Bank Ratings in a (Con)Divergent Europe

Abstract

During the last decades Europe has started a policy of convergence. The establishment of European Central Bank and the Euro as a common currency are two critical time and crucial points of the convergence effort. The crises of 2002 and 2008 have raised the issue of stability, status and structure of the European banking system. Ranking agencies have been used to evaluate the financial and governance adequacy of banks. The paper attempts to find the factors that determine the ranking system of banks in Europe and it’s capability of predict good performance in governance and performance.The methodology presented in this paper consists of two main blocks of research. The first block of research uses a constructed binary variable for Fitch’s ranking for Europe’s banks. The construction of the variable is based on the value of evaluation. The best value (AAA has value 24, A- has value 18 and B- has value 9 and so on. Good rank value (Fitch binary variable = 1) is considered to be above A- (value 18) and bad ranking below that number (Fitch binary variable = 0). Three econometric methods (Probit, Logit, OLS) have been used to create a system that predicts the good value of Fitch rank.The second block uses the average numerical value of Fitch ranking system for every bank calculated previously in order to create econometric models that can explain and clarify the factors that affect the ranking system. Three econometric methods (Ordinary Least Squares, Least Absolute Deviations, and Robust Regression) have been used to create a system that predicts the value of Fitch rank. The independent variables used in both groups of research can be categorized into seven groups of indicators: performance, size, ownership, corporate governance, capital adequacy or capital structure, locality-country ranking, and loan growth. Each group has more that on variable. The data used for the empirical analysis cover the period from 2004 to 2011, is focused on the twenty seven (27) European Union countries and only commercial and cooperative banks. The total number of banks, initially, collected from Bankscope were 4.573. After the analysis of outliers the sample was reduced to 4.536 banks (2.873 active and 1.663 inactive).The final sample is comprised only from data of active banks (in 2012). The initial data were filtered even more, new ratios were calculated and only major banks have been used as sample. The statistical results show that the rating system and especially Fitch’s ratings are determined by four main factors (performance, locality-country risk, governance and capital adequacy). The paper’s value and innovation is that it has given a systemic approach to find indicators of ranking process and it has excluded four groups of indicators as non-statistically important (ownership, size, capital structure and growth). Although some of the factors were expected to be either significant or having little effect (e.g. performance-capital adequacy, size), others are unexpected (e.g. governance, capital structure). The results show a large dependence of bank ranking to country ranking and so the macroeconomic environment is largely the most significant factor.