Bangkok--Oct 27--Moody's Investors Service
Moody's Investors Service today requested comment from all market participants on its proposal to incorporate its recently developed "Joint Default Analysis" (JDA) into its bank ratings to reflect national government (i.e. systemic) support. JDA functions on the principle that the risk of default for some obligations depends upon the performance of both the primary obligor and another entity that may provide support to the primary obligor. Moody's requests that interested parties send comments to [email protected] by 1 December 2005.
As the report points out, "banks worldwide -- which often are characterized by thin and volatile profitability, but are also crucial to their nations' financial systems -- are particularly well suited to the application of JDA." This is so largely because troubled banks, even if not government-owned, are often the beneficiaries of financial support from their national governments. Such support has often allowed a troubled bank to avoid defaulting on its local currency deposits.
Moody's deposit rating -- an opinion of relative credit risk -- incorporates a bank's intrinsic financial strength rating, as well as the likelihood of any external (including systemic) support. Moody's local-currency deposit ratings are opinions of a bank's ability to repay punctually its local-currency deposit obligations. The local currency deposit rating is also used by Moody's as a reference point when "notching" ratings for a bank's other obligations, and in determining the ratings on a bank's foreign currency deposits.
According to the report's author, Senior Vice President and Regional
Credit Officer David Fanger, the proposed application of JDA to systemic support for banks builds on Moody's existing methodology for rating banks. Moody's has long considered the potential for government support as well as other sources of external support in assigning bank ratings.
According to Mr. Fanger, "the proposed application of JDA would explicitly factor into Moody's bank ratings both the capacity of a national government to support any bank in its country and the probability that a bank would actually receive national government support in the event the bank was failing."
"By explicitly incorporating these factors into Moody's bank ratings
process," the analyst adds, "the application of JDA to banks may potentially result in higher local currency deposit ratings for a significant number of banks globally."
"The impact on those banks' foreign currency deposit ratings and the
ratings on their debt obligations may be more limited," Mr. Fanger says, "and will vary depending upon a number of other factors, including the risk of a foreign currency moratorium and the likelihood that national government support would be extended to non-deposit obligations."
A Government's Capacity to Support Banks Can Be Stronger Than Its Debt
Rating
As a part of its proposal, the rating agency is introducing a "local-currency deposit ceiling" -- a specific rating that reflects both a) the capacity of a national government to support a bank and b) the risk of a local-currency deposit freeze in that country. This rating will often be higher than a national government's own bond rating, Moody's states.
"As applied to rating banks," Mr. Fanger says, "we look to the government as the support provider, not necessarily in its capacity as a borrower,
as might be measured by its government bond rating, but in its capacity to create liquidity for the benefit of a bank's depositors." The analyst also notes that this capacity is a function of the monetary regime, which can limit the government's ability to create money.
The Government Can Be a Source of Risk
"However," Mr. Fanger says, "the government may also be a source of risk
for bank depositors." During a financial panic or in times of hyperinflation, he explains, monetary authorities can impose a systemwide local currency-deposit freeze.
After such a declaration, Moody's notes, depositors may be even more
injured by a redenomination or other forms of loss.
This highlights a key distinction in the application of JDA principles to banks versus other sectors. Under Moody's proposal, no bank's local-currency deposits, in any nation, could be rated higher than the local-currency deposit ceiling in its country.
However, Moody's points out that the local-currency deposit ceiling may
be higher than the government's local-currency bond rating. This means that local-currency bank deposits may also be rated higher than the supporting government's local-currency bond rating.
The Probability of Support Could Vary Widely
The request for comment highlights some of the factors that Moody's is
considering in assessing the probability that a national government would
provide support to any particular bank. Such factors include government
ownership, the bank's significance to the national (or local) economy or
payments system, the historical practices of the government in prior bank
failures, the overall strength of the banking system, and other factors.
Moody's notes that the probability of any individual bank being supported by its national government could range from at or near 100% for a bank
that is wholly owned by a national government, to 0 % for a bank where Moody's believes that national government support would be nonexistent.
The report is titled "Incorporation of Joint-Default Analysis for
Systemic Support into Moody's Bank Rating Methodology." End.