Banks’ credit ratings downgraded as state bailout guarantees recede

The scourge of “too-big-to-fail” banks in the UK is receding, according to the Moody’s credit rating agency.

Moody’s downgraded the outlook of British financial institutions yesterday from stable to negative and said the major reason for the change was the increasing likelihood that banks would not be able to count on a public bailout if they were to get into trouble again.

The previous Labour government pumped £66bn of taxpayers’ money into Lloyds and the Royal Bank of Scotland during the 2008/09 financial crisis because officials judged that allowing those insolvent banks to go bankrupt would inevitably impose catastrophic costs on the wider economy.

Since then, politicians and regulators have been trying to tackle the problem of too-big-to-fail by establishing a legal resolution regime for complex troubled financial institutions, whereby unsecured bondholders would automatically take losses in a crisis.

“The UK Government is now able to finalise the secondary legislation to implement the structural reforms relating to the UK resolution and bail-in regime and the related ring-fencing framework,” said Moody’s Carlos Suarez Duarte, who wrote the report.

Moody’s added that the Coalition’s legislation to impose a “ring-fence” around the retail arms of large banks by 2019 would also help remove the need for taxpayers to rescue banks in another emergency.

The withdrawal of the de facto state guarantee of banks’ liabilities means their credit rating should fall, which is why Moody’s has changed its grading of their bonds. Andy Haldane, the Bank of England’s chief economist, has estimated that the world’s big banks enjoyed an implicit taxpayer subsidy, through lower funding costs as a result of being too-big-to-fail, of €700bn (£550bn) a year at the height of the crisis in 2009.

Despite the downgrade on the back of the too-big-to-fail shift, Moody’s said the prospects of the major UK banks had improved due to the recovery. It argued the credit fundamentals of banks was better and that rising interest rates over the coming years should make banks more profitable. However, Moody’s also noted UK banks still face exposure to both conduct and litigation charges for rate fixing.

The share prices of the major banks were little changed on the back of Moody’s report. Royal Bank of Scotland was down 1.5 per cent, Barclays 1 per cent and Lloyds 0.7 per cent. HSBC was flat.

A report last month from the US Government Accountability Office suggested that the “too-big-to-fail” problem was also receding from the American financial sector as a result of new regulations from Congress since the financial crisis.

However, regulators seem less sure that too-big-to-fail is declining as a problem. Under the auspices of the global Financial Stability Board they are still hammering out an agreement on dealing with cross-border banks that get into difficulties.

The issue is due to be tabled at the G20 leaders meeting in Brisbane in November.

There are also indications some banks are pushing back against the reform agenda. The chairman of HSBC, Douglas Flint, has reportedly written to George Osborne asking him to push back the planned introduction of the retail “ring-fence” on the grounds that banks are facing too much regulatory uncertainty.