Bank of Finland
The solvency standards implicit in bank capital levels, as reported in Jackson et al (2002), are much higher than those required for top ratings, if standard single period economic capital models are taken seriously. The authors explain this excess capital puzzle by forward looking rating targeting behavior by banks, which aims at maintaining rating above a minimum target in future periods. They calibrate to data on actual bank capital the confidence level used by the median US AA rated bank to maintain at least a single A rating. The calibrated confidence level is in line with the historical probability of an AA rated bank to be downgraded below A.