Internal ratings systems, implied credit risk and the consistency of banks' risk classification policies

Our analysis makes clear that not only the formal design of a rating system, but also the way in which it is implemented (e.g. a rating grade composition; the degree of homogeneity within rating classes) can be quantitatively important for the shape of credit loss distributions and thus for banks' required capital structure. The evidence of differences between lenders also hints at the presence of differentiated market equilibria, that are more complex than might otherwise be supposed: different lending or risk management “styles” may emerge and banks strike their own balance between risk-taking and (the cost of) monitoring (that risk).