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A new study by Australian researchers has shed light on the methods used by ratings agencies to assign ratings to banks in Australia and the United Kingdom.

Professor Sirimon Treepongkaruna, from The University of Western Australia's Business School , along with Emawtee Bissoondoyal-Bheenick, from Monash University, analysed the quantitative determinants of bank ratings provided by Standard & Poor's, Moody's, and Fitch in the United Kingdom and Australia.

The study examined data from between 2006 and 2009, including the period of the global financial crisis.

‘The main finding of the study is that quantitative measures are only a part of the input into bank rating decisions,' said Professor Treepongkaruna. ‘On average, asset quality ratio, liquidity ratio, capital adequacy and operating performance measures are the key inputs to the determinants of ratings. The market risk factors and the macroeconomic factors (GDP, inflation) do not seem to have the same impact on bank ratings.

‘Quantitative measures, as focused on in our study, provide information on the historical performance and on banks' fundamental structural features. However, examination of past experience has to be supplemented by medium-term projections and by the construction of scenarios that will include financial situations that could occur after various shocks to the financial system.'

The study also found small differences in assessment methods between ratings agencies and ratings of banks in Australia and the United Kingdom.

Ratings, described by Professor Treepongkaruna as ‘a forward-looking estimate of the credit risk,' provide regulators, investors and customers with a simple way to assess the stability of banks.

‘Accurate bank ratings are critical, as banks play an important role in a country's macroeconomic and monetary policies,' said Professor Treepongkaruna.

‘The growing interlinkages among the world banking community are unavoidably leading to an increase in the demand for information across a broader range of markets and, consequently, greater demand for bank ratings.

‘Many investors have a limited understanding of the complexities of ratings and risk, leading to an undue reliance placed on the ratings for their investment decisions.'

Professor Treepongkaruna expects that bank ratings will remain an important tool for investors as Basle III is implemented over the coming years. The new accord will require banks to hold larger percentages of common equity and Tier 1 capital, in addition to introducing new capital buffers.

The study, ‘An Analysis of the Determinant of Bank Ratings: Comparison Across Ratings Agencies,' is published in the Australian Journal of Management. The study was funded by a 2009 research grant from the Melbourne Centre for Financial Studies.

Media references

Catherine Vogel
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UWA Business School
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Verity Chia
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UWA Business School
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