The Direct and Indirect Effects of Rating-Contingent Basel Regulations on Financing of Firms: Global Evidence

Abstract

We empirically examine how the rating-contingent Basel regulations impact the access and cost of debt for firms with varying characteristics around the world, and investigate how firms cope with the impact through alternative financing sources and adjustments to its capital investments. We find that the implementation of the rating-contingent regulations has a significant impact on the flow of credit and the cost of credit, particularly to the low rated firms. The results indicate that the access to debt financing has become more difficult for the lower rated firms. Firms mitigate the shortage in bank credit induced by the regulation, through a combination of higher trade credit, lower payouts and downward adjustment of their capital investments. Particularly, firms in the lower quartile of the credit rating distribution substitute the reduced bank credit with increased reliance on accounts payables. Such firms have also lowered their payouts to shareholders, in an effort to maintain the liquidity and capital needs. We also find that the lower rated firms have significant decline in their capital investment growth in the post Basel period, implying an active response to the deterioration in the access to credit. Our key results are robust to alternative estimations and are also confirmed by a smaller sample of firms in the loan-level data on syndications. The findings of the paper substantially contribute to the understanding of the real sector effects of rating-contingent Basel regulations.

Keywords: banking, basel regulations, real effects, credit rating, trade credit

JEL Classification: G21, G28, G32, F33, D82