Form or Substance? Incomplete Credit Rating Disambiguation in Bank Loans

Abstract

Corporate credit ratings have tightened slowly but substantially over two decades. We identify significant spillover effects in bank lending: risk-adjusted loan spreads do not fully adjust for the changing content of ratings. This incomplete adjustment increases bank financing costs, particularly for more bank-dependent borrowers. Newly rated bank borrowers should benefit from being rated but see increased bank loan spreads due to stricter ratings. Thus, while banks are viewed as specialists in information production, their lending practices do not uncover or reflect the soft information in changing rating standards. Form, not substance alone, matters even in a marketplace featuring only institutions.

Keywords: Credit Ratings, Syndicated Loans, Banking, Credit Default Swaps

JEL Classification: G21, G24, G14, G12