Moody's Warns on Banks' Rating Volatility

Moody’s has released a report on Canadian banks’ risk exposure due to investment banking activities:

While the Canadian banking system outperformed most developed country banking systems during the 2007–2009 credit crisis, the Canadian banks’ expansion of their capital markets platforms, particularly outside Canada, is not without risk, Moody’s Investors Service says in its new report.

The banks’ performance, coupled with the oligopolistic structure of the Canadian system, has allowed them to maintain very high ratings. Nevertheless, the mature domestic market raises a strategic challenge with regards to growth, and the void left by the retrenchment of many global investment banks represents one avenue for growth and revenue diversification. Therefore, several Canadian banks are now expanding their wholesale investment banking (WIB) activities.

Golly, not a word about the beneficial, if not to say brilliant and incisive, supervision by OSFI! I guess they forgot that bit.

Moody’s has previously cited the risks associated with WIB business and noted that even the most well-managed WIBs can suffer from unusual earnings volatility, and when serious risk-management failures occur, significant ratings transitions are possible.

The report is titled, “Capital Markets Activities of Canadian Banks: A Growing Risk”

A few tid-bits are disclosed in a Globe story on the report, Banks take $21.5-billion hit on risk:

Ratings agency Moody’s Investor Services has tallied up the hit Canadian banks took through their capital markets divisions from the start of 2007 to the end of 2009, and the toll has reached nearly $21.5-billion.

That is the amount Moody’s figures the banks would have recorded as profit if not for the writeoffs they took due to their exposure to the markets.

Canadian Imperial Bank of Commerce topped the list with a $10.5-billion hit during those three years, largely because of bets on U.S. structured debt products that went sour, followed by Royal Bank of Canada at $4.3-billion. Bank of Montreal ($2.9-billion), Bank of Nova Scotia ($2.2-billion) and National Bank of Canada ($1.1-billion) came next. Toronto Dominion Bank took the smallest hit at $727-million, the report says.

Moody’s has raised flags about this exposure in the past, notably when downgrading BMO prefs an extra notch last spring.

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