Moody's proposes changes to bank credit rating method to take new resolution regimes into account

It said that its proposed changes were motivated by the recent "dramatic shift in public policy" in favour of 'resolution' regimes, through which creditors would be expected to accept losses or convert their debt to equity before taxpayers could be called upon to provide emergency funding for a bank. The plans are open for consultation until 7 November and, if taken forward, would be introduced in the first quarter of next year, Moody's said.

"These changes reflect the better clarity available in respect of bank risk following the introduction of resolution regimes," said banking expert Tony Anderson of Pinsent Masons, the law firm behind Out-Law.com. "They key issues will be to what extent other ratings agencies follow suit as well as, of course, how effectively such a metric is employed in rating banks in the future."

The new framework includes a 'loss given failure' analysis, which would set out the likely effect on various categories of creditor should a bank need to be 'resolved' under the applicable regulatory regime. This would explicitly take into account where that class of creditor sits within the bank's capital structure and how many creditors are subordinate to it.

Moody’s would “preserve its existing notching practices based on the type of instrument” for those banks “more likely to be resolved through bail-out, bankruptcy or ad-hoc resolution” it said. It has proposed simplifying its support framework while preserving existing concepts of relative creditworthiness, probability of support and dependence.

Changes would also be made to the Baseline Credit Assessment (BCA) measure of a bank's standalone strength, which Moody's said would "reflect the insights gained from the crisis and more recent banking sector distress". The BCA feeds into deposit and debt ratings. Under the proposed new framework, the BCA would be structured around a new 'scorecard' focusing on five financial factors and incorporate a country specific 'macro profile'. Individual scores on each of the factors would incorporate a broader range of metrics while additional ratios, relevant to the individual institution, could be incorporated into the BCA if necessary.

Moody's has estimated that 95% of BCAs would not change under the new method, while 1% could fall by one notch and 4% could rise by one notch or more. The changes would have the biggest impact on the ratings of EU and US banks due to the adoption of resolution and recovery regimes by their financial supervisors in the years since the financial crisis.

Bigger changes could take place among local currency deposit ratings and local currency senior unsecured debt ratings because of the changes to the way that deposit and debt holders are treated under resolution regimes, Moody's said. On deposits, 34% are expected to be upgraded and 7% downgraded; while on debt, 30% are expected to be upgraded and 21% downgraded, according to the agency's estimates.