Prolonged Market Stress Is Negative For European Bank Credit Profiles

by: Research Recap

Fitch Ratings says that while share price declines and credit spread widening among European banks will not in themselves trigger rating actions, if the current heightened market risk aversion persists for a prolonged period, pressure on liquidity, profitability and eventually capital positions will negatively affect banks’ credit profiles and ratings.

Volatility and uncertainty across capital markets reflect increasingly acute and negative sentiment towards the overall banking sector. Furthermore, markets often appear not to be distinguishing between fundamentally healthy banks and weak banks, which causes concern as banking is a confidence-sensitive industry.

In Fitch’s view, several related factors are driving market volatility. The main driver is market concern about how the euro zone crisis will be resolved; in particular whether there will be an orderly, comprehensive and durable resolution or a ‘disorderly’ and thus more negative scenario. Markets are also increasingly questioning the aggregate impact of heightened regulation on banks’ earnings and risks to unsecured investors of evolving bank resolution or ‘bail-in’ regimes. Finally, recent data reinforces concerns over potential tepid global economic growth.

Fitch believes that the political and economic complexities of the current crisis suggest that it will not be resolved quickly and could persist at varying degrees of intensity for an extended time. Market sentiment may ease at given points, particularly in response to various measures implemented by policy makers (e.g., the recent dollar funding scheme). However, the collective impact of the multitude of challenges reinforces Fitch’s view that credit risk, and thus ratings, for many large and currently highly rated banks face greater downside pressure.