Wednesday’s multi-billion dollar settlements between U.S. and European regulators and six large banks over shady trading practices in the foreign exchange (FX) markets won’t impact banks’ credit ratings, but there is still plenty of litigation risk facing the financial industry, Fitch Ratings says.
In a new report, the rating agency says that the initial settlements between U.S., UK and Swiss regulators and six banks “are largely within litigation provision levels and so have no effect on ratings”. However, it also warns that criminal investigations into these activities are ongoing “and the final costs could be substantially higher.”
Fitch says that banks’ ratings could be affected “if future fines or business sanctions are large enough to affect capital or there are material constraints on operations.” Additionally, it says that investigations that lead to the termination of banks’ non-prosecution or deferred prosecution agreements would also be factored into its analysis.
For now, the viability ratings of the six banks that have entered settlements so far — UBS, Citi, JP Morgan, Royal Bank of Scotland, HSBC and Bank of America — are unaffected by the settlements, Fitch says, because of the relative size of the fine and the reserves the banks have made for these costs. However, it notes that “the banks all face further fines related to forex rate setting, which could be larger due to the nature of the allegations.”
And, it points out that two of the biggest players in the forex markets, Barclays and Deutsche Bank, have not yet reached settlements. Fitch says that it expects Barclays’ fines to be “manageable relative to earnings and provisions already made”, noting that the bank set aside an extra £500 million for the forex investigations. And, it notes that Deutsche raised its general litigation-related provisions by €894 million in the third quarter. “Together with strengthened capital ratios following its equity raising, this should enable [Deutsche] to absorb large fines, including payments related to the forex investigations, if these arise,” it says.
That said, Fitch also reports that a wide range of investigations into banks’ conduct are under way. “We expect further material litigation charges for global trading and universal banks as these progress, including customer redress costs,” it says; adding that these costs “should remain manageable… and we do not expect possible business restrictions to materially affect banks’ operations.”
“Nevertheless, we cannot rule out escalating conduct costs and more severe business sanctions given the investigations by the US Department of Justice and UK Serious Fraud Office into the manipulation of foreign-exchange rates,” it says. “Unpredictable regulatory fines have become a major risk for banks with global securities businesses.”
Large fines alone aren’t likely to lead to rating changes, Fitch says, unless the amount exceeded provisions already booked by more than two quarters’ of pre-tax profit. “Ratings are more likely to change where fines materially reduce capital and there is no credible plan to restore capital ratios within a year or less,” it says. “Sanctions that result in material business constraints that could affect earnings generation may affect ratings.”