Fitch finds banks are more likely to fail than to default; and S&P outlines its approach to risk-adjusted capital analysis.

The new study from Fitch Ratings notes that banks are nearly 10 times more likely to fail than they are to default. Bank failure is twice as likely as corporate default risk, yet the overall bank default rate is lower than the corporate default rate because of the provision of external support.

“The findings, which are based on Fitch’s 25-year history of assigning individual ratings to financial institutions, clearly show that in times of stress, banks do receive support from third parties, usually governments, reflecting their unique role in the economy and financial system,” ,said Ian Linnell, managing director of financial institutions, Europe, Middle East and Africa at Fitch. “Assessing potential support is clearly a critical rating issue. However, it is also a complex and subjective matter. Therefore we continue to view support as a potential floor, a point below which the issuer default ratings cannot fall for a given support rating.”

From 1990 to 2006, there were 117 bank failures, according to the study of 1768 banks in 101 countries. Of those, 12 went on to default on their financial obligations. Overall, 5.9% of banks failed within five years, with 0.7% defaulting compared with 3% of corporates defaulting.

Fitch expects failure rates to decline as banking systems in many countries move beyond the restructuring of the 1990s and early 2000s. By contrast, default rates may increase as more regulators look to market solutions to address bank failure.

STANDARD & POOR’S

APPROACH TO BUILDING A RISK-ADJUSTED CAPITAL FRAMEWORK

S&P plans to publish its own capital adequacy measures for global banks from Q1 2008. These will go beyond the Basel II rules and are being introduced to provide investors with capital ratios that are globally comparable, and more rigorous and transparent.

S&P’s effort to construct a global risk-adjusted capital framework will employ a three-level approach to risk-adjusted capital analysis:

  • a base case approach (BCA), which produces globally consistent capital charges by risk class and geographic region, based primarily on public disclosures;
  • a specific case assessment (SCA), which produces globally consistent capital charges by risk class and geographic region using institution-specific data. The SCA approach includes one-to-one discussions with institutions;
  • an economic capital assessment (ECA), which will assess the appropriateness and robustness of an institution’s internal models.

In the more than 100 countries planning to implement Basel II, a BCA will produce a measure of adjusted regulatory risk-weighted assets that will leverage on Pillar 3 disclosure. S&P will apply floors to the regulatory capital charges and will measure market risk in the trading book through a value-at-risk (VaR) based approach. It will also measure Pillar 2-type risks and apply overall adjustments and additional charges to capture other important banking risks. S&P believes that it would be misleading to rely directly on Basel II ratios.

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