The banking sector is unlikely to be thrown into crisis by any sudden interest rate increases, Standard & Poor's (S&P) said on June 07.
The ratings agency said any big jolt in borrowing costs that stalls global economic expansion, strains indebted families and companies and dampens demand for mortgages and other loans was likely to hamper banks' performance and creditworthiness.
Although it was unlikely that an outright interest rate shock would occur, S&P said the possibility had to be taken into account when considering the long-term outlook for the banking sector.
In addition, it said a sudden widening of credit spreads, fast depreciation of the US dollar, further energy price spike, large equity price fall or geopolitical shock could also take the shine off the current "golden age in global banking."
Still, it said smarter risk management strategies employed by banks - including securitisation, hedging and implementation of the Basel II accord - had helped protect against worst-case outcomes linked to overly strenuous monetary tightening by the US Federal Reserve and other central banks.
"If this (interest rate) shock or other negative scenarios occur, the banking sector will face the situation from a position of strength, due to the structural improvements that have taken place in the past decade," S&P said in a report.
Equity and debt markets world-wide have swung wildly in past weeks over fears the Federal Reserve will need to raise rates higher than first anticipated to halt persistent inflation. Fed Chairman Ben Bernanke said this week that the central bank will be vigilant on inflation even if economic growth starts to slow, raising concerns about a broad downturn after several heady years for debt-laden businesses and consumers.
In its report, S&P said companies that have recently engaged in leveraged buyouts, highly indebted households in the US, Britain and Australia, and emerging market banks would be most exposed to interest rate increases. The ratings agency said a moderation in house prices and slowdown in household lending - which has rocketed alongside low interest rates in past years - "will be manageable for the most mature market banking sectors ... from the perspective of credit risk."
Most banks should also be able to weather an increase in corporate defaults over the medium-term without damage to their fundamental creditworthiness, it said. S&P forecast corporate defaults would edge up to a 2.8 percent US speculative-grade rate by the end of this year, and rise further to 4.5 percent by end-2007 - still below the 4.7 percent long-term average.
While emerging market banking industries have enjoyed improved creditworthiness in past years, mostly as a result of economic restructuring and regulatory reform, S&P said they would likely see their problematic assets increase substantially in an economic recession. "Emerging market economies remain cyclical and volatile," it said. "Loan portfolios that appear healthy during expansions can turn very quickly during economic downturns."
Chinese banks are especially vulnerable, it said, noting the high level of debt of both private and public sector companies.
"State bank lending to unproductive companies and overheated industries remains a risk factor," the report said, noting the debt-financed build-up of capacity in China's metals, chemicals, cement, automobile, construction and mobile phone sectors.
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