Market Discipline through Credit Ratings and Too-Big-to-Fail in Banking
76 Pages Posted: 7 Mar 2017 Last revised: 9 Aug 2019
Date Written: August 5, 2019
Do credit ratings help enforce market discipline on banks? Analyzing a uniquely comprehensive dataset consisting of 1,081 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 banks, are associated with a significant CDS spread widening. However, this widening only occurs for banks that are not perceived as to be Too-Big-to-Fail (TBTF). Our findings question the reliability of credit ratings as a tool to discipline TBTF banks and suggest that 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