The sovereign-bank rating channel and rating agencies' downgrades during the European debt crisis

Abstract

We investigate the rating channel for the transmission of changes in sovereign risk to the banking sector, analysing data from Moody's, S&P and Fitch before and during the European debt crisis. Sovereign rating downgrades and negative watch signals have strong effects on bank rating downgrades in the crisis period. The impact is stronger for multiple-notch sovereign rating downgrades, and more pronounced in PIIGS countries. Secondly, we investigate rating agencies' competition in the banking sector during the same periods, finding significant differences in rating policies across the agencies. S&P credit actions tend to be the more independent ones, while Moody's appears to be more cautious, although it is by far the most likely to assign multiple-notch downgrades. In the pre-crisis period, we find no evidence that bank rating actions are linked to sovereign rating signals (nor vice versa) nor to prior bank rating changes by a competing agency.