Moody's takes tougher line on bank debt

Moody's Investors Service has downgraded its credit ratings for subordinated debt issued by Australia's big banks, as regulators toughen their stance on any future bailouts.

In a move that affects lenders including the Commonwealth Bank, Westpac, ANZ, NAB and Macquarie, the credit agency made a two-notch cut to its ratings for subordinated debt, which ranks after other types of debt if a company fails. The decision does not affect the banks' overall credit ratings, which are critical for their ability to raise funds on global markets.

The change comes as regulators try to protect the financial system against moral hazard - where lenders and their investors take excessive risks in the knowledge they will be bailed out by government in the event of a collapse.

During the global financial crisis, governments tended to support struggling banks by injecting equity, which shielded bondholders from wearing losses.

But Moody's analyst Patrick Winsbury said there was a growing international trend of "selectively imposing losses" on investors in more junior types of debt.

"We recognise that Australian bank supervisors have, in the past, acted in a manner to support all bank creditors," he said. "However, the global financial crisis has demonstrated that support can be provided selectively and bank recapitalisation costs shared with subordinated creditors without triggering any contagion, as was previously feared."

At the height of the 2008 crisis, Australian banks benefited from government guarantees of deposits and wholesale funding.

Recent rescue efforts in Europe, however, have inflicted losses on bondholders.

Moody's said the Australian Prudential Regulation Authority did not have an explicit power to impose losses on holders of subordinated debt. But it said APRA had the power to wind up ailing banks, and these powers could be used to "coerce" subordinated debt holders into taking a haircut.

The type of bonds downgraded plays a relatively minor role in meeting Australian lenders' funding requirements - there was $21.8 billion in subordinated debt on issue at the end of June. This is less than 5 per cent of the total long-term outstanding debt of $478 billion.

The downgrade comes after a global body of regulators this week said G20 governments had more work to do in developing laws to stamp out the problem where banks were seen as "too big to fail".

The Switzerland-based Financial Stability Board's report said Australia had made good progress in recent legal changes to help "resolve" banks in financial strife.