The study 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. Fitch is the only major rating agency with a dedicated rating scale (Support Ratings) to assess the probability that such support will be provided.
“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 IDR cannot fall for a given Support Rating. Indeed, to further increase transparency, we have recently begun assigning specific Support Rating Floors to the IDRs of financial institutions.”
From 1990 to 2006, there were 117 bank failures, according to the study of 1,768 banks in 101 countries. Of these, 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. These themes are further explored in two forthcoming research reports, which will look at support in practice in emerging markets and developed countries.