Bank credit ratings are estimates of the probability of a bank’s bankruptcy or default. They are grades assigned by agencies like Moody’s Investors Service. Bank credit ratings are estimates of the probability of a bank’s bankruptcy or default. They are grades assigned by agencies like Moody’s Investors Service.
Definition and Example of Bank Credit Rating
For consumers, your personal credit rating can affect the interest rate you get on loans, whether you can qualify for a mortgage, and even whether you can get a certain job. Banks have their own credit ratings based on the estimated likelihood of defaulting and failing to meet obligations.
Bank credit ratings provide:
- A common vocabulary for consumers, investors, government agencies, and financial institutions to use
- An external view regarding the reliability and risk level of financial institutions
Agencies such as Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s issue credit ratings for banks as well as other financial institutions and investments. These ratings are typically given in the form of letter grades, with AA or AAA being better than BB or BBB.
Note: A non-investment rating, also known as a “junk” rating, is assigned to distressed banks.
How Bank Credit Rating Works
Three global credit rating agencies (Moody’s, Fitch Ratings, and S&P Global Ratings) rate banks and other financial institutions based on their quality, reliability, and the risk of default. The scales used by each agency vary slightly but are generally equivalent.
Ratings by Agency:
| Moody’s | Fitch | S&P | Meaning |
|---|---|---|---|
| Aaa | AAA | AAA | Highest quality, lowest risk |
| Aa | AA | AA | High quality, low risk |
| A | A | A | Upper-medium quality, low risk |
| Baa | BBB | BBB | Medium quality, moderate risk |
| Ba | BB | BB | Possibly speculative, significant risk |
| B | B | B | Possibly speculative, high risk |
| Caa | CCC | CCC | Weak quality, very high risk |
| Ca | CC | CC | Highly vulnerable, likelihood of recovery |
| C | C | C | Highly vulnerable, low chance of recovery, may still be paying |
| C | D | D | In default, likely to continue doing so |
Fitch Ratings also includes a rating labeled “RD,” which means restricted default, between C and D. This indicates that the institution has defaulted on some of its financial obligations but has not entered bankruptcy or ceased operations.
Adjustments may be added to these ratings to show higher degrees of detail. Moody’s may add a 1, 2, or 3 to the letter grade. Standard & Poor’s may add a plus or minus sign. AA+ is equivalent to Aa1. It is at the upper end of the AA or Aa category. AA- is equivalent to Aa3 and is at the lower end of the AA or Aa category.
Note: Credit ratings are not assigned just once. They are re-evaluated and re-assigned, sometimes at very different levels, depending on the current financial situation and risk level of the financial institution.
Bank credit ratings do not indicate the likelihood of a bank committing fraud. Your bank may still be vulnerable to security breaches, even if it has a strong credit rating. It will depend on the security measures it follows for accounts and customer information.
Implications and Effects of Bank Credit Ratings
Bank credit ratings are just one tool consumers and investors can use to assess financial institutions, but they are not absolute measures of a financial institution’s reliability. They can impact customers in various ways, depending on the type of business they do with the bank. People holding large and unsecured loans may be particularly affected if the bank’s ability to meet its obligations deteriorates or even if its rating drops to “junk” status for a period of time. These loans include business lines of credit and home equity loans.
The bank must improve its liquidity by maintaining capital when faced with a difficult position. It may therefore have to withdraw its lines of credit, meaning it can lose borrowing capacity. Sometimes, troubled banks may also start closing branches and laying off employees. While these actions will not impact the safety of your deposits, they may affect your relationship with the bank if it decides to close your local branch.
Note:
High-rated banks are generally more trusted than government agencies, local businesses, and international companies, as well as customers.
Unexpected economic changes or poor business practices can lead to a bank’s bankruptcy even if it has a high rating. A lower rating does not guarantee that the bank will face financial problems. Consumers should always pay attention to a bank’s “junk” rating, which usually means the bank is in a state of significant financial distress. You would be safer if you decided to work with another financial institution.
You likely don’t need to worry about your credit rating if your bank is insured by the Federal Deposit Insurance Corporation (FDIC). The FDIC insures every bank deposit account up to $250,000 per depositor, per account. Similar insurance exists for credit unions: the National Credit Union Administration’s Share Insurance Fund. You can protect yourself by splitting your money among different banks to stay under the $250,000 limit if you have more than $250,000 in your deposits.
You will be protected if your bank fails, as long as your funds are insured by the Federal Deposit Insurance Corporation. Most consumers have accounts that are 100% guaranteed by federal deposit insurance. They do not need to worry much about bank credit ratings, if at all.
Source: https://www.thebalancemoney.com/what-is-a-bank-credit-rating-4586357
Leave a Reply