Credit Ratings in China: Evidence from the Upgrades in the Banking Sector

Abstract

We observe 180 upgrades, in contrast to two downgrades, among 657 Chinese banks during 2015-2017. Evidence shows that the upgrades were results of compromised rating standard rather than improvements to bank fundamentals. Investors reacted negatively to the upgrades, especially those granted by non-incumbent credit rating agencies (CRAs), suggesting that they were able to discover information. However, investors responded positively to the upgrades that led to regulatory benefits, implying that rating-contingent regulations play a central role in aligning the interests of issuer, investor and CRA for rating inflation---myopia induces investors to accept biased upgrading as incentive for regulatory arbitrage prevails; single-rating reporting policy and insufficient issuer-CRA contact disclosure play important accessary roles, while investor monitoring and agency reputation effect are absent.