Keywords: Business loans, risk ratings
Abstract: In recent years many banks have attempted to improve the measurement and
management of credit risk by assigning risk ratings to business loans.
Virtually all large banks now assign such ratings. However, until recently
there has been little information on the use of risk ratings by smaller
banks. Recent revisions to the Federal Reserve's Survey of Terms of Business
Lending and telephone consultations with more than 100 banks on the survey
panel provide data on the prevalence and precision of risk rating systems at
banks of all sizes. We find that the use of risk rating systems is quite
widespread, but that smaller banks generally have less detailed systems than
do larger banks. In addition, the new survey data allow us to asses the
relationships between loan risk ratings and loan terms. Not surprisingly,
riskier loans generally carry higher interest rates, even after taking
account of other loan terms. There are more complex relationships between
loan risk and other loan terms. Regression results indicate that banks of
all sizes price for risk. We do not find a relationship between reported
loan risk and delinquency and charge-off rates. However, this may reflect
how recently the risk rating data have become available.
Full paper (3163 KB PDF)
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