Implications of Moody's Downgrade on Bank Rates

This week Moody’s downgraded 28 Spanish banks, but last week was all about the hype surrounding Moody’s bank downgrade of some of the world’s biggest banks. In accordance to the story, Moody’s downgraded 15 global bank’s credit ratings last Thursday. Three of the nation’s largest financial institutions, JPMorgan Chase, Bank of America, and Citigroup, were included in the bunch.

According to Moody’s global banking managing director, Greg Bauer, “All of the banks affected by today’s actions have significant exposure to the volatility and risk outsized losses inherent to capital markets activities.” Despite this, the stock prices of five downgraded banks jumped Friday morning, speaking to investor confidence in the financial system. Truth is, banks are much stronger financially today than say three years ago.

Citigroup “strongly disagrees with Moody’s analysis of the banking industry and firmly believes its downgrade of Citi was arbitrary and completely unwarranted.”

Morgan Stanley believes “the ratings still do not fully reflect the key strategic actions” it has taken in recent years.

Royal bank of Scotland, states it has made “significant progress in strengthening its credit profile since 2008.”

Nonetheless, the downgrades did cite concerns about the welfare of the global financial system in terms of “more fragile funding conditions, wider credit spreads, increased regulatory burdens and more difficult operating conditions”, but in a more direct way, how do they affect banks and consumers like us?

Ratings by Moody’s and Standard & Poor’s help set rates at which banks can borrow money and ultimately the rate at which they can extend loans to businesses and consumers. Banks sell commercial papers to money market funds, a form of borrowing used to meet short-term cash needs. Truth is, the downgrades may make it difficult for banks to sell these commercial papers.

In the long run, banks with lower ratings will have to pay more to borrow money and finance lending activities. The higher cost of capital may equate to higher costs to consumers in terms of mortgages and small business loans. In theory, banks with higher ratings will not be affected and therefore be able to provide better rates says Jodie Lurie, corporate credit analyst at Janney Capital Markets.

However, the flip side of the story is that at least in the short run, the downgrades may in fact have little effect on consumers. In fact, some analysts do not see financing cost for banks as an issue. Joseph Morford, a bank analyst at RBC Capital Markets said, “The commercial banks are flush with deposits and liquidity, so if anything, many of them are retiring debt and are relying less on issuing debt to fund their operations.”

Experts do see any direct impacts on rates or fees offered by the downgraded banks to consumers. When revenues were pressed in the past banks have tried to raise and impose fees on things like debit cards. However, consumer complaints forced banks to roll back these fees and impose them in more discrete places. What this means is that for consumers, there will be, if any, few changes to bank rates. Bank customers will continue to see low yields on their CDs and savings accounts, in addition to low rates on mortgages based on qualifications.

According to Keith Gumbinger, vice president of HSH.com, a mortgage information website people won’t find any “appreciable effect” on mortgage lending. He also does not expect the downgrade to affect banks’ willingness to make huge loans to people buying costly homes.

Overall, as Lurie says, “the downgrades are likely to trigger some near – term volatility.” However, with regards to its implications, bank financials are strong, so we should not expect to see much change in bank savings rates and mortgage rates.