Are Bank Ratings Coherent with Bank Default Probabilities in Emerging Market Economies?

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Are Bank Ratings Coherent with Bank Default Probabilities in Emerging Market Economies?

by Christophe J. Godlewski of LaRGE, Université Robert Schuman

August 31, 2004

Abstract: In this paper we investigate the coherence between bank ratings and default probability in emerging market economies using scoring and mapping techniques. In order to achieve its disciplining role, the rating should be coherent with the default risk it summarizes and disseminate. This issue is particularly crucial in emerging economies where under-developed financial markets, banking sector accrued opacity, and inadequate regulatory, institutional and legal environment affect banker's risk taking behavior and bank's default risk. Scoring results show a correct quantification of agency rating grades and thus their coherence. Mapping results show a tendency of the rating to aggregate bank's default risk information into intermediate low category grades.

JEL Classification: C35, F39, G21.

Keywords: emerging market economies, default probability, bank rating, scoring and mapping methods.

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