Regulatory tools introduced after the financial crisis to manage bank collapses are positive for financial stability, reducing the risk of contagion and the likely overall losses from bank failure, Moody's Investors Service said in research published today.
The report "'Resolved' Banks Implications for Credit Risk: An Examination of Recent Case Studies", is available on www.moodys.com. Moody's subscribers can access this report via the link at the end of this press release. The research is an update to the markets and does not constitute a rating action. "The introduction of resolution regimes is positive for financial stability, reducing the risk of contagion and likely overall losses from bank failure," said Simon Ainsworth, Vice President -- Senior Credit Officer, and author of the report. "However, the use of resolution tools has in some cases resulted in creditors bearing a greater share of the losses than they might have done in the past."
Since the financial crisis, regulators have used a range of new tools to manage bank failures more effectively, rather than using traditional insolvency proceedings. Moody's report examines several case studies that illustrate the evolving risks facing investors in failed institutions as result of changing resolution practices. It also explores how Moody's ratings reflect those risks. Resolution tools have expanded and instances of "burden sharing" have occurred further up the failing bank's capital structure. Debt and deposits issued by these banks have either been kept with the failed bank, moved to "bad" banks, transferred to a bridge bank or kept in curatorship or assumed by a third party purchaser or newly created "good" bank.
The use of these tools has heightened credit risk for some investors, affecting banks' standalone intrinsic financial strength and reducing the likelihood of government support being made available in the event of need. The report adds that where these tools have been used, Moody's baseline credit assessments were downgraded and debt and deposit ratings positioned to reflect the increased risk to bank creditors.
While the details of bank failures tend to be idiosyncratic, one common theme is that the credit risks of a failed bank's financial obligations will likely remain elevated, on a standalone basis, for some time after regulators have taken steps to resolve the bank. The uncertainty around an institutions' creditworthiness is normally elevated in these circumstances and may not become clear until some months, or even longer, after any resolution.
Moody's report says that the limited examples of new and restructured banks from the past few years illustrates that that ratings of distressed banks can be more sensitive to negative indicators than positive ones. This reflects the inherent uncertainty around the credit risks faced by resolved banks.
