2002. “Analysis of Procyclical Effects on Capital Requirements Derived from a Rating System.” Working Paper

In the new universe of credit risk created on the basis of the current proposal of reform of the 1988 Capital Accord, ratings assessing borrowers ’ credit quality play an essential role. There is a vast literature on the analysis of ratings obtained from external rating agencies. However, very little has been said and done, so far, with respect to those calculated from internal systems. In this paper we propose a simple quantitative method based on obligors ' financial information and default data to estimate a rating system for the Spanish non-financial private-sector firms over the 1993-2000 period (almost an entire business cycle for the Spanish economy). As a consistent implementation demands that risk is measured adequately, special attention is dedicated to the sectoral analysis of the firms included in the sample. Additionally, as macroeconomic considerations are central in the new Basel Capital Accord, we also introduce the underlying economic activity as a fundamental part of the estimated system for the analysis of its impact on the quality of the credit portfolio. The particular transformation of each borrower's financial data regarding its economic activity permits a very intuitive interpretation of the common factor (identified with the business cycle) that equally affects the credit quality condition of every obligor included in the sample. As an additional by-product, and based on the results of the rating system, a crucial element is attained: the transition matrix. These matrices allow for the analysis of the credi