Estimating the Credit Risk of Malaysian Companies using Merton Model

The paper gives an overview of current conceptual framework for the credit risk assessment dedicated to banks. The framework utilises the Merton model to estimate the default probabilities of companies that are supposed to be the main borrowers causing a formation of a greater credit risk in banks. By doing this, banks are able to reaffirm the ability of their borrowers in meeting loan commitments. Conceivably, it can facilitate the banking decision-making process and next complementing the existing instruments of credit risk mitigation. The framework has been applied to 56 Malaysian companies listed in the market stock indicator that is Bursa Malaysia for the default probabilities estimation. In the meantime, the paper compares the estimated default probabilities with the companies’ rating issued by Malaysian Rating Corporation Berhad (MARC) and RAM Rating Holdings Berhad (RAM) in order to determine the capability of Merton model in estimating the default probabilities of Malaysian companies. It is found that the estimated default probabilities are compatible to the ratings issued by both rating agencies. The model is seen to be able to predict the default probabilities in two year advance and successful in describing the changes of the companies’ rating outlooks.