Work

Ratings-Based Regulation and Systematic Risk Incentives

Year: 2018

Type: article

Abstract: Our model shows that when regulation is based on credit ratings, banks with low charter value maximize shareholder value by minimizing capital and selecting identically rated loans and bonds with the highest systematic risk. This regulatory arbitrage is possible if the credit spreads on same-rated loans and bonds are greater when their systematic risk (debt beta) is higher. We empirically confirm this relationship between credit spreads, ratings, and debt betas. We also show that banks with lower capital select syndicated loans with higher debt betas and credit spreads. Banks with lower charter value choose overall assets with higher systematic risk. Received July 27, 2016; editorial decision May 29, 2018 by Editor Itay Goldstein.

Source: Review of Financial Studies

DOI: 10.1093/rfs/hhy091

Authors: Giuliano Iannotta, George Pennacchi, João A C Santos

Institutions: University of Illinois Urbana-Champaign, University of Illinois System, Federal Reserve Bank of New York, NOVA School of Business and Economics

Language: English

Topic: Credit Risk and Financial Regulations

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

Open Access status: green

OpenAlex ID: W2886698056

FWCI: 5.623

Cites: 66

Cited by: 41

Related to: 10