Downgrade, what downgrade?

This morning, the credit rating agency Moody's downgraded 12 UK banks and building societies. Understandably, people have been asking whether this means that these financial institutions are unsafe, and whether the overall credit rating for the UK is in danger - even though S&P, another credit rating agency, affirmed the UK's AAA rating only two days ago.

The statement from Moody's makes it clear that the reason for the downgrade is the expectation of less support from government for these financial institutions: 

"...announcements made, as well as actions already taken by UK authorities have significantly reduced the predictability of support over the medium to long-term."

Moody's still expect some support from government for the large systemically-important banks such as Lloyds TSB and RBS, although they believe that even this may be withdrawn in the medium to long-term, so the ratings for these banks are on negative watch.  But their view is that smaller institutions such as the Co-op Bank and smaller building societies would simply be allowed to fail in a crisis.  I am slightly surprised by the two-notch downgrade of RBS, since it is 84% government-owned. Would the government really fail to provide support to a bank in which it has a controlling interest?

The driver for this downgrade must surely be the Independent Commission on Banking's report. As I've commented in a previous post, the aim of the recommendations in this report is to allow banks to fail safely. Personally I think that the recommendations actually fall short of meeting this objective. But the fact that the government has accepted those recommendations is a clear signal that support for banks can no longer be taken for granted. A further consideration would be the fact that the Government allowed Southsea Bank to fail in June 2011.

It is quite wrong to view this downgrade as in any way reflecting on the viability of these financial institutions. In fact even the term "downgrade" is misleading. What Moody's has done is assess the commercial creditworthiness of these institutions in the absence (or reduced level) of government support and assign an appropriate rating. It's an adjustment to a more realistic level, not a downgrade as such.  It does not indicate any danger to these institutions - in fact their new commercial ratings are generally pretty good. Nor is there any danger to small depositors: deposits in all financial institutions are insured by the FSCS up to £85K.

What this adjustment will do, however, is raise the cost of capital and funding for these banks, which may find its way through into higher fees and charges, and possibly higher interest rates on lending. Not especially good news for bank customers. 

Finally, this adjustment in no way reflects on the creditworthiness of the UK itself. In fact as Moody's now clearly believes the UK government is quite happy to throw smaller banks and building societies to the wolves instead of bailing them out, and may think twice before throwing money at larger banks too, it may be more willing to maintain the UK's AAA rating.


  1. I think that the Government would need to be very, very careful in offering RBS any support that it would not offer to an equivalent bank in which they did not own a stake. The whole banking support fiasco has been dodging carefully around EU government support rules and other legal interference.

    Admittedly, the rest of the EU are likely to want to keep their freedom of movement as broad as possible until this all dies its eventual death, so we are unlikely to see much banging of war drums from the Commission.

    Perhaps Moody's are just reacting to Hester's announcement of even more bad trading conditions earlier in the week.


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