Comparison of Bank Credit Ratings Assigned by Rating Agencies

1. Comparison of Bank Credit Ratings Assigned by Rating Agencies Alexander Karminsky Vladimir Sosyurko Alexander Vasilyuk National Research University “Higher School of Economics” Moscow, Russia EBES 2011 CONFERENCE - ISTANBUL June, 1-3

2. Agenda • Problem of credit rating comparison • Rating agencies in Russia • Multiple mapping of rating scales. Concept & Development • Data gathering & Results • Conclusion Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

3. Purpose and constraints of credit ratings • Ratings are the independent estimates of: • financial performance of companies, banks or financial instruments • issuer’s creditworthiness (credit risk) • admission to various market products or activity • Ratings are the interest for business entities and market participants, as far as for the authorities and regulating organizations (Central Banks, Ministries of Finance, Deposit Insurance Agencies, etc.) • Limitations and constraints for ratings: • Low number of current relevant ratings • Problem of rating comparison for different rating agencies • Absence of multiplicative effect from presence of competitor’s rating estimations • Requirement for expanded use of independent rating estimations Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

4. Problem of rating comparison • Most relevant: • Possibility of comparison of various agency ratings • Diversified estimations with use of rating modeling • Lacks: • Only pair comparisons are used, scales’ correspondences are incompatible, displays are linear and use of econometric potential is limited • No settled approaches to rating scales comparison • Conclusion: required considering all restrictions on arrangement, data accessibility, etc. Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

5. Rating agencies in Russia 7 agencies = 3 international & 4 national 596 ratings at the end of 2010 Number of bank ratings 259 358 454 604 596 2006 2007 2008 2009 2010 Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

6. Concept of multiple mapping • Increase of comparison reliability of scales mapping by using all available statistical information (in time, on agencies, scales and structures) • Development of the database that includes ratings, financial and macro-indicators • Econometric exposure of the most significant publicly accessible explanatory variables that have an influence on ratings • Creation of a base scale for mapping transformation of all compared agency-ratings • Building up a criteria of scales correspondence, considering the peculiarities of explained component • Determination of mapping parameters using the optimization procedures. Carrying out the comparison of rating scales • Verification of criteria and estimation of parameters for scales conformity. Analysis of time dynamics and trends • Forming the methodical and practical basis for regular monitoring, modeling and verification of rating models Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

7. NS1 RS1 F1(α1) RatingScales NumericScales Fi(αi) BS RSi NSi Base Scale RSN FN(αN) NSN Comparison methods and base scale • Comparison methods for rating scales include: • Methodology and principles of mapping of rating scales • Criteria for comparison of rating scales (Mathematics) • Econometric models for scales’ comparison • Audit of the “conformity table” and the coordination of its structure • Comparison methods are concluded to have: • Choice of a base rating scale • Mapping system for displaying external and internal ratings into a base scale • Application to each class of rating entities (banks, companies, etc.) • Allowing simultaneous use of all independent rating estimations Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

8. Rating modeling (Ordered probit models) where xi– is a set of independent variables • Rating is a depended variable y • Less values of y are connected with higher agency-ratings • Ratings are represented as a numeric scale: 12+ grades Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

9. Research data • 10 rating scales: • 4 national rating agencies • 3 international agencies (3+3) • Time period: 1q2006 – 4q2010 (20 quarters) • 370 Russian bankswith at least 1 rating during this period • Total 7400 observations of banks Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

10. Numerical scales Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

11. Criteria for choosing the mapping function Q– set of allobservations {t – period of time, j – bank, Ri1jt– Moody’s rating (base scale), Ri2jt– rating of another agency } t = 1, … , T j = 1, …., K Fi1 : Ri → Rbase Fi = αi1 ∙ fi (Ri) + αi2 fi – linear, polynomial, logarithmic function that transforms rating into a base scale Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

12. Mapping function Multiple mapping into the base scale: • linear • logarithmic • polynomial (up to 5th power) Moody’s – S&P Moody’s – Moody’s (rus) Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

13. Logarithmic model of multiple mapping Logarithmic model for2006-2010 years: Moody’s credit ratings (R) and default probabilities (PD) of banks are approximatedby a logarithmic dependence during the years 1980-2008 M = const∙Ra↔ Ln(M) = a∙Ln(R)+b PD = 0,000218×R3,8 PD(%) R Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

14. Rating comparison (logarithmic scales) NRA Rus-Rating Expert RA AK&M Fitch (rus) Fitch S&P (rus) S&P Moody’s (rus) Moody’s Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

15. Comparison of international banks • 3639 pairs(Moody’s – another agency) • Bank data 1995 – 2010 • 290 different banks Fitch S&P Moody’s Credit rating’ comparison for scales of international agencies(logarithmic model) Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

16. Conclusion • Econometric models for ratings play significant role due to IRB Approach and other Basel II recommendations and should be developed • Scientific and practical basis of using econometric rating models for bank risk management is discussed • Comparison method of ratings of different agencies lies in the basis of Unified Rating Space modeling system • Scales Mapping Concept and methods are built • Including the criteriafor choosing the function of transformation of rating value into the base scale • Comparison of credit ratings has been performed • Models were verified by international bank data and other mapping approaches • The main problems are DATA, MONITORING and VERIFICATION of models Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL

17. Q & A Alexander Karminsky, Prof., Dr. AKarminsky@hse.ru karminsky@mail.ru Vladimir Sosyurkovsosyurko@mail.ru Alexander Vasilyuk a.a.vasilyuk@gmail.com Higher School of Economics (HSE) Moscow, Russia Thank you for your attention! Karminsky, Sosyurko, Vasilyuk - Comparison of Bank Credit Ratings Assigned by Rating Agencies EBES 2011 CONFERENCE - ISTANBUL