Credit rating agency DBRS Ltd. sees less predictability in the sort of government support that banks can be expected to receive, and suggests that this could negatively impact bank ratings.
The rating agency issued a revised version of its rating methodology for banks that sets out how it evaluates and incorporates the concept of support (both internal support and systemic support) into its ratings. These criteria have not changed significantly, it says; noting that the latest changes are largely for clarification and to reflect the evolving regulatory environment. As a result, there is no rating impact from the revised methodology.
However, DBRS also observes that “the environment is quickly evolving towards less predictable systemic support, albeit at different speeds in different countries and regions.” And, it says that this evolution is expected to affect its assessment of systemic support.
DBRS suggests that it could decide that there are more banking systems where a lack of predictability of systemic support negatively impacts bank ratings. “Support is possible, but not sufficiently predictable in timeliness and scope,” it says. “That determination would have consequences for the final ratings of systemically important banks that are currently benefiting from a notch of support that raises their final ratings.”
In some countries, DBRS says, legislation has been passed to limit systemic support for banks. Yet, it says, “Legislation alone is not sufficient. Also critical are the changes that reduce the potential for financial market contagion, if a systemically important bank has to be resolved.”
This includes higher capital requirements, tougher liquidity requirements, and other regulatory reforms that are driving banks to reduce risk. “More demanding requirements only work, if there is a strong, consistent supervisory framework to ensure that implementation is effective,” DBRS says; adding that strong supervision and improved supervisory tools, such as stress tests, can help banks’ risk management.
Other reforms, such as included oversight of derivatives markets, and the push toward centralized clearing, are also factors that may reduce the prospect of contagion, it suggests.
“Ultimately, the conclusion of our analysis may be that in some jurisdictions the willingness and ability have changed to such an extent that a notch uplift for support is no longer warranted,” DBRS says. “Such a change would not be a simple reflection of new legislation or a specific regulatory development, but rather the accumulation of changes across the various components.”