Internal Ratings, Non-Performing Loans, and Bank Opacity: Evidence from Analysts’ Forecasts

Abstract

We use a panel data set of large listed European banks to evaluate the effect of the usage of internal ratings-based (IRB) models on bank opacity. We find that a more intensive usage of these models is associated with lower forecast error and disagreement among analysts about bank earnings per share. These results seem to be driven by the more detailed disclosure of loan portfolios required of IRB users, and are stronger in banks adopting the advanced version of IRB models. In these banks the negative effect of non-performing loans on bank transparency is mitigated. However, the transparency-enhancing role of IRB models fades in low-capital banks, suggesting that capital constraints could favor an opportunistic usage of internal ratings that counterbalances their beneficial effect on bank transparency.