Judging the Risk of Banks: Why Can't Bond Raters Agree?

Federal Reserve Bank Staff Study

32 Pages Posted: 24 Apr 1999

Date Written: March 1999

Abstract

If bank risk were transparent to the market, the protection and regulation of banks would be unnecessary. I argue that banks are opaque, and that the veil is inherent to the business. Relative to the more fixed assets at non-financial firms, the risk of banks mostly financial assets is easier to conceal and/or to change. Their opaque or shiftable assets make the risk of banks difficult to monitor. As evidence, I show that the two most prominent credit analysts in the U.S.--Moody's and Standard and Poor's--disagree more over banks than over other types of firms. Among banks, the raters split more over opaque assets, like loans, and over more liquid assets, like cash and trading assets. Fixed assets, like premises, tend to reduce disagreement. The problem for banks as a class is that they hold very few fixed assets, so I conclude that they are regulated because they are opaque, not (as some argue) the other way around.

JEL Classification: G20, G21, G28

Suggested Citation

Morgan, Donald P., Judging the Risk of Banks: Why Can't Bond Raters Agree? (March 1999). Federal Reserve Bank Staff Study. Available at SSRN: https://ssrn.com/abstract=159754 or http://dx.doi.org/10.2139/ssrn.159754

Donald P. Morgan (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
Research Department
New York, NY 10045
United States
212-720-6573 (Phone)

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