More than half of participants polled at recent S&P Global Ratings webinars say they are negative on the global banking sector over the next 12-24 months. Among developed markets, they are most worried about U.K. and Italian banks. Turkiye and China are high in the risk watch list for emerging market banks.

Questions put to us at the interactive sessions further pointed to heightened risk awareness, with one participant asking if one of Europe's largest banks will "go under." Investors are also interested in identifying the major weak spots, including whether real estate or shadow banking markets are potential sparks for systemic financial contagion.

"A key message is that 2023 will be much darker for global financial sectors due to tougher economic conditions," said S&P Global Ratings credit analyst Emmanuel Volland.

Nonetheless, most banks we rate have stable outlooks, a reflection of strong capitalization and sound asset quality.

Credit analyst Elena Iparraguirre added: "Banks will enjoy higher net interest margins [NIMs], so they will have some flexibility to accommodate other negative impacts that are yet to come--such as higher credit costs and higher operational costs due to inflation."

A Darkening View On Bank Credit Strength

Audience polls conducted at the events pointed to darkening expectations for global banks. About half of investors are at least "somewhat negative" on relative credit strength going forward (see question 1 in chart below).

The polls were conducted at our two live webinars. The first was for the Asia-Pacific, Europe and Middle East (EMEA) time zone (click here for a replay), and the second for the Americas-EMEA time zone (click here). Both were held on Nov. 22, 2022, and titled "Global Banking Outlook 2023: Greater Divergence Ahead."

Question 1

Investors asked us how we could have stable outlooks on 79% of the global banks we rate--given our view that key economic areas like the U.S. and eurozone will face shallow recessions, and that many global economies will struggle in 2023 with inflation, currency volatility, higher funding costs, and energy risks (see "Global Bank Outlook 2023: Greater Divergence Ahead," published on RatingsDirect on Nov. 17, 2022).

"Despite this bleak outlook, we expect banks to show some resilience," said Mr. Volland. "The main reason is that our base case assumes a shallow recession in some regions, rather than a full-blown recession."

Most global banks were in recovery mode in 2022, and already enjoying higher NIMs. For U.S. banks, as an example, NIMs will likely expand further on higher rates, after a 15%-20% rise in 2022.

In Latin America, "nonperforming assets should increase in 2023, but it won't be a dramatic shift," said credit analyst Alexandre Birry.

Toughening conditions will test some financial systems more than others. Most vulnerable are emerging markets with large external funding needs; or those with economies vulnerable to potential energy restrictions. We also see nonbank financial institutions (NBFI) as a weak spot, given fast growth in asset bases for NBFIs in some place; possibly as a strategy to get around tightening regulations.

Which Geographies Are A Worry? U.K. And Italy Across Developed Markets

The U.K. and Italy "won the poll" for largest credit-deterioration risk among developed markets, according to our audience responses.

In the Asia-Pacific/EMEA poll, investors thought that the U.K.'s bank credit fundamentals would deteriorate the most over the next 12-24 months. In the Americas/EMEA poll, it was Italy (see question 2).

Question 2

In our view, the U.K. polled highly due to political uncertainty, the recent sharp rise in cost and volatility of funding across the economy, and the weaker economic and high inflation outlook. Nonetheless, we expect the U.K.'s largest banks can navigate what is likely to be a period of more difficult conditions in domestic and global wholesale funding markets (see "U.K. Banks' Funding And Liquidity Are On A Solid Footing As They Navigate A Turn In The Cycle," Dec. 1, 2022).

As to Italy, we agree that banks in country face higher economic risks than most peers do. Less effective insolvency and foreclosure procedures remain a weakness compared with that of most advanced economies. That said, the deterioration in Italian banks' nonperforming exposures will remain manageable for most banks over 2022-2023 (see "Banking Industry Country Risk Assessment: Italy," Sept. 1, 2022).

Germany, in our view, likely posted fairly high (more so for investors in the Asia-Pacific/EMEA event) due to energy risks, given the ongoing Ukraine-Russia war. "Banks exposed to potential energy restrictions face higher downside risks," said Mr. Volland.

Turkiye and China On Investors' Minds In Emerging Markets

Investors ranked Turkiye as the EM banking jurisdiction facing the largest risk of credit deterioration. China ran a fairly distant second.

Question 3

For emerging market banks, "the costs of risk will recede in most commodity exporting markets but increase in places like Turkiye," said credit analyst Mohamed Damak.

Besides hyperinflation, banks in Turkiye still have notable exposure to external funding--though lower than in the past. Dr. Damak estimates that more than US$80 billion in external funding needs to be refinanced over the next 12 months, and a recent drop in the rollover rate indicates that some banks might not be able to secure the funding.

"In theory, banks could withstand a drop in rollover rates to zero," said Dr. Damak. However, if banks can't get the refinancing, they may seek to withdraw their deposits held at the central bank, which in turn might prompt the authorities to impose capital controls.

About a fifth of investors polled pointed to China's banking system. This, in our view, is likely due to the country's economic uncertainty amid strict COVID restrictions, as well as its property slump.

"Some 40% of China property developers are in financial stress, by our estimates, so that's a top risk," said credit analyst Harry Hu. On the relative brighter side, default rates on mortgage loans are likely to stay low, even in light of recent "homebuyer mortgage strikes." We estimate that only 2.5% of mortgage loans are at risk.

Banks will be increasing their exposure to the sector under recent government initiatives to support the property market, including with fresh loans. While these interventions may stabilize the situation, they will not guarantee a recovery in underlying property market.

"At end, customers need to buy in and that's not yet visible," said Mr. Hu. "COVID restrictions are causing income uncertainty and reducing the willingness of households to take on mortgages."

Tough Questions

Investors are thinking defensively about risks on the horizon. Participants, for example, at the sessions queried us on risks for NBFIs. One asked: if banks began "derisking" in Japan, would they cut off funds to NFBIs, which in turn could spark a contagion that rebounds on the major banks (see "Global Bank Country-By-Country Outlook 2023: Greater Divergence Ahead," Nov. 17, 2022).

Ryoji Yoshizawa, credit analyst, agrees this risk is worth monitoring. "We are seeing volatile movements in markets, and funding and liquidity is generally weaker for NFBIs," he said.

However, he noted that the nonbank sector accounts for only 3% of total financial assets in Japan.

As to the U.S., Mr. Birry noted that bank loans to NBFIs have increased to more than US$700 billion, up by about 50% since year-end 2009, and now account for 7% of loan books.

"We see some risks given the high growth rate," said Mr. Birry. "That said, for most banks, the shadow loans are well collateralized and a small percentage of the total."

Another asked "where the weaknesses lie," to which Mr. Volland named a few:

• The slowdown spreads to the job market (though so far, so good).
• Real estate (we expect prices to fall in about 40% of the countries where we rate banks in 2023).
• Small and midsized enterprises and unsecured lending portfolios.
• Potential volatility in energy markets could hit countries exposed to energy restrictions, including in central eastern Europe.

Finally, one investor starkly asked: Will Credit Suisse go under?

"Our ratings do not suggest so," said Ms. Iparraguirre. We have an 'A-' long-term issuer credit rating on the operating bank Credit Suisse AG, with a stand-alone credit profile of 'bbb'.

We have downgraded the bank twice this year because we do believe it faces business risk challenges as it downsizes its underperforming investment bank. "This restructuring has to be delivered and implemented in a difficult environment," added Ms. Iparraguirre.

Yet the bank has announced plans to raise Swiss franc 4 billion to finance its restructuring and to maintain solid capital throughout the restructuring process.

Other questions covered issues specific to banking systems in India, China, the Philippines, Japan, Australia, and the U.K. We also fielded questions on winners and losers, emerging market banks, capital calculations, and the impact of fintech on the smaller banks.

Writer: Cathy Holcombe

Related Research

• Global Bank Country-By-Country Outlook 2023: Greater Divergence Ahead, Nov. 17, 2022
• Global Bank Outlook 2023: Greater Divergence Ahead, Nov. 17, 2022
• U.K. Banks' Funding And Liquidity Are On A Solid Footing As They Navigate A Turn In The Cycle, Dec. 1, 2022
• Sector And Industry Variables For Banking Industry Country Risk Assessment Published For November 2022, Nov. 29
• U.K. Banks' Funding And Liquidity Are On A Solid Footing As They Navigate A Turn In The Cycle, Nov. 1, 2022
• Banking Industry Country Risk Assessment: Italy, Sept. 1, 2022