Notching in Credit Ratings: What Australian Borrowers Need to Know (2025)

When Australians think about borrowing, investing, or dealing with banks, the world of credit ratings is rarely front of mind. Yet, in 2025, a technical concept called notching is quietly influencing the rates you pay, the risk banks take, and even the yields on your super fund’s fixed income investments. If you want to get ahead financially, understanding notching could give you an unexpected edge.

What is Notching? The Mechanics Behind Credit Ratings

Notching is a nuanced tool used by credit rating agencies (like S&P Global, Moody’s, and Fitch) to adjust the credit rating of specific financial instruments—such as bonds, loans, or hybrid securities—relative to the overall credit rating of the issuing entity.

• Base rating: A bank, company, or government is given a headline credit rating (e.g., AA, BBB).

• Instrument-level risk: Not all debts are equal. Some have more security, collateral, or seniority in a wind-up. Others are riskier, lower-ranked, or have complex terms.

• Notching adjustment: Agencies apply “notches” up or down (often in increments of one-third of a rating category) to reflect these differences.

For example, if a bank has an issuer rating of A, a senior unsecured bond might be rated A-, while a subordinated hybrid note could be notched down to BBB or lower. This process ensures that investors and regulators can accurately compare the true risk of individual products.

Why Notching Matters in Australia: Real-World Impacts in 2025

Notching isn’t just theoretical—it has major practical consequences for Australian borrowers, banks, and investors in 2025.

1. Loan and Bond Pricing

Banks use notched ratings to set interest rates on everything from business loans to mortgage-backed securities. A lower notched rating means higher funding costs for the bank, which often gets passed on to borrowers. For instance, a corporate borrower with a notched-down bond may face a premium of 0.20%–0.50% compared to a higher-rated peer.

2. Bank Capital Rules

APRA’s 2023–2025 bank capital reforms have tightened the relationship between risk and capital. Notched ratings play a direct role in determining how much capital banks must hold against different exposures, particularly for hybrid securities and structured products. As a result, banks are more sensitive to how their instruments are notched—and may alter product design or pricing to mitigate adverse impacts.

3. Superannuation and Investment Portfolios

Australian super funds and asset managers rely on notched ratings to construct compliant, diversified portfolios. Under ASIC’s 2024 guidance, funds must demonstrate that their “investment grade” allocations reflect the true, notched risk of underlying assets—not just the headline issuer rating. This has led to some funds rebalancing portfolios away from lower-notched debt, impacting yield and risk profiles for everyday Australians.

4. Case Study: 2025 Green Bonds

The surge in green and sustainability-linked bonds in Australia has spotlighted notching. Many green bonds are structurally subordinated or have unique covenants, leading to heavier notching compared to standard senior debt. In 2025, a major Australian bank’s green bond was notched two levels below its senior debt due to “structural subordination”—a warning for investors chasing yield in the ESG space.

How Notching Is Evolving: Trends and Policy Updates for 2025

• Climate and ESG Risks: Rating agencies are increasingly using notching to reflect climate risk, especially in sectors exposed to transition or physical risk. In 2025, several Australian utilities saw their subordinated debt notched down due to exposure to bushfire risk.

• Digital and Hybrid Products: The rise of digital banks and innovative debt products (like tokenised bonds) has forced agencies to refine notching criteria, leading to more transparency but also more complexity for investors.

• Regulatory Focus: Both APRA and ASIC have called for greater disclosure around notching and its impact on retail products. Product disclosure statements (PDS) for listed hybrids and retail bonds now require clearer language on how notching affects investor risk and returns.

What Should Borrowers and Investors Do?

• Don’t assume all ‘A-rated’ products are equal: Always check for instrument-level ratings and understand why a product may be notched up or down.

• Ask your bank or adviser: How does notching affect the price or risk of this loan, bond, or investment?

• Stay updated: Notching criteria and regulatory guidance continue to evolve. Watch for 2025 updates from major agencies and regulators.

Conclusion

Notching may sound like a technical footnote, but in the world of Australian finance, it’s a powerful force shaping the cost of borrowing, the safety of investments, and the stability of banks. In 2025, as regulation tightens and markets innovate, understanding notching could help you avoid hidden risks and seize smarter opportunities—whether you’re a borrower, investor, or just financially curious.