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Rethinking the Use of Credit Ratings in Capital Regulations: Evidence From the Insurance Industry
[Causes of the financial crisis]

Author

Listed:
  • Kathleen Weiss Hanley
  • Stanislava Nikolova

Abstract

We analyze an initiative by insurance regulators to reform capital regulations for mortgage-backed securities (MBS) by replacing credit ratings with third-party estimates of expected credit losses and by considering an insurer’s exposure to future losses when determining regulatory capital. After implementation, insurers are less likely to sell distressed MBS, gains trade corporate bonds, and/or raise external financing. However, the new regime allows insurers to purchase more low-rated MBS at significant capital savings and insurers with greater capital savings are more likely to do so. Our analysis highlights the potential costs and benefits of an alternative methodology for determining regulatory capital. JEL (G11, G18, G22, G28, G32, G38).Received May 6, 2019; editorial decision April 4, 2020 by Editor Andrew Ellul.

Suggested Citation

  • Kathleen Weiss Hanley & Stanislava Nikolova, 2021. "Rethinking the Use of Credit Ratings in Capital Regulations: Evidence From the Insurance Industry [Causes of the financial crisis]," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 10(2), pages 347-401.
    • Handle: RePEc:oup:rcorpf:v:10:y:2021:i:2:p:347-401.
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    File URL: http://hdl.handle.net/10.1093/rcfs/cfaa007
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    Citations

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    Cited by:

    1. Girardi, Giulio & Hanley, Kathleen W. & Nikolova, Stanislava & Pelizzon, Loriana & Sherman, Mila Getmansky, 2021. "Portfolio similarity and asset liquidation in the insurance industry," Journal of Financial Economics, Elsevier, vol. 142(1), pages 69-96.
    2. Bo Becker & Marcus M Opp & Farzad Saidi, 2022. "Regulatory Forbearance in the U.S. Insurance Industry: The Effects of Removing Capital Requirements for an Asset Class," The Review of Financial Studies, Society for Financial Studies, vol. 35(12), pages 5438-5482.
    3. Kirti, Divya, 2024. "When gambling for resurrection is too risky," Journal of Banking & Finance, Elsevier, vol. 162(C).
    4. Federico Apicella & Raffaele Gallo & Giovanni Guazzarotti, 2022. "Insurers' investments before and after the Covid-19 outbreak," Temi di discussione (Economic working papers) 1363, Bank of Italy, Economic Research and International Relations Area.
    5. Boermans, Martijn A. & van der Kroft, Bram, 2024. "Capital regulation induced reaching for systematic yield: Financial instability through fire sales," Journal of Banking & Finance, Elsevier, vol. 158(C).

    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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