The report, titled âKey Factors in Developing, Enhancing and Validating Internal Ratings Systems for Internal Ratings Based Approaches Under Basel II Using Standard & Poorâs Ratings Default Dataâ, outlines how Standard & Poorâs rating default data can be mapped accurately and consistently by banks using internal rating scales to calculate economic and regulatory capital. It also draws attention to the various qualitative and quantitative factors required within a credit risk assessment framework and how to weight or combine these accordingly.
The treatment of qualitative credit factors such as industry risk, market position and management quality in a template or model, and the application of these factors to the private, unrated segments of low default portfolios, present particular challenges that can easily lead to significant divergence in outcomes between an Internal Ratings Based-system and S&Pâs ratings, says Paul Waterhouse, managing director of Standard & Poorâs Risk Solutions.
âLow default sectors present a particular challenge for Internal Rating System development and validation due to either the limited number of defaults or small sector sample sizes on which to develop models based purely on a bankâs historical default experience, â Mr Waterhouse adds.
âThe stability across geographies and sectors of Standard & Poorâs ratings default histories provides an alternative data set to help meet this data gap.â