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Bank ratings: what determines their quality?

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

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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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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  1. Efraim Benmelech & Jennifer Dlugosz, 2010. "The Credit Rating Crisis," NBER Chapters, in: NBER Macroeconomics Annual 2009, Volume 24, pages 161-207 National Bureau of Economic Research, Inc.
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  8. Huizinga, H.P. & Laeven, L., 2009. "Accounting Discretion of Banks During a Financial Crisis," Discussion Paper 2009-58, Tilburg University, Center for Economic Research.
  9. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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  11. 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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  16. 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.
  17. Reinhart, Carmen M. & Rogoff, Kenneth S., 2009. "The Aftermath of Financial Crises," Scholarly Articles 11129155, Harvard University Department of Economics.
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  19. Wade Cook & Moshe Kress & Lawrence Seiford, 1986. "Information and preference in partial orders: A bimatrix representation," Psychometrika, Springer;The Psychometric Society, vol. 51(2), pages 197-207, June.
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  23. Matthias Efing, 2013. "Bank Capital Regulation with an Opportunistic Rating Agency," CESifo Working Paper Series 4267, CESifo Group Munich.
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  26. Paolo Fulghieri & Günter Strobl & Han Xia, 2014. "The Economics of Solicited and Unsolicited Credit Ratings," Review of Financial Studies, Society for Financial Studies, vol. 27(2), pages 484-518.
  27. 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.
  28. Frank Packer & Nikola Tarashev, 2011. "Rating methodologies for banks," BIS Quarterly Review, Bank for International Settlements, June.
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