Estimating probability of default and comparing it to credit rating classification by banks

Abstract

Credit risk is the main risk in the banking sector and is as such one of key issues for financial stability. We estimate various PD models and use them in the application to credit rating classification. Models include firm specific characteristics and macroeconomic or time effects. By linking estimated firms' PDs with all their relations to banks we find that estimated PDs and credit ratings exhibit quite different measures of firms' creditworthiness. Results also suggest that in the crisis banks kept riskier borrowers in higher credit grades. This could be due to additional borrower-related information that banks take into consideration in assessing borrowers' riskiness, to the lags in reclassification process or a possible underestimation of systemic risk factors by banks. [PUBLICATION ABSTRACT]