Key Takeaways
- Bank credit ratings are estimates of how likely a bank is to default or go out of business.
- These grades are given by three third-party agencies: Moody’s Investors Services, Fitch Ratings, and S&P Global Ratings.
- You’re likely not at risk even if your bank has a lower credit rating, as long as your accounts are FDIC insured.
- Consumers should avoid banks with “junk” ratings.
Definition and Example of a Bank Credit Rating
As a consumer, your personal credit rating can affect the interest rate you get on loans, whether you can qualify to take out a mortgage to purchase a home, and even whether you get a particular job. Banks have their own credit ratings based on an estimate of how likely they are to default on their debts and go out of business.
Bank credit ratings provide:
- A common vocabulary for consumers, investors, government agencies, and financial institutions to use
- Third-party insight into the reliability and risk level of financial institutions
Agencies such as Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s issue credit ratings for banks along with other financial institutions and investments. These ratings are normally given as letter grades, with an AA or AAA rating being better than a BB or BBB rating.
Note
A non-investment grade rating, also known as a “junk” rating, goes to banks that are in trouble.
You might be considering doing business with a bank with an AAA or AA rating. This does not guarantee that it will not default. It just means that these agencies don’t consider a default to be likely.
How a Bank Credit Rating Works
Three global credit rating companies (Moody’s, Fitch Ratings, and S&P Global Ratings) rate banks and other financial institutions according to their quality, reliability, and risk of default on obligations. The scales that each uses are slightly different, but they’re generally equivalent.
| Ratings by Agency | |||
|---|---|---|---|
| Moody’s | Fitch | S&P | Meaning |
| Aaa | AAA | AAA | Highest quality, lowest risk |
| Aa | AA | AA | High quality, low risk |
| TO | TO | TO | Upper-medium quality, low risk |
| Baa | BBB | BBB | Medium quality, moderate risk |
| Ba | BB | BB | Speculative quality, substantial risk |
| B | B | B | Speculative quality, high risk |
| Caa | CCC | CCC | Poor quality, very high risk |
| AC | DC | DC | In or near default, possibility of recovery |
| C | C | In default, low chance of recovery, may still be paying obligations | |
| C | D | D | Has defaulted on obligations, will likely continue to do so |
Fitch Ratings also includes an “RD” designation, meaning restricted default, between C and D. This indicates that the institution has defaulted on some financial obligations but has not entered bankruptcy or ceased operating.
These ratings may be given modifiers to show higher degrees of nuance. Moody’s ratings may add a 1, 2, or 3 to the letter rating. Standard & Poor’s may add a plus or minus sign. An AA+ is equal to an Aa1. It’s at the top end of the AA or Aa category. An AA- is equal to an Aa3 and is at the lower end of the AA or Aa category.
Note
Credit ratings aren’t given just once. They are re-evaluated and reassigned, sometimes at very different levels, depending on the current financial situation and the level of risk for the financial institution.
Bank credit ratings do not indicate the likelihood of bank fraud. Your bank could still be vulnerable to a security breach, even if it has a strong credit rating. It would depend on the security measures it has in place for accounts and customer information.
Implications and Effects of Bank Credit Ratings
Bank credit ratings are just one tool that consumers and investors can use to judge financial institutions, but they are not absolute measures of a financial institution’s reliability. They can impact customers differently, depending on what type of business they do with the bank. People who hold large, open-ended loans could be affected if a bank’s creditworthiness goes into “junk” territory or even slumps for a while. These include business lines of credit and home equity loans.
A bank has to improve its liquidity by preserving capital when it’s in trouble. You may therefore have to pull in your credit lines, so you could lose borrowing power. Sometimes, troubled banks will also begin to close branches and lay off employees. Such moves wouldn’t affect the safety of your deposits, but they could strain your relationship with your bank if it were to close your local branch.
Note
Banks with high-level ratings are trusted more by government agencies, local businesses, and international corporations, in addition to customers.
Unpredictable economic changes or poor business practices can cause even a highly-rated bank to go into default. A lower rating does not guarantee that a bank will experience financial distress. The one bank rating that consumers should always pay attention to is a “junk” grade, which usually means that a bank is in a great deal of distress. You’d likely be safer working with another financial institution.
You probably don’t have to worry about your credit rating if your bank is insured by the Federal Deposit Insurance Corporation (FDIC). The FDIC insures every bank deposit account up to $250,000 per depositor, per account. Similar insurance is in place for credit unions: The NCUSIF or National Credit Union Share Insurance Fund. You can protect yourself by splitting your money among different banks to stay under the $250,000 threshold if you have more than $250,000 on deposit,
You’ll be protected if your bank goes under, as long as your money is FDIC insured. Most consumers have accounts that are 100% guaranteed by FDIC insurance. They don’t have to worry about bank credit ratings much, if at all.
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