Monday, June 25, 2012

Caribbean Development Bank Receives Credit Rating Downgrade

Caribarena Antigua: CDB Downgrade Effects Unlikely

In the wake of the recent global financial crisis, many countries and banks are seeing a decline in their credit rating.  The Caribbean Development Bank (CDB) is no exception. Both American credit rating agencies, Moody’s and Standard & Poor’s (S&P),  recently downgraded the CDB from the top rating (AAA) to the second best rating (AA1 for Moody’s, AA+ for S&P). Both credit rating agencies attribute the decline in ratings due to the weakness in CDB’s risk management as well as rising national debt among the Caribbean nations, who are all CDB’s customers. Despite the decline in credit rating, S&P is optimistic that CDB can recover its credit rating. S&P contributes its optimism to the strong relationship CDB has with its Caribbean customers and its strong capitalization—the sum of a bank’s invested cash.

Risk management includes supervising, regulating, and avoiding investment risks. For a bank, risk management is often associated with avoiding bad debt, but also includes ensuring general financial stability. Much of the financial crisis of 2008 and 2009 is credited to poor risk management by financial institutions.
Both Moody’s and S&P justify the downgrade of the CDB due to weaknesses in the Bank’s risk management that led to  reduced liquidity—a bank’s cash on hand—and a low number of borrowers. To avoid financial risk, a bank will have a high level of liquidity and a wide range of borrowers. A bank must maintain sufficient liquidity to pay its obligations when they come due, and thus lower liquidity increases risk of not having enough cash to meet the bank’s obligations. Also, a wide range of borrowers is beneficial because it reduces the impact of a single borrower’s default as revenue continues to come in from the many other borrowers. Last year, the CDB saw its liquidity significantly reduced; in the past, the CDB has held enough liquidity to pay 200% of its debt coming due in 1 year or less, but last year it only have enough liquidity to pay for 143%. In addition, five countries account for 63% of the CDB’s loans. Because many of these Caribbean countries have been facing rising credit vulnerabilities, the CDB’s concentration of borrowers has increased its exposure to financial risk.

Another reason for the CDB’s credit downgrade is the rising credit vulnerability in the region, which is a result of high levels of public debt among Caribbean countries and slow regional economic growth. Among Caribbean countries, net public-sector debt—the amount of government debt minus its cash on hand—increased to 57% of regional gross domestic product (GDP) in 2011, up from 37% in just 2008. On an individual basis, some Caribbean countries have debt burdens of 100% of their GDP or more—a high debt burden is often associated with reduced economic growth.
Despite the poor regional economic outlook and downgrade of the CDB, S&P provided the CDB with a positive and stable short-term year outlook. This outlook is based on its strong relationship with the member countries who borrow from the CDP, as well as its strong capitalization. In addition, the CDB is responding to the downgrades by evaluating and implementing improvements in its risk management, which S&P specifically said would help improve the CDB’s rating in the future. However, the CDB has not stated the specific improvements it will make to its risk management.

While the CDB’s downgrade is a difficult setback, it is largely a reflection of the current financial difficulties worldwide. For example, S&P recently affirmed downgrading the United States’ credit rating, which is equal to the downgrade it gave the CDB. However, the outlook for the CDB is stable and positive, and it hopes to reaffirm that positive outlook by fixing its current weakness in risk management.

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