The lighter-touch approach to bank regulation being pursued in the U.S. — beyond just weaker capital requirements — will be a negative from a credit ratings perspective, says Moody’s Ratings.
Last week, U.S. regulators proposed revisions to the capital rules that are expected to ease banks’ capital requirements — a development that Moody’s characterized as a likely negative for the sector. Now, in a new report, the rating agency says that a possible broader shift away from regulations developed in response to the global financial crisis would also be a credit negative.
“Federal bank regulators are reviewing the entire post-2008 bank regulatory framework with an eye toward reducing compliance burdens, stimulating greater economic growth, reducing obstacles to innovation and increasing banks’ competitiveness with non-banks,” Moody’s noted in the report.
Yet the post-crisis regulatory regime has resulted in significant increases in bank capital liquidity, along with improvements in risk management, and simplified legal and organization structures, it said — adding that it’s worried that “a broad review of post-crisis rules” poses a risk that some of these beneficial changes will now be reversed.
While the report acknowledges that there’s always room to refine and improve bank regulation and oversight practices, Moody’s suggests that the kinds of reforms that are currently being contemplated — to encourage greater risk-taking by banks, to reduce regulatory burdens by tailoring the application of the rules to specific banks and to foster innovation — will ultimately be a negative for investors.
“Overall, we believe the new approach will be credit negative, shifting the balance away from post-crisis changes that, in many cases, were beneficial to bank bondholders,” it said.
For instance, while efforts to tailor banks’ rules may be more efficient, “as the bank failures in 2023 highlighted, past efforts at tailoring regulation and supervision largely according to a bank’s asset size allowed some fast-growing banks to avoid implementing appropriate risk control frameworks or holding sufficient capital to adequately absorb losses.”
Similarly, facilitating greater risk-taking and innovation also comes with increased risks for investors, it noted. To the extent that this shift is accompanied by an increased focus on “material financial risks” this could reduce banks’ incentive to strengthen their risk controls, or to focus on forward-looking risk detection and management, it said.
At the same time, reductions in supervisory staffing and shifts in supervisory communications could undermine the efficacy of banks’ oversight, and reduce banks’ incentives to strengthen their risk profiles, it noted.
“Potential regulatory changes go well beyond just capital requirements, which are far from the sole driver of bank credit risk,” the report said. “These other rule changes can also lead to increased credit risk for bondholders because, no matter what their capital ratios are, banks will continue to be highly levered and confidence sensitive.”