An Analysis of the Consistency of Banks' Internal Ratings

41 Pages Posted: 25 Jan 2017

See all articles by Tobias Berg

Tobias Berg

Frankfurt School of Finance & Management

Philipp Koziol

European Central Bank (ECB)

Date Written: January 24, 2017


Internal ratings-based models are used for a variety of important bank and regulatory decisions. Thus, model risk – the potential for different models to provide different probability-of-default (PD) estimates – is of crucial importance. Using a comprehensive dataset from 40 banks and 17,000 corporate borrowers from 2008-2012, we assess the consistency of internal PD estimates across banks. We find three main results. First, the variability of PD estimates for the same borrower across banks is large. Second, bank fixed effects explain 5% of the variation in PD estimates across banks, while 95% of the variation is idiosyncratic. For the 10 largest banks in our sample, reported regulatory capital ratios would change by a maximum of ±10%, equivalent to approximately 1 percentage point, when using average risk weights from all banks instead of risk weights based on banks’ individual PD estimates. Third, we explore various bank characteristics that explain the size of bank fixed effects.

Keywords: Internal Ratings, Basel Minimum Capital Requirements, IRB Approach, Bank Incentives, Bank Regulation

JEL Classification: G21, G28

Suggested Citation

Berg, Tobias and Koziol, Philipp, An Analysis of the Consistency of Banks' Internal Ratings (January 24, 2017). Journal of Banking and Finance, Forthcoming, Available at SSRN:

Tobias Berg (Contact Author)

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322

Philipp Koziol

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314

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