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Banks’ credit ratings take big hit

By Claes Bell, CFA · Bankrate.com
Friday, June 22, 2012
Posted: 12 pm ET

As a consumer, it's no fun when your credit takes a hit. It generally means you'll pay higher rates for loans and other credit products, or be shut out of credit altogether.

But what happens when an international bank with a balance sheet bigger than some countries gets its credit rating cut?

On Thursday, Moody's, a major international ratings agency, made substantial cuts to the credit ratings of 15 of the world's largest banks. Three of those banks, JPMorgan, Citibank and Bank of America, hold a quarter of all deposits in the U.S., according to the FDIC. While the agency had warned of the downgrade in February, it's likely JPMorgan's $2 billion trading loss this month may have increased the severity of the ratings crackdown.

So how will this affect you?

As far as the U.S. economy goes, it's never good to have three of your biggest banks receive credit downgrades from a major ratings agency. Instability in the banking sector was a big factor in the big economic mess we're still dragging ourselves out of, and banks have had to spend the last three years strengthening their financial positions, in part through massive and costly interventions by world governments.

That process has been painful for U.S. borrowers, who saw significant tightening of lending standards as banks sought to hold on to their remaining capital. In fact, four years after its peak in mid-2008, the amount of consumer credit outstanding still hasn't fully recovered, according to data from the Federal Reserve.

This downgrade could mean we're further away from having credit markets return to normal than we thought.

There could be a silver lining, though. The downgrade may provide market reinforcement to the as-yet-unfinished Volcker rule, which would prevent banks from gambling their own funds on international investing. Most of the downgraded banks engaged in that practice, called proprietary trading, to one degree or another. They'll now have to put up more of their capital when they gamble with borrowed money, potentially making it much less profitable and hopefully, less common.

The downgrade may also push banks to concentrate more on their traditional jobs: taking consumer deposits and making loans. According to its report, Moody's gave stronger ratings to banks that held large amounts of stable consumer deposits, rather than having to go and raise money in international capital markets, which tend to freeze up in a financial crisis like the one we had in 2009 and 2010. That mirrors some of the changes made in Basel III, and could lead banks to woo American depositors a little more strongly than they have of late to avoid future downgrades.

What do you think? Are banks too reliant on risky trading? Should they focus more on the fundamentals of banking, such as lending and deposits?

Follow me on Twitter: @ClaesBell

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2 Comments
bobby
June 22, 2012 at 3:21 pm

Banks suck!