Using Credit Ratings for Capital Requirements on Lending to Emerging Market Economies : Possible Impact of a New Basel Accord

The Basel Committee on Banking Supervision has proposed linking capital requirements for bank loans to ratings by commercial credit rating agencies. Estimates for 20 emerging market economies show that sovereign ratings react procyclically to crisis indicators. Ratings deteriorate if the real effective exchange rate depreciates, in contrast with the positive effect on overall debt service capacity depreciations are normally supposed to have. Simulations show that linking capital requirements to ratings would have drastically increased these requirements during the crisis periods after decreasing them in the run up to the crises. Simulations suggest modest efficiency gains of using sovereign credit ratings for capital requirements on emerging market lending