Study QIS2). Since the majority of obligations held by the world’s banks are not rated
(see Ferri, et al. (2001)), for example, it is estimated that less than 1,000 European
companies are rated,^26 the retention of an unrated risk bucket is a major lapse that
threatens to undermine the risk sensitivity of BIS II.^27 Specifically, actual default data
on nonrated loans puts them closer to the 150% bucket risk weight than the specified
100% risk weight. In addition, low-quality borrowers that anticipate receiving an ex-
ternal credit rating below BB- have an incentive to eschew independent rating agen-
cies altogether, choosing to reduce their costs of borrowing by remaining unrated, but
thereby reducing the availability of credit information available to the market.^28
On a more fundamental basis, concern has been expressed about tying capital re-
quirements to external ratings produced by rating agencies. Ratings are opinions about
the overall credit quality of an obligor, not issue-specific audits.^29 There is a certain
3 • 8 BIS BASEL INTERNATIONAL BANK CAPITAL ACCORDSHigher
AAA–AA A BBB–BB Below B risk loans UnratedLarge banks in 6% 9% 11% 1% 1% 72%
G10 countries
Small banks in 11% 9% 6% 2% 2% 70%
G10 countries
Large banks in 6% 8% 8% 1% 1% 75%
the EU
Small banks in 8% 10% 5% 2% 2% 73%
the EU
Developing 7% 3% 4% 2% 3% 81%
countries
Source:“Results of the Second Quantitative Impact Study,” November 5, 2001a.
Exhibit 3.5. Quality Distribution of Corporate Exposures (138 Banks from 25 Countries
Participating in the QIS2 Survey)
(^26) For less developed countries, the proportion of companies with external credit ratings is much lower
than for developed countries. Powell (2001) reports that only 150 corporates in Argentina are rated, al-
though the central bank’s credit bureau lists 25,000 corporate borrowers. Thus, Ferri et al. (2001) surmise
that borrowers in less developed countries are likely to suffer a substantial increase in borrowing costs
relative to those in developed countries upon adoption of BIS II.
(^27) Linnell (2001) and Altman and Saunders (2001b) suggest that, at the very least, the unrated classi-
fication risk weight should be 150%. There is evidence that the failure ratio on nonrated loans is similar
to the failure ratio in the lowest (150%) rated bucket; see Altman and Saunders (2001b).
(^28) To mitigate this problem, Griep and De Stefano (2001) suggest that more unsolicited ratings be
used. German bank associations plan to pool credit data so as to address the problem of unrated small
and medium sized businesses. Because of the importance of this market sector to the German economy,
Chancellor Schroder has threatened to veto the BIS II proposal. (See The Economist, November 10,
2001.) Allen (2002b) surveys the special problems of credit risk measurement for middle market firms.
(^29) Moody’s in its ratings of about 1,000 banks worldwide uses a complex interaction of seven funda-
mental factors: (1) operating environment (competitive, regulatory, institutional support); (2) ownership
and governance; (3) franchise value; (4) recurring earning power; (5) risk profile (credit, market, liquid-
ity risks, and asset-liability management, agency, reputation, operational, etc.) and risk management; (6)
economic capital analysis; (7) management priorities and strategies. See Cunningham (1999) and
Theodore (1999).