7 suffer from a substantial increase in their borrowing cost.<sup>5</sup> Even in the case in which this increase is generated by the desirable removal of previous subsidization schemes, it appears important to devote particular attention to the phasing-in process of any regulatory change in the domrain of minimum bank capital ratios. Such caution is needed in order to avoid undesired systemic implications, which could increase rather than reduce the fragility of banking systems.

More generally, all other things being equal, any risk-related criterion for the definition of minimum capital ratios would substantially decrease the cost of credit for internationally diversified fitms and could result in an increase in the share of credit to the domestic sector provided by internationally diversified firms. Although the equilibrium allocation should arguably benefit from the removal of an implicit subsidization scheme to the riskiest firms in the market, the potential consequences of a large reallocation of credit flows among different categories of financial interrnediaries would need to be analyzed carefully.

# **4. A tale from the 1997-98 crises: downgrading sovereigns, banks and corporations**

The experience of soviereign and private sector ratings in emerging economies in 1997-98 may provide an example in which the revision of ratings could have had some undesired macroeconomic consequences had it been related to banks minimum capital requirements. Indeed, the East Asian crisis and the other crises that hit emerging economies during 1997-98 induced markets and rating agencies to a delayed and large set of revisions of their assessment on crisis countries. Ratings were sharply downgraded for sovereigns. The astounding downgrading is depicted in the rating-transition Figure 3. Based on Moody's data for a. large set of countries,<sup>6</sup> Figure 3 reports on the x axis 1996 (pre-crisis) sovereign ratings and on the y axis the relative 1998 (peak-of-the-crisis) ratings. The rating-transition graph can be read as follows. Figure 3 is divided into different regions by three lines: the **450** continuous line contrasts 1996 with 1998 ratings; the vertical dotted line separates below-investment-grade from above-investment-grade ratings for 1996; the horizontal dotted line separates below-investment-grade from aboveinvestment-grade ratings for 1998. Points lying below the **450** line identify those countries suffering a downgrading between 1996 and 1998; points lying on the **450** line refer to those countries whose rating did not change; points above the **450** line identify those countries whose rating improved between 1996 and 1998. In addition, the horizontal and vertical dotted lines divide the graph into four quadrants. Points in the Northwest quadrant identify countries holding above-investment-grade ratings in both 1996 and 1998. Points in the Southeast quadrant identify countries holding belowinvestment-grade ratings in both 1996 and 1998. Points in the Southwest quadrant ' The limited number of rated firms in NHICs and the fact that those firms are likely to have easier access to non-bank sources of financing does not weaken our conclusions. Bank regulators, in fact, will not put at a disadvantage rated finns, which are likely to have lower risk profiles. They, instead, are expected to extend the higher capital requirements of rated firms to non-rated concerns as well.

**_6_** Specifically, for each of the two years, we consider the year-minimum sovereign rating for the following 31 countries: Argentina, Australia, Austria, Belgium, Brazil, Canada, Chile, China, Colombia, Denmark, Finland, France, Germany, India, Indonesia, Japan, Korea, Luxembourg, Malaysia, Mexico, Netherlands, New Zealand, Norway, Philippines, Singapore, Sweden, Switzerland, Thailand, UK, USA, Venezuela.

_Ferri, Liu, andMajnoni, "The Role of Rating Agency Assessments_ **_in_** _Less Developed Countries:_ **_Impactof_** _the ProposedBasel Guidelines"_