating.

Chapter 4 explains in detail the first two steps of the rating process: Modular Risk Scores and Company Score. It
details out all the parameters under each risk module and their respective weightages. This chapter also explains,
through an example, the approach to arrive at company score for different categories of NBFCs.

Chapter 5 explains the method to factor-in the parentage component in the company score computed in the
previous chapter.

Chapter 6 comprises of the method to convert the final score to a final rating and illustrates the same through a
reference table.

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3. Model Overview

3.1 Overview
DCB appointed CAAPL to provide the bank with credit scoring tools that would enable it to address its credit grading
/ scoring requirements for loan proposals for NBFC borrowers. This document provides a detailed description about
the model development exercise undertaken by CAAPL pertaining to NBFC Model including the parameters
considered, the scoring criteria, as well as the rationale behind the same.

3.2 Structure of the Model

The NBFC credit risk scoring model constructed by CAAPL entails the utilization of a diverse and comprehensive
list of indicators for arriving at a final score which serves as a predictor of creditworthiness of the counterparty.

The overview of the Model Structure is as shown below:

Financial Business Management Industry Transactional

Risk Risk Risk Risk Parameters

Company Score

Parentage

Rating

The above flow chart gives a high-level snapshot of the entire rating process. The steps involved in arriving at the
Final Credit Rating are further explained below:

Step 1: Modular Risk Scores

The model is built upon five basic risk modules. CAAPL has listed several risk parameters within these five risk
modules to assess the inherent credit risk of a borrower and these parameters are classified under five different
risk modules as listed below:

1) Financial Risk (FR),

2) Business Risk (BR),
3) Management Risk (MR),
4) Industry Risk (IR)
5) Transactional Parameters

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A modular risk score is a weighted average score based on a number of parameters listed under that particular
module. For example, let’s say Business Risk comprises of 5 parameters with their respective weights. A borrower
would be evaluated against each of these 5 parameters and then, the Modular Risk Score for Business Risk would
be arrived at by multiplying each of the parametric scores with their respective weights. The example is illustrated
in the following table:

Borrower Obtained Scores Weight of the Parametric Score

Business Risk
Against Each of the Parameters Parameters under X
Parameters
(On a scale of 1 to 10) Business Risk Parametric Weight

Parameter 1 10 50.00% 5.00

Parameter 2 6 10.00% 0.60
Parameter 3 8 5.00% 0.40
Parameter 4 2 30.00% 0.60
Parameter 5 0 5.00% 0.00
Modular Score under Business Risk 6.60

A similar exercise would be undertaken for each of the five risk modules.

Note: If any or multiple of the parameters is not applicable for a certain borrower, then the weight assigned to that
parameter will be distributed proportionately among the other applicable parameters. The same is applicable for
Modular Riks also.

➢ The output of this step is five different modular risk scores, which are further processed in the next step.

Step 2: Company Score

A company score is a weighted average score based on the modular scores obtained in the previous step.

Different weights are assigned to each of the five modules as per the category of borrower. DCB Bank has broadly
categorized its NBFC borrowers into three groups based on the number of years since the prospective borrower’s
business activity and relationship with the bank, namely,

a) Existing to Bank (ETB): The prospective borrower is an existing client of the bank. Hence, the bank has
access to historical financial and credit data of the client.
b) New to Bank (NTB): The prospective borrower has been operating as an NBFC but is not an existing
client of the bank. Hence, the bank has access to historical financial data but not to credit data of the
client.
c) Newly Incorporated Customers (NIC): The prospective borrower is a newly incorporated NBFC and
hence the bank does not have any historical data related to the financial performance or credit behaviour
of the client.

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➢ Accordingly, the company score of the borrower is determined as a function of the modular scores under
financial risk, business risk, management risk, industry risk and transactional parameters as per the above
categories.

Note: If any or multiple of the risk modules is not applicable for a certain borrower, then the weight assigned to that
module will be distributed proportionately among the applicable modules.

(Note: The modular parameters and weightages assigned have been detailed out in later sections of the
document.)

Step 3: Parentage

Parentage support is considered as the next step and a parentage adjusted score is computed.

After computing the stand-alone company score, the parentage of the company (if applicable) is factored in to
determine the final score. Parentage considers the parent’s own credit worthiness, level of ownership, strategic
importance of the company to the group and explicit commitment of support in the form of guarantees given.

Company score and parentage score are given weightages of 80.00% and 20.00% respectively in the final score.

Component of Final Score Weightage

Stand-alone Company Score 80.00%

Parentage Score 20.00%
Total 100.00%

(Note: A detailed method of factoring-in the parentage component has been explained in later sections of this
document.)

➢ The output of this step is a parentage adjusted company score which is the final score.

Step 4: Final Rating

The parentage adjusted score is then converted to a scale of 100 from a scale of 10, e.g., a score of 8.0 out of 10
is converted to 80 out of 100.

After that, the score is converted into a final rating on an 10-point scale using the reference table in section 6 of
this document.

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4. Company Score
A company score is a weighted average score based on parameters classified under five different risk modules.
The weighted average score is computed for an NBFC after considering its performance on different parameters
within five risk modules and the weights given to those modules.

• Score: Score is assigned on a scale of -10 to 10 for each parameter. Maximum score is 10. Negative scoring
is applicable in a few selective parameters.
• Weights: Weightage is assigned to various risk parameters separately for different risks based on the
sensitivity driver of the risk parameters. Further the weightage is different for Existing to Bank (ETB) Client,
New to Bank (NTB) Client and Newly Incorporated Customers (NIC). Weights are assigned as follows:

Risk Category ETB NTB NIC

Financial Risk 45.00% 50.00% 25.00%

Business Risk 25.00% 20.00% 25.00%
Management Risk 15.00% 15.00% 25.00%
Industry Risk 10.00% 15.00% 25.00%
Transactional Parameters 5.00% NA NA
Total Weightage 100.00% 100.00% 100.00%

Rationale on Weights:

• For an NBFC, Financial Risk is most critical, followed by Business Risk, Management Risk, Industry Risk
and Transactional Risk.
• Many NBFCs have defaulted in the past due to deterioration of financial risk parameters such as leverage,
liquidity, CAR, NPA levels, etc. After financial risk, Business profile affects the creditworthiness of NBFCs
the most and NBFCs have defaulted due to weak business profile such as limited diversification in products,
geography, inability to grow etc. After that, experience of the management and presence in specific
industries also limits/enhances the creditworthiness of the borrower. Lastly, how a borrower has conducted
its account with DCB has been captured by Transactional Risk which is one of the key risk factors for
arriving at final rating.
• The weightage is significantly higher for Financial Risk and marginally higher for Business Risk. Weightage
on financial risk is higher because the assessment of NBFCs is highly sensitive to these parameters. NBFCs
essentially act as financial intermediaries that raise capital (debt or equity) to provide loans (debt). So, their
business model is primarily based on parameters captured in financial risk like net interest margin and asset
quality. Also, these are highly regulated entities and the regulatory parameters like CAR and ALM (that are
part of financial risk) are very important.

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 • For Newly Incorporated, as certain information is not available, the objective is to ensure that the model
should conservatively reduce the score & rating until such information becomes available with time.
• For newly incorporated clients, the weightage for financial risk is lower than that of other clients as the
financial risk is assessed primarily based on projected financials with limited historical evidence.

Scoring Example:

An example explaining the scoring is as follows:

ETB NTB NIC

Risk Category Wtd. Wtd. Wtd.
Weights Score Weights Score Weights Score
Score Score Score
(A) (B) (A) (B) (A) (B)
(A x B) (A x B) (A x B)

Financial Risk 45.00% 8 3.6 50.00% 8 4.00 35.00% 8 2.80

Business Risk 25.00% 6 1.5 20.00% 10 2.00 25.00% 10 2.50

Management
15.00% 10 1.5 15.00% 6 0.90 20.00% 6 1.20
Risk

Industry Risk 10.00% 4 0.4 15.00% 4 0.60 20.00% 4 0.80

Transactional
5.00% 6 0.3 NA NA NA NA NA NA
Parameters

Company Score 100.00% 7.30 100.00% 7.50 100.00% 7.30

4.1 Financial Risk

The financials of a company are indicative of the health of the company and potential risks in lending to the
company. For example, if the company already has a large amount of debt on its balance sheet, compared to its
cash flow generation capacity, a loan to this company would be risky.

Determination of Financial Risk:

The financial strength of a company may be assessed by critically analyzing the financial performance. The key
areas of assessment cover Solvency, Liquidity and Profitability related risks.

The parameters and their weightage within financial risk determination are presented below:

Sr
Parameters ETB NTB NIC
No
1 Capital Adequacy Ratio (%) 7.50% 7.50% 15.00%
2 Borrowings / NOF 5.00% 5.00% 25.00%
3 AUM / NOF 2.50% 2.50% 10.00%
4 Gross NPA % 5.00% 5.00% 7.50%

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 Sr
Parameters ETB NTB NIC
No
5 Provision Coverage Ratio (%) 2.50% 2.50% 7.50%
6 Net NPA % 2.50% 2.50% 5.00%
7 Net NPA / NOF (%) 7.50% 7.50% NA
8 30+ PAR on AUM (%) 5.00% 5.00% NA
9 Net Interest Margin (%) 7.50% 7.50% NA
10 Cost to Income Ratio (%) 7.50% 7.50% NA
11 Return on Average Assets (%) 5.00% 5.00% 10.00%
12 Return on Net Owned Funds (%) 7.50% 7.50% 10.00%
13 % Growth in AUM 15.00% 12.50% NA
14 % Increase in NII 7.50% 7.50% NA
15 Cumulative ALM Mismatch up to 3 Months 5.00% 5.00% NA
16 Cumulative ALM Mismatch up to 12 Months 5.00% 5.00% NA
17 Sources of funding 2.50% 2.50% 10.00%
Total 100.00% 100.00% 100.00%
NA: Not applicable to this type of borrower

Detailed below are the rationale and scoring criteria for the parameters listed above:

1) Capital Adequacy Ratio (%):

This Ratio indicates the financial strength of the NBFC by calculating its capital with respect to its risk weighted
assets. The capital adequacy ratio (CAR) indicates that the NBFC has enough capital commensurate with its
exposure. The computational methodology is as follows:

CAR = (Tier 1 capital + Tier 2 capital) / Risk Weighted Assets

➢ Tier 1 capital is the core capital (going-concern capital) of the entity and consists of capital, share premium,
reserves and other regulatory adjustments. Tier 2 capital is the gone concern capital.
➢ Risk weighted assets are in relation to their relevant associated risk.

Capital Adequacy Ratio (%) Score

>= 25% 10
>= 20% and < 25% 8
>= 18% and < 20% 6
>= 15 and < 18% 4
Less than 15% 0

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2) Borrowings / NOF
This ratio compares an entity’s debt obligations vis-à-vis its Net Owned Funds (NOF) and is computed as:

Borrowings / NOF = Borrowings / Net Owned Funds

➢ ‘Borrowings’ include all funds raised from banks, commercial paper, non-convertible debentures, holding
company, external commercial borrowings, from India and/or outside India.
➢ ‘Net Worth’ means aggregate of the paid-up capital, free reserves, balance in share premium account and
capital reserves representing surplus arising out of sale proceeds of assets.
➢ ‘Adjusted Net Worth’ is arrived at as: ‘Net Worth’ minus reserves created by revaluation of asset, after
deducting therefrom accumulated balance of loss, deferred revenue expenditure and other intangible assets.
➢ 'Net Owned Fund' is the amount as arrived at above, minus the amount of investments of such company in
shares of its subsidiaries, companies in the same group and all other NBFCs.
NOF is computed using the following method with an example:

Add: Paid Up Capital 200

Add: Reserves & Surplus 350
Less: Deferred Revenue Expenditure 30
Less: Prelim Exp not written Off 45
Less: Revaluation Reserves 45
Less: Dr Balance in Profit & Loss 20
Less: Other Intangible Assets 20
Less: Deferred Tax Assets 50
Add: Deferred Tax Liabilities 140
Net Worth 480

Less: Investments in Subsidiary / Associates / JV 60

Net Owned Funds 420

Borrowings / NOF Score

<=4 10
> 4 and <=5 8
> 5 and <=6 6
> 6 and <=7 4
> 7 and <=9 2
>9 0

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3) AUM / Net Owned Funds (NOF)

This ratio compares the size of the Assets Under Management of an NBFC to its net worth. The computational
methodology is:

AUM / Net Owned Funds = Asset Under Management / Net Owned Funds

➢ Asset Under Management (AUM): AUM includes on-balance sheet loan portfolio as well as off-balance sheet
portfolio which includes securitized / assigned portfolio and portfolio co- originated under business
correspondence operations.

AUM / Net Owned Funds (NOF) Score

> 0 and <=5 10

> 5 and <=6 8
> 6 and <=7 6
> 7 and <=8 4
> 8 and <=10 2
> 10 0

4) Gross NPA %

This ratio calculates the percentage of gross advances which have become NPA as per the NPA recognition policy
of the NBFC and reflects the asset quality independent of the provisioning policy. The same is disclosed in the
Financial Statements of an NBFC.

Gross NPA % = (Gross NPA amount / Gross Advances amount) X 100

Gross NPA % Score

Up to 2.00% 10
>2.00% and <=2.50% 8
>2.50% and <=3.00% 6
>3.00% and <=4.00% 4
>4.00% and <=6.00% 2
Greater than 6.00% 0

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5) Provision Coverage Ratio (%)

Provision coverage ratio (PCR) refers to the percentage of provisions created against NPAs. A higher PCR ratio
reflects that the entity has enough to withstand asset quality pressures. The same is disclosed in the Financial
Statements.

Provision Coverage Ratio (%) Score

>90% and <=100% 10

>70% and <=90% 8
>50% and <=70%s 6
>40% and <=50% 4
>30% and <=40% 2
<= 30% 0

6) Net NPA %

Net NPA is the portion of Gross NPA against which no provisions have been made. Net NPA amount is computed
by deducting the NPA provisions from the Gross NPA amount. Net NPA ratio represents Net NPA as a percentage
of net advances. The same is disclosed in the Financial Statements.

Net NPA % = (Net NPA amount / Net Advances amount) X 100

Net NPA % Score

Up to 1.00% 10
>1.00% and <=1.50% 8
>1.50% and <=2.25% 6
>2.25% and <=3.00% 4
>3.00% and <=5.00% 2
Greater than 5.00% 0

7) Net NPA / NOF (%)

This ratio indicates the coverage available for the unprovided non-performing assets (Net NPA) to the Net Owned
Funds (NOF). The computational methodology is:

Net NPA / NOF (%) = (Net NPA amount / Net Owned Funds) X 100

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 Net NPA / NOF (%) Score

<=5% 10
>5% and <=10% 8
>10% and <=15% 6
>15% and <=20% 4
>20% and <=25% 2
> 25% 0

8) 30+ PAR on AUM (%)

‘Portfolio at Risk (PAR) 30+’ means the outstanding amount of all client loans of the NBFC Borrowers that have
one or more instalments of principal past due for thirty days or more. The computational methodology is:

30+ PAR on AUM (%) = (30+ Portfolio at Risk of the Assets under management / Assets under
management) X 100

30+ PAR on AUM (%) Score

Up to 3.00% 10
>3.00% and <=4.50% 8
>4.50% and <=6.00% 6
>6.00% and <=8.00% 4
>8.00% and <=10.00% 2
Greater than 10.00% 0

9) Net Interest Margin (%)

Net Interest Margin is the spread between the interest income and interest expenses made by an entity expressed
as a percentage of gross owned portfolios. The same is disclosed in the Financial Statements. NIM can be arrived
at by using the following computational methodology:

Net Interest Margin (%) = {(Interest Revenue – Interest Expenses) / (Average of Gross Own Portfolio) X
100

Net Interest Margin Score

>=10% 10
>=8% and < 10% 8
>=6% and < 8% 6
>=4% and < 6% 2

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 Net Interest Margin Score

<4% 0

10) Cost to Income Ratio (%)

The cost-to-income ratio is a key efficiency measurement parameter of an NBFC. It compares the operating costs
of an NBFC to its operating income. A lower CIR implies higher operational efficiency, which is an ideal scenario
for NBFCs. The computational methodology is:

Cost to Income Ratio (%) = (Operating Expenses / Gross Income) X 100

Cost to Income Ratio (%) Score

<30% 10
>=30% and < 40% 8
>=40% and < 50% 6
>=50% and < 60% 4
>=60% -2

11) Return on Average Assets (%)

Return on average assets (ROAA) shows how efficiently a company is utilizing its assets. ROAA is calculated by
taking net profits and dividing it by Total assets(tangible). The final ratio is expressed as a percentage of total
average assets. The computational methodology is:

ROAA (%) = (PAT / Total Assets (Tangible)) X 100

Return on Average Assets (%) Score

>=4.00% 10
>=3.00% and < 4.00% 8
>=2.50% and < 3.00% 6
>=2.00% and < 2.50% 2
<2.00% 0

12) Return on Net Owned Funds (%)

Return on Net Owned Funds (RoNOF) denotes the profit earned by the NBFC on the shareholder's funds. RoNOF
is a profitability indicator of a company expressed in percentage. It is calculated by dividing the Net Profit of the
company by the adjusted shareholder’s fund. Higher ratio indicates greater return on the shareholders’ funds. The
computational methodology is:

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 RoNOF (%) = (Net Profit / Net Owned Funds) X 100

Return on Net Owned Funds (%) Score

>=20.00% 10
>=17.00% and <20.00% 8
>=14.00% and < 17.00% 6
>=10.00% and < 14.00% 4
>=7.00% and <10.00% 2
<7.00% 0

13) % Growth in AUM

Lending being the primary activity of NBFCs, Asset under management is an important indicator of business
growth. While AUM in itself is not comparable across multiple entities due to scaling, we can look at the y-o-y
growth percentage in AUM. The computational methodology is:

% Growth in AUM = {(AUM at the end of year – AUM at the beginning of year) /

AUM at the beginning of year} X 100

% Growth in AUM Score

>=25% 10
>=15% and <25% 8
>=10% and < 15% 6
>=5% and < 10% 4
>=0% and < 5% 2
<0% -2

14) % Increase in NII

Change in Net Interest Income indicates the consistency of an entity in generating profitability. An increase in NII
is a good indicator of continuing healthy profitability. The computational methodology is:

% Increase in NII = {(NII of current period – NII of previous period) / NII of previous period} X 100

% Increase in NII Score

>20% growth from previous year 10

>15% to <=20% growth from previous year 8
>10% to <=15% growth from previous year 6

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 % Increase in NII Score

>5% to <=10% growth from previous year 4

>= 0% to <=5% growth from previous year 2
Negative growth % of NII from previous year -2

15) Cumulative ALM Mismatch up to 3 Months

‘ALM mismatch’ typically refers to a situation where there is a discrepancy or misalignment between assets and
liabilities of an NBFC. An entity is bound to face a liquidity crunch if the expected cash outflows are higher than the
expected cash inflows for a certain period up to three months in maturity terms. This ratio can be computed by
comparing the cumulative cash inflows to the cumulative cash outflows corresponding to a specified period of 3
months. The computational methodology is:

= (Cumulative Inflows up to 3 months / Cumulative Outflows up to 3 Months) X 100

Cumulative ALM Mismatch up to 3 Months Score

>=130% 10
>=120% and <130% 8
>=110% and < 120% 6
>=100% and < 110% 2
<100% 0

16) Cumulative ALM Mismatch up to 12 Months

‘ALM mismatch’ typically refers to a situation where there is a discrepancy or misalignment between assets and
liabilities of an NBFC. An entity is bound to face a liquidity crunch if the expected cash outflows are higher than the
expected cash inflows for a certain period up to 12 months in maturity terms. This ratio can be computed by
comparing the cumulative cash inflows to the cumulative cash outflows corresponding to a specified period of 12
months. The computational methodology is:

= (Cumulative Inflows up to 12 months / Cumulative Outflows up to 12 Months) X 100

Cumulative ALM Mismatch up to 12 Months Score

>=130% 10
>=120% and <130% 8
>=110% and < 120% 6
>=100% and < 110% 2
<100% 0

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17) Sources of Funding

Sources of funding means the various avenues for the fund requirements of the NBFC. Multiple avenues to raise
funds enables an NBFC to mitigate risk of concentration and dependency on a single/few avenues.

As a way to analyze the above parameter, we look at the various avenues to raise funds like bank borrowings,
commercial paper, non-convertible debentures, holding company, external commercial borrowings, from India
and/or outside India and the amount of total borrowings.

Sources of Funding Score

Well Diversified funding sources (each sourced contributing 20-25% each) 10

60% funding sourced from Bank Borrowings and rest from 3 other sources 8
60% funding sourced from Bank Borrowings and rest from 2 other sources 6
50% funding sourced from Bank Borrowings and 50% from NBFC 4
80% funding sourced from NBFCs 2

4.2 Business Risk

Introduction

The business performance of a company has a direct relationship with the credit risk of the company as the
business performance determines the generation of cash for debt repayment. The company's competence in its
activities is a key indicator of how a company is expected to perform and its ability to generate funds to repay its
debts.

Determination of Business Risk

The performance of a company is influenced both by its own set up as well as its competitive position within the
industry. Thus, the two broad sub-areas used to assess the business performance of a company are:

• Growth and Operating Efficiency: This covers the operations of a company and how efficient it is at
performing its core activities, how it has grown in recent times.
• Market Position: The business performance of an NBFC is not measured simply by its own operations
but also by the competition in the industry as well as its position vis-à-vis its competitors. This also covers
risks related to its customers and the regulations.

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The parameters and their weightage within business risk determination are presented below:

Sr
Parameters ETB NTB NIC
No
1 Stock Exchange of Listing 2.50% 2.50% NA
2 External Rating 40.00% 40.00% NA
3 AUM % of Top 1 State 10.00% 10.00% NA
4 RBI Layer Classification 10.00% 10.00% 5.00%
5 Product Diversification 7.50% 7.50% 20.00%
6 Business Vintage/ Promotor’s Strength 7.50% 7.50% 45.00%
7 Secured Portfolio % of Borrower 15.00% 15.00% 30.00%
8 Collection Efficiency 7.50% 7.50% NA
Total 100.00% 100.00% 100.00%

Detailed below are the rationale and scoring criteria for the parameters listed above:

1) Stock Exchange of Listing

This variable provides information whether the NBFC borrower is listed in the stock exchange or not. If it is listed,
then it is easier to get the information regarding the borrower.

Stock Exchange of Listing Score

EQUITY Listed 10
NCD Listed 5
NOT Listed 0

2) External Rating

This parameter is to know the external rating of the borrower entity which further helps for comfort on account of
lower cost of borrowings, wider sources of borrowings, market image and reduction of cost in public issues.

External Rating Score

AAA 10
AA 8
A 6
BBB 4
Unrated 2
BB and below 0

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3) AUM % of Top 1 State

This parameter looks at the concentration of business of the entity across the geographical states of the country.
The rationale is derived from the principle of diversification: the more diversified a business is, the lower the risk of
concentration and vice versa. In order to measure the concentration of the business of an NBFC, we rank the
states in a decreasing order of business volumes and look at the top-most state. The score is assigned as per the
percentage of business coming from that state vis-a vis the total AUM of the entity.

AUM % of Top 1 State Score

<=10% 10
>10% and <=30% 8
>30% and <=50% 6
>50% and <=80% 4
>80% 2

4) RBI Layer Classification

This parameter states the RBI's layer-based classification of NBFCs that helps in identifying and assessing the risk
profiles of different NBFCs, ensuring appropriate regulatory oversight, and maintaining financial stability in the
economy.

RBI Layer Classification Score

Upper Layer 10
Middle Layer 8
Base Layer 4

5) Product Diversification

This parameter is also based on the same principle of diversification: the more diversification, the less is the risk
involved. This parameter looks at how diversified the product portfolio is.

Product Diversification Score

Five or more than five loan products 10

Four loan products 8
Three loan products 6
Two loan products 4
One loan product 2

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6) Business Vintage/ Promotor’s Strength

The variable factors-in the experience of the NBFC in its line of business.

Business Vintage/ Promotor’s Strength Score

Greater than 10 years 10

>=6 to 10 years 8
>=3 to 6 years 6
>=1 and < 3 years 2
New Venture (up to 1 year) 0

7) Secured Portfolio % of Borrower

Having a more secure portfolio offers several benefits for financial institutions like NBFCs. A more secured portfolio
typically consists of assets that are backed by collateral or have strong creditworthiness. This reduces the risk of
default and credit losses for the NBFC, enhancing the overall stability of its business. Secured assets can
encompass a wide range of asset classes, including mortgages, automobile loans, and asset-backed securities.

Secured Portfolio % of Borrower Score

>=80% 10
>=60% to 80% 8
>=50% to 60% 6
>=40% to 50% 4
<40% 2

8) Collection Efficiency
Collection Efficiency refers to the effectiveness with which an NBFC is able to recover payments from its borrowers.
It is a critical parameter in assessing the credit risk associated with the NBFC's loan portfolio. Collection efficiency
serves as an important indicator of the operational effectiveness and risk management practices of an NBFC. A
higher collection efficiency indicates a lower credit risk.

Collection Efficiency Score

>=95% 10
>=90% to 95% 8
>=80% to 90% 6
>=70% to 80% 4
>=60% to 70% 2
<=50% 0

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4.3 Management Risk
Introduction

The quality of management and management structure are very important indicators of a company's credit risk.
The performance of a company driven by strong management is likely to be better than that of a company having
a poor management irrespective of the industry to which it belongs. Evaluation of management is important not
only due to its impact on the company's performance which determines its capability to repay, but also from the
point of view of its integrity. This is because the intentions of the management determine the willingness of the
company to repay its debts.

The management quality thus influences both aspects of default risk, the ability as well as the willingness of the
borrower to repay its debts. Thus, the evaluation of management quality is an essential input for credit risk
assessment.

Determination of Management Risk:

Evaluation of management is done to determine both their competence as well as their integrity. The two sub-
areas considered for this purpose are:

• Subjective assessment of management quality: Involves subjective assessment of Management on criteria

like integrity, honesty, track record etc.
• Achievement of past targets by the company: Gives an indication of the management’s ability to drive the
company by properly gearing it to the performance target set by them. The company is scored on the extent
to which the targets set at the beginning of the year are achieved.

The parameters and their weightage within management risk determination are presented below:

Sr
Parameters ETB NTB NIC
No
1 Competence of Management/Promotor/Founder 5.00% 5.00% 50.00%
2 Change in Auditors 5.00% 5.00% NA
3 Qualification in the Audit Report 5.00% 5.00% NA
Regulatory non-compliance/ Major Proceedings
4 5.00% 10.00% NA
or litigation against borrower entity
5 Frequent changes in Key Management Personnel 10.00% 10.00% NA
6 Unpaid statutory dues and its trend 10.00% 15.00% NA
7 Penalties Levied by the Regulator (RBI) 10.00% 15.00% NA
History of reneging on personal/ third-party
8 guarantee by promoter/director/guarantor entities 10.00% 10.00% 25.00%
in group entities
History of default by the Company or its
9 10.00% 15.00% 25.00%
Promoters
10 Succession Plan 10.00% 10.00% NA

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 11 Projection vs. Achievements in Net Profit 10.00% NA NA
12 Projection vs. Achievements in AUM 10.00% NA NA
Total 100.00% 100.00% 100.00%

1) Competence of Management/Promotor/Founder

The variable can capture the way the activities like planning, budgeting, execution, management, etc. are executed.
This can be a critical input to understand the operation of the company.

Competence of Management/Promotor/Founder Score

Senior management are of exceptionally good reputation (>20 years of management experience
10
with same/multiple organizations)
Senior management are of high reputation (>15 to <=20 years of management experience with
8
same/multiple organizations)
Senior management are of good reputation (>10 to <=15 years of management experience with
6
same/multiple organizations)
Senior management are of moderate reputation (>5 to <=10 years of management experience
4
with same/multiple organizations)
Senior management are in process of building reputation (>2 to <=5 years of management
2
experience with same/multiple organizations)

Senior management are new to industry 0

Leaders are experienced in the industry but carry 'negative reputation' -2

2) Change in Auditors

Frequent auditor changes may lead to negative perceptions in the market. Stakeholders may interpret such
changes to be signaling instability or potential issues within the company. Regulators may closely monitor
companies with a history of frequent auditor changes, viewing them as potentially higher risk. In essence, frequent
auditor changes can raise concerns about financial reporting integrity, governance, and market perceptions.

Change in Auditors Score

Change of auditors as per regulations 10

Auditors changed thrice or more during the last five financial years -10

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3) Qualification in the Audit Report

A qualified audit report is issued when auditors encounter specific limitations or exceptions in their examination of
a company's financial statements. The implications of a qualified audit report can vary depending on the nature
and significance of the qualifications. A qualified audit report can tarnish the company's reputation and credibility,
affecting its relationships with stakeholders.

Qualification in the Audit Report Score

No 10
Not Materialistic 5
Yes -10

4) Regulatory non-compliance/ Major Proceedings or litigation against borrower entity

Non-compliance with regulatory guidelines can have significant repercussions for companies, including legal,
financial, operational, and reputational consequences.

Regulatory non-compliance/ Major Proceedings or litigation against borrower entity Score

No 10
Present but not materialistic 5
Yes -10

5) Frequent changes in KMP/Promotor

Frequent changes in management can have several significant impacts on an NBFC, its employees, stakeholders,
and overall performance including disruption in Strategy Implementation, Employee Moral and Productivity and
impact on culture. For instance, in a promoter-driven organization, KMP should be the promoter and in a
professionally managed organization, it should be the MD and CFO.

Frequent changes in KMP/Promotor Score

No Change during the last three financial years 10

Change happened once during the last three financial years 8
Change happened more than 2-3 times during the last three financial years 6
Change happened more than 3 times during the last three financial years 4

6) Unpaid Statutory Dues and its Trend

This Variable captures the unpaid statutory dues like Corporate Income Tax and GST and the trend of non-payment
by the borrower entity. This is useful to know whether the borrower entity is compliant with the regulator or not.

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 Unpaid Statutory Dues and its Trend Score

Yes 0
Yes, but not material 5
No 10

7) Penalties Levied by the Regulator (RBI)

Penalty by RBI can have far-reaching and multifaceted impacts on NBFCs, including financial costs, reputational
damage, market reactions, leadership consequences, operational disruptions, loss of business opportunities, and
increased compliance obligations. It is essential for companies to prioritize regulatory compliance, establish robust
compliance programs, and proactively address regulatory risks to mitigate the adverse impacts of regulatory
enforcement actions.

Penalties Levied by the Regulator (RBI) Score

No instances of penalties by RBI 10

More than two instances in the last five financial years 0
More than four instances in the last five financial years -4

8) History of reneging on personal/ third-party guarantee by promoter/director/guarantor entities in

group entities

The impact of management reneging, or failing to fulfill commitments or promises, can be significant and wide-
ranging, affecting various stakeholders and aspects of the business leading to loss of trust and reputation.

History of reneging on personal/ third-party guarantee by promoter/director/guarantor Score

entities in group entities

Never happened 10
It happened once since Inception of business -4
It happened 2-3 times since Inception of business -6
It happened 4 times since Inception of business -8
It happened more than 4 times since Inception of business -10

9) History of default by the Company or its Promoters

Promoters of a company defaulting on their financial obligations can have significant consequences for the
company, its stakeholders, and its overall operations like creditworthiness concern, loss of investor confidence,
liquidity constraints etc.

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 History of default by the Company or its Promoters Score

Never happened 10
It happened once over the last 5 years 0
It happened more than once over the last 5 years -10

10) Succession Plan

A well-designed succession plan can have a positive impact on an NBFC by ensuring continuity of leadership,
retaining talent, reducing recruitment costs, preserving institutional knowledge, facilitating faster decision-making,
fostering leadership development, enhancing stakeholder confidence, and mitigating risks.

Succession Plan Score

The company has a clear succession plan and also access to a large managerial pool for
future leadership. Company's operations are expected to proceed smoothly in the event of a 10
change in top management.
The company has clear succession plan, but company's operations are dependent on the
8
present leadership.

Company's operations are fairly dependent on the present leadership for strategic direction 6

Company shows uncertainty regarding the future allocation of key managerial roles 4

NA 0

11) Projection vs. Achievements in Net Profit

The achievement of profit compared to projections has broad implications for investor confidence, market
reactions, shareholder value creation, creditworthiness, management incentives, strategic planning, and
operational performance.

Projection vs. Achievements in Net Profit Score

>= 90% 10
>= 70% but < 90% 8
>= 50% but <70% 6
< 50% 0

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12) Projection vs. Achievements in AUM

The achievement of AUM compared to projections has broad implications for investor confidence, market
reactions, shareholder value creation, creditworthiness, management incentives, strategic planning, and
operational performance.

Projection vs. Achievements in AUM Score

>= 90% 10
>= 70% but < 90% 8
>= 50% but <70% 6
< 50% 0

4.4 Industry Risk

The industry risk assessment provides benchmarks for ratings to which a particular company in the industry can
aspire. Strong industry fundamentals with good prospects for the future provide helpful support to companies
operating in such industries.

The industry risk has been mapped with Industry Risk Score (IRS) provided by Advisory & Research company.

The Industry Risk Score (IRS) is a multi-factor assessment model capturing the influence of industry variables on
the credit profile and debt repayment ability of companies in a specific industry over a 3–4 year horizon. The risk
score is arrived at by aggregating the scores assigned to relevant parameters such as demand-supply outlook,
input risk, competition, and financial performance. These parameters take into account financial performance over
the past five years to evaluate structural profitability in the sectors. They also factor in a forward-looking perspective
on expected trends in demand growth, capacity addition, competition, input cost expectations, and utilization levels
along with the impact of government regulations and policies.

4.5 Transactional Parameters

Introduction

The Transactional Risk arises out of the way a borrower conducts their account over a specific period. It’s a
measure of how a borrower’s existing accounts with the bank and with other banks are being conducted, also
whether any problems are being faced. The operational records/performance provide useful indications about the
ability and willingness of the borrower to meet its obligations. The manner in which the borrower has been
conducting his accounts in the past is a good indicator of how the account is likely to behave in the future as well.

Determination of Transactional Risk

The Transactional risk of the borrower entity is calculated on the basis of following parameters:

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 Sr
Parameters ETB NTB NIC
No
1 Relationship with the Bank 15.00% NA NA

2 Overdue with our Bank 15.00% NA NA

3 Frequency of occurrence of 31 DPD defaults 15.00% NA NA

4 Overdue with other Banks (CRILC/Credit Bureau) 30.00% NA NA

Submission of QIS/MSOD/Stock/Book debts/other
5 10.00% NA NA
compliance statements
Compliance with previous covenants / terms &
6 15.00% NA NA
conditions of the existing facilities with the bank
Total 100.00% NA NA

1) Relationship with the Bank

The parameter can provide inputs about the relationship between the borrower and the bank. A longer relationship
would mean that the bank would have more reliable information about the borrower.

Relationship with the Bank Score

>= 5 years 10
>= 3 and < 5 years 8
>= 1 and < 3 years 6
< 1 year 2

2) Overdue with our Bank since Last Sanction

The parameter can play a major role while capturing the repayment history. A good past repayment history would
give comfort to the lender about any further lending.

Overdue with our Bank since Last Sanction Score

Accounts running regular 10

Accounts remained irregular for up to 10 days 8
Accounts remained irregular for 10-20 days 6
Accounts remained irregular for more than 20 days 4
No loan account previously 0

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3) Frequency of occurrence of 31 DPD defaults since Last Sanction

This parameter helps to know the frequency of the borrower entity having been in default on its principle/interest
payment obligations for 30 days or more.

Frequency of occurrence of 31 DPD defaults since Last Sanction Score

It happened more than 4 times in a year -10

It happened >= 3 and < 4 times in a year -8
It happened >= 2 and < 3 times in a year -6
It happened >= 1 and < 2 times in a year -4
It has never happened 10

4) Overdue with other Banks excluding Technical Issues (CRILC/Credit Bureau)

The parameter can play a major role while capturing the repayment history. A good past repayment history would
give comfort to the lender about any further lending.

Overdue with other Banks (CRILC/Credit Bureau) Score

Never happened 10
It has happened once in 1 years -5
It has happened more than once in 1 years -10

5) Submission of QIS/MSOD/Stock/Book debts Statements

This parameter shows the timeliness of submission of these documents which further provides the information
about the health of borrower’s account.

Submission of QIS/MSOD/Stock/Book debts Statements Score

Timely Submission 10
Delayed Submission up to 2 occasions 8
Delayed Submission up to 4 occasions 6
Delayed Submission up to 5 occasions 4
Delayed Submission above 5 occasions 2

6) Compliance with previous covenants / terms & conditions of the existing facilities with the bank

Compliance with loan terms by NBFC is critical for maintaining the stability and integrity of the financial system as
a whole.

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 Compliance with previous covenants / terms & conditions of the existing facilities with Score
the bank

Fully compliant 10

Partial compliance or breach of some covenants / credit terms in the past, but subsequently
0
rectified

Breach of existing terms and conditions / covenants and not rectified -5

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5. Parentage
After computing the stand-alone score, the parentage of the company is factored in to determine the final score.
Parentage considers the parent’s own credit worthiness, level of ownership, strategic importance of the company
to the group and explicit commitment of support in the form of guarantees given.

Company score and parentage score are given weightages of 80.00% and 20.00% respectively in the final score.

Component of Final Score Weightage

Standalone Company Score 80.00%

Parentage Score 20.00%
Total 100.00%

Note: The Parentage component is not applicable in the following scenarios:

➢ In case the parent company is not rated externally, the parentage component is not applicable.

➢ In case the parent is rated below A- externally, the parentage component is not applicable.

Following is an example illustrating the methodology used to arrive at the Final Score:

Method Illustrative Scores Weight Weighted Scores Steps

Parent Company External Rating

Score (e.g., AA+ rated) 9.25 100.00% 9.25 B

Parent Company Score (C) 9.25 C

Parent Company Score (C) 9.25 40.00% 3.70 D
Parent Company Support Score 7.00 60.00% 4.20 E
Parentage Score (F) 7.90 F = D+E
Parentage Score (F) 7.90 20.00% 1.58 G
Stand-alone Company Score 8.00 80.00% 6.40 H
Final Score (I) 7.98 I = G+H

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5.1 Parentage Score
The parentage score is a weighted average of parent company score and parent company support score,
which carry a weightage of 40.00% and 60.00% respectively.

Component of Parentage Score Weightage

A Parent Company Score 50.00%

B Parent Company Support Score 50.00%
Total 100.00%

A. Parent Company Score

Score of the parent company (on a scale of 10) having external rating grades is determined as follows:

External Rating Score:

If the parent company has an external rating:

External Rating Score Score on a Scale of 10

PSU/Sovereign 100.00 10.00

AAA 97.50 9.75
AA+ 92.50 9.25
AA 85.00 8.50
AA- 77.50 7.75
A+ 72.50 7.25
A 67.50 6.75
A- 62.50 6.25

B. Parent Company Support Score

Level of parent support is determined using the following table:

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 S. No. Parameter Score Guide Weightage

Based on Ownership Percentage:

Ownership % Score

100% subsidiary 10
1 Ownership 25.00%
Significant majority parent ownership (>70%) 8
50-70% parent ownership 6
Part of the same group 4

Based on usage of brand, market perception, importance of

subsidiary / group company for the parent's business continuity.
Also, historically whether financial support was provided by parent in
distress.
Strategic
2 25.00%
importance Strategic Importance Score

High 10
Medium 6
Low 2

Based on guarantees given towards borrowings of the subsidiary:

Guarantees given Score

Guarantee given to significant proportion

10
(>70%) of borrowing of the subsidiary
Guarantees Selective guarantee given to some part of
3 8 50.00%
given the subsidiary borrowings
Letter of comfort or other explicit support
6
provided to subsidiary
Use of common group treasuries for raising
4
funding giving implicit support
No support 0

Total 100%

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6. Rating
The parentage adjusted score, or the Final Score, is then converted to a scale of 100 from a scale of 10, e.g., a
score of 8.0 out of 10 is converted to 80 out of 100.

After that, the score is converted into a final rating on an 10-point scale using the following reference table:

Score Score
Internal Range Range Ratings Grade
Ratings Ratings Definition
(Lower (Upper Category Description
Grade
Band) Band)
Issuers with this rating are considered to offer the
Highest
highest degree of safety regarding timely servicing
AAA 85.01 100.00 Plus
of financial obligations. Such issuers carry lowest
Safety
credit risk.
Highest Issuers with this rating are considered to offer a
AA+ 81.01 85.00
Safety high degree of safety regarding timely servicing
High of financial obligations. Such issuers carry very
AA 78.01 81.00 low credit risk
Safety
Investment
Adequate Grade
A+ 73.01 78.00 Plus Issuers with this rating are considered to offer an
Safety adequate degree of safety regarding timely
servicing of financial obligations. Such issuers
Adequate
A 67.01 73.00 carry low credit risk.
Safety
Issuers with this rating are considered to offer a
Moderate moderate degree of safety regarding timely
BBB 48.01 67.00
Safety servicing of financial obligations. Such issuers
carry moderate credit risk.
Issuers with this rating are considered to offer
Moderate
BB 26.01 48.00 moderate risk of default regarding timely
Risk
servicing of financial obligations.
Issuers with this rating are considered to offer
B 20.01 26.00 High Risk high risk of default regarding timely servicing of Non-
financial obligations. Investment
Issuers with this rating are considered to offer very Grade
Very
C 0.01 20.00 high risk of default regarding timely servicing of
High Risk
financial obligations.
Issuers with this rating are in default or are
D 0.00 0.00 Default
expected to be in default soon.

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