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Sept 11 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings today outlines its approach to addressing the important topic of support in its portfolio of bank ratings in light of the evolving support dynamics for banks worldwide. Some 28% of bank ratings globally benefit from state support. Over 1990-2012, the five-year cumulative default rate for rated financial institutions was 1.15%. In Fitch’s opinion, it would have been approximately six times higher without extraordinary support.
There are many legislative initiatives under way aimed at addressing the inadequacy of standard insolvency laws for resolving failed banks. While an appropriate legislative base is crucial, legislation on its own can be insufficient to force losses onto senior creditors in a manner that prevents contagion. Bank resolution is still a work in progress in most G20 jurisdictions. While additional laws and rules need to be developed and agreed, Fitch believes the direction of travel is sufficiently established to outline three rating paths in a pair of reports published today.
Under Fitch’s first rating path, where authorities do not change their approach to support, or where Fitch believes that despite legislative change, practical/political impediments mean support for senior creditors is effectively unchanged, Fitch’s Support Rating Floors (SRFs) are likely to remain unchanged.
Under our second path, where there is a weakening of support, ie when in Fitch’s opinion the probability of support for a failed bank is less certain than before, SRF revisions are likely. For systemically important banks, these are initially likely to be of up to one rating category. For example, an SRF in the ‘A’ range could potentially fall into the ‘BBB’ range. SRF revisions for mid-sized or smaller banks could be greater, potentially as far as ‘No Floor,’ implying greater polarisation of SRFs than previously due to resolution progress.
Under our third path, where support is eliminated, SRFs would be revised to ‘No Floor’, even for systemically important banks. This will be the case where Fitch considers that, in light of policymaker intent and changes in laws and regulation, senior-level support for a failed bank is possible but can no longer be relied upon. In other words, this would be the approach where Fitch is not confident that all senior unsecured creditors will be paid in full.
Offsetting factors include improving bank fundamentals. As Viability Ratings benefit from regulatory initiatives to reduce risk, this may cushion and in some instances prevent downgrades of bank Issuer Default Ratings (IDR) that are currently driven by support where the SRF is revised downwards. Other idiosyncratic considerations include the amount or nature of any government ownership, as well the status of the bank (i.e., policy bank vs. commercial bank, etc.)
Fitch will continue to assess support dynamics and engage further with market participants in the coming months. No rating actions arise directly from these reports. However, the aggregate impacts of the dynamics noted in these reports and other recent commentary will ultimately lead to rating actions. Where support is seen as weakening, any rating actions are expected to be preceded by Outlook revisions to IDRs that are driven by SRFs, potentially as early as Q413.
Fitch’s IDRs on Financial Institutions represent the higher of the SRF and the Viability Rating. Fitch assesses potential extraordinary support for banks using Support Ratings on a scale of 1-5, and SRFs on the ‘AAA’ scale, indicating the level below which Fitch would not expect the IDR to fall unless there were changes in support assumptions. There is also a ‘No Floor’ SRF if Fitch thinks extraordinary support, while possible, cannot be relied upon.
Support Ratings reflect a judgement as to the likelihood of an institute being supported. Fitch may conclude in certain jurisdictions that resolution frameworks are inadequate, unlikely to work as intended or unlikely to be deployed by authorities.
The reports “Bank Support: Likely Rating Paths” and “The Evolving Dynamics of Support for Banks” are available at www.fitchratings.com.
Fitch is holding a teleconference to discuss these two reports on Thursday 12 September. Further details will follow in a separate release.
Link to Fitch Ratings’ Report: Bank Support: Likely Rating Paths