Calculation for a Credit Risk Rating Model

Identify Key Credit Factors:

Determine the key factors that influence creditworthiness.

For simplicity, let's consider three factors: Payment History, Debt-to-Income Ratio, and Credit History.

Assign Weightage: Assign weightage to each factor based on its importance.

Let's assign equal weightage of 33.33% (or 0.3333) to each factor.

Calculate Individual Scores:

Assign a numerical score to each factor based on the borrower's information. Use a scale of, for example,
1 to 10, with 1 being the worst and 10 being the best.

a. Payment History: If the borrower has a consistent history of on-time payments, assign a score of 10. If
there have been occasional late payments, assign a lower score accordingly.

b. Debt-to-Income Ratio: If the borrower's debt-to-income ratio is low (indicating a lower level of debt
relative to income), assign a higher score. If the ratio is high, assign a lower score.

c. Credit History: If the borrower has a long and positive credit history, assign a higher score. If the
credit history is short or has negative remarks, assign a lower score.

Calculate Weighted Average: Multiply each factor score by its corresponding weightage, and then sum
the weighted scores.

Weighted Score = (Payment History Score * Weightage) + (Debt-to-Income Ratio Score * Weightage) +
(Credit History Score * Weightage)

Assign Credit Rating: Map the weighted average score to a credit rating scale.
For example:

Score above 8.5: Excellent Credit Rating

Score between 7.5 and 8.5: Good Credit Rating

Score between 6.0 and 7.5: Fair Credit Rating

Score below 6.0: Poor Credit Rating

Illustration of a Credit Risk Rating Model with step-by-step calculations. We'll consider the following
inputs:

Financial Ratio 1 (FR1): 0.5

Financial Ratio 2 (FR2): 0.8

Financial Ratio 3 (FR3): 0.6

Weight for FR1: 0.4

Weight for FR2: 0.3

Weight for FR3: 0.3

Step 1: Calculate the weighted score for each financial ratio:

Weighted Score for FR1 = FR1 * Weight for FR1

= 0.5 * 0.4

= 0.2

Weighted Score for FR2 = FR2 * Weight for FR2

= 0.8 * 0.3

= 0.24
Weighted Score for FR3 = FR3 * Weight for FR3

= 0.6 * 0.3

= 0.18

Step 2: Sum up the weighted scores to calculate the overall Credit Risk Rating Score:

Credit Risk Rating Score = Weighted Score for FR1 + Weighted Score for FR2 + Weighted Score for FR3

= 0.2 + 0.24 + 0.18

= 0.62

Step 3: Determine the Credit Risk Rating based on the Credit Risk Rating Score. Let's assume the
following rating ranges:

Excellent: Score above 0.8

Good: Score between 0.6 and 0.8

Fair: Score between 0.4 and 0.6

Poor: Score below 0.4

In this case, the Credit Risk Rating Score is 0.62, which falls in the "Good" range.

So, based on the calculations, the Credit Risk Rating for this borrower would be "Good." Please note that
the weight assignments, score ranges, and rating categories can vary depending on the specific Credit
Risk Rating Model being used.