Rating Methodology Request for Comment
Bank Financial Strength Ratings: Revid Methodology
Summary
This report details Moody’s proposal to revi our rating methodology for assigning Bank Financial Strength Ratings (BFSRs) globally.1 This revision does not change the main factors that Moody’s considers in rating banks. However,the revid approach provides a single, global methodology instead of parate methodologies for mature and develop-ing markets. It also establishes specific ranges for each factor that relate to different rating categories. The updated methodology is intended to provide investors and issuers with a transparent t of guidelines allowing them to better understand our rating process and how we reach our decisions.
T o this end, we have developed a rating scorecard that us a common t of globally available financial metrics together with key qualitative factors that Moody’s analysts consider critical in evaluating a bank’s intrinsic financial strength and specific weights for each factor. This scorecard will be ud by Moody’s analysts as the first step in deter-mining BFSRs. It should also enable investors and issuers to independently estimate a BFSR for most banks within two notches. This rep
ort describes the scorecard and discuss some of its limitations as well as some of the further adjust-ments that Moody’s analysts may employ in assigning BFSRs.
The revid methodology is also intended to improve the consistency of Moody’s BFSRs. As previously announced, Moody’s intends to incorporate joint-default analysis (JDA) into our asssment of external support for banks later this year.2 We believe the updated BFSR methodology will help ensure that existing BFSRs are indeed “pure” measures of stand-alone financial strength and do not include external support. This is important in order to avoid double counting external support when we implement JDA for banks. We are requesting comments becau we believe that the implementation of this methodology could lead to changes in the BFSRs for a significant number of banks, although we do not expect most of tho to exceed 2 notches.
Readers should note that this methodology is not an exhaustive treatment of every factor considered by Moody’s in assigning bank financial strength ratings, but it should enable our constituents to better understand how and why we arrive at a BFSR. Moody’s welcomes comments or suggestions on this proposal from market participants. Comments should be nt to by September 29, 2006.
1.Moody's current approach is outlined in the following Rating Methodology reports: "Bank Credit Risk -- An Analytical Framework for Banks in Developed Markets," April 1999 and "Bank Credit Risk in Emerging Markets -- An Analytical Framework," July 1999.
2.Plea e "Request for Comment: Incorporation of Joint-Default Analysis for Systemic Support into Moody's Bank Rating Methodology ," October 2005; "Update to Proposal to Incorporate Joint-Default Analysis into Moody's Bank Rating Methodology ," April 2006; and "Bank Joint Default Analysis: Rating Methodology Update," August 2006.New York
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September 2006
About Moody’s Bank Financial Strength Ratings
Bank credit risk is a function of a bank’s (i) intrinsic financial strength, (ii) the likelihood that it would benefit from external support in the ca of need, and (iii) the risk that it would fail to make payments owing to the actions of a sov-ereign. Moody’s assigns credit risk ratings to banks and their debt obligations using a multi-step process that incorpo-rates both a bank’s intrinsic risk profile and specific external support and risk elements that can affect its overall credit risk.
Moody’s Bank Financial Strength Ratings (BFSRs) reprent Moody’s opinion of a bank’s intrinsic safety and soundness. Assigning a BFSR is the first step in Moody’s bank credit rating process.
Unlike Moody’s deposit and debt ratings, BFSRs do not address either the probability of timely paym
ent (i.e. default risk) or the loss that an investor may suffer in the event of a misd payment (i.e. verity of loss). Instead, BFSRs are a measure of the likelihood that a bank will require assistance from third parties such as its owners, its industry group, or official institutions, in order to avoid a default. BFSRs do not take into account the probability that the bank will receive such external support, nor do they address the external risk that sovereign actions may interfere with a bank’s ability to honor its domestic or foreign currency obligations.
In order to differentiate Moody’s BFSRs from our bank deposit and debt ratings, we u different rating symbols. Moody’s BFSRs range from A to E, with “A” for banks with the greatest intrinsic financial strength and “E” for banks with the least intrinsic financial strength. A “+” modifier may be appended to ratings below the “A” category and a “-”modifier may be appended to ratings above the “E” category to identify tho banks which are placed higher (+) or lower (-) in a rating category.
Moody’s introduced BFSRs in 1995, and currently assigns them to almost a thousand banks and deposit-taking financial institutions worldwide. The factors considered in the assignment of BFSRs were described in Moody’s last bank rating methodologies published in 1999, and continue to form the basis of our updated approach as described in this report. The include bank-specific elements such as financial fundamentals, franchi value, and business and ast diversification, as well as ri
sk factors in the bank’s operating environment, such as the strength and prospective performance of the economy, the structure and relative fragility of the financial system, and the quality of banking reg-ulation and supervision.
The following diagram shows how BFSRs fit into Moody’s overall approach to assigning bank credit ratings. The left side shows the principal factors that are ud to determine a bank’s BFSR. This report describes how the are measured and analyzed to derive a BFSR.
2Moody’s Rating Methodology
The right side of the diagram summarizes the specific external support and risk elements that are combined with the BFSR to determine Moody’s local currency and foreign currency deposit and debt ratings. In October 2005 Moody’s propod to incorporate joint-default analysis (JDA) into how it evaluates external support factors for banks; we published updates on this proposal in April and August 2006. We expect to publish and implement a final method-ology incorporating JDA into Moody’s bank credit ratings later this year.
努力奋斗的英文The BFSR will be mapped directly to the baline credit asssment in Moody’s JDA framework. Like the BFSR, a baline credit asssment is a measure of an issuer’s stand-alone default risk assuming there is no systemic or other external support. For banks, the baline credit asssment reflects what the local currency deposit rating would be without any assumed external support from a government or other third party. In the October 2005 request for com-ment we published a mapping showing how Moody’s BFSRs translate into a baline credit asssment for banks using Moody’s traditional alphanumeric rating scale.
A more detailed discussion of how Moody’s evaluates the risk elements that affect foreign currency r
atings for banks can be found in the 1999 bank rating methodologies, as well as in more recent publications.3
About the Rated Univer
Moody’s currently assigns BFSRs to 959 financial institutions globally (as of August 21, 2006). The financial institu-tions generally fall under the category of deposit-taking institutions, including commercial banks, savings banks, build-ing societies, cooperative banks, thrifts, and government-owned banks. Moody’s BFSRs may also be assigned to other types of financial institutions such as multilateral development banks, government-sponsored financial institutions and national development financial institutions.
In a number of countries Moody’s also assigns BFSRs to a variety of other financial institutions (such as mortgage banks or other specialized banks) that, although they do not take deposits, are still chartered and regulated as banks and usually obtain some funding from the interbank market.
BFSRs are generally assigned to individual banks, including tho that are subsidiaries or affiliates of another bank. Therefore, there are some banking groups that have a number of banks with different BFSRs.
alreadyThe rated univer is spread throughout the world, with the highest concentrations in Europe, followed by the Americas, Asia (excluding Japan), Japan and the Middle East. Rated banks range in size from over $1 trillion in total asts to as small as $150 million. Some may be truly diversified global institutions, while others may operate on an extremely limited scale in a small local market.
Distribution of Moody’s Bank Financial Strength Ratings
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3.Plea e "Revid Country Ceiling Policy," June 2001; "Emerging Market Bank Ratings in Local and Foreign Currency: The Implications of Country Risk and Insti-
tutional Support," December 2001; "The Implications of Highly Dollarized Banking Systems for Sovereign Credit Risk," March 2003; and "Piercing the Country Ceil-ing: An Update," January 2005.
newsletterMoody’s Rating Methodology3
The inherent riskiness of the banking business – as characterized by high leverage (equity capital of only 5-10% of total asts), illiquid asts (loans) financed by short-term liabilities (deposits), and a cyclical business environment –makes it difficult for all but a lect number of banks that are generally extremely large and diversified to achieve and maintain a BFSR in the range from A to a high B. Solid, diversified and sustainable franchis and excellent manage-ment are also necessary attributes of A and B BFSRs.
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However, barring systemic stress and provided there is reasonable client confidence, banking, if conrvatively managed without excessive risk-taking, is also a business allowing a stable generation of interest and fee income, albeit perhaps at a lower level of overall profitability. Therefore, BFSRs in the C category are generally available to a large number of banks even if they have limited scale and franchis, and average financials. Many institutions fall under this category. BFSRs of D are generally assigned to tho that either are exhibiting modest capital, earnings, or business franchi, thus limiting their ability to deal with ast quality problems or other potential balance sheet risks, or are subject to unpredictable and unstable operating environments. BFSRs of E are typically restricted to tho institutions that are under pressure to maintain their capital due to external and internal factors such as a highly volatile operating environment, recurring loss and as
t quality problems, or a very high risk profile. However, regulatory forbearance can allow even insolvent banks to operate for an extended period of time, until the regulatory authorities arrange for either a rescue or a restructuring, or place the bank into liquidation.
Industry Overview and Current Risk Characteristics
The global banking industry is made up of a highly varied group of firms offering a wide range of products and pursu-ing a wide range of business models and customers. While most banks face the same fundamental risks -- credit risk, liquidity risk, market risk, interest rate risk, and operational risk -- the extent of such risks vary considerably depending upon the products sold, the bank’s funding profile, and the markets in which it operates.
General vs. Specific Risks
Banking risk can be broadly divided into general risks, which apply to all banks within a system and derive to a large extent from a country’s economic strength, and specific risks, which are the product of the bank itlf. In mature mar-kets, it is rare for rious difficulties experienced by a bank to be solely attributable to general risks, even though such risks certainly do have an impact on the bank’s performance. In most cas, bank failure in mature markets is the result of factors such as mismana
gement, risky strategies, structurally poor performance, and franchi collap. It is, in gen-eral, the weak banks and the highly risky banks that are the first to suffer in a shrinking or increasingly competitive market.
In developing markets, general risks loom larger. Not only can general risks be more vere, but it may also be dif-ficult for any bank to avoid the conquences of a vere economic shock (such as a massive currency devaluation) or a deep economic recession. Clearly, banks which are better managed and have stronger earnings, franchis, and balance sheets are better placed to cope with general risks. However, in cas where general risks prent a significant threat to the banking system of the country in question, it may well be that no bank can be assigned a BFSR at the upper end of the scale.
4Moody’s Rating Methodology
Five Broad Categories of Banking
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Overall, the diversity of the ctor can be broken down into five broad categories of banking institutions. Many banks may actually pursue a combination of the models, but we believe it is uful to address each of them parately to clarify the different risks that different banks can face.
1. Wholesale banks: The banks focus on rving large corporate or institutional customers. While many wholesale banks have traditionally focud primarily on lending (and, in some countries, making equity investments), they fre-quently offer a much broader array of rvices to their customers, including not just loans but also treasury manage-ment and transaction rvices, foreign exchange rvices, trade finance, derivatives, debt and equity underwriting and market-making, and insurance. Becau their customers are often very large entities, wholesale banks, especially smaller ones, can have significant customer concentration risks; they may also have industry concentration risks, espe-cially if they operate primarily within a particular region or market. Also, while a portion of their activities may be funded with corporate customer deposits, typically such banks are heavily reliant upon wholesale funding from both the interbank and capital markets. Such funding can be highly confidence-nsitive, exposing the bank to substantial liquidity risk if it is not conrvatively managed.4
Since their customers tend to be concentrated in larger cities and economic regions, wholesale banks generally do not require as substantial a physical prence as most retail banks. With fewer fixed costs, this often means a more flex-ible cost structure. However, customers can develop strong relationships with individual bankers (instead of with the bank itlf), making retention of personnel a critical element to long-term success.
As discusd below, both globalization and the growth of local capital markets can po significant challenges for wholesale banks, as more of their customers have the ability to tap the capital markets directly for funding. This can lead to greater earnings volatility, as wholesale banks increa their capital markets activities in order to retain their customers, and also expand into potentially riskier lending business to replace lost lending opportunities.
2. Retail banks: The banks focus primarily on rving individuals and/or small and middle market business. They may offer a wide array of products, including deposit-taking and lending, ast management and insurance, cash man-agement and transaction rvices, and even trade finance and foreign exchange rvices. A defining feature of such banks is that they are often locally or regionally focud. This reflects the retail nature of the customer ba. While some functions may be centralized, direct customer interaction remains an important part of the rvice most retail banks provide. Given the wide dispersion of potential customers (both individuals and business), and their preference for local interaction, this requires a physical prence in the form of retail branches. Many retail banks also site their branches in clusters to benefit from classic network economies, although this is not always the ca. (This is especially true for retail banks rving individuals; retail banks rving only small and middle market business may have less need for clusters of branches,
but are still likely to require more branches than a wholesale bank.) As retail banks grow, they may develop more and more clusters of branches, growing from merely a local or regional prence into a national or even international one. Nonetheless, even an international retail bank can usually best be thought of as a combination of local retail banks.
Given the need to have a significant physical infrastructure and to support significant daily customer transaction volumes, most retail banks have fairly inflexible cost structures. This makes stable revenue generation critical. T o address this need, most retail banks focus on generating recurring business with relationship customers and increasing the level of cross-lling of products including insurance products. Becau their customers are small, retail banks do not usually have significant customer concentration risks; however, they may still have industry concentration risks since they frequently operate within a particular region.5
Retail banks are often funded primarily with customer deposits. However, pressure to grow asts and earnings, especially in more mature markets, can lead to loan growth that far outstrips deposit growth. Such banks must rely more heavily upon wholesale funding, which can pressure net interest margins, reducing the bank’s profitability, while at the same time also exposing it to greater liquidity risk and interest rate risk.
info是什么意思As discusd below, both de-regulation and technological innovation can po a significant threat to retail banks becau they provide their customers with greater access to competing products through alternative distribution chan-nels, and may also reduce competitors’ costs to provide tho products. While retail banking has not traditionally pos-sd much in the way of economies of scale, to the extent that such technological innovations create economies of scale, it may po even greater challenges to the smaller retail providers.
4.Plea e discussion of Liquidity Management under Rating Factor 2.
5.Plea e discussion on Credit Risk Concentrations under Rating Factor 2.
Moody’s Rating Methodology5
