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Credit ratings and bank monitoring ability

  • Leonard I. Nakamura
  • Kasper Roszbach.

In this paper we use credit rating data from two large Swedish banks to elicit evidence on banks’ loan monitoring ability. For these banks, our tests reveal that banks’ credit ratings indeed include valuable private information from monitoring, as theory suggests. However, our tests also reveal that publicly available information from a credit bureau is not efficiently impounded in the bank ratings: The credit bureau ratings not only predict future movements in the bank ratings but also improve forecasts of bankruptcy and loan default. We investigate possible explanations for these findings. Our results are consistent with bank loan officers placing too much weight on their private information, a form of overconfidence. To the extent that overconfidence results in placing too much weight on private information, risk analyses of the bank loan portfolios in our data could be improved by combining the bank credit ratings and public credit bureau ratings. The methods we use represent a new basket of straightforward techniques that enable both financial institutions and regulators to assess the performance of credit rating systems. ; Supersedes Working Paper 10-21.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 13-21.

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Date of creation: 2013
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Handle: RePEc:fip:fedpwp:13-21
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  1. Sumit Agarwal, 2010. "Distance and Private Information in Lending," Review of Financial Studies, Society for Financial Studies, vol. 23(7), pages 2757-2788, July.
  2. Loffler, Gunter, 2004. "Ratings versus market-based measures of default risk in portfolio governance," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2715-2746, November.
  3. Mark Bils & Pete Klenow & Benjamin Malin, 2009. "Reset Price Inflation and the Impact of Monetary Policy Shocks," Discussion Papers 08-041, Stanford Institute for Economic Policy Research.
  4. Cantor, Richard, 2004. "An introduction to recent research on credit ratings," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2565-2573, November.
  5. Krahnen, Jan Pieter & Weber, Martin, 2000. "Generally accepted rating principles: A primer," CFS Working Paper Series 2000/02, Center for Financial Studies (CFS).
  6. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  7. Allen N. Berger & Sally M. Davies & Mark J. Flannery, 2000. "Comparing market and supervisory assessments of bank performance: who knows what when?," Proceedings, Federal Reserve Bank of Cleveland, pages 641-670.
  8. Gur Ofer & Richard Pomfret, 2004. "Introduction," Chapters, in: The Economic Prospects of the CIS, chapter 1 Edward Elgar.
  9. Paul Povel & Rajdeep Singh & Andrew Winton, 2003. "Booms, Busts, and Fraud," Finance 0312007, EconWPA.
  10. Keys, Benjamin J. & Mukherjee, Tanmoy & Seru, Amit & Vig, Vikrant, 2009. "Financial regulation and securitization: Evidence from subprime loans," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 700-720, July.
  11. Sanjiv Das & Darrell Duffie & Nikunj Kapadia & Leandro Saita, 2006. "Common Failings: How Corporate Defaults are Correlated," NBER Working Papers 11961, National Bureau of Economic Research, Inc.
  12. Dell'Ariccia, Giovanni & Marquez, Robert, 2004. "Information and bank credit allocation," Journal of Financial Economics, Elsevier, vol. 72(1), pages 185-214, April.
  13. Tor Jacobson & Jesper Lindé & Kasper Roszbach, 2013. "Firm Default And Aggregate Fluctuations," Journal of the European Economic Association, European Economic Association, vol. 11(4), pages 945-972, 08.
  14. Carey, Mark & Hrycay, Mark, 2001. "Parameterizing credit risk models with rating data," Journal of Banking & Finance, Elsevier, vol. 25(1), pages 197-270, January.
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  16. Altman, Edward I. & Rijken, Herbert A., 2004. "How rating agencies achieve rating stability," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2679-2714, November.
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