sectors and type of product in which they are active, or tailored to those segments that merit closer scrutiny during the visit. For example, for borrowers whose credit quality has deteriorated, banks’ largest obligors and connected borrowers could merit a more thorough review. When PCRs register individualized credit operations, they can produce samples to evaluate how new credit policies or financial products are impacting the bank’s risk profile, and if this is consistent with their credit strategy.

For prudential purposes, in many countries regulatory frameworks set a criteria or mandatory rating system that banks must use to risk classify their borrowers and to compute loan loss provisions. Increasingly, though, they are allowing banks to use their own rating systems for those purposes. At times they require these particular banks to map their grades into a single and homogeneous scale that allows performance comparisons across banks. In either case, during on-site inspections bank supervisors examine the reliability and robustness of banks’ risk rating processes and systems and, in particular, whether they are underestimating default risk. Banks’ portfolio samples obtained from PCRs should look for inconsistencies or abnormalities in rating systems or rogue credit policies.<sup>22</sup> For example, they should flag and track refinanced/restructured credits to monitor their payment behavior. It is also helpful that samples cross check risk ratings assigned by different banks to the same borrower: significant and systematic differences should be deemed abnormal and should trigger the necessity for further revisions.

# _Off-site monitoring_

Bank on-site examinations can be highly demanding in time and resources for both the supervisor and the inspected institution, and consequently are conducted at periodically timed intervals. Off-site monitoring procedures are thus an efficient aid for an effective ongoing supervision, allowing supervisors to monitor banks and observe how their risk profile evolves between inspections, with the possibility to promptly identify changes in their financial condition.

Besides its usefulness for conducting on-site supervision, PCR data can support continuous off-site bank monitoring. PCRs databases can be programmed to produce regular, timely supervisory reports (for internal use) containing key risk indicators that summarize banks’ exposure to credit risk. At the minimum, they should characterize the overall quality of a bank’s portfolio and of its various segments, depicting with particular detail the risk profile of the largest borrowers. These reports can also measure bank exposure to concentration risk by type of borrower, region, business sector, credit type, etc. It is important that they indicate the extent of connected lending and verify banks’ compliance with prudential regulation for borrower risk classification. This can be accomplished by comparing the rating for the same borrower in different banks or computing transition matrices to benchmark the deterioration of a bank’s portfolio relative to other banks.

In recent years, bank supervisors have been modernizing their toolboxes for assessing banks’ financial performance and risk profile, adapting diverse credit risk management methods that had been introduced or developed by the banking industry. This has

> 22 When revising a bank rating system, the supervisor may wish to perform some tests of discriminatory power and calibration with PCR data to assess the reliability of that model. For further details see section below on Basel III.

8