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Impacts of Australian Sovereign Rating Change on the Commonwealth Bank of Australia

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Executive Summary

Standard and Poor’s (S&P) believe there is a one-in-three chance that Australia’s sovereign rating may be lowered within the next two years. The purpose of this research project is to explore the potential impacts of a change in the Australian sovereign rating to the Commonwealth Bank of Australia (CBA) and provide key conclusions and recommendations for mitigating these impacts. Due to the relatively high probability of a rating downgrade to Australia’s sovereign rating, this is an important research topic as it has potentially material impacts to various stakeholders of CBA. As a sovereign downgrade impacts all of CBA’s main competitors, this is seen as somewhat of a benefit as it has minimal impact on their competitiveness. Key impacts have been identified through the investigation of S&P rating criteria, past events of downgrades for CBA and peers, comparisons to Europe and other sovereigns, academic literature, financial journals and news articles. From the investigation, it is believed that a sovereign downgrade to CBA may lead to a rating downgrade of CBA however this can be potentially mitigated and is also unlikely. This is due to CBA’s strong implicit government support, financials, is highly regulated and also currently complies with the Australian Prudential Regulation Authority’s (APRA) requirement for the big banks to be ‘unquestionably strong’. A CBA rating downgrade can be mitigated by improving their Stand-Alone Credit Profile (SACP) through various means but mainly through the reduction of wholesale funding exposure and deleveraging by increasing AUD15bn of equity. As a result, this is expected to increase funding costs by approximately 20bps, thus reducing profitability unless they are passed onto customers through increased lending rates. Research on the impact to shareholders appears to be somewhat contentious but minimal. The key factors appear to be the effect of the economy, expectations of government support, bank-level holdings of government debt and the nature of the rating downgrade. Overall it is believed that a fall in share price is unlikely. Implications regarding deposit rates, government, regulatory bodies and the RBA and employees are minimal as they are either already accounted for, pose no risk to a sovereign downgrade or immaterial due to the impact a sovereign downgrade has on CBA’s peers. Ultimately, to prevent a rating downgrade of CBA (based on S&P’s rating methodology) the recommendation for CBA is to improve their SACP by mainly deleveraging by raising AUD15bn equity and reduce wholesale funding exposure and attempt increase deposits. A key caveat of this strategy is that CBA may still be downgraded by one-notch following a sovereign downgrade if their anchor rating drops. Additional recommendations are further discussed in the recommendation section of this paper.


Credit Rating Agencies are key players in financial markets that provide independent opinions on the creditworthiness of debtors in terms of the debtor’s ability and willingness to make timely payments of debt and their probability of default.[1] Credit ratings range from C (highly risky, non-investment grade) to AAA (low-risk, investment grade, and strong capability to meet financial liabilities)[2] with notches in between (e.g. C+, BBB- which is the minimum rating for investment-grade, AA+, etc.). The credit ratings provided by credit rating agencies assist in bridging the gap in asymmetric information. Strong credit ratings for sovereigns are beneficial by providing wider to access financing on an international level.[3] Similarly, the same applies to large institutions such as CBA who have strong reliance on foreign investment. A rating downgrade for Australia’s sovereign rating would imply that the creditworthiness has decreased and could have flow on effects to CBA’s credit rating. This in turn could lead to restricted access to capital markets resulting in increased borrowing costs (lenders), lending rates (e.g. mortgages), reduced shareholder value as a result of lower profit margins, lower or limited growth in employee remuneration and government/regulatory intervention (e.g. stricter capital/liquidity requirements). By identifying the key impacts of a sovereign downgrade, recommendations have been derived so that CBA can position itself to mitigate the potential impacts of a sovereign downgrade. The key impacts identified are below which are explored in further detail in the Summary of Key Impacts:

  • CBA’s credit rating
  • Access and costs of funding
  • Lending Rates
  • Deposit Rates
  • Profits
  • Shareholders
  • Capital and Liquidity requirements
  • Government and Regulatory bodies and the RBA
  • Employees

Key Terms:

  • Sovereign rating – the credit rating of a sovereign which provides a view of its creditworthiness
  • Issuer Credit Rating (ICR) – S&P’s rating and view of creditworthiness of the  entity
  • Capital/Liquidity Requirements – minimum required ratios and levels of capital/liquidity enforced by financial regulators to ensure financial stability and robustness of the economy
  • Basel Accords (Basel I, Basel II and Basel III) – a set of recommended banking regulations to ensure that banks have sufficient capital to meet obligations and absorb unexpected losses.[4] Australia currently prescribes to the Basel Accords
  • Australian Prudential Regulation Authority (APRA) – a governing body for Australia’s financial services industry who aim to ensure “financial promises made by institutions we supervise are met within a stable, efficient and competitive financial system.”[5]

S&P Rating Methodology (for banks):

 Figure 1 S&P – Banks: Rating Methodolgy and Assumptions, Source: S&P Bank Rating Criteria  Figure 2 – S&P’s Bank Ratings Framework, Source: S&P Bank Rating Criteria In order to determine a bank’s rating, S&P makes an assessment on two main factors:

  • Stand-alone credit profile (SACP) of the bank
    • The SACP is based on six factors (see figure 3) where the first two factors (Economic and Industry risk scores) in figure 3 are a macro level assessment that apply the Banking Industry Country Risk Assessment (BICRA) methodology. These two factors are given a score from 1-10 (lowest to highest risk) and combine to provide an anchor SACP which is used as a “base” rating.
    • The remaining four factors are bank specific and range from -5 to +2 notches. These notches are netted on top of the anchor SACP.
  • Extraordinary support
    • The level of extraordinary support (i.e. government bail-out) aka “support uplift” is assessed.

These two main factors are then added together to determine the bank’s issuer credit rating (ICR).[6] Below in figure 3 is S&P’s bank rating for CBA in 31 Oct 2017, where they affirmed the long term AA- rating with a negative outlook and a short-term credit rating of A-1 (the highest). We can see that they have set the SACP to A- but due to the extraordinary government support, it received a support uplift of 3 notches, resulting in the final ICR of AA-. S&P rationalise the 3 notch uplift due to CBA being a domestic systemically important bank (D-SIB)[7], where they believe that the Australian government will be “highly supportive” to CBA in the event of a crisis.  Figure 3 – Sourced from CBA and S&P, 31 Oct 2017 S&P’s rating report for CBA explains that there is a one-in-three chance that the long-term and short-term ICR for CBA would fall to A+ and A-1 respectively. They state that this would be a result of either a downgrade to Australia’s sovereign rating to AA+ from AAA or a reduction in government support from ‘highly supportive’ to ‘supportive’.

Historical Ratings:

Snapshot of S&P’s Sovereign Rating History for Australia[8]

Date Foreign currency rating (LT/outlook/ST) Local currency rating (LT/outlook/ST) Country T&C assessment
Jul. 06, 2016 AAA/Negative/A-1+ AAA/Negative/A-1+ AAA
Nov. 01, 2005 AAA/Stable/A-1+ AAA/Stable/A-1+ AAA
Feb. 17, 2003 AAA/Stable/A-1+ AAA/Stable/A-1+
May. 17, 1999 AA+/Stable/A-1+ AAA/Stable/A-1+
Aug. 22, 1996 AA/Positive/A-1+ AAA/Stable/A-1+
Sep. 03, 1993 AA/Stable/A-1+ AAA/Stable/A-1+
Jul. 27, 1992 AA/Negative/A-1+ AAA/Stable/A-1+


CBA Credit Rating History [9]

Date Foreign Currency Local Currency
31-Oct-2017 AA-/Negative/A-1+ AA-/Negative/A-1+
07-Jul-2016 AA-/Negative/A-1+ AA-/Negative/A-1+
01-Dec-2011 AA-/Stable/A-1+ AA-/Stable/A-1+
21-Feb-2007 AA/Stable/A-1+ AA/Stable/A-1+

  Historically we can see that has been a 2-3 notch difference between Australia’s sovereign rating and CBA’s rating. In Dec 2011, CBA faced a downgrade where their ratings fell from AA to AA- as a result of S&P updating their rating criteria for banks. This one notch downgrade also applied to the other three big banks and was driven by the high reliance to foreign wholesale funding.

Summary of Key Impacts

CBA’s Credit Rating:

As per S&P’s rating methodology for banks, there are two core components which are used to derive the ICR for CBA – the SACP and extraordinary support. Therefore, it can be seen that there is a direct link between Australia’s sovereign rating and CBA’s rating. From the SACP perspective, S&P believe that CBA are among the strongest banks in the world in terms of their key earnings and asset quality metrics. They have however, highlighted in their Oct 2017 CBA rating report that CBA are materially dependent on offshore wholesale funding and are highly exposed to the recent rapid growth in property prices and private debt. This is seen as a key weakness in their creditworthiness. Under their BICRA methodology, CBA benefit from a strong Australian economy (81% exposure to Australia, 10% to New Zealand and the remaining to mostly US and UK) which has been resilient through negative cycles and external shocks (i.e. the 2009 global financial crisis). Furthermore, as APRA prescribe the Basel accords, S&P believe that the government and regulatory bodies of the Australian financial sector result in a very stable banking system. From the extraordinary support perspective, ceteris paribus, S&P believe that the support may reduce if the Australian government elect to align with other governments internationally, which have reduced the support of private sector banks. S&P have also stipulated that it is likely that the ratings of the big four banks in Australia are likely to lower in tandem with Australia’s sovereign rating if there was a downgrade. This link can be seen quantitatively with CBA’s exposure of approximately AUD 18bn in Australian sovereign debt (CBA Annual Report 2017). Comparison to other regions: The UK sovereign rating was downgraded by two notches from AAA to AA with a negative outlook as a result of Brexit, which S&P viewed as having a negative impact to the UK’s economic strength and certainty. During this period, there has been no impact to bank ratings (with the exception of the outlook changing from stable to negative) as a result of strong diversification and prospective adherence to regulatory capital requirements.[10] Less developed markets: In emerging markets, Williams et al. concluded that the rating changes of banks were sensitive to changes of the sovereign rating, depending on factors of “economic and financial freedom and macroeconomic conditions”. However, the higher the country’s GDP growth and external debt, the less likely a sovereign downgrade would result in a bank rating downgrade. They also found that private banks’ ratings were less likely to follow a sovereign downgrade than government owned banks. Ultimately, ceteris paribus, a credit rating downgrade for CBA is likely if Australia’s sovereign rating is downgraded. However, whilst the extraordinary support is independent of CBA’s control, the SACP is a factor that CBA can influence to mitigate a rating downgrade.[11] Chris Rands from Nikko Asset Management (NAM), believes that (ceteris paribus) by increasing its risk-adjusted capital ratio from the ‘adequate’ band to the ‘strong’ band, a AA- rating could be maintained. He highlights however that the there is a ceiling to the ratings uplift of AA- from an A+ SACP, therefore it is only advisable if CBA foresee a sovereign downgrade (to avoid unnecessary costs). Furthermore, increasing the capital for a rating uplift may be negated should the anchor rating be reduced. Chart 5: Rating matrix for government support Figure 4 – Likelihood of Extraordinary Government Support, source: S&P Bank Rating Criteria European Banks: In Drago and Gallo’s paper “The impact of sovereign rating changes on the activity of European banks”, they found that the impact of a sovereign downgrade has “a significant impact to domestic European banks in terms of their regulatory capital ratio, profitability, liquidity and lending supply[12]. They found that a sovereign downgrade resulted in reduced capital ratios, reduced lending supply and European banks having the tendency to increase their liquidity ratios.

Access and costs of funding:

Upon the downgrade of a sovereign rating, empirical evidence in Mensah et al 2017 that suggests an inverse relationship between sovereign ratings and funding costs. Their studies revealed that upon a sovereign rating upgrade, banks were provided wider access to funding in the international markets at lower costs compared to banks in lower rated sovereigns. Moreover, the size of the bank’s balance sheets appeared to have a significant impact to the cost of funding, with larger banks being able to achieve lower funding costs. On a sovereign level, Chen et al 2015 also support this notion, stating that changes in sovereign ratings have an impact on the cost of capital and the availability of credit. In the BIS’s paper, “The impact of sovereign credit risk on bank funding conditions[13], they identified four main channels of how a sovereign downgrade could impact a bank’s funding costs and access to funding:

  1. Increased funding costs due to large exposures of a bank’s sovereign portfolio (which are typically large for domestic sovereign debt).
  2. Decreased value of wholesale funding used by banks and liquidity from the central bank.
  3. Highly likely that it results in rating downgrades for domestic banks but more so for smaller banks and sovereigns.
  4. Reduction in a bank’s funding benefits from government guarantees.

Additional implications of a sovereign downgrade to banks highlighted include:

  • Increased the cost (via increased haircuts) or impairment/ ineligibility of sovereign debt used for liquidity (repos) and collateral purposes.
  • Increased risk of withdrawal of funds for banks that have higher exposure to short-term funding
  • Decreased investor demand for bank securities due to weakened public finance conditions
  • Reduced bank fee and trading income
  • Crowding out of bank debt issuance due to increased sovereign financing demand

In the case of CBA, they are Australia’s largest bank (but a non–G-SIB) and have the following funding composition (rounded) as of 31 Dec 2016:

  • Deposits and other public borrowings: 62%
  • Short-Term wholesale funding: 18%
  • Long-Term wholesale funding: 16%
  • Equity: 5%

Graph 1 Funding Composition of Banks in <a href=Australia*" /> Figure 5 – Funding composition of banks in Australia, Source: In the US Markets for US Bank Holding Companies, Karam et al. from the IMF, found that rating downgrades resulted in declines in access to non-core deposits and wholesale funding which was emphasised more so during the GFC. As a result, they saw reduced household lending but this was mitigated through increased liquidity and reducing exposure to rating sensitive sources of funding.[14]

Graph 6 Major Banks' Wholesale Funding Figure 6 – Source: RBA, Developments in Banks’ Funding Costs and Lending Rates pg. 48 Graph 2 Major Banks' Debt Funding Costs Figure 7 – Source: RBA, Developments in Banks’ Funding Costs and Lending Rates pg. 46

As per the RBA’s report “Developments in Banks’ Funding Costs and Lending Rates”, there is a large reliance of offshore funding – of the 32% of wholesale funding (which is relatively high compared to other sources – see figure 7), approximately two-thirds of wholesale funding for banks are sourced offshore (see figure 6). This was highlighted as a major weakness to CBA in S&P’s rating report. A sovereign downgrade would essentially lead investors to perceive CBA’s creditworthiness to deteriorate and therefore either limit the access to or increase the cost of offshore funding. This notion however has fallen under scrutiny from Assistant Governor, Guy Debelle of the RBA, who has firmly stated that the RBA would support the big four banks if their access to funding markets were limited.[15] The risk of increased funding costs of CBA upon a rating downgrade is limited due its conforming of the BASEL accords. Its financial stability has proven to be resilient through the cycles and CBA has the benefit of the RBA ensuring access to funding. To mitigate against the risk of reliance on short-term funding, CBA can increase the use of more stable funding sources e.g. long-duration bonds and retail deposits. Citi analysts have quantified the increased cost of funding upon a CBA rating downgrade (to A+) to a potential increase of 15-20bps in bank spreads.[16]

Lending Rates:

Lending rates are typically reflected by the cost of funding and the risk profile of borrower’s, with lending rates typically moving in tandem with funding rates as seen in the figure 7 below. The widening of the spread between lending and funding post the 2007 GFC can also be observed in figure 8 below which increased by approximately 50bps.

Graph 11 Major Banks' Lending and Funding Rates Figure 8 Graph 10 Major Banks' Lending Rates Figure 9

 Figure 10 – Historical RBA Cash Rate, Source: In recent times, there has been a divergence in lending rates for investor and owner occupied loans. This has been a reaction to APRA’s enforcement of limiting the growth rate of investor loans to 10% to ensure financial stability[17]. Historically, investors paid a 25-30bps premium over owner occupied loans but this has now widened to 60bps. As this applies to all big four banks, CBA’s vulnerability to providing competitive lending rates post a rating downgrade is limited to the investor lending landscape where non-ADI’s can compete.  Figure 11 – UK Cash Rate, Source:

Figure 12 – UK Mortgage Rates, Source: When we compare the lending rates during the bank rating downgrades of 2011, there does not appear to be a clear link. If a rating downgrade had a material impact, an increase in rates to account for increased funding costs upon would be expected. Furthermore, it can be observed that the lending and funding rates are highly correlated with the cash rate. This notion is further supported as evident in the falling lending rates in the UK after Brexit, where the cash rate had also fallen in the same period (see figures 11 and 12 above), despite bank rating downgrades.

Deposit Rates:

In the current competitive market, deposit rates are not the main driver for customers. Banks offer packaged deals which incentivise depositors to join them by offering combining products such as mortgages, credit cards, insurance, etc. Deposit rates are primarily driven by the cash rate, competitor’s rates and profit margins.  In the graph above, the bank deposit spreads to the cash rate subsequently increased following the one notch downgrade to the major banks in late 2011, suggesting that the downgrade did not have a negative impact to deposit rates. In the context of rising sovereign risk, this disconnection is also supported by what happened during the European sovereigns during 2009-11, where many sovereigns were downgraded, causing funding costs to increase. In this instance, the main driver of the increased costs were the wholesale markets as opposed to retail deposits. The figure 13 below shows that the rating downgrades had minimal impact to deposit rates.  Figure 13 – Source: CGFS Papers No 43, pg. 8 CBA has a strong reputation as Australia’s leading bank that offers a wide range of products that benefit their customers. With its already high rating, a two notch downgrade from AA- to A (Macquarie Bank’s current ICR) is unlikely deter depositors. The competitive landscape generally remains the same as the other big banks who would also suffer a downgrade and have fairly similar deposit rates. Furthermore the information presented in figure 13 above does not support a strong link between a rating downgrade and deposit rates.


The majority of a bank’s profits is primarily driven by lending money at higher rates (and lending fees) than their funding costs and to a lesser extent, providing financial services and trading financial instruments. The downgrade of CBA in late 2011 appears to have no impact on their profitability as seen in figure 14 below where net profit steadily increased from 2011 to 2015. In 2012, the net interest margin had dropped by 6bps from the previous year and was driven by higher wholesale and domestic deposit funding costs. This was partially offset by partially passing on these costs to borrowers through a 2% increase in average interest earning assets. S&P also agree that CBA have a strong track record of profits compared to their international peers, demonstrating resilience through the GFC, economic slowdown and commercial property downturn.[18]  Figure 14 – CBA 2015 Annual Report – Five Year Financial Summary pg. 68 Post Brexit, Moody’s changed the outlooks from stable to negative of 12 UK banks and societies, expecting that profitability to reduce. This can be distinguished from a sovereign downgrade of Australia as it has more far reaching consequences of “lower economic growth and heightened uncertainty over the UK’s future trade relationship with the EU to lead to reduced demand for credit, higher credit losses and more volatile wholesale funding conditions for UK financial institutions”. Overall, whilst a sovereign downgrade may result in increased funding costs, the expectation is that the impact to profitability will be minimised by passing on increased costs to borrowers. The impact also applies across CBA’s main peers and so they will be able to maintain their competitiveness. Deleveraging through equity raising (discussed in more detail in ‘Capital and Liquidity Requirements’) to improve the SACP (to maintain CBA’s credit rating) will also have an impact to profit margins but these too could be passed on to borrowers whilst maintaining competitiveness.


Sovereign downgrade: The impact of a rating downgrades is evident in Brooks et al. (2003)[19] where they found through their event study analysis that sovereign downgrades had a negative market impact to equity prices. In Australian markets, Creighton et al (2006) also share this sentiment where their studies showed Australian equities prices tended to fall on rating downgrades.  Correa et al. (2014) found that in general, equity prices for banks fell after a sovereign downgrade. They suggested three main factors which link sovereign credit risk and bank share prices – the effect of the economy, expectations of government support and bank-level holdings of government debt. However, share prices of banks with implicit government support in advanced economies were less sensitive to sovereign downgrades compared to those in less advanced economies. In the case of the former, shareholder value was bolstered by lower funding costs as a result of expected government support. Bank rating downgrade: On 20 June 2017, share prices for the big four banks fell after Moody’s downgraded their ratings (in line with S&P and Fitch) due to high household debt and rapid house price growth.[20] However, on 1 Dec 2011 when S&P downgraded the big four banks by one notch due to a revision in criteria, there appeared to be minimal or no impact to CBA’s share price, which closed higher than the previous day of the announcement. Notably, during this period, Macquarie Bank was downgraded two notches due to their high international exposure compared to the big four which were mostly domestic, yet still closed higher. When comparing these two instances of rating downgrades (2011 vs 2017), a key driver to the share price appears to be the nature of the downgrade.  Figure 15 – Macquarie Group Limited Historical Share Price, Source:

 Figure 16 – CBA Historical Share Price in 2017, Source:  Figure 17 – CBA Historical Share Price in 2011, Source:

AFR contributor Christopher Joye believes that in the case of the one in three chance of a sovereign downgrade, “If APRA requires the majors to raise… their RAC ratios rise above 10 per cent, they would earn SACP upgrades that offset both the sovereign and public support downgrades” and that it would ” compress shareholders’ returns on equity to around 12%”.[21] The findings above suggest that a sovereign downgrade may not necessarily have a materially negative impact to CBA’s share price as it has strong implicit government support, financial performance and is highly regulated. If however, CBA was to be downgraded whilst the sovereign rating was maintained but there was perceived increased risk in the economy, government support and bank-level holdings of government debt, then evidence suggests there is a possibility that its share price will fall. This however is deemed unlikely.

Capital and Liquidity Requirements:

APRA requires the big four banks to be ‘unquestionably strong’ by forcing them to hold sufficient levels of capital – CET1 capital ratios of at least 10.5%[22], above the Basel III requirements of 4.5%. They also require minimum leverage ratios of 3%, liquidity coverage ratios of > 100%[23] and net stable funding ratios >100%. This is to ensure financial stability in the economy such that the big four banks can withstand an economic crisis. Implementation of a Total Loss Absorbing Capacity (TLAC) regime has also been considered by APRA, so that the big four can align with G-SIBS. This would require them to replace AUD135b of existing debt at a 13bps premium.[24] S&P believe the capital ratio will rise in the short to medium term for the big four banks and that CBA will have no issues in meeting this by reducing dividends, employing dividend reinvestment plans or capital raising. They believe a common weakness among all the big four banks – limited qualifying liquid assets to meet liquidity coverage ratio requirements. The RBA has acknowledged this stating that Australia does not have a large supply of HQLA and that it is in high demand (from all big four banks).[25] As a result, the RBA has provided support in this case by providing committed liquidity facilities to these banks (mainly through self-securitised RMBS repos). In the context of a potential rating downgrade of CBA, NAM believe that CBA could maintain their rating from S&P if they were to improve their risk-adjusted capital (RAC) ratio of 9.1% (deemed ‘adequate’) to the 10-15% range (deemed ‘strong’). This can be achieved by raising approximately AUD15bn of equity[26] however as it is a more expensive form of funding, it is likely to have flow on effects to customers via increased lending rates. As a result, this would require a careful balancing act of maintaining the customer base vs profit margins. I.e. Higher lending rates could chase away borrowers but also reduce profit margins and therefore negatively affect shareholder value. The safest option may be to follow its peers, to mitigate this.

Government, Regulatory Bodies and the RBA:

In the event of a crisis, governments will provide support to banks that are large and systemically important (‘too big to fail’) to ensure that they continue as a going concern and maintain financial stability of the economy. In Australia, the big four banks have been defined as D-SIBs by APRA and there is evidence of the Australian government providing them government support under the Guarantee Scheme for Large Deposits and Wholesale Funding in Oct 2008 after the GFC.[27] This scheme ensured that the big four had access to wholesale funding in the capital markets at a reasonable cost. This allowed the big four to stay competitive amongst its international peers who also had received government support. Post the GFC, access to financing had been wiped out due to the great uncertainty and strong negative sentiment of banks. This was reflected in the massive increase in bank credit default swap premiums during this period, as seen in the figure 18 below. Graph 1: Banks' Senior 5-year CDS Premiums Figure 18 – Source: As mentioned previously, the RBA dismissed CRAs assumption that government support may weaken. CRA criticisms are also shared by Eiffinger (2012), where he states that CRAs have lagging judgement, flawed business models and provide “bad ratings”, stressing that there should be less reliance on them. The Basel Accords reacted to the GFC with Basel III which was a reform of Basel II and included additional capital and liquidity requirements including the requirement for systemically important banks to hold a minimum amount of common equity, a minimum liquidity and leverage ratio. The Basel Accords have been criticised in the past for allocating 0% risk weight to bank exposures to sovereigns however, the BIS has denied this stating that “Basel II and Basel III call for minimum capital requirements commensurate with the underlying credit risk, in line with the objective of ensuring risk sensitivity. This is the basic philosophy of the framework“.[28] Overall, this suggests that governments and regulators are unlikely to react to a one to two notch downgrade of CBA and instead maintain their focus on ensuring financial stability and robustness of the economy through the adaptation of the Basel accords. In any case, if there are any issues for the big four in accessing wholesale funding, the RBA will step in to provide support.


In the event of a rating downgrade of CBA, the company’s performance is expected to be effected through higher funding costs which in turn may reduce profit margins. Employee’s remunerations (particularly bonuses) are commonly tied to the performance of the company and so we would expect it to have a reducing effect. Employees play a crucial role in any company and a loss of key talent could have a material impact on the reputation and performance of the company. However, as a sovereign downgrade would have an impact across the wider banking industry, it is unlikely that CBA risk losing employees over a rating downgrade. There also does not appear to be any available literature to support the link between ratings and employee retention.


The key impacts addressed in this report have been investigated by considering past events of downgrades for CBA and peers (in 2011), Europe and other sovereigns, academic literature, financial journals and news articles. Below is a summary of the key impacts in the event of a downgrade of Australia’s sovereign rating:

  • CBA’s Credit Rating: In a worst case scenario, CBA’s credit rating may fall up to two notches from AA- to A as a result of weakened government support and no improvement in CBA’s SACP.
  • Access and costs of funding: Limitations to funding are minimal due to government support. Funding costs may increase (primarily driven by wholesale funding) due to market perception of reduced creditworthiness.
  • Deposit rates – no change cos rating downgrade applies to all banks so competitive landscape remains unchanged.
  • Profitability – past rating downgrades show minimal impact, increased funding costs passed on to borrowers to maintain profit margins.
  • Shareholders – may not necessarily have a material impact to share price due implicit government support, financial performance and highly regulated.
  • Capital and liquidity requirements – APRA already requires them to be unquestionably strong, increasing the requirements as time goes on. CBA abides by these. There is weakness in the RAC ratio but this can be improved.
  • Government, regulatory bodies and RBA – likely to step in if rating downgrade has an impact on availability of funding at a reasonable cost. RBA also dismissed CRA’s assumption of government weakened support, they will step in.
  • Employees – no clear link to rating downgrade and employee turnover.


The most viable way to mitigate the risks to CBA of a one in three chance that S&P downgrades Australia’s sovereign rating, is for CBA to improve their SACP via the capital and earnings and funding components. This can be improved by deleveraging via equity raising and reducing their wholesale funding exposure. Other avenues within the SACP include the funding component (average), capital and earnings, risk position and liquidity (all adequate). Given the nature of a sovereign downgrade, this has an impact on all of CBA’s main competitors and so it makes minimal difference to their competitive landscape. For capital and earnings, S&P have highlighted in CBA’s rating report that they expect CBA’s RAC ratio to stabilise in the 8.85%-9.35% range which is within the ‘adequate’ range within their SACP component. Improving the SACP can be accomplished by raising approximately AUD15bn of equity however, it should be noted that this is the most expensive form of funding. As a result, it may apply downward pressure to profit margins and shareholder value through dividend cuts and ROE. This may be partially offset by passing on the costs to borrowers and would also be favourable if the other banks followed suit (to maintain competitiveness). The benefit of going down this avenue is that it is in line with APRA’s requirements for the big four to continually increase their equity in the future. Another benefit is that there are no capital requirements to raising equity. S&P’s funding metrics are weakest at their stable funding ratio (94%) and their short-term wholesale funding to total funding base (20%). They could attempt to reduce their reliance on wholesale funding by adjusting their strategy to increase deposits through better rates but would have to factor in the potential reduction in profit margins. S&P also acknowledge the high competition in deposits therefore this may be a challenging task to accomplish. They can also attempt to improve their funding metrics by gearing towards more stable funding via longer term deposits and debt and re-composition of their debt maturity profile. Again, this would have to account for the increased costs of funding. In terms of liquidity, as the availability of HQLA is limited in Australia, CBA is limited to the availability of CLFs from the RBA. S&P have also highlighted the material reliance of wholesale funding which has been viewed as a negative rating factor. CBA’s risk position in light of their recent civil proceedings with AUSTRAC are deemed as manageable within their adequate range. CBA’s capital for interest rate risk sit at around 2% of its total risk weighted assets which S&P say align with their domestic and international peers. Again, they could increase their capital base but would have to weigh the cost and benefits in regards to a probability of rating downgrade. A key caveat to improving the SACP to mitigate against a rating downgrade for CBA, is that there is still the potential that a sovereign downgrade may still result in a one notch rating downgrade for CBA. This can occur if the anchor rating is further reduced as a result of increased risk in the high exposure (among all big four banks) to high household debt and rapid property price growth.


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[1] Standard and Poor’s Rating Definitions –
[2] These are the credit ratings for S&P and Fitch Ratings, Moody’s have a different rating notation.
[6] In most cases, the ICR is the same as the indicative ICR
[7] Australia-December-2013.pdf"> – page 18
[12] Drago and Gallo [Aug 2017]
[18] Pg. 7 in S&P’s 2017 CBA ratings report

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