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...
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| Format: | Policy Research Working Paper |
| Language: | English en_US |
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World Bank, Washington, DC
2014
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| Online Access: | http://documents.worldbank.org/curated/en/2000/06/437401/perverse-effects-ratings-related-capital-adequacy-system http://hdl.handle.net/10986/19828 |
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okr-10986-198282021-04-23T14:03:46Z Perverse Effects of a Ratings-Related Capital Adequacy System Honohan, Patrick BANK CAPITAL BANK FAILURE BANK FAILURES BANK LENDING BANK SAFETY BANKING CRISES BANKING SUPERVISION BANKING SYSTEM BANKS BONDS BORROWING BORROWING COSTS CAPITAL ADEQUACY CAPITAL MARKETS CAPITAL REQUIREMENT CAPITAL REQUIREMENTS CARBON CARBON DIOXIDE CARBON DIOXIDE EMISSIONS CENTRAL BANKS DEBT DEFAULT RISK DEPOSIT INSURANCE DEPOSITORS DEPOSITS ECONOMIC DEVELOPMENT EMISSIONS EMISSIONS TAXES ENVIRONMENTAL POLICY EQUILIBRIUM FINANCIAL MARKETS FORESTRY FREE ENTRY INFORMATION COSTS INSURERS JOINT IMPLEMENTATION LIBERALIZATION MARKET POWER OIL PRIVATIZATION RATES RATING AGENCIES RISK EVALUATION RISK FACTORS RISK OF DEFAULT SECURITIES SYSTEMIC RISK WATER SUPPLY 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. 2014-08-28T18:14:47Z 2014-08-28T18:14:47Z 2000-06 http://documents.worldbank.org/curated/en/2000/06/437401/perverse-effects-ratings-related-capital-adequacy-system http://hdl.handle.net/10986/19828 English en_US Policy Research Working Paper;No. 2364 CC BY 3.0 IGO http://creativecommons.org/licenses/by/3.0/igo/ World Bank, Washington, DC Publications & Research :: Policy Research Working Paper Publications & Research |
| repository_type |
Digital Repository |
| institution_category |
Foreign Institution |
| institution |
Digital Repositories |
| building |
World Bank Open Knowledge Repository |
| collection |
World Bank |
| language |
English en_US |
| topic |
BANK CAPITAL BANK FAILURE BANK FAILURES BANK LENDING BANK SAFETY BANKING CRISES BANKING SUPERVISION BANKING SYSTEM BANKS BONDS BORROWING BORROWING COSTS CAPITAL ADEQUACY CAPITAL MARKETS CAPITAL REQUIREMENT CAPITAL REQUIREMENTS CARBON CARBON DIOXIDE CARBON DIOXIDE EMISSIONS CENTRAL BANKS DEBT DEFAULT RISK DEPOSIT INSURANCE DEPOSITORS DEPOSITS ECONOMIC DEVELOPMENT EMISSIONS EMISSIONS TAXES ENVIRONMENTAL POLICY EQUILIBRIUM FINANCIAL MARKETS FORESTRY FREE ENTRY INFORMATION COSTS INSURERS JOINT IMPLEMENTATION LIBERALIZATION MARKET POWER OIL PRIVATIZATION RATES RATING AGENCIES RISK EVALUATION RISK FACTORS RISK OF DEFAULT SECURITIES SYSTEMIC RISK WATER SUPPLY |
| spellingShingle |
BANK CAPITAL BANK FAILURE BANK FAILURES BANK LENDING BANK SAFETY BANKING CRISES BANKING SUPERVISION BANKING SYSTEM BANKS BONDS BORROWING BORROWING COSTS CAPITAL ADEQUACY CAPITAL MARKETS CAPITAL REQUIREMENT CAPITAL REQUIREMENTS CARBON CARBON DIOXIDE CARBON DIOXIDE EMISSIONS CENTRAL BANKS DEBT DEFAULT RISK DEPOSIT INSURANCE DEPOSITORS DEPOSITS ECONOMIC DEVELOPMENT EMISSIONS EMISSIONS TAXES ENVIRONMENTAL POLICY EQUILIBRIUM FINANCIAL MARKETS FORESTRY FREE ENTRY INFORMATION COSTS INSURERS JOINT IMPLEMENTATION LIBERALIZATION MARKET POWER OIL PRIVATIZATION RATES RATING AGENCIES RISK EVALUATION RISK FACTORS RISK OF DEFAULT SECURITIES SYSTEMIC RISK WATER SUPPLY Honohan, Patrick Perverse Effects of a Ratings-Related Capital Adequacy System |
| relation |
Policy Research Working Paper;No. 2364 |
| description |
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. |
| format |
Publications & Research :: Policy Research Working Paper |
| author |
Honohan, Patrick |
| author_facet |
Honohan, Patrick |
| author_sort |
Honohan, Patrick |
| title |
Perverse Effects of a Ratings-Related Capital Adequacy System |
| title_short |
Perverse Effects of a Ratings-Related Capital Adequacy System |
| title_full |
Perverse Effects of a Ratings-Related Capital Adequacy System |
| title_fullStr |
Perverse Effects of a Ratings-Related Capital Adequacy System |
| title_full_unstemmed |
Perverse Effects of a Ratings-Related Capital Adequacy System |
| title_sort |
perverse effects of a ratings-related capital adequacy system |
| publisher |
World Bank, Washington, DC |
| publishDate |
2014 |
| url |
http://documents.worldbank.org/curated/en/2000/06/437401/perverse-effects-ratings-related-capital-adequacy-system http://hdl.handle.net/10986/19828 |
| _version_ |
1764441508663001088 |