Morgan Stanley: Why We Are Skeptical Banking Sector Turmoil Is Behind Us

By Vishwanath Tirupattur, global head of Quantitative Research at Morgan Stanley

In the euphoria of buoyant equity markets over the last few months, the many challenges facing regional banks have receded into the background. While it certainly has not been our view, a narrative has emerged that the issues in the sector which erupted in March are largely behind us. Moody’s rating downgrades of 10 US banks last week provide a reminder that the headwinds of increasing capital requirements, higher cost of funding, and rising loan losses continue to challenge the business models of the regional banking sector. While the total volume of debt downgraded thus far is relatively small at around $10 billion, Moody’s put six banks on review for possible downgrade and changed the outlooks of 11 banks to negative from stable. Thus, the volume of bank debt facing the prospect of a downgrade is much higher – well over $100 billion.

Moody’s ratings actions come on the heels of proposed rules to modify the capital requirements for banks with total assets of $100 billion or more (from an interagency group made up of the Fed, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency). Separately, the Fed has proposed a capital rule on implementing the capital surcharge for the eight US global systemically important banks. It is still early in the rulemaking process for both proposals; they may change after the comment period, and the rules will be phased in over several years once they are finalized. Nevertheless, they outline the framework of the regulatory regime ahead.