Multi criteria credit rating (MCCR) : a credit rating

MCDM 2006, Chania, Greece, June 19-23, 2006

MULTI CRITERIA CREDIT RATING (MCCR): A CREDIT RATING

ASSIGNMENT PROCESS FOR ITALIAN ENTERPRISES ACCORDING TO

BASEL II

Francesca Bernè1, Mattia Ciprian2, Maurizio Fanni3, Daria Marassi1,

Valentino Pediroda2

1Eu-ra Europe Rating S.p.A

L.go Don Francesco Bonifacio, 1

34125 Trieste, Italy

e-mail:

franceca.berne@eu-ra.com

daria.marassi@eu-ra.com

2Dipartimento di Ingegneria

Meccanica

Università degli Studi di Trieste

via Valerio 10

34127 Trieste, Italy

e-mail:

mciprian@units.it

pediroda@units.it

3Dipartimento di Economia e

Tecnica Aziendale

Università degli Studi di Trieste

Piazzale Europa 1

34127 Trieste, Italy

e-mail:

maurizio.fanni@econ.units.it

Keywords: Basel II, probability of default, statistical analysis, Multi Criteria Decision Making, rating

Summary: A Multi Criteria Decision Making Model has been applied to solve the credit rating

assignment process following Basel II guidelines. In order to select the input parameters, the

integration of three different statistical methods has been employed. The model has been tested

on a database that is representative of the Italian companies system.

1. Introduction to Basel II, a credit rating assignment process and probability of default

Credit risk affects virtually every financial contract. Therefore the measurement, pricing and management

of credit risk has received much attention from practitioners who have a strong interest in accurately

pricing and managing this kind of risk and from financial economists who have much to learn from the

way such risk is priced in the market, and from bank authorities who need to design minimum capital

requirements that correctly reflect the credit risk of banks’ loan portfolios. Following the work of the

Basel Committee on Banking Supervision to reform the capital adequacy framework by introducing risksensitive

capital requirements, significant attention has been devoted to the subject of credit risk

measurement by the international regulatory, academic and banking communities.

The agreement called “International Convergence of Capital Measurement and Capital Standards” and

known as “Basel II”, the last version of which was published in June 2004, will be applied on a

consolidated basis to internationally active banks from January 1, 2007. According to Basel II, banks

should have a process for assessing their overall capital adequacy in relation to their risk profile and a

strategy for maintaining their capital levels. All material risks faced by the bank should be evaluated as

part of the capital assessment process, in particular: a) credit risk; b) operational risk which is defined as

the risk of loss resulting from inadequate or failed internal processes, people and systems or from external

events; c) market risk; d) interest rate risk in the banking book; e) liquidity risk; f) other risks. The

Committee proposes to give banks a choice between two broad methodologies for calculating their capital

requirements for credit risk. One will be to measure credit risk in a standardised manner, supported by

external credit assessments (by external agencies called ECAI - External Credit Assessment Institution).

The second methodology, which is subject to explicit approval of bank authorities, would allow banks to

use their Internal Ratings Systems (IRS) for credit risk. Two different IRS can be utilized: a) FIRBA

(Foundation Internal Rating Approach); b) AIRBA (Advanced Internal Rating Based Approach).

Three main variables affect the credit risk of a financial asset: (i) the probability of default (PD); (ii) the

loss given default (LGD) which is equal to one minus the recovery rate in the event of default (RR); (iii)

the exposure at default (EAD); (iv) the maturity (M).

Credit risk literature has given particular attention to the estimation of the first component, probability of

default, which includes credit rating assignment processes with adequate models and methodologies.

What is credit rating? Credit rating is an opinion of the general creditworthiness of an obligor (issuer

rating), or the creditworthiness of an obligor in respect of a specific debt security or other financial

obligation (issue rating), based on relevant risk factors. A different probability of default (within one year,

two years and three years) is associated with each credit rating category (indicated by symbols: traditional

AAA to D).

In the view of an agency, the rating process for an issuer-company includes the estimate of the financial

risk

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