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Bank ratings: what determines their quality?

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  • Hau, Harald
  • Langfield, Sam
  • Marqués-Ibáñez, David

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 contribute to 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. JEL Classification: G21, G23, G28

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 1484.

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Date of creation: Oct 2012
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Handle: RePEc:ecb:ecbwps:20121484

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Keywords: conflicts of interest; credit ratings; Prudential Regulation; rating agencies;

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Cited by:
  1. 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.
  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. Oana Toader, 2014. "Quantifying and Explaining Implicit Public Guarantees for European Banks," Working Papers halshs-01015376, HAL.
  4. David G. Mayes & Hanno Stremmel, 2014. "The Effectiveness of Capital Adequacy Measures in Predicting Bank Distress," Chapters in SUERF Studies, SUERF - The European Money and Finance Forum.
  5. Reinhart, Carmen M. & Rogoff, Kenneth S., 2009. "The Aftermath of Financial Crises," Scholarly Articles 11129155, Harvard University Department of Economics.
  6. 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.
  7. 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.

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