| | The Role of Support and Joint Probability Analysis in Bank Ratings - (Consultation Document) by Gerry Rawcliffe of Fitch Ratings
et.at. May 31, 2006 Executive Summary: Alone amongst the three major rating agencies, Fitch has a track record of explicitly giving an opinion on the two major components of bank default risk, namely the stand-alone risk of the bank getting into difficulties, and the likelihood of it then being supported by a third party, either the state or an institutional owner. Indeed, Fitch has been doing this since 1980, when it first introduced its Individual and Support ratings.
In 2003 Fitch concluded a major review of its Support rating methodology. This involved a number of significant enhancements which have been welcomed by the market. These included the move to a fully ordinal scale, the introduction of explicit support floors for traditional debt ratings, and greater methodological transparency.
However, the world of credit ratings does not stand still, and Fitch, therefore, committed in March 2006 to undertake a further review of the role and use of Support ratings in the light of recent developments in credit rating theory and practice. Fitch is now seeking industry feedback on the extent, if at all, to which the existing methodology should be revised.
Fitch has looked at the possibility of joint probability analysis (JPD) playing a greater role in determining bank ratings in the past, but has discounted the approach for a number of reasons including: lack of data, potential ratings compression, correlation issues and increased ratings volatility.
That said, a statistical analysis of Fitch's universe of bank ratings shows that at a portfolio level, the existing combination of Individual, Support and Issuer Default Ratings is reasonably consistent with JPD-derived results. Specifically, roughly 75% of ratings under a ‘pure' JPD approach are within one notch of their actual published rating. Download paper (140K PDF) 12 pages
The Role of Support and Joint Probability Analysis in Bank Ratings - (Outcome of Consultation) by Gerry Rawcliffe of Fitch Ratings
et.at. July 25, 2006 Executive Summary & Conclusions: On 31 May 2006 Fitch published a consultation paper "The Role of Support and Joint Probability Analysis in Bank Ratings" inviting feedback from the market during a consultation period that closed on 30 June 2006. This paper presents the results of that consultation, leading to the following conclusions:
1. Although Fitch recognises the conceptual validity behind joint probability analysis, it also recognises the severe practical limitations, and, on this basis, Fitch has rejected the adoption of a JPD model methodology for assigning its bank ratings.
2. Fitch will continue to base its bank ratings on its current judgment based methodology, utilising the widest possible range of input variables, some of which are more easily quantifiable than others. Where models can assist this process they will be utilised.
3. Fitch will continue to research and publish material related to the role of external support in bank ratings, and will continue to provide the market with the explicit Support and Individual ratings with which it has become familiar. Specifically, Support Ratings will continue to set rating floors for bank LT IDRs.
4. Fitch will continue to evaluate whether external support is sufficiently factored into its ratings in the light of inter alia potential changes to supporter behaviour, fixed income market practice and expectations, and the availability of empirical data.
5. On the latter point, Fitch is committed to providing the markets with bank specific failure and default rates in order to facilitate transparency in this discussion. Special Report The Role of Support and Joint Probability Analysis in Bank Ratings. Download paper (62K PDF) 4 pages
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