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Credit FAQ: What's Behind The Proposals To Update Our Financial Institutions And BICRA Methodologies


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Credit FAQ: What's Behind The Proposals To Update Our Financial Institutions And BICRA Methodologies

S&P Global Ratings has published requests for comment (RFCs) on its proposed rating methodology for financial institutions and Banking Industry Country Risk Assessments (BICRA). See "Request For Comment: Financial Institutions Rating Methodology" and "Request For Comment: Banking Industry Country Risk Assessment Methodology And Assumptions," published June 8, 2021. Here we address the reasons why we're publishing the RFCs now and answer questions about the analytical rationales and RFC process.

Frequently Asked Questions

Why are you proposing changes to your financial institutions (FI) criteria now?

We're proposing these updates to our criteria, which don't change the fundamental analytical framework, because:

  • By consolidating our bank and nonbank financial institutions (NBFI) methodologies (and eight other criteria articles on related topics) into a single criteria article, we propose to enhance the consistency of our terminology and approaches across different types of financial institutions, while making the criteria more accessible;
  • The updates incorporate relevant developments since the publication of the existing articles (for example, 2011 for the bank and BICRA methodologies), including newer or emerging risks, such as those relating to technological change; and
  • The updates to the criteria will also mean that we can communicate more clearly on the drivers of rating changes.

The COVID-19 pandemic is the main global test of these FI rating methodologies since they were published. We have reflected on its impact on FI creditworthiness to date and our ability to reflect this in our rating approach, but the pandemic has not materially shaped our proposed criteria (see "How has the pandemic affected the proposals?").

We are not proposing significant changes to our analytical frameworks and not recalibrating our rating approach. We therefore expect rating changes to be limited in number, although there will be ratings that change due to some of the more targeted analytical changes in the proposals.

The main proposed changes from our current methodology are presentational, but there are several focused analytical changes. These include:

  • Our proposal to apply a potential one-notch adjustment at the stand-alone credit profile (SACP) level for all FIs (currently we apply it only at the issuer credit rating level for banks),
  • The increased ability to make a qualitative adjustment to the capital and earnings score to reflect more clearly the quality of capital and of earnings,
  • Some adjustments to our additional loss-absorbing capacity (ALAC) calculations based on the demarcation between going-concern loss-absorbing capacity and those resources that would be activated in the event of a resolution, and
  • Some updates to our approach to assign ratings to foreign branches.

The BICRA proposals also don't alter the fundamentals of the existing analytical framework. They do remove quantitative limits on the frequency of the use of adjustments, and replace the multiple subfactor-specific individual adjustments within each of the economic and industry risk factors with a proposal to determine an initial score for each factor with a single adjustment applied to arrive at the final score for each factor. The proposals also would reduce some mechanistic links with sovereign rating scores and allow for a wider range of metrics and economic indicators to be used to reflect the specifics of different economic structures. If adopted, the proposals could lead to a very small number of BICRA changes.

This is not an exhaustive list of the proposed changes to the methodologies--the RFCs contain complete lists.

These RFCs are consistent with, and do not affect, the proposals in "Request For Comment: Environmental, Social, And Governance Principles In Credit Ratings," which was published on May 17 and is open for comments until June 17. That RFC formalizes and restates in a single article our existing analytical approach to incorporating the impact of environmental, social, and governance (ESG) credit factors in our credit analysis.

How will ratings be affected if the RFC proposals are adopted?

We believe that, based on our testing and assuming that entities maintain their current credit characteristics, less than 10% of issuer credit ratings (ICRs) within the scope of the two proposed criteria articles will be affected (with about one-third of these driven by a potential change in BICRA scores). We estimate that the majority of the rating changes would be by one notch, with more upgrades than downgrades. Most FIs and banks do not have resolution counterparty ratings (RCRs), but if we change our ICR on a bank and the bank has an RCR, then it is likely that we will change the RCR in the same way.

We also expect that potentially 50 issue credit ratings on hybrid instruments (less than 3% of FI hybrid issue credit ratings) may change because of changes in SACPs due to the proposal to factor in a CRA adjustment at the SACP level. We expect the impact on these issue credit ratings would be to lower approximately two-thirds by one notch and raise one-third by a notch. In addition, based on our testing and assuming that entities maintain their current credit characteristics, less than 5% of SACPs could be affected by the proposals. We expect the majority of these SACP changes will be by one notch. Hybrid ratings on these issuers would likely be affected by the changes in the SACPs. Again, we expect that the majority of rating changes would be one notch.

Since we are not proposing any fundamental changes to the BICRA framework, we expect that, based on our testing, fewer than 2% of BICRAs may be altered, potentially changing by at most one category. However, our expectation is that the effect on industry risk scores will be greater, and we see the potential that up to 5% of industry risk scores will either improve or weaken. Based on our testing, and assuming that FIs we review maintain their current credit characteristics, fewer than 4% of our ICRs could be affected by the BICRA proposals (as included in the figures earlier in this section), most of which we estimate would be by no more than one notch, with more upgrades than downgrades.

How has the pandemic affected the proposals?

We did consider the observed and expected effects of the COVID-19 pandemic when reviewing the proposals. We haven't made any substantive changes as a result because we think the existing and proposed criteria provide the frameworks to assess the impact of unusual and infrequent stresses. For example, our BICRA framework gives us the ability to look at systemic developments across economies of vastly different strengths.

We have included some references in the proposals to demonstrate more clearly how we look at some of the policy responses to the pandemic. These include regulatory forbearance shown to banks, forbearance shown to borrowers by FIs, and various forms of systemic support governments provide to support economies (as seen throughout the pandemic).

Has your view of government support for banks changed?

The proposed criteria continue to allow for potential extraordinary government support of banks to be incorporated in ICRs when we see a bank as sufficiently likely to be in a stress scenario. This is because such support would affect the likelihood that the bank would default and, therefore, is relevant to our credit opinion.

But we continue to exclude such government support from bank ratings in other circumstances, such as when we expect the most likely response to a bank stress to be the bail-in of various bank obligations at the expense of certain creditors. We also consider it too uncertain that the governments of many countries would provide direct support to distressed banks to incorporate such support in our ratings. This is the case for many banks in parts of Western Europe and the U.S., for example.

However, banking systems received considerable systemic support in 2020, through the provision of central bank liquidity support, the indirect effect of government support to banks' borrowers, and relaxation of regulatory rules applying to banks. We incorporate such forms of systemic support in our BICRA framework and, when received, in our views of banks' SACPs. The extensive support public authorities have provided to banks across the globe doesn't affect our proposed calibration of the ICR uplift for potential extraordinary government support. We believe COVID-19 was an unusual shock. As such, it does not represent a reliable blueprint about how public authorities will handle future stress scenarios.

The proposals also allow for extraordinary government support to be reflected in the ICRs on NBFIs where relevant, and to assess the degree to which FIs that are government-related entities (GREs) could benefit from government support due to their systemic importance as opposed to their GRE status.

How do the RFCs affect S&P Global Ratings' risk-adjusted capital (RAC) model and its use to determine FI ratings?

We are not proposing any changes to the RAC criteria (see "Risk-Adjusted Capital Framework Methodology," published July 20, 2017) as part of these RFCs and expect no direct impact on RAC ratios.

However, we are proposing some changes to how we incorporate RAC ratios in our ratings framework. In particular, we propose to apply a qualitative adjustment when assessing capital and earnings, highlighting the role of other factors, such as quality of capital and earnings, in addition to that of the starting metric (for example, the RAC ratio). We expect that this proposal will enable us to better reflect and discuss the role of factors other than the RAC ratio within our assessment, while still keeping the RAC ratio as our starting point for the assessment of capital for banks and many finance companies.

Also, we propose to address in the capital and earnings adjustment some of the factors currently captured in risk position. This should enable us to more clearly communicate our views on topics such as asset quality, risk appetite, complexity, and risk management within our risk position assessment.

As part of the development of the criteria proposals, we considered whether recent and ongoing improvements in bank regulatory capital frameworks meant that we could move our capital analysis to rely more on regulatory capital ratios than on RAC. We carried out considerable testing of this but still found limited comparability of regulatory Tier 1 ratios. While revised regulatory capital standards represent a big step toward greater comparability since we first introduced the concept of RAC, we expect that inconsistencies will remain.

Regulatory ratios still don't support a ranking of banks' capitalization without use of significant additional information to look at the underlying dynamics of the balance sheet. Some banks, for instance, have higher regulatory ratios but weaker underlying capitalization that would require frequent and large adjustments to be reflected in the capital and earnings scores. For more details about why we believe the comparability of risk-sensitive regulatory metrics--for example, common equity Tier 1 and Tier 1 ratios--will remain somewhat elusive, see "The Basel Capital Compromise For Banks: Better Buffers, Elusive Comparability," published June 3, 2021.

The RFC proposals do enable a greater focus on the quality of capital and the information garnered from regulatory capital ratios than our existing criteria. For example, if a bank's Tier 1 ratio is calculated conservatively and highlights relative strengths not sufficiently reflected in our RAC ratio, this could contribute to a positive adjustment to the initial capital and earnings score.

Are you changing the components of the total adjusted capital (TAC) measure of capital?

No, we are not proposing any changes to TAC as part of these RFCs. TAC is the numerator of our RAC ratio and is typically a more conservative measure than regulatory Tier 1 capital. We include various hybrids in TAC where we consider that they can absorb losses on a going-concern basis. We do not consider such instruments, which are mainly additional Tier 1 securities for banks, to be as good a form of capital as common equity, however, because FIs (and regulators) may at times be reluctant to have such instruments absorb losses until a stress becomes severe. We therefore apply limits to the amount that can be included in TAC. The limits are linked to the amount of adjusted common equity, our measure of core capital, that an FI has.

Are the FI ratings based on probability of default or loss given default?

Our issuer credit ratings are measures of the relative likelihood of default but they are not probabilities of default over a specific time period. This is because there is no predetermined time horizon for a long-term ICR--it does not reflect the probability of default over the outlook period or only over the period for which we use financial projections. For this reason, our ICRs incorporate events that could occur after the outlook period if they are sufficiently visible and material to the entity's creditworthiness. This is also why we don't set our ratings on all FIs in a financial system at higher and similar levels in good times and then only start to differentiate more widely once a systemic stress emerges and is likely to lead to tougher conditions over the next two to three years.

Given the focus on the relative likelihood of default, our ICRs on FIs are not measures of loss given default. We don't think there are enough examples of banks going through standard bankruptcies to derive robust and stable assumptions on the magnitude of loss for creditors, given that many of the examples are based on idiosyncratic situations.

How does the alternative investment funds RFC interact with the FI and BICRA RFCs?

The existing alternative investment fund (AIF) criteria use a subfactor score from the existing BICRA criteria that we do not include as a separate score in the BICRA proposals. We therefore propose to include that specific assessment within our AIF criteria, and we have published an RFC requesting comments on that proposal (see "Request For Comment: Alternative Investment Funds Methodology"). The FI RFC has no implications for the AIF criteria.

Will the proposals be reflected in any rating actions while the RFCs are outstanding?

No, the proposals cannot be used in a rating committee. All committees will continue to apply the existing criteria until the new criteria have been finalized and published.

When will the final criteria be published?

We haven't set a date for publishing the final criteria. The comment period will close on July 20, 2021. The length of time that it will take to review the comments and finalize the criteria will depend on the number and nature of the comments that we receive.

What is the process for submitting comments?

We encourage interested market participants to submit their written comments on the proposed criteria by July 20, 2021, to where participants must choose from the list of available Requests for Comment links to launch the upload process (you may need to log in or register first). We will review and take such comments into consideration before publishing our definitive criteria once the comment period is over. S&P Global Ratings, in concurrence with regulatory standards, will receive and post comments made during the comment period to

Comments may also be sent to should participants encounter technical difficulties.

All comments must be published, but those providing comments may choose to have their remarks published anonymously or they may identify themselves. Generally, we publish comments in their entirety, except when the full text, in our view, would be unsuitable for reasons of tone or substance.

Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Michelle M Brennan, London + 44 20 7176 7205;
Alexandre Birry, London + 44 20 7176 7108;
Secondary Contacts:Steven Ader, New York + 1 (212) 438 1447;
Matthew B Albrecht, CFA, Centennial + 1 (303) 721 4670;
Richard Barnes, London + 44 20 7176 7227;
Brendan Browne, CFA, New York + 1 (212) 438 7399;
Matthew T Carroll, CFA, New York + 1 (212) 438 3112;
Sharad Jain, Melbourne + 61 3 9631 2077;
Ivana L Recalde, Buenos Aires + 54 11 4891 2127;
Emmanuel F Volland, Paris + 33 14 420 6696;

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