Why Moody’s Is Worried About the Global Banks

In a June 21, 2012 “Special Comment,” Moody’s explained its rationale for the ratings downgrades of 15 global banks, including U.S. banks:  Bank of America, Citigroup, Goldman Sachs,  JPMorgan Chase, and Morgan Stanley.  Below are excerpts from that summary. — Pam Martens/June 22, 2012   

“Our reassessment of the inherent risks of capital markets businesses is relevant to almost all financial institutions with some exposure to such activities.  But, it is most relevant for banks and nonbanking firms that have (or aspire to have) sizable underwriting and market-making operations and act as principal-taking intermediaries, trading securities and derivatives in global markets. Such firms typically operate through multiple subsidiaries and have meaningful platforms in the Americas, Europe and Asia. We believe the firms affected by today’s actions fit this profile, as do two other firms whose rating reviews we concluded earlier… 

“All of the firms included in this rating review have, in our view, significant exposure to the volatility and risk of outsized losses (i.e., tail risk) that are inherent in capital markets activities. However, they also engage in a range of diverse and often market-leading business activities that bring unique credit benefits and risks, and are central to the assessment of each firm’s credit profile. Several of these firms have major retail and commercial banking franchises, some have large global wealth management or asset management businesses, and certain firms have more specialized businesses, such as payment services and transaction processing. These other activities can provide important ‘shock absorbers’ that mitigate inherently volatile capital markets operations, but these other businesses also bring unique risks and challenges… 

“While Tier 1 regulatory ratios have increased significantly, other capital measures – including leverage ratios (not risk-weighted) and estimated Basel III ratios – indicate the still considerable leverage of essentially all capital markets firms… 

“Financial institutions that need to place very large absolute amounts of debt in the markets are susceptible to market disruptions even if these funds represent only a moderate portion of their total funding (diseconomies of scale)… 

“Significant earnings volatility at some firms with global capital markets operations indicate risk management and control failures. We note that such issues are being addressed, which is positive for creditors… 

“We believe the FDIC remains committed to achieving the goals set out under Title II (Orderly Liquidation Authority) of the Dodd-Frank Act, including ending bailouts of ‘too big to fail’ institutions. The FDIC’s stated objectives are to maximize value for creditors, minimize losses from its insurance fund, instill market discipline, and mitigate systemic risks. There are however inherent and perhaps irreconcilable tensions among these objectives, while resolving large financial institutions is made all the more challenging by the complexity of these firms’ corporate structures and their interconnectedness, and by the difficulty of cross-border coordination.”

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