The Impact of Sovereign Rating News on European Banks

Date01 January 2016
AuthorGino Gandolfi,Maria Gaia Soana,Stefano Caselli
Published date01 January 2016
The Impact of Sovereign Rating News
on European Banks
Stefano Caselli
Bocconi University, Department of Finance, via Roentgen 1, 20136 Milan and SDA Bocconi School of
Management, Milan, Italy
Gino Gandoland Maria Gaia Soana
University of Parma, Department of Economics, via Kennedy 6, 43100 Parma, SDA Bocconi School of
Management, Milan, Italy
This paper examines the spillover effect of Eurozone sovereign rating changes
announced by Standard and Poors, Moodys, and Fitch on domestic bank share
prices in the period 20022012. This spillover effect appears negative in the case of
downgrades, but insignicant for upgrades. Surprisingly, announcement of
sovereign negative credit watches results in increased bank stock returns. Bank
share price losses following sovereign downgrades increase as bank leverage,
efciency, and equity performance increase, and they decrease as bank systematic
risk and payout ratio increase. On the contrary, bank share prices rise following
sovereign negative credit watches, as leverage and bank size decrease and as bank
systematic risk increases.
Keywords: sovereign rating change, European banks, event study, spillovers
JEL classification: G14, G15, G21, G24
We thank an anonymous referee for very helpful suggestions. We thank also many
colleagues with whom we had a chance to discuss the items examined in this paper for their
helpful comments at various stages of the papers development: Andrea Beltratti, Francesco
Corielli, Douglas Cumming, Alberta Di Giuli, Stefano Gatti, Diego Valiante, and Giovanni
Verga. We also thank seminar participants at Fondazione Rosselli in Rome, ECMI at CEPS
in Brussels, OECD in Paris, CER in Rome, Università Bocconi, SDA Bocconi School of
Management, and Università di Parma. We are also grateful for financial support from the
project MIUR PRIN MISURA Multivariate models for risk assessment, and the
anonymous referees selected by the EFM journal. All remaining errors are our own.
European Financial Management, Vol. 22, No. 1, 2016, 142167
doi: 10.1111/eufm.12056
© 2014 John Wiley & Sons Ltd
1. Introduction
Credit rating agencies play a key role in the nancial markets, as they assess the
creditworthiness of assets, corporations, and countries. In recent years, both the regulatory
authorities and the nancial literature have given much attention to rating agency actions
and their effects on nancial markets.
On one hand, international supervisors believe that markets accord excessive weight to
external credit ratings and, for this reason, regulators have attempted to reformulate the
role of credit rating agencies. On this point, the Financial Stability Board (FSB) endorsed,
in October 2010, principles to reduce the reliance of regulatory authorities and nancial
institutions on credit ratings. At the European level, the European Parliament (2013) is
working toward reviewing references to external ratings in European Union law whenever
they trigger or have the potential to trigger sole or mechanistic reliance.
On the other hand, the nancial literature recognises the primary role played by credit
rating agencies in nancial markets. Specically, research to date has focused on the
market impact following announcement of new corporate or sovereign ratings. Some
authors test the impact of credit rating changes at the company level, nding that rating
downgrades are informative, but that upgrades are not (Hand et al., 1992; Ferreira and
Gama, 2007). The same results are conrmed at the country level. Studies investigating
the own-country nancial market impact of sovereign rating changes show that sovereign
rating downgrades have a negative impact on the re-rated countrys stock and bond
markets, while upgrades have limited or insignicant effects (Kaminsky and Schmukler,
2002; Brooks et al., 2004; Hill and Faff, 2010; Afonso et al., 2012). Some studies focus on
the spillover effects of sovereign rating news on foreign markets, nding that sovereign
downgrade news is contagious for foreign bond and stock markets (Kaminsky and
Schmukler, 2002; Gande and Parsley, 2005; Ferreira and Gama, 2007), while sovereign
upgrade news is not (Gande and Parsley, 2005; Ferreira and Gama, 2007).
There are no studies on the impact of sovereign rating changes on bank share prices,
although many authors believe that sovereign ratings are important for banks. The
Committee on the Global Financial System (2011) recognises that sovereign downgrades
have direct negative repercussions on the cost of bank debt and equity funding. Further,
the role of domestic banks as major lenders to governments is evident, especially during
times of nancial turmoil (Blundell-Wignall and Slovik, 2010; Blundell-Wignall, 2011;
Adler, 2012; Acharya and Rajan, 2013; Gennaioli et al., 2014). On this point, Adler
(2012) theorises that high bank exposure to sovereign risk causes a fragile
interdependence between scal and bank solvency, and that this interdependence creates
conditions conducive to a self-fullling crisis. In addition, sovereign downgrades often
lead to downgrades of domestic banks (Committee on the Global Financial System, 2011;
Williams et al., 2013). More specically, sovereign ratings generally represent a ceiling
for domestic bank ratings. Though credit rating agencies have gradually moved away
from the sovereign ceiling rule,
Borensztein et al. (2007) show that sovereign ratings
remain a signicant determinant of rm credit ratings. To date, only Arezki et al. (2011)
examine the impact of sovereign rating news on bank indices, showing that sovereign
rating changes affect bank index stock prices in Europe over the 20072010 period.
The sovereign ceiling ruleis the policy of never rating a private borrower above the
© 2014 John Wiley & Sons Ltd
The Impact of Sovereign Rating 143

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