Scandinavian Working Papers in Economics

Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

No 458: Predicting Credit Deterioration: Internal Default Models versus Lending Rates

Anders Kärnä () and Karin Östling Svensson
Additional contact information
Anders Kärnä: Financial Stability Department, Central Bank of Sweden, Postal: Research Institute of Industrial Economics (IFN)
Karin Östling Svensson: Financial Stability Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden

Abstract: This paper examines how accurately Swedish banks’ internal probability of default (PD) models under IFRS 9 accounting rules predict changes in the borrowing firms’ credit risk levels. Using a sample of matched bank lending and firm-level data, we find that PDs align well with aggregate transitions to an elevated risk level, but explain little of the variation across individual borrowers. Lending rates, in contrast, provide limited information on moderate distress levels but are more predictive of severe credit events. The findings suggest that PDs capture both risk assessment and accounting conventions in a non-linear and complex pattern, highlighting the importance of combining regulatory and market-based indicators when monitoring credit risk.

Keywords: Probability of Default; Bankruptcy; Financial Distress

JEL-codes: G33; L25

Language: English

38 pages, December 1, 2025

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