Worldwide, banks have benefited significantly from government support, without it their default rates would have been much higher, says a new report from Fitch Ratings.
The rating agency published a report today outlining its evolving approach to government support for banks amid efforts to reduce moral hazard and end “too-big-to-fail” policies, in response to the financial crisis.
The report notes that between 1990 and 2012, the five-year cumulative default rate for rated financial institutions was 1.15%. In Fitch’s opinion, it would have been approximately six times higher without extraordinary support from governments, it says. And, currently, about 28% of bank ratings globally benefit from state support, it adds.
Fitch notes that there are efforts underway to reduce government support, including numerous legislative initiatives aimed at addressing the inadequacy of standard insolvency laws for resolving failed banks. However, it also warns, “While an appropriate legislative base is crucial, legislation on its own can be insufficient to force losses onto senior creditors in a manner that prevents contagion.”
“Bank resolution is still a work in progress in most G20 jurisdictions,” Fitch says. And, while additional laws and rules need to be developed and agreed, it also says that “the direction of travel is sufficiently established to outline three rating paths” in reports published today.
For countries that do not change their approach to support, or where Fitch believes that despite legislative change, practical/political impediments mean support is effectively unchanged, its ratings are likely to remain unchanged.
In countries where the probability of support for a failed bank is less certain than before, ratings revisions are likely, it says. “For systemically important banks, these are initially likely to be of up to one rating category,” it says, whereas the revisions could be larger for mid-sized or smaller banks.
And, where it is convinced that government support has been eliminated, even for systemically important banks, this component of its ratings will be eliminated too. “This will be the case where Fitch considers that, in light of policymaker intent and changes in laws and regulation, senior-level support for a failed bank is possible but can no longer be relied upon. In other words, this would be the approach where Fitch is not confident that all senior unsecured creditors will be paid in full,” it says.
Reductions in support assumptions won’t necessarily lead to credit rating downgrades, it says. There may be offsetting factors, such as improving bank fundamentals, and benefits from regulatory initiatives to reduce risk, which it says “may cushion and in some instances prevent downgrades”.
For now, today’s reports aren’t going to lead directly to rating actions, it says. “However, the aggregate impacts of the dynamics noted in these reports and other recent commentary will ultimately lead to rating actions,” it notes.
For example, in countries where support is seen as weakening, any rating actions would likely be preceded by outlook revisions, possibly as early as the fourth quarter of this year.