Global banks have learned that nothing is as safe as it seems. These banks had gorged on all sorts of credit derivatives that the credit rating agencies had helpfully assigned the highest rating. There was a veritable AAA-bubble. A July report by the Bank of International Settlements said that only around 20% of fixed-income securities had a triple-A rating in 1990 and that this later jumped up to 55% of such assets in 2006, just before the North Atlantic financial crisis appeared on the horizon.
The AAA-bubble was one reason why risk was not priced correctly. What happened subsequently was a rude wake up call for many global banks, as securities that once seemed safe bets turned out to be duds. The banks are now getting a second shock. It is now increasingly clear that the sovereign bonds issued by governments are not that safe either. The fiscal crisis in Greece, Italy and some other European countries is a reminder that even government debt comes with certain risks attached. The hair cut that banks have to take on Greek debt is akin to a default by the Hellenic government.
The exterior of the Bank for International Settlements can be seen in Basel, Switzerland. (File photo)
The best credit rating should be available only to the strongest issuers, be they corporate or sovereign. Only 16 of the 131 governments rated by Standard and Poor’s now have an AAA rating. At one level this is a cause for worry but at another level it shows that there is more discretion in handing out certificates of safety.
It is still surprising that India --- for all its current troubles --- should have a lower credit rating than Italy. The same was the case with Greece not too long ago. It is quite likely that an Indian sovereign bond issued overseas would sell at a lower yield than a similar Italian bond. Most Asian governments probably deserve higher credit ratings than what they currently have.
The way global investors habitually perceived risks in the developed and developing countries led to issuers in the latter groups having to pay stiff premiums to raise money. There is now a structural case for the gradual narrowing down of this risk premium, as Asia emerges and Europe struggles.