Eurozone debt crisis risk 'most immediate' for banks

Risks for banks linked to the eurozone are "significant;" banks in emerging markets have better prospects, according to Moody's

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Banks’ asset quality and growth prospects will be under pressure this year because of weak macroeconomic fundamentals, with many European systems facing “continued deterioration in sovereign strength” while fiscal consolidation dampens consumer and business confidence, Moody’s said in a report on the outlook for the banking sector.

Banks in emerging markets and Asia in particular have a “considerably better than average” growth outlook, the rating agency added.

“Risks related to the euro area sovereign debt crisis remain most immediate” because of the tight links of financial firms and markets and the region’s importance as a trading partner for many other countries.

“The risk of generalized financial contagion and investor retrenchment remains significant, even absent an actual sovereign default, and bears close watching during 2013,” Moody’s said.

According to the agency, many banks, especially in Spain, Italy, Ireland and the UK, need “material amounts” of additional provisioning to clean up their balance sheets completely. The risks to asset quality are highest for exposure to commercial real estate and to small and medium-sized companies.

“Some banks have in recent years delayed full recognition of embedded loan losses, partly by restructuring loans,” the report by Moody’s shows.

“This strategy of buying time (often tolerated by regulators) limits a bank’s capacity for new lending and poses risks for creditors of European banks.”

2013 will be “another volatile year” for banks in Europe, as the economic slowdown has weakened the ability of private and, in some cases, public sector borrowers to service their debt, the rating agency warned.

LOW RATES HARM US BANKS

Banks’ earnings are also weighed down by increased credit expenses coupled with continued low interest rates, it said.

Low interest rates undermine banks’ profitability in the US as well.

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“With their large exposure to commercial and residential real estate, and despite progress made to date in addressing legacy asset quality issues, US banks remain vulnerable to a contraction in the economy,” the rating agency said.

It warned that the narrowing of the net interest margin was making banks “hungry for loan growth” and as a result they have “already begun to relax loan standards after they were tightened in response to the financial crisis.”

“This loosening will be further encouraged by greater risk appetite from the bond market, which the banks compete against in providing financing to their clients. Another threat is that banks take on greater credit or extension risk in their securities portfolios to achieve higher yields.”

By contrast, Asian banks are expected to remain generally isolated from the negative pressures on credit that plight their Western peers.

The rating agency sees “modest cyclical rises in non-performing loans (NPLs)” in many countries in the region in the first half of the year, especially in those focused on trade and most affected by the global economic slowdown.

However, NPLs are likely to peak in the first half of the year as the economic recovery takes root.

The main challenges for Asian banks will be the hot money inflows and asset price rises that they bring, said Moody’s, noting that housing prices have hit “historic highs” in many countries, particularly in Hong Kong, Malaysia, Singapore and Taiwan.

“This will add to the risks that future problems for Asian banking systems are building in this expansionary climate,” it said.

DELEVERAGING TO CONTINUE

For Central and Eastern Europe, exposure to the ongoing eurozone debt crisis remains a risk, but Moody’s does not expect the already high NPLs to increase at a fast pace this year, echoing opinions by the EBRD that the worst may be over for the region.

In Latin America, economic growth will continue, with Moody’s expecting Brazil to pick up this year, which bodes well for banks.

The main risks for both Emerging Europe and Latin America are external and include slower global growth, further fall in demand from eurozone countries and China and a sharp reversal of the high liquidity/low external interest rates environment.

Retrenchment of weakened parent banks in both areas is likely to continue, with Western European groups in Central and Eastern Europe and Spanish banks in Latin America posing challenges for regional subsidiaries through dividend requirements, contagion and shared infrastructure and event risk, according to the rating agency.

In Latin America, regional integration will continue to offset to a certain extent the retreat of Spanish banks.

Moody’s expects cross-border acquisitions in the financial sector in the region to continue, spearheaded by Brazilian, Chilean and Colombian banks.