Credit Rating, Banks' Capital Structure and Speed of Adjustment: A Cross-Country Analysis

Recent studies examining the effects of a credit rating on firms’ capital structure and adjustment of capital structure to target have focused predominantly on non-financial firms, with virtually no attention given to financial institutions. Using an international sample of 391 rated banks from 76 countries, this study examines the effects of credit ratings on the capital structure of banks. We find that, on average, banks near a credit rating upgrade have a higher capital to assets ratio compared to banks not near a rating upgrade. Most systematically important - too-big-to-fail banks near a credit rating upgrade tend to have lower capital relative to assets than the rest of the banks in our sample. Furthermore, banks downgraded from an investment-grade rating to a speculative-grade rating, on average, hold 1 (3) percentage points less capital relative to assets in the short (long) run. Contrary to studies based on non-financial firms, our results show that credit ratings have relatively little economic effect on the speed at which banks’ capital is adjusted. Our results suggest that while rating agencies exert influences on banks’ capital structure, they are fewer in number and tend to be weaker, compared to those documented in non-financial firms.