Assumptions of Implicit Government Support

Why is it not wise to ignore an important dimension of the bank rating, not even for capital adequacy purposes?

According to the Basel Framework as it will appear in the future on January 1, 2025, banks incorporated in jurisdictions that allow the use of external ratings for regulatory purposes will assign to their rated bank exposures the corresponding “base” risk weights determined by the external ratings according to the following table:

External Credit Risk Assessment Approach

“Such ratings must not incorporate assumptions of implicit government support, unless the rating refers to a public bank owned by its government. Banks incorporated in jurisdictions that allow the use of external ratings for regulatory purposes must only apply SCRA for their unrated bank exposures, in accordance with CRE20.21.”

This requirement contradicts the longstanding practice of leading rating agencies. Moody’s said in their banks’ rating methodology “our approach to incorporating our expectations related to various forms of external support, from affiliated entities, or from governments, based upon our Joint Default Analysis (JDA) framework.”

The requirement, that “such ratings must not incorporate assumptions of implicit government support, unless the rating refers to a public bank owned by its government”. The demand not only implies a disadvantage for private banks, which, due to their successful development and importance for the economy, can also count on political support. From an investor’s point of view, too, it is important to assess the default risk, including all aspects that are relevant for the classification of the probability of default. This also includes the assessment of the actions of politicians.