Declining tolerance for "too big to fail" may impact debt ratings at largest banks
Amid changing political headwinds Moody’s Investor Service has announced it may downgrade the debt ratings for three of the nation’s largest banks, a move that could ultimately increase borrowing costs for the financial firms.
The ratings agency is in the process of reviewing Citigroup Inc., Bank of America Corp. and Wells Fargo & Co, as Washington moves to enforce provisions of the Dodd-Frank Act designed to “constrain excessive risk” in the U.S. banking system.
Current ratings for the three banks incorporate assumptions made during the financial crisis that the federal government would give these banks unusually high levels of support. Moody’s review will determine whether the debt ratings should be adjusted to remove this “unusual uplift” to reflect pre-crisis levels of government support.
“The U.S. government’s intent under Dodd-Frank is very clear,” says Senior Vice President Sean Jones, in a prepared statement. “Going forward, it does not want to bail out even large, systemically important banking groups.”
In the heat of the economic crisis policymakers frequently resorted to bailouts instead of letting financial institutions collapse into bankruptcy, said Sheila Bair, FDIC chairman, speaking to Congress in May. The fear was the firms had become so large and intertwined that their failure could have caused the collapse of the whole banking industry. While it’s crucial the government serve as a lender of last resort and provide iron-clad guarantees that can forestall runs, said Bair, “it’s equally important that we uphold regulatory discipline through prudential supervision and promote market discipline by clearly limiting the extent of the government backstop.”
Moody’s government support assumptions for Bank of America, Citigroup, and Wells Fargo are higher than what similarly rated institutions would have received prior to the crisis, Moody’s said. Senior debt ratings are currently A2, A3 and A1, respectively
Moody’s maintains that the failure of any one of these banks continues to present the risk of “disorderly disruption” of the banking industry and broader economy. “Even so, the support assumptions built into these three banks’ ratings are unusually high, which may no longer be appropriate in the evolving post-crisis environment,” Jones said.
The ratings company is also evaluating whether it should reduce to below even pre-crisis levels its support assumptions for other U.S. banks benefitting from ratings uplift. These include Bank of New York Mellon, JPMorgan Chase & Co., The Goldman Sachs Group, Inc., Morgan Stanley and State Street Corporation.
The actions will have no impact on the FIDC-guaranteed debt issued by these firms, which is Aaa with a stable outlook, Moody’s said in a prepared statement.
Among its reforms the Dodd-Frank Act created the Financial Stability Oversight Council and charged it with indentifying and addressing “emerging threats” to financial stability. Chaired by the Secretary of the Treasury, the committee is empowered to constrain excessive risk in the financial system. The committee has the authority to recommend regulatory agencies impose stricter standards for the largest, most interconnected firms.