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Bank ratings-What determines their quality?

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Author Info

  • Harald Hau

    (University of Geneva, Swiss Finance Institute and CEPR)

  • Sam Langfield

    (European Systemic Risk Board Secretariat and UK Financial Services Authority)

  • David Marques-Ibanez

    (European Central Bank)

Abstract

This paper examines the quality of credit ratings assigned to banks in Europe and the United States by the three largest rating agencies over the past two decades. We interpret credit ratings as relative assessments of creditworthiness, and define a new ordinal metric of rating error based on banks’ expected default frequencies. Our results suggest that rating agencies assign more positive ratings to large banks and to those institutions more likely to provide the rating agency with additional securities rating business (as indicated by private structured credit origination activity). These competitive distortions are economically significant and help perpetuate the existence of ‘too-big-to-fail’ banks. We also show that, overall, differential risk weights recommended by the Basel accords for investment grade banks bear no significant relationship to empirical default probabilities.

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File URL: http://www.bangor.ac.uk/business/research/documents/BBSWP12012.pdf
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Bibliographic Info

Paper provided by Bangor Business School, Prifysgol Bangor University (Cymru / Wales) in its series Working Papers with number 12012.

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Length: 42 pages
Date of creation: Oct 2012
Date of revision:
Handle: RePEc:bng:wpaper:12012

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Keywords: Rating Agencies; Credit Ratings; Conflicts of Interest; Prudential Regulation;

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References

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Cited by:
  1. David G. Mayes & Hanno Stremmel, 2014. "The Effectiveness of Capital Adequacy Measures in Predicting Bank Distress," SUERF Studies, SUERF - The European Money and Finance Forum, number 2014/1.
  2. Jeon, Doh-Shin & Lovo, Stefano, 2013. "Credit Rating Industry: a Helicopter Tour of Stylized Facts and Recent Theories," TSE Working Papers 13-376, Toulouse School of Economics (TSE).
  3. Jeon, Doh-Shin & Lovo, Stefano, 2013. "Credit Rating Industry: a Helicopter Tour of Stylized Facts and Recent Theories," IDEI Working Papers 762, Institut d'Économie Industrielle (IDEI), Toulouse.
  4. Mike Mariathasan & Ouarda Merrouche, 2012. "The Manipulation of Basel Risk-Weights. Evidence from 2007-10," Economics Series Working Papers 621, University of Oxford, Department of Economics.
  5. Jeon, Doh-Shin & Lovo, Stefano, 2013. "Credit rating industry: A helicopter tour of stylized facts and recent theories," International Journal of Industrial Organization, Elsevier, vol. 31(5), pages 643-651.

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