LO 19.6: Compare agencies ratings to internal experts-based rating systems.
A rating agencys assignment processes will be different than the internal classification methods used by banks, even though the underlying processes are often analogous. Relative to a formal approach, such as quantitative analysis based on statistical models, experts-based approaches are neither considered to be inferior nor superior. An experts-based approach relying on judgment will require significant experience and repetitions in order for many judgments to converge. Also, the challenges of such an approach include the dynamic nature of organizational patterns; M&A activity, which blends portfolios and processes; and
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Topic 19 Cross Reference to GARP Assigned Reading – De Laurentis et al., Chapter 3
changing company cultures. A predictive performance that may work in one period is not necessarily indicative of future performance. Also, internal credit rating systems are difficult and time-consuming to develop. However, having a reliable internal system represents a significant value added for an entity.
In terms of the criteria for a good rating system discussed earlier, the following comparisons can be made between agencies ratings and internal experts-based rating systems:
Objectivity and Homogeneity. Agencies ratings are 73% compliant, while internal experts-
based rating systems are 30% compliant. Specificity. Agencies ratings are close to 100% compliant, while internal experts-based rating systems are 75% compliant.
Measurability and Verifiability. Agencies ratings are 75% compliant, while internal
experts-based rating systems are 25% compliant.
S t r u c t u r a l A p p r o a c h e s v s . R e d u c e d F o r m A p p r o a c h e s