Ongoing investigations into misconduct at global investment banks and accompanying litigation represent major risks to the banks’ businesses and their balance sheets, warns a new report from Moody’s Investors Service.
The report from the New York-based rating agency says that ongoing probes and litigation concerning the conduct and market practices of the 15 global investment banks Moody’s rates “pose a significant risk” to the banks’ earnings stability, capital and leverage positions and their franchises.
The greatest risk to banks’ core franchise value, the Moody’s report says, is potential criminal proceedings, which can lead to a loss of both existing and potential clients, damaging the banks’ franchise value. “This could erode margins, impair capital cushions and stifle the banks’ ability to generate capital internally.”
In addition to possible criminal charges, the Moody’s report says that the uncertain size, timing and impact of related litigation also represents a “considerable tail risk” for the big investment banks’ business models and franchises.
The Moody’s report adds that the banks have collectively recorded approximately US$219 billion in litigation provisions since the onset of the global financial crisis and that these provisions have grown in recent years.
The U.S.-based banks account for US$139 billion of that total whereas the European banks have recorded only US$80 billion in provisions, the Moody’s report says: “The split is largely attributable to U.S. [banks] having had higher exposures to U.S. mortgages and starting to provision for related litigations earlier than their European peers.”
The credit-rating agency estimates that Bank of America Corp. has recorded the highest provisions, at US$70 billion, followed by J.P. Morgan Chase & Co., at US$37 billion.
In the wake of the global financial crisis crisis, the big banks have also been shifting their businesses toward less volatile sources of revenue that aren’t so closely tied to the capital markets. They’ve also built up their capital positions, which should help cushion bondholders against any unexpected losses, the Moody’s report notes.
“The [banks’] improved capital bases and robust revenue from less volatile, non-capital markets activities support their credit strength. These provide a substantial buffer against potential losses arising from outstanding and future litigations,” says Alessandro Roccati, a senior vice president at Moody’s, in a statement. “However, tail risks remain a concern, in particular potential franchise damage which could arise in the event of criminal proceedings against these banks or steep penalties.”