Hard to rate Moody's local bank warning

Moody's concern over the balance sheets of Australia's biggest banks once again demonstrates the capacity of rating agencies to identify problems only after they have passed.

Lowy Interpreter

I've already remarked on the Teflon-coated reputations of the credit rating agencies, agencies which played such a key supporting role in producing the global financial crisis but which have bounced back, more self-assured than ever.

Moody's has now put Australia's big four banks on notice that it will probably downgrade them soon. I suppose last week's announcement could be seen as admitting that the credit rating agencies got it fundamentally wrong before the GFC, and that balance sheets banks, (which depend on international financial markets), are subject to risks which were not foreseen before 2007.

But the change is still breathtaking in its perverse logic. Australia's banks, with all their dependence on foreign borrowing, have just weathered the ultimate in stress tests: the worst international financial crisis in living memory, which effectively bankrupted numerous banks around the world.

Sure, the Australian banks got the help of the government guarantee and the US Fed swap. But the GFC made it clear (if it wasn't before) that this sort of support would be provided by governments to protect their financial systems. One of the lessons of the GFC is not to repeat the mistake of letting the likes of Lehman Brothers (not even a bank) go under during a systemic crisis.

At the same time the Australian banks have restructured their borrowings to reduce vulnerabilities. The share of short-term wholesale funds (domestic and foreign) has fallen by 10 percentage points over the past three years. The banks' net overseas borrowings have fallen from 4 per cent of GDP before the GFC to around 1 per cent since then. The Basel Rules have been tightened, and Australian banks will have to respond with more liquidity reserves and perhaps more capital in some cases. Moreover, the lessons have been learned around the world. The current generation of bank managers will not make those mistakes again.

Moody's is demonstrating once again the capacity of rating agencies to identify the problems only after they have passed. There is one tiny glimmer of light in this dismal scene: a sister agency, Standard and Poor's, recently downgraded Japanese government debt, and financial markets took no notice. They announced a wake, and no one came. Let's hope this irrelevance comes to be the norm.

This article first appeared on the Lowy Interpreter. It has been edited for style. Republished with permission.