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Recently, Moody's Investors Service – the credit rating arm of Moody's Corp. (MCO - Analyst Report) – downgraded the subordinated debt (subdebt) and junior subordinated debt of 11 Indian banks. Among these, 3 are private sector banks –  Axis Bank Limited, HDFC Bank Ltd. (HDB - Analyst Report), ICICI Bank Ltd. (IBN - Analyst Report). The remaining 8 are public sector banks – Bank of Baroda, Bank of India, Canara Bank, IDBI Bank Ltd, Indian Overseas Bank, State Bank of India, Syndicate Bank, and Union Bank of India.

Following the review, which started in Jun 2013, Moody’s downgraded the public sector banks’ subdebt and junior subdebt ratings by removing one or two notches of the two to three notches systemic support uplift that was earlier incorporated. Moreover, the rating agency lowered the private banks’ subdebt and junior subdebt ratings by removing the support uplift of one notch that was previously announced.  

The downgrade of these banks reflects the lower possibility of systemic support for the junior securities of the banks. However, this does not imply any change in the intrinsic credit quality or the expected support for issuer or senior debt ratings.

The downgrade of these banks by Moody’s indicates the current worldwide scenario wherein the banks, on becoming bankrupt, have to fulfill a pre-condition imposed on them in order to receive bailout packages from the government. As per the said pre-condition, the investors of the subdebt securities would be one of the least preferred to receive any money from the distressed banks. This prompted Moody’s to downgrade the ratings of subdebt and junior subordinated debt.

As per Moody’s, the regulators of the banking sector in India do not have any legal power to impose losses incurred on selective subdebt investors other than through the liquidation process. Moreover, the public sector banks in India are more likely to receive financial support from the government upon bankruptcy. This prompted an upgrade of one notch subdebt rating.

However, Moody’s believe that the chances of financial support for the private sector banks, which were previously high, are at present low to moderate. Due to this, Moody’s did not upgrade the rating at its current baseline credit assessments.

The downgrade by Moody’s is anticipated to further aggravate the problems of the Indian banks as the country’s economy is already in a distressed condition. Moreover, it might increase the cost of funding for the banks, thereby leading to higher expenditures in the future.   

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