LISBON/LONDON (Reuters) - Debt rating agencies had the knives out for some of Europe's weakened banks on Friday, highlighting the pressure for decisive government action in support for the industry.
By Andrei Khalip and Steve Slater
Moody's Investors Service downgraded its ratings on nine Portuguese banks, citing the increased asset risk linked to their holdings of Portuguese government debt and the sovereign downgrade of Portugal in July.
The same agency also cut the ratings of two top British banks, citing a likelihood of less state support in a future crisis as Britain sought to reassure investors the sector was well capitalized.
Meanwhile Standard and Poor's downgraded the core banks of Franco-Belgian financial group Dexia -- the bank which has come to epitomize the European debt crisis through its unusually large exposure to the debts of the euro zone's weakest country, Greece.
Rival Fitch placed Dexia bank entities on rating watch negative.
The downgrades come ahead of crucial summit talks on Sunday between German Chancellor Angela Merkel and French President Nicolas Sarkozy and as diplomats detected a split between them over how any strengthening of banks should take place.
Portugal's top listed bank Millennium bcp fell 2.8 percent on the downgrade news.
Moody's said it expected a further deterioration of Portuguese banks' domestic asset quality due to a weak economic growth outlook and government austerity measures, as well as liquidity strains due to a lack of access to wholesale funding.
Debt-laden Portugal is enacting painful tax hikes and spending cuts under a 78 billion euro EU/IMF bailout designed to shore up its public finances and restore investor confidence.
Banks have to boost their capital ratios under the bailout terms after becoming overly dependent on ECB funding. Moody's cut its credit rating on Portugal by four notches to Ba2 in July.
"The key driver for the downgrades of most banks' debt and deposit ratings is Moody's assessment of the deterioration of their unsupported financial strength," the ratings agency said.
The six banks whose standalone ratings and debt and deposit ratings were cut are the state-controlled Caixa Geral de Depositos, top listed bank Millennium bcp, Banco Espirito Santo, Banco BPI, Banco Santander Totta and Caixa Economica Montepio Geral.
Among the top listed banks, Moody's cut Millennium bcp's standalone rating by two notches to B1 -- which is four notches below investment grade -- citing concerns over its high reliance on wholesale funds, its exposure to Greece via its Greek subsidiary and weak profitability.
Britain, with its own currency, sits aloof from the euro zone sovereign debt crisis itself, but banks had been on review for possible downgrade as part of a trend where state support for lenders dates back to the 2008 crisis.
Concern is also growing that its banks may need more capital as part of a wider European move to shore up the industry.
Ratings agency Moody's cut its rating on Royal Bank of Scotland by two notches, downgraded Lloyds by one notch, and cut its ratings on Santander UK, the UK arm of Spain's Santander, the Co-Operative Bank, Nationwide Building Society and seven other smaller British building societies.
UK finance minister George Osborne said Britain's banks remained well-capitalized and in better shape than many of their European rivals, who face bigger losses on holdings of peripheral euro zone debt.
"I am confident that British banks are well capitalized, they are liquid, they aren't experiencing the kind of problems that some of the banks in the euro zone are experiencing at the moment," Osborne said in an interview with BBC radio.
Standard and Poor's downgrade of Dexia by one notch cited difficulties in securing wholesale funding and the need for increased collateral.
It comes at the end of a torrid week for the bank's shares and ahead of a board meeting this coming weekend to hammer out a rescue plan that will break up the bank.
Bank recapitalization needs are at the heart of the issue that has led to downgrades across the sector in Europe in recent weeks and months, even though the sector was widely refinanced after the 2008 crisis.
UK banks have raised over $120 billion in the last three years, forced by the government to raise low capital levels. Over the same period German banks have raised about $40 billion, Italian banks have raised $29 billion and French banks -- seen as most in need of fresh funds -- have raised $22 billion, according to Reuters data.
(Editing by Andrew Callus and David Cowell)