Understand current methods of credit risk assessment to understand their advantages and disadvantage

The International Journal of Business Management and Technology, Volume 2 Issue 6 November-December 2018 ISSN: 2581-3889 Research Article

Open Access

Understand current methods of credit risk assessment to understand their advantages and disadvantages Nabil Bouayad Amine, Khalid Rouggani, Najib Somoue University professors University Hassan 1st- Settat - Morocco Kingdom of Morocco University Hassan 1st Laboratory of Economics and Management (LEG)

Abstract : Attheir creation, the rating agencies were like the news agencies because they published newsletters and were paying by contributions subscribers. That method of remuneration then evolved, and these are the debtors who have paid the agencies. Meanwhile, rating methods have gradually evolved to take into account the use of increasingly important to companies called sophisticated financial products such as structured products. Although the method of compensation has evolved, the activity of agencies has not changed and their responsibilities have remained for a long timethose news agencies, that is to say protected by freedom of expression.

Thus, for years, they have enjoyed a special status allowing them to express opinions without any legal constraint weighs on them. Indeed, unlike, for example, an auditor who certified the accounts and give "reasonable assurance" of their quality based on professional standards of practice; no methodology stress weighs on agencies.

However, their responsibilities have been initiated for the first time in the history of the rating, after the crisiss structured products. We see in this article how the agencies evaluate the risk of industrial and commercial companies (corporate) and financial institutions, as well as before ages and limitations of the current methodology used by credit rating agencies.

Keywords : Rating, Risk, financial assessment, business, financial institutions.

I.

Introduction:

Rating agencies have a crucial role in modern finance. Both informants of the creditworthiness of an issuer, they are a label guaranteeing everyone a given level of risk. Their skills extend to all issuers of bonds and even to structured products.

They thus enable States, local authorities, financial institutions and enterprises to finance. They also offer advice on their grades and specialized publications. They are involved in many areas. Besides their volume of business continues to grow. This, mainly because of the tremendous growth of the bond market, whose assets now reached the sum of 100,000 billion euros (Senate, 2012) in the world, nearly 50 years of French GDP! This market should also continue to grow, thanks to the States that substitute increasingly, debt to inflation. The credit rating agencies have managed to become an indispensable intermediate operation of the désintermédiarisée economy.

They therefore hold a "power" in the bond market and indirectly on the shares. First, it is explained because of their seniority. Indeed, from the early twentieth century credit reporting agencies are beginning to appreciate the railway companies. Then it is linked to the reputation they have forged with low levels of error. Finally, their strength comes from the regulation, which, for years, made them unavoidable. Indeed, lawmakers have long considered their reliable enough to note that they are used to distinguish between active risk levels. www.theijbmt.com

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Understand current methods of credit risk assessment to understand their advantages and disadvantages Yet their sales remain weak given the challenges posed by obligations. Thus, in late 2012, the three major agencies, such as Standard & Poor's, Moody's and Fitch, represent a cumulative revenue of approximately € 3.5 billion.

Their role has also been seriously questioned at major corporate failures of the early millennium (Enron, Worldcom, Tyco, Parmalat ...), or even during the Asian crisis. Today, they are criticized because of the role they played in the subprime mortgage crisis and sovereignty of the euro area. Thus, for the first time in history, lawmakers reshuffle in depth the rules applicable to them on both sides of the Atlantic.

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Components of the financial rating

All methods of rating agencies aim to assess the risk to an investor when buying a bond. Agencies assess, for this, the credit risk can be defined as "the possibility of a loss sustained by a lender on a credit transaction (loan, obligation, commercial debt, derivative)" (Paget -White, Painvin, 2007).

1) Credit Risk Overview Credit risk materializes in two different forms:  credit loss : Debtor's failure to pay the principal or interest;  the risk of migration : In the case of a listed duty, it will be the potential loss caused by the deterioration of the situation of the issuer.

This risk consists of three elements:  the amount at risk (Or exposure): that is to say, the amount that will be affected in the event of default by the debtor; o it is noted: EAD: exposure at default;  the risk of default : That is to say, the delay in the payment of a deadline of ser-vice of debt either to the interests or the principal; o we note the PD: probability of default;  the risk of non-recovery (Or severity of the loss of credit): that is to say the part of the debt that will not be collected by the creditor after the pro-hard liquidation. This risk is related to the level of respect of the debt (ju-nior / mezzanine or senior) and the existence or not of guarantees relating to the debt; o there is the LGD: loss given default.

Hope Credit loss (expected credit loss) is defined as: ECL = EADxPDxLGD Two parameters are added for measuring the credit risk of a portfolio:  the degree of correlation between the risk of default commitments;  the degree of portfolio concentration. financial assessment agencies aim to estimate the probability of default (PD) and loss severity rates (LGD). To do this, they measure the credit loss probability noted: PCL = PD x LGD. severity rate of loss is estimated through the covering note. Two other methods used to estimate these parameters. For one, the one developed by the KMV firm (owned by Moody's) which uses changes in share prices.

On the other hand, the one developed by Credit Suisse First Boston. The difference is that the agencies use a "long term" horizon, while these methods have "short-term" horizons.

The recovery rate is the single most difficult to estimate ex ante. Indeed, it is difficult to know the speed of the bankruptcy procedure and the capital loss that can undergo the company's assets, particularly in the case of a coverexchange obligations, which the valuation estimated at default.

Scoring is a tool to assess the probability of default for each rating level based on a given maturity. This is called the term structure of default probabilities. This is to use the tables published by the agencies that associate to each rating level, a default rate observed. Applying the risk of default (PD), the risk of non-recovery (LGD) shareholders, we obtain a term structure of credit loss probabilities.

As notes give both the risk of default (PD) and the risk of non-recovery (LGD) is required to isolate each term.

To define the default probabilities for a given level of non-recovery, use the ratings of the senior debt (or subordinated www.theijbmt.com

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Understand current methods of credit risk assessment to understand their advantages and disadvantages nor secured by assets). Then, to obtain the probability of credit losses (PCL), just apply the severity rate (LGD: obtained by the severity of note) at risk of default (PD) associated with each of the types of debt. The probability of default arises from default rate (D (Y)) over a year that we obtain: D𝑎(Y) =𝑁𝑜𝑚𝑏𝑟𝑒𝑑𝑒𝑑é𝑓𝑎𝑢𝑡𝑠𝑐𝑜𝑛𝑠𝑡𝑎𝑡és𝑎𝑢𝑐𝑜𝑢𝑟𝑠𝑑𝑒𝑙'𝑎𝑛𝑛é𝑒𝑝𝑜𝑢𝑢𝑛𝑒𝑐𝑎𝑡é𝑔𝑜𝑟𝑖𝑒𝑑𝑒𝑛𝑜𝑡𝑒 / Number of rated issuers earlier this year for a category of not The average one year default rate, is then computed over a period of T years to obtain fault expectancy associated with a rating category (E (D (Y)), which corresponds to the probability annual default (PDa (Y)):

This calculation takes into account all obligations across the planet. Figure 1 shows the default rate for bonds rated by Moody's for each category for the period 1994-2007. Thus, it says that an obligation has an average annual default probability of 1.3%. Over the period, the "investment" category has a default probability of 0.27%, while the speculative category has a probability of 5.7%. This rate is influenced by market conditions and therefore fluctuates depending on the study period.

Figure 1: average annual default rate obligation rating level from 1994 to 2007

source: Moody's Investor Service (2008) 2) fault current Concept, rates of survival, and defect density The figure 1shows an annual default rate, but it is also possible to calculate for other periodicities. A population of companies composed of Np (Y) individuals rated by the rating Mt Y. (Y) represents the number of companies with the Y notes at beginning of period p and that defaulted during the period p. then we can define the default intensity (dt (Y)) (instant or default rates) as the default rate between periods t and t + dt fault no condition at the beginning of year t .dt is obtained (y) by the following calculation:𝑑𝑡(𝑌) = 𝑀𝑡(𝑌) / 𝑁𝑡(𝑌).

3) spread Notion and migration risk In an efficient and liquid market debt saw its prices fluctuate based on two parameters: the interest rate without risk and the cost of risk in the credit quality of the issuer. the spread can be defined as the difference between the yield of risk-free debt and cost required by the market to finance the business. So there is a relationship between the rating and the spread of a business.

The stability of ratings over time, which can be evaluated through the transition matrices published by the agencies, allows us to understand this relationship. They are obtained from the history, for a given horizon, changes in ratings.

The agencies calculate the transition rate is the ratio between the number of rated entities Y + dY end of the period, and the number of rated entities Y early in the period. He appears in these tables for each rating notch, the probability www.theijbmt.com

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Understand current methods of credit risk assessment to understand their advantages and disadvantages distribution can take a note for a given time horizon. These probabilities are calculated from the average transition rates observed on samples.

Table 1: corporate transition matrix to a year for the period 1990-2011

Source: Fitch Ratings (2012) Note that in the previous transition matrix (Table 1), An obligation rated A earlier this year, has a probability of 91.79% of rated A stay at the end of the year.

The probability of going to AA is 1.99% and that of being degraded to BBB is 5.45%. This matrix shows stability over time, notes issued. This is consistent with the objective of the agencies noted through economic fluctuations.

Going further, can be determined the probability of migration of each obligation. This is the approach taken by JP Morgan for its method of assessing losses due to credit risk called CreditMetrics. migration risk is defined as "the extent of the impact of a default risk modification of a debt issuer in the value of that debt" (Paget-Blanc, Painvin, p.59, 2007). In the market, an average spread rating category can be observed. Then the point spread in cost and the likelihood of degradation can be determined for a security with a level of rating.

4) Relationship between notes and spread As we have seen, a credit spread is "the component of the spread that compensates the investor for the credit risk to which it is exposed" (ibid, p.60). This component is variable over time.

It is necessary to know the degree of correlation between a rating change and the evolution of the risk premium. Our study, which aims to determine the impact on the market signals sent by the rating agencies, measures the price fluctuations and thus, indirectly, the change in the risk premium in correlation with the emission of a signal .

The crises also influence credit risk. Several studies have examined the components that determine the spread levels. The results show that the main component is the risk of default. However, there are two complementary factors.

On the one hand, the study of Tampéreau and Teïletche (2001), spreads are sensitive to three temporary factors: the general level of interest rates, the growth rate of the economy and market volatility. On the other hand, they are influenced by the composition of the bond offering. Thus, the level of business-related spreads increases when their financing needs compared to believe state funding requirements.

The sensitivity of the spread to these other factors depend on its rating level. The square of the correlation coefficient (R²), called the coefficient of determination, is all the more important that the note is low. Thus, in a crisis, investors become more risk averse and stop buying risky securities. They are not buying that "good" signatures. This is the phenomenon of "flight to quality", which enabled France and Germany to borrow on financial markets to negative rates in the euro sovereign crisis. With this "influx" of capital, the "good" borrowers who then spreads down the "bad" are forced to increase their risk premiums. This is what happened to Greece, which eventually fail. Finally,

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corporate valuation methodology and financial institutions

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Understand current methods of credit risk assessment to understand their advantages and disadvantages The evaluation of companies represents the historical activity of rating agencies, initially through the evaluation of railway companies. Then, the business has diversified to extend to public bodies. The last major diversification to rating structured products. For this category, the methodology and the conflict of interest it engenders are highly criticized. He criticized the agencies biased, because the complexity of these products requires involvement with the management of the company. Since the beginning of the euro crisis, it is the sovereign rating at the heart of the debate: the agencies do not use good risk assessment methods. This is detrimental not only to rated companies, but especially in the financial market (Raimbourg, 2003).

We present in this section, the tools used to assess the default risk of companies and financial institutions: organizations for which we measure the reaction to signals from the Standard & Poor's.

1) The rating of industrial and commercial enterprises The assessment is based, firstly, on a qualitative analysis of the strategy and competitive position of the company and, secondly, on a quantitative analysis is a financial analysis. These analyzes are made on industrial risk and financial risk.

1.1) The industrial risk This is to assess the economic environment of the company and the risks it poses. Qualitative analysis is based on three elements presented below.

1.1.1) The area Analysts are specialized by industry. They determine the sector's growth capacity and level of risk. Cyclical sectors (such as automotive) are considered more risky than acyclic (such as food). More capital intensive (and therefore the BFR), the greater the risk is important.

Indeed, profitability depends on the situation while the capital is invested matter what. However, significant equity can also be a barrier to entry. The agency also assesses the added value of the company and its technology. The objective is to determine the competitive advantage or the arrival of a new risk of not mastered technology. In addition, regulatory risk is appreciated.

The rating incorporates the fact that the issuer belongs to a sector deemed strategic by the issuer establishment of State (such as weapons) or the propensity of countries to support firms in difficulty (such as France with support PSA and Renault with the scrappage scheme). Degradation of EDF AAA to AA in 2004, when its status was a public establishment to that of SA illustrates this.

1.1.2) The competitive position First, the analyst assesses the competitive situation with Porter's analysis. The objective is to determine the size of the market, identify the key players and their market shares, and to evaluate the possibility of new entrants. Then it compares the size of the company and its positioning relative to the competition. A leader has strategic benefits (economies of scale, learning effect, reputation ...) which directly affect its credit risk. Finally, it identifies risks and opportunities for the company and its time horizons. This, difficult to assess, often explains sudden deterioration observable type of corporate bonds.

1.1.3) The analysis of the strategy and direction Financial theory, the Capital Asset Valuation Model (CAPM), shows the importance of the diversification of a portfolio. Indeed, the expected portfolio risk is lower than the expectation of risk securities in the. An agency must evaluate the ability of the company to diversify its investment to protect the heritage of bondholders.

However, conglomerates are less valued than monoactivity companies. Securityholders consider that the diversification of risk, permitted by the conglomerate, is not as efficient as if they themselves were diversifying risk by directly holding the securities activities carried on. Therefore a discount of 10 to 20% is observed for these businesses (conglomerate discount). This is what justifies, moreover, the existence of spin off operations: the sum of the parts is worth more than the whole. Although this last point concerns the shareholders, the agency must be able to assess www.theijbmt.com

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Understand current methods of credit risk assessment to understand their advantages and disadvantages because, in the medium / long term, an action that lost value may cause difficulties of equity financing, which may aggravate the bond risk.

More pragmatically, the analyst evaluates the risk management strategy. It can be a diversification, vertical integration (ie d. A sector strategy), with a cost per domination strategy of differentiation or a positioning a niche market. For each of these choices, it determines the impact on the repayment ability. It is notorious for acquisitions financed by leverage. In addition, the agency systematically evaluates the performance of leaders.

1.1.4) shareholding If the shareholding is diluted, the company is a takeover bid thank you, which can change its credit quality. The considerations of the shareholders must be considered: is it an ownership interest in an immediate return or rather by taking a strategic stake?

If ownership is tied to the company, it is more prone to refinance in case of difficulty. This therefore limits the bond wealth transfer to shareholders. Nevertheless, a majority shareholder is tempted to take excessive amounts, at the risk of compromising the company's credit quality, if it is too powerful.

1.2) The financial risk This is to assess the solvency and liquidity of the company. The analysis focuses on two points made below.

1.2.1) The ability to generate cash flow Cash flow allow debt service. The analyst is based on the income statement and cash flow statement of the last five years. First, he retired the intermediate balances, to make the data from the French accounting internationally comparable. Then it determines a sample of comparable companies in the same industry or the same geographical area (peer group).

The ratios used depend on the field. This is for example the sales growth rate of added value ratio (VA / CA) or the return on capital (EBITDA / (gross fixed assets + WCR)). The different flows generated by the company are then distinguished: operating, investing and financing; what brings this analysis table recommended by the Institute of Chartered Accountants.

All flows of purchases and disposals of tangible or intangible assets are added to investment flows. Financing flows enable the identification of resources used by the company to finance its growth.

Nevertheless, the use of debt is always a bad signal to the analyst.

The latter is very sensitive to the CAPM financial theory which advocates an optimal financial structure, realized in part through the tax savings generated. This is explained by the fact that the analyst represents the interests of bondholders and not the shareholders.

1.2.2) Financial flexibility This is to assess the company's ability to face new financing needs without questioning payments to the bondholders. The analyst determines the seasonality of the business to finely estimate future cash flows. He distinguishes between two elements.

The first element is the solvency, that is to say in the medium and long-term financial flexibility. It depends on the level of debt, which explains that some agencies take into account the debt does not appear in French accounting (eg leasing). In addition, several ratios are calculated in order to relativize the part of the debt, which facilitates comparison with other organizations. The second element is the liquidity that is to say, the short-term flexibility. This is to measure the company's ability to face its financial obligations for a period less than one year. We must therefore compare the short-term needs (mainly BFR) to short-term resources.

The agency analyzes all made financial investments to determine their liquidity and their actual risks. It also assesses the quality of banks and their sufficient numbers. Finally, she is interested in the existence of alternative sources of liquidity rapidly mobilized. There are two kinds: unused credit lines and liquid assets that can be sold in crisis.

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Understand current methods of credit risk assessment to understand their advantages and disadvantages 2) The rating of financial institutions 2.1) Features of financial activity

Banks have a particular role: they finance the economy, why states seek to limit their bankruptcies. This results either in direct support when they encounter difficulties, either through protective measures for investors to limit bank runs (ie d. Stampedes causing the massive withdrawal and very fast money deposited by savers generating the bank's collapse).

This is the case of the deposit insurance scheme that provides to investors in case of bankruptcy, the state will be in solidarity with the amounts due. This moral hazard encourages players to take more risks in the absence of protection. In fact, parties to contracts with the banks are exposed to default risk if the state did not intervene.

Moreover, because of the principle of "too big too fail" banks seek to achieve scale to obtain an implicit government guarantee. Indeed, if the bank reaches a systemic size also allows it to benefit from economies of scale, it is almost certain to be bailed out in the event of a liquidity crisis. Agencies assess that support the environment through specific notes. They come as well, complement the banking supervision system implemented by States. In France it is the Prudential Control Authority, responsible for the supervision of banking and insurance.

Finally, in addition to capital reallocation of activity in the economy, banks also have a so-called "commercial".

They are also interim financial markets, it is then investment banks. Indeed, as part of the "finance désintermédiarisée" seekers and capital providers are in direct interaction. In this case, the bank meets the debtor's financing needs by raising capital on the financial markets.

Europe has always had a relatively integrated banking system. Large banks are called "universal" because they operate on these two sectors at once.

This situation has long been different in the United States since the Glass-Steagall act, passed in 1933, has established a strict separation of these two activities following the crisis of 1929. Moreover, it is this separation that allowed the development of very large investment banks like Goldman Sachs or Merrill Lynch. This rule, taken by Japan, was nevertheless softened by the United States in the mid 80s, in a deregulation movement before finally being repealed in the United States in 1999.

In this context, we understand the critical role of rating agencies. Indeed, investors do not have sufficient knowledge of the business to demand adequate compensation to the risk taken. However, banks have access to inside information about customers they finance, and get adequate remuneration to the risk taken.

So agencies reduce information asymmetries in the circuit of the said finance "direct". In addition, they reduce the cost of access to capital by spreading the cost of analyzes related to default risk across the financial community.

Moreover, it is this last point that has been the most hotly contested in Europe. They are accused of having created a moral hazard by allowing the financial community (mainly insurance companies and banks) to outsource part of their heart failure risk analysis of trade. The aim of the new regulation is to reduce this phenomenon.

2.2) The banks' default risk Unlike other businesses, the risk of default of a bank is not necessarily linked to its ability to meet debt service.

Indeed, many commercial banks have their own financial resources from deposits. Banks are thereforeconsideredfailing in twocases: 

First, when the resources are not sufficient for the jobs. It is the liquidity risk resulting in an inability of the bank to repay its financial obligations at any given time: for example, the reimbursement of deposits to customers or debt on the interbank market;

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Understand current methods of credit risk assessment to understand their advantages and disadvantages 

On the other hand, when capital becomes insufficient even when there is no default. This is the credit risk that a potential bankruptcy of the bank and which is embodied in equity below the threshold of the Basel regulations.

Indeed, capital must allow to absorb unexpected losses whilethat provisions must absorb expected losses.

2.3) The risks to banks Equity is the "heart" of the risk measure of a bank. Nevertheless, these funds may be depleted due to insufficient profitability. This explains why the agency appreciates the bank's profitability. It does so with a ratio that measures both the return generated by capital and the level of risk taken to achieve this rate of return. But the agency also assesses other risks specific to the banking business.

2.3.1)Credit risk This is the same risk as that borne by the bondholders. This risk may come from banking operations related to loans granted by the bank, market or treasury operations (in the case of the financial deterioration of an issuer of bonds) or a default of a bank on the interbank market.

2.3.2) Market risk This is the risk that a financial instrument has a price vary over time. It consists of several elements: the risk of changes in interest rates, the risk of changes in other assets (which can impact the price of the financial instrument), and foreign exchange risk if the bank is involved in several currency areas.

2.3.3) The risk of transformation The specificity of the bank's business is to generate higher sales outstanding. Indeed, banks transform shortterm liabilities (customer deposits) on long-term loans (loans). This exposes it to increased cost of short-term resources compared to the returns it gets long-term loans granted which can not be renegotiated (except for a variable rate loan).

This is the risk of transformation.

2.3.4) Operational risk It emanates from a human operator or a technical resource. This risk is more difficult to assess by the rating agencies.

2.4) Methodology applied in the banking business The analysis by the credit reporting agencies are certainly similar to that made for companies, it nevertheless differs because of the specificity of the activity of financial institutions (ie d. Finance the economy) and weight regulation. banks' rating is based on two criteria that are evaluated on two specific scales. It is the support of the environment and the intrinsic creditworthiness. These two criteria are then combined to obtain a long-term rating.

The4is the process of scoring.

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Understand current methods of credit risk assessment to understand their advantages and disadvantages Figure 2: rating process for financial institutions Country Ceiling (long-term scale)

Final Rate

Individual rating

Rating Floor (long-term scale)

Will of

Note

support

support

ability to support

Source: Paget-Blanc, Painvin (2007) Fitch assesses the potential support for a bank on a scale from 1 (very high) to 5 (no support). This determines a rating floor which depends on the strength of the institution providing support. This score represents the minimum rating that can be awarded to the bank on its long-term scale.

The agency also evaluates the capacity to implement the commitments without resorting to external support (intrinsic note). This quality is rated on a scale from A (high) to E (very weak) with intermediate scores (A / B, C / E, ...).

The final score is equal to the highest rating from the rating floor under the note of support and the score for the intrinsic quality. The notes of financial institutions can not, in general, be higher than the sovereign ceiling.

2.4.1) The support of the environment 2.4.1.1) Support from States and Institutions We have seen, in case of bank run, the states involved. This support also provides insurance to protect their partners in case of default. The state intervention is more likely that the bank is "too big to fail", that is to say that bankruptcy might cost more in taxpayer support.

The lack of support from the US government to Lehman Brother, precipitated the financial system in the socalled subprime crisis, and ultimately cost more costly to taxpayers than bankruptcy reorganization financed by public funds.

However, the US administration, despite the political risk posed such support, supported AIG after the failure of Lehman Brothers. The aim was to avoid a collapse of the system caused by banks losing credibility with AIG refinanced These would then collapsed in a cascade, then, this event would have spread to the so-called "real" economy (systemic risk) .

In Europe, such support is limited by the European Commission in order not to distort competition. However, it authorized in the past, rescue plans by getting in return privatization of the entity (Banco di Napoli or credit Lyonnais).

Moreover, the euro has changed the latitude of action of governments. Indeed, the central bank is under German control, completely independent of power, yet it is the only institution able to intervene effectively and

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Understand current methods of credit risk assessment to understand their advantages and disadvantages sustainably in the event of system failure. It can "inject" one hand in case of a liquidity crisis, currency via the interbank market, and, secondly, directly support a failing bank, and avoid cascading failures, playing lender of last resort role.

However, the state can still give explicit guarantees; which allows the bank to get the rating of the sovereign. It can also provide implied warranties, with, for example, a law guaranteeing its involvement in case of bank failure.

The agency therefore studied the regulations of the country to determine what can the state do to protect debtors. It assesses in particular the ability of the liquidator to implement this legislation. In addition, the state may also hold shares in the bank; the agency issues a rating even closer to hers that his participation is high.

In fact, the agency assesses the degree of intervention by studying the institutions of past reactions. She is also interested in the will of the state and its ability to act through its sovereign rating. It takes into account the note in local currency, because the support does not require converting currencies.

2.4.1.2) Support from owners

The agencies give much less importance to this support at one from public institutions. In fact, everything depends on the interests of the shareholders, composition (majority vs. minority), its financial strength and its rating.

The shareholder support takes two forms. First, in the case of a liquidation, the shareholder may be required to support the bank coverage of liabilities, again the legislation to assess this support. Furthermore, the shareholder can have a strategic interest in supporting the entity. The example of the strong relationship between automakers and their financial institutions worth quoting.

2.4.2) The intrinsic creditworthiness of the financial institution 2.4.2.1) The scale of the financial institution A large reduces the cost of financial resources, and spreads over a maximum of transactions, the significant costs of the information system (strategic heart of the banking industry).

2.4.2.2) The reputation Banks with a good signing able to reduce their cost money. First, the agency assesses the competitive position of the bank, it is to determine the place of the bank on its market (leader or challenger), market growth and its ability to be proactive.

It then assesses the impact of regulations on the markets. Indeed, it appears as an asset guaranteeing economic rent through a monopoly on the distribution of financial products (as was the case of the Livret A in France, reserved, lately, a few privileged institutions). Finally, it assesses the strategic, technical and management of the bank.

2.4.2.3) The quality of capital Equity can both seize opportunities through external growth operations, but also to absorb unexpected losses.

First, the agency is interested in equity from accounting standards, compared to the overall total assets. It assesses their "quality" based on the regulation of "Basel 2.5", which distinguishes several types of (the best are those included in Tier 1), and requires compliance with a ratio of 8%. The aim is to ensure coverage of different risks associated with banking.

The agency also evaluates the economic capital corresponding to the funds needed to cover maximum losses that may save the bank, if all the risks it is exposed, are realized.

As the capital increase with positive results, the agency is interested in profitability. It calculates the global and operational profitability (to remove non-recurring events), and brings the GOI to total assets (to eliminate the cost of risk). It compares net banking income to the weighted assets (or certain portfolios of financial securities) to determine the recurring performance and take into account the risk borne by the institution. Like all banks can not be compared with each other; it is necessary to separate the different activities of the bank (commercial, investment, market). For www.theijbmt.com

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Understand current methods of credit risk assessment to understand their advantages and disadvantages example, the balance sheet of a bank trading is more volatile (due portfolios valued at fair value) than that of a commercial bank.

Finally, the analyst is interested in operating expenses. It calculates the cost to income ratio, comparing operating expenses to net banking income. This measure estimates the revenue available to cover the cost of risk and reward shareholders.

Indeed, the cost of risk corresponds to expenses related to provisions (less amounts occasions) and credit losses recorded by the bank in its accounts. It is therefore compared with a ratio to the different asset classes.

The analyst ensures that all risks are well provisioned, and therefore, the cost of risk is an economic reality. This ratio represents the risk appetite of the bank and strongly impacts the rating.

2.4.2.4) The risks to the financial institution For commercial banks, credit risk stems from the granting of loans or guarantees to customers. The agency uses its own risk assessment models.

However, it uses data from the bank as the proportion of bad loans in the portfolio or provisions. It observes loan concentration to measure how would behave the portfolio in case of failure of the largest debtors.

Furthermore, the agency determines the probability of default of other banks are contractual partners with the financial institution on the interbank market.

The risk related to market activity depends on the exposure to market risks and foreign exchange (and their volatilities). The bank made three markets transactions. It can be simple broker, perform trading operations (purchasing securities to sell short-term); Finally, conduct proprietary trading. This activity is seen as the most dangerous, is not always speculation; it can also be hedging or arbitrage.

To measure the risk of liquidity, the agency assesses the likelihood that a bank is no longer able to meet its short-term maturities. First, it compares jobs with short-term resources, to ensure that the assets will be transferable in case of decline in short-term resources. Then it evaluates the additional resources mobilized in the event of a liquidity crisis. Finally, it uses the confidential information available to carry out this analysis by maturity to determine the liquidity gaps Aura to face the financial institution in the future.

Operational risk can not be assessed quantitatively. It is measured by a review of internal control procedures, segregation of duties and management quality. The objective is to know the risk of occurrence of a "Kerviel affair"; that is to say to a potential diversion of internal control rules by a team of individuals.

Finally, the risk of the assets and liabilities transformation is measured in several ways. First, the agency compares the financing of fixed rate assets to fixed-rate resources. If the assets are financed with floating rate resources, it determines the proportion and considers the interest rate risk it poses to the institution. It then evaluates the sensitivity of the banking book, that is to say how varied the economic capital to a 1% change in interest rates. It uses the value at risk (VAR).

This is to observe "the distribution of variations on a given frequency of the price of the instrument in time and stopped a confidence interval: banking regulation retains 1%. VaR is the potential loss caused by price changes having a cumulative probability of occurrence of 99% taking into account the variations observed in the past "(Paget-Blanc and Painvin, 2007, p. 147).

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Understand current methods of credit risk assessment to understand their advantages and disadvantages III-

Conclusions :



Credit risk has three components, namely: the amount at risk, default risk and the risk of non-recovery.



These three parameters can be assessed through the ratings assigned by rating agencies.



A credit rating allows a comparison point between securities of the same class. Agencies summarize this information into matrices that can be used to estimate the spread that must have a title because of the risk it poses to the investor.



The methods used by rating agencies, which are specific to each area (sovereign, corporate and financial institutions), taking into account the quantitative and qualitative aspects.



The environment of the issuer and its ability to get support are key criteria for credit risk assessment method.



Rating agencies reduce information asymmetries in the circuit of the said funds 'direct' because they allow investors to have access to the same analysis capabilities of the situation of a debtor banks. They reduce further the cost of access to capital by spreading the cost analysis related to default risk across the financial community.



The agencies create moral hazard by allowing the financial community (mainly insurance companies and banks) to outsource part of their heart failure risk analysis of trade. The aim of the new regulation is to reduce this phenomenon.



There is a discrepancy between the legal role of rating agencies and the use as collateral of these opinions by investors.



The signals sent by the rating agencies for financial institutions should have a stronger impact on the market that the signals on the corporate sector. This is due, firstly, the credit risk analysis outsourcing phenomenon that grows more institutional investors who hold securities of other financial institutions to follow the signals emitted by the agencies; secondly, the default risk is more difficult to evaluate for such entities, which encourages use multiple default risk assessment sources.

Bibliography : Blanchet, A., &Gotman, A. (2010). L’entretien. Paris: A. Colin.

Brissy, Y., Guigou, D., &Mourot, A. (2008). Gouvernance et communication financière. Paris: Eyrolles-Éd. d’Organisation : IFA, Institut français des administrateurs.

Didier, S. (2012). Les dessous du triple A agences de notation: récit de l’intérieur. Montreuil: Omniscience.

DE LA BRUSLERIE Hubert (2010), « Analyse financière – information financière, évaluation, diagnostic », Dunod, Paris.

Gaillard, N. (2010). Les agences de notation. Paris: Découverte.

Gerst, C., &Groven, D. (2004). To B or not to B: le pouvoir des agences de notation en question. Paris: Village mondial.

MOODY’S INVESTORS SERVICE (2010), « Rating methodology : global consumer durables », Paget-Blanc, É., & Painvin, N. (2007). La notation financière: rôle des agences et méthodes de notation. Paris: Dunod.

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Understand current methods of credit risk assessment to understand their advantages and disadvantages English academic article : BOYLAN Scott J. (2011), “Credit Rating Agency Reform - Insight from the Accounting Profession”, The CPA Journal, USA. LIU Cathy Zishang, ROWE Beverly J., WANG Ya-Fang (2012), “The Impact of Restatements on Credit Ratings and the Enron Industry-Peer Effect”, 11p, Journal of Accounting & Finance, USA. French academic article : BOUGUERRA Faïza (2008), « Réformes du cadre législatif et réglementaire des agences de rating », Revue française de gestion 2/2008 (n° 182).

DARBELLAY Aline, PARTNOY Frank (2012), « Agences de notation et conflits d’intérêts », 10p, Revue d’Economie Financière.

DEGOS Jean-Guy, HMIDEN Oussama Ben, HENCHIRI Jamel (2012), « Les agences de notation financière », Revue Française de Gestion.

GAILLARD Norbert (2011), « Quelles Réformes Pour L'industrie De La Notation Financière », Revue d’Economie Financière.

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