The Impact of Sovereign Rating News on European Banks

• Date: 01 January 2016
• Author: Gino Gandolfi,Maria Gaia Soana,Stefano Caselli
• DOI: http://doi.org/10.1111/eufm.12056
• Published date: 01 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

E-mail: stefano.caselli@unibocconi.it

Gino Gandolfiand Maria Gaia Soana

University of Parma, Department of Economics, via Kennedy 6, 43100 Parma, SDA Bocconi School of

Management, Milan, Italy

E-mail: gino.gandolfi@unipr.it, mariagaia.soana@unipr.it

Abstract

This paper examines the spillover effect of Eurozone sovereign rating changes

announced by Standard and Poor’s, Moody’s, and Fitch on domestic bank share

prices in the period 2002–2012. This spillover effect appears negative in the case of

downgrades, but insignificant 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,

efficiency, 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 paper’s 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, 142–167

doi: 10.1111/eufm.12056

© 2014 John Wiley & Sons Ltd

1. Introduction

Credit rating agencies play a key role in the financial markets, as they assess the

creditworthiness of assets, corporations, and countries. In recent years, both the regulatory

authorities and the financial literature have given much attention to rating agency actions

and their effects on financial 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 financial

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 financial literature recognises the primary role played by credit

rating agencies in financial markets. Specifically, 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, finding that rating

downgrades are informative, but that upgrades are not (Hand et al., 1992; Ferreira and

Gama, 2007). The same results are confirmed at the country level. Studies investigating

the own-country financial market impact of sovereign rating changes show that sovereign

rating downgrades have a negative impact on the re-rated country’s stock and bond

markets, while upgrades have limited or insignificant 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, finding 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 financial 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 fiscal and bank solvency, and that this interdependence creates

conditions conducive to a self-fulfilling crisis. In addition, sovereign downgrades often

lead to downgrades of domestic banks (Committee on the Global Financial System, 2011;

Williams et al., 2013). More specifically, sovereign ratings generally represent a ceiling

for domestic bank ratings. Though credit rating agencies have gradually moved away

from the ‘sovereign ceiling rule’,

1

Borensztein et al. (2007) show that sovereign ratings

remain a significant determinant of firm 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 2007–2010 period.

1

The ‘sovereign ceiling rule’is the policy of never rating a private borrower above the

sovereign.

© 2014 John Wiley & Sons Ltd

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