The quality and accuracy of bank internal rating model. A case study from Czech Republic

Abstract

Credit risk is one of the most important risk in commercial banking. The commercial bank uses a range of methods and procedures for credit risk management. To access the credit quality of the clients, internal rating models are used by commercial banks. In this article we define theoretical aspects of quality of internal rating model and evaluate potential risks of rating process. In the case study the accuracy of a concrete rating model has been experimentally confirmed, which is used by commercial bank in the Czech Republic for the segment of small and medium-sized enterprises. Internal rating models represent banks' effort to assess objectively the credit quality of the borrower. Previous experiences from banking sector show that this process is necessary to optimize by adding other activities because the quality of this rating models is limited. Aim of our experiment was to verify the quality of concrete internal rating model, which is used by concrete bank in Czech Republic to assess the quality of borrowers in the small and medium sized-enterprises. Results of our experiment are surprising. The model evaluates an excellent company as a negative subject. The model is less sensitive on significant changes in key financial indicators to determine the loan repayment. Our experiment has been proved the fact, that the most important impact on the level of company's final rating has the financial parameter - profit. Other parameters like assets, revenues and long-term liabilities have demonstrated only minimal impact on the level of company's final rating.