Moody’s Cut Bank Ratings Because…?

Last week, Moody’s released its downgrade on the ratings of four U.S. banks – Goldman Sachs, Bank of New York Mellon, JP Morgan Chase and Morgan Stanley, as reported in these articles: Moody’s Lowers Ratings of Four U.S. Banks After Review (Bloomberg), Moody’s cuts ratings on 4 big U.S. banks (CNN Money).  The reason given in these reports on the rating downgrade is that Moody’s believes the U.S. government is less likely to step in to support a troubled financial institution.  It is said that this is due to regulatory reforms that put in place framework for resolving such bank in an event of failure => instead of government bail-out using taxpayers money, creditors will be “bailed-in” and bear the risk of a failed bank.

In June 2012, Moody’s also applied ratings downgrade to the banks.  In fact, 15 investment banks globally were downgraded then. The reason given for that downgrade was that the long-term prospects for profitability and growth were shrinking.    While that reason seems quite logical, the latest one sounds rather odd.  It seems to be on the premise of an expectation for government bail-out? And is it not the case any way that creditors should take the risk of default and failure, for which the reward is priced in by the interest rate?

Besides seeming quite precarious, the rating downgrade also demonstrates the power of the rating agencies.  The ratings downgrade of the ratings could mean the affected banks will have higher borrowing costs.  There are also implications for additional collaterals to be put up under derivatives contracts of the banks.

Incidentally, the rating agencies have been criticised for their role in the financial crisis, and Moody’s, Standard & Poor’s and Fitch ratings are facing allegations and charges of assigning artificially high ratings for mortgage-backed securities.

More transparency and understanding of rating agencies standards are probably needed.