The Relation of Bank Financial Strength Ratings to Retail and Commercial Bank Performance

John A Ruddy, Pace University

Abstract

The research outlined in this paper considers data from Nationally Recognized Statistical Rating Organizations relative to the performance of banking institutions. More specifically, the study considers two separate research topics: 1. whether bank financial strength ratings of global financial institutions contain new information for the financial markets; and 2. whether financial data reported by U.S. banks to banking regulators can explain bank financial strength ratings. For the first topic, if the financial markets are efficient and credit rating agencies utilize only publicly available information, security prices should change prior to financial strength rating changes. Prior research has considered the relationship of credit rating agency data and their impact on the credit default swap spreads of sovereigns (Ismailescu and Kazemi, 2010), corporate credit default swap spreads (Nordon and Weber, 2004) and/or both type of entities (Hull, Predescu and White, 2004; Finnerty, Miller and Chen, 2013). The finding that negative rating changes are more anticipated than positive rating events by the credit default swap market is consistent with prior research (Hull, Predescu and White, 2004; Nordon and Weber, 2004), but contradicts more recent research (Finnerty, Miller and Chen, 2013). This research makes a meaningful contribution in that it considers bank financial strength ratings, which are different from credit ratings utilized in previous research. The results of this research are important for investors who consider factors that affect credit default swap spreads. For the second topic, U.S. banking institutions are required to file quarterly financial reports with banking regulators. I consider whether ratios constructed from publicly available regulatory data explain bank financial strength ratings. I examine financial data and selected variables from a data set that included financial statement data on over 6,000 banks. The variables address the topics of bank capital, asset quality, management capacity, earnings, liquidity, and sensitivity to market risk. I found that one variable each from the above selected topic areas explain approximately 60% of bank financial strength ratings. Prior research has attempted to explain and predict bank financial strength ratings (Poon, Firth and Fung, 1999; Hammer, Kogan and Lejeune, 2012). Since the 2007–2010 financial crisis, prior research has attempted to predict the financial strength ratings of Turkish banks (Öğüt, Doğanay, Ceylan, Aktas, 2012), the performance of South African banks (Kumbirai and Webb, 2010) and bank performance in Malaysia and China (Said and Tumin, 2011). I utilize variables derived from a bank regulatory model to determine how well they explain financial strength ratings. The research is consistent with previous research as it found that asset quality, capital levels and institution performance are significant explanatory variables. This research adds to the literature by considering nearly the entire population of U.S. banks across time periods not previously studied. Exploring these topics has importance for three separate groups. The first is academic researchers. The existing research has considered the impact of credit rating changes on the financial markets but has not considered the impact of BFSR changes. The second is U.S. bank regulators, who are responsible for maintaining the health of U.S. banks and the banking system. The third and last group is market participants. The CDS spreads and stock prices of banks have been volatile since the beginning of the credit crisis. It would be helpful for market participants to have a broader understanding of the factors that influence security prices.

Subject Area

Finance|Banking

Recommended Citation

Ruddy, John A, "The Relation of Bank Financial Strength Ratings to Retail and Commercial Bank Performance" (2017). ETD Collection for Pace University. AAI13808734.
https://digitalcommons.pace.edu/dissertations/AAI13808734

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