Standard & Poor’s (S&P), one of the ‘big three’ New York City-based credit rating agencies (Fitch and Moody’s round out the trio), announced new rating criteria for banks on November 9, 2011. This week, S&P applied the new criteria to 37 of the world’s largest financial institutions, which resulted in the downgrading of 15 major institutions including Goldman Sachs, Bank of America, UBS, JP Morgan Chase, Citigroup, Morgan Stanley, and The Royal Bank of Scotland.
S&P’s new criteria consist of two key steps. First, S&P evaluates a bank’s financial health and ability to withstand severe or extreme economic stress without reliance on external support and assigns each bank a “stand-alone credit profile.” Second, S&P assesses the degree of extraordinary government or institutional support available to a given bank. These two conclusions are then factored into the broader credit rating methodology, which includes complex risk analysis and assumptions and an overall financial evaluation.
By taking into consideration the degree of external support a bank may have available from central banks or due to its association with a parent group, S&P attempts to create a more accurate credit profile by evaluating the bank not only as an independent financial entity, but also as to the position of the bank within the financial industry as a whole. The new criteria appear promising; however, it may also extend the reach of credit rating agencies and prove controversial. The new criteria allow S&P to consider a bank’s position within the broader context of global finance, governmental support, political climate and economic conditions and to reflect that information in the credit rating. The recent bank downgrades are largely a result of the industry’s susceptibility to such factors and increasing reliance on governments and central banks worldwide.
The new criteria were designed to allow the rating agency more flexibility to respond to rapidly changing market conditions and adjust credit ratings accordingly. Prior to implementing the new criteria, S&P detailed its underlying assumptions and methodologies for rating banks in a series of reports on January 6, February 16, November 1, and November 9, 2011. According to the November 9, 2011 report, “the criteria are designed to improve transparency of bank ratings globally.”