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Credit rating downgrades and systemic risk

Kladakis, G. & Skouralis, A. ORCID: 0000-0003-0835-1457 (2022). Credit rating downgrades and systemic risk (01/22). London, UK: Centre for Banking Research, Bayes Business School, City, University of London.

Abstract

Credit ratings aim to reduce information asymmetries and to increase transparency and competition in the financial markets. However, during the 2007-2009 Global Financial Crisis, credit ratings contributed significantly to risk mispricing that led to the build-up of systemic risk, up until the collapse of “too big to fail” institutions. In this paper, we examine if changes in issuer credit ratings by the three main providers are associated with changes in systemic risk. Our empirical findings suggest that rating downgrades result in an increase in bank systemic risk, whereas upgrades do not proportionally reduce systemic risk. We also document that the positive relationship between rating downgrades and systemic risk can be mitigated by accounting-based stability factors such as profitability and capital. Finally, we find that the beginning of the COVID19 crisis that included unprecedented government support towards the banking system globally also mitigated the contribution of rating downgrades to systemic risk. We argue that credit rating agencies have a pivotal role in financial stability and policymakers should adopt a formal assessment to deal with the inherent systemic importance of these agencies that regulate the market.

Publication Type: Monograph (Working Paper)
Additional Information: Copyright the authors, 2022.
Publisher Keywords: Credit rating agencies; Systemic Risk; Rating downgrades; Banks
Subjects: H Social Sciences > HJ Public Finance
Departments: Bayes Business School > Finance
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