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

See all articles by Kathleen Weiss Hanley

Kathleen Weiss Hanley

Lehigh University - College of Business

Stanislava (Stas) Nikolova

University of Nebraska - Lincoln

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

Hanley, Kathleen Weiss and Nikolova, Stanislava (Stas), Rethinking the Use of Credit Ratings in Capital Regulations: Evidence from the Insurance Industry (April 2020). Review of Corporate Finance Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2357145 or http://dx.doi.org/10.2139/ssrn.2357145

Kathleen Weiss Hanley (Contact Author)

Lehigh University - College of Business ( email )

Bethlehem, PA 18015
United States

Stanislava (Stas) Nikolova

University of Nebraska - Lincoln ( email )

Lincoln, NE 68588-0490
United States
402-472-6049 (Phone)

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