Bank Ratings in Emerging Asia—Methodology, Information and Technology

Abstract

Bank rating is as old as bank regulatory authorities. The most common approach to bank rating is on-site examination. The bank supervision authority conducts an audit of physical bank records and documents and other observations. In particular, the on-site examination looks at the bank’s assets, capital structure, management ability and professionalism of the bank practices. A summary rating is assigned based on this examination. This approach was reported in 1974 in a publication of the Federal Reserve Bank of New York. This rating system was called into question for the first time during the Asian Financial Crisis (AFC) of the 1997 that affected South Korea, Thailand, and Indonesia. IMF painfully restructured the South Korean economy. Thailand suffered a severe outflow of funds and banks collapsed. The entire Indonesian banking system had to be revamped. Then the global financial crisis struck in 2007–2008, where the western world was hit harder than the AFC that led to the collapse of venerable financial institutions such as Lehman Bros and Bear Sterns. This begs the question: why bank ratings did not, or cannot, forewarn imminent failures in the banking system. In 2009, it was reported that banks were usually rated higher if they had greater capitalization, larger assets, and higher return on assets and equity. In 2013, in a most scathing attack on bank ratings, it stated that most failing banks had enjoyed investment status ratings just before they defaulted. This paper revisits the age-old CAMEL model and its derivatives, and a more recent EAGLES framework that alerted the Asian Financial Crisis of the 1990s. Based on the experiences of two crises in the last two decades, what lessons did we learned, especially on the early warning signals, contagion effect, information transparency and the availability of technology processes to collect and harness critical information.