Fitch on European Banks
German, Italian Bank Prospects at Risk From Russian Gas Cut-Off
Fitch Ratings said that Banks in Germany and Italy are among the most exposed in western Europe to a potential halt in Russian gas supplies in a recent commentary.
Western Europe will face a serious macro shock if supplies are cut off, with Germany and Italy likely to be the worst-affected of the major economies. The shock would weaken business prospects for banks, and Fitch would be likely to lower its German and Italian banking sector outlooks to ‘Deteriorating’.
The recessions in Germany and Italy triggered by a Russian gas cut-off would weaken loan demand, dampening the business prospects for banks and leading to higher loan impairment charges. However, we expect the vast majority of German and Italian bank ratings would be resilient as the banks generally have strong asset quality relative to their ratings, sound capitalisation, and earnings tailwinds from rising interest rates.
German banks could face material asset quality deterioration if Russian gas supplies are cut off, particularly from their exposures to vulnerable corporate sectors. But asset quality is not an immediate rating sensitivity for most German banks given their sound asset quality indicators, so we would not expect widespread downgrades as a result.
Several German banks have carried out stress tests on the impact of a complete Russian gas cut-off while recognising that the results are subject to a high degree of uncertainty. The stress tests show that the consequences could be significant but not, we believe, enough to affect ratings.
Deutsche Bank, for example, expects its allowances for credit losses in such a scenario would increase by up to about 20bp of gross loans over a period of 18 months. This is compared to an annualised cost of risk of 22bp in 1H22, and does not assume any state support for the economy. We believe the impact on more domestically focused German banks could be higher as Deutsche Bank’s lending exposures include a large proportion of multi-national corporates that are less exposed to the German economy.
German banks should benefit from improving pre-impairment operating profitability in 2023 due to rising interest rates. Poor profitability has been the key weakness of the German banking sector for many years. However, the improvements are likely to be gradual as a significant proportion of lending is fixed-rate, particularly for residential mortgages.
The highest-rated Italian banks, including Italy’s two largest banks, Intesa Sanpaolo and UniCredit, are rated ‘BBB’, the same level as the Italian sovereign. A Russian gas cut-off would weaken business prospects for Italian banks, and asset quality would deteriorate, but the main rating sensitivity for the highest-rated Italian banks is a downgrade of Italy’s rating, which is on Stable Outlook. Intesa Sanpaolo and UniCredit believe that a domestic recession would have a modest impact on loan impairment. Intesa Sanpaolo estimates its cost of risk would double to about 60bp of gross loans, while UniCredit estimates its loan impairment charges would remain below 40bp of gross loans.
Italian banks plan to continue their impaired loan reduction, which has led to stronger balance sheets. Rising interest rates should support earnings growth given the sector’s large and stable retail deposit base and a sizeable proportion of variable-rate lending, including in residential mortgages.
Outside Germany and Italy, other major western European banking sectors are less exposed in the short-term to the macro-economic fall-out from a Russian gas cut-off. But in the longer term, they too would face deteriorating business prospects, which could also lead to ‘Deteriorating’ sector outlooks.
Link:
https://www.fitchratings.com/research/banks/german-italian-bank-prospects-at-risk-from-russian-gas-cut-off-30-08-2022?utm_source=newsletter&utm_medium=email&utm_campaign=Fitch-Wire&utm_content=main&mkt_tok=NzMyLUNLSC03NjcAAAGGk2R5SWDTp3JDjNcx4QXP6T-H1EACOvXYsoM4NUkwCY57vYu5DgiF44PUKeSDHFA-JnEaJOsFZdwAVaNwsG9JlLLT3UwmTzXiEMFLdcCUj0Jt2ZRP_gXB