Ratings, Rating Agencies and the Global Financial System

379 Pages·2002·11.23 MB·English

by  Richard M. Levich

RATINGS, RATING
AGENCIES AND THE
GLOBAL FINANCIAL SYSTEM
THE NEW YORK UNIVERSITY
SALOMON CENTER SERIES ON
FINANCIAL MARKETS AND INSTITUTIONS
VOLUME 8
1. LT. Vanderhoof and E. Altman (eds.): The Fair Value of Insurance
Liabilities. 1997 ISBN 0-7923-9941-2
2. R. Levich (ed.): Emerging Market Capital Flows. 1997
ISBN 0-7923-9976-5
3. Y. Amihud and G. Miller (eds.): Bank Mergers & Acquisitions:
An Introduction and an Overview. 1997 ISBN 0-7923-9975-7
4. J.E Carpenter and D.L.Yermack (eds.): Executive Compensation
and Shareholder Value. 1998 ISBN 0-7923-8179-3
5. I.T. Vanderhoof and E. Altman (eds.): The Fair Value of Insurance
Business 2000 ISBN 0-7923-8634-5
6. S.J. Brown and C.H. Liu (eds.): A Global Perspective on Real
Estate Cycles 2001 ISBN 0-7923-7808-3
7. R.A. Schwartz (ed.): The Electronic Call Auction:
Market Mechanism and Trading, Building a Better Stock
Market 2001 ISBN 0-7923-7256-5
8. S. Figlewski and R. Levich (eds.): Risk Management:
The State of the Art 2001 ISBN 0-7923-7427-4
RATINGS, RATING
AGENCIES AND THE
GLOBAL FINANCIAL SYSTEM
Edited by
RICHARD M. LEVICH
Stern School of Business
New York University
GIOVANNI MAJNONI
World Bank
CARMEN M. REINHART
University of Maryland
k4
SPRINGER SCIENCE+BUSINESS MEDIA, LLC
Library of Congress Cataloging-in-Publication Data
Ratings, rating agencies and the global financial system/edited by Richard M. Levich,
Giovanni Majnoni, Carmen Reinhart.
p. cm. — (New York University Salomon Center series on financial markets and
institutions ; v. 9)
Includes bibliographical references.
ISBN 978-1-4613-5344-7 ISBN 978-1-4615-0999-8 (eBook)
DOI 10.1007/978-1-4615-0999-8
1. Credit ratings. 2. Credit bureaus. 3. Corporations—finance. 4. International finance.
I. Majnoni, Giovanni. II. Levich, Richard M. III. Reinhart, Carmen M. IV Series.
HG375I.5 .R37 2002
332.7'42—dc21 2002016212
Copyright © 2002 by Springer Science+Business Media New York
Originally published by Kluwer Academic Publishers in 2002
Softcover reprint of the hardcover 1st edition 2002
All rights reserved. No part of this work may be reproduced, stored in a retrieval system, or transmitted
in any form or by any means, electronic, mechanical, photocopying, microfilming, recording, or other
wise, without the written permission from the Publisher, with the exception of any material supplied
specifically for the purpose of being entered and executed on a computer system, for exclusive use by
the purchaser of the work.
Printed on acid-free paper.
TABLE OF CONTENTS
List of Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vll
Preface .............................................. ix
Introduction: "Ratings, Rating Agencies and the Global Financial System:
Summary and Policy Implications," by Richard M. Levich,
Giovanni Majnoni and Carmen M. Reinhart . . . . . . .. ............. 1
Part I. History, Value and Industrial Structure of Credit Rating
and Reporting Agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
A Historical Primer on the Business of Credit Rating
RICHARD SYLLA ......................................... 19
2 The Credit Rating Industry: An Industrial Organization Analysis
LAWRENCE J. WHITE ....... . ......... 41
3 The Paradox of Credit Ratings
FRANK PARTNOY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
Discussants: MARTIN FRIDSON 85
MARK FLANNERY. 89
vi Table of Contents
Part II. Empirical Evidence on Credit Rating Agencies: Pricing and
Regulatory Aspects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
4 The Role of Credit Ratings in Bank Capital
EDWARD I. ALTMAN AND ANTHONY SAUNDERS .. ............ 99
5 A Guide to Choosing Absolute Bank Capital Requirements
MARK CAREY. . . . . . . . . . . . . . . . . . . . . . . . . . . . .. .........•. 117
6 Credit Ratings and the Japanese Corporate Bond Market
FRANK PACKER. . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..... 139
7 How Good is the Market at Assessing Bank Fragility? A Horse Race
Between Different Indicators
PAOLA BONGINI, LUC LAEVEN AND GIOVANNI MAJNONI. . . . . . . . . . . . .. 159
8 Rating Banks in Emerging Markets: What Credit Rating Agencies Should
Learn from Financial Indicators
LILIANA ROJAS-SUAREZ . . . . . . . . 177
Discussants: RICHARD J. HERRING. . 202
LARRY D. WALL. . 213
LINDA ALLEN. . . . . . 221
Part III. Empirical Evidence on Credit Ratings Agency's
Performance: Macroeconomic Aspects . . . . . . . . . . . . . . . . . . . . 225
9 Rating Agencies and Financial Markets
GRACIELA KAMINSKY AND SERGIO SCHMUKLER . ........... 227
10 Sovereign Credit Ratings Before and Mter Financial Crises
CARMEN M. REINHART .. ........... 251
11 Equity Risk Premiums
ASWATH DAMODARAN. . . . . . . . • . . . . . . . . . . . . . . . . . . . . . . . . . . . . 269
Part Iv. Policy Issues Facing Regulators and Credit Rating Agencies . . 287
12 Rating Agencies: Is There an Agency Issue?
ROY C. SMITH AND INGO WALTER . . . . . . . . ... 289
13 Do Banks Provision for Bad Loans in Good Times? Empirical Evidence
and Policy Implications
MICHELE CAVALLO AND GIOVANNI MAJNONI. ............•.•........ 319
14 Policy Issues Facing Rating Agencies
JEROME S. FONS. • . . . • . . . . . . .. ................•... ..... 343
15 Credit Risk and Financial Instability
RICHARD J. HERRING. .345
Author Index .369
Subject Index .375
LIST OF CONTRIBUTORS
Linda Allen, Baruch College, City University cif New York
Edward I. Altman, NYU Stern School of Business
Paola Bongini, Universita degli Studi di Macerata
Mark Carey, Federal Reserve Board of Governors
Michele Cavallo, New York University
Aswath Damodaran, NYU Stern School of Business
Mark J. Flannery, University cif Florida
Jerome S. Fons, Moody's Investor Service
Martin Fridson, Merrill Lynch
Richard J. Herring, The Marton School, University of Pennsylvania
Graciela Kaminsky, George Washington University
Luc Laeven, World Bank
Richard M. Levich, NYU Stern School of Business
Giovanni Majnoni, T-tbrld Bank
Frank Packer, Nikko Salomon Smith Barney, Ltd.
Frank Partnoy, University of San Diego School cif Law
Carmen M. Reinhart, International Monetary Fund
Liliana Rojas-Suarez, Institute for International Economics
Anthony Saunders, NYU Stern School of Business
Sergio Schmukler, T-tbrld Bank
Roy C. Smith, NYU Stern School of Business
viii List of Contributors
Richard Sylla, NYU Stern School cif Business
Larry D. Wall, Federal Reserve Bank oj Atlanta
Ingo Walter, NYU Stern School cif Business
Lawrence J. White, NYU Stern School oj Business
PREFACE
The business of credit ratings began in the United States in the early 1900s. Over
time, credit ratings have gradually taken on an expanding role, both in the United
States and abroad and in official financial market regulation as well as in private
capital market decisions. However, in 1999 the Bank for International Settlements
(through its Committee on Banking Supervision) proposed rule changes that would
provide an explicit role for credit ratings in determining a bank's required regula
tory risk capital. Once implemented, this BIS proposal (often referred to as Basel
2) would vastly elevate the importance of credit ratings by linking the required
measure of bank capital to the credit rating of the bank's obligors. With these regu
latory changes under active discussion, research into the role for ratings and rating
agencies in the global financial system is particularly apropos.
The research efforts in this volume took shape in the summer of 1999 based
on discussions among representatives from the Center for International Political
Economy (CIPE) and faculty at the New York University (NYU) Stern School of
Business and the University of Maryland. In early 2000, CIPE announced two
grants, one to the NYU Salomon Center at the Stern School of Business, and
another to the Center for International Economics in the Department of Economics
at the University of Maryland to study the impact of credit ratings and credit rating
agencies on the global financial markets, and address the impact of the proposed
Basel 2 regulatory changes. These grants funded eight research papers that are
included in this volume.! To develop these papers and foster exchanges among the
authors and other scholars, we held meetings at NYU in April and October 2000.
The World Bank hosted the final meeting in March 1, 2001, and contributed to
the project with papers by World Bank researchers examining the role of credit
x Preface
reporting bureaus and similar agencies around the world. Several of these papers and
comments have been included in this volume.2 Finally, several authors agreed to
meet again in New York on June 1, 2001 to present their papers to a new audi
ence (including several new authors and discussants) and generate still further dis
cussion of the issues. Thus we had the opportunity to include several additional
papers and comments related to our overall theme.3 Regrettably, not all of the pre
sentations and discussion at the March and June conferences can be included in this
volume.
The NYU Salomon Center and the Center for International Economics at the
University of Maryland are grateful to CIPE for their generous financial support.
We especially thank Jack Langlois for his sustained encouragement on this project.
The NYU authors are grateful to Ingo Walter, the Director of the NYU Salomon
Center, for actively working on the design of the NYU project. The Maryland
authors acknowledge Tracy Stanton, the Deputy Director of the Center for Inter
national Economics, for her oversight of the Maryland project. We thank the World
Bank for their hospitality and Demet Cabbar and Rose Vo for their assistance with
arrangements for the March 2001 Washington conference. We thank CIPE once
again for their sponsorship of the June 2001 New York conference, and acknowl
edge Mary Jaffier and her staff for ably handling the administrative tasks of the New
York conference. Finally, we thank the authors of the papers and the discussants for
contributing their energy and talents to the various stages of this project.
NOTES
1. These are the papers by Richard Sylla, Lawrence White, Edward Altman and Anthony Saunders,
Aswath Darnodaran, and Roy Smith and Ingo Walter (from the NYU grant) and the papers by Carmen
Reinhart, Liliana Rojas-Suarez, and Graciela Kaminsky and Sergio Schmukler (from the University of
Maryland grant).
2. The papers by Frank Partnoy, Frank Packer, Paola Bongini, Luc Laeven and Giovanni Majnoni,
and Michele Cavallo and Giovanni Majnoni were presented at the March 2001 conference, along with
discussant remarks by Mark Flannery, and Larry Wall.
3. The papers by Mark Carey; Richard Herring, and Jerome Fons were presented at the June 2001
conference, along with discussant remarks by Martin Fridson and Linda AlIen.
Richard M. Levich
Giovanni Majnoni
Carmen M. Reinhart