Using Basel Ii to Facilitate Access to Finance: The Disclosure of Internal Credit Ratings

Abstract

The advancement of their risk management activities makes it profitable for major banks to rely on internal credit ratings to calculate Basel II capital requirements (IRB approach). Firms and, more generally, market participants would benefit from the disclosure of these ratings, as it would reduce their cost of capital and facilitate investment diversification. Banks, however, have no interest in making their data publicly available. This paper proposes a regulatory framework to efficiently solve this incentive issue. It first shows that there are net benefits in requiring the disclosure of internal ratings. The paper then sketches regulatory requirements that would minimize disclosure costs and interest group opposition. Banks opting for the IRB approach would have to provide their internal ratings to one of several regional entities. The latter would consolidate the data collected and giver each borrower a rating equal to the average of the ratings it gets from its lenders. The average rating would be disclosed to the public unless the borrower has opted for non-disclosure. Relying upon multiple regional entities may cause some uncertainty (a given firm may get diverging average ratings), but it would also reduce moral hazard effects and foster competition in the rating industry.