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Basel II, Sovereign Ratings and Transfer Risk External versus Internal Ratings by

By Stijn Claessens and Geert Embrechts


Basel II puts great emphasis on external ratings, including from rating agencies, to quantify credit risks, but it also allows financial institutions to use their internal risk ratings. This is also the case for international lending, but following recent emerging markets ’ crises, the quality of sovereign ratings has received much criticism. At the same time, little is known about the quality of internal ratings of country risk. Using data from a major international bank, we assess the relative performance of internal and external country ratings. We find that internal and external ratings are driven by similar factors and both underestimate “event risks”, but that external ratings are somewhat slower in adjusting to a financial crisis

Year: 2002
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