Big Bank Downgrades

I am not sure that the 'average person on the omnibus' would have paid attention to the work of credit ratings agencies some ten years ago, or little understood the integral part that they play in steering financial processes, decisions and opinions over time. Names from the US, such as Moody's and Standard and Poors would rarely hit the headlines (either in the press or over household suppers) before the chill winds of change hit global economics in 2008 and thereafter. Over recent years this has changed.

Some of the economic crisis that has unfurled has been partly fuelled by the insatiable global appetite for debt. The 'pass-the-parcel' (of bundled and re-sold debt, buying and selling debt with an appropriate profit margin) approach to banking finance worked well as long as the music kept playing and all the participants were joining in. We have subsequently seen the effects of what happens when the music stops and some players fail (Lehman Brothers as an example). The debt that could always be bundled and passed/sold on leaving bank balance sheets looking healthy could not continue and the system and its effective cash flow collapsed.

The way banks borrow money and its cost to them is usually based on opinions and analysis of their credit-worthiness. In the same way that if you approach a bank for a loan, they will usually 'credit score' your financial circumstances to determine if you are a good risk and what interest rate (based on your risk) they will apply to the cost of the borrowing you want to take on. One way to determine the credit-worthiness of a bank is to look at the rating provided by a ratings agency, such as Moody's or Standard & Poors. This is a little simplistic in its analogy, but the principle is fair, based on the individual banks ability to meet their financial obligations, or an opinion on the credit quality of a debt or bond being issued and its likelihood of default.

On the 21st June 2012, we saw Moody's downgrade 15 Global Banks, including RBS, HSBC and Barclays in the UK and Credit Suisse and Morgan Stanley globally, to reflect the risk they are likely to encounter from volatile capital market activities. The grading system works on a 'Notch' system and one institution saw their rating fall by 3 'notches' in the announcement, after 4 months review analysis. (Notch range from AAA+ to BBB- then 'Junk' status).

What does this mean for the average 'person on the omnibus' we mentioned at the start of this blog? This may mean that the cost of borrowing to the various banks downgraded may well increase. It is unlikely they will suffer this additional cost (they were never charities), preferring to pass it on to their customers in the form of increased mortgage costs, business loan costs and other private lending. It will be interesting to see if the recent announcement by the Bank of England to release to the banks significant capital (£80 Billion) for low(er) cost lending to SME's will be realised. More details on this initiative can be found here: http://www.thefinancepages.co.uk/economics/bank-of-england-lending-scheme/01269/

We do not believe that this is the last set of downgrades to be seen and I am sure we all agree that we are not out of the woods yet when it comes to the end of the recession. Diversifying your assets and capital across more than one institution may be a sensible and prudent measure to protect your holdings from unforeseen future problems in the banking system.

No individual advice has been provided in this blog and if you looking at planning your personal or business finances then please talk to the team at Chapters Financial Limited.

Keith Churchouse FPFS, Chartered Financial Planner

Director, Chapters Financial Limited 

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