Standards and requirements for banks: Information on credit ratings

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Standards and requirements for banks

Information on credit ratings for banks currently registered in New Zealand.

Published:

What is a credit rating

A credit rating is an independent opinion on the capability and willingness of a financial institution to repay its debts — in other words, its financial strength or creditworthiness.

Credit ratings give investors an indication of a financial institution's relative strength, the likelihood that it will default and fail to repay investors. Credit ratings help investors assess whether the risk of investing is balanced by the rate of return on an investment.

A credit rating requirement is also likely to enhance incentives for banks to operate their business prudently to avoid a rating downgrade.

What banks must do

Under section 80 of the Banking (Prudential Supervision) Act 1989, we require registered banks to obtain and maintain a current credit rating applicable to their long-term, senior, unsecured obligations payable in New Zealand, in New Zealand dollars.

Banks may obtain a credit rating from Standard & Poor's, Moody's Investor Service or Fitch Ratings.

Registered banks must publish their credit rating in 6-monthly disclosure statements.

Registered banks in New Zealand

Comparing credit ratings

Different ratings systems are broadly comparable. For instance, an ‘AA’ rating from Standard & Poor’s and Fitch and an ‘Aa’ rating from Moody’s all imply that the chance of the rated organisation defaulting is approximately 1 in 300 over the next five years.

Table 1 Standardised rating scale

Description

S&P Scale

Moody’s Scale

Fitch Scale

Approx probability of default over 5 years*

Capacity to make timely payment

Extremely strong

AAA

Aaa

AAA

1 in 600

Capacity to make timely payment

Very strong

AA

Aa

AA

1 in 300

Capacity to make timely payment

Strong

A

A

A

1 in 150

Capacity to make timely payment

Adequate

BBB

Baa

BBB

1 in 30

Vulnerability to non-payment

Less vulnerable

BB

Ba

BB

1 in 10

Vulnerability to non-payment

More vulnerable

B

B

B

1 in 5

Vulnerability to non-payment

Currently vulnerable

CCC

Caa

CCC

1 in 2

Vulnerability to non-payment

Currently highly vulnerable

CC

CC

Vulnerability to non-payment

Default

D

C

D

• The approximate, median likelihood that an investor will not receive repayment on a five-year investment on time and in full based upon historical default rates published by each agency.

What credit ratings cannot do

Credit ratings are not a guarantee that a bank will be safe in the future. Indeed even an ‘AAA’ rated bank has an approximately 1 in 600 chance of default over a 5-year period. Although ratings are periodically revised, they are designed to provide a medium-term view of an institution’s financial strength. They do not respond to specific events or market volatility.

Credit ratings as investment advice

While credit ratings are useful indicators of risk for investors, they should not be relied on solely to make investment decisions.

Their key benefits lie in their availability, ability to convey a simple measure of risk, and that they allow investors to easily compare alternative opportunities. However, prudent investors should always consider their own personal circumstances, their willingness to take risks or otherwise, available investment strategies, and prevailing market conditions before making investment decisions.