LENDING is a business based on risk, but many banks today have only a rudimentary method, at best, for measuring risk in their loan portfolios.

With the nation's lenders still grappling with the accumulated credit woes of the 1980s, some bankers think its time for a change.

"We're in a risk business, and if we're going to stay in this business, we better understand how to manage that risk," said Keith Oldfield, executive vice president of Texas Commerce Bank in Houston.

To that end, Mr. Oldfield and other industry executives advocate the use of a numerical risk-rating scale for commercial loans, ranging from 1 to 10. The higher the score, the greater the risk of default.

For example, a 3 rating would be assigned to a loan deemed to have average credit risk, meaning that asset quality, liquidity, financial ratios, and the quality of management are all considered satisfactory. An 8 rating would apply to a loan for which normal repayment of principal and interest is in doubt.

Pass-or-Fail Limitations

While the nation's largest banks already have similar risk-rating systems in place, most smaller banks rate their loans according to the five categories used by the federal bank examiners.

Some banks don't even go that far.

Moreover, the regulatory rating categories apply mainly to loans that are substandard, or worse. A single "pass" category applies to all creditworthy loans.

The problem with this system is that it fails to distinguish between a high-quality loan and one that is barely aceptable.

Monitoring Credit Migration

Imagine if the bond-rating agencies used a single rating for credits ranging from triple-A to double B-minus, which is several notches below investment grade.

Since banks don't intentionally make substandard loans, it's important for lenders to understand how they get that way.

By subjecting new loans to a more comprehensive rating systems and reviewing those ratings regularly, banks can monitor the migration of credits down the rating scale.

In this way, banks can more easily spot a credit before it falls into the substandard category, and take corrective action.

Over time, the rating system should also enable banks to better assess the loss probabilities in their loan portfolios and allocate the appropriate reserves.

That, at least, is the thinking of an industry task force formed late last year by Robert Morris Associates, a trade group for commercial lenders, to study the merits of risk-rating systems.

For banks lacking a comprehensive rating system of their own the task force will soon recommend the use of a 10-point rating system developed by Loan Pricing Corp., a data base company in New York.

The recommendation will be made at Robert Morris' annual fall conference, to be held later this month in San Francisco, said Thomas H. O'Brien Jr., chairman of the task force, and senior credit policy officer at First Fidelity Bancorp, Lawrenceville, N.J.

Gaining Alertness at the Outset

Mr. Oldfield at Texas Commerce, a task force member, said using such a rating system has several benefits.

At the loan approval stage, it focuses a bank's attention on the risk it is undertaking at the outset, he said.

"And from a portfolio perspective, it focuses the mind on what sort of portfolio we have, and what we are building, and what we need to do to change if we're operating in the wrong [rating] band," Mr. Oldfield added.

Not a Panacea

Still, he and others acknowledged that such a rating system is not a panacea.

"No system protects you from bad underwriting decisions," the Texas banker observed.

At the same time, many of the factors that determine a particular borrower's rating are based on subjective judgments, such as the perceived quality of management.

"It's an art, not a science," said William Pierce, chief risk policy officer at Chemical Banking Corp.

Call for a Common System

David Eyles, vice chairman at Shawmut National Corp. in Hartford, Conn., said he would like to see all banks use a common risk-rating system, in order to promote liquidity in the loan sales market.

Some doubt it would ever be possible to arrive at universal consistency in risk rating, and question whether it's even desirable.

At least one member of the Robert Morris Association task force questions whether a 10-point rating scale is appropriate for all banks.

T. Lincoln Morison Jr., chairman of First Ipswich Bancorp in Massachusetts, said his bank's current rating system essentially mirrors the regulatory categories.

With just $85 million in assets, Mr. Morison said a small community banking company like First Ipswich probably doesn't have enough variety in its commercial loan portfolio to justify a significantly more elaborate risk-rating system.

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