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Sunday, 8 December 2013

The banks and the Dutch downgrade: how state support is still implicitely taken into account in the bank ratings from the large rating agencies

One of the most interesting topics in the printed FD (‘Het Financieele Dagblad’) of 30 November 2013, was a small article upon the prospective downgrade of ING Bank N.V., after the Dutch state lost its Standard & Poor's AAA-rating.

Unfortunately, it disappeared from my radar, due to a few other important events, but today I decided to write an article upon it after all.

The tendency in this eye-opening article was that the ING Bank N.V. would definitely be downgraded by Standard & Poor's, after the Dutch state had been downgraded to AA+ from AAA.

Here are the pertinent snips in this article:

ING will suffer from the fact that the Dutch state lost its AAA-rating. The rating of the banking part of ING Group – currently A+ – will be lowered by one notch.

This was disclosed by the last report of S&P, with respect to ING. It states that ‘one of the two notches of implicit state support in ING’s rating will be removed, when the rating for The Netherlands is lowered by one notch’.

For the other two large Dutch banks, ABN Amro and Rabobank, the lower credit rating of the state does not have repercussions. They can keep their current ratings (respectively A and AA-) at their own strenght.

The credit rating of the large banks is often partially dependent from the creditworthiness of the host country. In practice, bondholders of banks will be protected by their government after all, against the default risk of their bank: the government saves the bank, when such an event occurs. 

Consequently, the rating agencies make an estimate of the odds for a rescue; ING Bank’s rating is two notches higher than it would have been without this implicit state support.

And indeed, just as surprising as snow on the South Pole, the rating of ING Bank was lowered by one notch on Tuesday, 2 December:

On Nov. 29, 2013, we lowered to 'AA+' from 'AAA' our long-term sovereign credit rating on the State of The Netherlands.

We are […] reducing the uplift for government support that we factor into our ratings on ING Bank N.V. from two notches to one.

We are therefore lowering to 'A' from 'A+' our long-term ratings on ING Bank, and also lowering by one notch the long-term ratings on its subsidiaries, ING Belgium, ING Financial Markets, and holding company ING Groep.
The ratings on ING Groep's insurance operating subsidiaries are limited by the ratings on ING Bank. We are lowering to 'A' from 'A+' the ratings on Nationale-Nederlanden Levensverzekeringen Maatschappij N.V. and ING Re (Netherlands) N.V. and the rating on ING Verzekeringen N.V. to 'BBB+' from 'A-'.

Our ratings on other Dutch banks are unaffected by these actions.

The paper article in FD stated, as additional information, that the “bonus rating” for the large Dutch banks – as a consequence of having the Dutch state as a backstop – was set, using a certain calculation table. The fact that ABN Amro and Rabobank would not be downgraded this time, was purely coincidential, due to the usage of this table. However, when the Dutch state would get another downgrade, the rating of both these banks would also be downgraded.

For me personally, it is a discomforting idea that the financial strength (i.e. ‘the rating’) of a bank is not measured by its creditworthiness alone, but also by the creditworthiness of its ‘bodyguard’: the country or state in which it resides ( see the red and bold paragraph).

In other words, the Dutch citizens are still implicitely on the hook for the large banks in their countries. And so are the German citizens, the French citizens, the Belgian citizens, the Luxemburg citizens and all the other citizens in countries with a large banking system. 

This phenomena remains intact, in spite of the fact that chairman of the Eurogroup Jeroen Dijsselbloem tried to alter this mechanism during the Cypriot banking crisis.

Irrespective of how you call it, there is a certain amount of perversity in this implicit state guarantee. Banks, who have the implicit guarantee of a powerful and creditworthy host state, like The Netherlands or Germany, can (and probably will) take more risk than banks who don’t have this. Just like a mobster with an extremely skilled bodyguard will probably take more risk, than one who doesn’t have such a bodyguard.

In The Netherlands, when it comes to discussions upon the banking industry, there are roughly two groups:
  • The ‘bank bashers’, who see the banks as the root of all evil in the current crisis and think that the banks – all banks – must be kept at an extremely tight leash;
  • The ‘bank supporters’, who think that the bankers have changed their lifestyle for the better and state that the bankers have suffered enough from the negative public attitude and bad publicity during the last five years.
In my humble opinion, both groups are partially wrong. 

Personally, I think that a lot has indeed changed for the better in the banking industry. Banks are actively working on improving their solvability, by reducing the size of their balance sheet and abolishing high-risk loans. Although for many banks the deployment of additional equity is yet one bridge too far, they try at least to improve their core capital rates.  

Also in their core processes, like Savings, Payments, Investment and Trade, Mortgages and Private, SME (small and medium enterprise) and Corporate Lending, most banks show much more risk awareness; especially in the administrative organization of their core bank and in the loan approval process.

Nevertheless, during the last few years, we had our share of small and large banking scandals within highly reputed banks in Europe. Of these scandals, the Libor/Euribor-gate case was probably the most high-brow event, but some of the other scandals also led to public disapproval and (even) outrage.

And only a few weeks ago, I heard a high bank official state at a private party: "Don’t mind the law too much, when it comes to officially illegitimate actions with respect to computer data. As long as nobody notices it, you are fine".

Most banks DID change their behaviour and actions in daily banking business. 

However, I used this (unrecorded) statement as an example that, if you scratch the surface, you might find that the banks not always changed their attitude. 

This makes the stimulus coming from the ‘bonus ratings’ a perverse one.

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