The non-pecuniary determinants of sovereign and bank rating changes

Abstract

We study how the non-pecuniary incentives of credit rating agencies can lead to concurrent changes in both sovereign and bank ratings. While, following a sovereign downgrade, domestic banks are downgraded due to the application of the sovereign ceiling rule, we show that this rule is more strictly applied in countries which have lower geopolitical alignment vis-à-vis the rater's home country. Conversely, we also find that a reputation crisis experienced by the rating agency prompts it to relax the application of the rule and also mitigates the impact of its geopolitical preferences. Our results remain robust regardless of economic crisis events.