Banks face market pressure when determining their capital structures because they are subject to strict regulations. CFOs are willing to adjust their company’s capital structures in order to obtain higher ratings. The credit ratings are highly valuable not only because they assess the creditworthiness of the borrowers but also because those agencies take advantage of the information asymmetry and have access to data that companies might not disclose publicly. Also, this industry gained much interest after the BIS proposals back in 1999 and 2001 that the Basel Committee on Banking Supervision should consider the borrower’s credit ratings when examining banks’ solvency and adequacy. Factors used to determine the credit ratings are banks’ asset quality which is fundamental measure for the creditworthiness, banks’ capital which is related to the asset quality in relation to the RWA, banks’ profitability, and liquidity measurements. The purpose of this paper is to investigate whether the banks that keep excess equity to balance sheet receive better credit ratings, given the predictors capital, banks size and defaulted to total exposures. The European Banking Authority (EBA) stress test results are used as a benchmark for determining banks’ capital adequacy and solvency, whereas the credit ratings are obtained shortly after the EBA’s reports publication. The sample size is 73 and 95 banks for the years 2011 and 2014, respectively. The results from the multivariate ordinal regression do not show significant correlation results between the excess equity to balance sheet and the credit ratings, even though the estimated coefficient is negative, namely excess equity is associated with lower credit ratings. An explanation to this one can find in the low-quality capital relative to the banks’ capital base. Also, banks which plan to implement risker projects or currently hold risker assets are subject to higher capital requirements. Moreover, banks currently being rated low but with the potential of being upgraded would be more willing to issue equity than debt in order to avoid the corresponding risk and achieve the higher rating. The equity ratio and the defaulted to total exposures ratio show significant correlation to the banks’ credit ratings. Overall, since the results of the regression are insignificant, we do not have reasons to believe that holding excess equity is not beneficial for banks. When banks make changes in their leverage ratios they would either carry the cost of being downgraded or the cost related to issuing more equity, therefore at the end they will balance the leverage ratio close to the optimal and keep as much capital as required by regulations.

Ever since the great financial crisis of 2008 regulators have pushed toward more resilient banks, resulting in more demanding regulation and an increase of regulator’s insight and power. Through the revision of the BASEL framework, Contingent Convertible Bonds were introduced in 2010 as a part of regulatory capital and has since then grown increasingly popular. However, these instruments have never been tested in a stressed European financial system. Hence, there is no genuine information of how these instruments would behave. Neither have there been any published efforts in testing this through simulation, to the best of my knowledge. Using a temporally disaggregated augmentation of the EBA 2016 stress test, I simulate how the financial system would be affected by triggering the CoCos. Studying the implications of both low and high trigger instruments. Results indicate that there are low risks for a systemic fallout and showcases some notable differences as a result of CoCo design and type of trigger.