The Information Content of Bank Exam Ratings and Subordinated Debt Prices

Abstract

An important question for bank regulatory policy is whether supervisory examinations of large commercial banking firms - institutions that are already actively followed by many investors and their private sector agents - produce useful information that is not already reflected in market prices. We investigate this question using a new research methodology and a unique data set of national bank exam ratings and subordinated debt risk spreads for their parent holding companies. We find that government exams do produce significant new information that is value-relevant to financial markets; that debenture prices do not fully reflect this new information until several quarters after an exam; and that on net markets price the likely regulatory actions implied by this new information. These results have implications for the balance of market vs. regulatory discipline at large banking firms, and for proposals to make subordinated debt issues mandatory for these firms.

Keywords: Commercial banks, bank exam ratings, subordinated debt, market efficiency

JEL Classification: G21, G28, G34, G14.