Bangor University DOCTOR OF PHILOSOPHY Credit rating divergence and the role of opacity in emerging market banks Martin Merizalde, Andrea Award date: 2020 Awarding institution: Bangor University Link to publication General rights Copyright and moral rights for the publications made accessible in the public portal are retained by the authors and/or other copyright owners and it is a condition of accessing publications that users recognise and abide by the legal requirements associated with these rights. • Users may download and print one copy of any publication from the public portal for the purpose of private study or research. • You may not further distribute the material or use it for any profit-making activity or commercial gain • You may freely distribute the URL identifying the publication in the public portal ? Take down policy If you believe that this document breaches copyright please contact us providing details, and we will remove access to the work immediately and investigate your claim. Download date: 11. Oct. 2021 Credit rating divergence and the role of opacity in emerging market banks By Andrea Martin Merizalde PhD thesis Bangor Business School April 2020 Declaration and consent I hereby declare that this thesis is the results of my own investigations, except where otherwise stated. All other sources are acknowledged by bibliographic references. This work has not previously been accepted in substance for any degree and is not being concurrently submitted in candidature for any degree unless, as agreed by the University, for approved dual awards. Yr wyf drwy hyn yn datgan mai canlyniad fy ymchwil fy hun yw’r thesis hwn, ac eithrio lle nodir yn wahanol. Caiff ffynonellau eraill eu cydnabod gan droednodiadau yn rhoi cyfeiriadau eglur. Nid yw sylwedd y gwaith hwn wedi cael ei dderbyn o’r blaen ar gyfer unrhyw radd, ac nid yw’n cael ei gyflwyno ar yr un pryd mewn ymgeisiaeth am unrhyw radd oni bai ei fod, fel y cytunwyd gan y Brifysgol, am gymwysterau deuol cymeradwy. i | P a g e Abstract Prior credit rating literature focused on emerging economies is very limited and often country- specific, despite the significant expansion of the credit rating industry in these countries in recent years. Bank rating studies are particularly scarce, notwithstanding the pivotal role of banks as major funding providers in emerging economies. This thesis addresses these voids in the literature and investigates bank rating divergences between S&P, Moody’s and Fitch, the global rating agencies (GRAs), using a cross-country setting (11 emerging economies). Three perspectives are central to the thesis: (i) examining the drivers of national scale ratings (NSR) and global scale ratings (GSR) assignments by S&P; (ii) evaluating the effect of bank opacity on split bank ratings; and (iii) analysing to what extent split bank ratings are driven by systematic components including opacity at the sovereign government level and the sovereign rating ceiling. The first empirical chapter finds that bank size and competition between GRAs have the strongest effect on the probability of S&P rating assignments. GSR (NSR) assignments by S&P are more likely for larger (smaller) banks, although there exists a dependency on whether the bank has prior NSR (GSR) ratings. Fitch ratings potentially substitute S&P ratings, while Moody’s ratings complement S&P. The second empirical chapter uses bank size, capital, liquidity and profitability as proxies of bank opacity. The analysis demonstrates that bank opacity increases the probability of split bank ratings. Also, split-rated banks are more likely to experience future rating migrations than non-split rated banks, and wider rating differences have the strongest impact. The third empirical chapter presents evidence of a significant effect of split sovereign ratings and the ceiling effect on split bank ratings. The probability that S&P assigns bank ratings in a more conservative manner than Moody’s (Fitch), increases when S&P assigns lower sovereign ratings than Moody’s (Fitch). The same result is achieved when Moody’s assigns lower sovereign ratings than Fitch. Moreover, bank rating disagreements are more sensitive to split sovereign ratings when the ceiling effect of the GRA that assigns higher bank and sovereign ratings prevails. The thesis provides highly original contributions to the literature. New evidence on the rating dynamics between NSR and GSR assignments in emerging economies offers a novel perspective on the study of bank rating determinants. The thesis also provides clear insights on the strong effect of asset opacity and information quality on split bank ratings in emerging economies. These issues are of interest for policymakers, banks and other market participants due to their potential impact on debt issuance costs and foreign investment flows. ii | P a g e Acknowledgements First of all, I would like to thank my supervisors, Professor Owain ap Gwilym and Dr Rasha Alsakka, for all their guidance, support and advice during my PhD. I feel extremely fortunate to have supervisors who have also been my mentors, sharing their valuable expertise and providing insightful discussions about my research. Their encouragement, patience and confidence in my work have been invaluable throughout the PhD. I am also grateful with Bangor Business School for the PhD scholarship received to pursue my Doctoral studies and to Professor Aziz Jaafar for his constructive comments and suggestions. I would also like to thank all my PhD colleagues for the stimulating discussions during the PRSS and for making my PhD a pleasant journey. Also, a big thanks to the staff at Bangor Business School, especially Rachel Parry for her invaluable help coordinating my tutorials. My sincere gratitude also to my friends for their support and advice during my studies, specially to Marybeth, Calvin, Laurence, Lana and Quang for the interesting discussions and being unconditional friends, which has been essential during these academic years. I also want to express my gratitude to my family in Colombia for believing in me and have accompanied me during my academic endeavours. And finally, special thanks to Sebastian, my partner, who inspired me to pursue my doctoral degree and who has been by my side throughout this PhD journey, discussing my findings and giving me his patience, encouragement and unconditional support. iii | P a g e Contents Declaration and consent ................................................................................................................... i Abstract ........................................................................................................................................... ii Acknowledgements ........................................................................................................................ iii Contents .......................................................................................................................................... iv List of tables ................................................................................................................................. viii List of supporting tables ................................................................................................................. xi List of figures ................................................................................................................................ xii Abbreviations and acronyms ........................................................................................................ xiii Country codes ................................................................................................................................ xv Chapter 1 Introduction .................................................................................................................... 1 1.1 Introduction ........................................................................................................................... 2 Chapter 2 Background of the credit rating industry ........................................................................ 8 2.1 Introduction ........................................................................................................................... 9 2.2 Composition of the credit rating industry ............................................................................ 10 2.3 Credit rating scales .............................................................................................................. 15 2.4 CRAs’ business model......................................................................................................... 18 2.5 Conclusions ......................................................................................................................... 21 Chapter 2 Tables ........................................................................................................................ 22 Chapter 3 Literature review ........................................................................................................... 31 3.1 Introduction ......................................................................................................................... 32 3.2 The value and impact of GRAs’ credit ratings .................................................................... 33 3.2.1 Certification effect and reputation ................................................................................ 33 3.2.2 The role of competition on rating quality ....................................................................