When is a Supervisory Recognized External Rating Worthwhile for a Medium-Sized Enterprise and its Bank? – An Empirical Analysis Against the Background of Basel III

Abstract

In Germany, more than 95% of the credit institutions report their regulatory capital requirements for counterparty risk by means of the credit risk standardized approach (CRSA) instead of the more sophisticated internal rating based approach (IRBA). Though the CRSA allows a partially risk sensitive calculation of the banks’ regulatory capital German CRSA-banks cannot benefit from this provision as only around 100 non-financial companies have the required published agency rating on hand. We examine, whether the upcoming re-regulation of the banking business Basel III is a driver for both CRSA-banks and their preponderantly medium-sized corporate borrowers to push the use of external corporate ratings. Evaluating a unique sample of 26,025 data sets of German medium-sized companies, we find that under the provisions of Basel III CRSA-banks may experience only minor savings of about 0.5 billion euros in their regulatory capital if their corporate customers had a supervisory recognized rating available. Projected to the total population of German corporates, the exposures of around 9,000 of them potentially qualify for lower risk weights within the CRSA, while estimated 200 are eligible for financial benefits that match or even overcompensate the incurred costs of an external rating. Respectively, for the majority of German companies the benefits of such ratings rather reflect improvements in strategic management issues than lower financing costs.