Credit rating agency Moody’s Investors Service has issued a revised methodology for rating banks globally that aims to reflects lessons from the financial crisis, and subsequent impact on the banking industry.
The revised methodology incorporates several new components: a new Loss Given Failure (LGF) analysis; a scorecard that incorporates a broader range of metrics and qualitative considerations along with traditional financial ratios; and, a new counterparty risk assessment. Moody’s says that the revisions to the methodology reflect insights gained from the crisis and the resulting fundamental shift in the banking industry and its regulation. The revised approach aims to more accurately predict bank failures, and to evaluate how different creditors are likely to be affected when a bank enters resolution.
The rating agency says that in the coming days it will place the ratings of banks that are likely to be affected by the new methodology under review. It expects to conclude the large majority of these reviews in the first half of 2015.
“The first key change is the introduction of a loss given failure (LGF) analysis, which addresses expected loss and assesses the impact a bank’s failure would have on its various debt instruments and deposits in the absence of any support. For banks subject to operational resolution regimes, the LGF analysis will incorporate the cushion against loss that each creditor class derives from the amount of debt subordinate to it in a resolution,” says Gregory Bauer, managing director global banking at Moody’s.
“With the recent dramatic shift in public policy toward implementation of resolution regimes, it has become increasingly important for investors to know their position in a bank’s liability structure, and thus the potential losses they are exposed to in the event of a resolution,” Bauer adds. “LGF analysis directly addresses this key investor concern.”
“The second key change is the revision of our framework for assessing the risk of bank failure, expressed by our baseline credit assessment. This includes the introduction of a Macro Profile, which allows us to place greater emphasis on potential system-wide pressures that we believe are predictive of the propensity of banks to fail,” says Frederic Drevon, managing director global banking at Moody’s.
The revised framework focuses on five core ratios that Moody’s says that it has found to be predictive of bank failure: asset risk, capital, profitability, funding structure and liquid resources. The new Macro Profile considers six elements: economic strength, institutional strength, susceptibility to event risk, credit conditions, funding conditions and industry structure.
Finally, Moody’s has also introduced a counterparty risk assessment into its analysis to evaluate an issuer’s ability to avoid defaulting on certain operating obligations and other contractual commitments.