Banking at the crossroads and the role of S&P’s updated rating criteria

Ritesh Maheshwari, Standard & Poor’s lead analytical manager for Asia-Pacific financial services ratings, explains how its updated banking criteria will affect the industry.

The global banking sector is at a crossroads, following the unprecedented turmoil of the past four years. As it seeks to reinvent itself, the sector faces several critical inflection points that will affect the future creditworthiness of banks. Players in the banking space across Asia-Pacific aren’t in the centre of it all, but also are not immune.

Standard & Poor’s updated banking criteria provide a coherent, globally consistent framework to assess how these developments are likely to affect the creditworthiness of banks.

Why did Standard & Poor’s update its bank criteria?
Our updated criteria are the result of many months of considered development, not a reaction to recent market events. Our aim is to provide greater transparency and consistency to reflect the evolving global banking landscape. The criteria are a refinement of our analysis rather than a reinvention. It builds on what we knew before the financial crisis and incorporates what we have learned about how banks, investors and governments respond.

The outlook for the global banking industry is clouded by the potential shift in the balance of power among banks, the emergence of a more significant shadow banking sector and the potential for a different relationship between banks and governments. In our view, our new criteria provide a lens to understand these key themes, and their effect on banks.

It is the result of extensive market consultation following our requests for comments, during which we met with over 2,500 interested parties and spoke with more than 10,000 users of ratings. We have heard the market feedback about increased transparency loudly and clearly.

What are the key changes in your updated criteria?
There are four key changes in our updated criteria. Firstly, the criteria follow a building-block approach and provide greater transparency on how rating factors combine to form a rating. Consequently, investors and other market participants can now agree or disagree with our assumptions and do their own analysis.

Secondly, the criteria place greater emphasis on the country in which a bank operates, through an enhanced banking industry country risk assessment (BICRA) methodology. Our BICRA assessment provides us with the anchor rating, which is the starting point for our rating analysis on each bank.

Thirdly, we have specified explicit ranges of capitalisation, leveraging our risk-adjusted capital framework. For example, if a bank’s risk-adjusted ratio is in the 7% to 10% range, we deem it “Adequate”.

Lastly, but not least, we have modified our hybrid criteria in light of the experience during the 2007 to 2009 crisis, and we now notch down most hybrid ratings from the standalone credit profile.

How do these ‘building blocks’ work?
To borrow an analogy from the insurance market, a person’s home address can impact their house or car insurance premiums. In the same way, our new criteria are placing a greater emphasis on the country in which a bank operates, through an enhanced version of our existing BICRA methodology.

By doing this, we will give more weight to the risks associated with growing economic imbalances, the resilience of the economy, and the importance of system-wide funding and the role of governments and central banks in this funding. This analysis creates a framework to evaluate the relative strengths of banking systems and will be a consistent starting point for our rating.

This starting point is then adjusted up or down the rating scale to reflect our assessment of a bank’s specific strengths and weaknesses in business position, capital and earnings, risk position and funding and liquidity. After this, we assess the potential for government support or group support (for example, a parent company to a subsidiary).

Can you explain a bit more about BICRA?
The BICRA methodology is designed to evaluate and compare global banking systems. It is scored on a scale from 1 to 10, ranging from the lowest-risk banking systems (group 1) to the highest-risk (group 10), based on a time horizon of three to five years. The BICRA analysis, which incorporates the influence of government supervision and regulation of the banking system, is divided into two components: economic risk and industry risk. The analysis is then further divided into six factors that result in an economic and industry risk score for each country. A factor that is assessed as high-risk is given a greater weight in the assignment of the final BICRA scores. The criteria use metrics to enhance transparency and provide a basis for comparability among banking systems. The published criteria provide guidance in assessing and scoring each factor and sub-factor.

How do you view Asia-Pacific banking systems following the updated BICRA methodology?
In Asia-Pacific, our economic and industry risk scores and the resulting BICRA groups are widely dispersed. This reflects our view of the varying stages of economic and institutional development within the region. The distribution of economic risk scores broadly aligns with the level of economic development in the 16 systems we reviewed (see chart below).

Under the “economic resilience” factor, we scored Australia, Hong Kong, Japan and Singapore as either “very low risk” or “low risk”, reflecting their high income levels and resilient economies. At the opposite end, we assessed countries such as Papua New Guinea, the Philippines and Vietnam as “very high risk”, and Cambodia as “extremely high risk”, reflecting these economies’ earlier stage of development, narrower economic structures and greater exposure to economic volatility.

The majority of economies in Asia-Pacific are significantly less exposed to economic imbalances than countries in other regions. Consequently, we assessed nine of the 16 systems we reviewed as “low risk” or “very low risk” under this factor. Many of these systems benefit from several years of low or moderate growth in credit and asset prices. This mitigates the risk of a sudden, sharp drop in asset prices that could cause asset-quality problems for banking systems in the region. Five systems were assessed as “high risk” or worse. The assessment of “high risk” for China and Hong Kong stems from a rapid rise in private-sector credit and asset prices in recent years, despite sizable current account surpluses.

We assess “credit risk in the economy” as “low risk” for five banking systems, “intermediate risk” for one system and “high risk” or worse for 10 systems. For some systems classified as “low risk” (such as Singapore and Hong Kong), we note that previous declines in asset prices had a relatively insignificant effect. For systems assessed as “high risk” or worse, key constraints include moderate to high private-sector debt relative to income, or significant weaknesses in the payment culture and rule of law, which could result in low or delayed recoveries for creditors and a residual overhang of nonperforming assets. For example, banking systems in Thailand and the Philippines still carry some legacy nonperforming assets from the Asian financial crisis.

Although in terms of economic risk, Vietnam is in the “highest risk” category, we believe China represents the most significant future risk in Asia-Pacific. This is owing to the combination of China’s “high risk” of “economic imbalances” and “high risk” of “credit risk in the economy”, given its sizable economy and connections within the region and the globe.

How does Asia-Pacific banks fare with regard to the second component of BICRA, ie industry risk?
The distribution of industry risk scores is broadly similar to that for economic risk. Our assessment of “institutional framework” reflects a regional dichotomy. On the one hand, systems like Australia, Hong Kong and Singapore are among a handful of systems to be classified as “very low risk”. This reflects more conservative regulatory standards than observed globally, comprehensive regulatory coverage and a strong record of averting banking-sector problems. Additionally, we consider governance and transparency in these systems to be of a very high standard. On the other hand, half of the systems in the region have classifications of “high risk” or worse for “institutional framework”, reflecting our assessment of insufficiently robust regulatory frameworks, weak regulatory track records or limited governance and transparency standards.

Our assessment of “competitive dynamics” shows a concentration toward the higher risk categories. Eight of the 16 systems reviewed show “very high risk” or “extremely high risk”, taking into account important government ownership, significant directed lending or administrative controls in countries such as China, India, Indonesia, Thailand and Vietnam. Although we observe a minimal amount of targeted high-risk lending, we believe periods of rapid credit expansion could cause moderate to aggressive risk appetites.

We believe “systemwide funding” is an area of relative strength for the region, and we assess 10 of the 16 systems as “very low risk” or “low risk”. One reason for this is the region’s high domestic savings rate, which exceeds 30% of GDP in a number of countries. This is an important contributor to the relatively stable deposit bases that reduce the need for external funding.

When will you release the ratings based on the updated criteria?
From late November through mid-December, we intend to publish the ratings on all banks based on the new methodology. Our goal is to communicate all rating actions by mid-December. We have segmented banks into groups and will publish ratings on banks in these groups at the same time via a single “group media release”. The first group media release will include the biggest 30 global banks we rate, as measured by tier-1 capital. Subsequent group media releases will be more regionally focused.

For criteria documents and the explanatory materials, including interviews and training videos, please visit:

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