U.S. ratings downgrade could make it harder for banks to raise capital, experts say
By Emmanuel Olaoye
NEW YORK, July 20 (Thomson Reuters Accelus) – Any downgrade in the U.S. government’s credit rating stemming from a failure to raise the debt limit would make it harder for American banks to raise capital at a time that they are facing higher capital requirements, banking experts and industry representatives warned.
A downgrade could cause a spike in interest rates which would drive up funding costs and make it difficult for banks to attract capital, said V. Gerard Comizio, a partner at Paul Hastings. The challenges with raising capital could lead to a surge in bank failures, he said.
“With over  banks on the FDIC’s troubled banks list, the question is what is the likely impact of a spike in rates for some of the troubled banks. The shooting up of rates will cause a decline in their portfolios. A short term to mid impact [of a change in rates] will be a spike in bank failures,” Comizio said.
Comizio pointed out that the savings and loans crisis of the 1980s led to multiple bank failures because the banks were unable to fund themselves at higher interest rates.
“Banks are in the business of dealing with interest rates,” Comizio said. Many banks are so concerned about interest rates that they are making contingency plans “on everything from more capital to looking at their mortgage portfolio,” he said.
Congress must raise the U.S’s $14.3 trillion borrowing limit by Aug. 2 or the government will run out of money to pay its bills. Democrats and Republicans are at an impasse in negotiations on raising the borrowing limit, although a new initiative on Tuesday by a bipartisan group of senators breathed some life into hopes of a deal.
Credit-rating agencies Moody’s and Standard & Poor’s have in recent weeks said that they may downgrade the U.S’s gold-plated credit rating unless a deficit-reduction deal in the range of $4 trillion is reached.
Experts have warned that the credit rating could be cut even if a deal is reached on the debt ceiling. Randy Snook, executive vice president of the Securities Industry and Financial Markets Association, said a downgrade would be “catastrophic” for the financial markets.
“Without the triple-A rating, you could have certain banks, or certain funds or investors [who] can no longer buy Treasuries, or can’t buy them in the same quantity,”, Snook said. His comments were echoed by SIFMA president and chief executive officer Tim Ryan who said bank capital levels could shrink if a downgrade occurs.
“If there was a significant downgrade it clearly would have an impact on risk weighting and therefore have an impact potentially on capital levels,”, Ryan said.
Joseph Spivack, an executive consultant at CEIS Review Inc, a credit and risk management consultancy, said a change in interest rates would create problems in lending because commercial banks used the government’s rate as a proxy rate for their loans.
“Its hard to anticipate. It is certainly possible that there is a moderate increase in the general level in interest rates (that) could affect everybody,” Spivack said.
The standoff over the debt ceiling comes as global regulators are moving to impose capital surcharges on the largest banks to keep them safe and prevent future crises.
The international Financial Stability Board said on Monday that the largest banks would only be allowed to use top-quality capital. The FSB, which has been given responsibility by G20 countries to coordinate an overhaul of rules after the financial crisis, said it backed plans released last month by bank regulators as part of efforts to deal with so-called too-big-to fail banks
Community banks are also under pressure from their regulators to raise more capital to offset lending risks and prevent more bank failures. As of March 12, the U.S. Federal Deposit Insurance Corporation had more than 888 banks on its problem bank list, according to a spokesman for the regulator. A total of 377 banks have failed since Jan 2008, with 55 banks failing in 2011 so far.
“I think it is going to be tougher for everyone because of concerns [a downgrade] will heighten in the economy,” said Nicholas Ketcha, executive managing director at FinPro Inc and a former director of the division of supervision at the FDIC. “I’m hoping we don’t have to find out what a catastrophe [a downgrade] might be. It will certainly have an effect on markets. That will have spillover effects on banks.”
John Douglas, a partner at Davis Polk & Wardwell LLP and a former general counsel of the FDIC, was unconvinced that a downgrade would have a sustained negative impact on market confidence. He said this was unlikely because the market’s perception was that the U.S. government would always meet its obligations.
“Using Greece as an example, it doesn’t matter if the Greek government goes into default or not. Everyone knows Greek debt is not [worth] 100 cents on the dollar. If the U.S. loses its triple rating but people believe the debt will be paid in full, I don’t think it will have much of an impact at all.”
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