Rethinking the Use of Credit Ratings in Capital Regulations: Evidence from the Insurance Industry
Review of Corporate Finance Studies, Forthcoming
60 Pages Posted: 20 Nov 2013 Last revised: 24 Apr 2020
Date Written: April 2020
Abstract
We analyze an initiative by insurance regulators to reform capital regulations for mortgage-backed securities (MBS) by replacing credit ratings with third-party estimates of expected credit losses and by considering an insurer's exposure to future losses when determining regulatory capital. After implementation, insurers are less likely to sell distressed MBS, gains trade corporate bonds, and/or raise external financing. However, the new regime allows insurers to purchase more low-rated MBS at significant capital savings and insurers with greater capital savings are more likely to do so. Our analysis highlights the potential costs and benefits of an alternate methodology to determine regulatory capital.
Keywords: Insurance companies; Credit ratings; Capital requirements; RMBS; CMBS; Corporate bonds; Regulation; Dodd-Frank Act
JEL Classification: G11, G18, G22, G28, G32, G38
Suggested Citation: Suggested Citation