Acuité understands that development of a rating model is not a one-time exercise. It requires continuous updates and back-testing. With rising NPAs and stressed assets, the need to strengthen risk management practices and the credit appraisal process becomes important. This will enable institutions to keep up with the changing business environment.

It is believed that the current rating models used by banks/Financial Institutions (FIs) for credit assessment have a strong element of subjectivity which includes individual perceptions and beliefs, lack of adequate training and exposure among others. This clearly exposes the process and outcome to risk of subjectivity.

Hence, a rating model needs to take into account the changing business climate and economic scenario. Validation is an ongoing process of identification of limitations of a model and implementation of improvements. Rating Model validation will ensure that the model provides an objective, standardised and robust assessment.

The broad framework adopted by Acuité for conducting Rating Model Validation is as follows:

• Understanding of risk management practices in through interactions at various levels from General Manager to the credit analyst
• Evaluation of the components of the risk model viz. industry risk, business risk, management risk and financial risk to check for elements of subjectivity and align the same with best rating practices
• Comparison of the rating outcome with ratings assigned by Acuité and the industry trends for certain common cases
•  Calculation of key parameters of the evaluation model such as Gini coefficient, Significance analysis , PD and Transition matrix

Statistical models are built with data and they have the added benefit of quantifying the probability of default. Hence, a lot of emphasis is also given on Statistical methods for validating and revamping the model.