Bank Failure and Credit Ratings

Abstract

This study explores the role of credit ratings in predicting a bank failure in recent financial crisis. Both logistic regression and Cox proportion model confirm that credit ratings can predict the probability of bank failure, but only two quarters prior to bank failure, relatively sluggish compared to stock market returns, loan-loss provision and leverage variables. There is suspicion on the delay rating adjustment as the result of inflated credit ratings, issuers shop for favorable ratings, and window dressing by the bank managers. The Insight from these findings provides relevant implications to investors and regulators to utilize credit ratings as an alternative early warning system to prevent investment loss or social destruction in a subsequent bank run or contagion effect.