The 15 banks downgraded by Moody's Investors Service late Thursday may face significantly higher costs when lending to one another, as well as when it comes to making sure they have enough cash on their balance sheets.
The ratings agency reviewed of 17 of the world's biggest banks - including 10 of the largest banks in the UK and Europe - and downgraded all but two of these.
Moodys' culled the ratings, and in some cases the outlooks, for banks in the UK, France, Switzerland and Germany and the US citing their heightened risk exposure.
"All of the banks affected by [the] actions have significant exposure to the volatility and risk of outsized losses inherent to capital markets activities," said Greg Bauer, global banking managing director at Moody's. "However, they also engage in other, often market leading business activities that are central to Moody's assessment of their credit profiles. These activities can provide important 'shock absorbers' that mitigate the potential volatility of capital markets operations, but they also present unique risks and challenges."
The four largest banks in UK didn't escape the credit rating axe.
HSBC, RBS and Lloyds all had their ratings downgraded by one notch, while Barclays faced a two notch cut.
RBS' long-term credit rating was cut to Baa1 from A3 while Barclays was downgraded by two notches from A3 to A1 and HSBC from Aa3 to Aa2. Moody's kept the outlook of all the three firms negative.
It also downgraded Lloyds TSB Bank by one notch from A1 to A2.
Switzerland saw the downgrades its two incumbent banks. The credit rating at Credit Suisse was axed by three notches while UBS was lowered by two notches. In France, Societe Generale, Credit Agricole and BNP Paribas were also downgraded, with the latter two having two notches deducted and SG with one.
And in Germany, Deutsche Bank's long-term deposit rating was culled by two notches to A2 but with a stable outlook.
Across the pond, Moody's culled the ratings for Bank of America, Citigroup, Goldman Sachs, JP Morgan and Morgan Stanley.
While market reaction remained muted, due to investor consensus widely expecting the credit rating cuts, the knock-on effects of the downgrades could mean far greater damage to banking sector and wider economy.
"Banks and governments, governments and banks; investors are finding it ever more difficult to tell them apart," said Dr Pete Hahn at the Cass Business School."The tragedy is that, as a result of the weaker ratings, market capacity is now likely to be further reduced due to collateralisation demands on banks. Businesses need to find alternatives."
Out of the recently downgraded banks, the ones that rely heavily on markets for funding will find they have a battle on their hands.
The lowering of their credit ratings will make funding conditions worse as the price for funding will rise.
"Markets tend to discriminate more between issuers at lower ratings - in terms of funding costs - particularly during times of stress," said Citigroup analysts.
Indeed, some banks such as RBS hit back at the downgrades saying that it does not only disagree with the ratings action but it is also significantly going hurt them when it comes to funding.
"The group disagrees with Moody's ratings change, which the group feels is backward-looking and does not give adequate credit for the substantial improvements the group has made to its balance sheet, funding and risk profile," said the bank.
It also estimated that RBS' downgrade could mean it needing to find an extra £9bn in collateral for its debts.
In the US, outspoken analyst, Dick Bove also waded into the argument and said that the global ratings actions were "absurd."
"This is one of the most absurd things that Moody's has ever done perhaps in the history of the company," said Dick Bove, Vice President of Equity Research in the Financial Sector at Connecticut-based Rochdale Securities. "In any metric that you look at... the banks have shown improvement in earnings in every one of the past 11 quarters year over year. If you go into the bond market, where Moody's did the downgrade, prices of bank bonds are going up. Not only are they going up, they are going up faster than the prices of Treasurys, so what in heavens' name is Moody's doing?"
The comments have caused concern that banks will first of all tighten up on lending and thus stalling the economy further.
While the UK government warned that banks should not to use the downgrade as an excuse to charge more for borrowing on the high street, this is usually what happens when banks need to hang onto cash.
This week, Britain's biggest business group CBI said that the fragile economic recovery was at risk of being "choked off by a lack of finance".
Furthermore, credit ratings help determine what banks must pay to borrow money on international markets and therefore, the lower the rating, the higher the interest rates they pay and the more collateral they must offer.
Capital requirement pressure
At the IBTimes UK, we have consistently reported how European banks are fighting hard to shore up their balance sheets in time for regulatory changes that force them to hold a certain level of cash, in case of another major market crisis, just as they're being battered for not lending as much as governments would like.
Enforced and impending global regulatory changes have been designed to prevent another banking industry collapse.
At the centre of these changes are capital requirements and due to the substantial amount of cash that banks are legally required to hold, banks have been staggering towards the future enforcement date.
In Europe, Basel III commitment rules that the minimum requirement for banks' tier-one capital ratio (ratio of equity capital to risk-weighted assets [RWA]) has been raised from 2 percent to 4.5 percent and is effective as of 2019.
Lenders will also need to add a "conservation buffer" of 2.5 percent, meaning banks must hold a total core capital equal to 7 percent of their RWA.
Furthermore, European Banking Authority (EBA) published its formal Recommendation in December last year, and the final figures, related to banks' recapitalisation needs, which revealed that European banks must raise €114.7bn of additional capital buffers by June this year, which is 8 percent more than its initial estimate of €106bn.
Critics said that asking banks to keep capital requirements at such a level, on top of other regulatory pressures, will hurt lending. However, the EBA hit back and said that "as a result of the crisis, the deterioration of credit quality and the difficulties in attracting new funding, banks already started to reduce lending activities."
But it doesn't stop there.
In the UK, plans are ramping up to enforce the recommendations under the Vickers Report after the Osborne released the treasury's "White Paper" - a step which is usually followed by draft legislation that will be voted on by lawmakers.
The White Paper, which takes most of Vickers' recommendations, calls for a 17 percent capital buffer - the sternest of any country in the world apart from Switzerland.
Government estimates suggest the rules will cost the industry as much as £7bn a year.
Banks with larger international operations that don't put Britain's financial system at risk, such as HSBC, will be exempt from portions of the new capital rules.
Banks will likely need an extra £19bn to meet compliance, the government said, and it the legislation will be in place by 2015.