U.S. banks’ environment downgraded: Fitch

Amid growing economic, regulatory and political headwinds, Fitch Ratings cut its score for the operating environment for U.S. banks.

The operating environment score assesses the business backdrop for banks. The rating agency reduced the score from “aa” to “aa-” based on several factors, including the interest rate environment, heightened regulatory uncertainty, and downward pressure on the U.S. sovereign rating.

“Banks will be operating in an environment of higher rates for an extended period, pressuring deposit levels and increasing funding costs,” Fitch said in a research note outlining the revision.

“Many of these factors did not exist in previous tightening cycles and thus the potential impacts create additional uncertainty that could result in more adverse outcomes than anticipated,” it noted.

The stress generated by tighter financial conditions resulted in the failure of three large U.S. banks earlier in the year, which also revealed gaps in the regulatory framework, it noted.

Those vulnerabilities include deposit concentrations, significant asset/liability mismatches, and a lack of supervisory action to address these weaknesses, Fitch said.

“The second-order effects from the bank failures are key as we assess longer-term rating implications,” it said. “These include mix of interest- and non-interest-bearing deposits and shift toward higher-cost wholesale funding, increasing deposit betas, tightening underwriting standards, implications for loan growth and credit losses and the regulatory response to events.”

The policy response is expected to include changes to bank oversight, and to their capital and liquidity regulatory requirements.

“While tighter regulation is generally viewed as a credit positive for U.S. banks, it is uncertain to what degree these regulatory changes will impact the competitiveness of [banks that aren’t global systemically important banks] and result in materially lower profitability through market cycles,” it said.

“Some of these changes are likely to be phased in over a number of years, which means these vulnerabilities will remain for some time.”

The lower operating environment score isn’t expected to immediately impact banks’ credit ratings, “although it reduces ratings headroom,” Fitch said.

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.