Credit rating downgrades and systemic risk

Abstract

We examine whether changes in issuer credit ratings by the three main providers are associated with changes in systemic risk. First, we find that rating downgrades result in an increase in bank systemic risk, whereas upgrades do not proportionally reduce systemic risk. Second, we document that the positive relationship between rating downgrades and systemic risk can be mitigated by accounting-based stability factors, such as profitability and capital, but also enhanced by sovereign rating downgrades. Finally, we show that sovereign rating downgrades have a greater effect on bound banks’ systemic risk compared to non-bound banks.