The vast majority of institutions employ rating models to assess the credit worthiness of their obligors. Rating models provide essential metrics used as foundations to multiple core processes within institutions. Ratings have implications for key decisions, including but not limited to, risk management, provisioning, pricing, capital allocation and Pillar II capital assessment. Institutions should pay particular attention to the quality of their rating models and subsequent PD models, presented in the next section.
2.1.2
Inadequate rating models can result in material financial impacts due to a potentially incorrect estimation of credit risk. The CBUAE will pay particular attention to suitability of the design and calibration of rating and PD models. Rating models that are continuously underperforming even after several recalibrations should be replaced. These models should no longer be used for decision making and reporting.
2.1.3
For the purpose of the MMG, a rating and a score should be considered as identical concepts, that is a numerical quantity without units representing the relative creditworthiness of an obligor or a facility on predefined scale. The main objective of rating models is to segregate obligors (or facilities) that are likely to perform under their current contractual obligations from the ones that are unlikely to perform, given a set of information available at the rating assessment date.
2.1.4
The construction of rating models is well documented by practitioners and in academic literature. Therefore, it is not the objective of this section to elaborate on the details of modelling techniques. Rather, this section focuses on minimum expected practices and the challenging points that should attract institutions’ attention.