Are Agencies Over-Rated?

Barbara Kiviat*, a former Time staff writer, noted in an article last year on the global financial crisis that the jury is still out on what exactly happened, and who is to blame, five years after the event. More than 300 books on the subject saw the light, and still there is uncertainty on what needs to be done to make the financial system safer.

She explains the lack of clarity as follows:

To be fair, many accounts… draw from the same set of story lines and cast of villains. A composite might go something like this: Risk-happy executives at big financial firms, enjoying the freedom of hands-off regulators and aiming to satisfy return-greedy institutional investors, drove the growth of ill-conceived mortgage securities, which were enabled by credit-ratings agencies abdicating the responsibility of good judgment and house-hungry Americans wooed by collapsed lending standards — a situation magnified many times over by the financial wizardry of an unregulated shadow-banking system.

I was particularly intrigued by her view on credit-rating agencies following the downgrading by Moody’s of Capitec Bank in the wake of the African Bank crisis, and then, subsequently, the big four banks.

This action by Moody’s was followed by an announcement by Standards and Poor (S & P) that they would not follow suit as, in their view, the Reserve Bank has managed the collapse of African Bank correctly, and the rescue plan “…was in line with global best practice and principles on how to resolve problems with banks in crisis.”

Moody’s, in turn was of the view that the Reserve Bank’s “…failure to fully protect African Bank’s creditors raised concerns about the extent of future support for other banks, should they need it,” according to Business Day.

Capitec, in particular, was furious at being downgraded two notches and being placed on survey by Moody’s and called it a kneejerk reaction. In a Sens issued last Monday, it outlined the background to the decision as follows:

The bank was informed of this decision, following a short telephone review of 30 minutes, on Thursday 14 August 2014. Capitec Bank is extremely dissatisfied with the extent of the review and its conclusion.

The reasons given for this dissatisfaction are:

  1. Capitec Bank’s ratings were confirmed at the higher level by Moody’s as recently as 12 May 2014.
  2. Capitec Bank feels that the downgrade by Moody’s is a reaction to the situation pertaining to African Bank, which is not applicable to Capitec Bank.
  3. Despite assurances from Capitec Bank that our performance is according to plan… we feel Moody’s did not take this into account when assessing the bank. Moody’s was invited to review additional information to be provided by Capitec Bank, but unfortunately declined this opportunity.

The Reserve Bank felt compelled to issue the following media statement on 19 August 2014 in light of the downgrade of the four major banks:

The South African Reserve Bank (SARB) notes today’s decision by Moody’s Investor Service (Moody’s) to downgrade four of South Africa’s major commercial banks by one notch and placed them on review for a possible further downgrade. While the SARB respects the independent opinion of rating agencies, we do not agree with the rationale given in taking this step, nor do we agree with the assessment it is based on.

Once again, Moody’s refers to a lower likelihood of sovereign systemic support based on decisions taken recently in relation to African Bank Limited (African Bank). This concern stands in sharp contrast to the support actually provided by the SARB.

Notwithstanding this downgrade Moody’s has confirmed the resilience of the South African banking system and in their own view “… notes the broad resilience demonstrated by South African banks in the past, including the management of adverse economic environments, and recognises the solidity of key system financial metrics …”

With a capital adequacy of 14,87 per cent, of which Tier 1 capital comprises 12,05 per cent; a financial leverage multiple of 13,43, impaired advances to gross loans and advances of 3,57 per cent and a return on equity of 14,25 per cent, the South African banking sector remains healthy and robust.

These downgradings by Moody’s will most likely have a more detrimental impact on the reputation of rating agencies than on the banks. Their role during the events which led to the global financial crisis is indicated as follows by Kiviat:

“Mortgage brokers didn’t vet borrowers, credit-rating agencies rubber-stamped junk-laden mortgage securities with AAA ratings, and federal regulators refused to establish transparency in the quickly growing yet murky market for over-the-counter derivatives.”

Only time will tell who was right. In the meantime, the negative impact of the downgrading of the banks will be felt by all but the rating agencies.

*Barbara Kiviat, a former TIME staff writer, is pursuing a Ph.D. in sociology and social policy at Harvard University.

Dr. Roelof Botha se siening oor hierdie aangeleentheid kan hier gelees word.

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