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Did the rating standard for banks change after the crisis?

Abstract

Did rating agencies tighten their rating standard after the overwhelming critique on their generous ratings before 2008? This study aims to examine whether 2008 is the cutoff year to investigate whether the bank rating standard was loosened prior to the 2008 crisis and became stringent after the crisis. We discuss the rating standard for three objects, namely, issuer ratings, individual ratings, and government support. Our results show the rating standard for issuer rating was loosened before 2008 and is not tighter after 2008. The rating standard for individual rating did not change before the crisis but became increasingly stringent after the crisis. Third, the agencies highly evaluate government support, especially during 2007–2011 and 2015–2016.

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Notes

  1. The S&P said in a statement: “In the past 5 years, we have spent approximately $400 million to reinforce the integrity, independence and performance of our ratings. We also brought in new leadership, instituted new governance and enhanced risk management. Based on what we learned, we changed the way we rate almost every type of security that was affected by the financial crisis.”.

  2. A stringent rating standard means that rating agencies pay more attention to the rating’s quality so that it can more effectively reflect the fundamentals of the issuers and reduce information asymmetry.

  3. See Moody’s Investors Service (2016), Standard & Poor’s (2011), and Fitch Ratings (2015).

  4. Moody’s Investors Service (2009).

  5. Moody’s rating bank deposit ratings use upper-case letters from “Aaa” to “C”. The letter and numerical mapping are as follows. Aaa = 21, Aa1 = 20, Aa2 = 19, Aa3 = 18, A1 = 17, A2 = 16, A3 = 15, Baa1 = 14, Baa2 = 13, Baa3 = 12, Ba1 = 11, Ba2 = 10, Ba3 = 9, B1 = 8, B2 = 7, B3 = 6, Caa1 = 5, Caa2 = 4, Caa3 = 3, Ca = 2 and C = 1.

  6. We use the data on the previous 4 years to calculate the average and standard deviations of ROA.

  7. This paper does not include the dummy variable of explicit insurance deposit schemes. The reason for this is that most of our sample countries have explicit deposit insurance scheme. Furthermore, we have included country dummies in all empirical analysis to control for the country-specific effects on bank credit ratings.

  8. By construction, each governance measure is normally distributed with a zero mean and a unit variance that ranges from –2.5 to + 2.5 with higher numbers corresponding to better governance.

  9. Moody’s baseline credit assessments use lower-case letters from “aaa” to “c.”.

  10. Moody’s Investors Service (2009) indicates governments might also play a negative role by adding risk for bank depositors. The intervention occurs as deposits freeze and private sector debt payments to the government slow.

  11. See also Estrella and Schich (2011), Schich and Lindh (2012), Schich (2013), Toader (2013), and VanRoy and Vespro (2012) for the use of this measure.

  12. Moody’s assigns an adjusted baseline credit assessment to banks that obtain support from their parent and cooperative affiliations. Thus, to isolate the government support, we exclude all those banks having adjusted baseline credit ratings in our sample.

  13. These “converted rating notches” are equal to the converted rating notch = (coefficient × standard deviation of variable)/rating notch length, where the numerator is the product of the estimated coefficient and the standard deviation of the relevant independent variable. The denominator is the average distance between the rating categories (i.e., average rating notch length is calculated as (μ20 − μ1) / 19), and μ20 and μ1 are the largest and smallest cutoffs of 21 letter rating grades, respectively. The converted rating notch provides the number of rating notches required for the bank to improve its rating given one standard deviation increase in the relevant explanatory variable. The distance between the rating notches is not equal and is more of an average measure in an ordered probit model.

  14. We also report the coefficient estimates a1 and a2, the coefficient estimate in the units of the rating step length (that is, a1/Rating notch length and a2/Rating notch length), and the p-value for the Wald test for the hypotheses that a1 and a2 are equal to zero. The Wald test rejects the null of a1 and a2 equal intercepts at p-levels as indistinguishable from zero for the entire sample and the investment-grade subsample. Hence, the levels of intercepts before, during, and after crisis periods differ. If a bank kept all characteristics constant, then its rating increases 0.5 notches between 2007 and 2011 and decreases 0.47 notches between 2012 and 2016 when considering the entire sample. Its rating increases 0.66 notches between 2007 and 2011 and decreases 0.42 notches between 2012 and 2016 when considering the investment-grade subsample.

  15. When considering speculative-grade issuer ratings, the agencies do not change the standard during the crisis period. However, the ratings declined 0.54 notches between 2012 and 2016.

  16. The Wald test rejects the null of b2 equal intercepts at p-levels as indistinguishable from zero for the entire sample and the investment-grade subsamples. Hence, the levels of intercepts at the pre and post crisis periods differ. If a bank kept all characteristics constant, then its rating decreases 0.18 notches between 2007 and 2011 and decreases 1.07 notches between 2012 and 2016 when considering the entire sample. Its rating decreases 0.12 notches between 2007 and 2011 and 1.20 notches between 2012 and 2016 when considering the investment-grade subsample.

  17. The results are available on request.

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Correspondence to Kun-Li Lin.

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Huang, YL., Shen, CH. & Lin, KL. Did the rating standard for banks change after the crisis?. Rev Quant Finan Acc 58, 1617–1663 (2022). https://doi.org/10.1007/s11156-021-01031-x

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Keywords

  • Banks
  • Issuer rating
  • Individual rating
  • Government support
  • Rating standard
  • Financial crisis

JEL Classification

  • G15
  • G21