Assessing the consequences of Basel II: Are there incentives for cherry-picking when banks pool data across countries?
Working paper no 27, 2005
This paper illustrates the consequences on the calculated capital requirements of pooling data from several countries for estimation of probability of defaults when using the foundation internal ratings-based approach in Basel II. We construct a hypothetical bank portfolio of loans to small and medium-sized enterprises in France, Italy and Spain based on real world data extracted from the Amadeus database provided by Bureau van Dijk. The calculated capital requirements using probability of defaults estimated in single-country credit scoring models and multi-country credit scoring models shows that banks might be motivated to choose a certain method because it results in a lower capital requirement (cherry-picking), when they pool data.