Credit Ratings and Bank Monitoring Ability

Abstract

In this paper, the authors use credit rating data from two Swedish banks to elicit evidence on banks' loan monitoring ability. They test the banks' ability to forecast credit bureau ratings, and vice versa, and show that bank ratings are able to predict future credit bureau ratings. This is evidence that bank credit ratings, consistent with theory, contain valuable private information. However, the authors also find that public ratings have an ability to predict future bank ratings, implying that internal bank ratings do not fully or efficiently incorporate all publicly available information. This suggests that risk analyses by banks or regulators should be based on both internal bank ratings and public ratings. They also document that the credit bureau ratings add information to the bank ratings in predicting bankruptcy and loan default. The methods the authors use represent a new basket of straightforward techniques that enables both financial institutions and regulators to assess the performance of credit ratings systems.