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Rating targeting and the confidence levels implicit in bank capital

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  • Jokivuolle, Esa
  • Peura, Samu

Abstract

The solvency standards implicit in bank capital levels, as reported eg in Jackson et al (2002), are much higher than those required for top ratings, if standard single period economic capital models are taken seriously.We explain this excess capital puzzle by forward looking rating targeting behaviour by banks, which aims at maintaining rating above a minimum target in future periods.We calibrate to data on actual bank capital the confidence level used by the median US AA rated bank to maintain at least a single A rating.The calibrated confidence level is in line with the historical probability of an AA rated bank to be downgraded below A.

Suggested Citation

  • Jokivuolle, Esa & Peura, Samu, 2006. "Rating targeting and the confidence levels implicit in bank capital," Bank of Finland Research Discussion Papers 27/2006, Bank of Finland.
    • Handle: RePEc:zbw:bofrdp:rdp2006_027
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    References listed on IDEAS

    as
    1. Repullo, Rafael & Elizalde, Abel, 2004. "Economic and Regulatory Capital: What is the Difference?," CEPR Discussion Papers 4770, C.E.P.R. Discussion Papers.
    2. repec:zbw:bofrdp:2006_017 is not listed on IDEAS
    3. Nickell, Pamela & Perraudin, William & Varotto, Simone, 2000. "Stability of rating transitions," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 203-227, January.
    4. Jokipii, Terhi & Milne, Alistair, 2008. "The cyclical behaviour of European bank capital buffers," Journal of Banking & Finance, Elsevier, vol. 32(8), pages 1440-1451, August.
    5. Gordy, Michael B. & Howells, Bradley, 2006. "Procyclicality in Basel II: Can we treat the disease without killing the patient?," Journal of Financial Intermediation, Elsevier, vol. 15(3), pages 395-417, July.
    6. Arnoud W. A. Boot & Todd T. Milbourn & Anjolein Schmeits, 2006. "Credit Ratings as Coordination Mechanisms," The Review of Financial Studies, Society for Financial Studies, vol. 19(1), pages 81-118.
    7. Gordy, Michael B., 2003. "A risk-factor model foundation for ratings-based bank capital rules," Journal of Financial Intermediation, Elsevier, vol. 12(3), pages 199-232, July.
    8. Peura, Samu & Jokivuolle, Esa, 2004. "Simulation based stress tests of banks' regulatory capital adequacy," Journal of Banking & Finance, Elsevier, vol. 28(8), pages 1801-1824, August.
    9. Gordy, Michael B., 2000. "A comparative anatomy of credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 119-149, January.
    10. Jacob A. Bikker & Paul A. J. Metzemakers, 2007. "Is Bank Capital Procyclical? A Cross-Country Analysis," Credit and Capital Markets, Credit and Capital Markets, vol. 40(2), pages 225-264.
    11. 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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    More about this item

    Keywords

    bank capital; credit rating; value-at-risk; economic capital; capital structure;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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