February 17 (SeeNews) - Moody's Investors Service said on Tuesday the modernized banking system in eastern Europe is more vulnerable to financial and macroeconomic stress and this puts downward pressure on the ratings of their western European parent banks.
“The current challenging operating environment in Eastern Europe has already resulted in a significant number of negative rating actions for banks operating in this region. Moody's expects continuous downward pressure on East European bank ratings as a result of weakening financial metrics predominantly driven by deteriorating asset quality and vulnerable liquidity positions,"Moody’s said in a summary of its latest report on the banking sector in the region.
The report 'West European ownership of East European banks during financial and macroeconomic stress' observes that after years of strong economic growth, East European countries, including central and eastern Europe, southeastern Europe and the Commonwealth of Independent States, have now entered a deep and long economic downturn, thus exposing West European banks' claims on East European institutions.
Moody's acknowledges that whilst East European countries differ in terms of vulnerability, the investment grade countries exhibiting the highest external vulnerability tend to be those displaying sizeable fiscal deficits, like Baltic countries, Hungary, Croatia, Romania and Bulgaria.
Nonetheless, the rating agency also notes that several countries in the region, including Ukraine, Kazakhstan and Russia, are under pressure even though their public sectors have relatively little external debt.
West European parent banks of East European subsidiaries are primarily located in six countries - Austria, Italy, France, Belgium, Germany and Sweden - which account for 84% of total West European banks' claims on Eastern Europe.
Moody's notes that from a creditor point of view, the Austrian banking system is most exposed as Eastern Europe accounts for nearly half of that country's global bank claims. Italy's claims account for 27% of the total, mostly concentrated in Poland and Croatia, whilst Scandinavian banks claim the vast majority of the Baltic States' banking systems.
The rating agency also says that the activity of West European banks in Eastern Europe concentrates on very few banking groups, with Raiffeisen, Erste Bank, Societe Generale, UniCredit and KBC representing the strongest and most widely present Western players in the region, and this concentration, in turn, presents further rating implications.
Deteriorating financial strength of East European subsidiaries has a negative spillover effect on their West European parents. Maintaining a robust risk-return profile during a downturn in the untested and still more volatile East European markets will prove a challenge going forward, Moody's says.
A widespread deterioration in the economic health of core markets in Eastern Europe is exerting negative rating pressure on subsidiaries' and eventually may also lead to a weakening of the parent bank's ratings assuming East European activities represent a significant part of total banking activities of the parent, it adds.
This deterioration may lead to more selective support provided by West European parent banks to their subsidiaries, putting further downward pressure on their ratings. Most West European banks have several subsidiaries in the region and may carefully balance strategic importance, past investments, expected earnings and country risks.
Banks allocate capital to their subsidiaries depending on expected risk-adjusted returns. Thus, risks are particularly skewed to the downside in countries that have been identified as more vulnerable and that will post very weak or even negative economic growth in the medium term, the rating agency said.
Any evidence of reduced parental support and/or a deterioration of the quality of such support; like the parent Bank Financial Strength Rating (BFSR), exerts downward pressure on ratings in Eastern Europe. In addition to that, Moody's expects continuous downward rating pressure on East European subsidiaries as a result of further weakening of the parents' BFSRs as well as selective strategic actions by parents demonstrating weaker support to their subsidiaries.