No. 55 - Rating the Raters. A Central Bank Perspective

We use the Bank of Italy's credit assessment system for non-financial corporations as a benchmark to assess the ratings assigned by commercial banks through their own internal systems, which are also used for monetary policy purposes. We examine the distribution of ratings on bank loans pledged as collateral in monetary policy operations in Italy and test for underreporting of risk, which might generate unwarranted exposure for the central bank. The rating systems of commercial banks and of the central bank both show satisfactory discriminatory power and predictive ability, suggesting that they evaluate credit risk adequately. We find that banks' models are, on average, slightly less conservative than the central bank model for borrowers with loans eligible as collateral. We observe only some mild evidence of low economic significance that banks may strategically manage the credit risk assessment for borrowers whose loans are pledged. We find no evidence that banks using more central bank liquidity are more lenient in assigning default probabilities to their debtors.