The Role of Non-Financial Factors in Internal Credit Ratings

Abstract

Internal credit ratings are expected to gain in importance because of their potential use for determining regulatory capital adequacy and banks' increasing focus on the risk-return profile in commercial lending. Whereas the eligibility of financial factors as inputs for internal credit ratings is widely accepted, the role of non-financial factors remains ambiguous. Analyzing credit file data from four major German banks, we find evidence that the combined use of financial and non-financial factors leads to a more accurate prediction of future default events than the single use of each of these factors.

Keywords: Credit risk, Credit ratings, Debt default, Probit analysis

JEL Classification: G21