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Bank ratings-What determines their quality?

  • 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)

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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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
Contact details of provider: Postal: Gwynedd LL57 2DG
Phone: +44 (0) 1248 383648
Web page: http://www.bangor.ac.uk/business/research/

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  8. Marco Pagano & Paolo Volpin, 2009. "Credit Ratings Failures and Policy Options," EIEF Working Papers Series 0912, Einaudi Institute for Economics and Finance (EIEF), revised Sep 2009.
  9. Gustavo Manso, 2011. "Feedback Effects of Credit Ratings," 2011 Meeting Papers 1338, Society for Economic Dynamics.
  10. Vasiliki Skreta & Laura Veldkamp, 2009. "Ratings Shopping and Asset Complexity: A Theory of Ratings Inflation," NBER Working Papers 14761, National Bureau of Economic Research, Inc.
  11. Rebel Cole & Lawrence White, 2012. "Déjà Vu All Over Again: The Causes of U.S. Commercial Bank Failures This Time Around," Journal of Financial Services Research, Springer, vol. 42(1), pages 5-29, October.
  12. Lily Fang & Ayako Yasuda, 2009. "The Effectiveness of Reputation as a Disciplinary Mechanism in Sell-Side Research," Review of Financial Studies, Society for Financial Studies, vol. 22(9), pages 3735-3777, September.
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  15. Wade Cook & Moshe Kress & Lawrence Seiford, 1986. "Information and preference in partial orders: A bimatrix representation," Psychometrika, Springer, vol. 51(2), pages 197-207, June.
  16. Crouhy, Michel & Galai, Dan & Mark, Robert, 2000. "A comparative analysis of current credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 59-117, January.
  17. Mariathasan, Mike & Merrouche, Ouarda, 2013. "The Manipulation of Basel Risk-Weights," CEPR Discussion Papers 9494, C.E.P.R. Discussion Papers.
  18. Matthias Efing, 2013. "Bank Capital Regulation with an Opportunistic Rating Agency," CESifo Working Paper Series 4267, CESifo Group Munich.
  19. Jens Hilscher & Mungo Wilson, 2011. "Credit ratings and credit risk," Working Papers 31, Brandeis University, Department of Economics and International Businesss School.
  20. Mathis, Jérôme & McAndrews, James & Rochet, Jean-Charles, 2009. "Rating the raters: Are reputation concerns powerful enough to discipline rating agencies?," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 657-674, July.
  21. Becker, Bo & Milbourn, Todd, 2011. "How did increased competition affect credit ratings?," Journal of Financial Economics, Elsevier, vol. 101(3), pages 493-514, September.
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  23. Patrick Bolton & Xavier Freixas & Joel Shapiro, 2009. "The Credit Ratings Game," NBER Working Papers 14712, National Bureau of Economic Research, Inc.
  24. Sreedhar T. Bharath & Tyler Shumway, 2008. "Forecasting Default with the Merton Distance to Default Model," Review of Financial Studies, Society for Financial Studies, vol. 21(3), pages 1339-1369, May.
  25. Jie He & Jun Qian & Philip E. Strahan, 2011. "Credit Ratings and the Evolution of the Mortgage-Backed Securities Market," American Economic Review, American Economic Association, vol. 101(3), pages 131-35, May.
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  28. Donald P. Morgan, 2002. "Rating Banks: Risk and Uncertainty in an Opaque Industry," American Economic Review, American Economic Association, vol. 92(4), pages 874-888, September.
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