Can Market Actors Help Monitor European Banks?
This paper focuses on the use of equity market information for the monitoring of European banks. To this end, we conduct two event studies: 1) whether equity market variables can in a timely manner anticipate changes with a constructed rating- proxy of the supervisory rating- named ‘Financial Situation Evaluation’ (FSEvaluation), for audited banks, 2) whether Rating Agencies (RAs) can help monitor European banks during the period 1990- 2006. Results show that equity market returns help to anticipate, several quarters in advance, a balance-sheet-based evaluation. However, they issue a counterintuitive signal when European banks are facing a negative evaluation of their risk and/or capital position. RAs have an additional role especially effective in summarising positive information. However, RAs are shown to take time to downgrade banks. Finally, results find evidence that investors' behaviour is, at least in part, encouraged by a “too big to fail” policy from which large European banks benefit.
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