Are any British banks still Premier League?
- 21 June 2012
- From the section Business
Ahead of Thursday evening's announcement from Moody's that it is downgrading 15 global banks and securities firms, I spoke to the chief executive and chairman of a couple of very large banks. And they both said that the problem with Moody's analysis was that it was backward looking.
They both knew their respective banks would be downgraded, so they were getting their defence in early. But Moody's main rationale for all these downgrades - of US, Swiss, French, German and British banks - is that investment banking is a riskier business than many might have thought a few years ago.
Really? Some would certainly say that is a statement of the egregiously bloomin' obvious.
The most interesting thing about the Moody's analysis is that it, in effect, creates three new categories of global banks, the banking equivalent of the Premier League, the Championship and League One.
Of our biggest banks, only HSBC is in this Premier League. Barclays is in the Championship and Royal Bank of Scotland is in League One.
So what will be the effect of the downgrades? Well, they might push up the cost of borrowing for the banks fractionally. But it would be odd if the impact was terribly significant - largely because they have all been downgraded, and those who control vast pots of cash have to put their money somewhere.
In theory, most vulnerable to the risk that borrowing will become a bit harder and pricier are those in the bottom category of banks, which includes RBS. But RBS can take small comfort that some very big banks - notably Bank of America Corporation and Citigroup of the US - have lower ratings than it does.
Perhaps more importantly, its main operating subsidiary retains a long-term rating that would put it in the Championship rather than League One, although the short-term rating of this subsidiary has been downgraded by a notch, which the bank regards as of some significance.
Probably most reassuring about RBS is that its most recent balance sheet shows that its funding needs for the next year are minimal: it has cash and liquid resources of more than £150bn, compared with short-term funding needs (that's money that needs to be raised over the next year) of just £80bn.
So, the downgrade should not embarrass RBS in any terribly serious way.
By the way, even though Lloyds is not a global bank, it has suffered a modest downgrade too - and it would be in the same category as Barclays, the equivalent of the Championship, though a tiny bit higher up the table.
Finally, it is worth remembering that the Bank of England and HM Treasury have announced two new schemes to provide copious amounts of cheap loans to British banks, which can be seen as insurance against the downgrades leading to any kind of renewed credit crunch (see this blog for more on all this).
After all this, if you are worrying that British banks don't look as robust as you might like, I would direct your attention to Thursday's publication of how much capital Spanish banks may need to raise, as per the assessment of consultants hired by Spain's government.
They say Spain's banks need between 51bn euros (£41bn) and 62bn euros of additional capital as protection against future losses. Now, although that is less than many analysts think is needed, it is still a fair chunk of change, equivalent to around 6% of Spanish economic output or GDP.
No need to panic, because - as you will recall - Spain has already secured an agreement from other eurozone governments that they will lend it 100bn euros from their bailout funds to cover the costs of strengthening its banks.
So, unless the Spanish economy and housing market were to go from bad to meltdown in the coming months, Spain's banks should be endowed with sufficient additional capital to weather the coming storm (the so-called adverse case in the stress tests is for Spanish house prices to fall 19.9% this year, 4.5% next year and 2% the year after, and for Spain's GDP to contract by 4.1%, 2.1% and 0.3% in successive years).
For aficionados of financial gore, Oliver Wyman says that in the coming three years, and were the adverse scenario to become true, Spanish banks would lose up to 270bn euros collectively, on top of 150bn euros of credit losses since 2007. Or to put it another way, Spain's banks over seven years would lose a sum equivalent to two and a half times the entire annual output of Portugal. Yes, Spain's savings banks are a bit of a mess.
There are two caveats. First, these evaluations of losses faced by the Spanish banks are so-called "top down". Or to put it another way, the two firms carrying out the assessment, Roland Berger and Oliver Wyman, have not looked at the quality of individual loans. In the words of Wyman, they have instead considered "the different historical performance and asset mix for each institution at aggregate levels, applying conservative but similar estimates of loss behaviour across banks when more detailed bank-specific loss drivers are not available."
Or to put it another way, if this particular boom and bust turns out to very different from anything experienced in Spain over the past 30 years - and it might just be - then losses for banks could be rather greater than the consultants have estimated.
Also, the experience of Ireland's banks - where losses rose exponentially for month after relentless month following the 2008 crash - shows how foolish it is to ever assume that you've touched bottom when a massive debt-financed property bubble has been pricked.
For Spain there remains the big imponderable of whether the Spanish authorities will insure its banks against further losses on their dodgy loans or physically remove the dodgy loans and put them into a new bad bank. What happened in Ireland suggests that formal transfers of bad assets to a new institution can be very expensive indeed.