Friday, 22 June 2012

Bank Downgrades

Are perhaps a little more important than people realise. Of course many will understand that if a bank is downgraded then the cost of its borrowing will rise. If like RBS and Lloyds your cost of borrowing is already higher than that of your competitors then this is bad for business.

Of course, what is really bad for business is that the solvent banks like HSBC do not want to offer all the lending that the market suggests they could - this leads to firms wanting to borrow to go back to RBS and Lloyds, even as the interest rates creep up.

So a set of bank downgrades will lift the overall cost of borrowing in the UK, albeit not by too much.

However, many of the more complex transactions that banks have entered into have various default clauses in them - mainly against the customer not paying the interest, but some on the Bank for non-performance. One such frequent clause is the rating status of the lending bank. Thus the bank can be in default on its own obligations - remedies for this will of course be costly for the Bank in question.

In addition, may banks are in the clover due to the Swaps they sold to protect against rising interest rates which then collapsed in 2008. This means the banks are in a big profits on these swaps, even the the assets they lent against have fallen in value. The twist of the downgrade is customers being in a position to negotiate a set off of one against the other.

None of this makes pleasant reading if you are a major clearing bank today. In as much as people don't care they soon will if the crisis continues to deepen and the banks seize up altogether, shafted by the complexity of their position and inability to cope with the macro mess politicians have created.

9 comments:

sri said...
This comment has been removed by a blog administrator.
Bill Quango MP said...

Football irony strikes again.

Germany vs Greece tonight.
If Greece win Germany still goes through but they have to change the terms of the bailout.

Nick Drew said...

then the cost of its borrowing will rise ... in addition ... etc

also, cost of capital goes up, automatically reducing VaR limits etc etc - so impacting negatively on volume of trade

there's no end to the downside

(which, for anyone in doubt, is the reason the UK plc AAA must be defended to the death)

sri said...

thanks for sharing with uTruck Chrome stacks

Anonymous said...

Nick Drew a few days ago:
"yes, Anon the ratings agencies are deeply implicated

but after Enron (at the very latest), no-one in the banking sector believed them !"

So the fraudulent triple A ratings meant nothing then, but now all of a sudden what the ratings agencies say is vitally important!

If these ratings agencies had downgraded the banks and mortgages years ago they could have halted the boom and so prevented the bust.
If they are only here to shut the door after the horse has bolted then what use are they?

Baring in mind that you put a higher price on something you increase its supply.
Do we need to rebuild our capital, reserves, or not?
We should welcome a higher price.
Interest rates should be about 10%+!

Yes that will cause some problems, maybe a lot of problems, but they can't be avoided anyway.
We are not going to bounce back, especially when our European markets have just the same problems or worse.

Anonymous said...

we need immediate action to separate 'casino' banking from the bread-and-butter business where the risks can be understood.

If punters want to risk the farm on exotic bets, then good luck to them, but don't expect any bailouts.

Many 100s of banksters also need to do jail time for ignoring\silencing risk managers and choosing to indulge in mickey-mouse "investing" in CDOs etc.

Nick Drew said...

Anon - I like Baring in mind ! very good

anyhow

separate 'casino' banking from the bread-and-butter business where the risks can be understood

we agree with that around these parts (tho easier said than done)

also rebuilding capital reserves

but So the fraudulent triple A ratings meant nothing then, but now all of a sudden what the ratings agencies say is vitally important! - is just silly

they don't mean as much as they ought to mean; but a downgrade is still a downgrade and, as we know (& lament) they are the only game in town

if you are paying attention the cycle is:

(a) there is an incident like Enron

(b) rating agencies rush around, all mea culpa, promise to do better next time, big increase in analytic rigour + transparency for, oooh, 18 months ?

(c) 18 months passes

(d) memories short, bonuses to be made, everyone slides back into the bad old ways

Electro-Kevin said...

c) 18 months passes but next time around spotty faced bankers will have proper 'O' Levels and not GCSEs

We shall be saved.

Budgie said...

Anon 6:20pm said: "If these ratings agencies had downgraded the banks and mortgages years ago they could have halted the boom ...".

No, the 'boom' (such as it was) was caused by Gordon Brown increasing the money supply more than growth through the 2000s.