Are Banks' Internal Risk Parameters Consistent? Evidence from Syndicated Loans

Syndicated loans provide an exceptional opportunity to study differences in banks’ approaches to measuring risk because many of these loans are held by more than one bank. We study differences in banks’ estimates of risk parameters used to calculate regulatory capital requirements for syndicated loans. Using internal data from nine large U.S. banks, we find significant dispersion in the probability of default (PD) and loss given default (LGD) assigned by different banks to the same loans. Banks’ PDs differ substantially, but only a few systematically set PDs higher or lower than others in a statistically significant manner. However, many banks’ estimates of LGD differ from others in a systemic manner that is statistically and economically significant, causing large differences in minimum regulatory capital. In addition, we find that banks assign lower PDs to loans of which they hold larger shares, suggesting that incentives affect risk parameters.