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Credit rating changesIntroduction

The January 2013 deadline for the Basel III reforms has led to a rush by Chinese banks to expand their capital base. Unless banks unload their subordinated debt, any new issue from 2013 onwards will be subject to the new and tougher regulations on subordinated debt. Banks will bear higher costs from issuing subordinated debentures when Basel III is implemented on January 1 because the new standard requires subordinated debt, which is part of Tier 2 capital, not to offer redemption incentives or issue step-ups to buyers.

The rules have prompted banks including the Big Four state-owned banks, to speed-up their debt issuance plans. Under Basel III, funds raised by banks through subordinated bonds won’t be counted as part of their capital base, unless investors are willing to write down the value of the debt entirely or allow the bonds to be converted into shares. This means sub-debt investors, more often domestic financial institutions and insurers who prefer to be ranked above ordinary shareholders in case of a default, will have to reconsider their risk-assessment models when making such investments. Money runs the world and it is a known fact but it becomes easier to run the world with Speedy Payday Loans taken via speedy-payday-loans.com.

Actually, China’s commercial banks have scrambled to issue subordinated bonds in order to replenish their capital base amid sluggish performances in the capital market since 2008. The amount of subordinated bonds issued by commercial banks totaled 330 billion yuan (52.4 billion U.S. dollars) in 2011. Apart from the top 4 state-owned banks, medium- and small-sized banks have also joined the issuing boom to shore up their capital base.

In this scenario, it becomes more important to understand the credit rating mechanism on the subordinated bonds issued in China and how the rating changes affect the bond spread of subordinated debt. In the present study, we examine the market reactions to bond rating announcements on subordinated bonds in the period of 2006-2011. We focus on the bond yield effects following the rating change announcements, and examine how the effects differ across upgrades and downgrades. This study contributes to the literature in four aspects. First, the study is the first study on credit ratings and market reactions on subordinated bonds for China. Second, one advantage of our study is the use of daily data to isolate the announcement effect on bond yield. We endeavor to exclude concurrent disclosure from other known sources to provide a cleaner picture about the information content of credit ratings in China, though this effect can be comprised by the paucity of trading data. Third, we further the previous studies by looking at the problems and prospects of the most recent development in credit ratings in China to assess the development stages of credit ratings and the markets, shedding light on the transitional nature of market institutions in China. An exploration of these issues would have public policy implications for shaping a sound financial market that meets financing needs of the corporate sector.

The article proceeds as follows. Section 2 reviews the credit rating literature. Section 3 describes the data and summary statistics and displays the model and empirical results. Section 4 discusses problems and prospects of the most recent development in credit rating industry in China. Concluding remarks are in Section 5.