Moody’s is on a roll. After downgrading large swathes of the eurozone banking sector in recent weeks, the credit rating agency finally came out with the most eagerly watched of its proposed rating cuts – those of 15 global banks.
Though it relented on a few of its threatened downgrades, all the banks saw some of their ratings cut. There were downgrades for short-term debt, long-term debt, financial solidity on an independent basis and with governments’ support, compounding the barrage of bad news for the sector, especially for those with big investment banking operations.
It has been a long time coming. Moody’s signalled in February that it was planning downgrades of up to three notches for all the big global banks. After all that pondering, the broad conclusion was straightforward enough – it has created three buckets of global banks, leaving only three in the top-notch category – HSBC, Royal Bank of Canada and JP Morgan. Four are in the bottom-notch – Bank of America, Citigroup, Morgan Stanley and Royal Bank of Scotland. The rest are middling. Individual banks will quibble about which bucket they are in. But the broad idea of an ever more sharply tiered banking industry is hardly controversial.
So it is unclear why everyone seems to care so much. Yet the markets and financial media were abuzz with little else on Thursday and Friday. The mysterious appeal of the rating agencies is all the more puzzling given the reputational pasting they have taken throughout the financial crisis after sometimes failing to spot looming problems until they were blindingly evident to everyone else.
As analysts at HSBC remarked in a client note on Friday: "Broad reaction to the Moody’s downgrade has been ‘thanks, but you’re a bit late’, which is the typical shrug-off we get to major rating agency moves these days.”
Sure enough, for all the noise there was little immediate impact on investors’ faith in the world’s big banks. Bank share prices were not obviously hit by the actions. And a glance at banks’ credit default swap shows you pretty clearly that the market has been way ahead of the curve – the downgraded ratings have been implied for some time by market CDS price trends.
But anyone who writes off the agencies’ relevance is ignoring two crucial areas where they still dictate – in short-term debt ratings and in collateralised funding.
Six banks had their short-term ratings cut by Moody’s at either the group holding company or operating company level. This should matter less than it would have pre-crisis, as banks have moved for safety’s sake away from short-term funding of long-term liabilities towards better-matched financing arrangements.
All the same, banks that now have P2, rather than P1 ratings in this area, will find it tough to secure short-term funding from many of the investors that have traditionally bought their commercial paper.
Barclays, Citigroup, Goldman Sachs, Bank of America, Royal Bank of Scotland and Morgan Stanley are all affected.
Though the obvious solution – a further "terming-out” of funding, extending the duration of financing at these banks – will be popular with regulators from a safety point of view, the higher cost of such funds can only further damage profit margins, undermining another regulatory aim: the build-up of capital through retained earnings.
On collateralised funding, there is a similar vicious circle at work. Banks with lower credit ratings will need to deposit more collateral with a counterparty. At a time when secured funding is the only option for many, and banks’ collateral is already stretched to the limit, this is the last thing they need.
Might regulation be the answer? Regulators, particularly those in Europe, have been keen to clamp down on rating agencies ever since the crisis. But the motives have never been entirely noble. It has been governments with weak state finances and banks with troubled balance sheets that have squealed loudest about the unfettered power of the agencies.
Investors would not be fooled by self-interested intervention. But rating agency regulation could be designed for the greater good. Evolving bank regulation provides a blueprint. Supervisors today are thinking more flexibly about their rule-making with some signs they will ease off on some capital and liquidity requirements in the most troubled times in order to smooth cyclical problems.
Rating agencies could self-regulate and adopt a similar approach, avoiding the "arbitrary” and "backward-looking” decisions an embittered Citigroup accused Moody’s of last week. They could be more forward-looking to avoid compounding banks’ cyclical problems. And they could move more swiftly. If they do not, regulators should make them.
Patrick Jenkins is the Financial Times’s Banking Editor
Copyright The Financial Times Limited 2012.
Who's rating the rating agencies?
Rating agencies like Moody's still have relevance thanks to the role they play in short-term debt ratings and collateralised funding, but if they don't become more forward-looking on banks, regulators should make them.