Market Discipline through Credit Ratings and Too-Big-to-Fail in Banking
65 Pages Posted: 7 Mar 2017 Last revised: 13 Apr 2018
Date Written: March 27, 2018
Do credit ratings help enforce market discipline on banks? Analyzing a uniquely comprehensive dataset consisting of 1,117 rating change announcements for 154 international financial institutions between January 2004 and December 2015 we find that rating downgrades for internal reasons, such as adverse changes in the operating performance or capital structure of the banks, are associated with a significant CDS spread widening. But this widening only occurs for banks that are not perceived to be Too-Big-to-Fail (TBTF). Our findings question the reliability of credit ratings as a tool to discipline TBTF banks and suggests regulatory monitoring should remain the main mechanism for disciplining these banks.
Keywords: Credit Ratings, CDS, Too-Big-To-Fail
JEL Classification: G21, G13, G14
Suggested Citation: Suggested Citation