A Challenging European Credit Outlook

The fiscal exit strategies of Europe’s major economies will play a major part in the region’s recovery from the global financial crisis, according to Fitch. The ratings agency’s 2010 European Credit Outlook also predicted that the gap between the strongest and the weakest banks would continue to grow, and although there was a lack of appetite for bank failure, fiscal ‘safety nets’ were not as strong as previously.

Fiscal policy, the key driver of recovery, needed to be strongly pursued by European governments, according to Brian Coulton, head of EMEA sovereigns and global economies at Fitch. “The fiscal exit strategies of Europe’s major economies will play a key part in the outlook for sovereign creditworthiness this year and economic recovery and the withdrawal of discretionary stimulus will not be sufficient to stabilise and reduce public debt ratios.” He said that it was vital for governments to set out medium-term adjustment plans soon to create low inflation and sustainable public finances – and that these would be judged on the size and speed of measures announced, as well as their track record.

The report said financial flexibility had been key to explaining the differing effects of the crisis on individual European countries. For example, Ireland, despite the continued strong performance of its export sector, suffered considerably from its limited financing flexibility while France, despite lacking a track record of debt reduction, has benefited from strong financing flexibility.

Fitch’s view was that there was an urgent need for the UK to set out a ‘robust’ programme to reduce public debt. “Halving the debt over [the planned] four years is just not fast enough,” Coulton said.

He added that, despite predicting that a ‘double dip’ effect would not be seen in the economy: “Our three-year view is no more positive than that.” This was partly because, across Europe, there had been a much bigger drop in gross domestic product (GDP) than could be explained by quantitative easing. “It has gone much further in some countries. A year ago we thought the bailout would be the biggest part of public debt.” This has not been the case, with deficits and recessions accounting for a significant part of this.

According to Fitch, the ratings agencies also had their part to play in the recovery. “The need for certainty needs to be very harshly stressed. When the markets came to a shuddering halt, very few things proved to be liquid,” said Paul Taylor, group managing director of Fitch.

He enumerated the changes Fitch had implemented, including a much stricter separation between those carrying out analysis and those carrying out transactions. The establishment of a group credit officer, a non-externally facing role with a view of the macro picture, was also intended to ensure a realistic view in future of institutions’ credit positions.

The current financial challenges would continue for some time, said Julia Peach, head of EMEA financial institutions ratings at Fitch. “We expect continued, albeit moderate downside pressure on European bank ratings throughout 2010 as significant challenges remain: the need to raise additional capital and pressure on profitability in light of enhanced liquidity standards and deteriorating asset quality.”

Banks were continuing to step up their capital ratios against certain types of trading risk, Peach said. “There is a need to generate enough revenue to offset impairment charges. Further efforts to raise capital may be required.”

However, the ‘widening chasm’ between the strongest and the weakest banks was an increasing cause for concern. In some countries, there was a range of between less than 1% and up to 10% in the proportion of loans held that are impaired. This could be exacerbated, Peach said, by weaker governments’ differentiation between banks they consider systemically important and those they don’t.” She added: “It may be that the latter become the unwanted orphans in the workhouse of state ownership.”


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