Prototype risk rating system

This paper explores the traditional and prevalent approach to credit risk a ssessment the rating system. We first describe the rating systems of the tw o main credit rating agencies, Standard & Poor's and Moody's. Then we show how an internal rating system in a bank can be organized in order to rate c reditors systematically. We suggest adopting a two-tier rating system. Firs t. an obliger rating that can be easily mapped to a default probability buc ket. Second, a facility rating that determines the loss parameters in case of default. such as (i) "loss given default" (LGD), which depends on the se niority of the facility and the quality of the gurantees, and (ii) "usage g iven default" (UGD) for loan commitments, which depends on the nature of th e commitment and the rating history of the borrower. (C) 2001 Elsevier Scie nce B.V. All rights reserved. JEL classification. G21; G33.