Perverse Effects of a Ratings-Related Capital Adequacy System
It has recently been proposed that banks be allowed to hold less capital against loans to borrowers who have received a favorable rating by an approved rating agency. But a plausible model of rating-agency behavior shows that this strategy could ha...
| Main Author: | |
|---|---|
| Format: | Policy Research Working Paper |
| Language: | English en_US |
| Published: |
World Bank, Washington, DC
2014
|
| Subjects: | |
| Online Access: | http://documents.worldbank.org/curated/en/2000/06/437401/perverse-effects-ratings-related-capital-adequacy-system http://hdl.handle.net/10986/19828 |
| Summary: | It has recently been proposed that banks
be allowed to hold less capital against loans to borrowers
who have received a favorable rating by an approved rating
agency. But a plausible model of rating-agency behavior
shows that this strategy could have perverse results,
actually increasing the risk of deposit insurance outlays.
First, there is an issue of signaling, with low-ability
borrowers possibly altering their behavior to secure a lower
capital requirement for their borrowing. Second,
establishing a regulatory cut-off may actually reduce the
amount of risk information made available by raters.
Besides, the credibility of rating agencies may not be
damaged by neglect of the risk of unusual systemic shocks,
although deposit insurers greatest outlays come chiefly at
times of systemic crisis. And using agencies'
individual ratings is unlikely to be an effective
early-warning system for the risk of systemic failure, so
use of the ratings could lull policymakers into a false
sense of security. It is important to harness market
information to improve bank safety (for example, by
increasing the role of large, well-informed, but uninsured
claimants), but this particular approach could be
counterproductive. Relying on ratings could induce borrowers
to increase their exposure to systemic risk even if they
reduce exposure to specific risk. |
|---|