Internal Evaluation Model. "shadow" In The Chinese Banking Sector

The new Basel accord (Basel II) provides three possible approaches for banks and regulators to choose for calculating the capital requirement. Even bank loans extended to other banks are subject to a capital requirement and should be evaluated according to one of the three possible approaches. However, the immature rating industry and lacking of sufficient database make it difficult for Chinese banks to adopt anyone of the approaches. This paper aims to develop a "shadow rating model" as a reference for Chinese banks and regulators to assess the quality of banks as well as the accuracy of potential Internal Rating Model that is to be developed for the adoption of Basel II. The "shadow rating model" maps the ratings of banks worldwide to their specific financial variables and its discriminant power is validated. However, the peculiarity of Chinese banks data makes the model unfit. Suggestions are proposed to improve the model and to apply it to Chinese banks.