The Building Blocks of Credit Analysis and Credit Risk Rating
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This chapter fleshes out the borrower risk rating (BRR) components, and demonstrates the calculation of component and composite BRRs. A BRR scorecard would usually have four main building blocks: Industry Risk, Business Risk, Management Risk, and Financial Risk. Each block is usually defined by a set of Risk Factors and a set of Risk Elements, all weighted. The chapter discusses methods to dampen point-in-cycle effects on the BRR and the conditions that require the use of projected financial statements instead of current for more accurate BRR determination. The chapter provides a framework for creating descriptors/characteristics (for a given risk factor/risk element) to differentiate between risk ratings effectively and consistently. The monotonicity between descriptor and BRR is a necessary condition of a predictive risk-rating system.