Emerging Banks Methodology

July 1999 Rating Methodology
Bank Credit Risk In Emerging Markets

Contact Phone
London
Andrew Cunningham 44.171.772.5454
Samuel Theodore
Limassol
Elisabeth Jackson-Moore 357.5.586586
New York
Nicholas Krasno 1.212.553.1653
Jerome Fons
Christopher Mahoney
São Paulo
Christiana Aguiar 55.11.3043.7186
RATING METHODOLOGY
(An analytical framework)
1. Introduction
In April 1999, we published a Rating Methodology study entitled “Bank Credit Risk: An
Rating Methodology
Analytical Framework for Banks in Developed Markets”. That study outlines the conceptual basis of
our approach to bank analysis worldwide. The purpose of this study is to highlight issues which
are of particular importance when analysing the credit quality of banks in emerging markets
around the world.
continued on page 3
Author Editor Production Associates
Andrew Cunningham Giles O’Flynn Alba Ruiz, Susan Heckman
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2 Moody’s Rating Methodology

Table of Contents
1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cover
Common Factors When Analysing Banks In Developed And Emerging Markets . . . . . . . . . . . . . . . . . . . . . . . . . . .5
2. A Word On Semantics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5
3. Emerging Market Bank Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

3.1 Emerging Market Bank Universe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5
3.2 The Evolving Role Of Emerging Market Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6
3.3 Bank Credit Risk Is In Transition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7
3.4 Syntax And Semantics Of Moody’s Bank Ratings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7
3.5 General Vs Specific Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9
4. The Relationship Between Bank Ratings And Country Ratings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

4.1 The Role Of Bond/Deposit Ceilings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9
4.2 The Relationship Between Country Ceilings And Government Bond Ratings . . . . . . . . . . . . . . . . . . . . . . . . .9
4.3 Why Offshore Banks Can Be Rated Higher Than The Domestic Country Ceiling . . . . . . . . . . . . . . . . . . . . . 11
4.4 Local Currency Ratings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

4.5 The Significance Of Third Party Support . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
5. Key Differences Of Emphasis When Rating Emerging Market Banks

As Opposed To Those In Developed Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
5.1 Financial Statistics And Ratios Are Less Valuable As A Way Of Measuring Bank
Strength And Of Comparing Banks With Each Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
5.2 The Economy And Environment In Which The Banks Operate Is A Much More
Important Driver Of Financial Strength . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
5.3 The Strength Of Capital And Provisions Is A More Important Element In The Analysis
Of Emerging Market Banks Than Is The Case With Banks In Developed Markets . . . . . . . . . . . . . . . . . . . . 13
5.4 In Emerging Markets, It Is More Frequently The Case That Bond And Deposit Ratings
Are Either Enhanced By The Likelihood That A Bank Could Be Supported In A Crisis,
Or Constrained By The Limitations Of A Country Ceiling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
6. Rating Methodology For Emerging Market Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

6.1 Moody’s Rating Methodology Is Not Based On A “Checklist” Or “Scoring” . . . . . . . . . . . . . . . . . . . . . . . . . 14
7. The Banks’ Operating Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
7.1 Health And Structure Of The Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
7.2 Trends In Capital Markets, Disintermediation And Structure Of The Banking System . . . . . . . . . . . . . . . . . . . . . . 16
7.3 The Effectiveness Of Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
7.4 Assessing The Importance Of External Policy Influences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
7.5 Transparency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
7.6 The Legal System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
8. Ownership And Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
8.1 Public Ownership And Privatisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
8.2 Private Ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
8.3 Why Governance Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
(Continued)
Moody’s Rating Methodology 3

Table of Contents
9. Franchise Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
9.1 Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
9.2 Market Position And Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
9.3 Market Share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
10. Earning Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

10.1 The Uses And Abuses Of Ratios To Measure Earning Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
10.2 The Importance Of Non-Interest Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
10.3 New Lines Of Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
10.4 Line Of Business Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
11. Risk Profile And Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

11.1 The Management Of Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
11.2 Credit Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
11.3 Market Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
11.4 Liquidity Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
11.5 Asset/Liability Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
11.6 Operational And Other Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
11.7 Year 2000 (Y2K) Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
12. Economic Capital Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
12.1 Why Does Capital Matter? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
12.2 Capital Ratios Are A Management Issue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
12.3 Does Regulatory Capital Matter? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
12.4 Using Economic Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
12.5 Economic Capital Generation Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
13. Management Strategies And Management Quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

13.1 Assessing Management Quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
13.2 Agreements With Foreign Investors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
13.3 Strategies: Proactive, Or “Management By Inertia”? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
13.4 Mergers And Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Common Factors When Analysing Banks In Developed And Emerging Markets
Moody’s believes that the techniques of bank credit analysis are transferable across different geographic
regions and across banking systems which are at different stages of development. Our approach to
analysing a bank in, say, Asia, is essentially the same as our approach to analysing a bank in the United
States. For example, both such banks require strong business franchises in order to generate profits over
the long term. Both will need competent management teams in order to do this. In both cases, our analy-
sis will assess the banks’ vulnerability to a deterioration in economic conditions and the effects of changes
in the regulatory environment. And in both cases, we will consider the banks’ financial condition, both in
absolute terms and in relation to their peer groups.
But the relative importance which these, and other factors, play in our analysis may differ between a
developed and an emerging market. This is the case throughout the world. Factors of analysis differ even
between developed banking systems. For example, during the 1980s, the effects of privatisation and dereg-
ulation were an important consideration in our analysis of banks in some Western European countries.
They were not factors which greatly influenced the credit quality of US banks at that time. So when we
analyse emerging market banks we are not engaged in a fundamentally different exercise from when we
are analysing developed banks. We are always asking the same basic question – what is the credit quality of
this bank?
However it is true that analysts working on emerging market banks have to give greater emphasis to
some issues and less to others than is the case with banks in developed markets. Analytic tools which may
elucidate credit quality in developed markets may be less relevant in emerging markets, and vice versa. The
purpose of this special comment is to highlight and explain those differences of emphasis.
2. A Word On Semantics
Moody’s does not have a definition of what constitutes an “emerging market” or an “emerging market
bank”. We think it is unlikely that anyone could arrive at a consistently defensible definition. Emerging
banks fill various points on a continuum which runs from the strongest and most sophisticated banks
operating in the strongest and most developed economies, to the weakest and most simple banks in the
weakest and least developed economies. A single bank may display “developed market” characteristics in
some areas of its operations while being unsophisticated in others. More importantly, we just don’t think
the quality of our analysis would be enhanced by spending time trying to devise a definition. You will
therefore see references in Moody’s reports to emerging markets, developing economies, transitional
economies and so on. We do however, recognise that definitions do sometimes have to be employed sim-
ply in order to ensure a consistent processing of data. So for example the tables in Section 3 employ defin-
itions of emerging market economies employed by the IMF.
3. Emerging Market Bank Overview

3.1 Emerging Market Bank Universe
Moody’s has ratings on nearly 1,000 banks worldwide, and about 40% of these are now in countries gen-
erally considered “emerging”. Moody’s coverage of emerging market banks has increased considerably
during the last few years, as is evident from the table below.
Geographic Breakdown of Assigned Bank Financial Strength Ratings

September April April 1999
1995 1999 Europe and FSU
(6%)
Emerging markets 33 349 Latin America
(10%)
Industrialised countries
USA
excluding USA 219 315 (27%) Asia
(13%)
USA 288 248
Industrialised excl. USA
Total 540 912 (35%)
Mid East/Africa
(10%)

Ratings of banks comprise the vast majority of our rating activity in emerging markets. This is because
banks dominate financial intermediation in a way that is no longer the case in many of the more mature
economies. As financial markets develop, we expect that analysis of, for example, emerging market mort-
gage banks, finance companies, corporate bonds and structured instruments will increase.
Our report on Bank Credit Risk (An Analytical Framework for Banks in Developed Markets) identifies
four large categories of banking institutions: (i)universal (federated) banks, (ii) large retail banks (iii) spe-
cialised institutions and (iv) regional & local banks. Such distinctions are less applicable in emerging mar-
kets. The distinctions which can be drawn tend to be between:
• State-owned banks with specific mandates: eg development banks , agricultural banks; savings banks
(Sperbank in Russia, Ceska Sporitelna in the Czech Republic, Caixa Economica Federal in Brazil); and
banks with other specific areas of responsibility (Bank Bumiputra Malaysia).
These banks are often heavily dependent on government business which may or may not be prof-
itable. They frequently suffer from very poor asset quality but benefit from regulatory forbearance or
other forms of assistance. They typically have low financial strength ratings, but their deposit ratings are
often close to the country ceiling due to the strong likelihood that they would be supported by the state
during a crisis.
• State-owned banks with no specific mandate or whose original mandate has been subsumed in general
banking business: for example, the four state-owned banks in Egypt or Banco Do Brazil or Krung
Thai Bank. Their legal status is often that of a “state-owned enterprise”. These banks often have a
stronger business franchise than those with specific mandates but are often saddled with large amounts
of non-performing government loans. Often they are legally “state enterprises” and have to contend
with bureaucratic controls and interference from politicians.
• Private sector banks. The status of private sector banks varies greatly in emerging markets. In Latin
America they have been key players for many years. In some Middle East countries they have been
niche players but are now becoming more important as the role of the state sector diminishes. In some
Eastern European countries, private sector banks are a relatively new phenomenon. In Asia, private
banks have long been an important element in many countries financial systems.
Ownership structures vary greatly and are often a key distinguishing feature of private sector banks.
For example, some are owned by one or two business groups and are managed as “house banks” for
group interests – several Russian banks are like this. Some are closely held family concerns. But private
banks also exist whose shares are publicly quoted and are managed on a wholly commercial basis.
Private sector banks are usually unburdened by severe asset quality problems from the past and
have a better earnings profile, since they target only business which offers reasonable returns (unlike
state-owned banks which may be obliged to undertake unprofitable business). They tend to have high-
er financial strength ratings than state-owned banks, but their deposit ratings may be compromised by
a lower predictability of support from state authorities in a crisis.
At the risk of oversimplification, one can say that the key distinction between different types of banks
in emerging markets tends to be between state owned banks and private sector banks. But an important
feature of emerging markets is that privatisation and deregulation is leading to rapid changes in the own-
ership structure of the banking system. Not only do public sector banks pass into the private sector, but
the role which private sector banks play in the economy may change dramatically – from being niche play-
ers in a system dominated by publicly owned banks to being leading players. It is important for bank ana-
lysts to look forward and ask what the banking system will look like in future, and which type of banks will
prosper in such an environment.
3.2 The Evolving Role Of Emerging Market Banks

The banking system often has a dominant position within emerging financial markets. It is not just a ques-
tion of the banks controlling financial intermediation between savers and borrowers. They also sometimes
dominate all other areas of financial activity in their home markets, such as share brokerage, fund manage-
ment, leasing companies and perhaps insurance. This dominance, when it occurs, reflects a lack of devel-
opment in the local economy – all countries need banks, but many have only recently become convinced

of the utility of stock exchanges, or have liberalised their markets sufficiently to allow the creation of non-
bank financial institutions such as consumer credit agencies. As liberalisation and deregulation permit the
creation of new financial institutions and products, banks are in the vanguard because few other domestic
institutions have both the capital and the familiarity with financial markets required to enter such sectors.
However, over time we would expect to see new market participants challenging the banks’ position on
the margin through the creation, for example, of independent brokers, consumer finance companies or
leasing companies.
As financial markets mature, it becomes easier for banks to be assigned higher

financial strength ratings
These trends have contradictory implications for the ratings assigned to banks. As financial markets
develop, opportunities increase for banks to diversify and enhance their earnings through new services and
products. On the other hand, over the medium term, their earning power will be challenged by competi-
tion from new players. The net effect of these two trends has to be considered on a case by case basis, but
in general terms we believe that banks are more likely to prosper in a well-developed and predictable
financial market which enables diversification of risk and of earning streams, rather than in a narrow and
immature market albeit one dominated by banks. As financial markets mature, it becomes easier for banks
to be assigned higher financial strength ratings.1
3.3 Bank Credit Risk Is In Transition

Many emerging market banks have a poor conception of bank credit risk. When this is the case, it is usual-
ly because the banking system used to be controlled by the state which specified which sectors banks were
to lend to and the rate of interest to be charged. There was often little requirement to recognise that some
borrowers – often publicly owned companies – were not actually repaying their debts, nor any require-
ments to make provisions or preserve capital ratios. Banking was part of an internal system in which credit
circulated around various economic sectors. The accounting system, and ultimately the government’s
printing presses, could be used to bridge the gap between economic policy and financial reality. Between
accruals and cash. The Chinese banking system remains an example of this type of dirigiste banking.
Few central banks still allow this type of Panglossian accounting. Yet the credit culture (more precisely,
lack of credit culture) which it engendered often survives long after the accounting norms and prudential
regulations have been changed. This is a very important factor for us when rating banks in these countries.
We try to understand whether a bank has developed a credit culture based on analysing a client’s ability to
repay loans in cash and on time, as opposed to, say, the bank relying on imputed state-guarantees, the value
of collateral (which may not be realisable in an underdeveloped legal system) or a long-standing personal
relationship between a branch manager and the general manager of the borrowing company. We believe
that bureaucratic credit controls – credit committees, authorisation limits and a refusal to allow any one
manager to approve a loan – are a necessary but insufficient safeguard against poor lending practices. Over
time, a lack of a credit culture will undermine procedural safeguards such as credit committees. (The
importance of management in determining bank credit quality is considered more fully below.)
3.4 Syntax And Semantics Of Moody’s Bank Ratings

Moody’s assigns the same types of credit ratings in emerging markets as it does everywhere else in the
world. The most common ratings are the debt and deposit ratings and bank Financial Strength Ratings
(FSRs). The debt and deposit ratings range from Aaa to C for long term debt and deposits and Prime-1 to
Not Prime for short term. FSRs range from A to E.2
1 The development of financial markets brings risks as well as opportunities. Just as in developed markets, non-banking financial services (especially
securities trading and other investment banking businesses) contain substantially higher risks of losses and of earnings volatility, and this will be reflected in
our analysis of a bank that is engaged in these activities, be it in New York or Kuala Lumpur.
2 “Debt” refers to bonds or notes, including MTN programmes.

Moody’s Rating Symbols*
Long term debt/deposits Short term debt/deposits Financial Strength Ratings
Aaa Prime-1 A
Aa 1,2,3 Prime-2 B
A 1,2,3 Prime-3 C
Baa 1,2,3 Not Prime D
Ba 1,2,3 E
B 1,2,3
Caa 1,2,3
Ca
C
*Notes:
Long term ratings
Rating levels other than Aaa, Ca and C employ modifiers. So Aa1 is higher than Aa2 which is higher than Aa3.
Ratings of Baa3 and above are investment grade.
Short term ratings
Short term ratings refer to instruments with a maturity of one year or less. All ratings other than Not-Prime are investment grade.
Financial Strength Ratings
“A” is the strongest, “E” is the weakest. A “+” modifier may be attached to grades below the “A” level. The terms “investment grade” and
“sub-investment grade” do not apply to FSRs – there is no such thing as an “investment grade financial strength rating”.
The debt and deposit ratings measure, a) the probability that the bank will default on its debt obliga-
tions over their life and b) the expected monetary loss should such a default occur. In contrast, the FSRs,
which were introduced in 1994, measure the bank’s stand alone financial strength without reference to
either sovereign transfer risk or implicit or explicit support from third parties. The FSRs should be seen as
a sub-set of the debt and deposit ratings. They are not a substitute for them.
Moody’s ratings are globally comparable …the best bank in each market does not
receive an A rating for financial strength.
FSRs often receive more attention in the emerging market investor community than debt/deposit rat-
ings. This increased attention is usually the result of most or all of the banks in a country being con-
strained by a country ceiling (so the intrinsically strong banks receive the same deposit ratings as intrinsi-
cally weak banks) or in a country where it is very likely that all banks would be supported in a crisis (so
intrinsically weak banks are pulled up to the country ceiling and receive ratings similar to those assigned
to strong banks). It should be remembered that FSRs can never substitute for debt/deposit ratings – they
measure two different things.
So for example, if an investor needs to compare the repayment ability of several banks and finds that
they have identical deposit ratings but different FSRs, the investor cannot use the FSRs to identify the
bank with the strongest repayment ability. If their deposit ratings are the same, that means that their
repayment ability is the same. But other investors – whose priority is not repayment ability – may wish to
make a distinction between the banks. To the extent that they wish to distinguish the banks by intrinsic
financial strength, FSRs will enable them to do so. Where country risk has to be accepted if a transaction
is to be completed the most acceptable counterparty may be the bank with the highest financial strength.
Moody’s ratings are globally comparable and one result is that banks in emerging markets tend to have
lower ratings than those in developed markets. The best bank in each market does not receive an A rating
for financial strength. It can be the case– and frequently is – that the best banks in a country may be rated
no higher than D or D+ for financial strength. It is particularly difficult for banks whose business is based
in an unstable economic and financial environment to be assigned financial strength ratings at the higher
end of the scale.
Debt/Deposit Ratings Bank Financial Strength Ratings

• Measure a bank’s repayment ability • Measure a bank’s stand alone strength
• Answer the question “Will this bank be able to • Answer the question, “Will this bank need to be
repay its debt obligations ?” or “If I put a dollar supported by a third party at some point in the future?”
with this bank, will I get it back”?
• Use a rating scale from Aaa to C • Use a ratings scale from A (highest) to E. A “+”
signifier may be added to ratings B,C,D,E.

3.5 General Vs Specific Risks
Banking risk can be broadly divided into general risks, which apply to all banks in the system and derive to
a large extent from a country’s economic strength, and specific risks, which are the product of the bank
itself. In developed markets, it is hard to imagine that difficulties experienced by a bank can be solely
attributable to general risks, even though such risks certainly do have an impact on the bank’s perfor-
mance -- in most cases bank failure is the result of mismanagement, risky strategies, rogue traders, etc. In
emerging markets, general risks loom larger. Not only can general risks be more severe but also it may be
difficult for any bank to avoid the consequences of a severe economic shock (such a massive currency
devaluation) or a deep economic recession.
Clearly, banks which are better managed and have stronger balance sheets are better placed to cope
with general risks, but if general risks present a significant threat to the banking system it may well be that
no bank can be assigned an FSR at the upper end of the scale. For example, in the case of Lebanon, no
bank is rated higher than D because general risks include that of a severe devaluation and that the post-
civil war reconstruction could stall. In those circumstances, even well managed banks with currently sound
financial ratios may face difficulties. In some Asian countries devastated by the region’s financial crisis –
Indonesia and Thailand for example – the objective insolvency of all banks in the system is recognised by
their financial strength ratings being E or E+.
4. The Relationship Between Bank Ratings And Country Ratings

No bank may be assigned a rating for foreign currency debt which is higher than the country ceilings for
the country in which it is based. In developed markets this is rarely a constraint, because country ceilings
are usually quite high – often in the Aa range. But in emerging markets, the picture is very different.
Country ceilings are lower and frequently do act as a constraint on the debt and deposit ratings assigned to
banks. As a result, country ceilings are a far more important determinant of bank ratings in emerging mar-
kets than in developed markets. (As explained above, Financial Strength Ratings are not influenced by coun-
try ceilings since they measure stand-alone strength irrespective of external constraints or external support.)
4.1 The Role Of Bond/Deposit Ceilings

Before assigning bank ratings in a country Moody’s assigns country ceilings which applies to all foreign
currency bonds and deposits of banks in that country. These ceiling are not the same thing as a govern-
ment bond rating, although in practice, the two are nearly always set at the same level or in the case of
deposits are at any rate closely linked. A government rating is a rating assigned to specific bonds issued by
the government of a country: for example, the Central Bank of Tunisia, the Federative Republic of Brazil.
It is therefore conceptually incorrect to say that “no bank may be rated higher than the government of
the country in which it is based”, even though in practice such a statement nearly always holds true. The
conceptually correct statement would be “no bank may be rated higher than the country ceiling of the
country in which it is based”, although it should be clear that this statement is tautological, since a country
ceiling is a construct, the definition of which is “the highest rating that could be assigned to any bank
bond or deposit in that country”. (Note that all these comments refer to foreign currency ratings. Local
currency ratings are considered below.)
4.2 The Relationship Between Country Ceilings And Government Bond Ratings
It is generally the case that the lowest-risk issuer of foreign currency in any country is the government of
that country. This is due not only to the large holdings of foreign currency which a government com-
mands (foreign reserves, revenues from the export of state-owned commodities such as oil) but also to its
ability to appropriate foreign exchange from other sectors of the economy in order to discharge its own
obligations. The simplest case involves a government imposing transfer restrictions whereby private sector
entities may not transfer abroad foreign currency and/or are required to deposit foreign currency with the
national authorities. The central bank’s regulatory powers, the government’s legislative authority (and,
ultimately, the government’s monopoly of coercive force) enables it to do this.
This is not a theoretical point. When governments experience difficulties in discharging their own for-
eign obligations they do in practice seek to alleviate their own difficulties by restricting the transfer and use
of foreign currency by the private sector. And those measures tend to be effective. So when the Brazilian

authorities faced difficulties in the late 1980s, they prevented Brazilian banks from discharging their for-
eign currency obligations. There were some Brazilian banks which were not only able to discharge their
obligations but were very keen to do so in order to preserve their reputations, but they were unable to as a
result of the restrictions imposed by the authorities.
There is one major exception to this line of argument, and it helps to illustrate the underlying argu-
ment being made:
• The foreign currency bond/deposit ceiling in all 11 Euro-zone countries is Aaa, even in those coun-
tries where government bonds are rated lower (e.g. Italian government bonds at Aa3). This is because
the national governments of the Euro-zone no longer have the power to impose transfer restrictions
on national banks – that power has been ceded to the European Central Bank and we consider that the
lowest credit risk in the Euro-zone is associated with the European Central Bank. As a result, an
Italian bank (or corporate) could be rated higher than the Aa3 assigned to the Italian government.
Note that the potential for banks to be rated higher than their government is based on legal and
institutional structures to which both are subject, and not on their relative creditworthiness. (Though
of course creditworthiness will determine whether a bank was actually rated higher.) In emerging mar-
kets we are sometimes presented with arguments that banks should be rated higher than their govern-
ments because the banks are financially stronger. For example Lebanese banks point to their resilience
during the country’s civil war, when most governmental functions broke down. But the Lebanese
argument does not address the key point that their government has the ability to impose restrictions
on foreign currency transfers and, judging from the example of other countries, would likely do so in a
crisis in order to preserve its own ability to discharge foreign currency debts.
While it is only in such specific and rare cases as the Euro-zone that country bond ceilings are not
assigned at the same level as the government bond rating, it is much more frequent to see country deposit
ceilings diverging from the country bond ceiling (and therefore also from the government bond rating). In
the sub-investment grade range there is typically a one notch difference between the country ceiling for
bonds and that for deposits, and in some cases that gap is wider. In Mexico the bond ceiling was Ba2 in
June 1999, and the deposit ceiling B1; in Korea Ba1 and Caa1; in Indonesia B3 and Ca. (Again, note that
all references refer to foreign currency.)
The crucial point to remember here is that a distinction is being made between two types of instru-
ment – bonds vs deposits – rather than between issuers (banks vs governments)3.
The reason for putting the deposit ceiling lower than that for bonds is that in practice governments
are more willing to impose transfer restrictions on deposits than they are on bonds. This is mainly because
the consequences for a government of a bond default within its jurisdiction are greater than that of a
default on deposits. Bonds tend to be subject to tighter documentation and domiciled in international cen-
tres, with the result that legal action in response to a default is easier to mount. Furthermore, bonds are
often bearer instruments, making it difficult to identify creditors and communicate with them. In contrast,
deposits tend to be domestically registered. (For a full explanation of this point see our Special Comment,
Sovereign Risk: Bank Deposits vs. Bonds, October 1995.)
The reason why a rating distinction is made between bonds and deposits in the sub-investment grade
range and not in the investment grade range is that the greater riskiness of deposits derives from the con-
sequences of sovereign action (that the government would restrict the transfer of foreign exchange). In the
investment grade range the likelihood is remote that government would experience difficulties so serious
that it would have to impose such restrictions. In the sub-investment grade range, a government event
becomes a much greater factor in the analysis, so predictions of how a government would act (i.e. that it
would make a distinction between bonds and deposits) becomes more important.
Sometimes, deposit ceilings may be set more than one notch below the bond ceiling. This would typi-
cally occur if the banking system is particularly weak compared to other economic actors in the country.
A decision to open up a gap of more than one notch is driven by the particular circumstances of that coun-
try’s banking system rather than by a general observation of how bonds/deposits are treated as a class (as is
the rationale for the practice of always having a one notch gap in the sub-investment grade range).
(For more information on Moody’s Sovereign Ratings see our Special Comment, Moody’s Sovereign
Ratings, A Ratings Guide, March 1999.)
3 It’s hard to conceive of a distinction between issuers of deposits (bank deposits vs government deposits) since governments do not issue deposits.

4.3 Why Offshore Banks Can Be Rated Higher Than The Domestic Country Ceiling
Offshore banks may be subject to a different – higher — ceiling than that assigned to domestic banks.
Although regulatory and legal authorities usually have the power to impede offshore banks registered in
their market from discharging their foreign currency obligations, there are compelling reasons in practice
that make it highly unlikely that the authorities would ever seek to do so, even during an economic crisis.
The first reason is that if the authorities were to interfere with the free flow of offshore funds, confi-
dence in the offshore banking market would disappear and offshore operations would re-locate elsewhere.
The second reason is that the authorities’ willingness to try to interfere would be conditioned by their
ability to enforce any measures which they took. Offshore banks do not usually have a large amount of
domestic assets which could be appropriated nor do they usually conduct a large amount of business in the
host country which could be jeopardised if they incurred the wrath of the local regulators. In sum, host
authorities often have little incentive and only a limited capacity to interfere with cross boarder payments
of offshore banks even at times of crisis. As a result, Moody’s has in several cases set the ceiling for foreign
currency debt/deposits of offshore banks higher than that assigned to the foreign currency debt/deposits
of the on-shore banks. (For more explanation of this point, see Moody’s Special Comment, Offshore
Banking Centres and Country Risk, December 1997.)
Our analysis recognises that there are different types of offshore banks – for example the offshore mar-
ket in Bahrain comprises banks which are incorporated in Bahrain and have the seat of their operations
there, and banks which are subsidiaries of international banks incorporated and headquartered elsewhere
(eg, the Bahrain offshore bank of ABN-Amro). In the case of subsidiaries, the credit quality of the offshore
bank may be influenced by that of its parent. So for example, the Cayman Island subsidiary of a Brazilian
bank would be constrained by the Brazilian debt/deposit ceiling even though offshore banks in the
Cayman Islands may be rated as high as Aa3 or Aaa (depending on type of license).
4.4 Local Currency Ratings

Moody’s sometimes issues ratings on local currency debt instruments and a key point about these is that
the debt and deposits of banks can be rated higher than that of their home government. (As can the debt
of any other private sector issuers.) Although there have been numerous cases during the last 50 years of
governments imposing restrictions on foreign currency transfers, it is extremely rare to see such restric-
tions imposed on local currency transfers. The reason is partly that it is far more difficult for a govern-
ment to restrict the transfer of local currency than it is to restrict the transfer of foreign currency. The
analysis which underpins a local currency rating is more focused on the economic and legal environment
of the country, whereas a foreign currency rating is more focused on the government’s financial ability to
discharge its debts. (The difference is one of emphasis, both ratings consider all these issues.) Thus the
local currency rating looks at the risk of regime change or civil war, which could lead to a repudiation of
debts; the predictability of the legal system; the depth and liquidity of the payment system; and the danger
of hyper-inflation (governments might impose payment controls in an attempt to forestall a descent into
hyper-inflation).4
Rather than issuing “ceilings” as we do with foreign currency ratings, Moody’s has internal local cur-
rency “guidelines” which indicate the level which might be assigned to the financially strongest institu-
tions in the country. The strongest issuer of local currency might not be the government.5 Most local cur-
rency ratings are significantly higher than equivalent foreign currency ratings.
4 There can be exceptions to this rating rationale: the main reason for the low local currency rating of Brazil is its possible inability to discharge its local
currency debts.
5 The argument that the government could always avoid a local currency default by printing more money is valid in theory but not in practice. In practice,
governments do not generally print more money to avoid a payment crisis. One reason is that if they did so, hyper-inflation might result, destroying the
whole economic fabric of their society. Governments often conclude that hyper-inflation is too high a price to pay.

4.5 The Significance Of Third Party Support
A bank’s repayment ability is not only determined by its intrinsic financial strength. A weak bank may
have a strong repayment ability if it is sure to be supported in a crisis by a strong third party (such as the
government, its shareholders, or market peers). Judging the predictability of such support is a particularly
important issue in emerging markets where many banks do indeed have weak intrinsic financial strength.
A weak bank may have a strong repayment ability if it is sure to be supported in a

crisis by a strong third party
The predictability of support is frequently predicated on a view that a certain bank is “too big to fail”.
Yet that idea encompasses a huge range of issues, and even the phrase itself is misconceived – the correct
terminology is “too big to be allowed to fail”. Governments almost always have the resources to save a bank,
so if a bank fails it is because the authorities have allowed it to do so. A full deconstruction of these issues
was published as a Moody’s Special Comment “Analysing the Predictability of Official Support for Troubled
Banks”, May 1997.6 On this occasion the following points should be highlighted:
• It is rare for creditors to lose money as a result of a bank failure. Throughout the world, financial
authorities strive to avoid the repercussions which would affect their whole economy if one of their
banks failed. We do not see this situation changing significantly any time soon, although regulators are
also conscious of the risks of moral hazard which arise from a strong predictability of support.
• Despite this, we do think it is important to understand exactly why a specific bank or group of banks
would likely be supported in a crisis. We are very unimpressed by bland statements such as “the gov-
ernment would never allow a bank in this market to fail”. The statement might be true, but we need to
understand why. For example, it might be based on the fact that the country has been led by weak gov-
ernments which cannot take unpopular action, such as allowing any constituency of voters to lose their
savings. If a strong government emerges, the possibility of allowing this to happen might increase.
• Timeliness of support is an important issue. Under Moody’s definition, a bank which misses a pay-
ment is in default even if all money due, and interest on missed interest, is eventually paid. As a result,
one of the questions we consider is whether the government has a pre-arranged mechanism in place
with which to support banks during a crisis, and whether the government has determined in advance
the criteria which it would use to extend such support (eg, automatic support for the biggest five
banks, but case-by-case decision for all the rest).
• A strong predictability of support does not necessarily enable a bank to be rated at the country ceiling.
Consider the hypothetical example of two banks, both equally likely to be supported in a crisis but one
of which is intrinsically weak and the other intrinsically strong. The fact that the weaker bank is more
likely to require support gives its repayment ability an element of uncertainty which does not exist for
the strong bank. The onset of a crisis might not be identified in time to get support in place; logistical
problems might arise (eg, managers and regulators not in situ to deal with the problem); allowing a
bank to fail could be required as part of a economic support package being offered by external donors,
and so on. Ceteris paribus, this increased uncertainty would be expressed by giving the intrinsically
weaker bank a lower debt/deposit rating than the intrinsically stronger one.
5. Key Differences Of Emphasis When Rating Emerging Market Banks

As Opposed To Those In Developed Markets
5.1 Financial Statistics And Ratios Are Less Valuable As A Way Of Measuring Bank Strength
And Of Comparing Banks With Each Other
There are two reasons for this. First, disclosure is often less comprehensive and auditing standards less strict
than in more developed markets. Quite simply, the figures may not give an adequate picture of what is hap-
pening at the bank, and they may even be misleading. For example, our June 1998 Banking System Outlook –
China noted that “The financial performance of Chinese banks remains impossible for anyone to measure
6 Bear in mind that the concept of “failure” encompasses several scenarios. The closure of a bank may not lead to depositors losing money. Regulators could
take control of a “failed” bank, which could then continue to conduct day-to-day business as before.

accurately...published data may perhaps be best understood as an official means of carrying the official view
that Chinese banks are financially strong and getting stronger in an orderly and controlled manner.”
Second, numbers and ratios may be subject to enormous and rapid change in emerging markets, so
even figures which give a clear representation of a bank’s current position may have little value as predic-
tors of future positions.
As a general principle, we believe that in emerging markets, published figures are

more likely to be a lagging indicator of a bank’s problems rather than a leading one.
As a general principle, we believe that in emerging markets, published figures are more likely to be a
lagging indicator of a bank’s problems rather than a leading one. In emerging markets we cannot rely on
published numbers to signal a developing problem. By the time it is signalled in the figures, the bank may
already be on the point of insolvency.
5.2 The Economy And Environment In Which The Banks Operate Is A Much More Important
Driver Of Financial Strength
This is because the political and economic environment in emerging markets tends to be less stable than
in more developed markets, and because the scale of any change may be far greater. This is true at many
levels. For example:
• A change of government may have a great impact on the structure of the banking system (for example,
if an administration committed to privatisation replaces one which is not) and on the fortunes of indi-
vidual banks (for example, in Turkey the chairmen of state banks are political appointees — a problem
when governments change frequently).
• Banks may be affected by drastic measures taken by the government as part of its wider economic
agenda. For example in April 1998, we noted that in Brazil, a “hike in interest rates to levels of 43%
per annum in October 1997 from an already high 22%, coupled with a fiscal package aiming to save
nearly R$20billion to the Federal Government are causing an economic slowdown and a contraction
in credit demand.” It is unlikely that any developed market bank would have to cope with such huge
changes in the monetary environment.
• Banking systems in transition are by definition more subject to change than those which are mature.
For credit analysts the main implication of this is that the competitive environment may change, exist-
ing banks merge, new banks are created, the role and ownership of banks changed, and non-bank
financial institutions emerge to undermine historic business franchises. Competition will also come
from foreign banks (with more sophisticated systems and far larger resources), depending on the
degree of openness of the market allowed by the government.
We would also point out that in markets where statistics may not be a useful guide to a bank’s financial
strength it is particularly important to understand the general forces which are shaping the banking mar-
ket. Understanding the broader trends helps the analyst to interpret the figures presented by an individual
institution. For example, the huge swings in Turkish banks’ returns on assets are hard to understand
unless one appreciates the country’s hyper-inflationary environment.
5.3 The Strength Of Capital And Provisions Is A More Important Element In The Analysis Of
Emerging Market Banks Than Is The Case With Banks In Developed Markets
In developed markets, a decline in credit quality usually occurs gradually as part of the business cycle giv-
ing banks time to increase provisioning levels over a period of time. In emerging markets credit quality
may deteriorate suddenly.
We believe that a strong earnings base is the best way to safeguard financial strength. Strong earnings
enable a bank to consistently charge off a reasonable quantity of problematic loans without reducing its
equity, or to build capital and reserves against future contingencies. (Banks’ relative strength in this regard
can be compared through their ratios of pre-provision profit to net loans.) In emerging markets there is a
greater possibility that banks’ earnings could be overwhelmed by a dramatic reversal in the economy. In
such circumstances the bank may not be able to spread provisions over time but be forced to cover them

immediately from provisions and capital. As a result, the size of equity assumes greater importance. A key
ratio of solvency in emerging markets is equity as a percentage of net loans. This ratio is an indication of
the proportion of a bank’s loans which it could charge off while still retaining positive net worth. (See sec-
tions 11.2 and 12 below on credit risk and capital.)
5.4 In Emerging Markets, It Is More Frequently The Case That Bond And Deposit Ratings Are
Either Enhanced By The Likelihood That A Bank Could Be Supported In A Crisis, Or Constrained
By The Limitations Of A Country Ceiling
The possibility that a government or other third party will support a failing bank plays a greater role in
determining debt and deposit ratings in emerging markets. This is partly because bank failure is often a
much more immediate possibility for an emerging market bank than for those in developed markets. But
also, there are a greater number of intrinsically weak banks in emerging markets and some of these oper-
ate in countries where the government has a reasonable ability to ensure that they do not default on their
obligations. For example, Tunisia’s Banque Nationale Agricole is rated E for financial strength, reflecting
our view that the bank is extremely weak, yet it receives a foreign currency deposit rating of Ba1, because
the Tunisian central bank (rated Baa3) would probably be able to prevent it defaulting in a crisis.
On the other hand, because the country ceilings assigned in emerging markets are lower than those in
developing markets, it is more often the case that the ratings of strong banks are constrained. In North
West Europe, all country ceilings are Aa or higher, so few banks are likely to be constrained by a country
ceiling. Emerging markets are rarely rated as high as the A category and usually quite a bit lower. Another
way of conceptualising this is to say that banks face two main risks – bankruptcy and a sovereign-imposed
foreign currency moratorium. In the case of emerging market banks, the latter risk assumes a higher pro-
file, and this translates into lower country ceilings.
6. Rating Methodology For Emerging Market Banks

Moody’s rating model applies to banks throughout the world, regardless of where they are based, so the
“Seven Pillars” of bank analysis outlined in our Rating Methodology paper on Bank Credit Risk in devel-
oped markets also form the basis of our assessment of emerging market banks. Those “Seven Pillars” are:
1. Operating Environment
2. Ownership and Governance
3. Franchise Value
4. Earning Power
5. Risk Profile
6. Economic Capital Analysis
7. Management Priorities and Strategies
It is important to note that only two of these seven issues refers explicitly to a bank’s financial condi-
tion – earning power and risk profile. A bank’s financial condition today plays an important part in our
analysis, but we believe that over the long term, issues such as business franchise and management quality
are more powerful drivers of bank financial strength. Banks sometimes make a case for a higher rating on
the sole basis that their financial ratios are better than those of other banks which are rated higher. Yet it
is perfectly possible for a bank with weaker ratios to be rated higher if we believe that other more qualita-
tive factors will likely lead to stronger ratios over the long term.
6.1 Moody’s Rating Methodology Is Not Based On A “Checklist” Or “Scoring”

We are sometimes asked what weighting we assign to different factors of analysis when arriving at a rat-
ing – is asset quality the most important factor, or is it capital ratios? The answer is that we do not
approach ratings in that way. The questions we ask ourselves is, “What is driving the rating?” “What are
the features of this bank which are going to determine its credit quality – positively or negatively – over
the long term?”

Bank Analysts And Chess Players
Some years ago, scientists devised an experiment through which to investigate the differences between club
standard chess players and chess grandmasters. Sensors were attached to the players’ eyes which showed
the scientists where on the chessboard the players were looking as they considered which moves to make.
The difference between the two sets of players was striking. The club standard players looked all over the
chess board, weighing up a wide range potential moves by a large proportion of the chess pieces available.
In contrast, the grandmasters looked only at a handful of squares (a chess board has 64) and two or three of
the pieces. They had identified the key squares and pieces which were driving the outcome of the game. Of
the millions of potential moves available to them (and in chess, there are literally millions) the grandmasters
considered only few.
Moody’s bank analysts strive to work like the chess grandmasters. We are aware of the miriad of issues
which may affect a bank’s credit quality but we are focused on identifying those which are actually driving its
credit quality.
The issues which have the potential to affect a bank’s credit quality are the same in every case: they can
be distilled into the seven “pillars” noted above. But in practice, the key issues driving the rating differ
from bank to bank. For one bank, a strong earnings profile may override concerns about forthcoming
deregulation; for another, poor management may lead to a low rating despite strong financial indicators;
and so on. The art of bank analysis lies in identifying the key rating drivers and assessing the extent to
which they will impact the bank’s credit quality over the long term.
7. The Banks’ Operating Environment

Operating conditions are the single most important reason why emerging market banks as a class receive
lower financial strength ratings than those in developed markets. When we assess the operating environ-
ment, we ask the question, “What opportunities do banks in this market have to build a diverse, strong
and defensible earnings profile?” We think it is intuitively obvious that it is easier to build such an earn-
ings profile in a market which is mature, large, diverse and healthy, than in one which is not. Although
many emerging economies are large, they tend not to be mature; they are often based on a few sectors
(such as mineral extraction), and the solvency of the government and the private sector may be precarious.
Operating conditions are the single most important reason why emerging market banks
as a class receive lower financial strength ratings than those in developed markets.
7.1 Health And Structure Of The Economy

In emerging markets our analysis begins with an assessment of the macro-economic environment. Factors
include prospects for economic growth, exchange rate stability and inflationary trends. For example, it is
difficult for a bank to be strong if the economy in which it operates is suffering a serious recession.
Alternatively, a major currency devaluation could compromise an otherwise sound balance sheet.
Compare, for example, the operating environment in any of the Euro-11 countries, with that in Russia.
When we analyse banks in the Euro-11 states we can be very confident that they will not have to deal with
a sudden bout of inflation, or a currency devaluation. We can also be fairly sure of the range in which eco-
nomic growth will fluctuate over the next two or three years. In Russia, not only are those economic fac-
tors far less favourable, but they are also far less predictable. An unforeseen inflationary rise in Euro-land
might mean that inflation rises to 4-5% a year. In Russia, an unforeseen rise in inflation could mean an
increase to 200%!
(Bear in mind that this analysis is separate from the sovereign assessment mentioned earlier. In this
case, we are looking at the underlying conditions in which the bank is operating and how they affect a
bank’s intrinsic financial strength. We are not here assessing how those conditions affect the repayment
ability of the government – which could lead to the imposition of “sovereign acts” such as exchange con-
trols. That analysis of “sovereign acts” is captured by the debt/deposit ceiling which applies to the ratings
of all banks.)

The next stage of analysis is to look at the diversity and depth of the economy. Does the economy con-
tain a large number of healthy enterprises covering a wide range of economic activities whose perfor-
mance contains some degree of negative correlation (so that if one sector is performing badly, others may
still be doing well)? The oil-exporting states of the Arabian Gulf provide an example here. The oil and gas
industry, which is almost wholly state-owned, accounts for at least one third of GDP, and private sector
activity is heavily dependent on government contracts. Private sector activity which is not dependent on
government contracts barely extends beyond trading and import distribution. The result is that the “cor-
porate landscape” of these countries is very limited. Furthermore, if the price of oil falls, government liq-
uidity tightens (about three quarters of government revenues come from oil and gas sales). This does not
only affect those companies dependent on government business. Because government spending – direct
and indirect – is such a large part of total economic activity, nearly everyone is affected. It is therefore very
difficult for any bank to insulate itself from the influence of an economic slowdown. Some sectors will be
affected more than others, but all will be affected in some way.
7.2 Trends In Capital Markets, Disintermediation And Structure Of The Banking System
It is important to understand the banks’ role within the financial system as a whole. We said earlier that
banks tend to dominate the financial system in emerging markets. This dominance gives banks two big
advantages:
• Pricing power – banks are able to determine the “going rate” on deposits and loans, and on fees for
financial services. This power need not be dependent on any cartel arrangements. It may be the outcome
of pricing inertia among the existing players (who have no interest in disturbing pricing structures) and
the absence of new players pursuing an aggressive pricing strategy in order to capture market share.
• Ability to benefit from changes in the public’s asset distribution – for example, the effect of a move out
of bank deposits and into, say, mutual funds, is minimised if banks control the local mutual fund indus-
try. Clearly, issues of funding and liquidity arise, but if banks can recapture in management fees the
margin which they lose from deposit withdrawals, their profitability is protected.
As financial markets develop, new players appear and banks start to lose these two advantages. The
speed at which this takes place depends on several factors, including the attitude of the regulatory authori-
ties to licensing new institutions. Central banks are often very protective of their banking system, and do
not want to see them weakened by new players. The speed of change will also be affected by the potential
for capital market development – a large economy with a diverse corporate landscape and a strong public
sector is more likely to attract the attention of local financial entrepreneurs and foreign institutions seek-
ing a part of the action. A more staid market is likely to be left to the existing players.
The bank analyst therefore needs to consider the franchise which banks have within financial markets,
and the likelihood that this will change. As we indicated earlier, more diverse and mature financial markets
are part of an improved operating environment, so some banks (“winners”) may benefit even if the fran-
chise of banks as a class is weakened. Identifying winners and losers is a central part of this analysis.
Having considered the banks in the context of the financial system as a whole, the next step is to look
at how individual banks will be affected by the changing structure of the banking market. We look to see
whether the regulators are likely to licence new banks to compete with existing players, whether they
encourage or discourage mergers and acquisitions, and whether they will open the market to foreign com-
petitors. In a market where the major players are growing bigger, possibly through mergers or strategic
alliances with foreigners, smaller and weaker banks are likely to be marginalised. Under a non-competitive
and controlled banking system, such small banks may have been able to survive, but as markets are liber-
alised stronger banks are able to pursue aggressive pricing strategies. Economies of scale also come into
play. The most likely trend is for two types of institution to emerge – large banks with a national franchise
and universal operations, and niche or regional banks. Those caught in the middle find it increasingly
hard to survive.
The countries of the Former Soviet Union and Eastern Europe have seen rapid changes in the struc-
ture of their banking systems due to privatisation, the break-up of large banks, and the licensing of new
players, both local and foreign. In that context, a bank which is a leading player today may not be so
tomorrow. And since the regulation of banks is often a highly politicised issue, predicting the structure of

the banking market involves understanding the policy platforms of competing political factions, and the
likelihood that they will get into power.
7.3 The Effectiveness Of Regulation

As in developed markets, we assess the ability of regulators to ascertain the soundness of banks in the sys-
tem and also their capacity and willingness to intervene to prevent problems developing into crises. This
involves assessing not only the competence of the regulators but also the influence which they wield with-
in government circles. (A central bank rarely has sufficient resources to mount a major bank rescue – the
funds must come from Ministry of Finance, and the Ministry may have different priorities and more influ-
ence than the central bank.)
As regards the issue of competence, an analyst would want to know how regularly the central bank
inspects banks and how detailed those inspections are. For example, if the regulators have only a handful
of staff with whom to inspect 50 banks, then the quality of inspection is unlikely to be very strong unless,
as sometimes happens, independent auditors are called on to report on specific aspects of banking opera-
tions. An analyst would also try to get a sense of how well regulators understand some of the more com-
plex risks being faced by banks. For example, we have seen cases where regulators told banks to set up a
risk management department without having any clear idea of what they wanted the banks to be measur-
ing. The danger here is that the banks may be able to outsmart the people who are supposed to be super-
vising them.
The willingness and ability of regulators to enforce regulations is another crucial issue. An analyst
should ask what the regulators have done if they have discovered banks violating their rules, and whether
any have been closed down. This is an area where the scope of the bank analyst’s work extends beyond
meetings with bankers and regulators to include reading local press reports and maintaining contacts with
people such as journalists, lawyers and consultants. The fact that a small local bank was let off with a mild
reprimand after violating regulations may not in itself seem significant. But if a major shareholder in that
bank is the relative of a government minister, then the event starts to look more troubling. That type of
background information is often essential to understand the true significance of events and it is rarely
made available by primary sources.
7.4 Assessing The Importance Of External Policy Influences

External actors, such as the World Bank or the European Bank for Reconstruction and Development
(EBRD) can have an important influence on the direction which a country’s banking system takes, and how
local authorities might respond to a banking crisis. For example, when negotiating a support package with
the South Korean authorities in 1998, the World Bank and the IMF made clear their concern with the
moral hazard which would result if all banks were supported unequivocally, although the Korean authori-
ties very much wanted to continue exercising regulatory forbearance and support so that all could be pro-
tected. Events such as the Mexican crisis of 1995, those in Asia during 1997/98 and the Russian default of
August 1998 have led to much more thought being given to the issue of external support for troubled
economies. Going forward, it will be increasingly important for bank analysts to understand the policy pref-
erences of multi-lateral institutions – and of countries such as the USA – which will be determining the cir-
cumstances in which support is extended to emerging market economies and to individual banks.
7.5 Transparency
Emerging market banks and banking systems tend to be less transparent than those in developed markets,
and that is an important reason why they tend to be rated lower. Note that such lower ratings are not just
a product of analysts’ conservatism, although that certainly plays a part (when information is incomplete
or unreliable one has to be more cautious). Less transparency in a banking market leads directly to more
banking problems because banks in that market have to make business decisions based on incomplete or
incorrect information and they are therefore more prone to making wrong decisions.
It is also the case that lack of transparency is used to obscure problems – when a financial system or a
bank is sound, regulators tend to advertise the fact. When it is not, they are more inclined to cover it up.
Lack of transparency enables managers to postpone dealing with problems and continue to pretend that
nothing is wrong.

When assessing transparency we are looking at two things:
• the extent of disclosure about a bank’s operations and the macro-economy.
• the reliability of that disclosure (Simply put, Is it true?)
At the level of individual banks, we would first ask whether banks report in line with international
accounting standards, including disclosure of impaired loans, market value of securities and fair value of
unquoted investments. We would also look for consistency of accounting, so that trends can be discerned.
We are concerned if we see that a bank is constantly reclassifying items from previous years reports and
would want to understand why. As part of this analysis, Moody’s analysts often ask local accountants for
their opinion on local regulation and whether there are any specific areas where, in their opinion, trans-
parency is weak.
The first stage in assessing the reliability of a bank’s disclosure is to check the auditors’ opinion in the
Annual Report, and to take a view on the value of that auditor’s opinion. Market intelligence should indi-
cate whether any auditors have a reputation for being less strict than others. In our experience, the fact
that a local accountant is affiliated with one of the big international auditors is not in itself a guarantee of
strict auditing practices. Although market rumour and gossip should never form a basis for analysis, it may
alert the analyst to issues which can then be formally discussed with banks and regulators. It cannot be
stressed too often that an emerging market bank analyst cannot depend solely on information received
directly from banks and regulators.
We are concerned if we see that a bank frequently changes its auditor (except where regulators require
banks to change their auditors every few years). Another warning sign would be an instance of a bank pub-
lishing its annual results much later than it did the previous year. The delay may be due to a dispute with
the auditors or regulators.
It cannot be stressed too often that an emerging market bank analyst cannot depend
solely on information received directly from banks and regulators.
Most of these warning signs should be evident from the bank’s Annual Report. The value of thorough-
ly reading all the way through a bank’s Annual Report should not be underestimated. In particular, the
initial notes to the accounts covering the basis of presentation should not be overlooked, including, for
example, notes dealing with the basis of consolidation. In addition to answering specific questions the ana-
lyst may have, the Annual Report also gives a good indication of a bank’s general attitude to disclosure.
Quality of disclosure is more important than quantity. The Israeli banking system provides an exam-
ple. Israeli banks’ Annual Reports run to some 200 pages, about 100 which comprise the notes to the
financial statements. Yet, the analyst wanting to know an Israeli bank’s ratio of non-performing loans to
gross loans has a difficult task. The notes to the accounts do not show totalled numbers for non-perform-
ing loans and gross loans. The number can be worked out but errors are easy to make if one is not already
familiar with Israeli banks. The philosophy behind Israeli banks’ disclosure appears to be classification
rather than explanation. Non performing loans are classified into numerous categories – giving a far more
detailed breakdown than one would normally expect. But there is no attempt to consolidate that level of
detail into the type of meaningful ratios which a credit analyst uses. Without considerable additional work
by the credit analyst the numbers do not show whether the bank’s balance sheet is strong or weak. It is a
system designed for the benefit of regulators (whose priority is often classification) rather than for credit
analysts (whose priority is explanation). This is frequently the case in banking systems which used to be
state owned, like Israel’s.
Quality of disclosure is more important than quantity.
We attach particular importance to the quality of public disclosure, as opposed to information submit-
ted in confidence to rating agencies or other banks. Publicly disclosed information is subject to public
scrutiny and debate and may therefore be more accurate. (For more on the role of transparency see
Moody’s Special Comment Improving Transparency in Asian Banking Systems, November 1998).

7.6 The Legal System
Understanding the legal system is an important element in emerging market bank analysis. A legal system
which is unpredictable, unenforceable, incomplete and corrupt diminishes the effectiveness of all aspects
of society. There are in addition several ways in which a faulty legal system directly affects the performance
of banks.
The main question is whether banks are able to receive redress in the courts against delinquent bor-
rowers. The issue is not just whether the courts would ever rule in a bank’s favour. There is also the need
to have that judgement enforced (so a debtor’s house has to be re-possessed or their assets seized). And
even if judgement and enforcement are possible, if the whole process takes years and years, it may not be
worth pursuing. A bank which knows that it will take five years to recover collateral from a delinquent
debtor – even if the judgement goes in its favour – is likely to cut a deal to recover a portion of what is
owed. And of course debtors know that banks are going to face that choice.
In some societies, certain people appear to be beyond the reach of the legal system. Here the analyst has
to have some experience of the country concerned, and needs to speak to people outside the banking system.
There are several areas of the world where banks insist that they can sue any borrower, however important,
and obtain a judgement in their favour – and where we (and they) know that that is simply not true.
There is another way in which the legal system has an important bearing on the banking system. The
analyst should ask whether the legal system is facilitating or constraining the development of capital mar-
kets. In many emerging markets, issues such as subordination/priority of claim have no clear basis in law.
Securitisation, mortgages and even public share ownership may require changes in legislation before they
become practicable. Egypt provides an example – in the early 1990s Egypt was criticised for the lack of
progress on its economic liberalisation programme, and there was no denying that government targets on
issues such as privatisation were routinely missed. But one area which did see considerable change was the
laws which governed capital markets. So for example, a forty year old law setting a maximum rate of inter-
est of 7% on local bond issues was repealed. Banks were permitted to manage investment funds. Foreign
banks were permitted to operate in local currency. Without this overhaul of the legal framework govern-
ing financial activity in Egypt, the development of Egyptian capital markets later in the decade would have
been impossible.
8. Ownership And Governance

Strong and committed shareholders can have a positive influence on their bank’s debt/deposit ratings
because such shareholders would likely support their bank in a crisis. If those shareholders also strengthen
the bank’s business franchise and its financial condition, then they may also have a positive influence on
the financial strength rating. However, if the shareholders’ objective in founding the bank is to fund their
other business interests, and if close involvement of shareholders in the bank leads to low credit standards,
there could be negative implications for the financial strength rating.
8.1 Public Ownership And Privatisation

In emerging markets, public sector banks tend to be rated at or near the country ceiling for debt and
deposits because there is a strong likelihood that they would receive state support in a crisis. But public
sector banks are often inefficient and have large exposure to poorly performing public sector companies
and this in turn leads to low ratings for financial strength. If such institutions are privatised, the pre-
dictability of support might immediately diminish and this could mean that the debt/deposit ratings are
lowered from the country ceiling. But over the long term, greater efficiency and more stringent credit
controls might lead to a higher financial strength rating. Under this scenario, improved financial strength
could start to drive the debt/deposit ratings higher (with repayment ability then being based on the bank’s
intrinsic financial strength rather than on the presumption of support).7
Public ownership may give a bank an inside track to certain types of government business. It may also
assist the bank to win large deposits from state-run pension funds and other government bodies. The
question for the analyst is whether this business is profitable, whether it is likely to remain so, and whether
any profitable government contracts could be transferred away from the bank to another. For example,
7 Privatisation is often advertised well in advance, enabling Moody’s to factor into the ratings the likely loss of state support before it actually occurs.

state-owned agricultural banks tend to have a monopoly on lending to farmers, but this is notoriously
unprofitable business in a developing economy. Contracts which are profitable today may become unprof-
itable if the government changes the pricing structure. And the government could decide to assist an ailing
public sector bank by transferring to it a lucrative contract held by another, stronger public sector bank.
An unfortunate consequence of state ownership is that the chairmen or general managers of banks are
frequently political appointees. Although usually there is continuity of appointments when governments
change and often the intention is to appoint professional bankers (or competent businessmen) there can
be exceptions. In Turkey, banks see their chairman changed with every new government (and government
turnover is quite rapid in Turkey). The result is not only instability, but also questions about the ultimate
loyalty of a chairman – is he concerned with the bank’s best interests, or those of the government?
8.2 Private Ownership

The privatisation of banks in Europe generally led to higher ratings both for debt/deposits and for finan-
cial strength. There is no reason why this should not also be the case in emerging markets. Private share-
holders tend to demand higher rates of return than governments, and this forces management to focus on
profitability and efficiency.
Much depends on whether a small group of committed shareholders (or perhaps even a single share-
holder) exercises effective control over the bank, or whether ownership is dispersed among a large number
of shareholders none of whom act in concert. This in turn tends to be driven by the government’s privati-
sation policy — the analyst should be able to predict what sort of shareholder structure is likely to follow
privatisation. Active and cohesive shareholders are likely to exert greater influence over the way the bank
is run, whereas disparate shareholders will usually result in management retaining more freedom of action.
In some developing markets the trend from family-owned banks to professionally-managed banks is
also significant. When family owners are heavily involved in bank management analysts need to take
greater interest in succession issues and consider whether family members in the management team are
performing as well as outside professionals would. Transparency is also sometimes more limited in closely
held family-owned banks. Without the need to be accountable to outside shareholders, it is easier for
these banks to choose the path of less disclosure. It is also important for the analyst to understand that
some of the bank’s strategies may be influenced by the owners’ personal tax planning concerns.
8.3 Why Governance Matters

The issue of corporate governance is particularly important when analysing emerging market banks. It
embraces a number of questions:
What are the objectives of the owners and the board? We are concerned if we see that sharehold-
ers are using a bank to fund other companies which they own. Even if this is not explicitly evident (and it
rarely is) there is always the possibility that a bank could be used to extend uneconomic facilities to group
companies which are experiencing difficulties. In these circumstances, our analysis would involve taking a
view of the health of the group as a whole, looking for cross shareholdings and examining the facilities
extended by the bank to group companies. We would also look to see whether the bank has breached any
regulations governing inter-group business, such limitations on related party lending. Related party lend-
ing is often difficult for management and regulators to control, especially during times of economic diffi-
culty. Even the most vigilant regulator will be reacting after the exposure has been incurred.
We are also concerned if we think that investors have taken a stake in a bank with the objective of
making a short-term gain on the share price. Bank shares are often the most heavily traded stocks in
emerging markets, and banks are sometimes the only major assets with significant free float – the corpo-
rate sector being dominated by family trading groups who hold their shares closely. Short term investors
typically put immediate profit maximisation ahead of long-term strength. Rapid turnover of shareholders
may also lead to management instability.
We feel more confident when a bank is a strategic investment for its shareholders. A family is likely to
be committed to a bank if it is the only major asset it owns. An investor who controls a series of high pro-
file companies would not want his reputation tarnished by a bank which he owns going bankrupt.
Nevertheless, there is no ideal investor profile and it should not be thought that Moody’s automatically
disapproves of banks which form part of wider business groups. The commitment and investment objec-
tives of shareholders have to be considered case-by-case.

Who is running the bank: owners, the board or management? It is the job of management to
manage the bank and if owners and directors are not confident of their managers’ ability to do so, they
should replace them, not try to run the bank themselves. It is difficult to think of any circumstances in
which management performed by owners and directors could have a positive effect on the ratings. We
expect the board of directors, as representatives of the owners, to set broad policy objectives, approve
overall budgets, and then let management get on with the job8. For a bank in which shareholder interfer-
ence has been widespread, the institutionalisation of management may take many years. And it is a process
which has to be directed from above.
Interference by owners and directors is more of an issue in emerging markets than developing mar-
kets. This is mainly because a larger number of banks have a dominant shareholder or shareholders.
Educational and cultural factors also play a role. The middle ranks of emerging market banks are often
not staffed with well-qualified and self-confident people and it is often culturally impossible for employees
to question the decisions of their managers.
Interference by owners and managers will recede as ownership becomes more diffuse, and this is likely
to happen as capital markets deepen and become more liquid. It will also recede as investors become more
mature and experienced – and realise the negative long term effects of micro-management. Middle man-
agers may become better qualified and assertive. These trends will have positive implications for ratings.
Are the responsibilities of the directors formally defined in regulations or laws? The existence of
defined fiduciary responsibilities can go a long way in limiting abuses by owners and directors. They pro-
vide visible parameters within which directors must operate, with the threat of sanctions should they stray.
This is particularly useful when a bank is being is viewed by its owners as their private fiefdom, their
authority unchecked by other shareholder groups or strong management. The law under which a bank is
incorporated may also provide additional safeguards – for example, a public joint stock company is less
susceptible to exploitation than a private partnership.
9. Franchise Value
The value of a bank’s franchise is a key driver of bank financial strength, yet it is a concept which is often
misunderstood in the investor community. Simply put, a bank’s franchise is its ability to generate earnings
over the long term. Many factors feed into this ability – market share, risk profile, strategic choices and
the profitability of the bank’s business lines. But all the factors are ultimately manifest in a very concrete
form – the bank’s income statement. A bank’s franchise can be conceptualised as the present value of all its
future income streams. In crude terms, a strong franchise may be described as the ability to make lots of
money over the long term.
Two types of franchise should be distinguished: system-related and bank-related. A system-related
franchise refers to the profitability of the banking system as a whole, and its ability to maintain that prof-
itability in the face of competition, deregulation or regulatory changes. These issues were considered
above in the analysis of the banks’ operating environment.
A bank’s franchise can be conceptualised as the present value of all its future income
streams. In crude terms, a strong franchise may be described as the ability to make lots
of money over the long term.
As for a bank-related franchise, the key concepts include the following:
9.1 Efficiency
A low cost base enables banks to maintain profitability even if increased competition reduces gross earn-
ings. A bank with a low cost base will be able to ride out a temporary pricing war with other banks, and
will have time to restructure its operations to take account of long term shifts in market pricing. Such effi-
ciency is increasingly driven by technology and product mix – that is, by a bank’s ability to distribute its
products and services effectively and cheaply, and to blend them into powerful marketing combinations.
8 The only qualification we would make to this would be when a specific issue is of sufficient importance that a board member should be designated to watch
over it. Risk management and the Year2000 computer bug would be examples. Even here, the purpose is not to manage that function, but to provide
additional oversight. Another point is that the internal audit committee should report directly to the board.

The importance of this is evident, for example, in a market which is deregulating rapidly – controlled
interest rates may have assured banks wide interest margins, but as interest rates are deregulated, only
those banks with a low cost of funds will be able to maintain profitability.
Emerging market banks often have quite low costs since labour is plentiful and salary levels fall off
more sharply than in developed markets. But the importance of automation (to improve efficiency, help
the management run the business more effectively, and assist employees to cross sell products) means that
large investments will have to be made and such investments may be beyond the revenue bases of many
emerging market banks.
9.2 Market Position And Strategy

Even when a bank is efficient, its earnings will decline if its main lines of business become unprofitable or
if it fails to take advantage of new opportunities. A strong position in the local textile industry is of little
value if textile companies are steadily being driven out of business by foreign competition. Financial liber-
alisation in emerging markets is expanding the range of products and services which banks may offer, and
this process is being accelerated by technology. Banks which are able to build a strong position in new
areas of activity will see their earnings protected over the long term. Private sector banks are often better
able to take advantage of new opportunities because their decision making process is faster and their man-
agement is more open to new ideas. Diversification is another key factor – earnings based on one or two
key activities are less strong than the those which derive from a wide range of business lines.
We attach importance to a management’s ability to articulate its franchise by describing which areas of
activity it has selected as the key drivers of its long term earnings, and by explaining why it thinks it has a
competitive edge in those areas. An inability to do this is usually indicative of complacency and inertia,
which in time will see the bank losing market share and then revenues to more effective rivals.
9.3 Market Share

A strong market share may give the bank pricing power – an ability to set, or at least defend, the pricing of
its products. Even if there is no explicit attempt at price fixing, the ability to set prices which apply in a
large proportion of the market is a powerful weapon with which to defend market share. Smaller banks
will often follow the lead of larger rivals rather than challenge their pricing structure.
Does Size Matter?

We are often asked whether a bank has to be big in order to be strong. The answer is, no. We frequently
give higher financial strength ratings to small, nimble banks than we do to others many times their size. The
important point is whether a big bank is able to exploit its size, rather than the issue of size itself – whether,
for example, it can indeed set market prices which other banks then follow; or whether it has innovative
products which can be distributed through a large branch network. In emerging markets, many big banks
owe their size to government ownership and a public sector culture. They are often inefficient, lethargic, and
unable to exploit their potential. In contrast, smaller banks tend to be clearly focused on profitable areas of
business where they feel they have a competitive advantage. Decision making is quicker and a culture of
innovation encouraged. On the other hand, very small banks may be less diversified, and their smaller capital
base might limit their ability to sustain losses from systemic problems.
Size alone is not necessarily an indicator of market power. A bank can easily leverage up its balance sheet
by using repurchase agreements (repos) to build up a large securities portfolio. But such business hardly rep-
resents a core franchise, and may not be particularly profitable.
Big banks are more likely to be considered “too big to be allowed to fail” by the financial authorities and
as a result have a greater chance to be rated at or near the country ceiling, even if their intrinsic financial
strength would not warrant such a high debt/deposit rating. The failure of a small bank may have fewer
repercussions for the rest of the banking system or the country’s reputation abroad, and so financial authori-
ties may feel less need to provide timely support to a small bank in a crisis.

10. Earning Power
Earning power is perhaps the key determinant of the success or failure of a financial institution. It is the
most concrete expression of the value of the bank’s franchise and the effectiveness of its managers. Strong
earnings enable a bank to invest in new products and technology; to provide a return to shareholders; and
to cover credit or market losses without impairing capital.
We said earlier in this report that in emerging markets we attach greater importance to capital than we
do in developed markets – greater volatility means that protection against unexpected losses is more
important and capital is a bank’s protection against those unexpected losses. But capital is not a substitute
for earnings. We expect banks in emerging markets to have stronger capital in addition to having strong
earnings. Strong capital will protect the bank in a crisis, but lack of earnings will prevent investment and
development, with the result that the bank will lose ground over the long term and eventually face a crisis.
We attach importance to the “quality” of earnings, by which we mean that earnings should be sustain-
able and based on a bank’s core competences. An earnings stream generated by investment in domestic
treasury bills is not quality earnings, even if it is substantial. The bank cannot control the yield on the bills
and pricing could change at any time – turning what is a highly profitable business line today into one
which will be only marginally so in future. Similarly, non-recurring items do little to improve a bank’s
credit quality over the long term – examples include one-off gains from the sale of non-strategic invest-
ments, or dealing profits during a particularly good year. Diversity of earnings is also important, especially
when deregulation and liberalisation may render some business lines less profitable than in the past.
10.1 The Uses And Abuses Of Ratios To Measure Earning Power

Analysis of earning power is driven by financial ratios, but these can often be unreliable in emerging mar-
kets. The analyst first needs to check whether the data are compiled according to appropriate standards
(for example, could a high interest margin be due to the fact that the bank is accruing interest on loans
which have long been delinquent?) Secondly, the analyst needs to understand any peculiarities in the mar-
ket. For example, Turkish banks show prodigious ratios for returns on assets, but these are due to
Turkey’s high inflation. If inflation were to fall from, say, 60% to 30%, the ratios would look very differ-
ent. As a result of such peculiarities, it is often meaningless to compare profitability ratios between differ-
ent countries. (Whereas within a market which is fairly homogeneous and steadily converging such as
Western Europe, such comparisons are often quite valid.) But peer group comparison is important as a
way into understanding the performance of individual banks (“Why is bank X’s return on assets lower
than those of all other banks in the system?”) Even within a single country it is still important to compare
like with like – the ratios of mortgage banks are best compared with those of other mortgage banks.
We attach importance to the “quality” of earnings, by which we mean that earnings

should be sustainable and based on a bank’s core competences.
We look at a variety of ratios in order to get an all round picture of a bank’s profitability. No one ratio
can drive credit quality on its own. In emerging markets, the key indicators of quality earnings include:
Pre-provision return on average assets (sometimes known as “recurring earning power”). This is the
basic measure of a bank’s efficiency – its ability to generate revenues from its balance sheet. We are clearly
focussed on pre-provision return rather than net returns because of the possibility that a bank will be
forced to make sizeable provisions against credit or market losses. We want to assess the bank’s ability to
make such provisions without declaring a net loss. As credit analysts we are more concerned with returns
on assets than return on equity (the latter being of more interest to investment analysts). We recognise the
importance of returns on equity (explained below), but it ranks behind return on assets in importance.
Net interest margin. (NIM — net interest and dividend income divided by average earning assets).
Interest and dividend earnings generate the bulk of a bank’s earnings. The NIM quantifies the efficiency
with which a bank does that. The NIM is a sub-set of pre-provision return on assets, focussing only on the
interest/dividend earning part of the balance sheet. As with all financial ratios, it is important to under-
stand why one bank’s ratio is higher or lower than another’s. For example, a high net interest margin may
be the result of a bank having more of its assets deployed as loans, rather than in government securities or
interbank placements. Such a bank is generating higher returns by accepting greater credit risk and
reduced liquidity.

Cost to income ratio (Non-interest expenses divided by interest and non-interest income) This ratio
answers the question, “How much does the bank have to spend to generate a unit of revenue?” A low cost
base gives a bank the ability to withstand a decline in interest margins or other sources or revenues, and
the flexibility to invest in new products and technology. This is particularly important in emerging mar-
kets, where banking profitability may be changing rapidly: deregulation may lead to a contraction in inter-
est margins; liberalisation may open up new avenues of activity requiring investment in staff and technolo-
gy. In general we think that the cost to income ratio is a more telling measurement of a bank’s efficiency
than the ratio of non-interest expenses to assets. Banks which leverage up their balance sheets by raising
market funds and then investing them in government securities have low cost to asset ratios but those
ratios are not indicative of the efficiency with which the bank conducts is core business. (Raising money
from the market does not require the expense of a branch network and investment in government securi-
ties does not require an army of credit analysts.)
Return on equity: As credit analysts, we are mainly interested in return on equity from the perspective
of a bank’s ability to generate capital internally. A high return on equity enables a bank to increase its
equity without relying on shareholders or the stock market. Strong internal capital generation enables a
bank to grow its balance sheet, invest for the future and, within reason, participate in mergers and acquisi-
tions. In rapidly changing markets, this is essential if a bank is to retain market position. An ability to gen-
erate dividends to shareholders is also relevant to credit analysis – contented shareholders are more likely
to be committed to the bank.
Credit analysts should also be aware of movements in a bank’s stock price since this may affect the behav-
iour of management and shareholders. In thin and immature stock markets, prices may swing wildly and bear
little relation to financial fundamentals but as financial markets mature stock prices become increasingly rele-
vant – management performance starts to be judged in terms of price appreciation, and a high stock price
facilitates mergers and acquisitions. Credit analysts need to understand how important the share price is to
managers and key shareholders, and how significant the stock market is within overall financial markets – is it
a casino with a handful of rich players, or a credible vehicle through which to raise capital?
Staffing and branch ratios: Peer group comparisons of ratios such as “customers’ deposits per
branch”, “employees per branch” and “operating profit per employee” are useful in highlighting differ-
ences between banks in strategy and efficiency. If a bank claims to be focused on the wealthier end of the
market, yet its deposits per branch are no higher than those collected by a mass-retail bank, its strategy is
not working.
10.2 The Importance Of Non-Interest Income

One of the more predictable consequences of financial deregulation and liberalisation is that interest mar-
gins will be squeezed. Banks can respond to this either by increasing their credit risk profile (deploying a
greater proportion of their assets in loans and/or lending to riskier ventures) or by substituting interest
income with non-interest income. In emerging markets, the development of the financial system should
give banks plenty of opportunities to create new streams of non-interest revenues such as credit card fees,
arrangement fees on new types of loans, and brokerage commissions. There is no “ideal ratio” of interest
income to non-interest income, but in general we think that a diversified and strengthening stream of
non-interest income significantly enhances a bank’s credit quality, affording it a degree of protection
against any future narrowing of interest margins.
10.3 New Lines Of Business

In developed markets, we have taken a favourable view of banks which have successfully added new lines
of business such as bancassurance and asset management. These new areas diversify a bank’s earnings
away from interest rate risk; provide some protection against earnings loss due to disintermediation; and
increase opportunities for cross selling products. Emerging market banks will also benefit from this kind
of horizontal expansion, although in their case it is particularly important to ascertain that the new areas
of business are subject to competent supervision and that the bank is able to develop, or recruit, profes-
sionals with relevant experience.

10.4 Line Of Business Analysis
Where possible we like to analyse a bank’s earnings by line of business so as to better understand where a
bank is making its money. In emerging markets this is frequently difficult due to insufficient disclosure
and because managers often do not think in terms of line of business analysis. Yet it is a worrying admis-
sion if managers have no idea which parts of their business are the key drivers of profitability.
11. Risk Profile And Management

11.1 The Management Of Risk
A bank’s risk profile does not evolve by chance. It is the product of management strategies which can be
conservative, aggressive or some mixture of both. Within reason, an aggressive risk profile need not lead
to lower rating, provided that it leads to superior earnings to cover the greater potential losses. The
important point is that the bank’s management should be actively managing risk and should be able to
explain why it has chosen one risk profile over another, and show that this strategy is appropriate in the
light of market conditions and the returns which it generates.
The concept of Risk Management embraces many elements of which the most prominent are credit
risk and market risk. Others include liquidity risk, operational risk and reputational risk. But there is little
value in managers enumerating an ever lengthening list of risks types if they do not appreciate how those
risks apply specifically to their institution. Risk management may start with an identification and categori-
sation of risks, but it becomes useful only when it is incorporated into strategic thinking.
We welcome the consolidation of the various aspects of risk management into a single unit, often
headed by an executive with the title of Risk Manager. We do not think it is a priori necessary to have a
single Risk Manager, provided that all of a bank’s risks are being fed into a single body, such as a Risk
Management Committee, which can appraise them in their totality. (A Risk Manager has to combine
experience of both credit risk and market risk, and such an individual can often be difficult to find in
emerging markets.)
A bank’s risk profile does not evolve by chance. It is the product of management
strategies…
In emerging markets we are particularly focused on credit risk and operational risk. As in developed
markets, the growth of treasury activity, including the use of derivatives, and recent examples of extreme
market volatility is placing the spotlight on market risk. As emerging financial markets become more com-
plex, banks face a widening array of risks, yet it is credit and operational risk which pose the greatest and
most immediate threats to solvency.
Risk Management: Keeping Your Eye On The Ball

Moody’s analysts recently met with an emerging market bank which had just installed JP Morgan’s
Riskmetrics system. The Risk Manager gave a presentation during which he explained how the bank set
Value at Risk limits, how it measured its actual daily risks, and how the system had been performing since
installation. Having completed his comprehensive presentation he paused, turned to the Moody’s analysts
and said, “But of course, the main risk which this bank still faces is credit risk. Our maximum daily Value at
Risk from market risk is $40mn and we rarely go anywhere near that figure, but we have $3bn of credit
risk on our book every single day.” A comprehensive presentation on credit risk management followed.
Our analysts were encouraged by these comments. The bank had taken steps to improve its management
of market risk – a risk to which its exposure was increasing. But it recognised where the main risk lay, and
remained focused on it.

11.2 Credit Risk
Analysing the quality of a bank’s loan portfolio is inherently difficult. Decisions to lend money, allocate
provisions or write off a loan are subjective, and are the result of considerable discussion within the bank
based on first hand knowledge which is not available to outsiders. But what an (outside) credit analyst can
do is observe trends within the market as a whole which may impact loan quality, assess the success of the
bank in making correct lending decisions in the past; and quantify its ability to cope with a deterioration in
credit quality at some point in the future. When used in combination, these are powerful tools.
11.2.a The Nature Of Credit Risk
Cyclical And Systemic Risks

Cyclical risks are those which result from underlying economic trends such as recessions, high interest
rates, or low commodity prices. These are systemic in the sense that all banks in the system will be affect-
ed by them, even if the extent to which individual institutions are affected varies. Systemic risks need not
be cyclical. They can include sudden exchange rate devaluations or external shocks, such as a funding cri-
sis due to political events. Cyclical risks pose a greater threat to emerging market banks, because cycles
can be severe. In contrast, there is no recent example of a developed-market bank failing solely as a result
of cyclical trends.
The Bank's Own Credit Profile
Banks can reduce credit risk by diversifying their loans among many sectors and borrowers. This can be
difficult to do in underdeveloped economies, where private sector activity may be dominated by a few
powerful families: although the number of companies to lend to may be large, they may all be ultimately
connected to the same shareholders who transfer money from one part of the network to another as the
need arises. Such concentrations may not show up in statistics presented by a bank (even if the bank dis-
closes information such as “loans to the 20 largest borrowers”). They may be visible only to the analyst
who knows something about the corporate market. (And such concentrations may not fall foul of local
regulations, or be exposed in published accounts.)
Sound lending procedures are the main way in which banks can reduce credit risks specific to their
own balance sheet. Lending applications need to be appraised by qualified personnel, and approved
through a committee system, with larger loans requiring the assent of senior executives. Loan perfor-
mance needs to be systematically monitored by staff other than the lending officer who first appraised the
application. But procedures in themselves do not ensure that mistakes are not made – Moody’s places
great emphasis on the existence within the bank of a credit culture. In systems where most banks were
state-owned and credit highly regulated, credit appraisal hardly existed – most credit was distributed in
line with government quotas and there was scant obligation to recognise non-performing loans. Many of
the senior people now running emerging market banks were brought up in this culture, and we think it is
often more difficult for them to make the change to a commercial lending culture than they would have us
believe. When analysing a bank’s credit policies we do attach importance to rules and procedures, but
equally important is the impression we get of the bank’s credit culture.
Regulation
Central bank regulations covering issues such as loan concentration and provisioning set a prudential
framework within which all banks operate. Of course, regulation in itself is not a guarantee against credit
quality problems, but clear rules clearly enforced provide an additional restraint on lax lending and provi-
sioning procedures. For example, we are reassured when we see that banks are automatically required to
provision a certain percentage of a loan after it is past due by a specified number of months.
Collateral
We take a cautious approach to the use of collateral in safeguarding a bank’s solvency. This is because in
emerging markets collateral can be hard to seize due to imperfections or delays in the legal system.
Questions may also arise about the realisable value of collateral (as opposed to the value at which it is
booked). Furthermore, a dependence on collateral is often a substitute for credit analysis – loans should be
extended on the basis of borrowers’ ability to repay, not on the bank’s ability to attach collateral if they do
not. When considering these issues with banks we would pose questions such as, How is the current value
of collateral determined? What form does the collateral take (e.g. cash, real estate, shares)? How frequent-
ly has the bank actually realised collateral and how long does the process take?

Off Balance Sheet Risk
The risk potential in off-balance sheet instruments should not be overlooked. The danger here is that a
counterparty is unable to perform on a contract, with the result that a contingent liability for the bank
suddenly becomes a very concrete one. The simplest example is when a bank is called upon to fund a guar-
antee due to the failure of a counterparty to fulfil their side of a contract. But problems with off balance
sheet instruments were also very evident during the Russian financial crisis which began in August 1998 –
some international banks had taken Rouble exposure and then hedged it with local banks who were unable
to fulfil their side of the hedging contract when the exchange rate collapsed. Those international banks
were left with serious losses. With regard to off balance sheet business, it is critical to ask who a bank’s
counterparties are, and what the nature of this business is.
11.2.b Measuring Credit Risk
Using Ratios To Quantify Asset Quality
Analysis of a bank’s asset quality involves looking back at past trends, looking at the state of the balance
sheet today, and looking forward to the bank’s ability to withstand a deterioration of asset quality in future.
All three aspects can be considered with the help of financial ratios.
Looking back: The ratio of non-performing loans (NPLs) to gross loans indicates whether a bank
habitually lends money to people who do not pay it back.9 If the ratio is high, the analyst would then pose
a series of qualitative questions in order to understand what lay behind that ratio: do these NPLs date
from many years ago when this bank, along with others, was forced to lend money according to govern-
ment quotas; or do these bad loans date from a severe recession, again many years ago? Quantitative
analysis is also possible by calculating a “run rate” – the proportion of new loans which go bad.10 Write-
off policies also have a big impact on NPL ratios – a bank which refuses to write off loans will have worse
ratios than one which does. It is quite common to see banks in emerging markets not writing off loans.
This is sometimes because there are tax, legal or regulatory restrictions on doing so, but it may also be due
to a hostile legal system which makes enforcement of contracts and guarantees difficult. It is important to
understand the reasons why a bank does, or does not, write off loans.
The next stage is to look at provisions constituted against NPLs. We would look not only at the ratio
of provisions to NPLs today but also at the underlying provision trend. The bank’s provisioning policy is as
important as the ratios which it displays today – is this a bank which takes an aggressive approach to provi-
sioning and so builds up a stock of general provisions during profitable years; or does it only provision in
response to an increase in NPLs and then always provision the minimum required by the regulators?
Assessing the position today: Having assessed the bank’s track record, we investigate where the bank
has arrived at, in terms of its credit strength today. A good place to start is to compare NPLs with the sum
of loan loss provisions and equity. If the ratio exceeds 100%, then if the bank had to write off all of its
NPLs, it would be insolvent. For obvious reasons, this ratio is colloquially known as “the dead bank ratio”.
Of course, it is a very crude measure: it is rare that all of a bank’s NPLs are a total loss, but on the other
hand disclosed NPLs may not include some supposedly performing loans which are in fact impaired.
Nevertheless, the “dead bank ratio” is a quick and easy way into assessing the state of the bank’s solvency.
If the ratio exceeds 100% the next stage is to see how many years’ worth of pre-provision profits would be
required to return the bank to solvency. If many years would be required, then the bank will likely have to
rely on capital injections from outside.
Looking forward: Provided that a bank’s solvency is not under immediate threat (a fact which would
be evident from the ratios used in the previous two sections), the most important part of asset quality
analysis is that part which looks forward, to assess the bank’s ability to survive problems in future. In most
cases, loan losses are in the first instance charged against profits, not capital, so the first ratio to look at is
that of pre-provision profit (PPP) to net loans. This ratio is asking the question, “Assume that all this
bank’s bad loans have been properly classified as such, and that adequate provisions have been made
against them (hence the usage of net loans rather than gross loans in the denominator), what percentage of
9 In this report, the term NPL is used in its generally accepted sense, meaning a loan which is not being serviced according to the terms under which it was
granted. Typically a loan would be classified as non-performing when interest is more than 90 days past due. In the United States, NPL has a very specific
and, in some respects, different meaning. That is not the sense in which the term is used in this report.
10 This would normally be done on a lagged basis –the increase in NPLs in 1998 might be be compared with the increase in gross loans in 1997.

its currently performing loans could be written off without the bank having to make a charge on reserves
and equity?” This is a crucial ratio. A bank which cannot cover its annual loan losses from earnings may
not be insolvent, but after two or three years of net losses it will start to lose reputation and market posi-
tion, and may cease to be a going concern.
The level of earnings/net loan coverage required varies from market to market. In emerging markets
economic recessions may arise more suddenly, and may be more severe than in developed markets. So
while in a developed market a bank with a 3% PPP/net loan ratio may seem secure (ie, it can write off 3%
of loans in a year with out impacting general provisions and equity) in an emerging market a 3% ratio
would generally not be seen as giving much security at all.
If earnings are insufficient to cover loan losses, a bank falls back on equity, including general reserves,
so we look at the ratio of reserves and equity to net loans. The principle is the same as for PPP % net
loans. The ratio asks the question, “What percentage of your currently performing loan portfolio could
you write off without being insolvent?”
We think these two forward-looking ratios are far more powerful predictors of bank insolvency than
historical ratios such as NPL % gross loans, useful though historical ratios are in getting a sense of how
the bank has arrived at its present position.
Whenever numbers and ratios are being analysed it is important to look at trends as well as static posi-
tions. The question to ask is, “If the current trend were to continue, what would the position be after a
few years?” Statistics on growth may be useful in highlighting changing patterns.
11.3 Market Risk

Market risk is multifaceted but can broadly be conceptualised in two areas:
• the risk of losses due to changes in market prices, such as exchange rates, interest rates and stock values;
• the risks associated with asset/liability management (ALM).
These risks are not discrete and that is what makes market risk so complex – ALM ranges from simple
liquidity management (having enough money on hand to pay maturing liabilities) to managing the effects
on profitability of a change in interest rates.
Emerging market banks’ exposure to market risk is increasing as the banks diversify their activities
away from lending, and as the development of emerging capital markets creates opportunities which enable
them to diversify in that way. We would also point out that market risk can be severe in emerging markets
– exchange rate movements, interest rate hikes, and stock market peaks and troughs are all liable to be
more pronounced in emerging than in developed markets.
On one hand, the scope for market risk exposure is less in emerging markets because capital markets
are less complex (albeit becoming more so) but on the other hand, bank executives are less experienced in
managing and measuring market risk. The greatest risk to emerging market banks here is that as a result
of deregulation, executives will rush to expand their bank’s operations into areas involving market risk of
which they have little experience.
We think it is important for banks to be aware of new risk management techniques, such as Value-at-
Risk (VaR), but in emerging markets it is often the case that the market risks which present the greatest
threats to a bank’s solvency are simple ones such as liquidity management, losses on marked-to-market
securities, and foreign exchange dealing – or, on the other hand, unforeseeable event risks which are not
captured in VaR measures but rather require management to run stress scenarios of their positions.
Emerging market banks’ exposure to market risk is increasing as the banks diversify
their activities away from lending…
Specifically, we would analyse the rationale for a bank’s trading activity (foreign exchange, fixed
income and equities) and the significance which it plays in the bank’s overall earnings profile. We are far
more comfortable with stable and secure trading revenues than those which fluctuate widely from year to
year, even if the latter approach leads to occasional years of spectacular profits. The volume of trading

activity should be appropriate to the size of the institution. If we hear in the market that a small bank
accounts for a large portion of a the banking system’s daily foreign exchange trading, we would be curious
to find out why.
11.4 Liquidity Management

Banks which fail usually do so because they are illiquid, not because they are insolvent.11 Strong liquidity
enables a bank to survive a time of difficulty such as a year in which it has to declare a large loss, or a period
of exceptional market volatility. Our analysis therefore focuses on a bank’s ability to fund itself under stress.
The point of departure is to look at the provenance of a bank’s funding. This includes not only the mix
of deposit and market funding but also the mix between domestic and cross border funding, and personal
and corporate deposits. The key is to have an appropriate mix from all these sources since that increases
funding flexibility. Important issues include:
• The presence of particularly large deposits whose withdrawal could cause the bank a problem. A state-
owned bank may have access to large deposits from government organisations. After privatisation it
might lose them. Large deposits from private sector companies could present a danger if the compa-
nies themselves run into difficulties.
• The presence of short term cross border funds. As the banking crises in Asia showed, these funds can
quickly be withdrawn if international sentiment about a country changes. (Whether such withdrawals
are based on informed sentiment is irrelevant. Bankers often tell us that there are no fundamental rea-
sons why foreign depositors should withdraw their funds. That may be so, but the fact is that deposits
are often withdrawn anyway.)
• The presence of major relationship depositors. Depositors with whom a bank has a relationship are
more likely to maintain their deposits at a time of stress. So a Korean industrial firm is less likely to
withdraw its deposit from a stressed Korean bank than a foreign bank simply looking for an outlet for
surplus funds. Banks often point out that many of their corporate deposits have been rolled over for
years on end, even though their contractual maturities are very short. In such cases, the key point is
whether there is any relationship element to the deposit. If not, these deposits are liable to be with-
drawn in a crisis, even if, during normal times, they have been routinely rolled over.
• The presence of domestic retail deposits as the primary sources of deposits. Domestic retail savings are
a secure form of funding. In a crisis these depositors often have nowhere else to put their money (other
than under the mattress) and do not have the wealth or sophistication to transfer their money abroad
during a crisis.12
• The presence of medium term debt. Medium term debt gives a bank some stable funding with which
to match long term assets. A bank with such medium term funding would usually be thought to have a
stronger balance sheet than one which did not. The only qualification concerns a bank’s ability to refi-
nance debt issues – not being able to roll over a “chunky” piece of medium term debt can put enor-
mous strain on liquidity. Normally this is not a problem, but at times of market turbulence it can be.
Liquidity analysis also involves looking at the asset side of the balance sheet, to see how many of the
assets could be liquidated quickly to cover a loss of funding. At one level, such an assessment is simple, since
most banks give some form of disclosure on the contractual maturities of assets. But at another level, it is
much more difficult, perhaps impossible to predict whether assets could in fact be liquidated at any price in a
severely disrupted market. This is particularly true of quoted stocks in emerging markets – if prices are head-
ing downwards on a thinly traded exchange, it can be impossible to sell even a medium sized tranche of
shares. If a bank has a large portfolio of local shares and locally-issued corporate bonds on its balance sheet,
questions should be raised as to whether these are really “liquid” assets, even if they are quoted.
Sometimes banking systems can seem completely illiquid on the basis of the contractual maturities of
assets and liabilities on the banks’ balance sheets. For example, in Kuwait until recently, a large proportion
of bank assets comprised 20 year government bonds for which no discount window or secondary market
11 Although the perception that a bank is insolvent often leads to it having liquidity problems.
12 During the civil war in Lebanon, retail depositors kept their money in the local banking system. Withdrawing cash and putting it “under the mattress” would
have been an extremely risky alternative at a time when houses were being commandeered by armed militias, the front line between warring factions was
constantly changing, and personal security on the streets precarious.

existed. (The bonds were a product of a bad-debt bail out). Yet Moody’s took the view that in an emer-
gency the Kuwaiti government would find a way to discount these bonds (either for the whole system or
for an individual bank) so as to prevent a bank defaulting.
11.5 Asset/Liability Management

The concept of Asset/Liability Management (ALM) includes the liquidity issues just discussed but extends
beyond them to the implications for profitability of a given asset/liability structure and, in particular, the
implications of any changes in the asset/liability structure.
The first issue to address is whether the bank is aggressively managing its assets and liabilities in order
to maximise profits – for example by deliberately running large maturity mismatches or large mismatches
of fixed and floating rate assets/liabilities. The risks associated with an aggressive strategy can be mitigated
by sound management and by the presence of a deep and liquid capital market through which exposed
positions can quickly be unwound. A well-managed bank should have a ready knowledge of the effect
which interest or exchange rate movements would have on its profitability; should be able to explain the
level of risk which it is prepared to assume; and demonstrate that the earnings generated by its chosen risk
profile are appropriate to the risks being assumed.
The next issue is the effect on the bank’s earnings and capital ratios of changes in market prices.
Perhaps the simplest such question is, “what would be the effect on the bank’s earnings of a one percent
parallel shift increase in interest rates”. The literature on ALM is voluminous and increasing. The key
analytic issues are outlined in our Bank Credit Risk study on developed markets. Those issues apply equal-
ly in emerging markets. We would highlight the following two points for those engaged in analysing
emerging market banks:
• In immature markets, volatility is greater and the value of precedent less. Estimating potential risk
over the next six months through reference to what happened during the last six months is less valid
than in more stable and deep financial systems. We treat with extreme scepticism statements like,
“Such-and-such could never happen in this market.”
• When disclosure is poor, it is difficult to estimate the extent of a bank’s exposure to asset/liability risks.
11.6 Operational And Other Risks

Operational risk refers to the likelihood of losses or market embarrassment resulting from errors, fraud or
incompetence in operations. Specifically, the emerging market bank analyst should look for:
• Management errors due to inexperience – for example managers in recently deregulated markets tak-
ing their banks into new areas of activity which they poorly understand. Or inexperienced traders pur-
suing aggressive strategies.
• Fraud or errors due to lax controls and poor standards of corporate governance. Such fraud and errors
are often facilitated by poor legal systems and a lack of generally accepted “rules of the game” circum-
scribing professional ethics. Russia is a prime example of a market where operational risk is high. Poor
internal auditing, and a lack of appreciation of why internal auditing standards matter also generate
operational risk.
• Faulty or misused technology is also a generator of operational risk. Dangers include improperly mon-
itored trading positions (which may be due to human rather than technological error) and errors of
payment transmission (as happened to some European banks on the introduction of the Euro).
Other risks to be considered include reputational risk – counterparties may pull back from a bank
which has recently been in the newspapers following a trading loss, or which is subject to a police probe.
Neither event may in themselves be significant, but they can set off a chain of reactions out of all propor-
tion to the original cause. Legal risk arises from the possibility that dissatisfied customers or employees
may sue the bank.
At least one type of risk can be associated with every aspect of a bank. But the naming and listing of
risks is only a preliminary step along a road which involves sifting those risks which are most likely to alter
the bank’s credit quality and then managing them.

11.7 Year 2000 (Y2K) Risk
The risk that a bank’s computer system may not be able to recognise the year 2000 is a serious concern.
We view the Y2K issue as an operational risk. In the run-up to the year 2000, analysts are questioning man-
agers not only on the ability of their computer systems to recognise the year 2000, but also on their contin-
gency plans to cope with any difficulties which occur either at their own banks, or on the part of their
counterparties, or within the wider economy. Within that operational context lie specific credit, reputation-
al and liquidity risks. (Eg, that a transfer owing to the bank cannot be completed due to computer failure.)
Many emerging markets “benefit” from the fact that their banking technology is not particularly
sophisticated and so the process of conversion to Y2K compatible systems may be relatively simple. On
the other hand, awareness of Y2K risk is often deficient, especially in the wider economy. An important
question to ask is, “How damaging for the system as a whole could a Y2K computer failure be?” In an
unsophisticated system with little integration into global payment systems the potential damage may not
be great. The converse is equally true. For more information and an assessment of how different emerging
markets could be affected by Y2K, see Moody’s report “Emerging Markets Banks and the Year 2000 Bug”
published in March 1999.
12. Economic Capital Analysis

There is a common misconception that the more capital a bank has, the stronger the bank is, and by
extension, the higher its rating. Moody’s sees no automatic correlation between the level of a bank’s regu-
latory capital and its credit ratings. Over the long term, earning power is a stronger predictor of bank
financial strength than regulatory capital. This applies to banks everywhere, but with one qualification – in
relative terms, capital is more important in emerging markets than in developed markets because volatility
is greater and there are more frequent occasions when a bank has to fall back on its final line of defence
before insolvency – capital. Nonetheless, we would stress that, even in emerging markets, small adjust-
ments in capital ratios are often of little consequence. The protection which an equity/assets ratio of 6%
affords against catastrophic risk is hardly different from a ratio of 5%. But a ratio of 20% clearly gives sig-
nificantly more protection than 6%.
There is a common misconception that the more capital a bank has, the stronger the
bank is, and by extension, the higher its rating.
12.1 Why Does Capital Matter?

Capital is the bank’s protection against unanticipated losses. Protection against anticipated losses comes
from provisions. Even general provisions provide protection against anticipated losses – against unspeci-
fied but anticipated losses as opposed to specific and identified ones. But the role of capital goes beyond
that. It enables the bank to leverage its balance sheet. A strong capital ratio therefore provides managers
with greater flexibility to manage their business. A tight capital ratio restricts balance sheet growth, which
over time may result in the loss of market position.
12.2 Capital Ratios Are A Management Issue

A bank’s capital ratio should reflect a bank’s risk tolerance, which in turn is determined by management as
part of strategic discussions. A low level of capital should indicate a more aggressive risk strategy (and
should be accompanied by higher returns). Heavy capitalisation indicates a risk adverse strategy, although
it should be born in mind that excessive capital (the amount over and above what is required to provide
appropriate risk coverage) is not a healthy attribute, since it implies that management is unable to identify
growth opportunities, and yet for some reason is unwilling to return this excess to the shareholders.
In our analysis of bank’s capital, the reason why the bank has a certain capital ratio is as important as
what that ratio actually is. If comparing two banks, one of which had a lower low capital ratio but where
the management could explain why that level of capital was appropriate to their strategy and balance sheet
structure, and another, more highly capitalised bank where the management had no capital strategy, we
would often feel more comfortable with the former. A few years ago, Moody’s assigned a new rating to a
bank which for the previous five years had been by far the most heavily capitalised in its system. Yet dur-
ing those five years the tier one ratio had fallen steadily from 19% to 12 %. When we questioned manage-

ment on what level of capitalisation they thought would be appropriate for the bank over the medium
term, executives were unable to reply, and fell back on repeating that their bank was still the best capi-
talised in the system. We found their response, or rather, the lack of one, worrying even though the bank
was indeed more heavily capitalised than its peers, exceeded regulatory minima and, in our estimation, was
at that time appropriately capitalised for the risks on the balance sheet.
12.3 Does Regulatory Capital Matter?

Regulatory capital is the cost to a bank of being in business – if it does not have as much capital as the reg-
ulators demand it is liable to be shut down. Yet regulatory capital ratios give a very imprecise indication of
capital strength. This is so even when regulatory capital ratios are based on risk-weighted models, such as
the Basle criteria.13
From Moody’s perspective, the main value of regulatory capital ratios lies in providing a defined floor
below which no bank may fall, and hence in providing a clear benchmark which would alert the authori-
ties to the fact that a bank was having serious problems. (Whether regulators set minimum capital ratios at
a high or low level, it is a ratio which every bank will take care to meet, since not to do so would involve
penalties and perhaps an order to liquidate. A bank which cannot conform to such an important require-
ment clearly has major problems.)
However, Moody’s makes its own judgements of what constitutes an appropriate level of capital and
that may be quite different from the level implied by local regulations. Our judgement is based both on
the level of risk in the system as a whole and the risk profile of the individual institution. Banks in emerg-
ing markets often say that they exceed the regulatory capital requirements by a certain amount. But that
does not tell us whether or not they are well capitalised, because our assessment of economic capital needs
is not necessarily the same as the local regulatory requirement.
12.4 Using Economic Capital

“Economic capital” is difficult to quantify but what we mean by economic capital is funds which are per-
manent and immediately available to absorb losses before general creditors are affected in any way. As a
result we attach primary importance to tier one capital rather than tier two. We also look for any hidden
reserves which may not be declared on the balance sheet but could be used to absorb loses. Issues such as
unrealised gains (provided that they could be realised in extremis) and unrealised losses also affect the level
of economic capital.
In developed markets, a lot of time is spent assessing the value of hybrid capital instruments, such as
preferred shares. This will become more relevant to emerging market banks as they start to issue more of
this type of instrument. Our approach is to ask whether these hybrid capital instruments are truly available
to absorb losses. For example, if banks miss dividend payments on preferred shares they risk being shut
out of capital markets, and in developed countries we have seen cases of banks in financial difficulties mak-
ing every effort to meet preferred share dividends while letting common dividends lapse. In such circum-
stances preferred shares resemble bonds rather than equity. Tier 2 capital is a broad concept, and we
always make a judgement about how “hard” it is. (The terms used are “upper” and “lower” with “upper”
tier two being harder.)
An economic capital ratio is the relationship between economic capital and the true risks on the bal-
ance sheet. Regulatory capital ratios, even those which are risk weighted, often give equivalence to assets
which clearly bear different levels of risk – a loan to a Aa rated US auto manufacturer company and anoth-
er to a Ba rated Asian finance company, for example. Now while the level of economic capital can be
quantified with a fair degree of accuracy (having taken account of country differences, such as the permis-
sibility of hidden reserves), the economic capital ratio is much more difficult to assess, since bank disclo-
sure is insufficiently detailed to permit a complete investigation of risk assets, and because any such inves-
tigation is inherently subjective.
Nevertheless, analysts can make a judgement about the relative riskiness of different banks’ balance
sheets. A balance sheet comprising mainly loans to Chinese companies is inherently more risky than one
comprising mainly loans to Western European companies. A highly leveraged balance sheet is ceteris
13 In June 1999, proposals to revise the Basle standards were announced. For Moody’s initial reaction to the proposals, see our Special Comment, Implications
for Banks of the Basel Committee’s New Capital Adequacy Proposals, June 1999.

paribus more risky than a less leveraged one. Equity participations are generally more risky than loans.
Banks in a country which is at the top of an economic cycle are more likely to be at risk than those in a
country which is mid-way through a cyclical upturn. These criteria are not quantitative, but if intelligently
used they enable the analyst to make a judgement about the relative risks which a bank is taking.
In June 1999 we published a Special Comment which compared the economic capital of Mexican
Banks with their reported regulatory capital.14 We found that while all large Mexican banks showed rea-
sonably healthy capital ratios based on regulatory capital, nearly all had negative ratios on the basis of eco-
nomic capital. Steps taken to calculate economic capital included the following:
• Liabilities were increased by the unreserved portion of past due loans.
• We assumed that official estimates overstated the likely recoverable proportion of loans covered by a
state-sponsored workout (Fobaproa).
• Repossessed assets were valued at 75% of their reported value.
• The figure for “other intangible assets” was adjusted down by 50%
Appreciation of why economic capital is important should lead managers to consider internal capital
allocation – assigning portions of capital against lines of business. We think that internal capital allocation
is more likely to lead to banks having appropriate capital ratios, simply because managers are forced to
make a very detailed assessment of their true capital needs. Use of internal capital allocation is not yet
widespread in developed market banks, let alone those in emerging markets. However, even in emerging
markets, we expect managers to have an understanding that different classes of risk assets require greater
or lesser amounts of capital supporting them.
12.5 Economic Capital Generation Power

We attach considerable importance to a bank’s ability to consistently generate excess economic capital
from internal resources. Excess economic capital is capital which exceeds regulatory requirements and that
demanded by the market, after payment of dividends, allocation of provisions, etc. This excess capital is
what the bank uses for investment in new projects, acquisitions, and other franchise-building activities.
13. Management Strategies And Management Quality

Management quality is a key driver of bank financial strength, especially in emerging markets. In devel-
oped markets, our assessment of management is focussed more on management strategies — the ability of
management to do its job is rarely a major issue and tends to arise only in the context of a bank being left
without a CEO for some time (as was the case with Barclays in 1998/99). Issues such as
management/board relations are captured under the heading of Corporate Governance, considered above.
Management quality is important not only to avoid losses through loose lending and loose internal con-
trols, but also to formulate coherent and realistic business plans, and to see those plans through successfully.
13.1 Assessing Management Quality

When assessing a bank’s management we would ask the following questions:
• Do senior managers have appropriate experience? In emerging markets it is common to find managers
who have spent their lives working in a regulated, uncompetitive banking system, but are now at the
head of private sector banks in liberalised economies. Under the old system, the tools of their trade
were political contacts and influence. In the new system, they need to be commercial bankers.
• Is the bank being run by a dominant CEO or by a broad and cohesive team? Dominant CEOs can
be useful in pushing through overdue change and in making decisive strategic initiatives, but a dom-
inant CEO all too often becomes a domineering CEO, with the result that the expertise and opin-
ions of other senior managers are ignored and morale declines. There is also the problem that a
bank can lose direction if a dominant CEO suddenly leaves the bank. As analysts, we feel far more
comfortable with a bank which has a broadly-based senior management team with a demonstrated
ability to work together.
14 “Look Who’s Talking About Capital!”: The Mexican Banking System and Economic Capital.

• Is there a lot of management turnover? It is hard for a bank to pursue a consistent strategy if senior
managers are constantly leaving the bank. Furthermore, rapid turnover is usually indicative of dysfunc-
tions in corporate governance (e.g. micro-management by directors), a poor working environment, or
other deep seated problems. If managers don’t have faith in their own institution, we, as analysts of
that bank, want to know why.
• What is the quality of second tier management? “Second tier” managers are the people who actually
implement strategies formulated by the board and senior management. They are the people who have
to turn good ideas into action.
• How strong are internal controls? This issue has already be considered under “Operational risk”
above. The key point is less that a bank has control procedures formally laid down (although this is
important) and more that it has a culture in which the importance of control and audit is recognised.
• What constraints are there on managers’ freedom to manage? In many emerging markets, managers’
freedom of action is constrained by cultural factors or even by their country’s level of economic devel-
opment. It is often impossible to make staff compulsorily redundant, so a state bank’s inefficient
staffing structure can compromise costs and efficiency long after the bank has been privatised and
senior management changed. (This is one reason why mergers often make much less economic sense
in emerging markets – the scope for cost cutting is less.) As in developed markets, the role and power
of trade unions can compromise management initiatives. Management initiatives can also be hampered
by other factors – in the mid-1990s Lebanese banks were rebuilding their operations after a civil war,
but the process of linking branches on line and installing ATMs was delayed because the telephone
system was so unreliable.
Management quality is a key driver of bank financial strength, especially in emerging

markets.
13.2 Agreements With Foreign Investors

Foreign investors can bring a lot to an emerging market bank in terms of expertise and experience. They
have experience of introducing and managing more advanced products and more advanced technology.
They also have longer experience of credit cycles and consumer behaviour. Foreign investors may also
have some of their staff seconded into sensitive positions, such as head of credit or head of treasury. Such
foreign involvement almost invariably strengthens an emerging market bank’s management capability.
13.3 Strategies: Proactive, Or “Management By Inertia”?

An important part of bank analysis involves making a judgement about a bank’s strategic objectives and
about the likelihood that those objectives will be achieved. The point of departure is to find out whether
the bank has a strategic plan worthy of being described as such. All too often managers of emerging mar-
ket banks appear to have little sense of strategic direction beyond their immediate budget objectives
(“increase loans by 10% overall this year, and increase personal lending by 20%”). This is little more than
“management by inertia”.
When we ask managers about their strategic objectives what we are getting at is where they want to
position the bank in terms of its risk profile, customer base and product mix. Crucially, we see manage-
ment strategies as a process rather than as a checklist of goals to be achieved and crossed off. Changes in
market conditions, actions by competitors or just different priorities within the bank itself often make the
achievement of fixed goals elusive. That is not to deny any value to setting objectives such as “increase
market share to 10%” or “become the leading provider of auto-loans”. But we attach more importance to
the tools which management will use to achieve those goals, and the avenues along which they will travel
in pursuing them. We are more interested in the culture of management than in the precise goals them-
selves. That is because with the right culture and expertise managers will be able to respond to changing
circumstances and turn them to their advantage.

A key element of management culture is its risk appetite and this in turn is frequently conditioned by
the strength of a bank’s current franchise. Banks with weak franchises tend to embark on riskier strategies
with a view to rapidly increasing profitability and/or market share. Those with strong franchises not only
have less to gain from such a high risk strategy, but they also have more to lose. As a result, they tend to
pursue a more conservative course.
All too often managers of emerging market banks appear to have little sense of
strategic direction beyond their immediate budget objectives.
When banks find they are running out of opportunities at home, they often try to expand abroad. We
are sceptical of the value of such overseas initiatives unless there is a tie-in to the domestic market (eg,
trade and investment flows), or unless the bank is large enough to be a reasonably significant player in
whatever overseas markets it enters. Lending money as junior members of loan syndicates, in countries far
from the bank’s home base, to clients with whom it has no chance of winning related business (such as
L/C confirmations) is frequently a recipe for losses, however attractive the loan spreads may appear when
the money is offered. Many of the larger emerging market banks strain at the limitations of their domestic
economies. Cautious expansion into neighbouring countries where risks are well understood is one solu-
tion, but beyond that we think that the bigger emerging market banks would often be better off accepting
their fate as large banks in small markets, rather than embarking on over-ambitious strategies to become
medium sized players on the international stage.
13.4 Mergers And Acquisitions

The immediate commercial motivation for mergers and acquisitions (M&A) is often less apparent when
they occur in emerging markets. This is because the concept of shareholder value is less well established
(in shallow capital markets, stock prices may not reflect fundamental value) and because the scope for cost
cutting is often constrained by an inability to make staff redundant. But the non-commercial aspects of
M&A (personality plays by CEO’s, government pressure, and strategic positioning) are equally prevalent
in emerging markets, if not more so.
The impact of M&A on a bank’s rating depends on the motivation for the merger or acquisition, the
plausibility of post-merger strategic plans, the compatibility of cultures and business lines, and the relative
ratings of the two individual institutions. Management should be able to give a very clear account of what
the new institution’s balance sheet will look like, how earning power will be improved, and the manage-
ment structure of the merged institution.
The ability to merge with or acquire another institution is an important attribute in rapidly changing
economies. Mergers may be the only way for local banks to generate the size necessary to fend off large
foreign rivals who are allowed to operate in their home market for the first time. As new forms of financial
activity become significant (e.g. consumer loans, investment banking) mergers or acquisitions are often a
more efficient way of capturing a share of a new market than organic growth. 15
15 Mutual status can be a constraint in this respect, since a mutual bank would normally have to incorporate as a Public Limited Company (PLC) before being
able to buy or merge with another PLC. However, the experience of European mutuals is solutions to this problem are often available.

Title
Rating Methodology
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Emerging Banks Methodology

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Emerging Banks Methodology

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July 1999 Rating Methodology

Bank Credit Risk In Emerging Markets

2 Moody’s Rating Methodology

Common Factors When Analysing Banks In Developed And Emerging Markets . . . . . . . . . . . . . . . . . . . . . . . . . . .5

3. Emerging Market Bank Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

3.2 The Evolving Role Of Emerging Market Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6

3.3 Bank Credit Risk Is In Transition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7

3.4 Syntax And Semantics Of Moody’s Bank Ratings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7

3.5 General Vs Specific Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9

4. The Relationship Between Bank Ratings And Country Ratings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

4.4 Local Currency Ratings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

5. Key Differences Of Emphasis When Rating Emerging Market Banks

6. Rating Methodology For Emerging Market Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

7. The Banks’ Operating Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

7.1 Health And Structure Of The Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

7.3 The Effectiveness Of Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

7.4 Assessing The Importance Of External Policy Influences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

7.6 The Legal System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

8. Ownership And Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

8.1 Public Ownership And Privatisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

8.2 Private Ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

8.3 Why Governance Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Moody’s Rating Methodology 3

9.2 Market Position And Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

9.3 Market Share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

10. Earning Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

10.2 The Importance Of Non-Interest Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

10.3 New Lines Of Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

10.4 Line Of Business Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

11. Risk Profile And Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

11.2 Credit Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

11.3 Market Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

11.4 Liquidity Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

11.5 Asset/Liability Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

11.6 Operational And Other Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

11.7 Year 2000 (Y2K) Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

12. Economic Capital Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

12.1 Why Does Capital Matter? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

12.2 Capital Ratios Are A Management Issue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

12.3 Does Regulatory Capital Matter? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

12.4 Using Economic Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

12.5 Economic Capital Generation Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

13. Management Strategies And Management Quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

13.2 Agreements With Foreign Investors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34

13.3 Strategies: Proactive, Or “Management By Inertia”? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34

13.4 Mergers And Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

4 Moody’s Rating Methodology

3. Emerging Market Bank Overview

Geographic Breakdown of Assigned Bank Financial Strength Ratings

Moody’s Rating Methodology 5

3.2 The Evolving Role Of Emerging Market Banks

6 Moody’s Rating Methodology

As financial markets mature, it becomes easier for banks to be assigned higher

3.3 Bank Credit Risk Is In Transition

3.4 Syntax And Semantics Of Moody’s Bank Ratings

2 “Debt” refers to bonds or notes, including MTN programmes.

Moody’s Rating Methodology 7

Debt/Deposit Ratings Bank Financial Strength Ratings

8 Moody’s Rating Methodology

4. The Relationship Between Bank Ratings And Country Ratings

4.1 The Role Of Bond/Deposit Ceilings

Moody’s Rating Methodology 9

10 Moody’s Rating Methodology