More downgrades hit Europe: Italy, Spain and a dozen British banks

A dozen British banks and the governments of Italy and Spain were hit with fresh credit downgrades Friday in the latest blow to a European economy struggling to keep its footing amid accumulating signs of a slowdown.

Belgium — which had avoided the attention given to other highly indebted countries — was also put on notice that its credit standing may be cut in the future.

The decision by Fitch Ratings to downgrade Italy and Spain follows similar actions in recent months by Moody’s Investors Service and Standard & Poor’s, whose negative evaluations of European governments have unsettled investors and contributed to the sense of financial crisis battering the 17-nation euro currency zone.

On Friday, Moody’s also took aim at British banks, saying that a dozen were less creditworthy because it was less certain the financially constrained British government would be willing to bail out weakened lenders.

The action further highlights the difficulties facing the European financial system. Officials there are weighing options for a broad effort to pump potentially hundreds of billions of dollars into euro-zone banks. The issue is expected to be a key focus of talks Sunday in Berlin between French President Nicolas Sarkozy and German Chancellor Angela Merkel.

Merkel on Friday said she expected a “signal” from European leaders about how the recapitalization will proceed after a mid-month summit in Brussels.

The United Kingdom is not part of the euro region. But banks throughout the continent have been buffeted by concern over their investments in government bonds, as well as their overall health.

Within the euro region, officials differ on whether new capital should come through public funds — an approach that might offend taxpayers already impatient with bailouts of Greece and other national governments — or through new private investment.

In looking at the British banks, Moody’s judged that smaller banks may be less likely now to benefit from future government help.

The downgrades included the Royal Bank of Scotland (RBS) and Nationwide Building Society, both lowered by two notches on Moody’s scale, and one-notch cuts of Lloyds TSB Bank, Santander UK and Co-operative Bank.

Separately, Fitch Ratings downgraded the credit standing of Spain and Italy, two large economies that are struggling to avoid the need for a costly rescue by other European countries.

RBS shares tumbled 3.7 percent in afternoon trading while Lloyds fell 2.7 percent.

In a statement, Moody’s said that the cuts “do not reflect a deterioration in the financial strength of the banking system or that of the government” but that the government is “more likely now to allow smaller institutions to fail if they become financially troubled.”

Last month, the state-appointed Independent Commission on Banking recommended the British government force banks to separate their retail business from their investment arms. The government has yet to adopt the recommendations, “but Moody’s is making a value judgment they will,” said Simon Maughan, a banking commentator at MF Global.

Maughan also said that “banks are probably in a better position” than they were in May when Moody’s began their review. But because the global economic outlook had deteriorated, “Moody’s wanted to reflect the macro environment and so came up with a rationale for a downgrade.”

RBS said in a statement that it was “disappointed” that the credit rating agency’s decision did not reflect “the progress we have made in strengthening the bank’s credit profile.” But the bank added that “we do, however, see the removal of implicit government support for the UK banking sector as being a necessary and important step forward as the sector returns to standalone strength.”

The Financial Times reported on Friday that lawmakers were nervous about a fresh bailout of RBS, which is already 83 percent owned by the British government after a bailout in the wake of the 2008 financial crisis. This would come at a particularly bad time for the government, which has set ambitious deficit-reduction targets.

Playing down the news, British finance minister George Osborne told the BBC he was “confident that British banks are well capitalized, they are liquid, they are not experiencing the kinds of problems some of the banks in the euro zone are experiencing at the moment.”

The governor of the Bank of England said Thursday that Britain was in the grip of the “most serious financial crisis at least since the 1930s, if not ever,” and stepped up its quantitative easing program with an injection of $116 billion to help revive Britain’s faltering economy.

Schneider reported from Washington.

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