Credit Rating – Global rating agencies, S&P, Fitch and Moody’s provide a rating to banks that allows investors compare their relative financial strength. The higher the rating the less likely the financial institution will default on its financial commitments. Ratings are arranged in a descending order with AAA the highest rating and D typically, lowest.

Credit Default swaps (CDS) are a type of insurance contract bought to provide protection against banks defaulting on their debt obligations. They are traded on an intraday basis and may be more representative of how the general market views the credit worthiness of comparable institutions on a real time basis. CDS are quoted in terms of basis points (bps). A CDS of 350 bps on 5-year debt means that it costs €35,000 per annum to provide insurance of €1 million on the default of that bank. The higher the CDS, the higher the cost of insuring and by inference the higher the probability the market assigns to a bank defaulting on its debt obligations.

Tier 1 Capital Ratio is a measure of a bank’s financial strength. It is the ratio of the bank’s equity capital to its total risk-weighted assets (RWA).   Equity capital comprises common stock plus reserves/retained earnings. RWA are total assets held by the bank weighted by their credit risk.

The higher the risk weighting the less the asset is valued on this risk weighted approach. The higher the Tier 1 Capital Ratio the better capitalised the financial institution is considered to be.

5 Year Bonds issued by banks trade on a secondary market. Investors can buy and sell them after they have been issued. The yield (or annualised percentage return) at which investors can buy or sell these bonds provide an indication of the creditworthiness of the entity. If the yield is higher than the yield at issue then investors consider lending to this entity to have become more risky. Conversely if the current yield is lower than the issue yield investors consider it less risky to lend to the entity.