The New Basle Accord, Internal Ratings, and the Incentives of Banks

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German Working Papers in Law and Economics

AUTHOR:
Roland Kirstein

TITLE:
The New Basle Accord, Internal Ratings, and the Incentives of Banks

SUGGESTED CITATION:
Roland Kirstein (2001) "The New Basle Accord, Internal Ratings, and the Incentives of Banks", German Working Papers in Law and Economics: Vol. 2001: Article 11.
http://www.bepress.com/gwp/default/vol2001/iss1/art11

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ABSTRACT:
In its recent proposal for a new Basle Accord, the Basle Committee favors external ratings to determine the risk class of potential borrowers. German banks, however, would prefer the acknowledgement of their internal ratings. This paper shows that, even if banks have better screening skill than external rating agencies, they lack the incentives to reveal their screening results truthfully. As long as these incentives are not corrected, external ratings would be better able to implement the new Basle Accord's goals than internal ratings. Supervision of internal ratings, even if it is imperfect and takes place only occasionally, may correct the banks' incentives. This yet requires that a fine can be imposed on internal ratings that are identified as wrong.