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The Sovereign Effect on Bank Credit Ratings

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Abstract

We investigate the effect of sovereign credit ratings on bank credit ratings, known as the sovereign effect. Our study differs from the literature in three respects. First, we examine whether bank ratings below, at, or above the sovereign ceiling impact the sovereign effect. We find that the sovereign effect holds in all cases. Next, we consider the asymmetric impact of the sovereign effect on bank ratings with or without the ceiling effect. We find that a downgrade exhibits a stronger sovereign effect than an upgrade. Third, we examine whether the asset deterioration or the stable foreign fund hypotheses are possible explanations for the sovereign effect. Our results support both hypotheses.

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Notes

  1. National Bank of Egypt, Banque Misr, Banque du Caire, Commercial International Bank, and Bank of Alexandria.

  2. Of the 38 companies, 28 were Latin American and 29 were in banking and finance.

  3. See Bolton et al. (2012), Mathis et al. (2009), and Skreta and Veldkamp (2009).

  4. They likewise use the firms’ credit ratings to proxy for the firms’ cost of debt.

  5. Han et al. (2013), Poon and Firth (2005), Poon et al. (1999), Poon et al. (2009), and Roy (2013) investigate whether there is a difference between solicited and unsolicited ratings. Iannotta (2006) Rojas-Suarez (2001), Shen and Huang (2013), and Shen et al. (2012) investigate the determinants of bank credit ratings. Bongini et al. (2002), Poghosyan and Čihák (2011), and Wheelock and Wilson (2000) investigate the determinants of bank failures.

  6. Because not all banks provide this information, the number of sample banks is reduced when we include this variable in our model. The number of banks is reduced from 4,561 to 1,692 when using the S&P rating data, and from 5,752 to 1,882 when using the Fitch data.

  7. In his testimony before The Financial Crisis Inquiry Commission on April 7, 2010, former Chairman of the Federal Reserve Alan Greenspan identified the global proliferation of securitized U.S. subprime mortgages as the immediate trigger of the 2008 financial crisis.

  8. To control for the influence of the crisis, exclude 2008 because it is the hectic period of the subprime crisis in which many countries and banks were downgraded owing to the crisis.

  9. See Aizenman et al. (2013), Ismailescu and Kazemi (2010), Palladini and Portes (2011), and Pan and Singleton (2008).

  10. However, our sample periods are shortened when considering the CDS because most country CDS data began in 2004. Moreover, the CDS data are available for only half of the countries in Bloomberg. The sample countries are reduced when the models’ consider the CDS. Similar data problems occur in the government bond spread because most emerging countries do not issue bonds on a regular basis. The sample countries are reduced when the models’ consider this spread.

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Authors and Affiliations

  1. Department of Finance and Banking, Shih Chien University, Taipei, Taiwan

    Yu-Li Huang

  2. Department of Finance, National Taiwan University, Taipei, Taiwan

    Chung-Hua Shen

Authors
  1. Yu-Li Huang
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  2. Chung-Hua Shen
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Correspondence to Chung-Hua Shen.

Appendix

Appendix

Table 11 Matching the letter ratings with numerical ratings. The table describes the categories for credit ratings, as well as the numerical scale in the paper. Credit ratings are the long-term bank credit ratings compiled by S&P and Fitch and reported on the BankScope database. These ratings reflect the CRAs’ assessment of the creditworthiness of the obligor with respect to its senior debt obligations
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Huang, YL., Shen, CH. The Sovereign Effect on Bank Credit Ratings. J Financ Serv Res 47, 341–379 (2015). https://doi.org/10.1007/s10693-014-0193-7

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