Source: The Financial Executive, June 2009, nr. 45, www.feib.be
Small- and medium-sized enterprises (SMEs) are a major contributor to the creation of wealth in our developed economies. In industrialized countries SMEs account for more than 90 percent of all firms, employ about two-thirds of the workforce, and contribute to nearly 50 percent of value added in non-agricultural production. Like most active participants to the real sector of our developed economies, SMEs need access to funds in order to operate and to grow. It is well known that given their size, SMEs do not have a direct access to the money and capital markets. Their access to funds mainly depends on the banking sector. Without efficient bank lending, the development of SMEs will be hindered materially. Thus, the way banks price the funds they provide to the SMEs is of prime importance to guaranty an orderly economic development.
One of the highest risks a bank faces is the risk that one of the bank’s counterparties goes into default, not repaying interest and/or principal. A solid framework for measuring credit risk is therefore of the utmost importance to a bank to manage its credit risks properly and to minimize its expected and unexpected losses. Moreover, a good risk framework is vital to become compliant with the Basel II framework. The Basel II Internal Rating Based (IRB) approach requires banks to have an internal measure of credit risk, to determine the probability of default (PD) of their counterparties.
In this article, we address two main approaches to credit risk modeling: the traditional models and the structural form model approach. For privately held firms with no market data available, accounting-based traditional credit scoring models are the most common approach. Although these scoring models have well known disadvantages, it remains the most effective and widely used methodology for the prediction of default of private companies. The main disadvantages are the fact that ratios might correlate with each other which affects the results, and when using comparative ratio analyses, one must recognize differences between firms, for example use of different methods of accounting or methods of operations. The goal of this research is to develop a PD model for SMEs, using the structural form model approach, and to test the applicability in practice.
Published on 27/12/2010
