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.
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 |
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.