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

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Author Info
Roland Kirstein (Uni-Saarland)

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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.

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Paper provided by Berkeley Electronic Press in its series German Working Papers in Law and Economics with number 2001-1-1017.

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Handle: RePEc:bep:dewple:2001-1-1017

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Keywords: screening theory imperfect decision making credit worthiness tests

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References listed on IDEAS
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  1. Blum, Jurg, 1999. "Do capital adequacy requirements reduce risks in banking?," Journal of Banking & Finance, Elsevier, vol. 23(5), pages 755-771, May. [Downloadable!] (restricted)
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  1. Bertrand Rime, 2003. "The New Basel Accord: Implications of the Co-existence between the Standardized Approach and the Internal Ratings-based Approach," Working Papers 03.05, Swiss National Bank, Study Center Gerzensee. [Downloadable!]
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