Big banks are awarded higher grades from ratings firms because the lenders provide them with business including evaluating securitized debt, according to a European Central Bank study.
Larger financial institutions were more likely to receive better grades, according to the research report, which reviewed about 39,000 quarterly bank ratings from Standard & Poor’s, Moody’s Investors Service and Fitch Ratings from 1990 to 2011.
Inflated grades on bonds backed by subprime mortgages during the housing boom helped ignite the worst financial crisis since the Great Depression when their values plummeted five years ago. Analysts at the three firms were pressured to give their stamp of approval to complex investments to win lucrative business from Wall Street banks, the Senate Permanent Subcommittee on Investigations said last year in a report.
The “bias mostly reflects credit rating agencies’ conflicting incentives with respect to large banks,” authors Harald Hau, Sam Langfield and David Marques-Ibanez wrote in the report posted on the European Central Bank’s website, whose findings don’t represent that of the ECB.
“We strongly disagree with the methodology and conclusions of the study,” Michael Adler, a spokesman for Moody’s, said in a telephone interview, declining to give more details.
“To suggest that large bank ratings are conflicted simply because those banks might also be in a ’stronger client position’ is in our view a cynical leap -- or what the ECB report calls a ’hypothesis’,” Dan Noonan, a spokesman for Fitch, wrote in an e-mail. “No business model is completely free from potential conflicts of interest -- what matters is how well they are managed and communicated to the market.”
Ed Sweeney, a spokesman for S&P, declined to comment.
Big banks systematically obtain more favorable credit ratings than smaller institutions because of their size and economic power, according to the study. At the extreme, large banks might become ‘too big to downgrade’ for a rating company.
“A bank’s power in relation to a rating agency is related to its size,” the authors wrote. “Larger banks are more likely to have multiple and more comprehensive business relations with rating agencies.”
Banks may also enjoy higher ratings because many are considered to have “implicit” government support.
In 2007, S&P’s structured finance group took in $561 million in revenue, sometimes charging banks more than $1 million to rate a single offering, according to the Senate panel. About 90 percent of AAA securities backed by subprime mortgages from 2006 and 2007 were later cut to junk, or below Baa3 by Moody’s and lower than BBB- at S&P.