Transitioning From Internal Risk Ratings to Probabilities of Default
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Overview: How objective are your Risk Ratings? Every lender uses them. Do you use a scale of one to five, or letter grades with the occasional “+” thrown in to further complicate matters? The algorithm behind many risk rating approaches is typically no algorithm at all, but rather a subjective process that can mean different things to different people. With heavy emphasis placed on the quantification of credit risk in recent years, it is increasingly important to take a scientific approach when determining portfolio risk. By quantifying key risk descriptors and probabilities of default as part of your risk model, you can remove some of the subjectivity from the risk process and more accurately measure both individual loan risk and overall portfolio risk.